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 26, 2004
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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
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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
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(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
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Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes X No
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The number of shares of the registrant's common stock outstanding as of October
25, 2004 was 81,075,984.
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APPLEBEE'S INTERNATIONAL, INC.
FORM 10-Q
FISCAL QUARTER ENDED SEPTEMBER 26, 2004
INDEX
Page
Part I Financial Information
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets as of September 26, 2004
and December 28, 2003................................................................ 3
Consolidated Statements of Earnings for the 13 Weeks and 39 Weeks
Ended September 26, 2004 and September 28, 2003...................................... 4
Consolidated Statement of Stockholders' Equity for the
39 Weeks Ended September 26, 2004.................................................... 5
Consolidated Statements of Cash Flows for the 39 Weeks
Ended September 26, 2004 and September 28, 2003...................................... 6
Notes to Consolidated Financial Statements................................................ 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations........................................ 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 26
Item 4. Controls and Procedures................................................................... 26
Part II Other Information
Item 1. Legal Proceedings......................................................................... 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds............................... 27
Item 6. Exhibits.................................................................................. 27
Signatures .................................................................................................. 28
Exhibit Index................................................................................................ 29
-2-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share amounts)
September 26, December 28,
2004 2003
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 441 $ 17,867
Short-term investments, at market value.......................................... 281 27
Receivables (less allowance for bad debts of $4,290 in 2004 and $4,117 in 2003).. 37,079 31,950
Receivables related to captive insurance subsidiary.............................. 3,107 450
Inventories...................................................................... 33,950 20,799
Prepaid income taxes............................................................. 7,704 5,800
Other current assets related to captive insurance subsidiary..................... 850 657
Prepaid and other current assets................................................. 9,943 9,072
---------------- ----------------
Total current assets........................................................ 93,355 86,622
Property and equipment, net.......................................................... 457,071 421,536
Goodwill............................................................................. 116,344 105,326
Restricted assets related to captive insurance subsidiary............................ 18,311 10,763
Other intangible assets, net......................................................... 5,564 1,137
Other assets......................................................................... 23,403 18,617
---------------- ----------------
$ 714,048 $ 644,001
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt................................................ $ 213 $ 192
Notes payable.................................................................... 3,000 --
Accounts payable................................................................. 36,870 37,633
Accrued expenses and other current liabilities................................... 81,678 96,637
Loss reserve and unearned premiums related to captive insurance subsidiary....... 20,864 11,007
Accrued dividends................................................................ -- 3,863
---------------- ----------------
Total current liabilities................................................... 142,625 149,332
---------------- ----------------
Non-current liabilities:
Long-term debt - less current portion............................................ 43,529 20,670
Deferred income taxes............................................................ 32,141 5,880
Other non-current liabilities.................................................... 11,286 8,387
---------------- ----------------
Total non-current liabilities............................................... 86,956 34,937
---------------- ----------------
Total liabilities........................................................... 229,581 184,269
---------------- ----------------
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....................................................... 213,928 200,574
Retained earnings................................................................ 609,925 523,954
---------------- ----------------
824,938 725,613
Treasury stock - 27,514,031 shares in 2004 and 25,715,767 shares in 2003, at
cost.......................................................................... (340,471) (265,881)
---------------- ----------------
Total stockholders' equity.................................................. 484,467 459,732
---------------- ----------------
$ 714,048 $ 644,001
================ ================
See notes to 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 26, September 28, September 26, September 28,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues:
Company restaurant sales.......................... $ 247,173 $ 222,429 $ 738,502 $ 650,946
Franchise royalties and fees...................... 30,105 27,594 91,656 82,088
Other franchise income............................ 3,913 2,972 10,427 8,881
------------- ------------- ------------- -------------
Total operating revenues..................... 281,191 252,995 840,585 741,915
------------- ------------- ------------- -------------
Cost of company restaurant sales:
Food and beverage................................. 65,115 57,200 195,277 169,086
Labor............................................. 79,599 73,018 240,344 213,186
Direct and occupancy.............................. 61,642 55,869 180,951 160,816
Pre-opening expense............................... 998 576 1,939 1,131
------------- ------------- ------------- -------------
Total cost of company restaurant sales....... 207,354 186,663 618,511 544,219
------------- ------------- ------------- -------------
Cost of other franchise income........................ 3,521 2,837 11,493 8,510
General and administrative expenses................... 26,669 23,589 77,118 69,096
Amortization of intangible assets..................... 199 87 443 278
Loss on disposition of restaurants and equipment...... 441 116 1,520 1,314
------------- ------------- ------------- -------------
Operating earnings.................................... 43,007 39,703 131,500 118,498
------------- ------------- ------------- -------------
Other income (expense):
Investment income................................. 325 227 566 1,048
Interest expense.................................. (379) (330) (1,139) (1,369)
Impairment of Chevys note receivable (Note 9)..... -- -- -- (8,803)
Other income...................................... 568 395 1,410 601
------------- ------------- ------------- -------------
Total other income (expense)................. 514 292 837 (8,523)
------------- ------------- ------------- -------------
Earnings before income taxes.......................... 43,521 39,995 132,337 109,975
Income taxes.......................................... 15,232 14,398 46,318 39,591
------------- ------------- ------------- -------------
Net earnings.......................................... $ 28,289 $ 25,597 $ 86,019 $ 70,384
============= ============= ============= =============
Basic net earnings per common share................... $ 0.35 $ 0.31 $ 1.05 $ 0.85
============= ============= ============= =============
Diluted net earnings per common share................. $ 0.34 $ 0.30 $ 1.02 $ 0.82
============= ============= ============= =============
Basic weighted average shares outstanding............. 81,511 83,334 81,759 83,132
============= ============= ============= =============
Diluted weighted average shares outstanding........... 83,503 85,777 84,079 85,482
============= ============= ============= =============
See notes to consolidated financial statements.
-4-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
(in thousands, except share amounts)
Common Stock Additional Total
------------------------- Paid-In Retained Treasury Stockholders'
Shares Amount Capital Earnings Stock Equity
------------ ------------ ------------- ------------ ------------- --------------
Balance, December 28, 2003............. 108,503,243 $ 1,085 $ 200,574 $ 523,954 $ (265,881) $ 459,732
Net earnings....................... -- -- -- 86,019 -- 86,019
Purchases of treasury stock........ -- -- -- -- (88,224) (88,224)
Stock options exercised and
related tax benefit............. -- -- 9,675 -- 11,306 20,981
Shares issued under employee
benefit plans................... -- -- 3,150 -- 1,784 4,934
Restricted shares awarded
under equity incentive plan,
net of cancellations............ -- -- (544) -- 544 --
Amortization of unearned
compensation relating to
restricted shares............... -- -- 1,073 -- -- 1,073
Dividends paid for fractional
shares.......................... -- -- -- (48) -- (48)
------------ ------------ ------------- ------------ ------------- --------------
Balance, September 26, 2004........... 108,503,243 $ 1,085 $ 213,928 $ 609,925 $ (340,471) $ 484,467
============ ============ ============= ============ ============= ==============
See notes to consolidated financial statements.
-5-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
39 Weeks Ended
-----------------------------------
September 26, September 28,
2004 2003
--------------- ---------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings..................................................................... $ 86,019 $ 70,384
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization............................................... 33,708 30,091
Amortization of intangible assets........................................... 443 278
Amortization of unearned compensation....................................... 1,073 785
Other amortization.......................................................... 242 146
Inventory impairment........................................................ 2,100 --
Deferred income tax provision (benefit)..................................... 26,638 (541)
Gain on sale of investments................................................. -- (24)
Loss on disposition of restaurants and equipment............................ 1,520 1,314
Impairment of Chevys note receivable........................................ -- 8,803
Income tax benefit from exercise of options................................. 7,610 5,536
Changes in assets and liabilities (exclusive of effects of acquisitions or
disposition):
Receivables................................................................. (4,916) (5,890)
Receivables related to captive insurance subsidiary......................... (2,657) (290)
Inventories................................................................. (15,039) (2,454)
Prepaid income taxes........................................................ (1,904) 5,002
Other current assets related to captive insurance subsidiary................ (193) (1,134)
Prepaid and other current assets............................................ (1,185) 1,554
Accounts payable............................................................ (763) 7,300
Accrued expenses and other current liabilities.............................. (15,275) (1,798)
Loss reserve and unearned premiums related to captive insurance subsidiary.. 9,857 10,073
Accrued income taxes........................................................ -- 457
Other....................................................................... (1,010) 68
--------------- ---------------
NET CASH PROVIDED BY OPERATING ACTIVITIES................................... 126,268 129,660
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment.............................................. (68,224) (54,893)
Restricted assets related to captive insurance subsidiary........................ (7,548) (8,830)
Acquisition of restaurants....................................................... (13,817) (21,557)
Lease acquisition costs.......................................................... (4,857) --
Purchases of short-term investments.............................................. (253) --
Proceeds from sale of restaurants and equipment.................................. -- 8,579
Maturities and sales of short-term investments................................... -- 480
Other investing activities....................................................... (1,045) --
--------------- ---------------
NET CASH USED BY INVESTING ACTIVITIES....................................... (95,744) (76,221)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchases of treasury stock...................................................... (88,224) (49,757)
Dividends paid................................................................... (3,911) (3,323)
Issuance of common stock upon exercise of stock options.......................... 13,371 11,269
Shares issued under employee benefit plans....................................... 4,934 2,134
Proceeds from issuance of notes payable.......................................... 3,000 4,800
Net long-term debt proceeds (payments)........................................... 22,880 (30,372)
--------------- ---------------
NET CASH USED BY FINANCING ACTIVITIES....................................... (47,950) (65,249)
--------------- ---------------
NET DECREASE IN CASH AND CASH EQUIVALENTS............................................ (17,426) (11,810)
CASH AND CASH EQUIVALENTS, beginning of period....................................... 17,867 15,169
--------------- ---------------
CASH AND CASH EQUIVALENTS, end of period............................................. $ 441 $ 3,359
=============== ===============
See notes to consolidated financial statements.
-6-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Unaudited)
(in thousands)
39 Weeks Ended
-------------------------------------
September 26, September 28,
2004 2003
----------------- -----------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the 39 week period for:
Income taxes.................................................................. $ 13,561 $ 29,494
================= =================
Interest...................................................................... $ 544 $ 887
================= =================
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
We issued restricted common stock of $1,772,000 and $1,836,000 for the 39 weeks
ended September 26, 2004 and September 28, 2003, respectively.
On March 24, 2003, we assumed a loan of approximately $1,400,000 in connection
with the acquisition of 11 restaurants.
As of September 28, 2003, we recorded a receivable of $1,125,000 in connection
with the sale of a restaurant.
DISCLOSURE OF ACCOUNTING POLICY:
For purposes of the consolidated statements of cash flows, we consider all
highly liquid investments purchased with a maturity of three months or less to
be cash equivalents.
See notes to consolidated financial statements.
-7-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
Our consolidated financial statements included in this Form 10-Q have been
prepared without audit (except that the consolidated balance sheet information
as of December 28, 2003 has been derived from consolidated financial statements
which were audited) in accordance with the rules and regulations of the
Securities and Exchange Commission. Although certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted, we believe that the disclosures are adequate to
make the information presented not misleading. The accompanying 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 28, 2003.
We believe that all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the results of the interim
periods presented have been made. The results of operations for the interim
periods presented are not necessarily indicative of the results to be expected
for the full year.
We have made certain reclassifications to the prior periods' consolidated
financial statements to conform to the 2004 presentation.
2. Stock-Based Compensation
We have adopted the disclosure provisions of Statement of Financial Accounting
Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure, an amendment of FASB Statement No. 123." The
Statement requires prominent disclosures in both annual and interim financial
statements regarding the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. We account
for stock-based compensation awards under the intrinsic method of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
Opinion No. 25 requires compensation cost to be recognized based on the excess,
if any, between the quoted market price of the stock at the date of grant and
the amount an employee must pay to acquire the stock. All options awarded under
all of our plans are granted with an exercise price equal to the fair market
value on the date of the grant. The following table presents the effect on our
net earnings and earnings per share had we adopted the fair value method of
accounting for stock-based compensation under SFAS No. 123, "Accounting for
Stock-Based Compensation" (in thousands, except for per share amounts).
-8-
13 Weeks Ended 39 Weeks Ended
------------------------------- -------------------------------
September 26, September 28, September 26, September 28,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Net earnings, as reported............................. $ 28,289 $ 25,597 $ 86,019 $ 70,384
Add: Stock-based employee compensation
expense included in net earnings,
net of related taxes.............................. 327 433 616 1,393
Less: Total stock-based employee
compensation expense determined under
fair value based methods for all awards,
net of related taxes.............................. 2,220 2,159 6,719 7,088
--------------- --------------- --------------- ---------------
Pro forma net earnings................................ $ 26,396 $ 23,871 $ 79,916 $ 64,689
=============== =============== =============== ===============
Basic net earnings per common share,
as reported....................................... $ 0.35 $ 0.31 $ 1.05 $ 0.85
=============== =============== =============== ===============
Basic net earnings per common share,
pro forma......................................... $ 0.32 $ 0.29 $ 0.98 $ 0.78
=============== =============== =============== ===============
Diluted net earnings per common share,
as reported....................................... $ 0.34 $ 0.30 $ 1.02 $ 0.82
=============== =============== =============== ===============
Diluted net earnings per common share,
pro forma......................................... $ 0.32 $ 0.28 $ 0.95 $ 0.76
=============== =============== =============== ===============
3. Commitments and Contingencies
Litigation, claims and disputes: We are involved in various legal actions which
include, without limitation, employment law related matters, dram shop claims,
personal injury claims and other such normal restaurant operational matters. In
each instance, we believe that we have meritorious defenses to the allegations
made and we are vigorously defending these claims.
While the resolution of the matters described above may have an impact on our
financial results for the period in which they are resolved, we believe that the
ultimate disposition of these matters will not, individually or in the
aggregate, have a material adverse effect upon our business or consolidated
financial statements.
Lease guarantees: 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 26, 2004, the aggregate amount of
these lease payments totaled approximately $19,200,000. These leases expire at
various times throughout the next several years with the final lease agreement
expiring in 2025. The buyers have indemnified us from any losses related to
these guarantees. We have not recorded a liability as of September 26, 2004 or
December 28, 2003.
Franchisee guarantees: In November 2003, we arranged for a financing company to
provide up to $75,000,000 to qualified franchisees for short-term loans to fund
remodel investments. Under the terms of this financing program, we will provide
-9-
a limited guarantee pool for the loans advanced during the three-year period
ending December 2006. There was one loan outstanding for approximately $800,000
under this program as of September 26, 2004. The fair value of our guarantee was
immaterial and accordingly, we have not recorded a liability as of September 26,
2004.
In May 2004, we arranged for a financing company to provide up to $250,000,000
to qualified franchisees for loans to fund development of new restaurants
through October 2007. We will provide a limited guarantee of certain loans
advanced under this program. As of September 26, 2004, there was one loan
outstanding for approximately $2,400,000 under this program. The fair value of
our guarantee was immaterial and accordingly, we have not recorded a liability
as of September 26, 2004.
Severance agreements: We have severance and employment agreements with certain
officers providing for severance payments to be made in the event the employee
resigns or is terminated related to a change in control. The agreements define
the circumstances which will constitute a change in control. If the severance
payments had been due as of September 26, 2004, we would have been required to
make payments totaling approximately $12,300,000. In addition, we have severance
and employment agreements with certain officers which contain severance
provisions not related to a change in control. Those provisions would have
required aggregate payments of approximately $7,200,000 if such officers had
been terminated as of September 26, 2004.
4. Earnings Per Share
We compute basic earnings per share by dividing income available to common
shareholders by the weighted average number of common shares outstanding for the
reporting period. Diluted earnings per 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 earnings per
share. All amounts in the chart, except per share amounts, are expressed in
thousands.
13 Weeks Ended 39 Weeks Ended
------------------------------- -------------------------------
September 26, September 28, September 26, September 28,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Net earnings......................................... $ 28,289 $ 25,597 $ 86,019 $ 70,384
=============== =============== =============== ===============
Basic weighted average shares outstanding............ 81,511 83,334 81,759 83,132
Dilutive effect of stock options and
equity-based compensation.......................... 1,992 2,443 2,320 2,350
--------------- --------------- --------------- ---------------
Diluted weighted average shares outstanding.......... 83,503 85,777 84,079 85,482
=============== =============== =============== ===============
Basic net earnings per common share.................. $ 0.35 $ 0.31 $ 1.05 $ 0.85
=============== =============== =============== ===============
Diluted net earnings per common share................ $ 0.34 $ 0.30 $ 1.02 $ 0.82
=============== =============== =============== ===============
We excluded stock options with exercise prices greater than the average market
price of our common stock for the applicable periods from the computation of
diluted weighted average shares outstanding. There were approximately 1,520,000
and 5,000 of these options for the 13 weeks ended September 26, 2004 and
September 28, 2003, respectively, and 1,400,000 and 10,000 of these options for
the 39 weeks ended September 26, 2004 and September 28, 2003, respectively.
-10-
5. Stock Split
On May 13, 2004, we declared a three-for-two stock split, effected in the form
of a 50% stock dividend, to shareholders of record on May 28, 2004, payable on
June 15, 2004. We issued approximately 36,200,000 shares of common stock as a
result of the stock split. All references to the number of shares and per share
amounts of common stock have been restated to reflect the stock split. We have
reclassified an amount equal to the par value of the number of shares issued to
common stock from retained earnings.
6. Acquisitions
On April 26, 2004, we completed our acquisition of the operations and assets of
10 Applebee's restaurants located in Southern California for approximately
$13,700,000 in cash. Our financial statements reflect the results of operations
for these restaurants subsequent to the date of acquisition. The purchase price
was allocated to the fair value of property and equipment of $2,500,000,
goodwill of $10,800,000 and other net assets of approximately $400,000. We do
not expect this transaction to have a significant impact on our net earnings for
fiscal 2004.
On March 24, 2003, we acquired the operations and assets of 11 Applebee's
restaurants located in Illinois, Indiana, Kentucky and Missouri for $21,800,000
in cash and $1,400,000 in assumed debt from a franchisee. The total cash payment
included $20,800,000 paid at closing, approximately $200,000 paid as a deposit
in fiscal 2002 and approximately $800,000 paid in the second quarter of 2003.
Our financial statements reflect the results of operations for these restaurants
subsequent to the date of acquisition. The purchase price of $23,200,000 was
allocated to the fair value of property and equipment of $7,900,000, goodwill of
$16,600,000, and other net liabilities of $1,300,000.
The following table is comprised of actual company restaurant sales included in
our consolidated financial statements for each period presented and pro forma
company restaurant sales assuming the two acquisitions above occurred at the
beginning of each respective period (in thousands):
13 Weeks Ended 39 Weeks Ended
------------------------------- -------------------------------
September 26, September 28, September 26, September 28,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Actual company restaurant sales
for acquired restaurants.......................... $ 12,500 $ 6,100 $ 30,000 $ 13,100
=============== =============== =============== ===============
Pro forma company restaurant sales
for acquired restaurants.......................... $ 12,500 $ 11,600 $ 38,800 $ 35,600
=============== =============== =============== ===============
7. Disposition
On July 20, 2003, we completed the sale of eight company restaurants in the
Atlanta, Georgia market to an affiliate of an existing franchisee for
$8,000,000. In connection with the sale of these restaurants, we closed one
restaurant in the Atlanta market in June 2003. This transaction did not have a
significant impact on our net earnings for fiscal 2003. Actual company
restaurant sales included in our consolidated financial statements for the nine
restaurants were approximately $900,000 and $10,300,000 for the 13 weeks and 39
weeks ended September 28, 2003, respectively.
-11-
8. Inventory Impairment
In the second quarter of 2004, we determined that we had excess inventories of
riblets that no longer met our quality standards. Accordingly, we recorded an
inventory impairment of $2,100,000 (approximately $1,400,000 net of income
taxes) in our consolidated financial statements during the 39 weeks ended
September 26, 2004. The portion of the riblet inventory impairment related to
the company's historical usage of approximately $500,000 was recorded in food
and beverage cost and the portion related to the franchisee's historical usage
of approximately $1,600,000 was recorded in cost of other franchise income in
the consolidated statements of earnings.
9. Impairment of Chevys Note Receivable
In 1999, we received a $6,000,000, 8% subordinated note in connection with the
sale of the Rio Bravo concept to Chevys Holdings, Inc ("Chevys") due in 2009. In
June 2003, Chevys announced the sale of the majority of its restaurants.
Subsequent to the announcement, we received Chevys' audited financial statements
for the fiscal year ended December 31, 2002. During the fiscal quarter ended
June 29, 2003, we fully impaired the principal and accrued interest of
approximately $8,800,000. A charge for the impairment of this note is included
in our consolidated statements of earnings for the 39 weeks ended September 28,
2003. In October 2003, Chevys Inc. filed a voluntary petition to reorganize
under Chapter 11 of the U.S. Bankruptcy Code. We no longer accrue interest
receivable on this note and will record future interest income on this note only
upon the receipt of any related cash payments.
10. Goodwill and Other Intangible Assets
Changes in goodwill are summarized below (in thousands):
September 26, December 28,
2004 2003
---------------------- ----------------------
Carrying amount, beginning of the year.................. $ 105,326 $ 88,715
Goodwill acquired during the period..................... 11,018 16,611
---------------------- ----------------------
$ 116,344 $ 105,326
====================== ======================
Intangible assets subject to amortization pursuant to SFAS No. 142, "Goodwill
and Other Intangible Assets," are summarized below (in thousands):
September 26, 2004
------------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights....... $ 6,371 $ 5,482 $ 889
Lease acquisition costs............. 4,857 182 4,675
------------------ ---------------- -----------------
Total................................... $ 11,228 $ 5,664 $ 5,564
================== ================ =================
December 28, 2003
-----------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ---------------- -----------------
Amortized intangible assets:
Franchise interest and rights....... $ 6,371 $ 5,234 $ 1,137
================== ================ =================
-12-
In the second quarter of 2004, we acquired six restaurant leases for
approximately $4,900,000 in cash. The lease acquisition costs are being
amortized over the next 8 to 20 years and the franchise interest and rights are
being amortized over the next two to four years.
We expect annual amortization expense for all intangible assets for the next
five fiscal years to range from approximately $500,000 to $800,000.
11. Captive Insurance Subsidiary
In 2002, we formed Neighborhood Insurance, Inc., a Vermont corporation and a
wholly-owned captive insurance subsidiary to provide Applebee's International,
Inc. and qualified franchisees with workers' compensation and general liability
insurance. Applebee's International, Inc. and covered franchisees make premium
payments to the captive insurance company which pays administrative fees and
insurance claims, subject to individual and aggregate maximum claim limits under
the captive insurance company's reinsurance policies. Franchisee premium amounts
billed by the captive insurance company are established based upon third-party
actuarial estimates of settlement costs for incurred claims and administrative
fees. The franchisee premiums are included in other franchise income ratably
over the policy year. The related offsetting expenses are included in cost of
other franchise income. Accordingly, we do not expect franchisee participation
in the captive insurance company to have a material impact on our net earnings.
As of September 26, 2004, our consolidated balance sheet includes the following
balances related to the captive insurance subsidiary:
o Deferred policy acquisition costs of approximately $900,000 included in
other current assets related to captive insurance subsidiary.
o Franchise premium receivables of approximately $3,100,000 included in
receivables related to captive insurance subsidiary.
o Cash equivalent investments restricted for the payment of claims of
approximately $17,600,000 included in restricted assets related to
captive insurance subsidiary.
o Loss reserve and unearned premiums related to captive insurance
subsidiary of approximately $20,900,000.
o Other miscellaneous items, net, of approximately $700,000 included in
several line items in the consolidated balance sheet.
12. Deferred Income Taxes
In 2004, we implemented new tax planning strategies that accelerated
depreciation on restaurant assets which resulted in an increase in our deferred
income tax liability. Deferred income taxes of $32,141,000 are reflected in
non-current liabilities in our consolidated balance sheet as of September 26,
2004.
-13-
13. New Accounting Pronouncement
In December 2003, the FASB issued FASB Interpretation No. ("FIN") 46R,
"Consolidation of Variable Interest Entities and Interpretation of ARB No. 51."
This interpretation, which replaces FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities," clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to certain entities in
which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support. This
interpretation is required in financial statements for periods ending after
March 15, 2004 for those companies that have yet to adopt the provisions of FIN
46. We adopted FIN 46R in January 2004 and the initial adoption did not have a
material impact on our consolidated financial statements.
-14-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Our revenues are generated from three primary sources:
o Company restaurant sales (food and beverage sales)
o Franchise royalties and fees
o Other franchise income
Beverage sales consist of sales of alcoholic beverages, while non-alcoholic
beverages are included in food sales. Franchise royalties are generally 4% of
each franchise restaurant's monthly gross sales. Franchise fees typically range
from $30,000 to $35,000 for each restaurant opened. Other franchise income
includes insurance premiums from franchisee participation in our captive
insurance company and revenue from information technology products and services
provided to certain franchisees.
Comparable restaurant sales are based upon those restaurants open for at least
18 months and are compared from period to period.
Certain expenses relate only to company operated restaurants. These include:
o Food and beverage costs
o Labor costs
o Direct and occupancy costs
o Pre-opening expenses
Cost of other franchise income includes the costs related to franchisee
participation in our captive insurance company and costs related to information
technology products and services provided to certain franchisees. In addition,
cost of other franchise income in fiscal 2004 includes the franchisee portion of
the riblet inventory impairment (see Note 8).
Other expenses, such as general and administrative and amortization expenses,
relate to both company operated restaurants and franchise operations.
We operate on a 52 or 53 week fiscal year ending on the last Sunday in December.
Our fiscal quarters ended September 26, 2004 and September 28, 2003 each
contained 13 weeks and are referred to hereafter as the "2004 quarter" and the
"2003 quarter," respectively. Our 39 week periods ended September 26, 2004 and
September 28, 2003 are referred to hereafter as the "2004 year-to-date period"
and the "2003 year-to-date period," respectively.
In 2002, we formed Neighborhood Insurance, Inc., a Vermont corporation and a
wholly-owned captive insurance subsidiary to provide Applebee's International,
Inc. and qualified franchisees with workers' compensation and general liability
insurance. Applebee's International, Inc. and covered franchisees make premium
payments to the captive insurance company which pays administrative fees and
insurance claims, subject to individual and aggregate maximum claim limits under
the captive insurance company's reinsurance policies. Franchisee premium amounts
billed by the captive insurance company are established based upon third-party
actuarial estimates of settlement costs for incurred claims and administrative
-15-
fees. The franchisee premiums are included in other franchise income ratably
over the policy year. The related offsetting expenses are included in cost of
other franchise income. Accordingly, we do not expect franchisee participation
in the captive insurance company to have a material impact on our net earnings.
As of September 26, 2004, our consolidated balance sheet includes the following
balances related to the captive insurance subsidiary:
o Deferred policy acquisition costs of approximately $900,000 included in
other current assets related to captive insurance subsidiary.
o Franchise premium receivables of approximately $3,100,000 included in
receivables related to captive insurance subsidiary.
o Cash equivalent investments restricted for the payment of claims of
approximately $17,600,000 included in restricted assets related to
captive insurance subsidiary.
o Loss reserve and unearned premiums related to captive insurance
subsidiary of approximately $20,900,000.
o Other miscellaneous items, net, of approximately $700,000 included in
several line items in the consolidated balance sheet.
Application of Critical Accounting Policies
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based upon our 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 consolidated financial
statements and notes thereto. Actual results may differ from these estimates,
and such differences may be material to our consolidated financial statements.
We believe that the following significant accounting policies involve a higher
degree of judgment or complexity.
Franchise revenues: Franchise revenues consist of franchise royalties, franchise
fees and other franchise income. We recognize royalties on a franchisee's sales
in the period in which the sales are reported to have occurred. We also receive
a franchise fee for each restaurant that a franchisee opens. The recognition of
franchise fees is deferred until we have performed substantially all of our
related obligations as franchisor, typically when the restaurant opens. Other
franchise income includes insurance premiums from franchisee participation in
our captive insurance company and revenue from information technology products
and services provided to certain franchisees. Income from franchise premiums and
information technology services is recognized ratably over the related contract
period. Income from information technology products is recognized when the
products are installed at the restaurant.
Inventory valuation: We state inventories at the lower of cost, using the
first-in, first-out method, or market. Market is determined based upon the
estimated net realizable value.
We purchase and maintain inventories of certain specialty products to assure
sufficient supplies to the system. 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.
Property and equipment: Property and equipment are depreciated on a
straight-line basis over the estimated useful lives of the assets. 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.
Impairment of long-lived assets: We periodically review property and equipment
for impairment on a restaurant by restaurant basis using historical cash flows
as well as current estimates of future cash flows and/or appraisals. This
assessment process requires the use of estimates and assumptions which are
-16-
subject to a significant degree of judgment. In addition, we periodically assess
the recoverability of goodwill and other intangible assets, which requires us to
make assumptions regarding the future cash flows and other factors to determine
the fair value of the assets. If these assumptions change in the future, we may
be required to record impairment charges for these assets.
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.
Employee incentive compensation plans: We have various long-term employee
incentive compensation plans which require us to make estimates to determine our
liability based upon projected performance of plan criteria. If actual
performance against the criteria differs from our estimates in the future, we
will be required to adjust our liability accordingly.
Receivables: We continually assess the collectibility of our franchise
receivables. We establish our allowance for bad debts based on several factors,
including historical collection experience, the current economic environment and
other specific information available to us at the time. The allowance for bad
debts may change in the future due to changes in the factors above or other
developments.
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
On April 26, 2004, we completed our acquisition of the operations and assets of
10 Applebee's restaurants located in Southern California for approximately
$13,700,000 in cash. Our financial statements reflect the results of operations
for these restaurants subsequent to the date of acquisition. The purchase price
was allocated to the fair value of property and equipment of $2,500,000,
goodwill of $10,800,000 and other net assets of approximately $400,000. We do
not expect this transaction to have a significant impact on our net earnings for
fiscal 2004.
On March 24, 2003, we acquired the operations and assets of 11 Applebee's
restaurants located in Illinois, Indiana, Kentucky and Missouri for $21,800,000
in cash and $1,400,000 in assumed debt from a franchisee. The total cash payment
included $20,800,000 paid at closing, approximately $200,000 paid as a deposit
in fiscal 2002 and approximately $800,000 paid in the second quarter of 2003.
Our financial statements reflect the results of operations for these restaurants
subsequent to the date of acquisition. The purchase price of $23,200,000 was
allocated to the fair value of property and equipment of $7,900,000, goodwill of
$16,600,000, and other net liabilities of $1,300,000.
-17-
The following table is comprised of actual company restaurant sales included in
our consolidated financial statements for each period presented and pro forma
company restaurant sales assuming the two acquisitions above occurred at the
beginning of each respective period (in thousands):
13 Weeks Ended 39 Weeks Ended
------------------------------- -------------------------------
September 26, September 28, September 26, September 28,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Actual company restaurant sales
for acquired restaurants.......................... $ 12,500 $ 6,100 $ 30,000 $ 13,100
=============== =============== =============== ===============
Pro forma company restaurant sales
for acquired restaurants.......................... $ 12,500 $ 11,600 $ 38,800 $ 35,600
=============== =============== =============== ===============
Disposition
On July 20, 2003, we completed the sale of eight company restaurants in the
Atlanta, Georgia market to an affiliate of an existing franchisee for
$8,000,000. In connection with the sale of these restaurants, we closed one
restaurant in the Atlanta market in June 2003. This transaction did not have a
significant impact on our net earnings for fiscal 2003. Actual company
restaurant sales included in our consolidated financial statements for the nine
restaurants were approximately $900,000 and $10,300,000 for the 13 weeks and the
39 weeks ended September 28, 2003, respectively.
-18-
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.
13 Weeks Ended 39 Weeks Ended
------------------------------------ -----------------------------------
September 26, September 28, September 26, September 28,
2004 2003 2004 2003
---------------- ---------------- --------------- ----------------
Revenues:
Company restaurant sales...................... 87.9% 87.9% 87.9% 87.7%
Franchise royalties and fees.................. 10.7 10.9 10.9 11.1
Other franchise income........................ 1.4 1.2 1.2 1.2
---------------- ---------------- --------------- ----------------
Total operating revenues................. 100.0% 100.0% 100.0% 100.0%
================ ================ =============== ================
Cost of sales (as a percentage of company
restaurant sales):
Food and beverage............................. 26.3% 25.7% 26.4% 26.0%
Labor......................................... 32.2 32.8 32.5 32.8
Direct and occupancy.......................... 24.9 25.1 24.5 24.7
Pre-opening expense........................... 0.4 0.3 0.3 0.2
---------------- ---------------- --------------- ----------------
Total cost of sales...................... 83.9% 83.9% 83.8% 83.6%
================ ================ =============== ================
Cost of other franchise income (as a percentage
of other franchise income)...................... 90.0% 95.5% 110.2% 95.8%
General and administrative expenses............... 9.5 9.3 9.2 9.3
Amortization of intangible assets................. 0.1 -- 0.1 --
Loss on disposition of restaurants and equipment.. 0.2 -- 0.2 0.2
---------------- ---------------- --------------- ----------------
Operating earnings................................ 15.3 15.7 15.6 16.0
---------------- ---------------- --------------- ----------------
Other income (expense):
Investment income............................. 0.1 0.1 0.1 0.1
Interest expense.............................. (0.1) (0.1) (0.1) (0.2)
Impairment of Chevys note receivable.......... -- -- -- (1.2)
Other income.................................. 0.2 0.2 0.2 0.1
---------------- ---------------- --------------- ----------------
Total other income (expense)............. 0.2 0.1 0.1 (1.1)
---------------- ---------------- --------------- ----------------
Earnings before income taxes...................... 15.5 15.8 15.7 14.8
Income taxes...................................... 5.4 5.7 5.5 5.3
---------------- ---------------- --------------- ----------------
Net earnings...................................... 10.1% 10.1% 10.2% 9.5%
================ ================ =============== ================
-19-
The following table sets forth certain unaudited financial information and other
restaurant data relating to company and franchise restaurants, as reported to us
by franchisees:
13 Weeks Ended 39 Weeks Ended
------------------------------- -------------------------------
September 26, September 28, September 26, September 28,
2004 2003 2004 2003
------------- ------------- -------------- -------------
Number of restaurants:
Company:
Beginning of period....................... 405 373 383 357
Restaurant openings....................... 9 8 21 15
Restaurants closed........................ (1) -- (1) (2)
Restaurants acquired from franchisees..... -- -- 10 11
Restaurants acquired by franchisees....... -- (9) -- (9)
------------- ------------- -------------- -------------
End of period............................. 413 372 413 372
------------- ------------- -------------- -------------
Franchise:
Beginning of period....................... 1,207 1,155 1,202 1,139
Restaurant openings....................... 21 12 40 41
Restaurants closed(1)..................... (4) (5) (8) (7)
Restaurants acquired from franchisees..... -- -- (10) (11)
Restaurants acquired by franchisees....... -- 9 -- 9
------------- ------------- -------------- -------------
End of period............................. 1,224 1,171 1,224 1,171
------------- ------------- -------------- -------------
Total:
Beginning of period....................... 1,612 1,528 1,585 1,496
Restaurant openings....................... 30 20 61 56
Restaurants closed........................ (5) (5) (9) (9)
------------- ------------- -------------- -------------
End of period............................. 1,637 1,543 1,637 1,543
============= ============= ============== =============
Weighted average weekly sales per restaurant:
Company........................................ $ 46,365 $ 45,976 $ 47,489 $ 45,356
Franchise...................................... $ 47,253 $ 45,760 $ 48,258 $ 45,637
Total.......................................... $ 47,027 $ 45,812 $ 48,067 $ 45,569
Change in comparable restaurant sales:(2)
Company........................................ 1.1% 5.9% 5.0% 5.2%
Franchise...................................... 3.1% 4.4% 5.9% 3.5%
Total.......................................... 2.7% 4.8% 5.6% 3.9%
Total operating revenues (in thousands):
Company restaurant sales....................... $ 247,173 $ 222,429 $ 738,502 $ 650,946
Franchise royalties and fees(3)................ 30,105 27,594 91,656 82,088
Other franchise income(4)...................... 3,913 2,972 10,427 8,881
------------- ------------- -------------- -------------
Total.......................................... $ 281,191 $ 252,995 $ 840,585 $ 741,915
============= ============= ============== =============
(1) Subsequent to the end of the quarter, 12 franchise restaurants in the
Memphis, Tennessee area were closed.
(2) When computing comparable restaurant sales, restaurants open for at least 18
months are compared from period to period.
(3) Franchise royalties are generally 4% of each franchise restaurant's reported
monthly gross sales. Reported franchise sales, in thousands, were $746,239
and $687,292 in the 2004 quarter and the 2003 quarter, respectively, and
$2,274,777 and $2,047,735 in the 2004 year-to-date and 2003 year-to-date
period, respectively. Franchise fees typically range from $30,000 to $35,000
for each restaurant opened.
(4) Other franchise income includes insurance premiums from franchisee
participation in our captive insurance company and revenue from information
technology products and services provided to certain franchisees.
-20-
Company Restaurant Sales. Total company restaurant sales increased $24,744,000
(11%) from $222,429,000 in the 2003 quarter to $247,173,000 in the 2004 quarter
and increased $87,556,000 (13%) from $650,946,000 in the 2003 year-to-date
period to $738,502,000 in the 2004 year-to-date period. Company restaurant
openings contributed approximately 8% of the increase in total company
restaurant sales in both the 2004 quarter and the 2004 year-to-date period.
Increases in weighted average weekly sales contributed approximately 1% and 5%
of the total company sales increase in the 2004 quarter and 2004 year-to-date
period, respectively. Both periods were also favorably impacted by the
acquisition of 10 restaurants in Southern California in April 2004 which was
partially offset by the impact of the sale of 8 restaurants in the Atlanta,
Georgia market in July 2003.
Comparable restaurant sales at company restaurants increased by 1.1% and 5.0% in
the 2004 quarter and the 2004 year-to-date period, respectively. Weighted
average weekly sales at company restaurants increased 0.8% from $45,976 in the
2003 quarter to $46,365 in the 2004 quarter and increased 4.7% from $45,356 in
the 2003 year-to-date period to $47,489 in the 2004 year-to-date period. These
increases were due primarily to increases in the average guest check resulting
from a menu price increase of approximately 1.5% in both periods and increases
in guest traffic in the 2004 year-to-date period. In addition, a portion of the
increase resulted from the implementation of our Carside To Go(TM) initiative.
Carside To Go(TM) sales mix increased from 6.9% of company restaurant sales in
the 2003 quarter to 8.9% of company restaurant sales in the 2004 quarter.
Franchise Royalties and Fees. Overall franchise royalties and fees increased
$2,511,000 (9%) from $27,594,000 in the 2003 quarter to $30,105,000 in the 2004
quarter and increased $9,568,000 (12%) from $82,088,000 in the 2003 year-to-date
period to $91,656,000 in the 2004 year-to-date period. These increases were due
primarily to the increased number of franchise restaurants operating during the
2004 quarter and 2004 year-to-date period as compared to the same periods in
2003 and increases in comparable restaurant sales. Weighted average weekly sales
at franchise restaurants increased 3.3% and 5.7% in the 2004 quarter and 2004
year-to-date period, respectively, and franchise comparable restaurant sales
increased 3.1% and 5.9% in the 2004 quarter and 2004 year-to-date period,
respectively.
Other Franchise Income. Other franchise income increased $941,000 (32%) from
$2,972,000 in the 2003 quarter to $3,913,000 in the 2004 quarter and increased
$1,546,000 (17%) from $8,881,000 in the 2003 year-to-date period to $10,427,000
in the 2004 year-to-date period due primarily to revenues recognized related to
the franchise premium amounts billed by the captive insurance company. Franchise
premiums are included in other franchise income ratably over the policy year.
Cost of Company Restaurant Sales. Food and beverage costs increased from 25.7%
in the 2003 quarter to 26.3% in the 2004 quarter and increased from 26.0% in the
2003 year-to-date period to 26.4% in the 2004 year-to-date period. The increases
in both the 2004 quarter and 2004 year-to-date period were due primarily to
higher commodity costs and higher food costs related to new menu items and were
partially offset by menu price increases. The 2004 year-to-date period was also
unfavorably impacted by the company portion of the impairment of approximately
$500,000 for excess riblet inventories which no longer met our quality
standards.
Labor costs decreased from 32.8% in the 2003 quarter to 32.2% in the 2004
quarter and decreased from 32.8% in the 2003 year-to-date period to 32.5% in the
2004 year-to-date period. The decreases were due to lower management costs due
to higher sales volumes at company restaurants in the 2004 year-to-date period
and lower management incentive compensation in both the 2004 quarter and the
2004 year-to-date period. These decreases were partially offset by higher costs
related to the addition of dedicated Carside To Go(TM) hourly labor at most of
our restaurants beginning in the second half of 2003, increased hourly labor
wage rates and higher workers' compensation costs.
-21-
Direct and occupancy costs decreased from 25.1% in the 2003 quarter and 24.7% in
the 2003 year-to-date period to 24.9% in the 2004 quarter and 24.5% in the 2004
year-to-date period. The decrease in the 2004 quarter was due primarily to lower
advertising costs, as a percentage of sales, due to the timing of our menu
promotions. The decrease in the 2004 year-to-date period was due primarily to
higher sales volumes at company restaurants which resulted in favorable
depreciation expense, rent expense and repairs and maintenance expense, as a
percentage of sales, due to their relatively fixed nature. In addition,
decreases in both periods were partially offset by higher packaging costs as a
result of increased Carside To Go(TM) sales volumes.
Cost of Other Franchise Income. Cost of other franchise income increased
$684,000 (24%) from $2,837,000 in the 2003 quarter to $3,521,000 in the 2004
quarter and increased $2,983,000 (35%) from $8,510,000 in the 2003 year-to-date
period to $11,493,000 in the 2004 year-to-date due primarily to an increase in
costs related to the operation of our captive insurance company and the
franchisee portion of the inventory impairment of approximately $1,600,000 in
the 2004 year-to-date period for excess riblet inventories which no longer met
our quality standards.
General and Administrative Expenses. General and administrative expenses
increased from 9.3% in the 2003 quarter to 9.5% in the 2004 quarter and
decreased from 9.3% in the 2003 year to date period to 9.2% in the 2004
year-to-date period. General and administrative expenses were favorably impacted
in both periods by the absorption of general and administrative expenses over a
larger revenue base and lower incentive compensation. In addition, both periods
were unfavorably impacted by higher compensation expense due to staffing levels
and costs associated with compliance with Section 404 of the Sarbanes-Oxley Act.
Impairment of Chevys Note Receivable. In June 2003, Chevys announced the sale of
the majority of its restaurants. Subsequent to the announcement, we received
Chevys' audited financial statements for the fiscal year ended December 31,
2002. During the fiscal quarter ended June 29, 2003, we fully impaired the
principal and accrued interest of approximately $8,800,000. In October 2003,
Chevys Inc. filed a voluntary petition to reorganize under Chapter 11 of the
U.S. Bankruptcy Code.
Income Taxes. The effective income tax rate, as a percentage of earnings before
income taxes, decreased from 36.0% in both the 2003 quarter and the 2003
year-to-date period to 35.0% in both the 2004 quarter and the 2004 year-to-date
period due to a reduction in state and local income taxes.
Liquidity and Capital Resources
Our need for capital historically has resulted from the construction and
acquisition of restaurants, the repurchase of our common shares and investment
in information technology systems. In the past, we have obtained capital through
public stock offerings, debt financing, and our ongoing operations. Cash flows
from our ongoing operations include cash generated from company and franchise
operations, credit from trade suppliers, real estate lease financing, and
landlord contributions to leasehold improvements. We have also used our common
stock as consideration in the acquisition of restaurants. In addition, we have
assumed debt or issued new debt in connection with certain mergers and
acquisitions.
Capital expenditures were $82,562,000 in 2003 (excluding the acquisition of 11
restaurants) and $68,224,000 in the 2004 year-to-date period (excluding the
acquisition of 10 restaurants and lease acquisition costs). We currently expect
to open at least 32 company restaurants, and capital expenditures, excluding
acquisitions, are expected to be between $95,000,000 and $105,000,000 in 2004.
These expenditures will primarily be for the development of new restaurants,
-22-
refurbishment and capital replacement for existing restaurants, the enhancement
of information systems and lease acquisition costs. Because we expect to
continue to purchase a portion of our sites, the amount of actual capital
expenditures will be dependent upon, among other things, the proportion of
leased versus owned properties. In addition, if we open more restaurants than we
currently anticipate or acquire additional restaurants, our capital requirements
will increase accordingly.
On April 26, 2004, we completed our acquisition of the operations and assets of
10 Applebee's restaurants located in Southern California for approximately
$13,700,000 in cash. Our financial statements reflect the results of operations
for these restaurants subsequent to the date of acquisition. In addition, we
acquired six restaurant leases for approximately $4,900,000 in cash in the 2004
year-to-date period.
On July 20, 2003, we completed the sale of eight company restaurants in the
Atlanta, Georgia market to an affiliate of an existing franchisee for
$8,000,000. In connection with the sale of these restaurants, we closed one
restaurant in the Atlanta market in June 2003.
On March 24, 2003, we acquired the operations and assets of 11 Applebee's
restaurants located in Illinois, Indiana, Kentucky and Missouri for $21,800,000
in cash and $1,400,000 in assumed debt from a franchisee. The total cash payment
included $20,800,000 paid at closing, approximately $200,000 paid as a deposit
in fiscal 2002 and approximately $800,000 paid in the second quarter of 2003.
Our financial statements reflect the results of operations for these restaurants
subsequent to the date of acquisition.
Our bank credit agreement, as amended, expires in November of 2005 and provides
for a $150,000,000 unsecured revolving credit facility, of which $25,000,000 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, and limit additional indebtedness and capital
expenditures in excess of specified amounts. Cash dividends are limited to
$10,000,000 annually. The facility is subject to standard other terms,
conditions, covenants, and fees. We are currently in compliance with the
covenants contained in our credit agreement. As of September 26, 2004, we had
borrowings of $41,000,000, which included $3,000,000 in short-term borrowings,
and had standby letters of credit of approximately $11,970,000 outstanding under
our revolving credit facility.
Our Board of Directors authorized repurchases of our common stock of up to
$75,000,000 and $80,000,000 in 2002 and 2003, respectively. As of December 28,
2003, we had $99,800,000 remaining on our authorizations. During the 2004
year-to-date period, we repurchased 3,504,970 shares of our common stock at an
average price of $25.17 for an aggregate cost of $88,200,000. As of September
26, 2004, we had $11,500,000 remaining under our repurchase authorization. In
October 2004, our Board of Directors authorized additional repurchases of up to
$150,000,000 beginning in 2005 and approved a written plan for repurchases of
our common stock in the open market in accordance with Rule 10b5-1 of the
Securities Exchange Act of 1934.
As of September 26, 2004, our liquid assets totaled $722,000. These assets
consisted of cash and cash equivalents in the amount of $441,000 and short-term
investments in the amount of $281,000. The working capital deficit decreased
from $62,710,000 as of December 28, 2003 to $49,270,000 as of September 26,
2004. This decrease was due primarily to the redemption of gift cards in 2004
sold in 2003, repurchases of our common stock and increases in inventories and
receivables and was partially offset by increases in loss reserve and unearned
premiums related to the captive insurance subsidiary.
-23-
Our deferred income taxes liability increased from $5,880,000 as of December 28,
2003 to $32,141,000 as of September 26, 2004 which contributed to an increase in
our cash flows from operating activities of $26,638,000 in our consolidated
statement of cash flows for the 39 weeks ended September 26, 2004. In 2004, we
implemented new tax planning strategies that accelerated depreciation on
restaurant assets.
We believe that our liquid assets and cash generated from operations, combined
with borrowings available under our credit facilities, will provide sufficient
funds for our operating, capital and other requirements 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 26, 2004 (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)............................. $ 42,575 $ 3,121 $ 38,227 $ 87 $ 1,140
Capital Lease Obligations........................ 9,388 760 1,602 1,671 5,355
Operating Leases................................. 256,248 22,968 44,802 41,832 146,646
Purchase Obligations - Company(1)................ 223,771 176,369 31,432 12,043 3,927
Purchase Obligations - Franchise(2)............. 529,551 419,532 76,768 21,613 11,638
(1) The amounts for company purchase obligations include commitments for food
items and supplies, severance and employment agreements, and other
miscellaneous commitments.
(2) The amounts for franchise purchase obligations include commitments for food
items and supplies made by Applebee's International, Inc. for our
franchisees. Applebee's International, Inc. contracts with certain suppliers
to ensure competitive pricing. These amounts will only be payable by
Applebee's International, Inc. if our franchisees do not meet certain
minimum contractual requirements.
Other Contractual Obligations
We have outstanding lease guarantees of approximately $19,200,000 as of
September 26, 2004 (see Note 3). We have not recorded a liability for these
guarantees as of September 26, 2004 or December 28, 2003.
We have severance and employment agreements with certain officers providing for
severance payments to be made in the event the employee resigns or is terminated
related to a change in control. The agreements define the circumstances which
will constitute a change in control. If the severance payments had been due as
of September 26, 2004, we would have been required to make payments totaling
approximately $12,300,000. In addition, we have severance and employment
agreements with certain officers which contain severance provisions not related
to a change in control. Those provisions would have required aggregate payments
of approximately $7,200,000 if such officers had been terminated as of September
26, 2004.
In November 2003, we arranged for a financing company to provide up to
$75,000,000 to qualified franchisees for short-term loans to fund remodel
investments. Under the terms of this financing program, we will provide a
limited guarantee pool for the loans advanced during the three-year period
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ending December 2006. There was one loan outstanding for approximately $800,000
under this program as of September 26, 2004. The fair value of our guarantee was
immaterial and accordingly, we have not recorded a liability as of September 26,
2004.
In May 2004, we arranged for a financing company to provide up to $250,000,000
to qualified franchisees for loans to fund development of new restaurants
through October 2007. We will provide a limited guarantee of certain loans
advanced under this program. As of September 26, 2004, there was one loan
outstanding for approximately $2,400,000 under this program. The fair value of
our guarantee was immaterial and accordingly, we have not recorded a liability
as of September 26, 2004.
Inflation
Substantial increases in costs and expenses could impact our operating results
to the extent such increases cannot be passed along to customers. In particular,
increases in food, supplies, labor and operating expenses could have a
significant impact on our operating results. We do not believe that inflation
has materially affected our operating results during the past three years.
A majority of our employees are paid hourly rates related to federal and state
minimum wage laws and various laws that allow for credits to that wage. The
Federal government continues to consider an increase in the minimum wage.
Several state governments have increased the minimum wage and other state
governments are also considering an increased minimum wage. In the past, we have
been able to pass along cost increases to customers through food and beverage
price increases, and we will attempt to do so in the future. We cannot
guarantee, however, that all future cost increases can be reflected in our
prices or that increased prices will be absorbed by customers without at least
somewhat diminishing customer spending in our restaurants.
New Accounting Pronouncement
In December 2003, the FASB issued FASB Interpretation No. ("FIN") 46R,
"Consolidation of Variable Interest Entities and Interpretation of ARB No. 51."
This interpretation, which replaces FASB Interpretation No. 46, "Consolidation
of Variable Interest Entities," clarifies the application of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," to certain entities in
which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support. This
interpretation is required in financial statements for periods ending after
March 15, 2004 for those companies that have yet to adopt the provisions of FIN
46. We adopted FIN 46R in January 2004 and the initial adoption did not have a
material impact on our consolidated financial statements.
Forward-Looking Statements
The statements contained in the "Management's Discussion and Analysis of
Financial Condition and Results of Operations" section regarding restaurant
development, capital expenditures 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
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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, and our
ability to control restaurant operating costs which are impacted by market
changes, minimum wage and other employment laws, food costs and inflation. For a
more detailed discussion of the principal factors that could cause actual
results to be materially different, you should read our current report on Form
8-K which we filed with the Securities and Exchange Commission on February 11,
2004. We disclaim any obligation to update forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk from fluctuations in interest rates and changes in
commodity prices. Our revolving credit facility bears interest at either the
bank's prime rate or LIBOR plus 0.625%, at our option. As of September 26, 2004,
the total amount of debt subject to interest rate fluctuations was $41,000,000
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 $410,000
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. Many of the food
products we purchase are subject to price volatility due to factors that are
outside of our control such as available supply, weather and seasonality. 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 26, 2004, we have evaluated the effectiveness of the design and
operation of our disclosure controls and procedures under the supervision and
with the participation of the Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"). Based on this evaluation, our management, including
the CEO and CFO, concluded that our disclosure controls and procedures were
effective. During our most recent fiscal quarter, there have been no changes in
our internal control over financial reporting that have materially affected or
are reasonably likely to materially affect our internal control over financial
reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in various legal actions which include, without limitation,
employment law related matters, dram shop claims, personal injury claims and
other such normal restaurant operational matters. In each instance, we believe
that we have meritorious defenses to the allegations made and we are vigorously
defending these claims.
While the resolution of the matters described above may have an impact on our
financial results for the period in which they are resolved, we believe that the
ultimate disposition of these matters will not, individually or in the
aggregate, have a material adverse effect upon our business or consolidated
financial statements.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Issuer Purchases of Equity Securities.
------------------------------------------------------------------------------------------------------------------------------
Purchases of Equity Securities(1) (2)
------------------------------------------------------------------------------------------------------------------------------
-------------------------------- ------------------ ---------- ---------------------------- ----------------------------------
(a) (b) (c) (d)
-------------------------------- ------------------ ---------- ---------------------------- ----------------------------------
Average Total Number of Shares Maximum Dollar Value of Shares
Price Purchased as Part of that May Yet Be Purchased Under
Total Number of Paid Per Publicly Announced Plans the Plans or Programs
Period Shares Purchased Share or Programs (in thousands)
-------------------------------- ------------------ ---------- ---------------------------- ----------------------------------
June 28, 2004 through July 27,
2004 3,850(3) $25.81 -- $46,532
-------------------------------- ------------------ ---------- ---------------------------- ----------------------------------
July 28, 2004 through August
27, 2004 597,906(4) $25.25 594,115 $31,532
-------------------------------- ------------------ ---------- ---------------------------- ----------------------------------
August 28, 2004 through
September 26, 2004 813,405 $24.59 813,405 $11,532
-------------------------------- ------------------ ---------- ---------------------------- ----------------------------------
Total 1,415,161
================================ ================== ========== ============================ ==================================
(1) In May 2002, our Board of Directors authorized a repurchase of up to
$75,000,000 of our common stock through May 2005. In December 2003, our
Board of Directors authorized an additional repurchase of up to $80,000,000
of our common stock. The May 2002 authorization limit was met in January
2004. The December 2003 authorization has no expiration date.
(2) All references to the number of shares have been restated to reflect a
three-for-two stock split, effected as a 50% stock dividend, paid on June
15, 2004.
(3) Represents shares received as partial payment for shares issued under stock
option plans.
(4) Included 3,791 shares received as partial payment for shares issued under
stock option plans.
Item 6. Exhibits
The Exhibits listed on the accompanying Exhibit Index are filed as part of this
report.
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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 27, 2004 By: /s/ Lloyd L. Hill
--------------------------- ---------------------------------------------------------
Lloyd L. Hill
Chairman and Chief Executive Officer
(principal executive officer)
Date: October 27, 2004 By: /s/ Steven K. Lumpkin
--------------------------- ---------------------------------------------------------
Steven K. Lumpkin
Executive Vice President and
Chief Financial Officer
(principal financial officer)
Date: October 27, 2004 By: /s/ Beverly O. Elving
--------------------------- ---------------------------------------------------------
Beverly O. Elving
Vice President, Accounting
(principal accounting officer)
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APPLEBEE'S INTERNATIONAL, INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------------- ------------------------------------------------------------------------------------------------
10.1 Form of Nonqualified Stock Option Agreement
10.2 Form of Incentive Stock Option Agreement
10.3 Form of Restricted Stock Award Agreement
10.4 New Form of Change in Control and Noncompete Agreement and schedule
of parties thereto.
10.5 Amendment No. 2 to the Revolving Credit Agreement dated as of November 5, 2001
31.1 Certification of Chairman and Chief Executive Officer Pursuant to SEC Rule 13a-14
31.2 Certification of Chief Financial Officer Pursuant to SEC Rule 13a-14
32 Certification of Chairman and Chief Executive Officer and Chief Financial Officer Pursuant
to 18 U.S.C. Section 1350
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