IHOP 2009 Annual Report Download - page 29

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operate ten IHOP restaurants in the Cincinnati market primarily for testing new menu items and
operational or procedural systems and for other research and development purposes. We also operate
two IHOP Caf´
e restaurants, a new, non-traditional format currently under evaluation for possible
additional development. In addition we may also operate, from time to time on a temporary basis until
refranchised, IHOP restaurants that we reacquire for a variety of reasons from IHOP franchisees.
IHOP restaurants are located in all 50 states of the United States, in the District of Columbia, and
internationally in Canada, Mexico, Puerto Rico and the U.S. Virgin Islands.
IHOP restaurants feature full table service and high quality, moderately priced food and beverage
offerings in an attractive and comfortable atmosphere. Although the restaurants are best known for
their award-winning pancakes, omelets and other breakfast specialties, IHOP restaurants offer a variety
of lunch, dinner and snack items as well. IHOP restaurants are open throughout the day and evening
hours, and many operate 24 hours a day.
Franchising
Franchising activities include both company-financed and franchisee-financed development. For
clarity of presentation, the discussion below is separated between those activities specific to the
Company’s business model as it was in effect prior to 2003 (referred to as the Previous Business
Model) and those adopted in January 2003 (referred to as the Current Business Model). As discussed
in greater detail below, under the Previous Business Model the Company developed a substantial
majority of all IHOP restaurants with the intention of leasing them to franchisees. Under the Current
Business Model substantially all new IHOP restaurants are developed by franchise developers with the
intention of operating them as franchised restaurants.
Current Business Model
Under our Current Business Model, a potential franchisee first negotiates and enters into a single-
store development agreement or a multi-store development agreement with the Company and, upon
completion of a prescribed approval procedure, is primarily responsible for the development and
financing of one or more new IHOP franchised restaurants. In general, we do not provide any
financing with respect to the franchise fee or otherwise under the Current Business Model. The
franchise developer uses its own capital and financial resources along with third-party financial sources
arranged for by the franchise developer to purchase or lease a restaurant site, build and equip the
business and fund its working capital needs. The principal terms of the franchise agreements entered
into under the Previous Business Model and the Current Business Model, including the franchise
royalties and the franchise advertising fees, are substantially the same except with respect to the terms
relating to the franchise fee. Of the 1,443 IHOP restaurants subject to franchise and area license
agreements as of December 31, 2009, a total of 347 operate under the Current Business Model.
The revenues received by the Company from a typical franchise development arrangement under
the Current Business Model include (a) (i) a location fee equal to $15,000 upon execution of a single-
store development agreement or (ii) a development fee equal to $20,000 for each IHOP restaurant that
the franchisee contracts to develop upon execution of a multi-store development agreement; (b) a
franchise fee equal to (i) $50,000 (against which the $15,000 location fee will be credited) for a
restaurant developed under a single-store development agreement or (ii) $40,000 (against which the
$20,000 development fee will be credited) for each restaurant developed under a multi-store
development agreement, in each case paid upon execution of the franchise agreement; (c) franchise
royalties equal to 4.5% of weekly gross sales; (d) revenue from the sale of pancake and waffle
dry-mixes; and (e) franchise advertising fees. The franchise agreements generally provide for advertising
fees comprised of (i) a local advertising fee generally equal to 2.0% of weekly gross sales under the
franchise agreement, which was typically used to cover the cost of local media purchases and other
local advertising expenses incurred by a local advertising cooperative, and (ii) a national advertising fee
10