ITEM 1. BUSINESS
GENERAL OVERVIEW
Chartwell Leisure Inc. ("Chartwell" or the "Company"), is a hotel and motel owner, operator, developer and acquiror. Chartwell owns, directly or with joint venture partners, 130 hotel properties in both the full-service and limited-service segments, including approximately 11,410 guest rooms, located in 25 states and six Canadian provinces. In the full-service segment, Chartwell operates 27 hotels aggregating approximately 5,430 guest rooms that contributed approximately 63% of Chartwell's gross room revenues (including gross room revenues of unconsolidated joint ventures) during the twelve-month period ended December 31, 1996 on a pro forma basis. Chartwell's remaining 103 hotels, consisting of approximately 5,980 rooms, operate in the limited-service segment, principally under the Travelodge(R) brand.
Chartwell was spun-off from HFS Incorporated ("HFS") in 1994 and until late 1995 was engaged in the business of investing in casino gaming facilities. In December 1995, an investment group ("CL Associates") primarily consisting of members of the Fisher Brothers family and a trust for the benefit of Gordon Getty and members of his family acquired a 16.6% equity interest in Chartwell by purchasing 904,930 newly issued shares of Common Stock. In connection with that purchase, Richard L. Fisher, a member of the Fisher Brothers family, was elected to Chartwell's Board of Directors and to the chairmanship of Chartwell's executive committee. At the same time, Chartwell's Board of Directors decided to redirect the focus of Chartwell's business from gaming to lodging and Chartwell agreed to acquire full and partial interests in 115 Travelodge hotels, consisting of approximately 8,000 guest rooms, from Forte Hotels, Inc. ("Forte Hotels") for approximately $99 million (the "Travelodge Acquisition").
In connection with the closing of the Travelodge Acquisition in January 1996, Chartwell agreed in principle to issue four million shares of Common Stock for an aggregate purchase price of $57 million (the "CL Associates/FSNL Investment") to an expanded investment group consisting of CL Associates and a limited liability company owned principally by a trust for the benefit of Charles de Gunzburg ("FSNL"), Mr. Fisher was elected Chairman and Chief Executive Officer of Chartwell, a new senior management team was assembled, and Mr. Fisher and that new management team began to implement Chartwell's current strategy. Since that time, Chartwell has (i) acquired 21 Travelodge hotels in Canada (including a one-half interest in a joint venture) totalling approximately 3,500 guest rooms, for approximately $77 million (a cost of approximately $22,000 per guest room) (the "Canadian Acquisition"), (ii) obtained the 30-year exclusive master franchise licenses for the Travelodge brand in Canada and Mexico, (iii) formed a joint venture ("Chartwell de Mexico") with Grupo Piasa, S.A. de C.V., a diversified Mexican real estate and development company ("Grupo Piasa"), for the purpose of developing and operating Travelodge hotels throughout Mexico and (iv) formed a strategic alliance with Hilton Inns, Inc. ("Hilton") pursuant to which Chartwell expects to develop, own, manage and operate up to 20 Hilton Garden Inn(R) hotels in target markets nationwide under a franchise license. Chartwell has curtailed future activities in the gaming industry and, during the twelve-month period ended December 31, 1996, derived no revenues from gaming.
Chartwell's original gaming business was conducted as a division of HFS from August 1993 until September 1994, when the Company was formed as National Gaming Corp., a Delaware corporation and a wholly owned subsidiary of HFS created for the purpose of carrying on that business. In November 1994, the Company became an independent public company when HFS distributed all of the outstanding shares of the Company's Common Stock to the stockholders of HFS (the "Distribution"). In January 1996, the Company's name was changed to National Lodging Corp., and on August 8, 1996, the Company's name became Chartwell Leisure Inc. Chartwell's principal executive offices are located at 605 Third Avenue, New York, New York 10158, and its telephone number is (212) 692-1400. Unless the context otherwise requires, all references in this annual report to the Company include Chartwell, its subsidiaries and their respective predecessors, and references to "hotels" include both hotels and motels.
RECENT DEVELOPMENTS
Strategic Alliance with Hilton: On January 20, 1997, Chartwell announced that it had formed a strategic alliance with Hilton in which Chartwell expects to develop, own, manage and operate at least 20 Hilton Garden Inn hotels in target markets nationwide under a franchise license. The initial term of the alliance is three years and will require a total investment of up to $200 million by Chartwell, of which approximately $40 million is required to be funded by Chartwell as equity. Hilton is in negotiations with NationsBank Corp. ("NationsBank") and Nomura Asset Capital Corporation ("Nomura") to arrange for construction financing and permanent mortgage financing for the Hilton Garden Inn development program. There can be no assurance that such financing will be obtained. Of the total construction costs, NationsBank is expected to provide up to 80% of the financing, with Hilton expected to guarantee up to 25% of the NationsBank loan. Chartwell is required to fund the remaining 20% of the capital as equity. The financing terms are expected to provide that upon obtaining a certificate of occupancy for each Hilton Garden Inn, the construction loan allocated for such hotel is expected to convert to a 15-year permanent mortgage through an arrangement with Nomura. Chartwell expects to commence construction of its first Hilton Garden Inn shortly at Albuquerque International Airport and this spring expects to commence construction of its second Hilton Garden Inn site in Santa Fe, New Mexico at its Anasazi Plaza site. Chartwell expects to break ground on other Hilton Garden Inns as additional sites are secured. In addition to the Hilton Garden Inn franchise license, Hilton has formally approved the conversion of the 207 room, Chartwell-owned San Diego Travelodge to a full-service Hilton hotel. The property, on Harbor Island Drive, is scheduled to undergo a $3.3 million renovation, expected to be completed by this summer.
Sale of Common Stock to Brahman Funds: On January 31, 1997, Chartwell sold 1,000,000 shares of Common Stock to funds managed by affiliates of Brahman Management, LLC (collectively, "Brahman") at $14 per share, for a total investment of $14 million by Brahman (the "Brahman Private Placement"). Brahman manages investment funds, including one affiliated with George Soros. As a result of the Brahman Private Placement, the Brahman-Soros group owns approximately 1,300,000 shares of Common Stock, or approximately 9.7% of the Company's outstanding Common Stock, after giving effect to the issuance of 2,228,977 shares of Common Stock pursuant to the Rights Offering (discussed below).
Sale of Common Stock to Baron Fund: On March 6, 1997, Chartwell sold 658,929 shares of Common Stock to Baron Asset Fund ("Baron") at $14.00 per share, for a total investment of approximately $9.2 million by Baron (the "Baron Private Placement"). Baron is one of a family of funds managed by Ronald Baron. As a result of the Baron Private Placement, Baron owns 658,929 shares of Common Stock, or approximately 4.9% of the Company's outstanding Common Stock, after giving effect to the issuance of 2,228,977 shares of Common Stock pursuant to the Rights Offering.
Rights Offering: On March 13, 1997, Chartwell completed an offering (the "Rights Offering") of 2,228,977 shares of Common Stock pursuant to the exercise of transferable subscription rights ("Rights") that were distributed to holders of record ("Record Holders") at the close of business on February 13, 1997 of Chartwell's Common Stock and to holders of certain options ("Participating Option Holders") to purchase shares of Common Stock. The Rights, which were distributed to the Record Holders and the Participating Option Holders at no cost, were exercisable at a cash price of $14.00 per share. After deducting expenses of approximately $1.2 million, the net proceeds of the Rights Offering to Chartwell were approximately $30.0 million.
Notes Offering: Chartwell is in the process of pursuing a $100 million offering of senior notes (the "Notes") due 2007 (the "Notes Offering"). In connection with the Notes Offering, it is expected that Chartwell's existing $150.0 million credit facility will be terminated and replaced with a new secured facility of approximately $60.0 million and that HFS' $75 million guarantee of Chartwell's existing credit facility and a related $1.5 million annual fee will be eliminated. There can be no assurance that the Company will be able to successfully complete the Notes Offering or enter into a new credit facility and consummate the related refinancing of its existing credit facility. The Company intends to use the net proceeds from the Notes Offering, together with the net proceeds from the Brahman Private Placement, the Baron Private Placement and the Rights Offering, to repay existing indebtedness under its existing credit facility and for working capital and general corporate purposes, including to fund current and future development projects. In addition, as Chartwell evaluates from time to time potential acquisition opportunities, a portion of such net proceeds may be used to acquire additional hotels. See
"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--Equity Offerings" and "--Notes Offering."
GROWTH STRATEGY
Chartwell's new senior management team has implemented multiple strategies to increase cash flow, earnings and shareholder value by (i) internal growth through an extensive capital investments program, of rebranding and repositioning of its existing hotels and of reimaging and remarketing of the Travelodge brand name, while controlling costs and (ii) external growth through increasing and diversifying Chartwell's hotel portfolio by selectively acquiring and developing hotels in different market segments and geographic regions.
INTERNAL GROWTH OPPORTUNITIES: Chartwell believes that the hotels it acquired in the Travelodge Acquisition and the Canadian Acquisition, and the Travelodge brand as a whole, were allowed to significantly underperform their potential. Chartwell believes that capital investments and operational changes designed to bring the performance of these hotels up to or in excess of industry averages offer the potential for significant improvements in cash flow at these hotels.
. Capital Investments: The Company believes that the hotels it acquired in the Travelodge Acquisition and the Canadian Acquisition offer the opportunity for significant increases in revenue per available room ("REVPAR") through a capital expenditures program. The Company has launched an extensive capital improvement program to increase room and occupancy rates by improving the quality of its properties. As part of this program, the Company expects to upgrade the interior and exterior of all properties that do not meet corporate standards. In addition, the Company intends to redesign the architectural layout of its Travelodge hotels to provide them with a "curb appeal" necessary to compete in the limited-service market. During 1997, the Company intends to spend approximately $20 million in capital improvements at its U.S. and Canadian hotel properties. These investments are in addition to amounts budgeted for regular capital maintenance. As of December 31, 1996, the Company had invested approximately $5.8 million in capital expenditures. Once this capital initiative is completed, the Company intends to maintain a regular program of capital improvements, including the renovation and refurbishment of certain of its existing hotels. The Company believes that this program will enhance the competitiveness of its Travelodge hotels.
. Strategic Repositioning and Redevelopment of Current Hotels: Chartwell believes there is significant potential to increase REVPAR at selected hotels by repositioning those hotels through renovation and refurbishment as well as rebranding to more appropriate franchise affiliations. The Company believes that some of its Travelodge hotels would satisfy market demand through expanding the size of the hotel. For example, Chartwell intends to add approximately 100 guest rooms at the Fisherman's Wharf Travelodge, subject to local zoning approval. See "Business--Growth Strategy--External Growth Opportunities--Travelodge Acquisition." The Company believes that in conjunction with its capital improvements program, a number of its current hotels will become more competitive and increase revenues by brand repositioning through conversion to another leading national franchise affiliation and/or expanding the size of the hotel. Since the Travelodge Acquisition, Chartwell has converted both the 476-room Travelodge hotel at Kennedy Airport in New York and the 236-room Travelodge hotel in Portland, Oregon to Ramada Plaza(R) hotels and is in the process of converting the 207-room Travelodge hotel in San Diego, California to a Hilton hotel. The Company continues to evaluate and assess the strategic advantages of brand repositioning of all of its hotels in order to enhance the performance of its hotels.
. Reimaging and Remarketing the Travelodge Brand Name: HFS has implemented a program in cooperation with Chartwell to revitalize the Travelodge brand name, which includes (i) the proposed expenditure of approximately $5.5 million budgeted by HFS through December 31, 1997 for marketing the Travelodge brand name, (ii) the reintroduction of the Sleepy Bear mascot and (iii) the introduction of a program that will reward guests with "Travel Miles," exchangeable for gifts. In addition, Chartwell has budgeted approximately $3 million during 1997 for marketing individual hotels, generally in their local markets.
EXTERNAL GROWTH OPPORTUNITIES:
. Acquisition of Hotels: Chartwell seeks to continue the acquisition of underperforming hotels or portfolios of hotels throughout North America that are candidates for improved operating performance by implementing Chartwell's growth strategy of refurbishing, rebranding, repositioning, and reimaging underperforming hotels.
Travelodge Acquisition: On January 23, 1996, the Company completed the acquisition of all of the outstanding shares of Common Stock of Forte Hotels from Forte USA, Inc. for approximately $99 million. The principal assets of Forte Hotels consisted of fee and leasehold interests in 115 hotel properties, including sole ownership of 18 hotels and joint venture interests in 97 additional hotels (the "Acquired Forte Properties") constituting in the aggregate approximately 8,000 guest rooms. Substantially all of the Acquired Forte Properties operate under the names "Travelodge" and "Thriftlodge" pursuant to franchise agreements acquired by HFS or entered into with HFS in connection with the Travelodge Acquisition. See "Business--Franchise Agreements." In connection with the Travelodge Acquisition, the Company also acquired the lease on Forte Hotels' corporate headquarters in El Cajon, California, and a 50% profits interest in the hotel management operations of Royco, a hotel management company based in Calgary, Canada which manages Canadian hotel properties. See "Business--Growth Strategy--External Growth Opportunities--Canadian Acquisition." In a related transaction prior to consummation of the Travelodge Acquisition, HFS and Motels of America, Inc. acquired directly from Forte Hotels the Travelodge franchise system and 19 hotel properties, respectively, for an aggregate purchase price of $71.6 million. HFS also provided advisory services to the Company in connection with the Travelodge Acquisition for which the Company paid a $2.0 million fee.
In connection with the Travelodge Acquisition, the Company also acquired a retail arcade that adjoins its 250-room Travelodge hotel located at Fisherman's Wharf, San Francisco and a 255-car parking garage. The hotel and retail complex, which occupies an entire city block, overlooks the San Francisco Bay. The retail arcade consists of approximately 20,000 square feet of ground floor frontage located on San Francisco's Jefferson Street. Currently, the arcade is fully-leased to 14 shops and restaurants. In connection with the Company's development plan, the Company, subject to local zoning approval, intends to expand the retail space by an additional 30,000 square feet. The Company occupies the premises under a 74-year master land lease expiring in February 2035 with an annual rent fixed until termination of $80,000. In the twelve- month period ended December 31, 1996, the arcade generated approximately $2.0 million in net operating income.
Canadian Acquisition: On October 1, 1996, the Company purchased from Capital Properties Limited Partnership ("CPLP") 20 hotels and a one-half interest in an additional hotel (the "Acquired CPLP Properties"), which represent in the aggregate approximately 3,500 guest rooms, located throughout Canada. These hotels operate under the Travelodge brand name and are managed by Royco Hotels and Resorts, Ltd. ("Royco"). The Company accomplished the Canadian Acquisition by paying approximately $70 million to purchase substantially all of CPLP's existing bank debt and to pay certain specified closing costs (including real estate taxes of $1.8 million), and by assuming the liability for identified trade payables and property specific bank debt, aggregating approximately another $7.4 million. In addition, the Company will be obligated to make certain contingent payments to CPLP following a preferred return to the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." The Canadian Acquisition contributed approximately 29% of the Company's total revenues on a pro forma basis during the twelve-month period ended December 31, 1996. Of the $70 million payment, substantially all was financed by bank borrowings under the credit facility among the Company, Chartwell Canada Corp., which is a subsidiary of the Company, The Chase Manhattan Bank, as Administrative Agent, The Bank of Nova Scotia, as Syndication Agent, and the Banks (as defined therein) from time to time parties thereto (the "Credit Facility"). In connection with the Canadian Acquisition, the Company was granted the 30-year master license under an agreement with HFS pursuant to which the Company is entitled to develop and operate, or to franchise others to develop and operate, lodging facilities in Canada under the Travelodge and Thriftlodge brand names. Also in connection with the Canadian Acquisition, the Company entered into a management services and franchise development agreement (the "MSFDA") with Royco. Royco manages the Company's Canadian hotels and will manage any future hotels acquired by the Company in Canada. Subject to the Company's review, Royco may manage hotels on its own account. Under the MSFDA, Royco is also responsible for assisting the Company in developing new Travelodge and Thriftlodge lodging facilities in Canada under the Canadian Master License. As compensation for its services under the MSFDA, Royco receives 50% of the profits generated from these management and franchise
development operations. The MSFDA also provides for the payment to Royco of additional fees under certain circumstances, including, upon the satisfaction of fixed performance goals and the termination of the agreement. The term of the MSFDA commenced on December 31, 1996 and expires on December 31, 2006. The Company has the option to renew the MSFDA for three additional terms of ten years each. Upon the expiration of the MSFDA, or in the event the agreement is terminated, Royco has the option to acquire the Company's interest under the Canadian Master License. Under its terms, the Canadian Master License is assignable by the Company to Royco.
Other Acquisitions: In addition to the Travelodge Acquisition and Canadian Acquisition, in May 1996 the Company acquired a 112-room Ramada and a 101-room Shoney's Inn in Brunswick, Georgia, which the Company intends to reposition, refurbish and convert into a 213-room Ramada. Acquisitions entail risks that acquired hotels will fail to perform in accordance with expectations and that estimates of the cost of improvements necessary to reposition hotels will prove inaccurate, as well as general investment risks associated with any new real estate investment. In addition, future trends in the hotel industry may make future acquisitions economically impractical. Moreover, there can be no assurance that the Company will be able to acquire hotels that meet its investment criteria or that any such hotels' operations can be successfully improved. See "Risk Factors--Expansion Risks."
. Selected Development of Hotels: Selected development of new hotels is a key part of Chartwell's external growth program. Management believes that attractive opportunities exist for the development of new full-service and limited-service hotels in certain markets of the United States, Canada and Mexico. Consistent with its development strategy of diversifying and expanding its hotel portfolio, since the Travelodge Acquisition, the Company has purchased development sites in Albuquerque and Santa Fe, New Mexico, Phoenix, Arizona and Irving, Texas. In conjunction with its strategic alliance with Hilton, the Company is currently developing 120- room Hilton Garden Inn(R) hotels at its Albuquerque and Santa Fe development sites. The Santa Fe project, which is located adjacent to the historic district of Santa Fe, is scheduled for completion in late 1997 and will also include the construction of two free-standing casual-style restaurants and is expected to include the development of an additional hotel. The development site in Irving, Texas will consist of a 112-room Wingate Inn(R) located at the north entrance of the Dallas/Fort Worth International Airport. The hotel is scheduled for completion in the fourth quarter of 1997. The Company anticipates that most of its newly-developed hotels will be franchised under major franchise brands such as Hilton Garden Inn and Wingate Inn. Like acquisitions, new project development is also subject to numerous risks, including risks of construction delays or cost overruns that may increase project costs. Accordingly, there can be no assurance that the Company will be able to develop hotels that meet its investment criteria, site selection process or that any hotels can be successfully developed. See "Risk Factors--Expansion Risks."
. Chartwell de Mexico: On July 12, 1996, the Company entered into a joint venture with a wholly owned subsidiary of Grupo Piasa for the purpose of developing and operating, or franchising others to operate, lodging facilities in Mexico under the Travelodge and Thriftlodge brand names. Through Chartwell de Mexico, the Company intends to develop up to 30 Travelodge and other branded lodging facilities throughout Mexico and to establish Travelodge as the dominant limited service brand in Mexico's emerging market. The Company's joint venture with Grupo Piasa represents a significant step by the Company in pursuing its development strategy. Chartwell de Mexico is to be funded with up to $20 million in capital contributions, of which half are to be contributed by the Company. Chartwell de Mexico's development strategy is to seek development locations near major metropolitan markets, airports and commercial centers and to construct hotels to attract the economy-conscious business and leisure traveler. The Company believes that there is a significant demand in the Mexican market for an American franchise hotel brand. The Company will provide the joint venture with access to such an established brand through the Travelodge franchise. Chartwell de Mexico, in association with Wings, a Mexican casual dining restaurant chain, intends to permit Wings to construct and lease from the Company restaurant facilities in close proximity to its hotels in order to afford its guests convenient dining facilities. On September 18, 1996, the joint venture was granted the 30- year exclusive master license under an agreement with HFS, pursuant to which the joint venture is entitled to franchise others to develop and operate, lodging facilities in Mexico under the Travelodge and Thriftlodge brand names. Chartwell de Mexico is obligated under the Mexican Master License to
develop in various stages up to 1,140 hotel suites or resort lodging guest rooms by December 31 of each year through 2006. Under certain circumstances, including where the Company does not satisfy its development obligations in accordance with a prescribed schedule, the Mexican Master License may be terminated by HFS.
HOTEL PROPERTIES
The Company owns fee and leasehold interests in 130 hotel properties, including sole ownership of 39 hotel properties (totaling approximately 6,000 rooms) and joint venture interests in 91 additional hotel properties (totaling approximately 5,400 rooms). Where the properties are operated as a joint venture or partnership, the Company is, in most instances, the 50% general partner. The Company's hotels are located in 25 states and six Canadian provinces, with a particular concentration in the states of California, Washington, Oregon, Nevada, Arizona and Florida, as well as the Province of Ontario. As of March 15, 1997, the states and provinces in which those hotels are located, the number of rooms and brand affiliation of each hotel and the nature of the Company's ownership interest and percentage of the Company's joint venture interest, if applicable, are set forth in the following table:
THE COMPANY'S HOTELS
(AS OF MARCH 15, 1997)
- ------------------------ (1) The Company, subject to local zoning approval, intends to expand the retail space at the Travelodge Fisherman's Wharf hotel by 30,000 square feet to 50,000 total square feet of retail space and to add approximately 100 guest rooms to the 250-room hotel. (2) Conversion to Hilton pending. (3) Conversion to Ramada pending.
All but 20 of the Company's hotels are Travelodge properties. Virtually all of the Company's hotel properties operate under the "Travelodge" brand name, although eight operate under the affiliated "Thriftlodge(R)" brand name. The Company's hotels operated under the Travelodge brand name are generally of higher quality and provide a higher level of service than the Company's hotels operated under the Thriftlodge brand name. The Travelodge branded properties generally contain between 50 and 150 rooms and provide laundry services, complimentary newspapers, cable television with a premium movie channel, and in- room coffee service. The price per room for the limited-service Travelodge branded properties generally ranges from $40 to $60 per night. The Thriftlodge branded properties generally contain up to 75 rooms and provide fewer services than the Travelodge branded properties. The price per room for the Thriftlodge branded properties generally ranges from $25 to $45 per night. References herein to "Travelodge" properties include both Travelodge and Thriftlodge unless the context otherwise requires. The hotels currently owned by the Company that are not operated as Travelodges or Thriftlodges are operated under the franchise brands Ramada Plaza or Ramada or as independent hotels.
The Company's limited-service Travelodge hotels are designed to attract the economy-conscious business and leisure traveler seeking room quality and hotel locations that are generally comparable to those of mid-price hotels, but at lower average room rates. The Travelodge limited-service branded properties generally do not provide full-service management-intensive facilities and services, such as in-house restaurants or cocktail lounges, banquet centers, conference rooms, room service, recreational facilities or other services and facilities that the Company believes its targeted customers do not typically value. By omitting these facilities and services, the Company believes that its limited-service Travelodge properties are able to deliver a product that addresses both its customers' needs and price expectations.
OPERATIONS AND MANAGEMENT
Chartwell pursues a strategy of centralized control over its operations. Management believes that this strategy reduces operating costs and allows the Company to implement its business strategy more effectively.
U.S. Operations: The Company or one of its joint venture partners directly manages each of the hotels in the United States and does not utilize outside hotel managers who do not have an ownership interest in the hotel. Currently, each of the Company's hotels has its own on-site management and staff. On-site employees are supervised by regional managers at the Company's limited-service hotels and by a general manager at the Company's full-service hotels. Those regional and general managers, in turn, are supervised by the Company's senior management. The on-site management teams at each of the Company's hotels also receive direct support from the Company's centralized corporate department with accounting and finance, payroll, data processing and management information services, interior design, purchasing, hotel operations, human resources, recruiting and training, legal, advertising, insurance and telecommunications.
Canadian Operations: In Canada, 21 (including a one-half interest in a joint venture) of the Company's 24 hotels are managed by Royco. Royco's management team consists of a president of operations, a vice president of operations, two regional managers and support staff. See "Business--Growth Strategy--External Growth Opportunities--Canadian Acquisition."
Hotel Development Staff: The Company's development staff consists of a director of development and three support staff members. The development team, in accordance with the Company's development strategy, is responsible for finding new sites suitable for hotel development, negotiating with franchisors in flagging new properties and finding hotels suitable for acquisition. See "Business--Growth Strategy--External Growth Opportunities--Selected Development of Hotels."
MARKETING AND PROMOTIONS
The Company does not market its hotel properties on a company-wide level. Instead, it relies on HFS, as the franchisor of the Travelodge chain, and the franchisors of its other brands, to market the franchise brands under which the Company operates its hotels. Through the Travelodge brand franchise association, to which the Company appoints two members of the 12-member board, and the Company's close relationship with HFS, the Company is able to make recommendations to HFS' Travelodge sales and marketing department. For 1997, the Company has been informed by HFS that it has budgeted approximately $5.5 million for marketing the Travelodge brand.
HFS intends to implement a program in cooperation with the Company to revitalize the Travelodge brand name. Through promotional expenditures that highlight the affordable price, convenient location and consistent quality identified with the Travelodge brand, HFS intends to expand Travelodge's share of the leisure travel market. A core aspect of this strategy is HFS' reintroduction of the Sleepy Bear mascot for the Travelodge brand--at one time, a well-recognized symbol of the Travelodge chain. In 1997, HFS expects to introduce a "Travel Miles" program that will reward guests with "Travel Miles," exchangeable for gifts that include Sleepy Bear merchandise and free overnight guest rooms. The Company has also introduced "Sleepy Bear Rooms" at its Travelodge hotel in Walt Disney World Village. These family-targeted rooms are also available at 19 other Travelodge properties located in the United States and four Travelodge properties located in Canada.
On a local level, the Company's hotels generally advertise in their individual markets and some of the Company's larger hotels employ marketing staffs to carry on their local advertising and marketing programs. In
addition, each on-site general manager typically makes regular calls to local companies and organizations in an effort to promote the good will associated with that particular hotel in the community. The Company's two regional sales and marketing directors also provide sales and marketing consultation to both the regional managers and directly to the on-site general managers. In cooperation with the regional sales and marketing staff, each on-site general manager is encouraged to develop and implement an individualized short and intermediate-term marketing plan. For 1997, the Company has budgeted approximately $3 million for marketing individual hotels generally in their local markets.
GROUND LEASES
Approximately 69% of the Company's hotels are located on property covered by ground leases with unaffiliated third parties. All of these leases are net leases. Generally, the leases have fixed base rents of between $300 and $1,000 per month. In addition, the Company or the joint venture, as the case may be, is obligated to pay as rent a percentage, typically 7 1/2%, of its gross receipts that are in excess of an annual threshold amount, typically between $48,000 and $150,000. Gross receipts are typically defined as total revenue received by the joint venture, excluding sales from vending machines, newspapers, soda and telephone calls.
The ground leases have varying expiration dates, but most are scheduled to expire between 1998 and 2015. Upon termination of a ground lease, the hotel located on the leased property will become the property of the lessor. The Company intends to attempt to negotiate renewals of the ground leases or the purchase of the real property from the lessor where it considers it to be advantageous to do so, but there can be no assurance that the Company will be able to do so. See "Risk Factors--Risk of Expiration of Ground Leases."
JOINT VENTURE AGREEMENTS
Ninety-one of the Company's hotels are operated as joint ventures. The Company's percentage interests in these joint ventures vary, but the Company holds a 50% interest in 60 hotels and holds a joint venture interest greater than 50% in 14 hotels.
For approximately one-third of these hotel properties, the Company acts as the day-to-day business manager of the property. For the balance of these hotel properties, the day-to-day business decisions of joint ventures are generally made by the Company's partner. Significant business decisions that fall outside the scope of day-to-day decisions are made jointly by the Company and the Company's joint venture partner. See "Business--Operations and Management." In addition to profits and losses under the joint venture, the day-to-day managerial partner typically receives a management fee equal to a percentage of the gross room revenues received from the operation of the hotel.
FRANCHISE AGREEMENTS
All but nine of the Company's hotels are operated under franchise licenses with HFS and other nationally recognized hotel companies. The Company anticipates that most of the additional hotels in which it invests will be operated under franchise licenses. The Company believes that the public's perception of quality associated with a franchisor is an important feature in the operation of a hotel. Franchisors provide a variety of benefits for franchisees, which include national advertising, publicity, and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards, and centralized reservation systems.
The Travelodge Franchise: The Company's Travelodge properties operate under franchise agreements with an affiliate of HFS as the owner of the Travelodge franchise systems. HFS acquired those franchise systems in connection with the Travelodge Acquisition.
The franchise agreements covering the Travelodge properties which are wholly- owned by the Company require monthly payment by the Company of a royalty fee of 4% of the property's gross room revenues plus a marketing fee also currently set at 4% of gross room revenues. The marketing fee may be changed from time to time by the franchisor. These franchise agreements have scheduled terms of 20 years but may be terminated by the Company prior to their scheduled expiration upon the payment of liquidated damages by the Company. The Company entered into a license agreement (the "Omnibus License Agreement") with an affiliate of HFS as licensor covering the Company's Travelodge properties that are owned by joint ventures. Under the Omnibus License
Agreement, the Company is required to pay a license fee equal to 4% of gross room revenues multiplied by the Company's percentage interest in each of the hotel properties owned by joint ventures in which the Company acquired an interest, plus an additional amount, generally equal to 4.5% of gross room revenues, for national marketing and reservation services provided by HFS. The Omnibus License Agreement has a term of 20 years but may be terminated by the Company with respect to any particular joint venture prior to the scheduled expiration. Also, if any particular joint venture is terminated, then the franchisor may terminate the Omnibus License Agreement with respect to that particular property. In either case, the Company is required to pay liquidated damages upon the early termination of the Omnibus License Agreement with respect to any individual joint venture. No liquidated damages are due if a joint venture is terminated under the Omnibus License Agreement and becomes a licensee or franchisee of another HFS hotel brand.
The amount of liquidated damages payable by the Company upon termination of the franchise agreements covering any property equals five times the amount of the royalty fees payable in respect of that property during the twelve months most recently preceding the termination if the termination occurs before the end of the fourth year of the franchise agreement. If the termination occurs thereafter, the amount of liquidated damages scales down annually, reaching two times the amount of the royalty fees payable in respect of that property during the twelve months most recently preceding the termination if the termination occurs after the sixth year of the franchise agreement. The franchise agreements are subject to cancellation in the event of a default, including the failure to operate the hotel in accordance with the quality standards of the franchisor.
The Company's franchise agreements authorize the operation of a hotel under the "Travelodge" or "Thriftlodge" name at the specific location where the hotel is located and require that the hotel be operated in accordance with standards specified by the franchisor. The franchise agreements grant the franchisor a right of first refusal, exercisable for 30 days, if the Company proposes to sell, lease or sublease the franchised hotel and require the franchisor's consent to the transfer of the franchised hotel or of any interest in the subsidiary or joint venture that is a direct party to the franchise agreement. The Company's franchise agreements do not contain any territorial protection and, therefore, do not prohibit the franchisor from franchising competing properties in close proximity to the Company's property.
Other Franchises: The Company's other franchise agreements also generally specify certain management, operating, recordkeeping, accounting, reporting, and marketing standards and procedures with which the Company must comply. The franchise agreements obligate the Company to comply with each franchisor's standards and requirements with respect to training of operational personnel, safety, maintaining specified insurance, and the types of services and products ancillary to guest room services that may be provided by the Company.
The loss of a license for a hotel would, in most instances, result in the rebranding of the hotel, which might cause a loss of established customer good will and reduced revenues. The Company believes that the loss of a license for any individual hotel would not have a material adverse effect on the Company's financial condition and results of operations. The Company believes it will be able to renew its current licenses or obtain replacements of a comparable quality.
COMPETITION
The hotel industry is highly competitive. The Company's hotels compete with numerous other hotels, motels and other lodging establishments in their market areas. Chains such as Days Inn and Howard Johnson, both of which are franchised by HFS, Comfort Inns, Fairfield Inns, Hampton Inns, La Quinta, Motel 6 and Red Roof Inns are direct competitors of the Company's limited-service Travelodge brand hotels and Ramada, Holiday Inn and Quality Inns are direct competitors of the Company's full-service hotels. There is no single competitor or group of competitors of the Company's hotels that is dominant in the lodging industry. Competitive factors in the industry include reasonableness of room rates, quality of accommodations, degree of service, name recognition and convenience of locations.
Demographic, economic and geographic changes in any of the Company's markets could impact the convenience or desirability of the sites of certain hotels in that market, which would adversely affect the operations of the Company's hotels in that market. There can be no assurance that new or existing competitors will not significantly lower rates or offer greater convenience, services or amenities or significantly expand or improve facilities in a market in which the Company's hotels compete, thereby adversely affecting the Company's operations.
Competition may generally reduce the number of suitable hotel acquisition opportunities offered to the Company and increase the bargaining power of property owners seeking to sell, which could adversely affect the Company's financial performance.
The Company may be competing for investment opportunities with entities that have substantially greater financial resources than the Company. These entities may generally be able to accept more risk that the Company can prudently manage. Competition may generally reduce the number of suitable investment opportunities offered to the Company and increase the bargaining power of property owners seeking to sell.
SEASONALITY
The hotel industry is seasonal in nature. Room occupancy rates at the Company's hotels are affected by normally recurring seasonal patterns and, in most locations in the United States and Canada, are higher in the late spring through early fall months (May through October) than during the balance of the year, with the lowest occupancy rates occurring in the first quarter of the year. As a result, the Company expects to experience seasonal lodging revenue patterns similar to the hotel industry as a whole with the summer months, due to the increase in leisure travel, producing a higher revenue than other periods during the year.
REGULATION
The lodging industry is subject to numerous federal, state, local and foreign government regulations, including building and zoning requirements. Also, the Company is subject to laws governing its relationship with employees, including minimum wage requirements, overtime, working conditions and work permit requirements. An increase in the minimum wage rate, employee benefit costs or other costs associated with employees could adversely affect the Company. The Company does not expect that the recently enacted increases in the federal minimum wage rate to significantly affect its operations. 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. Although the Company believes that it is substantially in compliance with the ADA, no assurance can be given that a material ADA claim will not be asserted against the Company. These and other initiatives could adversely affect the Company, as well as the lodging industry in general. The Company is also subject to dramshop statutes or equivalent common law in some jurisdictions that give an injured person the right to recover damages from any establishment that wrongfully served alcoholic beverages to an intoxicated person who causes the injury. The Company believes that its insurance coverage with respect to any such liquor liability is adequate. The Company has hotels that are subject to alcohol sales regulations and/or dramshop statutes in Canada and the following states: California, Florida, Georgia, New Jersey, New York, Oregon, Pennsylvania and Texas.
ENVIRONMENTAL CONSIDERATIONS
The Company's hotels are subject to United States Federal, state and local, and Canadian and Mexican environmental laws and regulations. Certain of these laws may require a current or previous owner or operator of real estate to clean up designated hazardous or toxic substances affecting the property. In addition, the owner or operator may be held liable to a government entity or to third parties for damages or costs incurred by such parties in connection with such contamination. Some of the Company's hotels are located on or near properties, such as gasoline stations, on which activities have been conducted which have or may have released petroleum products or other hazardous substances into the soil or groundwater. The Company is aware of soil contamination, which the Company believes was caused by unrelated third parties, at several of its hotel sites in the United States and Canada. The Company has not received any notices of liability in connection with such contamination. Based on its present knowledge, the Company does not believe that environmental matters are likely to have a material adverse effect on the Company's business, assets, financial condition or results of operations. However, due to the absence of complete information, possible future changes in laws and regulations, possible future changes in the condition of the Company's properties and other factors, no assurance can be given that environmental matters will not ultimately have a material adverse impact on the Company's business, assets, financial condition or results of operations.
GAMING OPERATIONS
The Company continues to hold investments in casinos located in Mississippi and Arizona, and in various gaming-related businesses, but is not engaged in the business of operating casinos. As a result of reserves taken
as of December 31, 1996, book value totalled approximately $500,000. These investments represented less than one percent of the Company's total assets on December 31, 1996. The Company does not intend to make any further investments in the gaming industry. During the twelve-month period ended December 31, 1996, the Company derived no revenues from gaming operations.
The Company is subject to regulation by each state in which it holds investments that conduct activities in the gaming business, and to a certain extent under Federal law. Generally, the Company is required to obtain a gaming license for each location where it will conduct gaming operations, and each of the Company's officers, directors, managers and principal shareholders are subject to strict scrutiny and approval by the gaming commission or other regulatory body of each state or jurisdiction in which the Company may conduct gaming operations. The Company believes that, because it now holds only a limited number of gaming-related assets, gaming regulations do not have a significant effect on its business.
EMPLOYEES
As of December 31, 1996, the Company employed approximately 1,950 persons, of whom approximately 90% were compensated on an hourly basis. Management considers its employee relations to be good.
INSURANCE
The Company carries comprehensive liability, fire, extended coverage and business interruption insurance with respect to its hotels, with policy specifications, insured limits and deductibles customarily carried for similar hotels. The Company will carry similar insurance with respect to any other hotels developed or acquired in the future. There are, however, certain types of losses (such as losses arising from wars and losses arising from certain acts of nature) that are not generally insured because they are either uninsurable or not economically insurable. Should an uninsured loss or a loss in excess of insured limits occur, the Company could lose its capital invested in the affected hotel, as well as the anticipated future revenues from such hotel, and would continue to be obligated on any mortgage indebtedness or other obligations related to the hotel. Any such loss could adversely affect the business of the Company. Management of the Company believes that its hotels are adequately insured in accordance with industry practices.
RISK FACTORS
Expansion Risks
The Company's strategy includes increasing the number of its hotels through the acquisition and the redevelopment of existing hotels and development of new hotels. The Company's ability to expand depends on a number of factors, including the selection and availability of suitable locations at acceptable prices, the hiring and training of sufficiently skilled management and personnel and the availability of financing. There can be no assurance that financing, or desirable locations for acquisitions or new development, will be available or, if available, will be on terms acceptable to the Company.
Acquisition Risks: Expansion by acquisition of hotels entails risks that investments will fail to perform in accordance with expectations and that the anticipated costs of renovation or conversion will prove inaccurate, as well as general investment risks associated with any new real estate investment. In connection with acquired properties, the Company will incur additional costs relating to renovation and, if applicable, rebranding activities and operating expenses, which could adversely affect the Company's financial performance.
Development Risks: Expansion by development of new hotels is subject to a number of risks, including site acquisition cost and availability, risks of construction delay, inclement weather and labor or material shortages or cost overruns, risks that properties will not achieve anticipated occupancy levels or sustain expected room rate levels and commencement risks such as receipt of zoning, occupancy and other required governmental permits and authorizations, which in each case could adversely affect the Company's financial performance. Newly opened hotels generally begin with lower occupancy and room rates and improve those rates over time.
Redevelopment Risks: The redevelopment of hotels involves risks associated with construction and renovation of real property, including the possibility of construction cost overruns and delays due to various factors
(including receipt of regulatory approvals, inclement weather and labor or material shortages) and market or site determination after acquisition or renovation. The operations at the hotels under redevelopment can be substantially curtailed during portions of the redevelopment activity.
There can be no assurance that the Company's expansion strategy will be implemented successfully. The Company's inability to successfully implement its expansion plans would limit the Company's ability to grow its revenue base or contain its expenditures. Furthermore, there can be no assurance that suitable hotel acquisition candidates or development sites will be located, that hotel acquisitions can be consummated successfully or that acquired or developed hotels can be operated profitably or integrated successfully into the Company's operations.
Lodging Industry Risks
The lodging industry in general may be adversely affected by such factors as changes in national and regional economic conditions (particularly in geographic areas in which the Company has a high concentration of hotels), changes in local market conditions, oversupply of hotel space or a reduction in local demand for rooms and related services, competition in the hotel industry, changes in interest rates, the availability of financing and other factors relating to the operation of hotels.
Operating Risks: Operating factors affecting the Company and the lodging industry generally include (i) competition from other hotels, motels and recreational properties, (ii) demographic changes, (iii) the recurring need for renovations, refurbishment and improvements of hotels and increased expenses related to hotel security, (iv) restrictive changes in zoning and similar land use laws and regulations, or in health, safety, disability and environmental laws, rules and regulations, (v) changes in government regulations that influence or determine wages, prices or construction costs, (vi) changes in the characteristics of hotel locations, (vii) the inability to secure property and liability insurance to fully protect against all losses or to obtain such insurance at reasonable costs, (viii) changes in real estate tax rates and other operating costs, (ix) changes or cancellations in local tourist, athletic or cultural events, (x) changes in travel patterns that may be affected by increases in transportation costs or gasoline prices, changes in airline schedules and fares, strikes, weather patterns or relocation or construction of highways, (xi) increases in operating expenses and litigation as a result of injuries to guests, and (xii) changes in brand identity and reputation. Unexpected or adverse changes in any of the foregoing factors could have a material adverse effect on the Company's business, assets, financial condition or results of operations.
Cyclicality: The hotel industry is subject to periods of cyclical growth and downturn. In the past, the hotel industry has experienced cyclical downturns resulting from, among other things, overbuilding in the industry and sluggish general economic conditions in the United States. There can be no assurance that downturns or prolonged adverse conditions in the hotel industry, in real estate or capital markets or in national or local economics will not have a material adverse impact on the Company. In addition, the Company's hotels are located throughout the United States and Canada, but the Company has a geographic concentration of hotels in the State of California. As a result, the Company's cash flow may be affected by economic conditions and demand for hotel rooms within the State of California.
Seasonality: The hotel industry is seasonal in nature. Room occupancy rates at the Company's hotels are affected by normally recurring seasonal patterns and, in most locations in the United States and Canada, are higher in the late spring through early fall months (May through October) than during the balance of the year, with the lowest occupancy rates occurring in the first quarter of the year. As a result, the Company expects to experience seasonal lodging revenue patterns similar to the hotel industry with the summer months, due to the increase in leisure travel, producing a higher revenue than in other periods during the year.
Importance of Franchisor Relationships
Substantially all of the Company's hotels are operated under the Travelodge brand name pursuant to franchise agreements with affiliates of HFS. The Company expects that substantially all of the hotels that it acquires or develops in the future will be operated under hotel brands franchised by major hotel franchisors. While the Company believes that franchise arrangements offer the Company competitive advantages over nonfranchised lodging properties, the value of a brand name under which the Company's hotels operate and, as a result, the Company's business as a whole, could be adversely affected by a number of factors relating to the franchisor of that brand over which the Company has no control. These risks include the general reputation of the brand and the
success of the franchisor's marketing efforts. In addition, pursuant to the terms of an applicable franchise agreement, a franchisor can terminate the agreement if, among other things, its quality standards are not maintained or if payments due are not made in a timely fashion. If any of the franchise agreements were terminated by the franchisor, the Company could explore entering into a franchise agreement with another franchisor. There can be no assurance, however, that a desirable replacement relationship would be available. In addition, under the franchise agreements covering the Company's Travelodge hotels, the franchisor controls the marketing and promotional aspects of the Travelodge brand. The Company's program to revitalize the Travelodge brand name through increased promotional expenditures is dependent upon the cooperation of HFS as franchisor of the Travelodge name.
Risks Associated with International Operations
The Company has begun to expand its hotel operations in Mexico and Canada. As a result, the Company's operations may be affected adversely as a result of political changes or instability, general economic conditions, the imposition of regulations relating to the ownership of hotel properties or real estate or the franchising of hotel properties, the imposition of taxes, and other charges on international business activities, in Mexico or Canada, and the fluctuations in the value of the U.S. dollar against the Canadian dollar or the Mexican peso, as the case may be, or restrictions on international currency transactions.
Reliance on Current Management
Although the Company's management team includes individuals with substantial experience in operating, managing, developing and acquiring hotels and real estate properties, the Company relies upon the services and expertise of Richard L. Fisher, the Company's Chairman and Chief Executive Officer, and Martin L. Edelman, a Director and the Company's President. The occurrence of any event which would cause the Company to lose the services of either of Messrs. Fisher or Edelman could have a material adverse effect on the Company. The Company has purchased $5 million key-man life insurance policies covering each of Messrs. Fisher and Edelman. There is no assurance, however, that the Company will continue to maintain such insurance policies in effect or that any proceeds thereof would be sufficient to compensate the Company for the loss of services of either of Messrs. Fisher or Edelman. In addition to the substantial amounts of time that Messrs. Fisher and Edelman devote to the Company's business activities, both Messrs. Fisher and Edelman engage in other business activities. Neither Mr. Fisher nor Mr. Edelman has an employment agreement with the Company.
Relationship with HFS
In addition to the Company's relationship with HFS as the franchisor of the Travelodge brand name under which substantially all of the Company's hotels operate, $75 million of the Company's borrowings under its Credit Facility are currently guaranteed by HFS. The amount and availability of the Credit Facility could be adversely affected by adverse changes in the financial condition of HFS.
Risk of Expiration of Ground Leases
Approximately 69% of the Company's hotels are located on property covered by ground leases with unaffiliated third parties. Although the Company intends to attempt to obtain renewals of the ground leases or the purchase of the real property from the lessor when it considers renewal or purchase to be advantageous, there can be no assurance that the Company will be able to do so. The Company's failure to renew these ground leases or purchase the real property from the lessor could adversely affect the Company's financial performance. In addition, there can be no assurance that, should the Company decide to renew, it will be able to do so.
ITEM 2.
ITEM 2. PROPERTIES
The executive offices of the Company are located at 605 Third Avenue, New York, New York and are occupied pursuant to a lease (the "New York Lease") entered into in March 1996 with an affiliate of Chartwell and an unaffiliated third party, as landlords. Under the New York Lease, the Company has leased approximately 18,700 square feet of space for a period of ten years. The Company is obligated to pay approximately $542,000 per year
for each of the first five years, and approximately $600,000 per year for each of the last five years, of the term of the New York Lease for the use of the office space.
The Company also leases office space located at 1973 Friendship Drive, El Cajon, California, a suburb of San Diego, pursuant to a lease (the "El Cajon Lease") entered into in November 1991 with an unaffiliated third party, as landlord. Prior to January 1996, the office space served as the headquarters of Forte Hotels and as its reservation center. Under the El Cajon Lease, the Company is obligated to pay approximately $317,000 per year over a term of ten years for the use of the office space. In the seventh year of the term of the El Cajon Lease, the Company has an option to purchase at fair market value its landlord's interest, which is that of a sublessor. The Company subleases approximately half of the office space to HFS, which continues to operate the Travelodge reservation system from that space. Rental costs charged to HFS for the space used by it are allocated based upon the percentage of space occupied and the related overhead expenses associated with that percentage.
The Company is in the process of evaluating its operations at its three locations, El Cajon, New York and Calgary, with the intention of consolidating operations and improving operating efficiencies. Management estimates exit and severance costs of $1.0 million will be incurred during the first quarter of 1997 in connection with this consolidation.
See Item 1 under the caption "Business--External Growth Opportunities" and "-- Hotel Properties" for a description of the Company's ownership in various hotel properties and retail space.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not party to any litigation which it believes will have a material impact on the financial condition of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of 1996.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock, par value $.01 per share ("Common Stock"), commenced trading on the Nasdaq National Market on November 14, 1994 under the symbol "NAGC." From January 1996 until August 8, 1996, the Common Stock traded under the symbol "NALC" and, since August 8, 1996, has traded under the symbol "CHRT." The following table sets forth for the periods indicated the range of high and low sale prices per share of Common Stock, as reported on the Nasdaq National Market.
On March 25, 1997, the last reported sale price per share of Common Stock on the Nasdaq National Market was $14 3/4. As of March 25, 1997, there were approximately 176 holders of record of Common Stock.
The Company has never paid any dividends on the Common Stock. The Company expects to retain its earnings for the development and expansion of its business and the repayment of indebtedness and does not anticipate paying dividends on the Common Stock in the foreseeable future. Any future dividend policy will be determined by the Company's Board of Directors, and the payment of any dividend in the future will be based upon conditions then existing, including the Company's earnings, financial condition and capital requirements, as well as such economic and other factors as the Board may deem relevant at the time. In addition, the Company's Credit Facility prohibits the payment of dividends on the Common Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources--Credit Facilities".
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following is a summary of selected historical financial data for the Company and its subsidiaries since inception. All amounts are in thousands, except per share amounts.
There were no dividends declared during the periods presented above.
On November 22, 1994, HFS distributed to its stockholders one share of Common Stock for every ten shares of HFS common stock held on November 14, 1994 (the record date for the Distribution). Prior to November 22, 1994, the Company's operations were conducted by HFS and its subsidiaries.
The following is the operating data for the period February 1, 1995 through January 23, 1996 and the year ended January 31, 1995 for the Travelodge/Thriftlodge business acquired by the Company on January 23, 1996.
PRO FORMA FINANCIAL DATA CHARTWELL LEISURE INC. AND SUBSIDIARIES
The following table presents the unaudited pro forma consolidated results of operations for the twelve months ended December 31, 1996 and 1995 as if the Travelodge Acquisition and Canadian Acquisition described in Item 1 occurred on January 1, 1995, giving effect to the depreciation and amortization associated with the acquired properties and the sale of 4 million shares of newly issued common stock on August 8, 1996 and financing costs associated with acquisitions.
(A) EBITDA before gaming expenses represents earnings before extraordinary items, losses on gaming assets and gaming development costs, the $9.5 million charge for termination of corporate service agreement with HFS, interest expense, provision for income taxes (if applicable) and depreciation and amortization (plus depreciation, amortization and interest expense of joint venture interests) and excludes interest income on cash investments. EBITDA is used by the Company for the purpose of analyzing its operating
performance, leverage and liquidity. Such data are not a measure of financial performance under generally accepted accounting principles and should not be considered as an alternative to net income as an indicator of the Company's operating performance or as an alternative to cash flows as a measure of liquidity.
The pro forma results are not necessarily indicative of the actual results of operations that would have occurred had the transactions been consummated as indicated nor are they intended to indicate results that may occur in the future. See "Business--Growth Strategy--External Growth Opportunities-- Travelodge Acquisition" and "--Canadian Acquisition" and "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Liquidity and Capital Resources--Travelodge Acquisition" and "--Canadian Acquisition."
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL OVERVIEW
The Company was engaged in the development of prospective casino gaming facilities until the fourth quarter of 1995 when the Company announced a decision by its Board of Directors to curtail future gaming investments and focus on investments and acquisitions in non-gaming industries. In December 1995, the Company's Board of Directors decided that the Company should pursue a new strategic direction with a focus on becoming a hotel owner and operator.
While the Company's focus throughout 1996 has been on owning and operating hotels, management has continued to evaluate the recoverability of the Company's gaming assets and has recorded writedowns on gaming assets to continue to carry such assets at their estimated net realizable value. As a result of writedowns of $16.4 million for the twelve months ended December 31, 1996, the carrying value of the Company's remaining gaming assets equals $7.1 million. These assets consist of loans to a casino of $6.6 million which are performing in accordance with their contractual terms and other investments (which are not producing significant earnings) totaling $500,000 at December 31, 1996. Management continues to evaluate the recoverability of these investments and will record future writedowns to the extent necessary. The winding down of the gaming assets has had a significant negative effect on the Company's operations in 1996. As a result of the $16.4 million of writedowns on gaming assets and the $9.5 million charge for termination of the Corporate Services Agreement (as defined herein), the Company reported an operating loss of $24.3 million for the twelve months ended December 31, 1996. Without the above charges, the Company would have reported operating income of $1.6 million for the same period. Based on the relatively small remaining investment in gaming assets, management believes that future operations will not be impacted materially by the Company's disposal of its remaining gaming investments.
The Company believes that comparisons of its results during the period ended December 31, 1996 to prior periods should take into account the changes in the Company's primary business.
RESULTS OF OPERATION
PRO FORMA TWELVE-MONTHS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995
The pro forma financial data (see Item 6) includes the operations of the assets acquired in the Travelodge Acquisition and the Canadian Acquisition for the twelve months ended December 31, 1996 and 1995 as if those acquisitions had occurred on January 1, 1995, giving effect to depreciation and amortization associated with the acquired properties and financing costs associated with the Acquisitions. The pro forma financial data also includes revenues and expenses associated with the Company's gaming business which include writedowns on gaming assets of $16.4 million for the twelve month period ended December 31, 1996 and gaming development costs of $15.5 million for the twelve month period ending December 31, 1995. Included in the pro forma financial data for the twelve months ended December 31, 1996 is approximately $1.2 million of professional fees relating to CPLP's non-recurring workout of bank debt that occurred prior to the Canadian Acquisition as well as $1.5 million relating to the 1996 fee paid to HFS pursuant to the Corporate Services Agreement and $9.5 million for the termination of the Corporate Services Agreement.
Set forth below is a summary of the Company's full and limited-service properties and rooms as of March 10, 1997:
The Company's 27 full-service hotels contributed approximately 63% of the Company's gross room revenues (including the Company's share of gross room revenues of unconsolidated joint ventures) during the twelve month period ending December 31, 1996, on a pro forma basis. The Company's full-service hotels continue to be a significant revenue generator and are a primary focus for the Company's capital improvement program.
The Company has ownership interests in 89 joint venture limited-service hotels representing 4,715 rooms, with 2,395 rooms representing the Company's allocable ownership percentage in those hotels. The Company also has a 78% interest in a joint venture owning the full-service 250-room San Francisco Wharf Travelodge hotel and a 50% interest in a joint venture owning a 222-room Canadian Travelodge hotel. The Company's ownership interests in joint ventures range from 10% to 93.3% and average approximately 52%. These are interests in general partnerships established to conduct the operations of individual limited-service hotels. The joint venture limited-service hotels are located principally in the western region of the United States.
Set forth below is a summary of the Company's ownership interests in its hotels as of March 15, 1997:
Since December 31, 1996, the Company has sold ownership interests in four joint venture limited-service hotels. The transactions represent 171 rooms with the Company's share totaling 78 rooms.
In connection with the Travelodge Acquisition, the Company also acquired a retail arcade that adjoins its 250-room Travelodge hotel located at Fisherman's Wharf, San Francisco and a 255-car parking garage. The hotel and retail complex, which occupies an entire city block, overlooks the San Francisco Bay. The retail arcade consists of approximately 20,000 square feet of ground floor frontage located on San Francisco's Jefferson Street. Currently, the arcade is fully leased to 14 shops and restaurants. The Company occupies the premises under a 74-year master land lease expiring in February 2035 with an annual rent fixed until termination of $80,000. In the twelve-month period ended December 31, 1996, the arcade generated approximately $2.0 million in net operating income.
For all hotels, total pro forma hotel revenues increased by $13.0 million, or 12.2%, from $106.2 million in 1995 to $119.2 million in 1996. For all hotels representing the Company's ownership interest, pro forma occupancy increased 3.9% to 66.0% and the pro forma average daily rate increased 5.0% to $51.8 for the twelve months ended December 31, 1996 compared to the same period in 1995. Since acquiring the Acquired Forte Properties on January 23, 1996, the Company has begun its rebranding of certain properties, which has had a positive impact on both occupancy and rates. Two properties that have been rebranded are the hotel at the JFK airport in New York which became a Ramada Plaza Hotel and the Portland, Oregon Travelodge which also became a Ramada Plaza Hotel. As a result of the increases in occupancy and rates, pro forma REVPAR increased to
$34.20, or 9.0%, over the comparable twelve month period in 1995. Pro forma EBITDA increased $2.0 million, or 11.2%, over the comparable twelve month period in 1995.
HISTORICAL TWELVE MONTHS ENDED DECEMBER 31, 1996 AND DECEMBER 31, 1995
Since the Travelodge Acquisition, the Company's operations have been focused on the lodging business. Therefore, the results of operations for 1996 are not comparable to the prior years' periods when the Company was engaged in the development of prospective gaming facilities. Therefore, substantially all the categories of revenue and expense (other than gaming development costs and provisions for gaming losses) are related to the ownership and management of hotel and motel properties in 1996 with no comparative amounts for 1995. Accordingly, the Company's operating results for 1996 from operations other than lodging activities and 1995 (when the Company did not engage in lodging activities) consist of modest investment revenue. In addition, during 1996, the Company's interest expense was $6.5 million on acquisition debt while the Company had no interest bearing debt in 1995. Gaming development expense for the twelve months ended December 31, 1995 consisted primarily of writedowns of gaming assets and related expenses associated with terminated transactions. During 1996, in connection with the Company's ongoing periodic evaluation of its gaming assets, the Company wrote down $16.4 million on its gaming assets to account for estimated impairment on the value of these investments. These losses were based on the Company's evaluation of the ability to generate cash flow, which have been negatively impacted by the environment for alternative gaming venues and the inability to obtain gaming licenses in certain cases.
ACQUIRED FORTE PROPERTIES 1995 VERSUS 1994
Until January 1996 when the Company acquired the Acquired Forte Properties in the Travelodge Acquisition, the Company was engaged solely in the gaming business. Prior to the Travelodge Acquisition, the Acquired Forte Properties were owned by Forte Hotels. See "Business--Growth Strategy--External Growth Opportunities--Travelodge Acquisition." Revenue from the Acquired Forte Properties, while these hotels were assets of Forte Hotels, increased for the period February 1, 1995 to January 23, 1996 compared to the year ended January 31, 1995 by 4% due to an increase in overall occupancy and average daily rate. The occupancy rate of the Acquired Forte Properties increased by 3% to 66% for the period ended January 23, 1996 compared to the period ended January 31, 1995 while the average daily rate also increased by 3% during the same period. Revenue per available room of the Acquired Forte Properties increased by 5% for the period February 1, 1995 to January 23, 1996 as compared to the year ended January 31, 1995.
Earnings before taxes increased by approximately $1.0 million, or approximately 27%. This increase was primarily due to the increase in equity in earnings of the joint ventures, and the overall decrease in interest expense. The Travelodge results represent the financial results of the business acquired in the Travelodge Acquisition.
HISTORICAL TWELVE MONTHS ENDED DECEMBER 31, 1995 AND DECEMBER 31, 1994
The Company's operations from August 1, 1993 (date of inception) through November 1995 consisted of the pursuit of gaming development opportunities. Accordingly, the Company's operating results for 1995 and 1994 consist of modest investment revenue. In 1995, the Company's other income of $4.0 million consisted entirely of interest income compared to $2.4 million of other income in 1994, which consisted of $1.4 million of interest income and a $1.0 million gain on the sale of Capital Gaming International, Inc. common stock.
Development expenses for the year ended December 31, 1995, totaling $15.5 million, primarily consist of expenses associated with terminated investments and transactions, compared to $2.4 million of development expenses associated with the pursuit of equity and development investments in unsuccessful gaming opportunities in 1994. In 1995, due to the failure of the Pennsylvania legislature to adopt legislation contemplating a referendum on authorization of gaming in the state, the Company agreed in principle with its partners to dissolve its joint ventures to develop casino gaming facilities in Pittsburgh and Erie, Pennsylvania. As a result, the Company recorded $6.7 million of losses in 1995, primarily in the third quarter, representing a write-off of its Pittsburgh and Erie joint venture interests. In 1995, the Company also recognized approximately $2.4 million of write-downs of its investment in Boomtown, Inc.'s ("Boomtown") Biloxi, Mississippi casino to the investment's estimated net realizable value. In the second quarter of 1995, the Company recognized a $1.9 million expense for professional and loan commitment fees associated with the termination of its proposed acquisition of all of the outstanding common stock of Par-A-Dice Gaming Corporation ("Par-A-Dice") following the Illinois Gaming Board's determination not to approve the Company's acquisition of Par-A-Dice. The Company also recorded a $1.0 million loss for the permanent impairment of its investment in Century Casinos, Inc. ("Century") common stock and investment in a proposed joint venture with Century following the unfavorable decision of the State of Indiana in June 1995 towards Century's proposed casino in Switzerland County, Indiana. The Company recognized
approximately $1.4 million of professional fee expenses, primarily in the first quarter of 1995, incurred in connection with the Company's proposed merger with Boomtown which was terminated in April 1995.
Included in general and administrative expenses-related party ("Related Party G&A") in 1995 are approximately $3.2 million of fees paid to HFS in consideration for providing both corporate services and up to $75 million of available credit and/or guarantees on behalf of the Company. Related Party G&A totaling $339,000 in 1994 consisted of similar charges for only a 1 1/2 month period following the Distribution. Other general and administrative expenses (G&A) for 1995 of $2.8 million approximated 1994 expenses. The Company also expensed the net deferred tax assets previously recorded at December 31, 1994 which were expected to be realized from income generated from Par-A-Dice operations, following the Illinois Gaming Board's determination not to approve the Company's acquisition of Par-A-Dice.
LIQUIDITY AND CAPITAL RESOURCES
TRAVELODGE ACQUISITION
On January 23, 1996 the Company acquired the outstanding common stock of Forte Hotels for approximately $99 million. In a related transaction prior to consummation of the Travelodge Acquisition, HFS and MOA acquired from Forte Hotels the Travelodge franchise system and 19 hotel properties, respectively, for an aggregate purchase price of $71.6 million. The principal assets of Forte Hotels acquired by the Company consisted of fee and leasehold interests in 115 hotel properties, including sole ownership of 18 wholly-owned hotels and joint venture interests in 97 additional hotel properties. Seven of the Acquired Forte Properties were subsequently disposed of. The Company financed approximately $60 million of the purchase price and related expenses of the Travelodge Acquisition with proceeds from the Company's former credit facility with Chemical Bank and Bankers Trust Company and paid the balance of $38.4 million with existing cash.
CANADIAN ACQUISITION
On October 1, 1996, the Company purchased the Acquired CPLP Properties and a profits participation interest in certain hotel management contracts by paying approximately $70 million, including approximately $6.0 million for the profits participation interest, to purchase substantially all of CPLP's existing bank debt of $63.9 million and to pay certain specified closing costs (including real estate and transfer taxes of $1.8 million) and by assuming the liability for identified trade payables and property specific bank debt, aggregating approximately another $7.4 million.
In connection with the Canadian Acquisition, the Company became obligated to make certain payments to CPLP in future years pursuant to a future payments agreement (the "Future Payments Agreement"). Generally, the Company is obligated to pay to CPLP a percentage of net cash flow ("Remaining Cash Flow") generated by the hotels acquired from CPLP (the "CPLP Hotels") remaining after all expenses have been paid and the Company has received a cumulative, compounded, 13% per annum preferred return on its investment in the CPLP Hotels (the "Preferred Return"). The Company is required to pay CPLP (i) 100% of Remaining Cash Flow up to C$600,000, (ii) 16% of the next C$1.8 million of Remaining Cash Flow after C$600,000 and (iii) 25% of Remaining Cash Flow in excess of C$2.4 million. The Company is also required to pay an amount equal to 25% of the net capital proceeds realized by the Company from any sales and refinancings of any CPLP Hotel, after payment to the Company of its investment in the CPLP Hotels, the Preferred Return and transaction costs. The Company is able to terminate its obligation to make these payments to CPLP at any time after December 31, 2000 but no later than October 1, 2008, upon making a termination payment of no less than C$800,000, calculated in accordance with the terms of the Future Payments Agreement. The Company had made no payments as of December 31, 1996 in accordance with the agreement.
Also in connection with the Canadian Acquisition, the Company entered into a development agreement (the "Development Agreement") with NRG Management Services Ltd. ("NRG"), an affiliate of Royco Hotels and Resorts, Ltd. ("Royco") which manages the Company's Canadian hotels and any future hotels acquired by the Company in Canada, pursuant to which NRG has agreed to identify new hotel properties for acquisition and development in Canada on behalf of the Company. The Development Agreement provides that the Company will pay to NRG approximately $588,000 through October 1997, and approximately $370,000 during each of the years ended October 1998 and October 1999. The Development Agreement is terminable at will by either party after
October 1, 1997. The Company made payments totaling $310,000 as of December 31, 1996 pursuant to the Development Agreement.
Also in connection with the Canadian Acquisition, the Company entered into a management services and franchise development agreement (the "MSFDA") with Royco. Under the MSFDA, Royco is responsible for assisting the Company in developing new Travelodge and Thriftlodge lodging facilities in Canada under the Canadian Master License. As compensation for its services under the MSFDA, Royco receives 50% of the profits generated from these management and franchise development operations. The MSFDA also provides for the payment to Royco of additional fees under certain circumstances, including, upon the satisfaction of fixed performance goals and the termination of the agreement. The term of the MSFDA commenced on September 30, 1996 and expires on December 31, 2006. The Company has the option to renew the MSFDA for three additional terms of ten years each. Upon the expiration of the MSFDA, or in the event the agreement is terminated, Royco has the option to acquire the Company's interest under the Canadian Master License. Under its terms, the Canadian Master License is assignable by the Company to Royco. Under the termination or expiration of the MSFDA, Royco shall have the option to purchase the Canadian Master License from the Company.
CHARTWELL DE MEXICO
Through Chartwell de Mexico, the Company intends to develop up to 30 Travelodge and other facilities throughout Mexico. Chartwell de Mexico is to be funded with up to $20 million in capital contributions, of which half are to be contributed by the Company. On September 18, 1996, the joint venture entered into a 30-year exclusive master franchise agreement with HFS, pursuant to which the joint venture is entitled to franchise others to develop and operate, lodging facilities in Mexico under the Travelodge and Thriftlodge brand names. Chartwell de Mexico is obligated under the Mexican Master License to develop in various stages up to 1140 hotel suites or resort lodging guest rooms by December 31, 2006. Under certain circumstances, including where the Company does not satisfy its development obligations in accordance with a prescribed schedule, the Mexican Master License may be terminated by HFS.
HILTON ALLIANCE
On January 20, 1997, the Company formed an alliance with Hilton pursuant to which the Company will own, develop, manage and operate at least 20 Hilton Garden Inn hotels in target markets nationwide under a franchise license. The initial term of the agreement is three years and represents a total investment of nearly $200 million by the Company, of which approximately $40 million is required to be funded by the Company as equity. Hilton is in negotiations to arrange for construction financing and permanent mortgage financing for the Hilton Garden Inn development program through NationsBank and Nomura. There can be no assurance that such financing can be obtained. Of the total construction costs, NationsBank is expected to provide up to 80% of the financing with Hilton expected to guarantee up to 25% of the NationsBank loan. The Company is required to fund the remaining 20% of the capital as equity. The financing terms are expected to provide that upon obtaining a certificate of occupancy for each Hilton Garden Inn, the construction loan allocated for such hotel is expected to convert to a 15-year permanent mortgage through an arrangement with Nomura. The Company expects to begin construction shortly of its first two Hilton Garden Inns in Santa Fe and Albuquerque, New Mexico.
HFS TRANSACTIONS
On November 25, 1996, the Company and HFS agreed to terminate their advisory contract (the "Corporate Services Agreement") under which the Company was obligated to pay to HFS an annual fee of $1.5 million until 2019 in exchange for various advisory services by HFS. The termination of that agreement became effective on December 31, 1996. In connection with the termination, the Company agreed to pay to HFS a total of $9.5 million, consisting of a $2.5 million cash payment that was paid in December 1996 and a $7 million promissory note payable over seven years commencing on July 1, 1999. The promissory note will bear interest at 6% per year payable in semi-annual installments commencing on July 1, 1997. The Company recorded a $9.5 million expense in the fourth quarter of 1996 as a result of the termination of the Corporate Services Agreement.
On December 16, 1996, the Company received from HFS a development advance in the principal amount of $2.8 million to finance a portion of the costs incurred by the Company in connection with the acquisition or development of future hotel properties. The Company will have the right, but not the obligation, from time to time
as it acquires or develops new properties, to cause such properties to be operated under an HFS brand, pursuant to a franchise agreement entered into between the Company and HFS. The Company will receive a credit against repayment of the advance, and the outstanding balance of the advance shall be reduced, on a dollar for dollar basis for each dollar of qualifying franchise fees paid to HFS. The outstanding balance of the advance will become due and payable on December 31, 2000.
CAPITAL IMPROVEMENT PROGRAM
The Company has launched a major capital improvement program to increase room and occupancy rates by improving the quality of its properties. As part of this program, the Company expects to upgrade the interior and exterior of all U.S. and Canadian properties that do not meet corporate standards. During 1997, the Company intends to invest approximately $20 million in capital improvements, in addition to amounts budgeted for regular capital maintenance. Once this capital initiative is completed, the Company intends to maintain a regular program of capital improvements, including the renovation and refurbishment of certain of its existing hotels. The program is expected to enhance the competitiveness of its Travelodge hotels and increase profitability. The Company intends to finance this capital expenditure program with borrowings under the Credit Facility, proceeds from the Rights Offering, the Brahman Private Placement and the Baron Private Placement and excess cash on hand.
CONSOLIDATION OF OPERATIONS
The Company is in the process of evaluating its operations at its three locations, El Cajon, New York and Calgary, with the intention of consolidating operations and improving operating efficiencies. Management estimates exit and severance costs of $1.0 million will be incurred during the first quarter of 1997 in connection with this consolidation.
HOTEL BRAND REPOSITIONING
As part of the Company's repositioning of its existing hotels, it is reviewing the potential to increase revenues at selected hotels by rebranding them to more appropriate franchise affiliations. Pursuant to the terms of the franchise agreements with affiliates of HFS, the Company is obligated to pay franchise termination fees to affiliates of HFS where it terminates a hotel from the Travelodge system unless it enters into a franchise agreement with another HFS hotel franchise affiliate. Any such termination fees will be recorded as an operating expense during the period in which the hotel is terminated from the Travelodge system. As a result of the conversion of the Travelodge hotel in San Diego, California to a Hilton hotel, the Company is obligated to pay to HFS $750,000 in franchise termination fees over a five-year period. During the fourth quarter of 1996, the Company recorded the $750,000 operating expense associated with such termination.
GAMING BUSINESS
In connection with the joint venture to develop a gaming facility in Pittsburgh, the Company loaned the Urban Redevelopment Authority of Pittsburgh, Pennsylvania ("URA") approximately $9.5 million in September 1994. In September 1995, the URA exercised its option to extend the maturity of the loan by one year to September 30, 1996. The URA made a $3.8 million payment of principal and interest in January, 1996 and a $2.2 million payment of principal and interest in June, 1996. On September 30, 1996, the principal and accrued interest were paid in full.
In 1994, the Company loaned Rainbow Casino Corporation ("Rainbow") $10 million to finance the licensing, construction and start-up costs associated with the Rainbow Casino, a dockside casino located in Vicksburg, Mississippi, which commenced operations on July 12, 1994. In March 1995, the Company agreed to loan up to an additional $2.0 million to the partnership that owns the Rainbow Casino in Vicksburg, Mississippi. The Company advanced $1.2 million to Rainbow in 1995. The proceeds of such loan, together with additional capital to be contributed by the general partner of such partnership, are being used to finance certain improvements to the casino project, the completion of related facilities and to provide additional working capital. The loan is unsecured, bears interest at 10% per annum and will be repaid in equal monthly installments of principal and interest over its seven year term. In 1994, the Company entered into an agreement with Chartwell Leisure Associates L.P., an affiliate of CL Associates, to induce Chartwell Leisure Associates L.P. to build a family entertainment center, which opened in May 1995. In connection with the agreement, the Company agreed to pay Chartwell Leisure
Associates L.P., upon opening of the entertainment center, a percentage of principal and interest payments collected on the $10 million loan to Rainbow, ranging from 14% to 27% of such payouts adjusted annually in accordance with a schedule to the agreement. The Company commenced payments to Chartwell Leisure Associates L.P. in July 1995 and made approximately $0.2 million of payments in 1995 and $ 0.3 million in 1996. HFS also shares marketing fees from the Rainbow Casino with Chartwell Leisure Associates L.P. based on the same scheduled percentages. Chartwell Leisure Associates L.P. has agreed to share 50% of the net cash flow payable to Chartwell Leisure Associates L.P. with respect to the family entertainment center with HFS and HFS has agreed to share such amounts pro rata with the Company based on relative amounts paid by HFS and the Company, respectively, to Chartwell Leisure Associates L.P. each year.
CREDIT FACILITIES
Revolving Credit Facility
The Company is a party to a Credit Facility among the Company, Chartwell Canada Corp., which is a subsidiary of the Company ("Chartwell Canada"), The Bank of Nova Scotia, as Syndication Agent, The Chase Manhattan Bank, as Administrative Agent, and the Banks from time to time parties thereto (the "Credit Facility"). The Credit Facility provides that the Company may borrow up to $150 million under a revolving credit commitment (the "Commitment"), which may be utilized for the incurrence of revolving credit loans or the issuance of undrawn letters of credit. The Company is contemplating terminating the Credit Facility and replacing it with a new secured facility of approximately $60.0 million. See "--Notes Offering." An amount of up to C$95 million of the Commitment is available to be borrowed by Chartwell Canada or Bear Financial Corp. ("Bear"), which is also a subsidiary of the Company, as a subfacility under the Credit Facility (the "Canadian Subfacility"). As of December 31, 1996, $91.7 million was drawn on the Credit Facility, including $15 million representing issuance of undrawn letters of credit. The Company is jointly and severally liable for all borrowings by Chartwell Canada or Bear under the Canadian Subfacility. Pursuant to this agreement, HFS has guaranteed $75 million of the Company's borrowings under the Credit Facility, for which the Company pays HFS an annual fee of $1.5 million. As of December 31, 1996 approximately U.S.$11 million aggregate principal amount of revolving loans and C$90 million (approximately U.S. $66 million) aggregate principal amount of revolving loans were outstanding under the Credit Facility. In addition, as of December 31, 1996, the Company had issued $15 million of undrawn letters of credit under the Credit Facility. During March 1997, $11 million of loans were repaid. All outstanding obligations under the Credit Facility mature in August 2002.
Borrowings under the Credit Facility are available to the Company to finance the acquisition of hotel properties and to finance the Company's working capital and general corporate requirements. Borrowings under the Canadian Subfacility were used to finance the acquisition of hotels from CPLP and to pay the fees and expenses related to the Canadian Acquisition.
Revolving loans denominated in US dollars under the Credit Facility are available as base rate loans or Eurodollar loans. Revolving loans denominated in Canadian dollars under the Credit Facility are available as Eurodollar loans. Interest on the outstanding principal amount of each base rate loan is payable at an annual rate equal to the highest of (A) .5% in excess of the Federal Reserve reported certificate of deposit rate, (B) .5% in excess of the federal funds rate or (C) the prime lending rate of The Chase Manhattan Bank. Interest on the outstanding principal amount of each Eurodollar loan is payable at an annual rate equal to the sum of the applicable margin (which is within a range of .40% to .875% based on the principal amount of revolving loans and letters of credit outstanding) plus the Eurodollar rate. All borrowings as of December 31, 1996 were Eurodollar loans. The Company is obligated to pay a commitment fee on the unutilized portion of the facility at an annual rate of .2% to .375% depending on the principal amount of revolving loans and letters of credit outstanding. The Company is also obligated to pay a fee in respect of each outstanding letter of credit equal to the applicable margin on the stated amount of the letter of credit, plus an additional fee equal to the higher of (A) $500 and (B) a rate per annum agreed to in writing by the Company and the issuing bank of the letter of credit.
The aggregate revolving credit commitment will reduce by $7.5 million in 1998, $17.5 million in 1999, $20 million in 2000 and 2001, and $85 million in 2002. To the extent outstanding borrowings exceed the resulting commitment amount, principal will be required to be repaid. The revolving credit commitment amount also will be reduced and, to the extent outstanding borrowings exceed the resulting commitment amount, principal will be repaid upon the occurrence of certain events.
The Credit Facility contains covenants restricting, with certain exceptions, the Company and its subsidiaries and joint ventures from: (i) creating, incurring or assuming any liens; (ii) merging or consolidating or disposing of its assets, or acquiring assets from any other person; (iii) changing the nature of their respective businesses; (iv) incurring indebtedness other than existing indebtedness, subordinated indebtedness not to exceed $50 million to finance permitted acquisitions and other permitted indebtedness specified in the Credit Facility; (v) modifying the agreements relating to the Company's indebtedness and preferred stock or its corporate charter documents. The facility prohibits the payment of dividends.
In addition, the Credit Facility requires that the Company, in certain cases on a stand alone basis and in other cases on a consolidated basis with its subsidiaries and joint ventures, satisfy certain financial ratio coverage tests, including maintenance of net worth, minimum interest coverage, and maximum leverage coverages. The Credit Facility contains a restrictive covenant based on the ratio of pro-forma earnings to debt as defined in the credit facility document.
Bank of America Loan Agreement
The Company has a loan agreement with Bank of America National Trust and Savings Association ("B of A"). That loan agreement (the "B of A Loan Agreement") permits the Company and certain of the joint ventures through which it owns hotels to make revolving credit borrowings in an aggregate amount of up to $10 million and provides for an uncommitted credit facility, which is available at the sole discretion of B of A, in an aggregate amount of up to $5 million. The B of A Loan Agreement is scheduled to expire on March 31, 1997, at which time the Company's outstanding obligations under the agreement will become due. The Company is in negotiations to extend the B of A Loan Agreement until April 30, 1997. Although the Company expects to be able to extend the B of A Agreement, there can be no assurance that it will be successful in doing so. Revolving credit borrowings under the B of A Loan Agreement may be made, at the option of the Company, as short term borrowings, which have a maximum maturity of six months, or medium term borrowings, which have a maximum maturity of five years. Short term borrowings bear interest, at the option of the Company, at the B of A prime rate, 1/2 of 1% in excess of the B of A offshore rate or 3/4 of 1% in excess of the B of A CD rate. Medium term borrowings bear interest at the B of A prime rate. The borrowings under the B of A Loan Agreement are secured by a $15 million standby letter of credit issued under the Credit Facility. The Company is obligated to pay a commitment fee at an annual rate of .1875% on the unutilized portion of the B of A Loan Agreement. Borrowings under the B of A Loan Agreement were approximately $7.1 million at December 31, 1996, of which approximately $3.6 million is allocable to the Company.
New Credit Facility
In connection with the Notes Offering, it is expected that the Credit Facility will be terminated and replaced with a new secured facility (the "New Credit Facility") with The Chase Manhattan Bank and The Bank of Nova Scotia of approximately $60.0 million. At the same time, it is expected that the HFS guarantee and the related $1.5 million annual fee will be eliminated. Some of the expected terms of the New Credit Facility are described below. However, the terms of the New Credit Facility are currently being negotiated and there is no assurance that the Company will enter into the New Credit Facility or that a definitive agreement, if entered into, will contain the terms described below.
The New Credit Facility is expected to provide the Company with an aggregate revolving credit commitment of up to $60 million, which the Company will be entitled to utilize for the incurrence of revolving credit loans or the issuance of letters of credit.
Proceeds of borrowings under the New Credit Facility are expected to be available to the Company (i) to refinance the Company's indebtedness under the Credit Facility, (ii) to finance the acquisition of hotel properties and (iii) to finance the Company's working capital and general corporate requirements.
The New Credit Facility is expected to contain covenants restricting the Company and its subsidiaries and joint ventures from, among other things: (i) creating, incurring or assuming liens; (ii) merging or consolidating or disposing of assets, or acquiring assets from other persons; (iii) changing the nature of their respective businesses; (iv) incurring indebtedness; (v) paying dividends or making restricted payments; and (vi) modifying the
agreements relating to the Company's indebtedness and preferred stock or its corporate charter documents. The New Credit Facility is expected to prohibit the Company from paying dividends on its Common Stock.
In addition, the New Credit Facility is expected to require that the Company satisfy, in certain cases on a stand alone basis and in other cases on a consolidated basis with its subsidiaries and joint ventures, certain financial ratio coverage tests, including maintenance of net worth, minimum interest coverage, and minimum fixed charge and maximum leverage coverages.
EQUITY OFFERINGS
On August 8, 1996, the Company sold 4 million shares of the Company's Common Stock to CL Associates and FSNL for $57.0 million. In connection with the CL Associates/FSNL Investment, the Company incurred professional fees of approximately $2.2 million which were charged directly against paid-in capital.
During the first quarter of 1997, the Company raised approximately $54.0 million of equity through the Rights Offering, the Brahman Private Placement and the Baron Private Placement.
Pursuant to the Rights Offering, which closed on March 13, 1997, after deducting expenses of approximately $1.2 million, the Company raised approximately $30.0 million through the sale of 2,228,977 shares of Common Stock to the Company's February 13, 1997 record holders and to the Participating Option Holders. CL Associates and FSNL, the Company's two principal stockholders, invested approximately $15.8 million in the Company through the exercise of Rights they received. After giving effect to the Rights Offering, CL Associates and FSNL together own approximately 45.1% of the Company's outstanding shares of Common Stock.
Pursuant to the Brahman Private Placement and the Baron Private Placement, which closed on January 31, 1997 and March 6, 1997, respectively, the Company raised an aggregate of approximately $23.0 million through the sale of an aggregate of 1,658,929 shares of Common Stock at $14.00 per share. Brahman, which manages investment funds including one affiliated with George Soros, purchased 1,000,000 shares of Common Stock. Baron, which is one of a family of funds managed by Ronald Baron, purchased 658,929 shares of Common Stock. As a result of their two purchases and after giving effect to the Rights Offering, Brahman and Baron own approximately 9.7% and 4.9%, respectively, of the Company's outstanding shares of Common Stock.
The Company intends to use the proceeds of the Rights Offering, the Brahman Private Placement and the Baron Private Placement to fund the construction of Hilton Garden Inns under the Company's recently announced alliance with Hilton, to fund the Company's Mexican joint venture, to redevelop the Company's existing hotels and for general corporate purposes. In addition, as the Company from time to time evaluates potential acquisition opportunities, the Company may also use a portion of the net proceeds to acquire additional hotels.
NOTES OFFERING
The Company is in the process of pursuing a $100 million offering of senior notes due 2007. In connection with the Notes Offering, it is expected that the Credit Facility will be terminated and replaced with the New Credit Facility and that HFS' $75 million guarantee of the Credit Facility and the related $1.5 million annual fee will be eliminated. There can be no assurance that the Company will be able to successfully complete the Notes Offering or enter into the New Credit Facility and consummate the related refinancing of the Credit Facility. The Company intends to use the net proceeds from the Notes Offering to repay existing indebtedness under the Credit Facility and for working capital and general corporate purposes, including to fund current and future development projects. An extraordinary charge of $1.6 million will be incurred as a result of the early extinguishment of debt and the writeoff of the deferred financing costs associated with the Credit Facility if the offering of the Notes is completed.
The Notes will be unsecured, senior obligations of the Company ranking pari passu in right of payment with all other existing and future unsecured, senior indebtedness of the Company and senior in right of payment to all other existing and future subordinated indebtedness of the Company. The Notes will bear interest at a fixed rate and no amortization or sinking fund payments will be required with respect to the Notes. The Company has entered into treasury rate locks of approximately 6.630% totaling $80.0 million to partially hedge the interest rate of the proposed bond offering. The settlement date of the hedges is May 15, 1997. In connection with the Notes Offering, it is expected that the Company's existing $150.0 million credit facility will be terminated and replaced with a new secured facility of approximately $60.0 million and the HFS guarantee and related $1.5 million annual fee will be eliminated. See "--New Credit Facility."
CASH FLOWS
Cash provided by (used in) operating activities was $3.4 million for the twelve months ended December 31, 1996 compared to $(6.5) million for the twelve months ended December 31, 1995. The change relates primarily to the change in focus to the lodging industry which produced operating cash flow.
Cash (used in) provided by investing activities was $(167.4) million for the twelve months ended December 31, 1996 compared to $5.5 million for the twelve months ended December 31, 1995. This change related primarily to the Acquisitions as well as additions to plant and equipment and related costs offset by the receipt of principal payments on loans.
Cash provided by financing activities was $130.1 million for the twelve months ended December 31, 1996 compared to $8.3 million for the twelve months ended December 31, 1995. This change resulted from net borrowing proceeds and proceeds from the sale of stock to CL Associates and FSNL.
WORKING CAPITAL
The Company had $7.5 million of available working capital including $17.6 million of cash at December 31, 1996. The Company believes that its cash and existing financing arrangements will be adequate to fund cash needs during 1997, whether or not the Notes Offering and the contemplated replacement of the Credit Facility with a new secured facility are successful.
IMPACT OF INFLATION
The primary source of revenue of the Company is the lodging facilities' gross room revenue. As a result, the Company's revenue (excluding those changes attributable to new property acquisition or disposals) is expected to change consistent with the trend of the consumer price index. The Company does not believe that inflation would have an unfavorable impact on its operations.
SEASONALITY
Room occupancy rates at its hotels are affected by normally recurring seasonal patterns and, in most locations in the United States and Canada, are higher in the late spring through early fall months than during the balance of the year, with the lowest occupancy rates occurring in the first quarter of the year. As a result, as a company which will be primarily engaged in the lodging business in the future, the Company expects to experience seasonal lodging revenue patterns similar to the hotel industry with the summer months, due to the increase in leisure travel, producing a higher revenue than other periods during the year.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, FASB Statement No. 128, "Earnings Per Share" was released. The statement establishes standards for computing and presenting earnings per share ("EPS") for publicly traded companies. The statement simplifies the standards for computing earnings per share and makes them comparable to international EPS standards. The statement is effective for financial statements issued for periods ending after December 15, 1997. The Company does not believe that the requirements of the statement will have a significant impact on the presentation of EPS in the financial statements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See page of this Report, which includes an index to the Company's consolidated financial statements. Financial statement schedules and supplementary data are omitted for the reason that they are not applicable or the required information is included in the consolidated financial statements or notes thereto.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information concerning the directors and executive officers of the Company is set forth in the Proxy Statement (the "Proxy Statement") to be sent to stockholders in connection with the Company's 1997 Annual Meeting of Stockholders, under the heading "Election of Directors--Proposal 3," which information is incorporated herein by reference. With the exception of the information specifically incorporated herein by reference, the Company's Proxy Statement is not to be deemed filed as part of this report for the purposes of this Item.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning executive compensation is set forth in the Proxy Statement under the heading "Executive Compensation," which information is incorporated herein by reference. With the exception of the information specifically incorporated herein by reference, the Company's Proxy Statement is not to be deemed filed as part of this report for the purposes of this Item.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information concerning security ownership of certain beneficial owners and management is set forth in the Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management," which information is incorporated herein by reference. With the exception of the information specifically incorporated herein by reference, the Company's Proxy Statement is not to be deemed filed as part of this report for the purposes of this Item.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information concerning certain relationships and related transactions is set forth in the Proxy Statement under the heading "Certain Transactions," which information is incorporated herein by reference. With the exception of the information specifically incorporated herein by reference, the Company's Proxy Statement is not to be deemed filed as part of this report for the purposes of this Item.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements: -------------------- See Index to Financial Statements on page hereof.
2. Financial Statement Schedule: ---------------------------- Financial statement schedules and supplementary data are omitted for the reason that they are not applicable or the required information is included in the consolidated financial statements or notes thereto.
3. Exhibits: -------- See Exhibit Index commencing on page E-1 hereof.
(b) Reports on Form 8-K
1. Current Report on Form 8-K, dated October 1, 1996, filed with the Commission on October 15, 1996, Items 2 and 7, relating to the completion of the Canadian Acquisition, the financial statements for which were filed by amendment.
2. Current Report on Form 8-K/A, dated October 1, 1996, filed with the Commission on December 12, 1996, Items 2 and 7, relating to the completion of the Canadian Acquisition, including audited financial statements of Canadian Properties Limited Partnership for the periods indicated therein and the unaudited pro forma financial statements of the Company for the periods indicated therein, and Item 5, relating to the termination of the Corporate Services Agreement.
(c) See response to Item 14(a)(3) above.
(d) None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
CHARTWELL LEISURE INC.
By: /s/ Richard L. Fisher --------------------- Richard L. Fisher Chairman of the Board and Chief Executive Officer
Date: March 27, 1997
Each of the officers and directors of Chartwell Leisure Inc. whose signature appears below, in so signing, also makes, constitutes and appoints Richard L. Fisher and Martin L. Edelman, and each of them acting alone, his true and lawful attorney-in-fact, with full power and substitution, for him in any and all capacities, to execute and cause to be filed with the Securities and Exchange Commission any and all amendment or amendments to this Report on Form 10-K, with exhibits thereto and other documents connected therewith and to perform any acts necessary to be done in order to file such documents, and hereby ratifies and confirms all that said attorney-in-fact or his substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report on Form 10-K has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ----
/s/ Richard L. Fisher - ------------------------ Chairman of the Board, March 27, 1997 Richard L. Fisher Chief Executive Officer
/s/ Martin L. Edelman Director and President March 27, 1997 - ------------------------ Martin L. Edelman
/s/ Kenneth J. Weber Chief Financial Officer March 27, 1997 - ------------------------ (principal financial and Kenneth J. Weber accounting officer)
/s/ Henry R. Silverman - ------------------------ Director March 27, 1997 Henry R. Silverman
/s/ Stephen P. Holmes - ------------------------ Director March 27, 1997 Stephen P. Holmes
/s/ Rachel Robinson - ------------------------ Director March 27, 1997 Rachel Robinson
/s/ Marc E. Leland - ------------------------ Director March 27, 1997 Marc E. Leland
/s/ Michael J. Kennedy - ------------------------ Director March 27, 1997 Michael J. Kennedy
/s/ Dr. Guido Goldman - ------------------------ Director March 27, 1997 Dr. Guido Goldman
/s/ Arnold Fisher Director March 27, 1997 - ------------------------ Arnold Fisher
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Chartwell Leisure Inc.
We have audited the accompanying consolidated balance sheets of Chartwell Leisure Inc. (formerly known as National Lodging Corp.) and its subsidiaries (the "Company") as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Deloitte & Touche LLP Parsippany, New Jersey February 12, 1997, except for Note 20, as to which the date is March 21, 1997
CHARTWELL LEISURE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995 (In Thousands, Except Share Amounts) - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
CHARTWELL LEISURE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1996, 1995 AND (Amounts in Thousands, Except Per Share Amounts) - ------------------------------------------------------------------------------
See notes to consolidated financial statements.
CHARTWELL LEISURE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (Amounts in Thousands, Except for Common Stock Shares) - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
CHARTWELL LEISURE INC. AND SUBSIDIARIES
See Note 10 for interest paid
See notes to consolidated financial statements.
CHARTWELL LEISURE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 - --------------------------------------------------------------------------------
1. BUSINESS
Chartwell Leisure, Inc. (formerly known as National Lodging Corp.) and subsidiaries (the "Company") became an independent publicly traded company following the distribution of all outstanding capital stock of the Company by HFS Incorporated ("HFS") to HFS stockholders on November 22, 1994. At the distribution date, the Company was engaged in the business of developing and owning casino gaming facilities.
Due to a confluence of negative factors impacting the Company's gaming investments and the gaming industry, on November 9, 1995, the Company announced a decision by its Board of Directors to curtail future gaming investments and focus on investments and acquisitions in nongaming industries. On January 23, 1996, the Company acquired the outstanding common stock of Forte Hotels, Inc. ("FHI") for approximately $98.8 million subject to certain working capital adjustments and commenced engaging in the business of hotel ownership, management, and development (Note 4).
2. DISTRIBUTION
On November 22, 1994 (the "Distribution Date"), HFS distributed to its stockholders one share of the Company common stock for every 10 shares of HFS owned as of the November 14, 1994 record date. Subsequent to the Distribution Date, HFS no longer has an equity interest in the Company.
The net assets of the Company at the time of the distribution were as follows (amount in thousands):
At the Distribution Date, the Company and HFS entered into agreements for marketing, financing, advisory and corporate services, and a facility lease. The Company and HFS modified or terminated certain of these arrangements upon the acquisition of FHI. The marketing services agreement was canceled on January 24, 1996. Pursuant to the current financing agreement, HFS committed to provide up to $75 million in guarantees for a fee equal to 2% of its annual commitment. Included in interest expense is $1.5 million, $1.5 million, and $162,500 for the years ended December 31, 1996, 1995 and 1994, respectively, related to the financing agreement. HFS provided investment and advisory services to the Company under a 25-year arrangement for a fee equal to 2% of the total development or acquisition costs associated with completed transactions. The Company incurred costs of approximately $90,000 in 1994 under this agreement. The Company is no longer obligated to pay fees to HFS under the advisory agreement. Pursuant to a Corporate Services Agreement, HFS has provided to the Company advisory services in connection with business acquisitions, financings, and other transactions
by the Company. Under the Corporate Services Agreement, the Company has paid HFS a fixed annual fee of $1.5 million payable quarterly in advance. In November 1996, the Company and HFS agreed to terminate the Corporate Services Agreement in exchange for payment by the Company of $2.5 million and issuance of a $7 million promissory note payable over seven years commencing on January 1, 1999, and with interest payable at 6% per year in semiannual installments commencing on July 1, 1997.
The Company's cash requirements prior to the Distribution Date were supported by HFS. Significant requirements include the payment of salaries, related benefits, and development expenditures. Prior to the Distribution Date, General and Administrative - Related Party expenses include the allocation of certain HFS costs associated with corporate administration and other overhead costs based upon actual expenses incurred and an estimate of time spent by HFS employees for the benefit of the Company. Management believes that the costs allocated to the Company are reasonable. Expenditures made by HFS on behalf of the Company represented permanent capital and, accordingly, are included in Paid-in Capital through the Distribution Date. The Company is a party to a development advance agreement, dated as of October 1996, pursuant to which HFS made a $2.8 million development advance to the Company in December 1996. The development advance must be repaid by the company, without interest, on December 31, 2000, but the amount required to be repaid will be reduced to the extent that hotels acquired or constructed by the Company become HFS franchised hotels under franchise agreements of 10 years or longer using any HFS brand other than Wingate Inn. The development advance will be reduced on a dollar-for-dollar basis through December 31, 2000 for each dollar in initial and recurring royalty fees payable to HFS under those new franchise agreements.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Principles of Consolidation - The consolidated financial statements include the accounts and transactions of the Company, together with its wholly-owned subsidiaries and majority owned joint ventures. All material intercompany balances and transactions have been eliminated in consolidation.
b. Accounting for Investments in Joint Ventures - The Company accounts for its investments in joint ventures in which it does not have a controlling financial interest but exerts significant influence using the equity method of accounting.
c. Property and Equipment - Property and equipment includes a hotel under a capital lease which is stated at cost. The Company recorded the capital lease as an asset at an amount equal to the present value at the beginning of the lease term of minimum lease payments during the lease term, excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, together with any profit thereon. Expenditures for replacements and major improvements are capitalized and depreciated. Depreciation is recognized using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of their estimated useful lives (10 to 15 years) or the lease term. The hotel under the capital lease is amortized using the straight-line method over the term of the lease.
The Company periodically assesses the recoverability of the carrying value of property and equipment based on estimated undiscounted cash flows on an individual property basis. If the estimated undiscounted cash flows are less than the carrying value, an impairment loss is charged to operations based on the difference between the carrying value and the estimated discounted cash flows.
The Company considers interest expense on funds borrowed for the development and construction of new hotels to be a cost of the property and capitalizes such costs until the construction is completed. The amount capitalized is amortized over the life of the property once it becomes operational. The Company capitalized $89,388 and $0 of interest during the years ended December 31, 1996 and 1995, respectively.
d. Management Contracts - The management contracts are stated at cost and are being amortized over the 20-year term of the contracts. The Company periodically assesses the recoverability of the carrying value of its management contracts based on the estimated undiscounted cash flows to be generated from the contracts. If the estimated undiscounted cash flows are less than the carrying value, an impairment loss would be charged to operations based on the difference between the carrying value and the estimated discounted cash flows.
e. Investments - Investments in marketable equity securities are considered available for sale and are reported at fair value. Unrealized gains and losses are excluded from operations and reported in a separate component of stockholders' equity. Management periodically evaluates each investment to determine whether a decline in fair value below the amortized cost is other than temporary.
Investments which are nonmarketable equity securities are recorded at the lower of cost or net realizable value.
f. Loan Origination Costs - Included in other assets and loans receivables are costs directly associated with the issuance of loans to a casino gaming entity and the line of credit. These costs are amortized over the life of the related loans and credit line using the effective interest method.
g. Allowance for Loan Losses - The Company evaluates the collectability of loans receivable on a quarterly basis. The major factors considered in evaluating potential losses are the current financial position of the borrower, general economic considerations and the net realizable value of any collateral received.
h. Income Taxes - In accordance with SFAS No. 109, the Company uses the asset and liability method of accounting for income taxes. Differences between financial and tax reporting arise from differences in the recognition of income and expenses for financial and income tax purposes.
i. Cash and Cash Equivalents - The Company considers highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
j. Loss Per Share - Loss per share is computed based upon the weighted average number of shares outstanding. Common stock equivalents are not included as they would be antidilutive.
k. Significant Estimates, Risks and Uncertainties - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
l. Advertising Expense - The Company expenses advertising costs as incurred. The Company expensed $3.2 million in 1996, $0 in 1995, and $0 in 1994.
m. Presentation - Certain items have been reclassified from the prior year to conform with the current year's presentation.
4. ACQUISITIONS AND SALE OF STOCK
Travelodge Acquisition - On January 23, 1996, the Company acquired the outstanding common stock of Forte Hotels, Inc. ("FHI") for $98.8 million plus expenses. In related transactions on January 23, 1996, prior to consummation of the FHI acquisition, HFS Incorporated ("HFS") and Motels of America, Inc. acquired from FHI the Travelodge franchise system and 19 motel properties, respectively, for an aggregate purchase price of $71.6 million. The principal assets of FHI acquired by the Company include 18 wholly-owned hotels (one of which was subsequently disposed of), and joint venture interests in 97 other lodging facilities. The Company financed approximately $60 million of the purchase price with proceeds from a bank revolving credit facility and $38.4 million with existing cash. HFS provided advisory services in connection with the acquisition for which the Company paid a $2.0 million fee.
The FHI acquisition described above was accounted for by the purchase method. The operating results of the acquired company are included in the consolidated statements of operations from its acquisition date, January 23, 1996. The assets acquired and liabilities assumed are as follows (in thousands).
Canadian Acquisition - On October 1, 1996, the Company acquired from Capital Properties Limited Partnership ("CPLP") 20 hotels and a one-half interest in an additional hotel, consisting of approximately 3,500 guest rooms, which hotels are located throughout Canada and franchised under the "Travelodge" brand name (the "Canadian Acquisition"). The Company paid approximately $70 million to purchase substantially all of CPLP's existing bank debt and to pay certain specified closing costs (including real estate taxes and transfer taxes), as well as its assumption of liability for identified trade payables and property specific bank debt, aggregating approximately $7 million. Also the Company may be required to make certain contingent payments to CPLP's constituent partners following a preferred return to the Company. In connection with the acquisition of CPLP on October 1, 1996, the Company borrowed $65.9 million under its credit facility. The Canadian Acquisition was accounted for by the purchase method. The operating results of the acquired company are included in
the consolidated statements of operations from its acquisition date, October 1, 1996. The assets acquired and liabilities assumed are as follows (in thousands).
Sale of Stock - On February 14, 1996, the Company entered into an agreement with Chartwell Leisure Associates L.P. II ("CL Associates") and FSNL LLC ("FSNL") to sell 4 million newly issued shares of the Company's unregistered common stock to CL Associates and FSNL for $57 million. This transaction was completed on August 8, 1996. As of December 31, 1996, CL Associates and FSNL own approximately 52% of the outstanding common stock of the Company. HFS provided advisory services in connection with the transaction for which the Company paid a fee of $1.14 million.
The following presents the unaudited pro forma consolidated results of operations for the years ended December 31, 1996 and 1995 as if all of the transactions described above occurred on January 1, 1995, giving effect to the sale of stock and financing costs associated with the Travelodge Acquisition and Canadian Acquisition.
The pro forma results are not necessarily indicative of the actual results of operations that would have occurred had the transactions been consummated as indicated nor are they intended to indicate results that may occur in the future.
5. LOANS RECEIVABLE
Loans receivable consist of the following at December 31, 1996 and 1995 (amount in thousands):
a. Consists of a loan to Rainbow Casino Corporation ("Rainbow") to finance the licensing, construction and start-up costs for a dockside casino located in Vicksburg, Mississippi which commenced operations in July 1994. Under the terms of the promissory note, Rainbow pays $153,383 in monthly installments of principal and interest at 7-1/2% through maturity in August 2001, before the allocation of loan payments to CL Associates, an affiliate of the Company, in connection with the Company's interest in a family entertainment center located on the Rainbow site. The loan is secured by a first mortgage on existing real and tangible personal property excluding certain equipment.
At the inception of the loan, the Company recorded the loan receivable based upon an imputed interest rate of 10% which was determined to be a fair market rate based upon comparable loans with similar risk. Accordingly, a loan receivable discount approximating $0.8 million was recorded and a corresponding amount was assigned to HFS Incorporated's ("HFS") marketing agreements. The loan receivable discount is being amortized in accordance with the interest method over the life of the loan. Accumulated amortization of the loan receivable discount at December 31, 1996 was $373,692.
During 1995, the Company agreed to loan up to an additional $2.0 million to the partnership that owns the Rainbow casino; of this amount, $1.2 million was advanced in 1995. The proceeds of such loan, together with additional capital to be contributed by the general partner of such partnership, will be used to finance certain improvements to the casino project, the completion of related facilities, and to provide additional working capital. The loan is unsecured and bears interest at 10% per annum and is to be repaid in equal monthly installments of principal and interest over a seven-year term.
b. Consisted of a mortgage loan receivable from the Urban Redevelopment Authority of the City of Pittsburgh ("URA") in connection with the URA's purchase of a 100-acre tract on the Monogahela River in Pittsburgh, Pennsylvania. As of September 30, 1996, the loan and all accrued interest had been paid in full.
c. Notes receivable bear interest at rates ranging from 3% to 12% with various maturities to 2014. Certain of these notes aggregating $4.1 million were collateralized by real property at December 31, 1996.
d. Represents a loan made to an Officer of the Company. The loan was made in August 1996 in the principal amount of $753,750 and is secured by a first mortgage lien on the Officer's principal residence. The terms stipulate that the principal is due and payable in full two years from the commencement date with interest due and payable in monthly installments commencing on September 1, 1996. The rate at which interest accrues shall be the same as that on the Credit Facility (Note 8). A principal payment in the amount of $153,750 was made in September 1996.
6. INVESTMENTS
Investments consist of the following (amount in thousands):
a. The Boomtown, Mississippi investment approximates $4.8 million prior to the write-down. The Company is leasing a casino and barge in Biloxi, Mississippi to an unrelated third party under a 25- year lease. Rental income is equal to 16% of the facility's EBITDA net of marketing fees payable to HFS, Inc. Historically, the Company has not received cash flow after the marketing fees. The Company does not anticipate receiving cash flow during the remaining term of the lease and believes that the value after 25 years may be negligible. As a result the Company has written off its investment as of June 30, 1996.
b. The Company acquired a 19.9% limited partnership interest in Prescott Convention Center Limited Partnership on November 30, 1994 for $4.5 million plus expenses. Prescott owns and operates a hotel and convention center in Prescott, Arizona which includes an operating casino facility. Historically, the Company has not received net distributions after marketing fees payable to HFS and based on discussions with the general partner does not anticipate receiving net distributions in the future. As a result, the Company has written off its investment of $4.8 million as of December 31, 1996.
c. The Company acquired 200,000 shares of the common stock of Century Casinos, Inc. ("Century") in 1994 for $1.3 million. During 1995, the State of Indiana determined not to award a gaming license to Century for its proposed casino gaming operation in Switzerland County, Indiana. Based on this decision, the Company determined that its investment in Century common stock was permanently impaired and recorded a $1.0 million loss which is included in development expenses. Based on the current trading price of Century common stock and Century's historical results of operations, the Company believes the options will not become exercisable and, therefore, have no value. The 200,000 shares of Century stock were sold during 1996.
d. Includes nonvoting preferred stock convertible into common stock epresenting a 20% interest in Odyssey Gaming Corporation ("Odyssey ") acquired for approximately $3.8 million plus
approximately $1.5 million contingent upon the occurrence of certain events which have not occurred and are, in the opinion of management, unlikely to occur. The Company has also committed, under certain circumstances which are, in the opinion of management, unlikely to occur (including the execution of agreements between Odyssey and certain Native American tribes for the development and management of Class II (bingo, pulltabs and nonbanking card games) or Class III (casino style gaming facilities), to make secured project financing loans of up to an aggregate of $10 million to be used in connection with the development of Native American casino gaming facilities to be managed by Odyssey. As of June 30, 1996, Odyssey had no assets and was automatically dissolved by the Delaware Secretary of State for failure to pay its taxes and file annual reports. It is highly unlikely this casino will open due to the difficulties incurred to date in obtaining a gaming license. The Company has written off this asset through the provision for losses on gaming assets.
e. Consists of the Company's allocation of Rainbow loan payments (see Note 5(a)) to CL Associates as an inducement to CL Associates to own and finance a family entertainment center ( "Funtricity ") located on the Rainbow site. The Company agreed to pay a percentage of principal and interest payments on the $10 million loan with Rainbow to CL Associates ranging from 14% to 27% adjusted annually in accordance with a schedule to the agreement. Additionally, HFS agreed to share marketing fees from Rainbow with CL Associates based on the same scheduled percentages. CL Associates agreed to share with HFS 50% of the net cash flow payable to CL Associates in respect to the family entertainment center and HFS agreed to share such amounts pro rata with the Company based on relative amounts paid by HFS and the Company, respectively, to CL Associates each year. The entertainment center commenced operations on May 1, 1995. The Company paid approximately $290,000 and $215,000 in 1996 and 1995, respectively, in connection with the agreement. Based on analysis of expected future cash flows and the estimated net realizable value upon disposition, the Company reduced its investment to the estimated fair value at December 31, 1996.
f. The Company holds warrants to acquire 600,000 shares of Alpha Hospitality Corp. ("Alpha") common stock at $14 per share which expire in October 1998. The fair value of the underlying common stock approximated $1.43 per share at December 31, 1996 and $4 per share at December 31, 1995. The warrants were recorded at cost on date of receipt of approximately $1.5 million. These options were written down by $830,000 to fair value utilizing the Black-Scholes option valuation model at December 31, 1995 and subsequently written down to zero as a result of a comparison to the fair market value of similar marketable securities issued by Alpha at December 31, 1996.
7. JOINT VENTURE INTERESTS
The Company is a partner in joint ventures that own and operate hotels. The Company has a fifty percent interest in many of its joint ventures.
Assets, liabilities and the results of operations of joint ventures accounted for under the equity method are reflected in the following balance sheet data and statements of operation data (amount in thousands):
8. PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (amount in thousands):
9. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities are summarized as follows (amount in thousands):
10. LONG-TERM DEBT
Long-term debt is summarized as follows (amount in thousands):
Future principal payments required on the Company's debt are as follows (amount in thousands):
Credit Facility - The Company is a party to a credit facility among the Company, Chartwell Canada Corp., which is a subsidiary of the Company ("Chartwell Canada"), The Chase Manhattan Bank as Administrative Agent, The Bank of Nova Scotia, as Syndication Agent, and the Banks from time to time parties thereto (the "Credit Facility"). The Credit Facility provides that the Company may borrow up to $150 U.S. million under a revolving credit commitment (the "Commitment"), which may be utilized for the incurrence of revolving credit loans or the issuance of letters of credit. An amount of up to C$95 million of the Commitment is available to be borrowed by Chartwell Canada and Bear Financial Corp. ("Bear"), which are subsidiaries of the Company, as a Subfacility under the Credit Facility (the "Canadian Subfacility"). The Company is jointly and severally liable for all borrowings by Chartwell Canada and Bear under the Canadian Subfacility. HFS has guaranteed $75 million of the Company's
obligations under the Credit Facility. On October 1, 1996, in connection with the CPLP acquisition, the Company borrowed C$90 million ($65.9 U.S. million) under the Credit Facility. Total borrowings and letters of credit outstanding as of December 31, 1996 under the Credit Facility were $76.7 U.S. million and $15.0 U.S. million, respectively. All outstanding obligations under the Credit Facility mature in August 2002, except for mandatory Credit Facility reduction payments, noted below. The Company used the Credit Facility to refinance its prior credit facility. An extraordinary charge of $1.5 million was incurred as a result of the early extinguishment of debt and the write-off of the deferred financing costs associated with the prior credit facility.
Borrowings under the Credit Facility are available to the Company to finance the acquisition of hotel properties and to finance the Company's working capital and general corporate requirements. Borrowings under the Canadian Subfacility were used to finance the acquisition of hotels from CPLP and to pay the fees and expenses related to the Canadian Acquisition.
Revolving loans denominated in U.S. dollars under the Credit Facility are available as base rate loans or Eurodollar loans. Revolving loans denominated in Canadian dollars under the Credit Facility are available as Eurodollar loans. Interest on the outstanding principal amount of each base rate loan is payable at an annual rate equal to the highest of (a) .5% in excess of the Federal Reserve reported certificate of deposit rate, (b) .5% in excess of the Federal funds rate or (c) the prime lending rate of The Chase Manhattan Bank. Interest on the outstanding principal amount of each Eurodollar loan is payable at an annual rate equal to the sum of the applicable margin (which is within a range of .40% to .875% based on the principal amount of revolving loans and letters of credit outstanding) plus the Eurodollar rate. All loans outstanding at December 31, 1996 were Eurodollar loans. The Company is obligated to pay a commitment fee on the unutilized portion of the facility at an annual rate of .2% to .375% depending on the principal amount of revolving loans and letters of credit outstanding. The Company is also obligated to pay a fee in respect of each outstanding letter of credit equal to the applicable margin of the stated amount of the letter of credit, plus an additional fee equal to the higher of (a) $500 and (b) a rate per annum agreed to in writing by the Company and the issuing bank of the letter of credit.
The aggregate revolving credit commitment will reduce by $7.5 million in 1998, $17.5 million in 1999, $20 million in 2000, $20 million in 2001, and $85 million in 2002. To the extent outstanding borrowings exceed the resulting commitment amount, principal will be required to be repaid. The revolving credit commitment amount also will be reduced, and to the extent outstanding borrowings exceed the resulting commitment amount, principal will be repaid upon the occurrence of certain events specified in the Credit Facility. In addition, the Credit Facility is subject to termination upon a change of control as defined in the Credit Facility or if CL Associates or FSNL dispose any of their shares of common stock.
The Company's ability to borrow under the Credit Facility is subject to customary conditions and covenants, including that there not exist a material adverse change in the Company's operating performance. The Credit Facility also requires that the Company, in certain cases on a stand-alone basis and in other cases on a consolidated basis with its subsidiaries and joint ventures, satisfy certain financial ratio coverage tests, including maintenance of net worth, minimum interest coverage, and maximum leverage coverages.
The Credit Facility contains a restrictive covenant based upon the ratio of pro-forma earnings to debt as defined in the Credit Facility document. Additionally, the Credit Facility contains covenants restricting, with certain exceptions, the Company and its subsidiaries and joint ventures from: (i) creating, incurring or assuming any liens; (ii) merging or consolidating or disposing of its assets, or acquiring assets from any other person; (iii) changing the nature of their respective businesses; (iv) incurring indebtedness other than existing subordinated indebtedness not to exceed $50 million to finance permitted acquisitions and other permitted indebtedness specified in the Credit Facility; (v) paying dividends or making
restricted payments; and (vi) modifying the agreements relating to the Credit Facility's indebtedness and preferred stock or its corporate charter documents.
Bank of America Loan Agreement - The Company has a loan agreement with Bank of America National Trust and Savings Association ("B of A"). That loan agreement (the "B of A Loan Agreement") permits the Company and certain of the joint ventures through which it owns hotels to make revolving credit borrowings in an aggregate amount of up to $10 million and provides for an uncommitted credit facility, which is available at the sole discretion of B of A, in an aggregate amount of up to $5 million. Borrowings under the B of A Loan Agreement may be made until March 31, 1997. Revolving credit borrowings under the B of A Loan Agreement may be made, at the option of the Company, as short-term borrowings, which have a maximum maturity of six months, or medium-term borrowings, which have a maximum maturity of five years. Short-term borrowings bear interest, at the option of the Company, at the B of A prime rate, 1/2 of 1% in excess of the B of A offshore rate, or 3/4 of 1% in excess of the B of A CD rate. Medium-term borrowings bear interest at the B of A prime rate. The borrowings under the B of A Loan Agreement are secured by a $15 million standby letter of credit issued under the credit facility. The Company is obligated to pay a commitment fee at an annual rate of .1875% on the unutilized portion of the B of A Loan Agreement. Total borrowings under the B of A Loan Agreement were approximately $7.1 million at December 31, 1996.
Interest expense paid approximated $5.0 million for 1996 and $0 for 1995.
11. LEASES
Capital Lease - The Company has a lease that qualifies as a capital lease. The present value of the future minimum lease payments under this capital lease is based upon the estimated incremental borrowing rate of the Company in effect at the time of entering into the lease, which was 9.75%.
The present value of the future minimum lease payments as of December 31, 1996 is as follows (amount in thousands):
Operating Leases - The Company operates many of its hotels under long-term ground leases expiring at various dates through 2063. Some leases have renewal options exercisable after a specified number of years and all require the payment of real estate taxes and insurance. Contingent rentals, based on gross revenue, are also required by most leases. Additionally, the Company leases various office space and equipment, which leases are classified as operating leases.
The Company is obligated to pay future minimum rentals under noncancellable operating leases as follows (in thousands):
Rental expense on operating leases is summarized as follows (in thousands):
Expenses related to certain office equipment leases are classified as General and Administrative expenses.
12. INCOME TAXES
The components of income tax provision (benefit) for the years ended December 31, 1996, 1995 and 1994 are as follows (in thousands):
The following contains the major components of the deferred tax assets at December 31, 1996 and 1995.
The Company has approximately $16.9 million of tax loss carryforwards. The amount of $16.9 million includes net operating loss carryforwards of approximately $13.1 million of which $1.1 million expires in 2009, $9.9 expires in 2010, and $2.2 million expires in 2011. Also included in the $16.9 million of tax loss carryforwards are capital loss carryforwards of approximately $3.8 million which expire at December 31, 2001. The loss carryforwards will be restricted over several years pursuant to Section 382 of the Internal Revenue Code of 1986.
Due to the Company's recurring operating losses, the Company has not recorded any tax benefit for net operating loss carryforwards. As a result, the Company's net tax expense is limited to certain state and local taxes paid in 1996 and the write-off of deferred tax assets in 1995.
13. STOCKHOLDERS' EQUITY
a. Shares Reserved for Issuance - The Company reserved for issuance up to 433,290 shares of common stock to certain persons including directors and officers of HFS and the Company, in accordance with a distribution agreement signed in connection with the Distribution ( Note 2). The shares correspond with options to acquire HFS common stock granted pursuant to HFS' incentive stock option plan which were unexercised at the Distribution Date. The shares are stapled to the HFS options and have no exercise price. As such, the Company will not receive any proceeds from exercised options. As of December 31, 1996 and 1995, options to acquire 360,310 and 294,830 shares, respectively, were exercisable.
b. Stock Options - Pursuant to the Company's 1994 Stock Option Plan, as amended, options to purchase up to two million shares of common stock, which have been reserved for issuance, may be granted to employees of the Company and certain other persons over the 10-year term of the plan. In November 1996, the Board of Directors authorized an additional 1 million shares for grant. Options granted prior to November 7, 1996 become exercisable at the rate of 33-1/3% per year beginning one year after the date of grant. Shares granted on or subsequent to November 7, 1996 become exercisable at the rate of 66-2/3% in the year beginning one year after the date of grant and 33-1/3% the following year. All options granted generally expire 10 years from the date of grant. The following table summarizes the Company's stock option activity since the Effective Date (November 22, 1994).
(1) Based upon agreements with terminated employees 247,000 options will never be exercisable.
The weighted average fair values of options granted during 1996 and 1995 were $7.94 and $5.82, respectively.
The Company applies APB 25 and related interpretations in accounting for its stock option plan. Accordingly, no compensation cost has been recognized in the accompanying consolidated Statements of Operations for the years ended December 31, 1996 and 1995 for options granted during those years. Had compensation cost for these plans been determined
consistent with FAS 123, the Company's net loss would have been increased from the following as-reported amounts to the following pro forma amounts (in thousands):
The effect of FAS 123 on primary and fully diluted EPS is not shown as it is anti-dilutive.
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 used for grants in 1996 and 1995: risk-free interest rate of 6.5% representing the risk- free interest rate at the date of grant; expected dividend yields of 0%; expected lives of 7.5 years; and expected volatility of 25%.
c. Sale of Common Stock - The Company sold 904,930 shares of its unregistered common stock to CL Associates in December 1995, representing approximately 17% ownership interest in the Company, for approximately $8,484,000 ($8,311,000 net of expenses). CL Associates also designated two directors to the Board in December 1995. On August 8, 1996, the Company sold 4 million newly issued shares of unregistered common stock to CL Associates and FSNL for $57 million, increasing ownership to approximately 52% of the outstanding common stock of the Company.
14. MASTER FRANCHISE AGREEMENT
On September 30, 1996, the Company entered into an exclusive 30 year master franchise agreement with HFS, pursuant to which the Company will be entitled to develop and operate, or to franchise others to develop and operate, lodging facilities in Canada under the "Travelodge" and "Thriftlodge" names. The Company will be required to pay to HFS or its affiliates certain fees, including development fees, franchise fees, royalty fees based on gross room revenues, and certain other customary fees, such as for travel agency, marketing and consulting services.
15. RELATED PARTY TRANSACTION
Leases - During March 1996, the Company entered into a lease with an affiliate of CL Associates and an unaffiliated third party, as landlords, pursuant to which the Company has leased approximately 18,700 square feet of office space for a period of 10 years. Under this lease, the Company is obligated to pay approximately $542,000 per year for each of the first five years, and approximately $600,000 per year for each of the last five years of the term of the lease for the use of such office space. The terms of this lease are, in the opinion of the Company, substantially similar to the market terms that would be available from a third party for similar property.
Development Agreement - In connection with the Canadian Acquisition (see Note 2), the Company entered into a development agreement (the "Development Agreement") with NRG Management Services Ltd. ("NRG"), an affiliate of Royco Hotels and Resorts, Ltd. ("Royco"), pursuant to which NRG has agreed to identify new hotel properties for acquisition and development in Canada on behalf of the Company. The Development Agreement provides that the Company pay to NRG approximately $588,000 through October 1997, and approximately $370,000 during each of the years ended October 1998 and October 1999. The Company made payments of $266,454 through
December 31, 1996. The Development Agreement is terminable at will by either party after October 1, 1997.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair value of financial instruments at December 31, 1996 is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair values.
Loans - The fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings.
Investments- The Company's investment in Funtricity generates no current or determinable cash flow. As a result, management believes that a fair value assessment is not practicable. The value of this investment is impacted by the status of gaming legislation and the potential timing and uncertainty of future cash flows (Note 6). Management believes that the investment has been written down to its realizable value. Management believes that the carrying value of the other investment balance reflected here approximates its fair market value.
Long-Term Debt - The fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings.
17. FOREIGN OPERATIONS
The information presented below, in management's judgment, provides a reasonable representation of each region's contributions to the consolidated amounts as of, and for the year ended December 31, 1996. There were no foreign operations until 1996. Please see Notes 1 and 4 for description of operations.
18. COMMITMENTS AND CONTINGENCIES
a. Mexico Joint Venture - On July 12, 1996, the Company's subsidiary entered into a joint venture with a subsidiary of Grupo Piasa, a Mexican hotel company, for the purpose of developing and operating, or franchising others to operate, lodging facilities in Mexico under the "Travelodge" and "Thriftlodge" trade names. The joint venture is to be funded with up to $20 million in capital contributions, $10 million of which will be contributed by the Company and $10 million of which will be contributed by Grupo Piasa. The joint venture entered into an exclusive 30 year master franchise agreement with HFS, pursuant to which the joint venture will be entitled to develop and operate, or to franchise others to develop and operate, lodging facilities in Mexico under the "Travelodge" and "Thriftlodge" names. The Company will require the joint venture to pay to HFS or its affiliates certain fees, including development fees, franchise fees, royalty fees based on gross room revenues, and certain other customary fees, such as for travel agency, marketing and consulting services.
b. Century Casinos, Inc. - The Company also holds options in Century Casinos Inc. to purchase up to 230,000 shares of Century common stock at $3 per share if the closing price of Century's common stock exceeds certain specified levels ($10 to $13 per share) for 10 consecutive days prior to March 4, 1999. Based on the current trading price of Century's common stock and Century's historical results of operations, the Company believes the options will not become exercisable and, therefore, have no value.
c. Brahman Funds - Related to the sale of common stock to Brahman Funds (see Note 20), the Company is required to hold the proceeds of the of the Brahman Private Placement in a segregated interest-bearing account until CL Associates and FSNL have purchased at least 1,071,428 shares of Common Stock in the Rights Offering by April 15, 1997. If that condition is not satisfied, Brahman may require the Company to repurchase the shares sold to Brahman at a price of $14 per share plus the accrued interest in that segregated account. CL Associates and FSNL have informed the Company that they intend to exercise their basic subscription privileges (for approximately 1,128,134 shares of Common Stock) under the rights offering in full.
d. Litigation - In the normal course of business, certain litigation is initiated against the Company. Generally, these claims are insured and in the opinion of management, disposition of litigation will not have a material adverse effect on the Company's liquidity, consolidated financial position, or consolidated results of operation.
19. FOURTH QUARTER RESULTS
Included in fourth quarter results are charges of (i) $2.2 million in noncash provisions for losses on gaming assets, (ii) a charge of $9.5 million for cancellation of a corporate services agreement with HFS, (iii) an additional $.8 million charge for the Company's termination of its San Diego Harbor Island Travelodge franchise agreement in connection with the planned conversion of that hotel to a Hilton franchise.
20. SUBSEQUENT EVENTS
Alliance with Hilton Inns - On January 20, 1997, the Company announced that it formed an alliance with Hilton Hotels Corporation's franchising subsidiary, Hilton Inns, Inc., in which Chartwell will own, develop, manage and operate at least 20 Hilton Garden Inn hotels in target markets nationwide under a franchise license. The initial term of the agreement is three years and represents a total investment of approximately $200 million by Chartwell. Construction financing and permanent mortgage financing are expected to be arranged for the Hilton Garden Inn development program through Nationsbank and Nomura Securities. Of the total construction costs, Nationsbank is expected to provide up to 80% of the financing, with Hilton guaranteeing 25% of the loan. Chartwell will fund the remaining 20% of the capital as equity. Upon obtaining a certificate of occupancy, the construction loan is expected to convert to a 15-year permanent mortgage through an arrangement with Nomura Securities.
In addition to the Hilton Garden Inn agreement, Hilton has formally approved the conversion of the 207-room, Chartwell-owned San Diego Travelodge to a full-service Hilton Hotel. The property, on Harbor Island Drive, will undergo a $3.3 million renovation, to be completed by this summer.
Rights Offering - On January 23, 1997, the Company announced its intent to offer to its existing stockholders shares of common stock, par value $.01 per share, pursuant to a rights offering (the "Rights Offering"). CL Associates and FSNL LLC, the Company's two principal stockholders, have invested $15.8 million in the Company through the Rights Offering.
Through the Rights Offering, which closed on March 13, 1997, the Company sold 2,228,977 shares for total proceeds of approximately $31.2 million including the $15.8 million described above.
In addition, the Company announced that it had sold 1,000,000 shares of common stock to funds managed by affiliates of Brahman Management, LLC (the "Brahman Private Placement") and approximately 658,929 shares of common stock to Baron Funds at $14 per share, for a total investment of $14 million by Brahman and $9.2 million by Baron Funds.
The proceeds of the rights offering and the private placements will be used to fund the construction of Hilton Garden Inns under the Company's recently announced alliance with Hilton Hotels Corporation, to fund the Company's Mexican joint venture, the redevelopment of the Company's existing hotels, and for general corporate purposes.
Bond Offering - The company is in the process of completing a $100 million offering of 10% senior notes due 2007. The net proceeds from the Offering will be used by the Company to refinance certain existing indebtedness and to fund future capital expenditures. An extraordinary charge of $1.6 million would be incurred as a result of the early extinguishment of debt and the write-off of the deferred financing costs associated with the prior credit facility if the bond offering is completed. As part of the recapitalization, it is contemplated that the Company's existing $150 million credit facility would be terminated and replaced with a new secured facility of approximately $60 million and the HFS guarantee and related $1.5 million annual fee would be eliminated.
On March 4, 1997 the Company entered into a $50 million, 6.559% 10 year treasury instrument with a locked rate of 6.631% to partially hedge the proposed bond offering. The settlement date is May 15, 1997.
On March 7, 1997, the Company entered into a $20 million, 6.5478% 10 year treasury instrument with a locked rate of 6.620% to partially hedge the proposed bond offering. The settlement date is May 15, 1997.
On March 12, 1997, the Company entered into a $10 million, 6.605% 10 year treasury instrument with a locked rate of 6.675% to partially hedge the proposed bond offering. The settlement date is May 15, 1997.
The notes will be unsecured, senior obligations of the Company ranking pari passu in right of payment with all other existing and future unsecured, senior indebtedness of the Company and senior in right of payment to all other existing and future subordinated indebtedness of the Company.
New Accounting Pronouncements - In February 1997, FASB Statement No. 128, "Earnings Per Share" was released. The statement establishes standards for computing and presenting earnings per share ("EPS") for publicly traded companies. The statement simplifies the standards for computing earnings per share and makes them comparable to international EPS standards. The statement is effective for financial statements issued for periods ending after December 15, 1997. The Company does not believe that the requirements of the statement will have a significant impact on the presentation of EPS in the financial statements.
* * * * * *
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of National Lodging Corporation
We have audited the accompanying consolidated statements of operations and cash flows for the period from February 1, 1995 to January 23, 1996 of the Acquired Business (or "Company" as defined in Note 1 to the accompanying financial statements) These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in all material respects, the results of the Company's operations and cash flows for the period from February 1, 1995 to January 23, 1996 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP New York, New York April 19, 1996
Report of Independent Accountants
To the Board of Directors and Shareholders of National Lodging Corporation
In our opinion, the accompanying consolidated statements of operations and of cash flows present fairly, in all material respects, the results of operations and cash flows of the Acquired Business (or the "Company", as defined in Note 1 to the accompanying financial statements) for the year ended January 31, 1995 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
San Diego, California February 20, 1996
TRAVELODGE/THRIFTLODGE (Business Acquired by National Lodging Corporation)
CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in Thousands of Dollars) - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
TRAVELODGE/THRIFTLODGE (Business Acquired by National Lodging Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in Thousands of Dollars) - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
TRAVELODGE/THRIFTLODGE (Business Acquired by National Lodging Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in Thousands of Dollars) - --------------------------------------------------------------------------------
1. THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES
Forte Hotels, Inc. ("FHI"), is a subsidiary of Forte USA Inc. ("FUSA" or the "Seller"), whose ultimate parent is Forte Plc of London ("FPL"). FHI is primarily an owner, manager, and franchisor of hotels and motels in the United States, Canada, Mexico and South America. FHI operates hotels and motels under the Travelodge Hotel, Travelodge Motel and Thriftlodge names. In addition, FHI has an ownership interest in certain non-Travelodge related hotels, residential apartments, and other hospitality-related business ("Exclusive Properties and other business").
On January 23, 1996, two separate groups of FHI assets were purchased by two independent companies. One company purchased 19 motel properties, while the other purchased the Travelodge franchise system in North America, including the Travelodge and Thriftlodge service marks, franchise agreements and the assets comprising the reservation system in North America. Additionally, a special distribution was made by FHI to FUSA of the Exclusive Properties and other business. The stock of FHI was then purchased by National Lodging Corporation ("NLC", formerly known as National Gaming Corporation). Through such stock purchase, NLC acquired 15 wholly-owned properties and interest in 97 "joint venture" properties, certain management contracts, and retail space ("Acquired Business" or the "Company"). The accompanying financial statements include only those assets, liabilities, revenues and expenses arising from the operations of the Acquired Business. In connection with the anticipated sale of FHI, 23 management contracts for Canadian franchise properties were assigned to FHI from an affiliate of FPL. While the assets, amortization expense and management fees related to these contracts were not included in the historical financial statements of FHI, such amounts have been included in the accompanying financial statements of the Acquired Business from the time of the affiliate's acquisition of such contracts in June 1992.
The balances reflected in the financial statements include allocations from FHI, which were based on the number of properties acquired, percentage of acquired share of total account balance, or other appropriate bases. These allocations reflect the share of corporate overhead, results from operations, and assets and liabilities that pertain to the Acquired Business. Management believes the foregoing allocations were made on a reasonable basis and reflect the costs which would have been incurred on a stand-alone basis.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The financial information included herein may not necessarily reflect the financial position and results of operations of the Acquired Business in the future or what the financial position, results of operations, and cash flows of the Acquired Business would have been had it been a separate stand-alone company.
Accounting for Investments in Joint Ventures - The Company accounts for its investments in joint ventures in which it does not have a controlling financial interest using the equity method of accounting (Note 2).
Property and Equipment - Property and equipment is recorded at cost. Expenditures for replacements and major improvements are capitalized and depreciated. Depreciation is recognized using the straight line method over the estimated useful lives of the assets; buildings - 40 years, furniture and equipment - three to ten years. Leasehold improvements are amortized over the shorter of their estimated useful lives (ten to fifteen years) or the lease term. Expenditures for normal maintenance, repairs and minor renewal are charged to expense as incurred. Upon the sale or retirement of property or equipment, the asset cost and related accumulated depreciation are removed from the respective accounts and any gain or loss is included in the results of operations.
The Company periodically assesses the recoverability of the carrying value of property and equipment based on estimated nondiscounted cash flows on an individual property basis. If the estimated nondiscounted cash flows are less than the carrying value, an impairment loss is charged to operations based on the difference between the carrying value and the estimated discounted cash flows.
Although adoption is not required until its fiscal year 1997, the Company has assessed the impact of Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." Based on current conditions, the Company does not believe that adoption will have an adverse impact on its financial position or results of operations.
The Company considers interest expense on funds borrowed for the development and construction of new hotels and motels to be a cost of the property and capitalizes such costs until the construction is completed. The amount capitalized is amortized over the life of the property once it becomes operational. The Company did not capitalize any interest during the period February 1, 1995 to January 23, 1996 and the year ended January 31, 1995, respectively.
Other Assets - The management contracts for Canadian properties of $8,661,000 and $7,120,000 at January 23, 1996 and January 31, 1995, respectively are stated at cost and are being amortized over the 20-year term of the contracts. The Company periodically assesses the recoverability of the carrying value of its management contracts based on the estimated nondiscounted cash flows to be generated from the contracts. If the estimated nondiscounted cash flows are less than the carrying value, an impairment loss would be charged to operations based on the difference between the carrying value and the estimated discounted cash flows.
Income Taxes- The Acquired Business was included in the consolidated income tax returns of Forte Holdings, Inc. and its predecessor. Income tax expense for the Acquired Business has been computed on a stand-alone basis based on the operating results of the Acquired Business.
Pursuant to the terms of the acquisition and its income tax structure, a new income tax basis in the acquired assets and liabilities will be established by NLC. No historical income tax attributes will transfer to NLC.
2. INVESTMENT IN JOINT VENTURES
The Company is a partner in joint ventures that own and operate motels and hotels. The Company has a fifty percent interest in many of its joint ventures. The Company consolidates the joint ventures in
which it has a majority ownership interest. It records its interest under the equity method for those joint ventures in which the Company does not have a majority ownership interest.
Results of operations of joint ventures accounted for under the equity method are reflected in the following statements of operations (in thousands of dollars):
3. LONG-TERM DEBT
Interest paid approximated interest expense of $785,000 and $1,662,000 during fiscal 1996 and 1995, respectively.
4. LEASES
Operating Leases - The Company operates many of its hotels and motels under long-term leases expiring at various dates through 2035. Substantially all leases have renewal options exercisable after a specified number of years and require the payment of real estate taxes and insurance. Contingent rentals, based on sales volume, are also required by most leases.
Rental expense on operating leases is summarized as follows (in thousands of dollars):
5. EMPLOYEE BENEFIT PLANS
Defined Benefit Plan - The employees of the Acquired Business participated in the Seller's retirement plan (the "Plan"). The Plan is a noncontributory, defined benefit plan. The normal retirement benefit provided for by the Plan is determined based upon a covered employee's earnings and length of service at the time of retirement. The pension costs were funded by the Seller as they accrued in accordance
with the provisions of the Plan. In connection with the acquisition, the Plan was frozen, participants became fully vested in their accrued benefits and no further service benefit will accrue. The Plan obligations were retained by the Seller.
Pension expense of $540,000 and $574,000 was charged to the Acquired Business during the fiscal period February 1, 1995 to January 23, 1996 and the year ended January 31, 1995, respectively.
The weighted average discount rate used in determining the actuarial present value of projected benefit obligations was 7.0% and 8.5% in 1996 and 1995, respectively. The assumed rate of increase in future compensation levels was 5.0%. The expected long-term rate of return on assets was 9.0%.
6. OTHER RELATED PARTY BALANCES AND TRANSACTIONS
The Seller provided certain services to the Acquired Business including management, legal, accounting, income tax, treasury, employee benefits and human resource administration services. Costs related to these services as well as other overhead costs of the Seller have been allocated to the Acquired Business using allocation methods considered reasonable by management. The allocated costs were approximately $6,670,000 and $6,858,000 during the period February 1, 1995 to January 23, 1996 and the year ended January 31, 1995, respectively.
An affiliate of the Seller provided certain marketing and promotional services to the Acquired Business. Additionally, the Seller maintained and operated a reservation system network and provided such service to the Acquired Business. These services were charged to the properties under a cost reimbursement program and did not contain a profit margin. Amounts charged for these services were $1,912,000 and $1,908,000 during the period February 1, 1995 to January 23, 1996 and the year ended January 31, 1995, respectively, for the wholly-owned properties and consolidated joint ventures. Additionally, nonconsolidated joint ventures were charged $1,732,000 and $1,604,000 during the period February 1, 1995 to January 23, 1996 and the year ended January 31, 1995 , respectively, for such services.
The Seller also provided administrative and financial services to the joint ventures. The Company charged the joint ventures $432,000 and $436,000 for these services in the period February 1, 1995 to January 23, 1996 and the year ended January 31, 1995, respectively. Per agreement, charges for these services are primarily calculated at the rate of $8 per room per month.
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EXHIBIT INDEX
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-1
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-2
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-3
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-4
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-5
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-6
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-7
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-8
- --------------- /*/ Filed herewith. /1/ Management contract or compensatory plan or arrangement.
E-9