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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 34-0-22164
RFS HOTEL INVESTORS, INC.
(Exact name of Registrant as specified in its Charter)
TENNESSEE 62-1534743
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
850 RIDGE LAKE BOULEVARD, SUITE 200
MEMPHIS, TENNESSEE 38120
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (901) 767-7005
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.01 PAR VALUE
(Title of Class)
NEW YORK STOCK EXCHANGE
(Name of Market)
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the Registrant was approximately $264,009,745 based on the last sale price in
the New York Stock Exchange for such stock on March 14, 2000.
The number of shares of the Registrant's Common Stock outstanding was
24,559,046 as of March 14, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2000 Annual Meeting of Shareholders
are incorporated into Part I and Part III.
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PART I
ITEM 1. BUSINESS
RFS Hotel Investors, Inc. ("RFS" or the "Company") is a hotel real estate
investment trust which, at December 31, 1999, owned interests in 62 hotels with
9,086 rooms located in 24 states (collectively the "Hotels"). RFS owns an
approximate 90.7% interest in RFS Partnership L.P. (the "Operating
Partnership"). RFS, the Operating Partnership, and their subsidiaries are herein
referred to, collectively, as the "Company".
In 1999, the Company received 40% of its lease revenue from full service
hotels, 31% from extended stay hotels and 29% from limited service hotels.
The Company believes that owning a hotel portfolio diversified by brand,
market segment and geography is the best way to get the highest risk-adjusted
return on investment over time.
The following summarizes additional information for the 62 hotels owned at
December 31, 1999:
1999
FRANCHISE AFFILIATION HOTEL PROPERTIES ROOMS/SUITES LEASE REVENUE
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(IN THOUSANDS)
Full Service hotels:
Holiday Inn................................. 5 953 $ 9,844
Sheraton Four Points........................ 2 516 8,681
Sheraton.................................... 4 757 7,882
Independent................................. 2 326 6,705
DoubleTree.................................. 1 220 3,587
Ramada Plaza(1)............................. 1 234 2,858
-- ----- -------
15 3,006 39,557
-- ----- -------
Extended Stay hotels:
Residence Inn by Marriott................... 14 1,851 25,267
Hawthorn Suites............................. 1 280 3,147
TownePlace Suites by Marriott............... 3 285 1,226
Homewood Suites by Hilton................... 1 83 798
-- ----- -------
19 2,499 30,438
-- ----- -------
Limited Service hotels:
Hampton Inn................................. 19 2,368 18,204
Holiday Inn Express......................... 5 637 6,443
Comfort Inn................................. 3 474 3,074
Courtyard by Marriott....................... 1 102 1,246
-- ----- -------
28 3,581 28,967
-- ----- -------
Total............................... 62 9,086 $98,962
== ===== =======
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(1) To be converted to a Hilton full-service hotel in the second quarter of
2000.
The following summarizes the number of hotels owned for the periods
presented:
1999 1998 1997
---- ---- ----
Hotels owned at beginning of years.......................... 60 60 53
Acquisitions and developed hotels placed into service..... 2 6 10
Sales of hotels............................................. (6) (3)
-- -- --
Hotels owned at end of years.............................. 62 60 60
== == ==
At December 31, 1999, the Company leased 52 hotels to wholly owned
subsidiaries of Hilton Hotels Corporation ("Hilton"), six hotels to three other
lessees and four hotels were not leased. Fifty-one hotels are
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managed by wholly owned subsidiaries of Hilton and 11 hotels are managed by six
other third-party management companies. See Item 7 -- "Management's Discussion
and Analysis of Financial Condition and Results of Operations" for a discussion
of the Company's recent agreement with Hilton which provides the Company with
the right to terminate its leases with Hilton upon payment of certain amounts.
RFS, Inc., the wholly owned subsidiary of Hilton that leases 52 hotels, has
elected to provide its audited financial statements to the Company for inclusion
elsewhere in this Form 10-K. See "Index to Financial Statements" at page F-1.
GROWTH STRATEGIES
The Company's business objectives are to increase funds from operations and
enhance shareholder value primarily through (i) aggressive asset management and
the strategic investment of capital in its diversified hotel portfolio, (ii)
selectively acquiring hotels that have been underperforming due to the lack of
sufficient capital improvements, poor management or franchise affiliation, and
(iii) selectively disposing of hotels that have reached their earnings potential
or may in management's judgment, suffer adverse changes in their local market,
or require inordinately large capital outlays.
A part of the Company's asset management program is the licensing of all
but two of its Hotels under nationally franchised brands. The Company believes
that franchised properties generally have higher levels of occupancy and average
daily rate ("ADR") than properties which are unfranchised due to access to
national reservation systems and advertising and marketing programs provided by
franchisors.
During 1999, the Company spent $12.1 million of its budgeted $16.6 million
on capital improvements to its Hotels. The remaining $4.5 million is expected to
be completed by the second quarter of 2000. The Company expects to spend $21.3
million on capital improvements to its Hotels in 2000. Additionally,
approximately $6.5 million will be spent in 2000 at the Company's hotel in the
Fisherman's Wharf district of San Francisco, California to convert this hotel
from a Ramada Plaza to a Hilton full service hotel. The remaining capital
improvements are primarily designed to enhance revenues and/or the guests'
experience.
Currently, the Company's acquisition growth strategy has been curtailed due
to a variety of factors including the difficulty of obtaining equity financing
at prices deemed appropriate by management.
FINANCING
The Company believes that there is a competitive advantage in maintaining a
conservative capital structure and limiting the use of leverage. The Company's
Board of Directors has adopted a policy of limiting the amount of debt the
Company will incur to an amount not in excess of 40% of the Company's investment
in hotel properties at cost. The Board of Directors may change the debt policy
at any time without shareholder approval.
At December 31, 1999, the Company has relatively low leverage as evidenced
by the following credit and debt statistics:
- Trailing twelve month interest coverage ratio of 4.4x
- Total debt to EBITDA of 3.3x
- Weighted average maturity of fixed rate debt of 9.2 years
- Fixed interest rate debt equal to 63% of total debt
- Debt equal to 38.7% of investment in hotel properties, at cost (before
depreciation and after capital expenditures)
The Company increased the availability under its Line of Credit from $100
million to $130 million effective January 2000. The increased Line of Credit
matures on July 30, 2003. The interest rate remained substantially unchanged
ranging from 150 basis points to 225 basis points above LIBOR, depending on the
Company's ratio of total debt to its investment in hotel properties (as
defined). The interest rate was
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approximately 7.8% at December 31, 1999. The Line of Credit is collateralized by
first priority mortgages on 16 hotels and agreements restricting the transfer,
pledge or other hypothecation of an additional 16 hotels (collectively, the
"Collateral Pool"). The Company can obtain a release of the pledge of any hotel
in the Collateral Pool if the Company provides a substitute hotel or reduces the
total availability under the Line of Credit. The Line of Credit contains various
covenants including the maintenance of a minimum net worth, minimum debt
coverage and interest coverage ratios, and total indebtedness and total
liabilities limitations. The Company was not aware of any failure to comply with
these covenants at December 31, 1999.
COMPETITION
Substantially all of the Hotels are located in developed areas that include
other hotel properties. The number of competitive hotel properties in a
particular area could have a material adverse effect on occupancy, ADR and
RevPar of the Hotels. New, competing hotels may be opened in the Company's
markets which could materially and adversely affect hotel operations.
SEASONALITY
The Hotels' operations historically have been seasonal in nature,
reflecting higher occupancy during the second and third quarters. This
seasonality can be expected to cause fluctuations in the Company's quarterly
lease revenue to the extent that it receives Percentage Rent.
EMPLOYEES
At December 31, 1999, the Company had a total of 22 employees. Robert M.
Solmson, (age 52), Chairman of the Board and Chief Executive Officer, Randy L.
Churchey, (age 39), President and Chief Operating Officer, Michael J. Pascal,
(age 41), Executive Vice President and Chief Financial Officer, Secretary and
Treasurer, Angie Mock (age 36) Executive Vice President of Asset Management and
Craig Hofer (age 40), President of Centrafuse, Inc. each have employment
agreements with the Company. Information with respect to these employment
agreements is incorporated by reference to the Company's Proxy Statement.
TAX STATUS
The Company operated and intends to continue to operate so as to qualify as
a REIT under the federal income tax laws. Qualification as a REIT involves the
application of highly technical and complex rules for which there are only
limited judicial or administrative interpretations. There are no controlling
authorities that deal specifically with many tax issues affecting a REIT that
owns hotel properties. The determination of various factual matters and
circumstances not entirely within our control may affect our ability to qualify
as a REIT.
New regulations, administrative interpretations or court decisions could
adversely affect our qualification as a REIT or the federal income tax
consequences of such qualification. If we were to fail to qualify as a REIT in
any taxable year, we would not be allowed a deduction for distributions to
shareholders in computing our taxable income. We also would be subject to
federal income tax (including any applicable alternative minimum tax) on our
taxable income at regular corporate rates. Unless entitled to relief under
certain Code provisions, we also would be disqualified from taxation as a REIT
for the four taxable years following the year during which qualification was
lost. As a result, the cash available for distribution to shareholders would be
reduced for each of the years involved. Although we currently intend to operate
in a manner designed to qualify as a REIT, it is possible that future economic,
market, legal, tax or other considerations may cause the Board of Directors,
with the consent of a majority of the shareholders, to revoke the REIT election.
On December 17, 1999, the Ticket to Work and Work Incentive Improvement Act
of 1999 (the "Act") was signed into law. The Act includes several REIT
provisions (the "REIT Provisions"). The REIT Provisions generally will be
effective January 1, 2001 and will overhaul the existing tax rules applicable to
taxable subsidiaries of REITs. Under the REIT Provisions, we will be allowed to
own all of the stock in taxable REIT subsidiaries ("TRSs"). In addition, a TRS
will be allowed to perform "non-customary" services
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for our hotel guests and will be allowed to enter into many new businesses.
However, a TRS will not be allowed to franchise or manage hotels. The TRS would
be allowed to enter into management contracts for our hotels, with independent
third party management companies. The use of TRSs, however, would be subject to
restrictions, including the following:
- no more than 20% of the REIT's assets may consist of securities of TRSs,
- the tax deductibility of interest paid or accrued by a TRS to its
affiliated REIT would be limited, and
- a 100% excise tax would be imposed on non-arm's length transactions
between a TRS and its affiliated REIT or the REIT's tenants.
We expect to restructure our ownership interests in our current taxable
subsidiaries and establish additional taxable subsidiaries once the Act is
effective.
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, including, without limitation, statements containing the
words "believes", "anticipates", "expects" and words of similar import. Such
forward-looking statements relate to future events, the future financial
performance of the Company, and involve known and unknown risks, uncertainties
and other factors which may cause the actual results, performance or
achievements of the Company or industry results to be materially different from
any future results, performance or achievements expressed or implied by such
forward looking statements. Readers should specifically consider the various
factors identified in this report and in any other documents filed by the
Company with the Securities and Exchange Commission which could cause actual
results to differ. The Company disclaims any obligation to update any such
factors or to publicly announce the result of any revisions to any of the
forward-looking statements contained herein to reflect future events or
developments.
HOTEL OPERATING RISKS
The Hotels are subject to all operating risks common to the hotel industry.
These risks include, among other things: competition from other hotels; recent
over-building in the hotel industry which has adversely affected occupancy and
room rates; increases in operating costs due to inflation and other factors;
significant dependence on business and commercial travelers and tourism;
increases in energy costs and other expenses of travel; and adverse effects of
general and local economic conditions. These factors could adversely affect the
lessees' ability to make lease payments and therefore the Company's ability to
make distributions to shareholders.
The Company must rely on the lessees to generate sufficient cash flow from
the operations of the Hotels to enable the lessees to meet the rent obligations
under the Percentage Leases. The rent obligations under the Percentage Leases
are unsecured and are not guaranteed. At December 31, 1999, the lessees were in
compliance with the provisions of the Percentage Leases.
ENVIRONMENTAL RISKS
Under various federal, state and local laws and regulations, an owner or
operator of real estate may be liable for the costs of removal or remediation of
certain hazardous or toxic substances on such property. Such laws often impose
such liability without regard to whether the owner knew of, or was responsible
for, the presence of hazardous or toxic substances. Furthermore, a person that
arranges for the disposal or transports for disposal or treatment a hazardous
substance at another property may be liable for the costs of removal or
remediation of hazardous substances released into the environment at the
property. The costs of remediation or removal of such substances may be
substantial, and the presence of such substances, or the failure to promptly
remediate such substances, may adversely affect the owner's ability to sell such
real estate or to borrow using such real estate as collateral. Thus, if such
liability were to arise in connection with the ownership and operation of the
Hotels, the Company, the lessees, the managers, as the case may be, may be
potentially liable for such costs.
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Phase I Environmental Survey Assessments ("ESA's") were obtained on all of
the Hotels from independent environmental engineering firms at the time of
acquisition (and, for some Hotels, in connection with subsequent financing
transactions). The Phase I ESA's were intended to identify potential sources of
contamination for which the Hotels may be responsible and to assess the status
of environmental regulatory compliance. No assurance can be given that the Phase
I ESA's identified all significant environmental problems or that no additional
environmental liabilities exist. The Phase I ESA's included historical reviews
of the Hotels, reviews of certain public records, preliminary investigations of
the sites and surrounding properties, screening for the presence of asbestos,
PCBs, wetlands and underground storage tanks, and the preparation and issuance
of a written report. The Phase I ESA's did not include invasive procedures, such
as soil or ground water sampling and analysis.
The Phase I ESA for the Hampton Inn -- Airport in Indianapolis, indicated
that the Indianapolis Hotel disposes of approximately 10% of its solid waste at
a facility that is a state Superfund site. Such a site may be subject to
investigation and remediation under the federal and state Superfund laws, and
persons that sent hazardous substances to the site may be jointly and severally
liable for the costs of the that work. The Phase I ESA report states that solid
waste from the Indianapolis Hotel was disposed of into a domestic waste cell of
the facility. A state official informed the engineering firm conducting the
Phase I ESA that this domestic waste cell is segregated by a containment
structure and is adjacent to, but not part of, the Superfund site. The Phase I
audit did not indicate that the Indianapolis Hotel has arranged for the disposal
of any hazardous substances at this facility. If the Indianapolis Hotel in fact
arranged for such disposal, however, it could be found liable for at least a
part of any response costs.
Each former owner of the Hotels has represented to the Company that it
knows of no hazardous substance or PCBs in, on, or under the hotels or the real
property upon which the Hotels are situated. With respect to the Hotels each
such former owner will remain liable for all claims and costs arising from a
breach of such representation. In addition, the seller of the Hotel will remain
liable for all costs and claims incurred by the Company with respect to which
the Phase I ESA reports recommended corrective or remedial action, specifically
removal by the former owner of the Hotel in Clayton, Missouri of asbestos
materials. The Company believes the former owners of the Hotels have, and will
have, sufficient assets to satisfy their obligations to the Company which might
reasonably be expected to arise under the contacts pursuant to which such
properties were acquired by the Partnership. There can be no assurances,
however, that such former owners will be able to satisfy any of such
obligations.
Except as noted specifically above, the Phase I ESA reports have not
revealed an environmental liability or compliance concerns that the Company
believes would have a material adverse effect on the Company's business, assets
or results of operations, nor is the Company aware of an such liability or
compliance concerns. Nevertheless, it is possible that these reports do not
reveal all environmental liabilities or compliance concerns or that there are
material environmental liabilities or compliance concerns of which the Company
is unaware. Moreover, no assurances can be given that (i) future laws,
ordinances or regulations will not impose any material environmental liability
or (ii) the current environmental condition of the Hotels will not be affected
by the condition of the properties in the vicinity of the Hotels (such as the
presence of leaking underground storage tanks) or by third parties unrelated to
the Partnership or the Company.
POTENTIAL TAX RISKS
In order to qualify as a REIT, each year the Company must pay out to its
stockholders at least 95% of its taxable income (other than any net capital
gain). In addition, the Company would be subject to a 4% nondeductible tax if
the actual amount it pays out to its stockholders in a calendar year were less
than the minimum amount specified under federal tax laws. The Company has paid
out and intends to continue to pay out its income to its stockholders in a
manner intended to satisfy the 95% test and to avoid the 4% tax. In doing so,
the Company may be required to borrow money or sell assets to pay out enough of
its taxable income to satisfy the 95% test and to avoid the 4% tax in a
particular year.
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OWNERSHIP LIMITATION
In order for the Company to maintain its status as a REIT, no more than 50%
in value of its outstanding stock may be owned (actually or constructively under
the applicable tax rules) by five or fewer persons during the last half of any
taxable year. The Company's Charter prohibits, subject to certain exceptions,
any person from owning more than 9.9% (determined in accordance with the
Internal Revenue Code and the Securities Exchange Act of 1934, as amended) of
the number of outstanding shares of any class of its capital stock. The
Company's Charter also prohibits any transfer of its capital stock that would
result in a violation of the 9.9% ownership limit, reduce the number of
stockholders below 100 or otherwise result in the Company failing to qualify as
a REIT. Any attempted transfer in violation of the Charter prohibitions will be
void and the intended transferee will not acquire any right in the shares
resulting in such violation. The Company has the right to take any lawful action
that it believes necessary or advisable to ensure compliance with these
ownership and transfer restrictions and to preserve its status as a REIT,
including refusing to recognize any transfer of capital stock in violation of
its Charter.
If a person holds or attempts to acquire shares in excess of the Company's
ownership and transfer restrictions, these shares will be immediately designated
as "shares-in-trust" and transferred automatically and by operation of law, in
trust, to a trustee designated by the Company. The trustee will have the right
to receive all distributions on, to vote and to sell these shares. The holder of
the excess shares will have no right or interest in these shares, except the
right (under certain circumstances) to receive the lesser of: (i) the proceeds
of any sale of these shares by the trustee to a permitted owner and (ii) the
amount paid for these shares (or the market value of these shares, determined in
accordance with the Charter, if the shares were received by gift, bequest or
otherwise without payment). Accordingly, the record owner of any shares
designated as shares-in-trust would suffer a financial loss if the price at
which these shares are sold to a permitted owner is less than the price paid for
these shares.
ITEM 2. PROPERTIES
The following sets forth information regarding the Hotels in which the
Company had an ownership interest at December 31, 1999:
FOR THE YEAR ENDED DECEMBER 31, 1999
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DATE NUMBER ROOM
OPENED OF ROOMS REVENUE LEASE REVENUE REVPAR
------ -------- -------------- -------------- -------
(IN THOUSANDS) (IN THOUSANDS)
FULL SERVICE
BEVERLY HERITAGE
Milpitas, CA(3).................. 1988 232 $ 7,270 $ 4,552 $ 99.28
DOUBLETREE
San Diego, CA(3)................. 1990 220 7,035 3,587 87.60
HOLIDAY INN
Columbia, SC(3).................. 1969 175 3,067 1,066 48.01
Crystal Lake, IL(3).............. 1988 196 5,283 2,758 73.84
Flint, MI(3)..................... 1990 171 4,824 2,656 77.28
Lafayette, LA(3)................. 1983 242 4,121 1,631 46.66
Louisville, KY(3)................ 1970 169 2,676 1,053 43.38
HOTEL REX
San Francisco, CA(4)............. 1912 94 4,108 2,153 119.73
RAMADA PLAZA
San Francisco, CA(2)............. 1976 234 8,208 2,858 96.10
SHERATON FOUR POINTS
Bakersfield, CA(3)............... 1983 197 3,526 1,404 49.04
Pleasanton, CA(3)................ 1985 214 5,799 3,346 74.24
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FOR THE YEAR ENDED DECEMBER 31, 1999
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DATE NUMBER ROOM
OPENED OF ROOMS REVENUE LEASE REVENUE REVPAR
------ -------- -------------- -------------- -------
(IN THOUSANDS) (IN THOUSANDS)
SHERATON
Birmingham, AL(4)................ 1984 205 $ 3,595 $ 948 $ 48.04
Clayton, MO(3)................... 1965 255 5,510 2,712 59.20
Milpitas, CA(3).................. 1988 229 8,748 4,881 104.66
Sunnyvale, CA(3)................. 1980 173 7,100 3,952 112.42
----- ------- -------
3,006 80,870 39,557 74.48
----- ------- -------
EXTENDED STAY
HAWTHORN SUITES
Atlanta, GA(3)................... 1984 280 6,224 3,147 60.90
HOMEWOOD SUITES BY
HILTON
Chandler, AZ(4).................. 1998 83 1,771 798 58.47
RESIDENCE INN BY
MARRIOTT
Ann Arbor, MI(3)................. 1985 114 3,245 1,655 77.98
Atlanta, GA(3)................... 1987 128 3,172 1,450 67.89
Charlotte, NC(3)................. 1984 116 3,359 1,734 79.33
Fishkill, NY(3).................. 1988 136 4,559 2,178 91.84
Ft. Worth, TX(3)................. 1983 120 3,378 1,612 77.13
Jacksonville, FL................. 1997 120 2,916 1,329 66.57
Kansas City, MO(3)............... 1987 96 2,547 987 72.70
Orlando, FL(3)................... 1984 176 5,352 2,473 83.31
Sacramento, CA(3)................ 1987 176 5,032 2,568 78.33
Torrance, CA(3).................. 1984 247 7,724 3,796 85.68
Tyler, TX(3)..................... 1985 128 2,516 903 53.86
Warwick, RI(3)................... 1989 96 3,550 1,660 101.31
West Palm Beach, FL.............. 1998 78 2,044 979 71.80
Wilmington, DE(3)................ 1989 120 3,871 1943 88.38
TOWNEPLACE SUITES BY
MARRIOTT
Fort Worth, TX(1)(4)............. 1998 95 1,221 617 35.20
Miami West, FL(1)................ 1999 95 305 163 36.43
Miami Lakes, FL(1)............... 1999 95 819 446 41.67
----- ------- -------
2,499 63,605 30,438 73.04
----- ------- -------
LIMITED SERVICE
COMFORT INN
Farmington Hills, MI(3).......... 1987 135 2,275 1,190 46.16
Ft. Mill, SC(3).................. 1987 153 2,028 853 36.28
Marietta, GA(3).................. 1989 186 2,477 1,031 36.88
COURTYARD
Flint, MI(3)..................... 1996 102 2,433 1,245 65.35
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FOR THE YEAR ENDED DECEMBER 31, 1999
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DATE NUMBER ROOM
OPENED OF ROOMS REVENUE LEASE REVENUE REVPAR
------ -------- -------------- -------------- -------
(IN THOUSANDS) (IN THOUSANDS)
HAMPTON INN
Bloomington, MN(3)............... 1994 135 $ 2,836 $ 1,423 $ 57.55
Chandler, AZ(3).................. 1997 101 1,647 778 44.67
Denver, CO(3).................... 1985 138 1,619 569 32.14
Ft. Lauderdale, FL(3)............ 1986 123 2,142 805 48.11
Hattiesburg, MS(3)............... 1988 154 2,165 1,040 38.51
Houston, TX(3)................... 1996 119 2,009 883 46.24
Indianapolis, IN(3).............. 1994 131 2,511 1,310 52.51
Jacksonville, FL................. 1998 118 2,391 1,145 55.50
Lakewood, CO(3).................. 1987 150 2,147 860 39.21
Laredo, TX(3).................... 1995 119 2,407 1,125 55.38
Lincoln, NE(3)................... 1983 111 2,091 1,040 51.61
Memphis, TN(3)................... 1992 120 1,970 857 44.97
Minnetonka, MN(3)................ 1990 127 2,091 1,073 45.10
Oklahoma City, OK(3)............. 1986 134 2,125 895 43.44
Omaha, NE(3)..................... 1985 129 2,163 1,063 45.94
Plano, TX(3)..................... 1996 131 1,780 741 37.23
Sedona, AZ(3).................... 1997 56 1,180 514 57.72
Tulsa, OK(3)..................... 1986 148 2,231 1,006 41.29
Warren, MI(3).................... 1988 124 2,112 1,077 46.66
HOLIDAY INN EXPRESS
Arlington Heights, IL(3)......... 1989 125 2,627 1,448 57.57
Austin, TX(3).................... 1992 125 2,151 991 47.14
Bloomington, MN(3)............... 1987 142 3,111 1,487 60.02
Downers Grove, IL(3)............. 1984 123 2,475 1,292 55.13
Wauwatosa, WI(3)................. 1984 122 2,322 1,226 52.15
----- ------- -------
3,581 61,516 28,967 47.10
----- ------- -------
TOTAL/AVERAGE............ 9,086 $205,991 $98,962 63.13
===== ======= =======
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(1) Represents operations since the opening of the hotel in November 1998, June
1999 and November 1999 for the TownePlace Suites in Ft. Worth, TX, for the
TownePlace Suites in Miami Lakes, FL and Miami West, FL, respectively.
(2) The Ramada Plaza hotel is to be converted to a Hilton full service hotel in
the second quarter of 2000.
(3) Leased to a wholly owned subsidiary of Hilton.
(4) Lease revenue represents net operating income from this non-leased hotel.
MASTER AGREEMENT WITH ONE OF THE LESSEES, RFS, INC.
The Company has entered into a master agreement (the "Master Agreement"),
with one of the lessees, RFS, Inc., a wholly owned subsidiary of Hilton. Under
the Master Agreement, the Company has granted to RFS, Inc., a right of first
offer and right of first refusal (the "Right of First Refusal") to lease hotels
acquired by the Company prior to February 27, 2006 (the "Term"), subject to
agreeing upon economic terms.
The Company may terminate the Right of First Refusal at any time following
February 27, 2003, in the event the hotels leased by RFS, Inc. during the
seven-year period ending February 27, 2003 fail to meet certain financial
performance goals. The Company may also terminate the Right of First Refusal:
(i) upon the occurrence under a lease of an "Event of Default" by the lessee;
(ii) in the event the Company's status as a real estate investment trust is
terminated and the leases are terminated by the Company, and the Company
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(a) redeems all outstanding Series A Preferred Stock owned by the RFS, Inc. at a
price per share equal to the greater of (A) $19.00 or (B) the average sales
prices for the Company's Common Stock for the ten trading days prior to the
closing date, (b) the Company pays RFS, Inc. the fair market value of the
remaining terms of the leases and (c) if such termination occurs prior to
February 27, 2006, the Company pays RFS, Inc. an amount equal to $5 million
minus $42 thousand for each calendar month which has expired since February 27,
1996; or (iii) if RFS, Inc. fails to maintain a minimum net worth of $15 million
during the term of any lease or defaults under the terms of the Master
Agreement.
The lessee is required to maintain a $15 million tangible net worth (as
defined) during the terms of the leases. The Master Agreement provides that
there can be no change in control of RFS, Inc. without prior consent of the
Company.
Under the January 26, 2000 agreement with Hilton as described in Item
7 -- "Management's Discussion and Analysis of Financial Condition and Results of
Operations", the Right of First Refusal will be terminated if the Company
exercises its right to terminate the leases with Hilton.
THE PERCENTAGE LEASES
At December 31, 1999, the Company leased 52 hotels to wholly owned
subsidiaries of Hilton, six hotels to three other lessees and four hotels were
not leased.
The principal terms of the Percentage Leases are summarized below, although
certain terms vary from hotel to hotel.
Term: The Percentage Leases typically have an initial stated term of 15
years.
Rent: The Annual Base Rent is typically set at approximately 7% of the cost
of the hotel. Base Rent accrues and is payable monthly. The Percentage Rent is
calculated in three tiers as follows:
PROPERTY TYPE FIRST TIER MIDDLE TIER TOP TIER
- ------------- ---------- ----------- ----------
Full Service(1)................................. 17% to 53% 30% to 70% 50% to 75%
Extended Stay................................... 24% to 41% 45% to 50% 60% to 72%
Limited Service................................. 20% to 47% N/A 50% to 76%
- ---------------
(1) Percentage Rent formula also includes 20% of food and beverage revenue and
5% of food revenue.
The specific rent terms for each Percentage Lease for each Hotel are set
forth in Exhibit 10.2(a) to this Form 10-K.
The Base Rent and Percentage Rent thresholds for each year are adjusted to
reflect any year-to-year changes in the consumer price index ("CPI") in the two
preceding years. Approximately 40% of the Company's lease revenue was derived
from Base Rent in 1999.
Maintenance and Modifications. Under the Percentage Leases, the Company is
required to maintain the underground utilities and the structural elements of
the hotels, including exterior walls (excluding plate glass) and the roof of
each Hotel. The Company is required to fund capital improvements at the Hotels
subject to (i) the Company's right to approve capital budgets and (ii) the
Company's right in its sole discretion to refuse to make any capital
expenditures required by a franchisor. Otherwise, the lessees are required, at
their expense, to maintain the Hotels in good order and repair, except for
ordinary wear and tear, and to make non-structural, foreseen and unforeseen, and
ordinary and extraordinary, repairs which may be necessary and appropriate to
keep the Hotels in good order and repair.
Insurance and Property Taxes. The Company is responsible for paying real
estate taxes and casualty insurance premiums on the Hotels. The lessees are
required to pay or reimburse the Company for all other insurance on the Hotels,
which must include extended coverage, comprehensive general public liability,
workers' compensation and other insurance appropriate and customary for
properties similar to the Hotels and name the Company as an additional insured.
9
11
Indemnification. Under each of the Percentage Leases, the lessees have
agreed to indemnify, for certain losses relating to the Hotels, including losses
related to any accident or injury to person or property, certain environmental
liability, taxes and assessments and the sale or consumption of alcoholic
beverages.
Assignment and Subleasing. The Lessees are not permitted to sublet all or
any part of the Hotels or assign its interest under any of the Percentage
Leases, other than to an affiliate of the lessees, without the prior written
consent of the Company.
Events of Default. Events of Default under the Percentage Leases include,
among others, the following:
(i) the breach by the lessee of any term of the lease that is not
cured within specific periods or an Event of Default under any other lease;
or
(ii) if the lessees voluntarily discontinue operations of a Hotel for
more than 30 days, except as a result of damage, destruction, or
condemnation; or
(iii) if the franchise agreement with respect to a Hotel is terminated
by the franchisor as a result of any action or failure to act by the
lessees or its agents, other than a failure to complete a capital
improvement required by the franchisor as a result of the Company's failure
to fund the capital improvement; or
(iv) if the lessees default under the Master Agreement.
Termination of Percentage Leases on Disposition of the Hotels. In the
event the Company enters into an agreement to sell or otherwise transfer a
Hotel, the Company will have the right to terminate the Percentage Lease with
respect to such Hotel and either (i) pay the lessees the fair market value of
the lessee's leasehold interest in the remaining term of the Percentage Lease to
be terminated or (ii) within 120 days of termination of the lease, offer to
lease to the lessee a substitute hotel on terms that would create a leasehold
interest in such Hotel with a fair market value equal to or exceeding the fair
market value of the lessee's remaining leasehold interest under the Percentage
Lease to be terminated.
Franchise License. The lessees are the licensee under the franchise
licenses on the hotels currently owned by the Company. Upon the occurrence of
certain events of default by the lessees under a franchise license, each
franchisor has agreed to transfer the franchise license for the hotel to the
Partnership (or its designee). The Company anticipates that the franchisors of
the hotels currently under contract will agree to a similar arrangement. In
exchange, the Company has guaranteed all of the lessees' franchise payments
under the franchise agreements.
Other Lease Covenants. RFS, Inc. has agreed during the term of the
Percentage Leases to maintain a ratio of total debt to consolidated net worth
(as defined in the Percentage Leases) of not more than 50%, exclusive of
capitalized leases. Management fees paid to affiliates of the lessees are
subordinated to the lease payments.
Breach by Company. If the Company fails to cure a breach by it under a
Percentage Lease, the lessees may purchase the relevant Hotel from the Company
for a purchase price equal to the Hotel's then fair market value. Upon notice
from the lessees that the Company has breached the lease, the Company has 30
days to cure the breach or proceed to cure the breach, which period may be
extended in the event of certain specified, unavoidable delays.
ITEM 3. LEGAL PROCEEDINGS
The Company currently is not involved in any material litigation nor, to
the Company's knowledge, is any material litigation currently threatened against
the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
10
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
(a) Market Information
The Company's Common Stock is traded on the New York Stock Exchange
("NYSE") under the symbol "RFS". The following table sets forth for the
indicated periods the high and low sale prices for the Common Stock, as traded
on such exchange and the dividends declared per share:
DIVIDEND
STOCK PRICE DECLARED
------------------- ---------
HIGH LOW PER SHARE
---- --- ---------
1999
First Quarter........................................... $ 13.125 $10.4375 $0.385
Second Quarter.......................................... 14.50 11.3125 0.385
Third Quarter........................................... 12.625 10.875 0.385
Fourth Quarter.......................................... 12.1875 10.125 0.385
1998
First Quarter........................................... $ 20.125 $ 17.50 $0.375
Second Quarter.......................................... 21.4374 17.9375 0.375
Third Quarter........................................... 20.1875 12.00 0.385
Fourth Quarter.......................................... 14.4375 9.50 0.385
(b) Holders
The number of holders of record of shares of Common Stock was 328 as of
March 14, 2000.
(c) Distributions
The Company has adopted a policy of paying regular quarterly distributions
on its Common Stock, and cash distributions have been paid on the Company's
Common Stock each quarter since its inception.
Earnings and profits, which will determine the taxability of distributions
to shareholders, will differ from net income reported for financial reporting
purposes primarily due to the differences for federal tax purposes in the
estimated useful lives used to compute depreciation. Distributions made in 1999,
1998 and 1997 were considered 100% ordinary income for federal income tax
purposes.
The Company currently anticipates that it will maintain at least the
current dividend rate for the immediate future, unless actual results of
operations, economic conditions or other factors differ from its current
expectations.
11
13
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected historical financial data for the
Company that has been derived from the financial statements of the Company and
the notes thereto, audited by PricewaterhouseCoopers LLP, independent
accountants. Such data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
all of the financial statements and notes thereto.
SELECTED FINANCIAL DATA
1999 1998 1997 1996 1995
-------- -------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
OPERATING DATA:
Total revenue.............................. $ 99,662 $ 96,927 $ 83,069 $ 61,986 $ 48,307
Net income................................. 34,990 34,068 34,232 34,587 30,646
Net income applicable to common
shareholders............................. 33,578 32,656 32,820 33,392 30,646
Diluted earnings per share................. 1.34 1.31 1.34 1.37 1.26
BALANCE SHEET DATA:
Total assets............................... 687,242 683,991 617,128 499,129 376,926
Total debt................................. 282,278 272,799 208,909 133,064 30,186
Shareholders' equity....................... 361,283 366,937 362,070 357,482 388,813
OTHER DATA (UNAUDITED):
Funds from operations...................... 63,010 63,030 55,263 45,723 39,663
FFO per share.............................. 2.29 2.31 2.05 1.85 1.61
EBITDA..................................... 86,116 82,756 70,033 51,280 41,101
Ratio of EBITDA to interest
expense.............. 4.4 4.9 6.1 16.0 69.4
Ratio of Debt to EBITDA.................... 3.3 3.4 3.0 2.6 0.7
Dividends paid per share................... 1.54 1.51 1.455 1.39 1.18
CASH FLOWS DATA:
Cash provided by operating activities...... 66,837 55,092 58,590 46,448 38,896
Cash used by investing activities.......... (26,580) (65,932) (140,751) (74,518) (74,028)
Cash provided (used) by financing
activities............................... (36,358) 8,723 28,357 83,325 (7,838)
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14
QUARTERLY RESULTS OF OPERATIONS
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1999:
OPERATING DATA:
Total revenue.................................. $23,726 $26,238 $27,764 $21,934 $99,662
Net income..................................... 8,424 10,774 10,216 5,576 34,990
Net income applicable to Common Shareholders... 8,076 10,422 9,860 5,220 33,578
Diluted earnings per share..................... 0.32 0.41 0.39 0.21 1.34
OTHER DATA:
Funds From Operations.......................... 14,782 17,227 18,659 12,342 63,010
FFO per share.................................. 0.54 0.62 0.68 0.45 2.29
Dividends paid per share....................... 0.385 0.385 0.385 0.385 1.54
1998:
OPERATING DATA:
Total revenue.................................. $22,109 $25,753 $27,336 $21,729 $96,927
Income before minority interest................ 9,761 12,671 10,523 4,768 37,723
Net income..................................... 8,825 11,492 9,452 4,299 34,068
Net income applicable to Common Shareholders... 8,477 11,140 9,096 3,943 32,656
Diluted earnings per share..................... 0.35 0.44 0.37 0.16 1.31
OTHER DATA:
Funds From Operations.......................... 13,808 17,466 18,258 13,498 63,030
FFO per share.................................. 0.51 0.64 0.67 0.49 2.31
Dividends paid per share....................... 0.375 0.375 0.375 0.385 1.51
1997:
OPERATING DATA:
Total revenue.................................. $17,907 $21,747 $23,862 $19,553 $83,069
Net income..................................... 7,694 10,308 10,667 5,563 34,232
Net income applicable to Common Shareholders... 7,346 9,956 10,311 5,207 32,820
Diluted earnings per share..................... 0.3 0.41 0.42 0.21 1.34
OTHER DATA:
Funds From Operations.......................... 12,089 15,301 16,090 11,783 55,263
FFO per share.................................. 0.45 0.57 0.60 0.44 2.05
Dividends paid per share....................... 0.36 0.36 0.36 0.375 1.455
13
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE COMPANY
General
At December 31, 1999, the Company owned interests in 62 Hotels with 9,086
rooms located in 24 states. RFS owns an approximate 90.7% interest in the
Operating Partnership.
In 1999, the Company received 40% of its lease revenue from full service
hotels, 31% from extended stay hotels and 29% from limited service hotels. The
Company believes that owning a hotel portfolio diversified by brand, market
segment and geography is the best way to get the highest risk-adjusted return on
investment over time. The following summarizes additional information for the 62
Hotels owned at December 31, 1999:
FRANCHISE AFFILIATION HOTEL PROPERTIES ROOMS/SUITES 1999 LEASE REVENUE
- --------------------- ---------------- ------------ ------------------
(IN THOUSANDS)
Full Service hotels:
Holiday Inn.............................. 5 953 $ 9,844
Sheraton Four Points..................... 2 516 8,681
Sheraton................................. 4 757 7,882
Independent.............................. 2 326 6,705
DoubleTree............................... 1 220 3,587
Ramada Plaza(1).......................... 1 234 2,858
-- ----- -------
15 3,006 39,557
-- ----- -------
Extended Stay hotels:
Residence Inn by Marriott................ 14 1,851 25,267
Hawthorn Suites.......................... 1 280 3,147
TownePlace Suites by Marriott............ 3 285 1,226
Homewood Suites by Hilton................ 1 83 798
-- ----- -------
19 2,499 30,438
-- ----- -------
Limited Service hotels:
Hampton Inn.............................. 19 2,368 18,204
Holiday Inn Express...................... 5 637 6,443
Comfort Inn.............................. 3 474 3,074
Courtyard by Marriott.................... 1 102 1,246
-- ----- -------
28 3,581 28,967
-- ----- -------
Total............................ 62 9,086 $98,962
== ===== =======
- ---------------
(1) To be converted to a Hilton full-service hotel in the second quarter of
2000.
The following summarizes the number of hotels owned for the periods
presented:
1999 1998 1997
---- ---- ----
Hotels owned at beginning of years.......................... 60 60 53
Acquisitions and developed hotels placed into service....... 2 6 10
Sales of hotels............................................. -- (6) (3)
-- -- --
Hotels owned at end of years................................ 62 60 60
== == ==
At December 31, 1999, the Company leased 52 hotels to wholly owned
subsidiaries of Hilton, six hotels to three other lessees and four hotels were
not leased. Fifty-one hotels are managed by wholly owned subsidiaries of Hilton
and 11 hotels are managed by six other third-party management companies.
14
16
RESULTS OF OPERATIONS
Comparison of the Years Ended December 31, 1999 and 1998
Revenues
Lease revenue increased 2.7% in 1999 over 1998 due primarily to (i) an
average increase in RevPar at the 57 comparable hotels of 1.5% which resulted in
a 2.6% increase in lease revenues; (ii) one hotel opened in 1998, and two hotels
opened in 1999; and, (iii) a 40-room addition to the Beverly Heritage hotel in
Milpitas, California. These increases were partially offset by the sale of five
hotels during the latter half of 1998 and a decrease in RevPar at two hotels
undergoing major renovation in 1999.
The following shows hotel operating statistics for the 57 comparable hotels
for the year ended December 31, 1999. Excluded are one hotel opened in 1998, two
hotels opened in 1999, and two hotels undergoing major renovations in 1999
(Ramada Plaza in the Fisherman's Wharf district of San Francisco, California to
be converted to a Hilton full service hotel in the second quarter 2000 and the
Sheraton hotel in Birmingham, Alabama):
57 COMPARABLE HOTELS OPERATING STATISTICS
LEASE REVENUE ADR OCCUPANCY REVPAR
----------------------- -------------------- ----------------- -------------------
VARIANCE VARIANCE VARIANCE VARIANCE
SEGMENT 1999 VS. 1998 1999 VS. 1998 1999 VS. 1998 1999 VS. 1998
- ------- ---------- ---------- ------- ---------- ---- ---------- ------ ----------
(IN
THOUSANDS)
----------
Full Service................ $35,070 4.5% $103.24 4.8% 72.3% (0.9)% $74.62 3.8%
Extended Stay............... 29,213 5.8 95.24 3.2 79.6 (1.0) 75.81 2.2
Limited Service............. 28,967 (2.6) 68.86 2.9 68.4 (4.6) 47.10 (1.9)
Total............. $93,250 2.6 86.99 4.0 72.6 (2.4) 63.11 1.5
=======
The 15 full service hotels produced an average RevPar increase of 3.8% in
1999. The following four full service hotels located in Silicon Valley had
RevPar increases averaging 1.1% in 1999.
HOTEL LOCATION INCREASE (DECREASE) IN REVPAR
----- -------------- -----------------------------
173-room Sheraton........................................... Sunnyvale, CA 8.9%
201-room Beverly Heritage................................... Milpitas, CA 5.4
229-room Sheraton........................................... Milpitas, CA (2.9)
214-room Sheraton Four Points............................... Pleasanton, CA (5.8)
The Sunnyvale hotel was renovated and converted from a Sheraton Four Points
hotel to a Sheraton in December 1998. As a result, the ADR increased to $149.85
or 13.1% in 1999.
The Beverly Heritage hotel's RevPar gain is attributable to an 11.1%
occupancy increase in 1999 due to favorable market conditions and aggressive
marketing. The 5.4% RevPar gain in 1999 was achieved in spite of a 40-room
addition completed in November 1999.
The declines in 1999 RevPar for the Sheraton Milpitas hotel and the
Sheraton Four Points Pleasanton hotel are due, in part, to occupancy declines in
early 1999 attributable to the Asian financial crisis. Additionally, operations
at the Pleasanton hotel were adversely impacted by the reduction in business
from one major account. Both of these hotels produced improved RevPar
performances in the fourth quarter 1999. Fourth quarter 1999 RevPar increased
5.2% for the Sheraton Milpitas hotel and only decreased 1.3% for the Sheraton
Pleasanton hotel as compared to the fourth quarter 1998.
Other full service hotels include five Holiday Inn hotels that produced
RevPar increases of 5.8% in 1999 and the 255-room Sheraton hotel in Clayton, MO,
a suburb of St. Louis, which produced RevPar gains of 13.0% in 1999. The Clayton
hotel was renovated and converted from a Holiday Inn hotel to a Sheraton in
August 1999.
15
17
The Ramada Plaza hotel in the Fisherman's Wharf district of San Francisco,
California and the Sheraton hotel in Birmingham, Alabama were undergoing major
renovations in 1999. RevPar decreased 15.8% and 19.3%, respectively in 1999. The
Ramada Plaza hotel is expected to be converted to a Hilton full service hotel in
the second quarter 2000 after a $9 million renovation. The Sheraton Birmingham
hotel renovation of $1 million is primarily to correct construction-related
issues and should be completed in the second quarter of 2000.
The extended stay hotels experienced an average increase in RevPar of 2.2%
in 1999. Fourteen of the 16 extended stay hotels are Residence Inns by Marriott.
The Company's Residence Inns produced 2.1% RevPar growth in 1999 versus
Residence Inns by Marriott system-wide RevPar growth of 1.3%.
The limited service hotels experienced an average decrease in RevPar of
1.9% in 1999. Nineteen of the 28 limited service hotels are Hampton Inns. The
Company's Hampton Inns' RevPar decreased 3.0%. We are hopeful that the merger of
Promus Hotel Corporation with Hilton will provide stability in the Hampton Inn
brand and that including the brand in the Hilton Honors program, which is to be
introduced in April 2000, will improve the brand performance.
The improvement in room revenue significantly impacts the Company because
its principal source of revenue is lease payments from the lessees under the
Percentage Leases. The Percentage Leases provide for rent based on a percentage
of room revenue and other hotel revenue.
Expenses
As a percentage of total revenue, expenses, before the loss on sale of
hotel properties and franchise termination fees, increased from 61% in 1998 to
63% in 1999.
Taxes and insurance decreased 1.0% from 1998 to 1999 primarily due to the
sale of five hotels during the latter half of 1998 partially offset by an
average increase in real estate taxes of approximately 2.5% for the 57
comparable hotels and full year real estate taxes in 1999 for the one hotel
opened in 1998, and two hotels opened in 1999.
Depreciation increased 15.8% in 1999 over 1998 due to increases in
depreciable assets in 1999 relating to the one hotel opened in 1998, and two
hotels opened in 1999 and renovation expenditures at certain of the Hotels. As a
percentage of total revenue, depreciation increased from 21.6% to 24.3%. This
increase is the result of an increase in short-lived assets relative to total
fixed assets from the Company's renovation expenditures.
General and administrative expenses decreased 12.7% from 1998 to 1999 due
to the 1998 write-off of expenses in terminating a possible new REIT, Lodging
Trust USA and to a decrease in compensation expense of 18.2% attributable to an
overall decrease in bonuses under the Company's bonus programs for officers of
the Company.
Interest expense increased 18.2% in 1999 over 1998 due to an increase in
the weighted average debt balance outstanding in 1999 by approximately $30
million and an increase in the weighted average interest rate in 1999 from 7.35%
to 7.68%. Borrowings increased due to capital improvements and distributions to
shareholders being in excess of cash flow from operations. Interest rates
increased due to fixed rate 10-year financing of approximately $95 million
obtained in November 1998 which was used to repay lower variable interest rate
borrowings under the Line of Credit.
Comparison of the Years Ended December 31, 1998 and 1997
Revenues
Lease revenue increased 16.8% in 1998 over 1997 due primarily to (i) an
average increase in RevPar at 53 hotels of 5.5%; (ii) 10 hotels opened in 1997
which were open for the entire year in 1998; and, (iii) four hotels opened
during the first quarter of 1998. These increases were partially offset by the
sale of four hotels during the third quarter of 1998.
16
18
The following shows hotel operating statistics for 53 of the 60 hotels
owned at December 31, 1998 as if they were owned by the Company throughout both
years. Excluded are four hotels opened in 1998 and three hotels undergoing major
renovations in 1998.
LEASE REVENUE ADR OCCUPANCY REVPAR
------------------ ----------------- --------------- -----------------
VARIANCE VARIANCE VARIANCE VARIANCE
SEGMENT 1998 VS. 1997 1998 VS. 1997 1998 VS. 1997 1998 VS. 1997
- ------- ------- -------- ------ -------- ---- -------- ------ --------
(IN THOUSANDS)
Full Service.......................... $32,882 9.7% $99.81 9.7% 74.1% (2.1)% $73.93 7.4%
Extended Stay......................... 24,228 12.8 92.05 2.9 81.7 0.1 75.22 3.0
Limited Service....................... 29,029 8.0 66.68 5.9 72.1 (0.9) 48.07 4.9
-------
Total........................ $86,139 10.0 83.74 6.5 75.0 (0.9) 62.80 5.5
=======
Expenses
As a percentage of total revenue, expenses, before the loss and sale of
hotel properties and franchise termination fees, increased from 57% in 1997 to
61% in 1998.
Taxes and insurance increased 14.9% in 1998 over 1997 primarily due to the
increased number of hotels owned throughout 1998 as compared to being owned
during a portion of 1997 and an average increase in real estate taxes of 4.6%
for the 53 hotels.
Depreciation increased 18.4% in 1998 over 1997 due to increases in
depreciable assets in 1998 relating to the four hotels opened in 1998, an
increased number of hotels owned throughout 1998 as compared to being owned
during a portion of 1997 and renovation expenditures at certain of the Hotels.
As a percentage of total revenue, depreciation increased from 21.3% to 21.6%.
General and administrative expenses decreased 3.6% from 1997 to 1998
primarily due to a decrease in compensation expense due, primarily to the
resignation of one highly compensated employee, who resigned in the first
quarter of 1998.
Interest expense increased 43.6% in 1998 over 1997 due to an increase in
the weighted average debt balance outstanding in 1998 by approximately $50
million and an increase in the weighted average interest rate in 1998 from 7.1%
to 7.35%. The borrowings increase corresponds to the increase in the Company's
investment in hotel properties from 1997 to 1998.
FUNDS FROM OPERATIONS AND EBITDA
The Company considers Funds From Operations ("FFO") and Earnings Before
Interest, Taxes, Depreciation and Amortization ("EBITDA") to be appropriate
measures of a REIT's performance which should be considered along with, but not
as an alternative to, net income and cash flow as a measure of the Company's
operating performance and liquidity.
The National Association of Real Estate Investment Trusts (NAREIT), defines
FFO as net income (computed in accordance with generally accepted accounting
principles or GAAP), excluding gains (losses) from debt restructuring and sales
of property, plus real estate related depreciation and amortization and after
comparable adjustments for the Company's portion of these items related to
unconsolidated partnerships and joint ventures. The Company computes FFO in
accordance with standards established by NAREIT which may not be comparable to
FFO reported by other REITs that do not define the term in accordance with the
current NAREIT definition or that interpret the current NAREIT definition
differently than the Company. FFO and EBITDA do not represent cash flows from
operations as determined by GAAP and should not be considered as an alternative
to net income as an indication of the Company's financial performance or to cash
flow from operating activities determined in accordance with GAAP as a measure
of the Company's liquidity, nor is it indicative of funds available to fund the
Company's cash needs, including its ability to make cash distributions.
17
19
The following details the computation of FFO (in thousands except per share
amounts):
1999 1998 1997
------- ------- -------
Net income................................................ $34,990 $34,068 $34,232
Minority interest in Operating Partnership................ 3,620 3,655 3,615
Depreciation.............................................. 24,210 20,906 17,664
Attempted merger expenses................................. 1,664
Loss on sale of hotel properties and franchise termination
fees.................................................... 1,602 4,149 1,164
Preferred stock dividends................................. (1,412) (1,412) (1,412)
------- ------- -------
FFO....................................................... $63,010 $63,030 $55,263
======= ======= =======
Weighted average shares and partnership units
outstanding............................................. 27,569 27,343 26,952
FFO per share............................................. $ 2.29 $ 2.31 $ 2.05
The following details the computation of EBITDA (in thousands):
1999 1998 1997
------- ------- -------
FFO....................................................... $63,010 $63,030 $55,263
Interest expense, net..................................... 19,623 16,604 11,562
Amortization.............................................. 2,071 1,710 1,796
Preferred stock dividends................................. 1,412 1,412 1,412
------- ------- -------
$86,116 $82,756 $70,033
======= ======= =======
HILTON AGREEMENT
On January 26, 2000, the Company entered into an agreement with Hilton
which gives the Company the right to terminate 52 leases and related ancillary
agreements with Hilton. In the event that the Company elects to exercise this
right, the Company will be required to pay Hilton approximately $60 million, in
cash, at closing. Specifically, in order to exercise its right to terminate the
leases, the Company must notify Hilton on or before November 30, 2000, that the
Company intends to terminate the leases and related agreements and must complete
the termination within 60 days following the date of notice.
In connection with termination of the leases, Hilton may elect, at the
earlier of (i) ten days after receipt of the Company's notice of its intention
to terminate the Leases, or (ii) November 30, 2000, to require the Company to
repurchase the 973,684 shares of the Company's convertible preferred stock that
it currently owns. If the Company elects to terminate the leases, then Hilton
will have the right to require the Company to purchase the Series A Preferred
Stock for $13 million. If the Company elects not to terminate the leases, Hilton
will have the right to require the Company to redeem the Series A Preferred
Stock for $13.75 million. The Company may elect, in its sole discretion, to pay
all or part of the purchase price for the preferred shares in the form of shares
of its Common Stock.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of cash to meet its cash requirements,
including distributions to shareholders and repayments of indebtedness, is its
share of the Operating Partnership's cash flow from the Percentage Leases. For
the year ended December 31, 1999, cash flow provided by operating activities,
consisting primarily of Percentage Lease revenue, was $66.8 million and FFO was
$63.0 million.
The lessees' obligations under the Percentage Leases are unsecured.
However, the leases with Hilton contain certain covenants including the
maintenance of a ratio of total debt to consolidated net worth (as defined) of
the lessee of not more than 50%. Management fees paid to affiliates of Hilton
are subordinated to the lease payments. The lessees have limited capital
resources, and accordingly, their ability to make lease payments under the
Percentage Leases is substantially dependent on the ability of the lessees to
generate sufficient cash flow from the operations of the Hotels. At February 5,
2000, the lessees had paid all amounts due the Company under the Percentage
Leases as of December 31, 1999. At December 31, 1999, the
18
20
Company had $5.9 million of cash and cash equivalents and had utilized $98.8
million under its $130 million Line of Credit.
The following details the Company's debt outstanding at December 31, 1999
(dollar amounts in thousands):
COLLATERAL
------------------------------
# OF NET BOOK VALUE
BALANCE INTEREST RATE MATURITY HOTELS AT DEC. 31, 1999
-------- ------------- ------------- ------ ----------------
Line of Credit....... $ 98,807 LIBOR + 200bp Variable July 2003 32 $290,670
Mortgage............. 40,508 6.83% Fixed August 2008
Mortgage............. 25,000 7.03 Fixed November 2011 15 142,969
Mortgage............. 94,709 7.83 Fixed December 2008 10 130,326
Mortgage............. 18,815 8.22 Fixed November 2007 1 35,342
Mortgage............. 4,440 3.50 Variable January 2001 1 20,867
-------- --------
$282,279 $620,174
======== ========
The Company increased the availability under its Line of Credit from $100
million to $130 million effective January 2000. The increased Line of Credit
matures on July 30, 2003. The interest rate remained substantially unchanged
ranging from 150 basis points to 225 basis points above LIBOR, depending on the
Company's ratio of total debt (as defined) to its investment in hotel
properties. The interest rate was approximately 7.8% at December 31, 1999. The
Line of Credit is collateralized by first priority mortgages on 16 hotels and
agreements restricting the transfer, pledge or other hypothecation on an
additional 16 hotels (collectively, the "Collateral Pool"). The Company can
obtain a release of the pledge of any hotel in the Collateral Pool if the
Company provides a substitute hotel or reduces the total availability under the
Line of Credit. The Line of Credit contains various covenants including the
maintenance of a minimum net worth, minimum debt coverage and interest coverage
ratios, and total indebtedness and total liabilities limitations. The Company
was not aware of any failure to comply with these covenants at December 31,
1999.
The Company's other borrowings are nonrecourse to the Company and contain
provisions allowing for the substitution of collateral, upon satisfaction of
certain conditions, after the respective loans have been outstanding for
approximately four years. Most of the mortgage borrowings are repayable and
subject to various prepayment penalties, yield maintenance, or defeasance
obligations.
Future scheduled principal payments of debt obligations at December 31,
1999 are as follows (in thousands):
AMOUNT
--------
2000........................................................ $ 8,364
2001........................................................ 6,574
2002........................................................ 5,857
2003........................................................ 105,103
2004........................................................ 6,747
Thereafter.................................................. 149,634
--------
$282,279
========
Certain significant credit and debt statistics at December 31, 1999 are as
follows:
- Trailing twelve month interest coverage ratio of 4.4x
- Total debt to EBITDA of 3.3x
- Weighted average maturity of fixed rate debt of 9.2 years
- Fixed interest rate debt equal to 63% of total debt
- Debt equal to 38.7% of investment in hotel properties, at cost (before
depreciation and after capital expenditures)
19
21
The Company spent $12.1 of its budgeted $16.6 million on capital
improvements to its hotels. The Operating Partnership will use cash generated
from operations and borrowings under the Line of Credit to fund the remaining
$4.5 million of expenditures which is expected to be completed by the second
quarter of 2000.
The Company expects to spend approximately $21.3 million on capital
improvements to its hotels in 2000. Additionally, approximately $6.5 million
will be spent in 2000 at the Company's hotel in the Fisherman's Wharf district
of San Francisco, California to convert this hotel from a Ramada Plaza to a
Hilton full service hotel.
The Company in the future may seek to increase further the amount of its
credit facilities, negotiate additional credit facilities, or issue corporate
debt instruments. Although the Company has no charter restrictions on the amount
of indebtedness the Company may incur, the Board of Directors of the Company has
adopted a current policy limiting the amount of indebtedness that the Company
will incur to an amount not in excess of approximately 40% of the Company's
investment in hotel properties, at cost, (as defined). The Board of Directors
may modify its debt limitation policy at anytime without shareholder approval.
The Company intends to fund cash distributions to shareholders principally
out of cash generated from operations. The Company may incur, or cause the
Operating Partnership to incur, indebtedness to meet distribution requirements
imposed on a REIT under the Internal Revenue Code (including the requirement
that a REIT distribute to its shareholders annually at least 95% of its taxable
income) to the extent that working capital and cash flow from the Company's
investments are insufficient to make such distributions.
INFLATION
Operators of hotels, in general, possess the ability to adjust room rates
daily to reflect the effects of inflation. However, competitive pressures may
limit the ability of the lessees to raise room rates.
SEASONALITY
The Hotels' operations historically have been seasonal in nature,
reflecting higher occupancy during the second and third quarters. This
seasonality can be expected to cause fluctuations in the Company's quarterly
lease revenue to the extent that it receives Percentage Rent.
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101") which provides guidance on revenue
recognition. SAB 101 is effective for fiscal years beginning after December 15,
1999. SAB 101 requires that a lessor not recognize contingent rental income
until annual specified hurdles have been achieved by the lessee. During 1999 and
prior years, the Company has recognized contingent rentals throughout the year
since it was considered probable that the lessee would exceed the annual
specified hurdles. The Company has reviewed the terms of its Percentage Leases
and has determined that the provisions of SAB 101 materially impact the
Company's revenue recognition on an interim basis, effectively deferring the
recognition of revenue from its Percentage Leases from the first and second
quarters of the calendar year to the third and fourth quarters. SAB 101 will not
impact the Company's revenue recognition on an annual basis given that Company
has only calendar year leases. SAB 101 will have no impact on the Company's
interim or annual cash flow from its third party lessees, and therefore on its
ability to pay dividends. The Company will account for SAB 101 as a change in
accounting principle effective January 1, 2000.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, including, without
limitation, statements containing the words "believes," "anticipates," "expects"
and words of similar import. Such forward-looking statements relate to future
events and the future financial performance of the Company, and involve known
and unknown risks, uncertainties and other factors
20
22
including those described in the Company's Form 8-K filed with the Securities
and Exchange Commission on May 12, 1999 which may cause the actual results,
performance or achievements of the Company to be materially different from the
results or achievements expressed or implied by such forward-looking statements.
The Company is not obligated to update any such factors or to reflect the impact
of actual future events or developments on such forward-looking statements.
RFS, INC.
RESULTS OF OPERATIONS
Year Ended December 31, 1999 Compared with Year Ended December 31, 1998
Total revenues decreased $7.7 million or 3.8% to $195.4 million for the
year ended December 31, 1999 compared to $203.1 million for the year ended
December 31, 1998. The decrease in hotel revenues of $3.7 million was
attributable to declining markets. Additionally, on a same store basis as
compared to 1998, the average daily rate increased approximately $5 to $85 while
occupancy declined 2.0 percentage points to 72.5%. The margin on hotel results
(hotel revenues less hotel expenses and lease expenses) decreased $2.8 million
or 19.3%, from $14.5 million to $11.7 million, primarily due to the decline in
total revenues.
Management consulting fees decreased 55.1% or $0.7 million principally
reflecting the loss of six management contracts from the portfolio in 1999.
Other fees and income decreased $3.2 million or 64.2% primarily due to certain
non-recurring lease termination fees totaling $2.6 million that occurred in
1998, coupled with a decrease in limited partnership income of $0.7 million.
General and administrative expenses increased 15% or $0.6 million primarily
due to increased costs associated employee related benefits. Depreciation and
amortization increased $0.3 million or 46.4% due to increased amortization
associated with lease valuation costs in conjunction with the Hilton Hotels
Corporation's ("Hilton") acquisition of the Lessee.
The provision for income taxes in 1999 reflects a 39% effective tax rate,
which is consistent with the effective tax rate in 1998. The Lessee files a
consolidated tax return with Hilton.
Year Ended December 31, 1998 Compared with Year Ended December 31, 1997
Total revenues increased $6.3 million or 3.2% to $203.1 million for the
year ended December 31, 1998 compared to $196.8 million for the year ended
December 31, 1997. The increase in hotel revenues was attributable, on a same
store basis, as compared to the 1997 period, to the average daily rate
increasing approximately $4 to $80 while occupancy declined 1.0 percentage point
to 74.8%. The margin on hotel results (hotel revenues less hotel expenses and
lease expenses) decreased $0.7 million or 4.9% from $15.2 million to $14.5
million reflecting improved operating performance of the hotels on a same store
basis offset by the loss of six hotels sold during 1998.
Management and consulting fees decreased 21% to $1.3 million reflecting the
termination of five management contracts during 1998 that were active throughout
1997, partially offset by the impact of two new contracts. Other fees and income
increased $3.2 million primarily reflecting $2.7 million of revenue attributable
to lease termination fees on the hotels that were sold in 1998, and $0.5 million
of revenue generated through various partnership interests.
General and administrative expenses, as well as, depreciation and
amortization expense increased nominally.
The provision for income taxes in 1998 reflects a 39.1% effective tax rate
(the consolidated effective tax rate for Promus Hotel Corporation in 1998) as
compared to a 38.3% effective tax rate in 1997. The Company files a consolidated
tax return with Promus Hotel Corporation.
21
23
LIQUIDITY AND CAPITAL RESOURCES
The principal source of cash to the Lessee, other than capital
contributions from Hilton, will come from operations. Since inception, the
Lessee has been able to meet its rent obligations under the Percentage Leases.
During 1999, the Lessee generated cash flows from operations of $9.8 million as
compared to $8.0 million during 1998, excluding the effect of a cash flow
sharing agreement between Lessee and Hilton. The increase was principally due to
an increase in accounts receivable collections and an increase in the Lessee's
accounts payable and accrued expenses. The Lessee expects that its cash flows
from operations will be sufficient to meet its liquidity and capital
requirements.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to certain financial market risks, the most
predominant being fluctuations in interest rates. The Company monitors interest
rate fluctuations as an integral part of our overall risk management program,
which recognizes the unpredictability of financial markets and seeks to reduce
the potentially adverse effect on our results. The effect of interest rate
fluctuations historically has been small relative to other factors affecting
operating results, such as occupancy.
Our operating results are affected by changes in interest rates primarily
as a result of borrowing under our line of credit. If interest rates increased
by 25 basis points, our annual interest expense would have increased by
approximately $223 thousand, based on balances outstanding during the year
ending December 31, 1999.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INCLUDED HEREIN BEGINNING AT
PAGE F-1
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
Information about the Directors and Executive Officers of the Company is
incorporated herein by reference to the discussion under "Executive Officers of
RFS" in the Company's Proxy Statement for the 2000 Annual Meeting of
Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
Information about executive compensation is incorporated herein by
reference to the discussion under "Executive Compensation Tables" in the
Company's Proxy Statement for the 2000 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information about the security ownership of certain beneficial owners and
management of the Company is incorporated herein by reference to the discussion
under "Director and Officer Stock Ownership" and "Principal Stockholders" in the
Company's Proxy Statement for the 2000 Annual Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information about certain relationships and related transactions is
incorporated by reference to the discussion under "Certain Relationships and
Related Transactions" in the Company's Proxy Statement for the 2000 annual
Meeting of Shareholders.
22
24
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements
The following financial statements are included in this report on Form
10-K:
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Income for years ended December 31, 1999,
1998 and 1997
Consolidated Statements of Shareholders' Equity for years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for years ended December 31,
1999, 1998 and 1997
Notes to Consolidated Financial Statements
The following financial statement schedule and report of independent
accountants on the financial statement schedule is included in this report on
Form 10-K:
Report of Independent Accountants on the Financial Statement Schedules
Schedule III -- Real Estate and Accumulated Depreciation
The following financial statements of RFS, Inc. are included in this report
on Form 10-K:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Operations for the periods November 30,
1999 through December 31, 1999 and January 1, 1999 through November
29, 1999 and for the years ended December 31, 1998 and 1997
Consolidated Statements of Stockholder's Equity for years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the periods November 30,
1999 through December 31, 1999 and January 1, 1999 through November
29, 1999 and for the years ended December 31, 1998 and 1997
Notes to Consolidated Financial Statements
(b) Reports on Form 8-K
No filings of Form 8-K were made during the last quarter of 1999.
23
25
(c) Exhibits
EXHIBIT
NUMBER EXHIBIT
------- -------
3.1 -- Second Restated Charter of the Registrant (previously filed
as Exhibit 3.1 to the Company's Current report on form 8-K
dated March 6, 1996 and incorporated herein by reference).
3.2 -- By-Laws of the Registrant (previously filed as Exhibit 3.2
to the Company's form S-11 Registration Statement,
Registration No. 33-63696 and incorporated herein by
reference).
3.3 -- Second Amended and Restated Agreement of Limited Partnership
of RFS Partnership, L.P., (previously filed as Exhibit 3.3
to the Company's Form S-3 Registration Statement,
Registration No. 33-83450 and incorporated herein by
reference).
3.3(a) -- Third Amended and Restated Agreement of Limited Partnership
of RFS Partnership, L.P., (previously filed as Exhibit 4.3
to the Company's Form S-3 Registration Statement,
Registration No. 333-3307 and incorporated herein by
reference).
3.3(b) -- Fourth Amended and Restated Agreement of Limited Partnership
(previously filed as Exhibit 3.3(b) to the Company's Form
10-K for the year ended December 31, 1996 and incorporated
herein by reference).
10.1 -- Consolidated Lease Amendment (previously filed as Exhibit
10.3 to the Company's current report on Form 8-K, dated
February 27, 1996 and incorporated herein by reference).
10.2 -- Form of Future Percentage Lease (previously filed as Exhibit
10.4 to the Company's Current Report on Form 8-K, dated
February 27, 1996 and incorporated herein by reference).
10.2(a) -- Schedule of terms of Percentage Leases (previously filed as
Exhibit 10.2(a) to the Company's Form 10-K for the year
ended December 31, 1998 and incorporated herein by
reference).
10.3 -- Form of Sale and Purchase Agreement (previously filed as
Exhibit 10.2 to the Company's Form 10-K for the year ended
December 31, 1994 and incorporated herein by reference).
10.3(a) -- Schedule of terms of Sale and Purchase Agreements
(previously filed as Exhibit 10.3(2) to the Company's Form
10-K for the year ended December 31, 1998 and incorporated
herein by reference).
10.4 -- Second Amended and Restated Employment Agreement between RFS
Managers, Inc. and Robert M. Solmson (previously filed as
Exhibit 10.4 to the Company's Form 10-K for the year ended
December 31, 1997 and incorporated herein by reference).
10.5 -- Second Amended and Restated Employment Agreement between RFS
Managers, Inc. and J. William Lovelace (previously filed as
Exhibit 10.6 to the Company's Form 10-K for the year ended
December 31, 1997 and incorporated herein by reference).
10.6 -- Second Amended and Restated Employment Agreement between RFS
Managers, Inc. and Michael J. Pascal (previously filed as
Exhibit 10.6 to the Company's Form 10-K for the year ended
December 31, 1997 and incorporated herein by reference).
10.9 -- Master Agreement, dated February 1, 1996 (previously filed
as Exhibit 10.2 to the company's current Report on Form 8-K
dated February 27, 1996 and incorporated herein by
reference).
10.9(a) -- First Amendment to Master agreement dated as of November 21,
1996 (previously filed as Exhibit 10.9(a) to the Company's
Form 10-K for the year ended December 31, 1996 and
incorporated herein by reference).
10.10 -- Indenture dated as of November 21, 1996 (previously filed as
Exhibit 10.10 to the Company's form 10-K for the year ended
December 31, 1996 and incorporated herein by reference).
24
26
EXHIBIT
NUMBER EXHIBIT
------- -------
10.11 -- Form of Deed of Trust dated as of November 21, 1996
(previously filed as Exhibit 10.11 to the Company's Form
10-K for the year ended December 31, 1996 and incorporated
herein by reference).
10.12 -- Second Amended and Restated Revolving Credit and Term Loan
Agreement (previously filed as Exhibit 10.12 to the
Company's Form 10-K for the year ended December 31, 1997 and
incorporated herein by reference).
10.13 -- Third Amended and Restated Revolving Credit Agreement
(previously filed as Exhibit 10.13 to the Company's Form
10-K for the year ended December 31, 1997 and incorporated
herein by reference).
*10.14 -- Fourth Amended and Restated Revolving Credit Agreement.
*10.15 -- Termination Agreement dated as of January 26, 2000.
13.1 -- Annual Report to Shareholders for the year ended December
31, 1998 (previously filed as Exhibit 13.1 to the Company's
Form 10-K for the year ended December 31, 1998 and
incorporated herein by reference).
21.1 -- List of Subsidiaries of the Registrant (previously filed as
Exhibit 21.1 to the Company's Form 10-K for the year ended
December 31, 1998 and incorporated herein by reference).
*23.1 -- Consent of PricewaterhouseCoopers LLP
*23.2 -- Consent of KPMG LLP
*23.3 -- Opinion of KPMG LLP
*23.4 -- Consent of Arthur Andersen LLP
*27.1 -- Financial Data Schedule (for SEC use only)
- ---------------
* Filed herewith
25
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant as duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
RFS HOTEL INVESTORS, INC.
By: /s/ ROBERT M. SOLMSON
------------------------------------
Robert M. Solmson
Chairman of the Board and Chief
Executive Officer
Date: March 17, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
SIGNATURES TITLE DATE
---------- ----- ----
/s/ ROBERT M. SOLMSON Chairman of the Board, Chief March 17, 2000
- ----------------------------------------------------- Executive Officer and
Robert M. Solmson President
/s/ RANDALL L. CHURCHEY President and Chief Operating March 17, 2000
- ----------------------------------------------------- Officer
Randall L. Churchey
/s/ MICHAEL J. PASCAL Chief Financial Officer March 17, 2000
- ----------------------------------------------------- Secretary and Treasurer
Michael J. Pascal (principal financial and
accounting officer)
/s/ H. LANCE FORSDICK, SR. Director March 17, 2000
- -----------------------------------------------------
H. Lance Forsdick, Sr.
/s/ BRUCE E. CAMPBELL, JR. Director March 17, 2000
- -----------------------------------------------------
Bruce E. Campbell, Jr.
/s/ MICHAEL E. STARNES Director March 17, 2000
- -----------------------------------------------------
Michael E. Starnes
/s/ JOHN W. STOKES, JR. Director March 17, 2000
- -----------------------------------------------------
John W. Stokes, Jr.
/s/ HARRY W. PHILLIPS, SR. Director March 17, 2000
- -----------------------------------------------------
Harry W. Phillips, Sr.
/s/ R. LEE JENKINS Director March 17, 2000
- -----------------------------------------------------
R. Lee Jenkins
/s/ RICHARD REISS, JR. Director March 17, 2000
- -----------------------------------------------------
Richard Reiss, Jr.
26
28
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income and retained earnings and of cash
flows present fairly in all material respects, the consolidated financial
position of RFS Hotel Investors, Inc. and its subsidiaries at December 31, 1999
and 1998 and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1999, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Memphis, Tennessee
January 21, 2000, except for
Note 9 as to which the date is
February 15, 2000
F-1
29
RFS HOTEL INVESTORS, INC.
CONSOLIDATED BALANCE SHEETS
1999 1998
--------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
ASSETS
Investment in Hotel Properties, net......................... $651,988 $624,730
Hotels under development.................................... 18,289
Cash and cash equivalents................................... 5,913 2,014
Restricted cash............................................. 1,082 7,809
Due from Lessees............................................ 10,801 10,656
Notes receivable............................................ 4,902 4,949
Deferred expenses, net...................................... 4,458 5,216
Other assets................................................ 8,098 10,328
-------- --------
Total assets...................................... $687,242 $683,991
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses....................... $ 8,063 $ 8,281
Borrowings on Line of Credit................................ 98,807 82,307
Long-term obligations....................................... 183,471 190,492
Minority interest in Operating Partnership, 2,565 and 2,568
units issued and outstanding at December 31, 1999 and
1998, respectively........................................ 35,618 35,974
-------- --------
Total liabilities................................. 325,959 317,054
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred Stock, $.01 par value, 5,000 shares authorized,
974 shares issued and outstanding...................... 10 10
Common Stock, $.01 par value, 100,000 shares authorized,
25,157 and 25,116 shares issued at December 31, 1999
and 1998, respectively................................. 251 251
Additional paid-in capital................................ 374,087 373,156
Treasury stock, at cost, 262 and 110 shares at December
31, 1999 and 1998, respectively........................ (3,656) (2,012)
Distributions in excess of income......................... (9,409) (4,468)
-------- --------
Total shareholders' equity........................ 361,283 366,937
-------- --------
Total liabilities and shareholders' equity........ $687,242 $683,991
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
30
RFS HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Revenue:
Lease revenue............................................. $98,962 $96,371 $82,531
Other revenue............................................. 700 556 538
------- ------- -------
Total revenues.................................... 99,662 96,927 83,069
------- ------- -------
Expenses:
Taxes and insurance....................................... 9,859 9,949 8,657
Depreciation.............................................. 24,210 20,906 17,664
General and administrative................................ 3,687 4,222 4,379
Attempted merger expenses................................. 1,664
Loss on sale of hotel properties and franchise termination
fees................................................... 1,602 4,149 1,164
Amortization.............................................. 2,071 1,710 1,796
Interest expense, net..................................... 19,623 16,604 11,562
Minority interest in Operating Partnership................ 3,620 3,655 3,615
------- ------- -------
Total expenses.................................... 64,672 62,859 48,837
------- ------- -------
Net income.................................................. 34,990 34,068 34,232
Preferred stock dividends................................... (1,412) (1,412) (1,412)
------- ------- -------
Net income applicable to common shareholders...... $33,578 $32,656 $32,820
======= ======= =======
Basic earnings per share.................................... $ 1.34 $ 1.32 $ 1.35
Weighted average common shares outstanding.................. 25,002 24,775 24,389
Diluted earnings per share.................................. $ 1.34 $ 1.31 $ 1.34
Weighted average shares outstanding......................... 25,002 24,864 24,536
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
31
RFS HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
COMMON STOCK
------------------ ADDITIONAL DISTRIBUTIONS
PREFERRED NUMBER OF PAID-IN IN EXCESS OF TREASURY
STOCK SHARES AMOUNT CAPITAL INCOME STOCK TOTAL
--------- --------- ------ ---------- ------------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Balances at December 31, 1996.......... $10 24,384 $244 $354,223 $ 3,005 $357,482
Issuance of common shares............ 5 72 72
Contribution of capital.............. 90 90
Distributions on common shares,
$(1.455 per share)................. (35,488) (35,488)
Distributions on preferred shares,
$(1.45 per share).................. (1,412) (1,412)
Allocation to minority interest...... 6,356 6,356
Amortization of unearned
compensation....................... 738 738
Net income........................... 34,232 34,232
--- ------ ---- -------- -------- --------
Balances at December 31, 1997.......... 10 24,389 244 361,479 337 362,070
Issuance of common shares, net of
offering costs of $75.............. 643 6 11,034 11,040
Retirement of common shares.......... (45)
Purchase of treasury shares.......... $(2,012) (2,012)
Issuance of restricted common shares
to officers, directors and
employees.......................... 129 1 (1)
Distributions on common shares,
$(1.51 per share).................. (37,431) (37,431)
Distributions on preferred shares,
$(1.45 per share).................. (1,412) (1,412)
Distribution on partnership
interest........................... (30) (30)
Amortization of unearned
compensation....................... 644 644
Net income........................... 34,068 34,068
--- ------ ---- -------- -------- ------- --------
Balances at December 31, 1998.......... 10 25,116 251 373,156 (4,468) (2,012) 366,937
Purchase of treasury shares.......... 205 (1,644) (1,439)
Issuance of restricted common shares
to officers and directors.......... 41
Distributions on common shares,
$(1.54 per share).................. (38,519) (38,519)
Distributions on preferred shares,
$(1.45 per share).................. (1,412) (1,412)
Amortization of unearned
compensation....................... 726 726
Net income........................... 34,990 34,990
--- ------ ---- -------- -------- ------- --------
Balances at December 31, 1999.......... $10 25,157 $251 $374,087 $ (9,409) $(3,656) $361,283
=== ====== ==== ======== ======== ======= ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
32
RFS HOTEL INVESTORS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1999 1998 1997
--------- --------- ----------
(IN THOUSANDS)
Cash flows from operating activities:
Net income................................................ $ 34,990 $ 34,068 $ 34,232
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 26,281 22,616 19,460
Minority interest in Operating Partnership............. 3,620 3,655 3,615
Loss on sale of hotel properties and franchise
termination fees..................................... 79 1,441 1,164
Attempted merger expenses.............................. 1,664
Changes in assets and liabilities:
Due from Lessees..................................... (145) (769) (2,700)
Other assets......................................... 2,230 (6,053) (3,063)
Accounts payable and accrued expenses................ (218) (1,530) 5,882
-------- -------- ---------
Net cash provided by operating activities......... 66,837 55,092 58,590
-------- -------- ---------
Cash flows from investing activities:
Investment in hotel properties and hotels under
development............................................ (34,066) (78,839) (153,564)
Proceeds from sale of hotel properties.................... 808 19,627 15,566
Prepayments under purchase agreements..................... (1,425) (205)
Restricted cash........................................... 6,727 (5,295) (2,514)
Cash paid for franchise agreements........................ (49) (34)
-------- -------- ---------
Net cash used by investing activities............. (26,580) (65,932) (140,751)
-------- -------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock.................... 11,040 162
Purchase of treasury stock................................ (1,439) (2,012)
Proceeds from borrowings.................................. 16,500 54,264 73,843
Payments on debt.......................................... (7,021) (9,543) (3,523)
Distributions to common and preferred shareholders........ (39,931) (38,873) (36,900)
Distributions to limited partners......................... (3,954) (3,879) (3,738)
Redemption of shares/units................................ (22) (37)
Collections on notes receivable........................... 47 65
Loan fees paid............................................ (538) (2,302) (1,487)
-------- -------- ---------
Net cash provided (used) by financing
activities...................................... (36,358) 8,723 28,357
-------- -------- ---------
Net increase (decrease) in cash and cash equivalents........ 3,899 (2,117) (53,804)
Cash and cash equivalents at beginning of years............. 2,014 4,131 57,935
-------- -------- ---------
Cash and cash equivalents at end of years................... $ 5,913 $ 2,014 $ 4,131
======== ======== =========
Supplemental cash flow information:
Cash paid for interest.................................... $ 20,172 $ 16,474 $ 11,811
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OF RFS HOTEL INVESTORS, INC.
NOTE 1. ORGANIZATION
RFS Hotel Investors, Inc. ("RFS" or the "Company") is a hotel real estate
investment trust which, at December 31, 1999, owned interests in 62 hotels with
9,086 rooms located in 24 states (collectively the "Hotels"). RFS owns an
approximate 90.7% interest in RFS Partnership L.P. (the "Operating
Partnership"). RFS, the Operating Partnership, and their subsidiaries are herein
referred to, collectively, as the "Company".
In 1999, the Company received 40% of its lease revenue from full service
hotels, 31% from extended stay hotels and 29% from limited service hotels. The
Company believes that owning a hotel portfolio diversified by brand, market
segment and geography is the best way to get the highest risk-adjusted return on
investment over time.
The following summarizes additional information for the 62 hotels owned at
December 31, 1999:
FRANCHISE AFFILIATION HOTEL PROPERTIES ROOMS/SUITES 1999 LEASE REVENUE
- --------------------- ---------------- ------------ ------------------
(IN THOUSANDS)
Full Service hotels:
Holiday Inn.............................. 5 953 $ 9,844
Sheraton Four Points..................... 2 516 8,681
Sheraton................................. 4 757 7,882
Independent.............................. 2 326 6,705
DoubleTree............................... 1 220 3,587
Ramada Plaza(1).......................... 1 234 2,858
-- ----- -------
15 3,006 39,557
-- ----- -------
Extended Stay hotels:
Residence Inn by Marriott................ 14 1,851 25,267
Hawthorn Suites.......................... 1 280 3,147
TownePlace Suites by Marriott............ 3 285 1,226
Homewood Suites by Hilton................ 1 83 798
-- ----- -------
19 2,499 30,438
-- ----- -------
Limited Service hotels:
Hampton Inn.............................. 19 2,368 18,204
Holiday Inn Express...................... 5 637 6,443
Comfort Inn.............................. 3 474 3,074
Courtyard by Marriott.................... 1 102 1,246
-- ----- -------
28 3,581 28,967
-- ----- -------
Total............................ 62 9,086 $98,962
== ===== =======
- ---------------
(1) To be converted to a Hilton full-service hotel in the second quarter of
2000.
The following summarizes the number of hotels owned for the periods
presented:
1999 1998 1997
---- ---- ----
Hotels owned at beginning of years.......................... 60 60 53
Acquisitions and developed hotels placed into service....... 2 6 10
Sales of hotels............................................. -- (6) (3)
-- -- --
Hotels owned at end of years................................ 62 60 60
== == ==
At December 31, 1999, the Company leased 52 hotels to wholly owned
subsidiaries of Hilton Hotels Corporation ("Hilton"), six hotels to three other
lessees and four hotels were not leased. Fifty-one hotels are
F-6
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OF RFS HOTEL INVESTORS, INC. -- (CONTINUED)
managed by wholly owned subsidiaries of Hilton and 11 hotels are managed by six
other third-party management companies.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The consolidated financial statements include
the accounts of RFS, the Operating Partnership and their consolidated
subsidiaries. All significant intercompany balances and transactions have been
eliminated.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates.
Fair Value of Financial Instruments. The Company reports the carrying
amount of cash and cash equivalents, amounts due from lessees, accounts payable
and accrued expenses at cost, which approximates fair value due to the short
maturity of these instruments. The carrying values of the Company's borrowings
are estimated to be above fair value by approximately $2.8 million due to
changes in comparable interest rates.
Investment in Hotel Properties. Hotel properties are recorded at cost and
are depreciated using the straight-line method over estimated useful lives of 40
years for buildings and improvements and five to seven years for furniture and
equipment. The Company periodically reviews the carrying value of each Hotel to
determine if circumstances exist indicating an impairment in the carrying value
of the investment in the hotel or that depreciation periods should be modified.
If circumstances support the possibility of impairment, the Company will prepare
a projection of the undiscounted future cash flows, without interest charges, of
the specific hotel and determine if the investment in such hotel is recoverable
based on the undiscounted cash flows. If impairment is indicated, an adjustment
will be made to the carrying value of the hotel based on discounted future cash
flows. The Company does not believe that there are any facts or circumstances
indicating impairment of any of its investment in hotel properties.
Cash and Cash Equivalents. All highly liquid investments with a maturity
of three months or less when purchased are considered to be cash equivalents.
Restricted Cash. Restricted cash includes amounts the Company must make
available for the replacement and refurbishment of furniture and equipment and
amounts held in escrow by certain lenders for the payment of taxes and
insurance.
Deferred Expenses. Deferred expenses, consisting of initial fees paid to
franchisors, loan fees and other costs incurred in issuing debt, are recorded at
cost. Amortization of franchise fees is computed using the straight-line method
over the lives of the franchise agreements which range from 10 to 15 years.
Amortization of loan fees and other costs incurred in issuing debt are computed
using the interest method over the maturity period of the related debt.
Accumulated amortization of deferred expenses is $3.8 million and $2.6 million
at December 31, 1999 and 1998, respectively.
Minority Interest in Operating Partnership. Minority interest in the
Operating Partnership represents the limited partners' proportionate share of
the equity in the Operating Partnership. Income is allocated to minority
interest based on the weighted average percentage ownership throughout the year.
Treasury Stock. The Board of Directors approved a stock repurchase program
to buy back up to 3 million shares of common stock on the open market subject to
certain market conditions and other factors. During 1999, the Company
repurchased 136,400 shares of common stock at an average price per share of
$10.44 or $1.5 million.
F-7
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OF RFS HOTEL INVESTORS, INC. -- (CONTINUED)
Income Taxes. The Company has elected to be treated as a REIT under
Sections 856 to 860 of the Internal Revenue Code. Accordingly, no provision for
federal income taxes has been reflected in the consolidated financial
statements.
Earnings and profits, which will determine the taxability of distributions
to shareholders, will differ from net income reported for financial reporting
purposes primarily due to the differences for federal tax purposes in the
estimated useful lives used to compute depreciation. Distributions made in 1999,
1998, and 1997 were considered 100% ordinary income for federal income tax
purposes.
Revenue Recognition. Lease revenue is recognized as income over the lease
term as it becomes receivable from the lessees in accordance with the provisions
of the Percentage Lease agreements. The lessees are in compliance with their
rental obligations under the Percentage Leases.
Basic and Diluted Earnings Per Share. Basic earnings per share is computed
by dividing net income less preferred stock dividends by the weighted average
number of common shares outstanding. Diluted earnings per share is computed by
dividing net income by the weighted average number of common shares and
equivalents outstanding. Common share equivalents represent shares issuable upon
exercise of options and unvested directors and officers restricted stock grants.
For the years ended December 31, 1999, 1998 and 1997, the Company's Series A
Preferred Stock, if converted to common shares, would be antidilutive;
accordingly, the Series A Preferred Stock is not assumed to be converted in the
computation of diluted earnings per share.
Distributions. The Company pays regular quarterly distributions on its
common shares and Units. Additionally, the Company pays regular quarterly
dividends on its Series A Preferred Stock in accordance with its dividend
requirements. The Company's ability to make distributions is dependent upon
receipt of its quarterly distributions from the Operating Partnership.
NOTE 3. INVESTMENT IN HOTEL PROPERTIES
Investment in hotel properties consists of the following at December 31,
1999, and 1998, respectively (in thousands):
1999 1998
-------- --------
Land........................................................ $ 75,135 $ 73,050
Building and improvements................................... 542,931 516,238
Furniture and equipment..................................... 91,445 65,291
Capital improvements program expenditures................... 24,685 28,169
-------- --------
734,196 682,748
Accumulated depreciation.................................... (82,208) (58,018)
-------- --------
$651,988 $624,730
======== ========
Capitalized interest during 1999, 1998, and 1997 was $1.1 million, $1.4
million and $1.0 million, respectively.
F-8
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OF RFS HOTEL INVESTORS, INC. -- (CONTINUED)
NOTE 4. DEBT
The following details the Company's debt outstanding at December 31, 1999
(in thousands):
COLLATERAL NET BOOK VALUE
# OF AT DEC. 31,
BALANCE INTEREST RATE MATURITY HOTELS 1999
-------- ------------- ------------- ---------- --------------
Line of Credit......... $ 98,807 LIBOR + Variable July 2003 32 $290,670
200bp
Mortgage............... 40,508 6.83% Fixed August 2008
Mortgage............... 25,000 7.03% Fixed November 2011 15 142,969
Mortgage............... 94,709 7.83% Fixed December 2008 10 130,326
Mortgage............... 18,815 8.22% Fixed November 2007 1 35,342
Mortgage............... 4,440 3.50% Variable January 2001 1 20,867
-------- --------
$282,279 $620,174
======== ========
The Company increased the availability under its Line of Credit from $100
million to $130 million effective January 2000. The increased Line of Credit
matures on July 30, 2003. The interest rate remained substantially unchanged
ranging from 150 basis points to 225 basis points above LIBOR, depending on the
Company's ratio of total debt (as defined) to its investment in hotel
properties. The interest rate was approximately 7.8% at December 31, 1999. The
Line of Credit is collateralized by first priority mortgages on 16 hotels and
agreements restricting the transfer, pledge or other hypothecation of an
additional 16 hotels (collectively, the "Collateral Pool"). The Company can
obtain a release of the pledge of any hotel in the Collateral Pool if the
Company provides a substitute hotel or reduces the total availability under the
Line of Credit. The Line of Credit contains various covenants including the
maintenance of a minimum net worth, minimum debt coverage and interest coverage
ratios, and total indebtedness and total liabilities limitations. The Company
was not aware of any failure to comply with these covenants at December 31,
1999.
The Company's other borrowings are nonrecourse to the Company and contain
provisions allowing for the substitution of collateral, upon satisfaction of
certain conditions, after the respective loans have been outstanding for
approximately four years. Most of the mortgage borrowings are repayable and
subject to various prepayment penalties, yield maintenance, or defeasance
obligations.
Future scheduled principal payments of debt obligations at December 31,
1999 are as follows (in thousands):
YEAR AMOUNT
- ---- --------
2000........................................................ $ 8,364
2001........................................................ 6,574
2002........................................................ 5,857
2003........................................................ 105,103
2004........................................................ 6,747
Thereafter.................................................. 149,634
--------
$282,279
========
NOTE 5. CAPITAL STOCK
Preferred Stock. The Board of Directors is authorized to provide for the
issuance of up to 5 million shares of Preferred Stock in one or more series, to
establish the number of shares in each series and to fix the designation,
powers, preferences and rights of each such series and the qualifications,
limitations or restrictions thereof.
F-9
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OF RFS HOTEL INVESTORS, INC. -- (CONTINUED)
The Company has issued to one of the lessees 973,684 shares of Series A
Convertible Preferred Stock (the "Series A Preferred Stock"). The Series A
Preferred Stock has an initial preference value of $19.00 per share (the "Stated
Value"), a par value of $0.01, and is senior to the Company's common shares as
to distributions and upon liquidation of the Company. The shares of Series A
Preferred Stock are entitled to a $1.45 cumulative annual dividend per share.
Each share of Series A Preferred Stock has one vote and is convertible into one
share of common stock after February 2002. The shares of Series A Preferred
Stock have mandatory redemption rights upon the occurrence of certain events
which are under the Company's control. The Company can redeem the Series A
Preferred Stock after the seventh anniversary of issuance at the Stated Value,
together with all accrued and unpaid dividends. (See Subsequent Events
footnote).
Operating Partnership Units. RFS is the sole general partner of the
Operating Partnership and is obligated to contribute the net proceeds from any
issuance of its equity securities to the Operating Partnership in exchange for
units of partnership interest ("Units") corresponding in number and terms to the
equity securities issued. Units may also be issued by the Operating Partnership
to third parties in exchange for cash or property, and units so issued to third
parties are redeemable at the option of the holders thereof for a like number of
shares of RFS Common Stock or, at the option of RFS, for the cash equivalent
thereof.
NOTE 6. COMMITMENTS AND CONTINGENCIES
The Company is to receive rental income from the lessees under the
Percentage Leases which expire in 2003 (1 hotel), 2007 (3 hotels), 2008 (9
hotels), 2009 (28 hotels), 2010 (7 hotels), 2011 (5 hotels) and 2012 (5 hotels).
Minimum future rental income (base rents) to the Company under these
noncancelable operating leases at December 31, 1999, is as follows (in
thousands):
YEAR AMOUNT
- ---- --------
2000........................................................ $ 40,237
2001........................................................ 40,237
2002........................................................ 40,237
2003........................................................ 37,425
2004........................................................ 37,425
2005 and thereafter......................................... 180,725
--------
$376,286
========
Lease revenue is based on a percentage of room revenues, food and beverage
revenues and other revenues of the Hotels. Both the base rent and the threshold
room revenue in each lease computation are adjusted annually for changes in the
Consumer Price Index ("CPI"). The adjustment is calculated at the beginning of
each calendar year. The CPI adjustments made in January 1999 and 1998 were 2.3%
and 1.6%, respectively.
The Company has entered into an agreement with one of the lessees which
grants a ten-year right to lease hotel properties acquired or developed by the
Company through February 2006 subject to certain exceptions. Under the January
26, 2000 agreement with Hilton, this right will be terminated if the Company
exercises its right to terminate the 52 leases with Hilton. (See Subsequent
Events footnote).
The Company may terminate any lease agreement with respect to a hotel
property upon the sale of a hotel property in exchange for a termination payment
to the lessee. During 1998, the Company terminated six such leases and incurred
fees of $2.7 million which is included in the loss on sale of hotel properties.
Under the Percentage Leases, the Operating Partnership is obligated to pay
the costs of real estate taxes, property insurance, maintenance of underground
utilities and structural elements of the Hotels, and to set aside a portion of
the Hotels' revenues to fund capital expenditures for the periodic replacement
or
F-10
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OF RFS HOTEL INVESTORS, INC. -- (CONTINUED)
refurbishment of furniture, fixtures and equipment required for the retention of
the franchise licenses with respect to the Hotels.
The Company spent $12.1 million of its budgeted $16.6 million on capital
improvements to its hotels. The Operating Partnership will use cash generated
from operations and borrowings under the Line of Credit to fund the remaining
$4.5 million of expenditures which is expected to be completed by the second
quarter of 2000.
The Company expects to spend approximately $21.3 million on capital
improvements to its hotels in 2000. Additionally, approximately $6.5 million
will be spent in 2000 at the Company's hotel in the Fisherman's Wharf district
of San Francisco, California to convert this hotel from a Ramada Plaza to a
Hilton full service hotel.
NOTE 7. SUPPLEMENTAL CASH FLOW DISCLOSURE
In 1998, the Company assumed $19.2 million of debt in connection with the
purchase of a hotel. In addition, the Company sold two hotels for cash
consideration of $5.4 million and a note receivable of $2.7 million.
In 1997, the Company issued 2.2 million Units valued at approximately $38.2
million in connection with the purchase of four hotels. In a separate hotel
acquisition, the Company assumed debt of $5.5 million.
NOTE 8. STOCK-BASED COMPENSATION PLANS
The Company's Restricted Stock and Stock Option Plan (the "Plan") provides
for the grant of stock options to purchase a specified number of shares of
Common Stock ("Options") and grants of Restricted Shares of Common Stock
("Restricted Stock"). Approximately 2.6 million shares of Common Stock, of which
250,000 shares may be Restricted Stock, are available for awards to the officers
and key employees of the Company and 400,000 shares of Common Stock, of which
50,000 shares may be Restricted Stock, are available for awards to Directors of
the Company who are not officers or employees. Options issued under the plan
have a maximum term of ten years from the date of grant. The exercise price of
the options shall be determined on the date of each grant.
The Company applies APB Opinion No. 25 and related Interpretations in
accounting for the Plan. In 1995, the Financial Accounting Standards Board
issued SFAS Statement No. 123 "Accounting for Stock-Based Compensation" ("SFAS
123") which, if fully adopted by the Company, would change the methods the
Company applies in recognizing the cost of the Plan. Adoption of the cost
recognition provisions of SFAS 123 is optional and the Company has decided not
to adopt the provisions of SFAS 123. However, pro forma disclosures, as if the
Company adopted the cost recognition requirements of SFAS 123, are required by
SFAS 123 and are presented below.
F-11
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OF RFS HOTEL INVESTORS, INC. -- (CONTINUED)
A summary of the Company's stock options under the Plan as of December 31,
1999, 1998 and 1997, and the changes during the years are presented below:
1999 1998 1997
--------------------- --------------------- ---------------------
NUMBER OF WEIGHTED NUMBER OF WEIGHTED NUMBER OF WEIGHTED
SHARES AVERAGE SHARES AVERAGE SHARES AVERAGE
UNDERLYING EXERCISE UNDERLYING EXERCISE UNDERLYING EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
---------- -------- ---------- -------- ---------- --------
Outstanding at beginning of years... 1,090,800 $14.99 1,187,700 $15.92 775,000 $15.90
Granted............................. 600,000 11.99 210,000 11.88 417,700 15.95
Exercised........................... (95,000) 17.00 (5,000) 14.50
Forfeited........................... (207,000) 14.64 (211,900) 16.18
--------- --------- ---------
Outstanding at end of years......... 1,483,800 $13.83 1,090,800 $14.99 1,187,700 $15.92
========= ====== ========= ====== ========= ======
Exercisable at end of years......... 604,266 $15.34 520,000 $15.50 395,000 $15.48
========= ====== ========= ====== ========= ======
Price range of shares under
option............................ $10.50 to $11.87 to $13.50 to
$16.87 $16.87 $18.81
The weighted average remaining contractual life of options outstanding as
of December 31, 1999 is 6.1 years.
The fair value of each option granted is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions: dividend of $1.54; volatility of 29% for 1999 grants, 27% for 1998
grants and 24% for 1997 grants, risk-free interest rate of 5.9% for 1999, 4.6%
for 1998 and 6.2% for 1997 and expected life of 6 years for 1999, 1998 and 1997.
Had compensation cost for the Company's stock-based compensation plans been
determined consistent with SFAS 123, the Company's pro forma net income and net
income per common share for 1999, 1998 and 1997 would have decreased by less
than 1%.
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts.
Restricted Stock. The Company granted 41,000, 129,000, 290,000 shares of
Restricted Stock in 1999, 1998, and 1996 respectively, subject to vesting. At
December 31, 1999, 226,999 shares were vested. The weighted average fair value
per share of the Restricted Stock granted in 1999 and 1998 was $11.25 and
$11.875, respectively.
NOTE 9. SUBSEQUENT EVENTS
On January 2, 2000, the Company declared a distribution of $0.385 on each
share of Common Stock and Unit outstanding to shareholders of record on February
10, 2000 and a $0.3625 dividend on each share of Series A Preferred Stock
outstanding. The dividend was paid on February 15, 2000.
On January 26, 2000, the Company entered into an agreement with Hilton
which gives the Company the right to terminate 52 leases and related ancillary
agreements with Hilton. In the event that the Company elects to exercise this
right, the Company will be required to pay Hilton approximately $60 million, in
cash, at closing. Specifically, in order to exercise its right to terminate the
lease, the Company must notify Hilton on or before November 30, 2000, that the
Company intends to terminate the leases and related agreements and must complete
the termination within 10 days following the date of notice.
F-12
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OF RFS HOTEL INVESTORS, INC. -- (CONTINUED)
In connection with termination of the leases, Hilton may elect, at the
earlier of (i) ten days after receipt of the Company's notice of its intention
to terminate the Leases, or (ii) November 30, 2000, to require the Company to
repurchase the 973,684 shares of the Company's convertible preferred stock that
it currently owns. If the Company elects to terminate the leases, then Hilton
will have the right to require the Company to purchase the Series A Preferred
Stock for $13 million. If the Company elects not to terminate the leases, Hilton
will have the right to require the Company to redeem the Series A Preferred
Stock for $13.75 million. The Company may elect, in its sole discretion, to pay
all or part of the purchase price for the preferred shares in the form of shares
of its Common Stock.
F-13
41
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Shareholders
Our audits of the consolidated financial statements referred to in our
report dated January 21, 2000, except for Note 9 as to which the date is
February 15, 2000, appearing on page F-1 of the 1999 Form 10-K of RFS Hotel
Investors, Inc. also included an audit of the financial statement schedule
listed in Item 14(a) of this Form 10-K. In our opinion, this financial statement
schedule presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial
statements.
PricewaterhouseCoopers LLP
Memphis, Tennessee
January 21, 2000, except for
Note 9 as to which the date is
February 15, 2000
F-14
42
RFS HOTEL INVESTORS, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
COST CAPITALIZED GROSS AMOUNT AT WHICH
SUBSEQUENT TO CARRIED
INITIAL COST ACQUISITION AT END OF PERIOD
---------------------- ------------------- ----------------------
BUILDINGS BUILDINGS BUILDINGS
AND AND AND
DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS LAND IMPROVEMENTS LAND IMPROVEMENTS
- ----------- ------------ ------- ------------ ---- ------------ ------- ------------
(IN THOUSANDS AS OF DECEMBER 31, 1999)
Sheraton Hotel
Clayton, MO............... (1) $ 1,599 $ 4,968 $ 6,136 $ 1,599 $ 11,104
Holiday Inn
Columbia, SC.............. (1) 790 3,573 757 790 4,330
Holiday Inn Express
Louisville, KY............ (1) 1,328 3,808 1,035 1,328 4,843
Comfort Inn
Marietta, GA.............. (2) 989 5,509 142 989 5,651
Holiday Inn
Lafayette, LA............. (1) 700 8,858 843 700 9,701
Residence Inn
Kansas City, MO........... (2) 392 5,344 131 392 5,475
Comfort Inn
Ft. Mill, SC.............. (2) 763 6,612 140 763 6,752
Hampton Inn
Ft. Lauderdale, FL........ (1) 590 4,664 344 590 5,008
Holiday Inn Express
Arlington Heights, IL..... (1) 350 4,121 404 350 4,525
Hampton Inn
Denver, CO................ none 500 8,098 399 500 8,497
Holiday Inn Express
Downers Grove, IL......... (1) 400 5,784 356 400 6,140
Comfort Inn
Farmington Hills, MI...... (2) 525 4,118 270 525 4,388
Hampton Inn
Indianapolis, IN.......... (2) 475 8,008 329 475 8,337
Hampton Inn
Lincoln, NE............... (1) 350 4,829 377 350 5,206
Hampton Inn
Bloomington, MN........... (2) 375 8,657 192 375 8,849
Holiday Inn Express
Bloomington, MN........... (1) 780 6,910 $152 841 932 7,751
Hampton Inn
Minnetonka, MN............ (1) 475 5,066 132 475 5,198
LIFE UPON
ACCUMULATED WHICH
DEPRECIATION NET BOOK DEPRECIATION IN
BUILDINGS VALUE LATEST INCOME
AND BUILDINGS AND DATE OF STATEMENT IS
DESCRIPTION TOTAL IMPROVEMENTS IMPROVEMENTS ACQUISITION CALCULATED
- ----------- -------- ------------ ------------- ----------- ---------------
(IN THOUSANDS AS OF DECEMBER 31, 1999)
Sheraton Hotel
Clayton, MO............... $ 12,703 $ 1,039 $ 10,065 1993 40
Holiday Inn
Columbia, SC.............. 5,120 640 3,690 1993 40
Holiday Inn Express
Louisville, KY............ 6,171 692 4,151 1993 40
Comfort Inn
Marietta, GA.............. 6,640 852 4,799 1993 40
Holiday Inn
Lafayette, LA............. 10,401 1,461 8,240 1993 40
Residence Inn
Kansas City, MO........... 5,867 800 4,675 1994 40
Comfort Inn
Ft. Mill, SC.............. 7,515 962 5,790 1994 40
Hampton Inn
Ft. Lauderdale, FL........ 5,598 688 4,320 1994 40
Holiday Inn Express
Arlington Heights, IL..... 4,875 614 3,911 1994 40
Hampton Inn
Denver, CO................ 8,997 1,159 7,338 1994 40
Holiday Inn Express
Downers Grove, IL......... 6,540 832 5,308 1994 40
Comfort Inn
Farmington Hills, MI...... 4,913 591 3,797 1994 40
Hampton Inn
Indianapolis, IN.......... 8,812 1,142 7,195 1994 40
Hampton Inn
Lincoln, NE............... 5,556 704 4,502 1994 40
Hampton Inn
Bloomington, MN........... 9,224 1,219 7,630 1994 40
Holiday Inn Express
Bloomington, MN........... 8,683 988 6,763 1994 40
Hampton Inn
Minnetonka, MN............ 5,673 716 4,482 1994 40
F-15
43
RFS HOTEL INVESTORS, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION -- (CONTINUED)
COST CAPITALIZED GROSS AMOUNT AT WHICH
SUBSEQUENT TO CARRIED
INITIAL COST ACQUISITION AT END OF PERIOD
---------------------- ------------------- ----------------------
BUILDINGS BUILDINGS BUILDINGS
AND AND AND
DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS LAND IMPROVEMENTS LAND IMPROVEMENTS
- ----------- ------------ ------- ------------ ---- ------------ ------- ------------
(IN THOUSANDS AS OF DECEMBER 31, 1999)
Hampton Inn
Oklahoma City, OK......... (2) $ 530 $ 6,826 $ 452 $ 530 $ 7,278
Hampton Inn
Omaha, NE................. (2) 450 6,362 445 450 6,807
Hampton Inn
Tulsa, OK................. (1) 350 5,715 427 350 6,142
Hampton Inn
Warren, MI................ (1) 500 2,814 249 500 3,063
Holiday Inn Express
Wauwatosa, WI............. (2) 700 4,926 466 700 5,392
Residence Inn
Fishkill, NY.............. (1) 2,280 10,484 200 2,280 10,684
Residence Inn
Providence, RI............ (2) 1,385 7,742 273 1,385 8,015
Residence Inn
Tyler, TX................. (1) 855 6,212 232 855 6,444
Hampton Inn
Memphis, TN............... (2) 980 6,157 67 980 6,224
Residence Inn
Ft. Worth, TX............. (2) 985 10,726 165 985 10,891
Residence Inn
Wilmington, DE............ (1) 1,100 8,488 150 1,100 8,638
Residence Inn
Torrance, CA.............. (1) 2,600 17,789 748 2,600 18,537
Residence Inn
Ann Arbor, MI............. (2) 525 4,461 $227 3,031 752 7,492
Holiday Inn
Flint, MI................. (1) 1,220 11,994 307 1,220 12,301
Residence Inn
Charlotte, NC............. (2) 850 3,844 159 3,074 1,009 6,918
Hawthorn Suites
Atlanta, GA............... (1) 3,000 12,886 1,135 3,000 14,021
Holiday Inn Express
Austin, TX................ (2) 500 4,737 154 500 4,891
LIFE UPON
ACCUMULATED WHICH
DEPRECIATION NET BOOK DEPRECIATION IN
BUILDINGS VALUE LATEST INCOME
AND BUILDINGS AND DATE OF STATEMENT IS
DESCRIPTION TOTAL IMPROVEMENTS IMPROVEMENTS ACQUISITION CALCULATED
- ----------- -------- ------------ ------------- ----------- ---------------
(IN THOUSANDS AS OF DECEMBER 31, 1999)
Hampton Inn
Oklahoma City, OK......... $ 7,808 $ 985 $ 6,293 1994 40
Hampton Inn
Omaha, NE................. 7,257 923 5,884 1994 40
Hampton Inn
Tulsa, OK................. 6,492 835 5,307 1994 40
Hampton Inn
Warren, MI................ 3,563 410 2,653 1994 40
Holiday Inn Express
Wauwatosa, WI............. 6,092 722 4,670 1994 40
Residence Inn
Fishkill, NY.............. 12,964 1,431 9,253 1994 40
Residence Inn
Providence, RI............ 9,400 1,065 6,950 1994 40
Residence Inn
Tyler, TX................. 7,299 859 5,585 1994 40
Hampton Inn
Memphis, TN............... 7,204 813 5,411 1994 40
Residence Inn
Ft. Worth, TX............. 11,876 1,414 9,477 1994 40
Residence Inn
Wilmington, DE............ 9,738 1,152 7,486 1994 40
Residence Inn
Torrance, CA.............. 21,137 2,407 16,130 1994 40
Residence Inn
Ann Arbor, MI............. 8,244 774 6,718 1994 40
Holiday Inn
Flint, MI................. 13,521 1,572 10,729 1994 40
Residence Inn
Charlotte, NC............. 7,927 557 6,361 1994 40
Hawthorn Suites
Atlanta, GA............... 17,021 1,673 12,348 1994 40
Holiday Inn Express
Austin, TX................ 5,391 599 4,292 1995 40
F-16
44
RFS HOTEL INVESTORS, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION -- (CONTINUED)
COST CAPITALIZED GROSS AMOUNT AT WHICH
SUBSEQUENT TO CARRIED
INITIAL COST ACQUISITION AT END OF PERIOD
---------------------- --------------------- ----------------------
BUILDINGS BUILDINGS BUILDINGS
AND AND AND
DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS LAND IMPROVEMENTS LAND IMPROVEMENTS
- ----------- ------------ ------- ------------ ------ ------------ ------- ------------
(IN THOUSANDS AS OF DECEMBER 31, 1999)
Hampton Inn
Lakewood, CO............ (2) $ 957 $ 6,790 $ 110 $ 957 $ 6,900
Hampton Inn
Hattiesburg, MS......... (2) 785 4,653 1,587 785 6,240
Hampton Inn
Laredo, TX.............. (1) 1,037 4,116 2 1,037 4,118
Residence Inn
Atlanta, GA............. (1) 1,306 10,200 352 1,306 10,552
Holiday Inn
Crystal Lake, IL........ (2) 1,685 10,932 (20) 169 1,665 11,101
Residence Inn
Orlando, FL............. (2) 1,045 8,880 230 1,045 9,110
Residence Inn
Sacramento, CA.......... (2) 1,000 13,122 163 1,000 13,285
Doubletree Hotel
Del Mar, CA............. (2) 1,500 13,535 295 126 1,795 13,661
Hampton Inn
Plano, TX............... (1) 959 5,178 22 959 5,200
Courtyard by Marriott
Flint, MI............... (1) 600 4,852 183 600 5,035
Hampton Inn
Sedona, AZ.............. (1) 1,464 3,858 66 1,464 3,924
Hampton Inn
Chandler, AZ............ (1) 485 3,950 0 485 3,950
Hampton Inn
Houston, TX............. (1) 606 4,919 2 606 4,921
Sheraton Hotel
Milpitas, CA............ (2) 5,253 23,169 172 5,253 23,341
Sheraton Four Points
Sunnyvale, CA........... (2) 785 22,401 513 785 22,914
Sheraton Four Points
Pleasanton, CA.......... (2) 1,935 19,251 310 1,935 19,561
Sheraton Four Points
Bakersfield, CA......... (2) 1,390 7,554 253 1,390 7,807
LIFE UPON
ACCUMULATED WHICH
DEPRECIATION NET BOOK DEPRECIATION IN
BUILDINGS VALUE LATEST INCOME
AND BUILDINGS AND DATE OF STATEMENT IS
DESCRIPTION TOTAL IMPROVEMENTS IMPROVEMENTS ACQUISITION CALCULATED
- ----------- -------- ------------ ------------- ----------- ---------------
(IN THOUSANDS AS OF DECEMBER 31, 1999)
Hampton Inn
Lakewood, CO............ $ 7,857 $ 826 $ 6,074 1995 40
Hampton Inn
Hattiesburg, MS......... 7,025 688 5,552 1995 40
Hampton Inn
Laredo, TX.............. 5,155 454 3,664 1995 40
Residence Inn
Atlanta, GA............. 11,858 1,096 9,456 1995 40
Holiday Inn
Crystal Lake, IL........ 12,766 1,168 9,933 1995 40
Residence Inn
Orlando, FL............. 10,155 950 8,160 1995 40
Residence Inn
Sacramento, CA.......... 14,285 1,319 11,966 1996 40
Doubletree Hotel
Del Mar, CA............. 15,456 1,242 12,419 1996 40
Hampton Inn
Plano, TX............... 6,159 454 4,746 1996 40
Courtyard by Marriott
Flint, MI............... 5,635 386 4,649 1996 40
Hampton Inn
Sedona, AZ.............. 5,388 234 3,690 1997 40
Hampton Inn
Chandler, AZ............ 4,435 254 3,696 1997 40
Hampton Inn
Houston, TX............. 5,527 360 4,561 1997 40
Sheraton Hotel
Milpitas, CA............ 28,594 1,740 21,601 1997 40
Sheraton Four Points
Sunnyvale, CA........... 23,699 1,684 21,230 1997 40
Sheraton Four Points
Pleasanton, CA.......... 21,496 1,447 18,114 1997 40
Sheraton Four Points
Bakersfield, CA......... 9,197 569 7,238 1997 40
F-17
45
RFS HOTEL INVESTORS, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION -- (CONTINUED)
COST CAPITALIZED GROSS AMOUNT AT WHICH
SUBSEQUENT TO CARRIED
INITIAL COST ACQUISITION AT END OF PERIOD
---------------------- ------------------- ----------------------
BUILDINGS BUILDINGS BUILDINGS
AND AND AND
DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS LAND IMPROVEMENTS LAND IMPROVEMENTS
- ----------- ------------ ------- ------------ ---- ------------ ------- ------------
(IN THOUSANDS AS OF DECEMBER 31, 1999)
Beverly Heritage
Milpitas, CA.............. (1) $ 5,250 $ 25,118 $ 4,057 $ 5,250 $ 29,175
Sheraton Hotel
Birmingham, AL............ $4,440 3,108 13,491 $ (5) 3 3,103 13,494
Residence Inn
Jacksonville, FL.......... (1) 1,339 4,990 (3) 1,339 4,987
Residence Inn
West Palm Beach, FL....... (1) 1,293 4,025 1,293 4,025
Hampton Inn
Jacksonville, FL.......... (1) 1,047 4,375 1,047 4,375
Homewood Suites
Chandler, AZ.............. (1) 485 4,601 3 485 4,604
Hotel Rex
San Francisco, CA......... none 3,000 11,039 20 3,000 11,059
Ramada Inn
San Francisco, CA......... $18,815 3,007 28,308 120 3,007 28,428
TownePlace Suites
Ft. Worth, TX............. (1) 753 4,721 47 753 4,768
TownePlace Suites
Miami, FL................. (1) 914 5,187 914 5,186
TownePlace Suites
Miami (West), FL.......... none 836 5,210 60 896 5,209
Unimproved land
Crystal Lake, IL.......... none 252 508 252 508
------- -------- ---- ------- ------- --------
Totals.............. $74,267 $509,515 $868 $33,418 $75,135 $542,931
======= ======== ==== ======= ======= ========
LIFE UPON
ACCUMULATED WHICH
DEPRECIATION NET BOOK DEPRECIATION IN
BUILDINGS VALUE LATEST INCOME
AND BUILDINGS AND DATE OF STATEMENT IS
DESCRIPTION TOTAL IMPROVEMENTS IMPROVEMENTS ACQUISITION CALCULATED
- ----------- -------- ------------ ------------- ----------- ---------------
(IN THOUSANDS AS OF DECEMBER 31, 1999)
Beverly Heritage
Milpitas, CA.............. $ 34,425 $ 1,626 $ 27,549 1997 40
Sheraton Hotel
Birmingham, AL............ 16,597 759 12,735 1997 40
Residence Inn
Jacksonville, FL.......... 6,326 271 4,716 1997 40
Residence Inn
West Palm Beach, FL....... 5,318 184 3,841 1998 40
Hampton Inn
Jacksonville, FL.......... 5,422 200 4,175 1998 40
Homewood Suites
Chandler, AZ.............. 5,089 199 4,405 1998 40
Hotel Rex
San Francisco, CA......... 14,059 460 10,599 1998 40
Ramada Inn
San Francisco, CA......... 31,435 1,050 27,378 1998 40
TownePlace Suites
Ft. Worth, TX............. 5,521 119 4,649 1998 40
TownePlace Suites
Miami, FL................. 6,100 74 5,112 1997 40
TownePlace Suites
Miami (West), FL.......... 6,105 21 5,188 1997 40
Unimproved land
Crystal Lake, IL.......... 760 508 1995 n/a
-------- ------- --------
Totals.............. $618,066 $53,124 $489,807
======== ======= ========
- ---------------
(1) Property is collateral for the Line of Credit.
(2) Property is collateral for long-term, fixed rate debt.
F-18
46
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1999 AND 1998 AND FOR
THE PERIOD NOVEMBER 30, 1999 THROUGH DECEMBER 31, 1999, AND FOR
THE PERIOD JANUARY 1, 1999 THROUGH NOVEMBER 29, 1999,
AND FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
TOGETHER WITH AUDITORS' REPORT
F-19
47
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholder
of RFS, Inc. and Subsidiary:
We have audited the accompanying consolidated balance sheets of RFS, INC.
AND SUBSIDIARY (a wholly-owned subsidiary of Hilton Hotels Corporation, the
"Company") as of December 31, 1999 and 1998, the related consolidated statements
of operations, stockholder's equity and cash flows for the period November 30,
1999 through December 31, 1999, the period January 1, 1999 through November 29,
1999 (Predecessor Company) and the year ended December 31, 1998 (Predecessor
Company). 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 financial statements of the Company for the
year ended December 31, 1997, were audited by other auditors, whose report dated
January 23, 1998, expressed an unqualified opinion on those statements.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of RFS, Inc. and Subsidiary as
of December 31, 1999 and 1998, and the results of their operations and their
cash flows for the period November 30, 1999 through December 31, 1999, the
period January 1, 1999 through November 29, 1999 (Predecessor Company) and the
year ended December 31, 1998 (Predecessor Company), in conformity with
accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Memphis, Tennessee
February 4, 2000
F-20
48
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31
PREDECESSOR
COMPANY
1999 1998
----------- --------------
(IN THOUSANDS EXCEPT SHARE DATA)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 5,265 $ 3,986
Trade receivables, net of estimated uncollectible accounts
of $93 for 1999 and $80 for 1998....................... 4,675 6,854
Inventory................................................. 229 203
Prepaid expenses.......................................... 909 1,094
Due from Parent........................................... 34,376 24,883
-------- -------
Total current assets.............................. 45,454 37,020
INVESTMENTS................................................. 12,055 19,964
NOTE RECEIVABLE............................................. -- 1,529
LEASEHOLD IMPROVEMENTS AND OFFICE
EQUIPMENT, net of accumulated depreciation of $748 for
1999 and $616 for 1998................................. 598 253
CAPITALIZED FRANCHISE AND LEASE VALUATION
COSTS, net of accumulated amortization of $1,182 for 1999
and $617 for 1998...................................... 54,167 2,032
DEFERRED COSTS AND OTHER ASSETS, net........................ 429 720
-------- -------
Total assets...................................... $112,703 $61,518
======== =======
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses..................... $ 8,689 $ 7,576
Percentage lease payable.................................. 9,438 9,425
-------- -------
Total current liabilities......................... 18,127 17,001
DEFERRED INCOME TAXES....................................... 17,826 442
COMMITMENTS AND CONTINGENCIES
STOCKHOLDER'S EQUITY:
Common stock, no par value; 5,000 shares authorized; 100
shares issued and outstanding.......................... 282 282
Additional paid-in capital................................ 76,586 18,500
Accumulated other comprehensive income, net of income
taxes.................................................. (24) (54)
Retained earnings (deficit)............................... (94) 25,347
-------- -------
Total stockholder's equity........................ 76,750 44,075
-------- -------
Total liabilities and stockholder's equity........ $112,703 $61,518
======== =======
The accompanying notes are an integral part of these consolidated balance
sheets.
F-21
49
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
CONSOLIDATED STATEMENTS OF OPERATIONS
PREDECESSOR COMPANY
-------------------------------------
JANUARY 1, 1999 YEARS ENDED
NOVEMBER 30, 1999 THROUGH DECEMBER 31,
THROUGH NOVEMBER 29, -------------------
DECEMBER 31, 1999 1999 1998 1997
----------------- --------------- -------- --------
(IN THOUSANDS)
REVENUES:
Hotel revenue.............................. $12,503 $180,494 $196,749 $193,282
Management and consulting fees............. 50 519 1,267 1,611
Other...................................... 168 1,644 5,061 1,868
------- -------- -------- --------
Total revenues..................... 12,721 182,657 203,077 196,761
------- -------- -------- --------
COSTS AND EXPENSES:
Hotel expenses:
Salaries and benefits................... 3,556 39,338 42,790 43,173
Franchise costs......................... 951 13,265 13,874 13,183
Advertising and promotions.............. 233 2,631 3,075 3,199
Utilities............................... 549 7,052 7,962 8,368
Repairs and maintenance................. 324 3,705 4,159 4,240
Leases, insurance and taxes............. 140 1,287 1,331 1,317
Other operating costs................... 1,953 24,037 25,515 24,518
------- -------- -------- --------
7,706 91,315 98,706 97,998
General and administrative................. 276 4,356 4,027 3,972
Depreciation and amortization.............. 451 360 554 460
Percentage lease expense................... 4,442 77,865 83,550 80,049
------- -------- -------- --------
Total operating expenses........... 12,875 173,896 186,837 182,479
------- -------- -------- --------
Income (loss) before income taxes.......... (154) 8,761 16,240 14,282
Income taxes (benefit)..................... (60) 3,417 6,343 5,470
------- -------- -------- --------
Net income (loss).................. $ (94) $ 5,344 $ 9,897 $ 8,812
======= ======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-22
50
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
STATEMENTS OF STOCKHOLDER'S EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
ACCUMULATED
ADDITIONAL UNEARNED OTHER RETAINED
COMPREHENSIVE COMMON PAID-IN EMPLOYEE COMPREHENSIVE EARNINGS
INCOME STOCK CAPITAL COMPENSATION INCOME (DEFICIT) TOTAL
------------- ------ ---------- ------------ ------------- --------- -------
(IN THOUSANDS)
Balances, December 31, 1996
(Predecessor Company)............ $6,760 $282 $18,500 $(141) $114 $ 6,638 $25,393
======
Amortization of unearned employee
compensation................... -- -- 71 -- -- 71
Comprehensive income -- 1997
Net income..................... $8,812 -- -- -- -- 8,812 8,812
Other comprehensive income, net
of tax:
Change in unrealized gain on
marketable equity
securities, net of tax
benefit of $0.............. (2) -- -- -- (2) -- (2)
------ ---- ------- ----- ---- -------- -------
Balances, December 31, 1997
(Predecessor Company)............ $8,810 282 18,500 (70) 112 15,450 34,274
======
Amortization of unearned employee
compensation................... -- -- 70 -- -- 70
Comprehensive income -- 1998
Net income..................... $9,897 -- -- -- -- 9,897 9,897
Other comprehensive income, net
of tax:
Change in unrealized gain on
marketable equity
securities, net of tax
benefit of $(104).......... (166) -- -- -- (166) -- (166)
------ ---- ------- ----- ---- -------- -------
Balances, December 31, 1998
(Predecessor Company)............ $9,731 282 18,500 -- (54) 25,347 44,075
======
Comprehensive income -- 1999
Net income -- January 1, 1999
through November 29, 1999.... $5,344 -- -- -- -- 5,344 5,344
Other comprehensive income, net
of tax:
Change in unrealized gain on
marketable equity
securities, net of tax
benefit of $(26)........... (39) -- -- -- (39) -- (39)
------ ---- ------- ----- ---- -------- -------
Balances, November 29, 1999
(Predecessor Company)............ $5,305 282 18,500 -- (93) 30,691 49,380
======
Net adjustments of recording
assets and liabilities to fair
value due to Hilton Hotels
Corporation acquisition of RFS,
Inc............................ -- -- 58,086 -- 93 (30,691) 27,488
Comprehensive income -- 1999
Net income -- November 30, 1999
through December 31, 1999.... (94) -- -- -- -- (94) (94)
Other comprehensive income, net
of tax:
Change in unrealized gain on
marketable equity
securities, net of tax
benefit of $(16)........... (24) -- -- -- (24) -- (24)
------ ---- ------- ----- ---- -------- -------
Balances, December 31, 1999........ $ (118) $282 $76,586 $ -- $(24) $ (94) $76,750
====== ==== ======= ===== ==== ======== =======
The accompanying notes are an integral part of these consolidated financial
statements.
F-23
51
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
PREDECESSOR COMPANY
---------------------------------------
YEARS ENDED
NOVEMBER 30, 1999 JANUARY 1, 1999 DECEMBER 31,
THROUGH THROUGH -------------------
DECEMBER 31, 1999 NOVEMBER 29, 1999 1998 1997
----------------- ----------------- -------- --------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)....................... $ (94) $5,344 $ 9,897 $ 8,812
Adjustments to reconcile net income to
net cash (used in) provided by
operating activities:
Depreciation and amortization........ 451 360 554 460
Equity in (earnings) losses of
unconsolidated affiliates.......... -- 222 (509) --
Changes in working capital due to:
Accounts receivable.................. 1,358 821 (2,554) (620)
Inventory............................ (1) (25) 3 (13)
Prepaid expenses..................... 116 69 (151) (556)
Due from parent...................... (5,744) (2,220) (11,316) (11,818)
Deferred costs and other assets...... (379) 289 (530) (168)
Accounts payable and accrued
expenses........................... (718) 1,831 329 371
Percentage lease payable............. 1,642 (1,629) 524 2,126
Deferred income taxes................ 189 2 476 --
Net cash (used in) provided by
operating activities.......... (3,180) 5,064 (3,277) (1,406)
------- ------ -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of furniture and equipment.... (85) (520) (59) (78)
Collection of loans to owners of managed
hotels............................... -- -- -- 1,471
------- ------ -------- --------
Net cash (used in) provided by
investing activities.......... (85) (520) (59) 1,393
------- ------ -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable............... -- -- -- (325)
------- ------ -------- --------
Net (decrease) increase in cash
and cash equivalents.......... (3,265) 4,544 (3,336) (338)
CASH AND CASH EQUIVALENTS:
Beginning of period..................... 8,530 3,986 7,322 7,660
------- ------ -------- --------
End of period........................... $ 5,265 $8,530 $ 3,986 $ 7,322
======= ====== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
F-24
52
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. ORGANIZATION AND PRESENTATION
On November 30, 1999, Hilton Hotels Corporation ("Hilton" or "Parent")
purchased RFS, Inc. (the "Company" or "RFS") through its acquisition of Promus
Hotel Corporation ("Promus"). The acquisition of Promus by Hilton was accounted
for as a purchase, and as such, the assets and liabilities of Promus were
required to be restated to reflect the estimated fair value at the acquisition
date. The assets and liabilities of RFS as presented in the accompanying
financial statements were also required to be restated to reflect the estimated
fair value at the acquisition date. Hilton management has made a preliminary
allocation of the estimated fair value of the RFS assets and liabilities in the
accompanying financial statements. The assets and liabilities of RFS may be
subject to additional adjustments if better estimates of fair value become
available. Due to a lack of comparability, the accompanying financial statements
have been presented in a format detailing the historical results of the Company
prior to the Hilton acquisition and includes the effects of the acquisition
since November 30, 1999.
Promus purchased RFS on December 19, 1997, pursuant to its acquisition of
Doubletree Corporation ("Doubletree") in a transaction accounted for as a
pooling of interests. Doubletree had originally purchased the Company on
February 27, 1996.
The Company generates substantially all of its revenue from operating and
managing leased hotels owned by RFS Partnership, L.P. (the "Partnership"). The
Partnership is 90.5% owned by RFS Hotel Investors, Inc. (the "REIT"). The
Company's wholly-owned subsidiary, RFS Leasing, Inc., leases and manages 15
hotels owned by RFS Financing Partnership, L.P., a special purpose entity
wholly-owned by RFS Hotel Investors, Inc.
Substantially all of the hotels owned by the Partnership (the "Hotels") are
separately leased by the Partnership to the Company under individual lease
agreements (collectively, the "Percentage Leases"). The Percentage Leases
provide for the payment of annual rent equal to the greater of (i) fixed base
rent or (ii) percentage rent based on a percentage of gross room revenue, food
revenue and beverage revenue at the Hotels. In connection with the merger with
Doubletree, the Company amended each of the individual Percentage Leases. The
significant amendments include extending the terms of the leases, clarifying the
Company's and the Partnership's responsibilities with respect to repairs and
maintenance at the hotels and clarifying certain other provisions of the
Percentage Leases. These provisions include the Partnership granting the Company
a 10-year right of first refusal to manage and lease future hotels acquired or
developed by the Partnership.
At December 31, 1999, the Company leased 51 hotels from the Partnership and
operated 66 hotels. Four hotels leased by the Company are operated by other
third party management companies. Two of the hotels operated by the Company are
for unrelated entities. The Company leases and/or manages hotel properties in 27
states, primarily in the Southeast and Midwest and substantially all are
affiliated with a nationally recognized franchise.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents for purposes of the
statement of cash flows.
F-25
53
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Inventories
Inventories consisting of food and beverages are stated at the lower of
cost (generally first-in, first-out) or market.
Receivable with Parent
The Company maintains an intercompany balance with its Parent based on
available cash flows. This balance is due on demand and is non-interest bearing.
Investments
Investments in partnerships and joint ventures are accounted for using the
equity method when the Company has a general partnership interest or its limited
partnership interest exceeds 5% and the Company does not exercise control over
the venture. Preferred stock investments are accounted for using the cost
method, except for the restated value of the REIT convertible preferred stock on
November 30, 1999, to reflect estimated fair value, as discussed in Note 3.
Marketable equity securities are classified as available-for-sale and recorded
at fair value with unrealized gains or losses reflected in stockholder's equity.
Leasehold Improvements and Office Equipment
Maintenance and repairs are charged to operations as incurred; major
renewals and betterments at the hotels are the responsibility of the
Partnership.
Improvements to office leaseholds are amortized over the shorter of the
lives of the assets or the terms of the related leases. Office furniture and
equipment is depreciated using the straight-line basis over their estimated
useful lives, which is seven years for furniture and five years for equipment.
Capitalized Franchise and Lease Valuation Costs
Prior to Hilton's acquisition of the Company, RFS had recorded certain
franchise application fees in conjunction with obtaining franchise licenses. In
conjunction with Hilton's purchase of Promus, the Company recorded $52,723,000
related to lease valuation costs, which represents the estimated fair value of
the RFS hotel leases. These costs are being amortized over the estimated useful
lives of the franchise and lease agreements. The recoverability of these costs
is periodically evaluated to determine whether such costs will be realized from
future operations.
The initial cost of obtaining any new franchise licenses is paid by the
Partnership, and the ongoing franchise fees are paid by the Company. These fees
are usually computed as a percentage of room revenue in accordance with each
hotel's franchise agreements and are expensed as incurred.
Revenue Recognition
Revenue is recognized as earned. Ongoing credit evaluations are performed
and an allowance for potential credit losses is provided against the portion of
accounts receivable which is estimated to be uncollectible.
Percentage Lease Expenses
Lease expense is recognized as due to the Partnership under the Percentage
Leases commencing on the date a lease is executed between the Partnership and
the Company.
F-26
54
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Income Taxes
Under the asset and liability method of accounting for income taxes,
deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets, including net operating loss carryforwards,
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates in effect for the year in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period when the new rate is enacted.
Hilton files a consolidated federal income tax return. As such, the
intercompany settlement of taxes paid is based on an informal tax sharing
agreement which allocates taxes to the Company based upon a proportionate
allocation of Hilton's consolidated current and deferred income tax.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
Supplemental Disclosure of Non-Cash Activities
The following items represented non-cash activities of RFS (in thousands):
YEARS ENDED
NOVEMBER 30, 1999 JANUARY 1, 1999 DECEMBER 31,
THROUGH THROUGH -----------------
DECEMBER 31, 1999 NOVEMBER 29, 1999 1998 1997
----------------- ----------------- ------- -------
Lease valuation costs recorded as an
increase in additional paid-in
capital........................... $52,723 $ -- $ -- $ --
======= ====== ======= =======
Decrease in the fair value of REIT
preferred stock recorded as a
reduction of additional paid-in
capital........................... $ 7,662 $ -- $ -- $ --
======= ====== ======= =======
Net deferred income taxes recorded
as a reduction of additional
paid-in capital................... $17,573 $ -- $ -- $ --
======= ====== ======= =======
Note receivable assigned to Parent
and recorded as an increase in Due
from Parent....................... $ -- $1,529 $ -- $ --
======= ====== ======= =======
Recent Accounting Pronouncements
During 1998, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 130, "Reporting on Comprehensive Income." This
statement establishes standards for reporting and display of comprehensive
income and its components in a financial statement that is displayed with the
same
F-27
55
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
prominence as other financial statements. The change in the components of other
comprehensive income is reported net of income taxes in the accompanying
financial statements. Accumulated other comprehensive income is comprised solely
of unrealized gains and losses on marketable equity securities.
3. INVESTMENTS
Investments in RFS Hotel Investors, Inc.
At December 31, the Company has the following investments in the REIT, the
Partnership and other investments (in thousands):
1999 1998
------- -------
RFS HOTEL INVESTORS, INC.
Series A Convertible Preferred Stock...................... $10,837 $18,500
Common Stock.............................................. 366 429
RFS PARTNERSHIP, L.P. -- PARTNERSHIP UNITS.................. 841 841
Other....................................................... 11 194
------- -------
$12,055 $19,964
======= =======
On February 27, 1996, the Company bought from the REIT 973,684 shares of
Series A Convertible Preferred Stock ("Preferred Stock") for $18,500,000 or
$19.00 per share. The Preferred Stock has an initial preference value of $19.00
per share ("Stated Value"), a par value of $.01, and is senior to the REIT's
common stock as to dividends and upon liquidation of the REIT. Each share based
on Preferred Stock has one vote and is convertible into one share of the REIT's
common stock after the seventh anniversary of issuance. The owners of the
Preferred Stock are entitled to a $1.45 annual cumulative dividend per share.
The Preferred Stock has mandatory redemption rights upon the occurrence of
certain events which are under the REIT's control. The REIT can redeem the
Series A Preferred Stock after the seventh anniversary of issuance at the Stated
Value, together with all accrued and unpaid dividends. In conjunction with
Hilton's acquisition of RFS, the Preferred Stock was revalued at the market
value of the REIT's common stock at the acquisition date.
The Company's investment in the Partnership units is carried at cost, which
is approximately $841,000 on 77,904 units owned. At present, there is no quoted
market for the Partnership units. However, the Partnership units are convertible
into REIT common stock. The Company also owns 35,000 shares of REIT common
stock, which is carried at quoted market value.
4. NOTE RECEIVABLE
In June 1996, the Company obtained management agreements for eight hotel
properties owned by entities unrelated to the Company. In connection with
acquiring these contracts, the Company loaned $3,000,000 to the owners through
an unsecured promissory note with interest at 10% per annum. During 1996, the
note receivable was reduced by approximately $1,500,000 primarily from proceeds
of new debt financing and two hotel property sales by the owners.
On September 15, 1998, the owners of the hotels effectively terminated
their management agreement with the Company. Pursuant to the note agreement,
upon termination of the Company as manager of the hotels, the remaining
principal balance with unpaid interest was due within one year from the date of
termination. The Company subsequently assigned this note to its Parent.
F-28
56
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. PREFERRED AND COMMON STOCK
In connection with the Company's acquisition by Doubletree, the Company
retired all of its then outstanding common stock and issued 100 new shares of
common stock to Doubletree. In addition, Doubletree made an $18,500,000 capital
contribution to the Company. The proceeds from this capital contribution were
used by the Company to purchase the Preferred Stock issued by the REIT, as
discussed in Note 3.
6. INCOME TAXES
Effective December 19, 1997, the Company's results of operations were
included in Promus' consolidated U.S. Federal income tax return. Hilton has also
continued the practice of including the Company's results of operations in its
consolidated U.S. Federal income tax return. Prior to then, income taxes were
the responsibility of the Company. Under the terms of a tax sharing agreement,
the Company makes payments to its Parent for a proportionate allocation of its
consolidated income tax expense based on statutory tax rates then in effect. The
Company's deferred tax liabilities are primarily comprised of temporary
differences related to lease valuation costs and investments in joint ventures.
Income tax expense (deficit) attributable to income consisted of the
following (in thousands):
YEARS ENDED
NOVEMBER 30, 1999 JANUARY 1, 1999 DECEMBER 31,
THROUGH THROUGH ---------------
DECEMBER 31, 1999 NOVEMBER 29,1999 1998 1997
----------------- ----------------- ------ ------
Current
Federal............................. $(223) $3,051 $5,222 $4,999
State............................... (26) 364 645 471
Deferred
Federal............................. 169 2 424 --
State............................... 20 -- 52 --
----- ------ ------ ------
$ (60) $3,417 $6,343 $5,470
===== ====== ====== ======
YEARS ENDED
NOVEMBER 30, 1999 JANUARY 1, 1999 DECEMBER 31,
THROUGH THROUGH ------------
DECEMBER 31, 1999 NOVEMBER 29, 1999 1998 1997
----------------- ----------------- ---- ----
Income tax expense (benefit) at federal
statutory rate........................ (35.0)% 35.0% 35.0% 35.0%
State taxes, net of federal tax
benefit............................... (4.0) 4.0 4.1 3.3
----- ---- ---- ----
(39.0)% 39.0% 39.1% 38.3%
===== ==== ==== ====
The Company remitted $3,417,000, $6,343,000 and $5,470,000 to Promus for
income tax payments for the period January 1, 1999 through November 29, 1999 and
the years ended December 31, 1998 and 1997, respectively. No income tax payments
were made to Hilton for the period November 30, 1999 through December 31, 1999.
F-29
57
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. COMMITMENTS AND CONTINGENCIES
The Company leases office space and equipment under noncancelable operating
lease agreements expiring at varying intervals through 2002. The future minimum
rental payments required under these leases at December 31, 1999, were as
follows (in thousands):
YEAR AMOUNT
- ---- ------
2000........................................................ $270
2001........................................................ 247
2002........................................................ 62
----
$579
====
Rental expense, except for the lease expense described below, was
approximately $312,000 for the years ended December 31, 1999, and $301,000 for
the years ended December 31, 1998 and 1997.
The Company has future lease commitments to the Partnership under
percentage leases through 2014. At December 31, 1999, minimum future rental
payments under percentage leases were as follows (in thousands):
YEAR AMOUNT
- ---- --------
2000........................................................ $ 32,699
2001........................................................ 32,699
2002........................................................ 32,699
2003........................................................ 32,699
2004........................................................ 32,699
Thereafter.................................................. 173,962
--------
$337,457
========
The Company paid base rents of approximately $2,729,000, $30,019,000,
$33,665,000 and $34,956,000 and percentage rents in excess of base rents of
approximately $1,713,000, $47,846,000, $49,885,000 and $45,093,000 for the
period November 30, 1999 through December 31, 1999, the period January 1, 1999
through November 29, 1999, and the years ended December 31, 1998 and 1997,
respectively. At December 31, 1999 and 1998, the Company had a net payable to
the Partnership of $9,438,000 and $9,425,000, respectively, principally for
percentage rents. The Company has management agreements with two hotel operators
to manage four of the leased hotels. The management agreements have terms
ranging from 10 to 20 years and provide for a fee based on a percentage of each
hotel's revenue.
8. RELATED PARTY TRANSACTIONS
The Company has an intercompany receivable from its Parent subject to an
informal agreement where excess cash of the Company is transferred to the
Parent. No interest is earned on this receivable.
Certain of the partnerships in which the Company has an interest and
certain former stockholders owed the Company approximately $321,000 for advances
and other transactions at December 31, 1999 and 1998.
The Company has recognized, as income, approximately $164,000, $1,422,000,
$1,529,000 and $1,564,000 of distributions received from the Partnership with
respect to the Preferred Stock, Partnership units and REIT common stock owned by
the Company for the period November 30, 1999 through December 31, 1999, the
period January 1, 1999 through November 29, 1999, and the years ended December
31, 1998 and 1997, respectively.
F-30
58
RFS, INC. AND SUBSIDIARY
(A WHOLLY-OWNED SUBSIDIARY OF HILTON HOTELS CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
9. EMPLOYEE BENEFIT PLANS
The Company maintains an employee savings plan under Section 401(k) of the
Internal Revenue Code. This plan covers all full-time employees of the Company
who are 21 years of age and have completed at least one year of continuous
service. The participants' maximum contributions are limited under applicable
IRS regulations. The Company currently matches 50% of employee contributions to
the plan, up to a maximum of 2% of employee compensation. Prior to January 1,
1999, vesting in the employer contribution account was graduated over a seven
year period. Effective January 1, 1999, vesting in the employer contribution
account is graduated over a three year period. Contribution expense related to
this plan was approximately $15,000, $79,000, $139,000 and $151,000 for the
period November 30, 1999 through December 31, 1999, the period January 1, 1999
through November 29, 1999, and the years ended December 31, 1998 and 1997,
respectively.
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About
Fair Value of Financial Instruments," defines the fair value of a financial
instrument as the amount at which the instrument could be exchanged in a current
transaction between willing parties. The Company's financial instruments consist
primarily of cash and cash equivalents, trade receivables, note receivable, due
from Parent, investments in the REIT, investments in partnerships and ventures,
accounts payable and accrued expenses and Percentage Lease payable, each as
included in the balance sheets under such captions.
The carrying amounts of these financial instruments approximate fair value
due to the short maturity of those instruments or, in the case of marketable
equity securities, are carried at their estimated fair value.
11. YEAR 2000
The Company has noted no significant operational problems associated with
Year 2000 issues. The total cost to the Company for Year 2000 testing and
modifications was approximately $582,000.
12. LITIGATION CONTINGENCY
The Company has been named in a lawsuit by a former owner of a certain
hotel that was under management. The lawsuit asserts damages in the amount of
$350,000 plus attorney fees. The Company intends to vigorously defend this
claim. Due to the uncertainty of this lawsuit, no amounts related to this
contingency have been recorded in the accompanying financial statements.
13. SUBSEQUENT EVENT
On February 6, 2000, the Company entered into a lease termination agreement
("Agreement") with the REIT. The Agreement is contingent upon the REIT obtaining
the necessary capital to facilitate the termination. In conjunction with the
termination, the REIT will be required to make a termination payment to Hilton
of approximately $59,500,000, and Hilton has the unilateral option of requiring
the REIT to repurchase the Preferred Stock for $13,000,000, which may be settled
by either cash or common stock of the REIT. Management expects the transaction
to close by January 2001.
F-31