- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER: 0-8360 ---------------- IHOP CORP. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) <TABLE> <S> <C> DELAWARE 95-3038279 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) </TABLE> <TABLE> <S> <C> 525 NORTH BRAND BOULEVARD, GLENDALE, CALIFORNIA 91203-1903 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) </TABLE> REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (818) 240-6055 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: <TABLE> <CAPTION> NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- --------------------- <S> <C> NONE </TABLE> SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.01 PAR VALUE (TITLE OF CLASS) ---------------- 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] State the aggregate market value of the voting stock held by non-affiliates of the registrant as of January 31, 1998. $314 million Indicate the number of shares outstanding of each of the registrant's classes of common stock as of the latest practicable date. <TABLE> <CAPTION> OUTSTANDING AS OF CLASS JANUARY 31, 1998 ----- ----------------- <S> <C> Common Stock, $.01 par value........................... 9,735,762 </TABLE> DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for Annual Meeting of Shareholders to be held on Tuesday, May 12, 1998, (the "1998 Proxy Statement") are incorporated by reference into Part III. - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
PART I ITEM 1. BUSINESS. General Development of Business IHOP Corp. and its subsidiaries ("IHOP" or the "Company") develop, operate and franchise International House of Pancakes restaurants, one of America's best-known, national, family restaurant chains. As of December 31, 1997, the Company had 787 restaurants, of which 571 were operated by franchisees, 145 by area licensees and 71 by the Company. IHOP restaurants are located in 36 states, Canada and Japan. IHOP Corp. was incorporated under the laws of the State of Delaware in 1976. In July 1991, IHOP completed an initial public offering of its common stock. There were no significant changes to the Company's corporate structure during 1997, nor material changes in the Company's method of conducting business. Financial Information about Industry Segments IHOP Corp. and its subsidiaries are engaged exclusively in the foodservice industry, primarily in the United States, wherein IHOP develops, franchises and operates restaurants. Information with respect to revenues, operating profits and assets attributable to IHOP's sole industry segment is contained under the caption "Five Year Financial Summary" in the Financial Information Section beginning on page F-1 of this Annual Report on Form 10-K. Narrative Description of Business The Company develops, franchises and operates International House of Pancakes restaurants. IHOP restaurants feature moderately-priced, high-quality food and beverage items, and table service in an attractive and comfortable atmosphere. Although IHOP restaurants are best known for their award-winning pancakes, omelets and other breakfast specialties, IHOP restaurants are open throughout the day and evening hours and offer a broad array of lunch, dinner and snack items as well. More than 90% of IHOP restaurants are operated by franchisees, who are independent third parties. The Company's approach to franchising (discussed in greater detail below) is founded on the franchisees' active involvement in the day-to-day operations of their respective restaurants. The Company is selective in granting franchises, preferring to franchise to individuals who intend to be active in the management of their restaurant(s) and not to passive investors or investment groups. This provides a quality of management and dedication that, in the view of the Company, is generally unmatched by salaried employees or absentee owners. In addition, IHOP itself develops most new restaurants prior to franchising them and, following the franchising of the restaurant, becomes the franchisee's landlord. This landlord/tenant relationship provides IHOP with enhanced profits and greater control over its franchise system. Management seeks to increase revenues and profits by focusing on several areas of the Company's business. These areas include the development and franchising of new IHOP restaurants, improvements in sales levels at existing restaurants through the attraction of new guests and retention of existing customers, and restaurant-level operating changes designed to improve profitability. Restaurant Development The Company intends to add restaurants to the IHOP system primarily through the development of new restaurants in major markets where the Company already has a core customer base. Management believes that by concentrating growth in its existing markets, the Company will be able to achieve economies of scale with respect to supervisory, advertising and distribution functions. New restaurants are developed after a stringent site selection process which is supervised by senior management. In addition, the Company may acquire non-IHOP restaurants in existing markets for conversion to International House of Pancakes restaurants. In 1997, the Company developed 45 new restaurants and franchisees developed an additional 22 restaurants. 2
IHOP secondarily looks to develop new markets in which it has no presence or its presence is limited, primarily where such new markets are geographically near to existing markets and are deemed to present significant business opportunities. In such regard, management may consider proposals to acquire several non-IHOP units in markets in which the Company has little or no presence. Management evaluates such proposals on a case-by-case basis and may elect to acquire such restaurants for conversion to International House of Pancakes restaurants. In 1997, the Company built two types of new restaurant buildings. The larger format restaurant averages approximately 4,500 square feet with about 170 seats. The second building type is designed for use in smaller, high-potential markets and is approximately 3,900 square feet in size and seats about 128 people. Of the 45 new IHOP restaurants built by the Company in 1997, 25 were the larger format building, 13 were the smaller format building and 7 were existing restaurants converted to International House of Pancakes restaurants (restaurant conversions). The number of seats in a restaurant conversion is variable by location, and, in 1997, averaged 175 seats per restaurant. In comparison, IHOP's older A-Frame style restaurants, which have not been built since 1985, average approximately 3,000 square feet with 100 seats. The new restaurants feature larger kitchens designed to accommodate IHOP's continuing expansion of its lunch and dinner business and to more efficiently service the peak breakfast and brunch hours on weekends. To the greatest extent possible, the Company continues to use its familiar signature blue color on the roof, awnings and other exterior decor of its restaurants. The table below sets forth the average development cost per restaurant in 1997. For leased restaurants, the discounted present value of the lease and any "key money" have been allocated to land, building and site improvements and other costs, as appropriate. <TABLE> <CAPTION> AVERAGE PER RESTAURANT ----------- <S> <C> Land............................................................. $ 509,000 Building......................................................... 750,000 Equipment........................................................ 328,000 Site improvements and other costs................................ 168,000 ---------- Total.......................................................... $1,755,000 ========== </TABLE> New restaurants opened in 1996 have realized, on average, sales of $1,513,000 in their first twelve full months of operations. Franchising IHOP's approach to franchising is somewhat different from that of its franchising competitors in the foodservice industry. In most franchise systems, the franchisee is called upon to pay a modest initial fee and uses his/her own capital to acquire a site, build and equip the restaurant and fund working capital needs. While IHOP offers a Franchise Investor Program, which affords certain experienced franchisees the opportunity to fund the development of their own restaurants, the large majority of IHOP restaurants are developed directly by IHOP. In this regard, IHOP generally (i) identifies the site for the new restaurant, (ii) purchases the site or leases it from a third party, (iii) builds the restaurant and equips it with all required furniture, fixtures and equipment ("equipment"), (iv) selects the franchisee and trains the franchisee and supervisory personnel who will run the restaurant, (v) finances the purchase of the franchise, (vi) leases the restaurant and equipment to the franchisee and (vii) provides continuing support with respect to operations, marketing and new product development. Although IHOP incurs substantial obligations in the development, franchising and start-up operations of a new restaurant, its involvement in such development allows the Company to command a substantial franchise and development fee. In addition, IHOP derives income from the partial financing of the franchise and development fee and from the leasing of property and equipment to franchisees. IHOP's involvement in site selection and development, the training and supervising of franchisees, as well as its control over restaurant property, products and services, are an integral part of the Company's operating philosophy. 3
IHOP franchisees are predominantly owner/operators, not passive investors. The majority of franchisees own only one restaurant and only eleven franchisees (excluding area licensees) currently own more than six restaurants. It is the Company's belief that franchisees who are actively involved in the operation of their restaurants provide a quality of management and commitment to our guests that cannot be matched by salaried managers. In addition, a majority of new restaurants are franchised to current franchisees or restaurant managers who already understand IHOP's approach to the restaurant business. In the past five years sales to existing franchisees and IHOP employees, or their immediate families, constituted approximately 85% of franchise sales transactions. IHOP's franchise agreements generally require the payment of an initial franchise fee of approximately $200,000 to $350,000 for a newly developed restaurant (depending on the site), of which approximately 20% is initially paid in cash. The balance of the initial franchise fee is financed by the Company over five to eight years. IHOP also receives continuing revenues from the franchisee: a royalty equal to 4.5% of a franchisee's sales; income from the leasing of the restaurant and related equipment; revenue from the sale of certain proprietary products; a local advertising fee equal to about 2% of a franchisee's sales (which is usually paid to a local advertising cooperative); and a national advertising fee equal to 1% of a franchisee's sales. Franchise agreements relating to restaurants developed directly by franchisees under the Company's Franchise Investor Program provide for a reduced initial franchise fee of $50,000, revenue from the sale of certain proprietary products, and royalties and advertising fees in amounts similar to those described above. The Company or its predecessor has entered into long-term area licensing agreements covering the state of Florida and the Southern-most counties of Georgia, the province of British Columbia, Canada and the country of Japan. These agreements provide for royalties ranging from 0.5% to 2% of sales and advertising fees equal to 0.25% of sales. The Company also derives revenue from the sale of certain proprietary products to the area licensees. Area licensing arrangements, similar to those described above, may be used in the future for domestic and international expansion into areas where neither the Company nor investor program franchisees are likely to develop International House of Pancakes restaurants. Restaurant Operations and Support It is the Company's goal to make every dining experience at IHOP a satisfying one. IHOP franchisees and operators strive always to exceed guests' expectations, and hold firm to the belief that a satisfied customer will both be a return customer and will tell others about our restaurants. To ensure that our guests' expectations are fulfilled, all restaurants are operated in accordance with uniform operating standards and specifications relating to the quality and preparation of menu items, selection of menu items, maintenance, repair and cleanliness of premises, and the appearance and conduct of employees. The Company's Operations Department is charged with insuring that these high standards are met at all times. These operating standards are detailed in the Company's Manual of Standard Operating Procedures and have been developed by the Company in consultation with our franchisee operators. Each restaurant is assigned an Operations Consultant who regularly visits and evaluates the restaurant to ensure that it remains in compliance with the operating guidelines and procedures. In addition to frequent visits to the restaurant, the Operations Consultant conducts at least two annual comprehensive written evaluations of every aspect of the restaurant's operations. The Operations Consultant then meets with the franchisee or manager to discuss the results of his review and develop a plan to address any areas for improvement. The International House of Pancakes menu offers a large selection of high- quality, moderately-priced products designed to appeal to a broad customer base. These include a wide variety of pancakes, waffles, omelets and other breakfast specialties, chicken, steak and sandwiches. In most restaurants, IHOP offers special items for children and seniors at reduced prices. IHOP restaurants are located throughout the United States, and, in recognition of local tastes, most IHOP restaurants offer regional specialties that complement the IHOP core 4
menu. IHOP's Research and Development Department working together with franchisees and the Company's Operations and Marketing departments continually develop new menu ideas. These new menu items are thoroughly tested in the Company's test kitchen and in limited regional tests before being introduced throughout the system. The purpose of adding new items is to be responsive to our guests' needs and requests, and to keep the menu fresh and appealing to our customers. Training is ongoing at all IHOP restaurants. Each prospective franchisee is required to participate in an extensive training program before he/she is sold a franchise. The training program involves classroom study in the Company's training facility in San Dimas, California, and hands-on operational training in one of our regional training restaurants. Each franchisee learns to cook, wait on tables, serve as a host, wash dishes and each of the other myriad tasks necessary to operate a successful restaurant. Field training teams and new restaurant opening teams provide on-site instruction to Company and franchised restaurant employees to assist in the opening of new IHOP restaurants. The Company's regional headquarters offer additional training courses from time to time on subjects such as suggestive selling, improving service, managing people and diversity. Marketing and Advertising Most IHOP franchisees and Company-operated restaurants contribute about 2% of their sales to local advertising cooperatives and the Company provides additional funding to these cooperatives. The advertising co-ops use these funds to purchase television advertising time and place advertisements in printed media or direct mail. For many years, IHOP's television advertising has featured Cliff Bemis, as IHOP's affable spokesperson. The viewer's response to Cliff has always been positive and the Company is continuing to create new Cliff commercials. In these new commercials though, a greater emphasis is being placed on the appetizing appearance, quality and taste of the delicious IHOP food. In addition to television advertising, IHOP encourages local area marketing by its franchisees. These marketing programs include discounts and specials aimed at increasing customer traffic and encouraging repeat business. Company-Operated Restaurants The pool of Company-operated restaurants consists of those restaurants newly-developed by the Company which have not yet been franchised and those restaurants re-acquired by the Company through negotiation or franchisee defaults. The relative number and identity of restaurants in each group within the pool, and the total number of restaurants in the pool, varies from time to time as IHOP develops new restaurants, reacquires franchised restaurants and franchises new and reacquired restaurants. Those restaurants that the Company repossesses typically require investment in remodeling and rehabilitation by the Company before being refranchised and may remain in the pool for a substantial period of time. As a consequence of this adverse selection process, some Company-operated restaurants may incur operating losses during the period of their rehabilitation. Remodeling and Refranchising Program Restaurants reacquired by IHOP are usually underperforming as a result of having been poorly operated, physically neglected and/or badly staffed. When a restaurant enters the pool of Company-operated restaurants as a result of negotiation or franchisee default, IHOP begins a multi-step rehabilitation program for that restaurant. These restaurants are physically rehabilitated by IHOP. IHOP also hires and trains the restaurant staff. The Company then implements new marketing and operations programs designed to regain the business of former guests and attract new patrons. After a restaurant has been rehabilitated and its sales volume reaches acceptable levels, the restaurant is refranchised to a qualified franchisee. In the past five years IHOP reacquired a total of 61 restaurants from franchisees. In those same years restaurants that were refranchised totaled 36. 5
In the past five years IHOP has remodeled and updated approximately 33 then Company-operated restaurants at an average cost per restaurant of approximately $95,000. Management believes that, from 1991 through 1997, average sales in remodeled Company-operated restaurants increased approximately 14.7% in the 12 months subsequent to the remodeling. IHOP intends to continue this remodeling program with respect to Company-operated restaurants on an ongoing basis to facilitate the refranchising of these restaurants and to enhance the chain's image and maintain and expand its customer base. IHOP also requires most of its franchisees, and strongly encourages all of its franchisees, to periodically remodel their restaurants. In the past five years 175 restaurants have been remodeled by franchisees. Purchasing To minimize costs, achieve economies of scale, and ensure food quality and consistency, IHOP has set up informal purchasing cooperatives among franchisees to negotiate bulk orders of food products. IHOP has also entered into long-term supply contracts for various products, including pancake mixes, coffee, soft drinks and juices, to ensure the availability of quality products at competitive prices. Competition and Markets The restaurant business is highly competitive and is affected by, among other things, changes in eating habits and preferences, local, regional and national economic conditions, population trends and traffic patterns. The principal bases of competition in the industry are the quality and price of the food products served. Additionally, restaurant location, quality and speed of service, advertising, name identification and attractiveness of facilities are also important. The acquisition of sites is highly competitive as well, with IHOP often competing with other restaurant chains and retail businesses for suitable sites for the development of new restaurants. The current structure of the U.S. restaurant and institutional foodservice market is characterized by differentiated chains competing within their segments against each other and local, single-outlet operators. Foodservice chains in the United States include the following segments: quick-service sandwich, chicken, pizza, family restaurant, dinner house, grill-buffet, hotel restaurant and contract/catering. Information published in 1997 by an industry trade publication ranked IHOP 34th out of the top 100 chains based on estimated fiscal 1996 system-wide foodservice sales in the United States. The same publication included twelve family restaurant chains in its top 100 chains, and IHOP ranked fourth in this segment. A national consumer survey, performed by an independent restaurant industry publication in 1997, indicates that approximately 80% of all Americans are familiar with International House of Pancakes restaurants, making IHOP one of the two top family restaurant chains in terms of consumer awareness. In December 1997, based on a nation- wide sample of IHOP restaurants, the approximate guest check average per IHOP customer was $6.15. Trademarks and Service Marks The Company has registered "International House of Pancakes," "IHOP" and variations of each, as well as other trademarks and service marks, including "Any Time's a Good Time for Breakfast at IHOP," "the Home of the Never Empty Coffee Pot," "Rooty Tooty Fresh 'N Fruity," and "Harvest Grain 'N Nut" with the United States Patents and Trademark Office. IHOP also registers new trademarks and service marks from time to time. The Company is not aware of any infringing uses that could materially affect its business or any prior claim to these marks that would prevent IHOP from using or licensing the use thereof for restaurants in any area of the United States. The Company has registered its trademarks and service marks and variations thereof in Japan and Canada for use by current licensees and, where feasible and appropriate, registers its trademarks and service marks in other nations for future use. The Company's current registered trademarks and service marks will expire, unless renewed, at various dates from 1998 to 2013. IHOP routinely applies to renew its active trademarks and service marks prior to their expiration. 6
Seasonality IHOP's business, like that of most restaurants, is seasonal in that restaurants generally experience greater customer traffic and sales in the warmer months and during the Thanksgiving and Christmas seasons. Government Regulation IHOP is subject to various federal, state and local laws affecting its business as well as a variety of regulatory provisions relating to zoning of restaurant sites, sanitation, health and safety. As a franchisor, the Company is subject to state and federal laws regulating various aspects of franchise operations and sales. These laws impose registration and disclosure requirements on franchisors in the offer and sale of franchises and, in certain cases, also apply substantive standards to the relationship between franchisor and franchisee, including primarily defaults, termination and non- renewal of franchises. Various federal and state labor laws govern IHOP's relationships with its employees, including such matters as minimum wage requirements, overtime and other working conditions. Environmental requirements have not had a material effect on the operations of the Company or those of its franchisees. Significant additional government-imposed increases in minimum wages, paid leaves of absence, mandated health benefits or increased tax reporting and tax payment requirements in respect to employees who receive gratuities could, however, be detrimental to the economic viability of franchisee-operated and Company-operated International House of Pancakes restaurants. Employees At December 31, 1997, the Company employed approximately 2,600 persons, of whom 233 were full-time, non-restaurant, corporate personnel. The Company considers relations with its employees to be satisfactory. 7
ITEM 2. PROPERTIES. The table below shows the location and status of the 787 IHOP restaurants in operation as of December 31, 1997: <TABLE> <CAPTION> AREA LOCATION UNITED STATES FRANCHISE COMPANY LICENSE TOTAL - ---------------------- --------- ------- ------- ----- <S> <C> <C> <C> <C> Alabama......................................... 3 1 0 4 Arizona......................................... 15 0 0 15 Arkansas........................................ 3 0 0 3 California...................................... 135 23 0 158 Colorado........................................ 17 0 0 17 Connecticut..................................... 6 0 0 6 Delaware........................................ 1 0 0 1 Florida......................................... 0 0 108 108 Georgia......................................... 32 1 1 34 Hawaii.......................................... 2 0 0 2 Idaho........................................... 0 1 0 1 Illinois........................................ 28 11 0 39 Indiana......................................... 4 2 0 6 Kansas.......................................... 1 1 0 2 Maine........................................... 1 0 0 1 Maryland........................................ 23 1 0 24 Massachusetts................................... 15 0 0 15 Michigan........................................ 10 1 0 11 Mississippi..................................... 5 0 0 5 Missouri........................................ 11 0 0 11 Nevada.......................................... 9 3 0 12 New Hampshire................................... 2 0 0 2 New Jersey...................................... 26 1 0 27 New Mexico...................................... 7 0 0 7 New York........................................ 31 1 0 32 North Carolina.................................. 21 0 0 21 Oklahoma........................................ 1 0 0 1 Oregon.......................................... 5 9 0 14 Pennsylvania.................................... 11 2 0 13 Rhode Island.................................... 1 1 0 2 South Carolina.................................. 10 0 0 10 Tennessee....................................... 11 0 0 11 Texas........................................... 88 0 0 88 Virginia........................................ 15 0 0 15 Washington...................................... 8 10 0 18 Wisconsin....................................... 2 2 0 4 <CAPTION> INTERNATIONAL - ------------- <S> <C> <C> <C> <C> Canada(1)....................................... 11 0 0 11 Japan........................................... 0 0 36 36 --- --- --- --- Totals...................................... 571 71 145 787 === === === === </TABLE> - -------- (1) The Company reports restaurants in Canada as franchise restaurants although the eleven restaurants are operated under an area license agreement. 8
As of December 31, 1997, of the 71 Company-operated restaurants, 6 were located on Company-owned sites and 65 were located on Company-leased sites; of the 571 franchisee-operated restaurants, 39 were located on Company-owned sites, 425 were located on Company-leased sites and 107 were located on sites owned or leased by franchisees; and all of the restaurants operated by area licensees were located on sites owned or leased by area licensees. IHOP's leases with its landlords generally provide for an initial term of 15 to 25 years, with most having one or more five-year renewal options in favor of the Company. The leases typically provide for payment of rentals in an amount equal to the greater of a fixed amount or a specified percentage of gross sales and for payment by IHOP of taxes, insurance premiums, maintenance expenses and certain other costs. Historically, IHOP generally has been successful at renewing those leases that expire without further renewal options. However, from time to time the Company chooses not to renew a lease or is unsuccessful in negotiating satisfactory renewal terms, and, as a result, the restaurant is closed and possession returned to the landlord. IHOP leases its principal corporate offices in Glendale, California under a lease having a remaining term of approximately three years with two five-year options to renew. The Company also leases regional offices in Lyndhurst, New Jersey; Norcross, Georgia; Lombard, Illinois; Dallas, Texas; Portland, Oregon and Sylmar, California. The Sylmar office also houses the Company's Purchasing and Product Development Departments, which includes a warehouse facility of approximately 6,200 square feet and a test kitchen. ITEM 3. LEGAL PROCEEDINGS. The Company is subject to various claims and legal actions which arise in the ordinary course of business. The Company believes such claims and legal actions, individually or in the aggregate, will not have a material adverse effect on the business or financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. 9
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The Company's common stock is traded as a national market stock on the Nasdaq Stock Market under the symbol "IHOP". As of January 31, 1998, there were approximately 2,400 shareholders, including shareholders whose shares are held in street name. The following table sets forth the high and low prices of the stock as reported by the Nasdaq National Market. <TABLE> <CAPTION> QUARTER ENDED HIGH LOW QUARTER ENDED HIGH LOW - ------------- ------- ------- ------------- ------- ------- <S> <C> <C> <C> <C> <C> March 31, 1997................. $27 1/4 $23 5/8 March 31, 1996.............. $27 1/8 $21 1/2 June 30, 1997.................. 31 1/8 23 5/8 June 30, 1996............... 29 7/8 25 September 30, 1997............. 37 3/8 30 3/8 September 30, 1996.......... 27 1/8 22 December 31, 1997.............. 37 3/8 31 December 31, 1996........... 26 1/4 19 1/4 </TABLE> The Company has not paid any dividends on its Common Stock in the last five years and has no plans to do so in 1998. Any future determination to declare dividends will depend on the Company's earnings, financial condition, cash requirements, future prospects and other factors deemed relevant by the Company's Board of Directors. The purchase agreements governing the Company's 7.79% senior notes, its 7.42% senior notes, and its credit agreement with its bank limit the amount of retained earnings available for dividends and investments. At December 31, 1997, approximately $42 million of retained earnings was free of restriction as to distribution as dividends. ITEM 6. SELECTED FINANCIAL DATA. Certain selected financial data for each of the five years ended December 31, 1997, is contained under the caption "Five Year Financial Summary" in the Financial Information Section beginning on page F-1 of this Annual Report on Form 10-K. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION. A discussion of the Company's financial condition, changes in financial condition and results of operations is contained under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Financial Information Section beginning on page F-1 of this Annual Report on Form 10-K. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The consolidated balance sheets of IHOP Corp. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997, together with the related notes and the report of Coopers & Lybrand, L.L.P., independent accountants, are contained in the Financial Information Section beginning on page F-1 of this Annual Report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. 10
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information appearing under the captions "Information Concerning Nominees and Members of the Board of Directors," "Executive Officers of the Company" and "Compliance with Section 16(a) of the Securities Exchange Act" contained in the 1998 Proxy Statement is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. Information appearing under the captions "Executive Compensation--Summary of Compensation," "Executive Compensation--Stock Options and Stock Appreciation Rights" and "Executive Officers of the Company--Employment Agreements" contained in the 1998 Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information appearing under the caption "Security Ownership of Certain Beneficial Owners and Management" contained in the 1998 Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information appearing under the caption "Certain Relationships and Related Transactions" contained in the 1998 Proxy Statement is incorporated herein by reference. 11
PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a)(1) Consolidated Financial Statements The following documents are contained in the Financial Information Section beginning on page F-1 of this Annual Report on Form 10-K. Consolidated Balance Sheets as of December 31, 1997 and 1996. Consolidated Statements of Operations for each of the three years in the period ended December 31, 1997. Consolidated Statement of Shareholders' Equity for each of the three years in the period ended December 31, 1997. Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1997. Notes to the Consolidated Financial Statements. Report of Independent Accountants. (2) Financial Statement Schedules All schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto. (3) Exhibits Exhibits not incorporated by reference are filed herewith. The remainder of the exhibits have heretofore been filed with the Commission and are incorporated herein by reference. Management contracts or compensatory plans or arrangements are marked with an asterisk. <TABLE> <C> <S> 3.1 Restated Certificate of Incorporation of IHOP Corp. 3.2 Bylaws of IHOP Corp. 4.1 Senior Note Purchase Agreement, dated as of November 19, 1992, among IHOP Corp., International House of Pancakes, Inc. ("IHOP, Inc.") and Mutual Life Insurance Company of New York and other purchasers. 4.2 First Amendment to Senior Note Purchase Agreement, dated as of November 1, 1996, among IHOP Corp., IHOP Inc., and Mutual Life Insurance Company of New York and other purchasers. Exhibit 4.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, (the "1996 Form 10-K") is hereby incorporated by reference. 4.3 $10,000,000 Letter Agreement among IHOP, Inc., IHOP Corp. and Continental Bank, N.A., dated as of June 30, 1993. 4.4 First Amendment to Letter Agreement, dated as of December 31, 1994, among IHOP, Inc., IHOP Corp. and Bank of America Illinois (successor by merger to Continental Bank, N.A.). 4.5 Second Amendment to Letter Agreement, dated as of March 11, 1996, among IHOP, Inc., IHOP Corp. and Bank of America Illinois. 4.6 Third Amendment to Letter Agreement, dated as of September 3, 1996, among IHOP, Inc., IHOP Corp. and Bank of America Illinois. Exhibit 4.6 to the 1996 Form 10-K is hereby incorporated by reference. 4.7 Fourth Amendment to Letter Agreement, dated as of November 1, 1996, among IHOP, Inc., IHOP Corp. and Bank of America Illinois. Exhibit 4.7 to the 1996 Form 10-K is hereby incorporated by reference. </TABLE> 12
<TABLE> <C> <S> 4.8 Senior Note Purchase Agreement, dated as of November 1, 1996, among IHOP, Inc., IHOP Corp. and Jackson National Life Insurance Company and other purchasers. Exhibit 4.8 to the 1996 Form 10-K is hereby incorporated by reference. *10.1 IHOP Corp. Executive Incentive Plan effective January 1, 1998. *10.2 IHOP Corp. 1991 Stock Incentive Plan as Amended and Restated February 23, 1994. *10.3 IHOP Corp. 1994 Stock Option Plan for Non-Employee Directors. *10.4 Employment Agreement between the Company and Rand Michael Ferris. Exhibit 10.6 to the 1996 Form 10-K is hereby incorporated by reference. *10.5 Employment Agreement between the Company and Susan Henderson- Hernandez. Exhibit 10.7 to the 1996 Form 10-K is hereby incorporated by reference. *10.6 Employment Agreement between the Company and Richard K. Herzer. Exhibit 10.8 to the 1996 Form 10-K is hereby incorporated by reference. *10.7 Employment Agreement between the Company and Dennis M. Leifheit. Exhibit 10.9 to the 1996 Form 10-K is hereby incorporated by reference. *10.8 Employment Agreement between the Company and Naomi K. Shively. Exhibit 10.10 to the 1996 Form 10-K is hereby incorporated by reference. *10.9 Employment Agreement between the Company and Frederick G. Silny. Exhibit 10.11 to the 1996 Form 10-K is hereby incorporated by reference. *10.10 Employment Agreement between the Company and Anna G. Ulvan. Exhibit 10.12 to the 1996 Form 10-K is hereby incorporated by reference. *10.11 Employment Agreement between the Company and Mark D. Weisberger. Exhibit 10.13 to the 1996 Form 10-K is hereby incorporated by reference. *10.12 Employment Agreement between the Company and Richard C. Celio. Exhibit 10 to the Form 10-Q for the quarterly period ended March 31, 1997, is hereby incorporated by reference. *10.13 Employment Agreement between the Company and John Jordan. 10.14 Area Franchise Agreement, effective as of May 5, 1988, by and between IHOP, Inc. and FMS Management Systems, Inc. *10.15 International House of Pancakes Employee Stock Ownership Plan as Amended and Restated as of July 12, 1991 ("the ESOP"). *10.16 Amendment No. 1 to the ESOP. *10.17 Amendment No. 2 to the ESOP. *10.18 Amendment No. 3 to the ESOP. Exhibit 10 to the Form 10-Q for the quarterly period ended September 30, 1996, is hereby incorporated by reference. *10.19 Amendment No. 4 to the ESOP. Exhibit 10 to the Form 10-Q for the quarterly period ended September 30, 1997, is hereby incorporated by reference. 11.0 Statement Regarding Computation of Per Share Earnings. 21.0 Subsidiaries of the Company. 23.0 Consent of Coopers & Lybrand, L.L.P. 27.0 Financial Data Schedule. </TABLE> *Management contracts or compensatory plans or arrangements are marked with an asterisk. (b)No reports on Form 8-K were filed during the quarter ended December 31, 1997. (c)The exhibits described above in Item 14(a)(3) are incorporated herein by reference. (d)Information regarding schedules described above in Item 14(a)(2) is incorporated herein by reference. 13
FINANCIAL INFORMATION SECTION IHOP CORP. AND SUBSIDIARIES <TABLE> <CAPTION> PAGE ---- <S> <C> Five-Year Financial Summary............................................... F-2 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... F-3 Consolidated Balance Sheets............................................... F-10 Consolidated Statements of Operations..................................... F-11 Consolidated Statement of Shareholders' Equity............................ F-12 Consolidated Statements of Cash Flows..................................... F-13 Notes to the Consolidated Financial Statements............................ F-14 Report of Independent Accountants......................................... F-24 </TABLE> F-1
FIVE-YEAR FINANCIAL SUMMARY <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ----------------------------------------------- 1997 1996 1995 1994 1993 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <S> <C> <C> <C> <C> <C> INCOME STATEMENT DATA Revenues Franchise operations...... $113,722 $102,368 $ 93,039 $ 83,868 $ 71,451 Company operations........ 61,839 53,677 43,001 40,732 47,557 Other..................... 39,897 34,051 28,283 25,394 23,537 -------- -------- -------- -------- -------- Total revenues.......... 215,458 190,096 164,323 149,994 142,545 -------- -------- -------- -------- -------- Costs and expenses Franchise operations...... 50,614 47,104 43,519 39,733 33,775 Company operations........ 58,001 50,852 41,621 37,507 43,791 Field, corporate and administrative........... 29,437 26,052 22,193 21,967 21,004 Depreciation and amortization............. 10,029 8,279 6,918 6,382 5,738 Interest.................. 14,649 11,691 8,873 6,805 5,641 Other..................... 18,442 15,367 13,698 12,616 11,480 Severance charges......... -- -- 800 -- -- Nonrecurring charge....... -- -- -- -- 2,500 -------- -------- -------- -------- -------- Total costs and expenses............... 181,172 159,345 137,622 125,010 123,929 -------- -------- -------- -------- -------- Income before income taxes.. $ 34,286 $ 30,751 $ 26,701(a) $ 24,984 $ 18,616(b) -------- -------- -------- -------- -------- Net income.................. $ 20,914 $ 18,604 $ 16,154(a) $ 15,115 $ 10,733(b) ======== ======== ======== ======== ======== Net income per share(c) Basic..................... $ 2.18 $ 1.97 $ 1.73(a) $ 1.65 $ 1.19(b) ======== ======== ======== ======== ======== Diluted................... $ 2.15 $ 1.95 $ 1.70(a) $ 1.60 $ 1.15(b) ======== ======== ======== ======== ======== Weighted average shares outstanding(c) Basic..................... 9,596 9,444 9,319 9,159 9,043 ======== ======== ======== ======== ======== Diluted................... 9,743 9,523 9,488 9,444 9,310 ======== ======== ======== ======== ======== BALANCE SHEET DATA (END OF PERIOD) Cash and cash equivalents. $ 5,964 $ 8,658 $ 3,860 $ 2,036 $ 1,179 Property and equipment, net...................... 142,751 120,854 87,795 69,550 63,083 Total assets.............. 382,593 328,889 252,057 202,553 168,657 Long-term debt............ 54,950 58,564 30,584 34,855 36,981 Capital lease obligations. 102,578 80,673 61,836 43,180 29,424 Shareholders' equity(d)... 156,184 129,357 108,297 88,299 71,178 </TABLE> - -------- (a) Includes severance charges associated with a realignment of responsibilities in the Company's restaurant operations, restaurant development and purchasing functions of $800,000, or $484,000 net of income tax benefit, or $.05 per share. (b) Includes a nonrecurring charge unrelated to the Company's prior or ongoing restaurant and franchising activities pertaining to litigation of $2,500,000, or $1,440,000 net of income tax benefit, or $.16 per share. (c) Net income per share and weighted average shares outstanding for each of the four years ended December 31, 1996, have been restated in accordance with SFAS No. 128 (see Note 1 to the Consolidated Financial Statements). (d) The Company has not paid any dividends on its common stock in the last five years and has no plans to do so in 1998. Any future determination to declare dividends will depend on the Company's earnings, financial condition, cash requirements, future prospects and other factors deemed relevant by the Company's Board of Directors. F-2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL IHOP's revenues are recorded in three categories: (i) franchise operations, which includes payments from franchisees of rents, royalties and advertising fees, proceeds from the sale of proprietary products to distributors and franchisees, interest income received in connection with the financing of franchise and development fees and equipment sales, and payments from area licensees of royalties and advertising fees (except for restaurants in Japan from which the Company does not receive advertising fees); (ii) Company operations, which consists of retail sales at Company-operated restaurants; and (iii) other revenues, which consists primarily of sales of franchises and equipment and interest income received from direct financing leases on franchised restaurant buildings. Revenues from sales of franchises and equipment and their associated costs of sales are affected by the mix and number of restaurants franchised, as follows: (i) franchise rights with respect to restaurants newly developed by IHOP normally sell for a franchise fee of $200,000 to $350,000, and such restaurants have little if any franchise cost of sales and have equipment in excess of $300,000 that is usually sold at a price that includes little or no profit margin; (ii) franchise rights with respect to restaurants developed by franchisees normally sell for a franchise fee of $50,000, and such restaurants have minor associated franchise cost of sales and do not include an equipment sale; and (iii) previously reacquired franchises normally sell for a franchise fee of $100,000 to $300,000, include an equipment sale, and may have substantial costs of sales associated with both the franchise and the equipment. The timing of sales of franchises is affected by the timing of new restaurant openings and the number of restaurants in the Company's "inventory" of restaurants that are available for refranchising. IHOP reports separately those expenses that are attributable to franchise operations and Company operations. Certain expenses, such as those recorded under field, corporate and administrative, depreciation and amortization, and interest, relate to both franchise operations and Company operations. Other expenses consist primarily of IHOP's investment in restaurants and equipment which are sold as franchises. IHOP's results of operations are impacted by the timing of additions of new restaurants, and by the timing of the franchising of those restaurants. When a restaurant is franchised, IHOP no longer includes in revenues the retail sales from such restaurant, but receives a one-time franchise and development fee, periodic interest on the portion of such fee financed by the Company and recurring payments from franchisees described above and recorded under franchise operations. F-3
RESULTS OF OPERATIONS The following table sets forth certain operating data for IHOP restaurants. <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 -------- -------- -------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> Restaurant Data Effective restaurants(a) Franchise..................................... 540 503 463 Company....................................... 66 57 49 Area license.................................. 140 134 127 -------- -------- -------- Total....................................... 746 694 639 ======== ======== ======== System-wide Sales(b)....................................... $903,140 $796,555 $714,910 Percent increase.............................. 13.4 % 11.4 % 13.2% Average sales per effective restaurant........ $ 1,211 $ 1,148 $ 1,119 Percent increase.............................. 5.5 % 2.6 % 4.2% Comparable average sales per restaurant(c).... $ 1,248 $ 1,174 $ 1,120 Percent increase.............................. 3.7 % 1.7 % 0.9% Franchise Sales................................. $709,420 $622,969 $548,784 Percent increase.............................. 13.9 % 13.5 % 13.5% Average sales per effective restaurant........ $ 1,314 $ 1,239 $ 1,185 Percent increase.............................. 6.1 % 4.6 % 3.4% Comparable average sales per restaurant(c).... $ 1,292 $ 1,207 $ 1,159 Percent increase.............................. 4.0 % 1.7 % 0.9% Company Sales................................... $ 61,839 $ 53,677 $ 43,001 Percent increase.............................. 15.2 % 24.8 % 5.6% Average sales per effective restaurant........ $ 937 $ 942 $ 878 Percent change................................ (0.5)% 7.3 % 3.4% Area License Sales.............................. $131,881 $119,909 $123,125 Percent change................................ 10.0 % (2.6)% 15.0% Average sales per effective restaurant........ $ 942 $ 895 $ 969 Percent change................................ 5.3 % (7.6)% 6.7% </TABLE> - -------- (a) "Effective restaurants" are the number of restaurants in a given fiscal period adjusted to account for restaurants open only a portion of the period. (b) "System-wide sales" are retail sales of franchisees, area licensees and Company-operated restaurants, as reported to the Company. (c) "Comparable average sales" reflect sales for restaurants that are operated for the entire fiscal period in which they are being compared. Comparable average sales do not include data on restaurants located in Florida and Japan. F-4
The following table summarizes the Company's restaurant development and franchising activity: <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, ---------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- <S> <C> <C> <C> <C> <C> RESTAURANT DEVELOPMENT ACTIVITY(A) IHOP--beginning of year........................... 729 678 620 572 530 New openings IHOP-developed................................ 45 45 40 30 38 Investor program.............................. 13 11 17 14 17 Area license.................................. 9 7 8 10 9 --- --- --- --- --- Total new openings.............................. 67 63 65 54 64 --- --- --- --- --- Closings Company and franchise......................... (9) (10) (7) (5) (17) Area license.................................. -- (2) -- (1) (5) --- --- --- --- --- IHOP--end of year................................. 787 729 678 620 572 === === === === === Summary--end of year IHOP Franchise..................................... 571 535 496 451 407 Company....................................... 71 58 51 46 51 Area license.................................. 145 136 131 123 114 --- --- --- --- --- Total IHOP...................................... 787 729 678 620 572 === === === === === RESTAURANT FRANCHISING ACTIVITY(A) IHOP-developed.................................... 45 41 36 32 30 Investor program.................................. 13 11 17 14 17 Rehabilitated and refranchised.................... 6 5 3 10 12 --- --- --- --- --- Total restaurants franchised.................... 64 57 56 56 59 Reacquired by Company............................. (23) (11) (8) (10) (9) Closed............................................ (5) (7) (3) (2) (13) --- --- --- --- --- Net addition.................................... 36 39 45 44 37 === === === === === </TABLE> - -------- (a) The Company reports restaurants in Canada as franchise restaurants although the eleven restaurants are operated under an area license agreement. The following discussion and analysis provides information management believes is relevant to an assessment and understanding of the Company's consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and notes thereto. Certain forward-looking statements are contained in this annual report. They use such words as "may," "will," "expect," "believe," "plan," or other similar terminology. These statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to be materially different than those expressed or implied in such statements. These factors include, but are not limited to: availability, of suitable locations and terms of the sites designated for development; legislation and government regulation including the ability to obtain satisfactory regulatory approvals; conditions beyond the Company's control such as weather or natural disasters; availability and cost of materials and labor; cost and availability of capital; competition; continuing acceptance of the International House of Pancakes brand and concept by guests and franchisees; the Company's overall marketing, operational and financial performance; economic and political conditions; adoption of new, or changes in, accounting policies and practices and other factors discussed from time to time in the Company's filings with the Securities and Exchange Commission. Forward-looking information is provided by the Company pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 and should be evaluated in the context of these factors. In addition, the Company disclaims any intent or obligation to update these forward-looking statements. F-5
COMPARISON OF YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996 System-wide retail sales for 1997 grew 13.4% over system-wide retail sales for 1996. This was due to increases of 7.5% in the number of effective restaurants and 5.5% in the revenues per effective restaurant. System-wide comparable average sales per restaurant (exclusive of area license restaurants) for 1997 grew by 3.7% over those in 1996. Management continues to pursue growth in sales through the Company's restaurant development program, its advertising and marketing efforts, improvements in customer service and operations, and the Company's remodeling program. Franchise operations revenues for 1997 grew 11.1% over franchise operations revenues for 1996. This was primarily due to increases in the number of effective franchised restaurants of 7.4% and in the revenues per effective franchised restaurant of 6.1%. Franchise operations costs and expenses for 1997 increased 7.5% over costs and expenses for 1996. As a result of franchise revenues increasing in excess of franchise expenses, franchise margin rose to 55.5% in 1997 from 54.0% in 1996. The margin increased primarily because of (a) improved rent margin due, in part, to an increase in the number of IHOP- owned restaurants which do not have rent expense and (b) growth in interest- income associated with IHOP's financing of sales of franchises and equipment to its franchisees. Company-operated restaurant revenues in 1997 grew 15.2% over revenues for 1996. This was primarily due to an increase in the effective number of Company-operated restaurants of 15.8% mitigated by a decrease in the revenues per effective Company-operated restaurant of 0.5%. Company-operated restaurant costs and expenses for 1997 increased 14.1% from costs and expenses for 1996. Margin at Company-operated restaurants in 1997 was 6.2% compared to 5.3% in 1996. The improvement in margin was primarily due to operating reductions in food costs as a percentage of revenues. Other revenues in 1997 grew 17.2% over other revenues for 1996 primarily due to a 12.9% increase in sales of franchises and equipment augmented by an increase in interest income from direct financing leases of 30.4%. Sales of franchises and equipment in 1997 grew to $28,864,000 from $25,573,000 in the prior year. IHOP franchised 64 restaurants in 1997 compared with 57 in 1996. Other costs and expenses in 1997 increased 20.0% over 1996 primarily from the increase in franchise and equipment costs of sales to $15,986,000 from $14,334,000. Field, corporate and administrative costs and expenses in 1997 increased 13.0% over costs and expenses in 1996. The rise in expenses was primarily due to normal increases in salaries and wages and additions to headcount to support the Company's growth. Field, corporate and administrative expenses were 3.3% of system-wide sales in both 1997 and 1996. Depreciation and amortization expense in 1997 increased 21.1% over that of 1996 primarily reflecting the addition of new, larger restaurants and an increase in the number of Company-operated restaurants. Interest expense increased 25.3% in 1997 over that of 1996 primarily due to (a) interest associated with additional capital lease obligations and (b) increased debt levels due to the private placement of $35 million in senior notes in November 1996 (see Note 5 to the Consolidated Financial Statements). Provision for income taxes was 39.0% and 39.5% of income before income taxes in 1997 and 1996, respectively. The balance of long-term receivables at December 31, 1997, has increased over that of the prior year end primarily due to IHOP's financing activities associated with the sale of franchises and equipment and the leasing of restaurants to its franchisees. Balances of property and equipment, net and capital lease obligations and other at December 31, 1997, have increased over those of the prior year end primarily due to new restaurant development and the Company's capital lease obligations associated with that development. F-6
COMPARISON OF YEAR ENDED DECEMBER 31, 1996 TO YEAR ENDED DECEMBER 31, 1995 System-wide retail sales for 1996 grew 11.4% over system-wide retail sales for 1995. This was due to increases of 8.6% in the number of effective restaurants and 2.6% in the revenues per effective restaurant. The above results were mitigated by an unfavorable change in the Japanese yen--U.S. dollar exchange rate in 1996 versus the exchange rate in 1995. If the Japanese sales were excluded from the comparison, system-wide sales in 1996 would have grown by 13.2% over those in 1995. System-wide comparable average sales per restaurant (exclusive of area license restaurants) for 1996 grew by 1.7% over those in 1995. Comparable average sales in the restaurant industry remained weak during 1996, however, IHOP's performance in this area has been, in general, stronger than that of our competitors. Management continues to pursue growth in sales through the Company's restaurant development program, its advertising and marketing efforts, improvements in customer service and operations, and the Company's remodeling program. Franchise operations revenues for 1996 grew 10.0% over franchise operations revenues for 1995. This was primarily due to increases in the number of effective franchised restaurants of 8.6% and in the revenues per effective franchised restaurant of 4.6%. Franchise operations costs and expenses for 1996 increased 8.2% over costs and expenses for 1995. As a result of franchise revenues increasing in excess of franchise expenses, franchise margin rose to 54.0% in 1996 from 53.2% in 1995. The margin improved primarily because of increases in interest income associated with IHOP's financing of sales of franchises and equipment to its franchisees. Company-operated restaurant revenues in 1996 grew 24.8% over revenues for 1995. This was primarily due to increases in the effective number of Company- operated restaurants of 16.3% and in the revenues per effective Company- operated restaurant of 7.3%. Company-operated restaurant costs and expenses for 1996 increased 22.2% from costs and expenses for 1995. Margin at Company- operated restaurants in 1996 was 5.3% compared to 3.2% in 1995. The improvement in margin was primarily due to operating reductions in food costs, salaries and wages and other controllable costs as a percentage of revenues. Other revenues in 1996 grew 20.4% over other revenues for 1995 primarily due to a 15.2% increase in sales of franchises and equipment augmented by an increase in interest income from direct financing leases of 38.3%. Sales of franchises and equipment in 1996 grew to $25,573,000 from $22,202,000 in the prior year. IHOP franchised 57 restaurants in 1996 compared with 56 in 1995. Other costs and expenses in 1996 increased 12.2% over 1995 primarily from the increase in franchise and equipment costs of sales to $14,334,000 from $11,565,000. Field, corporate and administrative costs and expenses in 1996 increased 17.4% over costs and expenses in 1995. The rise in expenses was primarily due to (a) normal increases in salaries and wages and inflation, (b) additions to headcount in the Company's restaurant operations, restaurant development and training functions to support the Company's growth, and (c) additional travel costs associated with growth in the number of restaurants in the IHOP system. Field, corporate and administrative expenses were 3.3% of system-wide sales in 1996 compared to 3.1% in 1995. Depreciation and amortization expense in 1996 increased 19.7% over that of 1995 primarily reflecting the addition of new, larger restaurants and an increase in the number of Company-operated restaurants. Interest expense increased 31.8% in 1996 over that of 1995 primarily due to interest associated with additional capital lease obligations, although interest associated with debt also increased. Interest associated with debt rose due to higher levels of borrowings through most of the year under the Company's bank revolving credit agreement and the private placement of $35 million in senior notes in November 1996 (see Note 5 to the Consolidated Financial Statements). Provision for income taxes was 39.5% of income before income taxes in both 1996 and 1995. F-7
The balance of long-term receivables at December 31, 1996, has increased over that of the prior year end primarily due to IHOP's financing activities associated with the sale of franchises and equipment and the leasing of restaurants to its franchisees. Balances of property and equipment, net and capital lease obligations and other at December 31, 1996, have increased over those of the prior year end primarily due to new restaurant development and the Company's capital lease obligations associated with that development. LIQUIDITY AND CAPITAL RESOURCES The Company invests available funds into its business primarily through the development of additional restaurants and, to a lesser extent, through the remodeling of older Company-operated restaurants. In 1997, IHOP and its franchisees and area licensees developed and opened 67 IHOP restaurants. Of these, the Company developed and opened 45 restaurants. Capital expenditures in 1997, which included IHOP's portion of the above development program, were $59.7 million. Funds for this investment primarily came from operations, $41.6 million, and sale and leaseback arrangements of restaurant land and buildings, $18.0 million. The Company also incurred capital lease obligations of $22.8 million, a portion of which was due to the sale and leaseback transactions, and all of which was related to the acquisition of restaurant buildings. In 1998, IHOP and its franchisees and area licensees plan to develop and open approximately 70 to 85 restaurants. Included in that number are the development of 50 to 60 new restaurants by the Company and the development of 20 to 25 restaurants by IHOP franchisees and area licensees. Capital expenditure projections for 1998, which include IHOP's portion of the above development program, are approximately $60 to $75 million. In November 1998, the third annual installment of $4.6 million in principal becomes due on the Company's senior notes due 2002. The Company expects that funds from operations, sale and leaseback arrangements (estimated to be about $35 million) and its revolving line of credit will be sufficient to cover its operating requirements, its budgeted capital expenditures and its principal repayment on its senior notes in 1998. At December 31, 1997, $20 million was available to be borrowed under the Company's unsecured bank revolving credit agreement. YEAR 2000 COMPLIANCE The Year 2000 issue is a result of computer programs being written using two digits, e.g. "98," to define a year. Date-sensitive software may recognize the year "00" as the year 1900 rather than the year 2000. This would result in errors and miscalculations or even system failure causing disruptions in everyday business activities and transactions. Software is termed "Year 2000 compliant" when it is capable of performing transactions correctly in the year 2000. Based on a recent assessment of the Company's computer systems software, it has been determined that more than 90% of the Company's hardware and software systems are either currently Year 2000 compliant or have an existing upgrade available from the software vendor that is Year 2000 compliant. Included in the more than 60% of the Company's systems that are now Year 2000 compliant are the Company's financial systems for accounting and payroll and its point of sale (POS) systems in its restaurants. All systems that are not currently Year 2000 compliant will either be upgraded to be Year 2000 compliant or replaced with alternative systems that are Year 2000 compliant over the next eighteen months. While achieving Year 2000 compliance will be a major task, it is not expected to have a material impact on the Company's financial condition or results of operations. NEW ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 130 "Reporting Comprehensive Income," which establishes standards for reporting and F-8
displaying comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. Comprehensive income includes net income and other comprehensive income components which under generally accepted accounting principles (GAAP) bypass the income statement and are reported in the balance sheet as a separate component of equity. For the three years ended December 31, 1997, the Company had no other comprehensive income components as defined in SFAS No. 130. SFAS No. 130 does not apply to an enterprise that has no items of other comprehensive income in any of the periods presented. In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information," which changes current practice and establishes a new framework, referred to as the "management" approach, on which to base segment reporting. The management approach requires that management identify the "operating segments" based on the way that management disaggregates the entity for internal operating decisions. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997, and is not required for interim statements in the first year of adoption. Management believes that the adoption of this new standard will not have any material impact on the Company's financial position or results of operations. F-9
IHOP CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS) <TABLE> <CAPTION> DECEMBER 31, ----------------- 1997 1996 -------- -------- <S> <C> <C> ASSETS ------ Current assets Cash and cash equivalents.................................. $ 5,964 $ 8,658 Receivables................................................ 30,490 29,324 Reacquired franchises and equipment held for sale, net..... 2,321 1,474 Inventories................................................ 1,378 1,180 Prepaid expenses........................................... 629 676 -------- -------- Total current assets..................................... 40,782 41,312 -------- -------- Long-term receivables........................................ 171,967 143,338 Property and equipment, net.................................. 142,751 120,854 Reacquired franchises and equipment held for sale, net....... 13,151 8,352 Excess of costs over net assets acquired, net................ 12,481 12,908 Other assets................................................. 1,461 2,125 -------- -------- Total assets............................................. $382,593 $328,889 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Current liabilities Current maturities of long-term debt....................... $ 4,973 $ 4,731 Accounts payable........................................... 20,626 17,474 Accrued employee compensation and benefits................. 4,595 2,674 Other accrued expenses..................................... 4,602 5,024 Deferred income taxes...................................... 3,468 4,311 Capital lease obligations.................................. 1,062 870 -------- -------- Total current liabilities................................ 39,326 35,084 -------- -------- Long-term debt............................................... 54,950 58,564 Deferred income taxes........................................ 28,862 25,061 Capital lease obligations and other.......................... 103,271 80,823 Shareholders' equity Preferred stock, $1 par value, 10,000,000 shares authorized; issued and outstanding: 1997 and 1996, no shares.................................................... -- -- Common stock, $.01 par value, 40,000,000 shares authorized; shares issued and outstanding: 1997, 9,709,261 shares (net of 1,539 treasury shares); 1996, 9,467,294 shares......... 97 95 Additional paid-in capital................................. 54,629 48,768 Retained earnings.......................................... 100,158 79,244 Contribution to ESOP....................................... 1,300 1,250 -------- -------- Total shareholders' equity............................... 156,184 129,357 -------- -------- Total liabilities and shareholders' equity............... $382,593 $328,889 ======== ======== </TABLE> See the accompanying notes to the consolidated financial statements. F-10
IHOP CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, -------------------------- 1997 1996 1995 -------- -------- -------- <S> <C> <C> <C> Revenues Franchise operations rent......................... $ 33,692 $ 29,642 $ 27,986 Service fees and other............................ 80,030 72,726 65,053 -------- -------- -------- 113,722 102,368 93,039 Company operations................................ 61,839 53,677 43,001 Other............................................. 39,897 34,051 28,283 -------- -------- -------- Total revenues.................................. 215,458 190,096 164,323 -------- -------- -------- Costs and Expenses Franchise operations rent......................... 17,784 16,301 15,165 Other direct costs................................ 32,830 30,803 28,354 -------- -------- -------- 50,614 47,104 43,519 Company operations................................ 58,001 50,852 41,621 Field, corporate and administrative............... 29,437 26,052 22,193 Depreciation and amortization..................... 10,029 8,279 6,918 Interest.......................................... 14,649 11,691 8,873 Other............................................. 18,442 15,367 13,698 Severance charges................................. -- -- 800 -------- -------- -------- Total costs and expenses........................ 181,172 159,345 137,622 -------- -------- -------- Income before income taxes.......................... 34,286 30,751 26,701 Provision for income taxes.......................... 13,372 12,147 10,547 -------- -------- -------- Net income...................................... $ 20,914 $ 18,604 $ 16,154 ======== ======== ======== Net Income Per Share Basic............................................. $ 2.18 $ 1.97 $ 1.73 ======== ======== ======== Diluted........................................... $ 2.15 $ 1.95 $ 1.70 ======== ======== ======== Weighted Average Shares Outstanding Basic............................................. 9,596 9,444 9,319 ======== ======== ======== Diluted........................................... 9,743 9,523 9,488 ======== ======== ======== </TABLE> See the accompanying notes to the consolidated financial statements. F-11
IHOP CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS) <TABLE> <CAPTION> COMMON STOCK ADDITIONAL ----------------- PAID-IN RETAINED CONTRIBUTION SHARES AMOUNT CAPITAL EARNINGS TO ESOP TOTAL --------- ------ ---------- -------- ------------ -------- <S> <C> <C> <C> <C> <C> <C> Balance, December 31, 1994................... 9,183,327 $92 $42,621 $ 44,486 $1,100 $ 88,299 --------- --- ------- -------- ------ -------- Issuance of shares to ESOP................... 39,461 -- 1,100 -- (1,100) -- Issuance of shares pursuant to stock plans.................. 152,727 2 2,981 -- -- 2,983 Unearned compensation-- restricted stock....... -- -- (339) -- -- (339) Contribution to ESOP.... -- -- -- -- 1,200 1,200 Net income.............. -- -- -- 16,154 -- 16,154 --------- --- ------- -------- ------ -------- Balance, December 31, 1995................... 9,375,515 94 46,363 60,640 1,200 108,297 --------- --- ------- -------- ------ -------- Issuance of shares to ESOP................... 44,445 -- 1,200 -- (1,200) -- Issuance of shares pursuant to stock plans............ 47,334 1 1,092 -- -- 1,093 Unearned compensation-- restricted stock....... -- -- 113 -- -- 113 Contribution to ESOP.... -- -- -- -- 1,250 1,250 Net Income.............. -- -- -- 18,604 -- 18,604 --------- --- ------- -------- ------ -------- Balance, December 31, 1996 9,467,294 95 48,768 79,244 1,250 129,357 --------- --- ------- -------- ------ -------- Issuance of shares to ESOP................... 46,083 1 1,249 -- (1,250) -- Issuance of shares pursuant to stock plans............ 197,423 1 4,719 -- 4,720 Unearned compensation-- restricted stock....... -- -- (68) -- -- (68) Acquisition of treasury shares................. (1,539) -- (39) -- -- (39) Contribution to ESOP.... -- -- -- -- 1,300 1,300 Net income.............. -- -- -- 20,914 -- 20,914 --------- --- ------- -------- ------ -------- Balance, December 31, 1997 9,709,261 $97 $54,629 $100,158 $1,300 $156,184 ========= === ======= ======== ====== ======== </TABLE> See the accompanying notes to the consolidated financial statements. F-12
IHOP CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) <TABLE> <CAPTION> YEAR ENDED DECEMBER 31, --------------------------- 1997 1996 1995 -------- -------- ------- <S> <C> <C> <C> Cash flows from operating activities: Net income.......................................... $ 20,914 $ 18,604 $16,154 Adjustments to reconcile net income to cash provided by operating activities Depreciation and amortization...................... 10,029 8,279 6,918 Deferred taxes..................................... 2,958 4,441 5,790 Contribution to ESOP............................... 1,300 1,250 1,200 Change in current assets and liabilities: Accounts receivable............................... 648 (6,250) (3,860) Inventories....................................... (198) (388) 25 Prepaid expenses.................................. 47 (443) 435 Accounts payable.................................. 3,152 1,495 5,246 Accrued employee compensation and benefits........ 1,921 1,112 (759) Other accrued expenses............................ (422) 1,697 477 Other, net......................................... 1,226 1,804 (302) -------- -------- ------- Cash provided by operating activities............ 41,575 31,601 31,324 -------- -------- ------- Cash flows from investing activities: Additions to property and equipment................. (59,687) (57,159) (42,024) Proceeds from sale and leaseback arrangements....... 17,995 7,593 12,792 Additions to notes, equipment contracts and direct financing leases receivable................. (10,209) (11,427) (8,610) Principal receipts from notes, equipment contracts and direct financing leases receivable............. 8,562 7,019 6,718 Additions to reacquired franchises held for sale.... (1,917) (339) (926) -------- -------- ------- Cash used by investing activities................ (45,256) (54,313) (32,050) -------- -------- ------- Cash flows from financing activities: Proceeds from issuance of long-term debt............ 1,440 34,514 7,700 Repayment of long-term debt......................... (4,631) (7,478) (7,300) Principal payments on capital lease obligations..... (487) (419) (492) Exercise of stock options........................... 4,665 893 2,642 -------- -------- ------- Cash provided by financing activities............ 987 27,510 2,550 -------- -------- ------- Net change in cash and cash equivalents.............. (2,694) 4,798 1,824 Cash and cash equivalents at beginning of period..... 8,658 3,860 2,036 -------- -------- ------- Cash and cash equivalents at end of period....... $ 5,964 $ 8,658 $ 3,860 ======== ======== ======= Supplemental disclosures: Interest paid, net of capitalized amounts........... $ 14,478 $ 11,300 $ 8,953 Income taxes paid................................... 10,680 7,588 4,177 Capital lease obligations incurred.................. 22,778 19,786 19,423 </TABLE> See the accompanying notes to the consolidated financial statements. F-13
IHOP CORP. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Operations IHOP Corp. and its subsidiaries ("IHOP" or the "Company") engage exclusively in the food-service industry, primarily in the United States, wherein IHOP franchises and operates restaurants. IHOP grants credit to its franchisees and licensees, all of whom are in the restaurant business. In the majority of its franchised operations, IHOP has developed restaurants on sites that it either owns or controls through leases. IHOP then leases or subleases the restaurants to its franchisees. Additionally, IHOP finances up to 80% of the initial franchise fee, leases restaurant equipment and fixtures to its franchisees, and sells proprietary products to its franchisees and licensees. Basis of Presentation The consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated. Fiscal Periods IHOP's fiscal year ends on the Sunday nearest to December 31 of each year. For convenience, the Company reports all fiscal years as ending on December 31 and fiscal quarters as ending on March 31, June 30 and September 30. The fiscal years ended December 31, 1997, 1996 and 1995, are comprised of 52 weeks (364 days). Estimates The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents The Company at times purchases highly liquid, investment-grade securities with an original maturity of three months or less. These cash equivalents are stated at cost which approximates market value. IHOP does not believe it is exposed to any significant credit risk on cash and cash equivalents. Inventories Inventories consisting of merchandise and supplies are stated at the lower of cost (on a first-in, first-out basis) or market. Property and Equipment Property and equipment are stated at cost and depreciated on the straight- line method over the estimated useful lives as follows: <TABLE> <CAPTION> CATEGORY DEPRECIABLE LIFE -------- ---------------- <S> <C> Buildings and improvements............... Shorter of lease term or 25 years Leaseholds and improvements.............. 3-25 years Equipment and fixtures................... 3-10 years Properties under capital lease........... Primary lease term </TABLE> F-14
IHOP CORP. AND SUBSIDIARIES Leaseholds and improvements are amortized over a period not exceeding the term of the lease. Impairment losses to long-lived assets are recognized when the carrying amount of the asset exceeds the estimated fair value of the asset in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Excess of Costs Over Net Assets Acquired The excess of costs over net assets acquired is amortized utilizing the straight-line method over forty years. Accumulated amortization at December 31, 1997 and 1996, was $4,606,000 and $4,179,000, respectively. Franchise Revenues Revenue from the sale of franchises is recognized as income when IHOP has substantially performed all of its material obligations under the franchise agreement, and the franchisee has commenced operations. Continuing service fees, which are a percentage of the net sales of franchised operations, are accrued as income when earned. Leasing The Company leases restaurant equipment, furniture and fixtures (equipment) to its franchisees and retains title to the leased equipment. These equipment contracts are accounted for as sales-type leases upon acceptance of the equipment by the franchisee. Leases of restaurant facilities are recorded as direct financing leases upon acceptance. Preopening Expenses Expenditures related to the opening of new restaurants, other than those for capital assets, are charged to expense when incurred. Advertising Advertising costs are expensed as incurred. Advertising expense for the years ended December 31, 1997, 1996 and 1995, was $22,748,000, $20,450,000 and $18,018,000, respectively. Income Taxes Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities. They are measured using the enacted marginal tax rates and laws that will be in effect when the differences are expected to reverse. Net Income Per Share In February 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 128, "Earnings Per Share." SFAS No. 128 supersedes and simplifies the previous computational guidelines under Accounting Principles Board (APB) Opinion No. 15, "Earnings Per Share." Among other changes, SFAS No. 128 eliminates the presentation of primary EPS and replaces it with basic EPS for which common stock equivalents are not considered in the computation. It also revises the computation of diluted EPS. Basic net income per share is computed by dividing the net income attributable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income attributable to common shareholders by the weighted average number of F-15
IHOP CORP. AND SUBSIDIARIES common and common equivalent shares outstanding during the period. Common share equivalents included in the diluted computation represent shares issuable upon assumed exercise of stock options using the treasury stock method. Net income per share and weighted average shares outstanding for all prior periods have been restated in accordance with SFAS No. 128. New Accounting Standards In June 1997, the FASB issued SFAS No. 130 "Reporting Comprehensive Income," which establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. Comprehensive income includes net income and other comprehensive income components which under GAAP bypass the income statement and are reported in the balance sheet as a separate component of equity. For the three years ended December 31, 1997, the Company had no other comprehensive income components as defined in SFAS No. 130. SFAS No. 130 does not apply to an enterprise that has no items of other comprehensive income in any of the periods presented. In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information," which changes current practice and establishes a new framework, referred to as the "management" approach, on which to base segment reporting. The management approach requires that management identify the "operating segments" based on the way that management disaggregates the entity for internal operating decisions. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997, and is not required for interim statements in the first year of adoption. Management believes that the adoption of this new standard will not have any material impact on the Company's financial position or results of operations. Reclassification Certain reclassifications have been made to prior year information to conform to the current year presentation. 2. RECEIVABLES <TABLE> <CAPTION> 1997 1996 -------- -------- (IN THOUSANDS) <S> <C> <C> Accounts receivable....................................... $ 20,881 $ 21,372 Notes receivable.......................................... 34,347 31,924 Equipment contracts receivable............................ 63,714 53,580 Direct financing leases receivable........................ 84,117 66,231 -------- -------- 203,059 173,107 Less allowance for doubtful accounts...................... 602 445 -------- -------- 202,457 172,662 Less current portion...................................... 30,490 29,324 -------- -------- Long-term receivables..................................... $171,967 $143,338 ======== ======== </TABLE> Notes receivable include franchise fee notes due in five to eight years in the amount of $32,022,000 and $29,595,000 at December 31, 1997 and 1996, respectively. Franchise fee notes are due in equal weekly installments, primarily bear interest at 12.0% and are secured by the franchise. The term of an equipment contract coincides with the term of the corresponding restaurant building direct financing lease. Equipment contracts are due in equal weekly installments, primarily bear interest at 11.0% and are secured by the equipment. Where applicable, franchise fee notes, equipment contracts and direct financing leases contain cross-default provisions wherein a default under one constitutes a default under all. There is not a disproportionate concentration of credit risk in any geographic area. F-16
IHOP CORP. AND SUBSIDIARIES 3. PROPERTY AND EQUIPMENT, AT COST <TABLE> <CAPTION> 1997 1996 -------- -------- (IN THOUSANDS) <S> <C> <C> Land...................................................... $ 17,051 $ 17,512 Buildings and improvements................................ 33,603 32,529 Leaseholds and improvements............................... 79,025 66,295 Equipment and fixtures.................................... 11,853 10,776 Construction in progress.................................. 13,650 3,598 Properties under capital lease............................ 19,174 15,009 -------- -------- 174,356 145,719 Less accumulated depreciation and amortization............ 31,605 24,865 -------- -------- Property and equipment, net............................... $142,751 $120,854 ======== ======== </TABLE> Accumulated depreciation and amortization includes accumulated amortization for properties under capital lease in the amount of $2,326,000 and $1,740,000 at December 31, 1997 and 1996, respectively. 4. REACQUIRED FRANCHISES AND EQUIPMENT HELD FOR SALE Reacquired franchises and equipment held for sale are accounted for on the specific identification basis. At the date of reacquisition the franchise and equipment are recorded at the lower of (i) the sum of the franchise receivables and costs of reacquisition or (ii) the estimated net realizable value. Pending the sale of such franchise, the carrying value is amortized ratably over the remaining life of the asset or lease and the estimated net realizable value is reassessed each year. <TABLE> <CAPTION> 1997 1996 ------- ------ (IN THOUSANDS) <S> <C> <C> Franchises................................................... $ 8,596 $5,484 Equipment.................................................... 10,436 6,777 ------- ------ 19,032 12,261 Less amortization............................................ 3,560 2,435 ------- ------ 15,472 9,826 Less current portion......................................... 2,321 1,474 ------- ------ Long-term reacquired franchises and equipment held for sale, net......................................................... $13,151 $8,352 ======= ====== </TABLE> 5. DEBT Debt consists of the following: <TABLE> <CAPTION> 1997 1996 ------- ------- (IN THOUSANDS) <S> <C> <C> Senior notes due November 2008, payable in equal annual installments commencing November 2000, interest at 7.42%. $35,000 $35,000 Senior notes due November 2002, payable in equal annual installments commencing November 1996, interest at 7.79%. 22,858 27,429 Other..................................................... 2,065 866 ------- ------- Total debt................................................ 59,923 63,295 Less current maturities................................... 4,973 4,731 ------- ------- Long-term debt............................................ $54,950 $58,564 ======= ======= </TABLE> F-17
IHOP CORP. AND SUBSIDIARIES In November 1996, IHOP completed a private placement of $35 million of unsecured senior notes due November 2008. The notes have a fixed interest rate of 7.42% with annual principal payments of $3,889,000 commencing November 2000. Proceeds from the sale of the senior notes were used, in part, to repay $17.6 million outstanding under the Company's revolving credit agreement with its bank, to pay $4.7 million in principal and accrued interest for the senior notes due 2002, to fund capital expenditures for new restaurants and for general corporate purposes. The senior notes due November 2002 are also unsecured. The Company has an unsecured $20 million revolving credit agreement with its bank that was amended in June 1997 to extend the maturity date to June 2000. Borrowings under the agreement bear interest at the bank's reference rate (prime) or, at the Company's option, at the bank's quoted rate or at a Eurodollar rate. A commitment fee of 0.375% per annum is payable on unborrowed funds available under the agreement. There were no borrowings outstanding under this agreement at December 31, 1997 and 1996. The largest amount outstanding under the agreement during 1997 was $600,000. The senior note agreements and the bank revolving credit agreement contain certain restrictions and conditions, the most restrictive of which limit dividends and investments. At December 31, 1997, approximately $42 million of retained earnings was free of restriction as to distribution as dividends. The prime rate was 8.5% at December 31, 1997, and 8.25% at December 31, 1996. The Company's long-term debt maturities are as follows: 1998--$4,973,000; 1999--$5,344,000; 2000--$8,826,000; 2001--$8,784,000; 2002--$8,663,000; and thereafter--$23,333,000. 6. LEASES The Company leases the majority of its restaurants with the exception of those where a franchisee enters into a lease directly with a landlord and those associated with area license agreements. The restaurants are subleased to franchisees or operated by IHOP. These noncancelable leases and subleases consist primarily of land and buildings and improvements. Net investment in direct financing leases receivable is as follows: <TABLE> <CAPTION> 1997 1996 -------- -------- (IN THOUSANDS) <S> <C> <C> Total minimum rents receivable............................. $282,732 $224,554 Less unearned income....................................... 198,615 158,323 -------- -------- Net investment in direct financing leases receivable....... 84,117 66,231 Less current portion....................................... 693 615 -------- -------- Long-term direct financing leases receivable............... $ 83,424 $ 65,616 ======== ======== </TABLE> Contingent rental income for the years ended December 31, 1997, 1996 and 1995, was $14,812,000, $13,901,000 and $14,332,000, respectively. F-18
IHOP CORP. AND SUBSIDIARIES Minimum future lease payments on noncancelable leases at December 31, 1997, are as follows: <TABLE> <CAPTION> CAPITAL LEASES OPERATING LEASES -------------- ---------------- (IN THOUSANDS) <S> <C> <C> 1998......................................... $ 12,399 $ 18,632 1999......................................... 12,492 17,591 2000......................................... 12,617 16,839 2001......................................... 12,730 14,901 2002......................................... 12,880 13,762 Thereafter................................... 221,467 164,129 -------- -------- Total minimum lease payments................. 284,585 $245,854 ======== Less interest................................ 180,945 -------- Capital lease obligations.................... 103,640 Less current portion......................... 1,062 -------- Long-term capital lease obligations.......... $102,578 ======== </TABLE> The minimum future lease payments shown above have not been reduced by the future minimum rents to be received on noncancelable subleases and leases of owned property at December 31, 1997, as follows: <TABLE> <CAPTION> DIRECT FINANCING LEASES OPERATING LEASES ---------------- ---------------- (IN THOUSANDS) <S> <C> <C> 1998....................................... $ 11,976 $ 21,252 1999....................................... 12,015 20,615 2000....................................... 12,136 20,078 2001....................................... 12,225 19,311 2002....................................... 12,364 19,049 Thereafter................................. 222,016 286,395 -------- -------- Total minimum rents receivable............. $282,732 $386,700 ======== ======== </TABLE> IHOP has noncancelable leases, expiring at various dates through 2048, that require payment of contingent rents based upon a percentage of sales of the related restaurant as well as property taxes, insurance and other charges. Subleases to franchisees of properties under such leases are generally for the full term of the Company's lease obligation at rents that include IHOP's obligations for property taxes, insurance, contingent rents and other charges. Generally, the noncancelable leases include renewal options. Contingent rent expense for all noncancelable leases for the years ended December 31, 1997, 1996 and 1995, was $3,385,000, $3,161,000 and $3,391,000, respectively. Minimum rent expense for all noncancelable operating leases for the years ended December 31, 1997, 1996 and 1995, was $19,137,000, $17,557,000 and $15,464,000, respectively. 7. SHAREHOLDERS' EQUITY The Stock Incentive Plan (the "Plan" ) was adopted in 1991 and amended and restated in 1994 to authorize the issuance of up to 1,380,000 shares of common stock pursuant to options, restricted stock, and other long-term stock-based incentives to officers and key employees of the Company. The Company will be requesting approval from the Company's shareholders at the 1998 Annual Meeting of Shareholders (scheduled for May 12, 1998) to ratify an amendment to the Plan increasing the number of shares available for issuance thereunder from 1,380,000 to 1,880,000. Except for substitute stock options which were issued in 1991 pursuant to the cancellation of a stock appreciation rights plan, no option can be granted at an option price of less than 100% of fair market value at the date of grant. Exercisability of options is determined at, or after, the date of grant by the F-19
IHOP CORP. AND SUBSIDIARIES administrator of the plan. Options granted under the Plan through December 31, 1997, become exercisable 1/3 after one year, 2/3 after two years and 100% after three years or immediately upon change in control of the Company, as defined by the Plan, except for the substitute stock options which were immediately exercisable. The Stock Option Plan for Non-Employee Directors (the "Directors Plan" ) was adopted in 1994 to authorize the issuance of up to 200,000 shares of common stock pursuant to options to non-employee members of the Company's Board of Directors. Options are to be granted at an option price equal to 100% of the fair market value of the stock on the date of grant. Options granted pursuant to the Directors Plan vest and become exercisable 1/3 after one year, 2/3 after two years and 100% after three years. Options for the purchase of shares are granted to each non-employee Director under the Directors Plan as follows: (a) 7,500 on February 23, 1995, or on the Director's election to the Board of Directors if he or she was not a Director on such date, and (b) 2,500 biennially in conjunction with the Company's Annual Meeting of Shareholders for that year. The following summarizes stock option activity in IHOP's stock option plans for the years ended December 31, 1997, 1996 and 1995: <TABLE> <CAPTION> WEIGHTED AVERAGE SHARES UNDER OPTION SHARES EXERCISE PRICE ------------------- -------- ---------------- <S> <C> <C> Outstanding at December 31, 1994.................. 749,540 $18.68 Granted........................................... 298,000 26.58 Exercised......................................... (139,697) 12.86 Terminated........................................ (31,935) 27.77 -------- Outstanding at December 31, 1995.................. 875,908 22.24 Granted........................................... 170,500 27.71 Exercised......................................... (47,334) 12.55 Terminated........................................ (50,129) 27.83 -------- Outstanding at December 31, 1996.................. 948,945 23.33 Granted........................................... 214,000 27.16 Exercised......................................... (186,427) 21.03 Terminated........................................ (43,275) 27.03 -------- Outstanding at December 31, 1997.................. 933,243 $24.45 ======== ====== Exercisable at December 31, 1997.................. 551,546 $22.60 ======== ====== </TABLE> At December 31, 1997, the 933,243 outstanding shares under option have a range of exercise prices from $7.14 to $35.88 and a weighted average contractual life of 7.0 years. There were 9,456 and 13,030 shares of restricted stock awarded in 1997 and 1995, respectively. No shares of restricted stock were awarded in 1996. At December 31, 1997, there were 13,799 shares of restricted stock outstanding. F-20
IHOP CORP. AND SUBSIDIARIES IHOP has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" and will continue to use the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, no compensation cost has been recognized for the stock option plans. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards in 1995, 1996 and 1997 consistent with the provisions of SFAS No. 123, the Company's net earnings and diluted earnings per share would have been reduced to the pro forma amounts indicated below: <TABLE> <CAPTION> 1997 1996 1995 ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <S> <C> <C> <C> Net earnings, as reported............................ $20,914 $18,604 $16,154 Net earnings, pro forma.............................. 19,956 17,930 15,768 Earnings per share--diluted, as reported............. 2.15 1.95 1.70 Earnings per share--diluted, pro forma............... 2.05 1.86 1.66 Weighted average fair value of options granted....... 27.16 27.71 26.58 </TABLE> The fair value of each option grant issued in 1997, 1996 and 1995 is estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: <TABLE> <CAPTION> 1997 1996 1995 ------- ------- ------- <S> <C> <C> <C> Risk free interest rate........................... 6.25% 7.22% 7.22% Expected volatility............................... 37.0% 37.0% 37.0% Dividend yield.................................... -- -- -- Weighted average expected life.................... 3 years 3 years 3 years </TABLE> 8. OTHER REVENUES Other revenues include sales of franchises and equipment in the amount of $28,864,000, $25,573,000, and $22,202,000, for the years ended December 31, 1997, 1996 and 1995, respectively. 9. SEVERANCE CHARGES In the first quarter of 1995, the Company recognized severance charges of $800,000 associated with a realignment of responsibilities in its restaurant operations, restaurant development and purchasing functions. The effect of the charges was $484,000, net of income tax benefit, or $.05 per share. 10. INCOME TAXES <TABLE> <CAPTION> 1997 1996 1995 ------- ------- ------- (IN THOUSANDS) <S> <C> <C> <C> Provision for income taxes Current Federal.......................................... $ 8,805 $ 6,368 $ 3,832 State and foreign................................ 1,608 1,338 925 ------- ------- ------- 10,413 7,706 4,757 ------- ------- ------- Deferred Federal.......................................... 2,022 3,383 4,997 State............................................ 937 1,058 793 ------- ------- ------- 2,959 4,441 5,790 ------- ------- ------- Provision for income taxes........................... $13,372 $12,147 $10,547 ======= ======= ======= </TABLE> F-21
IHOP CORP. AND SUBSIDIARIES The provision for income taxes differs from the expected federal income tax rates as follows: <TABLE> <CAPTION> 1997 1996 1995 ---- ---- ---- <S> <C> <C> <C> Statutory federal income tax rate......................... 35.0% 35.0% 35.0% State and foreign income taxes, net of federal tax benefit.................................................. 4.0 4.2 4.2 Other, net................................................ -- 0.3 0.3 ---- ---- ---- Effective tax rate........................................ 39.0% 39.5% 39.5% ==== ==== ==== </TABLE> Deferred tax liabilities (assets) consist of the following: <TABLE> <CAPTION> 1997 1996 ------- ------- (IN THOUSANDS) <S> <C> <C> Franchise and equipment sales, including differences in capitalization and revenue recognition................... $39,558 $34,375 Property and equipment, including differences in capitalization and depreciation and amortization......... 8,025 8,037 Reacquired franchises and equipment held for resale, including differences in capitalization and depreciation and amortization......................................... (6,148) (7,083) Direct financing leases and capital lease obligations, including differences in capitalization and application of cash receipts and disbursements....................... (8,067) (6,315) Federal tax benefit of net deferred state tax liability... (1,766) (1,516) Other net liabilities..................................... 728 1,874 ------- ------- Deferred tax liabilities.................................. $32,330 $29,372 ======= ======= </TABLE> 11. EMPLOYEE BENEFIT PLANS In 1987, IHOP adopted a noncontributory Employee Stock Ownership Plan ("ESOP"). The ESOP is a stock bonus plan under Section 401(a) of the Internal Revenue Code. The plan covers IHOP employees who meet the minimum credited service requirements of the plan except for those employees whose terms of service are covered by a collective bargaining agreement (unless the terms of such agreement specifically provide for participation in the ESOP). The cost of the ESOP is borne by the Company through contributions determined by the Board of Directors in accordance with the ESOP provisions and Internal Revenue Service regulations. The contributions to the plan for the years ended December 31, 1997, 1996 and 1995, were $1,300,000, $1,250,000, and $1,200,000, respectively. The contribution for the year ended December 31, 1997, will be made in shares of the Company's common stock. Shares of stock acquired by the ESOP are allocated to each eligible employee and held by the ESOP. Upon the employee's termination after vesting, or in certain other limited circumstances, the employee's shares are distributed to the employee according to his or her direction. 12. COMMITMENTS AND CONTINGENCIES The Company is subject to various claims and legal actions that have arisen in the ordinary course of business. The Company believes such claims and legal actions, individually or in the aggregate, will not have a material adverse effect on the business or financial condition of the Company. F-22
IHOP CORP. AND SUBSIDIARIES 13. FAIR VALUE OF FINANCIAL INSTRUMENTS IHOP does not hold or issue financial instruments for trading purposes nor is it a party to derivative transactions, interest rate swaps or other transactions commonly utilized to manage interest rate or foreign currency risk. The estimated fair values of all cash and cash equivalents, notes receivable and equipment contracts receivable as of December 31, 1997 and 1996, approximated their carrying amounts in the Consolidated Balance Sheets as of those dates. The estimated fair values of notes receivable and equipment contracts receivable are based on current interest rates offered for similar loans in the Company's present lending activities. The estimated fair values of long-term debt are based on current rates available to IHOP for similar debt of the same remaining maturities. The carrying values of long-term debt at December 31, 1997 and 1996, were $54,950,000 and $58,564,000, respectively; and the fair values at those dates were $57,657,000 and $58,876,000, respectively. 14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) <TABLE> <CAPTION> NET INCOME NET INCOME PER SHARE - PER SHARE - REVENUES GROSS PROFIT NET INCOME BASIC (A) DILUTED (A) -------- ------------ ---------- ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) <S> <C> <C> <C> <C> <C> 1997 1st Quarter........ $46,441 $16,379 $3,550 $.37 $.37 2nd Quarter........ 51,574 19,192 5,038 .53 .52 3rd Quarter........ 56,312 20,536 5,733 .59 .58 4th Quarter........ 61,131 22,265 6,593 .68 .67 1996 1st Quarter........ $40,292 $14,414 $3,062 $.32 $.32 2nd Quarter........ 44,465 16,159 4,369 .46 .46 3rd Quarter........ 51,569 18,495 5,389 .57 .56 4th Quarter........ 53,770 19,426 5,784 .61 .61 </TABLE> - -------- (a) The quarterly amounts may not add to the full year amount due to rounding. F-23
REPORT OF INDEPENDENT ACCOUNTANTS The Shareholders and Board of Directors IHOP Corp. We have audited the accompanying consolidated balance sheets of IHOP Corp. and Subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of IHOP Corp. and Subsidiaries as of December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Coopers & Lybrand L.L.P. Los Angeles, California February 13, 1998 F-24
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, on this 18th day of March, 1998. IHOP CORP. /s/ Richard K. Herzer By: _________________________________ Richard K. Herzer Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant, in the capacities indicated, on this 18th day of March, 1998. <TABLE> <CAPTION> SIGNATURES TITLE ---------- ----- <S> <C> /s/ Richard K. Herzer Chairman of the Board, ____________________________________ President and Chief Richard K. Herzer Executive Officer (Principal Executive Officer) /s/ Frederick G. Silny Vice President--Finance and ____________________________________ Treasurer (Principal Frederick G. Silny Financial Officer) /s/ Gene A. Scott Controller (Principal ____________________________________ Accounting Officer) Gene A. Scott /s/ H. Frederick Christie Director ____________________________________ H. Frederick Christie /s/ Frank Edelstein Director ____________________________________ Frank Edelstein /s/ Michael S. Gordon Director ____________________________________ Michael S. Gordon /s/ Neven C. Hulsey Director ____________________________________ Neven C. Hulsey /s/ Larry Alan Kay Director ____________________________________ Larry Alan Kay /s/ Dennis M. Leifheit Executive Vice President-- ____________________________________ Operations, Chief Operating Dennis M. Leifheit Officer and Director /s/ Caroline W. Nahas Director ____________________________________ Caroline W. Nahas /s/ Patrick W. Rose Director ____________________________________ Patrick W. Rose </TABLE> S-1
EXHIBIT INDEX <TABLE> <CAPTION> SEQUENTIALLY EXHIBIT NUMBERED NUMBER DOCUMENT DESCRIPTION PAGE ------- -------------------- ------------ <C> <S> <C> 3.1 Restated Certificate of Incorporation of IHOP Corp. 3.2 Bylaws of IHOP Corp. 4.1 Senior Note Purchase Agreement, dated as of November 19, 1992, among IHOP Corp., International House of Pancakes, Inc. ("IHOP, Inc.") and Mutual Life Insurance Company of New York and other purchasers. 4.2 First Amendment to Senior Note Purchase Agreement, dated as of November 1, 1996, among IHOP Corp., IHOP Inc., and Mutual Life Insurance Company of New York and other purchasers. Exhibit 4.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, (the "1996 Form 10-K") is hereby incorporated by reference. 4.3 $10,000,000 Letter Agreement among IHOP, Inc., IHOP Corp. and Continental Bank, N.A., dated as of June 30, 1993. 4.4 First Amendment to Letter Agreement, dated as of December 31, 1994, among IHOP, Inc., IHOP Corp. and Bank of America Illinois (successor by merger to Continental Bank, N.A.). 4.5 Second Amendment to Letter Agreement, dated as of March 11, 1996, among IHOP, Inc., IHOP Corp. and Bank of America Illinois. 4.6 Third Amendment to Letter Agreement, dated as of September 3, 1996, among IHOP, Inc., IHOP Corp. and Bank of America Illinois. Exhibit 4.6 to the 1996 Form 10-K is hereby incorporated by reference. 4.7 Fourth Amendment to Letter Agreement, dated as of November 1, 1996, among IHOP, Inc., IHOP Corp. and Bank of America Illinois. Exhibit 4.7 to the 1996 Form 10-K is hereby incorporated by reference. 4.8 Senior Note Purchase Agreement, dated as of November 1, 1996, among IHOP, Inc., IHOP Corp. and Jackson National Life Insurance Company and other purchasers. Exhibit 4.8 to the 1996 Form 10-K is hereby incorporated by reference. *10.1 IHOP Corp. Executive Incentive Plan effective January 1, 1998. *10.2 IHOP Corp. 1991 Stock Incentive Plan as Amended and Restated February 23, 1994. *10.3 IHOP Corp. 1994 Stock Option Plan for Non-Employee Directors. *10.4 Employment Agreement between the Company and Rand Michael Ferris. Exhibit 10.6 to the 1996 Form 10-K is hereby incorporated by reference. *10.5 Employment Agreement between the Company and Susan Henderson-Hernandez. Exhibit 10.7 to the 1996 Form 10-K is hereby incorporated by reference. *10.6 Employment Agreement between the Company and Richard K. Herzer. Exhibit 10.8 to the 1996 Form 10-K is hereby incorporated by reference. *10.7 Employment Agreement between the Company and Dennis M. Leifheit. Exhibit 10.9 to the 1996 Form 10-K is hereby incorporated by reference. *10.8 Employment Agreement between the Company and Naomi K. Shively. Exhibit 10.10 to the 1996 Form 10-K is hereby incorporated by reference. *10.9 Employment Agreement between the Company and Frederick G. Silny. Exhibit 10.11 to the 1996 Form 10-K is hereby incorporated by reference. *10.10 Employment Agreement between the Company and Anna G. Ulvan. Exhibit 10.12 to the 1996 Form 10-K is hereby incorporated by reference. </TABLE>
EXHIBIT INDEX--(CONTINUED) <TABLE> <CAPTION> SEQUENTIALLY EXHIBIT NUMBERED NUMBER DOCUMENT DESCRIPTION PAGE ------- -------------------- ------------ <C> <S> <C> *10.11 Employment Agreement between the Company and Mark D. Weisberger. Exhibit 10.13 to the 1996 Form 10-K is hereby incorporated by reference. *10.12 Employment Agreement between the Company and Richard C. Celio. Exhibit 10 to the Form 10-Q for the quarterly period ended March 31, 1997, is hereby incorporated by reference. *10.13 Employment Agreement between the Company and John Jordan. 10.14 Area Franchise Agreement, effective as of May 5, 1988, by and between IHOP, Inc. and FMS Management Systems, Inc. *10.15 International House of Pancakes Employee Stock Ownership Plan as Amended and Restated as of July 12, 1991 ("the ESOP"). *10.16 Amendment No. 1 to the ESOP. *10.17 Amendment No. 2 to the ESOP. *10.18 Amendment No. 3 to the ESOP. Exhibit 10 to the Form 10- Q for the quarterly period ended September 30, 1996, is hereby incorporated by reference. *10.19 Amendment No. 4 to the ESOP. Exhibit 10 to the Form 10- Q for the quarterly period ended September 30, 1997, is hereby incorporated by reference. 11.0 Statement Regarding Computation of Per Share Earnings. 21.0 Subsidiaries of the Company. 23.0 Consent of Coopers & Lybrand, L.L.P. 27.0 Financial Data Schedule. </TABLE> - -------- * Management contracts or compensatory plans or arrangements are marked with an asterisk.