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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 June 27, 2004
-------------------------------------------------
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.
------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 43-1461763
- ------------------------------------ ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4551 W. 107th Street, Overland Park, Kansas 66207
-----------------------------------------------------------
(Address of principal executive offices and zip code)
(913) 967-4000
-----------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
------- -------
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes X No
------- -------
The number of shares of the registrant's common stock outstanding as of July 23,
2004 was 82,083,020.
-1-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
FORM 10-Q
FISCAL QUARTER ENDED JUNE 27, 2004
INDEX
Page
Part I Financial Information
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets as of June 27, 2004
and December 28, 2003................................................................ 3
Consolidated Statements of Earnings for the 13 Weeks and 26 Weeks
Ended June 27, 2004 and June 29, 2003................................................ 4
Consolidated Statement of Stockholders' Equity for the
26 Weeks Ended June 27, 2004......................................................... 5
Consolidated Statements of Cash Flows for the 26 Weeks
Ended June 27, 2004 and June 29, 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. Changes in Securities and Use of Proceeds................................................. 27
Item 4. Submission of Matters to a Vote of Security Holders....................................... 28
Item 6. Exhibits and Reports on Form 8-K.......................................................... 28
Signatures .................................................................................................. 29
Exhibit Index................................................................................................ 30
-2-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands, except share amounts)
June 27, December 28,
2004 2003
----------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents........................................................... $ 14,890 $ 17,867
Short-term investments, at market value............................................. 280 27
Receivables (less allowance for bad debts of $4,401 in 2004 and $4,117 in 2003)..... 41,166 31,950
Receivables related to captive insurance subsidiary................................. 4,775 450
Inventories......................................................................... 31,814 20,799
Prepaid income taxes................................................................ -- 5,800
Other current assets related to captive insurance subsidiary........................ 1,706 657
Prepaid and other current assets.................................................... 11,448 9,072
----------------- ----------------
Total current assets........................................................... 106,079 86,622
Property and equipment, net............................................................. 435,647 419,802
Goodwill................................................................................ 116,344 105,326
Restricted assets related to captive insurance subsidiary............................... 16,251 10,763
Other intangible assets, net............................................................ 5,819 1,137
Other assets............................................................................ 26,125 20,351
----------------- ----------------
$ 706,265 $ 644,001
================= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt................................................... $ 212 $ 192
Accounts payable.................................................................... 39,507 37,633
Accrued expenses and other current liabilities...................................... 81,026 96,637
Loss reserve and unearned premiums related to captive insurance subsidiary.......... 20,758 11,007
Accrued income taxes................................................................ 20,697 --
Accrued dividends................................................................... -- 3,863
----------------- ----------------
Total current liabilities...................................................... 162,200 149,332
----------------- ----------------
Non-current liabilities:
Long-term debt - less current portion............................................... 43,584 20,670
Other non-current liabilities....................................................... 17,656 14,267
----------------- ----------------
Total non-current liabilities.................................................. 61,240 34,937
----------------- ----------------
Total liabilities.............................................................. 223,440 184,269
----------------- ----------------
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.......................................................... 210,064 200,574
Retained earnings................................................................... 581,636 523,954
----------------- ----------------
792,785 725,613
Treasury stock - 26,631,822 shares in 2004 and 25,715,767 shares in 2003, at
cost............................................................................. (309,960) (265,881)
----------------- ----------------
Total stockholders' equity..................................................... 482,825 459,732
----------------- ----------------
$ 706,265 $ 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 26 Weeks Ended
----------------------------------- -----------------------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
---------------- ---------------- ---------------- ---------------
Revenues:
Company restaurant sales ......................... $ 247,769 $ 220,107 $ 491,329 $ 428,517
Franchise royalties and fees...................... 30,779 27,331 61,551 54,494
Other franchise income............................ 3,399 3,268 6,514 5,909
---------------- ---------------- ---------------- ---------------
Total operating revenues..................... 281,947 250,706 559,394 488,920
---------------- ---------------- ---------------- ---------------
Cost of company restaurant sales:
Food and beverage................................. 66,647 57,040 130,162 111,886
Labor............................................. 81,086 71,804 160,745 140,168
Direct and occupancy.............................. 60,240 54,386 119,309 104,947
Pre-opening expense............................... 391 334 941 555
---------------- ---------------- ---------------- ---------------
Total cost of company restaurant sales....... 208,364 183,564 411,157 357,556
---------------- ---------------- ---------------- ---------------
Cost of other franchise income........................ 5,035 3,173 7,972 5,673
General and administrative expenses................... 24,932 22,887 50,449 45,507
Amortization of intangible assets..................... 158 92 244 191
Loss on disposition of restaurants and equipment...... 584 731 1,079 1,198
---------------- ---------------- ---------------- ---------------
Operating earnings.................................... 42,874 40,259 88,493 78,795
---------------- ---------------- ---------------- ---------------
Other income (expense):
Investment income................................. 18 485 241 821
Interest expense.................................. (416) (518) (760) (1,039)
Impairment of Chevys note receivable (Note 9)..... -- (8,803) -- (8,803)
Other income...................................... 951 1 842 206
---------------- ---------------- ---------------- ---------------
Total other income (expense)................. 553 (8,835) 323 (8,815)
---------------- ---------------- ---------------- ---------------
Earnings before income taxes.......................... 43,427 31,424 88,816 69,980
Income taxes.......................................... 15,200 11,239 31,086 25,193
---------------- ---------------- ---------------- ---------------
Net earnings.......................................... $ 28,227 $ 20,185 $ 57,730 $ 44,787
================ ================ ================ ===============
Basic net earnings per common share................... $ 0.35 $ 0.24 $ 0.71 $ 0.54
================ ================ ================ ===============
Diluted net earnings per common share................. $ 0.34 $ 0.24 $ 0.68 $ 0.53
================ ================ ================ ===============
Basic weighted average shares outstanding............. 81,781 83,153 81,883 83,031
================ ================ ================ ===============
Diluted weighted average shares outstanding........... 84,098 85,548 84,371 85,303
================ ================ ================ ===============
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........................ -- -- -- 57,730 -- 57,730
Purchases of treasury stock......... -- -- -- -- (53,223) (53,223)
Stock options exercised and
related tax benefit............... -- -- 6,596 -- 7,362 13,958
Shares issued under employee
benefit plans..................... -- -- 2,603 -- 1,378 3,981
Restricted shares awarded
under equity incentive plan,
net of cancellations.............. -- -- (404) -- 404 --
Amortization of unearned
compensation relating to
restricted shares................. -- -- 695 -- -- 695
Dividends paid for fractional
shares............................ -- -- -- (48) -- (48)
------------ ------------ -------------- -------------- -------------- --------------
Balance, June 27, 2004................. 108,503,243 $ 1,085 $ 210,064 $ 581,636 $ (309,960) $ 482,825
============ ============ ============== ============== ============== ==============
See notes to consolidated financial statements.
-5-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
26 Weeks Ended
------------------------------------
June 27, June 29,
2004 2003
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings........................................................................ $ 57,730 $ 44,787
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization.................................................. 22,167 19,943
Amortization of intangible assets.............................................. 244 191
Amortization of unearned compensation.......................................... 695 539
Other amortization............................................................. 175 97
Inventory impairment........................................................... 2,300 --
Deferred income tax benefit.................................................... (245) (734)
Gain on sale of investments.................................................... -- (24)
Loss on disposition of restaurants and equipment............................... 1,079 1,198
Impairment of Chevys note receivable........................................... -- 8,803
Income tax benefit from exercise of stock options.............................. 5,169 3,879
Changes in assets and liabilities (exclusive of effects of acquisitions):
Receivables.................................................................... (9,003) (5,377)
Receivables related to captive insurance subsidiary............................ (4,325) (4,359)
Inventories.................................................................... (13,103) (8,019)
Prepaid income taxes........................................................... 5,800 1,880
Other current assets related to captive insurance subsidiary................... (1,049) (2,031)
Prepaid and other current assets............................................... (923) 2,347
Accounts payable............................................................... 1,874 2,547
Accrued expenses and other current liabilities................................. (15,927) (6,693)
Loss reserve and unearned premiums related to captive insurance subsidiary..... 9,751 8,210
Accrued income taxes........................................................... 20,697 --
Other.......................................................................... (2,667) 608
---------------- ----------------
NET CASH PROVIDED BY OPERATING ACTIVITIES...................................... 80,439 67,792
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment................................................. (36,543) (28,964)
Restricted assets related to captive insurance subsidiary........................... (5,488) (2,512)
Acquisition of restaurants.......................................................... (13,817) (21,557)
Lease acquisition costs............................................................. (4,919) --
Purchases of short-term investments................................................. (253) --
Proceeds from sale of restaurants and equipment..................................... -- 35
Maturities and sales of short-term investments...................................... -- 480
Other investing activities.......................................................... (966) --
---------------- ----------------
NET CASH USED BY INVESTING ACTIVITIES.......................................... (61,986) (52,518)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchases of treasury stock......................................................... (53,223) (13,282)
Dividends paid...................................................................... (3,911) (3,323)
Issuance of common stock upon exercise of stock options............................. 8,789 8,318
Shares issued under employee benefit plans.......................................... 3,981 1,418
Net long-term debt proceeds (payments).............................................. 22,934 (19,039)
---------------- ----------------
NET CASH USED BY FINANCING ACTIVITIES.......................................... (21,430) (25,908)
---------------- ----------------
NET DECREASE IN CASH AND CASH EQUIVALENTS............................................... (2,977) (10,634)
CASH AND CASH EQUIVALENTS, beginning of period.......................................... 17,867 15,169
---------------- ----------------
CASH AND CASH EQUIVALENTS, end of period................................................ $ 14,890 $ 4,535
================ ================
See notes to consolidated financial statements.
-6-
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Unaudited)
(in thousands)
26 Weeks Ended
------------------------------------
June 27, June 29,
2004 2003
---------------- ----------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the 26 week period for:
Income taxes........................................................... $ 749 $ 20,336
================ ================
Interest............................................................... $ 377 $ 709
================ ================
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
We issued restricted common stock, net of forfeitures, of $1,497,000 and
$1,618,000 for the 26 weeks ended June 27, 2004 and June 29, 2003, respectively.
On March 24, 2003, we assumed a loan of approximately $1,400,000 in connection
with the acquisition of 11 restaurants.
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 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 26 Weeks Ended
------------------------------- -------------------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Net earnings, as reported............................ $ 28,227 $ 20,185 $ 57,730 $ 44,787
Add: Stock-based employee compensation expense
(benefit) included in net earnings,
net of related taxes............................. (12) 506 290 960
Less: Total stock-based employee
compensation expense determined under
fair value based methods for all awards,
net of related taxes............................. 2,155 2,429 4,770 5,084
--------------- --------------- --------------- ---------------
Pro forma net earnings............................... $ 26,060 $ 18,262 $ 53,250 $ 40,663
=============== =============== =============== ===============
Basic net earnings per common share,
as reported...................................... $ 0.35 $ 0.24 $ 0.71 $ 0.54
=============== =============== =============== ===============
Basic net earnings per common share,
pro forma........................................ $ 0.32 $ 0.22 $ 0.65 $ 0.49
=============== =============== =============== ===============
Diluted net earnings per common share,
as reported...................................... $ 0.34 $ 0.24 $ 0.68 $ 0.53
=============== =============== =============== ===============
Diluted net earnings per common share,
pro forma........................................ $ 0.31 $ 0.21 $ 0.63 $ 0.48
=============== =============== =============== ===============
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 June 27, 2004, the aggregate amount of these
lease payments totaled approximately $19,800,000. 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 June 27, 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
a limited guarantee pool for the loans advanced during the three-year period
ending December 2006. There was one loan outstanding for approximately $400,000
under this program as of June 27, 2004. The fair value of our guarantee was
immaterial and accordingly, we have not recorded a liability as of June 27,
2004.
-9-
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 June 27, 2004, there were no loans
outstanding under this program.
Severance agreements: We have severance and employment agreements with certain
officers and other senior executives 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 June 27, 2004, we would
have been required to make payments totaling approximately $12,200,000. 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 June 27, 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 26 Weeks Ended
------------------------------- -------------------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Net earnings......................................... $ 28,227 $ 20,185 $ 57,730 $ 44,787
=============== =============== =============== ===============
Basic weighted average shares outstanding............ 81,781 83,153 81,883 83,031
Dilutive effect of stock options and
equity-based compensation........................ 2,317 2,395 2,488 2,272
--------------- --------------- --------------- ---------------
Diluted weighted average shares outstanding.......... 84,098 85,548 84,371 85,303
=============== =============== =============== ===============
Basic net earnings per common share.................. $ 0.35 $ 0.24 $ 0.71 $ 0.54
=============== =============== =============== ===============
Diluted net earnings per common share................ $ 0.34 $ 0.24 $ 0.68 $ 0.53
=============== =============== =============== ===============
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 1,470,000
and 1,000 of these options for the 13 weeks ended June 27, 2004 and June 29,
2003, respectively, and 90,000 and 55,000 of these options for the 26 weeks
ended June 27, 2004 and June 29, 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 26 Weeks Ended
------------------------------- -------------------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Actual acquired company restaurant sales.............. $ 11,000 $ 6,400 $ 17,500 $ 7,000
=============== =============== =============== ===============
Pro forma acquired company restaurant sales........... $ 13,200 $ 12,000 $ 26,300 $ 24,000
=============== =============== =============== ===============
In 2002, we acquired the operations and assets of 21 Applebee's restaurants
located in the Washington, D.C. area from a franchisee. The purchase agreement
provided for additional consideration to be paid in July 2004 if the restaurants
achieved cash flows in excess of historical levels. As of June 27, 2004, we have
determined that the additional payment will be approximately $100,000 which has
been recorded as goodwill in our consolidated financial statements.
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
-11-
$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 $4,600,000 and $9,300,000 for the 13 weeks and 26
weeks ended June 29, 2003, respectively.
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 $2,300,000 (approximately $1,500,000 net of income
taxes) in our consolidated financial statements. 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 $1,800,000 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.
The note receivable balance of approximately $8,800,000 as of June 27, 2004 and
December 28, 2003, respectively, is included in other assets in our consolidated
balance sheets. 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 13 weeks and 26
weeks ended June 29, 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):
June 27, 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):
June 27, 2004
------------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights........... $ 6,371 $ 5,400 $ 971
Lease acquisition costs................. 4,919 71 4,848
------------------ ------------------ ------------------
Total....................................... $ 11,290 $ 5,471 $ 5,819
================== ================== ==================
-12-
December 28, 2003
------------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights........... $ 6,371 $ 5,234 $ 1,137
================== ================== ==================
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 June 27, 2004, our consolidated balance sheet includes the following
balances related to the captive insurance subsidiary:
o Deferred policy acquisition costs of approximately $1,700,000 included
in other current assets related to captive insurance subsidiary.
o Franchise premium receivables of approximately $4,800,000 included in
receivables related to captive insurance subsidiary.
o Cash equivalent investments restricted for the payment of claims of
approximately $15,500,000 included in restricted assets related to
captive insurance subsidiary.
o Loss reserve and unearned premiums related to captive insurance
subsidiary of approximately $20,800,000.
o Other miscellaneous items, net, of approximately $1,200,000 included in
several line items in the consolidated balance sheet.
-13-
12. 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 results continue to be driven by the execution of integrated strategies,
including improved food, promotions backed by effective advertising, meeting our
guests' desires for more convenience, our focus on operations excellence and the
retention of better people.
We completed the rollout of our Carside To Go(TM) program in all company
restaurants where practicable in November 2003 and our franchisees will continue
implementation during 2004. We expect Carside To Go(TM) to be a significant
driver of sales and traffic growth in 2004.
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 June 27, 2004 and June 29, 2003 each contained 13
weeks and are referred to hereafter as the "2004 quarter" and the "2003
quarter," respectively. Our 26 week periods ended June 27, 2004 and June 29,
2003 are referred to hereafter as the "2004 year-to-date period" and the "2003
year-to-date period," respectively.
-15-
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 June 27, 2004, our consolidated balance sheet includes the following
balances related to the captive insurance subsidiary:
o Deferred policy acquisition costs of approximately $1,700,000 included in
other current assets related to captive insurance subsidiary.
o Franchise premium receivables of approximately $4,800,000 included in
receivables related to captive insurance subsidiary.
o Cash equivalent investments restricted for the payment of claims of
approximately $15,500,000 included in restricted assets related to captive
insurance subsidiary.
o Loss reserve and unearned premiums related to captive insurance subsidiary
of approximately $20,800,000.
o Other miscellaneous items, net, of approximately $1,200,000 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.
-16-
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
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 the 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.
-17-
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 26 Weeks Ended
------------------------------- -------------------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
--------------- --------------- --------------- ---------------
Actual acquired company restaurant sales.............. $ 11,000 $ 6,400 $ 17,500 $ 7,000
=============== =============== =============== ===============
Pro forma acquired company restaurant sales........... $ 13,200 $ 12,000 $ 26,300 $ 24,000
=============== =============== =============== ===============
In 2002, we acquired the operations and assets of 21 Applebee's restaurants
located in the Washington, D.C. area from a franchisee. The purchase agreement
provided for additional consideration to be paid in July 2004 if the restaurants
achieved cash flows in excess of historical levels. As of June 27, 2004, we have
determined that the amount of the additional payment will be approximately
$100,000 which has been recorded as goodwill in our consolidated financial
statements.
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 $4,600,000 and $9,300,000 for the 13 weeks and
the 26 weeks ended June 29, 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 26 Weeks Ended
------------------------- --------------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenues:
Company restaurant sales.................................. 87.9% 87.8% 87.8% 87.6%
Franchise royalties and fees.............................. 10.9 10.9 11.0 11.1
Other franchise income.................................... 1.2 1.3 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......................................... 26.9% 25.9% 26.5% 26.1%
Labor..................................................... 32.7 32.6 32.7 32.7
Direct and occupancy...................................... 24.3 24.7 24.3 24.5
Pre-opening expense....................................... 0.2 0.2 0.2 0.1
------------ ------------ ------------ ------------
Total cost of sales.................................. 84.1% 83.4% 83.7% 83.4%
============ ============ ============ ============
Cost of other franchise income (as a percentage of other
franchise income)......................................... 148.1% 97.1% 122.4% 96.0%
General and administrative expenses........................... 8.8 9.1 9.0 9.3
Amortization of intangible assets............................. -- -- -- --
Loss on disposition of restaurants and equipment.............. 0.2 0.3 0.2 0.2
------------ ------------ ------------ ------------
Operating earnings............................................ 15.2 16.1 15.8 16.1
------------ ------------ ------------ ------------
Other income (expense):
Investment income......................................... -- 0.2 -- 0.2
Interest expense.......................................... (0.1) (0.2) (0.1) (0.2)
Impairment of Chevys note receivable...................... -- (3.5) -- (1.8)
Other income.............................................. 0.3 -- 0.2 --
------------ ------------ ------------ ------------
Total other income (expense)......................... 0.2 (3.5) 0.1 (1.8)
------------ ------------ ------------ ------------
Earnings before income taxes.................................. 15.4 12.5 15.9 14.3
Income taxes.................................................. 5.4 4.5 5.6 5.2
------------ ------------ ------------ ------------
Net earnings.................................................. 10.0% 8.1% 10.3% 9.2%
============ ============ ============ ============
-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 26 Weeks Ended
------------------------------- -------------------------------
June 27, June 29, June 27, June 29,
2004 2003 2004 2003
------------- ------------- -------------- -------------
Number of restaurants:
Company:
Beginning of period....................... 391 371 383 357
Restaurant openings....................... 4 4 12 7
Restaurants closed........................ -- (2) -- (2)
Restaurants acquired from franchisees..... 10 -- 10 11
------------- ------------- -------------- -------------
End of period............................. 405 373 405 373
------------- ------------- -------------- -------------
Franchise:
Beginning of period....................... 1,212 1,142 1,202 1,139
Restaurant openings....................... 8 13 19 29
Restaurants closed........................ (3) -- (4) (2)
Restaurants acquired from franchisees..... (10) -- (10) (11)
------------- ------------- -------------- -------------
End of period............................. 1,207 1,155 1,207 1,155
------------- ------------- -------------- -------------
Total:
Beginning of period....................... 1,603 1,513 1,585 1,496
Restaurant openings....................... 12 17 31 36
Restaurants closed........................ (3) (2) (4) (4)
------------- ------------- -------------- -------------
End of period............................. 1,612 1,528 1,612 1,528
============= ============= ============== =============
Weighted average weekly sales per restaurant:
Company........................................ $ 47,758 $ 45,402 $ 48,075 $ 45,041
Franchise...................................... $ 48,759 $ 45,940 $ 48,763 $ 45,682
Total.......................................... $ 48,510 $ 45,807 $ 48,593 $ 45,526
Change in comparable restaurant sales:(1)
Company........................................ 5.5% 5.1% 7.0% 4.9%
Franchise...................................... 6.5% 3.2% 7.2% 3.0%
Total.......................................... 6.3% 3.6% 7.2% 3.5%
Total operating revenues (in thousands):
Company restaurant sales....................... $ 247,769 $ 220,107 $ 491,329 $ 428,517
Franchise royalties and fees(2)................ 30,779 27,331 61,551 54,494
Other franchise income(3)...................... 3,399 3,268 6,514 5,909
------------- ------------- -------------- -------------
Total.......................................... $ 281,947 $ 250,706 $ 559,394 $ 488,920
============= ============= ============== =============
(1) When computing comparable restaurant sales, restaurants open for at least 18
months are compared from period to period.
(2) Franchise royalties are generally 4% of each franchise restaurant's reported
monthly gross sales. Reported franchise sales, in thousands, were $764,422
and $684,131 in the 2004 quarter and the 2003 quarter, respectively, and
$1,528,538 and $1,360,443 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.
(3) 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 $27,662,000
(13%) from $220,107,000 in the 2003 quarter to $247,769,000 in the 2004 quarter
and increased $62,812,000 (15%) from $428,517,000 in the 2003 year-to-date
period to $491,329,000 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.
Weighted average weekly sales contributed approximately 5% and 7% 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. In addition, the March 2003 acquisition of 11 restaurants in Illinois,
Indiana, Kentucky and Missouri contributed approximately 1% of the total sales
increase in the 2004 year-to-date period.
Comparable restaurant sales at company restaurants increased by 5.5% and 7.0% in
the 2004 quarter and the 2004 year-to-date period, respectively. Weighted
average weekly sales at company restaurants increased 5.2% from $45,402 in the
2003 quarter to $47,758 in the 2004 quarter and increased 6.7% from $45,041 in
the 2003 year-to-date period to $48,075 in the 2004 year-to-date period. These
increases were due primarily to increases in guest traffic and in the average
guest check resulting from our food promotions. In addition, a portion of the
increase resulted from the implementation of our Carside To Go(TM) initiative
and menu price increases of approximately 1.5% in fiscal 2004. Carside To Go(TM)
sales mix increased from 6.8% of company restaurant sales in the 2003 quarter to
9.4% of company restaurant sales in the 2004 quarter.
Franchise Royalties and Fees. Franchise royalties and fees increased $3,448,000
(13%) from $27,331,000 in the 2003 quarter to $30,779,000 in the 2004 quarter
and increased $7,057,000 (13%) from $54,494,000 in the 2003 year-to-date period
to $61,551,000 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 6.1% and 6.7% in the 2004 quarter and 2004
year-to-date period, respectively, and franchise comparable restaurant sales
increased 6.5% and 7.2% in the 2004 quarter and 2004 year-to-date period,
respectively.
Other Franchise Income. Other franchise income increased $131,000 (4%) from
$3,268,000 in the 2003 quarter to $3,399,000 in the 2004 quarter and increased
$605,000 (10%) from $5,909,000 in the 2003 year-to-date period to $6,514,000 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 25.9%
in the 2003 quarter to 26.9% in the 2004 quarter and increased from 26.1% in the
2003 year-to-date period to 26.5% 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, higher food costs related to our menu promotions and the
company portion of the June 2004 impairment of approximately $500,000 for excess
riblet inventories which no longer met our quality standards. These increases
were partially offset by menu price increases in both the 2004 quarter and the
2004 year-to-date period.
Labor costs increased from 32.6% in the 2003 quarter to 32.7% in the 2004
quarter and were 32.7% in both the 2003 year-to-date period and the 2004
year-to-date period. Both periods were impacted by higher costs related to the
-21-
addition of dedicated Carside To Go(TM) hourly labor at most of our restaurants
beginning in the second half of 2003, higher preparation time and training costs
related to the May 2004 rollout of our new Weight Watchers menu and higher
workers' compensation costs. These higher costs were offset in both periods by
lower management and hourly costs due to higher sales volumes at company
restaurants and lower management incentive compensation.
Direct and occupancy costs decreased from 24.7% in the 2003 quarter and 24.5% in
the 2003 year-to-date period to 24.3% in both the 2004 quarter the 2004
year-to-date period due 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. The decrease in the 2004 quarter was also due to lower property and
liability insurance expense. Decreases in both periods were partially offset by
higher packaging costs as a result of increased Carside To Go(TM) sales volumes.
The 2004 year-to-date period was also unfavorably impacted by higher advertising
costs, as a percentage of sales, due primarily to Carside To Go(TM) advertising
in company markets.
Cost of Other Franchise Income. Cost of other franchise income increased
$1,862,000 from $3,173,000 in the 2003 quarter to $5,035,000 in the 2004 quarter
and increased $2,299,000 from $5,673,000 in the 2003 year-to-date period to
$7,972,000 in the 2004 year-to-date due primarily to the franchisee portion of
the June 2004 impairment of approximately $1,800,000 for excess riblet
inventories which no longer met our quality standards.
General and Administrative Expenses. General and administrative expenses
decreased from 9.1% in the 2003 quarter and 9.3% in the 2003 year-to-date period
to 8.8% in the 2004 quarter and 9.0% in the 2004 year-to-date period. General
and administrative expenses were lower in both the 2004 quarter and 2004
year-to-date period due to the absorption of general and administrative expenses
over a larger revenue base which were partially offset by higher compensation
expense due to staffing levels.
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 35.8% in the 2003 quarter and 36.0% in 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 $36,543,000 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.
-22-
These expenditures will primarily be for the development of new restaurants,
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
quarter.
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 June 27, 2004, we had
borrowings of $38,000,000 and had standby letters of credit of approximately
$11,920,000 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 2,097,450 shares of our common stock at an
average price of $25.38 for an aggregate cost of $53,200,000. As of June 27,
2004, we had $46,500,000 remaining under our repurchase authorization.
As of June 27, 2004, our liquid assets totaled $15,170,000. These assets
consisted of cash and cash equivalents in the amount of $14,890,000 and
short-term investments in the amount of $280,000. The working capital deficit
decreased from $62,710,000 as of December 28, 2003 to $56,121,000 as of June 27,
2004. This decrease was due primarily to the redemption of gift cards in 2004
sold in 2003, the payment of accrued dividends and bonuses and increases in
inventories and receivables and was partially offset by increases in accrued
income taxes and loss reserve and unearned premiums related to the captive
insurance subsidiary.
-23-
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 June 27, 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)........................... $ 39,612 $ 127 $ 38,249 $ 86 $ 1,150
Capital Lease Obligations........................ 9,474 754 1,588 1,701 5,431
Operating Leases................................. 245,675 21,441 41,149 40,026 143,059
Purchase Obligations - Company(1)................ 172,830 116,230 36,834 10,235 9,531
Purchase Obligations - Franchise(2).............. 385,240 254,780 97,505 21,421 11,534
(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 $19,800,000 as of June 27,
2004 (see Note 3). We have not recorded a liability for these guarantees as of
June 27, 2004 or December 28, 2003.
We have severance and employment agreements with certain officers and other
senior executives 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 June 27, 2004, we would have been required
to make payments totaling approximately $12,200,000. 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 June 27, 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
ending December 2006. There was one loan outstanding for approximately $400,000
under this program as of June 27, 2004. The fair value of our guarantee was
immaterial and accordingly, we have not recorded a liability as of June 27,
2004.
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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
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.
-25-
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 June 27, 2004, the
total amount of debt subject to interest rate fluctuations was $38,000,000 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 $380,000 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 June 27, 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. Changes in Securities and Use of Proceeds
(e) Issuer Purchases of Equity Securities.
- ------------------------------------------------------------------------------------------------------------
Purchases of Equity Securities(1) (2)
- ------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d)
- ---------------------------- -------------- ---------- ------------------------- ---------------------------
Maximum Dollar Value of
Average Total Number of Shares Shares that May Yet Be
Total Number Price Purchased as Part of Purchased Under the Plans
of Shares Paid Per Publicly Announced or Programs
Period Purchased Share Plans or Programs (in thousands)
- ---------------------------- -------------- ---------- ------------------------- ---------------------------
March 29, 2004 through
April 27, 2004 3,499(3) $28.39 -- $67,717
- ---------------------------- -------------- ---------- ------------------------- ---------------------------
April 28, 2004 through May
27, 2004 814,500 $26.01 814,500 $46,532
- ---------------------------- -------------- ---------- ------------------------- ---------------------------
May 28, 2004 through June
27, 2004 -- -- -- $46,532
- ---------------------------- -------------- ---------- ------------------------- ---------------------------
Total 817,999 814,500
============================ ============== ========== ========================= ===========================
(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.
-27-
Item 4. Submission of Matters to a Vote of Security Holders
Our annual meeting of stockholders was held on May 13, 2004. The stockholders
voted on the following matters:
Proposal I. Elect Jack Helms, Lloyd Hill, Burton Sack, Michael Volkema
and Steven Lumpkin as Directors.
Proposal II. Approve the Applebee's International, Inc. Amended and
Restated 1995 Equity Incentive Plan.
Proposal III. Approve the Executive Nonqualified Stock Purchase Plan
Proposal IV. Ratify Deloitte & Touche LLP as our independent auditors
for the 2004 fiscal year.
Proposal V. Act on a Shareholder Proposal to require us to issue a
report relating to genetically engineered ingredients.
The results of the voting were as follows:
Negative/
Affirmative Withheld Broker
Proposal Votes Votes Abstentions Non-Votes
- -------------------------- ---------------- -------------------- -------------------- -----------------
I (Helms) 48,558,417 1,572,327 -- --
I (Hill) 48,635,185 1,495,559 -- --
I (Sack) 48,654,681 1,476,063 -- --
I (Volkema) 48,851,107 1,279,637 -- --
I (Lumpkin) 48,361,854 1,768,890 -- --
II 26,778,025 15,673,253 860,428 6,819,038
III 30,704,447 11,734,261 872,998 6,819,038
IV 47,712,325 1,605,215 813,203 1
V 2,188,554 37,834,824 3,288,326 6,819,040
Proposals I, II, III and IV received the required affirmative votes and were
affirmatively adopted by the Stockholders. Proposal V did not receive the
required affirmative votes.
Item 6. Exhibits and Reports on Form 8-K
(a) The Exhibits listed on the accompanying Exhibit Index are filed as
part of this report.
(b) We filed a report on Form 8-K on April 2, 2004 announcing the
addition of a new executive officer.
We furnished a report on Form 8-K on April 23, 2004 announcing the
webcast of our first quarter earnings conference call over the
Internet.
We furnished a report on Form 8-K on April 28, 2004 reporting
first quarter diluted earnings per share.
We filed a report on Form 8-K on May 13, 2004 announcing a
three-for-two stock split.
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We filed a report on Form 8-K on May 14, 2004 announcing Mr.
Volkema's election to the Board of Directors.
We filed a report on Form 8-K on May 18, 2004 announcing the
temporary suspension of trading under an employee benefit plan.
We filed a report on Form 8-K on May 24, 2004 reporting May
comparable sales.
We furnished a report on Form 8-K on June 2, 2004 announcing our
presentation at the Piper Jaffray Consumer Conference.
We furnished a report on Form 8-K on June 10, 2004 announcing our
presentation at two Investment Conferences in June.
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: July 28, 2004 By: /s/ Lloyd L. Hill
-------------------- -----------------------------------------
Lloyd L. Hill
Chairman and Chief Executive Officer
(principal executive officer)
Date: July 28, 2004 By: /s/ Steven K. Lumpkin
-------------------- -----------------------------------------
Steven K. Lumpkin
Executive Vice President and
Chief Financial Officer
(principal financial officer)
Date: July 28, 2004 By: /s/ Beverly O. Elving
-------------------- -----------------------------------------
Beverly O. Elving
Vice President, Accounting
(principal accounting officer)
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APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
- ------------- ----------------------------------------------------------------------------------------
10.1 Amended and Restated 1995 Equity Incentive Plan
10.2 Executive Nonqualified Stock Purchase Plan
10.3 New Form of Indemnification Agreement with all Officers and Directors
10.4 Executive Retirement Plan (incorporated by reference to Exhibit 10.1 of the Registrant's
Quarterly Report on Form 10-Q for the fiscal quarter ended March 28, 2004) and schedule
of parties thereto
31.1 Certification of Chairman and Chief Executive Officer Pursuant to SEC Rule 13a-14(a)
31.2 Certification of Chief Financial Officer Pursuant to SEC Rule 13a-14(a)
32.1 Certification of Chairman and Chief Executive Officer and Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350
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