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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
------------------------
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, 2001
------------------------
INTERSTATE HOTELS CORPORATION
FOSTER PLAZA TEN
680 ANDERSEN DRIVE
PITTSBURGH, PENNSYLVANIA 15220
(412) 937-0600
<Table>
MARYLAND 0-26805 75-2767215
(State of Incorporation) (Commission File No.) (I.R.S. Employer
Identification Number)
</Table>
The Company (1) has filed all reports 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 12, 2001 was as follows: Class A shares
5,487,885 and Class B shares 242,555.
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INDEX
INTERSTATE HOTELS CORPORATION
<Table>
<Caption>
PAGE NO.
--------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)............................ 2
Condensed Consolidated Balance Sheets - December 31, 2000
and September 30, 2001...................................... 2
Condensed Consolidated Statements of Operations - Three
Months and Nine Months Ended September 30, 2000 and
September 30, 2001.......................................... 3
Condensed Consolidated Statements of Cash Flows - Nine
Months Ended September 30, 2000 and September 30, 2001...... 4
Notes to Condensed Consolidated Financial Statements........ 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 14
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................... 15
Item 6. Exhibits and Reports on Form 8-K............................ 15
</Table>
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED).
INTERSTATE HOTELS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
(A) (UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 51,327 $ 36,971
Accounts receivable, net of allowance for doubtful
accounts of $542 in 2000 and
$245 in 2001............................................ 17,066 14,561
Deferred income taxes..................................... 1,891 2,378
Other current assets...................................... 1,587 899
-------- --------
Total current assets.................................. 71,871 54,809
Restricted cash............................................. 2,173 1,348
Marketable securities....................................... 2,289 2,376
Property and equipment, net................................. 15,084 14,665
Officers and employees notes receivable..................... 3,442 2,357
Affiliates notes receivable, net of reserve for
uncollectible notes receivable of $1,016 in 2000 and $666
in 2001................................................... 10,235 2,234
Equity investments in hotel real estate..................... 8,779 11,608
Deferred income taxes....................................... 3,086 6,200
Intangible and other assets................................. 27,014 22,594
-------- --------
Total assets.......................................... $143,973 $118,191
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable -- trade................................. 2,922 717
Accounts payable -- health trust.......................... 4,459 5,161
Accounts payable -- related parties....................... 2,473 2,601
Accrued payroll and related benefits...................... 9,992 4,901
Accrued rent.............................................. 5,227 263
Other accrued liabilities................................. 14,449 10,249
Current portion of long-term debt......................... 8,343 8,156
-------- --------
Total current liabilities............................. 47,865 32,048
Deferred compensation....................................... 2,289 2,376
Long-term debt.............................................. 36,820 32,851
-------- --------
Total liabilities..................................... 86,974 67,275
Minority interest........................................... 433 433
Mandatorily redeemable preferred stock...................... 4,708 5,317
Commitments and contingencies............................... -- --
Stockholders' equity:
Preferred stock, $.01 par value; 10,000,000 shares
authorized; no shares issued or outstanding at December
31, 2000 and September 30, 2001......................... -- --
Common stock, $.01 par value; 64,939,361 shares
authorized; 6,399,744 and 5,730,440 shares issued and
outstanding at December 31, 2000 and September 30, 2001,
respectively............................................ 64 57
Paid-in capital........................................... 66,725 64,947
Retained deficit.......................................... (14,931) (19,838)
-------- --------
Total stockholders' equity............................ 51,858 45,166
-------- --------
Total liabilities and stockholders' equity............ $143,973 $118,191
======== ========
</Table>
- ---------------
(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.
2
INTERSTATE HOTELS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2000 2001 2000 2001
---------- ---------- ---------- ----------
Lodging revenues:
Rooms.................................... $ 52,971 $ 1,182 $ 147,879 $ 3,633
Other departmental....................... 3,089 41 8,983 114
Net management fees........................ 6,856 5,689 20,901 18,569
Other fees................................. 2,938 3,148 8,566 11,093
---------- ---------- ---------- ----------
65,854 10,060 186,329 33,409
---------- ---------- ---------- ----------
Lodging expenses:
Rooms.................................... 13,027 295 35,492 865
Other departmental....................... 1,962 21 5,471 66
Property costs........................... 16,337 410 45,891 1,231
General and administrative................. 3,779 2,745 10,251 8,493
Payroll and related benefits............... 5,132 4,516 15,885 15,334
Lease expense.............................. 24,851 192 69,228 474
Depreciation and amortization.............. 4,145 2,685 12,733 8,085
Loss on impairment of investment in hotel
lease contracts.......................... 12,550 -- 12,550 --
---------- ---------- ---------- ----------
81,783 10,864 207,501 34,548
---------- ---------- ---------- ----------
Operating loss............................. (15,929) (804) (21,172) (1,139)
Other income (expense):
Interest, net............................ 463 (560) 1,447 (792)
Other, net............................... -- 20 24 36
Losses from equity investments in hotel
real estate........................... (4) (2,576) (4) (2,258)
Loss on impairment of equity investment
in hotel real estate.................. -- (3,026) -- (3,026)
---------- ---------- ---------- ----------
Loss before income tax benefit............. (15,470) (6,946) (19,705) (7,179)
Income tax benefit......................... (2,771) (2,795) (3,648) (2,924)
---------- ---------- ---------- ----------
Loss before minority interest.............. (12,699) (4,151) (16,057) (4,255)
Minority interest.......................... (8,543) 40 (10,585) 130
---------- ---------- ---------- ----------
Net loss................................... (4,156) (4,191) (5,472) (4,385)
Mandatorily redeemable preferred stock:
Dividends................................ -- 158 -- 476
Accretion................................ -- 16 -- 46
---------- ---------- ---------- ----------
Net loss available to common
stockholders............................. $ (4,156) $ (4,365) $ (5,472) $ (4,907)
========== ========== ========== ==========
Loss per common share and common share
equivalent:
Basic.................................... $ (.66) $ (.72) $ (.88) $ (.77)
========== ========== ========== ==========
Diluted.................................. $ (.66) (.72)$ $ (.88) $ (.77)
========== ========== ========== ==========
Weighted average number of common share and
common share equivalents outstanding:
Basic.................................... 6,306,436 6,059,627 6,208,211 6,358,364
========== ========== ========== ==========
Diluted.................................. 6,306,436 6,059,627 6,208,211 6,358,364
========== ========== ========== ==========
</Table>
The accompanying notes are an integral part of the consolidated financial
statements.
3
INTERSTATE HOTELS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
2000 2001
-------- --------
Cash flows from operating activities:
Net loss.................................................. $ (5,472) $ (4,385)
Adjustments to reconcile net loss to net cash from
operating activities:
Depreciation and amortization.......................... 12,733 8,085
Losses from equity investments in hotel real estate.... 4 2,258
Loss on impairment of investment in hotel lease
contracts............................................. 12,550 --
Loss on impairment of equity investment in hotel real
estate................................................ -- 3,026
Minority interest...................................... (10,585) 130
Deferred income taxes.................................. (4,670) (3,601)
Amortization of mandatorily redeemable preferred
stock................................................. -- 563
Other.................................................. 1,283 385
Cash (used in) provided by assets and liabilities:
Accounts receivable, net............................... (1,484) 2,805
Other current assets................................... (333) 388
Accounts payable....................................... (276) (6,596)
Accrued liabilities.................................... 9,042 (9,479)
-------- --------
Net cash provided by (used in) operating
activities.......................................... 12,792 (6,421)
-------- --------
Cash flows from investing activities:
Change in restricted cash................................. (53) 825
Purchases of property and equipment, net.................. (350) (469)
Purchases of marketable securities........................ (1,806) (2,475)
Proceeds from sale of marketable securities............... 1,783 2,791
Net cash invested for equity investments in hotel real
estate................................................. (750) (8,112)
Change in officers and employees notes receivable, net.... (94) 1,085
Net investment in management contracts.................... (320) (471)
Change in affiliates notes receivable, net................ (248) 8,001
Deposits and other........................................ (88) (1,200)
-------- --------
Net cash used in investing activities................ (1,926) (25)
-------- --------
Cash flows from financing activities:
Proceeds from long-term debt.............................. 7,560 4,169
Repayment of long-term debt............................... (55) (8,325)
Financing fees paid....................................... (87) (1,491)
Proceeds from issuance of common stock.................... -- 214
Dividends paid on mandatorily redeemable preferred
stock.................................................. -- (476)
Accounts payable -- related parties....................... (4,591) (1)
Common stock repurchased and retired...................... -- (2,000)
-------- --------
Net cash provided by (used in) financing
activities.......................................... 2,827 (7,910)
-------- --------
Net increase (decrease) in cash and cash equivalents........ 13,693 (14,356)
Cash and cash equivalents at beginning of period............ 22,440 51,327
-------- --------
Cash and cash equivalents at end of period.................. $ 36,133 $ 36,971
======== ========
</Table>
The accompanying notes are an integral part of the consolidated financial
statements.
4
INTERSTATE HOTELS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION AND BASIS OF PRESENTATION:
Interstate Hotels Corporation (the "Company") was formed on June 18, 1999,
pursuant to a series of events culminating in the spin-off of the Company's
operations from Wyndham International, Inc. ("Wyndham") (the "Spin-off"). As of
September 30, 2001, the Company managed or performed related services for 133
hotels with a total of 28,171 rooms in 36 states in the United States, and in
Canada, the Caribbean and Russia. These hotels are operated under a number of
franchise agreements, with the largest franchisors being Marriott International,
Inc. and Promus Hotels, Inc. The Company wholly owns one of these properties,
the 156-suite Pittsburgh Airport Residence Inn by Marriott (the "Owned Hotel"),
and has non-controlling equity interests in 11 of these hotels.
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 (the "SEC"). 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 for the year ended December 31, 2000.
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 accepted accounting principles requires the Company's 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.
2. ACQUISITIONS:
On March 27, 2001, the Company acquired a non-controlling 0.5% general
partnership interest and a non-controlling 49.5% limited partnership interest in
a limited partnership that owns eight mid-scale hotels, for a total acquisition
cost, including closing costs, of approximately $8,548. FelCor Lodging Trust
Incorporated ("FelCor") owns the remaining 50% of the partnership. The eight
hotels are: Fairfield Inn Scottsdale-Downtown, Arizona; Courtyard by Marriott
Atlanta-Downtown, Georgia; Fairfield Inn Atlanta-Downtown, Georgia; Fairfield
Inn Dallas-Regal Row, Texas; Courtyard by Marriott Houston-Near the Galleria,
Texas; Fairfield Inn Houston-Near the Galleria, Texas; Fairfield Inn Houston
I-10-East, Texas; and Hampton Inn Houston I-10-East, Texas. The hotels are
leased to newly formed entities also owned 50% by FelCor and 50% by the Company,
and have been managed by Crossroads Hospitality Management Company, a subsidiary
of the Company, since January 1, 2001.
The Company used cash on hand of $4,378 and a $4,170 promissory note from
FelCor to fund the acquisition. The promissory note pays interest at the rate of
12% per annum and the principal balance is due and payable on December 31, 2010.
The Company is accounting for this investment using the equity method of
accounting. Pro forma financial information of the Company has not been
presented as this transaction would not materially differ the historical
financial statements presented herein.
3. EARNINGS PER SHARE:
Basic earnings per common share was calculated by dividing net loss
available to common stockholders by the weighted average number of shares of
common shares outstanding. Diluted earnings per common share
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
3. EARNINGS PER SHARE--CONTINUED:
assumes the issuance of common stock for all potentially dilutive equivalents
outstanding. The effect of the conversion of the Company's Subordinated
Convertible Notes and the Series B Convertible Preferred Stock into Class A
Common Stock and the Class A shares issuable upon the exercise of outstanding
stock options are considered to be anti-dilutive. The details of basic and
diluted earnings per common share for the three-and nine-month periods ended
September 30, 2000 and 2001 were as follows:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2000 2001 2000 2001
---------- ---------- ---------- ----------
Net loss available to common stockholders... $ (4,156) $ (4,365) $ (5,472) $ (4,907)
---------- ---------- ---------- ----------
Weighted average number of common shares
outstanding............................... 6,306,436 6,059,627 6,208,211 6,358,364
---------- ---------- ---------- ----------
Basic earnings (loss) per common share...... $ (.66) $ (.72) $ (.88) $ (.77)
---------- ---------- ---------- ----------
Shares issuable upon exercise of dilutive
outstanding stock options................. -- -- -- --
---------- ---------- ---------- ----------
Weighted average number of diluted common
shares outstanding........................ 6,306,436 6,059,627 6,208,211 6,358,364
---------- ---------- ---------- ----------
Diluted earnings (loss) per common share.... $ (.66) $ (.72) $ (.88) $ (.77)
========== ========== ========== ==========
</Table>
4. LOSS ON IMPAIRMENT OF EQUITY INVESTMENT IN HOTEL REAL ESTATE:
The loss on impairment of equity investment in hotel real estate of $3,026
in the third quarter of 2001 represents a non-cash impairment loss related to
the Company's 20% non-controlling interest in a partnership that owns the
Renaissance Worldgate Hotel in Kissimmee, Florida. The impairment loss was the
result of a permanent impairment of the future profitability of this hotel.
Since acquisition in the fourth quarter of 2000, the hotel has experienced lower
than expected operating cash flows, primarily due to decreased occupancy rates
and average daily room rates. In addition, the weakness in the U.S. economy
during 2001 coupled with the severe downturn in the Florida lodging market after
the September 11th terrorist attacks have resulted in significant financial
difficulties for the hotel. The hotel is currently unable to satisfy its debt
service obligations and is in discussions with its lenders to resolve current
mortgage defaults. The Company's management anticipates the possibility of a
foreclosure action against the hotel and does not expect the hotel to recover
from this situation in the foreseeable future. As a result, the Company's
management believes that the recoverability of the Company's equity investment
in this hotel is unlikely and is uncertain as to whether the Company will retain
its 20% non-controlling interest in the partnership that owns the hotel. As of
September 30, 2001, the Company's accounts receivable related to this hotel
amounted to approximately $984, which primarily relates to the reimbursement of
costs.
The majority owners and the principle lender for the hotel have
representation on the Company's board of directors and are affiliated with the
holders of the Subordinated Convertible Notes and the Series B Convertible
Preferred Stock.
5. COMMITMENTS AND CONTINGENCIES:
The Company has committed to invest $25,000 of the total proceeds received
from the issuance of the Company's Subordinated Convertible Notes and the Series
B Convertible Preferred Stock into a joint venture with entities affiliated with
Lehman Brothers Holdings Inc. Such amount is expected to be invested
concurrently with the closings of hotel property acquisitions.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. 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 primarily derives revenues from management
fees and certain specialized support services, as well as the operating revenues
from the Owned Hotel.
The table below presents revenue and operating income (loss) information
for each reportable segment for the three- and nine-month periods ended
September 30, 2000 and 2001.
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
2000 2001 2000 2001
-------- ------- -------- -------
REVENUES:
Luxury and Upscale Hotels..................... $ 8,678 $ 7,064 $ 26,144 $23,632
Mid-Scale, Upper Economy and Budget
Hotels(1)................................... 57,176 2,996 160,185 9,777
-------- ------- -------- -------
Consolidated totals......................... $ 65,854 $10,060 $186,329 $33,409
======== ======= ======== =======
OPERATING INCOME (LOSS):
Luxury and Upscale Hotels..................... $ (1,122) $ (332) $ (3,724) $(1,008)
Mid-Scale, Upper Economy and Budget
Hotels(1)................................... (14,807) (472) (17,448) (131)
-------- ------- -------- -------
Consolidated totals......................... $(15,929) $ (804) $(21,172) $(1,139)
======== ======= ======== =======
</Table>
- ---------------
(1) The 2000 amounts include the operating revenues and expenses of previously
leased hotels that are no longer reflected in the financial statements of
the Company as a result of the Equity Inns Conversion. In 2001, the Company
records revenues earned from management fees only. See Item 2, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
for information on the Equity Inns Conversion.
Depreciation and amortization included in segment operating income (loss)
information for the three-and nine-month periods ended September 30, 2000 and
2001 were as follows:
<Table>
<Caption>
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ------------------
2000 2001 2000 2001
------ ------ -------- -------
Luxury and Upscale Hotels........................ $3,303 $2,172 $ 9,937 $6,579
Mid-Scale, Upper Economy and Budget Hotels....... 842 513 2,796 1,506
------ ------ ------- ------
Consolidated totals............................ $4,145 $2,685 $12,733 $8,085
====== ====== ======= ======
</Table>
The net book value of intangible and other assets and equity investments in
hotel real estate by segment consisted of the following at December 31, 2000 and
September 30, 2001:
<Table>
<Caption>
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
Luxury and Upscale Hotels................................... $30,524 $20,854
Mid-Scale, Upper Economy and Budget Hotels.................. 5,269 13,348
------- -------
Consolidated totals....................................... $35,793 $34,202
======= =======
</Table>
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. SEGMENT INFORMATION--CONTINUED:
The following table reconciles the Company's measure of operating income
(loss) to consolidated net income (loss) for the three- and nine-month periods
ended September 30, 2000 and 2001.
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
2000 2001 2000 2001
-------- -------- -------- -------
Total after-tax operating income (loss)...... $(9,559) $ (482) $(12,703) $ (683)
Unallocated amounts, net of tax:
Interest, net.............................. 278 (336) 868 (475)
Other, net................................. -- 12 14 22
Loss from equity investments in hotel real
estate.................................. (2) (1,545) (2) (1,355)
Loss on impairment of equity investment in
hotel real estate....................... -- (1,816) -- (1,816)
Minority interest.......................... 5,127 (24) 6,351 (78)
------- ------- -------- -------
Consolidated net income (loss)............... $(4,156) $(4,191) $ (5,472) $(4,385)
======= ======= ======== =======
</Table>
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The Company has been adversely affected by the events of September 11th and
the aftermath of the terrorist attacks on the United States. Since the attacks,
the Company's managed hotels have experienced significant short-term declines in
occupancy compared to the same period in 2000. At present, it is not possible to
predict either the severity or duration of such declines in the near- or
long-term or the potential impact on the Company's results of operations,
financial condition or cash flows. Weaker hotel performance would reduce
management fees and could give rise to additional losses under minority
investments that were made in connection with hotels that the Company manages,
which could, in turn, have an adverse impact on the Company's financial
performance. The Company's management is currently unable to estimate the extent
of the impact that the terrorist attacks could have on the Company's operations,
liquidity or capital resources.
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2000
Lodging revenues consist of rooms, food and beverage and other departmental
revenues from the Owned Hotel and one leased hotel. Lodging revenues decreased
by $54.9 million, or 97.8%, from $56.1 million in the three months ended
September 30, 2000 (the "2000 Three Months") to $1.2 million in the three months
ended September 30, 2001 (the "2001 Three Months") and by $153.2 million, or
97.6%, from $156.9 million in the nine months ended September 30, 2000 (the
"2000 Nine Months") to $3.7 million in the nine months ended September 30, 2001
(the "2001 Nine Months"). Pursuant to a Master Lease Termination Agreement dated
September 12, 2000 between the Company and Equity Inns, Inc. ("Equity Inns"),
all of the lease agreements for 75 hotels previously leased from Equity Inns
were terminated effective January 1, 2001, and the Company and Equity Inns
simultaneously entered into management agreements for 54 of the hotels formerly
leased to the Company (the "Equity Inns Conversion"). As a result, effective
January 1, 2001, the operating revenues of these hotels are no longer reflected
in the financial statements of the Company. Instead, the Company records
revenues from management fees only. During 2000, the Company recorded lodging
revenues of $54.6 million in the three-month period and $152.7 million in the
nine-month period related to these leased hotels.
Net management fees decreased by $1.2 million, or 17.0%, from $6.9 million
in the 2000 Three Months to $5.7 million in the 2001 Three Months and by $2.3
million, or 11.2%, from $20.9 million in the 2000 Nine Months to $18.6 million
in the 2001 Nine Months.
During 2001, the Company earned lower base and incentive management fee
revenue on its hotels in the luxury and upscale hotel segment. Net management
fees earned from hotels in this segment decreased by $1.8 million and $4.5
million in the three- and nine-month periods. Pursuant to the Company's
redemption of substantially all of Wyndham's 55% non-controlling ownership
interest in Interstate Hotels, LLC ("IH LLC") in the fourth quarter of 2000, the
Company's management agreements for seven Wyndham-owned hotels were terminated.
During 2000, the Company earned management fee revenue of $0.6 million in the
three-month period and $1.9 million in the nine-month period from these hotels.
In addition, lower management fee revenue was earned from hotels in this segment
due to the weakness in the U.S. economy during the first three quarters of 2001
and significant declines in occupancy following the September 11th terrorist
attacks.
During 2001, net management fees earned from hotels in the mid-scale, upper
economy and budget hotel segment increased by $0.6 million and $2.2 million in
the three- and nine-month periods, respectively. This increase was primarily due
to additional management fee revenue of $0.4 million during the 2001 Three
Months and $1.2 million during the 2001 Nine Months earned from hotels as a
result of the Equity Inns Conversion, as discussed above.
In accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition
in Financial Statements," base and incentive management fees are accrued as
earned based on the profitability of the hotel, subject to the specific terms of
each individual management agreement.
9
Other fees increased by $0.2 million, or 7.1%, from $2.9 million in the
2000 Three Months to $3.1 million in the 2001 Three Months and by $2.5 million,
or 29.5%, from $8.6 million in the 2000 Nine Months to $11.1 million in the 2001
Nine Months. This increase was partially due to additional accounting fee
revenue of $0.5 million during the 2001 Nine Months earned from hotels as a
result of the Equity Inns Conversion, as discussed above. In addition, insurance
income increased by $1.1 million during the 2001 Nine Months as a result of an
increase in insurance premium revenue.
Lodging expenses consist of rooms, food and beverage, property costs and
other departmental expenses from the Owned Hotel and one leased hotel. Lodging
expenses decreased by $30.6 million, or 97.7%, from $31.3 million in the 2000
Three Months to $0.7 million in the 2001 Three Months and by $84.7 million, or
97.5%, from $86.9 million in the 2000 Nine Months to $2.2 million in the 2001
Nine Months. As a result of the Equity Inns Conversion, effective January 1,
2001, the operating expenses of the previously leased hotels are no longer
reflected in the financial statements of the Company. Instead, the Company
records revenues from management fees only. During 2000, the Company recorded
lodging expenses of $30.5 million in the three-month period and $84.6 million in
the nine-month period related to these 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 decreased by $1.1 million, or 27.4%, from $3.8 million in the 2000
Three Months to $2.7 million in the 2001 Three Months and by $1.8 million, or
17.1%, from $10.3 million in the 2000 Nine Months to $8.5 million in the 2001
Nine Months. During 2000, the Company incurred $0.7 million of expenses for
reserves for doubtful accounts related to notes receivable. The Company incurred
no such expenses during 2001. In addition, the Company incurred expenses during
2000 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 Company incurred no such deficiency
during 2001. General and administrative expenses as a percentage of revenues
increased to 27.3% during the 2001 Three Months compared to 5.7% during the 2000
Three Months and to 25.4% during the 2001 Nine Months compared to 5.5% during
the 2000 Nine Months. This increase was due to the decrease in total revenues
resulting from the Equity Inns Conversion.
Payroll and related benefits decreased by $0.6 million, or 12.0%, from $5.1
million in the 2000 Three Months to $4.5 million in the 2001 Three Months and by
$0.6 million, or 3.5%, from $15.9 million in the 2000 Nine Months to $15.3
million in the 2001 Nine Months. During the third quarter of 2001, the Company
reversed $0.3 million of variable plan stock option expense that was incurred by
the Company during the first two quarters of 2001. This reversal was recorded as
a result of a decline in the Company's stock price following the September 11th
terrorist attacks. In future periods, fluctuations in the Company's stock price
may have a non-cash effect on the future results of operations under variable
plan accounting for stock options. During 2001, the Company also incurred lower
expenses related to bonuses for executives and key employees. These expenses
decreased by $0.5 million and $1.0 million in the three- and nine-month periods,
respectively. Payroll and related benefits as a percentage of revenues increased
to 44.9% during the 2001 Three Months compared to 7.8% during the 2000 Three
Months and to 45.9% during the 2001 Nine Months compared to 8.5% during the 2000
Nine Months. This increase was due to the decrease in total revenues resulting
from the Equity Inns Conversion.
Lease expense represents base rent and participating rent that is based on
a percentage of rooms and food and beverage revenues from one leased hotel.
Lease expense decreased by $24.7 million, or 99.3%, from $24.9 million in the
2000 Three Months to $0.2 million in the 2001 Three Months and by $68.7 million,
or 99.2%, from $69.2 million in the 2000 Nine Months to $0.5 million in the 2001
Nine Months. As a result of the Equity Inns Conversion effective January 1,
2001, the Company no longer incurs lease expense related to the previously
leased hotels.
Depreciation and amortization decreased by $1.4 million, or 35.2%, from
$4.1 million in the 2000 Three Months to $2.7 million in the 2001 Three Months
and by $4.6 million, or 36.5%, from $12.7 million in the 2000 Nine Months to
$8.1 million in the 2001 Nine Months. This decrease was partially due to the
Equity Inns Conversion that resulted in a non-cash impairment loss of $12.6
million in 2000 related to the carrying
10
value of the Company's long-term intangible assets. This loss reduced the
Company's investment in lease agreements and resulted in decreased amortization
of $0.9 million in the 2001 Nine Months. In addition, during the fourth quarter
of 2000, the Company redeemed from affiliates of Wyndham substantially all of
their 55% non-controlling ownership interest in IH LLC, a subsidiary of the
Company, that Wyndham retained after the Spin-off. This redemption resulted in a
$14.1 million reduction of the carrying value of long-term intangible assets
related to the Company's investment in management agreements and resulted in
decreased amortization of $3.9 million in the 2001 Nine Months.
As a result of the changes noted above, an operating loss of $0.8 million
was incurred in the 2001 Three Months as compared to an operating loss of $15.9
million in the 2000 Three Months. In the nine-month periods, an operating loss
of $1.1 million was incurred in 2001 as compared to an operating loss of $21.2
million in 2000.
Net interest income of $0.5 million was recorded in the 2000 Three Months
as compared to net interest expense of $0.6 million in the 2001 Three Months
primarily due to $0.5 million of incremental interest expense that was incurred
by the Company related to the $25.0 million Subordinated Convertible Notes. In
the nine-month periods, net interest income of $1.4 million was recorded in 2000
as compared to net interest expense of $0.8 million in 2001.
Losses from equity investments in hotel real estate of $2.6 million in the
2001 Three Months and $2.3 million in the 2001 Nine Months consisted of losses
incurred by the Company related to four non-controlling equity investments in 11
hotels. These losses were incurred by the hotels due to the weakness in the U.S.
economy during the first three quarters of 2001 and significant declines in
occupancy following the September 11th terrorist attacks.
The loss on impairment of equity investment in hotel real estate of $3.0
million in the third quarter of 2001 represents a non-cash impairment loss
related to the Company's 20% non-controlling interest in a partnership that owns
the Renaissance Worldgate Hotel in Kissimmee, Florida. The impairment loss was
the result of a permanent impairment of the future profitability of this hotel.
Since acquisition in the fourth quarter of 2000, the hotel has experienced lower
than expected operating cash flows, primarily due to decreased occupancy rates
and average daily room rates. In addition, the weakness in the U.S. economy
during 2001 coupled with the severe downturn in the Florida lodging market after
the September 11th terrorist attacks have resulted in significant financial
difficulties for the hotel. The hotel is currently unable to satisfy its debt
service obligations and is in discussions with its lenders to resolve current
mortgage defaults. The Company's management anticipates the possibility of a
foreclosure action against the hotel and does not expect the hotel to recover
from this situation in the foreseeable future. As a result, the Company's
management believes that the recoverability of the Company's equity investment
in this hotel is unlikely and is uncertain as to whether the Company will retain
its 20% non-controlling interest in the partnership that owns the hotel.
Income tax expense (benefit) for 2000 and 2001 was computed based on an
effective tax rate of 40% after reduction of minority interest.
Minority interest in 2000 reflected Wyndham's 55% non-controlling interest
in IH LLC. Minority interest in 2001 reflected the reduction of Wyndham's common
interest in IH LLC in the fourth quarter of 2000 to a 1.6627% interest, as
discussed above.
As a result of the changes noted above, a net loss of $4.2 million was
incurred in the three-month periods of 2001 and 2000. In the nine-month periods,
a net loss of $4.4 million was incurred in 2001 as compared to a net loss of
$5.5 million in 2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalent assets were $37.0 million at
September 30, 2001 compared to $51.3 million at December 31, 2000, and current
assets exceeded current liabilities by $22.8 million at September 30, 2001
compared to $24.0 million at December 31, 2000. The Company has committed to
invest
11
$25.0 million of its cash and cash equivalents into a joint venture with
entities affiliated with Lehman Brothers Holdings Inc.
In 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. The mortgage note contains
restrictive covenants, including financial ratios, which are required to be
maintained by the Company as borrower and guarantor. As of September 30, 2001,
the Company was not in compliance with the minimum net worth covenant of the
guarantor. Therefore, the Company has classified the full amount of the mortgage
note as current portion of long-term debt on the consolidated balance sheet as
of September 30, 2001. The Company's management is currently in discussions with
the lender to waive such covenant and expects to obtain a waiver of compliance.
Net cash used in operating activities was $6.4 million during the 2001 Nine
Months compared to net cash provided by operating activities of $12.8 million
during the 2000 Nine Months. The decrease resulted primarily from an increase in
operating income (adjusted for non-cash items) of $0.6 million from 2000 to
2001, offset by a decrease of $19.8 million in cash used in changes in assets
and liabilities, primarily as a result of the payment of accrued rent and other
current liabilities associated with the previously leased hotels.
Net cash used in investing activities was $0.1 million during the 2001 Nine
Months compared to net cash used in investing activities of $1.9 million during
the 2000 Nine Months. In March 2001, the Company invested $8.7 million for a 50%
non-controlling equity interest in eight hotels. In August 2001, the Company
received an aggregate repayment of $8.3 million on two notes receivable made by
the owner of The Charles Hotel Complex in favor of the Company in 1999. The
Company's capital expenditure budget for the year ending December 31, 2001 is
approximately $0.5 million consisting primarily of expenditures for computer and
systems-related equipment. In addition, the Company has committed to invest
$25.0 million of the total proceeds received from the issuance of the $25.0
million Subordinated Convertible Notes and the $5.0 million Series B Convertible
Preferred Stock into a joint venture with entities affiliated with Lehman
Brothers Holdings Inc. Such amount is expected to be invested concurrently with
the closings of hotel property acquisitions by the joint venture. As of November
12, 2001, no amounts have been invested.
During the third quarter of 2001, the Company recorded a non-cash
impairment loss of $3.0 million related to the Company's 20% non-controlling
interest in a partnership that owns the Renaissance Worldgate Hotel in
Kissimmee, Florida. The impairment loss was the result of a permanent impairment
of the future profitability of this hotel. Since acquisition in the fourth
quarter of 2000, the hotel has experienced lower than expected operating cash
flows, primarily due to decreased occupancy rates and average daily room rates.
In addition, the weakness in the U.S. economy during 2001 coupled with the
severe downturn in the Florida lodging market after the September 11th terrorist
attacks have resulted in significant financial difficulties for the hotel. The
hotel is currently unable to satisfy its debt service obligations and is in
discussions with its lenders to resolve current mortgage defaults. The Company's
management anticipates the possibility of a foreclosure action against the hotel
and does not expect the hotel to recover from this situation in the foreseeable
future. As a result, the Company's management believes that the recoverability
of the Company's equity investment in this hotel is unlikely and is uncertain as
to whether the Company will retain its 20% non-controlling interest in the
partnership that owns the hotel.
As of September 30, 2001, the Company's accounts receivable related to this
hotel amounted to approximately $1.0 million, which primarily relates to the
reimbursement of costs. The Company's management currently believes that the
accounts receivable will be collected, however, there can be no assurance that
the amounts will be collected or, if so, the timing or terms thereof. The
Company's management will continue to evaluate the collectibility of the
accounts receivable on a quarterly basis. The majority owners and the principle
lender for the hotel have representation on the Company's board of directors and
are affiliated with the holders of the Subordinated Convertible Notes and the
Series B Convertible Preferred Stock.
Net cash used in financing activities was $7.9 million during the 2001 Nine
Months compared to net cash provided by financing activities of $2.8 million
during the 2000 Nine Months. In March 2001, the Company entered into a $4.2
million promissory note to fund the acquisition of a 50% non-controlling equity
interest in eight hotels. Interest on the note is payable monthly at the rate of
12% per annum and the outstanding
12
principal balance is due and payable on December 31, 2010. In July 2001, the
Company paid $8.25 million plus accrued interest to Wyndham in connection with
the Company's redemption of Wyndham's preferred membership interest in IH LLC.
In accordance with the terms of IH LLC's limited liability company
agreement, and prior to the execution of the redemption of substantially all of
Wyndham's 55% non-controlling interest, the Company was required to distribute
55% of IH LLC's cash flows from operations to Wyndham through October 31, 2000.
Thereafter, the Company is required to distribute 1.6627% of IH LLC's cash flows
from operations based on Wyndham's remaining common interest in IH LLC. The
Company's required distribution to Wyndham for the period from January 1, 2000
through October 31, 2000 totaled $2.5 million and is expected to be paid in the
fourth quarter of 2001.
In February 2001, the Company's Board of Directors approved a stock
repurchase program providing for the purchase of shares of its Class A Common
Stock. Through the third quarter of 2001, the Company purchased, and
subsequently cancelled, 826,000 shares of its Class A Common Stock for an
aggregate purchase price of approximately $2.0 million.
During the third quarter of 2001, the Company entered into a $40.0 million
senior secured credit facility co-arranged by Lehman Brothers Holdings Inc.,
d/b/a Lehman Capital, and Credit Lyonnais New York Branch. The credit facility,
which may be used to obtain management agreements for hotel properties and to
finance the acquisition of hotel properties, has a two-year term and carries
varying rates of interest. In addition to mandatory prepayment provisions, the
credit facility contains restrictive covenants, including the maintenance of
financial ratios, restrictions on the payment of dividends, restrictions on the
imposition of liens and limitations on additional indebtedness. As of November
12, 2001, there were no borrowings against the credit facility and the Company
was in compliance with all of the restrictive covenants. While there exists a
technical default under the credit facility as a result of the covenant
non-compliance under the Pittsburgh Residence Inn by Marriott mortgage note, the
Company's management expects to obtain a waiver of compliance with the covenant
and, upon obtaining such waiver, the full amount of availability under the
credit facility will be restored.
The Company intends to pursue future opportunities to manage hotels on
behalf of third-party owners, including through the joint venture, 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 Subordinated Convertible Notes and the Series B Convertible
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.
NEW ACCOUNTING PRONOUNCEMENTS
During the second quarter of 2001, the SEC proposed an announcement,
"Accounting for Management Fees Based on a Formula." This pronouncement is
consistent with the Company's method of recognizing incentive management fee
revenue. No significant financial impact is expected as a result of this
pronouncement.
The Financial Accounting Standards Board (the "FASB") issued Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets," on June 30, 2001. Management is currently investigating the impact of
this new pronouncement on the accounting for its intangible assets. Management
does not expect the implementation of this new pronouncement to have a
significant impact on the Company's financial position or its results of
operation.
The FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," on August 15, 2001, and SFAS No. 144, "Accounting for the
Impairment of Disposal of Long-Lived Assets," on October 4, 2001. These
pronouncements will be adopted in 2002 and management of the Company does not
expect the implementation of these new pronouncements to impact the Company's
financial position or its results of operations.
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FORWARD-LOOKING STATEMENTS
In addition to historical information, this Report contains 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 or phrases such as "will likely result,"
"are expected to," "will continue," "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 by
such factors as industry capacity, the seasonal nature of the lodging industry
and product demand and pricing.
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 material to the Company at this time. The
Company does not have any foreign currency or commodities contracts. Interest
rates governing the majority of the Company's outstanding debt are fixed and
therefore not subject to market risk.
The Company's current investment policy is to invest in highly liquid
investments with a maturity of 90 days or less. Such financial instruments
consist of cash and cash equivalents, individual municipal bonds and corporate
government bonds. The Company believes it minimizes its risk through proper
diversification along with the requirements that the securities must be of
investment grade with an average rating of "A" or better by the Standard and
Poor's. The Company believes that earnings and cash flows are not materially
affected by changes in interest rates, due to the nature and short-term
investment horizon for which these securities are invested.
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In January 2001, Columbus Hotels Properties, LLC sought termination of
eight hotel management agreements and a master agreement between it and a
subsidiary of the Company. In response to this attempt to terminate the
agreements, the Company filed a demand for arbitration with the American
Arbitration Association. Following the Company's demand for arbitration,
Columbus Hotel Properties, LLC and Corporate Capital, LLC commenced an action
against Interstate Hotels Company, Crossroads Hospitality Company (sic) and
Crossroads Hospitality Management Company, which are subsidiaries of the
Company, on March 22, 2001 in the Civil District Court for the Parish of Orleans
in the State of Louisiana. The action alleges, among other things, fraudulent
misrepresentations inducing the plaintiff to enter into a master agreement and
certain hotel management agreements and to purchase the Company's common stock.
In addition, the action alleges gross negligence in defendants' performance
under those agreements and breach of the agreements and fiduciary duties to the
plaintiffs. The action seeks, among other things, compensatory and consequential
damages in such amounts as may be determined by a jury, termination of the
agreements and a rescission of certain transactions between the parties.
On September 30, 1999, Chisholm Properties South Beach, Inc. ("Chisholm")
terminated the management agreement between it and a subsidiary of the Company
relating to the Surfcomber Hampton Inn in Miami Beach, Florida. Subsequently,
Chisholm filed a demand with the American Arbitration Association alleging
breach of contract. Specifically, the arbitration demand alleges, among other
things, failure to adequately market the hotel, commission of accounting and
management errors, and wrongful retention of a contractually agreed-upon
termination fee. Chisholm's claim seeks compensatory and consequential lost
profits damages in such amounts as may be determined by the panel of
arbitrators.
The parties completed two weeks of arbitration hearings in October 2001.
Another two weeks of hearings are scheduled for December 2001 and, if necessary,
two additional weeks of hearings are scheduled for March 2002.
The Company's management believes that these legal proceedings will not
have a material effect on the Company's financial condition or results of its
operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
10.1 Senior Secured Revolving Line of Credit Agreement, dated as of
July 31, 2001, by and among the Company, Lehman Brothers Holdings
Inc., Credit Lyonnais New York Branch, PNC Bank, N.A. and Lehman
Commercial Paper, Inc.
10.2 Employment Agreement, dated as of September 19, 2001, by and
between the Company and Charles R. Tomb.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which this
Report is filed.
15
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 13, 2001 By: /s/ J. WILLIAM RICHARDSON
------------------------------------
J. William Richardson
Vice Chairman and Chief Financial
Officer
(Principal Financial Officer)
16