Exhibit 99.1
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report.......................................................... F-2
Consolidated Statements of Financial Position as of December 31, 1997 and 1996........ F-3
Consolidated Statements of Operations for the years ended December 31, 1997
and 1996 and for the period from August 28, 1995 (inception) to
December 31, 1995................................................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
December 31, 1997 and 1996 and for the period from August
28, 1995 (inception) to December 31, 1995........................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1997 and
1996 and for the period from August 28, 1995 (inception) to
December 31, 1995................................................................... F-6
Notes to Consolidated Financial Statements............................................ F-7
F-1
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
U.S. Franchise Systems, Inc.:
We have audited the accompanying consolidated statements of financial
position of U.S. Franchise Systems, Inc. and subsidiaries (the "Company") as of
December 31, 1997 and 1996 and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for the years ended
December 31, 1997 and 1996 and for the period from August 28, 1995 (inception)
to December 31, 1995. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
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, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company at December 31,
1997 and 1996 and the results of its operations and its cash flows for the years
ended December 31, 1997 and 1996 and for the period from August 28, 1995
(inception) to December 31, 1995 in conformity with generally accepted
accounting principles.
/s/ DELOITTE & TOUCHE LLP
Atlanta, Georgia
February 20, 1998 (March 17, 1998 as to Note 15
and April 1, 1998 as to Note 14)
F-2
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
December 31,
1997 1996
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments.............................................. $ 15,890,000 $ 31,188,000
Accounts receivable (net allowance for doubtful accounts of $17,000 and $45,000
as of December 31, 1997 and 1996, respectively)................................ 268,000 114,000
Deposits......................................................................... 114,000 93,000
Prepaid expenses................................................................. 602,000 494,000
Promissory notes receivable...................................................... 862,000 784,000
Deferred commissions............................................................. 2,563,000 1,261,000
------------- -------------
Total current assets............................................................. 20,299,000 33,934,000
PROMISSORY NOTES RECEIVABLE........................................................ 2,869,000 390,000
PROPERTY AND EQUIPMENT--Net........................................................ 5,595,000 292,000
FRANCHISE RIGHTS--Net.............................................................. 3,322,000 3,264,000
DEFERRED COMMISSIONS............................................................... 3,049,000 1,492,000
OTHER ASSETS--Net.................................................................. 1,217,000 733,000
------------- -------------
Total assets..................................................................... $ 36,351,000 $ 40,105,000
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS EQUITY
CURRENT LIABILITIES:
Accounts payable................................................................. $ 1,138,000 $ 679,000
Commissions payable.............................................................. 1,171,000 837,000
Deferred application fees........................................................ 4,402,000 2,916,000
Accrued expenses................................................................. 990,000 1,110,000
Due to Hudson Hotels Corporation................................................. 454,000 277,000
------------- -------------
Total current liabilities........................................................ 8,155,000 5,819,000
DUE TO HUDSON HOTELS CORPORATION................................................... -- 454,000
DEFERRED APPLICATION FEES.......................................................... 4,586,000 2,749,000
SUBORDINATED DEBENTURES............................................................ 19,412,000 --
------------- -------------
Total liabilities................................................................ 32,153,000 9,022,000
REDEEMABLE STOCK:
Preferred shares, par value $0.01 per share; authorized 525,000 shares; issued
and outstanding 163,500 shares; cumulative exchangeable (entitled in
liquidation to $18,477,000 at December 31, 1996)............................... -- 18,477,000
Common Shares, par value $0.01 pr share; issued and outstanding 3,128,473 (net of
57,807 shares in Treasury) at December 31, 1997 and 3,186,280 at December 31,
1996 entitled to redemption under certain circumstances to $330,000 and
$324,000 (net of $6,000 in Treasury at December 31, 1997) at December 31, 1997
and 1996, respectively......................................................... 324,000 330,000
COMMITMENTS AND CONTINGENCIES (Notes 5 and 12)
STOCKHOLDERS' EQUITY:
Common shares, par value $0.01 per share; authorized 30,000,000 shares of Class A
Common Stock and 5,000,000 shares of Class B Common Stock; issued and
outstanding 6,716,499 Class A shares and 2,707,919 Class B shares at December
31, 1997; issued and outstanding 6,686,196 Class A shares and 2,707,919 Class B
shares at December 31, 1996.................................................... 96,000 96,000
Capital in excess of par......................................................... 21,092,000 20,547,000
Accumulated deficit.............................................................. (17,314,000) (8,367,000)
------------- -------------
Total Stockholders' Equity......................................................... 3,874,000 12,276,000
------------- -------------
$ 36,351,000 $ 40,105,000
------------- -------------
------------- -------------
See notes to consolidated financial statements.
F-3
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
PERIOD FROM
YEAR ENDED YEAR ENDED AUGUST 28, 1995
DECEMBER 31, DECEMBER 31, (INCEPTION) TO
1997 1996 DECEMBER 31, 1995
------------- ------------- -----------------
REVENUES:
Marketing and reservation fees................................. $ 1,921,000 $ 1,197,000 $ --
Franchise application and royalty fees......................... 1,610,000 20,000 --
Other.......................................................... 417,000 75,000 --
------------- ------------- -----------------
3,948,000 1,292,000 --
------------- ------------- -----------------
EXPENSES:
Marketing and reservations..................................... 2,058,000 1,597,000 13,000
Royalties paid to third parties................................ 158,000 1,000 --
Franchise sales commissions.................................... 641,000 29,000 --
Other franchise sales and advertising.......................... 3,461,000 2,714,000 550,000
Other general and administrative............................... 5,487,000 3,750,000 638,000
Depreciation and amortization.................................. 571,000 537,000 126,000
------------- ------------- -----------------
12,376,000 8,628,000 1,327,000
------------- ------------- -----------------
LOSS FROM OPERATIONS............................................. (8,428,000) (7,336,000) (1,327,000)
OTHER INCOME (EXPENSE):
Interest income................................................ 1,386,000 871,000 195,000
Interest expense............................................... (1,905,000) (126,000) (36,000)
------------- ------------- -----------------
NET LOSS......................................................... $ (8,947,000) $ (6,591,000) $ (1,168,000)
------------- ------------- -----------------
------------- ------------- -----------------
LOSS APPLICABLE TO COMMON STOCKHOLDERS........................... $ (8,947,000) $ (8,309,000) $ (1,577,000)
------------- ------------- -----------------
------------- ------------- -----------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING............. 12,563,772 11,059,576 10,755,409
------------- ------------- -----------------
------------- ------------- -----------------
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS PER SHARE-BASIC....... $ (0.71) $ (0.75) $ (0.15)
------------- ------------- -----------------
------------- ------------- -----------------
See notes to consolidated financial statements.
F-4
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
COMMON STOCK CAPITAL
-------------------------- IN EXCESS ACCUMULATED
SHARES AMOUNT OF PAR DEFICIT
-------------- ---------- -------------- ---------------
BALANCE AS OF AUGUST 28, 1995.......................... -- $ -- $ -- $ --
Issuance of common stock............................... 7,569,115 78,000 637,000 --
Undeclared dividends on redeemable preferred stock..... -- -- (409,000) --
Net loss............................................... -- -- -- (1,168,000)
-------------- ---------- -------------- ---------------
BALANCE AS OF DECEMBER 31, 1995........................ 7,569,115 78,000 228,000 (1,168,000)
Redemption of capital stock--other management.......... (1,149,502) (11,000) (108,000) --
Issuance of capital stock--other management............ 1,149,502 11,000 111,000 --
Issuance of capital stock--initial public offering
proceeds, net........................................ 1,825,000 18,000 21,373,000 --
Undeclared dividends on redeemable preferred stock..... -- -- (1,110,000) (608,000)
Fair value of options granted.......................... -- -- 53,000 --
Net loss............................................... -- -- -- (6,591,000)
-------------- ---------- -------------- ---------------
BALANCE AS OF DECEMBER 31, 1996........................ 9,394,115 96,000 20,547,000 (8,367,000)
Issuance of capital stock--acquisition of computer
software............................................. 30,303 -- 250,000 --
Fair value of options granted.......................... -- -- 295,000 --
Net loss............................................... -- -- -- (8,947,000)
-------------- ---------- -------------- ---------------
BALANCE AS OF DECEMBER 31, 1997........................ 9,424,418 $ 96,000 $ 21,092,000 $ (17,314,000)
-------------- ---------- -------------- ---------------
-------------- ---------- -------------- ---------------
TOTAL
SHAREHOLDERS'
EQUITY
(DEFICIT)
---------------
BALANCE AS OF AUGUST 28, 1995.......................... $ --
Issuance of common stock............................... 715,000
Undeclared dividends on redeemable preferred stock..... (409,000)
Net loss............................................... (1,168,000)
---------------
BALANCE AS OF DECEMBER 31, 1995........................ (862,000)
Redemption of capital stock--other management.......... (119,000)
Issuance of capital stock--other management............ 122,000
Issuance of capital stock--initial public offering
proceeds, net........................................ 21,391,000
Undeclared dividends on redeemable preferred stock..... (1,718,000)
Fair value of options granted.......................... 53,000
Net loss............................................... (6,591,000)
---------------
BALANCE AS OF DECEMBER 31, 1996........................ 12,276,000
Issuance of capital stock--acquisition of computer
software............................................. 250,000
Fair value of options granted.......................... 295,000
Net loss............................................... (8,947,000)
---------------
BALANCE AS OF DECEMBER 31, 1997........................ $ 3,874,000
---------------
---------------
See notes to consolidated financial statements.
F-5
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
PERIOD FROM
YEAR ENDED YEAR ENDED AUGUST 28, 1995
DECEMBER 31, DECEMBER 31, (INCEPTION) TO
1997 1996 DECEMBER 31, 1995
-------------- ------------- -----------------
OPERATING ACTIVITIES:
Net loss..................................................... $ (8,947,000) $ (6,591,000) $ (1,168,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.............................. 571,000 537,000 126,000
Deferred compensation amortization......................... 295,000 53,000 --
Changes in assets and liabilities:
Increase in deposit and accounts receivable................ (175,000) (120,000) (87,000)
Increase in prepaid expenses............................... (341,000) (329,000) (457,000)
Increase in promissory notes receivable.................... (2,557,000) (1,174,000) --
Increase in deferred commissions........................... (2,859,000) (2,712,000) (41,000)
Increase in other assets................................... (548,000) (560,000) (230,000)
Increase in accounts payable............................... 459,000 478,000 201,000
Increase (decrease) in accrued expenses.................... (120,000) 1,045,000 65,000
Increase in commissions payable............................ 334,000 815,000 22,000
Increase in deferred application fees...................... 3,323,000 5,545,000 120,000
Increase in subordinated debentures paid in kind........... 935,000 -- --
-------------- ------------- -----------------
Net cash used in operating activities.................... (9,630,000) (3,013,000) (1,449,000)
INVESTING ACTIVITIES:
Acquisition of property and equipment........................ (5,162,000) (263,000) (62,000)
Acquisition of franchise rights.............................. (223,000) (117,000) (1,991,000)
-------------- ------------- -----------------
Net cash used in investing activities...................... (5,385,000) (380,000) (2,053,000)
FINANCING ACTIVITIES:
Issuance of redeemable preferred stock....................... -- -- 16,350,000
Issuance of common stock, net................................ -- 21,513,000 1,045,000
Redemption of common stock................................... (6,000) (119,000) --
Principal payments on borrowings............................. (277,000) (706,000) --
-------------- ------------- -----------------
Net cash provided by (used in) financing activities........ (283,000) 20,688,000 17,395,000
-------------- ------------- -----------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH
INVESTMENTS.................................................. $ (15,298,000) $ 17,295,000 $ 13,893,000
CASH AND TEMPORARY INVESTMENTS
Beginning of period.......................................... 31,188,000 13,893,000 --
-------------- ------------- -----------------
End of period................................................ $ 15,890,000 $ 31,188,000 $ 13,893,000
-------------- ------------- -----------------
-------------- ------------- -----------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest....................................... $ 1,009,000 $ 144,000 --
-------------- ------------- -----------------
-------------- ------------- -----------------
Noncash activities:
Undeclared dividends accrued on redeemable preferred
stock.................................................... -- $ 1,718,000 $ 409,000
-------------- ------------- -----------------
-------------- ------------- -----------------
Portion of purchase price due to Hudson Hotels Corporation in
future years, discounted at 10%............................ -- -- $ 1,437,000
-------------- ------------- -----------------
-------------- ------------- -----------------
Issuance of 30,303 shares of Class A common stock for
reservations system software............................... $ 250,000 -- --
-------------- ------------- -----------------
-------------- ------------- -----------------
See notes to consolidated financial statements.
F-6
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
1. BASIS OF PRESENTATION AND ORGANIZATION
U.S. Franchise Systems, Inc. (the "Company") was incorporated under the laws
of the State of Delaware on August 28, 1995 to acquire, market, and license
distinct franchise brands principally within the United States. The consolidated
financial statements include the accounts of the Company and the following
wholly owned subsidiaries: (i) Microtel Inns and Suites Franchising, Inc.
("Microtel") (and its wholly owned subsidiaries Microtel International, Inc. and
Microtel Inns Realty Corp. ("MIRC") (and its wholly owned subsidiaries Tempe
Inns Realty Corp., Chandler Inns Realty Corp., Tempe Holdings, LLC, and Chandler
Holdings, LLC)); (ii) Hawthorn Suites Franchising, Inc. ("HSF"); (iii) US
Funding Corp. ("US Funding"); and (iv) U.S. Franchise Capital, Inc. The
consolidated financial statements also include the accounts of the marketing and
reservation funds of the Microtel and Hawthorn hotel systems. All significant
intercompany balances and transactions have been eliminated in consolidation.
On October 24, 1996, the Company completed an initial public offering of
1,825,000 shares of Class A Common Stock at $13.50 per share (the "Offering").
Net proceeds to the Company from the Offering were approximately $21,391,000.
Had the Offering occurred on January 1, 1996, pro forma loss applicable to
common stockholders per share would have been $.66 for the year ended December
31, 1996. Pro forma weighted average shares of 12,580,409 are assumed
outstanding for purposes of the pro forma loss applicable to common stockholder
per share calculation.
MICROTEL INNS AND SUITES FRANCHISING, INC.
On September 7, 1995, the Company entered into an agreement (the "Microtel
Agreement") with Hudson Hotels Corporation ("Hudson") to acquire the exclusive
worldwide franchising rights and operating assets of the Microtel hotel system
(the "Microtel Acquisition") for $3,037,000. The Company paid $1,600,000 at
closing and agreed to pay $1,437,000 (see Note 6) over a three year period with
interest at 10%. The Company also agreed to pay $700,000 for consulting
services, $400,000 of which was paid at closing, with $150,000 payable in each
of 1996 and 1997. As of December 31, 1997, the Company had made all required
payments for consulting services. As part of the Microtel Agreement, the Company
received warrants to purchase 100,000 common shares of Hudson through September
1, 2000 at an exercise price of $8.375 per share. The Microtel Agreement
requires the Company to pay a royalty for the right to use, and license others
to use, certain trademarks, service marks, and trade names (the "Microtel
Proprietary Marks") associated with the Microtel hotel system (see Note 12).
The Company did not acquire physical facilities, employee base, sales force,
production techniques, or an existing customer base in conjunction with the
acquisition of the worldwide Microtel franchising rights.
Pursuant to a Trademark, Service Mark, and System License Agreement (the
"Microtel License Agreement"), the Company granted to Microtel the exclusive
right to use, and license others to use, the Microtel Proprietary Marks in
connection with the operation of hotels under the Microtel hotel system.
MICROTEL INNS REALTY CORP.
MIRC, a Georgia corporation, is a wholly owned subsidiary of Microtel
incorporated on January 30, 1997. This subsidiary, and its wholly owned
subsidiaries Tempe Inns Realty Corp., Chandler Inns Realty Corp., Tempe
Holdings, LLC, and Chandler Holdings, LLC, acquire and develop real estate. The
F-7
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
1. BASIS OF PRESENTATION AND ORGANIZATION (CONTINUED)
Company intends to construct hotels on this real estate and subsequently sell
these hotel properties upon completion of construction. In the event that a
hotel is not sold upon completion of construction, MIRC would be responsible for
managing or causing the management of the property until a sale occurs. There
can be no assurance that MIRC will find a buyer for any or all of the
properties.
HAWTHORN SUITES FRANCHISING, INC.
On March 27, 1996, the Company entered into an agreement with HSA
Properties, LLC ("HSA") to acquire the exclusive worldwide franchising rights
with respect to the Hawthorn hotel system (the "Hawthorn Agreement"). The
Company made no payment to HSA at closing but agreed to remit to HSA all
royalties the Company actually receives for then existing Hawthorn franchises
and a portion of the royalties the Company actually receives from future
Hawthorn franchisees.
Pursuant to a Trademark, Service Mark, and System License Agreement which
expires in April 1998 (the "Hawthorn License Agreement"), the Company granted to
HSF the exclusive right to use, and license others to use, the Hawthorn
Proprietary Marks in connection with the Hawthorn hotel system (see Notes 12 and
15).
MARKETING AND RESERVATION FUNDS
Marketing and reservation fees are collected from franchisees and used at
the Company's discretion to develop, support, and enhance the reservation
systems and marketing programs of the Microtel and Hawthorn hotel systems. The
related revenues and expenses are reported gross in the accompanying financial
statements.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
APPLICATION FEE REVENUE AND RELATED COSTs--Initial franchise fee revenue
consists of application fees received by the Company's subsidiaries from
prospective franchisees. Such fees are recognized in income when the underlying
hotels open for business. Related franchise sales commissions are deferred until
the underlying hotels open for business, at which time such costs are charged to
expense.
CASH AND TEMPORARY CASH INVESTMENTS--The Company considers its investments
with an original maturity of three months or less to be cash equivalents. "Cash
and temporary cash investments" consisted of the following at December 31, 1997
and 1996, respectively:
1997 1996
------------- -------------
Cash in bank deposit........................................... $ 1,523,000 $ 2,355,000
Money market funds............................................. 14,367,000 28,833,000
------------- -------------
$ 15,890,000 $ 31,188,000
------------- -------------
------------- -------------
F-8
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ALLOWANCE FOR DOUBTFUL ACCOUNTS--During the years ended December 31, 1997
and 1996, the Company charged $10,000 and $46,000 as an allowance for estimated
uncollectible accounts, respectively, and reduced the allowance by $39,000
during 1997.
FRANCHISE RIGHTS--Franchise rights represent the cost of acquiring such
rights and are amortized on a straight-line basis over twenty-five years.
Accumulated amortization is $447,000 and $281,000 at December 31, 1997 and 1996,
respectively.
OTHER ASSETS--Other assets primarily consist of development subsidies
(amortized over the life of the license agreement upon the hotel opening),
architectural drawings and renderings (amortized over fifteen years), US Funding
Corp. loan participations, and organization and start-up costs (amortized over
five years). Other assets consisted of the following at December 31, 1997 and
1996:
1997 1996
------------ ----------
US Funding Corp. loan participation..................................................... $ 433,000
Architectural plans and renderings--net of accumulated amortization of $47,000 and
$18,000, respectively................................................................. $ 383,000 $ 397,000
Development subsidies--net of accumulated amortization of $2,000 and zero,
respectively.......................................................................... $ 107,000 $ 49,000
Other--net of accumulated amortization of $72,000 and $39,000,
respectively.......................................................................... $ 294,000 $ 287,000
------------ ----------
------------ ----------
$ 1,217,000 $ 733,000
------------ ----------
------------ ----------
IMPAIRMENT OF LONG-LIVED ASSETS--The Company has adopted Statement of
Financial Accounting Standards ("SFAS") 121, "Accounting for the Impairment of
Long-Lived Assets and Long-Lived Assets to Be Disposed of," as of January 1,
1996. Long-lived assets, principally intangibles, are evaluated quarterly and
written down to fair value when management believes that the unamortized balance
cannot be recovered through future undiscounted cash flows. No assets were
written down to fair value during the years ended December 31, 1997 and 1996,
respectively.
INCOME TAXES--The Company has adopted the provisions of SFAS 109,
"Accounting for Income Taxes," which requires the use of the asset and liability
approach in accounting for income taxes.
FAIR VALUE OF FINANCIAL INSTRUMENTS--The carrying amounts of cash and cash
equivalents, trade and notes receivables, other current assets, accounts
payable, accrueds, and notes payable meeting the definition of a financial
instrument approximate fair value.
STOCK-BASED COMPENSATION PLANS--The Company has elected to account for its
Stock Option plans in accordance with SFAS 123, "Accounting for Stock-Based
Compensation." Under the provisions of SFAS 123, compensation is recognized for
the fair value of options granted over the vesting period.
EARNINGS PER SHARE--In February 1997, the Financial Accounting Standards
Board issued SFAS 128, "Earnings per Share," which simplifies the standards for
computing earnings per share (EPS) information
F-9
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
and makes the computation comparable to international EPS standards. SFAS 128
replaces the presentation of "primary" (and when required "fully diluted") EPS
with a presentation of "basic" and diluted EPS. Net income per share basic is
computed based on net income divided by the weighted average common shares
outstanding. If required, on a diluted basis, net income per share -diluted is
computed by dividing net income by the weighted average common and common shares
during the year plus the incremental shares that would have been outstanding
under stock option plans.
MANAGEMENT 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 and 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 those estimates.
RECLASSIFICATIONS--Certain amounts in the prior year financial statements
have been reclassified to conform with the 1997 financial statement
presentation.
3. REDEEMABLE PREFERRED STOCK AND SUBORDINATED DEBENTURES
Until December 31, 1996, the cumulative redeemable exchangeable preferred
stock (the "Redeemable Preferred Stock") earned cumulative dividends at an
annual dividend rate of 10%, payable in additional shares of Redeemable
Preferred Stock.
On January 1, 1997, the Company exercised its option to exchange the
Redeemable Preferred Stock at its liquidation value of $18,477,000 into 10%
subordinated debentures due September 29, 2007 (the "Subordinated Debentures").
The Company is required to pay interest expense by issuing additional
Subordinated Debentures for 50% of the expense with the remaining 50% to be paid
in cash. Interest is payable semi-annually on the last business day in June and
December of each year. If Mr. Michael A. Leven's employment with the Company
terminates for any reason or the Company were to experience a change of control,
the Company would be obligated to redeem all outstanding Subordinated
Debentures.
F-10
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
4. PROPERTY AND EQUIPMENT
Property and equipment is recorded at historical cost and consisted of the
following at December 31, 1997 and 1996, respectively:
1997 1996
------------ ----------
Land................................................................ $ 1,847,000 $
Construction-in-progress............................................ 2,339,000
Furniture and fixtures.............................................. 175,000 124,000
Computer equipment and software..................................... 1,273,000 144,000
Truck............................................................... 25,000
Office equipment.................................................... 76,000 56,000
------------ ----------
5,735,000 342,000
Less accumulated depreciation....................................... 140,000 32,000
------------ ----------
------------ ----------
$ 5,595,500 $ 292,000
------------ ----------
------------ ----------
Computer software is depreciated on a straight-line basis over a period of
three years. Computer equipment is depreciated using the 200% declining-balance
method over a period of five years. The truck is depreciated on a straight-line
basis over eighteen months. The remaining fixed assets are depreciated using the
200% declining-balance method over a period of seven years. Depreciation expense
was $108,000, $30,000 and $2,000 for the years ended December 31, 1997 and 1996,
and the period from August 28, 1995 (inception) to December 31, 1995,
respectively. Included within property and equipment is capitalized interest of
$32,000 at December 31, 1997.
5. LEASES
The Company leases certain equipment and office space used in its
operations. Rental expense under operating leases was $366,000, $231,000 and
$41,000 for the years ended December 31, 1997 and 1996 and the period from
August 28, 1995 (inception) to December 31, 1995, respectively. The future
minimum rental commitments under non-cancelable operating leases at December 31,
1997 were as follows:
1998............................................................ $ 356,000
1999............................................................ 332,000
2000............................................................ 241,000
2001............................................................ 75,000
2002............................................................ 46,000
---------
Total........................................................... $1,050,000
---------
---------
F-11
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
6. DUE TO HUDSON HOTELS CORPORATION
The Company is required to pay Hudson $1,437,000 ($1,700,000 discounted at a
rate of 10%) of which $454,000 remains payable as of December 31, 1997 for the
assets of the Microtel hotel system (see Note 1) and is payable on October 5,
annually, as follows:
PAYABLE AS OF PAYABLE AS OF
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
1997................................................... $ -- $ 277,000
1998................................................... 454,000 454,000
-------- --------
454,000 731,000
Less current portion................................... 454,000 277,000
-------- --------
$ -- $ 454,000
-------- --------
-------- --------
7. PREPAID EXPENSES
Pursuant to the Microtel Agreement, Hudson is required, for a period of
three years, to consult with and assist in establishing the Company as an
operating entity in the business of selling and administering franchises
utilizing the Microtel hotel system. An initial payment in the amount of
$400,000 was made to Hudson in October 1995 and recorded as a deferred expense.
The Company paid its remaining obligation of $150,000 in 1997 in connection with
such consulting arrangements. Such amounts are being amortized over the term of
the Microtel Agreement. Amortization expense of $233,000, $233,000 and $58,000
was charged to expense for the years ended December 31, 1997 and 1996 and for
the period from August 28, 1995 (inception) to December 31, 1995, respectively.
8. STOCK PURCHASED BY EMPLOYEES
On October 5, 1995, as part of the initial capitalization of the Company,
two of its officers (the "Original Management Investors") purchased 5,485,259
shares of common stock (51% of the total issued) pursuant to employee stock
purchase agreements (as amended, the "Employee Stock Purchase Agreements") for
an aggregate purchase price of $567,245 or $.1034 per share. In conjunction with
the Offering, the Employee Stock Purchase Agreements were amended to revise the
vesting requirements with respect to 50% of the Restricted Shares (as
hereinafter defined) (approximately 13% of the Common Stock outstanding before
the Offering). Such Restricted Shares were deemed earned and vested
notwithstanding the fact that performance criteria were not yet met by the
Company. Pursuant to the terms of the Employee Stock Purchase Agreements, in
February 1996, the Company redeemed 826,833 shares, consisting of 608,359
Unrestricted Shares and 218,474 Restricted Shares (collectively, the
"Transferable Shares"), from the Original Management Investors at $.1034 per
share and resold such shares to other members of management, each of whom signed
Employee Stock Purchase Agreements, at the estimated fair value at that time of
$.1034 per share. In April 1996, the Company redeemed 322,669 Transferable
Shares from certain other management at $.1034 per share and subsequently resold
such shares to the same members of other management at the estimated fair value
at that time of $.1137 per share.
F-12
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
8. STOCK PURCHASED BY EMPLOYEES (CONTINUED)
As of December 31, 1996, 4,087,054 shares were unrestricted (the
"Unrestricted Shares") and 1,398,205 shares were restricted (the "Restricted
Shares").
As of December 31, 1997, the numbers of Unrestricted Shares and Restricted
Shares were 4,056,133 and 1,371,319, respectively. The decrease in the number of
Unrestricted and Restricted Shares during 1997 is attributable to the repurchase
by the Company of 30,921 Unrestricted and 26,886 Restricted Shares from two
management employees who left the Company during 1997 (collectively, the
"Forfeit Shares"). The Company repurchased 38,990 and 18,817 Forfeit Shares at
$.1034 and $.1137 per share, respectively, pursuant to the terms of the
departing management employees' respective Employee Stock Purchase Agreements.
As of December 31, 1997 the 57,807 Forfeit Shares are held by the Company as
treasury stock. Pursuant to the terms of their respective Employee Stock
Purchase Agreements, the Original Management Investors had the right to
purchase, at any time, the Forfeit Shares from the Company at the price paid by
the Company. However, as of December 10, 1997, the Original Management Investors
have permanently declined their option to purchase such Forfeit Shares held as
Treasury Stock.
Pursuant to the terms of their respective Employee Stock Purchase
Agreements, all members of management who own Transferable Shares must vote such
shares in the same manner as the Original Management Investors vote their
shares. Unrestricted Shares and Restricted Shares are subject to five year and
ten year vesting periods, respectively, subject to, among other things, the
management employee's continued employment by the Company. Any Transferable
Shares which are forfeited will be repurchased by the Company and will be
reoffered to the Original Management Investors at $.1034 or $.1137 per share, as
applicable, based on the price paid by the management employee for the forfeited
shares. Compensation expense will be recorded to the extent the fair value of
the reoffered shares exceeds $.1034 or $.1137, as applicable.
All Restricted Shares are subject to an earnings test formula based upon
increases in the Company's earnings before interest, taxes, and depreciation and
are deemed earned upon the satisfaction of these performance criteria (the
"Earned Shares"). Earned Shares are subject to forfeiture if the holder's
employment ceases with the Company before September 29, 2005. Any Restricted
Shares that have not been earned by September 29, 2005 will be redeemed by the
Company and reissued to the original stockholders of the Company (other than the
Original Management Investors) pro rata based on their original holdings of
common stock. Restricted Shares held by the Original Management Investors and
all Transferable Shares held by other members of management have been classified
as redeemable common stock in the balance sheet because they are redeemable by
the Company under certain circumstances for reasons not under the Company's
control.
In the event that substantially all of the Company's stock or assets are
transferred or sold, or upon a business combination, Earned Shares automatically
become Unrestricted Shares. In addition, any remaining Restricted Shares at the
time of a merger or sale of the Company become Unrestricted Shares to the extent
that the then value of the Company results in an internal rate of return to the
original stockholders of the Company of 40% compounded annually.
F-13
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
9. COMMON STOCK
On October 11, 1996, the stockholders approved the creation of two classes
of common stock: Class A Common Stock, par value $.01 per share and Class B
Common Stock, par value $.01 per share. The stockholders also agreed to split
and reclassify each share of the Company's existing common stock, par value $.10
per share, into 9.67 shares of Class A Common Stock. In connection with the
reclassification, certain members of management and related stockholders holding
2,707,919 shares of Class A Common Stock exchanged such shares for the same
number of shares of Class B Common Stock. Shares of Class A Common Stock and
Class B Common Stock are identical in all respects except that: (i) holders of
Class B Common Stock are entitled to ten votes per share and holders of Class A
Common Stock are entitled to one vote per share; and (ii) the shares of Class B
Common Stock are convertible into Class A Common Stock at the option of the
holder and, with limited exceptions, upon the transfer thereof. Following the
reclassification, there were 30 million shares of Class A Common Stock and 5
million shares of Class B Common Stock authorized for issuance. All references
in the financial statements to the number of shares and per share amounts of the
Company's common stock have been retroactively restated to reflect the increased
number of common shares outstanding.
10. STOCK OPTION PLANS
The Company has two stock option plans which reserve shares of Class A
Common Stock for officers, employees, consultants and advisors of the Company
(the "Employee Plan") and for its non-employee directors (the "Directors Plan").
Under the Employee Plan, the Option Committee of the Board of Directors may
grant options to Company employees for up to 325,000 shares of the Company's
Class A Common Stock. The options generally have a maximum life of seven years
and are generally exercisable in installments of 25% per year on each of the
first through the fourth anniversaries of the grant date. Under the Directors
Plan, the Company may grant options to its non-employee directors for up to
125,000 shares of the Company's Class A Common Stock. Non-employee directors are
each awarded options to purchase 2,000 shares upon their election to the Board
of Directors. In addition, commencing on January 1, 1998, each non-employee
director receives a grant of 2,000 stock options on January 1 of each year he
continues to serve on the Board. The director options become exercisable on the
first anniversary of the grant date and their maximum life is ten years.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions.
1997 1996
--------- ---------
Expected life (years)........................................................... 3.8 3.6
Expected volatility............................................................. 30.1% 30.4%
Risk free interest rate......................................................... 6.0% 6.2%
Dividend Yield.................................................................. 0.0% 0.0%
F-14
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
10. STOCK OPTION PLANS (CONTINUED)
Activity related to the Company's two stock option plans is summarized as
follows:
1997 1996
----------------------- -----------------------
WEIGHTED WEIGHTED
AVG. AVG.
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
---------- ----------- ---------- -----------
Options outstanding as of January 1................................. 178,500 $ 13.48 $ --
Granted............................................................. 105,700 8.66 179,100 13.48
Forfeited........................................................... (55,700) 12.72 (600) 13.50
---------- ----------
Options outstanding as of December 31............................... 228,500 $ 11.39 178,500 $ 13.48
---------- ----------
---------- ----------
Options exercisable as of December 31............................... 39,950
Weighted-average fair value of options granted during the year...... $ 2.78 $ 4.23
---------- ----------
---------- ----------
The following table summarizes information about stock options outstanding
at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- ----------------------------
WEIGHTED
AVERAGE WEIGHTED NUMBER WEIGHTED
NUMBER REMAINING AVERAGE EXERCISABLE AVERAGE
RANGE OF EXERCISES OUTSTANDING AT CONTRACTUAL EXERCISE AT EXERCISE
PRICES DEC. 31, 1997 LIFE PRICE DEC. 31, 1997 PRICE
- ------------------ -------------- --------------- ----------- ------------- -------------
$7.00 to $10.12.... 98,400 6.59 $ 8.62 -- $ --
$10.50 to $13.50... 130,100 6.00 13.48 39,950 13.49
$7.00 to $13.50.... 228,500 6.27 11.39 39,950 13.49
The fair value of options granted during the years ended December 31, 1997
and 1996 was $213,000 and $558,000, respectively, which is being amortized as
compensation expense over the vesting period. Compensation expense of $295,000
and $53,000 and $0 was recorded for the years ended December 31, 1997 and 1996
and for the period from August 28, 1995 (inception) to December 31, 1995,
respectively.
F-15
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
11. INCOME TAXES
Deferred income taxes in the accompanying consolidated statement of
financial position includes the following amounts of deferred tax assets and
liabilities at December 31, 1997 and 1996, respectively:
1997 1996
------------ ------------
Deferred tax liabilities:
Deferred Expenses................................................. $ (487,000) $ (330,000)
Other............................................................. (76,000) (8,000)
------------ ------------
Total............................................................. $ (563,000) $ (338,000)
------------ ------------
------------ ------------
Deferred tax assets:
Operating loss carryforwards.................................... $ 4,386,000 $ 2,446,000
Deferred revenue................................................ 2,165,000 648,000
Compensation cost............................................... 135,000 20,000
Other........................................................... 123,000 129,000
------------ ------------
Total............................................................. 6,809,000 3,243,000
------------ ------------
Valuation allowance............................................... (6,246,000) (2,905,000)
------------ ------------
Net deferred tax asset (liability)................................ $ -- $ --
------------ ------------
------------ ------------
For income tax purposes, as of December 31, 1997, the Company had
accumulated net operating loss carryforwards of $11,542,000 which begin to
expire in the year 2010.
During the year ended December 31, 1997, the Company increased the valuation
allowance by $3.3 million due to the uncertainty of the realizability of net
deferred tax assets.
The following is a reconciliation of the statutory rate to the effective
rate of the Company at December 31, 1997 and 1996, respectively:
1997 1996
--------- ---------
Statutory federal rate....................................................... 34% 34%
Statutory state rate less federal effect..................................... 4 4
Effect of income not subject to tax.......................................... (1) (1)
Change in valuation allowance................................................ (37) (37)
--- ---
Effective tax rate........................................................... --% --%
--- ---
--- ---
12. COMMITMENTS
The Company, as part of the Microtel Agreement, is required to fulfill
certain obligations under such Agreement. These include the following:
F-16
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
12. COMMITMENTS (CONTINUED)
- To execute franchise agreements and to have open or under development the
following number of Microtel hotels each December, annually:
YEAR NUMBER OF HOTELS
- ---------------------------------------------------------------- -------------------
1997............................................................ 50
1998............................................................ 100
1999............................................................ 175
2000............................................................ 250
- The above development schedule is considered to have been complied with
unless such schedule is not met for two consecutive years. If 75% of the
development level has been met, a fee of $1,000,000 may be paid and upon
such payment, the Company will be deemed to be in compliance with such
schedule.
- Hudson will retain the right to receive franchise application fees and all
franchise royalty payments under existing agreements at October 5, 1995 or
under agreements for which franchise applications had been received as of
October 5, 1995, except for reservation and marketing fees, which are
retained by the Company.
- As part of the Microtel Acquisition, Hudson retained the right to
franchise and to receive royalties on sixty franchises either issued or
which may be issued in the future to Hudson, its affiliates and certain
other persons. For each new franchise other than the sixty issued or which
may be issued to Hudson, its affiliates and such other persons, the
Company is required to remit to Hudson a continuing monthly royalty equal
to 1.0% of the revenues subject to royalties on the first 100 Microtel
properties opened by the Company's franchisees, 0.75% for the next 150
Microtel properties, and 0.5% for each new property after the first 250
properties.
If any of the above obligations are not met, including the payment of
amounts due to Hudson (see Note 6), all of the rights to the Microtel system
will, at Hudson's discretion, revert back to Hudson. In the event Hudson
exercises its rights to the Microtel system, the Company, through Microtel will
retain the rights to any franchise royalty payments due under franchises granted
by the Company and its subsidiary, less certain processing fees due to Hudson.
Pursuant to the Hawthorn Agreement which was in place on December 31, 1997,
the Company was required to fulfill certain obligations and was subject to
certain restrictions during 1997. The impact of these restrictions has been
negated pursuant to the series of transactions, completed on March 12, 1998,
which enabled it to acquire the entire interest in the Hawthorn Suites brand of
hotels. (see Note 15 for Subsequent Events relating to the Hawthorn Agreement).
The Company has employment agreements with its Chief Executive Officer and
Chief Financial Officer. The agreements are for a ten year term expiring on
September 30, 2005 and provide minimum salary levels and other fringe benefits.
F-17
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
13. SELECTED QUARTERLY FINANCIAL DATA--(UNAUDITED)
1997 FIRST SECOND THIRD FOURTH TOTAL YEAR
- ------------------------------------------ ------------ ------------ ------------ ------------ -------------
Revenue................................... $ 545,000 $ 892,000 $ 1,176,600 $ 1,335,000 $ 3,948,000
Loss from operations...................... 2,418,000 2,069,000 2,028,000 1,913,000 8,428,000
Net loss.................................. 2,515,000 2,174,000 2,181,000 2,077,000 8,947,000
Loss applicable to common stockholders.... 2,515,000 2,174,000 2,181,000 2,077,000 8,947,000
Weighted average shares outstanding....... 12,580,395 12,580,395 12,541,405 12,552,891 12,563,772
Net loss applicable to common stockholders
per share-basic......................... $ 0.20 $ 0.17 $ 0.17 $ 0.17 $ 0.71
1996 FIRST SECOND THIRD FOURTH TOTAL YEAR
- ------------------------------------------ ------------ ------------ ------------ ------------ -------------
Revenue................................... $ 31,000 $ 364,000 $ 469,000 $ 428,000 $ 1,292,000
Loss from operations...................... 1,537,000 1,917,000 1,888,000 1,994,000 7,336,000
Net loss.................................. 1,398,000 1,797,000 1,718,000 1,678,000 6,591,000
Loss applicable to common stockholders.... 1,817,000 2,216,000 2,158,000 2,118,000 8,309,000
Weighted average shares outstanding....... 10,755,409 10,755,409 10,755,409 11,059,576 11,059,576
Net loss applicable to common stockholders
per share-basic......................... $ 0.17 $ 0.21 $ 0.20 $ 0.19 $ 0.75
- ------------------------
(a) All per share information presented has been retroactively adjusted to
reflect the stock splits discussed in Note 9.
(b) Due to the changes in the numbers of shares outstanding, quarterly per share
amounts do not add to the total for the year.
14. PROPOSED ACQUISITION
BEST INNS ACQUISITION. On December 15, 1997, Best Acquisition, Inc., a
wholly owned subsidiary of USFS ("BAI"), signed a definitive agreement (the
"Best Acquisition Agreement") with America's Best Inns, Inc. and certain
other selling entities (collectively, the "Sellers") to acquire, among other
things, the exclusive worldwide rights to the Best Inns hotel brands,
including the franchise agreements for the existing Best Inns hotels. In
addition, under the Best Acquisition Agreement, BAI will acquire the
management contracts and related personnel relating to the management of 29
existing Best Inn hotels. The Best Acquisition Agreement also provides for
BAI to become the controlling member of the not-for-profit corporation which
supplies reservation services to Best Inn hotels.
On April 1, 1998, the Best Acquisition Agreement was amended to increase the
purchase price by $100,000 and require consummation of the transactions
contemplated thereunder by May 10, 1998 (the "Amendment Agreement"). Pursuant to
the Amendment Agreement, BAI paid the Sellers $3 million as a nonrefundable
advance on the purchase price and agreed to pay to the Sellers an additional
$100,000 per day, also to be considered as a nonrefundable advance on the
purchase price, for each day after April 20,
F-18
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
14. PROPOSED ACQUISITION (CONTINUED)
1998 that the transaction has not closed, until the earlier of the termination
of the Best Acquisition Agreement and May 10, 1998 (the "Further Advance").
In connection with this transaction, the Company and the Sellers are
expected to enter into an agreement with Alpine Hospitality Ventures LLC
("Ventures") pursuant to which Ventures (through a wholly-owned subsidiary)
will acquire 17 Best Inns hotels (the "Acquired Hotels"). The acquisition by
Ventures of the Acquired Hotels is a condition to USFS's right to acquire the
franchise rights and other assets to be acquired by it in the transaction. As
a result, the failure by Ventures to consummate such purchase would trigger
the obligation of BAI to make the full amount of the Further Advance ($2
million) to the Sellers and the Company would forfeit to the Sellers the $3
million non-refundable advance and the Further Advance. It is anticipated
that, contemporaneously with the closing of the transaction, new franchise
and management agreements will be entered into between the Company and
Ventures with respect to the Acquired Hotels. Upon completion of the
transaction, USFS or its subsidiaries will be the franchisor of 35 existing
Best Inns hotels and three hotels under development and manage 29 of the
existing Best Inns hotels and two Best Inns hotels under development.
To facilitate the transaction, the Company intends to make a $15 million
unsecured subordinated loan to Ventures at an interest rate of 12% per annum,
some or all of the interest on which will be paid-in-kind. The loan will be
subordinated to a guarantee provided by Ventures in connection with a
third-party loan in the principal amount of approximately $65 million to its
subsidiary that will own the Acquired Hotels and will also be subordinated to
such third party. The Company expects to make the subordinated loan and to
issue the Alpine Shares (as defined below) in order to induce Ventures to
purchase from the Sellers the Acquired Hotels. USFS intends to finance the
subordinated loan through a $10 million full recourse loan from NationsBank
N.A., the $1.6 million it expects to receive from an affiliate of Ventures
for the Alpine Shares and $3.4 million of its own cash. The Company expects
Ventures to be a highly leveraged entity and there can be no assurance that
the subordinated loan to Ventures will be repaid. It is anticipated that the
proceeds from the Offering will be utilized to repay the NationsBank loan.
Also in connection with the Best Acquisition Agreement, the Company is
expected to enter into an agreement with Alpine Hospitality Equities LLC
("Alpine Equities"), an affiliate of Ventures, pursuant to which Alpine
Equities will purchase 350,000 shares (the "Alpine Shares") of Class A Common
Stock for a purchase price of $1.6 million. Alpine Equities will be granted
certain demand and piggy-back registration rights on customary terms with
respect to the Alpine Shares, as well as certain tag-along rights on certain
sales of Common Stock made by Messrs. Leven and Aronson. Additionally, the
Company has agreed to pay to Alpine Equities $1,000 per year for each Best
Inns hotel that is added to the Best Inns system of hotels after the closing
date of the transaction, provided that such new hotels are paying royalties
to the Company or any of its subsidiaries (the "New Hotel Fee").
Richard D. Goldstein, a director of the Company, is a Senior Managing
Director of Alpine Equity Partners, L.P., the entity that indirectly owns and
controls a majority of Alpine Equities and Ventures.
F-19
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
AS OF DECEMBER 31, 1997 AND 1996 AND FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1996 AND FOR THE PERIOD
FROM AUGUST 28, 1995 (INCEPTION) TO DECEMBER 31, 1995
15. SUBSEQUENT EVENTS
HAWTHORN ACQUISITION. On March 12, 1998, USFS, USFS Hawthorn, Inc. ("USH"),
Hawthorn Suites Associates ("HSA") and HSA Properties, Inc. ("HPI") completed a
series of transactions whereby all of the ownership interests of HSA Properties
LLC ("HSA LLC"), a joint venture among USFS, HPI and HSA which owns an interest
in the Hawthorn Suites brand of hotels, were contributed to USH in return for
the issuance of shares of Class A Common Stock, par value $.01 per share ("USH
Class A Common Stock") of USH, and USFS merged into USH. Pursuant to these
transactions, HSI and HPI received 22,477 and 2,199,775 shares of Class A Common
Stock, respectively. In addition, the holders of Class A Common Stock of USFS
and Class B Common Stock of USFS received an equivalent number of USH Class A
Common Stock and Class B Common Stock, par value $.01 per share, as applicable.
Prior to these transactions, USFS and HSA LLC were parties to a Master Franchise
Agreement dated as of March 27, 1996 (the "Hawthorn Acquisition Agreement"),
pursuant to which USFS acquired the exclusive worldwide rights to franchise and
to control the development and operation of the Hawthorn Suites brand of hotels.
The Hawthorn Acquisition Agreement required that a percentage of royalties
received by USFS from the franchising of Hawthorn Suites Hotels be remitted to
HSA LLC and also contained certain restrictions on USFS's operations and imposed
standards relating to the development of the Hawthorn Suites brand of hotels.
The merger of USFS with and into USH permitted the surviving entity (renamed
"U.S. Franchise Systems, Inc.") to acquire all of the trademarks, copyrights and
other intellectual property related to the Hawthorn Suites hotel brand and as a
related consequence, eliminated the aforementioned royalty payments and
restrictive provisions previously governed by the Hawthorn Acquisition
Agreement.
ESTABLISHMENT OF DEVELOPMENT FUND. On March 17, 1998, NorthStar
Constellation, LLC (together with its affiliates, "NorthStar"), Lubert-Adler
Real Estate Opportunity Funds (together with its affiliates, "Lubert-Adler") and
Constellation Equity Corp., an entity controlled by NorthStar ("Constellation"),
formed Constellation Development Fund (the "Development Fund"). NorthStar,
Lubert-Adler and Constellation will contribute to the Development Fund equity
totaling $50 million, and will arrange debt financing for an additional $50
million in the form of a senior credit facility with a commercial bank. In
connection with the establishment of the Development Fund, the Company has made
a $10 million loan to Constellation, which will use the funds to make a
subordinated investment in the Development Fund. The loan bears interest at an
annual rate of 8%, is non-recourse and is repayable from distributions and
payments made to Constellation from the Development Fund.
In connection with the establishment of the Development Fund, the Company
sold an aggregate of 500,000 shares of Class A Common Stock to NorthStar and
Lubert-Adler for $5.6 million. NorthStar and Lubert-Adler also have the right to
purchase up to an additional 500,000 shares of Class A Common Stock, exercisable
on a pro-rata basis within eighteen months of the commitment of the Development
Fund's capital, at a price of $11.25 per share. In addition, David T. Hamamoto
was elected to the Board of Directors of the Company. Mr. Hamamoto is the
Co-Chief Executive Officer of NorthStar.
F-20