<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM ________TO__________
COMMISSION FILE NUMBER 0-23941
U.S. FRANCHISE SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)
<TABLE>
<S> <C>
DELAWARE 58-2361501
(State or other jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
13 CORPORATE SQUARE, SUITE 250
ATLANTA, GEORGIA 30329
(Address of Principal Executive Offices) (Zip Code)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (404) 321-4045
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Class A Common Stock, $0.01 par value
TITLE OF EACH CLASS
Indicate by check mark whether the registrant: (1) has filed all reports
required by Section 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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
<PAGE>
The aggregate market value of the outstanding shares of the registrant's
Class A Common Stock and Class B Common Stock held by non-affiliates of the
registrant was approximately $143,500,000 as of March 12, 1999. 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 March 12, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement to be delivered to
shareholders in connection with the Annual Meeting of Shareholders to be held on
May 27, 1999 are incorporated by reference in response to Part III of this
Report.
PART I
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K (this "Form 10-K"),
including statements under "Item 1. Business" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations," that
are not historical facts constitute "forward-looking statements" within the
meaning of 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.
(the "Company" or "USFS") and its subsidiaries 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-K. 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. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risk
Factors".
ITEM 1. BUSINESS.
USFS was formed in August 1995 to acquire, market and service well-positioned
brands with potential for rapid unit growth primarily through franchising. The
Company's three brands, which are in the lodging industry, are Microtel Inn &
Suites, Hawthorn Suites and Best Inns & Suites. 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. Since it began selling franchises in January 1996, the number of USFS
branded hotel properties open or in development has grown from 27 to 944 as of
January 22, 1999, consisting of 229 open,
2
<PAGE>
110 under construction, 404 for which franchise agreements had been executed but
that were not under construction and 201 accepted applications from prospective
franchisees. Based upon the Company's limited historical experience to date,
there can be no assurances that hotels in development or for which applications
have been accepted will result in open hotels.
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 variety of benefits and services designed to: (i)
decrease development costs, (ii) shorten the time frame and reduce the
complexity of the construction process and (iii) increase occupancy rates,
revenues and profitability of the franchised properties. The Company offers
prospective franchisees a business format, design and construction assistance
(including architectural plans), quality standards, training programs, national
reservations systems, national and local advertising and promotional campaigns
and volume purchasing discounts.
As discussed herein, the Company operates through five reportable segments,
as follows: (i) Microtel Inns & Suites, (ii) Hawthorn Suites, (iii) Best Inns,
(iv) management company and (v) other/corporate. See Note 10 to the Company's
consolidated financial statements for certain financial information relating to
these segments.
The Company was incorporated in November 1997 for purposes of acquiring the
Hawthorn Suites brand. See "Acquisition of the Microtel, Hawthorn Suites and
Best Inns Systems - Hawthorn Acquisition." The Company's predecessor, also known
as USFS, was incorporated in Delaware in August 1995. The Company's executive
offices are located at 13 Corporate Square, Suite 250, Atlanta, Georgia 30329
and its telephone number is (404) 321-4045. The term "the Company" refers to
USFS before the Hawthorn merger, and as the surviving corporation in the merger.
BUSINESS STRATEGY
The Company's business strategy is to: (i) rapidly increase the number of
open Microtel, Hawthorn Suites and Best Inns hotels, (ii) operate its
administrative and franchisee support departments in order to maximize the
operating leverage inherent in the franchising business, and (iii) acquire
additional lodging or other service-oriented brands that provide attractive unit
economics to franchisees and significant growth opportunities for the Company.
To successfully accomplish its growth strategy, the Company supports its
franchisees in their efforts to develop, acquire, open and operate hotels by
assisting in the areas of public relations, construction, design, marketing,
finance, national accounts purchasing and training.
THE COMPANY'S LODGING FRANCHISE SYSTEMS
MICROTEL INN & SUITES. Microtels are distinctively styled hotels with a
residential look that offer travelers an attractive and consistent appearance,
clean, comfortable rooms and the safety of interior corridor room access, all
for a competitive rate. Microtel typically is categorized as a budget hotel
chain. Microtel's efficient architectural design minimizes construction costs
and maintenance expenses through smaller room sizes, limited common areas,
smaller land requirements and built-in standardized furniture, all of which
enable franchisees to own and operate a Microtel at a lower cost. These lower
costs may reduce a franchisee's equity investment and may broaden its debt
financing alternatives, thereby expanding the appeal of the Microtel brand to
prospective franchisees.
The Company acquired the Microtel brand in October 1995, at which time
there were 27 properties open or in development. Since that time, the Company
has realized the following franchise sales growth:
3
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
- -----------------------------------------------------------------------------------------------------------------------
MICROTEL FRANCHISE DATA 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Properties open (1) 124 64 28
Executed agreements and under construction 62 52 25
Executed franchise agreements but not under construction 276 253 168
Accepted applications 115 77 82
--- --- ---
Total in development and accepted applications (2) 453 382 275
- -----------------------------------------------------------------------------------------------------------------------
OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS 577 446 303
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) The Company does not receive royalties from 29 hotels open as of December
31, 1998.
(2) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels.
HAWTHORN SUITES. As an upscale, extended-stay hotel, Hawthorn Suites
provides the traveler with the convenience of a hotel and the amenities
typically found in an apartment. Hawthorn Suites' hotel rooms contain
full-service kitchens with appliances, cookware and utensils, video cassette
players, modem ports, exercise facilities and valet service. Hawthorn Suites
hotels also offer a hot breakfast buffet every morning and guests are invited to
an evening social hour. A center courtyard, an outdoor pool, a multi-use sport
court, a barbecue area and a retail store selling sundry and meal items, snacks
and beverages, will also be part of newly constructed Hawthorn Suites hotels. In
addition to participating in the upscale, extended-stay segment, the Company
also franchises Hawthorn Suites LTD, a mid-price, all suites hotel brand that is
designed to meet the needs of both extended-stay and transient guests, and
Hawthorn Suites Golf Resorts, a new all suites lodging concept located on or
near golf courses and targeted to travelers who want to combine golf with a
meeting or conference retreat experience.
The extended-stay segment, targeting travelers staying five or more
consecutive nights, is a growing segment of the lodging industry, as travelers
demand better value and environments that feel more like home. Corporate
downsizing has resulted in an increased need for consultants, long-term project
work and growth in corporate training programs. Moreover, with extensive
corporate relocations each year, more people are away from home on longer trips.
Leisure and vacation travelers are also discovering the value of extended-stay
hotels. Due to the longer average stay of the extended-stay guest and lower
guest turnover, operators of extended-stay hotels enjoy reduced staffing needs,
both at the front desk and in housekeeping, relative to operators of transient
hotels. At the same time, reduced guest turnover contributes to lower supply
costs, as hotel operators are not required to replenish amenities such as soap
and shampoo on a daily basis.
Hotels that are part of the Hawthorn Suites system use the Spirit
Reservation System ("Spirit"). Spirit is operated under contract with Hyatt
Hotels Corporation ("Hyatt") by CSC Outsourcing, Inc. ("CSC") and Sabre
Technology Solutions ("Sabre"). Spirit receives and processes calls made to a
toll-free number dedicated to Hawthorn Suites. The Spirit system is directly
linked by computer to all Hawthorn Suites hotels. Spirit also currently operates
the reservations system for Hyatt hotels. Hyatt manages the voice and Global
Distribution System ("GDS") reservation activities for both Hawthorn Suites and
Hyatt through the Spirit Reservation Center located in Omaha, Nebraska. Persons
calling the Hyatt toll-free number who experience a sold out Hyatt or no Hyatt
in their desired market are automatically referred to the nearest Hawthorn
Suites hotel. There can be no assurance that CSC and Sabre will continue to
service Hawthorn Suites' future reservation needs.
The Company acquired the right to franchise the Hawthorn brand in March
1996, at which time there were 17 properties open or in development. Since that
time, the Company has realized the following franchise sales growth:
4
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
- -----------------------------------------------------------------------------------------------------------------------
HAWTHORN SUITES FRANCHISE DATA 1998 1997 1996*
(inception to date)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Properties open 51 26 19
Executed agreements and under construction 29 14 2
Executed franchise agreements but not under construction 96 54 17
Accepted applications 78 17 14
--- --- ---
Total in development and accepted applications (1) 203 85 33
- -----------------------------------------------------------------------------------------------------------------------
OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS 254 111 52
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
*The right to franchise the Hawthorn Suites brand was acquired on March 27,
1996.
(1) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels.
BEST INNS. Best Inns is a mid-level economy hotel chain. Properties offer
single, double, and in some cases suite accommodations with fully equipped
kitchens and business services. All Best Inns properties offer free local phone
calls, complimentary breakfast, cable television with one free movie and a
sports channel or pay per view. Best Suites provide accommodations with separate
living, dining and work areas, plus a wet bar, microwave and refrigerator,
exercise room, meeting facilities and a convenience store. When the Company
acquired the Best Inns brand in April 1998, it also acquired the assets of a
fee-based management company. The Company now offers its hotel management
expertise to franchisees of all its brands.
The Company acquired the Best Inns brand in April 1998, at which time there
were 38 properties open or in development. Since that time, the Company has
realized the following franchise sales growth:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
- ------------------------------------------------------------------------------------
BEST INNS FRANCHISE DATA 1998*
(inception to date)
- ------------------------------------------------------------------------------------
<S> <C>
Properties open 52
Executed agreements and under construction 12
Executed franchise agreements but not under construction 21
Accepted applications 142
---
Total in development and accepted applications (1) 175
- ------------------------------------------------------------------------------------
OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS 227
- ------------------------------------------------------------------------------------
</TABLE>
*The Best Inns brand was acquired on April 28, 1998.
(1) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels.
OPERATIONS
FRANCHISE SALES. The Company employs a national franchise sales force
consisting of approximately 48 people. The primary objectives of the Company's
franchise sales strategy are to identify potential franchisees and possible
locations for each of the Company's brands and to create an awareness and
general acceptance of its products with numerous participants in the hospitality
industry, including hotel owners, lodging consultants, vendors and operators.
The franchise sales force seeks to achieve these objectives through the
implementation of a multi-faceted sales strategy, which includes cold calling,
telemarketing, direct mail, trade advertising and public relations. The
compensation program is structured so that each franchise salesperson is
expected to earn at least 90% of his or her annual income in sales commissions.
5
<PAGE>
DESIGN AND CONSTRUCTION. The Company's design and construction department
provides development expertise in the disciplines associated with new
construction and renovation, with emphasis on low development costs, low
maintenance expense, quality construction and profit maximization for its
franchisees. The Company provides detailed architectural plans, CAD-CAM computer
files, specifications, system standards and manuals, and makes the services of
the department available to franchisees at various stages of the development
process. In order to maintain product quality and brand identity, the design and
construction department reviews the architectural plans of its franchisee's
projects.
QUALITY ASSURANCE. Franchise quality control is accomplished through
inspections prior to a franchisee's entry into the system and on an ongoing
basis. Quality assurance programs promote consistent standards throughout each
of the Company's franchise systems. The Company inspects each property up to
twice per year. Hotels that fail to meet certain franchise standards are
notified and are generally given 30 days to either correct the conditions that
led to the failure or to implement a plan to correct the failure. If they do not
correct the deficiencies, the Company can terminate the license.
MARKETING. The Company has two distinct marketing efforts. The first is
intended to build awareness of USFS among franchisees and shareholders. The
Company utilizes newsletters, both in print and in electronic e-mail format,
direct mail and special web site pages on usfsi.com, microtelinn.com,
hawthorn.com and bestinn.com, followed up with direct contact by the franchise
sales organization. The second marketing initiative is the brand-building
campaigns for Microtel, Best Inns and Hawthorn Suites. The 1999 marketing
campaigns for the three brands consists of the following:
- - TELEVISION ADVERTISING ON CNN: Microtel and Hawthorn Suites sponsor the
Business Travel Update at 6:55am EST and also advertise in Business Day
6:00-6:30am EST and Headline News 6:00-7:00am PST. Best Inns advertises in
similar time slots on CNNfn.
- - PRINT ADVERTISING: Hawthorn advertises in BUSINESS TRAVEL NEWS, an industry
trade journal that reaches corporate travel decision-makers and travel
agents. Microtel and Best Inns each take half-page color ads in the RAND
MCNALLY ROAD ATLAS and the AAA (TRIPLE-A) ROAD ATLAS.
- - INTERNET MARKETING: The Company employs an electronic marketing specialist
to update the websites for each of its brands, and to negotiate links to
other high-volume traffic sites. Each site allows reservations to be booked
directly via the Internet.
- - DATABASE MARKETING: The three brands are building databases of guest
addresses and e-mail addresses, to market directly to guests.
- - DIRECTORIES: All three brands publish hotel directories twice annually.
These directories are on display in each of the respective hotels as well
as visitor information centers, airports and other public areas.
CENTRAL RESERVATIONS SYSTEM. Microtel and Best Inns have built a new central
reservations center in Marion, Illinois, utilizing USFS's unique FIRST
reservations system, which communicates with the hotels via the Internet.
Hawthorn continues to outsource its central reservations operation to SPIRIT,
the reservation system used by Hyatt hotels.
PUBLIC RELATIONS. A targeted public relations program supports marketing and
franchise sales efforts by promoting awareness of the Company and its brands.
The Company works closely with such lodging industry trade publications as HOTEL
BUSINESS, HOTEL & MOTEL MANAGEMENT, LODGING HOSPITALITY, BUSINESS TRAVEL NEWS,
and AAHOA (the magazine dedicated to Asian American hoteliers). The Company has
also reached traveling consumers via THE WALL STREET JOURNAL and USA TODAY'S
"Business Travel Today" column. No less important have been the Company's
placements at the local level, where daily and business publications regularly
report on individual property ground breaks and openings. To spearhead this
effort, the Company has a public relations manager to act as the liaison with
franchisees, placing local stories and
6
<PAGE>
planning local public relations campaigns and special events.
TRAINING. The Company maintains training programs designed to teach its
franchisees how to best utilize the Company's reservations system and marketing
programs, as well as the fundamentals of hotel operations such as recruiting,
housekeeping, repairs and maintenance and personnel policies. The Company also
provides special on-site training upon request. In addition, each franchise
sales person must complete a structured initial training program and regular
retraining.
FRANCHISE RESOURCES. The franchise resources department functions as a single
point of contact for all franchisees to call for support on all issues prior to,
during, and after construction. Franchise resources acts as a liaison between
the franchisee and all departments of the Company.
PURCHASING. The Company has established relationships with various vendors to
make volume purchasing discounts for certain products, services, furnishings and
equipment available to its franchisees. In certain cases, the Company receives
payments from the vendors as well.
FRANCHISE AGREEMENTS
The Company's franchise agreements grant hotel owners the right to utilize
one of the brand names associated with the Microtel, Hawthorn Suites or Best
Inns hotel systems under long-term franchise agreements. In order to qualify for
a franchise from the Company, a candidate must undergo a screening process,
which typically includes a review of the potential franchisee's financial
condition and the proposed lodging location. A representative of the Company
conducts a site inspection to determine whether the location meets standards and
whether the brand name selected is appropriate at that location. All of the
Company's franchise agreements offer an area of exclusivity to each location,
the degree of which is negotiated individually with each franchisee. The
Company's current standard agreements are for 20-year terms although actual
lengths vary. The standard franchise agreements generally require franchisees to
satisfy certain development milestones.
Each franchise agreement provides for the payment of two types of on-going
fees: a royalty fee and a reservation and marketing fee, both of which are based
upon a percentage of the franchisee's gross room revenues. The royalty fee is
intended to cover the operating expenses of the franchisor, such as costs
incurred in providing quality assurance, administrative support and other
franchise services, and to provide the Company with operating profits. The
reservation and marketing fee is collected for administrative convenience by the
Company and remitted to independent not-for-profit reservation and marketing
corporations which exist for each of the three brands. The Company spends the
reservation and marketing funds on behalf of the franchisees for such services
as a reservation system, national advertising and certain promotional programs
(see "Reservations and Advertising Funds"). Reservation and marketing fees
collected by the Company on behalf of the three not-for-profit corporations
typically range from two (2%) percent to three (3%) percent of each franchisee's
gross room revenues per year. Franchisees also typically pay a franchise
application fee to the Company, the amount of which varies.
The terms of the Company's current standard forms of franchise agreements
state that, by year of operation, franchisees are required to pay the following
ongoing royalty fees (each, as a percentage of gross room revenues), although
actual fees may vary:
<TABLE>
<CAPTION>
MICROTEL HAWTHORN BEST
-------- -------- ----
<S> <C> <C> <C>
Year 1 .................................. 4.0% 5.0% 3.0%
Year 2 .................................. 5.0% 5.0% 4.0%
Year 3 and thereafter ................... 6.0% 5.0% 5.0%
</TABLE>
7
<PAGE>
The Company has agreed in certain situations to offer a wide range of
incentives to various franchisees, but no assurances can be given that such
incentives will be offered in the future.
The Company believes that it has a franchisee-friendly franchise agreement,
making the Company's franchises more attractive to potential franchisees. The
Company's standard form of franchise agreement is terminable by the Company if
the franchisee fails to maintain certain quality standards or to pay royalties,
reservation and marketing fees or other charges.
ACQUISITION OF THE MICROTEL, HAWTHORN SUITES AND BEST INNS SYSTEMS
MICROTEL ACQUISITION. The Company acquired the Microtel brand from Hudson
Hotel Corporation ("Hudson") on October 5, 1995. As part of the purchase of the
Microtel brand, royalties are payable to Hudson as follows: 1.0% of the
"revenues subject to royalties" on the first 100 Microtel properties opened
after the closing, 0.75% of such revenues for the next 150 Microtel properties
opened, and 0.50% of such revenues for each Microtel property opened after the
first 250. The Microtel Acquisition Agreement requires the Company to satisfy a
development schedule, which requires that new Microtel Properties be opened or
under construction in the following numbers, on a cumulative basis, by December
of each of the following years:
<TABLE>
<CAPTION>
NUMBER OF
YEAR MICROTEL PROPERTIES(*)
---- ----------------------
<S> <C>
1997...................................... 50
1998...................................... 100
1999...................................... 175
2000...................................... 250
</TABLE>
* Excludes the 29 open Microtel Properties that do not pay royalties to the
Company and the additional 21 Microtel properties and 10 Microtel all-suite
hotels that are currently entitled to be franchised without the payment of
royalties to the Company pursuant to the Microtel Acquisition Agreement.
The Microtel Acquisition Agreement further provides that, in the event the
Company fails to satisfy the development schedule, fails to pay monies due to
Hudson or otherwise fails to fulfill its material obligations under the Microtel
Acquisition Agreement, in each case subject to the Company's right to cure such
breach within the applicable notice and cure periods, all of the rights to the
Microtel system and all operating assets associated therewith will revert to
Hudson. In such instance, the Company will, however, retain the rights to any
franchise royalty payments due to it under franchise agreements entered into by
the Company after the closing of the Microtel Acquisition, less a servicing fee
payable to Hudson in an amount equal to 0.75% of all revenues subject to
royalties under such agreements.
HAWTHORN ACQUISITION. On March 12, 1998, the Company completed a series of
transactions (collectively, the "Merger") which enabled it to acquire the entire
interest in the Hawthorn Suites brand of hotels. Prior to the Merger, Hawthorn
Suites Associates, an Illinois joint venture ("HSA") and HSA Properties, Inc., a
Delaware corporation ("HPI"), collectively owned 99% of the membership interest
in HSA Properties, L.L.C., a Delaware limited liability company ("HSA LLC"),
which owned all of the trademarks, copyrights and other intellectual property
related to the Hawthorn Suites brand. Immediately prior to the Merger, all of
HSA's and HPI's respective membership interests in HSA LLC were transferred to
USFS Hawthorn, Inc., in a transaction whereby (i) HSA was issued 2,199,775
shares of Class A Common Stock, and (ii) HPI was issued 22,447 shares of Class A
Common Stock. Since the remaining 1% membership interest in HSA LLC was owned by
USFS, following the Merger, HSA LLC became a wholly owned subsidiary of the
Company and the Master Franchise Agreement dated as of March 27, 1996 between
USFS and HSA LLC was terminated. The Company now has the exclusive right to
franchise the Hawthorn Suites
8
<PAGE>
brand of hotels and to retain 100% of the royalties derived therefrom.
BEST INNS ACQUISITION. 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 management contracts and certain other assets
relating to the management of hotels on behalf of third party owners. To
facilitate the transaction, the Company made a $15 million unsecured
subordinated loan to Alpine Hospitality Ventures LLC ("Ventures") at an interest
rate of 12% per annum, interest on which will be paid in cash to the extent
available 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 acquired 17
Best Inns hotels in the Best Inns acquisition and is structurally subordinated
to such third party loan. The Company also committed to make up to $7.5 million
of additional loans to Ventures under certain circumstances. No such additional
loans have been made as of December 31, 1998. The Company also 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 hotel added to the Best Inns system after the
closing of the transaction, provided that such new hotels are paying royalties
to the Company or any of its affiliates. Richard D. Goldstein, a director of the
Company, is an Executive Vice President and a Senior Managing Director of the
general partner of Alpine Equity Partners L.P., the entity that indirectly
owns and controls a majority of Alpine Equities and Ventures.
ESTABLISHMENT OF DEVELOPMENT FUND
On March 17, 1998, NorthStar Constellation, LLC (together with its
affiliates, "NorthStar"), Lubert-Adler Real Estate Opportunity Funds (together
with its affiliates, "Lubert-Adler") and Constellation Equity Corp., an entity
controlled by NorthStar ("Constellation"), formed Constellation Development
Fund, LLC (the "Development Fund"). The Development Fund was established, in
part, to provide capital that will allow the Company to expand its Microtel and
Hawthorn Suites brands into high visibility, difficult to develop areas by
providing debt and equity financing to selected local developers. NorthStar,
Lubert-Adler and Constellation agreed to contribute to the Development Fund
equity up to $50 million. On October 31, 1998 the Development Fund entered into
a $60 million senior credit facility with NationsBank, N.A. As of December 31,
1998 the Development Fund has committed to fund the construction of eight
Microtel and two Hawthorn Suites hotels, and is currently in the process of
reviewing additional projects. In connection with the establishment of the
Development Fund, the Company committed to make a loan to Constellation of up to
$10 million. Constellation will use the funds to make an investment which is
subordinated to certain debt and equity returns of investors in the Development
Fund. The 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. As of December 31, 1998, the Company had made loans of
approximately $2.6 million in the aggregate to Constellation. The Company will
be paid $3.5 million over the first five years to manage the Development Fund.
The Company also sold an aggregate of 500,000 shares of Class A Common Stock to
NorthStar and Lubert-Adler for $5.6 million. NorthStar and Lubert-Adler also
have the right to purchase up to an additional 500,000 shares of Class A Common
Stock, exercisable on a pro-rata basis within 18 months of the commitment of the
Development Fund's capital at a price of $11.25 per share. In addition, David T.
Hamamoto, Co-Chief Executive Officer of NorthStar was elected to the Board of
Directors of the Company. Dean Adler, a director of the Company, serves as a
manager of Lubert-Adler. In addition, Mr. Adler, along with Mr. Hamamoto and
Neal Aronson, the Executive Vice President and a director of the Company, serve
as managers of the Development Fund.
9
<PAGE>
THE HOTEL FRANCHISING AND LODGING INDUSTRIES
HOTEL FRANCHISING. Over the years, owners of hotels not affiliated with
regional or national lodging companies have increasingly chosen to join hotel
franchise chains. The Company and other hotel franchise chains provide a number
of services designed to directly or indirectly increase hotel occupancy rates,
revenues and profitability. The Company believes that hotel operators often view
franchise chain membership as an important means of remaining competitive with
hotels that are either owned by or affiliated with national or regional lodging
companies. In determining whether to affiliate with a franchise chain, hotel
operators will compare costs of affiliation with the incremental revenues
anticipated to be derived from chain membership. Costs of affiliation include
capital expenditures and operating costs required to meet a chain's quality and
operating standards, plus the ongoing payment of franchise royalties and
assessments for the reservations system and marketing programs maintained by the
franchisor.
LODGING INDUSTRY. The lodging industry has traditionally been divided into
five segments, each of which is identified by the average daily room rate
generally charged by hotel operators in the segment (the "ADR"). These
categories include, in descending order of ADR, luxury, upscale, mid-price,
economy and budget. Hotels are further segmented into limited-service and
full-service, depending on the degree of food and beverage and other services
offered, and hotels are also segmented into transient hotels, which serve short-
term guests, and extended-stay hotels, which serve guests on multiple night or
multiple week stays. The Company's franchised properties typically operate in
the budget and economy segments of the limited-service sectors through its
Microtel brand, the economy and mid-price segment through its Best Inns brand
and the upscale and mid-price segment of the extended-stay and transient suite
sectors through its Hawthorn Suites brand.
COMPETITION
Competition among national brand franchisors and smaller chains in the
lodging industry to expand their franchise systems is intense. The Company
believes that competition for the sale of lodging franchises is based
principally upon (i) the perceived value and quality of the brand, (ii) the
nature and quality of services provided to franchisees, (iii) the franchisee's
view of the relationship of building or conversion costs and operating expenses
to the potential for revenue and profitability during operation and upon sale,
and (iv) the franchisee's ability to finance and buy or sell the property. The
Company's franchisees compete for guests with franchisees of, and properties
owned or operated by, other hotel chains, independent properties and
owner-operated chains. The success of the Company's franchisees affects the
profitability of the Company, as the Company's receipt of royalty fees under its
franchise agreements is tied directly to the gross room revenues earned by its
franchisees. In choosing a particular hotel, consumers consider differences in
room rates, quality and condition of accommodations, name recognition,
availability of alternative lodging (including short-term lease apartments),
service levels, reputation, safety, reservation systems and location.
Both among consumers and potential franchisees, Microtel competes with
independent hotels and brands such as Comfort Inn(R), Days Inn(R), Econo
Lodge(R), Fairfield Inn(R), Sleep Inn(R), Red Roof Inn(R), Budgetel Inn(R),
Super 8(R), Ramada Limited(R), Motel 6(R), Jameson Inns(R), Travelodge(R),
Thriftlodge(R), Knights Inn(R), Red Carpet Inn(R) and Scottish Inns(R). Best
Inns hotels compete for consumers and/or potential franchisees with independent
hotels and brands such as Bugetel Inn(R), Comfort Inn(R), Days Inn(R), Fairfield
Inn(R), Hampton Inn(R), La Quinta(R), and Red Roof Inn(R). Hawthorn Suites
hotels compete for consumers and/or potential franchisees with Residence Inn(R),
Homewood Suites(R), Summerfield Suites(R) and Woodfin Suites(R). In the
transient suites sector of the lodging industry, where the Company will be
competing through its Hawthorn Suites LTD brand, the Company's principal chain
competitors include AmeriSuites(R), Hampton Inn and Suites(R), Fairfield
Suites(R), MainStay(R), Candlewood(R), Wingate Inn(R), Towne Place(R) and
Courtyard by
10
<PAGE>
Marriott(R). Many of the Company's competitors are affiliated with larger chains
with substantially more properties, greater marketing budgets and greater brand
identity than the Company.
REGULATION
The sale of franchises is regulated by various state laws, as well as by
the Federal Trade Commission ("FTC"). The FTC requires that franchisors make
extensive disclosure to prospective franchisees, although it does not require
registration of offers to prospective franchisees. The required disclosure is
made through a Uniform Franchise Offering Circular, which must be provided to
potential franchisees at least 10 days prior to execution of a franchise
agreement. A number of states require registration and disclosure in connection
with franchise offers and sales. In addition, several states have "franchise
relationship laws" that limit the ability of franchisors to terminate franchise
agreements or to withhold consent to the renewal or transfer of these
agreements. While the Company's franchising operations have not been materially
adversely affected by such existing regulations, the Company cannot predict the
effect of any future legislation or regulation. Additionally, various federal,
state, and local laws and regulations may affect activities undertaken by the
Company in connection with the financing of franchisees. In particular, the
Company may be required to obtain a license or to register in certain states
in order to underwrite or promote loans to be made by third party lenders or
to make loans directly to franchisees.
EMPLOYEES
As of December 31, 1998 the Company employed approximately 141 full-time
and 7 part time persons. None of the Company's employees is represented by
unions. Management considers its employee relations to be satisfactory.
TRADEMARKS AND LICENSES
The Company either owns or has filed applications with regard to certain
trademarks and service marks, including, among others, US FRANCHISE SYSTEMS,
MICROTEL, MICROTEL with design, HAWTHORN SUITES, HAWTHORN SUITES with the tree
logo, HAWTHORN SUITES LTD. with design, and BEST INNS & SUITES. The Company
considers its marks to be material to its business and certain of the marks are
also registered with or applications for registration are pending with various
state and foreign government agencies. The Company is not aware of any material
adverse claim concerning its owned or licensed marks.
ITEM 2. PROPERTIES.
The principal executive and administrative offices of the Company are
located at 13 Corporate Square, Suite 250, Atlanta, Georgia 30329. The Company
currently leases a total of 15,489 square feet of office space at the foregoing
address, pursuant to a lease that expires on September 30, 2000 and two
subleases that expire on June 30, 1999 and September 30, 2001, respectively. The
Company also leases a total of 8,542 square feet of office space at 1205 Skyline
Drive, Marion, Illinois 62959 pursuant to a lease that expires on September 30,
2000.
ITEM 3. LEGAL PROCEEDINGS.
The Company is and may become party to claims and litigations that arise in
its normal course of business. In management's opinion, the outcome of any
currently pending matters will not have a material adverse effect on the
Company's consolidated financial statements.
11
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted during the fourth quarter ended December 31, 1998
to a vote of security holders of the Company.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Class A Common Stock is traded on the Nasdaq National Market
under the symbol USFS. As of March 12, 1999, there were 73 holders of record of
the Company's Class A Common Stock and 3 holders of record of the Company's
Class B Common Stock. Management of the Company believes that there are in
excess of 1,100 beneficial holders of its Class A Common Stock. The following
table shows the range of reported high and low closing prices per share of Class
A Common Stock.
<TABLE>
<CAPTION>
FISCAL 1997 HIGH LOW
----------- ----- ---
<S> <C> <C>
First quarter......................... $10.50 $7.63
Second quarter........................ 10.25 5.00
Third quarter......................... 10.13 7.00
Fourth quarter........................ 10.00 7.13
</TABLE>
<TABLE>
<CAPTION>
FISCAL 1998 HIGH LOW
----------- ------ ----
<S> <C> <C>
First quarter.......................... $13.75 $9.00
Second quarter......................... 12.50 7.63
Third quarter.......................... 7.94 4.00
Fourth quarter......................... 9.88 4.38
</TABLE>
DIVIDEND POLICY. The Company has not declared or paid any cash dividends on
its Class A or Class B Common Stock. The Company currently intends to retain any
earnings for use in its business and therefore does not anticipate paying any
cash dividends in the foreseeable future. Any future determination to pay cash
dividends will be made by the Board of Directors in light of the Company's
earnings, financial position, capital requirements and such other factors as the
Board of Directors deems relevant.
ITEM 6. SELECTED FINANCIAL DATA.
Presented below is selected consolidated historical financial information
of the Company and its subsidiaries for the years ended December 31, 1998, 1997
and 1996 and the period from August 28, 1995 (inception) to December 31, 1995,
respectively. The selected financial data has been derived from the consolidated
financial statements which were audited by the Company's independent public
accountants and should be read in conjunction with the Company's Consolidated
Financial Statements (and the related notes and schedules thereto) included
under "Item 8. Financial Statements and Supplementary Data" of this Report and
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations" of this Report.
12
<PAGE>
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) -----------------------
1998 1997 1996 1995
---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C> <C>
Revenues .......................... $ 10,584 $ 1,867 $ 94 $ --
Expenses .......................... 13,468 10,814 6,685 1,168
Net loss .......................... 2,884 8,947 6,591 1,168
Loss applicable to common
Stockholders ...................... 2,884 8,947 8,309 1,577
Net loss applicable to common
Stockholders per share ............ 0.16 0.71 0.75 0.15
Weighted average common
Shares outstanding (1) ............ 17,670,591 12,563,772 11,059,576 10,755,409
BALANCE SHEET DATA (at period end):
Working capital ................... $ 15,569 $ 12,144 $ 28,115 $ 13,265
Total assets ...................... 84,318 36,351 40,105 18,072
Total liabilities ................. 14,609 32,153 9,022 1,845
Redeemable Preferred Stock (2) .... -- -- 18,477 16,759
Redeemable Common Stock ........... 324 324 330 330
Stockholders' equity .............. $ 69,385 $ 3,874 $ 12,276 $ (862)
</TABLE>
- ---------------------------------
(1) Includes 3,128,473 shares for the periods ended December 31, 1998, and
December 31, 1997, respectively, and 3,186,280 shares for the period
ended December 31, 1996 of Class A Common Stock that are redeemable under
certain circumstances by the Company for reasons not under the Company's
control.
(2) On January 1, 1997, all the outstanding shares of redeemable preferred
stock were converted into $18,477,000 aggregate principal amount of 10%
subordinated debentures due September 29, 2007. The subordinated
debentures and associated interest were paid off with a portion of the
proceeds from the equity offering on May 19, 1998.
ITEM 7. 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 Reform Act. See "Special Note Regarding Forward-Looking
Statements" and "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risk Factors". Comparisons have been made
between the years ended December 31, 1998, 1997 and 1996 for the purposes of
the following discussion.
13
<PAGE>
RESULTS OF OPERATIONS
FRANCHISE SALES GROWTH
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
- ------------------------------------------------------------------ ----------------- ----------------- ----------------
MICROTEL FRANCHISE DATA 1998 1997 1996
- ------------------------------------------------------------------ ----------------- ----------------- ----------------
<S> <C> <C> <C>
Properties open (1) 124 64 28
Executed agreements and under construction 62 52 25
Executed franchise agreements but not under construction 276 253 168
Accepted applications 115 77 82
--- --- ---
Total in development and accepted applications (2) 453 382 275
- ------------------------------------------------------------------ ----------------- ----------------- ----------------
OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS 577 446 303
- ------------------------------------------------------------------ ----------------- ----------------- ----------------
</TABLE>
(1) The Company does not receive royalties from 29 hotels open as of December
31, 1998.
(2) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
- ------------------------------------------------------------------ ----------------- ----------------- ----------------
HAWTHORN SUITES FRANCHISE DATA 1998 1997 1996*
(inception to date)
- ------------------------------------------------------------------ ----------------- ----------------- ----------------
<S> <C> <C> <C>
Properties open 51 26 19
Executed agreements and under construction 29 14 2
Executed franchise agreements but not under construction 96 54 17
Accepted applications 78 17 14
-- -- --
Total in development and accepted applications (1) 203 85 33
- ------------------------------------------------------------------ ----------------- ----------------- ----------------
OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS 254 111 52
- ------------------------------------------------------------------ ----------------- ----------------- ----------------
</TABLE>
*The right to franchise the Hawthorn Suites brand was acquired on March 27,
1996.
(1) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
- ------------------------------------------------------------------ -----------------
BEST INNS FRANCHISE DATA 1998*
(inception to date)
- ------------------------------------------------------------------ -----------------
<S> <C>
Properties open 52
Executed agreements and under construction 12
Executed franchise agreements but not under construction 21
Accepted applications 142
---
Total in development and accepted applications (1) 175
- ------------------------------------------------------------------ -----------------
OPEN PLUS IN DEVELOPMENT PLUS ACCEPTED APPLICATIONS 227
- ------------------------------------------------------------------ -----------------
</TABLE>
*The Best Inns brand was acquired on April 28, 1998.
(1) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels.
14
<PAGE>
REVENUES:
The Company derived revenues from the following sources:
<TABLE>
<CAPTION>
- YEARS ENDED DECEMBER 31-
- ------------------------------------------------------ ------------------ ------------------- ------------------
1998 1997 1996
- ------------------------------------------------------ ------------------ ------------------- ------------------
<S> <C> <C> <C>
Royalty and fee income $ 6,938,000 $ 329,000 $ 49,000
Franchise application fees 3,320,000 1,208,000 12,000
OTHER 326,000 330,000 33,000
- ----- ------------------ ------------------- ------------------
TOTAL $ 10,584,000 $1,867,000 $ 94,000
- ------------------------------------------------------ ------------------ ------------------- ------------------
</TABLE>
YEAR ENDED 1998 COMPARED TO YEAR ENDED 1997
Royalty and fee income increased $6.6 million for the year ended December
31, 1998. The largest portion of the additional fee income was the increase in
royalties ($4.2 million) resulting from the increase in the number of royalty
paying hotels from 43 at the end of 1997 to 197 at the end of 1998. In 1998,
USFS also began receiving hotel management fees from third party property owners
and fund management fees from Constellation Development Fund which increased
royalty and fee income by $2.5 million in aggregate. Franchise application fees
increased $2.1 million for the year ended December 31, 1998, as a result of an
increase in the number of hotels opened during the year from 42 in 1997 to 107
in 1998 and application fees received from master license agreements in three
foreign countries. The main components of other revenues are commissions earned
from the national accounts program.
YEAR ENDED 1997 COMPARED TO YEAR ENDED 1996
Royalty and fee income increased $280,000 for the year ended December 31,
1997. The largest portion of the increase was the increase in the number of
royalty paying hotels from one to 43. Franchise application fees increased $1.2
million for the year ended December 31, 1997, as a result of an increase in the
number of hotels opened during the year from one in 1996 to 42 in 1997. Other
fee income increased $297,000 for the year ended December 31, 1997. The main
components of other revenues were management fees from an investment partnership
managed by the Company and commissions earned from the national accounts
program.
EXPENSES:
The Company's expenses are in the following areas:
<TABLE>
<CAPTION>
-YEARS ENDED DECEMBER 31-
- ---------------------------------------------------- ------------------- ------------------ ------------------
1998 1997 1996
- ---------------------------------------------------- ------------------- ------------------ ------------------
<S> <C> <C> <C>
General and administrative $ 11,590,000 $ 9,083,000 $ 6,864,000
Franchise sales commissions 2,216,000 641,000 29,000
Depreciation and amortization 1,393,000 571,000 537,000
Interest income (2,493,000) (1,386,000) (871,000)
Interest expense 762,000 1,905,000 126,000
------------------- ------------------ ------------------
TOTAL $ 13,468,000 $10,814,000 $6,685,000
- ---------------------------------------------------- ------------------- ------------------ ------------------
</TABLE>
15
<PAGE>
YEAR ENDED 1998 COMPARED TO YEAR ENDED 1997
General and administrative expenses increased $2.5 million for the year
ended December 31, 1998, the largest portions of which are: (i) the addition of
a management company (approximately $900,000), (ii) additional salaries and
wage-related costs pertaining to the increased number of executed and open
hotels (approximately $690,000), (iii) increased travel expenses (approximately
$485,000) and (iv) increased administrative expenses and other external advisory
services (approximately $360,000). Franchise sales commissions increased $1.6
million due to the increased number of hotel openings in 1998 compared to 1997.
Depreciation and amortization expense increased $822,000 for the year ended
December 31, 1998 primarily due to (i) increased amortization related to the
acquisitions of the Hawthorn and Best brands (approximately $600,000) and (ii)
increased depreciation due to the implementation of a new reservation system,
computers and related business equipment (approximately $210,000). Interest
income increased $1.1 million primarily due to additional loans to franchisees
and interest earned on the cash proceeds from the Company's May 1998 equity
offering. Interest expense decreased $1.1 million due to the payoff of the
Company's outstanding indebtedness in connection with the May 1998 equity
offering.
YEAR ENDED 1997 COMPARED TO YEAR ENDED 1996
General and administrative expenses increased $2.2 million for the year
ended December 31, 1997 primarily due to: (i) additional salaries, wages and
benefits for personnel hired to sell and handle the increased servicing
requirements of additional executed franchise agreements and newly introduced
programs (approximately $1.6 million), (ii) increased office and travel expenses
for the additional staff in place during 1997 (approximately $280,000) and (iii)
increased legal and professional expenses related to the Company's becoming
publicly traded in October 1996 (approximately $386,000). Franchise sales
commissions increased $612,000 for the year ended December 31, 1997 due to an
increase in the number of hotel openings in 1997 versus 1996. Depreciation and
amortization expense increased $34,000 for year ended December 31, 1997
primarily due to the additional depreciation of computer equipment and
associated software. Interest income increased $515,000 for the year ended
December 31, 1997 primarily as a result of additional interest earned on the
cash received from the Company's initial public offering in October 1996.
Interest expense increased $1.8 million for the year ended December 31, 1997 due
to conversion of the Company's redeemable preferred stock into subordinated
debentures and the related interest expense.
NET LOSS - A summary of operating results is as follows:
<TABLE>
<CAPTION>
-Years Ended December 31-
- ---------------------------------------------------------- ---------------- ------------------- --------------------
1998 1997 1996
- ---------------------------------------------------------- ---------------- ------------------- --------------------
<S> <C> <C> <C>
Loss ($ 2,884,000) ($ 8,947,000) ($ 6,591,000)
Loss applicable to common stockholders ($ 2,884,000) ($ 8,947,000) ($ 8,309,000)
- ---------------------------------------------------------- ---------------- ------------------- --------------------
</TABLE>
YEAR ENDED 1998 COMPARED TO YEAR ENDED 1997
The Company's net loss decreased by $6.0 million during 1998 primarily due
to the increased number of hotel openings and operating hotels resulting in
increased application fees and royalty revenues, various management fees, a
reduction in interest expense due to the pay-off of the Company's outstanding
indebtedness and an increase in interest income. The Company did not expect to
generate an overall profit in 1998 as it was still investing in its personnel,
systems and software to facilitate future growth. The Company had accumulated
net operating loss carry-forwards for income tax purposes of $17,844,000 and
$11,542,000 as of December 31, 1998 and 1997, respectively. Given the
uncertainty regarding eventual use of the carry-forward due to the limited
operating history of the Company, management recorded a valuation allowance for
the full amount of the deferred tax asset as of December 31, 1998.
16
<PAGE>
YEAR ENDED 1997 COMPARED TO YEAR ENDED 1996
The Company's net loss increased $2.4 million as of December 31, 1997
primarily because of the additional employees hired in 1997 and the additional
costs of being a public company for a full year. The Company did not expect to
generate a profit in 1996 or 1997 as it was investing in its personnel, systems
and software to facilitate future growth. The net loss applicable to common
stockholders includes $1.7 million of accumulated but undeclared and unpaid
dividends on its 10% Cumulative Redeemable Exchangeable Preferred Stock for the
year ended December 31, 1996. The Company had accumulated net operating loss
carry-forwards for income tax purposes of $11,542,000 and $6,437,000 as of
December 31, 1997 and 1996, respectively. Given the limited operating history of
the Company, management recorded a valuation allowance for the full amount of
the deferred tax asset as of December 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
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. Net proceeds were
approximately $21 million, all of which have been spent by the Company.
On May 19, 1998, the Company completed a public offering of 4,250,000
shares of Class A Common Stock at $10.50 per share. The Company received net
proceeds of approximately $41 million, of which approximately $30 million was
used to repay all of its outstanding indebtedness, including all principal and
accrued interest. The remaining $11 million was held either as cash or cash
equivalents to be used for working capital and general corporate purposes. Cash
and cash equivalents were $16 million as of December 31, 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 12 months.
In connection with the establishment of the Development Fund (see "Item 1.
Business - Development Fund"), the Company committed to make a loan of up to $10
million to Constellation. Constellation will use the funds to make an investment
which is subordinated to certain debt and equity returns of investors in the
Development Fund. The 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. As of December 31, 1998, the Company
had made loans of approximately $2.6 million in the aggregate to Constellation.
In addition, the Company sold an aggregate of 500,000 shares of Class A Common
Stock to NorthStar and Lubert-Adler for $5.6 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 be paid $3.5 million over the first
five years to manage the Development Fund.
In connection with the Best Inns Acquisition (see "Item 1. Business -
Acquisition of the Microtel, Hawthorn Suites and Best Inns Systems - 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 available 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 structurally subordinated to
such third party loan. The Company also committed to make up to $7.5 million of
additional loans to Ventures under certain circumstances. No such additional
loans have been made as of December 31, 1998. In connection with this
transaction, the Company also issued to Alpine 350,000 shares of Class A Common
Stock for a purchase price of $1.6 million. Additionally, the Company agreed to
pay to Alpine Equities $1,000 per year for each hotel added to the Best Inns
system after the closing of the transaction, provided that such new hotels are
paying royalties to the Company or any of its affiliates.
17
<PAGE>
The Company has no outstanding lines of credit in place. The Company uses
cash and its own stock as its primary capital resource.
For the year ended December 31, 1998, the Company had a net loss of $2.9
million. The net cash used in operating activities was $12.8 million. The net
use of cash was primarily a result of increases in promissory notes receivable
related to the application fees on executed franchise agreements, increases in
deferred commissions paid to salesmen for executed franchise agreements, and
increases in loans and subsidies provided to franchisees. Net cash used was
partially offset by cash inflows of application fees for executed franchise
agreements, depreciation and amortization, non-cash compensation cost related to
the Company's Amended and Restated Employee Stock Option Plan and increases in
commissions payable.
For the year ended December 31, 1997, the Company had a net loss of $8.9
million. The net cash used in operating activities was $9.6 million. The net use
of cash was primarily a result of increases in promissory notes receivable
related to the application fees on executed franchise agreements, increases in
deferred commissions paid to salesmen for executed franchise agreements,
increases in loans to franchisees, a decrease in the liability to Hudson and
increases in prepaid expenses. Net cash used was partially offset by cash
inflows of application fees for executed franchise agreements, depreciation and
amortization, non-cash compensation cost related to the Company's Amended and
Restated Employee Stock Option Plan, increases in commissions payable, and the
issuance of subordinated debentures.
For the year ended December 31, 1998, net cash used in investing activities
was $15.9 million which was primarily a result of the issuance of the previously
discussed long term notes receivable, acquisition of property and equipment and
acquisition of franchise rights.
For the year ended December 31, 1997, net cash used in investing activities
was $5.4 million which was primarily a result of costs related to the
acquisition of property and construction of hotels thereon. In addition, uses of
cash in investing activities included the acquisition of additional office
furniture and equipment, costs related to the construction of a national
reservation system and legal fees incurred in acquiring the Hawthorn brand.
For the year ended December 31, 1998, net cash provided by financing
activities was $28.8 million which was a result of the issuance of common stock,
partially offset by repayment of the Company's outstanding indebtedness. For the
year ended December 31, 1997, net cash used in financing activities was $283,000
which was a result of the Company repurchasing stock from certain members of
management who left the Company.
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 material 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 should not exceed $200,000, and in any event, does
not expect such costs to have a material adverse impact on the
18
<PAGE>
results of operations during any quarterly or annual reporting period. In
addition, management has recently converted the reservation systems that it
acquired as part of the Best Inns Acquisition to operate with the Microtel
reservation system. USFS anticipates that it will cease having any dependency on
the acquired Best Inns systems by June 1, 1999. Finally, management has
determined that the computer systems at certain USFS managed hotel properties
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 anticipated 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.
Royalties generated by gross room revenues of franchised properties are
expected to be the largest source of revenue for the Company for the immediate
future. The Company expects to experience seasonal revenue patterns similar to
those experienced by the lodging industry generally. The summer months, because
of increase in leisure travel, are expected to produce higher revenues for the
Company than other periods. 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.
INFLATION.
The rate of inflation has not had a material effect on the revenues or
operating results of the Company since its inception.
RESERVATIONS AND ADVERTISING FUNDS
During 1998, the Company created independent reservations and advertising
not-for-profit corporations owned by its franchisees (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 ceased reporting reservations and advertising fees and
expenses within its consolidated financial statements effective April 1, 1998.
Any deficits arising from reservations and advertising operations for quarterly
periods prior to April 1, 1998 have been included in general and administrative
expenses. 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, and has made interest-bearing loans to the Microtel Fund to supplement
reservation, advertising, and promotional efforts, and may make additional loans
in the future. The Company also administers reservations and advertising
programs on behalf of Best Inns franchisees by virtue of its management of Best
Reservations
19
<PAGE>
Corp., an Illinois not-for-profit corporation.
RISK FACTORS
In evaluating the Company and its business, the following risks should be
considered:
MANAGEMENT OF GROWTH
The Company has experienced rapid growth in the number of its employees and
the scope of its operations since its inception. This growth has resulted in,
and is expected to continue to create, new and increased responsibilities for
management personnel, as well as added demands on the Company's operating and
financial systems. The Company's success will depend on its ability to manage
this growth while implementing its strategy. The efforts of key management
personnel and the Company's ability to attract or develop new management
personnel and to integrate these new employees into its overall operations will
be crucial to continued growth. If the Company is unable to manage growth
effectively, the Company's business and results of operations could be
materially and adversely affected.
DEPENDENCE ON, AND OBSTACLES TO, HOTEL OPENINGS
The Company expects that in the future a principal source of revenues will
be royalty fees received from its franchisees. Accordingly, future revenues will
be highly dependent on the number of open hotels and their gross room revenues.
There are numerous factors beyond the control of the Company which affect the
probability of a hotel opening. These factors include, but are not limited to,
the ability of a potential hotel owner to (i) secure adequate financing or
satisfy financing payments during the construction period, (ii) locate an
appropriate site for a hotel, (iii) obtain all necessary state and local
construction, occupancy or other permits and approvals and (iv) reach a
satisfactory level of profitability at the hotel. There can be no assurance that
accepted franchise applications will result in executed franchise agreements or
that executed franchise agreements will result in open properties.
LIMITED OPERATING HISTORY; NET LOSSES
The Company began operating in October 1995 and therefore has a limited
operating history upon which investors can evaluate its performance. While the
Company believes that it has a well-conceived strategy, that it has assembled an
experienced and well-qualified management team to implement this strategy, and
that it was profitable in the second half of 1998, there can be no assurance
that it will be profitable in the future.
MANAGEMENT, BY VIRTUE OF OWNERSHIP OF SUPERVOTING CLASS B COMMON STOCK, CONTROLS
THE COMPANY
Holders of Class A Common Stock are entitled to one vote per share and
holders of Class B Common Stock are entitled to ten votes per share. Each share
of Class B Common Stock is convertible at any time into one share of the Class A
Common Stock and, with limited exceptions, will convert automatically upon any
transfer thereof. Michael A. Leven, Chairman, President and Chief Executive
Officer, and Neal K. Aronson, Executive Vice President and Chief Financial
Officer have the right to vote all of the outstanding shares of Class B Common
Stock, which, together with shares of Class A Common Stock which they
beneficially own (including stock held by other members of management),
represent approximately 65% of the combined voting power of the Company's
outstanding Common Stock. By reason of their right to vote the Class B Common
Stock, Messrs. Leven and Aronson will be able to (i) elect all of the Company's
directors (except as otherwise contractually provided), (ii) amend the Charter
with respect to most matters, (iii) effect a merger, sale or other major
corporate transaction, (iv) defeat an unsolicited takeover attempt and (v)
generally direct
20
<PAGE>
the affairs of the Company (including in a manner that may benefit themselves
disproportionately relative to other shareholders).
SUCCESSFUL COMPLETION AND INTEGRATION OF ACQUISITIONS
One element of the Company's business strategy is to continuously evaluate
acquisitions and business combinations. These acquisitions may be of brands in
the lodging industry or in other industries, or of businesses that the Company
does not expect to franchise, which would require the Company to develop
expertise in areas that it does not currently operate. There can be no assurance
that the Company will identify and complete suitable acquisitions or if
completed, that such acquisitions will be successfully integrated. Acquisitions
involve numerous risks, including difficulties assimilating new operations and
brands. There can be no assurance that any acquisitions would result in
long-term benefits to the Company or that management would be able to manage
effectively the resulting business.
DEPENDENCE ON SENIOR MANAGEMENT
The success of the Company is largely dependent on the efforts and
abilities of its senior management and certain other key personnel, particularly
Messrs. Leven, Aronson and Steve Romaniello, Executive Vice President-Franchise
Sales and Administration. The Company's success will depend in large part on its
ability to retain these individuals and other current members of its senior
management team and to attract and retain qualified personnel in the future. The
loss of members of senior management or of certain other key employees or the
Company's inability to retain other qualified employees could have an adverse
impact on the Company's business and results of operations. The Company does not
maintain key person life insurance on behalf of the lives of any of its officers
or employees.
RISKS RELATING TO MICROTEL ACQUISITION AGREEMENT
The Microtel Acquisition Agreement obligates the Company to execute new
franchise agreements and have open or under construction a specified number of
Microtels each year. Specifically, the Microtel Acquisition Agreement requires
that there are, on a cumulative basis, at least 50 "new" Microtels (i.e., not
open or under construction at the date of the Microtel Acquisition Agreement)
open or under construction by December 1997, 100 by December 1998, 175 by
December 1999, and 250 by December 2000. As of December 31, 1998 there were 157
"new" Microtels open or under construction. The Microtel Acquisition Agreement
further provides that if the Company is unable to comply with the development
schedule for two consecutive years but opens or has under construction at least
75% of the number of Microtels required by such schedule, the Company may cure
the default by making additional payments. If the Company fails to comply with
this development schedule and to make the requisite cure payment or payments,
all rights to the Microtel system automatically revert to Hudson. There can be
no assurance that the Company will comply with the foregoing development
schedule, and the Company's failure to meet such schedule or to pay the
requisite cure payments would have a material adverse effect on the Company. See
"Business -- Acquisition of the Microtel, Hawthorn Suites and Best Inns Systems
- - Microtel Acquisition."
COMPETITION FOR NEW FRANCHISE PROPERTIES AND HOTEL GUESTS
Competition among national brand franchisors and smaller chains in the
lodging industry to grow their franchise systems is intense. Many of the
Company's competitors are affiliated with larger chains with substantially more
properties, greater marketing budgets and greater brand identity than the
Company. There can be no assurance that the Company can franchise a sufficient
number of properties to generate operating efficiencies that will enable it to
compete with these larger chains. See "Business-Competition."
21
<PAGE>
GENERAL RISKS OF THE LODGING INDUSTRY
The Company is exposed to general risks of the lodging industry in a
number of ways. First, as a franchisor and manager, the Company's franchise
royalty and management fee revenues vary directly with its franchisees' gross
room revenues. As a result, the Company's franchise and management businesses
are, and will be, impacted by the effects of risks experienced by hotel
operators generally. Second, to the extent the Company directly or indirectly
makes equity or debt investments in hotel properties, those investments will be
subject to the risks experienced by the underlying properties. See "Business -
Development Fund," "Business - Acquisition of the Microtel, Hawthorn Suites and
Best Inns Systems - Best Inns Acquisition," and "Risks Relating to Financing of
Franchisees." Third, the Company may directly acquire ownership interests in its
branded hotel properties in order to promote the brand or for other reasons. To
the extent that the Company owns or leases hotel properties, it will be
subjected to the risks of a hotel operator.
The segments in which hotels franchised under the Company's brands
currently operate or plan to operate, may be adversely affected by changes in
national or local economic conditions and other local market conditions, such as
an oversupply of or a reduction in demand for lodging or a scarcity of potential
sites in a geographic area, changes is travel patterns, extreme weather
conditions, changes in governmental regulations that influence or determine
wages, prices, construction costs or methods of operation, changes in interest
rates, the availability of financing, and changes in real estate tax rates and
other operating expenses. In addition, due in part to the strong correlation
between the lodging industry's performance and economic conditions, the lodging
industry is subject to cyclical changes in revenues and profits. These risks may
be exacerbated by the relatively illiquid nature of real estate holdings.
Downturns or prolonged adverse conditions in real estate or capital markets or
in national or local economies could have a material adverse impact on the
Company's ability to locate new franchisees. In addition to the aforementioned
risks, the Company's current and potential future investments in or ownership of
hotel properties creates a risk of decreased earnings due to losses related to
start-up expenses or ongoing losses due to shortfalls in expected performance of
a hotel. In addition, any guaranty required to secure construction or permanent
loan financing could adversely affect the Company's financial condition.
The Company expects to experience seasonal revenue patterns similar to
those experienced by participants in the lodging industry generally.
Accordingly, the summer months, because of increases in leisure travel, are
expected to produce higher revenues for the Company than other periods during
the year. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - Seasonality."
DEVELOPMENT AND OWNERSHIP RISK
The Company's success depends upon the development or conversion and
opening of hotels. As a result, it is subject to risks experienced by hotel
developers. These risks, which are applicable to Microtels as new construction
properties, and to Hawthorn and Best Inns as both new construction and
conversion properties, include delays in the commencement or completion of
construction, failure to obtain all necessary zoning and construction permits,
discovery of environmental hazards, unavailability of financing on favorable
terms, if at all, the failure of developed properties to achieve desired revenue
or profitability levels once opened, competition for suitable development sites
from competing franchise chains, the risk of incurring substantial costs in the
event a development project must be abandoned prior to completion, changes in
governmental rules, regulations and interpretations and general economic and
business conditions. The Company's revenues may also be adversely affected by
increases in interest rates, which could increase the costs of financing new
hotel construction or the conversion of existing hotels. Any one of these risks
could discourage or prohibit potential franchisees from beginning or completing
hotel projects. To the extent the
22
<PAGE>
Company leases and/or owns hotel properties or makes, directly or indirectly,
equity or debt investments in hotel properties, it would be subject to risks
experienced by hotel operators generally.
RISKS RELATING TO THE FINANCING OF FRANCHISEES
The Company participates, from time to time, in construction loans, equity
investments, and long-term mortgage loans made to franchisees. In particular,
the Company has committed to lend up to $10 million to Constellation to be
invested by Constellation in the Development Fund and to be used by the
Development Fund to provide debt and equity financing to selected developers.
See "Business -- Development Fund." In addition, the Company made a $15 million
subordinated loan to Ventures in connection with the Best Inns acquisition. The
Company is also committed to make additional loans to Ventures under certain
circumstances. The Company expects Ventures to be a highly leveraged entity and
there can be no assurances that any loans to Ventures will be repaid. See
"Business -- Acquisition of the Microtel, Hawthorn Suites and Best Inns Systems
- - Best Inns Acquisition." The Company has also made various loans to individual
franchisees, to the Microtel Reservation and Advertising Fund, and loan
participations in a financing program with Nomura Asset Capital Corp. The
Company is subject to the risks experienced by lenders generally, including
risks of franchisee/borrower defaults and bankruptcies. In the event of a
default under such loans, the Company, as a lender, would bear the risk of loss
of principal to the extent the value of the collateral was not sufficient to pay
lenders which may be more senior in the capital structure. In connection with
equity investments, the Company would be subject to risks as an equity investor.
See "Business--Regulation."
REGULATION
The sale of franchises is regulated by various state laws, as well as by
the FTC. To the extent that the Company manages, owns or leases hotel
properties, it will be subject to additional governmental regulations. For
example, owners and operators of hotels are subject to numerous federal, state
and local government regulations, including those relating to the preparation
and sale of food and beverages (such as health and liquor license laws) and
building and zoning requirements. Under the Americans with Disabilities Act of
1990 (the "ADA"), all public accommodations are required to meet certain federal
requirements related to access and use by disabled persons. The determination
that hotels owned, managed or leased by the Company are not in compliance with
the ADA could result in the imposition of fines, and award of damages to private
litigants or significant expense to the Company in bringing these hotels into
compliance. Additionally, various national, state and local laws and regulations
may affect activities undertaken by the Company in connection with providing
financing to franchisees. In particular, the Company may be required to obtain a
license or to register in certain states in order to arrange loans to be made to
franchisees. See "Business--Regulation."
DEPENDENCE ON SPIRIT RESERVATION SYSTEM
Franchisees of the Hawthorn brand derive approximately 25% of their
reservations through the Spirit Reservation System, which is operated under
contract with Hyatt Hotels Corporation by CSC Outsourcing, Inc. ("CSC") and
Sabre Technology Solutions ("Sabre"). There can be no assurance that CSC and
Sabre will continue to service Hawthorn Suites' reservations needs in the
future. See "Business - The Company's Lodging Franchise Systems - Hawthorn
Suites."
23
<PAGE>
ABSENCE OF DIVIDENDS
The Company has not paid a dividend on its Common Stock since its
inception. The Company intends to retain any earnings to finance its growth and
for general corporate purposes and therefore does not anticipate paying any cash
dividends in the foreseeable future. See "Item 5-Dividend Policy." In addition,
future financing agreements may contain limitations on the payment of cash
dividends or other distributions of assets to the holders of Common Stock.
ANTI-TAKEOVER DEVICES
Certain identical provisions of the Certificate of Incorporation and the
By-Laws of the Company may be deemed to have anti-takeover effects and may
delay, deter or prevent a change in control of the Company that stockholders
might otherwise consider in their best interests. These provisions (i) allow
only the Board of Directors, the Chairman of the Board of Directors or the Chief
Executive Officer of the Company to call special meetings of the stockholders,
(ii) eliminate the ability of stockholders to take any action without a meeting,
(iii) establish certain advance notice procedures for nomination of candidates
for election as directors and for stockholder proposals to be considered at
stockholders' meeting, (iv) generally authorize the issuance of one or more
classes of "blank check" preferred stock, with such designations, rights and
preferences as may be determined from time to time by the Board of Directors,
(v) require approval of holders of 75% of the outstanding Class B Common Stock
for the Board of Directors to create a series of Preferred Stock with general
voting rights or with the right to elect a majority of directors under any
circumstances and (vi) require approval of holders of 75% of the outstanding
voting power to amend or repeal items (i), (ii) or (v) above or this item (vi).
YEAR 2000 COMPUTER MATTER
Management has determined that the Year 2000 issue will not pose material
operational problems for its computer systems, although the computer systems at
certain USFS managed properties are not currently Year 2000 compliant. 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. See "Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Year 2000 Computer Matter".
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
24
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Page
CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997 AND FOR THE
THREE YEARS ENDED DECEMBER 31, 1998:
<S> <C>
Independent Auditors' Report 26
Consolidated Statements of Financial Position 27
Consolidated Statements of Operations 28
Consolidated Statements of Stockholders' Equity 29
Consolidated Statements of Cash Flows 30
Notes to Consolidated Financial Statements 31
</TABLE>
25
<PAGE>
INDEPENDENT AUDITORS'REPORT
Board of Directors and Stockholders
U.S. Franchise Systems, Inc.:
We have audited the accompanying consolidated statements of financial position
of U.S. Franchise Systems, Inc. and subsidiaries (the "Company") as of December
31, 1998 and 1997 and the related consolidated statements of operations,
stockholders'equity (deficit), and cash flows for the three years ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company at December 31, 1998
and 1997 and the results of its operations and its cash flows for the three
years ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ DELOITTE & TOUCHE LLP
Atlanta, Georgia
March 20, 1999
26
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $15,966,000 $15,890,000
Accounts receivable (net of allowance for doubtful accounts of $74,000 and 2,070,000 268,000
$17,000, as of December 31, 1998 and 1997, respectively)
Deposits and prepaid expenses 328,000 716,000
Promissory notes receivable 919,000 862,000
Deferred commissions 1,615,000 2,563,000
-----------
Total current assets 20,898,000 20,299,000
PROMISSORY NOTES RECEIVABLE 23,590,000 2,869,000
PROPERTY AND EQUIPMENT -Net 3,396,000 5,595,000
FRANCHISE RIGHTS -Net 25,501,000 3,322,000
DEFERRED COMMISSIONS 7,355,000 3,049,000
OTHER ASSETS -(Net of accumulated amortization of $212,000 and $121,000 as of December 3,578,000 1,217,000
31, 1998 and 1997, respectively)
-----------
Total assets $84,318,000 $36,351,000
===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable $ 498,000 $ 1,138,000
Commissions payable 1,464,000 1,171,000
Deferred application fees 1,973,000 4,402,000
Accrued expenses 1,394,000 990,000
Current maturities of long-term debt -- 454,000
-----------
Total current liabilities 5,329,000 8,155,000
DEFERRED APPLICATION FEES 9,280,000 4,586,000
SUBORDINATED DEBENTURES -- 19,412,000
-----------
Total liabilities 14,609,000 32,153,000
COMMITMENTS AND CONTINGENCIES (Notes 6 and 12)
REDEEMABLE STOCK:
Common shares, par value $0.01 per share; issued and outstanding 3,128,473
(net of 58,807 shares in Treasury at December 31, 1998 and 57,807 as of
December 31, 1997) entitled to redemption under certain circumstances at
$324,000 (net of $6,000 in Treasury ) at December 31, 1998 and December
31, 1997, respectively.
324,000 324,000
STOCKHOLDERS' EQUITY :
Common shares, par value $0.01 per share; authorized 30,000,000 shares of Class 167,000 96,000
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 December
31, 1998; issued and outstanding 6,716,499 Class A shares and 2,707,919 Class B
shares at December 31, 1997
Capital in excess of par 89,416,000 21,092,000
Accumulated deficit (20,198,000) (17,314,000)
----------------------------------
Total stockholders'equity 69,385,000 3,874,000
----------------------------------
Total liabilities and stockholders'equity $84,318,000 $36,351,000
----------------------------------
----------------------------------
</TABLE>
See notes to consolidated financial statements.
27
<PAGE>
30
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
REVENUES:
<S> <C> <C> <C>
Royalty and fee income $6,938,000 $329,000 $ 49,000
Franchise application fees 3,320,000 1,208,000 12,000
Other 326,000 330,000 33,000
------------------------------------------------------------------------
Total revenues 10,584,000 1,867,000 94,000
------------------------------------------------------------------------
------------------------------------------------------------------------
General and administrative 11,590,000 9,083,000 6,864,000
Franchise sales commissions 2,216,000 641,000 29,000
Depreciation and amortization 1,393,000 571,000 537,000
Interest income (2,493,000) (1,386,000) (871,000)
Interest expense 762,000 1,905,000 126,000
------------------------------------------------------------------------
13,468,000 10,814,000 6,685,000
------------------------------------------------------------------------
NET LOSS $2,884,000 $8,947,000 $6,591,000
------------------------------------------------------------------------
------------------------------------------------------------------------
Net loss applicable to common
shareholders $2,884,000 $8,947,000 $8,309,000
Weighted average shares outstanding 17,670,591 12,563,772 11,059,576
Net loss applicable to common
shareholders per share - basic $0.16 $ 0.71 $0.75
----- ------ -----
----- ------ -----
</TABLE>
28
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
CAPITAL TOTAL
COMMON STOCK IN EXCESS ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT OF PAR DEFICIT EQUITY (DEFICIT)
-------------- ------------ -------------------- -------------------- ----------------------
<S> <C> <C> <C> <C> <C>
Balance as of January 1, 1996 7,569,115 $ 76,000 $ 230,000 $ (1,168,000) $ (862,000)
Redemption of capital stock -
other management (1,149,502) (11,000) (108,000) -- (119,000)
Issuance of capital stock -
other management 1,149,502 11,000 111,000 -- 122,000
Issuance of capital stock - initial
public offering proceeds, net 1,825,000 18,000 21,373,000 -- 21,391,000
Undeclared dividends on
redeemable preferred stock -- -- (1,110,000) (608,000) (1,718,000)
Fair value of options granted -- -- 53,000 -- 53,000
Net loss -- -- -- (6,591,000) (6,591,000)
------------ ------------ ------------ ------------ ------------
Balance as of December 31, 1996 9,394,115 94,000 20,549,000 (8,367,000) 12,276,000
Issuance of capital stock -
acquisition of computer software 30,303 -- 250,000 -- 250,000
Fair value of options granted -- -- 295,000 -- 295,000
Net loss -- -- -- (8,947,000) (8,947,000)
------------ ------------ ------------ ------------ ------------
Balance as of December 31, 1997 9,424,418 94,000 21,094,000 (17,314,000) 3,874,000
Issuance of capital stock-
Hawthorn acquisition 2,222,222 22,000 17,754,000 -- 17,776,000
Development fund 500,000 5,000 5,602,000 -- 5,607,000
Stock offering 4,250,000 43,000 40,758,000 -- 40,801,000
Best acquisition 350,000 3,000 3,890,000 -- 3,893,000
Fair value of options granted -- -- 318,000 -- 318,000
Net loss (2,884,000) (2,884,000)
------------ ------------ ------------ ------------ ------------
Balance as of December 31, 1998 16,746,640 $ 167,000 $ 89,416,000 $(20,198,000) $ 69,385,000
------------ ------------ ------------ ------------ ------------
------------ ------------ ------------ ------------ ------------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
29
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (2,884,000) $ (8,947,000) $ (6,591,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 1,393,000 571,000 537,000
Deferred compensation amortization 318,000 295,000 53,000
Changes in assets and liabilities:
(Increase) in accounts receivable (1,802,000) (154,000) (114,000)
(Increase) in prepaid expenses and deposits 388,000 (362,000) (335,000)
(Increase) in promissory notes receivable (5,778,000) (2,557,000) (1,174,000)
(Increase) in deferred commissions (3,358,000) (2,859,000) (2,712,000)
(Increase) in other assets (3,389,000) (548,000) (560,000)
(Increase) in accounts payable (640,000) 459,000 478,000
Increase (decrease) in accrued expenses 404,000 (120,000) 1,045,000
Increase in commissions payable 293,000 334,000 815,000
Increase in deferred application fees 2,265,000 3,323,000 5,545,000
Increase in subordinated debentures paid in kind 935,000 --
------------ ------------ ------------
Net cash used in operating activities (12,790,000) (9,630,000) (3,013,000)
INVESTING ACTIVITIES:
Issuance of long-term note receivable (15,000,000)
Acquisition of property and equipment (5,349,000) (5,162,000) (263,000)
Proceeds from sale of properties 7,183,000
Acquisition of franchise rights (2,735,000) (223,000) (117,000)
------------ ------------ ------------
Net cash used in investing activities (15,901,000) (5,385,000) (380,000)
FINANCING ACTIVITIES:
Issuance of redeemable preferred stock -- --
Repayment of subordinated debt (19,866,000)
Issuance of common stock, net 48,633,000 -- 21,513,000
Redemption of common stock (6,000) (119,000)
Principal payments on borrowings (277,000) (706,000)
------------ ------------ ------------
Net cash provided by (used in) financing activities 28,767,000 (283,000) 20,688,000
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY
CASH INVESTMENTS 76,000 $(15,298,000) $ 17,295,000
CASH AND TEMPORARY INVESTMENTS
Beginning of period 15,890,000 31,188,000 13,893,000
------------ ------------ ------------
End of period $ 15,966,000 $ 15,890,000 $ 31,188,000
------------ ------------ ------------
------------ ------------ ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest $ 762,000 $ 1,009,000 $ 144,000
------------ ------------ ------------
------------ ------------ ------------
Noncash activities;
Undeclared dividends accrued on redeemable preferred stock -- $ 1,718,000
------------ ------------ ------------
------------ ------------ ------------
Issuance of 30,303 shares of Class A common stock for
Reservations System Software $ 250,000 --
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
30
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
1. ORGANIZATION AND BASIS OF PRESENTATION
U.S. Franchise Systems, Inc. (the "Company") was incorporated in November
1997 for purposes of acquiring the Hawthorn Suites brand. See "Hawthorn
Acquisition." The Company's predecessor also known as USFS, was incorporated in
Delaware in August 1995. The term "the Company" refers to USFS before the
Merger, and as the surviving corporation in the merger. The consolidated
financial statements include the accounts of the Company and its wholly owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation.
MICROTEL INNS AND SUITES FRANCHISING, INC.: On September 7, 1995, the
Company entered into an agreement (the "Microtel Agreement") with Hudson Hotels
Corporation ("Hudson") to acquire the exclusive worldwide franchising rights and
operating assets of the Microtel hotel system (the "Microtel Acquisition"). The
Microtel Agreement requires the Company to pay a royalty for the right to use,
and license others to use, certain trademarks, service marks, and trade names
associated with the Microtel hotel system.
HAWTHORN SUITES FRANCHISING, INC.: On March 12, 1998, the Company
completed a series of transactions (collectively, the "Merger") which enabled it
to acquire the entire interest in the Hawthorn Suites brand of hotels. Prior to
the Merger, Hawthorn Suites Associates, an Illinois joint venture ("HSA") and
HSA Properties, Inc., a Delaware corporation ("HPI"), collectively owned 99% of
the membership interest in HSA Properties, L.L.C., a Delaware limited liability
company ("HSA LLC"), which owned all of the trademarks, copyrights and other
intellectual property related to the Hawthorn Suites brand. Immediately prior
to the Merger, all of HSA's and HPI's respective membership interests in HSA LLC
were transferred to USFS Hawthorn, Inc., in a transaction whereby (i) HSA was
issued 2,199,775 shares of Class A Common Stock, and (ii) HPI was issued 22,447
shares of Class A Common Stock. Since the remaining 1% membership interest in
HSA LLC was owned by USFS, following the Merger, HSA LLC became a wholly owned
subsidiary of the Company and the Master Franchise Agreement dated as of March
27, 1996 between USFS and HSA LLC was terminated. The Company now has the
exclusive right to franchise the Hawthorn Suites brand of hotels and to retain
100% of the royalties derived therefrom.
BEST INNS AND SUITES FRANCHISING, INC.: 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 assets of a fee-based hotel
management company. To facilitate the transaction, the Company made a $15
million unsecured subordinated loan to Alpine Hospitality Ventures LLC
("Ventures") at an interest rate of 12% per annum, interest on which will be
paid in cash to the extent available 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 acquired 17 Best Inns hotels in the Best Inns acquisition (the
"Acquired Hotels") and is structurally subordinated to such third party loan.
The Company also committed to make up to $7.5 million of additional loans to
Ventures under certain circumstances. No such additional loans had been made as
of December 31, 1998. The Company also 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
31
<PAGE>
sales of Common Stock made by the Company's CEO (Mr. Leven), and CFO (Mr.
Aronson). Additionally, the Company agreed to pay to Alpine Equities $1,000 per
year for each hotel added to the Best Inns system after the closing of the
transaction, provided that such new hotels are paying royalties to the Company
or any of its affiliates.
RESERVATIONS AND ADVERTISING FUNDS: In 1998, the Company created
independent reservations and advertising not-for-profit corporations owned by
its franchisees (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 ceased reporting
reservations and advertising fees and expenses within its consolidated financial
statements effective April 1, 1998. Any deficits arising from reservations and
advertising operations for quarterly periods prior to April 1, 1998 have been
included in general and administrative expenses. The Company manages the
reservations and advertising programs on behalf of the Funds and has made
interest bearing loans to the Microtel Fund to supplement reservation,
advertising and promotional efforts and may make additional loans in the future.
The Company also administers reservations and advertising programs on behalf of
Best Inns franchisees by virtue of its management of Best Reservations Corp, an
Illinois not-for-profit corporation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
APPLICATION FEE REVENUE AND RELATED COSTS - Initial franchise fee revenue
consists of application fees received by the Company's subsidiaries from
prospective franchisees. Such fees are recognized in income when the
underlying hotels open. Franchise sales commissions, and other related
selling costs are deferred until the underlying hotels open, at which time
such costs are charged to expense.
ROYALTY AND FEE REVENUE - The Company recognized royalty fee income on the
accrual method.
ALLOWANCE FOR DOUBTFUL ACCOUNTS- During the years ended December 31, 1998
and 1997 the Company charged $116,000 and $10,000 as an allowance for
estimated uncollectible accounts, respectively, and reduced the allowance
by $59,000 and $39,000, respectively. Charges to the account are made on a
specific identification basis.
CASH AND TEMPORARY CASH INVESTMENTS - The Company considers its investments
with an original maturity of three months or less to be cash equivalents.
FRANCHISE RIGHTS - Franchise rights represent the cost of acquiring such
rights and are amortized on a straight-line basis over 25 years for
Microtel, 31 years for Hawthorn and 33 years for Best Inns. The accumulated
amortization is $1.2 million and $447,000 at December 31, 1998 and 1997,
respectively.
OTHER ASSETS - Other assets primarily consist of development subsidies
(amortized over the operating life of the license agreement), architectural
drawings and renderings (amortized over 15 years ), loans and loan
participations and organization and start-up costs (amortized over five
years).
IMPAIRMENT OF LONG-LIVED ASSETS - The Company has adopted Statement of
Financial Accounting Standards ("SFAS") 121, "Accounting for the Impairment
of long-lived Assets and long-lived Assets to Be Disposed of," as of
January 1, 1996. Long-lived assets, principally intangibles, are evaluated
quarterly and written down to fair value when management believes that the
unamortized balance cannot be recovered through future undiscounted cash
flows. No assets were written down to fair value during the three years
ended December 31, 1998.
32
<PAGE>
INCOME TAXES - The Company has adopted the provisions of SFAS 109,
"Accounting for Income Taxes," which requires the use of the asset and
liability approach in accounting for income taxes.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying amounts of cash and cash
equivalents, trade and notes receivables, other current assets, accounts
payable, accrueds, and notes payable meeting the definition of a financial
instrument approximate fair value.
STOCK-BASED COMPENSATION PLANS - The Company has elected to account for its
Stock Option plans in accordance with SFAS 123, "Accounting for Stock-Based
Compensation." Under the provisions of SFAS 123, compensation is recognized
for the fair value of options granted over the vesting period.
EARNINGS PER SHARE - In February 1997, the Financial Accounting Standards
Board issued SFAS 128, "Earnings per Share," which simplifies the standards
for computing earnings per share (EPS) information and makes the
computation comparable to international EPS standards. SFAS 128 replaces
the presentation of "primary" (and when required "fully diluted") EPS with
a presentation of "basic" and "diluted" EPS. Net income per share basic is
computed based on net income divided by the weighted average common shares
outstanding. If required, on a diluted basis, net income per share -
diluted is computed by dividing net income by the weighted average common
and common shares during the year plus the incremental shares that would
have been outstanding under stock option plans.
MANAGEMENT ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
RECLASSIFICATIONS - Certain amounts in the prior year financial statements
have been reclassified to conform with the 1998 financial statement
presentation.
3. STOCKHOLDERS EQUITY
The Company has two classes of common stock: Class A Common Stock, par
value $.01 per share and Class B Common Stock, par value $.01 per share
outstanding at December 31, 1998 and 1997, respectively. Shares of Class A
Common Stock and Class B Common Stock are identical in all respects except
that: (i) holders of Class B Common Stock are entitled to ten votes per
share and holders of Class A Common Stock are entitled to one vote per
share; and (ii) the shares of Class B Common Stock are convertible into
Class A Common Stock at the option of the holder and, with limited
exceptions, upon the transfer thereof. There are 30 million shares of Class
A Common Stock and 5 million shares of Class B Common Stock authorized for
issuance.
On October 24, 1996, the Company completed an initial public offering of
1,825,000 shares of Class A Common Stock at $13.50 per share. Net proceeds
to the Company were approximately $21 million. Had the offering occurred on
January 1, 1996, pro forma loss applicable to common stockholders per share
would have been $.66 for the year ended December 31, 1996. Pro forma
weighted average shares of 12,580,409 are assumed outstanding for purposes
of the pro forma loss applicable to common stockholder per share
calculation. On May 19, 1998, the Company completed a public offering of
4,250,000 shares of Class A Common Stock at $10.50 per share. Net proceeds
were approximately $41 million, of which approximately $30 million was used
by the Company to repay all of its outstanding indebtedness including all
principal and accrued interest. The remaining $11 million was
33
<PAGE>
held either as cash or cash equivalents and will be used for working
capital and general corporate purposes.
4. PROPERTY AND EQUIPMENT
Property and equipment is recorded at historical cost and consisted of the
following at December 31, 1998 and 1997, respectively:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Land $1,122,000 $1,847,000
Construction-in-progress 198,000 2,339,000
Furniture, fixtures, and equipment 594,000 276,000
Computer equipment and software 1,978,000 1,273,000
---------- ----------
$3,892,000 5,735,000
Less accumulated depreciation 496,000 140,000
---------- ----------
---------- ----------
$3,396,000 $5,595,000
---------- ----------
---------- ----------
</TABLE>
PC based computer software is depreciated on a straight-line basis over a
period of three years. The reservation system and accounting system
software are depreciated on a straight-line basis over a period of five
years. Computer equipment is depreciated using the 200% declining-balance
method over a period of five years. The remaining fixed assets are
depreciated using the 200% declining-balance method over a period of seven
years. Depreciation expense was $365,000, $108,000 and $30,000 for the
years ended December 31, 1998, and 1997 and 1996, respectively.
5. LEASES
The Company leases certain equipment and office space used in its
operations. Rental expense under operating leases was $461,000, $366,000
and $231,000 for the years ended December 31, 1998, 1997 and 1996,
respectively. The future minimum rental commitments under non-cancelable
operating leases at December 31, 1997 were as follows:
<TABLE>
<CAPTION>
<S> <C>
1999 $ 454,000
2000 372,000
2001 131,000
2002 66,000
2003 17,000
-----------------
Total $ 1,040,000
-----------------
-----------------
</TABLE>
34
<PAGE>
6. REDEEMABLE PREFERRED STOCK AND SUBORDINATED DEBENTURES
Until December 31, 1996, the cumulative redeemable exchangeable preferred
stock earned cumulative dividends at an annual dividend rate of 10%,
payable in additional shares of redeemable preferred stock. On January 1,
1997, the Company exercised its option to exchange the redeemable preferred
stock at its liquidation value of $18,477,000 into 10% subordinated
debentures due September 29, 2007. In May 1998 the Company repaid all
outstanding principal and interest on the subordinated debentures with a
portion of the proceeds from its $41 million equity offering (note 3).
7. STOCK PURCHASED BY EMPLOYEES
Under the terms of certain employee stock purchase agreements, Company
management holds 4,056,133 shares of restricted stock and 1,371,319 shares
of unrestricted stock at December 31, 1998.
The Company repurchased 30,921 unrestricted and 26,886 restricted shares
(57,807 shares in the aggregate) from two management employees who left the
Company during 1997 at $.1034 and $.1137 per share, respectively, pursuant
to the terms of the departing management employees' respective employee
stock purchase agreements. As of December 31, 1997 and 1998 the 57,807
shares are held by the Company as treasury stock. Pursuant to the terms of
their respective employee stock purchase agreements, certain management
shareholders have the right to purchase, at any time, the repurchased
shares from the Company at the price paid by the Company. Such shareholders
permanently declined the option to repurchase such shares held as treasury
stock. Unrestricted shares and restricted shares are subject to five year
and ten year vesting periods, respectively, subject to, among other things,
the management employee's continued employment by the Company. Any shares
which are forfeited will be repurchased by the Company and reoffered to
certain management shareholders at $.1034 or $.1137 per share, as
applicable, based on the price paid by the management employee for the
shares. Compensation expense will be recorded to the extent the fair value
of the reoffered shares exceeds $.1034 or $.1137, as applicable. All
restricted shares are subject to an earnings test formula based upon
increases in the Company's earnings before interest, taxes, and
depreciation and are deemed earned upon the satisfaction of these
performance criteria (the "Earned Shares"). Earned Shares are subject to
forfeiture if the holder's employment ceases with the Company before
September 29, 2005. Any restricted shares that have not been earned by
September 29, 2005 will be redeemed by the Company and reissued to the
original stockholders of the Company (other than certain management
shareholders) pro rata based on their original holdings of common stock.
Restricted shares and all other shares subject to the employee stock
purchase agreements held by other members of management have been
classified as redeemable common stock in the balance sheet because they are
redeemable by the Company under certain circumstances for reasons beyond
the Company's control.
8. STOCK OPTION PLANS
The Company has two stock option plans which reserve shares of Class A
Common Stock for its officers, employees, consultants and advisors (the
"Employee Plan") and for its non-employee directors (the "Directors Plan").
Under the Employee Plan, the Option Committee of the Board of Directors may
grant options for up to 725,000 shares of the Company's Class A Common
Stock. The options generally have a maximum life of seven years. Under the
Directors Plan, the Company may grant options to its non-employee directors
for up to 125,000 shares of the Company's Class A Common Stock.
Non-employee directors are each awarded options to purchase 2,000 shares
upon their election to the Board of Directors. In addition, commencing on
January 1, 1998, each non-employee director receives a grant of 2,000 stock
options on January 1 of each year they continue to serve on the Board. The
director options become exercisable on the first anniversary of the grant
date and their maximum life is ten years.
35
<PAGE>
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions.
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Expected life (years) 3.9 3.8
Expected volatility 30.0% 30.1%
Risk free interest rate 6.0% 6.0%
Dividend Yield 0.0% 0.0%
</TABLE>
Activity related to the Company's two stock option plans is summarized as
follows:
<TABLE>
<CAPTION>
1998 1997
------------------------- ------------------------
WEIGHTED AVG. WEIGHTED AVG.
SHARES EXERCISE PRICE SHARES EXERCISE-PRICE
------ -------------- ------ --------------
<S> <C> <C> <C> <C>
Options outstanding as of January 1 228,500 $ 11.39 178,500 $ 13.48
Granted 326,757 7.66 105,700 8.66
Forfeited (70,400) 9.38 (55,700) 12.72
-------- --------- -------- ---------
Options outstanding as of December 31 484,857 $ 9.28 228,500 $ 11.39
-------- --------- -------- ---------
-------- --------- -------- ---------
Options exercisable as of December 31 53,163 39,950
------ ------
------ ------
Weighted-average fair value of options
granted during the year $2.23 $2.78
------ ------
------ ------
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------- ---------------- ------------- --------------
NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
EXERCISE PRICES DEC. 31, 1998 CONTRACTUAL LIFE EXERCISE PRICE DEC. 31, 1998 EXERCISE PRICE
--------------- ------------- ---------------- --------- ------------- --------------
<S> <C> <C> <C> <C> <C>
$.1034 to $.11375 30,921 3.50 $ 0.11 0 $ 0
$ 5.75 to $7.63 115,000 4.56 6.58 313 7.00
$ 8.13 to $9.88 90,950 3.15 8.60 17,650 8.57
$10.38 to $ 13.50 221,100 2.20 12.26 35,200 13.50
---------- ------- ----------- --------- ---------
Total 457,971 3.07 $ 9.28 53,163 $ 11.83
---------- ------- ----------- --------- ---------
---------- ------- ----------- --------- ---------
Performance
Based Options* 26,886
----------
Total options ** 484,857
----------
</TABLE>
* Performance Based options have been granted to an employee at an
average exercise price of $ .105 per share. Vesting of these options is
conditional on the Company achieving certain profitability targets.
Compensation cost will be estimated and recorded for these options when
management can reasonably estimate the likelihood that the performance
criteria will be achieved by the Company.
** The fair value of options granted during the years ended December 31,
1998 and 1997 was $610,000 and $213,000 respectively, which is being
amortized as compensation expense over the vesting period. Compensation
expense of $318,000, $295,000 and $53,000 was recorded for the years
ended December 31, 1998, 1997 and 1996, respectively.
36
<PAGE>
9. ESTABLISHMENT OF DEVELOPMENT FUND
On March 17, 1998, NorthStar Constellation, LLC (together with its
affiliates, "NorthStar"), Lubert-Adler Real Estate Opportunity Funds
(together with its affiliates, "Lubert-Adler") and Constellation Equity
Corp., an entity controlled by NorthStar ("Constellation"), formed
Constellation Development Fund (the "Development Fund"). The Development
Fund was established, in part, to provide capital that will allow the
Company to expand its Microtel and Hawthorn Suites brands into high
visibility, difficult to develop areas by providing debt and equity
financing to selected local developers. NorthStar, Lubert-Adler and
Constellation agreed to contribute to the Development Fund equity up to
$50 million. On October 31, 1998 the Development Fund entered into a $60
million senior credit facility with NationsBank, N.A. As of December 31,
1998 the Development Fund has committed to fund the construction of eight
Microtel and two Hawthorn Suites hotels, and is currently in the process
of reviewing additional projects. In connection with the establishment of
the Development Fund, the Company committed to make a loan of up to $10
million to Constellation. Constellation will use the funds to make an
investment which is subordinated to certain debt and equity returns of
investors in the Development Fund. The 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. As of December
31, 1998, the Company had made loans of approximately $2.6 million in the
aggregate to Constellation. Due to the uncertainty surrounding ultimate
recoverability of the subordinated loan, the Company is accounting for it
on the cost-recovery basis, where interest income is recorded only after
recovery of principal. The Company will be paid $3.5 million over the
first five years to manage the Development Fund. In connection with this
transaction, the Company also sold an aggregate of 500,000 shares of Class
A Common Stock to NorthStar and Lubert-Adler for $5.6 million. NorthStar
and Lubert-Adler also have the right to purchase up to an additional
500,000 shares of Class A Common Stock, exercisable on a pro-rata basis
within 18 months of the commitment of the Development Fund's capital at a
price of $11.25 per share. In addition, David T. Hamamoto, Co-Chief
Executive Officer of NorthStar was elected to the Board of Directors of
the Company. Dean Adler, a director of the Company, serves as a manager of
Lubert-Adler, and Mr. Adler, along with Mr. Hamamoto and Mr. Aronson,
serve as managers of the Development Fund.
37
<PAGE>
10. SEGMENT REPORTING
The Company owns three brands and operates a management company in the United
States. Revenues, net income (after allocation of corporate overhead), and
identifiable assets are estimated as follows:
<TABLE>
<CAPTION>
Management Other/
Microtel Hawthorn Best Company Corporate Consolidated
<S> <C> <C> <C> <C> <C> <C>
Revenues
1998 $ 3,646,000 $ 3,410,000 $ 1,072,000 $ 1,407,000 $ 1,049,000 $ 10,584,000
1997 $ 1,394,000 $ 203,000 $ - $ - $ 270,000 $ 1,867,000
1996 $ 26,000 $ - $ - $ - $ 68,000 $ 94,000
Net Income (loss)
1998 $ (956,000) $ (107,000) $ (523,000) $ (365,000) $ (933,000) $ (2,884,000)
1997 $ (163,000) $ (40,000) $ - - $ (8,744,000) $ (8,947,000)
1996 $ 45,000 $ 24,000 $ - - $ (6,660,000) $ (6,591,000)
Identifiable Assets
1998 $ 15,255,000 $ 26,086,000 $ 21,895,000 $ 1,043,000 $ 20,039,000 $ 84,318,000
1997 $ 15,921,000 $ 7,693,000 $ - $ - $ 12,737,000 $ 36,351,000
1996 $ 13,506,000 $ 6,091,000 - $ - $ 20,508,000 $ 40,105,000
Capital Expenditures
1998 $ 4,341,000 $ 18,362,000 $ 4,583,000 - $ 1,008,000 $ 28,294,000
1997 $ 4,211,000 $ 223,000 - - $ 951,000 $ 5,385,000
1996 $ 432,000 - - - $ - $ 432,000
</TABLE>
38
<PAGE>
11. INCOME TAXES
Deferred income taxes in the accompanying consolidated statement of
financial position includes the following amounts of deferred tax assets and
liabilities at December 31, 1998 and 1997, respectively:
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C>
DEFERRED TAX LIABILITIES:
Deferred expenses $ (2,955,000) $ (487,000)
Other (251,000) (76,000)
------------ -------------
Total $ (3,206,000) $ (563,000)
------------ -------------
------------ -------------
DEFERRED TAX ASSETS:
Operating loss carryforwards $ 6,781,000 $ 4,386,000
Deferred revenue 3,905,000 2,165,000
Compensation cost 259,000 135,000
Other 112,000 123,000
------------ -------------
Total 11,057,000 6,809,000
------------ -------------
Valuation allowance $ (7,851,000) ( 6,246,000)
------------ -------------
Net deferred tax asset (liability) $ -- $ --
------------ -------------
------------ -------------
</TABLE>
As of December 31, 1998 and 1997, the Company had accumulated net operating
loss carryforwards of $17,844,000 and $11,542,000, respectively which begin
to expire in the year 2010.
During the years ended December 31, 1998, and 1997 the Company increased
the valuation allowance against its net deferred tax asset by $1.6 million
and $3.3 million, respectively due to the uncertainty of the realizability
of net deferred tax assets.
The following is a reconciliation of the statutory tax rate to the
effective tax rate of the Company at December 31, 1998 and 1997,
respectively:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Statutory federal rate 34% 34%
Statutory state rate less federal effect 4% 4
Effect of income not subject to tax (1)
Change in valuation allowance (38) (37)
---- ----
Effective tax rate - % - %
---- ----
---- ----
</TABLE>
39
<PAGE>
12. COMMITMENTS
The Company, as part of the Microtel Agreement, is required to fulfill certain
obligations under such Agreement. Among such obligations, the Company is
required to execute franchise agreements and to have open or under construction
the following number of Microtel hotels each December, annually:
<TABLE>
<CAPTION>
Year Number of Hotels
---- ----------------
<S> <C>
1997 50
1998 100
1999 175
2000 250
</TABLE>
The above development schedule is considered to have been complied with unless
such schedule is not met for two consecutive years. If 75% of the development
level has been met, a fee of $1,000,000 may be paid and upon such payment, the
Company will be deemed to be in compliance with such schedule. Hudson has
retained the right to receive franchise application and royalty payments for
hotels open or under development on October 5, 1995. In addition, Hudson has the
right to build an additional 31 hotels without paying franchise application or
royalty fees. The Company is required to remit to Hudson a continuing monthly
royalty equal to 1.0% of the revenues subject to royalties on the first 100
Microtel properties opened by the Company's franchisees, 0.75% for the next 150
Microtel properties, and 0.5% for each new property after the first 250
properties. If any of the above obligations are not met, including the payment
of amounts due to Hudson, the rights to the Microtel system will, at Hudson's
discretion, revert back to Hudson. In the event Hudson exercises its rights to
the Microtel system, the Company, through Microtel will retain the rights to any
franchise royalty payments due under franchises granted by the Company and its
subsidiary, less certain processing fees due to Hudson.
The Company has employment agreements with its Chief Executive Officer and Chief
Financial Officer. The agreements are for a ten year term expiring on September
30, 2005 and provide minimum salary levels and other fringe benefits.
13. SELECTED QUARTERLY FINANCIAL DATA - (UNAUDITED)
<TABLE>
<CAPTION>
1998 First Second Third Fourth Total Year
---- ----- ------ ----- ------ ----------
<S> <C> <C> <C> <C> <C>
Revenue $ 1,296,000 $ 2,795,000 $ 3,354,000 $ 3,139,000 $ 10,584,000
Net income (loss) (1,855,000) (1,256,000) 109,000 118,000 (2,884,000)
Income (loss) applicable to common
stockholders (1,855,000) (1,256,000) 109,000 118,000 (2,884,000)
Weighted avg shares outstanding 13,094,249 17,837,891 19,875,113 19,875,113 17,670,591
Net income (loss) applicable to common
stockholders per share-basic (.14) (.07) .01 .01 (.16)
</TABLE>
<TABLE>
1997 First Second Third Fourth Total Year
---- ----- ------ ----- ------ ----------
<S> <C> <C> <C> <C> <C>
Revenue $ 158,000 $ 384,000 $ 590,000 $ 735,000 $ 1,867,000
Net loss 2,515,000 2,174,000 2,181,000 2,077,000 8,947,000
Loss applicable to common
stockholders 2,515,000 2,174,000 2,181,000 2,077,000 8,947,000
Weighted avg shares outstanding 12,580,395 12,580,395 12,541,405 12,552,891 12,563,772
Net loss applicable to common
stockholders per share-basic $ 0.20 $ 0.17 $ 0.17 $ 0.17 $ 0.71
</TABLE>
(a) Due to the changes in the numbers of shares outstanding, quarterly per share
amounts do not add to the total for the year.
40
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
There have been no disagreements on accounting and financial disclosure matters
which are required to be described by Item 304 of Regulation S-K.
PART III
Items 10, 11, 12, and 13 to be furnished by amendment hereto on or prior to
April 30, 1999 or the Company will otherwise have filed a definitive Proxy
Statement involving the election of directors pursuant to Regulation 14A which
will contain such information.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS:
See Table of Contents to Financial Statements ("Item 8. Financial Statements and
Supplementary Data").
2. FINANCIAL STATEMENT SCHEDULES:
No schedules are included with this Report, as they are not applicable or the
information required to be set forth therein is included in the consolidated
financial statements or notes thereto.
3. EXHIBITS: The following exhibits are filed with or incorporated by
reference into this Report. Except as otherwise indicated, the exhibit number
corresponds to the exhibit number in the referenced document.
41
<PAGE>
EXHIBIT
NUMBER DESCRIPTION
2.1 Agreement and Plan of Merger, dated December 9, 1997, between U.S.
Franchise Systems, Inc. and USFS Hawthorn, Inc. (incorporated by
reference from the Company's Registration Statement on Form S-4
(Registration No. 333-46185)).
2.2 Contribution Agreement, dated December 9, 1997, among Hawthorn Suites
Associates, HSA Properties, Inc., USFS Hawthorn, Inc. and U.S.
Franchise Systems, Inc. (incorporated by reference from the Company's
Registration Statement on Form S-4 (Registration No. 333-46185)).
3.1 Certificate of Incorporation (incorporated by reference from the
Company's Registration Statement on Form S-4 (Registration No.
333-46185)).
3.2 By-laws (incorporated by reference from the Company's Registration
Statement on Form S-4 (Registration No. 333-46185)).
4.2 Specimen Class A Common Stock Certificate (incorporated by reference
from the Company's Registration Statement on Form S-4 (Registration No.
333-46185)).
4.3 Specimen Class B Common Stock Certificate (incorporated by reference
from the Company's Registration Statement on Form S-4 (Registration No.
333-46185)).
4.4 Shareholders Agreement, dated as of March 12, 1998 by and among
Hawthorn Suites Associates, HSA Properties, Inc., Michael A. Leven,
Neal K. Aronson and U.S. Franchise Systems, Inc. (incorporated by
reference from the Company's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1998 (File No. 0-23941)).
4.5 Registration and Tag-Along Rights Agreement dated as of March 17, 1998
between (i) U.S. Franchise Systems, Inc., (ii) Sextant Trading LLC,
Lubert-Adler Real Estate Opportunity Fund, L.P., Lubert-Adler Real
Estate Opportunity Fund II, L.P. and Lubert-Adler Capital Real Estate
Opportunity Fund, L.P., and (iii) Michael Leven and Neal K. Aronson
(incorporated by reference from the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 1998 (File No. 0-23941)).
4.6 Registration Rights Agreement dated as of April 28, 1998 among U.S.
Franchise Systems, Inc., Alpine Hospitality Equities LLC, Michael A.
Leven and Neal K. Aronson (incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the quarterly period ended March 31,
1998 (File No. 0-23941)).
10.1 Form of License Agreement for Microtel brand hotels (incorporated by
reference from the Company's Registration Statement on Form S-1
(Registration No. 333-11427)).
10.2 Form of License Agreement for Hawthorn Suites brand hotels
(incorporated by reference from the Company's Registration Statement on
Form S-1 (Registration No. 333-11427)).
10.3 Joint Venture Agreement between Microtel Franchise and Development
Corporation and U.S. Franchise Systems, Inc. dated as of September 7,
1995 (incorporated by reference from the Company's Registration
Statement on Form S-1 (Registration No. 333-11427)).
42
<PAGE>
10.5 Amended and Restated Stockholders' Agreement, dated as of September 29,
1995, as amended on October 11, 1996, among the Company and the
Original Investors (incorporated by reference from the Company's
Registration Statement on Form S-1 (Registration No. 333-11427)).
10.6 Amended and Restated Employee Stock Purchase Agreement between U.S.
Franchise Systems, Inc. and Michael A. Leven, entered into as of
September 29, 1995, as amended effective October 24, 1996 (incorporated
by reference from the Company's Registration Statement on Form S- 1
(Registration No. 333-11427)).
10.7 Amended and Restated Employee Stock Purchase Agreement between U.S.
Franchise Systems, Inc. and Neal K. Aronson, entered into as of
September 29, 1995, as amended effective October 24, 1996 (incorporated
by reference from the Company's Registration Statement on Form S-1
(Registration No. 333-11427)).
10.8 Employment Agreement by and between U.S. Franchise Systems, Inc. and
Michael A. Leven, dated October 1, 1995 (incorporated by reference from
the Company's Registration Statement on Form S-1 (Registration No.
333-11427)).
10.9 Employment Agreement by and between U.S. Franchise Systems, Inc. and
Neal K. Aronson, dated October 1, 1995 (incorporated by reference from
the Company's Registration Statement on Form S-1 (Registration No.
333-11427)).
10.10 Voting Agreement between Michael A. Leven and Andrea Leven entered into
on October 30, 1996 (incorporated by reference from the Company's
Registration Statement on Form S-1 (Registration No. 333-11427)).
10.11 Voting Agreement between Michael A. Leven and Neal K. Aronson entered
into on October 30, 1996 (incorporated by reference from the Company's
Registration Statement on Form S-1 (Registration No. 333-11427)).
10.12 Office Lease Agreement between Hallwood Real Estate Investors Fund XV
and U.S. Franchise Systems, Inc., dated September 25, 1995
(incorporated by reference from the Company's Registration Statement on
Form S-1 (Registration No. 333-11427)).
10.13 First Amendment to Office Lease between Hallwood 95, L.P. and U.S.
Franchise Systems, Inc., dated May 20, 1996 (incorporated by reference
from the Company's Registration Statement on Form S-1 (Registration No.
333-11427)).
10.14 U.S. Franchise Systems, Inc. Amended and Restated 1996 Stock Option
Plan (incorporated by reference from the Company's Registration
Statement on Form S-8 (Registration No. 333-5707, Exhibit 4.3).
10.15 U.S. Franchise Systems, Inc. 1996 Stock Option Plan for Non-Employee
Directors (incorporated by reference from the Company's Registration
Statement on Form S-1 (Registration No. 333-11427)).
10.16 Term Sheet, dated May 14, 1996, between the Company and NACC regarding
the Franchise Financing Facility (incorporated by reference from the
Company's Registration Statement on Form S-1 (Registration No.
333-11427)).
43
<PAGE>
10.17 Voting Agreement between Michael A. Leven and Andrea Leven entered into
on March 12, 1998 (incorporated by reference from Exhibit 10.11 to the
Company's Registration Statement on Form S-4 (Registration No.
333-46185)).
10.18 Voting Agreement between Michael A. Leven and Neal K. Aronson entered
into on March 12, 1998 (incorporated by reference from Exhibit 10.13 to
the Company's Registration Statement on Form S-4 (Registration No.
333-46185)).
10.21 Agreement of Purchase and Sale between America's Best Inns, Inc. and
The Other Selling Entities Listed on Schedule I thereto and Best
Acquisition, Inc., dated December 15, 1997. The Registrant agrees to
furnish copies of the schedules hereto supplementally to the Commission
on request (incorporated by reference from the Company's Registration
Statement on Form S-4 (Registration No. 333-46185)).
10.22 Promissory Note, dated March 18, 1998, from Constellation Equity Corp.
to the Registrant in the principal amount of $10 million.
10.23 Management Services Agreement, dated March 17, 1998, between the
Registrant and Constellation Development Fund LLC.
10.24 Asset Transfer Agreement dated as of April 28, 1998 among Best
Acquisition, Inc., Alpine Hospitality Ventures LLC, RSVP-BI OPCO, LLC,
RSVP-ABI REALCO, LLC, America's Best Inns, Inc. and the entities
identified on Schedule 1 thereto. The Company agrees to furnish copies
of the schedules hereto supplementally on request (incorporated by
reference from the Company's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1998 (File No. 0-23941)).
10.25 Securities Purchase Agreement dated as of April 28, 1998 by and between
U.S. Franchise Systems, Inc. and Alpine Hospitality Equities LLC. The
Company agrees to furnish copies of the schedules hereto supplementally
on request (incorporated by reference from the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 1998 (File
No. 0-23941)).
10.26 Hotel Management Agreement made and entered into on April 28, 1998 by
and among Alpine Hospitality Ventures LLC, RSVP-BI OPCO, LLC, RSVP-ABI
REALCO, LLC and USFS Management, Inc. (incorporated by reference from
the Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 1998 (File No. 0-23941)).
10.27 Amended and Restated License Agreement dated April 28, 1998 by and
between Best Franchising, Inc. and RSVP-BI OPCO, LLC (incorporated by
reference from the Company's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1998 (File No. 0-23941)).
10.28 Best Franchising, Inc. current form of License Agreement for Best Inns
hotels (incorporated by reference from the Company's Quarterly Report
on Form 10-Q for the quarterly period ended March 31, 1998 (File No.
0-23941)).
10.30 Senior Subordinated Note Purchase Agreement dated as of April 28, 1998
between Alpine Hospitality Ventures LLC and U.S. Franchise Systems,
Inc. The Company agrees to furnish copies of the schedules hereto
supplementally on request (incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the quarterly period ended March 31,
1998 (File No. 0-23941)).
44
<PAGE>
10.31 Subscription Agreement dated as of March 17, 1998 between (i) U.S.
Franchise Systems, Inc., (ii) Sextant Trading LLC, and (iii)
Lubert-Adler Real Estate Opportunity Fund, L.P., Lubert-Adler Real
Estate Opportunity Fund II, L.P. and Lubert-Adler Capital Real Estate
Opportunity Fund, L.P. (incorporated by reference from the Company's
Quarterly Report on Form 10-Q for the quarterly period ended March 31,
1998 (File No. 0-23941)).
21.1* List of Subsidiaries of U.S. Franchise Systems, Inc.
23.1* Consent of Deloitte & Touche, LLP.
27.1* Financial Data Schedule for the years ended December 31, 1998, 1997 and
1996, submitted to the Securities and Exchange Commission in electronic
format.
* Filed herewith.
Copies of the exhibits are available at a charge of $.25 per page upon written
request to the Secretary of the Company at 13 Corporate Square, Suite 250,
Atlanta, Georgia 30329.
(B) REPORTS ON FORM 8-K
-------------------
During the period from October 1, 1998 to December 31, 1998 the Company did not
file any reports on Form 8-K.
45
<PAGE>
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
U.S. Franchise Systems, Inc.
(Registrant)
By /S/ MICHAEL A. LEVEN
Michael A. Leven
Chairman of the Board, President
and Chief Executive Officer
Dated March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on March 30, 1999 by the following persons on behalf of
the Registrant in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLES
<S> <C>
/S/ MICHAEL A. LEVEN
- ----------------------------------
(Michael A. Leven) Chairman, President and Chief Executive Officer and Director
(Principal Executive Officer)
/S/ NEAL K. ARONSON
- ----------------------------------
(Neal K. Aronson) Executive Vice President, Chief Financial Officer and
Director (Principal Financial and Accounting Officer)
/S/ DEAN ADLER
- ----------------------------------
(Dean Adler) Director
/S/ IRWIN CHAFETZ
- ----------------------------------
(Irwin Chafetz) Director
/S/ DOUG GEOGA
- ----------------------------------
(Doug Geoga) Director
/S/ RICHARD D. GOLDSTEIN
- ----------------------------------
(Richard D. Goldstein) Director
/S/ DAVID T. HAMAMOTO
- ----------------------------------
(David T. Hamamoto) Director
/S/ STEVE ROMANIELLO
- ----------------------------------
(Steve Romaniello) Director
/S/ JEFFREY A. SONNENFELD
- ----------------------------------
(Jeffrey A. Sonnenfeld) Director
- ----------------------------------
(Barry Sternlicht) Director
</TABLE>
46
<PAGE>
EXHIBIT INDEX
21.1 List of Subsidiaries of U.S. Franchise Systems, Inc.
23.1 Consent of Deloitte & Touche, LLP.
27.1 Financial Data Schedule for the years ended December 31, 1998, 1997 and
1996, submitted to the Securities and Exchange Commission in electronic
format.
47
<PAGE>
EXHIBIT 21.1
LIST OF SUBSIDIARIES OF U.S. FRANCHISE SYSTEMS, INC.
<TABLE>
<CAPTION>
SUBSIDIARY STATE OF INCORPORATION/ORGANIZATION
- ---------- -----------------------------------
<S> <C>
Microtel Inns and Suites Franchising, Inc. Georgia
Hawthorn Suites Franchising, Inc. Georgia
Microtel Inns Realty Corp. Georgia
Microtel International, Inc. Georgia
U.S. Funding Corp. Georgia
U.S. Franchise Capital, Inc. Georgia
USFS Equity, LLC Delaware
Tempe Inns Realty Corp. Georgia
Chandler Inns Realty Corp. Georgia
HSA Properties, LLC Delaware
Best Acquisition, Inc. Georgia
USFS Management, Inc. Georgia
Best Franchising, Inc. Georgia
Hawthorn International, Inc. Georgia
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF DELOITTE & TOUCHE, LLP
We consent to the incorporation by reference in Registration Statement Nos.
333-36629 and 333-50707 of U.S. Franchise Systems, Inc. on Form S-8 of our
report dated March 20, 1999, appearing in this Annual Report on Form 10-K of
U.S. Franchise Systems, Inc. for the year ended December 31, 1998.
/s/ DELOITTE & TOUCHE, LLP
Atlanta, Georgia
March 20, 1999
<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 years ended
December 31, 1998, 1997 and 1996, respectively and is qualified in its entirety
by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1998 JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<CASH> 15,966 15,890 31,188
<SECURITIES> 0 0 0
<RECEIVABLES> 2,070 268 114
<ALLOWANCES> 74 0 0
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 20,898 20,299 33,934
<PP&E> 3,396 5,595 292
<DEPRECIATION> 365 140 32
<TOTAL-ASSETS> 84,318 36,351 40,105
<CURRENT-LIABILITIES> 5,329 8,155 5,819
<BONDS> 0 19,412 0
0 0 18,477
0 0 0
<COMMON> 491 420 426<F1>
<OTHER-SE> 68,894 3,454 11,850
<TOTAL-LIABILITY-AND-EQUITY> 84,318 36,351 40,105
<SALES> 10,584 1,867 94
<TOTAL-REVENUES> 10,584 1,867 94
<CGS> 0 0 0
<TOTAL-COSTS> 13,468 10,814 6,685<F3>
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 0 1,905 126
<INCOME-PRETAX> (2,884) (8,947) (6,591)
<INCOME-TAX> 0 0 0
<INCOME-CONTINUING> (2,884) (8,947) (6,591)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (2,884) (8,947) (8,309)
<EPS-PRIMARY> (0.16) (0.71) (0.75)<F2>
<EPS-DILUTED> (0.16) (0.71) (0.75)<F2>
<FN>
<F1> Includes 3,128,473 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 represents net loss adjusted for dividends accreted on
the redeemable preferred stock.
<F3> Includes interest income and interest expense.
</FN>
</TABLE>
