UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 25, 2005
-------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------------------- -----------------------
Commission File Number: 000-17962
-------------------------------
Applebee's International, Inc.
----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 43-1461763
--------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4551 W. 107th Street, Overland Park, Kansas 66207
-------------------------------------------------------------------------------
(Address of principal executive offices and zip code)
(913) 967-4000
---------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes X No
----- -----
Indicate by check mark whether the registrant is a shell company (as defined by
Rule 12b-2 of the Exchange Act). Yes No X
----- -----
The number of shares of the registrant's common stock outstanding as of October
26, 2005 was 76,280,910.
1
APPLEBEE'S INTERNATIONAL, INC.
FORM 10-Q
FISCAL QUARTER ENDED SEPTEMBER 25, 2005
INDEX
Page
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements:
Consolidated Balance Sheets as of September 25, 2005
and December 26, 2004................................................................ 3
Consolidated Statements of Earnings for the 13 Weeks and 39 Weeks
Ended September 25, 2005 and September 26, 2004 (as restated)........................ 4
Consolidated Statement of Stockholders' Equity for the
39 Weeks Ended September 25, 2005.................................................... 5
Consolidated Statements of Cash Flows for the 39 Weeks
Ended September 25, 2005 and September 26, 2004 (as restated)........................ 6
Notes to Condensed Consolidated Financial Statements.................................... 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations........................................ 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............................. 32
Item 4. Controls and Procedures................................................................. 32
PART II OTHER INFORMATION
Item 1. Legal Proceedings....................................................................... 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............................. 33
Item 6. Exhibits................................................................................ 33
Signatures ................................................................................................. 34
Exhibit Index............................................................................................... 35
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share amounts)
September 25, December 26,
2005 2004
---------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents..................................................... $ 10,140 $ 10,642
Short-term investments, at market value....................................... 284 282
Receivables (less allowance for bad debts of $346 in 2005 and $417 in 2004)... 36,171 39,152
Receivables related to captive insurance subsidiary........................... 3,248 2,566
Inventories................................................................... 21,499 35,936
Prepaid and other current assets.............................................. 13,035 12,079
---------------- ---------------
Total current assets...................................................... 84,377 100,657
Property and equipment, net........................................................ 567,157 486,548
Goodwill........................................................................... 138,788 116,344
Restricted assets related to captive insurance subsidiary.......................... 20,186 17,386
Other intangible assets, net....................................................... 7,921 8,524
Other assets, net.................................................................. 29,699 24,972
---------------- ---------------
$ 848,128 $ 754,431
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt............................................. $ 254 $ 222
Notes payable................................................................. 9,700 --
Accounts payable.............................................................. 53,755 42,830
Accrued expenses and other current liabilities................................ 76,294 89,064
Loss reserve and unearned premiums related to captive insurance subsidiary.... 13,481 12,137
Accrued dividends............................................................. -- 4,867
Accrued income taxes.......................................................... 14,930 2,578
---------------- ---------------
Total current liabilities................................................. 168,414 151,698
---------------- ---------------
Non-current liabilities:
Long-term debt - less current portion......................................... 126,280 35,472
Deferred income taxes......................................................... 27,589 28,995
Other non-current liabilities................................................. 47,112 41,539
---------------- ---------------
Total non-current liabilities............................................. 200,981 106,006
---------------- ---------------
Total liabilities......................................................... 369,395 257,704
---------------- ---------------
Commitments and contingencies (Note 4)
Stockholders' equity:
Preferred stock - par value $0.01 per share: authorized - 1,000,000 shares;
no shares issued............................................................ -- --
Common stock - par value $0.01 per share: authorized - 125,000,000 shares;
issued -108,503,243 shares.................................................. 1,085 1,085
Additional paid-in capital.................................................... 233,615 220,897
Unearned compensation......................................................... (3,175) (1,924)
Retained earnings............................................................. 704,597 623,315
---------------- ---------------
936,122 843,373
Treasury stock - 31,105,048 shares in 2005 and 27,375,044 shares in 2004, at
cost........................................................................ (457,389) (346,646)
---------------- ---------------
Total stockholders' equity................................................ 478,733 496,727
---------------- ---------------
$ 848,128 $ 754,431
================ ===============
See notes to condensed consolidated financial statements.
3
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
(in thousands, except per share amounts)
13 Weeks Ended 39 Weeks Ended
----------------------------------- -----------------------------------
September 25, September 26, September 25, September 26,
2005 2004 2005 2004
--------------- ---------------- ---------------- ---------------
(as restated) (as restated)
Revenues:
Company restaurant sales ....................... $ 272,673 $ 247,173 $ 815,834 $ 738,502
Franchise royalties and fees.................... 31,589 30,048 97,090 91,485
Other franchise income.......................... 1,064 3,913 3,553 10,427
--------------- ---------------- --------------- ---------------
Total operating revenues.................... 305,326 281,134 916,477 840,414
--------------- ---------------- --------------- ---------------
Cost of company restaurant sales:
Food and beverage............................... 71,555 65,115 215,755 195,277
Labor........................................... 90,231 79,195 269,070 239,533
Direct and occupancy............................ 74,706 61,914 212,111 181,769
Pre-opening expense............................. 1,089 1,020 3,524 2,012
--------------- ---------------- --------------- ---------------
Total cost of company restaurant sales...... 237,581 207,244 700,460 618,591
--------------- ---------------- --------------- ---------------
Cost of other franchise income....................... 790 3,521 2,838 11,493
General and administrative expenses.................. 26,329 26,752 81,255 77,134
Amortization of intangible assets.................... 204 199 658 443
Impairment of long-lived assets...................... 3,900 -- 3,900 --
Loss on disposition of restaurants and equipment..... 480 441 1,341 1,520
--------------- ---------------- ---------------- ---------------
Operating earnings.................................. 36,042 42,977 126,025 131,233
--------------- ---------------- ---------------- ---------------
Other income (expense):
Investment income............................... 568 325 976 566
Interest expense................................ (1,232) (379) (2,203) (1,139)
Other income.................................... 593 754 1,612 1,777
--------------- ---------------- ---------------- ---------------
Total other income (expense)................ (71) 700 385 1,204
--------------- ---------------- ---------------- ---------------
Earnings before income taxes ........................ 35,971 43,677 126,410 132,437
Income taxes......................................... 13,836 15,080 45,128 45,974
--------------- ---------------- ---------------- ---------------
Net earnings......................................... $ 22,135 $ 28,597 $ 81,282 $ 86,463
=============== ================ ================ ===============
Basic net earnings per common share.................. $ 0.28 $ 0.35 $ 1.02 $ 1.06
=============== ================ ================ ===============
Diluted net earnings per common share................ $ 0.28 $ 0.34 $ 1.00 $ 1.03
=============== ================ ================ ===============
Basic weighted average shares outstanding............ 78,485 81,511 79,692 81,759
=============== ================ ================ ===============
Diluted weighted average shares outstanding.......... 79,691 83,503 81,121 84,079
=============== ================ ================ ===============
See notes to condensed consolidated financial statements.
4
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
(in thousands)
Common Stock Additional Total
------------------ Paid-In Unearned Retained Treasury Stockholders'
Shares Amount Capital Compensation Earnings Stock Equity
--------- -------- ---------- ------------ ---------- ----------- -------------
Balance, December 26, 2004...................... 108,503 $ 1,085 $220,897 $ (1,924) $623,315 $(346,646) $ 496,727
Net earnings................................. -- -- -- -- 81,282 -- 81,282
Purchases of treasury stock.................. -- -- -- -- -- (120,856) (120,856)
Stock options exercised and related
tax benefit................................ -- -- 8,429 -- -- 8,058 16,487
Shares issued under employee benefit plans... -- -- 2,095 -- -- 1,333 3,428
Restricted shares awarded under equity
incentive plans, net of cancellations..... -- -- 2,194 (2,916) -- 722 --
Amortization of unearned compensation
relating to restricted shares.............. -- -- -- 1,665 -- -- 1,665
----------- -------- ---------- ------------ ---------- ----------- -------------
Balance, September 25, 2005..................... 108,503 $ 1,085 $233,615 $ (3,175) $704,597 $(457,389) $ 478,733
=========== ======== ========== ============ ========== =========== =============
See notes to condensed consolidated financial statements.
5
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
39 Weeks Ended
------------------------------------
September 25, September 26,
2005 2004
---------------- ---------------
(as restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings.................................................................... $ 81,282 $ 86,463
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization............................................... 39,765 34,059
Amortization of intangible assets........................................... 658 443
Amortization of unearned compensation....................................... 1,665 1,073
Other amortization.......................................................... 182 242
Inventory impairment........................................................ -- 2,100
Deferred income tax provision (benefit)..................................... (3,270) 26,455
Impairment of long-lived assets............................................. 3,900 --
Loss on disposition of restaurants and equipment............................ 1,341 1,520
Income tax benefit from exercise of stock options........................... 4,665 7,610
Changes in assets and liabilities (exclusive of effects of acquisitions):
Receivables................................................................. 2,981 (4,745)
Receivables related to captive insurance subsidiary......................... (682) (2,657)
Inventories................................................................. 14,627 (15,039)
Other current assets related to captive insurance subsidiary................ -- (193)
Prepaid and other current assets............................................ 908 (470)
Accounts payable............................................................ 8,981 (763)
Accrued expenses and other current liabilities.............................. (13,024) (17,081)
Loss reserve and unearned premiums related to captive insurance subsidiary.. 1,344 8,602
Income taxes................................................................ 12,352 (2,399)
Other non-current liabilities............................................... 2,524 --
Other....................................................................... (1,523) 1,048
---------------- ---------------
NET CASH PROVIDED BY OPERATING ACTIVITIES................................... 158,676 126,268
---------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............................................. (100,802) (68,224)
Restricted assets related to captive insurance subsidiary....................... (2,800) (7,548)
Acquisitions of restaurants..................................................... (46,848) (13,817)
Lease acquisition costs......................................................... -- (4,857)
Purchases of short-term investments............................................. -- (253)
Proceeds from the sale of restaurants and equipment............................. 1,205 --
Other investing activities...................................................... -- (1,045)
---------------- ---------------
NET CASH USED BY INVESTING ACTIVITIES....................................... (149,245) (95,744)
---------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchases of treasury stock..................................................... (120,856) (88,224)
Dividends paid.................................................................. (4,867) (3,911)
Issuance of common stock upon exercise of stock options......................... 11,822 13,371
Shares issued under employee benefit plans...................................... 3,428 4,934
Net debt proceeds............................................................... 100,540 25,880
---------------- ---------------
NET CASH USED BY FINANCING ACTIVITIES....................................... (9,933) (47,950)
---------------- ---------------
NET DECREASE IN CASH AND CASH EQUIVALENTS............................................ (502) (17,426)
CASH AND CASH EQUIVALENTS, beginning of period....................................... 10,642 17,867
---------------- ---------------
CASH AND CASH EQUIVALENTS, end of period............................................. $ 10,140 $ 441
================ ===============
6
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Unaudited)
(in thousands)
39 Weeks Ended
------------------------------------
September 25, September 26,
2005 2004
---------------- ---------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the 39 week period for:
Income taxes............................................................ $ 31,381 $ 13,561
================ ===============
Interest................................................................ $ 1,438 $ 544
================ ===============
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
We issued restricted common stock, net of forfeitures, of $2,916,000 and
$1,772,000 for the 39 weeks ended September 25, 2005 and September 26, 2004,
respectively.
In 2002, we entered into a rabbi trust agreement to protect the assets of the
nonqualified deferred compensation plan for certain of our associates. The plan
investments are included in other assets and the offsetting obligation is
included in other non-current liabilities in our consolidated balance sheets. We
had non-cash increases in these balances of $3,049,000 and $2,014,000 for the 39
weeks ended September 25, 2005 and September 26, 2004, respectively.
In the first quarter of fiscal 2004, we made matching contributions in shares of
our common stock to a profit sharing plan and trust established in accordance
with Section 401(k) of the Internal Revenue Code of $1,308,000.
We had property and equipment purchases accrued in accounts payable of
approximately $11,200,000 as of September 25, 2005.
See notes to condensed consolidated financial statements.
7
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
Our condensed consolidated financial statements included in this Form 10-Q have
been prepared without audit in accordance with the rules and regulations of the
Securities and Exchange Commission. Although certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted, we believe that the disclosures are adequate to
make the information presented not misleading. The accompanying condensed
consolidated financial statements should be read in conjunction with the audited
financial statements and notes thereto included in our Annual Report on Form
10-K for the fiscal year ended December 26, 2004.
We believe that all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the results of the interim
periods presented have been made. The results of operations for the interim
periods presented are not necessarily indicative of the results to be expected
for the full year.
We have made certain reclassifications to the condensed consolidated financial
statements to conform to the fiscal 2005 presentation.
2. Restatement of Financial Statements
Like many other companies in the restaurant, retail and other industries, we
reviewed our accounting treatment of leases and depreciation of related
leasehold improvements during the fourth fiscal quarter of 2004 and we restated
our consolidated financial statements for fiscal years 2003 and 2002 and the
first three fiscal quarters of fiscal 2004 in our Annual Report on Form 10-K for
the fiscal year ended December 26, 2004.
Historically, when accounting for leases with renewal options, we had recorded
rent expense on a straight-line basis over the initial non-cancelable lease
term, with the term commencing when actual rent payments began and depreciated
leasehold improvements on those properties over a maximum period of 20 years
which, in certain cases, included a portion of the renewal option periods. We
corrected our lease term to include option periods where failure to recognize
such options would result in an economic penalty such that the renewal appears
reasonably assured. The primary result of this correction was to accelerate the
recognition of rent expense under certain leases that include fixed-rent
escalations. In addition, the lease term is deemed to commence on the date the
company becomes legally obligated for rent payments. Therefore, we adopted a
policy to capitalize the straight-line rent amounts during the construction
period of leased properties, which resulted in an increase to depreciation
expense in the restated consolidated statements of earnings. Straight-line rent
subsequent to the construction period and prior to the restaurant opening is
recognized as expense, which resulted in an increase to previously reported
pre-opening expenses in the restated consolidated statements of earnings.
In connection with the restatement for lease accounting matters, we also
corrected previously identified immaterial errors, primarily related to vacation
and workers' compensation expense.
8
The following table contains information regarding the impact of the restatement
adjustments on our consolidated statements of earnings for the 13 and 39 weeks
ended September 26, 2004. These amounts, except per share amounts, are in
thousands.
Consolidated Statements of Earnings
-----------------------------------
13 Weeks Ended 13 Weeks Ended
September 26, 2004 September 26,
(As previously Restatement 2004
reported) amounts (As restated)
------------------ ----------- ------------------
Revenues:
Company restaurant sales................................................ $ 247,173 $ -- $ 247,173
Franchise royalties and fees............................................ 30,105 (57) 30,048
Other franchise income.................................................. 3,913 -- 3,913
------------------ ----------- ------------------
Total operating revenue............................................ 281,191 (57) 281,134
------------------ ----------- ------------------
Cost of company restaurant sales:
Food and beverage....................................................... 65,115 -- 65,115
Labor................................................................... 79,599 (404) 79,195
Direct and occupancy.................................................... 61,642 272 61,914
Pre-opening expense..................................................... 998 22 1,020
------------------ ----------- ------------------
Total cost of company restaurant sales............................. 207,354 (110) 207,244
------------------ ----------- ------------------
Cost of other franchise income.............................................. 3,521 -- 3,521
General and administrative expenses......................................... 26,669 83 26,752
Amortization of intangible assets........................................... 199 -- 199
Loss on disposition of restaurants and equipment............................ 441 -- 441
------------------ ----------- ------------------
Operating earnings.......................................................... 43,007 (30) 42,977
------------------ ----------- ------------------
Other income (expense):
Investment income....................................................... 325 -- 325
Interest expense........................................................ (379) -- (379)
Other income............................................................ 568 186 754
------------------ ----------- ------------------
Total other income................................................. 514 186 700
------------------ ----------- ------------------
Earnings before income taxes................................................ 43,521 156 43,677
Income taxes................................................................ 15,232 (152) 15,080
------------------ ----------- ------------------
Net earnings................................................................ $ 28,289 $ 308 $ 28,597
================== =========== ==================
Basic net earnings per common share......................................... $ 0.35 $ -- $ 0.35
================== =========== ==================
Diluted net earnings per common share....................................... $ 0.34 $ -- $ 0.34
================== =========== ==================
Basic weighted average shares outstanding................................... 81,511 81,511
================== ==================
Diluted weighted shares outstanding......................................... 83,503 83,503
================== ==================
9
39 Weeks Ended 39 Weeks Ended
September 26, 2004 September 26,
As previously Restatement 2004
reported) Amounts (As restated)
---------------- ----------- ----------------
Revenues:
Company restaurant sales............................................... $ 738,502 $ -- $ 738,502
Franchise royalties and fees........................................... 91,656 (171) 91,485
Other franchise income................................................. 10,427 -- 10,427
---------------- ----------- ----------------
Total operating revenue........................................... 840,585 (171) 840,414
---------------- ----------- ----------------
Cost of company restaurant sales:
Food and beverage...................................................... 195,277 -- 195,277
Labor.................................................................. 240,344 (811) 239,533
Direct and occupancy................................................... 180,951 818 181,769
Pre-opening expense.................................................... 1,939 73 2,012
---------------- ----------- ----------------
Total cost of company restaurant sales............................ 618,511 80 618,591
---------------- ----------- ----------------
Cost of other franchise income............................................. 11,493 -- 11,493
General and administrative expenses........................................ 77,118 16 77,134
Amortization of intangible assets.......................................... 443 -- 443
Loss on disposition of restaurants and equipment........................... 1,520 -- 1,520
---------------- ----------- ----------------
Operating earnings......................................................... 131,500 (267) 131,233
---------------- ----------- ----------------
Other income (expense):
Investment income...................................................... 566 -- 566
Interest expense....................................................... (1,139) -- (1,139)
Other income........................................................... 1,410 367 1,777
---------------- ----------- ----------------
Total other income................................................ 837 367 1,204
---------------- ----------- ----------------
Earnings before income taxes............................................... 132,337 100 132,437
Income taxes............................................................... 46,318 (344) 45,974
---------------- ----------- ----------------
Net earnings............................................................... $ 86,019 $ 444 $ 86,463
================ =========== ================
Basic net earnings per common share........................................ $ 1.05 $ 0.01 $ 1.06
================ =========== ================
Diluted net earnings per common share...................................... $ 1.02 $ 0.01 $ 1.03
================ =========== ================
Basic weighted average shares outstanding.................................. 81,759 81,759
================ ================
Diluted weighted shares outstanding........................................ 84,079 84,079
================ ================
3. Stock-Based Compensation
We have adopted the disclosure provisions of Statement of Financial Accounting
Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure, an amendment of FASB Statement No. 123." The
Statement requires prominent disclosures in both annual and interim financial
statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We account
for stock-based compensation awards under the intrinsic method of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Opinion No. 25 requires compensation cost to be recognized based on the excess,
if any, between the quoted market price of the stock at the date of grant and
the amount an employee must pay to acquire the stock. All options awarded under
all of our plans are granted with an exercise price equal to the fair market
value on the date of the grant. The following table presents the effect on our
net earnings and net earnings per share had we adopted the fair value method of
accounting for stock-based compensation under SFAS No. 123, "Accounting for
Stock-Based Compensation" (in thousands, except for per share amounts).
10
13 Weeks Ended 39 Weeks Ended
----------------------------------- ----------------------------------
September 25, September 26, September 25, September 26,
2005 2004 2005 2004
--------------- --------------- --------------- ---------------
(as restated) (as restated)
Net earnings, as reported............................ $ 22,135 $ 28,597 $ 81,282 $ 86,463
Add: Stock-based employee compensation
expense included in net earnings,
net of related taxes............................. 385 327 1,071 616
Less: Total stock-based employee
compensation expense determined under
fair value based methods for all awards,
net of related taxes............................. 2,049 2,220 5,416 6,719
--------------- --------------- --------------- ---------------
Pro forma net earnings............................... $ 20,471 $ 26,704 $ 76,937 $ 80,360
=============== =============== =============== ===============
Basic net earnings per common share,
as reported...................................... $ 0.28 $ 0.35 $ 1.02 $ 1.06
=============== =============== =============== ===============
Basic net earnings per common share,
pro forma........................................ $ 0.26 $ 0.33 $ 0.96 $ 0.98
=============== =============== =============== ===============
Diluted net earnings per common share,
as reported...................................... $ 0.28 $ 0.34 $ 1.00 $ 1.03
=============== =============== =============== ===============
Diluted net earnings per common share,
pro forma........................................ $ 0.26 $ 0.32 $ 0.95 $ 0.96
=============== =============== =============== ===============
4. Commitments and Contingencies
Litigation, claims and disputes: We are involved in various legal actions which
include, without limitation, employment law and wage and hourly labor related
matters, dram shop claims, personal injury claims and other such restaurant
operational matters. In each instance, we believe that we have meritorious
defenses to the allegations made and we are vigorously defending these claims.
We believe that the ultimate disposition of these matters will not, individually
or in the aggregate, have a material adverse effect upon our business or
consolidated financial position.
Lease guarantees and contingencies: In connection with the sale of restaurants
to franchisees and other parties, we have, in certain cases, remained
contingently liable for the remaining lease payments. As of September 25, 2005,
we have outstanding lease guarantees of approximately $17,700,000. These leases
expire at various times with the final lease agreement expiring in 2025. In
addition, we or our subsidiaries are contingently liable for various leases that
we have assigned in connection with the sale of restaurants to franchisees and
other parties, in the potential amount of $14,600,000. We have not recorded a
liability as of September 25, 2005 or December 26, 2004.
Franchisee guarantees: In November 2003, we arranged for a third-party financing
company to provide up to $75,000,000 to qualified franchisees for short-term
loans to fund remodel investments, subject to our approval. Under the terms of
this financing program, we will provide a limited guarantee pool for the loans
advanced during the three-year period ending December 2006. As of September 25,
2005, there were loans outstanding to four franchisees aggregating approximately
$1,300,000 under this program.
11
In May 2004, we arranged for a third-party financing company to provide up to
$250,000,000 to qualified franchisees for loans to fund development of new
restaurants through October 2007, subject to our approval. We will provide a
limited guarantee of certain loans advanced under this program. As of September
25, 2005, there were loans outstanding to six franchisees aggregating
approximately $41,800,000 under this program. The fair value of our guarantee
under these two financing programs was less than $100,000 and is recorded in
other non-current liabilities and other assets in our consolidated balance sheet
as of September 25, 2005.
Severance agreements: We have severance and employment agreements with certain
officers providing for severance payments to be made in the event the employee
resigns or is terminated related to a change in control. The agreements define
the circumstances which will constitute a change in control. If the severance
payments had been due as of September 25, 2005, we would have been required to
make payments totaling approximately $13,300,000. In addition, we have severance
and employment agreements with certain officers which contain severance
provisions not related to a change in control. Those provisions would have
required aggregate payments of approximately $6,200,000 if such officers had
been terminated as of September 25, 2005.
5. Net Earnings Per Share
We compute basic net earnings per common share by dividing income available to
common shareholders by the weighted average number of common shares outstanding
for the reporting period. Diluted net earnings per common share reflects the
potential dilution that could occur if holders of options or other contracts to
issue common stock exercised or converted their holdings into common stock.
Outstanding stock options and equity-based compensation represent the only
dilutive effects on weighted average shares. The chart below presents a
reconciliation between basic and diluted weighted average shares outstanding and
the related net earnings per share. All amounts in the chart, except per share
amounts, are expressed in thousands.
13 Weeks Ended 39 Weeks Ended
---------------------------------- ---------------------------------
September 25, September 26, September 25, September 26,
2005 2004 2005 2004
--------------- --------------- --------------- ---------------
(as restated) (as restated)
Net earnings......................................... $ 22,135 $ 28,597 $ 81,282 $ 86,463
=============== =============== =============== ===============
Basic weighted average shares outstanding............ 78,485 81,511 79,692 81,759
Dilutive effect of stock options and
equity-based compensation.......................... 1,206 1,992 1,429 2,320
--------------- --------------- --------------- ---------------
Diluted weighted average shares outstanding.......... 79,691 83,503 81,121 84,079
=============== =============== =============== ===============
Basic net earnings per common share.................. $ 0.28 $ 0.35 $ 1.02 $ 1.06
=============== =============== =============== ===============
Diluted net earnings per common share................ $ 0.28 $ 0.34 $ 1.00 $ 1.03
=============== =============== =============== ===============
We excluded stock options with exercise prices greater than the average market
price of our common stock for the applicable periods from the computation of
diluted weighted average shares outstanding as the effect would be
anti-dilutive. We have excluded approximately 3,410,000 and 1,520,000 of these
options for the 13 weeks ended September 25, 2005 and September 26, 2004,
respectively, and 910,000 and 1,400,000 of these options for the 39 weeks ended
September 25, 2005 and September 26, 2004, respectively, from our diluted
weighted average share computation.
12
6. Acquisitions
All of our acquisitions below have been accounted for using the purchase method
of accounting and, accordingly, our consolidated financial statements reflect
the results of operations for each acquisition subsequent to the date of
acquisition. The assets acquired and liabilities assumed are recorded at
estimates of fair values as determined by management based upon information
available. We finalize the allocation of purchase price to the fair value of
assets acquired and liabilities assumed when we obtain information sufficient to
complete the allocation, but in each case, no longer than one year after the
acquisition date.
In May 2005, we completed the acquisition of 12 Applebee's restaurants, which
included one restaurant under construction, in Missouri, Kansas and Arkansas for
approximately $39,500,000. Through September 2005, we have paid approximately
$39,000,000, which has been allocated to the fair value of property and
equipment of $16,900,000, goodwill of $21,900,000 and other net assets of
approximately $200,000. Emerging Issues Task Force Issue No. 04-1 ("EITF 04-1"),
"Accounting for Preexisting Relationships between the Parties to a Business
Combination" requires certain reacquired rights (including the rights to the
acquirer's trade name under a franchise agreement) to be recognized as
intangible assets apart from goodwill. We are currently evaluating the impact of
EITF 04-1 on the allocation of the purchase price of these 12 restaurants.
The following table is comprised of actual company restaurant sales for the
restaurant acquisition above, which are included in our condensed consolidated
financial statements for each period presented and pro forma company restaurant
sales assuming the acquisition above occurred at the beginning of each
respective period (in thousands):
13 Weeks Ended 39 Weeks Ended
------------------------------------- -------------------------------------
September 25, September 26, September 25, September 26,
2005 2004 2005 2004
------------------ ------------------ ------------------ ------------------
Actual acquired company
restaurant sales........................ $ 7,500 $ -- $ 10,300 $ --
================== ================== ================== ==================
Pro forma acquired company
restaurant sales........................ $ 7,500 $ 6,600 $ 21,900 $ 20,000
================== ================== ================== ==================
In April 2005, we finalized the acquisition of eight Applebee's restaurants in
the Memphis market that were closed in fiscal 2004 by a former franchisee for
approximately $8,800,000 payable in cash. In connection with this acquisition,
we paid approximately $800,000 in cash in the fourth quarter of fiscal 2004,
approximately $5,700,000 in cash in the first quarter of fiscal 2005 and
approximately $2,300,000 in cash in the second quarter of fiscal 2005. The
purchase price of $8,800,000 has been allocated to the fair value of property
and equipment of approximately $8,200,000 and goodwill of approximately
$600,000. As of September 25, 2005, we have remodeled and opened seven
restaurants and the remaining restaurant was sold to a third party.
In April 2004, we completed our acquisition of the operations and assets of ten
Applebee's restaurants located in Southern California for approximately
$13,800,000 in cash. The purchase price was allocated to the fair value of
property and equipment of $2,500,000, goodwill of $10,800,000 and other net
assets of approximately $500,000. Company restaurant sales for these restaurants
were $6,500,000 and $11,200,000 for the 13 weeks ended and 39 weeks ended
September 26, 2004, respectively. Proforma company restaurant sales for these
restaurants would have been approximately $6,500,000 and $20,000,000 for the 13
weeks and 39 weeks ended September 26, 2004 had this acquisition been completed
at the beginning of fiscal 2004.
13
7. Inventory Impairment
In the second quarter of fiscal 2004, we determined that we had excess
inventories of riblets that no longer met our quality standards. Accordingly, we
recorded an inventory impairment of $2,100,000 (approximately $1,400,000 net of
income taxes) in our condensed consolidated financial statements during the 39
weeks ended September 26, 2004. The portion of the riblet inventory impairment
related to the company's historical usage of approximately $500,000 was recorded
in food and beverage cost and the portion related to the franchisees' historical
usage of approximately $1,600,000 was recorded in cost of other franchise income
in the consolidated statement of earnings. In the fourth quarter of fiscal 2004,
we recovered a portion of the inventory impairment as a result of higher than
anticipated sales of these inventories.
8. Impairment of Long-lived Assets
In connection with the review of long-lived assets during our preparation of the
third quarter of fiscal 2005 condensed consolidated financial statements, we
recorded an asset impairment charge of $3,900,000 consisting of a $2,600,000
write-down of the carrying value of the property and equipment of three
restaurants that are not performing as expected and one restaurant that will be
closed and relocated and a $1,300,000 write-down of one other long-lived asset.
This impairment charge has been included in our condensed consolidated
statements of earnings for the 13 and 39 weeks ended September 25, 2005. We use
current and historical operating results to estimate future cash flows on a
restaurant by restaurant basis. The asset impairment charge was calculated by
comparing the carrying value of the assets to the estimated future cash flow
projections. We continue to operate the restaurants, although we may close some
or all of the underperforming restaurants in the future.
9. Goodwill and Other Intangible Assets
Changes in goodwill are summarized below (in thousands):
39 Weeks Ended 52 Weeks Ended
September 25, December 26,
2005 2004
---------------------- ----------------------
Carrying amount, beginning of the year.................. $ 116,344 $ 105,326
Goodwill acquired during the period..................... 22,444 11,018
---------------------- ----------------------
Goodwill amount, end of the period...................... $ 138,788 $ 116,344
====================== ======================
14
Intangible assets subject to amortization pursuant to SFAS No. 142, "Goodwill
and Other Intangible Assets," are summarized below (in thousands):
September 25, 2005
-----------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights....... $ 6,371 $ 5,813 $ 558
Lease acquisition costs............. 4,940 631 4,309
Noncompete agreement................ 350 87 263
------------------ ------------------ ------------------
Total................................... $ 11,661 $ 6,531 $ 5,130
================== ================== ==================
December 26, 2004
-----------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights....... $ 6,371 $ 5,565 $ 806
Lease acquisition costs............. 4,875 294 4,581
Noncompete agreement................ 350 22 328
------------------ ------------------ ------------------
Total................................... $ 11,596 $ 5,881 $ 5,715
================== ================== ==================
In the fourth quarter of fiscal 2004, we acquired the exclusive right to operate
Applebee's restaurants in the Memphis, Tennessee market from a former franchisee
group for approximately $2,800,000. This intangible asset has an indefinite
life, and accordingly, will not be amortized but tested for impairment at least
annually. In connection with this acquisition, we entered into an expanded
4-year noncompete agreement with the former franchise principals which is being
amortized over the life of the agreement.
In the second quarter of fiscal 2004, we acquired six restaurant leases which
were formerly operated as Ground Round restaurants for approximately $4,900,000
in cash.
Franchise interest and rights are being amortized over the next two to four
years, the lease acquisition costs are being amortized over the next 8 to 20
years and the noncompete agreement is being amortized over the next four years.
We expect annual amortization expense for all intangible assets for the next
five fiscal years to range from approximately $400,000 to $900,000.
10. Captive Insurance Subsidiary
In 2002, we formed Neighborhood Insurance, Inc., a Vermont corporation and a
wholly-owned captive insurance subsidiary to provide Applebee's International,
Inc. and qualified franchisees with workers' compensation and general liability
insurance. Applebee's International, Inc. and covered franchisees make premium
payments to the captive insurance company which pays administrative fees and
insurance claims, subject to individual and aggregate maximum claim limits under
15
the captive insurance company's reinsurance policies. Franchisee premium amounts
billed by the captive insurance company are established based upon third-party
actuarial estimates of settlement costs for incurred claims and administrative
fees. The franchisee premiums are included in other franchise income ratably
over the policy year. The related offsetting expenses are included in cost of
other franchise income. Accordingly, we do not expect franchisee participation
in the captive insurance company to have a material impact on our net earnings.
In fiscal 2005, we reduced the types of insurance coverage plans which resulted
in fewer franchisee participants in our captive insurance program. Our
consolidated balance sheets include the following balances related to the
captive insurance subsidiary:
o Franchise premium receivables of approximately $2,500,000 and
$1,900,000 as of September 25, 2005 and December 26, 2004,
respectively, included in receivables related to captive insurance
subsidiary.
o Cash equivalent and other long-term investments restricted for the
payment of claims of approximately $19,500,000 and $16,700,000 as of
September 25, 2005 and December 26, 2004, respectively, included in
restricted assets related to captive insurance subsidiary.
o Loss reserve and unearned premiums related to captive insurance
subsidiary of approximately $20,900,000 and $19,600,000 as of September
25, 2005 and December 26, 2004, respectively. Approximately $7,400,000
and $7,500,000 as of September 25, 2005 and December 26, 2004,
respectively, is included in other non-current liabilities.
o Other miscellaneous items, net, of approximately $1,100,000 and
$1,000,000 as of September 25, 2005 and December 26, 2004,
respectively, included in several line items in the consolidated
balance sheets.
11. Treasury Shares
As of September 25, 2005, we had approximately 31,105,000 shares held in
treasury. A reconciliation of our treasury shares for the 39 weeks ended
September 25, 2005 is provided below (shares in thousands):
Treasury
Shares
---------------
Balance as of December 26, 2004........................ 27,375
Purchases of treasury stock............................ 4,918
Stock options exercised................................ (930)
Shares issued under employee benefit plans............. (154)
Restricted shares awarded under equity incentive
plans............................................. (104)
---------------
Balance as of September 25, 2005....................... 31,105
===============
12. New Accounting Pronouncements
In October 2005, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") 13-1, "Accounting for Rental Costs Incurred during a
Construction Period." The guidance requires the rental costs recognized for
ground or building operating leases during the construction period be recognized
as rental expense. The guidance permits either retroactive or prospective
treatment for periods beginning after December 15, 2005. We will prospectively
change our policy from capitalization to expensing beginning in fiscal 2006. The
adoption of this FSP will result in an expected increase of approximately
$25,000 in preopening expenses recognized for every new restaurant opened but
will not have a material effect on our consolidated financial statements.
16
In June 2005, the FASB's EITF reached a consensus on Issue No. 05-6,
"Determining the Amortization Period for Leasehold Improvements" ("EITF 05-6").
The guidance requires that leasehold improvements acquired in a business
combination or purchased subsequent to the inception of a lease be amortized
over the lesser of the useful life of the assets or a term that includes
renewals that are reasonably assured at the date of the business combination or
purchase. The guidance is effective for periods beginning after June 29, 2005.
The adoption of EITF 05-6 did not have an impact on our consolidated financial
statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards No.
154, "Accounting Changes and Error Corrections--A Replacement of APB Opinion No.
20 and FASB Statement No. 3." SFAS No. 154 requires retrospective application to
prior periods' financial statements for changes in accounting principle, unless
it is impracticable to determine either the period-specific effects or the
cumulative effect of the change. SFAS No. 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005.
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations," ("FIN 47"). FIN 47 clarifies the term
"conditional" as used in SFAS No. 143, "Accounting for Asset Retirement
Obligations." This Interpretation refers to a legal obligation to perform an
asset retirement activity even if the timing and/or settlement is conditional on
a future event that may or may not be within the control of an entity.
Accordingly, the entity must record a liability for the conditional asset
retirement obligation if the fair value of the obligation can be reasonably
estimated. FIN 47 is effective for fiscal years ending after December 15, 2005.
We are evaluating the impact the adoption of FIN 47 will have on our
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-based
Payment," which replaces SFAS No. 123, "Accounting for Stock-Based
Compensation," and supersedes Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees." SFAS No. 123 (revised 2004)
requires compensation costs related to share-based payment transactions to be
recognized in the financial statements. With limited exceptions, the amount of
compensation cost will be measured based on the fair value on the grant date of
the equity or liability instruments issued. Compensation cost will be recognized
over the period that an employee provides service for that award, resulting in a
decrease in our net earnings. We will adopt the provisions of this Statement, as
amended, using the modified prospective method beginning in fiscal 2006. We
expect that the adoption of this Standard will be material to our consolidated
financial statements; however, we are still in the process of evaluating its
impact.
13. Subsequent Events
In October 2005, the Board of Directors declared an annual dividend of $0.20 per
share to be payable on January 23, 2006 to shareholders of record on December
23, 2005. In addition, the Board of Directors approved an additional
$175,000,000 authorization to repurchase our common stock, subject to market
conditions.
In October 2005, we entered into an amendment to our credit facility which
increased the revolving credit commitment available from $200,000,000 to
$250,000,000 and provided for an additional $75,000,000 of revolving credit upon
satisfaction of the conditions set forth in the credit facility.
17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Restatement of Financial Statements
The accompanying Management's Discussion and Analysis gives effect to the
restatement of our condensed consolidated financial statements for quarterly and
year-to-date information in 2004 to correct our accounting treatment for leases,
depreciation of related leasehold improvements and for previously identified
immaterial errors, primarily related to vacation and workers' compensation, as
described in Note 2 to the condensed consolidated financial statements.
General
We operate on a 52 or 53 week fiscal year ending on the last Sunday in December.
Our fiscal years and fiscal periods are as follows:
Number
Fiscal Year Fiscal Year End of Weeks
------------------------ -------------------------- ----------------
2004 December 26, 2004 52
2005 December 25, 2005 52
2006 December 31, 2006 53
Number
Fiscal Period Fiscal Period End of Weeks
------------------------ -------------------------- ----------------
2004 Quarter September 26, 2004 13
2005 Quarter September 25, 2005 13
2004 Year-to-date period September 26, 2004 39
2005 Year-to-date period September 25, 2005 39
Our revenues are generated from three primary sources:
o Company restaurant sales (food and beverage sales)
o Franchise royalties and fees
o Other franchise income
Beverage sales consist of sales of alcoholic beverages, while non-alcoholic
beverages are included in food sales. Franchise royalties are generally 4% of
each franchise restaurant's monthly gross sales. Franchise fees typically range
from $30,000 to $35,000 for each restaurant opened. Other franchise income
includes insurance premiums for the current year and premium audit adjustments
for prior years from franchisee participation in our captive insurance program
and revenue from information technology products and services provided to
certain franchisees. In fiscal 2005, we have fewer franchisee participants in
the captive insurance program due to the termination of one of our insurance
programs, which will result in a total decrease in franchise premiums recognized
throughout the 2005 fiscal year in other franchise income of approximately
$9,200,000.
18
Certain expenses relate only to company operated restaurants. These include:
o Food and beverage costs
o Labor costs
o Direct and occupancy costs
o Pre-opening expenses
Cost of other franchise income includes the costs related to franchisee
participation in our captive insurance program and costs related to information
technology products and services provided to certain franchisees. In fiscal
2005, we have fewer franchisee participants in the captive insurance program due
to the termination of one of our insurance programs, which will result in a
total decrease in franchise premiums expense throughout the 2005 fiscal year in
the cost of other franchise income of approximately $9,200,000.
Other expenses, such as general and administrative and amortization expenses,
relate to both company operated restaurants and franchise operations.
Overview
Applebee's International, Inc. and our subsidiaries develop, franchise and
operate casual dining restaurants under the name "Applebee's Neighborhood Grill
& Bar," which is the largest casual dining concept in the world with over 1,700
system-wide restaurants open as of September 25, 2005. The casual dining segment
of the restaurant industry is highly competitive and there are many factors that
affect our profitability. Our industry is susceptible to changes in economic
conditions, trends in lifestyles, fluctuating costs, government regulation,
availability of resources and consumer perceptions. When evaluating and
assessing our business, we believe there are five key factors:
o Development - the number of new company and franchise restaurants opened
during the period. As the largest casual dining concept in the world,
Applebee's has a unique opportunity to leverage our brand, system size and
scale to optimize our future growth. Our expansion strategy has been to
cluster restaurants in targeted markets, thereby increasing consumer
awareness and convenience, and enabling us to take advantage of operational,
distribution and advertising efficiencies. We currently expect that the
Applebee's system will encompass at least 3,000 restaurants in the United
States, as well as the potential for at least 1,000 restaurants
internationally. In the 2005 quarter and the 2005 year-to-date period, we
and our franchisees opened 35 and 91 restaurants, respectively. Together, we
have opened at least 100 restaurants system-wide each year for the past 12
fiscal years. In fiscal 2005, we currently expect to open at least 135
restaurants system-wide, comprised of 50 company and 85 franchise
restaurants. Construction costs have increased approximately 10% in fiscal
2005 as compared to fiscal 2004. Further increases are expected as a result
of increased demand for material and labor due to recent catastrophic
hurricanes. We are evaluating the impact of rising construction costs on the
near-term pipeline of future openings.
o Comparable restaurant sales - a year-over-year comparison of sales for
restaurants open at least 18 months. Our revenues are generated primarily
from company restaurant sales, franchise royalties and fees and other
franchise income. Increases in company and franchise comparable restaurant
sales will result in increases in company restaurant sales and franchise
fees and royalties. In the 2005 quarter, company comparable sales decreased
1.6% while franchise and system-wide comparable sales were up 1.8% and 0.9%,
19
respectively. For the 2005 year-to-date period, company comparable sales
were down 0.8% while franchise and system-wide comparable sales were up 3.1%
and 2.1%, respectively. We have had 29 consecutive quarters of positive
system-wide comparable sales growth. We currently expect comparable sales
for the remainder of the year to be in a range from down 3.0% to up 1.0% for
company restaurants and from flat to up 3.0% for franchise restaurants.
Comparable restaurant sales increases are driven by increases in the average
guest check and/or increases in guest traffic. Average guest check increases
result from menu price increases and/or a change in menu mix. Although we
may have increases in our average guest check from period to period, our
main focus has been increasing guest traffic as we view this component to be
more indicative of the long-term health of the Applebee's brand. We are
constantly seeking to increase guest traffic by focusing on operations and
improving our menu with new menu rollouts and implementation of new programs
such as Carside to Go(TM)and Weight Watchers(TM). Carside To Go(TM)is
expected to be a driver of company, franchise and system-wide comparable
sales growth in fiscal 2005.
o Company restaurant margin - company restaurant sales less food and beverage,
labor, direct and occupancy restaurant costs and pre-opening expenses
expressed as a percentage of company restaurant sales. Company restaurant
margins were 12.9% and 14.1% in the 2005 quarter and 2005 year-to-date
period, respectively, as compared to 16.2% in both the 2004 quarter and 2004
year-to-date period. We currently expect full year fiscal 2005 company
restaurant margins to be less than full year fiscal 2004 results and will be
dependent on comparable sales performance at company restaurants. Company
restaurant margins are susceptible to fluctuations in commodity costs, labor
costs and other operating costs such as utilities. We attempt to negotiate
contracts for the majority of our food products in order to mitigate the
impact of rising commodity costs. We currently expect commodity costs for
beef, poultry and other proteins to increase by approximately 1.5% in fiscal
2005. We expect labor costs to continue to be negatively impacted by health
insurance costs and the impact of wage rate increases. Higher energy costs
will have a negative impact on margins in the fourth quarter of fiscal 2005,
including higher utilities, fuel surcharges and packaging costs.
o General and administrative expenses - general and administrative expense
expressed as a percentage of total operating revenues. General and
administrative expense leverage is a key focus for us. We currently expect
that revenues will grow faster than general and administrative expenses. In
fiscal 2005, general and administrative expenses as a percent of total
revenues are currently expected to be approximately 9%.
o Return on equity - net earnings expressed as a percent of average
stockholders' equity. We believe this is an important indicator as it allows
us to evaluate our ability to create value for our shareholders. We have
exceeded our stated goal of at least 20% return on equity for the past six
years and we are a leader in the casual dining industry in this category.
The above overview contains forward-looking statements. Please refer to
"Forward-Looking Statements" later in this section.
Application of Critical Accounting Estimates
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based upon our condensed consolidated financial statements, which
were prepared in accordance with accounting principles generally accepted in the
United States of America. These principles require us to make estimates and
assumptions that affect the reported amounts in the condensed consolidated
financial statements and notes thereto. Actual results may differ from these
estimates, and such differences may be material to our condensed consolidated
financial statements. We believe that the following significant accounting
policies involve a significant degree of judgment or complexity.
20
Inventory valuation: We state inventories at the lower of cost, using the
first-in, first-out method, or market. Market is determined based upon our
estimates of the net realizable value.
We purchase and maintain inventories of certain specialty products to ensure
sufficient supplies to the system and to control food costs. We review and make
quality control inspections of our inventories to determine obsolescence on an
ongoing basis. These reviews require management to make certain estimates and
judgments regarding projected usage which may change in the future and may
require us to record an inventory impairment.
Property and equipment: We report property and equipment at historical cost less
accumulated depreciation. Depreciation is provided on a straight-line method
over the estimated useful lives of the assets. Leasehold improvements are
amortized over the lesser of the lease term or the estimated useful life of the
related asset. The useful lives of the assets are based upon management's
expectations. We periodically review the assets for changes in circumstances
which may impact their useful lives. If there are changes in circumstances that
revise an asset's useful life, we will adjust the depreciation expense
accordingly for that asset in future periods.
Impairment of long-lived assets: We periodically review restaurant property and
equipment for impairment on a restaurant by restaurant basis using certain
market and restaurant operating indicators including historical cash flows as
well as current estimates of future cash flows and/or appraisals. We review
other long-lived assets at least annually and when events or circumstances
indicate that the carrying value of the asset may not be recoverable. The
recoverability is assessed in most instances by comparing the carrying value to
its undiscounted cash flows. This assessment process requires the use of
estimates and assumptions regarding future cash flows and estimated useful lives
which are subject to a significant degree of judgment. If these assumptions
change in the future, we may be required to record impairment charges for these
assets.
Income taxes: We record valuation allowances against our deferred tax assets,
when necessary, in accordance with Statement of Financial Accounting Standards
("SFAS") No. 109, "Accounting for Income Taxes." Realization of deferred tax
assets is dependent on future taxable earnings and is therefore uncertain. We
assess the likelihood that our deferred tax assets in each of the jurisdictions
in which we operate will be recovered from future taxable income. Deferred tax
assets do not include future tax benefits that we deem likely not to be
realized.
We are periodically audited by foreign and domestic tax authorities for both
income and sales and use taxes. We record accruals when we determine it is
probable that we have an exposure in a matter relating to an audit. The accruals
may change in the future due to new developments in each matter.
Legal and insurance reserves: We are periodically involved in various legal
actions. We are required to assess the probability of any adverse judgments as
well as the potential range of loss. We determine the required accruals after a
review of the facts of each legal action.
We use estimates in the determination of the appropriate liabilities for general
liability, workers' compensation and health insurance. The estimated liability
is established based upon historical claims data and third-party actuarial
estimates of settlement costs for incurred claims. Unanticipated changes in
these factors may require us to revise our estimates.
We periodically reassess our assumptions and judgments and make adjustments when
significant facts and circumstances dictate. A change in any of the above
estimates could impact our consolidated statements of earnings and the related
21
asset or liability recorded in our consolidated balance sheets would be adjusted
accordingly. Historically, actual results have not been materially different
than the estimates that are described above.
Acquisitions
All of our acquisitions below have been accounted for using the purchase method
of accounting and, accordingly, our consolidated financial statements reflect
the results of operations for each acquisition subsequent to the date of
acquisition. The assets acquired and liabilities assumed are recorded at
estimates of fair values as determined by management based upon information
available. We finalize the allocation of purchase price to the fair value of
assets acquired and liabilities assumed when we obtain information sufficient to
complete the allocation, but in each case, no longer than one year after the
acquisition date.
In May 2005, we completed the acquisition of 12 Applebee's restaurants, which
included one restaurant under construction, in Missouri, Kansas and Arkansas for
approximately $39,500,000. Through September 2005, we have paid approximately
$39,000,000, which has been allocated to the fair value of property and
equipment of $16,900,000, goodwill of $21,900,000 and other net assets of
approximately $200,000. Emerging Issues Task Force Issue No. 04-1 ("EITF 04-1"),
"Accounting for Preexisting Relationships between the Parties to a Business
Combination" requires certain reacquired rights (including the rights to the
acquirer's trade name under a franchise agreement) to be recognized as
intangible assets apart from goodwill. We are currently evaluating the impact of
EITF 04-1 on the allocation of the purchase price of these 12 restaurants.
The following table is comprised of actual company restaurant sales for the
restaurant acquisition above, which are included in our condensed consolidated
financial statements for each period presented and pro forma company restaurant
sales assuming the acquisition above occurred at the beginning of each
respective period (in thousands):
13 Weeks Ended 39 Weeks Ended
------------------------------------- --------------------------------------
September 25, September 26, September 25, September 26,
2005 2004 2005 2004
------------------ ------------------ ------------------ -------------------
Actual acquired company
restaurant sales....................... $ 7,500 $ -- $ 10,300 $ --
================== ================== ================== ===================
Pro forma acquired company
restaurant sales....................... $ 7,500 $ 6,600 $ 21,900 $ 20,000
================== ================== ================== ===================
In April 2005, we finalized the acquisition of eight Applebee's restaurants in
the Memphis market that were closed in fiscal 2004 by a former franchisee for
approximately $8,800,000 payable in cash. In connection with this acquisition,
we paid approximately $800,000 in cash in the fourth quarter of fiscal 2004,
approximately $5,700,000 in cash in the first quarter of fiscal 2005 and
approximately $2,300,000 in cash in the second quarter of fiscal 2005. The
purchase price of $8,800,000 has been allocated to the fair value of property
and equipment of approximately $8,200,000 and goodwill of approximately
$600,000. As of September 25, 2005, we have remodeled and opened seven
restaurants and the remaining restaurant was sold to a third party.
In April 2004, we completed our acquisition of the operations and assets of ten
Applebee's restaurants located in Southern California for approximately
$13,800,000 in cash. The purchase price was allocated to the fair value of
22
property and equipment of $2,500,000, goodwill of $10,800,000 and other net
assets of approximately $500,000. Company restaurant sales for these restaurants
were $6,500,000 and $11,200,000 for the 13 weeks ended and 39 weeks ended
September 26, 2004, respectively. Proforma company restaurant sales for these
restaurants would have been approximately $6,500,000 and $20,000,000 for the 13
weeks and 39 weeks ended September 26, 2004 had this acquisition been completed
at the beginning of fiscal 2004.
Captive Insurance Subsidiary
In 2002, we formed Neighborhood Insurance, Inc., a Vermont corporation and a
wholly-owned captive insurance subsidiary to provide Applebee's International,
Inc. and qualified franchisees with workers' compensation and general liability
insurance. Applebee's International, Inc. and covered franchisees make premium
payments to the captive insurance company which pays administrative fees and
insurance claims, subject to individual and aggregate maximum claim limits under
the captive insurance company's reinsurance policies. Franchisee premium amounts
billed by the captive insurance company are established based upon third-party
actuarial estimates of settlement costs for incurred claims and administrative
fees. The franchisee premiums are included in other franchise income ratably
over the policy year. The related offsetting expenses are included in cost of
other franchise income. Accordingly, we do not expect franchisee participation
in the captive insurance company to have a material impact on our net earnings.
In fiscal 2005, we reduced the types of insurance coverage plans which resulted
in fewer franchisee participants in our captive insurance program. Our
consolidated balance sheets include the following balances related to the
captive insurance subsidiary:
o Franchise premium receivables of approximately $2,500,000 and
$1,900,000 as of September 25, 2005 and December 26, 2004,
respectively, included in receivables related to captive insurance
subsidiary.
o Cash equivalent and other long-term investments restricted for the
payment of claims of approximately $19,500,000 and $16,700,000 as of
September 25, 2005 and December 26, 2004, respectively, included in
restricted assets related to captive insurance subsidiary.
o Loss reserve and unearned premiums related to captive insurance
subsidiary of approximately $20,900,000 and $19,600,000 as of September
25, 2005 and December 26, 2004, respectively. Approximately $7,400,000
and $7,500,000 as of September 25, 2005 and December 26, 2004,
respectively, is included in other non-current liabilities.
o Other miscellaneous items, net, of approximately $1,100,000 and
$1,000,000 as of September 25, 2005 and December 26, 2004,
respectively, included in several line items in the consolidated
balance sheets.
23
Results of Operations
The following table contains unaudited financial information derived from our
consolidated statements of earnings expressed as a percentage of total operating
revenues, except where otherwise noted. Percentages may not add due to rounding.
13 Weeks Ended 39 Weeks Ended
-------------------------------- --------------------------------
September 25, September 26, September 25, September 26,
2005 2004 2005 2004
---------------- --------------- --------------- ----------------
(as restated) (as restated)
Revenues:
Company restaurant sales................................ 89.3% 87.9% 89.0% 87.9%
Franchise royalties and fees............................ 10.3 10.7 10.6 10.9
Other franchise income.................................. 0.3 1.4 0.4 1.2
---------------- --------------- --------------- ----------------
Total operating revenues........................... 100.0% 100.0% 100.0% 100.0%
================ =============== =============== ================
Cost of sales (as a percentage of company restaurant sales):
Food and beverage....................................... 26.2% 26.3% 26.4% 26.4%
Labor................................................... 33.1 32.0 33.0 32.4
Direct and occupancy.................................... 27.4 25.0 26.0 24.6
Pre-opening expense..................................... 0.4 0.4 0.4 0.3
---------------- --------------- --------------- ----------------
Total cost of sales................................ 87.1% 83.8% 85.9% 83.8%
================ =============== =============== ================
Cost of other franchise income (as a percentage of other
franchise income)....................................... 74.2% 90.0% 79.9% 110.2%
General and administrative expenses......................... 8.6 9.5 8.9 9.2
Amortization of intangible assets........................... 0.1 0.1 0.1 0.1
Impairment of long-lived assets............................. 1.3 -- 0.4 --
Loss on disposition of restaurants and equipment............ 0.2 0.2 0.1 0.2
---------------- --------------- --------------- ----------------
Operating earnings.......................................... 11.8 15.3 13.8 15.6
---------------- --------------- --------------- ----------------
Other income (expense):
Investment income....................................... 0.2 0.1 0.1 0.1
Interest expense........................................ (0.4) (0.1) (0.2) (0.1)
Other income............................................ 0.2 0.3 0.2 0.2
---------------- --------------- --------------- ----------------
Total other income................................. -- 0.2 -- 0.1
---------------- --------------- --------------- ----------------
Earnings before income taxes................................ 11.8 15.5 13.8 15.8
Income taxes................................................ 4.5 5.4 4.9 5.5
---------------- --------------- --------------- ----------------
Net earnings................................................ 7.2% 10.2% 8.9% 10.3%
================ =============== =============== ================
24
The following table sets forth certain unaudited financial information and other
restaurant data relating to company and franchise restaurants, as reported to us
by franchisees:
13 Weeks Ended 39 Weeks Ended
------------------------------- -------------------------------
September 25, September 26, September 25, September 26,
2005 2004 2005 2004
------------- ------------- ------------- -------------
Number of restaurants:
Company:
Beginning of period....................... 462 405 424 383
Restaurant openings....................... 12 9 39 21
Restaurant closings....................... (1) (1) (1) (1)
Restaurants acquired from franchisees..... -- -- 11 10
------------- ------------- ------------- -------------
End of period............................. 473 413 473 413
------------- ------------- ------------- -------------
Franchise:
Beginning of period....................... 1,260 1,207 1,247 1,202
Restaurant openings....................... 23 21 52 40
Restaurants closed........................ (1) (4) (6) (8)
Restaurants acquired from franchisees..... -- -- (11) (10)
------------- ------------- ------------- -------------
End of period............................. 1,282 1,224 1,282 1,224
------------- ------------- ------------- -------------
Total:
Beginning of period....................... 1,722 1,612 1,671 1,585
Restaurant openings....................... 35 30 91 61
Restaurants closed........................ (2) (5) (7) (9)
------------- ------------- ------------- -------------
End of period............................. 1,755 1,637 1,755 1,637
============= ============= ============= =============
Weighted average weekly sales per restaurant:
Company........................................ $ 44,825 $ 46,365 $ 46,561 $ 47,489
Franchise...................................... $ 48,036 $ 47,253 $ 49,809 $ 48,258
Total.......................................... $ 47,170 $ 47,027 $ 48,954 $ 48,067
Change in comparable restaurant sales:(1)
Company........................................ (1.6)% 1.1% (0.8)% 5.0%
Franchise...................................... 1.8 % 3.1% 3.1 % 5.9%
Total.......................................... 0.9 % 2.7% 2.1 % 5.6%
Total operating revenues (in thousands):
Company restaurant sales....................... $ 272,673 $ 247,173 $ 815,834 $ 738,502
Franchise royalties and fees(2)................ 31,589 30,048 97,090 91,485
Other franchise income(3)...................... 1,064 3,913 3,553 10,427
------------- ------------- ------------- -------------
Total.......................................... $ 305,326 $ 281,134 $ 916,477 $ 840,414
============= ============= ============= =============
(1) When computing comparable restaurant sales, restaurants open for at least 18
months are compared from period to period.
(2) Franchise royalties are generally 4% of each franchise restaurant's reported
monthly gross sales. Reported franchise sales, in thousands, were $790,949
and $746,239 in the 2005 quarter and the 2004 quarter, respectively, and
$2,444,429 and $2,274,777 in the 2005 year-to-date and 2004 year-to-date
period, respectively. Franchise fees typically range from $30,000 to $35,000
for each restaurant opened.
(3) Other franchise income includes insurance premiums from franchisee
participation in our captive insurance program and revenue from information
technology products and services provided to certain franchisees.
25
2005 Quarter Compared With 2004 Quarter and 2005 Year-to-Date Period Compared
With 2004 Year-to-Date Period
Company Restaurant Sales. Total company restaurant sales increased $25,500,000
(10.3%) from $247,173,000 in the 2004 quarter to $272,673,000 in the 2005
quarter and increased $77,332,000 (10.5%) from $738,502,000 in the 2004
year-to-date period to $815,834,000 in the 2005 year-to-date period. The
percentage increase in total company restaurant sales for the 2005 quarter was
due to an increase in the number of restaurant weeks open of approximately 14%
which was partially offset by a decline in average weekly sales of 3.3%, and the
increase in the 2005 year-to-date period was due to an increase in the number of
restaurant weeks open of approximately 13% which was partially offset by a
decline in average weekly sales of 2.0%.
Comparable restaurant sales at company restaurants decreased by 1.6% and 0.8% in
the 2005 quarter and the 2005 year-to-date period, respectively. Weighted
average weekly sales at company restaurants decreased 3.3% from $46,365 in the
2004 quarter to $44,825 in the 2005 quarter and decreased 2.0% from $47,489 in
the 2004 year-to-date period to $46,561 in the 2005 year-to-date period. These
decreases were a result of a reduction in guest traffic in fiscal 2005 as
compared to fiscal 2004 due primarily to the launch of our Weight Watchers(TM)
menu system-wide in May 2004. In addition, we have experienced more significant
guest count declines in Kansas City, Michigan, Minnesota, New England and St.
Louis where more than 60% of our company restaurants are located, which is
consistent with industry trends in these markets. Weighted average weekly sales
declined more than comparable sales due to weaker new restaurant opening volumes
in Kansas City, Minnesota, New England and St. Louis. These decreases were
partially offset by increases in the average guest check resulting from menu
price increases of approximately 1.0% in November 2004 and 1.5% in May 2005 and
our Carside To Go(TM) initiative. Carside To Go(TM) sales mix increased from
8.9% of company restaurant sales in the 2004 quarter to 9.8% of company
restaurant sales in the 2005 quarter.
Franchise Royalties and Fees. Franchise royalties and fees increased $1,541,000
(5%) from $30,048,000 in the 2004 quarter to $31,589,000 in the 2005 quarter and
increased $5,605,000 (6%) from $91,485,000 in the 2004 year-to-date period to
$97,090,000 in the 2005 year-to-date period. These increases were due primarily
to the increased number of franchise restaurants operating during the 2005
quarter and 2005 year-to-date period as compared to the same periods in 2004 and
increases in comparable restaurant sales. Weighted average weekly sales at
franchise restaurants increased 1.7% and 3.2% in the 2005 quarter and 2005
year-to-date period, respectively, and franchise comparable restaurant sales
increased 1.8% and 3.1% in the 2005 quarter and 2005 year-to-date period,
respectively. These increases were due in part to the implementation of the
Carside To Go(TM) program in most franchise restaurants during fiscal 2005 which
were partially offset by sales increases in 2004 as compared to 2005 which
resulted from the launch of our Weight Watchers(TM) menu system-wide in May
2004.
Other Franchise Income. Other franchise income decreased $2,849,000 (73%) from
$3,913,000 in the 2004 quarter to $1,064,000 in the 2005 quarter and decreased
$6,874,000 (66%) from $10,427,000 in the 2004 year-to-date period to $3,553,000
in the 2005 year-to-date period due primarily to fewer franchisee participants
in our captive insurance program resulting from the reduction of the types of
insurance coverage plans offered. Franchise premiums are included in other
franchise income ratably over the policy year.
Cost of Company Restaurant Sales. Food and beverage costs decreased slightly
from 26.3% in the 2004 quarter to 26.2% in the 2005 quarter and were 26.4% in
both the 2004 year-to-date period and the 2005 year-to-date period. Both periods
26
were favorably impacted by menu price increases of 1.0% in November 2004 and
1.5% in May 2005, which were offset by higher commodity costs and lower order
incidences of both alcoholic and non-alcoholic beverages which have a lower cost
of sales. The 2004 quarter and 2004 year-to-date period were unfavorably
impacted by the company portion of the June 2004 impairment of approximately
$500,000 for excess riblet inventories which no longer met our quality
standards.
Labor costs increased from 32.0% in the 2004 quarter to 33.1% in the 2005
quarter and increased from 32.4% in the 2004 year-to-date period to 33.0% in the
2005 year-to-date period. The increases in both periods were due primarily to
higher management and hourly costs due to lower sales volumes, higher wage rates
and higher group insurance costs which were partially offset by lower management
incentive compensation and workers' compensation expense.
Direct and occupancy costs increased from 25.0% in the 2004 quarter and 24.6% in
the 2004 year-to-date period to 27.4% in the 2005 quarter and 26.0% in the 2005
year-to-date period due primarily to lower sales volumes at company restaurants
which resulted in unfavorable year over year comparisons of depreciation, rent
and property tax expenses as a percentage of sales, due to their relatively
fixed nature, as well as higher utilities, packaging and advertising costs, as a
percentage of sales. The increase in the 2005 quarter was also due to higher
repairs and maintenance costs.
Cost of Other Franchise Income. Cost of other franchise income decreased
$2,731,000 (78%) from $3,521,000 in the 2004 quarter to $790,000 in the 2005
quarter and decreased $8,655,000 (75%) from $11,493,000 in the 2004 year-to-date
period to $2,838,000 in the 2005 year-to-date period due to fewer franchisee
participants in our captive insurance program resulting from the reduction of
the types of insurance coverage plans offered and the franchisee portion of the
June 2004 impairment of approximately $1,600,000 for excess riblet inventories
which no longer met our quality standards.
General and Administrative Expenses. General and administrative expenses
decreased from 9.5% in the 2004 quarter to 8.6% in the 2005 quarter and
decreased from 9.2% in the 2004 year-to-date period to 8.9% in the 2005
year-to-date period. General and administrative expenses were favorably impacted
in both periods by lower incentive compensation expense and the absorption of
general and administrative expenses over a larger revenue base. General and
administrative expenses were unfavorably impacted in both periods by higher
compensation expense due to staffing levels and higher management training costs
due to the increased number of company restaurant openings as compared to 2004.
Impairment of Long-lived Assets. In the third quarter of 2005, we recorded an
asset impairment charge of $3,900,000 consisting of a $2,600,000 write-down of
the carrying value of the property and equipment of three restaurants that are
not performing as expected and one restaurant that will be closed and relocated
and a $1,300,000 write-down of one other long-lived asset.
Interest Expense. Interest expense increased from $379,000 in the 2004 quarter
to $1,232,000 in the 2005 quarter and from $1,139,000 in the 2004 year-to-date
period to $2,203,000 in the 2005 year-to-date period due primarily to increased
borrowings under our credit facility used to acquire 12 restaurants in May 2005
and to fund repurchases of our common stock.
Income Taxes. The effective income tax rate, as a percentage of earnings before
income taxes, increased from 34.5% in the 2004 quarter to 38.5% in the 2005
quarter and increased from 34.7% in the 2004 year-to-date period to 35.7% in the
2005 year-to-date period. We increased the rate in the 2005 quarter and 2005
year-to-date period due to higher state tax rates discovered following the
recent completion of our 2004 tax returns.
27
Liquidity and Capital Resources
Our primary sources of liquidity are cash provided by operations and borrowings
under our credit facility. Our need for capital resources historically has
resulted from the construction and acquisition of restaurants, the repurchase of
our common stock and investment in information technology systems. In the past,
we have obtained capital through our ongoing operations, public stock offerings
and debt financing. Cash flows from our ongoing operations primarily include
cash generated from company and franchise operations, management of credit from
trade suppliers and decisions to enter into restaurant operating leases. In
addition, we have assumed debt or issued new debt in connection with certain
mergers and acquisitions. The following table presents a summary of our cash
flows for the 2005 and 2004 year-to-date period (in thousands):
2005 2004
Year-to-Date Year-to-Date
Period Period
------------------- -------------------
(as restated)
Net cash provided by operating activities.......... $ 158,676 $ 126,268
Net cash used by investing activities.............. (149,245) (95,744)
Net cash used by financing activities.............. (9,933) (47,950)
------------------- -------------------
Net decrease in cash and cash equivalents.......... $ (502) $ (17,426)
=================== ===================
Capital expenditures, excluding acquisitions, were $68,224,000 in the 2004
year-to-date period and $100,802,000 in the 2005 year-to-date period. In fiscal
2005, we currently expect to open at least 50 company restaurants, and capital
expenditures are expected to be between $150,000,000 and $160,000,000, including
the costs to re-open seven company restaurants that were closed in fiscal 2004
by a former franchisee in Memphis, Tennessee, but excluding the costs to acquire
the assets of 12 Applebee's restaurants in Missouri, Kansas and Arkansas.
Future capital expenditures will primarily be for the development of new
restaurants, refurbishment and capital replacement for existing restaurants and
the enhancement of information systems. In addition, we expect to incur costs
associated with the purchase of land for a new corporate headquarters in fiscal
2006. Because we expect to continue to purchase a portion of our sites, the
amount of actual capital expenditures will be dependent upon, among other
things, the proportion of leased versus owned properties. In addition, if we
construct more or fewer restaurants than we currently anticipate or acquire
additional restaurants, our capital requirements will increase or decrease
accordingly.
In May 2005, we completed the acquisition of 12 Applebee's restaurants, which
included one restaurant under construction, in Missouri, Kansas and Arkansas for
approximately $39,500,000. Through September 2005, we have paid approximately
$39,000,000, which has been allocated to the fair value of property and
equipment of $16,900,000, goodwill of $21,900,000 and other net assets of
approximately $200,000.
In April 2005, we finalized the acquisition of eight Applebee's restaurants in
the Memphis market that were closed in fiscal 2004 by a former franchisee for
approximately $8,800,000 payable in cash. In connection with this acquisition,
we paid approximately $800,000 in cash in the fourth quarter of fiscal 2004,
approximately $5,700,000 in cash in the first quarter of fiscal 2005 and
approximately $2,300,000 in cash in the second quarter of fiscal 2005.
28
In April 2004, we completed our acquisition of the operations and assets of ten
Applebee's restaurants located in Southern California for approximately
$13,800,000 in cash.
In December 2004, we completed the refinancing of our $150,000,000 unsecured
revolving credit facility. The new bank credit agreement provided for a
$150,000,000 five-year unsecured revolving credit facility, of which $40,000,000
may be used for the issuance of letters of credit. The facility is subject to
various covenants and restrictions which, among other things, require the
maintenance of stipulated fixed charge, leverage and indebtedness to
capitalization ratios, as defined. There is no limit on cash dividends provided
that the declaration and payment of such dividend does not cause a default of
any other covenant contained in the agreement. The facility is subject to other
standard terms, conditions, covenants, and fees. In September 2005, we entered
into an amendment to our credit facility which increased the revolving credit
commitment available from $150,000,000 to $200,000,000. As of September 25,
2005, we are in compliance with the covenants contained in our credit agreement.
As of September 25, 2005, we had borrowings of $130,700,000, standby letters of
credit of $9,400,000 outstanding and approximately $59,900,000 available under
our revolving credit facility. In October 2005, we entered into a second
amendment to our credit facility which increased the revolving credit commitment
available from $200,000,000 to $250,000,000 and provided for an additional
$75,000,000 of revolving credit upon satisfaction of the conditions set forth in
the credit facility. During fiscal 2005, we expect to fund operations, capital
expansion, any repurchases of common stock and the payment of dividends from
operating cash flows and borrowings under our revolving credit facility.
In October 2004, our Board of Directors authorized additional repurchases of our
common stock of up to $150,000,000 beginning in fiscal 2005 and approved a
written plan for repurchases of our common stock in the open market. During the
2005 year-to-date period, we repurchased 4,917,600 shares of our common stock at
an average price of $24.58 for an aggregate cost of $120,856,000. As of
September 25, 2005, we had $29,177,000 remaining under our repurchase
authorization. In October 2005, our Board of Directors approved an additional
$175,000,000 authorization to repurchase our common stock, subject to market
conditions.
In October 2005, the Board of Directors declared an annual dividend of $0.20 per
share to be payable on January 23, 2006 to shareholders of record on December
23, 2005.
As of September 25, 2005, our liquid assets totaled $10,424,000. These assets
consisted of cash and cash equivalents in the amount of $10,140,000 and
short-term investments in the amount of $284,000. The working capital deficit
increased from $51,041,000 as of December 26, 2004 to $84,037,000 as of
September 25, 2005. This increase was due primarily to increases in accrued
income taxes and notes payable and decreases in inventories and cash and cash
equivalents due to repurchases of our common stock, acquisition of restaurants
and capital expenditures in the 2005 year-to-date period and was partially
offset by the redemption of gift cards in the 2005 year-to-date period sold in
fiscal 2004.
We believe that our liquid assets and cash generated from operations, combined
with borrowings available under our credit facility, will provide sufficient
funds for capital expenditures, repurchases of our common stock, the payment of
dividends and other such operating activities for the foreseeable future.
29
The following table shows our debt amortization schedule, future capital lease
commitments (including principal and interest payments), future operating lease
commitments and future purchase obligations as of September 25, 2005 (in
thousands):
Payments due by period
----------------------------------------------------------------------
Certain Less than 1 1-3 3-5 More than 5
Contractual Obligations Total year Years years years
------------------------------------------------- ------------- ------------- ------------- ------------ -------------
Long-term Debt (excluding capital
lease obligations) (1)...................... $ 132,153 $ 9,828 $ 141 $ 121,097 $ 1,087
Capital Lease Obligations....................... 8,526 787 1,658 1,776 4,305
Operating Leases (2)............................ 374,820 26,026 52,433 52,347 244,014
Purchase Obligations - Company(3)............... 211,151 185,248 16,713 9,190 --
Purchase Obligations - Franchise(4)............ 420,445 370,905 27,342 22,198 --
(1) The amounts for long-term debt are primarily borrowings under our revolving
credit facility and exclude interest payments which are variable in nature.
(2) The amounts for operating leases include option periods where failure to
exercise such options would result in an economic penalty such that the renewal
appears reasonably assured.
(3) The amounts for company purchase obligations include commitments for land
for a new corporate headquarters, food items, energy, supplies, severance and
employment agreements, and other miscellaneous commitments.
(4) The amounts for franchise purchase obligations include commitments for food
items and supplies made by Applebee's International, Inc. for our franchisees.
Applebee's International, Inc. contracts with certain suppliers to ensure
competitive pricing. These amounts will only be payable by Applebee's
International, Inc. if our franchisees do not meet certain minimum contractual
requirements.
Other Contractual Obligations
In connection with the sale of restaurants to franchisees and other parties, we
have, in certain cases, remained contingently liable for the remaining lease
payments. As of September 25, 2005, we have outstanding lease guarantees of
approximately $17,700,000. These leases expire at various times with the final
lease agreement expiring in 2025. In addition, we or our subsidiaries are
contingently liable for various leases that we have assigned in connection with
the sale of restaurants to franchisees and other parties, in the potential
amount of $14,600,000. We have not recorded a liability as of September 25, 2005
or December 26, 2004.
We have severance and employment agreements with certain officers providing for
severance payments to be made in the event the associate resigns or is
terminated related to a change in control. The agreements define the
circumstances which will constitute a change in control. If the severance
payments had been due as of September 25, 2005, we would have been required to
make payments totaling approximately $13,300,000. In addition, we have severance
and employment agreements with certain officers which contain severance
provisions not related to a change in control. Those provisions would have
required aggregate payments of approximately $6,200,000 if such officers had
been terminated as of September 25, 2005.
In November 2003, we arranged for a third-party financing company to provide up
to $75,000,000 to qualified franchisees for short-term loans to fund remodel
investments, subject to our approval. Under the terms of this financing program,
we will provide a limited guarantee pool for the loans advanced during the
three-year period ending December 2006. As of September 25, 2005, there were
loans outstanding to four franchisees for approximately $1,300,000 under this
program.
30
In May 2004, we arranged for a third-party financing company to provide up to
$250,000,000 to qualified franchisees for loans to fund development of new
restaurants through October 2007, subject to our approval. We will provide a
limited guarantee of certain loans advanced under this program. As of September
25, 2005, there were loans outstanding to six franchisees aggregating
approximately $41,800,000 under this program. The fair value of our guarantees
under these two financing programs was less than $100,000 and is recorded in
other non-current liabilities and other assets in our consolidated balance sheet
as of September 25, 2005.
New Accounting Pronouncements
In October 2005, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") 13-1, "Accounting for Rental Costs Incurred during a
Construction Period." The guidance requires the rental costs recognized for
ground or building operating leases during the construction period be recognized
as rental expense. The guidance permits either retroactive or prospective
treatment for periods beginning after December 15, 2005. We will prospectively
change our policy from capitalization to expensing beginning in fiscal 2006. The
adoption of this FSP will result in an expected increase of approximately
$25,000 in preopening expenses recognized for every new restaurant opened but
will not have a material effect on our consolidated financial statements.
In June 2005, the FASB's EITF reached a consensus on Issue No. 05-6,
"Determining the Amortization Period for Leasehold Improvements" ("EITF 05-6").
The guidance requires that leasehold improvements acquired in a business
combination or purchased subsequent to the inception of a lease be amortized
over the lesser of the useful life of the assets or a term that includes
renewals that are reasonably assured at the date of the business combination or
purchase. The guidance is effective for periods beginning after June 29, 2005.
The adoption of EITF 05-6 did not have an impact on our consolidated financial
statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards No.
154, "Accounting Changes and Error Corrections--A Replacement of APB Opinion No.
20 and FASB Statement No. 3." SFAS No. 154 requires retrospective application to
prior periods' financial statements for changes in accounting principle, unless
it is impracticable to determine either the period-specific effects or the
cumulative effect of the change. SFAS No. 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning after December
15, 2005.
In March 2005, the FASB issued FASB Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations," ("FIN 47"). FIN 47 clarifies the term
"conditional" as used in SFAS No. 143, "Accounting for Asset Retirement
Obligations." This Interpretation refers to a legal obligation to perform an
asset retirement activity even if the timing and/or settlement is conditional on
a future event that may or may not be within the control of an entity.
Accordingly, the entity must record a liability for the conditional asset
retirement obligation if the fair value of the obligation can be reasonably
estimated. FIN 47 is effective for fiscal years ending after December 15, 2005.
We are evaluating the impact the adoption of FIN 47 will have on our
consolidated financial statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-based
Payment," which replaces SFAS No. 123, "Accounting for Stock-Based
Compensation," and supersedes Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees." SFAS No. 123 (revised 2004)
requires compensation costs related to share-based payment transactions to be
recognized in the financial statements. With limited exceptions, the amount of
compensation cost will be measured based on the fair value on the grant date of
31
the equity or liability instruments issued. Compensation cost will be recognized
over the period that an employee provides service for that award, resulting in a
decrease in our net earnings. We will adopt the provisions of this Statement, as
amended, using the modified prospective method beginning in fiscal 2006. We
expect that the adoption of this Standard will be material to our consolidated
financial statements; however, we are still in the process of evaluating its
impact.
Forward-Looking Statements
The statements contained in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section regarding restaurant
development, comparable sales, Carside To Go(TM), revenue growth, restaurant
margin, commodity costs, general and administrative expenses, capital
expenditures, return on equity and financial commitments are forward-looking and
based on current expectations. There are several risks and uncertainties that
could cause actual results to differ materially from those described. These
risks include but are not limited to our ability and the ability of our
franchisees to open and operate additional restaurants profitably, the ability
of our franchisees to obtain financing, the continued growth of our franchisees,
our ability to attract and retain qualified franchisees, the impact of intense
competition in the casual dining segment of the restaurant industry, the impact
of economic factors on consumer spending, and our ability to control restaurant
operating costs which are impacted by market changes, minimum wage and other
employment laws, food costs and inflation. For a more detailed discussion of the
principal factors that could cause actual results to be materially different,
you should read our current report on Form 8-K which we filed with the
Securities and Exchange Commission on February 9, 2005. We disclaim any
obligation to update forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk from fluctuations in interest rates and changes in
commodity prices. Our revolving credit facility bears interest at either the
bank's prime rate or LIBOR plus 0.625%, at our option. As of September 25, 2005,
the total amount of debt subject to interest rate fluctuations was $130,700,000
which was outstanding on our revolving credit facility. A 1% change in interest
rates would result in an increase or decrease in interest expense of $1,307,000
per year. We may from time to time enter into interest rate swap agreements to
manage the impact of interest rate changes on our earnings. A substantial
portion of the food products and utilities we purchase are subject to price
volatility due to factors that are outside of our control such as weather,
seasonality and fuel costs. As part of our strategy to moderate this volatility,
we have entered into fixed price purchase commitments.
Item 4. Controls and Procedures
As of September 25, 2005, we have evaluated the effectiveness of the design and
operation of our disclosure controls and procedures under the supervision and
with the participation of the Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"). Based on this evaluation, our management, including
the CEO and CFO, concluded that our disclosure controls and procedures were
effective. During our most recent fiscal quarter, there have been no changes in
our internal control over financial reporting that occurred that have materially
affected or are reasonably likely to materially affect our internal control over
financial reporting.
32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in various legal actions which include, without limitation,
employment law and wage and hourly labor related matters, dram shop claims,
personal injury claims and other such restaurant operational matters. In each
instance, we believe that we have meritorious defenses to the allegations made
and we are vigorously defending these claims.
We believe that the ultimate disposition of these matters will not, individually
or in the aggregate, have a material adverse effect upon our business or
consolidated financial position.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Issuer Purchases of Equity Securities.
------------------------------------------------------------------------------------------------------------------
Purchases of Equity Securities(1)
------------------------------------------------------------------------------------------------------------------
------------------------------ ------------------ ----------- ------------------------- --------------------------
Approximate Dollar
Value of Shares that
Average Total Number of Shares May Yet Be
Total Number Price Purchased as Part of Purchased Under the
of Shares Paid Per Publicly Announced Plans or Programs
Period Purchased Share Plans or Programs (in thousands)
------------------------------ ------------------ ----------- ------------------------- --------------------------
June 27, 2005 through July
24, 2005 463,700 $ 25.87 463,700 69,797
------------------------------ ------------------ ----------- ------------------------- --------------------------
July 25, 2005 through August
21, 2005 365,227(2) $ 24.66 361,300 60,891
------------------------------ ------------------ ----------- ------------------------- --------------------------
August 22, 2005 through
September 25, 2005 1,432,600 $ 22.14 1,432,600 29,177(3)
------------------------------ ------------------ ----------- ------------------------- --------------------------
Total 2,261,527 2,257,600
============================== ================== =========== ========================= ==========================
(1) In October 2004, our Board of Directors authorized additional repurchases of
our common stock of up to $150,000,000 beginning in fiscal 2005.
(2) Includes 3,927 shares received as partial payment for shares issued under
stock option plans.
(3) In October 2005, our Board of Directors approved an additional $175,000,000
authorization to repurchase our common stock, subject to market conditions.
Item 6. Exhibits
The Exhibits listed on the accompanying Exhibit Index are filed as part of this
report.
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
APPLEBEE'S INTERNATIONAL, INC.
(Registrant)
Date: October 31, 2005 By: /s/ Lloyd L. Hill
------------------------------ --------------------------------------
Lloyd L. Hill
Director, Chairman of the Board and
Chief Executive Officer
(principal executive officer)
Date: October 31, 2005 By: /s/ Steven K. Lumpkin
------------------------------ --------------------------------------
Steven K. Lumpkin
Director, Executive Vice President,
Chief Financial Officer and Treasurer
(principal financial officer)
Date: October 31, 2005 By: /s/ Beverly O. Elving
------------------------------ --------------------------------------
Beverly O. Elving
Vice President and Controller
(principal accounting officer)
34
APPLEBEE'S INTERNATIONAL, INC AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------------- ------------------------------------------------------------------------------------------------
10.1 Amendment No. 1 to the 5-year Revolving Credit Agreement dated September 14, 2005
(incorporated by reference to Form 8-K filed on September 15, 2005)
10.2 Amendment No. 2 to the 5-year Revolving Credit Agreement dated October 26, 2005
(incorporated by reference to Form 8-K filed on October 27, 2005)
31.1 Certification of Chairman and Chief Executive Officer Pursuant to SEC Rule 13a-14(a)
31.2 Certification of Chief Financial Officer Pursuant to SEC Rule 13a-14(a)
32.1 Certification of Chairman and Chief Executive Officer and Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350
35