EXHIBIT 10.15
OMNIBUS AMENDMENT AGREEMENT
THIS OMNIBUS AMENDMENT AGREEMENT (this "Agreement") is made this
28/th/ day of December, 1998 by and between CHOICE HOTELS INTERNATIONAL, INC., a
Delaware corporation ("Choice"), and SUNBURST HOSPITALITY CORPORATION, a
Delaware corporation ("Sunburst").
WHEREAS, in connection with the spin-off of Choice by Sunburst (the
"Spin-off"), Choice and Sunburst entered into a Strategic Alliance Agreement
(the "Strategic Alliance Agreement") dated October 15, 1997 pursuant to which,
among other things, the parameters of the operating relationship between Choice
and Sunburst with regard to matters of mutual interest are set forth;
WHEREAS, the Strategic Alliance Agreement contains a form of
Franchising Agreement (the "Franchising Agreement") as Exhibit A to be entered
---------
into by and between Choice and Sunburst whenever Choice is to brand any hotel or
lodging property of any kind that Sunburst develops or acquires and intends to
franchise during the term of the Strategic Alliance Agreement;
WHEREAS, Choice and Sunburst have entered into numerous franchising
agreements substantially in the form of the Franchising Agreement and now desire
to amend the provisions relating to liquidated damages contained in the
aforementioned franchising agreements;
WHEREAS, Choice and Sunburst desire to eliminate the option contained
in the Strategic Alliance Agreement for Sunburst to purchase the Mainstay Suite
Hotels system from Choice in exchange for Choice's forgiveness of $16,900,000 of
the $19,900,000 receivable to Choice from Sunburst currently outstanding
pursuant to the Distribution Agreement;
WHEREAS, in connection with the Spin-off, Choice and Sunburst entered
into a Distribution Agreement (the "Distribution Agreement") dated October 15,
1997 pursuant to which, among other things, Choice agreed to loan to Sunburst
$115,000,000 which was evidenced by a subordinated note (the "Term Note") with
an aggregate principal amount of $115,000,000 and a maturity date of five years;
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WHEREAS, Choice and Sunburst desire to amend the Term Note;
NOW, THEREFORE, Choice and Sunburst agree as follows:
ARTICLE ONE
AMENDMENTS TO STRATEGIC ALLIANCE AGREEMENT
Section 1.1. Definitions. Any defined term used within this Article
-----------
One and not defined within this Agreement, will have the meaning ascribed to
such term in the Strategic Alliance Agreement.
Section 1.2. Elimination of Option to Purchase Mainstay Suite Hotels
-------------------------------------------------------
System. The Strategic Alliance Agreement is hereby amended such that Sections
- ------
4.3 and 4.4 of the Strategic Alliance Agreement are deleted in their entirety.
Section 1.3. Liquidated Damages Provision in Franchising Agreements.
------------------------------------------------------
Notwithstanding Section 3.1 of the Strategic Alliance Agreement and as long as
Sunburst is not in default under the Term Note:
(a) Any and all franchising agreements entered into prior to the date
hereof by and between Choice and Sunburst (or any of their respective
predecessors or affiliates), except any franchising agreements related to
(i) Mainstay Suites and Sleep Inns or (ii) any other hotels owned by
Sunburst that carried a Choice brand which is not sold by Sunburst within
three years from the date such hotel was reflagged with a different non-
Choice brand (the "Reflagged Hotels"), are hereby amended such that any
references to liquidated damages are deleted and Choice agrees that it
waives any claim it may have against Sunburst for lost future profits
arising from such franchising agreements; and
(b) Section 10.d.2 of the respective franchising agreements entered
into prior to, on or after the date hereof by and between Choice and
Sunburst related to Mainstay Suites and Sleep Inns or any Reflagged Hotel
is hereby amended to include the following:
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"Any liquidated damages to be paid pursuant to this section will
not exceed a maximum of $100,000."
Section 1.4. Development. Section 4.1 of the Strategic Alliance
-----------
Agreement is hereby amended and restated as follows:
Realco and Franchising are currently in the midst of a program under which
Realco will develop Sleep Inns and Mainstay Suite Hotels franchised by
Franchising. Realco agrees that absent (i) a material change in market
conditions that would render construction of further hotels pursuant to
this program uneconomical (meaning that reasonable projections by Realco
demonstrate that the hotel would provide a return on investment to Realco
that is less than the hurdle rate of return established by Realco for its
investments in similar types of hotels), (ii) Realco's inability to finance
construction or acquisition of such hotels, or (iii) Franchising's
discontinuance of efforts to support the Mainstay Suite Hotel brand, Realco
will continue to develop Sleep Inns and Mainstay Suite Hotels so that it
will have opened no fewer than a total of thirteen Sleep Inns and twenty-
five Mainstay Suite Hotels no later than forty-eight months from the
effective date.
Section 1.5. Other Amendments to Franchising Agreements.
------------------------------------------
Notwithstanding anything contained in any franchising agreements entered into
prior to the date hereof by and between Choice and Sunburst (or any of their
respective predecessors or affiliates), the following terms shall apply from and
after the date hereof to the relevant franchising agreements:
(a) Sunburst shall pay to Choice in cash an application fee of
$20,000 upon execution of a franchise agreement from and after the date
hereof.
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(b) No royalty, marketing or reservation fees shall be payable for a
period of two years with respect to the first ten such agreements entered
into by Sunburst after the date hereof and at the end of such period, the
initial fee schedule will commence; and such ten agreements shall contain a
provision permitting termination by either party only on the tenth or
fifteenth anniversary of the date of the contract.
(c) Choice agrees that if Sunburst sells any property that is the
subject of an existing franchising agreement, if that property is not past
due on any fees or failing a quality assurance review then Choice will
enter into a new franchise agreement on customary/market terms with the
buyer.
ARTICLE TWO
AMENDMENTS TO TERM NOTE
Section 2.1. Definitions. Any defined term used within this Article
-----------
Two and not defined within this Agreement, will have the meaning ascribed to
such term in the Term Note.
Section 2.2. Interest. Section 1.1 of the Term Note is hereby
--------
amended so that commencing on October 15, 2000 interest payable under the Term
Note shall accrue at a rate of 11.00% per annum compounded daily on both the
principal amount and the amount of unpaid interest outstanding under the Term
Note.
Section 2.3. Asset Sale Proceeds. Section 1 of the Term Note is
-------------------
hereby amended to include the following:
1.6. Asset Sale Proceeds.
-------------------
(a) The Payor will pay to the Payee within fourteen (14)
calendar days after the consummation of an Asset Sale by wire transfer to
the bank account designated by the Payee such aggregate principal amount of
this Note as equals fifty percent (50%) of Asset Sale Proceeds in excess of
the aggregate of amounts required to be used to pay secured Senior Debt and
the Payor shall apply the remaining fifty percent (50%) of Asset Sale
Proceeds to the development of Mainstay Suite Hotels.
-5-
(b) The Payor will provide the Payee notice in writing at least
fifteen (15) days prior to a proposed Asset Sale and such notice will
include a detailed description of the specific terms of the Asset Sale and
the proposed uses for the portion of the proceeds to be retained by Payor
in accordance with Section 1.6(a).
(c) The Payor will provide to the Payee within fourteen (14)
calendar days after the closing of an Asset Sale a certificate signed by
the Chief Financial Officer certifying the amount and form of consideration
received and the use of the Asset Sale Proceeds received in respect of such
Asset Sale.
Section 5 of the Term Note is hereby amended to include the following:
"Asset Sale" means the sale, transfer or other disposition (other than
----------
to the Payor or a Subsidiary) in any single transaction or series of
related transactions of (a) any capital stock of or other equity interest
in any Subsidiary unless such transfer is to another wholly-owned
Subsidiary or (b) any hotel or any interest in any hotel, the real property
on which any hotel is located, the personal property located at any hotel
(unless sold as part of a refurbishment of a hotel and the proceeds are
reinvested in the hotel), or the earnings or profits generated by any hotel
owned or operated by the Payor or any Subsidiary.
"Asset Sale Proceeds" means, with respect to any Asset Sale, (i) cash
-------------------
received (net of reasonable broker commissions and closing costs) by the
Payor or a Subsidiary from such Asset Sale (including cash received as
consideration for the assumption of liabilities incurred in connection with
or in anticipation of such Asset Sale) and (ii) promissory notes and other
non-cash consideration received (net of reasonable broker commissions and
closing costs) by the Payor or a Subsidiary from such Asset Sale or other
disposition upon the liquidation or conversion of such notes or non-cash
consideration into cash.
Section 2.4. Penalty Interest Payments. Section 1 of the Term Note
-------------------------
is hereby amended to include the following:
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1.7 Default Payments. Upon the occurrence and during the
----------------
continuation of any Event of Default, the outstanding principal amount
under this Note and, to the extent permitted by applicable law, any
interest payments thereon not paid when due, shall thereafter bear interest
(including post-petition interest in any proceeding under the applicable
bankruptcy laws) at a rate that is 2% per annum in excess of the interest
rate otherwise payable under this Note.
ARTICLE THREE
DISTRIBUTION AGREEMENT
Section 3.1. Satisfaction of Receivable. In consideration for the
--------------------------
termination of Sunburst's option to purchase the Mainstay Suites brand,
$16,900,000 of the $19,900,000 receivable currently owing from Sunburst to
Choice pursuant to Section 3.03 of the Distribution Agreement shall be deemed
satisfied and no longer due and owing. The remaining $3,000,000 of the
receivable is to be paid by Sunburst to Choice by wire transfer to the bank
account designated by Choice no later than three business days after the date
hereof.
ARTICLE FOUR
MISCELLANEOUS PROVISIONS
Section 4.1. Conflicts. In the event of any conflict between the
---------
terms of this Agreement and the terms of the Strategic Alliance Agreement, any
franchising agreement entered into by and between Choice and Sunburst referred
to in this Agreement, the Term Note, the Distribution Agreement and any other
documents related thereto and executed by one or more parties hereto in
connection with any of the aforementioned agreements, the terms and provisions
of this Agreement shall control.
Section 4.2. Agreements Remain in Effect. The Strategic Alliance
---------------------------
Agreement, any franchising agreement entered into by and between Choice and
Sunburst referred to in this Agreement, the Term Note and the Distribution
Agreement shall remain fully effective and are changed only as specifically
provided herein and shall bind the parties to each in all respects as originally
contemplated.
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Section 4.3. Counterparts. This Agreement may be executed in one or
------------
more counterparts, all of which taken together shall constitute one instrument.
SIGNATURES ON FOLLOWING PAGE
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IN WITNESS WHEREOF, intending to be legally bound hereby, the parties
hereto have executed this Agreement as of the day and year first written above.
CHOICE HOTELS INTERNATIONAL, INC.
_/s/ Michael J. DeSantis______
Name:
Title:
SUNBURST HOSPITALITY CORPORATION
__/s/James A. MacCutcheon_____
Name:
Title:
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13.1
<SEQUENCE>6
<DESCRIPTION>EXHIBIT 13.1
<TEXT>
Financial Highlights
Choice Hotels International, Inc. and Subsidiaries
Seven months
YEAR ENDED ended Fiscal years ended
DECEMBER 31, December 31, May 31,
1998 1997 1997 1996
---------------------------------------------------
COMPANY RESULTS (IN MILLIONS, EXCEPT PER SHARE DATA)
Royalty Revenues........................................ $115.4 $ 70.3 $ 97.2 $ 88.0
Total Revenues.......................................... 165.4 107.8 168.0 151.7
Recurring Income from Operations........................ 80.0 46.4 59.6 45.7
Recurring Net Income.................................... 46.7 27.3 34.7 25.4
Net Income.............................................. 55.3 27.3 34.7 11.7
Cash Flow from Operations............................... 44.1 33.6 45.5 32.7
Basic Earnings per Share (a)............................ $ 0.94 $ 0.46 $ 0.55 $ 0.19
Diluted Earnings per Share (a).......................... $ 0.93 $ 0.45 $ 0.55 $ 0.19
SYSTEM RESULTS - DOMESTIC ONLY
Revenue (estimated in millions)......................... $3,063 $1,862 $2,678 $2,381
Franchise Hotels Open................................... 3,039 2,880 2,781 2,495
Franchise Hotels Under Development...................... 866 725 710 616
Revenue Per Available Room.............................. $34.35 $36.39 $32.52 $31.60
(a) Note: December 1998 earnings per share includes $0.12 related to the early
extinguishment of certain long-term debt obligations.
[GRAPH OF HOTEL PROPERTY APPEARS HERE]
. Properties Under Development Worldwide
. Properties Open Worldwide
[GRAPH OF HOTEL ROOM APPEARS HERE]
. Rooms Under Development Worldwide
. Rooms Open Worldwide
To Our Shareholders:
[PHOTO APPEARS HERE]
Our company had a terrific year in 1998. Net income increased by 43 percent
to $55.3 million. The number of hotels in operation grew to more than 3,600 in
36 countries. At the same time, we managed the business well, keeping our
selling, general and administrative expense (SGA) virtually flat. As the world's
second largest hotel franchisor, we offer more than 110 million available room
nights to our guests, who continue to show high levels of satisfaction with our
brands.
This strong growth sets the stage for another banner year in 1999. Much of
the past year was dedicated to putting in place a revamped management team to
better define our long-term strategy. Much of our energy this year will be
devoted to enhancing our brand focus to provide our hotel guests and our
franchisees with added value.
We are eagerly moving forward, Building Value Through Brands of Choice -
for guests, for franchisees, for vendors, for our associates and for you, our
shareholders. This year's annual report tells the story of how we are building
that value, and why we believe Choice Hotels will prove a valuable investment
for its many constituents.
As a pure-play franchising company, Choice has no direct real estate
ownership exposure. It has significant, growing free cash flow, an experienced
management team and proven business systems. With more than 2,300 franchisees,
no franchisee accounts for more than 5 percent of total royalty revenues. So the
basic attributes of the business are fundamentally sound.
We have a superb foundation for future growth. And, we have a rich heritage
in the lodging industry as an innovator and a leader, dating back 60 years to
the first meeting of Quality Courts owners.
A Vibrant, Growing Industry
Some of you may wonder about the overall state of our industry. In 1998,
the hotel industry earned record profits of $20 billion, as room demand remained
very strong and new supply came on line in key markets. Some industry observers
raised the possibility of a slowdown in development because supply growth moved
slightly ahead of demand growth. As a result of the perceived slowdown, stock
prices for the industry as a whole endured a drop.
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But our experience in the segments we serve shows that the level of demand
remains strong and will continue in a vibrant economy. This demand continues to
encourage sound development in key locations. Our franchised hotels are less
affected by tightening of credit markets because many of our projects are
financed locally and have significant equity in them.
For 1999, many observers are forecasting another strong year for the
industry since the economy shows little sign of slowing down. The surprising
fourth quarter 1998 growth reported for the economy and the growing government
surplus lead most economists to conclude that the risk of any recession is
fading. If these trends hold, we have every expectation that 1999 will be a year
of excellent growth for our branded hotels.
Growth Platforms For The Future
Looking to the future, we have two growth platforms: our organic hotel
growth and the distribution opportunity afforded by those 110 million available
room nights.
By organic hotel growth, I mean the franchise development through which we
continue to add hotels marketed under our brands: Comfort, Quality, Clarion,
Sleep Inn, Econo Lodge, Rodeway Inn and MainStay Suites. These brands enjoy
growing consumer recognition and acceptance. They provide us with new
construction and conversion development opportunities, both domestically and
internationally.
In the past year, we executed 440 new hotel franchise contracts and opened
318 new hotels in the United States. At the beginning of this year, we had 866
domestic projects in design or under development, as well as another 611
international hotels in the pipeline.
Because we already have the infrastructure needed to service these hotels,
such as our reservations system, our regional Market Area support and our
International Regions, each new hotel adds significantly to our bottom line. At
the same time, we are investing substantial resources to improve our
infrastructure, including new computer capability for our central reservations
system in Phoenix, an expanded call center in Minot, N.D., and the rollout of
Profit Manager, our proprietary property management system for our hotels.
This year we also will open THE LEARNING CENTER, a new facility for
training hotel owners, general managers and our associates. A key component of
that training will be Choice Operations and Revenue Enhancement (CORE) training,
which is designed to speed the integration of new properties into the Choice
system and improve performance at the property level.
We also are tightening our brand standards and raising the bar on our
quality assurance inspections. By sharpening our focus on service and quality in
our franchisees' hotels, we help protect their individual investments and give
our guests a more satisfying
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stay. Higher brand standards lead to more added value for our guests. And, in a
highly competitive market, the battle for market share will be won by those who
exceed their promises to the public.
Distribution Driving Future Growth
Which leads me to our second growth platform: distribution. With more than
110 million available room nights and 3,600 franchised properties in our system,
we have a tremendous opportunity to take advantage of our scale and create new
revenue streams for a host of products and services.
On our franchise side, we have created a proprietary purchasing system,
ChoiceBuys.com, for our franchisees. Through the Internet, they can purchase
goods and services for their hotels at our volume discounts. This program serves
as a solid business model for other parts of our enterprise.
We believe that we can create a similar service for our guests that will
open up new revenue streams while adding greater value to our room stay
experience and to our franchisees. Discussions are underway with vendors, and we
are hopeful to make this opportunity a reality for us in short order.
What makes this distribution opportunity so attractive is that our hotels
operate in segments that reach about 70 percent of the domestic hotel guests
available. With the sheer number of hotels in our system, the demographics of
our guests and the scope of our operations worldwide, we believe we will have
something truly unique to offer our guest and franchisees.
A World Of Opportunity
The international arena provides us with a promising opportunity - and a
challenge. The opportunity lies in the vast number of markets available to us
for development and expansion of our brands. The challenge comes in finding the
right strategic partners to establish hotel franchising as a valued and viable
business concept in parts of the world where franchising is truly foreign.
In 1998, our partnerships with the Friendly organization in Europe and the
Flag organization in Australia gave us new momentum to spur international
growth. In Great Britain and Europe, our agreement with Friendly brought 250
properties in 10 countries under the Choice Hotels Europe banner into our
system. Down under, our strategic alliance with Flag will bring almost 500
hotels into our system in 1999.
Other territories are opening up as well. Choice Atlantica, our partner in
South America, has announced plans to develop 140
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Comfort, Quality, Clarion and Sleep Inn hotels over the next five years. In
Japan, the Vessel Group has unveiled plans to build 20 Sleep Inn hotels
throughout eastern Japan.
A Word Of Thanks
When I joined Choice last September, I found a company with solid
fundamentals - great hotel brands, widespread consumer recognition, successful
reservations and business systems, a strong base of committed franchisees and a
dedicated core of 2,000 associates, many of whom have served our company for two
and three decades.
Having worked for almost two decades in the hospitality industry, I
appreciate the innovation Choice has brought to the industry. I also value the
willingness of our associates to accept new leadership and new ideas. I cannot
thank them enough for the warm reception I have received.
In 1998, two company leaders who played crucial roles in the company's
growth and evolution into an industry leader retired from our Board of
Directors. Stewart Bainum and Bob Hazard gave many years of dedicated service to
Choice. Their legacy is a company that is the second largest hotel franchisor
in the world. We salute them for their achievements and wish them well.
At the company's Annual Meeting this April, Fred Malek, a nine-year member
of our Board, will be stepping down as well. We wish Fred every success in his
future endeavors. Joining our Board on February 1, 1999, was Larry Levitan,
recently retired from a 34-year career with Andersen Consulting, having most
recently served as head of the Worldwide Communications Industry Group. Larry's
vast experience in finance, technology and international business will serve our
company well.
I am very excited about this company, its business prospects and the future
we can create working together with our associates, franchisees and strategic
partners. We enjoy the support of a committed Board of Directors, whose
expertise has proven invaluable in creating a long-term strategy to drive this
company to even higher performance.
Thank you for your continued support as we define an even brighter future
for Choice Hotels.
/s/ Charles A. Ledsinger, Jr
Charles A. Ledsinger, Jr.
President & Chief Executive Officer
5
Creating Value For Every Occasion
The lodging business is an occasion-driven business. So a hotel
franchising company faces the critical challenge of offering the right choice, A
CHOICE WITH STRONG VALUE, to its prospective guests in order to gain and grow
market share.
"Our seven brands span the widest range of customer segments of any hotel
company, from economy to mid-priced to upscale," said Mark Wells, senior vice
president of marketing. "So we are in a great position to match our offerings
with what guests truly need on any occasion."
[LOGO APPEARS HERE]
For business or leisure travelers, those choices meet a broad range of
price and amenity needs, so that Choice brand hotels can serve more than 70
percent of the total domestic hotel guest market.
Comfort, the company's largest single brand with more than 1,500 Comfort
Inn hotels and almost 200 Comfort Suites hotels, succeeds by delivering on the
promise of its name.
"Our hotels strive to consistently provide a comfortable, high-value stay
for business and leisure travelers," explained Dan Shoen, Comfort brand
management vice president. "Our suites product has given guests another good
reason to seek out the Comfort brand."
In Econo Lodge and Rodeway Inn, the company's economy brands, brand
management provides value-added programs that attract guests from distinct
niches.
[PICTURE APPEARS HERE]
In conjunction with Procter & Gamble's Mr. Clean brand, the Econo Lodge
brand has just launched the first program in the industry to certify
housekeepers, with the goal of providing a clean room guarantee to guests.
[PICTURE APPEARS HERE]
"By teaming up with a recognizable, reputable consumer brand like Mr.
Clean, we provide our Econo Lodge franchisees with a new edge in attracting
value-oriented consumers looking for cleanliness assurance," said Tim Shuy,
Econo Lodge brand management vice president.
Mike Cothran, Rodeway Inn brand management vice president, noted, "We know
that Rodeway Inn hotels have special appeal for value-seeking guests,
particularly senior citizens. That is why we have targeted our marketing to
highlight that 25 percent
6
[PICTURE APPEARS HERE]
The Clarion Hotel
Pembroke Corporate Center, an upscale hotel in Virginia Beach, Va., relies
on direct sales support and guidance from Choice to help fill its conference and
banquet facilities as well as its 149 guest rooms.
"We have worked well with Choice over the years," said General Manager Tony
Torbati. "They have done a good job of providing information to us about company
programs."
A productive relationship with Choice is especially important to Richard
Wilburn, the hotel's sales director, because the hotel is faced with the
challenge of maximizing revenue in a seasonal destination.
"I meet face-to-face with Kim Ellison, Choice's franchise service director,
several times a year," he said. "She shows us how best to take advantage of
Choice's programs to improve our revenues and occupancy."
The hotel, owned by Sunburst Hospitality Corp. of Silver Spring,
Md., was honored with a Gold Hospitality Award in 1998, signifying that it had
exceeded Choice's quality standards for exceptional service, facilities and
hospitality.
of our rooms are designated Choice Room for seniors, with special amenities such
as brighter lighting, large-button phones and level-handle doors."
In a different part of the brand spectrum, Clarion brand management vice
president Don Kolodz is working with franchisees to bring better definition to
the brand.
"As our entry in the upscale, full-service market, the Clarion brand gives
us an offering of high value for business customers seeking full-service
amenities," he said. "With meeting space and food and beverage service as brand
hallmarks, we can provide meeting planners with an affordable alternative in the
upscale market."
[GUEST PRIVILEGES LOGO]
As a major step in building both brand identity and brand loyalty, the
company launched Guest Privileges, a frequent stay rewards program, in the fall
of 1998. Guest Privileges members can earn free stays, gifts and travel by
choosing select Choice brand hotels (Comfort, Quality, Clarion, Sleep Inn) for
their lodging. In addition to a free stay after just 10 visits, the program
also allows members to earn points that can be used with such partners as
American Airlines, JC Penney, the Home Depot and Eddie Bauer.
[PICTURE APPEARS HERE]
Rebecca Ferrin, member services coordinator, enrolls another Guest Privileges
member in Choice's new rewards program for frequent guests.
Building Value In Each Hotel
Given the highly competitive nature of the hotel franchising business,
Choice continues to improve and diversify the products and services it makes
available to franchisees. At the heart of that competition is the drive to stay
on the leading edge of technology.
"Like virtually every other business at the end of this century, the hotel
industry is changing rapidly with new technology," said Tom Mirgon, senior vice
president of administration. "We have to bring greater value to our franchises
by giving our franchisees the best technology options to keep their properties
operating at maximum effectiveness."
[LOGO OF PROFIT MANAGER APPEARS HERE]
To enable franchisees to better manage their hotels, Choice is implementing
Profit Manager, a proprietary property management system designed to manage
reservations, rates and inventory more efficiently and effectively.
Janna Morrison, vice president of property systems, acknowledged the
challenge of the ambitious project to outfit every Clarion, Quality, Comfort,
Sleep Inn and MainStay Suites hotel with Profit Manager by the end of 2000.
"In our first roll-out phase in 1997, we encountered some difficulties in
larger properties with managing group business," she explained. "As a result, we
designed a new release of the software, and we will continue to evolve the
product to meet our franchisees' needs."
A comprehensive Windows-based system, Profit Manager includes InSync, a
communications tool that allows instantaneous synchronization between the CHOICE
2001 central reservations system and each hotel. CHOICE 2001 gathers
reservations from a variety of sources, including global distribution systems
(GDS) run by airlines, the Internet and call centers to provide the ability to
manage room inventory and rates. This real-time, two-way communication helps
increase property revenue and decrease the likelihood of overbookings.
Profit Maximizer, another Profit Manager feature, helps the individual
hotel predict future occupancy and demand for hotel rooms. Using past property
data, each hotel can forecast future stay patterns and more effectively set
rates to meet guest demand.
For the company's economy hotel brands, Econo Lodge and Rodeway Inn, the
company has developed ChoiceLink for Windows to provide a gateway to
reservations through CHOICE 2001, thus giving them access to the GDS and
Internet.
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[LOGO]
Choice's Strategic Partnerships program is another way to build value for
both guests and franchisees. Operating under a "4-Win" strategy, the program
ensures that products and services endorsed by Choice benefit the guest, the
franchisee, the vendor and Choice.
"The guest enjoys brand-name products and services that help build guest
loyalty for the franchisee, who also benefits from competitively priced
products," explained Daniel Rothfeld, vice president, partner services. "Vendor
partners gain access to a critical mass of franchisees, which in turn generates
residual income for the company."
When Choice needs a well-managed hotel with technologically savvy personnel to
help test the latest version of its Profit Manager property management system
software, one of the places it turns is the Comfort Inn hotel of Scottsdale,
Ariz., the 1998 Comfort Inn of the Year award winner.
The 124-room property, owned by Zenith Management of Duluth, Minn., is
located just five miles from Choice's Western Regional Headquarters where Choice
software programmers develop and refine products, including Profit Manager, the
company's state-of-the-art property management system.
"With its consistently high occupancy, the Comfort Inn hotel of Scottsdale
is a perfect `beta site' for testing new releases of Profit Manager software,"
said Christopher Yellen, Choice director of product management. "They can
thoroughly test all aspects of Profit Manager in real day-to-day business
situations,"
David Dolliver, the hotel's general manager, noted he and his staff are
happy to help test Profit Manager and any other software designed to make his
hotel more profitable. "We have a great relationship with Choice, and we're
eager to continue working with them to make programs like Profit Manager the
best they can be," he said.
Serving as a test site offers certain advantages, including the opportunity
to suggest changes to benefit local hotel operators. "Not only are we one of
the first to see and use the most up-to-date version of a particular software
program, but we have the opportunity to provide input from an operations
standpoint that hopefully will enhance the program for all users," he said.
[PICTURE APPEARS HERE]
David Dolliver (right), general manager of the Comfort Inn in Scottsdale, Ariz.,
reviews the new Profit Manager property management software with Robert Mason
(left), Choice manager of information systems administration, and Christopher
Yellen, Choice director of product management.
The Quality brand's Serta bed program underscores the value of this
initiative. Banking on the inherent quality of the Serta name, Quality brand
hotels promote the restful sleep assured by the Serta beds featured in every
room. Taking the program one step further, participating Quality brand hotels
now can offer guests the opportunity to purchase Serta beds at a significant
discount.
"The Serta bed promotion gives everyone an opportunity to win," said Pete
Jordan, Quality brand management vice president. "Our guests not only can enjoy
the Serta experience in our hotels, but now they can take it home. Franchisees
can offer guests a `quality' night's rest. And Serta, our preferred vendor,
gains access to yet another sales channel."
[PICTURE APPEARS HERE]
Another value-added service for franchisees is the Internet Project
Management system, or IPM, which consolidates the design, sourcing, purchasing,
management and financing of renovation and refurbishment projects into a single
turnkey, competitively priced package for franchisees. Through partner
relationships with The Gettys Group, an interior design and procurement firm,
and McClier Corporation, a leading architecture, engineering, construction and
project management company, the level of service has been enhanced through
access to these services over the Internet and a toll-free hotline.
As a successful underpinning to the franchisor-franchisee relationship,
Choice continues to review and update its franchise agreement to stay
competitive in the industry.
"We have worked hard to improve our basic agreement by rewriting it into plain
English and reducing its
[PICTURE APPEARS HERE]
length significantly," said Michael DeSantis, senior vice president, general
counsel & secretary. "We just announced a reduction in the cap on liquidated
damages paid upon termination, from 60 months to 36 months. This revision
follows another recent cutting edge change to the agreement, which implemented
five year mutual outs for franchisees in good standing, making Choice one of
only a few hotel franchisors to provide this opportunity."
Confronted with new competition springing up around their nine-year-old Econo
Lodge hotel in Lenoir City, Tenn., owner-operator Howard Patel and his family
carefully considered strategies for maintaining their impressive base of
business. They decided to participate in the Econo Lodge Exterior Enhancement
Program, a solution devised by Choice to revitalize the brand's older
properties. Since the program was introduced three years ago, the more than 320
franchisees who participated have seen the performance of their hotels improve
significantly.
Choice helped the Patel family design a pleasing new facade featuring
columns, parapets, arches, a canopy entrance and improved lighting. The
objective was to modernize the hotel's exterior to more accurately represent the
value of its guest rooms, which are upgraded on an ongoing basis.
"In the lodging business, it's important to stay on top of the competition
so that you don't lose your existing guests," Patel said. "The Econo Lodge
Exterior Enhancement Program has helped us hold our own and compete effectively
against the new hotels that are being constructed in our market."
Patel manages the 42-room hotel in partnership with his wife, Indira, and
the help of their college-age sons, Ketan and Hitesh. They have taken several
additional steps to make the property stand out from the pack. For example,
they introduced free continental breakfast, put hair dryers in every room,
upgraded guest room television sets to 25-inch models and established a policy
of free local telephone calls.
[PICTURE APPEARS HERE]
Owner Howard Patel and his wife, Indra, are proud of the exterior renovation of
their 42-room Ecomo Lodge hotel in Lenior City, Tenn.
Providing Value To Every Customer
Each day brings new opportunities for Choice's 2,000 associates to serve a
myriad of customers - hotel guests, franchisees, shareholders and strategic
partners.
Before a hotel opens its doors, Choice associates work hard to help
franchisees launch a successful property. "For our Sleep Inn brand we hold a
pre-construction meeting with each new franchisee to review the operational and
marketing resources available from Choice," said Norm Cavin, Sleep Inn brand
management vice president.
The drive to provide more value through successful hotel openings has led
to creation of a new team of property opening specialists who work with
franchisees to develop marketing plans and programs that will get the property
operating at market level more quickly.
12
"The sooner a hotel can ramp up its occupancy and bring its room rate to
market level, the better the franchisee feels about his or her investment, and
the faster our royalties can grow," said Wells. "Working with our Market Area
staff, we've created a program that can add value for all concerned."
To further generate business for its franchisees, Choice also maintains a
strong national sales program aimed at travel agents, tour operators,
corporations and other high volume accounts. Last fall, the company enrolled all
of its franchisees as members of the American Society of Travel Agents (ASTA) to
enhance the relationship with the travel agent community. Unlike many other
hotel companies, Choice continues to pay full commissions on business placed
through travel agents.
At the same time, the company cultivates its relationships with travel
promotion organizations such as AAA through special discount programs for AAA
members at Choice brand hotels and by encouraging franchisees to earn and
improve their AAA designation.
[LOGO OF AAA APPEARS HERE]
This same dedicated spirit helps Choice internationally, working with
master franchisees to open up new territories for Choice hotel brands. A 1998
agreement with the Flag organization in Australia will bring almost 500 hotels
into the Choice global system, generating greater brand equity and driving more
business to Choice hotels in the United States and internationally.
[LOGO OF FLAG APPEARS HERE]
"As our brands truly become more global, and as guests experience their
amenities and services in their own countries, we will cultivate travelers
coming to our domestic locations looking for the same satisfaction," noted Bruno
Geny, senior vice president, international.
While strengthening its regional teams internationally for further growth
and development worldwide, Choice also is undertaking globalization of marketing
services and brand management to improve its marketing to leisure and business
travel intermediaries.
For developer Greg Averbuch, it all comes down to synergy. Averbuch, president
of Summit Management Corp., uses the word a lot when describing the Sleep Inn
and MainStay Suites hotels he plans to operate side by side in Atlanta. He also
views his relationship with Choice as highly synergistic.
Averbuch opened his first Choice franchise, a Sleep Inn hotel, in downtown
Memphis, Tenn., in 1996. It has performed exceptionally well and received a
Choice award in 1998 for achieving the highest RevPAR of any Sleep Inn hotel.
The success of his Memphis property not only inspired Averbuch to build a
second Sleep Inn hotel in Atlanta's Buckhead section but also to consider
another Choice brand for a plot of land directly adjacent to the new Sleep Inn
site. "I wanted a brand that would complement Sleep Inn by meeting different
needs for the same customer," he said.
Enter Choice's MainStay Suites mid-priced, extended-stay brand. "By
offering a new, fresh lodging product for extended-stay guests directly next
door to a similarly positioned product for transient guests, we are truly a
full-service provider here in Atlanta," Averbuch said. "It's brand segmentation
at the local level."
According to Averbuch, Choice professionals were integrally involved in
each step of the development and marketing phases for both Sleep Inn projects
and for the new MainStay Suites hotel. "Choice ensures consistency in these
products by being available for consultation throughout, from groundbreaking
through construction," he said.
[PICTURE APPEARS HERE]
Anne Curtis (left), Choice director of corporate communications, reviews plans
for the grand opening of the Sleep Inn in Atlanta with Owner Greg Averbach.
14
"Our greater brand focus will give us global brands with clear definition and
differentiation," said Wells. "We can build on our presence in 36 countries to
become the pre-eminent global lodging franchisor if we can create the proper
value proposition for our regional partners and property owners."
The Value Is In Our Name.Choice
There are three basic reasons for a hotel franchisor to offer a portfolio
of different brands: (1) to serve different customer demographics and
lifestyles; (2) to serve different travel occasions; or (3) to effectively do a
combination of both.
Choice does both. After all, it's in the name. The company offers both
traveling consumers and hotel franchisees the best and most varied choice of
lodging in the industry. From the economy segment to the upscale market,
diverse brands provide more than 110 million available room nights a year around
the globe. Beneath the Choice identity are seven distinct hotel brands, each
serving a par-
Located in the Buckhead section of Atlanta, the new 142-room Sleep Inn is the
200/th/ hotel opened under that brand since the brand's introduction in 1989.
[PICTURE APPEARS HERE]
ticular segment of the broad travel industry. At a time when the industry is
undergoing consolidation, new brands are being unveiled and old brands are being
revamped, the ability to differentiate brands becomes more critical.
"We must trade on our brand diversity," said Wells. "We must continue to
create an understandable and unique identity for each of our brands by focusing
on offering guests clear choices."
In the fiercely competitive market for guests visiting Colonial Williamsburg,
Va., one of the top tourist destinations in the country, the 118-unit Quality
Suites hotel has gained a decisive advantage by offering two-room suites with
separate living and sleeping areas.
"In this area, many traveling families are looking for more than just a
standard room," said Joe Puhl, general manager. "Guests also appreciate our
hotel's free full buffet breakfast and room amenities, such as free coffee, a
refrigerator, microwave, two remote-controlled televisions, a video cassette
player, stereo cassette player and the Quality Sleeper mattress by Serta."
Business travelers ask for the hotel's Quality Executive Rooms, which
feature a large work desk, speakerphone with data port and easy chair, in
addition to all the other standard amenities.
The hotel, owned and operated by the Newport Hospitality Group of
Williamsburg, received a top honor from Choice in 1998, the Gold Hospitality
Award, for exceeding Choice's rigid quality assurance standards.
Last year, Gold Hospitality Awards were presented to just six percent of
the eligible hotels in the Choice system.
[PICTURE APPEARS HERE]
Joe Puhl, general manager, shows off the breakfast offered at his Quality
Suites hotel in Williamsburg, Va.
Choice's close working relationship with individual franchisees encompasses a
wide range of operational issues including one of the lodging industry's
greatest challenges: providing continuity despite ongoing personnel turnover.
When the Rodeway Inn Airport East of Tempe, Ariz., recently lost its general
manager, a Choice field representative worked with the new manager to make the
transition.
Clark Ward was brought in during a peak travel season to serve as interim
general manager of the hotel, owned by Choice's largest multiple franchisee,
Sunburst Hospitality Corp. of Silver Spring, Md. Chris Bates, Choice's
franchise service director assigned to the hotel, took the initiative to
intervene and help Ward keep the property on track and maintain its award-
winning reputation.
Bates' first order of business was to help Ward set optimal rates for his
hotel. "Living in Phoenix, I was able to share my knowledge of the area with
Clark, brief him on the area's seasons and help him set the appropriate rates,"
Bates said. "Clark arrived at Fiesta Bowl time, which is a huge money-maker for
his hotel. I helped him set the appropriate rates based on the demand in the
area at that time."
Jeff Heath, area manager for Sunburst Hospitality Corp., said the company's
hotel managers work closely with Choice's field representatives. "Our franchise
service directors help us with various projects including marketing programs,"
he said. "We feel comfortable picking up the phone and asking for their
assistance."
"By eliminating the assignment of multiple field staff representatives to
each hotel, there now is a ratio of one franchise service representative to
approximately 45 hotels in comparison to the previous ratio of one to 90," said
Brent Russell, Choice vice president of franchise operations for the South
Central Market Area. "Our franchisees appreciate the focus on revenue
generation and extra service they receive."
Chris Bates (left), Choice franchise service director for the Smith Central
Market Area, discuses local marketing with Mr Adams, directors of sales for the
Rodeway Inn Airport East in Tempe, Ariz.
[PICTURE APPEARS HERE]
Brand standards and quality are central to the drive for better brand
identity. Choice continues to raise the bar for its franchisees in terms of
quality assurance and guest satisfaction. As standards tighten, under-
performing hotels will leave the system through termination. The result will be
more consistent quality within brands, which will better protect the individual
franchisee's investment.
The drive to build value continues. Block by block, the foundation for an
industry leader gets stronger. Each day Choice and its associates create new
opportunities for future success.
17
Sleep Inn
[LOGO OF SLEEP INN APPEARS HERE]
The Sleep Inn brand offers consistent quality with an all-new construction, mid-
priced product featuring a walk-in, oversized shower, complimentary continental
breakfast and affordable rates, all backed by a 100 percent satisfaction
guarantee.
1998 Highlights:
. The Sleep Inn brand was spotlighted in the June issue of Consumer Reports as
the top hotel chain in its segment and received the magazine's highest rating
for value
. Smith Travel Research listed the Sleep Inn brand among the top five fastest-
growing midscale chains over the last five years
[PICTURE APPEARS HERE]
The Sleep Inn hotel of Jerome, Idaho 1998 Inn of the Year award winner
Hotels Rooms
------ -----
Open: 200 15,214
Under Development: 193 14,979
Total: 393 30,193
Quality Inns, Hotels & Suites
[LOGO OF QUALITY APPEARS HERE]
The Quality brand offers an established mid-priced lodging product with rooms
designed for today's business travelers, backed by a 100 percent satisfaction
guarantee.
1998 Highlights:
. An advertising campaign was launched in Business Week, PC Magazine, and U.S.
News and World Report
. Higher quality assurance standards were established, and guest complaints
dropped by 36 percent
. New Quality Suites and Quality Inn & Suites prototypes were introduced
. Millions of television viewers watched tennis pros Jimmy Connors and John
McEnroe play at The Quality Challenge Tennis Tournament; Commercials
spotlighting Quality's commitment to service ran during The Challenge and
during the U.S. Open Golf Preview show
[PICTURE APPEARS HERE]
The Quality Inn Baltimore of Asheville, N.C., 1998 Inn of the Year award winner
Hotels Rooms
------ -----
Open: 679 75,472
Under Development: 177 18,782
Total: 856 94,254
Comfort Inns & Comfort Suites
[LOGO OF COMFORT APPEARS HERE]
The Comfort brand is a leading limited-service
hotel chain offering affordable rates, free deluxe continental breakfast and
exceptional rooms and suites, all backed by a 100 percent satisfaction
guarantee.
1998 Highlights:
. Millions of viewers learned about the deluxe complimentary continental
breakfast offered at Comfort Inn and Comfort Suites hotels this summer during
network television advertising
. Comfort added 38 Comfort Suites hotels to its domestic portfolio in 1998,
representing a 25 percent increase
. The Comfort brand continued to sponsor such highly visible golf tournaments as
the Wendy's Three-Tour Challenge, Shell's Wonderful World of Golf and the
Comfort Classic at the Brickyard
[PICTURE APPEARS HERE]
The Comfort Suites hotel of Madison, Wls.
1998 Inn of the Year award winner
Hotels Rooms
------ -----
Open: 1,718 133,065
Under Development: 385 33,061
Total: 2,103 166,126
Clarion Inns, Hotels, Suites & Resorts
[LOGO OF CLARION APPEARS HERE]
The Clarion brand features upscale full-service
hotels that provide outstanding value to both business and leisure travelers as
well as superior service and a 100 percent satisfaction guarantee.
1998 Highlights:
. More than 40 percent of all Clarion rooms are Clarion Class Business or
Leisure rooms, designed expressly for business and leisure travelers and
equipped with amenities including coffee makers, irons, ironing boards,
compact refrigerators, microwaves, hair dryers, signature Class One Office
workstations, oversized desks, two-line speakerphones with data ports,
ergonomic desk chairs and easy-access electrical outlets
. The Clarion brand launched a print advertising campaign aimed at business
travelers in USA Today's News and Money sections as well the paper's New York
Stock Exchange and mutuals pages
[PICTURE APPEARS HERE]
The clarion Hotel & Conference Center of Edison, N.J.
1998 Inn of the Year award winner
Hotels Rooms
------ -----
Open: 130 21,355
Under Development: 45 7,037
Total: 175 28,392
United States
Choice continued its leadership in the U.S. lodging industry in 1998
with 3,039 hotels open and 866 under development under the brand names Comfort,
Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn and MainStay Suites.
It was a year of honors and tributes as the editors of Entrepreneur
magazine named Choice the top lodging franchisor of the year, Consumer Reports
recognized the Sleep Inn brand as the nation's top budget chain and Success
magazine rated the Comfort and Quality brands among the top franchises.
A highlight of the year was the launch of the Guest Privileges frequent-
stay program, designed to generate repeat business and build loyalty with
existing customers by awarding points that can be redeemed for room nights, gift
certificates and vacations in exotic destinations.
The Americas
Choice Atlantica Hotels, master franchisor for Choice in most of South
America, announced plans to develop 140 Comfort, Quality, Clarion and Sleep Inn
hotels during the next five years beginning with three hotels in Brazil starting
with a 117-room property in Sao Paulo.
Nicholas Brady, former U.S. Treasury secretary who recently was named vice
chairman of the Choice Atlantica board, explained the decision, saying the
"growing volume of international business travelers to markets throughout the
continent is boosting demand for high-quality, reputable, well-run hotels."
For the third consecutive year, Choice Hotels Canada was named the Hotel
Chain of the Year by the North West Commercial Travelers' Association of Canada.
[MAPP APPEARS HERE]
Econo Lodge
[LOGO OF ECONO LODGE APPEARS HERE]
The Econo Lodge brand is among the best roadside names in its category, offering
clean, affordable economy lodging for travelers who know "Our Rates Are Low, Not
Our Standards."
1998 Highlights
. The Econo Lodge brand launched an industry first: a clean-room initiative tied
to one of the best known household cleaning brands in the country, Procter &
Gamble's Mr. Clean. The program offers housekeeping certification and provides
information on ways to promote cleanliness and value
. Econo Lodge guest satisfaction ratings as measured by D.K. Shifflet &
Associates, a leading travel research and consulting firm, rose eight
percentage points during 1998, as opposed to a four-point increase for the
lodging industry overall
. More than 300 hotels participated in the Econo Lodge Exterior Enhancement
Program, which has boosted revenue per available room systemwide
[PICTURE APPEARS HERE]
The Econo Lodge hotel of Brunswick, Ga.
1998 Inn of the Year award winner
Hotels Rooms
------ -----
Open: 723 45,656
Under Development: 132 9,636
Total: 855 55,292
Rodeway Inn
[LOGO OF RODEWAY INN APPEARS HERE]
The Rodeway Inn brand offers economy hotels with national consumer exposure
specializing in meeting the needs of the senior travel market in cities and
towns large and small.
1998 Highlights:
. Baseball Hall of Famer Tommy Lasorda endorsed the brand's senior-friendly
amenities in print advertisements in Reader's Digest
. Based upon data provided by Smith Travel Research, revenue per available room
for the Rodeway Inn brand grew 4.7 percent while its competitive set grew by
only 3.4 percent
. Rodeway Inn hotels opened in key locations including Denver, Mobile Ala., Salt
Lake City, Baltimore, Phoenix, Palm Springs Calif., and Virginia Beach,Va.
[PICTURE APPEARS HERE]
The Rodeway Inn hotel of Macon, Ga.
1998 Inn of the Year award winner
Hotels Rooms
------ -----
Open: 202 12,873
Under Development: 51 3,532
Total: 253 16,402
International Offices
THE AMERICAS REGION
Choice Hotels International
10750 Columbia Pike
Silver Spring, MD 20901
(301) 592-6166
EUROPE, MIDDLE EAST,
AND AFRICA REGION
Choice Hotels International
1 Warwick Row
London, England SW1E 5ER
44-171-808-5656
ASIA PACIFIC REGION*
Level 8, 52 Alfred Street
Milsons Point, Sydney NSW 2061 Australia
61-2-9929-6444
*new office to open in Singapore in 1999
International Inns of the Year
[PICTURE APPEARS HERE]
The Comfort Suites Paradise Island, Nassau, Bahamas
1998 Americas Region Hotel of the Year award winner
[PICTURE APPEARS HERE]
Comfort HomeHotel Bolinder Munktell, Eskiltuna, Sweden
1998 International Hotel of the Year award winner
[PICTURE APPEARS HERE]
The Quality Resort Terraces, Queenstown, New Zealand
1998 Asta/Pacific Region Hotel of the Year award winner
18
[MAPP APPEARS HERE]
Europe, Middle East & Africa
Friendly Hotels, Choice's master franchisor for western Europe, announced
plans to develop 750 hotels within the next decade. At year's end, the Choice
Hotels Europe portfolio included 241 hotels open and 41 under development in the
United Kingdom, France, Germany, Belgium, Ireland, Italy, Switzerland, Portugal
and Spain.
Choice Hotels Europe launched its own frequent-stay program, the Favoured
Guest Card, which awards one free night for 10 paid stays at its hotels in the
United Kingdom, Ireland and France.
Choice Hotels Scandinavia consolidated its formidable position in Sweden,
Norway and Denmark by integrating hotels acquired as a result of the previous
year's acquisition of the Inter-Nor, Home Hotels and Eurostop hotel groups. At
year's end the master franchisor's portfolio stood at 84 hotels and one under
development. Choice's own direct development will continue to focus on key
cities in the Middle East, Mediterranean countries and major African
destinations
Asia/Pacific
Choice formed a strategic alliance with Flag International Limited to
create the largest hotel franchising company in Australia. At year's end, the
new Flag Choice Hotels organization included 537 hotels in Australia, New
Zealand, Fiji and Papua New Guinea. The Quality brand is now the leading mid-
market hotel product in New Zealand.
Quality and Clarion brand hotels are targeted for major gateway locations
that are fast-growing and supported by business travel.
MainStay Suites
[LOGO OF MAINSTAY SUITES]
The MainStay Suites brand is Choice's newest lodging concept: the industry's
first franchised mid-market, extended-stay hotel with advanced technological
design and residential amenities designed to serve professionals on extended
assignments.
1998 Highlights:
. Launched in 1996, the MainStay Suites brand has more than quadrupled in size
since year-end 1997, with 20 more hotels projected to open by year-end 1999
. The Mariner kiosk, an automated check-in, check-out system that also offers
conciege assistance, is available to guests 24 hours a day
. Many corporate travel offices have begun booking year-long stays at MainStay
Suites hotels for employees on extended assignments
[PICTURE APPEARS HERE]
The MainStay Suites hotel of Lake Mary, Fla.
Hotels Rooms
------ -----
Open: 19 1,817
Under Development: 22 1,917
Total: 41 3,734
International
The International presence of Choice brands is significant, with 632 properties
open outside of the United States in 36 countries. The total includes 242 in the
Americas (excluding the United States); 331 in Europe and the Middle East; and
59 in Asia-Pacific.
1998 Highlights:
. Choice's International division announced it would introduce the 100 percent
satisfaction guarantee program worldwide, beginning with hotels in New
Zealand, India, Indonesia, Scandinavia and the Caribbean
. Choice announced it formed a strategic alliance with Flag International
Limited creating Flag Choice Hotels, the largest hotel franchising company in
Australia
. Choice Hotels Europe announced the launch of a frequent-stay program, the
Favoured Guest Card, which awards one free night for every 10 paid stays at
any of the more than 150 hotels in the United Kingdom, Ireland and France
[PICTURE APPEARS HERE]
The Comfort Inn Kensington of London
Hotels Rooms
------ ------
Open: 632 53,095
Under Development: 611 40,375
Total: 1,243 93,470
Hotel and Room statistics as of December 31, 1998
Financial Information
Choice Hotels International, Inc. and Subsidiaries
TABLE OF CONTENTS
Management's Discussion & Analysis............ 20
Report of Independent Public Accountants...... 28
Consolidated Financial Statements............. 29
Notes to Consolidated Financial Statements.... 33
Board of Directors and Corporate Officers..... 45
Corporate Information......................... 46
19
Management's Discussion & Analysis
Choice Hotels International, Inc. and Subsidiaries
The Company is one of the largest hotel franchisors in the world with 3,671
hotels open and 1,477 hotels under development as of December 31, 1998
representing 305,452 rooms open and 115,607 rooms under development in 36
countries. The Company franchises hotels under the Comfort, Quality, Econo
Lodge, Sleep Inn, Clarion, Rodeway Inn and MainStay Suites brand names. The
Company has over 2,300 franchisees in the franchise system with no single
franchisee accounting for more than 5% of its royalty or total revenues. The
Company operates in all 50 states and the District of Columbia and 35 additional
countries with 95% of its franchising revenue derived from hotels franchised in
the United States. Accordingly, management's discussion of its franchise
operating results focuses on the performance of the domestic system.
The principal factors that affect the Company's results are: growth in the
number of hotels under franchise; occupancies and room rates achieved by the
hotels under franchise; the number and relative mix of franchised hotels; and
the Company's ability to manage costs. The number of 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. The key industry standard for measuring hotel
operating performance is revenue per available room ("RevPAR"), which is
calculated by multiplying the percentage of occupied rooms by the average daily
room rate realized. The variable overhead costs associated with franchise system
growth are substantially less than incremental royalty fees generated from new
franchisees; therefore, the Company is able to capture a significant portion of
those royalty fees as operating income.
During 1997, the Company changed its fiscal year-end from May 31 to December 31.
Accordingly, the following discussion includes a discussion of the results of
the seven months ended December 31, 1997, as compared to unaudited results from
the comparable seven month period in 1996.
COMPARISON OF CALENDAR YEAR 1998 OPERATING RESULTS AND CALENDAR YEAR 1997
OPERATING RESULTS
The Company recorded net income of $55.3 million for the year ended December 31,
1998 ("Calendar 1998"), an increase of $16.6 million, compared to net income of
$38.7 million for the year ended December 31, 1997 ("Calendar 1997"). The
increase in net income for Calendar 1998 was primarily attributable to an
increase in franchise revenue as a direct result of the addition of new
franchisees to the system, improvements in the operating performance of hotels
and an increase in the effective royalty rates achieved. Additionally, in
Calendar 1998 the Company recognized a gain on early extinguishment of debt of
$7.2 million.
SUMMARIZED FINANCIAL RESULTS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 ARE
AS FOLLOWS:
1998 1997
(unaudited)
REVENUES: (In thousands)....................... --------- -----------
Royalty fees............................... $115,369 $106,299
Product sales.............................. 21,256 23,806
Initial franchise fees & relicensing fees.. 16,571 16,096
Partner services revenue and other......... 11,081 11,912
European hotel operations.................. 1,098 17,303
---------------------
TOTAL REVENUES............................. 165,375 175,416
---------------------
OPERATING EXPENSES:
Selling, general & administrative.......... 50,670 50,782
Product cost of sales...................... 19,736 22,769
Depreciation & amortization................ 7,116 9,173
European hotel operations.................. 1,133 15,624
---------------------
TOTAL OPERATING COSTS...................... 78,655 98,348
---------------------
Operating income................................ 86,720 77,068
Gain on sale of stock........................... (2,370) --
Interest expense and other...................... 19,326 13,295
Interest and dividend income.................... (12,636) (2,503)
---------------------
Income before income taxes
and extraordinary item..................... 82,400 66,276
Income taxes.................................... 34,327 27,604
---------------------
Net income before extraordinary item............ 48,073 38,672
Gain on early extinguishment of debt,
net of $4,532 of income taxes.............. 7,232 --
---------------------
NET INCOME................................. $ 55,305 $ 38,672
---------------------
FRANCHISE REVENUES: Management analyzes its business based on "net franchise
revenue," which is total revenue excluding product sales and European hotel
operations, and franchise operating expenses which are reflected as selling,
general and administrative expenses.
20
Management's Discussion & Analysis
Choice Hotels International, Inc. and Subsidiaries
Net franchise revenues were $143.0 million for Calendar 1998 and $134.3 million
for Calendar 1997. Royalties increased $9.1 million to $115.4 million from
$106.3 million in Calendar 1997, an increase of 8.5%. The increase in royalties
is attributable to a net increase of 159 franchisees during the period
representing an additional 10,196 rooms added to the system, an improvement in
domestic RevPAR of 2.3% and an increase in the effective royalty rate of the
domestic hotel system to 3.6% from 3.5%. Domestic initial fee revenue generated
from franchise contracts signed increased 3.0% to $16.6 million from $16.1
million in Calendar 1997. Total franchise agreements signed in Calendar 1998
were 440, up 4.5% from the total contracts signed in Calendar 1997 of 421.
Revenues generated from partner service relationships increased to $6.4 million
from $6.1 million in Calendar 1997. Under the partner services program the
Company generates revenue from hotel industry vendors in exchange for being
designated as preferred providers of goods or services to hotel owners and the
millions of hotel guests who stay in the Company's franchised hotels.
The number of domestic rooms under development increased to 75,232 from 62,384,
an increase of 20.6% for the year ended December 31, 1998. The total number of
international hotels on line increased to 632 from 605 an increase of 4.5% for
the year ended December 31, 1998. International rooms on line increased to
53,095 as of December 31, 1998 from 50,639, an increase of 4.9%. The total
number of international hotels under development increased to 611 from 119 for
the year ended December 31, 1998. The number of international rooms under
development increased to 40,375 as of December 31, 1998 from 12,029 as of
December 31, 1997. These increases are primarily attributable to a strategic
alliance in June 1998 with Flag International Limited.
FRANCHISE EXPENSES: The cost to operate the franchising business is reflected
in selling, general and administrative expenses. Selling, general and
administrative expenses were $50.7 million for Calendar 1998, a decrease of $0.1
million from the Calendar 1997 total of $50.8 million. As a percentage of net
franchise revenues, selling, general and administrative expenses declined to
35.5% in Calendar 1998 from 37.8% in Calendar 1997. The improvement in the
franchising margins relates to the economies of scale generated from operating a
larger franchisee base, cost control initiatives and improvements in franchised
hotel performance.
MARKETING AND RESERVATIONS: The Company's franchise agreements require the
payment of franchise fees which include marketing and reservation fees. These
fees, which are based on a percentage of the franchisees' gross room revenues,
are used exclusively to reimburse the Company for expenses associated with
providing such franchise services as central reservation systems, national
marketing, and media advertising. The Company is contractually obligated to
expend the reservation and marketing fees it collects from franchisees in
accordance with the franchise agreements; as such, no income or loss to the
Company is generated. During the second quarter of 1998, the Company changed its
presentation of marketing and reservation fees such that the fees collected and
associated expenses are reported net. All prior periods have been reclassified
to conform to the new presentation.
The total marketing and reservation fees received by the Company (previously
reported as revenue) were $127.4 million and $110.2 million for the years ended
December 31, 1998 and December 31, 1997, respectively. Depreciation and
amortization charged to reservation and marketing expenses was $5.7 million and
$2.9 million for the years ended December 31, 1998 and December 31, 1997,
respectively. Reservation fees and marketing fees not expended in the current
year are carried over to the next fiscal year and expended in accordance with
the franchise agreements. Shortfall amounts are similarly recovered in
subsequent years. Excess or shortfall amounts from the operation of these
programs are recorded as a payable or receivable from the particular fund. As of
December 31, 1998 the Company's balance sheet includes a receivable in amounts
due from marketing and reservation funds of $13.4 million related to shortfalls
in the marketing ($7.8 million) and reservation ($5.6 million) funds. As of
December 31, 1997, the Company's balance sheet includes a receivable in
amounts due from marketing and reservation funds of $5.2 million related to a
shortfall in the marketing fund and a current liability in accounts payable of
$4.5 million related to excess monies in the reservation fund. The Company
expects to be able to recover these receivables through future marketing and
reservation fees.
PRODUCT SALES: Sales made to franchisees through the Company's group purchasing
program declined $2.6 million to $21.3 million in Calendar 1998 from $23.8
million in Calendar 1997. The group purchasing program utilizes bulk purchases
to obtain favorable pricing from third party vendors for franchisees ordering
similar products. The Company acts as a clearing house
21
Management's Discussion & Analysis
Choice Hotels International, Inc. and Subsidiaries
between the franchisee and the vendor, and orders are shipped directly to the
franchisee.
Similarly, product cost of sales decreased $3.0 million (or 13.3%) from Calendar
1997. The product services margins increased for the year ended December 31,
1998 to 7.2% from 4.4% in Calendar 1997. This purchasing program is provided to
the franchisees as a service and is not expected to be a major component of the
Company's profitability. In the fourth quarter of 1998, the Company discontinued
the group purchasing program as previously operated.
EUROPEAN HOTEL OPERATIONS: In January 1998, the Company and Friendly Hotels,
PLC ("Friendly") consummated a transaction in which Friendly acquired from the
Company the master franchise rights for the Comfort, Quality and Clarion brands
for all of Europe, with the exception of Scandinavia, for a payment of $8.0
million. As part of this transaction, Friendly acquired ten hotels in France,
two in Germany and one in the United Kingdom from the Company in exchange for
$22.2 million in 5.75% convertible preferred shares in Friendly. In addition,
Friendly will pay the Company deferred compensation of $4.0 million in cash,
payable by the fifth anniversary or sooner depending on the level of future
profits of the hotels acquired.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization decreased to $7.1
million in Calendar 1998 from $9.2 million in Calendar 1997. This decrease was
primarily attributable to the sale of the Company's European hotels.
INTEREST EXPENSE AND INTEREST INCOME: The increase in interest expense of $6.0
million in Calendar 1998 from $13.3 million in Calendar 1997 results from
additional debt incurred in connection with the Distribution (as defined in the
notes to the consolidated statements). Included in Calendar 1998 results is
approximately $10.4 million of interest income earned on the note receivable
from Sunburst Hospitality Corporation and $2.2 million in dividend income from
the Company's investment in Friendly.
EXTRAORDINARY ITEM: During 1998, the Company recorded extraordinary gains for
the early extinguishment of a capitalized lease obligation. The Company retired
$13.7 million in debt and removed related assets of $1.7 million from the
consolidated balance sheets. The extraordinary gain was $7.2 million, after
income tax benefits of $4.7 million, or $0.12 per diluted share.
COMPARISON OF SEVEN MONTH PERIOD ENDED DECEMBER 31, 1997 OPERATING RESULTS AND
SEVEN MONTH PERIOD ENDING DECEMBER 31, 1996 OPERATING RESULTS
The Company recorded net income of $27.3 million for the seven months ended
December 31, 1997 ("December 1997"), an increase of $4.0 million, compared to
net income of $23.3 million for the seven months ended December 31, 1996
("December 1996"). The increase in net income for December 1997 was primarily
attributable to an increase in franchise revenue as a direct result of the
addition of new franchisees to the system, improvements in the operating
performance of hotels and an increase in the effective royalty rates achieved.
SUMMARIZED FINANCIAL RESULTS FOR THE SEVEN MONTHS ENDED DECEMBER 31, 1997 AND
1996 ARE AS FOLLOWS:
1997 1996
(unaudited)
------------------
REVENUES: (in thousands)
Royalty fees................................ $ 70,308 $61,821
Product sales............................... 13,524 14,717
Initial franchise fees & relicensing fees... 8,597 9,304
Partner services revenue and other.......... 4,869 3,161
European hotel operations................... 10,541 10,975
-------------------
TOTAL REVENUE............................... 107,839 99,978
-------------------
OPERATING EXPENSES:
Selling, general & administrative........... 29,454 28,132
Product cost of sales....................... 13,031 13,481
Depreciation & amortization................. 3,977 3,153
European hotel operations................... 9,203 9,745
-------------------
TOTAL OPERATING COSTS....................... 55,665 54,511
-------------------
Operating income................................. 52,174 45,467
Interest expense, net............................ 5,791 5,784
-------------------
Income before income taxes....................... 46,383 39,683
Income taxes..................................... 19,096 16,338
-------------------
NET INCOME.................................. $ 27,287 $23,345
-------------------
FRANCHISE REVENUES: Net franchise revenues were $83.8 million for the seven
months ended December 31, 1997 and $74.3 million for the seven months ended
December 31, 1996. Royalties increased $8.5 million to $70.3 million from $61.8
million for the seven months ended December 31, 1996, an increase of 13.7%. The
increase in royalties is attributable to a net increase of 264 franchisees
during the period representing an additional 19,881
22
Management's Discussion & Analysis
Choice Hotels International, Inc. and Subsidiaries
rooms added to the system, an improvement in domestic RevPAR of 2.4% and an
increase in the effective royalty rate of the domestic hotel system to 3.5% from
3.4%. Domestic initial fee revenue generated from franchise contracts signed
declined 7.5% to $8.6 million from $9.3 million for the seven months ended
December 31, 1997 as compared to the seven months ended December 31, 1996. Total
franchise agreements signed for the seven months ended December 31, 1997 were
368, down 14.0% from the total contracts signed in December 1996 of 428. The
decline in initial fees is partly a result of the Company's sales force
reorganization and the resulting temporary displacement of the sales force. The
reorganization of the regional market management sales and support force was
completed in September 1997. Revenues generated from partner service
relationships increased to $3.4 million from $1.5 million in December 1996.
The number of domestic rooms under development as of December 31, 1997 increased
to 62,384 from 59,023, at December 31, 1996 an increase of 5.7%. The total
number of international hotels on line increased to 605 from 548 at December 31,
1996 an increase of 10.4%. International rooms on line increased 9.0% to 50,639
as of December 31, 1997 from 46,473 as of December 31, 1996. The total number of
international hotels under development decreased to 119 from 143, a decrease of
16.8% from December 31, 1996. The number of international rooms under
development decreased to 12,029 as of December 31, 1997 from 13,906 as of
December 31, 1996, a decrease of 13.5%.
FRANCHISE EXPENSES: Selling, general and administrative expenses were $29.5
million for the seven months ended December 31, 1997, an increase of $1.3
million from the comparable period in 1996. The increase in selling, general and
administrative expenses was primarily due to additional personnel to support
company growth and new company initiatives. As a percentage of net franchise
revenues, selling, general and administrative expenses declined to 35.2% for the
seven months ended December 31, 1997 from 37.8% for the seven months ended
December 31, 1996. The improvement in the franchising margins relates to the
economies of scale generated from operating a larger franchisee base, cost
control initiatives and improvements in franchised hotel performance.
MARKETING AND RESERVATIONS: The total marketing and reservation fees received
by the Company (previously reported as revenue) were $72.3 million and $66.3
million for the seven months ended December 31, 1997 and December 31, 1996,
respectively. Depreciation and amortization charged to reservation and marketing
expenses was $1.7 million and $1.4 million for the seven months ended December
31, 1997 and December 31, 1996, respectively.
PRODUCT SALES: Sales made to franchisees through the Company's group purchasing
program declined $1.2 million to $13.5 million for the seven months ended
December 31, 1997 from $14.7 million for the seven months ended December 31,
1996.
Similarly, product cost of sales decreased $0.4 million (or 3.3%) for the seven
months ended December 31, 1997. The product services margins decreased for the
seven months ended December 31, 1997 to 3.6% from 8.4% for the seven months
ended December 31, 1996.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization increased to $4.0
million for the seven months ended December 31, 1997 from $3.2 million for the
seven months ended December 31, 1996. The increase was primarily due to capital
improvements to the Company's financial and billing information systems.
COMPARISON OF FISCAL YEAR 1997 OPERATING RESULTS AND FISCAL YEAR 1996 OPERATING
RESULTS
The Company recorded net income of $34.7 million for the year ended May 31, 1997
("Fiscal 1997"), an increase of $23.0 million, compared to net income of $11.7
million for the year ended May 31, 1996 ("Fiscal 1996"). Fiscal 1996 results
include a $24.8 million asset impairment charge related to the Company's
European hotel operations. Exclusive of this charge, Fiscal 1996 net income was
$26.7 million. The increase in net income for Fiscal 1997 was primarily
attributable to an increase in franchise revenue as a direct result of the
addition of new franchisees to the franchise system and improvements in the
operating performance of franchised hotels.
FRANCHISE REVENUES: Net franchise revenues were $126.7 million for Fiscal 1997
and $110.6 million for Fiscal 1996. Royalties increased $9.2 million to $97.2
million from $88.0 million in ended Fiscal 1996, an increase of 10.5%. The
increase in royalties is attributable to a net increase of 292 franchisees
during the period representing an additional 21,578 rooms added to the system,
an improvement in domestic RevPAR of 2.9% and an increase in the effective
royalty rate of the domestic hotel system to 3.4% from
23
Management's Discussion & Analysis
Choice Hotels International, Inc. and Subsidiaries
3.3%. Domestic initial fee revenue generated from franchise contracts signed
increased 14.8% to $14.0 million from $12.2 million in Fiscal 1996. Total
franchise agreements signed in Fiscal 1997 were 495, up 13.5% from the total
contracts signed in Fiscal 1996 of 436. Revenues generated from partner services
relationships increased to $6.1 million from $1.8 million in Fiscal 1996.
The number of domestic rooms under development increased to 61,754 from 54,172,
an increase of 14.0% for the period ending May 31, 1997. The total number of
international hotels on line increased to 563 from 557 an increase of 1.1% as of
May 31, 1997. International rooms online increased 1.6% from 46,843 as of May
31, 1996 to 47,603 as of May 31, 1997. The total number of international hotels
under development increased to 110 from 100, an increase of 10.0% for the period
ending May 31, 1997. The number of international rooms under development
increased to 10,339 as of May 31, 1997 from 9,613 as of May 31, 1996, an
increase of 7.6%.
FRANCHISE EXPENSES: Selling, general and administrative expenses were $51.1
million in Fiscal 1997, an increase of $5.9 million from the Fiscal 1996 total
of $45.2 million. Of the increase, $4.8 million was directly attributable to
additional costs of operating as an independent company apart from Manor Care.
These additional costs were primarily additional staffing, incremental rental
expenses, and consulting fees as the Company assumed certain administrative
tasks previously provided by Manor Care. The remaining increases in selling,
general and administrative expenses were primarily due to additional personnel
to support company growth and new company initiatives.
As a percentage of total net franchising revenues, total franchising selling,
general and administrative expenses were 40.3% in Fiscal year 1997 and 40.9% in
Fiscal year 1996. Exclusive of the $4.8 million increase resulting from the
distribution, as a percentage of net franchising revenues, selling, general and
administrative expenses declined to 36.5% in Fiscal 1997 from 40.9% in Fiscal
1996. 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 increased $2.0 million to $23.6 million in Fiscal 1997 from $21.6
million in Fiscal 1996.
Similarly, product cost of sales increased $2.1 million (or 9.9%) in Fiscal
1997. The product services margins decreased in Fiscal 1997 to 3.7% from 4.0% in
Fiscal 1996.
EUROPEAN HOTEL OPERATIONS: Total revenues at the Company's owned hotel
operations in Europe declined to $17.7 million in Fiscal 1997 from $19.6 million
in Fiscal 1996. Operating margins at the hotels declined to 8.9% in Fiscal 1997
from 10.6% in Fiscal 1996. The decline in revenue and operating performance
reflects the difficult economic and competitive climates in which a number of
the European hotels operated.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization decreased $1.6
million (or 16.7%) to $7.6 million in Fiscal 1997 from $9.2 million in Fiscal
1996. The decrease was primarily due to an asset impairment charge against
European fixed assets which reduced the asset base upon which depreciation is
determined.
PROVISION FOR ASSET IMPAIRMENT: In Fiscal 1996, the Company recorded a charge
against earnings of $24.8 million relating to impairment of certain long-lived
assets related to the Company's European hotel operations.
OTHER: In Fiscal 1997, the Company recognized $943,000 in dividend income from
its investment in Friendly Hotels, PLC.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $44.1 million for the year ended
December 31, 1998, an increase of $10.5 million from $33.6 million for the seven
months ended December 31, 1997. As of December 31, 1998, the total long-term
debt outstanding for the Company was $279.2 million.
Cash used in investing activities for the year ended December 31, 1998, the
seven months ended December 1997 and Fiscal years 1997, and 1996 was $14.2
million, $149.7 million, $16.9 million, and $78.5 million, respectively.
Included in Other items (investing activities) for the year ended December 31,
1998 was an increase of $12.7 million due from the marketing and reservation
funds.
On October 15, 1997, the Company funded a $115 million, five year Subordinated
Term Note to Sunburst with an initial simple interest rate of 11% per annum. In
connection with the amendment
24
Management's Discussion & Analysis
Choice Hotels International, Inc. and Subsidiaries
of the strategic alliance agreement discussed below, effective October 15, 2000
interest payable shall accrue at a rate of 11% per annum compounded daily. The
Company will implement this amendment prospectively beginning January 1, 1999 by
recognizing interest on the outstanding principal and accrued interest amounts
at an effective rate of 10.58%. The note is payable in full, along with accrued
interest on October 15, 2002. Total interest accrued at December 31, 1998 and
1997 was $10.4 million and $2.4 million, respectively.
During 1998, Sunburst repaid $8 million of the approximately $25 million of
estimated receivables due to the Company. On December 28, 1998, the Company and
Suburst amended the strategic alliance agreement entered into in connection with
the Sunburst Distribution. As part of that amendment, the Company exchanged the
remaining $17 million balance in return for, among other things, the exclusive
rights to the MainStay Suites brand from Sunburst and a commitment from Sunburst
to build a total of 25 MainStay Suites. The $17 million, net of income taxes of
approximately $7 million, was recorded as an adjustment to additional paid in
capital as it represents an adjustment to the accounting for the Sunburst
Distribution.
On May 31, 1996, the Company repurchased the remaining 5.5% minority interest
held by its management for $27.9 million. Approximately $26.4 million was
allocated to goodwill. During Fiscal 1996, the Company purchased a 5% common
stock interest and a preferred stock interest in Friendly, for approximately $17
million.
Investment in property and equipment includes computer hardware as well as new
developments and enhancements of reservation and finance systems. During the
year ended December 31, 1998, the seven months ended December 31, 1997 and the
fiscal years ended May 31, 1997, and 1996, capital expenditures totaled $12.3
million, $7.3 million, $10.6 million and $6.5 million, respectively, and related
primarily to the development of a new property management system and the
installation of new financial systems. Capital expenditures in prior years
include amounts for computer hardware, reservation systems and European hotel
capital improvements.
On October 15, 1997, the Company entered into a five-year $300 million
competitive advance and multi-currency credit facility. The credit facility
provides for a term loan of $150 million and a revolving credit facility of $150
million, $50 million of which is available in foreign currency borrowings. At
the time of the Distribution, the Company borrowed $150 million under the term
loan and $140 million under the revolving credit facility, the proceeds of which
were used to fund the $115 million Sunburst note and to refinance existing
indebtedness. As of December 31, 1998, the Company had $135 million of term
loans outstanding and $37 million of revolving loans. The term loan is payable
over five years, $22.5 million of which is due in 1999. The credit facility
includes customary financial and other covenants that require the maintenance of
certain ratios including maximum leverage, minimum net worth and interest
coverage and restrict 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 the time of
borrowing.
On May 1, 1998, the Company completed a $100 million senior unsecured note
offering (the "Notes"), bearing a coupon rate of 7.13% with an effective rate of
7.22%. The Notes will mature on May 1, 2008, with interest on the Notes to be
paid semi-annually. The Company used the net proceeds from the offering of
approximately $99 million to repay amounts outstanding under the Company's $300
million revolving credit facility.
As of March 12, 1999, the Company has repurchased 5.4 million shares of its
common stock at a total cost of $74.1 million. The Company has authorization
from its Board of Directors to repurchase up to an additional 3.3 million
shares. As of March 12, 1999, there were 55.4 million total common shares
outstanding (a weighted average of 56.1 million).
The Company has entered into interest rate swap agreements with a notional
amount of $115 million at December 31, 1998, to fix certain of its variable rate
debt in order to reduce the Company's exposure to fluctuations in interest
rates. The interest rate differential to be paid or received on interest rate
swap agreements is accrued as interest rates change and is recognized as an
adjustment to interest expense. On average, the interest rate swap agreements
have a life of one and one-half years with a fixed rate of 5.85% and a variable
rate at December 31, 1998 of 5.07%. As of December 31, 1998, the interest rate
swap agreements have a fair market valuation of approximately $(2.8 million).
25
Management's Discussion & Analysis
Choice Hotels International, Inc. and Subsidiaries
The Company believes that cash flow from operations and available financing
capacity is adequate to meet the expected operating, investing, financing and
debt service requirements for the business for the immediate future.
YEAR 2000 COMPLIANCE
The Company is engaged in an ongoing effort to evaluate and remediate the Year
2000 computer problem shared by virtually all companies and businesses. As part
of this effort, a cross-functional Year 2000 Compliance Committee was
established to manage and supervise the efforts to become compliant and a Year
2000 action plan has been developed. The Company has completed the first three
phases of the plan, which include (i) making the Company's internal
organizations aware of the Year 2000 issue and assigning responsibility
internally, (ii) inventorying and initial testing of its proprietary software
and (iii) inventorying and testing secondary internal systems (e.g. employee
PCs). The Company is in the process of completing the remaining phases which
include: (i) assessing the risk from third party vendors and franchisees (ii)
contingency planning, and (iii) educating the franchise community. Throughout
the process, remedial actions have been or will be taken as warranted.
The Company's exposure to potential Year 2000 problems exists in two general
areas: technological operations in the sole control of the Company, and
technological operations dependent in some way on one or more third parties.
With respect to the Company's internal systems, it has conducted Year 2000
compliance testing on all of its proprietary software, including its
reservations and reservations support systems, its franchise support system and
its franchisee property management support systems. The tests have indicated
that, except for two DOS based systems, the proprietary software is Year 2000
compliant. The DOS version of ChoiceLINKS is not Year 2000 compliant and the DOS
version of the Company's property management system is only compliant through
December 31, 2000. The Company has communicated this to franchisees using these
systems and has recommended that they migrate to the Windows based versions of
these systems. The Company has also been in the process of replacing its
hardware platforms for these systems and a number of smaller support systems and
has kept them updated so that by the end of 1998, all of the Company's large
system computers are no more than eighteen months old. Based on manufacturers
specifications, the Company believes that these new hardware platforms are Year
2000 compliant. However, the company will have to update the operating systems
for several of its servers.
The Company has completed its process of conducting an inventory of third party
software, including PC operating systems and word processing and other
commercial software. The inventory did not disclose any material compliance
issues.
The Year 2000 Compliance Committee is currently identifying third party vendors
and service providers whose non-compliant systems could have a material impact
on the Company and undertaking an assessment as to such parties' compliant
status. These parties include airline global distribution systems (GDS), utility
providers, telephone service providers, banks and data processing services. The
GDS companies, which provide databases through which travel agents can book
hotel rooms, have assured the Company in writing that they are compliant and the
Company has conducted tests with three of the four major GDS companies. The Year
2000 Compliance Committee is in the process of assessing other third parties as
to their compliance and the consequences in the event they are not compliant. As
of February 1999, the Company has received responses from approximately one-half
of its vendors. Such vendors have indicated that they are, or expect to be, Year
2000 compliant. Throughout 1999, the committee will continue to seek and assess
responses from all of its material vendors.
As of February 1999, the Company has devised contingency plans for its Phoenix,
Arizona reservation center. These plans include access to alternative power
sources and insuring the availability of key employees. Contingency plans for
the Silver Spring, Maryland corporate headquarters and other Company locations
will be developed throughout the second and third quarters of 1999.
Costs of addressing potential Year 2000 problems have not been material to date.
The value of employee time devoted to testing and development has been
approximately $200,000. Total costs for replacement of hardware and operating
systems are expected to
26
Management's Discussion & Analysis
Choice Hotels International, Inc. and Subsidiaries
be approximately $700,000. However, these replacements (as well as replacements
undertaken in prior years) are being implemented primarily as part of the
Company's ongoing technology updating, rather than specifically for Year 2000
compliance reasons. Based upon preliminary information gathered to date, Year
2000 compliance costs are not currently expected to have a material adverse
impact on the Company's financial position, results of operations or cash flows.
However, if the Company, its vendors or franchisees are unable to resolve such
Year 2000 issues in a timely manner, it could result in a material financial
risk, including loss of revenue, substantial unanticipated costs and service
interruptions.
The Company is not in a position to guarantee the performance of others with
respect to their Year 2000 compliance or predict whether any of the assurances
that others provide regarding Year 2000 compliance may prove later to be
inaccurate or overly optimistic.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," and SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information" in
Calendar 1998. The adoption of these pronouncements required the Company to make
certain additional disclosures.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
Accounting for Derivative Instruments and Hedging Activities which requires
recognition of the fair value of derivatives in the statement of financial
position, with changes in the fair value recognized either in earnings or as a
component of other comprehensive income dependent upon the nature of the
derivative. Implementation of SFAS No. 133 is required for Fiscal year 2000. The
Company does not expect SFAS No. 133 to have a material impact on the Company's
earnings or other comprehensive income.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this annual report, including those in the
section entitled "Management's Discussion and Analysis," 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
and various Form 8-K filings, including the nature and extent of future
competition, and political, economic and demographic developments in countries
where the Company does business or may do business in the future. 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.
27
Report of Independent Public Accountants
Choice Hotels International, Inc. and Subsidiaries
TO CHOICE HOTELS INTERNATIONAL, INC.
We have audited the accompanying consolidated balance sheets of Choice Hotels
International, Inc. and subsidiaries, as defined under "Basis of Presentation"
in the Notes to Consolidated Financial Statements, as of December 31, 1998 and
December 31, 1997, and the related consolidated statements of income and cash
flows for the year ended December 31, 1998, the seven months ended December 31,
1997 and for each of the two fiscal years in the period ended May 31, 1997, and
the consolidated statement of shareholders' equity and comprehensive income for
the period from October 15, 1997 (inception) to December 31, 1997 and the year
ended December 31, 1998. These consolidated financial statements are the
responsibility of Choice Hotels International, Inc.'s management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Choice Hotels
International, Inc. and subsidiaries as of December 31, 1998 and December 31,
1997, and the consolidated results of their operations and their consolidated
cash flows for the year ended December 31, 1998 and the seven months ended
December 31, 1997, and each of the two fiscal years in the period ended May 31,
1997, and the consolidated statements of shareholders' equity and comprehensive
income for the period from October 15, 1997 (inception) to December 31, 1997 and
the year ended December 31, 1998, in conformity with generally accepted
accounting principles.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Washington, D.C.,
January 29, 1999
28
Consolidated Statements of Income
Choice Hotels International, Inc. and Subsidiaries
Year ended Seven months ended Fiscal years ended
(In thousands) December 31, December 31, May 31,
1998 1997 1997 1996
---------------------------------------------------------
REVENUES
Royalty fees................................................ $ 115,369 $ 70,308 $ 97,215 $ 87,994
Product sales............................................... 21,256 13,524 23,643 21,570
European hotel operations................................... 1,098 10,541 17,737 19,609
Initial franchise fees and relicensing fees................. 16,571 8,597 16,802 15,578
Partner services revenue and other.......................... 11,081 4,869 12,642 6,997
---------------------------------------------------------
Total revenues......................................... 165,375 107,839 168,039 151,748
OPERATING EXPENSES
Selling, general and administrative......................... 50,670 29,454 51,102 45,196
Product cost of sales....................................... 19,736 13,031 22,766 20,709
European hotel operations................................... 1,133 9,203 16,166 17,521
Depreciation and amortization............................... 7,116 3,977 7,643 9,179
Provision for asset impairment.............................. -- -- -- 24,760
---------------------------------------------------------
Total operating expenses............................... 78,655 55,665 97,677 117,365
---------------------------------------------------------
Operating income............................................ 86,720 52,174 70,362 34,383
---------------------------------------------------------
OTHER
Minority interest........................................... -- -- -- 1,532
Gain on sale of stock....................................... (2,370) -- -- --
Interest on notes payable to Manor Care..................... -- -- 7,083 7,083
Interest expense and other.................................. 19,326 8,788 4,647 4,791
Interest and dividend income (including interest
income on Sunburst Note of $10.4 million and
$2.7 million for the year ended December 31, 1998 and
the seven months ended December 31, 1997, respectively).. (12,636) (2,997) (943) --
---------------------------------------------------------
Total other............................................ 4,320 5,791 10,787 13,406
---------------------------------------------------------
Income before income taxes and extraordinary item.............. 82,400 46,383 59,575 20,977
Income taxes................................................... (34,327) (19,096) (24,845) (9,313)
---------------------------------------------------------
Net income before extraordinary item........................... $ 48,073 $ 27,287 $ 34,730 $ 11,664
Extraordinary gain on early extinguishment of debt
(net of taxes of $4,532)..................................... 7,232 -- -- --
---------------------------------------------------------
Net income..................................................... $ 55,305 $ 27,287 $ 34,730 $ 11,664
---------------------------------------------------------
Weighted average shares outstanding............................ 58,717 59,798 62,680 62,628
---------------------------------------------------------
Diluted shares outstanding..................................... 59,548 61,300 62,680 62,628
---------------------------------------------------------
Basic EPS:
Income before extraordinary item............................... $0.82 $0.46 $0.55 $0.19
Extraordinary item............................................. 0.12 -- -- --
---------------------------------------------------------
Net income..................................................... $0.94 $0.46 $0.55 $0.19
---------------------------------------------------------
Diluted EPS:
Income before extraordinary item............................... $0.81 $0.45 $0.55 $0.19
Extraordinary item............................................. 0.12 -- -- --
---------------------------------------------------------
Net income..................................................... $0.93 $0.45 $0.55 $0.19
=========================================================
See notes to consolidated statements.
29
Consolidated Balance Sheets
Choice Hotels International, Inc. and Subsidiaries
As of (In thousands) December 31, December 31,
1998 1997
----------------------------
ASSETS
Current assets
Cash and cash
equivalents..................................................................... $ 1,692 $ 10,282
Receivables (net of allowance for doubtful accounts of $8,082,
and $7,608, respectively)..................................................... 28,117 24,278
Income taxes receivable......................................................... 5,427 1,242
Receivable from Sunburst Hospitality............................................ -- 25,066
Other current assets............................................................ 425 3,442
----------------------------
Total current assets.......................................................... 35,661 64,310
Property and equipment, net........................................................ 32,845 37,040
Goodwill, net...................................................................... 66,749 68,792
Franchise rights, net.............................................................. 44,981 48,819
Investment in Friendly Hotels, PLC................................................. 45,139 17,581
Assets held for sale............................................................... -- 10,752
Amounts due from marketing and reservation funds................................... 23,364 13,087
Other assets....................................................................... 21,637 8,567
Note receivable from Sunburst Hospitality.......................................... 127,849 117,447
----------------------------
TOTAL ASSETS.................................................................. $398,225 $ 386,395
============================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current portion of long term debt............................................... $ 22,646 $ 15,041
Accounts payable................................................................ 16,216 26,452
Accrued expenses................................................................ 19,606 20,702
Income taxes payable............................................................ -- 6,007
----------------------------
Total current liabilities..................................................... 58,468 68,202
Long term debt..................................................................... 256,564 267,780
Deferred income taxes ($19,569 and $0 respectively)
and other liabilities............................................................ 26,683 1,155
----------------------------
Total liabilities............................................................. 341,715 337,137
============================
SHAREHOLDERS' EQUITY
Common stock, $ .01 par value, 160,000,000 shares authorized;
56,726,917 and 59,828,878 shares issued and outstanding at
December 31, 1998 and 1997, respectively......................................... 607 598
Additional paid-in-capital......................................................... 43,432 47,907
Accumulated other comprehensive income (loss)...................................... 2,112 (8,316)
Treasury stock..................................................................... (54,204) (189)
Retained earnings.................................................................. 64,563 9,258
----------------------------
Total shareholders' equity.................................................... 56,510 49,258
----------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................................... $398,225 $ 386,395
============================
See notes to consolidated statements.
30
Consolidated Statements of Cash Flows
Choice Hotels International, Inc. and Subsidiaries
Year ended Seven months ended Fiscal years ended
(In thousands) December 31, December 31, May 31,
1998 1997 1997 1996
-----------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income........................................................... $ 55,305 $ 27,287 $ 34,730 $ 11,664
Reconciliation of net income to net cash provided by operating
activities:
Depreciation and amortization...................................... 12,544 6,159 10,438 11,839
Provision for bad debts............................................ 1,473 2,274 2,238 685
Increase (decrease) in deferred taxes.............................. 14,852 (4,828) 3,171 (13,527)
Non cash interest and dividend income.............................. (12,364) (2,997) (943) --
Extraordinary gain on early extinguishment of debt................. (11,964) -- -- --
Provision for asset impairment..................................... -- -- -- 24,760
Changes in assets and liabilities:
Receivables.................................................... (4,311) (10,606) (4,835) (7,533)
Prepaid expenses and other current assets...................... (1,849) 2,403 1,615 (990)
Current liabilities............................................ (6,180) 11,226 (2,145) 4,050
Income taxes payable/receivable................................ (3,411) 2,689 1,061 (265)
Other liabilities.............................................. -- -- 175 2,059
-----------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES................... 44,095 33,607 45,505 32,742
-----------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property and equipment................................. (12,254) (7,329) (10,630) (6,506)
Purchase of minority interest........................................ -- -- (2,494) (55,269)
Investment in Friendly Hotels, PLC................................... -- -- -- (17,069)
Repayments from (advances to) Sunburst Hospitality................... 8,145 (25,066) -- --
Note receivable from Sunburst Hospitality............................ -- (115,000) -- --
Other items, net..................................................... (10,090) (2,344) (3,804) 345
-----------------------------------------------------------
NET CASH UTILIZED IN INVESTING ACTIVITIES................... (14,199) (149,739) (16,928) (78,499)
-----------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from mortgages and other long-term debt..................... 194,901 236,509 31,107 17,296
Principal payments of debt........................................... (184,300) (78,851) (51,260) (350)
Purchase of treasury stock........................................... (54,015) (189) -- --
Cash transfers (to) from Parent, net................................. -- (35,222) (8,069) 31,567
Proceeds from issuance of common stock............................... 4,928 -- -- --
-----------------------------------------------------------
NET CASH PROVIDED BY (UTILIZED IN) FINANCING ACTIVITIES..... (38,486) 122,247 (28,222) 48,513
-----------------------------------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS.............................. (8,590) 6,115 355 2,756
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD..................... 10,282 4,167 3,812 1,056
-----------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD........................... $ 1,692 $ 10,282 $ 4,167 $ 3,812
-----------------------------------------------------------
See notes to consolidated statements.
31
Consolidated Statements Of Shareholders' Equity And Comprehensive Income
Choice Hotels International, Inc. and Subsidiaries
(In thousands, except share amounts) Accumulated
Other
Common Stock Additional Comprehensive
Shares Amount Paid-in-Capital Income (Loss)
==========================================================
Initial capitalization - October 15, 1997 .................... 59,767,716 598 $ 48,064 $ (8,662)
Comprehensive income
Net income ................................................ -- -- -- --
Other comprehensive income, net of tax
Foreign currency translation adjustment ................... -- -- -- 346
Comprehensive income ......................................... -- -- -- --
Exercise of stock options/grants, net ........................ 71,876 -- (157) --
Treasury purchases ........................................... (10,714) -- -- --
Transfers of net income to Sunburst prior to
the distribution ........................................... -- -- -- --
----------------------------------------------------------
Balance as of December 31, 1997 .............................. 59,828,878 598 $ 47,907 $ (8,316)
==========================================================
Comprehensive income
Net income ................................................ -- -- -- --
Other comprehensive income, net of tax
Foreign currency translation adjustments, net -- -- -- --
Unrealized loss on securities, net of
reclassification adjustment (see notes) -- -- -- --
Other comprehensive income ................................ -- -- -- 10,428
Comprehensive income ......................................... -- -- -- --
Exercise of stock options/grants, net ........................ 827,439 9 5,665 --
Treasury purchases, net ...................................... (3,929,400) -- -- --
Purchase of MainStay brand option
from Sunburst .............................................. -- -- (10,140) --
----------------------------------------------------------
Balance as of December 31, 1998 .............................. 56,726,917 607 $ 43,432 $ 2,112
==========================================================
Treasury Comprehensive Retained
Stock Income Earnings Total
=============================================================
Initial capitalization - October 15, 1997 ................. $ -- $ -- $ 40,000
Comprehensive income
Net income ............................................. -- $ 27,287 27,287 27,287
Other comprehensive income, net of tax
Foreign currency translation
adjustment ............................................. -- 346 -- 346
--------
Comprehensive income ...................................... -- $ 27,633 -- --
========
Exercise of stock options/grants, net ..................... -- -- (157)
Treasury purchases ........................................
Transfers of net income to Sunburst prior to (189) -- (189)
the distribution ........................................
-- $(18,029) (18,029)
------------------------------------------------------------
Balance as of December 31, 1997 ........................... $ (189) $ 9,258 $ 49,258
============================================================
Comprehensive income
Net income ............................................. -- $ 55,305 $ 55,305 55,305
Other comprehensive income, net of tax
Foreign currency translation adjustments, net -- 10,892 -- (18,029)
Unrealized loss on securities, net of
reclassification adjustment (see notes) -- (464) -- (464)
--------
Other comprehensive income ............................. -- 10,428 -- --
--------
Comprehensive income ...................................... -- $ 65,733 -- --
========
Exercise of stock options/grants, net ..................... -- 5,674
--
Treasury purchases, net ................................... (54,015) -- (54,015)
Purchase of MainStay brand option
from Sunburst ........................................... -- -- (10,140)
------------------------------------------------------------
Balance as of December 31, 1998 ........................... $(54,204) $ 64,563 $ 56,510
============================================================
See notes to consolidated statements.
32
Notes To Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
BASIS OF PRESENTATION
On March 7, 1996, Manor Care, Inc. ("Manor Care") announced its intention to
proceed with the separation of its lodging business ("Choice Hotels Holdings,
Inc." or "Holdings") from its health care business via a spin-off of its lodging
business (the "Manor Care 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 Holdings for each share of Manor Care stock, and the
Board set the Record Date and the Distribution Date. The Manor Care Distribution
was made on November 1, 1996 to holders of record of Manor Care's Common Stock
on October 10, 1996. Choice Hotels International, Inc. (the "Company"), which
was a subsidiary of Manor Care became a wholly-owned subsidiary of Holdings.
The Manor Care Distribution separated the lodging and health care businesses of
Manor Care into two public corporations. The operations of Holdings consisted
principally of the hotel franchise operations and the owned and managed hotel
operations formerly conducted by Manor Care directly or through its subsidiaries
(the "Lodging Business").
On November 1, 1996, concurrent with the Manor Care Distribution, Holdings
changed its name from Choice Hotels Holdings, Inc. to Choice Hotels
International, Inc. ("CHI") and the Company changed its name to Choice Hotels
Franchising, Inc.
On April 29, 1997, CHI's Board of Directors announced its intention to separate
CHI's franchising business from its owned hotel business (referred to as the
"Sunburst Distribution"). On September 16, 1997, the Board of Directors and
shareholders of CHI approved the separation of the business via a spin-off of
the Company, 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, CHI shareholders received one share in the Company (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 changed its name to
Sunburst Hospitality Corporation, (referred to hereafter as "Sunburst") and
effected a one-for-three reverse stock split of its common stock.
The Company is in the business of hotel franchising. As of December 31, 1998,
the Company had franchise agreements with 3,671 hotels open and 1,477 hotels
under development in 36 countries under the following brand names: Comfort,
Clarion, Sleep, Quality, Rodeway, Econo Lodge, and MainStay Suites.
The consolidated financial statements present the financial position, results of
operations and cash flows and equity of the Company as if it were formed as a
separate entity of its parent (Manor Care prior to Manor Care Distribution and
Sunburst prior to Sunburst Distribution) 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 transfers between the Company and Manor Care through
November 1, 1996 and Sunburst through October 15, 1997.
An analysis of the activity in the "Investments and advances from Parent"
account for the three years ended May 31, 1997 and the seven months ended
December 31, 1997 is as follows:
(In thousands)
----------------
Balance, May 31, 1995 ............................... $ (12,699)
Transfers from Parent, net .......................... 31,567
Net income .......................................... 11,664
----------------
Balance, May 31, 1996 ............................... 30,532
Transfers to Parent, net ............................ (8,069)
Net income .......................................... 34,730
----------------
Balance, May 31, 1997 ............................... 57,193
Net income from June 1, 1997
through October 15, 1997 ....................... 18,029
Transfers to Parent, net through
October 15, 1997 ............................... (35,222)
Initial capitalization .............................. (40,000)
----------------
Balance, October 15, 1997 ........................... $ 0
----------------
33
Notes To Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
The average balance of the Investments and advances from Parent was $48.6
million, $43.9 million and $8.9 million for the seven months ended December 31,
1997 and the fiscal years ended May 31, 1997 and 1996, respectively.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year financial statements
to conform to the current year presentation.
SIGNIFICANT ACCOUNTING POLICIES
FISCAL YEAR
During October 1997, the Company changed its fiscal year from a May 31 year end
to a December 31 year end.
ASSETS HELD FOR SALE
Assets held for sale by the Company are stated at the lower of cost or estimated
net realizable value.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with a maturity of
three months or less at the date of purchase to be cash equivalents.
PROPERTY AND EQUIPMENT
The components of property and equipment in the consolidated balance sheets
were:
DECEMBER 31,
(In thousands) 1998 1997
---------------------
Land................................................. $ 1,603 $ 996
Facilities in progress............................... 1,600 --
Building and improvements............................ 8,023 18,238
Furniture, fixtures and equipment.................... 33,494 31,228
-------------------
44,720 50,462
Less: Accumulated depreciation....................... (11,875) (13,422)
-------------------
$ 32,845 $ 37,040
-------------------
During 1998, approximately $1.7 million of fixed assets were eliminated in
conjunction with the termination of a capital lease obligation. (See Long Term
Debt and Notes Payable.)
Depreciation has been computed for financial reporting purposes using the
straight-line method. A summary of the ranges of estimated useful lives upon
which depreciation rates have been based follows:
Building and improvements.................................. 10-40 years
Furniture, fixtures and equipment.......................... 3-20 years
GOODWILL
Goodwill primarily represents an allocation of the excess purchase price of the
stock of the Company over the recorded minority interest. Goodwill is amortized
on a straight-line basis over 40 years. Such amortization amounted to $2.0
million, $1.1 million, $1.9 million and $1.1 million for the year ended December
31, 1998, the seven months ended December 31, 1997, and the fiscal years ended
May 31, 1997 and 1996, respectively. Goodwill is net of accumulated amortization
of $8.1 million and $6.1 million at December 31, 1998 and 1997.
FRANCHISE RIGHTS
Franchise rights are intangible assets and represent an allocation in purchase
accounting for the value of long-term franchise contracts. The majority of the
balance results from the Econo Lodge and Rodeway acquisitions made in fiscal
year 1991. Franchise rights acquired are amortized over an average life of 15
years. Amortization expense for the year ended December 31, 1998 and the seven
months ended December 31, 1997, and the fiscal years ended May 31, 1997 and 1996
amounted to $3.8 million, $1.7 million, $2.9 million and $2.6 million,
respectively. Franchise rights are net of accumulated amortization of $19.5
million and $15.7 million at December 31, 1998 and 1997.
The Company periodically assesses the amortization lives of its franchise
rights. Effective January 1, 1998, the Company changed its estimate of the
useful life of Econo Lodge franchise rights to a 17 year period and Rodeway
franchise rights to a 3 year period to more closely match the remaining
estimated contract lives of franchise contracts acquired in 1991. The effect of
this change in estimate was to increase depreciation and amortization expense by
approximately $900,000 and decrease net income by $0.01 per dilutive share for
the year ended December 31, 1998.
DEFERRED FINANCING COSTS
Debt financing costs are deferred and amortized, using the interest method, over
the term of the related debt.
34
Notes To Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
SELF-INSURANCE PROGRAM
Subsequent to the Manor Care Distribution, the Company maintained its own self-
insurance program for certain levels of general and professional liability,
automobile liability and worker's compensation coverage. The estimated costs of
these programs were accrued at present values based on actuarial projections for
known and anticipated claims. As of June 1, 1997, the Company was no longer self
insured.
Prior to the Manor Care Distribution, the Company participated in Manor Care's
self-insurance program for certain levels of general and professional liability,
automobile liability and workers' compensation coverage. The estimated costs of
these programs are accrued at present values based on actuarial projections for
known and anticipated claims. All accrued self-insurance costs through November
1, 1996 were assumed by Manor Care, and have been treated as paid to Manor Care,
and as such, amounts paid to Manor Care up to November 1, 1996 have been charged
directly to Investments and advances from Parent.
REVENUE RECOGNITION
The Company enters into numerous franchise agreements committing to provide
franchisees with various marketing services, a centralized reservation system
and limited rights to utilize the Company's registered tradenames. These
agreements are typically for a period of twenty years, with certain rights to
the franchisee to terminate after five, 10, or 15 years. Initial franchise fees
are recognized upon sale because the initial franchise fee is non-refundable and
the Company has no continuing obligations related to the franchisee. Royalty
fees, primarily based on gross room revenues of each franchisee, are recorded
when earned. Reserves for uncollectible accounts are charged to bad debt expense
and included in selling, general and administrative expenses in the accompanying
consolidated statements of income.
The Company's franchise agreements require the payment of franchise fees which
include marketing and reservation fees. These fees, which are based on a
percentage of the franchisees' gross room revenues, are used exclusively to
reimburse the Company for expenses associated with providing such franchise
services as central reservation systems, national marketing, and media
advertising. The Company is contractually obligated to expend the reservation
and marketing fees it collects from franchisees in accordance with the franchise
agreements; as such, no income or loss to the Company is generated. During the
second quarter of 1998, the Company changed its presentation of marketing and
reservation fees such that the fees collected and associated expenses are
reported net. All prior periods have been reclassified to conform to the new
presentation.
The total marketing and reservation fees received by the Company (previously
reported as revenue) for the year ended December 31, 1998, the seven months
ended December 31, 1997, and the fiscal years ended May 31, 1997 and 1996
amounted to $127.4 million, $72.3 million, $104.2 million and $98.9 million,
respectively. Depreciation and amortization charged to reservation and marketing
expenses for the year ended December 31, 1998, the seven months ended December
31, 1997, and the fiscal years ended May 31, 1997 and 1996 amounted to $5.7
million, $2.2 million, $2.8 million and $2.7 million, respectively. Reservation
fees and marketing fees not expended in the current year are carried over to the
next fiscal year and expended in accordance with the franchise agreements.
Shortfall amounts are similarly recovered in subsequent years. Excess or
shortfall amounts from the operation of these programs are recorded as a payable
or receivable from the particular fund. As of December 31, 1998 the Company's
balance sheet includes a receivable in amounts due from marketing and
reservation funds of $13.4 million related to shortfalls in the marketing ($7.8
million) and reservation ($5.6 million) funds. As of December 31, 1997, the
Company's balance sheet includes a receivable in amounts due from marketing and
reservation funds of $5.2 million related to a shortfall in the marketing fund
and a current liability in accounts payable of $4.5 million related to excess
monies in the reservation fund. The Company expects to be able to recover these
receivables through future marketing and reservation fees.
IMPAIRMENT POLICY
The Company evaluates the recoverability of long lived assets, including
franchise rights and goodwill, whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability is measured based on net, undiscounted expected cash flows.
Assets are considered to be impaired if the net, undiscounted expected cash
flows are less than the carrying amount of the assets. Impairment charges are
recorded based upon the difference between the carrying value of the asset and
the expected net cash flows, discounted at an appropriate interest rate.
35
Notes To Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
CAPITALIZATION POLICIES
Major renovations and replacements are capitalized to appropriate property and
equipment accounts. Upon sale or retirement of property, the cost and related
accumulated depreciation are eliminated from the accounts and the related gain
or loss is taken into income. Maintenance, repairs and minor replacements are
charged to expense.
INTEREST RATE HEDGES
The Company has entered into interest rate swap agreements with a notional
amount of $115 million at December 31, 1998 to fix certain of its variable rate
debt in order to reduce the Company's exposure to fluctuations in interest
rates. The interest rate differential to be paid or received on interest rate
swap agreements is accrued as interest rates change and is recognized as an
adjustment to interest expense. On average at December 31, 1998, the interest
rate swap agreements have a life of one and one-half years with a fixed rate of
5.85% and variable rate of 5.07%. As of December 31, 1998 and 1997, the interest
rate swap agreements have a fair market valuation of approximately $(2.8
million) and $(0.5 million), respectively.
FOREIGN OPERATIONS
The Company accounts for foreign currency translation in accordance with SFAS
No. 52, "Foreign Currency Translation." Revenues generated by foreign operations
for the year ended December 31, 1998, the seven months ended December 31, 1997
and the fiscal years ended May 31, 1997 and 1996 were $5.8 million, exclusive of
$2.1 million of foreign dividends; $16.2 million, exclusive of $0.6 million of
foreign dividends; $27.5 million and $29.9 million, respectively. The Company's
foreign operations had net income (loss) of $2.3 million, $0.3 million, $(1.8
million) and $(19.4 million) for the year ended December 31, 1998, the seven
months ended December 31, 1997 and the fiscal years ended May 31, 1997 and 1996.
The majority of the revenues and assets of foreign operations relate to the
Company's European business operations (see "Acquisitions and Divestitures").
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from these estimates.
EARNINGS PER SHARE
The Company adopted Financial Accounting Standards Board Statement ("SFAS") No.
128, "Earnings Per Share" in 1997. The following table illustrates the
reconciliation of the earnings and number of shares used in the basic and
diluted earnings per share calculations.
Seven months
Year ended ended
December 31, December 31,
(In millions, except per share amounts) 1998 1997
---------------------------
Computation of Basic Earnings Per Share:
Net income..................................... $55.3 $27.3
Weighted average shares outstanding............ 58.7 59.8
Basic earnings per share....................... $0.94 $0.46
Computation of Diluted Earnings Per Share:
Net income for diluted earnings per share...... $55.3 $27.3
Weighted average shares outstanding............ 58.7 59.8
Effect of Dilutive Securities
Employee stock option plan..................... 0.8 1.5
--------------------
Shares for diluted earnings per share.......... 59.5 61.3
--------------------
Diluted earning per share...................... $0.93 $0.45
====================
The effect of dilutive securities is computed using the treasury stock method
and average market prices during the period. In 1998 the Company excluded
497,864 antidilutive options from the computation of diluted earnings per share.
The Company had no shares outstanding to the public or material dilutive
securities prior to the Sunburst Distribution and therefore, no reconciliation
has been provided for periods prior to December 31, 1997.
The weighted average number of common shares outstanding is based on the
Company's weighted average number of outstanding common shares for the period
October 15, 1997 through December 31, 1998, Sunburst's weighted average number
of outstanding common shares for the period November 1, 1996 through October 15,
1997 and Manor Care's weighted average number of outstanding common shares prior
to November 1, 1996.
COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income," which establishes new rules for the reporting and display
of comprehensive income and its
36
Notes To Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
components; however, the adoption of SFAS 130 had no impact on the Company's net
income or shareholders' equity. SFAS 130 requires unrealized gains or losses on
the Company's available-for-sale securities and the foreign currency translation
adjustments, which prior to adoption were reported separately in shareholders'
equity, to be included in other comprehensive income. Prior year financial
statements have been reclassified to conform to the requirements of SFAS 130.
The components of total accumulated other comprehensive income in the balance
sheet are as follows:
DECEMBER 31,
(In thousands) 1998 1997
---------------------------
Unrealized losses on available
for sale securities............................ $ (464) $ --
Foreign currency
translation adjustment......................... 2,576 (8,316)
---------------------------
Total accumulated other
comprehensive income (loss).................... $ 2,112 $ (8,316)
---------------------------
The related income tax effect allocated to each component of other comprehensive
income is as follows:
Amount Before Income Tax Amount
(In thousands) Taxes (Expense)/Benefit Net of Taxes
---------------------------------------------------
Calendar year 1998
Net unrealized losses $(1,450) $ 986 $ (464)
Foreign currency
translation adjustments, net 9,972 920 10,892
------------------------------------------------
Total other
comprehensive income $ 8,522 $1,906 $10,428
------------------------------------------------
Fiscal year 1997
Foreign currency
translation adjustments $(1,298) $ -- $(1,298)
------------------------------------------------
Total other
comprehensive loss $(1,298) $ -- $(1,298)
------------------------------------------------
Below represents the detail of other comprehensive income:
1998
----
Foreign currency translation adjustments........................ $ 2,760
Plus: reclassification of loss on liquidation
of foreign subsidiaries....................................... 8,132
Net foreign currency translation adjustments.................... $10,892
-------
Unrealized holding gains arising
during the period............................................. $ 920
Less: reclassification adjustments for gains
included in net income.......................................... (1,384)
-------
Net unrealized holding losses arising
during the period............................................... $ (464)
-------
INCOME TAXES
The Company was included in the consolidated federal income tax returns of Manor
Care and Sunburst Hospitality Corporation prior to October 15, 1997. Subsequent
to October 15, 1997, the Company is required to make its own filings. The income
tax provision included in these consolidated financial statements reflects the
historical income tax provision and temporary differences attributable to the
operations of the Company on a separate return basis. Deferred taxes are
recorded for the tax effect of temporary differences between book income and
taxable income.
Income before income taxes for the year ended December 31, 1998, the period
beginning June 1, 1997 and ending December 31, 1997 ("December 1997") and the
fiscal years ended May 31, 1997 and 1996 were derived from the following:
(In thousands) CY 1998 December 1997 FY 1997 FY 1996
==========================================
Income before
income taxes:
Domestic operations $82,400 $45,866 $62,641 $ 52,801
Foreign operations -- 517 (3,066) (31,824)
-------------------------------------------
Income
before income taxes $82,400 $46,383 $59,575 $ 20,977
===========================================
The provision for income taxes follows for the year ended December 31, 1998, the
period beginning June 1, 1997 and ended December 31, 1997 ("December 1997") and
the fiscal years ended May 31, 1997 and 1996:
(In thousands) CY 1998 December 1997 FY 1997 FY 1996
----------------------------------------------
Current tax (benefit)
expense:
Federal $ 25,594 $15,742 $19,421 $20,097
Federal (benefit)
expense of foreign
operations (9,674) 204 (1,213) (2,792)
State 3,482 3,475 3,950 3,754
Deferred tax
(benefit) expense:
Federal 2,482 (223) 2,293 125
Federal (benefit)
expense of foreign
operations 9,938 -- -- (9,778)
State 2,505 (102) 394 (2,093)
-----------------------------------------------
$ 34,327 $19,096 $24,845 $ 9,313
===============================================
37
Notes to Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
Deferred tax assets (liabilities) are comprised of the following as of December
31.
(In thousands) 1998 1997
========================================
Depreciation and
amortization $(16,013) $(3,184)
Prepaid expenses (3,975) (1,484)
Other (5,316) (2,458)
----------------------------------------
Gross deferred tax
liabilities (25,304) (7,126)
----------------------------------------
Foreign operations 2,211 2,843
Accrued expenses 5,035 5,283
Net operating losses 187 398
Other 1,860 1,001
----------------------------------------
Gross deferred tax
assets 9,293 9,525
----------------------------------------
Net deferred tax
asset (liability) $(16,011) $ 2,399
========================================
A reconciliation of income tax expense at the statutory rate to income tax
expense included in the accompanying consolidated statements of income follows:
CY 1998 December 1997 FY 1997 FY 1996
=================================================
(In thousands, except Federal income tax rate)
Federal income
tax rate 35% 35% 35% 35%
Federal taxes at
statutory rate $28,856 $16,234 $20,853 $7,345
State income taxes,
net of federal tax benefit 3,892 2,192 2,824 1,080
Minority interest -- -- -- 536
Other 1,579 670 1,168 352
-------------------------------------------------
Income tax expense $34,327 $19,096 $24,845 $9,313
=================================================
Cash paid for state income taxes was $3,398,000; $197,000; and $1,302,000 for
the year ended December 31, 1998, the seven months ended December 31, 1997 and
the fiscal year ended May 31, 1997, respectively. Federal income taxes were
paid by Manor Care for the period ending October 31, 1996. Federal income taxes
were paid by Sunburst Hospitality Corporation for the period beginning November
1, 1996 through May 31, 1997. The Company paid $18,880,000 in income taxes
for the calendar year ended December 31, 1998, and $9,060,000 for the short
period beginning June 1, 1997 and ending December 31, 1997.
Consistent with the existing Company tax-sharing policy, current Federal
provision amounts prior to October 15, 1997 have been treated as paid to, or
received from, the Company, and as such, there are no current tax provision
balances due to the Sunburst Hospitality Corporation at May 31, 1997.
Differences between amounts paid to or received from Sunburst Hospitality
Corporation and the Company have been charged or credited directly to
Investments and advances from Parent. As part of the tax-sharing agreement, the
current taxes payable as of October 15, 1997 were assumed by Sunburst.
ACCRUED EXPENSES
Accrued expenses were as follows as of December 31:
(In thousands) 1998 1997
-----------------------
Accrued salaries & benefits $ 10,152 $ 8,495
Accrued interest 3,302 2,026
Reservation fund payable -- 4,542
Other 6,152 5,639
-----------------------
Total $ 19,606 $ 20,702
=======================
LONG TERM DEBT AND NOTES PAYABLE
As of December 31, debt consisted of the following:
(In thousands) 1998 1997
---------------------
$300 million competitive advance
and multi-currency revolving credit
facility with an average rate of
5.91% and 6.60% at December
31, 1998 and 1997, respectively $172,000 $267,600
$100 million senior note offering
with an average rate of 7.22% at
December 31, 1998 99,382 --
$15 million line of credit with a rate
of 6.1% at December 31, 1998 6,200 --
Capital lease obligation -- 13,469
Other notes with an average rate
of 5.85% and 5.6% at December
31, 1998 and 1997 1,628 1,752
---------------------
Total indebtedness $279,210 $282,821
=====================
38
Notes to Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
Maturities of debt as of December 31, 1998 were as follows:
YEAR (In thousands)
1999........................................ $ 22,646
2000........................................ 32,646
2001........................................ 42,646
2002........................................ 74,646
2003........................................ 146
Thereafter.................................. 106,480
--------
Total....................................... $279,210
========
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. The Credit Facility provides for a term loan of $150
million and a revolving credit facility of $150 million, $50 million of which is
available for borrowings in foreign currencies. The credit facility includes
customary financial and other covenants that require 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. The term loan is payable over five years,
$22.5 million of which is due in 1999. Borrowings under the facility are, at the
option of the borrower, at one of several rates including LIBOR plus 20.0 to
87.5 basis points, based upon a defined financial ratio and the loan type. In
addition, the Company has the option to request participating banks to bid on
loan participation at lower rates than those contractually provided by the
facility. The Credit Facility requires the Company to pay annual fees of 1/10
of 1% to 1/3 of 1%, based upon a defined financial ratio of the total loan
commitment. 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 Note to Sunburst.
The Subordinated Term Note of $115 million accrues interest monthly at an
initial simple rate of 11% per annum through October 14, 2000. In connection
with the amendment of the strategic alliance agreement discussed in
"Transactions with Sunburst," effective October 15, 2000, interest shall accrue
at a rate of 11% per annum compounded daily. The Company will implement this
amendment prospectively beginning January 1, 1999, recognizing interest on the
outstanding principal and accrued interest amounts at an effective rate of
10.58%. The note is payable in full, along with accrued interest, on October 15,
2002. Total interest accrued as of December 31, 1998 and 1997 was $12.8 million
and $2.4 million, respectively.
On May 1, 1998, the Company issued $100 million of senior unsecured notes (the
"Notes") at a discount of $0.6 million, bearing a coupon rate of 7.13% with an
effective rate of 7.22%. The Notes will mature on May 1, 2008, with interest on
the Notes to be paid semi-annually. The Company used the net proceeds from the
offering of approximately $99 million to repay amounts outstanding under the
Company's $300 million revolving credit facility. Total interest expense of
$4.8 million was recorded in the consolidated statements of income for the year
ended December 31, 1998.
During April 1998, the Company obtained a revolving line of credit for $15
million in order to finance short term working capital requirements and other
short term general corporate goals. The line of credit is due to expire on
April 30, 1999 and bears interest at floating rates. Interest accrues monthly
on the outstanding balance. The line of credit contains essentially the same
covenants as the Credit Facility and is prepayable without penalty.
Cash paid for interest was $19.2 million, $7.9 million, $11.6 million and $11.8
million for the year ended December 31, 1998, the seven months ended December
31, 1997, and the fiscal years ended May 31, 1997 and 1996, respectively.
LEASES
Rental expense under non-cancelable operating leases was approximately $1.7
million, $181,000, $171,000 and $231,000 for the year ended December 31, 1998,
the seven months ended December 31, 1997 and the fiscal years ended May 31, 1997
and 1996, respectively. The Company paid office rent of $977,500 and $1.1
million to Sunburst for the year ended December 31, 1998 and the seven months
ended December 31, 1997 based on the portion of total space occupied by the
Company. Future minimum lease payments are as follows:
YEAR (In thousands)
1999........................................ $ 2,462
2000........................................ 2,499
2001........................................ 2,530
2002........................................ 2,489
2003........................................ 2,250
Thereafter.................................. --
-------
Total....................................... $12,230
=======
39
Notes to Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
During 1998, the Company recorded an extraordinary gain for the early
extinguishment of a capitalized lease obligation. The Company retired $13.7
million in debt and removed related assets of $1.7 million from the consolidated
balance sheets. Accordingly, an extraordinary gain of $7.2 million was
recognized, after income tax benefits of $4.5 million, or $0.12 per diluted
share.
Prior to May 31, 1998, the Company was a guarantor of Sunburst's obligations
under leases between Sunburst and Manor Care. Additionally, Sunburst and Choice
had entered into a sublease agreement with respect to the Company's principal
executive offices. On May 31, 1998, the Company and Manor Care entered into a
new lease for the Silver Spring, Maryland corporate headquarters and the
Company's guarantees of Sunburst lease obligations and the sublease were
cancelled. The new lease has a fifteen year term.
ACQUISITIONS AND DIVESTITURES
On May 31, 1995, the Company repurchased one-half of the 11% interest held by
its management in the Company. Approximately $19.8 million was allocated to
goodwill; the purchase cost of $27.4 million was paid in June and July 1995. On
May 31, 1996, the Company repurchased the remaining 5.5% minority interest in
the Company for $27.9 million. Approximately $26.4 million was allocated to
goodwill.
On May 31, 1996, the Company invested approximately $17.1 million in the capital
stock of Friendly Hotels, PLC ("Friendly"). In exchange for the $17.1 million
investment, the Company received 750,000 shares of common stock and 10 million
newly issued immediately convertible preferred shares. In addition, the Company
granted to Friendly a Master Franchise Agreement for the United Kingdom and
Ireland in exchange for 333,333 additional shares of common stock. The
preferred shares carry a 5.75% dividend payable in cash or in stock, at the
Company's option. The dividend accrues annually with the first dividend paid
on the earlier of the third anniversary of completion or on a conversion date.
The proceeds of the investment received by Friendly were used to support the
construction of 10 Quality or Comfort hotels. As a condition to the investment,
the Company has the right to appoint three directors to the board of Friendly.
In January 1998, the Company completed a transaction with Friendly in which
Friendly would 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, the Company will receive from Friendly $8.0
million, payable in eight equal annual installments. As of December 31, 1998,
the Company had received $1.0 million. The master franchise payment is being
recognized over the life of the agreement.
As part of the transaction, Friendly acquired European hotels owned by the
Company for $26.2 million in convertible preferred shares and cash. In exchange
for 10 hotels in France, two in Germany and one in the United Kingdom, the
Company received $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 the Company 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 Company reflected the net assets
subject to this transaction as assets held for sale in the December 31, 1997,
accompanying consolidated balance sheet. At December 31, 1998, the Company
owned approximately 5.2% of the outstanding ordinary shares of Friendly which
would increase to approximately 45% if the Company's preferred stock were
converted.
The Company recognized $2.1 million, $0.6 million and $0.9 million in preferred
dividend income from the Friendly investment for the year ended December 31,
1998, the seven months ended December 31, 1997 and the fiscal year ended May 31,
1997, respectively. As of December 31, 1998 and 1997, accrued but unpaid
preferred dividends were $3.7 million and $1.5 million, respectively.
TRANSACTIONS WITH SUNBURST
Subsequent to the Manor Care Distribution, the Company participated in a cash
concentration system with Sunburst and as such maintained no significant cash
balances or banking relationships. Substantially all cash received by the
Company was immediately deposited in and combined with Sunburst's corporate
funds through its cash management system. Similarly, operating expenses, capital
expenditures and other cash requirements of the Company have been paid by
Sunburst and charged to the Company. The net result of all of these
intercompany transactions were reflected in Investments and advances from
Parent.
40
Notes to Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
As part of the Sunburst Distribution, Sunburst and the Company have entered into
a strategic alliance agreement. Among other things, the agreement provides
for: (i) a right of first refusal to the Company to franchise any lodging
properties to be acquired or developed by Sunburst, (ii) certain commitments by
Sunburst for the development of Sleep Inn and MainStay Suites hotels, (iii)
continued cooperation of both parties with respect to matters of mutual
interest, such as new product and concept testing, (iv) continued cooperation
with respect to third party vendor arrangements; and (v) certain limitations on
competition in each others' line of business. The strategic alliance agreement
extends for a term of 20 years with mutual rights of termination on the fifth,
10th and 15th anniversaries. In December 1998, the parties amended the
strategic alliance agreement (vi) to eliminate Sunburst's option to acquire the
MainStay Suites brand, (vii) to amend Sunburst's development commitments and
(viii) to provide certain global amendments to Sunburst's franchise agreements.
For purposes of providing an orderly transition after the Sunburst Distribution,
Sunburst and the Company entered into various agreements, including, among
others, a Distribution Agreement, a Tax Sharing Agreement, a Corporate Services
Agreement and an Employee Benefits Allocation Agreement. Effective as of
October 15, 1997, these agreements provide, among other things, that Sunburst
(i) will receive, human resources certain corporate and support services, such
as accounting, tax and computer systems support, (ii) will provide to the
Company certain services including asset management, and payables processing;
(iii) will adjust outstanding options to purchase shares of Company Common Stock
held by Company employees, Sunburst employees, and employees of Manor Care,
(iii) is responsible for filing and paying the related taxes on consolidated
federal tax returns and consolidated or combined state tax returns for itself
and any of its affiliates (including the Company) for the periods of time that
the affiliates were members of the consolidated group, (v) will be reimbursed by
the Company for the portion of income taxes paid that relate to the Company and
its subsidiaries, and (vi) guarantees that the Company will, at the date of
distribution, have a specified minimum level of net worth. These agreements
will extend for a maximum period of 30 months from the Distribution date or
until such time as the Company and Sunburst have arranged to provide such
services in-house or through another unrelated provider of such services. As of
March 31, 1999, all services provided by each party under the Corporate Services
Agreement, except for human resources and tax services provided by the Company,
will be terminated. Costs associated with the Corporate Services Agreement as
well as costs of services provided by Sunburst to the Company or provided by the
Company to Sunburst have been allocated between the entity providing the
services and the entity receiving the services in the accompanying financial
statements. As a result, future administrative and corporate expenses are
expected to vary from historical results. However, the Company has estimated
that general and administrative expenses incurred annually will not materially
change.
During the periods presented, Sunburst operated substantially all of its hotels
pursuant to franchise agreements with the Company. Total fees paid to the
Company included in the accompanying financial statements for franchising
royalty, marketing and reservation fees were $11.2 million for the year ended
December 31, 1998, $6.2 million for the seven months ended December 31, 1997 and
$9.5 million and $7.5 million for the fiscal years ended May 31, 1997 and 1996,
respectively.
In accordance with the Sunburst Distribution Agreement, the Company agreed to
assume and pay certain liabilities of Sunburst, subject to the Company
maintaining a minimum net worth of $40 million, at the date of Distribution. As
of December 31, 1997, the Company reflected a $25 million receivable due from
Sunburst on the consolidated balance sheet. In 1998, net payments of
approximately $8 million were collected from Sunburst in cash. On December 28,
1998, the Company and Sunburst amended the strategic alliance agreement entered
into in connection with the Sunburst Distribution. As part of that amendment,
the Company exchanged the remaining $17 million balance in return for, among
other things, the exclusive rights to the MainStay Suites brand from Sunburst
and a commitment from Sunburst to build a total of 25 MainStay Suites. The $17
million, net of income taxes of approximately $7 million, was recorded as an
adjustment to additional paid in capital as it represents an adjustment to the
accounting for the Sunburst Distribution.
RELATED PARTY TRANSACTIONS
During 1998, the Company entered into a bridge loan agreement with a Company
executive approximating $754,000, which is reflected as a receivable at December
31, 1998. The bridge loan was repaid in March 1999.
41
Notes to Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
COMMITMENTS AND CONTINGENCIES
The Company is a defendant in a number of lawsuits arising in the ordinary
course of business. In the opinion of management and general counsel to the
Company, the ultimate outcome of such litigation will not have a material
adverse effect on the Company's business, financial position or results of
operations.
PENSION, PROFIT SHARING, AND INCENTIVE PLANS
Bonuses accrued for key executives of the Company under incentive compensation
plans were $755,000 and $520,000 at December 31, 1998 and 1997, respectively.
During 1998, employees of the Company participated in 401(k) retirement plans
sponsored by the Company. For the year ended December 31, 1998, the Company
recorded compensation expense of $1.2 million related to the plan. Prior to the
Manor Care Distribution and Sunburst Distribution, employees participated in
retirement plans sponsored by Manor Care and Sunburst. Costs allocated to the
Company under those plans were based on the size of its payroll relative to the
sponsor's payroll. Costs allocated to the Company were approximately $1.2
million, $1.4 million and $0.8 million for the seven months ended December 31,
1997, and the fiscal years ended May 31, 1997 and 1996, respectively.
CAPITAL STOCK
In 1998, the Company granted key executives 84,592 restricted shares of common
stock with a value of $1,105,403 on the grant date. The restricted stock vests
over a three year period. In 1997, the Company granted a key executive 85,470
restricted shares of common stock with a value of $1.25 million on the grant
date and vesting over a three year period. In 1998, 42,735 of these shares were
forfeited.
On February 19, 1998, the Board of Directors adopted a shareholder rights plan
under which a dividend of one preferred stock purchase right was distributed for
each outstanding share of the Company's common stock to shareholders of record
on April 3, 1998. Each right will entitle the holder to buy 1/100th of a share
of a newly issued series of a junior participating preferred stock of the
Company at an exercise price of $75 per share. The rights will be exercisable,
subject to certain exceptions, 10 days after a person or a group acquires
beneficial ownership of 10% or more of the Company's common stock. Shares owned
by a person or group on February 19, 1998, and held continuously thereafter are
exempt for purposes of determining beneficial ownership under the rights plan.
The rights will be non-voting and will expire on January 31, 2008, unless
exercised or previously redeemed by the Company for $.001 each. If the Company
is involved in a merger or certain other business combinations not approved by
the Board of Directors, each right will entitle its holder, other than the
acquiring person or group, to purchase common stock of either the Company or the
acquiror or having a value of twice the exercise price of the right.
The Company has stock option plans for which it is authorized to grant options
to purchase up to 7.1 million shares of the Company's common stock, of which 1.5
million shares remain available for grant. Stock options may be granted to
officers, key employees and non-employee directors with an exercise price not
less than the fair market value of the common stock on the date of grant. In
connection with the Sunburst Distribution, the outstanding options held by
current and former employees of the Company were redenominated in stock of the
newly separated companies and the number and exercise prices of the options were
adjusted based on
A SUMMARY OF THE OPTION ACTIVITY UNDER THE ABOVE PLANS IS AS FOLLOWS AS OF
DECEMBER 31, 1998 AND 1997:
1998 1997
==================================================================
Shares Weighted-Option Shares Weighted-Option
FIXED OPTIONS (000) Price (000) Price
==================================================================
Outstanding at beginning of year.................. 4,167,045 $ 8.62 4,689,515 $ 8.71
Granted........................................... 933,263 14.01 15,000 17.63
Exercised......................................... (738,318) 4.75 (28,550) 3.32
Cancelled......................................... (392,681) 11.88 (508,920) 10.05
---------- ------- --------- -------
Outstanding at end of year........................ 3,969,309 $10.28 4,167,045 $ 8.62
==================================================================
Options exercisable at year end................... 1,813,541 1,845,642
Weighted-average fair value of
options granted during the year................... $ 7.96 $ 8.79
42
Notes to Consolidated Finanical Statements
Choice Hotels International, Inc. and Subsidiaries
THE FOLLOWING TABLE SUMMARIZES INFORMATION ABOUT STOCK OPTIONS OUTSTANDING AT
DECEMBER 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
========================================================================================
RANGE OF NUMBER WEIGHTED-AVERAGE WEIGHTED NUMBER WEIGHTED
EXERCISE PRICES OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
12/31/98 CONTRACTUAL LIFE EXERCISE PRICE 12/31/98 EXERCISE PRICE
==============================================================================================================
$ 2.64 to 3.96 608,383 1.8 years $ 3.17 578,498 $ 3.12
3.96 to 5.94 223,054 3.3 years 4.99 165,797 4.99
5.94 to 8.91 464,642 4.7 years 7.02 270,501 6.92
8.91 to 13.37 1,677,295 7.8 years 12.08 773,453 11.78
13.37 to 17.63 995,935 9.6 years 14.31 25,292 16.91
--------- ---------
3,969,309 1,813,541
--------- ---------
the relative trading prices of the common stock of the two companies in order to
retain the intrinsic value of the options.
SFAS No. 123 "Accounting for Stock-Based Compensation," requires companies to
provide additional note disclosures about employee stock-based compensation
plans based on a fair value based method of accounting. As permitted by this
accounting standard, the Company continues to account for these plans under APB
Opinion 25, under which no compensation cost has been recognized. Compensation
cost for the Company's stock option plan was determined based on the fair value
at the grant dates for awards under those plans consistent with the method of
SFAS No. 123. The fair value of each option grant has been estimated on the
date of grant using an option-pricing model with the following weighted average
assumptions used for grants in 1998 and 1997:
1998 1997
---- ----
Risk-free interest rate 4.7% 5.65%
Volatility 36.7% 23.6%
Expected Lives 10 years 10 years
Dividend Yield 0% 0%
If options had been reported as compensation expense based on their fair value
pro forma, net income would have been $54.0 million and $27.3 million for the
year ended December 31, 1998 and the seven months ended December 31, 1997, and
pro forma earnings per share would have been $0.90 and 0.46, respectively. Since
this methodology has not been applied to options granted prior to the Sunburst
distribution date, the resulting pro forma compensation cost is not likely to be
representative of that to be expected in future years.
REPORTABLE SEGMENT INFORMATION
The Company has a single reportable segment encompassing its franchising
business. Franchising business revenues for the year ended December 31, 1998,
the seven months ended December 31, 1997 and fiscal years ended May 31, 1997 and
1996 were $138.3 million, $84.1 million, $120.1 million and $105.4 million; and
operating expenses were $28.2 million, $15.4 million, $13.3 million and $14.7
million. Operating expenses include only costs directly associated with the
Company's domestic and international franchising service offices and do not
include allocation of corporate overhead. Depreciation expense for the
franchise segment was $0.2 million for the year ended December 31, 1998 and
relates primarily to furniture, fixtures and equipment utilized in these
offices. The Company does not allocate amortization expense, interest income,
interest expense or income taxes to its franchising segment.
All other revenues and expenses included on the Company's statement of income
for the year ended December 31, 1998 relate to corporate and other activities.
For the year ended December 31, 1998, the seven months ended December 31, 1997
and fiscal years ended May 31, 1997 and 1996 revenues generated by corporate and
other activities were $27.1 million, $23.7 million, $47.9 million and $46.4
million; operating expenses were $22.5 million, $14.1 million, $37.8 million and
$30.5 million; and depreciation and amortization expense was $6.9 million, $4.0
million, $7.6 million and $9.2 million, respectively.
The Company's international operations had revenues of $7.1 million, $11.8
million, $19.8 million and $21.4 million for the year ended December 31, 1998,
the seven months ended
43
Notes to Consolidated Financial Statements
Choice Hotels International, Inc. and Subsidiaries
December 31, 1997 and the fiscal years ended May 31, 1997 and 1996,
respectively. Long-lived assets related to international operations were $57.0
million and $38.7 million as of December 31, 1998 and 1997. All other long-lived
assets of the Company are associated with domestic activities.
FAIR VALUE OF FINANCIAL STATEMENTS
The balance sheet carrying amount of cash and cash equivalents and receivables
approximate fair value due to the short term nature of these items. Long term
debt consists of bank loans and senior notes. Interest rates on bank loans
adjust frequently based on current market rates; accordingly, the carrying
amount of bank loans is equivalent to fair value. The carrying amounts for
long-term debt approximate fair market values.
The Note Receivable from Sunburst approximates fair value based on its current
yield to maturity, which is equivalent to those investments of similar quality
and terms.
PROVISION FOR ASSET IMPAIRMENT
During fiscal year 1996, the Company began restructuring its European
operations. This restructuring effort included the purchase of an equity
interest in Friendly and a reevaluation of key geographic markets in Europe. In
connection with this restructuring, the Company performed a review of its
European operations and in May 1996 recognized a $15.0 million non-cash charge
(net of an $9.8 million income tax benefit) against earnings related to the
impairment of assets associated with certain European hotel operations.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," and SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information"
during 1998. The adoption of these pronouncements required the Company to make
certain additional disclosures.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133
Accounting for Derivative Instruments and Hedging Activities which requires
recognition of the fair value of derivatives in the statement of financial
position, with changes in the fair value recognized either in earnings or as a
component of other comprehensive income dependent upon the hedging nature of the
derivative. Implementation of SFAS No. 133 is required for Fiscal 2000. SFAS
No. 133 will not have a material impact on the Company's earnings or other
comprehensive income.
SUBSEQUENT EVENTS (UNAUDITED)
As of March 12, 1999, the Company has repurchased 5.4 million shares of its
common stock at a total cost of $74.1 million. The Company has authorization
from its Board of Directors to repurchase up to an additional 3.3 million
shares. As of March 12, 1999, there were 55.4 million total common shares
outstanding (a weighted average of 56.1 million).
THE FOLLOWING DATA IS INCLUDED FOR 1998 ONLY, AS THE COMPANY WAS NOT A PUBLIC
COMPANY FOR THE FULL YEAR OF 1997.
SELECTED QUARTERLY FINANCIAL DATA -- (UNAUDITED)
(In thousands, except per share data)
TOTAL
1998 FIRST SECOND THIRD FOURTH YEAR
==============================================================================================================================
Revenues $33,171 $44,436 $46,731 $41,037 $165,375
Operating income 14,133 23,519 26,736 22,332 86,720
Income before income taxes and extraordinary item 13,961 22,258 25,224 20,957 82,400
Net income before extraordinary item 8,146 12,988 14,718 12,221 48,073
Net income 8,146 12,988 21,950 12,221 55,305
Per basic share:
Net income before extraordinary item $ 0.14 $ 0.22 $ 0.25 $ 0.21 $ 0.82
Extraordinary item $ 0.00 $ 0.00 $ 0.12 $ 0.00 $ 0.12
Net income $ 0.14 $ 0.22 $ 0.37 $ 0.21 $ 0.94
Per diluted share:
Net income before extraordinary item $ 0.13 $ 0.22 $ 0.25 $ 0.21 $ 0.81
Extraordinary item $ 0.00 $ 0.00 $ 0.12 $ 0.00 $ 0.12
Net income $ 0.13 $ 0.22 $ 0.37 $ 0.21 $ 0.93
44
Board of Directors & Corporate Officers
Choice Hotels International, Inc. and Subsidiaries
BOARD OF
DIRECTORS
STEWART BAINUM, JR.
. Chairman of the Board:
HCR Manor Care, Inc.
Sunburst Hospitality Corp.
BARBARA BAINUM
. President, Secretary & Director:
Commonweal Foundation
. Secretary & Director:
Realty Investment Co.
CHARLES A. LEDSINGER, JR.
. President & Chief Executive
Officer:
Choice Hotels International
LARRY R. LEVITAN
. Retired Managing Partner:
Andersen Consulting's
Worldwide Communications
Industry Group
FREDERIC V. MALEK*
. Chairman:
Thayer Capital Partners
. Co-Chairman:
CB Richard Ellis, Inc.
JERRY E. ROBERTSON, PH.D.
. Retired Executive Vice President:
3M Life Sciences Sector
and Corporate Services
GERALD W. PETTIT
. President & Chief Executive
Officer:
Creative Hotel Associates
LLC
JAMES H. REMPE
. Retired Senior Vice President,
General Counsel & Secretary:
Manor Care, Inc.
* Retiring at the April 29, 1999,
board meeting
CORPORATE EXECUTIVE
OFFICERS
STEWART BAINUM, JR.
. Chairman of the Board
CHARLES A. LEDSINGER, JR.
. President & Chief Executive
Officer
MICHAEL J. DESANTIS
. Senior Vice President, General
Counsel & Secretary
BRUNO GENY
. Senior Vice President,
International
THOMAS MIRGON
. Senior Vice President,
Administration
MARK C. WELLS
. Senior Vice President,
Marketing
CORPORATE
OFFICERS
JOSEPH M. SQUERI
. Vice President, Treasurer &
Controller
DANIEL ROTHFELD
. Vice President, Partner Services
KEVIN M. ROONEY
. Assistant General Counsel &
Assistant Secretary
GERALD F. HICKEY
. Assistant Treasurer
MARKET AREA
VICE PRESIDENTS
BRENDAN M. EBBS
. Senior Vice President, Franchise
Operations, Northeast
Market Area
WILLIAM WEATHERFORD
. Senior Vice President, Franchise
Operations, Southeast
Market Area
MICHAEL BARNARD
. Vice President, Franchise
Operations, West Market Area
GARY DECATUR
. Vice President, Franchise
Operations, North Central
Market Area
BRENT RUSSELL
. Vice President, Franchise
Operations, South Central
Market Area
BRAND
MANAGEMENT
NORMAN CAVIN
. Sleep Inn Brand Management
Vice President
MICHAEL COTHRAN
. Rodeway Inn Brand
Management
Vice President
PETER JORDAN
. Quality Brand Management
Vice President
DONALD KOLODZ
. Clarion Brand Management
Vice President
DAN SHOEN
. Comfort Brand Management
Vice President
TIM SHUY
. Econo Lodge & MainStay
Suites Brand Management
Vice President
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Corporate Information
Choice Hotels International, Inc. and Subsidiaries
STOCK LISTING
Choice Hotels International
common stock trades on the
New York Stock Exchange
under the ticker symbol CHH.
TRANSFER AGENT & REGISTRAR
ChaseMellon
Shareholder Services LLC
Overpeck Centre
85 Challenger Road
Ridgefield, NJ 07660
INDEPENDENT AUDITORS
Arthur Andersen LLP
Washington, D.C.
ANNUAL MEETING DATE
Choice Hotels International
will hold its Annual Meeting
of Stockholders on Thursday,
April 29, 1999, at 9 a.m. at its
corporate headquarters, 10750
Columbia Pike, Silver Spring, Md.
FORM 10-K
A stockholder may receive without
charge a copy of the Form 10-K
Annual Report filed with the
Securities and Exchange
Commission by written request
to the Corporate Secretary at the
corporate headquarters.
CORPORATE HEADQUARTERS
Choice Hotels International
10750 Columbia Pike
Silver Spring, MD 20901
GENERAL INQUIRIES:
(301) 592-5000
FRANCHISE SALES:
(800) 547-0007
INVESTOR INQUIRIES:
(800) 404-5050, ext. 5026 or
(301) 592-5026
e-mail:
investor_relations@choicehotels.com
MEDIA RELATIONS:
(301) 592-5032
CORPORATE INTERNET SITE:
www.choicehotels.com
(C)1999 Choice Hotels International, Inc.
Quality, Comfort, Clarion, Sleep Inn,
Econo Lodge, Rodeway Inn and
MainStay are registered trademarks, ser-
vice marks and trade names owned by
Choice Hotels International, Inc. Choice
Hotels also owns and uses common law
marks, including Guest Privileges and
Profit Manager.
Design: Choice Graphic Design
Principal Photographer: Cameron Davidson
Printer: S&S Graphics
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