-----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, NUGd3wuttpvJWUVgtzgfWLQekKXC24mI3WzxRDzlS6py32ejfoYtbgFe6+ESFgkr AXYnFfHvgygXeLDR3ugVWA== 0000891104-97-000014.txt : 19970717 0000891104-97-000014.hdr.sgml : 19970717 ACCESSION NUMBER: 0000891104-97-000014 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19970715 ITEM INFORMATION: Other events ITEM INFORMATION: Financial statements and exhibits FILED AS OF DATE: 19970716 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: HFS INC CENTRAL INDEX KEY: 0000891104 STANDARD INDUSTRIAL CLASSIFICATION: PATENT OWNERS & LESSORS [6794] IRS NUMBER: 223059335 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-11402 FILM NUMBER: 97641160 BUSINESS ADDRESS: STREET 1: 339 JEFFERSON RD CITY: PARSIPPANY STATE: NJ ZIP: 07054 BUSINESS PHONE: 2014289700 MAIL ADDRESS: STREET 2: 339 JEFFERSON RD CITY: PARSIPPANY STATE: NJ ZIP: 07054 FORMER COMPANY: FORMER CONFORMED NAME: HOSPITALITY FRANCHISE SYSTEMS INC DATE OF NAME CHANGE: 19940202 8-K 1 CURRENT REPORT ON FORM 8-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------ Form 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 ------------ July 15, 1997 (July 15, 1997) (Date of Report (date of earliest event reported)) HFS Incorporated (Exact name of Registrant as specified in its charter) Delaware 1-11402 22-3059335 (State or other jurisdiction (Commission File No.) (I.R.S. Employer of incorporation or organization) Identification Number) 6 Sylvan Way Parsippany, New Jersey 07054 (Address of principal executive office) (Zip Code) (201) 428-9700 (Registrant's telephone number, including area code) None (Former name, former address and former fiscal year, if applicable) Item 5. Other Events This Current Report on Form 8-K includes the financial statements and management's discussion and analysis of financial condition and results of operations of HFS Incorporated (the "Company") and gives retroactive effect to the acquisition by merger of PHH Corporation with and into the Company which has been accounted for as a pooling of interests. Item 7. Exhibits Exhibit No. Description 11 Computation of per share earnings 23.1 Consent of Deloitte & Touche LLP 23.2 Consent of KPMG Peat Marwick LLP 27 Financial data schedule 99.1 Management's discussion and analysis of financial condition and results of operations of HFS Incorporated. 99.2 The financial statements of HFS Incorporated as restated to give effect to the acquisition by merger of PHH Corporation which has been accounted for as a pooling of interests. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. HFS INCORPORATED By: /s/ Scott E. Forbes Scott E. Forbes Senior Vice President and Chief Accounting Officer Date: July 15, 1997 HFS INCORPORATED CURRENT REPORT ON FORM 8-K/A Report Dated July 15, 1997 (July 15, 1997) EXHIBIT INDEX Exhibit No. Description Page No. 11 Computation of per share earnings 23.1 Consent of Deloitte & Touche LLP 23.2 Consent of KPMG Peat Marwick LLP 27 Financial data schedule 99.1 Management's discussion and analysis of financial condition and results of operations of HFS Incorporated. 99.2 The financial statements of HFS Incorporated as restated to give effect to the acquisition by merger of PHH Corporation which has been accounted for as a pooling of interests. EX-11 2 EX. 11 COMPUTATION OF PER SHARE EARNINGS HFS Incorporated and Subsidiaries COMPUTATION OF PER SHARE EARNINGS (In thousands, except per share amounts)
For the Years Ended December 31, 1996 1995 1994 --------------------------------------------------------------------------------- Fully Fully Fully Primary Diluted Primary Diluted Primary Diluted ----------- ----------- ----------- ----------- ----------- ----------- Net income $ 257,241 $ 257,241 $ 157,850 $ 157,850 $ 122,533 $ 122,533 Convertible debt interest and amortization of deferred loan costs, net of tax 4,500 4,500 4,505 4,505 -- -- ----------- ----------- ----------- ----------- ----------- ----------- Net income, as adjusted $ 261,741 $ 261,741 $ 162,355 $ 162,355 $ 122,533 $ 122,533 =========== =========== =========== =========== =========== =========== Weighted average common shares outstanding 144,784 144,784 125,967 125,967 118,746 118,746 Incremental shares for outstanding stock options and warrants 11,342 12,110 8,257 10,256 7,663 7,691 Contingent shares -- -- -- -- 3,126 3,126 Convertible debt 8,252 8,252 8,266 8,266 -- -- ----------- ----------- ----------- ----------- ----------- ----------- Weighted average common common equivalent shares outstanding 164,378 165,146 142,490 144,489 129,535 129,563 =========== =========== =========== =========== =========== =========== Net income per share $ 1.59 $ 1.58 $ 1.14 $ 1.12 $ .95 $ .95 =========== =========== =========== =========== =========== ===========
EX-23.1 3 CONSENT OF INDEPENDENT AUDITORS INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements Nos. 33-56354, 33-70632, 33- 72752, 33-83956, 33-94756, 333-06733, 333-06939 and 333-25635 of HFS Incorporated (the "Company") on Form S-8 and Registration Statements No. 333-11031 and 333-17453 of the Company on Form S-3 of our report dated March 31, 1997 (May 27, 1997 as to note 2a, April 30, 1997 as to Note 2b) related to the consolidated financial position of HFS Incorporated and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996. /s/ Deloitte & Touche LLP Parsippany, New Jersey July 15, 1997 EX-23.2 4 CONSENT OF INDEPENDENT AUDITORS INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No.s 33-56354, 33-70632, 33-72752, 33-83956, 33-94756, 333-06733, 333-06939 and 333-25635 of HFS Incorporated (the "Company) on Form S-8 and Registration Statements No. 333-11031 and 333-17453 of the Company on Form S-3 of our report dated April 30, 1997 related to the consolidated balance sheets of PHH Corporation and subsidiaries at December 31, 1996 and January 31, 1996 and the related consolidated statements of income, stockholders' equity, and cash flows for the year ended December 31, 1996 and each of the years in the two year period ended January 31, 1996. Our report contains an explanatory paragraph that states that the Company adopted the provisions of Statement of Financial Accounting Standards No. 122 "Accounting for Mortgage Servicing Rights" in the year ended January 31, 1996. /s/ KPMG Peat Marwick LLP Baltimore, Maryland July 15, 1997 EX-27 5 FDS WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
5 1,000 THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEET AND STATEMENT OF OPERATIONS OF THE COMPANY AS OF AND FOR THE YEAR ENDED DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BE REFERENCED TO SUCH FINANCIAL STATEMENTS. AMOUNTS ARE IN THOUSANDS, EXCEPT PER SHARE DATA. [/LEGEND] Year Dec-31-1996 Jan-01-1996 Dec-31-1996 153,390 22,500 687,907 27,265 0 1,058,415 328,528 128,723 10,866,000 1,070,572 748,421 0 0 1,588 3,145,473 10,866,000 0 1,440,172 0 817,426 171,184 0 19,695 431,867 174,626 257,241 0 0 0 257,241 1.59 1.58
EX-99.1 6 MANAGEMENT'S DISCUSSION AND ANALYSIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL OVERVIEW In 1996, HFS Incorporated (together with its subsidiaries, the "Company") evolved from the world's largest franchisor of lodging properties and real estate brokerage offices to a leading global service provider. Although the Company provides fee-based services that primarily fall within the Travel and Real Estate industries, the Company generally neither owns the assets nor shares the risks associated with the underlying businesses of its customers. The businesses acquired by merger with PHH Corporation ("PHH") on April 30, 1997 are consistent with this profile and provide the Company with various cross-marketing opportunities within its business segments. On May 27, 1997, the Company entered into a definitive merger agreement with CUC International, Inc. ("CUC") pursuant to which the Company's shareholders will exchange all Company common stock for approximately $11 billion of CUC common stock. CUC, a leading membership-based consumer services company with shares traded on the New York Stock Exchange, reported $2.5 billion of total assets at January 31, 1997 and $2.3 billion and $164.1 million of revenue and net income, respectively, for the fiscal year ended January 31, 1997. CUC's business profile is consistent with the Company's in that CUC's primary revenue source consists of recurring membership revenue rather than revenue from the sale of goods and services to club members. Membership is generated through CUC's technology-driven direct marketing efforts. The combination of CUC and HFS is intended to provide CUC's membership businesses access to the Company's' more than 100 million consumer contacts, while providing Company businesses with the technology-driven, direct marketing expertise necessary to successfully cross-market within its existing business units. In the travel industry, the Company is the world's largest franchisor of lodging facilities ("Lodging"), the leading provider of vacation timeshare exchange services ("Timeshare") and a leading provider of international fleet management services. The Company also owns HFS Car Rental, Inc., (formerly Avis, Inc.) which through an indirect subsidiary ("ARAC") operates directly or through licensees, the second largest car rental system worldwide. The Company expects to undertake an initial public offering (the "IPO") of ARAC in September 1997. The IPO is expected to dilute the Company's interest in ARAC to 25% and replace car rental ownership earnings with revenue from reservation and information technology agreements in 1996 and from a master franchise agreement to be effective as of January 1, 1997 ("Car Rental"). In the real estate industry, the Company is the world's largest franchisor of real estate brokerage offices ("Real Estate Franchise"), the world's largest provider of corporate relocation services ("Relocation") and operates the twelfth largest mortgage service business in the United States. Since the merger with PHH was accounted for as a pooling of interests, the financial results discussed herein have been restated to include PHH for all periods presented. All comparisons within the following discussion are to the comparable period in previous year, unless otherwise stated. RESULTS OF OPERATIONS 1996 Compared to 1995 Consolidated net income increased 63% ($99.4 million) to $257.2 million in 1996 while earnings per share ("EPS") increased 41% ($.46) to $1.58. Operating income (revenue less expenses excluding interest and income taxes increased 55% ($160.6 million) to $451.6 million. Consolidated net revenue increased 36% ($383.3 million) to $1.44 billion. Net interest expense decreased 14% ($3.3 million) to $19.7 million primarily as a result of $11.4 million of incremental interest income earned primarily from excess cash generated from a June 1996 equity offering. Gross interest expense increased 33% ($8.1 million) as a result of the issuance of $240 million, 4-3/4% Convertible Senior Notes ("4-3/4% Notes") in February 1996. The Company's weighted average effective interest rate decreased from 5.94% to 5.67%. The Company collects certain service fees from lodging and real estate franchisees, which it disburses completely for marketing and reservation activities on behalf of franchisees. Since the Company administers such funds on a pass through basis, management analyzes business results for the Lodging and Real Estate franchise segments in terms of revenue, net of marketing and reservation expenses ("adjusted net revenue") and operating expenses. Adjusted net revenue consists of net revenue of $1.44 billion, $1.06 billion and $892.1 million for 1996, 1995 and 1994, respectively, less $169.3 million, $144.0 million and $130.3 million of marketing and reservation expenses, for the same respective periods. Operating expenses include depreciation and amortization but exclude interest expense and income taxes. Results for the combined segments are as follows: Operating income ($000's) 1996 1995 Variance - ------------------------- ---------- ---------- --------- Adjusted net revenue .......... $1,270,856 $ 912,925 39% Operating expenses ............ 819,294 621,956 32% ---------- ---------- Operating income .............. $ 451,562 $ 290,969 55% ========== ========== TRAVEL INDUSTRY Lodging The Company operates eight nationally recognized brands with approximately 5,400 lodging properties under franchise contracts of up to 20 years in duration. The Company provides central reservation system services and national marketing programs, which are completely funded by its franchisees based on a designated portion of its franchise fee. The Company charges a royalty fee based on a percentage of franchisee gross room sales to fund all expenses not covered by marketing and reservation fees, such as quality inspections and franchise sales and service functions as well as generates profits for the Company. Accordingly, the significant revenue drivers of the Company are the number of royalty-paying franchise units and the average rate at which they pay. Relevant but less significant are the average daily rates and occupancy percentage of the underlying lodging properties. Operating income ($000's) 1996 1995 Variance ------------------------- -------- -------- ---------- Adjusted net revenue ............. $228,349 $195,631 17% Operating expenses ............... 82,551 75,025 10% -------- -------- Operating income ................. $145,798 $120,606 21% ======== ======== Operating income increased 21% and adjusted net revenue increased 17% as a result of a 13% increase in royalty fees and 41% increase in revenue from preferred alliance partners seeking access to the Company's franchisees and their underlying consumer base. Results for 1996 demonstrated that room growth is the most significant outcome driver for franchisee royalty, as the Company added 55,253 net rooms in 1996, representing a 133% increase from 1995 results. The Company added 94,506 rooms in 1996 (including 30,274 rooms added by the acquisition of Travelodge franchise contracts) and terminated 39,253 rooms in 1996 (including 6,053 Park Inn International rooms, comprising the franchise system sold in September 1996 for $2.2 million). In 1995, the Company added 63,280 rooms (including 9,780 rooms added by the acquisition of Knights Inn franchise contracts) and terminated 39,603 rooms (including 22,151 related to a special year-end removal of properties as a result of the repositioning and tightening of quality standards of the Company's brands). Total U.S. system revenue per available room ("REVPAR") increased 1.3% primarily due to a 1.9% increase in the average ("same store basis") daily rates ("ADR") charged at franchised lodging facilities, however, REVPAR for comparable properties increased 3.3% as a result of increases in ADR. The 10% ($7.5 million) increase in operating expenses included an 18% increase ($4.8 million) in depreciation and amortization, primarily related to the excess of cost over net assets acquired ("goodwill") associated with the acquisitions of the Travelodge and Knights Inn franchise systems in January 1996 and August 1995, respectively. Other operating expenses increased 6% ($2.7 million), primarily as a result of $1.9 million of scheduled Ramada license fee increases and increases in franchise sales and other expenses associated with system growth. Car Rental The Company acquired Avis, Inc. on October 17, 1996 for $806.5 million in cash, indebtedness and Company common stock. Prior to the acquisition date, the Company announced its plan to undertake an initial public offering ("IPO") of Avis' car rental subsidiary ("ARAC") within one year of the acquisition date and dilute its interest in ARAC to approximately 25%. The Company will retain assets that are consistent with the Company's service provider business profile, including the trademarks, franchise agreements, reservation system and information technology system assets. ARAC will pay fees to the Company pursuant to a master franchise agreement commencing in 1997 (as well as fees associated with reservation and information technology agreements) that are typical of a traditional franchise relationship. The car rental segment generated $537,000 of operating income which was comprised of $10.0 million of revenue and $9.5 million of operating expenses for the period October 17, 1996 to December 31, 1996. Net revenue consisted primarily of fees for information technology services provided to ARAC from the October 17, 1996 acquisition date. Operating expenses consisted of $3.4 million of depreciation and amortization expenses primarily associated with the Avis trademark and goodwill and $6.0 million of technology related expenses for services provided to ARAC and other rental car companies. Timeshare The Company acquired RCI on November 12, 1996 for $487.1 million plus up to $200 million of contingent consideration. RCI sells subscription memberships to owners of vacation timeshare resorts which allow members to exchange their timeshare accommodations for timeshare accommodations owned by other members at participating affiliated resorts worldwide. In addition to membership fees, RCI earns fees for exchanges processed by its call center. The key timeshare revenue drivers include the number of fee paying members and exchanges and the corresponding average fees. The operating income summary for the period November 12, 1996 to December 31, 1996 is as follows: Operating income ($000's) - ------------------------- Adjusted net revenue ..................................... $30,723 Operating expenses ....................................... 27,404 ------- Operating income ......................................... $ 3,319 ======= Adjusted net revenue primarily consists of $ 11.3 million of membership fees and $12.1 million of exchange fees. Assuming Company ownership of timeshare operations since January 1, 1995, pro forma annual membership and exchange fee revenue increased 12% to $102.0 million and 11% to $157.6 million, respectively. Total members and exchanges for calendar year 1996 increased 8% to 2.2 million and 9% to 1.7 million compared to 1995, respectively. Operating expenses consisted primarily of $15.4 million and $2.5 million for staff and communication costs associated with member services (call centers), respectively, and other timeshare functions for the period November 12, 1996 to December 31, 1996. Fleet Management Services Fleet management services are offered to corporate clients and government agencies to assist them in effectively managing their vehicle fleet costs, reducing in-house administrative costs and enhancing driver productivity. Services consist of leasing (which generally requires an investment by the Company in the vehicle and includes new vehicle purchasing, open and closed-end operating leasing, direct finance leasing and used vehicle marketing) as well as a variety of fee-based services including fuel purchasing, maintenance management programs, expense reporting, fuel management programs, accident and safety programs and other driver services for managing clients' vehicle fleets. The Company has experienced minimal losses associated with its investment in vehicles due to the overall creditworthiness of its corporate clients. Operating income ($000's) 1996 1995 Variance - ------------------------- -------- -------- ---------- Adjusted net revenue ............ $260,740 $258,877 1% Operating expenses .............. 184,480 201,959 (9%) -------- -------- Operating income ................ $ 76,260 $ 56,918 34% ======== ======== Operating income increased $19.3 million (34%) to $76.3 million, primarily as a result of an increase in fee-based services and an $11.7 million gain on the sale of the Company's truck fuel management business ("NTS") which was sold in January 1996. The adjusted net revenue increase generated in 1996 included the increase in fee-based services but was offset by the absence of approximately $21.8 million of revenue from the sold NTS business. The $17.5 million (9%) decrease in operating expenses was primarily associated with $19.1 million of expenses associated with the sold NTS business. REAL ESTATE INDUSTRY Real Estate Franchise The Company licenses brand names to independently owned brokerage offices associated with three of the four largest franchise systems in the world. The Company acquired the world's largest franchise system, the CENTURY 21 system, in August 1995, the ERA franchise system in February 1996 and the Coldwell Banker franchise system in May 1996. The most significant revenue driver for real estate franchise is the number of transactions for which the broker receives commission revenue. Royalties are calculated based on a percentage of franchisee commission revenue and fund franchise sales, service and training expenses. Marketing fee collections fund national advertising expenditures and other marketing activities. Operating income ($000's) 1996 1995 Variance - ------------------------- -------- -------- ---------- Adjusted net revenue ............. $221,724 $ 43,771 407% Operating expenses ............... 111,189 24,494 354% -------- -------- Operating income ................. $110,535 $ 19,277 473% ======== ======== Operating income and adjusted net revenue increased 473% and 407%, respectively, as a result of the CENTURY 21 franchise system's first full year contribution to operating results and partial year contributions from the acquired Coldwell Banker and ERA franchise systems. These franchises systems licensed their trademarks to approximately 184,000 sales associates at December 31, 1996. The royalty portion of revenue increased $162.8 million (361%) and revenue from preferred affiliates grew from $208,000 to $13.4 million, net of the Company's $11.0 million fourth quarter write-off of revenue associated with the license of the CENTURY 21 trademark to Amre, Inc., which filed for bankruptcy protection in February 1997. The Company is currently negotiating with home improvement companies to license the CENTURY 21 trademark. Operating expenses increased 354% ($86.7 million) as a result of incremental expenses associated with acquired franchise systems. Operating expenses also included a $5.0 million restructuring charge associated with the second quarter 1996 contribution of Coldwell Banker's former owned brokerage business to National Realty Trust ("Trust"), an independent entity governed by independent trustees. Relocation Relocation segment services primarily consist of the purchase, management and resale of homes for transferred employees of corporate clients, members of affinity group clients and government agencies. Although the Company acquires the homes of client employees, the client corporations reimburse the Company for carrying costs until the home is sold and for home sale losses. Accordingly, the Company earns a fee for services with minimal real estate risk. Operating expenses primarily consist of staffing and related costs for sales and service functions. Operating results include contributions from PHH Relocation for all periods shown, from Coldwell Banker Relocation Services, Inc. ("CBRS") since the May 31, 1996 acquisition date and from Worldwide Relocation Management, Inc. ("WRM") since the August 1, 1995 acquisition date. Operating income ($000's) 1996 1995 Variance - ------------------------- -------- -------- ---------- Adjusted net revenue ............. $344,865 $301,667 14% Operating expenses ............... 290,563 259,949 12% -------- -------- Operating income ................. $ 54,302 $ 41,718 30% ======== ======== Operating income increased 30% ($12.6 million) as a result of a 14% ($43.2 million) increase in adjusted net revenue, net of a 12% ($30.6 million) increase in operating expenses. Acquired CBRS and WRM operations generated $19.2 million of operating income and PHH Relocation operating income decreased $6.6 million (18%). PHH relocation adjusted net revenue increased $23.7 million due to an expansion of services provided to corporate clients while revenue from home sale assistance was flat compared to 1995. The revenue increase was offset by $30.3 million of increased expenses associated with the development of the expanded full service infrastructure. Mortgage Services Mortgage services primarily consist of the origination, sale and servicing of residential first mortgage loans. The Company packages its originated loans for sale in secondary markets generally within 90 days of origination and retains servicing rights. The Company markets a variety of first mortgage products to consumers through relationships with corporations, affinity groups, government agencies, financial institutions, real estate brokerage firms and mortgage banks by a combination of retail teleservices delivery and wholesale correspondent lending arrangements. Operating income ($000's) 1996 1995 Variance - ------------------------- -------- -------- ---------- Adjusted net revenue ............ $126,570 $ 93,251 36% Operating expenses .............. 85,268 51,507 66% -------- -------- Operating income ................ $ 41,302 $ 41,744 (1%) ======== ======== Operating income decreased 1% as a result of a 36% increase in adjusted net revenue, net of a 66% increase in operating expenses. The increase in adjusted net revenue resulted from a 149% increase in loan origination revenue offset by a 28% decrease in loan servicing fees. The volume of loan closings increased 34% from $6.3 billion to $8.4 billion and the average fee increased from 54 to 100 basis points. Whereas the portfolio of loans serviced increased 16% from $19.4 billion to $22.5 billion, the average fee decreased 38% from 30.8 to 19.2 basis points. The increase in origination fees and decrease in servicing fees results from the implementation of SFAS 122 in 1995, which had the effect of reallocating revenue from servicing fees to origination fees. A reduction in gains recorded from the sale of a portion of the loan servicing portfolio also contributed to the decrease in service fees. The gain on the sale of servicing amounted to $17.4 million in 1995 compared to $1.5 million in 1996. Operating expenses increased as a result of higher closing volume experienced in expanded retail teleservices delivery arrangements in 1996. Other Segment Other segment business operations primarily consist of casino credit information and marketing services ("Casino Services"), the equity in earnings from the Company's investment in ARAC (net of information technology fees charged to ARAC) and other operations or transactions which are not included in the Company's primary business segments. Operating expenses also include corporate overhead expenses which could not be allocated to other operating business segments. Operating income is summarized as follows: Operating income ($000's) 1996 1995 Variance - ------------------------- ------- ------- ---------- Adjusted net revenue ............. $47,871 $19,728 143% Operating expenses ............... 28,362 9,022 214% ------- ------- Operating income ................. $19,509 $10,706 82% ======= ======= Operating income increased $8.8 million primarily as a result of $9.5 million of consideration received by the Company related to the termination of a corporated services agreement and $2.3 million equity in earnings from the Company's investment in ARAC, which was acquired on October 17, 1996. 1995 Compared to 1994 Consolidated net income increased 29% ($35.3 million) to $157.9 million in 1995 while EPS increased 18% to $1.12. Consolidated revenue increased 19% to $1.1 billion in 1995. Net interest expense increased $4.5 million as a result of incremental financing costs associated with the CENTURY 21 transaction, and a general rise in interest rates in 1995 compared to 1994. Despite average LIBOR rate increases approximating 84 basis points, the Company's average borrowing rate increased only 40 basis points to 6.0%, principally as a result of favorable fixed rate debt securities issued in 1994 and 1993. Results for the combined segments on an operating income basis follows: Operating income ($000's) 1995 1994 Variance - ------------------------- -------- -------- ---------- Adjusted net revenue ............. $912,925 $761,852 20% Operating expenses ............... 621,956 535,961 16% -------- -------- Operating income ................. $290,969 $225,891 29% ======== ======== TRAVEL INDUSTRY Lodging Operating income ($000's) 1995 1994 Variance - ------------------------- -------- -------- ---------- Adjusted net revenue ............. $195,631 $170,426 15% Operating expenses ............... 75,025 67,939 10% -------- -------- Operating income ................. $120,606 $102,487 18% ======== ======== Adjusted net revenue increased 15% as a result of a $20.7 million (16%) increase in royalty fees and a $6.8 million (49%) increase in revenue from preferred alliances seeking access to franchisees and their customers. Room growth represented the most significant revenue outcome driver contributing to the revenue increase. The Company added 63,280 rooms during 1995, representing an 18.8% increase, but also terminated 39,603 rooms including 22,151 rooms in a special year-end removal of properties as a result of the repositioning and tightening of quality standards of the Company's brands. Total REVPAR increased 3.0% primarily due to a 2.6% increase in the average daily rates charged at franchisee hotels and a 1.8% increase in average royalty rates. Demonstrating the Company's ability to translate revenue into earnings, operating income increased $18.1 million (18%) while operating expenses increased only $7.1 million (10%). The increase in operating expenses included $4.6 million of franchise sales and bad debt expenses associated with system growth as well as $1.5 million of scheduled Ramada license fee increases. Depreciation expense also increased $4.1 million in part from a full year's expense in 1995 related to the newly developed reservation system for Days Inn which was implemented in October 1994. The increase was also attributable to goodwill amortization associated with the issuance of Company common stock in December 1994 and September 1995, pursuant to an earnout agreement entered into with Bryanston Group, Inc., an affiliate of the sellers of the Days Inn franchise system. Fleet Management Services Operating income ($000's) 1995 1994 Variance - ------------------------- -------- -------- ------------ Adjusted net revenue ............. $258,877 $249,571 4% Operating expenses ............... 201,959 197,248 2% -------- -------- Operating income ................. $ 56,918 $ 52,323 9% ======== ======== Operating income increased 9% ($4.6 million) to $56.9 million in 1995 as a result of a 4% ($9.3 million) increase in adjusted net revenue, net of 2% ($4.7 million) increase in operating expenses. The revenue increase primarily resulted from an increase in service fees generated by growth in fuel and maintenance management programs. Such growth reflects increased market penetration in the United States and United Kingdom. Operating expenses increased only 2% reflecting a cost reduction program implemented in 1995 net of certain expenses that vary with revenue growth. REAL ESTATE INDUSTRY Real Estate Franchise The CENTURY 21 franchise system contributed $43.8 million of adjusted net revenue and $19.3 million of operating profit for the five months following the Company's August 1, 1995 acquisition. Franchise fees paid by the approximately 6,000 CENTURY 21 franchised brokerage offices approximated $42.1 million and comprised the significant portion of Real Estate Franchise net revenue. Operating expenses included $21.5 million of SG&A, including franchise sales, service and training expenses and $3.0 million of depreciation and amortization associated with goodwill and franchise agreements acquired in the CENTURY 21 acquisition. Relocation The Company operated PHH Relocation in both 1994 and 1995 and WRM from August 1, 1995, the date it was acquired. Operating income ($000's) 1995 1994 Variance - ------------------------- -------- -------- ---------- Adjusted net revenue ............. $301,667 $255,974 18% Operating expenses ............... 259,949 221,440 17% -------- -------- Operating income ................. $ 41,718 $ 34,534 21% ======== ======== Operating income increased 21% ($7.2 million) as a result of an 18% ($45.7 million) increase in adjusted net revenue offset by a 17% ($38.5 million) increase in operating expenses. The 18% increase in adjusted net revenue resulted primarily from an expansion of full service products offered to corporate clients and a 7% ($7.8 million) increase in home sale assistance fees. 1995 also included revenue and expense contributions from WRM which was acquired on August 1, 1995. The operating expense increase resulted from growth in the infrastructure necessary to match competition for fee-based services other than home sale assistance and system related expenses associated with U.S. and Canadian asset management businesses. Mortgage Services Operating income ($000's) 1995 1994 Variance - ------------------------- ------- ------- ---------- Adjusted net revenue ............. $93,251 $74,494 25% Operating expenses ............... 51,507 44,322 16% ------- ------- Operating income ................. $41,744 $30,172 38% ======= ======= Operating income increased 38% ($11.6 million) as a result of a 25% ($18.8 million) increase in adjusted net revenue partially offset by a 16% ($7.2 million) increase in operating expenses. Adjusted net revenue increased as a result of $55.6 million of higher net revenue associated with the capitalization of originated mortgage servicing rights partially offset by a $10.7 million reduction in the gain on sale of servicing rights and a 32% increase in total loan closings from 1994 to 1995. In addition, operating expenses increased as the Company responded to the increase in loan production volume and the increased servicing portfolio. Mortgage loan closings increased from $3.4 billion to $6.3 billion in 1995. These increases resulted from the increased consumer demand discussed above and the Company's increased market share due primarily to expanded relationships with affinity groups which represented 29% of the total increase, and with financial institutions which represented 24% of the total increase. Servicing net revenue increased 13% as a result of an increase in the average servicing portfolio partially offset by increased amortization of servicing rights. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 122, "Accounting for Mortgage Servicing Rights," effective May 1, 1995. This statement requires that originated mortgage servicing rights be recognized as income when the loan is sold and servicing is retained. The effect of this change in accounting was partially offset by a decrease in margins realized on loans sold. This decline in margins reflects the competition in the industry to capture lower demand for mortgages created by the changes in interest rates during 1995. Other Segment Operating income ($000's) 1995 1994 Variance - ------------------------- ------- ------- ---------- Adjusted net revenue ............. $19,728 $11,387 73% Operating expenses ............... 9,022 5,012 80% ------- ------- Operating income ................. $10,706 $ 6,375 68% ======= ======= Operating income increased 68% ($4.3 million) as a result of the incremental profits from Central Credit Inc. ("CCI"), which conducts a casino credit information business and was acquired by the Company in May 1995. LIQUIDITY AND CAPITAL RESOURCES Acquisition Overview The Company continues to seek to expand and strengthen its leadership position in its travel and real estate industry segments with additional acquisitions. Following the April 30, 1997 merger with PHH, the Company believes it has achieved, annually, points of contact with over 100 million consumers involved in significant dollar volumes of transactions in the travel and real estate industries. The Company's desire to cross-market within its businesses and expand the revenue streams of each business as well as market to its millions of consumer contacts was the primary motivation for the proposed merger with CUC, which the Company believes currently possesses expertise in direct marketing necessary to accomplish the Company's objectives. The Company's acquired businesses share similar characteristics, foremost of which is that each was immediately accretive to Company cash flow and earnings. Revenue is substantially generated from service fees and not dependent on tangible assets or the need for capital expenditures other than technology investments which support and historically have been significantly funded by the Company's customers. These service businesses each generate significant cash flow which is enhanced by the Company's operating leverage that supports acquired revenue streams without corresponding increases in operating infrastructure expenses. Assuming the successful completion of the proposed CUC merger, the Company is imminently positioned to cross-market within its existing business segments. The Company continues to pursue acquisitions and/or investments in service businesses that fit the profile described above. PHH Merger On April 30, 1997, the Company acquired PHH by merger (the "PHH Merger") for approximately 30.3 million shares of Company common stock in exchange for all of the outstanding common stock of PHH. PHH is the world's largest provider of corporate relocation services and also provides mortgage and fleet management services. Since this transaction has been accounted for as a pooling of interests, all financial information has been restated for the PHH merger. The Company will incur a one-time restructuring charge of approximately $287 million before related tax benefits in the second quarter of 1997 in connection with the merger. The charge includes severance, facility consolidation and other transaction related costs associated with the restructuring of Company and PHH businesses. The restructuring charge will be paid with borrowings under the Company's revolving credit facility and cash flow from operations. The Company estimates the charge to result in annual pre-tax savings of approximately $100 million with the full benefit of cost reductions beginning in 1998. Although PHH debt to equity ratio approximates 7 to 1, such debt corresponds directly with related net investments in leased vehicles, equity advances on homes and mortgage loans held for sale. Accordingly, Standard and Poor's Corporation ("S&P") and Moody's Investors Service, Inc. ("Moody's") assigned investment grade ratings of A+ and A2, respectively, to PHH debt and A1 and P1, respectively to PHH commercial paper. Pending Acquisitions Value - On March 3, 1997, the Company announced that it reached an agreement in principle to acquire Value Rent-A-Car ("Value") for $175 million in cash. The Company determined not to pursue the acquisition of Value and terminated such agreement in April 1997. Sheraton - On January 27, 1997, Hilton Hotels Corporation ("Hilton") announced that it had reached a preliminary understanding to license certain assets to the Company in connection with its pending tender offer for the outstanding common stock of ITT Corporation ("ITT"). Pursuant to the preliminary understanding, subject to Hilton's successful acquisition of ITT, the Company would license the Sheraton trademark, franchise system and management agreements worldwide under a long-term contract. The transaction is subject to Hilton's acquisition of ITT as well as negotiation of definitive agreements relating to the proposed license agreement. There can be no assurance that Hilton's attempt to acquire ITT will be successful or that the Company and Hilton will consummate their proposed transaction. Completed Acquisitions RCI - On November 12, 1996, the Company completed the acquisition of all the outstanding common stock of RCI for approximately $487 million comprised of $412 million in cash and $75 million of Company common stock plus future contingent payments of up to $200 million over the next five years. The cash portion of the purchase price was funded with borrowings under a revolving credit facility, acquired RCI cash and excess proceeds from a second quarter public offering of approximately 19.4 million shares which generated $1.2 billion of proceeds (the "Offering"). RCI, based in Indianapolis Indiana, is the world's largest provider of timeshare exchange programs, providing services for approximately 2.2 million timeshare owners and approximately 3,100 resorts around the world. RCI is also engaged in publishing related to the timeshare industry and provides other travel-related services, integrated software systems and resort management and consulting services. Avis - On October 17, 1996, the Company completed the acquisition of all of the outstanding capital stock HFS Car Rental Inc. (formerly Avis, Inc.) ("Avis"), including payments under certain employee stock plans of Avis and the redemption of certain series of preferred stock of Avis for $806.5 million. The purchase price was comprised of approximately $367.2 million in cash, $100.9 million in indebtedness and $338.4 million (approximately 4.6 million shares) of Company common stock. The cash portion of the purchase price was funded with excess proceeds from the Offering. Prior to the consummation of the acquisition, the Company announced its plan to undertake an IPO of ARAC within one year of the acquisition date and dilute its interest in ARAC to approximately 25%. ARAC will license the Avis trademark from the Company in return for a license fee based on a percentage of ARAC revenue. The Company also provides reservation and information technology services to ARAC. Coldwell Banker - On May 31, 1996, the Company acquired by merger Coldwell Banker for $640 million of cash plus repayment of approximately $105 million of indebtedness. At that time, Coldwell Banker Corporation ("Coldwell Banker") had 2,164 franchised brokerage offices and owned 318 residential real estate brokerage offices ("Owned Brokerage Business") in the United States, Canada and Puerto Rico, representing the third largest real estate brokerage system in the United States. The Company financed the Coldwell Banker transaction with a portion of the approximately $1.2 billion of proceeds from the Offering. Immediately following the closing of the Coldwell Banker merger, the Company conveyed the Owned Brokerage Business to the Trust and recorded a $5 million pre-tax restructuring charge. CENTURY 21 Non-owned Regions - During the second quarter of 1996, the Company completed the acquisition of six U.S. CENTURY 21 regions which were licensed to four independent master licensees. The aggregate purchase price consisted of approximately $96.4 million of cash, $5 million of notes and $46 million (approximately 0.9 million shares) of the Company's common stock. These acquisitions resulted in the Company receiving royalty fees of up to 6% of the franchisee gross commissions generated by such offices compared to less than 1% previously received under the master licensing agreements. The cash portion of the aggregate purchase price was financed with proceeds from the issuance of 4 3/4% Notes. ERA - On February 12, 1996, the Company purchased substantially all of the assets comprising the ERA residential real estate brokerage system for approximately $39.4 million, which was financed by borrowings under the Company's revolving credit facility. CENTURY 21 - On August 1, 1995, a majority-owned Company subsidiary, C21 Holding Corp. ("Holding"), acquired Century 21 from Metropolitan Life Insurance Company ("MetLife") for an aggregate purchase price of $245 million plus expenses. In February 1996, the Company paid the $30 million contingent portion of the purchase price of Century 21 and redeemed $80 million of Century 21 redeemable preferred stock issued by MetLife prior to the acquisition. The Company financed these payments with proceeds from the 4-3/4% Notes. Effective October 29, 1996 (the "Effective Date"), the Company amended the Subscription and Stockholders' Agreement dated as of August 1, 1995 among C21 Holding Corp., the Company and a group of former executives of Century 21 Real Estate Corporation ("the Former Management") pursuant to which the Company owned 87.5% of C21 Holding Corp. and the Former Management owned 12.5% of C21 Holding Corp. Such amendment provided for the acceleration of the Company's option to purchase the 12.5% ownership from the Former Management at fair market value, determined as of the Effective Date. The Company completed such purchase in the second quarter of 1997 for $52.8 million. Travelodge - On January 23, 1996, the Company purchased the assets comprising the Travelodge hotel franchise system in North America, including the Travelodge and Thriftlodge service marks and franchise agreements from Forte Hotels, Inc. ("FHI") for $39.3 million. The Company financed the acquisition with borrowings under its revolving credit facility and repaid the borrowings with proceeds from the 4-3/4% Notes. Concurrent with the Company's acquisition of the Travelodge franchise system, Motels of America, Inc., through a wholly owned subsidiary, (collectively "MOA"), purchased 20 Travelodge motels from FHI for $32.3 million. Chartwell Leisure, Inc. ("CHRT") (formerly National Lodging Corp.), a former wholly owned Company subsidiary which was distributed to the Company shareholders in November 1994, purchased all of the capital stock of FHI for $98.4 million. FHI owned or had an interest in 112 hotel and motel properties at the acquisition date. MOA, a significant Company franchisee, entered into twenty year Travelodge franchise agreements for the lodging properties it acquired from FHI. The Company financed $10 million of MOA's purchase price under a $10 million revolving credit facility, bearing interest at 14% per annum. The loan is guaranteed by the parent company of MOA and secured by approximately 80% of MOA's outstanding common stock. In connection with CHRT's acquisition of FHI, the Company guaranteed $75 million of CHRT borrowings under a $125 million revolving credit facility entered into by CHRT with certain banks. The Company is paid a guarantee fee of 2% per annum of the outstanding guarantee commitment by the Company pursuant to a Financing Agreement. Concurrent with the acquisition of the Travelodge franchise system and CHRT's acquisition of FHI, the marketing and advisory agreements between the Company and CHRT were terminated. The corporate services agreement was modified to provide that the Company was to provide financial and other corporate administrative support and advisory services through September 1996 and thereafter advisory services through January 2019 for a fee of $1.5 million per year. This agreement was terminated in November 1996 by mutual agreement, with the Company receiving $9.5 million in consideration for consenting to early termination of such agreement. Additionally, CHRT paid a $2.0 million advisory fee to the Company in connection with CHRT's acquisition of FHI. Equity Transactions Treasury Purchases - On January 7, 1997, the Board of Directors authorized the purchase of 2.6 million shares of Company common stock to satisfy stock option exercises and conversions of convertible debt securities and to fund future acquisitions. The Company acquired approximately 2.6 million treasury shares in January and February 1997 for $179.4 million with revolving credit borrowings. The Company completed the offering of 19.4 million shares of common stock in the second quarter of 1996 which yielded net proceeds to the Company after expenses of approximately $1.2 billion. Approximately $755 million of the proceeds were used to finance the acquisition of Coldwell Banker and $75 million was used to repay outstanding borrowings under the Company's revolving credit facility. The remaining $331 million of proceeds were used as partial consideration for the October 17, 1996 and November 12, 1996 acquisitions of Avis and RCI, respectively. The Company issued 0.9 million shares of common stock in May 1996 in connection with the acquisition of the CENTURY 21 non-owned regions. Also, the Company issued 4.6 million and 1.0 million shares in connection with the October 17, 1996 and November 12, 1996 acquisitions of Avis and RCI, respectively. Financing The Company continues to believe that it has excellent liquidity and access to liquidity through various sources. Most significant, the Company has generated significant positive cash flow from operations in every quarter since its initial public offering in December 1992. The Company has also demonstrated its ability to access equity and public debt markets and financial institutions to generate capital for strategic acquisitions. Indicative of the Company's creditworthiness, following the announcement of the PHH merger, S&P and Duff & Phelps affirmed their A credit rating of the Company's publicly issued debt and Moody's upgraded the Company's debt rating to A3. Liquidity is available to the Company through revolving credit facilities which may provide up to $1.5 billion of unsecured borrowings at interest rates generally approximating LIBOR plus a margin of 25 basis points. At December 31, 1996, the Company had $205 million of outstanding borrowings under its revolving credit facilities. The Company filed a shelf registration statement with the Securities and Exchange Commission effective August 29, 1996, for the aggregate issuance of up to $1 billion of debt and equity securities. These securities may be offered from time to time, or separately based on terms to be determined at the time of sale. The proceeds may be used for general corporate purposes, which may include future acquisitions. Long-term debt, which totaled $748.4 million at December 31, 1996, primarily consists of $537 million of publicly issued debt and $205 million of borrowings under the Revolving Credit Facilities. Publicly issued debt includes the $240 million of 4-3/4% Notes (convertible) due 2003, $147 million of 4-1/2% convertible senior notes due 1999 and $150 million of 5-7/8% senior notes due December 1998. Interest on the publicly issued debt is paid semi-annually. Long-term debt increased from $303.0 million at December 31, 1995 to $748.4 million at December 31, 1996, due to the issuance of the 4-3/4% Notes and $205 million of borrowings under the Revolving Credit Facilities which partially financed the November acquisition of RCI. PHH operates mortgage services, fleet management and relocation businesses as a separate public reporting entity and supports purchases of leased vehicles and originated mortgages primarily with $5.1 billion of borrowings at December 31, 1996, including the issuance of $3.1 billion of commercial paper and $1.7 billion of medium term notes. Such borrowings are included in liabilities under management and mortgage programs rather than long-term debt since such debt corresponds directly with high quality related assets. Although PHH's debt to equity ratio approximates 7 to 1, in recognition of the relationship between borrowings and high quality assets, following the announcement of the PHH merger, S&P and Moody's affirmed investment grade ratings of A+ and A2, respectively to PHH debt and A1 and P1, respectively to PHH commercial paper. Although PHH debt is issued without recourse to the Company, the combined company will continue to maintain broad access to global capital markets by maintaining the quality of its assets under management. This is achieved by establishing credit standards to minimize credit risk and the potential for losses. Depending upon asset growth and financial market conditions, PHH utilizes the United States, European and Canadian commercial paper markets, as well as other cost-effective short-term instruments. In addition, PHH will continue to utilize the public and private debt markets to issue unsecured senior corporate debt. Augmenting these sources, PHH will periodically reduce outstanding debt by the sale or transfer of managed assets to third parties while retaining fee-related servicing responsibility. To provide additional financial flexibility, PHH's current policy is to ensure that minimum committed facilities aggregate 80 percent of the average amount of outstanding commercial paper. PHH maintains a $2.5 billion syndicated unsecured credit facility which is backed by domestic and foreign banks and is comprised of $1.25 billion of lines of credit maturing in 364 days and $1.25 billion maturing in five years. In addition, PHH has approximately $300 million of uncommitted lines of credit with various financial institutions. Management closely evaluates not only the credit of the banks but the terms of the various agreements to ensure ongoing availability. The full amount of PHH's committed facilities in 1997 to date are undrawn and available. Management believes that its current policy provides adequate protection should volatility in the financial markets limit PHH's access to commercial paper or medium-term notes funding. The Company minimizes its exposure to interest rate and liquidity risk by effectively matching floating and fixed interest rate and maturity characteristics of funding to related assets, varying short and long-term domestic and international funding sources, and securing available credit under committed banking facilities. The Company generated $1.2 billion of cash flow from operations during the year ended December 31, 1996, representing a $372.4 million (44%) increase from the year ended December 31, 1995. The Company reported a $12.2 million working capital deficiency at December 31, 1996 primarily as a result of $313 million of deferred subscription revenue acquired in the November 1996 RCI acquisition without the benefit of acquiring the corresponding up-front cash collected for the same subscriptions. Cash and cash equivalents increased $46.6 million from December 31, 1995 to December 31, 1996. Approximately $372.4 million and $1.1 billion of the increase was attributable to net cash provided by operating activities and financing activities, respectively. This increase was offset by $1.4 billion of net cash used in investing activities. The increase from operating activities was primarily attributable to $99.4 million of incremental net income and $98.5 million of incremental depreciation and amortization. Investing activities required the use of $1.5 billion more cash in 1996 to purchase the net assets of acquired business exclusive of acquired cash, and $14.2 million of incremental property and equipment additions including company headquarters improvements (first occupied in September 1996), a new reservation system for the Super 8 franchise systems and computer equipment following the Company's termination of a contract with an information technology services provider. The $1.1 billion increase in net cash provided by financing activities resulted from approximately $1.2 billion and $447.1 million of proceeds received in connection with the Offering and borrowings under the Revolving Credit Facilities, respectively. On October 2, 1996, the Company replaced an existing $300 million revolving credit facility with $1 billion of revolving credit facilities consisting of (i) a $500 million, five year revolving credit facility and a $500 million, 364 day credit facility (the "364 Day Revolving Credit Facility") (collectively the "Revolving Credit Facilities"). The Company may renew the 364 Day Revolving Credit Facility on an annual basis for an additional 364 days up to a maximum aggregate term of five years upon receiving lender approval. The Revolving Credit Facilities, at the option of the Company, bear interest at rates based on competitive bids of lenders participating in the facilities, at the prime rate or at LIBOR plus a margin approximating 25 basis points. In 1997, the Company has requested and received an additional $500 million of credit availability under the Revolving Credit Agreement. Outstanding borrowings under the Revolving Credit Facilities approximates $205 million at December 31, 1996. IMPACT OF INFLATION The primary source of revenue of the Company through December 31, 1996 is based on a percentage of the franchised lodging facilities' gross room revenue and franchised real estate brokerage offices' gross commission revenue. As a result, the Company's revenue (excluding those changes attributable to a change in the number of franchises) is expected to change consistent with the trend of the consumer price index. The Company does not believe that inflation would have an unfavorable impact on its operations. IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," which is effective for the Company in financial statements issued after January 1, 1997. The Company does not expect the adoption of SFAS 125 to have a material impact on the financial condition or results of operations. In March 1997, FASB issued SFAS No. 128, "Earnings per Share" which is effective for the Company in financial statements issued after December 15, 1997. SFAS 128 supersedes APB 15 and replaces the presentations of primary EPS with a presentation of Basic EPS. It also requires presentation of Basic and Diluted EPS on the income statement for all entities with complex capital structures. Assuming SFAS 128 was applicable for 1996, the Company would have reported the following: Pro forma: Basic EPS $ 1.78 Diluted EPS $ 1.59 As reported: Primary EPS $ 1.59 Diluted EPS $ 1.58 SEASONALITY The principal sources of revenue for the Company are fees for services provided. Lodging and Car Rental franchise royalty fees share the same pattern of revenue experienced by their respective underlying industries, wherein summer months produce higher revenue due to increased leisure travel. Although the Timeshare business services the leisure traveler, exchanges are made and earned consistently throughout the year. The Fleet Management segment services corporate fleet consumers that lease vehicles throughout the year and accordingly, earnings from such services are earned consistently throughout the year. Real Estate franchise fees and Relocation service fees are earned when residential home sale closings peak, which is generally in summer months. Mortgage service fees are amortized and earned consistently over the term of the loan being serviced: however; revenue derived from loan originations and sales of servicing may fluctuate depending on interest rate changes which influence the market for loan refinancings, pay-offs and lending activity. On a weighted average basis, pro forma for acquired companies, the aggregate principal sources of revenue generate 22%, 26%, 28% and 24% of total annual revenue in the first, second, third and fourth calendar quarters, respectively. EX-99.2 7 RESTATED FINANCIAL STATEMENTS OF HFS INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders of HFS Incorporated: We have audited the consolidated balance sheets of HFS Incorporated and its subsidiaries (the "Company") as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The consolidated financial statements give retroactive effect to the merger of HFS Incorporated and PHH Corporation, which has been accounted for as a pooling of interests as described in Note 2 to the consolidated financial statements. We did not audit the financial statements of PHH Corporation for the years ended December 31, 1996, January 31, 1996 and January 31, 1995, which statements reflect assets of $6,574,646,000 and $5,775,627,000 as of December 31, 1996 and January 31, 1996, respectively, and revenues of $1,938,537,000, $1,815,120,000, $1,609,340,000 for the years ended December 31, 1996, January 31 1996 and January 31, 1995, respectively. Those financial statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for PHH Corporation for such periods, is based solely on the report of such other auditors. 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, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of HFS Incorporated and subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in the notes to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights", in the year ended December 31, 1995. /s/ Deloitte & Touche LLP Parsippany, New Jersey March 31, 1997 (May 27, 1997 as to Note 2a and April 30, 1997 as to Note 2b) INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors PHH Corporation We have audited the consolidated balance sheets of PHH Corporation and subsidiaries as of December 31, 1996 and January 31, 1996, and the related consolidated statements of income, stockholders' equity and cash flows for the year ended December 31, 1996 and each of the years in the two-year period ended January 31, 1996, not presented separately herein. 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PHH Corporation and subsidiaries as of December 31, 1996 and January 31, 1996, and the results of their operations and their cash flows for the year ended December 31, 1996 and for each of the years in the two-year period ended January 31, 1996, in conformity with generally accepted accounting principles. As discussed in the notes to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights", in the year ended January 31, 1996. /s/ KPMG Peat Marwick LLP Baltimore, Maryland April 30, 1997 HFS Incorporated and Subsidiaries CONSOLIDATED BALANCE SHEETS (In thousands) December 31, ASSETS 1996 1995 ----------- ----------- CURRENT ASSETS Cash and cash equivalents .......................... $ 69,541 $ 22,923 Restricted cash .................................... 89,849 -- Investment in equity securities .................... 22,500 -- Other accounts and notes receivable, net of allowance for doubtful accounts of $27,265 and $27,008, respectively .................................. 687,907 565,484 Other current assets ............................... 94,820 83,220 Deferred income taxes .............................. 93,798 41,242 ----------- ----------- TOTAL CURRENT ASSETS ............................... 1,058,415 712,869 Property and equipment - net ....................... 328,528 164,220 Franchise agreements - net of accumulated amortization of $87,876 and $65,905, respectively ............. 995,947 517,218 Excess of cost over fair value of net assets acquired net of accumulated amortization of $63,725 and $25,021, respectively ............ 1,783,409 406,414 Other intangibles - net of accumulated amortization of $4,441 ....................... 604,535 -- Investment in car rental operations of Avis, Inc. ................................ 76,540 -- Other assets ....................................... 289,392 172,483 ----------- ----------- Total assets exclusive of assets under programs .... 5,136,766 1,973,204 ----------- ----------- Assets under management and mortgage programs: Net investment in leases and leased vehicles .. 3,418,666 3,243,236 Relocation receivables ........................ 773,326 736,038 Mortgage loans held for sale .................. 1,248,299 784,901 Mortgage servicing rights and fees ............ 288,943 191,434 ----------- ----------- 5,729,234 4,955,609 ----------- ----------- TOTAL ASSETS ....................................... $10,866,000 $ 6,928,813 =========== =========== See accompanying notes to consolidated financial statements. HFS Incorporated and Subsidiaries CONSOLIDATED BALANCE SHEETS (In thousands, except share data) December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995 ------------ ------------ CURRENT LIABILITIES Accounts payable and other accrued expenses .... $ 855,770 $ 600,203 Short-term debt ................................ 150,000 -- Due to car rental operations of Avis, Inc., net ............................... 61,807 -- Current portion of long-term debt .............. 2,995 2,249 ------------ ------------ TOTAL CURRENT LIABILITIES ...................... 1,070,572 602,452 Long-term debt ................................. 748,421 300,778 Deferred revenue ............................... 397,034 64,591 Other liabilities .............................. 131,021 72,079 ------------ ------------ Total liabilities exclusive of liabilities under programs .................... 2,347,048 1,039,900 ------------ ------------ Liabilities under management and mortgage programs: Debt ...................................... 5,089,943 4,427,872 Deferred income taxes ..................... 281,948 234,918 ------------ ------------ 5,371,891 4,662,790 Series A adjustable rate Preferred Stock ....... -- 80,000 ------------ ------------ Commitments and contingencies (Note 12) SHAREHOLDERS' EQUITY Preferred stock, $1.00 par value - authorized 10,000,000 shares; none issued and outstanding ............... -- -- Common stock, $.01 par value - authorized 600,000,000 shares; issued and outstanding 158,728,807 and 130,991,148 shares, respectively .......... 1,588 1,310 Additional paid-in capital ..................... 2,337,297 566,795 Retained earnings .............................. 830,970 601,118 Net unrealized gain on investment .............. 4,366 -- Currency translation adjustment ................ (8,008) (23,100) Treasury stock, at cost (322,500 shares) ....... (19,152) -- ------------ ------------ TOTAL SHAREHOLDERS' EQUITY ..................... 3,147,061 1,146,123 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ..... $ 10,866,000 $ 6,928,813 ============ ============ See accompanying notes to consolidated financial statements. HFS Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share amounts) Years Ended December 31, ------------------------------------ 1996 1995 1994 ---------- ---------- ---------- REVENUES Service fees, net ................... $1,340,534 $ 962,954 $ 815,423 Fleet leasing (net of depreciation and interest costs of $1,132,408, $1,088,993 and $976,244, respectively) ...................... 56,660 52,079 47,860 Other, net .......................... 42,978 41,857 28,837 ---------- ---------- ---------- Net revenues ........................ 1,440,172 1,056,890 892,120 ---------- ---------- ---------- EXPENSES Operating ........................... 660,079 528,571 458,462 Marketing and reservation ........... 157,347 137,715 124,603 General and administrative .......... 73,373 36,457 29,452 Depreciation and amortization ....... 97,811 63,178 53,712 Interest, net ....................... 19,695 22,949 18,490 ---------- ---------- ---------- Total expenses ...................... 1,008,305 788,870 684,719 ---------- ---------- ---------- Income before income taxes .......... 431,867 268,020 207,401 Provision for income taxes .......... 174,626 110,170 84,868 ---------- ---------- ---------- NET INCOME .......................... $ 257,241 $ 157,850 $ 122,533 ========== ========== ========== PER SHARE INFORMATION Net income Primary ........................ $ 1.59 $ 1.14 $ 0.95 Fully diluted .................. 1.58 1.12 0.95 Weighted average shares outstanding Primary ........................ 164,378 142,490 129,535 Fully diluted .................. 165,146 144,489 129,563 See accompanying notes to consolidated financial statements. HFS Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (In thousands, except per share data)
Net Additional Unrealized Currency Common Stock Paid-in Retained Gain on Translation Treasury Shares Amount Capital Earnings Investment Adjustment Stock --------- --------- ----------- ----------- ----------- ----------- --------- Balance, January 1, 1994 116,997 $ 1,170 $ 334,449 $ 445,002 $ -- $ (21,191) $ -- Issuance of common stock 4,140 41 55,901 -- -- -- -- Exercise of stock options 464 5 5,154 -- -- -- -- Tax benefit from exercise of stock options -- -- 1,935 -- -- -- -- Cash dividends declared(1) -- -- -- (21,680) -- -- -- Retirement of common stock (1,180) (12) (25,433) -- -- -- -- Currency translation adjustment -- -- -- -- -- 2,336 -- Distribution of Chartwell Leisure Inc. -- -- (18,445) (79,775) -- -- -- Net income -- -- -- 122,533 -- -- -- --------- --------- ----------- ----------- ----------- --------- --------- Balance, December 31, 1994 120,421 1,204 353,561 466,080 -- (18,855) -- Issuance of common stock 8,341 83 178,240 -- -- -- -- Exercise of stock options 1,249 13 16,891 -- -- -- -- Tax benefit from exercise of stock options -- -- 3,484 -- -- -- -- Exercise of stock warrants 991 10 14,872 -- -- -- -- Cash dividends declared(1) -- -- -- (22,812) -- -- -- Conversion of 4 1/2% Senior Notes 2 -- 29 -- -- -- -- Retirement of common stock (13) -- (282) -- -- -- -- Currency translation adjustment -- -- -- -- -- (4,245) -- Net income -- -- -- 157,850 -- -- -- --------- --------- ----------- ----------- ----------- ---------- ---------- Balance, December 31, 1995 130,991 1,310 566,795 601,118 -- (23,100) -- Issuance of common stock 25,706 257 1,712,015 -- -- -- -- Exercise of stock options 1,879 19 25,909 -- -- -- -- Tax benefit from exercise of stock options -- -- 29,922 -- -- -- -- Cash dividends declared(1) -- -- -- (24,984) -- -- -- Conversion of 4 1/2% Senior Notes 181 2 3,291 -- -- -- -- Purchase of common stock -- -- -- -- -- -- (19,152) Currency translation adjustment -- -- -- -- -- 12,712 -- Net unrealized gain on investment -- -- -- -- 4,366 -- -- Net income -- -- -- 257,241 -- -- -- Less PHH activity for January 1996 to reflect change in PHH fiscal year: Exercise of stock options (28) -- (635) -- -- -- -- Cash dividend declared(1) -- -- -- 5,859 -- -- -- Currency translation adjustment -- -- -- -- -- 2,380 -- Net income -- -- -- (8,264) -- -- -- --------- --------- ----------- ----------- ----------- ---------- ---------- Balance, December 31, 1996 158,729 $ 1,588 $2,337,297 $ 830,970 $ 4,366 $ (8,008) $ (19,152) ========= ========= =========== ========== =========== ========== ==========
(1) Represents cash dividends declared and paid to PHH Corporation common shareholders prior to the merger between HFS Incorporated and PHH Corporation. See accompanying notes to consolidated financial statements. HFS Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
For the Years Ended December 31, Operating Activities 1996 1995 1994 ----------- ----------- ----------- Net income ...................................... $ 257,241 $ 157,850 $ 122,533 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ................ 103,279 65,649 58,239 Depreciation on vehicles under operating leases ........................... 970,633 929,341 849,523 Amortization and write-down of mortgage servicing rights and fees ......... 51,128 31,572 20,284 Additions to originated mortgage servicing rights ........................... (97,568) (61,095) -- Additions to excess mortgage servicing rights ........................... (66,825) (51,191) (24,679) Gain on sales of mortgage servicing rights ... (5,194) (17,400) (28,076) Deferred income taxes ........................ 92,351 54,700 45,900 Proceeds from repayment of relocation receivables and equity advances ............ 4,348,857 6,070,490 5,059,017 Relocation receivables and equity advances generated ......................... (4,307,978) (6,238,538) (4,989,953) Gain on sale of subsidiaries ................. (14,632) -- -- Increase (decrease) from changes in: Accounts and notes receivable .............. (43,620) (32,409) (52,050) Accounts payable, accrued expenses and other (42,105) 65,156 (75,770) Mortgage loans held for sale ............... (73,308) (139,520) 42,562 All other operating activity ............... 43,491 9,116 (46,038) ----------- ----------- ----------- Net cash provided by operating activities ....... 1,215,750 843,721 981,492 ----------- ----------- ----------- Investing Activities Property and equipment additions ................ (66,595) (45,554) (34,243) Due to car rental operations of Avis, Inc. ...... (11,228) -- -- Loans and investments ........................... (12,721) (33,783) (42,524) Net assets acquired, exclusive of cash acquired ............................... (1,597,231) (70,647) -- Investment in leases and leased vehicles ........ (1,738,426) (2,008,559) (1,703,690) Repayment of investment in leases and leased vehicles ......................... 595,852 576,670 593,155 Proceeds from sales and transfers of leases and leased vehicles to third parties ............. -- 109,859 105,087 Purchases of mortgage servicing rights .......... -- (17,849) (17,241) Proceeds from sales of mortgage servicing rights 7,113 21,742 36,836 Proceeds from sale of subsidiaries .............. 38,018 -- -- Funding of grantor trusts ....................... (89,849) -- -- All other investing activities .................. 6,844 (23,821) 10,511 ----------- ----------- ----------- Net cash used in investing activities ........... (2,868,223) (1,491,942) (1,052,109) ----------- ----------- -----------
See accompanying notes to consolidated financial statements. HFS Incorporated and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (In thousands)
For the Years Ended December 31, 1996 1995 1994 ----------- ----------- ----------- Financing Activities Principal payments on borrowings ............. $(1,649,040) $(1,283,975) $(1,236,563) Net change in borrowings with terms of less than 90 days ...................... 231,819 17,419 27,852 Proceeds from other borrowings ............... 2,103,104 1,858,826 1,365,449 Issuance of common stock ..................... 1,179,388 65,537 6,080 Redemption of warrants ....................... -- 14,877 -- Cash distribution ............................ -- -- (50,000) Purchases of treasury stock .................. (19,152) (282) (25,445) Redemption of Series A Preferred Stock ....... (80,000) -- -- Payment of dividends ......................... (24,984) (22,812) (21,680) ----------- ----------- ----------- Net cash provided by financing activities .... 1,741,135 649,590 65,693 ----------- ----------- ----------- Effect of changes in exchange rates on cash and cash equivalents .............. (46,321) 6,545 2,665 ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents ...................... 42,341 7,914 (2,259) Add PHH activity for January 1996 to reflect change in PHH fiscal year (Note 2b) ....... 4,277 -- -- Cash and cash equivalents, beginning of period 22,923 15,009 17,268 ----------- ----------- ----------- Cash and cash equivalents, end of period ..... $ 69,541 $ 22,923 $ 15,009 =========== =========== =========== Supplemental Disclosures of Cash Flow Information Cash paid during the year for: Interest .................................. $ 287,339 $ 280,279 $ 203,259 =========== =========== =========== Taxes ..................................... $ 58,637 $ 34,410 $ 32,317 =========== =========== ===========
See accompanying notes to consolidated financial statements. HFS Incorporated and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of Significant Accounting Policies DESCRIPTION OF BUSINESS: HFS Incorporated (together with its subsidiaries, the "Company"), is a leading global provider of services to businesses serving consumer industries. The Company primarily engages in travel related and real estate related industries. TRAVEL RELATED BUSINESSES: o Lodging franchise (lodging segment). The Company franchises guest lodging facilities and residential real estate brokerage offices and provides operational and administrative services to its franchisees under the Days Inn(R), Howard Johnson(R), Knights Inn(R), Ramada(R), Super 8(R), Travelodge(R), Villager Lodge(R) ("Villager") and Wingate Inn(R) service marks. As a franchisor, the Company licenses the owners and operators of independent hotels to use the Company's brand names. The Company provides its customers with services designed to increase their revenue and profitability. These services permit franchisees to retain independence and local control while benefiting from the economies of scale of widely promoted brand names and standards of service, national and regional direct marketing and co-marketing arrangements and global procurement. Services include access to a national reservation system, national advertising and promotional campaigns, co- marketing programs and volume purchasing discounts. o Car Rental (car rental segment). The Company currently owns HFS Car Rental Inc. (formerly Avis, Inc.) ("Avis"), including the car rental operations of Avis ("ARAC") which provides vehicle rentals to businesses and individual customers worldwide as well as other rental-related products such as insurance, refueling services and loss damage waivers. The Company intends to undertake an initial public offering of ARAC (the "IPO") in 1997 which will dilute the Company's ownership interest to 25%. The Company will retain the Avis trademark and entered into a franchise agreement with ARAC effective as of January 1, 1997. (See "Principles of Consolidation"). In 1996, the Company provided franchise services to licensees other than ARAC, and operated a telecommunications and computer processing system which is used by ARAC and other independent car rental companies for reservations, rental agreement processing, accounting, fleet control and other purposes. o Timeshare (timeshare segment). The Company operates Resort Condominiums International ("RCI"), a provider of timeshare exchange programs, publications and other travel related services to the timeshare industry. The "RCI network" enables members who own timeshare interests in resort properties that are affiliated with the RCI Network to exchange such timeshare interests for an equivalent value in other affiliated resorts. o Fleet Management (fleet management segment). The Company provides services which primarily consist of the management, purchase, leasing, and resale of vehicles for corporate clients and government agencies. These services also include fuel, maintenance, safety and accident management programs and other fee-based services for clients' vehicle fleets. The Company leases vehicles primarily to corporate fleet users under operating and direct financing lease arrangements. Open-end operating leases and direct financing leases generally have a minimum lease term of 12 months with monthly renewal options thereafter. Closed-end operating leases typically have a longer term, usually 30 months or more, but are cancelable under certain conditions. REAL ESTATE RELATED BUSINESSES: o Real estate franchise (real estate segment). The Company franchises residential real estate brokerage offices and provides operational and administrative services to its franchisees under the CENTURY 21(R), Coldwell Banker(R), and Electronic Realty Associates(R) (ERA(R)) service marks. As franchisor, the Company licenses the owners and operators of independent real estate brokerage offices to use the Company's brand names. The Company provides services designed to increase franchisee revenue and profitability including national advertising and promotions, referrals, training and volume purchasing discounts. o Relocation (relocation segment). The Company provides relocation services to client corporations through its HFS Mobility Services Division. These services include the responsibility of selling transferee residences, providing equity advances on transferee residences for the purchase of new homes and certain home management services. The Company also offers fee-based programs such as home marketing assistance, household goods moves, destination services and property dispositions for financial institutions and government agencies. o Mortgage services (mortgage services segment). The Company provides services which primarily include the origination, sale and servicing of residential first mortgage loans. The Company markets a variety of first mortgage products to consumers through relationships with corporations, affinity groups, financial institutions, real estate brokerage firms and other mortgage banks. OTHER (other segment). The Company records equity in the earnings from its investment in ARAC and provides marketing and other services to casino gaming facilities. PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts and transactions of the Company together with its wholly owned and majority owned subsidiaries except for the Company's ownership of ARAC which is accounted for under the equity method. ARAC is not consolidated because of the Company's plan to undertake the IPO which will dilute the Company's ownership interest to 25%. If the IPO is not consummated within one year of the Company's acquisition of Avis, the Company will consolidate ARAC. On April 30, 1997, HFS (the Company prior to the merger with PHH Corporation) acquired PHH Corporation ("PHH") by merger which has been accounted for as a pooling of interests. Accordingly, the accompanying consolidated financial statements have been restated as if PHH and HFS had operated as one entity since inception (See Note 2b). All material intercompany balances and transactions have been eliminated in consolidation. ASSETS AND LIABILITIES UNDER MANAGEMENT AND MORTGAGE PROGRAMS: The Company presents assets and liabilities of its fleet management and mortgage programs relating to leases, receivable under relocation programs and residential mortgage services in an unclassified manner in its balance sheet. CASH AND CASH EQUIVALENTS: The Company considers highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. RESTRICTED CASH: Restricted cash consists of cash held in trust for employee benefit liabilities which were required to be funded prior to consummation of the merger of HFS with PHH. PHH funded several grantor trusts in accordance with the merger agreement. INVESTMENT SECURITIES: The Company determines the appropriate classifications of its investment securities at the time of purchase and periodically reevaluates such determinations. Unrestricted investment securities for which the Company does not have the intent or ability to hold to maturity are classified as "available for sale". Available for sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity. PROPERTY AND EQUIPMENT: Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation is computed by the straight-line method over the estimated useful lives of the related assets. Amortization of leasehold improvements is computed by the straight-line method over the estimated useful lives of the related assets or the lease term, if shorter. Interest costs of $564,000, $82,000 and $246,000 in 1996, 1995 and 1994, respectively, for the construction of property and equipment were capitalized and are being amortized over the estimated useful lives of the related assets. The Company periodically evaluates the recoverability of property and equipment by comparing the carrying value to current and expected cash flows separately for each business segment in which the property and equipment is employed. FRANCHISE AGREEMENTS: Franchise agreements are recorded at their estimated fair values upon acquisition and amortized over the estimated period to be benefited, ranging from 12 to 40 years using the straight-line method. The Company periodically evaluates the recoverability of franchise agreements by comparing the carrying value to current and expected future cash flows on a separate basis for each franchise brand. EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED: The excess of cost over fair value of net assets acquired is being amortized on a straight- line basis over the estimated useful lives, ranging from 20 to 40 years. The Company periodically evaluates the recoverability of excess of cost over fair value of net assets acquired by comparing the carrying value to current and expected future cash flows on a separate basis for each acquisition. OTHER INTANGIBLES: Other intangibles, consisting of the Avis trademark, customer lists and a reservation system are recorded at their estimated fair values at the dates acquired and are amortized on a straight-line basis over the estimated periods to be benefited, ranging from 6.5 to 40 years. The Company periodically evaluates the recoverability of other intangibles by comparing the carrying values to current and expected future cash flows. FRANCHISE ACQUISITION COSTS : The Company expenses direct costs relating to franchise sales on the date the property opens. OTHER DEFERRED COSTS: Deferred financing costs are amortized over the life of the related debt using the interest method. REVENUE RECOGNITION: Revenue primarily consists of fees for providing services to businesses in consumer industries. Franchise revenue: Franchise revenue principally consists of royalty, marketing and reservation fees which are based on a percentage of franchised lodging properties' gross room sales ("Gross Room Sales") and franchised real estate brokerage offices' gross commissions earned on sales of residential real estate properties ("Gross Closed Commissions"). Royalty, marketing and reservation fees are accrued as the underlying franchisee revenue is earned. Franchise revenue also includes initial franchise fees which are recorded as revenue when the lodging property or real estate brokerage office opens as a franchised unit. Relocation services revenue: The relocation services provided by the Company include facilitating the purchase and resale of the transferee's residence, providing equity advances on the transferee's residence and home management services. The home is purchased under a contract of sale and the Company obtains a deed to the property; however, it does not generally record the deed or transfer of title. Transferring employees are provided equity on their home based on an appraised value determined by independent appraisers, after deducting any outstanding mortgages. The mortgage is generally retired concurrently with the advance of the equity and the purchase of the home. Based on its client agreements, the Company is given parameters under which it negotiates for the ultimate sale of the home. The gain or loss on resale is generally borne by the client corporation. While homes are held for resale, the amount funded for such homes carry an interest charge computed at a floating rate based on various indices. Direct costs of managing the home during the period the home is held for resale, including property taxes and repairs and maintenance are generally borne by the client. All such advances are generally guaranteed by the client corporation. The client normally advances funds to cover a portion of such carrying costs. When the home is sold, a settlement is made with the client corporation netting actual costs with any advanced billing. The fair value of equity advances and other relocation receivables approximates the carrying value. Revenues associated with the resale of a residence are recognized when services are performed from the date the property is acquired through the date the residence is sold to a third party. Timeshare revenue: Revenues generated from services provided to the timeshare industry include subscription and exchange revenue. Subscription revenue is deferred upon receipt and recorded as income as the contractual services (delivery of publications) are provided to subscribers. Exchange fees are recognized as revenue when the exchange request has been confirmed to the subscriber. Fleet management revenue: Revenues from fleet management services other than leasing are recognized over the period in which services are provided and the related expenses are incurred. The Company records the cost of leased vehicles as " net investment in leases and leased vehicles." Amounts charged to lessees for interest on the unrecovered investment are credited to income on a level yield method which approximates the contractual terms. Vehicles under operating leases are amortized using the straight-line method over the expected lease term. Mortgage services revenue: Loan origination fees, commitment fees paid in connection with the sale of loans, and direct loan origination costs associated with the loans held for resale, are deferred until the loan is sold. Fees received for servicing loans owned by investors are based on the difference between the weighted average yield received on the mortgages and the amount paid to the investor, or on a stipulated percentage of the outstanding monthly principal balance on such loans. Servicing fees are credited to income when received. Costs associated with loan servicing are charged to expense as incurred. Sales of mortgage loans are generally recorded on the date a loan is delivered to an investor. Sales of mortgage securities are recorded on the settlement date. Gains or losses on sales of mortgage loans are recognized based upon the difference between the selling price and the carrying value of the related mortgage loans sold. Beginning May 1, 1995 the carrying value of the loans excludes the cost assigned to originated servicing rights (see Note 7). Such gains and losses are also increased or decreased by the amount of deferred mortgage servicing fees recorded. The Company acquires mortgage servicing rights and excess servicing fees by originating or purchasing mortgage loans and selling those loans with servicing retained, or it may purchase mortgage servicing rights separately. The carrying value of mortgage servicing rights and excess servicing fees is amortized over the estimated life of the related loan portfolio. Such amortization is recorded net within service fees in the consolidated statements of income. Gains or losses on the sale of mortgage servicing rights are recognized when title and all risks and rewards have irrevocably passed to the buyer and there are no significant unresolved contingencies. The Company reviews the recoverability of excess servicing fees by discounting anticipated future excess servicing cash flows at original discount rates utilizing externally published prepayment rates. If the discounted value is less than the recorded balance, due to higher than expected prepayments, the difference is recognized as a write-down in the consolidated statement of income. Other revenue: Other principal sources of revenue included in each business segment primarily consist of service fees from agreements that provide preferred alliance partners access to the Company's customers and its customers' customers; telecommunications and computer processing services provided to the car rental industry; and marketing and other services provided to casino gaming facilities which are recognized as services are provided. DIVESTITURE: In 1996, the Company sold its North American truck fuel management operations, and recorded an $11.7 million net gain which is reflected in other net revenues. INCOME TAXES: The Company uses the liability method of recording deferred income taxes. Differences in financial and tax reporting result from differences in the recognition of income and expenses for financial and income tax purposes as well as differences between the fair value of assets acquired in business combinations accounted for as purchases and their tax bases. The Company and its subsidiaries file a consolidated federal income tax return for periods subsequent to each acquisition. SHARE INFORMATION: Earnings per share are based upon the weighted average number of common and common equivalent shares outstanding during the respective periods. The $240 million 4-3/4% Convertible Senior Notes issued in February 1996 are antidilutive and, accordingly, are not included in the computation of earnings per share. In addition, the $150 million 4-1/2% Convertible Senior Notes issued in October 1994 are anti-dilutive for the year ended December 31, 1994 and, accordingly, are not included in the computation of earnings per share for 1994. In each of November 1995 and February 1994, the Company's Board of Directors authorized a two-for-one split of the Company's common stock which was effected in the form of a 100% stock dividend in February 1996 and April 1994, respectively. All share, per share, stock price and stock award plan information presented herein has been retroactively adjusted to reflect the stock splits. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. STOCK-BASED COMPENSATION: The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards ("SFAS") No. 123 "Accounting for Stock-Based Compensation" but applies Accounting Principle Board Opinion ("APB") No. 25 and related interpretations in accounting for its stock option plans. Under APB No. 25, because the exercise prices of the Company's employee stock options are equal to the market prices of the underlying Company stock on the date of grant, no compensation expense is recognized. DERIVATIVE FINANCIAL INSTRUMENTS: As a matter of policy, the Company does not engage in derivatives trading or market-making activities. Rather, derivative financial instruments including interest rate swaps and forward exchange contracts are used by the Company principally in the management of its interest rate exposures and foreign currency exposures on intercompany borrowings. Additionally, the Company enters into forward delivery contracts, financial futures programs and options to reduce the risks of adverse price fluctuation with respect to both mortgage loans held for sale and anticipated mortgage loan closings arising from commitments issued. Amounts to be paid or received under interest rate swap agreements are accrued as interest rates change and are recognized over the life of the swap agreements as an adjustment to interest expense. The fair value of the swap agreements is not recognized in the consolidated financial statements since they are accounted for as hedges. Market value gains and losses on the Company's foreign currency transaction hedges are recognized in income and substantially offset related foreign exchange gains and losses. Market value gains and losses on positions used as hedges in the mortgage banking services operations are deferred and considered in the valuation of lower of cost or market value of mortgage loans held for sale. TRANSLATION OF FOREIGN CURRENCIES: Assets and liabilities of the foreign subsidiaries are translated at the exchange rates as of the balance sheet dates, equity accounts are translated at historical exchange rates and revenues, expenses and cash flows are translated at the average exchange rates for the periods presented. Translation gains and losses are included in stockholders' equity. Gains and losses resulting from the change in exchange rates realized upon settlement of foreign currency transactions are substantially offset by gains and losses realized upon settlement of forward exchange contracts. Therefore, the resulting net income effect of transaction gains and losses in the years ended December 31, 1996, 1995 and 1994, was not significant. NEW ACCOUNTING PRONOUNCEMENT: In 1996, the FASB issued SFAS No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The statement provides accounting and reporting standards for transfers and servicing of financial assets and, among other things, SFAS No. 125 also requires that previously recognized servicing receivables that exceed contractually specified servicing fees shall be reclassified as interest-only strips receivable, and subsequently measured under the provisions of SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities." The Company will adopt the provisions of SFAS No. 125 on January 1, 1997 and will reclassify a portion of its excess servicing fees to interest-only strips. The effect of adopting SFAS No. 125 was not material to the Company's operations or financial condition. RECLASSIFICATIONS: Certain reclassifications have been made to the historical financial statements of HFS and PHH to conform to the restated presentation. 2. Mergers and Acquisitions 2a. Pending Merger with CUC International, Inc. (the "CUC Merger") On May 27, 1997, the Company entered into a definitive merger agreement (the "Merger Agreement") with CUC International Inc. ("CUC") pursuant to which each share of the Company's common stock shall be converted into the right to receive 2.4031 shares of CUC common stock. CUC is a leading technology-driven, membership- based consumer services company, providing its members with access to a variety of goods and services worldwide, including such components as shopping, travel, auto, dining, home improvement, lifestyle, vacation exchange, credit card and checking account enhancement packages, financial products and discount programs. CUC recorded total revenues and net income of $2.3 billion and $164.1 million, respectively, for the year ended January 31, 1997. Consummation of the transaction is subject to approval of the shareholders of each company at special meetings of such shareholders to be held in the second half of 1997. The CUC Merger will be accounted for as a pooling of interests. 2b. Merger with PHH Corporation (the "PHH Merger") On April 30, 1997, HFS acquired PHH by merger for which was satisfied by the issuance of 30.3 million shares of Company common stock in exchange for all of the outstanding common stock of PHH. The PHH Merger has been accounted for as a pooling of interests. Accordingly, the accompanying consolidated financial statements have been restated as if PHH and HFS had operated as one entity since inception. PHH is the world's largest provider of corporate relocation services and also provides mortgage services and vehicle management services. Prior to the merger, PHH had an April 30 fiscal year end. In connection with the merger, PHH prepared financial statements for the twelve month periods ended December 31, 1996, January 31, 1996 and January 31, 1995. To conform to the HFS calendar year end, the PHH statements of income for the aforementioned twelve month periods have been combined with the HFS statements of income for the years ended December 31, 1996, 1995 and 1994, respectively. In combining PHH's twelve month periods to the HFS calendar years, the consolidated statement of income for the year ended December 31, 1996 included one month (January 1996) of PHH's operating results which was also included in the consolidated statement of income for the year ended December 31, 1995. Accordingly, an adjustment has been made to the Company's 1996 retained earnings for the duplication of net income of $8.3 million and cash dividends declared of $5.9 million for such one month period. The following table shows the historical results of HFS and PHH for the periods prior to the PHH merger ($000's):
For the Years Ended December 31, 1996 1995 1994 -------------- ------------- ------------- Net revenues HFS $ 785,980 $ 411,299 $ 312,081 PHH 654,192 645,591 580,039 -------------- ------------- ------------- Total $ 1,440,172 $ 1,056,890 $ 892,120 ============== ============= ============= For the Years Ended December 31, 1996 1995 1994 -------------- ------------- ------------- Net income HFS $ 169,584 $ 79,730 $ 53,489 PHH 87,657 78,120 69,044 -------------- ------------- ------------- Total $ 257,241 $ 157,850 $ 122,533 ============== ============= =============
The Company recorded a one-time pre-tax restructuring charge of approximately $287 million upon consummation of the PHH merger for severance, facility consolidation, professional fees and other transaction related costs to be incurred in connection with the PHH Merger. 2c. Completed Acquisitions The following acquisitions were accounted for using the purchase method of accounting; accordingly, assets acquired and liabilities assumed were recorded at their estimated fair values. The operating results of the following acquired companies are reflected in the Company's consolidated statements of income since the respective dates of acquisition. RESORT CONDOMINIUMS INTERNATIONAL, INC.: On November 12, 1996, the Company completed the acquisition of all the outstanding capital stock of Resort Condominiums International, Inc. and its affiliates ("RCI") for $487.1 million. The purchase price was comprised of $412.1 million in cash and $75.0 million (approximately 1.0 million shares) of Company common stock. The purchase agreement provides for contingent payments of up to $200 million over the next five years which are based on components which measure RCI's future performance, including EBITDA, net revenues and number of members, as defined. Any contingent payments made will be accounted for as additional excess of cost over fair value of net assets acquired. HFS CAR RENTAL INC.: On October 17, 1996, the Company completed the acquisition of all of the outstanding capital stock of Avis, initially including payments under certain employee stock plans of Avis and the redemption of certain series of preferred stock of Avis for an aggregate $806.5 million. The purchase price was comprised of $367.2 million in cash, $100.9 million in indebtedness and $338.4 million (4.6 million shares) in Company common stock. Subsequently, the Company made contingent cash payments of: (a) $17.6 million to General Motors Corporation ("GM"), representing the amount by which the value attributable under the Stock Purchase Agreement to the Company common stock received by GM in the Avis acquisition exceeded the proceeds realized upon the subsequent sale of such Company common stock; and (b) $26.0 million of credit facility termination fees which were not at the Company's discretion since the facility termination resulted from change of control provisions and the elimination of the ESOP in connection with the Avis acquisition. See Note 21 for a discussion of the Company's business plan and related accounting treatment regarding Avis. COLDWELL BANKER CORPORATION: On May 31, 1996, the Company acquired by merger Coldwell Banker Corporation ("Coldwell Banker"), the largest gross revenue producing residential real estate company in North America and a leading provider of corporate relocation services. The Company paid $640.0 million in cash for all of the outstanding capital stock of Coldwell Banker and repaid $105.0 million of Coldwell Banker indebtedness. The aggregate purchase price for the transaction was financed through the May 9, 1996 sale of an aggregate 19.4 million shares of Company common stock pursuant to a public offering. Subsequent to the acquisition of Coldwell Banker, the Company acquired for $2.8 million a relocation consulting firm which was merged into the Coldwell Banker relocation business. Immediately following the closing of the Coldwell Banker acquisition, the Company conveyed Coldwell Banker's 318 owned real estate brokerage offices (the "Owned Brokerage Business") to National Realty Trust (the "Trust"), an independent trust in which the Company has no beneficial interest. The Company recorded a $5.0 million charge ($3.1 million, net of tax or $.02 per share) in the second quarter of 1996 representing the fair value of operations contributed to the Trust. The charge represents the fair value of the Owned Brokerage Business based upon a valuation which considered earnings, cash flow, assets and business prospects to the contributed business. CENTURY 21 NON-OWNED REGIONS: During the second quarter of 1996, the Company purchased from four independent master licensees, the six U.S. previously non-owned CENTURY 21 regions ("CENTURY 21 NORS") consisting of more than 1,000 franchised real estate offices. The $147.4 million aggregate purchase price for the Century 21 NORS consisted of $96.4 million in cash, $5 million of notes and $46.0 million (0.9 million shares) of Company common stock. ELECTRONIC REALTY ASSOCIATES: On February 12, 1996, the Company purchased substantially all the assets comprising the Electronic Realty Associates ("ERA") residential real estate brokerage franchise system, the fourth largest franchise system in terms of franchised brokerage offices, for $39.4 million in cash. TRAVELODGE: On January 23, 1996, the Company purchased the assets comprising the Travelodge hotel franchise system in North America, including the Travelodge and Thriftlodge(R) service marks, and franchise agreements from Forte Hotels, Inc. ("FHI") for $39.3 million in cash. Concurrent with the Company's acquisition of the Travelodge franchise system, Motels of America, Inc., through a wholly owned subsidiary, (collectively "MOA"), purchased 20 Travelodge motels from FHI for $32.3 million. In addition MOA, a significant Company franchisee, entered into twenty year franchise agreements for nineteen of its acquired Travelodge motels and one acquired Ramada motel. In addition, Chartwell Leisure Inc. ("CHRT"), formerly National Lodging Corp., a former wholly owned Company subsidiary which was distributed to the Company shareholders in November, 1994 (the "Distribution Date"), purchased all of the capital stock of FHI for $98.4 million. FHI owns or has an interest in 112 hotel and motel properties. In connection with CHRT's acquisition, the Company guaranteed $75 million of CHRT borrowings under a $125 million revolving credit facility entered into by CHRT with certain banks. The Company is paid a guarantee fee of 2% per annum of the outstanding guarantee commitment by the Company pursuant to a financing agreement entered into between CHRT and the Company at the Distribution Date (the "Financing Agreement"). The Financing Agreement was modified to allow the Company to provide credit enhancements for hotel industry investments. In connection with the acquisition of the Travelodge franchise system and CHRT's acquisition of FHI, the marketing and advisory agreements previously entered into by the Company and CHRT at the Distribution Date were terminated. In November 1996, the Corporate Services Agreement was terminated by mutual agreement. The Company received $9.5 million in consideration for consenting to the early termination of such agreement which was recorded as other revenue. Additionally, CHRT paid a $2.0 million advisory fee to the Company in connection with CHRT's acquisition of FHI. KNIGHTS INN: In August 1995, the Company acquired the assets comprising the Knights Inn hotel franchise system, an economy hotel franchise system, for $14.5 million plus expenses. CENTURY 21: On August 1, 1995, a majority owned Company subsidiary, C21 Holding Corp. ("Holding"), acquired Century 21 Real Estate Corporation ("Century 21"), the world's largest residential real estate brokerage franchisor, from Metropolitan Life Insurance Company ("MetLife"). Aggregate consideration for the acquisition consisted of $245.0 million plus expenses, including an initial cash payment of $70.2 million, 4.0 million shares of the Company's common stock valued at $64.8 million, the assumption of $80.0 million of Century 21 redeemable preferred stock issued to MetLife prior to the acquisition (subsequently redeemed in February 1996) and a $30.0 million contingent payment made in February 1996. The excess of cost over fair value of net assets acquired recorded in connection with the acquisition, includes the contingent payment and purchase price adjustments subsequent to the acquisition. In connection with the acquisition, the Company executed an agreement, the Subscription and Stockholders' Agreement, with a management group pursuant to which the ownership of Century 21 Holding Corp. common stock would be divided 87.5% to the Company and 12.5% to the management group. In addition, the management group executives entered into renewable employment agreements with the Company with initial terms that commenced on November 1, 1995 and would expire on December 31, 1997. The Company had a call option to purchase Holding common stock owned by the management group after January 1, 1998 for the fair market value of such stock when and if the option is exercised and the management group had a put option to require the Company to purchase all their Holding common stock after January 1, 1998 at fair market value. Effective October 29, 1996 (the "Effective Date"), the Company amended the Subscription and Stockholders' Agreement to provide that the Company's call option to purchase Holding common stock at fair value from the management group was accelerated to the Effective Date with the fair value determined as of the Effective Date. Pursuant to such amendment, the employment agreements were terminated in October 1996 and the put and call options have been exercised. The 12.5% interest was acquired by the Company for $52.8 million in the second quarter of 1997. The Company and certain stockholders sold approximately 6.4 million common shares pursuant to a public offering in September 1995 (the "C21 Offering"). Included in the C21 Offering were 4.0 million shares issued to MetLife (the "MetLife Shares") as partial consideration for the acquisition of Century 21. In accordance with Century 21 acquisition agreements, the Company received $28.9 million representing proceeds from the sale of the MetLife Shares in excess of $17.50 per share, net of certain expenses of the C21 Offering. In connection with the C21 Offering, the Company also received $20.1 million of proceeds, net of certain expenses from the sale of shares issued upon the exercise of an underwriter over-allotment option. Net proceeds from the C21 Offering received by the Company resulted in corresponding increases in stockholders' equity. CENTRAL CREDIT, INC.: On May 11, 1995, the Company acquired by merger (the "CCI Merger") Casino & Credit Services, Inc.'s ("CACS") gambling patron credit information business, Central Credit, Inc. ("CCI"). The Company acquired all of the common stock of CACS for $36.8 million by issuing 2.4 million shares of the Company's common stock and warrants to acquire up to 1.0 million additional shares of the Company's common stock. The exercise prices for the warrants ranged from $28.56 to $39.27 per share. The range of exercise prices is a result of the various exercise prices of the underlying warrants which were issued at various dates and prices. Prior to the acquisition, CACS distributed to its shareholders all net assets not related to the gambling patron credit information business. The following tables reflect the fair values of assets acquired and liabilities assumed in connection with the acquisitions described above. The excess of cost over fair value of net assets acquired for each of the acquisitions is being amortized on a straight-line basis over 40 years.
(In Millions) Acquired in 1996 ----------------------------------------------------------------------- Century 21 Coldwell Non-owned RCI Avis Banker Regions ERA Travelodge ---------- ----------- -------- ----------- --------- ----------- Cash paid $ 412.1 $ 367.2 $ 747.8 $ 96.4 $ 39.4 $ 39.3 Common stock issued 75.0 338.4 - 46.0 - - Note issued - 100.9 - 5.0 - - ---------- ----------- -------- ----------- --------- ----------- Total consideration 487.1 806.5 747.8 147.4 39.4 39.3 ---------- ----------- --------- ----------- --------- ----------- Cash and cash equivalents 144.9 2.4 (16.2) - 3.9 - Royalty and notes receivable 37.9 12.0 88.4 - 3.0 5.7 Investment in ARAC - 75.0 - - - - Property and equipment 55.7 61.8 21.7 .2 1.1 - Intangibles 100.0 509.0 437.2 11.0 20.0 30.0 Other assets 100.6 123.7 10.6 5.6 4.1 1.5 Accounts payable and other 221.3 223.5 118.3 9.4 25.3 6.9 Due to ARAC - 73.0 - - - - Other non-current liabilities 208.4 14.9 30.2 3.5 2.2 - ---------- ----------- --------- ----------- --------- ----------- Fair value of net assets acquired 9.4 472.5 393.2 3.9 4.6 30.3 ---------- ----------- --------- ----------- --------- ----------- Excess of cost over fair value of net assets acquired $ 477.7 $ 334.0 $ 354.6 $ 143.5 $ 34.8 $ 9.0 ========== =========== ========= =========== ========= ===========
(In Millions) Acquired in 1995 ------------------------------------- Knights Inn Century 21 CCI ----------- ----------- ----------- Cash paid $ 14.5 $ 100.2 $ - Common stock issued - 64.8 36.8 Preferred stock issued - 80.0 - ----------- ----------- ----------- Total consideration 14.5 245.0 36.8 ----------- ----------- ----------- Cash and cash equivalents - 14.0 - Royalty and notes receivable - 57.4 - Property and equipment - 4.6 8.5 Intangibles 5.2 33.5 - Other assets .4 11.1 1.5 Accounts payable and other 1.0 58.9 5.9 Other non-current liabilities - 16.4 3.8 ----------- ----------- ----------- Fair value of net assets acquired 4.6 45.3 .3 ----------- ----------- ----------- Excess of cost over fair value of net assets acquired $ 9.9 $ 199.7 $ 36.5 =========== =========== ===========
In connection with the acquisitions of Century 21, the CENTURY 21 NORS, ERA, Coldwell Banker and RCI, the Company developed related business plans to restructure each of the respective companies. Acquisition liabilities were recorded at the dates of consummation and are included in the respective purchase price allocations. These liabilities include costs associated with restructuring activities such as planned involuntary termination and relocation of employees, the consolidation and closing of certain facilities and the elimination of duplicative operating and overhead activities. Restructuring costs recognized as accrued acquisition obligations related to each acquired entity are summarized by type as follows ($000's): Century Century Coldwell 21 21 NORS ERA Banker RCI ------- ------- ------- ------- ------- Personnel-related .. $12,647 $ 1,720 $ 3,822 $ 4,237 $ 9,845 Facility-related ... 16,511 2,293 1,558 5,491 6,929 Other costs ........ 990 711 169 211 7,025 ------- ------- ------- ------- ------- Total .............. $30,148 $ 4,724 $ 5,549 $ 9,939 $23,799 ======= ======= ======= ======= ======= Terminated employees 319 73 202 87 252 Personnel-related charges include termination benefits such as severance, wage continuation, medical and other benefits. Facility-related costs include contract and lease terminations, temporary storage and relocation costs associated with assets to be disposed of, and other charges incurred in the consolidation and closure of excess space. During 1995, approximately $14.3 million was paid and charged against the acquisition liability for restructuring charges related to the Century 21 acquisition. During 1996, approximately $11.3 million, $2.6 million, $5.1 million, $3.9 million and $0.5 million was paid and charged against the acquisition liabilities for restructuring charges related to the Century 21, CENTURY 21 NORS, ERA, Coldwell Banker and RCI acquisitions, respectively. Additional restructuring charges were accrued during 1996 for Century 21 of $6.1 million. The adjustment to the restructuring liability represented revised cost estimates for activities contemplated in management's original restructuring plans. The Company has fully executed its business plans to restructure Century 21, the CENTURY 21 NORS, ERA and Coldwell Banker. Remaining accrued acquisition obligations related to the restructuring of such acquired companies pertain primarily to future lease commitments and other contractual obligations that existed at the respective acquisition dates. The Company is in the process of executing and completing its current business plan to restructure RCI, which it expects to complete in the second half of 1997. Pro Forma Information (Unaudited) The following information reflects pro forma statements of income data for the years ended December 31, 1996 and 1995 assuming the aforementioned completed acquisitions were consummated on January 1, 1995. The acquisitions have been accounted for using the purchase method of accounting. Accordingly, assets acquired and liabilities assumed have been recorded at their estimated fair values, which are subject to further refinement, based upon appraisals and other analyses with appropriate recognition given to the effect of current interest rates and income taxes. Management does not expect that the final allocation of the purchase price for the above acquisitions will differ materially from the preliminary allocations. The pro forma results are not necessarily indicative of the operating results that would have occurred had the transactions been consummated as indicated nor are they intended to indicate results that may occur in the future. The underlying pro forma information includes the amortization expense associated with the assets acquired, the reflection of the Company's financing arrangements, the elimination of redundant costs and the related income tax effects. (In thousands, except per share amounts) Years Ended December 31, ------------------------ 1996 1995 ---------- ---------- Net revenues ....................... $2,002,938 $1,775,158 Income before income taxes ......... 515,200 400,359 Net income ......................... 307,059 235,065 Net income per share: Primary ................... $ 1.76 $ 1.42 Fully diluted ............. $ 1.75 $ 1.41 Weighted average shares outstanding: Primary ................... 177,072 168,175 Fully diluted ............. 177,840 170,157 3. Property and Equipment Property and equipment consists of ($000's):
Useful Lives December 31, In Years 1996 1995 ------------- ------------ ----------- Land $ 12,122 $ 12,082 Building and leasehold improvements 5 - 50 163,750 73,924 Furniture, fixtures and equipment 5 - 7 121,214 123,832 Information technology support systems 3 - 10 160,165 65,341 ------------- ----------- 457,251 275,179 Accumulated depreciation and amortization (128,723) (110,959) ------------- ------------ Property and equipment - net $ 328,528 $ 164,220 ============ ===========
4. Accounts Payable and Other Accrued Expenses Accounts payable and other accrued expenses consist of ($000's): December 31, -------------------- 1996 1995 -------- ---------- Accounts payable ................................ $415,847 $311,438 License restructuring and acquisition obligations 65,649 13,227 Accrued payroll and related ..................... 89,938 36,500 Advances from relocation clients ................ 78,761 95,869 Other ........................................... 205,575 143,169 -------- -------- Accounts payable and other accrued expenses ..... $855,770 $600,203 ======== ======== 5. Net Investment in Leases and Leased Vehicles The net investment in leases and leased vehicles consisted of ($000's): December 31, ----------------------- 1996 1995 ---------- ---------- Vehicles under open-end operating leases .... $2,617,263 $2,585,953 Vehicles under closed-end operating leases .. 443,853 320,894 Direct financing leases ..................... 356,699 335,498 Accrued interest on leases .................. 851 891 ---------- ---------- Net investments in leases and leased vehicles $3,418,666 $3,243,236 ========== ========== The Company leases vehicles for initial periods of twelve months or more under either operating or direct financing lease agreements. The Company's experience indicates that the full term of the leases may vary considerably due to extensions beyond the minimum lease term. Lessee repayments of investments in leases and leased vehicles for 1996 and 1995 were $1.6 billion and $1.5 billion, respectively, and the ratio of such repayments to the average net investment in leases and leased vehicles was 47.19% and 47.96%, respectively. The Company has two types of operating leases. Under one type, open-end operating leases, resale of the vehicles upon termination of the lease is generally for the account of the lessee except for a minimum residual value which the Company has guaranteed. The Company's experience has been that vehicles under this type of lease agreement have consistently been sold for amounts exceeding the residual value guarantees. Maintenance and repairs of vehicles under these agreements are the responsibility of the lessee. The original cost and accumulated depreciation of vehicles under this type of operating lease was $4.6 billion and $2.0 billion, respectively at December 31, 1996 and $4.4 billion and $1.8 billion, respectively at December 31, 1995. Under the other type of operating lease, closed-end operating leases, resale of the vehicles on termination of the lease is for the account of the Company. The lessee generally pays for or provides maintenance, vehicle licenses and servicing. The original cost and accumulated depreciation of vehicles under these agreements was $600.6 million and $156.7 million, respectively at December 31, 1996 and $482.9 million and $162.0 million, respectively at December 31, 1995. The Company believes adequate reserves are maintained in the event of loss on vehicle disposition. Under the direct financing lease agreements, resale of the vehicles upon termination of the lease is generally for the account of the lessee. Maintenance and repairs of these vehicles are the responsibility of the lessee. Leasing revenues, which are reflected in fleet leasing on the consolidated statement of income consist of ($000's): For the years ended December 31, 1996 1995 1994 - ------------------------------- ---------- ---------- ---------- Operating leases ....................... $1,145,745 $1,098,697 $ 982,416 Direct financing leases, primarily interest 43,323 42,375 41,688 ---------- ---------- ---------- $1,189,068 $1,141,072 $1,024,104 ========== ========== ========== Other managed vehicles are subject to leases serviced by the Company for others, and neither the vehicles nor the leases are included as assets of the Company. The Company receives a fee under such agreements which covers or exceeds its cost of servicing. The Company has transferred existing managed vehicles and related leases to unrelated investors and has retained servicing responsibility. Credit risk for such agreements is retained by the Company to a maximum extent in one of two forms: excess assets transferred, which were $7.1 million and $5.9 million at December 31, 1996 and 1995, respectively; or guarantees to a maximum extent of $0 and $263,000 at December 31, 1996 and 1995, respectively. All such credit risk has been included in the Company's consideration of related reserves. The outstanding balances under such agreements aggregated $158.5 million and $98.4 million at December 31, 1996 and 1995, respectively. Other managed vehicles with balances aggregating $93.9 million and $114.9 million at December 31, 1996 and 1995, respectively, are included in a special purpose entity which is not owned by the Company. This entity does not require consolidation as it is not controlled by the Company and all risks and rewards rest with the owners. Additionally, managed vehicles totaling approximately $47.4 million and $48.5 million at December 31, 1996 and 1995, respectively, are owned by special purpose entities which are owned by the Company. However, such assets and related liabilities have been netted in the balance sheet since there is a two-party agreement with determinable accounts, a legal right of setoff exists and the Company exercises its right of setoff in settlement with client corporations. 6. Mortgage Loans Held for Sale Mortgage loans held for sale represent mortgage loans originated by the Company and held pending sale to permanent investors. Such mortgage loans are recorded at the lower of cost or market value as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. The valuation reserve was approximately $10.1 million and $1.9 million at December 31, 1996 and 1995, respectively. The Company issues mortgage-backed certificates insured or guaranteed by the Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC), Government National Mortgage Association (GNMA) and other private insurance agencies. The insurance provided by FNMA and FHLMC and other private insurance agencies are on a non-recourse basis to the Company. However, the guarantee provided by GNMA is only to the extent recoverable from insurance programs of the Federal Housing Administration and the Veterans Administration. The outstanding principal balance of mortgages backing GNMA certificates issued by the Company aggregated approximately $3.4 billion and $2.3 billion at December 31, 1996 and 1995, respectively. Additionally, the Company sells mortgage loans as part of various mortgage-backed security programs sponsored by FNMA, FHLMC and GNMA. Certain of these sales are subject to recourse or indemnification provisions in the event of default by the borrower. As of December 31, 1996, mortgage loans sold with recourse amounted to approximately $83.0 million. The Company believes adequate reserves are maintained to cover all potential losses. 7. Mortgage Servicing Rights and Fees Mortgage servicing rights and fees activity was as follows ($000's):
Excess Purchased Originated Servicing Servicing Servicing Impairment Fees Rights Rights Allowance Total ----------- ----------- ----------- ----------- ----------- Balance, January 1, 1994 $ 75,529 $ 8,808 $ - $ - $ 84,337 Additions 24,679 17,241 - - 41,920 Amortization (13,512) (6,772) - - (20,284) Sales (8,729) (31) - - (8,760) ----------- ----------- ----------- ----------- ----------- Balance December 31, 1994 77,967 19,246 - - 97,213 Additions 51,191 17,849 61,095 - 130,135 Amortization (18,609) (5,858) (4,089) - (28,556) Write-down/provision (1,630) - - (1,386) (3,016) Sales (1,080) (3,262) - - (4,342) ----------- ----------- ----------- ----------- ----------- Balance December 31, 1995 107,839 27,975 57,006 (1,386) 191,434 Less: PHH activity for January 1996 to reflect change in PHH fiscal year (3,623) (170) (10,227) 183 (13,837) Additions 66,825 - 97,568 - 164,393 Amortization (31,235) (4,763) (15,752) - (51,750) Write-down/provision - - - 622 622 Sales (1,291) (628) - - (1,919) ----------- ----------- ----------- ----------- ----------- Balance December 31, 1996 $ 138,515 $ 22,414 $ 128,595 $ (581) $ 288,943 ========== ========== ========== ========== ==========
Excess servicing fees represent the present value of the differential between the actual servicing fees and normal servicing fees which are capitalized at the time loans are sold with servicing rights retained. Purchased servicing rights represent the cost of acquiring the rights to service mortgage loans for others. Originated servicing rights represents the present value of normal servicing fees which are capitalized at the time loans are sold with servicing rights retained. In May 1995, the FASB issued Statement of Financial Accounting Standards No. 122, "Accounting for Mortgage Servicing Rights" (SFAS No. 122). This Statement requires that mortgage servicing rights be recognized when a mortgage loan is sold and servicing rights are retained. The Company adopted SFAS No. 122 effective May 1, 1995 and, accordingly, capitalized originated servicing rights, net of amortization and valuation allowances of approximately $82.4 million and $55.6 million in the years ended December 31, 1996 and 1995, respectively. SFAS No. 122 requires that a portion of the cost of originating a mortgage loan be allocated to the mortgage servicing rights based on the fair value of the servicing rights' fair value relative to the loan as a whole. To determine the fair value of mortgage servicing rights, the Company uses market prices for comparable mortgage servicing, when available, or alternatively uses a valuation model that calculates the present value of future net servicing income using assumptions that market participants would use in estimating future net servicing income. SFAS No. 122 also requires the impairment of originated and purchased servicing rights to be measured based on the difference between the carrying amount and current fair value of the servicing rights. In determining impairment, the Company aggregates all mortgage servicing rights, excluding those capitalized prior to the adoption of SFAS No. 122, and stratifies them based on the predominant risk characteristic of interest rate band. For each risk stratification, a valuation allowance is maintained for any excess of amortized book value over the current fair value by a charge or credit to income. Prior to the adoption of SFAS No. 122, the Company reviewed the recoverability of purchased servicing rights by discounting anticipated future cash flows at appropriate discount rates, utilizing externally published prepayment rates. If the recorded balance exceeded the discounted anticipated future cash flows, the amortization of the purchased servicing rights was accelerated on a prospective basis. 8. Marketing And Reservation Activities DAYS INN, HOWARD JOHNSON, SUPER 8, TRAVELODGE, KNIGHTS INN, VILLAGER, COLDWELL BANKER AND ERA: The Company receives marketing and reservation fees from its Days Inn, Howard Johnson, Super 8, Travelodge, Knights Inn, Villager, Coldwell Banker and ERA franchisees. Marketing and reservation fees related to the Company's lodging brands' franchisees are calculated based on a specified percentage of gross room sales. Marketing and reservation fees received from the Company's real estate brands' franchisees are based on a specified percentage of gross closed commissions earned on the sale of real estate. As provided in the franchise agreements, at the Company's discretion, all of these fees are to be expended for marketing purposes and the operation of a centralized brand-specific reservation system for the respective franchisees and are controlled by the Company until disbursement. Franchise revenue includes marketing and reservation fees of $110.6 million, $93.4 million, $86.2 million for the years ended December 31, 1996, 1995 and 1994, respectively. RAMADA: Ramada Inns National Association ("RINA") is an unincorporated association representing the owners of the hotels in the Ramada system. RINA provides a worldwide reservation system and provides advertising, promotional services and training to Ramada franchisees. The Company receives a combined fee for marketing and reservation activities based on a percentage of monthly gross room revenues from members of RINA which are controlled by the Company until disbursement. As provided in the franchise agreement, at the Company's discretion, all of these fees will be expended for advertising, promotional services, training and the operation of a worldwide reservation system. Franchise revenue includes RINA fees of $47.0 million, $46.7 million and $44.4 million for the periods ended December 31, 1996, 1995 and 1994, respectively. CENTURY 21: The Century 21 National Advertising Fund ("NAF") is an independent entity managed by the Company, the funds of which are used exclusively for advertising and public relations purposes for the collective benefit of the CENTURY 21 organization, including all CENTURY 21 franchisees. The NAF receives fees from CENTURY 21 franchisees equal to 2% of their respective gross closed commissions earned on sales of residential real estate properties, subject to monthly minimum and maximum contributions. In addition, the Company is required to contribute 10% of net royalty fees collected from CENTURY 21 franchisees to the NAF. The contributions are expensed by the Company when the corresponding royalty fee is recognized. Marketing and reservation expense includes $11.7 million and $4.2 million, for the year ended December 31, 1996 and the five month period ended December 31, 1995, respectively. The NAF cash balance was $7.0 million and $4.3 million at December 31, 1996 and 1995, respectively. Such amount is not included in the Company's consolidated financial statements. Advertising Expense: Advertising expense approximated $55.2 million, $48.0 million and $43.6 million for the years ended December 31, 1996, 1995 and 1994, respectively. 9. Debt Short-term debt Short-term debt consists of acquired Avis fleet financing, borrowed on behalf of ARAC, and is expected to be repaid upon settlement of the corresponding intercompany loan due from ARAC prior to the IPO. The credit facilities provide up to $150 million of financing and expire in September 1997. The outstanding borrowings under these facilities as of December 31, 1996 were $150 million and had a weighted average interest rate of 7.47%. Long-term debt Long-term debt consists of ($000's): December 31, -------------------- 1996 1995 -------- -------- Revolving Credit Facilities (A) ................ $205,000 $ -- 5-7/8% Senior Notes (B) ...................... 149,811 149,715 4-1/2% Convertible Senior Notes (C) ............ 146,678 149,971 4-3/4% Convertible Senior Notes (D) ............ 240,000 -- Obligations under capital leases and other loans 9,927 3,341 -------- -------- 751,416 303,027 Less current portion ........................... 2,995 2,249 -------- -------- Long-term debt ................................. $748,421 $300,778 ======== ======== A. REVOLVING CREDIT FACILITIES: At December 31, 1996, the Company had $1 billion in revolving credit facilities consisting of (i) a $500 million, five year revolving credit facility (the "Five Year Revolving Credit Facility") and (ii) a $500 million, 364 day revolving credit facility (the "364 Day Revolving Credit Facility" and collectively with the five year Revolving Credit Facility the "Revolving Credit Facilities"). The Company may renew the 364 Day Revolving Credit Facility on an annual basis for an additional 364 days up to a maximum aggregate term of five years upon receiving lender approval. The Five Year Revolving Credit Facility and the 364 Day Revolving Credit Facility, at the option of the Company, bear interest based on competitive bids of lenders participating in the facilities, at the prime rates or at LIBOR plus a margin of 16 basis points. The Company is also required to pay a per annum facility fee of .09% and .07% of the average daily availability of the Five Year Revolving Credit Facility and 364 Revolving Credit Facility, respectively. The interest rates and facility fees are subject to change based upon credit ratings on the Company's senior unsecured long-term debt by nationally recognized statistical rating companies. The Revolving Credit Facilities contain certain restrictive covenants including restrictions on indebtedness, mergers, liquidations and sale and leaseback transactions and requires the maintenance of certain financial ratios, including a 3:1 minimum interest average ratio and a 3.5:1 maximum coverage ratio, as defined. Amounts outstanding under the Revolving Credit Facilities as of December 31, 1996 are classified as long-term based on the Company's intent and ability to maintain these loans on a long-term basis. B. SENIOR NOTES: In December 1993, the Company completed a public offering of $150 million, unsecured 5-7/8% Senior Notes due December 15, 1998 the ("Senior Notes"). Interest is payable semi-annually. C. 4-1/2% CONVERTIBLE SENIOR NOTES: In October 1994, the Company completed a public offering of $150 million unsecured 4-1/2% Convertible Senior Notes (the "4-1/2% Notes") due 1999, which are convertible at the option of the holders at any time prior to maturity into shares of the Company's common stock at a conversion price of $18.15 per $1,000 principal amount of the 4-1/2% Notes. The 4-1/2 1/2% Notes are redeemable at the option of the Company, in whole or in part, at any time on or after October 1, 1997 at a redemption price of 101.125% of principal if redeemed prior to September 30, 1998 or at 100% of principal any time thereafter until maturity. Interest is payable semi-annually commencing April 1995. D. 4-3/4% CONVERTIBLE SENIOR NOTES: On February 22, 1996, the Company completed a public offering of $240 million unsecured 4-3/4% convertible senior notes (the "4-3/4 Notes") due 2003, which are convertible at the option of the holder at any time prior to maturity into 14.993 shares of the Company's common stock per $1,000 principal amount of the 4-3/4% Notes, representing a conversion price of $66.70 per share. The 4-3/4% Notes are redeemable at the option of the Company, in whole or in part, at any time on or after March 3, 1998 at redemption prices decreasing from 103.393% of principal at March 3, 1998 to 100% of principal at March 3, 2003. However, on or after March 3, 1998 and prior to March 3, 2000, the 4-3/4% Notes will not be redeemable at the option of the Company unless the closing price of the Company's common stock shall have exceeded $93.38 per share (subject to adjustment upon the occurrence of certain events) for 20 trading days within a period of 30 consecutive trading days ending within five days prior to redemption. Interest on the 4-3/4% Notes is payable semi-annually commencing September 1, 1996. Long-term debt payments including obligations under capital leases at December 31, 1996 are due as follows ($000's): Year Amount ----------- ----------- 1997 $ 2,995 1998 151,542 1999 148,333 2000 977 2001 205,925 Thereafter 241,644 ----------- Total $ 751,416 =========== 10. Liabilities Under Management and Mortgage Programs Borrowings to fund assets under management and mortgage programs, classified as "Liabilities under management and mortgage programs" consisted of ($000's): December 31, ----------------------- 1996 1995 ---------- ---------- Commercial paper ............... $3,090,843 $2,348,732 Medium-term notes .............. 1,662,200 2,031,200 Other .......................... 336,900 47,940 ---------- ---------- Liabilities under management and mortgage programs - debt .. $5,089,943 $4,427,872 ========== ========== Commercial paper, all of which matures within 90 days, is supported by committed revolving credit agreements described below and short-term lines of credit. The weighted average interest rates on the Company's outstanding commercial paper were 5.4% and 5.8% at December 31, 1996 and 1995, respectively. Medium-term notes of $1.6 billion represent unsecured loans which mature in 1997. The weighted average interest rates on such medium-term notes were 5.7% and 5.8% at December 31, 1996 and 1995, respectively. The remaining $0.1 billion of medium-term notes represents an unsecured obligation having a fixed interest rate of 6.5% with interest payable semi-annually and a term of seven years payable in full in 2000. Other liabilities under management and mortgage programs is principally comprised of unsecured debt, all of which matures in 1997, which includes borrowings under short-term lines of credit and other bank facilities. The weighted average interest rate on unsecured debt was 5.8% and 6.9% at December 31, 1996 and 1995, respectively. Interest expense is incurred on indebtedness which is used to finance vehicle leasing activities, relocation services, and mortgage servicing activities. Interest incurred on borrowings used to finance vehicle leasing activities of $161.8 million, $159.7 million and $126.7 million for the years ended December 31, 1996, 1995 and respectively is included net within fleet leasing revenue in the consolidated statements of income. Interest on borrowings used to finance both equity advances on homes and mortgage servicing activities are recorded net within service fee revenue in the consolidated statements of income. Interest related to equity advances on homes were $35.0, $26.0 and $20.0 for the years ended December 31, 1996, 1995 and 1994, respectively. Interest related to mortgage servicing activities were $63.4 million, $49.9 million and $32.8 million for the years ended December 31, 1996, 1995 and 1994, respectively. The Company has a $2.5 billion syndicated unsecured credit facility backed by a consortium of domestic and foreign banks. The facility is comprised of $1.25 billion of lines maturing in 364 days and $1.25 billion maturing in five years. Under the credit facilities, the Company is obligated to pay annual commitment fees which were $2,417 and $2,297 for the years ended December 31, 1996 and 1995, respectively. The Company had other unused lines of credit of $301,468 at December 31, 1996 with various banks. Although the period of service for a vehicle is at the lessee's option, and the period a home is held for resale varies, management estimates, by using historical information, the rate at which vehicles will be disposed and the rate at which homes will be resold. Projections of estimated liquidations of assets under management and mortgage programs and the related estimated repayment of liabilities under management and mortgage programs as of December 31, 1996, as set forth in the table below, indicate that the actual repayments of liabilities under management and mortgage programs will be different than required by contractual maturities. ($000's) Assets under Management Liabilities Under Management Years and Mortgage Programs and Mortgage Programs - --------- -------------------------- ---------------------------- 1997 $2,961,264 $2,608,179 1998 1,539,172 1,471,407 1999 673,535 671,623 2000 318,643 217,143 2001 53,843 71,061 2002-2006 182,777 50,530 ---------- ---------- $5,729,234 $5,089,943 ========== ========== 11. Fair Value of Financial Instruments and Servicing Rights The following methods and assumptions were used by the Company in estimating its fair value disclosures for material financial instruments. The fair values of the financial instruments presented may not be indicative of their future values. Cash and cash equivalents: The carrying amount reported in the balance sheet for cash and cash equivalents approximates its fair value. Investment in securities: The Company has classified a certain equity security as available-for-sale at December 31, 1996. In accordance with SFAS 115, the security is recorded at fair value with an unrealized holding gain of $4.4 million, net of the related tax effect, reported as a component of stockholders' equity. The fair value recorded is based on quoted market prices. Mortgage loans held for sale: Fair value is estimated using the quoted market prices for securities backed by similar types of loans and current dealer commitments to purchase loans. These loans are priced to be sold with servicing rights retained. Gains (losses) on mortgage-related positions, used to reduce the risk of adverse price fluctuations, for both mortgage loans held for sale and anticipated mortgage loan closings arising from commitments issued, are included in the carrying amount of mortgage loans held for sale. Mortgage servicing rights and fees: Fair value is estimated by discounting the expected net cash flow of servicing rights and fees using discount rates that approximate market rates and externally published prepayment rates, adjusted, if appropriate, for individual portfolio characteristics. Long and short-term debt: The carrying amount of the Company's borrowings under its revolving credit facilities and commercial paper borrowings approximates fair value. The fair values of the Company's Senior Notes, Convertible Senior Notes and Medium-term Notes are estimated based on quoted market prices. Interest rate swaps, foreign exchange contracts, forward delivery commitments, futures contracts and options. The fair value of interest rate swaps, foreign exchange contracts, forward delivery commitments, futures contracts and options is estimated, using dealer quotes, as the amount that the company would receive or pay to execute a new agreement with terms identical to those remaining on the current agreement, considering interest rates at the reporting date. The carrying amounts and fair values of the Company's financial instruments at December 31, are as follows ($000's):
1996 1995 ------------------------------------- ------------------------------------- Estimated Estimated Notional Carrying Fair Notional Carrying Fair Amount Amount Value Amount Amount Value ----------- ----------- ----------- ----------- ----------- ----------- Assets Cash and cash equivalents $ - $ 159,390 $ 159,390 $ - $ 22,923 $ 22,923 Investment in securities (a) 22,500 22,500 - 15,353 19,200 Relocation receivables - 773,326 773,326 - 736,038 736,038 Mortgage loans held for sale - 1,248,299 1,248,299 - 784,901 784,901 Excess mortgage servicing fees - 138,515 155,033 - 107,839 107,966 Originated mortgage servicing rights - 128,014 139,776 - 55,620 58,764 Purchased mortgage servicing rights - 22,414 29,326 - 27,975 33,268 Liabilities Long-term debt and medium- term notes - 2,413,616 2,841,579 - 2,334,227 2,439,720 Off balance sheet Interest rate swaps 1,670,155 - - 2,630,567 - - In a gain position - - 2,457 - - 4,969 In a loss position - - (10,704) - - (13,828) Foreign exchange forwards 329,088 - 10,010 118,069 - 6,413 Mortgage-related positions:(b) Forward delivery commitments 1,703,495 11,425 7,448 1,323,285 5,407 (6,997) Option contracts to sell 265,000 952 746 330,000 839 69 Option contracts to buy 350,000 1,346 (463) 485,000 3,388 528 Treasury options used to hedge servicing rights 313,900 1,327 278 - - -
- --------- (a) At December 31, 1995, the sale of the Company's investment in equity security was restricted by contractual requirement. (b) Gains (losses) on mortgage-related positions are already included in the determination of market value of mortgage loans held for sale. 12. Commitments And Contingencies LEASES: The Company has noncancelable operating leases covering various equipment and facilities, which expire through 2004. Rental expense for the years ended December 31, 1996, 1995 and 1994 approximated $40.7 million, $29.3 million and $26.8 million respectively, excluding real estate taxes and other fees that are also the responsibility of the Company. Operating lease commitments over the next five years and thereafter are as follows ($000's): For the year ending December 31, 1997 $ 49,462 1998 43,560 1999 30,939 2000 23,527 2001 16,193 Remaining years 29,930 ----------- Total minimum lease payments $ 193,611 =========== The future minimum lease payments exclude future minimum sublease income of approximately $1.0 million annually for each year presented. The Company has been granted rent abatements for varying periods on certain of its facilities. Deferred rent relating to those abatements is being amortized on a straight-line basis over the applicable lease terms. DISCONTINUED AVIATION SERVICES SEGMENT: The Company is contingently liable under the terms of an agreement involving its discontinued aviation services segment for payment of Industrial Revenue Bonds issued by local governmental authorities operating at two airports, one of which comes due in the year 2013 and the other which comes due in the year 2014, each of which is in the amount of $3.5 million. The Company believes its allowance for disposition loss is sufficient to cover all potential liability. LITIGATION: In the normal course of business, litigation is initiated against the Company. Generally, these claims are insured and, in the opinion of management, disposition of such litigation will not have a material adverse effect on the Company's liquidity, consolidated financial position or results of operation. 13. Income Taxes The income tax provision consists of ($000's): For the years ended December 31, -------------------------------- 1996 1995 1994 -------- -------- -------- Current Federal .............. $ 22,215 $ 36,102 $ 23,498 State ................ 7,681 12,230 9,387 Foreign .............. 8,806 7,138 6,083 -------- -------- -------- 38,702 55,470 38,968 -------- -------- -------- Deferred Federal .............. 116,823 51,954 42,231 State ................ 18,301 1,746 4,669 Foreign .............. 800 1,000 (1,000) -------- -------- -------- 135,924 54,700 45,900 -------- -------- -------- Provision for income taxes $174,626 $110,170 $ 84,868 ======== ======== ======== Net deferred income tax assets and liabilities are comprised of the following ($000's): December 31, 1996 1995 --------- --------- Provision for doubtful accounts ............. $ 8,100 $ 7,600 Deferred income ............................. 46,400 7,800 Acquisition related reserves ................ 19,600 4,200 Franchise acquisition costs ................. (2,600) (2,400) Accrued liabilities and deferred income ..... 21,598 21,042 Other ....................................... 700 3,000 --------- --------- Current net deferred tax asset .............. $ 93,798 $ 41,242 ========= ========= Intangible asset amortization ............... $(166,800) $ (73,600) Accrued liabilities and deferred income ..... 46,250 20,276 Acquired net operating loss carryforward .... 85,900 -- Other ....................................... (24,300) (9,200) --------- --------- Noncurrent net deferred tax liability ....... $ (58,950) $ (62,524) ========= ========= Depreciation ................................ $(245,146) $(223,337) Unamortized mortgage servicing rights ....... (51,239) (23,489) Accrued liabilities and deferred income ..... 1,359 2,101 Alternative minimum tax and net operating loss carryforwards ........................ 13,078 9,807 --------- --------- Net deferred tax liabilities under management and mortgage programs ................... $(281,948) $(234,918) ========= ========= Net operating loss carryforwards at December 31, 1996 acquired in connection with the acquisition of Avis, Inc. expire as follows: 2001, $14.8 million; 2002, $89.6 million; 2005, $7.2 million; 2009, $17.7 million; and 2010, $116.0 million. The Company's effective income tax rate differs from the statutory federal rate as follows: For the years ending December 31, 1996 1995 1994 ----- ----- ----- Federal statutory rate .................. 35.0% 35.0% 35.0% State income taxes net of federal benefit 3.8% 4.1% 4.4% Amortization of non-deductible goodwill . 1.0% 0.9% 1.6% Other ................................... 0.6% 1.1% (0.1%) ---- ---- ---- Effective tax rate ...................... 40.4% 41.1% 40.9% ==== ==== ==== 14. Shareholders' Equity A. STOCK WARRANTS: On December 15, 1995, the Company redeemed all outstanding warrants in accordance with the provisions of the warrant agreement underlying warrant obligations assumed in the CCI Merger transaction (See Note 2). The Company received aggregate proceeds approximating $14.8 million from the exercise of such warrants, resulting in the issuance of approximately 1.0 million shares of Company common stock. B. AUTHORIZED SHARES: On January 22, 1996, the Company's shareholders approved an amendment to the Company's Restated Certificate of Incorporation to increase the number of authorized shares of common stock to 300 million. On April 30, 1997, the Company's shareholders approved an amendment to the Company's Restated Certificate of Incorporation to increase the number of authorized shares of common stock to 600 million. 15. Stock Option Plans The Company has two stock option plans, the 1992 Stock Option Plan (the "1992 Plan") and the amended and restated 1993 Stock Option Plan, (the "1993 Plan"). The 1993 Plan provides for the granting of options to certain directors, officers, employees and independent contractors of the Company's common stock at prices not less than the fair market values at the date of grant. No further grants will be made under the 1992 Plan. Generally, stock options have a ten-year term and vest within five years from the date of grant. On April 30, 1997, the Company's stockholders approved an amendment to the 1993 Plan to increase the number of authorized shares of common stock, for which options may be granted, to 34,541,600. Prior to the PHH Merger, PHH had stock option plans for its key employees and outside directors. The plans allowed for the purchase of common stock at prices not less than fair market value on the date of grant. Either incentive stock options or non-statutory stock options were granted under the plans. Options became exercisable after one year from date of grant on a vesting schedule provided by the plans and expired ten years after the date of the grant. On April 30, 1997, in connection with the PHH Merger, all unexercised PHH stock options were canceled and converted to 736,903 shares of Company common stock. The table below summarizes the annual activity of the Company's stock option plans ($000's):
Options Options Outstanding Price Range ----------- -------------------------- Balance at January 1, 1994 15,468 $ 2.87 to $ 25.45 Granted 3,631 11.71 to 23.64 Canceled (447) 3.74 to 24.02 Exercised (464) 3.13 to 22.88 Distribution of CHRT 454 7.94 to 13.41 Balance at December 31, 1994 18,642 2.87 to 25.45 Granted 5,786 13.63 to 29.13 Canceled (371) 4.08 to 24.17 Weighted Exercised (1,249) 3.31 to 24.62 Avg. Exercise Price ------------- Balance at December 31, 1995 22,808 2.87 to 29.13 10.97 Granted 11,858 30.38 to 77.88 56.24 Canceled (513) 7.94 to 76.75 55.32 Exercised (1,879) 2.87 to 40.31 13.86 Less: PHH activity for January 1996 to reflect change in PHH fiscal year 20 Balance at December 31, 1996 32,294 2.87 to 77.88 24.29
The Company adopted the disclosure-only provisions of SFAS No. 123 and accordingly, no compensation cost was recognized in connection with its stock option plans. Had the Company elected to recognize compensation cost for its stock option plans based on the calculated fair value at the grant dates for awards under such plans, consistent with the method prescribed by SFAS No. 123, net income per share would have reflected the pro forma amounts indicated below ($000's, except per share data): For the years ended December 31, 1996 1995 ------------- ------------- Net income: as reported $ 257,241 $ 157,850 pro forma 178,388 155,399 Net income per share: Primary as reported $ 1.59 $ 1.14 pro forma 1.14 1.13 Fully diluted as reported 1.58 1.12 pro forma 1.13 1.11 The fair values of the stock options are estimated on the dates of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for options granted in 1996 and 1995:
HFS PHH Plans Plans --------------------- ---------------------- 1996 1995 1996 1995 --------- -------- -------- --------- Dividend yield 0% 0% 2.8% 3.5% Expected volatility 37.5% 37.5% 21.5% 19.8% Risk-free interest rate 6.4% 6.4% 6.5% 6.9% Expected holding period 9.1 years 9.1 years 7.5 years 7.5 years
The weighted average fair values of stock options granted during the years ended December 31, 1996 and 1995 were $26.33 and $11.51, respectively. The effect of applying SFAS 123 on the pro forma net income per share disclosures is not indicative of future amounts because it does not take into consideration option grants made prior to 1995 or in future years. The tables below summarize information regarding stock options outstanding and exercisable as of December 31, 1996 (shares in 000's):
HFS Options Options Outstanding Options Exercisable ------------------------------ -------------------------- Weighted Avg. Weighted Weighted Remaining Average Average Range of Exercise Contractual Exercise Exercise Prices Shares Life Price Shares Price ---------------------- --------- --------------- ----------- ----------- ----------- $ 2.87 to $ 19.99 17,776 6.4 $ 8.68 14,792 $ 8.09 $ 20.00 to $ 39.99 1,262 8.6 24.11 226 24.21 $ 40.00 to $ 59.99 5,276 9.2 44.92 2,016 40.31 $ 60.00 to $ 77.88 5,189 9.6 69.16 320 62.13 --------- ----------- Total 29,503 7.5 26.46 17,354 13.04 ========= =========== PHH Options Less than $16.50 1,425 4.5 $ 20.28 1,452 $ 20.28 Greater than $16.50 1,366 8.7 31.14 439 24.38 --------- ----------- Total 2,791 6.5 25.49 1,891 21.23 ========= ===========
Shares exercisable and available for grant were as follows (000's): HFS Options PHH Options ---------------- ---------------- At December 31, At December 31, 1996 1995 1996 1995 ------ ----- ----- ------ Shares exercisable ....... 17,354 7,079 1,891 2,451 Shares available for grant 1,647 35 492 1,380 16. Employee Savings and Pension Plans The Company sponsors several defined contribution plans that provide certain eligible employees of the Company an opportunity to accumulate funds for their retirement. The Company matches the contributions of participating employees on the basis of the percentages specified in the plans. The Company's matching contributions to the plans were approximately $5,546, $4,850 and $4,757 in 1996, 1995 and 1994, respectively. During 1996, the Company implemented a Deferred Compensation Plan providing senior executives with the opportunity to participate in a funded, deferred compensation program. The assets of the Plan are held in an irrevocable rabbi trust. Under the program, participants may defer up to 80% of their base compensation and up to 98% of bonuses earned. The Company contributes $0.50 for each $1.00 contributed by a participant, regardless of length of service, up to a maximum of six percent of the employee's compensation. The program is not qualified under Section 401 of the Internal Revenue Code. The Company's matching contribution to the Deferred Compensation Plan in 1996 was approximately $111,000. Pension and Supplemental Retirement Plans The Company's PHH subsidiary has a non-contributory defined benefit pension plan covering substantially all US employees of the Company and its subsidiaries. PHH's subsidiary located in the UK has a contributory defined benefit pension plan, with participation at the employee's option. Under both the US and UK plans, benefits are based on an employee's years of credited service and a percentage of final average compensation. The Company's policy for both plans is to contribute amounts sufficient to meet the minimum requirements plus other amounts as the Company deems appropriate from time to time. The Company also sponsors two unfunded supplemental retirement plans to provide certain key executives with benefits in excess of limits under the federal tax law and to include annual incentive payments in benefit calculations. Net costs included the following ($000's): For the Years Ended December 31, 1996 1995 1994 -------- -------- --------- Service cost ................ $ 5,594 $ 4,927 $ 4,599 Interest cost ............... 8,268 7,391 6,602 Actual return on assets ..... (10,313) (9,019) (2,870) Net amortization and deferral 3,905 3,712 (1,786) -------- -------- -------- Net cost .................... $ 7,454 $ 7,011 $ 6,545 ======== ======== ======== A summary of the plans' status and the Company's recorded liability recognized in the Consolidated Balance Sheets is as follows ($000's): Funded Plans December 31, 1996 1995 -------- -------- Accumulated benefit obligation: Vested ...................................... $ 69,743 $ 58,774 Unvested .................................... 7,058 6,442 -------- -------- $ 76,801 $ 65,216 ======== ======== Projected benefit obligation ..................... $ 97,145 $ 85,553 Funded assets, at fair value (primarily common stock and bond mutual funds) ............................... (88,416) (74,278) Unrecognized net loss from past experience different from that assumed and effects of changes in assumptions (4,544) (7,033) Unrecognized prior service cost .................. (761) (70) Unrecognized net obligation ...................... (356) (126) -------- -------- Recorded liability ............................... $ 3,068 $ 4,046 ======== ======== Unfunded Plans ................................... December 31, 1996 1995 -------- -------- Accumulated benefit obligation: Vested ...................................... $ 13,031 $ 11,295 Unvested .................................... 601 831 -------- -------- $ 13,632 $ 12,126 ======== ======== Projected benefit obligation ..................... $ 17,977 $ 15,484 Unrecognized net loss from past experience different from that assumed and effects of changes in assumptions ... (3,087) (1,626) Unrecognized prior service cost .................. (2,641) (2,936) Unrecognized net obligation ...................... (1,237) (1,450) Minimum liability adjustment ..................... 2,620 2,654 -------- -------- Recorded liability ............................... $ 13,632 $ 12,126 ======== ======== Significant percentage assumptions used in determining the cost and related obligations under the US pension and unfunded supplemental retirement plans are as follows: For the Years Ended December 31, 1996 1995 1994 ------ ----- ----- Discount rate .................... 8.00% 8.00% 8.50% Rate of increase in compensation . 5.00% 5.00% 5.00% Long-term rate of return on assets 10.00% 9.50% 9.50% Postretirement Benefits Other Than Pensions The Company's PHH subsidiary provides health care and life insurance benefits for certain retired employees up to the age of 65. A summary of the plan's status and the Company's recorded liability recognized in the consolidated balance sheets was as follows ($000's):
December 31, 1996 1995 ------- ------- Accumulated postretirement benefit obligation: Active employees ..................................................... $ 5,811 $ 5,693 Current retirees ..................................................... 1,670 1,754 ------- ------- 7,481 7,447 Unrecognized transition obligations ....................................... (4,799) (5,069) Unrecognized net gain ..................................................... 1,832 873 ------- ------- Recorded liability ........................................................ $ 4,514 $ 3,251 ======= =======
Net periodic postretirement benefit costs included the following components ($000's): For the Years Ended December 31, 1996 1995 1994 ------ ------ ------ Service cost ................ $ 830 $ 755 $ 693 Interest cost ............... 526 519 507 Net amortization and deferral 199 237 294 ------ ------ ------ Net cost .................... $1,555 $1,511 $1,494 ====== ====== ====== Significant percentage assumptions used in determining the cost and obligations under the postretirement benefit plan are as follows: For the Years Ended December 31, 1996 1995 1994 ------ ------ ------ Discount rate .............. 8.00% 8.00% 8.25% Health care costs trend rate for subsequent year ....... 10.00% 10.00% 12.00% The health care cost trend rate is assumed to decrease gradually through 2004 when the ultimate trend rate of 4.75% is reached. At December 31, 1996, a one-percentage-point increased in the assumed health care cost trend rate for each future year would increase the annual service interest cost by approximately $126,000 and the accumulated postretirement benefit obligations by approximately $582,000. 17. Franchising Activities Revenue from franchising activities consists of initial fees charged to lodging properties and real estate brokerage offices upon execution of a franchise contract based on the number of rooms at the lodging property and estimated real estate brokerage offices gross closed commissions. Initial franchise fees approximate $24.2 million, $15.7 million and $13.8 million for the years ended December 31, 1996, 1995 and 1994, respectively. Franchising activity for the years ended December 31, 1996, 1995 and 1994 is as follows: Lodging Real Estate ----------------------- ---------------- 1996 1995 1994 1996 1995 ----- ----- ----- ------ ----- Franchises in Operation Units at end of year .... 5,397 4,603 4,229 11,349 5,990 Executed but Not Opened Acquired ........... 24 31 -- 110 104 New agreements ..... 1,142 983 870 829 248 Backlog, end of year 786 682 594 275 176 18. Derivative Financial Instruments The Company employs interest rate swap agreements to match effectively the fixed or floating rate nature of liabilities to the assets funded. A key assumption in the following information is that rates remain constant at December 31, 1996 levels. To the extent that rates change, both the maturity and variable interest rate information will change. However, the net rate the Company pays remains matched with the assets funded. The following table summarizes the maturity and weighted average rates of the Company's interest rate swaps employed at December 31, 1996. These characteristics are effectively offset within the portfolio of assets funded by the Company ($000's):
Maturities --------------------------------------------------------------------------- Total 1997 1998 1999 2000 2001 2002 -------- -------- -------- -------- -------- --------- ---------- United States Commercial Paper: Pay fixed/receive floating: Notional value $427,181 $199,528 $136,176 $ 59,346 $ 20,531 $ 4,625 $ 6,975 Weighted average receive rate 5.72% 5.72% 5.72% 5.72% 5.72% 5.72% Weighted average pay rate 6.21% 6.33% 6.47% 6.37% 6.51% 6.60% Medium-Term Notes: Pay floating/receive fixed: Notional value 336,000 250,000 86,000 Weighted average receive rate 6.59% 6.50% Weighted average pay rate 5.95% 5.86% Pay floating/receive floating: Notional value 357,200 357,200 Weighted average receive rate 5.51% Weighted average pay rate 5.90% Canada Commercial Paper: Pay fixed/receive floating: Notional value 68,255 32,631 22,849 10,585 2,190 Weighted average receive rate 3.11% 3.11% 3.11% 3.11% Weighted average pay rate 6.25% 5.89% 5.63% 4.58% Pay floating/receive floating: Notional value 52,730 28,010 14,961 4,342 2,853 2,564 Weighted average receive rate 7.21% 7.09% 6.93% 7.61% 7.61% Weighted average pay rate 3.38% 3.38% 3.38% 3.38% 3.38%
(Continued) Maturities ------------------------------------------------------------------------- Total 1997 1998 1999 2000 2001 2002 -------- -------- -------- -------- -------- --------- -------- Pay floating/receive fixed: Notional value 36,481 36,481 Weighted average receive rate 4.92% Weighted average pay rate 3.07% UK Commercial Paper: Pay floating/receive fixed: Notional value 379,308 37,708 93,070 138,834 109,696 Weighted average receive rate 6.56% 6.56% 6.56% 6.56% Weighted average pay rate 6.17% 7.85% 6.96% 7.10% Germany Commercial Paper: Pay fixed/receive fixed: Notional value 13,000 1,950 2,925 (6,825) 3,575 11,375 Weighted average receive rate 3.25% 3.25% 3.25% 3.25% 3.25% Weighted average pay rate 5.34% 5.34% 5.34% 5.34% 5.34% --------- -------- -------- -------- -------- --------- Total $1,670,155 $943,508 $269,981 $292,282 $138,845 $ 18,564 $ 6,975 ========== ======== ======== ======== ======== ========= =========
For the years ended December 31, 1996 and 1995, the Company's hedging activities increased interest expense $4.1 million and $2.0 million respectively, and had no effect on its weighted average borrowing rate. For the same period in the year ended December 31, 1994, hedging activities increased interest expense $8,389 and increased the weighted average borrowing rate 0.2%. The Company enters into foreign exchange contracts as hedges against currency fluctuations on certain intercompany loans. Such contracts effectively offset the currency risk applicable to approximately $329.1 million and $118.1 million of obligations at December 31, 1996 and 1995, respectively. The Company is exposed to credit-related losses in the event of non-performance by counterparties to certain derivative financial instruments. The Company manages such risk by periodically evaluating the financial position of counterparties and spreading its positions among multiple counterparties. The Company presently does not expect non-performance by any of the counterparties. 19. Industry Segment Information The Company is principally in the business of providing services to businesses that serve consumer industry customers. The Company's major business segments are reflective of the industries in which it serves. See Note 1. "Summary of Significant Accounting Policies - Description of Business" for a more detailed description of each of the Company's industry segments. The following table presents certain financial information regarding the company's industry segments. Operations by segment ($000's): Year Ended December 31, 1996
Real Estate -------------------------------------------- Real Estate Mortgage Consolidated Franchise Relocation Services ------------- ----------- ----------- ------------- Net revenues $ 1,440,172 $ 233,469 $ 344,865 $ 126,570 Operating income 451,562 110,535 54,302 41,302 Identifiable assets 10,866,000 1,295,501 1,086,374 1,742,409 Depreciation and amortization 97,811 27,317 11,168 4,442 Capital expenditures 66,595 9,932 9,112 9,859 Travel ----------------------------------------------------------- Car Lodging Rental Timeshare Fleet Other ----------- ----------- ----------- ------------- ----------- Net revenues $ 385,920 $ 10,014 $ 30,723 $ 260,740 $ 47,871 Operating income 145,798 537 3,319 76,260 19,509 Identifiable assets 954,649 882,397 772,585 3,868,472 263,613 Depreciation and amortization 30,852 3,439 2,559 13,214 4,820 Capital expenditures 19,302 -- 1,473 9,999 6,918 Year Ended December 31, 1995 Real Estate -------------------------------------------- Real Estate Mortgage Consolidated Franchise Relocation Services ------------ ----------- ----------- ------------- Net revenues $ 1,056,890 $ 47,965 $ 301,667 $ 93,251 Operating income 290,969 19,277 41,718 41,744 Identifiable assets 6,928,813 195,157 1,031,978 1,142,272 Depreciation and amortization 63,178 2,997 10,385 3,099 Capital expenditures 45,554 2,034 8,678 2,987 Travel -------------------------- Lodging Fleet Other ----------- ----------- ----------- Net revenues $ 335,402 $ 258,877 $ 19,728 Operating income 120,606 56,918 10,706 Identifiable assets 724,673 3,641,536 193,197 Depreciation and amortization 26,058 18,837 1,802 Capital expenditures 5,059 9,872 16,924 Year Ended December 31, 1994 Real Estate --------------------------- Mortgage Consolidated Relocation Services ------------ ----------- ----------- Net revenues $ 892,120 $ 255,974 $ 74,494 Operating income 225,891 34,534 30,172 Identifiable assets 5,664,920 794,372 849,131 Depreciation and amortization 53,712 9,280 2,944 Capital expenditures 34,243 11,541 2,471
Travel -------------------------- Lodging Fleet Other ----------- ----------- ----------- Net revenues $ 300,694 $ 249,571 $ 11,387 Operating income 102,487 52,323 6,375 Identifiable assets 738,543 3,247,320 35,554 Depreciation and amortization 21,921 17,765 1,802 Capital expenditures 9,378 8,854 1,999 The Company's operations outside of North America principally include fleet management and relocation segment operations in Europe. Geographic operations of the Company are as follows ($000's): North Year Ended December 31, 1996 America Europe Consolidated - ---------------------------- ---------- --------- ----------- Net revenues ............... 1,372,840 67,332 1,440,172 Income before income taxes . 409,682 22,185 431,867 Identifiable assets ........ 10,146,012 719,988 10,866,000 Year Ended December 31, 1995 Net revenues ............... 994,910 61,980 1,056,890 Income before income taxes . 254,182 13,838 268,020 Identifiable assets ........ 6,331,896 596,917 6,928,813 Year Ended December 31, 1994 Net revenues ............... 836,182 55,938 892,120 Income before income taxes . 201,171 6,230 207,401 Identifiable assets ........ 5,150,232 514,688 5,664,920 20. Selected Quarterly Financial Data - (Unaudited)
(In thousands, except per share data) 1996 First Second Third Fourth Total Year ---- ----------- ----------- ----------- ----------- ----------- Net revenues $ 278,956 $ 344,777 $ 410,525 $ 405,914 $ 1,440,172 Income before income taxes 73,823 100,951 141,822 115,271 431,867 Net income 43,678 59,942 84,880 68,741 257,241 Net income per share: Primary $ .30 $ .39 $ .54 $ .36 $ 1.59 Fully diluted $ .30 $ .39 $ .54 $ .36 $ 1.58 1995 Net revenues $ 230,621 $ 256,523 $ 294,594 $ 275,152 $ 1,056,890 Income before income taxes 55,595 65,967 79,657 66,801 268,020 Net income 32,835 38,484 46,683 39,848 157,850 Net income per share: Primary $ .25 $ .28 $ .34 $ .27 $ 1.14 Fully diluted $ .25 $ .28 $ .33 $ .27 $ 1.12
21. Investment in ARAC As discussed in Note 1, at the time the Company acquired Avis, it had developed and announced a plan (the "Plan") to do the following: 1. Retain certain assets acquired, including the reservations system, franchise agreements, trademarks and tradenames and certain liabilities. 2. Segregate the assets used in the car rental operations in ARAC, a separate subsidiary, and within one year, undertake an initial public offering (the "IPO") of ARAC, which would result in deleting the Company's interest in ARAC to approximately 25%. 3. Enter into a license agreement with ARAC for use of the trademarks and tradename and other franchise services. Based on the Plan, the purchase price for Avis has been allocated to the assets acquired and liabilities assumed by the Company, including its investment in ARAC, based on their respective estimated fair values at the date of acquisition. The amount allocated to ARAC was based on the estimated valuation of ARAC including the effect of royalty, reservation and information technology agreements with the Company. Under the Plan, ARAC will sell approximately a 75% interest at an assumed price of $225 million thereby diluting the Company's interest to 25%. All of the proceeds from the IPO will be retained by ARAC. The condensed balance sheet at December 31, 1996 and the condensed income statement for the period October 17, 1996 through December 31, 1996 of ARAC is as follows: Rental Car Operations of Avis, Inc. (ARAC) Combined Balance Sheet (in thousands) ASSETS Cash and cash equivalents ............................. $ 50,886 Accounts receivable, net .............................. 311,179 Due from affiliates, net .............................. 61,807 Vehicles, net ......................................... 2,243,492 Property and equipment ................................ 98,887 Cost in excess of net assets acquired net ............. 196,765 Other ................................................. 168,341 ---------- Total Assets ...................................... $3,131,357 ========== LIABILITIES AND STOCKHOLDER'S EQUITY Accounts payable on accrued liabilities ............... $ 504,780 Income tax liabilities ................................ 40,778 Public liability, property damage and other liabilities 213,785 Debt .................................................. 2,295,474 ---------- Total Liabilities ................................. 3,054,817 Stockholders' Equity .................................. 76,540 ---------- Total Liabilities and Stockholders' Equity ........ $3,131,357 ========== * * * Rental Car Operations of Avis, Inc. (ARAC) Combined Income Statement (in thousands) Revenue ................................................. $362,844 -------- Costs and expenses Direct operating .................................... 167,682 Vehicle depreciation and lease charges .............. 89,448 Selling general and administrative .................. 68,215 Interest, net ....................................... 34,212 Amortization of cost in excess of net assets acquired 1,026 -------- 360,583 Income before provision for income tax .................. 2,261 Provision for income tax ................................ 1,040 -------- Net income .............................................. $ 1,221 ======== * * * Note A - Summary of Significant Accounting Policies of ARAC Vehicles Vehicles are stated at cost net of accumulated depreciation. In accordance with industry practice, when vehicles are sold, gains or losses are reflected as an adjustment to depreciation. Vehicles are generally depreciated at rates ranging from 10% to 25% per annum. Manufacturers provide ARAC with incentives and allowances (such as rebates and volume discounts) which are amortized to income over the holding period of the vehicles. Cost in Excess of Net Assets Acquired Cost in excess of net assets acquired is amortized over a 40 year period and is shown net of accumulated amortization of $1.0 million at December 31, 1996. Public Liabilities, Property Damage and Other Insurance Liabilities Insurance liabilities on the accompanying combined statement of financial position include additional liability insurance, personal effects protection insurance, public liability and property damage ("PLPD") and personal accident insurance claims for which ARAC is self-insured. ARAC is self-insured up to $1.0 million per claim under its auto liability insurance program for PLPD and additional liability insurance. Costs in excess of $1.0 million per claim are insured under various contracts with commercial insurance carriers. The insurance liabilities include a provision for both claims reported to ARAC as well as claims incurred but not yet reported to ARAC. The insurance liabilities include a provision for both claims reported to ARAC as well as claims incurred but not yet reported to ARAC. This method is an actuarially accepted loss reserve method. Adjustments to this estimate and differences between estimates and the amounts subsequently paid are reflected in operations as they occur. Income Taxes ARAC is included in the consolidated federal income tax return of the Company. Pursuant to the regulations promulgated under the Internal Revenue Code, ARAC's pro rate share of the consolidated federal income tax liability of the Company is allocated to ARAC on a separate return basis. ARAC files separate income tax returns in states where a consolidated return is not permitted. In accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", deferred income tax assets and liabilities are measured based upon the difference between the financial accounting and tax basis of assets and liabilities. Note B - Intercompany Transactions of ARAC Amount due from affiliates represents the net balance due to or from the Company which will be settled upon or before consummation of the IPO. Net amount of approximately $61.8 million consists of notes receivable due to the Company from an indirect wholly owned subsidiary of the Company, long term subordinated vehicle financing notes payable to the Vehicle Trust (see note C) and miscellaneous non-interest bearing advances made by ARAC to the Company. Expense items include charges from the Company and affiliates of the Company totaling $31.8 million. Reservations and data processing services are charged to ARAC based on actual cost. All other charges are based on actual costs incurred. Effective January 1, 1997, the Company will charge ARAC a royalty fee of 4.0% of revenue for the use of the Avis trade name. On an unaudited pro forma basis, had the franchise fee been charged to ARAC beginning on October 17, 1996, net income for the period October 17, 1996 to December 31, 1996 would have been reduced by $8.7 million resulting in a pro forma net loss of approximately $7.5 million. Note C - Financing and Debt of ARAC Debt outstanding at December 31, 1996 is not guaranteed by the Company and consists of the following ($000's): VEHICLE TRUST FINANCING Short term vehicle trust financing - revolving credit facilities $ 1,970,000 Long term vehicle manufacturer's notes - payable through 2001 185,000 OTHER FINANCING Short term debt including foreign short term notes, capital leases and current portion of other long term debt 106,745 Floating rate notes - foreign subsidiaries due through August 1998 30,813 Other debt - domestic 2,916 ------------- $ 2,295,474 ============= The primary source of funding for domestic vehicles is provided by the Vehicle Trust (a grantor trust). Amounts drawn against this facility may be used to purchase vehicles and pay certain expenses of the Vehicle Trust. The security for the Vehicle Trust financing facility consists of a lien on the vehicles acquired under the facility, which at December 31, 1996 totaled approximately $2.1 billion, exclusive of related valuation reserves. The security for the Vehicle Trust financing facility also consists of security interests in certain other assets of the Vehicle Trust. Additionally, the Vehicle Trust and its security agreement require that there be outstanding, at all times, subordinated debt in a specified percentage range (10% - 25%) of the net book value of the vehicles owned by the Vehicle Trust. Pursuant to the agreement, the subordinated debt is to be provided by vehicle manufacturer finance companies and by a Company subsidiary. The Vehicle Trust consists of loans from banks, vehicle manufacturer finance companies and a Company subsidiary. The short term notes are issued pursuant to a $2.5 billion revolving credit facility dated as of October 17, 1996 which expires on October 16, 1997. On December 31, 1996, the weighted average interest rate of borrowings under this facility was 6.00%. For the period from October 17, 1996 to December 31, 1996, the average outstanding borrowings under this facility were $2.0 billion with a weighted average interest rate of 5.98%. This facility requires a fee of 1/8 of 1% on the committed amount. Subordinated debt of $318 million was required under the Vehicle Trust financing, of which $247.5 million is due to a Company subsidiary. At December 31, 1996, the Vehicle Trust had financing outstanding from vehicle manufacturer finance companies under terms of loan agreements dated October 17, 1996. Under these agreements, the maximum amount of borrowings allowed is $267 million, of which up to $260 million may be issued as subordinated debt. On December 31, 1996, $185 million was outstanding, of which $70.5 million of the outstanding debt was deemed subordinated. On December 31, 1996, the weighted average interest rate of borrowings under this facility was 8.50%. For the period October 17, 1996 to December 31, 1996, the average outstanding borrowings under this facility was $185 million with a weighted average interest rate of 8.41%. In November 1992, the predecessor to ARAC entered into a five year capital lease under which $96.7 million of vehicles were leased. The lease is cancelable at ARAC's option, however, additional costs may be incurred upon termination based upon the fair value of the vehicles at the time the option is exercised. At the termination of the lease, ARAC may purchase the vehicles at an agreed upon fair market value or return them to the lessor. The future minimum lease payments due under ARAC's capital lease obligation, which terminates on November 30, 1997 are $41,500,000 (including interest of $1,331,000). Mandatory maturities of long term obligations for each of the five years ending December 31, and thereafter, are as follows ($000's): 1997 $ 41,229 1998 98,950 1999 1,086 2000 209 2001 118,228 Thereafter 256 Other Credit Facilities At December 31, 1996, ARAC had letters of credit/working capital agreements totaling $102.6 million, which may be renewed bi-annually at ARAC's option and the banks' discretion. The collateral for certain of these agreements consists of a lien on property and equipment and certain receivables with a carrying value of $136.9 million. At December 31, 1996, ARAC has outstanding letters of credit amounting to $55.1 million. In addition, for certain of its international operations, ARAC has available at December 31, 1996, unused lines of credit of $224.3 million. The unused lines of credit agreements require a quarterly fee of 0.2% to 0.5% of the unused line. Interest Rate Swap Agreements ARAC has entered into interest rate swap agreements to reduce the impact of changes in interest rates on certain outstanding debt obligations. These agreements effectively change ARAC's interest rate exposure on $44.0 million of its outstanding debt from a weighted average variable interest rate to a fixed rate of 7.1% at December 31, 1996. The variable interest element with respect to these interest rate swap agreements is reset quarterly. The interest rate swap agreements will terminate in March 1997, July 1998 and November 1998. The differential to be paid or received is recognized ratably as interest rates change over the life of the agreements as an adjustment to interest expense. The net interest differential charge to interest expense for the period October 17, 1996 to December 31, 1996 was $285,000. ARAC is exposed to credit risk in the event of nonperformance by counter parties to its interest rate swap agreements. Credit risk is limited by entering into such agreements with primary dealers only; therefore, ARAC does not anticipate that nonperformance by counter parties will occur. Notwithstanding this, ARAC's treasury department monitors counter party credit ratings at least quarterly through reviewing independent credit agency reports. Both current and potential exposure are evaluated as necessary, by obtaining replacement cost information from alternative dealers. Potential loss to ARAC from credit risk on these agreements is limited to amounts receivable, if any. Note D - Litigation Related to ARAC Certain litigation has been initiated against ARAC which has arisen during the normal course of operations. Since litigation is subject to many uncertainties, the outcome of any individual matter is not predictable with any degree of certainty, and it is reasonably possible that one or more of these matters could be decided unfavorably against ARAC. The Company maintains insurance policies that cover most of the actions brought against ARAC. Two legal actions have been filed against ARAC alleging discrimination in the rental of vehicles. The Company has agreed to indemnify ARAC from any unfavorable outcome with respect to these matters upon the consummation of an IPO. ARAC is not currently involved in any legal proceeding which it believes would have a material adverse effect upon its combined financial condition or results of operations. *** Accounting Treatment for ARAC The Company's interest in ARAC of $75 million at the October 17, 1996 acquisition date represents the estimated value of its 100% interest in ARAC at the date of acquisition and is accounted for under the equity method since the Company's control is temporary based on the planned IPO of ARAC. Upon completion of the IPO, the value of ARAC is expected to increase to $300 million (with the $225 million of IPO proceeds retained by ARAC) with the Company's interest at 25% equal to $75 million, its current investment balance. If the results of the IPO do not confirm the preliminary purchase price allocation, for the investment in ARAC, then such investment will be adjusted with a corresponding adjustment to excess of cost over fair value of net assets acquired. Following is a Pro Forma Condensed Consolidated Balance Sheet at December 31, 1996 and a Pro Forma Condensed Consolidated Income Statement for the year ended December 31, 1996 assuming the ARAC was consolidated. HFS Incorporated Pro Forma Condensed Consolidated Balance Sheet (in thousands) Assets Cash and cash equivalents ........................................ $ 120,427 Restricted cash .................................................. 89,849 Accounts receivable - net ........................................ 999,086 Other current assets ............................................. 211,118 ----------- Total current assets ......................................... 1,420,480 ---------- Property and equipment, net ...................................... 427,415 Vehicles, net ................................................... 2,243,492 Franchise agreements, net ......................................... 995,947 Other intangibles ................................................... 604,535 Excess of cost over fair value of net assets acquired ............... 1,980,174 Other assets ..................................................... 457,733 ----------- 8,129,776 ----------- Assets under Management and Mortgage Programs: Net investment in leases and leased vehicles ............ ... 3,418,666 Equity advances on homes .................................... 773,326 Mortgage loans held for sale ................................ 1,248,299 Mortgage servicing rights and fees .......................... 288,943 ----------- 5,729,234 ----------- Total Assets ..................................................... $13,859,010 =========== Liabilities and Stockholders' Equity Accounts payable and accrued expenses ............................. $ 1,401,328 Short term debt .................................................. 150,000 Current portion of long term debt ................................. 2,995 ----------- Total Current Liabilities ..................................... 1,554,323 ---------- Public liability, property damage and other ...................... 213,785 Long term debt ................................................... 3,043,895 Deferred revenue ................................................ 397,034 Other liabilities ................................................ 131,021 ----------- 3,785,735 ----------- Liabilities under management and mortgage programs: Debt ........................................................ 5,089,943 Deferred income taxes ........................................ 281,948 ----------- 5,371,891 ----------- Total Liabilities .................................................. 10,711,949 ----------- Stockholders' equity ............................................... 3,147,061 ----------- $13,859,010 =========== HFS Incorporated Pro Forma Consolidated Income Statement (in thousands) Revenues $ 1,801,795 Expenses Operating ............................ 827,761 Marketing and reservation ............ 157,347 Vehicle depreciation and lease charges 95,245 Selling and administrative ........... 135,791 Depreciation and amortization ........ 98,837 Interest ............................. 53,907 ---------- Total expenses .................. 1,368,888 Income before income taxes ........... 432,907 Provision for income taxes ........... 175,666 ---------- Net income ........................... $ 257,241 ========== -----END PRIVACY-ENHANCED MESSAGE-----