Dine Brands Global Inc (DIN) 2002 Q4 法說會逐字稿

Good day ladies and gentlemen, and welcome to the IHOP fourth quarter 2002 earnings conference call. As a reminder today's conference is being recorded. We do ask that you stay on the line for the duration of today's call, and we will be conducting a question-and-answer session. Directions on how to participate will be given at that time.

And now for opening remarks and introductions I would like to turn the call over to Miss Stacy Roughan, please go ahead.

Good morning, and thank you for joining us for IHOP's fourth quarter 2002 conference call. Today with us from management are Julia Stewart, President and CEO, and Tom Conforti, CFO. Before I turn the call over to management. I'd like to remind you that today's conference call contains forward-looking statements. These forward-looking statements include such words as may, will, expect, believe, plan, or other similar terminology. These statements involve known and unknown risks, uncertainties, and other factors, which may cause the actual results to be materially different than those expressed or implied in such statements.

These factors include, but are not limited to, risks associated with the implementation of the company's new strategic growth plan, the availability of suitable locations and terms of the sites designated for development, legislation and government regulation, including the ability to obtain satisfactory regulatory approval, conditions beyond IHOP's control such as weather, natural disasters or acts of war or terrorism, availability and cost of materials and labor, cost and availability of capital, competition, continuing acceptance as the International House of Pancakes brand and concepts by guests and franchisees, IHOP's overall marketing, operational, and financial performance, economic and political conditions, adoption of new or changes in accounting policies and practices, and other factors discussed from time to time in IHOP's filings with the Securities and Exchange Commission.

Forward-looking information is provided by IHOP pursuant to the Safe Harbor established under the private securities litigation reformat of 1995, and should be evaluated in the context of these factors. In addition, IHOP disclaims any intent or obligation to update these forward-looking statements.

Now I'd like to turn the call over to Julia Stewart.

Thanks, Stacy. Good morning everyone, and thanks again for joining us today. First let me share some performance highlights for the fourth quarter and for full year 2002.

We reported net income of 12 million or 56 cents per diluted share for the quarter, and 40.8 million or $1.92 per diluted share for 2002, which is consistent with the previously revised 2002 guidance we provided you all last October.

We achieved 371.9 million in system wide sales for the quarter, which is an 8.9 percent gain over the fourth quarter last year. System wide sales reached 1.5 billion for 2002. System wide sales growth was driven by an increase in the number of effective units during the year as well as increases in average sales per effective restaurant.

We generated total revenues of 17.4 million during the quarter from franchise operations, sales of franchises and equipment, company operations, and 364 - excuse me - 365.9 million in total revenues for the full year.

Comp store sales were down one percent for fourth quarter and up seven tenths of a percent for the year. Our comp store sales were impacted by the difficult overall economic environment we faced during the fourth quarter. We've seen an improvement in the first two months of this year driven by marketing, promotion, and brand initiative. However, the winter weather could also prove challenging from a comp store sales perspective.

We opened 45 new restaurants primarily in the Mid-West, Rocky Mountain, and Western regions of which 41 were IHOP developed, three were developed by franchises, and one was developed by our area licensee. I'm pleased to report that we franchised all but one of the 45 stores we opened during the quarter. A total of 101 new restaurants opened during 2002, and we ended the year with a total of 1,103 IHOP restaurants nationwide and in Canada.

Now while Tom will walk you through the numbers in more detail in a minute I wanted to provide a perspective on our financial performance for the quarter and for the year.

First it's important to consider the impact of the strategic decisions we made during 2002 to enable IHOP to grow as a company and as a brand. Now I began 2002 promising that we were going to take IHOP to the next level. Now I can categorically say we've built this foundation to do just that. We invested in our business, and while that did have an impact on the bottom line for 2002, we expect to see the benefits of this investment in 2003 and beyond.

We strengthened our brand through a new advertising campaign with strong value messages and a touch of humor to make it memorable. We're enhancing our presence in the market place with improved media buying strategies that will deliver IHOP brand messages to an expanded audience. Our marketing strategy now features new product promotions, which will work together with our media efforts to provide new reasons for guests to visit IHOP.

We began 2003 with a never-ending pancakes promotion, and the results have been encouraging. And this past Monday we introduced our first new product of the year, stuff French toast. It's a great product that fits into our brand and leverages our expertise in breakfast. The stuffed French toast promotion is supported by our first national cable advertising effort. The product did extremely well in tests, and we expect comp store sales to be favorably impacted as it rolls out this month. Now in addition we have a full product promotional lineup for the remainder of the year, which will continue to build upon the momentum we're now establishing.

You know providing new reasons for guests to visit IHOP will be a key focus for us as we look to foster real growth through stronger comp store sales results. However, executing at the restaurant level is critical as we drive increased traffic through our restaurants. And as a result we have focused on improving operations to ensure a high level of guest responsiveness and more personal interaction with our guests.

We've begun testing a mystery shop program, which has been well received by our franchisees. We'll kick off the program system wide at our upcoming national franchise convention in May. We then plan to conduct approximately six mystery shops per restaurant per quarter thereafter. And we've identified and defined best-demonstrated practices and work to operationalize our findings. Most of our efforts focused on providing better speed of service and serving hot food hot, which are two key issues that were sited both regular and infrequent guests.

We've taken training to an unprecedented level in conjunction with our new product promotion rollout. Each new product promotion is accompanied by a general manager, cook, and server training, which aims to improve unit level execution so that our guests will want to come back to IHOP more often.

This is significantly more training than we've ever done before. It provides a huge benefit through increased involvement with each of our general managers as well as the opportunity to educate and promote a culture change in the process.

Strengthening our brand and operations has been critical. However we also needed to have the right operating model in place to facilitate IHOP's ability to sustain long-term system wide sales growth. Therefore during 2003 we will transition from a company finance development model to a traditional franchise development model. This will enable IHOP to leverage our entrepreneurial base of franchisees and extend our franchising options to add additional restaurants to our system.

We already have strong interest from several franchisees, both from within our system as well as franchisees new to IHOP who already are ready to participate in our model. Franchisees, employees, and investors have embraced our new operating model. Now we're now working to develop the process to support the operating model transition.

With this shift IHOP Corp will be able to focus on effectively growing our brand, and providing the operational support that a system of more than 1100 restaurants demand. Our new model will generate positive free cash flows, improve our return on investment, significantly decrease our capital requirements allowing us to re-deploy cash to support brand and operational efforts and lower our debt burden.

Now I'd like to turn the call over to our CFO, Tom Conforti.

Thanks, Julia. Good morning, everyone. Overall we were pleased with our business execution for the fourth quarter and fiscal year. While Julia has provided the highlights, let's look through the numbers in more detail starting with the top line.

Total revenues for the quarter were 107.4 million and 365.8 million for the full year, an increase of 18.8 percent and 12.8 percent respectively versus 2002 - excuse me - versus 2001.

Franchise operations revenue grew to 61.2 million for the quarter and 238.4 million for the full year. This was due to an increase in retail sales in franchise restaurants of nine percent in the quarter and 11.5 percent for the full year. Retail sales in franchise restaurants grew 8.8 percent in the quarter and 9.9 percent for the full year, primarily due to an increase in the number of effective restaurants. Average sales per effective restaurants were basically flat for the quarter at $372,000, an increase 1.5 percent to $1,516,000 for the full year.

Franchise operations margin increased to 33.5 million for the quarter and 132.7 million for the year. However, on a percentage basis franchise operations margin decreased to 54.7 percent in the fourth quarter and 55.7 percent for the full year. This was due to an increase in rent expense associated with operating leases. Most of the leases entered into by IHOP beginning in 2000 have been operating leases, whereas most leases prior to 2000 were capital leases. As a result rent expense is increasing over a relatively small base amount.

Sales of franchises and equipment increased to 27.2 million for the quarter and 53 million in 2002 due to an increase in the number of IHOP developed restaurants sold.

Margin on the sales of franchises and equipment increased to 9.2 million for the quarter and 17.7 million for 2002. On a percentage basis margin on sales of franchises and equipment for the quarter was basically flat at 33.8 percent, and decreased to 33.4 percent through the full year. This reflects the mix of an increased number of rehabilitated restaurants and a decreased number of franchise investor programs set units that were franchised in 2002.

Company operations revenues increased to 19 million for the quarter and 74.4 million for the full year. This was due to an increase in the number of effective IHOP operated restaurants and the increase in average sales per IHOP operated restaurant.

Effective IHOP operated restaurants increased to 79 from 72 during the quarter, and 76 from 72 in 2002 for the full year.

Average sales per effective IHOP operated restaurant increased to 241,000 from 234,000 for the quarter and to 979,000 from 956,000 for the full year.

Company operations margin decreased to a negative 233,000 from a positive 510,000 for the quarter and to 2.2 million from 2.5 million for the year. On a percentage basis company operations margin was a negative 1.2 percent for the quarter and a positive 2.9 percent for the full year. This variance was attributable to higher labor costs during both the quarter and full year.

We ended the year with 48.3 million in (fields), corporate, and administrative expenses, which was a 16 percent increase over 2001. This increase is attributable to IHOP's previously announced increase n (fields), corporate, and administrative expenses for 2002 related to consumer research, the development of new product promotions and consulting projects. These projects amounted to approximately 800,000 in the fourth quarter and 2.4 million for the full year.

The expenditures represent an investment in the future of IHOP's business designed to achieve a better understanding of our consumers, optimization of our development practice, and evaluation of our strategic options for a successful, long-term business strategy.

(Fields), corporate, and admin expenses were 3.3 percent of system wide sales in 2002 compared to three percent in the same period for 2001. Excluding the costs I mentioned above relating to consulting and consumer research, (fields), corporate, and admin expenses were 3.1 percent of system wide sales in 2002.

Depreciation and amortization expense increased to 4.2 million for the quarter and 16 million for the full year, an increase of 6.7 percent and 7.8 percent respectively. This increase was caused by the addition of new restaurants to the IHOP system from our restaurant development program.

The effective tax rate remains at 37.5 percent for 2002.

All of the above led to our bottom line performance, which is in line, as Julia mentioned, with previous guidance.

For the quarter net income was 12 million or 56 cents per diluted share and 40.8 million or $1.92 per diluted share for the full year.

Turning to the balance sheet, the balance of cash and cash equivalents at December 31st, 2002 increased substantially to 98.7 million from 6.3 million the year before. As a result of the funds provided by our successful $100 million private placement completed in November of 2002.

Property and equipment increased 20.2 percent to $286.2 million from $238 million at the end of 2001. This increase was due to new restaurant development.

Long-term receivables at December 31st, 2002 increased 8.1 percent to $332.8 million from $307.9 million in 2001. This was due to IHOP's financing activities associated with the sales of franchises and equipment.

Franchise notes totaled 46.9 million versus 42.6 million in 2001, while the equipment notes totaled 153.3 million versus 131.2 million in 2001.

The third component, our direct financing lease receivable was 132.6 million versus 134.1 million in 2001. This decrease was attributable to the de-emphasis of capital leases in rent transactions.

Long-term debt increased by 190.3 percent due to our completed $100 million private placement. Conventional debt totaled 145.8 million versus 50 million, 50.2 million in 2001. And stockholders equity at the end of the year was 364.4 million versus 312.4 million in 2001.

All of the above led to a slight improvement in free cash flow. At the end of 2002 free cash flow was a negative $63.5 million compared to a negative $66.7 million in 2001.

From a development standpoint we opened 45 new restaurants and franchised a total of 49 restaurants during the fourth quarter, which overcame the temporary franchising delays that impacted third quarter 2002's performance.

In 2002 IHOP and its franchisees and area licensees developed and opened 101 IHOP restaurants. Of these we developed and opened 86 restaurants, and franchisees and area licensees developed and opened 15 restaurants.

Capital expenditures in 2002, which includes our portion of restaurant development, totaled $141.7 million. Funds for investment where sourced from cash generated from operations of $78.1 million. The previously mentioned private placement of $100 million of non-collateralized senior notes and proceeds from sale and lease (backed arrangements) of restaurant, land and buildings of $58.5 million. We also executed a term loan of $17.2 million.

As Julia mentioned, last month we announced significant changes to the way we will conduct our business. Transitioning from a company financed development model to a traditional franchised model. Under the new model, IHOP's approach to franchising will be similar to that of most of our franchising competitors in the food service industry. The franchisee will be called upon to pay an initial franchise fee to IHOP. The franchisee will then use his or her own capital resources to acquire a site, build, and equip the business, and fund working capital (lease).

The benefits of the model shift are significant. Our new model will generate positive free cash flows, improve our returns on investment, and significantly decrease our capital requirements. This will allow us to re-deploy cash to support brand and operational efforts as well as other strategic uses including lowering our debt burden.

Now for an outlook on 2003 I'd like to turn the call back to Julia.

Thanks, Tom. First we want to reaffirm the EPS guidance we provided last month. We expect net income per diluted share to range between $1.55 and $1.70 in 2003, compared with net income per share of $1.92 in 2002.

Initially lowering financing related fees from franchisees are expected to result in a decline in EPS during the year. However as the new development strategy is implemented we expect EPS to resume positive growth in 2004. Therefore, 2003 will be a transition year as we roll out our new operating model and discontinue the old franchise model.

Taken this into account we are providing the following performance guidance for the full year 2003.

The development of 55 to 60 company financed restaurants and 20 to 25 franchise-developed restaurants for a total of between 75 to 85 new restaurants compared to the development of 86 company financed restaurants and 15 franchise or area licensed developed restaurants in 2002.

Capital expenditures are estimated to be approximately 90 million to 100 million.

System wide sales are expected to range between 1.55 billion and 1.6 billion compared to system wide sales of 1.48 billion in 2002.

Free cash flow is expected to improve between a negative 25 million and negative 35 million. This compares with negative free cash flow of 63.5 million in 2002.

Other assumptions investors should consider as we transition our operating model include growth in franchised operations revenues in 2003 will be impacted by our new business model as the result of IHOP developing and financing fewer restaurants during the year. The revenue from the sale of IHOP developed restaurants will decline over time.

(Field), corporate, and administrative costs and expenses will continue to grow at a rate which exceeds the rate of growth in revenues for at least the next 12 months and beyond that. We expect that the rate of growth in the (field), corporate, and administration will be less than the growth in revenue.

We expect our long-term receivables to increase at a lower rate in 2003, and begin to decline in 2004.

And we expect that substantially all new IHOP restaurants will be financed and developed by franchisees or area licensees in 2004 and thereafter.

As we've stated before our new operating model provides us with increased financial flexibility through greater cash generation. We are committed to exploring strategic options for the use of that cash, which is an important consideration as we continue to grow the company. Efforts are still underway to identify these options, and we anticipate reaching a decision within the next 30 days.

The result of all of our efforts in 2002 is a clear path for 2003 and beyond. We are excited about IHOP's prospects for the future as we implement our brand, operations, and operating model strategies developed over the past year. We're confident that these strategies will ultimately led to improved results and increasing shareholder value in both the short and longer-term.

With that we'd be pleased to answer any questions you might have. Operator?

Thank you. At this time we will proceed with the electronic question-and-answer session. If you would like to ask a question please respond by pressing the star key followed by the digit one on your touch-tone phone. And as a reminder if you are using a speakerphone please remove the mute function in order for your signal to reach our equipment. Once again that's star one to ask a question.

Our first question today will come from Michael Gallo.

Hi, good morning.

Hi, Mike.

Just have a couple quick questions. The first question is can you give any more specific information on where same store sales are quarter to date? I mean you did mention that they had improved from the fourth quarter. I was wondering if we can get a little more quantification on that?

Yes, I'm really not liberty at this point to talk about first quarter other than to tell you that we definitely saw never-ending pancakes take hold. People were very excited about it. We saw guests we hadn't seen in a long time. Franchisees say it's some of the best they've seen in a while. Lot of positive feedback on never-ending pancakes, so I'm very optimistic, but again we got off on a nice climb and then of course the winter weather took a real decline, but it's really too early to tell yet in terms of first quarter.

OK, that's fair enough. Second question I have is this is in regards to the company operations in the fourth quarter; obviously you have a net loss from company operations. I was wondering just if you could talk about initiatives for getting that not only back on the positive side, but maybe, you know, (writing) those with a little sharper operating focus, and sort of where do you think ultimately you can get those operations?

You know, Mike, that's a very fair question. Two things on the labor and the company stores, one is, as you know, those are largely rehabilitated restaurants, and many of those restaurants did not have an assistant restaurant general manager and we felt very strongly that we would never turn and improve the operations of the overall profitability without adding management. A lot of these GMs were working, you know, 24/7, which is not a good way to run a business. So we did employ an assistant restaurant general manager in every restaurant throughout our company stores, which is the right thing to do for the business, but we probably wont see the full effect of that until 2003.

It is my expectation that in 2003 we will see improved operating margins for the company stores, not just because we've added an assistant restaurant general manager, but we are employing many of the processes and systems that we got out of best-demonstrated practices. Frankly many of those from franchisees, and we are employing them on the company side of the business. So we've got a full court press in company ops. The biggest single item besides that which I described to you is insuring we get the top line this year in those company stores. I think they've demonstrated to us they know how to make money, the big issues is we've got to get the top line, so I think that's the very, that's the focus for us in company ops. And now with every single company store with a full management compliment it should make a huge difference for us in 2003.

Great. And then the final question I have for now is you'd announced the share buyback program in mid-January. I was wondering if you had bought back any stock so far year-to-date?

This is Tom, Mike. No we haven't bought any stock back just yet.

OK, great. Thanks a lot.

Thanks, Mike.

Thank you. And we'll move forward to Peter Black.

Yes, just two quick questions, in the system wide sales projection that you gave for next year of 1.55 to 1.6 billion, what's the assumption for comp store sales growth built into that?

We haven't really disclosed that at this point.

I mean is it positive or negative? Or ...

It's positive.

OK, and how about from a gross margin standpoint? Would you anticipate from the franchise operations for gross margins to continue to decline next year, or do you have any take on that?

We should do, yes, I would, I can take that. For 2003 you should see gross margin increase on the franchise operating side.

OK, all right, thanks.

Thanks, Peter.

Thank you. We'll next move to Beth Lilly with Woodland Partners.

Good morning.

Hi, Beth.

I have a couple questions. The first question has to do with as you move forward into the new operating model what do you anticipate the depreciation and amortization being, and what do you anticipate the capital expenditures being kind of on a normalized basis in like 2004?

The, well I'll let Tom handle the depreciation amortization. The cap ex really for - are you talking about 2004?

Yes. As you move out under this operating model of having the franchisees develop the store, the locations.

Yes, we really expect that will, to almost go to zero because we wont be in the development business, and we'll do something less than 10 million for anything else that may be associated either with POS systems or small needs for the remodels for the company stores, but we've been telling everyone less than 10.

And so what will the D&A then run?

We haven't giving any guidance on D&A, Beth, in 2004 or beyond, but we would expect as we're not building up our asset base obviously that over time that will level itself out and start declining.

Because for the 12 months in your income statement the D&A was 15, almost 16 million, is that right?

Yes, $16 million.

OK, all right. Great. And then the other question I had is, you know, Julia, I was a little surprised to hear you say that, you know, you anticipate making a decision in the next 30 days about, you know, the free cash flow and the capitalization of the company, and you know, there's been talk about this (circuitization) of the receivables. I mean I was a little surprised to hear you say that you were ready to make a decision so quickly.

I'll take that as a compliment, Beth. We've been working hard.

Yes, is there some, I mean, you know, what, I just assumed that as the year unfolded and you got a better sense of how the business is unfolding and the franchisee development and everything, I'm just, I'm, can you provide a little insight into why 30 days?

Well we've been working, as I think I've said before, very diligently on the process. We've been working with our banker, Salomon Smith Barney. We want to bring this to closure. You know, for all of us we need to get to the business at hand of running our business, and so I in particular want us to stay focused on doing what's right for the business, right for our shareholders, and right for our franchisees, so very much want to get back to the business or running the business. And that's why I'd like to bring this to closure in an appropriate fashion, and frankly I think working with the board of directors and Salomon Smith Barney we'll be able to do that very shortly.

OK, great. Thank you so much.

Thank you.

Thank you. We'll now move forward to Dennis Joe with Sidoti and Company.

Morning.

Hey, Dennis.

Hey, Dennis.

You mentioned that there was a lot of interest from the franchisee community regarding building new units. I was wondering if you've signed any franchise commitments in this last month? And then second of all I was wondering where exactly are franchisees looking to build?

Great question. A lot of interest in our current franchised community, so much so we actually put a timeout for a couple of weeks to finalize the new development process because, as you might well imagine, that really hasn't been the way we've been doing it historically, and so we want to ensure that all the process and systems are in play so that we can maximize their development, but also ensure it's being done correctly. So we actually are working with our franchise community and have put together an appropriate development process here quickly. But there is interest throughout the system. It's not at any particular one place. It's not geographically in one place. It's throughout the system.

We also, as you might well imagine, have legal requirements. We've got to file and re-file our (UFOX), so there's a lot of work we are currently doing. But the interest from our existing franchisees is really across the board and geographically dispersed, and then we've got several, as I mentioned, franchisees not currently at IHOP, but they're franchisees of other concepts, largely fast food, if you will, who have an interest, and they too are geographically dispersed. There's not really any one area that is, has stood out, but there's a tremendous amount of interest. We've just got to finalize the development process here quickly to make certain that we are doing it appropriately and giving due consideration for our existing franchisees. So that's the process that we're going through.

And we should be able to announce here fairly quickly some of the players that were looking to build in larger areas. But smaller areas there is lots of interest. You know, a franchisee may want to build a restaurant here or restaurant there, not everybody has to build out, you know, entire states for us to maximize value.

OK, fair enough. Any thoughts to increasing that $50,000 franchisee fee?

Yes. We've actually looked at that, are in the process of analyzing what is the right number. I think we've been very candid with our franchise community that $50,000 may need, may not be the right number. It may be something higher than that. And they've been I think quite candidly acknowledged that that's probably in the works. So we're evaluating what is the right number. Can't tell you today, but it may be something north of 50.

OK, and just one last question. I've been hearing that you might be upgrading some of the technology at the corporate stores, specifically point-to-sale and back offices. If that's true, how much is that costing per store, and is that being rolled out to the franchisees?

Dennis, it's Tom. We are taking a serious look at the technology infrastructure at our stores, and the technology infrastructure that connects us to our franchisees, and we have selected a POS system named (Micros) and it's in a 100 plus stores so far. We continue to build an experience level with (Micros) and then as we feel we have reached a point where it is functioning in the best interest of our franchisees and of the company we'll put in place some incentives to move it forward. I think of about our 76 stores I think there are probably 15 to 20 (Micros) in our company stores, and our goal obviously there is once we get an experience base that we feel terrific about that we will make changes to all our company stores and put (Micros) in our company stores. And then ultimately work with the franchisees to make this the standard for our system.

Dennis, it's Julia. The one thing I would tell you is we've been pretty adamant with ourselves and with our franchise community that eventually we do need to migrate to one system. You might well imagine the implications of not having one system. It's going to take a while, but we do believe that is possible.

So how much is this going to cost per store, because I heard somewhere in the magnitude of 25 to $30,000 per store? And if that's true, what kind of incentives can you give to the franchisees to actually accept that kind of a system?

Well it's a little north of $30,000, and Julia and I are brainstorming about once we get a track record - ultimately these things should argue for themselves, you know, Dennis? The return on investment should be there and apparent. And the franchisees should be eager to implement the system. We have to get that experience base built up, and the Julia and I will make an assessment as time goes on about what the most effective way to sort of expedite that process. And we're just not at a point where we can speak in certainties about that.

OK, OK, thanks a lot.

Thanks, Dennis. Great questions.

Thank you. And Josh Schecheter with Steel Partners has our next question.

Hi, Josh.

Hi. I was wondering if you could tell me what you think the expected SG&A level is on a go forward basis, and if you have an idea as to what the EBITDA margins would be on a go forward basis once you've implemented the new plan?

We haven't commented about EBITDA margins, so I can't do that here. But certainly on SG&N our guidance has been twofold. One, that this year our guidance will be in the 50 to $60 million range, and that two, that as we reach, as we go forward after this year we expect that the rate of growth of SG&A will be less than the rate of growth of the sales. And that will be leveraging our SG&A investment. Those are the only, Josh, those are the only points that we've made publicly so far in SG&A.

But have privately determined what those levels are? Or are you still working through that?

For what?

For instance, if you have the system wide sales at roughly 1.5, $5 billion and as you go to a royalty, as you go to royalties operating model theoretically you would say, OK, well I get about five percent or five and a quarter percent of my franchise royalties coming to me, and then there should be a certain amount of SG&A and marketing expense that gets netted against those royalties. And you know, that's the EBITDA of the company.

Yes, of course we've thought through them. For this year particularly with a finer, with a more sharpened pencil because we have a plan in place that we're executing against. And then going forward, you know, to before we made the decision to move to the operating model we built the long-term financial model and we understand what our business can afford to deliver certain profit and return ratios, and so we have targets in place for years moving forward. Is that the question that you had for me, Josh?

Yes I guess I was looking for a specific answer, but.

Well we haven't given to anyone specific answers so we can't do that here.

OK, and then my assumption on the five and a quarter as the royalty percentage that you receive from the stores, is that accurate for new stores?

The royalty we receive is four and a half, and then there's a margin on our proprietary product, which brings that total sort of variable payment from the franchisees up to about five and a quarter.

And then, I guess I may have missed this in your presentation earlier, but can you discuss I guess what's going on with the excess cash flow that you're going to make this decision on over the next 30 days?

What's going on with the ...

Yes, sorry if I missed it.

... decision making process is that we've been going through?

Yes.

Sure. You know, we've taken a look at various ways to (monetize) the long-term receivable on our balance sheet. We have a much better understanding now than we did three months ago, of what those options are. And now we're really just sharpening our pencils and really understanding sort of the tactical level of it. And then along with that comes, if you can (monetize) what should you do with the cash?

And certainly our ongoing business we, I think demonstrated unquestionably will generate ongoing streams of cash, and so we're thinking about what to do with that ongoing stream of cash year in and year out. And then we're looking at this one time opportunity whether it is an opportunity to (monetize) our receivable and then decide what to do with that cash. And so we're considering both the issue of whether to (monetize) or not, and then what to do with the cash if we (monetize). That's the basic framework of our process.

OK, thanks.

Yes, and as I said no decision has been made on it. And so we have a better understanding, but certainly we've not made a decision as a company.

Thanks, Josh.

All right, Josh, thanks.

Thank you. And as a reminder if you'd like to ask a question please press the star key followed by the digit one at this time.

And we'll take our next question from Mike Smith with Fahnestock.

Hi, Mike.

How are you?

Fine. I think it's a little warmer here than for you.

Oh so true. It's tough living in southern California, isn't it?

Let me make sure I've got this right, in 30 days we're going to know what you're going to do or what you're not going to do and then what to do with the money if you have any?

That's it.

It's finally coming to an end, that's great. You indicated you were going to do some promotions this year. Are those all going to be centered around breakfast items?

No, actually they're, we, not to give full disclosure, but we are looking at some lunch and dinner items. We've got, if you know, a full calendar for fiscal 2003 of what I would call product promotions that go on television for a limited period of time. And we're looking at one, if maybe even more of those not being around breakfast to begin to be more of a full breakfast, lunch, dinner orientation to the guest.

How much will you spend on advertising?

I knew you were going to ask me that. It's, between the coops and the national fund ...

Well it's three percent of system sales.

Well it's plus, yes, you've got to be careful about plus or minus ...

... but (as far as) three percent of system sales, which is contractual, plus or minus a little bit.

It's about 42 million plus or minus. It's fine. It's 42 million plus or minus. Mike, part of that's national fund, part of that's coop.

The other question I guess, in terms of model building when will we get a handle on how many agreements you'll have for franchisee developed units in 04?

Gosh, ask me that again. I want to make sure I answer that correctly.

Well when we're trying to model 04 and modeling higher earnings is going to take I guess, my guess is it's probably going to take a fairly sizeable number of franchisee openings. When will we have a handle on, you know, that number?

Hi, Mike, it's Tom. You know, when we did our public, when we did our public disclosure last time we gave you guidance on 2003 and we gave you guidance on steady (stay), and what we suggested - and steady (stay) was 2005 - and what we suggested in 2004 is that we would be somewhere in between 2003 and 2005. We never gave, we never gave clear - and I guess that's the reason for your asking the question. But what we did guide is to say that we wanted to build a plan that we felt was attainable and that in 2004 we were not projecting that we would be at the same level as we would be at steady (stay).

Yes, I'm aware of that. I guess I was wondering, you know, what kind of point do I look forward to because you're changing your franchisee system. When will I get a handle on how well that's going for you? I'm not looking for a number so much as ...

Yes, no, I think that's fair. I think later in the year we'll be in a much better place to share with you the kinds of people we've brought on board, the kinds of interest that we're getting, be able to quantify that more toward the end of the year, and share with you not only a real live number for 2004, but give you a lot more depth and color commentary on the kinds of folks that are coming in both within our existing system and outside our system that are sharing an interest in committing to some areas. I think we'll be in a much better position to share that with you. It's a fair question. I just, I think we ought to postpone that until later in the year.

Are you shooting for people who can develop let's say 10 units, or is it a smaller or bigger number?

All of the above. The truth of the matter is I welcome all. I'm fair trade. There are people who want to build one unit. There are people who very much want to take an area and something in between. I think the concept and what we've shared with you previously suggests that we can do all of the above.

Well thanks.

Thanks, Mike.

Thank you. Our next question comes from Andrew Jones with Northstar Partners.

Hi, Andrew.

Hi. Thank you. What is the argument from a perspective franchisee's point of view to open an IHOP versus opening some other format?

I think there's - I'll let Tom speak a little bit to this, but from a top line perspective opening an IHOP versus opening some of either the hot new concepts that are out there or something else, there's a couple of major reasons that I think people come to us. One is that with a 45 year old American icon we have an incredible infrastructure here of existing franchisees and management that are just absolutely entrenched and based in the understanding of the concept, how to operate it, and how it runs.

And never underestimate the power of this huge source of knowledge base of people who know it, understand it, and know how to work it. And that's incredibly invaluable either to a new franchisee or an existing franchisee that they can pull from this incredible wealth of data, or as we always like to say when you open up a franchisee's veins here at IHOP, or a general manager's veins, out comes syrup. That's a real plus for our concept versus a lot of the new concepts out there where they just, they don't have that kind of infrastructure or broad brush appeal.

Secondarily because it is a 45-year-old American icon it has about a 99 percent (aided) awareness, and that's a pretty high number. And so when you think about it, we are so well known that if you go into a new area is more of a pull push strategy that people really want you and if they see (you coming) and the blue roof under construction there's just a huge amount of interest. So that appeals, I think, to a lot of the either perspective franchisees or even existing franchisees.

And frankly, thirdly, because I think we do have a reputation especially in more recent times of working well, collaborating as a teamwork, a perspective franchisee or even existing franchisee likes to go into a system where it is what I would call user friendly, knows how to work with franchisees, likes that, has a lot of process and systems in place. So those are more maybe qualitative than quantitative, but that's the feedback I get on sort of a regular basis both from existing and new franchisees.

And in the past the company didn't actively pursue that? Or didn't allow it specifically the kind of the investor program is always small?

Yes, I think by and large when you're building the number of units we are you sort of have to look everywhere. So often times the feedback that I would get, and this would be presumably logical to me, every time a franchisee would bring a franchise investor program site we would literally be looking in the same area. And so often times we would deny that because in order to build the number of sites we had to build we would take precedence over a franchisee, and you know, that became sort of a rub between the corporation building and the franchisee building. And that goes away in this new program.

And Andrew, it's Tom. We had a distinctly different sort of financial appeal if you think about it. And I'm not sure you and I have walked through this before, but in the old model because we financed everything the trade off was the franchisee gave potential cash flow (upside) to us because we were financing it. We were extracting a great deal out of his profit equation, and so the aggregate amount of profitability for the franchisee was affected by the amount that we were taking out. In this new model it really allows the franchisee, the operator, to get a much larger aggregate profitability. Of course it's straight up there that you've got to have access to capital and be able to fund and execute, you know, from soup to nuts, the whole development and operations of a restaurant. But the payoff is much bigger in this new model than the old model.

Right. I guess I was looking at the investor program and wondering if that was a legitimate indication of the interest in outside people to simply pay you a fee and then go build the restaurant on their own.

No, I think the reality is we've had a few of those every year for several years, but the real focus here as an organization had been in the old model, which is really we did the building. You know, every year we had a lot more interest than we were able to acknowledge or approve because we were so preoccupied with building. So we did turn down a fair amount of sites because again the old program was about us building.

And ...

I would not look at what we built last year and say gee that's the interest level, quite the contrary.

And is there any chance that this year that you would, might actually build less restaurants yourself if the outside interest was such that there were demand for those sites or whatever, or are the plans so far in advance that this is kind of going to happen?

Yes, and that's a great question, Andrew, and the answer is the plans are so far in advance, as you might well imagine, to have that kind of development growth you have to start the process so far ahead of time, so in fact the reality is we are absolutely entrenched in this 55 to 60 number because they are so far along. In fact we probably have over a quarter of them either under construction or being built as we speak. It's just, you know, you're stopping a fairly large train. So the reality is we will absolutely need to build that 55 to 60.

OK, and lastly could you just talk a little bit about the spending increases on the SG&A line? This year, in 02 they went by just seven or $8 million and a lot of, there was a big chunk of it related to consultants and market research and that kind of stuff, which I guess is embedded in the numbers going forward when we're looking for another, you know, using a mid point I guess, another seven or eight million growth this year. Are there any big pieces of that you can talk about? And does that well of expenses become baked into the business going forward so that you have to achieve, you know, a fairly good amount of growth to offset that?

Yes, I'll take about the strategy pieces and then I'll let Tom finish up with the numbers. From a strategy piece there are investments in the business. We have been so focused on developing restaurants, and all of our resources and investment have really gone against developing restaurants. In this new scenario, in this new model we have an opportunity and a need quite frankly to make investments in the operating side of the business and the branding side of the business.

So when you think about 2003, big chunks that you would think about is the mystery shop program, which I spoke of earlier, which is an investment in improving the overall operations of our business. You think about core menu research, improving our overall menu offerings to the consumer, or you think about the branding and the marketing or the advertising. These are major investments that we're making. Or IT if you will, these are major investments so that we become more of an operating company as opposed to just a developer. That's sort of at a strategic level, the kinds of things we are looking at from an investment perspective.

I'll let Tom talk to the number piece of it.

You know, Andrew, I wouldn't add much more to what Julia has said except to point out conceptually that this is the year we're operating two business models, OK? In order for us to do a buck 55 to buck 70 as based on your previous question we basically of, you know, how many are you going to develop yourself, we basically have to run the old business to deliver that 155 to 170, but at the same time, and concurrently we have to build a great deal of momentum so that we're hitting the ground running. We feel like we're running out of time already.

We want to be ahead of the curve to building this new operating model, and so while we expect eventually that some of the costs associated with the old way of doing businesses will be assessed and be stripped from our system, we just can't do that this year because we're required to run two businesses instead of one. And so I keep that in mind because that leads to the larger issue of guidance that we've given which is our belief that SG&A after this year will grow at rates that are lower than the rate of growth of sale. OK?

Yes sure, I guess, what if, there's a big gulf between the existing numbers and the steady (stay) model that you guys put out with pretty specific guidance, you know, going a month back. And it's, there's a lot of pieces in between that you guys aren't willing to talk to, so it makes it difficult to try and bridge between what we have currently and where we go to. And I think it would be very helpful if you guys would think about talking to people about simple things like depreciation levels and what you think the finance charges will be, and help people build a little certainty into their models. It would be greatly helpful, at least on my end.

You know I would expect that in a reasonable period of time, Andrew, we're, you know, we're going to help people understand in more detail than we have today, you know, what the impact of this new operating model is going to be. And so we can help, we'll walk you through that ...

You know, Andrew, that's ...

... but not, we wont do it, you know, in the next week or so, but in the near-term.

No, that's good feedback, and I think over time you're absolutely right we can provide that.

Thank you.

Thank you.

Thank you. And next we'll move forward to Harvey Hanerfeld of West Creek Capital.

Good morning.

Morning.

Hi, Harvey.

Hi. I had two questions, one sort of maybe reiterative of the last comment, but the first is if you could define free cash flow for us, you know, both as used in your guidance today and in your projections going forward. And the second, I was just going to reiterate what a few people previously have said, which is you've given this long-term guidance and yet you're somewhat hesitant talking about the operating model. It's somewhat confusing. I mean you've obviously given it a tremendous, tremendous amount of thought and you're executing against the plan, and we're sort of here to say well I guess we have to take them at their word even though they're not really willing to say, you know, this is the operating model. And that's somewhat confusing. So I mean I'm just reiterating what others have said.

Well Harvey your first question again was?

Can you define free cash flow?

Yes, let me handle that one. That's an easy one. It's after tax cash operations less expenditure, basically. OK? So in our case it would be an after tax cash from operations less whatever we re-deploy in the business.

OK, and that's true as well for the projections that (you projected)?

Yes. Yes.

OK.

The 40 to 50 million that we guided on earlier calls.

So that's a steady (state) after tax number?

That's correct.

OK, thank you.

And Harvey I guess on the latter, you're absolutely right and I think as we get farther down the road and we have begun to look at how you operate the current model for the balance of the year and transition quickly out of that model into the new model we'll be in a better position to share with you some very specific numbers as it relates to that model. (Visa vie) for 2004 development, SG&N, and so forth, so look for that in coming months. We absolutely want to be forthcoming we just need to finalize some of that work.

Thanks.

Thank you.

Thank you. And next we'll go to a follow up from Mike Smith.

Julia, the mystery shopper program, having a mystery shopper at your stores every other week, it sounds like a lot. Is it unusual in the industry, and if so what actually are you trying to accomplish, or what problem are you trying to address?

Well there's two things, and that's a fair question. Typically, you know, Mike, you know over time mystery shop is not nearly as effective as it is initially, and so six shops a quarter is absolutely more than the average, but there's a reason for that. IHOP has never had a (mys shop) program, and there is a lot of opportunity for us in making certain that everyone that is in our system is absolutely an A or a B operator.

And one of the ways to do that very rapidly as opposed to over some long period of time with just your existing folks out in the field doing a check is to have mystery shoppers very quickly in a very short period of time, which in my way of thinking the balance of this year is a short period of time, out there lot in the restaurants giving an awful lot of feedback to management in the restaurants and the franchise community, what they're seeing calibrated against the rest of the system. You can quickly see where you are and you can make immediate responses to it. So it's a real jump start, if you will, for the system.

And I do believe at least in the initial test which started 30 days ago I am warmed in my heart by the support we've gotten in the operations community and the franchisees being so supportive of what they're hearing and seeing because quite candidly it's very specific ways to get better immediately. And that's a good thing. And so yes we are being more aggressive in our approach early on to sort of bring the system from where it's been very quickly, sort of move the bell curve, if you will, Mike, as opposed to doing that over some long period of time. Do it in a much shorter span to support the marketing effort and all else that we're doing.

Well is it fair to say that the mystery shopper program is sort of a way to weed out some poor operators that you might have?

I don't know if it's weed out. It certainly brings to the surface issues that are there in a very timely, quick process, and get everybody to move from the bell curve if they're on the other end, be very clear about what that looks like and move them very quickly to the other end. And frankly also reinforce great behavior for guys out there doing a great job, which I believe the large majority of the system is. But if you are a C or average operator it's not good enough. And so this quickly brings that to the forefront.

And I would imagine that this is kind of important for your ability to sell franchisees is to I guess move the bell curve, I guess as you put it, up the scale. If you find that you have a poor operator, according to your contract how easy is it to get rid of them?

Well, good question. You know, I'd like to think that we don't manage by the contract. We manage by the relationship. It's more of a philosophy that I have that says if we've got a good working relationship, you care, you have tried, you want to make your restaurant better, and we're giving you a tool to do that in. So I'd like to believe we can manage by the relationship and not the contract. But let's hope we don't ever get to the point where we have to do that, but if we do, you know, we frankly have a well written franchise agreement that would allow for that and provide for that. I hope I don't ever have to get to that. And I hope we're talking about such a few that it's inconsequential. I truly believe that, you know, 99.9 percent of the system gets up in the morning and wants to figure out a way to deliver and deliver it well.

Well thank you.

Thanks, Mike.

Thank you. And there are no further questions at this time. Miss Stewart I will go ahead and turn it over to you for closing comments.

Well thanks, operator, and thank you all for participating this morning. We are confident about the steps we've taken to really enhance shareholder value and we're very excited about our 2003 prospects. Should you have any additional questions Tom and I are here and we welcome them. We look forward to speaking to you on our next quarterly conference call or frankly sooner. Thanks so much. Bye-bye.

And that does conclude today's conference. We appreciate your participation. And you may now disconnect.