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EX-31.2 - EX-31.2 - DineEquity, Inca10-17501_1ex31d2.htm
EX-32.1 - EX-32.1 - DineEquity, Inca10-17501_1ex32d1.htm
EX-31.1 - EX-31.1 - DineEquity, Inca10-17501_1ex31d1.htm
EX-32.2 - EX-32.2 - DineEquity, Inca10-17501_1ex32d2.htm
EX-10.3 - EX-10.3 - DineEquity, Inca10-17501_1ex10d3.htm

Table of Contents

 

 

 

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 30, 2010

 

 

 

OR

 

 

 

o

 

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 001-15283

 


 

DineEquity, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware
(State or other jurisdiction of incorporation or
organization)

 

95-3038279
(I.R.S. Employer Identification No.)

 

 

 

450 North Brand Boulevard,
Glendale, California

 

91203-1903

(Address of principal executive offices)

 

(Zip Code)

 

(818) 240-6055
(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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller
reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding as of October 29, 2010

 

Common Stock, $.01 par value

 

18,022,990

 

 

 

 



Table of Contents

 

DINEEQUITY, INC. AND SUBSIDIARIES

 

INDEX

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

Item 1—Financial Statements

2

 

Consolidated Balance Sheets—September 30, 2010 (unaudited) and December 31, 2009

2

 

Consolidated Statements of Income (unaudited)—Three and Nine Months Ended September 30, 2010 and 2009

3

 

Consolidated Statements of Cash Flows (unaudited)—Nine Months Ended September 30, 2010 and 2009

4

 

Notes to Consolidated Financial Statements

5

 

Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

Item 3—Quantitative and Qualitative Disclosures about Market Risk

36

 

Item 4—Controls and Procedures

37

PART II.

OTHER INFORMATION

38

 

Item 1—Legal Proceedings

38

 

Item 1A—Risk Factors

38

 

Item 2—Unregistered Sales of Equity Securities and Use of Proceeds

40

 

Item 3—Defaults Upon Senior Securities

40

 

Item 4—[Removed and Reserved]

40

 

Item 5—Other Information

40

 

Item 6—Exhibits

41

 

Signatures

42

 

1



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1.  Financial Statements.

 

DINEEQUITY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

105,230

 

$

82,314

 

Restricted cash

 

50,790

 

72,690

 

Receivables, net

 

72,080

 

104,690

 

Inventories

 

11,977

 

12,236

 

Prepaid income taxes

 

306

 

7,702

 

Prepaid gift cards

 

14,609

 

19,878

 

Prepaid expenses

 

16,024

 

13,425

 

Deferred income taxes

 

19,091

 

15,444

 

Assets held for sale

 

35,613

 

8,765

 

Total current assets

 

325,720

 

337,144

 

Non-current restricted cash

 

44,696

 

48,173

 

Restricted assets related to captive insurance subsidiary

 

3,779

 

4,344

 

Long-term receivables

 

246,650

 

259,775

 

Property and equipment, net

 

711,991

 

771,372

 

Goodwill

 

697,470

 

697,470

 

Other intangible assets, net

 

840,685

 

849,552

 

Other assets, net

 

123,538

 

133,038

 

Total assets

 

$

2,994,529

 

$

3,100,868

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current maturities of long-term debt

 

$

25,200

 

$

25,200

 

Accounts payable

 

28,408

 

31,729

 

Accrued employee compensation and benefits

 

34,022

 

37,397

 

Gift card liability

 

55,723

 

105,465

 

Other accrued expenses

 

50,000

 

58,176

 

Total current liabilities

 

193,353

 

257,967

 

Long-term debt, less current maturities

 

1,557,053

 

1,637,198

 

Financing obligations, less current maturities

 

302,980

 

309,415

 

Capital lease obligations, less current maturities

 

146,253

 

152,758

 

Deferred income taxes

 

366,287

 

369,127

 

Other liabilities

 

119,794

 

117,449

 

Total liabilities

 

2,685,720

 

2,843,914

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Preferred stock, Series A, $1.00 par value, 220,000 shares authorized; 190,000 shares issued and outstanding as of September 30, 2010 and December 31, 2009

 

187,050

 

187,050

 

Stockholders’ equity:

 

 

 

 

 

Convertible preferred stock, Series B, at accreted value, 10,000,000 shares authorized; 35,000 shares issued and outstanding at September 30, 2010 and December 31, 2009

 

41,433

 

39,623

 

Common stock, $0.01 par value, 40,000,000 shares authorized; September 30, 2010: 24,175,599 shares issued and 17,975,691 shares outstanding; December 31, 2009: 23,780,015 shares issued and 17,564,449 shares outstanding

 

242

 

238

 

Additional paid-in-capital

 

184,369

 

171,207

 

Retained earnings

 

184,531

 

155,397

 

Accumulated other comprehensive loss

 

(13,915

)

(20,811

)

Treasury stock, at cost (September 30, 2010: 6,199,908 shares; December 31, 2009: 6,215,566 shares)

 

(274,901

)

(275,750

)

Total stockholders’ equity

 

121,759

 

69,904

 

Total liabilities and stockholders’ equity

 

$

2,994,529

 

$

3,100,868

 

 

See the accompanying Notes to Consolidated Financial Statements.

 

2



Table of Contents

 

DINEEQUITY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(Unaudited)

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Segment Revenues:

 

 

 

 

 

 

 

 

 

Franchise revenues

 

$

92,083

 

$

90,198

 

$

280,562

 

$

278,922

 

Company restaurant sales

 

206,907

 

206,357

 

642,216

 

668,149

 

Rental revenues

 

32,210

 

32,929

 

98,329

 

99,182

 

Financing revenues

 

4,200

 

4,067

 

12,188

 

12,504

 

Total segment revenues

 

335,400

 

333,551

 

1,033,295

 

1,058,757

 

Segment Expenses:

 

 

 

 

 

 

 

 

 

Franchise expenses

 

25,513

 

25,377

 

76,368

 

77,411

 

Company restaurant expenses

 

177,230

 

179,306

 

551,837

 

573,343

 

Rental expenses

 

23,916

 

24,264

 

72,165

 

73,081

 

Financing expenses

 

763

 

14

 

1,234

 

360

 

Total segment expenses

 

227,422

 

228,961

 

701,604

 

724,195

 

 

 

107,978

 

104,590

 

331,691

 

334,562

 

General and administrative expenses

 

39,365

 

35,897

 

116,531

 

117,015

 

Interest expense

 

42,864

 

45,231

 

131,434

 

139,611

 

Impairment and closure charges

 

889

 

4,471

 

3,085

 

6,472

 

Amortization of intangible assets

 

3,077

 

3,019

 

9,230

 

9,056

 

Gain on extinguishment of debt

 

 

 

(4,640

)

(38,803

)

Loss (gain) on disposition of assets

 

745

 

(2,111

)

923

 

(7,253

)

Other expense, net

 

838

 

888

 

2,783

 

1,017

 

Income before income taxes

 

20,200

 

17,195

 

72,345

 

107,447

 

Provision for income taxes

 

(5,869

)

(3,690

)

(24,302

)

(31,987

)

Net income

 

$

14,331

 

$

13,505

 

$

48,043

 

$

75,460

 

 

 

 

 

 

 

 

 

 

 

Net income available to common stockholders

 

 

 

 

 

 

 

 

 

Net income

 

$

14,331

 

$

13,505

 

$

48,043

 

$

75,460

 

Less: Series A preferred stock dividends

 

(5,640

)

(4,750

)

(17,100

)

(14,250

)

Less: Accretion of Series B preferred stock

 

(612

)

(577

)

(1,810

)

(1,706

)

Less: Net income allocated to unvested participating restricted stock

 

(307

)

(301

)

(1,113

)

(2,211

)

Net income available to common stockholders

 

$

7,772

 

$

7,877

 

$

28,020

 

$

57,293

 

Net income available to common stockholders per share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.45

 

$

0.46

 

$

1.63

 

$

3.39

 

Diluted

 

$

0.44

 

$

0.46

 

$

1.60

 

$

3.34

 

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

17,227

 

16,942

 

17,168

 

16,904

 

Diluted

 

17,568

 

16,942

 

17,519

 

17,717

 

 

See the accompanying Notes to Consolidated Financial Statements.

 

3



Table of Contents

 

DINEEQUITY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

48,043

 

$

75,460

 

Adjustments to reconcile net income to cash flows provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

47,594

 

48,406

 

Non-cash interest expense

 

31,203

 

29,338

 

Gain on extinguishment of debt

 

(4,640

)

(38,803

)

Impairment and closure charges

 

3,085

 

6,472

 

Deferred income taxes

 

(10,976

)

5,723

 

Non-cash stock-based compensation expense

 

11,150

 

7,367

 

Tax benefit from stock-based compensation

 

1,407

 

472

 

Excess tax benefit from stock options exercised

 

(2,211

)

(48

)

Loss (gain) on disposition of assets

 

923

 

(7,253

)

Other

 

(1,847

)

(5,628

)

Changes in operating assets and liabilities

 

 

 

 

 

Receivables

 

30,930

 

39,704

 

Inventories

 

226

 

(1,323

)

Prepaid expenses

 

9,411

 

5,950

 

Accounts payable

 

(4,699

)

(9,194

)

Accrued employee compensation and benefits

 

(3,460

)

(14,863

)

Gift card liability

 

(49,742

)

(50,753

)

Other accrued expenses

 

(8,893

)

11,901

 

Cash flows provided by operating activities

 

97,504

 

102,928

 

Cash flows from investing activities

 

 

 

 

 

Additions to property and equipment

 

(11,421

)

(9,513

)

Proceeds from sale of property and equipment and assets held for sale

 

1,975

 

16,132

 

Principal receipts from notes and equipment contracts receivable

 

11,990

 

11,419

 

Reduction of long-term receivables

 

2,949

 

1,937

 

Other

 

1,842

 

922

 

Cash flows provided by investing activities

 

7,335

 

20,897

 

Cash flows from financing activities

 

 

 

 

 

Proceeds from issuance of long-term debt

 

 

10,000

 

Repayment of long-term debt

 

(80,658

)

(108,463

)

Principal payments on capital lease and financing obligations

 

(12,191

)

(10,722

)

Dividends paid

 

(17,100

)

(14,250

)

Repurchase of restricted stock

 

(1,029

)

(426

)

Proceeds from stock options exercised

 

2,487

 

324

 

Excess tax benefit from stock options exercised

 

2,211

 

48

 

Payment of debt issuance costs

 

(1,008

)

(20,257

)

Restricted cash related to securitization

 

25,377

 

10,676

 

Other

 

(12

)

(123

)

Cash flows used in financing activities

 

(81,923

)

(133,193

)

Net change in cash and cash equivalents

 

22,916

 

(9,368

)

Cash and cash equivalents at beginning of period

 

82,314

 

114,443

 

Cash and cash equivalents at end of period

 

$

105,230

 

$

105,075

 

Supplemental disclosures

 

 

 

 

 

Interest paid

 

$

113,755

 

$

124,493

 

Income taxes paid

 

$

29,350

 

$

15,716

 

 

See the accompanying Notes to Consolidated Financial Statements.

 

4


 


Table of Contents

 

DINEEQUITY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. General

 

The accompanying unaudited consolidated financial statements of DineEquity, Inc. (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month and nine-month periods ended September 30, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010.

 

The consolidated balance sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

 

These consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

 

2. Basis of Presentation

 

The Company owns and operates two restaurant concepts: Applebee’s Neighborhood Grill and Bar®, or Applebee’s, in the bar and grill segment of the casual dining category of the restaurant industry, and International House of Pancakes®, or IHOP®, in the family dining category of the restaurant industry.

 

The Company’s fiscal quarters end on the Sunday closest to the last day of each quarter. For convenience, the fiscal quarters are reported as ending on March 31, June 30, September 30 and December 31. The first three fiscal quarters of 2010 ended April 4, 2010, July 4, 2010 and October 3, 2010, respectively; the first three fiscal quarters of 2009 ended March 29, 2009, June 28, 2009 and September 27, 2009, respectively.

 

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries that are consolidated in accordance with U.S. GAAP. All intercompany balances and transactions have been eliminated in consolidation. However, the subsidiaries have not guaranteed the obligations of the Company, and the assets of the subsidiaries generally are not available to pay creditors of the Company. Also, the Company has not guaranteed the obligations of the subsidiaries, and the assets of the Company generally are not available to pay creditors of the subsidiaries.

 

The preparation of financial statements in conformity with U.S. GAAP requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to provisions for doubtful accounts, legal contingencies, income taxes, long-lived assets, goodwill and intangible assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates.

 

Subsequent events

 

The Company has evaluated the period after the balance sheet date through the date the consolidated financial statements were issued and determined there were no subsequent events or transactions that required recognition or disclosure in the consolidated financial statements other than the items described in Note 17, Subsequent Events.

 

3. Accounting Policies

 

Recently Adopted Accounting Standards

 

In December 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.” This ASU, among other things, (i) changes existing guidance for determining whether an entity is a Variable Interest Entity (“VIE”); (ii) requires ongoing reassessments of whether an entity is the primary beneficiary of a VIE; and (iii) requires enhanced disclosures about an entity’s involvement in a VIE. The Company adopted these amendments effective January 1, 2010, and adoption had no impact on the Company’s consolidated financial statements.

 

5



Table of Contents

 

3. Accounting Policies, continued

 

In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures About Fair Value Measurement” (“ASU 2010-06”). This ASU added disclosure requirements about transfers related to assets and liabilities measured using Level 1 and 2 inputs (as defined); clarified existing fair value disclosure requirements about the appropriate level of disaggregation; and clarified that a description of valuation techniques and inputs used to measure fair value was required for recurring and nonrecurring fair value measurements of assets and liabilities using Level 2 and 3 inputs (as defined).  The Company adopted these provisions of the ASU beginning with the consolidated financial statements for the period ended March 31, 2010.  The adoption of these provisions of this ASU only affected the disclosure requirements for fair value measurements and as a result had no impact on the Company’s balance sheets, statements of income or statements of cash flows.

 

In February 2010, the FASB issued ASU 2010-09, “Subsequent Events: Amendments to Certain Recognition and Disclosure Requirements.”  This ASU retracts the existing requirement to disclose the date through which subsequent events have been evaluated and whether that date is the date the financial statements were issued or were available to be issued. The guidance was effective immediately upon issuance and adoption had no impact on the Company’s consolidated financial statements.

 

New Accounting Standards

 

ASU 2010-06 also requires that disclosures about purchase, sale, issuance, and settlement activity related to assets and liabilities whose fair value is measured using Level 3 inputs be presented on a gross basis rather than as a net number as currently permitted.  This provision of this ASU will be effective for the Company’s reporting period ending March 31, 2011.  As this provision amends only the disclosure requirements for fair value measurements, the adoption will have no impact on the Company’s balance sheets, statements of income or statements of cash flows.

 

In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.”  This ASU amends disclosure requirements with respect to the credit quality of financing receivables and the related allowance for credit losses. Entities will be required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. Disclosures to be made as of the end of a reporting period will be effective for the Company’s reporting period ending December 31, 2010; the disclosures about activity that occurs during a reporting period will be effective for the Company’s reporting period ending March 31, 2011. Since this ASU will only amend disclosure requirements, not current accounting practice, the Company does not anticipate that adoption of this ASU will have any impact on the Company’s balance sheets, statements of income or statements of cash flows.

 

The Company reviewed all other significant newly issued accounting pronouncements and concluded that they either are not applicable to the Company’s operations or that no material effect is expected on the Company’s financial statements as a result of future adoption.

 

4. Assets Held for Sale

 

The Company classifies assets as held for sale and ceases the depreciation and amortization of the assets when there is a plan for disposal of the assets and those assets meet the held for sale criteria, as defined in applicable U.S. GAAP. The balance of assets held for sale at December 31, 2009 of $8.8 million was primarily comprised of four parcels of land previously intended for future restaurant development, four parcels of land on which Applebee’s franchised restaurants are situated, the net assets of one Applebee’s restaurant expected to be sold, property and equipment from one previously closed Applebee’s restaurant and one IHOP restaurant held for refranchising.

 

The following table summarizes the changes in the balance of assets held for sale during 2010:

 

 

 

(In millions)

 

Balance December 31, 2009

 

$

8.8

 

Assets transferred to held for sale

 

29.4

 

Assets sold

 

(2.1

)

Assets refranchised

 

(0.5

)

Balance September 30, 2010

 

$

35.6

 

 

During the nine months ended September 30, 2010, the Company entered into an asset purchase agreement for the sale of 63 company-operated Applebee’s restaurants located in Minnesota and Wisconsin. The transaction is expected to close in the fourth quarter of 2010 (see Note 17, Subsequent Events). Accordingly, $22.6 million, representing the net book value of the assets related to these restaurants, was transferred to assets held for sale. Additionally, $4.7 million was transferred to assets held for sale related to parcels of land on which three of the 63 restaurants being sold are situated. These parcels were not part of the asset purchase agreement but are being actively marketed. An impairment of $0.7 million was recognized on these transferred assets.

 

6



Table of Contents

 

4. Assets Held For Sale, continued

 

The Company also placed a single restaurant and the land on which it is situated up for sale. In accordance with criteria under U.S. GAAP, the Company transferred $2.1 million, representing the fair value of the assets related to this restaurant as determined by the sales price, to assets held for sale and an impairment of $0.5 million was recognized.

 

Assets sold of $2.1 million comprised the Applebee’s restaurant and property and equipment held for sale at December 31, 2009, and the IHOP restaurant held for sale at December 31, 2009 was refranchised. The balance of assets held for sale at September 30, 2010 of $35.6 million was primarily comprised of assets of the 63 restaurants in Minnesota and Wisconsin, land and building of one Applebee’s restaurant, seven parcels of land on which Applebee’s franchised restaurants are situated and four parcels of land previously intended for future restaurant development.

 

5. Long-Term Debt

 

Long-term debt consists of the following components:

 

 

 

September 30, 2010
(unaudited)

 

December 31,
2009

 

 

 

(In millions)

 

Series 2007-1 Class A-2-II-A Fixed Rate Term Senior Notes due December 2037, at a fixed rate of 7.1767% (inclusive of an insurance premium of 0.75%)

 

$

599.1

 

$

599.1

 

Series 2007-1 Class A-2-II-X Fixed Rate Term Senior Notes due December 2037, at a fixed rate of 7.0588%

 

366.0

 

434.2

 

Series 2007-1 Class M-1 Fixed Rate Term Subordinated Notes due December 2037, at a fixed rate of 8.4044%

 

85.1

 

104.0

 

Series 2007-1 Class A-1 Variable Funding Senior Notes, final maturity date December 2037, at a rate of 2.92% and 2.89% as of September 30, 2010 and December 31, 2009, respectively

 

100.0

 

100.0

 

Series 2007-1 Fixed Rate Notes due March 2037, at a fixed rate of 5.744% (inclusive of an insurance premium of 0.60%)

 

175.0

 

175.0

 

Series 2007-2 Variable Funding Notes, final maturity date March 2037, at a rate of 0.39% and 0.30% as of September 30, 2010 and December 31, 2009, respectively

 

25.0

 

25.0

 

Series 2007-3 Fixed Rate Term Notes due December 2037, at a fixed rate of 7.0588%

 

245.0

 

245.0

 

Discount on Fixed Rate Notes

 

(12.9

)

(19.9

)

Total debt

 

1,582.3

 

1,662.4

 

Less current maturities

 

(25.2

)

(25.2

)

Long-term debt

 

$

1,557.1

 

$

1,637.2

 

 

For a description of the respective instruments, refer to Note 8 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

 

During the nine-month periods ended September 30, 2010 and 2009, the Company recognized the following gains on the early retirement of debt:

 

Transaction Date

 

Instrument

 

Face Amount
Retired

 

Cash Paid

 

Gain (1)

 

 

 

 

 

(In millions)

 

March 2010

 

Class A-2-II-X

 

$

48.7

 

$

43.8

 

$

3.5

 

June 2010

 

Class A-2-II-X

 

19.5

 

18.0

 

1.1

 

 

 

Total 2010

 

$

68.2

 

$

61.8

 

$

4.6

 

 

 

 

 

 

 

 

 

 

 

March 2009

 

Class A-2-II-X

 

$

78.4

 

$

49.0

 

$

26.4

 

May 2009

 

Class A-2-II-A

 

35.2

 

24.3

 

9.6

 

June 2009

 

Class A-2-II-X

 

15.6

 

12.1

 

2.8

 

 

 

Total 2009

 

$

129.2

 

$

85.4

 

$

38.8

 

 


(1) After write-off of the discount and deferred financing costs related to the debt retired.

 

7



Table of Contents

 

5. Long-Term Debt, continued

 

Scheduled monthly payments on the Series 2007-1 Class M-1 Fixed Rate Term Subordinated Notes due December 2037 totaled $18.9 million during the nine months ended September 30, 2010.

 

Debt Covenant Compliance

 

The Company was in compliance with all the covenants related to its securitized indebtedness as of September 30, 2010 and has been in compliance each month since the issuance of the securitized indebtedness.

 

Subsequent Event

 

On October 19, 2010, the Company completed a refinancing of all long-term debt that was outstanding at September 30, 2010. See Note 17, Subsequent Events.

 

6. Financing Obligations

 

As of September 30, 2010, future minimum lease payments under financing obligations during the initial terms of the leases related to sale-leaseback transactions are as follows:

 

Fiscal Years

 

(In millions)

 

Remainder of 2010

 

$

8.0

 

2011

 

31.9

 

2012(1)

 

29.3

 

2013

 

32.0

 

2014

 

32.0

 

Thereafter

 

415.2

 

Total minimum lease payments

 

548.4

 

Less interest

 

(236.3

)

Total financing obligations

 

312.1

 

Less current portion(2)

 

(9.1

)

Long-term financing obligations

 

$

303.0

 

 


(1)               Due to the varying closing dates of the Company’s fiscal year, 11 monthly payments will be made in fiscal 2012.

(2)               Included in “other accrued expenses” on the consolidated balance sheet.

 

7. Other Accrued Expenses

 

As of September 30, 2010, other accrued expenses included $9.1 million of the current portion of financing obligations, $8.6 million of the current portion of capital lease obligations and $3.7 million of accrued interest. As of December 31, 2009, other accrued expenses included $9.1 million of the current portion of financing obligations, $8.0 million of the current portion of capital lease obligations and $3.6 million of accrued interest.

 

8. Impairment and Closure Charges

 

The Company assesses tangible long-lived assets for impairment when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The following table summarizes the components of impairment and closure charges for the three-month and nine-month periods ended September 30, 2010 and 2009:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In millions)

 

Impairment and closure charges:

 

 

 

 

 

 

 

 

 

Impairment

 

$

1.3

 

$

3.9

 

$

1.6

 

$

5.9

 

Closure

 

(0.4

)

0.6

 

1.5

 

0.6

 

Total impairment and closure charges

 

$

0.9

 

$

4.5

 

$

3.1

 

$

6.5

 

 

8



Table of Contents

 

8. Impairment and Closure Charges, continued

 

For the three months ended September 30, 2010 impairment charges totaled $1.3 million and related primarily to assets reclassified as held for sale during the period (see Note 4, Assets Held for Sale). Closure costs were a credit of $0.4 million due to an adjustment for the estimated lease cost of one closed Applebee’s restaurant. For the nine months ended September 30, 2010, the impairment and closure charges comprised the items recorded in the three-month period ended September 30, 2010 in addition to closure charges related primarily to two company-operated IHOP Cafe restaurants (a non-traditional restaurant test format that was evaluated but will no longer be utilized) and to the closure of a company-operated Applebee’s restaurant in China.

 

For the three months ended September 30, 2009, impairment charges totaled $3.9 million and related primarily to four parcels of real estate and one Applebee’s restaurant. The Company had fee ownership of the properties on which four Applebee’s company-operated restaurants were located. These restaurants were franchised in the fourth quarter of 2008 but the Company retained ownership of the land and continued to lease the property to the franchisee. The Company’s strategy does not contemplate retaining such properties as a lessor on a long-term basis. During the third quarter of 2009, the Company determined the properties met the requirements under U.S. GAAP to be reclassified as assets held for sale. The properties were written down to the estimated fair value that will be received upon sale, and an impairment of $2.8 million was recognized. As part of the Company’s quarterly assessment of the recoverability of long-lived assets, an impairment of $1.1 million was recognized related to one Applebee’s company-operated restaurant whose carrying value was not considered recoverable from undiscounted future cash flows.  The closure costs of $0.6 million related to changes in sublease revenue assumptions for a single Applebee’s restaurant that had been closed prior to 2009.

 

For the nine months ended September 30, 2009, the impairment and closure charges comprised the items recorded in the three-month period ended September 30, 2009 in addition to charges related to leasehold improvements and related assets of one IHOP restaurant closed during the period and an additional write-down to the estimated sales value, based on a current letter of intent, of one Applebee’s restaurant that had been closed in a prior period and was included in assets held for sale.

 

9. Stock-Based Compensation

 

From time to time, the Company grants stock options and restricted stock to officers and employees of the Company under the 2001 Stock Incentive Plan (the “2001 Plan”) and restricted stock or restricted stock units to non-employee directors of the Company under the 2005 Stock Incentive Plan for Non-Employee Directors (the “2005 Plan”). The stock options generally vest over a three-year period and have a term of ten years from the issuance date. Option exercise prices equal the closing price of the Company’s common stock on the New York Stock Exchange on the date of grant. Restricted shares of the Company’s common stock are issued at no cost to the holder and vest over terms determined by the Compensation Committee of the Company’s Board of Directors, generally three years. Restricted stock granted to officers and employees generally vests only if the officer or employee is actively employed by the Company on the vesting date, and unvested restricted stock is forfeited upon either termination, retirement before age 65, death or disability, unless the Compensation Committee of the Company’s Board of Directors determines otherwise. When vested options are exercised and restricted stock is issued, the Company generally issues new shares from its authorized but unissued share pool or utilizes treasury stock.

 

The following table summarizes the components of the Company’s stock-based compensation expense included in general and administrative expenses in the consolidated financial statements:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September  30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In millions)

 

Total Stock-Based Compensation:

 

 

 

 

 

 

 

 

 

Pre-tax compensation expense

 

$

4.7

 

$

2.1

 

$

12.9

 

$

7.4

 

Tax benefit

 

(1.9

)

(0.7

)

(5.1

)

(2.3

)

Total stock-based compensation expense, net of tax

 

$

2.8

 

$

1.4

 

$

7.8

 

$

5.1

 

 

As of September 30, 2010, $6.3 million and $7.1 million (including estimated forfeitures) of total unrecognized compensation cost related to restricted stock and stock options, respectively, is expected to be recognized over a weighted average period of 1.29 years for restricted stock and 1.59 years for stock options.

 

9


 


Table of Contents

 

9. Stock-Based Compensation, continued

 

The estimated fair values of the options granted during 2010 were calculated using a Black-Scholes option pricing model. The following summarizes the assumptions used in the Black-Scholes model:

 

Risk-free interest rate

 

2.31

%

Weighted average historical volatility

 

80.1

%

Dividend yield

 

 

Expected years until exercise

 

4.89

 

Forfeitures

 

11.0

%

Weighted average fair value of options granted

 

$

18.61

 

 

Option balances as of September 30, 2010 and activity under the Company’s stock option plan during the nine-month period then ended were as follows:

 

 

 

Shares

 

Weighted
Average
Exercise
Price

 

Weighted Average
Remaining
Contractual Term
(in Years)

 

Aggregate
Intrinsic
Value

 

Outstanding at December 31, 2009

 

1,659,100

 

$

21.30

 

 

 

 

 

Granted

 

370,804

 

28.88

 

 

 

 

 

Exercised

 

(261,178

)

9.52

 

 

 

 

 

Expired

 

(22,717

)

44.67

 

 

 

 

 

Forfeited

 

(34,314

)

27.90

 

 

 

 

 

Outstanding at September 30, 2010

 

1,711,695

 

24.30

 

7.30

 

$

36,030,000

 

Vested at September 30, 2010 and Expected to Vest

 

1,467,057

 

25.44

 

7.08

 

29,289,000

 

Exercisable at September 30, 2010

 

667,487

 

34.35

 

5.13

 

7,690,000

 

 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company’s closing stock price on the last trading day of the third quarter of 2010 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2010. The amount of aggregate intrinsic value will change based on the fair market value of the Company’s stock and the number of in-the-money options.

 

A summary of restricted stock activity during the nine-month period ended September 30, 2010 is presented below:

 

 

 

Restricted
Stock

 

Weighted
Average
Grant Date
Fair Value

 

Restricted
Stock Units

 

Weighted
Average
Grant Date
Fair Value

 

Outstanding at December 31, 2009

 

650,323

 

$

33.09

 

 

 

Granted

 

191,605

 

28.85

 

20,000

 

$

29.32

 

Released

 

(109,118

)

48.89

 

(2,000

)

29.32

 

Forfeited

 

(24,179

)

35.07

 

 

 

Outstanding at September 30, 2010

 

708,631

 

$

29.46

 

18,000

 

29.32

 

 

10. Income Taxes

 

The Company or one of its subsidiaries files federal income tax returns and income tax returns in various state and foreign jurisdictions. With few exceptions, the Company is no longer subject to federal, state or non-U.S. tax examinations by tax authorities for years before 2006 for federal returns and 2005 for other jurisdictions. Applebee’s is currently under audit by the U.S. Internal Revenue Service for the period ended November 29, 2007.  The Company is currently under audit by the U.S. Internal Revenue Service for the period ended December 30, 2007.

 

At September 30, 2010, the Company had a liability for unrecognized tax benefits including potential interest and penalties, net of related tax benefit, totaling $14.4 million, of which approximately $2.8 million is expected to be paid within one year. For the remaining liability, due to the uncertainties related to these tax matters, the Company is unable to make a reasonably reliable estimate when cash settlement with a taxing authority will occur.

 

10



Table of Contents

 

10. Income Taxes, continued

 

The total unrecognized tax benefit as of September 30, 2010 and December 31, 2009 was $10.3 million and $11.0 million, respectively, excluding interest, penalties and related income tax benefits. The decrease was due primarily to settlements with taxing authorities resulting in a decrease in unrecognized tax benefits related to prior year positions. The entire $10.3 million will be included in the Company’s effective income tax rate if recognized. The Company estimates the unrecognized tax benefits may decrease over the upcoming 12 months by an amount up to $5.0 million related to settlements with taxing authorities and the lapse of statutes of limitations.

 

As of September 30, 2010, accrued interest and penalties were $10.2 million and $1.5 million, respectively, excluding any related income tax benefits. As of December 31, 2009, the accrued interest and penalties were $11.6 million and $1.6 million, respectively, excluding any related income tax benefits. The decrease of $1.4 million of accrued interest is primarily related to the release of reserves as a result of the expiration of statutes of limitations, partially offset by the accrual of interest during the nine months ended September 30, 2010. The Company recognizes interest accrued related to unrecognized tax benefits and penalties as a component of income tax expense which is recognized in the Consolidated Statements of Income.

 

The Company has various state net operating loss carryovers representing $1.7 million of state taxes. The net operating loss carryovers will expire, if unused, during the period from 2010 through 2028. In 2009, the Company completed the certification process for High Performance Incentive Program (“HPIP”) credits associated with the Applebee’s Restaurant Support Center in Lenexa, Kansas.  As of September 30, 2010, the HPIP credits available for carry back and carry forward are approximately $3.2 million and will expire, if unused, during the period from 2016 through 2019.

 

As of September 30, 2010 the Company had a valuation allowance against deferred tax assets totaling $9.8 million.  Of this amount, $7.0 million is related to a change in the enacted tax law for the state of Michigan, $1.2 million is related to the Massachusetts enacted legislation requiring unitary businesses to file combined reports and $1.6 million is related to the HPIP credits associated with the Applebee’s Restaurant Support Center.

 

The effective tax rate was 33.6% for the nine-month period ended September 30, 2010. The effective tax rate was lower than the federal statutory rate of 35% primarily due to tax credits and the release of tax contingency reserves as a result of the expiration of statutes of limitations.  The tax credits are primarily FICA tip and other compensation-related tax credits associated with Applebee’s company-owned restaurant operations.

 

11. Segments

 

The Company’s revenues and expenses are recorded in four segments: franchise operations, company restaurant operations, rental operations and financing operations.

 

As of September 30, 2010, the franchise operations segment consisted of (i) 1,607 restaurants operated by Applebee’s franchisees in the United States, one U.S. territory and 16 countries outside the United States; and (ii) 1,473 restaurants operated by IHOP franchisees and area licensees in the United States, two U.S. territories, Canada and Mexico. Franchise operations revenue consists primarily of franchise royalty revenues, sales of proprietary products, certain franchise advertising fees and the portion of the franchise fees allocated to intellectual property.  Franchise operations expenses include advertising expense, the cost of proprietary products, pre-opening training expenses and costs related to intellectual property provided to certain franchisees.

 

As of September 30, 2010, the company restaurant operations segment consisted of 392 company-operated Applebee’s restaurants and ten company-operated IHOP restaurants, all in the United States. Company restaurant sales are retail sales at company-operated restaurants. Company restaurant expenses are operating expenses at company-operated restaurants and include food, labor, benefits, utilities, rent and other restaurant operating costs.

 

Rental operations revenue includes revenue from operating leases and interest income from direct financing leases. Rental operations expenses are costs of operating leases and interest expense on capital leases on franchise-operated restaurants. Financing operations revenue consists of the portion of franchise fees not allocated to intellectual property, sales of equipment and interest income from the financing of franchise fees and equipment leases. Financing expenses are primarily the costs of restaurant equipment.

 

11



Table of Contents

 

11. Segments, continued

 

Information on segments is as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September  30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In millions)

 

Revenues from external customers

 

 

 

 

 

 

 

 

 

Franchise operations

 

$

92.1

 

$

90.2

 

$

280.6

 

$

278.9

 

Company restaurants

 

206.9

 

206.4

 

642.2

 

668.2

 

Rental operations

 

32.2

 

32.9

 

98.3

 

99.2

 

Financing operations

 

4.2

 

4.1

 

12.2

 

12.5

 

Total

 

$

335.4

 

$

333.6

 

$

1,033.3

 

$

1,058.8

 

Interest expense

 

 

 

 

 

 

 

 

 

Company restaurants

 

$

0.2

 

$

0.2

 

$

0.6

 

$

0.7

 

Rental operations

 

4.6

 

4.9

 

14.3

 

14.8

 

Corporate

 

42.9

 

45.2

 

131.4

 

139.6

 

Total

 

$

47.7

 

$

50.3

 

$

146.3

 

$

155.1

 

Depreciation and amortization

 

 

 

 

 

 

 

 

 

Franchise operations

 

$

2.5

 

$

2.4

 

$

7.5

 

$

7.4

 

Company restaurants

 

7.2

 

7.2

 

22.1

 

22.1

 

Rental operations

 

2.7

 

2.9

 

8.3

 

8.7

 

Corporate

 

3.0

 

3.5

 

9.7

 

10.2

 

Total

 

$

15.4

 

$

16.0

 

$

47.6

 

$

48.4

 

Income (loss) before income taxes

 

 

 

 

 

 

 

 

 

Franchise operations

 

$

66.6

 

$

64.8

 

$

204.2

 

$

201.5

 

Company restaurants

 

29.7

 

27.1

 

90.4

 

94.8

 

Rental operations

 

8.3

 

8.7

 

26.1

 

26.1

 

Financing operations

 

3.4

 

4.0

 

11.0

 

12.2

 

Corporate

 

(87.8

)

(87.4

)

(259.4

)

(227.2

)

Total

 

$

20.2

 

$

17.2

 

$

72.3

 

$

107.4

 

 

12. Other Comprehensive Income

 

The components of comprehensive income, net of taxes, are as follows:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September  30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In millions)

 

Net income

 

$

14.3

 

$

13.5

 

$

48.0

 

$

75.5

 

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Interest rate swap

 

2.4

 

2.2

 

6.9

 

6.3

 

Temporary decline in available-for-sale securities

 

 

0.1

 

 

0.1

 

Total comprehensive income

 

$

16.7

 

$

15.8

 

$

54.9

 

$

81.9

 

 

The amount of income tax benefit allocated to the interest rate swap was $1.5 million and $1.4 million for the three months ended September 30, 2010 and 2009, respectively. The amount of income tax benefit allocated to the interest rate swap was $4.5 million and $4.2 million for the nine months ended September 30, 2010 and 2009, respectively. The loss related to an interest rate swap designated as a cash flow hedge that was terminated in 2007 and is being reclassified into earnings as interest expense over the expected life of the related debt, estimated to be approximately five years. See Note 17, Subsequent Events

 

The accumulated comprehensive loss of $13.9 million (net of tax) as of September 30, 2010 is comprised of $13.6 million related to a terminated interest rate swap and $0.3 million related to a temporary decline in available-for-sale securities. The accumulated comprehensive loss of $20.8 million (net of tax) as of December 31, 2009 is comprised of $20.5 million related to a terminated interest rate swap and $0.3 million related to a temporary decline in available-for-sale securities.

 

12



Table of Contents

 

13. Net Income Per Share

 

The computation of the Company’s basic and diluted net income per share is as follows:

 

 

 

Three Months Ended
September 30,

 

 

 

2010

 

2009

 

 

 

(In thousands, except per
share data)

 

Numerator for basic and dilutive income—per common share:

 

 

 

 

 

Net income

 

$

14,331

 

$

13,505

 

Less: Series A Preferred Stock dividends

 

(5,640

)

(4,750

)

Less: Accretion of Series B Preferred Stock

 

(612

)

(577

)

Less: Net income allocated to unvested participating restricted stock

 

(307

)

(301

)

Net income available to common stockholders— basic

 

7,772

 

7,877

 

Effect of unvested participating restricted stock in two-class calculation

 

6

 

 

Accretion of Series B Preferred Stock*

 

 

 

Net income available to common stockholders— diluted

 

$

7,778

 

$

7,877

 

Denominator:

 

 

 

 

 

Weighted average outstanding shares of common stock

 

17,227

 

16,942

 

Dilutive effect of:

 

 

 

 

 

Stock options

 

341

 

 

Convertible Series B Preferred Stock*

 

 

 

Common stock and common stock equivalents

 

17,568

 

16,942

 

Net income per common share:

 

 

 

 

 

Basic

 

$

0.45

 

$

0.46

 

Diluted

 

$

0.44

 

$

0.46

 

 

 

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

 

 

(In thousands, except per
share data)

 

Numerator for basic and dilutive income—per common share:

 

 

 

 

 

Net income

 

$

48,043

 

$

75,460

 

Less: Series A Preferred Stock dividends

 

(17,100

)

(14,250

)

Less: Accretion of Series B Preferred Stock

 

(1,810

)

(1,706

)

Less: Net income allocated to unvested participating restricted stock

 

(1,113

)

(2,211

)

Net income available to common stockholders— basic

 

28,020

 

57,293

 

Effect of unvested participating restricted stock in two-class calculation

 

21

 

99

 

Accretion of Series B Preferred Stock*

 

 

1,706

 

Net income available to common stockholders— diluted

 

$

28,041

 

$

59,098

 

Denominator:

 

 

 

 

 

Weighted average outstanding shares of common stock

 

17,168

 

16,904

 

Dilutive effect of:

 

 

 

 

 

Stock options

 

351

 

249

 

Convertible Series B Preferred Stock *

 

 

564

 

Common stock and common stock equivalents

 

17,519

 

17,717

 

Net income per common share:

 

 

 

 

 

Basic

 

$

1.63

 

$

3.39

 

Diluted

 

$

1.60

 

$

3.34

 

 


*       The effect of adding 598,700, 598,700 and 564,000 shares from the assumed conversion of Series B Convertible Preferred Stock to the denominator and the related dividends on Series B Convertible Preferred Stock to the numerator is anti-dilutive for the three months ended September 30, 2010 and 2009 and the nine months ended September 30, 2010.

 

13



Table of Contents

 

14. Fair Value Measurements

 

U.S. GAAP pertaining to fair value measurements defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). U.S. GAAP establishes a three-tier hierarchy that prioritizes the inputs used in measuring fair value. These tiers are: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets or liabilities; Level 2, defined as inputs that are either directly or indirectly observable, including quoted prices in active markets for similar assets or liabilities; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

Financial Assets Measured at Fair Value on a Recurring Basis

 

The Company believes the carrying amounts of cash, accounts receivable, accounts payable and the current portion of long-term debt approximate their fair values due to their short duration.

 

The following table summarizes cost and market value of our financial instruments measured at fair value on a recurring basis at September 30, 2010 and December 31, 2009:

 

September 30, 2010

 

Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

 

 

(In millions)

 

Cash equivalents and money market funds

 

$

1.2

 

$

 

$

 

$

1.2

 

Auction-rate securities

 

$

2.9

 

$

 

$

(0.3

)

$

2.6

 

 

December 31, 2009

 

Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

 

 

(In millions)

 

Cash equivalents and money market funds

 

$

1.7

 

$

 

$

 

$

1.7

 

Auction-rate securities

 

$

2.9

 

$

 

$

(0.3

)

$

2.6

 

 

Cash equivalents and money market funds are valued based on Level 1 inputs. Auction-rate securities are valued using Level 3 inputs. The Level 3 input used is a discounted cash flow model under the income approach using primarily assumptions as to future interest payments and a discount rate. There was no change in the valuation methodology between the periods presented. During the nine-month period ending September 30, 2010 there were (i) no changes in fair value or impact on earnings resulting from Level 3 fair value measurements; (ii) no purchases and sales of financial instruments or resulting gains and losses; and (iii) no transfers into, out of or between fair value hierarchies.  The scheduled maturity of one auction-rate security valued at $0.6 million is December 2030. The remaining balance of auction-rate securities is in mutual funds invested in auction rate securities with no scheduled maturity for the funds.

 

Other Fair Value Disclosures

 

The fair values of non-current financial liabilities are shown in the following table:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Carrying
Amount

 

Fair Value

 

Carrying
Amount

 

Fair Value

 

 

 

(In millions)

 

Long-term debt, less current maturities

 

$

1,557.1

 

$

1,615.8

 

$

1,637.2

 

$

1,547.5

 

Series A Preferred Stock

 

$

187.1

 

$

194.6

 

$

187.1

 

$

168.3

 

 

14



Table of Contents

 

14. Fair Value Measurements, continued

 

At September 30, 2010, the fair value of the non-current financial liabilities was based on Level 3 inputs as determined by the retirement or redemption price paid in October 2010 (see Note 17, Subsequent Events). At December 31, 2009, the fair value of the non-current financial liabilities was determined based on Level 3 inputs using a risk-adjusted discounted cash flow model under the income approach.

 

15. Involvement with Variable Interest Entities

 

In December 2009 the FASB amended U.S. GAAP by replacing a quantitative-based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a variable interest entity (“VIE”) with a primarily qualitative analysis. The qualitative analysis is based on identifying the party that has both the power to direct the activities that most significantly impact the VIE’s economic performance and the obligation to absorb losses from or the right to receive benefits of the VIE that could potentially be significant to the VIE. The party that meets both these criteria is deemed to have a controlling financial interest. The party with the controlling financial interest is considered to be the primary beneficiary and as a result is required to consolidate the VIE. The amendments also require ongoing reassessments of whether an entity is the primary beneficiary of a VIE and require enhanced disclosures about an entity’s involvement in a VIE. The Company adopted these amendments effective January 1, 2010.

 

In adopting the amendments, the Company performed an assessment as to whether franchise agreements between the Company and its franchisees (both IHOP and Applebee’s) were VIEs. The Company concluded that both the IHOP and Applebee’s franchisees have key decision-making abilities which enable them to have a significant impact on the success and the fair value of their respective franchises and, therefore, that the franchise agreements are not VIEs.

 

In adopting the amendments, the Company also assessed whether Centralized Supply Chain Services, LLC (“CSCS”), a purchasing co-operative formed in February 2009  by the Company and owners of Applebee’s and IHOP franchise restaurants to manage procurement activities for the Applebee’s and IHOP restaurants choosing to join CSCS, was a VIE and whether the Company was the primary beneficiary. Under the terms of the membership agreements, each member restaurant belonging to CSCS has equal and identical voting rights, ownership rights and obligations. The Company does not have voting control of CSCS. Accordingly, the Company is not considered to be the primary beneficiary of the VIE and therefore does not consolidate the results of CSCS. This assessment was reaffirmed as of September 30, 2010 as there have been no changes in the significant facts and circumstances related to the Company’s involvement with CSCS.

 

CSCS does not purchase items on behalf of member restaurants; rather, it facilitates purchasing agreements and distribution arrangements between suppliers and member restaurants. Because of this, CSCS acquires a minimal amount of assets and incurs a minimal amount of liabilities. Each member restaurant is responsible for only the goods and services it chooses to purchase and bears no responsibility or risk of loss for goods and services purchased by other member restaurants. Based on these facts, the Company believes its maximum estimated loss related to its membership in the CSCS is insignificant.

 

16. Commitments and Contingencies

 

Litigation, Claims and Disputes

 

The Company is subject to various lawsuits, claims and governmental inspections or audits arising in the ordinary course of business. Some of these lawsuits purport to be class actions and/or seek substantial damages. In the opinion of management, these matters are adequately covered by insurance or, if not so covered, are without merit or are of such a nature or involve amounts that would not have a material adverse impact on the Company’s business or consolidated financial statements.

 

Gerald Fast v. Applebee’s

 

The Company is currently defending a collective action filed under the Fair Labor Standards Act styled Gerald Fast v. Applebee’s International, Inc., in which named plaintiffs claim that tipped workers in company restaurants perform excessive amounts of non-tipped work for which they should be compensated at the minimum wage.  The court has conditionally certified a nationwide class of servers and bartenders who have worked in company-operated Applebee’s restaurants since June 19, 2004.  Unlike a class action, a collective action requires potential class members to “opt in” rather than “opt out.”  On February 12, 2008, 5,540 opt-in forms were filed with the court.

 

In cases of this  type, conditional  certification of the plaintiff class is  granted under  a  lenient  standard.  On January 15, 2009, the Company filed a  motion seeking to have the  class de-certified and  the plaintiffs filed a motion for summary judgment, both of which were denied by the court. 

 

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Table of Contents

 

16. Commitments and Contingencies, continued

 

The parties stipulated to a bench trial which was set to begin on September 8, 2009 in Jefferson City, Missouri.  Just prior to trial, however, the court vacated the trial setting in order to submit key legal issues to the Eighth Circuit Court of Appeals for review on interlocutory appeal. The Court of Appeals has agreed to hear the interlocutory appeal. Briefing is complete; however, no date has been set for oral argument.

 

The Company believes it has strong defenses to the substantive claims asserted and intends to vigorously defend this case.  An estimate of the possible loss, if any, or the range of the loss cannot be made and, therefore, the Company has not accrued a loss contingency related to this matter.

 

Lease Guarantees

 

In connection with the sale of Applebee’s restaurants or previous brands to franchisees and other parties, the Company has, in certain cases, guaranteed or had potential continuing liability for lease payments totaling $111.4 million as of      September 30, 2010. This amount represents the maximum potential liability of future payments under these leases. These leases have been assigned to the buyers and expire at the end of the respective lease terms, which range from 2010 through 2044. In the event of default, the indemnity and default clauses in our sale or assignment agreements govern our ability to pursue and recover damages incurred.  No material liabilities have been recorded as of September 30, 2010.

 

17. Subsequent Events

 

On October 8, 2010, the Company entered into a Credit Agreement, by and among the Company, the lenders and other financial institutions party thereto (the “Credit Agreement”). The Credit Agreement established a senior secured credit facility consisting of a $900.0 million senior secured term loan facility maturing in October 2017 (the “Term Facility”) and a $50.0 million senior secured revolving credit facility maturing in October 2015 (the “Revolving Facility”). Loans made under the Term Facility and the Revolving Facility will bear interest, at the Company’s option, at an annual rate equal to (i) a LIBOR-based rate (which will be subject to a floor of 1.50%) plus a margin of 4.50% or (ii) the base rate (which will be subject to a floor of 2.50%) which will be equal to the highest of (a) the federal funds rate plus 0.50%, (b) the prime rate and (c) the one-month LIBOR rate (which will be subject to a floor of 1.50%) plus 1.00%, plus a margin of 3.50%.  The margin for the Revolving Facility is subject to leverage-based step-downs.  The Term Facility and the Revolving Facility are subject to upfront fees of 1.0% and 1.5%, respectively, of the principal amount thereof. The loans made under the Credit Agreement will be guaranteed by the Company’s domestic wholly-owned restricted subsidiaries, other than immaterial subsidiaries (the “Guarantors”), and secured by a perfected first priority security interest in substantially all of the tangible and intangible assets of the Company and the Guarantors, including, without limitation, (i) substantially all personal, real and mixed property, (ii) all intercompany debt owing to the Company and the Guarantors and (iii) 100% of the equity interests held by the Company and each of the Guarantors (with customary limits for foreign subsidiaries), subject to certain customary exceptions.

 

On October 11, 2010, the Company announced that it had entered into an asset purchase agreement for the sale of 20 company-operated Applebee’s restaurants located in the Roanoke and Lynchburg markets in Virginia. This transaction is expected to close in the fourth quarter of 2010. On the same date, the Company also announced that it had entered into an asset purchase agreement for the sale of 36 company-operated Applebee’s restaurants located in the St. Louis, Missouri area and parts of Illinois. This transaction is expected to close in the first quarter of 2011. The agreements for the sales of these restaurants do not contain financing contingencies, but are subject to regulatory processes related to liquor license transfer and other customary closing conditions.

 

On October 19, 2010 (the “Closing Date”), the Company issued $825,000,000 aggregate principal amount of its 9.5% Senior Notes due 2018 (the “Notes”) pursuant to an Indenture, by and among Wells Fargo Bank, National Association, as trustee, the Company and the Guarantors. On the Closing Date, the Company used the net proceeds of the offering of the Notes, along with borrowings made on the Closing Date under the Credit Agreement and other cash on hand, to fund (i) the repayment, through various transactions, of all of the Company’s securitized long-term debt (see Note 5, Long-Term Debt), including make-whole payments of approximately $46 million associated with the early retirement of the securitized long-term debt and (ii) the redemption of 143,000 shares of its Series A Perpetual Preferred Stock, par value $1.00 per share, in accordance with its terms, at a redemption price equal to 104.0% of the stated value of $1,000 per share plus accrued and unpaid dividends to, but not including, the Closing Date.

 

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Table of Contents

 

17. Subsequent Events, continued

 

On October 21, 2010, the Company completed the sale of 61 of 63 Applebee’s company-operated restaurants located in Minnesota and Wisconsin pursuant to the terms of an asset purchase agreement. As discussed in Note 4, Assets Held for Sale, these restaurants were reported as assets held for sale in the Consolidated Balance Sheet as of September 30, 2010. The Company received proceeds of approximately $27.6 million from this sale. The sale of the remaining two restaurants is expected to close in the fourth quarter of 2010.

 

On November 1, 2010, the Company used the net proceeds from the sale of 61 of 63 company-operated restaurants in Minnesota and parts of Wisconsin, along with $19.5 million in cash that previously had been restricted for the collateralization of letters of credit, to redeem 44,800 shares of Series A Perpetual Preferred Stock, par value $1.00 per share, in accordance with its terms, at a redemption price equal to 104.0% of the stated value of $1,000 per share plus accrued and unpaid dividends to, but not including, the date of redemption.

 

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Table of Contents

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Forward-Looking Statements

 

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements in certain circumstances. This report contains statements that involve expectations, plans or intentions (such as those relating to future business or financial results, new features or services, or management strategies). These statements are forward-looking and are subject to risks and uncertainties, so actual results may vary materially from those expressed or implied by any forward-looking statements. You can identify these forward-looking statements by words such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. You should consider our forward-looking statements in light of the risks discussed under the heading “Risk Factors” in our most recent Annual Report on Form 10-K, as well as our consolidated financial statements, related notes, and the other financial information appearing elsewhere in this report and our other filings with the U.S. Securities and Exchange Commission. These factors include, but are not limited to: the implementation of the Company’s strategic growth plan; the availability of suitable locations and terms for sites designated for development; the ability of franchise developers to fulfill their commitments to build new restaurants in the numbers and time frames covered by their development agreements; legislation and government regulation, including the ability to obtain satisfactory regulatory approvals; risks associated with the Company’s indebtedness; conditions beyond the Company’s control, such as weather, natural disasters, disease outbreaks, epidemics or pandemics impacting the Company’s customers or food supplies, or acts of war or terrorism; availability and cost of materials and labor; cost and availability of capital; competition; potential litigation and associated costs; continuing acceptance of the IHOP and Applebee’s brands and concepts by guests and franchisees; the Company’s overall marketing, operational and financial performance; economic and political conditions; adoption of new, or changes in, accounting policies and practices; and other factors discussed from time to time in the Company’s news releases, public statements and/or filings with the Securities and Exchange Commission. We assume no obligation to update any forward-looking statements.

 

Overview

 

The following discussion and analysis provides information we believe is relevant to an assessment and understanding of our consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 1 of Part I of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009. Except where the context indicates otherwise, the words “we,” “us,” “our” and the “Company” refer to DineEquity, Inc., together with its subsidiaries that are consolidated in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).

 

The Company was incorporated under the laws of the State of Delaware in 1976. The first International House of Pancakes® (“IHOP”) restaurant opened in 1958 in Toluca Lake, California. Since that time, the Company or its predecessors have engaged in the development, operation and franchising of IHOP restaurants. In November 2007, we completed the acquisition of Applebee’s International, Inc. (“Applebee’s”), which became a wholly-owned subsidiary of the Company. Through various IHOP and Applebee’s subsidiaries, we own, operate and franchise two restaurant concepts in the casual dining and family dining categories of the food service industry: Applebee’s Neighborhood Grill and Bar® and IHOP®. DineEquity, Inc. is the parent of the IHOP and Applebee’s subsidiaries. References herein to Applebee’s and IHOP restaurants are to these two restaurant concepts, whether operated by franchisees, area licensees or the Company. References herein to “system sales” include retail sales at restaurants that are owned by franchisees and area licensees and are not attributable to the Company, as well as retail sales at Company-owned restaurants. With nearly 3,500 franchised or owned-and-operated restaurants combined, we are the largest full-service restaurant company in the world.

 

Since the completion of the Applebee’s acquisition, we have been pursuing a strategy which contemplates transitioning from an Applebee’s system that was 74% franchised at the time of the acquisition to an approximately 98% franchised Applebee’s system, similar to IHOP’s 99% franchised system. As of September 30, 2010, we have franchised 110 Applebee’s company-operated restaurants in the California, Nevada, Delaware, Texas and New Mexico markets since the acquisition. We have entered into asset purchase agreements for the sale of 63 company-operated restaurants in Minnesota and parts of Wisconsin, 36 company-operated restaurants in the St. Louis, Missouri area and parts of Illinois, and 20 company-operated restaurants in Virginia. On October 21, 2010, the sale of 61 of the 63 restaurants in Minnesota and Wisconsin was completed; sales of the remaining 58 restaurants under these three asset purchase agreements are expected to close in the fourth quarter of fiscal 2010 or the first fiscal quarter of 2011. Following these transactions, the Applebee’s system will be approximately 86% franchised, based on the September 30, 2010 restaurant total.  A more heavily franchised business model is expected to require less capital investment and reduce the volatility of cash flow performance over time.

 

A range of factors, including the overall market for restaurant franchises, the availability of financing and the financial and operating performance of Applebee’s company-owned restaurants, can impact the likelihood and timing of the completion of this strategy as well as the ultimate proceeds we will receive from franchising the company-operated

 

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Table of Contents

 

restaurants.  We continually monitor these factors to assess their impact on possible franchise transactions. We may choose to suspend or revise our franchising strategy for Applebee’s company-operated restaurants if we do not believe that conditions will lead to satisfactory proceeds from the franchising of the Applebee’s company-operated restaurants.

 

Restaurant Development Activity

 

The following table summarizes Applebee’s restaurant development and franchising activity:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(unaudited)

 

Applebee’s Restaurant Development Activity

 

 

 

 

 

 

 

 

 

Total restaurants, beginning of period

 

2,001

 

1,992

 

2,008

 

2,004

 

New openings

 

 

 

 

 

 

 

 

 

Company-developed

 

 

 

 

 

Franchise-developed

 

3

 

13

 

11

 

23

 

Total new openings

 

3

 

13

 

11

 

23

 

Closings

 

 

 

 

 

 

 

 

 

Company

 

(1

)

 

(7

)

 

Franchise

 

(4

)

(3

)

(13

)

(25

)

Total closings

 

(5

)

(3

)

(20

)

(25

)

Total restaurants, end of period

 

1,999

 

2,002

 

1,999

 

2,002

 

Summary-end of period

 

 

 

 

 

 

 

 

 

Franchise

 

1,607

 

1,603

 

1,607

 

1,603

 

Company

 

392

 

399

 

392

 

399

 

Total

 

1,999

 

2,002

 

1,999

 

2,002

 

Restaurant Franchising Activity

 

 

 

 

 

 

 

 

 

Domestic franchise-developed

 

3

 

5

 

5

 

12

 

International franchise-developed

 

 

8

 

6

 

11

 

Refranchised

 

 

2

 

 

7

 

Total restaurants franchised

 

3

 

15

 

11

 

30

 

Closings

 

 

 

 

 

 

 

 

 

Domestic franchise

 

(3

)

(3

)

(11

)

(21

)

International franchise

 

(1

)

 

(2

)

(4

)

Total franchise closings

 

(4

)

(3

)

(13

)

(25

)

Net franchise restaurant additions (reductions)

 

(1

)

12

 

(2

)

5

 

 

The increase in Applebee’s company closings in 2010 relates to closures of six domestic underperforming restaurants and our one restaurant in China.

 

The following table represents Applebee’s restaurant development commitments for 2010 and 2011. We have disclosed development commitments for only a two-year period as the Applebee’s development agreements generally provide for a series of two-year development commitments after the initial development period.

 

 

 

Contractual
Opening of
Restaurants by Year

 

 

 

2010

 

2011

 

Domestic development agreements

 

19

 

16

 

International development agreements

 

15

 

10

 

 

 

34

 

26

 

 

In 2010, we expect franchisees to open 25 to 30 new Applebee’s franchise restaurants. We currently do not plan to open any company-operated restaurants. The actual number of openings may differ from both our expectations and development commitments due to various factors, including economic conditions, franchisee access to capital and the impact of currency fluctuations on our international franchisees. The timing of new restaurant openings also may be affected by various factors including weather-related and other construction delays and difficulties in obtaining regulatory approvals.

 

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Table of Contents

 

The following table summarizes IHOP restaurant development and franchising activity:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September  30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(unaudited)

 

IHOP Restaurant Development Activity

 

 

 

 

 

 

 

 

 

Total restaurants, beginning of period

 

1,476

 

1,421

 

1,456

 

1,396

 

New openings

 

 

 

 

 

 

 

 

 

Company-developed

 

 

 

 

 

Franchise-developed

 

9

 

12

 

35

 

43

 

Area license

 

1

 

1

 

3

 

4

 

Total new openings

 

10

 

13

 

38

 

47

 

Closings

 

 

 

 

 

 

 

 

 

Company

 

 

 

(2

)

 

Franchise

 

(3

)

(1

)

(6

)

(8

)

Area license

 

 

 

(3

)

(2

)

Total new closings

 

(3

)

(1

)

(11

)

(10

)

Total restaurants, end of period

 

1,483

 

1,433

 

1,483

 

1,433

 

Summary-end of period

 

 

 

 

 

 

 

 

 

Franchise

 

1,309

 

1,260

 

1,309

 

1,260

 

Company

 

10

 

11

 

10

 

11

 

Area license

 

164

 

162

 

164

 

162

 

Total

 

1,483

 

1,433

 

1,483

 

1,433

 

Restaurant Franchising Activity

 

 

 

 

 

 

 

 

 

Domestic franchise-developed

 

7

 

11

 

32

 

39

 

International franchise-developed

 

2

 

1

 

3

 

4

 

Refranchised

 

2

 

 

3

 

1

 

Total restaurants franchised

 

11

 

12

 

38

 

44

 

Closings

 

 

 

 

 

 

 

 

 

Domestic franchise

 

(3

)

(1

)

(6

)

(8

)

International franchise

 

 

 

 

 

Total franchise closings

 

(3

)

(1

)

(6

)

(8

)

Reacquired by the Company

 

(2

)

 

(2

)

(1

)

Net franchise restaurant additions

 

6

 

11

 

30

 

35

 

 

The Company closures in 2010 relate to two IHOP Cafe restaurants, a non-traditional restaurant format that was evaluated for possible development but will not be utilized in the future.

 

As of December 31, 2009, we had signed commitments from franchisees to build 254 IHOP restaurants over the next eight years plus options for an additional 103 restaurants. This number includes 16 restaurants under single-store development agreements, 266 restaurants under multi-store development agreements and 75 restaurants under international development agreements.

 

 

 

 

 

Contractual Openings of
Restaurants by Year

 

 

 

Number of Signed
Agreements at 12/31/09

 

2010

 

2011

 

2012

 

2013 and
thereafter

 

Total

 

Single-store development agreements

 

16

 

12

 

4

 

 

 

16

 

Multi-store development agreements

 

72

 

57

 

49

 

34

 

126

 

266

 

International development agreements

 

6

 

7

 

6

 

3

 

59

 

75

 

 

 

94

 

76

 

59

 

37

 

185

 

357

 

 

In 2010, we expect our franchisees to open 60 to 70 new IHOP restaurants, including 50 to 55 domestic franchise restaurants, two to four area license restaurants in Florida and seven to 11 restaurants outside the U.S. or in non-traditional channels. The actual number of openings in any period may differ from both our expectations and the number of signed commitments. Historically, the actual number of restaurants developed in a particular year has been less than the total number committed to be developed due to various factors including weather-related delays, other construction delays, difficulties in obtaining timely regulatory approvals and various economic factors.

 

20



Table of Contents

 

Restaurant Data

 

The following table sets forth, for the three-month and nine-month periods ended September 30, 2010 and 2009, the number of effective restaurants in the Applebee’s and IHOP systems and information regarding the percentage change in sales at those restaurants compared to the same periods in the prior year. “Effective restaurants” are the number of restaurants in a given period, adjusted to account for restaurants open for only a portion of the period. Information is presented for all effective restaurants in the IHOP and Applebee’s systems, which includes restaurants owned by the Company, as well as those owned by franchisees and area licensees. Sales at restaurants that are owned by franchisees and area licensees are not attributable to the Company. However, we believe that presentation of this information is useful in analyzing our revenues because franchisees and area licensees pay us royalties and advertising fees that are generally based on a percentage of their sales, as well as rental payments under leases that are usually based on a percentage of their sales. Management also uses this information to make decisions about future plans for the development of additional restaurants as well as evaluation of current operations.

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September  30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(unaudited)

 

Applebee’s Restaurant Data

 

 

 

 

 

 

 

 

 

Effective restaurants(a)

 

 

 

 

 

 

 

 

 

Franchise

 

1,607

 

1,598

 

1,606

 

1,592

 

Company

 

393

 

399

 

394

 

402

 

Total

 

2,000

 

1,997

 

2,000

 

1,994

 

System-wide(b)

 

 

 

 

 

 

 

 

 

Sales percentage change(c)

 

3.4

%

(6.3

)%

(0.9

)%

(4.2

)%

Domestic same-restaurant sales percentage change(d)

 

3.3

%

(6.5

)%

(0.5

)%

(4.5

)%

Franchise(e)

 

 

 

 

 

 

 

 

 

Sales percentage change(c)(g)

 

4.1

%

(1.0

)%

(0.2

)%

2.3

%

Same-restaurant sales percentage change(d)

 

3.8

%

(6.2

)%

(0.2

)%

(4.4

)%

Average weekly domestic unit sales (in thousands)

 

$

44.8

 

$

42.9

 

$

46.2

 

$

46.3

 

Company

 

 

 

 

 

 

 

 

 

Sales percentage change(c)(g)

 

0.4

%

(22.7

)%

(3.9

)%

(23.9

)%

Same-restaurant sales percentage change(d)

 

1.2

%

(7.6

)%

(1.7

)%

(5.1

)%

Average weekly domestic unit sales (in thousands)

 

$

39.7

 

$

39.0

 

$

40.9

 

$

41.9

 

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September  30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(unaudited)

 

IHOP Restaurant Data

 

 

 

 

 

 

 

 

 

Effective restaurants(a)

 

 

 

 

 

 

 

 

 

Franchise

 

1,297

 

1,251

 

1,289

 

1,237

 

Company

 

10

 

11

 

11

 

11

 

Area license

 

164

 

162

 

164

 

160

 

Total

 

1,471

 

1,424

 

1,464

 

1,408

 

System-wide(b)

 

 

 

 

 

 

 

 

 

Sales percentage change(c)

 

2.9

%

3.8

%

3.4

%

4.3

%

Domestic same-restaurant sales percentage change(d)