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 JUNE 30, 2002 COMMISSION FILE NO. 1-11915
CHOICE HOTELS INTERNATIONAL, INC.
10750 COLUMBIA PIKE
SILVER SPRING, MD. 20901
(301) 592-5000
Delaware 52-1209792
------------------------ ---------------------------------
(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
--- ---
SHARES OUTSTANDING
CLASS AT JUNE 30, 2002
- ------------------- ------------------
Common Stock, $0.01
par value per share 39,486,348
----------
================================================================================
1
CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION:
Consolidated Statements of Income -
Three and six months ended June 30, 2002 and June 30, 2001 (Unaudited) 3
Consolidated Balance Sheets -
June 30, 2002 (Unaudited) and December 31, 2001 4
Consolidated Statements of Cash Flows -
Six months ended June 30, 2002 and June 30, 2001 (Unaudited) 6
Notes to Consolidated Financial Statements (Unaudited) 7
Management's Discussion and Analysis of Operations and Financial Condition 11
Quantitative and Qualitative Analysis of Market Risk 14
PART II. OTHER INFORMATION AND SIGNATURE 15
2
PART I. FINANCIAL INFORMATION
CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended Six Months Ended
As revised As revised
(See Note 1) (See Note 1)
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
(Unaudited) (Unaudited)
REVENUES
Royalty fees $ 36,156 $ 36,048 $ 62,140 $ 63,003
Initial franchise and relicensing fees 3,596 3,331 5,737 5,649
Partner services revenue 4,341 3,964 6,492 5,902
Marketing and reservation revenues 54,497 39,253 98,349 73,658
Hotel operations 910 921 1,609 1,706
Other revenue 969 943 1,894 2,297
--------- --------- --------- ---------
Total revenues 100,469 84,460 176,221 152,215
--------- --------- --------- ---------
OPERATING EXPENSES
Selling, general and administrative 14,991 15,194 27,403 27,694
Depreciation and amortization 2,798 3,002 5,525 5,892
Marketing and reservation expenses 54,497 39,253 98,349 73,658
Hotel operations expense 736 661 1,389 1,181
--------- --------- --------- ---------
Total operating expenses 73,022 58,110 132,666 108,425
--------- --------- --------- ---------
OPERATING INCOME 27,447 26,350 43,555 43,790
--------- --------- --------- ---------
OTHER INCOME AND EXPENSES
Interest and dividend income (1,138) (1,023) (2,277) (2,172)
Interest expense 3,407 3,764 6,598 8,064
Equity loss on Friendly investment - 763 - 2,921
Gain on sale of investments - (42) - (42)
Write-off of deferred financing costs - 650 - 650
--------- --------- --------- ---------
Total other income and expenses 2,269 4,112 4,321 9,421
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 25,178 22,238 39,234 34,369
INCOME TAXES 9,872 8,673 15,354 13,404
--------- --------- --------- ---------
NET INCOME $ 15,306 $ 13,565 $ 23,880 $ 20,965
========= ========= ========= =========
WEIGHTED AVERAGE SHARES OUTSTANDING-BASIC 39,812 44,349 40,544 44,759
--------- --------- --------- ---------
WEIGHTED AVERAGE SHARES OUTSTANDING-DILUTED 40,663 44,778 41,332 45,174
--------- --------- --------- ---------
BASIC EARNINGS PER SHARE $ 0.38 $ 0.31 $ 0.59 $ 0.47
========= ========= ========= =========
DILUTED EARNINGS PER SHARE $ 0.38 $ 0.30 $ 0.58 $ 0.46
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated statements
of income.
3
CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
June 30, 2002 December 31, 2001
------------- -----------------
(Unaudited)
ASSETS
- ------
CURRENT ASSETS
Cash and cash equivalents $ 15,199 $ 16,871
Receivables (net of allowance for doubtful accounts of $5,444 and
$5,392, respectively) 33,394 25,223
Income taxes receivable and other current assets 329 889
-------- --------
Total current assets 48,922 42,983
PROPERTY AND EQUIPMENT, NET 68,086 70,458
GOODWILL, NET 60,620 60,620
FRANCHISE RIGHTS, NET 34,804 36,257
RECEIVABLE FROM MARKETING AND RESERVATION FUNDS 61,806 49,358
OTHER ASSETS 20,157 22,443
NOTE RECEIVABLE FROM SUNBURST HOSPITALITY CORP 41,281 39,059
-------- --------
Total assets $335,676 $321,178
======== ========
The accompanying notes are an integral part of these consolidated balance
sheets.
4
CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
June 30, 2002 December 31, 2001
------------- -----------------
(Unaudited)
LIABILITIES AND SHAREHOLDERS' DEFICIT
- -------------------------------------
CURRENT LIABILITIES
Current portion of long-term debt $ 15,479 $ 13,563
Accounts payable 29,196 24,724
Accrued expenses and other 22,736 30,054
Income taxes payable 4,765 2,836
--------- ---------
Total current liabilities 72,176 71,177
--------- ---------
LONG-TERM DEBT 305,635 267,733
DEFERRED INCOME TAXES ($46,417 and $35,159, respectively) AND
OTHER LIABILITIES 57,912 46,807
--------- ---------
Total liabilities 435,723 385,717
--------- ---------
SHAREHOLDERS' DEFICIT
Common stock, $.01 par value 394 420
Additional paid-in-capital 71,257 70,130
Accumulated other comprehensive income (loss) 201 (354)
Deferred compensation (2,300) (2,857)
Treasury stock (372,654) (311,053)
Retained earnings 203,055 179,175
--------- ---------
Total shareholders' deficit (100,047) (64,539)
--------- ---------
Total liabilities and shareholders' deficit $ 335,676 $ 321,178
========= =========
The accompanying notes are an integral part of
these consolidated balance sheets.
5
CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
Six Months Ended
As Revised
(See Note 1)
June 30, 2002 June 30, 2001
------------- -------------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 23,880 $ 20,965
Reconciliation of net income to net cash provided by operating activities:
Depreciation and amortization 5,525 5,892
Non-cash interest and dividend income (2,222) (2,117)
Non-cash stock compensation and other charges 397 359
Provision for bad debts 348 124
Equity loss on Friendly investment - 2,921
Write-off of deferred financing costs - 650
Changes in assets and liabilities:
Receivables (8,520) (260)
Receivable from marketing and reservation funds, net (6,181) 10,795
Current liabilities (2,621) (4,592)
Income taxes payable/receivable and other current assets 3,671 6,994
Deferred income taxes and other liabilities 11,357 (3,452)
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 25,634 38,279
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in property and equipment (6,229) (7,627)
Other items, net 828 (326)
Proceeds from Sunburst note - 101,954
--------- ---------
NET CASH (UTILIZED IN) PROVIDED BY INVESTING ACTIVITIES (5,401) 94,001
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt 210,802 344,392
Principal payments of long-term debt (171,016) (356,461)
Purchase of treasury stock (66,171) (134,552)
Proceeds from exercise of stock options 4,480 1,638
--------- ---------
NET CASH UTILIZED IN FINANCING ACTIVITIES (21,905) (144,983)
--------- ---------
Net change in cash and cash equivalents (1,672) (12,703)
Cash and cash equivalents at beginning of period 16,871 19,701
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 15,199 $ 6,998
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash payments during the period for:
Income taxes, net of refunds $ 978 $ 10,250
Interest 7,767 10,095
Non-cash investing activities:
Properties assumed through the restructuring of Sunburst note $ - $ 1,475
Non-cash financing activities:
Income tax benefit realized from employee stock options exercised $ 1,182 $ 256
The accompanying notes are an integral part of these
consolidated statements of cash flows.
6
CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Company Information / Basis of Presentation / Presentation of Marketing and
Reservation Fees and Expenses
The accompanying consolidated financial statements of Choice Hotels
International, Inc. and subsidiaries (the "Company") have been prepared by the
Company without audit. Certain information and footnote disclosures normally
included in financial statements presented in accordance with accounting
principles generally accepted in the United States of America have been 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, 2001 and notes thereto included in the Company's Form 10-K, dated
March 26, 2002 (the "10-K"). 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 in consolidation. Certain
reclassifications have been made to the prior year quarterly period financial
statements to conform to the current year presentation, however all
classifications are consistent with those in the 10-K.
The Company revised its presentation of marketing and reservation fees
during the fourth quarter of 2001 to comply with the Emerging Issues Task Force
("EITF") Issue 99-19 "Reporting Revenue Gross as a Principal versus Net as an
Agent." The Company had previously presented these fees net of related expenses
in its Consolidated Statements of Income. EITF 99-19 requires that these fees be
recorded gross and accordingly, the Company has revised its financial statement
presentation for all periods presented. In addition, net advances and repayments
of marketing and reservation fees have been reclassified to present these
activities as cash flows from operating activities for all periods presented.
These revisions have no effect on the net income or cash flows reported during
the periods presented.
2. Receivable from Marketing and Reservation Funds
The receivable from marketing and reservation funds at June 30, 2002 and
December 31, 2001 was $61.8 million and $49.4 million, respectively.
Depreciation and amortization expense incurred by the marketing and reservation
funds was $3.1 million and $2.9 million for the three months ended June 30, 2002
and 2001, respectively, and $6.3 million and $5.8 million for the six months
ended June 30, 2002 and 2001, respectively. Interest expense incurred by the
reservation fund was $0.3 million and $0.6 million for the three months ended
June 30, 2002 and 2001, respectively, and $0.7 million and $1.1 million for the
six months ended June 30, 2002 and 2001, respectively.
3. Restructuring Programs
During 2001, the Company recognized $5.9 million in restructuring charges.
The restructuring charges include severance and termination benefits for 64
employees (consisting of brand management and new hotels support, reservation
sales and administrative personnel and franchise sales and operations support),
the cancellation of preexisting contracts for termination of domestic leases and
exit costs related to the termination of a corporate hotel construction project.
The Company charged $0.9 million (including $0.8 million of termination
benefits) against the restructuring liability during the three months ended June
30, 2002 and $2.1 million (including $1.9 million of termination benefits) for
the six months ended June 30, 2002. As of June 30, 2002, the remaining $2.6
million liability is recorded in the accrued expenses and other line item on the
balance sheet. The remaining $2.6 million, which is comprised of termination
benefits, will be substantially paid in the year of 2002.
During 2000, the Company recognized $5.6 million in restructuring charges.
The restructuring charges include severance and termination benefits for 176
employees (consisting of property and yield management system installers,
reservation agents and field service administrative support), the cancellation
of pre-existing international lease contracts, and the termination of its
internet initiative launched in 1999. As of June 30, 2002, the Company maintains
a $0.2 million liability in accrued expenses and other on the accompanying
consolidated balance sheet, for the 2000 reorganization related to severance
benefits and international lease agreements. The Company expects the remaining
liability to be paid in 2002.
4. Income Taxes
The income tax provisions for the three and six month periods ended June
30, 2002 and 2001 are based on the effective tax rates expected to be applicable
for the corresponding full year periods. The 2002 and 2001 six month rates of
39% differ from the statutory rates primarily because of state income taxes.
7
5. Comprehensive Income
Comprehensive income was $15.7 million and $13.6 million for the three
months ended June 30, 2002 and 2001, respectively, and $24.4 million and $20.5
million for the six months ended June 30, 2002 and 2001. The differences between
net income and comprehensive income include foreign currency translation
adjustments and unrealized gains and losses on available for sale securities.
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
(In thousands) 2002 2001 2002 2001
---------------------- ----------------------
Net income $ 15,306 $ 13,565 $ 23,880 $ 20,965
Other Comprehensive income, net of tax:
Unrealized gains (losses) on marketable
equity securities (35) 27 80 12
Foreign currency translation adjustments 434 (3) 475 (526)
-------- -------- -------- --------
Other comprehensive income (loss) 399 24 555 (514)
-------- -------- -------- --------
Comprehensive income $ 15,705 $ 13,589 $ 24,435 $ 20,451
-------- -------- -------- --------
6. Earnings Per Share
Basic earnings per share ("EPS") amounts are computed by dividing earnings
applicable to common shareholders by the weighted average number of common
shares outstanding. Diluted EPS amounts assume the issuance of common stock for
all potentially dilutive equivalents outstanding.
7. 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, partner services revenue, marketing and reservation fees
and other. The Company is obligated under its franchise agreements to provide
marketing and reservation services appropriate for the successful operation of
its systems. These funds do not represent separate reportable segments as their
operations are directly related to the Company's franchising business. The
revenues received from franchisees that are used to pay for part of the
Company's central on-going operations are included in franchising revenues and
are offset by the related expenses paid from the marketing and reservation funds
to calculate franchising operating income. Corporate and other revenue consists
of hotel operations. The Company does not allocate interest and dividend income,
interest expense or income taxes to its franchising segment.
The following table presents the financial information for the Company's
franchising segment.
Three Months Ended June 30, 2002 Three Months Ended June 30, 2001
Corporate & Corporate &
(In thousands) Franchising Other Consolidated Franchising Other Consolidated
--------------------------------------- -----------------------------------------
Revenues $ 99,559 $ 910 $100,469 $ 83,539 $ 921 $ 84,460
Operating income
(loss) 38,165 (10,718) 27,447 40,493 (14,143) 26,350
Six Months Ended June 30, 2002 Six Months Ended June 30, 2001
Corporate & Corporate &
(In thousands) Franchising Other Consolidated Franchising Other Consolidated
--------------------------------------- -----------------------------------------
Revenues $174,612 $ 1,609 $176,221 $150,510 $ 1,705 $152,215
Operating income
(loss) 62,954 (19,399) 43,555 67,214 (23,424) 43,790
8
8. Commitments
As of June 30, 2002, the Company's letter of credit with Friendly Hotels
PLC (currently known as C.H.E. Group PLC) ("Friendly") is (pound)4.2 million
(approximately US $6.0 million). The Company extended its guarantee on the
letter of credit to June 30, 2003.
9. Impact of Recently Issued Accounting Standards
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets,"
on January 1, 2002, which updated accounting and reporting standards for the
amortization of goodwill and recognition of other intangible assets. SFAS No.
142 requires goodwill to be assessed on at least an annual basis for impairment
using a fair value basis. Because the Company operates in one reporting unit in
accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" and EITF 98-3, "Determining Whether a Nonmonetary
Transaction Involves Receipt of Productive Assets or of a Business", the fair
value of the Company's total assets are used to determine if goodwill may be
impaired. According to SFAS No. 142, quoted market prices in active markets are
the best evidence of fair value and shall be used as the basis for the
measurement if available. The Company is no longer required to record goodwill
amortization expense of approximately $2.0 million per year. Pursuant to the
requirements of SFAS No. 142, the Company will evaluate its goodwill and
intangibles for impairment on an annual basis and/or when events or
circumstances change that would more likely than not reduce the fair value of a
reporting unit below its carrying amount.
The impact of the adoption of SFAS No. 142 on our net income, basic EPS and
diluted EPS for the three and six months ended June 30, 2002 and 2001, as if the
adoption had taken place during the first quarter of 2001 is as follows:
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
(In thousands, except per share amounts) 2002 2001 2002 2001
------------------------- -------------------------
Reported net income $ 15,306 $ 13,565 $ 23,880 $ 20,965
Add back: Goodwill amortization - 511 - 973
---------- ---------- ---------- ----------
Adjusted net income $ 15,306 $ 14,076 $ 23,880 $ 21,938
========== ========== ========== ==========
Basic earnings per share:
Reported net income $ 0.38 $ 0.31 $ 0.59 $ 0.47
Goodwill amortization - 0.01 - 0.02
---------- ---------- ---------- ----------
Adjusted basic earnings per share $ 0.38 $ 0.32 $ 0.59 $ 0.49
========== ========== ========== ==========
Diluted earnings per share:
Reported net income $ 0.38 $ 0.30 $ 0.58 $ 0.46
Goodwill amortization - 0.01 - 0.02
---------- ---------- ---------- ----------
Adjusted diluted earnings per share $ 0.38 $ 0.31 $ 0.58 $ 0.48
========== ========== ========== ==========
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations," which addresses the accounting and reporting standards
for the retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 requires the fair value of a liability for an
asset retirement obligation be recognized in the period in which it is incurred
if a reasonable estimate of fair value can be made. The Company will be required
to adopt SFAS No. 143 by January 1, 2003. The Company does not expect the
adoption of SFAS No. 143 to have a material effect on the Company's earnings or
comprehensive income.
In September 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which updates accounting and
reporting standards for the recognition and measurement of impairment of
long-lived assets to be held and used or disposed of by sale. The Company
adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not
have an impact on the Company's earnings or comprehensive income.
10. Subsequent Events
On July 1, 2002, the Company entered into an agreement with Flag
International Limited, ("FIL") to increase the Company's investment in Flag
Choice Hotels ("FCH") (the "Flag Transaction"). In conjunction with the Flag
Transaction, Choice (i) converted an existing $1.9 (Australian) million
convertible note receivable from FCH to equity (approximately US$1.1 million)
increasing the Company's existing total equity investment in FCH from 15% to
30%, (ii) purchased an additional 25% of FCH from FIL for A$2.8 million
(approximately US$1.6 million) increasing the Company's total ownership in FHC
to 55%, and (iii) was granted authority to
9
enter into a put/call arrangement with FIL whereby either party can require the
Company to purchase the remaining 45% of FCH for A$2.0 million (approximately
US$1.1 million). The exercise period of the put option begins on January 1, 2003
and ends on June 30, 2007. The exercise period of the call option begins on July
1, 2004 and ends on June 30, 2007.
The Company will begin to consolidate FCH on the effective date of the Flag
Transaction, based on its 55% holding in FCH and its control over the board of
directors.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
Comparison of Three Month Period Ended June 30, 2002 Operating Results and Three
Month Period Ended June 30, 2001 Operating Results
The Company recorded net income of $15.3 million, or $0.38 per diluted
share, for the quarter ended June 30, 2002, compared to net income for the same
period of 2001 of $13.6 million, or $0.30 per diluted share. The increase in net
income for the period is primarily attributable to the $0.8 million equity loss
on the investment in Friendly for the three months ended June 30, 2001, a $0.7
million write-off of deferred financing costs for the three months ended June
30, 2001, and goodwill amortization of $0.5 million recorded during the second
quarter of 2001, which is no longer required under SFAS No. 142, "Goodwill and
Other Intangible Assets."
Franchise Revenues
Management analyzes its business based on "net franchise revenue," which is
total revenue excluding hotel operations and marketing and reservation revenues,
and franchise operating expenses which are reflected in selling, general and
administrative expenses.
The Company's franchise revenues were $45.1 million and $44.3 million for
the three months ended June 30, 2002 and 2001, respectively. Royalty revenue
increased by $0.2 million to $36.2 million for the three months ended June 30,
2002, from $36.0 million during the corresponding period in 2001. A slight
increase in royalty revenues was attributable to an increase of 145 domestic
units, coupled with a domestic effective royalty rate increase of 4 basis
points, partially offset by a 5.0% decline in RevPAR. Revenues generated from
partner service relationships increased by 7.5% from $4.0 million in 2001 to
$4.3 million in 2002 due to increased revenues earned from higher usage of guest
services programs available to franchisees. Under the partner services program,
the Company generates revenue from hotel industry vendors (who have been
designated as preferred providers) based on the level of goods or services
purchased by hotel owners and guests of the Company's franchised hotels.
The total number of domestic hotels online increased to 3,394 from 3,249,
an increase of 4.5% for the three months ended June 30, 2002, as compared to the
corresponding prior year period. This represents an increase in the number of
rooms open of 3.8% from 266,187 as of June 30, 2001 to 276,380 as of June 30,
2002. As of June 30, 2002, the Company had 391 hotels under development in its
domestic hotel system representing 29,765 rooms.
The total number of international hotels online was 1,032 as of June 30,
2002, compared to 1,184 as of the corresponding prior year period. The decrease
in international hotels online is primarily due to termination of certain Flag
properties not being appropriate for the Company's brand standards or due to the
Flag properties lack of interest in being a part of a formal franchise
relationship. The total number of international rooms was 84,294 as of June 30,
2002, compared to 88,574 as of June 30, 2001. As of June 30, 2002, the Company
had 191 franchised hotels under development in its international hotel system
representing 19,045 rooms.
Franchise Expenses
The cost to operate the franchising business is reflected in selling,
general and administrative ("SG&A") expenses. SG&A expenses decreased to $15.0
million from $15.2 million, a decrease of $0.2 million for the three months
ended June 30, 2002, as compared to the corresponding prior period. As a
percentage of total net franchising revenues, total SG&A expenses were 33.3% for
the second quarter of 2002, compared to 34.3% for 2001. The improvement in the
franchising margins relates to cost control initiatives from the 2001
restructuring and the economies of scale generated from operating a larger
franchisee base.
Marketing and Reservations
The total marketing and reservation fees received by the Company were $54.5
million and $39.3 million for the three months ended June 30, 2002 and 2001,
respectively. Depreciation and amortization expense incurred by the marketing
and reservation funds were $3.1 million and $2.9 million for the three months
ended June 30, 2002 and 2001, respectively. Interest expense incurred by the
reservation fund was $0.3 million and $0.6 million for the three months ended
June 30, 2002 and 2001, respectively. The Company's balance sheet includes a
receivable of $61.8 million and $49.4 million related to advances made to the
marketing and reservation funds as of June 30, 2002, and December 31, 2001,
respectively. Advances to the marketing and reservation funds represent the
legal obligation of the franchise system and the Company has the legal right to
demand repayment at any point.
Other
The Company acquired three MainStay properties from Sunburst in September
2000. For each of the three months ended June 30, 2002 and June 30, 2001, the
Company recognized $0.9 million, respectively, of revenue from hotel operations.
For each of the
11
three months ended June 30, 2002 and June 30, 2001, the Company recognized $0.7
million, respectively, of expenses from hotel operations.
For the three months ended June 30, 2002 and June 30, 2001, the Company
recognized approximately $1.1 million and $1.0 million, respectively, of
interest income from its subordinated term note to Sunburst.
The Company recorded an equity loss of $0.8 million for the three months
ended June 30, 2001, relating to changes in its equity investment in Friendly.
The loss was primarily due to adverse fixed asset valuation adjustments due to a
decline in economic conditions. The Company disposed of its entire preferred and
common equity interest in Friendly on March 20, 2002. As of June 30, 2002,
(pound)4.2 million (approximately US $6.0 million) is outstanding on the
existing letter of credit. The Company extended its guarantee on the letter of
credit to June 30, 2003.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
Comparison of Six Month Period Ended June 30, 2002 Operating Results and Six
Month Period Ended June 30, 2001 Operating Results
The Company reported net income of $23.9 million, or $0.58 per diluted
share, for the six months ended June 30, 2002, compared to net income for the
same period of 2001 of $21.0 million, or $0.46 per diluted share. The increase
in net income for the period is primarily attributable to the following pretax
items: a $2.9 million equity loss on the investment in Friendly for the six
months ended June 30, 2001; a $0.7 million write-off of deferred financing costs
for the six months ended June 30, 2001; a reduction of $1.5 million in interest
expense for 2002 due to a decrease in interest rates for the period; and
goodwill amortization of $1.0 million recorded during 2001, which is no longer
required under SFAS No. 142.
Franchise Revenues
The Company's franchise revenues were $76.3 million for the six months
ended June 30, 2002 and $76.9 million for the six months ended June 30, 2001.
Royalty revenue decreased by $0.9 million to $62.1 million for the six months
ended June 30, 2002, from $63.0 million during the corresponding period in 2001,
a decrease of 1.4%. This decrease is primarily attributable to a decrease in
domestic RevPAR of 6.2% from 2001, partially offset by the 4.5% growth in the
number of hotels online. Revenues generated from partner service relationships
increased 10.2% from $5.9 million in 2001 to $6.5 million in 2002 due to
increased revenues earned from higher usage of guest services programs available
to franchisees.
Franchise Expenses
Selling, general and administrative ("SG&A") expenses decreased to $27.4
million from $27.7 million, a decrease of $0.3 million for the six months ended
June 30, 2002, as compared to the corresponding prior period. As a percentage of
total net franchising revenues, total SG&A expenses remained constant for 2002
as compared to 2001.
Marketing and Reservations
The total marketing and reservation fees received by the Company were $98.3
million and $73.7 million for the six months ended June 30, 2002 and 2001,
respectively. Depreciation and amortization expense incurred by the marketing
and reservation funds were $6.3 million and $5.8 million for the six months
ended June 30, 2002 and 2001, respectively. Interest expense incurred by the
reservation fund was $0.7 million and $1.1 million for the six months ended June
30, 2002 and 2001, respectively. The Company's balance sheet includes a
receivable of $61.8 million and $49.4 million related to advances made to the
marketing and reservation funds as of June 30, 2002, and December 31, 2001,
respectively. Advances to the marketing and reservation funds represent the
legal obligation of the franchise system and the Company has the legal right to
demand repayment at any point.
Other
Revenue from hotel operations were $1.6 million and $1.7 million for the
six months ended June 30, 2002 and 2001, respectively. Expenses from hotel
operations were $1.4 million and $1.2 million for the six months ended June 30,
2002 and 2001, respectively.
For the six months ended June 30, 2002 and June 30, 2001, the Company
recognized $2.2 million and $2.1 million, respectively, of interest income from
its subordinated term note to Sunburst.
The Company recorded an equity loss of $2.9 million for the six months
ended June 30, 2001, relating to changes in its equity investment in Friendly.
The loss was primarily due to adverse fixed asset valuation adjustments due to a
decline in economic conditions. The Company disposed of its entire preferred and
common equity interest in Friendly on March 20, 2002.
12
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $25.6 million for the six
months ended June 30, 2002, a decrease of $12.7 million from $38.3 million for
2001. This decrease is primarily due to the net advances of $6.2 million made to
the marketing and reservation funds during the six months ended June 30, 2002,
versus net proceeds from the marketing and reservation funds of $10.8 million in
2001. The advances are due to the timing of advertising costs incurred
associated with the marketing fund. Also contributing to the operating cash
outflow was an increase in accounts receivable of $8.5 million for the six
months ended June 30, 2002, primarily due to the abnormally low balance at the
end of December 31, 2001, associated with the impact of the tragic events of the
September 11, 2001. Partially offsetting these adverse operating cash flows were
favorable increases in deferred income taxes of $11.4 million for the six months
ended June 30, 2002, which are primarily associated with changes in the
marketing and reservation fund balances and the disposition of the Friendly
stock.
At June 30, 2002, the total long-term debt outstanding for the Company was
$321.1 million, $15.5 million of which matures in the next twelve months.
The Company realigned its corporate structure in November 2001 to increase
its strategic focus on delivering value-added services to franchisees, including
centralizing the Company's franchise service and sales operations, consolidating
its brand management functions and realigning its call center operations. The
Company charged $0.9 million against the 2001 restructuring liability during the
three months ended June 30, 2002 and $2.1 million for the six months ended June
30, 2002. The Company expects the remaining $2.6 million liability to be
substantially paid in 2002. The Company also implemented a corporate-wide
reorganization during 2000 to provide improved service and support to the
Company's franchisees and to create a more competitive overhead structure. As of
June 30, 2002, the Company maintains a $0.2 million liability in accrued
expenses and other on the accompanying consolidated balance sheet, for the 2000
reorganization related to severance benefits and international lease agreements.
The Company expects the liability to be paid in 2002.
The Company had net cash advances of $6.2 million to the marketing and
reservation funds during the six months ended June 30, 2002. These advances are
primarily associated with the Company's winter/spring advertising campaign. The
Company has the right to recoup these advances as outlined in its franchise
agreements and expects to continue to recover the advances through future
marketing and reservation fees. The Company expects a positive net cash flow
from the marketing and reservation funds to approximate $15.0 million for the
year 2002. The receivable from the marketing and reservation funds is expected
to approximate $48.0 million at December 31, 2002.
For the first six months of 2002, the Company has repurchased 2.8 million
shares of its common stock at a total cost of $66.2 million. The Company has
authorization from its Board of Directors to repurchase up to an additional 2.4
million shares. At July 12, 2002, the Company has 39.5 million shares
outstanding.
The Company believes that cash flows from operations and available
financing capacity is adequate to meet the expected operating, investing and
financing requirements for the business for the immediate future.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this quarterly report, including those in
the section entitled Management's Discussion and Analysis, that are not
historical facts constitute "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act. Words such as "believes,"
"anticipates," "expects," "intends," "estimates," "projects," and other similar
expressions, which are predictions of or indicate future events and trends,
typically 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 and construction of hotels; the cost
and other effects of legal proceedings; 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 September 30, 2001. 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.
13
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 June 30, 2002 and December 31, 2001, the Company had $321.1 million and
$281.3 million of debt outstanding at an effective interest rate of 4.3% and
4.9%, respectively. A hypothetical change of 10% in the Company's effective
interest rate from quarter-end June 30, 2002 levels would increase or decrease
interest expense by $0.7 million. The Company expects to refinance the $115
million variable rate term loan as it amortizes throughout the maturity dates
using the Company's current Credit Facility. Upon expiration of the Credit
Facility in 2006, the Company expects to refinance its obligations. For more
information related to the Company's use of interest rate instruments, see
Long-Term Debt, Interest Rate Hedges and Fair Value of Financial Instruments in
the Notes to the Consolidated Financial Statements in the Company's December 31,
2001 Form 10-K.
14
PART II OTHER INFORMATION
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders of the Company was held on April 30,
2002. At the meeting, Stewart Bainum, Jr. and William L. Jews were elected to a
three year term expiring in 2005. The terms of the following directors continue
after the meeting:
Barbara Bainum
Charles A. Ledsinger, Jr.
Lawrence R. Levitan
Raymond E. Schultz
Ervin Shames
Jerry E. Robertson
No other matters were voted upon at the meeting.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 99 - Written statement of Chief Executive Officer and Chief
Financial Officer
(b) The following reports were filed pertaining to the period ended June 30,
2002.
Date of Report Item Reported Financial Statements Filed
-------------- ------------- --------------------------
May 6, 2002 Item 4 - Changes in None
Registrant's Certifying
Accountant
May 15, 2002 Item 4 - Changes in None
(8 - K/A) Registrant's Certifying
Accountant
15
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: August 14, 2002 /s/ Joseph M. Squeri
--------------- --------------------------------------
By: Joseph M. Squeri
Sr. VP, Development and Chief
Financial Officer
16