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15
more "costly" conversion privileges customarily
offered in order to hold down interest rates in connection with conventional junior financing. Dilution of
the common stock equity resulting from the sale of
"convertibles" can be far more burdensome to a
growth company than would be an increase in "if
earned" tax deductible interest requirements.
Profit margins have also been affected to some
degree by certain changes in Company policy. There
has, for instance, been a trend to new construction.
This procedure often involves a delay of several years
before adequate earnings are achieved. We estimate
that a new 500-room hotel must attract the patronage
of some 24,000 individuals one or more times a year in
order to achieve a satisfactory level of occupancy. We
expect, of course, to more than recover in future years
for any initial sacrifice required while a new hotel is
under construction and while we are building up a
customer following. During the past five years Sheraton undertook some 50 million dollars of new construction. Had Sheraton during these years been able
to create an "interest credit for properties under construction," a procedure commonly used in the public
utility industry, substantial improvements in reported
earnings could have been reported.
The new Philadelphia Sheraton was opened early
in 1957. The following illustrates the progress of a
major new downtown hotel able to benefit from the
advantages of large scale multiple operation.
1958 1959 1960 1961
Basic Earnings $1,639,000 $1,618,000 $1,750,000 $1,928,000
Reported Pre-Tax Earnings —303,000 —155,000 157,000 488,000
Seven other new Sheraton hotel projects have been
completed since the opening of the Philadelphia Sheraton four years ago. Unlike the Philadelphia Sheraton
Hotel, most of these properties have been subject to
the expected lag in earnings from investments made in
new construction. However, all of these properties are
now enjoying a marked upward trend. Two, however,
have not as yet reached the point where satisfactory
basic earnings are being reported. Accordingly, for net
asset value purposes, Sheraton's interest in these two
hotels is for the present carried at a small fraction of
our original investment.
Another factor which affects profit margins is our
growing emphasis on so called specialty restaurants.
These usually involve a high volume of sales with
correspondingly narrower profit margins. This is
illustrated by the following comparison:
Estimated Departmental Profit Margin on Room Sales 70%
Estimated Departmental Profit Margin on
Specialty Restaurants 25%
Despite these reduced margins, we consider this business eminently desirable.
Perhaps a major factor influencing profit margins
was the fact that at the end of last year over $28,000,000
of temporarily non-productive assets held by the Company had been contributing little or nothing to basic
earnings. The major items of this nature momentarily
reducing profit margins, each amounting to several
million dollars, are the following:
Unimproved land in various locations held for
anticipated future construction.
Sheraton-Chicago Hotel (not opened until
May 1, 1961).
Other recently completed hotels. Includes
Baltimore Inn, Tel Aviv and two Hawaiian
hotels. These represent an investment showing only nominal earnings prior to the current
fiscal year.
Diners' Club stock received in exchange for
Sheraton's Credit Card Club presently valued
at three million dollars. One million dollars
of this stock was recently sold for cash;
another million has been exchanged for other
diversified marketable securities. Balance is
being held for possible future appreciation
in value.
Sheraton's leasehold interest in an office building. See "Hidden Asset" below.
Other miscellaneous investments.
Twenty-two millions of these assets should be
contributing to earnings before the end of this current
year. The remaining non-income producing properties
should be generating income in the near future.
Among investments held for longer range future
potentials is a two-acre ocean-front lot on Waikiki
Beach. We received an offer of several million dollars
for this land recently. We felt, however, it could
eventually yield a substantially higher return if held by
Sheraton. We expect to hold this land for another year
or two, until we are ready to build in that desirable
location.
Sheraton does recognize that lower profit margins
do currently prevail. Whether these margins can be
restored entirely without a return to lower interest
rates on borrowed money, is possibly open to debate.
It might, however, be noted that, had we not invested
twenty-eight millions in temporarily non-income producing holdings, and had we inaugurated our three
million dollar "belt-tightening" program a year or
two earlier, the Company's cash flow in relation to its
rising sales and indicated net asset values, could have
been for the past year the highest on record for the
Company. However, despite favorable prospects in
coming years, Sheraton may find it desirable — in
accord with the experience of a large segment of
American business—to seek expanded sales as the
best solution for meeting narrowing corporate profit
margins.
A "Hidden Asset"
Sheraton has an important asset previously referred to, which, though currently virtually non-
income producing, is presently believed nonetheless to
be worth over five million dollars. For eleven years
this investment has been carried at virtually no book
value, and during these years it has recorded only
nominal earnings, since nearly all operating income
received, close to $850,000 a year, had to be applied
during this period to rental charges and to modernization of the property. This investment represented our
interest in the large Sheraton-Whitehall Building, an
office building in New York often referred to as "the
first building on the right as you enter New York
Harbor." Situated on the southern tip of Manhattan
Island, it enjoys a superb view of the water front.
Eleven years ago we sold this building for
$6,500,000 cash to a life insurance company, and
leased it back for a period of sixty years, with the
proviso that rental payments should be reduced after
the first eleven years to coincide with the anticipated
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