IHOP 2011 Annual Report Download - page 38

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to open the restaurants required by their agreements. It cannot be assured that franchisees will successfully participate in our
strategic initiatives or operate their restaurants in a manner consistent with our concepts and standards.
Concentration of Applebee's franchised restaurants in a limited number of franchisees subjects us to greater credit
risk. As of December 31, 2011, Applebee's franchisees operated 1,694 Applebee's restaurants in the United States, comprising
91% of the total Applebee's restaurants in the United States. Of those restaurants, the nine largest Applebee's franchisees owned
933 restaurants, representing 55% of all franchised Applebee's restaurants in the United States. The concentration of franchised
restaurants in a limited number of franchisees subjects us to a potentially higher level of credit risk in respect of such franchisees
because their financial obligations to us are greater as compared to those franchisees with fewer restaurants. The risk associated
with these franchisees is also greater where franchisees are the sole or dominant franchisee for a particular region of the United
States, as is the case for most domestic Applebee's franchised territories. In particular, if any of these franchisees experiences
financial or other difficulties, the franchisee may default on its obligations under multiple franchise agreements including payments
to us and the maintenance and improvement of its restaurants. If any of these franchisees are subject to bankruptcy or insolvency
proceedings, a bankruptcy court may prevent the termination of the related franchise agreements and development agreements.
Any franchisee that is experiencing financial difficulties may also be unable to participate in implementing changes to our business
strategy. Any franchisee that owns and operates a significant number of Applebee's restaurants and fails to comply with its other
obligations under the franchise agreement, such as those relating to the quality and preparation of food and maintenance of
restaurants, could cause significant harm to the Applebee's brand and subject us to claims by consumers even if we are not legally
liable for the franchisee's actions or failure to act. The refranchising of most of the company-operated Applebee's restaurants that
is part of our strategy may increase the degree of concentration of franchised Applebee's restaurants because the existing franchisees
are the likely candidates to acquire company-operated restaurants. The concentration of the franchised Applebee's restaurants in
a limited number of franchisees also may reduce our negotiating power with respect to the terms of sale of the company-operated
Applebee's restaurants. Development rights for Applebee's restaurants are also concentrated among a limited number of existing
franchisees. If any of these existing franchisees experience financial difficulties, future development of Applebee's restaurants
may be materially adversely affected.
We are subject to credit risk from our IHOP franchisees operating under our Previous Business Model, and a default by
these franchisees may negatively affect our cash flows. Of the 1,535 IHOP restaurants subject to franchise and area license
agreements as of December 31, 2011, over half operate under the Previous Business Model. The Company was involved in all
aspects of the development and financing of the IHOP restaurants established prior to 2003. Under the Previous Business Model,
the Company typically identified and leased or purchased the restaurant sites, built and equipped the restaurants and then franchised
them to franchisees. In addition, IHOP typically financed as much as 80% of the franchise fee for periods ranging from five to
eight years and leased the restaurant and equipment to the franchisee over a 25-year period. Therefore, in addition to franchise
fees and royalties, the revenues received from an IHOP franchisee operating under the Previous Business Model include, among
other things, lease or sublease rents for the restaurant property building, rent under an equipment lease and interest income from
the financing arrangements for the unpaid portion of the franchise fee under the franchise notes. If any of these IHOP franchisees
were to default on their payment obligations to us, we may be unable to collect the amounts owed under our notes and equipment
contract receivables as well as outstanding franchise royalties. The higher amounts owed to us by each of these IHOP franchisees
subject us to greater credit risk and defaults by IHOP franchisees operating under our Previous Business Model may negatively
affect our cash flows.
Termination or non-renewal of franchise agreements may disrupt restaurant performance. Each franchise agreement is
subject to termination by us in the event of default by the franchisee after applicable cure periods. Upon the expiration of the initial
term of a franchise agreement, the franchisee generally has an option to renew the franchise agreement for an additional term.
There is no assurance that franchisees will meet the criteria for renewal or will desire or be able to renew their franchise agreements.
If not renewed, a franchise agreement, and payments required thereunder, will terminate. We may be unable to find a new franchisee
to replace such lost revenues. Furthermore, while we will be entitled to terminate franchise agreements following a default that
is not cured within the applicable grace period, if any, such termination may disrupt the performance of the restaurants affected.
Franchisees may breach the terms of their franchise agreements in a manner that adversely affects our
brands. Franchisees are required to conform to specified product quality standards and other requirements pursuant to their
franchise agreements in order to protect our brands and to optimize restaurant performance. However, franchisees may receive
through the supply chain or produce sub-standard food or beverage products, which may adversely impact the reputation of our
brands. Franchisees may also breach the standards set forth in their respective franchise agreements.
Franchisees are subject to potential losses that are not covered by insurance that may negatively impact their ability to
make payments to us and perform other obligations under franchise agreements. Franchisees may have insufficient insurance
coverage to cover all of the potential risks associated with the ownership and operation of their restaurants. A franchisee may have
insufficient funds to cover unanticipated increases in insurance premiums or losses that are not covered by insurance. Certain
extraordinary hazards may not be covered and insurance may not be available (or may be available only at prohibitively expensive