ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Hospitality Worldwide Services, Inc. (the "Company"), formerly known as Light Savers U.S.A., Inc., was formed under the laws of the State of New York in October 1991. In January 1994, the Company consummated an initial public offering of its common stock. At such time, the Company's principal line of business was to design and market decorative, energy efficient lighting fixtures for the hotel and hospitality industry. The Company's primary marketing tool was the utilization of Con Edison's Applepower Rebate Program (the "Rebate Program"), under which Con Edison offered rebates to those who utilized energy saving devices, such as the Company's lighting fixtures. In 1994, Con Edison substantially reduced the Con Edison Rebate Program, making it less advantageous for the Company to use the Rebate Program as a marketing tool. As a result, the Company's revenues were substantially reduced.
In August 1995, the Company acquired substantially all of the assets and assumed certain liabilities of AGF Interior Services Co., a Florida Corporation ("AGF"), a company that, through its wholly-owned subsidiary, Hospitality Restoration & Builders, Inc., a New York Corporation ("HRB") provided renovation services to the hospitality industry. In December 1995, the Company's Board of Directors, in response to Con Edison's decision to reduce substantially the Con Edison Rebate Program, determined to dispose of the Company's lighting business and concentrate the Company's efforts on renovation services. In February 1996, the Company, AGF, Tova Schwartz, the Company's former President and Chief Executive Officer, and certain other parties thereto entered into a Divestiture, Settlement and Reorganization Agreement (the "Divestiture Agreement") pursuant to which, among other things, (i) the Company sold its lighting business to Tova Schwartz; (ii) Ms. Schwartz resigned from her positions as a director and officer of both the Company and HRB; (iii) the Company repurchased 500,000 shares of Common Stock, $.01 par value of the Company (the "Common Stock") from Ms. Schwartz for $250,000 (which shares were subsequently sold by the Company in a private placement offering); (iv) Ms. Schwartz granted to the Company an option to purchase an additional 1,000,000 shares of Common Stock (all of which were subsequently repurchased by the Company and later sold by the Company); and (v) the Company agreed to pay Ms. Schwartz consulting fees for a period of three years of $100,000 per year.
In October 1996, the Company changed its name from Light Savers, U.S.A., Inc., to Hospitality Worldwide Services, Inc. The change of the corporate name is more indicative of the nature of the Company's business in view of the significant change in the character and strategic focus resulting from the acquisition of AGF and disposal of the Company's lighting business. These transactions were part of a strategic corporate program to refocus the Company's business operations into areas with higher growth potential.
Until January 1997, the Company's only line of business was to provide, through HRB, a complete package of renovation services to the hospitality industry ranging from pre-planning and scope preparation of a project to
performing the renovation requirements and delivering furnished rooms. HRB offers hospitality maintenance services to hotels and hotel chains throughout the continental United States. For over 19 years the Company's renovation division has provided to the hospitality industry renovation and improvements such as vinyl, paint, wallpaper, carpet, installation of new furniture, light carpentry, and masonry work. HRB generally provides its renovation services in an on time, on budget manner, while causing little or no disruption to the ongoing operation of a hotel. HRB has successfully responded to the hotel industry's efforts to increase occupancy, room rates and market share through cosmetic upgrades, which are generally required every four to seven years.
In January 1997, the Company completed the acquisition of The Leonard Parker Company, ("LPC") and its subsidiary, Parker Reorder Online ("Parker Reorder"). LPC, founded in 1969, is a leading purchasing company for the hospitality industry which acts as an agent or principal for the purchase of goods and services for its customers which include major hotel and management companies worldwide. LPC purchases furniture, fixtures and equipment, kitchen supplies, linens and uniforms, guestroom amenities, and other supplies to meet its customers' requirements for new hotel openings and major renovations. LPC purchases annually approximately $350 million of goods and services for its customers. Parker Reorder has developed and is marketing a new proprietary software product, Parker Fully Integrated Reorder Systems Tracking ("Parker FIRST"), which allows clients to reorder operating supplies and equipment ("OS & E") and other products on-line and will provide such clients with access to forecasting and product evaluation capabilities. Parker Reorder offers hotel properties the ability to order, on an as needed basis, any and all OS & E products used by such properties. Parker Reorder does not plan to sell or lease its Parker FIRST software to customers. Instead, commencing in 1998, Parker Reorder has installed the Parker FIRST software at hotel properties and charges the hotel properties a service fee based on the volume of transactions. The purchase price of LPC and Parker Reorder, including acquisition costs and after final adjustments, was approximately $12,140,000 which consisted primarily of 1,250,000 newly issued shares of Common Stock and $5 million stated value of 200,000 newly issued shares of 6% convertible preferred stock of the Company (the "LPC Preferred"). In October 1998, 80,000 shares of LPC Preferred were converted into an aggregate of 584,800 shares of Common Stock. The remaining LPC Preferred is convertible until January 10, 2000, into (i) 600,000 shares of the Company's common stock, subject to an upward adjustment in the event that the market price of the Company's common stock is below $5.00 at the time of conversion, based on a defined conversion formula, up to a maximum of 2,400,000 shares, or (ii) 5.88% of the outstanding capital stock of Parker Reorder. The conversion formula related to the conversion into the Company's common stock is defined as the number of shares of common stock equal to the product of 25 (which represents the stated value per share of the LPC Preferred) and the number of shares of LPC Preferred, divided by the average closing sale price for the common stock for the 20 trading days immediately prior to the date written notice of the intention to exercise the conversion option is given, provided, however, that in no case shall the number of shares of common stock into which each share of LPC Preferred may be converted be less than 5 or greater than 20. At any time after January 10, 2000, the Company shall have the option to redeem the LPC Preferred at a redemption price equal to the Stated Value for each such share of LPC Preferred, plus an amount equal to all accrued and unpaid Preferred Dividends and interest thereon, if any. The acquisition has been accounted for as a purchase with the results of LPC included in the consolidated financial statements of the Company from the acquisition date. With the consent of the Company, Watermark Investments Limited, LLC ("Watermark"), an affiliate of Robert Berman, Chairman and Chief Executive Officer of the Company, has entered into a Stock Purchase Agreement dated March 30, 1999 to purchase the LPC Preferred no later than April 26, 1999.
In May 1997, the Company entered into a joint venture ("Apollo Joint Venture") with Apollo Real Estate Advisors II, L.P. ("Apollo") and Watermark to identify, acquire, renovate, refurbish and sell hotel properties. The Company will perform all of the renovation and procurement services for each of the properties purchased by the Apollo Joint Venture. In addition, the Company will receive an equity interest in each of the entities formed to purchase such properties equal to its contribution to the total equity required to acquire, renovate and sell such properties. The Apollo Joint Venture intends to own and operate the properties only for the time necessary to upgrade and market them for resale. As an inducement to enter into the Joint Venture Agreement, the Company issued to Apollo a seven-year warrant to purchase 750,000 shares of Common Stock at $8.115 per share (the average closing price of the Common Stock for the 20 trading days prior to issuance). The warrant expires in 2004. The warrant is currently exercisable as to 350,000 shares and becomes exercisable as to the remaining 400,000 shares in increments of 100,000 shares for every $7,500,000 of incremental renovation revenue and purchasing fees earned and to be earned by the Company from the Apollo Joint Venture. In September 1997, the Apollo Joint Venture acquired the Warwick Hotel in Philadelphia, Pennsylvania. As of March 30, 1999, the Company
contributed approximately $875,000 to the joint venture operating entity that was formed to purchase the property. There are no additional material capital commitments to be made by the Company with respect to this project. The joint venture operating entity is owned 95% by the general partner, which is owned by Apollo and Watermark, and 5% by the Company as a limited partner. The Company is accounting for this investment on the cost method as all decisions are made by the general partner. In addition, in March 1998 the Apollo Joint Venture acquired the Historic Inn in Richmond, Virginia. As of March 30, 1999, the Company has made capital contributions totaling $275,000 to the joint venture operating entity that was formed in connection with the purchase of the property. There are no additional material capital commitments to be made by the Company with respect to this project. The joint venture operating entity is owned 57% by Apollo, 3% by the Company and 40% by the former sole owner. The Company is accounting for this investment on the cost method. The Company is fully renovating and refurbishing these properties pursuant to contracts with the Apollo Joint Venture operating entity.
In November 1997, the Company formed a wholly owned subsidiary, Hospitality Construction Corporation ("HCC"). HCC specialized in projects such as new construction or "footprint" moving (re-designation of walls and related remodeling). Operations under this subsidiary were transferred to HRB in August 1998.
On January 6, 1998, the Company reached an agreement in principle to enter into a master development agreement with Prime Hospitality Corp. ("Prime") to develop up to 20 hotel properties over a two-year period under the AmeriSuites brand name. In June 1998, the Company and Prime executed the master development agreement. Under the agreement, the Company was responsible for identification of target markets, specific site identification through its wholly-owned subsidiary HWS Real Estate Advisory Group, Inc. ("HWS REAG"), negotiation, due diligence, entitlement, planning, zoning and other approval requirements, selection of contractors, and design and construction of new hotels, as well as development, construction and purchasing services required for each project. Prime was responsible for project design, management and franchise services once each property was complete. The Company and Prime were to be equally responsible for the financing requirements (up to $30 million each) and were to have a 50% equity interest in the new hotels. In December 1997, the Company formed a wholly-owned subsidiary, Hospitality Development Services Corporation ("HDS"), based in New York, New York, to manage the Prime project and any other hotel development projects in the future. In late 1998, the Company was informed by Prime that Prime was no longer going to pursue new development opportunities and that they were abandoning their responsibilities under the master development agreement, even though the company had incurred significant costs up to such time. The Company is pursuing recovery of its costs and lost profits from Prime under a demand for arbitration as provided for in the master development agreement. As a result, in December 1998, the management decided to discontinue its hotel development business. The Company anticipates ceasing operations by April 1999, although the resolution date to recover costs and lost profits from Prime is uncertain. The Company has reflected the current year operating results associated with its development business, as well as the estimated loss on disposal, as discontinued operation on the statements of operations.
In January 1998, the Company acquired Bekins Distribution Services, Inc. ("Bekins"), a leading provider of transportation, warehousing and installation services to a variety of customers worldwide. Founded in 1969, Bekins is a logistical services company that serves clients who are opening, renovating or relocating facilities by assuring that materials, fixtures, furniture and merchandise are moved from multiple vendor locations to their ultimate destinations in a controlled orderly sequence so that each item can be installed on schedule. The purchase price of Bekins of approximately $11,000,000 consisted of 514,117 shares of Common Stock and the assumption of certain Bekins' debt. Additionally, under the terms of the purchase agreement, the Company was required to issue an additional 639,512 shares of Common Stock in January 1999, as a post closing adjustment to the purchase price based on the price of the Company's common stock on the one year anniversary of the date of acquisition. The acquisition has been accounted for as a purchase with the results of Bekins included in the consolidated financial statements of the Company from the acquisition date.
In February 1998, the Company, through HWS REAG, purchased the assets of Watermark's real estate advisory business, consisting primarily of development contracts. Watermark is an international management company that is the general partner of and manages Watertone Holdings LP, a shareholder of the Company. The
purchase price for such business was $1,500,000 of cash. The acquisition has been accounted for as a purchase with the results included in the consolidated financial statements of the Company from the acquisition date.
In March 1998, the Company entered into a joint venture with ING Realty Partners ("ING Joint Venture"), to acquire the Clarion Quality Hotel in Chicago, Illinois. As of March 30, 1999, the Company contributed approximately $2.1 million to the ING Joint Venture. There are no additional material capital commitments to be made by the Company with respect to this project. In addition, the ING Joint Venture obtained financing for $38.65 million to fund the purchase of the hotel as well as the renovation and refurbishment costs. The Company has an approximately 18.09% interest in the ING Joint Venture. The other partners in the ING Joint Venture are entitled to specified, preferred returns and priority distributions of capital. In addition, the joint venture agreement provides ING Realty Partners with the right to have the joint venture sell the property after March 2000, and certain buy/sell provisions which may be exercised by any partner. The Company is accounting for this investment under the equity method. The Company is fully renovating and refurbishing this property pursuant to a contract with the ING Joint Venture.
On March 30, 1999 the Company, Watermark Investments Limited LLC, an affiliate of Robert Berman, Chairman of the Board and Chief Executive Officer of the Company, Leonard Parker, a Director of the Company, Douglas Parker, President of the Company and a Director and certain members of the family of Leonard Parker and Douglas Parker (collectively, the "Parker Family") entered into an agreement (the "Parker Agreement") pursuant to which members of the Parker Family agreed to sell to Watermark all remaining shares of the LPC Preferred held by members of the Parker Family and 1,397,000 shares of Common Stock of the Company, constituting substantially all of the Common Stock held by members of the Parker Family. Also under the Agreement and effective upon the closing of the transactions contemplated under the Agreement, Leonard Parker and Douglas Parker have agreed to resign as Directors of the Company, and Douglas Parker will relinquish his position as President of the Company. Leonard Parker and Douglas Parker will remain executive officers of the Company in different capacities. Consummation of the transactions contemplated by the Agreement are subject to, among other things, financing of the purchase of the shares of LPC Preferred and Common Stock.
Financial information about the Company's business segments appears in Footnote 17 to the Consolidated Financial Statements in Part II, Item 8 of this report.
SALES AND MARKETING
The Company's sales and marketing strategy is to obtain and maintain strategic alliances with hotel chains and franchises and to focus on customer needs to upscale full service hotels with a global presence.
The Company's sales and marketing efforts are coordinated by senior executives of the Company, together with salespersons who contact and maintain relationships with appropriate hotel personnel. Because of the Company's commitment to service and customer relationships, the majority of the Company's business comes from referrals and repeat customers.
COMPETITION
Servicing the hospitality industry is a highly competitive business, with competition based largely on price and quality of service. In its renovation business, the Company primarily competes with small, closely held or family owned businesses. In its purchasing and reorder businesses, the Company competes with other independent procurement companies, hotel purchasing companies and food service distribution companies. With respect to Parker FIRST, the Company expects competition from a number of hotel management companies, hotel companies, franchise operators and other entities who are pursuing the development of software systems that attempt to provide on-line procurement services. In its logistics business, the Company competes with national, regional and local trucking and installation companies. There is no single competitor or small number of competitors that are dominant in the Company's business areas. However, some of the Company's competitors and potential competitors possess substantially greater financial, personnel, marketing and other resources than the Company.
REGULATION
The Company's renovation and logistics businesses are subject to various federal, state and local laws and regulations, pursuant to which it is required to, among other things, obtain licenses and general liability insurance, workers compensation insurance and surety bonds. The Company believes that it is currently in compliance with these laws and regulations in those states in which it currently operates. There are a number of states in which the Company operates where a license is not required. The Company's renovation business currently operates in 22 states and has applications pending in an additional 6 states and the District of Columbia.
The Company's procurement business is subject to regulation by various state laws and regulations and international customs, duties, taxing and other authorities that regulate the import and distribution of goods. Domestically, the freight carrier provides bills of lading and other documentation that record the pick-up, shipping
and delivery of merchandise purchased by the Company on behalf of its clients. Internationally, the Company must comply with the individual country's requirements as they relate to commercial documentation. The Company believes that it is currently in compliance with the laws and regulations in those states and countries in which it currently operates.
DEPENDENCE ON CUSTOMERS
Most of the Company's customers are in the hospitality industry with few of them accounting for a substantial portion of the Company's annual revenues. During the year ended December 31, 1998, two customers, a major lodging company and a major hotel development company, accounted for 15% and 10%, respectively, of the Company's net revenues. During the year ended December 31, 1997, one customer, a high-ranking government official of the United Arab Emirates, accounted for 14% of the Company's net revenues. During the year ended December 31, 1996, two customers accounted for 49% and 31% of the Company's net revenues. As the Company continues to grow and expand its businesses and diversify its offerings through acquisitions, the Company believes its dependence on significant customers will decrease. There are no assurances that either continued growth or decreased dependence on significant customers will occur.
EMPLOYEES
As of December 31, 1998, the Company employed 385 employees. A typical renovation project is staffed by a field supervisor, who hires subcontractors and laborers specifically for the particular project. Each project is staffed by trade subcontractors that may or may not be unionized. The Company purchases workman's compensation insurance for each of its projects. Every contractor and subcontractor is required to sign the Company's standard contract before working on a project. Other than Bekins employees at the Las Vegas warehouse, none of the Company's employees are represented by labor unions and the Company believes that its relationship with its employees is good.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTIES
The Company maintains its executive office in New York, New York, where it occupies approximately 6,000 square feet in a multi-story office complex. The Company has entered into a ten-year lease, which expires in January 2007, with an unaffiliated lessor pursuant to which it currently pays an annual fixed rental of $278,000.
HRB maintains its office in Los Angeles, California, where it occupies approximately 7,400 square feet in a multi-story office complex. HRB has entered into a five-year lease, which expires in March 2003, with an unaffiliated lessor pursuant to which it currently pays an annual fixed rental of approximately $208,000.
LPC and Parker Reorder maintain their offices in Coral Gables, Florida. LPC occupies approximately 18,400 square feet under a lease which expires in August 2002 at an annual fixed rental of $412,000 (exclusive of rent adjustments). LPC also maintains satellite offices in Los Angeles, Singapore, The Netherlands and South Africa. Parker Reorder occupies approximately 7,300 square feet under a lease which expires in September 2001 at an annual fixed rental of $199,500.
HDS maintained its office in New York, New York where it occupied approximately 4,600 square feet under a five-year lease which expires in December 2002 at an annual fixed rental of approximately $145,000. The Company is currently in the process of exploring sublease alternatives for the space.
Bekins maintains its office in St. Louis, Missouri under a lease which expires in December 1999 at an annual fixed rental of approximately $100,000 for 8,000 square feet. Bekins also owns a 78,000 square foot warehouse in Orlando, Florida and leases warehouse space in Las Vegas, Nevada where it occupies 22,000 square feet under a lease which expires in October, 1999 at an annual fixed rental of $112,000.
HWS REAG maintains its offices in Chicago, Illinois where it occupies approximately 3,200 square feet under a lease expiring in March 2003 at an annual fixed rental of $58,000. HWS REAG also maintains satellite offices in Denver, Colorado and Stamford, Connecticut.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Given the nature of the construction industry and the contracting process, disputes often arise among contractors, subcontractors and customers. These disputes have the potential to result in the assertion of claims and litigation.
We are a defendant in various litigation incident to our business, and in certain instances the amounts sought include substantial claims and counterclaims. Although we cannot predict the outcome with certainty, in our opinion based on the facts known by us at this time, we anticipate that the resolution of such litigation will not have a material adverse effect on our business, operating results or financial condition.
On June 1, 1998, an action (the "State Action") was brought against the Company by West Atlantic Corp. in the Supreme Court of the State of New York, County of New York. The State Action alleges that the Company retained West Atlantic Corp. pursuant to an agreement dated March 1, 1995 (the "Agreement") to perform certain marketing and selling services for the Company. The State Action further alleges that fees were earned and not paid under the Agreement and seeks damages for breach of contract of not less than $10,000,000, damages with respect to "significant benefits to the Company" in an amount of not less than $5,000,000 and damages relating to breach of the duties of good faith and fair dealing in an amount of not less than $10,000,000. The Company believes that the three claims are duplicative. The State Action also seeks interest and specific performance. The Company believes that since it has performed all obligations required to be performed under the Agreement, the State Action does not have merit and intends to vigorously defend the claims asserted against it. In addition, the Company has brought claims in federal and state court against Tova Schwartz, the former President and Chief Executive Officer of the Company's predecessor, seeking indemnity and punitive damages. The state and federal actions claim that, among other things, Schwartz failed to disclose to the Company the existence of the Agreement when the Company purchased from Schwartz certain shares of Common Stock which she then held. Schwartz has filed a motion to dismiss the Company's State Action claims. The motion has been fully briefed, argued, and submitted, and is presently awaiting decision. By agreement of the parties, the Federal Action has been stayed, subject to reinstatement upon notice by either party.
Prime and the Company entered into a master development agreement in June 1998 which committed Prime and the Company to the joint development of up to 20 AmeriSuite Hotels. Pursuant to the master development agreement, the Company committed its resources to the development of the AmeriSuite Hotel projects. Prior to the completion of development of several approved AmeriSuite projects, Prime, in late 1998, withdrew from the venture. On March 17, 1999, the Company filed an arbitration demand with the New York office of the American Arbitration Association seeking to recover damages incurred by the Company due to Prime's withdrawal from the joint development of the AmeriSuite projects. The amount of damages calculated by the Company are $1,702,320 for out-of-pocket costs and overhead plus $34,534,685 in lost profits.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market Information. The Common Stock has traded on the American Stock Exchange under the symbol "HWS" since September 18, 1997 and prior thereto traded on the NASDAQ SmallCap Market under the symbol "ROOM." The following table sets forth, for the periods indicated, the range of high and low bid prices of the Common Stock for the fiscal periods specified.
High Low First Quarter $ 8-11/16 $ 5-5/16 Second Quarter 9-3/8 5-3/8 Third Quarter 14-13/16 7-3/8 Fourth Quarter 13-15/16 8-1/2
First Quarter $ 13-1/2 $8-3/4 Second Quarter 10-7/16 7-7/8 Third Quarter 9-5/16 2-7/8 Fourth Quarter 6-1/4 1-7/8
On March 26, 1999, the last reported sales price of the Common Stock on the American Stock Exchange was $3.625 per share.
(b) Holders. As of March 26, 1999, there were approximately 92 record holders and approximately 1,500 beneficial holders of the Common Stock.
(c) Dividends. The Company has not paid or declared any dividends upon its Common Stock since its inception and does not intend to pay any dividends upon its Common Stock in the foreseeable future. The payment by the Company of dividends, if any, in the future rests within the discretion of its Board of Directors and will depend, among other things, upon the Company's earnings, its capital requirements and its financial condition, as well as, other relevant factors.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (A)
(a) No cash dividends were declared during the five-year period presented above. See Item 1. Description of Business for a description of all acquisitions during the five-year period.
(b) Antidilutive.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
From its inception in 1991 to August 1995, the Company's only source of revenues was its decorative energy-efficient lighting fixture design, manufacturing and installation business. The Company acquired its renovation business in August 1995 and disposed of its lighting business in February 1996. As part of its strategy to further its position as one of the leading providers of services to the hospitality industry on a global basis, the Company acquired its procurement and reorder businesses in January 1997 and its logistics business in January 1998. As a result of this significant change in the Company's business focus, period to period historical comparisons are not considered meaningful.
RESULTS OF OPERATIONS: 1998 COMPARED TO 1997
Revenues for the year ended December 31, 1998 were $229,979,210, compared to $85,441,712 for the year ended December 31, 1997. The increase in revenues resulted from growth in the customer base and project scope across all product lines, along with the purchase of Bekins in January 1998 and HWS REAG in February 1998.
Gross profit for 1998 was $22,260,891 or 9.7% of revenues, compared to $10,806,820 or 12.6% of revenues for 1997. The growth in gross profit in dollars was a result of the increase in sales volume. The decrease in gross profit as a percent of sales was due primarily to the provision on contract revenues recorded in 1998 related to specific renovation projects which have been substantially completed but have not yet been closed out with the customer.
Selling, general and administrative ("SG&A") expenses for 1998 totaled $21,113,908 or 9.2% of revenues, as compared to $10,622,184 or 12.4% of revenues for 1997. The increase in SG&A expenses in 1998 was due primarily to the expansion of administrative staff to support the higher sales level as well as the acquisition of Bekins and HWS REAG in early 1998. The drop in SG&A expenses as a percent of revenue was the result of operating efficiencies achieved as sales increased.
Income from operations for 1998 totaled $1,146,983 as compared to $184,636 for the previous year. Operating profits increased in the current year due to higher sales coupled with a slower growth rate in expenses. As a result, income from operations increased to 0.5% in 1998 from 0.2% in 1997.
Interest expenses increased from $287,633 in 1997 to $756,100 in 1998. The rise in interest expense was the result of increased borrowings under the Company's lines of credit and the addition of Bekins debt to the balance sheet upon its acquisition. Interest income grew in 1998 to $1,314,605 from $774,836 in the prior year due primarily to interest earned on invested funds raised in the public offering of the Company's common stock in September 1997.
The provision for income taxes for the year ended December 31, 1998 was $755,150, based on an effective tax rate of 44.3%. For 1997, the provision for taxes was $227,988. The increase in the provision in 1998 was due to the higher level of pre-tax income. For 1997, the Company recorded a provision for income taxes despite a pre-tax loss primarily due to the non-deductibility of goodwill amortization as well as state and local taxes payable.
Based on factors discussed above, income from continuing operations increased from a $843,649 loss in 1997 to $950,338 of income in 1998. Basic earnings per share increased from a $0.13 loss in 1997 to $0.06 of income in 1998.
The discontinued operations for 1998 relate to the Company's subsidiary, HDS, which was formed to manage the Company's hotel development projects. Based on the abandonment of the hotel devlopment program with Prime in late 1998 and an assessment of its future viability, the Company, in December 1998, decided to discontinue its hotel development business. The Company anticipates ceasing operations by April, 1999 and has no future material cost obligations related to this business.
RESULTS OF OPERATIONS: 1997 COMPARED TO 1996
Revenues for the year ended December 31, 1997 were $85,441,712, compared to $24,367,112 for 1996. The increase in revenue resulted primarily from the acquisition of LPC and Parker Reorder in January 1997.
Gross profit for the year ended December 31, 1997 was $10,806,820, or 12.6% of revenues, compared to $6,077,188, or 24.9% of revenues, for 1996. The decrease in gross profit as a percent of revenues in 1997 was due to the addition of LPC and Parker Reorder, whose purchasing operations operate at a lower gross profit percentage than the Company's renovation business. A significant portion of its purchasing revenues and costs included the resale of furniture and fixtures at little or no markup. The Company's purchasing income is the result of fees charged to its clients based upon the amount of time and effort it expects to spend on projects. Customer deposits and advances to vendors increased during 1997 due to the acquisition of LPC.
Selling, general and administrative ("SG&A") expenses for the year ended December 31, 1997 were $10,622,184, or 12.4% of revenues, compared to $3,218,520, or 13.2% of revenues, for 1996. Included in SG&A expenses for the years ended December 31, 1997 and 1996 were $778,825 and $383,922, respectively, of amortization of goodwill and other intangible assets on acquisitions. The increase in SG&A expenses in 1997 was due to the addition of LPC and Parker Reorder as well as the development of an administrative infrastructure.
Income from operations for the year ended December 31, 1997 was $184,636, compared to $2,858,668, for 1996. Operating profits decreased in 1997 due to an increase in SG&A expenses and a decrease in gross profit percentage. As an inducement to enter into the Apollo Joint Venture, the Company issued to Apollo a warrant to purchase 750,000 shares of common stock, of which 250,000 shares were exercisable upon entering into the agreement in May 1997 and the remaining shares become exercisable based on incremental revenue to the Company. The fair value of the warrants for the 250,000 shares were recognized as warrant expense in 1997 in the amount of $1,287,500.
The provision for income taxes for the year ended December 31, 1997 was $227,988, compared to $926,325 for the same period last year. The decrease in the provision for income taxes was primarily due to the decrease in income before income taxes. For 1997, although the Company had a loss from continuing operations before income taxes, an income tax provision was recorded primarily due to the non-deductibility of goodwill amortization and state and local taxes payable.
The net loss for the year ended December 31, 1997 was $843,649, compared to net income of $1,842,678, for 1996. As disclosed in Note 15 to the consolidated financial statements, if the Company accounted for its stock-based employee compensation plans using the fair value-based method, rather than the permitted intrinsic value-based method, the net loss would have been approximately $2,031,000 as compared to the reported net loss of approximately $844,000.
LIQUIDITY AND CAPITAL RESOURCES
The Company's short-term and long-term liquidity requirements generally consist of operating capital for its business and SG&A expenses. The Company continues to satisfy its short-term and long-term liquidity requirements with cash generated from operations, bank lines of credit and funds from a public offering of its Common Stock in September 1997. Debt maturing in 1999 and capital expenditures in 1999 will be paid from funds available from these sources.
Net cash used in operating activities was $17,696,601 for the year ended December 31, 1998, compared to net cash provided of $3,693,798 for 1997. Due to the Company's significant revenue growth and acquisitions, the Company's accounts receivable and advances to vendors increased by $40,156,030. This increase was only partially offset by an increase in accounts payable and customer deposits of $20,518,174. The Company expects to collect the receivables fully in 1999.
Net cash used in investing activities for 1998 was $2,432,068, compared to net cash used of $21,131,147 for last year. The difference is primarily due to the net sale of marketable securities in 1998 as opposed to the net purchase of marketable securities in 1997 using funds from the proceeds of the public offering in September, 1997. The 1998 sale of marketable securities was offset by the cash purchase of HWS REAG for $1,500,000, an investment in real estate ventures of $4,187,260 an investment in mortgages receivable for $3,637,000 and property and equipment purchases of $3,461,494.
Net cash provided by financing activities for 1998 was $10,343,396 as compared to net cash provided in 1997 of $29,539,760. The major items for each year were a net borrowing under lines of credit of $10,925,000 in 1998, as opposed to proceeds from the public offering in 1997 of $32,126,630.
In March 1998, the Company obtained a $7,000,000 unsecured line of credit with Marine Midland Bank of New York. Borrowings under the line of credit bear interest at the bank's prime lending rate. Proceeds from the borrowing are utilized to fund short-term cash requirements. At December 31, 1998, there was $4,975,000 in outstanding borrowings under the line of credit.
In July 1998, the Company obtained a new unsecured line of credit with NationsBank N.A. which provides the Company a maximum of borrowing of $6,000,000. Borrowings under the line bear interest at the bank's prime lending rate. Proceeds from the borrowing are used to fund short-term cash requirements. At December 31, 1998, there was $5,950,000 in outstanding borrowings under the line of credit.
In January 1998, the Company acquired 100% of the outstanding capital stock of Bekins. The purchase price for Bekins of approximately $11,000,000 consisted of 514,117 shares of Common Stock issued in January 1997, and the assumption of certain Bekins' debt. In addition, under the terms of the acquisition agreement, in January 1998 the Company was required to issue an additional 639,512 shares of common stock given the decrease in the price of the Company's common stock.
In February 1998, the Company acquired the assets of Watermark's real estate advisory business consisting primarily of development contracts. The purchase price for such business was $1,500,000 of cash.
Capital expenditures for property and equipment were $3.5 million compared to $2.7 million in 1997, an increase of $0.8 million. Significant capital expenditures were incurred during the past two years in developing the Parker FIRST system. The Company does not anticipate incurring this level of expenditures for the Parker FIRST system in 1999, given that the system became operational in 1998.
As the Company grows and continues to explore opportunities for strategic alliances and acquisitions, investment in additional support systems, including infrastructure and personnel, will be required. The Company expects to increase its costs and expenses in 1998 as it continues to invest in the development of its businesses. Although these increases may result in a short-term reduction in operating margin as a percentage of revenues, the Company anticipates that its investments will have a positive impact on its net revenues on a long-term basis. The Company anticipates making substantial expenditures as it continues to explore expansion though strategic alliances and acquisitions. The Apollo Joint Venture has acquired the Warwick Hotel in Philadelphia, Pennsylvania, and the Historic Hotel in Richmond, Virginia. The Company does not anticipate having to make additional capital commitments related to these Apollo Joint Venture acquisitions. The ING Joint Venture has acquired the Clarion Hotel in Chicago, Illinois and the Company anticipates that its capital commitments will not be significant going forward.
The Company believes its present cash position, including anticipated increasing revenues, cash on hand, availability under bank lines of credit and its ability to obtain additional financing as necessary, will allow the Company to meet its anticipated capital commitments and its short-term operating needs for at least the next twelve months.
INFLATION
Inflation and changing prices during the current year did not significantly affect the major markets in which the Company conducts its business. In view of the moderate rate of inflation, its impact on the Company's business has not been significant.
YEAR 2000
The Year 2000 issue results from computer programs and circuitry that do not differentiate between the year 1900 and the year 2000 because they were written using two- rather than four-digit dates to define the applicable year. If not corrected, many computer applications and date-sensitive devices could fail or create
erroneous results before, on or after January 1, 2000. The Year 2000 issue affects virtually all companies and organizations, including the Company.
The Company has developed, and is implementing a plan, the goal of which is to assure that the Company will achieve Year 2000 readiness in time to avoid significant Year 2000 failures. The Company is proceeding with its assessment of the Year 2000 readiness issues for its computer systems, business processes, facilities and equipment to assure their continued functionality. The Company is continuing its assessment of the readiness of external entities, including subcontractors, suppliers, vendors, and customers that interface with us. To that end, the Company has taken the following actions:
o Computer Systems. The Company periodically upgrades its computer systems as its needs require. The Company began the process of upgrading the software for its internal computer systems in 1998, and expects to complete this process, including the upgrade of its financial and project management systems by the third quarter of 1999. Vendors of the new internal computer systems certified them to be Year 2000 compliant. The Company's computer hardware is limited to stand-alone and networked desk-top systems. The Company has assessed the Year 2000 readiness of its computer hardware and potential risks to operations, and intends to replace those systems that may pose a risk to operations in 1999. Parker FIRST, the Company's new proprietary software product, has been developed and maintained by Parker Reorder. Parker FIRST software was designed to account for the Year 2000 and beyond. This software product was in use by hotel companies beginning in 1998.
o Business Processes. The Company has and continues to assess the potential impact of Year 2000 on its business processes. Management for each division is assessing the risks of Year 2000 issues as it specifically relates to such businesses, and the division's readiness. The Company is in the process of contacting its key vendors, suppliers and subcontractors regarding their Year 2000 readiness.
The costs incurred for upgrading the Company's computer systems are being funded with cash flows from operations and available financing. The costs incurred principally relate to new systems being implemented to improve business functionality rather that solely to address Year 2000 issues. These costs associated with the computer systems upgrades and implementation are anticipated to be significant.
The Company believes that its internal computer systems, facilities, and equipment will be Year 2000 compliant. However there is no assurance that all of the planned upgrades will be completed in time or function as intended. As the Company has no contingency plan other than to deal as expeditiously as possible with situations if and when they arise, the Company may experience significant disruptions, the costs of which the Company is unable to estimate at this time. The Company also believes that disruptions in some of our vendors' or subcontractors' operations will not significantly affect our projects because the Company has relationships with other vendors and subcontractors with similar expertise. The Company cannot assume, however, that an adequate supply of vendors or subcontractors will be available.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have a material exposure to risks associated with foreign currency fluctuations related to our operations. The Company does not use derivative financial instruments in its operations. The Company does not have a material exposure to market risks associated with changes in interest rates given (a) the relative stability of interest rates currently, (b) the types of debt securities the Company invests in, and (c) the Company's lack of significant balances of variable interest rate debt. The Company does not believe that it has any other material exposure to market risks associated with interest rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
See Index to Financial Statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On November 19, 1997, the Company dismissed BDO Seidman, LLP ("BDO") as its independent accountants. The Company's Board of Directors approved such dismissal. BDO's accountant's report on the financial statements of the Company for the prior two years did not contain an adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles. There were no other reportable events or disagreements with BDO to report in response to Item 304 of Regulation S-K.
On November 20, 1997, Arthur Andersen LLP was engaged as independent accountants to the Company.
PART IV
ITEM 14.
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Financial Statements: * Hospitality Worldwide Services, Inc. and Subsidiaries * Report of Independent Public Accountants * Consolidated Financial Statements
(b) Exhibits
Exhibit Number Exhibits
3.1 Certificate of Incorporation, as amended, of the Company (Incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q for the quarter ended June 30, 1998). 3.2 Amended and Restated By-laws of the Company (Incorporated by reference to Exhibit 3.2 to the Company's Form 10-Q for the quarter ended June 30, 1998). 4.1 Specimen Common Stock Certificate (Incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form SB-2, No. 33-7094-NY). 4.2 Rights Agreement dated as of November 24, 1997, by and between the Company and Continental Stock Transfer & Trust Company, as rights agent (the "Rights Agreement") (Incorporated by reference to the Company's Registration Statement on Form 8-A filed with the Commission on December 2, 1997). 4.3 Amendment to Rights Agreement dated January 7, 1998 (Incorporated by reference to Exhibit 4.3 of the Company's Form 10-K for the year ended December 31, 1997). 10.1 Asset Purchase Agreement dated as of April 1, 1995, by and among AGF Interior Services Co., Watermark Investments Limited (Bahamas), Watermark Investments Limited (Delaware), HRB, the Company and Tova Schwartz (Incorporated by reference to the Company's Current Report on Form 8-K dated August 22, 1995). 10.2 Divestiture, Settlement and Reorganization Agreement dated as of February 26, 1996, by and among the Company, HRB, Watermark Investments Limited (Bahamas), Watermark Investments Limited (Delaware), AGF Interior Services Co., Tova Schwartz, Alan G. Friedberg and Guillermo Montero (Incorporated by reference to Exhibit 10.2 of the Company's Form 10-KSB for the year ended December 31, 1995). 10.3 Memorandum Agreement dated April 12, 1996, by and between the Company and Watermark (Incorporated by reference to Exhibit 10.3 of the Company's Form 10-KSB for the year ended December 31, 1995). 10.4 Bill of Sale and Assumption Agreement dated February 26, 1996, by and between the Company and Tova Schwartz (Incorporated by reference to Exhibit 10.4 of the Company's Form 10-KSB for the year ended December 31, 1995). 10.5 Consulting Agreement dated February 28, 1996, by and between to Company and Resource Holdings Associates (Incorporated by reference to Exhibit 10.6 of the Company's Form 10-KSB for the year ended December 31, 1995). 10.6 Employment Agreement, dated January 1, 1988, by and between the Company and Robert A. Berman (Incorporated by reference to Exhibit 10.6 to Amendment No. 1 to the Company's Form 10-K, filed on April 29, 1998, for the year ended December 31, 1997). 10.7 Employment Agreement dated January 1, 1998, by and between the Company and Howard G. Anders (Incorporated by reference to Exhibit 10.7 to Amendment No. 1 to the Company's Form 10-K, filed on April 29, 1998, for the year ended December 31, 1997). 10.8 1996 Stock Option Plan (Incorporated by reference to Exhibit 4(a) to the Company's Registration Statement on Form S-8 filed on February 12, 1997, File No. 333-21689). 10.9 Form of Option Agreement for the 1996 Plan (Incorporated by reference to Exhibit 4(b) to the Company's Registration Statement on Form S-8 filed on February 12, 1997, File No. 333-21689).
10.10 Form of Stock Agreement for the Outside Directors' Plan (Incorporated by reference to Exhibit 4(c) to the Company's Registration Statement on Form S-8 filed on February 12, 1997, File No. 333-21689). 10.11 Form of Option Granted to Officers (Incorporated by reference to Exhibit 4(d) to the Company's Registration Statement on Form S-8 filed on February 12, 1997, File No. 333-21689). 10.12 Agreement and plan of Merger dated as of January 9, 1997, by and among Leonard Parker Company, LPC Acquisition Corp., and the Company (incorporated by reference to Exhibit 2.1 of the Company's Current Report on Form 8-K filed January 24, 1997). 10.13 Employment Agreement, dated as of January 9, 1997, by and among The Leonard Parker Company, the Company and Leonard Parker (Incorporated by reference to Exhibit 10.13 to the Company's Registration Statement on Form SB-2 filed July 22, 1997, No. 333-31765). 10.14 Employment Agreement, dated as of January 1, 1998, by and between the Company and Douglas Parker (Incorporated by reference to Exhibit 10.14 to Amendment No. 1 to the Company's Form 10-K, filed on April 29, 1998, for the year ended December 31, 1997. 10.15 Registration Rights Agreement, date as of January 9, 1997, by and among the Company, Leonard Parker, Douglas Parker, Bradley Parker, Philip Parker, Gregg Parker and Mitchell Parker (Incorporated by reference to Exhibit 10.18 to the Company's Registration Statement on Form SB-2 filed July 22, 1997, No. 333-31765). 10.16 Agreement to Joint Venture, dated as of May 12, 1997, by and among Apollo Real Estate Advisors II, L.P., the Registrant and Watermark Investments Limited, LLC. (Incorporated by reference to Exhibit 10.19 to the Company's Registration Statement on Form SB-2 filed July 22, 1997, No. 333-31765). 10.17 Warrant dated May 12, 1997 issued to Apollo Real Estate Advisors II, L.P. (Incorporated by reference to Exhibit 10.20 to the Company's Registration Statement on Form SB-2 filed July 22, 1997, No. 333-31765). 10.18 Agreement and Plan of Merger, dated as of January 1, 1998, by and among the Company, HWS Acquisition Corp., a Delaware corporation, Bekins Distribution Services Co., Inc. and the Sellers named therein (Incorporated by reference to Exhibit 2.1 the Company's Current Report on Form 8-K dated January 9, 1998). 10.19 Registration Rights Agreement dated as of January 1, 1998, by and among the Company and the Shareholders named therein (Incorporated by reference to Exhibit 10.1 to the Company's Amendment No. 3 to Current Report on Form 8-K, dated September 16, 1998). 10.20 Financial Advisory Agreement dated April 10, 1997, by and between the Company and Resource Holdings Associates (Incorporated by reference to the Company's Registration Statement on Form SB-2, No. 333-31765). 10.21 Master Development Agreement, dated June 5, 1998, by and between the Company and Prime Hospitality Corp. (Incorporated by reference to Exhibit 10 to the Company's Form 10-Q for the quarter ended June 30, 1998). *10.22 Stock Purchase Agreement, dated March 30, 1999, by and among the Company, Watermark Investments Limited, LLC, Leonard Parker, Douglas Parker, Philip Parker, Mitchell Parker, Gregg Parker and Bradley Parker. 11 Computation of earnings per share (Incorporated herein by reference to Note 16 to the Company's Consolidated Financial Statements). *21 Subsidiaries of the Company. *27 Financial Data Schedule
*Filed herewith.
(c) Reports on Form 8-K
Form 8-K dated January 9, 1998, filed with the Commission on January 23, 1998, as amended on March 24, 1998, April 16, 1998 and September 16, 1998 reporting Item 2, Acquisition or Disposition of Assets.
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.
HOSPITALITY WORLDWIDE SERVICES, INC.
Dated: March 30, 1999 By: /s/ Robert A. Berman -------------------- Robert A. Berman, Chairman of the Board, Chief Executive Officer, (principal executive officer) and Director
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:
SIGNATURE TITLE DATE
/s/ Robert A. Berman Chairman of the Board, March 30, 1999 - ------------------------ Chief Executive Officer Robert A. Berman (principal executive officer) and Director
/s/ Leonard F. Parker Chairman Emeritus of the Board March 30, 1999 - ------------------------ and Director Leonard F. Parker
/s/ Douglas A. Parker President and Director March 30, 1999 - ------------------------ Douglas A. Parker
/s/ Howard G. Anders Executive Vice President, March 30, 1999 - ------------------------ Chief Financial Officer, Howard G. Anders (principal financial officer, principal accounting officer) and Secretary
/s/ Scott A. Kaniewski Director March 30, 1999 - ------------------------ Scott A. Kaniewski
/s/ Louis K. Adler Director March 30, 1999 - ------------------------ Louis K. Adler
/s/ George C. Asch Director March 30, 1999 - ------------------------ George C. Asch
/s/ Richard A. Bartlett Director March 30, 1999 - ------------------------ Richard A. Bartlett
FINANCIAL STATEMENTS
Page No.
HOSPITALITY WORLDWIDE SERVICES, INC. AND SUBSIDIARIES
REPORTS OF INDEPENDENT PUBLIC ACCOUNTANTS ,
CONSOLIDATED FINANCIAL STATEMENTS: Balance sheets Statements of operations Statements of stockholders' equity Statements of cash flows , Notes to consolidated financial statements -F-23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of Hospitality Worldwide Services, Inc.
We have audited the accompanying consolidated balance sheet of Hospitality Worldwide Services, Inc. (a New York Corporation) and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Hospitality Worldwide Services, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP - ----------------------- Arthur Andersen LLP
New York, New York March 30, 1999
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors Hospitality Worldwide Services, Inc. New York, New York
We have audited the consolidated statements of operations, stockholders' equity and cash flows of Hospitality Worldwide Services, Inc. (formerly Light Savers U.S.A., Inc.) and subsidiary for the year ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects the results of its operations and cash flows of Hospitality Worldwide Services, Inc. and subsidiary for the year ended December 31, 1996, in conformity with generally accepted accounting principles.
/s/ BDO Seidman, LLP - -------------------- BDO Seidman, LLP
New York, New York March 21, 1997
HOSPITALITY WORLDWIDE SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
ASSETS
The accompanying notes to consolidated financial statements are an integral part of these statements.
HOSPITALITY WORLDWIDE SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
(a) Antidilutive The accompanying notes to consolidated financial statements are an integral part of these statements.
HOSPITALITY WORLDWIDE SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The accompanying notes to consolidated financial statements are an integral part of these statements.
HOSPITALITY WORLDWIDE SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes to consolidated financial statements are an integral part of these statements.
HOSPITALITY WORLDWIDE SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes to consolidated financial statements are an integral part of these statements.
HOSPITALITY WORLDWIDE SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
Hospitality Worldwide Services, Inc., formerly known as Light Savers U.S.A., Inc. (the "Company"), was incorporated in the State of New York on October 10, 1991. Through its wholly owned operating subsidiaries, the Company provides interior and exterior cosmetic renovations and maintenance, acts as a purchasing agent and principal for leading hotel and hospitality customers, provides logistical services to a wide variety of customers and provides real estate advisory services to the hospitality industry throughout the United States, with limited operations abroad.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company also has investments in real estate joint ventures, which are accounted for under the equity and cost method, as appropriate. All significant inter-company balances and transactions have been eliminated. Certain prior year balances have been reclassified in the consolidated financial statements in order to provide a presentation consistent with the current year.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management believes that the estimates utilized in preparing the Company's financial statements are reasonable and prudent, however, actual results could differ from those estimates.
REVENUE RECOGNITION
RENOVATION
The Company determines renovation earnings under the percentage of completion method. Under this method, the Company recognizes as earnings that portion of the total earnings anticipated from a contract which the cost of the work completed bears to the estimated total cost of the work covered by the contract. To the extent that contracts extend over more than one year, revisions in costs and earnings estimates during the course of the work are reflected in the year in which the facts which require the revision become known. Due to uncertainties inherent in the estimation process, it is reasonably possible that such estimates will be revised over the next year. When a loss is forecasted for a contract, the full amount of the anticipated loss is recognized in the period in which it is determined that a loss will occur. Unapproved change orders and claims are included in earnings from renovation contracts at their estimated recoverable amounts based on the related contract costs when realization is probable and the amount can be reliably estimated.
The Company continuously reviews estimated earnings from renovation contracts and makes necessary adjustments based on current evaluations of the indicated outcome.
Cost of renovation contracts include all direct material, labor and subcontracting costs, and those indirect costs related to contract performance that are identifiable with or allocable to contracts.
PROCUREMENT
The Company recognizes procurement earnings for fixed fee service contracts under the percentage of completion method. Under this method, the Company recognizes as earnings that portion of the total earnings anticipated from a contract which the efforts expended bears to the estimated efforts over the life of the contract. Earnings for variable fee service contracts are generally recognized upon completion of the associated service.
The Company performs procurement services either acting as a principal, for which it functions in a manner similar to a purchaser and reseller of merchandise, or as an agent. As an agent, revenues include solely the service fee income and the cost of the contracts includes labor and other direct costs associated with the contract and those indirect costs related to contract performance. As a principal, the revenues and cost of the contracts also include the associated merchandise purchased for the customer, which are recognized when the merchandise is shipped directly from the vendor to the customer.
Customer deposits consist of amounts remitted to the Company by customers as deposits on specific contracts. Advances to vendors consist of amounts paid by the Company to vendors on specific contracts.
LOGISTICS
The Company recognizes earnings on logistics and installation services under the percentage of completion method. Under this method, the Company recognizes as earnings that portion of the total earnings anticipated from a contract which the efforts expended bears to the estimated efforts over the life of the contract. The cost of the contracts includes labor and other direct costs associated with the contract and those indirect costs related to contract performance.
DEPRECIATION AND AMORTIZATION
The Company calculates depreciation on property and equipment on the straight-line method. Estimated useful lives are as follows: office equipment, 5 years; software, 7 years; furniture and fixtures, 10 years; and building, 25 years. Leasehold improvements to property used in the Company's operations are amortized on a straight-line basis over the lease terms. Maintenance and repairs are expensed currently, while expenditures for betterments are capitalized.
GOODWILL
Goodwill is amortized on a straight-line basis over its estimated useful life of 15-30 years. Goodwill represents the costs of an acquisition in excess of the fair value of net assets acquired at the date of acquisition. Accumulated amortization was $2,439,238 and $1,489,855 at December 31, 1998 and 1997, respectively.
EARNINGS PER COMMON SHARE
In 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share are very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for prior periods have been restated to conform to the new requirements.
Basic earnings per common share are based on net income less preferred stock dividends divided by the weighted average number of common shares outstanding. Diluted earnings per common share are adjusted to reflect the incremental number of shares issuable under stock-based compensation plans, the assumed conversion of convertible preferred stock and the elimination of the preferred stock dividends, if such adjustments are dilutive.
INCOME TAXES
Deferred income tax assets or liabilities are computed based on the difference between the financial reporting and income tax bases of assets and liabilities using the enacted marginal tax rate. Deferred income tax expenses or benefits are based on the changes in the asset or liability from period to period.
CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with maturities of 90 days or less to be cash equivalents.
MARKETABLE SECURITIES
Marketable securities consisted of certificates of deposit maturing in six months or less as of December 31, 1998 and commercial paper and treasury notes maturing in six months or less as of December 31, 1997. These securities are classified as available-for-sale or as held-to-maturity, based on the Company's intended holding period. Available-for-sale securities are reported at fair value with unrealized gains or losses, if any, reported as other comprehensive income. Held-to-maturity investments are reported at amortized cost. The cost basis of securities is determined on a specific identification basis in calculating gains and losses.
LONG-LIVED ASSETS
Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If such review indicates that the asset is impaired, when the carrying amount of an asset exceeds the sum of its expected future cash flows, on an undiscounted basis, the asset's carrying amount is written down to fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell.
STOCK -BASED COMPENSATION
The Company accounts for its stock-based employee compensation plans using the intrinsic value based method, under which compensation cost is measured as the excess of the stock's market price at the grant date over the amount an employee must pay to acquire the stock. Expenses related to stock options and warrants issued to non-employees are accounted for using the fair value of the security at the date of grant based on option-pricing models.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments including cash and cash equivalents, accounts receivable, accounts payable, and accrued and other liabilities approximate the fair values as of December 31, 1998, due to the short-term maturity of these instruments. The carrying amounts as of December 31, 1998 of costs and estimated earnings in excess of billings, advances to vendors, billings in excess of costs and estimated earnings and customer deposits approximate fair value as these amounts are due or payable within the Company's operating cycle. The fair value of marketable securities is based on settlement amounts for such instruments given the intended holding period and approximate their carrying amounts as of December 31, 1998. The carrying amount of the loan payable approximates its fair value given the short term maturity of the loan. The fair value of long-term debt is estimated based on the Company's year-end, risk-adjusted incremental borrowing rate for similar liabilities. As of December 31, 1998, the carrying amount of the debt approximated fair value.
COMPREHENSIVE INCOME
In 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components in a separate financial statement. Comprehensive income includes net income plus other comprehensive income, which includes changes in cumulative foreign translation adjustments and
unrealized gains and losses on marketable securities that are available-for-sale. The Company has not presented statements of comprehensive income, as other comprehensive income was not material.
3. ACQUISITION OF BUSINESSES
In January 1997, the Company completed the acquisition of Leonard Parker Company ("LPC") and Parker Reorder Online, Inc, ("Parker Reorder"). LPC, a leading purchasing company for the hospitality industry, acts as an agent or principal for the purchase of goods and services for its customers which include major hotel and management companies worldwide. Parker Reorder has developed and is marketing a new proprietary software product, Parker FIRST, which allows clients to reorder operating supplies and equipment ("OS&E") and other products on-line and provides such clients with access to forecasting and product evaluation capabilities. The purchase price of LPC and Parker Reorder, including acquisition costs and after final adjustments, was approximately $12,140,000 which consisted primarily of 1,250,000 newly issued shares of Common Stock and $5 million stated value of newly issued 6% convertible preferred stock of the Company. The acquisition resulted in goodwill and other intangible assets of approximately $11,400,000, which are being amortized on a straight-line basis over their estimated useful life of 30 years. The acquisition was accounted for as a purchase with the results of LPC and Parker Reorder included in the consolidated financial statements of the Company from the acquisition date.
In January 1998, the Company acquired Bekins Distribution Services, Inc. ("Bekins"), a leading provider of transportation, warehousing and installation services to a variety of customers worldwide. Founded in 1969, Bekins is a logistical services company that serves clients who are opening, renovating or relocating facilities by assuring that materials, fixtures, furniture and merchandise are moved from multiple vendor locations to their ultimate destinations in a controlled orderly sequence so that each item can be installed on schedule. The purchase price of Bekins of approximately $11,000,000 consisted of 514,117 shares of Common Stock and the assumption of certain Bekins' debt. Additionally, under the terms of the purchase agreement, the Company was required to issue an additional 639,512 shares of Common Stock in January 1999 given the decrease in the price of the Company's common stock on the one year anniversary date of the acquisition. The acquisition resulted in goodwill of approximately $7,000,000 which is being amortized on a straight-line basis over its estimated useful life of 30 years. The acquisition has been accounted for as a purchase with the results of Bekins included in the consolidated financial statements of the Company from the acquisition date.
In February 1998, the Company, through HWS REAG, purchased the assets of Watermark Investments Limited's ("Watermark") real estate advisory business, consisting primarily of development contracts. Watermark is an international management company that is the general partner of and manages Watertone Holdings LP, a shareholder of the Company. The purchase price for such business was $1,500,000 of cash and its results have been included in the consolidated financial statements of the Company from the acquisition date.
The following pro forma consolidated financial information has been prepared to reflect the acquisition of the assets and business of LPC, Parker Reorder and Bekins. The pro forma financial information is based on the historical financial statements of the Company and LPC, Parker Reorder and Bekins and should be read in conjunction with the accompanying footnotes. The accompanying pro forma operating statements are presented as if the acquisitions occurred on January 1, 1996. The pro forma financial information is unaudited and is not necessarily indicative of what the actual results of operations of the Company would have been assuming the transactions had been completed as of January 1, 1996, and neither is it necessarily indicative of the results of operations for future periods.
Year Ended December 31 1997 1996 - -------------------------------------------------------------------------------- (unaudited) Net sales $105,357,000 $76,429,000 Income (loss) from continuing operations applicable to common shares (457,000) 428,000 Diluted loss per share from continuing operations (.04) _____ - --------------------------------------------------------------------------------
The above unaudited pro forma statements have been adjusted to reflect the amortization of goodwill and other intangible assets as generated by the acquisitions over a 30 year period, dividends of 6% on preferred shares in the LPC transaction, officers compensation based on employment agreements entered into at the date of acquisition, additional income taxes on pro forma income and given Bekin's organizational structure and the 1,764,117 common shares and $5,000,000 preferred shares issued as consideration in the transactions through December 31, 1998.
4. DISCONTINUED OPERATIONS
In December 1998, the Company decided to discontinue its hotel development business, especially in light of Prime Hospitality Corp.'s ("Prime") decision to no longer pursue new development opportunities with the Company. The Company anticipates ceasing operations by April 1999, although the resolution date as to the recovery from Prime of costs incurred by the Company under their master development agreement is uncertain. The Company has reflected the current year operating results associated with its development business, as well as the estimated loss on disposal, as discontinued operations on the statement of operations.
In December 1995, the Company determined to focus its resources on its hospitality and restoration business and discontinue its lighting business. On February 26, 1996, the Company entered into a divestiture agreement with its former President. In accordance with the agreement, the Company disposed of the lighting business, together with its accounts receivable, inventory and fixed assets to the former President, who also assumed certain liabilities. Additionally, in accordance with the agreement, the following occurred: (i) the Company repurchased 500,000 shares of common stock from the former President for $250,000 with a market value of $437,500; (ii) the Company retained the former President as a consultant for a three year period at an annual salary of $100,000, (iii) the former President granted to the Company the option to purchase an additional 1,000,000 shares of common stock over a two year period at a 33% discount from the average trading price for the 20 trading days prior to purchase, but not below certain minimum set prices. The Company repurchased 500,000 of the optioned shares in October 1996 for $715,000 and repurchased the remaining 500,000 shares in May 1997 for $2,210,000. In 1996, the Company incurred additional losses from discontinued operations of $64,705.
5. ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE
Accounts receivables include retainages of $3,756,317 at December 31, 1998 and $636,577 at December 31, 1997, on contracts which are collectible upon the acceptance by the owner. All amounts at December 31, 1997 were collected in 1998 and amounts at December 31, 1998 are anticipated to be collected in their entirety in 1999. Accounts receivable is shown net of the 1998 provision on contract revenues of $8,863,000 at December 31, 1998.
Accounts receivables and costs and estimated earnings in excess of billings include unapproved change orders and estimated net claims, which involves negotiations with the custmer and in some cases may result in litigation. The Company believes it has established legal bases for pursuing recovery of recorded amounts and it is management's intention to pursue these claims and litigate, if necessary, until a decision or settlement is reached. Claims involve the use of estimates and it is reasonably possible that revisions to the estimated recoverable amounts of recorded claims could be made within the next year. The settlement of the amounts depends on the individual circumstances, accordingly, the timing of the collection will vary and may extend beyond one year. The amounts recorded at December 31, 1998 were approximately $12,200,000.
The Company withholds a portion of payments due subcontractors as retainages, which amounted to $1,348,124 at December 31, 1998 and $212,278 at December 31, 1997. The subcontractor balances are paid when the Company collects its retainages receivable.
6. COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Costs and estimated earnings in excess of billings on uncompleted contracts represent unbilled receivables. Billings on uncompleted contracts in excess of costs and estimated earnings represent deferred revenue, and consist of:
7. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
8. LOAN PAYABLE
In 1996, the Company obtained a secured line of credit with a bank. The line provided for borrowings of up to $2.5 million, with interest at prime plus 1/2% and was collateralized by all Company assets and was guaranteed by the Company's renovation subsidiary. In September 1997, the Company repaid all outstanding borrowings under the line.
In May 1997, the Company borrowed $2.2 million at an annual interest rate of 12%. The proceeds of the borrowing were used to repurchase 500,000 shares from the Company's former President (Note 4). The note was paid in full in September 1997.
In March 1998, the Company obtained a unsecured line of credit with Marine Midland Bank. The line provides for borrowings of up to $7,000,000 with interest at the bank's prime lending rate. At December 31, 1998, there were $4,975,000 in outstanding borrowings under the line. The line of credit matures on May 31, 1999.
In July 1998, the Company obtained an unsecured line of credit with NationsBank. The line provides for borrowings of up to $6,000,000 with interest at the bank's prime lending rate. At December 31, 1998, there were $5,950,000 in outstanding borrowings under the line. The line of credit matures on May 30, 1999.
The weighted average interest rates for 1998 and 1997 on the loans outstanding during the year were 8.20% and 8.92%, respectively.
9. LONG-TERM DEBT
Long-term debt consists of the following:
The term loan and mortgage payable contain restrictive covenants that require, among other things, Bekins to maintain certain ratios of operating cash flow to fixed charges and total funded debt to operating cash flows, as well as minimum operating cash flows. At December 31, 1998, Bekins was in violation of one of the covenants and received a waiver of such violation from the bank.
The following represents the schedule of the aggregate annual principal payments on long-term debt for the years ended December 31:
1999 $621,000 2000 633,931 2001 2,330,931 2002 -- thereafter -- ------------- $3,585,862
10. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
For the year ended December 31, 1998, the Company recorded a provision for income taxes for continuing operations of $755,150 and a benefit for income taxes for discontinued operations of $596,000.
The following is a reconciliation of the Company's income taxes based on the statutory rate and the actual provision for income taxes for both continuing operations and discontinued operations:
Deferred income taxes result from temporary differences between the financial reporting carrying amounts and the tax bases of assets and liabilities. The source of these differences and tax effect of each at December 31, 1998 and 1997 are as follows:
The Company has recorded net deferred tax assets at December 31, 1998 and 1997 primarily representing expenses recognized for financial reporting purposes that will be deductible in future years for tax purposes. Management believes that no valuation allowance is required for these assets due to the expectation that the Company will generate taxable income in future years.
11. RELATED PARTY TRANSACTIONS
(a) The Company hired Interstate Interior Services ("Interstate") as a subcontractor on certain of its projects. The President of Interstate is the sister of one of the Company's officers. During 1996 the Company paid fees of $172,786 to Interstate.
(b) During 1997 and 1996, the Company performed renovation services for Watermark LLC. Watermark LLC is the general partner of Watertone Holdings LP, which is a shareholder of Company common stock. In addition, the Chief Executive Officer of the Company was a director of Watermark LLC. During 1997, the Company and Watermark LLC renegotiated the renovation contract to provide for fees more consistent with a project of similar scope and complexity. As a result of the renegotiations, the Company recognized additional revenues for the year ended December 31, 1997 of $780,183 without an accompanying increase in costs. As of December 31, 1998 and December 31, 1997 the Company had no receivables due from Watermark.
The following revenues and gross profit have been reflected in the consolidated financial statements:
(c) In connection with the Apollo Joint Venture (see Note 14), on April 10, 1997, the Company and Resource Holdings entered into a financial advisory agreement pursuant to which Resource Holdings agreed to assist the Company in connection with negotiations relating to the Apollo Joint Venture and to provide general financial advisory, strategic planning and acquisition advice to the Company. In consideration for those services, the Company agreed to pay Resource Holdings 16 1/2% of certain distributions received by the Company from the Apollo Joint Venture (after certain distributions to the joint venture parties and returns on capital invested in each project in which the Apollo Joint Venture participates) and such additional fees to be mutually agreed upon between Resource Holdings and the Company. No distributions were received by the Company from Apollo in 1998 and 1997.
12. COMMITMENTS AND CONTINGENCIES
(A) LEASE COMMITMENTS
The Company leases office space in New York, Los Angeles, St. Louis, Chicago and Coral Gables which expire at various dates through 2007. In conjunction with the acquisition of Bekins in January, 1998 the Company assumed a ground lease on a building in Orlando, Florida which expires in 2085, with a minimum annual payment of $6,489.
The aggregate future minimum lease payments due under operating leases are as follows:
December 31 - -------------------------------------------------------------------------------- 1999 $ 2,614,970 2000 1,958,723 2001 1,752,330 2002 1,675,677 2003 1,635,314 Thereafter 8,387,794 --------- $18,024,808
Rent expense for 1998, 1997 and 1996 was $2,581,948, $1,093,686 and $120,534 respectively.
(B) EMPLOYMENT AGREEMENTS
The Company currently has employment agreements with twelve members of management personnel that expire from January 2000 to March 2001 at an aggregate annual compensation of $2,575,000.
(C) LITIGATION
The Company is a defendant in various litigation incident to its business and in some instances the amounts sought include substantial claims and counterclaims. Although the outcome of the litigation cannot be predicted with certainty, in the opinion of management based on the facts known at this time, the resolution of such litigation is not anticipated to have a material adverse effect on the financial position or results of operations of the Company. As these matters continue to proceed through the litigation process to ultimate resolution, it is reasonably possible that the Company's estimation of the effect of such matters could change within the next year.
(D.) OFFICER AND EMPLOYEE LOANS
At various times during the year, the Company has provided short-term loans to various of its officers and employees of the Company bearing interest at 12%. Loans provided during 1998, 1997 & 1996 amounted to 3,590,000, 767,000 and 0, respectively. The balance owed to the Company was 250,000 and 647,500 at December 31, 1998 and 1997, respectively.
13. MAJOR CUSTOMERS AND SUBCONTRACTORS
Most of the Company's customers are in the hospitality industry with a few of them accounting for a substantial portion of annual revenues. As a result, the trade accounts receivable and costs and estimated earnings in excess of billings subject the Company to concentration of credit risk. As of December 31, 1998, one customer accounted for approximately 27% of accounts receivable.
The largest customers of the Company for 1998, a major lodging company and a major hotel development company high ranking official of the United Arab Emirates accounted for 15% and 10%, respectively, of the Company's net revenue. The largest customer of the Company for 1997, a high-ranking government official of the United Arab Emirates, accounted for 14% of the Company's net revenues. The two largest customers of the Company for 1996 accounted for 49% and 31% of net revenues.
During 1998 and 1997, no subcontractors accounted for over 10% of the Company's cost of revenues. During 1996, 35% of the Company's cost of revenues were costs charged by one subcontractor.
14. STOCKHOLDERS' EQUITY
In January 1997, in connection with the acquisition of LPC and Parker Reorder, the Company issued 200,000 shares of 6% Convertible Preferred Stock ("LPC Preferred"). The holders of LPC Preferred are entitled to receive cash dividends at the rate of six percent (or $1.50) per annum per share of LPC Preferred (the "Preferred Dividend"), accruing from the date of issuance and payable commencing March 31, 1998. Dividends for 1998 have been accrued as of December 31, 1998. If the Company is legally capable of paying the Preferred Dividend and elects to accrue such amount, such accrued dividends shall bear interest at the rate of 13 1/2% per annum until paid. The holders of the LPC Preferred are also entitled to receive out of the cumulative net profits of Parker Reorder (the "Cumulative Net Profits"), an annual cash payment (the "Participating Dividend") equal to 12% of (i) the Cumulative Net Profits of Parker Reorder measured from January 1, 1997, less (ii) all Participating Dividends previously made to the holders of the LPC Preferred. The holders of the LPC Preferred are also entitled to a liquidation preference at the stated value of the stock.
In October 1998, 80,000 shares of LPC Preferred were converted into an aggregate of 584,800 shares of common stock. The remaining 120,000 shares of LPC Preferred are convertible, at any one time during the period from January 10, 1998 to January 10, 2000, into (i) 600,000 shares of the Company's common stock, subject to an
upward adjustment in the event that the market price of the Company's common stock is below $5.00 at the time of conversion, based on a defined conversion formula, up to a maximum of 2,400,000 shares, or (ii) 5.88% of the outstanding capital stock of Parker Reorder. The conversion formula related to the conversion into the Company's common stock is defined as the number of shares of common stock equal to the product of 25 (which represents the stated value per share of the LPC Preferred) and the number of shares of LPC Preferred, divided by the average closing sale price for the common stock for the 20 trading days immediately prior to the date written notice of the intention to exercise the conversion option is given, provided, however, that in no case shall the number of shares of common stock into which each share of LPC Preferred may be converted be less than 5 or greater than 20. At any time after January 10, 2000, the Company shall have the option to redeem the LPC Preferred at a redemption price equal to the Stated Value for each such share of LPC Preferred, plus an amount equal to all accrued and unpaid Preferred Dividends and interest thereon, if any.
The holders of LPC Preferred are entitled to vote on all matters submitted to the holders of the Common Stock and each share of LPC Preferred is entitled to 4.17 votes. The holders of record of the LPC Preferred, voting as a class, are entitled to elect two directors to the Company's Board of Directors at any time that any of the LPC Preferred is outstanding.
The Company cannot pay or declare dividends on any capital stock other than the LPC Preferred, so long as such LPC Preferred is outstanding, unless all accrued and unpaid dividends on the LPC Preferred for all prior applicable periods have been declared and paid and the dividends on the LPC Preferred Stock for the current and applicable period has been declared and set apart for payment. The Company is not otherwise restricted from declaring and paying dividends to its shareholders.
In January 1998, in connection with the acquisition of Bekins, the Company issued 514,117 shares of Common Stock. Further, pursuant to a make-whole adjustment in the purchase agreement, 639,512 additional shares of Common Stock were issued by the Company in January 1999 (Note 3).
In May 1997, the Company entered into an Agreement to Joint Venture ("Apollo Joint Venture") with Apollo Real Estate Advisors II, L.P. ("Apollo") and Watermark Limited LLC to identify, acquire, renovate, refurbish and sell hotel properties. The Company will perform all of the renovation and procurement services for each of the properties purchased by the Apollo Joint Venture. In addition, the Company will receive a five percent equity interest in each of the joint venture entities formed to purchase such properties in exchange for its contribution of five percent of the total equity required to acquire, renovate and sell such properties. The joint venture intends to own and operate the properties only for the time necessary to upgrade and market them for resale. In September 1997, the Apollo Joint Venture acquired the Warwick Hotel in Philadelphia, Pennsylvania. As of December 31, 1998, the Company contributed approximately $720,000 to the joint venture operating entity that was formed to purchase the property. As of December 31, 1998, there are no additional material capital commitments to be made by the Company. The joint venture operating entity is owned 95% by the general partner, which is owned by Apollo and Watermark, and 5% by the Company as a limited partner. The Company is accounting for this investment on the cost method as all decisions are made by the general partner. As an inducement to enter into the Apollo Joint Venture, the Company issued to Apollo a seven-year warrant to purchase 750,000 shares of Common Stock at $8.115 per share. The warrant expires in 2004. The warrant is currently exercisable as to 350,000 shares and becomes exercisable as to the remaining 400,000 shares in increments of 100,000 shares for every $7,500,000 of incremental renovation revenue and purchasing fees earned and to be earned by the Company from the joint venture. The costs associated with the warrants for the 100,000 share increments earned and anticipated to be earned by Apollo are recognized as an additional cost of the related renovation and procurement contract. The fair value of the warrant for 250,000 shares was $1,287,500 (or $5.15 per share) and the warrant for 100,000 shares was $550,000 (or $5.50 per share). In 1997, the Company recognized an expense of approximately $1,593,400, of which $1,287,500 is reflected as Warrant Expense and $305,900 is included in Cost of Revenues on the accompanying consolidated Statement of Operations. In 1998, the Company recognized an expense of $213,575, which is included in Cost of Revenues on the accompanying Consolidated Statement of Operations.
The Company completed a secondary public offering in September 1997 of 3,450,000 shares of Common Stock (inclusive of 1,000,000 shares held in treasury) at $10.25 per share. The net proceeds of the offering, net of issuance costs and expenses, were $32,126,630. A portion of the proceeds was used to repay short-term indebtedness with the remainder available for general corporate purposes, including the financing of working capital needs and business development. In conjunction with the offering, the underwriter was granted a warrant to purchase 356,723 shares of the Company's common stock at an exercise price of $12.00 per share. The fair value of the warrants was $5.04. The warrant is exercisable in full after one year (September 17, 1998) and expires on September 17, 2002. The number of shares issuable under this warrant is subject to change upon certain events, among them, the declaration of dividends, stock splits or reverse stock splits.
15. STOCK OPTION PLAN
At December 31, 1998, the Company has three stock option plans. As permitted by SFAS No. 123, when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation cost is recognized.
During 1994, the Company's Board of Directors adopted a non-statutory stock option plan for purposes of issuance of shares of the Company's common stock to certain key employees or consultants. With respect thereto, options to purchase a total of 160,000 shares were granted. The stock option plan has been retired, and there are no shares available for grant.
On September 26, 1996, the Company's Board of Directors adopted the 1996 Stock Option Plan (the "Plan") for the purpose of providing incentive to the officers and employees of the Company who are primarily responsible for the management and growth of the Company. Each option granted pursuant to the Plan shall be designated at the time of grant as either an "incentive stock option" or as a "non-qualified stock option". The term for each option granted is determined by the Stock Option Committee, which is composed of two or more members of the Board of Directors, provided the maximum length of the term of each option granted will be no more than ten years. Options granted vest over five years.
On September 26, 1996, the Company's Board of Directors adopted, and the shareholders approved, the 1996 Outside Directors Stock Option Plan (the "Outside Directors' Plan") for the purpose of securing for the Company and its shareholders the benefits arising from stock ownership by its outside directors. Subject to shareholder approval, each outside director who becomes an outside director after March 1, 1996 shall receive the grant of an option to purchase 15,000 shares of common stock. To the extent that shares of common stock remain available for the grant of options under the Outside Directors Plan on April 1 of each year, beginning on April 1, 1997, each outside director shall be granted an option to purchase 10,000 shares of common stock. Options granted under the Outside Directors Plan vest over two years and shall be exercisable in three equal installments beginning on the first anniversary of the grant date.
SFAS No. 123 requires the Company to provide pro forma information regarding net income and earnings per share as if compensation cost for the Company's stock option plans had been determined in accordance with the fair value-based method prescribed in SFAS No. 123. The Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1998, 1997 and 1996, respectively: no dividends paid for all years; expected volatility of 98%, 9% and 40%; risk-free interest rate of 5.54%, 6.04% and 6.41%; and expected lives of 5.8 years, 5.3 years and 2 years.
Under the accounting provisions of SFAS 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below.
(a) Antidilutive
The following table contains information on stock options for the three year period ended December 31, 1998.
The following table summarizes information about stock options outstanding at December 31, 1998.
16. EARNINGS PER SHARE
The following table reconciles the components of basic and diluted earnings per common share for income (loss) from continuing operations for the years ended December 31, 1998, 1997 and 1996.
(a) The common stock equivalent shares for the year ended December 31, 1998 was 1,020,474 shares for the convertible preferred stock and for the year ended December 31, 1997 was 991,232 shares for the Stock-based compensation plans; and 1,000,000 shares for the convertible preferred stock. The common stock equivalents for these shares were not included in the calculation of diluted earnings (loss) per common share because the effect would be antidilutive.
17. OPERATING SEGMENTS
The Company's operating segments are based on the separate lines of business acquired over the past several years which provide different services to the hospitality industry, namely renovation, purchasing and logistics services.
All transactions between reportable segments are accounted for on an arms length basis and are eliminated in consolidation.
The Company's revenue and assets predominately relate to our United States operations, with immaterial amounts related to foreign operations.
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which revised the disclosures about the Company's operating segments. The Company has restated prior year to conform to the new disclosure requirements.
18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) (A)
(a) All amounts except per share data presented in thousands. (b) The quarterly per share amounts are computed independently of annual amounts. (c) Antidilutive (d) The fourth quarter includes a non cash charge of $1,434 related to the recognition of warrants issued in connection with the Apollo Joint Venture.