ITEM 1. BUSINESS.
GENERAL
The Company develops, owns and operates all-suites hotels under the Sumner Suites brand name and is an operator and the exclusive franchisor of Shoney's Inns. The Company's 17 Sumner Suites are mid-scale, all-suites hotels located in Arizona, Colorado, Florida, Georgia, Indiana, New Mexico, Ohio, Tennessee and Texas. The Shoney's Inn lodging system consists of 88 Shoney's Inns Containing approximately 8,800 rooms of which 33 containing approximately 4,000 rooms are owned or managed by the Company. Shoney's Inns are currently located in 21 states with a concentration in the Southeast.
Sumner Suites hotels are marketed primarily to business travelers and, to a lesser extent, leisure travelers by offering an all-suite setting in a convenient location at an attractive price/value relationship. Sumner Suites offer mid-scale accommodations at rates between $75 and $95 per night and are usually located in or near business or leisure travel destinations in mid-sized and larger metropolitan markets. A typical Sumner Suites contains from 110 to 135 rooms, lounge facilities, meeting rooms, swimming pool and a fitness room, and offers a deluxe continental breakfast.
The Sumner Suites concept was launched in 1995 with three hotels. From 1990 until 1995, the Company developed and managed 12 mid-scale, all-suites hotels under another brand name before selling its interests in those hotels in March 1995. The Company believes that its experience in developing, constructing and managing mid-scale, all-suites hotels will enable it to expand effectively its development and ownership of the Sumner Suites system. In addition, as Sumner Suites has a limited presence in the marketplace, the Company is utilizing its proprietary reservation system, INNLINK, to further expand awareness of Sumner Suites.
Shoney's Inns operate in the upper economy limited-service segment and are designed to appeal to both business and leisure travelers, with rooms usually priced between $40 and $65 per night. The typical Shoney's Inn includes 100 to 125 rooms and, in most cases, meeting rooms. Although Shoney's Inns do not offer full food service, most offer continental breakfast and 77 of the 88 Shoney's Inns are located adjacent or in close proximity to Shoney's restaurants. Management believes that its strategy of locating most of its Shoney's Inns in close proximity to free-standing Shoney's restaurants has given it a competitive advantage over many other limited-service lodging chains by offering guest services approximating those of full-service facilities without the additional capital expenditures, operating costs or higher room rates.
The Company was incorporated under the laws of the State of Tennessee in 1976.
GROWTH STRATEGY
The Company's strategy is to increase cash flow and earnings by (i) developing additional Sumner Suites, (ii) increasing REVPAR while maintaining the Company's attractive suite and room
price/value relationships and controlling operating costs, and (iii) expanding the Shoney's Inn system through the addition of new franchised units.
Development of Additional Sumner Suites. The Company intends to continue to develop Sumner Suites in mid-sized and larger metropolitan markets across the United States. In addition to the two Sumner Suites that were opened in December 1995 and a property that was converted to a Sumner Suites in July 1995, the Company developed and opened ten Sumner Suites in fiscal 1996 and four Sumner Suites in fiscal 1997. Currently, ten additional Sumner Suites are scheduled to be open by the end of fiscal 1998, six of which are currently under construction. In addition, the Company has another eight sites under contract for purchase. The Company expects to finance the construction and development of additional Sumner Suites currently under development primarily through a combination of available cash and available credit under the Company's revolving credit facility. See "Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources."
Internal Growth. The Company intends to increase cash flow and earnings from its existing hotels through increases in REVPAR while controlling operating costs. The Company seeks to increase REVPAR by increasing average daily room rates and supporting or increasing occupancy rates through targeted marketing and advertising strategies, employing promotional activities in local markets and capitalizing on the Company's proprietary central reservation system. In addition, the Company is committed to sustaining the quality of its properties through an ongoing renovation and maintenance program in order to increase REVPAR. The Company seeks to minimize costs throughout its operations primarily through the use of an in-house development and construction team and increased economies of scale in purchasing.
Expansion of Shoney's Inn System. The Company is expanding the Shoney's Inn system principally through the addition of new franchises. Four franchised Shoney's Inns were opened in fiscal 1997, four hotels left the Shoney's Inn system and currently six franchised Shoney's Inns are under construction. As of 1997 fiscal year-end, there were 88 Shoney's Inns (of which 31 are Company owned) with a total of 8,826 rooms. Through March 31, 1998, three additional franchised Shoney's Inns have opened, three hotels have left the Shoney's Inn system and the Company has received notice that five other hotels intend to leave the system. The Company targets existing Shoney's Inn franchises, other hotel brand developers and contacts within the industry as potential franchisees for additional Shoney's Inns.
SUMNER SUITES CONCEPT
Sumner Suites are all-suites hotels positioned in the mid-scale segment to appeal primarily to business travelers and, to a lesser extent, leisure travelers. The Sumner Suites hotels are generally located in mid-sized to larger metropolitan markets near business and leisure travel destinations such as business parks, office buildings, local attractions and restaurants. The current daily room rates typically range from $75 to $95; however, room rates vary depending upon a number of factors, including location and competition. For fiscal 1997, the average daily room rate for the Sumner Suites hotels was $71.94.
The Sumner Suites prototype hotel is a five story, interior corridor, stucco building containing 110 to 135 rooms. The bedroom in each suite is furnished with either a king size bed or two double beds, a night stand, vanity, and closet area, and the sitting area contains a sleeper sofa,
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a desk, chairs and reading lamps. A kitchenette area includes a sink, refrigerator, microwave oven and cabinets that contain kitchen and cooking utensils. Additional room amenities include new 26 inch remote control color televisions with premium channel selections, in room coffee makers and dual line telephones for computer connections.
The lobby area of each Sumner Suites hotel features marble floors and seating areas with numerous couches, tables and chairs allowing for informal meeting and lounge space. Adjacent to the seating area is a combination buffet and beverage service area. Each Sumner Suites is equipped with large meeting rooms that can be sectioned to meet individual guests' or groups' needs. An exercise facility and swimming pool are additional features. Guests at the Sumner Suites are offered a wide range of amenities and services, such as deluxe continental breakfast, fitness center, free unlimited local telephone calls, on premises coin operated laundry, same-day laundry and dry cleaning, fax services, 24-hour front desk message service and free parking. Typically, the Sumner Suites are located near free standing restaurants such as Ruby Tuesday's, Applebee's, Chili's, O'Charley's and Red Lobster. The Company believes that Sumner Suites provides its guests with quality accommodations at an attractive price/value relationship within the all-suites segment.
SHONEY'S INNS CONCEPT
Shoney's Inns are limited-service hotels positioned in the upper economy segment to appeal to both business and leisure travelers and are located in 21 states in markets ranging from small towns to larger metropolitan areas. Shoney's Inns are generally located in proximity to interstate highways, major streets and highways providing convenient access to business establishments. Seventy-seven of the 88 Shoney's Inns are located adjacent or in close proximity to a Shoney's restaurant. Management believes that its strategy of locating its Shoney's Inns in close proximity to free-standing Shoney's restaurants gives it a competitive advantage over many other limited-service lodging chains. Daily room rates at Shoney's Inns range from $40 to $65 and vary depending upon a number of factors, including location, competition and type of room. For fiscal 1997, the average daily room rate for Company-owned Shoney's Inns was $52.07.
Historically, the typical Shoney's Inn has been a two story, exterior corridor, brick veneer building with plate glass fronts, containing 100 to 125 rooms. New prototypes for Shoney's Inns include a four story, interior corridor, brick or stucco building containing 100 to 120 rooms as well as smaller prototype buildings containing 80 rooms. In some cases franchisees construct smaller Shoney's Inns. Each room is professionally decorated and is generally furnished with two double beds, a dresser, table and chairs and a color television.
Amenities featured at most Shoney's Inns include swimming pools, meeting rooms, facsimile machine service and continental breakfast. The Company believes that Shoney's Inns provides its guests with quality accommodations at an attractive price/value relationship within the upper economy segment.
HOTEL CONSTRUCTION AND DEVELOPMENT
The Company's construction subsidiary has a full time core staff of approximately 145 people who manage, supervise, control and perform the construction of the Company's hotels. Local subcontractors are employed by the Company for most of the major construction components of a new hotel, including plumbing, electrical, and mechanical subcontracts. The Company intends to
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continue to build its own hotels because it believes that its in-house capabilities provide advantages in controlling costs, quality, and development schedule as compared to using independent contractors. The Company believes that its construction experience and its relationship with many subcontractors will facilitate the effective development of additional hotels.
The Company devotes significant resources to the identification and evaluation of potential sites for its hotels. The Company generally targets mid-sized to larger metropolitan markets for locating its Sumner Suites. In identifying cities for possible expansion, the Company typically targets markets with populations of 500,000 or more that have high levels of business development and multiple sources of room demand. The site selection process for Sumner Suites focuses on the competitive environment, including room and occupancy rates and proximity to business parks, office buildings, and other demand generators. The Company focuses on sites for its Shoney's Inns in proximity to interstate highway access roads and major streets and highways providing convenient access to local business establishments and tourist attractions.
The Company anticipates developing Sumner Suites hotels averaging from 110 to 135 suites. Management believes that the development cost of a new Sumner Suites hotel will be approximately $62,000 to $66,000 per suite, depending on the location of the hotel, size of the hotel (number of suites), cost of land, local zoning and permitting costs, construction period and local building costs which are affected by the cost of building materials and construction labor. Based on the Company's experience to date, the capital investment (including land and construction period interest) for a typical 135 suite Sumner Suites is approximately $8.5 million (approximately $63,000 per suite).
The construction phase of a hotel generally requires six months after the site and all approvals and permits have been obtained. The Company's experience in selection and acquisition of sites has varied and generally averages six months. The approval and permitting phase can occur simultaneously with site acquisition and generally requires three months. The entire development process generally ranges from 10 to 12 months but may take longer.
SALES AND MARKETING
The Company directs marketing efforts on behalf of both Sumner Suites and Shoney's Inns primarily to business travelers, whom management believes have represented the largest segment of its customers in recent years.
Sumner Suites. Marketing of the Sumner Suites brand is targeted primarily towards the business traveler through a variety of efforts. Initially, pre-opening sales calls are made by the general manager and director of sales of each property in the local market area during the 90 days prior to opening. In addition, advertisements are placed in the Hotel Travel Index, a comprehensive listing of hotels worldwide used by travel agents for booking clients into destination cities. Advertising is also placed in local business publications, direct mail to targeted business travel and a comprehensive on-line directory on the worldwide web at www.sumnersuites.com. The Sumner Suites toll-free reservation number, 1-800-74-SUITE, is promoted to the travel agents through advertising and direct mailings. The Company believes that approximately one quarter of all Sumner Suites room sales are booked through the reservation center.
Shoney's Inns. All Shoney's Inns participate in the "Sho Business" frequent traveler program, entitling members to receive the lowest available corporate rate, complimentary coffee and
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newspaper, free room upgrades, express check-in and other privileges upon presentation of a membership card. Approximately 9% of the rooms booked through INNLINK for Shoney's Inns during fiscal 1997 have been reserved by guests who are members of the Sho Business program. Historically, the Company has also marketed its hotels directly to businesses whose employees travel in the southeastern United States.
Additionally, the Company attempts to take advantage of the Shoney's brand name recognition in the over-50 age group and in the package tour market through advertisement in publications targeting such readers and by encouraging franchisee participation in promotional discounts for frequent customers over-50 and for tour operators. The Company's program for the over-50 age group is tied to AARP membership and entitles its members to receive special room rate discounts, complimentary coffee and newspaper and other benefits. The Shoney's Inn system also advertises in Shoney's restaurants, and individual Shoney's Inns are encouraged to participate in joint mailings and other promotions with local Shoney's restaurants.
The Company annually publishes a Shoney's Inn system directory showing, for each Inn, its address and telephone number, location as indicated on a locator map, a brief description of the facilities, the services and amenities provided and other relevant information. These directories are distributed in each Shoney's Inn and state travel centers and are provided directly to travel agents, sponsors of group tours, corporate travel departments and other selected potential customers. The Company also provides a comprehensive on-line directory on the worldwide web at www.shoneysinns.com.
Many properties have a full-time director of sales whose responsibilities include local marketing and direct and group sales. At the corporate level, a Director of Marketing oversees national marketing plans and provides marketing support for each corporate and franchised property. The Director of Marketing also oversees management of the Shoney's Inn national advertising fund, into which all Shoney's Inns pay 1% of revenue to support national marketing efforts such as the annual system directory and national advertising (e.g. USA Today, Reader's Digest, Compass Travel Directory inserts).
Travel Agents. The Company has a policy of paying to travel agents a commission, standard in the hotel industry, on all revenue booked by them. The Company, with respect to all Sumner Suites and both owned and franchised Shoney's Inns, has joined the TACS-Lite Program run by Citibank. TACS-Lite (Travel Agent Commission Settlement) is a program where each hotel property reports to the Company each week by fax (or by electronic transmission if capable) all of its room sales generated through travel agents. The Company in turn forwards this information to Citibank which automatically generates checks each month to travel agents across the country for the total commissions earned. The Company believes that travel agents are more likely to book guests into a Shoney's Inn or Sumner Suite knowing that their commissions will be paid by Citibank without the travel agent having to go to the trouble and expense of billing each separate location.
LODGING OPERATIONS
Hotel Management. Overall hotel operations are the responsibility of the Director of Operations for Shoney's Inns and the Vice President of Operations for Sumner Suites. Shoney's Inns and Sumner Suites are further managed by regional managers, who directly supervise the general managers of each property. The general manager of each Shoney's Inns or Sumner Suites is fully
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responsible for day-to-day operations and is compensated by salary and bonus systems which reward revenue and operating margin performance. Each general manager, in conjunction with senior management, develops the property's operating budget and is held accountable for meeting the goals and objectives of the hotel.
Reservation System. The Company's proprietary central reservation system, INNLINK, provides important support for the room reservation process for both Sumner Suites and Shoney's Inns and is marketed to other chains as well. Other chains that contract with the Company for the service include Country Hearth Inns, Key West Inns and Wilson Inns & Hotels. INNLINK operates 24 hours a day, 7 days a week. The INNLINK system may be accessed by individual travelers as well as by travel agents, tour and group booking agents at 1-800-222-2222 for Shoney's Inns and 1-800-74-SUITE for Sumner Suites. Electronically, INNLINK is accessed through numerous global distribution systems (e.g., SABRE Travel Information Network, Galileo International, Amadeus and WorldSpan). The reservation system includes specially designed hotel reservation software, with adequate capacity, and state of the art hardware and telecommunications devices. The Company believes that approximately 28% and 17% of room sales for Sumner Suites and Shoney's Inns, respectively, are made through INNLINK.
Quality Control. To ensure quality and consistency, the Company regularly inspects each of its company owned and/or operated hotels and each Shoney's Inn in the Shoney's Inn system for compliance with facility and service standards. The Company also conducts unannounced visits by unidentified "guests" who report on the quality of services at individual hotels. Generally, in addition to its ongoing refurbishment activities, the Company fully renovates each of the Company-owned Shoney's Inns after approximately seven years of operation and expects a similar renovation schedule for Sumner Suites. During fiscal 1997 the Company completed full or partial renovations of eleven Company-owned Shoney's Inns and is in the process of completing the renovations of two additional Shoney's Inns that will be completed in fiscal 1998.
Training. The Company utilizes the services of an "opening team" to assist with hiring and training new staff and opening new Company-owned hotels. The opening team trains local hotel personnel in front desk operations, operational policies, hotel accounting and cash handling procedures, record-keeping, housekeeping and laundry, maintenance and repair, marketing, personnel management, purchasing, quality assurance and sales. Sales training includes a team of direct sales personnel that assists the local staff in the actual pre-selling of rooms. An opening team generally remains on site for one to four weeks depending on the prior experience of the local general manager.
FRANCHISE OPERATIONS
Franchise Sales. The Company markets the Shoney's Inn franchise principally to existing Shoney's Inn franchisees, other hotel brand developers and other prospects known through management's contacts in the lodging industry. The Company also markets franchises through advertisements in trade publications and participation in trade shows and franchising conventions.
Management believes that the Company attracts potential new franchisees by offering a comparable level of franchisee support services at a lower price than its competitors. Management periodically monitors the initial fee, royalty fee, advertising fee, reservation fee and other charges
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imposed by other franchisors with whom the Company competes and believes that the fees charged by the Company are competitive and, in most cases, lower than such other franchisors.
Fees. Under the standard Shoney's Inn franchise arrangement offered to prospective franchisees, a potential franchisee pays a $2,500 application fee. Upon approval of the application, the Company and the franchisee enter into a 20-year license agreement, and the franchisee generally pays a license fee equal to the greater of $250 per room or $15,000. The application fee is applied against the license fee.
Under the standard Shoney's Inn franchise arrangement offered to prospective franchisees, the franchisee pays monthly royalties of 3.5% of the licensed hotel's gross sales during the term of the license agreement. Additionally, a marketing cooperative fee of 1% of gross sales and a fee for participation in the Shoney's Inn central reservation system of 1% of gross sales are charged.
Franchisee Services. Management believes that the support the Company offers to franchisees is a significant factor in determining its success as a franchisor and that the Company's successful record as a Shoney's Inn builder, owner and operator evidences valuable experience and abilities which can enhance the franchisee support function. As franchisor, the Company draws on its own operational experience to assist franchisees.
Once a Shoney's Inn is constructed, the Company requires the franchisee to send the site general manager to a management training class conducted by the Company covering topics including human resources, sales and marketing, yield management and cost controls. The Company also makes available some of the most successful Company-owned Shoney's Inns as training centers. Currently the Company does not charge for the training program but reserves the right to do so in the future.
The Company inspects every Shoney's Inn at least three times a year, at least two of which are unannounced, through its Quality Standards and Compliance program, using trained field representatives. The Company encourages franchisees to renovate each of the Shoney's Inns after approximately seven years of operations, in the same manner that the Company renovates its own hotels.
The Company offers to provide management services to Shoney's Inn franchisees pursuant to contractual arrangements. The Company's fee for these services is a percentage of the managed hotel's gross revenues. Currently, the Company manages two hotels under contract arrangement.
LICENSE AGREEMENT WITH SHONEY'S
Under the License Agreement with Shoney's, Inc., the Company acts as exclusive franchisor of Shoney's Inns and has certain rights to use and to license the use of the service marks "Shoney's Inn" and "Shoney's Inn & Suites" in connection with lodging operations. Under the License Agreement, Shoney's retains certain rights, including the right to approve the styles, shapes, colors and forms in which the "Shoney's Inn" and "Shoney's Inn & Suites" marks are displayed, the nature and extent of on-site food and beverage service and the terms of franchise agreements (other than the maximum fees and other financial terms). Further, Shoney's retains the right to terminate the License Agreement under limited circumstances, including the bankruptcy of the Company, the failure to
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comply with the terms of the License Agreement and the failure to desist from conduct likely to impair Shoney's goodwill and reputation.
Prior to October 25, 1996, the License Agreement entitled Shoney's to receive a portion of the franchise fees collected by the Company equal, in substantially all cases, to 1.5% of 52 Shoney's Inns' gross revenues through October 1999 and 0.5% of the remaining and all future Shoney's Inns' gross revenues for the first ten years of their operation. Shoney's right to receive such fees was terminated on October 25, 1996.
LODGING INDUSTRY
Smith Travel Research divides lodging chains into various segments based on price. Shoney's Inns would be included in the economy segment. Sumner Suites would be included in the mid-scale (without food and beverage) segment, although because the average daily room rate at Sumner Suites exceeds $75.00, the Sumner Suites could be included in the upscale segment.
The following tables illustrate certain comparative information regarding REVPAR and its components for the years indicated:
(1) Room revenues divided by the number of rented rooms. (2) Information with respect to Sumner Suites is unavailable or not meaningful prior to 1996, as two of the first three Sumner Suites hotels did not open until late 1995.
Source: Smith Travel Research, Standard Historical Trend Report for years ended 1995, 1996 and 1997, for industry wide, economy, mid-scale (w/o food and beverage) and upscale lodging chains, and the Company's internal data for all Shoney's Inns and Sumner Suites statistics.
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COMPETITION
The lodging industry is highly competitive. In franchising the Shoney's Inn system and managing its own lodging facilities, the Company encounters competition from numerous lodging companies, many of which have greater industry experience, name recognition, and financial and marketing resources than the Company. While the actual competition for individual lodging facilities varies by location, the primary competition for Shoney's Inns includes lodging chains such as Holiday Inn Express, La Quinta, Comfort Inns, Drury Inns, Fairfield Inns and Travelodges. The Company's Sumner Suites hotels experience competition from chains such as Embassy Suites, Hampton Inns, Residence Inn, Courtyard by Marriott, Quality Suites, AmeriSuites and Comfort Suites. Each of the Company's hotels is located in a developed area that includes competing lodging facilities, and the Company expects that most of its future hotels which it constructs will be located in similar areas. Management believes that the principal competitive factors in its lodging operations are room rates, quality of accommodations, name recognition, supply and availability of alternative lodging facilities, service levels, reputation, reservation systems and convenience of location. In its franchising operations, the principal competitive factors are fee structure and support services. Management further believes that the Company is presently competitive in all these respects.
GOVERNMENT REGULATION
The Company is subject to various federal, state and local laws, regulations and administrative practices affecting its business. The Company's lodging operations must comply with provisions relating to health, sanitation and safety standards, equal employment, minimum wages, building codes and zoning ordinances, and licenses to operate lodging facilities. The sale of franchises is regulated by various state laws as well as by the Federal Trade Commission ("FTC") Rules on Franchising. The FTC requires that franchisors make extensive disclosure to prospective franchisees but does not require registration. A number of states require registration or disclosure in connection with franchise offers and sales. In addition, several states have "franchise relationship laws" that limit the ability of franchisors to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements.
Federal and state environmental regulations are not expected to have a material effect on the Company's operations, but more stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors could delay construction of lodging facilities and add to their cost. A significant portion of the Company's personnel are paid at rates related to federal minimum wages and, accordingly, increases in the minimum wage could adversely affect the Company's operating results.
The Americans With Disabilities Act (the "ADA") prohibits discrimination on the basis of disability in public accommodations and employment. The ADA became effective as to public accommodations in January 1992 and as to employment in July 1992. The Company currently designs its lodging facilities to be accessible to the disabled and believes that it is in substantial compliance with all current applicable regulations relating to accommodations for the disabled. The Company intends to comply with future regulations relating to accommodating the needs of the disabled, and the Company does not currently anticipate that such compliance will require the Company to expend substantial funds.
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SERVICE MARKS
The Company has the right to use the "Shoney's Inn" and "Shoney's Inns & Suites" service marks in its lodging operations under its License Agreement with Shoney's (See "License Agreement with Shoney's," above). The "Shoney's Inn" and "Shoney's Inns and Suites" marks may not be used in certain limited areas in southern and western Virginia and in northeastern Tennessee; however, the Company does not believe that these limitations are material to its present business or its expansion strategy. The Company believes that its ability to use the Shoney's marks is material to its business. The Company has registered the service mark "INNLINK," which it uses in connection with its reservation system, with the United States Patent and Trademark Office. The Company has applied to register the service mark "Sumner Suites" with the United States Patent and Trademark Office.
INSURANCE
The Company maintains general liability insurance and property insurance for all its locations and operations, as well as specialized coverage, including guest property and liquor liability insurance, in connection with its lodging business. Generally, the costs of insurance coverage and the availability of liability insurance coverage have varied widely in recent years. While the Company believes that its present insurance coverage is adequate for its current operations, there can be no assurance that the coverage is sufficient for all future claims or will continue to be available in adequate amounts or at a reasonable cost.
EMPLOYEES
As of December 28, 1997 the Company had approximately 1,785 employees, including approximately 113 in the Company's corporate headquarters. The company's employees are not represented by a labor union. The Company considers its relationships with employees to be good.
ITEM 2.
ITEM 2. PROPERTIES.
The Company's corporate headquarters, owned by the Company, is located in Hendersonville, Tennessee and contains approximately 42,000 square feet of space including storage and food services. Management believes that its corporate headquarters building contains sufficient space to accommodate the Company's currently anticipated needs.
Approximately 28 of the 48 Company-owned hotels are located on sites owned by the Company or a partnership in which the Company holds a majority interest. The remaining hotels are located on sites that are leased pursuant to long-term leases.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is subject to litigation from time to time in the ordinary course of its business. The Company is not aware of any material legal action pending or threatened against it, except for the following:
Frank Rudy Heirs Associates, et. al. v. Moore and Associates, Inc., Leon Moore and Gulf Coast Development, Inc., was filed in the Chancery Court for Davidson County, Tennessee (93- 2957-II) on October 8, 1994. The plaintiff, a limited partner in one of the Company's partnerships, claims, among other things, that the Company breached the partnership agreement by not offering
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the partnership the right to participate in the profits from the management of a neighboring AmeriSuites hotel. In February 1995, the court entered summary judgment in favor of the plaintiff on this claim and referred the issue of damages to a special master of the court. In November 1995, the special master issued her report finding damages on this claim payable to the partnership (of which the Company is a 60% partner) in the amount of approximately $3.0 million. The report of the special master was confirmed by the court in December 1995 and the Company subsequently appealed the judgment in March 1996. In March 1997, the Court of Appeals reversed the trial court's ruling in favor of the plaintiff, vacated the judgment against the Company and remanded the case to the trial court to enter summary judgment on this claim in favor of the Company. The plaintiff filed an application for permission to appeal to the Supreme Court of Tennessee but the court has refused to grant such permission. In May 1997, the trial court granted summary judgment in favor of the Company on five additional claims that were made by the plaintiff. The trial of the remaining issues was held in December 1997. On March 4, 1998, the trial court found in favor of the Company as to each of the issues for which a trial was held. It is likely that the plaintiff will appeal. The Company currently does not anticipate that the pending litigation will have any material adverse effect on the Company.
Tri-State Inns, Inc. and Motels of America, Inc. v. ShoLodge Franchise Systems, Inc., Superior Court of Liberty County, Georgia, Civil Action File No. 97-V-00591. In this action, Tri-State Inns, Inc., the franchisee of the Shoney's Inn located in Hinesville, Georgia, originally sought to be discharged, relieved and excused of any future performance under the License Agreement relating to such Shoney's Inn, and Motels of America, Inc. sought to be discharged, relieved and excused of any further performance under a Guaranty Agreement whereby the obligations of Tri-State Inns, Inc. under such License Agreement were guaranteed by Motels of America, Inc., or in the alternative compensatory damages, based on theories of alleged breach of contractual obligations and implied warranties of good faith and fair dealing, alleged fraudulent inducement based on alleged misrepresentations and alleged failure to make material disclosures of fact, alleged promissory estoppel and alleged breach of fiduciary duty. In addition, the plaintiffs originally sought a declaratory judgment concerning the provision of the License Agreement which specifies the damages due upon termination of the License Agreement. This action was removed to the U.S. District Court for the Southern District of Georgia, Case No. CV- 497-129. Subsequent to removal, the action was thereafter transferred to the U.S. District Court for the Middle District of Tennessee, where it is now pending as Civil Action No. 3-98-0028. On December 19, 1997, the plaintiffs filed a Second Amended Complaint in which they sought to be relieved of obligations not simply as to the Hinesville Shoney's Inn but also with regard to 13 other license agreements between plaintiffs and the Company. In the alternative, the plaintiffs seek an as yet undisclosed amount in compensatory damages. The case is currently in the discovery stage. The Company intends to continue to defend the case vigorously.
Lorraine Donergue v. ShoLodge, Inc., et al., Case No. 3-98-0295, United States District Court for the Middle District of Tennessee. On March 31, 1998, the Company was named as a defendant in a purported class action lawsuit filed by Lorraine Donergue, who claims to be a shareholder of the Company. The lawsuit alleges that the Company violated Section 10(b) of the Securities Exchange Act of 1934 by issuing allegedly false and misleading statements and financial information to the investing public during 1997. The lawsuit also names as defendants three of the Company's officers, Leon Moore, Bob Marlowe, and Michael A. Corbett. The plaintiff seeks
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an unspecified amount of damages. The Company has not yet filed a response to the lawsuit but intends to defend the case vigorously.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS.
No matters were submitted to a vote of security holders in the fourth quarter of 1996.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.
The Company's Common Stock is traded in the over-the-counter market and is quoted on The Nasdaq Stock Market ("NASDAQ") under the symbol "LODG." The prices set forth below reflect the high and low sales prices for the Company's Common Stock as reported by NASDAQ for the periods indicated.
On April 9, 1998, the last reported sale price for the Company's Common Stock as reported by NASDAQ was $10.00 per share. As of April 9, 1998, there were approximately 63 holders of record of the Company's Common Stock and approximately 1,300 beneficial owners.
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The Company has never declared or paid any cash dividends on its Common Stock. The Company currently intends to retain its earnings to finance future development of its business, and does not therefore anticipate paying any cash dividends in the foreseeable future. The Company's primary revolving credit agreements prohibit the payment of dividends without the lender's consent.
The Company declared a five-to-four stock split of its Common Stock to be effected as a 25% stock dividend which was payable on May 14, 1993 to those shareholders of record on April 30, 1993. The Company more recently declared a four-to-three stock split of its Common Stock to be effected as a 33 1/3% stock dividend payable on March 28, 1994 to the shareholders of record on March 14, 1994.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data set forth on the following page as of and for each of the five fiscal years in the period ended December 28, 1997 have been derived from the Company's audited Consolidated Financial Statements. The Consolidated Financial Statements for each of the two fiscal years ended December 29, 1996 and December 28, 1997, which have been audited by Deloitte & Touche LLP, independent auditors, are included elsewhere in this Report. The information set forth on the following page should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements and the related notes thereto included elsewhere in this Report.
SHOLODGE, INC. AND SUBSIDIARIES SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
OVERVIEW
The Company derives revenue primarily from hotel room sales at its Sumner Suites and Company-owned Shoney's Inn hotels. Through March 1995, the Company managed AmeriSuites hotels and earned management fees for such services. The Company also receives management fees for services it performs for two franchised Shoney's Inns. The Company derives additional revenue from franchise fees it receives as the exclusive franchisor of Shoney's Inns.
The Company's hotel operations have been supplemented by contract revenues from construction and development of franchised Shoney's Inns and, until March 1995, AmeriSuites hotels for third parties. Revenues from these activities have varied widely from period to period, depending upon whether the Company's construction and development activities were primarily focused on its own facilities or on outside projects. The Company has generally undertaken construction and development projects for third parties only when its capacity has been underutilized in constructing its own facilities. Construction revenues are recognized on the percentage of completion basis. Because the Company expects to concentrate on the development of Sumner Suites, management does not anticipate generating further significant contract revenues from construction and development.
From 1990 through the first quarter of fiscal 1995, the Company developed and owned or managed hotels in the AmeriSuites hotel chain. In March 1995, the company terminated its relationship with AmeriSuites by (i) selling its option to purchase 50% of the voting stock of Suites of America, Inc. ("Suites of America") to Prime Hospitality Corp. ("Prime Hospitality") for $27.3 million and (ii) conveying to Suites of America its interest in one additional AmeriSuites hotel for $6.2 million. Five million dollars of the aggregate purchase price was paid in cash on closing, while the remaining $28.5 million was paid pursuant to a note that was repaid in January 1996. In connection with the sale of its option in Suites of America to the company, the Company canceled $14.9 million in existing indebtedness of Suites of America to the Company. These transactions, together with the sale of five AmeriSuites hotels in 1993 and 1994 (collectively, the "AmeriSuites Transaction"), have been accounted for as installment sales of real estate in the Company's Consolidated Financial Statements, and a pre-tax gain of $15.6 million was recognized through 1996 in connection therewith. The transactions also resulted in the recognition in fiscal 1995 of $2.9 million of previously deferred management fee revenue.
During first quarter of fiscal 1996, the Company sold its 60% ownership in five restaurants to the 40% owner for a note receivable. The income or loss from restaurant operations for each of the reported periods is reported as discontinued operations net of applicable income taxes and minority interest. The Company initially deferred recognition of the gain from the sale of this segment until further principal payments on the note were received. In fiscal 1996 $40,000 of this gain was recognized and in fiscal 1997, the remaining $813,000 was recognized as gain on disposal of discontinued business segment.
The Company's hotel operations have historically been seasonal in nature, reflecting higher occupancy rates during spring and summer months, which may be expected to cause fluctuations in the Company's quarterly revenues and earnings from hotel operations. The Company's fiscal year ends on the last Sunday of the calendar year. This resulted in fiscal 1995 consisting of 53 weeks as compared with 52 weeks in fiscal 1996 and 1997.
The Company has elected to make a change in accounting for pre-opening costs effective with the beginning of its 1997 fiscal year to reflect the preferable method of expensing pre-opening costs as incurred, rather than capitalizing those expenditures and amortizing them over a three-year period. The cumulative effect of this accounting change for periods prior to 1997 recognized in 1997, net of income tax effect, is a reduction in net earnings of $1,164,000, or $0.14 per share. The pro forma effect of this change in accounting for pre-opening costs on 1995 and 1996 would be to increase hotel operating expenses by $462,000 and $1,265,000, respectively, for expensing these costs as incurred, and to reduce depreciation and amortization expense for 1995 and 1996 by $356,000 and $550,000, respectively.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage relationship of certain items of revenue and expense to the total revenues of the Company.
For the Fiscal Years Ended December 28, 1997 and December 29, 1996
For the fiscal year ended December 28, 1997, total operating revenues increased 18.3% to $75.1 million from $63.5 million for the fiscal year ended December 29, 1996.
Revenues from hotel operations in fiscal 1997 increased 25.1% to $71.9 million from $57.5 million for fiscal 1996. This increase resulted primarily from more available hotel rooms in 1997 as compared to fiscal 1996. Sixteen hotels which opened during fiscal 1996 and fiscal 1997 contributed $15.4 million more to room revenues in fiscal 1997 than in fiscal 1996. Two Shoney's Inns were opened in the first quarter of 1996; the remaining 14 hotels opened during 1996 and 1997 were Sumner Suites hotels. All-Hotels RevPAR (revenue per available room) from the 17 Sumner Suites hotels increased by $5.61, or 15.6%, from $36.05 in 1996 to $41.66 in 1997. Same-Hotels RevPAR from the Sumner Suites hotels increased by $6.78, or 16.1%, from $42.24 in 1996 to $49.02 in 1997. RevPAR for the Company-owned Shoney's Inns declined slightly from $31.41 in 1996 to $30.83 in 1997.
There were no revenues from construction and development activities during 1997 compared with $1.7 million in 1996. Revenues from construction and development can vary widely from period to period depending upon the volume of outside contract work and the timing of those projects. Only one outside construction project was finished in early 1996 and the balance of construction and development-other related to the AmeriSuites Transaction (discussed in the overview) was earned in 1996. No outside construction contracts are currently in progress nor planned at present.
Franchise revenues in fiscal 1997 declined 26.3% to $3.0 million from $4.1 million in fiscal 1996. The decrease was due primarily to the cancellation of reservation services by two hotel chains in the first quarter of 1997 and to a decrease of $315,000 in initial franchise fee revenue from 1996 to 1997. Initial franchise fees may vary widely from year to year. At the end of fiscal 1997 there were 57 franchised Shoney's Inns in operation. One franchisee has given the Company notice of cancellation of license agreements on 14 Shoney's Inns; therefore, future franchise revenues could be negatively impacted by the potential loss of these franchises. Management Fee revenue in fiscal 1997 decreased 25.2% to $139,000 from $185,000 in fiscal 1996, due to the cancellation of one management contract on one hotel in the third quarter of 1996.
Hotel operating expenses for fiscal 1997 increased by 38.7% to $43.0 million from $31.0 million in fiscal 1996. Operating expenses of the 32 Shoney's Inns increased by $1.9 million in 1997 over 1996 even though revenues from these Inns declined by $1.3 million. The gross operating profit margin on these 32 Inns declined from 46.6% in 1996 to 40.7% in 1997. The increases in operating expenses which accounted for the negative impact on profit margin were primarily in the areas of real estate taxes, insurance, advertising, complimentary food and beverage, and payroll related expenses. Operating expenses of the same-hotel Sumner Suites increased by $277,000 due primarily to the $557,000 increase in hotel revenues. The gross profit margin on these same-hotels
increased from 46.0% in 1996 to 46.4% in 1997. All 17 Sumner Suites hotels reflected an increase in hotel operating expenses of $10.1 million from $6.3 million in 1996 to $16.4 million in 1997, due primarily to the $15.8 million increase in revenues from these properties. The 14 non-same Sumner Suites hotels (those not open for the full year in both 1996 and 1997) reduced the gross operating profit margin on all Sumner Suites hotels from 44.4% in 1996 to 39.5% in 1997. The change in accounting for pre-opening costs effective with the 1997 fiscal year to expense these costs as incurred versus the capitalization of such costs in 1996 and prior years, accounted for $664,000 of the increase in hotel operating expenses in 1997 over 1996. This negatively impacted the gross profit margin on all-hotel Sumner Suites by 2.4 percentage points, or approximately 50% of the total decline in gross profit margin from 1996 to 1997.
There were no costs and expenses of construction and development in 1997 as there were no outside construction contracts, compared with $1.2 million in 1996 as one outside construction contract was completed early in the year.
Franchising operating expenses for 1997 decreased 29.3% to $2.3 million from $3.3 million in 1996. The primary reason for this decrease was the cancellation in the fourth quarter of 1996 of the Company's obligation to pay a portion of franchise fees collected to Shoney's, Inc. The reduction of this royalty fee expense from 1996 to 1997 was $758,000. The balance of the reduction in franchise operating expenses from 1996 to 1997 was due primarily to reduced expenses associated with loss of revenues from the cancellation of reservation services by two hotel chains in the first quarter of 1997.
General and administrative expense increased 83.2% to $4.0 million in fiscal 1997 from $2.2 million in 1996. This increase was due primarily to an increase in professional fees, payroll costs, insurance, internal development expenses, and taxes other than income taxes.
Depreciation and amortization expense increased by 32.0% to $10.4 million in fiscal 1997 from $7.9 million in fiscal 1996, due primarily to the 16 hotels opened during fiscal 1996 and fiscal 1997. This increase was partially offset by the effect of the change in accounting for pre-opening costs in 1997 to expense these costs as incurred. Consequently there was no pre-opening cost amortization in 1997 versus $550,000 reported for 1996.
Rent expense increased from $861,000 in 1996 to $2.0 million in 1997. The $1.1 million increase was due entirely to a sale/leaseback transaction on 14 of the Company's Sumner Suites hotels in the fourth quarter of 1997. Net rent expense on these 14 hotels is currently at a rate of approximately $9.0 million per year.
For 1997, interest expense and interest income increased $6.7 million and $371,000, respectively, from 1996, resulting in an increase in net interest expense of $6.3 million. The increase in interest expense resulted primarily from the additional borrowings incurred for the 16 hotels opened in 1996 and 1997.
Other income in fiscal 1997 increased by $3.1 million over fiscal 1996, from $1.6 million to $4.7 million. The increase was due primarily to gains of $1.6 million relating to the sale of excess land and $2.2 million relating to the sale of one hotel in 1997, compared with only $340,000 from the sale of excess land in 1996. Minority interests in earnings and losses of consolidated subsidiaries and partnerships decreased $250,000 in 1997 compared with 1996, due to less profitable consolidated entities which include minority ownership, the write-off of a $72,000 minority interest receivable in 1997, and the recovery of fees and expenses from a subsidiary partnership in 1997.
The lower effective income tax rate in 1997 is due primarily to refunds of prior years' state taxes.
The gain on disposal of a discontinued business segment in 1997 was the result of the recognition of previously deferred profit from the sale of the Company's 60% interest in a restaurant subsidiary to the then 40% owner.
The extraordinary loss on early extinguishment of debt in 1997 was due to approximately $10.5 million of equipment loans being paid off in connection with the sale/leaseback transaction with a real estate investment trust. The cumulative effect of a change in accounting principle represents the write-off of the unamortized balance of previously capitalized pre-opening costs as of the beginning of the 1997 fiscal year. Beginning with 1997, these costs are expensed as incurred.
For the Fiscal Years Ended December 29, 1996 and December 31, 1995
For the fiscal year ended December 29, 1996, total operating revenues declined 19.3% to $63.5 million from $78.6 million for the fiscal year ended December 31, 1995. However, revenues in fiscal 1995 included $21.9 million from the AmeriSuites Transaction, in contrast to only $775,000 from this source in fiscal 1996. Exclusive of the AmeriSuites Transaction, total revenues increased by $6.0 million, or 10.6%, from $56.7 million in fiscal 1995 to $62.7 million in fiscal 1996.
Revenues from hotel operations in fiscal 1996 increased 30.3% to $57.5 million from $44.1 million for fiscal 1995. This increase resulted primarily from more hotels being operated in fiscal 1996 as compared to fiscal 1995. Sixteen hotels which opened during fiscal 1995 and fiscal 1996 contributed $14.3 million more to revenues in fiscal 1996 than in fiscal 1995. One hotel which was sold during 1995, contributed $549,000 to hotel revenues in that year. Revenues from the 29 same-hotels declined slightly to $42.0 million in fiscal 1996 from $42.4 million in fiscal 1995. Average daily room rates from same-hotels increased 5.1% to $50.66 in fiscal 1996 from $48.18 in fiscal 1995, and average occupancy rates on these hotels decreased to 61.7% in fiscal 1996 from 64.5% in fiscal 1995. For all 45 hotels owned at the end of fiscal 1996, total revenues increased 32.0% to $57.5 million in fiscal 1996 from $43.6 million in fiscal 1995. These hotels reflected an increase of 12.8% in average daily room rates to $54.69 in fiscal 1996 from $48.49 in fiscal 1995, and average occupancy rates on these hotels declined to 58.9% in fiscal 1996 from 64.1% in fiscal 1995.
Revenues from regular construction and development activities for 1996 were $889,000 in contrast to $9.2 million for the prior year. Revenues from construction and development can vary widely from period to period depending upon the volume of outside contract work and the timing of those projects. Three outside construction projects were in progress during 1995 compared with only one during 1996. No outside construction contracts are currently in progress.
Revenues from Construction and development-other of $14.8 million in fiscal 1995, resulted from recognizing, in connection with the consummation of the AmeriSuites Transaction, profits deferred from fiscal 1993 and fiscal 1994 relating to the development and management of hotels for Suites of America. The Company's relationship with Suites of America ended on March 31, 1995, allowing portion of the previously deferred construction profit to be recognized in the first fiscal quarter of 1995. Additional previously deferred construction profit was recognized throughout fiscal 1995, with the final $775,000 recognized in 1996, when the balance of the note receivable from Suites of America was collected.
Revenue from the sale of hotels in 1995 was $4.2 million, net of profits not recognized on installment sales of $2.0 million, representing the sale of one hotel in 1995 in conjunction with the AmeriSuites Transaction. These net revenues were offset by the cost of hotels sold, resulting in no gross operating profit from these transactions.
Franchise revenues in fiscal 1996 increased 40.7% to $4.1 million from $2.9 million in fiscal 1995, as a result of an increase in the number of Shoney's Inn franchises sold, combined with franchisees' increased hotel revenues upon which royalty and reservation fees are based. At the end of fiscal 1996 there were 56 franchised Shoney's Inns in operation compared with 50 at the end of fiscal 1995. Management fee revenue in fiscal 1996 decreased to $185,000 from $3.3 million in fiscal 1995, due to the cancellation of management contracts on 11 hotels on March 31, 1995 as a part of the AmeriSuites Transaction, and to the cancellation of a management contract on one franchised Shoney's Inn in 1996. $2.9 million of the management revenue in 1995 had been previously deferred to 1995 when it was recognized in connection with the consummation of the AmeriSuite Transaction on March 31, 1995.
Hotel operating expenses for fiscal 1996 increased by 23.1% to $31.0 million from $25.2 million in fiscal 1995. The 16 hotels opened during fiscal 1995 and fiscal 1996, which were not in operation during the full year in either fiscal 1995 or fiscal 1996, accounted for $7.6 million of the total increase. Additionally, operating expenses for the 29 hotels operating for all of both years declined by $1.4 million, and operating expenses on the hotel sold during the first fiscal quarter of 1995 declined by $400,000. These increases and decreases in operating costs and expenses are related to the corresponding increases and decreases in operating revenues on these hotels. The resulting gross profit margin on the hotels operating for all of both years increased from 42.8% in fiscal 1995 to 45.7% in fiscal 1996.
Costs and expenses of construction and development for 1996 decreased to $1.2 million from $10.1 million for 1995. There were three outside construction contracts in 1995 compared to one during 1996.
Franchising operating expenses for 1996 increased 13.8% to $3.3 million from $2.9 million for the prior year, primarily due to additional expenses incurred by the reservation center in meeting the added demand from additional properties served by that department. As a result of the Shoney's Transaction, the Company will no longer be required to pay a portion of its franchise fee revenues to Shoney's in the form of royalty fees. During 1996, franchising operating expenses included $758,000 of royalty fees to Shoney's, compared to $980,000 in 1995.
General and administrative expense increased 11.9% to $2.2 million in fiscal 1996 from $1.9 million in fiscal 1995, due primarily to additional staffing levels for present and future growth of the Company, and to increased professional fees and expenses incurred.
Depreciation and amortization expense increased by 49.1% to $7.9 million in fiscal 1996 from $5.3 million in fiscal 1995, due primarily to the 16 hotels opened during fiscal 1995 and fiscal 1996. Rent expense increased 9.9% in 1996 over 1995 due primarily to rent paid based upon the financial performance of certain hotels.
For 1996, interest expense and interest income decreased $1.6 million and $4.4 million, respectively, from 1995, resulting in an increase in net interest expense of $2.8 million. The decrease in interest income resulted primarily from the collection of the balance of first mortgage notes receivable of approximately $44 million from Suites of America in the first quarter of 1996, which resulted in a reduction of interest income for 1996 of $4.2 million. The proceeds were used to reduce outstanding debt, significantly reducing interest expense for 1996 as compared to 1995. Additional borrowings to fund new hotels opened in 1996, however, offset a portion of this reduced interest expense.
Other income in fiscal 1996 increased to $1.6 million from $765,000 in fiscal 1995. The $834,000 increase was due to gains on the sale of securities available for sale and to a gain on the sale of excess land acquired for the development of a Company owned hotel.
The loss from discontinued operations, net of applicable income taxes and minority interest, in 1995 resulted from the Company's sale of its 60% interest in a restaurant subsidiary in the first quarter of 1996 to Mr. Don Knight, previously the 40% owner. Also, during fiscal 1996, a gain of $40,000 was recognized on the disposal of discontinued business segment. The extraordinary loss, net of income tax benefit, in 1995 represents the extraordinary non-cash write-off of unamortized deferred financing costs, and early redemption premiums paid, associated with the refinancing of certain indebtedness during 1995.
Liquidity and Capital Resources
The Company's cash flows used in operating activities were $2.4 million in 1997, compared with $15.8 million provided by operating activities in 1996 and $31.6 million provided in 1995. Fiscal 1995 was unusually high due to the AmeriSuites Transaction discussed above. A large payment of estimated income taxes in the fourth quarter of 1997 on taxable income on the sale/leaseback transaction, most of which does not constitute earnings in 1997 for financial statement purposes, resulted in a use of cash from operating activities. Deferred income taxes positively impacted cash flow by $6.9 million in fiscal 1995, due to the AmeriSuites Transaction. The $6.1 million in income taxes receivable in fiscal 1997 was due primarily to the overpayment of state and federal taxes totaling $6.1 million at fiscal year-end 1997, for which refunds are expected to be received in 1998. The decrease in accounts payable and accrued expenses in fiscal 1997 of $1.1 million contrasted to an increase in fiscal 1996 of $4.3 million, accounting for a total reduction in operating cash flows of $5.4 million from this source from fiscal 1996 to fiscal 1997.
The Company's cash flows provided by investing activities were $56.9 million in fiscal 1997, in contrast to cash flows used in investing activities of $41.0 million in fiscal 1996 and $47.9 million in fiscal 1995. The increase of $97.9 million in cash provided by investing activities in fiscal 1997 over fiscal 1996 was due primarily to the sale/leaseback of 14 hotels in 1997, of which net proceeds approximated $137.0 million. An additional $4.9 million in 1997 was provided from the sale of one other hotel and excess land. The Company requires capital principally for the construction and acquisition of new lodging facilities and the purchase of equipment and leasehold improvements. Capital expenditures for such purposes were $55.9 million in 1997, $86.6 million in 1996, and $56.2 million in 1995. The $44.1 million repayment from related parties in 1996 represented the collection by the Company of the balance of notes receivable from Suites of America, Inc. related to the AmeriSuites Transaction previously discussed.
Net cash provided by financing activities was $393,000 in 1997, $27.0 million in 1996 and $16.5 million in 1995. In November of 1996 the Company issued $33.2 million in 9.75% Senior Subordinated Notes, due 2006, Series A in the first series of notes issued under a $125 million shelf registration. In September of 1997 the Company issued $35.0 million of 9.55% Senior Subordinated Notes, due 2007, Series B under the Company's shelf registration. Net proceeds of both of these issues were used to reduce the outstanding balances under the Company's revolving credit facilities. A portion of the net proceeds from the sale/leaseback of 14 hotels in 1997 was also used to pay off the balance of the revolving credit facilities, a bank line of credit loan, and approximately $10.5 million of furniture, fixture and equipment loans. Proceeds from the financing of new furniture, fixtures and equipment were approximately $4.0 million in 1997 and $5.6 million in 1996. In fiscal 1996 the Company paid approximately $2.1 million to Shoney's Inc. to repurchase a stock warrant in conjunction with the Shoney's Transaction.
At December 28, 1997 the company had a $75.0 million unsecured three-year revolving credit facility with a group of five banks, which became effective April 30, 1997. The interest rate on this credit facility at December 28, 1997 was at the lender's base rate, or one hundred seventy-five basis points over the 30, 60, 90, or 180 day LIBOR rate, at the Company's option. Thereafter, the interest rate is based on the ratio of senior debt to EBITDA, as defined in the credit facility (the "Senior Leverage Ratio") and ranges from base rate to base rate plus 0.50% or 175 to 250 basis points over the 30, 60, 90, or 180 day LIBOR rate, at the Company's option. The Company pays commitment fees on the unused portion of the facility ranging from 0.20% to 0.50% based on the Senior Leverage Ratio and certain other fees under the credit facility. The credit facility contains covenants which, inter alia, limit or prohibit incurrences of certain additional indebtedness, liens on assets, investments, asset sales, mergers, dividends and amendments to indebtedness subordinated to the credit facility. It also contains financial covenants by the Company, including covenants with respect to net worth, indebtedness to total capitalization, interest coverage and the Senior Leverage Ratio. As of December 28, 1997, the Company had no borrowings outstanding under this credit facility.
Effective January 16, 1998, the company amended its $75.0 million unsecured three-year revolving credit facility with the same group of five banks. The interest rate on this amended credit facility is at the lender's base rate or one hundred seventy-five basis points over the 30, 60, 90, or 180 day LIBOR rate, at the Company's option. Thereafter, the interest rate is based on the ratio of senior debt to EBITDAR, as defined in the credit facility (the "Senior Leverage Ratio") and ranges from base rate minus .25% to base rate plus .50% or 150 to 250 basis points over the 30, 60, 90 or 180 day LIBOR rate, at the Company's option. The Company pays commitment fees on the unused portion of the facility ranging from .15% to .40% based on the Senior Leverage Ratio and certain other fees under the credit facility. The credit facility contains covenants which, inter alia, limit or prohibit incurrences of certain additional indebtedness, liens on assets, investments, asset sales, mergers, dividends and amendments to indebtedness subordinated to the credit facility. It also contains financial covenants by the Company, including covenants with respect to net worth, indebtedness to total capitalization, interest coverage and the Senior Leverage Ratio. Currently the Company has no borrowings outstanding under this credit facility.
The Company also has a $1.0 million unsecured line of credit with another bank, bearing interest at the lender's prime rate, maturing May 31, 1998. As of December 28, 1997, the Company had no borrowings outstanding under this credit facility.
The Company sold and leased back 14 Sumner Suites hotels for a total price of $140.0 million. The transaction was consummated in November 1997. The Company used the net proceeds to pay off its bank credit facilities and approximately $10.5 million of furniture, fixtures, and equipment loans on the hotels being sold and leased back. The balance of net proceeds was invested in short-term securities until needed to fund capital expenditures. The holders of the Company's Credit Facility consented to the sale/leaseback transaction provided that any outstanding balance under the Credit Facility
was paid off and no new balance was drawn under the Credit Facility prior to amendment of the terms of the Credit Facility, which occurred January 16, 1998.
The Company opened two Shoney's Inns and ten Sumner Suites hotels in 1996 and four Sumner Suites hotels in 1997. Additionally, renovations of several existing properties were completed in 1996 and 1997, and several others are scheduled for completion in fiscal 1998. Furthermore, the Company's new corporate headquarters building was completed in 1997. The Company currently has six Sumner Suites hotels under construction. In addition, the Company has another eight Sumner Suites hotels under contract which are scheduled to open in 1998. The Company expects that approximately $100 million in additional capital funds will be necessary through 1998 to fulfill these plans.
The Company has principal payments totaling approximately $2.6 million due under existing debt instruments through 1998. The Company believes that a combination of the balance of net proceeds from the sale/leaseback transaction, net cash provided from operations, borrowings under existing or new credit facilities, proceeds from sale of excess land and available furniture, fixtures, and equipment financing packages will be sufficient to fund its scheduled development and debt repayments for the next twelve months.
Year 2000 Compliance
The Company has commenced a comprehensive review of its computer systems to identify the systems that could be affected by the "Year 2000" issues and is developing an implementation plan to resolve the issue. The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's programs that have two-digit time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations. The Company has designated its Information Systems Director to coordinate its Year 2000 compliance program. Preliminary analysis has been conducted and areas have been identified where the Company might be most vulnerable. A sample of hardware and software has been tested and has operated satisfactorily. Vendors of all the major third party applications have been contacted and the Company is obtaining assurances of Year 2000 compliance from those vendors. The Company currently believes that it will be Year 2000 compliant on a timely basis to avoid any material operations disruptions. To date the Company has not identified any material expenditures which will be required to become Year 2000 compliant. However, there can be no assurance that such operations difficulties or expenditures will not be identified or experienced in the future.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Financial Statements required by Item 8 are filed at the end of this Report.
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 REGISTRANT.
The information concerning the directors and officers of the Company under the heading "Election of Director" and the information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934 under the heading "Delinquent Filings of Ownership Reports" to be contained in the Company's Proxy Statement with respect to the next Annual Meeting of Shareholders is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information under the heading "Executive Compensation" and the information under the heading "Performance Graph" to be contained in the Company's Proxy Statement with respect to the next Annual Meeting of Shareholders is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information under the heading "Security Ownership of Certain Beneficial Owners and Management" to be contained in the Company's Proxy Statement with respect to the next Annual Meeting of Shareholders is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information under the heading "Certain Transactions" to be contained in the Company's Proxy Statement with respect to the next Annual Meeting of Shareholders is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
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INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders ShoLodge, Inc. Hendersonville, Tennessee
We have audited the accompanying consolidated balance sheets of ShoLodge, Inc. and subsidiaries as of December 29, 1996 and December 28, 1997, and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the three years in the period ended December 28, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of ShoLodge, Inc. and subsidiaries as of December 29, 1996, and December 28, 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 28, 1997, in conformity with generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements the Company changed its method of accounting for pre-opening costs for the year ended December 28, 1997.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Nashville, Tennessee April 1, 1998
SHOLODGE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS DECEMBER 29, 1996 AND DECEMBER 28, 1997 - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
- --------------------------------------------------------------------------------
SHOLODGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS YEARS ENDED DECEMBER 31, 1995, DECEMBER 29, 1996 AND DECEMBER 28, 1997 - --------------------------------------------------------------------------------
SHOLODGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS - CONTINUED YEARS ENDED DECEMBER 31, 1995, DECEMBER 29, 1996 AND DECEMBER 28, 1997 - --------------------------------------------------------------------------------
(Concluded) See notes to consolidated financial statements.
SHOLODGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, DECEMBER 29, 1996 AND DECEMBER 28, 1997 - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
SHOLODGE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, DECEMBER 29, 1996 AND DECEMBER 28, 1997 - --------------------------------------------------------------------------------
See notes to consolidated financial statements.
SHOLODGE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1995, DECEMBER 29, 1996 AND DECEMBER 28, 1997 - --------------------------------------------------------------------------------
1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The business activities of ShoLodge, Inc. and subsidiaries (the "Company") are composed primarily of owning, franchising, managing and constructing lodging facilities. A summary of the significant accounting policies used in the preparation of the accompanying consolidated financial statements follows.
THE CONSOLIDATED FINANCIAL STATEMENTS include the accounts of the Company and its majority-owned and controlled subsidiaries and partnerships. The Company is the managing general partner in the partnership entities. All significant intercompany items and transactions have been eliminated.
THE FISCAL YEAR of the Company consists of 52/53 weeks ending the last Sunday of the calendar year.
ACCOUNTING ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS include highly liquid investments with original maturities of three months or less. At December 28, 1997, remaining proceeds from the sale transaction described in Note 17 are invested in cash equivalents.
PROPERTY AND EQUIPMENT is recorded at cost. Depreciation is computed primarily on the straight-line method over the estimated useful lives of the related assets, generally forty years for buildings and improvements and seven years for furniture, fixtures and equipment. Equipment under capitalized leases is amortized over the shorter of the estimated useful lives of the related assets or the lease term using the straight-line method. Significant improvements are capitalized while maintenance and repairs are expensed as incurred. The Company capitalizes interest on construction and development costs using the effective interest rate on outstanding debt.
LAND UNDER DEVELOPMENT OR HELD FOR SALE consists of excess land adjacent to Company owned hotels. The Company actively develops these sites to enhance the profitability of the hotels. The profit on sales of these sites is included in other income.
DEFERRED CHARGES include loan costs incurred in obtaining financing and are amortized using the interest method over the respective lives of the related debt. In addition, deferred charges include cost incurred in amending the Company's franchise license agreement (see Note 16). This charge is being amortized on the straight-line method over twenty years. The amounts reported are net of accumulated amortization of $4,734,566 and $5,703,264 as of December 29, 1996 and December 28, 1997, respectively.
INVESTMENTS. The Company's investment securities have been classified as either available-for-sale or held to maturity. The available-for-sale securities are carried at fair value with unrealized holding gains
and losses, net of tax effects, reported as a separate component of shareholders' equity. The held to maturity securities are carried at amortized cost.
INTANGIBLE ASSETS include excess of cost over fair value of net assets acquired (goodwill) in the amount of $3,136,965 at December 29, 1996 and $2,986,992 at December 28, 1997, which is amortized on the straight-line method over a period of twenty-five years. The amounts reported are net of accumulated amortization of $612,361 and $762,334 as of 1996 and 1997, respectively. In addition, costs of trademark is included in the amount of $448,733 as of 1997 and is amortized on the straight-line method over a period of twenty years. This amount is net of accumulated amortization of $10,600.
OTHER ASSETS include long-term portion of notes receivables, cash surrender value of life insurance, and base linens stock. Base linens stock is amortized to fifty percent of its initial cost on a straight-line basis over a thirty-six month period.
ASSET IMPAIRMENT. The Company accounts for asset impairment according to Statement of Financial Accounting Standards ("SFAS") No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The Company assesses the recoverability of property and equipment and other long-lived assets using undiscounted cash flows and, if impairment is present, discounted cash flows to determine the amount of impairment.
ADVERTISING. The Company charges the costs of advertising to expense at the time the costs are incurred. Advertising expense was approximately $1,620,000, $2,012,000 and $2,988,000 for the years ended December 31, 1995, December 29, 1996 and December 28, 1997, respectively.
INCOME TAXES. The Company reports income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Under SFAS No. 109 the asset and liability method is used for computing future income tax consequences of events which have been recognized in the Company's consolidated financial statements or income tax returns.
REVENUES from hotel operations are recognized as services are rendered, while construction and development revenues, which relate to construction and development of hotel properties for others, are recognized based on the percentage of completion method. Franchising and management revenues are recognized under the accrual basis of accounting.
EARNINGS PER COMMON SHARE for all periods has been computed in accordance with SFAS No. 128, Earnings per Share. Basic earnings per share is computed by dividing earnings by the weighted average number of common shares outstanding during the year. Diluted earnings per common share is computed by dividing earnings by weighted average number of common shares outstanding during the year plus incremental shares that would have been outstanding upon the assumed exercise of dilutive options and the assumed conversion of dilutive debentures. See Note 10 for a reconciliation of basic and diluted earnings per share.
STOCK-BASED COMPENSATION. SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to adopt the fair value method of accounting for stock-based compensation. The Company has chosen to continue to account for stock-based employee compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations.
CONCENTRATIONS OF CREDIT RISK. Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash investments and trade receivables. The Company places its cash investments with high credit quality financial institutions who are members of the FDIC thus reducing any potential risk. Concentrations of credit risk with respect to trade
receivables are limited due to the Company's large number of customers and their dispersion across many geographic areas.
RECENTLY ISSUED ACCOUNTING STANDARDS. In June 1997, SFAS No. 130, Reporting Comprehensive Income, was issued and will become effective for the Company in 1998. Management does not expect the adoption of this standard to have a material impact on its consolidated financial statements, except to the extent that unrealized gains and losses on available-for-sale securities are included in comprehensive income.
Also in June 1997, SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, was issued. This standard will become effective for the Company in 1998; however, management does not expect the adoption of this standard to have a material impact on the consolidated financial statements.
RECLASSIFICATIONS. Certain reclassifications have been made in the 1995 and 1996 consolidated financial statements to conform to the classifications used in 1997.
2. ACCOUNTING CHANGE
In the fourth quarter of fiscal 1997, the Company changed its method of accounting for pre-opening costs, effective December 30, 1996, whereby pre-opening costs are expensed as incurred rather than the previous method of capitalizing such costs and amortizing them over a three-year period. The Company believes the new method is preferable in the circumstances and conforms to the predominant practice in the industry.
The cumulative effect of the change for periods prior to fiscal 1997, net of income tax effect, is a reduction in net earnings of $1,164,114 or $0.14 per share and was recognized in the first quarter of 1997. The pro forma effect on fiscal 1996, as if the change in accounting for pre-opening costs had been adopted prior to fiscal 1996, would be to increase hotel operating expenses by $1,264,558 and to reduce depreciation and amortization expense by $549,982, resulting in a reduction of earnings before income taxes of $714,576 ($449,409 after income taxes) to $9,047,315, or $1.08 per diluted share for the year ended 1996, from $9,496,724 or $1.12 per diluted share as previously reported. The pro forma effect on fiscal 1995, as if the change in accounting for pre-opening costs had been adopted prior to fiscal 1995, would be to increase hotel operating expenses by $462,159 and to reduce depreciation and amortization expense by $355,667, resulting in a reduction of earnings before income taxes of $106,492 ($66,345 after income taxes) to $16,910,587, or $1.79 per diluted share for the year ended 1995, from $16,976,932 or $1.80 per diluted share as previously reported.
3. INVESTMENT SECURITIES
The cost, unrealized gain and fair value of the equity securities available-for-sale are as follows:
The Company is required to maintain certain restricted investments in U.S. Treasury securities (see Note 7). The securities are classified as held to maturity and are carried at cost adjusted on the interest method for accretion of discounts which is recognized as interest income.
4. DIRECT FINANCING LEASES
Direct financing leases consist of:
Minimum lease payments to be received from direct financing leases are as follows:
The lease terms are primarily twenty years with renewal options for various periods. The property leased consists primarily of retail restaurant properties. Future minimum lease payments do not include amounts for contingent rentals. Minimum rental income recorded under these leases was $106,450 for each of the three years in the period ended December 28, 1997 and contingent rentals received were approximately $164,000, $144,000 and $116,090, during the years ended December 31, 1995, December 29, 1996 and December 28, 1997, respectively.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of:
Interest costs capitalized during the years ended December 31, 1995, December 29, 1996 and December 28, 1997 were approximately $1,930,000, $4,657,000, and $3,485,000, respectively.
6. OTHER ASSETS
Other assets consist of:
7. LONG-TERM DEBT
Long-term debt associated with lodging facilities consists of:
Other long-term debt consists of:
All Industrial Revenue Bonds ("IRB's") and substantially all notes payable are collateralized by property and equipment. Additionally, all IRB's as of December 28, 1997 are collateralized by irrevocable letters of credit, approximately $3,788,240 of which is guaranteed by a related party and approximately $12,230,300 is guaranteed by the Company. The Revenue Participation Bonds ("RPB's") are secured by U.S. Treasury securities having a book value of approximately $8,947,000 as of December 28, 1997 (see Note 3). These securities, upon maturity, will fund the complete obligation under the RPB's. In addition, all obligations under the RPB's are collateralized by an assignment of gross room revenues.
Throughout the year ended December 31, 1995, the Company repaid approximately $15,070,000 of fixed rate IRB's with proceeds from the issuance of variable rate industrial revenue refunding bonds. The refunding bonds bear interest at a rate determined weekly by the bond's remarketing agent whereas the original bonds bore interest at fixed rates ranging from 6.5% to 10%. The early retirement of the indebtedness resulted in an extraordinary pretax charge of approximately $1,128,000 during the year ended December 31, 1995.
The $11,355,000 RPB's require a 40% participation in the gross room revenues of Shoney's Inns Group IV, Inc. payable to the bondholders in semiannual installments through April 15, 2001. The effective interest rate on these bonds was 9.3%, 9.4%, and 9.5%, respectively, for the years ended December 31, 1995, December 29, 1996 and December 28, 1997.
During June 1994, the Company issued $54,000,000 of 7.50% convertible subordinated debentures maturing in May 2004 with interest payable in semi-annual installments. The debentures are convertible at any time before maturity, unless previously redeemed, into common stock of the Company at a conversion price of $23.31 per share, subject to adjustment. The debentures are unsecured and subordinated in right of payment to the prior payment in full of all existing and future senior indebtedness as defined in the debentures. The Company, at its option, can redeem the bonds beginning in May 1997 at 105.25% of par, declining .75% each year thereafter to par in May 2004.
During November 1996, the Company issued $33,150,000 of 9.75% Senior subordinated notes, Series A, under an aggregate $125,000,000 Senior subordinated indenture agreement. The notes mature in November 2006, with interest payable quarterly. The notes are unsecured and subordinated in right of payment to the prior payment in full of all existing and future senior indebtedness of the Company. Additionally, in September 1997, the Company issued $35,000,000 of 9.55% senior subordinated notes, Series B, also under the aggregate $125,000,000 senior subordinated indenture agreement. The notes mature in September 2007, with interest payable quarterly. The notes are unsecured and subordinated in right of payment in full of all other senior indebtedness of the Company and will be senior in right of payment to, or pari passu with, all other subordinated indebtedness of the Company, including the Series A notes.
At December 29, 1996, the Company had approximately $22,100,000 of borrowings outstanding under unsecured lines of credit aggregating $54,000,000. Effective April 30, 1997, the Company consolidated certain unsecured lines of credit into an unsecured $75 million, three-year revolving credit facility with a group of five banks. The interest rate on this credit facility at December 28, 1997 was at the lender's base rate, or one hundred seventy-five basis points over the 30, 60, 90 or 180 day LIBOR rate, at the Company's option. There were no amounts outstanding under this credit facility at December 28, 1997. In January 1998, the Company amended its revolving credit facility for changes in certain financial covenants. The Company also has a $1,000,000 unsecured line of credit with another bank, of which no amounts are outstanding at December 28, 1997.
The loan agreements contain certain financial covenants of which the most restrictive includes maintenance of certain operating ratios, minimum liquidity ratios, interest coverage and minimum tangible net worth. The Company was in compliance with all financial covenants.
In November 1997, the Company repaid approximately $10,500,000 of equipment loans with the proceeds of the sale/leaseback transaction (Note 17). This early retirement of loans resulted in an extraordinary pretax charge of approximately $287,000 for the year ended December 28, 1997.
Maturities of long-term debt are as follows:
8. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries lease certain property and equipment under noncancelable operating and capitalized lease agreements. Total rental expense under operating leases for the years ended December 31, 1995, December 29, 1996 and December 28, 1997 was approximately $1,541,000, $1,355,000 and $1,177,000, respectively.
Minimum rental commitments are as follows:
In addition to the operating leases above, the Company is also committed to minimum annual lease payments of $14,000,000 through November 2007, related to the sale/leaseback transaction entered into in the current year (see Note 17).
The Company is self-insured for workers' compensation benefits up to $500,000 annually in aggregate and $250,000 per occurrence and has recorded a reserve for all outstanding claims at December 28, 1997. While the Company's ultimate liability may exceed or be less than the amount accrued, the Company believes that it is unlikely that it would experience losses that would be materially in excess of such estimated amounts. In addition to the reserves recorded, the Company had outstanding letters of credit in the amount of $610,000 and $667,000, as of December 29, 1996 and December 28, 1997, respectively, to satisfy workers compensation self insurance security deposit requirements.
The Company is a party to legal proceedings incidental to its business. In the opinion of management, any ultimate liability with respect to these actions will not materially affect the consolidated financial position or results of operations of the Company.
On March 31, 1998, the Company was named as a defendant in a purported class action lawsuit filed by a shareholder of the Company. The lawsuit alleges that the Company violated Section 10(b) of the Securities Exchange Act of 1934 by issuing allegedly false and misleading statements and financial information. The lawsuit also names three officers of the Company. The Company intends to defend the case vigorously.
9. SUITES OF AMERICA TRANSACTIONS
On March 31, 1995, the Company, and Suites of America, Inc. ("Suites"), a wholly-owned subsidiary of Prime Hospitality Corp. ("Prime") entered into an agreement (the "Cancellation Agreement") under which the Company sold its option to acquire 50% of the voting stock of Suites for approximately $27,327,000. In addition, the Company conveyed one AmeriSuites hotel to Suites for approximately $6,174,000. Approximately $4,997,000 of the aggregate purchase price of $33,501,000 was paid upon closing with the remaining $28,504,000, along with approximately $25,015,000 of existing indebtedness from Suites, consolidated into one note. Approximately $14,880,000 of existing indebtedness from Suites was canceled by the Company in connection with the sale of the option. The transactions have been accounted for as installment sales of real estate in the accompanying 1995 and 1996 consolidated financial statements. As of January 1996, the note was fully repaid and the Company recorded gains of $14,826,675 and $775,000 for the years ended December 31, 1995 and December 29, 1996, respectively.
Prior to March 31, 1995, the Company operated all AmeriSuites hotels for Suites under formal management agreements in return for management fees based upon a percentage of the annual gross revenues of each hotel. The Company also received a profit participation fee on certain of the hotels managed based upon a percentage of the cash flows of each hotel. During January 1993, the Company entered into an agreement with Suites whereby the Company had the right, exercisable in whole or in part, to relinquish its profit participation in all or any of four hotels owned by Suites and managed by the Company in exchange for payments aggregating up to $2,862,000. During fiscal 1993 and 1994, the Company elected to exercise its right to relinquish its profit participation in all of the hotels, and the entire $2,862,000, which was originally deferred, was recognized during the year ended December 31, 1995 upon the sale of the option. Concurrent with the execution of the Cancellation Agreement, all of the management agreements were terminated.
10. EARNINGS PER SHARE
The following tables reconcile earnings and weighted average shares used in the earnings per share ("EPS") calculations for fiscal years 1997, 1996 and 1995:
Bonds convertible into 2,316,602 shares of stock were outstanding at December 28, 1997, but were not included in the computation of diluted EPS as such securities were anti-dilutive.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, Disclosures About Fair Value of Financial Instruments. The carrying value of cash and cash equivalents, and borrowings under lines of credit approximate fair values due to the short-term maturities of these instruments. The carrying value of certain industrial revenue bonds approximate fair values due to the recent refinancing of these instruments, while the fair value of all other industrial revenue bonds was estimated based upon current rates available to the Company upon refinancing of similar properties. The fair value of convertible subordinated debentures and senior subordinated notes was based upon quoted market prices. In the opinion of management, the carrying value of all instruments approximates market value as of December 29, 1996 and December 28, 1997.
As of December 29, 1996 and December 28, 1997, securities available-for-sale are carried at fair value in accordance with SFAS No. 115. It was not practicable to estimate the fair value of the restricted securities held to maturity and the related revenue participation bonds. As discussed in Note 7, the restricted securities, upon maturity, will be used to fund the complete obligation under the bonds.
12. STOCK WARRANT
In connection with the Company's acquisition of Shoney's Lodging, Inc. in 1991, the Company issued a warrant to a wholly-owned subsidiary of Shoney's, Inc. ("Shoney's") to purchase five percent of the
Company's common stock that is issued and outstanding on the date of exercise of the warrant. During October 1996, the Company repurchased the warrant for approximately $2,064,000. This transaction was recorded as a reduction of shareholders' equity in the accompanying consolidated financial statements for the year ended December 29, 1996.
13. STOCK OPTION PLAN
During December 1991, the Company adopted the 1991 Stock Option Plan (the "Plan") that authorizes the grant to key employees of options to purchase up to an aggregate of 616,667 shares of common stock. The exercise price of options granted under the terms of the Plan must not be less than 100% of the fair market value of the shares as of the date of grant, or 110% of the fair market value for incentive stock options granted to option holders possessing more than 10% of the total combined voting power of all classes of stock of the Company. Under the Plan, the options are exercisable at various periods from one to five years after date of grant and expire ten years after date of grant. During the year ended December 29, 1996 an additional 283,333 shares were authorized for future grants.
A summary of the status of the Plan for the years ended December 31, 1995, December 29, 1996 and December 28, 1997, follows:
On July 31, 1996, the Company repriced approximately 168,000 stock options that had been granted in previous years. The options were repriced to $13.00 per share, which was the market value of the Company's stock on July 31, 1996. These repriced options are included as cancellations and new grants in the table above for the year ended December 29, 1996.
The weighted average fair value of options granted during the year was $8.75 and $9.09 for the year ended December 29, 1996 and December 28, 1997, respectively.
The following table summarizes information relating to the stock options outstanding as of December 28, 1997:
Had the fair value of options granted under the plan beginning in 1995 been recognized as compensation expense on a straight-line basis over the vesting period of the options, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
The pro forma effect on net earnings for 1995, 1996 and 1997 is not representative of the pro forma effect on net earnings in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995.
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 1995, 1996 and 1997: no dividend yield for all years; expected volatility of 40%, 45% and 52%, respectively; risk free interest rates of 6.09%, 6.79% and 6.67%, respectively; and expected lives of 10, 10 and 9 years, respectively.
14. SHAREHOLDERS' EQUITY
During October 1996, in conjunction with the amendment of the Company's franchise license agreement with Shoney's, all Series A redeemable nonparticipating stock was repurchased by the Company (see Note 16). The Company's charter authorizes the issuance of 1,000 shares of Series A stock, without par value, however as of December 28, 1997 none has been issued.
The Company's charter authorizes the issuance of 1,000,000 shares of preferred stock without par value. As of December 28, 1997, none has been issued.
15. INCOME TAXES
The provision for income taxes from continuing operations consists of the following:
The difference between income taxes using the effective income tax rate and the statutory federal income tax rate is as follows:
Deferred tax (liabilities) assets are comprised of the following:
As of December 29, 1996, $217,000 of the deferred tax liability was current due to the nature of the items that created the temporary differences. This current deferred tax liability and a current income tax payable of $900,000 is classified as current income taxes payable in the accompanying consolidated balance sheet as of December 29, 1996.
Additionally, as of December 29, 1996 and December 28, 1997, the Company has recorded a deferred tax liability resulting from the unrealized gain on securities available-for-sale of $30,000 and $59,000, respectively.
In December 1997, the Company recorded state income tax refunds attributable to certain restructuring changes. The effect of these refunds has been included as a reduction to the state income tax provision, net of the federal taxes due on such amount.
In accordance with SFAS No. 109, the Company has determined that no valuation allowance is required as management believes it is more likely than not that the benefits of these deferred tax assets will be realized.
16. RELATED PARTY TRANSACTIONS
The Company has had extensive working and contractual relationships with Shoney's which previously held a stock warrant to purchase five percent of the Company's common stock and all of the Company's Series A redeemable nonparticipating stock. In addition, two officers of Shoney's had previously served as directors of the Company. During October 1996, the Company repurchased the stock warrant (see Note 12). As of the same date, the Company amended the franchise license agreement between the Company and Shoney's whereby the Company paid approximately $5,395,000 in exchange for, among other items, 1) the cancellation of Shoney's right to receive a portion of the franchise fees collected by the Company equal to approximately 1.5% of certain Shoney's Inns' gross room revenues through October 1999 and .5% of the remaining and all future Shoney's Inns' gross room revenues for the first ten years of their operations and 2) the repurchase of all of the Company's Series A redeemable nonparticipating stock (see Note 14). As a result of the Company's repurchase of the Series A redeemable nonparticipating stock, Shoney's no longer has the right to designate two members of the Company's board of directors.
The Company has paid approximately $922,000 and $911,000 in franchise and royalty fees to Shoney's during the years ended December 31, 1995 and December 29, 1996, respectively, under the franchise license agreement. Additionally, the Company purchased food products and supplies approximating $1,979,000 from a wholly-owned subsidiary of Shoney's during the year ended December 31, 1995.
Effective January 1, 1996, the Company sold its sixty percent interest in Knight Enterprises, Inc. ("KEI") to the minority shareholder in exchange for approximately $848,000. The entire purchase price, along with approximately $1,250,000 of previously existing indebtedness of KEI and the minority shareholder, was financed by the Company over a seven year period with interest accruing annually at the prime rate as defined in the note agreements. As a result of the transaction, the restaurant business segment operations are reported as discontinued operations in the accompanying consolidated financial statements for the period ended December 31, 1995. The Company initially deferred recognition of the approximate $853,000 gain from the sale of this segment until such time further principal payments on the note were received which would support full collectibility of the note. For the year ended December 29, 1996, approximately $40,000 was recorded as a gain on disposal of discontinued business segment. In December 1997, management determined the amount to be fully collectible based on positive cash flows of the restaurants and past collection experience, therefore the remaining $813,000 was recorded as a gain on disposal of discontinued business segment for the year ended December 28, 1997.
During 1996, the Company sold approximately 175,600 shares of its available-for-sale investment securities to the Company's chairman and chief executive officer. The average cost of these securities was approximately $1,117,000 and the total cash proceeds received was approximately $1,847,000 resulting in a realized gain of $730,000. The total value received for these securities approximated fair value based upon quoted market prices. The gain is recorded in other income in the accompanying consolidated financial statements for the year ended December 29, 1996.
17. SALE/LEASEBACK TRANSACTION
In November 1997, the Company entered into a sale and leaseback agreement for certain of its Sumner Suites hotels. The assets of the hotels were sold to a real estate investment trust and the hotels continue to be operated by the Company. The lease is classified as an operating lease in accordance with SFAS No. 13, Accounting for Leases. The original lease term is for ten years with five renewal periods of ten years each.
The Company sold assets with a net book value of approximately $101.5 million in exchange for $140 million in cash. The gain of approximately $34.9 million has been deferred and will be recognized on the straight-line method over the 10 year lease term as adjustments to rent expense. The minimum base rental is $14 million annually with contingent rent due of 8% of the excess of the leased hotels base revenues (as defined in the lease agreement) beginning in 1999.
The Company was required to pay a deposit of $14 million to be retained by the purchaser in the event of default or nonobservance of the lease agreement. The deposit will be refunded to the Company at the end of the lease term in the event no default has occurred. This non-interest bearing deposit is included in long-term deposits on sale/leaseback.
The Company was also required to provide an additional deposit of $14 million. This deposit, included in long-term deposits on sale/leaseback, earns interest at a rate of 11.11% annually. Interest earned is credited to the required rent payment due the lessor. The Company will have the deposit refunded upon the earlier of achievement of certain operating results of the leased hotels or expiration of the lease.
18. SUPPLEMENTAL CASH FLOW INFORMATION
19. BUSINESS SEGMENT INFORMATION
The Company's significant business segments include hotel operations and construction and development. In fiscal 1997, the Company did not recognize any revenues from construction and development as all such activities were for internal projects and, therefore, revenues and expenses were
eliminated in consolidation. None of the Company's segments conduct foreign operations. Operating profit includes the operating revenues and expenses directly identifiable with the business segment. Identifiable assets are those used directly in the operations of each segment.
20. Subsequent Events (unaudited)
On April 10, 1998, the Company terminated its chief financial officer. There may be certain claims arising out of that termination.
In the opinion of management, any potential losses arising out of such claims will not have a material adverse effect on the financial condition of the Company. Losses, if any, cannot be determined at this time.
* * * * * *
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders ShoLodge, Inc. Hendersonville, Tennessee
We have audited the consolidated financial statements of ShoLodge, Inc. and subsidiaries as of December 29, 1996 and December 28, 1997, and for each of the three years in the period ended December 28, 1997 and have issued our report thereon dated April 1, 1998, such report is included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedule of ShoLodge, Inc. listed in Item 14. This consolidated financial statements schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Nashville, Tennessee April 1, 1998
S-1
SHOLODGE, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS SCHEDULE II - -------------------------------------------------------------------------------
S-2
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The Registrant agrees to furnish to the Securities and Exchange Commission, upon request, any and all instruments defining the rights of holders of long-term debt of the Registrant and its subsidiaries, the total amount of which does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis.
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* Filed herewith
(b) No reports on Form 8-K were filed during the fourth quarter ended December 28, 1997 except the following:
Form 8-K dated October 24, 1997 relating to the sale and leaseback of certain Sumner Suites to Hospitality Properties Trust.
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Form 8-K dated November 19, 1997 relating to the sale and leaseback of certain Sumner Suites to Hospitality Properties Trust.
(c) Exhibits required by Item 601 of Regulation S-K are listed above.
(d) All financial statement schedules required by Regulation S-X are filed following the Financial Statements listed above.
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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 to be signed on its behalf by the undersigned, thereunto duly authorized.
SHOLODGE, INC.
By: /s/ Leon Moore ------------------------------------ Leon Moore, President and Chief Executive Officer
April 9, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
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