<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
_____________________
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996].
For the fiscal year ended December 31, 1998
-----------------
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED].
For the transition period from _________ to _________
Commission file number 001-11915
---------
SUNBURST HOSPITALITY CORPORATION
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 52-1985619
- ----------------------------------------------------- ----------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
10770 Columbia Pike, Silver Spring, Maryland 20901
- ------------------------------------------------------ --------------
(Address of Principal Executive Offices) ZipCode
Registrant's telephone number, including area code (301) 592-3800
-----------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
Common Stock, Par Value $.01 per share New York Stock Exchange
- -------------------------------------- ----------------------------------
Securities registered pursuant to Section 12(g) of the Act:
____________________________________________________________________
(Title of Class)
____________________________________________________________________
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed in Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months as for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No ________
-----
<PAGE>
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K.
The aggregate market value of voting stock of Sunburst Hospitality
Corporation held by non-affiliates was $83,325,525 as of December 31, 1998 based
upon a closing price of $4.25 per share.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ______ No ______
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
The number of shares outstanding of Sunburst Hospitality Corporation's
common stock at December 31, 1998 was 19,606,006.
DOCUMENTS INCORPORATED BY REFERENCE.
None.
2
<PAGE>
PART I
ITEM 1. BUSINESS
Sunburst Hospitality Corporation ("Sunburst" or the "Company") owns and
operates hotels in one of four principal categories within the lodging industry:
extended-stay, traditional all-suites, full service and limited service. As of
March 1, 1999, the Sunburst portfolio included 88 hotels open with 12,081 rooms
in 27 States and 6 hotels under construction or in development. Each hotel is
branded with a Choice Hotels International, Inc. ("Choice") brand and Sunburst
is Choice's largest franchisee. Thirty-five of the 89 hotels, with a net book
value of $139.2 million at December 31, 1998, serve as collateral for the
Company's multi-class mortgage pass-through certificates.
Sunburst has a successful record of managing ahead of industry cycles.
Prior to the last industry downturn in the late 1980s, the Company was able to
liquidate a substantial portion of its existing hotel portfolio. Then in 1992,
the Company began to opportunistically acquire hotels at prices well below their
replacement cost. All of these hotels have benefited from a significant
investment of capital used to renovate and upgrade the properties. The hotels
have also benefited from the installation of professional management and
marketing systems. In the past two years the Company has responded to changing
industry cycles by shifting its development strategy to the new construction of
mid-market, all-suite extended-stay MainStay Suites hotels.
Sunburst's strategy is to: (i) actively manage the Company's existing
portfolio to optimize performance by applying proven operating systems and
procedures, to increase EBITDA and operating margins at newly-acquired hotels,
to maintain the Company's competitive advantage through capital spending, and to
sell hotels projected to underperform and redeploying capital into higher
yielding assets; (ii) develop MainStay Suites hotels to capitalize on the
positive fundamentals of the mid-market, extended-stay segment; and (iii)
selectively pursue opportunistic development, acquisition, renovation and
repositioning opportunities.
Historical Acquisition Strategy
The primary focus of Sunburst from 1992 through 1996 was the acquisition of
hotels. During this period many hotels were facing financial hardship, creating
an opportunity for Sunburst to acquire properties at prices well below
replacement cost. Sunburst's strategy was to acquire and renovate the hotels,
install professional management and marketing systems, and in some cases
reposition the hotels to a different brand or service level. Since June 1992,
Sunburst has acquired 55 hotels, containing 7,809 rooms, for an aggregate
purchase price of $187.7 million. An additional approximately $95.6 million has
been spent on capital improvements to the same hotels. The total investment
basis in the 55 acquired hotels is approximately $290 million, approximately 60%
of the estimated replacement value of the hotels at their respective dates of
acquisition.
The Company believes that there are currently limited opportunities to
acquire hotels at a substantial discount to replacement value. As a result, no
hotels have been acquired by the Company since February 1997 when the beachfront
Howard Johnson Hotel in Miami Beach, Florida was acquired. The Company will
continue to evaluate acquisitions on an opportunistic basis when it is felt that
long-term value can be created.
Hotel Development
The Company's recent strategy to concentrate on the development of MainStay
Suites hotels is intended to capitalize on the demand/supply imbalance in the
extended-stay, all-suite segment. Historically, these hotels have produced
higher than average returns on investment and management believes that demand in
this segment significantly exceeds supply. The mid-priced market of the
extended-stay segment is particularly under-served.
3
<PAGE>
Sunburst's focus on external development is geared to capitalize on the
under-served, high-growth, mid-priced extended-stay all-suite segment, and the
development of other high-quality, consumer-focused hotels.
The following is a list of new hotels developed by Sunburst since 1994
or under development as of March 1, 1999.
<TABLE>
<CAPTION>
CALENDAR YEAR OF
----------------
MARKET BRAND OPENING
- ------ ----- -------
<S> <C> <C>
Dallas/Plano, TX............................................... Sleep Inn 1994
San Antonio, TX................................................ Sleep Inn 1995
Baton Rouge, LA................................................ Sleep Inn 1996
Houston/Airport, TX............................................ Sleep Inn 1996
Austin/Round Rock, TX.......................................... Sleep Inn 1996
Dallas/Plano, TX............................................... MainStay Suites 1996
Raleigh, NC.................................................... Sleep Inn 1997
Dallas/Arlington, TX........................................... Sleep Inn 1997
Kansas City/Airport, MO........................................ Sleep Inn 1997
Charlotte, NC.................................................. Sleep Inn 1997
Rockville, MD.................................................. Sleep Inn 1997
Providence/Airport, RI......................................... MainStay Suites 1997
Cincinnati/Blue Ash, OH........................................ MainStay Suites 1997
Kansas City/Airport, MO........................................ MainStay Suites 1998
Indianapolis, IN............................................... MainStay Suites 1998
Louisville, KY................................................. MainStay Suites 1998
Greenville, SC................................................. MainStay Suites 1998
Denver/Airport, CO............................................. Sleep Inn 1998
Orlando/Lake Mary, FL.......................................... MainStay Suites 1998
Denver/Tech Center, CO......................................... MainStay Suites 1999
Jacksonville, FL............................................... MainStay Suites 1998
Nashville, Brentwood, TN....................................... MainStay Suites 1998
Miami/Airport, FL.............................................. MainStay Suites 1998
Pittsburgh/Airport, PA......................................... MainStay Suites 1998
Fishkill/Poughkeepsie, NY...................................... MainStay Suites 1998
Denver/Tech Center, CO (1)..................................... Sleep Inn 1999
Tempe, AZ (1).................................................. MainStay Suites 1999
Miami/Airport, FL (1).......................................... Sleep Inn 1999
Annapolis, MD (2).............................................. MainStay Suites 1999
Peabody, MA (2)................................................ MainStay Suites 1999
Raleigh, NC (2)................................................ MainStay Suites 1999
North Charleston, SC (2)....................................... MainStay Suites 1999
Malvern, PA (2)................................................ MainStay Suites 1999
Secaucus, NJ (2)............................................... MainStay Suites 2000
</TABLE>
________________________
(1) Hotel under construction at December 31,1998, but completed prior to
March 1, 1999
(2) Hotel under construction at December 31, 1998.
Sunburst's focus on developing the MainStay Suites all-suite, extended-stay
product is based on statistics indicating the demand/supply imbalance. According
to various industry studies, demand in the extended-stay market is strong, yet
supply is limited, particularly in the mid-price segment. Industry sources
define the extended-stay demand as stays of five or more nights, approximately
30% of total U.S. lodging industry demand. Only approximately 3% of total room
supply is dedicated to extended-stay rooms. By applying its hotel real estate
development expertise, Sunburst is targeting markets with ideal conditions for
the extended-stay product and building MainStay Suites hotels.
4
<PAGE>
The MainStay Suites brand, which was created by the Company in conjunction
with Choice Hotels International, Inc, has a unique product design and service
package which enhance property level appeal, productivity and profitability.
Among the MainStay Suites most unique features are the automatic check-in kiosk
(which allows guests to check in and out without assistance from an employee)
and the optional daily light touch housekeeping (full housekeeping just every
five days). These features enable MainStay Suites hotels to operate with fewer
full time equivalent employees than a similar limited service hotel that
provides 24-hour front desk coverage and full housekeeping daily.
Sunburst anticipates that its MainStay Suites projects can produce
stabilized, unleveraged pre-tax property level returns on investment of
approximately 15%. This belief is supported by the Company's experience at the
MainStay Suites hotels that are nearing stabilization. The belief is further
supported by projections for the MainStay Suites recently opened and under
construction. These projections are based on rate and occupancy forecasts
generated internally by the Company and by external feasibility consultants, as
well as internal operating guidelines, land cost and projected construction
costs. The ultimate returns will, however, be impacted by a number of factors,
including the extent of new competitive supply in each market, and there can be
no assurance that projected returns will be achieved or that actual results will
not differ materially. (See Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Forward Looking Statements,
below.)
Each of the Company's MainStay Suites hotels averages approximately 100
suites and are developed on 2.5 to 3.0 acres of land in suburban office parks or
locations in close proximity to major employers, restaurants and retail
amenities. MainStay Suites feature high quality, interior corridor building
construction with amenities and features provided in direct response to consumer
demand. The suites feature bedroom areas, a living room area with a pull-out
couch or recliner, private bathroom and fully furnished kitchen. The kitchen
includes a full-size refrigerator, dishwasher, microwave, stove, coffee maker,
toaster and all cooking utensils. Each suite also features an over-sized counter
which serves as an eating area and work center, along with two ergonomic chairs.
Suite alternatives include a studio suite or one-bedroom suite. Each suite
includes two direct dial phone lines with data ports, voice mail and other
automated phone services.
The Company has sold one hotel since December 31, 1998 and currently has 12
hotels being marketed for sale. The Company anticipates closing on the sale of
these hotels during 1999. The net book value of hotels held for sale at December
31,1998 was $37.1 million.
Operations
Sunburst's owned and managed hotels typically operate under one of the
Choice brand names. Sunburst's hotels take advantage of the same systems and
services available to Choice franchisees with respect to a particular brand.
The hotels participate in Choice's central reservation system, marketing and
advertising efforts and volume purchasing discounts and are subject to Choice's
same quality assurance program. In addition, Sunburst has instituted the
following systems in the hotels it operates.
. Yield Management. An automated yield management system allows each
property's management to take advantage of the supply and demand
conditions in the local marketplace. The automated system performs
calculations and suggests pricing strategies to the local hotel
management. The system continuously updates information based on the
availability of room supply, reservation volume and projected demand
and stay patterns within each hotel.
. Training. Sunburst has developed a training system for all guest
services representatives that teaches the basic sales techniques. A
computerized guest comment system solicits the comments of guests and
the experiences they had at the hotel while providing management with
immediate guest feedback.
. Accounting Systems. Each of the Sunburst-operated hotels has a
computerized front desk and accounting system. This system allows key
financial indicators (such as daily occupancy and
5
<PAGE>
revenue) to be immediately gathered from each hotel and electronically
transmitted to the key operating officers and managers of Sunburst.
This instant access to information allows management to quickly spot
trends and make corrections and changes where necessary. The system
also allows for cost savings in the accounting and bookkeeping
departments of each hotel. In addition, control over operational and
capital expenditures is provided by a dedicated group of corporate-
based financial controllers. This group works with the hotel
operations group to maintain expense standards as well as established
operating procedures.
. Time and Attendance System. Sunburst hotels maintains automated time
and attendance systems that are tied into a central payroll system at
the corporate headquarters. This computerized method of tracking time
allows management to make quick decisions on controlling labor costs
and provides immediate information on projected costs.
. Food and Beverage. The food and beverage efforts are headed by a vice
president of food and beverage. The department is responsible for the
daily food and beverage activities of the various hotels, as well as
the development of new food concepts. This group was responsible for
the development, testing and implementation of the Choice Picks food
court concept. Recently, Sunburst opened a new food and beverage
concept called "Classic Sports Food, Drink and Memories". This sports
theme restaurant concept has been developed jointly with the Classic
Sports Network, a national cable television service. This agreement
allows for the use of certain trademarks at Sunburst's hotels.
"Classic Sports Food, Drink and Memories" are currently open in four
Sunburst hotels in Springfield, Missouri, Charlotte, North Carolina,
Richardson, Texas and Hot Springs, Arkansas.
. Capital Reinvestment Program. Each of Sunburst's hotels completes a
detailed capital spending budget annually. The hotels spend on average
5%-7% of total revenues on capital improvements annually. This
reinvestment allows the hotels to maintain a competitive advantage in
the local markets.
. Annual Business Planning Process. Each hotel prepares a zero-based
annual business plan which incorporates historical performance and
market conditions. The plan, which is reviewed and approved by senior
management, provides detailed strategies in the key operating areas of
marketing, guest services and food and beverage. The annual plan
serves as a fundamental measurement of management's performance.
The Hotel Properties
Sunburst's hotel properties serve four categories of the lodging industry;
traditional/all-suite, extended stay, full service and limited service. Hotels
are typically branded with Choice franchise flags.
ALL SUITE HOTELS
All-Suite Hotels. Sunburst has five hotels in the traditional all-suite
segment. Sunburst's all-suite hotel properties compete in the mid-price and
upscale price segments.
<TABLE>
<CAPTION>
BRAND NUMBER OF HOTELS NUMBER OF ROOMS PRICE SEGMENT
----- ---------------- --------------- -------------
<S> <C> <C> <C>
Quality Suites......................................... 3 345 upscale
Comfort Suites......................................... 2 232 mid-price
</TABLE>
EXTENDED-STAY HOTELS
Extended-Stay Hotels. Sunburst has 15 hotels with another 6 under
construction in the extended stay segment. All are branded MainStay Suites and
compete in the mid-price price segment.
<TABLE>
<CAPTION>
BRAND NUMBER OF HOTELS NUMBER OF ROOMS PRICE SEGMENT
- ----- ---------------- --------------- -------------
<S> <C> <C> <C>
MainStay Suites........................................ 15 1,466 mid-price
</TABLE>
6
<PAGE>
FULL-SERVICE HOTELS
Full-Service Hotels. Sunburst has 16 hotels in the full-service segment.
Sunburst's full-service hotels compete in the mid-price and upscale price
segments. The table below identifies Sunburst's full service hotels by brand
and price segment.
<TABLE>
<CAPTION>
BRAND NUMBER OF HOTELS NUMBER OF ROOMS PRICE SEGMENT
- ----- ---------------- --------------- -------------
<S> <C> <C> <C>
Clarion Hotels & Inns.................................. 11 2,114 upscale
Quality Hotel & Inns................................... 5 1,327 mid-price
</TABLE>
LIMITED SERVICE HOTELS
Limited Service Hotels. Sunburst has 52 hotels in the limited service
segment open. Sunburst's limited service hotel properties compete in the mid-
price and economy price segments. The table below identifies Sunburst's limited
service hotels by brand and price segment.
<TABLE>
<CAPTION>
BRAND NUMBER OF HOTELS NUMBER OF ROOMS PRICE SEGMENT
- ----- ---------------- --------------- -------------
<S> <C> <C> <C>
Comfort Inn............................................ 29 3,914 mid-price
Quality Inns........................................... 8 1,014 mid-price
Sleep Inns............................................. 13 1,448 mid-price
Econo Lodge............................................ 1 120 economy
Rodeway Inns........................................... 1 101 economy
</TABLE>
Franchise and Strategic Alliance Agreements
Each Franchise Agreement with Choice Hotels International, Inc. has an
initial term of twenty years, except the agreement for Tempe, Arizona which is a
year to year agreement. The Franchise Agreements have varying original dates,
from 1982 through 1998. Certain Franchise Agreements allow for unilateral
termination by either party on the 5th, 10th, or 15th anniversary of the
Franchise Agreement. Sunburst's Franchise Agreements with Choice allow for early
termination by Sunburst, subject to liquidated damage provisions which range
from zero dollars to a maximum of $100,000 per property.
The Franchise Agreements require the payment of certain fees and charges,
including the following: (a) a royalty fee of between 1.93% to 5.0% of monthly
gross room revenues; (b) a marketing fee of between 0.7% and 2.5% plus $0.28 per
day multiplied by the specified room count; and (c) a reservation fee of 0.88%
to 1.75% of monthly gross room revenues (or 1% of monthly gross room revenues
plus $1.00 per room confirmed through Choice's reservation system). The
marketing fee and the reservation fee are subject to reasonable increases during
the term of the franchise if Choice raises such fees uniformly among all its
franchisees, generally. Late payments (i) will be a breach of the Franchise
Agreement and (ii) will accrue interest from the date of delinquency at a rate
of 1.5% per month or portion thereof.
At the time of the Spin-off and as subsequently amended, Choice and the
Company entered into a Strategic Alliance Agreement pursuant to which: (i) the
Company granted a right of first refusal to Choice to franchise any lodging
property that the Company develops or acquires and intends to operate under
franchise; (ii) the Company has also agreed, barring a material change in market
conditions, to continue to develop MainStay Suites hotels so that it will have
opened a total 25 MainStay Suites hotels by October 15, 2001; (iii) Choice and
the Company have agreed to continue to cooperate with respect to matters of
mutual interest, including new product and concept testing for Choice in hotels
owned by the Company; and (iv) the Company has authorized Choice to negotiate
with third party vendors on the Company's behalf for the purchase of certain
items. The Strategic Alliance Agreement extends for a term of 20 years with
unilateral rights of termination by either party on the fifth, tenth and
fifteenth anniversaries.
7
<PAGE>
Competition
The Company is a leading owner and operator of hotels in the United States.
Competition in the United States lodging industry is generally based on
convenience of location, price, range of services and guest amenities offered,
plus the quality of customer service and overall product. Newer, recently
constructed hotels compete effectively against older hotels if such hotels are
not refurbished on a regular basis. The effect of local economic conditions on
the Company's results is reduced by the Company's geographic diversity of its
properties, which are located in 27 states, as well as its range of products and
room rates.
Seasonality
The Company's principal sources of revenue are revenues generated by its
properties. The Company experiences seasonal revenue patterns similar to those
of the lodging industry in general. This seasonality can be expected to cause
quarterly fluctuations in the Company's revenues, profit margins and net income.
Regulation and Environmental Matters
The Company's hotels are subject to numerous federal, state and local
government regulation, including those pertaining to the preparation and sale of
food and beverages (such as health and liquor license laws), building and zoning
requirements and laws governing a hotel owner's relationship with employees,
including minimum wage requirements, overtime, working conditions and work
permit requirements. While the Company's operations have not been materially
affected by such regulation, the Company cannot predict the effect of future
regulation or legislation.
The hotel properties are subject to environmental regulations under
Federal, state and local laws. Certain of these laws may require a current or
previous owner or operator of real estate to clean up designated hazardous or
toxic substances or petroleum product releases affecting the property. In
addition, the owner or operator may be held liable to a governmental entity or
to third parties for damages or costs incurred by such parties in connection
with the contamination. The Company does not believe that it is subject to any
material environmental liability.
Employees
At December 31, 1998, Sunburst employed approximately 4,000 employees. As
is typical in the lodging industry, the Company experiences high rates of
employee turnover. Less than 5% of the Company's employees are represented by
unions. All of the Company's union employees are employed at Comfort Inn By the
Bay, San Francisco, California. The Company considers its relations with its
employees to be good.
ITEM 2. PROPERTIES
The following chart lists by market segment Sunburst's hotels at
March 1, 1999:
<TABLE>
<CAPTION>
YEAR
NO. OF CONSTRUCTED/LAST
HOTEL MARKET ROOMS MAJOR RENOVATION
- ----- ------ ----- ----------------
<S> <C> <C> <C>
TRADITIONAL ALL-SUITE
Upscale
Quality Suites Deerfield...................... Fort Lauderdale, Florida 107 1991/1995
Quality Suites................................ Raleigh, North Carolina 114 1988/1994
Quality Suites Shady Grove.................... Rockville, Maryland 124 1978/1996
Mid-Price
Comfort Suites Haverhill...................... Boston, Massachusetts 131 1989/1997
Comfort Suites Deerfield...................... Fort Lauderdale, Florida 101 1991/1995
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
YEAR
NO. OF CONSTRUCTED/LAST
HOTEL MARKET ROOMS MAJOR RENOVATION
- ----- ------ ----- ----------------
<S> <C> <C> <C>
EXTENDED-STAY
MainStay Suites Plano......................... Dallas, Texas 96 1996
MainStay Suites Warwick....................... Providence, Rhode Island 94 1997
MainStay Suites Blue Ash...................... Cincinnati, Ohio 100 1997
MainStay Suites Airport....................... Kansas City, Missouri 88 1998
MainStay Suites Northwest..................... Indianapolis, Indiana 88 1997
MainStay Suites Louisville.................... Louisville, Kentucky 100 1998
MainStay Suites Tech Center................... Denver, Colorado 100 1998
MainStay Suites Lake Mary..................... Orlando, Florida 100 1998
MainStay Suites South Pointe.................. Jacksonville, Florida 100 1998
MainStay Suites Greenville.................... Greenville, South Carolina 100 1998
MainStay Suites Brentwood..................... Nashville, Tennessee 100 1998
MainStay Suites Miami Springs................. Miami Springs, Florida 100 1998
MainStay Suites Fishkill...................... Fishkill, New York 106 1998
MainStay Suites Annapolis(2).................. Annapolis, Maryland 88 1999
MainStay Suites Pittsburgh.................... Pittsburgh, Pennsylvania 100 1998
MainStay Suites Raleigh(2).................... Raleigh, North Carolina 100 1999
MainStay Suites Tempe(1)...................... Tempe, Arizona 94 1999
MainStay Suites Peabody(2).................... Peabody, Massachusetts 97 1999
MainStay Suites King of Prussia(2)............ Malvern, PA 78 1999
MainStay Suites Secaucus,(2).................. Secaucus, NJ 132 2000
MainStay Suites N. Charleston(2).............. Charleston, SC 97 2000
FULL SERVICE
Upscale
Clarion Hotel Baltimore....................... Baltimore, Maryland 103 1927/1996
Clarion Hotel Worthington..................... Columbus, Ohio 232 1975/1996
Clarion Hotel Richardson...................... Dallas, Texas 296 1982/1995
Clarion on the Lake........................... Hot Springs, Arkansas 151 1965/1997
Clarion Hotel Miami Airport................... Miami, Florida 103 1970/1996
Clarion Hotel Hollywood Beach................. Miami-Ft. Lauderdale, Florida 309 1972/1996
Clarion Hotel................................. Mobile, Alabama 250 1979/1994
Clarion Hotel Virginia Beach.................. Norfolk-Virginia Beach, Virginia 149 1985/1995
Clarion Hotel Roanoke......................... Roanoke, Virginia 148 1981/1997
Clarion Hotel Springfield..................... Springfield, Missouri 199 1974/1997
Clarion Hotel................................. Charlotte, North Carolina 174 1974/1997
Mid-Price
Quality Inn South Point....................... Jacksonville, Florida 184 1988/1994
Quality Hotel Airport......................... Los Angeles, California 278 1971/1994
Quality Hotel Maingate Anaheim(3)............. Los Angeles, California 284 1970/1995
Quality Inn & Suites Hampton.................. Norfolk-Virginia Beach, Virginia 190 1972/1995
Quality Hotel Arlington....................... Washington, DC 391 1962/1997
LIMITED SERVICE
Mid-Price
Comfort Inn Albuquerque....................... Albuquerque, New Mexico 114 1985/1996
Quality Inn Anderson.......................... Anderson, South Carolina 121 1988/1995
Comfort Inn N.W. Pikesville(4)................ Baltimore, Maryland 186 1964/1994
Comfort Inn University........................ Baton Rouge, Louisiana 150 1972/1994
Comfort Inn Danvers........................... Boston, Massachusetts 136 1972/1997
Comfort Inn Brooklyn.......................... Brooklyn, New York 67 1926/1997
Comfort Inn Canton............................ Canton, Ohio 124 1989/1994
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
YEAR
NO. OF CONSTRUCTED/LAST
HOTEL MARKET ROOMS MAJOR RENOVATION
- ----- ------ ----- ----------------
<S> <C> <C> <C>
Comfort Inn Airport........................... Charleston, South Carolina 122 1986/1994
Comfort Inn Charlotte......................... Charlotte, North Carolina 150 1985/1996
Quality Inn & Suites--Crown Point............. Charlotte, North Carolina 100 1988/1996
Comfort Inn Middleburg Heights................ Cleveland, Ohio 136 1989
Comfort Inn College Station................... College Station, Texas 114 1984/1995
Comfort Inn Columbia.......................... Columbia, South Carolina 98 1987/1996
Comfort Inn DFW Airport....................... Dallas-Fort Worth, Texas 152 1986/1995
Quality Inn Plymouth.......................... Detroit, Michigan 123 1989/1996
Comfort Inn Deerfield Beach................... Fort Lauderdale, Florida 69 1975/1997
Comfort Inn Hershey........................... Hershey, Pennsylvania 125 1990/1997
Comfort Inn Hilton Head....................... Hilton Head, South Carolina 150 1988/1996
Quality Inn & Suites Indianapolis............. Indianapolis, Indiana 116 1982/1996
Quality Inn Lincoln........................... Lincoln, Nebraska 108 1969/1996
Quality Inn & Suites Lumberton................ Lumberton, North Carolina 120 1974/1996
Comfort Inn Collierville...................... Memphis, Tennessee 94 1984/1996
Comfort Inn & Suites, Miami Springs........... Miami, Florida 165 1970/1996
Comfort Inn Miami Springs..................... Miami, Florida 110 1986/1996
Comfort Inn Miami Beach....................... Miami, Florida 150 1952/1997
Comfort Inn--Lee Road......................... Orlando, Florida 145 1985/1994
Comfort Inn--Turf Paradise.................... Phoenix, Arizona 155 1981/1995
Comfort Inn--North............................ Phoenix, Arizona 153 1986/1997
Comfort Inn Portland.......................... Portland, Maine 126 1984/1996
Quality Inn Richmond.......................... Richmond, Virginia 194 1985/1997
Quality Inn Midvalley......................... Salt Lake City, Utah 132 1972/1995
Comfort Inn by the Bay(3)..................... San Francisco, California 135 1971/1996
Comfort Inn Westport.......................... St. Louis, Missouri 170 1971/1995
Comfort Inn Traverse City..................... Traverse City, Michigan 96 1989/1996
Comfort Inn Tyson's........................... Washington, DC 250 1982/1995
Comfort Inn West Palm Beach................... West Palm Beach, Florida 158 1974/1995
Comfort Inn Wichita........................... Wichita, Kansas 114 1985/1997
Sleep Inn Round Rock.......................... Austin, Texas 107 1996
Sleep Inn Six Flags........................... Dallas-Fort Worth, Texas 124 1997
Sleep Inn Baton Rouge......................... Baton Rouge, Louisiana 101 1996
Sleep Inn Plano............................... Dallas, Texas 104 1994
Sleep Inn Intercontinental.................... Houston, Texas 107 1996
Sleep Inn Raleigh............................. Raleigh, North Carolina 107 1996
Sleep Inn San Antonio......................... San Antonio, Texas 107 1995
Sleep Inn University.......................... Charlotte, North Carolina 120 1997
Sleep Inn Airport............................. Kansas City, Missouri 107 1997
Sleep Inn Rockville........................... Washington, DC 107 1997
Sleep Inn Airport............................. Denver, Colorado 119 1998
Sleep Inn Denver Tech(1)...................... Denver, Colorado 119 1999
Sleep Inn Miami Airport(1).................... Miami Springs, Florida 119 1999
Economy
Econo Lodge Tolleson.......................... Phoenix, Arizona 120 1988/1997
Rodeway Inn Tempe............................. Phoenix, Arizona 101 1989
</TABLE>
(1) Hotel under construction at December 31, 1998 but completed prior to
March 1, 1999
(2) Hotel under construction at March 1, 1999
(3) Leased property
(4) Hotel on leased land
10
<PAGE>
The following chart shows operating statistics for all of Sunburst's owned
and managed hotels presented by market segment for the four fiscal years ended
May 31, 1997, the seven months ended December 31, 1997, and the twelve months
ended December 31, 1998.
<TABLE>
<CAPTION>
FY 1994 FY 1995 FY 1996
-------------------------- -------------------------- --------------------------
ADR OCCUPANCY REVPAR ADR OCCUPANCY REVPAR ADR OCCUPANCY REVPAR
------ ---------- ------ ------ ---------- ------ ------ ---------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Traditional All-Suite.. $60.62 71.58% $43.39 $58.74 61.34% $36.03 $64.70 69.00% $44.65
Extended-Stay.......... - - - - - - - - -
Full Service........... 54.37 60.74 33.02 54.04 65.43 35.36 58.85 65.41 38.49
Limited Service........ 45.09 66.71 30.08 48.39 69.15 33.46 53.36 67.11 35.81
All Hotels............. 49.15 64.18 31.54 51.28 67.10 34.40 55.97 66.61 37.28
</TABLE>
<TABLE>
<CAPTION>
SEVEN MONTHS ENDED
FY 1997 DECEMBER 31, 1997(1) YEAR ENDED DECEMBER 31, 1998
--------------------------- -------------------------- ----------------------------
ADR OCCUPANCY REVPAR ADR OCCUPANCY REVPAR ADR OCCUPANCY REVPAR
------ ---------- ------- ------ ---------- ------ ------- ----------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Traditional All-Suite.. $70.55 73.42% 51.80% $70.03 72.05% $50.45 $75.27 72.65% $54.69
Extended-Stay.......... 57.09 65.55 37.42 61.57 48.64 29.95 56.03 57.17 32.04
Full Service........... 63.25 67.05 42.41 65.23 66.46 43.35 67.69 66.81 45.23
Limited Service........ 56.39 69.23 39.04 59.11 68.01 40.20 59.98 67.36 40.40
All Hotels............. 59.60 68.69 40.94 61.81 67.41 41.67 62.90 66.57 41.87
</TABLE>
_______________________________________
(1) The information provided in the table above for the seven months ended
December 31, 1997is not representative of a full fiscal year due to the
seasonality of the hotel industry.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED MAY 31
-------------------------------------------------------------
SEVEN MONTHS
ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1994 1995 1996 1997 1997 (1) 1998
------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Number of properties, end of period..... 32 48 65 71 76 86
Number of rooms, end of period.......... 5,605 7,941 9,713 10,330 10,885 11,910
Average occupancy percentage............ 64.18% 67.10% 66.61% 68.70% 67.41% 66.57%
Average daily room rate (ADR)........... $49.15 $51.28 $55.97 $ 59.62 $ 61.81 $ 62.90
RevPAR.................................. $31.54 $34.40 $37.28 $ 40.96 $ 41.67 $ 41.87
</TABLE>
_____________________________________
(1) The information provided in the table above for the seven months ended
December 31,1997 is not representative of a full fiscal year due to the
seasonality of the hotel industry.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any litigation, other than routine litigation
incidental to its business. None of such litigation, either individually or in
the aggregate, is expected to be material to the business, financial condition
or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 1998.
Executive Officers Of Sunburst Hospitality Corporation
The name, age, title, present principal occupation, business address and
other material occupations, positions, offices and employment of each of the
executive officers of Sunburst are set forth below. The business address of
each executive officer is 10770 Columbia Pike, Silver Spring, Maryland 20901,
unless otherwise indicated.
11
<PAGE>
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
Stewart Bainum, Jr....................... 53 Chairman of the Board of Directors
Donald J. Landry......................... 50 Vice Chairman and Chief Executive Officer
James A. MacCutcheon..................... 46 Executive Vice President, Chief Financial Officer and Treasurer
Antonio DiRico........................... 45 President and Chief Operating Officer
Kevin P. Hanley.......................... 41 Senior Vice President, Real Estate and Development
Gregory D. Miller........................ 44 Senior Vice President, Human Resources
Douglas H. Verner........................ 45 Senior Vice President, General Counsel & Secretary
Charles G. Warczak, Jr................... 51 Vice President, Finance and Systems
Pamela W. Williams....................... 43 Vice President, Assistant General Counsel and Assistant Secretary
</TABLE>
Stewart Bainum, Jr., Chairman of the Board of the Company since December 1998
and from November 1996 to July 1998; Chairman of the Board of Choice from March
1987 to November 1996 and since October 1997; Chairman of the Board and Chief
Executive Officer of Manor Care, Inc. from March 1987 through September 1998;
Chairman of the Board of HCR/Manor Care since September 1998; Vice Chairman of
the Board of Manor Care and subsidiaries from June 1982 to March 1987; Director
of Manor Care since August 1981, of Vitalink from September 1991 through June
1998; President of MCHS from May 1990 to May 1991; Chairman of the Board and
Chief Executive Officer of Vitalink from September 1991 to February 1995 and
President and Chief Executive Officer from March 1987 to September 1991.
Donald J Landry. Chief Executive Officer and Vice Chairman of the Company since
October 1997; President of the Company from January 1995 to October 1997;
President of Manor Care Hotel Division ("MCHD") from March 1992 to November
1996; various executive positions with Richfield Hotel Management, Inc. and its
predecessors for more than 20 years, including President of MHM Corporation.
James A. MacCutcheon. Executive Vice President, Chief Financial Officer and
Treasurer of the Company since November 1996; Senior Vice President, Chief
Financial Officer and Treasurer of the Company from September 1993 to November
1996; Senior Vice President, Chief Financial Officer and Treasurer of Manor Care
from October 1987 through November 1996; Treasurer of Vitalink from September
1992 to January 1997 and a Director from September 1994 to June 1998.
Antonio DiRico. President of the Company since October 1997; Senior Vice
President, Hotel Operations of the Company from November 1996 to October 1997;
Senior Vice President of MCHD from May 1992 to November 1996; Senior Vice
President of Richfield Hotel Management, Inc. and its predecessor, MHM
Corporation.
Kevin P. Hanley. Vice President, Real Estate and Development of the Company
since December 1994; Vice President, Real Estate and Development of MCHD from
December 1994 to November 1996; Executive Vice President of Hospitality
Investment Trust from September 1994 to November 1994; Senior Vice President;
Development and Acquisitions of Motel 6, L.P. from May 1992 to September 1994;
various other positions with Motel 6, L.P. since January 1987.
Gregory D. Miller. Senior Vice President, Human Resources of the Company since
October 1997; Vice President, Marketing of MCHS from March 1995 to October 1997;
Vice President, Strategic Planning of Manor Care from May 1992 to September
1995.
Douglas H. Verner. Senior Vice President, General Counsel and Secretary of the
Company since March 1998; Executive Vice President, General Counsel and
Secretary of Chartwell Leisure from January 1996 to March 1998; Senior Vice
President, General Counsel and Secretary of Forte Hotels, Inc. from November
1990 to November 1996.
Charles G. Warczak, Jr. Vice President, Finance and Systems of the Company
since October 1997; Vice President, Hotel Accounting of the Company from March
1997 to October 1997; Vice President, Finance and Controller of the Company from
November 1996 to March 1997; Vice President, Finance of Manor Care from 1992 to
November 1996.
12
<PAGE>
Pamela M. Williams. Vice President, Assistant General Counsel and Assistant
Secretary of the Company since October 1997; Senior Attorney of the Company from
December 1996 to October 1997, Attorney from November 1996 to December 1996;
Attorney of Manor Care from December 1995 to November 1996; Associate of Hogan
and Hartson, L.L.P. from August 1988 to December 1995.
13
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The shares of Sunburst's Common Stock are listed and traded on the New York
Stock Exchange. The following table sets forth the high and low sales prices of
Sunburst's Common Stock since it began trading on November 4, 1996:
<TABLE>
<CAPTION>
High Low
<S> <C> <C>
FISCAL YEAR ENDED MAY 31, 1997
November 4 - November 30, 1996 $ 16 $13 3/4
Quarter ended February 28, 1997 17 5/8 15
Quarter ended May 31, 1997 15 7/8 12 3/4
TRANSITION PERIOD ENDED DECEMBER 31, 1997 (1)
Quarter ended August 30, 1997 19 5/16 15 1/2
Quarter ended November 30, 1997 (2)
Prior to October 15, 1997 20 3/8 18 3/4
October 15, 1997 through November 30, 1997 11 5/8 9 1/8
December 1, 1997 - December 31, 1997 10 1/4 8 5/8
FISCAL YEAR ENDED DECEMBER 31, 1998
Quarter ended March 31, 1998 9 15/16 8 1/4
Quarter ended June 30, 1998 9 5 3/8
Quarter ended September 30, 1998 6 7/8 3
Quarter ended December 31, 1998 4 3/4 4 7/16
</TABLE>
_____________
(1) On September 16, 1997, the Company changed its fiscal year-end from May 31
to December 31. The Company elected to continue reporting its operations
pursuant to its historical fiscal quarters during the transition period
ended December 31, 1997.
(2) On October 15, 1997, the Company spun off the Choice Franchising Business
through a special dividend to the Company's shareholders of all of the
common stock of Choice and effected a one-for-three reverse stock split. The
stock prices for the quarter ended November 30, 1997 have not been adjusted
to give effect to the substantially simultaneous spin-off of Choice and the
reverse stock split. Accordingly, the high and low sales prices are
presented for both the period prior to and after the Choice Spin-Off and the
reverse stock split.
On October 15, 1997, the Company made a special dividend, consisting of the
distribution to holders of the Company's common stock, on a share-for-share
basis, of all of the outstanding shares of the common stock of Choice Hotels
Franchising, Inc. (now known as Choice Hotels International, Inc.). This was
the only dividend paid since November 4, 1996. The Company does not anticipate
the payment of any cash dividends on its common stock in the foreseeable future.
Payments of dividends on Company common stock may be subject to limitations as
may be imposed by the Company's credit facilities from time to time. The
declaration of dividends will be subject to the discretion of the Board of
Directors.
As of March 1, 1999, there were 2,647 record holders of Company common
stock.
14
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
For the seven
months ended
Calendar Year December 31, For the year ended May 31
----------------------------------------------------
1998 1997 1997 1996 1995 1994
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA
REVENUES
Rooms $178,755 $100,670 $165,239 $137,001 $101,381 $66,031
Food and beverage 17,247 9,231 13,356 11,392 8,121 5,001
Other 8,094 4,652 7,158 6,232 5,012 3,152
-------- -------- -------- -------- -------- -------
Total Revenues 204,096 114,553 185,753 154,625 114,514 74,184
-------- -------- -------- -------- -------- -------
OPERATING EXPENSES
Departmental Expenses
Rooms 51,227 33,484 58,502 51,657 43,168 25,826
Food and beverage 13,183 7,319 10,887 9,792 6,866 4,335
Other 3,056 1,530 2,674 2,570 1,476 1,012
Undistributed Operating Expenses
Administrative and general 18,514 9,486 17,990 16,358 11,550 6,741
Marketing 16,430 8,862 14,545 12,152 9,008 5,507
Utility costs 9,632 5,697 8,816 7,712 5,670 3,583
Property operation and maintenance 10,470 5,746 9,428 8,118 5,891 3,813
Property taxes, rent and insurance 9,369 5,010 6,857 6,044 3,959 2,241
Depreciation and amortization 27,227 14,246 20,632 16,636 12,513 8,434
Corporate 13,961 8,244 7,691 8,026 6,038 2,864
Provision for asset impairment and
other non-recurring charges 4,264 5,119 - 24,595 - -
-------- -------- -------- -------- -------- -------
Total operating expenses 177,333 104,743 158,022 163,660 106,139 64,356
-------- -------- -------- -------- -------- -------
Operating income (loss) 26,763 9,810 27,731 (9,035) 8,375 9,828
-------- -------- -------- -------- -------- -------
Interest expense 20,512 10,138 15,891 12,839 9,155 3,214
-------- -------- -------- -------- -------- -------
Income (loss) from continuing operations
before income taxes 6,251 (328) 11,840 (21,874) (780) 6,614
Income taxes 2,563 (44) 5,035 (8,523) (323) 3,000
-------- -------- -------- -------- -------- -------
Income (loss) from continuing operations 3,688 (284) 6,805 (13,351) (457) 3,614
Discontinued operations (1) - 16,369 35,219 21,809 17,268 6,045
-------- -------- -------- -------- -------- -------
Net income before extraordinary item 3,688 16,085 42,024 8,458 16,811 9,659
Extraordinary item - loss from early
extinguishment of debt (net of
tax benefit) 308 - 1,144 - - -
-------- -------- -------- -------- -------- -------
Net income $ 3,380 $ 16,085 $ 40,880 $ 8,458 $ 16,811 $ 9,659
======== ======== ======== ======== ======== =======
Basic earnings per share data
From continuing operations $ 0.18 $ (0.01) $ 0.32 $ (0.64) $ (0.02) $ 0.18
From discontinued operations - 0.82 1.69 1.05 0.83 0.30
From extraordinary item (.01) - (0.05) - - -
-------- -------- -------- -------- -------- -------
Net income $ 0.17 $ 0.81 $ 1.96 $ 0.41 $ 0.81 $ 0.48
======== ======== ======== ======== ======== =======
Diluted earnings per share data
From continuing operations $ 0.18 $ (0.01) $ 0.32 $ (0.64) $ (0.02) $ 0.18
From discontinued operations - 0.82 1.66 1.05 0.83 0.30
From extraordinary item (0.01) - (0.05) - - -
-------- -------- -------- -------- -------- -------
Net income $ 0.17 $ 0.81 $ 1.93 $ 0.41 $ 0.81 $ 0.48
======== ======== ======== ======== ======== =======
Weighted average common shares outstanding(2) 19,956 19,979 20,893 20,876 20,827 20,175
======== ======== ======== ======== ======== =======
</TABLE>
(1) Discontinued operations represents the income of the discontinued
franchising business less applicable income taxes of $11,825, $25,165,
$15,923, $13,467, $5,019, and $6,422, respectively).
(2) Weighted average common shares outstanding represents the weighted average
common shares outstanding of the Company's parent Manor Care, Inc. for
fiscal years 1994 through 1996. Fiscal year 1997 represents the weighted
average common shares of Manor Care, Inc. for the period through November
1, 1997. The period following November 1, 1997 represents the weighted
average common shares of the Company. Fiscal year 1994 through 1997 have
been adjusted for the one-for-three reverse stock split.
15
<PAGE>
<TABLE>
<CAPTION>
As of December 31, As of May 31,
-------------------------------------------------------------------------------------------
1998 1997 1997 1996 1995 1994
-------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Total assets 422,511 400,983 426,429 328,311 254,229 178,652
Notes payable to Manor Care, Inc. - - 37,022 147,023 119,823 68,361
Total debt 281,189 248,120 260,369 163,497 137,122 88,711
Total liabilities 319,874 311,676 301,942 180,752 188,400 123,444
Equity or investments and
advances from Parent 102,637 89,307 124,487 147,559 65,829 55,208
</TABLE>
16
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The Company owned and operated 86 hotels with 11,910 rooms in 28 states at
December 31, 1998. The hotels are under the brand names Comfort, Clarion, Sleep,
Quality, MainStay Suites, 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 distributed, through a special dividend,
its franchising business and European hotel operations ("Choice") to
shareholders. On the date of distribution, Company shareholders of record on
October 7, 1997, received one share of Choice (renamed Choice Hotels
International, Inc.) for each share of the Company held. In addition, the
Company, which was previously named Choice Hotels International, Inc., changed
its name to Sunburst Hospitality Corporation and effected a one-for-three
reverse stock split.
European hotel operations, which were distributed with Choice, are
presented as part of continuing operations in the consolidated financial
statements in accordance with generally accepted accounting principles. However,
for purposes of analyzing the operations of the Company, management focuses on
the ongoing 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.
Comparison of Calendar Year 1998 and Calendar Year 1997 (Domestic Hotels)
- -------------------------------------------------------------------------
The following tables present calendar quarter and full calendar year
information showing the results of operations of the Company's ongoing domestic
hotel operations for 1998 and 1997 (in thousands, unaudited).
<TABLE>
<CAPTION>
Quarter Ending
---------------------------------------------------------------
March 31 June 30 September 30 December 31
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended December 31, 1998
Domestic Revenue $46,139 $54,440 $56,320 $47,197
Recurring Domestic EBITDA (1) 12,549 16,518 16,719 12,468
Year ended December 31, 1997
Domestic Revenue $41,258 $46,982 $49,052 $42,760
Recurring Domestic EBITDA (1) 11,793 15,484 14,092 8,413
</TABLE>
________________________
(1) Recurring domestic EBITDA consists of the sum of net income (loss),
interest expense, income taxes, and depreciation and amortization and non-
recurring charges for the Company's ongoing domestic operations. EBITDA is
presented because such data is used by certain investors to determine the
Company's ability to meet debt service, fund capital expenditures and
expand its business. 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.
Cash expenditures (including nondiscretionary expenditures) for various
long-term assets, interest expense and income taxes have been, and will be,
incurred which are not reflected in the EBITDA presentation and therefore
EBITDA does not represent funds available for management's discretionary
use.
17
<PAGE>
<TABLE>
<CAPTION>
Year ending
December 31,
-------------------------------------
1998 1997
-------------------------------------
<S> <C> <C>
Revenues
Rooms $178,755 $157,380
Food and beverage 17,247 14,991
Other 8,094 7,681
Total revenues 204,096 180,052
-------------------------------------
Operating Expenses
Departmental Expenses
Rooms 51,227 45,606
Food and beverage 13,183 11,972
Other 3,056 2,828
Undistributed Operating Expenses
Administrative and general 18,519 16,662
Marketing 16,430 14,975
Utility costs 9,632 9,399
Property operation and maintenance 10,470 9,815
Property taxes, rent and insurance 9,364 7,933
Depreciation and amortization 27,227 22,372
Corporate 13,961 11,079
Provision for asset impairment and other
non-recurring charges 4,264 5,119
Total operating expenses 177,333 157,760
-------------------------------------
Operating income 26,763 22,292
-------------------------------------
Interest expense 20,512 16,461
-------------------------------------
Income from continuing operations before
Income taxes 6,251 5,831
Income taxes 2,563 2,537
-------------------------------------
Income from continuing operations $ 3,688 $ 3,294
=====================================
Basic Earnings Per Share from Continuing $0.18 $0.16
Operations
=====================================
</TABLE>
Hotel revenues increased from $180.1 million in calendar 1997 to $204.1
million in 1998, an increase of 13.3%. Gross operating margin (operating income
before corporate expense, depreciation and amortization and non-recurring
charges) increased from 21.4% in 1997 to 22.0% in 1998.
Increases in revenue were the result of an increase in the size of the
Company's portfolio and improved Revenue Per Available Room ("RevPAR"). The
portfolio increased from 76 hotels in December 31, 1997 to 86 hotels at December
31,1998, an increase of 9.4% in the number of rooms. The Company utilizes
RevPAR, which is calculated by multiplying the percentage of occupied rooms by
the average daily room rate realized, as a measure of the operating performance
of its hotels. RevPAR increased 0.5% from $41.67 to $41.87, due primarily to an
increase of 1.8% in average daily rate. A changing portfolio mix with greater
representation of newly opened, mid-priced, extended stay MainStay Suites
impacted the RevPAR comparisons as, on a same store basis, year-over-year RevPAR
increased 1.9%.
In general, rate, occupancy and RevPAR trends have been consistent with
industry results. On a same store basis, the company's full service hotels
experienced a 2.8% increase in RevPAR, while the limited service hotels
increased RevPAR 0.54%.
18
<PAGE>
Food and beverage ("F&B") revenues increased 15.1% and F&B operating margins
increased from 20.1% to 23.6% as a result of an increased focus on improving F&B
operating margins.
The increase in depreciation expense from 1997 to 1998 is the result of the
growth in the portfolio. While two, older limited service hotels were sold
during 1998, the Company opened 12 newly-constructed hotels.
Calendar year 1998 represented the first full year operating as a separate,
stand-alone company and, accordingly, general corporate expense increased from
6.2% of revenues to 6.8% of revenues in 1998. Recurring domestic EBITDA
increased 17% to $58.3 million in 1998 from $49.8 million in 1997. EBITDA
margin for 1998 was 28.5% as compared to 27.7% in 1997.
Included in provision for asset impairment and other non-recurring charges
in 1998 were non-cash write-downs of approximately $4 million (pre-tax) to
reduce several hotels being marketed for sale to estimated net realizable value,
net of disposition costs. In 1997, non-recurring loss provisions of
approximately $5 million (pre-tax) were recorded in order to reserve for various
items related to the Manor Care and Choice spin-offs.
Interest expense increased from $16.5 million to $20.5 million in 1998, an
increase of 24.2%. The increase results from an increased amount of debt
outstanding over the respective periods. The Company's debt has increased over
the period to fund the development of hotels.
Income from continuing operations of $3.7 million, increased 12% from $3.3
million in 1997.
Not reflected in the above discussion are the European hotel operations
which were spun-off to shareholders along with the discontinued franchise
business. In 1997, European hotel operations contributed $7.0 million of revenue
and $0.40 in EBITDA, through the spin-off date in October, 1997.
Comparison of Calendar Year 1997 and Calendar Year 1996 - Domestic hotels
- -------------------------------------------------------------------------
In September 1997, the Company changed its year end from May 31 to December
31. This change in fiscal year end, combined with the seasonality of the lodging
industry, has a significant impact on the comparability of the seven months
ended December 31, 1997 with prior fiscal years. To assist in comparisons, the
following discusses the operating results of calendar year 1996 as compared to
calendar year 1997.
The following tables present calendar quarter and full calendar year
information showing the results of operations of the Company's domestic hotels
for 1996 and 1997 (in thousands, unaudited).
<TABLE>
<CAPTION>
Quarter ending
----------------------------------------------------------------------------
March 31 June 30 September 30 December 31
----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended December 31, 1997
Domestic Revenue $41,258 $46,982 $49,052 $42,760
Domestic EBITDA (1) 11,793 15,484 14,092 3,294
Year ended December 31, 1996
Domestic Revenue 34,656 40,987 43,615 37,683
Domestic EBITDA (1) 8,542 2,585 13,226 7,413
</TABLE>
________________________
(1) Recurring domestic EBITDA consists of the sum of net income (loss),
interest expense, income taxes, and depreciation and amortization and non-
recurring charges for the Company's ongoing domestic operations. EBITDA is
presented because such data is used by certain investors to determine the
Company's ability to meet debt service, fund capital expenditures and expand its
business. 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
19
<PAGE>
liquidity performance measure prescribed by GAAP. Cash expenditures (including
nondiscretionary expenditures) for various long-term assets, interest expense
and income taxes have been, and will be, incurred which are not reflected in the
EBITDA presentation and therefore EBITDA does not represent funds available for
management's discretionary use.
<TABLE>
<CAPTION>
Year ending
December 31,
----------------------------
1997 1996
----------------------------
<S> <C> <C>
Revenues
Rooms $157,380 $137,114
Food and beverage 14,991 12,950
Other 7,681 6,877
----------------------------
Total revenues 180,052 156,941
----------------------------
Operating Expenses
Departmental Expenses
Rooms 45,606 39,701
Food and beverage 11,972 10,835
Other 2,828 2,400
Undistributed Operating Expenses
Administrative and general 16,662 18,520
Marketing 14,975 13,895
Utility costs 9,399 8,423
Property operation and maintenance 9,815 8,922
Property taxes, rent and insurance 7,933 7,521
Depreciation and amortization 22,372 17,335
Corporate 11,079 6,383
Provision for asset impairment and other
non-recurring charges 5,119 8,575
----------------------------
Total operating expenses 157,760 142,510
----------------------------
Operating income 22,292 14,431
----------------------------
Interest expense 16,461 12,726
----------------------------
Income from continuing operations before
Income taxes 5,831 1,705
Income taxes 2,537 716
----------------------------
Income from continuing operations $ 3,294 $ 989
============================
Basic Earnings Per Share from Continuing
Operations $ 0.16 $ 0.05
============================
</TABLE>
Domestic hotel revenues increased from $156.9 million in calendar year 1996
to $180.1 million in calendar year 1997, an increase of 14.7%. Domestic gross
operating margin (operating income before corporate expense, depreciation and
amortization, and non-recurring charges), increased from 29.8% in 1996 to 33.8%
in 1997. Increases in revenues were due to improved Revenue Per Available Room
("RevPAR") and an increase in the number of hotels from 69 at the end of 1996 to
76 at the end of 1997. The Company utilizes RevPAR, which is calculated by
multiplying the percentage of occupied rooms by the average daily room rate
realized, as a measure of the operating performance of its hotels. Overall,
RevPAR increased from $39.34 to $41.68, an increase of 6.0%. Increases in RevPAR
by service sector are consistent with industry trends and are caused principally
by aggressive rate increases. Average daily rates for the Company's full-service
hotels increased 6.9% to $65.68 in calendar year 1997. Limited-service average
daily rates of $58.25 in calendar year 1997 represented a 6.1% increase over the
prior year.
20
<PAGE>
Consistent with past experience, hotels recently acquired and renovated enjoyed
substantial RevPAR increases. For example, hotels acquired in fiscal year 1995
experienced a 12.0% increase in RevPAR and hotels acquired in 1996 had a 19.7%
increase in RevPAR.
Comparison of Seven Months Ended December 31, 1997 and Seven Months Ended
- -------------------------------------------------------------------------
December 31, 1996 (Domestic Hotels) Operating Results
- -----------------------------------------------------
Hotel revenues increased from $106.5 million for the seven months ended
December 31, 1996, to $114.6 million for the same period of 1997. Domestic hotel
revenues during those seven month periods increased from $95.5 million to $107.6
million, an increase of 12.7%. This increase in revenue was primarily a result
of additional rooms achieved through hotel acquisition and development and
overall RevPAR increases. At December 31, 1996, there were 69 domestic hotels
open and operating as compared to 76 hotels as of December 31, 1997. The
additional hotels contributed $3.6 million to the revenue increase. Domestic
RevPAR for the comparative periods by service level are as follows:
<TABLE>
<CAPTION>
1997 1996 % Increase
-------- -------- --------------
<S> <C> <C> <C>
Full Service $ 42.96 $ 40.51 6.0%
Limited Service $ 40.20 $ 39.19 2.6%
Suite $ 47.01 $ 48.39 (2.9%)
Combined $ 41.67 $ 40.38 3.2%
</TABLE>
The Company's full-service hotels enjoyed RevPAR increases higher than the
overall industry averages. The Company's limited service hotels, notwithstanding
a 5.6% increase in ADR to $59.11, saw the rate of RevPAR growth slow as
occupancies declined. The suite RevPAR comparison was impacted by the opening
and occupancy ramp-up of two MainStay Suite hotels opened late in the calendar
year.
Hotels recently acquired and renovated continue to lead in terms of RevPAR
growth as it typically takes several years to reach stabilized levels of
operating performance. For example, hotels acquired and renovated in fiscal year
1996 realized a 20.0% RevPAR increase.
Domestic operating income before non-recurring provisions amounted to $14.5
million during the seven months ended December 31, 1997. This compares to $14.4
million during the same period in the preceding year. Increases in depreciation
and amortization due to the Company's development program and increases in
general corporate expenses relating to the Company's emergence as a separate,
stand-alone company, impact the year-over-year comparison of these stub periods.
Earnings before interest, taxes, depreciation and amortization (EBITDA) and
before non-recurring provisions was $29.2 million for the seven months ended
December 31, 1997. This compares to $26.4 million for the same period in the
preceding year. Property level gross operating profit, however, increased from
$31.2 million in the seven month period ended December 31, 1996 to $37.4 million
for the same period ended December 31, 1997, an increase of 19.9%. An increase
in general corporate expense from 4.5% of revenues in 1996 to 7.2% of revenues
in 1997 was due primarily to incremental costs associated with the Company's
emergence as a stand-alone, publicly traded company and other investments in
infrastructure to support a growing company.
Included in provision for asset impairment and other non-recurring charges
in 1997 are non-recurring loss provisions totaling $5.1 million (pre-tax). This
loss provision was recorded in December 1997 in order to reserve $2.1 million of
previously capitalized costs and future payment obligations related to a data
processing services agreement and computer system which will be replaced in
1998, to accrue the estimated cost of $1.0 million for future lease costs
associated with space the Company has vacated, and to reserve $2.0 million for
future obligations related to an agreement expiring in May, 1999, for services
which the Company will no longer utilize and, therefore, have no future
benefits. The service and lease agreements are with Manor Care and Choice and
were entered into in conjunction with the distribution and the Manor Care
distribution. Recent corporate decisions, including a consolidation of leased
office space, resulted in the recognition of these costs currently.
21
<PAGE>
Interest expense increased from $8.6 million for the seven months ended
December 31, 1996 to $10.1 million for the same period of 1997, an increase of
17.4%. The increase results from an increased amount of debt outstanding over
the respective periods. The Company's debt has increased over the period to
fund the acquisition and development of hotels.
The Company had a loss from continuing operations of $284,000 for the seven
months ended December 31, 1997 as compared to income of $3.6 million for the
same period of 1996. The decrease in income from continuing operations results
primarily from the provision for asset impairment and other non-recurring
charges and the increase in interest expense for the period ended December 31,
1997.
Income from discontinued operations amounted to $16.4 million in the seven
months ended December 31, 1997 compared to $22.5 million in the same period in
the prior year as those amounts reflect the spun-off franchise business only
through the October 15, 1997 distribution date.
Included in continuing operations but also spun-off at October 16, 1997
were the Company's European hotel operations which contributed $7.0 million of
revenue and $0.4 million of operating income in 1997 compared to $11.0 million
of revenue and $0.4 million of operating income in the prior year.
Comparison of Fiscal Year 1997 and Fiscal Year 1996 Operating Results
- ---------------------------------------------------------------------
Sunburst's domestic revenues were $168.0 million for fiscal year 1997, an
increase of 24.4% from $135.0 million for fiscal year 1996. The increases in
revenue were primarily the result of additional rooms achieved through hotel
acquisitions and the construction of new hotels. Overall average daily room
rates increased 6.5% from fiscal year 1996 to fiscal year 1997, and occupancy
increased 3.1% over the corresponding period. Revenue per available room, or
RevPAR, increased to $40.96 from $37.28, an improvement of 9.9%. Increases in
food and beverage sales of $2.0 million in fiscal year 1997 also contributed to
revenue growth.
Domestic operating expenses increased $12.7 million or 10.0% in fiscal year
1997 resulting primarily from the addition of six hotels during the year and to
a lesser extent a $1.1 million increase in food and beverage costs.
Depreciation expense increased 24.0% in fiscal year 1997 as a result of the
addition of new hotels and renovation of existing hotel properties during fiscal
years 1997 and 1996.
Hotel gross operating margins increased to 30.2% in fiscal year 1997 from
26.0% in fiscal year 1996 due primarily to RevPAR increases significantly in
excess of increases in operating costs.
General corporate expense was 4.1% of revenue in fiscal year 1997 as
compared to 5.2% of revenue in 1996. Operating income, before non-recurring
provisions, increased from $15.6 million in 1996 to $27.7 million in 1997.
Operating income margins, exclusive of non-recurring charges, increased from
10.1% in fiscal 1996 to 14.9% in fiscal 1997. Income from continuing operations
before income taxes and non-recurring charges amounted to $11.8 million in 1997,
an increase from $2.7 million in 1996.
During fiscal 1996, the Company recorded a provision for asset impairment
and other non-recurring charges amounting to $24.6 million (pre-tax). The
provision related primarily to the impairment of certain European hotel
operations subsequently spun-off with Choice.
Interest expense for the Company increased $3.1 million or 23.8% in fiscal
year 1997 as a result of increased borrowings to support the development
program.
The discontinued franchise operations spun-off in October 1997 contributed
$35.2 million of the after-tax income in 1997, an increase of 61.5% from the
$21.8 million contributed in fiscal year 1996.
22
<PAGE>
The Company incurred an extraordinary loss of $1.1 million (net of tax) in
fiscal year 1997 in connection with the prepayment of debt to Manor Care, Inc.
Liquidity and Capital Resources
- -------------------------------
The Company maintains an $80 million committed line of credit with a group
of four banks to support on-going operations and to fulfill capital
requirements. The credit facility expires in October 2000. Availability under
that line of credit is a function of trailing cash flow, but amounted to the
full $80.0 million at December 31, 1998. Borrowings under the line amounted to
$41million at December 31, 1998.
The Company intends to develop MainStay Suites, a mid-priced extended-stay
hotel product. At December 31, 1998, 14 MainStay Suites were open and operating
with another seven hotels under construction. The cost to develop a MainStay
Suites hotel approximates $5.5 to $6.0 million. In order for the Company to
continue on a long-term basis the MainStay Suites development program,
additional capital will be required. Subject to market conditions, the Company
anticipates raising additional debt capital during calendar year 1999.
At the distribution date, the Company owed Choice $115.0 million in the
form of a pay-in-kind subordinated note with a five year maturity. The note
provides additional financial flexibility due to the fact that accrued interest
is payable at maturity. The Company does, however, expect to refinance the
Choice note with a longer-term and lower cost subordinated debt financing as
soon as practicable.
At the distribution date, Sunburst owed Choice an additional approximately
$15.0 million relative to the final allocation of assets, liabilities and equity
between the two parties. This obligation was effectively satisfied with the
execution in December 1998 of an amendment to the Company's Strategic Alliance
Agreement, which, among other things, terminated the Company's option to
purchase the MainStay Suites brand name.
On April 23, 1997, the Company, through its indirect subsidiary, First
Choice Properties, completed an offering of $117.5 million multi-class mortgage
pass-through certificates. This CMBS debt is non-recourse and is collateralized
by 35 hotel properties with a net book value of $139.2 million owned by the
Company. The CMBS debt carries 7.8% blended weighted average interest rate and
has a final maturity of May 5, 2012. The hotel properties so collateralized
reported EBITDA of $31.1 million for calendar year 1998. The Company used the
proceeds to repay debt payable to its former parent, Manor Care, Inc.
Net cash provided by continuing operating activities was $35.5 million for
the year ended December 31, 1998, as compared to $21.4 million, for the seven
months ended December 31, 1997.
During 1998, the Company sold two hotels and an unimproved parcel of land
generating cash proceeds of $6.1 million. The proceeds were used to retire
debt, including $2.2 million of CMBS debt which resulted in a pre-payment
penalty of $308,000, after-tax.
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 intends to continue to strategically
dispose of hotels not meeting its criteria for long-term retention and utilize
the proceeds to retire debt and fund future development. Between December 31,
1998 and March 1, 1999, the Company sold an additional hotel for $2.2 million in
cash and, at March 1, 1999, has an additional twelve hotels being marketed for
sale.
At December 31, 1998, the Company's debt to book capitalization amounted to
73%, while debt to market capitalization was 77%. Debt to recurring EBITDA
amounted to 4.8:1 and recurring EBITDA to interest was 2.5:1 for calendar year
1998.
While operating cash flow along with the credit available under the
Company's bank facility and the proceeds from the sale of hotels is expected to
be adequate to fund operations and committed
23
<PAGE>
construction projects, accessing additional capital is imperative in order for
the Company to expand its development and growth plans.
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 construction of
hotels in 1999 are projected to be approximately $20 million. Sunburst may also
pursue additional acquisitions of significantly under valued properties.
Year 2000
- ----------
Many existing computer programs use two digits to identify a year. These
programs were designed and developed without considering the impact of the
upcoming change in the century. If the programs are not corrected, computer
applications could fail or create erroneous results at the turn of the century.
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 are being taken as issues arise. The
following discusses the Companies progress in addressing both in-house systems
and third party vendors.
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 all 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 systems. Therefore, the cost of upgrading the systems, outside of
previously planned upgrades, is estimated to be immaterial.
The Company has inventoried systems with embedded chips used at the
Company's corporate headquarters as well as building systems at the company's
hotel properties (i.e., elevators, room key systems, HVAC equipment, as fire
safety equipment) and has begun 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 is developing 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.
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 evaluate their
contingency plans. 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
complaint, the Company will take actions to correct the non-compliant situation
or 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
24
<PAGE>
for Year 2000 is critical to the Company. Therefore, a description of Choice
plan to address the Year 20000 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.
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, Choice, banks and credit card payment
processing centers. In addition, the severity and duration of failures will
greatly affect the impact of such failures on the Company.
As a result of the considerable publicity surrounding, and the increased
consumer awareness of, the Year 2000 issue, it is possible that travel patterns
may be disrupted. The Company is unable to estimate the effect such
disruptions, if any, may have on its hotel operations.
Seasonality
- -----------
Demand at many of the hotels is affected by recurring seasonal patterns,
depending upon the location of the hotel. Accordingly, the Company's operations
are seasonal in nature, with lower revenue and operating profit in November
through February and higher revenue and operating profit in March through
October.
Inflation
- ---------
Inflation has not had a material effect on the revenues or operating
results of the Company during calendar 1998, the seven months ended December 31,
1997 or the three fiscal years ended May 31, 1997.
Forward Looking Statements
- --------------------------
Management's Discussion and Analysis, as well as other parts of this
Annual Report on Form 10-K, contain information based on management's beliefs
and forward-looking statements that involve a number of risks, uncertainties and
assumptions. There can be no assurances that actual results will not materially
differ from the forward-looking statements as a result of various factors,
including, but not limited to: the Company's substantial leverage and its plan
to realize cash proceeds through leveraging its remaining assets; its plans to
make selected strategic investments and acquisitions and develop new hotels; its
success in implementing its business strategy, including its success in
arranging financing where required; competition; government regulation; and
general economic and business conditions. The Company's intentions with respect
to the development of MainStay Suites and other new hotels is subject to: the
Company's ability to access sufficient capital to continue such development; the
acceptance of and demand for such products by the consumer and competition.
25
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants.................. 27
Consolidated Balance Sheets............................... 28
Consolidated Statements of Income......................... 29
Consolidated Statements of Cash Flows..................... 30
Consolidated Statements of Stockholders' Equity........... 31
Notes to Consolidated Financial Statements................ 32
</TABLE>
26
<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 Basis of Presentation) as of December 31, 1998
and 1997, the related consolidated statements of income and cash flows for the
year ended December 31, 1998, the seven months ended December 31, 1997, and each
of the two fiscal years in the period ended May 31, 1997, and stockholders'
equity and comprehensive income for the year ended December 31, 1998 and the
seven months ended December 31, 1997 and May 31, 1997. These financial
statements and schedules referred to below are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules 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 and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for the year ended December 31, 1998,
the seven months ended December 31, 1997 and each of the two fiscal years in the
period ended May 31, 1997, in conformity with generally accepted accounting
principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the index at Item
14(a)(2) are presented for purposes of complying with the Securities and
Exchange Commission rules and are not part of the basic financial statements.
These schedules have been subjected to the auditing procedures applied in the
audit of the basic financial statements and, in our opinion, fairly state in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Washington, D.C.
February 10, 1999
27
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
As of
---------------------------------------------
December 31, December 31,
1998 1997
--------------------- --------------------
ASSETS
<S> <C> <C>
Real estate, net $ 363,023 $ 371,305
Real estate held for sale 37,122 -
Receivables (net of allowance for doubtful
accounts of $611 and $616, respectively) 7,271 6,261
Other assets 10,982 17,509
Cash and cash equivalents 4,113 5,908
--------------------- --------------------
TOTAL ASSETS $ 422,511 $ 400,983
===================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Debt
Mortgages and other long term debt $ 153,341 $ 133,648
Note payable to Choice Hotels International, Inc. 127,848 117,120
--------------------- --------------------
281,189 250,768
Accounts payable and accrued expenses 32,633 33,415
Payable to Choice Hotels International, Inc. - 25,066
Deferred income taxes ($1,352 and $1,378, respectively) and
other liabilities 6,052 2,427
--------------------- --------------------
Total liabilities 319,874 311,676
--------------------- --------------------
STOCKHOLDERS' EQUITY
Common stock (60,000,000 and 60,000,000 authorized, at $0.01 par
value, 21,445,696 and 21,366,282 issued and 19,606,004 and
19,947,042 outstanding at December 31, 1998 and 1997,
respectively) 244 243
Additional paid-in-capital 171,462 169,536
Treasury stock (2,331,920 and 1,821,505 shares, respectively) (65,856) (63,926)
Retained earnings (3,213) (16,546)
--------------------- --------------------
Total stockholders' equity 102,637 89,307
--------------------- --------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 422,511 $ 400,983
===================== ====================
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
28
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
For the seven
months
For the year ended ended For the fiscal year ended
December 31, December 31, May 31,
-----------------------------
1998 1997 1997 1996
-------------------- ------------------ ------------ --------------
<S> <C> <C> <C> <C>
REVENUES
Rooms $ 178,755 $ 100,670 $ 165,239 $ $137,001
Food and beverage 17,247 9,231 13,356 11,392
Other 7,789 4,652 7,378 6,816
Net gains (losses) on property transactions 305 - (220) (584)
-------------------- ------------------ ------------ --------------
Total revenues 204,096 114,553 185,753 154,625
-------------------- ------------------ ------------ --------------
OPERATING EXPENSES
Departmental Expenses
Rooms 51,227 33,484 58,502 51,657
Food and beverage 13,183 7,319 10,887 9,792
Other 3,056 1,530 2,674 2,570
Undistributed Operating Expenses
Administrative and general 18,514 9,486 17,990 16,358
Marketing 16,430 8,862 14,545 12,152
Utility costs 9,632 5,697 8,816 7,712
Property operation and maintenance 10,470 5,746 9,428 8,118
Property taxes, rent and insurance 9,369 5,010 6,857 6,044
Depreciation and amortization 27,227 14,246 20,632 16,636
Corporate 13,961 8,244 7,691 8,026
Provision for asset impairment and other
non-recurring charges 4,264 5,119 - 24,595
-------------------- ------------------ ------------ --------------
Total operating expenses 177,333 104,743 158,022 163,660
==================== ================== ============ ==============
OPERATING INCOME (LOSS) 26,763 9,810 27,731 (9,035)
-------------------- ------------------ ------------ --------------
INTEREST EXPENSE 20,512 10,138 15,891 12,839
-------------------- ------------------ ------------ --------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES 6,251 (328) 11,840 (21,874)
Income taxes 2,563 (44) 5,035 (8,523)
-------------------- ------------------ ------------ --------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE EXTRAORDINARY ITEM 3,688 (284) 6,805 (13,351)
DISCONTINUED OPERATIONS: Income from
operations of discontinued franchising business
(less applicable income taxes of $0, $11,825, $25,165,
and $15,923, respectively) - 16,369 35,219 21,809
-------------------- ------------------ ------------ --------------
NET INCOME BEFORE EXTRAORDINARY ITEM 3,688 16,085 42,024 8,458
EXTRAORDINARY ITEM -- LOSS FROM EARLY
EXTINGUISHMENT OF DEBT (NET OF $201 AND $747
TAX BENEFIT) 308 - 1,144 -
-------------------- ------------------ ------------ --------------
NET INCOME $ 3,380 $ 16,085 $ 40,880 $ 8,458
==================== ================== ============ ==============
Basic earnings per share
- ------------------------
From continuing operations $ 0.18 $ (0.01) $ 0.32 $ (0.64)
From discontinued operations - 0.82 1.69 1.05
From extraordinary item (0.01) - (0.05) -
-------------------- ------------------ ------------ --------------
Earnings per share $ 0.17 $ 0.81 $ 1.96 $ 0.41
==================== ================== ============ ==============
Diluted earnings per share
- --------------------------
From continuing operations $ 0.18 $ (0.01) $ 0.32 $ (0.64)
From discontinued operations - 0.82 1.66 1.05
From extraordinary item (0.01) - (0.05) -
-------------------- ------------------ ------------ --------------
Earnings per share $ 0.17 $ 0.81 $ 1.93 $ 0.41
==================== ================== ============ ==============
</TABLE>
The accompanying notes are an integral part of these consolidated statements of
income.
29
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
For the year For the seven
ended months ended For the fiscal year ended
December 31, December 31, May 31,
--------------------------
CASH FLOWS FROM OPERATING ACTIVITIES 1998 1997 1997 1996
------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
Income (loss) from continuing operations before extraordinary item $ 3,688 $ (284) $ 6,805 $ (13,351)
Reconciliation of net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 27,227 14,246 20,632 16,636
Amortization of deferred financing fees 244 248 - -
Amortization of debt discount 1,921 528 29 34
Deferred interest on Choice Hotels International, Inc. Note 8,808 2,648 - -
Provision for bad debts, net 424 247 560 289
Increase (decrease) in deferred taxes 466 695 2,920 (7,726)
(Gain) loss on sale of property (65) - 220 584
Provision for asset impairment and other non-recurring charges 3,983 5,119 - 19,420
Change in assets and liabilities:
Change in receivables (1,434) (152) (1,686) 468
Change in other assets (2,351) (357) (3,963) (3,106)
Change in accounts payable and accrued expenses (781) (9,323) 17,391 7,722
Change in payable to Choice Hotels International, Inc. (8,601) 10,066 - -
Change in current taxes receivable 2,018 (2,310) (483) 1,441
Change in other liabilities (9) - - 384
------------ ------------ ----------- -----------
NET CASH PROVIDED BY CONTINUING OPERATIONS 35,538 21,371 42,425 22,795
NET CASH PROVIDED BY DISCONTINUED OPERATIONS - 20,876 44,833 32,645
------------ ------------ ----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 35,538 42,247 87,258 55,440
------------ ------------ ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in property and equipment (60,720) (61,460) (75,523) (46,966)
Acquisition of operating hotels - - (5,550) (49,617)
Distribution of New Choice - (4,166) - -
Proceeds from sale of property and equipment 5,864 170 2,522 5,479
------------ ------------ ----------- -----------
NET CASH UTILIZED BY CONTINUING OPERATIONS (54,856) (65,456) (78,551) (91,104)
NET CASH UTILIZED BY DISCONTINUED OPERATIONS - (118,474) (15,864) (78,844)
------------ ------------ ----------- -----------
NET CASH UTILIZED BY INVESTING ACTIVITIES (54,856) (183,930) (94,415) (169,948)
------------ ------------ ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from mortgages and other long term debt 25,000 16,023 208,000 -
Proceeds from note payable to Choice Hotels International, Inc. - 115,000 - -
Principal payments of debt (5,256) (92,171) (1,157) (645)
(Payments on) proceeds from notes payable to Manor Care, Inc. - (37,022) (110,000) 27,201
Payment of financing fees - - (3,959) -
Payment of prepayment penalty (439) - (1,891) -
Proceeds from issuance of common stock 359 1,153 3,410 -
Purchases of treasury stock (2,141) (10,554) (53,150) -
Payable to Choice Hotels International, Inc. for net worth Guarantee - 15,000 - -
Advances (to) from Manor Care, Inc., net - - (9,971) 73,272
------------ ------------ ----------- -----------
NET CASH PROVIDED BY CONTINUING OPERATIONS 17,523 7,429 31,282 99,828
NET CASH PROVIDED BY (UTILIZED BY) DISCONTINUED OPERATIONS - 129,337 (17,839) 17,131
------------ ------------ ----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 17,523 136,766 13,443 116,959
------------ ------------ ----------- -----------
NET CHANGE IN CASH AND CASH EQUIVALENTS (1,795) (4,917) 6,286 2,451
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,908 10,825 4,539 2,088
------------ ------------ ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,113 $ 5,908 $ 10,825 $ 4,539
============ ============ =========== ===========
Cash and cash equivalents of continuing operations $ 4,113 $ 5,908 $ 7,033 $ 1,436
Cash and cash equivalents of discontinued operations $ - $ - $ 3,792 $ 3,103
</TABLE>
The accompanying notes are an integral part of these consolidated statements of
cash flows.
30
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
Accumulated
Other
Common Stock Additional Comprehensive Retained Comprehensive
------------------
Shares Amount Paid-in-Capital Income Earnings Treasury Stock Income
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
DISTRIBUTION FROM MANOR CARE INC. 63,081,129 $ 631 $162,512 $(1,750) $ - $ - $ -
Net Income 40,880 40,880
Transfer of net income to Manor Care, Inc. (23,805)
Exercise of stock options/grants 781,542 8 4,651
Other comprehensive income, net of tax
Translation adjustment (5,268) (5,268)
-------
Comprehensive income $35,612
=======
Treasury purchases (53,372)
-----------------------------------------------------------------------
BALANCE, MAY 31, 1997 63,862,671 639 167,163 (7,018) 17,075 (53,372)
-----------------------------------------------------------------------
Net income 16,085 $16,085
Adjustment to Nov. 1, 1996 distribution
from Manor Care Inc. (1,044)
Exercise of stock options/grants 202,386 2 1,910
Stock grants issued from Treasury shares 13,786 65
Treasury purchases (10,554)
Other comprehensive income, net of tax
Translation adjustment (1,644) (1,644)
Comprehensive income $14,441
=======
Distribution of Franchising 8,662 (48,662)
One-for-three reverse stock split on
October 15, 1997 (39,845,146) (398) 398
-----------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 24,233,697 243 169,536 - (16,546) (63,926)
-----------------------------------------------------------------------
Net income 3,380
Sale of MainStay brand option to Choice
Hotels International, Inc. 9,953
Exercise of stock options/grants 79,414 1 1,926
Stock grants issued from Treasury shares 216
Treasury purchases (2,146)
-----------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 24,313,111 $244 $171,462 $ - $(3,213) $(65,856)
=======================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated statements of
stockholders' equity and comprehensive income.
31
<PAGE>
SUNBURST HOSPITALITY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - DECEMBER 31, 1998 AND 1997
Summary of Significant Accounting Policies
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. At that time, the operations of the
Company consisted principally of the hotel franchise operations and the owned
and managed domestic and European 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. ("Choice").
On April 29, 1997, the Company's Board of Directors announced its intention to
separate the Company's franchising business from its owned, domestic 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 Choice (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 were 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).
<TABLE>
<CAPTION>
SEVEN MONTHS ENDED DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING
DECEMBER 31, 1997 OPERATIONS OPERATIONS OPERATIONS
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $107,574 $6,979 $114,553
Operating expenses 98,169 6,574 104,743
----------------------------------------------
Operating income 9,405 405 9,810
----------------------------------------------
Interest expense 9,800 338 10,138
----------------------------------------------
Pretax income (loss) (395) 67 (328)
Income tax expense (benefit) (71) 27 (44)
----------------------------------------------
Net income (loss) from
continuing operations $ (324) $ 40 $ (284)
==============================================
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
FISCAL YEAR ENDING DOMESTIC HOTEL EUROPEAN 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>
FISCAL YEAR ENDING DOMESTIC HOTEL EUROPEAN 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>
An analysis of the activity in the "Advances (to) from Manor Care Inc., net"
account for the year ended May 31, 1996 and the five months ended October 31,
1996 is as follows (in thousands):
<TABLE>
<S> <C>
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>
FISCAL YEAR
In October 1997, the Company changed its fiscal year end from May 31 to December
31. Therefore, the period ending December 31, 1997 includes seven months of
operations. Information for the comparable seven month period of June 1, 1996
through December 31, 1996 is included in the table below (unaudited, in
thousands, except per share data).
33
<PAGE>
<TABLE>
<CAPTION>
SEVEN MONTHS ENDED DECEMBER 31, 1996
-------------------------------------------------------------
DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING
(Unaudited) OPERATIONS OPERATIONS OPERATIONS
-------------------------------------------------------------
<S> <C> <C> <C>
Revenues $95,535 $10,975 $106,510
Operating expenses 70,364 9,746 80,110
Depreciation and amortization 10,772 813 11,585
-------------------------------------------------------------
Operating income 14,399 416 14,815
Interest expense 7,987 606 8,593
-------------------------------------------------------------
Pretax income (loss) from
continuing operations 6,412 (190) 6,222
Income tax expense (benefit) 2,697 (75) 2,622
-------------------------------------------------------------
Income (loss) from continuing
operations $ 3,715 $ (115) $ 3,600
=============================================================
Earnings per share:
Basic $ 0.18 $ (0.01) $ 0.17
=============================================================
</TABLE>
The following table presents the Company's results of operations for the full
calendar year 1997 (unaudited, in thousands, except per share data).
<TABLE>
<CAPTION>
CALENDAR YEAR 1997
-------------------------------------------------------------
(Unaudited) DOMESTIC HOTEL EUROPEAN HOTEL CONTINUING
OPERATIONS OPERATIONS OPERATIONS
-------------------------------------------------------------
<S> <C> <C> <C>
Revenues $180,052 $13,741 $193,793
Operating expenses 135,388 12,401 147,789
Depreciation and amortization 22,372 1,399 23,541
-------------------------------------------------------------
Operating income 22,292 (59) 22,463
Interest expense 16,461 724 17,185
-------------------------------------------------------------
Pretax income (loss) from
continuing operations 5,831 (783) 5,278
Income tax expense (benefit) 2,537 (310) 2,319
-------------------------------------------------------------
Income (loss) from continuing
operations $ 3,294 $ (473) $ 2,959
=============================================================
Earnings per share:
Basic $ 0.16 $ (0.02) $ 0.15
=============================================================
</TABLE>
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 $724,000 and $1.2 million, net
of accumulated amortization, at December 31, 1998 and 1997, respectively.
Pursuant to the American Institute of Certified Public Accountants Statement of
Position No. 98-5, "Reporting on the Costs of Start-up Activities"(the "SOP"),
on January 1, 1999, the Company will begin expensing costs related to start-up
activities as incurred. 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 increase income from continuing operations by approximately
$274,000 for the year ended December 31, 1998, and to decrease net income for
the year by approximately $420,000, as a result of a charge for the cumulative
effect of a change in accounting principle of $694,000 (net of taxes).
34
<PAGE>
REAL ESTATE
The components of real estate are as follows:
<TABLE>
<CAPTION>
December 31, December 31,
1998 1997
-------------------------------------
<S> <C> <C>
Land $ 56,007 $ 61,959
Buildings 281,821 263,405
Furniture, fixtures and equipment 77,127 70,598
Hotels under construction 31,962 41,869
-------------------------------------
446,917 437,831
Less: accumulated depreciation (83,894) (66,526)
-------------------------------------
$363,023 $371,305
=====================================
</TABLE>
Depreciation has been computed for financial reporting purposes using the
straight-line method. A summary of the ranges of estimated useful lives upon
which depreciation rates have been based follows:
<TABLE>
<S> <C>
Building and improvements 10-40 years
Furniture, fixtures and equipment 3-20 years
</TABLE>
SELF-INSURANCE PROGRAM
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. All self-insurance
liabilities through November 1, 1996, were assumed by Manor Care.
Subsequent to the Manor Care distribution, the Company has maintained its own
insurance program, which includes certain levels of retained risk. Estimated
costs are accrued at present values based on actuarial projections for known and
anticipated claims.
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 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 fair value. Real estate held for sale is recorded based on its estimated
fair value less cost to sell.
CAPITALIZATION POLICIES
The Company capitalizes interest costs and property taxes incurred during the
construction of capital assets. The Company capitalized $2.4 million, $1.9
million and $0.8 million in interest costs for the year ended December 31, 1998,
the seven months ending December 31, 1997 and the fiscal year ending May 31,
1997, respectively. Maintenance, repairs and minor replacements are charged to
expense.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
The Company is required to adopt Statement of Financial Accounting Standard
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," in 2000. As the Company does not actively use derivative
instruments, the standard will not have a material impact on the financial
statements of the Company.
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income," and SFAS
No. 131, "Disclosures About Segments of an Enterprise and Related Information,"
in 1998. The components of other comprehensive income consists solely of foreign
currency translation adjustments. Subsequent to the Distribution, the Company
does not have any items that are considered to be other comprehensive income.
The adoption of the standards did not have a material impact on the financial
statements of the Company.
35
<PAGE>
RECLASSIFICATIONS
Certain amounts previously presented have been reclassified to conform to the
December 31, 1998 presentation.
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 was derived from the
following (in thousands):
<TABLE>
<CAPTION>
For the year For the seven
ended months ended
December 31, December 31, For the fiscal year ended May 31,
-------------------------------------
1998 1997 1997 1996
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income (loss) from continuing
operations before income taxes
Domestic operations $6,251 $(395) $12,649 $ (5,119)
Foreign operations - 67 (809) (16,755)
---------------------------------------------------------------------------------
Income (loss) before
income taxes $6,251 $(328) $11,840 $(21,874)
=================================================================================
</TABLE>
The provision for income taxes for continuing operations (in thousands):
<TABLE>
<CAPTION>
For the year For the seven
ended months ended
December 31, December 31, For the fiscal year ended May 31,
--------------------------------------
1998 1997 1997 1996
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Current tax (benefit) expense
Federal $1,723 $ 621 $2,583 $ 94
Foreign operations - 27 (320) (315)
State 386 134 292 26
Deferred tax (benefit) expense
Federal 371 (680) 2,048 (1,676)
Foreign operations - - - (6,295)
State 83 (146) 432 (357)
---------------------------------------------------------------------------------
$2,563 $ (44) $5,035 $(8,523)
=================================================================================
</TABLE>
Deferred tax liabilities were composed of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1998 1997
------------------- -----------------
<S> <C> <C>
Depreciation and amortization $(2,667) $(2,956)
Accrued expenses 2,428 2,702
Other (1,113) (1,124)
------------------- -----------------
Net deferred tax liability $(1,352) $(1,378)
=================== =================
</TABLE>
36
<PAGE>
A reconciliation of income tax expense (benefit) at the statutory rate to income
tax expense included in the accompanying consolidated statements follows:
<TABLE>
<CAPTION>
For the year For the seven
(In thousands, except Federal income ended months ended
tax rate) December 31, December 31, For the fiscal year ended May 31,
---------------------------------------
1998 1997 1997 1996
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Federal income tax rate 35% 35% 35% 35%
Federal taxes at statutory rate $2,188 $(115) $4,144 $(7,656)
State income taxes, net of Federal
tax benefit 305 (4) 573 (982)
Other 70 75 318 115
------------------------------------------------------------------------------
Income tax expense (benefit) $2,563 $ (44) $5,035 $(8,523)
==============================================================================
</TABLE>
Cash paid for state income taxes was $687,000, $486,000, $805,000 and
$165,000, for the year ended December 31, 1998, the seven months ending December
31, 1997 and the fiscal years ending May 31, 1997 and 1996, respectively.
Federal income taxes were paid by Manor Care for the period ending October 31,
1996 and the fiscal year ended May 31, 1996. The Company paid Federal income
taxes of $2,630,000 for the Company for the year ended December 31, 1998 and for
the consolidated group (including Choice and its subsidiaries) of $5.8 million
for the seven months ending December 31, 1997 and $5.5 million for the period
from November 1, 1996 through May 31, 1997. At December 31, 1997, the Company
had an income tax receivable of $4.3 million.
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 Choice, the Company and Choice entered into a tax-
sharing agreement to allocate pre-distribution tax liabilities among the Company
and Choice 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 Choice and its subsidiaries through the
date of the distribution) and (ii) paying the taxes related to such returns to
the applicable taxing authorities. Choice will reimburse the Company for the
portion of such taxes that relates to Choice and its subsidiaries.
ACCRUED EXPENSES
Accrued expenses were as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1998 1997
------------------- -----------------
<S> <C> <C>
Payroll $ 5,534 $ 4,449
Taxes, other than income 4,331 3,995
Other 6,354 3,566
$16,219 $12,010
=================== =================
</TABLE>
37
<PAGE>
LONG-TERM DEBT AND NOTES PAYABLE
Debt consisted of the following at December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1998 1997
------------------- -----------------
<S> <C> <C>
$80.0 million revolving credit facility with an
average rate of 7.68% and 8.27% at December 31,
1998 and 1997, respectively $ 41,000 $ 16,000
Multi-class mortgage pass-through certificates
with a blended weighted average rate of 7.8% at
December 31, 1998 and 1997 110,913 115,816
Note payable to Choice with an effective rate of
10.60% and 8.80% at December 31, 1998 and
1997, respectively 127,849 117,120
Capital lease obligations 1,427 1,832
------------------- -----------------
Total indebtedness $281,189 $250,768
=================== =================
</TABLE>
Maturities of debt at December 31, 1998 were as follows (in thousands):
<TABLE>
<CAPTION>
Year
- ----
<S> <C>
1999 $ 3,271
2000 44,543
2001 4,065
2002 131,518
2003 3,964
Thereafter 93,828
----------------
Total 281,189
================
</TABLE>
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 CMBS debt"). The CMBS
debt, which carries a blended, weighted average interest rate of 7.8% and has 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, consolidations,
and transfers of cash to affiliates. Restricted net assets related to the CMBS
debt were $31.3 million and $35.4 million as of December 31, 1998 and 1997,
respectively. The Company had $2.2 million and $6.1 million in escrow at
December 31, 1998 and 1997, respectively, related to the CMBS debt. The escrow,
which is included in other assets, is for property taxes, insurance and capital
expenditures of the properties collateralizing the CMBS debt. The CMBS debt is
non-recourse and is collateralized by 36 hotels owned by the Company. The
offering's net proceeds of $110 million were 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 the fiscal year ended May 31,
1997. During 1998, the sale of one of the collateralized hotels resulted in a
prepayment of CMBS debt in the amount of $2.2 million and a prepayment penalty.
This prepayment resulted in an extraordinary loss of $308,000, net of tax.
In conjunction with the April 1997 issuance of the CMBS debt, 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.
The Company entered into two debt facilities in October 1997 in connection with
the distribution: (i) a $80.0 million revolving credit facility (the "October
1997 credit facility"); and (ii) a $115.0 million pay-in-kind note payable to
Choice (the "Choice Note"). Proceeds from the new debt were used to repay the
Company's remaining portion of the loan from Manor Care and the outstanding
balance of revolving credit facility, and for advances previously made
38
<PAGE>
by Choice to the Company. The unused portion of the October 1997 credit facility
will be used by the Company for working capital, 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. Availability under the October 1997 credit facility is a
function of trailing cash flow. At December 31, 1998, the Company had the full
$80.0 million of availability under the October 1997 credit facility, resulting
in excess borrowing capacity of $39.0 million. 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 Choice Note has a maturity of five years and accrues simple interest at a
rate equal to 500 basis points above the interest rate on a five-year U.S.
Treasury Note, resulting in an effective rate of 8.8% through December 28, 1998.
In December 1998, the Choice Note terms were amended providing that the Choice
Note will accrue interest at a rate of 11.0% per annum compounded daily on
principal and unpaid interest beginning on October 15, 2000. As a result of the
amendment, the effective rate of the note increased to 10.6%. The Choice Note
contains restrictive covenants that restrict or limit the ability of the Company
to merge or consolidate with any other person or entity unless the Company is
the surviving entity, or sell, assign, transfer, lease, convey or otherwise
dispose of all or substantially all of the assets of the Company.
Cash paid for interest was $9.9 million, $10.7 million, $14.8 million, and $12.8
million for the year ended December 31, 1998, the seven months ended December
31, 1997 and fiscal years 1997 and 1996, respectively. At December 31, 1998,
real estate property with a net book value of $138.6 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 (in
thousands):
<TABLE>
<CAPTION>
Operating Leases Capitalized Leases
---------------------------------------------
<S> <C> <C>
1999 $ 1,223 $ 497
2000 1,239 497
2001 1,255 819
2002 1,108 -
2003 800
Thereafter 14,565 -
---------------------------------------------
Total minimum lease payments $20,190 1,813
======================
Less: interest (386)
-----------------------
Present value of lease payments $1,427
=======================
</TABLE>
Rental expense under non-cancelable operating leases was $1.9 million, $1.9
million, $329,000 and $332,000 in the year ended December 31, 1998, the seven
months ended December 31, 1997, and fiscal years 1997 and 1996, respectively.
For the year ended December 31, 1998 and the seven months ended December 31,
1997, the Company paid $2.5 million and $2.9 million, respectively, to Manor
Care for office rent, of which Choice reimbursed the Company $1.0 million and
$1.0 million, respectively, for its portion of the total space occupied. In
fiscal year 1997, the Company paid $4.5 million to Manor Care for office rent,
of which Choice reimbursed the Company $4.0 million for its portion of total
space occupied.
ACQUISITIONS AND DIVESTITURES
During 1998, the Company sold two hotels containing 193 rooms for $4.5 million
and two parcels of unimproved land for $1.6 million. During fiscal year 1997,
the Company acquired two hotels containing 324 rooms for $10.7
39
<PAGE>
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.
In addition to the two hotels sold in 1998, the Company has thirteen hotels that
are currently being marketed for sale with a carrying value of $37.1 million as
of December 31, 1998. The Company anticipates the sale of the properties to be
completed during 1999. 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, which had
the effect of reducing depreciation expense in 1998 by approximately $1.3
million. 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
sestimated fair values less costs to sell. As a result, the Company recognized a
$4.0 million provision for asset impairment (included in "Provision for asset
impairment and other non-recurring charges" in the Consolidated Statement of
Income) in 1998 to reduce the carrying value of certain of the assets to the
estimated fair value less costs to sell. The thirteen hotels held for sale
reported total revenues of $19.7 million for the year ended December 31, 1998.
Income from operations before interest, taxes, depreciation and amortization and
allocations for corporate expenses of the thirteen hotels was $5.1 million for
the year ended December 31, 1998.
DISCONTINUED OPERATIONS
The revenues, income from discontinued operations before income taxes, and net
income from discontinued operations were as follows (in thousands):
<TABLE>
<CAPTION>
Seven months
ended December
31, Fiscal year ended May 31,
----------------------------------------------
1997 1997 1996 1995
----------------- ----------------------------------------------
<S> <C> <C> <C> <C>
Revenue $112,286 $249,822 $227,277 $190,441
Expenses 84,092 189,438 189,545 159,706
----------------- ----------------------------------------------
Income from discontinued
operations before income taxes 28,194 60,384 37,732 30,735
Income taxes 11,825 25,165 15,923 13,467
----------------- -----------------------------------------------
Net income from discontinued
operations $ 16,369 $ 35,219 $ 21,809 $ 17,268
================= ==============================================
</TABLE>
Net income from discontinued operations for the seven months ended December 31,
1997 includes the results of operations of the franchising business through
October 15, 1997 and costs associated with the distribution of $1.9 million (net
of taxes).
COMMITMENTS AND CONTINGENCIES
The Company is a defendant in a number of lawsuits arising in the ordinary
course of business. In the opinion of management and legal counsel, the ultimate
outcome of such litigation will not have a material adverse effect on the
Company's business, financial position, or results of operations.
PENSION, PROFIT SHARING AND INCENTIVE PLANS
Bonuses accrued for key executives of the Company under incentive compensation
plans were $1.1 million, $357,000, $200,000 and $100,000 for the year ended
December 31, 1998, the seven months ended December 31, 1997 and in fiscal years
ended May 31, 1997 and 1996, 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. Retirement costs were
approximately $506,000, $217,000,
40
<PAGE>
$800,000 and $583,000 for the year ended December 31, 1998, the seven months
ended December 31, 1997 and fiscal years ended May 31, 1997 and 1996,
respectively.
CAPITAL STOCK
On September 16, 1998, the Company's board of directors approved a plan for the
Company to repurchase up to 2.5 million shares of common stock. During the year
ended December 31, 1998, the Company repurchased 510,414 shares of its common
stock at a total cost of $2.1 million. During the seven months ended December
31, 1997 and the fiscal year ended May 31, 1997, the Company repurchased 588,931
and 3,697,724 shares of its common stock at a total cost of $10.6 million and
$53.4 million, respectively.
On February 23, 1998, the Board of Directors adopted a shareholder rights plan
under which a dividend of one preferred stock purchase right will be distributed
for each outstanding share of the Company's common stock to shareholders of
record on April 3, 1998. Each right will, upon exercise, entitle the holder to
buy 1/100th of a share of a newly issued series of junior participating
preferred stock of the Company at an exercise price of $50 per share. The rights
are exercisable, subject to certain exceptions, after a person or group acquires
beneficial ownership of 10% or more of the Company's common stock (such a person
or group, an "Acquiring Person"), or begins a tender or exchange offer that
would result in a person or group becoming an Acquiring Person. The rights are
non-voting and expire on January 31, 2008, unless exercised or previously
redeemed by the Company for $.001 each. If the Company is involved in a merger
or certain other business combinations not approved by the Board of Directors,
each right will entitle its holder, other than the acquiring person or group, to
purchase common stock of either the Company or the acquirer having a value of
twice the exercise price of the right.
At December 31, 1998, the Company had 527,291 shares authorized under its stock
option program. 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>
Number of Shares Weighted
Option Price
-----------------------------------------
<S> <C> <C>
Outstanding at November 1, 1996 5,920,648 $2.83
Granted 397,693 4.93
Exercised (1,110,164) 4.20
Cancelled (259,145) 3.67
-----------------------------------------
Outstanding at May 31, 1997 4,949,032 3.02
Adjustment as a result of the Distribution (2,687,141)
Granted 552,441 8.04
Exercised (202,386) 2.03
Cancelled (30,241) 4.94
-----------------------------------------
Outstanding at December 31, 1997 2,581,705 5.67
Granted 442,536 6.57
Exercised (79,414) 1.80
Cancelled (114,458) 7.29
-----------------------------------------
Outstanding at December 31, 1998 2,830,369 $5.88
=========================================
</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 Choice 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 for the period prior to May 31, 1997 in the table above have been
adjusted for the reverse stock split.
41
<PAGE>
The following table provides information on the exercise prices of options
outstanding at December 31, 1998.
<TABLE>
<CAPTION>
Weighted Average Number of Options
Exercise Price Number of Options Weighted Average Contractual Life Currently
Range Outstanding Exercise Price (in years) Exercisable
----- ----------- -------------- ---------- -----------
<S> <C> <C> <C> <C>
$ 1.57 to $ 2.00 166,788 $ 1.67 1.16 166,768
2.01 to 3.50 331,018 2.75 2.90 172,086
3.51 to 5.50 416,004 4.33 4.73 154,442
5.51 to 8.50 1,805,793 7.00 8.04 428,766
8.51 to 10.00 110,766 9.24 8.73 12,906
--------- -------
2,830,369 934,968
========= =======
</TABLE>
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. 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. The fair value
of each option grant has been estimated on the date of grant using an option-
pricing model. For the year ended December 31, 1998, the seven months ended
December 31, 1997 and fiscal year 1997 the Company assumed a risk free interest
rate of 4.7%, 5.7% and 6.4%, respectively, expected volatility of 34.5%, 25.7%
and 30.0%, respectively, a dividend yield of 0% and expected lives of ten years.
The weighted average fair value per option granted during the year ended
December 31, 1998, the seven months ended December 31, 1997 and fiscal year 1997
was $4.16, $4.12 and $8.35, respectively. If options had been reported as
compensation expense based on their fair value pro forma, net income and
earnings per share would have been as follows for the year ended December 31,
1998, the seven months ended December 31, 1997 and fiscal year 1997.
<TABLE>
<CAPTION>
For the seven
For the year ended months ended For the year ended
December 31, 1998 December 31, 1997 May 31, 1997
------------------------------------------------------------------------
<S> <C> <C> <C>
Net income:
As reported $ 3,380 $ 16,085 $ 40,880
Pro forma $ 2,352 $ 15,563 $ 40,296
Earnings per share:
Basic, as reported $ 0.17 $ 0.81 $ 1.96
Basic, pro forma $ 0.12 $ 0.78 $ 1.92
Diluted, as reported $ 0.17 $ 0.81 $ 1.93
Diluted, pro forma $ 0.12 $ 0.78 $ 1.90
</TABLE>
The Company has not presented information for the period prior to the Manor Care
Distribution since there were no options for the Company's stock granted until
after the Manor Care Distribution. 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.
EARNINGS PER SHARE FROM CONTINUING OPERATIONS
The following table illustrates the reconciliation of income from continuing
operations and number of shares used in the calculation of basic and diluted
earnings per share from continuing operations.
42
<PAGE>
<TABLE>
<CAPTION>
(in thousands, except per share amounts) Fiscal Year
Ended
December 31, May 31,
1998 1997
------------------ ------------------
<S> <C> <C>
Computation of basic earnings per share from
continuing operations:
Income from continuing operations before
extraordinary item $ 3,688 $ 6,805
Weighted average shares outstanding 19,956 20,893
----------- ----------
Basic earnings per share from continuing
operations $ 0.18 $ 0.32
=========== ==========
Computation of diluted earnings per share from
continuing operations:
Income from continuing operations before
extraordinary item $ 3,688 $ 6,805
Weighted average share outstanding 19,956 20,893
Effect of dilutive securities:
Employee stock option plan 320 298
----------- ----------
Shares for diluted earnings per share 20,276 21,191
----------- ----------
Diluted earnings per share from continuing
operations $ 0.18 $ 0.32
=========== ==========
</TABLE>
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>
December 31, Fiscal Year
1998 Ended May 31,
1997
------------------------------------
<S> <C> <C>
Number of shares (in thousands) 1,734 60
Weighted average exercise price $ 7.28 $ 5.20
</TABLE>
Earnings per common share is computed by dividing net income by the weighted
average number of common shares outstanding. The 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 and stock options outstanding subsequent to November 1, 1996. Because
the Company's continuing operations had a net loss for the seven months ended
December 31, 1997, diluted earnings per share was not calculated as any
potentially dilutive securities would have an anti-dilutive effect on earnings
per share from continuing operations. No diluted earnings per share is
presented for fiscal year 1996 as the Company had no stock options or other
dilutive securities outstanding prior to the Manor Care Distribution.
43
<PAGE>
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 Choice) 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 and Gaithersburg, 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%, and (v) Manor Care would provide certain corporate and
consulting services to the Company.
For the year ended December 31, 1998, the seven months ended December 31, 1997
and the fiscal year ended May 31, 1997, the Company incurred $1.3 million, $1.9
million and $525,000, respectively, in rent expense for office space leased from
Manor Care, $0, $1.2 million and $12.4 million, respectively, in interest
expense on the loan that was repaid in October 1997, and $2.0 million, $1.4
million and $2.1 million, respectively, in corporate expense for corporate
services provided by Manor Care.
In February 1999, the Company entered into a release agreement with Manor Care
which effectively terminated all inter-company service, consulting and lease
agreements.
RELATIONSHIP WITH CHOICE HOTELS INTERNATIONAL, INC.
For purposes of providing an orderly transition after the distribution, the
Company and Choice 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) would
receive and/or provide certain corporate and support services, such as
accounting, tax and computer systems support, (ii) would adjust outstanding
options to purchase shares of Company common stock held by Company employees,
Choice 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 Choice) for the periods of time that the affiliates were members of
the consolidated group, (iv) would be reimbursed by Choice for the portion of
income taxes paid that relate to Choice and its subsidiaries, (v) would enter
into a five-year loan agreement with Choice 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 Choice would, at the date of distribution, have a
specified level of net worth. At December 31, 1997, approximately $25 million of
liabilities were due to Choice that related to the net worth guarantee. This
liability related to the net worth guarantee and the reimbursement of various
expenses subsequent to the distribution date.
On December 28, 1998, the Company and Choice entered into an agreement to amend
a prior strategic alliance agreement and amend the Choice Note. The amendment
provided for, among other things, (i) the elimination of the Company's option to
purchase the MainStay Suites Hotel system from Choice in exchange for the
satisfaction of $16.5 million of the remaining $19.5 million payable to Choice;
(ii) waiver of liquidated damage provisions on all franchising agreements
entered into prior to December 28, 1998 (excluding MainStay Suites or Sleep
Inns) and limitation of liquidated damages on all other franchise agreements to
$100,000; (iii) commitment by the Company to develop a total of 25 MainStay
Suites hotels by October 2001, and; (iv) an increase in the effective interest
rate of the Note during its final two years. In conjunction with this
agreement, the Company paid the remaining $3.0 million due to Choice for the net
worth guarantee. The satisfaction of the Choice payable, net of tax, is
reflected as a credit to equity as an adjustment to the accounting for the
Distribution.
The Company operates substantially all of its hotels pursuant to franchise
agreements with Choice. Total fees paid to Choice included in the accompanying
financial statements for franchising marketing, reservation and royalty fees are
$11.5 million, $6.2 million, $9.5 million and $7.5 million for the year ended
December 31, 1998, the seven months ended December 31, 1997 and the fiscal years
ended May 31, 1997 and 1996, respectively.
44
<PAGE>
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. The interest rate
on the October 1997 credit facility adjusts frequently based on market rates;
accordingly, the carrying amount is equivalent to fair value. At December 31,
1998, the fair value of the Choice Note and the mortgage securities is $132.7
million and $106.9 million, respectively, based on rates for similarly
structured instruments. At December 31, 1997, the carrying amount of the Choice
note and the mortgage securities approximated fair value.
PROVISION FOR ASSET IMPAIRMENT AND OTHER NON-RECURRING CHARGES
The Company recognized a provision for asset impairment and other non-recurring
charges of $4.3 million (pre-tax) in the year ended December 31, 1998. Included
in the provision is a $4.0 million in asset impairment charge related to certain
hotels held for sale and $300,000 in non-recurring charges. Non-recurring
charges includes a restructuring charge of $146,000 to account for a reduction
in force at the Company's corporate headquarters. The restructuring charge
includes transition pay and benefits of the twelve employees terminated.
Benefits totaling $109,000 have been paid and charged against the liability
through December 31, 1998.
Included in the provision for asset impairment and other non-recurring charges
in the seven months ended December 31, 1997 are non-recurring loss provisions
totaling $5.1 million (pretax). This loss provision was recorded in December
1997 in order to reserve $2.1 million of previously capitalized costs and future
payment obligations related to a data processing services agreement and computer
system which was replaced in 1998, to accrue the estimated cost of $1.0 million
of future lease costs associated with space the Company has vacated, and to
reserve $2.0 million for future obligations related to an agreement expiring in
May 1999, for services which the Company will no longer utilize and, therefore,
have no future benefits. The service and lease agreements are with Manor Care
and Choice and were entered into in conjunction with the distribution and the
Manor Care Distribution.
During fiscal year 1996, the Company began restructuring its European
operations. This restructuring effort included the purchase of an equity
interest in Friendly Hotels PLC and a re-evaluation of key geographic markets in
Europe. In connection with this restructuring, the Company performed a review
of its European operations and in May 1996 recognized a $19.4 million non-cash
charge against earnings related primarily to the impairment of assets associated
with certain European hotel operations.
In addition, the Company recognized a restructuring charge of $5.2 million in
May 1996. Restructuring costs include severance and employee benefit plan
restructuring costs and other costs directly associated with the distribution.
GEOGRAPHIC AND BUSINESS SEGMENT INFORMATION
The Company operates in one business segment, hotel ownership. The Company's
hotels are operated under Choice Hotels International, Inc. brands, contain an
average of 140 rooms, and supply other amenities such as meeting space; a
variety of restaurants and lounges, gifts shops and swimming pools. They are
typically located in suburban locations. The Company evaluates the performance
of its segment based primarily on operating profit before depreciation,
corporate expenses, and interest expense.
45
<PAGE>
The following table presents segmented financial information, (in
thousands):
<TABLE>
<CAPTION>
For the year ended December 31, 1998
-------------------------------------------------------------------
Hotels Corporate & Other Consolidated
-------------------------------------------------------------------
<S> <C> <C> <C>
Revenues.......................................... $ 203,822 $ 274 $ 204,096
Operating income.................................. 33,392 (6,629) 26,763
Interest expense.................................. - 20,512 20,512
Depreciation and amortization..................... - 27,227 27,227
Capital expenditures.............................. - 60,720 60,720
Total assets...................................... 419,661 2,850 422,511
For the Seven Months Ended December 31, 1997
-------------------------------------------------------------------
Hotels Corporate & Other Consolidated
-------------------------------------------------------------------
Revenues.......................................... $ 113,251 $ 1,302 $ 114,553
Operating income.................................. 18,067 (8,257) 9,810
Interest expense.................................. - 10,138 10,138
Depreciation and amortization..................... - 14,246 14,246
Capital expenditures.............................. - 61,460 61,460
Total assets...................................... 397,527 3,456 400,983
For the Fiscal Year Ended May 31, 1997
-------------------------------------------------------------------
Hotels Corporate & Other Consolidated
-------------------------------------------------------------------
Revenues.......................................... $ 184,707 $ 1,046 $ 185,753
Operating income.................................. 27,072 659 27,731
Interest expense.................................. - 15,891 15,891
Depreciation and amortization..................... - 20,632 20,632
Capital expenditures.............................. - 75,523 75,523
Total assets...................................... 424,033 2,396 426,429
</TABLE>
There were no intercompany sales between the properties and the
Company. The following table presents revenues and long-lived assets for each
of the geographical areas in which the Company operates (in thousands):
<TABLE>
<CAPTION>
For the Year For the Seven Months Ended For the Fiscal Year Ended
Ended December 31, 1998 December 31, 1997 May 31, 1997
-------------------------------------------------------------------------------------
Long-lived Long-lived Long-lived
Revenues assets Revenues assets Revenues assets
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Unites States............... $ 204,096 $ 400,145 $ 107,574 $ 371,305 $ 168,016 $ 321,119
International............... - - 6,979 - 17,737 17,300
--------- ---------- ---------- ---------- ---------- ---------
Total..................... $ 204,096 $ 400,145 $ 114,553 $ 371,305 $ 185,753 $ 338,419
========== ========== ========== ========== ========== =========
</TABLE>
46
<PAGE>
SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
<TABLE>
<CAPTION>
QUARTERS ENDED (IN
THOUSANDS, EXCEPT PER OPERATING NET BASIC DILUTED
SHARE DATA) REVENUES (1) INCOME (2,3) INCOME EPS (4) EPS (4)
------------------------------------------------------------------------
1998
<S> <C> <C> <C> <C> <C>
March 31, 1998 $ 46,139 $ 6,167 $ 708 $ 0.04 $ 0.03
June 30, 1998 54,440 9,194 2,358 0.12 0.12
September 30, 1998 56,320 6,237 448 0.02 0.02
December 31, 1998 47,197 5,165 (134) (0.01) (0.01)
SEVEN MONTHS ENDED
DECEMBER 31, 1997
August 31, 1997 $ 54,098 $ 11,368 $ 16,115 $ 0.80 $ 0.80
November 30, 1997 48,169 5,510 5,503 0.28 0.27
FISCAL 1997
November 30, 1996 $ 44,950 $ 4,822 $ 10,615 $ 0.51 $ 0.50
February 28, 1997 39,703 2,263 3,448 0.16 0.16
May 31, 1997 51,447 9,920 11,420 0.56 0.55
</TABLE>
(1) Revenues reflect revenues from continuing operations.
(2) Operating income reflects income from continuing operations before interest
expense, income taxes and extraordinary items.
(3) Operating income for the quarter ending August 31, 1997 was adjusted to
reclassify certain expenses relating to European hotels from discontinued
operations to continuing operations. The adjustment has no impact on Net
Income for the quarter.
(4) Basic EPS and Diluted EPS for periods prior to October 15, 1997 have been
effected for the one-for-three reverse stock split.
47
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The name, age, title present principal occupation, business
address and other material occupations, positions, offices and employment of
each of the Company's executive directors are set forth below. The business
address of each director is 10770 Columbia Pike, Silver Spring, Maryland 20901.
<TABLE>
<CAPTION>
NAME Age Position
---- --- -------
<S> <C> <C>
Stewart Bainum, Jr.................. 53 Chairman of the Board of Directors
Frederic V. Malek................... 62 Director
Paul A. Gould....................... 53 Director
Carole Y. Prest..................... 47 Director
Keith B. Pitts...................... 41 Director
Christine A. Shreve................. 41 Director
Donald J. Landry.................... 50 Chief Executive Officer and Vice Chairman
</TABLE>
Stewart Bainum, Jr. Chairman of the Board of the Company from November
1996 to July 1998 and since December 1998; a member of the Board of the
Company's predecessors from 1982 to July 1998; Chairman of the Board of Choice
from March 1987 to November 1996 and since October 1997; Chairman of the Board
of HCR/Manor Care since September 1998; Chairman of the Board and Chief
Executive Officer of Manor Care and Manor Care Health Services, Inc. ("MCHS")
March 1987 to September 1998, Chief Executive Officer of Manor Care since March
1987 and President since June 1989; Vice Chairman of the Board of Vitalink
Pharmacy Services, Inc. ("Vitalink") since December 1994; Vice Chairman of the
Board of Manor Care and subsidiaries from June 198 to March 1987; Director of
Manor C are since August 1981, of Vitalink since September 1991 and of MCHS
since 1976; President of MCHS from May 1990 to May 1991; Chairman of the Board
and Chief Executive Officer of Vitalink from September 1991 to February 1995 and
President and Chief Executive Officer from March 1987 to September 1991.
Frederic V. Malek. Member of the Board of the Company since November 1996.
Chairman of Thayer Capital Partners since March 1993; Co-Chairman of CB
Commercial Real Estate group, Inc. from April 1989 to October 1996; Champaign
Manager for Bush-Quayle '92 from January 1992 to November 1992; Vice Chairman of
NWA, Inc. (airlines), July 1990 to December 1991; Director: American Management
Systems, Inc., Automatic Data Processing Corp., CB Commercial Real Estate Group,
Inc., Choice Hotels International, Inc., Northwest Airlines and various Paine
Webber mutual funds.
Paul A. Gould. Member of the Board of the Company since November 1996.
Managing Director of Allen & Company Incorporated (investment banking firm) for
over five years and other positions at Allen Company Incorporated since 1973.
Director: Telecommunications International, Inc.,: Ascent Entertainment Group;
United Video Satellite Group, Inc.: and National Patent Development Corporation;
Board of Trustees of The New School, The Hackley School and The Holderness
School.
Carole Y Prest. Member of the Board of the Company since November 1997.
Vice President, Corporate Strategic Planning of Manor Care since September 1995;
Vice President and General Manager and various other positions at Gen Rad, Inc.
from May 1985 to 1994.
48
<PAGE>
Keith B. Pitts. Member of the Board of the Company since November 1997.
Chairman and Chief Executive Officer of the Mariner Post-Acute Network, Inc.
since November 1997; Consultant to Apollo from August 1997 to November 1997;
Consultant to Tenant Healthcare Corp. ("Tenant") from February 1997 to August
1997; Executive Vice President and Chief Executive Financial Officer of orNda
HealthCorp from August 1992 until its merger with Tenet in January 1997.
Director: Mariner Post-Acute Network, Inc.
Christine A. Shreve. Member of the Board of the Company since June 1998.
President, Shreve, Bowersox, P.C. since 1992.
Donald J. Landry. Chief Executive Officer and Vice Chairman of the Company
since October 1997; President of the Company from January 1995 to October 197;
President of Manor Care Hotel Division ("MCHD") from March 1992 to November
1996; various executive positions with Richfield Hotel Management, Inc. ("RHM")
and its predecessors for more than 16 years, including President of MHM
Corporation.
The required information on executive officers is set forth in Part I of
this Form 10-K under an unnumbered item captioned "Executive Officers of
Sunburst Hospitality Corporation."
ITEM 11. EXECUTIVE COMPENSATION.
EXECUTIVE COMPENSATION
<TABLE>
<CAPTION>
Summary Compensation Table
ANNUAL COMPENSATION(1) LONG-TERM COMPENSATION
---------------------- ----------------------
Fiscal Restricted Stock
Name and Principal Position Year(1) Salary Bonus Other Awards ($)(2)
--------------------------- ------- ------ ----- ----- -------------
<S> <C> <C> <C> <C> <C>
Stewart Bainum, Jr. (5) 1998 0 (6) --
Chairman 1997A 148,310 47,683 (6) --
1997B 656,357 388,520 (6) --
Donald J. Landry (8) 1998 424,463 198,533 95,077.85
Vice Chairman and Chief 1997A 421,975 200,508
Executive Officer 1997B 404,250 200,508 (6) --
James A. MacCutcheon (11) 1998 322,980, 141,196 52,542.01
Executive Vice President, 1997A 312,900 52,263 --
Chief Financial Officer & Treasurer 1997B 313,578 158,953 (6) --
Antonio DiRico 1998 259,500 100,120 35,194.56
President 1997A 259,499 86,524 --
1997B 196,200 86,584 (6) --
Kevin D. Hanley 1998 175,000 51,594 27,750.79
Senior Vice President 1997A 174,999 84,452 (6) --
Real Estate Development 1997B 144,890 51,776 (6) --
Gregory Miller 1998 158,350.34 66,538.92 (6) 20,297.20
Senior Vice President 1997A -- -- --
Human Resources 1997B -- -- --
Douglas H. Verner 1998 117,691.68(18) 12,326.09 76,660.70(19) 7,610.32
Senior Vice President 1997A -- -- --
General Counsel & Secretary 1997B -- -- --
<CAPTION>
Stock Option All Other
Name and Principal Position Shares (#)(3) Compensation (4)
--------------------------- ------------- ----------------
<S> <C> <C>
Stewart Bainum, Jr. (5) -- --
Chairman -- --
60,000 (7) --
Donald J. Landry (8) 110,000 19,631
Vice Chairman and Chief 106,000 (9) 6,035
Executive Officer 100,000 (10) 6,035
James A. MacCutcheon (11) 50,000 20,304
Executive Vice President, 46,500 (12) 18,682
Chief Financial Officer & Treasurer 67,500 (13) 18,682
Antonio DiRico 65,000 8,360
President 80,600 (14) 3,043
25,000 (15) 3,043
Kevin D. Hanley 45,000 --
Senior Vice President 51,200 (16) --
Real Estate Development 2,727 (17) --
Gregory Miller 20,000 7,110
Senior Vice President -- --
Human Resources -- --
Douglas H. Verner 45,036 --
Senior Vice President -- --
General Counsel & Secretary -- --
</TABLE>
(1) On September 16, 1997, the Company changed its fiscal year end on May 31 to
December 31. Accordingly, the summary compensation information presented is
for the twelve months ended December 31, 1997 ("1997A"), the fiscal year
ended May 31, 1997 ("1997B"). Summary compensation data paid to the Named
Officers during the period between January 1, 1997 and May 31, 1997 is
reflected in each of the 1997A and 1997B periods.
49
<PAGE>
(2) On June 29, 1998, the Company issued restricted stock to officers in lieu
of merit increases for calendar year 1998. The restricted stock vest over
three (3) years.
(3) For all of the Named Officers, except for Mr. MacCutcheon the grants in
1997B represent options to purchase shares of Manor Care common stock. In
connection with the Manor Care Spin-off, the options to purchase Manor Care
common stock were converted, in some cases 100%, to options to purchase
Company common stock. For Mr. MacCutcheon and with respect to grants in
1997B and or all of the Named Officers with respect to grants in 1997A,
represents options to acquire shares of Company common stock. In
connection with the Spin-off, the options to purchase Company common stock
were converted to successor options to purchase Company common stock and
Choice common stock. In all cases, however, the exercise prices were
adjusted to maintain the same financial value to the option holder before
and after the Manor Care Spin-off and the Choice Spin-off.
(4) Represents amounts contributed by the Company for 1998, 1997A and 1997B
under their respective 401(k) Plan and Non-Qualified Savings Plan, which
provide retirement and other benefits to eligible employees, including the
Named Officers. The value of the amounts contributed in stock by the
Company for 1998, 1997A and 1997B under the 401(k) Plan and Non-qualified
Savings Plan, respectively, for the Named Offices were as follows: Mr.
Landry, $19,631.91, $2,375 and $3,660; Mr. MacCutcheon, $20,304.00, $6,240
and $12,443; Mr. DiRico, $8,360.15, $966 and $2,077; and Mr. Miller
$7,110.37.
(5) For part of 1998 and 1997B, Mr. Bainum, Jr. was the Chairman and Chief
Executive Officer of Manor Care and the Company. The compensation
reflected here for 1997B is the total compensation received for services
rendered to both Manor Care and Company. Nineteen Hundred and ninety-seven
A (1997A), represents the amount of compensation paid solely by the
Company.
(6) The value of perquisites and other compensation does not exceed the lesser
of $50,000 or 10% of the amount of annual salary and bonus paid as to any
of the Named Officers.
(7) In connection with the Spin-off, these options were converted on a pro rata
basis into options to acquire 20,000 shares of Company common stock at an
exercise price of $7.1894 and 60,000 shares of Choice at an exercise price
of $12.1130.
(8) Mr. Landry was appointed Vice Chairman and Chief Executive Officer upon the
Spin-off. Prior to the Spin-off, he was President of the Company.
(9) In connection with the Spin-off, these options were converted into options
to purchase 124,631 shares of Company common stock at an exercise price of
$7.8815 and 53,000 shares of Choice common stock at an exercise price of
$13.2791.
(10) In connection with the Spin-off, these options were converted into options
to purchase 291,795 shares of Company common stock at an exercise price of
$7.1894 and 153,497 shares of Choice common stock at an exercise price of
$12.113.
(11) For 1996 and part of 1997B, Mr. MacCutcheon was Senior Vice President,
Chief Financial Officer and Treasurer of Manor Care and the Company. On
November 1, 1996, Mr. MacCutcheon resigned from Manor Care and assumed the
position of Executive Vice President, Chief Financial Officer and Treasurer
of the Company. The compensation reflected for 1996 and 1997B are total
compensation received for services rendered to both Manor Care and the
Company. For the period of 1997B after the Manor Care Spin-off, the amount
of compensation paid solely by the Company was 209,052 for salary and
$103,690 for bonus. In connection with the Spin-off, the Company and
Choice entered into a Consulting Agreement whereby Choice would reimburse
the Company for 30% of Mr. MacCutcheon's base salary and bonus from October
15, 1997 through November 1, 2001. See "Certain Relationships and Related
Transactions."
(12) In connection with the Spin-off, these options were converted into options
to purchase 54,673 shares of Company common stock at an exercise price of
$7.835 and 23,250 shares of Choice common stock at an exercise price of
$13.2008.
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<PAGE>
(13) In connection with the Spin-off, these options were converted into options
to purchase 138,806 shares of Company common stock at an exercise price of
$6.884, 47,082 shares of Company common stock at an exercise price of
$7.1894, 30,308 shares of Choice at an exercise price of $11.5986 and
15,642 shares of Choice common stock at an exercise price of $12.113.
(14) In connection with the Spin-off, these options were converted into options
to purchase 111,739 shares of Company common stock at an exercise price of
$7.835 and 30,225 shares of Choice common stock at an exercise price of
$13.2008.
(15) In connection with the Spin-off, these options were converted into options
to purchase 82,498 shares of Company common stock at an exercise price of
$7.1894 and 32,706 shares of Choice common stock at an exercise price of
$12.113.
(16) In connection with the Spin-off, these options were converted into options
to purchase 70,981 shares of Company common stock at an exercise price of
$7.835 and 19,200 shares of Choice common stock at an exercise price of
$13.2008.
(17) In connection with the Spin-off, these options were converted into options
to purchase 3,779 shares of Company common stock at an exercise price of
$7.1894 and 1,024 shares of Choice common stock at an exercise price of
$12.113.
(18) Mr. Verner joined Sunburst in March 1998 as Senior Vice President, General
Counsel and Secretary. On an annualized basis, his base salary is $150,000
per year.
(19) Other compensation for Mr. Verner is reimbursement of relocation expenses.
STOCK OPTIONS
The following tables set forth certain information at December 31, 1998 and for
the twelve months then ended concerning options to purchase Company common stock
granted to Named Officers. All common stock figures and exercise prices have
been adjusted to reflect stock dividends and stock splits effective in prior
fiscal years. With the Choice Spin-off, existing Company stock options were
subject to certain adjustments or conversions into options to purchase shares of
Company common stock and Choice common stock. The table below represents the
options grants on a post-conversion basis.
STOCK OPTION GRANTS IN 1998
<TABLE>
<CAPTION>
Individual Grants
-----------------
Percentage of Rate of Stock Price
Number of Total Options Appreciation for
Options Granted to all Exercise Base Expiration Option Term (1)
---------------
Name Granted Employees in 1998 Price Per Share Date 5%(2) 10%(3)
----- ------- ----------------- --------------- ---------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Stewart Bainum, Jr.......... 0 -- -- -- -- --
Donald J. Landry (4)........ 10,000 25.6% $ 6.406 6/29/08 $ 443,157 $1,123,045
James A. MacCutcheon (4).... 50,000 11.5% 6.406 6/29/08 201,435 510,475
Antonio DiRico (4).......... 65,000 15.1% 6.406 6/29/08 261,866 663,618
Kevin P. Hanley (4)......... 45,000 10.4% 6.406 6/29/08 181,292 459,428
Gregory Miller (4).......... 20,000 4.6% 6.406 6/29/08 80,574 204,190
Douglas Verner (4).......... 35,036 10.4% 8.759 3/31/08 192,798 489,089
10,000 6.406 6/29/08 40,287 102,095
</TABLE>
(1) The dollar amounts under these columns are the result of calculations at
the 5% and 10% rates set by the Securities and Exchange Commission and
therefore are not intended to forecast future possible appreciation, if
51
<PAGE>
any, of the stock price. Since options are granted at market price, a zero
percent gain in the stock price will result in no realizable value to the
optionees.
(2) A 5% per year appreciation in stock price from $6.406 per share yields
$10.437 and from $8.759 per share yields $14.2675.
(3) A 10% per year appreciation in stock price from $6.406 per share yields
$16.6155 and from $8.759 per share yields $22.7186.
(4) The options granted to the officers vest at the rate of 20% per year on the
first through the fifth anniversaries of the date of the stock option
grant.
AGGREGATED OPTION EXERCISES IN 1998
AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Shares Number of Unexercised Options at
Acquired on Value Options at December 31, 1998
----------------------------
Exercise Realized Exercisable Unexercisable
-------- -------- ----------- -------------
Name # $ # #
---- --- --- --- ---
<S> <C> <C> <C> <C>
Stewart Bainum, Jr........................... 83,889 36,112
Donald J. Landry............................. 233,605 707,962
James A. MacCutcheon......................... 181,595 310,332
Antonio DiRico............................... 66,595 239,230
Kevin P. Hanley.............................. 15,707 104,053
Gregory Miller............................... 10,739 62,953
Douglas H. Verner............................ - 45,036
<CAPTION>
Value of Unexercised in-the-money
Options at December 31, 1998
----------------------------
Name Exercisable Unexercisable
---- ----------- -------------
<S> <C> <C>
Stewart Bainum, Jr........................... 126,381.38 8,811.35
Donald J. Landry............................. 96,294.03 238,468.96
James A. MacCutcheon......................... 92,639.01 41,629.29
Antonio DiRico............................... 2,513.98 4,154.01
Kevin P. Hanley.............................. - -
Gregory Miller............................... - -
Douglas H. Verner............................ - -
</TABLE>
(1) The closing prices of Company common stock and Choice's common stock as
reported by the New York Stock Exchange on December 31, 1998 was $4.25.
The value is calculated on the basis of the difference between the option
exercise price and such closing price multiplied by the number of shares of
Company common stock underlying the option.
EMPLOYMENT AGREEMENTS
On October 15, 1997, the Company amended and restated an employment agreement
with Stewart Bainum, Jr., providing for Mr. Bainum, Jr.'s employment as Chairman
of the Company's Board of Directors. The agreement had a term of three years.
The Agreement terminated on July 15, 1998 when Mr. Bainum, Jr. resigned form the
Board. Mr. Bainum, Jr. rejoined the Board on December 4, 1998, as a non-
employee director.
The Company entered into an Employment Agreement with Donald J. Landry on June
25, 1997, effective upon the Spin-off on October 15, 1997. The agreement has a
term of three years from October 15, 1997 and provides for a base salary of
$424,462 per annum, subject to annual adjustments, and an annual bonus of up to
60% of his base compensation, based upon the Company's performance.
The Company entered into an Employment Agreement with James A. MacCutcheon on
October 31, 1996, effective November 1, 1996. The agreement has a term of five
years and provides for a base salary of $313,578 per annum, subject to annual
adjustments, and an annual bonus of up to 55% of his base compensation, based
upon the Company's performance.
The Company adopted an Officer Retention and Severance Plan (the "Plan")
effective January 21, 1999, which provides that any officer who is terminated
(i) due to a Change of Control as that term is defined in the Second Amendment
to the 1996 Long-Term Incentive Plan; (ii) without cause; or (iii)
constructively through a significant reduction in compensation and
responsibilities measured as of the date of the Plan and, who is not under
contract with the Company, shall receive base salary for twelve months plus two
weeks for each year of service with the Company and its predecessor companies,
to be paid bi-weekly. Payments will be reduced by any salary earned from other
employment by the officer. Any officer under contract will be covered by the
terms of the individual contract.
52
<PAGE>
RETIREMENT PLANS
The Company has adopted the Sunburst Hospitality Corporation Supplemental
Executive Retirement Plan (the "SERP"). Participants are Senior Vice Presidents
and other officers selected by the Board of Directors to participate.
Participants in the SERP receive a monthly benefit for life based upon final
average salary and years of service. Final average salary is the average of the
monthly base salary, excluding bonuses or commissions, earned in a 60 month
period which produces the highest average out of the 120 months of employment,
prior to the first occurring of the early retirement date or the normal
retirement date. The nominal retirement age is 65, and participants must have a
minimum of 15 years of service. Participants may retire at age 60 and may elect
to receive reduced benefits commencing prior to age 65, subject to Board
approval. All of the Named Officers who are participants are age 55 or younger,
so that none of their compensation reported above would be included in the final
average salary calculation.
Assuming that the following officers continue to be employed by the Company
until they reach age 65, their credited years of service are as follows:
<TABLE>
<CAPTION>
CURRENT YEARS YEARS OF SERVICE
NAME OF INDIVIDUAL OF SERVICE AT AGE 65
------------------ ----------------------------------
<S> <C> <C>
Donald J. Landry 7 22
James A. MacCutcheon 11 30
Antonio DiRico 5 25
Kevin P. Hanley 4 28
Douglas H. Verner 1 20
Gregory Miller 5 26
</TABLE>
The table below sets forth estimated annual benefits payable upon retirement to
persons in specified compensation and years of service classifications. These
benefits are straight life annuity amounts, although participants have the
option of selecting a joint and 50% survivor annuity or ten-year certain
payments. The benefits are not subject to offset for social security and other
amounts.
YEARS OF SERVICE/BENEFIT AS
PERCENTAGE OF FINAL AVERAGE SALARY
----------------------------------
<TABLE>
<CAPTION>
25 OR
REMUNERATION 15/15% 20/22.5%
------------ ------ --------
MORE/30%
--------
<S> <C> <C> <C>
$ 300,000 $ 45,000 $ 67,500 $ 90,000
350,000 52,500 78,750 105,000
400,000 60,000 90,000 120,000
450,000 67,500 101,250 135,000
500,000 75,000 112,500 150,000
600,000 90,000 135,000 180,000
</TABLE>
In November 1996, the Company established the Sunburst Hospitality Corporation
Retirement Savings and Investment Plan (the "401(k) Plan"). The 401(k) Plan is
a defined contribution retirement, savings and investment plan qualified under
Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"),
and includes a cash or deferred arrangement under Section 401(k) of the Code.
All employees age 21 or over and who have worked for the Company for a twelve
month period during which such employee completed at least 1,000 hours will be
eligible to participate. Subject to certain non-discrimination requirements,
each employee will be able to contribute an amount to the 401(k) Plan on a pre-
tax basis up to 15% of the employee's salary, but not more than the current
Federal limit of $10,000. The Company will match contributions made by its
employees subject to certain limitations. The amount of the match will be equal
to a percentage of the amount of salary reduction
53
<PAGE>
contribution made on behalf of a participant during the plan year based upon a
formula that involves the profits of the Company for the year and the number of
years of service of the participant. Amounts contributed by the Company pursuant
to its 401(k) Plan for Named Officers are included in the Summary Compensation
Table under the column headed "All Other Compensation."
The Company also adopted the Sunburst Hospitality Corporation Non-Qualified
Retirement Savings and Investment Plan ("Non-Qualified Savings Plan"). Certain
select highly compensated members of management of the Company will be eligible
to participate in the Non-Qualified Savings Plan. The Non-Qualified Savings
Plan is structured so as to provide the participants with a pre-tax savings
vehicle to the extent that pre-tax savings are limited under the 401(k) Plan as
a result of various governmental regulations, such as non-discrimination
testing. Amounts contributed by the Company under its Non-Qualified Savings
Plan for fiscal year 1998 for the Named Officers are included in the Summary
Compensation Table under the column headed "All Other Compensation."
The Company match under the 401(k) Plan and the Non-Qualified Savings Plan is
limited to a maximum aggregate of 6% of the annual salary of a participant.
Likewise, participant contributions under the two plans will not exceed the
aggregate of 15% of the annual salary of a participant.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth the amount of the Company's common stock
beneficially owned by (i) each director of the Company, (ii) the Company's chief
executive officer and the other four most highly compensated executive officers
(the "Named Officers"), (iii) all officers and directors of the Company as a
group and (iv) all persons who are expected to own beneficially more than 5% of
the Company's common stock, as of December 31, 1998. Unless otherwise
specified, the address for each of them is 10770 Columbia Pike, Silver Spring,
Maryland, 20901.
<TABLE>
<CAPTION>
SHARES OF
COMMON STOCK PERCENT OF SHARES
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED OUTSTANDING(1)
------------------------ ------------------ --------------
<S> <C> <C>
Stewart Bainum, Jr.......................................... 5,330,691(2) 27.19%
Antonio DiRico.............................................. 85,854(3) *
Gregory Miller.............................................. 13,881(4) *
Paul A. Gould............................................... 126,038(5) *
Kevin P. Hanley............................................. 19,773(6) *
Donald J. Landry............................................ 252,103(7) *
James A. MacCutcheon........................................ 188,393(8) *
Frederic V. Malek........................................... 7,938(9) *
Keith B. Pitts.............................................. 5,318(10) *
Carole Y. Prest............................................. 8,485(11) *
Christine A. Shreve......................................... 5,782(12) *
All Directors and Officers as a Group (12 persons).......... 7,126,943(13) 36.35%
Barbara Bainum.............................................. 1,925,585(14) 9.82%
Bruce Bainum................................................ 1,922,434(15) 9.81%
Stewart Bainum.............................................. 3,484,597(16) 17.77%
Ronald Baron................................................ 5,870,140(17) 29.94%
</TABLE>
___________________________________
*Less than 1% of class.
(1) Percentages are based on 19,606,006 shares outstanding on December 31, 1998
(the "Record Date") plus, for each person, the shares which would be issued
assuming that such person exercises all options it holds which are
exercisable on such date or become exercisable within 60 days thereafter.
54
<PAGE>
(2) Includes 183,051 shares owned directly by the Stewart Bainum, Jr.
Declaration of Trust dated March 13, 1996, the sole trustee and beneficiary
of which is the reporting person. Also includes 1,805,920 shares owned by
Bainum Associates Limited Partnership ("Bainum Associates") and 1,471,750
shares owned by MC Investments Limited Partnership ("MC Investments"), in
both of which Mr. Bainum, Jr. is managing general partner with the sole
right to dispose of the shares; 1,189,290 shares held directly by Realty
Investment Company, Inc. ("Realty"), a real estate management and
investment company in which Mr. Bainum, Jr. has shared voting authority;
593,209 shares owned by Mid Pines Associates Limited Partnership ("Mid
Pines"), in which Mr. Bainum, Jr. is managing general partner and has
shared voting authority and 3,533 shares owned by the Foundation for
Maryland's Future, in which Mr. Bainum, Jr. is the sole director. Also
includes 83,889 shares which Mr. Bainum, Jr. has the right to acquire
pursuant to stock options which are presently exercisable or which become
exercisable within 60 days after the Record Date, and 49 shares which Mr.
Bainum, Jr. has the right to receive upon termination of his employment
with Sunburst pursuant to the terms of the Non-Qualified Retirement Savings
and Investment Plan ("Non- Qualified Savings Plan").
(3) Includes 3,561 shares held directly by Mr. DiRico and 3,779 shares and
11,919 shares, respectively, which Mr. DiRico has the right to receive upon
termination of his employment pursuant to the terms of the Retirement
Savings and Investment Plan ("401(k) Plan") and Non-Qualified Savings and
Investment Plan ("Non-Qualified Plan'). Also includes 66,595 shares, which
Mr. DiRico has the right to acquire pursuant to stock options which are
currently exercisable or become exercisable upon 60 days of the Record
Date.
(4) Includes 2,406 held directly by Mr. Miller and 164 and 572 shares,
respectively, which Mr. Miller has the right to receive upon termination of
his employment pursuant to the terms of the 401(k) Plan and Non-Qualified
Plan. Also includes 10,739 shares which Mr. Miller has the right to
acquire pursuant to stock options which are currently exercisable or become
exercisable upon 60 days of the Record Date.
(5) Includes 124,079 shares held directly by Mr. Gould, 4132 shares of
restricted stock granted under the Non-Employee Director Stock Compensation
Plan to Mr. Gould which are not vested but which Mr. Gould has the right to
vote and 1,959 shares which Mr. Gould has a right to acquire pursuant to
stock options which are presently exercisable or become exercisable within
60 days of the Record Date.
(6) Includes 4,066 shares held directly by Mr. Hanley and 15,707 shares Mr.
Hanley has the right to acquire pursuant to stock options which are
presently exercisable or which become exercisable within 60 days after the
Record Date.
(7) Includes 18,498 shares owned directly by Mr. Landry and 233,605 shares Mr.
Landry has the right to acquire pursuant to stock options which are
presently exercisable or which become exercisable within 60 days after the
Record Date.
(8) Includes 5,000 shares owned directly by Mr. MacCutcheon and 659 and 1,167
shares, respectively, which Mr. MacCutcheon has the right to receive upon
termination of his employment pursuant to the 401(k) and Non-Qualified
Plan. Also includes 100 shares held by minor children. Beneficial
ownership of such shares is disclaimed. Also includes 181,567 shares Mr.
MacCutcheon has the right to acquire pursuant to stock options which are
presently exercisable or which become exercisable within 60 days after the
Record Date.
(9) Includes 1,162 shares held directly by Mr. Malek, 2,555 shares which Mr.
Malek has the right to acquire pursuant to stock options which are
presently exercisable or become exercisable within 60 days of the Record
Date and 4,221 restricted shares granted under the Non-Employer Director
Stock Compensation Plan which are not vested, but which Mr. Malek has the
right to vote.
(10) Consists of 5,318 restricted shares granted under the Non-Employer Director
Stock Compensation Plan which are not vested, but which Mr. Pitts has the
right to vote.
(11) Includes 5,457 restricted shares granted under the Non-Employer Director
Stock Compensation Plan which are not vested, but which Ms. Prest has the
right to
55
<PAGE>
vote. Also includes 3,028 shares Ms. Prest has the right to acquire
pursuant to stock options which are presently exercisable or which become
exercisable within 60 days after the Record Date.
(12) Includes 1,600 shares held directly by Ms. Shreve and 4,182 restricted
shares granted under the Non-Employer Director Stock Compensation Plan
which are not vested, but which Ms. Shreve has the right to vote.
(13) Includes a total of 599,644 shares which the officers and directors
included in the group have the right to acquire pursuant to stock options
which are presently exercisable, or exercisable within 60 days of the
Record Date, and a total of 4,602 shares and 13,707 shares, respectively,
which such directors and officers have the right to receive upon
termination of their employment with Sunburst pursuant to the terms of the
401(k) Plan and the Non-Qualified Savings Plan.
(14) Includes 34,236 shares held directly by Ms. Bainum and 415 restricted
shares granted under the Non-Employer Director Stock Compensation Plan
which are not vested, but which Ms. Bainum has the right to vote. Also
includes 593,209 shares owned by Mid Pines, in which Ms. Bainum is a
general partner and has shared voting authority, 1,189,290 shares owned by
Realty in which Ms. Bainum's trust has voting stock and shared voting
authority 85,000 shares owned by Vintage LP in which Ms. Bainum is a
shareholder and director of the corporate general partner and has share
voting authority, and 23,435 shares owned by Commonweal Foundation, in
which Ms. Bainum is a Director and has shared voting authority. Ms.
Bainum's address is 8737 Colesville Road, Suite 800, Silver Spring,
Maryland, 20910.
(15) Includes 31,500 shares held directly by Mr. Bainum . Also includes 593,209
shares owned by Mid Pines, in which Ms. Bainum is a general partner and has
shared voting authority, 1,189,290 shares owned by Realty in which Mr.
Bainum's trust has voting stock and shared voting authority, 85,000 shares
owned by Vintage LP in which Mr. Bainum is a shareholder and director of
the corporate general partner and has shared voting authority, and 23,435
shares owned by Commonweal Foundation, in which Mr. Bainum is a Director
and has shared voting authority. Mr. Bainum's address is 8737 Colesville
Road, Suite 800, Silver Spring, Maryland, 20910.
(16) Includes 1,303,010 shares held directly by the Stewart Bainum Declaration
of Trust, of which Mr. Bainum is the sole trustee and beneficiary, his
interest in 312,308 shares owned by Bainum Associates and 387,803 shares
owned by MC Investments, each of which is a limited partnership in which
Mr. Bainum has ownership as a limited partner and as such has the right to
acquire at any time a number of shares equal in value to the liquidation
preference of his limited partnership interests; 1,189,290 shares held
directly by Realty, in which Mr. Bainum and his wife have shared voting
authority; and 23,435 shares held by the Commonweal Foundation of which Mr.
Bainum is Chairman of the Board of Directors and has shared voting
authority. Also includes 266,237 shares held by the Jane L. Bainum
Declaration of Trust, the sole trustee and beneficiary of which is Mr.
Bainum's wife, and 2,000 shares which Mr. Bainum has the right to acquire
pursuant to stock options which are presently exercisable or which become
exercisable within 60 days after the Record Date. Also includes 514 shares
of restricted stock granted under the Company's Non-Employee Director Stock
Compensation Plan ("Non-Employee Director Stock Compensation Plan") to Mr.
Bainum which are not vested but which Mr. Bainum has the right to vote.
(17) As of October 16, 1997 based on a Schedule 13-D, as amended, filed by Mr.
Baron with the Securities and Exchange Commission (the "Commission"). Mr.
Baron's address is 450 Park Avenue, Suite 2800, New York, New York 10022.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
RELATIONSHIP WITH MANOR CARE
Stewart Bainum, Jr. is the Chairman of the Company's Board of Directors and of
HCR Manor Care's Board of Directors.
56
<PAGE>
at which the Company's principal executive offices were located (the "Silver
Spring Lease"). After the Spin-off, the Company remained obligated under the
Silver Spring Lease and had subleased space at 10750 Columbia Pike to Choice
Hotels International, Inc. ("Choice") pursuant to a sublease. In June 1998,
Manor Care sold the Silver Spring Complex and the Company enter into a new lease
with the new owner. The sublease was terminated.
The Company and Manor Care also entered into (i) a sublease agreement with
respect to certain office space in Gaithersburg, Maryland (the "Gaithersburg
Lease") pursuant to which the Company was obligated to rent from Manor Care,
certain additional space as such space became available during the 30 month
period following the date of the Manor Care Spin-off. The Gaithersburg lease
was terminated in February 1999. In addition, at the time of the Manor Care
spin-off, the parties entered into a sublease agreement with respect to the
Comfort Inn N.W., Pikesville, Maryland, pursuant to which the Company subleases
the property from Manor Care on the same terms and conditions that govern Manor
Care's rights and interests under the lease relating to such property.
During the twelve month period ended December 31, 1998, the Company paid to
Manor Care under the Gaithersburg Lease and the Silver Spring Lease
approximately $1.3 million.
CORPORATE SERVICES AGREEMENT
The Company and Manor Care entered into the Corporate Services Agreement (the
"Corporate Services Agreement") which provides for the provision, by Manor Care,
of certain corporate services, including administrative, accounting, systems
and, for a fixed annual fee of $1.0 million, certain consulting services. The
term of the Consulting Services Agreement is 30 months from November 1, 1996.
The Company terminated all services except the consulting services under the
Corporate Service Agreement in the first quarter of 1998. In February 1999,
this Company entered into a release with Manor Care which effectively terminated
the consulting services payment obligation.
TIME SHARING AGREEMENT
On October 10, 1996, the Company entered into a Time Sharing Agreement with
Manor Care under which the Company had the right to use from time to time a
Cessna Citation III and a Cessna Conquest I owned by Manor Care. The agreement
had a term of one year with automatic renewals unless otherwise terminated. In
January 1998, Manor Care gave notice that it was terminating the Time Share
Agreement. During 1998, there were no charges for aircraft usage pursuant to
the agreement.
RELATIONSHIP WITH CHOICE
In connection with the Choice Spin-off, the Company and Choice entered into
certain agreements intended to govern the relationship between the parties after
the Choice Spin-off. In addition, the Company is Choice's largest franchisee.
The material terms of certain of these agreements and other arrangements,
entered into between the Company and Choice, including the franchise agreements
with respect to the Company's hotels, are described below.
DISTRIBUTION AGREEMENT
In connection with the Choice Spin-off, the Company and Choice entered into a
Distribution Agreement which provided for, among other things, the principal
corporate transactions required to effect the Choice Spin-off, the assumption by
Choice of all liabilities relating to its business and the allocation between
the Company and Choice of certain other liabilities, certain indemnification
obligations of the Company and Choice and certain other agreements governing the
relationship between the Company and Choice with respect to or in consequence of
the Choice Spin-off.
Subject to certain exceptions, Choice has agreed to indemnify the Company and
its subsidiaries against any loss, liability or expense incurred or suffered by
the Company or its subsidiaries arising out of or related to the failure by
Choice to perform or otherwise discharge liabilities allocated to and assumed by
Choice under the Distribution Agreement, and the Company has agreed to indemnify
Choice against any loss, liability or expense incurred or suffered by Choice
arising out of or related to the failure by the Company to perform or otherwise
discharge the
57
<PAGE>
liabilities retained by the Company under the Distribution Agreement. The
foregoing cross-indemnities do not apply to indemnification for tax claims and
liabilities, which are addressed in the Tax Sharing Agreement described below.
To avoid adversely affecting the intended tax consequences of the Choice Spin-
off, each of Choice and the Company will agree to comply in all material
respects with each representation and statement made to any taxing authority in
connection with the IRS tax ruling or any other tax ruling obtained by Choice
and the Company in connection with the Choice Spin-off.
Under the Distribution Agreement, each of Choice and the Company will be granted
access to certain records and information in the possession of the other, and
requires the retention of such information in its possession for specified
periods and thereafter requires that each party give the other prior notice of
its intention to dispose of such information. In addition, the Distribution
Agreement provides for the allocation of shared privileges with respect to
certain information and requires each of Choice and the Company to obtain the
consent of the other prior to waiving any shared privilege.
In accordance with the Distribution Agreement, Choice agreed to assume and pay
certain liabilities of the Company, subject to Choice maintaining a minimum net
worth of $40 million, at the date of the Choice Spin-off. As of December 31,
1997, the Company reflected a $25 million receivable due to Choice on its
consolidated balance sheet. In 1998, net payments of approximately $8 million
were paid in cash to Choice. On December 28, 1998, the Company and Choice
amended the Strategic Alliance Agreement (defined below). As part of that
amendment, Choice exchanged the remaining $17 million balance in return for,
among other things, the termination of the Company's option for the exclusive
rights to the MainStay Suites brand and a commitment to build a total of 25
MainStay Suites.
STRATEGIC ALLIANCE AGREEMENT
At the time of the Choice Spin-off, Choice and the Company entered into a
Strategic Alliance Agreement pursuant to which: (i) the Company granted a right
of first refusal to Choice to franchise any lodging property that the Company
develops or acquires and intends to operate under franchise; (ii) the Company
has also agreed, barring a material change in market conditions, to continue to
develop Sleep Inns and MainStay Suites hotels so that it will have opened a
total of 14 Sleep Inns and 15 MainStay Suites hotels by October 15, 2001 (48
months of the Distribution Date); (iii) Choice has granted to the Company an
option, exercisable under certain circumstances, to purchase the brand names,
marks, franchise agreements and other assets of the MainStay Suites hotel
system; (iv) Choice and the Company have agreed to continue to cooperate with
respect to matters of mutual interest, including new product and concept testing
for Choice in hotels owned by the Company; and (v) the Company has authorized
Choice to negotiate with third party vendors on the Company's behalf for the
purchase of certain items. The Strategic Alliance Agreement extends for a term
of 20 years with rights of mutual termination on the fifth, tenth and fifteenth
anniversaries.
On December 28, 1998, Choice and the Company amended the Strategic Alliance
Agreement to: (i) cancel the Company's option to acquire the MainStay Suites
system; (ii) eliminate liquidated damages with respect to franchise agreements
entered into before December 12, 1998 (except for MainStay Suites and Sleep Inn
franchise agreements); (iii) cap liquidated damages for MainStay Suites and
Sleep Inn franchise agreements; (iv) change the Company's development
obligations to 13 Sleep Inns and 25 MainStay Suites by October 15, 2001; and (v)
provide certain other global amendments to the Company's franchise agreements.
AMENDMENT AND GUARANTY
In connection with the Choice Spin-off, Choice entered into the Amendment and
Guaranty for the purpose of adding Choice as a party to certain agreements
entered into between Former Choice and Manor Care in connection with the Manor
Care Spin-off and adding Choice as a guarantor of certain payment obligations of
the Company to Manor Care pursuant to agreements between Former Choice and Manor
Care. For a discussion of the Amendment and Guaranty, see "Certain
Relationships and Related Transactions--Relationship with Manor Care" and "--
Lease Agreements."
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<PAGE>
TERM NOTE
In connection with the Choice Spin-off, Choice loaned to the Company
approximately $115 million which was used by the Company to repay approximately
$96 million outstanding under Former Choice's credit facility and to repay that
portion of the Former Choice indebtedness under Note allocated to the Company in
connection with the Spin-off (approximately $37 million).
This loan is represented by a Term Note in an aggregate principal amount of $115
million (the "Term Note"). The Term Note has a maturity of five years and
accrues interest at a rate equal to 500 basis points above the interest rate on
a 5-year U.S. Treasury Note. The Term Note is subordinated to all senior debt
of the Company and contains certain restrictive covenants comparable to those
contained in the Company's senior credit facility (including restrictions on the
Company's ability to make certain investments, incur debt, pay dividends,
dispose of assets and create liens on its assets).
CORPORATE SERVICES AGREEMENT
The Company and Choice entered into a Corporate Service Agreement which provides
that Choice will provide to the Company certain corporate support services,
including human resources, accounting, tax and computer systems support, and the
Company will provide to Choice certain services including asset management and
accounts payable processing. As of March 31, 1999, all services provided by
either party under the Corporate Services Agreement, except for human resources
and tax services provided by Choice, will be terminated. During fiscal year
1998, Choice paid the Company $168,660 and the Company paid Choice $1,664,750
for services under the Corporate Services Agreement.
CONSULTING AGREEMENT
The Company and Choice entered into a Consulting Agreement in which the Company
will provide consulting and advisory services to Choice related to financial
issues affecting Choice. The term of the agreement commences October 15, 1997
and terminated on November 1, 2001. The Company is entitled to an annual
retainer fee equal to 30% of the annual compensation (including base salary,
incentive bonus and fringe benefits) paid to James A. MacCutcheon by the Company
during such period. If Mr. MacCutcheon ceases to be employed by the Company,
the agreement can be terminated by either party, but if terminated by Choice,
then Choice shall pay the Company a termination fee equal to 30% of any amount
due by the Company to Mr. MacCutcheon under his employment agreement as a result
of his separation. During fiscal year 1998, Choice paid the Company $116,268
pursuant to the Consulting Agreement.
TAX SHARING AGREEMENT
Choice and the Company have entered into a Tax Sharing Agreement for purposes of
allocating tax liabilities of Former Choice from before the Choice Spin-off
among Choice and the Company and their respective subsidiaries. In general, the
Company will be responsible for (i) filing consolidated federal income tax
returns for the Company affiliated group and combined or consolidated state tax
returns for any group that includes a member of the Company affiliated group,
including in each case Choice and its subsidiaries for the periods of time that
such companies were members of the applicable group and (ii) paying the taxes
relating to such tax returns to the applicable taxing authorities (including any
subsequent adjustments resulting from the redetermination of such tax
liabilities by the applicable taxing authorities). Choice will reimburse the
Company for the portion of such taxes that relates to Choice and its
subsidiaries, as determined based on their hypothetical separate company income
tax liabilities. Choice 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.
EMPLOYEE BENEFITS ALLOCATION AGREEMENT
In connection with the Choice Spin-off, Choice and the Company entered into an
Employee Benefits and Other Employment Matters Allocation Agreement (the
"Employee Benefits Allocation Agreement"). The Employee Benefits Allocation
Agreement provides for the allocation subsequent to Choice Spin-off of employee
benefits, as
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<PAGE>
they relate to employees who remained employed by the Company or its
subsidiaries ("Sunburst Employees") after the Spin-off and employees who are
employed by Choice or its subsidiaries after the Spin-off ("Choice Employees").
Pursuant to the Employee Benefits Allocation Agreement, the Company will
continue sponsorship of the various Sunburst profit sharing plans, stock plans
and health and welfare plans with respect to Sunburst Employees. Choice has
established a number of plans which allow it to provide to its employees
substantially the same benefits currently provided to them as employees of the
Company. The Employee Benefits Allocation Agreement provides for cross-
guarantees between Choice and the Company with respect to the payment of
benefits under certain plans and for cross-indemnification with respect to
employment-related claim relating to prior to the Choice Spin-off.
The Employee Benefits Allocation Agreement also provided for the adjustment of
outstanding options to purchase shares of Sunburst common stock held by Sunburst
Employees, Choice Employees and employees of Manor Care who held such options as
a result of the Manor Care Spin-off.
TRANSITIONAL SERVICE AGREEMENTS
Choice and the Company have entered into a number of agreements pursuant to
which Choice provides, or will provide, certain continuing services to the
Company for a transitional period. Such services will be provided on market
terms and conditions. Subject to the termination provisions of the specific
agreements, the Company will be free to procure such services from outside
vendors or may develop an in-house capability in order to provide such services
internally. The primary transitional services agreements are summarized below.
Pursuant to the Employee Benefits Administration Agreement, Choice provides
certain benefits, compensation and other services. Such other services may
include benefit plan administration and accounting, COBRA administration,
regulatory compliance and certain fiduciary services. Pursuant to the Tax
Administration Agreement, Choice provides certain sales, use, occupancy, real
and personal property tax return administration, audit and appeals services for
the Company.
FRANCHISE AGREEMENTS
The Clarion, Comfort, Econo Lodge, Sleep Inn, Quality, MainStay Suites and
Rodeway marks are each owned by Choice. Each hotel property owned by the Company
is subject to a franchise agreement between Choice and the Company, as
franchisee (the "Franchise Agreements"). (The material terms of such agreements
are described below.) Total fees paid to Choice for franchising, royalty,
marketing and reservation fees for fiscal year 1998 were $11.2 million.
TERM
Each Franchise Agreement has an initial term of 20 years, except the agreement
for Tempe, Arizona which is a year to year agreement. The Franchise Agreements
have varying original dates, from 1982 through 1996. Certain Franchise
Agreements allow for unilateral termination by either party on the 5th, 10th, or
15th anniversary of the Franchise Agreement. In addition, all franchise
agreements allow for early termination by Sunburst, subject to liquidated damage
provisions which range from zero dollars to a maximum of $100,000 per property.
TERMINATION BY SUNBURST
The Company (except with respect to one property as described below) may
terminate a Franchise Agreement if Choice defaults on its material obligations
under such Franchise Agreement and fails to cure such defaults within 30 days
following written notice. The Franchise Agreement with respect to the Quality
Hotel--Arlington (the "Non-Standard Franchise Agreement") does not allow such a
termination.
TERMINATION BY CHOICE
Choice (except with respect to the Non-Standard Franchise Agreement) may suspend
or terminate a Franchise Agreement at any time, if, among other things, the
Company (a) fails to submit reports when due; (b) fails to pay amounts due under
such Franchise Agreement; (c) fails to pay its debts generally as they become
due; or (d) receives
60
<PAGE>
two or more notices of default for similar reasons for any 12 month period.
Choice (except with respect to the Non-Standard Franchise Agreement) may
terminate a Franchise Agreement immediately upon notice to the Company if, among
other things, (a) certain bankruptcy events occur with respect to the Company;
(b) the Company loses possession or the right to possession of the Property; (c)
the Company breaches transfer restrictions in the related Franchise Agreement;
(d) any action is taken to dissolve or liquidate the Company; or (e) there is a
threat or danger to the public health and safety in the continued operation of
the Property.
The Non-Standard Franchise Agreement has termination provisions similar to those
in the other Franchise Agreements. Choice may terminate the Non-Standard
Franchise Agreement immediately upon notice to the Company if, among other
things, (a) certain bankruptcy events occur with respect to the Company; (b)
certain breaches of the related agreements are not remedied; (c) any action is
taken to dissolve or liquidate the Company; or (d) legal proceedings against the
Company are not dismissed within a certain period of time. Upon termination, the
Franchise Agreement for the Rodeway Inn-Phoenix (Tempe) calls for Special
Interest of the greater of (i) $50,000 and (ii) the sum of the previous two
years of fees paid by the licensee.
FEES
The Franchise Agreements require the payment of certain fees and charges,
including the following: (a) a royalty fee of between 1.93% to 5.0% of monthly
gross room revenues; (b) a marketing fee of between 0.7% and 2.5% plus $0.28 per
day multiplied by the specified room count; and (c) a reservation fee of 0.88%
to 1.75% of monthly gross room revenues (or 1% of monthly gross room revenues
plus $1.00 per room confirmed through Choice's reservation system). The
marketing fee and the reservation fee are subject to reasonable increases during
the term of the franchise if Choice raises such fees uniformly among all its
franchisees, generally. Late payments (i) will be a breach of the Franchise
Agreement and (ii) will accrue interest from the date of delinquency at a rate
of 1.5% per month or portion thereof.
In December 1998, the Company and Choice entered into an amendment which
provided that (i) the Company shall pay an application fee of $20,000 on all
future MainStay Suites franchise agreements, and (ii) no royalties, marketing or
reservation fees shall be payable for a period of two years for the next ten
MainStay Suites franchise agreements entered into after the amendment.
CERTAIN COVENANTS
The Franchise Agreements impose certain affirmative obligations upon Choice
including: (a) to lend the Franchisee an operations manual; (b) to utilize money
collected from marketing and reservation fees to promote those aspects of the
franchise business; and (c) to periodically inspect the Property. The Franchise
Agreements also impose affirmative obligations upon the Company including: (a)
to participate in a specified reservation system; (b) to keep and comply with
the up-to-date version of Choice's rules and regulations for properly running
the specified franchise; (c) to prepare monthly financial and other records; (d)
to not interfere with the franchised mark(s) and Choice's rights thereto; and
(e) to maintain certain specified insurance policies.
ASSIGNMENTS
The Company is prohibited from directly or indirectly selling, assigning,
transferring, conveying, pledging or mortgaging its interest in the Franchise
Agreement, or any equity interest in such franchise interests without the
consent of Choice except that, among other things, certain percentages of
ownership interests in the Company may be transferred without Choice's consent.
Choice's consent to such transfers, will not be given unless, among other
things: (a) all monetary obligations due under the Franchise Agreement are paid
to Choice; (b) no defaults under the Franchise Agreement remain uncured; (c) the
transferee agrees in writing to upgrade the related Property to the then-current
standards; and (d) the transferee agrees to remain liable for all obligations
under the Franchise Agreement so transferred.
Choice is permitted to assign all or any part of its rights or obligations under
the Franchise Agreements. However, the Franchise Agreements (with the exception
of the Non-Standard Franchise Agreement) do not permit Choice to absolve itself
from the obligations that it transfers under the Franchise Agreement. Upon the
assignment of Choice's
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<PAGE>
obligations under the Non-Standard Franchise Agreement, Choice will no longer be
liable with respect to the obligations it so transfers.
NONCOMPETITION AGREEMENT
Choice and the Company have entered into a non-competition agreement that
defines the rights and obligations with respect to certain businesses to be
operated by Choice and the Company. Under the non-competition agreement, for a
period of five years from the date of the Spin-off, subject to the exceptions
set forth below, the Company will be prohibited from conducting any business
that competes with the business operated by Former Choice transferred to Choice
as part of the Spin-off ("the Choice Business"). The Company will also be
prohibited from acquiring any entity conducting a business that competes with
the Choice Business, with certain exceptions outlined below, unless, prior to
such acquisition, the Company offers to sell such competing business to Choice
on substantially the same terms and conditions; provided, however, that the
Company will not be required to make such an offer to Choice where the competing
business is not readily divisible from other businesses permitted to be held or
acquired by the Company and the gross sales from such competing business for the
12 months prior to such acquisition do not exceed the greater of $1,000,000 (as
adjusted for increases to the Consumer Price Index during the term) or 5% of
gross sales of the businesses to be acquired. Subject to the foregoing, however,
the non-competition agreement does not prohibit the Company from engaging in the
following activities: (i) the continued operation and development of any
business operated as of the date of the Spin-off by the Company and retained by
the Company; (ii) any activities otherwise permitted under the Strategic
Alliance Agreement; (iii) the ownership of up to 5% of the equity interests of a
publicly-traded entity that competes with Choice's business; and (iv) the
ownership of equity interests of any entity that competes with Choice's
business, if (A) the competing business does not comprise such entity's primary
business, (B) the gross sales of such entity for the prior 12 months
attributable to such competing business does not exceed 20% of such entity's
consolidated gross sales, and (C) neither the fair market value of, nor the
value, if any, attributed by the acquisition agreement to, the competing
business is in excess of $5,000,000 (as adjusted for increases to the Consumer
Price Index during the term).
During the term of the non-competition agreement, subject to the exceptions set
forth below, Choice will be prohibited from conducting any business that
competes with the business operated by the Company and retained by Company in
the Spin-off (the "Hotel Business"). Choice is also prohibited from acquiring
any entity conducting a business that competes with the Hotel Business, with
certain exceptions outlined below, unless, prior to such acquisition, Choice
offers to sell such competing business to the Company on substantially the same
terms and conditions; provided, however, that Choice will not be required to
make such an offer to the Company where the competing business is not readily
divisible from other business permitted to be held or acquired by Choice and the
gross revenues from such competing business for the 12 months prior to such
acquisition do not exceed the greater of $1,000,000 (as adjusted for increases
to the Consumer Price Index during the term) or 5% of gross sales of the
businesses to be acquired. Subject to the foregoing, however, the non-
competition agreement will not prohibit Choice from the following activities:
(i) continued operation and development of any business operated as of the date
of the Spin-off by Choice, (ii) any activities otherwise permitted under the
Strategic Alliance Agreement, (iii) the ownership of up to 5% of the equity
interests of a publicly-traded entity that competes with the Hotel Business,
(iv) the ownership of equity interests of any entity that competes with the
Hotel Business, if (A) the competing business does not comprise such entity's
primary business, (B) the gross revenue of such entity for the prior 12 months
attributable to such competing business does not exceed 20% of such entity's
consolidated gross sales, and (C) neither the fair market value of, nor the
value, if any, attributed by the acquisition agreement to, the competing
business is in excess of $5,000,000 (as adjusted for increases to the Consumer
Price Index during the term).
POTENTIAL CONFLICT
The ongoing relationship between Choice and the Company resulting from the
agreements and arrangements described above may potentially give rise to
conflict of interest between Choice and the Company. With respect to the
agreements between the parties, the potential exists for disagreements as to the
quality of the services provided by the parties and as to contract compliance.
Nevertheless, the Company believes that there will be sufficient mutuality of
interest between the two companies to result in a mutually productive
relationship.
Stewart Bainum Jr. serves as Chairman of the Boards of Directors of both the
Company and Choice. Frederick V. Malek serves as a director of each of the
Company and Choice. As a result of the Choice Spin-off, Messrs. Bainum,
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Jr. and Malek, as well as certain other officers and directors of the
Company and Choice, also own shares and/or options or other right to
acquire shares in each of the Company and Choice. Appropriate polices and
procedures are followed by the Board of Directors of Choice and the Company
to limit the involvement of the overlapping directors (and, if appropriate,
relevant officers of such companies) in conflict situations, including
requiring them to abstain from voting as directors of either Choice or the
Company on certain matters which present a conflict between the two
companies.
OTHER RELATIONSHIPS
During the twelve months ended December 31, 1998, the Company paid to Allen
& Company Incorporated a total of $12,350 in brokerage commissions in
connection with the repurchase of Company common stock by the Company. Paul
A. Gould, a director of the Company, is a Managing Director of Allen &
Company.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
1. FINANCIAL STATEMENTS
The Consolidated Financial Statements filed with this Form 10-K
are listed in Item 8 above.
2. FINANCIAL STATEMENT SCHEDULES
<TABLE>
<S> <C>
The following reports are filed herewith on the pages indicated:
Schedule I: Condensed Financial Information......................... p.
Schedule III: Real Estate and Accumulated Depreciation.............. p.
All other schedules are not applicable.
</TABLE>
3. EXHIBITS
3.01 Restated Certificate of Incorporation of the Registrant*
3.02 Amendments to Restated Certificate of Incorporation
3.03 By-laws of the Registrant*
4.01 Common Stock certificate*
4.02 Competitive Advance and Multi-Company Credit Facility Agreement
between the Registrant and Chase Manhattan Bank dated October 15,
1997
4.03 Subordinated Note due October 15, 2002 by the Registrant payable to
Choice Hotels International, Inc.***
4.05 Promissory Note dated April 22, 1997 by First Choice Properties Corp.
in favor of QI Capital Corp. in the principal amount of
$117,500,000****
4.06 Loan Agreement dated as of April 22, 1997 by and between First Choice
Properties Corp. and QI Capital Corp.****
10.01 Distribution Agreement, dated October 31, 1996, between Manor Care,
Inc. and the Registrant*
10.02 Corporate Services Agreement between Manor Care, Inc. and the
Registrant*
10.03 Office Lease between Manor Care, Inc. and the Registrant*
10.04 Office Lease between Manor Care, Inc. and the Registrant*
10.05 Strategic Alliance Agreement dated as of October 15, 1997 by and
between the Registrant and Choice Hotels Franchising, Inc. (renamed
Choice Hotels International, Inc.)**
10.06 Non-Competition Agreement dated as of October 15, 1997 by and between
the Registrant and Choice Hotels Franchising, Inc. (renamed Choice
Hotels International, Inc.)**
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<PAGE>
10.07 Amended and Restated Agreement dated as of October 15, 1997 by and
between the Registrant and Stewart A, Jr.**
10.08 Employment Agreement between the Registrant and James A.
MacCutcheon*
10.09 Supplemental Executive Retirement Plan*
10.10 Non-Employee Director Stock Option and Deferred Compensation Stock
Purchase Plan*
10.11 1996 Non-Employee Director Stock Compensation Plan*
10.12 1996 Long-Term Incentive Plan*
10.13 A Sublease between Manor Care, Inc. and the Registrant*
10.14 Employee Benefits and Other Employment Matters Allocation Agreement
between Manor Care, Inc. and the Registrant*
10.15 Distribution Agreement dated as of October 15, 1997 by and between
Registrant and Choice Hotels Franchising, Inc. (renamed Choice
Hotels International, Inc.)**
10.16 Employee Benefits Allocation Agreement dated as of October 15, 1997
by and between the Registrant and Choice Hotels Franchising, Inc.
(renamed Choice Hotels International, Inc.**
10.17 Employee Benefits Administration Agreement dated as of October 15,
1997 by and between the Registrant and Choice Hotels Franchising,
Inc. (renamed Choice Hotels International, Inc.)**
10.18 Tax Administration Agreement dated as of October 15, 1997 by and
between the Registrant and Choice Hotels Franchising, Inc. (renamed
Choice Hotels International, Inc.)
10.19 Tax Sharing Agreement dated as of October 15, 1997 by and between
the Registrant and Choice Hotels Franchising, Inc. (renamed Choice
Hotels International, Inc.)**
10.20 Office Sublease dated as of October 15, 1997 by and between the
Registrant and Choice Hotels Franchising, Inc. (renamed Choice
Hotels International, Inc.)**
10.21 Corporate Services Agreement dated as of October 15, 1997 by and
between the Registrant and Choice Hotels Franchising, Inc. (renamed
Choice Hotels International, Inc.)**
10.22 Omnibus Agreement and Guaranty dated as of October 15, 1997 by and
among the Registrant, Choice Hotels Franchising, Inc. (renamed
Choice Hotels International, Inc.) and Manor Care, Inc.**
10.23 The Rights Agreement dated February 23, 1998 by and between the
Registrant and Chase Mellon Shareholder Services, L.L.C., as Rights
Agents*****
10.24 Omnibus Amendment Agreement dated as of December 29, 1998 by and
among Registrant and Choice Hotels International, Inc.******
21.01 Subsidiaries of the Registrant
27.01 Financial Data Schedule
99.01 Proxy Statement dated March 23, 1998 (information incorporated by
reference)
__________________
* Incorporated by reference to the Company's Registration Statement on Form
10, File No. 001-11915.
** Incorporated by reference to the Company's 8-K dated October 15, 1997,
filed October 29, 1997.
*** Incorporated by reference to the Company's 8-K dated October 15, 1997,
filed December 17, 1997.
**** Incorporated by reference to the Company's Registration Form 10-K for the
fiscal year ended May 31, 1997, filed August 15, 1997.
***** Incorporated by reference to Company's 8-K dated February 23, 1998, filed
March 11, 1998.
****** Incorporated by reference to Company's 8-K dated December 29, 1998, filed
December 31, 1998.
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<PAGE>
(b) One report on Form 8-K was filed during the last quarter of the fiscal year
ended December 31, 1998.
Form 8-K, dated December 29, 1998 and filed December 31, 1998 reporting that the
Company and Choice entered into an Omnibus Amendment Agreement (the "OAA") which
(i) resolved matters relating to a debt of $19.9 million owed by the Company to
Choice; (ii) eliminated the Company's option to acquire the MainStay Suites
brand from Choice; (iii) limited the Company's liability for terminating Choice
franchise agreements in the event of the sale or rebranding of a Company hotel;
and (iv) committed the Company to open 25 MainStay Suites hotels by October
2001.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: March 29, 1999 SUNBURST HOSPITALITY CORPORATION
--
By:________________________________
James A. MacCutcheon
Executive Vice President,
Chief Financial Officer
and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
____________________________
Stewart Bainum, Jr. Chairman March 29, 1999
--
Vice Chairman and March 29, 1999
____________________________ Chief Executive Officer --
Donald J. Landry
Director March 29, 1999
____________________________ --
Paul A. Gould
Director March 29, 1999
____________________________ --
Frederic V. Malek
Director March 29, 1999
____________________________ --
Keith B. Pitts
Director March 29, 1999
____________________________ --
Carole Y. Prest
Director March 29, 1999
____________________________ --
Christine A. Shreve
Vice President- March 29, 1999
____________________________ Accounting and Hotel --
Charles M. Warczak, Jr. Systems (Chief
Accounting Officer)
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<PAGE>
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
reports included in this Form 10-K, into the Company's previously filed
Registration Statements File No. 333-14203, No.333-15661, No. 333-17577 and No.
333-17575.
Arthur Andersen LLP
Washington, D.C.
March 26, 1999
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<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT PAGE 1 OF 4
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
As of
--------------------------------------
December 31, December 31,
1998 1997
---------------- ----------------
ASSETS
<S> <C> <C>
Real estate, net $253,812 $225,893
Real estate held for sale 7,698 -
Receivables, net 4,620 3,896
Net investment in restricted subsidiaries 31,342 35,439
Other assets 4,914 6,664
Cash and cash equivalents 3,576 4,348
---------------- ----------------
TOTAL ASSETS $305,962 $276,240
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Debt $170,292 $132,304
Accounts payable and accrued expenses 26,981 52,202
Other liabilities 6,052 2,427
---------------- ----------------
Total liabilities 203,325 186,933
STOCKHOLDERS' EQUITY
Total stockholders' equity 102,637 89,307
--------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $305,962 $276,240
================ ================
</TABLE>
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT PAGE 2 OF 4
STATEMENTS OF INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
For the year For the seven
ended months ended For the fiscal year ended May 31,
December 31, December 31, -----------------------------------
1998 1997 1997 1996
------------------- --------------- --------------- -----------------
<S> <C> <C> <C> <C>
Revenues $104,494 $55,487 $87,262 $ 62,467
Operating expenses 82,480 44,506 69,780 56,336
Provision for asset impairment and other
non-recurring charges 4,264 5,119 - 24,595
Depreciation and amortization 17,118 8,561 10,988 7,562
Interest expense 11,549 4,580 6,484 3,211
------------------- --------------- --------------- -----------------
Total expenses 115,411 62,766 87,252 91,704
------------------- --------------- --------------- -----------------
Income before income taxes and equity
in earnings of restricted subsidiaries (10,917) (7,279) 10 (29,237)
Equity in earnings of restricted 17,168 6,951 11,830 7,363
subsidiaries
Income tax (benefit) expense 2,563 (44) 5,035 (8,523)
------------------- --------------- --------------- -----------------
Income (loss) from continuing operations 3,688 (284) 6,805 (13,351)
Income from discontinued operations, net
of tax 16,369 35,219 21,809
------------------- --------------- --------------- -----------------
Net income before extraordinary item 3,688 16,085 42,024 8,458
Extraordinary item -- loss from early
extinguishment of debt (net of tax) 308 - 1,144 -
------------------- --------------- --------------- -----------------
Net income $ 3,380 $16,085 $40,880 $ 8,458
=================== =============== =============== =================
</TABLE>
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT PAGE 3 OF 4
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
For the year For the seven
ended months ended For the fiscal year ended
December 31, December 31, May 31
---------------- --------------------------------------------------------
1998 1997 1997 1996
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net cash provided by (utilized by)
continuing operations $ 27,411 $ 2,316 $ 20,282 $ 10,474
Net cash provided by discontinued operations - 20,876 46,724 32,645
---------------- ---------------- ---------------- ----------------
Net cash provided from operating activities 27,411 23,192 67,006 43,119
---------------- ---------------- ---------------- ----------------
Cash flows from investing activities
Investment in property and equipment, net (52,735) (51,213) (60,641) (28,735)
Acquisition of operating hotel - - (5,550) (49,617)
Distribution of Franchising segment - (4,166) - -
---------------- ---------------- ---------------- ----------------
Net cash utilized by continuing operations (52,735) (55,379) (66,191) (78,352)
Net cash utilized by discontinued operations - (118,474) (15,864) (78,844)
---------------- ---------------- ---------------- ----------------
Net cash utilized by investing activities (52,735) (173,853) (82,055) (157,196)
---------------- ---------------- ---------------- ----------------
Cash flows from financing activities
Proceeds from mortgages and other long term debt 25,000 16,023 90,500 -
Principal payments of debt (353) (90,694) (951) (645)
(Repayment of) proceeds from notes payable to
Manor Care, Inc. - (37,022) - 27,201
Proceeds from note payable to Choice Hotels
International - 115,000 - -
Proceeds from issuance of common stock 359 1,153 3,410 -
Purchases of treasury stock (2,141) (10,554) (53,150) -
Payable to Choice Hotels International, Inc.
for net worth guarantee - 15,000 - -
Advances from (to) restricted subsidiaries 1,687 6,503 11,028 (73)
Advances (from) to Manor Care, Inc., net - - (9,971) 73,272
---------------- ---------------- ---------------- ----------------
Net cash provided by continuing operations 24,552 15,409 40,866 99,755
Net cash provided by (utilized by)
discontinued operations - 129,337 (19,730) 17,131
---------------- ---------------- ---------------- ----------------
Net cash utilized by financing activities 24,552 144,746 21,136 116,886
---------------- ---------------- ---------------- ----------------
Net change in cash and cash equivalents (772) (5,915) 6,087 2,809
Cash and cash equivalents at beginning of
period 4,348 10,263 4,176 1,367
---------------- ---------------- ---------------- ----------------
Cash and cash equivalents at end of period $ 3,576 $ 4,348 $ 10,263 $ 4,176
================ ================ ================ ================
Cash and cash equivalents of continuing
operations $ 3,576 $ 4,348 $ 6,471 $ 1,073
Cash and cash equivalents of discontinued
operations - - 3,792 3,103
</TABLE>
<PAGE>
SUNBURST HOSPITALITY CORPORATION
CONDENSED FINANCIAL INFORMATION OF REGISTRANT PAGE 4 OF 4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
BASIS OF PRESENTATION
The accompanying condensed financial information of Sunburst Hospitality
Corporation (the "Parent Company") presents the financial condition, results of
operations and cash flows of the Parent Company with the investment in and
operations of its restricted subsidiary, First Choice Properties Corporation
("First Choice') on the equity method of accounting. Pursuant of the rules and
regulations of the Securities and Exchange Commission, the condensed financial
statements of the registrant do not include all of the information and notes
normally included with financial statements prepared in accordance with
generally accepted accounting principles and the statements should therefore be
read in conjunction with the Consolidated Financial Statements and Notes thereto
included in this Form 10-K.
As more fully described in the notes to the Company's consolidated financial
statements, the company distributed its franchising business to its shareholders
on October 15, 1997 (distribution date). The accompanying condensed financial
information has been stated to reflect the franchising business as discontinued
operations through the distribution date.
In April 1997, First Choice, an indirect, wholly-owned subsidiary of the Parent
Company, issued $117.5 million multi-class mortgage pass-through certificates
(collectively, "CMBS debt"). The CMBS debt are non-recourse and collateralized
by 36 hotels owned by First choice. CMBS debt carries a blended weighted
average interest rate of 7.8% and have a final maturity of May 5, 2012.
The CMBS debt contains customary covenants with respect to, among other things,
limits on the incurrence of debt, liens, certain investments, transactions with
affiliates asset sales, mergers, and consolidations and transfer to cash to
affiliates.
The accompanying condensed financial statements present the debt of First Choice
as a components of net investment in restricted subsidiaries. Prior to the
April 1997 issuance of the CMBS debt, the financial statements include the
pushed down effect of $110 million in Manor Care notes payable, as the April
1997 proceeds of the mortgage securities were used to repay the Manor Care notes
payable.
DEBT
Aggregate debt maturities at December 31, 1998, are (in thousands):
1999 $ 377
2000 41,399
2001 688
2002 127,828
--------
Total $170,292
========
DIVIDENDS
First Choice has not ever paid cash dividends to the Parent Company.
<PAGE>
SUNBURST HOSPITALITY CORPORATION
REAL ESTATE AND ACCUMULATED DEPRECIATION PAGE 1 OF 2
DECEMBER 31, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
Initial cost to Company Subsequent Gross Amount at December 31, 1998
---------------------------------- ----------------------------------
Building and Capitalized Asset Buildings and
Description Encumbrances Land Improvements Costs Writedowns Land Improvements Total
- ----------- -------------- ------- ------------------------- -------------- ------------ ------- --------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
All
properties,
each less
than 5% of
total $110,913 $45,846 $210,666 $84,716 $(3,400) $56,007 $281,821 $337,828
<CAPTION>
Accumulated Date of Date Depreciation
Description Depreciation Construction Acquired Life
- ----------- -------------- -------------- ---------- ---------------
<S> <C> <C> <C> <C>
All
properties,
each less
than 5% of
total $55,078 Various Various Various
</TABLE>
<PAGE>
SUNBURST HOSPITALITY CORPORATION
REAL ESTATE AND ACCUMULATED DEPRECIATION PAGE 2 OF 2
DECEMBER 31, 1998
(IN THOUSANDS)
(A) The change in total cost of properties for the calendar year ended December
31, 1998, the seven months ended December 31, 1997 and fiscal years ended May
31, 1997 and 1996 is as follows:
Balance at May 31, 1995 $192,919
Additions:
Acquisitions 52,270
Capital expenditures 17,599
Deductions:
Dispositions and other (10,652)
Write-downs (3,400)
------------
Balance at May 31, 1996 248,736
Additions:
Acquisitions 21,278
Capital expenditures 16,363
Transfers from construction-in-progress 3,831
Deductions:
Dispositions and other (7,008)
------------
Balance at May 31, 1997 283,200
Additions:
Acquisitions -
Capital expenditures 22,562
Transfer from construction-in-progress 19,772
Deductions:
Dispositions and other (170)
------------
Balance at December 31, 1997 325,364
Additions:
Acquisitions -
Cap. Exp. 6,478
Transfer from construction-in-progress 48,930
Deductions:
Dispositions and other (42,944)
------------
Balance at December 31, 1998 $337,828
============
(B) The change in accumulated depreciation and amortization for the calendar
year ended December 31, 1998, the seven months ended December 31, 1997, and
fiscal years ended May 31, 1997, 1996, and 1995 is as follows:
Balance at May 31, 1995 $ 28,204
Depreciation and amortization 6,478
Disposals (4,865)
------------
Balance at May 31, 1996 29,817
------------
Depreciation and amortization 8,992
Disposals (2,145)
------------
Balance at May 31, 1997 36,664
------------
Depreciation and amortization 7,247
Disposals -
------------
Balance at December 31, 1997 43,911
------------
Depreciation and amortization 16,154
Disposals (4,987)
------------
Balance at December 31, 1998 $ 55,078
============
(C) The write-down in fiscal year 1996 relates to impairment charges taken in
accordance with Statement of Financial Accounting Standards No. 121.
(D) The total cost of properties excludes construction-in-progress and European
hotels, which were distributed on October 15, 1997 with Franchising.
(E) The aggregate cost of properties for Federal income tax purposes
approximates $337 million at December 31, 1998.
<PAGE>
EXHIBIT 21.01
SUBSIDIARIES
BOULEVARD MOTEL CORP.
Arlington Spirits Corp.
Bay Ridge Spirits Corp.
Biscayne Land Associates, Inc.
Biscayne Properties, Inc.
Bowling Green Inn - Brandywine, Inc.
Cardinal Beverage Corp.
Everglades Beverage Corp.
Fairways Beverage Corp.
Fairways, Inc.
First Choice Properties Corp.
First Choice Capital Corp.
QI Capital Corp.
MCH Baltimore Corp.
MCH Hot Springs Corp.
MCH Lincoln Corp.
MCH Roanoke Corp.
MCH Springfield Corp.
MCH Wichita Corp.
MCHD Cypress Creek Corp.
MCHD Ft. Lauderdale Corp.
MCHD Hampton Corp.
Pikesville Hotel Corp.
Raleigh Hotel Holdings, Inc.
West Montgomery Hotel Holdings, Inc.
MCH Shady Grove Corp.
CACTUS HOTEL CORP.
CHOICE MANAGEMENT & REALTY SERVICES, INC.
Beltway Management Company
COMFORT CALIFORNIA, INC.
GULF HOTEL CORP.
HEFRU FOOD SERVICES, INC.
QCM BEVERAGES, INC. (49%; 51% Texas resident)
QCM CORPORATION
SUNBURST HOTEL CORP.
THICKET, INC. (THE) (Non-Profit; owned by members)
Subsidiaries are wholly-owned except where indicated.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,113
<SECURITIES> 0
<RECEIVABLES> 7,271
<ALLOWANCES> 611
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 446,917
<DEPRECIATION> 83,894
<TOTAL-ASSETS> 422,511
<CURRENT-LIABILITIES> 0
<BONDS> 279,762
0
0
<COMMON> 244
<OTHER-SE> 105,606
<TOTAL-LIABILITY-AND-EQUITY> 422,511
<SALES> 0
<TOTAL-REVENUES> 204,096
<CGS> 0
<TOTAL-COSTS> 173,069
<OTHER-EXPENSES> 4,264
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 20,512
<INCOME-PRETAX> 6,251
<INCOME-TAX> 2,563
<INCOME-CONTINUING> 3,688
<DISCONTINUED> 0
<EXTRAORDINARY> (308)
<CHANGES> 0
<NET-INCOME> 3,380
<EPS-PRIMARY> 0.17
<EPS-DILUTED> 0.17
</TABLE>
