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 AUGUST 31, 1997 COMMISSION FILE NO. 1-11915
CHOICE HOTELS INTERNATIONAL, INC.
10750 COLUMBIA PIKE
SILVER SPRING, MD. 20901
(301) 979-5000
Delaware 52-1209792
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(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
Choice Hotels Franchising, Inc.
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(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 OCTOBER 31, 1997
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Common Stock, $0.01
par value per share 59,811,570
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CHOICE HOTELS INTERNATIONAL, INC.
INDEX
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PAGE NO.
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PART I. FINANCIAL INFORMATION:
Consolidated Balance Sheets -
August 31, 1997 (Unaudited) and May 31, 1997 3
Consolidated Statements of Income -
Three months ended August 31, 1997 and August 31, 1996
(Unaudited) 5
Consolidated Statements of Cash Flows -
Three months ended August 31, 1997 and August 31, 1996 (Unaudited) 6
Notes to Consolidated Financial Statements (Unaudited) 7
Management's Discussion and Analysis of Results of
Operations and Financial Condition 9
PART II. OTHER INFORMATION AND SIGNATURE 14
2
PART I. FINANCIAL INFORMATION
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
August 31,
1997 May 31,
ASSETS (Unaudited) 1997
----------- -----------
CURRENT ASSETS
Cash and cash equivalents $ 4,348 $ 4,167
Receivables (net of allowance
for doubtful accounts of
$6,985 and $6,159, respectively) 30,446 24,472
Prepaid expenses -- 599
Current deferred taxes receivable 1,069 --
Other 5,561 5,077
-------- --------
Total current assets 41,424 34,315
PROPERTY AND EQUIPMENT, AT COST, NET OF
ACCUMULATED DEPRECIATION 45,560 43,377
GOODWILL, NET OF ACCUMULATED AMORTIZATION 69,464 69,939
FRANCHISE RIGHTS, NET OF ACCUMULATED
AMORTIZATION 49,779 50,503
INVESTMENT IN FRIENDLY HOTELS, INC. 16,475 17,161
OTHER ASSETS 6,619 6,178
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Total assets $229,321 $221,473
======== ========
The accompanying notes are an integral part of these Consolidated Balance
Sheets.
3
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
August 31,
1997 May 31,
(Unaudited) 1997
----------- --------
LIABILITIES & EQUITY
CURRENT LIABILITIES
Current portion long-term debt $ 34 $ 36
Accounts payable 24,237 20,412
Accrued expenses 8,567 10,965
Income taxes payable 4,705 3,318
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Total current liabilities 37,543 34,731
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MORTGAGES AND OTHER LONG-TERM DEBT 46,383 46,427
NOTES PAYABLE TO MANOR CARE, INC. 78,700 78,700
DEFERRED INCOME TAXES AND OTHER
LIABILITIES 5,093 4,422
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Total liabilities 167,719 164,280
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INVESTMENTS AND ADVANCES FROM PARENT 61,602 57,193
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Total liabilities & equity $229,321 $221,473
======== ========
The accompanying notes are an integral part of these Consolidated Balance
Sheets.
4
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended
------------------
August 31, August 31,
1997 1996
(Unaudited)
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REVENUES
Royalty fees $30,686 $27,288
Marketing and reservation fees 31,275 29,115
Product sales 5,843 8,093
European hotel operations 4,322 4,536
Initial franchise fee 2,097 3,357
Other 1,851 2,378
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Total revenues 76,074 74,767
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OPERATING EXPENSES
Marketing and reservations 30,252 28,792
Selling, general and administrative 10,494 10,561
Product cost of sales 5,463 7,439
European hotel operations 3,831 4,249
Depreciation and amortization 3,079 2,552
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Total operating expenses 53,119 53,593
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INCOME BEFORE INTEREST AND TAXES 22,955 21,174
INTEREST EXPENSE 2,316 2,487
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INCOME BEFORE INCOME TAXES 20,639 18,687
INCOME TAXES 8,497 7,693
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NET INCOME $12,142 $10,994
======= =======
Pro forma weighted average shares outstanding 60,156 63,000
======= =======
Pro forma earnings per share $0.20 $0.17
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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
----------------------
August 31, August 31,
1997 1996
(Unaudited)
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $12,142 $10,994
Reconciliation of net income to net cash provided by
operating activities:
Depreciation and amortization 3,079 2,552
Provision for bad debts (990) (939)
(Decrease) increase in deferred taxes (398) --
Changes in assets and liabilities:
Change in receivables (4,984) (3,340)
Change in inventories and other current assets 115 (245)
Change in current liabilities 1,427 744
Change in income taxes payable 1,387 2,448
Change in other liabilities -- (44)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 11,778 12,170
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CASH FLOW FROM INVESTING ACTIVITIES:
Investment in property and equipment (4,063) (3,673)
Other items, net 245 (2,622)
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NET CASH UTILIZED BY INVESTING ACTIVITIES (3,818) (6,295)
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CASH FLOW FROM FINANCING ACTIVITIES:
Principal payments of debt (46) --
Cash transfers to Parent, net (7,733) (6,010)
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NET CASH UTILIZED BY FINANCING ACTIVITIES (7,779) (6,010)
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Net change in cash and cash equivalents 181 (135)
Cash and cash equivalents, beginning of period 4,167 3,812
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,348 $ 3,677
======= =======
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. On March 7, 1996, Manor Care, Inc. ("Manor Care") announced its intention to
proceed with the separation of its lodging business from its health care
business via a spin-off of its lodging business (the "Distribution"). On
September 30, 1996 the Board of Directors of Manor Care declared a special
dividend to its shareholders of one share of common stock of the Company for
each share of Manor Care Stock, and the Board set the Record Date and the
Distribution Date. The Stock Distribution was made on November 1, 1996 to
holders of record of Manor Care's Common Stock on October 10, 1996.
The Distribution separated the lodging and health care businesses of Manor Care
into two public corporations. The operations of the Company consist principally
of the hotel franchise operations and the owned and managed hotel operations
formerly conducted by Manor Care, Inc. directly or through its subsidiaries (the
"Lodging Business").
On November 1, 1996, concurrent with the Distribution, the Lodging Business
changed its name from Choice Hotels Holdings, Inc. to Choice Hotels
International, Inc. ("CHI") and CHI's franchising subsidiary, formerly named
Choice Hotels International, Inc., changed its name to Choice Hotels
Franchising, Inc. ("Franchising").
2. On April 29, 1997, CHI's Board of Directors announced its intention to
separate CHI's franchising business from its owned hotel business (commonly
referred to as the "Sunburst Distribution"). On September 16, 1997 the Board of
Directors and shareholders of the Company approved the separation of the
business via a spin-off of the franchising business, along with CHI's European
hotel and franchising operations, to its shareholders. The Board set October
15, 1997 as the date of distribution and on that date, Company shareholders
received one share in Franchising (renamed "Choice Hotels International, Inc."
and referred to hereafter as the "Company") for every share of CHI stock held on
October 7, 1997 (the date of record). Concurrent with the October 15, 1997
distribution date, CHI (renamed "Sunburst Hospitality Corporation") effected a
one-for-three reverse stock split of its common stock.
3. The accompanying consolidated financial statements of Choice Hotels
International, Inc. 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 fiscal year ended May 31, 1997 and
notes thereto included in the Form 10 Registration Statement, dated September
28, 1997. Certain reclassifications have been made to the prior year amounts to
conform to current period presentation.
The consolidated financial statements present the financial position, results of
operations and cash flows of the Company as if it were formed as a separate
entity of the Parent which conducted the hotel franchising business and European
hotel operations and as if the Company were a separate company for all periods
presented. The Parent's historical basis in the assets and liabilities of the
Company has been carried over to the consolidated financial statements. All
material intercompany transactions and balances between the Company and its
subsidiaries have been eliminated. Changes in the Investments and advances from
Parent represent the net income of the Company plus the net change in cash
transferred between the Company and Manor Care through November 1, 1996 and
Sunburst through August 31, 1997.
4. Earnings per share for the periods presented is calculated on a pro forma
basis using the weighted average number of outstanding common shares for Manor
Care for August 31, 1996 and the weighted average number of outstanding shares
of Sunburst Hospitality Corporation for August 31, 1997 as the Company was
a wholly owned subsidiary of Manor Care and Sunburst, respectively.
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5. As of August 31, 1997, the Company had franchise agreements with hotels with
292,629 rooms operating in 34 countries principally under the following brand
names: Comfort, Clarion, Sleep, Quality, MainStay, Rodeway and Econo Lodge.
6. Choice Hotels International, Inc. announced it has signed a conditional
agreement with Friendly Hotels, PLC ("Friendly") in which Friendly will assume
the master franchise rights for Choice's Comfort, Quality and Clarion brand
hotels throughout Europe (with the exception of Scandinavia) for the next 10
years. In exchange, Franchising will receive from Friendly $8.0 million,
payable in eight equal annual installments.
As part of the transaction, Friendly will also acquire European hotels currently
owned by Franchising for a total consideration of approximately $26.2 million
in convertible preferred shares and cash. In exchange for 10 hotels in France,
two in Germany and one in the UK, Franchising will receive $22.2 million in new
unlisted 5.75 percent convertible preferred shares in Friendly at par,
convertible for one new Friendly ordinary share for every 150p nominal of the
preferred convertible shares In addition, Friendly will pay Franchising
deferred compensation of $4.0 million in cash, payable by the fifth anniversary
of completion or sooner dependent on the level of future profits of the hotels
acquired. The European hotels included in this transaction have a carrying
value of approximately $22.9 million. The transaction is subject to final
documentation and Friendly shareholder approval and is expected to close in
January of 1998.
7. On October 15, 1997, the Company entered into a $300 million competitive
advance and multi-currency revolving credit facility (the "Credit Facility")
provided by a group of 14 banks. This Credit Facility provides that up to $50
million is available for borrowings in foreign currencies. Interest on the
borrowings under the Credit Facility is calculated, at the option of the
borrower, at one of several rates including LIBOR plus a spread which is
dependent on the leverage of the Company at the time of borrowing. The Credit
Facility will terminate on October 15, 2002.
In connection with the Sunburst Distribution, the Company borrowed $115 million
under its Credit Facility in order to fund a subordinated term loan to Sunburst.
The Subordinated Term Note of $115 million accrues interest monthly at 11% and
is due on October 15, 2002.
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
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The principal factors that affect the Company's results are: growth in the
number of hotels under franchise; occupancies and room rates achieved by
Franchising's brands; the number of relative mix of franchised hotels; and the
Company's ability to manage costs. The rooms at franchised properties and
occupancies and room rates at those properties significantly affect the
Company's results because franchise royalty fees are based upon room revenues at
franchised hotels. Increases in franchise fee revenues have a disproportionate
impact on the Company's operating margin due to the lower incremental costs
associated with these revenues.
The Company recorded net income for the three-month period ended August 31, 1997
of $12.1 million, an increase of 10% over August 31, 1996 results of $11.0
million. The August 31, 1996 results are prepared as if the Company was a
separate stand alone subsidiary of Manor Care. The August 31, 1997 results are
prepared as if the Company was a separate stand alone subsidiary of Sunburst.
The increase in net income for the period is primarily attributable to an
increase in franchise revenue as a direct result of the addition of new
licensees to the franchise system and improvements in the operating performance
of franchised hotels.
Combined revenues increased $1.3 million (or 1.7%) to $76.1 million for the
period ended August 31, 1997 from $74.8 million at August 31, 1996.
Franchise Operating Revenues
- ----------------------------
In operating the franchise business, the Company collects marketing and
reservation fees and assessments from its franchisees. The Company is
contractually obligated to disburse these fees for marketing and reservation
activities to be provided on behalf of its franchisees. The Company also
provides certain services to its franchisees, specifically a group purchasing
program, where the Company utilizes bulk purchasing power to obtain favorable
pricing from third-party vendors for franchisees. This program is provided to
the franchisees as a service and is not designed to be a major component of the
Company's profitability. Management therefore analyzes its franchise business
based on revenues net of marketing and reservation fees and product sales ("net
franchise revenues").
Net franchise revenues include base royalty fees, initial fees earned on
contracts signed and other revenues including strategic vendor fees. Net
franchise revenues are dependent upon additional franchise properties in the
system as well as the underlying performance of the hotels for continued growth.
The key industry standard for measuring operating performance is revenue per
available room, or RevPAR, which is calculated by multiplying the percentage of
occupied rooms by the average daily room rate realized.
The Company's net franchise revenues were $34.7 million for the three months
ended August 31, 1997 and $33.0 million for the three months ended August 31,
1996.
9
Total net franchise revenues are computed as follows:
(In millions)
August 31, 1997 August 31, 1996
---------------- ----------------
Total Franchise revenues $ 71.8 $ 70.2
Less: Marketing and reservation fees (31.3) (29.1)
Product sales (5.8) (8.1)
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Total net franchise revenues $ 34.7 $ 33.0
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Royalties increased $3.4 million to $30.7 million in 1997 from $27.3 million in
1996, an increase of 12.5%. The increase in royalties is attributable to a net
increase of 313 franchisees during the period representing an additional 25,061
rooms added to the system, an improvement in domestic RevPAR of 2.1% and an
increase in the effective royalty rate of the domestic hotel system to 3.46%
from 3.42%. Initial fee revenue generated from domestic franchise contracts
signed decreased to $2.1 million from $3.4 million in 1996. Total franchise
agreements signed in the first quarter of fiscal year 1998 were 135, as compared
to 181 for the first quarter of fiscal year 1997. The decline in initial fees is
partly a result of the Company's sales force reorganization effected during the
first quarter of fiscal year 1998 and the resulting temporary displacement of
the sales force. The reorganization of the regional marketing management sales
and support force was completed in September of 1997.
Franchise Operating Expenses
- ----------------------------
The cost to operate the franchising business is reflected in selling, general
and administrative costs. Total selling, general and administrative expenses of
the franchise business remained stable between years. As a percentage of total
net franchising revenues, total franchising selling, general and administrative
expenses declined to 30.3% for the first quarter of fiscal year 1998 as compared
to 32.1% for fiscal year 1997. Fiscal year 1998 costs also include
approximately $500,000 of expenses resulting from the Distribution from Manor
Care. Excluding these costs, as a percentage of net franchising revenues,
selling, general and administrative expenses declined to 28.8% in first quarter
of fiscal year 1998 from 32.1% in the first quarter of fiscal year 1997. The
improvement in the franchising margins primarily relates to the economies of
scale generated from operating a larger franchisee base.
Product Sales
- -------------
Sales made to franchisees through the Company's group purchasing program
decreased $2.3 million (or 28%) to $5.8 million for the three months ended
August 31, 1997 from $8.1 million at August 31, 1996 due to the elimination of
catalog sales. The group purchasing program utilizes bulk purchases to obtain
favorable pricing from third party vendors for franchisees ordering similar
products. Franchising acts as a "clearing-house" between the franchisee and the
vendor, and orders are shipped directly to the franchisee.
Similarly, product cost of sales decreased $2.0 million (or 27%) for the three
months ended August 31, 1997. The product services margins decreased for the
three months ended August 31, 1997 to 6.5% from 8.1% at August 31, 1996. This
purchasing program is provided to the franchisees as a service and is not
expected to be a major component of Franchising's profitability.
European Hotel Operations
- -------------------------
Franchising owns or operates 14 hotels in Germany, France and Great Britain.
Total revenues at Franchising's owned hotel operations in Europe declined to
$4.3 million for the three months ended August 31, 1997 from $4.5 million at
August 31, 1996. Operating margins at the hotels increased to 11.4% at August
31, 1997 from 6.3% at August 31, 1996. The increase in operating performance
reflects the significant cost cutting measures undertaken during fiscal 1998.
On October 28, 1997, the Company signed a conditional agreement with Friendly in
10
which Friendly will assume the master franchise rights for Choice's Comfort,
Quality and Clarion brand hotels throughout Europe for total consideration of
$34.2 million for the next ten years. In addition, the Company is pursuing
strategies with the objective of improving the profitability of the hotels
including, among others, divestiture, strategic alliances and joint ventures.
Other Expenses
- --------------
Depreciation and amortization increased $500,000 or 19.2% to $3.1 million for
the three months ended August 31, 1997 from $2.6 million at August 31, 1996.
The increase was primarily due to an increase in fixed assets purchased.
For the three months ended August 31, 1997, Franchising recognized $235,750 in
dividend income from its investment in Friendly.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Net cash provided by operating activities was $11.8 million for the first
quarter of fiscal year 1998, a decrease of $400,000 from $12.2 million for the
first quarter of fiscal year 1997. At August 31, 1997, the total long-term debt
outstanding for Franchising was $125 million.
In connection with the Sunburst Distribution, management executed agreements
with its lenders which it believes will provide adequate financing for both
businesses post-distribution. The total debt outstanding prior to the
distribution of $384 million was allocated to the two businesses. The Note
Payable to Manor Care of approximately $115.7 million was satisfied and
discharged and all outstanding bank obligations, excluding capital leases and
the $116 million collateralized mortgage backed securities, were refinanced. In
addition, the Company will settle certain trade payables and payroll obligations
incurred by Sunburst prior to the distribution date subject to the net equity of
the Company being no less than $40 million. An analysis of the Company's debt
structure follows.
The Company has secured a five year $300 million revolving credit facility. The
Credit Facility includes customary financial and other covenants that requires
the maintenance of certain ratios including maximum leverage, minimum net worth
and interest coverage and restricts the Company's ability to make certain
investments, repurchase stock, incur debt, and dispose of assets. At the
Company's option, the interest rate may be based on LIBOR, a certificate of
deposit rate or an alternate base rate(as defined), plus a facility fee
percentage. The rate is determined based on the Company's consolidated leverage
ratio at time of borrowing. Interest on the initial borrowings is expected to
be at one of several rates utilizing the three-month LIBOR rate.
At the time of the Sunburst Distribution, the Company had approximately $140
million of existing indebtedness. On October 15, 1997, the existing debt was
refinanced using borrowings under the new revolver and the Company borrowed an
additional $115 million. The $115 million was used to fund a 5 year, 11%
Subordinated Term Note to Sunburst, which is payable in full, along with accrued
interest on October 15, 2002.
The Company believes that cash flows from operations and available financing
capacity is adequate to meet the expected operating and debt service
requirements for the business for the immediate future.
FORWARD-LOOKING STATEMENTS
- --------------------------
The statements contained in this document that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995.
A number of important factors could cause the Company's actual results for
future periods to differ materially from those expressed in any forward-looking
statements made by, or on behalf of the Company.
Certain statements contained in this Form 10-Q, including those in the section
entitled "Management's Discussion and Analysis of Operating Results and
11
Financial condition," contain forward-looking information that involves risk and
uncertainties. Actual future results and trends may differ materially depending
on a variety of factors discussed in the "Risk Factors" section included in the
Company's Form 10 Registration Statement, including the nature and extent of
future competition, and political, economic and demographic developments in
countries where the Company does business or in the future may do business.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. The Company undertakes no
obligation to revise or update these forward-looking statements.
12
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 27.01 - Financial Data Schedule - August 31, 1997
(b) The following reports were filed pertaining to the quarter ended August
31,1997.
Form 8-K dated June 26, 1997 - Discussion of Management's Strategic Plan.
Form 8-K dated August 8, 1997 - Reclassification of quarterly results for
fiscal year 1997.
Form 8-K dated October 1, 1997 - Announcement of both the Company and
Franchising's change in its fiscal year end. Also, an announcement of the
Board's acceptance of the spin-off.
13
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: November 7, 1997 /s/ Michael J. DeSantis
--------------- -----------------------------
By: Michael J. DeSantis
Senior Vice President,
General Counsel and Secretary
14