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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the period ended October 3, 1998
or
/ / TRANSITION PERIOD REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to _________________
Commission File Number: 1-14058
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RED ROOF INNS, INC.
(Exact name of registrant as specified in its charter)
Delaware 31-1393666
(State of Incorporation) (I.R.S. Employer Identification Number)
4355 DAVIDSON ROAD
HILLIARD, OHIO 43026-2491
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (614) 876-3200
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Number of shares of Common Stock outstanding at October 3, 1998
27,318,010
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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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
- - -----------------------------
The accompanying unaudited condensed consolidated financial statements
of Red Roof Inns, Inc. ("Red Roof" or the "Company"), a Delaware corporation,
have been prepared in accordance with the instructions to Form 10-Q, and
therefore do not include all information and notes necessary for complete
financial statements in conformity with generally accepted accounting
principles. The results for the periods indicated are unaudited, but reflect all
adjustments (consisting only of normal recurring accruals) which management
considers necessary for a fair presentation of operating results. Results of
operations for interim periods are not necessarily indicative of a full year of
operations or results for other interim periods. All material intercompany
transactions and balances between Red Roof Inns, Inc. and its subsidiaries have
been eliminated in consolidation. These condensed consolidated financial
statements should be read in conjunction with the Company's 1997 audited
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the fiscal year ended January 3, 1998.
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RED ROOF INNS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
JANUARY 3, 1998 AND OCTOBER 3, 1998
(IN THOUSANDS)
(UNAUDITED)
JANUARY 3, OCTOBER 3,
1998 1998
--------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 13,154 $ 12,299
Receivables 9,006 13,215
Supplies and other 14,422 17,715
-------- --------
Total current assets 36,582 43,229
PROPERTY AND EQUIPMENT:
Land 155,456 150,853
Buildings and improvements 608,323 631,091
Furniture, fixtures and equipment 108,564 129,059
Construction in progress 49,326 36,671
-------- --------
Total property and equipment 921,669 947,674
Less accumulated depreciation and amortization 89,287 109,172
-------- --------
Property and equipment - net 832,382 838,502
OTHER ASSETS:
Goodwill, net of accumulated amortization 70,181 68,482
Deferred loan fees and other - net 15,613 22,697
-------- --------
Total other assets 85,794 91,179
-------- --------
TOTAL $954,758 $972,910
======== ========
See notes to condensed consolidated financial statements.
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RED ROOF INNS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
JANUARY 3, 1998 AND OCTOBER 3, 1998
(IN THOUSANDS, EXCEPT PAR VALUES)
(UNAUDITED)
JANUARY 3, OCTOBER 3,
1998 1998
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 15,128 $ 11,580
Accrued expenses 24,617 37,584
Current maturities of long-term debt 11,998 14,869
--------- ---------
Total current liabilities 51,743 64,033
LONG-TERM DEBT (LESS CURRENT MATURITIES):
Mortgage notes and obligations under capital leases 173,842 157,487
Bank facility 165,365 156,000
Senior unsecured notes 200,000 200,000
--------- ---------
Total long-term debt 539,207 513,487
OTHER LONG-TERM LIABILITIES 25,072 29,332
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 10,000 shares authorized,
no shares issued
Common stock, $.01 par value; 100,000 shares authorized,
shares issued: 1997 - 28,531, 1998 - 28,579 285 286
Additional paid-in capital 268,140 269,041
Less treasury stock, at cost: 1997 - 951 shares, 1998 - 1,261 shares (13,822) (18,714)
Retained earnings 84,133 115,445
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Total stockholders' equity 338,736 366,058
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TOTAL $ 954,758 $ 972,910
========= =========
See notes to condensed consolidated financial statements.
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RED ROOF INNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE THIRTEEN WEEKS AND THIRTY-NINE WEEKS ENDED SEPTEMBER 27, 1997 AND
OCTOBER 3, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THIRTEEN WEEKS ENDED THIRTY-NINE WEEKS ENDED
--------------------------- ----------------------------
SEPTEMBER 27, OCTOBER 3, SEPTEMBER 27, OCTOBER 3,
1997 1998 1997 1998
------------- ---------- ------------- ----------
REVENUES $ 99,758 $ 103,007 $ 264,968 $ 285,929
OPERATING EXPENSES:
Direct room 40,912 44,213 121,325 134,658
Depreciation and amortization 7,824 9,059 24,523 27,840
Corporate 7,683 7,376 22,212 23,586
Marketing 5,165 3,512 16,593 13,508
Special charges 2,333 461 11,874 461
-------- --------- --------- ---------
Total operating expenses 63,917 64,621 196,527 200,053
-------- --------- --------- ---------
OPERATING INCOME 35,841 38,386 68,441 85,876
INTEREST EXPENSE - NET (11,229) (11,150) (33,704) (34,629)
-------- --------- --------- ---------
INCOME BEFORE INCOME TAXES
AND EXTRAORDINARY ITEM 24,612 27,236 34,737 51,247
INCOME TAX EXPENSE (9,660) (10,595) (13,634) (19,935)
-------- --------- --------- ---------
INCOME BEFORE EXTRAORDINARY ITEM 14,952 16,641 21,103 31,312
EXTRAORDINARY LOSS -- -- (746) --
-------- --------- --------- ---------
NET INCOME $ 14,952 $ 16,641 $ 20,357 $ 31,312
======== ========= ========= =========
EARNINGS PER SHARE BEFORE
EXTRAORDINARY ITEM:
Basic $ 0.53 $ 0.60 $ 0.75 $ 1.13
======== ========= ========= =========
Diluted $ 0.53 $ 0.60 $ 0.75 $ 1.13
======== ========= ========= =========
EXTRAORDINARY LOSS PER SHARE:
Basic $ -- $ -- $ (0.02) $ --
======== ========= ========= =========
Diluted $ -- $ -- $ (0.03) $ --
======== ========= ========= =========
EARNINGS PER SHARE:
Basic $ 0.53 $ 0.60 $ 0.73 $ 1.13
======== ========= ========= =========
Diluted $ 0.53 $ 0.60 $ 0.72 $ 1.13
======== ========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 28,032 27,633 28,011 27,642
======== ========= ========= =========
Diluted 28,273 27,758 28,197 27,814
======== ========= ========= =========
See notes to condensed consolidated financial statements.
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RED ROOF INNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THIRTY-NINE WEEKS ENDED SEPTEMBER 27, 1997 AND OCTOBER 3, 1998
(IN THOUSANDS)
(UNAUDITED)
THIRTY-NINE WEEKS ENDED
----------------------------
SEPTEMBER 27, OCTOBER 3,
1997 1998
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CASH FLOWS FROM OPERATIONS:
Net income $ 20,357 $ 31,312
Adjustments to reconcile net income to net cash provided
by operations:
Depreciation and amortization 22,598 25,188
Amortization of goodwill 1,699 1,699
Net loss from sale, disposal or retirement of assets 896 951
Write-off of loan fees and costs 1,228 --
Amortization of loan fees and costs 1,041 1,254
Deferred income taxes 7,391 4,549
Change in assets and liabilities:
Receivables (1,964) (4,209)
Supplies and other (619) (1,221)
Accounts payable (540) 587
Accrued expenses 7,300 13,373
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Net cash provided by operations 59,387 73,483
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CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of assets 1,302 24,128
Expenditures for property and equipment (101,968) (61,085)
Change in other assets 46 (3,742)
--------- ---------
Net cash used by investing activities (100,620) (40,699)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bank facility 290,603 138,806
Principal reduction in mortgage notes and bank facility (261,127) (168,224)
Issuance of common stock 2,098 1,178
Purchase of treasury stock -- (5,399)
--------- ---------
Net cash provided (used) by financing activities 31,574 (33,639)
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (9,659) (855)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 19,659 13,154
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 10,000 $ 12,299
========= =========
See notes to condensed consolidated financial statements.
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ITEM 1 - FINANCIAL STATEMENTS (CONTINUED)
- - -----------------------------------------
RED ROOF INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THIRTEEN WEEKS AND THIRTY-NINE WEEKS ENDED SEPTEMBER 27, 1997 AND
OCTOBER 3, 1998 (UNAUDITED)
1. GENERAL
The condensed consolidated financial statements include the accounts of
Red Roof Inns, Inc. and its wholly owned subsidiaries. All material intercompany
transactions and balances have been eliminated in consolidation.
The Company is an owner/operator and franchisor of economy chain
segment inns. At September 27, 1997, the Company operated 252 inns and had two
franchised inns. At October 3, 1998, the Company operated 255 inns and had 24
franchised inns.
Unaudited interim results for the thirteen weeks and thirty-nine weeks
ended September 27, 1997 and October 3, 1998 contain all adjustments, consisting
of normal recurring accruals, which management considers necessary for a fair
presentation of interim financial position and results of operations for such
periods. The results are not necessarily indicative of the results for any other
interim period or the full fiscal year.
Certain amounts in the 1997 financial statements have been reclassed to
conform with the 1998 presentation.
2. PROPERTY AND EQUIPMENT
In April 1998, the Company sold four of its California properties with
a net book value of $13.1 million to a franchisee for approximately $13 million.
The Company used the net proceeds to repay certain mortgage indebtedness and
borrowings on the bank facility. A fifth property in California was leased to
the franchisee with an option to purchase. The five inns contained a total of
577 rooms. In May 1998 the Company sold, at cost, an inn under construction in
Atlanta, GA to a franchisee for approximately $11 million. The Company used the
proceeds to repay borrowings on the bank facility. The sale of these properties
will not have a significant effect on the results of operations for the Company.
3. LONG-TERM DEBT
As of October 3, 1998, there was $94 million available for borrowing
under the Company's $250 million bank facility. In May 1997, the Company
refinanced its $150 million bank facility with a $250 million bank facility. In
connection with the refinancing, the Company recognized an extraordinary charge
against income of $0.7 million, net of tax ($.02 per share - basic and $.03 per
share - diluted) in the thirty-nine week period ended September 27, 1997 related
to the write-off of unamortized loan fees and costs of the $150 million bank
facility.
4. STOCKHOLDERS' EQUITY
In January 1998, the Company sold 34,916 shares of common stock out of
treasury to employees at $15.19 per share under the Employee Stock Purchase Plan
for the 1997 plan year.
During the thirty-nine week period ended October 3, 1998, the Company
granted options to certain officers and employees under the Company's stock
option plans to purchase 740,250 shares at a weighted average price of $18.49
per share. The options vest at the rate of 25% per year.
During the thirty-nine week period ended October 3, 1998, options were
exercised for 55,575 shares at prices ranging from $5.43 to $14.13 per share
under the Company's Management Stock Option Plan. In connection with the
termination of the employment of certain plan participants, 17,400 options
awarded under the Plan lapsed.
In September 1998, the Board of Directors authorized the Company to
repurchase up to 1,000,000 of its common shares, either in the open market or in
privately negotiated transactions. During the thirty-nine weeks ended October 3,
1998, the Company purchased 344,400 shares of its common stock in the open
market for an aggregate purchase price of $5.4 million, or $15.68 per share.
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5. INN RENEWAL PROGRAM
The Company substantially completed in the third quarter of 1998 its
inn renewal program to refurbish the majority of its inns at a total cost of
approximately $68 million. For the thirty-nine weeks ended September 27, 1997
and October 3, 1998, the Company spent $46.2 million and $7.8 million,
respectively, related to the inn renewal program, of which $35.3 million and
$7.8 million, respectively, was capitalized. In addition, through the
thirty-nine weeks of 1997 the Company wrote-off assets with a net book value of
approximately $1 million related to early asset retirements in connection with
the program.
6. SUPPLEMENTAL CASH FLOW INFORMATION
For the thirty-nine weeks ended September 27, 1997 and October 3, 1998,
interest payments were $30.9 million and $31.2 million, respectively, and
interest capitalized for the corresponding periods was $1.8 million and $2.1
million, respectively. Income tax payments for the thirty-nine week periods in
1997 and 1998 were $0.7 million and $10.5 million, respectively.
The following is a summary of non-cash transactions for the thirty-nine
weeks ended September 27, 1997 and October 3, 1998 (in thousands):
Thirty-Nine Weeks Ended
------------------------------------------
September 27, October 3,
1997 1998
------------------ -----------------
Prepaid insurance financed by notes payable $ 6,569
Capital expenditures included in accounts payable $ 6,588 2,164
Sale of assets financed by notes receivable 1,439
7. SPECIAL CHARGES
The Company recognized special charges of $2.3 million and $11.9
million related to its inn renewal program for the thirteen week and thirty-nine
week periods ended September 27, 1997, respectively. During the thirteen week
and thirty-nine week periods ended October 3, 1998, the Company recognized
special charges of $0.4 million related to the termination of a Company pension
plan and $0.1 million related to costs incurred to address the Company's year
2000 issues.
8. SUBSEQUENT EVENTS
In October 1998, the Company repurchased the face amount of $27.6
million of senior unsecured notes due in 2003. In connection with the
repurchase, the Company will recognize an extraordinary charge against income of
$0.2 million, net of tax ($0.01 per share - basic and diluted) in the fourth
quarter related to the write-off of unamortized loan costs, net of discount. In
October 1998, the Company terminated its employment of certain officers and
employees. In the fourth quarter of 1998, the Company will recognize
approximately $1.5 million in severance costs related to these terminations.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
- - --------------------------------------------------------------------------
FINANCIAL CONDITION
- - -------------------
RESULTS OF OPERATIONS
- - ---------------------
The principal factors affecting Red Roof Inns' results are: occupancy
and room rates, continued growth in the number of inns, fee based income from
franchising and partner programs, the Company's ability to manage expenses, the
level of competition and seasonality. Demand, and thus occupancy, is affected by
normally recurring seasonal patterns and, in most locations, is lower in the
winter and early spring months than the balance of the year.
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The Company sold four operating inns and leased an operating inn to a
franchisee during the second quarter of 1998. The sale of these properties has
not had and should not have a significant effect on the results of operations of
the Company. Two Company owned inns and seven franchised inns opened during the
third quarter of 1998, increasing the total number of inns operating at October
3, 1998, to 279 (including 24 franchised inns). At September 27, 1997, 254 inns
were in operation, including two franchised inns. Unless otherwise indicated,
inn data presented in this report is based on the 238 inns (the "Comparable
Inns") that the Company owned and operated for the thirty-nine weeks ended
October 3, 1998 following four successive quarters as open, operating, fully
renovated or constructed properties. Management believes that the remaining 17
Company operated inns acquired or constructed (the "Inns in Stabilization") have
not been operated by the Company for a sufficient period to provide meaningful
period-to-period comparisons. Included in the Inns in Stabilization are acquired
inns that underwent renovation causing rooms to be out of service. Therefore,
the average daily room rates and occupancy for these inns are not comparable to
stabilized Red Roof inns. Both acquired and newly constructed inns historically
begin with lower occupancy and average daily rates which should improve over
time as these inns implement the Company's operating policies and procedures and
become integrated into the Company's central reservation system.
The following Comparable Inns data is a comparison of the thirteen
weeks and thirty-nine weeks ended October 3, 1998 versus the comparable periods
ended September 27, 1997. During the third quarter, the average daily rate
("ADR") increased $0.84 or 1.7%, from $50.25 per occupied room in 1997 to $51.09
per occupied room in 1998. Occupancy of 75.7% in the third quarter of 1997
remained unchanged for the comparable period in 1998. Revenue per available room
("REVPAR"), increased $0.64, or 1.7%, from $38.04 in 1997 to $38.68 in 1998. For
the thirty-nine weeks ended October 3, 1998, ADR decreased $0.86 or 1.8% from
$48.10 per occupied room in 1997 to $47.24 per occupied room in 1998. Occupancy
for the thirty-nine weeks increased 3.9 percentage points from 71.1% in 1997 to
75.0% in 1998. REVPAR for the thirty-nine weeks increased $1.23 or 3.6% from
$34.20 in 1997 to $35.43 in 1998. REVPAR increases have declined over the last
two quarters and the trend has continued into the fourth quarter. The Company
attributes the decrease in ADR for the thirty-nine weeks in 1998 to planned
price decreases earlier in the year coupled with recently implemented discount
programs targeted toward senior citizens and members of the American Automobile
Association (AAA). The decrease in ADR was more than offset by demand generated
by these programs which contributed to the occupancy and REVPAR increases. The
Company also attributes the positive effects of its revenue management system
and the substantial completion of its inn renewal program to the occupancy and
REVPAR increases.
THIRTEEN WEEKS ENDED OCTOBER 3, 1998 COMPARED TO THIRTEEN WEEKS ENDED
---------------------------------------------------------------------
SEPTEMBER 27, 1997
- - ------------------
The Company's revenues are principally derived from room rentals.
However, the Company's financial strategy is to focus on increasing its
fee-based income from franchising and partner programs. As part of this
strategy, the Company has significantly scaled back the development of
company-owned inns. As a result, revenue growth from company-owned inns has
slowed, while growth related to franchised inns and other fee-based programs is
beginning to increase. Revenues increased $3.3 million, or 3.3%, from $99.7
million in 1997 to $103.0 million in 1998. Revenues for the 238 Comparable Inns
(243 in 1997) increased $0.2 million from 1997 to 1998 primarily as a result of
the increase in REVPAR. Revenues for the Inns in Stabilization increased $2.8
million, of which $2.2 million resulted from eight inns opened since September
27, 1997. Revenues increased $0.3 million in 1998 over 1997 from programs
implemented in the third quarter of 1997 to franchise the Company brand and from
the formation of alliances with well-known consumer product and service
companies to promote partners' products and services.
Direct room expenses include salaries, wages, utilities, repairs and
maintenance, property taxes, room supplies and security. Direct room expenses
increased $3.3 million, or 8.1%, from $40.9 million in 1997 to $44.2 million in
1998. The increase is primarily due to operating additional inns and an increase
in net telephone expenses. As a percentage of revenues, direct room expenses
increased from 41.1% in 1997 to 43.2% in 1998.
Gross operating profit (hotel revenues less direct expenses) decreased
$0.3 million, or 0.5%, from $58.5 million in 1997 to $58.2 million in 1998. As a
percentage of room revenues, gross operating profit decreased from 58.9% in 1997
to 56.8% in 1998.
Depreciation and amortization increased $1.3 million from $7.8 million
in 1997 to $9.1 million in 1998. The increase primarily reflects depreciation of
operating inns acquired or developed during 1997 and 1998 and depreciation of
assets associated with the inn renewal program.
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Corporate expenses include the cost of general management, training and
field supervision of inn managers, franchising, development, reservations and
administrative expenses. Corporate expenses decreased $0.3 million, or 4.0%,
from $7.7 million in 1997 to $7.4 million in 1998. The decrease is primarily
related to reengineering initiatives implemented in the fourth quarter of 1997
which were offset by annual compensation increases for salaried and hourly
employees, increased reservation costs attributed to the operation of an
additional reservation center and the increase in occupancy. As a percentage of
revenue, corporate expenses decreased from 7.7% in 1997 to 7.2% in 1998.
Marketing expenses include the cost of media advertising and related
production costs, billboard expenses and expenses associated with the Company's
corporate sales group. Marketing expenses decreased $1.7 million, or 32%, from
$5.2 million in 1997 to $3.5 million in 1998. The decrease is primarily related
to the timing of a seven week national advertising campaign beginning in
mid-September versus a corresponding campaign which was completed in August
1997, and a reduction in outdoor advertising costs. The decrease was partially
offset by increases in payroll costs and expenses associated with additional
corporate sales staff. As a percentage of revenue, marketing expenses decreased
from 5.2% in 1997 to 3.4% in 1998.
In the fourth quarter of 1996, the Company commenced a chainwide inn
renewal program to refurbish the majority of its inns. The Company incurred
special charges of $2.3 million in 1997 associated with the inn renewal program.
During the thirteen week period ended October 3, 1998, the Company recognized
special charges of $0.4 million related to the termination of a Company pension
plan and $0.1 million related to costs incurred to address the Company's year
2000 issues.
Net interest expense remained unchanged at $11.2 million in 1997 and
1998.
The effective income tax rates for 1997 and 1998 were 39.3% and 38.9%,
respectively. The decline in the 1998 effective tax rate is due to a reduction
in state and local income taxes.
THIRTY-NINE WEEKS ENDED OCTOBER 3, 1998 COMPARED TO THIRTY-NINE WEEKS
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ENDED SEPTEMBER 27, 1997
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Revenues increased $20.9 million or 7.9% from $265.0 million in 1997 to
$285.9 million in 1998. Revenues for the 238 Comparable Inns and the five inns
sold in the second quarter of 1998 increased $9.4 million, or 3.7%, from $255.6
million in 1997 to $265.0 million in 1998. Revenues increased $9.4 million for
the Inns in Stabilization, of which $5.6 million resulted from eight inns opened
since September 27, 1997, with $3.3 million of the $5.6 million increase
attributed to the addition of six inns in 1998. Revenues increased $2.1 million
from programs implemented in the third quarter of 1997 to franchise the Company
brand and from the formation of alliances with well-known consumer product and
service companies to promote partners' products and services.
Direct room expenses increased $13.3 million, or 11.0% from $121.3
million in 1997 to $134.6 million in 1998. The expenses increased primarily
because of the addition of new inns, generally higher salary and wage expenses,
an increase in net telephone expenses and an increase in planned repairs and
maintenance expenses. As a percentage of revenues, direct room expenses
increased from 45.8% in 1997 to 47.4% in 1998.
Gross operating profit increased $6.2 million, or 4.3%, from $143.3
million in 1997 to $149.5 million in 1998 primarily as a result of operating
additional inns and increased REVPAR. As a percentage of revenues, gross
operating profit was 54.2% in 1997 and 52.6% in 1998.
Depreciation and amortization increased $3.3 million, from $24.5
million in 1997 to $27.8 million in 1998. The increase generally reflects
depreciation of new inns acquired since the third quarter of 1997 and
depreciation of assets associated with the inn renewal program.
Corporate expenses increased $1.4 million, or 6.3%, from $22.2 million
in 1997 to $23.6 million in 1998, primarily due to increased reservation costs
attributed to the operation of an additional reservation center and the increase
in occupancy and increased franchise expenses related to the franchise program
which were partially offset by reengineering initiatives implemented in the
fourth quarter of 1997. As a percentage of revenue, corporate expenses were 8.4%
in 1997 and 8.3% in 1998.
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Marketing expenses decreased $3.1 million, or 18.6%, from $16.6 million
in 1997 to $13.5 million in 1998. The decrease is primarily related to a less
expensive spring advertising campaign, the timing of a mid-year advertising
campaign completed in the third quarter of 1997 versus a similar campaign which
will primarily fall in the fourth quarter of 1998 and a reduction in billboard
expenses. These decreases were partially offset by increases in payroll costs
and expenses associated with additional corporate sales staff. As a percentage
of revenue, marketing expenses decreased from 6.3% in 1997 to 4.7% in 1998.
In the fourth quarter of 1996, the Company commenced a chainwide inn
renewal program to refurbish the majority of its inns. The Company incurred
special charges of $11.9 million in 1997 associated with the inn renewal
program. During 1998, the Company recognized special charges of $0.4 million
related to the termination of a Company pension plan and $0.1 million related to
costs incurred to address the Company's year 2000 issues.
Net interest expense increased $0.9 million, from $33.7 million in 1997
to $34.6 million in 1998 because of a higher average outstanding balance on the
bank facility related to the funding of construction and renovation activity.
The effective income tax rates for 1997 and 1998 were 39.3% and 38.9%,
respectively. The decline in the 1998 effective tax rate is due to a reduction
in state and local income taxes.
SUPPLEMENTAL INFORMATION
- - ------------------------
Management believes the following supplemental information presents
meaningful summary comparisons of on-going operations of the Company adjusted to
reflect the elimination of certain special charges to arrive at adjusted
operating income, net income and earnings per share amounts. These amounts do
not represent operating income, net income and earnings per share as defined by
generally accepted accounting principles.
Thirteen Weeks Ended Thirteen Weeks Ended
September 27, 1997 October 3, 1998
----------------------- ------------------------
Operating Net Operating Net
Income Income Income Income
As reported $35,841 $14,952 $38,386 $16,641
Special charges:
Inn renewal program 2,333 1,417
Year 2000 costs 90 55
Pension plan termination 371 227
------- ------- ------- -------
As adjusted $38,174 $16,369 $38,847 $16,923
======= ======= ======= =======
Earnings per share:
Basic $ 0.58 $ 0.61
======= ========
Diluted $ 0.58 $ 0.61
======= ========
Thirty-Nine Weeks Ended Thirty-Nine Weeks Ended
September 27, 1997 October 3, 1998
------------------------ -------------------------
Operating Net Operating Net
Income Income Income Income
As reported $68,441 $20,357 $85,876 $31,312
Special charges:
Inn renewal program 11,874 7,213
Year 2000 costs 90 55
Pension plan termination 371 227
Extraordinary loss 746
------- ------- ------- -------
As adjusted $80,315 $28,316 $86,337 $31,594
======= ======= ======= =======
Earnings per share:
Basic $ 1.01 $ 1.14
======= =======
Diluted $ 1.00 $ 1.14
======= =======
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CAPITAL RESOURCES AND LIQUIDITY
- - -------------------------------
GENERAL
Cash and cash equivalents decreased $0.9 million from $13.2 million on
January 3, 1998 to $12.3 million on October 3, 1998. Total debt outstanding
decreased $22.8 million from $551.2 million at January 3, 1998 to $528.4 million
at October 3, 1998. The decrease is due to $9.4 million in net payments on the
bank facility, $9.3 million of scheduled principal amortization of mortgage
notes and obligations under capital leases and the pay-off of $10.7 million of
mortgage notes from proceeds from the sale of assets, partially offset by a $6.6
million note to fund prepaid insurance premiums.
Management anticipates that its working capital needs will be financed
by internally generated cash and the bank facility.
CAPITAL EXPENDITURES
The Company substantially completed in the third quarter of 1998 its
inn renewal program to refurbish the majority of its inns. For the thirty-nine
week periods ended September 27, 1997 and October 3, 1998, the Company spent
$35.3 million and $7.8 million, respectively, for such capital improvements.
For the thirty-nine week periods ended September 27, 1997 and October
3, 1998, the Company spent $10.2 million and $18.7 million, respectively, in
connection with normal recurring capital maintenance improvements to existing
inns, corporate facilities and equipment and expects to spend a total of
approximately $20 million for such capital maintenance improvements for 1998.
Additionally, the Company is completing construction of new inns and renovation
of acquired properties. In connection with the construction and renovation of
these properties, the Company spent $34.1 million during the thirty-nine week
period ended October 3, 1998, and expects to spend approximately $12 million
through the end of the year.
During the thirty-nine week period ended October 3, 1998, the Company
spent approximately $0.5 million to acquire one construction site. Management is
currently evaluating whether to develop the site or sell the parcel to a
franchisee.
Currently, the Company has one construction site under contract to
purchase for an estimated cost of $3.3 million.
Management expects to fund the Company's capital expenditures
associated with improvements to the Comparable Inns and Inns in Stabilization
from cash flow from operations and from borrowings under the bank facility.
Expenditures for new construction, acquisitions and renovations will be financed
from these sources together with joint venture equity, property level debt and
available cash.
HISTORICAL CASH FLOWS
Cash provided by operations increased $14.1 million from $59.4 million
in 1997 to $73.5 million in 1998, due to the $11.0 million increase in net
income, a $1.2 million decrease in non-cash expenses and a $4.3 million increase
in various working capital components.
Net cash used by investing activities decreased $59.9 million from
$100.6 million in 1997 to $40.7 million in 1998, primarily due to proceeds of
$24.1 million from the sale of assets, a reduction in spending associated with
the inn renewal program and management's decision in late 1997 to curtail
company-owned inn development. Expenditures for property and equipment in 1998
include the acquisition of one development site for a total cost of $0.5 million
and $34.1 million related to construction on 16 development sites and renovation
of seven acquired properties.
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Net cash provided by financing activities decreased $65.2 million from
$31.6 million provided in 1997 to $33.6 million used in 1998, primarily as the
result of the reduced need for financing to fund company-owned inn development
and inn renewal costs, the early retirement of mortgage notes, net payments on
the bank facility, normal amortization of mortgage notes and capital leases and
the purchase of treasury stock for $5.4 million.
EBITDA
EBITDA is operating income plus the sum of interest income, other
income, depreciation and amortization. EBITDA for the thirty-nine weeks ended
October 3, 1998 increased $20.6 million from $93.7 million in 1997 to $114.3
million in 1998. EBITDA in 1997 includes a special charge of $11.9 million
related to the inn renewal program. EBITDA in 1998 includes special charges of
$0.5 million related to termination of a Company pension plan and to year 2000
costs. Had such special charges not been incurred, EBITDA would have been $105.6
million and $114.8 million in 1997 and 1998, respectively. EBITDA is not
intended to represent cash flow from operations as defined by generally accepted
accounting principles, and such information should not be considered as an
alternative to net income, cash flow from operations or any other measure of
performance prescribed by generally accepted accounting principles. EBITDA is
included herein because management believes that certain investors find it to be
a useful tool for measuring the ability to service debt and fund the Company's
operations.
YEAR 2000 ISSUES
The Company utilizes computer technologies throughout its business to
effectively carry out its day-to-day operations. Computer technologies include
both information technology in the form of hardware and software, as well as
embedded technology in the Company's facilities and equipment. Similar to most
companies, the Company must determine whether its systems are capable of
recognizing and processing date-sensitive information properly as the year 2000
approaches. The Company has substantially completed its assessment of all
date-sensitive hardware and software and has identified four critical areas
requiring remediation: property management systems at its inns, reservations
system, accounting systems and telephone switching equipment. The Company is
actively correcting and replacing those systems which are not year 2000
compliant in order to ensure the Company's ability to continue to meet its
internal needs and those of its suppliers and customers. This process includes
the testing of critical systems to ensure that year 2000 readiness has been
accomplished. The Company has taken the following actions to address year 2000
issues for its critical areas:
- Property management systems at the inns - All modifications to
software have been made to be year 2000 compliant. These modifications
are being tested and will be implemented by the end of the fourth
quarter of 1998.
- Reservations system - New software has been written in-house to be
year 2000 compliant and will be implemented during the fourth quarter
of 1998.
- Accounting systems - The Company has purchased accounting systems
software and hardware from outside vendors that are year 2000 compliant
and is currently installing and testing these systems and related
sub-systems. The Company expects implementation of the accounting
systems to be completed by the end of the first quarter of 1999.
- Telephone switching equipment - The Company has identified all
telephone switching equipment that is not year 2000 compliant and will
replace this equipment during 1999.
The Company currently believes it will be able to modify, replace, or
mitigate all affected systems in time to avoid any material detrimental impact
on its operations. If the Company determines that it may be unable to remediate
and properly test affected systems on a timely basis, the Company intends to
develop appropriate contingency plans for any such mission-critical systems at
the time such determination is made. While the Company is not presently aware of
any significant exposure that its systems will not be properly remediated on a
timely basis, there can be no assurances that all year 2000 remediations
processes will be completed and properly tested before the year 2000, or that
contingency plans will sufficiently mitigate the risk of a year 2000 readiness
problem. An interruption of the Company's ability to conduct its business due to
a year 2000 readiness problem could have a material adverse effect on the
Company.
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The Company estimates that all the aggregate costs for remediation of
year 2000 issues will be approximately $6 million, including $2.3 million of
costs already incurred. The total estimated aggregate costs include $4.8 million
of capitalized costs associated with the replacement of the Company's accounting
system and phone switches at certain of it's locations. In addition, the Company
estimates it will incur charges to earnings of $1.4 million of which $1.1
million will be incurred in 1998. The anticipated impact and costs of the
project, as well as the date on which the Company expects to complete the
project, are based on management's best estimates using information currently
available. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Based on
current estimates and information currently available, the Company does not
anticipate that the costs associated with this project will have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows in future periods.
The Company is heavily dependent on a national carrier for its
telephone services both at inn level and for its reservations system and a
national processing service for its credit card transactions. The Company has
initiated formal communications with its significant suppliers, customers and
critical partners to determine the extent to which the Company may be vulnerable
in the event that those parties fail to properly remediate their own year 2000
issues. The Company has taken steps to monitor the progress made by those
parties, and intends to test critical system interfaces, as the year 2000
approaches. The Company will develop appropriate contingency plans, to the
extent possible, in the event that a significant exposure is identified relative
to the dependencies on third-party systems. There can be no guarantee that the
systems of third-parties on which the Company relies will be converted in a
timely manner, or that a failure to properly convert by another company would
not have a material adverse effect on the Company.
FORWARD LOOKING STATEMENTS
This Form 10-Q includes certain forward looking statements, including
without limitation statements concerning the financing of the Company's working
capital needs, year 2000 issues, expected capital expenditures in connection
with improvements to existing properties, the sale of existing properties, the
purchase of and construction on sites under contract to purchase and
improvements and renovations to newly acquired properties. Any forward looking
statements contained in this Form 10-Q or any other reports or documents
prepared by the Company or made by management of the Company involve risks and
uncertainties, and are subject to change based on various important factors that
could cause actual results to differ materially from such forward looking
statements. The following factors, among others, in some cases have affected and
in the future could affect the Company's actual financial performance: economic
conditions, both national and regional; oversupply of hotel rooms; competition;
expansion into new markets; pricing and availability of construction materials;
changes in interest rates; availability of financing; and changes in federal,
state and local government regulations pertaining to building requirements,
environmental matters and year 2000 issues. For a more detailed discussion of
these factors, please refer to the section entitled "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Forward Looking
Statements; Certain Factors Affecting Future Results" in the Company's Annual
Report on Form 10-K for the fiscal year ended January 3, 1998.
PART II - OTHER INFORMATION
ITEM 5 - OTHER INFORMATION
- - --------------------------
None
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
- - -----------------------------------------
(a) Exhibits:
Ex - 27 Financial Data Schedule
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the thirteen weeks ended
October 3, 1998.
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SIGNATURE
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RED ROOF INNS, INC.
(Registrant)
Date: November 17, 1998 /s/ David L. Rea
-------------------------------------
David L. Rea
Executive Vice President,
Chief Financial Officer and Treasurer
Date: November 17, 1998 /s/ Robert M. Harshbarger
-------------------------------------
Robert M. Harshbarger
Senior Vice President, Controller
and Chief Accounting Officer
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