ITEM 1. BUSINESS
General
Servico, Inc., its wholly-owned subsidiaries and consolidated partnerships (collectively, the "Company") is one of the leading hotel companies in the United States. At December 31, 1996, the Company had ownership interests in 57 hotels containing 11,059 rooms and managed four additional hotels for third parties. These 61 hotels, located in 22 states, contain a total of 11,979 rooms and substantially all of the hotels are "full service" properties offering lodging, food, beverage and meeting facilities. At December 31, 1996, the Company was the largest franchisee of Holiday Inns in the United States.
The Company's business strategy is to seek to maximize the value and income potential of its wholly owned, partially owned and third party managed hotels through increases in occupancy, room rate and food and beverage revenues. Additionally, the Company seeks to pursue growth of its operations through the identification and acquisition of properties where there is a significant opportunity for potential growth. The Company has historically achieved growth by repositioning its hotel properties through operational improvements, renovation of physical facilities and changes in franchise affiliations.
During the period from 1991 through 1994, the Company devoted significant resources and efforts to renovating and repositioning its existing hotel properties. Approximately $6,700 per room was spent on hotel renovations and upgrading of hotel operating systems and equipment. Fourteen of the Company's hotels underwent changes in franchise affiliations to enhance their competitive position in their respective markets. These efforts resulted in hotels with increased room revenue per available room ("RevPAR"), while increasing the desirability of the hotels to potential guests.
Having stabilized its core base of hotels (the "Stabilized Hotels"), the Company embarked on an aggressive program of external growth through the acquisition, repositioning and renovation of additional hotel properties (the "Reposition Hotels"). Since August 1993, the Company has acquired ownership interests in 29 additional hotel properties. The following table sets forth information concerning the acquisition of ownership interests in hotels during 1995 and 1996:
The Company purchased 15 hotels and purchased majority partnership interests in 9 hotels during 1995 and 1996. The average purchase price of these hotels was $32,940 per room and the Company expects to spend approximately $7,100 per room in renovations and capital assets for a total cost per room of $40,040. The Company believes this cost per room is significantly below replacement cost, which the Company estimates to be between $75,000 and $90,000 per room for new construction of hotels with similar facilities in the respective markets. The Company recognizes that, although contributing to the Company's earnings before interest, taxes, depreciation and amortization ("EBITDA") and net income, during the repositioning period (generally 12 to 36 months) hotels will usually experience lower operating results such as RevPAR and profit margins.
The following table displays key hospitality performance measures for 1994, 1995 and 1996 for both the Stabilized Hotels and Reposition Hotels included in the Company's consolidated financial statements:
(a) Excludes a 240 room hotel in which the Company has a minority ownership interest.
For the year ended December 31, 1996, the operating performance of the Stabilized Hotels improved significantly, as demonstrated by a 5.5% increase in revenues, a 20.0% increase in net operating income and a 6.1% increase in RevPAR over the comparable prior year period. The operating performance at all of the Company's hotels during the same period does not reflect the same significant increases primarily because of the lower operating results of the Reposition Hotels. Management believes that the Reposition Hotels were acquired at attractive prices and represent significant opportunities for improved operating results in the future.
The Company is in the process of repositioning and renovating the Reposition Hotels based on strategic plans designed to address the opportunities presented by each hotel and the hotel's particular market. Renovations are chosen based on anticipated returns on investment. These renovations include enhancing lobbies, restaurants and public areas, upgrading guest rooms and converting unprofitable lounge areas to meeting rooms to accommodate the needs of business travelers. In certain instances, hotel properties are reflagged with different franchise brands to further identify the improved property to the community.
As a fully integrated owner and manager, Servico seeks to capitalize on its management experience and expertise by continuing to acquire underperforming full service hotels and improving the operating performance of hotels after acquisition. The Company's management team has successfully managed hotels in all segments of the hotel industry. Management believes that the Company's past success and future performance depend on its ability (i) to identify underperforming hotels and quickly implement successful turnaround plans; (ii) to develop and implement marketing plans that particularly position each hotel property within its local market and (iii) to develop management plans that focus on guest satisfaction, revenue yield, cost control and labor productivity. The Company's management culture stresses entrepreneurship and creativity.
Franchise Affiliations
In recent years, operators of hotels not owned or managed by major lodging companies have affiliated their hotels with national hotel franchisors as a means of remaining competitive with hotels owned by or affiliated with national lodging companies. Franchisors provide a number of services to hotel operators which can positively contribute to the improved financial performance of their properties, including national reservation systems, marketing and advertising programs and direct sales programs. The Company believes that hotel franchisors with larger numbers of hotels enjoy greater brand awareness among potential hotel guests than those with fewer numbers of hotels. Hotels typically operate with high fixed costs, and increases in revenues generated by affiliation with a national franchisor can, at times, contribute positively to a hotel's financial performance. As reported by Smith Travel Research, approximately 930 hotel properties changed their affiliation in 1995, the latest date such information was available. 77% of these affiliation changes converted from independent status to affiliation with a national franchisor or converted from one national franchisor to another, while only 23% canceled or were required to cancel their franchise affiliation.
At December 31, 1996, all of the Company's owned or managed hotels were affiliated with national hotel franchises, including Holiday Inn, Best Western, Clarion, Crowne Plaza, Days Inn, Embassy Suites, Hampton Inn, Hilton, Howard Johnson, Omni, Quality Inn, Radisson, Sheraton and Westin as set forth in the following table:
The Company's license agreements with the national hotel franchises typically authorize the operation of a hotel under the licensed name, at a specific location or within a specific area, and require that the hotel be operated in accordance with standards specified by the licensor. The license agreements also permit the Company to utilize the licensor's reservation system. Generally, the license agreements require the Company to pay a royalty fee, an advertising/marketing fee, a fee for the use of the licensor's nationwide reservation system and certain ancillary charges. Royalty fees under the Company's various license agreements generally range from three percent to five percent of gross room revenues, while advertising/marketing fees provided for in the agreements generally are one and one half percent of gross room revenues and reservation system fees generally are one percent of gross room revenues. The license agreements are subject to cancellation in the event of a default, including the failure to operate the hotel in accordance with the quality standards and specifications of the licensor. The license agreements generally have an original ten year term, although certain license agreements provide for original 15 and 20 year terms. The majority of the Company's license agreements have five to nine years remaining on the term. The licensor may require the Company to upgrade its facilities at any time to comply with the licensor's then current standards. The licensee may apply for a license renewal as existing licenses expire. In connection with license renewals, the licensor may require payment of a renewal fee, increased royalty and other recurring fees and substantial renovation of the facility or the licensor may elect not to renew the license. It is the Company's policy to review individual property franchise affiliations at the time of property acquisition and, thereafter, on a regular basis. These reviews may result in changes in such affiliations.
Management Agreements
At December 31, 1996, the Company managed four hotels for third parties. All hotels managed for third parties are done so in accordance with written management agreements. These management agreements provide that the Company be paid a base fee calculated as a percentage of gross
revenues, and generally provide for an accounting services fee and an incentive management fee. The incentive fees are generally a percentage of gross operating profits exceeding negotiated amounts. All operating and other expenses are paid by the owner. The management agreements provide for original terms of from one to five years. Fees payable to the Company under the management agreements range from one and one half to three percent of gross sales, and accounting fees range from $1,600 to $2,500 per month.
One of the Company's hotels, the Westin William Penn Hotel located in Pittsburgh, Pennsylvania, is managed by an unaffiliated third party. The terms of this management agreement provide for the manager to receive the greater of a base fee of three percent of gross revenues or an incentive fee based on profits available for debt service. The agreement also provides for the Company to make funds available for capital improvements.
Hotel Operations
Each of the hotels owned or managed by the Company has its own on-site management and staff which are employed at the hotel level. These employees are, in turn, supervised by regional managers and the Company's senior management. The Company also has centralized corporate departments which support the on-site management in the following areas: accounting and finance, payroll, data processing and management information services, interior design, purchasing, food and beverage services, human resources, recruiting and training, corporate sales and marketing, legal, advertising, insurance and telecommunications.
The Company seeks to attract conventions, business meetings and other large groups to the Company's hotels. To this end, the Company maintains corporate sales and marketing departments, which, together with the regional managers assist the individual hotels in the solicitation, organization and planning of major guest functions.
Executive Officers
The Company believes it has a strong management team which is capable of leading the Company as it pursues its business strategy. Information regarding the executive officers of Servico at December 31, 1996, follows:
David Buddemeyer has been the Chief Executive Officer of Servico since December 1995, a director since April 1994 and its President since May 1993. Mr. Buddemeyer served as the Chief Operating Officer of the Company from May 1993 to December 1995 and its Executive Vice President from June 1990 to May 1993. Prior to such time, from 1987 to June 1990, he served as Vice President-Operations of Prime Motor Inns, Inc., a hotel management company.
Warren M. Knight has been Vice President-Finance of Servico and its Chief Financial Officer since December 1991. Prior to such time, from March 1988 to November 1991, Mr. Knight served as Director of Finance for W.A. Taylor & Co., an importer of distilled spirits into the United States.
Robert D. Ruffin has been Vice President-Administration of Servico since June 1991 and Secretary of Servico since January 1992. Mr. Ruffin joined Servico in November 1990, and, prior to such time, Mr. Ruffin was employed by Kendavis Holding Company for 29 years, and served as its Vice President-Industrial Relations from 1986 through 1990.
Peter J. Walz has been Vice President-Acquisitions of Servico since February 1996. Prior to such time, from December 1994 to January 1996, he was a consultant to the Company. From October 1993 to November 1994, Mr. Walz was an executive officer of Hospitality Investment Trust, Inc., a development stage lodging real estate investment trust. Prior to such time, from April 1987 to September 1993, Mr. Walz was Executive Vice President of CMS Development, Inc., a developer of office buildings, condominiums and hotels.
Financing Arrangements
Substantially all of the Company's hotels are subject to mortgage financing, which at December 31, 1996, totaled approximately $284 million. Approximately $24 million of the mortgage financing collateralized by the Company's hotels, and entered into by the various subsidiaries, is guaranteed by Servico, Inc. Servico, Inc.'s guarantees of mortgage financing generally provide for direct recourse by the lender against Servico, Inc., without requiring the lender to seek recourse against either the applicable subsidiary or the hotel property securing the mortgage financing. As a consequence, if payments under mortgage financing guaranteed by Servico, Inc. are not timely made, Servico, Inc. may be required to make payments in accordance with its guarantees.
In April 1996, the Company refinanced certain long-term obligations on twenty of its hotels. This transaction is more fully discussed in "Item 7. Liquidity and Capital Resources".
Competition and Seasonality
The hotel business is highly competitive. The demand for accommodations and the resulting cash flow vary seasonally. The off-season tends to be the winter months for properties located in colder weather climates and the summer months for properties located in warmer weather climates. Levels of demand are dependent upon many factors including general and local economic conditions and changes in levels of tourism and business-related travel. The Company's hotels depend upon both commercial and tourist travelers for revenues. Generally, the Company's hotels operate in areas that contain numerous other competitive lodging facilities, including hotels associated with franchisors which may have more extensive reservation networks than those which may be available to the Company. The Company competes with other facilities on various bases, including room prices, quality, service, location and amenities customarily offered to the traveling public.
Employees
At December 31, 1996, the Company had 4,249 full time and 2,272 part time employees. There are 79 full time employees and 2 part time employees of the Company engaged in administrative and executive activities and the balance of the Company's employees manage, operate and maintain the Company's properties. At December 31, 1996, 908 of the Company's full and part time employees located at four hotels were covered by collective bargaining agreements. Management considers its relations with its employees to be satisfactory.
Insurance
The Company maintains insurance covering liabilities for personal injuries and property damage. The Company also maintains, among other types of insurance coverage, real and personal property insurance, directors and officers liability insurance, liquor liability insurance, workers' compensation insurance, travel accident insurance for certain of its employees, fiduciary liability insurance and business automobile insurance. The Company believes it maintains sufficient insurance coverage for the operation of its business.
Regulation
The Company's hotels are subject to state and local regulations with respect to the sale of alcoholic beverages, and the Company must obtain and maintain various licenses and permits. All such licenses and permits must be periodically renewed and may be revoked or suspended for cause at any time. Certain of these licenses and permits are material to the Company's business and the loss of such licenses could have a material adverse effect on the Company's financial condition and results of operations. The Company is not aware of any reason why it should not be in a position to maintain its licenses. The Company is also subject in certain states to dramshop statutes, which may give an injured person the right to recover damages from any establishment which wrongfully served alcoholic beverages to the person who, while intoxicated, caused the injury. The Company believes that its insurance coverage with respect to any such liquor liability is adequate.
The Company is subject to certain federal and state labor laws and regulations such as minimum wage requirements, regulations relating to working conditions, laws restricting the employment of illegal aliens and the Americans with Disabilities Act. As a provider of restaurant services, the Company is also subject to certain federal, state and local health laws and regulations. The Company believes it complies with such laws and regulations in all material respects.
To date, federal and state environmental regulations have not had a material effect on the Company's operations. However, such laws potentially impose cleanup costs for hazardous waste contamination on property owners. If any material hazardous waste contamination problems do exist on any of the Company's properties, the Company may be exposed to liability for the costs associated with the cleanup of such sites.
Background
The Company's predecessor was incorporated in 1956 under the laws of the state of Delaware. From 1956 through 1990, the Company engaged in the ownership and operation of hotels under a series of different ownerships. In September 1990, the Company's predecessor filed for protection under Chapter 11 of the United States Bankruptcy Code. The Company emerged from reorganization proceedings in August 1992 and, in accordance with the Company's Plan of Reorganization, the Company's creditors were issued 7,000,000 shares of the Company's common stock.
ITEM 2.
ITEM 2. PROPERTIES
At December 31, 1996, the Company had ownership interests in 57 hotels containing 11,059 rooms. The Company's hotels generally target commercial, convention, association and vacation travelers as customers. Substantially all of the hotels are "full service" properties with lodging, food, beverage and meeting facilities, and are subject to financing as described in "Item 1. Financing Arrangements".
Set forth below is information regarding the Company's hotels at December 31, 1996:
(a) Partially owned hotels are owned by partnerships of which Company subsidiaries, in most instances, are the general partner. The Company's partially owned hotels consist of 30% ownership of one hotel containing 240 rooms, 50% ownership of four hotels containing 903 rooms and 51% ownership of nine hotels containing 1,966 rooms.
Four of the Company's hotels are located on land subject to long-term leases, and four are subject to leases covering the land and improvements. Three of the Company's hotels are leased with Industrial Revenue Bond financing from the municipalities in which they are located. Generally, the leases are for terms in excess of the depreciable lives of the improvements or contain a purchase option and provide for fixed rents. In certain instances, additional rents based on a percentage of revenue or cash flow may be payable. The leases generally require the Company to pay the cost of repairs, insurance and real estate taxes.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to legal proceedings arising in the ordinary course of its business, the impact of which would not, either individually or in the aggregate, in management's opinion, have a material adverse effect on the Company's financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the quarter ended December 31, 1996, no matter was submitted to a vote of the Company's shareholders through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Servico's common stock is listed on the American Stock Exchange and its trading symbol is SER. The following table sets forth the high and low sales prices for Servico's common stock on the American Stock Exchange on a quarterly basis for the past two years.
As of March 10, 1997, there were 3,040 shareholders of record of Servico's common stock.
The Company has not paid any cash dividends since its reorganization and has no current plans to initiate the payment of dividends. The Company currently anticipates that it will retain any future earnings for use in its business. The Board of Directors of the Company will determine future dividend policies based on the Company's financial condition, profitability, cash flow, capital requirements and business outlook, among other factors. There are no restrictions on the Company's ability to pay dividends.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Selected Consolidated Financial Data
The following table presents selected financial data derived from the Company's historical financial statements for the years ended December 31, 1993 through 1996. The Company changed its fiscal year from June 30 to December 31 during 1992, and in order to provide meaningful comparative data, unaudited 1992 financial data is being presented for the twelve months ended December 31.
This financial data should be read in conjunction with "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Occupancy levels, average daily rate and RevPAR are important hospitality performance measures. These performance measures for the Company's hotels are impacted by a variety of factors including national, regional and local economic conditions, the degree of competition with other hotels in the area and, in the case of occupancy levels, changes in travel patterns. The demand for accommodations is also affected by normally recurring seasonal patterns and most Company hotels experience lower occupancy levels in the fall and winter (November through February) which may result in lower revenues, lower net income and less cash flow during these months.
The discussion of results of operations, income taxes and liquidity and capital resources that follows is derived from the Company's Audited Consolidated Financial Statements set forth in "Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14 for a list of the Servico, Inc. Consolidated Financial Statements and Schedules filed as part of this report.
Supplementary Information-Quarterly Results of Operations.
The following table summarizes the unaudited quarterly financial data (in thousands, except share data):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
The information required in Item 10
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following are filed as part of this report:
(1) (2) Financial Statements
The financial statements, financial statement schedules and supplementary information listed in the accompanying Index to Financial Statements Covered by Report of Independent Certified Public Accountants.
(3) Exhibits
The exhibits listed in the accompanying Index to Exhibits.
(b) Reports on Form 8-K:
During the quarter ended December 31, 1996, the Company did not file any reports on Form 8-K.
Servico, Inc. and Subsidiaries
Covered by Report of Independent Certified Public Accountants [Item 14(a)(1) and (2)]
All schedules have been omitted since the required information is not applicable or is not present in amounts sufficient to require submission of the schedules or because the information required is included in the consolidated financial statements or notes thereto.
Report of Independent Certified Public Accountants
The Shareholders and Board of Directors Servico, Inc.
We have audited the accompanying consolidated balance sheets of Servico, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended, December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Servico, Inc. and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
West Palm Beach, Florida February 13, 1997
Servico, Inc. and Subsidiaries
Consolidated Balance Sheets
SEE ACCOMPANYING NOTES.
Servico, Inc. and Subsidiaries
Consolidated Statements of Income
See accompanying notes
Servico, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
See accompanying notes.
Servico, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
CONTINUED ON THE FOLLOWING PAGE
Servico, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (continued)
See Notes 5 and 6 for a description of other non-cash transactions.
See accompanying notes.
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Servico, Inc., its wholly-owned subsidiaries and consolidated partnerships (collectively, the "Company"), own or manage hotels in 22 states. At December 31, 1996 and 1995, the Company owned, either wholly or partially, or managed 61 and 55 hotels, respectively.
PRINCIPLES OF CONSOLIDATION
The financial statements consolidate the accounts of Servico, Inc. ("Servico"), its wholly-owned subsidiaries (owning 43 hotels) and partnerships in which Servico exercises control over the partnerships' assets and operations (owning 13 hotels). Servico believes it has control of partnerships when the Company manages and has control of the partnerships' assets and operations, has the ability and authority to enter into financing arrangements on behalf of the entity or to sell the assets of the entity within reasonable business guidelines. An unconsolidated entity (owning 1 hotel) in which the company exercises significant influence over operating and financial policies is accounted for on the equity method. The accounts of 9 hotels which the Company managed for third party owners during all or part of 1996 (4 at December 31, 1996) are not consolidated, however, management fee income earned from these hotels is included in other revenues. All significant intercompany accounts and transactions have been eliminated.
INVENTORIES
Inventories consist primarily of food and beverage, linens, china, tableware and glassware and are valued at the lower of cost (computed on the first-in, first-out method) or market.
MINORITY INTERESTS
Minority interests represent the minority interests' proportionate share of equity or deficit of partnerships which are accounted for by the Company on a consolidated basis. The Company generally allocates to minority interests their share of any profits or losses in accordance with the provisions of the applicable agreements. However, if the loss applicable to a minority interest exceeds its total investment and advances, such excess is charged to the Company.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Property under capital leases is amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the lease term. The
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT (CONTINUED)
Company capitalizes interest costs incurred during the construction of capital assets. During the years ended December 31, 1996, 1995 and 1994, the Company capitalized $644,000, $632,000 and $506,000 of such costs, respectively.
Management periodically evaluates the Company's property and equipment to determine if there has been any impairment other-than-temporary in the carrying value of the assets in accordance with Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of " ("Statement 121"). Statement 121 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Statement 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company adopted Statement 121 in 1995 and, such adoption has had no effect on the Company's financial position or results of operations.
DEFERRED COSTS
Deferred franchise, financing, and other deferred costs are stated at cost, net of accumulated amortization of $4,129,000 and $1,411,000 at December 31, 1996 and 1995, respectively, which is computed using the straight-line method, over the terms of the related franchise, loan or other agreements. The straight-line method of amortizing deferred financing costs approximates the interest method.
CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of current assets and current liabilities are assumed to be equal to their reported carrying amounts. The fair values of the Company's long-term debt are estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. In the opinion of management, the carrying value of these instruments approximates market value as of December 31, 1996 and 1995.
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT RISK
Concentration of credit risk associated with cash and cash equivalents is considered low due to the credit quality of the issuers of the financial instruments held by the Company and due to their short duration to maturity. Accounts receivable are primarily from major credit card companies, airlines and other travel related companies. The Company performs ongoing evaluations of its significant customers and generally does not require collateral. The Company maintains an allowance for doubtful accounts at a level which management believes is sufficient to cover potential credit losses. At December 31, 1996 and 1995, these allowances were $305,000 and $266,000, respectively.
EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE
Earnings per share is calculated based on the weighted average number of common shares and dilutive common equivalent shares outstanding during the periods. Earnings per common share include the Company's outstanding stock options, if dilutive, and common stock contributed or to be contributed by the Company to its employee 401(k) Plan (the "401(k)").
STOCK BASED COMPENSATION
The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and, because the exercise price of the Company's employee stock options is equal to the market price of the underlying stock on the date of grant, no compensation expense is recognized. Under Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation", net income and earnings per share are not materially different from amounts reported, therefore, no pro forma information has been presented.
ADVERTISING EXPENSE
The cost of advertising is expensed as incurred. The Company incurred $1,613,000, $1,194,000 and $928,000 in advertising costs during 1996, 1995 and 1994, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES (CONTINUED)
and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
2. PROPERTY AND EQUIPMENT
At December 31, 1996 and 1995, property and equipment consisted of the following:
During the year ended December 31, 1996, the Company purchased eight hotels and entered into three partnerships which purchased an additional three hotels. The aggregate purchase price for the eleven hotels was $60,700,000 and was paid for by the delivery of mortgage notes totaling $40,600,000 and cash for the balance, of which approximately $2,000,000 was contributed by the minority partners. In addition, in May 1996, the Company increased its ownership interests in two partnerships, owning two hotels, from 25% to 51% for approximately $3,000,000. As a result of the increase in ownership, the accounts of these two partnerships are included in the Company's consolidated financial statements. The minority partners in all five of the above partnerships are affiliates of Energy Management Corporation ("EMC") (see Note 8 for further information on EMC). The thirteen hotels combined above, containing an aggregate of 2,479 guest rooms, are operated under license agreements with nationally recognized franchisors and are managed by the Company.
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. PROPERTY AND EQUIPMENT (CONTINUED)
Unaudited pro forma results of operations assuming the 13 hotels were acquired on January 1, 1995, are as follows:
During the year ended December 31, 1995, the Company purchased seven hotels and entered into four partnerships with affiliates of EMC, which purchased four additional hotels. The aggregate purchase price for the eleven hotels was $70,800,000 and was paid for by the delivery of mortgage notes totaling $54,200,000 and cash for the balance, of which $5,400,000 was contributed by the minority partners. The eleven hotels combined above, containing an aggregate of 1,876 rooms, are operated under license agreements with nationally recognized franchisors and are managed by the Company.
3. INVESTMENTS IN UNCONSOLIDATED ENTITIES
At December 31, 1996, the Company had an investment in one unconsolidated hotel. In addition, in May 1996, the Company increased its ownership interests in two partnerships, owning two hotels, from 25% to 51% for approximately $3,000,000. These hotels were accounted for by the Company on the equity method prior to May 1996. As a result of the increase in ownership, the accounts of these two partnerships are included in the Company's consolidated financial statements from May 1996. The minority partners in these partnerships are affiliates of EMC.
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
4. ACCRUED LIABILITIES
At December 31, 1996 and 1995, accrued liabilities consisted of the following:
5. LONG-TERM OBLIGATIONS
At December 31, 1996 and 1995, long-term obligations consisted of the following:
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. LONG-TERM OBLIGATIONS (CONTINUED)
(a) The Company is obligated under long-term capital leases primarily for the lease of two hotel properties. The hotel leases provide for specific minimum annual payments. In addition, the Company is responsible for property tax, insurance and maintenance expenses. One hotel lease has a remaining term of less than one year and the other of 18 years at December 31, 1996. The hotel leases contain renewal options from 20 to 80 years and one of the hotel leases includes a purchase option.
Substantially, all of the Company's property and equipment are pledged as collateral for long-term obligations. Certain of the mortgage notes are subject to a prepayment penalty if repaid prior to their maturity.
During 1996, the Company refinanced certain long-term obligations on 20 of its hotels. The Company issued approximately $123,200,000 in new variable rate mortgage notes, satisfied approximately $84,500,000 of existing obligations, paid approximately $5,000,000 in fees and expenses, escrowed approximately $1,300,000 for future use by the Company and generated approximately $32,400,000 of net proceeds. In addition, the Company recorded approximately $7,400,000 in non-cash deferred loan costs which are being amortized over 36 months. These deferred loan costs are payable in May 1999. In connection with this refinancing the Company recorded a loss on early extinguishment of debt of $348,000 (net of income taxes of $232,000) as an extraordinary item.
During 1995, the Company completed a series of transactions for the refinancing of certain long-term obligations on 11 of its hotels. The Company executed $64,400,000 in new fixed rate mortgages maturing in 15 years, satisfied approximately $43,700,000 of existing obligations, paid approximately $3,200,000 in fees and expenses, escrowed approximately $3,300,000 for future use by the Company and generated in excess of $14,200,000 of net proceeds. In 1994, the Company prepaid certain obligations at a reduced amount and recorded a gain on early extinguishment of debt of $1,436,000 (net of income taxes of $956,000). This transaction was recorded as an extraordinary item.
Maturities of long-term obligations for each of the five years after December 31, 1996 and thereafter, are as follows (in thousands):
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. LONG-TERM OBLIGATIONS (CONTINUED)
Subsequent to December 31, 1996, the Company entered into financing agreements to refinance $12,000,000 in debt which would have matured in 1997. This debt is classified as long-term debt at December 31, 1996.
6. INCOME TAXES
Provision for income taxes for the Company is as follows:
The components of the cumulative effect of temporary differences in the deferred income tax liability and asset balances at December 31, 1996 and 1995, are as follows:
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
The difference between income taxes using the effective income tax rate and the federal income tax statutory rate of 34% is as follows:
As of December 31, 1996, the Company had a net operating loss carryforward of approximately $28,800,000 for federal income tax purposes which expires in the years 2005 through 2008. The full amount of the income tax benefit of this net operating loss carry forward has been reflected in the Consolidated Financial Statements of the Company in prior years.
7. COMMITMENTS AND CONTINGENCIES
Four of the Company's hotels are subject to long-term ground leases expiring from 2014 through 2056 which provide for minimum payments as well as incentive rent payments and most of the Company's hotels have noncancellable operating leases, mainly for operating equipment. The land covered by one lease can be purchased by the Company for approximately $2,500,000. For the years ended December 31, 1996, 1995 and 1994, lease expense for the three noncancellable ground leases and noncancellable operating leases was approximately $1,381,000, $1,280,000 and $1,060,000, respectively.
At December 31, 1996, the future minimum commitments for noncancellable leases are as follows (in thousands):
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company has entered into license agreements with various hotel chains which require annual payments for license fees, reservation services and advertising fees. The license agreements generally have an original ten year term. The majority of the Company's license agreements have four to nine years remaining on the term. The licensor may require the Company to upgrade its facilities at any time to comply with the licensor's then current standards. Upon the expiration of the term of a license, the licensee may apply for a license renewal. In connection with the renewal of a license, the licensor may require payment of a renewal fee, increased license, reservation and advertising fees, as well as substantial renovation of the facility.
The license agreements are subject to cancellation in the event of a default, including the failure to operate the hotel in accordance with the quality standards and specifications of the licensor. The Company believes that the loss of a license for any individual hotel would not have a material adverse effect on the Company's financial condition and results of operations. The Company believes it will be able to renew its current licenses or obtain replacements of a comparable quality. Payments made in connection with these agreements totaled approximately $12,401,000, $8,649,000 and $6,593,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
Fourteen hotels which the Company owns are operated under license agreements that require the Company to make certain capital improvements in accordance with a specified time schedule. Further, in connection with the refinancing of the Company's hotels (see Note 5) and the acquisition of other hotels (see Note 2), the Company has agreed to make certain capital improvements and has approximately $12,300,000 escrowed for such improvements. The Company estimates its remaining obligations for all the above commitments to be approximately $18,000,000 of which approximately $13,000,000 is expected to be spent in 1997 and the balance by 1999.
The Company has maintenance agreements, primarily on a one to three year basis, which resulted in expenses of approximately $2,106,000, $1,699,000 and $1,520,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
In accordance with the provisions of one mortgage payable, in the event the property is sold, the lender has the right to any appreciation in the property to the extent the appreciation does not exceed the difference between the then outstanding carrying amount of the mortgage payable and the lender's security interest. The difference between the carrying amount of the mortgage payable and the lender's security interest was approximately $1,300,000 at December 31, 1996.
The Company is a party to legal proceedings arising in the ordinary course of its business, the impact of which would not, either individually or in the aggregate, in management's opinion, based upon the facts known by management and the advice of counsel, have a material adverse effect on the Company's financial condition or results of operations.
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS
In March 1995, the Company issued 800,000 shares of its common stock at a price of $10 per share to an affiliate of EMC on terms similar to the EMC transaction described below. In connection with the acquisition of the 800,000 shares, an affiliate of EMC agreed to make an additional $8,000,000 equity investment in partnerships or joint ventures with the Company for the purpose of acquiring hotel properties. This obligation had been satisfied as of December 31,1995.
In April 1994, the Company issued one million shares of its common stock to EMC for $7,000,000 in cash. In connection with a certain Stock Acquisition and Standstill Agreement (the "Acquisition Agreement"), the Company agreed, during the term of the Acquisition Agreement, to cause the nomination of one designee of EMC to the Company's Board of Directors. This event occurred in April 1994.
In accordance with the Acquisition Agreement, as amended, EMC also agreed to certain standstill provisions generally prohibiting it from acquiring voting securities of the Company with voting rights in excess of 30% (on a fully diluted basis) of the voting rights of all outstanding voting securities of the Company. EMC is also generally restricted in the amount and manner by which it may transfer any of the Company's common stock which it owns.
9. EMPLOYEE BENEFITS PLANS AND STOCK OPTION PLAN
The Company makes contributions to several multi-employer pension plans for employees of various subsidiaries covered by collective bargaining agreements. These plans are not administered by the Company and contributions are determined in accordance with provisions of negotiated labor contracts. Certain withdrawal penalties may exist, the amount of which are not determinable at this time. The cost of such contributions during the years ended December 31, 1996, 1995 and 1994, was approximately $499,000, $433,000 and $438,000, respectively.
The Company adopted, the 401(k) for the benefit of its non-union employees under which participating employees may elect to contribute up to 10% of their compensation. The Company may match an employee's elective contributions to the 401(k) subject to certain conditions with shares of the Company's common stock equal to up to 100% of the amount of such employee's elective contributions. These employer contributions vest at a rate of 20% per year beginning in the third year of employment. The cost of these contributions during the years ended December 31, 1996, 1995 and 1994, was $548,000, $322,000 and $422,000, respectively. The 401(k) does not require a contribution by the Company.
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. EMPLOYEE BENEFITS PLANS AND STOCK OPTION PLAN (CONTINUED)
The Company has also adopted the Servico, Inc. Stock Option Plan, as amended, (the "Option Plan"). In accordance with the Option Plan, options to acquire up to 1,425,000 shares of common stock may be granted to employees, directors, independent contractors and agents as determined by a committee appointed by the Board of Directors. Options may be granted at an exercise price not less than fair market value on the date of grant. These options will generally vest over five years.
The following table indicates the options granted and their status as of December 31, 1996:
At December 31, 1996, there were 576,000 options exercisable, of which 26,400 were subsequently exercised at prices between $4.00-$10.75 per share.
The income tax benefit, if any, associated with the exercise of stock options is credited to additional paid-in capital.
10. CERTAIN NON-RECURRING EVENTS
In January 1996, the Company entered into an agreement with its former Chief Executive Officer in connection with his resignation from the Company and its Board of Directors. This agreement provides for payments totaling approximately $830,000 over a twenty-four month period, the cost of which is included in other operating expenses for the year ended December 31, 1996. Additionally, in accordance with the terms of the agreement, the former Chief Executive Officer
Servico, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
10. CERTAIN NON-RECURRING EVENTS (CONTINUED)
exercised stock options to acquire 300,000 shares of the Company's common stock by delivery of a $1,200,000 promissory note payable to the Company. This note was repaid in full during 1996.
In March 1996, the Company received approximately $3,900,000 in connection with the settlement of a lawsuit brought on behalf of Servico, against a bank group and law firm, based on alleged breaches prior to 1990 of their duties to the Company. This amount, less approximately $300,000 of associated expenses, is included in other income for the year ended December 31, 1996.
INDEX TO EXHIBITS
(I) This exhibit is incorporated by reference to exhibits to the Company's Form 10 Registration Statement filed June 17, 1992.
(II) This exhibit is incorporated by reference to exhibits to the Company's Form 10-K for the fiscal year ended June 30, 1992, filed September 21, 1992.
(III) This exhibit is incorporated by reference to exhibits to the Company's Form 10-K for the transition period from July 1, 1992 to December 31, 1992, filed March 24, 1993.
(IV) This exhibit is incorporated by reference to exhibits to the Company's Form 10-K for the year ended December 31, 1993, filed March 2, 1994.
(V) This exhibit is incorporated by reference to the Company's Form 10-K for the year ended December 31, 1994, filed March 27, 1995.
(VI) This exhibit is incorporated by reference to the Company's Form 10-K for the year ended December 31, 1995, filed March 27, 1996.
(VII) This exhibit is incorporated by reference to the Company's Form 10-Q for the period ended March 31, 1996, filed May 10, 1996.
(VIII) This exhibit is incorporated by reference to the Company's Form 10-Q for the period ended June 30, 1996, filed August 13, 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 26, 1997.
SERVICO, INC.
By: /s/David Buddemeyer --------------------------- David Buddemeyer, President And Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities indicated, on March 26, 1997.