-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VjkhhinFHVTWTt6UlaOqSsqcnxnsC6UfhXazqMncBg2OwpuqKM+G4lt6a+860kjn 1rGib3kmZTl+Z5DMlf83FQ== 0000950144-99-004469.txt : 19990415 0000950144-99-004469.hdr.sgml : 19990415 ACCESSION NUMBER: 0000950144-99-004469 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981227 FILED AS OF DATE: 19990414 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SHOLODGE INC CENTRAL INDEX KEY: 0000881924 STANDARD INDUSTRIAL CLASSIFICATION: HOTELS & MOTELS [7011] IRS NUMBER: 621015641 STATE OF INCORPORATION: TN FISCAL YEAR END: 1229 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-19840 FILM NUMBER: 99593531 BUSINESS ADDRESS: STREET 1: 130 MAPLE DR N CITY: HENDERSONVILLE STATE: TN ZIP: 37075 BUSINESS PHONE: 6152648000 MAIL ADDRESS: STREET 1: 130 MAPLE DRIVE NORTH CITY: HENDERSONVILLE STATE: TN ZIP: 37075 10-K405 1 SHOLODGE INC FORM 10-K405 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 27, 1998 COMMISSION FILE NUMBER 0-19840 SHOLODGE, INC. (Exact name of registrant as specified in its charter) TENNESSEE 62-1015641 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 130 MAPLE DRIVE, NORTH, HENDERSONVILLE, TENNESSEE 37075 (Address of principal executive offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (615) 264-8000 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, NO PAR VALUE (Title of Class) Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period as the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Aggregate market value of the voting stock held by non-affiliates of the registrant on April 6, 1999, was approximately $22,000,000. The market value calculation was determined using the last sale price of registrant's common stock on April 6, 1999, as reported on The Nasdaq Stock Market, and assumes that all shares beneficially held by executive officers and directors of the registrant are shares owned by "affiliates," a status which each of the officers and directors individually disclaims. Shares of common stock, no par value, outstanding on April 6, 1999, were 7,262,910. 2 DOCUMENTS INCORPORATED BY REFERENCE DOCUMENTS FROM WHICH PORTIONS ARE PART OF FORM 10-K INCORPORATED BY REFERENCE - ----------------- ------------------------- Part III Proxy Statement for registrant's annual meeting of shareholders to be held during the second quarter of fiscal 1999. Part IV Registration Statement on Form S-1, Commission File No. 33-44504. Part IV Registration Statement on Form S-3, Commission File No. 33-77910. Part IV Registration Statement on Form S-3, Commission File No. 333-14463 Part IV Registration Statement on Form S-8, filed with the Commission on June 24, 1997 3 PART I ITEM 1. BUSINESS. GENERAL The Company develops, owns and operates all-suites hotels under the Sumner Suites brand name and is an operator and the exclusive franchisor of Shoney's Inns. The Company's 24 Sumner Suites are mid-scale, all-suites hotels located in Arizona, Colorado, Florida, Georgia, Indiana, Kansas, New Mexico, North Carolina, Ohio, Tennessee and Texas. The Shoney's Inn lodging system consists of 74 Shoney's Inns containing approximately 7,200 rooms of which 17 containing approximately 1,900 rooms are owned or managed by the Company. Shoney's Inns are currently located in 21 states with a concentration in the Southeast. Sumner Suites hotels are marketed primarily to business travelers and, to a lesser extent, leisure travelers by offering an all-suite setting in a convenient location at an attractive price/value relationship. Sumner Suites offer mid-scale accommodations at rates between $75 and $100 per night and are usually located in or near business or leisure travel destinations in mid-sized and larger metropolitan markets. A typical Sumner Suites contains from 110 to 135 rooms, lounge facilities, meeting rooms, swimming pool and a fitness room, and offers a deluxe continental breakfast. The Sumner Suites concept was launched in 1995 with three hotels. From 1990 until 1995, the Company developed and managed 12 mid-scale, all-suites hotels under another brand name before selling its interests in those hotels in March 1995. The Company believes that its experience in developing, constructing and managing mid-scale, all-suites hotels has enabled it to expand effectively its development and ownership of the Sumner Suites system. In addition, as Sumner Suites has a limited presence in the marketplace, the Company is utilizing its proprietary reservation system, INNLINK, to further expand awareness of Sumner Suites. Shoney's Inns operate in the upper economy limited-service segment and are designed to appeal to both business and leisure travelers, with rooms usually priced between $40 and $65 per night. The typical Shoney's Inn includes 60 to 120 rooms and, in most cases, meeting rooms. Although Shoney's Inns do not offer full food service, most offer continental breakfast and most of the Shoney's Inns are located adjacent or in close proximity to Shoney's restaurants. Management believes that its strategy of locating most of its Shoney's Inns in close proximity to free-standing Shoney's restaurants has given it a competitive advantage over many other limited-service lodging chains by offering guest services approximating those of full-service facilities without the additional capital expenditures, operating costs or higher room rates. The Company was incorporated under the laws of the State of Tennessee in 1976. GROWTH STRATEGY The Company's strategy has been to increase cash flow and earnings by (i) developing additional Sumner Suites, (ii) increasing REVPAR while maintaining the Company's attractive suite and room price/value relationships and controlling operating costs, and (iii) expanding the Shoney's Inn system through the addition of new franchised units. Development of Additional Sumner Suites. The Company intends to continue to develop Sumner Suites in mid-sized and larger metropolitan markets across the United States although the Company has decided to slow its aggressive development schedule in the near term. In addition to the two Sumner Suites that were opened in December 1995 and a property that was converted to a Sumner Suites in July 1995, the Company developed and opened ten Sumner Suites in fiscal 1996, four Sumner Suites in fiscal 1997 and six Sumner Suites in fiscal 1998. Currently, three additional Sumner Suites are under construction. In addition, the Company has purchased another five development sites. The Company expects to finance the construction and development of additional 4 Sumner Suites currently under development primarily through a combination of available cash, available credit under the Company's current or new credit facilities, proceeds from cash provided by future sale-leaseback transactions, the sale of excess land and furniture, fixture and equipment financing packages. See "Management's Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources." Internal Growth. The Company seeks to increase cash flow and earnings from its existing hotels through increases in REVPAR while controlling operating costs. The Company seeks to increase REVPAR by increasing average daily room rates and supporting or increasing occupancy rates through targeted marketing and advertising strategies, employing promotional activities in local markets and capitalizing on the Company's proprietary central reservation system. In addition, the Company is committed to sustaining the quality of its properties through an ongoing renovation and maintenance program in order to increase REVPAR. The Company seeks to minimize costs throughout its operations primarily through the use of an in-house development and construction team and increased economies of scale in purchasing. Expansion of Shoney's Inn System. In the recent past the Company has focused on expanding the Shoney's Inn system principally through the addition of new franchises. Six franchised Shoney's Inns were opened in fiscal 1998, 20 hotels left the Shoney's Inn system and currently ten franchised Shoney's Inns are under construction. As of 1998 fiscal year-end, there were 74 Shoney's Inns (of which 15 are Company owned) with a total of 7,210 rooms. The Company targets existing Shoney's Inn franchises, other hotel brand developers and contacts within the industry as potential franchisees for additional Shoney's Inns. In addition to the strategies described above, the Company may from time to time investigate various alternatives to maximize shareholder value. These alternatives could include, without limitation, a continuation of the development and operation of Sumner Suites and the franchising and operation of Shoney's Inns, a sale of the remaining Shoney's Inns, the sale-leaseback of some of the Company's hotels, negotiating new credit arrangements, an increase in developing hotels for other owners, the repurchase of additional shares of the Company's common stock or outstanding debt securities, or any combination of these or other strategies. SUMNER SUITES CONCEPT Sumner Suites are all-suites hotels positioned in the mid-scale segment to appeal primarily to business travelers and, to a lesser extent, leisure travelers. The Sumner Suites hotels are generally located in mid-sized to larger metropolitan markets near business and leisure travel destinations such as business parks, office buildings, local attractions and restaurants. The current daily room rates typically range from $75 to $100; however, room rates vary depending upon a number of factors, including location and competition. For fiscal 1998, the average daily room rate for the Sumner Suites hotels was $77.43. The Sumner Suites prototype hotel is a five story, interior corridor, stucco building containing 110 to 135 rooms. The bedroom in each suite is furnished with either a king size bed or two double beds, a night stand, vanity, and closet area, and the sitting area contains a sleeper sofa, a desk, chairs and reading lamps. A kitchenette area includes a sink, refrigerator, microwave oven and cabinets that contain kitchen and cooking utensils. Additional room amenities include new 26 inch remote control color televisions with premium channel selections, in room coffee makers and dual line telephones for computer connections. The lobby area of each Sumner Suites hotel features marble floors and seating areas with numerous couches, tables and chairs allowing for informal meeting and lounge space. Adjacent to the seating area is a combination buffet and beverage service area. Each Sumner Suites is equipped with large meeting rooms that can be sectioned to meet - 2 - 5 individual guests' or groups' needs. An exercise facility and swimming pool are additional features. Guests at the Sumner Suites are offered a wide range of amenities and services, such as deluxe continental breakfast, fitness center, free unlimited local telephone calls, on premises coin operated laundry, same-day laundry and dry cleaning, fax services, 24-hour front desk message service and free parking. Typically, the Sumner Suites are located near free standing, full service restaurants. The Company believes that Sumner Suites provides its guests with quality accommodations at an attractive price/value relationship within the all-suites segment. - 3 - 6 SHONEY'S INNS CONCEPT Shoney's Inns are limited-service hotels positioned in the upper economy segment to appeal to both business and leisure travelers and are located in 21 states in markets ranging from small towns to larger metropolitan areas. Shoney's Inns are generally located in proximity to interstate highways, major streets and highways providing convenient access to business establishments. Most of the Shoney's Inns are located adjacent or in close proximity to a Shoney's restaurant. Management believes that its strategy of locating its Shoney's Inns in close proximity to free-standing Shoney's restaurants gives it a competitive advantage over many other limited-service lodging chains. Daily room rates at Shoney's Inns range from $40 to $65 and vary depending upon a number of factors, including location, competition and type of room. For fiscal 1998, the average daily room rate for Company-owned Shoney's Inns was $51.95. Historically, the typical Shoney's Inn has been a two story, exterior corridor, brick veneer building with plate glass fronts, containing 100 to 125 rooms. New prototypes for Shoney's Inns include a four story, interior corridor, brick or stucco building containing 100 to 120 rooms as well as smaller prototype buildings containing 80 rooms. In some cases franchisees construct smaller Shoney's Inns. Each room is professionally decorated and is generally furnished with two double beds, a dresser, table and chairs and a color television. Amenities featured at most Shoney's Inns include swimming pools, meeting rooms, facsimile machine service and continental breakfast. The Company believes that Shoney's Inns provides its guests with quality accommodations at an attractive price/value relationship within the upper economy segment. HOTEL CONSTRUCTION AND DEVELOPMENT The Company's construction subsidiary has a full time staff who manage, supervise, control and perform the construction of the Company's hotels. Subcontractors are employed by the Company for most of the major construction components of a new hotel, including plumbing, electrical, and mechanical subcontracts. The Company intends to continue to build any hotels that the Company may own because it believes that its in-house capabilities provide advantages in controlling costs, quality, and development schedule as compared to using independent contractors. The Company believes that its construction experience and its relationship with many subcontractors will facilitate the effective development of additional hotels. The Company devotes significant resources to the identification and evaluation of potential sites for its hotels. The Company generally targets mid-sized to larger metropolitan markets for locating its Sumner Suites. In identifying cities for possible expansion, the Company typically targets markets with populations of 500,000 or more that have high levels of business development and multiple sources of room demand. The site selection process for Sumner Suites focuses on the competitive environment, including room and occupancy rates and proximity to business parks, office buildings, and other demand generators. The Company's franchisees focus on sites for its Shoney's Inns in proximity to interstate highway access roads and major streets and highways providing convenient access to local business establishments and tourist attractions. Management believes that the development cost of a new Sumner Suites hotel is approximately $65,000 to $70,000 per suite, depending on the location of the hotel, size of the hotel (number of suites), cost of land, local zoning and permitting costs, construction period and local building costs which are affected by the cost of building materials and construction labor. Based on the Company's experience to date, the capital investment (including land and construction period interest) for a typical 135 suite Sumner Suites is approximately $9.0 million (approximately $66,000 per suite). - 4 - 7 The construction phase of a hotel generally requires six months after the site and all approvals and permits have been obtained. The Company's experience in selection and acquisition of sites has varied and generally averages six months. The approval and permitting phase can occur simultaneously with site acquisition and generally requires three months. The entire development process generally ranges from 10 to 12 months but may take longer. SALES AND MARKETING The Company directs marketing efforts on behalf of both Sumner Suites and Shoney's Inns primarily to business travelers, whom management believes have represented the largest segment of its customers in recent years. Sumner Suites. Marketing of the Sumner Suites brand is targeted primarily towards the business traveler through a variety of efforts. Initially, pre-opening sales calls are made by the general manager and director of sales of each property in the local market area during the 90 days prior to opening. In addition, advertisements are placed in the Hotel Travel Index, a comprehensive listing of hotels worldwide used by travel agents for booking clients into destination cities. Advertising is also placed in local business publications, direct mail to targeted business travel and a comprehensive on-line directory on the worldwide web at www.sumnersuites.com. The Sumner Suites toll-free reservation number, 1-800-74-SUITE, is promoted to travel agents through advertising and direct mailings. The Company believes that approximately thirty percent (30%) of all Sumner Suites room sales are booked through the Company's reservation center. Shoney's Inns. All Shoney's Inns participate in the "Sho Business" frequent traveler program, entitling members to receive the lowest available corporate rate, complimentary coffee and newspaper, free room upgrades, express check-in and other privileges upon presentation of a membership card. Approximately 9% of the rooms booked through INNLINK for Shoney's Inns during fiscal 1997 have been reserved by guests who are members of the Sho Business program. Historically, the Company has also marketed its hotels directly to businesses whose employees travel in the southeastern United States. Additionally, the Company attempts to take advantage of the Shoney's brand name recognition in the over-50 age group and in the package tour market through advertisement in publications targeting such readers and by encouraging franchisee participation in promotional discounts for frequent customers over-50 and for tour operators. The Company's program for the over-50 age group is tied to AARP membership and entitles its members to receive special room rate discounts, complimentary coffee and newspaper and other benefits. The Shoney's Inn system also advertises in Shoney's restaurants, and individual Shoney's Inns are encouraged to participate in joint mailings and other promotions with local Shoney's restaurants. The Company annually publishes a Shoney's Inn system directory showing, for each Inn, its address and telephone number, location as indicated on a locator map, a brief description of the facilities, the services and amenities provided and other relevant information. These directories are distributed in each Shoney's Inn and state travel centers and are provided directly to travel agents, sponsors of group tours, corporate travel departments and other selected potential customers. The Company also provides a comprehensive on-line directory on the worldwide web at www.shoneysinns.com. Many properties have a full-time director of sales whose responsibilities include local marketing and direct and group sales. At the corporate level, a Director of Marketing oversees national marketing plans and provides marketing support for each corporate and franchised property. The Director of Marketing also oversees management of the Shoney's Inn national advertising fund, into which all Shoney's Inns pay 1% of revenue to support national marketing efforts such as the annual system directory and - 5 - 8 national advertising (e.g. USA Today, Reader's Digest, Compass Travel Directory inserts). Travel Agents. The Company has a policy of paying travel agents a commission, standard in the hotel industry, on all revenue booked by them. The Company, with respect to all Sumner Suites and both owned and franchised Shoney's Inns, has joined the TACS-Lite Program administered by Citibank. TACS-Lite (Travel Agent Commission Settlement) is a program where each hotel property reports to the Company each week by fax (or by electronic transmission if capable) all of its room sales generated through travel agents. The Company in turn forwards this information to Citibank which automatically generates checks each month to travel agents across the country for the total commissions earned. The Company believes that travel agents are more likely to book guests into a Shoney's Inn or Sumner Suites knowing that their commissions will be paid by Citibank without the travel agent having to go to the trouble and expense of billing each separate location. LODGING OPERATIONS Hotel Management. Overall hotel operations are the responsibility of the Director of Operations for Shoney's Inns and the Vice President of Operations for Sumner Suites. Shoney's Inns and Sumner Suites are further managed by regional managers, who directly supervise the general manager of each property. The general manager of each Shoney's Inns or Sumner Suites is fully responsible for day-to-day operations and is compensated by salary and bonus systems which reward revenue and operating margin performance. Each general manager, in conjunction with senior management, develops the property's operating budget and is held accountable for meeting the goals and objectives of the hotel. Reservation System. The Company's proprietary central reservation system, INNLINK, provides important support for the room reservation process for both Sumner Suites and Shoney's Inns and is marketed to other chains as well. Other chains that contract with the Company for the service include Country Hearth Inns, Key West Inns and Wilson Inns & Hotels. INNLINK operates 24 hours a day, 7 days a week. The INNLINK system may be accessed by individual travelers as well as by travel agents, tour and group booking agents at 1-800-222-2222 for Shoney's Inns and 1-800-74-SUITE for Sumner Suites. Electronically, INNLINK is accessed through numerous global distribution systems (e.g., SABRE Travel Information Network, Galileo International, Amadeus and WorldSpan). The reservation system includes specially designed hotel reservation software, with adequate capacity, and state of the art hardware and telecommunications devices. The Company believes that approximately 30% and 17% of room sales for Sumner Suites and Shoney's Inns, respectively, are made through INNLINK. Quality Control. To ensure quality and consistency, the Company regularly inspects each of its company owned and/or operated hotels and each Shoney's Inn in the Shoney's Inn system for compliance with facility and service standards. Generally, in addition to its ongoing refurbishment activities, the Company fully renovates each of the Company-owned Shoney's Inns after approximately seven years of operation and expects a similar renovation schedule for Sumner Suites. During fiscal 1998 the Company completed full or partial renovations of 13 Company-owned Shoney's Inns. Training. The Company utilizes the services of an "opening team" to assist with hiring and training new staff and opening new Company-owned hotels. The opening team trains local hotel personnel in front desk operations, operational policies, hotel accounting and cash handling procedures, record-keeping, housekeeping and laundry, maintenance and repair, marketing, personnel management, purchasing, quality assurance and sales. Sales training includes a team of direct sales personnel that assists the local staff in the actual pre-selling of rooms. An opening team generally remains on site for one to four weeks depending on the prior experience of the local general manager. - 6 - 9 FRANCHISE OPERATIONS Franchise Sales. The Company markets the Shoney's Inn franchise principally to existing Shoney's Inn franchisees, other hotel brand developers and other prospects known through management's contacts in the lodging industry. The Company employs three full-time licensed franchise salesmen. The Company also markets franchises through advertisements in trade publications and participation in trade shows and franchising conventions. Management believes that the Company attracts potential new franchisees by offering a comparable level of franchisee support services at a lower price than its competitors. Management periodically monitors the initial fee, royalty fee, advertising fee, reservation fee and other charges imposed by other franchisors with whom the Company competes and believes that the fees charged by the Company are competitive and, in most cases, lower than such other franchisors. Fees. Under the standard Shoney's Inn franchise arrangement offered to prospective franchisees, a potential franchisee pays a $2,500 application fee. Upon approval of the application, the Company and the franchisee enter into a 20-year license agreement, and the franchisee generally pays a license fee equal to the greater of $250 per room or $15,000. The application fee is applied against the license fee. Under the standard Shoney's Inn franchise arrangement offered to prospective franchisees, the franchisee pays monthly royalties of 3.5% of the licensed hotel's gross sales during the term of the license agreement. Additionally, a marketing cooperative fee of 1% of gross sales and a fee for participation in the Shoney's Inn central reservation system of 1% of gross sales are charged. Franchisee Services. Management believes that the support the Company offers to franchisees is a significant factor in determining its success as a franchisor and that the Company's successful record as a Shoney's Inn builder, owner and operator evidences valuable experience and abilities which can enhance the franchisee support function. As franchisor, the Company draws on its own operational experience to assist franchisees. Once a Shoney's Inn is constructed, the Company requires the franchisee to send the site general manager to a management training class conducted by the Company covering topics including human resources, sales and marketing, yield management and cost controls. Currently the Company does not charge for the training program but reserves the right to do so in the future. The Company inspects every Shoney's Inn at least three times a year, at least two of which are unannounced, through its Quality Standards and Compliance program, using trained field representatives. The Company encourages franchisees to renovate each of the Shoney's Inns after approximately seven years of operations, in the same manner that the Company renovates its own hotels. The Company offers to provide management services to Shoney's Inn franchisees pursuant to contractual arrangements. The Company's fee for these services is a percentage of the managed hotel's gross revenues. Currently, the Company manages two hotels under contract arrangement. LICENSE AGREEMENT WITH SHONEY'S Under the License Agreement with Shoney's, Inc., the Company acts as exclusive franchisor of Shoney's Inns and has certain rights to use and to license the use of the service marks "Shoney's Inn" and "Shoney's Inn & Suites" in connection with lodging operations. Under the License Agreement, Shoney's retains certain rights, including the right to approve the styles, shapes, colors and forms in which the "Shoney's Inn" and "Shoney's Inn & Suites" marks are displayed, the nature and extent of on-site food and - 7 - 10 beverage service and the terms of franchise agreements (other than the maximum fees and other financial terms). Further, Shoney's retains the right to terminate the License Agreement under limited circumstances, including the bankruptcy of the Company, the failure to comply with the terms of the License Agreement and the failure to desist from conduct likely to impair Shoney's goodwill and reputation. Prior to October 25, 1996, the License Agreement entitled Shoney's to receive a portion of the franchise fees collected by the Company equal, in substantially all cases, to 1.5% of 52 Shoney's Inns' gross revenues through October 1999 and 0.5% of the remaining and all future Shoney's Inns' gross revenues for the first ten years of their operation. Shoney's right to receive such fees was terminated on October 25, 1996. LODGING INDUSTRY Smith Travel Research divides lodging chains into various segments based on price. Shoney's Inns are included in the economy segment. Sumner Suites are included in the mid-scale (without food and beverage) segment, although because the average daily room rate at Sumner Suites exceeds $75.00, the Sumner Suites could be included in the upscale segment. The following tables illustrate certain comparative information regarding REVPAR and its components for the years indicated:
AVERAGE AVERAGE DAILY REVPAR OCCUPANCY RATE ROOM RATE (1) --------------------------- ------------------------- -------------------------- 1996 1997 1998 1996 1997 1998 1996 1997 1998 - ------------------------------------------------------------------------------------------------------------------------- Industry-wide $46.24 $48.68 $50.32 65.1% 64.6% 64.0% $71.00 $75.30 $78.62 Economy segment 25.01 25.17 31.25 59.7 58.1 58.6 41.89 51.34 53.33 Mid-scale (w/o food and beverage) segment 38.32 39.77 41.09 68.5 67.5 66.6 55.96 58.94 61.69 Upscale segment 60.70 63.97 61.65 72.4 71.9 67.4 83.80 88.94 91.47 All Shoney's Inns 28.18 28.00 27.96 61.5 59.2 57.3 45.86 47.30 48.80 Company-owned Shoney's Inns 31.41 30.83 29.98 61.1 59.2 57.7 51.45 52.07 51.95 Same hotel Sumner Suites(2) 42.26 42.78 46.60 N/A 59.3 60.9 N/A 72.12 76.56 All Sumner Suites(2) 36.05 41.66 42.96 48.4 57.9 55.5 74.55 71.94 77.43
(1) Room revenues divided by the number of rented rooms. (2) Information with respect to same hotel Sumner Suites is not meaningful prior to 1997, as all of the Sumner Suites hotels opened in late 1995 or thereafter. All Sumner Suites in 1996 represent the 13 hotels which as included in same hotel Sumner Suites in 1997 and 1998. Source: Smith Travel Research, Standard Historical Trend Report for years ended 1996, 1997 and 1998, for industry wide, economy, mid-scale (w/o food and beverage) and upscale lodging chains, and the Company's internal data for all Shoney's Inns and Sumner Suites statistics. - 8 - 11 COMPETITION The lodging industry is highly competitive. In franchising the Shoney's Inn system and managing its own lodging facilities, the Company encounters competition from numerous lodging companies, many of which have greater industry experience, name recognition, and financial and marketing resources than the Company. While the actual competition for individual lodging facilities varies by location, the primary competition for Shoney's Inns includes lodging chains such as Holiday Inn Express, La Quinta, Comfort Inns, Drury Inns, Fairfield Inns and Travelodges. The Company's Sumner Suites hotels experience competition from chains such as Embassy Suites, Hampton Inns, Residence Inn, Courtyard by Marriott, Quality Suites, AmeriSuites and Comfort Suites. Each of the Company's hotels is located in a developed area that includes competing lodging facilities, and the Company expects that most of its future hotels which it constructs will be located in similar areas. Management believes that the principal competitive factors in its lodging operations are room rates, quality of accommodations, name recognition, supply and availability of alternative lodging facilities, service levels, reputation, reservation systems and convenience of location. In its franchising operations, the principal competitive factors are fee structure and support services. Management further believes that the Company is presently competitive in all these respects. GOVERNMENT REGULATION The Company is subject to various federal, state and local laws, regulations and administrative practices affecting its business. The Company's lodging operations must comply with provisions relating to health, sanitation and safety standards, equal employment, minimum wages, building codes and zoning ordinances, and licenses to operate lodging facilities. The sale of franchises is regulated by various state laws as well as by the Federal Trade Commission ("FTC") Rules on Franchising. The FTC requires that franchisors make extensive disclosure to prospective franchisees but does not require registration. A number of states require registration or disclosure in connection with franchise offers and sales. In addition, several states have "franchise relationship laws" that limit the ability of franchisors to terminate franchise agreements or to withhold consent to the renewal or transfer of these agreements. Federal and state environmental regulations are not expected to have a material effect on the Company's operations, but more stringent and varied requirements of local governmental bodies with respect to zoning, land use and environmental factors could delay construction of lodging facilities and add to their cost. A significant portion of the Company's personnel are paid at rates related to federal minimum wages and, accordingly, increases in the minimum wage could adversely affect the Company's operating results. The Americans With Disabilities Act (the "ADA") prohibits discrimination on the basis of disability in public accommodations and employment. The ADA became effective as to public accommodations in January 1992 and as to employment in July 1992. The Company currently designs its lodging facilities to be accessible to the disabled and believes that it is in substantial compliance with all current applicable regulations relating to accommodations for the disabled. The Company intends to comply with future regulations relating to accommodating the needs of the disabled, and the Company does not currently anticipate that such compliance will require the Company to expend substantial funds. SERVICE MARKS The Company has the right to use the "Shoney's Inn" and "Shoney's Inn & Suites" service marks in its lodging operations under its License Agreement with Shoney's (See "License Agreement with Shoney's" above). The "Shoney's Inn" and "Shoney's Inn & Suites" marks may not be used in certain limited areas in southern and western Virginia - 9 - 12 and in northeastern Tennessee; however, the Company does not believe that these limitations are material to its present business or its expansion strategy. The Company believes that its ability to use the Shoney's marks is material to its business. The Company has registered the service mark "INNLINK," which it uses in connection with its reservation system, with the United States Patent and Trademark Office. The Company has registered the service mark "Sumner Suites" with the United States Patent and Trademark Office. INSURANCE The Company maintains general liability insurance and property insurance for all its locations and operations, as well as specialized coverage, including guest property and liquor liability insurance, in connection with its lodging business. Generally, the costs of insurance coverage and the availability of liability insurance coverage have varied widely in recent years. While the Company believes that its present insurance coverage is adequate for its current operations, there can be no assurance that the coverage is sufficient for all future claims or will continue to be available in adequate amounts or at a reasonable cost. EMPLOYEES As of December 27, 1998 the Company had approximately 1,400 employees, including approximately 115 in the Company's corporate headquarters. The company's employees are not represented by a labor union. The Company considers its relationships with employees to be good. ITEM 2. PROPERTIES. The Company's corporate headquarters, owned by the Company, is located in Hendersonville, Tennessee and contains approximately 42,000 square feet of space including storage and food services. Management believes that its corporate headquarters building contains sufficient space to accommodate the Company's currently anticipated needs. Thirteen of the fifteen Company-owned Shoney's Inns and nine of the 24 Company-owned or operated Sumner Suites are located on sites owned by the Company either directly or through subsidiaries. The remaining hotels are located on sites that are leased pursuant to long-term ground leases or through sale-leaseback arrangements with a real estate investment trust involving both the land and improvements. ITEM 3. LEGAL PROCEEDINGS. The Company is subject to litigation from time to time in the ordinary course of its business. The Company is not aware of any material legal action pending or threatened against it, except for the following: Frank Rudy Heirs Associates, et. al. v. Moore and Associates, Inc., Leon Moore and Gulf Coast Development, Inc., was filed in the Chancery Court for Davidson County, Tennessee (93- 2957-II) on October 8, 1994. The plaintiff, a limited partner in one of the Company's partnerships, claimed, among other things, that the Company breached the partnership agreement by not offering the partnership the right to participate in the profits from the management of a neighboring AmeriSuites hotel. In February 1995, the court entered summary judgment in favor of the plaintiff on this claim and referred the issue of damages to a special master of the court. In November 1995, the special master issued her report finding damages on this claim payable to the partnership (of which the Company is a 60% partner) in the amount of approximately $3.0 million. The report of the special master was confirmed by the court in December 1995 and the Company subsequently appealed the judgment in March 1996. In March 1997, the Court of Appeals reversed the trial court's ruling in favor of the plaintiff, vacated the judgment against the Company and remanded the case to the trial court to enter summary judgment - 10 - 13 on this claim in favor of the Company. The plaintiff filed an application for permission to appeal to the Supreme Court of Tennessee but the court has refused to grant such permission. In May 1997, the trial court granted summary judgment in favor of the Company on five additional claims that were made by the plaintiff. The trial of the remaining issues was held in December 1997. On March 4, 1998, the trial court found in favor of the Company as to each of the issues for which a trial was held. No appeal was taken from the trial court's ruling and the case has now concluded. Tri-State Inns, Inc. and Motels of America, Inc. v. ShoLodge Franchise Systems, Inc., Superior Court of Liberty County, Georgia, Civil Action File No. 97-V-00591. In this action, Tri-State Inns, Inc., the franchisee of the Shoney's Inn located in Hinesville, Georgia, originally sought to be discharged, relieved and excused of any future performance under the License Agreement relating to such Shoney's Inn, and Motels of America, Inc. sought to be discharged, relieved and excused of any further performance under a Guaranty Agreement whereby the obligations of Tri-State Inns, Inc. under such License Agreement were guaranteed by Motels of America, Inc., or in the alternative compensatory damages, based on theories of alleged breach of contractual obligations and implied warranties of good faith and fair dealing, alleged fraudulent inducement based on alleged misrepresentations and alleged failure to make material disclosures of fact, alleged promissory estoppel and alleged breach of fiduciary duty. In addition, the plaintiffs originally sought a declaratory judgment concerning the provision of the License Agreement which specifies the damages due upon termination of the License Agreement. This action was removed to the U.S. District Court for the Southern District of Georgia, Case No. CV- 497-129. Subsequent to removal, the action was thereafter transferred to the U.S. District Court for the Middle District of Tennessee, where it is now pending as Civil Action No. 3-98-0028. On December 19, 1997, the plaintiffs filed a Second Amended Complaint in which they sought to be relieved of obligations not simply as to the Hinesville Shoney's Inn but also with regard to 13 other license agreements between plaintiffs and the Company. In the alternative, the plaintiffs seek an as yet undisclosed amount in compensatory damages. On March 18, 1998, the plaintiffs filed a motion for summary judgment seeking to invalidate the non-competition and stipulated damages provisions set forth in the License Agreements. On August 6, 1998, the court denied the plaintiffs' motion. The case has been set for trial on May 18, 1999. The Company intends to continue to defend the case vigorously. Lorraine Donergue v. ShoLodge, Inc., et al., Case No. 3-98-0295, United States District Court for the Middle District of Tennessee. On March 31, 1998, the Company was named as a defendant in a purported class action lawsuit filed by Lorraine Donergue, who claimed to be a shareholder of the Company. The lawsuit alleged that the Company violated Section 10(b) of the Securities Exchange Act of 1934 by issuing allegedly false and misleading statements and financial information to the investing public during 1997. The lawsuit also named as defendants three of the Company's officers, Leon Moore, Bob Marlowe, and Michael A. Corbett. The plaintiff sought an unspecified amount of damages. In August 1998, this case was dismissed with respect to all named defendants. Paul Senior v. ShoLodge, Inc., Leon Moore and Bob Marlowe, Case No. 98C-136, Chancery Court for Sumner County, Tennessee at Gallatin, filed April 29, 1998 (the "Senior Case"). This case names the Company and two of its officers, Leon Moore and Bob Marlowe, as defendants in a class action lawsuit by plaintiffs who claim to be shareholders of the Company. The case originally named Michael A. Corbett, former chief financial officer of the Company, as a defendant, but the plaintiffs subsequently deleted Mr. Corbett as a named defendant. The Senior Case alleges that the Company violated certain anti-fraud provisions of the Tennessee Securities Act of 1980, as amended, by issuing allegedly false and misleading statements and financial information to the investing public during the first three quarters of 1997. The Company moved to dismiss the complaint on the basis that the plaintiff's allegations failed to state a cause of action under the Tennessee Securities Act of 1980. The court denied the motion but granted the Company's request that the Tennessee Court of Appeals review the court's decision on an interlocutory basis. The court's denial of the Company's motion - 11 - 14 is now before the Court of Appeals. On January 29, 1999, the Company filed its appellate brief. A date for oral argument before the Court of Appeals has not as yet been set. Because of the pendency of the appeal, the chancery court has continued the trial date to September 13, 1999. Stanley Gale v. ShoLodge, Inc., Leon Moore and Bob Marlowe, Case No. 98C-208, Chancery Court for Sumner County, Tennessee at Gallatin, filed July 2, 1998. This case names the Company and two of its officers, Leon Moore and Bob Marlowe, as defendants in a purported class action lawsuit by plaintiffs who claim to be holders of the Company's debt securities. The case alleges that the Company violated certain anti-fraud provisions of the Tennessee Securities Act of 1980, as amended, based on essentially the same factual allegations as the Senior Case. The complaint seeks an unspecified amount of damages and unspecified injunctive relief. The Company filed a motion to dismiss the case for failure to state a cause of action under the applicable state statute. The trial court denied the motion. The case has now been set for trial on September 13, 1999. Michael A. Corbett v. ShoLodge, Inc. and Leon Moore, Case No. 98C-184, Chancery Court for Sumner County, Tennessee at Gallatin, filed June 12, 1998. This case was filed by Michael A. Corbett, the former chief financial officer of the Company, and alleges that his employment by the Company was wrongfully terminated. The plaintiff alleges breach of contract, fraud, retaliatory discharge and related claims. The plaintiff seeks $3 million in compensatory damages and punitive and treble damages. On December 31, 1998 the Company filed a motion to dismiss this lawsuit on the basis that the plaintiff has intentionally destroyed relevant evidence during the pendency of the case. The court granted this motion on January 28, 1999 and dismissed the case with prejudice. On March 8, 1999 the plaintiff filed a Motion to Alter or Amend the Judgment dismissing the case. The court has not yet ruled on the plaintiff's motion. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS. No matters were submitted to a vote of security holders in the fourth quarter of 1998. - 12 - 15 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS. The Company's Common Stock is traded in the over-the-counter market and is quoted on The Nasdaq Stock Market ("NASDAQ") under the symbol "LODG." The prices set forth below reflect the high and low sales prices for the Company's Common Stock as reported by NASDAQ for the periods indicated.
FISCAL 1997 HIGH LOW - ------------------------------------------------------------------------------------------------------- First Quarter $14 $11 1/2 Second Quarter 15 11 Third Quarter 16 7/8 13 Fourth Quarter 18 14 1/2 FISCAL 1998 HIGH LOW - ------------------------------------------------------------------------------------------------------- First Quarter 16 1/2 7 7/8 Second Quarter 10 3/8 7 5/8 Third Quarter 10 3/8 3 3/8 Fourth Quarter 7 1/2 3 3/8 FISCAL 1999 HIGH LOW - ------------------------------------------------------------------------------------------------------- First Quarter (through April 6, 1999) 7 1/2 4
On April 6, 1999, the last reported sale price for the Company's Common Stock as reported by NASDAQ was $4 5/8 per share. As of April 6, 1999, there were approximately 59 holders of record of the Company's Common Stock and approximately 1,200 beneficial owners. The Company has never declared or paid any cash dividends on its Common Stock. The Company currently intends to retain its earnings to finance future development of its business, and does not therefore anticipate paying any cash dividends in the foreseeable future. The Company's primary revolving credit agreements prohibit the payment of dividends without the lender's consent. The Company declared a five-to-four stock split of its Common Stock to be effected as a 25% stock dividend which was payable on May 14, 1993 to those shareholders of record on April 30, 1993. The Company more recently declared a four-to-three stock split of its Common Stock to be effected as a 33 1/3% stock dividend payable on March 28, 1994 to the shareholders of record on March 14, 1994. ITEM 6. SELECTED FINANCIAL DATA. The selected financial data set forth on the following page as of and for each of the five fiscal years in the period ended December 27, 1998 have been derived from the Company's audited Consolidated Financial Statements. The Consolidated Financial Statements for each of the two fiscal years ended December 28, 1997 and December 27, 1998, which have been audited by independent auditors, are included elsewhere in this Report. The information set forth on the following page should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements and the related notes thereto included elsewhere in this Report. - 13 - 16 SHOLODGE, INC. AND SUBSIDIARIES SELECTED FINANCIAL DATA (amounts in thousands except for per share data)
FISCAL YEAR ENDED --------------------------------------------------------- DEC. 25, DEC. 31, DEC. 29, DEC. 28, DEC. 27, 1994 1995 1996 1997 1998 --------------------------------------------------------- REVENUES: HOTEL $ 36,440 $ 44,144 $ 57,528 $ 71,945 $ 69,240 CONSTRUCTION AND DEVELOPMENT 6,213 24,041 1,665 0 81 FRANCHISING AND MANAGEMENT 3,539 6,217 4,290 3,164 3,119 SALE OF HOTELS 17,366 6,174 0 0 0 PROFITS NOT RECOGNIZED ON INSTALLMENT SALES (2,782) (1,956) 0 0 0 --------- -------- ------------------------------- TOTAL OPERATING REVENUES 60,776 78,620 63,483 75,109 72,440 COSTS AND EXPENSES: OPERATING EXPENSES: HOTEL 20,211 25,178 30,998 42,988 44,934 CONSTRUCTION AND DEVELOPMENT 5,242 10,096 1,200 0 71 FRANCHISING AND MANAGEMENT 2,475 2,861 3,255 2,301 2,393 COST OF HOTELS SOLD 14,584 4,218 0 0 0 --------------------------------------------------------- TOTAL OPERATING EXPENSES 42,512 42,353 35,453 45,289 47,398 --------------------------------------------------------- GENERAL AND ADMINISTRATIVE 1,378 1,929 2,158 3,953 6,358 RENT EXPENSE 727 784 861 1,991 9,838 DEPRECIATION AND AMORTIZATION 3,831 5,272 7,863 10,376 8,012 --------------------------------------------------------- INCOME FROM OPERATIONS 12,328 28,282 17,148 13,500 834 OTHER INCOME (EXPENSES): INTEREST EXPENSE (5,777) (6,222) (4,605) (11,298) (10,415) INTEREST INCOME 5,311 5,815 1,391 1,762 4,949 GAIN ON SALE OF PROPERTY 293 212 340 3,819 20,632 OTHER INCOME 970 553 1,219 837 441 --------------------------------------------------------- EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, MINORITY INTEREST, EXTRAORDINARY ITEMS, AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING POLICY 13,125 28,640 15,493 8,620 16,441 INCOME TAXES (4,838) (10,529) (5,598) (2,259) (6,581) MINORITY INTEREST IN EARNINGS OF CONSOLIDATED SUBSIDIARIES & PARTNERSHIPS (294) (351) (423) (173) (647) ----------------------------------------------------------- EARNINGS FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY ITEMS AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING POLICY 7,993 17,760 9,472 6,188 9,213 DISCONTINUED OPERATIONS: INCOME (LOSS) FROM OPERATIONS OF RESTAURANT SUBSIDIARY DISPOSED OF, NET OF APPLICABLE INCOME TAXES & MINORITY INTEREST 18 (75) 0 0 0 GAIN ON DISPOSAL OF DISCONTINUED BUSINESS SEGMENT, NET OF INCOME TAX EFFECT 0 0 25 526 0 EXTRAORDINARY LOSSES, NET OF INCOME TAX BENEFIT (215) (708) 0 (186) (1,067) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING POLICY, NET OF INCOME TAX EFFECT 0 0 0 (1,164) 0 --------------------------------------------- -------- NET EARNINGS $ 7,796 $ 16,977 $ 9,497 $ 5,364 $ 8,146 ========================================================= EARNINGS PER COMMON SHARE BASIC: EARNINGS FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY ITEMS AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING POLICY $ 0.97 $ 2.16 $ 1.15 $ 0.75 $ 1.12 ========================================================= NET EARNINGS $ 0.95 $ 2.06 $ 1.15 $ 0.65 $ 0.99 ========================================================= DILUTED:
- 14 - 17 EARNINGS FROM CONTINUING OPERATIONS BEFORE EXTRAORDINARY ITEMS AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING POLICY $ 0.80 $ 1.87 $ 1.12 $ 0.74 $ 1.07 ========================================================= NET EARNINGS $ 0.78 $ 1.80 $ 1.12 $ 0.64 $ 0.95 ========================================================= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING BASIC 8,203 8,227 8,232 8,245 8,191 ========================================================= DILUTED 9,946 10,842 10,757 8,415 8,611 ========================================================= BALANCE SHEET DATA: WORKING CAPITAL $ 714 $ 4,786 $(21,745) $ 54,120 $(19,109) TOTAL ASSETS 180,391 220,790 263,709 299,877 295,001 LONG-TERM DEBT AND CAPITALIZED LEASES 87,739 89,343 138,794 154,638 128,946 SHAREHOLDERS' EQUITY 65,158 82,737 89,736 95,352 98,099
- 15 - 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. OVERVIEW The Company derives revenue primarily from hotel room sales at its Sumner Suites and Company-owned Shoney's Inn hotels. Through March 1995, the Company managed AmeriSuites hotels and earned management fees for such services. The Company also receives management fees for services it performs for two franchised Shoney's Inns. The Company derives additional revenue from franchise fees it receives as the exclusive franchisor of Shoney's Inns. The Company's hotel operations have been supplemented by contract revenues from construction and development of franchised Shoney's Inns and, until March 1995, AmeriSuites hotels for third parties. Revenues from these activities have varied widely from period to period, depending upon whether the Company's construction and development activities were primarily focused on its own facilities or on outside projects. Construction revenues are recognized on the percentage of completion basis. From 1990 through the first quarter of fiscal 1995, the Company developed and owned or managed hotels in the AmeriSuites hotel chain. In March 1995, the company terminated its relationship with AmeriSuites by (i) selling its option to purchase 50% of the voting stock of Suites of America, Inc. ("Suites of America") to Prime Hospitality Corp. ("Prime Hospitality") for $27.3 million and (ii) conveying to Suites of America its interest in one additional AmeriSuites hotel for $6.2 million. Five million dollars of the aggregate purchase price was paid in cash on closing, while the remaining $28.5 million was paid pursuant to a note that was repaid in January 1996. In connection with the sale of its option in Suites of America to Prime Hospitality, the Company canceled $14.9 million in existing indebtedness of Suites of America to the Company. These transactions, together with the sale of five AmeriSuites hotels in 1993 and 1994 (collectively, the "AmeriSuites Transaction"), have been accounted for as installment sales of real estate in the Company's Consolidated Financial Statements, and a pre-tax gain of $15.6 million was recognized through 1996 in connection therewith. The transactions also resulted in the recognition in fiscal 1995 of $2.9 million of previously deferred management fee revenue. During first quarter of fiscal 1996, the Company sold its 60% ownership in five restaurants to the 40% owner for a note receivable. The income or loss from restaurant operations for each of the reported periods is reported as discontinued operations net of applicable income taxes and minority interest. The Company initially deferred recognition of the gain from the sale of this segment until further principal payments on the note were received. In fiscal 1996 $40,000 of this gain was recognized and in fiscal 1997, the remaining $813,000 was recognized as gain on disposal of discontinued business segment. - 16 - 19 The Company's hotel operations have historically been seasonal in nature, reflecting higher occupancy rates during spring and summer months, which may be expected to cause fluctuations in the Company's quarterly revenues and earnings from hotel operations. The Company's fiscal year ends on the last Sunday of the calendar year. The Company elected to make a change in accounting for pre-opening costs effective with the beginning of its 1997 fiscal year to reflect the preferable method of expensing pre-opening costs as incurred, rather than capitalizing those expenditures and amortizing them over a three-year period. - 17 - 20 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage relationship of certain items of revenue and expense to the total revenues of the Company.
FISCAL YEAR ENDED ----------------------------------------- DEC. 29, DEC. 28, DEC. 27, 1996 1997 1998 ----------------------------------------- Revenues: Hotel 90.6% 95.8% 95.6% Construction and development 2.6% 0.0% 0.1% Franchising and management 6.8% 4.2% 4.3% Total operating revenues 100.0% 100.0% 100.0% Costs and Expenses: Operating expenses: Hotel 48.8% 57.2% 62.0% Construction and development 1.9% 0.0% 0.1% Franchising and management 5.1% 3.1% 3.3% ------ ------ ------- Total operating expenses 55.8% 60.3% 65.4% ------ ------ ------- General and administrative 3.4% 5.3% 8.8% Rent expense 1.4% 2.7% 13.6% Depreciation and amortization 12.4% 13.8% 11.1% ------ ------ ------- Income from operations 27.0% 18.0% 1.2% Other Income (expenses): Interest expense (7.3)% (15.0)% (14.4)% Interest income 2.2% 2.3% 6.8% Gain on sale of property 0.5% 5.1% 28.5% Other income 1.9% 1.1% 0.6% ------ ------ ------- Earnings from Continuing Operations Before Income Taxes, Minority Interest, Extraordinary Items and Cumulative Effect of Change in Accounting Policy 24.4% 11.5% 22.7% Income Taxes (8.8)% (3.0)% (9.1)% Minority Interest in Earnings of Consolidated Subsidiaries and Partnerships (0.7)% (0.2)% (0.9)% ------ ------ ------- Earnings from Continuing Operations Before Extraordinary Items and Cumulative Effect of Change in Accounting Policy 14.9% 8.2% 12.7% Discontinued Operations: Gain on disposal of discontinued business segment, net of income tax effect 0.0% 0.7% 0.0% Extraordinary Losses, net of income tax benefit 0.0% (0.2)% (1.5)% Cumulative Effect of Change in Accounting Policy, net of income tax effect 0.0% (1.5)% 0.0% ------ ------ ------- Net earnings 15.0% 7.1% 11.2% ====== ====== =======
- 18 - 21 FOR THE FISCAL YEARS ENDED DECEMBER 27, 1998 AND DECEMBER 28, 1997 For the fiscal year ended December 27, 1998, total operating revenues decreased 3.6% to $72.4 million from $75.1 million for the fiscal year ended December 28, 1997. Revenues from hotel operations in fiscal 1998 decreased by 3.8% to $69.2 million from $71.9 million for fiscal year 1997. For the 28 hotels opened for all of both years (same hotels), average daily room rates in 1998 increased 3.7% to $63.01 from $60.74 in 1997, while average occupancy rates increased to 57.3% from 56.5%, resulting in a total increase in same hotel revenues per available room (RevPAR) of 5.1%, from $34.34 in 1997 to $36.10 in 1998. The remaining (non-same) hotels contributed $25.5 million to hotel revenues in 1998 compared with $29.9 million in 1997. The $25.5 million revenues from non-same hotels in 1998 consisted of $10.1 million from new hotels and $15.4 million from 17 hotels which were sold (one in fourth quarter 1997 and 16 in third quarter 1998). The $29.9 million revenues from non-same hotels in 1997 consisted of $1.9 million from new hotels and $28.0 million from the 17 hotels sold in 1997 and 1998. The Company owns and operates two hotel brands - Shoney's Inns and Sumner Suites hotels. RevPAR for all Company-owned Shoney's Inns declined by 2.8% in 1998 from 1997, from $30.83 to $29.98; however, for this same period, RevPAR for the 15 Shoney's Inns which the Company currently owns, declined only slightly, from $26.94 in 1997 to $26.90 in 1998. The 23 Sumner Suites hotels' RevPAR increased in 1998 by 3.1% from 1997, from $41.66 to $42.96. The 13 Sumner Suites same hotels' RevPAR increased by 8.9% from $42.78 in 1997 to $46.60 in 1998. All future Company-owned hotels currently planned are the Sumner Suites brand. Effective August 1, 1998, the Company sold 16 of its Company-owned Shoney's Inns, and will consider additional opportunities to sell its remaining 15 Company-owned Shoney's Inns. Revenues from construction and development activities during 1998 were only $81,000 compared with none in 1997. Revenues from construction and development can vary widely from period to period depending upon the volume of outside contract work and the timing of those projects. Franchising and management revenues in fiscal 1998 declined by 1.4% from 1997 to $3.1 million in 1998 compared with $3.2 million in 1997. A decrease in monthly franchising fees resulted primarily from (1) the loss of 14 Shoney's Inns from the chain in the first half of 1998, and (2) the cancellation of reservation services by two hotel chains in the first half of 1997. These decreases were offset by (1) the addition of new franchisees, primarily the 16 acquired from the Company in the third quarter of 1998, and (2) franchise termination fees of $257,000 earned in 1998 from the termination of four franchises compared with no such fees in 1997. Initial franchise fees and franchise termination fees may vary widely from year to year. At the end of fiscal 1998 there were 59 franchised Shoney's Inns in operation. Management fee revenue in fiscal 1998 decreased by 1.5%, from $139,000 in 1997 to $137,000 in 1998, on the two Company-managed Shoney's Inns. Hotel operating expenses for fiscal 1998 increased by 4.6% to $44.9 million from $43.0 million in 1997. Operating expenses of all Company-owned Shoney's Inns declined by $6.0 million; however, revenues from these hotels declined by $12.9 million. Both declines were due to the sale of the hotels discussed earlier. The gross operating profit margin on all 32 Shoney's Inns declined from 40.5% in 1997 to 35.3% in 1998. Operating expenses on the 15 Shoney's Inns not sold increased by 1.6% in 1998 over 1997 even though revenues from these hotels declined by 1.5% from 1997 to 1998. The gross operating profit margin on these Shoney's Inns currently owned declined from 34.3% in 1997 to 32.2% in 1998. Operating expenses of the 13 same-hotel Sumner Suites increased by $1.5 million due primarily to the $1.9 million increase in hotel revenues. The gross profit margin on these same-hotels declined slightly, from 42.2% in 1997 to 40.9% - 19 - 22 in 1998. All 23 Sumner Suites hotels reflected an increase in hotel operating expenses of $8.0 million from $16.1 million in 1997 to $24.0 million in 1998, due primarily to the $10.2 million increase in hotel revenues. The gross profit margin on all Sumner Suites hotels declined from 39.8% in 1997 to 34.9% in 1998. Hotel operating expenses and gross profit margins for the Sumner Suites hotels reflects the pre-opening costs for new hotels. In 1998, six new hotels were opened and three additional hotels were nearing completion by year-end. Only four new hotels were opened in 1997. The increased number of new hotels in 1998 as compared with 1997 caused pre-opening expenses to be higher in 1998 than in 1997. Other hotel operating expenses which increased as percentages of hotel revenues in 1998 over 1997 were payroll related costs, replacement reserve provisions, real estate taxes, repairs and maintenance, complimentary food and beverage cost, and travel agent commissions. Construction and development costs on outside contracts was $71,000 in 1998 versus none in 1997. These costs were incurred in connection with the $81,000 earned in construction and development revenues in 1998. Franchising and management operating expenses in 1998 increased by 4.0% to $2.4 million from $2.3 million in 1997. The increase was due primarily to increases in travel expense, inspections cost and training expenses. General and administrative expense increased 60.9% to $6.4 million in 1998 from $4.0 million in 1997. The increase was due primarily to increased professional fees, increased land acquisition costs as a result of implementing Emerging Issues Task Force ("EITF") No. 97-11, increased corporate franchise taxes, and increased expenses related to the occupancy of the new corporate headquarters building. Rent expense increased by $7.8 million, from $2.0 million in 1997 to $9.8 million in 1998. This increase was due to the sale-leaseback of 14 hotels in November 1997, for which rent expense in 1998 was $9.0 million compared with $1.1 million in 1997. This increase was partially offset by reduction in rent expense due to the sale of certain Shoney's Inns in 1998 which were on leased land. Depreciation and amortization expense decreased by 22.8% to $8.0 million in 1998 from $10.4 million in 1997. The sale-leaseback of 14 hotels in late 1997 caused depreciation expense to be eliminated on those hotels for 1998; depreciation expense on those 14 hotels in 1997 was $2.8 million. The sale of one hotel in December 1997 and 16 hotels in August 1998 reduced depreciation expense as well; depreciation expense on those 17 hotels declined by $1.3 million, from $3.4 million in 1997 to $2.1 million in 1998. These reductions were partially offset, however, with increases totaling $1.7 million in depreciation and amortization on additions to depreciable and amortizable assets beginning with first quarter 1997. Ten new hotel openings and several renovations of existing hotels occurred during 1997 and 1998. In 1998, interest expense decreased by $883,000 while interest income increased by $3.2 million, for a total decrease in net interest expense of $4.1 million as compared with 1997. This reduction in net interest expense from 1997 to 1998 was primarily the result of (1) the sale-leaseback of 14 hotels in late 1997, the proceeds of which were used to reduce indebtedness and to invest in interest earning funds until needed for capital expenditures for new hotels, (2) the sale of 17 hotels in December 1997 and August 1998, the proceeds of which were used to reduce indebtedness and to invest in interest-earning funds until needed, and (3) interest earned on the seller-financed promissory notes resulting from the sales transactions. The gain on sale of property in 1998 primarily represents a portion of the gain on the sale of 16 hotels in third quarter 1998 for $90.0 million, consisting of $22.5 million in cash with the balance of $67.5 million in the form of interest-bearing promissory notes. Profit was recognized on 12 of the sales under the full accrual method of accounting. Profit recognition on the other 4 hotels sold is being accounted for under the installment method. Of the approximately $12.0 million profit on these - 20 - 23 4 hotels, $77,000 was recognized in 1998, with the balance to be recognized in future quarters on the installment method of accounting. $194,000 of the 1998 gain on sale of property was from the sale of properties other than the 16 hotels. The $3.8 million gain on sale of property in 1997 consisted of $2.2 million from the sale of one hotel and $1.6 million from the sale of land held for resale. Other income declined by 47.3% in 1998 from 1997, from $838,000 to $441,000. This decline was due primarily to the sale of hotels in 1998 which generated rental income. Minority interests in earnings and losses of subsidiaries and partnerships increased by $475,000 in 1998 from 1997, due primarily to minority ownership interest in the gain on sale of property in third quarter 1998. Income tax expense as a percentage of pre-tax earnings from continuing operations before extraordinary items in 1998 was 41.7% compared with 26.7% in 1997. The unusually high effective rate in 1998 was due primarily to interest due to the Internal Revenue Service resulting from the deferral of federally taxable income due to the installment sales accounting resulting from the sale of 16 hotels in 1998. The unusually low effective income tax rate in 1997 was due primarily to refunds of prior years' state taxes. The gain on disposal of a discontinued business segment in 1997 was the result of the recognition of previously deferred profit from the sale of the Company's 60% interest in a restaurant subsidiary to the then 40% owner. The extraordinary loss from early extinguishment of debt in 1998 was a result of debt paid off in conjunction with the sale of 16 hotels previously discussed. In 1997, the loss was a result of debt paid off in connection with the sale-leaseback transaction with a real estate investment trust. The cumulative effect of a change in accounting principle in 1997 represents the write-off of the unamortized balance of previously capitalized pre-opening costs as of the beginning of the 1997 fiscal year. Beginning with 1997, these costs are expensed as incurred. FOR THE FISCAL YEARS ENDED DECEMBER 28, 1997 AND DECEMBER 29, 1996 For the fiscal year ended December 28, 1997, total operating revenues increased 18.3% to $75.1 million from $63.5 million for the fiscal year ended December 29, 1996. Revenues from hotel operations in fiscal 1997 increased 25.1% to $71.9 million from $57.5 million for fiscal 1996. This increase resulted primarily from more available hotel rooms in 1997 as compared to fiscal 1996. Sixteen hotels which opened during fiscal 1996 and fiscal 1997 contributed $15.4 million more to room revenues in fiscal 1997 than in fiscal 1996. Two Shoney's Inns were opened in the first quarter of 1996; the remaining 14 hotels opened during 1996 and 1997 were Sumner Suites hotels. All-Hotels RevPAR (revenue per available room) from the 17 Sumner Suites hotels increased by $5.61, or 15.6%, from $36.05 in 1996 to $41.66 in 1997. Same-Hotels RevPAR from the Sumner Suites hotels increased by $6.78, or 16.1%, from $42.24 in 1996 to $49.02 in 1997. RevPAR for the Company-owned Shoney's Inns declined slightly from $31.41 in 1996 to $30.83 in 1997. There were no revenues from construction and development activities during 1997 compared with $1.7 million in 1996. Revenues from construction and development can vary widely from period to period depending upon the volume of outside contract work and the timing of those projects. Only one outside construction project was finished in early 1996 and the balance of construction and development related to the AmeriSuites Transaction (discussed in the overview) was earned in 1996. Franchising and management revenues in fiscal 1997 declined 26.3% to $3.2 million from $4.3 million in fiscal 1996. The decrease was due primarily to the cancellation of reservation services by two hotel chains in the first quarter of 1997 and to a decrease of $315,000 in initial franchise fee revenue from 1996 to 1997. Initial - 21 - 24 franchise fees may vary widely from year to year. At the end of fiscal 1997 there were 57 franchised Shoney's Inns in operation. One franchisee has cancelled license agreements on 14 Shoney's Inns; therefore, future franchise revenues could be negatively impacted by the loss of these franchises. Management Fee revenue in fiscal 1997 decreased 25.2% to $139,000 from $185,000 in fiscal 1996, due to the cancellation of one management contract on one hotel in the third quarter of 1996. Hotel operating expenses for fiscal 1997 increased by 38.7% to $43.0 million from $31.0 million in fiscal 1996. Operating expenses of the 32 Shoney's Inns increased by $1.9 million in 1997 over 1996 even though revenues from these Inns declined by $1.3 million. The gross operating profit margin on these 32 Inns declined from 46.6% in 1996 to 40.7% in 1997. The increases in operating expenses which accounted for the negative impact on profit margin were primarily in the areas of real estate taxes, insurance, advertising, complimentary food and beverage, and payroll related expenses. Operating expenses of the same-hotel Sumner Suites increased by $277,000 due primarily to the $557,000 increase in hotel revenues. The gross profit margin on these same-hotels increased from 46.0% in 1996 to 46.4% in 1997. All 17 Sumner Suites hotels reflected an increase in hotel operating expenses of $10.1 million from $6.3 million in 1996 to $16.4 million in 1997, due primarily to the $15.8 million increase in revenues from these properties. The 14 non-same Sumner Suites hotels (those not open for the full year in both 1996 and 1997) reduced the gross operating profit margin on all Sumner Suites hotels from 44.4% in 1996 to 39.5% in 1997. The change in accounting for pre-opening costs effective with the 1997 fiscal year to expense these costs as incurred versus the capitalization of such costs in 1996 and prior years, accounted for $664,000 of the increase in hotel operating expenses in 1997 over 1996. This negatively impacted the gross profit margin on all-hotel Sumner Suites by 2.4 percentage points, or approximately 50% of the total decline in gross profit margin from 1996 to 1997. There were no costs and expenses of construction and development in 1997 as there were no outside construction contracts, compared with $1.2 million in 1996 as one outside construction contract was completed early in the year. Franchising and management operating expenses for 1997 decreased 29.3% to $2.3 million from $3.3 million in 1996. The primary reason for this decrease was the cancellation in the fourth quarter of 1996 of the Company's obligation to pay a portion of franchise fees collected to Shoney's, Inc. The reduction of this royalty fee expense from 1996 to 1997 was $758,000. The balance of the reduction in franchise operating expenses from 1996 to 1997 was due primarily to reduced expenses associated with loss of revenues from the cancellation of reservation services by two hotel chains in the first quarter of 1997. General and administrative expense increased 83.2% to $4.0 million in fiscal 1997 from $2.2 million in 1996. This increase was due primarily to an increase in professional fees, payroll costs, insurance, internal development expenses, and taxes other than income taxes. Rent expense increased from $861,000 in 1996 to $2.0 million in 1997. The $1.1 million increase was due entirely to a sale/leaseback transaction on 14 of the Company's Sumner Suites hotels in the fourth quarter of 1997. Net rent expense on these 14 hotels is currently at a rate of approximately $9.0 million per year. Depreciation and amortization expense increased by 32.0% to $10.4 million in fiscal 1997 from $7.9 million in fiscal 1996, due primarily to the 16 hotels opened during fiscal 1996 and fiscal 1997. This increase was partially offset by the effect of the change in accounting for pre-opening costs in 1997 to expense these costs as incurred. Consequently there was no pre-opening cost amortization in 1997 versus $550,000 reported for 1996. - 22 - 25 For 1997, interest expense and interest income increased $6.7 million and $371,000, respectively, from 1996, resulting in an increase in net interest expense of $6.3 million. The increase in interest expense resulted primarily from the additional borrowings incurred for the 16 hotels opened in 1996 and 1997. Gain on sale of property increased by $3.5 million in 1997 from 1996. The $3.8 million gain in 1997 consisted of $2.2 million from the sale of one hotel and $1.6 million from the sale of land held for resale. The $340,000 gain in 1996 was from the sale of land held for resale. Other income in fiscal 1997 decreased by $381,000 from fiscal 1996, from $1.2 million to $838,000. The decrease was due primarily to a gain of $430,000 in 1996 on the sale of available-for-sale securities. Minority interests in earnings and losses of consolidated subsidiaries and partnerships decreased $250,000 in 1997 compared with 1996, due to less profitable consolidated entities which include minority ownership, the write-off of a $72,000 minority interest receivable in 1997, and the recovery of fees and expenses from a subsidiary partnership in 1997. The lower effective income tax rate in 1997 is due primarily to refunds of prior years' state taxes. The gain on disposal of a discontinued business segment in 1997 was the result of the recognition of previously deferred profit from the sale of the Company's 60% interest in a restaurant subsidiary to the then 40% owner. Only $25,000 of this deferred gain was recognized in 1996. The extraordinary loss on early extinguishment of debt in 1997 was due to approximately $10.5 million of equipment loans being paid off in connection with the sale/leaseback transaction with a real estate investment trust. The cumulative effect of a change in accounting principle represents the write-off of the unamortized balance of previously capitalized pre-opening costs as of the beginning of the 1997 fiscal year. Beginning with 1997, these costs are expensed as incurred. LIQUIDITY AND CAPITAL RESOURCES The Company's cash flows used in operating activities were $2.7 million in 1998, compared with $4.0 million used in operating activities in 1997 and $14.2 million provided in 1996. Earnings from continuing operations before extraordinary losses and cumulative effect of change in accounting policy were $9.2 million in 1998, $6.2 million in 1997, and $9.5 million in 1996. Depreciation and amortization was $8.0 million, $11.0 million, and $8.2 million in 1998, 1997, and 1996, respectively, with the $3 million net decrease in 1998 being due to the sale of properties in 1997 and 1998. The Company recognized $20.6 million from gains on sale of property during 1998, of which $20.4 million was from the sale of 16 lodging facilities. The $3.8 million gain on sale of property in 1997 represented $2.2 million from the sale of one lodging facility and $1.6 million from the sale of land held for resale. Only $340,000 in gains from property sales occurred in 1996. A reduction of income taxes receivable of $1.4 million from 1997 to 1998 provided cash flow in 1998 versus using cash in 1997. Other assets increased by $1.2 million, decreased by $1.0 million, and increased by $1.7 million in 1998, 1997, and 1996, respectively. Accounts payable and accrued expenses increased by $519,000 in 1998, providing cash, decreased by $1.1 million in 1997, using cash, and increased by $4.3 million in 1996, providing cash. Decreases in income and other taxes used $493,000 and $350,000 in funds in 1998 and 1997, respectively, while increases in 1996 provided $2.7 million cash. The Company's cash flows used in investing activities were $63.2 million in 1998 and $39.4 million in 1996, whereas cash flows provided by investing activities were $58.1 million in 1997. The increase of $97.4 million in cash provided by investing activities in 1997 over 1996 was due primarily to the sale/leaseback of 14 hotels in 1997, of which net proceeds approximated $137.0 million. $28.0 million of the proceeds - 23 - 26 are being held by the acquirer of the properties as security and guaranty deposits. An additional $4.9 million in 1997 was provided from the sale of one other hotel and land held for resale. In 1998, the Company sold 16 hotels providing cash of $8.1 million. Various other properties were sold, providing an additional $1.0 million cash in 1998. The $44.1 million repayment of notes receivable in 1996 represented the collection by the Company of the balance of notes receivable from Suites of America, Inc. related to the AmeriSuites Transaction previously discussed. The Company has required capital principally for the construction and acquisition of new lodging facilities and the purchase of equipment and leasehold improvements. Capital expenditures for such purposes were $72.5 million, $55.9 million, and $86.6 million in 1998, 1997, and 1996, respectively. Net cash provided by financing activities was $9.8 million, $284,000 and $26.9 million in 1998, 1997 and 1996, respectively. In November of 1996 the Company issued $33.2 million in 9.75% Senior Subordinated Notes, due 2006, Series A in the first series of notes issued under a $125 million shelf registration. In September of 1997 the Company issued $35.0 million of 9.55% Senior Subordinated Notes, due 2007, Series B under the Company's shelf registration. Net proceeds of both of these issues were used to reduce the outstanding balances under the Company's revolving credit facilities. A portion of the net proceeds from the sale/leaseback of 14 hotels in 1997 was also used to pay off the balance of the revolving credit facilities, a bank line of credit loan, and approximately $10.5 million of furniture, fixture and equipment loans. Proceeds from the financing of new furniture, fixtures and equipment were approximately $4.0 million in 1997 and $5.6 million in 1996. In 1998, the Company sold 16 hotels, using a portion of the net proceeds to reduce indebtedness. The transaction also resulted in the write-off of deferred financing charges related to the debt paid off early, and distributions of $2.0 million to minority owners of two of the hotels sold. In 1996 the Company paid approximately $2.1 million to Shoney's, Inc. to repurchase a stock warrant. In 1998, the Company repurchased 784,000 shares of its common stock for $5.4 million pursuant to a plan to repurchase up to $12.5 million of the Company's outstanding common stock. The Company maintains a revolving credit facility with a group of five banks. Effective October 21, 1998, the Company amended the terms of this revolving credit agreement. The availability under the amended credit agreement totals $30 million and is secured by a pledge of certain promissory notes payable to the Company, received in connection with the sale of 16 of the Company's lodging facilities in the third quarter of 1998. The amended credit facility terminates June 30, 1999. Other terms and conditions of the credit agreement as amended in October 1998, including interest rates and covenant requirements, were similar to the previous credit agreement. As of December 27, 1998, the Company had $20.3 million borrowed under this credit facility and has borrowed an additional $4.9 million under this credit facility since December 27, 1998. On April 9, 1999, the Company and its lenders further amended the agreement to eliminate any future LIBOR borrowings, to amend the base interest rate to prime plus 1.25% and to require a monthly maintenance fee. The Company also maintains a $1 million unsecured line of credit with another bank, bearing interest at the lender's prime rate, maturing May 31, 1999. As of December 27, 1998 and through April 7, 1999, the Company had no borrowings outstanding under this credit facility. The Company opened six new Sumner Suites hotels in 1998 and, as of the end of fiscal 1998, had three Sumner Suites hotels under construction which are expected to open in the first quarter of 1999. The Company estimates that approximately $3.6 million in capital funds will be necessary to complete the construction of the three hotels under construction. Additionally, the Company has acquired five sites for future development and estimates that approximately $34.6 million in capital funds will be required to complete their development, some or all of which may be complete by the end of 1999. The Company has decided to slow its aggressive development schedule of new Sumner Suites hotels in the near term. This decision was based on current market conditions, rooms supply in certain areas, and capital availability. - 24 - 27 On September 23, 1998, the Company's Board of Directors authorized the use of up to $12.5 million for the repurchase of shares of the Company's common stock. The purchases, including block purchases, are to be made from time to time in the open market at prevailing market prices, or in privately negotiated transactions at the Company's discretion. No time limit has been placed on the duration of the stock repurchase plan, and the Company may discontinue the plan at any time. 784,000 shares had been repurchased by the end of fiscal 1998 at a cost of $5.4 million. The Company is investigating various alternatives to maximize shareholder value. These alternatives could include, without limitation, a continuation of the development and operation of Sumner Suites and the franchising and operation of Shoney's Inns, a sale of the remaining Shoney's Inns, the sale-leaseback of some of the Company's Sumner Suites hotels, negotiating new credit arrangements, an increase in developing hotels for other owners, the repurchase of additional shares of the Company's common stock or outstanding debt securities, or any combination of these or other strategies. The Company believes that a combination of net cash provided by operations, net proceeds from possible future sale-leaseback transactions, the collection of notes receivable, borrowings under new credit facilities or mortgage debt, and available furniture, fixture and equipment financing packages will be sufficient to fund the Company's currently anticipated needs for the next twelve months, including the repayment of amounts maturing in June 1999 under the Company's revolving line of credit. YEAR 2000 ISSUE The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing a possible disruption of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Based on recent assessments, the Company has determined that it will be required to modify or replace significant portions of its software and certain hardware so that those systems will properly utilize dates beyond December 31, 1999. The Company presently believes that with modifications or replacements of existing software and certain hardware, the Year 2000 Issue can be mitigated. However, if such modifications or replacements are not made, or are not completed timely, the Year 2000 Issue could have a material impact on the operations of the Company. The Company has divided the Year 2000 Issue into what it considers being critical and non-critical issues. The Company believes that in its line of business the critical issues involve the ability to process hotel sales transactions beginning with hotel reservations through settlement and collection. Additionally, critical importance has been placed on the Company's ability to process and maintain accurate accounting, financial and corporate records. The systems that the Company has identified as being critical are the core business software applications including, but not limited to, the following: the IBM AS400 operating system, the accounting and financial reporting system, the front desk and credit card payment system, the room door key system, the central reservations system, and the cash management software. In addition, the computer systems maintained by the Company's banks and the telecommunications systems maintained by the Company's telecommunications vendor have been identified as critical systems. The Company has also identified non-critical issues relating to peripheral business software including, but not limited to: stand alone personal computers, in-house development applications, Windows NT and the 98 operating system, spreadsheet software, word processing software, network server back-up software, development tools software and computer systems maintained by other third party vendors. - 25 - 28 The Company is currently in the process of making the required modifications to its existing software systems and scheduling the required replacements of software and hardware. The Company will utilize both internal and external resources to program, replace, implement and test these changes. The Company has not determined the total cost of the Year 2000 project; however, these costs are not expected to exceed $100,000 nor have a material effect on its financial statements. The Company has spent less than $25,000 on external costs on the Year 2000 project through the end of fiscal 1998; however, the Company's internal staff has spent substantial time on the issue. These costs have been expensed as incurred. The Company plans to complete the Year 2000 project not later than September, 1999 and is currently on schedule to meet this target. The Company believes it has an effective program in place to resolve the Year 2000 Issue in a timely manner. As noted above, the Company has not yet completed all necessary phases of the Year 2000 project. In the event that the Company does not timely complete the project, the Company could be unable to take reservations, invoice customers or collect payments. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect the Company's operations. The amount of potential liability or lost revenue cannot be reasonably estimated at this time. The Company currently has no contingency plans in place in the event it does not complete the Year 2000 project. The Company plans to evaluate the status of completion in June 1999 and determine whether a contingency plan may be necessary. FORWARD-LOOKING STATEMENT DISCLAIMER The statements appearing in this report which are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in the forward-looking statements, including delays in concluding or the inability to conclude transactions, the establishment of competing facilities and services, cancellation of leases or contracts, changes in applicable laws and regulation, in margins, demand fluctuations, access to debt or equity financing, adverse uninsured determinations in existing or future litigation or regulatory proceedings and other risks. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The Company has not entered into any transactions using derivative financial instruments and believes that its exposure to market risk associated with other financial instruments is not material. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Financial Statements required by Item 8 are filed at the end of this Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. On November 24, 1998, the firm of Deloitte & Touche LLP verbally notified the Company that they were resigning as auditors of the Company and confirmed such resignation in writing by letter dated November 30, 1998. A copy of that letter was attached as Exhibit 7.1 to the Company's Form 8-K filed with the Securities and Exchange Commission on December 2, 1998. - 26 - 29 The reports of Deloitte & Touche LLP on the Company's financial statements for the past two fiscal years did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles. Disagreements: In connection with the audits of the Company's financial statements for the fiscal years ended December 28, 1997 and December 29, 1996, and during the subsequent unaudited interim periods since 1997 Deloitte & Touche LLP cited three disagreements on matters of accounting principles or practices which if not resolved to the satisfaction of Deloitte & Touche LLP would have caused Deloitte & Touche LLP to make reference to the matter in their report. The disagreements as communicated to the Company's Audit Committee related to the 1997 (i) accounting for profits on certain real estate transactions, (ii) capitalization of general and administrative costs, and (iii) recording intercompany revenues for rooms rented to construction workers. The matter of accounting for profits on certain real estate transactions involved the question of the timing of earnings recognition and also the allocation of cost basis among various outparcels of land sold to third parties. The matter of capitalization or general and administrative costs concerned the method of allocating certain indirect costs, such as salaries and related employee benefits, utilities, telephone expense, printing and supplies, and other overhead expenses, to internal development costs to be capitalized. The matter of recording intercompany revenues for rooms rented to construction workers resulted from the Company's recording room revenues at the hotel properties earned from the construction company subsidiary of the Company during renovation or construction of Company-owned hotels. Management recorded adjustments relating to each of these transactions and also restated its financial statements for each of the quarters in fiscal 1997, as described in three Form 10-Q/A's filed on March 30, 1998 with the Securities and Exchange Commission; Deloitte & Touche LLP indicated that the disagreements were satisfactorily resolved. The Company's Audit Committee discussed each of these disagreements with Deloitte & Touche LLP. The Company authorized Deloitte & Touche LLP to respond fully to any successor independent auditing firm regarding each disagreement. Deloitte & Touche LLP cited no disagreements in this two year period regarding financial statement disclosure or auditing scope and procedures which if not resolved to the satisfaction of Deloitte & Touche LLP would have caused Deloitte & Touche LLP to make reference to the matter in their report. There were no disagreements on any types of matters described in Regulation S-K Item 304 in 1996 or in the subsequent unaudited interim periods since 1997. Reportable Conditions In addition, in connection with the 1997 audit there were six "reportable conditions" as that term is described in Item 304(a)(1)(v)(A) of Regulation S-K; that is, Deloitte & Touche LLP advised the Company that the internal controls necessary for the development of reliable financial statements were inadequate. The 1997 reportable conditions related to the following matters: accounting structure and internal controls (which matter is considered by Deloitte & Touche LLP to be a material weakness), accounting for certain real estate transactions, capitalization of indirect costs associated with internal development and construction, construction company accounting, capitalization of interest on land under development, and accounts receivable allowance analysis. There were four "reportable conditions" in connection with the 1996 audit; also of the type described in Item 304(a)(1)(v)(A) of Regulation S-K. They related to the accounting for capitalization of indirect costs associated with internal development and construction, capitalization of construction period interest, capitalization of pre-opening costs and accounting structure and the reporting process. The Company's present accounting systems and internal controls appeared to Deloitte & Touche LLP to be inadequate to ensure that transactions are recorded and reported in conformity with generally accepted accounting principles. - 27 - 30 The Company's Audit Committee discussed each of these "reportable conditions" with Deloitte & Touche LLP. The Company authorized Deloitte & Touche LLP to respond fully to any successor independent auditing firm regarding each reportable condition. The Company requested Deloitte & Touche LLP to furnish a letter addressed to the Commission stating whether it agreed with the above statements. The letter from the former accountant dated December 2, 1998 was filed as Exhibit 7.2 to the Company's Report on Form 8-K filed with the Commission on December 2, 1998. A subsequent letter from the former accountant dated December 18, 1998 and received by the Company on December 22, 1998 was filed as Exhibit 7.2 to the Company's Report on Form 8-K/A filed with the Commission on December 23, 1998. Engagement of New Auditors On December 7, 1998 the Board of Directors and the Audit Committee of the Company approved the engagement of Ernst & Young LLP as its independent auditors for the fiscal year ending December 27, 1998. The Company did not consult with Ernst & Young LLP during the fiscal year ended December 29, 1996, the fiscal year ended December 28, 1997 or during the subsequent interim periods since 1997 with respect to the application of accounting principles, the type of audit opinion that might be rendered on the Company's financial statements or any matter that was the subject of a disagreement or reportable event with the Company's former auditors. The Company requested Deloitte & Touche LLP to furnish a letter stating whether it agreed with the above statements. A copy of that letter, dated December 8, 1998 was filed as Exhibit 7.1 to the Company's Report on Form 8-K filed with the Commission on December 8, 1998. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information concerning the directors and officers of the Company under the heading "Election of Director" and the information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934 under the heading "Delinquent Filings of Ownership Reports" to be contained in the Company's Proxy Statement with respect to the next Annual Meeting of Shareholders is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. The information under the heading "Executive Compensation" and the information under the heading "Performance Graph" to be contained in the Company's Proxy Statement with respect to the next Annual Meeting of Shareholders is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information under the heading "Security Ownership of Certain Beneficial Owners and Management" to be contained in the Company's Proxy Statement with respect to the next Annual Meeting of Shareholders is incorporated herein by reference. - 28 - 31 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information under the heading "Certain Transactions" to be contained in the Company's Proxy Statement with respect to the next Annual Meeting of Shareholders is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
PAGE - ------------------------------------------------------------------------------------------------------------------------- (a) 1. Financial Statements: The following Financial Statements are included herein: Independent Auditors' Report F-1 Report of Ernst & Young LLP F-1 Report of Deloitte & Touche LLP F-2 Consolidated Balance Sheets at December 28, 1997 and December 27, 1998 F-3 - F-4 Consolidated Statements of Earnings for each of the three years in the period ended December 27, 1998 F-5 - F-6 Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 27, 1998 F-7 Consolidated Statements of Cash Flows for each of the three years in the period ended December 27, 1998 F-9 Notes to consolidated financial statements F-11 - F-35 2. Financial Statement Schedules: Independent Auditors' Report S-1 Report of Ernst & Young LLP Report of Deloitte & Touche LLP S-2 Schedule II - Valuation and Qualifying Accounts S-3 All other schedules required by Regulation S-X are omitted as the required information is inapplicable or the information requested thereby is set forth in the financial statements or the notes thereto. 3. Exhibits: The exhibits required by Item 601 of Regulation S-K and paragraph (c) of this Item 14 are listed below. Management contracts and compensatory plans and arrangements required to be filed as exhibits to this form are: 10(14) -- 1991 Stock Option Plan 10(15) -- First Amendment to 1991 Stock Option Plan 10(16) -- Second Amendment to 1991 Stock Option Plan 10(17) -- Key Employee Supplemental Income Plan
- 29 - 32
EXHIBIT NUMBER EXHIBIT - ------ ------- 3(1) -- Amended and Restated Charter. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 3(2) -- Articles of Amendment to Charter creating Series A Subordinated Preferred Stock. Incorporated by reference to the Company's Registration Statement on Form 8-A filed with the Commission on July 3, 1997 3(3) -- Articles of Amendment to Amended and Restated Charter dated September 8, 1997. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on April 13, 1998 3(4) -- Amended and Restated Bylaws. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 3(5) -- Amendment to the Amended and Restated Bylaws adopted on July 31, 1996. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on April 13, 1998 4(1) -- Amended and Restated Charter. Section 6 of the Amended and Restated Charter is included in Exhibit 3(1) 4(2) -- Registration Rights Agreement, dated December 11, 1991 between the Registrant and Richard L. Johnson. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 4(3) -- First Amendment to Registration Rights Agreement between Registrant and Richard L. Johnson, dated as of October 10, 1986. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on November 20, 1996 4(4) -- Second Amendment to Registration Rights Agreement between Registrant and Richard L. Johnson, dated as of June 20, 1997. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on August 27, 1997 4(5) -- Third Amendment to Registration Rights Agreement between Registrant and Richard L. Johnson, dated as of July 21, 1998. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on November 19, 1998 4(6) -- Indenture dated as of June 6, 1994, by and between the Registrant and Third National Bank in Nashville, Tennessee, Trustee, relating to $54,000,000 in 7 1/2 Convertible Subordinated Debentures due 2004. Incorporated by reference to the Company's Registration Statement on Form S-3, Commission File No. 33-77910, filed with the Commission on April 19, 1994 4(7) -- Indenture dated as of November 15, 1996, by and between the Registrant and Bankers Trust Company, Trustee, relating to Senior Subordinated Notes. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on November 20, 1996
- 30 - 33
EXHIBIT NUMBER EXHIBIT - ------ ------- 4(8) -- First Supplemental Indenture dated as of November 15, 1996 by and between the Registrant and Bankers Trust Company, Trustee, relating to 9 3/4% Senior Subordinated Notes due 2006, Series A. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on November 20, 1996 4(9) -- Second Supplemental Indenture dated as of September 25, 1997 by and between the Registrant and Bankers Trust Company, Trustee, relating to 9.55% Senior Subordinated Notes due 2007, Series B. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on September 30, 1997 The Registrant agrees to furnish to the Securities and Exchange Commission, upon request, any and all instruments defining the rights of holders of long-term debt of the Registrant and its subsidiaries, the total amount of which does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis.
- 31 - 34
EXHIBIT NUMBER EXHIBIT - ------ ------- 10(1) -- Second Amended and Restated Partnership Agreement of Shoney's Inn of Baton Rouge dated February 16, 1994. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on March 28, 1994 10(2) -- Second Amended and Restated Partnership Agreement of Shoney's Inn of Independence dated February 16, 1994. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on March 28, 1994 10(3) -- Amended and Restated Partnership Agreement of Demonbreun Hotel Associates, Ltd., dated October 22, 1991. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(4) -- Agreement of Limited Partnership of Shoney's Inn North, Ltd., dated December 31, 1987. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(5) -- Partnership Agreement of Shoney's Inn of Atlanta, N.E., dated December 26, 1988. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(6) -- Partnership Agreement of Shoney's Inn of Stockbridge, dated December 26, 1988. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(7) -- Joint Venture Agreement of Atlanta Shoney's Inns Joint Venture, dated May 4, 1988. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(8) -- Amended and Restated Limited Partnership Agreement of Shoney's Inns of Gulfport, Ltd., dated January 1, 1987. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(9) -- Second Amended and Restated Limited Partnership Agreement of Shoney's Inn of Bossier City, Ltd., dated January 1, 1987. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(10) -- Second Amended and Restated Limited Partnership Agreement of Shoney's Inn of New Orleans, Ltd., dated January 1, 1987. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(11) -- Amended and Restated Limited Partnership Agreement of Shoney's Inn of Opryland, Ltd., dated August 4, 1986, and subsequent amendments. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991
- 32 - 35
EXHIBIT NUMBER EXHIBIT - ------ ------- 10(12) -- 1991 Stock Option Plan. Incorporated by reference to the Company's Registration statement on Form S-8, filed with the Commission on June 24, 1997 10(13) -- First Amendment to 1991 Stock Option Plan. Incorporated by reference to the Company's Registration statement on Form S-8, filed with the Commission on June 24, 1997 10(14) -- Second Amendment to 1991 Stock Option Plan. Incorporated by reference to the Company's Registration statement on Form S-8, filed with the Commission on June 24, 1997 10(15) -- Key Employee Supplemental Income Plan. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(16) -- License Agreement, dated October 25, 1991, by and among the Registrant, Shoney's Investments, Inc. and ShoLodge Franchise Systems, Inc. Incorporated by reference to the Company's Registration statement on Form S-1, Commission File No. 33-44504, filed with the Commission on December 12, 1991 10(17) -- Amendment No. 1 to License Agreement, dated September 16, 1992 by and among Shoney's Investments, Inc., ShoLodge Franchise Systems, Inc. and the Registrant. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on March 29, 1993 10(18) -- Amendment No. 2 to License Agreement, dated March 18, 1994 by and among Shoney's Investments, Inc., ShoLodge Franchise Systems, Inc. and the Registrant. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on March 28, 1994 10(19) -- Amendment No. 3 to License Agreement, dated March 13, 1995 by and among Shoney's Investments, Inc., ShoLodge Franchise Systems, Inc. and the Registrant. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on April 11, 1995 10(20) -- Amendment No. 4 to License Agreement, dated June 26, 1996, by and among Shoney's Investments, Inc., ShoLodge Franchise Systems, Inc. and Registrant. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on August 28, 1996 10(21) -- Amendment No. 5 to License Agreement, dated October 25, 1996, by and among Shoney's Investments, Inc., ShoLodge Franchise Systems, Inc. and Registrant. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on November 20, 1996 10(22) -- Agreement dated March 15, 1994 between ShoLodge Franchise Systems, Inc. and Shoney's of Knoxville, Inc. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on March 28, 1994 10(23) -- Warrant Purchase Agreement between the Registrant and Shoney's Investments, Inc. dated October 25, 1996. Incorporated by reference to the Company's Quarterly Report on For 10-Q, filed with the Commission on November 20, 1996 10(24) -- First Amendment to Amended and Restated Stock Option Agreement dated as of October 10, 1996 between Leon Moore and Richard L. Johnson. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on November 20, 1996
- 33 - 36
EXHIBIT NUMBER EXHIBIT - ------ ------- 10(25) -- Second Amendment to Amended and Restated Stock Option Agreement dated as of June 20, 1997 between Leon Moore and Richard L. Johnson. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on August 27, 1997 10(26) -- Third Amendment to Amended and Restated Stock Option Agreement dated as of July 21, 1998 between Leon Moore and Richard L. Johnson. Incorporated by reference to the Company's Quarterly Report on Form 10- Q, filed with the Commission on November 18, 1998 10(27) -- Credit Agreement dated as of April 30, 1997 by and among the Registrant and certain Subsidiaries of the Registrant, as Borrowers, and the Lenders referred to therein, First Union National Bank of Tennessee, as Administrative Agent, and NationsBank of Tennessee, as Co-Agent. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on August 27, 1997 10(28) -- Joinder Agreement Number 1 to the Credit Agreement, dated as of June 11, 1997. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on August 27, 1997 10(29) -- First Amendment to Credit Agreement, dated as of January 16, 1998, by and among the Registrant and certain subsidiaries of the Registrant, as Borrower, the Lenders referred to therein, First Union National Bank of Tennessee, as Administrative Agent, and NationsBank of Tennessee, as Co-Agent. Incorporated by reference to the Company's Annual Report on Form 10-K, filed with the Commission on April 13, 1998 10(30) -- Second Amendment and Waiver Agreement to Credit Agreement dated as of October 21, 1998, by and among the Registrant and certain subsidiaries, as Borrower, the Lenders referred to therein, First Union National Bank of Tennessee, as Administrative Agent, and NationsBank of Tennessee, as Co-Agent. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on November 19, 1998 10(31) -- Pledge and Security Agreement dated as of October 21, 1998, by the Registrant and certain subsidiaries, as Pledgors, and First Union National Bank as Administrative Agent. Incorporated by reference to the Company's Quarterly Report on Form 10-Q, filed with the Commission on November 18, 1998 10(32) -- Rights Agreement between the Registrant and SunTrust, Atlanta, as Rights Agent, dated as of June 27, 1997. Incorporated by reference to the Company's Registration Statement on Form 8-A filed with the Commission on July 3, 1997 10(33) -- Purchase and Sale Agreement by and between the Registrant and certain of its Affiliates, as Sellers, and Hospitality Properties Trust, as Purchaser, dated October 24, 1997. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on November 13, 1997 10(34) -- Agreement to Lease between Hospitality Properties Trust and the Registrant dated October 24, 1997. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on November 13, 1997
- 34 - 37
EXHIBIT NUMBER EXHIBIT - ------ ------- 10(35) -- Form of Lease Agreement to be entered into between certain Affiliates of the Registrant, as Tenant, and Hospitality Properties Trust, as Landlord. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on November 13, 1997 10(36) -- Form of Security Agreement to be entered into between certain Affiliates of the Registrant, as Tenant, and Hospitality Properties Trust, as Secured Party. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on November 13, 1997 10(37) -- Form of Assignment and Security Agreement to be entered into between certain Affiliates of the Registrant, as Assignor, and Hospitality Properties Trust, as Assignee. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on November 13, 1997 10(38) -- Form of Stock Pledge Agreement to be entered into between the Registrant, as Pledgor, and Hospitality Properties Trust, as Secured Party. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on November 13, 1997 10(39) -- Form of Limited Guaranty Agreement to be entered into by the Registrant, as Guarantor, for the benefit of Hospitality Properties Trust. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on November 13, 1997 10(40) -- Letter between Hospitality Properties Trust and the Registrant dated November 19, 1997. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on December 3, 1997 10(41) -- Motel Purchase Agreement made as of July 22, 1998. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on September 18, 1998 10(42) -- First Amendment to Motel Purchase Agreement made as of July 22, 1998. Incorporated by reference to the Company's Current Report on Form 8-K, filed with the Commission on September 18, 1998 21 -- Subsidiaries of the Registrant* 23(1) -- Consent of Ernst & Young LLP* 23(2) -- Consent of Deloitte & Touche LLP* 27 -- Financial Data Schedule*
* Filed herewith (b) The following reports on Form 8-K were filed during the fourth quarter ended December 27, 1998: Current Report on Form 8-K filed with the Commission on December 2, 1998 relating to the resignation of Deloitte & Touche LLP as auditors of the Registrant Current Report on Form 8-K filed with the Commission on December 8, 1998 relating to the engagement of Ernst & Young LLP as auditors for the Registrant - 35 - 38 Amended Current Report on Form 8-K/A filed with the Commission on December 16, 1998 relating to the resignation of Deloitte & Touche LLP as auditors of the Registrant Amended Current Report on Form 8-K/A filed with the Commission on December 23, 1998 relating to the resignation of Deloitte & Touche LLP as auditors of the Registrant (c) Exhibits required by Item 601 of Regulation S-K are listed above. (d) All financial statement schedules required by Regulation S-X are filed following the Financial Statements listed above. - 36 - 39 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SHOLODGE, INC. By: /s/ Leon Moore Leon Moore, President and Chief Executive Officer April 12, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - --------- ----- ---- /s/ Leon Moore President, Chief Executive April 12, 1999 Leon Moore Officer, Principal Executive Officer, Director /s/ Bob Marlowe Secretary, Treasurer, Chief April 12, 1999 Bob Marlowe Accounting Officer, Principal Accounting Officer, Director /S/ Steven P. Birdwell Senior Vice President and April 12, 1999 Steven P. Birdwell Chief Financial Officer /s/ Richard L. Johnson Executive Vice President, April 12, 1999 Richard L. Johnson Director /s/ Earl H. Sadler Director April 12, 1999 Earl H. Sadler /s/ Helen L. Moskovitz Director April 12, 1999 Helen L. Moskovitz
- 37 - 40 Report of Independent Auditors Shareholders and Board of Directors ShoLodge, Inc. We have audited the consolidated balance sheet of ShoLodge, Inc. and subsidiaries as of December 27, 1998, and the related consolidated statements of earnings, shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 1998 financial statements referred to above present fairly, in all material respects, the consolidated financial position of ShoLodge, Inc. and subsidiaries at December 27, 1998, and the consolidated results of their operations and cash flows for the year then ended, in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Atlanta, Georgia April 12, 1999 F-1 41 DELOITTE & TOUCHE LLP - --------------------- ------------------------------------------------------- Suite 2400 Telephone: (615) 259-1800 424 Church Street Facsimile: (615) 259-1857 SunTrust Center Nashville, Tennessee 37219-2396 INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders ShoLodge, Inc. Hendersonville, Tennessee We have audited the accompanying consolidated balance sheets of ShoLodge, Inc. and subsidiaries as of December 29, 1996 and December 28, 1997, and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of ShoLodge, Inc. and subsidiaries as of December 29, 1996, and December 28, 1997, and the results of their operations and their cash flows for each of the years then ended, in conformity with generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements the Company changed its method of accounting for pre-opening costs for the year ended December 28, 1997. /s/ Deloitte & Touche LLP April 1, 1998 - --------------- DELOITTE TOUCHE TOHMATSU INTERNATIONAL - --------------- F-2 42 ShoLodge, Inc. and Subsidiaries Consolidated Balance Sheets
DECEMBER 27, DECEMBER 28, 1998 1997 -------------------------------- ASSETS Current assets: Cash and cash equivalents $ 2,480,984 $ 58,609,505 Restricted cash 701,484 496,000 Accounts receivable - Trade, net of allowance for doubtful accounts of $642,780 and $352,500 for 1998 and 1997, respectively 3,251,104 2,903,422 Construction contracts 27,799 125,001 Income taxes receivable 4,775,686 6,132,154 Prepaid expenses 519,534 532,698 Notes receivable, net 3,363,394 191,253 Other current assets 443,967 164,638 -------------------------------- Total current assets 15,563,952 69,154,671 Notes receivable, net 58,390,170 6,506,706 Property and equipment 187,360,706 197,129,415 Less accumulated depreciation and amortization (20,335,047) (39,790,321) -------------------------------- 167,025,659 157,339,094 Land under development or held for sale 9,556,720 9,404,966 Deferred charges, net 9,201,837 10,787,233 Securities held to maturity (restricted) -- 8,946,985 Deposits on sale/leaseback 28,000,000 28,000,000 Deferred tax asset 127,035 4,416,887 Intangible assets 3,290,162 3,435,725 Other assets 3,845,824 1,884,725 -------------------------------- $295,001,359 $299,876,992 ================================
See accompanying notes. F-3 43
DECEMBER 27, DECEMBER 28, 1998 1997 ------------------------------- LIABILITIES Current liabilities: Accounts payable and accrued expenses $ 11,438,292 $ 10,919,712 Taxes payable other than on income 1,636,220 1,040,956 Income taxes payable -- 473,962 Current portion of long-term debt and capitalized lease obligations 21,597,951 2,599,740 ------------------------------ Total current liabilities 34,672,463 15,034,370 Long-term debt and capitalized lease obligations, less current portion 128,945,784 154,637,929 Deferred gain on sale/leaseback 30,158,244 34,377,131 Deferred credits 2,368,523 -- Minority interests in equity of consolidated subsidiaries and partnerships 757,311 475,590 Shareholders' equity: Preferred stock (no par value; 1,000,000 shares authorized; no shares issued) -- -- Series A redeemable nonparticipating stock (no par value; 1,000 shares authorized; no shares issued) -- -- Common stock (no par value; 20,000,000 shares authorized, 7,472,310 and 8,255,810 shares issued and outstanding as of December 27, 1998 and December 28, 1997, respectively) 1,000 1,000 Additional paid-in capital 42,433,395 42,431,520 Retained earnings 60,973,496 52,827,145 Unrealized gain on securities available-for-sale, net of income taxes 67,704 92,307 Less treasury stock, at cost, 784,000 shares in 1998 (5,376,561) -- ------------------------------ Total shareholders' equity 98,099,034 95,351,972 ------------------------------ $295,001,359 $299,876,992 ==============================
F-4 44 ShoLodge, Inc. and Subsidiaries Consolidated Statements of Earnings
YEAR ENDED ------------------------------------------------------------ DECEMBER 27, DECEMBER 28, DECEMBER 29, 1998 1997 1996 ------------------------------------------------------------ Revenues: Hotel $ 69,240,264 $ 71,944,716 $57,528,105 Franchising and management 3,118,789 3,163,938 4,290,389 Construction and development 81,077 -- 1,664,365 ---------------------------------------------------------- Total revenues 72,440,130 75,108,654 63,482,859 Cost and expenses: Operating expenses: Hotel 44,933,620 42,987,647 30,998,166 Franchising and management 2,392,978 2,301,401 3,255,372 Construction and development 71,351 -- 1,199,413 ---------------------------------------------------------- Total operating expenses 47,397,949 45,289,048 35,452,951 General and administrative 6,357,877 3,952,603 2,157,549 Rent expense, net 9,838,105 1,991,400 861,140 Depreciation and amortization 8,012,436 10,376,484 7,863,381 ---------------------------------------------------------- Income from operations 833,763 13,499,119 17,147,838 Other income (expenses): Interest expense (10,414,876) (11,298,126) (4,605,449) Interest income 4,949,404 1,762,450 1,391,066 Gain on sale of property 20,631,641 3,818,692 340,289 Other income 441,292 837,611 1,218,838 ----------------------------------------------------------- Earnings from continuing operations before income taxes, minority interests, extraordinary loss, and cumulative effect of change in accounting policy 16,441,224 8,619,746 15,492,582 Income taxes (6,581,000) (2,259,000) (5,598,200) Minority interests in earnings of consolidated subsidiaries and partnerships (647,407) (172,710) (422,858) ----------------------------------------------------------- Earnings from continuing operations before extraordinary loss and cumulative effect of change in accounting policy 9,212,817 6,188,036 9,471,524 Discontinued operations: Gain on disposal of discontinued business segment, net of income tax provision of $287,000 and $14,800 for 1997 and 1996, respectively -- 526,000 25,200
F-5 45 ShoLodge, Inc. and Subsidiaries Consolidated Statements of Earnings (continued)
YEAR ENDED ------------------------------------------------------------- DECEMBER 27, DECEMBER 28, DECEMBER 29, 1998 1997 1996 ------------------------------------------------------------- Extraordinary loss on early extinguishment of debt, net of income tax benefit of $600,000 and $101,000 for 1998 and 1997, respectively (1,066,466) (186,124) -- Cumulative effect of change in accounting policy, net of income tax benefit of $691,000 -- (1,164,114) -- -------------------------------------------------------- Net earnings $ 8,146,351 $ 5,363,798 $ 9,496,724 ======================================================== Net earnings per common share: Basic: Continuing operations before extraordinary loss and cumulative effect $ 1.12 $ 0.75 $ 1.15 Discontinued operations -- 0.06 -- Extraordinary loss (0.13) (0.02) -- Cumulative effect of change in accounting policy -- (0.14) -- -------------------------------------------------------- Net earnings $ 0.99 $ 0.65 $ 1.15 ======================================================== Diluted: Continuing operations before extraordinary loss and cumulative effect $ 1.07 $ 0.74 $ 1.12 Discontinued operations -- 0.06 -- Extraordinary loss (0.12) (0.02) -- Cumulative effect of change in accounting policy -- (0.14) -- -------------------------------------------------------- Net earnings $ 0.95 $ 0.64 $ 1.12 ======================================================== Weighted average common shares outstanding: Basic 8,190,593 8,244,572 8,231,548 ======================================================== Diluted 8,611,401 8,414,955 10,757,492 ======================================================== Pro forma amounts assuming the change in accounting policy is applied retroactively: Earnings from continuing operations before extraordinary item $ 6,188,036 $ 9,022,115 Earnings per share: Basic 0.75 1.10 Diluted 0.74 1.08 Net earnings: 6,527,912 8,996,915 Basic 0.79 1.09 Diluted 0.78 1.07
See accompanying notes. F-6 46 ShoLodge, Inc. and Subsidiaries Consolidated Statements of Shareholders' Equity Years ended December 29, 1996, December 28, 1997 and December 27, 1998
SERIES A REDEEMABLE NONPARTICIPATING STOCK COMMON STOCK ADDITIONAL -------------------------------------------------------- PAID-IN SHARES AMOUNT SHARES AMOUNT CAPITAL -------------------------------------------------------------------- Balance, December 31, 1995 1,000 $ -- 8,228,502 $1,000 $ 44,235,396 Repurchase of stock warrant -- -- -- -- (2,063,809) Repurchase of Series A redeemable nonparticipating stock (1,000) -- -- -- -- Exercise of stock options, net -- -- 4,816 -- 40,455 Net earnings -- -- -- -- -- Change in unrealized gain on securities available-for-sale, net of income taxes -- -- -- -- -- ------------------------------------------------------------------- Balance, December 29, 1996 -- -- 8,233,318 1,000 42,212,042 Exercise of stock options, net -- -- 22,492 -- 219,478 Net earnings -- -- -- -- -- Change in unrealized gain on securities available-for-sale, net of income taxes -- -- -- -- -- ------------------------------------------------------------------- Balance, December 28, 1997 -- -- 8,255,810 1,000 42,431,520 Exercise of stock options, net -- -- 500 -- 1,875 Net earnings -- -- -- -- -- Change in unrealized gain on securities available-for-sale, net of income taxes -- -- -- -- -- Repurchased -- -- (784,000) -- -- ------------------------------------------------------------------- Balance, December 27, 1998 -- $ -- 7,472,310 $1,000 $ 42,433,395 ===================================================================
F-7 47 ShoLodge, Inc. and Subsidiaries Consolidated Statements of Shareholders' Equity Years ended December 29, 1996, December 28, 1997 and December 27, 1998
UNREALIZED GAIN ON SECURITIES COST OF AVAILABLE-FOR- COMMON RETAINED SALE, NET OF SHARES EARNINGS INCOME TAXES REPURCHASED TOTAL ------------------------------------------------------------------- Balance, December 31, 1995 $ 37,966,623 $ 533,481 $ -- $ 82,736,500 Repurchase of stock warrant -- -- -- (2,063,809) Repurchase of Series A redeemable non participating stock -- -- -- -- Exercise of stock options, net -- -- -- 40,455 Net earnings 9,496,724 -- -- 9,496,724 Change in unrealized gain on securities available-for-sale, net of income taxes -- (473,742) -- (473,742) ------------------------------------------------------------------- Balance, December 29, 1996 47,463,347 59,739 -- 89,736,128 Exercise of stock options, net -- -- -- 219,478 Net earnings 5,363,798 -- -- 5,363,798 Change in unrealized gain on securities available-for-sale, net of income taxes -- 32,568 -- 32,568 ------------------------------------------------------------------- Balance, December 28, 1997 52,827,145 92,307 -- 95,351,972 Exercise of stock options, net -- -- -- 1,875 Net earnings 8,146,351 -- -- 8,146,351 Change in unrealized gain on securities available-for-sale, net of income taxes -- (24,603) -- (24,603) Repurchased -- (5,376,561) (5,376,561) ------------------------------------------------------------------- Balance, December 27, 1998 $ 60,973,496 $ 67,704 $ (5,376,561) $ 98,099,034 ===================================================================
See accompanying notes. F-8 48 ShoLodge, Inc. and Subsidiaries Consolidated Statements of Cash Flows
YEAR ENDED ----------------------------------------------------------- DECEMBER 27, DECEMBER 28, DECEMBER 29, 1998 1997 1996 ----------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES Earnings from continuing operations before extraordinary loss and cumulative effect of change in accounting policy $ 9,212,817 $ 6,188,036 $ 9,471,524 Adjustments to reconcile earnings from continuing operations before extraordinary loss and cumulative effect of change in accounting policy to net cash (used in) provided by operating activities: Gain from discontinued operations -- 813,000 40,000 Extraordinary loss on early extinguishment of debt (1,666,466) (287,124) -- Depreciation and amortization 8,012,436 11,034,031 8,249,666 Accretion of discount on securities held to maturity (442,427) (691,175) (637,779) Recognition of previously deferred profit (1,850,364) (1,194,555) (1,681,312) Gain on sale of property and other assets (20,631,641) (3,818,692) (340,289) Gain on sale of securities available-for-sale -- -- (732,339) Deferred income tax provision 4,289,852 (8,831,039) (1,710,028) Minority interests in earnings of consolidated subsidiaries and partnerships 647,407 172,710 422,858 Changes in assets and liabilities: Increase in restricted cash (205,484) (496,000) -- (Increase) decrease in accounts receivable (250,480) (272,466) 1,327,498 Decrease (increase) in income taxes receivable 1,356,468 (6,132,154) -- Decrease (increase) in prepaid expenses 13,164 (60,875) (86,208) Increase in deferred charges from franchising -- -- (5,394,848) (Increase) decrease in other assets (1,220,678) 1,066,360 (1,669,143) Increase (decrease) in accounts payable and accrued expenses 518,580 (1,126,003) 4,295,247 (Decrease) increase in income and other taxes (492,538) (349,950) 2,671,549 ---------------------------------------------------- Net cash (used in) provided by operating activities (2,709,354) (3,985,896) 14,226,396 CASH FLOWS FROM INVESTING ACTIVITIES Payments from notes receivable 174,424 -- 44,100,071 Capital expenditures (72,473,490) (55,907,485) (86,583,428) Proceeds from sale of property and other assets 9,089,264 141,959,540 1,282,070 Proceeds from sale of securities available-for-sale -- -- 1,847,120 Deposits on sale/leaseback of hotels -- (28,000,000) -- ---------------------------------------------------- Net cash (used in) provided by investing activities (63,209,802) 58,052,055 (39,354,167)
F-9 49 ShoLodge, Inc. and Subsidiaries Consolidated Statements of Cash Flows (continued)
YEAR ENDED ------------------------------------------------------- DECEMBER 27, DECEMBER 28, DECEMBER 29, 1998 1997 1996 ------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Decrease (increase) in deferred loan financing charges 1,236,761 (2,353,085) (1,549,867) Proceeds from long-term debt 25,300,000 124,207,614 131,212,249 Payments on long-term debt (8,758,117) (120,946,562) (99,655,062) Payments on capitalized lease obligations (603,743) (642,719) (588,945) Distributions to minority interests (2,009,580) (201,148) (452,472) Exercise of stock options 1,875 219,478 40,455 Repurchase of stock warrant -- -- (2,063,809) Purchase of treasury stock (5,376,561) -- -- ----------------------------------------------------- Net cash provided by financing activities 9,790,635 283,578 26,942,549 Net (decrease) increase in cash and cash equivalents (56,128,521) 54,349,737 1,814,778 Cash and cash equivalents at beginning of year 58,609,505 4,259,768 2,444,990 ----------------------------------------------------- Cash and cash equivalents at end of year $ 2,480,984 $ 58,609,505 $ 4,259,768 =====================================================
See accompanying notes. F-10 50 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements Years ended December 29, 1996, December 28, 1997 and December 27, 1998 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The business activities of ShoLodge, Inc. and subsidiaries (the "Company") are composed primarily of owning, franchising, operating and constructing lodging facilities. Presently there are two brands, Sumner Suites and Shoney's Inns. As of December 27, 1998, the Company derives its hotel revenues from both brands from 24 owned properties and 14 leased properties located in 16 states across the United States. Of these 38 properties, 13 are located in Texas and six are located in Georgia. No other state has more than three properties. A summary of the significant accounting policies used in the preparation of the accompanying consolidated financial statements follows. The Consolidated Financial Statements include the accounts of the Company and its majority-owned and controlled subsidiaries and partnerships. All significant intercompany items and transactions have been eliminated. The Company is the managing general partner in the partnership entities. The Fiscal Year of the Company consists of 52/53 weeks ending the last Sunday of the calendar year. Accounting Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents include highly liquid investments with original maturities of three months or less. F-11 51 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Restricted Cash represents the cash funded in a reserve account as provided for in the lease agreement on the sale/leaseback transaction (see Note 13) to cover the cost of replacement, renewals, certain repairs and maintenance, major repairs, alteration improvements, and renewals or replacements to the hotels' buildings, furnishings, fixtures and equipment. The amount initially funded to the account was $496,000, to be increased in the future by a percentage of total hotel sales as defined in the lease agreement. The applicable percentage was 3% in 1998 and will be 4% in 1999 and 5% each year thereafter during the term of the lease. The disbursements from this fund are restricted to the above-listed uses as defined in the lease agreement. Property and Equipment is recorded at cost. Depreciation is computed primarily on the straight-line method over the estimated useful lives of the related assets, generally forty years for buildings and improvements and seven years for furniture, fixtures and equipment. Equipment under capitalized leases is amortized over the shorter of the estimated useful lives of the related assets or the lease term using the straight-line method. Significant improvements are capitalized while maintenance and repairs are expensed as incurred. The Company capitalizes direct and indirect costs of construction and interest during the construction period. Interest costs capitalized during the years ended December 29, 1996, December 28, 1997 and December 27, 1998 were approximately $4,657,000, $3,485,000 and $3,219,000, respectively. Preopening costs are expensed as incurred effective at the beginning of fiscal year 1997 (See Note 2). Land Under Development or Held For Sale consists of land adjacent to Company-owned hotels. The Company actively develops these sites to enhance the profitability of the hotels. Deferred Charges include loan costs incurred in obtaining financing and are amortized using the interest method over the respective terms of the related debt. In addition, deferred charges include costs incurred in amending the Company's franchise license agreement (see Note 12), which is being amortized on the straight-line method over twenty years. Accumulated amortization totaled $2,626,771 and $3,541,811 as of December 28, 1997 and December 28, 1998, respectively. F-12 52 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Investments. The Company's investment securities have been classified as either available-for-sale or held to maturity. The available-for-sale securities are carried at fair value with unrealized holding gains and losses, net of tax effects, reported as a separate component of shareholders' equity. The held-to-maturity securities are carried at amortized cost. Intangible Assets include excess of cost over fair value of net assets acquired (goodwill) in the amount of $2,986,992 at December 28, 1997 and $2,837,019 at December 27, 1998, respectively, which is amortized on the straight-line method over a period of twenty-five years. The amounts reported are net of accumulated amortization of $762,334 and $912,306, as of 1997 and 1998, respectively. In addition, costs of trademark are included in the amount of $448,733 and $453,143 as of 1997 and 1998, respectively, and is amortized on the straight-line method over a period of twenty years. This amount is net of accumulated amortization of $10,600 and $33,620 as of 1997 and 1998, respectively. Other Assets include the long-term portion of notes receivables, cash surrender value of life insurance, non-current portion of direct financing leases, securities available for sale, and base linens stock. Base linens stock is amortized to fifty percent of its initial cost on a straight-line basis over a thirty-six month period. Asset Impairment. The Company records impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows related to those assets are less than their carrying amounts. Advertising. The Company charges the costs of advertising to expense as incurred. Advertising expense was approximately $2,012,000, $2,988,000 and $2,311,000 for the years ended December 29, 1996, December 28, 1997 and December 27, 1998, respectively. F-13 53 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Income Taxes. The Company uses the liability method to account for income taxes. Revenues from hotel operations are recognized as services are rendered, while construction and development revenues that relate to construction and development of hotel properties for others, are recognized based on the percentage of completion method. Franchising and management revenues are recognized as earned. Profit from the sale of land and hotel properties is recognized at the time the sale is consummated, the minimum down payment is received, and there is no significant continuing involvement. Earnings Per Common Share for all periods has been computed in accordance with SFAS No. 128, Earnings per Share. Basic earnings per share is computed by dividing earnings by the weighted average number of common shares outstanding during the year. Diluted earnings per common share is computed by dividing earnings by weighted average number of common shares outstanding during the year plus incremental shares that would have been outstanding upon the assumed exercise of dilutive options and the assumed conversion of dilutive debentures. See Note 7 for a reconciliation of basic and diluted earnings per share. Stock-Based Compensation. The Company uses the intrinsic value method for valuing its awards of stock options and recording the related compensation expense, if any. See Note 9 for pro forma disclosures using the fair value method as described in SFAS No. 123. Concentrations of Credit Risk. Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash investments and trade receivables. The Company places its cash investments with high credit quality financial institutions who are members of the FDIC thus reducing any potential risk. Concentrations of credit risk with respect to trade receivables are limited due to the Company's large number of customers and their dispersion across many geographic areas. Notes receivable are from a group of affiliated companies which acquired and operate the 16 hotels described in Note 14. F-14 54 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Comprehensive Income. On December 29, 1997, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." Comprehensive income includes net income and other comprehensive income which is defined as non-owner transactions in equity. The following table sets forth the amounts of other comprehensive income included in equity for the years ended December 27, 1998, December 28, 1997 and December 29, 1996.
1998 1997 1996 ------------------------------------------- Net unrealized (loss) gain on securities available for sale $(25,000) $33,000 $(474,000)
Reclassifications. Certain reclassifications have been made in the 1996 and 1997 consolidated financial statements to conform to the classifications used in 1998. 2. ACCOUNTING CHANGE In the fourth quarter of fiscal 1997, the Company changed its method of accounting for pre-opening costs, effective December 30, 1996, whereby pre-opening costs are expensed as incurred rather than the previous method of capitalizing such costs and amortizing them over a three-year period. The Company believes the new method is preferable in the circumstances and conforms to the predominant practice in the industry. The cumulative effect of the change for periods prior to fiscal 1997, net of income tax effect, is a reduction in net earnings of $1,164,114 or $0.14 per share and was recognized in the first quarter of 1997. The pro forma effect on fiscal 1996, as if the change in accounting for pre-opening costs had been adopted prior to fiscal 1996, would be to increase hotel operating expenses by $1,264,558 and to reduce depreciation and amortization expense by $549,982, resulting in a reduction of earnings before income taxes of $714,576 ($449,409 after income taxes) to $9,047,315, or $1.08 per diluted share for the year ended 1996, from $9,496,724 or $1.12 per diluted share as previously reported. F-15 55 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 2. ACCOUNTING CHANGE (CONTINUED) On December 29, 1997, the Company adopted the practice of capitalizing only directly identifiable internal costs of identifying and acquiring commercial properties to be developed in accordance with Emerging Issues Task Force ("EITF") Issue No. 97-11, "Accounting for Internal Costs Relating to Real Estate Property Acquisitions." The implementation of this EITF resulted in increased operating costs of approximately $1,353,000 in 1998. 3. PROPERTY AND EQUIPMENT Property and equipment consists of:
DECEMBER 27, DECEMBER 28, 1998 1997 ---------------------------------- Land and improvements $ 36,842,353 $ 20,838,391 Buildings and improvements 100,989,405 113,621,999 Furniture, fixtures and equipment 29,686,485 43,778,242 Equipment under capitalized leases 2,103,182 3,408,888 Construction in progress 17,739,281 15,481,895 ------------- ------------- 187,360,706 197,129,415 Less accumulated depreciation and amortization (20,335,047) (39,790,321) ------------- ------------- $ 167,025,659 $ 157,339,094 ============= =============
F-16 56 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. LONG-TERM DEBT AND CAPITALIZED LEASE OBLIGATIONS Long-term debt and capitalized lease obligations consist of:
1998 1997 ------------------------------- Industrial revenue bonds (IRB's), bearing interest at 4.30% to 4.06%, due in varying amounts through 2017 $ 3,120,000 $ 16,015,000 Revenue participation bonds (RPB's), due April 2001 -- 11,355,000 7.50% Convertible subordinated debentures 54,000,000 54,000,000 9.75% Series A senior subordinated notes 33,021,000 33,125,000 9.55% Series B senior subordinated notes 34,995,000 35,000,000 Bank revolving credit facility 20,300,000 -- Notes payable - bank and other, bearing interest at 7.50% to 8.94%, due in varying amounts through 2003 4,497,859 6,203,049 Notes payable - due in varying amounts through 2000 41,745 77,576 Capitalized lease obligations 568,131 1,462,044 ------------- ------------- 150,543,735 157,237,669 Less current portion (21,597,951) (2,599,740) ------------- ------------- $ 128,945,784 $ 154,637,929 ============= =============
The Industrial Revenue Bonds ("IRB's") and substantially all notes payable are collateralized by property and equipment with a net book value of approximately $10 million at December 27, 1998. Additionally, the IRBs as of December 27, 1998, are collateralized by irrevocable letters of credit, and are guaranteed by the Company. The $11,355,000 RPB's required a 40% participation in the gross room revenues of Shoney's Inns Group IV, Inc. payable to the bondholders in semi-annual installments through April 15, 2001. The effective interest rate on these bonds was 9.4%, and 9.5%, respectively, for the years ended December 29, 1996 and December 28, 1997. These bonds were assumed by the purchaser of certain hotels in 1998 (See Note 14). F-17 57 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. LONG-TERM DEBT AND CAPITALIZED LEASE OBLIGATIONS During June 1994, the Company issued $54,000,000 of 7.50% convertible subordinated debentures maturing in May 2004 with interest payable in semi-annual installments. The debentures are convertible at any time before maturity, unless previously redeemed, into common stock of the Company at a conversion price of $23.31 per share, subject to adjustment. The debentures are unsecured and subordinated in right of payment to the prior payment in full of all existing and future senior indebtedness, as defined in the debentures. The Company, at its option, can redeem the bonds beginning in May 1997 at 105.25% of par, declining .75% each year thereafter to par in May 2004. During November 1996, the Company issued $33,150,000 of 9.75% senior subordinated notes, Series A, under an aggregate $125,000,000 senior subordinated indenture agreement. The notes mature in November 2006, with interest payable quarterly. The notes are unsecured and subordinated in right of payment to the prior payment in full of all existing and future senior indebtedness of the Company. Additionally, in September 1997, the Company issued $35,000,000 of 9.55% senior subordinated notes, Series B, also under the aggregate $125,000,000 senior subordinated indenture agreement. The notes mature in September 2007, with interest payable quarterly. The notes are unsecured and subordinated in right of payment in full of all other senior indebtedness of the Company and will be senior in right of payment to, or pari passu with all other subordinated indebtedness of the Company, including the Series A notes. Effective April 30, 1997, the Company consolidated certain unsecured lines of credit into an unsecured $75 million, three-year revolving credit facility with a group of five banks. The interest rate on this credit facility at December 28, 1997, was at the lender's base rate, or one hundred seventy-five basis points over the 30, 60, 90 or 180 day LIBOR rate, at the Company's option. There were no amounts outstanding under this credit facility at December 28, 1997. In January and October 1998, the Company amended its revolving credit facility for changes in certain financial covenants, collateralization, availability and maturity date. As of December 27, 1998, the availability under the amended credit agreement totals $30 million and is secured by a pledge of $43,344,000 promissory notes payable to the Company, received in connection with the sale of sixteen of the Company's lodging facilities in 1998. The amended credit facility matures June 30, 1999. Other terms and conditions of the credit agreement as amended in October 1998, including interest rates, were similar to the previous credit agreement. As of December 27, 1998, the Company had $20,300,000 outstanding under this credit facility. F-18 58 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 4. LONG-TERM DEBT AND CAPITALIZED LEASE OBLIGATIONS As of April 9, 1999, the Company has borrowed $25.2 million under its revolving line of credit, which matures June 30, 1999. On this same date, the Company and its lenders amended the agreement to eliminate any future LIBOR borrowings; to amend the base interest rate to prime plus 1.25% and to require a monthly maintenance fee. The Company intends to repay such borrowing with monies obtained from various sources including hotel equipment financing, land sales and other debt sources, which the Company is currently negotiating. The Company also has a $1,000,000 unsecured line of credit with another bank, of which no amounts are outstanding at December 27, 1998. The loan agreements contain certain financial covenants of which the most restrictive includes maintenance of certain operating ratios, minimum liquidity ratios, interest coverage and minimum tangible net worth. In November 1997, the Company repaid approximately $10,500,000 of equipment loans with the proceeds of the sale/leaseback transaction (Note 13). This early retirement of loans resulted in an extraordinary pretax charge of approximately $287,000 for the year ended December 28, 1997. In September 1998 the Company repaid approximately $14,111,000 of debt with the proceeds of the sale of 16 hotels (Note 14). This early retirement of debt resulted in an extraordinary pretax charge of approximately $1,666,466 for the year ended December 27, 1998. Maturities of long-term debt are as follows: 1999 $ 21,186,683 2000 928,913 2001 811,749 2002 310,717 2003 1,996,542 Thereafter 124,741,000 ------------ $149,975,604 ============
See Note 5 for capitalized lease obligation maturities. F-19 59 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. COMMITMENTS AND CONTINGENCIES The Company and its subsidiaries lease certain property and equipment under noncancelable operating and capitalized lease agreements. Total rental expense under operating leases for the years ended December 29, 1996, December 28, 1997 and December 27, 1998 was approximately $1,248,000, $1,177,000 and $1,056,000, respectively. Future minimum rental payments are as follows:
OPERATING CAPITALIZED LEASES LEASES --------------------------------- 1999 $ 14,524,861 $ 445,755 2000 14,496,095 160,914 2001 14,445,000 - 2002 14,445,000 - 2003 14,445,000 - Thereafter 60,460,479 - --------------------------------- $ 132,816,435 606,669 =============== Less amount representing interest at rates ranging from 7.25% to 9.5% (38,538) Less current portion (411,268) ------------ $ 156,863 ============
The Company is self-insured for workers' compensation benefits up to $500,000 annually in aggregate and $250,000 per occurrence and has recorded a reserve for all outstanding claims at December 27, 1998. While the Company's ultimate liability may exceed or be less than the amount accrued, the Company believes that it is unlikely that it would experience losses that would be materially in excess of such estimated amounts. In addition to the reserves recorded, the Company had outstanding letters of credit in the amount of $610,000, $667,000 and $667,000, as of December 29, 1996, December 28, 1997, and December 27, 1998, respectively, to satisfy workers compensation self-insurance security deposit requirements. As of December 27, 1998, the Company's estimated costs to complete three properties under construction approximated $3,627,000. F-20 60 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. COMMITMENTS AND CONTINGENCIES (CONTINUED) The Company is a party to legal proceedings incidental to its business. In the opinion of management, any ultimate liability with respect to these actions will not materially affect the consolidated financial position or results of operations of the Company. However, legal action pending against the Company include the following: In 1997, Tri-State Inns, Inc. and Motels of America, Inc. filed a suit against ShoLodge Franchise Systems, Inc., a subsidiary of the Company, seeking to be discharged, relieved and excused of any future performance under the License Agreement relating to 14 Shoney's Inns, or in the alternative, compensatory damages, based on theories of alleged breach of contractual obligations and implied warranties of good faith and fair dealing, alleged fraudulent inducement based on alleged misrepresentations and alleged failure to make material disclosures of fact, alleged promissory estoppel and alleged breach of fiduciary duty. In addition, the plaintiffs originally sought a declaratory judgment concerning the provision of the License Agreement which specifies the damages due upon termination of the License Agreement. On March 18, 1998, the plaintiffs filed a motion for summary judgment seeking to invalidate the non-competition and stipulated damages provisions set forth in the License Agreements. On August 6, 1998, the court denied the plaintiff's motion. The Company also has filed counter claims against the plaintiffs. The case has been set for trial on May 18, 1999. The Company intends to continue to defend the suit vigorously. Neither management or legal counsel can predict the outcome at this time. In 1998, two purported class action lawsuits were filed against the Company and certain officers of the Company, by plaintiffs who claim to be shareholders and debt security holders of the Company, respectively, both alleging that the Company violated certain anti-fraud provisions of the Tennessee Securities Act of 1980, as amended, by issuing allegedly false and misleading statements and financial information to the investing public. The complaints seek an unspecified amount of damages and unspecified injunctive relief. The Company filed motions to dismiss both suits on the basis that the plaintiff's allegations failed to state a cause of action under the applicable state statute. The trial court denied both motions. The court's denial of the Company's motions on these suits are currently before the Court of Appeals, but a date for oral argument has not F-21 61 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 5. COMMITMENTS AND CONTINGENCIES (CONTINUED) been set. Both cases have been set for trial on September 13, 1999. The Company believes both suits are without merit and will defend itself vigorously. Neither management or legal counsel can predict the outcome at this time. In 1998, the former chief financial officer of the Company, filed a lawsuit against the Company and its chief executive officer alleging that his employment by the Company was wrongfully terminated, claiming breach of contract, fraud, retaliatory discharge and related claims. The plaintiff seeks $3 million in compensatory damages and punitive and treble damages. On December 31, 1998 the Company filed a motion to dismiss this lawsuit on the basis that the plaintiff has intentionally destroyed relevant evidence during the pendency of the case. The court granted this motion on January 28, 1999 and dismissed the case with prejudice. On March 8, 1999 the plaintiff filed a Motion to Alter or Amend the Judgment dismissing the case. The Company believes the suit is without merit and will defend itself vigorously. Neither management or legal counsel can predict the outcome at this time. 6. SUITES OF AMERICA TRANSACTIONS On March 31, 1995, the Company, and Suites of America, Inc. ("Suites"), a wholly-owned subsidiary of Prime Hospitality Corp. ("Prime") entered into an agreement (the "Cancellation Agreement") under which the Company sold its option to acquire 50% of the voting stock of Suites for approximately $27,327,000. In addition, the Company conveyed one AmeriSuites hotel to Suites for approximately $6,174,000. Approximately $4,997,000 of the aggregate purchase price of $33,501,000 was paid upon closing with the remaining $28,504,000, along with approximately $25,015,000 of existing indebtedness from Suites, consolidated into one note. Approximately $14,880,000 of existing indebtedness from Suites was canceled by the Company in connection with the sale of the option. The transactions have been accounted for as installment sales of real estate in the accompanying 1996 consolidated financial statements. As of January 1996, the note was fully repaid and the Company recorded gains of $775,000 for the year ended December 29, 1996. F-22 62 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. EARNINGS PER SHARE The following tables reconcile earnings and weighted average shares used in the earnings per share ("EPS") calculations for fiscal years 1998, 1997 and 1996.
FOR THE YEARS ENDED DECEMBER 27, DECEMBER 28, DECEMBER 29, 1998 1997 1996 --------------------------------------------- NUMERATOR: Earnings from continuing operations before extraordinary loss and cumulative effect of change in accounting policy $ 9,212,817 $ 6,188,036 $ 9,471,524 Gain on disposal of discontinued business segment -- 526,000 25,200 Extraordinary loss (1,066,466) (186,124) -- Cumulative effect of change in accounting policy -- (1,164,114) -- ------------------------------------------- Numerator for basic earnings per share - earnings available to shareholders 8,146,351 5,363,798 9,496,724 Dilutive effect of 7.5% convertible debentures -- -- 2,541,375 ------------------------------------------- Numerator for diluted earnings per share - earnings available to stockholders after assumed conversion $ 8,146,351 $ 5,363,798 $12,038,099 =========================================== DENOMINATOR: Denominator for basic earnings per share - weighted-average shares 8,190,593 8,244,572 8,231,548 Effect of dilutive securities: Options 420,808 170,383 117,478 Warrants -- -- 91,864 7.5% Convertible debentures -- -- 2,316,602 ------------------------------------------- Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversion 8,611,401 8,414,955 10,757,492 =========================================== BASIC EARNINGS PER SHARE: Continuing operations before extraordinary loss and cumulative effect $ 1.12 $ 0.75 $ 1.15 Discontinued operations -- 0.06 -- Extraordinary Loss (0.13) (0.02) -- Cumulative effect of change in accounting policy -- (0.14) -- ------------------------------------------- Net earnings $ 0.99 $ 0.65 $ 1.15 ===========================================
F-23 63 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 7. EARNINGS PER SHARE (CONTINUED)
FOR THE YEARS ENDED DECEMBER 27, DECEMBER 28, DECEMBER 29, 1998 1997 1996 --------------------------------------------- DILUTED EARNINGS PER SHARE: Continuing operations before extraordinary loss and cumulative effect $ 1.07 $ 0.74 $1.12 Discontinued operations -- 0.06 -- Extraordinary Loss (0.12) (0.02) -- Cumulative effect of change in accounting policy -- (0.14) -- --------------------------------------------- Net earnings $ 0.95 $ 0.64 $1.12 ===============================================
The Company's debentures which are convertible into 2,316,602 shares of stock were outstanding at December 27, 1998 and December 28, 1997, but were not included in the computation of diluted EPS, as such securities were anti-dilutive. 8. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of cash and cash equivalents, accounts receivable, and borrowings under lines of credit approximate fair values due to the short-term maturities of these instruments. The carrying value of notes receivable approximate fair value due to the recent advancement of funds at market interest rates and terms based upon the nature of the loans. The carrying value of industrial revenue bonds approximate fair value due to the recent refinancing of these instruments. The fair value of convertible subordinated debentures and senior subordinated notes was based upon quoted market prices. The convertible subordinated debentures and senior subordinated notes have the following estimated fair values as of December 27, 1998: convertible subordinated debentures $33,480,000 ($54,000,000 carrying value) and senior subordinated notes $44,210,000 ($68,016,000 carrying value). As of December 27, 1998 and December 28, 1997, securities available-for-sale are carried at fair value in accordance with SFAS No. 115. F-24 64 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. STOCK OPTION PLAN The Company's 1991 Stock Option Plan (the "Plan"), authorizes the grant to key employees of options to purchase up to an aggregate of 616,667 shares of common stock. The exercise price of options granted under the terms of the Plan must not be less than 100% of the fair market value of the shares as of the date of grant, or 110% of the fair market value for incentive stock options granted to option holders possessing more than 10% of the total combined voting power of all classes of stock of the Company. Under the Plan, the options are exercisable at various periods from one to five years after date of grant and expire ten years after date of grant. During the year ended December 29, 1996, an additional 283,333 shares were authorized for future grants. F-25 65 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. STOCK OPTION PLAN (CONTINUED) A summary of the status of the Plan for the years ended December 29, 1996, December 28, 1997 and December 27, 1998, follows:
SHARES SUBJECT TO OPTION ------------------------------------- AVAILABLE FOR WEIGHTED AVERAGE GRANT OUTSTANDING EXERCISE PRICE ---------------------------------------------------------- December 31, 1995 62,805 537,317 $ 10.86 Additional authorized 283,333 -- -- Granted (296,660) 296,660 13.00 Exercised -- (4,816) 8.40 Canceled 187,303 (187,303) 15.71 ------------------------------------ December 29, 1996 236,781 641,858 10.45 Granted (194,000) 194,000 13.25 Exercised -- (22,492) 9.76 Canceled 12,494 (12,494) 12.88 ------------------------------------ December 28, 1997 55,275 800,872 11.11 Granted (722,537) 722,537 3.75 Exercised -- (500) 3.75 Canceled 800,872 (800,872) 11.11 ---------------------------------------------------------- December 27, 1998 133,610 722,037 $ 3.75 ==========================================================
On July 31, 1996, the Company repriced approximately 168,000 stock options that had been granted in previous years. The options were repriced to $13.00 per share, which was the market value of the Company's stock on July 31, 1996. These repriced options are included as cancellations and new grants in the table above for the year ended December 29, 1996. On September 23, 1998, the Company repriced approximately 723,000 stock options that had been granted in previous years. The options were repriced to $3.75 per share, which was the market value of the Company's stock on September 23, 1998. These repriced options are included as cancellations and new grants in the table above for the year ended December 27, 1998. F-26 66 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. STOCK OPTION PLAN (CONTINUED) The weighted average fair value of options granted during the year was $9.09 and $3.75 for the years ended December 28, 1997 and December 27, 1998, respectively. The following table summarizes information relating to the stock options outstanding as of December 27, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ------------------------------------------------------------------------------------------------------- NUMBER WEIGHTED- NUMBER OUTSTANDING AVERAGE WEIGHTED- EXERCISABLE WEIGHTED- AT REMAINING AVERAGE AT AVERAGE EXERCISE DECEMBER 27, CONTRACTUAL EXERCISE DECEMBER 27, EXERCISE PRICE 1998 LIFE PRICE 1998 PRICE - ------------------------------------------------------------------------------------------------------- $3.75 313,835 3.13 $3.75 313,835 $3.75 3.75 69,202 5.05 3.75 69,202 3.75 3.75 66,000 6.33 3.75 39,600 3.75 3.75 104,000 7.59 3.75 41,600 3.75 3.75 169,000 8.42 3.75 33,800 3.75 ------------ ------------ 3.75 722,037 5.49 3.75 498,037 3.75 ============ ============
Had the fair value of options granted under the plan beginning in 1996 been recognized as compensation expense on a straight-line basis over the vesting period of the options, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below:
1998 1997 1996 --------------------------------------------------- Net earnings As reported $8,146,351 $5,363,798 $9,496,724 Pro forma 7,276,109 4,889,823 9,250,941 Basic earnings per As reported .99 0.65 1.15 share Pro forma .89 0.59 1.12 Diluted earnings per As reported .95 0.64 1.12 share Pro forma .84 0.58 .86
F-27 67 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 9. STOCK OPTION PLAN (CONTINUED) The pro forma effect on net earnings for 1996, 1997 and 1998 is not representative of the pro forma effect on net earnings in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995. The fair value of each option grant is estimated on the date of grant using the Black Scholes option pricing model with the following weighted average assumptions used for grants in 1995, 1996 and 1997: no dividend yield for all years; expected volatility of 40%, 45% and 52%, respectively; risk free interest rates of 6.09%, 6.79% and 6.67%, respectively; and expected lives of 10, 10 and 9 years, respectively. 10. SHAREHOLDERS' EQUITY During 1998, the Company repurchased 784,000 shares of its common stock for $5,376,561. As of December 27, 1998, the Company's Board of Directors authorized the repurchase of up to $7,123,439 in additional shares under the current common stock repurchase program. F-28 68 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. INCOME TAXES The provision for income taxes from continuing operations consists of the following:
1998 1997 1996 ------------------------------------------- Current expense (benefit): Federal $ 2,215,788 $ 11,785,000 $ 6,393,200 State 75,247 (207,000) 900,000 ------------------------------------------- 2,291,035 11,578,000 7,293,200 Deferred expense (benefit) 4,289,965 (9,319,000) (1,695,000) ------------------------------------------- $ 6,581,000 $ 2,259,000 $ 5,598,200 ===========================================
The difference between income taxes using the effective income tax rate and the statutory federal income tax rate is as follows:
1998 1997 1996 ------------------------------------------- Federal income tax based on the statutory rate $ 5,754,428 $ 3,017,000 $ 5,436,000 State income taxes, less federal income tax benefit 603,393 317,000 505,000 State income tax refund received, less Federal income tax provision (137,337) (1,115,000) -- Interest payable to the IRS related to gains from installment sales 314,015 -- -- Other 46,501 40,000 (342,800) ------------------------------------------- $ 6,581,000 $ 2,259,000 $ 5,598,200 ===========================================
F-29 69 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 11. INCOME TAXES (CONTINUED) Deferred tax (liabilities) assets are comprised of the following:
1998 1997 ----------------------------- Deferred tax liabilities: Differences between book and tax basis of property $ (7,548,000) $ (7,218,000) Profits not recognized on installment sales (5,434,000) (640,000) Direct financing leases (114,000) (281,000) Other -- (319,000) ----------------------------- (13,096,000) (8,458,000) Deferred tax assets: Deferred profit on sales of hotels 11,996,000 12,000,000 Differences between book and tax losses recognized by minority interests 742,000 740,000 Allowance for doubtful accounts 249,000 135,000 Other 236,035 -- ----------------------------- 13,223,035 12,875,000 ----------------------------- Net deferred tax asset $ 127,035 $ 4,417,000 =============================
As of December 27, 1998 and December 28, 1997, the Company has recorded a deferred tax liability resulting from the unrealized gain on securities available-for-sale of $45,000 and $59,000, respectively. In 1998 and 1997, the Company recorded state income tax refunds attributable to certain restructuring changes. The effect of these refunds has been included as a reduction to the state income tax provision, net of the federal taxes due on such amount. F-30 70 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 12. RELATED PARTY TRANSACTIONS The Company has had extensive working and contractual relationship with Shoney's which previously held a stock warrant to purchase five percent of the Company's common stock and all of the Company's Series A redeemable nonparticipating stock. In addition, two officers of Shoney's had previously served as directors of the Company. During October 1996, the Company repurchased the stock warrant. As of the same date, the Company amended the franchise license agreement between the Company and Shoney's whereby the Company paid approximately $5,395,000 in exchange for, among other items, 1) the cancellation of Shoney's right to receive a portion of the franchise fees collected by the Company equal to approximately 1.5% of certain Shoney's Inns' gross room revenues through October 1999 and .5% of the remaining and all future Shoney's Inns' gross room revenues for the first ten years of their operations and 2) the repurchase of all of the Company's Series A redeemable nonparticipating stock. As a result of the Company's repurchase of the Series A redeemable nonparticipating stock, Shoney's no longer has the right to designate two members of the Company's board of directors. The Company has paid approximately $911,000 in franchise and royalty fees to Shoney's during the year ended December 29, 1996, under the franchise license agreement. Effective January 1, 1996, the Company sold its sixty percent interest in a corporation which owned five restaurants to the minority shareholder in exchange for approximately $848,000. The entire purchase price, along with approximately $1,250,000 of previously existing indebtedness of the corporation and the minority shareholder, was financed by the Company over a seven year period with interest accruing annually at the prime rate as defined in the note agreements. As a result of the transaction, the Company initially deferred recognition of the approximate $853,000 gain from the sale of this segment until such time further principal payments on the note were received which would support full collectibility of the note. For the year ended December 29, 1996, approximately $40,000 was recorded as a gain on disposal of discontinued business segment. In December 1997, management determined the amount to be fully collectible based on positive cash flows of the restaurants and past collection experience, therefore the remaining pre-tax $813,000 was recorded as a gain on disposal of discontinued business segment for the year ended December 28, 1997. F-31 71 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 12. RELATED PARTY TRANSACTIONS (CONTINUED) During 1996, the Company sold approximately 175,600 shares of its available-for-sale investment securities to the Company's chairman and chief executive officer. The average cost of these securities was approximately $1,117,000 and the total cash proceeds received was approximately $1,847,000 resulting in a realized gain of $730,000. The total value received for these securities approximated fair value based upon quoted market prices. The gain is recorded in other income in the accompanying consolidated financial statements for the year ended December 29, 1996. 13. SALE/LEASEBACK TRANSACTION In November 1997, the Company entered into a sale and leaseback agreement for certain of its Sumner Suites hotels. The assets of the hotels were sold to a real estate investment trust and the hotels continue to be operated by the Company. The lease is classified as an operating lease. The original lease term is for ten years with five renewal periods of ten years each. The Company sold assets with a net book value of approximately $101.5 million in exchange for $140 million in cash. The gain of approximately $34.9 million was initially deferred and is being recognized on the straight-line method over the 10 year lease term as reductions of rent expense. The minimum base rental is $14 million annually with contingent rent due of 8% of the excess of the leased hotels' base revenues (as defined in the lease agreement) beginning in 1999. The Company was required to pay a deposit of $14 million to be retained by the purchaser in the event of default or nonobservance of the lease agreement. The deposit will be refunded to the Company at the end of the lease term in the event no default has occurred. This non-interest bearing deposit is included in long-term deposits on sale/leaseback on the accompanying consolidated balance sheets. The Company was also required to provide an additional deposit of $14 million. This deposit, included in long-term deposits on sale/leaseback, earns interest at a rate of 11.11% annually. Interest earned is credited to the required rent payment due the lessor. The deposit will be refunded to the Company upon the earlier of achievement of certain operating results of the leased hotels or expiration of the lease. F-32 72 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 14. SALE OF HOTELS During 1998, the Company sold 16 of its company-owned Shoney's Inn hotels for $90 million. The sales price consisted of $22.5 million in cash with the balance of $67.5 million in the form of interest-bearing promissory notes. Profit was recognized on twelve of the sales under the full accrual method of accounting. Profit of approximately $12 million on the other four hotels sold is being accounted for under the installment method, $77,000 of which was recognized in 1998, with the remaining $11.9 million deferred, to be recognized as the criteria for full accrual sales accounting are satisfied. The deferred profit of $4.6 million and $7.3 million are netted against current notes receivable and non-current notes receivable, respectively, as of December 27, 1998. Deferred credits totaling $2.4 million related to the 12 hotels on which profit was recognized under the full accrual method were recorded as of December 27, 1998, of which $262,000 will be used for the completion of renovation and replacement expenditures. The remaining $2.2 million deferred credit will be reduced as the buyer reduces its payments to the Company for payments of interest on debt assumed by the buyer. 15. SUPPLEMENTAL CASH FLOW INFORMATION
1998 1997 1996 --------------------------------------------------------- Cash paid during the year for interest $ 13,669,330 $11,800,125 $8,484,298 ======================================================== Cash paid during the year for income taxes $ 2,572,681 $18,604,588 $4,389,928 ======================================================== Significant non-cash investing and financing activities: Sales of hotels: Notes receivable $ 67,500,001 $ 4,500,000 $ -- Property and equipment (67,500,001) (4,500,000) -- -------------------------------------------------------- $ -- $ -- $ -- ========================================================
F-33 73 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 16. OPERATING SEGMENT INFORMATION The Company's significant operating segments are hotel operations, franchising and other. The hotel operating segment has exceeded 90% of total revenues for each of the last three fiscal years. None of the Company's segments conduct foreign operations. Operating profit includes the operating revenues and expenses directly identifiable with the operating segment. Identifiable assets are those used directly in the operations of each segment. A summary of the Company's operations by segment follows (in thousands of dollars):
1998 1997 1996 ----------------------------------- Revenues: Hotel revenues from external customers $ 69,240 $ 71,945 $ 57,528 Franchising and other 65,514 44,853 80,077 Elimination of intersegment revenue franchising and other (62,314) (41,689) (74,122) ----------------------------------- Total revenues $ 72,440 $ 75,109 $ 63,483 =================================== Operating profit: Hotel $ 6,989 $ 16,780 $ 18,188 Franchising and other (6,156) (3,281) (1,040) ----------------------------------- Total operating profit $ 833 $ 13,499 $ 17,148 =================================== Total assets: Hotel $ 245,893 $ 201,302 $ 239,098 Franchising and other 49,108 98,575 24,611 ----------------------------------- Total assets $ 295,001 $ 299,877 $ 263,709 =================================== Capital expenditures: Hotel $ 71,416 $ 47,464 $ 83,276 Franchising and other 1,057 8,443 3,307 ----------------------------------- Total capital expenditures $ 72,473 $ 55,907 $ 86,583 =================================== Depreciation and amortization: Hotel $ 6,911 $ 9,765 $ 7,572 Franchising and other 1,101 611 291 ----------------------------------- Total depreciation and amortization $ 8,012 $ 10,376 $ 7,863 ===================================
F-34 74 ShoLodge, Inc. and Subsidiaries Notes to Consolidated Financial Statements (continued) 17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following is a summary of the unaudited quarterly financial information for the years ended December 27, 1998 and December 28, 1997:
(IN (000'S) EXCEPT FOR PER SHARE DATA) For the year ended December 27, 1998 Net Income (Loss) Net Income Gross Per Share Per Share Total Operating Net Income (Loss) ------------------------------------------------ Revenues Profit As Originally Adjusted Basic Diluted Basic Diluted Reported As Originally Reported Adjusted First Quarter(a) $ 23,614 $ 9,359 $ 391 $ 130 $ 0.05 $ 0.05 $ 0.02 $ 0.02 Second Quarter(b) 19,907 7,804 290 159 0.04 0.04 0.02 0.02 Third Quarter(c) 15,671 5,036 11,629 10,860 1.41 1.12 1.32 1.05 Fourth Quarter 13,249 2,844 (3,003) (0.38) (0.38)
(a) Decrease in net income relates to increase in interest expense and general and administrative expense which had previously been capitalized as hotel properties under development. (b) Decrease in net income relates to increase in interest expense and general and administrative expense which had previously been capitalized as hotel properties under development. (c) Decrease in net income relates to increase in interest expense and general and administrative expense which had previously been capitalized as hotel properties under development, and additional franchise taxes (classified as general and administrative expense) and interest due to the IRS (classified as income tax expense) related to installment sales of 16 hotels.
For the year ended December 28, 1997 Gross Net Income Per Share Total Operating Net ----------------------- Revenues Profit Income Basic Diluted First Quarter $ 21,913 $ 9,769 $ 875 $ 0.10 $ 0.10 Second Quarter 18,694 8,781 2,841 0.34 0.32 Third Quarter 18,413 7,960 1,427 0.17 0.17 Fourth Quarter 16,089 3,310 221 0.03 0.03
F-35 75 Shareholders and Board of Directors ShoLodge, Inc. We have audited the consolidated financial statements of ShoLodge, Inc. and subsidiaries as of December 27, 1998 and for the year then ended, and have issued our report thereon dated April 12, 1999 (included elsewhere in this Registration Statement). Our audit also included the financial statement schedule in Item 14 of this Registration Statement. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Atlanta, Georgia April 12, 1999 S-1 76 INDEPENDENT AUDITORS' REPORT Board of Directors and Shareholders ShoLodge, Inc. Hendersonville, Tennessee We have audited the consolidated financial statements of ShoLodge, Inc. and subsidiaries as of December 29, 1996 and December 28, 1997, and for each of the years then ended and have issued our report thereon dated April 1, 1998, such report is included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedule of ShoLodge, Inc. listed in Item 14. This consolidated financial statements schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Nashville, Tennessee April 1, 1998 S-2 77 Sholodge, Inc. and Subsidiaries Schedule II Valuation and Qualifying Accounts Years ended December 29, 1996, December 28, 1997 and December 27, 1998
ADDITIONS ADDITIONS BALANCE AT CHARGED CHARGED BALANCE BEGINNING TO COSTS AND TO OTHER AT END OF YEAR EXPENSES ASSETS DEDUCTIONS OF YEAR ------------------------------------------------------------------------------ Year ended December 29, 1996 Allowance for doubtful accounts receivable $ 14,728 $157,264 $ - $ (21,992) $150,000 ============================================================================== Year ended December 28, 1997 Allowance for doubtful accounts receivable $150,000 $202,500 $ - $ - $352,500 ============================================================================== Year ended December 27, 1998 Allowance for doubtful accounts receivable $352,500 $427,904 $ 55,945 $(193,569) $642,780 ==============================================================================
S-3 EX-21 2 SUBSIDIARIES OF THE REGISTRANT 1 Exhibit 21 SUBSIDIARIES OF THE REGISTRANT
PERCENTAGE OF VOTING JURISDICTION OF STOCK OWNED NAME OF CORPORATION INCORPORATION BY SHOLODGE, INC. Two Seventeen, Inc. Tennessee 100% MOBAT, Inc. Tennessee 100% Shoney's Inn of Lebanon, Inc. Tennessee 100% Shoney's Inn, Inc. Tennessee 100% Nashville Air Associates, Inc. Tennessee 100% Security Financial Corporation Tennessee 100% Moore and Associates, Inc. Tennessee 100% Virginia Inns, Inc. Tennessee 100% Airport Inn, Inc. Tennessee 100% ShoLodge Franchise Systems, Inc. Tennessee 100% Sunshine Inns, Inc. Tennessee 100% Inn Partners, Inc. Tennessee 100% LAFLA Inn, Inc. Tennessee 100% Midwest Inns, Inc. Tennessee 100% Southeast Texas Inns, Inc. Tennessee 100% The Hotel Group, Inc. Kansas 100%(1) Delaware Inns, Inc. Tennessee 100% Carolina Inns, Inc. Tennessee 100% Alabama Lodging Corporation Tennessee 100% Far West Inns, Inc. Tennessee 100% ShoLodge Beverage Corporation Texas 100%(2) Suite Tenant, Inc. Tennessee 100%
- ---------------- (1) Through Midwest Inns, Inc. (2) Through Southeast Texas Inns, Inc. EX-23.1 3 CONSENT OF ERNST & YOUNG LLP 1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-3 No. 333-14463) of ShoLodge, Inc. pertaining to senior subordinated notes and the related Prospectus, the Registration Statement (Form S-8 No. 33-52092) pertaining to the 1991 Stock Option Plan, and in the related Prospectus, the Registration Statement (Form S-8 No. 333-29881) pertaining to the 1991 Stock Option Plan, as amended and the related Prospectus and the registration statement (Form S-3 No. 33-77910) pertaining to the convertible subordinated debentures due 2004 and the related prospectus of our report dated April 12, 1999 with respect to the consolidated financial statements and schedules of ShoLodge, Inc. included in the Annual Report (Form 10-K) for the year ended December 27, 1998. ERNST & YOUNG LLP Atlanta, Georgia April 12, 1999 EX-23.2 4 CONSENT OF DELOITTE & TOUCHE LLP 1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 33-52092 and 333-29881 on Form S-8 and 333-14463 and 33-77910 on Form S-3 of ShoLodge, Inc. of our reports dated April 1, 1998, appearing in this Annual Report on Form 10-K of ShoLodge, Inc. for the year ended December 28, 1997. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Nashville, Tennessee April 12, 1999 EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS FOR THE FISCAL YEAR ENDED DECEMBER 27, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-27-1998 DEC-27-1998 3,182,468 0 3,921,683 642,780 0 15,563,952 187,360,706 20,335,047 295,001,359 34,672,463 128,945,784 0 0 1,000 98,098,034 295,001,359 69,240,264 72,440,130 0 71,606,367 0 0 10,414,876 15,793,817 6,581,000 9,212,817 0 (1,066,466) 0 8,146,351 0.99 0.95
-----END PRIVACY-ENHANCED MESSAGE-----