-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, An9GPk9GLgw6PdKpSxgOu2Th8paVMFkrupEXeHVb7Ddfp5mrBgRO5ravQzZGphv0 j0bQu4kX1KjxWzEhawuudw== 0000928385-99-003314.txt : 19991115 0000928385-99-003314.hdr.sgml : 19991115 ACCESSION NUMBER: 0000928385-99-003314 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHOICE HOTELS INTERNATIONAL INC /DE CENTRAL INDEX KEY: 0001046311 STANDARD INDUSTRIAL CLASSIFICATION: HOTELS & MOTELS [7011] IRS NUMBER: 521209792 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13393 FILM NUMBER: 99746943 BUSINESS ADDRESS: STREET 1: 10770 COLUMBIA PIKE CITY: SILVER SPRING STATE: MD ZIP: 60563 BUSINESS PHONE: 3015925000 MAIL ADDRESS: STREET 1: 10770 COLUMBIA PIKE CITY: SILVER SPRING STATE: MD ZIP: 60563 FORMER COMPANY: FORMER CONFORMED NAME: CHOICE HOTELS FRANCHISING INC DATE OF NAME CHANGE: 19971118 FORMER COMPANY: FORMER CONFORMED NAME: CHOICE HOTELS INTERNATIONAL INC/ DATE OF NAME CHANGE: 19971022 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 1999 COMMISSION FILE NO. 1- 11915
CHOICE HOTELS INTERNATIONAL, INC. 10750 COLUMBIA PIKE SILVER SPRING, MD. 20901 (301) 592-5000 Delaware 52-1209792 ------------------------ ------------------------- (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER) ------------------------------------------- (Former name, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- SHARES OUTSTANDING CLASS AT SEPTEMBER 30, 1999 - ----------------------- ------------------------ Common Stock, $0.01 par value per share 54,042,626 ---------- ============================================================================== CHOICE HOTELS INTERNATIONAL, INC. INDEX -----
PAGE NO. ------- PART I. FINANCIAL INFORMATION: Condensed Consolidated Balance Sheets - September 30, 1999 (Unaudited) and December 31, 1998 3 Consolidated Statements of Income - Three months ended September 30, 1999 and September 30, 1998 and Nine Months ended September 30, 1999 and September 30, 1998 (Unaudited) 5 Consolidated Statements of Cash Flows - Nine months ended September 30, 1999 and September 30, 1998 (Unaudited) 6 Notes to Consolidated Financial Statements (Unaudited) 7 Management's Discussion and Analysis of Results of Operations and Financial Condition 8 Quantitative and Qualitative Analysis of Market Risk 12 PART II. OTHER INFORMATION AND SIGNATURE 14
2 PART I. FINANCIAL INFORMATION CHOICE HOTELS INTERNATIONAL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
September 30, 1999 December 31, 1998 ------------------- ----------------- (Unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 8,732 $ 1,692 Receivables (net of allowance for doubtful accounts of $8,237 and $8,082, respectively) 32,772 28,117 Income taxes receivable and other 3,589 5,852 -------- -------- Total current assets 45,093 35,661 PROPERTY AND EQUIPMENT, AT COST, NET OF ACCUMULATED DEPRECIATION 42,398 32,845 GOODWILL, NET OF ACCUMULATED AMORTIZATION 65,217 66,749 FRANCHISE RIGHTS, NET OF ACCUMULATED AMORTIZATION 44,108 44,981 INVESTMENT IN FRIENDLY HOTELS, PLC 47,018 45,139 OTHER ASSETS 79,125 45,001 NOTE RECEIVABLE FROM SUNBURST HOSPITALITY, INC 138,354 127,849 -------- -------- Total assets $461,313 $398,225 ======== ========
The accompanying notes are an integral part of these condensed consolidated balance sheets. 3 CHOICE HOTELS INTERNATIONAL, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
September 30, 1999 December 31, 1998 ------------------ ----------------- (Unaudited) LIABILITIES & EQUITY CURRENT LIABILITIES Current portion long term debt $ 30,146 $ 22,646 Accounts payable 24,690 16,216 Accrued expenses 26,621 19,606 --------- -------- Total current liabilities 81,457 58,468 --------- -------- LONG TERM DEBT 277,346 256,564 DEFERRED INCOME TAXES AND OTHER LIABILITIES 44,708 26,683 --------- -------- Total liabilities 403,511 341,715 --------- -------- SHAREHOLDERS' EQUITY Common stock, $.01 par value 615 607 Additional paid-in-capital 49,314 43,432 Accumulated other comprehensive income 1,057 2,112 Treasury stock (100,902) (54,204) Retained earnings 107,718 64,563 --------- -------- Total shareholders' equity 57,802 56,510 --------- -------- Total liabilities & shareholders' equity $ 461,313 $398,225 ========= ========
The accompanying notes are an integral part of these condensed consolidated balance sheets. 4 CHOICE HOTELS INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended Nine Months Ended September 30, September 30, 1999 1998 1999 1998 -------- -------- -------- -------- REVENUES Royalty fees $40,472 $35,680 $ 95,545 $ 85,739 Product sales 1,157 5,009 4,514 17,383 Initial franchise fees and relicensing fees 3,300 4,905 9,893 12,554 Partner service revenue 2,354 1,683 6,162 4,638 European hotel operations - - - 1,098 Other 733 454 2,471 2,926 -------- -------- -------- -------- Total revenues 48,016 47,731 118,585 124,338 -------- -------- -------- -------- OPERATING EXPENSES Selling, general and administrative 15,191 14,176 38,808 36,840 Product cost of sales 845 4,511 3,962 16,119 Depreciation and amortization 1,774 2,308 5,245 5,858 European hotel operations - - - 1,133 -------- -------- -------- -------- Total operating expenses 17,810 20,995 48,015 59,950 -------- -------- -------- -------- OPERATING INCOME 30,206 26,736 70,570 64,388 OTHER Gain on sale of stock - - (1,260) (2,190) Interest and dividend income (5,244) (3,338) (14,900) (9,298) Interest expense 5,069 4,850 14,796 14,433 -------- -------- -------- -------- Total other (175) 1,512 (1,364) 2,945 -------- -------- -------- -------- INCOME BEFORE INCOME TAXES AND EXTRAORDINARY ITEM 30,381 25,224 71,934 61,443 INCOME TAXES 12,043 10,506 28,787 25,591 -------- -------- -------- -------- NET INCOME BEFORE EXTRAORDINARY ITEM 18,338 14,718 43,147 35,852 -------- -------- -------- -------- GAIN ON EXINGUISHMENT OF DEBT, NET OF $4,732 OF INCOME TAXES - 7,232 - 7,232 -------- -------- -------- -------- NET INCOME $18,338 $21,950 $ 43,147 $ 43,084 ======== ======== ======== ======== WEIGHTED AVERAGE SHARES OUTSTANDING 54,619 58,360 55,174 59,130 ======== ======== ======== ======== DILUTED SHARES OUTSTANDING 55,501 59,165 55,898 60,124 -------- -------- -------- -------- BASIC EARNINGS PER SHARE BEFORE EXTRAORDINARY ITEM $ 0.34 $ 0.26 $ 0.78 $ 0.61 ======== ======== ======== ======== BASIC EARNINGS PER SHARE - EXTRAORDINARY ITEM $ - $ 0.12 $ - $ 0.12 ======== ======== ======== ======== BASIC EARNINGS PER SHARE $ 0.34 $ 0.38 $ 0.78 $ 0.73 ======== ======== ======== -------- DILUTED EARNINGS PER SHARE BEFORE EXTRAORDINARY ITEM $ 0.33 $ 0.25 $ 0.77 $ 0.60 ======= ======== ======== ======== DILUTED EARNINGS PER SHARE - EXTRAORDINARY ITEM $ - $ 0.12 $ - $ 0.12 ======== ======== ======== ======== DILUTED EARNINGS PER SHARE $ 0.33 $ 0.37 $ 0.77 $ 0.72 ======= ======== ======== ========
The accompanying notes are an integral part of these consolidated statements of income. 5 CHOICE HOTELS INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED, IN THOUSANDS)
Nine Months Ended September 30, 1999 1998 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 43,147 $ 43,084 Reconciliation of net income to net cash by operating activities: Depreciation and amortization 10,682 8,930 Provision for doubtful accounts 551 876 Increase in deferred income taxes 8,785 12,878 Non cash interest and dividend income (12,209) (9,252) Gain on extinguishment of capital lease obligations - (11,964) Changes in assets and liabilities: Change in receivables (4,459) (11,859) Change in income taxes payable and other 5,874 (5,850) Change in accounts payable and accrued expenses 7,212 (2,913) -------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 59,583 23,930 -------- --------- CASH FLOW FROM INVESTING ACTIVITIES: Investment in property and equipment (16,509) (6,753) Repayments of Sunburst Hospitality advances, net - 5,145 Increase in amounts due from marketing and reservation funds, net (18,566) (3,506) Other items, net (5,698) 108 -------- --------- NET CASH UTILIZED BY INVESTING ACTIVITIES (40,773) (5,006) -------- --------- CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from long term borrowings 73,230 177,504 Principal payments of long term borrowings (43,918) (171,234) Purchase of treasury stock (45,702) (36,965) Proceeds from issuance of common stock 4,620 3,991 -------- --------- NET CASH UTILIZED BY FINANCING ACTIVITIES (11,770) (26,704) -------- --------- Net change in cash and cash equivalents 7,040 (7,780) Cash and cash equivalents, beginning of period 1,692 10,282 -------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 8,732 $ 2,502 ======== =========
The accompanying notes are an integral part of these consolidated statements of cash flows. 6 CHOICE HOTELS INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. The accompanying consolidated financial statements of Choice Hotels International, Inc. (the "Company") and subsidiaries have been prepared by the Company without audit. Certain information and footnote disclosures normally included in financial statements presented in accordance with generally accepted accounting principles have been condensed or omitted. The Company believes the disclosures made are adequate to make the information presented not misleading. The consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended December 31, 1998 and notes thereto included in the Company's Form 10-K, dated March 29, 1999. In the opinion of management, all adjustments (which include any normal recurring adjustments) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of fiscal year performance because of seasonal and short-term variations. All intercompany transactions and balances between Choice Hotels International, Inc. and its subsidiaries have been eliminated. Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. 2. During the nine months ended September 30, 1999, the Company's comprehensive income (consisting of net income plus foreign currency translation adjustments and unrealized gains on available for sale securities) exceeded net income by approximately $795,000. 3. SFAS 128 replaced the calculation of primary and fully diluted earnings per share pursuant to Accounting Principles Board Opinion ("APB") No. 15, "Earnings Per Share," with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is computed similarly to fully diluted earnings per share. Earnings per share amounts for all years have been presented in conformity with SFAS 128. Basic and diluted earnings per common share are computed by dividing net income by the weighted average number of shares of common stock outstanding. The weighted average number of shares outstanding was 55,173,832 and 59,130,054 for basic earnings per share and 55,897,569 and 60,123,703 for earnings per share assuming dilution for the nine months ended September 1999 and 1998, respectively. The difference between the weighted average number of shares of common stock outstanding used in the basic and diluted earnings per share computations is entirely due to the assumed exercise of outstanding stock options for diluted earnings per common share. 4. Marketing and Reservation Funds The Company presents marketing and reservation fees such that the fees collected and associated expenses are reported net. The total marketing and reservation fees received by the Company (previously reported as revenue) was $41.9 million and $38.9 million for the three months ended September 30, 1999 and 1998 and $105.8 million and $95.6 million for the nine months ended September 30, 1999 and 1998. Depreciation and amortization incurred by the marketing and reservation funds was $1.9 million and $0.9 million for the three months ended September 30, 1999 and 1998 and $5.4 million and $3.1 million for the nine months ended September 30, 1999 and 1998. Interest expense incurred by the marketing and reservation funds was $0.9 and $0.5 for the three months ended September 30,1999 and 1998 and $2.5 million and $1.1 million for the nine months ended September 30, 1999 and 1998. Reservation fees and marketing fees not expended in the current year are carried over to the next fiscal year and expended in accordance with the franchise agreements. Shortfall amounts are similarly recovered in subsequent years. Excess or shortfall amounts from the operation of these programs are recorded as a payable or receivable from the particular fund. The Company advances capital as necessary to the marketing and reservation funds to support the development and ongoing operations of the franchise system. As of September 30, 1999, the Company's balance sheet includes an investment in and a receivable in amounts due from marketing and reservation funds of $46.9 million related to shortfalls in the marketing ($15.5 million) and reservation ($31.4 million) funds. As of December 31, 1998, the Company's balance sheet includes an investment in and a receivable in amounts due from marketing and reservation funds of $23.4 million related to shortfalls in the marketing ($7.8 million) and reservation ($15.6 million) funds. The Company expects to recover these receivables through future marketing and reservation fees. 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION - -------------------------------------------------------------------------- The principal factors that affect the Company's results are: (i) growth in the number of hotels under franchise, (ii) occupancies and room rates achieved by the hotels under franchise, (iii) the number and relative mix of franchised hotels, and (iv) the Company's ability to manage costs. The number of rooms at franchised properties and occupancy and room rates at those properties significantly affect the Company's results because franchise royalty fees are based upon room revenues at franchised hotels. The key industry standard for measuring hotel operating performance is revenue per available room ("RevPAR") which is calculated by multiplying the percentage of occupied rooms by the average daily room rate realized. The variable overhead costs associated with franchise system growth are substantially less than incremental royalty fees generated from new franchisees; therefore, the Company is able to capture a significant portion of those royalty fees as operating income. Comparison of Three Month Period Ended September 30, 1999 Operating Results and - ------------------------------------------------------------------------------- Three Month Period Ended September 30, 1998 Operating Results - ------------------------------------------------------------- The Company reported net income of $18.3 million, or $0.33 per diluted share, for the third quarter ended September 30, 1999, compared to net income for the same period of 1998 of $21.9 million, or $0.37 per diluted share. The $0.37 per diluted share in 1998 includes $0.12 resulting from a gain on exinguishment of debt. Exclusive of this extraordinary item, diluted earnings per share increased 32.0%. The increase in net income for the period is attributable to an increase in royalty fees as a direct result of the addition of new franchised hotels to the franchise system, improved RevPar and increases in the effective royalty rate achieved for the domestic hotel system. Franchise Revenues - ------------------ Management analyzes its business based on "net franchise revenue," which is total revenue excluding product sales and European hotel operations, and franchise operating expenses, which are reflected as selling, general and administrative expenses. The Company's net franchise revenues were $46.9 million for the three months ended September 30, 1999 and $42.7 million for the three months ended September 30, 1998. Royalties increased $4.8 million to $40.5 million in 1999 from $35.7 million in 1998, an increase of 13.4%. The increase in royalties is attributable to a net increase of 82 franchised hotels during the period (representing an additional 6,535 rooms) an improvement in domestic RevPAR of 2.1% and an increase in the effective royalty rate of the domestic hotel system to 3.77% from 3.61%. Initial and relicensing fee revenue generated from domestic franchise contracts signed decreased to $3.3 million from $4.9 million in 1998 as a result of a decrease in total franchise agreements signed to 68, as compared to 119 for the third quarter of 1998. An increasingly competitive hotel franchising environment coupled with stricter hotel brand standards being enforced by the Company contributed to the decline in the total franchise agreements signed in the period. The total number of domestic hotels online increased to 3,121 from 3,024 an increase of 3.2% for the period ending September 30, 1999. This represents an increase in the number of rooms open of 3.0% from 251,415 as of September 30, 1998 to 258,892 as of September 30, 1999. As of September 30, 1999, the Company had 563 hotels under development in its domestic hotel system representing 44,366 rooms. The total number of international hotels online increased to 1,058 from 619 an increase of 70.9% as of September 30, 1999. International rooms open increased 46.1% from 52,437 as of September 30, 1998 to 76,632 as of September 30, 1999. These increases are primarily attributable to the Company's 1998 Strategic Alliance with Flag International Limited. The master franchise agreement with Flag Choice Hotels includes several countries including Australia, Papua New Guinea and Fiji. The total number of international hotels and rooms under development was 161 and 14,910, respectively, as of September 30, 1999. 8 Franchise Expenses - ------------------ The cost to operate the franchising business is reflected in selling, general and administrative expenses. Selling, general and administrative expenses increased slightly between years. As a percentage of total net franchising revenues, total selling, general and administrative expenses declined to 32.4% for the third quarter of 1999 as compared to 33.2% for 1998. The improvement in the franchising margins relates to the economies of scale generated from operating a larger franchisee base. Product Sales - ------------- Sales made to franchisees through the Company's group purchasing program decreased approximately $3.8 million to $1.2 million for the three months ended September 30, 1999 from $5.0 million for the three months ended September 30, 1998. In the fourth quarter of 1998, the Company discontinued the group purchasing program as previously operated. Remaining sales represent the fulfillment of orders placed in 1998. Other - ----- For the three months ended September 30, 1999, and September 30, 1998 the Company recognized approximately $0.8 million and $0.6 million, respectively, in dividend income from its investment in Friendly Hotels, PLC and approximately $3.6 million and $2.7 million, respectively, of interest income from its subordinated term note to Sunburst Hospitality, Inc. During the third quarter of 1998, the Company recognized a gain of $7.2 million, net of tax, on the extinguishment of certain capital lease obligations. Comparison of Nine Month Period Ended September 30, 1999 Operating Results and - ------------------------------------------------------------------------------ Nine Month Period Ended September 30, 1998 Operating Results - ------------------------------------------------------------ The Company reported net income of $43.1 million, or $0.77 per diluted share, for the nine months ended September 30, 1999, compared to net income for the same period of 1998 of $43.1 million, or $0.72 per diluted share. The $0.72 per diluted share in 1998 includes approximately $0.12 resulting from a gain on early extinguishment of debt. Exclusive of this extraordinary item, diluted earnings per share increased 28.3%. The increase in net income for the period is attributable to an increase in royalty fees as a direct result of the addition of new franchised hotels to the franchise system, improved RevPar and increases in the effective royalty rate achieved for the domestic hotel system. Franchise Revenues - ------------------ The Company's net franchise revenues were $114.1 million for the nine months ended September 30, 1999 and $105.9 million for the nine months ended September 30, 1998. Royalties increased $9.8 million to $95.5 million in 1999 from $85.7 million in 1998, an increase of 11.4%. The increase in royalties is attributable to a net increase of 114 franchised hotels during the period (representing an additional 8,178 rooms) an improvement in domestic RevPAR of 3.2% and an increase in the effective royalty rate of the domestic hotel system to 3.69% from 3.55%. Initial and relicensing fee revenue generated from domestic franchise contracts signed decreased to $9.9 million from $12.6 million in 1998 as a result of a decrease in total franchise agreements signed to 224, as compared to 328 for the nine months ended September 30, 1998. An increasingly competitive hotel franchising environment coupled with stricter hotel brand standards being enforced by the Company contributed to the decline in total franchise agreements signed in the period. Franchise Expenses - ------------------ Selling, general and administrative expenses increased approximately $2.0 million between years. As a percentage of total net franchising revenues, total selling, general and administrative expenses declined to 34.0% for the nine months ended 1999 as compared to 34.8% for 1998. The improvement in the franchising margins relates to the economies of scale generated from operating a larger franchisee base. 9 Product Sales - ------------- Sales made to franchisees through the Company's group purchasing program decreased approximately $12.9 million to $4.5 million for the nine months ended September 30, 1999 from $17.4 million for the nine months ended September 30, 1998. In the fourth quarter of 1998, the Company discontinued the group purchasing program as previously operated. Remaining sales represent the fulfillment of orders placed in 1998. Other - ----- For the nine months ended September 30, 1999, and September 30, 1998 the Company recognized approximately $1.9 million and $1.6 million, respectively, in dividend income from its investment in Friendly Hotels, PLC and approximately $10.5 million and $7.6 million, respectively, of interest income from its subordinated term note to Sunburst Hospitality, Inc. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- Net cash provided by operating activities was $59.6 million for the nine months ended September 30, 1999, an increase of approximately $35.7 million from $23.9 million for 1998. The increase results from improved operating performance and stronger management of working capital. At September 30, 1999, the total long- term debt outstanding for the Company was $307.5 million, $30.1 million of which matures in the next twelve months. The Company has repurchased 7.2 million shares of its common stock at a total cost of $103.2 million in 1999. The Company has authorization from its Board of Directors to repurchase up to an additional 1.5 million shares. The Company believes that cash flows from operations and available financing capacity is adequate to meet the expected operating, investing, financing and debt service requirements for the business for the immediate future. Year 2000 Compliance - -------------------- We are engaged in an ongoing effort to evaluate and remediate the Year 2000 computer problem shared by virtually all companies and businesses. This Year 2000 problem is a result of two-digit date codes used in many computer programs and embedded chip systems. These systems cannot recognize a year that begins with "20" rather than "19". As part of our effort, a cross-functional Year 2000 Compliance Committee was established to manage and supervise the efforts to become compliant and a Year 2000 action plan has been developed. The Year 2000 action plan includes the following phases: 1. Awareness: making our internal organizations and business units aware of the Year 2000 issue and assigning responsibility internally. 2. Inventorying and testing our proprietary software and systems (e.g., reservation system, property management system). 3. Inventorying and testing secondary internal systems (e.g., network infrastructure, phone system, employee PCs). 4. Assessing the risk from third party vendors and franchisees. 5. Contingency planning. 6. Educating the franchise community. Throughout the process, remedial actions have been or will be taken as warranted. We consider a system to be Year 2000 compliant if it will perform its essential functions on and after January 1, 2000, or will be able to do so with readily available one-time modifications. 10 The table below summarizes the status of our Year 2000 action plan as of November 1, 1999.
Year 2000 Step Status Compliance Issues - ---- ------ ----------------- Awareness Complete None Inventorying and Complete Two DOS-based systems are non- testing of proprietary compliant. Compliant Windows software and systems based versions are available. Inventorying and Complete No material compliance issues. testing of secondary systems Assessment of 75% No material compliance issues. third-party vendors Contingency Planning 75% No material compliance issues. Franchisee education 80% Not applicable.
Our exposure to potential Year 2000 problems exists in two general areas: technological operations solely in our control, and technological operations dependent in some way on one or more third parties. With respect to our internal systems, we have conducted Year 2000 compliance testing on all of our proprietary software, including our "Choice 2001" reservations system and related reservations support systems, our franchise support system and franchisee property management support systems. The tests have indicated that, except for two DOS-based systems, the proprietary software is Year 2000 compliant. The Choice 2001 system is currently accepting and successfully processing reservations for January 1, 2000 and beyond. The DOS version of ChoiceLINK (the system used by the hotels to communicate with the Choice 2001 system) is not Year 2000 compliant and the DOS version of the Company's property management system is only compliant through December 31, 2000. We have communicated this to franchisees using these systems and have recommended that they migrate to the Windows based versions of these systems. In September 1999, we established financial incentives for franchisees using the DOS version of ChoiceLINK to switch to the Windows-based version. We have also been in the process of replacing our hardware platforms for our internal systems and a number of smaller support systems and have kept them updated so that all of our large system computers are no more than three years old. Based on manufacturers specifications, we believe that these new hardware platforms, except for several servers, are Year 2000 compliant. These servers will be replaced before December 31, 1999. We have completed the process of conducting an inventory of third party software, including financial and accounts payable systems, PC operating systems and word processing and other commercial software. For hardware or software systems which do not appear to be compliant, we are obtaining upgrades or replacement systems. The Year 2000 Compliance Committee has identified third party vendors and service providers whose non-compliant systems could have a material impact on the Company and has undertaken an assessment as to such parties' compliant status. These parties include airline global distribution systems (GDS), utility providers, telephone service providers, banks and data processing services. The GDS companies, which provide databases through which travel agents can book hotel rooms, have assured us in writing that they are compliant and we have conducted tests with three of the four major GDS companies. The Year 2000 Compliance Committee continues to assess other third parties as to their compliance and the consequences in the event they are not compliant. Vendors who have responded indicated that they are, or expect to be, Year 2000 compliant. Throughout 1999, the Year 2000 Compliance Committee will continue to seek and assess responses from all of its material vendors. In June 1999, we initiated an assessment of all of our domestic franchised hotels. The assessment seeks to determine the level of preparedness of the domestic franchise system. The assessment attempts to solicit whether the hotels have undertaken a Year 2000 compliance assessment with respect to building automation and maintenance systems, hotel management systems (other than those acquired from the Company), information technology systems and third party products and services. As of November 1, 1999, responses have been received from approximately 20% of domestic franchised hotels. While the response rate is not statistically significant to determine system-wide trends, 80% of those who responded indicated that they had completed a Year 2000 assessment. We continue to seek responses from the remainder of our franchisees. Upon completion of the assessment, we will be better able to determine risks which may be posed if a significant number of hotel owners have not addressed the Year 2000 status of such systems. 11 Our educational efforts with respect to our franchisees have included seminars at our annual convention and management conferences and distribution of sample assessment checklists and other materials. In November 1999, we will distribute to all franchised hotels a Year 2000 guide which will advise franchisees of suggested Year 2000 preparedness and contingency plans. We have devised contingency plans for our Silver Spring, Maryland corporate offices, our Phoenix, Arizona reservation center and our reservation call centers. These plans include insuring the availability of key employees and, with respect to the reservation center, access to alternative power sources. Costs of addressing potential Year 2000 compliance/remediation problems have not been material to date. The value of employee time devoted to testing and development has been approximately $250,000. Total costs for replacement of hardware and operating systems are expected to be approximately $700,000. However, these replacements (as well as replacements undertaken in prior years) are being implemented primarily as part of our ongoing technology updating, rather than specifically for Year 2000 compliance reasons. Based upon information gathered to date, potential Year 2000 business interruptions or liability costs are not currently expected to have a material adverse impact on the Company's financial position, results of operations or cash flows. However, such Year 2000 issues (including incomplete or inaccurate 3rd party information and system failures) could pose unforeseen material financial risk, including loss of revenue, substantial unanticipated costs and service interruptions. We are not in a position to guarantee the performance of others with respect to their Year 2000 compliance or predict whether any of the assurances that others provide regarding Year 2000 compliance may prove later to be inaccurate or overly optimistic. FORWARD-LOOKING STATEMENTS - -------------------------- When used throughout this report, the words "believes," "anticipates," "expects," "intends," "estimates," "projects," and other similar expressions, which are predictions of or indicate future events and trends, identify forward- looking statements. Such statements are subject to a number of risks and uncertainties which could cause actual results to differ materially from those projected, including: competition within each of our business segments; business strategies and their intended results; the balance between supply of and demand for hotel rooms; our ability to obtain new franchise agreements; our ability to develop and maintain positive relations with current and potential hotel owners; the effect of international, national and regional economic conditions; the availability of capital to allow us and potential hotel owners to fund investments; our ability, and that of other parties upon which our businesses also rely, to modify or replace on a timely basis, their computer software and other systems in order to function properly prior to, in and beyond, the year 2000; and other risks described from time to time in our filings with the Securities and Exchange Commission, including those set forth under the heading "Risk Factors" in our Report on Form 10-Q for the Period ended June 30, 1999. Given these uncertainties, you are cautioned not to place undue reliance on such statements. We also undertake no obligation to publicly update or revise any forward-looking statement to reflect current or future events or circumstances. ITEM 3. QUANTITATIVE AND QUALITATIVE ANALYSIS OF MARKET RISK ----------------------------------------------------- The Company is exposed to market risk from changes in interest rates and the impact of fluctuations in foreign currencies on the Company's foreign investments. The Company manages its exposure to this market risk through the monitoring of its available financing alternatives including in certain circumstances the use of derivative financial instruments. The Company's strategy to manage exposure to changes in the interest rates and foreign currencies remains unchanged from 1997. Furthermore, the Company does not foresee any significant changes in exposure in these areas or in how such exposure is managed in the near future. The following table summarizes information about derivative financial information and other financial instruments that are sensitive to changes in interest rates, including interest rate swap agreements and debt obligations. For interest rate swap agreements, the table presents notional amounts and weighted average interest rates by expected (contractual) maturity date. 12 Expected Maturity Date
1999 Fair 1999 2000 2001 2002 2003 Thereafter Total Value ---- ---- ---- ---- ---- ---------- ----- ----- Liabilities: Long-term debt (1) Fixed rate - - - - - 100,000 100,000 96,410 Average interest rate 7.13% Variable rate (2) - - - 207,492 - - 207,492 207,492 Average interest (3) rate 6.64%
Interest Rate Derivatives Expected Maturity Date
1999 Fair 1999 2000 2001 2002 2003 Thereafter Total Value ---- ---- ---- ---- ---- ---------- ----- ----- Notional Amount - - - 115,000 (193) Average interest rate 5.85% Receivable 0 Payable (65)
(1) A hypothetical one hundred basis point change in interest rates would change the fair value of long-term debt by $6.8 million. (2) The Company will refinance the $150 million variable rate term loan as it amortizes throughout the expected maturity dates. Upon expiration of the credit facility in 2002, the Company expects to refinance its obligations. (3) Weighted average variable rates are based on implied forward rates in the yield curve at the reporting date. The Company is also exposed to fluctuations in foreign currency relating to its preferred stock investment in Friendly Hotels, PLC which is denominated in British Pounds. The Company does not have any derivative financial instruments related to its foreign investments. 13 PART II OTHER INFORMATION - ------------------------- ITEM 1. LEGAL PROCEEDINGS ----------------- The Company is not party to any litigation, other than routine litigation incidental to the business of the Company. None of such litigation, either individually or in the aggregate, is expected to be material to the business, financial condition or results of operations of the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- (a) Exhibits Exhibit 27.01 - Financial Data Schedule - September 30, 1999 (b) The following reports were filed pertaining to the period ended September 30, 1999. None 14 SIGNATURE Pursuant to the requirements of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CHOICE HOTELS INTERNATIONAL, INC. Date: November 10, 1999 /s/ Charles A. Ledsinger, Jr. ------------------ ---------------------------- By: Charles A. Ledsinger, Jr. President and Chief Executive Officer 16 EX-27.01 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS, THE CONSOLIDATED STATEMENTS OF INCOME AND THE CONSOLIDATED STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND THE NOTES THERETO. 1,000 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 8,732 0 41,009 8,237 0 45,093 60,643 18,245 461,313 81,457 277,346 0 0 615 57,187 461,313 0 118,585 0 48,015 (1,364) 551 14,796 71,934 28,787 43,147 0 0 0 43,147 0.78 0.77
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