<PAGE>
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- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
(MARK ONE)
/x/ QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------ -------------------
Commission file number 0-23941
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U.S. FRANCHISE SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 58-2361501
(State or other jurisdiction of (I.R.S Employer
Incorporation or Organization) Identification No.)
13 Corporate Square, Suite 250 30329
Atlanta, Georgia (Zip Code)
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (404) 321-4045
-----------
Indicate by check mark whether the registrant: (1) has filed all reports
required by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or 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 / /
There were 17,167,194 shares of the registrant's Class A Common Stock and
2,707,919 shares of the registrant's Class B Common Stock outstanding as of
October 1, 1998.
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1
<PAGE>
U.S. FRANCHISE SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Financial Position at December 31, 1997 and September 30, 1998 (Unaudited)........ 3
Consolidated Statements of Operations for the three, and nine months ended September 30, 1998 and 1997
(Unaudited).................................................................................................. 4
Consolidated Statement of Cash Flows for the nine months ended September 30, 1998 and 1997 (Unaudited)....... 5
Notes to Consolidated Financial Statements (Unaudited)....................................................... 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS........................ 8
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................................... 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................................................................ 15
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.................................................................... 16
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.............................................................................. 16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......................................................... 16
ITEM 5. OTHER INFORMATION............................................................................................ 16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................................. 16
SIGNATURES................................................................................................... 16
EXHIBIT INDEX................................................................................................ 17
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments ................................................. $ 19,221,000 $ 15,890,000
Accounts receivable (net of allowance for doubtful accounts of $42,000 and $17,000 as
of September 30, 1998 and December 31, 1997, respectively) ....................... 1,701,000 268,000
Deposits ............................................................................ 385,000 114,000
Prepaid expenses .................................................................... 201,000 602,000
Promissory notes receivable ......................................................... 3,254,000 862,000
Deferred commissions ................................................................ 2,229,000 2,563,000
------------ ------------
Total current assets ........................................................ 26,991,000 20,299,000
PROMISSORY NOTES RECEIVABLE ............................................................ 20,080,000 2,869,000
PROPERTY AND EQUIPMENT-Net ............................................................. 2,998,000 5,595,000
FRANCHISE RIGHTS-Net ................................................................... 25,732,000 3,322,000
DEFERRED COMMISSIONS ................................................................... 5,558,000 3,049,000
OTHER ASSETS-Net ....................................................................... 2,495,000 1,217,000
------------ ------------
Total assets ................................................................ $ 83,854,000 $ 36,351,000
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable .................................................................... $ 530,000 $ 1,138,000
Commissions payable ................................................................. 1,187,000 1,171,000
Deferred application fees ........................................................... 3,640,000 4,402,000
Accrued expenses .................................................................... 927,000 990,000
Due to Hudson Hotels Corporation .................................................... 454,000 454,000
------------ ------------
Total current liabilities ................................................... 6,738,000 8,155,000
DEFERRED APPLICATION FEES .............................................................. 7,618,000 4,586,000
SUBORDINATED DEBENTURES ................................................................ -- 19,412,000
------------ ------------
Total liabilities ........................................................... 14,356,000 32,153,000
REDEEMABLE STOCK:
Common shares, par value $0.01 per share; issued and outstanding 3,128,473
(net of 58,807 shares in Treasury) at September 30, 1998 and December
31, 1997 entitled to redemption under certain circumstances to $324,000
(net of $6,000 in Treasury) at September 30, 1998 and December 31, 1997,
respectively ..................................................................... 324,000 324,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common shares, par value $0.01 per share; authorized 30,000,000 shares of
Class A Common Stock and 5,000,000 shares of Class B Common Stock;
issued and outstanding 14,038,721 Class A shares and 2,707,919 Class B
shares at September 30, 1998; issued and outstanding 6,716,499 Class A
shares and 2,707,919 Class B shares at December 31, 1997.......................... 167,000 96,000
Capital in excess of par ............................................................... 89,322,000 21,092,000
Accumulated deficit .................................................................... (20,315,000) (17,314,000)
------------ ------------
Total stockholders' equity .................................................. 69,174,000 3,874,000
------------ ------------
$ 83,854,000 $ 36,351,000
------------ ------------
------------ ------------
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Three Months Nine months Nine months
Ended Ended Ended Ended
September 30, 1998 September 30, 1997 September 30, 1998 September 30, 1997
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
REVENUES:
Royalty and fee income .................... $ 2,326,000 $ 94,000 $ 4,732,000 $ 177,000
Franchise application fees ............... 973,000 443,000 2,478,000 863,000
Other .................................... 55,000 53,000 234,000 92,000
------------ ------------ ------------ ------------
3,354,000 590,000 7,444,000 1,132,000
EXPENSES:
General and administrative ................ 2,855,000 2,217,000 8,702,000 6,742,000
Franchise sales commissions ............... 799,000 259,000 1,628,000 496,000
Depreciation and amortization ............. 415,000 142,000 1,018,000 409,000
Interest income ........................... (836,000) (339,000) (1,664,000) (1,097,000)
Interest expense .......................... 12,000 492,000 761,000 1,452,000
------------ ------------ ------------ ------------
3,245,000 2,771,000 10,445,000 8,002,000
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Net Income (Loss) ........................... $ 109,000 $ (2,181,000) $ (3,001,000) $ (6,870,000)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING.................................. 19,875,113 12,541,405 16,935,751 12,567,398
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
NET INCOME (LOSS) PER SHARE-BASIC AND DILUTED $ 0.01 $ (0.17) $ (0.18) $ (0.55)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Nine Months
Ended Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss ................................................................. $ (3,001,000) $ (6,870,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ......................................... 1,018,000 409,000
Deferred compensation amortization .................................... 223,000 218,000
Changes in assets and liabilities:
Increase in deposits and accounts receivable .......................... (1,704,000) (94,000)
Decrease/Increase in prepaid expenses ................................. 226,000 (210,000)
Increase in promissory notes receivable ............................... (4,603,000) (1,739,000)
Increase in deferred commissions ...................................... (2,175,000) (1,849,000)
Increase in other assets .............................................. (1,339,000) (1,755,000)
Decrease in accounts payable .......................................... (608,000) (463,000)
Decrease/Increase in accrued expenses ................................. (63,000) 282,000
Increase in commissions payable ....................................... 16,000 185,000
Increase in deferred application fees ................................. 2,270,000 2,365,000
Increase in subordinated debentures ................................... 364,000 698,000
------------ ------------
Net cash used in operating activities ............................... (9,376,000) (8,823,000)
INVESTING ACTIVITIES:
Acquisition of property and equipment .................................... (3,400,000) (621,000)
Increase in long-term notes receivable ................................... (15,000,000)
Proceeds from short-term debt ............................................ 10,000,000
Repayment of short-term debt ............................................. (10,000,000)
Proceeds from sale of properties ......................................... 5,752,000
Acquisition of franchise rights .......................................... (2,877,000) --
------------ ------------
Net cash used in investing activities ............................... (15,525,000) (621,000)
FINANCING ACTIVITIES:
Repayment of subordinated debentures ..................................... (19,776,000) --
Issuance of common stock ................................................. 48,008,000 --
------------ ------------
Treasury Stock ............................................................ (4,000)
------------ ------------
Net cash provided by financing activities ........................... 28,232,000 (4,000)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH INVESTMENTS............... $ 3,331,000 $ (9,448,000)
CASH AND TEMPORARY INVESTMENTS
Beginning of period ...................................................... 15,890,000 31,188,000
------------ ------------
End of period ............................................................ $ 19,221,000 $ 21,740,000
------------ ------------
------------ ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Noncash activities:
Issuance of 2,222,222 shares for acquisition of Hawthorn franchise
rights ............................................................. $ 17,777,000 $ --
------------ ------------
------------ ------------
Issuance of stock for acquisition of Best Inns and Suites franchise
rights ............................................................ $ 2,293,000 $ --
------------ ------------
------------ ------------
Exchange of redeemable preferred stock for subordinated debentures ... $ -- $ 18,477,000
------------ ------------
------------ ------------
Portion of purchase price due to Hudson Hotels Corporation in future
years, discounted at 10% ........................................... $ -- $ 454,000
------------ ------------
------------ ------------
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission for
reporting on Form 10-Q. Accordingly, certain information and footnotes required
by generally accepted accounting principles for complete financial statements
have been omitted. In the opinion of management, all adjustments, consisting of
normal recurring adjustments, which are necessary for a fair presentation of
financial position and results of operations have been made. These interim
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto, presented in the U.S. Franchise Systems,
Inc. ("USFS" or the "Company") Annual Report on Form 10-K for the year ended
December 31, 1997 and the Form 10-K/A dated on April 29, 1998, filed with the
Securities and Exchange Commission. The results of operations for the nine
months ended September 30, 1998 are not necessarily indicative of results that
may be expected for the full year.
2. RECLASSIFICATIONS
Certain amounts in the September 30, 1997 statement of operations have been
reclassified to conform to current year classifications.
3. EARNINGS PER SHARE
Earnings per share for the three and nine months ended September 30, 1998
and three and nine months ended September 30, 1997 have been calculated by
dividing the net income (loss) applicable to common shareholders by the weighted
average shares outstanding. Weighted averaged shares include redeemable common
shares outstanding.
4. RESERVATIONS AND ADVERTISING FUNDS
On August 7, 1998 the Company created independent reservations and
advertising funds ("the Funds") for the purpose of collecting and disbursing
reservations and advertising fees related to the Microtel and Hawthorn brands.
In connection with the creation of the Funds, the Company eliminated reporting
reservations and advertising fees and expenses from its consolidated financial
statements effective April 1, 1998. Any differences between reservations and
advertising revenues and expenses for quarterly periods prior to April 1, 1998
have been included in general and administrative expenses. The Company may
choose to make interest bearing loans to the Funds from time to time in order to
supplement reservation, advertising and promotional efforts. The new
presentation is considered preferable to prior practice giving consideration to
industry trends, to providing a consistent reporting policy among its brands and
in understanding the Company's operating performance. The Company manages the
reservations and advertising programs on behalf of the Funds.
5. ACQUISITION OF BEST INNS
On April 28, 1998, the Company completed its acquisition of the exclusive
worldwide franchise rights to the Best Inns hotel brands, including the
franchise agreements for the existing Best Inns hotels. In addition, the Company
acquired the management contracts and became the employer of certain personnel
engaged in the corporate management of 29 Best Inns hotels.
In connection with this transaction, the Company and the sellers entered
into an agreement with Alpine Hospitality Ventures LLC ("Ventures") pursuant to
which Ventures (through a wholly-owned subsidiary) acquired 17 Best Inns hotels
(the "Acquired Hotels"). Contemporaneously with the closing of the transaction,
new franchise and management agreements were entered into between the Company
and Ventures with respect to the Acquired
6
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Hotels. As a result of the transaction, the Company owns the exclusive worldwide
franchise rights to the Best Inns hotel brands which were recorded at $4,500,000
comprised of 150,000 shares of Class A Common Stock valued at $11.13 per share
($1,668,000 in the aggregate), and the discount to the market of $11.13 per
share on 200,000 shares of Class A Common Stock sold for cash at $8.00 per share
($625,000 in the aggregate) and related expenses.
To facilitate the transaction, the Company made a $15 million unsecured
subordinated loan to Ventures at an interest rate of 12% per annum, interest on
which will be paid in cash to the extent there is available cash and otherwise
will be paid-in-kind. The loan is subordinated to a guarantee provided by
Ventures in connection with a third-party loan in the principal amount of
approximately $65 million to its subsidiary that owns the Acquired Hotels and is
subordinated to such third party loan. The Company made the subordinated loan
and issued the Alpine Shares (as defined below) in order to induce Ventures to
purchase from the Sellers the Acquired Hotels. The Company also committed to
make up to $7.5 million of additional loans to Ventures under certain
circumstances.
Also in connection with the Best Inns acquisition, the Company issued to
Alpine Hospitality Equities LLC ("Alpine Equities"), an affiliate of Ventures,
350,000 shares (the "Alpine Shares") of Class A Common Stock for a purchase
price of $1.6 million. Alpine Equities was granted certain demand and piggy-back
registration rights on customary terms with respect to the Alpine Shares, as
well as certain tag-along rights on certain sales of Common Stock made by
Messrs. Leven and Aronson. Additionally, the Company agreed to pay to Alpine
Equities $1,000 per year for each Best Inns hotel that is added to the Best Inns
system of hotels after the closing date of the transaction, provided that such
new hotels are paying royalties to the Company or any of its affiliates (the
"New Hotel Fee").
Richard D. Goldstein, a director of the Company, is an Executive Vice
President and a Senior Managing Director of the general partner Alpine Equity
Partners LP, the entity that indirectly owns and controls a majority of Alpine
Equities and Ventures.
6. COMPLETION OF EQUITY OFFERING
On May 19, 1998, the Company completed a secondary public offering of
4,250,000 shares of Class A Common Stock at $10.50 per share (the "Equity
Offering"). Net proceeds to the Company from the Equity Offering were
approximately $40,800,000. As of September 30, 1998, approximately $30,100,000
of such net proceeds had been used by the Company, primarily to: (i) repay
approximately $20,100,000 on the Company's 10% Subordinated Debentures due
September 29, 2007, consisting of the aggregate principal amount outstanding
plus interest accrued thereon to May 15, 1998, the date of repayment, and (ii)
repay approximately $10 million aggregate principal amount outstanding under a
loan incurred on April 28, 1998 in connection with the Company's acquisition of
the exclusive worldwide franchise rights to the Best Inns hotel brands, plus
interest accrued thereon to May 19, 1998, the date of repayment. The remaining
proceeds of approximately $10,700,000 were held either as cash or cash
equivalents and will be used for working capital and general corporate purposes.
7. ACCOUNTING PRONOUNCEMENTS
The Company adopted Financial Accounting Standards Board (FASB) Statement
No. 130, "Reporting Comprehensive Income," at the beginning of fiscal year 1998.
Statement No. 130 established standards for reporting and display of
comprehensive earnings and its components in financial statements; however, the
adoption of this Statement had no impact on the Company's net earnings or
shareholders' equity.
The Financial Accounting Standards Board (FASB) has issued two accounting
pronouncements which the Company will adopt in the fourth quarter of 1998. FASB
Statement No. 131 "Disclosures about Segments of an Enterprise and Related
Information" requires that a publicly-held company report financial and
descriptive information about its operating segments in financial statements
issued to shareholders for interim and annual periods. The
7
<PAGE>
statement also requires additional disclosures with respect to products and
services, geographic areas of operation, and major customers.
FASB Statement No. 132 "Employers' Disclosures about Pensions and Other
Postretirement Benefits-an amendment of FASB Statements NO. 87, 88, and 106"
requires revised disclosures about pension and other postretirement benefit
plans. The Company does not expect that adoption of the disclosure requirements
of this pronouncement will have a material impact on its financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
GENERAL
This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" should be read in conjunction with the consolidated
financial statements included herein of the Company and its subsidiaries.
Certain statements under this caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" constitute "forward-looking
statements" under the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). Certain, but not necessarily all, of such forward-looking
statements can be identified by the use of forward-looking terminology such as
"believes," "expects," "may," "will," "should," or "anticipates" or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy that involve risks and uncertainties. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of U.S.
Franchise Systems, Inc. and its subsidiaries ("USFS" or the "Company") to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
but are not limited to, the following: general economic and business conditions;
competition in the lodging and franchising industries; success of acquisitions
and operating initiatives; management of growth; dependence on senior
management; brand awareness; general risks of the lodging and franchising
industries; development risk; risk relating to the availability of financing for
franchisees; the existence or absence of adverse publicity; changes in business
strategy or development plan; availability, terms and deployment of capital;
business abilities and judgment of personnel; availability of qualified
personnel; labor and employee benefit costs; changes in, or failure to comply
with, government regulations; construction schedules; the costs and other
effects of legal and administrative proceedings; and other factors referenced in
this Form 10-Q. The Company will not undertake and specifically declines any
obligation to publicly release the results of any revisions which may be made to
any forward-looking statement to reflect events or circumstances after the date
of such statements or to reflect the occurrence of anticipated or unanticipated
events.
The Company was formed to acquire, market and service well-positioned
brands with potential for rapid unit growth through franchising. The Company's
initial brands, which are in the lodging industry, were the Microtel and
Hawthorn Suites brands. The Company acquired the rights to these brands because
of their potential for significant growth, which reflects, among other things,
their potential profitability for franchisees at the property level and their
positions in attractive segments of the lodging industry. In addition, the
Company recently acquired the exclusive worldwide franchise rights to the Best
Inns brand, an economy and upper economy brand positioned between the budget
Microtel and upscale Hawthorn Suites brands. With the acquisition of the Best
Inns brand, the Company also acquired management contracts and capabilities.
(See footnote 5.- Acquisition of Best Inns.)
As a franchisor, the Company licenses the use of its brand names to
independent hotel owners and operators (i.e. franchisees). The Company provides
its franchisees with a
8
<PAGE>
variety of benefits and services designed to (i) decrease the development costs,
(ii) shorten the time frame and reduce the complexity of the construction
process and (iii) increase the occupancy rates, revenues and profitability of
the franchised properties. The Company offers prospective franchisees access to
financing, a business format, design and construction assistance (including
architectural plans), uniform quality standards, training programs, national
reservations systems, national and local advertising, promotional campaigns and
volume purchasing discounts.
The Company expects that its future revenues will consist primarily of (i)
franchise royalty fees, (ii) franchise application fees, (iii) various
management fees, and (iv) payments made by vendors who supply the Company's
franchisees with various products and services. The Company recognizes franchise
application fees as revenue only upon the opening of the underlying hotels.
The Company's predecessor was incorporated in Delaware in August 1995. The
Company was incorporated in Delaware on November 26, 1997 and merged with its
predecessor on March 12, 1998 with the Company as the surviving corporation. The
Company's executive offices are located at 13 Corporate Square, Suite 250,
Atlanta, Georgia 30329 and its telephone number is (404) 321-4045.
Comparisons have been made between the three and nine months ended
September 30, 1998 and September 30,1997 for the purposes of the following
discussion:
Results of Operations
FRANCHISE SALES GROWTH-Since acquiring the Microtel brand in October 1995
and establishing its sales force by January 1996, the Company has realized
franchise sales growth as follows:
<TABLE>
<CAPTION>
Microtel Franchise Data As of September As of September
----------------------- 30, 1998 30, 1997
---------------- ----------------
<S> <C> <C>
Properties open (1) .......................................... 110 58
Executed agreements & under construction .................. 59 40
Executed franchise agreements but not under construction(2) 267 224
Accepted applications ..................................... 79 92
Total under development and accepted applications (3) ........ 405 356
--- ---
OPEN PLUS UNDER DEVELOPMENT AND ACCEPTED APPLICATIONS ........ 515 414
</TABLE>
- -----------
(1) The Company does not receive royalties from 29 and 28 hotels open as of
September 30, 1998 and September 30, 1997, respectively.
(2) The Company will not receive royalties from 5 of the executed franchise
agreements not under construction as of September 30, 1997.
(3) There can be no assurance that properties under development or for which
applications have been accepted will result in open hotels.
9
<PAGE>
Since acquiring the Hawthorn Suites brand in March 1996 and establishing
its sales force by July 1996, the Company has realized franchise sales growth as
follows:
<TABLE>
<CAPTION>
Hawthorn Suites Franchise Data As of September As of September
------------------------------ 30, 1998 30, 1997
--------------- ----------------
<S> <C> <C>
Properties open (1) ....................................... 44 22
Executed agreements & under construction ............... 26 9
Executed franchise agreements but not under construction 85 51
Accepted applications .................................. 66 23
Total under development and accepted applications (2) ..... 177 83
--- ---
OPEN PLUS UNDER DEVELOPMENT AND ACCEPTED APPLICATIONS ..... 221 105
</TABLE>
- -----------
(1) The Company was not receiving royalties from 18 of the hotels open as of
September 30, 1997. As a result of the Company acquiring the full ownership
and interest to the exclusive worldwide rights to franchise and control the
development and operation of the Hawthorn Suites brand of hotels on March
12, 1998 ("HSA Acquisition"), the Company now receives and retains
royalties from 43 of the 44 open hotels as of September 30, 1998.
(2) There can be no assurance that properties under development or for which
applications have been accepted will result in open hotels.
Since acquiring the Best Inns brand in April 1998, the Company has realized
franchise sales growth as follows:
<TABLE>
<CAPTION>
As of September As of September
Best Inns Franchise Data 30, 1998 30, 1997
- ------------------------ ------------------- -------------------
<S> <C> <C>
Properties open....................................................................... 45 -
Executed agreements & under construction......................................... 9 -
Executed franchise agreements but not under construction......................... 11 -
Accepted applications............................................................ 101 -
Total under development and accepted applications (1)............................... 121 -
------------------- -------------------
OPEN PLUS UNDER DEVELOPMENT AND ACCEPTED APPLICATIONS............................... 166 -
</TABLE>
- -----------
(1) There can be no assurance that properties under development or for which
applications have been accepted will result in open hotels.
REVENUE-The Company has derived revenues from the following sources:
<TABLE>
<CAPTION>
Three Months Three Months Nine months Nine months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Royalty and fee income ... $2,326,000 $ 94,000 $4,732,000 $ 177,000
Franchise application fees 973,000 443,000 2,478,000 863,000
Other .................... 55,000 53,000 234,000 92,000
---------- ---------- ---------- ----------
TOTAL .................... $3,354,000 $ 590,000 $7,444,000 1,132,000
</TABLE>
10
<PAGE>
Three months ended September 30, 1998 compared to three months ended September
30, 1997
Royalty and fee income increased $2,232,000 for the three months ended
September 30, 1998 as compared to the comparable prior year's period. The
increase is primarily attributable to (i) the royalty fees received on the 52
Microtels and 22 Hawthorn Suites open on September 30, 1998 which were not open
on September 30, 1997, (ii) the royalty fees received on the 18 Hawthorn Suites
which started paying royalties to the Company in March 1998 with the completion
of the HSA Acquisition, (iii) the royalty fees received on 45 Best Inns hotels
that were open as of September 30, 1998 in connection with the Company's
acquisition of the Best Inns brands in April 1998 (see footnote 5.-Acquisition
of Best Inns), (iv) Development Fund management fee revenue, and (v) management
fees for the hotels that the Company manages as a result of the Best Inns
acquisition.
Franchise application fees increased $530,000 for the three months ended
September 30, 1998 as compared to the comparable prior year's period. The
increase is primarily attributable to the application fees received on 32
Microtel, Hawthorn Suites and Best Inns properties opened during the third
quarter of 1998 compared to the application fees received on 18 properties
opened during the third quarter of 1997.
Other income increased $2,000 for the three months ended September 30, 1998
as compared to the comparable prior year's period.
Nine months ended September 30, 1998 compared to nine months ended September 30,
1997
Royalty and fee income increased $4,555,000 for the nine months ended
September 30, 1998 as compared to the comparable prior year's period. The
increase is primarily attributable to (i) the royalty fees received on the 52
Microtels and 22 Hawthorn Suites open on September 30, 1998 which were not open
on September 30, 1997, (ii) the royalty fees received on the 18 Hawthorn Suites
which started paying royalties to the Company in March 1998 with the completion
of the HSA Acquisition, (iii) the royalty fees received on 45 Best Inns hotels
in connection with the Company's acquisition of the Best Inns brands in April
1998 (see footnote 5.-Acquisition of Best Inns), (iv) Development Fund
management fee revenue, and (v) management fees for the hotels that the Company
manages as a result of the Best Inns acquisition.
Franchise application fees increased $1,615,000 for the nine months ended
September 30, 1998 as compared to the comparable prior year's period. The
increase is primarily attributable to the application fees received on the 75
Microtel, Hawthorn Suites and Best Inns properties opened during the first three
quarters of 1998 compared to the 34 properties opened during the first three
quarters of 1997.
Other income increased $142,000 for the nine months ended September 30,
1998 as compared to the comparable prior year's period. The majority of the
increase is attributable to the incremental fees received from the National
Accounts program for the nine months ended September 30, 1998.
EXPENSES-The Company's expenses were as summarized below:
<TABLE>
<CAPTION>
Three Months Three Months Nine months Nine months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
General and administrative .. $ 2,855,000 $ 2,217,000 $ 8,702,000 6,742,000
Franchise sales commissions . 799,000 259,000 1,628,000 496,000
Depreciation and amortization 415,000 142,000 1,018,000 409,000
Interest income ............. (836,000) (339,000) (1,664,000) (1,097,000)
Interest expense ............ 12,000 492,000 761,000 1,452,000
------------ ------------ ------------ ------------
TOTAL ....................... $ 3,245,000 $ 2,771,000 $ 10,445,000 $ 8,002,000
</TABLE>
11
<PAGE>
Three months ended September 30, 1998 compared to three months ended September
30, 1997
Franchise sales commissions increased $540,000 for the three months ended
September 30, 1998 as compared to the comparable prior year's period because
commissions were expensed for the 32 hotels which opened during the third
quarter of 1998 compared to the 18 hotels which opened during the third quarter
of 1997.
General and administrative expenses increased $638,000 for the three months
ended September 30, 1998 as compared to the comparable prior year's period
primarily due to additional salaries, wages and benefits, and general office and
travel expenses in connection with the acquisition of the Best Inns brand and
the related management contracts.
Depreciation and amortization expense primarily includes amortization for
the cost of acquiring the Microtel, Hawthorn Suites and Best Inns hotel brands
and depreciation of fixed assets.
Interest income, resulting primarily from investments in cash and
marketable securities, increased $497,000 for the three months ended September
30, 1998 as compared to the comparable prior year's period.
Interest expense decreased $480,000 for the three months ended September
30, 1998 as compared to the comparable prior year's period. The decrease is a
result of repayment of the Company's 10% Subordinated Debentures during the
second quarter 1998.
Nine months ended September 30, 1998 compared to nine months ended September 30,
1997
Franchise sales commissions increased $1,132,000 for the nine months ended
September 30, 1998 as compared to the comparable prior year's period because
commissions were expensed for the 75 hotels which opened during the first three
quarters of 1998 compared to 34 hotels which opened during the first three
quarters of 1997.
General and administrative expenses increased $1,960,000 for the nine
months ended September 30, 1998 as compared to the comparable prior year's
period primarily due to additional salaries, wages and benefits, and general
office and travel expenses in connection with the acquisition of the Best Inns
brand and the related management contracts.
Depreciation and amortization expense primarily includes amortization for
the cost of acquiring the Microtel, Hawthorn Suites and Best Inns hotel brands
and depreciation of fixed assets.
Interest income, resulting primarily from investments in cash and
marketable securities, increased $567,000 for the nine months ended September
30, 1998 as compared to the comparable prior year's period.
Interest expense decreased $691,000 for the nine months ended September 30,
1998 as compared to the comparable prior year's period. The decrease is a result
of repayment of the Company's 10% Subordinated Debentures during the second
quarter 1998.
NET INCOME (LOSS)-A summary of operating results is as follows:
<TABLE>
<CAPTION>
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net Income (Loss) $ 109,000 $(2,181,000) $(3,001,000) $(6,870,000)
</TABLE>
12
<PAGE>
Three months Ended September 30, 1998 compared to three months ended September
30, 1997
The Company reported net income of $109,000 for the three months ended
September 30, 1998 compared with a loss of $2,181,000 for the three months ended
September 30, 1997. Revenues increased $2,764,000 and were offset by an increase
in operating expenses of $474,000. Total hotels open plus under development and
accepted applications increased from 519 to 902 from September 30, 1997 to
September 30, 1998. A total of 169 of the 199 hotels open as of September 30,
1998 were paying royalties to the Company compared to only 34 of the 80
properties open as of September 30, 1997.
Nine months ended September 30, 1998 compared to nine months ended September 30,
1997
The Company's net loss decreased $3,869,000 for the nine months ended
September 30, 1998 as compared to the comparable prior year's period. Revenues
increased $6,312,000 and was offset by an increase in operating expenses of
$2,443,000. The Company did not expect to generate a profit for the nine months
ended September 30, 1998 or 1997 as it was investing in its infrastructure to
facilitate future growth. Total hotels open plus under development and accepted
applications increased from 519 to 902 from September 30, 1997 to September 30,
1998. A total of 169 of the 199 hotels open as of September 30, 1998 were paying
royalties to the Company compared to only 34 of the 80 properties open as of
September 30, 1997.
Liquidity and Capital Resources
From August 28, 1995 (inception) to October 24, 1996, the Company financed
its operations primarily through a private placement of securities, franchise
application fees, and interest income. In October 1995, the Company raised
approximately $17.5 million in gross proceeds through private sales of shares of
its old common stock (i.e., stock prior to the reclassification of shares on
October 11, 1996) and Redeemable Preferred Stock.
On October 24, 1996, the Company completed a public offering of 1,825,000
shares of Class A Common Stock at $13.50 per share (the "Initial Offering"). Net
proceeds to the Company from the Initial Offering were approximately
$21,390,000. As of September 30, 1998 approximately all of such proceeds had
been used by the Company.
In connection with the establishment of Constellation Development Fund, LLC
("the Development Fund") on March 17, 1998, the Company has committed to lend up
to $10 million to Constellation Equity Corp. ("Constellation"), which will use
the funds to make a subordinated equity investment in the Development Fund. As
of September 30, 1998, the Company has lent $1,565,000 to Constellation. The
Company's loan bears interest at an annual rate of 8%, is non-recourse and is
repayable from distributions and payments made to Constellation from the
Development Fund. In addition, the Company sold an aggregate of 500,000 shares
of Class A Common Stock to NorthStar Capital Partners LLC (together with its
affiliates, "NorthStar")and Lubert-Adler Real Estate Opportunity Funds (together
with its affiliates, "Lubert-Adler") for a purchase price of $11.25 per share
totaling $5.625 million. NorthStar and Lubert-Adler also have the right to
purchase up to an additional 500,000 shares of Class A Common Stock, exercisable
as funds are committed by the Development Fund, at a price of $11.25 per share.
The Company will also be paid $3.5 million over the next five years to manage
the Development Fund.
On April 28, 1998 in connection with the Best Inns acquisition, the Company
made a $15 million unsecured subordinated loan to Ventures at an interest rate
of 12% per annum, (interest on which will be paid in cash to the extent there is
available cash and otherwise will be paid-in-kind) and issued to Alpine Equities
350,000 shares of Class A Common Stock for a purchase price of $1.6 million.
(See footnote 5. Acquisition of Best Inns.) The Company used the proceeds of a
$10.0 million loan from NationsBank N.A., the $1.6 million it received from the
sale to Alpine Equities of 350,000 shares of Class A Common Stock, and $3.4
million of its own cash to make the $15 million loan to Ventures. In addition,
the Company used its own cash to pay the expenses incurred in connection with
these transactions.
13
<PAGE>
On May 19, 1998, the Company completed a secondary public offering of
4,250,000 shares of Class A Common Stock at $10.50 per share (the "Equity
Offering"). Net proceeds to the Company from the Equity Offering were
approximately $40,800,000. As of September 30, 1998, approximately $30,100,000
of such net proceeds had been used by the Company, primarily to: (i) repay
approximately $20,100,000 on the Company's 10% Subordinated Debentures due
September 29, 2007, consisting of the aggregate principal amount outstanding
plus interest accrued thereon to May 15, 1998, the date of repayment, and (ii)
repay approximately $10 million aggregate principal amount outstanding under a
loan incurred on April 28, 1998 in connection with the Company's acquisition of
the Best Inns brands, plus interest accrued thereon to May 19, 1998, the date of
repayment. The remaining proceeds of approximately $10,700,000 were held either
as cash or cash equivalents and will be used for working capital and general
corporate purposes.
Cash and cash equivalents were $19,221,000 as of September 30, 1998. In
Management's opinion, based on the Company's current operations, the Company's
capital resources are sufficient to fund operations for the next twelve months.
The Company expects to satisfy its cash requirements during the next twelve
months with its cash and cash equivalents. The Company has no outstanding lines
of credit in place.
For the nine months ended September 30, 1998, the Company had a net loss of
$3,001,000. Net cash used in operating activities was $9,376,000 and the primary
operating adjustment to the net loss was an increase in promissory notes
receivable related to the application fees on executed franchise agreements. For
the nine months ended September 30, 1998 net cash used in investing activities
was $15,525,000. Such investments were primarily a result of (i) the $15 million
loan to Ventures in connection with the Best Inns acquisition, (ii) repayment of
the $10 million loan from NationsBank in connection with the Best Inns
acquisition, (iii) the capitalization of costs incurred in the acquisition of
the Hawthorn and Best Inns brands, and (iv) expenditures related to the
construction of hotels, the acquisition of additional office furniture and
equipment, and the purchase of a national reservation system. Such expenditures
were substantially offset by proceeds from the sale of the two properties built
by the Company and the $10 million NationsBank loan received in connection with
the Best Inns acquisition. For the nine months ended September 30, 1998, such
operating and investing uses of cash were funded by net cash provided by
financing activities of $28,232,000. The primary financing activities included a
secondary public offering of 4,250,000 shares of Class A Common Stock, issuance
of 350,000 shares of Class A Common Stock in connection with the Best Inns
Acquisition, and 500,000 shares of Class A Common Stock issued in connection
with the establishment of the Development Fund during the period. The cash
received from these financing activities was partially offset by repayment of
the Company's 10% Subordinated Debentures.
Year 2000 Computer Matter
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions or customer
reservations or engage in similar normal business activities.
Management has determined that the Year 2000 Issue will not pose
significant operational problems for its computer systems. Management expects
that costs incurred in connection with the Year 2000 Issue, including, but not
limited to all costs of ensuring Year 2000 compliance for the financial system
software at both its Atlanta, Georgia headquarters and the Marion, Illinois
offices of its wholly owned management company subsidiary, USFS Management,
Inc., should not exceed $200,000, and in any event, does not expect such costs
to have a material adverse impact on the results of operations during
14
<PAGE>
any quarterly or annual reporting period. In addition, management is currently
in the process of converting the reservation systems that it acquired in April
1998 as part of the Best Inns Acquisition. USFS anticipates that it will cease
having any dependency on the acquired systems of USFS Management, Inc. by May 1,
1999. Finally, management has determined that the computer systems at certain
hotel properties managed by USFS Management, Inc. are not currently Year 2000
compliant. Management expects to achieve compliance at its managed properties by
July 1, 1999.
The Company is in the process of communicating with its significant
suppliers of goods and services to determine the extent to which the Company's
operations and systems are vulnerable to those third parties' failure to
remediate their own Year 2000 Issues. There can be no guarantee that the systems
of other companies on which the Company's operations and systems rely will be
timely converted and would not have an adverse effect on the Company's systems
or results of operations.
The Company will utilize both external and internal resources to reprogram,
or replace, and test its software for Year 2000 modifications. The Company
anticipates completing the Year 2000 projects by July 1, 1999, which is prior to
any material adverse impact on its operating systems.
The costs of the project and the date on which the Company believes it will
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these estimates will
be achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes, and similar
uncertainties.
Seasonality
The Company expects to experience seasonal revenue patterns similar to
those experienced by the lodging industry generally. Accordingly, the summer
months, because of increase in leisure travel, are expected to produce higher
revenues for the Company than other periods during the year. In addition,
developers of new hotels typically attempt, whenever feasible, to schedule the
opening of a new property to occur prior to the spring and summer seasons. This
also may have an impact on the seasonality of the Company's revenues, a
significant portion of which is not recognized until the opening of a property.
Accordingly, the Company may experience lower revenues and profits in the first
and fourth quarters and higher revenues and profits in the second and third
quarters.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is not a party to any material litigation. However, claims and
litigation may arise in the Company's normal course of business.
15
<PAGE>
Item 2. Recent Sale of Unregistered Securities
Not applicable
Item 3. Defaults upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits:
<TABLE>
<CAPTION>
Exhibit Description
Number ------------
-------
<S> <C>
27.1 Financial Data Schedule.
</TABLE>
b) Reports on Form 8-K
During the third quarter ended September 30, 1998, the Company did not
file a report on Form 8-K.
SIGNATURES
Pursuant to the requirements 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.
U.S. FRANCHISE SYSTEMS, INC.
By
By /s/ /s/
----------------------- ------------------------
Michael A. Leven Neal K. Aronson
Chairman of the Board, President Executive Vice President and Chief
and Chief Executive Officer Financial Officer
Dated: November , 1998
----
16
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Description
Number ------------
-------
<S> <C>
27.1 Financial Data Schedule.
</TABLE>
17
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from U.S.
Franchise Systems, Inc. consolidated financial statements for the nine months
ended September 30, 1998 and is qualified in its entirety by reference to such
financial statements.
</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> 19,221
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 42
<INVENTORY> 0
<CURRENT-ASSETS> 26,991
<PP&E> 3,381
<DEPRECIATION> 383
<TOTAL-ASSETS> 83,854
<CURRENT-LIABILITIES> 6,738
<BONDS> 0
0
0
<COMMON> 491<F1>
<OTHER-SE> 69,007
<TOTAL-LIABILITY-AND-EQUITY> 83,854
<SALES> 7,444
<TOTAL-REVENUES> 7,444
<CGS> 0
<TOTAL-COSTS> 10,445
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 761
<INCOME-PRETAX> (3,001)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,001)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,001)<F2>
<EPS-PRIMARY> (0.18)<F2>
<EPS-DILUTED> (0.18)
<FN>
<F1>Includes 3,128,473 (net of 58,807 shares in treasury) shares of Class A common
stock that are redeemable under certain circumstances by the Company for
reasons not under the Company's control.
<F2>Per share amounts are determined by dividing loss applicable to common
stockholders by weighted average shares outstanding. Weighted average shares
include redeemable common shares outstanding. Loss applicable to common
stockholders represent net loss adjusted for dividends accreted on the
redeemable preferred stock.
</FN>
</TABLE>
