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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
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INTERSTATE HOTELS CORPORATION
FOSTER PLAZA TEN
680 ANDERSEN DRIVE
PITTSBURGH, PENNSYLVANIA 15220
(412) 937-0600
MARYLAND 0-26805 75-2767215
(State of Incorporation) (Commission File No.) (I.R.S. Employer
Identification Number)
The Company (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.
The total number of shares of the Company's Common Stock, par value $0.01
per share, outstanding at November 13, 2000 was as follows: Class A shares
6,339,105; Class B shares 242,555; and Class C shares 60,639.
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INDEX
INTERSTATE HOTELS CORPORATION
PAGE NO.
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)............................ 2
Consolidated Balance Sheets - December 31, 1999 and
September 30, 2000.......................................... 2
Consolidated Statements of Operations - Three Months and
Nine Months Ended September 30, 1999 and September 30,
2000........................................................ 3
Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1999 and September 30, 2000................... 4
Notes to Consolidated Financial Statements.................. 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 12
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 18
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds................... 19
Item 4. Submission of Matters to a Vote of Security Holders......... 19
Item 6. Exhibits and Reports on Form 8-K............................ 20
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED).
INTERSTATE HOTELS CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
(A) (UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 22,440 $ 36,133
Accounts receivable, net of allowance for doubtful
accounts of $486 in 1999 and
$570 in 2000............................................ 16,779 18,349
Deferred income taxes..................................... 1,172 2,230
Net investment in direct financing leases................. 464 294
Prepaid expenses and other assets......................... 1,148 1,481
Related party receivables -- management contracts......... 423 337
-------- --------
Total current assets.................................. 42,426 58,824
Restricted cash............................................. 1,701 1,754
Marketable securities....................................... 2,134 2,399
Property and equipment, net................................. 16,049 15,485
Officer and employee notes receivable....................... 3,541 3,169
Notes receivable -- affiliates, net of reserve for
uncollectible notes receivable of
$666 in 2000.............................................. 10,838 10,420
Net investment in direct financing leases................... 928 589
Investment in hotel real estate............................. -- 746
Deferred income taxes....................................... -- 1,158
Intangible and other assets................................. 64,842 41,149
-------- --------
Total assets.......................................... $142,459 $135,693
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable -- trade................................. 3,430 2,584
Accounts payable -- health trust.......................... 3,358 3,979
Accounts payable -- related parties....................... 3,991 1,664
Accrued payroll and related benefits...................... 8,252 8,201
Accrued rent.............................................. 5,348 11,038
Other accrued liabilities................................. 12,486 15,406
Current portion of long-term debt......................... -- 90
-------- --------
Total current liabilities............................. 36,865 42,962
Deferred income taxes....................................... 2,454 --
Deferred compensation....................................... 2,134 2,399
Long-term debt.............................................. -- 7,415
-------- --------
Total liabilities..................................... 41,453 52,776
Minority interest........................................... 41,000 28,150
Commitments and contingencies............................... -- --
Stockholders' equity:
Preferred stock, $.01 par value; 10,000,000 shares
authorized; no shares issued or outstanding at September
30, 2000................................................ -- --
Common stock, $.01 par value; 65,000,000 shares
authorized; 6,642,299 shares issued and outstanding at
September 30, 2000...................................... 64 64
Paid-in capital........................................... 66,705 66,705
Retained deficit.......................................... (5,889) (11,361)
Unearned compensation..................................... (874) (641)
-------- --------
Total stockholders' equity............................ 60,006 54,767
-------- --------
Total liabilities and stockholders' equity............ $142,459 $135,693
======== ========
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(A) The year-end balance sheet information was derived from audited financial
statements, but does not include all disclosures required by generally
accepted accounting principles.
The accompanying notes are an integral part of the consolidated financial
statements.
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INTERSTATE HOTELS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 2000 1999 2000
-------- -------- -------- --------
Lodging revenues:
Rooms........................................ $ 52,013 $ 52,971 $141,137 $147,879
Other departmental........................... 2,899 3,089 7,958 8,983
Net management fees............................ 7,535 6,856 24,857 20,901
Other fees..................................... 3,114 2,938 9,294 8,566
-------- -------- -------- --------
65,561 65,854 183,246 186,329
-------- -------- -------- --------
Lodging expenses:
Rooms........................................ 12,075 13,027 32,895 35,492
Other departmental........................... 1,919 1,962 5,194 5,471
Property costs............................... 15,141 16,337 41,863 45,891
General and administrative..................... 3,765 3,779 11,353 10,251
Payroll and related benefits................... 4,935 5,132 14,891 15,885
Lease expense.................................. 25,595 24,851 70,104 69,228
Depreciation and amortization.................. 4,620 4,145 14,712 12,733
Loss on impairment of investment in hotel lease
contracts.................................... -- 12,550 -- 12,550
-------- -------- -------- --------
68,050 81,783 191,012 207,501
-------- -------- -------- --------
Operating loss................................. (2,489) (15,929) (7,766) (21,172)
Other income (expense):
Interest, net................................ 517 463 672 1,447
Other, net................................... -- (4) 1,563 20
Loss on sale of investment in hotel real
estate.................................... -- -- (876) --
-------- -------- -------- --------
Loss before income tax benefit................. (1,972) (15,470) (6,407) (19,705)
Income tax benefit............................. (376) (2,771) (1,752) (3,648)
-------- -------- -------- --------
Loss before minority interest.................. (1,596) (12,699) (4,655) (16,057)
Minority interest.............................. (1,031) (8,543) (2,027) (10,585)
-------- -------- -------- --------
Net loss....................................... $ (565) $ (4,156) $ (2,628) $ (5,472)
======== ======== ======== ========
Earnings per common share and common share
equivalent (Note 4):
Basic........................................ $ (.09) $ (.66) -- $ (.88)
======== ======== ======== ========
Diluted...................................... $ (.09) $ (.66) -- $ (.88)
======== ======== ======== ========
Weighted average number of common share and
common share equivalents outstanding:
Basic........................................ 6,063 6,306 -- 6,208
======== ======== ======== ========
Diluted...................................... 6,063 6,306 -- 6,208
======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
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INTERSTATE HOTELS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1999 2000
------------ ------------
Cash flows from operating activities:
Net loss.................................................. $(2,628) $(5,472)
Adjustments to reconcile net loss to net cash from
operating activities:
Depreciation and amortization.......................... 14,712 12,733
Equity in earnings from unconsolidated subsidiaries.... (1,525) 4
Loss on impairment of investment in hotel lease
contracts............................................. -- 12,550
Minority interest...................................... (2,027) (10,585)
Deferred income taxes.................................. (782) (4,670)
Other.................................................. 836 1,283
Cash (used in) provided by assets and liabilities:
Accounts receivable, net............................... (1,223) (1,570)
Prepaid expenses and other assets...................... (983) (333)
Related party receivables.............................. 664 86
Accounts payable....................................... 2,485 (276)
Accrued liabilities.................................... 13,495 9,042
------- -------
Net cash provided by operating activities............ 23,024 12,792
------- -------
Cash flows from investing activities:
Net investment in direct financing leases................. 807 509
Change in restricted cash................................. 555 (53)
Purchase of property and equipment, net................... (302) (350)
Purchases of marketable securities........................ (2,030) (1,806)
Proceeds from sale of marketable securities............... 1,941 1,783
Proceeds from sale of investment in hotel real estate..... 13,654 --
Net cash received from (invested in) unconsolidated
subsidiaries........................................... 1,176 (750)
Change in officer and employee notes receivable........... (770) (94)
Net investment in management contracts.................... (352) (320)
Merger-related acquisition costs.......................... (8,941) --
Change in notes receivable -- affiliates, net............. (482) (248)
Other..................................................... (16) (597)
------- -------
Net cash provided by (used in) investing
activities.......................................... 5,240 (1,926)
------- -------
Cash flows from financing activities:
Proceeds from long-term debt.............................. -- 7,560
Repayment of long-term debt............................... -- (55)
Financing costs paid...................................... -- (87)
Proceeds from sale of common stock........................ 2,120 --
Net contributions from minority interest.................. 6,934 --
Related party payables.................................... (18,597) (4,591)
Net contributions from owners............................. 16,659 --
------- -------
Net cash provided by financing activities............ 7,116 2,827
------- -------
Net increase in cash and cash equivalents................... 35,380 13,693
Cash and cash equivalents at beginning of period............ 1,652 22,440
------- -------
Cash and cash equivalents at end of period.................. $37,032 $36,133
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
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INTERSTATE HOTELS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION AND BASIS OF PRESENTATION:
Interstate Hotels Corporation (together with its subsidiaries and
predecessors, the "Company") was formed pursuant to a series of events
culminating in the spin-off of the Company's operations from Wyndham
International, Inc., formerly Patriot American Hospitality, Inc. ("Wyndham"), on
June 18, 1999. On June 2, 1998, Interstate Hotels Company (the predecessor of
the Company, and together with its subsidiaries, "Old Interstate") merged into
Wyndham (the "Merger"). Prior to the Merger, Marriott International, Inc.
("Marriott") filed a lawsuit to stop the closing of the Merger as a result of a
dispute over certain franchise agreements between Marriott and Old Interstate.
On June 18, 1999, pursuant to a settlement agreement with Marriott, Wyndham
transferred to the Company, which was then a newly formed corporation, the
third-party hotel management business of Old Interstate, equity interests in The
Charles Hotel Complex, a hotel, retail and office complex located in Cambridge,
Massachusetts, and long-term leasehold interests in 79 hotels. Wyndham then
spun-off the Company to its shareholders (the "Spin-off"). In connection with
the Spin-off, Marriott purchased 4% of the Company's common stock, Wyndham
retained 4% of the Company's common stock, and the remaining 92% of the
Company's common stock was distributed to Wyndham's shareholders.
The Company's principal subsidiaries include Interstate Hotels, LLC ("IH
LLC") and Interstate Pittsburgh Hotel Holdings, L.L.C. IH LLC has assumed the
third-party hotel management business previously conducted by Old Interstate and
holds the leasehold interests in the Company's leased hotels, as well as
provides ancillary services such as centralized purchasing, equipment leasing
and insurance services. The Company owns a 45% managing member interest and
Wyndham owns a 55% non-controlling ownership interest in IH LLC. Interstate
Pittsburgh Hotel Holdings, L.L.C. is a wholly owned subsidiary of the Company
which owns the Pittsburgh Airport Residence Inn by Marriott.
In accordance with IH LLC's limited liability company agreement, the
Company is required to distribute 55% of IH LLC's cash flows from operations to
Wyndham and allocate between IH LLC and the Company the costs and expenses
relating to services provided by one party for the benefit of the other in
accordance with generally accepted accounting principles, on the basis of which
party benefited from the expenditure. To the extent that the allocation of any
such costs and expenses, including general and administrative expenses, cannot
be fairly apportioned, IH LLC and the Company will allocate such costs and
expenses based upon their respective gross revenues, so that each party's profit
margins are substantially the same for similar services.
The Company includes the revenues and expenses and the working capital of
the leased hotels in the financial statements because the risk of operating
these hotels is borne by the Company, as lessee, under the terms of the leases.
Revenues and expenses from the operation of the managed hotels are not included
in the financial statements because the hotel management contracts are generally
cancellable, not transferable and do not shift the risks of operation to the
Company. Therefore, the Company records revenues from management fees only for
its managed hotels.
2. INTERIM FINANCIAL STATEMENTS:
The accompanying consolidated interim financial statements have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to such
rules and regulations. These consolidated interim financial statements should be
read in conjunction with the consolidated financial statements, notes thereto
and other information included in the Company's Annual Report on Form 10-K/A for
the year ended December 31, 1999.
The accompanying consolidated interim financial statements reflect, in the
opinion of management, all adjustments necessary for a fair presentation, in all
material respects, of the financial position and results of operations for the
periods presented. The preparation of financial statements in accordance with
generally
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2. INTERIM FINANCIAL STATEMENTS--CONTINUED
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
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. The results
of operations for the interim periods are not necessarily indicative of the
results for the entire year.
3. PRO FORMA INFORMATION:
The following pro forma information for the three and nine-month periods
ended September 30, 1999 and 2000 is presented to include the effects of the
Spin-off, the sale of equity interests in The Charles Hotel Complex and certain
other adjustments as if all of the transactions had occurred on January 1, 1999.
Such other adjustments principally include the elimination and addition of
certain management fee and other fee revenues related to Wyndham-owned hotels,
the management of which was transferred to Wyndham, Marriott or the Company as a
result of the Spin-off. The adjustments also include the elimination of a $2,000
one-time charge in the first quarter of 1999 for additional incentive lease
expense for 1999 paid in settlement of a dispute with Equity Inns, Inc.
resulting from the Merger, and the addition of minority interest to reflect
Wyndham's 55% non-controlling interest in IH LLC prior to the Spin-off.
In management's opinion, all material pro forma adjustments necessary to
reflect the effects of these transactions have been made. The pro forma
information does not include earnings on the Company's pro forma cash and cash
equivalents or certain one-time charges to income relating to the Merger, and
does not purport to present what the actual results of operations of the Company
would have been if the previously mentioned transactions had occurred on such
date or to project the results of operations of the Company for any future
period.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- --------------------
1999 2000 1999 2000
------- -------- -------- --------
Total revenues.................................. $64,846 $ 65,854 $178,281 $186,329
Operating loss.................................. (3,354) (15,929) (11,625) (21,172)
Net loss........................................ (802) (4,156) (2,816) (5,472)
Pro Forma basic earnings per common share....... (.13) (.64) (.44) (.84)
Pro Forma diluted earnings per common share..... (.13) (.64) (.44) (.84)
4. EARNINGS PER SHARE:
Prior to the Spin-off, the Company was not a separate legal entity.
Therefore, the accompanying consolidated financial statements of the Company
have been carved out of the financial statements of Old Interstate and Wyndham,
and principally include those assets, liabilities, revenues and expenses
directly attributable to the third-party hotel management and leasing businesses
conducted by the Company. Accordingly, the Company believes that the historical
earnings per share calculations required in accordance with Statement of
Financial Accounting Standard No. 128 are not meaningful for periods prior to
the Spin-off and, therefore, have not been provided.
5. LONG-TERM DEBT:
In February 2000, Interstate Pittsburgh Hotel Holdings, L.L.C. entered into
a limited-recourse mortgage note with a bank. The proceeds from the note, which
has a two-year term with a one-year extension if certain minimum financial
requirements are met, totaled $7,560. Monthly payments are due based on a
25-year amortization schedule for principal, with interest based on variable
rate options using the prime rate or the LIBOR rate. The note is collateralized
by the Pittsburgh Airport Residence Inn by Marriott, which was acquired by the
Company in November 1999, and provides for a guarantee by the Company of up to
$3,000. The outstanding principal balance on the note is due and payable at
maturity.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. EQUITY INNS, INC.:
On July 21, 2000, the Company executed a binding Memorandum of
Understanding (the "Memorandum") with Equity Inns, Inc. ("Equity Inns") with
respect to the hotel lease agreements between the Company and Equity Inns, which
was superseded by a Master Lease Termination Agreement dated September 12, 2000
(the "Termination Agreement"). Pursuant to the Termination Agreement, all of the
lease agreements for the 75 hotels leased from Equity Inns will be terminated
effective January 1, 2001, and Equity Inns and the Company simultaneously will
enter into management agreements for 54 of the hotels formerly leased to the
Company. The management agreements will expire on a staggered basis beginning
January 1, 2002 through 2005. As a result effective January 1, 2001, the
revenues and expenses and the working capital of these hotels will no longer be
reflected in the financial statements of the Company. Instead, the Company will
record revenues from management fees only. The Company will also continue to
manage, under a new management agreement, one additional hotel it currently
manages for Equity Inns (but does not lease). The closing of the transaction is
contingent upon obtaining the consents of certain third parties. Upon closing,
the Company will account for the transaction as an exchange of nonmonetary
assets in accordance with Accounting Principles Board ("APB") No. 29,
"Accounting for Nonmonetary Transactions."
Concurrent with the Company's decision to enter into the Memorandum, the
Company recorded a non-cash impairment loss of $12,550 in the third quarter of
2000 related to its leased hotel intangible assets included in the mid-scale,
upper economy and budget hotels segment. The impairment loss was the result of a
permanent impairment of the future profitability of these hotels, as well as the
expected new terms of the lease and management agreements. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Assets to be Disposed Of," the
Company evaluated the recoverability of the intangible assets by measuring the
carrying amount of the intangible assets against the estimated future cash flows
of the individual properties. The Company estimated the discounted cash flows
utilizing estimates of future operating results for the remaining lease and
anticipated management agreement terms, in accordance with the provisions of the
Memorandum.
In addition, the Termination Agreement addresses a dispute between the
Company and Equity Inns regarding certain performance standards currently in
place with respect to the leased hotels, including requirements to maintain
revenue per available room and expenditures to within specified percentages of
the amounts targeted in the hotels' operating budgets. Previously, Equity Inns
had asserted that the Company had failed to spend the required percentages of
the amounts targeted in certain categories of the hotels' operating budgets for
the measuring period from July 1, 1999 through December 31, 1999 with respect to
41 leases. Equity Inns' sole remedy for a failure to satisfy the performance
standards was to terminate the subject lease or leases, without penalty. The
Company vigorously disagreed with and disputed Equity Inns' interpretation of
this requirement. The execution of the Termination Agreement suspends the
application of the performance standards as to all periods prior to and after
the date of execution and through the closing. In the event that the transaction
does not close, the performance standards will be reinstated retroactively,
unless the failure to close is the result of a breach by Equity Inns of its
obligations under the Termination Agreement, in which case the performance
standards will be reinstated on a forward-looking basis with an effective date
of January 1, 2001.
During the period prior to the closing of the transaction, the Company is
still required to maintain a certain minimum net worth. A failure to maintain
the minimum net worth would be a default under the leases.
7. SEGMENT INFORMATION:
The Company's reportable segments are: (i) operations of luxury and upscale
hotels, and (ii) operations of mid-scale, upper economy and budget hotels. The
luxury and upscale hotels segment derives revenues from management fees and
other services which directly relate to providing management services, including
revenues from insurance, purchasing and equipment leasing. The mid-scale, upper
economy and budget hotels segment derives revenues from managing and leasing
hotels and certain specialized support services.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
7. SEGMENT INFORMATION--CONTINUED:
The table below presents revenue and operating loss information for each
reportable segment for the three and nine-month periods ended September 30, 1999
and 2000.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
1999 2000 1999 2000
------- -------- -------- --------
REVENUES:
Luxury and Upscale Hotels................... $ 9,519 $ 8,678 $ 31,137 $ 26,144
Mid-Scale, Upper Economy and Budget
Hotels.................................... 56,042 57,176 152,109 160,185
------- -------- -------- --------
Consolidated totals....................... $65,561 $ 65,854 $183,246 $186,329
======= ======== ======== ========
OPERATING INCOME (LOSS):
Luxury and Upscale Hotels................... $ (207) $ (1,122) $ 557 $ (3,724)
Mid-Scale, Upper Economy and Budget
Hotels*................................... (2,282) (14,807) (8,323) (17,448)
------- -------- -------- --------
Consolidated totals....................... $(2,489) $(15,929) $ (7,766) $(21,172)
======= ======== ======== ========
- ---------------
* The 1999 amount includes a $2,000 one-time charge in the first quarter of 1999
for additional incentive rent paid in settlement of a dispute with Equity
Inns, Inc. resulting from the Merger. The 2000 amount includes a $12,550
non-cash impairment charge on leased hotel intangible assets.
Depreciation and amortization included in segment operating loss for the
three and nine-month periods ended September 30, 1999 and 2000 were as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1999 2000 1999 2000
-------- -------- -------- --------
Luxury and Upscale Hotels.................... $ 3,343 $ 3,303 $ 10,844 $ 9,937
Mid-Scale, Upper Economy and Budget Hotels... 1,277 842 3,868 2,796
------- ------- -------- --------
Consolidated totals........................ $ 4,620 $ 4,145 $ 14,712 $ 12,733
======= ======= ======== ========
The net book value of intangible and other assets by segment consisted of
the following at December 31, 1999 and September 30, 2000:
DECEMBER 31, 1999 SEPTEMBER 30, 2000
----------------- ------------------
Luxury and Upscale Hotels....................... $42,736 $34,046
Mid-Scale, Upper Economy and Budget Hotels...... 22,106 7,103
------- -------
Consolidated totals........................... $64,842 $41,149
======= =======
The following table reconciles the Company's measure of segment profit to
consolidated net loss for the three and nine-month periods ended September 30,
1999 and 2000.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
1999 2000 1999 2000
-------- -------- ------- --------
Total after-tax operating loss................ $(1,494) $(9,559) $(4,659) $(12,703)
Unallocated amounts, net of tax:
Interest, net............................... 310 278 403 868
Other, net.................................. -- (2) 412 12
Minority interest........................... 619 5,127 1,216 6,351
------- ------- ------- --------
Consolidated net loss......................... $ (565) $(4,156) $(2,628) $ (5,472)
======= ======= ======= ========
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10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
8. SUBSEQUENT EVENTS:
The transactions described below were approved by the stockholders of the
Company on October 16, 2000. These transactions will be accounted for in the
fourth quarter of 2000.
Securities Purchase Agreement
On October 20, 2000, the Company issued 8.75% Subordinated Convertible
Notes (the "Notes") for $25,000 and 500,000 shares of its Series B Convertible
Preferred Stock, par value $.01 per share, (the "Preferred Stock") for $5,000.
These securities were issued to CGLH Partners I LP and CGLH Partners II LP
(collectively, the "Investor"), which are entities affiliated with Lehman
Brothers Holdings, Inc., pursuant to a Securities Purchase Agreement dated
August 31, 2000 between the Company and the Investor. The Preferred Stock
accrues cumulative dividends payable in cash at 8.75% per annum, with up to 25%
of the dividends payable in kind (at the option of the Company), and must be
redeemed by the Company no later than 2007. The Notes mature no later than 2007
and accrue interest at a rate of 8.75% per annum, with up to 25% of the interest
payable in kind (at the option of the Company). Both the Preferred Stock and the
Notes are convertible at any time into Class A Common Stock of the Company at
$4.00 per share. Initially, these securities are convertible into an aggregate
of 7,500,000 shares of Class A Common Stock, representing approximately 52% of
the Company's Class A Common Stock after conversion (taking into account the
Class A Common Stock outstanding as of September 30, 2000). However, no holder
of either the Notes or the Preferred Stock may convert these securities if that
conversion would cause the holder and its affiliates or any group of which any
of them is a member to have beneficial ownership of more than 49% of the
Company's total Common Stock outstanding after the conversion.
The Notes and Preferred Stock will be recorded at fair value in the fourth
quarter of 2000. Transaction costs incurred in connection with the Notes will be
deferred and amortized over the next seven years. Costs incurred in connection
with the issuance of the Preferred Stock will be netted against the fair value
of the Preferred Stock at issuance. The Preferred Stock will be accreted to
redemption value over the next seven years using the interest method.
In connection with the transactions contemplated under the Securities
Purchase Agreement, the Company also entered into amended and restated
employment agreements with each of Thomas F. Hewitt, J. William Richardson and
Kevin P. Kilkeary, members of senior management of the Company. These amended
and restated employment agreements became effective upon the closing of the
transactions contemplated under the Securities Purchase Agreement and provided,
among other things, for the issuance of an aggregate of 225,000 shares of
Preferred Stock to these individuals and the immediate vesting of restricted
stock awards for Messrs. Hewitt and Richardson that were issued under their
previous employment agreements, in exchange for their waiver of severance
payments owed to them by the Company under their previous employment agreements.
These shares were issued on October 20, 2000 and are convertible, subject to
vesting restrictions, into an aggregate of 562,500 shares of Class A Common
Stock, representing approximately 4% of the Company's Class A Common Stock after
conversion (taking into account the Class A Common Stock outstanding as of
September 30, 2000).
The issuance of the Preferred Stock will initially be recorded as deferred
compensation at fair value and amortized as compensation expense over the
three-year vesting period. The immediate vesting of the existing restricted
stock issued under previous employment agreements will be recorded as a
compensation charge of approximately $600 in the fourth quarter of 2000. Other
costs incurred in connection with the employment agreement amendments will be
expensed as incurred.
The terms of the Notes and Preferred Stock contain various voting rights of
the Investor and covenants by the Company with respect to the operation of the
business of the Company on an ongoing basis.
In connection with the issuance of the Notes and Preferred Stock, the
Company and the Investor entered into an Investor Agreement providing for
certain restrictions on, and rights of, the Investor with respect to the
Company, including a standstill agreement, restrictions on transfer of the
Preferred Stock and Notes (and
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11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
8. SUBSEQUENT EVENTS--CONTINUED:
Common Stock into which they are convertible) and rights to currently designate
five out of 11 of the members of the Board of Directors of the Company.
Joint Venture
$25,000 of the proceeds raised by the sale of the Notes and the Preferred
Stock will be invested by the Company in a newly formed joint venture (the
"Joint Venture") with the Investor for acquisition of hotel properties that will
be managed by the Company. The Investor has committed to invest $20,000 of
additional capital to the Joint Venture.
The Joint Venture is structured as a limited partnership with an affiliate
of the Investor serving as the managing general partner having decision-making
authority and an affiliate of the Company serving as a general partner having
limited authority and responsibility. The limited partnership interests will be
owned by affiliates of the Investor, by affiliates of the Company, and by
Messrs. Hewitt and Richardson, (collectively, the "Executives"). The Executives
will receive aggregate limited partnership interests of 5.25% without any
capital contribution and will be subject to a vesting period of up to three
years as well as other conditions. The Company will own a minority common
percentage interest of the Joint Venture. The decision by the Joint Venture to
acquire any hotel property or an interest in any hotel property will require the
unanimous approval of all the partners, other than the Executives. Approximately
$11,667 of the Company's affiliate investment in the Joint Venture will be
entitled to a 15% per annum preferential return from available cash before the
same return is payable on the remaining capital investments by the partners.
Under the terms of the partnership agreement for the Joint Venture, an
affiliate of the Company will manage for ten years all hotel properties
acquired, directly or indirectly, by the Joint Venture, except for minority,
non-controlling investments by the Joint Venture in hotel properties. The
manager will be entitled to a base management fee of 2.5% of hotel gross
revenues and an incentive management fee of 10% of net cash flow. An affiliate
of the Investor will serve as the asset manager for all Joint Venture properties
and will receive an annual fee of 0.75% of the amount of capital invested in the
joint venture as of December 31 of every year. The management agreement for each
property is subject to termination in certain circumstances, including the sale
of the property by the Joint Venture, and provides for a termination fee to the
manager in some circumstances.
The Joint Venture has a seven-year term subject to extension by the
Investor. Within two years of a change of control of the Company, the Investor
has a right to require the Company to acquire all the partnership interests
owned by affiliates of the Investor. The Joint Venture interests are also
subject to a buy/sell agreement which may be triggered in certain circumstances
by any partner and may result in the non-triggering partners either buying the
triggering partner's interest or selling their interests to the triggering
partner, provided that the Executives may not be buyers under the buy/sell
agreement, without the consent of the other partners.
The Joint Venture will be accounted for by the Company using the equity
method of accounting beginning in the fourth quarter of 2000. Transaction costs
incurred in connection with the formation of the Joint Venture will be expensed
or capitalized based on the nature of the costs. The Company will also record
compensation expense to the extent of the fair value of the Executives interest
in the Joint Venture, subject to the Executives' vesting periods.
Senior Credit Facility
In connection with this transaction with the Investor, the Company is
negotiating with Lehman Brothers Inc. ("Lehman") for a $50,000 senior secured
revolving credit facility. The Company and Lehman have executed a commitment
letter, pursuant to which Lehman has committed to lend $25,000 and an affiliate
of Lehman has agreed to syndicate an additional $25,000 on a best efforts basis.
The term of the credit facility will be two years with an option to extend for
an additional year in certain circumstances, including a reduction
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12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
8. SUBSEQUENT EVENTS--CONTINUED:
of the facility over a period of time. The credit facility will be secured by a
pledge of the Company's equity interests (i.e., stock, partnership interests and
membership interests) in the Company's major current and future direct and
indirect subsidiaries, mortgages on all hotel properties owned directly by the
Company or by its wholly-owned subsidiaries and a security interest in the
rights of the Company to receive payments under hotel management agreements and
hotel leases. The Company is permitted to draw upon the facility for several
purposes including to make investments in hotel properties or loans to obtain
management contracts, provide letters of credit and to satisfy the Company's
general working capital needs. Lehman will receive customary fees under the
facility, including a commitment fee of 1.25% of the facility amount, an
arrangement fee of $250, an administration fee of $75 per year and an annual
commitment fee that will vary depending upon the level of the facility usage.
The Company expects to close on the credit facility in the first quarter of
2001.
Wyndham Redemption
In connection with the Investor's investments in the Preferred Stock and
the Notes, the Company has agreed to cause its principal operating subsidiary,
Interstate Hotels, LLC ("IH LLC") to consummate a transaction contemplated by an
agreement to redeem from affiliates of Wyndham International, Inc. (collectively
with its affiliates, "Wyndham") their aggregate 55% non-voting economic interest
in IH LLC (the "Wyndham Interest"). Pursuant to this agreement and
contemporaneously with the issuance of the Notes and Preferred Stock, IH LLC
transferred to Wyndham a management agreement of IH LLC for one hotel owned by
Wyndham and amended management agreements with respect to six other hotels owned
by Wyndham to reduce the management fees and to permit termination by the owner
upon 30 days notice. In addition, approximately 9% of the Wyndham Interest was
redeemed by IH LLC and substantially all of the remainder was converted into a
preferred membership interest in IH LLC. At any time on or after July 1, 2001,
both IH LLC and Wyndham have the right to require that IH LLC redeem the
preferred membership interest for approximately $12,682 to be paid with a
combination of cash and promissory notes. The portion of the Wyndham Interest
that was not converted into a preferred membership interest will remain
outstanding after the preferred membership interest is redeemed. Thereafter, at
any time on or after July 1, 2004, both IH LLC and Wyndham have the right to
require that IH LLC redeem the remaining common interest at an amount that is
the lesser of (a) the product of (i) five times IH LLC's EBITDA as of December
31, 2003 and (ii) the percentage of total equity interest in IH LLC which is
represented by the remaining interest, or (b) approximately $433. As additional
consideration for the redemption and conversion of the Wyndham Interest, Wyndham
caused its current representative on the Company's Board of Directors to resign
and relinquished its right to appoint a member to the Company's Board of
Directors in the future. In addition, Wyndham granted the Company an option
exercisable within 90 days of October 20, 2000, to acquire all of the Company's
stock owned by Wyndham at a weighted average trading price per share, as
defined. The Company has exercised this option and expects to close the
acquisition in the fourth quarter of 2000. Further the Company's Bylaws have
been amended to remove the right of the Class B and Class C directors to approve
appointments of members to the committees of the Board of Directors.
The redemption of Wyndham's Interest will be accounted for by the Company
during the fourth quarter of 2000 using purchase accounting as prescribed by APB
No. 16, "Accounting for Business Combinations." Transaction costs incurred in
connection with the Wyndham redemption will be included in the total purchase
price. The purchase of the Company's stock owned by Wyndham will be accounted
for as a treasury stock transaction.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RECENT DEVELOPMENTS
Securities Purchase Agreement
On October 20, 2000, the Company issued 8.75% Subordinated Convertible
Notes (the "Notes") for $25.0 million and 500,000 shares of its Series B
Convertible Preferred Stock, par value $.01 per share, (the "Preferred Stock")
for $5.0 million. These securities were issued to CGLH Partners I LP and CGLH
Partners II LP (collectively, the "Investor"), which are entities affiliated
with Lehman Brothers Holdings, Inc., pursuant to a Securities Purchase Agreement
dated August 31, 2000 between the Company and the Investor. The Preferred Stock
accrues cumulative dividends payable in cash at 8.75% per annum, with up to 25%
of the dividends payable in kind (at the option of the Company), and must be
redeemed by the Company no later than 2007. The Notes mature no later than 2007
and accrue interest at a rate of 8.75% per annum, with up to 25% of the interest
payable in kind (at the option of the Company). Both the Preferred Stock and the
Notes are convertible at any time into Class A Common Stock of the Company at
$4.00 per share. Initially, these securities are convertible into an aggregate
of 7,500,000 shares of Class A Common Stock, representing approximately 52% of
the Company's Class A Common Stock after conversion (taking into account the
Class A Common Stock outstanding as of September 30, 2000). However, no holder
of either the Notes or the Preferred Stock may convert these securities if that
conversion would cause the holder and its affiliates or any group of which any
of them is a member to have beneficial ownership of more than 49% of the
Company's total Common Stock outstanding after the conversion.
The Notes and Preferred Stock will be recorded at fair value in the fourth
quarter of 2000. Transaction costs incurred in connection with the Notes will be
deferred and amortized over the next seven years. Costs incurred in connection
with the issuance of the Preferred Stock will be netted against the fair value
of the Preferred Stock at issuance. The Preferred Stock will be accreted to
redemption value over the next seven years using the interest method.
In connection with the transactions contemplated under the Securities
Purchase Agreement, the Company also entered into amended and restated
employment agreements with each of Thomas F. Hewitt, J. William Richardson and
Kevin P. Kilkeary, members of senior management of the Company. These amended
and restated employment agreements became effective upon the closing of the
transactions contemplated under the Securities Purchase Agreement and provided,
among other things, for the issuance of an aggregate of 225,000 shares of
Preferred Stock to these individuals and the immediate vesting of restricted
stock awards for Messrs. Hewitt and Richardson that were issued under their
previous employment agreements, in exchange for their waiver of severance
payments owed to them by the Company under their previous employment agreements.
These shares were issued on October 20, 2000 and are convertible, subject to
vesting restrictions, into an aggregate of 562,500 shares of Class A Common
Stock, representing approximately 4% of the Company's Class A Common Stock after
conversion (taking into account the Class A Common Stock outstanding as of
September 30, 2000).
The issuance of the Preferred Stock will initially be recorded as deferred
compensation at fair value and amortized as compensation expense over the
three-year vesting period. The immediate vesting of the existing restricted
stock issued under previous employment agreements will be recorded as a
compensation charge of approximately $0.6 million in the fourth quarter of 2000.
Other costs incurred in connection with the employment agreement amendments will
be expensed as incurred.
The terms of the Notes and Preferred Stock contain various voting rights of
the Investor and covenants by the Company with respect to the operation of the
business of the Company on an ongoing basis.
In connection with the issuance of the Notes and Preferred Stock, the
Company and the Investor entered into an Investor Agreement providing for
certain restrictions on, and rights of, the Investor with respect to the
Company, including a standstill agreement, restrictions on transfer of the
Preferred Stock and Notes (and Common Stock into which they are convertible) and
rights to currently designate five out of 11 of the members of the Board of
Directors of the Company.
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14
Joint Venture
$25.0 million of the proceeds raised by the sale of the Notes and the
Preferred Stock will be invested by the Company in a newly formed joint venture
(the "Joint Venture") with the Investor for acquisition of hotel properties that
will be managed by the Company. The Investor has committed to invest $20.0
million of additional capital to the Joint Venture. The Company believes that
the $45.0 million in capital contributed to the Joint Venture will support
$250-$300 million of acquisitions, subject to market conditions. However, there
is no assurance that the Joint Venture will be able to complete acquisitions or
otherwise successfully pursue its strategy.
The Joint Venture is structured as a limited partnership with an affiliate
of the Investor serving as the managing general partner having decision-making
authority and an affiliate of the Company serving as a general partner having
limited authority and responsibility. The limited partnership interests will be
owned by affiliates of the Investor, by affiliates of the Company, and by
Messrs. Hewitt and Richardson, (collectively, the "Executives"). The Executives
will receive aggregate limited partnership interests of 5.25% without any
capital contribution and will be subject to a vesting period of up to three
years as well as other conditions. The Company will own a minority common
percentage interest of the Joint Venture. The decision by the Joint Venture to
acquire any hotel property or an interest in any hotel property will require the
unanimous approval of all the partners, other than the Executives. Approximately
$11.7 million of the Company's affiliate investment in the Joint Venture will be
entitled to a 15% per annum preferential return from available cash before the
same return is payable on the remaining capital investments by the partners.
Under the terms of the partnership agreement for the Joint Venture, an
affiliate of the Company will manage for ten years all hotel properties
acquired, directly or indirectly, by the Joint Venture, except for minority,
non-controlling investments by the Joint Venture in hotel properties. The
manager will be entitled to a base management fee of 2.5% of hotel gross
revenues and an incentive management fee of 10% of net cash flow. An affiliate
of the Investor will serve as the asset manager for all Joint Venture properties
and will receive an annual fee of 0.75% of the amount of capital invested in the
joint venture as of December 31 of every year. The management agreement for each
property is subject to termination in certain circumstances, including the sale
of the property by the Joint Venture, and provides for a termination fee to the
manager in some circumstances.
The Joint Venture has a seven-year term subject to extension by the
Investor. Within two years of a change of control of the Company, the Investor
has a right to require the Company to acquire all the partnership interests
owned by affiliates of the Investor. The Joint Venture interests are also
subject to a buy/sell agreement which may be triggered in certain circumstances
by any partner and may result in the non-triggering partners either buying the
triggering partner's interest or selling their interests to the triggering
partner, provided that the Executives may not be buyers under the buy/sell
agreement, without the consent of the other partners.
The Joint Venture will be accounted for by the Company using the equity
method of accounting beginning in the fourth quarter of 2000. Transaction costs
incurred in connection with the formation of the Joint Venture will be expensed
or capitalized based on the nature of the costs. The Company will also record
compensation expense to the extent of the fair value of the Executives interest
in the Joint Venture, subject to the Executives' vesting periods.
Senior Credit Facility
In connection with this transaction with the Investor, the Company is
negotiating with Lehman Brothers Inc. ("Lehman") for a $50.0 million senior
secured revolving credit facility. The Company and Lehman have executed a
commitment letter, pursuant to which Lehman has committed to lend $25.0 million
and an affiliate of Lehman has agreed to syndicate an additional $25.0 million
on a best efforts basis. The term of the credit facility will be two years with
an option to extend for an additional year in certain circumstances, including a
reduction of the facility over a period of time. The credit facility will be
secured by a pledge of the Company's equity interests (i.e., stock, partnership
interests and membership interests) in the Company's major current and future
direct and indirect subsidiaries, mortgages on all hotel properties owned
directly by the Company or by its wholly-owned subsidiaries and a security
interest in the rights of the Company to receive payments
13
15
under hotel management agreements and hotel leases. The Company is permitted to
draw upon the facility for several purposes including to make investments in
hotel properties or loans to obtain management contracts, provide letters of
credit and to satisfy the Company's general working capital needs. Lehman will
receive customary fees under the facility, including a commitment fee of 1.25%
of the facility amount, an arrangement fee of $250,000, an administration fee of
$75,000 per year and an annual commitment fee that will vary depending upon the
level of the facility usage. The Company expects to close on the credit facility
in the first quarter of 2001.
Wyndham Redemption
In connection with the Investor's investments in the Preferred Stock and
the Notes, the Company has agreed to cause its principal operating subsidiary,
Interstate Hotels, LLC ("IH LLC") to consummate a transaction contemplated by an
agreement to redeem from affiliates of Wyndham International, Inc. (collectively
with its affiliates, "Wyndham") their aggregate 55% non-voting economic interest
in IH LLC (the "Wyndham Interest"). Pursuant to this agreement and
contemporaneously with the issuance of the Notes and Preferred Stock, IH LLC
transferred to Wyndham a management agreement of IH LLC for one hotel owned by
Wyndham and amended management agreements with respect to six other hotels owned
by Wyndham to reduce the management fees and to permit termination by the owner
upon 30 days notice. In addition, approximately 9% of the Wyndham Interest was
redeemed by IH LLC and substantially all of the remainder was converted into a
preferred membership interest in IH LLC. At any time on or after July 1, 2001,
both IH LLC and Wyndham have the right to require that IH LLC redeem the
preferred membership interest for approximately $12.7 million to be paid with a
combination of cash and promissory notes. The portion of the Wyndham Interest
that was not converted into a preferred membership interest will remain
outstanding after the preferred membership interest is redeemed. Thereafter, at
any time on or after July 1, 2004, both IH LLC and Wyndham have the right to
require that IH LLC redeem the remaining common interest at an amount that is
the lesser of (a) the product of (i) five times IH LLC's EBITDA as of December
31, 2003 and (ii) the percentage of total equity interest in IH LLC which is
represented by the remaining interest, or (b) approximately $433,000. As
additional consideration for the redemption and conversion of the Wyndham
Interest, Wyndham caused its current representative on the Company's Board of
Directors to resign and relinquished its right to appoint a member to the
Company's Board of Directors in the future. In addition, Wyndham granted the
Company an option exercisable within 90 days of October 20, 2000, to acquire all
of the Company's stock owned by Wyndham at a weighted average trading price per
share, as defined. The Company has exercised this option and expects to close
the acquisition in the fourth quarter of 2000. Further the Company's Bylaws have
been amended to remove the right of the Class B and Class C directors to approve
appointments of members to the committees of the Board of Directors.
The redemption of Wyndham's Interest will be accounted for by the Company
during the fourth quarter of 2000 using purchase accounting as prescribed by APB
No. 16, "Accounting for Business Combinations." Transaction costs incurred in
connection with the Wyndham redemption will be included in the total purchase
price. The purchase of the Company's stock owned by Wyndham will be accounted
for as a treasury stock transaction.
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 1999
Lodging revenues consist of rooms, food and beverage and other departmental
revenues from the leased hotels and one hotel acquired by the Company in
November 1999. Lodging revenues increased by $1.2 million, or 2.1%, from $54.9
million in the three months ended September 30, 1999 (the "1999 Three Months")
to $56.1 million in the three months ended September 30, 2000 (the "2000 Three
Months") and by $7.8 million, or 5.2%, from $149.1 million in the nine months
ended September 30, 1999 (the "1999 Nine Months") to $156.9 million in the nine
months ended September 30, 2000 (the "2000 Nine Months"). This increase was
partially due to incremental revenues of $1.1 million in the 2000 Three Months
and $3.2 million in the 2000 Nine Months related to the acquired hotel. In
addition, the Company entered into leases for two newly constructed hotels in
June 1999 that earned incremental revenues of approximately $1.6 million during
the 2000 Three Months and $8.8 million during the 2000 Nine Months. These
additional revenues were offset
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16
by the loss of 7 hotel operating leases since January 1, 1999, increased
competition and general negative trends in the limited-service hotel sector.
The average daily room rate for the leased hotels increased by 3.6%, from
$79.17 during the 1999 Three Months to $82.04 during the 2000 Three Months, and
the average occupancy rate increased slightly to 70.7% during the 2000 Three
Months from 70.0% during the 1999 Three Months. This resulted in an increase in
room revenue per available room of 4.6% to $57.96 during the 2000 Three Months.
During the nine-month periods average daily room rate for the leased hotels
increased by 4.4%, from $76.73 during the 1999 Nine Months to $80.14 during the
2000 Nine Months, and the average occupancy rate decreased slightly to 67.1%
during the 2000 Nine Months from 67.2% during the 1999 Nine Months. This
resulted in an increase in room revenue per available room of 4.3% to $53.78
during the 2000 Nine Months. The operating results of the Company's leased
hotels were consistent with the current trends within the lodging industry. The
increase in the average daily room rate primarily resulted from inflationary
rate increases.
Net management fees decreased by $0.6 million, or 9.0%, from $7.5 million
in the 1999 Three Months to $6.9 million in the 2000 Three Months and by $4.0
million, or 15.9%, from $24.9 million in the 1999 Nine Months to $20.9 million
in the 2000 Nine Months. This decrease was due to the net loss of 10 management
contracts since January 1, 1999, which were primarily hotels whose management
was transferred to either Wyndham or Marriott in connection with the Spin-off.
Contributing to the net loss of management contracts was the uncertainty
surrounding the timing and completion of the Spin-off, which impaired the
Company's ability to add new management contracts. Other fees decreased by $0.2
million, or 5.7%, from $3.1 million in the 1999 Three Months to $2.9 million in
the 2000 Three Months and by $0.7 million, or 7.8%, from $9.3 million in the
1999 Nine Months to $8.6 million in the 2000 Nine Months. The decrease in other
fees related to the reduction in the total number of hotels operated by the
Company in 2000 as compared to 1999.
Lodging expenses consist of rooms, food and beverage, property costs and
other departmental expenses from the leased hotels and one hotel acquired by the
Company in November 1999. Lodging expenses increased by $2.2 million, or 7.5%,
from $29.1 million in the 1999 Three Months to $31.3 million in the 2000 Three
Months and by $6.9 million, or 8.6%, from $80.0 million in the 1999 Nine Months
to $86.9 million in the 2000 Nine Months. This increase was partially due to
incremental expenses of $0.4 million in the 2000 Three Months and $1.2 million
in the 2000 Nine Months related to the acquired hotel. For the leased hotels,
increased competition resulting from an increased supply of limited-service
hotels in certain markets required higher operating costs to maintain and
increase revenue levels. In addition, the Company entered into leases for two
newly constructed hotels in June 1999 that incurred incremental operating
expenses of approximately $0.5 million during the 2000 Three Months and $4.7
million during the 2000 Nine Months. These additional expenses were offset by
the loss of 7 hotel operating leases since January 1, 1999. The operating margin
of the leased and owned hotels decreased from 46.9% during the 1999 Three Months
to 44.1% during the 2000 Three Months and from 46.3% during the 1999 Nine Months
to 44.6% during the 2000 Nine Months due primarily to the increased operating
costs associated with the leased hotels. The Company expects the increased
competition and over-supply of limited-service hotels to continue to affect
negatively the future operating margin of the Company's leased hotels.
General and administrative expenses are associated with the management of
hotels and consist primarily of centralized management expenses such as
operations management, sales and marketing, finance and other hotel support
services, as well as general corporate expenses. General and administrative
expenses remained constant at $3.8 million during the three-months periods and
decreased by $1.1 million, or 9.7%, from $11.4 million in the 1999 Nine Months
to $10.3 million in the 2000 Nine Months. During the 2000 Nine Months, the
Company incurred an expense for a $0.9 million deficiency between the amount of
premiums received as compared to actual and estimated claims incurred under the
Company's self-insured health and welfare plan. The corresponding deficiency
that was recorded by the Company during the 1999 Nine Months was $2.0 million.
General and administrative expenses as a percentage of revenues remained
constant at 5.7% during the three-month periods and decreased to 5.5% during the
2000 Nine Months compared to 6.2% during the 1999 Nine Months. This decrease was
due to the increase in total revenues and the decrease in general and
administrative expenses.
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Payroll and related benefits increased by $0.2 million, or 4.0%, from $4.9
million in the 1999 Three Months to $5.1 million in the 2000 Three Months and by
$1.0 million, or 6.7%, from $14.9 million in the 1999 Nine Months to $15.9
million in the 2000 Nine Months. This increase was due to the addition of the
Company's Chief Executive Officer and three marketing and development
vice-presidents who were hired after the Spin-off. Payroll and related benefits
as a percentage of revenues increased to 7.8% during the 2000 Three Months
compared to 7.5% during the 1999 Three Months and to 8.5% during the 2000 Nine
Months compared to 8.1% during the 1999 Nine Months.
Lease expense represents base rent and participating rent that is based on
a percentage of rooms and food and beverage revenues from the leased hotels,
adjusted for increases in the consumer price index. Lease expense decreased by
$0.7 million, or 2.9%, from $25.6 million in the 1999 Three Months to $24.9
million in the 2000 Three Months. In the nine-month periods, lease expense
decreased by $0.9 million, or 1.2%, from $70.1 million in the 1999 Nine Months
to $69.2 million in the 2000 Nine Months. During the 2000 Nine Months, the
Company paid additional incentive rent of $0.5 million to Equity Inns in
connection with the sale of one of the Company's leased hotels by Equity Inns.
The impact on lease expense related to the increase in lodging revenues was
offset by a $2.0 million one-time charge that was incurred by the Company in the
first quarter of 1999 for additional incentive rent paid in settlement of a
dispute with Equity Inns resulting from the Merger.
Depreciation and amortization decreased by $0.5 million, or 10.3%, from
$4.6 million in the 1999 Three Months to $4.1 million in the 2000 Three Months
and by $2.0 million, or 13.4%, from $14.7 million in the 1999 Nine Months to
$12.7 million in the 2000 Nine Months. In the fourth quarter of 1999, a $16.4
million non-cash impairment loss was incurred related to the Company's leased
hotel intangible assets and three leased hotels were sold by Equity Inns, both
of which events reduced amortization in 2000.
The loss on impairment of investment in hotel lease contracts of $12.6
million in 2000 represents a non-cash impairment loss related to the Company's
leased hotel intangible assets. As discussed in Note 6 to the consolidated
financial statements, the lease agreements for the 75 hotels leased from Equity
Inns will be terminated and the Company will enter into management agreements
for 54 of the hotels formerly leased to the Company effective as of January 1,
2001. This transaction resulted in a permanent impairment of the future
profitability of these hotels, based upon the remaining lease and anticipated
management contract terms. The Company believes that eliminating the risk of
potential operating losses in the future under the leases and replacing them the
management fee revenue will positively impact future cash flows and
profitability.
As a result of the changes noted above, an operating loss of $15.9 million
was incurred in the 2000 Three Months as compared to an operating loss of $2.5
million in the 1999 Three Months. In the nine-month periods, an operating loss
of $21.2 million was incurred in 2000 as compared to an operating loss of $7.8
million in 1999.
Other income in 1999 consisted primarily of equity in earnings from The
Charles Hotel Complex, which was sold on June 18, 1999.
Loss on sale of investment in hotel real estate in 1999 resulted from the
sale of the Company's equity interests in The Charles Hotel Complex.
Income tax expense (benefit) for both 1999 and 2000 was computed based on
an effective tax rate of 40% after reduction of minority interest, except for
the $0.9 million loss on the sale of equity interests in The Charles Hotel
Complex in 1999, which was allocated 100% to Wyndham.
Minority interest in 2000 reflects Wyndham's 55% non-controlling interest
in IH LLC that it retained after the Spin-off. In addition, in the 2000 Nine
Months an additional one-time $0.6 million was distributed to Wyndham. Minority
interest in 1999 reflects the $0.9 million loss on the sale of equity interests
in The Charles Hotel Complex that was allocated 100% to Wyndham, in addition to
Wyndham's 55% non-controlling interest in IH LLC.
As a result of the changes noted above, a net loss of $4.2 million was
incurred in the 2000 Three Months as compared to a net loss of $0.6 million in
the 1999 Three Months. In the nine-month periods, a net loss of $5.5 million was
incurred in 2000 as compared to a net loss of $2.6 million in 1999.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalent assets were $36.1 million at
September 30, 2000 compared to $22.4 million at December 31, 1999 and current
assets exceeded current liabilities by $15.9 million at September 30, 2000.
The Company's principal source of liquidity during the 2000 Nine Months was
cash from operations and proceeds from the issuance of long-term debt. Net cash
provided by operating activities was $12.8 million during the 2000 Nine Months
compared to $23.0 million during the 1999 Nine Months. The decrease resulted
primarily from a decrease in operating income (adjusted for non-cash items) of
$2.7 million from 1999 to 2000, and a decrease of $7.5 million in cash provided
by changes in assets and liabilities.
Net cash of $2.8 million was provided by financing activities during the
2000 Nine Months compared to $7.1 million during the 1999 Nine Months. In the
first quarter of 2000, the Company entered into a $7.6 million limited-recourse
mortgage note that is collateralized by the Pittsburgh Airport Residence Inn by
Marriott, which was acquired by the Company in November 1999. These proceeds
were offset by a $3.9 million payment to Wyndham in the second quarter of 2000
which represents Wyndham's 55% cash flow distribution from IH LLC for the period
from the Spin-off through December 31, 1999.
Net cash of $1.9 million was used by investing activities during the 2000
Nine Months compared to net cash of $5.2 million provided by investing
activities during the 1999 Nine Months. During the 1999 Nine Months, the Company
received $13.6 million of proceeds from the sale of equity interests in The
Charles Hotel Complex, which were offset by amounts paid in connection with the
Merger and Spin-off. The Company's capital expenditure budget for the year
ending December 31, 2000 relating to current operations is approximately
$150,000 consisting primarily of expenditures for office and telephone
equipment.
In accordance with the terms of IH LLC's limited liability company
agreement, the Company is required to distribute 55% of IH LLC's cash flows from
operations to Wyndham. The Company's required distribution to Wyndham for the
period from the January 1, 2000 through September 30, 2000 totaled $1.6 million.
In addition, the agreement requires the Company to allocate between IH LLC and
the Company the costs and expenses relating to services provided by one party
for the benefit of the other in accordance with generally accepted accounting
principles, on the basis of which party benefited from the expenditure. To the
extent that the allocation of any such costs and expenses, including general and
administrative expenses, cannot be fairly apportioned, IH LLC and the Company
will allocate such costs and expenses based upon their respective gross
revenues, so that each party's profit margins are substantially the same for
similar services. During the third quarter of 2000, the Company reached an
agreement with Wyndham with respect to such allocation of costs and expenses
between IH, LLC and the Company. As a result, the Company recorded a one-time
$0.6 million charge to minority interest in the second quarter, which represents
a settlement of expense allocations for the period from January 1, 2000 through
April 30, 2000.
On August 31, 2000, the Company also reached an agreement with Wyndham
providing for the redemption over time of Wyndham's entire 55% interest in IH
LLC for approximately $12.7 million. Pursuant to such agreement, on October 20,
2000, IH LLC's limited liability company agreement was amended and restated to
provide, among other things, that a) substantially all of Wyndham's interest in
IH LLC was converted to a preferred membership interest earning a quarterly
yield equal to the yield earned by the Company on certain escrowed funds until
the date of redemption of such preferred interest on or after July 1, 2001, and
b) the remainder of Wyndham's interest, comprising a 1.6627% common interest in
IH LLC, is entitled to receive its percentage share of cash distributions after
payment of the quarterly yield on Wyndham's preferred interest, until the date
of redemption of such common interest on or after July 1, 2004.
The Company intends to pursue future opportunities to manage or lease
hotels on behalf of third-party owners, including through its joint venture with
the Investor, as well as pursue other business opportunities, such as selective
hotel investments and the formation of strategic alliances. Such opportunities
may require capital investments by the Company. The Company believes that the
proceeds from the issuance of the Notes and Preferred Stock, together with the
credit facility, cash on hand and future cash flows from operations, will be
sufficient to pursue its business strategy and to fund its presently foreseeable
capital requirements.
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NEW ACCOUNTING PRONOUNCEMENT
In December 1999, the Securities and Exchange Commission (the "SEC") issued
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in Financial
Statements." This SAB summarizes and clarifies the SEC's position in applying
generally accepted accounting principles to revenue recognition in financial
statements. In June 2000, the SEC issued SAB No. 101B, "Second Amendment:
Revenue Recognition in Financial Statements," which extends the date that the
Company may report a change in accounting principle to no later than the fourth
quarter of 2000. Management is currently assessing the impact of this SAB on the
Company's consolidated financial statements.
FORWARD-LOOKING STATEMENTS
This Report contains certain forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995 and information based on
the beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management. When used herein,
words such as "anticipate," "believe," "estimate," "expect," "intend" and
similar expressions, as they relate to the Company or the Company's management,
are intended to identify these forward-looking statements. Such statements are
subject to certain risks and uncertainties that could cause the Company's
business and results of operations to differ materially from those reflected in
the Company's forward-looking statements.
Forward-looking statements are not guarantees of future performance. The
Company's forward-looking statements are based on trends that the Company's
management anticipates in the lodging industry and the effect on those trends of
such factors as industry capacity, the seasonal nature of the lodging industry
and product demand and pricing. In addition, such forward-looking statements are
subject to the Company's reversing the current negative trend in its business
and financial results.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The quantitative and qualitative disclosures required by this Item 3 and by
Rule 305 of SEC Regulation S-K are not applicable to the Company at this time.
Interest rate exposure on indebtedness is discussed in "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
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PART II--OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
The Company has amended its Rights Agreement, dated as of July 8, 1999, by
and between the Company and American Stock Transfer and Trust Company, as
transfer agent, to ensure that the transactions contemplated by the Securities
Purchase Agreement, including the conversion of the Notes and the Preferred
Stock into Class A Common Stock, will not result in a distribution of separate
rights certificates or the occurrence of a distribution date under the Rights
Agreement.
On October 20, 2000, the Company issued to the Investor 500,000 shares of
its Series B Convertible Preferred Stock for $5,000 in a private sale exempt
from registration under the Securities Act of 1933, as amended. The Preferred
Stock is convertible into Class A Common Stock of the Company at $4.00 per
share. For additional details of the terms of the Preferred Stock see Part I,
Item 2, "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Recent Developments." See also, including the description of
working capital restrictions and limitations on the payment of dividends, the
text under the headings "Notes" and "Preferred Stock" in the Company's Proxy
Statement on Schedule 14A filed with the Securities and Exchange Commission on
September 15, 2000 and incorporated herein by this reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of the stockholders of Interstate Hotels Corporation was
held on July 18, 2000. The stockholders of record at the close of business on
May 26, 2000 elected one Class A-1 Director to the Company's Board of Directors,
with votes cast as follows:
VOTES FOR VOTES WITHHELD
NOMINEE --------- --------------
J. William Richardson.................................... 4,962,277 18,628
In addition, Wyndham International, Inc. and PAH-Interstate Holdings, Inc.,
the holders of the Company's Class C Common Stock voted all their respective
Class C Shares in favor of the election of Fred J. Kleisner as the sole Class C
director. The following directors continued their term as directors: Michael L.
Ashner and Benjamin D. Holloway as Class A-2 directors; Thomas F. Hewitt and
Phillip H. McNeill, Sr. as Class A-3 directors; and Stephen P. Joyce as Class B
director.
The stockholders also voted to ratify the appointment of
PricewaterhouseCoopers LLP as the independent accountants to audit the financial
statements of the Company, with votes cast as follows: 4,949,460 votes for,
23,967 votes against and 7,477 votes abstained.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
3.1 Form of Articles Supplementary to the Charter of the Company
Designating the Series B Convertible Preferred Stock(1)
3.2 Second Amended and Restated Bylaws of the Company, adopted
and effective as of August 31, 2000 and amended as of
October 12, 2000
4.1 Amendment No. 1, effective as of August 31, 2000, to the
Rights Agreement, dated as of July 8, 1999, by and between
the Company and American Stock Transfer and Trust Company(2)
10.1 Conversion and Redemption Agreement, dated as of August 31,
2000, by and among Interstate Hotels, LLC, PAH-Interstate
Holdings, Inc., Wyndham International, Inc., Patriot
American Hospitality, Inc., Northridge Holdings, Inc. and
the Company(2)
10.2 Securities Purchase Agreement, dated as of August 31, 2000,
by and among the Company and CGLH Partners I LP and CGLH
Partners II LP(1)
10.3 Amended and Restated Employment Agreement, dated as of
August 31, 2000, by and between the Company and Kevin P.
Kilkeary
10.4 Amended and Restated Employment Agreement, dated as of
August 31, 2000, by and between the Company and J. William
Richardson(2)
10.5 Amended and Restated Employment Agreement, dated as of
August 31, 2000, by and between the Company and Thomas F.
Hewitt
10.6 Stockholders Agreement, dated as of August 31, 2000, by and
among Thomas F. Hewitt, J. William Richardson and Kevin P.
Kilkeary, as stockholders, and CGLH Partners I LP and CGLH
Partners II LP(2)
10.7 Form of 8.75% Subordinated Convertible Note due 2007(1)
10.8 Form of Investor Agreement by and among the Company and CGLH
Partners I LP and CGLH Partners II LP(1)
10.9 Form of Registration Rights Agreement by and among the
Company and CGLH Partners I LP and CGLH Partners II LP(2)
10.10 Form of Agreement of Limited Partnership of CGLH-IHC Fund I,
L.P. by and among CGLH Partners III LP, as managing general
partner, Interstate Investment Corporation, as general
partner, CGLH Partners IV LP, Interstate Property
Partnership, L.P., J. William Richardson and Thomas F.
Hewitt, as limited partners(2)
27.1 Financial Data Schedule
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(1) Filed previously as an appendix to the Company's Proxy Statement on
Schedule 14A for Special Meeting of Stockholders, dated September 15,
2000, and incorporated herein by reference.
(2) Filed previously as an exhibit to the Company's Current Report on 8-K,
dated August 31, 2000, and incorporated herein by reference.
(b) Reports on Form 8-K.
During the three months ended September 30, 2000, the Company filed a
Current Report on Form 8-K, dated August 31, 2000, under Item 5.
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SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this Report to be signed on its behalf
by the undersigned thereunto duly authorized.
INTERSTATE HOTELS CORPORATION
Date: November 14, 2000 By: /s/ J. WILLIAM RICHARDSON
------------------------------------
J. William Richardson
Vice Chairman and Chief Financial
Officer
(Principal Financial Officer)
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