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 25, 2006
-------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
----------------------- ------------------------
Commission File Number: 000-17962
--------------------------------------------------------
Applebee's International, Inc.
--------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 43-1461763
--------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
4551 W. 107th Street, Overland Park, Kansas 66207
-------------------------------------------------------------------------------
(Address of principal executive offices and zip code)
(913) 967-4000
--------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---------- ----------
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer X Accelerated filer Non-accelerated filer
---- ---- ----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act).
Yes No X
---------- ----------
The number of shares of the registrant's common stock outstanding as of July 24,
2006 was 74,427,928.
1.
APPLEBEE'S INTERNATIONAL, INC.
FORM 10-Q
FISCAL QUARTER ENDED JUNE 25, 2006
INDEX
Page
PART I FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements:
Consolidated Balance Sheets as of June 25, 2006
and December 25, 2005 ..................................... 3
Consolidated Statements of Earnings for the 13 Weeks
and 26 Weeks Ended June 25, 2006 and June 26, 2005 ........ 4
Consolidated Statement of Stockholders' Equity for the
26 Weeks Ended June 25, 2006 .............................. 5
Consolidated Statements of Cash Flows for the 26 Weeks
Ended June 25, 2006 and June 26, 2005...................... 6
Notes to Condensed Consolidated Financial Statements......... 8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............. 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk... 33
Item 4. Controls and Procedures...................................... 33
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................ 34
Item 1A. Risk Factors................................................. 34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.. 35
Item 4. Submission of Matters to a Vote of Security Holders.......... 36
Item 6. Exhibits..................................................... 36
Signatures .............................................................. 37
Exhibit Index............................................................ 38
2.
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
June 25, December 25,
2006 2005
-------------- -------------
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 6,896 $ 13,040
Short-term investments, at market value..................................... 289 286
Receivables (less allowance of $325 in 2006 and $340 in 2005)............... 37,706 37,857
Receivables related to captive insurance subsidiary......................... 503 1,712
Inventories................................................................. 12,525 20,373
Prepaid income taxes........................................................ 55 3,488
Prepaid and other current assets............................................ 18,339 13,518
-------------- -------------
Total current assets..................................................... 76,313 90,274
Property and equipment, net...................................................... 619,638 590,593
Goodwill......................................................................... 139,111 138,443
Restricted assets related to captive insurance subsidiary........................ 17,267 19,329
Other intangible assets, net..................................................... 6,713 8,050
Other assets, net................................................................ 33,712 31,899
-------------- -------------
$ 892,754 $ 878,588
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt........................................... $ 283 $ 259
Notes payable............................................................... 4,400 7,900
Accounts payable............................................................ 41,773 63,445
Accrued expenses and other current liabilities.............................. 83,661 100,995
Loss reserve related to captive insurance subsidiary........................ 7,103 10,235
Accrued dividends........................................................... -- 14,840
Accrued income taxes........................................................ 275 --
-------------- -------------
Total current liabilities................................................ 137,495 197,674
-------------- -------------
Non-current liabilities:
Long-term debt, less current portion........................................ 197,066 180,208
Deferred income taxes....................................................... 34,235 37,722
Other non-current liabilities............................................... 55,784 50,374
-------------- -------------
Total non-current liabilities............................................ 287,085 268,304
-------------- -------------
Total liabilities........................................................ 424,580 465,978
-------------- -------------
Commitments and contingencies (Note 3)
Stockholders' equity:
Preferred stock - par value $0.01 per share: authorized - 1,000,000 shares;
no shares issued......................................................... -- --
Common stock - par value $0.01 per share: authorized - 125,000,000 shares;
issued - 108,503,243 shares.............................................. 1,085 1,085
Additional paid-in capital.................................................. 248,656 234,988
Unearned compensation....................................................... -- (2,614)
Retained earnings........................................................... 757,832 710,277
-------------- -------------
1,007,573 943,736
Treasury stock - 34,133,112 shares in 2006 and 34,304,693 shares
in 2005, at cost......................................................... (539,399) (531,126)
-------------- -------------
Total stockholders' equity............................................... 468,174 412,610
-------------- -------------
$ 892,754 $ 878,588
============== =============
See notes to condensed consolidated financial statements.
3.
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
(in thousands, except per share amounts)
13 Weeks Ended 26 Weeks Ended
----------------------------------- -----------------------------------
June 25, June 26, June 25, June 26,
2006 2005 2006 2005
--------------- ---------------- ---------------- ---------------
Operating revenues:
Company restaurant sales ....................... $ 296,128 $ 272,703 $ 604,027 $ 543,161
Franchise royalties and fees.................... 34,306 32,493 70,241 65,501
Other franchise income.......................... 539 1,424 984 2,489
--------------- ---------------- ---------------- ---------------
Total operating revenues.................... 330,973 306,620 675,252 611,151
--------------- ---------------- ---------------- ---------------
Cost of company restaurant sales:
Food and beverage............................... 78,433 72,565 160,669 144,200
Labor........................................... 100,296 90,115 201,327 178,839
Direct and occupancy............................ 80,411 71,038 159,357 137,405
Pre-opening expense............................. 1,157 1,268 1,907 2,435
--------------- ---------------- ---------------- ---------------
Total cost of company restaurant sales...... 260,297 234,986 523,260 462,879
--------------- ---------------- ---------------- ---------------
Cost of other franchise income....................... 281 1,229 1,047 2,048
General and administrative expenses.................. 32,320 27,980 67,926 54,926
Amortization of intangible assets.................... 204 226 408 454
Impairment and other restaurant closure costs........ 3,000 -- 4,600 --
Loss on disposition of property and equipment........ 430 564 1,007 861
--------------- ---------------- ---------------- ---------------
Operating earnings................................... 34,441 41,635 77,004 89,983
--------------- ---------------- ---------------- ---------------
Other income (expense):
Investment income (loss)........................ (285) 449 460 408
Interest expense................................ (2,985) (634) (5,539) (971)
Other income.................................... 101 584 237 1,019
--------------- ---------------- ---------------- ---------------
Total other income (expense)................ (3,169) 399 (4,842) 456
--------------- ---------------- ---------------- ---------------
Earnings before income taxes......................... 31,272 42,034 72,162 90,439
Income taxes......................................... 10,868 14,544 24,607 31,292
--------------- ---------------- ---------------- ---------------
Net earnings......................................... $ 20,404 $ 27,490 $ 47,555 $ 59,147
=============== ================ ================ ===============
Basic net earnings per common share.................. $ 0.28 $ 0.34 $ 0.64 $ 0.74
=============== ================ ================ ===============
Diluted net earnings per common share................ $ 0.27 $ 0.34 $ 0.63 $ 0.72
=============== ================ ================ ===============
Basic weighted average shares outstanding............ 74,112 79,897 74,113 80,295
=============== ================ ================ ===============
Diluted weighted average shares outstanding.......... 75,083 81,360 75,161 81,861
=============== ================ ================ ===============
See notes to condensed consolidated financial statements.
4.
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
(in thousands)
Common Stock Additional Total
------------------- Paid-In Unearned Retained Treasury Stockholders'
Shares Amount Capital Compensation Earnings Stock Equity
---------- -------- ----------- ------------- --------- ------------- -------------
Balance, December 25, 2005 .................... 108,503 $ 1,085 $234,988 $ (2,614) $710,277 $ (531,126) $ 412,610
Net earnings................................ -- -- -- -- 47,555 -- 47,555
Purchases of treasury stock................. -- -- -- -- -- (16,134) (16,134)
Reclassification of unearned compensation
related to the adoption of Statement of
Financial Accounting Standards
No. 123(R) (Note 2)...................... -- -- (2,614) 2,614 -- -- --
Stock options exercised and related tax
benefit.................................. -- -- 4,664 -- -- 5,749 10,413
Shares issued under employee benefit plans.. -- -- 1,188 -- -- 1,130 2,318
Nonvested shares awarded under equity
incentive plans........................... -- -- (982) -- -- 982 --
Stock-based compensation expense related
to employee-based awards.................. -- -- 11,412 -- -- -- 11,412
--------- -------- ----------- ------------- --------- ------------- -------------
Balance, June 25, 2006......................... 108,503 $ 1,085 $248,656 $ -- $757,832 $ (539,399) $ 468,174
========= ======== =========== ============= ========= ============= =============
See notes to condensed consolidated financial statements.
5.
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
26 Weeks Ended
--------------------------------
June 25, June 26,
2006 2005
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings....................................................... $ 47,555 $ 59,147
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization................................... 31,577 25,676
Amortization of intangible assets............................... 408 454
Stock-based compensation........................................ 11,412 1,067
Other amortization.............................................. 156 63
Deferred income tax benefit..................................... (1,046) (2,294)
Impairment and other restaurant closure costs................... 4,600 --
Loss on disposition of property and equipment................... 1,007 861
Income tax benefit from stock-based compensation................ 1,403 3,794
Changes in assets and liabilities, exclusive of effect of
acquisitions:
Receivables..................................................... 148 834
Receivables related to captive insurance subsidiary............. 1,209 (1,342)
Inventories..................................................... 7,906 9,014
Income taxes.................................................... 3,708 10,552
Prepaid and other current assets................................ (7,262) (217)
Accounts payable................................................ (18,985) 4,626
Accrued expenses and other current liabilities.................. (17,509) (6,902)
Loss reserve and unearned premiums related to
captive insurance subsidiary.................................. (3,132) 1,875
Other non-current liabilities................................... 4,138 1,759
Other........................................................... (1,461) (1,177)
------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES....................... 65,832 107,790
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment................................ (59,976) (59,922)
Change in restricted assets related to captive
insurance subsidiary............................................ 2,062 (1,417)
Acquisition of restaurants......................................... (8,040) (46,777)
Proceeds from sale of property and equipment....................... 242 --
------------- -------------
NET CASH USED BY INVESTING ACTIVITIES........................... (65,712) (108,116)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchases of treasury stock........................................ (16,134) (68,238)
Dividends paid..................................................... (14,840) (4,867)
Issuance of common stock upon exercise of stock options............ 7,856 9,929
Shares issued under employee benefit plans......................... 2,318 2,323
Excess tax benefits from stock-based compensation.................. 1,154 --
Net debt proceeds ................................................. 13,382 51,198
------------- -------------
NET CASH USED BY FINANCING ACTIVITIES........................... (6,264) (9,655)
------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS............................... (6,144) (9,981)
CASH AND CASH EQUIVALENTS, beginning of period.......................... 13,040 10,642
------------- -------------
CASH AND CASH EQUIVALENTS, end of period................................ $ 6,896 $ 661
============= =============
See notes to condensed consolidated financial statements.
6.
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
(Unaudited)
(in thousands)
26 Weeks Ended
------------------------------------
June 25, June 26,
2006 2005
---------------- ----------------
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash paid during the 26 week period for:
Income taxes........................................................ $ 19,388 $ 20,316
================ ================
Interest............................................................ $ 5,616 $ 654
================ ================
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
We issued nonvested shares (previously referred to as restricted stock prior to
fiscal 2006) with grant date fair values of $2,447,000 for the 26 weeks ended
June 25, 2006 and nonvested shares, net of forfeitures, of $2,601,000 for the 26
weeks ended June 26, 2005.
In 2002, we entered into a rabbi trust agreement to protect the assets of the
nonqualified deferred compensation plan for certain of our associates. The plan
investments are included in other assets and the offsetting obligation is
included in other non-current liabilities in our consolidated balance sheets. We
had non-cash increases in these balances of $566,000 and $2,094,000 for the 26
weeks ended June 25, 2006 and June 26, 2005, respectively.
We had property and equipment purchases accrued in accounts payable of
approximately $11,600,000 as of June 25, 2006.
See notes to condensed consolidated financial statements.
7.
APPLEBEE'S INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
Our condensed consolidated financial statements included in this Form 10-Q have
been prepared without audit in accordance with the rules and regulations of the
Securities and Exchange Commission. Although certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
have been condensed or omitted, we believe that the disclosures are adequate to
make the information presented not misleading. The accompanying condensed
consolidated financial statements should be read in conjunction with the audited
financial statements and notes thereto included in our Annual Report on Form
10-K for the fiscal year ended December 25, 2005.
We believe that all adjustments, consisting only of normal recurring adjustments
necessary for a fair presentation of the results of the interim periods
presented, have been made. The results of operations for the interim periods
presented are not necessarily indicative of the results to be expected for the
full year.
2. Stock-Based Compensation
Our Board of Directors has approved the Amended and Restated 1995 Equity
Incentive Plan ("1995 Plan") and the 1999 Employee Incentive Plan ("1999 Plan")
which allow the granting of stock options, stock appreciation rights ("SARs"),
nonvested shares, performance units and performance shares to eligible
participants. Grants of stock options may be either incentive or nonqualified.
There are 19,900,000 and 2,473,875 shares authorized under the 1995 Plan and the
1999 Plan, respectively. As of June 25, 2006, we had 3,368,993 shares available
for grant under the 1995 Plan. We will not make additional grants under the 1999
Plan. We issue shares out of our treasury for stock option exercises, SARs
exercises and nonvested share issuances.
Prior to fiscal 2006, we accounted for these stock-based compensation awards
under the intrinsic method of Accounting Principles Board ("APB") Opinion No.
25. Opinion No. 25 required compensation cost to be recognized based on the
excess, if any, between the quoted market price of the stock at the date of
grant and the amount an employee must pay to acquire the stock. All options
awarded under both of our plans were granted with an exercise price equal to the
fair market value on the date of the grant and, accordingly, no compensation
expense was recognized for stock option awards. In addition, we adopted the
disclosure provisions of Statements of Financial Accounting Standards ("SFAS")
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an amendment of FASB Statement No. 123." The Statement required prominent
disclosures in financial statements regarding the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results.
Under APB Opinion No. 25, pro forma expense for stock-based compensation was
calculated using a graded vesting schedule over the explicit vesting period. The
following table presents the effect on our net earnings and earnings per share
had we adopted the fair value method of accounting for stock-based compensation
under SFAS No. 123, "Accounting for Stock-Based Compensation" for the 13 weeks
and 26 weeks ended June 26, 2005 (in thousands, except for per share amounts).
8.
13 Weeks Ended 26 Weeks Ended
June 26, June 26,
2005 2005
---------------------- ----------------------
Net earnings, as reported........................................ $ 27,490 $ 59,147
Add: Stock-based compensation expense included
in net earnings, net of related taxes....................... 373 655
Less: Total stock-based employee compensation expense
determined under fair value-based methods for all
awards, net of related taxes (1)............................ 1,735 3,428
---------------------- ----------------------
Pro forma net earnings........................................... $ 26,128 $ 56,374
====================== ======================
Basic net earnings per common share, as reported................. $ 0.34 $ 0.74
====================== ======================
Basic net earnings per common share, as adjusted................. $ 0.33 $ 0.70
====================== ======================
Diluted net earnings per common share, as reported............... $ 0.34 $ 0.72
====================== ======================
Diluted net earnings per common share, as adjusted............... $ 0.32 $ 0.69
====================== ======================
(1) SFAS No. 123 (revised 2004) requires compensation expense to be recognized
over the requisite service period which is generally from the grant date to
the earlier of a) the explicit vesting date or b) the date on which the
employee becomes retirement eligible. If pro forma expense for the 13 weeks
ended June 26, 2005 ("2005 quarter") and the 26 weeks ended June 26, 2005
("2005 year-to-date period") had been derived using this approach,
additional stock-based compensation would have been $356 and $1,614, net of
tax, respectively, and pro forma net income would have been $25,772 and
$54,760, respectively. Additionally, basic and diluted pro forma earnings
per share would both have been $0.32 for the 2005 quarter and $0.68 and
$0.67, respectively, for the 2005 year-to-date period.
We adopted the fair value recognition provisions of SFAS No. 123(R),
"Share-Based Payment" ("SFAS 123(R)") at the beginning of fiscal year 2006. SFAS
123(R) requires all stock-based compensation, including grants of employee stock
options, to be recognized in the statement of earnings based on fair value. With
limited exceptions, the amount of compensation cost will be measured based on
the fair value on the grant date of the equity or liability instruments issued.
Compensation cost will be recognized over the period that an employee provides
service for that award. We adopted this accounting treatment using the modified
prospective transition method; therefore, results for prior periods have not
been restated.
Beginning in fiscal 2006, we changed our method of determining the fair value of
stock-based awards from the Black-Scholes model to a binomial model. The
binomial model considers a range of assumptions relative to volatility,
risk-free interest rates and employee exercise behavior, which more accurately
models actual employee behaviors. We believe the binomial model provides a fair
value that is more representative of actual and future experience.
9.
Compensation costs for the 13 weeks ended June 25, 2006 ("2006 quarter") and the
26 weeks ended June 25, 2006 ("2006 year-to-date period") have been recognized
for all new awards granted in fiscal 2006 and those awards granted prior to
fiscal 2006 that have yet to reach the end of their service period. As required
by SFAS 123(R), we began recognizing expense for employee stock-based
compensation over the shorter of the vesting period or the period from the date
of the grant until the date the employee becomes eligible for retirement. We
recognize expense for stock-based compensation over the graded vesting period.
We recognized stock-based compensation in the condensed consolidated financial
statements as follows:
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
--------------- --------------- --------------- ---------------
Labor................................................ $ 243 $ -- $ 487 $ --
General and administrative expenses.................. 5,004 571 10,925 1,002
Income taxes......................................... (1,769) (197) (3,933) (346)
--------------- --------------- --------------- ---------------
Stock-based compensation expense included
in net earnings, net of related tax............... $ 3,478 $ 374 $ 7,479 $ 656
=============== =============== =============== ===============
As of June 25, 2006, we had unrecognized compensation expense for stock options
and SARs of $20,200,000 to be recognized over a weighted average period of 2.2
years.
As required by SFAS 123(R), unearned compensation of $2,614,000, which was
previously reflected as a reduction to stockholders' equity as of December 25,
2005, was reclassified as a reduction to additional paid-in capital upon our
adoption of this Statement.
Stock Options
Prior to fiscal 2005, we granted substantially all of our awards through stock
options once per year. These stock options generally vest over three years and
expire ten years from the date of the grant.
In fiscal 2005, we granted substantially all of our awards through quarterly
stock options grants. Grants issued in the first quarter of each year vest three
years from the date of the grant. Grants issued in subsequent quarters vest on
the same date as the first quarterly stock option grant of that year. In fiscal
2005, we also granted certain employees stock options with 25% of the grant
vesting four years from the grant date and the remaining 75% of the grant
vesting five years from the grant date. Beginning in fiscal 2005, option grants
expire six to seven years from the date of the grant. In the first quarter of
fiscal 2006, we issued grants to certain employees and members of the board of
directors which vest either one or three years from the date of the grant. As
part of their compensation package, the outside members of the board of
directors receive a grant of options in the first quarter of every year which
expire 10 years from the grant date.
10.
Transactions for stock options relative to both plans for the 2006 year-to-date
period were as follows:
1995 Plan
---------------------------------------------------------------------
Weighted
Weighted Average
Average Remaining
Number of Exercise Contractual Aggregate
Options Price Life Intrinsic Value
------------------ -------------- ---------------- ------------------
(in thousands)
Options outstanding at
December 25, 2005............ 7,365,933 $ 21.33 6.5 years
Granted................... 335,510 $ 22.30
Exercised................. (496,950) $ 12.20 $ 5,857
Expired................... (120) $ 8.30
Forfeited................. (247,686) $ 25.74
------------------
Options outstanding at
June 25, 2006................ 6,956,687 $ 21.87 6.2 years $ 11,863
==================
Options exercisable at
June 25, 2006................ 2,354,237 $ 15.16 5.7 years $ 11,855
==================
1999 Plan
---------------------------------------------------------------------
Weighted
Weighted Average
Average Remaining
Number of Exercise Contractual Aggregate
Options Price Life Intrinsic Value
------------------ -------------- ---------------- ------------------
(in thousands)
Options outstanding at
December 25, 2005............ 664,656 $ 13.73 6.0 years
Granted................... -- --
Exercised................. (131,324) $ 14.49 $ 1,180
Expired................... -- --
Forfeited................. (505) $ 13.22
------------------
Options outstanding at
June 25, 2006................ 532,827 $ 13.54 5.4 years $ 3,199
==================
Options exercisable at
June 25, 2006................ 528,327 $ 13.52 5.4 years $ 3,183
==================
The aggregate intrinsic value was calculated using the difference between the
current market price and the grant price for only those awards that have a grant
price that is less than the current market price.
11.
We derived the following weighted-average assumptions using the binomial model
in the 2006 quarter and the 2006 year-to-date period and the Black-Scholes model
for the 2005 quarter and the 2005 year-to-date period for stock options:
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
-------------- ---------------- --------------- ---------------
(Binomial) (Black-Scholes) (Binomial) (Black-Scholes)
Expected term in years.................... 5.2 4.2 4.8 4.3
Expected stock price volatility........... 31.6% 31.2% 31.3% 32.6%
Expected dividend yield................... 1.0% 0.3% 0.9% 0.3%
Risk-free interest rate................... 5.0% 3.7% 4.6% 4.0%
Fair value of options granted............. $ 6.61 $ 8.28 $ 6.89 $ 8.84
Stock Appreciation Rights
Beginning in the first quarter of 2006, we began granting substantially all of
our awards through quarterly nonvested share and SAR grants which are
exercisable in shares of our common stock. Grants issued for the first quarter
of each year vest three years from the date of the grant. Grants issued in
subsequent quarters vest on the same date as the first quarterly stock option
grant of that year. The SARs granted in the 2006 year-to-date period expire six
to seven years from the date of the grant.
1995 Plan
---------------------------------------------------------------------
Weighted
Weighted Average
Average Remaining
Number of Exercise Contractual Aggregate
SARs Price Life Intrinsic Value
------------------ -------------- ---------------- ------------------
(in thousands)
SARs outstanding at
December 25, 2005............ -- --
Granted(1)................ 665,350 $ 21.96
Exercised................. -- --
Expired................... -- --
Forfeited................. (10,175) $ 23.57
------------------
SARs outstanding at
June 25, 2006................ 655,175 $ 21.94 6.7 years --
==================
SARs exercisable at
June 25, 2006............... --
==================
(1) Upon exercise of SARs, employees will receive the number of shares of common
stock equal to the appreciation in the fair market value of the number of
shares based on the difference between the fair market value on the grant
date and the fair market value on the date of exercise. The number of shares
of common stock delivered as payment of such appreciation will reduce the
shares available for issuance under the 1995 Plan.
12.
We derived the following weighted-average assumptions for SARs using the
binomial model:
2006
2006 Year-to-Date
Quarter Period
---------------- --------------
Expected term in years 4.2 4.2
Expected stock price volatility 31.6% 31.5%
Expected dividend yield 1.0% 0.9%
Risk-free interest rate 5.0% 4.8%
Fair value of SARs granted $ 5.90 $ 6.31
Assumptions
We determined our assumptions for stock options and SAR grants based on the
following methodology:
Expected term: We have determined the expected term based upon the assumption
that all outstanding options and SARs will be exercised at the midpoint of the
current holding period and the full contractual term.
Expected volatility: We have determined the expected volatility based on a
weighted average of Applebee's volatility over the expected term, historical
volatility of certain peer group restaurant volatilities and Applebee's implied
volatility.
Expected dividend yield: We have determined the expected dividend yield based
upon our expected dividends as a percentage of our current stock price.
Risk-free interest rate: We have determined the risk-free interest rate using
the U.S. Treasury yield curve in effect at the time of the grant for the
expected term of the award.
Nonvested Shares
We grant nonvested shares under our 1995 Plan. Nonvested shares vest either one,
two or three years after the date of the grant. The fair value of nonvested
shares granted is equal to the market price of the stock at the date of grant.
The weighted average fair value of nonvested shares granted was $20.34 in the
2006 quarter, and $22.08 and $28.05 in the 2006 year-to-date period and the 2005
year-to-date period, respectively. There were no nonvested shares granted in the
2005 quarter. Transactions during the 2006 year-to-date period were as follows
(in thousands, except fair values):
Weighted
Number of Average
Awards Fair Value
--------------- --------------
Nonvested share awards outstanding as of December 25, 2005................. 257,813 $ 24.03
Granted.................................................................... 110,820 22.08
Vested..................................................................... (88,179) 18.57
Forfeited.................................................................. (4,506) 26.11
--------------- --------------
Nonvested share awards outstanding as of June 25, 2006..................... 275,948 $ 24.96
=============== ==============
13.
As of June 25, 2006, we had unrecognized compensation expense related to
nonvested share awards of approximately $2,500,000 which will be recognized over
a weighted average period of 1.3 years.
Employee stock purchase plan
Our Board of Directors has authorized an employee stock purchase plan that
allows associates to purchase shares of our common stock at a 15% discount
through a payroll deduction. We record compensation for this plan using the
Black-Scholes valuation model in the quarter that the purchase occurs. As of
June 25, 2006, 239,614 shares of the 1,850,000 shares which were authorized
under this plan were available for purchase.
3. Commitments and Contingencies
Litigation, claims and disputes: We are subject from time to time to lawsuits,
claims and governmental inspections or audits arising in the ordinary course of
business. Some of these lawsuits purport to be class actions and/or seek
substantial damages. In the opinion of management, these matters are adequately
covered by insurance, or if not so covered, are without merit or are of such a
nature or involve amounts that would not have a material adverse impact on our
business or consolidated financial position.
Lease guarantees and contingencies: In connection with the sale of restaurants
to franchisees and other parties, we have, in certain cases, remained
contingently liable for the remaining lease payments. As of June 25, 2006, we
have outstanding lease guarantees of approximately $16,300,000. In addition, we
or our subsidiaries are contingently liable for various leases that we have
assigned in connection with the sale of restaurants to franchisees and other
parties, in the potential amount of $13,200,000. These leases expire at various
times with the final lease agreement expiring in 2018. We have not recorded a
liability related to these contingent lease liabilities as of June 25, 2006 or
December 25, 2005.
In 2004, we arranged for a third-party financing company to provide up to
$250,000,000 to qualified franchisees for loans to fund development of new
restaurants through October 2007, subject to our approval. We will provide a
limited guarantee of 10% of certain loans advanced under this program. We will
be released from our guarantee if certain operating results are met after the
restaurant has been open for at least two years. As of June 25, 2006, there were
loans outstanding to six franchisees for approximately $55,900,000 under this
program. The fair value of our guarantees under this financing program is
approximately $110,000 and is recorded in non-current liabilities in our
consolidated balance sheet as of June 25, 2006.
Severance agreements: We have severance and employment agreements with certain
officers providing for severance payments to be made in the event the associate
resigns or is terminated not related to a change in control, some of which
require payments to be made only if we enforce certain terms in the agreements.
If the severance payments had been due as of June 25, 2006, we would have been
required to make payments totaling approximately $13,200,000. In addition, we
have severance and employment agreements with certain officers which contain
severance provisions related to a change in control. The agreements define the
circumstances which will constitute a change in control. Those provisions would
have required additional aggregate payments of approximately $7,400,000 if such
officers had been terminated as of June 25, 2006.
14.
4. Net Earnings Per Share
We compute basic net earnings per common share by dividing income available to
common shareholders by the weighted average number of common shares outstanding
for the reporting period. Diluted net earnings per common share reflects the
potential dilution that could occur if holders of options or other contracts to
issue common stock exercised or converted their holdings into common stock.
Outstanding stock options and equity-based compensation represent the only
dilutive effects on weighted average shares. The chart below presents a
reconciliation between basic and diluted weighted average shares outstanding and
the related net earnings per share. All amounts in the chart, except per share
amounts, are expressed in thousands.
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
--------------- --------------- --------------- ---------------
Net earnings......................................... $ 20,404 $ 27,490 $ 47,555 $ 59,147
=============== =============== =============== ===============
Basic weighted average shares outstanding............ 74,112 79,897 74,113 80,295
Dilutive effect of stock options and
equity-based compensation......................... 971 1,463 1,048 1,566
--------------- --------------- --------------- ---------------
Diluted weighted average shares outstanding.......... 75,083 81,360 75,161 81,861
=============== =============== =============== ===============
Basic net earnings per common share.................. $ 0.28 $ 0.34 $ 0.64 $ 0.74
=============== =============== =============== ===============
Diluted net earnings per common share................ $ 0.27 $ 0.34 $ 0.63 $ 0.72
=============== =============== =============== ===============
We excluded stock options and SARs with exercise prices greater than the average
market price of our common stock for the applicable periods from the computation
of diluted weighted average shares outstanding as the effect would be
anti-dilutive. We excluded approximately 4,900,000 and 600,000 of these options
and SARs from our diluted weighted average share computation for the 2006
quarter and the 2005 quarter, respectively, and approximately 5,000,000 and
300,000 of these options and SARs for the 2006 year-to-date period and 2005
year-to-date period, respectively.
5. Acquisitions
All of our acquisitions discussed below have been accounted for using the
purchase method of accounting and, accordingly, our condensed consolidated
financial statements reflect the results of operations for each acquisition
subsequent to the date of acquisition. The assets acquired and liabilities
assumed are recorded at estimates of fair value as determined by management
based upon information available. We finalize the allocation of purchase price
to the fair value of assets acquired and liabilities assumed when we obtain
information sufficient to complete the allocation, but in each case, no longer
than one year after the acquisition date.
In January 2006, we completed the acquisition of four Applebee's restaurants in
the Houston market for approximately $8,200,000. The purchase price was
allocated to the fair value of property and equipment of $7,400,000, goodwill of
approximately $600,000, reacquired franchise rights of approximately $100,000,
and other net assets of approximately $100,000. In connection with this
acquisition, we paid approximately $8,000,000 in the 2006 year-to-date period.
15.
In May 2005, we completed the acquisition of 12 Applebee's restaurants in
Missouri, Kansas and Arkansas, which included one restaurant under construction,
for approximately $39,500,000 in cash. The purchase price was allocated to the
fair value of property and equipment of $17,500,000, goodwill of $21,500,000,
reacquired franchise rights of approximately $300,000, and other net assets of
approximately $200,000.
The following table is comprised of actual company restaurant sales for the two
restaurant acquisitions above, which are included in our condensed consolidated
financial statements for each period presented, and proforma company restaurant
sales assuming the acquisitions occurred at the beginning of the preceding
fiscal year for each acquisition (in thousands):
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
-------------- ------------- --------------- --------------
Actual company restaurant sales for acquired
restaurants...................................... $ 1,800 $ 2,800 $ 3,300 $ 2,800
============== ============= =============== ==============
Pro forma company restaurant sales for acquired
restaurants...................................... $ 1,800 $ 8,200 $ 4,000 $ 16,400
============== ============= =============== ==============
In April 2005, we completed the acquisition of eight Applebee's restaurants in
the Memphis market, which were closed in 2004 by a former franchisee, for
approximately $8,800,000 payable in cash. In connection with this acquisition,
we paid approximately $800,000 in 2004 and $8,000,000 in 2005. The purchase
price of $8,800,000 was allocated to the fair value of property and equipment of
approximately $8,200,000 and goodwill of approximately $600,000. We have
remodeled and opened seven restaurants and the remaining restaurant was sold to
a third party.
6. Goodwill and Other Intangible Assets
Changes in goodwill are summarized below (in thousands):
June 25, December 25,
2006 2005
--------------------- -------------------
Carrying amount, beginning of the year.................. $ 138,443 $ 116,344
Goodwill acquired during the period..................... 668 22,099
--------------------- -------------------
Goodwill amount, end of the period...................... $ 139,111 $ 138,443
===================== ===================
16.
Intangible assets subject to amortization pursuant to SFAS No. 142, "Goodwill
and Other Intangible Assets," are summarized below (in thousands):
June 25, 2006
--------------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights....... $ 6,371 $ 6,034 $ 337
Lease acquisition costs (1)......... 3,867 966 2,901
Noncompete agreement................ 350 153 197
------------------ ------------------ ------------------
Total................................... $ 10,588 $ 7,153 $ 3,435
================== ================== ==================
December 25, 2005
--------------------------------------------------------------
Gross Carrying Accumulated Net Book
Amount Amortization Value
------------------ ------------------ ------------------
Amortized intangible assets:
Franchise interest and rights....... $ 6,371 $ 5,896 $ 475
Lease acquisition costs (1)......... 4,939 743 4,196
Noncompete agreement................ 350 109 241
------------------ ------------------ ------------------
Total................................... $ 11,660 $ 6,748 $ 4,912
================== ================== ==================
(1) In connection with the review of long-lived assets during our preparation of
the 2006 quarter condensed consolidated financial statements, we recorded an
asset impairment charge of approximately $1,100,000 for lease acquisition
costs related to two restaurants that were not performing as expected (Note
8). This charge has been reflected as a reduction to the gross carrying
amount.
We expect annual amortization expense for amortizable other assets for the next
five fiscal years to range from approximately $200,000 to $700,000.
Intangible assets not subject to amortization are summarized below (in
thousands):
June 25, December 25,
2006 2005
---------------------- --------------------
Carrying amount, beginning of the year.................. $ 3,138 $ 2,793
Nonamortizable intangible assets acquired
during the period.................................. 140 345
---------------------- --------------------
Nonamortizable intangible assets amount,
end of the period.................................. $ 3,278 $ 3,138
====================== ====================
In connection with our acquisition of four Applebee's restaurants in Houston
from a franchisee in January 2006, we recorded approximately $100,000 of
reacquired franchise rights (Note 5).
17.
In connection with our acquisition of 12 Applebee's restaurants in Missouri,
Kansas and Arkansas from a franchisee in May 2005, we recorded approximately
$300,000 of reacquired franchise rights (Note 5).
The amount allocated to reacquired franchise rights is based upon the initial
franchise fees received from these franchisees. This intangible asset has an
indefinite life and, accordingly, will not be amortized but tested for
impairment at least annually.
7. Captive Insurance Subsidiary
In 2002, we formed Neighborhood Insurance, Inc., a Vermont corporation and a
wholly-owned captive insurance subsidiary to provide Applebee's International,
Inc. and qualified franchisees with workers' compensation and general liability
insurance. In 2005, we reduced the types of insurance coverage plans offered
which resulted in fewer franchisee participants in our captive insurance
program. Through 2005, Applebee's International, Inc. and covered franchisees
made premium payments to the captive insurance company which pays administrative
fees and insurance claims, subject to individual and aggregate maximum claim
limits under the captive insurance company's reinsurance policies. Franchisee
premium amounts billed by the captive insurance company were established based
upon third-party actuarial estimates of settlement costs for incurred and
anticipated claims and administrative fees. Franchisee premiums were included in
other franchise income ratably over the policy year and the related offsetting
expenses were included in cost of other franchise income. In 2006, we
discontinued writing any new coverage. Franchise premium adjustments will be
included in other franchise income and cost of other franchise income when
audited. Cost of other franchise income includes costs related to the resolution
of claims arising from franchisee participation in our captive insurance
program. We do not expect franchisee participation in the captive insurance
company to have a material impact on our net earnings. Our consolidated balance
sheets include the following balances related to the captive insurance
subsidiary:
o Franchise premium receivables of approximately $500,000 and
$1,700,000 as of June 25, 2006 and December 25, 2005,
respectively, included in receivables related to captive insurance
subsidiary.
o Cash equivalent and other long-term investments restricted for the
payment of claims of approximately $16,600,000 and $18,600,000 as
of June 25, 2006 and December 25, 2005, respectively, included in
restricted assets related to captive insurance subsidiary.
o Loss reserve related to captive insurance subsidiary of
approximately $17,100,000 and $20,700,000 as of June 25, 2006 and
December 25, 2005, respectively. Approximately $8,000,000 and
$10,500,000 for June 25, 2006 and December 25, 2005, respectively,
is included in other non-current liabilities.
8. Impairment and Other Restaurant Closure Costs
In connection with the review of long-lived assets during our preparation of the
2006 quarter condensed consolidated financial statements, we recorded an asset
impairment charge of $3,000,000 for two restaurants that are not performing as
expected. The impairment charge consisted of approximately $1,900,000 write-down
of the carrying value of the property and equipment and approximately $1,100,000
write-off for lease acquisition costs. In the first quarter of fiscal 2006, we
recorded an asset impairment charge of approximately $900,000 consisting of the
write-down of the carrying value of the property and equipment of two other
restaurants that are not performing as expected and we recorded approximately
$700,000 relating to remaining lease obligations for two restaurants that were
closed in the first quarter of fiscal 2006. The total expense of $3,000,000 and
$4,600,000 for the 2006 quarter and the 2006 year-to-date period, respectively,
is included in impairment and other restaurant closure costs in the consolidated
statements of earnings.
18.
In assessing restaurants for impairment, we use current and historical operating
results to estimate future cash flows on a restaurant by restaurant basis. The
asset impairment charges for the 2006 year-to-date period were calculated by
comparing the carrying value of the restaurants' assets to the estimated future
cash flow projections.
9. Treasury Shares
As of June 25, 2006, we had approximately 34,133,000 shares held in treasury. A
reconciliation of our treasury shares for the 2006 year-to-date period is
provided below (shares in thousands):
Treasury
Shares
---------------
Balance as of December 25, 2005........................ 34,305
Purchases of treasury stock............................ 687
Stock options exercised................................ (625)
Shares issued under employee benefit plans............. (123)
Nonvested shares awarded under equity incentive plans.. (111)
---------------
Balance as of June 25, 2006............................ 34,133
===============
10. New Accounting Pronouncements
In March 2006, the Emerging Issues Task Force ("EITF") issued EITF Issue 06-3,
"How Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross versus Net
Presentation)." A consensus was reached that entities may adopt a policy of
presenting sales taxes in the income statement on either a gross or net basis.
If taxes are significant, an entity should disclose its policy of presenting
taxes and the amounts of taxes. The guidance is effective for periods beginning
after December 15, 2006. We present company sales net of sales taxes. This issue
will not impact the method for recording these sales taxes in our consolidated
financial statements.
In July 2006, the FASB issued FASB Interpretation No. ("FIN") 48, "Accounting
for Uncertainty in Income Taxes," which clarifies the accounting for uncertainty
in income taxes recognized in the financial statements in accordance with SFAS
No. 109, "Accounting for Income Taxes." FIN 48 is effective for fiscal years
beginning after December 15, 2006. We are evaluating the impact the adoption of
FIN 48 will have on our consolidated financial statements.
19.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
The statements contained in the Management's Discussion and Analysis of
Financial Condition and Results of Operations section regarding restaurant
development, comparable sales, revenue growth, restaurant margins, commodity
costs, general and administrative expenses, capital expenditures, return on
equity and financial commitments are forward-looking and based on current
expectations. There are several risks and uncertainties that could cause actual
results to differ materially from those described. These risks include, but are
not limited to, our ability and the ability of our franchisees to open and
operate additional restaurants profitably, the ability of our franchisees to
obtain financing, the continued growth of our franchisees, our ability to
attract and retain qualified franchisees, the impact of intense competition in
the casual dining segment of the restaurant industry, the impact of economic
factors on consumer spending and our ability to control restaurant operating
costs which are impacted by market changes, minimum wage and other employment
laws, food costs and inflation. For a more detailed discussion of the principal
factors that could cause actual results to be materially different, you should
read our risk factors in Item 1A of our 2005 Annual Report on Form 10-K. We
disclaim any obligation to update forward-looking statements.
General
We operate on a 52 or 53 week fiscal year ending on the last Sunday in December.
Our fiscal years and fiscal periods are as follows:
Number
Fiscal Year Fiscal Year End of Weeks
-------------------------------- -------------------------- -----------------
2005 December 25, 2005 52
2006 December 31, 2006 53
2007 December 30, 2007 52
Fiscal Number
Period Fiscal Period End of Weeks
-------------------------------- -------------------------- -----------------
2005 Quarter June 26, 2005 13
2006 Quarter June 25, 2006 13
2005 Year-to-date period June 26, 2005 26
2006 Year-to-date period June 25, 2006 26
Our revenues are generated from three primary sources:
o Company restaurant sales (food and beverage sales)
o Franchise royalties and fees
o Other franchise income
Beverage sales consist of sales of alcoholic beverages, while non-alcoholic
beverages are included in food sales. Franchise royalties are generally 4% of
each franchise restaurant's monthly gross sales. Franchise fees typically range
from $30,000 to $35,000 for each restaurant opened. Other franchise income
includes revenue from information technology products and services provided to
certain franchisees. In 2005, other franchise income also included insurance
premiums for the current year and premium audit adjustments for prior years from
franchisee participation in our captive insurance program. In 2006, we
discontinued writing any new coverage. Franchise premium adjustments will be
included in other franchise income when audited.
20.
Certain expenses relate only to company operated restaurants. These include:
o Food and beverage costs
o Labor costs
o Direct and occupancy costs
o Pre-opening expenses
Cost of other franchise income includes costs related to information technology
products and services provided to certain franchisees. In 2005, cost of other
franchise income included the costs related to franchisee participation in our
captive insurance program. In fiscal 2006, we discontinued writing any new
coverage. Cost of other franchise income will include costs related to the
resolution of claims arising from franchisee participation in our captive
insurance program.
Other expenses, such as general and administrative and amortization expenses,
relate to both company operated restaurants and franchise operations.
Overview
Applebee's International, Inc. and our subsidiaries develop, franchise and
operate casual dining restaurants under the name "Applebee's Neighborhood Grill
& Bar," which is the largest casual dining concept in the world with over 1,800
system-wide restaurants open as of June 25, 2006. The casual dining segment of
the restaurant industry is highly competitive and there are many factors that
affect our profitability. Our industry is susceptible to changes in economic
conditions, trends in lifestyles, fluctuating costs, government regulation,
availability of resources, and consumer perceptions. When evaluating and
assessing our financial performance, we believe there are five key factors:
o Development - the number of new company and franchise restaurants opened
during the period. As the largest casual dining concept in the world,
Applebee's has a unique opportunity to leverage our brand, system size and
scale to optimize our future growth. Our expansion strategy has been to
cluster restaurants in targeted markets, thereby increasing consumer
awareness and convenience, and enabling us to take advantage of operational,
distribution and advertising efficiencies. We currently expect that the
Applebee's system will encompass at least 3,000 restaurants in the United
States, as well as the potential for at least 1,000 restaurants
internationally. In the 2006 quarter and the 2006 year-to-date period, we
and our franchisees opened 35 and 64 restaurants, respectively. Together, we
have opened at least 100 restaurants system-wide each year for the past 13
fiscal years. In 2006, we currently expect to open approximately 125
restaurants system-wide, comprised of approximately 35 company and at least
90 franchise restaurants. Development costs, which include construction
costs, fixtures and equipment and land costs, continue to increase as a
result of increased demand for material, labor and commercial real estate.
We are evaluating the impact of rising development costs, as well as slower
sales trends, on the pipeline of future openings. We currently expect fiscal
year 2007 company openings to be fewer than fiscal year 2006.
21.
o Comparable restaurant sales - a year-over-year comparison of sales for
restaurants open at least 18 months. Changes in comparable restaurant sales
are driven by changes in the average guest check and/or changes in guest
traffic. Average guest check changes result from menu price changes and/or
changes in menu mix. Although we may have changes in our average guest check
from period to period, our main focus has been increasing guest traffic as
we view this component to be more indicative of the long-term health of the
Applebee's brand. We are constantly seeking to increase guest traffic by
focusing on operations and improving our menu with new food and beverage
offerings. In 2006, we began implementation of a plan to substantially
improve the quality and flavor profile of our food and beverage offerings as
a result of comprehensive consumer research we completed in 2005. In the
2006 quarter, company comparable sales decreased 2.0% while domestic
franchise and domestic system-wide comparable sales decreased 1.7% and 1.8%,
respectively. In the 2006 year-to-date period, company comparable sales
decreased 0.4%, while domestic franchise and domestic system-wide comparable
sales increased 0.7% and 0.4%, respectively. We believe our sales and
traffic growth have been negatively impacted by multiple factors. Lower
income households, which represent a significant portion of our guests, have
been impacted by higher energy costs and interest rates. The bar and grill
category of the restaurant industry has been negatively impacted by
increased trade-down to quick-service restaurants. In addition, the supply
growth of the category has outpaced demand contributing to weaker sales
trends. We believe less effective advertising has also impacted traffic in
fiscal 2006. As a result of these factors, we currently expect system-wide
comparable sales for the remainder of the year to be in a range from flat to
down 4.0%.
o Company restaurant margins - company restaurant sales, less food and
beverage, labor, direct and occupancy restaurant costs and pre-opening
expenses, expressed as a percentage of company restaurant sales. Company
restaurant margins were 12.1% and 13.4% in the 2006 quarter and the 2006
year-to-date period, respectively, and 13.8% and 14.8% in the 2005 quarter
and the 2005 year-to-date period, respectively. We currently expect fiscal
2006 company restaurant margins, which will be dependent on comparable sales
performance at company restaurants, to be less than fiscal 2005. Company
restaurant margins are susceptible to fluctuations in commodity costs, labor
costs and other operating costs such as utilities. We attempt to negotiate
contracts for the majority of our food products in order to mitigate the
impact of rising commodity costs. In 2006, we currently expect net commodity
costs to be flat, including the negative impact of fuel surcharges. In
addition, the improved menu offerings may increase food costs, as a
percentage of sales, when compared to other menu offerings. We expect labor
costs to continue to be negatively impacted by health insurance costs and
the impact of wage rate increases. In addition, higher energy costs,
including utilities and the cost of materials used in the production of
packaging, will have a negative impact on company restaurant margins, but
will be partially offset by the favorable impact of a change in accounting
convention for smallwares that was implemented in the 2006 quarter.
o General and administrative expenses - general and administrative expenses
expressed as a percentage of total operating revenues. General and
administrative expenses were 9.8% and 9.1% in the 2006 quarter and the 2005
quarter, respectively, and 10.1% and 9.0% for the 2006 year-to-date period
and the 2005 year-to-date period, respectively. Stock-based compensation
included in general and administrative expenses was 1.5% and 0.2% in the
2006 quarter and the 2005 quarter, respectively, and 1.6% and 0.2% in the
2006 year-to-date period and the 2005 year-to-date period, respectively.
General and administrative expenses, as a percentage of operating revenues,
for fiscal 2006 are expected to be in the low-to-mid 10 percent range,
including the impact of stock-based compensation.
o Return on equity - net earnings expressed as a percent of average
stockholders' equity. We believe this is an important indicator as it allows
us to evaluate our ability to create value for our shareholders. We have
exceeded our stated goal of at least 20% return on equity for the past seven
years, and we are a leader in the casual dining industry in this category.
22.
Application of Critical Accounting Policies
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based upon our condensed consolidated financial statements, which
were prepared in accordance with accounting principles generally accepted in the
United States of America. These principles require us to make estimates and
assumptions that affect the reported amounts in the condensed consolidated
financial statements and notes thereto. Actual results may differ from these
estimates, and such differences may be material to our condensed consolidated
financial statements. We believe that the following significant accounting
policies involve a significant degree of judgment or complexity.
Inventory valuation: We state inventories at the lower of cost, using the
first-in, first-out method, or market. Market is determined based upon our
estimates of the net realizable value.
We purchase and maintain inventories of certain specialty products to ensure
sufficient supplies to the system, to ensure continuity of supply, and to
control food costs. We review and make quality control inspections of our
inventories to determine obsolescence on an ongoing basis. These reviews require
management to make certain estimates and judgments regarding projected usage
which may change in the future and may require us to record an inventory
impairment.
Property and equipment: We report property and equipment at historical cost less
accumulated depreciation. Depreciation is provided on the straight-line method
over the estimated useful lives of the assets. Leasehold improvements are
amortized over the lesser of the lease term or the estimated useful life of the
related asset. The useful lives of the assets are based upon management's
expectations. We periodically review the assets for changes in circumstances
which may impact their useful lives. If there are changes in circumstances that
revise an asset's useful life, we will adjust the depreciation expense
accordingly for that asset in future periods.
Stock-based compensation: Beginning in 2006, we account for stock-based
compensation in accordance with SFAS No. 123(R). As required by SFAS No. 123(R),
stock-based compensation is estimated for equity awards at fair value at the
grant date. We determine the fair value of equity awards using a binomial model.
The binomial model requires various highly judgmental assumptions including the
expected life, stock price volatility and the forfeiture rate. If any of the
assumptions used in the model change significantly, stock-based compensation
expense may differ materially in the future from that recorded in the current
period.
Impairment of long-lived assets: We periodically review restaurant property and
equipment for impairment on a restaurant-by-restaurant basis using certain
market and restaurant operating indicators including historical cash flows as
well as current estimates of future cash flows and/or appraisals. We review
other long-lived assets at least annually and when events or circumstances
indicate that the carrying value of the asset may not be recoverable. The
recoverability is assessed in most instances by comparing the carrying value to
its undiscounted cash flows. This assessment process requires the use of
estimates and assumptions regarding future cash flows and estimated useful
lives, which are subject to a significant degree of judgment. If these
assumptions change in the future, we may be required to record impairment
charges for these assets.
Income taxes: We record valuation allowances against our deferred tax assets,
when necessary, in accordance with SFAS No. 109, "Accounting for Income Taxes."
Realization of deferred tax assets is dependent on future taxable earnings and
is therefore uncertain. We assess the likelihood that our deferred tax assets in
each of the jurisdictions in which we operate will be recovered from future
taxable income. Deferred tax assets do not include future tax benefits that we
deem likely not to be realized.
23.
We are periodically audited by foreign and domestic tax authorities for both
income and sales and use taxes. We record accruals when we determine it is
probable that we have an exposure in a matter relating to an audit. The accruals
may change in the future due to new developments in each matter.
Legal and insurance reserves: We are periodically involved in various legal
actions. We are required to assess the probability of any adverse judgments as
well as the potential range of loss. We determine the required accruals after a
review of the facts of each legal action.
We use estimates in the determination of the appropriate liabilities for general
liability, workers' compensation and health insurance. The estimated liability
is established based upon historical claims data and third-party actuarial
estimates of settlement costs for incurred claims. Unanticipated changes in
these factors may require us to revise our estimates.
We periodically reassess our assumptions and judgments and make adjustments when
significant facts and circumstances dictate. A change in any of the above
estimates could impact our consolidated statements of earnings and the related
asset or liability recorded in our consolidated balance sheets would be adjusted
accordingly. Historically, actual results have not been materially different
than the estimates that are described above.
Acquisitions
All of our acquisitions discussed below have been accounted for using the
purchase method of accounting and, accordingly, our condensed consolidated
financial statements reflect the results of operations for each acquisition
subsequent to the date of acquisition. The assets acquired and liabilities
assumed are recorded at estimates of fair value as determined by management
based upon information available. We finalize the allocation of purchase price
to the fair value of assets acquired and liabilities assumed when we obtain
information sufficient to complete the allocation, but in each case, no longer
than one year after the acquisition date.
In January 2006, we completed the acquisition of four Applebee's restaurants in
the Houston market for approximately $8,200,000. The purchase price was
allocated to the fair value of property and equipment of $7,400,000, goodwill of
approximately $600,000, reacquired franchise rights of approximately $100,000,
and other net assets of approximately $100,000. In connection with this
acquisition, we paid approximately $8,000,000 in the 2006 year-to-date period.
In May 2005, we completed the acquisition of 12 Applebee's restaurants in
Missouri, Kansas and Arkansas, which included one restaurant under construction,
for approximately $39,500,000 in cash. The purchase price was allocated to the
fair value of property and equipment of $17,500,000, goodwill of $21,500,000,
reacquired franchise rights of approximately $300,000, and other net assets of
approximately $200,000.
The following table is comprised of actual company restaurant sales for the two
restaurant acquisitions above, which are included in our condensed consolidated
financial statements for each period presented, and pro forma company restaurant
sales assuming the acquisitions occurred at the beginning of the preceding
fiscal year for each acquisition (in thousands):
24.
2006 2005
2006 2005 Year-to-Date Year-to-Date
Quarter Quarter Period Period
-------------- ------------- --------------- --------------
Actual company restaurant sales for acquired
restaurants...................................... $ 1,800 $ 2,800 $ 3,300 $ 2,800
============== ============= =============== ==============
Pro forma company restaurant sales for acquired
restaurants..................................... $ 1,800 $ 8,200 $ 4,000 $ 16,400
============== ============= =============== ==============
In April 2005, we completed the acquisition of eight Applebee's restaurants in
the Memphis market, which were closed in 2004 by a former franchisee, for
approximately $8,800,000 payable in cash. In connection with this acquisition,
we paid approximately $800,000 in 2004 and $8,000,000 in 2005. The purchase
price of $8,800,000 was allocated to the fair value of property and equipment of
approximately $8,200,000 and goodwill of approximately $600,000. We have
remodeled and opened seven restaurants and the remaining restaurant was sold to
a third party.
Captive Insurance Subsidiary
In 2002, we formed Neighborhood Insurance, Inc., a Vermont corporation and a
wholly-owned captive insurance subsidiary to provide Applebee's International,
Inc. and qualified franchisees with workers' compensation and general liability
insurance. In 2005, we reduced the types of insurance coverage plans offered
which resulted in fewer franchisee participants in our captive insurance
program. Through 2005, Applebee's International, Inc. and covered franchisees
made premium payments to the captive insurance company which pays administrative
fees and insurance claims, subject to individual and aggregate maximum claim
limits under the captive insurance company's reinsurance policies. Franchisee
premium amounts billed by the captive insurance company were established based
upon third-party actuarial estimates of settlement costs for incurred and
anticipated claims and administrative fees. Franchisee premiums were included in
other franchise income ratably over the policy year and the related offsetting
expenses were included in cost of other franchise income. In 2006, we
discontinued writing any new coverage. Franchise premium adjustments will be
included in other franchise income and cost of other franchise income when
audited. Cost of other franchise income includes costs related to the resolution
of claims arising from franchisee participation in our captive insurance
program. We do not expect franchisee participation in the captive insurance
company to have a material impact on our net earnings. Our consolidated balance
sheets include the following balances related to the captive insurance
subsidiary:
o Franchise premium receivables of approximately $500,000 and
$1,700,000 as of June 25, 2006 and December 25, 2005,
respectively, included in receivables related to captive insurance
subsidiary.
o Cash equivalent and other long-term investments restricted for the
payment of claims of approximately $16,600,000 and $18,600,000 as
of June 25, 2006 and December 25, 2005, respectively, included in
restricted assets related to captive insurance subsidiary.
o Loss reserve related to captive insurance subsidiary of
approximately $17,100,000 and $20,700,000 as of June 25, 2006 and
December 25, 2005, respectively. Approximately $8,000,000 and
$10,500,000 for June 25, 2006 and December 25, 2005, respectively,
is included in other non-current liabilities.
25.
Results of Operations
The following table contains information derived from our consolidated
statements of earnings expressed as a percentage of total operating revenues,
except where otherwise noted. Percentages may not add due to rounding.
2006 2005
Year-to- Year-to-
2006 2005 Date Date
Quarter Quarter Period Period
------------- ------------ ------------- -------------
Operating revenues:
Company restaurant sales.............................. 89.5% 88.9% 89.5% 88.9%
Franchise royalties and fees.......................... 10.4 10.6 10.4 10.7
Other franchise income................................ 0.2 0.5 0.1 0.4
------------- ------------ ------------- -------------
Total operating revenues........................... 100.0% 100.0% 100.0% 100.0%
============= ============ ============= =============
Cost of sales (as a percentage of company
restaurant sales):
Food and beverage..................................... 26.5% 26.6% 26.6% 26.5%
Labor................................................. 33.9 33.0 33.3 32.9
Direct and occupancy.................................. 27.2 26.0 26.4 25.3
Pre-opening expense................................... 0.4 0.5 0.3 0.4
------------- ------------ ------------- -------------
Total cost of sales................................ 87.9% 86.2% 86.6% 85.2%
============= ============ ============= =============
Cost of other franchise income (as a percentage of other
franchise income)..................................... 52.1% 86.3% 106.4% 82.3%
General and administrative expenses........................ 9.8 9.1 10.1 9.0
Amortization of intangible assets.......................... 0.1 0.1 0.1 0.1
Impairment and other restaurant closure costs.............. 0.9 -- 0.7 --
Loss on disposition of property and equipment.............. 0.1 0.2 0.1 0.1
------------- ------------ ------------- -------------
Operating earnings......................................... 10.4 13.6 11.4 14.7
------------- ------------ ------------- -------------
Other income (expense):
Investment income (loss).............................. (0.1) 0.1 0.1 0.1
Interest expense...................................... (0.9) (0.2) (0.8) (0.2)
Other income.......................................... -- 0.2 -- 0.2
------------- ------------ ------------- -------------
Total other income (expense)....................... (1.0) 0.1 (0.7) 0.1
------------- ------------ ------------- -------------
Earnings before income taxes............................... 9.4 13.7 10.7 14.8
Income taxes............................................... 3.3 4.7 3.6 5.1
------------- ------------ ------------- -------------
Net earnings............................................... 6.2% 9.0% 7.0% 9.7%
============= ============ ============= =============
26.
The following table sets forth certain financial information and other
restaurant data relating to company and franchise restaurants, as reported to us
by franchisees:
2006 2005
Year-to- Year-to-
2006 2005 Date Date
Quarter Quarter Period Period
------------- ------------- -------------- -------------
Number of restaurants:
Company:
Beginning of period....................... 497 437 486 424
Restaurant openings....................... 10 14 19 27
Restaurants closings...................... -- -- (2) --
Restaurants acquired from franchisees..... -- 11 4 11
------------- ------------- -------------- -------------
End of period............................. 507 462 507 462
------------- ------------- -------------- -------------
Franchise:
Beginning of period....................... 1,332 1,257 1,318 1,247
Restaurant openings....................... 25 16 45 29
Restaurants closings...................... (4) (2) (6) (5)
Restaurants acquired from franchisees..... -- (11) (4) (11)
------------- ------------- -------------- -------------
End of period............................. 1,353 1,260 1,353 1,260
------------- ------------- -------------- -------------
Total:
Beginning of period....................... 1,829 1,694 1,804 1,671
Restaurant openings....................... 35 30 64 56
Restaurants closings...................... (4) (2) (8) (5)
------------- ------------- -------------- -------------
End of period............................. 1,860 1,722 1,860 1,722
============= ============= ============== =============
Weighted average weekly sales per restaurant:
Company....................................... $ 45,245 $ 46,800 $ 46,650 $ 47,483
Domestic franchise............................ $ 50,127 $ 51,056 $ 51,863 $ 51,547
Domestic total................................ $ 48,736 $ 49,894 $ 50,383 $ 50,452
Change in comparable restaurant sales:(1)
Company....................................... (2.0)% (1.2)% (0.4)% (0.4)%
Domestic franchise............................ (1.7)% 2.3 % 0.7 % 3.6 %
Domestic total................................ (1.8)% 1.4 % 0.4 % 2.6 %
Total operating revenues (in thousands):
Company restaurant sales...................... $ 296,128 $ 272,703 $ 604,027 $ 543,161
Franchise royalties and fees(2)............... 34,306 32,493 70,241 65,501
Other franchise income(3)..................... 539 1,424 984 2,489
------------- ------------- -------------- -------------
Total......................................... $ 330,973 $ 306,620 $ 675,252 $ 611,151
============= ============= ============== =============
(1) When computing comparable restaurant sales, restaurants open for at least 18
months are compared from period to period.
(2) Franchise royalties are generally 4% of each franchise restaurant's reported
monthly gross sales. Reported franchise sales (including international
restaurants), in thousands, were $859,557 and $820,483 in the 2006 quarter
and the 2005 quarter, respectively, and $1,764,201 and $1,653,480 in the
2006 year-to-date period and the 2005 year-to-date period, respectively.
Franchise fees typically range from $30,000 to $35,000 for each restaurant
opened.
(3) Other franchise income includes revenue from information technology products
and services provided to certain franchisees. In addition, the 2005 period
includes insurance premiums from franchisee participation in our captive
insurance program.
27.
2006 Quarter Compared With 2005 Quarter and 2006 Year-to-Date Period Compared
With 2005 Year-to-Date Period
Company Restaurant Sales. Total company restaurant sales increased $23,425,000
(9%) from $272,703,000 in the 2005 quarter to $296,128,000 in the 2006 quarter
and increased $60,866,000 (11%) from $543,161,000 in the 2005 year-to-date
period to $604,027,000 in the 2006 year-to-date period. The percentage increase
in total company restaurant sales was due to an increase in the number of
restaurant weeks open of approximately 12% in the 2006 quarter and 13% in the
2006 year-to-date period, which was partially offset by a decline in weighted
average weekly sales in the 2006 quarter and the 2006 year-to-date period,
respectively.
Comparable restaurant sales at company restaurants decreased by 2.0% and 0.4% in
the 2006 quarter and the 2006 year-to-date period, respectively. Weighted
average weekly sales at company restaurants decreased 3.3% from $46,800 in the
2005 quarter to $45,245 in the 2006 quarter and decreased 1.8% from $47,483 in
the 2005 year-to-date period to $46,650 in the 2006 year-to-date period. The
decrease in average weekly sales was due to a reduction in guest traffic in 2006
as compared to 2005. These decreases were partially offset by an increase in the
average guest check resulting from menu price increases of approximately 2.5% in
2005. In both periods, we experienced more significant guest count declines in
New England, Virginia and Michigan where approximately 40% of our company
restaurants are located. Lower income households, which represent a significant
portion of our guests, have been impacted by higher energy costs and interest
rates. The bar and grill category of the restaurant industry has been negatively
impacted by increased trade-down to quick-service restaurants. In addition, the
supply growth of the category has outpaced demand contributing to weaker sales
trends. We believe less effective advertising has also impacted traffic in
fiscal 2006. Weighted average weekly sales declined more than comparable sales
declined due to weaker new restaurant opening volumes primarily in St. Louis,
New England, and Virginia for both periods and Minnesota for the 2006
year-to-date period.
Franchise Royalties and Fees. Franchise royalties and fees increased $1,813,000
(6%) from $32,493,000 in the 2005 quarter to $34,306,000 in the 2006 quarter and
increased $4,740,000 (7%) from $65,501,000 in the 2005 year-to-date period to
$70,241,000 in the 2006 year-to-date period due primarily to the increased
number of franchise restaurants operating during both periods as compared to the
prior year. In addition, the increase in the 2006 year-to-date period was due
partially to increases in franchisee comparable restaurant sales. Domestic
franchise weighted average weekly sales and comparable restaurant sales
decreased 1.8% and 1.7%, respectively, in the 2006 quarter and increased by 0.6%
and 0.7%, respectively, in the 2006 year-to-date period.
Other Franchise Income. Other franchise income decreased $885,000 (62%) from
$1,424,000 in the 2005 quarter to $539,000 in the 2006 quarter and decreased
$1,505,000 (60%) from $2,489,000 in the 2005 year-to-date period to $984,000 in
the 2006 year-to-date period due primarily to the decision to discontinue
writing new coverage in our captive insurance program. In 2005, franchisee
premiums were included in other franchise income ratably over the policy year.
Cost of Company Restaurant Sales. Food and beverage costs decreased slightly
from 26.6% in the 2005 quarter to 26.5% in the 2006 quarter and increased
slightly from 26.5% in the 2005 year-to-date period to 26.6% in the 2006
year-to-date period. Food and beverage costs in both periods were negatively
impacted by food costs associated with our improved menu, a shift in menu mix
and higher alcoholic beverage costs, as a percentage of sales, related to our
late-night value strategy. These increases were offset by menu price increases
of 2.5% and improved management of food spoilage and waste in both periods.
28.
Labor costs increased from 33.0% in the 2005 quarter to 33.9% in the 2006
quarter and increased from 32.9% in the 2005 year-to-date period to 33.3% in the
2006 year-to-date period due primarily to higher hourly and management wage
rates, payroll taxes and the impact of lower sales volumes, as a percentage of
sales, which were partially offset by lower workers' compensation expense and
incentive compensation expense.
Direct and occupancy costs increased from 26.0% in the 2005 quarter to 27.2% in
the 2006 quarter and increased from 25.3% in the 2005 year-to-date period to
26.4% in the 2006 year-to-date period due primarily to higher utilities and
unfavorable year-over-year comparisons for depreciation, as a percentage of
sales, due to their relatively fixed nature, which were partially offset by the
favorable impact of a change in accounting convention for smallwares that was
implemented in the 2006 quarter.
Cost of Other Franchise Income. Cost of other franchise income decreased
$948,000 (77%) from $1,229,000 in the 2005 quarter to $281,000 in the 2006
quarter and decreased $1,001,000 (49%) from $2,048,000 in the 2005 year-to-date
period to $1,047,000 in the 2006 year-to-date period due to the decision to
discontinue writing new coverage in our captive insurance program, which was
partially offset by $500,000 recorded for estimated insurance losses from
franchise participants in the first quarter of 2006.
General and Administrative Expenses. General and administrative expenses
increased from 9.1% in the 2005 quarter to 9.8% in the 2006 quarter and
increased from 9.0% in the 2005 year-to-date period to 10.1% in the 2006
year-to-date period due primarily to an increase in stock-based compensation
related to adoption of SFAS 123(R), higher compensation expense due to staffing
levels and a shift in the timing of our general manager meeting in the 2006
year-to-date period. Stock-based compensation included in general and
administrative expenses was 1.5% and 0.2% in the 2006 quarter and the 2005
quarter, respectively, and 1.6% and 0.2% in the 2006 year-to-date period and the
2005 year-to-date period, respectively. The increase in both periods was
partially offset by the absorption of general and administrative costs over a
larger revenue base as well as decreases in the return on investments of our
nonqualified deferred compensation plan and lower accrued incentive
compensation.
Impairment and Other Restaurant Closure Costs. Impairment and other restaurant
closure costs were $3,000,000 in the 2006 quarter and $4,600,000 in the 2006
year-to-date period. These costs consisted of $1,900,000 impairment of the
carrying value of the property and equipment and approximately $1,100,000 for
the write-off of lease acquisition costs in the 2006 quarter. In addition, we
recorded an impairment of $900,000 of the carrying value of the property and
equipment and $700,000 of lease obligations for closed restaurants in the first
quarter of fiscal 2006.
Investment Income (Loss). Investment income decreased from income of $449,000 in
the 2005 quarter to a loss of $285,000 in the 2006 quarter due to a decrease in
the return on investments in our nonqualified deferred compensation plan.
Investment income increased from $408,000 in the 2005 year-to-date period to
$460,000 in the 2006 year-to-date period.
Interest Expense. Interest expense increased from $634,000 in the 2005 quarter
to $2,985,000 in the 2006 quarter and from $971,000 in the 2005 year-to-date
period to $5,539,000 in the 2006 year-to-date period due primarily to higher
interest rates and increased borrowings used for capital expenditure funding,
repurchases of our common stock, and acquisitions.
29.
Income Taxes. The effective income tax rate, as a percentage of earnings before
income taxes, increased from 34.6% in the 2005 quarter to 34.8% in the 2006
quarter and decreased from 34.6% in the 2005 year-to-date period to 34.1% in the
2006 year-to-date period. Both periods were impacted by favorable hourly
employment tax credits and the resolution of state tax matters.
Liquidity and Capital Resources
Our primary sources of liquidity are cash provided by operations and borrowings
under our credit facility. Our need for capital resources historically has
resulted from the construction and acquisition of restaurants, the repurchase of
our common stock, and investment in information technology systems. In the past,
we have obtained capital through our ongoing operations and debt financing. Cash
flows from our ongoing operations primarily include cash generated from company
and franchise operations, management of credit from trade suppliers, decisions
to enter into restaurant operating leases, and cash received from the exercise
of employee stock options. In addition, we have assumed debt or issued new debt
in connection with certain mergers and acquisitions. The following table
presents a summary of our cash flows for the 2006 year-to-date period and the
2005 year-to-date period (in thousands):
2006 2005
Year-to-Date Year-to-Date
Period Period
------------------- ------------------
Net cash provided by operating activities......... $ 65,832 $ 107,790
Net cash used by investing activities............. (65,712) (108,116)
Net cash used by financing activities............. (6,264) (9,655)
------------------- ------------------
Net decrease in cash and cash equivalents......... $ (6,144) $ (9,981)
=================== ==================
Capital expenditures were $59,922,000 in the 2005 year-to-date period and
$59,976,000 in the 2006 year-to-date period. In 2006, we currently expect to
open approximately 35 company restaurants, and capital expenditures, excluding
franchise acquisitions, are expected to be between $135,000,000 and
$145,000,000.
Future capital expenditures will primarily be for the development of new
restaurants, refurbishment and capital replacement for existing restaurants, and
the enhancement of information systems. Because we expect to continue to
purchase a portion of our restaurant sites, the amount of actual capital
expenditures will be dependent upon, among other things, the proportion of
leased versus owned properties. If we construct more or fewer restaurants than
we currently anticipate, or acquire additional restaurants, our capital
requirements will increase or decrease accordingly.
In fiscal 2006, we expect to incur approximately $16,000,000 in costs associated
with the construction of our new corporate headquarters including $4,500,000 for
land, which we paid in January 2006. We will incur additional construction costs
in fiscal 2007, the amount of which has yet to be determined.
In January 2006, we completed the acquisition of four Applebee's restaurants in
the Houston area for approximately $8,200,000. In connection with this
acquisition, we paid approximately $8,000,000 in the 2006 year-to-date period.
In May 2005, we completed the acquisition of 12 Applebee's restaurants in
Missouri, Kansas and Arkansas, which included one restaurant under construction,
for approximately $39,500,000 in cash.
30.
In April 2005, we completed the acquisition of eight Applebee's restaurants in
the Memphis market, which were closed in 2004 by a former franchisee, for
approximately $8,800,000 in cash. In connection with this acquisition, we paid
approximately $800,000 in 2004 and $8,000,000 in 2005.
In December 2004, we completed the refinancing of our $150,000,000 unsecured
revolving credit facility. The new bank credit agreement provided for a
$150,000,000 five-year unsecured revolving credit facility, of which $40,000,000
may be used for the issuance of letters of credit. The facility is subject to
various covenants and restrictions which, among other things, require the
maintenance of stipulated fixed charge, leverage and indebtedness to
capitalization ratios, as defined. There is no limit on cash dividends provided
that the declaration and payment of such dividend does not cause a default of
any other covenant contained in the agreement. The facility is subject to other
standard terms, conditions, covenants and fees. In September 2005, we entered
into an amendment to our credit facility which increased the revolving credit
commitment available from $150,000,000 to $200,000,000. In October 2005, we
entered into a second amendment to our credit facility which increased the
revolving credit commitment available from $200,000,000 to $250,000,000 and
provided for an additional $75,000,000 of revolving credit upon satisfaction of
the conditions set forth in the credit facility. As of June 25, 2006, we were in
compliance with the covenants contained in our credit agreement. As of June 25,
2006, we had borrowings of $196,400,000, standby letters of credit of
$16,400,000 outstanding and approximately $37,200,000 available under our
revolving credit facility.
In October 2005, our Board of Directors approved a $175,000,000 authorization to
repurchase our common stock, subject to market conditions. During the 2006
year-to-date period, we repurchased 687,200 shares of our common stock at an
average price of $23.48 for an aggregate cost of $16,134,000. As of June 25,
2006, we had $112,833,000 remaining under our repurchase authorization.
In October 2005, the Board of Directors declared an annual dividend of $0.20 per
share payable to shareholders of record on December 23, 2005. We paid
approximately $14,800,000 in January 2006 related to this dividend.
As of June 25, 2006, our liquid assets totaled $7,185,000. These assets
consisted of cash and cash equivalents in the amount of $6,896,000 and
short-term investments in the amount of $289,000. The working capital deficit
decreased from $107,400,000 as of December 25, 2005 to $61,182,000 as of June
25, 2006. This decrease was due primarily to the redemption of gift cards in the
2006 quarter sold in 2005 and decreases in accounts payable and accrued
dividends.
We believe that our liquid assets and cash generated from operations, combined
with available borrowings, will provide sufficient funds for capital
expenditures, repurchases of our common stock, the payment of dividends and
other such operating activities for at least the next 12 months and thereafter
for the foreseeable future.
31.
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 25, 2006 (in thousands):
Payments due by period
----------------------------------------------------------------------
Certain Less than 1 1-3 3-5 More than 5
Contractual Obligations Total year years years years
-------------------------------------------- ------------- ------------- ------------- ------------ -------------
Long-term Debt (excluding capital
lease obligations) (1).................. $ 197,756 $ 4,521 $ 86 $ 192,104 $ 1,045
Capital Lease Obligations.................. 7,940 808 1,701 1,822 3,609
Operating Leases (2)....................... 393,789 28,351 56,850 55,598 252,990
Purchase Obligations - Company(3).......... 233,319 62,462 137,510 33,347 --
Purchase Obligations - Franchise(4)........ 574,252 123,389 361,872 88,991 --
(1) The amounts for long-term debt are primarily borrowings under our revolving
credit facility and exclude interest payments which are variable in nature.
(2) The amounts for operating leases include option periods where failure to
exercise such options would result in an economic penalty such that the
renewal appears reasonably assured.
(3) The amounts for company purchase obligations include commitments for food
items, energy, supplies, severance and employment agreements, and other
miscellaneous commitments.
(4) The amounts for franchise purchase obligations include commitments for food
items and supplies made by us for our franchisees. We contract with certain
suppliers to ensure competitive pricing. These amounts will only be payable
by us if our franchisees do not meet certain minimum contractual
requirements.
Other Contractual Obligations
In connection with the sale of restaurants to franchisees and other parties, we
have, in certain cases, remained contingently liable for the remaining lease
payments. As of June 25, 2006, we have outstanding lease guarantees of
approximately $16,300,000. In addition, we or our subsidiaries are contingently
liable for various leases that we have assigned in connection with the sale of
restaurants to franchisees and other parties, in the potential amount of
$13,200,000. These leases expire at various times with the final lease agreement
expiring in 2018. We have not recorded a liability related to these contingent
lease liabilities as of June 25, 2006 or December 25, 2005.
In 2004, we arranged for a third-party financing company to provide up to
$250,000,000 to qualified franchisees for loans to fund development of new
restaurants through October 2007, subject to our approval. We will provide a
limited guarantee of 10% of certain loans advanced under this program. We will
be released from our guarantee if certain operating results are met after the
restaurant has been open for at least two years. As of June 25, 2006, there were
loans outstanding to six franchisees for approximately $55,900,000 under this
program. The fair value of our guarantees under this financing program is
approximately $110,000 and is recorded in non-current liabilities in our
consolidated balance sheet as of June 25, 2006.
We have severance and employment agreements with certain officers providing for
severance payments to be made in the event the associate resigns or is
terminated not related to a change in control, some of which require payments to
be made only if we enforce certain terms in the agreements. If the severance
payments had been due as of June 25, 2006, we would have been required to make
payments totaling approximately $13,200,000. In addition, we have severance and
employment agreements with certain officers which contain severance provisions
related to a change in control. The agreements define the circumstances which
will constitute a change in control. Those provisions would have required
additional aggregate payments of approximately $7,400,000 if such officers had
been terminated as of June 25, 2006.
32.
New Accounting Pronouncements
In March 2006, the Emerging Issues Task Force ("EITF") issued EITF Issue 06-3,
"How Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That Is, Gross versus Net
Presentation)." A consensus was reached that entities may adopt a policy of
presenting sales taxes in the income statement on either a gross or net basis.
If taxes are significant, an entity should disclose its policy of presenting
taxes and the amounts of taxes that are recognized on a gross basis. The
guidance is effective for periods beginning after December 15, 2006. We present
company sales net of sales taxes. This issue will not impact the method for
recording these sales taxes in our consolidated financial statements.
In July 2006, the FASB issued FASB Interpretation No. ("FIN") 48, "Accounting
for Uncertainty in Income Taxes," which clarifies the accounting for uncertainty
in income taxes recognized in the financial statements in accordance with SFAS
No. 109, "Accounting for Income Taxes." FIN 48 is effective for fiscal years
beginning after December 15, 2006. We are evaluating the impact the adoption of
FIN 48 will have on our consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk from fluctuations in interest rates and changes in
commodity prices. Our revolving credit facility bears interest at either the
bank's prime rate or LIBOR plus 0.75%, at our option. As of June 25, 2006, the
total amount of debt subject to interest rate fluctuations was $196,400,000,
which was outstanding on our revolving credit facility. A 1% change in interest
rates would result in an increase or decrease in interest expense of $1,964,000
per year. We may from time to time enter into interest rate swap agreements to
manage the impact of interest rate changes on our earnings. A substantial
portion of the food products and utilities we purchase are subject to price
volatility due to factors that are outside of our control such as weather,
seasonality and fuel costs. As part of our strategy to moderate this volatility,
we have entered into fixed price purchase commitments.
Item 4. Controls and Procedures
As of June 25, 2006, we have evaluated the effectiveness of the design and
operation of our disclosure controls and procedures, under the supervision and
with the participation of the principal executive officer and Chief Financial
Officer ("CFO"). Based on this evaluation, our management, including the
principal executive officer and CFO, concluded that our disclosure controls and
procedures are effective.
During the 2006 quarter, there have been no changes in our internal control over
financial reporting that occurred that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
33.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are subject from time to time to lawsuits, claims and governmental
inspections or audits arising in the ordinary course of business. Some of these
lawsuits purport to be class actions and/or seek substantial damages. In the
opinion of management, these matters are adequately covered by insurance, or if
not so covered, are without merit or are of such a nature or involve amounts
that would not have a material adverse impact on our business or consolidated
financial position.
Item 1A. Risk Factors
There have been no material changes in our risk factors from those disclosed in
our 2005 Annual Report on Form 10-K.
34.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Issuer Purchases of Equity Securities.
--------------------------------------------------------------------------------------------------------------
Purchases of Equity Securities(1)
--------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d)
------------------------------- ------------- ----------- ------------------------- --------------------------
Maximum Dollar Value of
Total Number of Shares Shares that May Yet Be
Total Average Purchased as Part of Purchased Under the
Number of Price Publicly Announced Plans or Programs
Period Shares Paid Per Plans or Programs (in thousands)
Purchased Share
------------------------------- ------------- ----------- ------------------------- --------------------------
March 27, 2006 through
April 23, 2006 256,700 $23.37 256,700 $117,798
------------------------------- ------------- ----------- ------------------------- --------------------------
April 24, 2006 through
May 21, 2006 212,300 $23.39 212,300 $112,833
------------------------------- ------------- ----------- ------------------------- --------------------------
May 22, 2006 through
June 25, 2006 -- -- -- $112,833
------------------------------- ------------- ----------- ------------------------- --------------------------
Total 469,000 469,000
=============================== ============= =========== ========================= ==========================
(1) In October 2005, our Board of Directors authorized additional repurchases of
our common stock of up to $175,000,000, subject to market conditions.
35.
Item 4. Submission of Matters to a Vote of Security Holders
Our Annual Meeting of Stockholders was held on May 11, 2006. The stockholders
voted on the following matters:
Proposal I. Election of six directors.
Proposal II. Approve the Applebee's International, Inc. 2001 Senior
Executive Bonus Plan, as amended.
Proposal III. Ratify the selection of Deloitte & Touche LLP as our
independent registered public accounting firm for the 2006
fiscal year.
Proposal IV. Act on a shareholder proposal to require us to issue
quarterly reports in 2006 detailing the progress made toward
accelerating the development of an alternative method of
poultry slaughter.
The results of the voting were as follows:
Negative/
Affirmative Withheld Broker
Proposal Votes Votes Abstentions Non-Votes
-------------------------- ---------------- -------------------- -------------------- -----------------
I (Boswell) 68,637,606 327,981 -- --
I (Goebel) 68,300,086 665,501 -- --
I (Conant) 66,696,411 2,269,176 -- --
I (Curran) 68,350,630 614,957 -- --
I (Lumpkin) 67,187,199 1,778,388 -- --
I (Rebolledo) 68,681,772 283,815 -- --
II 64,584,445 1,193,592 3,187,550 --
III 68,783,912 110,705 70,970 --
IV 2,383,094 51,937,081 5,363,347 9,282,065
Proposals I, II, and III received the required affirmative votes and were
adopted by the stockholders. Proposal IV did not receive the required
affirmative votes.
Item 6. Exhibits
The Exhibits listed on the accompanying Exhibit Index are filed as part of this
report.
36.
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 26, 2006 By: /s/ David L. Goebel
--------------------- --------------------------------------
David L. Goebel
Director, President and
Chief Operating Officer
(principal executive officer)
Date: July 26, 2006 By: /s/ Steven K. Lumpkin
--------------------- --------------------------------------
Steven K. Lumpkin
Director, Executive Vice President,
Chief Financial Officer and Treasurer
(principal financial officer)
Date: July 26, 2006 By: /s/ Beverly O. Elving
--------------------- --------------------------------------
Beverly O. Elving
Vice President and Controller
(principal accounting officer)
37.
APPLEBEE'S INTERNATIONAL, INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------------- ------------------------------------------------------------------
10.1 2001 Senior Executive Bonus Plan, as amended (incorporated by
reference to the Registrant's Form 8-K filed on May 16, 2006).
10.2 Separation Agreement, Release and Waiver dated May 17, 2006 by and
between the Company and John C. Cywinski (incorporated by
reference to the Registrant's Form 8-K filed on May 18, 2006).
10.3 Amendment to the Amended and Restated 1995 Equity Incentive Plan.
31.1 Certification of Principal Executive Officer Pursuant to SEC Rule
13a-14(a).
31.2 Certification of Chief Financial Officer Pursuant to SEC Rule
13a-14(a).
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
38.