<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report
(Date of earliest event reported)
February 12, 1998
Sunburst Hospitality Corporation
(Exact name of registrant as specified in its charter)
Delaware 52-1985619
-------- ----------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation)
10770 Columbia Pike, Silver Spring, Maryland 20901
- -------------------------------------------- -----
(Address of principal executive offices) (Zip code)
Registrant's telephone number,
including area code (301)979-5000
-------------
<PAGE>
Item 5.
- -------
The Registrant is filing restated financial statements to reflect the
franchising operations of Choice Hotels International, Inc. as discontinued
operations.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
- ------ ------------------------------------------------------------------
(a) Report of Independent Public Accountants
(b) Consolidated Balance Sheets as of May 31, 1997 and 1996
(c) Consolidated Statements of Income, Fiscal Year Ended May 31, 1997,
1996 and 1995
(d) Consolidated Statements of Cash Flows, Fiscal Year Ended May 31, 1997,
1996 and 1995
(e) Consolidated Statement of Stockholders' Equity for the seven months
ended May 31, 1997
(f) Notes to Consolidated Financial Statements
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
SUNBURST HOSPITALITY CORPORATION
(Registrant)
By: /s/ James A. MacCutcheon
----------------------------
Name: James A. MacCutcheon
Title: Chief Financial Officer
Date: February 12, 1998
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of Sunburst Hospitality Corporation:
We have audited the accompanying consolidated balance sheets of
Sunburst Hospitality Corporation and subsidiaries (the "Company" formerly Choice
Hotels International, Inc., See Note 1) as of May 31, 1997 and 1996, and the
related consolidated statements of income and cash flows for each of the three
fiscal years in the period ended May 31, 1997, and the statement of
stockholders' equity for the seven months ended May 31, 1997. 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, the financial statements referred to above present
fairly, in all material respects, the financial position of Sunburst Hospitality
Corporation as of May 31, 1997, and 1996, and the results of its operations and
its cash flows for each of the three fiscal years in the period ended May 31,
1997, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Washington, D.C.
January 27, 1998
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF MAY 31
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
----------------------------
ASSETS
<S> <C> <C>
Property and equipment, net $338,419 $281,214
Receivables (net of allowance for doubtful
accounts of $585 and $309, respectively) 7,659 6,533
Deferred income taxes ($7,205 and $10,125)
and other assets 20,982 14,526
Cash and cash equivalents 7,033 1,436
Net investment in discontinued operations 52,336 24,602
------------ ------------
TOTAL ASSETS $426,429 $328,311
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Debt
Mortgages and other long term debt 223,347 16,474
Notes payable to Manor Care, Inc. 37,022 147,023
------------ ------------
260,369 163,497
Accounts payable 25,605 8,724
Accrued expenses 15,968 8,531
------------ ------------
Total liabilities 301,942 180,752
------------ ------------
STOCKHOLDERS' EQUITY
Common stock 639 -
Additional paid-in-capital 167,163 -
Retained earnings 17,075 -
Cumulative translation adjustment (7,018) -
Treasury stock, at cost (53,372) -
Investments and advances from Manor Care, Inc. - 147,559
------------ ------------
Total stockholders' equity 124,487 147,559
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $426,429 $328,311
============ ============
</TABLE>
The accompanying notes are an integral part of these
Consolidated Balance Sheets.
4
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
FISCAL YEARS ENDED MAY 31
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1997 1996 1995
-------------------------------------------
REVENUES
<S> <C> <C> <C>
Rooms $165,239 $137,001 $101,381
Food and beverage 13,356 11,392 8,121
Other 7,158 6,232 5,012
------------ ------------ ------------
Total revenues 185,753 154,625 114,514
------------ ------------ ------------
OPERATING EXPENSES
Departmental Expenses
Rooms 58,502 51,657 43,168
Food and beverage 10,887 9,792 6,866
Other 2,674 2,570 1,476
Undistributed Operating Expenses
Administrative and general 17,990 16,358 11,550
Marketing 14,545 12,152 9,008
Utility costs 8,816 7,712 5,670
Property operation and maintenance 9,428 8,118 5,891
Property taxes, rent and insurance 6,857 6,044 3,959
Depreciation and amortization 20,632 16,636 12,513
Corporate 7,691 8,026 6,038
Provision for asset impairment - 24,595 -
------------ ------------ ------------
Total operating expenses 158,022 163,660 106,139
------------ ------------ ------------
OPERATING INCOME (LOSS) 27,731 (9,035) 8,375
------------ ------------ ------------
INTEREST EXPENSE 15,891 12,839 9,155
------------ ------------ ------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES 11,840 (21,874) (780)
Income taxes 5,035 (8,523) (323)
------------ ------------ ------------
INCOME (LOSS) FROM CONTINUING OPERATIONS 6,805 (13,351) (457)
DISCONTINUED OPERATIONS: Income from operations of
discontinued franchising business (less applicable
income taxes of $25,165, $15,923 and $13,467, respectively) 35,219 21,809 17,268
------------ ------------ ------------
NET INCOME BEFORE EXTRAORDINARY ITEM 42,024 8,458 16,811
------------ ------------ ------------
EXTRAORDINARY ITEM -- LOSS FROM EARLY
EXTINGUISHMENT OF DEBT (NET OF $747 TAX BENEFIT) 1,144 - -
------------ ------------ ------------
NET INCOME $40,880 $ 8,458 $16,811
============ ============ ============
Pro forma weighted average common shares outstanding 20,893 20,876 20,827
============ ============ ============
Earnings per share from continuing operations $ 0.32 $ (0.64) $ (0.02)
Earnings per share from discontinued operations 1.69 1.05 0.83
Earnings per share from extraordinary item (0.05) - -
------------ ------------ ------------
Earnings per share $ 1.96 $ 0.41 $ 0.81
============ ============ ============
</TABLE>
The accompanying notes are an intergral part of these
Consolidated Statements of Income.
5
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEARS ENDED MAY 31
(IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
--------------- --------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 40,880 $ 8,458 $ 16,811
Reconciliation of net income to net cash
provided by operating activities:
Depreciation and amortization 29,797 26,062 21,841
Amortization of debt discount 29 34 171
Provision for bad debts, net 2,798 974 906
Increase (decrease) in deferred taxes 6,289 (12,885) 827
Loss on sale of operating hotel 220 584 -
Provision for asset impairment - 28,160 -
Change in assets and liabilities:
Change in receivables (6,771) (7,036) (4,529)
Change in other assets (13,396) (3,452) 5,343
Change in payable and accrued expenses 17,845 10,922 5,691
Change in current taxes payable 289 1,176 634
Change in other liabilities (1,831) 2,443 1,803
--------------- --------------- --------------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 76,149 55,440 49,498
--------------- --------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property and equipment (81,743) (53,472) (34,889)
Acquisition of operating hotels (5,550) (49,617) (59,766)
Proceeds from sale of operating hotels 2,522 5,479 -
Purchase of minority interest (2,494) (55,269) -
Investment in Friendly Hotels PLC - (17,069) -
--------------- --------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (87,265) (169,948) (94,655)
--------------- --------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from mortgages and other long
term debt 239,108 17,296 15,567
Principal payments of debt (51,995) (810) (16,382)
(Principal payments on) proceeds from
notes payable to Manor Care, Inc. (110,000) 27,201 51,461
Proceeds from issuance of common stock 3,410 - -
Purchases of treasury stock (53,150) - -
Advances (to) from Manor Care, Inc., net (9,971) 73,272 (6,190)
--------------- --------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 17,402 116,959 44,456
--------------- --------------- --------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 6,286 2,451 (701)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF PERIOD 4,539 2,088 2,789
--------------- --------------- --------------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD $10,825 $4,539 $2,088
--------------- --------------- --------------
CASH AND CASH EQUIVALENTS OF
DISCONTINUED OPERATIONS $ 3,792 $3,103 $ 427
-------------- -------------- --------------
CASH AND CASH EQUIVALENTS OF
CONTINUING OPERATIONS $ 7,033 $1,436 $1,661
============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these
Consolidated Statements of Cash Flows.
6
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
Common Stock
------------------------------ Additional Translation Retained Treasury
Shares Amount Paid-in-Capital Adjustment Earnings Stock
------------------------------ ------------------ -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
DISTRIBUTION FROM
MANOR CARE, INC.,
NOV. 1, 1996 63,081,129 $631 $162,512 $(1,750) $ - $ -
Net income 40,880
Transfer of net income
to Manor Care, Inc. (23,805)
Exercise of stock
options/grants 781,542 8 4,651
Translation adjustment (5,268)
Treasury purchases (3,697,724) (53,372)
--------------------------------------------------------------------------------------------------------
BALANCE, MAY 31, 1997 60,164,947 $639 $167,163 $(7,018) $ 17,075 $(53,372)
========================================================================================================
</TABLE>
The accompanying notes are an integral part of these
Consolidated Statement of Stockholders' Equity.
7
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
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 through 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. (the "Company") for each share of Manor Care
stock, and the Board of Directors set the Record Date and the Distribution Date.
The Manor Care Distribution was made on November 1, 1996 to holders of record of
Manor Care's common stock on October 10, 1996.
The Manor Care Distribution separated the lodging and health care businesses of
Manor Care into two public corporations. The operations of the Company consist
principally of the hotel franchise operations and the owned and managed hotel
operations formerly conducted by Manor Care directly or through its subsidiaries
(the "Lodging Business").
On November 1, 1996, concurrent with the Manor Care Distribution, 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 from its owned hotel business. On
September 16, 1997 the Board of Directors and shareholders of the Company
approved the separation of the businesses through a spin-off of the franchising
business, along with the Company's European hotel and franchising operations, to
its shareholders (the "distribution"). The Board of Directors set October 15,
1997 as the date of distribution and on that date, Company shareholders received
one share in Franchising (to be 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.
The consolidated financial statements present the financial position, results of
operations and cash flows of the Company for the period prior to November 1,
1996 as if it were formed as a separate entity of Manor Care. In connection
with the spin-off of the franchising business, the Company has presented the
franchising business as a discontinued operation in the consolidated financial
statements. Although the Company's European hotel operations are being
distributed to shareholders along with the franchising business, generally
accepted accounting principles do not permit presenting this operation as
discontinued. Therefore, the European hotel operations are included in
continuing operations. The following tables illustrate the impact of the
European hotel operations on the continuing operations of the Company (in
thousands).
8
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
DOMESTIC EUROPEAN
FISCAL YEAR ENDING HOTEL HOTEL CONTINUING
MAY 31, 1997 OPERATIONS OPERATIONS OPERATIONS
- ----------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $168,016 $17,737 $185,753
Operating expenses 140,468 17,554 158,022
---------------------------------------------
Operating income 27,548 183 27,731
---------------------------------------------
Interest expense 14,899 992 15,891
Pretax income (loss) 12,649 (809) 11,840
Income tax expense
(benefit) 5,355 (320) 5,035
---------------------------------------------
Net income (loss) from
continuing operations $ 7,294 $ (489) $ 6,805
=============================================
</TABLE>
<TABLE>
<CAPTION>
DOMESTIC EUROPEAN
FISCAL YEAR ENDING HOTEL HOTEL CONTINUING
MAY 31, 1996 OPERATIONS OPERATIONS OPERATIONS
- ----------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $135,022 $ 19,603 $154,625
Operating expenses 127,722 35,938 163,660
---------------------------------------------
Operating income (loss) 7,300 (16,335) (9,035)
--------------------------------------------
Interest expense 12,419 420 12,839
Pretax loss (5,119) (16,755) (21,874)
Income tax benefit (1,913) (6,610) (8,523)
---------------------------------------------
Net loss from
continuing operations $ (3,206) $(10,145) $(13,351)
============================================
</TABLE>
<TABLE>
<CAPTION>
DOMESTIC EUROPEAN
FISCAL YEAR ENDING HOTEL HOTEL CONTINUING
MAY 31, 1995 OPERATIONS OPERATIONS OPERATIONS
- ----------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $95,876 $18,638 $114,514
Operating expenses 85,777 20,362 106,139
---------------------------------------------
Operating income (loss) 10,099 (1,724) 8,375
---------------------------------------------
Interest expense 9,155 - 9,155
Pretax income (loss) 944 (1,724) (780)
Income tax expense
(benefit) 361 (684) (323)
---------------------------------------------
Net income (loss) from
continuing operations $ 583 $(1,040) $ (457)
=============================================
</TABLE>
9
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
DOMESTIC EUROPEAN
HOTEL HOTEL
AS OF MAY 31, 1997 OPERATIONS OPERATIONS CONSOLIDATED
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Property and equipment,
net $326,867 $11,552 $338,419
Other assets 77,648 10,362 88,010
----------------------------------------------
Total assets $404,515 $21,914 $426,429
==============================================
Debt $246,840 $13,529 $260,369
Other liabilities 38,907 2,666 41,573
----------------------------------------------
Total liabilities 285,747 16,195 301,942
----------------------------------------------
Stockholders' equity 118,768 5,719 124,487
----------------------------------------------
Total liabilities
and stockholders'
equity $404,515 $21,914 $426,429
==============================================
</TABLE>
<TABLE>
<CAPTION>
DOMESTIC EUROPEAN
HOTEL HOTEL
AS OF MAY 31, 1996 OPERATIONS OPERATIONS CONSOLIDATED
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Property and equipment,
net $267,215 $13,999 $281,214
Other assets 36,336 10,761 47,097
----------------------------------------------
Total assets $303,551 $24,760 328,311
==============================================
Long term debt $149,546 $13,951 $163,497
Other liabilities 12,376 4,879 17,255
----------------------------------------------
Total liabilities 161,922 18,830 180,752
----------------------------------------------
Stockholders' equity 141,629 5,930 147,559
----------------------------------------------
Total liabilities
and stockholders'
equity $303,551 $24,760 $328,311
==============================================
</TABLE>
An analysis of the activity in the "Advances (to) from Manor Care Inc., net"
account for the two years ended May 31, 1996 and the five months ended October
31, 1996 is as follows (in thousands):
<TABLE>
<S> <C>
Balance, May 31, 1994 $ 55,208
Cash transfers to Manor Care (6,190)
Net income 16,811
--------------
Balance, May 31, 1995 65,829
Cash transfers from Manor Care 73,272
Net income 8,458
--------------
Balance, May 31, 1996 147,559
Cash transfers to Manor Care (9,971)
Net income through October 31, 1996 23,805
--------------
Balance, October 31, 1996 $161,393
==============
</TABLE>
10
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
PRO FORMA EARNINGS PER SHARE (UNAUDITED)
The pro forma earnings per common share is computed by dividing net income by
the pro forma weighted average number of common shares outstanding. The pro
forma weighted average number of common shares outstanding is after giving
effect to the one for three reverse stock split and is based on Manor Care's
weighted average number of outstanding common shares for the period prior to
November 1, 1996 and the Company's own shares outstanding subsequent to November
1, 1996.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents.
PRE-OPENING COSTS
Pre-opening costs of an operating nature incurred prior to the opening of hotel
properties are deferred and amortized over two years for hotels opened prior to
November 1, 1996 and one year for hotels opened after that date. Such costs,
which are included in other assets, amounted to $1.6 million and $2.4 million,
net of accumulated amortization, at May 31, 1997 and 1996, respectively.
PROPERTY AND EQUIPMENT
The components of property and equipment are as follows:
<TABLE>
<CAPTION>
(In thousands) May 31
1997 1996
-----------------------------
<S> <C> <C>
Land $ 56,009 $ 48,153
Buildings 255,106 221,826
Furniture, fixtures and equipment 54,561 44,995
Hotels under construction 36,633 18,224
-----------------------------
402,309 333,198
Less: accumulated depreciation (63,890) (51,984)
-----------------------------
$338,419 $281,214
=============================
</TABLE>
Depreciation has been computed for financial reporting purposes using the
straight-line method. A summary of the ranges of estimated useful lines upon
which depreciation rates have been based follows:
<TABLE>
<CAPTION>
<S> <C>
Building and improvements 10-40 years
Furniture, fixtures and equipment 3-20 years
</TABLE>
SELF-INSURANCE PROGRAM
The Company maintains its own self-insurance program for certain levels of
general and professional liability, automobile liability and workers'
compensation coverage. The estimated costs of these programs are accrued at
present values based on actuarial projections for known and anticipated claims.
11
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Prior to the Manor Care Distribution, the Company participated in Manor Care's
self-insurance program for certain levels of general and professional liability,
automobile liability and workers' compensation coverage. The estimated costs of
these programs were accrued at present values based on actuarial projections for
known and anticipated claims. All self-insurance liabilities through November
1, 1996, were assumed by Manor Care.
IMPAIRMENT POLICY
The Company evaluates the recoverability of long-lived assets whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability is measured based on net, undiscounted expected
cash flows. Assets are considered to be impaired if the net, undiscounted
expected cash flows are less than the carrying amount of the assets. Impairment
charges are recorded based upon the difference between the carrying value of the
asset and the expected net cash flows, discounted at an appropriate interest
rate.
CAPITALIZATION POLICIES
The Company capitalizes interest costs and property taxes incurred during the
construction of capital assets. Major renovations and replacements are
capitalized to appropriate property and equipment accounts. Maintenance, repairs
and minor replacements are charged to expense.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from these estimates.
INCOME TAXES
The Company was included in the consolidated federal income tax returns of Manor
Care prior to the Manor Care Distribution. Subsequent to November 1, 1996, the
Company is a separate taxpayer and files its own tax returns. The income tax
provision included in these consolidated statements reflects the historical
income tax provision and temporary differences attributable to the operations of
the Company on a separate return basis. Deferred taxes are recorded for the tax
effect of temporary differences between book and tax income.
Income before income taxes from continuing operations for the fiscal year ended
May 31, 1997, 1996 and 1995 was derived from the following (in thousands):
12
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------------------
<S> <C> <C> <C>
Income before income taxes
Domestic operations $12,649 $ (5,119) $ 944
Foreign operations (809) (16,755) (1,724)
----------------------------------------
Combined income (loss) before
income taxes $11,840 $(21,874) $ (780)
========================================
</TABLE>
The provision for income taxes for continuing operations follows for the fiscal
year ended May 31, 1997, 1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
-----------------------------------------
<S> <C> <C> <C>
Current tax (benefit) expense
Federal $2,583 $ 94 $ (32)
Federal benefit of foreign operations (320) (315) (684)
State 292 26 (126)
Deferred tax (benefit) expense
Federal 2,048 (1,676) 427
Federal benefit of foreign operations (6,295)
State 432 (357) 92
-----------------------------------------
$5,035 $(8,523) $(323)
=========================================
</TABLE>
Deferred tax asset (liabilities) were composed of the following at May 31, 1997
and 1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
---------------------------
<S> <C> <C>
Depreciation and amortization $5,672 $ 7,736
Foreign operations 1,565 1,366
Accrued expenses 626 1,692
Other (658) (669)
---------------------------
Net deferred tax asset $7,205 $10,125
===========================
</TABLE>
A reconciliation of income tax expense at the statutory rate to income tax
expense included in the accompanying consolidated statement of income for the
year ended May 31, 1997, 1996 and 1995 follows:
<TABLE>
<CAPTION>
(In thousands, except federal income tax rate) 1997 1996 1995
-----------------------------------------
<S> <C> <C> <C>
Federal income tax rate 35% 35% 35%
Federal taxes at statutory rate $4,144 $(7,656) $(273)
dState income taxes, net of federal tax benefit 573 (982) (22)
Other 318 115 (28)
-----------------------------------------
Income tax expense $5,035 $(8,523) $(323)
=========================================
</TABLE>
Cash paid for state income taxes was $805,000, $165,000, and $86,000 for the
year ending May 31, 1997, 1996 and 1995. Federal income taxes were paid by
Manor Care for the period ending October 31, 1996 and the years ended May 31,
1996 and 1995. The Company paid federal income taxes for the consolidated group
(including Franchising and its subsidiaries) of $5.5 million for the period from
November 1, 1996 through May 31, 1997.
13
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company and Manor Care entered into a tax-sharing agreement for purposes of
allocating pre-Manor Care Distribution tax liabilities among the Company and
Manor Care and their respective subsidiaries. In general, Manor Care is
responsible for (i) filing the consolidated federal income tax return that
include the Company and its subsidiaries and (ii) paying the taxes relating to
such tax returns to the applicable taxing authorities. The Company will
reimburse Manor Care for the portion of such taxes that relates to the Company
and its subsidiaries. In addition, the Company will assume liability for all
taxes payable by the Company or by Manor Care in the event the Manor Care
Distribution is determined not to be tax-free for federal income tax purposes.
Manor Care and the Company have agreed to cooperate with each other and to
share information in preparing such tax returns and in dealing with other tax
matters.
Following the distribution of Franchising, the Company and Franchising entered
into a tax-sharing agreement to allocate pre-distribution tax liabilities among
the Company and Franchising and their respective subsidiaries. In general, the
Company will be responsible for (i) filing the consolidated federal income tax
return for the Company's affiliated group (including Franchising and its
subsidiaries through the date of the distribution) and (ii) paying the taxes
related to such returns to the applicable taxing authorities. Franchising will
reimburse the Company for the portion of such taxes that relates to Franchising
and its subsidiaries.
ACCRUED EXPENSES
Accrued expenses were as follows:
<TABLE>
<CAPTION>
(In thousands) May 31,
1997 1996
--------------------------
<S> <C> <C>
Payroll $ 8,479 $3,531
Taxes, other than income 4,097 3,237
Other 3,392 1,763
--------------------------
$15,968 $8,531
==========================
</TABLE>
LONG TERM DEBT AND NOTES PAYABLE
Debt consisted of the following at May 31, 1997 and 1996:
<TABLE>
<CAPTION>
(In thousands) 1997 1996
--------------------------
<S> <C> <C>
$125 million competitive advance and multi-
currency revolving credit facility with an
average rate of 6.28% at May 31, 1997 $ 90,500 $ -
Multi-class mortgage pass-through certificates
with a blended weighted average rate of 7.8% 117,294 -
Notes payable to Manor Care with a rate of 9%
at May 31, 1997 37,022 147,023
Capital lease obligations 15,553 16,474
--------------------------
Total indebtedness $260,369 $163,497
==========================
</TABLE>
14
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Maturities of debt at May 31, 1997 were as follows:
<TABLE>
<CAPTION>
FISCAL YEAR
(In thousands)
<S> <C>
1998 $ 27,919
1999 2,929
2000 105,940
2001 3,704
2002 4,125
Thereafter 115,752
-------------
$260,369
=============
</TABLE>
On October 30, 1996, the Company entered into a $100.0 million competitive
advance and multi-currency revolving credit facility (the "October 1996 credit
facility") provided by a group of seven banks. This facility provides that up
to $75.0 million is available for borrowings in foreign currencies. Borrowings
under the October 1996 credit facility are, at the option of the borrower, at
one of several rates including LIBOR plus 30 basis points. In addition, the
Company has the option to request participation at lower rates than those
contractually provided by the October 1996 credit facility. This facility
presently requires the Company to pay annual fees of 2/10 of 1% of the total
loan commitment. On May 5, 1997, the Company increased the size of the facility
from $100 million to $125 million through December 31, 1997, at which time the
incremental difference of $25 million is due. The October 1996 credit facility
was terminated on October 15, 1997 in conjunction with the distribution.
On April 23, 1997 the Company, through its indirect subsidiary First Choice
Properties Corporation, completed an offering of $117.5 million multi-class
mortgage pass through certificates (collectively, "the mortgage securities").
The mortgage securities, which bear a blended weighted average interest rate of
7.8% and have a final maturity of May 5, 2012, contain customary covenants with
respect to, among other things, limits on levels of indebtedness, liens, certain
investments, transactions with affiliates, asset sales, mergers, and
consolidations. The Company had $3.9 million in escrow at May 31, 1997 related
to the mortgage securities. The escrow, which is included in other assets, is
for property taxes, insurance and capital expenditures of the properties
collateralizing the mortgage securities. The mortgage securities are
nonrecourse and collateralized by 36 hotels owned by the Company. The
offering's net proceeds of $110 million have been used to prepay a portion of a
loan from Manor Care. The prepayment resulted in an extraordinary loss from
early debt redemption of $1.1 million, net of taxes.
In conjunction with the April 1997 issuance of the mortgage securities, the
Company entered into a series of interest rate swap agreements having a total
notional principal amount of $50.0 million. The agreements were terminated
concurrent with the pricing of the mortgage securities, resulting in a $862,000
gain. The gain has been deferred and is being amortized over the life of the
mortgage securities as an offset to interest expense.
15
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company entered into two new debt facilities in October 1997 in connection
with the distribution: (i) a $80 million revolving credit facility (the "October
1997 credit facility"); and (ii) a $115.0 million pay-in-kind note payable to
Franchising (the "Franchising Note"). Proceeds from the new debt were used to
repay the Company's remaining portion of the loan from Manor Care and the
October 1996 credit facility, and for advances previously made by Franchising to
the Company. The unused portion of the October 1997 credit facility will be
used by the Company for working capital, including capital expenditures and
acquisitions.
The October 1997 credit facility includes customary financial and other
covenants that will require the maintenance of certain ratios including maximum
leverage, minimum net worth and interest coverage, and will restrict the
Company's ability to make certain investments, repurchase stock, incur debt, and
dispose of assets. At the Company's option, the interest rate may be based on
LIBOR, a certificate of deposit rate or an alternate base rate (as defined),
plus a facility fee. The rate is determined based on the Company's consolidated
leverage ratio at the time of borrowing.
The Franchising Note has a maturity of five years, accrues interest at a rate
equal to 500 basis points above the interest rate on a five-year U.S. Treasury
Note and contains restrictive covenants similar to those in the October 1997
credit facility.
Cash paid for interest was $14.8 million, $12.8 million and $9.1 million for
fiscal years 1997, 1996 and 1995, respectively. At May 31, 1997, owned property
with a net book value of $146.7 million was pledged or mortgaged as collateral.
LEASES
The Company operates certain property and equipment under leases that expire at
various dates through 2014. Future minimum lease payments are as follows:
<TABLE>
<CAPTION>
(In thousands) Operating Capitalized
Leases Leases
<S> <C> <C>
1998 $ 685 $ 1,420
1999 140 1,400
2000 140 1,498
2001 140 1,498
2002 140 1,613
Thereafter 6,575 21,746
------- ---------
Total minimum lease payments $7,820 29,175
=======
Less: interest (13,622)
---------
Present value of lease payments $ 15,553
=========
</TABLE>
Rental expense under non-cancelable operating leases was $329,000, $332,000, and
$321,000 in 1997, 1996 and 1995, respectively. In fiscal year 1997, the
Company paid $4.5 million to Manor Care for office rent,
16
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of which Franchising reimbursed the Company $4.0 million for its portion of
total space occupied.
ACQUISITIONS AND DIVESTITURES
During fiscal year 1997, the Company acquired two hotels containing 324 rooms
valued at $10.7 million and disposed of one hotel containing 153 rooms for $2.5
million. During fiscal year 1996, the Company purchased 16 hotels containing
more than 1,900 rooms for $49.6 million. During fiscal year 1995, the Company
purchased 16 hotels containing more than 2,300 rooms for $59.8 million.
DISCONTINUED OPERATIONS
The revenues, income from discontinued operations before income taxes, and net
income from discontinued operations were as follows:
<TABLE>
<CAPTION>
Fiscal year ended May 31,
1997 1996 1995
-----------------------------------------
<S> <C> <C> <C>
Revenue $249,822 $227,277 $190,441
Expenses, excluding income taxes 189,438 189,545 159,706
-----------------------------------------
Income from discontinued
operations before income taxes 60,384 37,732 30,735
Income taxes 25,165 15,923 13,467
-----------------------------------------
Net income from discontinued
operations $ 35,219 $ 21,809 $ 17,268
=========================================
</TABLE>
Net investment in discontinued operations is composed of the following:
<TABLE>
<CAPTION>
As of May 31,
1997 1996
----------------------------
<S> <C> <C>
Property and equipment, net $31,825 $24,306
Goodwill, net 69,938 65,377
Franchising rights, net 50,504 53,138
Receivables 23,322 20,475
Other assets 31,880 31,270
----------------------------
Total assets $207,469 $194,566
============================
Debt $111,634 $131,364
Other liabilities 43,499 38,600
----------------------------
Total liabilities 155,133 169,964
----------------------------
Net investment and advances from
parent 52,336 24,602
----------------------------
Total liabilities and equity $207,469 $194,566
============================
</TABLE>
COMMITMENTS AND CONTINGENCIES
The Company is a defendant in a number of lawsuits arising in the ordinary
course of business. In the opinion of management, the ultimate
17
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
outcome of such litigation will not have a material adverse effect on the
Company's business, financial position, or results of operations.
PENSION, PROFIT SHARING AND INCENTIVE PLANS
Bonuses accrued for key executives of the Company under incentive compensation
plans were $200,000, $100,000, and $300,000 in fiscal years 1997, 1996 and 1995,
respectively.
Employees participate in retirement plans sponsored by the Company, and prior to
the Manor Care Distribution, employees participated in retirement plans
sponsored by Manor Care. Costs allocated to the Company were based on the size
of its payroll relative to the sponsor's payroll. Costs allocated to the
Company for continuing operations were approximately $800,000, $583,000 and
$424,000 in 1997, 1996 and 1995, respectively.
CAPITAL STOCK
During fiscal year 1997, the Company repurchased 3,697,724 shares of its common
stock at a total cost of $53.4 million.
The Company has stock option plans for which it is authorized to grant options
to purchase up to 7.3 million shares of the Company's common stock. Stock
options may be granted to officers, key employees and non-employee directors
with an exercise price not less than the fair market value of the common stock
on the date of grant.
Options outstanding at November 1, 1996 represent options that resulted from the
Manor Care Distribution. Option activity under the above plans is as follows:
<TABLE>
<CAPTION>
Weighted
Number Option
of Shares Price
--------------------------
<S> <C> <C>
Outstanding at November 1, 1996 5,920,648 $ 8.49
Granted 397,693 14.79
Exercised (1,110,164) 12.60
Cancelled (259,145) 11.02
--------------------------
Outstanding at May 31, 1997 4,949,032 $ 9.05
==========================
</TABLE>
In connection with the distribution, the outstanding options held by current and
former employees of the Company as of October 15, 1997 were redenominated in
both Company and Franchising stock, and the number and exercise prices of the
options were adjusted based on the relative trading prices of shares of the
common stock of the two companies to retain the intrinsic value of the options.
The option prices in the table above have not been adjusted for the distribution
or the reverse stock split.
At May 31, 1997, the options with a weighted average remaining life of 3.4 years
covering 1,614,891 shares were exercisable at $2.70 to $12.52 per share with a
weighted average of $5.11 per share.
18
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATMENTS
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," ("SFAS No. 123"), requires companies to provide additional
disclosures about employee stock-based compensation plans based on a fair value
based method of accounting. SFAS No. 123 is effective for fiscal years that
begin after December 15, 1995. As permitted by this accounting standard, the
Company continues to account for these plans under Accounting Principles Board
Opinion 25, under which no compensation cost has been recognized.
Compensation cost for the Company's stock option plan was determined based on
the fair value at the grant dates for awards under those plans consistent with
the method of SFAS No. 123. The fair value of each option grant has been
estimated on the date of grant using an option-pricing model with the following
weighted average assumptions used for grants in 1997: risk-free interest rate of
6.4% and volatility of 30%, expected lives of 10 years and 0% dividend yield.
The weighted average fair value per option granted during fiscal year 1997 was
$8.35. If options had been reported as compensation expense based on their fair
value pro forma, net income would have been $40.3 million for 1997, and pro
forma earnings per share would have been $1.92.
Since this methodology has not been applied to options granted prior to the
Manor Care Distribution date, the resulting pro forma compensation cost is not
likely to be representative of that to be expected in future years.
RELATIONSHIP WITH MANOR CARE
The Company entered into various agreements in connection with the Manor Care
Distribution which provide, among other things, that (i) Manor Care is
responsible for filing and paying the related taxes on consolidated federal tax
returns and consolidated or combined state tax returns for itself and any of its
affiliates (including the Company and Franchising) for the periods of time that
the affiliates were members of the consolidated group, (ii) the Company would
reimburse Manor Care for the portion of such taxes that relates to the Company
and its subsidiaries, (iii) Manor Care would lease office space to the Company
in Silver Spring, Maryland, (iv) the Company would enter into a loan agreement
with Manor Care for $225.7 million previously advanced at an interest rate of 9%
($37.0 million of which is outstanding at May 31, 1997 as an obligation of the
Company following the distribution), and (v) Manor Care would provide certain
corporate services to the Company.
In 1997, the Company incurred $525,000 in rent expense for office space leased
from Manor Care, $12.4 million in interest expense on the loan, and $2.1 million
in corporate expense for corporate services provided by Manor Care.
RELATIONSHIP WITH CHOICE HOTELS INTERNATIONAL, INC.
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,
19
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, (v) will enter into a loan agreement with
Franchising for $115.0 million at an interest rate of 500 basis points over the
interest rate of a five-year U.S. Treasury Note, and (vi) guarantees that
Franchising will, at the date of distribution, have a specified level of net
worth.
The Company and Franchising have entered into a strategic alliance agreement.
Among other things, the agreement will provide for (i) a right of first refusal
to Franchising to franchise properties to be acquired or developed by the
Company, (ii) certain commitments by the Company for the development of Sleep
Inns and MainStay Suites hotels, (iii) continued cooperation of both parties
with respect to matters of mutual interest, such as new product and concept
testing, (iv) continued cooperation with respect to third party vendor
arrangements and certain limitations on competition in each others' line of
business. The strategic alliance agreement extends for a term of 20 years with
mutual rights of termination on the 5th, 10th and 15th anniversaries. The
Company and Franchising also entered into a financial consulting agreement which
provides for certain payments to the Company by Franchising.
During 1997, the Company operated substantially all of its hotels pursuant to
franchise agreements with Franchising. Total fees paid to Franchising included
in the accompanying financial statements for franchising marketing, reservation
and royalty fees are $9.5 million, $7.5 million, and $5.3 million for the years
ending May 31, 1997, 1996 and 1995, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The balance sheet carrying amount of cash and cash equivalents and receivables
approximate fair value due to the short term nature of these items. Mortgages
and other long term debt consist of bank loans and mortgages. Interest rates on
bank loans adjust frequently based on current market rates; accordingly, the
carrying amount of bank loans is equivalent to fair value. The carrying amount
for the notes payable to Manor Care approximates fair value. Because the
mortgage securities were originated in April 1997 at market rates, the fair
value at May 31, 1997, approximates the carrying value.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Company adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," during
20
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
fiscal year 1997. The adoption of SFAS No. 121 did not have an impact on the
Company's financial statements.
The Company is required to adopt SFAS No. 128, "Earnings Per Share," and SFAS
No. 129, "Disclosure of Information about Capital Structure," no later than
fiscal year 1998. The adoption of these pronouncements will not materially
affect the Company's financial statements.
The Company is required to adopt SFAS No. 130, "Reporting Comprehensive Income,"
and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," no later than fiscal year 1999. The adoption of these
pronouncements will not materially affect the continuing operations of the
Company.
21
