DineEquity (DIN) Q4 2017 Earnings Conference Call Transcript

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DineEquity (NYSE: DIN) Q4 2017 Earnings Conference CallFeb. 20, 2018 8:00 a.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the Q4 2017 Dine Brand Global Inc. Earnings Conference Call. My name is Paulette, and I will be your operator for today's call. At this time all participants are in the listen-only mode.

Later we will conduct a question-and-answer session. During the question-and-answer session, if you have a question please press *, then 1 on your touchtone phone. Please note that this conference is being recorded. I will now turn the call over to Ken Diptee, executive director, investor relations.

You may begin.

Ken Diptee -- Executive Director, Investor Relations

Thank you. Good morning and welcome to DineEquity's fourth-quarter and fiscal 2017 conference call. I'm joined by Steve Joyce, CEO; Greg Kalvin, interim CFO and corporate controller; Darren Rebelez, president of IHOP and John Cywinski, president of Applebee's. Before I turn the call over to Steve, please remember our safe harbor regarding forward-looking information.

During the call, management may discuss information that's forward-looking and both known and unknown risks, uncertainties, and other factors which may cause the actual results to be different than those expressed or implied. Please evaluate the forward-looking information in the context of these factors which are detailed in today's press release and 10-K filing. The forward-looking statements are as of today and assumes no obligation to update or supplement these statements. We may also refer to certain non-GAAP financial measures, which are described in our press release and also available on DineEquity's website.

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With that, I'll turn the call over to Steve.

Steve Joyce -- Chief Executive Officer

Thanks, Ken. Well, good morning, everyone. Over the course of 2017, we took several strategic steps to stabilize and grow performance at IHOP and Applebee's. We shifted resources from corporate directly to the brands to provide greater autonomy and accountability.

This has further enabled our two strong brands to quickly respond to changes in the competitive environment in which we operate. We've enhanced our leadership team in key areas across the organization, including brand leadership, culinary, operations, and marketing to accelerate sustainable growth. We believe that investing in talent is absolutely necessary. We developed top-tier consumer insights and analytics to know who our guests are and to understand what they expect from us better than ever before.

This information has provided support and validation to our decision-making process. To expand our base business, we invested in technology and growth platforms such as our to-go offering to develop incremental revenue channels to IHOP and Applebee's. I am very pleased to say that our plan has produced improvement in off-premises business at both brands in 2017 compared to the previous year.Now, I don't want to give away too much for competitive reasons, but these are just a few exciting initiatives that are part of our strategy to return to growth. We continue to make good progress against our plan to stabilize and grow performance at both brands.

With that said, I am pleased to report encouraging positive sales and traffic performance of both brands in January, with comps up approximately 5% at Applebee's and 2% at IHOP. While we have more work to do, I am very confident in the steps we are taking to build on these early results and drive sustainable momentum. To achieve our goals, we must have a value-based performance culture. I firmly believe that leadership drives culture with a very seasoned leadership team in place that can affect the type of change needed to transition Dine back to a growth company and to ensure that our brands remain the leaders in their respective categories.We are a company in transition.

To reflect the change in our philosophy and the changes to come, we announced today the rebranding of our company name to Dine Brands Global Inc. The new name Dine Brands reflects a shift in our culture, our way of thinking and a new strategy. As I mentioned, we're currently implementing several initiatives as part of the shift in culture and new plan to transition to a growth company and create significant value for our shareholders and our franchisees.Now, let me walk you through what you can expect from Dine. First and foremost, we must stabilize the performance of our brands.

To that end, we are currently executing against a comprehensive growth plan. To provide some color, our strategy encompasses utilizing better guest analytics from our dedicated consumer insights teams for each brand, employing more effective breakthrough advertising to drive traffic in our restaurants, taking culinary innovation to the next level by providing our guests with unique offerings that they can only get at IHOP and Applebee's, providing guests with abundant value that differentiates us from the competition, creating additional touch points for consumers to engage with our brands when and how they want, strategically expanding our domestic footprint through the combination of traditional as well as nontraditional formats which allow us to penetrate additional high-traffic markets such as airports and travel centers, growing our international presence by leveraging the strong affinity guests have for our brands outside of the US. And to tie this all together, we're focusing on operations excellence in the back and front of the house to ensure that our guests have an exceptional experience on every visit.Secondly, you can expect that the return of capital will remain the top priority for us. We've maintained a consistent record of returning meaningful capital to our shareholders.

Since the quarterly cash dividend was funded in the first quarter of 2013, we've returned over $500 million combined in the form of dividends and share repurchases. We remain focused on delivering a strong return to our shareholders. As you saw in our press release this morning, we announced our quarterly dividend of $0.63 per share. After a very comprehensive and thoughtful review, we believe that we have set our dividend where it can be grown gradually over time, as we've done in the past, with an appropriate target payout ratio of 35% to 45%.

The savings from the dividend will be reallocated to provide a more efficient return of capital to shareholders through opportunistic and meaningful share repurchases. We intend to continue to have one of the highest attractive dividend yields in the industry.Third, after we've stabilized the performance of both brands, you can expect us to explore additional small tuck-in acquisitions or joint ventures to drive sustainable long-term growth for our company. We have an extremely scalable business model. We will continue to evaluate all growth opportunities as we move forward.

As I've said in the past, the franchise business is all about scale, as this allows us to spread our cost over a larger number of units. The incremental value of each unit added has 90%-plus flow-through to our bottom line. This is another great benefit of our 100% franchise model.Lastly, in addition to growing domestically, expect us to continue expanding our international presence. Since we formed our international division in 2013, we have grown our global footprint from 206 units to 269 at the end of 2017, representing a 7% [Inaudible].

I am pleased to say that in 2017 we experienced the strongest international development in over a decade, with our franchisees opening 37 restaurants across both brands. This represents a 23% increase over 2016. We intend to build on this momentum to achieve our long-term goal of having approximately 500 international restaurants by 2022. Key to our strategy is the ability to be flexible with our formats in terms of size and design.

This allows us to test initiatives internationally before leveraging best practices in the US. This division remains a meaningful and growing part of our business.As you can see, we are executing on several initiatives to create significant value for our shareholders and franchisees. We have a strong leadership team in place and we believe that successful execution of our plan will culminate in sustainable positive growth. To that end, both brands experienced sequential improvement in sales.

Applebee's comps improved 900 basis points in the fourth quarter compared to the third quarter and, more importantly, were positive for the first time since the second quarter of 2015. IHOP also experienced marked improvement over the quarter, with a shift of 280 basis points. I am confident that the steps we are taking will drive sustainable results as we work to build on this momentum and the positive comps and traffic at both brands in January. I'm incredibly excited to be part of this company and part of this team as we transition to growth.With that, I'm now going to ask Greg to walk you through the financial results and our 2018 performance guidance. Greg.

Greg Kalvin -- Interim Chief Financial Officer and Comptroller

Thank you, Steve. Good morning, everyone. I'll briefly cover our financial performance for the fourth quarter and 2017 year to date before returning to our fall 2018 performance guidance. For the fourth quarter, our adjusted earnings per share were $0.74, compared to $2.37 for the same period in 2016.

The decline was mainly due to a decrease in gross profit from franchise operations as a result of lower Applebee's royalties, not recognized until paid in cash; an increase in Applebee's bad-debt expense; the impact of 2017 closures; an increase in our contribution to the Applebee's national advertising fund; and a modest increase in G&A due to personnel-related costs. Please note that franchise operation expenses in the fourth quarter of 2017 were higher compared to the same period of 2016 primarily due to an increase in Applebee's bad-debt expense and a $4 million franchisor contribution to the Applebee's national advertising fund. For the full year 2017, our adjusted earnings per share was $4.15, compared to $6.01 for the same period of 2016. The decline was mainly due to a decrease in gross profit from franchise operations as a result of the increase in Applebee's bad-debt expense, lower Applebee's revenue due to a 5.3% decline in comp sales, an increase in our contribution to the Applebee's national ad fund, and royalties not recognized until paid in cash, the 2017 closures, and a modest increase in G&A due to Applebee's brand-stabilization initiatives primarily in the first half of the year.Regarding our fourth-quarter GAAP income tax benefits, as a result of the Tax Cuts and Jobs Act legislation in December 2017, we're required under GAAP accounting to perform a revaluation of our deferred-tax assets and liabilities on our balance sheet to reflect the federal corporate tax rate reduction from 35% to 21%.

As a result of this revaluation, we recorded an approximately $74 million income tax benefit in our statement of income in the fourth quarter to reset our future net deferred-tax liabilities at the new 21% rate. Regarding our 2017 tax rate, our effective tax rate for the full year 2017 was 40% on an adjusted earnings per share basis.Turning to our cash flow statement. Cash flows from operating activities for the full year 2017 were approximately $66 million, compared to approximately $118 million for the same period of last year. The overall decline was mainly attributed to lower net income resulting from a decrease in gross profit from Applebee's franchise operation and higher G&A.

The increase in G&A was primarily due to approximately $6 million of nonrecurring cash severance charges and $8 million incurred for the Applebee's stabilization initiatives. Adjusted free cash flow for 2017 was approximately $63 million, compared to approximately $123 million for the comparable period of 2016. The variance was due to declining cash from operations as previously discussed and higher capital expenditures compared to 2016. The increase in capital expenditures for 2017 compared to the same period last year was mainly due to construction costs related to the test kitchen at our corporate headquarters and additional investments in IT for consumer-facing initiatives.Turning to an update on our Applebee's franchisees' financial health.

We continue to closely partner with our franchisees and their lenders and real-estate lessors. This partnership includes the ability of franchisees to avail themselves to various financial assistance programs including restaurant closures and direct financial support. Franchisee financial health matters are reviewed by the brand on a real-time basis. Direct financial support will continue as necessary.

Currently, only a minority number of Applebee's franchisees have availed themselves of any direct financial assistance in this program. However, I'd like to point out that all but a few franchisees have participated in the approved closure process for underperforming restaurants.Now, I will review our 2018 financial guidance. Please see our press release we issued today for complete details on our guidance. Financial performance guidance for fiscal 2018 is as follows.

Applebee's domesticwide comparable same-restaurant sales performance is expected to range between flat and positive 3%. IHOP's domestic systemwide comparable same-restaurant sales performance is also expected to range between flat and positive 3%. Applebee's franchisees are expected to develop between 10 to 15 new restaurants globally, the majority of which are expected to be international openings. As part of our ongoing systemwide analysis to optimize the health of the franchisee system, we anticipate the closure of approximately 60 to 80 restaurants, primarily domestic.

The expected closures will be based on several criteria, including meeting our brand and image standards as well as operational results. IHOP franchisees and its area licensees are expected to develop between 85 and 100 restaurants globally, the majority of which are expected to be domestic openings. We expect the closure of approximately 30 to 40 restaurants. Franchise segment profit is expected to be approximately $289 million to $307 million.

Included in this amount is a one-time $30-million franchise expense that will be contributed to the Applebee's national advertising fund, continuing the 2017 contribution of $9.5 million. We expect the 2017 and 2018 combined contributions to be adequate to support Applebee's marketing initiatives in the first half of 2018. We expect the $30 million to be expensed ratably over the first and second quarters of 2018. Rental and financing segments are expected to generate approximately $37 million in combined profit.

General administrative expenses are expected to range between $147 million and $156 million, including non-cash stock compensation expense and depreciation of approximately $21 million. Interest expense is expected to be approximately $61 million. Approximately $3 million is projected to be non-cash interest expense. Weighted average diluted shares outstanding are expected to be approximately 18 million shares.

Our income tax rate is expected to be approximately 26%. Cash flows provided by operating activities are expected to range between $100 million and $120 million. Capital expenditures are projected to be $16 million. GAAP diluted earnings per share are expected to range from $4.31 to $4.61.

Adjusted earnings per diluted share are expected to range from $4.95 to $5.25. Adjusted free cash flow is expected to range between $94 million and $114 million.With that, I'll now turn the call over to John.

John Cywinski -- Applebee's President

Thanks, Greg, and good morning, everyone. I've previously categorized, 2017 as a transitional year, perhaps even a foundational year for Applebee's in terms of assessment, strategy, structure, and, of course, execution. While we anticipated our initiatives beginning to gain traction in Q1 of '18, we're certainly pleased to see early results materialize in Q4. From a strategy perspective, we have returned to our roots.

We've embraced Applebee's core DNA as a neighborhood place folks come to connect with family and friends. We're a familiar, welcoming, and all-American brand, and we love our position in the marketplace. We're comfortable with who we are and what we stand for, and we simply wouldn't pretend to be an overly hip or trendy brand. We strive to be neighborly, with abundant value and variety at our core, and we plan to leverage these strengths moving forward.From a guest perspective, we have a firm grasp on both demographics and occasion-based insights.

Said differently, we know who we're targeting and we know what drives purchase behavior at Applebee's and across the CDR category. Demographically, our guest profile is wonderfully diverse from an age perspective with an equal percentage of millennials, Gen-X-ers, boomers, which we view as a real strength. Importantly, our guests' household income ranges from $50,000 to $100,000 which certainly guides our culinary and marketing development process. Now, I have mentioned previously that we target routine traditionalists and value-seekers, both of whom have tendencies and characteristics conducive to Applebee's preference.

Without getting into detail, these folks represent our sweet spot and we're well-positioned to drive frequency here and moving forward.As an example of getting back to our roots, chef Stephen Bulgarelli and his team are focused on mainstream and broadly appealing menu items for our guests. We're not about niche or polarizing flavor profiles at Applebee's. So, it's unlikely you'll see sriracha, quinoa, or pomegranate anytime soon. You'll continue to see an emphasis on abundant value and simplification across our innovation pipeline.

On the structural side, our leadership team is now firmly in place. The team is deep, talented, and experienced, very experienced in navigating this challenging industry in particular. Our goal is simple: reestablish Applebee's unique brand personality, enhance relevance through innovation and execution, and generate sustained profitable growth in partnership with our great franchisees. While never easy in this category, we're pleased with our early progress and certainly confident about our future.

From an execution standpoint, restaurant excellence remains our top brand priority at Applebee's. Kevin Carroll, our chief operations officer, and his team have done a terrific job of partnering with our franchisees to create a relentless focus on guest satisfaction. All guest metrics have shown improvement from 2016 to 2017 while system ops variability has narrowed considerably. Our franchisees take great pride in these results and embrace accountability around brand standards while we continue to remove complexity from the restaurants.Now, on the marketing front, I recently announced the arrival our new chief marketing officer, Joel Yashinsky, and I couldn't be more pleased with his immediate impact on the business.

Joel comes to us as a highly regarded executive from McDonald's, where he was directly involved in two successful turnarounds. His franchisee and results orientation are already on full display here at Applebee's. Under Joel's leadership, we're bringing to life "Eating Good in the Neighborhood" across all consumer touch points, as we actively showcase the emotional and rational benefits that make Applebee's such a likable and approachable brand. From an innovation standpoint, our disciplined development process has now been in place for about nine months and our culinary and marketing pipeline is beginning to populate quite nicely.

Additionally, our supply chain partnership with Pricewaterhouse Coopers is now in full swing as we begin to implement food packaging and labor initiatives to enhance restaurant-level profitability, importantly without compromising the guest experience. Franchisees remain very enthusiastic about this initiative as we expect to see meaningful P&L benefits beginning this year and continuing throughout 2019 and 2020.Now, let's turn our attention to Applebee's results. Comp sales were up 1.3% in Q4 and positive comp sales have continued into Q1. The very good news here is that traffic growth has returned to Applebee's in both Q4 and Q1 for the first time since late 2014.

Additionally, Applebee's has outperformed the CDR category over the same time frame. While still in the early stages of our strategic initiatives, we're pleased with the change and trajectory that we've been able to achieve here. From my perspective, our recent performance can be attributed to a combination of variables and the execution of our strategic plan. In particular, there are five components that stand out: Our franchisee collaboration partnership and alignment, that's certainly No. 1, it's genuine and it's making a huge difference. Franchisee focus on guest satisfaction continues to show consistent and meaningful progress, that's No. 2. No. 3 is value-oriented food and beverage propositions are proving relevant, complementary, and buzzworthy. No. 4, refined targeting and media placement have elevated the effectiveness and impact of our media buy. And No. 5, and certainly last but not least, "Eating Good in the Neighborhood" has clarified our brand position as a point of difference and it's really resonated with our guests. As highlighted in the release, a one-time contribution to the ad fund will allow us to support marketing propositions with proper testing, advertising production, digital and social media, while increasing our number of on-air weeks.Now, on the portfolio front, I have mentioned previously the likelihood of some very selective consolidation among existing franchisees as well as the introduction of perhaps a new franchise to the brand. Both of these very positive scenarios will likely occur over the balance of this year as part of our planned portfolio evolution. In closing, our leadership team is now in place and they are truly exceptional.

Our resilient and passionate franchisees are now walking the talk every day on restaurant-level execution and they're hungry to win. Together we remain committed to enhancing relevance while unlocking the sustained growth embedded within this powerful Applebee's brand. With that, I'll turn it to Darren.

Darren Rebelez -- IHOP President

Thanks, John. Good morning, everyone. IHOP's fourth-quarter comp sale declined 0.4%, reflecting a decrease in our comp traffic that's consistent with category traffic declines, were not offset with check increases. Although fourth-quarter comp sales for the family dining category declined sequentially by approximately 70 basis points, IHOP's fourth-quarter comps improved by nearly 300 basis points versus the third quarter.

This improvement was primarily driven by strong growth in our to-go business, which accounted for over 6% of total sales in the fourth quarter, reflecting an increase of 100 basis points compared to the same period last year. We're very encouraged by the overall results of our off-premise business, which have also contributed to our positive sales performance in January.Turning briefly to development, our franchisees have opened an average of 61 restaurants annually over the last decade. I'm pleased to say that the pace of development continued at a very strong pace in 2017. Our franchisees opened 77 restaurants globally, of which 28 were international locations.

This represents an impressive 25% growth in overall development compared to the 10-year average. This is a testament to the strength of our franchisee base and the strong demand for our brand, both domestically and outside the U.S. To drive sustainable growth, we're continuing to execute our four-pronged strategy, which encompasses significantly enhancing the guest experience, running great restaurants, driving traffic to those restaurants, and being where the guest is. I'll touch on each of these briefly starting with significantly enhancing the guest experience.We understand that guests consider many factors when deciding where to dine.

Among them is the atmosphere. To provide our guests with a warm and welcoming environment as well as drive traffic, we implemented the Rise and Shine remodel program, which is the most comprehensive in the brand's nearly 60-year history. Our franchisees have made great progress on this front. I'm pleased to report that we exceeded our goal of 300 remodels for the second consecutive year.

A total of 90 restaurants were remodeled in the fourth quarter to bring the full tally to 320. Since the program was rolled out in the first quarter of 2016, we've completed 620 remodels. Looking ahead, I'm really encouraged by the success of this program. We will continue at a pace of 250 to 300 remodels per year until the system is complete.Another important aspect of providing the best guest experience possible every day is meeting the convenience needs of our guests.

Approximately 46% of adults and 61% of millennials say the most important factors when choosing a restaurant are availability, convenience, and friendliness. For these reasons, offering convenient carry-out service in our restaurants is more important now than ever. In addition to enhancing the guest experience inside of our restaurants, we're also focused on providing our exceptional food to guests on the go. With that said, we've seen extremely positive results from our IHOP and Go platform, which features innovative carry-out packaging specifically designed to transport IHOP's delicious pancakes and other unique menu items so they maintain the right temperature and quality long after leaving the restaurant.

As I mentioned earlier, we experienced strong growth in our IHOP and Go platform in the fourth quarter of 2017 compared to the same quarter a year ago. To provide some color, overall to-go comp sales in the fourth quarter were up a very strong 23%. On a full-year basis, we also saw impressive 11% increase. Additionally, we saw solid growth in both traffic and check in each of the comparable periods.

IHOP and Go is an important part of our long-term off-premise strategy, and online ordering is integral to letting our guests choose IHOP on their own timetables and wherever they are. In fact, 24% of Americans order to go or delivery two times each week, resulting in 44% of all restaurant dining occasions being enjoyed off-premise. Given that our guests have told us that they want the same great IHOP experience at home that they get in our restaurants, we knew we had to launch IHOP and Go and online ordering at exactly the right time. In fact, the average online to-go check size in the fourth quarter of 2017 experienced a mid-single-digit-percentage increase since the first quarter.

The average check price for online to-go orders in the fourth quarter was approximately 45% higher than the average check size for all other to-go orders, including call-ins. Lastly, we continue to utilize technology to enhance the guest experience. The expansion of our IHOP and Go platform includes completion of the national roll-out of a fully integrated online ordering system through IHOP.com. To provide our guests with even more ways to access the brand, we also completed the roll-out of our IHOP's mobile app in the fourth quarter.

We're very excited about the steps we're taking to extend the reach of our brand and to create a compelling omnichannel experience for our guests.Turning to the next part of our strategy, running great restaurants. We've been laser-focused on operations excellence in both the front and back of the house. I'd like to commend the efforts of our franchisees and team members for their hard work to ensure that our guests receive the best service in our restaurants. To that end, I'm happy to report that we saw a marked improvement in our overall guest satisfaction scores in 2017.

Not only did we see an improvement of 500 basis points in the scores, we achieved a new record high in December. So congratulations to the entire team. To reinforce providing our guests with an unparalleled experience every day, we launched our iHospitality Training Program. This program provides an additional tier of training to ensure that our team members are well-versed, making a genuine connection with guests, and making them feel valued.

iHospitality encompasses a recognition program to acknowledge team members for excellence in various areas, such as hospitality, teamwork, food preparation, and extraordinary performance. We believe the program has the potential to drive visitation to our restaurants. In addition to this program, we've also taken steps to provide franchisees with the resources they need to ensure their restaurants meet or exceed our high brand standards. To achieve this, we've restructured our field operations to bring more training and regional marketing resources to our operators.Switching gears to the third prong of our strategy, driving traffic.

We announced last quarter that we selected top-tier advertising firm Droga5 as our ad agency of record to assist us in creating breakthrough creative and more effective messaging. We're very pleased with their initial campaign, themed "Pancakes, Pancakes, Pancakes" to kick off our very popular all-you-can-eat pancakes for $3.99 promotion, which launched on January 2, 2018. This combination of breakthrough creative combined with a compelling value proposition has led to a strong start of the year, with IHOP outperforming the category according to Black Box data on sales and traffic.Regarding the final prong, being where the guest is, as I mentioned earlier, we've seen strong and consistent development by our franchisees. In 2017 our franchisees developed 40 new IHOP restaurants in the domestic business, yielding a net of 35 new restaurants for the year.

This represents the best year of net development for the IHOP brand since 2011. With the success of our new small-format prototype and our expansion into nontraditional venues, we expect to see accelerated restaurant growth into the future.To wrap, as you can see, the scope of our strategy to drive sustainable positive performance is very broad. While there's more work to be done, we're very encouraged by IHOP's positive sales and traffic performance in January. We're working tirelessly to build on that momentum.

Finally, I'd like to remind everyone that February 27 is IHOP's National Pancake Day. I encourage you to enjoy a free short stack of our delicious buttermilk pancakes between 7:00 a.m. and 7:00 p.m. at participating locations and donate to help children battling critical illnesses.With that, I'll now turn the call back over to Steve for his closing comments. Steve.

Steve Joyce -- Chief Executive Officer

Thanks, Darren. We have a clear vision and a plan to drive sustainable positive performance at both brands. While the positive sales and traffic results for January are very encouraging, we still have a lot of work to do. I provided some high-level details on our comprehensive strategy to return Dine to growth and I am confident in the steps that we are taking to realize our full potential.

We have not lost sight of our commitment to return capital to shareholders. We believe that lowering the dividend will provide for returns in the most efficient manner through share repurchases while maintaining the highest dividend in the industry. To close, I look forward to updating you on our progress during the year as we continue to implement our go-forward strategy. For those of you who have not had the chance to register for our Investor Day being held in New York tomorrow at the W Union Square, please feel free to join us.

You can contact Ken Diptee for details.Now we'd be pleased to open the call to any questions you might have. Operator.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. If you have a question, please press *, then 1 on your touchtone phone. If you wish to be removed from the queue, please press the # sign or the # key.

If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press *, then 1 on your touchtone phone. And our first question comes from Michael Gallo from C.L. King.

Please go ahead.

Michael Gallo -- C.L. King -- Analyst

Good morning.

Operator

Michael, your line is now open.

Michael Gallo -- C.L. King -- Analyst

Yeah, congratulations on the improved results. So my question is, I guess, for Greg. Given the $30 million contributions or roughly $20 million or $21 million incremental year over year, I know you called that out as one-time in the press release, but clearly, 1) you're getting a significant benefit. So, I was wondering why you think that that will be enough.

And then 2) are there offsets in the franchisee-expense line in 2018 that are going to be more favorable than 2017 that's going to allow you to grow profit contribution despite that? Thanks.

Greg Kalvin -- Interim Chief Financial Officer and Comptroller

I'll take the second question first. Essentially in 2018, because of the improved guidance and projections that we have, we should see less collectability issues, if you will. So that will be a positive to the franchise-expense line. You got a lot of moving pieces in there because of the ad spend but that'll be the major positive event, if you will, going through that line, coming through.

For 2017, we obviously experienced both on the revenue line, as we stated in prepared remarks, and also through the bad-debt expense which flows through the franchise-expense line, a historically higher amount which we expect to improve this year. Regarding advertising, Steve is going to talk to that.

Steve Joyce -- Chief Executive Officer

So the advertising fund contribution is an important part of the overall strategy, there's no question, but when I came in, we made a commitment for both '17 and '18, which we are now fulfilling. We believe that we needed to make that contribution to get the story out about what we're doing and clearly, we're getting some traction from that story. John and his team are using those funds to dominate the airwaves with 30-second commercials that we think are making a difference with programs that we think resonate with our customers and our guests. So in our restaurants, we are seeing a difference both in traffic and in sales, and the contribution that we made and are making, we think, is vital to that.

However, we think that ad fund in and of itself, based on the way it's structured, will be sufficient to continue the same type of momentum going forward but, as I mentioned, in '17 we thought it was important and John made the commitment to his franchisees, that we were going to stand side by side with them and turn a positive story into a really strong growth story. So far, that seems to be working pretty well. And so, we have no anticipation of making a contribution beyond this point because we think we're getting the appropriate traction that we had hoped to get and we think we can build from here.

Michael Gallo -- C.L. King -- Analyst

Thank you very much.

John Cywinski -- Applebee's President

This is John. the only thing I would add to that is that's not an arbitrary figure. There is strong rhyme and reason and rationale behind that figure. We're putting it to use in a very specific manner, as Steve outlined.

So we anticipate results and our franchisees are fully aligned with this investment.

Michael Gallo -- C.L. King -- Analyst

Just one quick follow-up. Do you anticipate [Inaudible] with the $30 million contribution, obviously projecting positive comps, [Inaudible] rolling it in with all the closures, do you expect you'll have the advertising spending will be up in '18 versus '17?

John Cywinski -- Applebee's President

Well, with our contribution, the answer is, yes it will be at the same levels and then going forward we expect it to be at that level and higher.

Michael Gallo -- C.L. King -- Analyst

Great. Thank you.

Operator

Our next question comes from Steven Anderson from the Maxim Group. Please go ahead.

Steven Anderson -- Maxim Group -- Analyst

Yes, good morning. A couple of quick questions. Actually, I've been tracking menu pricing. I just wanted to ask you if you have had any discussions with franchisees about menu pricing at both Applebee's and IHOP and what kind of range are you looking at.

And I have a follow-up.

Steve Joyce -- Chief Executive Officer

I'll start with that but let me turn it over to both [Inaudible] guys because they're much more integrally involved in this discussion. We believe our long-term success is all about value, and value is a combination of the service provided, the restaurant environment, the food in particular, and overall providing memorable dining experiences. However, having said that, we believe value is and will continue to be a major segment of our strategy going forward on both brands, and we believe that makes us more relevant to our consumer and to our restaurant guests because they are a hard-working group that values their money and wants to see great value in the entire equation as part of what they expect. Look, we represent the 99%.

We are not in a luxury-restaurant business. We are in a business where we want people to frequent us many times during the month and we want them to think of us as a quiet and a fun and an enjoyable respite in a world that is not. And so, as we think about that going forward, we need to continue to offer relevant things to our guests that make them want to come to our restaurants and the rest of it will turn into success.Darren, do you have comment?

Darren Rebelez -- IHOP President

Yeah, this is Darren. Steven, we on an ongoing basis, our franchisees in council with them on approaching their pricing from a more strategic standpoint. I would say that the IHOP franchisees have been pretty savvy about this and probably a little bit ahead of the curve on taking some price perhaps a year, 18 months ago, and they've started to moderate that a bit more recently. Moving forward, we're really trying to work with them to be a little bit more strategic and dial in some more data into that analysis so that we're staying within a relevant range versus our competition.

So, it would be difficult for me to handicap that at this point but I would say that to Steve's comments regarding value, we believe value is important. We're going to continue to work with our franchisees on balancing that value equation out.

Steven Anderson -- Maxim Group -- Analyst

OK. And this is a follow-up question. You mentioned the potential of looking at tuck-in acquisitions within the industry, and is there any one particular category, whether it be casual dining, or it'd be fast-casual categories that you'd be looking at for potential [Inaudible] acquisitions?

John Cywinski -- Applebee's President

Steven, your question on pricing, look, we collaborate with partner franchisees frequently on strategy, right? They're all free to price as they see fit. We're cautious in this environment. There's a direct inverse correlation between pricing and traffic, and we're fixated on traffic. So, that's our No.

1 priority outside of executing at the restaurant level. Historically, you see brands in this category in the 1% to 2% range annually. We'd be on the lower side of that in terms of guidance to our franchisees but, again, our focus is on traffic and we'll deliver value in a number of ways at the restaurant level.

Darren Rebelez -- IHOP President

To answer your question about where we're interested in going to add to our brand, clearly, we have the No. 1 brands in both of our categories, both casual dining and family restaurants. We've been No. 1 for 10 years which is pretty remarkable achievement.

We think both brands have enormous runway going forward. I've read a lot about the death of our categories. In fact, if you look at our numbers, half of our customers are under the age of 34. So, we think we've got quite a bit of run left in these brands.

Having said that, we think complementary to our brands would be something in different categories. While we're just beginning that search, we're hoping to find something that fits us in terms of a relatively small but accretive transaction that we can grow nationally, and the kind of area we're going to look at, fast casual is obviously attractive to us but also in terms of the actual brand itself, we like ethnic, we like healthy. So, you could see us having conversations with folks with small brands that fit those categories and we're hoping to do something probably at the tail end of this year or early next to start what we hope is a gradual transition to a multibrand platform.

Steven Anderson -- Maxim Group -- Analyst

Thank you.

Operator

Our next question comes from Brian Vaccaro from Raymond James. Please go ahead.

Brian Vaccaro -- Raymond James -- Analyst

Thank you and good morning. I had a detailed question on the fourth-quarter Applebee's franchise segment line items and then a couple of high-level ones, if I could but, Greg, in the fourth quarter, what was the bad-debt expense embedded in that $13 millionish and change franchise expense? Do you have that number handy?

Greg Kalvin -- Interim Chief Financial Officer and Comptroller

Probably about approximately $7 million to $8 million.

Brian Vaccaro -- Raymond James -- Analyst

OK. And then as I think about your guidance for the franchise segment profitability, if we ex out the one-time NAF of $30 million, your guidance assumes an improvement in Applebee's franchise segment profitability as we think about cash basis, royalties, and also bad-debt expense. Did I hear that correctly?

Greg Kalvin -- Interim Chief Financial Officer and Comptroller

Yes.

Brian Vaccaro -- Raymond James -- Analyst

OK. All right, great. And then transitioning, I wanted to follow up on the Applebee's sales improvement and maybe ask it through the lens of some of the consumer-insights work that your team has done, and you mentioned specifically the routine traditionalist and the value-seekers, and I guess the question is has the sales improvement in recent months been concentrated in one of these groups or has it been more balanced across, say, demographics or the occasion groups that you mentioned?

John Cywinski -- Applebee's President

Hey, Brian, this is John. It's been very balanced, almost surprisingly so. We've seen it through a multitude of initiatives. We're pleased primarily with the fact that the growth is coming organically through traffic.

From an occasion standpoint, it's both those kind of older folks who have some discretionary dollars as well as category or brand-switchers within the category and it's coming from Gen-Xers and millennials as well. So, we're pleased with the diversity of what we're seeing and more than anything else, we're pleased with the organic component of this. We haven't seen it in quite some time.

Brian Vaccaro -- Raymond James -- Analyst

OK, and as part of that you mentioned the improvement in quite a bit, I think, of your guest-satisfaction scores and different metrics, but could you maybe provide some more color on where you've seen the most improvement or where that improvement has been most impactful to the business?

John Cywinski -- Applebee's President

Actually, we've seen it on all guest metrics. So, guest satisfaction would be, overall satisfaction would be at the top of that list, a meaningful, we'll call it a 7-percentage-point shift from 2016 to 2017. On the flip side of that, we track problems, guests who experience problems at the restaurant level. At one point that was a double-digit number for this brand.

It's down to about 5%. I would expect it to hover in the 4%- to 5%-range moving forward. And then other attributes around speed, cleanliness, friendliness, engagement, hot food, quality food have all been moving in the right direction and part of that is our effort to simplify on behalf of general managers and servers, and to make their jobs a little easier. So, look, we've got formidable competitors and we're in a brutal category, but the evidence is very clear in terms of restaurant-level execution.

All the attributes are moving in the right direction and I attribute that to our franchisees.

Brian Vaccaro -- Raymond James -- Analyst

All right, that's helpful. Just one last one for me. I wanted to go circle back on that Applebee's franchisee profitability, if I could. I know there a lot of initiatives to improve profitability and positive comps are a critically important factor there, but could you level-set, even at a high level, where the average profitability stands today and has it stabilized in recent months as the traffic and comps have improved or are we still yet to bottom on just sort of maybe store margins, etc.?

Greg Kalvin -- Interim Chief Financial Officer and Comptroller

This is Greg, Brian. I think consistent with the improvement in the same-store sales, I mean, it's going to directionally push it up and especially at the franchisee level, at our level also the collectability is important and as this improves, we're seeing some positive signs in that area also. So, I think from both sides things are looking up in the last three or four months.

Brian Vaccaro -- Raymond James -- Analyst

All right, that's helpful. Thank you.

Operator

Our next question comes from Alex Mergard from J.P.Morgan. Please go ahead.

Alex Mergard -- J.P.Morgan -- Analyst

Hi, thank you for the question. It's on capital allocation, and on your balance sheet, your debt has an expected maturity in September 2021. So, with some of the incremental free cash flow from reducing the dividend or improved operations, is it your expectation at this point in time to reallocate any of that for debt pay-down or what should we be thinking on that front?

Steve Joyce -- Chief Executive Officer

So, I think our approach is we think we're at an appropriate debt level. We like the space sort of in the 5 to 5.5 category. We want to restructure our debt. That's something we've actually already started discussions on.

We will time it based on both pricing in the market but also when the appropriate offers are made to us. So, we're looking at that probably over the next year to determine the right timing. We've got a well-structured debt position today but obviously, it does have maturity in the mid-term. And so, our view is we don't want to wait until the end of that.

We want to sort of start thinking about it at this point and our structuring will be based on both the market, the pricing, and what we think the appropriate debt levels are for our company, but let's be clear, we're very comfortable where we reside today. And so, at these levels of leverage, because of the stability of our cash flow, we think it helps us optimize the balance sheet, and you'll see us continue to do that mostly in terms of as we generate cash and begin to delever, we will figure out ways to get that cash to shareholders because that is our No. 1 priority. And then we'll also look for investing in the brands and growth.

Alex Mergard -- J.P.Morgan -- Analyst

OK, got it. That's very helpful. Thank you for that. And then I've got just one follow-up.

So, on the IHOP rental-income stream, it's my understanding that a lot of that is derived from a strategy that was really developed back in 2003 in prior time period. So, as those franchisees face lease expirations, to this day are you still trying to renew those sublease agreements with your franchisees and essentially stay in the middle on them?

Greg Kalvin -- Interim Chief Financial Officer and Comptroller

This is Greg. Yes, as those renew, they go into a new lease and we continue with our process under the old business model. If a store closes ever, then it goes to the new business model, but most of those stores, there's probably over 700 of them, that have those leases, we would continue with a new lease, if you will, into the future.

Alex Mergard -- J.P.Morgan -- Analyst

Thank you.

Operator

Once again, if you have a question, please press *-1. And we are showing no further questions. I will now turn the call back to Steve Joyce for closing comments.

Steve Joyce -- Chief Executive Officer

So, thank you for joining us. We are clearly excited about the results generated and for reporting to you throughout the year as we continue to make progress. We are very satisfied with our results to date but we also believe that the bulk of our work is in front of us.

Duration: 58 minutes

Call Participants:

Ken Diptee -- Executive Director, Investor Relations

Steve Joyce -- Chief Executive Officer

Greg Kalvin -- Interim Chief Financial Officer and Comptroller

John Cywinski -- Applebee's President

Darren Rebelez -- IHOP President

Michael Gallo -- C.L. King -- Analyst

Steven Anderson -- Maxim Group -- Analyst

Brian Vaccaro -- Raymond James -- Analyst

Alex Mergard -- J.P.Morgan -- Analyst

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