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 24, 2006
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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
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Applebee's International, Inc.
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(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
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(Address of principal executive offices and zip code)
(913) 967-4000
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(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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer X Accelerated filer Non-accelerated filer
---- ---- ----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act).
Yes No X
---- ----
The number of shares of the registrant's common stock outstanding as of October
23, 2006 was 74,239,024.
1.
APPLEBEE'S INTERNATIONAL, INC.
FORM 10-Q
FISCAL QUARTER ENDED SEPTEMBER 24, 2006
INDEX
PART I FINANCIAL INFORMATION Page
Item 1. Condensed Consolidated Financial Statements:
Consolidated Balance Sheets as of September 24, 2006
and December 25, 2005 ............................................................. 3
Consolidated Statements of Earnings for the 13 Weeks and 39 Weeks
Ended September 24, 2006 and September 25, 2005 ................................... 4
Consolidated Statement of Stockholders' Equity for the
39 Weeks Ended September 24, 2006 ................................................. 5
Consolidated Statements of Cash Flows for the 39 Weeks
Ended September 24, 2006 and September 25, 2005.................................... 6
Notes to Condensed Consolidated Financial Statements................................. 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...................................... 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................... 35
Item 4. Controls and Procedures.............................................................. 35
PART II OTHER INFORMATION
Item 1. Legal Proceedings.................................................................... 36
Item 1A. Risk Factors......................................................................... 36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.......................... 37
Item 5. Other Information.................................................................... 37
Item 6. Exhibits............................................................................. 38
Signatures ........................................................................................ 39
Exhibit Index...................................................................................... 40
2.
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
September 24, December 25,
2006 2005
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents................................................. $ 9,776 $ 13,040
Short-term investments, at market value................................... 291 286
Receivables (less allowance of $325 in 2006 and $340 in 2005)............. 36,958 37,857
Receivables related to captive insurance subsidiary....................... 463 1,712
Inventories............................................................... 10,400 20,373
Prepaid income taxes...................................................... 55 3,488
Prepaid and other current assets.......................................... 12,086 13,518
Assets held for sale...................................................... 7,498 --
-------------- ------------
Total current assets................................................... 77,527 90,274
Property and equipment, net.................................................... 620,983 590,593
Goodwill....................................................................... 139,111 138,443
Restricted assets related to captive insurance subsidiary...................... 15,011 19,329
Other intangible assets, net................................................... 6,561 8,050
Other assets, net.............................................................. 34,827 31,899
-------------- ------------
$ 894,020 $ 878,588
============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt......................................... $ 274 $ 259
Notes payable............................................................. 10,000 7,900
Accounts payable.......................................................... 38,016 63,445
Accrued expenses and other current liabilities............................ 84,426 100,995
Loss reserve related to captive insurance subsidiary...................... 6,025 10,235
Accrued dividends......................................................... -- 14,840
Accrued income taxes...................................................... 4,007 --
-------------- ------------
Total current liabilities.............................................. 142,748 197,674
-------------- ------------
Non-current liabilities:
Long-term debt, less current portion...................................... 184,006 180,208
Deferred income taxes..................................................... 27,757 37,722
Other non-current liabilities............................................. 60,372 50,374
-------------- ------------
Total non-current liabilities.......................................... 272,135 268,304
-------------- ------------
Total liabilities...................................................... 414,883 465,978
-------------- -------------
Commitments and contingencies (Note 3)
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................................................ 255,029 234,988
Unearned compensation..................................................... -- (2,614)
Retained earnings......................................................... 772,673 710,277
-------------- ------------
1,028,787 943,736
Treasury stock - 34,563,782 shares in 2006 and 34,304,693 shares
in 2005 at cost........................................................ (549,650) (531,126)
-------------- ------------
Total stockholders' equity............................................. 479,137 412,610
-------------- ------------
$ 894,020 $ 878,588
============== ============
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 24, September 25, September 24, September 25,
2006 2005 2006 2005
--------------- ---------------- ---------------- ---------------
Operating revenues:
Company restaurant sales........................ $ 286,938 $ 272,673 $ 890,965 $ 815,834
Franchise royalties and fees.................... 33,340 31,589 103,581 97,090
Other franchise income.......................... 371 1,064 1,355 3,553
--------------- ---------------- ---------------- ---------------
Total operating revenues.................... 320,649 305,326 995,901 916,477
--------------- ---------------- ---------------- ---------------
Cost of company restaurant sales:
Food and beverage............................... 76,616 71,555 237,285 215,755
Labor........................................... 99,105 90,231 300,432 269,070
Direct and occupancy............................ 80,047 74,706 239,404 212,111
Pre-opening expense............................. 1,115 1,089 3,022 3,524
--------------- ---------------- ---------------- ---------------
Total cost of company restaurant sales...... 256,883 237,581 780,143 700,460
--------------- ---------------- ---------------- ---------------
Cost of other franchise income....................... 694 790 1,741 2,838
General and administrative expenses.................. 35,601 26,329 103,527 81,255
Amortization of intangible assets.................... 154 204 562 658
Impairment and other restaurant closure costs........ 1,900 3,900 6,500 3,900
Loss on disposition of property and equipment........ 685 480 1,692 1,341
--------------- ---------------- ---------------- ---------------
Operating earnings................................... 24,732 36,042 101,736 126,025
--------------- ---------------- ---------------- ---------------
Other income (expense):
Investment income............................... 885 568 1,345 976
Interest expense................................ (2,970) (1,232) (8,509) (2,203)
Other income.................................... 301 593 538 1,612
--------------- ---------------- ---------------- ---------------
Total other income (expense)................ (1,784) (71) (6,626) 385
--------------- ---------------- ---------------- ---------------
Earnings before income taxes......................... 22,948 35,971 95,110 126,410
Income taxes......................................... 8,107 13,836 32,714 45,128
--------------- ---------------- ---------------- ---------------
Net earnings......................................... $ 14,841 $ 22,135 $ 62,396 $ 81,282
=============== ================ ================ ===============
Basic net earnings per common share.................. $ 0.20 $ 0.28 $ 0.84 $ 1.02
=============== ================ ================ ===============
Diluted net earnings per common share................ $ 0.20 $ 0.28 $ 0.83 $ 1.00
=============== ================ ================ ===============
Basic weighted average shares outstanding............ 73,902 78,485 74,044 79,692
=============== ================ ================ ===============
Diluted weighted average shares outstanding.......... 74,673 79,691 75,007 81,121
=============== ================ ================ ===============
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 25, 2005 .................... 108,503 $ 1,085 $234,988 $ (2,614) $710,277 $ (531,126) $ 412,610
Net earnings................................ -- -- -- -- 62,396 -- 62,396
Purchases of treasury stock................. -- -- -- -- -- (27,528) (27,528)
Reclassification of unearned compensation
related to the adoption of Statement of
Financial Accounting Standards
No. 123(R) (Note 2)...................... -- -- (2,614) 2,614 -- -- --
Stock options exercised and related tax
benefit.................................. -- -- 5,112 -- -- 6,618 11,730
Shares issued under employee benefit plans.. -- -- 1,616 -- -- 1,729 3,345
Nonvested shares awarded under equity
incentive plans........................... -- -- (657) -- -- 657 --
Stock-based compensation expense related
to employee-based awards.................. -- -- 16,584 -- -- -- 16,584
--------- -------- ----------- ------------- --------- ------------- -------------
Balance, September 24, 2006.................... 108,503 $ 1,085 $255,029 $ -- $772,673 $ (549,650) $ 479,137
========= ======== =========== ============= ========= ============= =============
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 24, September 25,
2006 2005
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings....................................................... $ 62,396 $ 81,282
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization................................... 48,092 39,765
Amortization of intangible assets............................... 562 658
Stock-based compensation........................................ 16,584 1,665
Other amortization.............................................. 233 182
Deferred income tax benefit..................................... (8,615) (3,270)
Impairment and other restaurant closure costs................... 6,500 3,900
Loss on disposition of property and equipment................... 1,692 1,341
Income tax benefit from stock-based compensation................ 1,233 4,665
Changes in assets and liabilities, exclusive of effect of
acquisitions:
Receivables..................................................... 1,540 2,981
Receivables related to captive insurance subsidiary............. 1,249 (682)
Inventories..................................................... 10,031 14,627
Prepaid and other current assets................................ 115 908
Accounts payable................................................ (24,502) 8,981
Accrued expenses and other current liabilities.................. (16,750) (13,024)
Loss reserve and unearned premiums related to
captive insurance subsidiary.................................. (4,210) 1,344
Income taxes.................................................... 7,440 12,352
Other non-current liabilities................................... 7,770 2,524
Other........................................................... (1,922) (1,523)
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES....................... 109,438 158,676
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment................................ (86,635) (100,802)
Change in restricted assets related to captive
insurance subsidiary............................................ 4,318 (2,800)
Acquisition of restaurants......................................... (8,053) (46,848)
Proceeds from sale of property and equipment....................... 281 1,205
------------- -------------
NET CASH USED BY INVESTING ACTIVITIES........................... (90,089) (149,245)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchases of treasury stock........................................ (27,528) (120,856)
Dividends paid..................................................... (14,840) (4,867)
Issuance of common stock upon exercise of stock options............ 8,814 11,822
Shares issued under employee benefit plans......................... 3,345 3,428
Excess tax benefits from stock-based compensation.................. 1,683 --
Net debt proceeds ................................................. 5,913 100,540
------------- -------------
NET CASH USED BY FINANCING ACTIVITIES........................... (22,613) (9,933)
------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS............................... (3,264) (502)
CASH AND CASH EQUIVALENTS, beginning of period.......................... 13,040 10,642
------------- -------------
CASH AND CASH EQUIVALENTS, end of period................................ $ 9,776 $ 10,140
============= =============
See notes to condensed consolidated financial statements.
6.
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Unaudited)
(in thousands)
39 Weeks Ended
------------------------------------
September 24, September 25,
2006 2005
---------------- ----------------
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the 39 week period for:
Income taxes........................................................ $ 27,699 $ 31,381
================ ================
Interest............................................................ $ 8,938 $ 1,438
================ ================
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
We issued nonvested shares (previously referred to as restricted stock prior to
fiscal 2006) with grant date fair values of $3,598,000 for the 39 weeks ended
September 24, 2006 and nonvested shares, net of forfeitures, of $2,916,000 for
the 39 weeks ended September 25, 2005.
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 $1,522,000 and $3,049,000 for the 39
weeks ended September 24, 2006 and September 25, 2005, respectively.
We had property and equipment purchases accrued in accounts payable of
approximately $13,500,000 and $11,200,000 as of September 24, 2006 and September
25, 2005, respectively.
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 ("SEC"). 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 25, 2005.
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.
2. Stock-Based Compensation
Our Board of Directors has approved the Amended and Restated 1995 Equity
Incentive Plan ("1995 Plan") and the 1999 Employee Incentive Plan ("1999 Plan")
which allow for the granting of stock options, stock appreciation rights
("SARs"), nonvested shares, performance units and performance shares to eligible
participants. Grants of stock options may be either incentive or nonqualified.
There are 19,900,000 and 2,473,875 shares authorized under the 1995 Plan and the
1999 Plan, respectively. As of September 24, 2006, we had 3,487,420 shares
available for grant under the 1995 Plan. We will not make additional grants
under the 1999 Plan. We issue shares out of our treasury for stock option
exercises, SAR exercises and nonvested share issuances.
Prior to fiscal 2006, we accounted for these stock-based compensation equity
awards under the intrinsic method of Accounting Principles Board ("APB") Opinion
No. 25. Opinion No. 25 required 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 both of our plans were granted with an exercise price equal to the
fair market value on the date of the grant and, accordingly, no compensation
expense was recognized for stock option awards. In addition, we 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 required prominent
disclosures in financial statements regarding the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results.
Under APB Opinion No. 25, pro forma expense for stock-based compensation was
calculated using a graded vesting schedule over the explicit vesting period. The
following table presents the effect on our net earnings and 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" for the 13 weeks
and 39 weeks ended September 25, 2005 (in thousands, except for per share
amounts).
8.
13 Weeks Ended 39 Weeks Ended
September 25, September 25,
2005 2005
---------------------- ----------------------
Net earnings, as reported........................................ $ 22,135 $ 81,282
Add: Stock-based compensation expense included
in net earnings, net of related taxes........................ 385 1,041
Less: Total stock-based employee compensation expense
determined under fair value-based methods for all
equity awards, net of related taxes (1)..................... 2,049 5,416
---------------------- ----------------------
Pro forma net earnings........................................... $ 20,471 $ 76,907
====================== ======================
Basic net earnings per common share, as reported................. $ 0.28 $ 1.02
====================== ======================
Basic net earnings per common share, as adjusted................. $ 0.26 $ 0.97
====================== ======================
Diluted net earnings per common share, as reported............... $ 0.28 $ 1.00
====================== ======================
Diluted net earnings per common share, as adjusted............... $ 0.26 $ 0.95
====================== ======================
(1) SFAS No. 123 (revised 2004) requires compensation expense to be recognized
over the requisite service period which is generally from the grant date to the
earlier of a) the explicit vesting date or b) the date on which the employee
becomes retirement eligible. If pro forma expense for the 13 weeks ended
September 25, 2005 ("2005 quarter") and the 39 weeks ended September 25, 2005
("2005 year-to-date period") had been derived using this approach, additional
stock-based compensation would have been $626 and $2,240, net of tax,
respectively, and pro forma net income would have been $19,845 and $74,667,
respectively. Additionally, basic and diluted pro forma earnings per share would
both have been $0.25 for the 2005 quarter and $0.94 and $0.92, respectively, for
the 2005 year-to-date period.
We adopted the fair value recognition provisions of SFAS No. 123(R),
"Share-Based Payment" ("SFAS 123(R)") at the beginning of fiscal year 2006. SFAS
123(R) requires all stock-based compensation, including grants of employee stock
options, to be recognized in the statement of earnings based on fair value. 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. We adopted this accounting treatment using the modified
prospective transition method; therefore, results for prior periods have not
been restated.
Beginning in fiscal 2006, we changed our method of determining the fair value of
stock-based equity awards from the Black-Scholes model to a binomial model. The
binomial model considers a range of assumptions relative to volatility,
risk-free interest rates and employee exercise behavior, which models actual
employee behaviors. We believe the binomial model provides a fair value that is
more representative of actual and future experience as compared to the
Black-Scholes model.
Compensation costs for the 13 weeks ended September 24, 2006 ("2006 quarter")
and the 39 weeks ended September 24, 2006 ("2006 year-to-date period") have been
recognized for all new equity awards granted in fiscal 2006 and those equity
awards granted prior to fiscal 2006 that have yet to reach the end of their
9.
service period. As required by SFAS 123(R), we began recognizing expense for
employee stock-based compensation over the shorter of the vesting period or the
period from the date of the grant until the date the employee becomes eligible
for retirement. We recognize expense for stock-based compensation over the
graded vesting period. We recognized stock-based compensation in the condensed
consolidated financial statements as follows:
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
--------------- --------------- --------------- ---------------
Labor................................................ $ 216 $ -- $ 703 $ --
General and administrative expenses.................. 4,956 598 15,881 1,600
Income taxes......................................... (1,827) (213) (5,760) (559)
--------------- --------------- --------------- ---------------
Stock-based compensation expense included
in net earnings, net of related tax............... $ 3,345 $ 385 $10,824 $ 1,041
=============== =============== =============== ===============
As of September 24, 2006, we had unrecognized compensation expense for stock
options and SARs of $18,400,000 to be recognized over a weighted average period
of 2.0 years.
As required by SFAS 123(R), unearned compensation of $2,614,000, which was
previously reflected as a reduction to stockholders' equity as of December 25,
2005, was reclassified as a reduction to additional paid-in capital upon our
adoption of this statement.
Stock Options
Prior to fiscal 2005, we granted substantially all of our equity awards through
stock options once per year. These stock options generally vest over three years
and expire ten years from the date of the grant.
In fiscal 2005, we granted substantially all of our equity awards through
quarterly stock option grants. Grants issued in the first quarter of each year
vest three years from the date of the grant. Grants issued in subsequent
quarters vest on the same date as the first quarterly stock option grant of that
year. In fiscal 2005 and the 2006 year-to-date period, we also granted to
certain employees stock options with 25% of the grant vesting four years from
the grant date and the remaining 75% of the grant vesting five years from the
grant date. The fiscal 2005 option grants expire six to seven years from the
date of the grant. In the first quarter of fiscal 2006, we issued grants to
certain employees and members of the board of directors which vest either one or
three years from the date of the grant. As part of their compensation package,
the outside members of the board of directors receive a grant of options in the
first quarter of every year which expire 10 years from the grant date.
10.
Transactions for stock options relative to both plans for the 2006 year-to-date
period were as follows:
1995 Plan
---------------------------------------------------------------------
Weighted
Weighted Average
Average Remaining
Number of Exercise Contractual Aggregate
Options Price Life Intrinsic Value
------------------ -------------- ---------------- ------------------
(in thousands)
Options outstanding at
December 25, 2005............ 7,365,933 $ 21.33 6.5 years
Granted................... 410,921 $ 22.14
Exercised................. (559,100) $ 11.98 $ 5,042
Expired................... (120) $ 8.30
Forfeited................. (476,398) $ 25.63
------------------
Options outstanding at
September 24, 2006........... 6,741,236 $ 21.85 6.0 years $ 16,955
==================
Options exercisable at
September 24, 2006........... 2,308,902 $ 15.34 5.5 years $ 16,550
==================
1999 Plan
---------------------------------------------------------------------
Weighted
Weighted Average
Average Remaining
Number of Exercise Contractual Aggregate
Options Price Life Intrinsic Value
------------------ -------------- ---------------- ------------------
(in thousands)
Options outstanding at
December 25, 2005............ 664,656 $ 13.73 6.0 years
Granted................... -- --
Exercised................. (155,853) $ 14.21 $ 1,411
Expired................... -- --
Forfeited................. (505) $ 13.22
------------------
Options outstanding at
September 24, 2006........... 508,298 $ 13.58 5.2 years $ 4,336
==================
Options exercisable at
September 24, 2006........... 503,798 $ 13.56 5.2 years $ 4,307
==================
The aggregate intrinsic value was calculated using the difference between the
current market price and the grant price for only those equity awards that have
a grant price that is less than the current market price.
11.
We derived the following weighted-average assumptions using the binomial model
in the 2006 quarter and the 2006 year-to-date period and the Black-Scholes model
for the 2005 quarter and the 2005 year-to-date period for stock options:
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
-------------- ---------------- --------------- ---------------
(Binomial) (Black-Scholes) (Binomial) (Black-Scholes)
Expected term in years.................... 5.2 5.6 4.8 5.2
Expected stock price volatility........... 32.1% 32.0% 31.4% 32.2%
Expected dividend yield................... 1.0% 0.9% 0.9% 0.7%
Risk-free interest rate................... 4.7% 3.7% 4.6% 3.8%
Fair value of options granted............. $ 6.90 $ 8.56 $ 6.89 $ 8.64
Stock Appreciation Rights
Beginning in the first quarter of fiscal 2006, we began granting substantially
all of our equity awards through quarterly nonvested share and SAR grants which
are exercisable in shares of our common stock. Grants issued for the first
quarter of each year vest three years from the date of the grant. Grants issued
in subsequent quarters vest on the same date as the first quarterly grant of
that year. The SARs granted in the 2006 year-to-date period expire six to seven
years from the date of the grant. Transactions for SARs for the 2006
year-to-date period were as follows:
1995 Plan
---------------------------------------------------------------------
Weighted
Weighted Average
Average Remaining
Number of Exercise Contractual Aggregate
Options Price Life Intrinsic Value
------------------ -------------- ---------------- ------------------
(in thousands)
SARs outstanding at
December 25, 2005............ -- --
Granted(1)................ 960,414 $ 21.67
Exercised................. -- --
Expired................... -- --
Forfeited................. (46,725) $ 22.32
------------------
SARs outstanding at $ 882
September 24, 2006........... 913,689 $ 21.63 6.4 years
==================
SARs exercisable at
September 24, 2006.......... --
==================
(1) Upon exercise of SARs, employees will receive the number of shares of common
stock equal to the appreciation in the fair market value based on the difference
between the fair market value on the grant date and the fair market value on the
date of exercise. The number of shares of common stock delivered as payment of
such appreciation will reduce the shares available for issuance under the 1995
Plan.
12.
We derived the following weighted-average assumptions for SARs using the
binomial model:
2006
2006 Year-to-Date
Quarter Period
--------------- --------------
Expected term in years 4.2 4.2
Expected stock price volatility 32.1% 31.7%
Expected dividend yield 1.0% 0.9%
Risk-free interest rate 4.7% 4.8%
Fair value of SARs granted $ 6.09 $ 6.24
Assumptions
We determined our assumptions for stock options and SAR grants based on the
following methodology:
Expected term: We have determined the expected term based upon the assumption
that all outstanding options and SARs will be exercised at the midpoint of the
current holding period and the full contractual term.
Expected volatility: We have determined the expected volatility based on a
weighted average of Applebee's volatility over the expected term, historical
volatility of certain peer group restaurant volatilities and Applebee's implied
volatility.
Expected dividend yield: We have determined the expected dividend yield based
upon our expected dividends as a percentage of our current stock price.
Risk-free interest rate: We have determined the risk-free interest rate using
the U.S. Treasury yield curve in effect at the time of the grant for the
expected term of the equity award.
Nonvested Shares
We grant nonvested shares under our 1995 Plan. Nonvested shares vest either one,
two or three years after the date of the grant. The fair value of nonvested
shares granted is equal to the market price of the stock at the date of grant.
The weighted average fair value of nonvested shares granted was $20.84 and
$25.77 in the 2006 quarter and the 2005 quarter, respectively, and $21.67 and
$27.81 in the 2006 year-to-date period and the 2005 year-to-date period,
respectively. Transactions during the 2006 year-to-date period were as follows:
Weighted
Number of Average
Awards Fair Value
--------------- --------------
Nonvested share awards outstanding as of December 25, 2005................. 257,813 $ 24.03
Granted.................................................................... 166,050 21.67
Vested..................................................................... (98,618) 19.09
Forfeited.................................................................. (35,157) 26.09
--------------- --------------
Nonvested share awards outstanding as of September 24, 2006................ 290,088 $ 24.11
=============== ==============
13.
As of September 24, 2006, we had unrecognized compensation expense related to
nonvested share awards of approximately $2,500,000 which will be recognized over
a weighted average period of 1.3 years.
Employee stock purchase plan
Our Board of Directors has authorized an employee stock purchase plan that
allows associates to purchase shares of our common stock at a 15% discount
through a payroll deduction. We record compensation for this plan using the
Black-Scholes valuation model in the quarter that the purchase occurs. As of
September 24, 2006, 190,590 shares of the 1,850,000 shares which were authorized
under this plan were available for purchase.
3. Commitments and Contingencies
Litigation, claims and disputes: We are subject from time to time to lawsuits,
claims and governmental inspections or audits arising in the ordinary course of
business. Some of these lawsuits purport to be class actions and/or seek
substantial damages. In the opinion of management, these matters are adequately
covered by insurance, or if not so covered, are without merit or are of such a
nature or involve amounts that would not have a material adverse impact on 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 24, 2006,
we have outstanding lease guarantees of approximately $15,800,000. 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 $12,800,000. These leases expire at various
times with the final lease agreement expiring in 2018. We did not record a
liability related to these contingent lease liabilities as of September 24, 2006
or December 25, 2005.
In 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 10% of certain loans advanced under this program. We will
be released from our guarantee if certain operating results are met after the
restaurant has been open for at least two years. As of September 24, 2006, there
were loans outstanding to six franchisees for approximately $69,200,000 under
this program. The fair value of our guarantees under this financing program is
approximately $140,000 and is recorded in non-current liabilities in our
consolidated balance sheet as of September 24, 2006.
Severance agreements: 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 not related to a change in control, some of which
require payments to be made only if we enforce certain terms in the agreements.
If the severance payments had been due as of September 24, 2006, we would have
been required to make payments totaling approximately $12,100,000. In addition,
we have severance and employment agreements with certain officers which contain
severance provisions related to a change in control. The agreements define the
circumstances which will constitute a change in control. Those provisions would
have required additional aggregate payments of approximately $5,300,000 if such
officers had been terminated as of September 24, 2006.
14.
4. 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.
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
--------------- --------------- --------------- ---------------
Net earnings......................................... $ 14,841 $ 22,135 $ 62,396 $ 81,282
=============== =============== =============== ===============
Basic weighted average shares outstanding............ 73,902 78,485 74,044 79,692
Dilutive effect of stock options and
equity-based compensation......................... 771 1,206 963 1,429
--------------- --------------- --------------- ---------------
Diluted weighted average shares outstanding.......... 74,673 79,691 75,007 81,121
=============== =============== =============== ===============
Basic net earnings per common share.................. $ 0.20 $ 0.28 $ 0.84 $ 1.02
=============== =============== =============== ===============
Diluted net earnings per common share................ $ 0.20 $ 0.28 $ 0.83 $ 1.00
=============== =============== =============== ===============
We excluded stock options and SARs 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 excluded approximately 5,700,000 and 3,400,000 of these
options and SARs from our diluted weighted average share computation for the
2006 quarter and the 2005 quarter, respectively, and approximately 5,300,000 and
900,000 of these options and SARs for the 2006 year-to-date period and the 2005
year-to-date period, respectively.
5. Acquisitions
All of our acquisitions discussed below have been accounted for using the
purchase method of accounting and, accordingly, our condensed 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 value 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 January 2006, we completed the acquisition of four Applebee's restaurants in
the Houston market for approximately $8,200,000. The purchase price was
allocated to the fair value of property and equipment of $7,400,000, goodwill of
approximately $600,000, reacquired franchise rights of approximately $100,000,
and other net assets of approximately $100,000. In connection with this
acquisition, we paid approximately $8,100,000 in the 2006 year-to-date period.
15.
In May 2005, we completed the acquisition of 12 Applebee's restaurants in
Missouri, Kansas and Arkansas, which included one restaurant under construction,
for approximately $39,500,000 in cash. The purchase price was allocated to the
fair value of property and equipment of $17,500,000, goodwill of $21,500,000,
reacquired franchise rights of approximately $300,000, and other net assets of
approximately $200,000.
The following table is comprised of actual company restaurant sales for the two
restaurant acquisitions above, which are included in our condensed consolidated
financial statements for each period presented, and pro forma company restaurant
sales. The pro forma company restaurant sales for the 2006 quarter and the 2006
year-to-date period include sales related to the January 2006 acquisition
discussed above as if the acquisition had occurred as of the beginning of each
respective period. The pro forma company restaurant sales for the 2005 quarter
and the 2005 year-to-date period include sales for the two acquisitions
discussed above as if the acquisitions had occurred as of the beginning of each
respective period.
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
-------------- ------------- -------------- --------------
Actual company restaurant sales for acquired
restaurants...................................... $ 1,500 $ 7,500 $ 4,800 $ 10,300
============== ============= ============== ==============
Pro forma company restaurant sales for acquired
restaurants..................................... $ 1,500 $ 8,200 $ 5,500 $ 24,600
============== ============= ============== ==============
In April 2005, we completed the acquisition of eight Applebee's restaurants in
the Memphis market, which were closed in 2004 by a former franchisee, for
approximately $8,800,000 payable in cash. In connection with this acquisition,
we paid approximately $800,000 in 2004 and $8,000,000 in 2005. The purchase
price of $8,800,000 was allocated to the fair value of property and equipment of
approximately $8,200,000 and goodwill of approximately $600,000. We have
remodeled and opened seven restaurants and the remaining restaurant was sold to
a third party.
6. Goodwill and Other Intangible Assets
Changes in goodwill are summarized below (in thousands):
September 24, December 25,
2006 2005
------------------- -------------------
Carrying amount, beginning of the year.................. $ 138,443 $ 116,344
Goodwill acquired during the period..................... 668 22,099
------------------- -------------------
Goodwill amount, end of the period...................... $ 139,111 $ 138,443
=================== ===================
16.
Intangible assets subject to amortization pursuant to SFAS No. 142, "Goodwill
and Other Intangible Assets," are summarized below (in thousands):
September 24, 2006
--------------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights....... $ 6,371 $ 6,103 $ 268
Lease acquisition costs (1)......... 3,430 590 2,840
Noncompete agreement................ 350 175 175
------------------ ------------------ ------------------
Total................................... $ 10,151 $ 6,868 $ 3,283
================== ================== ==================
December 25, 2005
--------------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights....... $ 6,371 $ 5,896 $ 475
Lease acquisition costs (1)......... 4,939 743 4,196
Noncompete agreement................ 350 109 241
------------------ ------------------ ------------------
Total................................... $ 11,660 $ 6,748 $ 4,912
================== ================== ==================
(1) In connection with the review of long-lived assets during our preparation of
the second quarter of fiscal 2006 condensed consolidated financial statements,
we recorded an asset impairment charge of approximately $1,100,000, net of
accumulated amortization, for lease acquisition costs related to two restaurants
whose carrying amounts were not deemed recoverable (Note 9).
We expect annual amortization expense for amortizable other assets for the next
five fiscal years to range from approximately $200,000 to $700,000.
Intangible assets not subject to amortization are summarized below (in
thousands):
September 24, December 25,
2006 2005
---------------------- --------------------
Carrying amount, beginning of the year.................. $ 3,138 $ 2,793
Nonamortizable intangible assets acquired
during the period.................................. 140 345
--------------------- --------------------
Nonamortizable intangible assets amount,
end of the period.................................. $ 3,278 $ 3,138
====================== ====================
In connection with our acquisition of four Applebee's restaurants in Houston
from a franchisee in January 2006, we recorded approximately $100,000 of
reacquired franchise rights (Note 5).
In connection with our acquisition of 12 Applebee's restaurants in Missouri,
Kansas and Arkansas from a franchisee in May 2005, we recorded approximately
$300,000 of reacquired franchise rights (Note 5).
The amount allocated to reacquired franchise rights is based upon the initial
franchise fees received from these franchisees. This intangible asset has an
indefinite life and, accordingly, will not be amortized but tested for
impairment at least annually.
17.
7. Assets Held for Sale
We classify assets as held for sale when there is a plan for disposal of assets
and those assets meet the held for sale criteria as defined in SFAS No. 144,
"Accounting for Impairment or Disposal of Long-Lived Assets." During the 2006
quarter, we began to actively market our existing corporate headquarters under a
plan approved by management. Consequently, we have classified the building and
land as held for sale as of September 24, 2006. In addition, we began to
actively market a corporate aircraft. As a result, we recorded an impairment
charge of approximately $900,000 to reduce the carrying amount to its fair
value, which was based on an independent third-party estimate.
8. 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. In 2005, we reduced the types of insurance coverage plans offered
which resulted in fewer franchisee participants in our captive insurance
program. Through 2005, Applebee's International, Inc. and covered franchisees
made 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 were established based
upon third-party actuarial estimates of settlement costs for incurred and
anticipated claims and administrative fees. Franchisee premiums were included in
other franchise income ratably over the policy year and the related offsetting
expenses were included in cost of other franchise income. In 2006, we
discontinued writing any new insurance coverage. Franchise premium adjustments
will be included in other franchise income and cost of other franchise income
when audited. Cost of other franchise income includes costs related to the
resolution of claims arising from franchisee participation in our captive
insurance program. We do not expect franchisee participation in the captive
insurance company to have a material impact on our net earnings. Our
consolidated balance sheets include the following balances related to the
captive insurance subsidiary:
o Franchise premium receivables of approximately $500,000 and $1,700,000
as of September 24, 2006 and December 25, 2005, 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 $14,300,000 and $18,600,000 as of
September 24, 2006 and December 25, 2005, respectively, included in
restricted assets related to captive insurance subsidiary.
o Loss reserve related to captive insurance subsidiary of approximately
$16,000,000 and $20,700,000 as of September 24, 2006 and December 25,
2005, respectively. Approximately $8,000,000 and $10,500,000 for
September 24, 2006 and December 25, 2005, respectively, is included in
other non-current liabilities.
9. Impairment and Other Restaurant Closure Costs
During the 2006 year-to-date period, we had impairment and other restaurant
closure costs as follows:
o In connection with the review of long-lived assets during our
preparation of the 2006 quarter condensed consolidated financial
statements, we recorded an asset impairment charge of $1,900,000. The
impairment charge consisted of approximately $1,000,000 write-down of
the carrying value of two restaurants whose carrying amounts were deemed
not recoverable and approximately $900,000 write-down of a corporate
aircraft.
18.
o We previously recorded impairment and other restaurant closure costs of
$3,000,000 in the second quarter of fiscal 2006 and $1,600,000 in the
first quarter of fiscal 2006.
In assessing restaurants for impairment, we use current and historical operating
results to estimate future cash flows on a restaurant by restaurant basis. The
asset impairment charges for the 2006 year-to-date period were calculated by
comparing the carrying value of the restaurants' assets to the estimated future
cash flow projections.
10. Treasury Shares
As of September 24, 2006, we had approximately 34,564,000 shares held in
treasury. A reconciliation of our treasury shares for the 2006 year-to-date
period is provided below (shares in thousands):
Treasury
Shares
---------------
Balance as of December 25, 2005........................ 34,305
Purchases of treasury stock............................ 1,286
Stock options exercised................................ (711)
Shares issued under employee benefit plans............. (185)
Nonvested shares awarded under equity incentive
plans.............................................. (131)
---------------
Balance as of September 24, 2006....................... 34,564
===============
11. New Accounting Pronouncements
In March 2006, the Emerging Issues Task Force ("EITF") issued EITF Issue 06-3,
"How Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross versus Net
Presentation)." A consensus was reached that entities may adopt a policy of
presenting sales taxes in the income statement on either a gross or net basis.
If taxes are significant, an entity should disclose its policy of presenting
taxes and the amounts of taxes. The guidance is effective for periods beginning
after December 15, 2006. We present company sales net of sales taxes. This issue
will not impact the method for recording these sales taxes in our consolidated
financial statements.
In July 2006, the FASB issued FASB Interpretation No. ("FIN") 48, "Accounting
for Uncertainty in Income Taxes," which clarifies the accounting for uncertainty
in income taxes recognized in the financial statements in accordance with SFAS
No. 109, "Accounting for Income Taxes." FIN 48 is effective for fiscal years
beginning after December 15, 2006. We are evaluating the impact the adoption of
FIN 48 will have on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This
statement defines fair value, establishes a framework for using fair value to
measure assets and liabilities, and expands disclosures about fair value
measurements. The statement applies whenever other statements require or permit
assets or liabilities to be measured at fair value. SFAS No. 157 is effective
for fiscal years beginning after November 15, 2007. We are evaluating the impact
the adoption of SFAS No. 157 will have on our consolidated financial statements.
19.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans." This statement requires
companies to recognize a net liability or asset and an offsetting adjustment to
accumulated other comprehensive income to report the funded status of defined
benefit pension and other postretirement benefit plans. The statement requires
prospective application, and the recognition and disclosure requirements are
effective for companies with fiscal years ending after December 15, 2006.
Additionally, SFAS No. 158 requires companies to measure plan assets and
obligations at their year-end balance sheet date. This requirement is effective
for fiscal years ending after December 15, 2008. We are evaluating the impact
the adoption of SFAS No. 158 will have on our consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements," which provides interpretive
guidance regarding the consideration given to prior year misstatements when
determining materiality in current year financial statements. SAB No. 108 is
effective for fiscal years ending after November 15, 2006. We are evaluating the
impact of SAB No. 108 on our consolidated financial statements.
20.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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, revenue growth, restaurant margins, 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 risk factors in Item 1A of our 2005 Annual Report on Form 10-K. We
disclaim any obligation to update forward-looking 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
-------------------------------- -------------------------- -----------------
2005 December 25, 2005 52
2006 December 31, 2006 53
2007 December 30, 2007 52
Fiscal Number
Period Fiscal Period End of Weeks
-------------------------------- -------------------------- -----------------
2005 Quarter September 25, 2005 13
2006 Quarter September 24, 2006 13
2005 Year-to-date period September 25, 2005 39
2006 Year-to-date period September 24, 2006 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 revenue from information technology products and services provided to
21.
certain franchisees. In fiscal 2005, other franchise income also included
insurance premiums for the current year and premium audit adjustments for prior
years from franchisee participation in our captive insurance program. In fiscal
2006, we discontinued writing any new insurance coverage. Franchise premium
adjustments will be included in other franchise income when audited.
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 costs related to information technology
products and services provided to certain franchisees. In fiscal 2005, cost of
other franchise income included the costs related to franchisee participation in
our captive insurance program. In fiscal 2006, we discontinued writing any new
insurance coverage. Cost of other franchise income includes costs related to the
resolution of claims arising from franchisee participation in our captive
insurance program.
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 nearly
1,900 system-wide restaurants open as of September 24, 2006. 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 financial performance, 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 2006 quarter and the 2006 year-to-date period, we
and our franchisees opened 28 and 92 restaurants, respectively. Together, we
have opened at least 100 restaurants system-wide each year for the past 13
fiscal years. In 2006, we currently expect to open approximately 125
restaurants system-wide, comprised of approximately 35 company and at least
90 franchise restaurants. Development costs, which include construction
costs, fixtures and equipment and land costs, continue to increase as a
result of increased demand for material, labor and commercial real estate.
We continually evaluate our development strategy. As a result of rising
development costs, slower industry sales trends and the underperformance of
several of our newer restaurants, we currently expect to open approximately
10 to 15 company restaurants in fiscal 2007.
22.
o Comparable restaurant sales - a year-over-year comparison of sales for
restaurants open at least 18 months. Changes in comparable restaurant sales
are driven by changes in the average guest check and/or changes in guest
traffic. Average guest check changes result from menu price changes and/or
changes in menu mix. During the 2006 quarter and the 2006 year-to-date
period, the impact of menu price increases on company restaurants was 2.5%.
In the fourth quarter, we will roll over a 1% price increase taken in
November of 2005. We do not expect to take further company restaurant price
increases for the remainder of fiscal 2006. Although we may have changes 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 food and beverage offerings. In 2006, we began implementation of a plan
to substantially improve the quality and flavor profile of our food and
beverage offerings as a result of comprehensive consumer research we
completed in 2005. In the 2006 quarter, company comparable sales decreased
1.7% while domestic franchise and domestic system-wide comparable sales
decreased 2.5% and 2.3%, respectively. In the 2006 year-to-date period,
company comparable sales decreased 0.8%, while domestic franchise and
domestic system-wide comparable sales decreased 0.4% and 0.5%, respectively.
We believe our sales and traffic have been negatively impacted by multiple
factors. Lower income households, which represent a significant portion of
our guests, have been impacted by higher energy costs and interest rates.
The bar and grill category of the restaurant industry has been negatively
impacted by increased trade-down to quick-service restaurants. In addition,
the supply growth of chains in the category in 2006 and 2005 has outpaced
demand contributing to weaker sales trends. As a result of these factors, we
currently expect system-wide comparable sales for the remainder of the year
to be in a range from down 1.0% to down 3.0%.
o Company restaurant margins - 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 10.5% and 12.9% in the 2006 quarter and the 2005
quarter, respectively, and 12.4% and 14.1% in the 2006 year-to-date period
and the 2005 year-to-date period, respectively. We currently expect fiscal
2006 company restaurant margins, which will be dependent on comparable sales
performance at company restaurants, to be lower than margins in fiscal 2005.
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 fiscal
2006 net commodity costs to be flat, including the negative impact of fuel
surcharges. In addition, our improved menu offerings are expected to
increase food costs, as a percentage of sales, when compared to other menu
offerings. We expect labor costs to continue to be negatively impacted by
hourly wage rate increases (including the potential impact of various state
and federal minimum wage rate initiatives), incremental hourly training
labor to support our new food campaigns, management wage rate increases to
remain competitive and modifications to our bonus plan designed to retain
our best restaurant managers. In addition, higher energy costs, including
utilities and the cost of materials used in the production of packaging,
will have a negative impact on company restaurant margins, but will be
partially offset by the favorable impact of a change in accounting
convention for smallwares that was implemented in the second quarter of
fiscal 2006 and the impact of the 53rd week in fiscal 2006.
o General and administrative expenses - general and administrative expenses
expressed as a percentage of total operating revenues. General and
administrative expenses were 11.1% and 8.6% in the 2006 quarter and the 2005
quarter, respectively, and 10.4% and 8.9% in the 2006 year-to-date period
and the 2005 year-to-date period, respectively. Stock-based compensation
included in general and administrative expenses was 1.5% and 0.2% in the
2006 quarter and the 2005 quarter, respectively, and 1.6% and 0.2% in the
2006 year-to-date period and the 2005 year-to-date period, respectively.
23.
General and administrative expenses, as a percentage of operating revenues,
for fiscal 2006 are expected to be in the low-to-mid 10 percent range,
including the impact of stock-based compensation.
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. In fiscal
2006, our return on equity has declined due primarily to the impact of
stock-based compensation and lower than expected sales and company
restaurant margins. We now expect our return on equity in fiscal 2006 to be
lower than our stated goal of at least 20%.
Application of Critical Accounting Policies
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 accounting policies involve
a significant degree of judgment or complexity.
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 may periodically purchase and maintain inventories of certain specialty
products to ensure sufficient supplies to the system, to ensure continuity of
supply, or 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 the 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.
Stock-based compensation: Beginning in fiscal 2006, we account for stock-based
compensation in accordance with SFAS No. 123(R). As required by SFAS No. 123(R),
stock-based compensation is estimated for equity awards at fair value at the
grant date. We determine the fair value of equity awards using a binomial model.
The binomial model requires various highly judgmental assumptions including the
expected life, stock price volatility and the forfeiture rate. If any of the
assumptions used in the model change significantly, stock-based compensation
expense may differ materially in the future from that recorded in the current
period.
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
24.
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 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
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 discussed below have been accounted for using the
purchase method of accounting and, accordingly, our condensed 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 value 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 January 2006, we completed the acquisition of four Applebee's restaurants in
the Houston market for approximately $8,200,000. The purchase price was
allocated to the fair value of property and equipment of $7,400,000, goodwill of
approximately $600,000, reacquired franchise rights of approximately $100,000,
and other net assets of approximately $100,000. In connection with this
acquisition, we paid approximately $8,100,000 in the 2006 year-to-date period.
In May 2005, we completed the acquisition of 12 Applebee's restaurants in
Missouri, Kansas and Arkansas, which included one restaurant under construction,
for approximately $39,500,000 in cash. The purchase price was allocated to the
fair value of property and equipment of $17,500,000, goodwill of $21,500,000,
reacquired franchise rights of approximately $300,000, and other net assets of
approximately $200,000.
25.
The following table is comprised of actual company restaurant sales for the two
restaurant acquisitions above, which are included in our condensed consolidated
financial statements for each period presented, and pro forma company restaurant
sales. The pro forma company restaurant sales for the 2006 quarter and the 2006
year-to-date period include sales related to the January 2006 acquisition
discussed above as if the acquisition had occurred as of the beginning of each
respective period. The pro forma company restaurant sales for the 2005 quarter
and the 2005 year-to-date period include sales for the two acquisitions
discussed above as if the acquisitions had occurred as of the beginning of each
respective period.
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
-------------- ------------- -------------- --------------
Actual company restaurant sales for acquired
restaurants...................................... $ 1,500 $ 7,500 $ 4,800 $ 10,300
============== ============= =============== ==============
Pro forma company restaurant sales for acquired
restaurants..................................... $ 1,500 $ 8,200 $ 5,500 $ 24,600
============== ============= =============== ==============
In April 2005, we completed the acquisition of eight Applebee's restaurants in
the Memphis market, which were closed in 2004 by a former franchisee, for
approximately $8,800,000 payable in cash. In connection with this acquisition,
we paid approximately $800,000 in 2004 and $8,000,000 in 2005. The purchase
price of $8,800,000 was allocated to the fair value of property and equipment of
approximately $8,200,000 and goodwill of approximately $600,000. We have
remodeled and opened seven restaurants and the remaining restaurant was sold to
a third party.
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. In 2005, we reduced the types of insurance coverage plans offered
which resulted in fewer franchisee participants in our captive insurance
program. Through 2005, Applebee's International, Inc. and covered franchisees
made 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 were established based
upon third-party actuarial estimates of settlement costs for incurred and
anticipated claims and administrative fees. Franchisee premiums were included in
other franchise income ratably over the policy year and the related offsetting
expenses were included in cost of other franchise income. In 2006, we
discontinued writing any new insurance coverage. Franchise premium adjustments
will be included in other franchise income and cost of other franchise income
when audited. Cost of other franchise income includes costs related to the
resolution of claims arising from franchisee participation in our captive
insurance program. We do not expect franchisee participation in the captive
insurance company to have a material impact on our net earnings. Our
consolidated balance sheets include the following balances related to the
captive insurance subsidiary:
26.
o Franchise premium receivables of approximately $500,000 and $1,700,000
as of September 24, 2006 and December 25, 2005, 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 $14,300,000 and $18,600,000 as of
September 24, 2006 and December 25, 2005, respectively, included in
restricted assets related to captive insurance subsidiary.
o Loss reserve related to captive insurance subsidiary of approximately
$16,000,000 and $20,700,000 as of September 24, 2006 and December 25,
2005, respectively. Approximately $8,000,000 and $10,500,000 for
September 24, 2006 and December 25, 2005, respectively, is included in
other non-current liabilities.
Results of Operations
The following table contains 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.
2006 2005
Year-to- Year-to-
2006 2005 Date Date
Quarter Quarter Period Period
------------- ------------ ------------- -------------
Operating revenues:
Company restaurant sales.............................. 89.5% 89.3 % 89.5% 89.0%
Franchise royalties and fees.......................... 10.4 10.3 10.4 10.6
Other franchise income................................ 0.1 0.3 0.1 0.4
------------- ------------ ------------- -------------
Total operating revenues........................... 100.0% 100.0% 100.0% 100.0%
============= ============ ============= =============
Cost of sales (as a percentage of company
restaurant sales):
Food and beverage..................................... 26.7% 26.2% 26.6% 26.4%
Labor................................................. 34.5 33.1 33.7 33.0
Direct and occupancy.................................. 27.9 27.4 26.9 26.0
Pre-opening expense................................... 0.4 0.4 0.3 0.4
------------- ------------ ------------- -------------
Total cost of sales................................ 89.5% 87.1% 87.6% 85.9%
============= ============ ============= =============
Cost of other franchise income (as a percentage of other
franchise income)..................................... 187.1% 74.2% 128.5% 79.9%
General and administrative expenses........................ 11.1 8.6 10.4 8.9
Amortization of intangible assets.......................... -- 0.1 0.1 0.1
Impairment and other restaurant closure costs.............. 0.6 1.3 0.7 0.4
Loss on disposition of property and equipment.............. 0.2 0.2 0.2 0.1
------------- ------------ ------------- -------------
Operating earnings......................................... 7.7 11.8 10.2 13.8
------------- ------------ ------------- -------------
Other income (expense):
Investment income..................................... 0.3 0.2 0.1 0.1
Interest expense...................................... (0.9) (0.4) (0.9) (0.2)
Other income ......................................... 0.1 0.2 0.1 0.2
------------- ------------ ------------- -------------
Total other income (expense)....................... (0.6) -- (0.7) --
------------- ------------ ------------- -------------
Earnings before income taxes............................... 7.2 11.8 9.6 13.8
Income taxes............................................... 2.5 4.5 3.3 4.9
------------- ------------ ------------- -------------
Net earnings............................................... 4.6% 7.2% 6.3% 8.9%
============= ============ ============= =============
27.
The following table sets forth certain 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 24, September 25, September 24, September 25,
2006 2005 2006 2005
-------------- -------------- --------------- --------------
Number of restaurants:
Company:
Beginning of period....................... 507 462 486 424
Restaurant openings....................... 6 12 25 39
Restaurant closings....................... (1) (1) (3) (1)
Restaurants acquired from franchisees..... -- -- 4 11
-------------- -------------- --------------- --------------
End of period............................. 512 473 512 473
-------------- -------------- --------------- --------------
Franchise:
Beginning of period....................... 1,353 1,260 1,318 1,247
Restaurant openings....................... 22 23 67 52
Restaurant closings....................... (3) (1) (9) (6)
Restaurants acquired from franchisees..... -- -- (4) (11)
-------------- -------------- --------------- --------------
End of period............................. 1,372 1,282 1,372 1,282
-------------- -------------- --------------- --------------
Total:
Beginning of period....................... 1,860 1,722 1,804 1,671
Restaurant openings....................... 28 35 92 91
Restaurant closings....................... (4) (2) (12) (7)
-------------- -------------- --------------- --------------
End of period............................. 1,884 1,755 1,884 1,755
============== ============== =============== ==============
Weighted average weekly sales per restaurant:
Company....................................... $ 43,331 $ 44,825 $ 45,527 $ 46,561
Domestic franchise............................ $ 47,516 $ 48,677 $ 50,394 $ 50,521
Domestic total................................ $ 46,327 $ 47,598 $ 49,011 $ 49,424
Change in comparable restaurant sales:(1)
Company....................................... (1.7)% (1.6)% (0.8)% (0.8)%
Domestic franchise............................ (2.5)% 1.6 % (0.4)% 2.9 %
Domestic total................................ (2.3)% 0.8 % (0.5)% 2.0 %
Total operating revenues (in thousands):
Company restaurant sales...................... $ 286,938 $ 272,673 $ 890,965 $ 815,834
Franchise royalties and fees(2)............... 33,340 31,589 103,581 97,090
Other franchise income(3)..................... 371 1,064 1,355 3,553
-------------- -------------- --------------- --------------
Total......................................... $ 320,649 $ 305,326 $ 995,901 $ 916,477
============== ============== =============== ==============
(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 (including international
restaurants), in thousands, were $830,458 and $790,949 in the 2006 quarter and
the 2005 quarter, respectively, and $2,594,659 and $2,444,429 in the 2006
year-to-date period and the 2005 year-to-date period, respectively. Franchise
fees typically range from $30,000 to $35,000 for each restaurant opened.
(3) Other franchise income includes revenue from information technology products
and services provided to certain franchisees. In addition, the 2005 period
includes insurance premiums from franchisee participation in our captive
insurance program.
28.
2006 Quarter Compared With 2005 Quarter and 2006 Year-to-Date Period Compared
With 2005 Year-to-Date Period
Company Restaurant Sales. Total company restaurant sales increased $14,265,000
(5%) from $272,673,000 in the 2005 quarter to $286,938,000 in the 2006 quarter
and increased $75,131,000 (9%) from $815,834,000 in the 2005 year-to-date period
to $890,965,000 in the 2006 year-to-date period. The percentage increase in
total company restaurant sales was due to an increase in the number of
restaurant weeks open of approximately 9% in the 2006 quarter and 12% in the
2006 year-to-date period, which was partially offset by a decline in weighted
average weekly sales in the 2006 quarter and the 2006 year-to-date period.
Comparable restaurant sales at company restaurants decreased by 1.7% and 0.8% in
the 2006 quarter and the 2006 year-to-date period, respectively. Weighted
average weekly sales at company restaurants decreased 3.3% from $44,825 in the
2005 quarter to $43,331 in the 2006 quarter and decreased 2.2% from $46,561 in
the 2005 year-to-date period to $45,527 in the 2006 year-to-date period. The
decrease in average weekly sales was due to a decline in guest traffic in 2006
as compared to 2005 as well as the underperformance of restaurants open less
than 18 months. In both periods, we experienced more significant guest count
declines in New England and Virginia, where approximately 25% of our company
restaurants are located. These decreases were partially offset by an increase in
the average guest check resulting from menu price increases of approximately
2.5% in the 2006 quarter and the 2006 year-to-date period.
Franchise Royalties and Fees. Franchise royalties and fees increased $1,751,000
(6%) from $31,589,000 in the 2005 quarter to $33,340,000 in the 2006 quarter and
increased $6,491,000 (7%) from $97,090,000 in the 2005 year-to-date period to
$103,581,000 in the 2006 year-to-date period due primarily to the increased
number of franchise restaurants operating during both periods as compared to the
prior year. Domestic franchise weighted average weekly sales and comparable
restaurant sales decreased 2.4% and 2.5%, respectively, in the 2006 quarter and
decreased 0.3% and 0.4%, respectively, in the 2006 year-to-date period.
Other Franchise Income. Other franchise income decreased $693,000 (65%) from
$1,064,000 in the 2005 quarter to $371,000 in the 2006 quarter and decreased
$2,198,000 (62%) from $3,553,000 in the 2005 year-to-date period to $1,355,000
in the 2006 year-to-date period due primarily to the decision to discontinue
writing new coverage in our captive insurance program. In 2005, franchisee
premiums were included in other franchise income ratably over the policy year.
Cost of Company Restaurant Sales. Food and beverage costs increased from 26.2%
in the 2005 quarter to 26.7% in the 2006 quarter and increased from 26.4% in the
2005 year-to-date period to 26.6% in the 2006 year-to-date period. Food and
beverage costs in both periods were negatively impacted by an increase in food
spoilage and waste associated with a reduction in the number of menu items
offered, our enhanced bar menu and a new fall menu. In addition, we experienced
an unfavorable shift in menu mix and higher alcoholic beverage costs, as a
percentage of sales, partially related to our late-night value strategy. These
increases were partially offset by menu price increases of 2.5% in the 2006
quarter and the 2006 year-to-date period.
Labor costs increased from 33.1% in the 2005 quarter to 34.5% in the 2006
quarter and increased from 33.0% in the 2005 year-to-date period to 33.7% in the
2006 year-to-date period. Both periods were unfavorably impacted by hourly state
minimum wage rate increases, higher management wage rates, training related to
29.
the rollout of a new promotion, payroll taxes and the impact of lower sales
volumes, as a percentage of sales, which were partially offset by lower workers'
compensation expense. In addition, the 2006 quarter was favorably impacted by
lower health insurance expense and was unfavorably impacted by higher incentive
compensation as a result of modifications to our bonus plan designed to retain
our best restaurant managers.
Direct and occupancy costs increased from 27.4% in the 2005 quarter to 27.9% in
the 2006 quarter and increased from 26.0% in the 2005 year-to-date period to
26.9% in the 2006 year-to-date period due primarily to higher utilities and
unfavorable year-over-year comparisons for depreciation and rent expense, as a
percentage of sales, due to their relatively fixed nature, which were partially
offset by the favorable impact of a change in accounting convention for
smallwares that was implemented in the second quarter of fiscal 2006. The 2006
quarter was favorably impacted by lower advertising expense due to the timing of
our food promotions.
Cost of Other Franchise Income. Cost of other franchise income decreased $96,000
(12%) from $790,000 in the 2005 quarter to $694,000 in the 2006 quarter and
decreased $1,097,000 (39%) from $2,838,000 in the 2005 year-to-date period to
$1,741,000 in the 2006 year-to-date period due to the decision to discontinue
writing new coverage in our captive insurance program, which was partially
offset by $425,000 in the 2006 quarter and $925,000 in the 2006 year-to-date
period recorded for estimated insurance losses from franchise participants.
General and Administrative Expenses. General and administrative expenses
increased from 8.6% in the 2005 quarter to 11.1% in the 2006 quarter and
increased from 8.9% in the 2005 year-to-date period to 10.4% in the 2006
year-to-date period due primarily to the recognition of stock-based compensation
related to adoption of SFAS 123(R), higher compensation expense due to staffing
levels and an accrued legal expense of $1,500,000 related to the pending
settlement and related costs of a California wage and hour lawsuit. The impact
of the pending legal settlement is 0.5% and 0.2% in the 2006 quarter and the
2006 year-to-date period, respectively. Stock-based compensation included in
general and administrative expenses was 1.5% and 0.2% in the 2006 quarter and
the 2005 quarter, respectively, and 1.6% and 0.2% in the 2006 year-to-date
period and the 2005 year-to-date period, respectively. In addition, expenses
incurred related to the development of international markets increased our
general and administrative expenses by 0.4% in both 2006 periods.
Impairment and Other Restaurant Closure Costs. Impairment and other restaurant
closure costs decreased $2,000,000 from $3,900,000 in the 2005 quarter to
$1,900,000 in the 2006 quarter and increased from $3,900,000 in the 2005
year-to-date period to $6,500,000 in the 2006 year-to-date period. During the
2006 year-to-date period, we had impairment and other restaurant closure costs
as follows:
o In connection with the review of long-lived assets during our
preparation of the 2006 quarter condensed consolidated financial
statements, we recorded an asset impairment charge of $1,900,000. The
impairment charge consisted of approximately $1,000,000 write-down of
the carrying value of two restaurants whose carrying amounts were deemed
not recoverable and approximately $900,000 write-down of a corporate
aircraft.
o We previously recorded impairment and other restaurant closure costs of
$3,000,000 in the second quarter of fiscal 2006 and $1,600,000 in the
first quarter of fiscal 2006.
Interest Expense. Interest expense increased from $1,232,000 in the 2005 quarter
to $2,970,000 in the 2006 quarter and from $2,203,000 in the 2005 year-to-date
period to $8,509,000 in the 2006 year-to-date period due primarily to higher
interest rates and increased borrowings used for capital expenditure funding,
repurchases of our common stock and acquisitions.
30.
Income Taxes. The effective income tax rate, as a percentage of earnings before
income taxes, decreased from 38.5% in the 2005 quarter to 35.3% in the 2006
quarter and decreased from 35.7% in the 2005 year-to-date period to 34.4% in the
2006 year-to-date period. Both periods were impacted by favorable employment tax
credits. The year-to-date period was also favorably impacted by the resolution
of state tax matters. In addition, the income tax rates in the 2005 quarter and
the 2005 year-to-date period were impacted by higher state tax rates discovered
following the completion of the 2004 tax returns.
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 and debt financing.
Cash flows from our operating activities primarily include the net cash
generated from company and franchise operations and management of credit from
trade suppliers. Cash flows from investing activities include capital
expenditures for restaurant construction, refurbishment, information technology,
acquisitions of franchisee restaurants and asset sales. Cash flows from
financing activities include borrowings and repayments of debt, repurchases of
our common stock, dividends to shareholders and the cash received from the
exercise of employee stock options. The following table presents a summary of
our cash flows for the 2006 year-to-date period and the 2005 year-to-date period
(in thousands):
2006 2005
Year-to-Date Year-to-Date
Period Period
------------------- ------------------
Net cash provided by operating activities.......... $ 109,438 $ 158,676
Net cash used by investing activities.............. (90,089) (149,245)
Net cash used by financing activities.............. (22,613) (9,933)
------------------- ------------------
Net decrease in cash and cash equivalents.......... $ (3,264) $ (502)
=================== ==================
Capital expenditures were $100,802,000 in the 2005 year-to-date period and
$86,635,000 in the 2006 year-to-date period. In 2006, we currently expect to
open approximately 35 company restaurants, and capital expenditures, excluding
franchise acquisitions, are expected to be between $115,000,000 and
$125,000,000. The decrease in the expected capital expenditures of $20,000,000
from the amount reported in the second quarter of fiscal 2006 is due to a
reduction in 2007 restaurant openings and a delay in the timing of capital
expenditures related to the new corporate headquarters.
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. Because we expect to continue to
purchase a portion of our restaurant sites, the amount of actual capital
expenditures will be dependent upon, among other things, the proportion of
leased versus owned properties. If we construct more or fewer restaurants than
we currently anticipate, or acquire additional restaurants, our capital
requirements will increase or decrease accordingly.
In fiscal 2006, we expect to incur approximately $12,500,000 in costs associated
with the construction of our new corporate headquarters including $4,500,000 for
land, which we paid in January 2006. We will incur additional construction costs
in fiscal 2007, the amount of which has yet to be determined. We intend to enter
into a sale leaseback arrangement of the new headquarters upon its completion or
thereafter, depending upon market conditions.
31.
In January 2006, we completed the acquisition of four Applebee's restaurants in
the Houston area for approximately $8,200,000. In connection with this
acquisition, we paid approximately $8,100,000 in the 2006 year-to-date period.
In May 2005, we completed the acquisition of 12 Applebee's restaurants in
Missouri, Kansas and Arkansas, which included one restaurant under construction,
for approximately $39,500,000 in cash.
In April 2005, we completed the acquisition of eight Applebee's restaurants in
the Memphis market, which were closed in 2004 by a former franchisee, for
approximately $8,800,000 in cash. In connection with this acquisition, we paid
approximately $800,000 in 2004 and $8,000,000 in 2005.
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. 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. As of September 24, 2006, we
were in compliance with the covenants contained in our credit agreement. As of
September 24, 2006, we had borrowings of $189,000,000, standby letters of credit
of $16,400,000 outstanding and approximately $44,600,000 available under our
revolving credit facility.
In October 2005, our Board of Directors approved a $175,000,000 authorization to
repurchase our common stock, subject to market conditions. During the 2006
year-to-date period, we repurchased 1,285,900 shares of our common stock at an
average price of $21.41 for an aggregate cost of $27,528,000. As of September
24, 2006, we had $101,439,000 remaining under our repurchase authorization.
In October 2005, the Board of Directors declared an annual dividend of $0.20 per
share payable to shareholders of record on December 23, 2005. We paid
approximately $14,800,000 in January 2006 related to this dividend.
As of September 24, 2006, our liquid assets totaled $10,067,000. These assets
consisted of cash and cash equivalents in the amount of $9,776,000 and
short-term investments in the amount of $291,000. The working capital deficit
decreased from $107,400,000 as of December 25, 2005 to $65,221,000 as of
September 24, 2006. This decrease was due primarily to the higher redemption of
gift cards as compared to sales of gift cards in the 2006 year-to-date period, a
reclass of property and equipment to assets held for sale and decreases in
accounts payable and dividends accrued in fiscal 2005.
We believe that our liquid assets and cash generated from operations, combined
with available borrowings, will provide sufficient funds for capital
expenditures, repurchases of our common stock, the payment of dividends and
32.
operating activities for at least the next 12 months and thereafter for the
foreseeable future.
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 24, 2006 (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).................. $ 190,324 $ 12,099 $ 88 $ 177,106 $ 1,031
Capital Lease Obligations.................. 7,739 815 1,716 1,814 3,394
Operating Leases (2)....................... 395,875 28,876 57,571 56,292 253,136
Purchase Obligations - Company(3).......... 183,907 163,574 12,074 8,259 --
Purchase Obligations - Franchise(4)........ 424,250 369,765 32,355 22,130 --
(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 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 us for our franchisees. We contract with certain
suppliers to ensure competitive pricing. These amounts will only be payable by
us 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 24, 2006, we have outstanding lease guarantees of
approximately $15,800,000. 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
$12,800,000. These leases expire at various times with the final lease agreement
expiring in 2018. We did not record a liability related to these contingent
lease liabilities as of September 24, 2006 or December 25, 2005.
In 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 10% of certain loans advanced under this program. We will
be released from our guarantee if certain operating results are met after the
restaurant has been open for at least two years. As of September 24, 2006, there
were loans outstanding to six franchisees for approximately $69,200,000 under
this program. The fair value of our guarantees under this financing program is
approximately $140,000 and is recorded in non-current liabilities in our
consolidated balance sheet as of September 24, 2006.
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 not related to a change in control, some of which require payments to
be made only if we enforce certain terms in the agreements. If the severance
payments had been due as of September 24, 2006, we would have been required to
33.
make payments totaling approximately $12,100,000. In addition, we have severance
and employment agreements with certain officers which contain severance
provisions related to a change in control. The agreements define the
circumstances which will constitute a change in control. Those provisions would
have required additional aggregate payments of approximately $5,300,000 if such
officers had been terminated as of September 24, 2006.
New Accounting Pronouncements
In March 2006, the Emerging Issues Task Force ("EITF") issued EITF Issue 06-3,
"How Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross versus Net
Presentation)." A consensus was reached that entities may adopt a policy of
presenting sales taxes in the income statement on either a gross or net basis.
If taxes are significant, an entity should disclose its policy of presenting
taxes and the amounts of taxes. The guidance is effective for periods beginning
after December 15, 2006. We present company sales net of sales taxes. This issue
will not impact the method for recording these sales taxes in our consolidated
financial statements.
In July 2006, the FASB issued FASB Interpretation No. ("FIN") 48, "Accounting
for Uncertainty in Income Taxes," which clarifies the accounting for uncertainty
in income taxes recognized in the financial statements in accordance with SFAS
No. 109, "Accounting for Income Taxes." FIN 48 is effective for fiscal years
beginning after December 15, 2006. We are evaluating the impact the adoption of
FIN 48 will have on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." This
statement defines fair value, establishes a framework for using fair value to
measure assets and liabilities, and expands disclosures about fair value
measurements. The statement applies whenever other statements require or permit
assets or liabilities to be measured at fair value. SFAS No. 157 is effective
for fiscal years beginning after November 15, 2007. We are evaluating the impact
the adoption of SFAS No. 157 will have on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for
Defined Benefit Pension and Other Postretirement Plans." This statement requires
companies to recognize a net liability or asset and an offsetting adjustment to
accumulated other comprehensive income to report the funded status of defined
benefit pension and other postretirement benefit plans. The statement requires
prospective application, and the recognition and disclosure requirements are
effective for companies with fiscal years ending after December 15, 2006.
Additionally, SFAS No. 158 requires companies to measure plan assets and
obligations at their year-end balance sheet date. This requirement is effective
for fiscal years ending after December 15, 2008. We are evaluating the impact
the adoption of SFAS No. 158 will have on our consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements," which provides interpretive
guidance regarding the consideration given to prior year misstatements when
determining materiality in current year financial statements. SAB No. 108 is
effective for fiscal years ending after November 15, 2006. We are evaluating the
impact of SAB No. 108 on our consolidated financial statements.
34.
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 0.75%, at our option. As of September 24, 2006,
the total amount of debt subject to interest rate fluctuations was $189,000,000,
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
approximately $1,900,000 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 24, 2006, 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 are
effective.
During the 2006 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.
35.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are subject from time to time to lawsuits, claims and governmental
inspections or audits arising in the ordinary course of business. Some of these
lawsuits purport to be class actions and/or seek substantial damages. In the
opinion of management, these matters are adequately covered by insurance, or if
not so covered, are without merit or are of such a nature or involve amounts
that would not have a material adverse impact on our business or consolidated
financial position.
Item 1A. Risk Factors
There have been no material changes in our risk factors from those disclosed in
our 2005 Annual Report on Form 10-K.
36.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Issuer Purchases of Equity Securities.
--------------------------------------------------------------------------------------------------------------
Purchases of Equity Securities(1)
--------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d)
------------------------------- ------------- ----------- ------------------------- --------------------------
Maximum Dollar Value of
Total Average Total Number of Shares Shares that May Yet Be
Number of Price Purchased as Part of Purchased Under the
Shares Paid Per Publicly Announced Plans or Programs
Period Purchased Share Plans or Programs (in thousands)
------------------------------- ------------- ----------- ------------------------- --------------------------
June 26, 2006 through July
23, 2006 -- -- -- $112,833
------------------------------- ------------- ----------- ------------------------- --------------------------
July 24, 2006 through August
20, 2006 388,800 $18.61 388,800 $105,596
------------------------------- ------------- ----------- ------------------------- --------------------------
August 21, 2006 through
September 24, 2006 209,900 $19.81 209,900 $101,439
------------------------------- ------------- ----------- ------------------------- --------------------------
Total 598,700 598,700
=============================== ============= =========== ========================= ==========================
(1) In October 2005, our Board of Directors authorized additional repurchases of
our common stock of up to $175,000,000, subject to market conditions.
Item 5. Other Information
(a) None
(b) As disclosed in our Current Report on Form 8-K filed with the SEC on
August 30, 2006, the Board of Directors has adopted Amended and Restated
Bylaws of the Company (the "Bylaws"). These Bylaws change the procedures
by which holders of our common stock may nominate persons for election
to our Board of Directors at a meeting of stockholders and adopt a new
advance notice procedure for stockholders who wish to submit matters to
a meeting of our stockholders. The previous bylaw for submitting
nominations of directors has been deleted and the new provision governs
all submissions by stockholders of proposals to our stockholder
meetings.
Under Article II, Section 7 of the Bylaws, any stockholder proposal,
including, without limitation, a notice of intention to nominate an
individual for election to the Board, must be delivered to the our
corporate secretary not less than 120 days nor more than 165 days prior
to the date on which we first mailed our proxy materials for the prior
year's annual meeting of stockholders; provided, however, that in the
event the date of the annual meeting is advanced by more than 30 days or
delayed (other than as a result of adjournment) by more than 30 days
from the anniversary of the previous year's annual meeting, notice by
the stockholder to be timely must be delivered not later than the close
of business on the later of the 60th day prior to such annual meeting or
the tenth day following the date on which public announcement of the
date of such meeting is first made. The notice must contain the
information specified in the Bylaws.
37.
As previously stated in our 2006 definitive Proxy Statement, if a
stockholder wants us to include a proposal in our proxy statement and
form of proxy for presentation at the 2007 meeting, it must be submitted
no later than December 12, 2006, and must comply with the rules of the
Securities and Exchange Commission.
Under the Bylaws, if a stockholder (i) wants to submit a proposal for
the 2007 annual meeting but does not ask us to include it in the proxy
statement, or (ii) intends to nominate a person as a candidate for
election to the Board directly, rather than through the Corporate
Governance/Nominating Committee, the stockholder still must submit the
proposal or nomination under the timeframes set forth above. For our
2007 annual meeting, we must receive proposals and nominations no
earlier than October 28, 2006 and no later than December 12, 2006. If
the date of the 2007 annual meeting is advanced by more than 30 days or
delayed (other than as a result of adjournment) by more than 30 days
from the anniversary of the 2006 annual meeting, the stockholder must
submit any such proposal or nomination no later than the close of
business on the later of the 60th day prior to the 2007 annual meeting
or the tenth day following the day on which public announcement of the
date of such meeting is first made. If we do not receive notice of a
proposal by the dates set forth above, or if we meet certain other
requirements of the SEC rules, the persons named as proxies in the proxy
materials relating to that meeting will use their discretion in voting
the proxies when these matters are raised at the meeting.
The revised Bylaws also change some procedural aspects of how
stockholders may recommend nominees for the board of directors.
Stockholders may still submit recommendations for nominees to the Board
of Directors to the Corporate Governance/Nominating Committee but must
now deliver to the corporate secretary the same information within the
same time periods as required by the revised Bylaws for a direct
nomination at a meeting. The committee will consider these candidates
the same way it evaluates all other candidates.
Item 6. Exhibits
The Exhibits listed on the accompanying Exhibit Index are filed as part of this
report.
38.
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 25, 2006 By: /s/ David L. Goebel
------------------- ----------------------------------------
David L. Goebel
Director, President and
Chief Executive Officer
(principal executive officer)
Date: October 25, 2006 By: /s/ Steven K. Lumpkin
------------------- ----------------------------------------
Steven K. Lumpkin
Director, Executive Vice President,
Chief Financial Officer and Treasurer
(principal financial officer)
Date: October 25, 2006 By: /s/ Beverly O. Elving
------------------- ----------------------------------------
Beverly O. Elving
Vice President and Controller
(principal accounting officer)
39.
APPLEBEE'S INTERNATIONAL, INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------------ -----------------------------------------------------------------------------------------------
10.1 Amended and Restated Bylaws of Applebee's International Inc. (incorporated by reference to
the Registrant's Form 8-K filed on August 30, 2006).
10.2 Personal Use of Corporate Aircraft by Non-Executive Chairman (incorporated by reference to
the Registrant's Form 8-K filed on August 30, 2006).
10.3 Severance Plan for Officers (incorporated by reference to the Registrant's Form 8-K filed
on August 30, 2006).
10.4 Amended and Restated Nonqualified Deferred Compensation Plan.
10.5 Form of Officer Restricted Stock Award Agreement for shares subject to the Company's stock
ownership guidelines.
10.6 Form of Officer Restricted Stock Award Agreement for Participants in the Executive
Retirement Plan.
10.7 Amended Executive Stock Ownership Guidelines.
31.1 Certification of 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 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
40.