(10) Franchise Operations

The Company franchises Ruth’s Chris Steak House restaurants. The Company executes franchise agreements for each franchisee-owned restaurant, which sets out the terms of its arrangement with the franchisee. The franchise agreements typically require the franchisee to pay an initial, non-refundable fee and continuing fees based upon a percentage of sales. The Company collects ongoing royalties of 5% of sales at franchisee-owned restaurants plus a 1% advertising fee applied to national advertising expenditures. The Company is not required to perform any services for the ongoing royalties and thus these royalties are recognized when the royalties are due from the franchisee on a monthly basis. These ongoing royalties are reflected in the accompanying consolidated statements of income as franchise income. The 1% advertising fee is not recorded as revenue, but rather is recorded as a liability against which specified advertising and marketing costs are charged.

The Company executes an area development agreement with franchisees that gives each franchisee exclusive rights to develop a specific number of restaurants within a specified area. The Company receives a development fee at the time that an area development agreement is executed. The development fee is recognized as revenue as franchisee-owned restaurants are opened. The Company also executes separate, site-specific franchise agreements for each restaurant developed by a franchisee under an area development agreement. The Company charges a site-specific fee at the time the franchise agreement is executed. This fee is related to construction assistance and consulting regarding operating procedures and purchasing. These services are performed prior to the restaurant opening. The Company recognizes the site-specific franchise fee when the related restaurant opens.

The Company currently has 77 franchisee-owned Ruth’s Chris Steak House restaurants, including 20 international restaurants. In January 2013, the Company signed an agreement with the Ko Group for the development of four new franchised Ruth’s Chris Steak House restaurants to be opened in the People’s Republic of China over three years. Three new franchisee-owned restaurants opened in fiscal year 2014 – one in Boise, ID in February, one in Panama City, Panama in September and one in Taipei, Taiwan in December. During fiscal year 2013, four new Ruth’s Chris Steak House franchise locations opened, including a second franchisee-owned restaurant located in San Juan in April 2013, a franchisee-owned restaurant located in Chattanooga, TN in July 2013, a location in Las Vegas, NV operating under a license agreement with the Company and a franchisee-owned restaurant located in Shanghai in December 2013. One of two franchisee-owned restaurants located in Dubai was closed in July 2013. During fiscal year 2012, the Company opened four franchisee-owned restaurants in Dubai, Singapore, San Salvador and Niagara Falls, Ontario. In February 2014, the Company acquired a franchisee-owned restaurant located in Austin, TX. No franchisee-owned restaurants were sold or purchased during fiscal years 2013 or 2012. Franchise income includes opening and development fees and income generated from existing franchisee-owned restaurants. The Company classifies franchise income separately in the consolidated statements of income (in thousands):