SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED MARCH 31, 2000 COMMISSION FILE NO. 1-11915
CHOICE HOTELS INTERNATIONAL, INC.
10750 COLUMBIA PIKE
SILVER SPRING, MD. 20901
(301) 592-5000
Delaware 52-1209792
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(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
-------------------------------------------
(Former name, if changed since last report)
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, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
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SHARES OUTSTANDING
CLASS AT MARCH 31, 2000
- ----------------------- ------------------------
Common Stock, $0.01
par value per share 53,362,840
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CHOICE HOTELS INTERNATIONAL, INC.
INDEX
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PAGE NO.
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PART I. FINANCIAL INFORMATION:
Condensed Consolidated Balance Sheets -
March 31, 2000 (Unaudited) and December 31, 1999 3
Consolidated Statements of Income -
Three months ended March 31, 2000 and March 31, 1999 (Unaudited)
5
Consolidated Statements of Cash Flows -
Three months ended March 31, 2000 and March 31, 1999 (Unaudited) 6
Notes to Consolidated Financial Statements (Unaudited) 7
Management's Discussion and Analysis of
Operations and Financial Condition 8
Quantitative and Qualitative Analysis of Market Risk 10
PART II. OTHER INFORMATION AND SIGNATURE 11
2
PART I. FINANCIAL INFORMATION
CHOICE HOTELS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
March 31, 2000 December 31, 1999
--------------- -----------------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 9,226 $ 11,850
Receivables (net of allowance for doubtful
accounts of $8,124 and $6,203, respectively) 25,465 30,035
Income taxes receivable and other 1,707 37
-------- --------
Total current assets 36,398 41,922
PROPERTY AND EQUIPMENT, AT COST, NET OF
ACCUMULATED DEPRECIATION 58,166 58,255
GOODWILL, NET OF ACCUMULATED AMORTIZATION 64,195 64,706
FRANCHISE RIGHTS, NET OF ACCUMULATED AMORTIZATION 42,130 43,101
INVESTMENT IN FRIENDLY HOTELS, PLC 39,181 41,195
ADVANCES TO MARKETING AND RESERVATION FUNDS 52,739 32,807
OTHER ASSETS 39,172 40,819
NOTE RECEIVABLE FROM SUNBURST HOSPITALITY CORP. 145,636 141,853
-------- --------
Total assets $477,617 $464,658
======== ========
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
3
CHOICE HOTELS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
March 31, 2000 December 31, 1999
-------------- -----------------
(Unaudited)
LIABILITIES & EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $38,346 $44,646
Accounts payable 21,194 21,362
Accrued expenses 18,252 22,283
Income taxes payable - 1,367
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Total current liabilities 77,792 89,658
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LONG TERM DEBT 281,771 262,710
--------- ---------
DEFERRED INCOME TAXES ($36,387 and $30,648,
respectively) AND OTHER LIABILITIES 52,213 46,674
--------- ---------
Total liabilities 411,776 399,042
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SHAREHOLDERS' EQUITY
Common stock, $.01 par value 615 614
Additional paid-in-capital 53,763 52,386
Accumulated other comprehensive income 780 1,205
Deferred compensation (1,718) (1,937)
Treasury stock (118,125) (108,370)
Retained earnings 130,526 121,718
--------- ---------
Total shareholders' equity 65,841 65,616
--------- ---------
Total liabilities & shareholders' equity $477,617 $464,658
========= =========
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
4
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended
March 31, 2000 March 31, 1999
-------------- ---------------
(Unaudited)
REVENUES
Royalty fees $24,885 $23,798
Initial franchise and relicensing fees 3,348 2,849
Partner service revenue 2,298 1,716
Other 1,114 581
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Total revenues 31,645 28,944
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OPERATING EXPENSES
Selling, general and administrative 12,228 10,979
Depreciation and amortization 2,683 1,762
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Total operating expenses 14,911 12,741
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OPERATING INCOME 16,734 16,203
OTHER
Interest and dividend income (4,900) (4,703)
Interest expense and other 5,470 4,799
Equity loss - Friendly Hotels, PLC 1,725 95
Gain on sale of stock - (1,260)
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Total other 2,295 (1,069)
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INCOME BEFORE INCOME TAXES 14,439 17,272
INCOME TAXES 5,631 6,995
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NET INCOME $ 8,808 $10,277
======= =======
WEIGHTED AVERAGE SHARES OUTSTANDING 53,390 55,886
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DILUTED SHARES OUTSTANDING 54,262 56,508
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BASIC EARNINGS PER SHARE $0.16 $0.18
======= =======
DILUTED EARNINGS PER SHARE $0.16 $0.18
======= =======
The accompanying notes are an integral part of these consolidated statements of
income.
5
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
Three Months Ended
March 31,2000 March 31, 1999
-------------- ---------------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $8,808 $10,277
Reconciliation of net income to net cash
by operating activities:
Depreciation and amortization 5,460 3,530
Provision for doubtful accounts 372 408
Increase in deferred income taxes 5,711 2,222
Non cash interest and dividend income (3,783) (4,060)
Equity loss - Friendly Hotels, PLC 1,725 95
Changes in assets and liabilities:
Change in receivables 4,300 1,490
Change in income taxes receivable and other (2,781) 4,719
Change in accounts payable and accrued expenses (4,199) (5,533)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 15,613 13,148
-------- --------
CASH FLOW FROM INVESTING ACTIVITIES:
Investment in property and equipment (3,309) (6,281)
Advances to marketing and reservation funds, net (19,931) (4,046)
Other items, net 1,095 (2,530)
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NET CASH UTILIZED BY INVESTING ACTIVITIES (22,145) (12,857)
-------- --------
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from long term borrowings 34,700 36,930
Principal payments of long term borrowings (22,036) (13,137)
Proceeds from exercise of stock options 998 788
Purchase of treasury stock (9,755) (22,297)
Proceeds from issuance of common stock 1 269
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NET CASH PROVIDED BY FINANCING ACTIVITIES 3,908 2,553
-------- --------
Net change in cash and cash equivalents (2,624) 2,844
Cash and cash equivalents, beginning of period 11,850 1,692
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $9,226 $4,536
======== ========
The accompanying notes are an integral part of these consolidated statements of
cash flows.
6
CHOICE HOTELS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying consolidated financial statements of Choice Hotels
International, Inc. (the "Company") and subsidiaries have been prepared by the
Company without audit. Certain information and footnote disclosures normally
included in financial statements presented in accordance with generally accepted
accounting principles have been condensed or omitted. The Company believes the
disclosures made are adequate to make the information presented not misleading.
The consolidated financial statements should be read in conjunction with the
consolidated financial statements for the year ended December 31, 1999 and notes
thereto included in the Company's Form 10-K, dated March 30, 2000. In the
opinion of management, all adjustments (which include any normal recurring
adjustments) considered necessary for a fair presentation have been included.
Interim results are not necessarily indicative of fiscal year performance
because of seasonal and short-term variations. All intercompany transactions
and balances between Choice Hotels International, Inc. and its subsidiaries have
been eliminated. Certain reclassifications have been made to the prior year
financial statements to conform to the current year presentation.
2. Comprehensive Income - During the three months ended March 31, 2000, the
Company's comprehensive income (consisting of net income plus/minus foreign
currency translation adjustments and unrealized gains/losses on available for
sale securities) was lower than net income by approximately $425,000.
3. Marketing and Reservation Funds - The Company presents marketing and
reservation fees such that the fees collected and associated expenses are
reported net. The total marketing and reservation fees received by the Company
were $30.2 million and $28.0 million for the three months ended March 31, 2000
and 1999. Depreciation and amortization expense incurred by the marketing and
reservation funds was $2.8 million and $1.8 million for the three months ended
March 31, 2000 and 1999. Interest expense incurred by the reservation fund was
$1.1 million and $0.6 million for the three months ended March 31, 2000 and
1999.
Reservation fees and marketing fees not expended in the current year are carried
over to the next fiscal year and expended in accordance with the franchise
agreements. Shortfall amounts are similarly recovered in subsequent years.
Excess or shortfall amounts from the operation of these programs are recorded as
a payable or receivable from the particular fund. The Company advances capital
as necessary to the marketing and reservation funds to support the development
and ongoing operations of the franchise system. As of March 31, 2000, the
Company's balance sheet includes a receivable of $52.7 million related to
advances made to the marketing ($24.5 million) and reservation ($28.2 million)
funds. As of December 31, 1999, the Company's balance sheet includes a
receivable of $32.8 million related to advances made to the marketing ($12.5
million) and reservation ($20.3 million) funds.
The $12 million increase in the marketing advance for the quarter ended March
31, 2000 was due to planned accelerated media spending early in the calendar
year. The Company projects the marketing advance to decline over the remainder
of the year to approximately $17.5 million from the current $24.5 million
amount. The reservation advance is forecasted to increase approximately $20
million for the remaining nine months to $48 million. This increase is
associated with the continued roll-out of property management and yield systems
to franchisees. The Company has the ability under existing franchise agreements
and expects to recover these advances through future marketing, reservation and
technology fees.
4. Income Taxes - The income tax provision for the period is based on the
effective tax rate expected to be applicable for the full year. The 2000 first
quarter rate of 39% differs from the statutory rate primarily because of state
income taxes.
5. Earnings Per Share - Basic earnings per share (EPS) amounts are computed by
dividing earnings applicable to common shareholders by the average number of
common shares outstanding. Diluted EPS amounts assume the issuance of common
stock for all potentially dilutive equivalents outstanding.
6. Reportable Segment Information - The Company has a single reportable segment
encompassing its franchising business. Franchising revenues are comprised of
royalty fees, initial franchise and relicensing fees, and partner services
revenue and other.
7
Marketing and reservation fees and expenses are excluded from
reportable segment information as such fees and associated expenses are reported
net.
The following table presents the financial information for the Company's
franchising segment.
Three Months Ended March 31, 2000
(In thousands) Franchising Corporate & Other Consolidated
----------------------------------------------------------------------------
Revenues $31,645 $ - $31,645
Operating income (loss) 25,521 (8,787) 16,734
Three Months Ended March 31, 1999
Franchising Corporate & Other Consolidated
----------------------------------------------------------------------------
Revenues $28,944 $ - $28,944
Operating income (loss) 21,936 (5,733) 16,203
7. Put/Call Agreement - In March 2000, the Company and Sunburst Hospitality
Corporation ("Sunburst")entered into a "put/call" agreement related to three
MainStay properties for a period ending June 30, 2000. During this period, the
Company can "call" any or all specified properties for purchase at Sunburst's
original cost (approximately $16 million in the aggregate) and at the end of
this period Sunburst may "put" any or all specified properties at such cost. If
the put/call agreement is exercised, the Company would recognize a loss of
approximately $5 million on the transaction based on the estimated current fair
market value for the three MainStay properties.
8. Subsequent Event - In February 2000, the Company established Stay Connect,
Inc. ("Stay Connect") which was initially a wholly-owned subsidiary. Stay
Connect was formed to provide in-room internet solutions to the hospitality
industry and related markets. In April 2000, Stay Connect issued Series A
Convertible Preferred Stock to a third party, providing the third party an
effective 20% ownership interest in Stay Connect in exchange for $5 million.
Stay Connect is an early stage company with limited operating history. Stay
Connect expects to incur losses in its first year of operations and will require
significant capital to fund its future development and operations. Because the
Company maintains a majority interest, it will consolidate the operating
results, cash flows and balance sheet activity of Stay Connect in its financial
statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
- --------------------------------------------------------------------------
The Company reported net income of $8.8 million, or $0.16 per diluted share, for
the quarter ended March 31, 2000, compared to net income for the same period of
1999 of $10.3 million, or $0.18 per diluted share. The decrease in net income
for the period is attributable to an equity loss of $1.7 million related to the
Company's 5.3% interest in the common shares of Friendly Hotels, PLC
("Friendly"). The 1999 net income included a $1.3 million gain on the sale of
stock.
Franchise Revenues
- ------------------
The Company's net franchise revenues were $31.6 million for the three months
ended March 31, 2000 and $28.9 million for the three months ended March 31,
1999. Royalties increased $1.1 million to $24.9 million in 2000 from $23.8
million in 1999, an increase of 4.6%. The increase in royalties is attributable
to a net increase of 90 franchised hotels during the twelve month period between
March 31, 1999 and March 31, 2000 (representing an additional 6,725 rooms) and
an increase in the effective royalty rate of the domestic hotel system to 3.75%
from 3.61%. Initial and relicensing fee revenue generated from domestic
franchise contracts signed increased to $3.3 million from $2.8 million in 1999
as a result of 156 franchise agreements signed in 2000, as compared to 130 for
the first quarter of 1999.
8
Revenues generated from partner service relationships increased to $2.3 million
in 2000 from $1.7 million in 1999.
The total number of domestic hotels online increased to 3,143 from 3,053, an
increase of 2.9% for the period ending March 31, 2000. This represents an
increase in the number of rooms open of 2.7% from 253,106 as of March 31, 1999
to 259,831 as of March 31, 2000. As of March 31, 2000, the Company had 552
hotels under development in its domestic hotel system representing 42,993 rooms.
The total number of international hotels online increased to 1,110 from 1,003,
an increase of 10.7% as of March 31, 2000. International rooms open increased
10.7% from 72,220 as of March 31, 1999 to 79,913 as of March 31, 2000. The total
number of international hotels and rooms under development was 176 and 17,493,
respectively, as of March 31, 2000. International net franchise revenues
represented $1.4 million and $2.0 million of the Company's total net franchise
revenues for the quarters ended March 31, 2000 and 1999, respectively.
Franchise Expenses
- ------------------
The cost to operate the franchising business is reflected in selling, general
and administrative expenses. Selling, general and administrative expenses
increased 11.4% between years, partially related to increased variable expenses
associated with new and relicensed franchise agreements. As a percentage of
total net franchising revenues, total selling, general and administrative
expenses remained constant for the first quarter of 2000 as compared to 1999.
Other
- ------
For the three months ended March 31, 2000 and March 31, 1999, the Company
recognized approximately $3.8 million and $3.4 million, respectively, of
interest income from its subordinated term note to Sunburst.
The Company holds a common and preferred equity investment of approximately $39
million in Friendly. Friendly recently announced a loss of approximately $27
million, which was generated as a result of significant one-time, nonrecurring
asset provisions, and also stated a negative balance on its accumulated
distributable reserves. The Company accounts for its common equity in Friendly
under the equity method of accounting. As a result, the Company recognized an
equity loss of $1.7 million in its financial statements for the period ended
March 31, 2000, representing the Company's 5.3% interest in Friendly's common
shares.
Under English law, Friendly cannot pay preferred or ordinary share dividends as
long as the negative distributable reserve balance exists. Accordingly, Choice
ceased to accrue dividends effective January 1, 2000 for the Friendly preferred
shares until such time as Friendly is permitted under English law to declare and
pay dividends. Until such dividends are paid, Choice has the right under the
Friendly articles of association to vote at Friendly shareholder meetings as if
it had exercised its conversion rights into ordinary shares, giving the Company
44% fully diluted voting rights in the shares.
Given Friendly's current financial condition, the Company's increased voting
rights and the strategic importance of franchising in Europe, the Company is in
the process of reviewing its strategic options with respect to its investment in
Friendly.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Net cash provided by operating activities was $15.6 million for the three months
ended March 31, 2000, an increase of approximately $2.5 million from $13.1
million for 1999. The increase resulted from improved operating performance and
stronger management of working capital. At March 31, 2000, the total long-term
debt outstanding for the Company was $320.1 million, $38.3 million of which
matures in the next twelve months.
The Company made advances to the marketing and reservation funds totaling $19.9
million for the three months ended March 31, 2000. The advances are associated
with a system-wide property and yield management systems implementation and the
timing of expenditures associated with specific brand initiatives of the
marketing fund. The Company has the ability under existing franchise agreements
and expects to recover these advances through future marketing and reservation
fees. The Company expects approximately $13.0 million of increases in advances
to the marketing and reservation funds for the remainder of 2000 due to the
continued property and yield management systems implementation and expenditures
associated with specific brand initiatives.
9
The Company has repurchased 700,000 shares of its common stock at a total cost
of $10.7 million as of April 20, 2000. The Company has authorization from its
Board of Directors to repurchase up to an additional 5.6 million shares.
In February 2000, the Company established Stay Connect which was initially a
wholly-owned subsidiary. Stay Connect was formed to provide in-room internet
solutions to the hospitality industry and related markets. In April 2000, Stay
Connect issued Series A Convertible Preferred Stock to a third party, providing
the third party an effective 20% ownership interest in Stay Connect in exchange
for $5 million. Stay Connect is an early stage company with limited operating
history. Stay Connect expects to incur losses in its first year of operations
and will require significant capital to fund its future development and
operations.
The Company believes that cash flows from operations and available financing
capacity is adequate to meet the expected operating, investing, financing and
debt service requirements for the business for the immediate future.
Year 2000 Compliance
- --------------------
The Company has materially remedied the Year 2000 computer problem shared by
virtually all companies and businesses. Initially, this Year 2000 problem was
associated with two-digit date codes used in many computer programs and embedded
chip systems. As an on-going effort, the Company continues to monitor its
systems as well as third party vendors and franchisees.
While the Company has not experienced any material non-compliance issues to
date, it is not in a position to guarantee the performance of others with
respect to their Year 2000 compliance or predict whether any of the assurances
that others provide regarding Year 2000 compliance may prove later to be
inaccurate or overly optimistic.
FORWARD-LOOKING STATEMENTS
- --------------------------
When used throughout this report, the words "believes," "anticipates,"
"expects," "intends," "estimates," "projects," and other similar expressions,
which are predictions of or indicate future events and trends, identify forward-
looking statements. Such statements are subject to a number of risks and
uncertainties which could cause actual results to differ materially from those
projected, including: competition within each of our business segments; business
strategies and their intended results; the balance between supply of and demand
for hotel rooms; our ability to obtain new franchise agreements; our ability to
develop and maintain positive relations with current and potential hotel owners;
the effect of international, national and regional economic conditions; the
availability of capital to allow us and potential hotel owners to fund
investments; our ability, and that of other parties upon which our businesses
also rely, to modify or replace on a timely basis, their computer software and
other systems in order to function properly prior to, in and beyond, the year
2000; and other risks described from time to time in our filings with the
Securities and Exchange Commission, including those set forth under the heading
"Risk Factors" in our Report on Form 10-Q for the Period ended June 30, 1999.
Given these uncertainties, you are cautioned not to place undue reliance on such
statements. We also undertake no obligation to publicly update or revise any
forward-looking statement to reflect current or future events or circumstances.
ITEM 3. QUANTITATIVE AND QUALITATIVE ANALYSIS OF MARKET RISK
-----------------------------------------------------
The Company is exposed to market risk from changes in interest rates and the
impact of fluctuations in foreign currencies on the Company's foreign
investments and revenues. The Company manages its exposure to this market risk
through the monitoring of its available financing alternatives including in
certain circumstances the use of derivative financial instruments. The
Company's strategy to manage exposure to changes in interest rates and foreign
currencies remains unchanged from 1997. Furthermore, the Company does not
foresee any significant changes in exposure in these areas or in how such
exposure is managed in the near future.
At March 31, 2000 and December 31, 1999, the Company had $320.1 million and
$307.4 million of debt outstanding at an effective interest rate of 6.6% on both
dates, after the impact of interest rate swaps is taken into account. A
hypothetical change of 10% in the Company's effective interest rate from
quarter-end 2000 levels would increase or decrease interest expense by $1.5
million. The Company will refinance the $150 million variable rate term loan as
it amortizes throughout the expected maturity dates. Upon expiration of the
Credit Facility in 2002, the Company expects to refinance its obligations. For
more information related to the Company's use of interest rate instruments, see
Long-Term Debt and Notes Payable, Interest Rate Hedges and Fair Value of
Financial Instruments in the Notes to the Consolidated Financial Statements in
the Company's December 31, 1999 Form 10-K.
The Company is also exposed to fluctuations in foreign currency relating to its
preferred stock investment in Friendly that is denominated in British Pounds.
The Company does not have any derivative financial instruments related to its
foreign investments.
10
PART II OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS
-----------------
The Company is not party to any litigation, other than routine litigation
incidental to the business of the Company. None of such litigation, either
individually or in the aggregate, is expected to be material to the business,
financial condition or results of operations of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
---------------------------------
(a) Exhibits
Exhibit 10.25 - Put/Call Agreement dated March 27, 2000 between Choice
Hotels International, Inc. and Sunburst Hospitality Corporation.
Exhibit 27.01 - Financial Data Schedule - March 31, 2000
(b) The following reports were filed pertaining to the period ended March 31,
2000.
None
11
SIGNATURE
Pursuant to the requirements of the Securities Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
CHOICE HOTELS INTERNATIONAL, INC.
Date: May 11, 2000 /s/ Charles A. Ledsinger, Jr.
--------------------------------------
By: Charles A. Ledsinger, Jr.
President and Chief Executive Officer
12