1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
THE COMPANY
On December 19, 1997, Doubletree Corporation (Doubletree) and Promus Hotel
Corporation (PHC) merged in accordance with the Agreement and Plan of Merger
(the Merger Agreement or the Merger) by and among Doubletree, PHC and Parent
Holding Corp., a corporation formed and jointly owned by Doubletree and PHC to
facilitate the Merger. Concurrent with the Merger, PHC was renamed Promus
Operating Company, Inc. (POC), and Parent Holding Corp. was renamed Promus Hotel
Corporation. Promus Hotel Corporation and subsidiaries are collectively referred
to herein as Promus or the Company.
As a result of the Merger Agreement, (i) Doubletree and PHC became
wholly-owned subsidiaries of Promus; (ii) each outstanding share of common stock
of Doubletree was converted into one share of common stock of Promus; and (iii)
each outstanding share of PHC common stock was converted into 0.925 of a share
of common stock of Promus. The Merger qualified as a tax free exchange and was
accounted for as a pooling-of-interests; accordingly, the accompanying
consolidated financial statements and financial information contained herein
have been restated to combine the historical results of both Doubletree and PHC
for 1997 and 1996.
As of December 31, 1998, the Promus hotel system contained 1,337 hotels,
representing approximately 192,000 hotel rooms, in all 50 states, the District
of Columbia, Puerto Rico, the U.S. Virgin Islands and six foreign countries.
Promus brands include Doubletree Hotels, Doubletree Guest Suites, Club Hotels by
Doubletree, Embassy Suites, Hampton Inn, Hampton Inn & Suites, and Homewood
Suites. The Promus system also includes certain properties that are not
Promus-branded.
Of these 1,337 hotels, 998 are owned and operated by franchisees, and 339
are operated by the Company. Depending on the hotel brand, Promus charges
franchisees royalty fees of up to four percent of suite or room revenues in
exchange for the use of one of its brand names and franchise-related services.
Company operated properties include 62 wholly-owned hotels, 77 leased hotels, 23
hotels partially-owned through joint ventures and 177 hotels managed for third
parties. As a manager of hotels, Promus is typically responsible for supervising
or operating the hotel in exchange for fees based on a percentage of the hotel's
gross revenues, operating profits, cash flow, or a combination thereof. The
Company's results of operations for owned and leased hotels reflect the revenues
and expenses of these hotel operations.
Promus also licenses eight vacation interval ownership properties under the
Embassy Vacation Resort and Hampton Vacation Resort brand names, for which the
Company earns franchise fees on net interval sales and on revenues related to
the rental of interval units.
Promus' primary focus is to grow its franchise and management businesses,
while limiting its ownership of real estate. The Company owns a mix of
Promus-brand hotels that can enhance its role as manager and franchisor for
its brands, but periodically sells hotels as opportunities arise.
FORWARD-LOOKING STATEMENTS
Certain matters discussed in this report may constitute forward-looking
statements within the meaning of the federal securities laws.
Forward-looking statements are those that express management's view of
future performance and trends, and usually are preceded with "expects",
"anticipates", "believes", "hopes", "estimates", "plans" or similar phrasing,
and include statements regarding Year 2000 readiness and potential exposure, the
Company's ability to increase rates, margin improvements and projected
expenditures, capital spending and availability of capital resources. Such
statements are based on management's beliefs, assumptions and expectations,
which in turn are based on information currently available to management. The
Company's actual performance and results could materially differ from those
expressed in or contemplated by the forward-looking statements due to a number
of factors, many of which are beyond Promus' ability to predict or control. Such
factors include, but are not limited to, operations of existing hotel
properties, including the effects of competition and customer demand; changes in
the size of Promus' hotel system, including anticipated scope and opening dates
of new developments, planned future capital spending, terminations of franchise
or management agreements or dispositions of properties; relationships with third
parties, including franchisees, lessors, hotel owners, lenders and others;
litigation or other judicial actions; changes in the national economy or
regional economies, which among other things, affects business and leisure
travel and expenditures and capital availability for hotel development; and
adverse changes in interest rates for both Promus and its franchisees and
business partners which, among other things, affects new hotel development; real
estate values; and credit availability. Promus disclaims any obligation to
update forward-looking information.
2
RESULTS OF OPERATIONS
The principal factors affecting Promus' operating results are: continued
growth in the number of system hotels; occupancy and room rates achieved by
hotels; the relative mix of owned, leased, managed and franchised hotels; and
Promus' ability to manage costs. The number of rooms at franchised and managed
properties and revenue per available room (RevPAR) significantly affect Promus'
results because franchise royalty and management fees are generally based upon a
percentage of room revenues. Increases in franchise royalty and management fee
revenues have a favorable impact on Promus' operating margin due to minimal
incremental costs associated with this type of revenue.
Summarized operating results for the three years ended December 31, 1998
are as follows (in millions, except percentages and per share data):
Percentage
Years ended December 31, Increase (Decrease)
------------------------------------------ ----------------------------------
1996 1997 1998 97 vs 96 98 vs 97
- - ---------------------------------------------------------------------------------------------------------
Revenues $ 560.2 $ 1,038.0 $ 1,107.3 85.3% 6.7%
Operating income 165.4 183.9 303.4 11.2 65.0
Net income 90.7 95.4 154.1 5.2 61.5
Basic earnings per share 1.25 1.10 1.79 (12.0) 62.7
Diluted earnings per share 1.23 1.09 1.78 (11.4) 63.3
- - ---------------------------------------------------------------------------------------------------------
Comparisons of the actual financial results presented above are difficult
as a result of recent acquisition activity and unusual items, including business
combination expenses experienced in 1998, 1997 and 1996. The Company's November
8, 1996 acquisition of Red Lion Hotels, Inc. (Red Lion) was accounted for under
the purchase method of accounting and, accordingly, Red Lion's operating results
prior to the acquisition are not included in the Company's reported results. The
following table sets forth the actual results of operations for the years ended
December 31, 1997 and 1998, as compared to the pro forma results of operations
for the year ended December 31, 1996, assuming that the November 8, 1996
acquisition of Red Lion and related transactions had occurred as of January 1,
1996. The Company believes that this information provides a more meaningful
basis for comparison than the historical results of the Company and includes all
necessary adjustments for a fair presentation of such pro forma information. The
pro forma results of operations are not necessarily indicative of the results of
operations as they might have been had the Red Lion transaction been consummated
at the beginning of 1996.
Years ended December 31,
---------------------------------------------
(in thousands, except per Pro Forma
share data) 1996(a)(b) 1997(b) 1998(c)
- - -------------------------------------------------------------------------
Revenues:
Franchise and management
fees $ 151,488 $ 185,546 $ 218,113
Owned hotel revenues 362,905 368,012 401,016
Leased hotel revenues 326,594 410,526 415,339
Purchasing and service
fees 14,947 19,304 27,348
Other fees and income 34,618 54,623 45,473
- - -------------------------------------------------------------------------
Total revenues 890,552 1,038,011 1,107,289
Operating Costs and
Expenses:
General and
administrative
expenses 72,274 79,249 80,429
Owned hotel expenses 227,633 224,052 248,990
Leased hotel expenses 287,584 362,681 367,176
Depreciation and
amortization 72,616 73,127 79,254
Business combination
expenses -- 115,000 28,065
- - -------------------------------------------------------------------------
Total operating costs
and expenses 660,107 854,109 803,914
- - -------------------------------------------------------------------------
Operating income 230,445 183,902 303,375
Interest and dividend
income 22,727 22,982 21,281
Interest expense (75,178) (72,027) (61,917)
Gain on sale of real
estate and securities 4,439 43,330 10,390
- - -------------------------------------------------------------------------
Income before income taxes
and minority interest 182,433 178,187 273,129
Minority interest share
of net income (1,892) (3,087) (3,460)
- - -------------------------------------------------------------------------
Income before income taxes 180,541 175,100 269,669
Income tax expense (74,557) (79,664) (115,581)
- - -------------------------------------------------------------------------
Net income $ 105,984 $ 95,436 $ 154,088
- - -------------------------------------------------------------------------
Basic earnings per share $ 1.22 $ 1.10 $ 1.79
- - -------------------------------------------------------------------------
Diluted earnings per share $ 1.21 $ 1.09 $ 1.78
- - -------------------------------------------------------------------------
Basic weighted average
shares outstanding 86,649 86,573 86,178
- - -------------------------------------------------------------------------
Diluted weighted average
shares outstanding 87,647 87,904 86,764
- - -------------------------------------------------------------------------
(a) 1996 results are presented on a pro forma basis to give effect to the
November 8, 1996 acquisition of Red Lion and related transactions, as if
they had occurred on January 1, 1996.
(b) 1997 results of operations include certain unusual items, including a
provision for business combination expenses of $115.0 million, a $10.9
million break-up fee received in connection with the terminated Renaissance
Hotel Group transaction, $43.3 million of gains on the sale of real estate
and securities, and other net gains of $0.9 million. In 1996, unusual items
include gains of $4.4 million on the sale of real estate and securities.
Excluding the effects of these transactions, net income would have been
$103.4 million and $143.8 million and diluted earnings per share would have
been $1.18 and $1.64, for 1996 and 1997, respectively.
(c) 1998 results of operations include certain unusual items, including a $28.1
million charge for severance and employment related expenses associated
with the Promus/Doubletree merger, a $10.1 million charge for accrued
severance and employment related expenses associated with the resignations
of the Company's CEO and President, gains of $10.4 million on the sale of
real estate and securities, and a gain of $1.3 million on the sale of
excess joint venture land. Excluding the effects of these transactions, net
income would have been $180.3 million and diluted earnings per share would
have been $2.08.
3
Though its revenues come from various sources, nearly all components of
Promus' revenues are favorably impacted by system-wide increases in RevPAR. On a
comparable hotel basis, RevPAR increases were as follows:
REVENUE PER AVAILABLE ROOM
COMPARABLE HOTELS(a)
Years ended December 31, Increase
---------------------------------------------- -------------------------------
1996 1997 1998 97 vs 96 98 vs 97
- - -------------------------------------------------------------------------------------------------------------------
Doubletree Hotels $ 70.28 $ 77.93 $ 82.35 10.9% 5.7%
Red Lion Hotels converted to
Doubletree Hotels (b) N/A 62.73 63.88 N/A 1.8
Embassy Suites 78.95 85.56 88.76 8.4 3.7
Hampton Inn 44.58 46.50 47.86 4.3 2.9
Hampton Inn & Suites 47.28 51.92 56.41 9.8 8.6
Homewood Suites 67.93 72.19 74.29 6.3 2.9
Other hotels (c) 59.23 62.00 63.96 4.7 3.2
- - -------------------------------------------------------------------------------------------------------------------
(a) Revenue statistics are for comparable hotels, and include information only
for those hotels in the system as of December 31, 1998 and managed or
franchised by PHC or managed by Doubletree since January 1, 1996.
Doubletree franchised hotels are not included in the statistical
information.
(b) Revenue statistics for the Red Lion Hotels converted to the Doubletree brand
are included only from the initial date of conversion (Phase I - 4 hotels on
April 4, 1997; Phase II - 36 hotels on July 1, 1997) through December 31,
1998.
(c) Includes results for 15 Red Lion hotels as well as the results for hotels
managed/leased under other franchisors' brands or as independent hotels.
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
1998 revenues increased 6.67%, or $69.3 million, over 1997 revenues, to
$1,107.3 million.
Revenues from franchise and management fees increased $32.6 million, or
17.6%, due to growth in the number of franchised and managed properties as well
as improved performance at existing franchised and managed properties. The
number of franchised properties increased by 132 properties, or 15.2%, to 998
hotels at December 31, 1998. The Company added five new management contracts,
net of terminations, during 1998. New management and franchise contracts
represented 59.7% of the increase in franchise and management fees for the year.
Incentive management fees increased 23.1% in 1998 to $28.5 million.
Owned hotel revenues for the year increased 8.9%, or $33.0 million from the
prior year. Owned hotel expenses increased by 11.1%, or $24.9 million from 1997.
Leased hotel revenues increased $4.8 million, or 1.2% compared to 1997. Leased
hotel expenses increased $4.5 million, or 1.2% over 1997's total. Owned hotel
margins decreased from 39.1% for 1997 to 37.9% for 1998. Leased hotel margins
decreased slightly from 11.7% in 1997 to 11.6% for 1998. During the first half
of 1997, the Company implemented a cost reduction program at its owned and
leased Red Lion conversion hotels, the impact of which was fully realized during
the last six months of 1997. Since then inflationary cost increases coupled with
moderating revenue growth have contributed to the decline in operating margins.
Additionally, the owned and leased hotels have been affected by the opening of
new hotels during 1998, which typically generate lower margins prior to reaching
maturity.
Purchasing and service fees increased 41.7%, or $8.0 million, over 1997
levels. The increase is due to continued growth in existing preferred vendor
programs, the impact of new initiatives, and the introduction of the programs to
all managed and franchised hotels in the system.
Other fees and income decreased $9.2 million, or 16.8%. During 1998, the
Company realized one unusual item, a $1.3 million gain on the sale of excess
joint venture land compared to several unusual items of $17.3 million in 1997.
The unusual items in 1997 included the receipt of a break-up fee of $10.9
million (net of expenses) resulting from the terminated Renaissance transaction,
a gain of $3.0 million from the sale of the Company's management rights for a
planned hotel in Atlantic City and $3.4 million in gains from the sale of joint
venture hotels. Excluding the effect of the unusual items, other fees and income
increased $6.9 million primarily due to an increase in earnings from
unconsolidated joint ventures.
General and administrative expenses, excluding a $10.1 million charge for
accrued severance and employment related expenses associated with the
resignations of the Company's CEO and President in 1998 and a $5.5 million
charge related to the establishment of certain long-term executive compensation
plans in 1997, decreased $3.5 million.
Depreciation and amortization increased in 1998 as compared to 1997, due to
the acquisition of Harrison Conference Associates (Harrison) on January 2, 1998
and the increase in owned hotels since 1997.
In the fourth quarter of 1998, the Company recorded a $28.1 million charge
for severance and employment-related expenses associated with the Merger. The
Company recorded a $115.0 million provision for Merger-related business
combination expenses in the fourth quarter of 1997. These expenses included
$40.3 million of transaction costs and $74.7 million of severance and exit costs
related to the consolidation of administrative functions and asset write-offs.
Interest and dividend income decreased $1.7 million in 1998. The decrease
was split almost evenly between income earned on loans to hotel owners due to a
decrease in the outstanding balance and lower dividend income due to sales
during 1997 and 1998 of portions of the Company's common stock investments.
Interest expense decreased 14.0%, or $10.1 million in 1998 as compared to 1997,
primarily due to overall lower borrowing costs and a decrease in the amount of
average borrowings. The Company's current interest rate is more favorable than
Doubletree's and PHC's separate borrowing rates prior to the Merger.
The 1998 operating results include $10.4 million in pre-tax gains on the
sale of real estate and common stock investments. In 1998, the Company realized
$10.2 million in gains on the sale of common stock. Included in the 1997
operating results were $43.3 million in pre-tax gains on the sale of real estate
and common stock investments. During 1997, Promus sold five hotels and
recognized a net $30.3 million gain. Promus continues to manage four of the five
hotels under long-term management contracts. In 1996, in connection with
strategic alliances with three publicly traded real estate investment trusts
(REITs), Promus had purchased common stock and limited partnership interests in
these REITs. During 1997, Promus sold portions of its common stock holdings in
two of these REITs for $57.4 million, recognizing a gain of $13.0 million.
Operating results for 1998 reflect an overall tax rate of 42.9%, compared with
an overall rate of 45.5% for the 1997 period. The decrease in the overall rate
is primarily due to the lower level of nondeductible business combination
expenses in 1998 which decreased the impact on the effective tax rate on these
items from 6.6% in 1997 to 3.1% in 1998.
Net income and earnings per diluted share for the year ended December 31,
1998 were $154.1 million and $1.78, respectively, compared to $95.4 million and
$1.09 for 1997. Excluding the effect of the unusual items described above, net
income and earnings per diluted share for 1998 were $180.3 million and $2.08,
respectively, compared to $143.8 million and $1.64, respectively, in 1997.
4
YEAR ENDED DECEMBER 31, 1997 (ACTUAL) COMPARED WITH YEAR ENDED DECEMBER 31,
1996 (PRO FORMA)
1997 revenues increased 16.6%, or $147.5 million, over 1996 pro forma
revenues, to $1,038.0 million.
Revenues from franchise and management fees increased $34.1 million, or
22.5%, due to growth in the number of franchised and managed properties as well
as improved performance at existing franchised and managed properties. The
number of franchised properties increased by 164 properties, or 23.4%, to 866
hotels at December 31, 1997. The Company added 19 new management contracts, net
of terminations, during 1997. New contracts represented 59.0% of the increase in
franchise and management fees for the year. Incentive management fees increased
32.0% in 1997 to approximately $23.0 million.
Owned hotel revenues for the year increased 1.4% from the prior year.
Revenues from newly opened or acquired hotels, and higher revenues from
comparable hotels, were offset by the effects of hotel sales during the year.
Despite the inclusion of $2.0 million in preopening expenses for new hotels,
owned hotel expenses actually decreased by 1.6% in 1997 as compared to 1996, as
a result of both hotel sales during the year and cost containment measures at
same store hotels. These measures helped to increase operating margins from
37.3% in 1996 to 39.1% in 1997.
Leased hotel revenues for 1997 increased $83.9 million, or 25.7% from the
prior year, due to the net addition of four leased properties during 1997,
property performance improvements, and the impact of a full year of operations
for 1996 additions. Leased hotel expenses increased 26.1% from the prior year,
also primarily due to the increase in the numbers of leased properties. The
operating margin on leased hotels decreased slightly from 11.9% in 1996 to 11.7%
in 1997.
Purchasing and service fees increased 29.1%, or $4.4 million, over 1996
levels, due to an increase in the number of preferred vendor programs, whereby
the Company earns an administrative fee as opposed to purchasing and reselling
goods, combined with improvements related to the integration of the Doubletree
and Red Lion purchasing programs.
Other fees and income increased $20.0 million, or 57.8%. During 1997, the
Company realized unusual items totaling $17.3 million compared to $1.5 million
in 1996. 1997 unusual items include the receipt of a break-up fee of $10.9
million (net of expenses) resulting from the terminated Renaissance transaction,
a gain of $3.0 million from the sale of the Company's management rights for a
planned hotel in Atlantic City and $3.4 million in gains from the sale of joint
venture hotels. 1996 included $1.5 million in gains from joint venture asset
sales. The remainder of the increase is primarily due to increases in earnings
from unconsolidated joint ventures.
General and administrative expenses increased 9.7%, or $7.0 million, in
1997. This increase is the result of overall corporate growth to support the
Company's expanding hotel system, combined with the inclusion in first quarter
1997 of a $5.5 million charge related to the establishment of certain long-term
executive compensation programs. Depreciation and amortization was virtually
flat in 1997 as compared to 1996, as depreciation expense on new hotels was
offset by the impact of hotel sales.
The Company recorded a $115.0 million provision for Merger-related business
combination expenses in the fourth quarter of 1997. These expenses include $40.3
million of transaction costs and $74.7 million of severance costs, exit costs
related to the consolidation of administrative functions and asset write-offs.
Interest and dividend income increased slightly in 1997, with higher
interest income earned on loans to hotel owners partially offset by lower
dividend income due to sales during the year of portions of the Company's common
stock investments. Interest expense decreased 4.2% in 1997 as compared to 1996,
as the Company maintained a lower average outstanding debt balance during 1997
due to increased operating cash flow.
1997 operating results include $43.3 million in pre-tax gains on the sale
of real estate and common stock investments. During 1997, Promus sold five
hotels and recognized a net $30.3 million gain. Promus continues to manage four
of the five hotels under long-term management contracts. In 1996, in connection
with strategic alliances with three publicly traded REITs, Promus purchased
common stock and limited partnership interests in these REITs. During 1997,
Promus sold portions of its common stock holdings in two of these REITs for
$57.4 million, recognizing a gain of $13.0 million.
1997 operating results reflect an overall tax rate of 45.5%, compared with
an overall rate of 41.3% for the 1996 period. The increase in the overall rate
is primarily due to the nondeductibility of certain business combination costs,
which increased the effective tax rate by 6.6%.
The increase of $1.2 million in the minority interest share of net income
reflects the profits allocable to third party owners of consolidated joint
venture hotels.
Net income and earnings per diluted share for the year ended December 31,
1997 were $95.4 million and $1.09, respectively, compared to $106.0 million and
$1.21 for 1996. Excluding the effect of the unusual items described above, net
income and earnings per diluted share for 1997 would have been $143.8 million
and $1.64, respectively, compared to $103.4 million and $1.18, respectively, in
1996.
5
YEAR ENDED DECEMBER 31, 1997 (ACTUAL) COMPARED WITH YEAR ENDED DECEMBER 31,
1996 (ACTUAL)
1997 revenues increased $477.8 million or 85.3% due in large measure to the
full year effect of the November 8, 1996 acquisition of Red Lion. Red Lion's
1996 results were only included for the period subsequent to the acquisition.
Also contributing to the revenue growth were increases in the number of hotels
in the system, improved hotel performance and growth in the Company's preferred
vendor programs. Other fees and income increased $23.1 million primarily due to
the $10.9 million (net of expenses) Renaissance break-up fee, the $3.0 million
gain on the sale of the Company's management rights for a hotel under
development and $3.4 million in gains from the sale of joint venture
investments.
Operating costs increased $459.3 million or 116.3% primarily due to the
full year impact of the Red Lion acquisition, expenses related to the merger of
Doubletree and PHC, and costs resulting from growth in the Company's hotel
system.
Interest and dividend income increased $5.8 million or 33.8% due to
increases in interest earned on loans to hotel owners and dividends on REIT
stock.
Interest expense increased $35.4 million or 96.5% primarily due to higher
borrowings resulting from the Red Lion acquisition.
Gains on the sale of real estate and securities increased $38.9 million.
The Company realized $30.3 million of gains from the sale of five hotels and
$13.0 million from the sale of a portion of its investments in the common stock
of two REITs.
The increase in minority interest share of net income reflects the increase
in the number of consolidated joint ventures resulting from the Red Lion
acquisition.
Net income and diluted earnings per share, excluding the effect of unusual
items, were $143.8 million and $1.64, respectively. Net income for 1997 was
$95.4 million or $1.09 per diluted share. Net income for 1996 was $90.7 million
or $1.23 per diluted share.
OVERALL
Excluding unusual items, Promus' operating income has increased each year
over prior year levels. Though these increases are in part due to the revenue
growth discussed above, growth has also come from the changing mix of Promus'
business. Due to the size and strength of Promus' infrastructure and systems,
openings of additional franchised or managed properties require fewer
incremental costs, and the growth which has occurred in the Promus system over
the past several years has served to improve overall operating margins. Promus'
overall operating margin increased from 25.9% in pro forma 1996 to 28.1% in 1997
(excluding unusual items); the 1998 operating margin (excluding unusual items)
increased to 30.8%. Due to the continuing growth of Promus' franchise and
management businesses, growth in fee revenues has outpaced growth in operating
expenses, resulting in higher operating margins. This trend of margin
improvement has continued over the past several years, as Promus' franchising
and management businesses have grown, although the Company faces continuing
competitive and wage pressures, which can adversely affect margins.
6
HOTEL DEVELOPMENT
Overview
Promus continues to be an industry leader in hotel development. During
1998, the Company added 13,241 net rooms to its hotel system, increasing its
system room size by 7% during the year. This compares to the addition of 19,137
net rooms during 1997. Net room additions, by brand, are as follows:
Net Rooms Added
-----------------------------------
1997 1998
- - ------------------------------------------------------------
Doubletree Hotels 16,116 1,999
Hampton Inn 10,049 8,494
Hampton Inn & Suites 1,608 2,137
Embassy Suites 1,444 482
Homewood Suites 1,364 2,604
Other (11,444) (2,475)
- - ------------------------------------------------------------
19,137 13,241
- - ------------------------------------------------------------
Hampton Inn continued to lead the Company's unit growth, with a net of 100
properties adding 8,494 rooms or 64% of the total system growth in 1998. 1997's
dramatic increase in Doubletree rooms and corresponding decrease in Other hotel
rooms, is due to the conversion during 1997 of 40 Red Lion hotels, containing
almost 12,000 rooms, to the Doubletree brand. Promus expects to continue growing
the Hampton Inn brand as demand from franchisees and guests appears strong.
However, the Company has seen a modest decline in approved Hampton Inn franchise
applications, in part because of the supply growth over the past several years
in Hampton Inn's mid-price market segment.
Promus' hotel development pipeline as of December 31, 1998 contained 346
properties that were either in the design or construction phase, as follows:
Under
Construction/ In
Conversion Design Total
- - --------------------------------------------------------------------------
Hampton Inn 103 95 198
Hampton Inn & Suites 24 27 51
Homewood Suites 14 17 31
Embassy Suites 13 25 38
Club Hotels by Doubletree 3 7 10
Doubletree Hotels and
Guest Suites 5 10 15
Other 1 2 3
- - ---------------------------------------------------------------------------
163 183 346
- - ---------------------------------------------------------------------------
When completed, the 163 properties under construction or conversion will
add over 20,000 rooms to the Promus hotel system. The remaining 183 hotels in
the design phase, if completed, would add almost 23,000 additional rooms.
Eighteen of the properties within the pipeline are being developed by the
Company; the remainder are being developed by franchisees.
Although most development is expected to come through franchising, growth
plans could include ground-up construction of new hotels, either for sale to
strategic partners or for operation as company owned properties. In addition,
Promus is assessing the market position of individual properties/markets, and
could reposition itself by rebranding existing properties or acquiring or
selling selected properties. The success of Promus' development activities is
affected by, among other things, national and regional economic conditions,
capital markets, credit availability, relationships with franchisees and owners
as well as competition from other hotel franchisors and managers.
7
Strategic Alliances and Joint Ventures
Promus has entered into a strategic alliance with FelCor Suite Hotels, Inc.
and FelCor Suites Limited Partnership (collectively, FelCor), under which FelCor
has committed to invest up to $100.0 million in Embassy Suites developments,
most of which is expected to be applied to five Embassy Suites which are
currently in design or under construction. Upon completion of construction,
Promus will sell a 90% interest in each property to FelCor at cost. Completed
hotels will operate under Promus management contracts and franchise agreements
with 15 and 20-year terms, respectively. Promus began funding the projects in
1998, and the first hotel under this alliance is expected to open in 1999.
In 1995, Promus invested $75.0 million in FelCor limited partnership
interests and common stock and guaranteed repayment of up to $25.0 million of a
third party loan advanced to FelCor. The limited partnership interests are
convertible to common stock, which may be sold on the open market. During 1997,
Promus sold approximately $38.9 million of its FelCor investment for $50.1
million, resulting in pre-tax gains of $11.2 million. Based on the market value
of its remaining FelCor common stock as of December 31, 1998, Promus has
recorded an unrealized loss on marketable equity securities of $3.7 million
(pre-tax). This amount will fluctuate based on the market value of FelCor stock,
but no earnings impact will be realized until the stock is actually sold.
As of December 31, 1998, FelCor owned or had an interest in 76 Promus brand
hotels, which represents 6% and 9% of all Promus hotels and hotel rooms,
respectively. Promus owns a 50% interest in 12 of the 76 hotels. These 76 hotels
contributed approximately 16% of the Company's franchise and management fee
revenue in 1998.
At December 31, 1998, the Company owned approximately 29% of the
outstanding common stock (13% assuming conversion of outstanding preferred
stock) of Candlewood Hotel Company, Inc. (Candlewood). The Company's investment
consists of 2,587,500 shares of Candlewood's common stock, the fair value of
which was $13.6 million at December 31, 1998. The Company also has a note
receivable from Candlewood with a balance at December 31, 1998 of $14.6 million.
Acquisitions and Investments
On January 2, 1998, Promus completed its acquisition of Harrison Conference
Associates, Inc. (Harrison) for $61.2 million in cash. Harrison is a leading
conference center operator with over 1,200 rooms under management, including two
owned and six managed properties.
During 1997, Promus purchased two Homewood Suites hotels, in Salt Lake
City, Utah and Plano, Texas, and an Embassy Suites hotel in Portland, Oregon,
for $60.7 million. All three properties are being operated as company owned
hotels.
Development Financing
In order to assist prospective owners in obtaining financing for Promus
hotel projects, Promus has initiated programs to provide alternative capital
sources to owners.
Promus Acceptance Corp. (ProMAC), a third party lending entity, provides
first mortgage construction financing to Promus franchisees for select Homewood
Suites, Hampton Inn & Suites, Hampton Inn and Embassy Suites hotels by issuing
up to an aggregate of $152.5 million in commercial paper that is backed by a
liquidity facility from participating financial institutions. ProMAC loan terms
generally provide for favorably-priced floating and fixed rate loans ranging
from $3.0 million to $12.0 million with six-year terms and 20-year amortization
schedules. Promus has provided a guarantee up to $36.0 million and expects to
increase the guarantee to $45.8 million in 1999 on loans outstanding under the
program and has also provided a $1.0 million working capital guarantee to
ProMAC. Promus loaned $2.0 million to ProMAC in the form of a start-up loan.
This loan, which bears interest at prime, matures in April 2005. As of December
31, 1998, ProMAC had committed and funded $97.6 million (20 loans) and $50.5
million (14 loans), respectively, in hotel financing.
Under its mezzanine financing program, Promus provides secondary financing
to franchisees. A minimum of 20% equity is required by the borrower, and the
investment must meet certain defined underwriting criteria. The terms of the
first mortgage and the mezzanine financing must be acceptable to Promus and the
first mortgage lender, with whom Promus will enter into an inter-creditor
agreement. During 1998, Promus provided $7.7 million in mezzanine loans, and
$4.8 million in such loans were repaid during the year. Loans outstanding at
December 31, 1998, totaled $17.9 million and bore interest at rates ranging from
8.0% to 10.0%.
The Company provides credit support for a loan facility utilized by
Candlewood to provide construction and permanent financing to Candlewood and its
franchisees on terms that, in most cases, are more attractive than those which
could otherwise be obtained. The Company's maximum exposure on any individual
loan ranges from $0.9 million to $1.9 million per hotel, with the aggregate
amount of exposure for all such credit support capped at $30.0 million. As of
December 31, 1998, the Company had guaranteed $12.0 million in such financing.
8
VACATION RESORT DEVELOPMENT
Promus Vacation Resorts (PVR) allows the Company to expand upon its
reputation and expertise in the lodging industry, by extending that knowledge to
the vacation interval ownership business. Development of PVR properties consists
of the construction or acquisition of resort-quality accommodations in
destination locations throughout the United States. These accommodations consist
of full-featured one, two and three bedroom units, which are sold in one week
intervals as an alternative to renting. Each unit contains 51 saleable weekly
intervals, with one week reserved for annual maintenance. By purchasing an
interval, owners are entitled to a one week stay during each year. Owners have
several options with an interval purchase, including splitting their week,
spending their week at other timeshare resorts (by trading with other interval
owners), or renting the unit to others during their interval in any year. Units
containing unsold intervals are also rented on a daily basis.
The Company has two licensed PVR products: Embassy Vacation Resorts and
Hampton Vacation Resorts. Promus receives a one-time franchise licensing fee
upon the sale of an interval; the Company then receives ongoing franchise
royalty fees from interval owners, as well as royalty fees for hotel revenues
earned from any interval rentals. For properties which Promus manages, the
Company will also earn a management fee from the operation of the facility. To
facilitate growth and development of PVR properties, Promus has entered into
alliances with Sunterra Corporation (Sunterra) and Vistana Development Ltd.
(Vistana).
Promus has licensed four Embassy Vacation Resorts to Sunterra. These
properties are the Embassy Vacation Resort in Orlando, Florida, Embassy Vacation
Resort in Lake Tahoe, California and Embassy Vacation Resorts in Kauai and Maui,
Hawaii. Plans for additional Embassy Vacation Resort properties to be developed
or acquired by Sunterra and licensed by the Company are being discussed.
In 1996, Promus entered into a five-year joint venture development
agreement with Vistana to acquire, develop, manage and market vacation ownership
resorts in North America under Promus brand names. Vistana will serve as
managing partner and project developer and will market the timeshare units.
Promus will serve as franchisor and manager of these joint venture properties
and will own a 50% interest in certain projects developed pursuant to this
agreement. In addition to the proposed joint venture developments, Vistana has
licensed three other PVR properties. These properties are the Embassy Vacation
Resort in Scottsdale, Arizona, Embassy Vacation Resort in Myrtle Beach, South
Carolina and Hampton Vacation Resort in Kissimmee, Florida.
Promus Vacation Resort statistics were as follows as of December 31,:
1996 1997 1998
- - ----------------------------------------------------------------------------
Total vacation resorts open 3 6 8
Total available timeshare units 371 1,046 1,374
Total available timeshare intervals 18,921 53,346 70,074
Total timeshare intervals sold* 4,524 10,304 24,425
- - ---------------------------------------------------------------------------
* Includes presold intervals for resorts under construction
OTHER
In addition to ground-up development of hotels, strategic alliances with
others, and incentives provided to hotel owners as a means of obtaining
franchise and management contracts, the Company pursues other means of system
growth, including strategic hotel acquisitions. The hotel industry is in a
period of consolidation, which is expected to continue for several more years.
Promus may, from time to time, pursue such opportunities as they become
available.
9
CAPITAL SPENDING
Investment in Franchise System
Promus' net investment in its franchise system infrastructure at December
31, 1998 increased $6.6 million from December 31, 1997. The Company expects its
investment in the franchise system to decrease in 1999, as reimbursements from
hotel assessments outpace additional spending on system enhancements.
Other
In order to maintain Promus' quality standards, ongoing refurbishment of
existing company owned and leased hotel properties will continue in 1999 at an
estimated annual cost of approximately $60.0 million. During 1998, the Company
spent approximately $32.0 million on hotel refurbishment and conversions.
In April 1997, PHC's Board of Directors authorized the Company to
repurchase up to $150.0 million of its common stock. PHC repurchased 1,573,800
shares of its common stock at a cost of $60.0 million. As a result of the Merger
of PHC into Promus, the Company terminated this share repurchase program.
In August 1998, Promus' Board of Directors authorized the Company to
repurchase up to $200 million of its common stock for cash. The authorization
allows the Company to conduct the repurchase program in the open market, or in
negotiated or block transactions at prevailing market prices until December 31,
1999. Through December 31, 1998, the Company had repurchased 3,620,000 shares of
its common stock at a total cost of approximately $117.6 million. The average
price per share, including transaction costs, was $32.48.
Promus' capital expenditures, excluding the Harrison purchase, totaled
$205.0 million for the twelve months ended December 31, 1998. The Company
currently expects to spend between $230.0 million and $250.0 million during 1999
to fund hotel and resort development, refurbish existing facilities, support its
hotel management and business systems, loan funds to hotel owners, invest in
joint ventures and pursue other corporate related projects. If the Company
identifies other significant acquisition and/or investment opportunities, 1999
capital spending could increase from these planned levels.
Cash necessary to finance projects currently identified, as well as
additional projects to be pursued by Promus, will be made available from
operating cash flows, the revolving credit facility, joint venture partners,
specific project financing, sales of existing hotel assets and/or investments
and, if necessary, Promus debt and/or equity offerings.
LIQUIDITY AND CAPITAL RESOURCES
Operating cash flow for 1998 decreased $6.5 million from 1997 levels. This
decrease is primarily due to the payment of $56.2 million of business
combination expenses and lower gains on the sales of real estate and securities
in 1998. The 1998 decrease was partially offset by the increase in operating
income excluding unusual items. The increase in 1997 operating cash flow of
$57.6 million over 1996 was due in part to higher income levels and the full
year effect of the Red Lion acquisition, combined with the noncash impact of
unusual items including business combination expenses.
Cash flows used in investing activities increased $105.2 million in 1998
from 1997 levels due to the $61.2 million purchase of Harrison, the acquisition
of two newly built Homewood Suites Hotels for $17.9 million, and the decrease in
the proceeds from the sale of real estate, securities and investments from
$190.7 million to $15.1 million. The 1998 increase was partially offset by an
increase in cash from partnership distributions and an increase in collections
of loans to owners of managed and franchised hotels. Cash flows used in
investing activities decreased substantially in 1997 from 1996 levels, due to
the 1996 purchase of Red Lion. Capital spending in 1997 was also partially
offset by proceeds from the sales of real estate, securities and investments.
Cash flows used in financing activities during 1998 include approximately
$117.6 million used by Promus to repurchase common stock which was offset by
$32.2 million in proceeds from the exercise of stock options and $52.7 million
in net borrowings of long-term debt. In 1997, cash flows used in financing
activities consisted of approximately $60.0 million used to repurchase common
stock and approximately $77.4 million to retire debt. For 1996, the Company had
net cash provided by financing activities primarily due to $866.3 million in
cash received from debt and equity offerings that was used to purchase Red Lion.
On December 31, 1998, the Company had a working capital deficit of $29.3
million, compared to a $120.7 million deficit that existed at December 31, 1997.
This decrease is primarily the result of payments of $56.2 million made on
accrued business combination expenses and the refinancing of $45 million of a
consolidated joint venture's mortgage debt which was included in the current
portion of notes payable at December 31, 1997. Cash needed to fund business
combination expenses has been and will continue to be made available from
operations or borrowings under the Promus Facility.
The Company's cash management program uses all excess cash to pay down
amounts outstanding under the Promus Facility. Promus does not believe that the
current ratio is an appropriate measure of its short-term liquidity without
considering the aggregate availability of its capital resources. Promus believes
that these resources, consisting of operating cash flow, available borrowings
under the Promus Facility, and Promus' ability to obtain additional financing
through various financial markets, are sufficient to meet its liquidity needs.
10
PROMUS FACILITY AND OTHER INDEBTEDNESS
Promus has an unsecured revolving credit arrangement (the Promus Facility),
which consists of two separate agreements, the significant terms of which are as
follows:
Total Facility Maturity Date Interest Rate Facility Fees
- - -------------------------------------------------------------------------------------------------------------------------
Five-Year Revolver $750,000,000 December 19, 2002 Base Rate, as defined, 0.100% of the total facility
or LIBOR +25.0 basis
points
- - -------------------------------------------------------------------------------------------------------------------------
Extendible Revolver $209,600,000 December 17, 1999 Base Rate, as defined, 0.100% of the total facility plus
or LIBOR +25.0 basis usage fee
points
- - -------------------------------------------------------------------------------------------------------------------------
Promus borrowed $592.0 million under the Promus Facility on December 19,
1997, which was used to repay the existing indebtedness of Doubletree and PHC.
Previously capitalized financing costs were written off and costs incurred to
obtain the Promus Facility were capitalized and are being amortized over the
term of the Promus Facility.
The Five-Year Revolver includes a sublimit for letters of credit of $100.0
million. At December 31, 1997 and 1998, approximately $16.0 million and $47.8
million, respectively, in letters of credit were outstanding under this
agreement. The Extendible Revolver is a 364-day facility with annual renewals
and may be converted into a four-year term loan with equal quarterly amortizing
payments. Promus Facility availability at December 31, 1998, was $277.6 million.
The remaining borrowing capacity is available for working capital, hotel
development and other general corporate purposes.
Facility fees and interest on Base Rate loans are paid quarterly. The
agreements contain a tiered scale for facility fees and the applicable LIBOR
spread that, subsequent to June 1998, is based on the more favorable of Promus'
current credit rating or the leverage ratio, as defined. Based on the terms of
the Promus Facility, Promus' current fee structure (reflected in the table)
follows a tiered scale. At December 31, 1997 and 1998, the weighted average
interest rate on outstanding Promus Facility borrowings, including the
applicable LIBOR spread, was 6.6% and 6.2%, respectively.
Both the Extendible Revolver and the Five-Year Revolver contain provisions
that allow Promus to request increases in total capacity of $50.0 million and
$200.0 million, respectively. Though all the banks which currently participate
in the Promus Facility are not obligated to provide this additional capacity,
Promus can approach banks outside the current facility. The Promus Facility also
contains provisions that restrict certain investments, limit the Company's
ability to dispose of property, and require that certain performance ratios be
maintained. As of December 31, 1997 and 1998, Promus was in compliance with all
such covenants.
In addition to the Promus Facility, the Company has other notes payable,
which are primarily mortgage financing on consolidated joint venture hotel
properties.
Promus also has a $20.0 million five-year convertible rate unsecured term
loan which matures October 28, 2002. This loan bears interest through October
28, 1999 at the three month LIBOR rate minus 15 basis points (5.1% at December
31, 1998); thereafter the rate changes to a fixed rate of 6.7%. The bank may
elect to convert this fixed rate to the three month LIBOR rate plus 32.5 basis
points, under a conversion option that is exercisable annually beginning on
October 28, 1999.
As of December 31, 1998, Promus was a party to several interest rate swap
agreements, bearing a total notional amount of $376.7 million, which serve to
convert a portion of the Company's variable rate debt to a fixed rate of
interest. The weighted average fixed rate pursuant to the agreements, which
expire between January 1999 and January 2002, was approximately 6.2% at December
31, 1998, resulting in a weighted average effective rate (including the
applicable spreads) of approximately 6.5%.
11
YEAR 2000
The "Year 2000 Problem" is the result of many computer programs that were
designed to save valuable computer storage space by representing years with a
two-digit number such as "99" for 1999. When the change in the millennium occurs
and year 2000 is represented as "00", such computer programs as well as certain
chip-embedded technology systems may interpret the year as 1900. If not
corrected, computer applications could fail or deliver unreliable and erroneous
results.
As a franchisor, manager and owner of hotels, Promus relies heavily on
computer systems. These computer systems are present at Promus' corporate
offices and at its franchised, managed and owned hotels.
Promus' Computer Technologies
Promus groups the computer technologies used in support of its business
into the following three categories:
() Enterprise-wide, mission-critical business systems that support Promus'
franchised, managed and owned hotels as well as other corporate
requirements, including reservation, marketing, property management, and
revenue management systems; financial, human resources and operational
reporting systems; and corporate support technologies that provide external
and internal management reporting.
Most of these systems were built and installed after 1990 when the
Year 2000 Problem was well understood within the technology industry. These
systems were largely Year 2000 compliant when built.
() Property-based systems that perform functions relating to the operational
support of all of Promus' franchised, managed and owned hotels, including
PBX, call accounting, point-of-sale, and local sales systems. These systems
are selected by the hotel owners and managers and are not consistently
implemented at all hotels.
() Facility systems that contain embedded computer chips and perform functions
relating to the operation of all of Promus' franchised, managed and owned
hotels, including elevators, automated room key systems, HVAC, and fire and
safety systems. These systems also are selected by the hotel owners and
managers and are not consistently implemented at all hotels.
Promus' Response to the Year 2000 Problem
Beginning in early 1997, Promus developed and began implementing a plan
designed to identify its exposure to the Year 2000 problem and to minimize
potential disruptions and losses. The initial steps in this plan are as follows:
() Enterprise-Wide, Mission-Critical Business Systems
The remediation steps for the enterprise-wide, mission-critical business
systems have been executed and tested. No significant issues have surfaced
in the integration testing to date. This phase is substantially complete
and is expected to be finished in May 1999.
() Vendor Identification and Contact
The external businesses that provide technology systems and other products
and services to Promus and its hotels have been sent letters requesting
verification of their Year 2000 readiness. Responses are tracked and a
vendor database accessible through Promus' Intranet for hotel owners and
managers is being developed. This effort will continue throughout 1999.
() Property-Based Systems and Facility Systems
Promus has engaged an independent consultant to perform on-site inventories
and assessments of the property-based systems and facility systems at all
hotels that are managed or owned by Promus. This phase is scheduled to be
completed in July 1999, although it is anticipated that assessment and
remediation activities will continue throughout the remainder of the year.
For franchised hotels, Promus has provided their owners and general
managers with a Year 2000 Compliance Guide and additional communications to
assist them in performing their own assessments. Year 2000 readiness will
be part of Promus' 1999 quality assurance audits of all hotels.
() Contingency Planning
Promus is engaged in a reassessment of its contingency plans to respond to
business disruptions that may occur as a result of Year 2000 problems. The
principal areas of focus for contingency planning are hotel operations,
corporate finance, human resources, information technology, and corporate
facilities. Completion is scheduled for July 1999, subject to updating and
refinement throughout the remainder of the year.
12
Year 2000 Remediation Costs
As of December 31, 1998, Promus has spent approximately $1.1 million on the
remediation of the Year 2000 problem in the computer systems at its corporate
offices and hotels, most of which were internal labor costs. Promus expects to
incur approximately $1.0 million in additional Year 2000 problem remediation
costs in 1999.
The costs associated with remediation of the Year 2000 problem of property-
based systems and facility systems at the hotels that are managed by Promus and
at the franchised hotels are borne by their respective owners.
Risks Arising from the Year 2000 Problem
The Company believes that the Year 2000 problem will not have a material
adverse effect on the Company, its business or its financial condition.
Promus believes that its enterprise-wide, mission-critical business
systems, as well as the property-based systems and facility systems at its owned
hotels, will be ready for Year 2000 in all material respects and will pose
minimal risks of business disruption. Promus cannot predict with certainty the
Year 2000 readiness of the property-based systems and facility systems at its
managed and franchised hotels, because the decision-making authority with
respect to Year 2000 assessment and remediation, and the incurrence of costs
related thereto, rests principally with the owners of those hotels.
Promus and all of its franchised, managed and owned hotels depend on
numerous independent, external providers of products and services. These
external businesses include suppliers of electricity, natural gas, telephone
service and other public utilities; financial institutions and credit card
companies; food, beverage and linen suppliers; and airlines, air traffic control
systems, car rental companies, and gasoline station operators. Promus does not
control these external businesses and cannot ensure that they and their products
and services will be ready for Year 2000. The most reasonably likely worst case
Year 2000 scenario for Promus and its hotels would be the failure by one or more
critical external businesses (e.g., airlines, utilities or credit card
companies) to be ready for Year 2000, which in turn could disrupt service or
cause potential hotel guests to postpone or cancel their travel plans or make
claims under the "100% Satisfaction Guarantee" program available at most
Promus-branded hotels, causing a disruption of Promus' business. Promus is
seeking to verify the Year 2000 readiness of these external businesses; however,
if these external businesses--particularly critical ones--were to experience a
Year 2000 problem, the resulting business disruption could have a material
adverse effect on Promus' results of operations and financial condition.
SEASONALITY
The operating results of hotels are affected by seasonality. Though the
Company's hotels are geographically dispersed, revenues and profits are
typically higher in summer periods than winter periods.
INFLATION
Although operations of the Company can be impacted by inflation, Promus has
not typically experienced a significant negative effect on its hotels and food
and beverage operations as a result of inflation. To date, the Company has
generally been able to increase rates and prices and thereby pass on the effects
of inflationary cost increases. Although competitive conditions may limit the
industry's future ability to raise room rates at the rate of inflation and
although inflation can also impact the travel patterns of guests, management
believes that each of its hotel brands has rate growth potential in excess of
the inflation rate. Promus will continue to emphasize cost containment and
productivity improvement programs. Inflation tends to increase the underlying
value of Promus' real estate and management and franchise contracts.
NEWLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This statement establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives), and for hedging activities. It requires that an entity recognize
all derivatives either as assets or liabilities in the statement of financial
position and measure those instruments at fair value.
SFAS No. 133 allows an entity to designate a derivative instrument, if
certain conditions are met, as one of the following three types: 1) a Fair Value
Hedge, which is a hedge of the exposure to changes in the fair value of a
recognized asset or liability, or of an unrecognized firm commitment, 2) a Cash
Flow Hedge, which is a hedge of the exposure to variability in the cash flow of
a recognized asset or liability, or of a forecasted transaction, or 3) a Foreign
Currency Hedge, which is a hedge of the foreign currency exposure of an
unrecognized firm commitment, an available-for-sale security, a forecasted
transaction, or a net investment in a foreign operation. The accounting for
changes in the fair value of a derivative (that is, gains and losses) depends on
the intended use of the derivative and the resulting designation. The Company's
derivatives at December 31, 1998 are Cash Flow Hedges.
This Statement is effective for all fiscal quarters of fiscal years
beginning after September 15, 1999. The adoption of SFAS No. 133 is not
anticipated to have a material impact on the financial position or results of
operations of the Company.
13
CONSOLIDATED BALANCE SHEETS
As of December 31,
(In thousands, except share amounts) 1997 1998
- - --------------------------------------------------------------------------
ASSETS
Cash and cash equivalents $ 24,066 $ 6,466
Accounts receivable, net 78,941 101,742
Other 43,222 44,485
- - --------------------------------------------------------------------------
Total current assets 146,229 152,693
- - --------------------------------------------------------------------------
Property and equipment, net 960,231 1,109,868
Investments 250,688 220,268
Management and franchise contracts,
net 440,568 427,421
Goodwill, net 374,500 392,419
Notes receivable 89,452 68,991
Investment in franchise system 50,421 57,023
Deferred costs and other assets 66,957 45,318
- - --------------------------------------------------------------------------
$ 2,379,046 $ 2,474,001
- - --------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 220,924 $ 180,189
Current portion of notes payable 46,020 1,797
- - --------------------------------------------------------------------------
Total current liabilities 266,944 181,986
- - --------------------------------------------------------------------------
Deferred income taxes 264,859 276,498
Notes payable 671,978 768,891
Other long-term obligations 79,530 87,931
- - --------------------------------------------------------------------------
1,283,311 1,315,306
- - --------------------------------------------------------------------------
Commitments and contingencies
Stockholders' equity
Common stock, $0.01 par value.
Authorized 500,000,000 shares;
86,118,141 and 87,457,099 shares
issued and outstanding 861 875
Additional paid-in capital 856,008 898,900
Accumulated other comprehensive
income 13,601 (2,909)
Unearned employee compensation (70) --
Retained earnings 225,335 379,423
Treasury stock, at cost (3,620,000
shares) -- (117,594)
- - ------------------------------------------------------------------------------
1,095,735 1,158,695
- - ------------------------------------------------------------------------------
$ 2,379,046 $ 2,474,001
- - ------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
14
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31,
(In thousands, except per share
amounts) 1996 1997 1998
- - ---------------------------------------------------------------------------
REVENUES
Franchise and management
fees $ 140,768 $ 185,546 $ 218,113
Owned hotel revenues 172,893 368,012 401,016
Leased hotel revenues 205,163 410,526 415,339
Purchasing and service fees 9,867 19,304 27,348
Other fees and income 31,522 54,623 45,473
- - ---------------------------------------------------------------------------
Total revenues 560,213 1,038,011 1,107,289
- - ---------------------------------------------------------------------------
OPERATING COSTS AND EXPENSES
General and administrative
expenses 62,638 79,249 80,429
Owned hotel expenses 105,146 224,052 248,990
Leased hotel expenses 190,797 362,681 367,176
Depreciation and
amortization 36,276 73,127 79,254
Business combination
expenses -- 115,000 28,065
- - ---------------------------------------------------------------------------
Total operating costs and
expenses 394,857 854,109 803,914
- - ---------------------------------------------------------------------------
Operating income 165,356 183,902 303,375
- - ---------------------------------------------------------------------------
Interest and dividend
income 17,175 22,982 21,281
Interest expense (36,647) (72,027) (61,917)
Gain on sale of real estate
and securities 4,439 43,330 10,390
- - ---------------------------------------------------------------------------
Income before income
taxes and minority
interest 150,323 178,187 273,129
Minority interest share of
net income (539) (3,087) (3,460)
- - ---------------------------------------------------------------------------
Income before income
taxes 149,784 175,100 269,669
Income tax expense (59,126) (79,664) (115,581)
- - ---------------------------------------------------------------------------
Net income $ 90,658 $ 95,436 $ 154,088
- - ---------------------------------------------------------------------------
Net income per share
Basic $ 1.25 $ 1.10 $ 1.79
- - ---------------------------------------------------------------------------
Diluted $ 1.23 $ 1.09 $ 1.78
- - ---------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
15
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31, 1996, 1997 and 1998
Accumulated
Other
Unearned Compre-
Additional Employee hensive
(In thousands, except share Common Paid-In Compen- Income Retained Treasury
amounts) Stock Capital sation (Loss) Earnings Stock Total
- - ---------------------------------------------------------------------------------------------------------------------------------
Balance--December 31, 1995 $ 696 $ 241,181 $ (1,209) $ 1,844 $ 39,241 $ -- $ 281,753
Net income -- -- -- -- 90,658 -- 90,658
Other comprehensive income,
net of taxes:
Unrealized gain on equity
securities, net of
reclassification
adjustment (Note 2) -- -- -- 15,293 -- -- 15,293
- - ---------------------------------------------------------------------------------------------------------------------------------
Comprehensive income for 1996 -- -- -- 15,293 90,658 -- 105,951
Proceeds from sale of 952,300
shares of common stock to
the public, net of offering
costs of $1,045 10 27,362 -- -- -- -- 27,372
Proceeds from sale of
9,067,534 shares of common
stock, net of offering
costs of $1,500 91 340,681 -- -- -- -- 340,772
Issuance of 7,381,588 shares
to the shareholders of Red
Lion 74 291,499 -- -- -- -- 291,573
Net shares issued under
incentive compensation
plans, including income tax
benefit of $584 -- 1,728 470 -- -- -- 2,198
- - ---------------------------------------------------------------------------------------------------------------------------------
Balance--December 31, 1996 871 902,451 (739) 17,137 129,899 -- 1,049,619
Net income -- -- -- -- 95,436 -- 95,436
Other comprehensive income,
net of taxes:
Unrealized gain (loss) on
equity securities, net of
reclassification
adjustment (Note 2) -- -- -- (3,536) -- -- (3,536)
- - ---------------------------------------------------------------------------------------------------------------------------------
Comprehensive income for 1997 -- -- -- (3,536) 95,436 -- 91,900
Net shares issued under
incentive compensation
plans, including income tax
benefit of $4,136 5 13,534 669 -- -- -- 14,208
Treasury repurchases (15) (59,977) -- -- -- -- (59,992)
- - ---------------------------------------------------------------------------------------------------------------------------------
Balance--December 31, 1997 861 856,008 (70) 13,601 225,335 -- 1,095,735
Net income -- -- -- -- 154,088 -- 154,088
Other comprehensive income,
net of taxes:
Unrealized gain (loss) on
equity securities, net of
reclassification
adjustment (Note 2) -- -- -- (16,510) -- -- (16,510)
- - ---------------------------------------------------------------------------------------------------------------------------------
Comprehensive income for 1998 -- -- -- (16,510) 154,088 -- 137,578
Net shares issued under
incentive compensation
plans, including income tax
benefit of $10,624 14 42,892 70 -- -- -- 42,976
Purchases of treasury shares -- -- -- -- -- (117,594) (117,594)
- - ---------------------------------------------------------------------------------------------------------------------------------
Balance--December 31, 1998 $ 875 $ 898,900 $ -- $ (2,909) $ 379,423 $(117,594) $ 1,158,695
- - ---------------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
16
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31,
(In thousands) 1996 1997 1998
- - ------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING
ACTIVITIES
Net income $ 90,658 $ 95,436 $ 154,088
Adjustments to reconcile net
income to net cash provided by
operations:
Provision for business
combination expenses, net of
payments -- 93,591 (28,099)
Depreciation and amortization 36,276 73,127 79,254
Other noncash (income)
expenses (3,578) 11,742 3,233
Equity in earnings of
nonconsolidated affiliates (7,677) (10,722) (16,415)
Gain on sale of real estate,
securities and investments (3,279) (46,775) (11,955)
Changes in assets and
liabilities:
Increase in accounts
receivable, net (9,363) (9,882) (20,993)
(Increase) decrease in other
current assets (5,766) (3,243) (1,642)
Increase in deferred costs and
other assets (3,275) (16,313) (5,632)
Increase (decrease) in
accounts payable and accrued
expenses 10,506 1,452 (3,085)
Increase (decrease) in other
long-term obligations and
deferred income taxes 11,812 (14,520) 18,623
- - ------------------------------------------------------------------------------
Net cash provided by
operating activities 116,314 173,893 167,377
- - ------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING
ACTIVITIES
Acquisitions (819,025) (20,607) (61,150)
Purchases of property and
equipment (60,277) (155,988) (153,292)
Proceeds from sale of real
estate, securities and
investments 45,933 190,686 15,053
Investments in and advances to
partnerships and affiliates (112,203) (47,285) (27,261)
Distributions from partnerships
and affiliates 11,104 16,004 36,859
Net investment in management and
franchise contracts (1,284) (372) 659
Escrow deposits used for (held
for) development -- (22,053) 20,537
Loans to owners of managed and
franchised hotels (26,941) (18,818) (24,370)
Collections of loans to owners
of managed and franchised
hotels 2,750 15,553 48,339
Net investment in franchise
system (10,817) (3,257) (7,004)
Other 4,210 (943) (643)
- - ------------------------------------------------------------------------------
Net cash used in investing
activities (966,550) (47,080) (152,273)
- - ------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING
ACTIVITIES
Net proceeds from issuance of
common stock 368,144 -- --
Proceeds from exercise of common
stock options 1,219 6,817 32,229
Purchases of treasury stock -- (59,992) (117,594)
Net activity under revolving
credit facilities 14,500 383,950 25,925
Proceeds from notes payable 498,200 40,000 29,422
Principal payments on notes
payable (37,596) (501,351) (2,686)
Other (263) (1,459) --
- - ------------------------------------------------------------------------------
Net cash provided by (used
in) financing activities 844,204 (132,035) (32,704)
- - ------------------------------------------------------------------------------
Net decrease in cash and cash
equivalents (6,032) (5,222) (17,600)
Cash and cash equivalents,
beginning of period 35,320 29,288 24,066
- - ------------------------------------------------------------------------------
Cash and cash equivalents, end of
period $ 29,288 $ 24,066 $ 6,466
- - ------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
NOTE 1--SUMMARY OF ORGANIZATION AND BUSINESS OPERATIONS
Company History
On December 19, 1997, Doubletree Corporation (Doubletree) and Promus Hotel
Corporation (PHC) merged in accordance with the Agreement and Plan of Merger
(the Merger Agreement or the Merger) by and among Doubletree, PHC and Parent
Holding Corp., a corporation formed and jointly owned by Doubletree and PHC to
facilitate the Merger. This transaction was accounted for as a
pooling-of-interests. Accordingly, the accompanying consolidated financial
statements have been restated to combine the historical results of both
Doubletree and PHC for 1997 and 1996. Concurrent with consummation of the
Merger, PHC was renamed Promus Operating Company, Inc. (POC) and Parent Holding
Corp. was renamed Promus Hotel Corporation. Promus Hotel Corporation and
subsidiaries are collectively referred to herein as Promus or the Company.
On November 8, 1996, the Company acquired Red Lion Hotels, Inc. (Red Lion)
in a business combination accounted for as a purchase. Accordingly, the
financial results of Red Lion and its subsidiaries are included since November
8, 1996.
On February 27, 1996, the Company acquired RFS, Inc. (RFS Management) in a
transaction accounted for as a pooling-of-interests. Accordingly, the
accompanying consolidated financial statements have been restated to include the
historical results of RFS Management for all periods presented.
Description of Business
Through its wholly-owned subsidiaries, Promus franchises and manages hotels
with the following brands: Doubletree Hotels, Doubletree Guest Suites, Club
Hotels by Doubletree, Embassy Suites, Hampton Inn, Hampton Inn & Suites and
Homewood Suites. Promus may also own all or a portion of these hotels or lease
these hotels from others. In addition, Promus leases and manages hotels that are
not Promus-branded. At December 31, 1998, Promus franchises 998 hotels and
operates 339 hotels, of which 62 hotels are wholly-owned, 23 are partially-owned
through joint ventures, 77 are leased from third parties and 177 are managed for
third parties. These hotels are located in all 50 states, the District of
Columbia, Puerto Rico, the U.S. Virgin Islands and six foreign countries. The
Company also operates and licenses vacation interval ownership systems under the
Embassy Vacation Resort and Hampton Vacation Resort names.
Promus' primary focus is to develop, grow and support its franchise and
management business. Promus' primary sources of revenues are from the operations
of owned and leased hotels, franchise royalty fees and management fees. Promus
charges franchisees a royalty fee of up to four percent of room revenues.
Management fees are based on a percentage of the managed hotels' gross revenues,
operating profits, cash flow, or a combination thereof. Generally, the Company
is also reimbursed for certain costs associated with providing central
reservations, sales, marketing, accounting, data processing, internal audit and
employee training services to hotels.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of
the Company and its majority-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated. The preparation of financial
statements in accordance with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenues, and expenses and the disclosure of contingent
assets and liabilities. While management endeavors to make accurate estimates,
actual results could differ from these estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, cash equivalents are highly
liquid investments with an original maturity of three months or less.
Property and Equipment
Property and equipment are stated at cost. Improvements that extend the
life of the asset are capitalized. Maintenance and repairs are expensed as
incurred. Interest expense is capitalized on constructed assets at Promus'
overall weighted average borrowing rate. The Company capitalized interest of
$1.6 million, $2.3 million and $3.2 million in 1996, 1997 and 1998,
respectively. Depreciation expense is calculated using the straight-line method
over the shorter of the estimated useful life of the assets or over the related
lease term, as follows:
- - ---------------------------------------------------------------------
Land improvements 12 to 15 years
Buildings and improvements 10 to 40 years
Furniture, fixtures and equipment 2 to 15 years
- - ---------------------------------------------------------------------
18
Investments
Investments in partnerships and ventures are accounted for using the equity
method of accounting when the Company has a general partnership interest or its
limited partnership interest exceeds 5%, but the Company does not control the
venture. Profits and losses are allocated in accordance with the partnership or
joint venture agreements. The Company's share of the income or losses before
interest expense and extraordinary items is included in other fees and income in
the accompanying consolidated statements of operations. Promus' proportionate
share of interest expense of such joint ventures is included in interest expense
in the accompanying consolidated statements of operations. The Company's
proportionate share of interest expense totaled $12.2 million, $13.3 million and
$14.5 million for the years ended December 31, 1996, 1997 and 1998,
respectively. All other investments are accounted for using the cost method.
Management and Franchise Contracts
Management and franchise contracts acquired in acquisitions that were
accounted for as purchases are recorded at the estimated present value of net
cash flows expected to be received over the lives of the contracts. This value
is amortized using the straight-line method over the estimated weighted average
contract life or 40 years, whichever is less. Costs incurred to acquire
individual management and franchise contracts are amortized using the
straight-line method over the life of the respective contract. Management and
franchise contracts are carried net of accumulated amortization of $36.3 million
and $50.8 million at December 31, 1997 and 1998, respectively.
Goodwill
Goodwill arose in connection with purchase acquisitions and is amortized
using the straight-line method over 40 years. Goodwill is carried net of
accumulated amortization of $12.1 million and $22.5 million at December 31, 1997
and 1998, respectively.
Notes Receivable
Notes receivable consist primarily of loans to owners of managed and
franchised hotels. Management considers a note to be impaired when it is
probable that the Company will be unable to collect all amounts due according to
the contractual terms of the note. When a loan is considered to be impaired, the
amount of the impairment is measured based on the present value of expected
future cash flows discounted at the note's effective interest rate. Impairment
losses are charged to expense. Generally, cash receipts will first be applied to
reduce accrued interest and then to reduce principal.
Investment in Franchise System
Promus' investment in its franchise system includes the costs for computer
systems to operate the centralized marketing and reservation centers and a
property management system that interacts with several operational software
packages which are available to each Promus franchised hotel. Promus is
reimbursed for these costs by its system funds over their estimated useful
lives. In addition to computer system costs, these funds reimburse Promus for
related personnel and fringe benefits, advertising, promotional fees and other
reservation costs. The owner of each hotel, including Promus' company owned
hotels, contributes a percentage of room revenues to its brand's fund.
Deferred Costs and Other Assets
Deferred costs and other assets include escrow deposits, debt issuance
costs, franchise application fees paid and cash surrender value of insurance
policies. Escrow deposits represent proceeds received from 1997 hotel sales
which were used in 1998 to purchase replacement property. Costs related to the
issuance of debt are capitalized and amortized to interest expense over the
lives of the related debt.
Revenue Recognition
Franchise and management fees, hotel revenues and purchasing and service
fees are recognized when earned. Owned hotel revenues and leased hotel revenues
represent revenue derived primarily from the rental of rooms and suites and food
and beverage sales for hotels owned or leased by the Company.
Earnings per Share
As of December 31, 1997, the Company adopted the provisions of Statement of
Financial Accounting Standard (SFAS) No. 128, "Earnings per Share." In adopting
this pronouncement, the Company restated prior period earnings per share data
for all periods presented in the accompanying consolidated financial statements.
For Promus, basic earnings per share is determined by dividing net income by the
weighted average number of common shares outstanding during the year. Diluted
earnings per share is computed by dividing net income by the weighted average
number of common and common equivalent shares outstanding during the year.
Common equivalent shares include employee stock options, restricted stock and
warrants deemed exercisable for the purpose of computing diluted earnings per
share. The Company has no other potentially dilutive securities.
Income Taxes
Under the asset and liability method of accounting for income taxes,
deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets, including net operating loss carryforwards,
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates in effect for the year in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period when the new rate is enacted.
Long-Lived Assets
The recoverability of hotel real estate, investments, management contracts
and goodwill are periodically evaluated to determine whether such costs will be
recovered from future operations. Evaluations are based on projected cash flows
on an undiscounted basis. If the undiscounted cash flows are insufficient to
recover the recorded assets, then the projected cash flows are discounted and an
impairment loss is recognized for the difference.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of notes receivable,
marketable equity securities, notes payable and interest rate swap agreements.
The carrying amounts of financial instruments other than notes receivable and
interest rate swap agreements approximate fair value due to the short maturity
of those instruments, interest terms or, in the case of marketable equity
securities, they are carried at their estimated fair value. The Company has
determined that the fair value of its notes receivable approximates carrying
value based on interest rate and payment terms the Company would currently offer
on notes with similar security to borrowers of similar creditworthiness.
19
Comprehensive Income
Effective January 1, 1998, the Company adopted the provisions of SFAS No.
130 "Reporting Comprehensive Income," which established standards for reporting
and display of comprehensive income in the financial statements. The Company has
elected to present comprehensive income as a component of the Consolidated
Statements of Stockholders' Equity. SFAS No. 130 requires the disclosure of the
reclassification adjustments necessary to avoid double counting in comprehensive
income items that are displayed as part of net income. The following table
provides the disclosure of the reclassification adjustment (in thousands):
1996 1997 1998
- - ------------------------------------------------------------------------------
Disclosure of reclassification amount:
Net change in the unrealized
gain (loss) in equity securities
arising during the period:
Before-tax amount $ 24,972 $ 7,253 $ (16,777)
Tax (expense) or benefit (9,679) (2,826) 6,415
Less: reclassification
adjustment for gains included in
net income:
Before-tax amount -- 13,054 10,246
Tax expense -- (5,091) (4,098)
- - ------------------------------------------------------------------------------
Net unrealized gain (loss) on
equity securities $ 15,293 $ (3,536) $ (16,510)
- - ------------------------------------------------------------------------------
Recent Pronouncements
In June of 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."
This statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives), and for hedging activities.
It requires that an entity recognize all derivatives either as assets or
liabilities in the statement of financial position and measure those instruments
at fair value.
SFAS No. 133 allows an entity to designate a derivative instrument, if
certain conditions are met, as one of the following three types: 1) a Fair Value
Hedge, which is a hedge of the exposure to changes in the fair value of a
recognized asset or liability, or of an unrecognized firm commitment; 2) a Cash
Flow Hedge, which is a hedge of the exposure to variability in the cash flow of
a recognized asset or liability, or of a forecasted transaction; or 3) a Foreign
Currency Hedge, which is a hedge of the foreign currency exposure of an
unrecognized firm commitment, an available-for-sale security, a forecasted
transaction, or a net investment in a foreign operation. The accounting for
changes in the fair value of a derivative (that is, gains and losses) depends on
the intended use of the derivative and the resulting designation. The Company's
derivatives at December 31, 1998 are Cash Flow Hedges.
This statement is effective for all fiscal quarters of fiscal years
beginning after September 15, 1999. The adoption of SFAS No. 133 is not
anticipated to have a material impact on the financial position or results of
operations of the Company.
20
NOTE 3--BUSINESS COMBINATIONS
Doubletree/Promus Merger
The Company was formed on December 19, 1997, as a result of the Merger of
Doubletree and PHC. As a result of the Merger Agreement, (i) Doubletree and PHC
became wholly-owned subsidiaries of Promus; (ii) each outstanding share of
common stock of Doubletree was converted into one share of common stock of
Promus; and (iii) each outstanding share of PHC common stock was converted into
0.925 of a share of common stock of Promus. The Merger qualified as a tax free
exchange and was accounted for as a pooling-of-interests. Historical financial
results of Doubletree and PHC have been combined for 1997 and 1996.
The results of operations for the separate companies and the pro forma
combined results presented in the accompanying consolidated financial statements
are as follows (in thousands):
(Unaudited)
Nine Months
Year ended ended
December 31, September 30,
1996 1997
- - ------------------------------------------------------------------
Revenues:
Doubletree $ 292,710 $ 570,446
PHC 267,503 223,820
- - ------------------------------------------------------------------
Combined $ 560,213 $ 794,266
- - ------------------------------------------------------------------
Net Income:
Doubletree $ 25,934 $ 55,518
PHC 64,724 87,017
- - ------------------------------------------------------------------
Combined $ 90,658 $ 142,535
- - ------------------------------------------------------------------
In connection with the Merger, the Company recorded a $115.0 million
provision for business combination expenses, including both transaction costs
and restructuring costs in 1997. Transaction costs of approximately $40.3
million consist primarily of fees for investment bankers, attorneys,
accountants, financial printing and other related charges. Restructuring costs
of approximately $74.7 million include severance costs, exit costs related to
the consolidation of administrative functions, and the write-off of certain
assets whose benefits will not be realized after the Merger. Transaction costs
of $26.5 million and $12.0 million and restructuring costs of $22.7 million and
$44.2 million were paid or charged-off in 1997 and 1998, respectively. In the
fourth quarter of 1998, an additional $28.1 million was accrued for severance
and employment-related expenses associated with the Merger. None of this $28.1
million was paid before year-end 1998. At December 31, 1998, the $37.7 million
remaining estimated obligation was included in current liabilities.
Acquisition of Red Lion Hotels, Inc.
On November 8, 1996, the Company acquired all of the outstanding common
stock of Red Lion in a transaction valued at approximately $1.2 billion. The
Company paid $695.0 million in cash, repaid $124.0 million of existing Red Lion
indebtedness, issued 7.4 million shares of common stock to the shareholders of
Red Lion with a fair value at the date of closing of $291.5 million and assumed
net liabilities of $90.0 million. The acquisition has been accounted for as a
purchase and the results of operations of Red Lion have been included in the
consolidated financial statements since November 8, 1996. The purchase price was
allocated to the net assets acquired based upon their estimated fair market
values. The excess of the purchase price over the estimated fair value of the
net assets acquired of $372.3 million was recorded as goodwill and is being
amortized over a 40-year life.
The following unaudited pro forma summary financial data presents the
consolidated results of operations of the Company as if Red Lion had been
acquired at the beginning of 1996 with pro forma adjustments to give effect to
(a) amortization of goodwill, (b) additional depreciation expense as a result of
a step-up in the basis of properties and equipment and investments in
unconsolidated joint ventures, (c) increased interest expense on acquisition
debt, (d) the operating results of three hotels acquired in 1996 and (e) related
income tax effects. The pro forma results have been prepared for comparative
purposes only and do not purport to be indicative of the results of operations
that would actually have resulted had the combination been in effect on the date
indicated (in thousands, except per share amounts):
(Unaudited)
Year ended
December 31,
1996
- - -------------------------------------------------------------
Revenues $ 890,552
Operating income 230,445
Income before taxes and extraordinary items 180,541
Net income 105,984
Basic earnings per share $ 1.22
Diluted earnings per share $ 1.21
- - -------------------------------------------------------------
Acquisition of RFS, Inc.
In February 1996, the Company issued 2.7 million shares of common stock in
exchange for all of the outstanding stock of RFS Management in a transaction
accounted for as a pooling-of-interests. Accordingly, the accompanying
consolidated financial statements were restated to include the results of RFS
Management for all periods presented.
Acquisition of Harrison Conference Associates, Inc.
On January 2, 1998, the Company acquired Harrison Conference Associates,
Inc. (Harrison) for approximately $61.2 million cash in a transaction accounted
for as a purchase. The results of operations of Harrison have been included in
the consolidated financial statements since January 2, 1998. The purchase price
was allocated to the net assets acquired based upon their estimated fair values.
The excess of the purchase price over the estimated fair value of the net assets
acquired of $28.5 million was recorded as goodwill and is being amortized over a
40-year life. Harrison is a leading conference center operator with over 1,200
rooms under management, including two owned and six managed properties.
21
NOTE 4--PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
December 31,
------------------------------------
1997 1998
- - ----------------------------------------------------------------------------
Land and improvements $ 140,826 $ 135,200
Buildings and improvements 682,113 786,809
Furniture, fixtures and equipment 207,422 289,035
Construction in progress 55,878 67,064
- - -----------------------------------------------------------------------------
1,086,239 1,278,108
Accumulated depreciation (126,008) (168,240)
- - -----------------------------------------------------------------------------
$ 960,231 $ 1,109,868
- - -----------------------------------------------------------------------------
NOTE 5--NOTES RECEIVABLE
Notes receivable consist of the following (in thousands):
December 31,
-----------------------------------
1997 1998
- - -------------------------------------------------------------------------
Secured
Due from Red Lion MLP $ 23,133 $ --
Secured notes, with interest at
rates varying from 6.0%-12.0%,
maturing through 2016 38,241 26,348
- - ---------------------------------------------------------------------------
61,374 26,348
Unsecured
Candlewood $15.0 million credit
facility, with interest at rates
varying from 7.0%-10.0% in 1997
and 10.0%-15.0% in 1998, maturing
in 2001 14,608 14,608
Unsecured notes, with interest at
rates varying from 5.0%-15.0%,
maturing through 2008 14,541 28,037
- - ---------------------------------------------------------------------------
90,523 68,993
Less current portion (1,071) (2)
- - ---------------------------------------------------------------------------
$ 89,452 $ 68,991
- - ---------------------------------------------------------------------------
Interest is generally received monthly with principal due upon the earlier
of termination of the management contract or sale of the hotel. Certain of the
notes receivable bear a variable interest rate based on Prime or LIBOR. At
December 31, 1998, the variable interest rates ranged from Prime minus 1.5%
(7.0% and 6.25% at December 31, 1997 and 1998, respectively) to Prime plus 2%
(10.5% and 9.75% at December 31, 1997 and 1998, respectively). At December 31,
1998, management does not consider any of its notes receivable to be impaired.
The note receivable due from Red Lion MLP generally bore interest at Prime plus
0.5% (9.0% at December 31, 1997). In May 1998, Red Lion MLP merged with Boykin
Lodging Company (Boykin). This merger resulted in the Company being paid in
full. The Company continues to manage for Boykin the 10 hotels formerly owned by
Red Lion MLP.
22
NOTE 6--INVESTMENTS
Investments consist of the following (in thousands):
December 31,
-------------------------------------
1997 1998
- - -------------------------------------------------------------------------
Hotel partnerships $ 168,884 $ 165,678
Investments in common stock (at
market) 63,304 36,090
Convertible preferred stock 18,500 18,500
- - ---------------------------------------------------------------------------
$ 250,688 $ 220,268
- - ---------------------------------------------------------------------------
The Company's noncontrolling general and/or limited partnership interests
in hotel partnerships range from less than 1.0% to 50.0%. Investments in common
stock are carried at market value and include investments in FelCor Suite
Hotels, Inc. and FelCor Limited Partnership (collectively, FelCor), Boykin,
Winston Hotels, Inc. (Winston) and RFS Hotel Investors, Inc. (RHI). Promus' cost
of these investments at December 31, 1997 and 1998 was approximately $41.1
million and $40.9 million, respectively.
In 1995, Promus invested $75.0 million in FelCor limited partnership
interests and common stock. FelCor used the proceeds to help acquire all- suites
upscale hotels which it converted to the Embassy Suites brand. The limited
partnership interests may be converted to shares of FelCor common stock on a
one-for-one basis. During 1997, Promus sold approximately $38.9 million of its
original investment in FelCor stock, resulting in a pre-tax gain of
approximately $11.2 million.
During 1996, Promus invested $7.1 million and $1.5 million in the common
stock of Equity and Winston, respectively, in exchange for their purchase of
four hotels and one hotel, respectively. During 1997, Promus sold approximately
$5.5 million of its original Equity stock, resulting in a pre-tax gain of $1.8
million. In 1998, Promus sold the remaining $1.6 million of its Equity stock at
a pre-tax gain of $0.6 million.
In 1996, the Company purchased 973,684 shares of convertible preferred
stock of RHI for $19 per share, or approximately $18.5 million. This investment
is recorded at cost as there is no ready market for these securities. The
convertible preferred stock pays a fixed annual dividend of $1.45 per share and
is convertible on a one-for-one basis at the end of seven years. RHI also owns a
partnership in which the Company has an investment. This partnership investment
is convertible into common stock of RHI. RHI granted the Company a 10-year first
right of refusal to manage and lease future hotels acquired or developed by RHI.
The Company has committed to RHI to maintain $15.0 million of net worth in RFS
Management.
In 1998, Promus sold all of its common stock in Pegasus Systems, Inc. which
had a cost basis of $0.2 million, resulting in a pre-tax gain of $9.7 million.
NOTE 7--LEASES
The Company leases hotel properties, land and administrative office space.
All such leases are operating leases. As of December 31, 1996, 1997 and 1998,
the Company leased 82, 86 and 77 hotels, respectively. As of December 31, 1998,
51 of these hotels are leased from RHI. All of the Company's hotel leases
require the payment of rent equal to the greater of fixed base rent or
percentage rent based on a percentage of gross room revenue, beverage revenue
and food revenue (if the hotel offers food and beverage service) and expire
beginning December 1999 through July 2015, with varying renewal options.
Substantially all of the hotels leased from RHI are cross-defaulted with one
another. Promus' land leases represent ground leases for certain owned hotels
and, in addition to minimum base rental payments, may require the payment of
percentage rents based on hotel revenues, a share of maintenance expenses and/
or real estate taxes.
Total rent expense incurred under the Company's leases was as follows (in
thousands):
Years ended December 31,
-----------------------------------------
1996 1997 1998
- - -----------------------------------------------------------------------
Hotel and ground leases:
Base rent $ 35,776 $ 63,452 $ 64,956
Percentage rent 40,121 57,786 64,957
Other leases 2,814 3,954 3,737
- - -----------------------------------------------------------------------
Total $ 78,711 $ 125,192 $ 133,650
- - -----------------------------------------------------------------------
The following is a schedule of future minimum rental payments required
under Promus' noncancelable operating leases for years ending December 31, as
follows (in thousands):
- - ---------------------------------------------------------
1999 $ 56,899
2000 50,336
2001 49,819
2002 49,768
2003 49,099
Thereafter 189,372
- - ---------------------------------------------------------
Total future minimum lease payments $ 445,293
- - ---------------------------------------------------------
23
NOTE 8--NOTES PAYABLE
Promus' indebtedness consists of the following (in thousands):
December 31,
--------------------------------------
1997 1998
- - ------------------------------------------------------------------------------
Promus Facility $ 607,050 $ 634,250
Mortgages, 6.9%-8.6%, maturities
through 2008 85,037 95,660
Convertible rate term loan 20,000 20,000
Notes payable and other unsecured
debt, 6.0%-13.0%, maturities
through 2022 5,911 20,778
- - ------------------------------------------------------------------------------
717,998 770,688
Current portion of notes payable (46,020) (1,797)
- - ------------------------------------------------------------------------------
$ 671,978 $ 768,891
- - ------------------------------------------------------------------------------
In the third quarter of 1998, a consolidated joint venture of the Company
refinanced its debt. At December 31, 1997, the debt outstanding was $45 million
and was included in the current portion of notes payable.
Annual maturities of long-term debt are: 1999, $1.8 million; 2000, $1.9
million; 2001, $2.1 million; 2002, $707.1 million; 2003, $1.3 million; and $56.5
million, thereafter.
Promus Facility
Concurrent with the Merger, Promus entered into a revolving credit facility
(the Promus Facility), under which it borrowed $592.0 million on December 19,
1997. These funds were used to repay the existing bank facilities of both
Doubletree and PHC. The Promus Facility consists of a $750.0 million revolving
credit facility which is scheduled to mature on December 19, 2002 (the Five-
Year Revolver) and a $250.0 million annually extendible revolving credit
facility (the Extendible Revolver) which matured on December 18, 1998. On
December 18, 1998, the Extendible Revolver was extended through December 17,
1999, and the borrowing capacity was changed from $250.0 million to $209.6
million. The Extendible Revolver is convertible into a four-year term loan with
equal amortizing payments over the four-year period.
Interest on the drawn portion of the Promus Facility is, at the Company's
option, equal to either (i) the base rate, as defined, or (ii) LIBOR plus the
applicable spread. Both agreements incorporate a tiered scale that defines the
applicable LIBOR spread and a facility fee based upon the more favorable of the
Company's current debt rating or leverage ratio, as defined. At December 31,
1998, the LIBOR spread on the Five-Year Revolver and the Extendible Revolver was
reduced to 0.225% and 0.25%, respectively, from 0.25% and 0.27%, respectively,
at December 31, 1997. The facility fee required on the total amount of both the
Five-Year Revolver and the Extendible Revolver was 0.1% at December 31, 1998,
compared to 0.125% and 0.105%, respectively, at December 31, 1997. Additionally,
the Extendible Revolver incorporates a tiered scale of additional usage fees
that apply when at least 25% of the Extendible Revolver is used. The fee begins
at 0.1% for borrowings of 25% to 49% and increases 0.1% for each additional 25%
borrowed to a maximum of 0.3% for the use of the entire $209.6 million of the
Extendible Revolver.
At December 31, 1997 and 1998, the weighted average interest rate on
outstanding Promus Facility borrowings, including the applicable LIBOR spread,
was 6.6% and 6.2%, respectively. Both the Five-Year Revolver and the Extendible
Revolver are unsecured. The Promus Facility contains provisions that restrict
certain investments, limit the Company's ability to dispose of property and
require that certain performance ratios be maintained. As of December 31, 1997
and 1998, Promus was in compliance with all such covenants.
The Five-Year Revolver also provides a sublimit for letters of credit of
$100.0 million. At December 31, 1997 and 1998, approximately $16.0 million and
$47.8 million, respectively, in letters of credit were outstanding under this
agreement.
Convertible Rate Term Loan
This $20.0 million loan is unsecured and bears interest until October 28,
1999 at the three-month LIBOR rate minus 15 basis points (5.7% and 5.1% at
December 31, 1997 and 1998, respectively). Thereafter, the rate changes to a
fixed rate of 6.71%. The bank may elect to convert this fixed rate to the
three-month LIBOR rate plus 32.5 basis points, under a conversion option that is
exercisable annually beginning on October 28, 1999. The loan matures on October
28, 2002.
Derivative Financial Instruments
Promus' use of derivative financial instruments is limited to the
management of its interest rate exposure. The Company maintains interest rate
swap agreements which exchange floating interest payments for fixed interest
payments over the life of the agreements. Existing swap agreements, with an
aggregate notional amount of $376.6 million, expire between January 1999 and
January 2002, and as of December 31, 1997 and 1998, carried a weighted average
fixed rate of approximately 6.1% and 6.2%, respectively, and a weighted average
effective rate of 6.7% and 6.5%, respectively, (including the applicable
spreads). The differential to be paid or received is accrued as interest rates
change and is recognized as an adjustment to interest expense. At December 31,
1997 and 1998, the fair value of the swap agreements, which Promus would have
been required to pay to terminate them, was approximately $2.1 and $3.6 million,
respectively.
These agreements contain a credit risk that the counterparties may be
unable to meet the terms of the agreements. Promus minimizes that risk by
evaluating the creditworthiness of its counterparties, which are limited to
major banks and financial institutions, and does not anticipate nonperformance
by the counterparties.
NOTE 9--STOCKHOLDERS' EQUITY
One special right (Right) is attached to each outstanding share of common
stock. These Rights entitle the holders to purchase, under certain conditions,
units consisting of fractional shares of preferred stock at an exercise price to
be determined by Promus' Board of Directors. Under certain conditions, the
Rights also entitle the holders to purchase, at the Rights' then exercise price,
new shares of common stock having a market value of twice the Rights' exercise
price. These Rights expire on December 17, 2007, unless Promus decides to redeem
them earlier at $0.01 per Right or upon the occurrence of certain other events.
In April 1997, PHC's Board of Directors authorized PHC to repurchase up to
$150.0 million of its common stock pursuant to which PHC repurchased 1,573,800
shares at a cost of $60.0 million. All shares repurchased have been retired and
are not available for reissuance. As a result of the Merger of PHC into Promus,
the Company terminated this share repurchase program.
In August 1998, Promus' Board of Directors authorized the Company to
repurchase up to $200.0 million of its common stock for cash. The authorization
allows the Company to conduct the repurchase program in the open market, or in
negotiated or block transactions at prevailing market prices until December 31,
1999. Through December 31, 1998, the Company had repurchased 3,620,000 shares of
its common stock at a total cost of approximately $117.6 million.
In addition to its common stock, the Company has 10,000,000 shares of
authorized but unissued preferred stock, with a $0.01 par value.
24
NOTE 10--EARNINGS PER SHARE
The following table reflects Promus' weighted average common shares
outstanding and the impact of its dilutive common share equivalents (in
thousands):
Years ended December 31,
---------------------------------------
1996 1997 1998
- - ---------------------------------------------------------------------------
Basic weighted average shares
outstanding 72,581 86,573 86,178
Effect of dilutive securities:
Restricted stock 14 15 --
Stock options and warrants 984 1,316 586
- - ---------------------------------------------------------------------------
Diluted weighted average shares
outstanding 73,579 87,904 86,764
- - ---------------------------------------------------------------------------
Options to purchase approximately 792,000, 54,000 and 4,736,466 shares of
common stock were outstanding at December 31, 1996, 1997 and 1998, respectively,
but were not included in the above computations of diluted weighted average
outstanding shares because the options' exercise prices were greater than the
average market price of the common shares.
NOTE 11--TRANSACTIONS WITH RELATED PARTIES
Revenues and expenses include amounts derived from or paid to entities in
which affiliates of the Company own interests and, in general, exercise
operational control. A summary of these transactions is as follows (in
thousands):
Years ended December 31,
--------------------------------------
1996 1997 1998
- - --------------------------------------------------------------------------
Revenues
Franchise and management fees $ 11,198 $ 12,925 $ 13,588
Interest income 881 1,192 1,244
Purchasing and service fees 279 383 807
Expenses
Hotel rent 4,123 5,407 6,204
- - --------------------------------------------------------------------------
Amounts due from affiliates included in accounts receivable at December 31,
1997 and 1998 were $4.1 million and $1.0 million, respectively. Notes receivable
include amounts due from affiliates at December 31, 1997 and 1998 of $6.0
million and $4.7 million, respectively.
NOTE 12--COMMITMENTS AND CONTINGENCIES
Promus is liable under certain lease agreements pursuant to which it has
assigned the direct obligation to third party interests. Additionally, Promus
manages certain hotels for others under agreements that provide for payments or
loans to the hotel owners if stipulated levels of financial performance are not
maintained. The Company has also provided guarantees for certain loans and
leases related to joint venture investments. Management believes the likelihood
is remote that material payments will be required under these agreements.
Promus' estimated maximum exposure under such agreements is approximately $41.0
million over the next 30 years. Promus also has construction commitments
pursuant to development agreements, other than those specifically discussed
below, of approximately $12.0 million.
FelCor Agreements
On May 1, 1998, Promus announced an agreement with FelCor under which
Promus will manage five Embassy Suites hotels and one Doubletree hotel that were
purchased by FelCor. These hotels, all of which were previously franchised
properties, will operate under 20-year license agreements and 10- year
management contracts. Under the terms of this agreement, Promus has guaranteed
payment of 12.5% of the first year's rent to the lessee.
In connection with its FelCor agreements, Promus has guaranteed repayment
of a third party loan to FelCor of up to $25.0 million. During 1997, Promus
announced the formation of a new strategic alliance with FelCor, under which
Promus committed to construct at least five Embassy Suites hotel properties.
Upon completion of these developments, FelCor will purchase a 90% interest in
the properties. As part of this new alliance, Promus sold two company owned
Embassy Suites hotels to FelCor in 1997 for approximately $46.7 million. Promus
will receive 20-year license agreements and 15-year management contracts for all
hotels developed pursuant to this agreement. In 1997, FelCor also purchased two
Embassy Suites hotels from a joint venture in which Promus owned a 50% interest.
FelCor owns or has an interest in 76 Promus hotels as of December 31, 1998,
which represents 5.7% and 9.4% of all Promus brand hotels and hotel rooms,
respectively. These hotels contributed approximately 16% of the Company's
franchise and management fee revenue for 1998. Of these 76 hotels, the Company
owns a 50% interest in 12 hotels.
Promus Acceptance Corp.
Promus Acceptance Corp. (ProMAC), a third party lending entity, provides
first mortgage financing to Promus franchisees for newly constructed Hampton
Inn, Hampton Inn & Suites, Homewood Suites and Embassy Suites hotels. ProMAC
will be able to issue up to an aggregate of $152.5 million in commercial paper
backed by a liquidity facility from participating financial institutions. The
terms generally provide for favorably priced floating and fixed rate loans
ranging from $3.0 million to $12.0 million with six-year terms and 20-year
amortization schedules. Promus has provided a guarantee up to $36.0 million and
can increase the guarantee to $45.8 million on loans outstanding under the
program, and has also provided a $1.0 million working capital guarantee to
ProMAC. Additionally, Promus has provided a $2.0 million start-up loan to
ProMAC, which earns interest at Prime and matures in April 2005.
Candlewood
A subsidiary of the Company has committed to provide credit support for a
loan facility utilized by Candlewood to provide construction and permanent
financing to Candlewood and its franchisees on terms that, in most cases, are
more attractive than those which could otherwise be obtained. The Company's
maximum exposure on any individual loan will range from $0.9 million to $1.9
million per hotel, with the aggregate amount of exposure for all such credit
support capped at $30.0 million. As of December 31, 1998, the Company has
guaranteed $12.0 million in such financing.
Litigation
The Company is party to various inquiries, administrative proceedings and
litigation relating to contracts, sales of property and other matters arising in
the normal course of business. While any proceeding or litigation has an element
of uncertainty and could have a material impact on quarterly or annual results
of operations, management believes that the final outcome of these matters will
not have a material impact on Promus' consolidated financial position.
Self-Insurance Reserves
Promus self-insures various levels of general liability, workers'
compensation and employee medical coverage. All self-insurance reserves include
accruals of estimated settlements for known claims, as well as accruals of
actuarial estimates of incurred but not reported claims. These estimates are
based on historical information along with certain assumptions about future
events. Though changes in assumptions for such things as medical costs and legal
expenses, as well as changes in actual experience, could cause these estimates
to change significantly in the near term, the Company maintains stop-loss
insurance to minimize the effect of large claims on its financial results.
25
NOTE 13--EMPLOYEE BENEFIT PLANS
Retirement Savings Plans
Promus and its subsidiaries maintain three defined contribution savings and
retirement plans. Employees who are over 21 years of age and have completed one
year of service are eligible to participate in the plans. Depending on the plan,
participating employees may elect to make pre-tax and after-tax contributions of
up to 16% of their eligible earnings and the Company matches employee
contributions up to 6% of an employee's eligible compensation. Amounts
contributed to the plans are invested in one or more investment funds, at the
participant's option.
The Company also has two nonqualified supplemental employee retirement
plans (SERP). One SERP was designed to supplement key employees whose benefits
would otherwise be reduced or lost due to the statutory limits of 401(k) plans.
This plan is fully funded. The second plan was designed to supplement retirement
income for certain executive officers of the Company. The liability under this
plan at December 31, 1998 was $4.1 million.
The aggregate expense to the Company under all retirement savings plans
amounted to $2.0 million, $4.5 million and $3.1 million for the years ended
December 31, 1996, 1997 and 1998, respectively.
Deferred Compensation Plans
Promus has deferred compensation plans under which certain employees may
defer a portion of their compensation. Amounts deposited into these plans are
unsecured and earn interest at rates approved by the Human Resources Committee
of the Board of Directors. In connection with the administration of the deferred
compensation plans, company-owned life insurance policies have been purchased.
As of December 31, 1997 and 1998, the total liability under these plans was
$14.5 million and $18.5 million, respectively, and the related value of life
insurance policies and other investments was $18.0 million and $19.4 million,
respectively.
NOTE 14--STOCK OPTIONS
The 1997 Equity Participation Plan (the Plan) is a new stock option plan,
approved in conjunction with the Merger, in which options may be granted to key
personnel to purchase shares of the Company's stock at a price not less than the
current market price at the date of grant. The options vest annually and ratably
over a four-year period from the date of grant and expire ten years after the
grant date. An aggregate of 10,000,000 shares have been authorized for issuance.
The Plan also provides for the issuance of stock appreciation rights, restricted
stock or other awards.
Additionally, both PHC and Doubletree had stock option plans prior to the
Merger date. Concurrent with the Merger, options were issued by Promus to
replace PHC options and Doubletree options which were outstanding under the
prior plans. The replacement options were issued with identical remaining terms
and conditions, except such options were immediately vested, in accordance with
the terms of the prior plans.
Promus applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
stock option plans. Accordingly, no compensation cost has been recognized in the
consolidated statements of operations for these plans. In accordance with SFAS
No. 123, "Accounting for Stock-Based Compensation," the Company has estimated
the fair value of each option grant using the Black-Scholes option- pricing
model. Had compensation cost for awards under the Plan and each predecessor plan
been determined based on the fair value at the grant dates, Promus' net income
and earnings per share would have been reduced to the pro forma amounts
indicated below (in thousands, except earnings per share):
1996 1997 1998
- - --------------------------------------------------------------------------
Net income
As reported $ 90,658 $ 95,436 $ 154,088
Pro forma 85,184 86,544 135,205
Basic earnings per share
As reported $ 1.25 $ 1.10 $ 1.79
Pro forma 1.17 1.00 1.57
Diluted earnings per share
As reported $ 1.23 $ 1.09 $ 1.78
Pro forma 1.16 0.98 1.56
- - --------------------------------------------------------------------------
26
A summary of Promus stock option transactions, from January 1, 1996 through
December 31, 1998, are as follows:
Options Outstanding
-----------------------------
Weighted Common
Average Stock
Exercise Available
Price Number for Grant
- - ------------------------------------------------------------------------------
Balance--January 1, 1996 $ 18.78 2,872,151 3,725,743
Granted 34.27 2,333,230 (2,333,230)
Exercised 13.83 (89,206) --
Canceled 22.91 (167,386) 167,386
- - ------------------------------------------------------------------------------
Balance--December 31, 1996 26.03 4,948,789 1,559,899
Approval of new options -- -- 11,200,000
Granted 39.91 4,503,369 (4,503,369)
Exercised 16.52 (410,851) --
Canceled 27.02 (160,334) (1,769,530)
- - ------------------------------------------------------------------------------
Balance--December 31, 1997 33.49 8,880,973 6,487,000
Approval of new options
Granted 31.73 3,551,135 (3,551,135)
Exercised 24.30 (1,331,550) --
Canceled 38.85 (461,308) 461,308
- - ------------------------------------------------------------------------------
Balance--December 31, 1998 $ 34.12 10,639,250 3,397,173
- - ------------------------------------------------------------------------------
Options exercisable at
December 31,
1997 $ 29.44 5,367,973
1998 32.47 5,099,125
- - ------------------------------------------------------------------------------
The weighted average fair value of options granted by Promus based on the
Black-Scholes option-pricing model for the options granted during 1996, 1997 and
1998 are $10.71, $19.47 and $16.02, respectively. Assumptions included risk-free
interest rates ranging from 5.9% to 6.2%, expected lives of 3.0 years to 6.0
years, volatility factors of 30% to 46%, and no dividends.
The following table summarizes information about options outstanding at
December 31, 1998:
Options Outstanding Options Exercisable
--------------------------------------------------------------- ---------------------------------------
Weighted Average Number
Number Outstanding Remaining Weighted Average Exercisable at Weighted Average
Range of at December 31, Contractual Exercise December 31, Exercise
Exercise Prices 1998 Life Price 1998 Price
- - ---------------------------------------------------------------------------------------------------------------------------------
$ 3.64 to $25.50 852,755 5.15 $ 14.35 852,755 $ 14.35
$26.55 to $34.73 4,648,726 8.90 31.09 1,649,476 29.93
$34.75 to $39.69 3,441,388 8.88 39.54 1,081,013 39.25
$40.13 to $50.00 1,696,381 8.26 41.37 1,515,881 40.60
- - ---------------------------------------------------------------------------------------------------------------------------------
10,639,250 8.49 $ 34.12 5,099,125 $ 32.47
- - ---------------------------------------------------------------------------------------------------------------------------------
NOTE 15--INCOME TAXES
Income tax expense attributable to income before extraordinary items
consisted of the following (in thousands):
1996 1997 1998
- - -----------------------------------------------------------------------
Current
Federal $ 40,535 $ 79,559 $ 85,787
State 9,085 16,843 13,373
Deferred
Federal 8,612 (13,410) 15,582
State 894 (3,328) 839
- - -----------------------------------------------------------------------
$ 59,126 $ 79,664 $ 115,581
- - -----------------------------------------------------------------------
27
The differences between the statutory federal income tax rate and the
effective tax rate expressed as a percentage of income before income taxes and
extraordinary items were as follows:
1996 1997 1998
- - ------------------------------------------------------------------------------
Income tax expense at federal
statutory rate 35.0% 35.0% 35.0%
Business combination expenses -- 6.6% 3.1%
State taxes, net of federal tax
benefit 4.0% 4.3% 3.3%
Goodwill and other permanent
differences 0.6% 2.2% 1.6%
Tax reserve reduction (1.7)% (2.8)% --%
Other 1.6% 0.2% (0.1)%
- - -------------------------------------------------------------------------------
39.5% 45.5% 42.9%
- - -------------------------------------------------------------------------------
As a result of the acquisition of the common stock of Red Lion and
Harrison, the allocation of the purchase price to the assets and liabilities for
financial reporting purposes significantly exceeds the tax basis carried over
from Red Lion and Harrison. Accordingly, the acquisitions created nondeductible
goodwill and substantial temporary differences. The tax effects of temporary
differences that give rise to significant portions of the deferred tax assets
and liabilities are as follows (in thousands):
1997 1998
- - -----------------------------------------------------------------------------
Deferred tax assets:
Net operating loss
carryforwards $ 4,181 $ 3,562
Compensation 22,280 25,627
Deferred income 3,102 2,997
Business combination expenses 11,287 12,592
Reserves 7,137 5,748
Other 1,210 531
Valuation allowance (3,781) (3,562)
- - -----------------------------------------------------------------------------
Total deferred tax assets 45,416 47,495
- - -----------------------------------------------------------------------------
Deferred tax liabilities:
Basis difference in other
assets (167,637) (168,567)
Property and equipment (101,736) (119,313)
Investments (29,313) (19,330)
Franchise system fund
prepayments (3,338) (1,929)
- - -----------------------------------------------------------------------------
Total deferred tax
liabilities (302,024) (309,139)
- - -----------------------------------------------------------------------------
Net deferred tax liability $ (256,608) $ (261,644)
- - -----------------------------------------------------------------------------
28
The Company estimates that, more likely than not, it will not realize a
portion of the benefits of its deferred tax assets. Accordingly, it has
established a valuation allowance to reflect this uncertainty. The valuation
allowance was established as a result of deferred tax assets created by previous
business combinations in accordance with purchase accounting methodology and, to
the extent the tax benefits to which this allowance relates are recognized, the
reduction in the valuation allowance will be applied to reduce goodwill. During
1996, 1997 and 1998, $0.5 million, $1.6 million and $0.2 million was used and
credited to goodwill, respectively.
The Company's federal net operating loss carryforwards (NOLs) of $10.2
million expire as follows (in thousands):
Year of Expiration Amount of Federal NOLs
- - ------------------------------------------------------------
2005 $ 9,210
2008 968
- - ------------------------------------------------------------
Total NOLs for state income tax purposes are less than the amounts stated
above due primarily to shorter carryforward periods.
Tax Sharing Agreement
POC and Harrah's Entertainment, Inc. (Harrah's) are parties to a tax
sharing agreement that defines each company's rights and obligations with
respect to deficiencies and refunds of federal, state and other income or
franchise taxes relating to POC's business for tax years ending on or before
December 31, 1995, and with respect to certain tax attributes of POC after June
30, 1995. POC will reimburse Harrah's for the portion of subsequent tax
liability redeterminations relating to Harrah's hotel operations.
NOTE 16--DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
Other current assets consist of the following (in thousands):
1997 1998
- - ----------------------------------------------------------------------------
Federal and state income tax
receivables $ 17,361 $ 7,502
Prepayments 9,507 12,686
Deferred tax assets 8,251 14,854
Other 8,103 9,443
- - -----------------------------------------------------------------------------
$ 43,222 $ 44,485
- - -----------------------------------------------------------------------------
Accounts payable and accrued expenses consist of the following (in
thousands):
1997 1998
- - ----------------------------------------------------------------------------
Business combination accruals $ 65,789 $ 37,690
Self-insurance reserves 31,654 27,789
Accounts payable 31,404 19,875
Accrued payroll and other
compensation 31,275 29,692
Operating leases payable 12,146 13,382
Refundable deposits and customer
funds 10,845 5,663
Taxes payable, other than income
taxes 10,495 7,887
Other 27,316 38,211
- - -----------------------------------------------------------------------------
$ 220,924 $ 180,189
- - -----------------------------------------------------------------------------
NOTE 17--SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest, net of interest capitalized, amounted to $22.9
million, $56.2 million, and $50.9 million for the years ended December 31, 1996,
1997 and 1998, respectively. Cash paid for income taxes amounted to $62.0
million, $100.5 million and $78.1 million for the years ended December 31, 1996,
1997 and 1998, respectively.
NOTE 18--SUMMARIZED FINANCIAL INFORMATION
Promus Hotels, Inc. (PHI) is a wholly-owned subsidiary of PHC and an entity
through which a significant portion of the operations of Promus are conducted.
Among other things, PHI holds the franchise license for many of the Company's
franchised hotels. Summarized financial information for PHI, prepared on the
same basis as Promus, as of and for the years ended December 31, is as follows
(in thousands):
1996 1997 1998
- - ------------------------------------------------------------------------------
ASSETS
Current assets $ 43,695 $ 36,737
Property and equipment, net 336,553 426,406
Other assets 329,728 409,404
- - ------------------------------------------------------------------------------
$ 709,976 $ 872,547
- - ------------------------------------------------------------------------------
LIABILITIES
Current liabilities $ 73,522 $ 86,412
Notes payable 218,581 242,883
Other long-term obligations 91,524 118,466
- - ------------------------------------------------------------------------------
383,627 447,761
- - ------------------------------------------------------------------------------
Net assets $ 326,349 $ 424,786
- - ------------------------------------------------------------------------------
Revenues $ 266,625 $ 289,905 $ 315,637
- - ------------------------------------------------------------------------------
Operating income $ 129,496 $ 104,079 $ 166,491
- - ------------------------------------------------------------------------------
Net income $ 65,124 $ 73,698 $ 93,196
- - ------------------------------------------------------------------------------
29
NOTE 19--SEGMENT REPORTING
On January 1, 1998, the Company adopted the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." Under
SFAS No. 131, the Company has one operating segment, lodging, which is managed
as one business unit. The accounting policies of the segment are the same as
those described in the summary of significant accounting policies. The Company
does not record taxes at the segment level.
The following table presents the revenues, operating profit and assets of
the Company's reportable segment for the years ended December 31, (in
thousands):
1996 1997 1998
- - ------------------------------------------------------------------------------
Revenues
Lodging $ 544,553 $ 1,016,511 $ 1,074,541
Other (a) 15,660 21,500 32,748
- - ------------------------------------------------------------------------------
560,213 1,038,011 1,107,289
- - ------------------------------------------------------------------------------
Operating profit (b)
Lodging $ 219,731 $ 365,609 $ 389,982
Other 8,263 12,542 21,887
- - ------------------------------------------------------------------------------
227,994 378,151 411,869
- - ------------------------------------------------------------------------------
Depreciation and
amortization
Lodging $ 31,180 $ 61,217 $ 67,960
Corporate 5,096 11,910 11,294
- - ------------------------------------------------------------------------------
36,276 73,127 79,254
- - ------------------------------------------------------------------------------
Segment assets
Lodging $ 1,939,091 $ 1,707,362 $ 1,856,700
Other 9,731 34,330 45,646
Corporate 414,092 637,353 571,655
- - ------------------------------------------------------------------------------
2,362,914 2,379,045 2,474,001
- - ------------------------------------------------------------------------------
Capital expenditures (c)
Lodging $ 41,389 $ 139,258 $ 143,327
Other -- -- --
Corporate 18,888 16,730 9,965
- - ------------------------------------------------------------------------------
60,277 155,988 153,292
- - ------------------------------------------------------------------------------
(a) Other revenues are derived from Promus Vacation Resorts and Promus'
purchasing subsidiary.
(b) Operating profit excludes corporate and business combination expenses,
interest and gain on sale of real estate and securities.
(c) Capital expenditures do not include the purchases of Red Lion in 1996 or
Harrison in 1998.
The Company does not record gains on the sales of real estate and
securities, interest and dividend income, or interest expense at the segment
level; therefore, segment assets do not include investments or notes receivable.
30
NOTE 20--QUARTERLY RESULTS OF OPERATIONS
(Unaudited)
------------------------------------------------
(In thousands, except per First Second Third Fourth
share amounts) Quarter Quarter Quarter Quarter
- - --------------------------------------------------------------------------------
1998
Revenues $ 254,543 $ 290,727 $ 296,227 $ 265,792
Operating income 69,903 94,430 89,774 49,268
Net income 36,016 52,189 51,829 14,054
Basic earnings per share (a) $ 0.42 $ 0.60 $ 0.60 $ 0.17
Basic weighted average shares
outstanding 86,415 87,202 86,552 84,882
Diluted earnings per share (a) $ 0.41 $ 0.59 $ 0.60 $ 0.16
Diluted weighted average shares
outstanding 87,639 88,137 86,999 85,214
- - --------------------------------------------------------------------------------
1997
Revenues $ 259,486 $ 260,065 $ 274,715 $ 243,745
Operating income (loss) 74,821 70,121 89,358 (50,398)
Net income (loss) 38,902 47,376 56,257 (47,099)
Basic earnings (loss) per
share (a) $ 0.45 $ 0.55 $ 0.65 $ (0.55)
Basic weighted average shares
outstanding 87,097 86,916 86,206 86,050
Diluted earnings (loss) per
share (a) $ 0.44 $ 0.54 $ 0.64 $ (0.54)
Diluted weighted average shares
outstanding 88,420 88,225 87,939 87,620
- - --------------------------------------------------------------------------------
1996
Revenues $ 113,787 $ 129,994 $ 138,921 $ 177,511
Operating income 33,768 42,388 48,201 40,999
Net income 17,627 25,685 27,712 19,634
Basic earnings per share (a) $ 0.25 $ 0.37 $ 0.39 $ 0.25
Basic weighted average shares
outstanding 69,581 70,087 70,588 80,086
Diluted earnings per share (a) $ 0.25 $ 0.36 $ 0.39 $ 0.24
Diluted weighted average shares
outstanding 70,293 70,982 71,713 81,412
- - --------------------------------------------------------------------------------
(a) The sum of the quarterly per share amounts may not equal the annual amount
reported, as per share amounts are computed independently for each quarter
while the full year is based on the annual weighted average shares
outstanding.
31
MANAGEMENT'S REPORT ON FINANCIAL STATEMENTS
Promus is responsible for preparing the financial statements and related
information appearing in this report. Management believes that the financial
statements present fairly its financial position, results of operations and cash
flows in conformity with generally accepted accounting principles. In preparing
its financial statements, Promus is required to include amounts based on
estimates and judgments which it believes are reasonable under the
circumstances.
Promus maintains accounting and other control systems designed to provide
reasonable assurance that financial records are reliable for purposes of
preparing financial statements and that assets are properly accounted for and
safeguarded. Compliance with these systems and controls is reviewed through a
program of audits by an internal auditing staff. Limitations exist in any
internal control system, recognizing that the system's cost should not exceed
the benefits derived.
The Board of Directors pursues its responsibility for Promus' financial
statements through its Audit Committee, which is composed solely of directors
who are not officers or employees of Promus. The Audit Committee meets from time
to time with the independent public accountants, management and the internal
auditors. Promus' internal auditors report directly to, and the independent
public accountants have access to, the Audit Committee, with and without the
presence of management representatives.
/s/ Norman P. Blake, Jr.
Norman P. Blake, Jr.
Chairman of the Board, President & Chief Executive Officer
/s/ Dan L. Hale
Dan L. Hale
Executive Vice President & Chief Financial Officer
32
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Promus Hotel Corporation:
We have audited the accompanying consolidated balance sheets of Promus
Hotel Corporation (a Delaware corporation) and subsidiaries (Promus) as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years
ended December 31, 1998. These financial statements are the responsibility of
Promus' management. Our responsibility is to express an opinion on these
financial statements based on our audits. These financial statements include the
financial position and results of operations of Doubletree Corporation
(Doubletree), pursuant to a merger of Doubletree and Promus effective December
19, 1997. As discussed in Note 1, this merger was accounted for as a
pooling-of-interests, and the financial position and results of operations for
Promus and Doubletree have been combined for the years ended December 31, 1997
and 1996. We have not audited the financial statements of Doubletree for the
year ended December 31, 1996. Those statements were audited by other auditors
whose report, dated March 17, 1997, was furnished to us and our opinion, insofar
as it relates to amounts included for Doubletree, is based solely upon the
report of the other auditors. The financial statements of Doubletree for the
year ended December 31, 1996, audited by other auditors, represent 52 percent of
total consolidated revenues for the year ended December 31, 1996.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the financial statements referred to above present fairly, in all material
respects, the financial position of Promus Hotel Corporation and subsidiaries as
of December 31, 1998 and 1997, and the results of its operations and its cash
flows for each of the three years ended December 31, 1998, in conformity with
generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Memphis, Tennessee,
February 12, 1999.