IHOP 2013 Annual Report Download - page 39

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Concentration of Applebee's franchised restaurants in a limited number of franchisees subjects us to greater credit
risk. As of December 31, 2013, Applebee's franchisees operated 1,988 Applebee's restaurants in the United States, comprising
99% of the total Applebee's restaurants in the United States. Of those restaurants, the ten largest Applebee's franchisees owned
1,255 restaurants, representing 63% of all franchised Applebee's restaurants in the United States. The largest Applebee's
franchisee owned 448 restaurants, representing 23% 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.
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 1,439 IHOP restaurants subject to franchise agreements as of
December 31, 2013, 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 the building property lease/sublease agreement and our notes and equipment contract receivables, as well as outstanding
franchise royalties. The additional 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 and 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 the related payments 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 rates) with respect to many other risks. Moreover, there is no assurance that any loss incurred will not
exceed the limits on the policies obtained, or that payments on such policies will be received on a timely basis, or even if
obtained on a timely basis, that such payments will prevent losses to such franchisee or enable timely franchise payments.