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CHOICE HOTELS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
5. Investment in Friendly Hotels
As of December 31, 2001, the Company had 1,227,622 shares of common stock and 31,097,755 shares of
5.75% convertible preferred stock in Friendly Hotels PLC (currently known as C.H.E. Group PLC) (“CHE” or “Friendly”), the Company’s master franchisor for the Comfort Inn, Quality and Clarion brand hotels in the United Kingdom, Ireland and throughout Europe (with the exception of Scandinavia). Friendly’s master franchise rights expire in January 2008 subject to certain renewal rights of CHE.
Until March 2002, the Company appointed three directors to the board of Friendly giving the Company the ability to exercise significant influence over the operations of Friendly. Accordingly, the Company was required to apply the equity method of accounting.
In exchange for granting the master franchise rights to Friendly, the Company received Friendly common stock and was to receive $8.0 million payable in cash in eight equal annual installments from Friendly.
On January 19, 2001, the shareholders of Friendly approved a capital reorganization intended to provide Friendly with a stronger balance sheet and to improve its operations. Pursuant to the capital reorganization, the Company waived certain royalty and marketing fees due from Friendly for the period between December 27, 1999 and December 31, 2005, waived the then five remaining annual installments related to the master franchise agreement and provided Friendly with a £7.8 million (approximately US $11.4 million) secured letter of credit in consideration for, among other things, a reduction in the conversion price of the convertible preferred shares held by the Company from 150p to 60p. The letter of credit was secured by substantially all of Friendly’s assets in France, valued in excess of £4.2 million (approximately US $6.1 million). Other modifications to the convertible preferred shares included a change in the dividend rate from 5.75% (payable in cash) to 2% per annum, (payable in additional convertible preferred shares). Friendly was also permitted to elect to pay cash dividends at the rate of 3.5% per annum up until January 13, 2013 and thereafter at the rate of 5.75%. In addition, accrued dividends due to the Company as of February 7, 2001 were converted to additional convertible preferred shares of Friendly. As of December 31, 2001, Friendly had drawn £5.3 million (approximately US $7.7 million) of the available letter of credit and the balance available on the letter of credit was reduced to £5.0 million (approximately US $7.3 million) as of January 21, 2002. The letter of credit was terminated on January 28, 2003.
During 2001, Friendly settled a $4.0 million deferred consideration due to the Company through the issuance of 2,404,013 convertible preferred shares. The effect of the reduction in the conversion price together with the conversion of dividend arrearage to additional convertible preferred shares of Friendly and the settlement of the deferred consideration, both resulting in the issuance of convertible preferred shares, on a fully converted basis, the Company’s ownership in Friendly would have been approximately 71%. Due to Friendly’s restructuring, the Company recorded equity losses on Friendly of $16.4 million for the year ended December 31, 2001 in accordance with EITF 99-10, “Percentage Used to Determine the Amount of Equity Method Losses.” Adverse fixed asset valuation adjustments due to a decline in economic conditions and incremental professional fees associated with the reorganization primarily account for the $16.4 million charge in 2001.
The Company waived its royalty fees from Friendly for the periods from 2001 through 2005 as part of Friendly’s restructuring. No dividends were accrued during 2001.
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