<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 1998 COMMISSION FILE NO. 1-11915
CHOICE HOTELS INTERNATIONAL, INC.
10750 COLUMBIA PIKE
SILVER SPRING, MD. 20901
(301) 592-5000
Delaware 52-1209792
------------------------ ----------------------
(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
-------------------------------------------
(Former name, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
---- ----
SHARES OUTSTANDING
CLASS AT SEPTEMBER 30, 1998
- - ----------------------- ---------------------------
Common Stock, $0.01
par value per share 57,869,220
-----------
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<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
INDEX
-----
<TABLE>
<CAPTION>
PAGE NO.
-------
<S> <C>
PART I. FINANCIAL INFORMATION:
Consolidated Balance Sheets -
September 30, 1998 (Unaudited) and December 31, 1997 3
Consolidated Statements of Income -
Three months ended September 30, 1998 and September 30, 1997 and Nine
Months Ended September 30, 1998 and September 30, 1997 (Unaudited) 5
Consolidated Statements of Cash Flows -
Nine months ended September 30, 1998 and September 30, 1997 (Unaudited) 6
Notes to Consolidated Financial Statements (Unaudited) 7
Management's Discussion and Analysis of Results of
Operations and Financial Condition 9
PART II. OTHER INFORMATION AND SIGNATURE 14
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
ASSETS 1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $ 2,502 $ 10,282
Receivables (net of allowance
for doubtful accounts of
$8,484 and $7,608, respectively) 36,262 24,278
Other 10,353 9,904
Receivable from Sunburst Hospitality 19,921 25,066
-------- --------
Total current assets 69,038 69,530
PROPERTY AND EQUIPMENT, AT COST, NET OF
ACCUMULATED DEPRECIATION 29,494 37,040
GOODWILL, NET OF ACCUMULATED AMORTIZATION 67,255 68,792
FRANCHISE RIGHTS, NET OF ACCUMULATED
AMORTIZATION 45,939 48,819
INVESTMENT IN FRIENDLY HOTELS, PLC 46,470 17,011
OTHER ASSETS 29,620 17,004
ASSETS HELD FOR SALE -- 10,752
NOTE RECEIVABLE FROM SUNBURST HOSPITALITY 125,078 117,447
-------- --------
Total assets $412,894 $386,395
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
3
<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
-------------- -------------
(UNAUDITED)
<S> <C> <C>
LIABILITIES & SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt $ 20,146 $ 15,041
Accounts payable 21,464 26,452
Accrued expenses 22,777 20,702
Income taxes payable 941 6,007
-------- --------
Total current liabilities 65,328 68,202
-------- --------
LONG-TERM DEBT 255,505 267,780
DEFERRED INCOME TAXES AND OTHER 21,164 1,155
-------- --------
Total liabilities 341,997 337,137
-------- --------
SHAREHOLDERS' EQUITY
Common stock, $.01 par value 604 598
Additional paid-in capital 51,892 47,907
Accumulated other comprehensive income 3,213 (8,316)
Treasury stock (37,154) (189)
Retained earnings 52,342 9,258
-------- --------
Total shareholders' equity 70,897 49,258
-------- --------
Total liabilities & shareholders' equity $412,894 $386,395
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
4
<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES
Royalty fees $35,680 $33,799 $ 85,739 $ 78,970
Product sales 5,009 5,800 17,383 17,700
Initial franchise fees and relicensing fees 4,905 2,870 12,554 11,701
Partner service revenue and other 1,137 588 7,564 7,786
European hotel operations - 4,284 1,098 12,872
------- ------- -------- --------
Total revenues 46,731 47,341 124,338 129,029
------- ------- -------- --------
OPERATING EXPENSES
Selling, general and administrative 13,176 12,137 36,840 36,818
Product cost of sales 4,511 5,510 16,119 16,856
Depreciation and amortization 2,308 2,333 5,858 7,595
European hotel operations - 3,786 1,133 11,675
------- ------- -------- --------
Total operating expenses 19,995 23,766 59,950 72,944
------- ------- -------- --------
OPERATING INCOME 26,736 23,575 64,388 56,085
OTHER
Gain on sale of stock - - (2,190) -
Interest and dividend income (3,338) - (9,298) -
Interest expense 4,850 3,087 14,433 8,095
------- ------- -------- --------
Total other 1,512 3,087 2,945 8,095
------- ------- -------- --------
INCOME BEFORE INCOME TAXES AND EXTRAORDINARY ITEM 25,224 20,488 61,443 47,990
INCOME TAXES 10,506 8,533 25,591 19,988
NET INCOME BEFORE EXTRADORDINARY ITEM ------- ------ ------- -------
14,718 11,955 35,852 28,002
======= ======= ======== ========
Gain on extinguishment of debt,
net of $4,732 of income taxes 7,232 - 7,232 -
------- ------- -------- --------
NET INCOME $21,950 $11,955 $ 43,084 $ 28,002
======= ======= ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 58,360 59,998 59,130 61,252
======= ======= ======== ========
DILUTED SHARES OUTSTANDING 59,165 59,998 60,124 61,252
======= ======= ======== ========
DILUTED EARNINGS PER SHARE BEFORE EXTRAORDINARY ITEM 0.25 0.20 0.60 0.45
------- ------- -------- --------
DILUTED EARNINGS PER SHARE - EXTRAORDINARY ITEM 0.12 - 0.12 -
------- ------- -------- --------
DILUTED EARNINGS PER SHARE $ 0.37 $ 0.20 $ 0.72 $ 0.45
======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated statements of income.
5
<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
---------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1998 1997
------------- -------------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 43,084 $ 28,002
Reconciliation of net income to net cash provided by
operating activities:
Depreciation and amortization 8,930 9,695
Provision for bad debts 876 1,683
Increase in deferred taxes 12,878 3,900
Non cash interest and dividend income (9,252) -
Gain on extinguishment of capital lease obligations (11,964) -
Changes in assets and liabilities:
Change in receivables (11,859) (8,289)
Change in inventories and other current assets (784) (4,760)
Change in current liabilities (2,913) (736)
Change in income taxes payable (5,066) 3,398
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 23,930 32,893
--------- ---------
CASH FLOW FROM INVESTING ACTIVITIES:
Investment in property and equipment (6,753) (9,236)
Repayments of Sunburst Hospitality advances, net 5,145 -
Other items, net (3,398) 593
--------- ---------
NET CASH UTILIZED BY INVESTING ACTIVITIES (5,006) (8,643)
--------- ---------
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from long-term debt 177,504 -
Repayment of long-term debt (171,234) (22,637)
Purchase of treasury stock (36,965) -
Proceeds from issuance of common stock 3,991 -
Transfers to Parent, net - (1,045)
--------- ---------
NET CASH UTILIZED BY FINANCING ACTIVITIES (26,704) (23,682)
--------- ---------
Net change in cash and cash equivalents (7,780) 568
Cash and cash equivalents, beginning of period 10,282 2,973
---------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,502 $ 3,541
========== =========
</TABLE>
The accompanying notes are an integral part of these
consolidated statements of cash flows.
6
<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. The accompanying consolidated financial statements of Choice Hotels
International, Inc. (the "Company") and subsidiaries have been prepared by the
Company without audit. Certain information and footnote disclosures normally
included in financial statements presented in accordance with generally accepted
accounting principles have been condensed or omitted. The Company believes the
disclosures made are adequate to make the information presented not misleading.
The consolidated financial statements should be read in conjunction with the
consolidated financial statements for the stub year ended December 31, 1997 and
notes thereto included in the Company's Form 10-K, dated March 31, 1998. In the
opinion of management, all adjustments (which include any normal recurring
adjustments) considered necessary for a fair presentation have been included.
Interim results are not necessarily indicative of fiscal year performance
because of seasonal and short-term variations. All intercompany transactions
and balances between Choice Hotels International, Inc. and its subsidiaries have
been eliminated. Certain reclassifications have been made to the prior year
amounts to conform to current period presentation.
2. In January 1998, the Company completed a transaction with Friendly Hotels,
PLC ("Friendly")in which Friendly assumed the master franchise rights for
Choice's Comfort, Quality and Clarion brand hotels throughout Europe (with the
exception of Scandinavia) for the next 10 years. In exchange, the Company will
receive from Friendly $8.0 million, payable in eight equal annual installments.
This transaction followed a transaction completed in May 1996 whereby the
Company subscribed to approximately $17 million in unlisted 5.75 percent
convertible preferred shares in Friendly at par (the "1996 shares").
As part of the transaction, Friendly acquired European hotels owned by the
Company for a total consideration of approximately $26.2 million in convertible
preferred shares and cash. In exchange for 10 hotels in France, two in Germany
and one in the United Kingdom, the Company received $22.2 million in new
unlisted 5.75 percent convertible preferred shares in Friendly at par (the "1998
shares"), convertible into one new Friendly ordinary share for every 150p
nominal of the preferred convertible shares. Dividends accrue and are payable in
cash or additional preferred shares at the Company's option beginning, except
upon an earlier conversion, on January 30, 2001 in the case of the 1998 shares,
and May 30, 1999 in the case of the 1996 shares. In addition, Friendly will pay
the Company deferred compensation of $4.0 million in cash, payable by the fifth
anniversary of completion or sooner dependent on the level of future profits of
the hotels acquired. The European hotels included in this transaction had a
carrying value, which includes a cumulative translation adjustment of $(6.6)
million, totaling approximately $19.9 million.
3. In May 1998, the Company completed a $100 million senior unsecured note
offering (the "Notes"), bearing a coupon rate of 7.125%. The Notes will mature
on May 1, 2008, with interest on the Notes to be paid semi-annually. The
Company has used the net proceeds from the offering of approximately $99 million
to repay amounts outstanding under the Company's $300 million revolving credit
facility.
4. During the nine months ended September 30, 1998, the Company's comprehensive
income (consisting of net income plus foreign currency translation adjustments
and unrealized gains on available for sale securities) exceeded net income by
approximately $11.5 million.
5. During the second quarter of 1998, the Company changed its presentation of
marketing and reservation fees such that the fees collected and associated
expenses are reported net. The Company's franchise agreements require the
payment of franchise fees which include marketing and reservation fees. These
fees, which are based on a percentage of the franchisees' gross room revenues,
are used exclusively to reimburse the Company for expenses associated with
providing such franchise services as central reservation systems, national
marketing, and media advertising. The Company is contractually obligated to
expend the reservation and marketing fees it collects from franchisees in
accordance with the franchise agreements; as such, no income or loss to the
Company is generated. All prior periods have been restated to conform to the
new presentation.
The total marketing and reservation fees received by the Company (previously
reported as revenue) were $95.6 million and $74.4 million for the nine months
ended September 30, 1998 and September 30, 1997, respectively. Depreciation and
amortization charged to reservation and marketing
7
<PAGE>
expenses was $3.1 million and $2.1 million for the nine months ending
September 30, 1998 and September 30, 1997, respectively. Reservation fees and
marketing fees not expended in the current year are carried over to the next
fiscal year and expended in accordance with the franchise agreements. Shortfall
amounts are similarly recovered in subsequent years. Excess or shortfall amounts
from the operation of these programs are recorded as a payable or receivable
from the particular fund. The shortfall amount recorded as a current receivable
in other assets on the Company's balance sheet is attributable to the Marketing
Fund and was $7.7 million and $5.2 million at September 30, 1998 and December
31, 1997, respectively. The excess amount recorded as a current payable in
accounts payable on the Company's balance sheet is attributable to the
Reservation Fund and was $0.5 million and $3.5 million at September 30, 1998 and
December 31, 1997, respectively.
6. The Company recognized a gain of $7.2 million, net of tax on the
extinguishment of certain capital lease obligations in the third quarter of
1998.
7. Sunburst Hospitality Corporation has asserted in its public filings that it
intends to assert various claims with respect to $19.9 million owed by Sunburst
to the Company under the terms of the Distribution Agreement. This amount
represents liabilities of Sunburst discharged or assumed by the Company in
connection with the spinoff of the Company in October 1997. The Company believes
that it has a strong legal basis to collect such amount and will vigorously
assert its rights under the Distribution Agreement. In the opinion of
management, resolution of any dispute involving this amount will not have a
material adverse impact on the Company.
8
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION
--------------------------------------------------------------------------
The principal factors that affect the Company's results are: (i) growth in the
number of hotels under franchise, (ii) occupancy and room rates achieved by the
hotels under franchise, (iii) the number and relative mix of franchised hotels,
and (iv) the Company's ability to manage costs. The number of rooms at
franchised properties and occupancy and room rates at those properties
significantly affect the Company's results because franchise royalty fees are
based upon room revenues at franchised hotels. The variable overhead costs
associated with franchise system growth are substantially less than incremental
royalty fees generated from new franchisees; therefore, the Company is able to
capture a significant portion of those royalty fees as operating income.
Comparison of Three Month Period Ended September 30, 1998 Operating Results and
Three Month Period Ended September 30, 1997 Operating Results
The Company reported net income of $21.9 million, or $0.37 per diluted share,
for the third quarter ended September 30, 1998, compared to net income for the
same period of 1997 of $12.0 million, or $0.20 per diluted share. The $0.37 per
share includes $0.12 resulting from a gain on extinguishment of debt. Exclusive
of this extraordinary item, diluted earnings per share increased 25.0% to $0.25
per share. The increase in net income for the period is attributable to an
increase in franchise revenue as a direct result of the addition of new
licensees to the franchise system, increases in the effective royalty rate
achieved for the domestic hotel system and the control of the Company's selling,
general and administrative costs.
Franchise Revenues
- - ------------------
In operating the franchise business, the Company collects marketing and
reservation fees and assessments from its franchisees. The Company is
contractually obligated to disburse these fees for marketing and reservation
activities to be provided on behalf of its franchisees. Therefore, the Company
presents these fees and expenses on a net basis in the accompanying consolidated
statements of income. The Company also provides certain services to its
franchisees, including a group purchasing program, whereby the Company utilizes
bulk purchasing power to obtain favorable pricing from third-party vendors for
franchisees. This program is provided to the franchisees as a service and is
not designed to be a major component of the Company's profitability.
Management, therefore, analyzes its franchise business based on revenues net of
marketing and reservation fees and product sales ("net franchise revenues").
Net franchise revenues include royalty fees, initial franchise fees and
relicensing fees earned on contracts signed and other revenues, including
partner service revenue. Net franchise revenues are dependent upon growth in
the number of franchised properties as well as the underlying performance of the
franchised hotels for continued growth. The key industry standard for measuring
hotel operating performance is revenue per available room, ("RevPAR"), which is
calculated by multiplying the percentage of occupied rooms by the average daily
room rate realized.
The Company's net franchise revenues were $41.7 million for the three months
ended September 30, 1998 and $37.3 million for the three months ended
September 30, 1997.
Total net franchise revenues are computed as follows:
<TABLE>
<CAPTION>
(In millions)
Three Months Ended Three Months Ended
September 30, 1998 September 30, 1997
------------------- -------------------
<S> <C> <C>
Total franchise revenues $46.7 $43.1
Product sales (5.0) (5.8)
----- -----
Total net franchise revenues $41.7 $37.3
===== =====
</TABLE>
9
<PAGE>
Royalties increased $1.9 million to $35.7 million in 1998 from $33.8 million in
1997, an increase of 5.6%. The increase in royalties is attributable to a net
increase of 71 franchisees during the period representing an additional 5,007
rooms, an improvement in domestic RevPar of 1.9% and an increase in the
effective royalty rate of the domestic hotel system to 3.60% from 3.48%. Initial
and relicensing fee revenue generated from domestic franchise contracts signed
increased to $4.9 million from $2.9 million in 1997 as a result of an increase
in total franchise agreements signed to 218, as compared to 145 for the third
quarter 1997. The total number of domestic hotels online increased to 3,024 from
2,852 an increase of 6.0% for the period ending September 30, 1998. This
represents an increase in the number of rooms open of 4.4% from 240,908 as of
September 30, 1997 to 251,415 as of September 30, 1998. As of September 30,
1998, the Company had 792 hotels under development in its domestic hotel system
an increase of 10.1% from 719 as of September 30, 1997.
The number of domestic rooms under development increased to 68,759 from 61,560,
an increase of 11.7% for the period ending September 30, 1998. The total number
of international hotels on line increased to 619 from 609 an increase of
1.6% as of September 30, 1998. International rooms online increased 12.2% from
51,191 as of September 30, 1997 to 57,437 as of September 30, 1998. The total
number of international hotels under development increased to 577 from 104 an
Increase of 454.8% for the period ending September 30, 1998. The number of
international rooms under development increased to 36,098 as of September 30,
1998 from 9,209 as of September 30, 1997, an increase of 292.0%. These increases
are primarily attributable to the Company's June 1998 Strategic Alliance with
Flag International Limited.
Franchise Expenses
- - ------------------
The cost to operate the franchising business is reflected in selling, general
and administrative costs. Selling, general and administrative expenses increased
approximately $1.0 million between years. As a percentage of total net
franchising revenues, total franchising selling, general and administrative
expenses declined to 31.6% for the third quarter of 1998 as compared to 32.4%
for 1997. The improvement in the franchising margins relates to the economies of
scale generated from operating a larger franchisee base and cost control
initiatives, and improvements in franchised hotel performance.
Product Sales
- - -------------
Sales made to franchisees through the Company's group purchasing program
decreased approximately $0.8 million (or 13.6%) to $5.0 million for the three
months ended September 30, 1998 from $5.8 million for the three months ended
September 30, 1997. The group purchasing program utilizes bulk purchases to
obtain favorable pricing from third party vendors for franchisees ordering
similar products. The Company acts as a "clearing-house" between the franchisee
and the vendor, and orders are shipped directly to the franchisee.
Product cost of sales decreased $1.0 million (or 18.1%) for the three months
ended September 30, 1998. The product services margins increased for the three
months ended September 30, 1998 to 9.9% from 5.0% at September 30, 1997. This
purchasing program is provided to the franchisees as a service and is not
expected to be a major component of the Company's profitability.
Other
- - ------
For the three months ended September 30, 1998, the Company recognized
approximately $0.6 million in dividend income from its investment in Friendly
and approximately $2.7 million of interest income from its subordinated term
note to Sunburst Hospitality, Inc. During the third quarter of 1998, the Company
recognized a gain of $7.2 million, net of tax on the extinguishment of certain
capital lease obligations.
Comparison of Nine Month Period Ended September 30, 1998 Operating Results and
Nine Month Period Ended September 30, 1997 Operating Results
The Company reported net income of $43.1 million, or $0.72 per diluted share,
for the nine months ended September 30, 1998, compared to net income for the
same period of 1997 of $28.0 million, or $0.45 per diluted share. The $0.72 per
share includes approximately $0.02 resulting from a sale of certain investments
held by the Company and approximately $0.12 resulting from a gain on early
extinguishment of debt. Exclusive of this gain and extraordinary item, diluted
earnings per share increased 28.9% to $0.58 per share from $0.45 per share. The
increase in net income for the period is primarily attributable to an increase
in franchise revenue as a direct result of the addition of new licensees to the
franchise system, improvements in the operating performance of franchised hotels
and the control of the Company's selling, general and administrative costs.
10
<PAGE>
Franchise Revenues
- - ------------------
The Company's net franchise revenues were $105.8 million for the nine months
ended September 30, 1998 and $98.5 million for the nine months ended
September 30, 1997.
Total net franchise revenues are computed as follows:
<TABLE>
<CAPTION>
(In millions)
September 30, 1998 September 30, 1997
------------------- -------------------
<S> <C> <C>
Total franchise revenues $123.2 $116.2
Product sales (17.4) (17.7)
------ ------
Total net franchise revenues $105.8 $ 98.5
====== ======
</TABLE>
Royalties increased $6.7 million to $85.7 million in 1998 from $79.0 million in
1997, an increase of 8.5%. The increase in royalties is attributable to a net
increase of 144 franchisees during the period representing an additional 9,150
rooms, an improvement in domestic RevPAR of 1.5% and an increase in the
effective royalty rate of the domestic hotel system to 3.54% from 3.42%. Initial
franchise fee and relicensing fee revenue generated from domestic franchise
contracts signed increased to $12.6 million from $11.7 million in 1997 as a
result of an increase in agreements signed in the nine months ended September
30, 1998 to 586, as compared to 469 for the nine months ended September 30,
1997. The total number of domestic hotels online increased to 3,024 from
2,852 an increase of 6.0% for the period ending September 30, 1998. This
represents an increase in the number of rooms open of 4.4% from 240,908 as of
September 30, 1997 to 251,415 as of September 30, 1998. As of September 30,
1998, the Company had 792 hotels under development in its domestic hotel system
an increase of 10.1% from 719 as of September 30, 1997.
The number of domestic rooms under development increased to 68,759 from 61,560,
an increase of 11.7% for the period ending September 30, 1998. The total number
of international hotels on line increased to 619 from 609 an increase of 1.6% as
of September 30, 1998. International rooms online increased 12.2% from 51,191 as
of September 30, 1997 to 57,437 as of September 30, 1998. The total number of
international hotels under development increased to 577 from 104 an increase of
454.8% for the period ending September 30, 1998. The number of International
rooms under development increased to 36,098 as of September 30, 1998 from 9,209
as of September 30, 1997, an increase of 292.0%. These increases are primarily
attributable to the Company's June 1998 Strategic Alliance with Flag
International Limited.
Franchise Expenses
- - ------------------
Selling, general and administrative expenses remained flat at $36.8 million for
the nine months ended September 30, 1998 and 1997. As a percentage of total net
franchising revenues, total franchising selling, general and administrative
expenses declined to 34.8% for the nine months ended September 30, 1998 as
compared to 37.4% for 1997. The improvement in the franchising margins relates
to the economies of scale generated from operating a larger franchisee base,
cost control initiatives and improvements in franchised hotel performance.
Product Sales
- - -------------
Sales made to franchisees through the Company's group purchasing program
decreased $0.3 million (or 1.7%) to $17.4 million for the nine months ended
September 30, 1998 from $17.7 million at September 30, 1997. The group
purchasing program utilizes bulk purchases to obtain favorable pricing from
third party vendors for franchisees ordering similar products. The Company acts
as a "clearing-house" between the franchisee and the vendor, and orders are
shipped directly to the franchisee.
Similarly, product cost of sales decreased approximately $0.7 million (or 4.4%)
for the nine months ended September 30, 1998. The product services margins
increased for the nine months ended September 30, 1998 to 7.3% from 4.8% at
September 30, 1997. This purchasing program is provided to the franchisees as a
service and is not expected to be a major component of the Company's
profitability.
Other
- - ------
For the nine months ended September 30, 1998, the Company recognized
approximately $1.6 million in dividend income from its investment in Friendly
and approximately $7.6 million of interest income from its subordinated term
note to Sunburst Hospitality, Inc. For the nine months ended September 30,
1998, the Company recognized approximately $2.2 million from the sale of certain
investments and $7.2 million, net of tax on the extingishment of certain capital
lease obligations.
LIQUIDITY AND CAPITAL RESOURCES
- - -------------------------------
Net cash provided by operating activities was $23.9 million for the nine months
ended September 30, 1998, a decrease of approximately $9.0 million from $32.9
million for 1997. The decrease is primarily a result of an increase in cash
interest paid due to additional indebtedness from Sunburst Hospitality, and
income tax payment timing changes related to the Company's change to a calendar
tax year. At September 30, 1998, the total long-term debt outstanding
for the Company was $275.7 million which includes approximately $20.1 million
which matures in the next twelve months.
11
<PAGE>
In May 1998, the Company consummated a $100 million senior unsecured note
offering (the "Notes"), bearing a coupon rate of 7.125%. The Notes mature on
May 1, 2008, with interest to be paid semi-annually. The Company used the net
proceeds from the offering of approximately $99 million to repay amounts
outstanding under the Company's $300 million revolving credit facility.
As of November 12, 1998, the Company has repurchased 3.4 million shares of its
common stock at a total cost of $48.6 million. The Company has authorization
from its Board of Directors to repurchase up to an additional 5.3 million
shares.
The Company believes that cash flow from operations and available financing
capacity is adequate to meet the expected operating, investing, financing and
debt service requirements for the business for the immediate future.
Year 2000 Compliance
- - --------------------
The Company is engaged in an ongoing effort to evaluate and remediate the Year
2000 computer problem shared by virtually all companies and businesses. As part
of this effort, a cross-functional Year 2000 Compliance Committee was
established to manage and supervise the efforts to become compliant and a Year
2000 action plan has been developed. The Company has completed the first two
phases of the plan, which include (i) making the Company's internal
organizations aware of the Year 2000 issue and assigning responsibility
internally, and (ii) inventorying and initial testing of its proprietary
software. The remaining phases include: (i) assessing the risk from third party
vendors and franchisees and (ii) inventorying and testing secondary internal
systems (e.g. employee PCs ). Throughout the process, remedial actions have
been or will be taken as warranted.
The Company's exposure to potential Year 2000 problems exists in two general
areas: technological operations in the sole control of the Company, and
technological operations dependent in some way on one or more third parties.
With respect to the Company's internal systems, it has conducted Year 2000
compliance testing on all of its proprietary software, including its
reservations and reservations support systems, its franchise support system and
its franchisee property management support systems. The tests have indicated
that, except for two DOS based systems, the proprietary software is year 2000
compliant. The DOS version of ChoiceLINKS is not Year 2000 compliant and the
DOS version of the Company's property management system is only compliant
through December 31, 2000. The Company has communicated this to franchisees
using these systems and has recommended that they migrate to the Windows(R)
based versions of these systems. The Company has also been in the process of
replacing its hardware platforms for these systems and a number of smaller
support systems and has kept them updated so that by the end of 1998, all of the
Company's large system computers will be no more than eighteen months old. Based
on manufacturer's specifications, the Company believes that these new hardware
platforms are year 2000 compliant.
The Company is also in the process of conducting an inventory of third party
software, including PC operating systems and word processing and other
commercial software. The Company anticipates that it will need to upgrade
approximately 80% of its employee workstation PCs. The Company has not
quantified the costs of such upgrades to its PC based systems, but the Company
does not currently expect such costs to be material.
The Year 2000 Compliance Committee is currently identifying third party vendors
and service providers whose non-compliant systems could have a material impact
on the Company and undertaking an assessment as to such parties compliant
status. These parties include 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 the Company in writing that
they are making the necessary changes in their system to become compliant and
the Company expects to finish with the GDS companies in November 1998. The Year
2000 Compliance Committee is in the process of assessing other third parties as
to their compliance and the consequences in the event they are not compliant.
The Committee expects that such assessment will be completed by the end of the
fourth quarter of 1998.
Costs of addressing potential Year 2000 problems have not been material to date
and, based upon preliminary information gathered to date, are not currently
expected to have a material adverse impact on the Company's financial position,
results of operations or cash flows. However, if the Company, its vendors or
franchisees are unable to resolve such Year 2000 issues in a timely manner, it
could result in a material financial risk, including loss of revenue,
substantial unanticipated costs and service interruptions.
12
<PAGE>
The Company is not in a position to guarantee the performance of others with
respect to their Year 2000 compliance or predict whether any of the assurances
that others provide regarding Year 2000 compliance may prove later to be
inaccurate or overly optimistic.
FORWARD-LOOKING STATEMENTS
- - --------------------------
The statements contained in this document that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995.
A number of important factors could cause the Company's actual results for
future periods to differ materially from those expressed in any forward-looking
statements made by, or on behalf of the Company.
Certain statements contained in this Form 10-Q, including those in the section
entitled "Management's Discussion and Analysis of Operating Results and
Financial Condition," contain forward-looking information that involves risk and
uncertainties. Actual future results and trends may differ materially depending
on a variety of factors discussed in the "Risk Factors" section included in the
Company's SEC filings, including the nature and extent of future competition,
and political, economic and demographic developments in countries where the
Company does business or in the future may do business.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. The Company undertakes no
obligation to revise or update these forward-looking statements.
13
<PAGE>
PART II OTHER INFORMATION
-------------------------
ITEM 1. LEGAL PROCEEDINGS
-----------------
The Company is not party to any litigation, other than routine litigation
incidental to the business of the Company. None of such litigation, either
individually or in the aggregate, is expected to be material to the business,
financial condition or results of operations of the Company.
ITEM 5. Other Information
------------------
The Securities & Exchange Commission has amended the requirements of the proxy
rules under the Securities Exchange Act of 1934 (the "1934 Act") regarding
submission to the Board of Directors proposals to be considered for submission
to the stockholders at an annual meeting of stockholders. Under the
requirements of Rule 14a8 under the 1934 Act, the notice of a proposal must be
submitted in writing to the Corporation no later than 45 days prior to the month
and day of the mailing of the prior year's proxy statement. For the 1999 Annual
Meeting, this date would be February 16, 1999.
However, the provisions of Rule 14a8 do not override the requirements of the
Corporation's by-laws, which provide that notice of such proposals must be
received by the Corporation not less than 60 nor more than 90 days prior to the
first anniversary of the previous year's annual meeting. For the 1999 Annual
Meeting, notice of such proposals must be received no earlier than January 30,
1999 and no later than March 1, 1999.
Such notice shall be delivered or mailed by first-class United States mail,
postage prepaid, to the Corporate Secretary, Choice Hotels International, Inc.,
10750 Columbia Pike, Silver Spring, Maryland 20901, and shall set forth as to
each matter the stockholder proposes to bring before the annual meeting: (a) a
brief description of the business desired to be brought before the annual
meeting and the reasons for conducting such business at the meeting, (b) the
name and address, as they appear on the Corporation's books, of the stockholder
proposing such business and the name and address of the beneficial owner on
whose behalf the proposal is being made, (c) the class, series and number of
shares of the Corporation which are beneficially owned by the stockholder or by
the beneficial owner on whose behalf the proposal is being made, (d) any
material interest of the stockholder, or the beneficial owner on whose behalf
the proposal is being made, in such business, (e) a representation that the
stockholder is a holder of record of stock of the Corporation entitled to vote
at such meeting and intends to appear in person or by proxy at the meeting, and
(f) a description of all arrangements or understandings between the stockholder,
the beneficial owner on whose behalf the proposal is being made, or any other
person or persons (naming such person or persons) relating to the matter being
proposed.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
----------------------------------
(a) Exhibits
Exhibit 27.01 - Financial Data Schedule September 30, 1998
(b) The following reports were filed pertaining to the period ended
September 30, 1998.
None.
14
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
CHOICE HOTELS INTERNATIONAL, INC.
Date: November 16, 1998 /s/ Charles A. Ledsinger, Jr.
----------------- -----------------------------
By: Charles A. Ledsinger, Jr.
President and Chief Executive Officer
15
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<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF INCOME AND THE
CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS AND THE NOTES THERETO.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,502
<SECURITIES> 0
<RECEIVABLES> 44,746
<ALLOWANCES> 8,484
<INVENTORY> 381
<CURRENT-ASSETS> 69,038
<PP&E> 45,608
<DEPRECIATION> 16,114
<TOTAL-ASSETS> 412,894
<CURRENT-LIABILITIES> 65,328
<BONDS> 255,505
0
0
<COMMON> 604
<OTHER-SE> 70,293
<TOTAL-LIABILITY-AND-EQUITY> 412,894
<SALES> 0
<TOTAL-REVENUES> 124,338
<CGS> 0
<TOTAL-COSTS> 59,950
<OTHER-EXPENSES> (11,488)
<LOSS-PROVISION> 876
<INTEREST-EXPENSE> 14,433
<INCOME-PRETAX> 61,443
<INCOME-TAX> 25,591
<INCOME-CONTINUING> 35,852
<DISCONTINUED> 0
<EXTRAORDINARY> 7,232
<CHANGES> 0
<NET-INCOME> 43,084
<EPS-PRIMARY> 0.73
<EPS-DILUTED> 0.72
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