<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
<TABLE>
<S> <C>
FOR THE QUARTER ENDED SEPTEMBER 30, 1999 COMMISSION FILE NO. 1- 11915
</TABLE>
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, 1999
- ----------------------- ------------------------
Common Stock, $0.01
par value per share 54,042,626
----------
==============================================================================
<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
INDEX
-----
<TABLE>
<CAPTION>
PAGE NO.
-------
<S> <C>
PART I. FINANCIAL INFORMATION:
Condensed Consolidated Balance Sheets -
September 30, 1999 (Unaudited) and December 31, 1998 3
Consolidated Statements of Income -
Three months ended September 30, 1999 and September 30, 1998 and Nine
Months ended September 30, 1999 and September 30, 1998 (Unaudited) 5
Consolidated Statements of Cash Flows -
Nine months ended September 30, 1999 and September 30, 1998 (Unaudited) 6
Notes to Consolidated Financial Statements (Unaudited) 7
Management's Discussion and Analysis of Results of
Operations and Financial Condition 8
Quantitative and Qualitative Analysis of Market Risk 12
PART II. OTHER INFORMATION AND SIGNATURE 14
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
CHOICE HOTELS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------- -----------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 8,732 $ 1,692
Receivables (net of allowance for doubtful
accounts of $8,237 and $8,082, respectively) 32,772 28,117
Income taxes receivable and other 3,589 5,852
-------- --------
Total current assets 45,093 35,661
PROPERTY AND EQUIPMENT, AT COST, NET OF
ACCUMULATED DEPRECIATION 42,398 32,845
GOODWILL, NET OF ACCUMULATED AMORTIZATION 65,217 66,749
FRANCHISE RIGHTS, NET OF ACCUMULATED AMORTIZATION 44,108 44,981
INVESTMENT IN FRIENDLY HOTELS, PLC 47,018 45,139
OTHER ASSETS 79,125 45,001
NOTE RECEIVABLE FROM SUNBURST HOSPITALITY, INC 138,354 127,849
-------- --------
Total assets $461,313 $398,225
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
balance sheets.
3
<PAGE>
CHOICE HOTELS INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
------------------ -----------------
(Unaudited)
<S> <C> <C>
LIABILITIES & EQUITY
CURRENT LIABILITIES
Current portion long term debt $ 30,146 $ 22,646
Accounts payable 24,690 16,216
Accrued expenses 26,621 19,606
--------- --------
Total current liabilities 81,457 58,468
--------- --------
LONG TERM DEBT 277,346 256,564
DEFERRED INCOME TAXES AND OTHER LIABILITIES 44,708 26,683
--------- --------
Total liabilities 403,511 341,715
--------- --------
SHAREHOLDERS' EQUITY
Common stock, $.01 par value 615 607
Additional paid-in-capital 49,314 43,432
Accumulated other comprehensive income 1,057 2,112
Treasury stock (100,902) (54,204)
Retained earnings 107,718 64,563
--------- --------
Total shareholders' equity 57,802 56,510
--------- --------
Total liabilities & shareholders' equity $ 461,313 $398,225
========= ========
</TABLE>
The accompanying notes are an integral part of these condensed 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,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
REVENUES
Royalty fees $40,472 $35,680 $ 95,545 $ 85,739
Product sales 1,157 5,009 4,514 17,383
Initial franchise fees and
relicensing fees 3,300 4,905 9,893 12,554
Partner service revenue 2,354 1,683 6,162 4,638
European hotel operations - - - 1,098
Other 733 454 2,471 2,926
-------- -------- -------- --------
Total revenues 48,016 47,731 118,585 124,338
-------- -------- -------- --------
OPERATING EXPENSES
Selling, general and administrative 15,191 14,176 38,808 36,840
Product cost of sales 845 4,511 3,962 16,119
Depreciation and amortization 1,774 2,308 5,245 5,858
European hotel operations - - - 1,133
-------- -------- -------- --------
Total operating expenses 17,810 20,995 48,015 59,950
-------- -------- -------- --------
OPERATING INCOME 30,206 26,736 70,570 64,388
OTHER
Gain on sale of stock - - (1,260) (2,190)
Interest and dividend income (5,244) (3,338) (14,900) (9,298)
Interest expense 5,069 4,850 14,796 14,433
-------- -------- -------- --------
Total other (175) 1,512 (1,364) 2,945
-------- -------- -------- --------
INCOME BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM 30,381 25,224 71,934 61,443
INCOME TAXES 12,043 10,506 28,787 25,591
-------- -------- -------- --------
NET INCOME BEFORE EXTRAORDINARY ITEM 18,338 14,718 43,147 35,852
-------- -------- -------- --------
GAIN ON EXINGUISHMENT OF DEBT, NET
OF $4,732 OF INCOME TAXES - 7,232 - 7,232
-------- -------- -------- --------
NET INCOME $18,338 $21,950 $ 43,147 $ 43,084
======== ======== ======== ========
WEIGHTED AVERAGE SHARES OUTSTANDING 54,619 58,360 55,174 59,130
======== ======== ======== ========
DILUTED SHARES OUTSTANDING 55,501 59,165 55,898 60,124
-------- -------- -------- --------
BASIC EARNINGS PER SHARE BEFORE
EXTRAORDINARY ITEM $ 0.34 $ 0.26 $ 0.78 $ 0.61
======== ======== ======== ========
BASIC EARNINGS PER SHARE -
EXTRAORDINARY ITEM $ - $ 0.12 $ - $ 0.12
======== ======== ======== ========
BASIC EARNINGS PER SHARE $ 0.34 $ 0.38 $ 0.78 $ 0.73
======== ======== ======== --------
DILUTED EARNINGS PER SHARE BEFORE
EXTRAORDINARY ITEM $ 0.33 $ 0.25 $ 0.77 $ 0.60
======= ======== ======== ========
DILUTED EARNINGS PER SHARE -
EXTRAORDINARY ITEM $ - $ 0.12 $ - $ 0.12
======== ======== ======== ========
DILUTED EARNINGS PER SHARE $ 0.33 $ 0.37 $ 0.77 $ 0.72
======= ======== ======== ========
</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,
1999 1998
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 43,147 $ 43,084
Reconciliation of net income to net cash
by operating activities:
Depreciation and amortization 10,682 8,930
Provision for doubtful accounts 551 876
Increase in deferred income taxes 8,785 12,878
Non cash interest and dividend income (12,209) (9,252)
Gain on extinguishment of capital lease obligations - (11,964)
Changes in assets and liabilities:
Change in receivables (4,459) (11,859)
Change in income taxes payable and other 5,874 (5,850)
Change in accounts payable and accrued expenses 7,212 (2,913)
-------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 59,583 23,930
-------- ---------
CASH FLOW FROM INVESTING ACTIVITIES:
Investment in property and equipment (16,509) (6,753)
Repayments of Sunburst Hospitality advances, net - 5,145
Increase in amounts due from marketing and
reservation funds, net (18,566) (3,506)
Other items, net (5,698) 108
-------- ---------
NET CASH UTILIZED BY INVESTING ACTIVITIES (40,773) (5,006)
-------- ---------
CASH FLOW FROM FINANCING ACTIVITIES:
Proceeds from long term borrowings 73,230 177,504
Principal payments of long term borrowings (43,918) (171,234)
Purchase of treasury stock (45,702) (36,965)
Proceeds from issuance of common stock 4,620 3,991
-------- ---------
NET CASH UTILIZED BY FINANCING ACTIVITIES (11,770) (26,704)
-------- ---------
Net change in cash and cash equivalents 7,040 (7,780)
Cash and cash equivalents, beginning of period 1,692 10,282
-------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 8,732 $ 2,502
======== =========
</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 year ended December 31, 1998 and notes
thereto included in the Company's Form 10-K, dated March 29, 1999. 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
financial statements to conform to the current year presentation.
2. During the nine months ended September 30, 1999, 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 $795,000.
3. SFAS 128 replaced the calculation of primary and fully diluted earnings per
share pursuant to Accounting Principles Board Opinion ("APB") No. 15, "Earnings
Per Share," with basic and diluted earnings per share. Unlike primary earnings
per share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share is computed
similarly to fully diluted earnings per share. Earnings per share amounts for
all years have been presented in conformity with SFAS 128.
Basic and diluted earnings per common share are computed by dividing net income
by the weighted average number of shares of common stock outstanding. The
weighted average number of shares outstanding was 55,173,832 and 59,130,054 for
basic earnings per share and 55,897,569 and 60,123,703 for earnings per share
assuming dilution for the nine months ended September 1999 and 1998,
respectively. The difference between the weighted average number of shares of
common stock outstanding used in the basic and diluted earnings per share
computations is entirely due to the assumed exercise of outstanding stock
options for diluted earnings per common share.
4. Marketing and Reservation Funds
The Company presents marketing and reservation fees such that the fees collected
and associated expenses are reported net. The total marketing and reservation
fees received by the Company (previously reported as revenue) was $41.9 million
and $38.9 million for the three months ended September 30, 1999 and 1998 and
$105.8 million and $95.6 million for the nine months ended September 30, 1999
and 1998. Depreciation and amortization incurred by the marketing and
reservation funds was $1.9 million and $0.9 million for the three months ended
September 30, 1999 and 1998 and $5.4 million and $3.1 million for the nine
months ended September 30, 1999 and 1998. Interest expense incurred by the
marketing and reservation funds was $0.9 and $0.5 for the three months ended
September 30,1999 and 1998 and $2.5 million and $1.1 million for the nine months
ended September 30, 1999 and 1998.
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 Company advances capital
as necessary to the marketing and reservation funds to support the development
and ongoing operations of the franchise system. As of September 30, 1999, the
Company's balance sheet includes an investment in and a receivable in amounts
due from marketing and reservation funds of $46.9 million related to shortfalls
in the marketing ($15.5 million) and reservation ($31.4 million) funds. As of
December 31, 1998, the Company's balance sheet includes an investment in and a
receivable in amounts due from marketing and reservation funds of $23.4 million
related to shortfalls in the marketing ($7.8 million) and reservation ($15.6
million) funds. The Company expects to recover these receivables through future
marketing and reservation fees.
7
<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) occupancies 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 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 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, 1999 Operating Results and
- -------------------------------------------------------------------------------
Three Month Period Ended September 30, 1998 Operating Results
- -------------------------------------------------------------
The Company reported net income of $18.3 million, or $0.33 per diluted share,
for the third quarter ended September 30, 1999, compared to net income for the
same period of 1998 of $21.9 million, or $0.37 per diluted share. The $0.37 per
diluted share in 1998 includes $0.12 resulting from a gain on exinguishment of
debt. Exclusive of this extraordinary item, diluted earnings per share
increased 32.0%. The increase in net income for the period is attributable to
an increase in royalty fees as a direct result of the addition of new franchised
hotels to the franchise system, improved RevPar and increases in the effective
royalty rate achieved for the domestic hotel system.
Franchise Revenues
- ------------------
Management analyzes its business based on "net franchise revenue," which is
total revenue excluding product sales and European hotel operations, and
franchise operating expenses, which are reflected as selling, general and
administrative expenses.
The Company's net franchise revenues were $46.9 million for the three months
ended September 30, 1999 and $42.7 million for the three months ended September
30, 1998.
Royalties increased $4.8 million to $40.5 million in 1999 from $35.7 million in
1998, an increase of 13.4%. The increase in royalties is attributable to a net
increase of 82 franchised hotels during the period (representing an additional
6,535 rooms) an improvement in domestic RevPAR of 2.1% and an increase in the
effective royalty rate of the domestic hotel system to 3.77% from 3.61%. Initial
and relicensing fee revenue generated from domestic franchise contracts signed
decreased to $3.3 million from $4.9 million in 1998 as a result of a decrease in
total franchise agreements signed to 68, as compared to 119 for the third
quarter of 1998. An increasingly competitive hotel franchising environment
coupled with stricter hotel brand standards being enforced by the Company
contributed to the decline in the total franchise agreements signed in the
period. The total number of domestic hotels online increased to 3,121 from
3,024 an increase of 3.2% for the period ending September 30, 1999. This
represents an increase in the number of rooms open of 3.0% from 251,415 as of
September 30, 1998 to 258,892 as of September 30, 1999. As of September 30,
1999, the Company had 563 hotels under development in its domestic hotel system
representing 44,366 rooms. The total number of international hotels online
increased to 1,058 from 619 an increase of 70.9% as of September 30, 1999.
International rooms open increased 46.1% from 52,437 as of September 30, 1998 to
76,632 as of September 30, 1999. These increases are primarily attributable to
the Company's 1998 Strategic Alliance with Flag International Limited. The
master franchise agreement with Flag Choice Hotels includes several countries
including Australia, Papua New Guinea and Fiji. The total number of
international hotels and rooms under development was 161 and 14,910,
respectively, as of September 30, 1999.
8
<PAGE>
Franchise Expenses
- ------------------
The cost to operate the franchising business is reflected in selling, general
and administrative expenses. Selling, general and administrative expenses
increased slightly between years. As a percentage of total net franchising
revenues, total selling, general and administrative expenses declined to 32.4%
for the third quarter of 1999 as compared to 33.2% for 1998. The improvement in
the franchising margins relates to the economies of scale generated from
operating a larger franchisee base.
Product Sales
- -------------
Sales made to franchisees through the Company's group purchasing program
decreased approximately $3.8 million to $1.2 million for the three months ended
September 30, 1999 from $5.0 million for the three months ended September 30,
1998. In the fourth quarter of 1998, the Company discontinued the group
purchasing program as previously operated. Remaining sales represent the
fulfillment of orders placed in 1998.
Other
- -----
For the three months ended September 30, 1999, and September 30, 1998 the
Company recognized approximately $0.8 million and $0.6 million, respectively,
in dividend income from its investment in Friendly Hotels, PLC and approximately
$3.6 million and $2.7 million, respectively, 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, 1999 Operating Results and
- ------------------------------------------------------------------------------
Nine Month Period Ended September 30, 1998 Operating Results
- ------------------------------------------------------------
The Company reported net income of $43.1 million, or $0.77 per diluted share,
for the nine months ended September 30, 1999, compared to net income for the
same period of 1998 of $43.1 million, or $0.72 per diluted share. The $0.72 per
diluted share in 1998 includes approximately $0.12 resulting from a gain on
early extinguishment of debt. Exclusive of this extraordinary item, diluted
earnings per share increased 28.3%. The increase in net income for the period
is attributable to an increase in royalty fees as a direct result of the
addition of new franchised hotels to the franchise system, improved RevPar and
increases in the effective royalty rate achieved for the domestic hotel system.
Franchise Revenues
- ------------------
The Company's net franchise revenues were $114.1 million for the nine months
ended September 30, 1999 and $105.9 million for the nine months ended September
30, 1998.
Royalties increased $9.8 million to $95.5 million in 1999 from $85.7 million in
1998, an increase of 11.4%. The increase in royalties is attributable to a net
increase of 114 franchised hotels during the period (representing an additional
8,178 rooms) an improvement in domestic RevPAR of 3.2% and an increase in the
effective royalty rate of the domestic hotel system to 3.69% from 3.55%. Initial
and relicensing fee revenue generated from domestic franchise contracts signed
decreased to $9.9 million from $12.6 million in 1998 as a result of a decrease
in total franchise agreements signed to 224, as compared to 328 for the nine
months ended September 30, 1998. An increasingly competitive hotel franchising
environment coupled with stricter hotel brand standards being enforced by the
Company contributed to the decline in total franchise agreements signed in the
period.
Franchise Expenses
- ------------------
Selling, general and administrative expenses increased approximately $2.0
million between years. As a percentage of total net franchising revenues, total
selling, general and administrative expenses declined to 34.0% for the nine
months ended 1999 as compared to 34.8% for 1998. The improvement in the
franchising margins relates to the economies of scale generated from operating a
larger franchisee base.
9
<PAGE>
Product Sales
- -------------
Sales made to franchisees through the Company's group purchasing program
decreased approximately $12.9 million to $4.5 million for the nine months ended
September 30, 1999 from $17.4 million for the nine months ended September 30,
1998. In the fourth quarter of 1998, the Company discontinued the group
purchasing program as previously operated. Remaining sales represent the
fulfillment of orders placed in 1998.
Other
- -----
For the nine months ended September 30, 1999, and September 30, 1998 the Company
recognized approximately $1.9 million and $1.6 million, respectively, in
dividend income from its investment in Friendly Hotels, PLC and approximately
$10.5 million and $7.6 million, respectively, of interest income from its
subordinated term note to Sunburst Hospitality, Inc.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Net cash provided by operating activities was $59.6 million for the nine months
ended September 30, 1999, an increase of approximately $35.7 million from $23.9
million for 1998. The increase results from improved operating performance and
stronger management of working capital. At September 30, 1999, the total long-
term debt outstanding for the Company was $307.5 million, $30.1 million of which
matures in the next twelve months.
The Company has repurchased 7.2 million shares of its common stock at a total
cost of $103.2 million in 1999. The Company has authorization from its Board of
Directors to repurchase up to an additional 1.5 million shares.
The Company believes that cash flows 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
- --------------------
We are engaged in an ongoing effort to evaluate and remediate the Year 2000
computer problem shared by virtually all companies and businesses. This Year
2000 problem is a result of two-digit date codes used in many computer programs
and embedded chip systems. These systems cannot recognize a year that begins
with "20" rather than "19".
As part of our 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 Year 2000 action plan includes the
following phases:
1. Awareness: making our internal organizations and business units aware
of the Year 2000 issue and assigning responsibility internally.
2. Inventorying and testing our proprietary software and systems (e.g.,
reservation system, property management system).
3. Inventorying and testing secondary internal systems (e.g., network
infrastructure, phone system, employee PCs).
4. Assessing the risk from third party vendors and franchisees.
5. Contingency planning.
6. Educating the franchise community.
Throughout the process, remedial actions have been or will be taken as
warranted. We consider a system to be Year 2000 compliant if it will perform
its essential functions on and after January 1, 2000, or will be able to do so
with readily available one-time modifications.
10
<PAGE>
The table below summarizes the status of our Year 2000 action plan as of
November 1, 1999.
<TABLE>
<CAPTION>
Year 2000
Step Status Compliance Issues
- ---- ------ -----------------
<S> <C> <C>
Awareness Complete None
Inventorying and Complete Two DOS-based systems are non-
testing of proprietary compliant. Compliant Windows
software and systems based versions are available.
Inventorying and Complete No material compliance issues.
testing of secondary
systems
Assessment of 75% No material compliance issues.
third-party vendors
Contingency Planning 75% No material compliance issues.
Franchisee education 80% Not applicable.
</TABLE>
Our exposure to potential Year 2000 problems exists in two general areas:
technological operations solely in our control, and technological operations
dependent in some way on one or more third parties. With respect to our
internal systems, we have conducted Year 2000 compliance testing on all of our
proprietary software, including our "Choice 2001" reservations system and
related reservations support systems, our franchise support system and
franchisee property management support systems. The tests have indicated that,
except for two DOS-based systems, the proprietary software is Year 2000
compliant. The Choice 2001 system is currently accepting and successfully
processing reservations for January 1, 2000 and beyond.
The DOS version of ChoiceLINK (the system used by the hotels to communicate with
the Choice 2001 system) is not Year 2000 compliant and the DOS version of the
Company's property management system is only compliant through December 31,
2000. We have communicated this to franchisees using these systems and have
recommended that they migrate to the Windows based versions of these systems.
In September 1999, we established financial incentives for franchisees using the
DOS version of ChoiceLINK to switch to the Windows-based version.
We have also been in the process of replacing our hardware platforms for our
internal systems and a number of smaller support systems and have kept them
updated so that all of our large system computers are no more than three years
old. Based on manufacturers specifications, we believe that these new hardware
platforms, except for several servers, are Year 2000 compliant. These servers
will be replaced before December 31, 1999.
We have completed the process of conducting an inventory of third party
software, including financial and accounts payable systems, PC operating systems
and word processing and other commercial software. For hardware or software
systems which do not appear to be compliant, we are obtaining upgrades or
replacement systems.
The Year 2000 Compliance Committee has identified third party vendors and
service providers whose non-compliant systems could have a material impact on
the Company and has undertaken an assessment as to such parties' compliant
status. These parties include 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 us in writing that they are compliant and we
have conducted tests with three of the four major GDS companies. The Year 2000
Compliance Committee continues to assess other third parties as to their
compliance and the consequences in the event they are not compliant. Vendors
who have responded indicated that they are, or expect to be, Year 2000
compliant. Throughout 1999, the Year 2000 Compliance Committee will continue to
seek and assess responses from all of its material vendors.
In June 1999, we initiated an assessment of all of our domestic franchised
hotels. The assessment seeks to determine the level of preparedness of the
domestic franchise system. The assessment attempts to solicit whether the
hotels have undertaken a Year 2000 compliance assessment with respect to
building automation and maintenance systems, hotel management systems (other
than those acquired from the Company), information technology systems and third
party products and services. As of November 1, 1999, responses have been
received from approximately 20% of domestic franchised hotels. While the
response rate is not statistically significant to determine system-wide trends,
80% of those who responded indicated that they had completed a Year 2000
assessment. We continue to seek responses from the remainder of our
franchisees. Upon completion of the assessment, we will be better able to
determine risks which may be posed if a significant number of hotel owners have
not addressed the Year 2000 status of such systems.
11
<PAGE>
Our educational efforts with respect to our franchisees have included seminars
at our annual convention and management conferences and distribution of sample
assessment checklists and other materials. In November 1999, we will distribute
to all franchised hotels a Year 2000 guide which will advise franchisees of
suggested Year 2000 preparedness and contingency plans.
We have devised contingency plans for our Silver Spring, Maryland corporate
offices, our Phoenix, Arizona reservation center and our reservation call
centers. These plans include insuring the availability of key employees and,
with respect to the reservation center, access to alternative power sources.
Costs of addressing potential Year 2000 compliance/remediation problems have not
been material to date. The value of employee time devoted to testing and
development has been approximately $250,000. Total costs for replacement of
hardware and operating systems are expected to be approximately $700,000.
However, these replacements (as well as replacements undertaken in prior years)
are being implemented primarily as part of our ongoing technology updating,
rather than specifically for Year 2000 compliance reasons.
Based upon information gathered to date, potential Year 2000 business
interruptions or liability costs are not currently expected to have a material
adverse impact on the Company's financial position, results of operations or
cash flows. However, such Year 2000 issues (including incomplete or inaccurate
3rd party information and system failures) could pose unforeseen material
financial risk, including loss of revenue, substantial unanticipated costs and
service interruptions.
We are 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
- --------------------------
When used throughout this report, the words "believes," "anticipates,"
"expects," "intends," "estimates," "projects," and other similar expressions,
which are predictions of or indicate future events and trends, identify forward-
looking statements. Such statements are subject to a number of risks and
uncertainties which could cause actual results to differ materially from those
projected, including: competition within each of our business segments; business
strategies and their intended results; the balance between supply of and demand
for hotel rooms; our ability to obtain new franchise agreements; our ability to
develop and maintain positive relations with current and potential hotel owners;
the effect of international, national and regional economic conditions; the
availability of capital to allow us and potential hotel owners to fund
investments; our ability, and that of other parties upon which our businesses
also rely, to modify or replace on a timely basis, their computer software and
other systems in order to function properly prior to, in and beyond, the year
2000; and other risks described from time to time in our filings with the
Securities and Exchange Commission, including those set forth under the heading
"Risk Factors" in our Report on Form 10-Q for the Period ended June 30, 1999.
Given these uncertainties, you are cautioned not to place undue reliance on such
statements. We also undertake no obligation to publicly update or revise any
forward-looking statement to reflect current or future events or circumstances.
ITEM 3. QUANTITATIVE AND QUALITATIVE ANALYSIS OF MARKET RISK
-----------------------------------------------------
The Company is exposed to market risk from changes in interest rates and the
impact of fluctuations in foreign currencies on the Company's foreign
investments. The Company manages its exposure to this market risk through the
monitoring of its available financing alternatives including in certain
circumstances the use of derivative financial instruments. The Company's
strategy to manage exposure to changes in the interest rates and foreign
currencies remains unchanged from 1997. Furthermore, the Company does not
foresee any significant changes in exposure in these areas or in how such
exposure is managed in the near future.
The following table summarizes information about derivative financial
information and other financial instruments that are sensitive to changes in
interest rates, including interest rate swap agreements and debt obligations.
For interest rate swap agreements, the table presents notional amounts and
weighted average interest rates by expected (contractual) maturity date.
12
<PAGE>
Expected Maturity Date
<TABLE>
<CAPTION>
1999 Fair
1999 2000 2001 2002 2003 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities:
Long-term debt (1)
Fixed rate - - - - - 100,000 100,000 96,410
Average interest
rate 7.13%
Variable rate (2) - - - 207,492 - - 207,492 207,492
Average interest (3)
rate 6.64%
</TABLE>
Interest Rate Derivatives
Expected Maturity Date
<TABLE>
<CAPTION>
1999 Fair
1999 2000 2001 2002 2003 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Notional Amount - - - 115,000 (193)
Average interest rate 5.85%
Receivable 0
Payable (65)
</TABLE>
(1) A hypothetical one hundred basis point change in interest rates would
change the fair value of long-term debt by $6.8 million.
(2) The Company will refinance the $150 million variable rate term loan as it
amortizes throughout the expected maturity dates. Upon expiration of the
credit facility in 2002, the Company expects to refinance its obligations.
(3) Weighted average variable rates are based on implied forward rates in the
yield curve at the reporting date.
The Company is also exposed to fluctuations in foreign currency relating to its
preferred stock investment in Friendly Hotels, PLC which is denominated in
British Pounds. The Company does not have any derivative financial instruments
related to its foreign investments.
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 6. EXHIBITS AND REPORTS ON FORM 8-K
--------------------------------
(a) Exhibits
Exhibit 27.01 - Financial Data Schedule - September 30, 1999
(b) The following reports were filed pertaining to the period ended
September 30, 1999.
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 10, 1999 /s/ Charles A. Ledsinger, Jr.
------------------ ----------------------------
By: Charles A. Ledsinger, Jr.
President and Chief Executive Officer
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF INCOME AND THE
CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS AND THE NOTES THERETO.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 8,732
<SECURITIES> 0
<RECEIVABLES> 41,009
<ALLOWANCES> 8,237
<INVENTORY> 0
<CURRENT-ASSETS> 45,093
<PP&E> 60,643
<DEPRECIATION> 18,245
<TOTAL-ASSETS> 461,313
<CURRENT-LIABILITIES> 81,457
<BONDS> 277,346
0
0
<COMMON> 615
<OTHER-SE> 57,187
<TOTAL-LIABILITY-AND-EQUITY> 461,313
<SALES> 0
<TOTAL-REVENUES> 118,585
<CGS> 0
<TOTAL-COSTS> 48,015
<OTHER-EXPENSES> (1,364)
<LOSS-PROVISION> 551
<INTEREST-EXPENSE> 14,796
<INCOME-PRETAX> 71,934
<INCOME-TAX> 28,787
<INCOME-CONTINUING> 43,147
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 43,147
<EPS-BASIC> 0.78
<EPS-DILUTED> 0.77
</TABLE>
