SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
Commission File No. 1-10308
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Cendant Corporation
(Exact name of Registrant as specified in its charter)
Delaware 06-0918165
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification Number)
organization)
6 Sylvan Way
Parsippany, New Jersey 07054
(Address of principal executive (Zip Code)
office)
(973) 428-9700
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if applicable)
------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days: Yes [T] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
The number of shares outstanding of each of the Registrant's classes of
common stock was 853,078,387 shares of Common Stock outstanding as of November
12, 1998.
CENDANT CORPORATION AND SUBSIDIARIES
INDEX
PART I Financial Information PAGE NO.
Item 1. Financial Statements
Consolidated Statements of Operations -
Three and Nine Months Ended September 30, 1998 and 1997 3-4
Consolidated Balance Sheets -
September 30, 1998 and December 31, 1997 5-6
Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1998 and 1997 7-8
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk 44
PART II Other Information
Item 1. Legal Proceedings 45
Item 6. Exhibits and Reports on Form 8-K 45
Certain statements in this Quarterly Report on Form 10-Q constitute "forward
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. Such forward looking statements involve known and unknown
risks, uncertainties and other factors which may cause the actual results,
performance, or achievements of the Company to be materially different from any
future results, performance, or achievements expressed or implied by such
forward looking statements. These forward looking statements were based on
various factors and were derived utilizing numerous important assumptions and
other important factors that could cause actual results to differ materially
from those in the forward looking statements. Important assumptions and other
important factors that could cause actual results to differ materially from
those in the forward looking statements, include, but are not limited to: the
resolution or outcome of the pending litigation and government investigation
relating to the previously announced accounting irregularities, uncertainty as
to the Company's future profitability and, the Company's ability to develop and
implement operational and financial systems to manage rapidly growing
operations; competition in the Company's existing and potential future lines of
business; the Company's ability to integrate and operate successfully acquired
and merged businesses and the risks associated with such businesses, including
the merger that created Cendant, the National Parking Corporation acquisition
and the Royal Automobile Club motoring services acquisition, the completion and
impact of the sale of discontinued operations, such as Hebdo Mag International,
International, Inc. and the Company's software businesses, the Company's ability
to obtain financing on acceptable terms to finance the Company's growth strategy
and for the Company to operate within the limitations imposed by financing
arrangements; uncertainty as to the future profitability of acquired businesses,
the ability of the Company and its vendors to complete the necessary actions to
achieve a year 2000 conversion for its computer systems and applications and
other factors. Other factors and assumptions not identified above were also
involved in the derivation of these forward looking statements, and the failure
of such other assumptions to be realized as well as other factors may also cause
actual results to differ materially from those projected. The Company assumes no
obligation to update these forward looking statements to reflect actual results,
changes in assumptions or changes in other factors affecting such forward
looking statements.
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
CENDANT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
As Restated As Restated
(Note 2) (Note 2)
----------------------- -----------------------
Revenues
Membership and service fees - net $ 1,416.4 $ 1,099.3 $ 3,678.8 $ 2,932.5
Fleet leasing (net of depreciation and interest
costs of $324.9, $307.9, $954.6 and $892.2) 18.5 12.8 57.5 42.9
Other 22.9 74.4 128.8 164.4
---------- --------- ---------- ----------
Net revenues 1,457.8 1,186.5 3,865.1 3,139.8
Expenses
Operating 515.9 344.3 1,306.9 958.1
Marketing and reservation 297.2 278.5 853.2 750.3
General and administrative 187.6 150.6 487.4 455.0
Depreciation and amortization 88.9 59.0 241.3 175.4
Other charges:
Merger-related costs and other unusual charges (credits) - - (24.4) 278.9
Investigation related costs and termination benefits 61.9 - 81.4 -
Financing costs 14.5 - 27.2 -
Asset impairments 50.0 - 50.0 -
Interest - net 31.0 13.5 72.9 36.3
---------- --------- ---------- ----------
Total expenses 1,247.0 845.9 3,095.9 2,654.0
---------- --------- ---------- ----------
Income from continuing operations before
income taxes, minority interest and cumulative
effect of accounting change 210.8 340.6 769.2 485.8
Provision for income taxes 73.2 137.6 273.0 238.4
Minority interest, net 14.5 - 34.3 -
---------- -------- ---------- ---------
Income from continuing operations before
cumulative effect of accounting change 123.1 203.0 461.9 247.4
Loss from discontinued operations,
net of taxes (Note 7) (12.1) (0.4) (25.0) (12.2)
----------- ---------- ----------- -----------
Income before cumulative effect of
accounting change 111.0 202.6 436.9 235.2
Cumulative effect of accounting change, net of tax - - - (283.1)
--------- -------- --------- -----------
Net income (loss) $ 111.0 $ 202.6 $ 436.9 $ (47.9)
========== ========= ========== ===========
See accompanying notes to consolidated financial statements.
CENDANT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
(In millions, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
As Restated As Restated
(Note 2) (Note 2)
----------------------- -----------------------
Income (Loss) Per Share:
Basic
Income from continuing operations
before cumulative effect of accounting change $ 0.14 $ 0.25 $ 0.55 $ 0.31
Loss from discontinued operations, net (0.01) - (0.03) (0.02)
Cumulative effect of accounting change, net - - - (0.35)
--------- -------- --------- -----------
Net income (loss) $ 0.13 $ 0.25 $ 0.52 $ (0.06)
========== ========= ========= ===========
Diluted
Income from continuing operations
before cumulative effect of accounting change $ 0.14 $ 0.23 $ 0.53 $ 0.29
Loss from discontinued operations, net (0.01) - (0.03) (0.01) (1)
Cumulative effect of accounting change, net - - - (0.32) (1)
--------- -------- --------- -----------
Net income (loss) $ 0.13 $ 0.23 $ 0.50 $ (0.04)
========== ========= ========= ===========
(1) The number of weighted average shares used to compute income from
continuing operations per share was also used to calculate the per share
amounts for the net loss from discontinued operations, the cumulative
effect of accounting change, net of tax and net loss. As a result of
losses recorded for such amounts, the per share amounts for the net loss
from discontinued operations, the cumulative effect of accounting change,
net of tax and net loss are anti-dilutive to their respective basic per
share amounts.
See accompanying notes to consolidated financial statements.
CENDANT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
September 30, December 31,
1998 1997
------------- -------------
Assets
Current assets
Cash and cash equivalents $ 1,611.2 $ 67.0
Receivables, net 1,327.8 1,170.7
Deferred income taxes 330.9 311.9
Other current assets 973.7 767.2
Net assets of discontinued operations 520.2 273.3
------------- -------------
Total current assets 4,763.8 2,590.1
------------- -------------
Property and equipment 1,298.2 460.8
Franchise agreements, net 961.3 890.3
Goodwill, net 4,015.8 2,148.2
Other intangibles, net 1,043.6 897.5
Other assets 688.5 642.8
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Total assets exclusive of assets under programs 12,771.2 7,629.7
------------- ------------
Assets under management and mortgage programs
Net investment in leases and leased vehicles 3,738.0 3,659.1
Relocation receivables 631.0 775.3
Mortgage loans held for sale 2,360.8 1,636.3
Mortgage servicing rights 573.4 373.0
------------- ------------
7,303.2 6,443.7
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Total assets $ 20,074.4 $ 14,073.4
============= =============
See accompanying notes to consolidated financial statements.
CENDANT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
September 30, December 31,
1998 1997
------------- -------------
Liabilities and shareholders' equity
Current liabilities
Accounts payable and other current liabilities $ 1,489.3 $ 1,492.4
Current portion of long-term debt 2,702.7 -
Deferred income 1,392.2 1,042.0
------------- -------------
Total current liabilities 5,584.2 2,534.4
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Deferred income 227.8 292.1
Long-term debt 1,308.5 1,246.0
Other noncurrent liabilities 320.6 181.2
------------- -------------
Total liabilities exclusive of liabilities under programs 7,441.1 4,253.7
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Liabilities under management and mortgage programs
Debt 6,195.8 5,602.6
Deferred income taxes 257.9 295.7
Mandatorily redeemable preferred securities issued by subsidiaries 1,472.1 --
Commitments and contingencies (Note 15)
Shareholders' Equity
Preferred stock, $.01 par value - authorized
10 million shares; none issued and outstanding -- --
Common stock, $.01 par value - authorized
2 billion shares; issued 858,281,922
and 838,333,800 shares, respectively 8.6 8.4
Additional paid-in capital 3,405.2 3,088.4
Retained earnings 1,377.5 940.6
Accumulated other comprehensive loss (6.7) (38.2)
Restricted stock, deferred compensation (2.7) (3.4)
Treasury stock, at cost 6,750,546 shares (74.4) (74.4)
-------------- --------------
Total shareholders' equity 4,707.5 3,921.4
------------- -------------
Total liabilities and shareholders' equity $ 20,074.4 $ 14,073.4
============= =============
See accompanying notes to consolidated financial statements.
CENDANT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Nine Months Ended
September 30,
1998 1997
------------- --------------
As Restated
(Note 2)
Operating Activities
Net income (loss) $ 436.9 $ (47.9)
Loss from discontinued operations, net of taxes 25.0 12.2
Cumulative effect of accounting change, net of tax - 283.1
Depreciation and amortization 241.3 175.4
Other charges - asset impairments and termination benefits 62.5 -
Merger-related costs and other unusual charges (credits) (24.4) 278.9
Payments of merger-related costs and other unusual
charge liabilities (127.2) (157.6)
Other (76.1) (305.5)
-------------- --------------
Net cash provided by operations exclusive of
management and mortgage programs 538.0 238.6
------------- -------------
Management and mortgage programs:
Depreciation and amortization 944.9 812.3
Mortgage loans held for sale (724.4) 86.1
-------------- -------------
220.5 898.4
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Net cash provided by operating activities
of continuing operations 758.5 1,137.0
------------- -------------
Investing Activities
Property and equipment additions (240.8) (97.4)
Investments (94.2) (181.2)
Net change in marketable securities 4.7 (646.5)
Net assets acquired (net of cash acquired) and acquisition-related payments (2,658.2) (539.9)
Other, net 77.0 (131.3)
------------- --------------
Net cash used in investing activities of continuing
operations exclusive of management
and mortgage programs (2,911.5) (1,596.3)
-------------- --------------
Management and mortgage programs:
Investment in leases and leased vehicles (1,876.4) (1,629.4)
Payments received on investment in leases and leased vehicles 765.5 615.2
Proceeds from sales and transfers of leases and leased vehicles to third parties 136.8 63.5
Equity advances on homes under management (5,186.5) (4,185.5)
Repayment of advances on homes under management 5,333.8 4,341.3
Additions to originated mortgage servicing rights (338.7) (147.6)
Proceeds from sales of mortgage servicing rights 75.2 49.0
------------- -------------
(1,090.3) (893.5)
-------------- --------------
Net cash used in investing activities of
continuing operations (4,001.8) (2,489.8)
-------------- --------------
See accompanying notes to consolidated financial statements.
CENDANT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(In millions)
Nine Months Ended
September 30,
1998 1997
------------- --------------
As Restated
(Note 2)
Financing Activities
Proceeds from borrowings $ 3,279.6 $ 917.5
Principal payments on borrowings (420.5) (174.2)
Issuance of convertible debt - 542.8
Issuance of common stock 160.4 119.9
Purchases of common stock - (171.3)
Proceeds from mandatorily redeemable preferred securities
issued by subsidiaries, net 1,446.7 -
Other, net - (6.6)
------------- --------------
Net cash provided by financing activities of continuing operations
exclusive of management and mortgage programs 4,466.2 1,228.1
------------- -------------
Management and mortgage programs:
Proceeds from debt issuance or borrowings 2,455.1 2,129.2
Principal payments on borrowings (2,215.7) (1,575.8)
Net change in short-term borrowings 347.0 (693.9)
------------- --------------
586.4 (140.5)
------------- --------------
Net cash provided by financing activities of
continuing operations 5,052.6 1,087.6
------------- -------------
Effect of changes in exchange rates on cash and cash equivalents (9.7) (0.4)
Net cash used in discontinued operations (255.4) (45.0)
-------------- --------------
Net increase (decrease) in cash and cash equivalents 1,544.2 (310.6)
Cash and cash equivalents, beginning of period 67.0 448.1
------------- -------------
Cash and cash equivalents, end of period $ 1,611.2 $ 137.5
============= =============
See accompanying notes to consolidated financial statements.
CENDANT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
Cendant Corporation, together with its subsidiaries (the "Company"), is
one of the foremost consumer and business services companies in the
world. The Company was created through the merger (the "Cendant Merger")
of HFS Incorporated ("HFS") and CUC International Inc. ("CUC") in
December 1997 with the merged company being renamed Cendant Corporation.
The Company provides fee-based services to consumers within the Travel,
Real Estate and Alliance Marketing business segments.
The consolidated balance sheet of the Company as of September 30, 1998,
the consolidated statements of operations for the three and nine months
ended September 30, 1998 and 1997 and the consolidated statements of
cash flows for the nine months ended September 30, 1998 and 1997 are
unaudited. The accompanying consolidated financial statements include
the accounts and transactions of the Company and all wholly-owned
subsidiaries. All intercompany balances and transactions have been
eliminated in consolidation. The accompanying unaudited consolidated
financial statements have been prepared in accordance with generally
accepted accounting principles for interim financial information and
with the instructions of Form 10-Q and Rule 10-01 of Regulation S-X
promulgated under the Securities Exchange Act of 1934. The December 31,
1997 consolidated balance sheet was derived from the Company's audited
financial statements included in the Company's Annual Report on
Form10-K/A for the year ended December 31, 1997 and should be read in
conjunction with such consolidated financial statements and notes
thereto.
In the opinion of the Company's management, all adjustments considered
necessary for a fair presentation have been included. Operating results
for the three and nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year
ending December 31, 1998.
2. Restatement
As publicly announced on April 15, 1998, the Company discovered
accounting irregularities in certain business units of CUC. As a result,
the Company together with its counsel and assisted by auditors,
immediately began an intensive investigation (the "Company
Investigation"). In addition, the Audit Committee of the Company's Board
of Directors initiated an investigation into such matters (the "Audit
Committee Investigation", together with the Company Investigation, the
"Investigations"). On July 14, 1998, the Company announced that the
accounting irregularities were greater than those initially discovered
in April and that the irregularities affected the accounting records of
the majority of the CUC business units. On August 13, 1998, the Company
announced that the Company Investigation was completed and, on August
27, 1998, the Company announced that the Audit Committee had submitted
its report to the Board of Directors on the Audit Committee
Investigation into the accounting irregularities and its conclusions
regarding responsibility for those actions. As a result of the findings
from the Investigations, the Company restated its financial statements
for the years ended December 31, 1997, 1996 and 1995. Such restated
financial statements were audited and filed on Form 10-K/A with the
Securities and Exchange Commission ("SEC") on September 29, 1998. In
addition, as a result of the Investigations and a concurrent internal
financial review process by the Company which revealed both accounting
errors and accounting irregularities, the Company restated its financial
statements for the quarterly periods ended March 31 and June 30, 1998,
respectively. The Company's restated financial statement for the
quarterly periods ended March 31, 1998 and 1997 and June 30, 1998 and
1997 were filed on Quarterly Reports Form 10-Q/A with the SEC on October
13, 1998. The financial statements for the three and nine months ended
September 30, 1997 are restated herein in this Form 10-Q.
In connection with the Company Investigation and coincident with the
audit and restatement process, certain adjustments were made in 1997 for
accounting errors (that were not a result of irregularities) which
relate to the former HFS businesses. Such adjustments were substantially
comprised of $47.8 million in reductions to merger-related costs and
other unusual charges, which increased 1997 income from continuing
operations.
In connection with the aforementioned accounting irregularities, the SEC
and the United States Attorney for the District of New Jersey are also
conducting investigations relating to the accounting irregularities (See
Note 15). In connection with the SEC's investigation, in August 1998,
the SEC requested that the Company change its accounting policies with
respect to revenue and expense recognition for its membership businesses
effective January 1, 1997. Although the Company believed that its
accounting for memberships had been appropriate and consistent with
industry practice, the Company complied with the SEC's request and
adopted new accounting policies for its membership businesses. (See Note
3-Accounting Change). Accordingly, the financial results for the three
and nine months ended September 30, 1997 as set forth herein have been
restated for the accounting change.
The Company has recorded all corrections arising from the findings of
the Investigations. Such corrections were the result of accounting
irregularities, the misapplication of generally accepted accounting
principles and the aforementioned change in accounting for memberships.
Provided below is a summary of the impact of such corrections and a
reconciliation of the financial results from amounts previously reported
to the restated financial statement amounts, as presented in this
Quarterly Report on Form 10-Q. The reconciliation includes the
reclassification of discontinued operations (see Note 7 Discontinued
Operations). While management has made all adjustments considered
necessary as a result of the findings of the Investigations, there can
be no assurance that additional adjustments will not be required as a
result of the ongoing SEC investigation.
STATEMENT OF OPERATIONS
(In millions, except per share data)
Three Months Ended September 30, 1997
------------------------------------------------------------------
Accounting
adjustments
for errors,
As irregularities
previously Discontinued and accounting As
reported operations change restated
------------- -------------- ---------------- -------------
Net revenues $ 1,431.3 $ (142.0) $ (102.8) $ 1,186.5
------------- -------------- ---------------- -------------
Expenses
Operating 464.5 (78.6) (41.6) 344.3
Marketing and reservation 360.9 (26.4) (56.0) 278.5
General and administrative 105.8 (25.5) 70.3 150.6
Depreciation and amortization 70.2 (9.9) (1.3) 59.0
Interest, net 15.6 (4.2) 2.1 13.5
------------- -------------- --------------- -------------
Total expenses 1,017.0 (144.6) (26.5) 845.9
------------- -------------- ---------------- -------------
Income from continuing operations
before income taxes 414.3 2.6 (76.3) 340.6
Provision (benefit) for income taxes 166.0 2.2 (30.6) 137.6
------------- ------------- ---------------- -------------
Income from continuing operations 248.3 0.4 (45.7) 203.0
Loss from discontinued operations,
net of taxes - (0.4) - (0.4)
-------------- -------------- --------------- --------------
Net income $ 248.3 $ - $ (45.7) $ 202.6
============= ============= ================ =============
Income per share
Basic
Income from continuing
operations $ 0.31 $ 0.25
Loss from discontinued
operations, net - -
------------ ------------
Net income $ 0.31 $ 0.25
============= ============
Income per share
Diluted
Income from continuing
operations $ 0.29 $ 0.23
Loss from discontinued
operations, net - -
------------ ------------
Net income $ 0.29 $ 0.23
============= ============
Weighted Average Shares
Basic 805.9 805.9
Diluted 889.0 889.0
STATEMENT OF OPERATIONS
(In millions, except per share data)
Nine Months Ended September 30, 1997
--------------------------------------------------------------------
Accounting
adjustments
for errors,
As irregularities
previously Discontinued and accounting As
reported operations change restated
------------- -------------- ---------------- -------------
Net revenues $ 3,890.0 $ (407.2) $ (343.0) $ 3,139.8
------------- -------------- ---------------- -------------
Expenses
Operating 1,317.8 (209.4) (150.3) 958.1
Marketing and reservation 963.4 (97.2) (115.9) 750.3
General and administrative 324.1 (65.4) 196.3 455.0
Depreciation and amortization 190.6 (23.9) 8.7 175.4
Merger-related costs and other unusual charges 303.0 (16.5) (7.6) 278.9
Interest, net 43.9 (14.2) 6.6 36.3
------------- -------------- --------------- -------------
Total expenses 3,142.8 (426.6) (62.2) 2,654.0
------------- -------------- ---------------- -------------
Income (loss) from continuing operations
before income taxes and cumulative
effect of accounting change 747.2 19.4 (280.8) 485.8
Provision (benefit) for income taxes 346.5 7.2 (115.3) 238.4
------------- ------------- ---------------- -------------
Income (loss) from continuing operations
before cumulative effect of accounting change 400.7 12.2 (165.5) 247.4
Loss from discontinued operations,
net of taxes - (12.2) - (12.2)
------------ -------------- --------------- --------------
Income (loss) before cumulative effect
of accounting change 400.7 - (165.5) 235.2
Cumulative effect of accounting change,
net of tax - - (283.1) (283.1)
------------ ------------- ---------------- --------------
Net income (loss) $ 400.7 $ - $ (448.6) $ (47.9)
============= ============= ================ ==============
Income (loss) per share
Basic
Income from continuing operations before
cumulative effect of accounting change $ 0.50 $ 0.31
Loss from discontinued operations, net - (0.02)
Cumulative effect of accounting change, net - (0.35)
------------ ---------------
Net income (loss) $ 0.50 $ (0.06)
============= ===============
Income (loss) per share
Diluted
Income from continuing operations before
cumulative effect of accounting change $ 0.47 $ 0.29
Loss from discontinued operations, net - (0.01)
Cumulative effect of accounting change, net - (0.32)
------------ ---------------
Net income (loss) $ 0.47 $ (0.04)
============= ===============
Weighted Average Shares
Basic 804.3 804.3
Diluted 877.1 877.1
3. Accounting Change
Effective January 1, 1997, the Company adopted a change in accounting for
the recognition of membership revenues and expenses. Prior to such
adoption, the Company recorded deferred membership income, net of estimated
cancellations, at the time members were billed (upon expiration of the free
trial period), which was recognized as revenue ratably over the membership
term and modified periodically based on actual cancellation experience. In
addition, membership acquisition and renewal costs, which related primarily
to membership solicitations were capitalized as direct response advertising
costs due to the Company's ability to demonstrate that the direct response
advertising resulted in future economic benefits. Such costs were amortized
on a straight-line basis as revenues were recognized (over the average
membership period). The Company believed that such accounting policies were
appropriate and consistent with industry practice.
In August 1998, in connection with the Company's cooperation with the SEC
investigation into accounting irregularities discovered in the former CUC
business units, the SEC concluded that when membership fees are fully
refundable during the entire membership period, membership revenue should
be recognized at the end of the membership period upon the expiration of
the refund offer. The SEC further concluded that non-refundable
solicitation costs should be expensed as incurred since such costs are not
recoverable if membership fees are refunded. Accordingly, effective January
1, 1997, the Company recorded a non-cash after-tax charge of $283.1 million
or $.32 per diluted share for the nine months ended September 30, 1997, to
account for the cumulative effect of the accounting change.
4. Earnings Per Share ("EPS")
Basic EPS is computed based solely on the weighted average number of common
shares outstanding during the period. Diluted EPS reflects all potential
dilution of common stock. Basic and diluted EPS from continuing operations
is calculated as follows:
Three Months Ended Nine Months Ended
(In millions, except per share amounts) September 30, September 30,
-------------------------- --------------------------
1998 1997 1998 1997
----------- ---------- ----------- -----------
Income from continuing operations
before cumulative effect of accounting
change $ 123.1 $ 203.0 $ 461.9 $ 247.4
Convertible debt interest 2.8 5.8 8.6 11.3
----------- ---------- ----------- -----------
Income from continuing operations,
before cumulative effect of accounting
change, as adjusted $ 125.9 $ 208.8 $ 470.5 $ 258.7
=========== ========== =========== ===========
Weighted average shares - basic 850.8 805.9 844.8 804.3
Potential dilution of common stock:
Stock options 8.5 34.6 31.2 33.7
Convertible debt 18.0 48.5 19.0 39.1
----------- ---------- ----------- -----------
Weighted average shares - diluted 877.4 889.0 895.0 877.1
=========== ========== =========== ===========
EPS - continuing operations before
cumulative effect of accounting
change
Basic $ 0.14 $ 0.25 $ 0.55 $ 0.31
=========== ========== =========== ===========
Diluted $ 0.14 $ 0.23 $ 0.53 $ 0.29
=========== ========== =========== ===========
5. Comprehensive Income
The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 130 "Reporting Comprehensive Income" effective January 1, 1998. This
statement establishes standards for the reporting and display of an
alternative income measurement and its components in the financial
statements.
Components of comprehensive income (loss) are summarized as follows:
Nine Months Ended
(In millions) September 30,
------------------------------
1998 1997
------------- -------------
Net income (loss) $ 436.9 $ (47.9)
------------- --------------
Other comprehensive income (loss), net of tax:
Currency translation adjustment 35.5 (16.4)
Unrealized gains (losses) on marketable securities:
Unrealized holding gains (losses)
arising during the period (4.0) -
Reclassification adjustment for gains included
in earnings - (4.3)
------------- --------------
Comprehensive income (loss) $ 468.4 $ (68.6)
============= ==============
The components of accumulated other comprehensive income (loss) for the
nine months ended September 30, 1998 are as follows:
Net unrealized Accumulated
gain (loss) on Currency other
marketable translation comprehensive
(In millions) securities adjustment income (loss)
-------------- -------------- --------------
Balance, January 1, 1998 $ 0.2 $ (38.4) $ (38.2)
Currency translation adjustment - 35.5 35.5
Net unrealized gain (loss) on marketable
securities (4.0) - (4.0)
-------------- ------------- --------------
Balance, September 30, 1998 $ (3.8) $ (2.9) $ (6.7)
============== ============== ==============
6. Business Combinations
The acquisitions discussed below were accounted for using the purchase
method of accounting. Accordingly, assets acquired and liabilities assumed
were recorded at their estimated fair values. Excess purchase price over
fair value of the underlying net assets acquired is allocated to goodwill.
Goodwill is amortized on a straight-line basis over the estimated benefit
periods, ranging from 25 to 40 years. The operating results of such
acquired companies are reflected in the Company's consolidated statements
of operations since the respective dates of acquisition.
The following table reflects the fair values of assets acquired and
liabilities assumed in connection with the Company's acquisitions
consummated and other acquisition-related payments made during the nine
months ended September 30, 1998.
(In millions)
Total consideration:
Cash paid (net of $52.4 million of cash acquired) $ 2,658.2
-------------
Assets acquired 1,187.3
Liabilities assumed 495.8
Fair value of identifiable net assets acquired 691.5
-------------
Goodwill $ 1,996.7
=============
National Parking Corporation - On April 27, 1998, the Company completed the
acquisition of National Parking Corporation Limited ("NPC") for $1.6
billion in cash, which included the repayment of approximately $227 million
of outstanding NPC debt. NPC is substantially comprised of two operating
subsidiaries: National Car Parks and Green Flag. National Car Parks is the
largest private (non-municipal) single car park operator in the United
Kingdom ("UK") and Green Flag operates the third largest roadside
assistance group in the UK and offers a wide-range of emergency support and
rescue services.
Harpur Group - On January 20, 1998, the Company completed the acquisition
of The Harpur Group Ltd. ("Harpur"), a leading fuel card and vehicle
management company in the UK for approximately $186.0 million in cash plus
future contingent payments of up to $20.0 million over two years.
Jackson Hewitt - On January 7, 1998, the Company completed the acquisition
of Jackson Hewitt Inc. ("Jackson Hewitt"), for approximately $480.0 million
in cash. Jackson Hewitt operates the second largest tax preparation service
franchise system in the United States. The Jackson Hewitt franchise system
specializes in computerized preparation of federal and state individual
income tax returns.
Other 1998 Acquisitions and Acquisition-Related Payments - The Company
acquired certain other entities for an aggregate purchase price of
approximately $336.9 million in cash during the nine month period ended
September 30, 1998. Additionally, the Company made a $100.0 million cash
payment to the seller of Resort Condominiums International, Inc. in
satisfaction of a contingent purchase liability.
Pro forma Information - The following table reflects the unaudited
operating results of the Company for the nine months ended September 30,
1998 and 1997 on a pro forma basis, which gives effect to the acquisition
of NPC, accounted for under the purchase method of accounting. The
remaining acquisitions completed during 1998 are not significant on a pro
forma basis and are therefore not included. The pro forma results are not
necessarily indicative of the operating results that would have occurred
had the NPC transaction been consummated on January 1, 1997 nor are they
intended to be indicative of results that may occur in the future. The
underlying pro forma information includes the amortization expense
associated with the assets acquired, the Company's financing arrangements,
certain purchase accounting adjustments and the related income tax effects.
Nine Months Ended
(In millions, except per share amounts) September 30,
1998 1997
------------- -------------
Net revenues $ 4,066.6 $ 3,565.8
Income before cumulative effect of accounting change (1) 436.8 228.9
Net income (loss) 436.8 (54.2) (2)
Per share information:
Income per share before cumulative effect of accounting
change (1)
Basic $ 0.52 $ 0.28
Diluted 0.50 0.27
Net income (loss) per share
Basic $ 0.52 $ (0.07)
Diluted 0.50 (0.05) (2)
Weighted average shares outstanding:
Basic 844.8 804.3
Diluted 895.0 877.1
- -------------------
(1) Includes loss from discontinued operations, net of taxes for the nine
months ended September 30, 1998 and 1997 of $25.0 million ($.03 per diluted
share) and $12.2 million ($.01per diluted share), respectively.
(2) Includes the cumulative effect of a change in accounting of $283.1
million ($0.32 per diluted share) related to revenue and expense
recognition for memberships with full refund offers.
7. Discontinued Operations
On August 12, 1998 (the "Measurement Date"), the Company announced that its
Executive Committee of the Board of Directors committed to discontinue the
Company's classified advertising and consumer software businesses by
disposing of Hebdo Mag International, Inc. ("Hebdo Mag") and Cendant
Software Corporation ("Cendant Software"), respectively. The Company has
since entered into a definitive agreement, as amended, to sell Hebdo Mag to
its former 50% owners for 7.1 million shares of Company common stock and
approximately $360 million in cash. The transaction is expected to be
consummated in the fourth quarter of 1998 and is subject to certain
conditions, including regulatory approval and financing by the purchaser.
The Company expects to recognize a gain of approximately $230 million upon
the disposal of Hebdo Mag, assuming a Company stock price of $13.25 per
share, the closing price of the Company's common stock on November 3, 1998.
In addition, the Company has engaged investment bankers to analyze various
strategic alternatives in regard to the disposition of Cendant Software and
the Company is currently in various stages of discussions with certain
parties regarding the potential sale of such business unit. The Company
anticipates that the disposition of Cendant Software will also result in a
significant gain.
Summarized financial data of discontinued operations are as follows:
Statement of Operations Data:
Consumer Software
------------------------------------------------------------------
Three Months Ended Nine Months Ended
(In millions) September 30, September 30,
------------------------------- -------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
Net revenues $ 119.5 $ 90.7 $ 345.8 $ 261.4
------------- ------------- ------------- -------------
Loss before income taxes (20.2) (4.6) (57.3) (31.6)
Benefit from income taxes (9.7) (3.2) (22.9) (12.1)
-------------- -------------- -------------- --------------
Net loss $ (10.5) $ (1.4) $ (34.4) $ (19.5)
============== ============== ============== ==============
Classified Advertising
------------------------------------------------------------------
Three Months Ended Nine Months Ended
(In millions) September 30, September 30,
------------------------------- -------------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
Net revenues $ 65.2 $ 51.3 $ 202.4 $ 145.8
------------- ------------- ------------- -------------
Income (loss) before income taxes (0.2) 2.0 20.4 12.2
Provision for income taxes 1.4 1.0 11.0 4.9
------------- ------------- ------------- -------------
Net income (loss) $ (1.6) $ 1.0 $ 9.4 $ 7.3
============== ============= ============= =============
The Company has allocated $13.8 million and $3.8 million of interest
expense to discontinued operations for the nine months ended September 30,
1998 and 1997, respectively. Such interest expense represents the cost of
funds associated with businesses acquired by the discontinued business
segments at an interest rate consistent with the Company's consolidated
effective borrowing rate.
Balance Sheet Data:
Consumer Software Classified Advertising
----------------------------------- -------------------------------------
September 30, December 31, September 30, December 31,
(In millions) 1998 1997 1998 1997
---------------- --------------- ----------------- ---------------
Current assets $ 163.0 $ 209.1 $ 69.0 $ 58.6
Goodwill 111.3 42.2 273.3 181.5
Other assets 94.5 49.2 34.5 33.2
Total liabilities (102.6) (127.0) (122.8) (173.5)
---------------- ---------------- ---------------- ----------------
Net assets of discontinued
operations $ 266.2 $ 173.5 $ 254.0 $ 99.8
=============== =============== =============== ===============
8. Financing Transactions
Term Loan Facility - On May 29, 1998, the Company entered into a 364-day
term loan agreement with a syndicate of financial institutions which
provided for borrowings of $3.25 billion (the "Term Loan Facility"). The
Term Loan Facility, as amended, bears interest at LIBOR plus an applicable
LIBOR spread, as defined. Upon the execution of the Term Loan Facility,
temporary credit agreements, which provided for $1.0 billion of borrowings,
were terminated. The Term Loan Facility, as amended, contains certain
restrictive covenants, which are substantially similar to and consistent
with the covenants in effect for the Company's existing revolving credit
agreements. At September 30, 1998, the Term Loan Facility was fully
utilized with approximately $700 million of borrowings classified as
long-term based on the Company's ability and intent to refinance such
borrowings on a long-term basis. The Company used $2 billion of the
proceeds from the Term Loan Facility to repay the outstanding borrowings
under its revolving credit facilities.
Issuance of FELINE PRIDES and Trust Preferred Securities - On March 2,
1998, Cendant Capital I (the "Trust"), a statutory business Trust formed
under the laws of the State of Delaware and a wholly-owned consolidated
subsidiary of the Company, issued 29.9 million FELINE PRIDES and 2.3
million trust preferred securities and received approximately $1.5 billion
in gross proceeds therefrom. The Trust invested the proceeds in 6.45%
Senior Debentures due 2003 (the "Debentures") issued by the Company, which
represents the sole asset of the Trust. The obligations of the Trust
related to the FELINE PRIDES and trust preferred securities are
unconditionally guaranteed by the Company to the extent the Company makes
payments pursuant to the Debentures. Upon the issuance of the FELINE PRIDES
and trust preferred securities, the Company recorded a liability of $43.3
million with a corresponding reduction to shareholders' equity equal to the
present value of the total future contract adjustment payments to be made
under the FELINE PRIDES. The FELINE PRIDES, upon issuance, consisted of
27.6 million Income PRIDES and 2.3 million Growth PRIDES, each with a face
amount of $50 per PRIDE. The Income PRIDES consist of trust preferred
securities and forward purchase contracts under which the holders are
required to purchase common stock from the Company in February 2001. The
Growth PRIDES consist of zero coupon U.S. Treasury securities and forward
purchase contracts under which the holders are required to purchase common
stock from the Company in February 2001. The trust preferred securities and
the trust preferred securities forming a part of the Income PRIDES, each
with a face amount of $50, bear interest, in the form of preferred stock
dividends, at the annual rate of 6.45 percent payable in cash. Such
preferred stock dividends are presented as minority interest, net of tax in
the consolidated statements of operations. Payments under the forward
purchase contract forming a part of the Income PRIDES will be made by the
Company in the form of a contract adjustment payment at an annual rate of
1.05 percent. The forward purchase contract forming a part of the Growth
PRIDES will be made by the Company in the form of a contract adjustment
payment at an annual rate of 1.30 percent. The forward purchase contracts
require the holder to purchase a minimum of 1.0395 shares and a maximum of
1.3514 shares of Company common stock per PRIDES security, depending upon
the average of the closing price per share of Company common stock for a 20
consecutive day period ending in mid-February of 2001. The Company has the
right to defer the contract adjustment payments and the payment of interest
on its Debentures to the Trust. Such election will subject the Company to
certain restrictions, including restrictions on making dividend payments on
its common stock until all such payments in arrears are settled.
Redemption of 4-3/4% Notes - On May 4, 1998, the Company redeemed all of
the outstanding ($144.5 million principal amount) 4-3/4% Convertible Senior
Notes (the "4-3/4% Notes") at a price of 103.393% of the principal amount
together with interest accrued to the redemption date. Prior to the
redemption date, during 1998, holders of such notes exchanged $95.5 million
of the 4-3/4% Notes for 3.4 million shares of Company common stock (See
Note 11).
Redemption of 6-1/2% Notes - On April 8, 1998, the Company exercised its
option to call its 6-1/2% Convertible Subordinated Notes (the "6-1/2%
Notes") for redemption on May 11, 1998, in accordance with the provisions
of the indenture relating to the 6-1/2% Notes. Prior to the redemption
date, during 1998, all of the outstanding 6-1/2% Notes were converted into
2.1 million shares of Company common stock.
9. Merger-Related Costs and Other Unusual Charges
The Company incurred merger-related costs and other unusual charges
("Unusual Charges") in 1997 related to continuing operations of $704.1
million primarily associated with and/or coincident to the Cendant Merger
(the "Fourth Quarter 1997 Charge") and the merger with PHH Corporation (the
"Second Quarter 1997 Charge"). The remaining liabilities at December 31,
1997, which are classified as accounts payable and other current
liabilities and the reduction of such liabilities for the nine months ended
September 30, 1998 are summarized by category of expenditure and by charge
as follows:
Liabilities Liabilities at
at December 31, Cash September 30,
(In millions) 1997 Payment Non-Cash Adjustments 1998
------------- ------------- ------------- -------------- -------------
Professional fees $ 50.7 $ 37.6 $ - $ (9.3) $ 3.8
Personnel related 168.5 72.2 - (18.2) 78.1
Business terminations 3.9 1.8 1.4 (2.4) 1.1
Facility related and other 50.4 15.7 2.5 5.5 42.7
------------- ------------- ------------- ------------- -------------
Total $ 273.5 $ 127.3 $ 3.9 $ (24.4) $ 125.7
============= ============= ============= ============== =============
Liabilities Liabilities at
at December 31, Cash September 30,
(In millions) 1997 Payment Non-Cash Adjustments 1998
------------- ------------- ------------- -------------- ------------
Fourth Quarter 1997
Charge $ 197.4 $ 99.3 $ 0.9 $ (13.2) $ 85.8
Second Quarter 1997
Charge 76.1 28.0 3.0 (11.2) 39.9
------------- ------------- ------------- -------------- -------------
Total $ 273.5 $ 127.3 $ 3.9 $ (24.4) $ 125.7
============= ============= ============= ============== =============
Fourth Quarter 1997 Charge. The $85.8 million of liabilities remaining at
September 30, 1998 are primarily comprised of $63.3 million of severance
and other personnel related costs and $18.8 million of outstanding
facility-related liabilities. Approximately $4.1 million of remaining
severance costs will be paid upon the closure of nine European call centers
which will be substantially completed in 1998. Approximately $37.8 million
of executive termination benefits will be paid or otherwise extinguished
upon the settlement of employment obligations. Outstanding facility-related
liabilities will be paid or otherwise extinguished upon the aforementioned
closures of European call centers and other office consolidations. During
the nine months ended September 30, 1998, the Company recorded a net credit
of $13.2 million to Unusual Charges with a corresponding reduction to
liabilities primarily as a result of a change in the original estimate of
costs to be incurred.
Second Quarter 1997 Charge. The $39.9 million of liabilities remaining at
September 30, 1998 primarily consists of $14.8 million of future severance
and benefit payments and $23.9 million of future lease termination
payments. During the nine months ended September 30, 1998, the Company
recorded a net credit of $11.2 million to Unusual Charges with a
corresponding reduction to liabilities as a result of a change in the
original estimate of costs to be incurred. Such credit was net of $24.1
million of costs incurred related to lease terminations.
10. Investigation Related Costs and Termination Benefits
The Company records all costs incurred in connection with and as a result
of the investigations into accounting irregularities as "investigation
related costs and termination benefits" in the consolidated statement of
operations.
On July 28, 1998, the Company announced that Walter A. Forbes resigned as
Chairman of the Company and as a member of the Board of Directors. The
severance agreement reached with Mr. Forbes entitles him the benefits
required by his employment contract relating to a termination of Mr.
Forbes' employment with the Company for reasons other than for cause.
Aggregate benefits resulted in a $50.4 million third quarter 1998 charge
comprised of $37.9 million in cash payments and 1.3 million of Company
stock options with a Black-Scholes value of $12.5 million. Such options
were immediately vested and expire on July 28, 2008. Other costs for the
three and nine months ended September 30, 1998 of $11.5 million and $31.0
million, respectively, are primarily comprised of professional fees and
public relations costs incurred in connection with the investigations.
11. Other Charges - Financing Costs
The Company paid $25 million of banking fees on May 29, 1998 in connection
with executing the Term Loan Facility (see Note 8 Financing Transactions).
Such financing was arranged to ensure Company liquidity in the absence of
access to public financing markets as a result of the Company's discovery
and announcement of accounting irregularities and the corresponding lack of
audited financial statements. The financing costs have been deferred and
are being amortized over six months, the anticipated borrowing period.
In connection with the Company exercising its option to redeem the 4 3/4%
Notes, the Company anticipated that all holders of the 4 3/4% Notes would
elect to convert the 4 3/4% notes to Company common stock based upon the
fair value of the common stock at such time. However, during the redemption
period, the Company's common stock price experienced a significant
decrease. As a result, holders of the 4 3/4% Notes elected not to convert
the 4 3/4% notes to common stock and redeemed such notes at a premium (see
Note 8 - Financing Transactions). Accordingly, the Company recorded a $7.2
million ($4.5 million after-tax) loss on early extinguishment of debt which
is classified in the statement of operations as Other Charges - Financing
Costs.
12. Other Charges - Asset Impairments
The Company periodically evaluates the recoverability of its investments
and long-lived assets. As a result of such practices, the Company recorded
a $50.0 million non-cash charge during the third quarter of 1998. Based on
a recent evaluation of its long-lived assets and in connection with the
Company's regular budget and forecasting processes, the Company determined
that $37 million of goodwill associated with a Company subsidiary within
its Alliance Marketing segment, National Library of Poetry, was impaired.
In addition, the Company had equity investments in interactive businesses
within its Other segment, which were generating negative cash flows and
were unable to access sufficient liquidity through equity or debt
offerings. As a result, the Company wrote-off $13 million of such
investments.
13. Investment in Avis Rent A Car, Inc.
The Company's equity interest in Avis Rent A Car, Inc. ("Avis ") was
reduced from 27.5% to 20.4% as a result of a secondary offering by Avis of
its common stock in March 1998 in which the Company sold one million shares
of Avis common stock. The Company recognized a pre-tax gain of
approximately $17.7 million as a result of the sale, which is included in
other revenue in the consolidated statement of operations.
14. Pending Acquisition
RAC Motoring Services - On May 21, 1998, the Company announced that it
reached a definitive agreement with the Board of Directors of Royal
Automobile Club Limited ("RACL") to acquire their RAC Motoring Services
subsidiary ("RACMS") for approximately $735 million in cash. The sale of
RACMS has subsequently been approved by its shareholders. On September 24,
1998, the UK Secretary of State for Trade and Industry referred the RACMS
acquisition to the UK Monopolies and Mergers Commission (the "MMC") for its
approval. Closing is subject to certain conditions, including MMC approval.
Although no assurances can be made, the Company currently anticipates that
the transaction, if completed, will close in the spring of 1999. RACMS is
the second-largest roadside assistance company in the UK and also owns the
UK's largest driving school company.
15. Company Investigation and Litigation
Accounting Irregularities, Litigation and Investigation. On April 15, 1998,
the Company announced that it discovered accounting irregularities in the
former CUC business units. Since the Company's announcement and prior to
the date hereof, seventy-one purported class action lawsuits, two purported
derivative lawsuits and one individual lawsuit have been filed against the
Company and certain current and former officers and directors of the
Company and HFS, asserting various claims under the federal securities law
(the "Federal Securities Actions"). Some of the actions also name as
defendants Merrill Lynch & Co. and, in one case, Chase Securities, Inc.,
underwriters for the Company's PRIDES securities offering; and two others
also name Ernst & Young LLP, the Company's former independent accountants.
Sixty-four of the Federal Securities Actions were filed in the United
States District Court for the District of New Jersey, six were filed in the
United States District Court for the District of Connecticut (including the
individual action), one was filed in the United States District Court for
the Eastern District of Pennsylvania, and one was filed in New Jersey
Superior Court. The Federal Securities Actions filed in the District of
Connecticut and the Eastern District of Pennsylvania have been transferred
to the District of New Jersey. On June 10, 1998, the Company moved to
dismiss or stay the Federal Securities Actions filed in New Jersey Superior
Court on the ground that, among other things, it is duplicative of the
actions filed in federal courts. The court granted that motion on August 7,
1998 without prejudice to the plaintiff's right to refile the case in the
District of New Jersey.
Certain of these Federal Securities Actions purport to be brought on behalf
of purchasers of the Company's common stock and/or options on common stock
during various periods, most frequently beginning May 28, 1997 and ending
April 15, 1998 (although the alleged class periods begin as early as March
21, 1995 and ends as late as July 15, 1998). Others claim to be brought on
behalf of persons who exchanged common stock of HFS for the Company's
common stock in connection with the Cendant Merger. Some plaintiffs purport
to represent both of these types of investors. In addition, eight actions
pending in the District of New Jersey purport to be brought, either in
their entirety or in part, on behalf of purchasers of the Company's PRIDES
securities. The complaints in the Federal Securities Actions allege, among
other things, that as a result of accounting irregularities, the Company's
previously issued financial statements were materially false and misleading
and that the defendants knew or should have known that these financial
statements caused the prices of the Company's securities to be inflated
artificially. The Federal Securities Actions variously allege violations of
Section 10(b) of the Securities Exchange Act of 1934, as amended, (the
"Exchange Act") and Rule 10b-5 promulgated thereunder, Section 14(a) of the
Exchange Act and Rule 14a-9 promulgated thereunder, Section 20(a) of the
Exchange Act and Sections 11, 12 and 15 of the Securities Act of 1933, as
amended (the "Securities Act"). Certain actions also allege violations of
common law. The individual action also alleges violations of Section 18(a)
of the Exchange Act and the Florida securities law. The class action
complaints seek damages in unspecified amounts. The individual action seeks
damages in the amount of approximately $9 million plus interest and
expenses.
On May 29, 1998, United States Magistrate Judge Joel A. Pisano entered an
order consolidating the 50 Federal Securities Actions that had at that time
been filed in the United States District Court for the District of New
Jersey, under the caption In re: Cendant Corporation Litigation, Master
File No. 98-1664 (WHW). Pursuant to the Order, all related actions
subsequently filed in the District of New Jersey are to be consolidated
under that caption. United States District Court Judge William H. Walls has
selected lead plaintiffs and lead counsel to represent all potential class
members in the consolidated actions and ordered that a consolidated amended
complaint be filed by December 14, 1998. On November 11, 1998, the lead
plaintiff representing purchasers of the Company's PRIDES securities filed
an amended and consolidated complaint. Simultaneously, that lead plaintiff
filed motions seeking: (1) certification of a class of persons who
purchased the Company's PRIDES securities between February 24, and April
15, 1998 pursuant to a registration statement and prospectus prepared in
connection with the public offering of the Company's PRIDES securities; (2)
summary judgment against the Company on the claims brought pursuant to
Section 11 of the Securities Act; and (3) a preliminary injunction
requiring the Company to place $300 million in trust for the benefit of the
proposed class of PRIDES purchasers. The Company intends to vigorously
oppose the motions; however, the Company can make no assurances as to the
timing, outcome or resolutions thereof.
In addition, on April 27, 1998, a shareholder derivative action, Deutch v.
Silverman, et al., No. 98-1998 (WHW), was filed in The District of New
Jersey against certain of the Company's current and former directors and
officers; The Bear Stearns Companies, Inc., Bear Stearns & Co., Inc. and,
as a nominal party, the Company. The complaint in the Deutch action alleges
that certain individual officers and directors of the Company breached
their fiduciary duties by selling shares of the Company's stock while in
possession of non-public material information concerning accounting
irregularities. The complaint also alleges various other breaches of
fiduciary duty, mismanagement, negligence and corporate waste and seeks
damages on behalf of the Company.
Another action, entitled Corwin v. Silverman, et al., No. 16347-NC, was
filed on April 29, 1998 in the Court of Chancery for the State of Delaware.
The Corwin action is purportedly brought both derivatively, on behalf of
the Company, and as a class action, on behalf of all shareholders of HFS
who exchanged their HFS shares for the Company's shares in connection with
the Cendant Merger. The Corwin action names as defendants HFS and
twenty-eight individuals who are and were directors of Cendant and HFS. The
complaint in the Corwin action alleges that the defendants breached their
fiduciary duties of loyalty, good faith, care and candor in connection with
the Cendant Merger, in that they failed to properly investigate the
operations and financial statements of the Company before approving the
Cendant Merger at an allegedly inadequate price. The amended complaint also
alleges that the Company's directors breached their fiduciary duties by
entering into an employment agreement with Cendant's former Chairman,
Walter Forbes, in connection with the Cendant Merger that purportedly
amounted to corporate waste. The Corwin action seeks, among other things,
recision of the Cendant Merger and compensation for all losses and damages
allegedly suffered in connection therewith. On October 7, 1998, the Company
filed a motion to dismiss the Corwin action or, in the alternative, for a
stay of the Corwin action pending determination of the Federal Securities
Actions.
The staff of the Securities and Exchange Commission (the "SEC") and the
United States Attorney for the District of New Jersey are conducting
investigations relating to the matters referenced above. The SEC staff has
advised the Company that its inquiry should not be construed as an
indication by the SEC or its staff that any violations of law have
occurred.
In connection with the Cendant Merger, certain officers and directors of
HFS exchanged their shares of HFS common stock and options exercisable for
HFS common stock for shares of the Company's common stock and options
exercisable for the Company's common stock, respectively. As a result of
the aforementioned accounting irregularities, such officers and directors
have advised the Company that they believe they have claims against the
Company in connection with such exchange. In addition, certain current and
former officers and directors of the Company would consider themselves to
be members of any class ultimately certified in the Federal Securities
Actions now pending in which the Company is named as a defendant by virtue
of their have been HFS stockholders at the time of the Cendant Merger.
The Company does not believe it is feasible to predict or determine the
final outcome of these proceedings or investigations or to estimate the
amounts or potential range of loss with respect to the resolution of these
proceedings or investigations. In addition, the timing of the final
resolution of the proceedings or investigations is uncertain. The possible
outcomes or resolutions of the proceedings could include a judgment against
the Company or a settlement and could require substantial payments by the
Company. The Company's management believes that adverse outcomes
with respect to such proceedings could have a material adverse impact on
the financial condition, results of operations and cash flows of the
Company.
ABI Litigation. On October 14, 1998, an action entitled P Schoenfeld Asset
Management LLC v. Cendant Corp., et al., No. 98-4734 (WHW) (the "ABI
Action"), was filed in the United States District Court for the District of
New Jersey against the Company and four of its former officers and
directors. The plaintiff in the ABI Action claims to be bringing the action
on behalf of a class of all persons who purchased securities of American
Bankers between March 23, 1998 and October 13, 1998. The complaint in the
ABI Action alleges that the plaintiff and the putative class members
purchased American Bankers securities in reliance on false and misleading
public announcements and filings with the SEC made by the Company in
connection with its proposed acquisition of American Bankers. The complaint
alleges that those public announcements and filings contained materially
misstated financial statements, because of accounting irregularities
discussed above, and that the Company falsely announced its intention to
consummate the acquisition of American Bankers. It is asserted that these
misstatements were made in violation of Sections 10(b) and 20(a) of the
Exchange Act and caused the plaintiff and other putative class members to
purchase American Bankers securities at inflated prices.
Other pending litigation. The Company and its subsidiaries are involved in
pending litigation in the usual course of business. In the opinion of
management, such litigation will not have a material adverse effect on the
Company's consolidated financial position, results of operations or cash
flows.
16. New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative
Instruments and Hedging Activities" effective for all quarterly and annual
periods beginning after June 15, 1999. SFAS No. 133 requires the
recognition of all derivatives in the consolidated balance sheet as either
assets or liabilities measured at fair value. The Company will adopt SFAS
No. 133 effective January 1, 2000. The Company has not yet determined the
impact SFAS No. 133 will have on its financial position or results of
operations when such statement is adopted.
17. Subsequent Events
Repricing of Stock Options
On September 23, 1998, the Compensation Committee of the Board of Directors
approved a repricing and option exchange program for mid-management
employees relating to Company stock options granted to such employees
during December 1997 and the first quarter of 1998. Such options were
repriced on October 15, 1998 at $9.8125 per share (the "New Price"), which
was the market price at the time of repricing. On September 23, 1998, the
Compensation Committee also approved a repricing and option exchange
program for certain executive officers and senior managers of the Company
subject to certain conditions including revocation of a portion of existing
options. Additionally, a management equity ownership program was adopted
that requires these executive officers and senior managers to acquire
Company common stock at various levels commensurate with their respective
compensation levels. The repricing was accomplished by canceling existing
options and issuing new options at the New Price and, with respect to
certain options of executive officers and senior managers, at prices above
the New Price.
Termination of Acquisition Agreements
American Bankers Insurance Group, Inc. Due to uncertainties concerning the
eventual completion of the Company's pending acquisition of American
Bankers Insurance Group, Inc. ("American Bankers") on October 13, 1998, the
Company and American Bankers entered into a settlement agreement (the
"Settlement Agreement"), pursuant to which the Company and American Bankers
terminated a definitive agreement dated March 23, 1998 (the "Merger
Agreement") which provided for the Company's acquisition of American
Bankers for $3.1 billion. Accordingly, the Company's pending tender offer
for American Bankers shares was also terminated.
Pursuant to the Settlement Agreement and in connection with termination of
the Company's proposed acquisition of American Bankers, the Company made a
$400 million cash payment to American Bankers and wrote-off approximately
$30 million of costs, primarily professional fees, which were deferred in
connection with the proposed transaction. Such charges were recorded by the
Company during the fourth quarter of 1998. The Company also terminated a
bank commitment to provide a $650 million, 364-day revolving credit
facility, which was made available to partially fund the acquisition.
Providian Auto and Home Insurance Company. On October 5, 1998, the Company
announced the termination of an agreement to acquire Providian Auto and
Home Insurance Company ("Providian") for $219 million in cash. The
termination date in the such agreement to acquire Providian was September
30, 1998. Certain representations and covenants in acquisition agreement
had not been fulfilled and the conditions to closing had not been met. The
Company did not pursue an extension of the termination date of the
agreement because Providian no longer met the Company's acquisition
criteria.
Share Repurchase Program
In October 1998, the Company announced that its Board of Directors had
authorized a $1 billion common share repurchase program. Subject to
compliance with bank credit facility covenants and rating agency
constraints, the Company expects to execute the program through open-market
purchases.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General Overview
In December 1997, Cendant Corporation (the "Company") was created through the
merger (the "Cendant Merger") of HFS Incorporated ("HFS") and CUC International
Inc. ("CUC"). The Company is one of the foremost consumer and business services
companies in the world. The Company provides fee-based services to consumers
within the Travel, Real Estate and Alliance Marketing business segments. The
Company generally does not own the assets or share the risks associated with the
underlying businesses of its customers.
In the Travel Services segment, the Company is the world's largest franchisor of
lodging facilities and rental car facilities, the leading provider of vacation
timeshare exchange services, a leading provider of international fleet
management services, a leading roadside assistance company in the U.K. and the
largest operator of brand name parking garages in the U.K. In the Real Estate
Services segment, the Company is both the world's largest franchisor of
residential real estate brokerage offices and provider of corporate relocation
services and is a leading mortgage lender in the United States. In the Alliance
Marketing segment, the Company is a leading provider of membership consumer
services and products, a significant marketer and administrator of insurance
products through financial institutions and a provider of products and services
designed to enhance customers' lifestyles.
As publicly announced on April 15, 1998, the Company discovered accounting
irregularities in certain business units of CUC. As a result, the Company
together with its counsel and assisted by auditors, immediately began an
intensive investigation (the "Company Investigation"). In addition, the Audit
Committee of the Company's Board of Directors initiated an investigation into
such matters (the "Audit Committee Investigation", together with the Company
Investigation, the "Investigations"). As a result of the findings from the
Investigations and a concurrent internal financial review process by the
Company, the Company restated its financial statements for the years ended
December 31, 1997, 1996 and 1995 and the six months ended June 30, 1998. The
financial information contained herein has been restated to incorporate all
relevant information obtained from the Investigations. The 1997 results,
presented herein, have also been restated for a change in accounting, effective
January 1, 1997, related to revenue and expense recognition for memberships with
full refund offers.
The Company recently changed its focus from making strategic acquisitions of new
businesses to maximizing the opportunities and growth potential of its existing
businesses. In connection with this change in focus, the Company intends to
review and evaluate its existing businesses to determine whether certain
businesses continue to meet its business objectives. As part of its ongoing
evaluation of such businesses, the Company intends from time to time to explore
and conduct discussions with regard to divestitures and related corporate
transactions. However, the Company can give no assurance with respect to the
magnitude, timing, likelihood or financial or business effect of any possible
transaction. The Company also cannot predict whether any divestitures or other
transactions will be consummated or, if consummated, will result in a financial
or other benefit to the Company. The Company intends to use a portion of the
proceeds from such dispositions, if any, together with the proceeds of this and
future debt issues and bank borrowings and cash from operations, to retire the
Company's outstanding $3.25 billion bank term loan, to execute a program to
initially repurchase up to $1.0 billion of the Company's common stock and for
other general corporate purposes.
As a result of the Company's change in focus, on August 12, 1998, the Company
announced that it agreed to sell 100% of its classified advertising business
unit, Hebdo Mag International, Inc. ("Hebdo Mag") to a company organized by
Hebdo Mag management and engaged Credit Suisse First Boston to analyze strategic
alternatives in regard to a potential third party sale of the Company's entire
consumer software business unit. The Company is currently in various stages of
discussions with certain parties regarding the potential sale of such consumer
software business unit (see "Liquidity and Capital Resources - Discontinued
Operations").
Results of Operations - Three Months Ended September 30, 1998 vs Three Months
Ended September 30, 1997
The operating results of the Company and certain of its underlying business
segments for the three months ended September 30, 1998 and 1997 are comprised of
business combinations accounted for by the purchase method of accounting.
Accordingly, the results of operations of such acquired companies have been
included in the consolidated operating results of the Company and its applicable
business segments from the respective dates of acquisition.
In the underlying Results of Operations discussion of the Company and its
business segments, operating expenses exclude net interest expense and income
taxes. The operating results of the Company for the three months ended September
30, 1998 and 1997 are as follows:
Three Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Continuing operations:
Net revenues $ 1,457.8 $ 1,186.5 23%
------------- -------------
Operating income 256.3 354.1 (28%)
Interest, net (1) 45.5 13.5 237%
------------- -------------
Pre-tax income before minority interest 210.8 340.6 (38%)
Provision for income taxes 73.2 137.6 (47%)
Minority interest, net 14.5 - *
------------- -------------
Income from continuing operations 123.1 203.0 (39%)
Loss from discontinued operations (12.1) (0.4) *
-------------- --------------
Net income $ 111.0 $ 202.6 (45%)
============= =============
- ---------------
(1) Includes $14.5 million of financing costs incurred as a result of the
Company's discovery of accounting irregularities in the CUC business units.
* Not meaningful.
Operating income from continuing operations decreased $97.8 million (28%) in
1998 despite a $271.3 million (23%) revenue increase and continued operating
income growth in the Travel (35%) and Real Estate (52%) segments. The decrease
in operating income resulted primarily from increased operating expenses in the
Company's Alliance Marketing and Other segments. Such incremental expenses
included $61.9 million of costs associated with the Investigations and
non-recurring termination benefits provided to the former CUC and Company
Chairman, Walter Forbes, as well as $50.0 million of non-cash write-offs of
impaired intangible assets and interactive marketing business investments.
Net interest expense increased $32.0 million (237%) in 1998 primarily due to
financing costs associated with $2.7 billion of 1998 acquisitions, including
$1.6 billion for National Park Corporation ("NPC"), $0.5 billion for Jackson
Hewitt ("Jackson Hewitt") and $0.2 billion for the Harpur Group Ltd. ("Harpur").
The Company also incurred $14.5 million of incremental financing costs incurred
in connection with the execution of a term loan facility. The term loan facility
provided liquidity to the Company in the absence of access to public financing
markets prior to the filing of restated financial statements in the wake of the
discovery of accounting irregularities in previously issued financial
statements.
The Company's effective tax rate was reduced to 34.7% from 40.4%. Such decrease
is due to the Company's execution of certain tax minimization strategies, the
favorable impact of lower tax rates in international jurisdictions and lower
non-deductible amortization expense as a percentage of pre-tax income.
Minority interest of $14.5 million in 1998 related to the preferred dividend
payable on mandatorily redeemable preferred securities issued on March 2, 1998
(See "Liquidity And Capital Resources - Financing Exclusive of Management and
Mortgage Program Financing").
Discontinued operations, consisting of the Company's consumer software and
classified advertising businesses generated net losses in 1998 and 1997 of $12.1
million and $0.4 million, respectively. The consumer software business incurred
net losses of $10.5 million in 1998 and $1.4 million in 1997. Net income of the
classified advertising business decreased $2.6 million primarily as a result of
economic volatility in Russia.
Segment Discussions
The underlying discussion of each segment's operating results for the three
months ended September 30, 1998 and 1997 focuses on profits from continuing
operations, excluding interest and taxes.
Travel Services Segment
The Company provides a spectrum of services necessary to domestic and
international travelers. The Company is the world's largest franchisor of
nationally recognized hotel brands and car rental operations (Avis). Royalty
revenue is received from franchisees under contracts that generally range from
10 to 50 years in duration. The Company is the world's largest provider of
timeshare exchange services (RCI) to timeshare owners under one to three year
membership programs which require both exchange fees for exchanging vacation
weeks and recurring membership fees. In addition, the Company is a leading
provider of corporate fleet management and leasing services and also operates
the largest value-added tax refund service worldwide.
The Company acquired NPC on April 27, 1998. NPC owns National Car Parks, the
largest private (non-municipal) single car park operator in the United Kingdom
("UK"). NPC also owns Green Flag, the third largest roadside assistance group in
the UK, which offers a wide-range of emergency support and rescue services to
approximately 3.5 million members in the UK.
Three Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Net revenues $ 564.4 $ 354.8 59%
Operating expenses 396.4 230.5 72%
------------- -------------
Operating income $ 168.0 $ 124.3 35%
============= =============
Operating income increased $43.7 million (35%) as a result of a $209.6 million
(59%) increase in revenue while expenses increased $165.9 million (72%).
Excluding the 1998 acquisitions of Harpur and NPC, operating income increased
$25.8 million (21%), revenue increased $48.6 million (14%), operating expenses
increased $22.8 million (10%) and operating margins increased from 35% to 37%.
In addition to acquisitions, revenue increases were achieved by all major
business units comprising the Travel Services segment. Corporate fleet
management revenue, exclusive of Harpur, increased $11.5 million (16%) due to a
$7.5 million (25%) increase in leasing revenue and a $6.8 million (16%) increase
in service fees. While the increase in lease revenue was attributable to a 16%
increase in the average fee per vehicle, the increase in servicing fees resulted
primarily from a 15% increase in the number of fuel and other service based
cards. Lodging franchise fees increased $5.1 million (4%) due to a 2% increase
in revenue per available room and a 1% increase in the royalty rate. Timeshare
exchange revenue increased $5.7 million (13%) due to a 10% increase in the
average fee and timeshare subscription revenue increased $1.4 million (4%) due
to a 6% increase in members. The operating expense increase was due primarily to
$143.1 million in acquisitions while the remaining $22.8 million increase in
operating expenses represents a 10% increase reflecting the Travel Services
segment's operating leverage.
Real Estate Services Segment
The Company provides a range of services related to home sales, principally in
the United States. The Company is the world's largest franchisor of real estate
brokerage offices through its CENTURY 21(R), COLDWELL BANKER(R) and ERA(R)
franchise brands. Similar to the Travel Services Segment franchise business, the
Company receives royalty revenue from approximately 12,000 franchisees under
contracts with terms ranging from 5 to 50 years. The Company is the world's
largest provider of corporate employee relocation services and receives fees for
providing an array of services such as reselling relocating employees' homes
with the employee or client corporation bearing the economic risk of such
transaction, assisting relocating employees in finding homes, moving household
goods, expense reporting and other services. The Company also operates the
largest in-bound mortgage telemarketing operation in the United States
generating origination profits from the sale of mortgage notes, but retains
recurring servicing revenue streams over the life of the mortgage. In addition,
the Company is a distributor of welcome packages, which provide discounts from
local merchants to new homeowners. Customer referrals are made within the
various real estate related services as well as generating a database for
prospective Alliance Marketing Segment cross selling.
Three Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Net revenues $ 360.0 $ 281.3 28%
Operating expenses 183.4 165.1 11%
------------- -------------
Operating income $ 176.6 $ 116.2 52%
============= =============
Operating income increased $60.4 million (52%) primarily as a result of
increases in mortgage origination revenue and real estate franchise royalty fees
while operating expenses increased a modest 11% generating a 7.7 percentage
point operating margin improvement for the Real Estate Services Segment. Revenue
increased $78.7 million (28%) principally comprised of a $30.9 million (36%)
increase in real estate franchise royalty fees and a $42.5 million (121%)
increase in mortgage origination revenue. A 23% increase in home sale volume and
an 11% increase in underlying average price of homes sold drove the royalty fee
increase while a $3.4 billion (96%) increase in mortgage originations generated
the mortgage origination revenue growth. Operating expenses increased $18.3
million (11%) consisting of an $11.8 million (139%) increase in information
technology expenses required to support growth and the consolidation of
duplicate systems of acquired companies and $5.7 million (39%) additional
depreciation and amortization due to expansion with the balance being other
growth related expenses.
Alliance Marketing Segment
The Company derives its Alliance Marketing revenue principally from membership
fees, insurance premiums and product sales. The Alliance Marketing segment is
divided into three divisions: individual membership ("Individual Membership");
insurance/wholesale ("Insurance/Wholesale"); and lifestyle ("Lifestyle").
Individual Membership, with more than 33 million members, provides customers
with access to a variety of products and services in such areas as retail
shopping, travel, auto, dining and home improvement. Insurance/Wholesale, with
nearly 31 million customers, markets and administers insurance products,
primarily accidental death insurance. Insurance/Wholesale also provides services
such as checking account enhancement packages, various financial products and
discount programs to financial institutions, which in turn provide these
services to their customers. Lifestyle, with over 11 million customers, provides
customers with unique products and services that are designed to enhance a
customer's lifestyle.
Three Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Net revenues $ 499.0 $ 437.6 14%
Operating expenses 484.6 377.2 28%
------------- -------------
Operating income $ 14.4 $ 60.4 (76%)
============= =============
Operating income decreased $46.0 million (76%) to $14.4 million despite a $61.4
million (14%) increase in revenue. A $107.4 million increase in operating
expenses primarily resulted from a $37.0 million non-cash write-off related to
impaired goodwill associated with a Company subsidiary, the National Library of
Poetry, $18.1 million of incremental marketing expenditures in the individual
membership businesses, $11.7 million of costs associated with expanding
international operations and $15.2 million of expenses associated with
Credentials, Inc. ("Credentials") an individual membership business acquired in
March 1998. The Company's decision to increase marketing solicitation costs
preceded the Company's awareness of the requirement to change its accounting for
memberships sold with a full refund offer, which requires the deferral of
revenue generated by such solicitation efforts until the refund offer expires
and to expensing such solicitation costs as incurred.
The $61.4 million increase in revenue to $499.0 million resulted principally
from a $30.5 million increase in individual membership revenue. Excluding $10.6
million of revenue from acquired Credentials operations, individual membership
revenue increased $19.9 million (12%) primarily from an increase in the average
price of a membership. Insurance/wholesale revenue increased $17.0 million (14%)
primarily from a $10.2 million (50%) increase in revenue from international
sources and a $6.8 million (7%) domestic revenue increase. Revenue from the
Company's North American Outdoor Group subsidiary ("NAOG") increased $13.5
million (58%) to $36.8 million primarily as a result of $6.3 million of
increased book and video sales and $3.9 million of increased subscription
revenue.
Other Segment
The Company operates a variety of other businesses in addition to those which
comprise each of the Company's core business segments. Such business operations
and transactions are primarily comprised of (i) franchising the second largest
tax preparation service system in the United States as a result of the Company's
first quarter 1998 acquisition of Jackson Hewitt; (ii) information technology
and reservation system support services provided to the car rental, hotel and
other travel related industries; (iii) casino credit information and marketing
services; (iv) financial products provided to banks and (v) equity in earnings
from the Company's investment in the Avis Rent A Car, Inc. ("Avis") car rental
company.
Three Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Net revenues $ 34.4 $ 112.8 (70%)
Operating expenses 137.1 59.6 130%
------------- -------------
Operating income $ (102.7) $ 53.2 (293%)
============== =========
Operating income decreased $155.9 million (293%) from both a $78.4 million
decrease in revenue and a $77.5 million increase in expenses.
The increase in expenses was primarily comprised of $61.9 million of costs
incurred during 1998 associated with the Investigations including a $50.4
million non-recurring termination benefit provided to former Company Chairman
Walter Forbes upon his July 1998 separation from the Company in accordance with
his employment contract. The remaining $15.6 million increase resulted from a
$13.0 million write-off of certain Company investments in interactive
businesses. Other increases in 1998 operating expenses reflect the acquisitions
and integration of acquired businesses and assets such as Jackson Hewitt and
travel agency operations. Such increases were partially offset by $23.3 million
of 1997 expenses associated with Interval International, Inc. ("Interval"), a
former Company subsidiary which was sold in December 1997.
The $78.4 million decrease in revenue resulted primarily from a $23.8 million
decrease in equity in earnings from the Company's investment in Avis due to a
decrease in common equity ownership interest from 100% to approximately 20%, a
$32.0 million decrease from the absence of revenue associated with Interval
operations and $22.6 million of other revenue, including gains on sales of
casino marketing assets.
Results of Operations - Nine Months Ended September 30, 1998 vs Nine Months
Ended September 30, 1997
The operating results of the Company and certain of its underlying business
segments for the nine months ended September 30, 1998 and 1997 are comprised of
business combinations accounted for by the purchase method of accounting.
Accordingly, the results of operations of such acquired companies have been
included in the consolidated operating results of the Company and its applicable
business segments from the respective dates of acquisition.
In the underlying Results of Operations discussion of the Company and its
business segments, operating expenses exclude net interest expense, income taxes
and minority interest. The operating results of the Company for the nine months
ended September 30, 1998 and 1997 are as follows:
Nine Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Continuing operations:
Net revenues $ 3,865.1 $ 3,139.8 23%
------------- -------------
Operating expenses:
Excluding Unusual Charges 3,020.2 2,338.8 29%
Unusual Charges (1) (24.4) 278.9 *
-------------- -------------
Total operating expenses 2,995.8 2,617.7 14%
------------- -------------
Operating income 869.3 522.1 67%
Interest, net (2) 100.1 36.3 176%
------------- -------------
Pre-tax income before minority interest
and cumulative effect of accounting change 769.2 485.8 58%
Provision for income taxes 273.0 238.4 15%
Minority interest, net 34.3 - *
------------- -------------
Income from continuing operations
before cumulative effect of accounting change 461.9 247.4 87%
Loss from discontinued operations,
net of taxes (25.0) (12.2) (105%)
Cumulative effect of accounting change,
net of tax - (283.1) *
------------- --------------
Net income (loss) $ 436.9 $ (47.9) *
============= ==============
- ------------
(1) Merger-related costs and other unusual charges.
(2) Includes $27.2 million of financing costs incurred as a result of the
Company's discovery of accounting irregularities in the CUC business units.
*Not meaningful.
Operating income from continuing operations increased $347.2 million which was
comprised of a $725.3 million (23%) increase in net revenues and a $378.1
million (14%) increase in operating expenses. Contributing to the increase in
operating income was a reduction of Unusual Charges of $303.3 million primarily
attributable to $278.9 million of Unusual Charges incurred during the second
quarter of 1997 principally in connection with and coincident to the April 1997
merger of PHH Corporation ("PHH") with and into HFS. A net credit to Unusual
Charges of $24.4 million was recorded in 1998, which primarily represented
changes in previously recorded estimates. Excluding incurred Unusual Charges
operating income increased $43.9 million in 1998 from 1997 despite $81.4 million
of costs incurred related to the Investigations and a non-recurring termination
benefit provided to Walter Forbes, the former CUC and Company Chairman, as well
as $50.0 million of non-cash write-offs of impaired Alliance Marketing segment
intangible assets and Other segment interactive marketing business investments.
In addition, in 1998, the Company incurred $62.1 million of incremental
individual membership solicitation costs which were planned before management
was aware of the accounting change associated with memberships sold with a full
refund offer, requiring the Company to expense such costs as incurred. The
Company experienced increases in operating income in 1998 primarily as a result
of the continued growth in the Travel (38%) and Real Estate (75%) segments. In
addition, businesses acquired during 1998 accounted for $46.8 million of the
incremental increase in operating income in 1998. A discussion of operating
income excluding merger related costs and other unusual charges is included in
the segment discussion to follow.
Interest expense, net, increased $63.8 million in 1998 primarily due to (i)
$27.2 million of incremental financing costs which were primarily incurred in
connection with the execution of a term loan facility; (ii) incremental average
borrowings which the Company used to finance more than $2.6 billion of
acquisitions during the nine months ended September 30, 1998 including the
acquisitions of NPC, Jackson Hewitt and Harpur (See "Liquidity and Capital
Resources - Completed Acquisitions"); and (iii) interest income earned in 1997
on the proceeds from the February 1997 issuance of $550 million 3% Convertible
Subordinated Notes and other available cash, which were invested in short-term
marketable securities.
The Company's effective tax rate was reduced from 49.1% in 1997 to 35.5% in 1998
due to the non-deductibility of a significant amount of Unusual Charges recorded
during 1997 and the Company's continued focus on executing strategies to
optimize its effective tax rate. The 1997 effective income tax rate includes a
tax benefit from only a 25.3% effective tax rate on Unusual Charges due to the
significant non-deductibility of such costs. Excluding Unusual Charges, the
effective income tax rate on income from continuing operations decreased from
40.4% in 1997 to 35.6% in 1998. Such decrease is due to the Company's execution
of certain tax minimization strategies, the favorable impact of lower tax rates
in international jurisdictions and lower non-deductible amortization expense as
a percentage of pre-tax income.
Minority interest of $34.3 million in 1998 primarily related to the preferred
dividend payable in cash on the FELINE PRIDES and the trust preferred securities
issued on March 2, 1998 (See "Liquidity and Capital Resources - Financing
Exclusive of Management and Mortgage Program Financing").
Discontinued operations, consisting of the Company's consumer software and
classified advertising businesses generated net losses in 1998 and 1997 of $25.0
million and $12.2 million, respectively. The operating results of discontinued
operations in 1997 included Unusual Charges, after tax, of $10.0 million for
severance associated with the termination of certain consumer software
executives. Excluding Unusual Charges, the consumer software business unit
incurred incremental net losses in 1998 compared to 1997 of $24.9 million
comprised of increased net revenues of $84.4 million, which were more than
offset by a $121.2 million increase in operating expenses. Additional operating
expenses were incurred during 1998 for development and marketing costs. Net
income of the classified advertising business increased $2.1 million on a net
revenue increase of $56.6 million. Operating income within the classified
advertising business unit increased $13.1 million primarily as a result of
profits from businesses acquired by Hebdo Mag International, Inc. prior to its
merger with the Company, during the fourth quarter of 1997. The operating income
increase within the classified advertising unit was partially offset by a higher
effective tax rate in 1998.
The Company recorded a non-cash after tax charge in 1997 of $283.1 million to
account for the cumulative effect of an accounting change, effective January 1,
1997, related to revenue and expense recognition for memberships with full
refund offers.
Segment Discussion
The underlying discussion of each segment's operating results for the nine
months ended September 30, 1998 and 1997 focuses on results from continuing
operations, excluding interest, taxes, Unusual Charges and the cumulative effect
of a change in accounting ("Operating Income"). Management believes such
discussion is the most informative representation of recurring,
non-transactional related operating results of the Company's business segments.
Travel Services Segment
Nine Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Net revenues $ 1,415.4 $ 1,015.0 39%
Operating expenses 931.0 663.1 40%
------------- -------------
Operating income $ 484.4 $ 351.9 38%
============= =============
Operating income increased $132.5 million (38%) due to a revenue increase of
$400.4 million (39%) while expenses increased $267.9 million (40%). Excluding
the 1998 acquisitions of Harpur and NPC, operating income increased $94.5
million (27%), revenue increased $112.3 million (11%), operating expenses
increased $17.8 million (3%) and operating margins increased from 35% to 40%.
In addition to acquisitions, revenue increases were achieved by all business
units comprising the Travel Services segment. Corporate fleet management
revenue, exclusive of Harpur, increased $17.9 million (7%) due primarily to a
$17.1 million (17%) increase in vehicle leasing due to a 10% price improvement
and an $18.2 million (14%) increase in service fees due to a 24% increase in the
number of fuel and other service based cards. Lodging franchise fees increased
$17.3 million (6%) driven by a 2% increase in revenue per available room and a
2% increase in royalty rate. Timeshare exchange revenue increased $14.5 million
(11%) driven by a 7% increase in the exchange fee and subscription revenue
increased $5.3 million (6%) driven by 6% growth in the member base. The
operating expense increase was due to $250.2 million in acquisitions while the
remaining $17.7 million increase in operating expenses represents only a 3%
increase reflecting the Travel Segment's operating leverage.
Real Estate Services Segment
Nine Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Net revenues $ 994.0 $ 718.4 38%
Operating expenses 555.9 468.1 19%
------------- -------------
Operating income $ 438.1 $ 250.3 75%
============= =============
Operating income increased $187.8 million (75%) primarily as a result of
significant increases in mortgage origination revenue, real estate franchise
royalty fees and relocation revenue while operating expenses increased a
moderate 19% generating a 9.2 percentage point operating margin improvement for
the Real Estate Services Segment. Revenue increased $275.6 million (38%)
principally comprised of an $87.8 million (42%) increase in real estate
franchise royalty fees, a $126.0 million (147%) increase in mortgage origination
revenue and a $40.7 million (14%) increase in relocation related revenue. A 23%
increase in home sale volume and a 14% increase in the underlying average price
of homes sold drove the royalty fee increase while a $10.3 billion (132%)
increase in mortgage originations generated the mortgage origination revenue
growth with government home sales and referrals driving $27.6 and $11.7 million
respectively of growth in relocation revenue. Operating expenses increased $87.8
million (19%) consisting of a $24.7 million (111%) increase in information
technology expenses required to support growth and the consolidation of
duplicate systems of acquired companies, $28.7 million (46%) incremental
mortgage production and support department costs, $14.0 million (30%) additional
government home sale expense and $16.5 million additional depreciation and
amortization due to expansion with the balance being other growth related
expenses.
Alliance Marketing Segment
Nine Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Net revenues $ 1,248.3 $ 1,123.9 11%
Operating expenses 1,273.9 1,019.8 25%
------------- -------------
Operating income (loss) $ (25.6) $ 104.1 (125%)
============== =============
Operating income decreased $129.7 million (125%) to a loss of $25.6 million
despite a $124.4 million (11%) increase in revenue. A $254.1 million increase in
operating expenses primarily resulted from a $37.0 million non-cash write-off
related to impaired goodwill associated with a Company subsidiary, the National
Library of Poetry, $77.0 million of incremental marketing expenditures in the
individual membership businesses, $27.3 million of costs associated with
expanding international operations, $28.8 million associated with revenue growth
and increased marketing expenditures at NAOG and $31.7 million of expenses
associated with Credentials, Inc. ("Credentials"), an individual membership
business acquired in March 1998. The Company's decision to increase marketing
solicitation costs preceded the Company's awareness of the requirement to change
its accounting for memberships sold with a full refund offer, which requires the
deferral of revenue generated by such solicitation offers until the refund offer
expires and expensing such solicitation costs as incurred.
Individual membership revenues increased $54.8 million (11%) due primarily to
the Credentials acquisition and an increase in average membership prices.
Insurance/wholesale revenues increased $57.1 million (16%) primarily from a
$25.3 million (41%) increase in revenues from international sources and a $31.8
million (11%) domestic revenue increase. NAOG revenues increased $25.1 million
(36%) due primarily to increases in book video and advertising revenues.
Other Segment
Nine Months Ended September 30,
------------------------------------------------
(In millions) 1998 1997 Variance
------------- ------------- -------------
Net revenues $ 207.4 $ 282.5 (27%)
Operating expenses 259.4 187.8 38%
------------- -------------
Operating income (loss) $ (52.0) $ 94.7 (155%)
============== =============
Operating income decreased $146.7 million (155%) from both a $75.1 million
decrease in revenue and a $71.6 million increase in expenses.
The increase in expenses included $81.4 million of costs incurred during 1998
associated with the Investigations including a $50.4 million termination benefit
provided to the former Company Chairman Walter Forbes upon his July 1998
separation from the Company in accordance with his employment contract.
Incremental expenses incurred during 1998 also included a $13.0 million
write-off of certain Company investments in interactive businesses and other net
increases in operating expenses resulting from acquisitions and the integration
of acquired businesses and assets including $30.2 million of Jackson Hewitt
expenses and other travel agency operations. The increase in operating expenses
during 1998 were partially offset by $64.4 million of 1997 expenses incurred by
Interval which was sold in December 1997.
The $75.1 million decrease in revenue resulted primarily from a $39.1 million
decrease in equity of earnings from the Company's investment in Avis due to a
decrease in common equity ownership interest from 100% to approximately 20% and
a $90.7 million decrease from the absence of revenue from Interval operations
net of $52.4 million increase associated with acquired Jackson Hewitt
operations.
Liquidity and Capital Resources
Pending Acquisition
RAC Motoring Services - On May 21, 1998, the Company announced that it has
reached a definitive agreement with the Board of Directors of Royal Automobile
Club Limited ("RACL") to acquire their RAC Motoring Services subsidiary
("RACMS") for approximately $735 million in cash. The sale of RACMS has
subsequently been approved by its shareholders. On September 24, 1998, the UK
Secretary of State for Trade and Industry referred the RACMS acquisition to the
UK Monopolies and Mergers Commission (the "MMC") for its approval. Closing is
subject to certain conditions, including MMC approval. Although no assurances
can be made, the Company currently anticipates that the transaction, if
completed, will close in the spring of 1999. The Company plans to fund this
acquisition with proceeds from borrowings under its committed facilities,
operating cash flows or a combination of the above.
Completed Acquisitions
National Parking Corporation Limited - On April 27, 1998, the Company acquired
NPC for $1.6 billion in cash, which included the repayment of approximately $227
million of outstanding NPC debt. NPC is substantially comprised of two operating
subsidiaries: National Car Parks and Green Flag. National Car Parks is the
largest private (non-municipal) single car park operator in the UK and Green
Flag operates the third largest roadside assistance group in the UK and offers a
wide-range of emergency support and rescue services. The Company funded the NPC
acquisition with borrowings under its revolving credit facilities.
Harpur Group - On January 20, 1998, the Company completed the acquisition of
Harpur, a leading fuel card and vehicle management company in the UK, from
privately held H-G Holdings, Inc. for approximately $186 million in cash plus
future contingent payments of up to $20 million over two years.
Jackson Hewitt - On January 7, 1998, the Company completed the acquisition of
Jackson Hewitt for approximately $480 million in cash. Jackson Hewitt operates
the second largest tax preparation service franchise system in the United
States. The Jackson Hewitt franchise system specializes in computerized
preparation of federal and state individual income tax returns.
Other 1998 Acquisitions and Acquisition-Related Payments - The Company acquired
certain other entities for an aggregate purchase price of approximately $336.9
million in cash during the nine months ended September 30, 1998. Additionally,
the Company made a $100 million cash payment to the seller of Resort
Condominiums International, Inc. in satisfaction of a contingent purchase
liability.
Termination of Acquisition Agreements
American Bankers Insurance Group, Inc. Due to uncertainties concerning the
eventual completion of the Company's pending acquisition of American Bankers
Insurance Group, Inc. ("American Bankers") on October 13, 1998, the Company and
American Bankers entered into a settlement agreement (the "Settlement
Agreement"), pursuant to which the Company and American Bankers terminated the
definitive agreement dated March 23, 1998 (the "Merger Agreement") which
provided for the Company's acquisition of American Bankers for $3.1 billion.
Accordingly, the Company's pending tender offer for American Bankers shares was
also terminated.
Pursuant to the Settlement Agreement and in connection with termination of the
Company's proposed acquisition of American Bankers, the Company made a $400
million cash payment to American Bankers and wrote off approximately $30 million
of costs, primarily professional fees which were deferred in connection with the
proposed transaction. Such charges were recorded by the Company during the
fourth quarter of 1998. The Company also terminated a bank commitment to provide
a $650 million, 364-day revolving credit facility, which was made available to
partially fund the acquisition.
Providian Auto and Home Insurance Company. On October 5, 1998, the Company
announced it terminated its agreement to acquire for $219 million in cash
Providian Auto and Home Insurance Company ("Providian"). The termination date in
the Company's agreement to acquire Providian was September 30, 1998. Certain
representations and covenants in the acquisition agreement had not been
fulfilled and the conditions to closing had not been met. The Company did not
pursue an extension of the termination date of the agreement because Providian
no longer met the Company's acquisition criteria.
Discontinued Operations
On August 12, 1998 (the "Measurement Date"), the Company announced that its
Executive Committee of the Board of Directors committed to discontinue the
Company's classified advertising and consumer software businesses by disposing
of Hebdo Mag International ("Hebdo Mag") and Cendant Software Corporation
("Cendant Software"), respectively. The Company has since entered into a
definitive agreement, as amended, to sell Hebdo Mag to its former 50% owners for
7.1 million shares of Company common stock and approximately $360 million in
cash. The transaction is expected to be consummated in the fourth quarter of
1998 and is subject to certain conditions, including regulatory approval and
financing by the purchaser. The Company expects to recognize a gain of
approximately $230 million upon the disposal of Hebdo Mag, assuming a Company
stock price of $13.25 per share, the closing price of the Company's common stock
on November 3, 1998. In addition, the Company has engaged investment bankers to
analyze various strategic alternatives in regard to the disposition of Cendant
Software. The Company is currently in various stages of discussions with certain
parties regarding the potential sale of the consumer software business unit. The
Company anticipates that the disposition of Cendant Software will also result in
a significant gain. The Company believes that the divesting of its Hebdo Mag and
Cendant Software subsidiaries will generate significant proceeds.
Financing (Exclusive of Management and Mortgage Program Financing)
The Company believes that it has adequate liquidity and access to liquidity
through various sources. The Company had been unable to access equity and public
debt markets until October 13, 1998, the date in which the Company completed the
filing of its restated financial statements with the SEC. Accordingly, the
Company has secured additional liquidity through other sources including a
364-day, $3.25 billion term loan facility and committed revolving credit
facilities of $1.75 billion.
On May 29, 1998, the Company entered into a 364-day term loan facility with a
syndicate of financial institutions which provides for borrowings of $3.25
billion (the "Term Loan Facility"). The Term Loan Facility bears interest at
LIBOR plus the applicable LIBOR spread, as defined. The Company intends to repay
all outstanding borrowings under the Term Loan Facility as soon as practicable.
Upon the execution of the Term Loan Facility, temporary credit agreements, which
provided for $1.0 billion of borrowings, were terminated. The Term Loan Facility
contains certain restrictive covenants, which are substantially similar to and
consistent with the covenants in effect for the Company's then existing
revolving credit agreements. At September 30, 1998, the full amount of the
commitment under the Term Loan Facility was drawn. The Company used $2.0 billion
of the proceeds from the Term Loan Facility to repay the outstanding borrowings
under its revolving credit facilities and intends to use the remainder for the
acquisition of RACMS and for general corporate purposes.
The Company's primary credit facility, as amended, consists of (i) a $750.0
million, five year revolving credit facility (the "Five Year Revolving Credit
Facility") and (ii) a $1.0 billion, 364 day revolving credit facility (the "364
Day Revolving Credit Facility") (collectively the "Revolving Credit
Facilities"). The 364 Day Revolving Credit Facility will mature on October 29,
1999 but may be renewed on an annual basis for an additional 364 days upon
receiving lender approval. The Five Year Revolving Credit Facility will mature
on October 1, 2001. Borrowings under the Revolving Credit Facilities, at the
option of the Company, bear interest based on competitive bids of lenders
participating in the facilities, at prime rates or at LIBOR, plus a margin of
approximately 60 basis points. The Company is required to pay a per annum
facility fee of .175% and .15% of the average daily unused commitments under the
Five Year Revolving Credit Facility and 364 Day Revolving Credit Facility,
respectively. The interest rates and facility fees are subject to change based
upon credit ratings on the Company's senior unsecured long-term debt by
nationally recognized debt rating agencies. The Revolving Credit Facilities
contain certain restrictive covenants including restrictions on indebtedness,
mergers, liquidations and sale and leaseback transactions and requires the
maintenance of certain financial ratios, including a 3:1 minimum interest
coverage ratio and a 3.5:1 maximum debt coverage ratio, as defined.
The Company filed an amended shelf registration statement (the "Shelf
Registration Statement") on February 6, 1998 with the SEC for the issuance of up
to an aggregate $4.0 billion of debt and equity securities. Pursuant to the
Shelf Registration Statement, on March 2, 1998, Cendant Capital I (the "Trust"),
a statutory business Trust formed under the laws of the State of Delaware and a
wholly-owned subsidiary of the Company, issued 29.9 million FELINE PRIDES and
2.3 million trust preferred securities and received approximately $1.5 billion
in gross proceeds therefrom. The Trust invested the proceeds in 6.45% Senior
Debentures due 2003 (the "Debentures"), issued by the Company, which represent
the sole asset of the Trust. The obligations of the Trust related to the FELINE
PRIDES and trust preferred securities are unconditionally guaranteed by the
Company to the extent the Company makes payments pursuant to the Debentures. The
issuance of the FELINE PRIDES and trust preferred securities resulted in the
utilization of approximately $3.0 billion of availability under the Shelf
Registration Statement. Upon issuance, the FELINE PRIDES consisted of 27.6
million Income PRIDES and 2.3 million Growth PRIDES, each with a face amount of
$50 per PRIDE. The Income PRIDES consist of trust preferred securities and
forward purchase contracts under which the holders are required to purchase
common stock from the Company in February of 2001. The Growth PRIDES consist of
zero coupon U.S. Treasury securities and forward purchase contracts under which
the holders are required to purchase common stock from the Company in February
2001. The trust preferred securities and the trust preferred securities under
the Income PRIDES, each with a face amount of $50 per security, bear interest,
in the form of preferred stock dividends, at the annual rate of 6.45 percent,
payable in cash. Payments under the forward purchase contract forming a part of
the Income PRIDES will be made by the Company in the form of a contract
adjustment payment at an annual rate of 1.05 percent. The forward purchase
contract forming part of the Growth PRIDES will be made by the Company in the
form of a contract adjustment payment at an annual rate of 1.30 percent. The
forward purchase contracts require the holder to purchase a minimum of 1.0395
shares and a maximum of 1.3514 shares of the Company common stock per PRIDES
security, depending upon the average of the closing price per share of the
Company common stock for a 20 consecutive trading day period ending in
mid-February of 2001. The Company has the right to defer the contract adjustment
payments and the payment of interest on its Debentures to the Trust. Such
election will subject the Company to certain restrictions, including
restrictions on making dividend payments on its common stock until all such
payments in arrears are settled.
The Company filed a shelf registration statement with the SEC, which has not yet
become effective for the aggregate issuance of up to $3.0 billion of debt and
equity securities. The Company expects to issue debt securities during the
fourth quarter of 1998 pursuant to such registration statement for purposes of
refinancing a portion of the Term Loan Facility.
On May 4, 1998, the Company redeemed all of the outstanding ($144.5 million
principal amount) 4-3/4% Convertible Senior Notes due 2003 at a price of
103.393% of the principal amount, together with interest accrued to the
redemption date. Prior to the redemption date, during 1998, $95.5 million of
such notes were exchanged for 3.4 million shares of the Company's common stock.
On April 8, 1998, the Company exercised its option to call its 6-1/2%
Convertible Subordinated Notes (the "6-1/2% Notes") for redemption on May 11,
1998, in accordance with the provisions of the indenture relating to the 6-1/2%
Notes. Prior to the redemption date, during 1998, all of the outstanding 6-1/2%
Notes were converted into 2.1 million shares of Company common stock.
The Company's long-term debt, including current portion, was $4.0 billion at
September 30, 1998, which primarily consisted of $3.25 billion of borrowings
under the Company's Term Loan Facility and $700 million of publicly issued fixed
rate debt.
Management and Mortgage Program Financing
PHH, a wholly-owned subsidiary of the Company, operates their mortgage services,
fleet management services and relocation services businesses as a separate
public reporting entity and supports purchases of leased vehicles and originated
mortgages primarily by issuing commercial paper and medium term notes. Financial
covenants related to such debt are designed to ensure the self-sufficient
liquidity status of PHH. Accordingly, PHH's publicly filed financial statements
were not impacted by the accounting irregularities previously disclosed and PHH
continues to issue debt securities in public markets. Such borrowings are not
classified based on contractual maturities, but rather are included in
liabilities under management and mortgage programs rather than long-term debt
since such debt corresponds directly with high quality related assets.
Additionally, PHH continues to pursue opportunities to reduce its borrowing
requirements by securitizing increasing amounts of its high quality assets. In
May 1998, PHH commenced a program to sell originated mortgage loans to an
unaffiliated buyer, at the option of the Company, up to the buyer's asset limit
of $1.5 billion. The buyer may sell or securitize such mortgage loans into the
secondary market, however, servicing rights are retained by the Company. The
Company has entered into negotiations and, in the near future, expects to
increase the amount of mortgage loans it may sell to this buyer to $2.25
billion.
PHH debt is issued without recourse to the Company. PHH expects to continue to
maximize its access to global capital markets by maintaining the quality of its
assets under management. This is achieved by establishing credit standards to
minimize credit risk and the potential for losses. Depending upon asset growth
and financial market conditions, PHH utilizes the United States, European and
Canadian commercial paper markets, as well as other cost-effective short-term
instruments. In addition, PHH will continue to utilize the public and private
debt markets as sources of financing. Augmenting these sources, PHH will
continue to manage outstanding debt with the potential sale or transfer of
managed assets to third parties while retaining fee-related servicing
responsibility. At September 30, 1998, PHH had outstanding debt of $6.2 billion
comprised of $3.0 billion in commercial paper, $3.0 billion of medium term notes
and other borrowings of $0.2 billion.
Consistent with general market trends for issuers of commercial paper with
comparable credit ratings, maturities of recent PHH commercial paper issuances
have become shorter than PHH's historical experiences or desirable by PHH. In
the event that the public debt market is unable to meet PHH's funding needs, the
Company believes that it has appropriate alternative sources to provide adequate
liquidity, including PHH's $2.7 billion of revolving credit facilities.
PHH filed a shelf registration statement with the SEC effective March 2, 1998,
for the aggregate issuance of up to $3 billion of medium-term note debt
securities. These securities may be offered from time to time, together or
separately, based on terms to be determined at the time of sale. The proceeds
will be used to finance assets PHH manages for its clients and for general PHH
corporate purposes. As of September 30, 1998, PHH had approximately $1.5 billion
of medium-term notes outstanding under this shelf registration statement.
To provide additional financial flexibility, PHH's current policy is to ensure
that minimum committed facilities aggregate 80 percent of the average amount of
outstanding commercial paper. It is PHH's intention to increase the minimum
percentage of committed bank facilities to outstanding commercial paper to 100
percent by December 31, 1998. PHH maintains a $2.5 billion syndicated unsecured
credit facility which is backed by domestic and foreign banks and is comprised
of $1.25 billion of lines of credit maturing in March 1999 and $1.25 billion
maturing in the year 2000. In addition, PHH has a $200 million revolving credit
facility, which matures on June 24, 1999, and other uncommitted lines of credit
with various financial institutions which were unused at September 30, 1998.
Management closely evaluates not only the credit of the banks but also the terms
of the various agreements to ensure ongoing availability. The full amount of
PHH's committed facilities at September 30, 1998 was undrawn and available.
Management believes that its current policy provides adequate protection should
volatility in the financial markets limit PHH's access to commercial paper or
medium-term notes funding. PHH continuously seeks additional sources of
liquidity to accommodate PHH asset growth and to provide further protection from
volatility in the financial markets.
PHH minimizes its exposure to interest rate and liquidity risk by effectively
matching floating and fixed interest rate and maturity characteristics of
funding to related assets, varying short and long-term domestic and
international funding sources, and securing available credit under committed
banking facilities.
On July 10, 1998, PHH entered into a Supplemental Indenture No. 1 (the
"Supplemental Indenture") with The First National Bank of Chicago, as trustee,
under the Senior Indenture dated as of June 5, 1997, which formalizes the policy
for PHH of limiting the payment of dividends and the outstanding principal
balance of loans to the Company to 40% of consolidated net income (as defined in
the Supplemental Indenture) for each fiscal year. The Supplemental Indenture
prohibits PHH from paying dividends or making loans to the Company if upon given
effect to such dividend and/or loan, PHH's debt to equity ratio exceeds 8 to 1
at the time of the dividend or loan as the case may be.
Credit Ratings
In October 1998, Duff & Phelps Credit Rating Co. ("DCR"), Standard & Poor's
("S&P"), and Moody's reduced the Company's long-term debt credit rating to A-
from A, BBB from A, and A3 to Baa1, respectively. In October 1998, Moody's and
S&P reduced PHH's long-term and short-term debt ratings to A3/P2 and A-/A2 from
A2/P1 and A+/A1, respectively. PHH's long-term and short-term credit ratings
remain A+/F1 and A+/D1 with Fitch IBCA and DCR, respectively. While the recent
downgrading caused PHH to incur an increase in cost of funds, management
believes its sources of liquidity continue to be adequate. (A security rating is
not a recommendation to buy, sell or hold securities and is subject to revision
or withdrawal at any time).
Cash Flows
Cash flows provided from operations in 1998 were $758.5 million, representing a
$378.5 million decrease from the same period in 1997. The decrease in operating
cash flows reflects growth in mortgage loan origination volume and a
corresponding $810.5 million decrease in related cash flow. Rapid growth
contributed to the 138% increase in Mortgage Services operating income. The
Company used $4.0 billion in cash flows from investing activities in 1998, which
consisted of $2.7 billion of acquisitions and acquisition-related payments and
$1.1 billion of net investment in assets under management and mortgage-programs.
Cash provided by financing activities of $1.4 billion primarily reflects the
issuance of the FELINE PRIDES and proceeds of $3.3 billion from borrowings under
the Term Loan Facility and $586.4 million of proceeds from debt issued under
management and mortgage programs.
Capital Expenditures
The Company incurred $240.8 million of costs for capital expenditures and
anticipates investing up to approximately $300 million in capital expenditures
in 1998. Such capital expenditures are primarily associated with the development
of integrated corporate relocation business systems in accordance with the
merger plan developed upon the PHH merger date, mortgage services office and
system additions to support the rapid growth in origination volume and the
consolidation of internationally-based call centers.
Litigation
As a result of the aforementioned accounting irregularities, which were
discovered in the former CUC business units, numerous purported class action
lawsuits, two purported derivative lawsuits and an individual lawsuit have been
filed against the Company and, among others, its predecessor HFS, and certain
current and former officers and directors of the Company and HFS, asserting
various claims under the federal securities laws and certain state statutory and
common laws. In addition, the staff of the SEC and the United States Attorney
for the District of New Jersey are conducting investigations relating to the
accounting issues. The SEC staff advised the Company that its inquiry should not
be construed as an indication by the SEC or its staff that any violations of law
have occurred (See Note 15 to the financial statements for a more detailed
litigation discussion).
The Company does not believe that it is feasible to predict or determine the
final outcome of these proceedings or investigations or to estimate the amounts
or potential range of loss with respect to these proceedings or investigations.
The possible outcomes or resolutions of the proceedings could include a judgment
against the Company or a settlements and could require substantial payments by
the Company. In addition, the timing of the final resolution of the proceedings
or investigations is uncertain. Management believes that a adverse
outcome with respect to such proceedings or investigations could have a material
impact on the financial condition, results of operations and cash flows of the
Company.
Severance Agreement
On July 28, 1998, the Company announced that Walter A. Forbes resigned as
Chairman of the Company and as a member of the Board of Directors. The severance
agreement reached with Mr. Forbes entitles him the benefits required by his
employment contract relating to a termination of Mr. Forbes' employment with the
Company for reasons other than for cause. Aggregate benefits resulted in a $50.4
million third quarter 1998 charge comprised of $37.9 million in cash payments
and 1.3 million of Company stock options, with a Black-Scholes value of $12.5
million. Such options were immediately vested and expire on July 28, 2008.
Repricing of Stock Options
On September 23, 1998, the Compensation Committee of the Board of Directors
approved a repricing and option exchange program for mid-management employees
relating to Company stock options granted to such employees during December 1997
and the first quarter of 1998. Such options were repriced on October 15, 1998 at
$9.8125 per share (the "New Price"), which was the fair market value as defined
in the option plans. On September 23, 1998, the Compensation Committee also
approved a repricing and option exchange program for certain executive officers
and senior managers of the Company subject to certain conditions including
revocation of a portion of existing options. Additionally, a management equity
ownership program was adopted that requires these executive officers and senior
managers to acquire Company common stock at various levels commensurate with
their respective compensation levels. The repricing was accomplished by
canceling existing options and issuing new options at the New Price and, with
respect to certain options of executive officers and senior managers, at prices
above the New Price.
Share Repurchase Program
In October 1998, the Company announced that its Board of Directors had
authorized a $1 billion common share repurchase program. Subject to compliance
with bank credit facility covenants and rating agency constraints, the Company
expects to execute the program through open-market purchases.
Impact of New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 131 "Disclosures About Segments
of an Enterprise and Related Information" effective for annual periods beginning
after December 15, 1997 and interim periods subsequent to the initial year of
application. SFAS No. 131 establishes standards for the way that public business
enterprises report information about their operating segments in their annual
and interim financial statements. It also requires public enterprises to
disclose company-wide information regarding products and services and the
geographic areas in which they operate. The Company will adopt SFAS No. 131
effective for the 1998 calendar year end.
In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures about
Pension and Other Postretirement Benefits" effective for period beginning after
December 15, 1997. The Company will adopt SFAS No. 132 effective for the 1998
calendar year end.
SFAS No. 131 and No. 132 establish standards for disclosures only and therefore
will have no impact on the Company's financial position or results of
operations.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative Instrument
and Hedging Activities" effective for all quarterly and annual periods beginning
after June 15, 1999. SFAS No. 133 requires the recognition of all derivatives in
the consolidated balance sheet as either assets or liabilities measured at fair
value. The Company will adopt SFAS No. 133 effective January 1, 2000. The
Company has not yet determined the impact SFAS No. 133 will have on its
financial statements.
Year 2000 Compliance
The Year 2000 presents the risk that information systems will be unable to
recognize and process date-sensitive information properly from and after January
1, 2000.
To minimize or eliminate the effect of the year 2000 risk on the Company's
business systems and applications, the Company is continually identifying,
evaluating, implementing and testing changes to its computer systems,
applications and software necessary to achieve Year 2000 compliance. The
Company's predecessor, HFS, implemented a Year 2000 initiative in March 1996
that has now been adopted by all business units of the Company. As part of such
initiative, the Company has selected a team of managers to identify, evaluate
and implement a plan to bring all of the Company's critical business systems and
applications into Year 2000 compliance prior to December 31, 1999. The Year 2000
initiative consists of four phases: (i) identification of all critical business
systems subject to Year 2000 risk (the "Identification Phase"); (ii) assessment
of such business systems and applications to determine the method of correcting
any Year 2000 problems (the "Assessment Phase"); (iii) implementing the
corrective measures (the "Implementation Phase"); and (iv) testing and
maintaining system compliance (the "Testing Phase"). The Company has
substantially completed the Identification and Assessment Phases and has
identified and assessed five areas of risk: (i) internally developed business
applications; (ii) third party vendor software, such as business applications,
operating systems and special function software; (iii) computer hardware
components; (iv) electronic data transfer systems between the Company and its
customers; and (v) embedded systems, such as phone switches, check writers and
alarm systems. Although no assurances can be made, the Company believes that it
has identified substantially all of its systems, applications and related
software that are subject to Year 2000 compliance risk and has either
implemented or initiated the implementation of a plan to correct such systems
that are not Year 2000 compliant. The Company has targeted December 31, 1998 for
completion of the Implementation Phase. Although the Company has begun the
Testing Phase, it does not anticipate completion of the Testing Phase until
sometime prior to December 1999.
The Company relies on third party service providers for services such as
telecommunications, internet service, utilities, components for its embedded and
other systems and other key services. Interruption of those services due to Year
2000 issues could affect the Company's operations. The Company has initiated an
evaluation of the status of such third party service providers' efforts to
determine alternative and contingency requirements. While approaches to reducing
risks of interruption of business operations vary by business unit, options
include identification of alternative service providers available to provide
such services if a service provider fails to become Year 2000 compliant within
an acceptable timeframe prior to December 31, 1999.
The Company is revising its existing business interruption contingency plans to
address internal and external issues specific to Year 2000 compliance. In
addition, where necessary, the Company is establishing contingency plans for
specific issues that may arise. We anticipate completing and testing these
contingency plans by July 1999. These plans, which are intended to enable the
Company to function operationally, include performing certain processes
manually, repairing or obtaining replacement systems; changing suppliers; and
reducing or suspending operations. The Company believes, however, that due to
the widespread nature of potential Year 2000 issues, the contingency planning
process is an ongoing one which will require further modifications as the
Company obtains additional information regarding the Company's internal systems
and equipment during the remediation and testing phases of its Year 2000 program
and the status of third party Year 2000 readiness.
The total cost of the Company's Year 2000 compliance plan is anticipated to be
$53 million. Approximately $19 million of these costs have been incurred through
September 30, 1998, and the Company expects to incur the balance of such costs
to complete the compliance plan. The remainder of the costs is expected to be
funded through operating cash flows or from borrowings under the Company's
credit facilities. The Company has been expensing and capitalizing the costs to
complete the compliance plan in accordance with appropriate accounting policies.
Variations from anticipated expenditures and the effect on the Company's future
results of operations are not anticipated to be material in any given year.
However, if Year 2000 modifications and conversions are not made, or are not
completed in time, the Year 2000 problem could have a material impact on the
operations and financial condition of the Company.
The estimates and conclusions herein are forward-looking statements and are
based on management's best estimates of future events. Risks of completing the
plan include the availability of resources, the ability to discover and correct
the potential Year 2000 sensitive problems that could have a serious impact on
certain operations and the ability of the Company's service providers to bring
their systems into Year 2000 compliance.
ITEM 3--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In recurring operations, the Company must deal with effects of changes in
interest rates and currency exchange rates. The following discussion presents an
overview of how such changes are managed and a view of their potential effects.
The Company uses various financial instruments, particularly interest rate and
currency swaps and currency forwards, to manage its respective interest rate and
currency risks. The Company is exclusively an end user of these instruments,
which are commonly referred to as derivatives. The Company does not engage in
trading, market-making or other speculative activities in the derivatives
markets. Established practices require that derivative financial instruments
relate to specific asset, liability or equity transactions or to currency
exposures.
The Securities and Exchange Commission requires that registrants include
information about potential effects of changes in interest rates and currency
exchange in their financial statements. Although the rules offer alternatives
for presenting this information, none of the alternatives is without
limitations. The following discussion is based on so-called "shock tests," which
model effects of interest rate and currency shifts on the reporting company.
Shock tests, while probably the most meaningful analysis permitted, are
constrained by several factors, including the necessity to conduct the analysis
based on a single point in time and by their inability to include the
extraordinarily complex market reactions that normally would arise from the
market shifts modeled. While the following results of shock tests for interest
rate and currencies may have some limited use as benchmarks, they should not be
viewed as forecasts.
o One means of assessing exposure in interest rate changes is a
duration-based analysis that measures the potential loss in net earnings
resulting from a hypothetical 10% change (decrease) in interest rates
across all maturities (sometimes referred to as a "parallel shift in the
yield curve"). Under this model, it is estimated that, all else constant,
such decrease would not adversely impact the 1998 net earnings of the
Company based on September 30, 1998 positions.
o One means of assessing exposure to changes in currency exchange rates is
to model effects on future earnings using a sensitivity analysis. Nine
months ended September 30, 1998 consolidated currency exposures, including
financial instruments designated and effective as hedges, were analyzed to
identify the Company's assets and liabilities denominated in other than
their relevant functional currency. Net unhedged exposures in each
currency were then remeasured assuming a 10% change (decrease) in currency
exchange rates compared with the U.S. dollar. Under this model, it is
estimated that, all else constant, such a decrease would not adversely
impact the 1998 net earnings of the Company based on September 30, 1998
positions.
The categories of primary market risk exposure of the Company are: (i)
long-term U.S. interest rates due to mortgage loan origination
commitments and an investment in mortgage loans held for resale; (ii)
short-term interest rates as they impact vehicle and relocation
receivables; and (iii) LIBOR and commercial paper interest rates due to
their impact on variable rate borrowings.
PART II. OTHER INFORMATION
ITEM 1--LEGAL PROCEEDINGS
The discussion contained under the heading "Company Investigation and
Litigation" in Note 15 contained in Part 1--FINANCIAL INFORMATION, Item
1--Financial Statements, is incorporated herein by reference in its entirety.
ITEM 6--EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(b) Reports on Form 8-K
The Company filed a report on Form 8-K, dated July 14, 1998, reporting in
Item 5 that the accounting irregularities at the former CUC International
Inc. business units, were greater than those initially discovered in
April 1998.
The Company filed a report on Form 8-K, dated July 15, 1998, reporting in
Item 5 certain supplemental information regarding the accounting
irregularities and affirmed its intention to complete the American
Bankers Insurance Group, Inc. acquisition.
The Company filed a report on Form 8-K, dated July 28, 1998, reporting in
Item 5 management and corporate governance changes and an audit committee
investigation update.
The Company filed a report on Form 8-K, dated August 4, 1998, reporting
in Item 5 announcing the timing of the release of second quarter earnings
and the timing for the submission of shareholder proposals for the 1998
Annual Meeting of Shareholders.
The Company filed a report on Form 8-K, dated August 13, 1998, reporting
in Item 5 the completion of the accounting investigation, second quarter
earnings, approval of the Royal Automobile Club acquisition, the intent
to sell Hebdo Mag and Cendant Software and segment information.
The Company filed a report on Form 8-K, dated August 28, 1998, reporting
in Item 5 the completion of the Audit Committee Report on the
investigation, the delay in the filing of the Form 10-K/A and the
postponement of the 1998 Annual Meeting.
The Company filed a report on Form 8-K/A, dated August 28, 1998,
reporting in Item 5 the filing of an appendix to the Report to the Audit
Committee and the record date for the 1998 Annual Meeting.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CENDANT CORPORATION
By: /s/ David M. Johnson
David M. Johnson
Senior Executive Vice President and
Chief Financial Officer
By: /s/ Scott E. Forbes
Scott E. Forbes
Executive Vice President
and Chief Accounting Officer
Date: November 16, 1998