<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 1998 COMMISSION FILE NO. 1-11915
SUNBURST HOSPITALITY CORPORATION
10770 COLUMBIA PIKE
SILVER SPRING, MD. 20901
(301) 592-3000
Delaware 53-1985619
- ------------------------ ----------------------
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
-------------------------------------------
(Former name, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
--- ---
SHARES OUTSTANDING
CLASS AT SEPTEMBER 30, 1998
------ ---------------------
Common Stock, $0.01 19,973,538
par value per share ----------
===============================================================================
<PAGE>
SUNBURST HOSPITALITY CORPORATION
INDEX
-----
PAGE NO.
-------
PART I. FINANCIAL INFORMATION:
<TABLE>
<CAPTION>
<S> <C>
Condensed Consolidated Balance Sheets -
September 30, 1998 (Unaudited) and December 31, 1997 3
Condensed Consolidated Statements of Income -
Three and nine months ended September 30, 1998 and
September 30, 1997 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 1998
and September 30, 1997 (Unaudited) 5
Notes to Condensed Consolidated Financial
Statements (Unaudited) 6
Management's Discussion and Analysis of Results of
Operations and Financial Condition 10
PART II. OTHER INFORMATION 18
</TABLE>
2
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
As of
-------------------------------
September 30, December 31,
1998 1997
------------- ------------
(unaudited)
ASSETS
<S> <C> <C>
Real estate, net $ 355,369 $ 371,305
Real estate held for sale 39,571 -
Receivables (net of allowance for doubtful
accounts of $596 and $616, respectively) 9,151 6,261
Other assets 16,195 17,509
Cash and cash equivalents 5,106 5,908
------------- ------------
Total assets $ 425,392 $ 400,983
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Debt
Mortgages and other long term debt $ 149,118 $ 133,648
Note payable to Choice Hotels International, Inc. 125,078 117,120
------------- ------------
274,196 250,768
Accounts payable and accrued expenses 32,996 33,415
Payable to Choice Hotels International, Inc. 19,921 25,066
Deferred income taxes ($1,681 and $1,378,
respectively) and other liabilities 3,544 2,427
------------- ------------
Total liabilities 330,657 311,676
------------- ------------
STOCKHOLDERS' EQUITY
Common stock (60,000,000 and 60,000,000 authorized,
at $0.01 par value, 21,392,778 and 21,366,282
issued and 19,973,538 and 19,947,042 outstanding
at September 30, 1998 and December 31, 1997,
respectively) 200 200
Additional paid-in-capital 107,567 105,653
Retained earnings (13,032) (16,546)
------------- ------------
Total stockholders' equity 94,735 89,307
------------- ------------
Total liabilities and stockholders' equity $ 425,392 $ 400,983
============= ============
</TABLE>
The accompanying notes are an integral part of these Condensed Consolidated
Balance Sheets.
3
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
September 30, September 30,
------------------------ -----------------------
1998 1997 1998 1997
---------- ----------- ---------- ----------
REVENUES
<S> <C> <C> <C> <C>
Rooms $ 50,404 $ 47,496 $ 138,077 $ 133,703
Food and beverage 3,947 3,517 12,487 10,552
Other 1,969 2,323 6,335 5,909
---------- ----------- ---------- ----------
Total revenues 56,320 53,336 156,899 150,164
---------- ----------- ---------- ----------
OPERATING EXPENSES
Departmental expenses 18,284 19,844 51,131 56,328
Undistributed operating expenses 17,973 15,051 49,146 43,923
Depreciation and amortization 6,768 5,720 20,474 16,651
Corporate 3,344 3,852 10,836 7,347
Provision for asset impairment and other
non-recurring charges 3,714 - 3,714 -
---------- ----------- ---------- ----------
Total operating expenses 50,083 44,467 135,301 124,249
---------- ----------- ---------- ----------
OPERATING INCOME 6,237 8,869 21,598 25,915
---------- ----------- ---------- ----------
INTEREST EXPENSE 4,951 4,384 15,126 13,549
---------- ----------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES AND EXTRAORDINARY
ITEM 1,286 4,485 6,472 12,366
Income taxes 530 1,971 2,650 5,435
---------- ----------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS
BEFORE EXTRAORDINARY ITEM 756 2,514 3,822 6,931
DISCONTINUED OPERATIONS: Income from
operations of discontinued franchising
business (less applicable income taxes
of $8,585 and $20,035, respectively) - 12,002 - 28,011
EXTRAORDINARY ITEM: Loss from early
extinguishment of debt (net of $201 and
$747 tax benefit, respectively) 308 - 308 1,144
---------- ----------- ---------- ----------
NET INCOME $ 448 $ 14,516 $ 3,514 $ 33,798
========== =========== ========== ==========
Basic earnings per share
From continuing operations before
extraordinary item $ 0.04 $ 0.13 $ 0.19 $ 0.34
From discontinued operations - 0.60 - 1.37
From extraordinary item (0.02) - (0.01) (0.05)
---------- ----------- ---------- ----------
Earnings per share $ 0.02 $ 0.73 $ 0.18 $ 1.66
========== =========== ========== ==========
Diluted earnings per share
From continuing operations before
extraordinary item $ 0.04 $ 0.12 $ 0.19 $ 0.33
From discontinued operations - 0.58 - 1.33
From extraordinary item (0.02) - (0.02) (0.05)
---------- ----------- ---------- ----------
Earnings per share $ 0.02 $ 0.70 $ 0.17 $ 1.61
========== =========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these Condensed Consolidated
Statements of Income.
4
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
For the nine months ended
September 30,
-------------------------
1998 1997
---------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Income from continuing operations before extraordinary item $ 3,822 $ 6,931
Reconciliation of net income to net cash
provided by operating activities:
Depreciation and amortization 20,474 16,651
Provision for asset impairment 3,433 -
Other non-cash items 8,809 2,422
Change in assets and liabilities:
Change in receivables (3,148) (2,609)
Change in other assets (3,215) (3,523)
Change in accounts payable and accrued expenses (419) 15,013
Decrease in payable to Choice Hotels International, Inc. (5,145) -
Change in current taxes receivable 2,430 9,041
---------- ----------
NET CASH PROVIDED BY CONTINUING OPERATIONS 27,041 43,926
NET CASH PROVIDED BY DISCONTINUED OPERATIONS - 41,886
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 27,041 85,812
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property and equipment (45,185) (61,734)
Acquisition of operating hotels - (5,550)
Proceeds from sale of property and equipment 2,260 2,522
---------- ----------
NET CASH UTILIZED BY CONTINUING OPERATIONS (42,925) (64,762)
NET CASH UTILIZED BY DISCONTINUED OPERATIONS - (12,511)
---------- ----------
NET CASH UTILIZED BY INVESTING ACTIVITIES (42,925) (77,273)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from mortgages and other long term debt 20,000 205,300
Principal payments on notes payable to Manor Care, Inc. - (110,000)
Principal payments of debt (4,531) (1,440)
Payment of prepayment penalty (439) (1,891)
Payment of financing fees - (3,959)
Proceeds from issuance of common stock 52 4,400
Purchases of treasury stock - (63,704)
---------- ----------
NET CASH PROVIDED BY CONTINUING OPERATIONS 15,082 28,706
NET CASH UTILIZED BY DISCONTINUED OPERATIONS - (23,043)
---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 15,082 5,663
---------- ----------
NET CHANGE IN CASH AND CASH EQUIVALENTS (802) 14,202
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,908 4,170
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,106 $ 18,372
========== ==========
Cash and cash equivalents of continuing operations $ 5,106 $ 15,928
Cash and cash equivalents of discontinued operations $ - $ 2,444
</TABLE>
The accompanying notes are an integral part of these Condensed Consolidated
Statements of Cash Flows.
5
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
1. The accompanying consolidated financial statements of Sunburst Hospitality
Corporation and subsidiaries (the "Company") have been prepared by the Company
without audit. Certain information and footnote disclosures normally included in
financial statements presented in accordance with generally accepted accounting
principles have been condensed or omitted. The Company believes the disclosures
made are adequate to make the information presented not misleading. The
consolidated financial statements should be read in conjunction with the
Company's consolidated financial statements for the seven months ended December
31, 1997 and notes thereto included in the Company's Form 10-K, dated March 30,
1998. Certain reclassifications have been made to the prior year amounts to
conform to current period presentation.
In the opinion of the Company, the accompanying unaudited condensed consolidated
financial statements reflect all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position of the
Company as of September 30, 1998, the results of operations for the three and
nine months ended September 30, 1998 and 1997, respectively, and cash flows for
the nine months ended September 30, 1998 and 1997, respectively. Interim results
are not necessarily indicative of full year performance because of the impact of
seasonal and short-term variations.
2. On March 7, 1996, Manor Care, Inc. ("Manor Care") announced its intention to
proceed with the separation of its lodging business from its health care
business via a spin-off of its lodging business (the "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 Choice Hotels
International, Inc. for each share of Manor Care stock, and the Board set the
Record Date and the Distribution Date. The Stock Distribution was made on
November 1, 1996 to holders of record of Manor Care's common stock on October
10, 1996.
The Manor Care Distribution separated the lodging and health care businesses of
Manor Care into two public corporations. The operations of the Company consisted
principally of the hotel franchise operations and the owned and managed hotel
operations formerly conducted by Manor Care directly or through its
subsidiaries.
On November 1, 1996, concurrent with the Manor Care Distribution, the Company
changed its name from Choice Hotels Holdings, Inc. to Choice Hotels
International, Inc. and the Company's franchising subsidiary, formerly named
Choice Hotels International, Inc., changed its name to Choice Hotels
Franchising, Inc. ("Franchising").
On April 29, 1997, the Company's Board of Directors announced its intention to
separate the Company's franchising business ("Choice Franchising Business") from
its owned hotel business. On September 16, 1997, the Board of Directors and
shareholders of the Company approved the separation of the business via a spin-
off of the franchising business, along with the Company's European hotel and
franchising operations (the "Choice Spin-Off"), to its shareholders. The Board
set October 15, 1997 as the date of distribution and on that date, Company
shareholders received one share in Franchising (renamed "Choice Hotels
International, Inc.") for every share of Company stock held on October 7, 1997
(the date of record). Concurrent with the October 15, 1997 distribution date,
the Company changed its name to Sunburst Hospitality Corporation and effected a
one-for-three reverse stock split of its common stock.
In connection with the Distribution, the Company has presented the franchising
business as a discontinued operation in the consolidated statement of income and
consolidated statement of cash flows for the three and nine months ended
September 30, 1997. Although the Company's European hotel operations were
distributed to shareholders along with the franchising business, generally
accepted accounting principles do not permit presenting this operation as
discontinued. The following schedules illustrate the impact of the European
hotel operations on the operating results of the Company for the three and nine
months ended September 30, 1997.
6
<PAGE>
<TABLE>
<CAPTION>
Three months ended Domestic Hotel European Hotel Continuing
September 30, 1997 Operations Operations Operations
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $49,052 $4,284 $53,336
Operating income 8,701 168 8,869
Pretax income 4,539 (54) 4,485
Net income 2,547 (33) 2,514
</TABLE>
<TABLE>
<CAPTION>
Nine months ended Domestic Hotel European Hotel Continuing
September 30, 1997 Operations Operations Operations
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $137,292 $12,872 $150,164
Operating income 25,751 164 25,915
Pretax income 12,887 (521) 12,366
Net income 7,247 (316) 6,931
</TABLE>
3. The following table illustrates the reconciliation of income from
continuing operations and number of shares used in the basic and diluted
earnings per share calculations.
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
----------------------------------------------------------------------------
(in thousands, except per share amounts) September 30, September 30,
----------------------------------------------------------------------------
1998 1997 1998 1997
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
COMPUTATION OF BASIC EARNINGS PER SHARE
Income from continuing operations before
extraordinary item $ 756 $ 2,514 $ 3,822 $ 6,931
Weighted average shares outstanding 19,973 19,999 19,966 20,414
----------------------------------------------------------------------------
Basic earnings per share from continuing
operations before extraordinary item $ 0.04 $ 0.13 $ 0.19 $ 0.34
============================================================================
COMPUTATION OF DILUTED EARNINGS PER SHARE
Income from continuing operations before
extraordinary item $ 756 $ 2,514 $ 3,822 $ 6,931
Weighted average shares outstanding 19,973 19,999 19,966 20,414
Effect of dilutive securities:
Employee stock option plan 213 615 383 544
----------------------------------------------------------------------------
Shares for diluted earnings per share 20,186 20,614 20,349 20,958
----------------------------------------------------------------------------
Diluted earnings per share from continuing
operations before extraordinary item $ 0.04 $ 0.12 $ 0.19 $ 0.33
============================================================================
</TABLE>
7
<PAGE>
The effect of dilutive securities is computed using the treasury stock method
and average market prices during the period. Certain options to purchase common
stock were not included in the computation of diluted earnings per share because
the exercise price of the options exceeded the average market price of the
common shares for the period. The following table summarizes such options.
<TABLE>
<CAPTION>
September 30,
---------------------------------------
1998 1997
---------------------------------------
<S> <C> <C>
Number of shares 1,667,271 -
Weighted average exercise price $ 7.14 -
</TABLE>
The weighted average number of common shares outstanding for the three and nine
months ended September 30, 1997 is after giving effect to the one-for-three
reverse stock split.
4. As of September 30,1998, the Company owned and managed 86 hotels with
11,850 rooms in 27 states under the following brand names: Comfort, Clarion,
Sleep, Quality, MainStay, Rodeway and Econo Lodge.
5. At September 30, 1998, the Company has fourteen hotels that are currently
being marketed for sale with a carrying value of $39.6 million. In accordance
with Statement of Financial Accounting Standards No. 121 ("SFAS No. 121"),
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," the Company has discontinued depreciating these assets while
they are held for sale. In addition, SFAS No. 121 requires that assets held for
sale be reported at the lower of the carrying amount or fair value less costs to
sell. As the Company began actively marketing these hotels, it became apparent,
given current real estate values, that certain asset carrying values exceeded
estimated fair values less costs to sell. As a result, the Company recognized a
$3.4 million provision for asset impairment in the third quarter of 1998 to
reduce the carrying value of certain of the assets to the estimated fair value
less costs to sell. The fourteen hotels held for sale reported total revenues of
$5.5 million and $16.2 million for the three and nine months ended September 30,
1998, and $5.4 million and $16.5 million for the three and nine months ended
September 30, 1997, respectively. Income from operations before interest, taxes,
depreciation and amortization and allocations for corporate expenses of the
fourteen hotels was $1.6 million and $4.9 million for the three and nine months
ended September 30, 1998, respectively and $1.8 million and $5.7 million for the
three and nine months ended September 30, 1997.
6. The Company recognized an extraordinary loss of $308,000, net of taxes, in
the three months ended September 30, 1998. The extraordinary loss represents a
prepayment penalty and deferred financing fees associated with the early
extinguishment of a portion of the Company's multi-class mortgage pass-through
certificates (collectively, "the mortgage securities"). The prepayment was made
as a result of the sale of one of the properties collateralizing the mortgage
securities.
7. For purposes of providing an orderly transition after the Distribution,
the Company and Franchising 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 the Company
(i) will receive and/or provide certain corporate and support services, such as
accounting, tax and computer systems support, (ii) will adjust outstanding
options to purchase shares of Company Common Stock held by Company employees,
Franchising 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 Franchising) for the periods of time that the affiliates were members
of the consolidated group, (iv) will be reimbursed by Franchising for the
portion of income taxes paid that relate to Franchising and its subsidiaries,
and (v) guarantees that Franchising will, at the date of the Distribution have a
specified minimum level of net worth. As of September 30, 1998, the Company has
a $19.9 million liability to Choice related to the net worth guarantee, the
estimated final allocation of liabilities and assets and for expenses incurred
by Choice on behalf of the Company.
8. The Company recognized a restructuring charge of $146,000 in September 1998
to account for a reduction in force at the Company's corporate headquarters.
The restructuring charge includes transition pay and benefits
8
<PAGE>
of the twelve employees terminated and is included in "Provision for asset
impairment and other non-recurring charges" in the condensed consolidated
statements of income. No benefits had been paid and charged against the
liability at September 30, 1998.
9. In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-5, "Reporting on the Costs of Start-up
Activities"(the "SOP"). The SOP, which is effective for fiscal years beginning
after December 15, 1998, requires costs related to start-up activities to be
expensed as incurred. Presently, the Company capitalizes such costs and
amortizes them over a period of one year. The Company intends to adopt the
standard on January 1, 1999. Initial application of the SOP will be reported as
a cumulative effect of a change in accounting principle.
If the Company would have adopted this standard on January 1, 1998, the effect
would have been to decrease income from continuing operations by approximately
$105,000 for the three months ended September 30, 1998, and to increase income
from continuing operations by approximately $13,000 for the nine months ended
September 30, 1998. Net income for the nine month period would have decreased by
approximately $681,000, as a result of a charge for the cumulative effect of a
change in accounting principle of $694,000 (net of taxes).
10. The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 130, "Reporting Comprehensive Income," on January 1, 1998. The adoption of
SFAS No. 130 does not impact the operations of the Company as the Company does
not have any items considered to be other comprehensive income under SFAS No.
130.
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
--------------------------------------------------------------------------
The Company is a national owner and operator of hotel properties with a
portfolio at September 30, 1998 of 86 hotels (11,850 rooms) in a total of 27
states. The Company operates each of its hotels under one of the Choice Brands:
MainStay, Comfort, Quality, Clarion, Sleep, Rodeway and Econo Lodge. The
Company's continuing business consists primarily of guest room revenue, meeting
room revenue, and food and beverage revenue from owned and operated hotels.
On October 15, 1997, the Company separated the Choice Franchising Business
(which had previously been conducted primarily through Franchising) and its
European owned and managed hotels from its other operations pursuant to a pro
rata distribution to its shareholders of all the common stock of Franchising. At
the time of the Choice Spin-Off, Franchising changed its name to "Choice Hotels
International, Inc." The Company changed its name to "Sunburst Hospitality
Corporation" and effected a one-for-three reverse stock split.
European hotel operations, which were distributed to Choice in the Choice
Spin-Off, are presented as part of continuing operations in the condensed
consolidated financial statements for all periods prior to the Choice Spin-Off
in accordance with generally accepted accounting principles ("GAAP"). However,
for purposes of analyzing the operations of the Company, management focuses on
domestic hotel operations. Therefore, the following discussion focuses on the
results of operations of the domestic hotels, which constitute the ongoing
operations of the Company subsequent to October 15, 1997.
COMPARISON OF RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
- -----------------------------------------------------------------------------
Continuing Operations
- ----------------------
Total revenues for the three months ended September 30, 1998 increased 5.6%
to $56.3 million, compared to $53.3 million in the third quarter of 1997.
Recurring domestic revenues increased $7.3 million, or 14.8%, from $49.0 million
for the three months ended September 30, 1997 to $56.3 million for the same
period of 1998. The increase in recurring domestic revenues is primarily
attributable to a $7.2 million, or 16.6% increase in room revenue resulting from
an 11.4% increase in the number of rooms, from 10,638 at September 30, 1997 to
11,850 at September 30, 1998, and a 1.8% increase in comparable hotel average
daily rates.
Operating expenses increased 12.6%, or $5.6 million for the three months
ended September 30, 1998 compared to the same period of 1997. Recurring
domestic operating expenses increased $9.7 million from $40.4 million in 1997 to
$50.1 in 1998. Operating expenses for the third quarter of 1998 includes a $3.4
million asset impairment charge related to certain of the hotels held for sale
and $300,000 in non-recurring expenses. The non-recurring expenses includes a
restructuring charge taken to account for a reduction in force at the Company's
corporate headquarters. In addition to the impairment charge and non-recurring
expenses, the increase in domestic operating expenses results from the net
addition of 12 hotels to the Company's portfolio. Domestic departmental
operating expenses increased $2.2 million or 13.9%, while undistributed
operating expenses increased 19.4%. Domestic depreciation and amortization
expense increased $1.4 million to $6.8 million in the third quarter of 1998.
Corporate expense for the three months ended September 30, 1998 was $3.3
million, compared with $3.9 million for the same period of 1997.
Income from continuing operations before interest, taxes, depreciation and
amortization, and non-cash asset impairment writedowns ("EBITDA") increased
12.7%, from $14.6 million for the three months ended September 30, 1997, to
$16.4 million for the same period of 1998. Domestic EBITDA increased 16.6% from
$14.1 million for the September 1997 quarter to $16.4 million for the September
1998 quarter. The Company considers EBITDA to be an indicative measure of
operating performance, particularly due to the large amount of depreciation and
amortization. Such information should not be considered an alternative to net
income, operating income, cash flow from operations, or any other operating or
liquidity performance measure prescribed by GAAP. EBITDA presented by the
Company may not be comparable to EBITDA defined and presented by other
companies. Gross profit from hotel operations (operating income before
depreciation and amortization, corporate expense and provision for asset
impairment and other non-recurring charges) increased $1.6 million to $20.1
million in the third quarter of 1998, while gross profit from recurring domestic
hotel operations increased 11.8%.
10
<PAGE>
Interest expense increased $567,000 to $5.0 million for the three months
ended September 30, 1998 compared to the same period of 1997. Domestic interest
expense increased $789,000, or 19.0%, from $4.2 million for the three months
ended September 30, 1997 to $5.0 million for the same period of 1998. The
increase is a result of additional borrowings associated with the Company's
development of hotels.
Income from continuing operations before extraordinary item decreased $1.8
million from $2.5 million for the three months ended September 30, 1997 to
$756,000 for the same period of 1998. Domestic income from continuing
operations before extraordinary item decreased $1.8 million for three months
ended September 30, 1998 compared to the same period of 1997. The decrease
results from the provision for asset impairment and other non-recurring charges
recognized during the third quarter of 1998 and increased interest and
depreciation and amortization resulting from the net addition of 12 hotels to
the Company's portfolio. Excluding the impact of the provision for asset
impairment and other non-recurring charges, income from continuing operations
before extraordinary item for the third quarter of 1998 would have been
approximately $2.9 million.
The Company's net income for the three months ended September 30, 1998,
includes an extraordinary loss of $308,000 (net of taxes) for the early
extinguishment of debt associated with a property sold during the quarter.
Diluted earnings per share from continuing operations before extraordinary
item decreased from $0.12 per share for the 1997 period to $0.04 per share for
the 1998 period. The decrease is attributable to the provision for asset
impairment and other non-recurring charges. Excluding the impact of the charge,
earnings per share from continuing operations before extraordinary item would
have been approximately $0.15 per share.
The following table breaks-out the operating results of the Company's
portfolio into four segments: extended-stay (consisting of the Company's
MainStay Suites hotels), traditional all-suite, full-service, and limited-
service for the three months ended September 30, 1998 and 1997.
11
<PAGE>
<TABLE>
<CAPTION>
Number of
Hotels Three months ended
September 30, September 30,
---------------------------------------
1998/1997 1998 1997
-----------------------------------------------------------
<S> <C> <C> <C>
Extended-Stay (1) 13 / 2
Average daily rate $55.67 $61.77
Occupancy % 68.6% 70.1%
RevPAR $38.16 $43.32
Traditional All-Suite 5 / 5
Average daily rate $72.57 $69.56
Occupancy % 74.6% 72.6%
RevPAR $54.10 $50.52
Full-Service 16 / 16
Average daily rate $66.77 $64.10
Occupancy % 70.6% 69.9%
RevPAR $47.16 $44.77
Limited-Service 52 / 51
Average daily rate $61.93 $62.38
Occupancy % 74.2% 73.4%
RevPAR $45.95 $45.75
Total Portfolio 86 / 74
Average daily rate $63.22 $63.33
Occupancy % 72.6% 72.1%
RevPAR $45.91 $45.67
</TABLE>
(1) Only one of the Company's MainStay Suites has been open during all periods
presented. The decline in average daily rates, RevPAR and occupancy rates for
the Company's MainStay Suites primarily results from the lower average daily
rate, RevPAR and occupancy rates at the Company's twelve recently opened
MainStay Suites which are currently experiencing the stabilization period common
to newly opened hotels.
Discontinued operations
- -----------------------
Income from discontinued operations of $12.0 million for the three months
ended September 30, 1997, represents the income, net of taxes, of the
Franchising segment. The Franchising segment, along with European hotel
operations, was distributed to shareholders on October 15, 1997.
COMPARISON OF RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
- ----------------------------------------------------------------------------
Continuing Operations
- ---------------------
Total revenues for the nine months ended September 30, 1998 were $156.9
million, an increase of $6.7 million over the same period of 1997. Recurring
domestic revenues increased $19.6 million, or 14.3%, in the first nine months of
1998 compared to the same period of 1997. The increase results primarily from
the net addition of 12 hotels and 1,212 rooms to the Company's portfolio and a
3.9% increase in comparable hotel average daily rates. Food and beverage
revenue also contributed $1.9 million to the increase in revenue for the first
nine months of 1998.
12
<PAGE>
Total operating expenses increased 8.9%, or $11.1 million, for the nine
months ended September 30, 1998 compared to the same period of 1997. Recurring
domestic operating expenses increased $23.8 million for the first nine months of
1998 compared to the same period of 1997. Operating expenses for the third
quarter of 1998 includes a $3.4 million asset impairment charge related to
certain of the hotels held for sale and $300,000 in non-recurring expenses. The
non-recurring expenses includes a restructuring charge taken to account for a
reduction in force at the Company's corporate headquarters. In addition to the
impairment charge and non-recurring expenses, the increase in operating expenses
is the result of the addition of 1,212 rooms to the Company's portfolio and the
increased cost of operating as a stand-alone company. Domestic depreciation and
amortization expense increased $4.9 million, while corporate expense increased
$3.5 million for the nine months ended September 30, 1998. Included in corporate
expense for the nine months ended September 30, 1998 are $350,000 of non-
recurring expenses associated with a public offering of common stock that was
withdrawn during the second quarter.
Total EBITDA increased $2.9 million from $42.6 million for the nine months
ended September 30, 1997 to $45.5 million for the same period of 1998. Domestic
hotel EBITDA increased $4.1 million, or 10.0%, to $45.5 million in 1998.
Recurring domestic gross profit from hotel operations (operating income before
depreciation and amortization, corporate expense and the provision for asset
impairment and other non-recurring charges) increased 16.2%, from $48.7 million
for the nine months ended September 30, 1997, to $56.6 for the same period of
1998.
Interest expense increased $1.6 million to $15.1 million. Domestic
interest expense increased $2.3 million, or 17.6%, in 1998 as a result of
increased borrowings associated with the development and construction of new
hotels.
Income from continuing operations before extraordinary item decreased $3.1
million for the first half of 1998. Recurring domestic income from continuing
operations before extraordinary item decreased $3.4 million from $7.2 million
for the nine months ended September 30, 1997 to $3.8 million for the same period
of 1998. The decrease is primarily attributable to the provision for asset
impairment and other non-recurring charges recognized in the third quarter of
1998, as well as increased depreciation and amortization expense and interest
expense associated with the development of new hotels and increased corporate
expense associated with operating the company on a stand-alone basis.
The Company's net income for the nine months ended September 30, 1998,
includes an extraordinary loss of $308,000 (net of taxes) for the early
extinguishment of debt associated with a property sold during the quarter.
Diluted earnings per share from continuing operations before extraordinary
item decreased from $0.33 per share for the 1997 period to $0.19 per share for
the 1998 period.
The following table breaks-out the operating results for the nine months
ended September 30, 1998 and 1997 of the Company's portfolio into four segments:
extended-stay (consisting of the Company's MainStay Suites hotels), traditional
all-suite, full-service, and limited-service.
<TABLE>
<CAPTION>
Number of
Hotels Nine months ended
September 30, September 30,
---------------------------------------
1998/1997 1998 1997
-----------------------------------------------------------
<S> <C> <C> <C>
Extended-Stay (1) 13 / 2
Average daily rate $55.44 $57.52
Occupancy % 58.6% 71.9%
RevPAR $32.49 $41.37
Traditional All-Suite 5 / 5
Average daily rate $76.52 $73.32
Occupancy % 74.6% 73.5%
RevPAR $57.05 $53.86
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Full-Service 16 / 16
Average daily rate $69.41 $66.01
Occupancy % 67.0% 67.9%
RevPAR $46.47 $44.80
Limited-Service 52 / 51
Average daily rate $60.39 $58.86
Occupancy % 70.0% 71.5%
RevPAR $42.29 $42.07
Total Portfolio 86 / 74
Average daily rate $63.54 $61.94
Occupancy % 68.4% 70.4%
RevPAR $43.48 $43.62
</TABLE>
(1) Only one of the Company's MainStay Suites has been open during all periods
presented. The decline in average daily rates, RevPAR and occupancy rates for
the Company's MainStay Suites primarily results from the lower average daily
rates, RevPAR and occupancy rates at the Company's twelve recently opened
MainStay Suites which are currently experiencing the stabilization period common
to newly opened hotels.
Discontinued Operations
- -----------------------
Income from discontinued operations of $28.0 million for the nine months
ended September 30, 1997, represents the income, net of taxes, of the
Franchising segment. The Franchising segment, along with European hotel
operations, was distributed to shareholders on October 15, 1997.
LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------
Net cash provided by operating activities was $27.0 million for the nine
months ended September 30, 1998 compared to $85.8 million for the nine months
ended September 30, 1997. Net cash provided by operating activities for the nine
months ended September 30, 1997 includes net cash provided by discontinued
operations, as well as net cash provided by European hotel operations, which
were distributed to shareholders pursuant to the Choice Spin-Off. Net cash
provided by continuing operations was $27.0 million for the nine months ended
September 30, 1998, compared to net cash provided by continuing operations of
$43.9 million for the nine months ended September 30, 1997. The difference
between periods was predominantly due to changes in the balance of certain
working capital items.
At September 30, 1998, the Company had $274.2 million of long-term debt
outstanding, none of which matures in the next 12 months. Of this amount, $36.0
million reflects amounts outstanding under the Company's $80 million credit
facility (the "Credit Facility"). The Credit Facility expires in October 2000.
At September 30, 1998, permitted availability under the Credit Facility amounted
to $66.0 million. The Credit facility's permitted availability is computed as a
multiple of the Company's cash flow and will expand to certain levels as the
Company's cash flow increases.
At September 30, 1998, the Company owed Choice $125.1 million (including
$12.1 million in accrued interest) pursuant to the Choice Note, a subordinated
note that matures October 15, 2002. The Choice Note provides additional
financial flexibility due to the fact that no interest is payable until
maturity.
At September 30, 1998, the Company owed Choice $19.9 million representing
liabilities of the Company discharged or assumed by Choice in connection with
the Choice Spin-Off. The Company intends to assert various claims which may
ultimately result in a reduction in this amount and, in any event, does not
intend to satisfy this obligation until such matters are resolved with
Choice. These amounts are classified as "Payable to Choice Hotels
International, Inc." on the Company's balance sheet.
14
<PAGE>
At September 30, 1998, the Company's debt to book capitalization amounted
to 74.3%, while debt to market capitalization was 75.3%.
Notwithstanding the real estate-intensive nature of the Company's business,
the Company's objective is to reduce its overall leverage while continuing to
grow through development. The Company continuously evaluates its existing
portfolio and seeks to sell hotels that have limited upside potential or are
projected to underperform in order to redeploy capital in higher-yielding
assets. The Company has identified fifteen such properties that it is marketing
for sale in 1998, one of which was sold in the third quarter of 1998.
On September 17, 1998, the Company announced that it was reducing its
development of MainStay Suites hotels from the previous rate of 15 to 20 per
year. Future development will be limited to those hotels currently under
construction and to certain select sites that may be identified. At September
30, 1998, six MainStay Suites and two Sleep Inns were under construction. In
addition to those under construction, there were another three projects under
development. A typical MainStay Suites costs approximately $5.0 to $6.9 million
to develop and construct (including land cost), with an average cost per room
ranging from $50,000 to $65,000. Excluding development, recurring capital
expenditures required to maintain operating assets in the appropriate condition
are estimated to be approximately $15 million per year. Planned capital
expenditures for the development of MainStay Suites and Sleep Inns in the fourth
quarter of 1998 are projected to be approximately $12.0 million. Planned capital
expenditures for the development of MainStay Suites in calendar 1999 are
projected to be $23.0 million. The Company will also continue to pursue
selectively the acquisition of hotel properties in all segments of the lodging
industry where the Company believes long-term value can be created from
renovation and, where appropriate, the repositioning of the hotel to a different
brand or service level.
On September 25, 1998, the Company announced a share repurchase program of
up to 2.5 million shares. Through November 2, 1998, the Company repurchased
211,800 shares in open market purchases for a total cost of $871,000. The
Company intends to utilize cash flow from operations to fund the continuing
execution of this program while maintaining availability under the Credit
Facility to finance construction and development.
YEAR 2000
- ---------
The Company has developed a plan to address the impact of the year 2000 on its
computer systems and other systems with embedded microprocessors that could be
date sensitive (collectively, "in-house systems"), as well as issues related to
third party vendors and suppliers of the Company. The Company's plan consists
of four phases: 1) Assess computer systems and other systems with embedded
microprocessors and determine which such systems are critical to the ongoing
operations of the Company; 2) Inventory critical systems to determine
manufacturers, suppliers or vendors; 3) Test or assess the readiness of systems
and vendors and suppliers, and; 4) Inventory and assess the readiness of non-
critical systems. Corrective actions will be taken throughout the phases as
issues arise. The following discusses the Companies progress in addressing both
in-house systems and third party vendors.
In-house Systems
- ----------------
The Company's financial accounting and reporting systems are scheduled to
be upgraded in early 1999 to a version that has been certified to be Year 2000
compliant. Following the upgrade, the accounting and reporting systems are
expected to adequately provide information and reporting needs into the next
century. Non-compliant computer hardware and software at the Company's
corporate headquarters and at its hotels has been identified and a schedule to
upgrade affected systems by September 1999 has been established. The Company
estimates that approximately 85% of its employee workstations will need to be
upgraded. In order to accommodate a new property management system required by
Choice Hotels International, Inc., the Company had previously planned to update
these sytstems. Therefore, the cost of upgrading the systems, outside of
previously planned upgrades, is estimated to be immaterial.
15
<PAGE>
The Company is in the process of inventorying systems with embedded chips
used at the Company's corporate headquarters as well building systems at the
Company's hotel properties (i.e., elevators, room key systems, HVAC equipment,
fire safety equipment). Following the completion of inventorying the systems in
December 1998, the Company will begin contacting manufacturers to determine the
readiness of the systems for the Year 2000. Any systems determined to be Year
2000 sensitive and non-compliant will be replaced or modified as necessary.
Although the Company does not have an estimate for the cost to bring all
critical systems into compliance, it is not believed to be material.
The Company has not yet developed a contingency plan to address the
possible failure of any in-house systems. As critical non-compliant systems are
identified that the Company believes may not be compliant by the year 2000,
contingency plans will be created.
Third Party Systems
- -------------------
The Company relies significantly on third party systems to provide various
goods and services. The Company has identified those vendors and suppliers that
it believes to be critical to the ongoing operations of the Company and has
begun contacting them to verify their state of readiness and contingency plans
they have in place. Based on the responses received, the Company believes that
the critical third party systems are or will be Year 2000 compliant. To the
extent that a third party cannot certify that their systems will be Year 2000
compliant, the Company will take actions to correct the non-compliant situations
and develop contingency plans.
Because the Company relies significantly on Choice Hotels International,
Inc. ("Choice") for reservation and property management systems as well as
overall franchisee support, their state of readiness for Year 2000 is critical
to the Company. Therefore, a description of Choice's plan to address the Year
2000 issue, as set forth in its SEC filings, follows.
Choice's exposure to potential Year 2000 problems exists in two general
areas: technological operations in the sole control of Choice, and technological
operations dependent in some way on one or more third parties. With respect to
internal systems, Choice 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. Choice has indicated that the proprietary software is year 2000
compliant.
Choice's Year 2000 Compliance Committee is currently identifying third
party vendors and service providers whose non-compliant systems could have a
material impact on Choice and undertaking an assessment as to such parties'
compliant status. These parties include franchisees, 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 Choice in writing that they are
making the necessary changes in their system to become compliant and Choice has
begun conducting tests with the GDS companies.
Additional information regarding Choice's Year 2000 preparedness can be
obtained from their SEC filings.
Risks
- -----
Failure by the Company or one or more of its third party vendors to
adequately address the Year 2000 issue could have a material adverse impact on
the Company. The Company is not able to estimate the impact such failure could
have due to its dependence on third parties including utility companies,
airlines, hotel reservation centers, banks and credit card payment processing
centers. In addition, the severity and duration of failures greatly affects the
impact of such failures on the Company.
FORWARD-LOOKING STATEMENTS
- ---------------------------
The statements contained in this document that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995.
16
<PAGE>
A number of important factors could cause the Company's actual results for
future periods to differ materially from those expressed in any forward-looking
statements made by, or on behalf of the Company.
Certain statements contained in this Form 10-Q, including those in the
section entitled "Management's Discussion and Analysis of Operating Results and
Financial Condition," contain forward-looking information that involves risk and
uncertainties, including the Company's plans to address the Year 2000 issue.
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 SEC
filings, including (a) the Company's success in implementing its business
strategy, including its success in arranging financing where required, (b) the
nature and extent of future competition, and political, economic and demographic
developments in regions where the Company does business or in the future may do
business, and; (c) the timely resolution by the Company and its vendors and
suppliers of the Year 2000 issue.
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.
17
<PAGE>
PART II OTHER INFORMATION
-------------------------
ITEM 1. LEGAL PROCEEDINGS
-----------------
The Company is not party to any litigation, other than routine litigation
incidental to the business of the Company. None of such litigation, either
individually or in the aggregate, is expected to be material to the business,
financial condition or results of operations of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
Exhibit 27.01 - Financial Data Schedule September 30, 1998
(b) The following reports were filed pertaining to the quarter ended September
30, 1998.
None
18
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
SUNBURST HOSPITALITY CORPORATION
Date: November 10, 1998 /s/ James A. MacCutcheon
----------------- ---------------------------
By: James A. MacCutcheon
Executive Vice President,
Chief Financial Officer and
Treasurer
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF INCOME AND THE
CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS AND THE NOTES THERETO.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 5,106
<SECURITIES> 0
<RECEIVABLES> 9,747
<ALLOWANCES> 596
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 483,048
<DEPRECIATION> 88,108
<TOTAL-ASSETS> 425,392
<CURRENT-LIABILITIES> 0
<BONDS> 274,196
0
0
<COMMON> 200
<OTHER-SE> 94,535
<TOTAL-LIABILITY-AND-EQUITY> 425,392
<SALES> 0
<TOTAL-REVENUES> 156,899
<CGS> 0
<TOTAL-COSTS> 135,301
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 15,126
<INCOME-PRETAX> 6,472
<INCOME-TAX> 2,650
<INCOME-CONTINUING> 3,822
<DISCONTINUED> 0
<EXTRAORDINARY> (308)
<CHANGES> 0
<NET-INCOME> 3,514
<EPS-PRIMARY> .18
<EPS-DILUTED> .17
</TABLE>
