<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-23941
-----------
U.S. FRANCHISE SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 58-2361501
(State or other jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
13 Corporate Square, Suite 250 30329
Atlanta, Georgia (Zip Code)
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (404) 321-4045
-----------
Indicate by check mark whether the registrant: (1) has filed all
reports required by Sections 12, 13, or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
There were 17,190,969 shares of the registrant's Class A Common Stock
and 2,707,919 shares of the registrant's Class B Common Stock outstanding as of
October 26, 1999.
1
<PAGE>
U.S. FRANCHISE SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Financial Position at December 31, 1998
and September 30, 1999 (Unaudited).................................. 3
Consolidated Statements of Operations for the three and nine months
ended September 30, 1999 and 1998 (Unaudited)....................... 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1999 and 1998 (Unaudited)............................. 5
Notes to Consolidated Financial Statements (Unaudited) ............. 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS............................................... 7
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........... 19
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.................................................... 20
ITEM 2. RECENT SALE OF UNREGISTERED SECURITIES............................... 20
ITEM 3. DEFAULTS UPON SENIOR SECURITIES...................................... 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................. 20
ITEM 5. OTHER INFORMATION.................................................... 20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..................................... 20
SIGNATURES........................................................... 21
EXHIBIT INDEX........................................................ 22
</TABLE>
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and temporary cash investments................................................... $ 5,228,000 $ 15,966,000
Accounts receivable .................................................................. 3,934,000 2,070,000
Deposits and prepaid expenses......................................................... 370,000 315,000
Promissory notes receivable........................................................... 4,584,000 919,000
Deferred commissions.................................................................. 6,458,000 1,615,000
----------- ------------
TOTAL CURRENT ASSETS.......................................................... 20,574,000 20,885,000
PROMISSORY NOTES RECEIVABLE.............................................................. 23,968,000 23,590,000
PROPERTY AND EQUIPMENT-Net............................................................... 2,468,000 3,396,000
FRANCHISE RIGHTS-Net..................................................................... 24,601,000 25,138,000
DEFERRED COMMISSIONS..................................................................... 3,048,000 6,682,000
DEVELOPMENT SUBSIDIES.................................................................... 10,442,000 1,299,000
OTHER ASSETS-Net......................................................................... 4,596,000 3,186,000
----------- ------------
TOTAL ASSETS.................................................................. $89,697,000 $ 84,176,000
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable...................................................................... $ 427,000 $ 498,000
Commissions payable................................................................... 1,285,000 1,464,000
Deferred application fees............................................................. 7,671,000 1,973,000
Accrued expenses...................................................................... 833,000 1,252,000
----------- ------------
TOTAL CURRENT LIABILITIES..................................................... 10,216,000 5,187,000
DEFERRED APPLICATION FEES................................................................ 4,148,000 9,280,000
----------- ------------
TOTAL LIABILITIES............................................................. 14,364,000 14,467,000
REDEEMABLE STOCK:
Common shares, par value $0.01 per share; issued and outstanding 3,128,473 (net of
58,807 shares in Treasury at September 30, 1999 and December 31, 1998)
entitled to redemption under certain circumstances at $324,000 (net of
$6,000 in Treasury ) as of September 30, 1999 and December 31, 1998 324,000 324,000
STOCKHOLDERS' EQUITY:
Common shares, par value $0.01 per share; authorized 30,000,000 shares of Class A
Common Stock and 5,000,000 shares of Class B Common Stock; issued and outstanding
14,062,496 Class A shares and 2,707,919 Class B shares at September 30, 1999; issued and
outstanding 14,038,721 Class A shares and 2,707,919 Class B shares at December 31, 1998 167,000 167,000
Capital in excess of par............................................................... 89,988,000 89,416,000
Accumulated deficit.................................................................... (15,146,000) (20,198,000)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY............................................................ 75,009,000 69,385,000
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.............................................. 89,697,000 84,176,000
----------- -----------
----------- -----------
</TABLE>
See notes to consolidated financial statements.
3
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS THREE MONTHS NINE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998 SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
REVENUES:
Royalty and Other Fee Income ......... $ 4,874,000 $ 2,381,000 $ 10,823,000 $ 4,966,000
Franchise application fees ........... 2,118,000 973,000 4,096,000 2,478,000
------------ ------------ ------------ ------------
6,992,000 3,354,000 14,919,000 7,444,000
EXPENSES:
General and administrative .......... 2,502,000 2,855,000 7,301,000 8,702,000
Franchise sales commissions ......... 1,363,000 799,000 3,226,000 1,628,000
Depreciation and amortization ....... 415,000 415,000 1,120,000 1,018,000
Interest income ..................... (659,000) (836,000) (2,204,000) (1,664,000)
Interest expense .................... 0 12,000 0 761,000
Write-off of a franchisee loan ...... 250,000 0 250,000 0
------------ ------------ ------------ ------------
3,871,000 3,245,000 9,693,000 10,445,000
------------ ------------ ------------ ------------
NET INCOME (LOSS) BEFORE TAXES ......... 3,121,000 109,000 5,226,000 (3,001,000)
Income taxes ......................... 87,000 0 174,000 0
------------ ------------ ------------ ------------
NET INCOME (LOSS) AFTER TAXES .......... $ 3,034,000 $ 109,000 $ 5,052,000 $ (3,001,000)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
Weighted average number of
common shares outstanding .............. 19,891,538 19,875,113 19,881,725 16,935,751
Weighted average number of
common shares outstanding,
assuming dilution ...................... 20,087,111 19,875,113 20,046,911 16,935,751
Earnings (loss) per share (Basic) ...... $ 0.15 $ 0.01 $ 0.25 $ (0.18)
Earnings (loss) per share (Diluted) .... $ 0.15 $ 0.01 $ 0.25 $ (0.18)
</TABLE>
See Notes to Consolidated Financial Statements.
4
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30,1998
------------------ -----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net Income/(Loss) .................................................................... $ 5,052,000 $ (3,001,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization ..................................................... 1,120,000 1,018,000
Deferred compensation amortization ................................................ 361,000 223,000
Gain on sale of land .............................................................. (155,000) --
Write-off of a franchisee loan .................................................... 250,000 --
Changes in assets and liabilities:
Decrease/(Increase) in accounts receivable, prepaid
expenses & deposits ............................................................. (1,919,000) (1,478,000)
Decrease/(Increase) in promissory notes receivable ................................ (4,293,000) (4,603,000)
Decrease/(Increase) in deferred commissions ....................................... (1,209,000) (2,175,000)
Decrease/(Increase) in other assets ............................................... (1,422,000) (1,028,000)
(Decrease)/Increase in accounts payable ........................................... (71,000) (608,000)
(Decrease)/Increase in accrued expenses ........................................... (419,000) (63,000)
(Decrease)/Increase in commissions payable ........................................ (179,000) 16,000
(Decrease)/Increase in deferred application fees .................................. 566,000 2,270,000
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES ............................................. (2,318,000) (9,065,000)
------------ ------------
INVESTING ACTIVITIES:
Acquisition of property and equipment ................................................. (184,000) (3,400,000)
Proceeds from sale of properties ...................................................... 809,000 5,752,000
Issuance of development subsidies ..................................................... (9,143,000) (311,000)
Issuance of long-term note receivable ................................................. -- (15,000,000)
Proceeds from short-term debt ......................................................... -- 10,000,000
Repayment of short-term debt .......................................................... -- (10,000,000)
Acquisition of franchise rights ....................................................... (113,000) (2,877,000)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES ............................................. (8,631,000) (15,836,000)
------------ ------------
FINANCING ACTIVITIES:
Exercise of stock options ............................................................. 211,000 --
Repayment of subordinated debt ........................................................ -- (19,776,000)
Issuance of common stock, net ......................................................... -- 48,008,000
------------ ------------
NET CASH PROVIDED/(USED) IN FINANCING ACTIVITIES .................................. 211,000 28,232,000
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALANTS .................................... (10,738,000) 3,331,000
CASH AND TEMPORARY INVESTMENTS
Beginning of period .................................................................. 15,966,000 15,890,000
End of period ........................................................................ $ 5,228,000 $ 19,221,000
------------ ------------
------------ ------------
SUPPLEMENTAL DISCLOSURES OF CASHFLOW INFORMATION
Noncash activities:
Issuance of 2,222,222 shares for acquisition of Hawthorn
franchise rights ................................................................... -- $ 17,777,000
------------ ------------
------------ ------------
Issuance of stock for acquisition of Best Inns and Suites
franchise rights ................................................................... -- $ 2,293,000
------------ ------------
------------ ------------
</TABLE>
See Notes to Consolidated Financial Statements
5
<PAGE>
U.S. FRANCHISE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission
for reporting on Form 10-Q. Accordingly, certain information and footnotes
required by generally accepted accounting principles for complete financial
statements have been omitted. In the opinion of management, all adjustments,
consisting of normal recurring adjustments, which are necessary for a fair
presentation of financial position and results of operations, have been made.
These interim financial statements should be read in conjunction with the
consolidated financial statements and notes thereto, presented in the U.S.
Franchise Systems, Inc. ("USFS" or the "Company") Annual Report on Form 10-K for
the year ended December 31, 1998, filed with the Securities and Exchange
Commission. The results of operations for the nine months ended September 30,
1999 are not necessarily indicative of results that may be expected for the full
year.
2. RECLASSIFICATIONS
Certain amounts in the September 30, 1999 statement of operations and
consolidated statement of cash flows have been reclassified to conform to
current year classifications. In addition, certain reclassifications have been
made in the balance sheet from December 31, 1998.
3. EARNINGS PER SHARE
Basic earnings per common share are computed using the weighted average
number of common shares outstanding during the period. Diluted earnings per
common share incorporates the incremental shares issuable upon the assumed
exercise of stock options. Certain of the Company's stock options were excluded
from the calculation of diluted earnings per share because they were
antidilutive, but these options could be dilutive in the future.
4. STOCK OPTION PLANS
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>
- - -----------------------------------------------------------------------------------
THREE MONTHS NINE MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED ENDED ENDED
30-SEPT-99 30-SEPT-99 30-SEPT-98 30-SEPT-98
------------ ----------- ------------ -----------
<S> <C> <C> <C> <C>
NEW STOCK OPTION
GRANTS:
Expected life(years) N/A 3.75 4.16 3.86
Expected volatility N/A 34.8% 30.0% 30.0%
Risk free interest rate N/A 5.9% 6.0% 6.0%
Dividend yield N/A 0% 0% 0%
Number of options granted N/A 277,100 88,800 219,222
Weighted average exercise
price N/A 11.77 6.81 7.68
FORFEITURES AND EXERCISES:
Number of options forfeited 11,550 50,225 8,500 23,600
Number of options exercised 9,150 24,775 0 0
STOCK OPTION EXPENSE $100,000 $275,000 $ 94,000 $224,000
- - --------------------------------------------------------------------------------------
</TABLE>
6
<PAGE>
5. SEGMENT REPORTING
The Company owns three hotel brands and operates a management company
primarily in the United States. Revenues, expenses and capital expenditures
directly attributable to each business segment are reflected as such and shown
below. Common expenses and common capital expenditures are classified in
other/corporate. The amount in capital expenditures for 1999 for Hawthorn and
Best represent adjustments to prior expenditures.
<TABLE>
<CAPTION>
THREE MONTHS ENDED, SEPTEMBER 30, 1999
MICROTEL HAWTHORN BEST MANAGEMENT OTHER/ CONSOLIDATED
COMPANY CORPORATE
REVENUE
- - --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Sept. 30, 1999 $ 1,894,000 $ 2,709,000 $ 1,515,000 $ 524,000 $ 350,000 $ 6,992,000
Sept. 30, 1998 1,145,000 1,229,000 422,000 558,000 0 3,354,000
NET INCOME
(LOSS)
- - --------------------------------------------------------------------------------------------------
Sept. 30, 1999 $ 1,491,000 $ 1,977,000 $ 1,355,000 $ 192,000 $(1,980,000) $ 3,035,000
Sept. 30, 1998 770,000 835,000 693,000 241,000 (2,430,000) 109,000
CAPITAL
EXPENDITURES
- - --------------------------------------------------------------------------------------------------
Sept. 30, 1999 $ 36,000 $ 503,000 $(176,000) $ 23,000 $ 17,000 $ 403,000
Sept. 30, 1998 384,000 30,000 184,000 0 133,000 731,000
<CAPTION>
NINE MONTHS ENDED, SEPTEMBER 30, 1999
MICROTEL HAWTHORN BEST MANAGEMENT OTHER/ CONSOLIDATED
COMPANY CORPORATE
REVENUE
- - -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Sept. 30, 1999 $ 4,811,000 $ 5,353,000 $ 2,947,000 $ 1,457,000 $ 350,000 $ 14,918,000
Sept. 30, 1998 3,253,000 2,662,000 608,000 921,000 0 7,444,000
NET INCOME
(LOSS)
- - -----------------------------------------------------------------------------------------------------
Sept. 30, 1999 $ 3,488,000 $ 4,030,000 $ 2,924,000 $ 502,000 (5,892,000) $ 5,052,000
Sept. 30, 1998 2,395,000 1,737,000 1,455,000 395,000 (8,983,000) (3,001,000)
CAPITAL
EXPENDITURES
- - -----------------------------------------------------------------------------------------------------
Sept. 30, 1999 $ 401,000 $ 4,266,000 $ 4,603,000 $ 86,000 $ 84,000 $ 9,440,000
Sept. 30, 1998 3,435,000 18,392,000 4,761,000 29,000 219,000 26,836,000
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" should be read in conjunction with the consolidated
financial statements included herein of the Company and its subsidiaries.
Certain statements under this caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" constitute "forward-looking
7
<PAGE>
statements" under the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). Certain, but not necessarily all, of such forward-looking
statements can be identified by the use of forward-looking terminology such as
"believes," "expects," "may," "will," "should," or "anticipates" or the negative
thereof or other variations thereon or comparable terminology, or by discussions
of strategy that involve risks and uncertainties. Such forward-looking
statements involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of U.S.
Franchise Systems, Inc. and its subsidiaries ("USFS" or the "Company") to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such factors include,
but are not limited to, the following: general economic and business conditions;
aggressive competition in the lodging and franchising industries; success of
acquisitions and operating initiatives; management of growth; risks relating to
the Company's loans to and other investments in franchisees; dependence on
senior management; brand awareness; general risks of the lodging and franchising
industries; development risk and construction; risk of loss of management
contracts; 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; and the costs and other effects of legal
and administrative proceedings and other factors referenced below under the
sub-heading "Risk Factors" in this Form 10-Q. The Company will not undertake and
specifically declines any obligation to publicly release the results of any
revisions which may be made to any forward-looking statement to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events.
The Company was formed to acquire, market and service well-positioned
brands with potential for rapid unit growth through franchising. The Company's
initial brands, which are in the lodging industry, were the Microtel and
Hawthorn Suites brands. The Company acquired the rights to these brands because
of their potential for significant growth, which reflects, among other things,
their potential profitability for franchisees at the property level and their
positions in attractive segments of the lodging industry. In addition, in April
1998 the Company acquired the exclusive worldwide franchise rights to the Best
Inns brand, a mid-priced economy brand positioned between the budget Microtel
and upscale Hawthorn Suites brands. With the acquisition of the Best Inns brand,
the Company also acquired management contracts and capabilities.
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 the occupancy rates, revenues and
profitability of the franchised properties. The Company offers prospective
franchisees access to financing, a business format, design and construction
assistance (including architectural plans), uniform quality standards, training
programs, national reservations systems, national and local advertising,
promotional campaigns and volume purchasing discounts.
The Company expects that its future revenues will consist primarily of
(i) franchise royalty fees, (ii) franchise application fees, (iii) various
management fees, (iv) various master license fees, and (v) payments made by
vendors who supply the Company's franchisees with various products and services.
The Company recognizes franchise application fees as revenue only upon the
opening of the underlying hotels.
The Company's predecessor was incorporated in Delaware in August 1995.
The Company was incorporated in Delaware on November 26, 1997 and merged with
its predecessor on March 12, 1998 with the Company as the surviving corporation.
The Company's executive offices are located at 13 Corporate Square, Suite 250,
Atlanta, Georgia 30329 and its telephone number is (404) 321-4045.
8
<PAGE>
Comparisons have been made between the three months and nine months
ended September 30, 1999 and September 30, 1998 for the purposes of the
following discussion:
RESULTS OF OPERATIONS
FRANCHISE SALES GROWTH- Since acquiring the Microtel brand in October
1995 and establishing its sales force by January 1996, the Company has realized
franchise sales growth as follows:
<TABLE>
<CAPTION>
FRANCHISE SALES GROWTH
AS OF SEPTEMBER 30,
- - ---------------------------------------------------------------- -------------- ------------------
MICROTEL FRANCHISE DATA 1999 1998
- - ---------------------------------------------------------------- -------------- ------------------
<S> <C> <C>
Properties open (1) 169 110
Executed agreements and under construction 55 59
Executed franchise agreements but not under construction 262 267
Accepted applications 95 79
-------------- ------------------
Total in development and accepted applications (2) 412 405
- - ---------------------------------------------------------------- -------------- ------------------
OPEN PLUS IN DEVELOPMENT AND ACCEPTED APPLICATIONS 581 515
- - ---------------------------------------------------------------- -------------- ------------------
</TABLE>
(1) The Company does not receive royalties from 27 hotels open as of
September 30, 1999.
(2) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels.
Since acquiring the Hawthorn Suites brand in March 1996 and
establishing its sales force by July 1996, the Company has realized franchise
sales growth as follows:
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
- - ---------------------------------------------------------------- ---------------- -------------------
HAWTHORN SUITES FRANCHISE DATA 1999 1998
- - ---------------------------------------------------------------- ---------------- -------------------
<S> <C> <C>
Properties open (1) 90 44
Executed agreements and under construction 33 26
Executed franchise agreements but not under construction 125 85
Accepted applications 62 66
---------------- -------------------
Total in development and accepted applications(2) 220 177
- - ---------------------------------------------------------------- ---------------- -------------------
OPEN PLUS IN DEVELOPMENT AND ACCEPTED APPLICATIONS 310 221
- - ---------------------------------------------------------------- ---------------- -------------------
</TABLE>
(1) The Company does not receive royalties from 1 hotel open as of September
30, 1999.
(2) There can be no assurance that properties in development or for
which applications have been accepted will result in open hotels.
Since acquiring the Best Inns brand on April 28, 1998 and establishing
its sales force in June 1998, the Company has realized franchise sales growth as
follows:
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
- - -------------------------------------------------------------------------- --------- -----------
BEST INNS FRANCHISE DATA 1999 1998
- - -------------------------------------------------------------------------- --------- -----------
<S> <C> <C>
Properties open 108 45
Executed agreements and under construction 15 9
Executed franchise agreements but not under construction 38 11
Accepted applications 107 101
--------- -----------
Total in development and accepted applications (1) 160 121
- - -------------------------------------------------------------------------- --------- -----------
OPEN PLUS IN DEVELOPMENT AND ACCEPTED APPLICATIONS 268 166
- - -------------------------------------------------------------------------- --------- -----------
</TABLE>
(1) There can be no assurance that properties in development or for which
applications have been accepted will result in open hotels.
9
<PAGE>
REVENUE- The Company has derived revenues from the following sources:
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998 SEPTEMBER 30, 1999 SEPTEMBER 30, 1998
------------------ ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Royalty and other fee income... $4,874,000 $2,381,000 $10,823,000 $4,966,000
Franchise application fees..... 2,118,000 973,000 4,096,000 2,478,000
--------- ------- --------- ---------
TOTAL.......................... $6,992,000 $3,354,000 $14,919,000 $7,444,000
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998 Royalty and other fee income increased
approximately $2.5 million for the three months ended September 30, 1999 as
compared to the comparable prior year's period. The increase is primarily
attributable to the increase in royalty paying hotels from 169 to 339.
Included in the third quarter 1999 royalty and fee income was $350,000
received from a supplier as an inducement to switch services from an
alternative provider and $185,000 received from international master license
agreements. This increase in revenues was offset by the loss of nine
management contracts that generated $113,000 of management fee income for the
three months ended September 30, 1998 and no fees for the same period in 1999.
Franchise application fees increased approximately $1.1 million for the
three months ended September 30, 1999 as compared to the comparable prior year's
period. The increase is primarily attributable to an increase in the number of
hotels opened during the quarter and a higher average application fee associated
with the Hawthorn and Best openings during such period.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1998 Royalty and other fee income increased approximately $5.9
million for the nine months ended September 30, 1999 as compared to the prior
year's period. The increase is primarily attributable to the increase in
royalty paying hotels from 169 to 339. Included in the nine months ended
September 30, 1999 royalty and fee income was $350,000 received from a
supplier as an inducement to switch services from an alternative provider.
The increase in revenues in 1999 was offset by the loss of nine management
contracts that generated $192,000 of management fee income for the nine
months ended September 30, 1998 and $58,000 of management fee income for the
nine months ended September 30, 1999.
Franchise application fees increased $1,618,000 for the nine months
ended September 30, 1999 as compared to the comparable prior year's period. The
increase is primarily attributable to an increase in the number of hotels opened
during the period and a higher average application fee associated with the
Hawthorn and Best openings during such periods.
10
<PAGE>
EXPENSES-The Company's expenses were as summarized below:
<TABLE>
<CAPTION>
THREE MONTHS ENDED THREE MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998 SEPTEMBER 30,1999 SEPTEMBER 30,1998
------------------ ------------------ ----------------- -----------------
<S> <C> <C> <C> <C>
General and administrative.................. $2,502,000 $2,855,000 $7,301,000 $8,702,000
Franchise sales commissions................. 1,363,000 799,000 3,226,000 1,628,000
Depreciation and amortization............... 415,000 415,000 1,120,000 1,018,000
Interest income............................. (659,000) (836,000) (2,204,000) (1,664,000)
Interest expense............................ 0 12,000 0 761,000
Write-off of a franchisee loan.............. 250,000 0 250,000 0
--------------------------------------------------------------------------
TOTAL....................................... $3,871,000 $3,245,000 $9,693,000 $10,445,000
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1998
General and administrative expenses declined by approximately $353,000 for the
three months ended September 1999 as compared to the comparable prior year's
period due primarily to: (i) reduction of approximately $221,000 in compensation
expense resulting primarily from the change to a completely incentive-based plan
for senior sales personnel that moved them from a combination of salary and
commission to draw against commission; (ii) lower professional fees of
approximately $160,000; and (iii) reversal of approximately $209,000 of a
reserve taken in 1998 in anticipation of a move to new office space that was no
longer required after the Company executed an addendum to the lease for its
existing office space in July 1999. This decline was partially offset by certain
higher expenses such as bad debt reserves and various marketing programs.
Franchise sales commissions increased $564,000 for the three months
ended September 30, 1999 as compared to the comparable prior year's period due
primarily to an increase in the number of hotels opened during the quarter.
Depreciation and amortization expense was flat.
Interest income, resulting primarily from promissory notes receivable
and investments in cash and marketable securities, increased $177,000 for the
three months ended September 30, 1999 as compared to the comparable prior year's
period due primarily to higher cash balances and greater interest income on
loans to franchisees and others.
Interest expense decreased $12,000 for the three months ended
September 30, 1999 as compared to the comparable prior year's period due to
the repayment of the associated note to Hudson Hotels Corporation
("Hudson") related to the purchase of the Microtel brand.
A write-off of $250,000 was taken for the three months ended September
30, 1999 relating to a loan made to a franchisee.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1998
General and administrative expenses declined by approximately $1,401,000 for the
nine months ended September 1999 as compared to the comparable prior year's
period due primarily to: (i) reduction of approximately $457,000 in compensation
expense resulting primarily from the change to a completely incentive-based plan
for senior sales personnel that moved them from a combination of salary and
commission to draw against commission; (ii) reversal of approximately $209,000
of a reserve taken in 1998 in anticipation of a move to new
11
<PAGE>
office space that was no longer required after the Company executed an
addendum to the lease for its existing office space in July 1999; (iii)
elimination of certain marketing programs (approximately $150,000); (iv)
elimination of consultancy payments to Hudson (approximately $290,000)
related to the acquisition of the Microtel brand; (v) lower professional fees
of $275,000; (vi) gain on sale of land of $155,000; and (vii) decreased
financial public relations expenses of approximately $120,000. This decline
was partially offset by certain higher expenses such as bad debt reserves and
travel expenses.
Franchise sales commissions increased by approximately $1.6 million for
the nine months ended September 30, 1999 as compared to the comparable prior
year's period due to an increase in the number of hotels opened during the
period.
Depreciation and amortization expense increased $102,000 primarily due
to the amortization of the Best Inns and Hawthorn acquisitions and increased
depreciation of development subsidies.
Interest income, resulting primarily from promissory notes receivable
and investments in cash and marketable securities, increased $541,000 for the
nine months ended September 30, 1999 as compared to the comparable prior year's
period due primarily to higher cash balances.
Interest expense decreased $761,000 for the nine months ended September
30, 1999 as compared to the comparable prior year's period due primarily to the
repayment of the Company's 10% Subordinated Debentures during the second quarter
of 1998.
A write-off of $250,000 was taken for the nine months ended September
30, 1999 relating to a loan made to a franchisee.
SUBSEQUENT DEVELOPMENTS
Based on discussions with a number of large multi-unit owners and
operators, the Company has focused more intensely on the increasingly
difficult environment now being encountered by its franchisees. The hotel
industry continues to experience declining occupancies and percentages of
room rate increases, and increases in the costs of doing business,
particularly in the limited services segment. Additionally, hotel operators
face increasing new room supply and increased interest rates. As the Company
has begun its planning process for 2000, this heightened awareness has caused
the Company to reexamine all of its operating assumptions. These assumptions
include the time-line for hotel openings, average property sizes, system
occupancy rates and room rates, ramp-up periods for new hotels and the
prospects of the Company's management company business line. The uncertainty
of the future performance of the hotels that are managed by the Company
jeopardizes management contracts, may lead to a reduction in management fees,
potentially impairs various loans made by the Company and may cause the
deferral or elimination of interest income associated with such loans. These
recent meetings and budget discussions also have highlighted the negative
effects that the increasing number of aggressive hotel franchisor competitors
may have on the Company's business. The Company expects to increase the
number of personnel in services, quality and training to provide additional
support to customers which will result in higher corporate overhead. The
combination of these factors could have a material adverse effect on the
financial condition and results of operations of the Company.
LIQUIDITY AND CAPITAL RESOURCES
The Company had approximately $5.2 million in cash or equivalents as of
September 30, 1999. The Company expects to satisfy its cash requirements during
the next twelve months with its cash and cash equivalents. The Company has no
outstanding lines of credit in place.
12
<PAGE>
For the nine months ended September 30, 1999, the Company had net
income of $5.1 million. Net cash used in operating activities was $2,318,000
and the primary operating adjustment to net income was an increase in
promissory notes receivable ($4.3 million). For the nine months ended
September 30, 1999 net cash used in investing activities was $8.6 million with
the primary investment being development subsidies issued to franchisees
($9.1 million). The Company received proceeds of approximately $809,000 from
the sale of land. For the nine months ended September 30, 1999 net
cash provided in financing activities was $211,000, resulting from the
exercise of stock options by certain current and former employees.
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. The Company has
devoted substantial resources and time to analyzing and remediating Year 2000
Issues that are within the Company's control that may significantly impact the
Company's operations. Based on these efforts, management believes that the Year
2000 Issue will not pose material operational problems for its computer systems
and does not expect that any remaining costs of compliance will have a
materially adverse impact on the results of operations during any quarterly or
annual reporting period. 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 in the Company's
systems or results of operations. Although the Company has utilized both
external and internal resources to reprogram or replace and test its software
and systems for Year 2000 modifications, there can be no assurances that
circumstances will not arise in the future that will require management to take
additional action on the Year 2000 Issues. The Company has considered the need
for establishing applicable contingency plans related to Year 2000 Issues and
will put such contingency plans in place should it become evident that such
arrangements are required by the relevant circumstances.
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.
RISK FACTORS
In evaluating the Company and its business, the following risks should
be considered. These are not the only risks the Company faces. Some risks are
not yet known to the Company and others that the Company does not consider
material but could later turn out to be so. All of these risks could adversely
affect the Company's business:
13
<PAGE>
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. The recent aggressive
competition in the franchise business has made it more difficult and more costly
to attract qualified personnel. 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 its principal source of revenue
will be franchise 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 and timing 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 of a hotel; (iii) obtain
all necessary state and local construction, occupancy or other permits and
approvals; (iv) obtain necessary construction materials; and (v) reach a
satisfactory level of profitability at the hotel. Under industry and general
economic conditions prevailing in 1999, hotel developers have had and may
continue to have difficulty accessing needed capital and attaining satisfactory
levels of profitability. As a result, the number and timing of franchised hotel
openings, and accordingly the Company's franchise fees, could be adversely
affected if current conditions do not improve. Additionally, 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. Deteriorating conditions in the lodging industry can be
expected to adversely affect the likelihood that properties in development will
open on a timely basis or at all.
LIMITED OPERATING HISTORY; NET LOSSES; OUR RESULTS FLUCTUATE AND THESE
FLUCTUATIONS CAN BE UNPREDICTABLE
The Company began operating in October 1995 and therefore has a
limited operating history upon which investors can evaluate its performance.
While the Company was profitable during the first three quarters of 1999,
believes that it has a well-conceived strategy and has assembled an
experienced and well-qualified management team to implement its strategy,
there can be no assurance that it will be profitable in the future.
Additionally, events outside our control, including those set forth in other
risk factors, may cause the Company to experience fluctuations in revenues
and operating results. As a result, management has concluded that the
Company's future results may be below market expectations, including the
expectations of financial analysts and investors. A failure to meet such
expectations may adversely affect the trading price of the Company's Class A
Common Stock.
14
<PAGE>
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 any unsolicited takeover attempt and (v)
generally direct 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 and attract 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 Company acquired the Microtel brand from Hudson on October 5,
1995 pursuant to the terms of an acquisition agreement (the "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 September 30, 1999, there were 195 "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
15
<PAGE>
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.
COMPETITION FOR NEW FRANCHISE PROPERTIES AND HOTEL GUESTS
Competition among national brand franchisers and smaller chains in the
lodging industry to grow their franchise systems is fierce and has intensified
during 1999. During 1999, an increasing number of hotel companies have announced
new franchise initiatives. As a result, the Company believes there has been a
marked increase in franchise sales personnel throughout the lodging industry and
more aggressive financial incentives are being offered to hotel owners and
developers. 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 and its brands. 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.
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 franchiser 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, affected by 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. 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.
Recently, the Company made a $750,000 nonrefundable deposit to purchase
an existing Hawthorn Suites property. If the Company is unable to locate a
purchaser for this property prior to January 7, 2000, the Company will either be
required to finance the purchase of this property, if financing is available, or
forfeit its deposit. If the Company acquires this property, it will be subject
to all of the risks of ownership.
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 in 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. In fact, during
1999, the Company believes that hotel operators have been negatively affected by
increased room supply, weaker room demand and higher interest rates, among other
things. 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, the timing of new hotel
openings, the number of rooms at newly-opened hotels, and the amount of royalty
and management fee income earned by the Company and could result in the
cancellation of the Company's franchise agreements and management contracts and
increase risks of impairment on loans or other investments made
16
<PAGE>
by the Company directly or indirectly to or in franchisees and developers and
potential deferral or loss of the interest income associated with such
potential write-offs. In fact, during 1999, nine of the Company's management
contracts were terminated. 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.
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 or harm the profitability of an open hotel, which could result in
the termination of franchise agreements and management contracts.
If the 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
Equity Corp. ("Constellation") to be invested by Constellation in Constellation
Development Fund, LLC (the "Development Fund") and to be used by the Development
Fund to provide debt and equity financing to selected developers. As of
September 30, 1999, the Company has loaned $6.2 million to Constellation. The
loan to Constellation is subordinated to returns of other partners. If such
returns are not met, this loan could be jeopardized. In addition, the Company
made a $15 million subordinated loan to Alpine Hospitality Ventures LLC
("Ventures") in connection with the Best Inns acquisition. The Company is also
committed to make additional loans of up to $7.5 million to Ventures under
certain circumstances. Each of Ventures and Constellation is a highly leveraged
entity and there can be no assurances that any loans to Ventures or
Constellation will be repaid. In late October 1999, the Company was advised by
Ventures that the senior lender to its operating subsidiary planned to institute
a "lock box" arrangement because of the deteriorating financial condition of the
operating subsidiary. The lock box arrangement would effectively preclude the
payment of cash interest to the Company while such arrangement is in place. The
Company will continue to receive interest as in-kind payments. Recognition of
such in-kind payments as income is dependent upon the amount of underlying
property values of the borrower, relative to other lenders and shareholders.
There can
17
<PAGE>
be no assurance that those values will continue to be sufficient to permit the
Company to continue to record such interest income. The Company has also made
various loans and advances to individual franchisees, the reservation and
marketing funds for the Microtel and Best Inns brands, and loan participations
in a financing program with Nomura Asset Capital Corp. (See Part II, Item 1.
"Legal Proceedings" for a discussion of a pending litigation concerning these
loan participations).
The Company is subject to the risks experienced by lenders
generally, including risks of franchisee/borrower defaults and bankruptcies.
Among other things, the ability of the borrowers to repay these loans will be
affected by the factors discussed under "General Risks of the Lodging
Industry" and "Development and Ownership Risk." The failure of a borrower to
pay interest could have a material adverse effect on the Company's results of
operations during a quarterly period. In the event of 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. As of September 30, 1999,
the Company had outstanding loans made to borrowers of $31 million aggregate
principal amount and accrued $1.8 million of interest income for the nine
month period then ended. If the financial condition of the borrowers of these
loans were to worsen, the loans could be deemed to be impaired, which could
result in a significant charge to the Company and future interest income
related to these loans could be deferred or eliminated which could have a
materially adverse effect on future income. In connection with equity
investments, the Company would be subject to risks as an equity investor.
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.
DEPENDENCE ON SPIRIT RESERVATION SYSTEM
For the nine months ended September 30, 1999 franchisees of the
Hawthorn brand derived approximately 23% 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.
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. 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.
18
<PAGE>
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable
19
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. 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, except as
described below, the outcome of any currently pending matters will not have a
material adverse effect on the Company's consolidated financial statements.
Nomura Asset Capital Corporation has commenced an action against the Company and
its subsidiary seeking damages in an amount not less than $704,910. The
complaint alleges, among other things, that the Company owes Nomura this amount
in connection with certain construction loans Nomura has made to the Company's
franchisees as to which Nomura alleges the Company agreed to lend a 5% "first
loss" loan participation. In addition, Nomura has asserted that it is entitled
to foreclose on $432,949 in loan participations previously funded by the Company
and pledged to Nomura. The Company believes that it has meritorious defenses to
these claims and has filed a counterclaim for unspecified damages. The Company
cannot predict the outcome of this matter.
ITEM 2. RECENT SALE OF UNREGISTERED SECURITIES
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the quarter.
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A) EXHIBITS:
EXHIBIT DESCRIPTION
NUMBER
27.1 Financial Data Schedule.
B) REPORTS ON FORM 8-K
During the period from July 1, 1999 to September 30, 1999,
the Company did not file any reports on Form 8-K.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
U.S. FRANCHISE SYSTEMS, INC.
By /s/ By /s/
----------------------------- --------------------------------
Michael A. Leven Neal K. Aronson
CHAIRMAN OF THE BOARD, PRESIDENT EXECUTIVE VICE PRESIDENT AND CHIEF
AND CHIEF EXECUTIVE OFFICER FINANCIAL OFFICER
Dated: November 1, 1999
21
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION
NUMBER
27.1 Financial Data Schedule.
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from U.S.
Franchise Systems, Inc. consolidated financial statements for the nine months
ended September 30, 1999 and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 5,228
<SECURITIES> 0
<RECEIVABLES> 4,118
<ALLOWANCES> (184)
<INVENTORY> 0
<CURRENT-ASSETS> 20,574
<PP&E> 3,424
<DEPRECIATION> 235
<TOTAL-ASSETS> 89,697
<CURRENT-LIABILITIES> 10,216
<BONDS> 0
0
0
<COMMON> 491<F1>
<OTHER-SE> 74,842
<TOTAL-LIABILITY-AND-EQUITY> 89,697
<SALES> 14,919
<TOTAL-REVENUES> 14,919
<CGS> 0
<TOTAL-COSTS> 11,897
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 5,226
<INCOME-TAX> 174
<INCOME-CONTINUING> 5,052
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,052<F2>
<EPS-BASIC> 25<F2>
<EPS-DILUTED> 25
<FN>
<F1>Includes 3,128,473 (net of 58,807 shares in treasury) shares of Class A common
stock that are redeemable under certain circumstances by the Company for
reasons not under the Company's control.
<F2>Per share amounts are determined by dividing net income applicable to common
stockholders by weighted average shares outstanding. Weighted average shares
include redeemable common shares outstanding.
</FN>
</TABLE>
