1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
------------------------
INTERSTATE HOTELS COMPANY
FOSTER PLAZA TEN
680 ANDERSEN DRIVE
PITTSBURGH, PENNSYLVANIA 15220
(412) 937-0600
PENNSYLVANIA 1-11731 25-1788101
(State of Incorporation) (Commission File No.) (IRS Employer
Identification No.)
------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of each exchange
Title of each class on which registered
- - ----------------------------------------------- -----------------------------------------
Common Stock, $.01 par value (35,324,968 shares New York Stock Exchange
outstanding as of March 14, 1997)
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 period that the Company
has been required to file such reports, and (2) has been subject to such filing
requirements for the past 90 days.
Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K will
be contained in a definitive Proxy Statement incorporated by reference into Part
III of this Report.
There were 21,731,139 shares of the Company's Common Stock outstanding as
of March 14, 1997 that were held by non-affiliates. The aggregate market value
of these shares, based upon the last sale price as reported on the New York
Stock Exchange Composite Tape on March 14, 1997, was approximately $605,755,500.
------------------------
DOCUMENT INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the Annual Meeting of Shareholders to
be held on May 21, 1997 are incorporated by reference in Part III of this Report
to the extent stated herein. Except with respect to information specifically
incorporated by reference herein, the Proxy Statement is not deemed to be filed
as a part hereof.
================================================================================
2
INDEX
INTERSTATE HOTELS COMPANY
PAGE
--------
PART I
Items 1 & 2 Business and Properties................................................ 2
Item 3 Legal Proceedings...................................................... 3
Item 4 Submission of Matters to a Vote of Security Holders.................... 3
PART II
Item 5 Market for Registrant's Common Equity and Related Stockholder
Matters................................................................ 3
Item 6 Selected Financial Data................................................ 3
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operations.......................................................... 6
Item 8 Financial Statements and Supplementary Data............................ 10
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure................................................... 10
PART III
Item 10 Directors and Executive Officers of the Registrant..................... 10
Item 11 Executive Compensation................................................. 11
Item 12 Security Ownership of Certain Beneficial Owners and Management......... 11
Item 13 Certain Relationships and Related Transactions......................... 11
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K........ 12
3
PART I
ITEMS 1 & 2. BUSINESS AND PROPERTIES
GENERAL
Interstate Hotels Company (the "Company") is the largest independent hotel
management company in the United States based on number of properties, number of
rooms and total revenues produced for owners. As of December 31, 1996, the
Company owned, managed, leased or performed related services for 212 hotels with
a total of 43,178 rooms in the United States, Canada, Israel, the Caribbean,
Thailand, Panama and Russia. The Company owned or had a majority equity interest
in 27 of these properties with 7,736 rooms (the "Owned Hotels"), all of which
are geographically diverse upscale or luxury properties operating under various
brand names. The Owned Hotels operate under the Embassy Suites(R), Hilton(TM),
Holiday Inn(R), Marriott(R), Radisson(TM) and Westin(TM) trade names principally
in major metropolitan markets such as Atlanta, Boston, Chicago, Denver, Fort
Lauderdale, Houston, Los Angeles, Miami, Philadelphia, Phoenix and Washington,
D.C. In January 1997, the Company acquired one additional hotel with 250 rooms.
The Company is the largest franchisee of upscale hotels in the Marriott(R)
system, owning, managing or providing services to 39 hotels totaling 13,539
rooms, bearing the Marriott(R) flag. The Company also operates in the mid-scale,
upper economy and budget segments of the lodging industry and is the largest
franchisee and independent manager in the Hampton Inn(R) system, providing
services to 39 hotels totaling 4,624 rooms, bearing the Hampton Inn(R) flag.
1996 DEVELOPMENTS
In 1996, 83% of the Company's management fee revenues were derived from
upscale or luxury hotels and resorts. The Owned Hotels produced superior
operating results, achieving an average occupancy rate of 74.6%, an average
daily room rate ("ADR") of $94.29, and room revenue per available room
("REVPAR") of $70.36 in 1996. The Company expects further improvement in the
results of operations of the Owned Hotels as the effects of the repositioning of
certain of them, and the implementation of the Company's management practices to
all of them, are realized.
In June 1996, the Company completed its initial public offering of 12.4
million shares of Common Stock at $21.00 per share (the "IPO"). In connection
with the IPO, the Company acquired 14 of the Owned Hotels (or a majority equity
interest therein), entered into a credit facility which provided a total of $295
million of financing, consisting of a seven-year $100 million revolving credit
facility and a seven-year $195 million term loan facility, and entered into
$29.3 million of mortgage indebtedness encumbering six Owned Hotels in which the
Company owns a 75% equity interest. In October 1996, the credit facility was
amended to (i) convert $100 million of revolving credit borrowings to term debt,
(ii) increase the revolving credit capacity to $200 million and (iii) increase
the Company's permitted third-party nonrecourse and subordinated indebtedness to
fund acquisitions from $50 million to $250 million.
Since the IPO and through the end of 1996, the Company acquired 13
additional Owned Hotels for a total acquisition cost, including estimated
capital expenditures for anticipated renovations, closing costs, and initial
working capital, of $358.5 million. In addition, in November 1996, the Company
acquired for 1,957,895 shares of Common Stock the management and leasing
businesses affiliated with Equity Inns, Inc., a publicly traded real estate
investment trust ("Equity Inns"), pursuant to which it acquired eight management
contracts and entered into 48 long-term leases (the "Leased Hotels") for
mid-scale and upper economy hotels totaling 6,587 rooms (the "Equity Inns
Transaction"). As of March 1, 1997, the Company entered into four additional
long-term leases. In connection with the Equity Inns Transaction, Equity Inns
became obligated through November 15, 2001, subject to certain limitations, to
offer the Company the right to lease and manage any hotel acquired or developed
by Equity Inns.
In December 1996, the Company completed its second public offering of 4.0
million shares of Common Stock at $25.00 per share. In January 1997, the
underwriters purchased an additional 600,000 shares at $25.00 per share pursuant
to over-allotment options.
2
4
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of its business, the Company is named as a defendant
in legal proceedings resulting from incidents at its hotels. The Company
maintains liability insurance, requires hotel owners to maintain adequate
insurance coverage and is generally entitled to indemnity from third-party hotel
owners for lawsuits and damages against it in its capacity as a hotel manager.
Giving effect thereto, the Company believes that the legal proceedings to which
it is subject will not have a material effect on the Company's financial
condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 1996.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been listed on the New York Stock Exchange
("NYSE") since June 20, 1996 under the symbol "IHC." Prior to that date, the
Common Stock was not publicly traded. The following table sets forth, for the
periods indicated, the high and low sales prices per share of Common Stock as
reported on the NYSE Composite Tape.
PRICE
------------
PERIOD HIGH LOW
------------------------------------------------------------- ---- ---
June 20, 1996 through June 30, 1996.......................... $23 3/8 $21
Quarter ended September 30, 1996............................. 27 3/4 22 1/8
Quarter ended December 31, 1996.............................. 29 5/8 24 1/8
The Company has not paid any cash dividends on the Common Stock and does
not anticipate that it will do so in the foreseeable future. Further, the terms
of the Company's credit facility prohibit the payment of dividends on the Common
Stock.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected historical financial data of the
Company as of and for each of the years ended December 31, 1992, 1993, 1994,
1995 and 1996, selected pro forma financial data of the Company for the years
ended December 31, 1995 and 1996, and certain other data. The selected financial
data of the Company as of December 31, 1995 and 1996 and for each of the years
ended December 31, 1994, 1995 and 1996 have been derived from audited financial
statements of the Company included elsewhere herein. The selected financial data
of the Company as of December 31, 1992, 1993 and 1994 and for each of the years
ended December 31, 1992 and 1993 have been derived from audited financial
statements of the Company which are not required to be included herein. The
selected pro forma financial data for the years ended December 31, 1995 and 1996
give effect to the IPO (including the over-allotment options), the Company's
acquisitions in connection with and since the IPO, the Company's second public
offering (including the over-allotment options) and certain other adjustments,
as if all such transactions had occurred as of January 1, 1995. The pro forma
financial data is not necessarily indicative of what the results of operations
of the Company would have been for the periods indicated, nor does it purport to
represent the Company's future results of operations. The selected financial
data should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements and
notes thereto included elsewhere in this Report.
3
5
SELECTED FINANCIAL AND OTHER DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND HOTEL DATA)
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995 1996 1995 1996
-------- -------- -------- ---------- ---------- ----------- -----------
STATEMENT OF INCOME DATA:
Lodging revenues:
Rooms......................... $ -- $ -- $ -- $ -- $ 89,930 $ 279,804 $ 301,970
Food and beverage............. -- -- -- -- 42,502 101,990 105,812
Other departmental............ -- -- -- -- 8,685 23,592 24,787
Management and related fees(1).. 19,873 25,564 36,726 45,018 49,268 40,086 44,937
-------- -------- -------- ---------- ---------- ----------- -----------
Total revenues.............. 19,873 25,564 36,726 45,018 190,385 445,472 477,506
Lodging expenses:
Rooms......................... -- -- -- -- 20,900 67,046 69,856
Food and beverage............. -- -- -- -- 31,033 78,501 79,740
Other departmental............ -- -- -- -- 3,936 9,494 8,948
Property costs................ -- -- -- -- 41,707 127,862 130,871
General and administrative...... 4,096 5,057 8,302 9,811 10,912 11,307 11,207
Payroll and related benefits.... 8,803 10,321 12,420 15,469 17,529 16,928 18,827
Non-cash compensation (2)....... -- -- -- -- 11,896 -- --
Lease expense................... -- -- -- -- 3,477 39,069 41,479
Depreciation and amortization... 3,352 3,282 3,659 4,201 14,862 35,374 35,313
-------- -------- -------- ---------- ---------- ----------- -----------
Operating income............ 3,622 6,904 12,345 15,537 34,133 59,891 81,265
Other income (expense):
Interest, net................. 98 12 30 99 (12,421) (28,511) (26,058)
Other, net.................... (100) (6) 14 203 (270) (698) (2,065)
-------- -------- -------- ---------- ---------- ----------- -----------
Income before income tax
expense................... 3,620 6,910 12,389 15,839 21,442 30,682 53,142
Income tax expense (3).......... -- -- -- -- 15,325 11,659 20,194
-------- -------- -------- ---------- ---------- ----------- -----------
Income before extraordinary
items..................... 3,620 6,910 12,389 15,839 6,117 19,023 32,948
Extraordinary items (4)......... -- -- -- -- 7,733 -- --
-------- -------- -------- ---------- ---------- ----------- -----------
Net income (loss)........... $ 3,620 $ 6,910 $ 12,389 $ 15,839 $ (1,616) $ 19,023 $ 32,948
======== ======== ======== ========== ========== =========== ===========
Pro forma net income per common
share (5)..................... $ 0.54 $ 0.93
=========== ===========
Pro forma common shares
outstanding (5)............... 35,387,677 35,387,677
=========== ===========
BALANCE SHEET DATA (AT YEAR END):
Cash and cash equivalents....... $ 4,461 $ 4,520 $ 6,702 $ 14,035 $ 32,323
Total assets.................... 24,270 24,436 30,741 61,401 883,761
Current portion of long-term
debt.......................... 576 600 673 363 11,767
Long-term debt, excluding
current portion............... 1,500 1,209 3,217 35,907 396,044
Total equity.................... 16,685 16,627 18,858 9,256 409,298
OTHER FINANCIAL DATA:
EBITDA (6)...................... $ 6,874 $ 10,180 $ 16,018 $ 19,930 $ 49,228 $ 95,265 $ 116,578
Net cash provided by operating
activities.................... 7,332 10,389 15,318 25,328 41,271
Net cash used in investing
activities.................... (481) (3,088) (3,852) (22,858) (449,414)
Net cash (used in) provided by
financing activities.......... (5,387) (7,242) (9,285) 4,863 426,431
TOTAL PORTFOLIO HOTEL DATA: (7)
Total portfolio hotel
revenues...................... $584,344 $760,766 $858,986 $1,056,279 $1,326,581
Number of hotels (8)............ 53 82 136 150 212
Number of rooms (8)............. 18,985 24,202 31,502 35,044 43,178
OWNED HOTEL OPERATING DATA: (9)
Average occupancy rate (10)..... 74.6% 73.8% 74.3%
ADR (11)........................ $ 94.29 $ 92.54 $ 99.51
REVPAR (12)..................... $ 70.36 $ 68.33 $ 73.91
4
6
- - ---------------
(1) Pro forma management and related fees are adjusted to reflect consolidation
of the Owned Hotels and the resultant pro forma elimination of management
and related fees actually derived from the Owned Hotels in 1995 and 1996,
respectively.
(2) Represents a non-recurring expense relating to the issuance of 785,533
shares of Common Stock to certain executives and key employees of the
Company in consideration for the cancellation of stock options issued by
the Company's predecessor, Interstate Hotels Corporation.
(3) Until immediately prior to the consummation of the IPO, the Company and its
predecessors were organized as S corporations, partnerships and limited
liability companies and, accordingly, were not subject to federal and
certain state income taxes. The Company recorded income tax expense of
$4,881 to establish deferred income taxes as of the date of the Company's
change of status from a pass-through entity for tax purposes to a C
corporation. The pro forma statement of income data has been computed as if
the Company had been subject to federal and state income taxes, based on
the applicable statutory tax rates then in effect.
(4) Represents an extraordinary loss resulting from the early extinguishment of
indebtedness, net of a tax benefit of $3,997.
(5) Based on 35,239,296 shares of Common Stock outstanding on a pro forma basis
plus an additional 148,381 shares of Common Stock to reflect the dilutive
effect of outstanding options.
(6) EBITDA represents earnings before interest, income taxes, depreciation and
amortization, minority interests and extraordinary items. Management
believes that EBITDA is a useful measure of operating performance because
it is industry practice to evaluate hotel properties based on operating
income before interest, depreciation and amortization, which is generally
equivalent to EBITDA, and EBITDA is unaffected by the debt and equity
structure of the property owner. EBITDA does not represent cash flow from
operations as defined by generally accepted accounting principles ("GAAP"),
is not necessarily indicative of cash available to fund all cash flow needs
and should not be considered as an alternative to net income under GAAP for
purposes of evaluating the Company's results of operations.
(7) Represents all hotels, including the Owned Hotels, for which the Company
provides management or related services.
(8) As of the end of the years presented.
(9) Represents 27 Owned Hotels purchased on varying dates during 1996.
(10) Represents total rooms occupied by hotel guests on a paid basis divided by
total available rooms. Total available rooms represents the number of rooms
available for rent multiplied by the number of days in the reported period.
(11) Represents total room revenues divided by the total number of rooms
occupied by hotel guests on a paid basis.
(12) Represents total room revenues divided by total available rooms.
5
7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
As of December 31, 1996, the Company owned, managed, leased or performed
related services for 212 hotels with a total of 43,178 rooms. The Company owned
or had a majority equity interest in 27 of these properties with 7,736 rooms.
The Owned Hotels were purchased on varying dates in connection with and since
the Company's IPO. In connection with the IPO, the Company entered into a $295
million credit facility, which included a $100 million revolving credit facility
and a $195 million term loan facility, and entered into $29.3 million of
mortgage indebtedness encumbering six Owned Hotels. In October 1996, the credit
facility was amended to convert $100 million of revolving credit borrowings to
term debt, increase the revolving credit capacity to $200 million and permit an
additional $200 million of third-party borrowings. Additionally, in November
1996, the Company completed the Equity Inns Transaction. The following
discussion and analysis includes the Company's pro forma results of operations
in addition to its historical data. The pro forma financial information has been
prepared to include the effects of the IPO, the Company's second public
offering, the borrowings under the Company's credit facility, the acquisitions
of the Owned Hotels on varying dates and the Equity Inns Transaction as if all
of the transactions had occurred on January 1, 1995. The historical data has
been derived from the audited financial statements of the Company.
PRO FORMA YEAR ENDED DECEMBER 31, 1996 COMPARED TO PRO FORMA YEAR ENDED DECEMBER
31, 1995
Pro forma total revenues increased by $32.0 million, or 7.2%, from $445.5
million in 1995 to $477.5 million in 1996. The most significant portion of this
increase related to lodging revenues, which consists of rooms, food and beverage
and other departmental revenues. Pro forma lodging revenues increased by $27.2
million, or 6.7%, from $405.4 million in 1995 to $432.6 million in 1996. This
increase was due to the overall improvement in the operating performance of the
Owned Hotels, which was attributed to changes in franchise affiliations and
market repositioning for certain of the Owned Hotels, and an overall improvement
in economic conditions in certain geographic regions. The increase in lodging
revenues was consistent with the increase in the Owned and Leased Hotels' room
revenues of $22.2 million, or 7.9%, to $302.0 million in 1996. The pro forma ADR
for the Owned Hotels increased by 7.5%, from $92.54 during 1995 to $99.51 during
1996, and the pro forma average occupancy rate increased from 73.8% to 74.3%,
respectively. This resulted in an 8.2% increase in pro forma REVPAR to $73.91
during 1996. The Atlanta, Colorado Springs, Denver, Philadelphia and San Jose
markets had the most significant impact on average rate and REVPAR growth. Pro
forma management and related fees increased by $4.8 million, or 12.1%, from
$40.1 million in 1995 to $44.9 million in 1996 primarily due to the performance
improvement of the Company's portfolio of managed hotels and incremental
revenues associated with the net addition of new hotels, many of which provide
for incentive management fees and utilize the Company's other contractual
services.
Pro forma lodging expenses, which consists of rooms, food and beverage,
property costs and other departmental expenses, increased by $6.5 million, or
2.3%, from $282.9 million in 1995 to $289.4 million in 1996. The pro forma
operating margin of the Owned and Leased Hotels increased from 30.2% during 1995
to 33.1% during 1996. This increase was attributed to the increase in pro forma
revenues and the overall improvement in operating performance and operating
efficiencies of the Owned and 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. Pro forma general and
administrative expenses in 1996 and 1995 remained consistent due to the
relatively fixed nature of these expenses. Pro forma general and administrative
expenses as a percentage of pro forma revenues decreased to 2.3% during 1996
compared to 2.5% during 1995 as a result of operating leverage.
Pro forma payroll and related benefits expenses increased by $1.9 million,
or 11.2%, from $16.9 million in 1995 to $18.8 million in 1996. This increase was
primarily due to the addition of new employees related to the growth of the
Company's hotel management business and the acquisitions of the Owned Hotels.
Pro forma
6
8
payroll and related benefits expenses as a percentage of pro forma revenues
increased slightly to 3.9% during 1996 compared to 3.8% during 1995.
Lease expense represents base rent and participating rent that is based on
a percentage of room and food and beverage revenues from the Leased Hotels. Pro
forma lease expense increased by $2.4 million, or 6.2%, from $39.1 million in
1995 to $41.5 million in 1996. This increase was primarily due to higher Leased
Hotels' room revenues. The ADR for the Leased Hotels increased by 7.1%, from
$59.89 during 1995 to $64.15 during 1996.
Pro forma operating income increased by $21.4 million, or 35.7%, from $59.9
million in 1995 to $81.3 million in 1996. Accordingly, pro forma operating
margin increased from 13.4% during 1995 to 17.0% during 1996. As discussed
above, the improvement in the pro forma operating margin was attributed to the
increase in pro forma revenues and the overall decrease in pro forma operating
expenses as a percentage of pro forma revenues.
Pro forma net interest expense decreased by $2.4 million, or 8.6%, from
$28.5 million in 1995 to $26.1 million in 1996. This decrease was due to lower
outstanding debt balances resulting primarily from escalating scheduled
principal payments.
Pro forma income tax expense for 1995 and 1996 was computed as if the
Company were subject to federal and state income taxes, based on an effective
tax rate of 38%.
As a result of the changes noted above, pro forma net income increased by
$13.9 million, or 73.2%, from $19.0 million in 1995 to $32.9 million in 1996.
Accordingly, pro forma net income margin increased from 4.3% during 1995 to 6.9%
during 1996.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Total revenues increased by $145.4 million, or 322.9%, from $45.0 million
in 1995 to $190.4 million in 1996. The most significant portion of this increase
related to lodging revenues, which increased by $141.1 million due to the
operations of the Owned Hotels acquired during 1996 and the Leased Hotels.
Management fees increased by $2.3 million, or 8.4%, from $27.0 million in 1995
to $29.3 million in 1996 due to the addition of 90 new management contracts and
increased revenues associated with the performance improvement of existing
managed hotels. The increase in management fees was partially offset by the loss
of 28 management contracts primarily due to the divestiture of hotels by
third-party owners. Other management-related fees increased by $2.0 million, or
10.9%, from $18.0 million in 1995 to $20.0 million in 1996 due to incremental
revenues associated with the net addition of new hotels, many of which utilize
the Company's other contractual services.
The Company had lodging expenses of $97.6 million in 1996 due to the
operations of the Owned Hotels acquired during 1996 and the Leased Hotels. The
operating margin of the Owned Hotels and the Leased Hotels was 30.9% during
1996.
General and administrative expenses increased by $1.1 million, or 11.2%,
from $9.8 million in 1995 to $10.9 million in 1996. This increase was primarily
due to incremental expenses associated with the growth of the Company's hotel
management business and the acquisitions of the Owned Hotels, as well as
additional costs associated with managing and administering a publicly held
company. General and administrative expenses as a percentage of revenues
decreased to 5.7% during 1996 compared to 21.8% during 1995 as a result of the
operations of the Owned Hotels acquired during 1996 and the Leased Hotels.
Payroll and related benefits expenses increased by $2.0 million, or 13.3%,
from $15.5 million in 1995 to $17.5 million in 1996. This increase was related
to the addition of corporate management and staff personnel as the Company's
portfolio of hotels for which it provides management and other services grew.
Payroll and related benefits expenses as a percentage of revenues decreased to
9.2% during 1996 compared to 34.4% during 1995 as a result of the operations of
the Owned Hotels acquired during 1996 and the Leased Hotels.
7
9
Non-cash compensation of $11.9 million in 1996 resulted from the issuance
of 785,533 shares of Common Stock to certain executives and key employees of the
Company in consideration for the cancellation of stock options issued by the
Company's predecessor, Interstate Hotels Corporation, in 1995.
The Company had lease expense of $3.5 million in 1996 due to the addition
of the Leased Hotels.
Depreciation and amortization increased by $10.7 million, or 253.8%, from
$4.2 million in 1995 to $14.9 million in 1996 due to incremental depreciation
related to the acquisitions of the Owned Hotels, the amortization of deferred
financing fees and the amortization of goodwill and lease contracts associated
with the Equity Inns Transaction.
Operating income (exclusive of non-cash compensation) increased by $30.5
million, or 196.3%, from $15.5 million in 1995 to $46.0 million in 1996.
Operating margin decreased from 34.5% during 1995 to 24.2% during 1996. This
decrease in the operating margin reflects the inclusion of the operating results
of the Owned Hotels, which were not reflected in the Company's results prior to
their respective acquisition dates in 1996, and the Leased Hotels.
The Company had $0.1 million of net interest income in 1995 compared to
$12.4 million of net interest expense in 1996. This increase in interest expense
was primarily due to additional borrowings related to the acquisitions of the
Owned Hotels in 1996.
Other expense of $0.3 million in 1996 consisted primarily of minority
interests.
Income tax expense in 1996 included deferred tax expense of $4.9 million
which was recorded in June 1996, coinciding with the date that the Company
changed its tax status from a pass-through entity for tax purposes to a C
corporation.
An extraordinary loss of $7.7 million, net of a tax benefit of $4.0
million, in 1996 resulted from the early extinguishment of certain indebtedness
and was related to the payment of prepayment penalties and loan commitment fees
and the write-off of deferred financing fees.
As a result of the changes noted above, a net loss of $1.6 million was
recorded in 1996 compared to net income of $15.8 million in 1995.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Total revenues increased by $8.3 million, or 22.6%, from $36.7 million in
1994 to $45.0 million in 1995. Management fees increased by $4.7 million, or
21.3%, from $22.3 million in 1994 to $27.0 million in 1995 due to the addition
of 43 new management contracts and increased revenues associated with the
performance improvement of existing managed hotels. The increase in management
fees was partially offset by the loss of 29 management contracts primarily due
to the divestiture of hotels by third-party hotel owners. Approximately $3.1
million, or 66%, of this increase resulted from increases in base management
fees, and $1.6 million, or 34%, of this increase resulted from increases in
incentive management fees due to the performance improvement of existing managed
hotels and the increase in the number of new contracts that provide for
incentive management fees. Purchasing and other fees increased by $2.8 million,
or 38.0%, from $7.5 million in 1994 to $10.3 million in 1995 primarily due to
incremental revenues of $0.7 million relating to additional franchise/marketing
representation fees related to the acquisition of the Colony portfolio in May
1994 and incremental revenues of $2.1 million related to the net addition of new
managed hotels, many of which utilize the Company's purchasing, project
management and other contractual services. Insurance income increased by $0.7
million, or 10.2%, from $7.0 million in 1994 to $7.7 million in 1995 due to the
net addition of new managed hotels that elected to participate in the Company's
insurance program.
General and administrative expenses increased by $1.5 million, or 18.2%,
from $8.3 million in 1994 to $9.8 million in 1995. This increase was primarily
due to incremental expenses of $1.3 million associated with the acquisition of
the Colony portfolio. General and administrative expenses as a percentage of
revenues decreased to 21.8% in 1995 compared to 22.6% in 1994.
8
10
Payroll and related benefits expenses increased by $3.1 million, or 24.5%,
from $12.4 million in 1994 to $15.5 million in 1995. This increase was primarily
due to incremental expenses of $1.5 million associated with the acquisition of
the Colony portfolio and the growth of the Crossroads portfolio and $1.3 million
related to an increase in incentive bonuses paid to certain executive officers
and development staff. Payroll and related benefits expenses as a percentage of
revenues increased to 34.4% in 1995 compared to 33.8% in 1994.
Operating income increased by $3.2 million, or 25.9%, from $12.3 million in
1994 to $15.5 million in 1995. Operating margin increased from 33.6% during 1994
to 34.5% during 1995. The improvement in the operating margin was attributed to
the increase in revenues and improvements in the operating expenses as a
percentage of revenues.
As a result of the changes noted above, net income increased by $3.4
million, or 27.8%, from $12.4 million in 1994 to $15.8 million in 1995. Net
income margin increased from 33.7% during 1994 to 35.2% during 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity during 1996 were cash from
operations, proceeds from the issuance of Common Stock and borrowings under its
credit facility. Net cash provided by operations was $41.3 million in 1996
compared to $25.3 million in 1995. The Company used cash of $449.4 million in
investing activities which principally related to the acquisitions of Owned
Hotels in the amount of $417.6 million, net of cash received. Net cash provided
from financing activities in the amount of $426.4 million was primarily used to
finance these acquisitions. The principal sources of this cash were $357.5
million from the issuance of Common Stock and $360.1 million from proceeds from
long-term debt, offset by long-term debt repayments of $247.9 million. The
Company's cash and cash equivalent assets were $32.3 million and $14.0 million
at December 31, 1996 and 1995, respectively.
At December 31, 1996, the Company's total indebtedness was $407.8 million,
comprised of $292.5 million of term loans, $29.1 million of borrowings under its
revolving credit facility, $29.3 million of mortgage indebtedness encumbering
six Owned Hotels in which the Company owns a 75% equity interest, $56.4 million
of loans related to the acquisitions of two Owned Hotels in December 1996, and
$0.5 million of other debt. The Company's available funds under its revolving
credit facility totaled $170.9 million at December 31, 1996. In addition, at
that date, the credit facility permitted $193.6 million of third-party
nonrecourse and subordinated indebtedness to fund acquisitions. The Company
utilizes various interest rate hedge contracts to limit its interest rate
exposures on indebtedness. Future changes in interest rates applicable to
outstanding borrowings are therefore not expected to have a significant impact
on the Company's results of operations.
Management of the Company believes that, with respect to its current
operations, the Company's cash on hand and funds from operations will be
sufficient to cover its reasonably foreseeable working capital, ongoing capital
expenditure and debt service requirements. In 1996, the Company spent $16.3
million on capital expenditures. The Company's capital expenditure budget
relating to existing operations for 1997 is $42.2 million.
The Company intends to pursue a growth-oriented strategy involving, among
other things, the acquisition of interests in additional hotel properties and
hotel management companies, as well as the acquisition of additional management
contracts (which may from time to time require capital expenditures by the
Company). Management believes that the available funds remaining under its
revolving credit facility, permitted third-party nonrecourse and subordinated
indebtedness and cash provided by operations will be sufficient to pursue the
Company's acquisition strategy and to fund its other presently foreseeable
capital requirements. However, the Company believes that, absent a presently
unforeseen change, additional acquisition opportunities will continue to exist
for the foreseeable future, and depending upon conditions in the capital and
other financial markets as well as other factors, the Company may from time to
time consider the issuance of debt or other securities, the proceeds of which
could be used to finance acquisitions, to refinance debt or for other general
corporate purposes.
9
11
SEASONALITY
The lodging industry is affected by seasonal patterns. At most of the
Company's hotels, demand is higher in the second and third quarters than during
the remainder of the year.
INFLATION
The effects of inflation, as measured by fluctuations in the consumer price
index, have not had a material impact on the Company's revenues or net income in
recent years.
FORWARD-LOOKING STATEMENTS
This Report contains certain forward-looking statements and information
relating to the Company that are 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, identify forward-looking
statements. Such statements reflect the current views of the Company with
respect to future events and are subject to certain risks, uncertainties and
assumptions, relating to the operations and results of operations of the
Company, the Company's rapid expansion, the ownership and leasing of real
estate, competition from other hospitality companies and changes in economic
cycles, as well as the other factors described herein. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results or outcomes may vary materially from those described
herein as anticipated, estimated, expected or intended.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is set forth in the Company's
Consolidated Financial Statements and Supplementary Data contained in this
Report and is incorporated herein by reference. Specific financial statements
and supplementary data can be found at the pages listed in the following index:
PAGE
--------
Report of Independent Accountants........................................ F-1
Consolidated Balance Sheets as of December 31, 1995 and 1996............. F-2
Consolidated Statements of Operations for the years ended December 31,
1994, 1995 and 1996.................................................... F-3
Consolidated Statements of Shareholders' Equity for the years ended
December 31, 1994, 1995 and 1996....................................... F-4
Consolidated Statements of Cash Flows for the years ended December 31,
1994, 1995 and 1996.................................................... F-5
Notes to Consolidated Financial Statements............................... F-6
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is set forth under the caption
"Election of Directors--Nominees for Election of Directors" and "--Executive
Officers Who Are Not Directors" in the Company's Proxy Statement for the Annual
Meeting of Shareholders to be held on May 21, 1997 (the "Proxy Statement") and
incorporated herein by reference.
10
12
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is set forth under the caption
"Election of Directors--Executive Compensation" in the Proxy Statement and
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is set forth under the caption
"Election of Directors--Beneficial Ownership of Common Stock" in the Proxy
Statement and incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is set forth under the caption
"Election of Directors--Certain Relationships and Related Transactions" in the
Proxy Statement and incorporated herein by reference.
11
13
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report
1. Financial Statements
The list of financial statements required by this item is set forth
in Item 8, "Consolidated Financial Statements and Supplementary Data,"
and is incorporated herein by reference.
2. Financial Statement Schedules
All financial statement schedules are omitted as they are either
not applicable or the required information is included in the
consolidated financial statements or the notes thereto.
3. Exhibits
EXHIBIT NO. DESCRIPTION
- - ----------- -------------------------------------------------------------------------------
2.1 Formation Agreement, dated as of June 25, 1996, among the Company and the
parties identified on the signature page thereof(1)
3.1 Amended and Restated Articles of Incorporation of the Company(1)
3.2 Amended and Restated Bylaws of the Company(1)
4.1 Specimen Common Stock Certificate(2)
4.2(a) Credit Agreement, dated as of June 25, 1996, among Interstate Hotels
Corporation, Credit Lyonnais and the other parties signatory thereto(1)
4.2(b) First Amendment to Credit Agreement, dated as of October 21, 1996, among
Interstate Hotels Corporation, Credit Lyonnais and the other parties signatory
thereto(2)
10.1 Agreement of Purchase and Sale, dated as of March 29, 1996, among the Sellers
named therein and IHC Member Corporation(3)
10.2 Contribution Agreement, dated as of March 29, 1996, among Interstate Hotels
Corporation and the other persons signatory thereto(3)
10.3 Stockholders Agreement, dated as of June 25, 1996, among the Company,
Blackstone Real Estate Advisors L.P. and the shareholders named therein(1)
10.4 Registration Rights Agreement, dated as of June 25, 1996, among the Company and
the shareholders named therein(1)
10.5 Master Agreement, dated as of April 1, 1996, among Host Funding, Inc.,
Crossroads Hospitality Tenant Company, L.L.C. and Crossroads Hospitality
Company, L.L.C.(3)
10.6 Interstate Hotels Company Executive Retirement Plan(3)
10.7 Interstate Hotels Company Equity Incentive Plan(3)
10.8 Interstate Hotels Company Stock Purchase Plan(3)
10.9 Interstate Hotels Company Management Bonus Plan(3)
10.10 Interstate Hotels Company Stock Option Plan for Non-Employee Directors(3)
10.11(a) Employment Agreement between the Company and Milton Fine(3)
10.11(b) Employment Agreement between the Company and W. Thomas Parrington, Jr.(3)
10.11(c) Employment Agreement between the Company and J. William Richardson(3)
10.11(d) Employment Agreement between the Company and Robert L. Froman(3)
10.11(e) Employment Agreement between the Company and Marvin I. Droz(3)
10.11(f) Employment Agreement between the Company and Thomas D. Reese(2)
10.12 Form of Severance Agreement between the Company and each of Milton Fine, W.
Thomas Parrington, Jr., J. William Richardson, Robert L. Froman and Marvin I.
Droz(3)
12
14
EXHIBIT NO. DESCRIPTION
- - ----------- -------------------------------------------------------------------------------
10.13 Form of Indemnification Agreement between the Company and each of its
directors(3)
10.14(a) Interstate Hotels Company Supplemental Deferred Compensation Plan(3)
10.14(b) Deferred Compensation Agreement between the Company and W. Thomas Parrington,
Jr.(3)
10.14(c) Deferred Compensation Agreement between the Company and J. William
Richardson(3)
10.15(a) Contribution Agreement, dated as of October 4, 1996, as amended, among Trust
Leasing, Inc., Trust Management, Inc., Phillip H. McNeill, Sr.,
Crossroads/Memphis Company, L.L.C. and Crossroads/Memphis Partnership, L.P.(2)
10.15(b) Master Agreement, dated as of November 4, 1996, as amended, among Equity Inns
Partnership, L.P., Interstate Hotels Corporation, Equity Inns, Inc.,
Crossroads/Memphis Partnership, L.P. and Crossroads Future Company, L.L.C.(2)
10.16(a) Contribution Agreement, dated as of December 19, 1996, among Casa Marina Ltd.,
Casa Marina Realty Corporation, Interstone Partners I, L.P. and Casa Marina
Realty Partnership, L.P.(4)
10.16(b) Contribution Agreement and Agreement to Assign Partnership Interests and Enter
into First Amended and Restated Limited Partnership Agreement, dated as of
December 19, 1996, among IHC Reach Corporation, Reach Resort Investment
Corporation, Interstone Partners I, L.P. and The Key West Reach Limited
Partnership(4)
21.1 List of Subsidiaries of the Company
23.1 Consent of Coopers & Lybrand L.L.P.
24.1 Powers of Attorney executed by the Company, Michael J. Aranson, David J. Fine,
Milton Fine, R. Michael McCullough, W. Thomas Parrington, Jr., J. William
Richardson, Thomas J. Saylak and Steven J. Smith
27.1 Financial Data Schedule
- - ---------
(1) Filed previously as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1996 and incorporated herein by
reference.
(2) Filed previously as an exhibit to the Company's Registration Statement on
Form S-1, as amended (Registration. No. 333-15507), and incorporated herein
by reference.
(3) Filed previously as an exhibit to the Company's Registration Statement on
Form S-1, as amended (Registration. No. 333-3958), and incorporated herein
by reference.
(4) Filed previously as an exhibit to the Company's Current Report on Form 8-K
dated December 27, 1997 and incorporated herein by reference.
(b) Reports on Form 8-K
None.
13
15
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Company has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of Pittsburgh, in the
Commonwealth of Pennsylvania, on March 20, 1997.
INTERSTATE HOTELS COMPANY
By: /s/ J. WILLIAM RICHARDSON
-------------------------------------
J. William Richardson
Executive Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- - ------------------------------------- ------------------------------------- ---------------
* President, Chief Executive Officer March 20, 1997
- - ------------------------------------- and Director
W. Thomas Parrington, Jr. (principal executive officer)
/s/ J. WILLIAM RICHARDSON Executive Vice President and March 20, 1997
- - ------------------------------------- Chief Financial Officer
J. William Richardson (principal financial and accounting
officer)
* Director March 20, 1997
- - -------------------------------------
Milton Fine
* Director March 20, 1997
- - -------------------------------------
David J. Fine
* Director March 20, 1997
- - -------------------------------------
Michael J. Aranson
* Director March 20, 1997
- - -------------------------------------
R. Michael McCullough
* Director March 20, 1997
- - -------------------------------------
Thomas J. Saylak
* Director March 20, 1997
- - -------------------------------------
Steven J. Smith
The undersigned, by signing his name hereto, does sign and execute this
Annual Report on Form 10-K pursuant to the powers of attorney executed by the
above-named officers and directors and filed herewith.
By: /s/ J. WILLIAM RICHARDSON
-------------------------------------
J. William Richardson
Attorney-in-Fact
14
16
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Interstate Hotels Company:
We have audited the accompanying consolidated balance sheets of Interstate
Hotels Company (the Company) as of December 31, 1995 and 1996, and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of December 31, 1995 and 1996, and the consolidated results of its
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles.
/S/ COOPERS & LYBRAND L.L.P.
600 Grant Street
Pittsburgh, Pennsylvania
February 12, 1997, except
for Note 21, as to which the
date is March 19, 1997
F-1
17
INTERSTATE HOTELS COMPANY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
ASSETS
DECEMBER 31,
---------------------
1995 1996
-------- --------
Current assets:
Cash and cash equivalents........................................... $ 14,035 $ 32,323
Accounts receivable, net............................................ 10,654 21,556
Stock subscription receivable, net.................................. -- 14,286
Deferred income taxes............................................... -- 1,649
Prepaid expenses and other assets................................... 712 11,961
-------- --------
Total current assets........................................ 25,401 81,775
Restricted cash....................................................... 2,096 15,995
Property and equipment, net........................................... 1,894 709,151
Investments in hotel real estate...................................... 12,884 5,605
Officers and employees notes receivable............................... 1,219 4,643
Affiliates notes receivable........................................... 8,718 --
Intangibles and other assets.......................................... 9,189 66,592
-------- --------
Total assets........................................... $ 61,401 $883,761
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable--trade............................................. 926 12,152
Accounts payable--health trust...................................... 5,505 2,440
Accrued payroll and related benefits................................ 3,026 15,072
Other accrued liabilities........................................... 5,546 23,926
Current portion of long-term debt................................... 363 11,767
-------- --------
Total current liabilities................................... 15,366 65,357
Long-term debt........................................................ 35,907 396,044
Deferred income taxes................................................. -- 4,081
Other liabilities..................................................... -- 1,213
-------- --------
Total liabilities........................................... 51,273 466,695
-------- --------
Minority interests.................................................... 872 7,768
Commitments and contingencies......................................... -- --
Shareholders' equity:
Preferred stock, $.01 par value; 25,000 shares authorized; no shares
outstanding as of December 31, 1996.............................. -- --
Common stock, $.01 par value; 75,000 shares authorized; 34,639
shares issued and outstanding as of December 31, 1996............ 3 352
Paid-in capital..................................................... 26,883 407,784
Retained (deficit) earnings......................................... (12,737) 1,432
Unearned compensation............................................... (3,263) (270)
Receivable from shareholders........................................ (1,630) --
-------- --------
Total shareholders' equity.................................. 9,256 409,298
-------- --------
Total liabilities and shareholders' equity............. $ 61,401 $883,761
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
18
INTERSTATE HOTELS COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
---------
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1995 1996
------- ------- --------
Lodging revenues:
Rooms...................................................... $ -- $ -- $ 89,930
Food and beverage.......................................... -- -- 42,502
Other departmental......................................... -- -- 8,685
Management fees.............................................. 22,285 27,022 29,304
Other management-related fees................................ 14,441 17,996 19,964
------- ------- --------
36,726 45,018 190,385
------- ------- --------
Lodging expenses:
Rooms...................................................... -- -- 20,900
Food and beverage.......................................... -- -- 31,033
Other departmental......................................... -- -- 3,936
Property costs............................................. -- -- 41,707
General and administrative................................... 8,302 9,811 10,912
Payroll and related benefits................................. 12,420 15,469 17,529
Non-cash compensation........................................ -- -- 11,896
Lease expense................................................ -- -- 3,477
Depreciation and amortization................................ 3,659 4,201 14,862
------- ------- --------
24,381 29,481 156,252
------- ------- --------
Operating income...................................... 12,345 15,537 34,133
Other income (expense):
Interest, net.............................................. 30 99 (12,421)
Other, net................................................. 14 203 (270)
------- ------- --------
Income before income tax expense...................... 12,389 15,839 21,442
Income tax expense........................................... -- -- 15,325
------- ------- --------
Income before extraordinary items..................... 12,389 15,839 6,117
Extraordinary loss from early extinguishment of debt, net of
tax benefit of $3,997...................................... -- -- 7,733
------- ------- --------
Net income (loss) (Note 19)........................... $12,389 $15,839 $ (1,616)
======= ======= ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
19
INTERSTATE HOTELS COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
---------
RETAINED RECEIVABLE
COMMON PAID-IN (DEFICIT) UNEARNED PARTNERS' FROM
STOCK CAPITAL EARNINGS COMPENSATION CAPITAL STOCKHOLDERS TOTAL
------ -------- -------- ------------ --------- ------------ --------
Balance at December 31, 1993........... $ 57 $ 17,856 $ (269) $ -- $ 1,962 $ (2,979) $ 16,627
Effect of recapitalization........... (21) 21 -- -- -- -- --
Common stock of new entities and
capital contributions.............. 6 3 -- -- -- -- 9
Net decrease in receivable from
shareholders....................... -- -- -- -- -- 776 776
Distributions paid................... -- -- (5,987) -- (4,956) -- (10,943)
Net income........................... -- -- 5,517 -- 6,872 -- 12,389
---- -------- -------- ------- ------- ------- --------
Balance at December 31, 1994........... 42 17,880 (739) -- 3,878 (2,203) 18,858
Effect of reorganization............. (42) 4,520 -- -- (4,478) -- --
Assumption of liability by principal
shareholder........................ -- 1,220 -- -- -- -- 1,220
Common stock of new entities and
capital contributions.............. 3 -- -- -- 600 -- 603
Stock options granted................ -- 3,263 -- (3,263) -- -- --
Assumption of shareholders'
liability.......................... -- -- (12,995) -- -- -- (12,995)
Net decrease in receivable from
shareholders....................... -- -- -- -- -- 573 573
Distributions paid................... -- -- (14,842) -- -- -- (14,842)
Net income........................... -- -- 15,839 -- -- -- 15,839
---- -------- -------- ------- ------- ------- --------
Balance at December 31, 1995........... 3 26,883 (12,737) (3,263) -- (1,630) 9,256
Cancellation of stock options issued
in 1995............................ -- (3,263) -- 3,263 -- -- --
Issuance of stock (Note 11).......... 8 12,154 -- (379) -- -- 11,783
Unearned compensation recognized..... -- -- -- 109 -- -- 109
Net decrease in receivable from
shareholders....................... -- -- -- -- -- 1,630 1,630
Dividends and capital
distributions...................... -- (30,000) (8,423) -- -- -- (38,423)
Contribution of IHC's net assets for
Common Stock....................... 125 (24,333) 24,208 -- -- -- --
Issuance of Common Stock, net........ 186 357,287 -- -- -- -- 357,473
Stock subscription receivable, net... 6 14,280 -- -- -- -- 14,286
Issuance of Common Stock for
acquisitions....................... 24 54,776 -- -- -- -- 54,800
Net loss............................. -- -- (1,616) -- -- -- (1,616)
---- -------- -------- ------- ------- ------- --------
Balance at December 31, 1996........... $352 $407,784 $ 1,432 $ (270) $ -- $ -- $409,298
==== ======== ======== ======= ======= ======= ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
20
INTERSTATE HOTELS COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
---------
YEAR ENDED DECEMBER 31,
---------------------------------------
1994 1995 1996
-------- -------- ---------
Cash flows from operating activities:
Net income (loss)....................................... $ 12,389 $ 15,839 $ (1,616)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization......................... 3,659 4,201 14,862
Minority interests' share of equity (loss) income from
investment in hotel real estate.................... -- (10) 503
Non-cash compensation................................. -- -- 11,896
Deferred income taxes................................. -- -- 6,671
Write-off of deferred financing fees.................. -- -- 6,169
Other................................................. (53) (299) (231)
Cash (used) provided by assets and liabilities:
Accounts receivable, net.............................. (2,652) (2,377) 1,280
Prepaid expenses and other assets..................... (17) (257) (11,289)
Accounts payable...................................... 915 4,775 2,953
Other accrued liabilities............................. 1,077 3,456 10,073
-------- -------- ---------
Net cash provided by operating activities.......... 15,318 25,328 41,271
-------- -------- ---------
Cash flows from investing activities:
Increase in restricted cash............................. (814) (811) (13,899)
Acquisition of hotels, net of cash received............. -- -- (417,601)
Purchase of property and equipment, net................. (607) (438) (16,253)
Restricted funds used to purchase property and
equipment............................................. -- -- 10,383
Investments in hotel real estate........................ -- (13,038) (5,605)
Change in notes receivable, net......................... 529 (7,686) (3,424)
Other................................................... (2,960) (885) (3,015)
-------- -------- ---------
Net cash used in investing activities.............. (3,852) (22,858) (449,414)
-------- -------- ---------
Cash flows from financing activities:
Proceeds from long-term debt............................ 3,548 35,000 360,100
Repayment of long-term debt............................. (2,642) (15,265) (247,939)
Financing costs paid, net............................... (33) (2,088) (14,997)
Minority interests...................................... -- 882 6,896
Proceeds from issuance of Common Stock, net............. -- -- 357,473
Capital contributions................................... 9 603 --
Funds advanced to shareholders.......................... (1,689) (3,245) (6,423)
Repayment of funds advanced to shareholders............. 2,465 3,818 8,053
Repayment of notes payable to shareholders.............. -- -- (30,000)
Dividends and capital distributions paid................ (10,943) (14,842) (6,732)
-------- -------- ---------
Net cash (used in) provided by financing
activities....................................... (9,285) 4,863 426,431
-------- -------- ---------
Net increase in cash and cash equivalents................. 2,181 7,333 18,288
Cash and cash equivalents at beginning of period.......... 4,521 6,702 14,035
-------- -------- ---------
Cash and cash equivalents at end of period................ $ 6,702 $ 14,035 $ 32,323
======== ======== =========
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
21
INTERSTATE HOTELS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
1. ORGANIZATION AND BASIS OF PRESENTATION:
Interstate Hotels Company (the Company) was formed on April 19, 1996 in
anticipation of an initial public offering of the Company's Common Stock (see
Note 3). As of December 31, 1996, the Company owned 18 hotels and had a majority
equity interest in nine other hotels (collectively, the Owned Hotels). As a
result of the transactions discussed in Notes 3 and 4, the consolidated
financial statements of the Company consist of the historical results of
Interstate Hotels Corporation and Affiliates (IHC), the Company's predecessor,
and the operations of the Owned Hotels from the respective dates of their
acquisitions. Prior thereto, the consolidated financial statements reflect only
the historical activity of IHC. The working capital and operating results of
hotels operated under long-term operating leases (the Leased Hotels) are also
included in the Company's consolidated financial statements because the
operating performance associated with such hotels is guaranteed by the Company
(see Note 9).
The Company provides management and other related services principally to
owned, managed and leased hotels through its wholly owned subsidiaries. The
Company provides these services to hotels located in 34 states, the District of
Columbia, Canada, Israel, the Caribbean, Thailand, Panama and Russia, with the
largest concentration of hotels in the states of Florida and California. These
hotels are operated under a number of franchise agreements, with the largest
franchisors being Marriott International, Inc. and Promus Hotels, Inc.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company
and entities more than 50% owned. All significant intercompany transactions and
balances have been eliminated in consolidation. The Company accounts for
investments in less than 50% but greater than 20% owned entities in which it can
exert significant influence under the equity method of accounting. All other
investments are accounted for under the cost method. These investments are
included in investments in hotel real estate in the consolidated balance sheets.
Minority interests represent the proportionate share of the equity that is
owned by third parties in entities more than 50% owned by the Company. The net
income or loss of such entities is allocated to the minority interests based on
their percentage ownership throughout the year and is included in other income
(expense) in the consolidated statements of operations.
The preparation of financial statements in conformity with generally
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 periods. Actual results could differ from these estimates.
Cash and Cash Equivalents:
All unrestricted, highly liquid investments purchased with a remaining
maturity of three months or less are considered to be cash equivalents.
F-6
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
Restricted Cash:
The long-term debt agreements discussed in Note 8 and the franchise
agreements referred to in Note 17 provide that cash from hotel operations be
restricted for the future acquisition or replacement of property and equipment
each year based on a percentage of gross hotel revenues. The requirements range
from 3% to 6%. Capital restricted under applicable government insurance
regulations is also included in restricted cash, and represents 20% of the
annual insurance premiums written by the Company (see Note 15).
Property and Equipment:
Property and equipment are recorded at cost, which includes the allocated
purchase price for hotel acquisitions, and are depreciated primarily on the
straight-line method over their estimated useful lives. Expenditures for
maintenance and repairs are expensed as incurred. Expenditures for major
renewals and betterments that significantly extend the useful life of existing
property and equipment are capitalized and depreciated. The cost and related
accumulated depreciation applicable to property no longer in service are
eliminated from the accounts and any gain or loss thereon is included in
operations.
The Company is currently in the process of finalizing certain purchase
price allocations for hotel acquisitions that occurred in the fourth quarter of
1996. Management anticipates that such purchase price allocations will be
finalized in the first half of 1997. Adjustments, if any, would not result in
material changes in the results of operations, but may result in the
reclassification of certain long-term assets.
Officers and Employees Notes Receivable:
Officers notes receivable consist principally of notes from two executives.
Such notes bear interest, are fully recourse to the borrowers and are forgiven
and expensed ratably, if certain conditions are met, until the notes mature in
June 2006. The Company also makes loans from time to time to other employees,
which are payable upon demand and generally do not bear interest until such
demand is made. Certain officers and employees notes receivable may be forgiven
and expensed provided certain conditions are satisfied.
Intangibles and Other Assets:
Intangibles and other assets consist of the amounts paid to obtain
management and lease contracts and deferred financing fees. Goodwill is also
included in intangibles and other assets, and represents the excess of the
purchase price over the net assets of businesses acquired. Intangibles and other
assets are amortized on the straight-line method over the life of the underlying
contracts or estimated useful lives.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of:
The carrying values of long-lived assets, which include property and
equipment and all intangibles, are evaluated periodically in relation to the
operating performance and future undiscounted cash flows of the underlying
assets. Adjustments are made if the sum of expected future net cash flows is
less than book value.
Deferred Income Taxes:
Deferred income taxes are recorded using the liability method. Under this
method, deferred tax assets and liabilities are provided for the differences
between the financial statement and the tax basis of assets and liabilities
using enacted tax rates in effect for the years in which the differences are
expected to reverse.
F-7
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--CONTINUED
Revenue Recognition:
Management fees and other management-related fees are recognized when
earned. The Owned Hotels and Leased Hotels recognize revenue from their rooms,
food and beverage and other departments as earned on the close of each business
day. Hotels managed under short-term operating leases with certain lessee and
lessor cancellation clauses are treated as management contracts, with the
revenue earned from those leases recognized when earned.
Reimbursable Expenses:
The Company is reimbursed for costs associated with providing insurance
services, purchasing and renovation services, MIS support, centralized
accounting, leasing, training and relocation programs to owned, managed and
leased hotels. These revenues are included in other management-related fees and
the corresponding costs are included in general and administrative and payroll
and related benefits in the consolidated statements of operations.
Insurance:
Insurance premiums are recorded as income on a pro-rata basis over the life
of the related policies, with the portion applicable to the unexpired terms of
the policies in force recorded as unearned premium reserves. Losses are provided
for reported claims, claims incurred but not reported and claims settlement
expense at each balance sheet date. Such losses are based on management's
estimate of the ultimate cost of settlement of claims. Actual liabilities may
differ from estimated amounts. Any changes in estimates are reflected in current
earnings.
Concentration of Credit Risk:
The Company maintains cash and cash equivalents with various financial
institutions in excess of the amount insured by the Federal Deposit Insurance
Corporation. Management believes the credit risk related to these cash and cash
equivalents is minimal.
Financial Instruments:
The Company uses interest rate hedge contracts for the purpose of hedging
interest rate exposures, which involve the exchange of fixed and floating rate
interest payments without the exchange of the underlying principal amounts. The
amounts to be paid or received are accrued as interest rates change and
recognized over the life of the contracts as an adjustment to interest expense.
Gains and losses realized from the termination of interest rate hedges are
recognized over the remaining life of the hedge contract. As a policy, the
Company does not engage in speculative or leveraged transactions, nor does the
Company hold or issue financial instruments for trading purposes.
Reclassifications:
Certain amounts in previously issued financial statements have been
reclassified to conform to the presentation adopted in the 1996 consolidated
financial statements.
F-8
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
3. PUBLIC OFFERINGS:
Initial Offering:
In June 1996, the Company completed an initial public offering of its
Common Stock resulting in the sale of 12,448,350 shares (including 1,448,350
shares from the underwriters' exercise of over-allotment options) at a price of
$21 per share (the Initial Offering). Net proceeds to the Company were $240,453.
In connection with the Initial Offering, Blackstone Real Estate Advisors, L.P.
and certain of its affiliates (collectively, Blackstone) exercised an option to
receive 2,133,333 shares of Common Stock of the Company for an exercise price of
$23,300.
In connection with the Initial Offering, the Company acquired all of
Blackstone's equity interests in 13 of the Owned Hotels for a cash purchase
price of $124,400, and Blackstone contributed to the Company its equity interest
in one Owned Hotel in consideration of $8,300 of Common Stock of the Company.
Additionally, in connection with the Initial Offering, the principal
shareholders of IHC contributed to the Company all of the outstanding shares of
common stock of IHC and their equity interests in these 14 Owned Hotels in
exchange for Common Stock of the Company. The acquisition of Blackstone's equity
interests has been accounted for using the purchase method of accounting, except
that carryover basis was used for 9.3% of the acquired interests. The
contributions of IHC's common stock and equity interests in hotels in exchange
for Common Stock of the Company have been accounted for using carryover bases.
Follow-on Offering:
In December 1996, the Company completed a follow-on public offering of
4,000,000 shares of its Common Stock at a price of $25 per share (the Follow-on
Offering). In January 1997, the underwriters purchased an additional 600,000
shares of Common Stock at $25 per share pursuant to over-allotment options. Net
proceeds to the Company were $93,720 from the Follow-on Offering and $14,286
from the exercise of the over-allotment options. The Company recorded the
exercise of the over-allotment options as stock subscription receivable, net of
the underwriting discount, in the consolidated balance sheets as of December 31,
1996.
4. POST-INITIAL OFFERING ACQUISITIONS:
Subsequent to the Initial Offering and related transactions discussed in
Note 3, the Company acquired 13 hotels with an aggregate purchase price of
approximately $323,579. On November 15, 1996, the Company acquired for 1,957,895
shares of Common Stock the management and leasing businesses affiliated with
Equity Inns, Inc., a publicly traded real estate investment trust, which
resulted in goodwill of approximately $21,691. The businesses consisted of eight
management contracts and 48 long-term lease contracts. The above acquisitions
were accounted for using the purchase method of accounting. One of the hotels
acquired since the Initial Offering was purchased from an entity partially owned
by a significant shareholder (see Note 17).
5. PRO FORMA FINANCIAL INFORMATION (UNAUDITED):
The following unaudited pro forma information is presented as if the
transactions discussed in Notes 3, 4 and 8 had occurred on January 1, 1995. In
management's opinion, all 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, and does not purport to present what the actual
results of operations of the Company would have been if the previously
F-9
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
5. PRO FORMA FINANCIAL INFORMATION (UNAUDITED)--CONTINUED
mentioned transactions had occurred on such date or to project the results of
operations of the Company for any future period.
YEAR ENDED
DECEMBER 31,
----------------------
1995 1996
-------- --------
Total revenues............................................... $445,472 $477,506
Operating income............................................. 59,891 81,265
Net income................................................... 19,023 32,948
Pro forma earnings per common share and common share
equivalent................................................. .54 .93
Weighted average common shares and common share
equivalents................................................ 35,387,677 35,387,677
6. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following:
DECEMBER 31,
--------------------
1995 1996
------ --------
Land........................................................... $ -- $ 95,192
Buildings and improvements (15 to 40 years).................... 678 545,565
Furniture, fixtures and equipment (5 to 10 years).............. 3,776 112,808
Construction in progress....................................... -- 669
------ --------
4,454 754,234
Less accumulated depreciation.................................. 2,560 45,083
------ --------
$1,894 $709,151
====== ========
Depreciation expense was approximately $421, $467 and $8,420 for the years
ended December 31, 1994, 1995 and 1996, respectively.
7. INTANGIBLES AND OTHER ASSETS:
Intangibles and other assets consisted of the following:
DECEMBER 31,
--------------------
1995 1996
------- -------
Management contracts (3 to 10 years)........................... $22,794 $24,825
Lease contracts (15 years)..................................... -- 22,600
Goodwill (25 years)............................................ -- 21,691
Deferred financing fees (3 to 7 years)......................... 2,101 14,862
Other.......................................................... 2,088 4,477
------- -------
26,983 88,455
Less accumulated amortization.................................. 17,794 21,863
------- -------
$ 9,189 $66,592
======= =======
F-10
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
8. LONG-TERM DEBT:
Long-term debt consisted of the following:
DECEMBER 31,
---------------------
1995 1996
------- --------
Term Loans and Revolving Credit Facility....... $ -- $321,600
CGL Loan....................................... -- 29,250
Owned Hotel Loans.............................. -- 56,420
IHC revolving credit and term loan facility.... 35,000 --
Other.......................................... 1,270 541
------- --------
36,270 407,811
Less current portion........................... 363 11,767
------- --------
$35,907 $396,044
======= ========
In June 1996, the Company entered into a $195,000 Term Loan and a $100,000
Revolving Credit Facility (collectively, the Credit Facilities). In October
1996, the Company amended the Credit Facilities by converting the borrowings
outstanding under the Revolving Credit Facility to a $100,000 Term Loan and
increasing the Revolving Credit Facility capacity to $200,000. The Term Loans
are payable through June 2003 in escalating quarterly installments and a final
balloon payment. The Revolving Credit Facility, payable in June 2003, provides
for borrowings under letters of credit, revolving loans for working capital and
acquisition loans to be used to finance additional hotel acquisitions. The
Credit Facilities include certain mandatory prepayment provisions.
The Company purchased a subordinated participation interest in the $119,250
mortgage indebtedness of Interstone/CGL Partners, L.P., a majority-owned
subsidiary of the Company (the CGL Loan). As of December 31, 1996, on a
consolidated basis, the Company had outstanding, in addition to the Credit
Facilities, $29,250 of the CGL Loan. The CGL Loan requires no principal payments
until the indebtedness matures in June 2003. All other terms of the CGL Loan,
including interest and covenants, are identical to the Credit Facilities.
Interest on the Credit Facilities and the CGL Loan is payable subject to
the Company's election of the base rate option or the Eurodollar option. The
base rate option is the lender's prime rate plus 1%. The Eurodollar option is
LIBOR plus 2%. The Company elected the Eurodollar option to be in effect as of
December 31, 1996, which was 7.69%. Additionally, the Company has entered into
five interest rate hedge contracts: an interest rate cap that limits LIBOR to 6%
on up to $105,000 of the indebtedness through June 1999; an interest rate cap
that limits LIBOR to 6% on up to $234,750 of the indebtedness through October
1997; an interest rate cap that limits LIBOR to 6% on up to $225,900 of the
indebtedness from October 1997 through October 1998; an interest rate cap that
limits LIBOR to 7% on up to $208,750 of the indebtedness from October 1998
through October 1999; and an interest rate swap that provides for a fixed LIBOR
rate of 5.8% on $72,000 of the indebtedness through December 2000.
A nonrefundable commitment fee equal to 3/8 of 1% of the unused portion of
the Revolving Credit Facility is payable quarterly. Additionally, letter of
credit fees equal to 2.25% of the outstanding letters of credit are payable
quarterly.
The Credit Facilities and the CGL Loan contain certain restrictive
covenants, including several financial ratios and restrictions on the payment of
dividends, among other things. The Company has pledged substantially all of the
assets of the Company and an interest in the rights to the cash flows of certain
of the Owned Hotels as collateral for the Credit Facilities and the CGL Loan.
F-11
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
8. LONG-TERM DEBT--CONTINUED
In December 1996, the Company incurred loans (the Owned Hotel Loans)
totaling $56,420 related to the acquisitions of two hotels. One of the Owned
Hotel Loans is non recourse and is due in the form of a balloon payment of
$31,000 in January 1998. The other loans are payable monthly through October
2005 and include certain mandatory prepayment provisions. Interest is payable
monthly on the Owned Hotel Loans at rates between 7.5% and 9.08% as of December
31, 1996. The Owned Hotel Loans are collateralized by the assets of the two
hotels.
Aggregate scheduled maturities of long-term debt for each of the five years
ending December 31 and thereafter are as follows:
1997...................................................... $ 11,767
1998...................................................... 50,495
1999...................................................... 31,024
2000...................................................... 46,057
2001...................................................... 57,581
Thereafter................................................ 210,887
--------
$407,811
========
9. COMMITMENTS AND CONTINGENCIES:
The Company provides financial guarantees to the owners of the Leased
Hotels for certain minimum operating performance levels, which are annually
increased by the consumer price index and expire through 2011. Presently,
management does not expect to incur any claims against these lease guarantees.
Minimum future lease payments are computed based on the base rent of each lease,
as defined, and are as follows:
1997...................................................... $ 25,709
1998...................................................... 25,709
1999...................................................... 25,709
2000...................................................... 25,709
2001...................................................... 25,709
Thereafter................................................ 254,944
--------
$383,489
========
The Company accounts for the leases of office space (the office leases
expire at varying times through 2002), certain office equipment (the equipment
leases expire at varying times through 2003) and land leases associated with two
of the Owned Hotels (the land leases expire at varying times through 2086) as
operating leases. Total rent expense amounted to approximately $739, $912 and
$2,922 for the years ended Decem-
F-12
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
9. COMMITMENTS AND CONTINGENCIES--CONTINUED
ber 31, 1994, 1995 and 1996, respectively. The following is a schedule of future
minimum lease payments under these leases:
1997................................................... $ 2,975
1998................................................... 2,692
1999................................................... 2,358
2000................................................... 1,988
2001................................................... 1,728
Thereafter............................................. 35,527
--------
$ 47,268
========
In the ordinary course of business, various lawsuits, claims and
proceedings have been or may be instituted or asserted against the Company.
Based on currently available facts, management believes that the disposition of
matters that are pending or asserted will not have a material adverse effect on
the consolidated financial position, results of operations or liquidity of the
Company.
10. PREFERRED AND COMMON STOCK:
The Company has the authority to issue up to 25,000,000 shares of preferred
stock having such rights, preferences and privileges as designated by the Board
of Directors of the Company. The rights of the holders of the Company's Common
Stock will be subject to, and may be adversely affected by, the rights of the
holders of any shares of such preferred stock that may be issued in the future.
The following represents shares of Common Stock authorized for issuance
under the Company's stock plans:
NUMBER OF
SHARES
---------
Equity Incentive Plan, including the Stock Option
Plan for Non-Employee Directors............................ 2,500,000
Employee Stock Purchase Plan................................. 500,000
Management Bonus Plan........................................ 250,000
---------
3,250,000
=========
The Equity Incentive Plan provides for options to be granted to eligible
employees to purchase shares of Common Stock. The option price is established at
the grant date at a price not less than the current market value. The options
generally vest over a three year period and expire after ten years. The Employee
Stock Purchase Plan is designed to be a non-compensatory plan, whereby eligible
employees may elect to withhold a maximum of 8% of their salary and use such
amounts to purchase Common Stock. The Management Bonus Plan provides for bonuses
to be paid to key executives of the Company based upon the achievement of
specified goals of both the Company and the executive. Bonuses are based on a
percentage of the individual's annual salary, and up to 20% of each executive's
bonus, at the discretion of management, may be payable in the form of shares of
Common Stock.
The Company has elected to account for stock-based employee compensation
arrangements under the provisions of Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" rather than Statement of Financial
Accounting Standard (SFAS) No. 123 "Accounting for Stock-Based Compensation." If
compensation cost had been determined based on the fair value at the grant dates
F-13
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
10. PREFERRED AND COMMON STOCK--CONTINUED
according to SFAS No. 123, the Company's net loss would have been increased to
the pro forma amount shown below:
1996
-------
Net loss:
As reported.............................................. $(1,616)
Pro forma................................................ (2,781)
The effect on earnings per share is not meaningful and, therefore, has not
been provided (see Note 19).
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes pricing model with the following assumptions:
1996
----
Weighted average risk-free interest rate...................... 6.3%
Expected dividend yield....................................... --
Expected volatility........................................... 30.3%
Expected life (number of years)............................... 3
The transactions for stock options issued under the Equity Incentive Plan
and the Stock Option Plan for Non-Employee Directors were as follows:
WEIGHTED AVERAGED
-------------------------------------
NUMBER OF REMAINING VALUE EXERCISE RANGE OF
OPTIONS LIFE (YEARS) PER SHARE PRICE EXERCISE PRICE
--------- ------------ --------- -------- --------------
Outstanding, December 31, 1995.......... --
Granted................................. 1,589,250 $22.66 $21.00--$26.75
Exercised............................... -- -- --
Canceled................................ 12,500 $21.00 $21.00
---------
Outstanding, December 31, 1996.......... 1,576,750 9.6 $6.44 $22.66 $21.00--$26.75
=========
Exercisable, December 31, 1996.......... --
Shares reserved for future options as of
December 31, 1996..................... 923,250
11. NON-CASH COMPENSATION:
In December 1995, IHC granted stock options to certain officers to purchase
shares of common stock of IHC. The exercise price of certain stock options was
determined to be below fair market value based on an independent market
valuation. No stock options were exercisable at December 31, 1995. The unearned
compensation related to the stock options granted by IHC was being charged to
expense over the vesting period.
Prior to the Initial Offering, the Company issued 785,533 shares of Common
Stock to certain employees in consideration for the cancellation of the stock
options issued by IHC in 1995. The shares were valued based on the estimated
value of the Common Stock at the time the shares were issued. As a result of the
cancellation of the stock options issued by IHC in 1995 and the issuance of the
Common Stock at no cost to the recipients, the Company reversed the unamortized
unearned compensation recorded by IHC in 1995 and recorded non-cash compensation
expense of $11,896.
F-14
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
12. INCOME TAXES:
Prior to the consummation of the Initial Offering, the Company's
predecessors were organized as S corporations, partnerships and limited
liability companies for federal and state income tax purposes. Accordingly, the
predecessors were not subject to income tax because all taxable income or loss
of the predecessors was reported on the tax returns of their owners. As a result
of the change in the Company's tax status to a C corporation concurrent with the
Initial Offering, the Company recorded income tax expense of $4,881 to establish
deferred taxes existing as of the date of the change in tax status.
The provision for income taxes for the year ended December 31, 1996
consisted of:
Current
Federal.......................................................... $ 4,153
State............................................................ 504
-------
4,657
-------
Deferred:
Federal:......................................................... 6,223
State............................................................ 448
-------
6,671
-------
Income tax expense................................................. 11,328
Income tax benefit from extraordinary loss......................... 3,997
-------
$15,325
=======
A reconciliation of the Company's effective tax rate to the federal
statutory rate for the year ended December 31, 1996 follows:
Federal statutory rate............................................. 35%
State taxes, net of federal benefit................................ 2
IHC loss as an S corporation....................................... 23
Conversion from S corporation to C corporation..................... 50
Other.............................................................. 7
---
Effective tax rate................................................. 117%
===
The components of net deferred tax assets and liabilities as of December
31, 1996 consisted of:
DEFERRED TAX
-----------------------
ASSETS LIABILITIES
------ -----------
Depreciation and amortization................ $ -- $10,809
Minority interests........................... 7,298 --
Payroll and related benefits................. 1,588 --
Self-insured health trust.................... 927 --
Other........................................ -- 1,436
------ -------
$9,813 $12,245
====== =======
13. EXTRAORDINARY ITEMS:
In 1996, the Company recorded an extraordinary loss of $7,733, net of a tax
benefit of $3,997, as a result of the early extinguishment of certain debt. The
extraordinary loss related principally to the payment of prepayment penalties
and loan commitment fees and the write-off of deferred financing fees.
F-15
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
14. SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest and income taxes consisted of:
1994 1995 1996
------ ------- -------
Interest............................................... $ 261 $ 507 $13,629
Income taxes........................................... -- -- 7,710
Non-cash investing and financing activities consisted of:
1994 1995 1996
------ ------- --------
Notes payable issued to acquire contracts............. $1,176 $ -- $ --
Assumption of liability by principal shareholder...... -- 1,220 --
Assumption of shareholders' liability................. -- 12,295 --
Unearned compensation related to 1995 stock options... -- 3,263 (3,263)
Unearned compensation related to Common Stock (Note
11)................................................. -- -- 379
Notes payable issued to shareholders.................. -- -- 30,000
Stock subscription receivable, net.................... -- -- 14,286
Issuance of Common Stock for acquisitions............. -- -- 54,800
15. INSURANCE:
The Company provides certain insurance coverage to hotels under the terms
of the various management and lease contracts. This insurance is generally
arranged through a third-party carrier. Northridge Insurance Company
(Northridge), a subsidiary of the Company, reinsures a portion of the coverage
from this third-party primary insurer. The policies provide for layers of
coverage with minimum deductibles and annual aggregate limits. The policies are
for coverage relating to innkeepers' losses (general/comprehensive liability),
wrongful employment practices, garagekeeper's legal liability, replacement cost
automobile losses and real and personal property insurance. All policies are
short-duration contracts and expire through March, 1997.
The Company is liable for any deficiencies in the IHC Employee Health and
Welfare Plan (and related Health Trust), which provides employees of the Company
with group health insurance benefits. The Company has a financial indemnity
liability policy with Northridge which indemnifies the Company for certain
obligations for the deficiency in the related Health Trust. The premiums for
this coverage received from the properties managed by the Company, net of
intercompany amounts paid for employees at the Company's corporate offices and
Owned and Leased Hotels, are recorded as direct premiums written. There was no
deficiency in the related Health Trust at December 31, 1996.
All accounts of Northridge are classified with assets and liabilities of a
similar nature in the consolidated balance sheets. The consolidated statements
of operations include the insurance income earned and related insurance expenses
incurred. The insurance income earned has been included in other
management-related fees in the consolidated statements of operations and is
comprised of the following:
YEAR ENDED DECEMBER 31,
----------------------------
1994 1995 1996
------ ------ ------
Reinsurance premiums written............................. $3,428 $4,981 $4,848
Direct premiums written.................................. 2,581 2,477 2,032
Reinsurance premiums ceded............................... -- (422) (414)
Change in unearned premiums reserve...................... 42 (62) 158
Loss sharing premiums.................................... 910 698 1,101
------ ------ ------
Insurance income......................................... $6,961 $7,672 $7,725
====== ====== ======
F-16
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
16. FINANCIAL INSTRUMENTS:
The carrying values and fair values of the Company's financial instruments
at December 31 consisted of:
1995 1996
------------------- -------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- ------- -------- -------
Cash and cash equivalents................... $14,035 $14,035 $32,323 $32,323
Restricted cash............................. 2,096 2,096 15,995 15,995
Investment in marketable securities......... -- -- 540 540
Noncurrent receivables...................... 9,937 9,937 4,643 4,643
Interest rate caps.......................... -- -- 5,056 3,268
Interest rate swap.......................... -- -- -- 976
Long-term debt, including current portion... 36,207 36,207 407,811 406,835
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Cash and cash equivalents and restricted cash:
The carrying amounts approximate fair value because of the short maturity
of these investments.
Investment in marketable securities:
The fair value of the investment in marketable securities is based on the
quoted market price at December 31, 1996, and is included in investments in
hotel real estate in the consolidated balance sheets.
Noncurrent receivables:
The fair value of noncurrent receivables is based on anticipated cash flows
and approximates carrying value.
Interest rate hedges:
The Company manages its debt portfolio by using interest rate caps and
swaps to achieve an overall desired position of fixed and floating rates. The
fair value of interest rate hedge contracts is estimated based on quotes from
the market makers of these instruments and represents the estimated amounts that
the Company would expect to receive or pay to terminate the contracts. Credit
and market risk exposures are limited to the net interest differentials. The
Company is exposed to credit loss in the event of nonperformance by
counterparties on the above instruments, but does not anticipate nonperformance
by any of the counterparties.
Long-term debt:
The fair value of long-term debt is based on interest rates that are
currently available to the Company for issuance of debt with similar terms and
remaining maturities. The fair value of the notional amount of long-term debt
hedged by the swap has been reduced by the fair value of the swap.
F-17
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
17. FRANCHISE AGREEMENTS AND RELATED PARTY TRANSACTIONS
Franchise Agreements:
The Owned Hotels and the Leased Hotels are generally operated under
franchise agreements with various franchisors. The Owned Hotels are licensed
under the following franchise names: Marriott (13), Hilton (4), Radisson (4),
Embassy Suites (2), Westin (2) and Holiday Inn (1). The Leased Hotels are
licensed under the following franchise names: Hampton Inn (32), Holiday Inn (5),
Residence Inn (5), Super 8 Motel (5), Sleep Inn (4), Homewood Suites (3) and
Comfort Inn (3). The terms of the franchise agreements range from 2 to 28 years
and require ongoing fees principally based on a percentage of hotel room
revenues and food and beverage revenues.
Revenues and Accounts Receivable:
Of the total revenues earned, approximately $6,678, $7,886 and $7,386 for
the years ended December 31, 1994, 1995 and 1996, respectively, was earned from
hotels in which a significant shareholder of the Company has an ownership
interest. Accounts receivable of approximately $1,028 and $302 at December 31,
1995 and 1996, respectively, was due from these hotels. The Company has waived
the management fees for one of these hotels through November 1998.
Transaction with Significant Shareholders:
In December 1996, the Company acquired a 97.12% interest in one hotel for
$23,787, which includes a $10,000 contribution for future capital expenditures
and $9,627 in loans to the previous owners. Significant shareholders of the
Company previously owned a 50% interest in the hotel, one of which retained a
1.44% limited partnership interest as a result of the acquisition. The $9,627 in
loans incurred as a result of the acquisition includes a $2,733 note payable to
the significant shareholder, which is included in the Owned Hotel Loans
described in Note 8.
18. PREDECESSOR ENTITY EQUITY TRANSACTIONS:
In 1994, IHC recapitalized certain companies and created two classes of
common stock. The recapitalization resulted in the reclassification of $21
between common stock and paid-in capital.
Pursuant to a reorganization in 1995, IHC merged a number of companies and
created subsidiaries for certain other entities which were all under common
control. The reorganization was accounted for in a manner similar to that used
in pooling-of-interests accounting. Additionally, concurrent with the
reorganization, IHC assumed a $12,995 obligation of its principal shareholder
that was accounted for as a distribution of capital. IHC also recorded a
contribution of capital when indebtedness in the amount of $1,220 that was owed
to an affiliate was assumed by the principal shareholder. The reorganization
resulted in the reclassification of $42 between common stock and paid-in capital
and the reclassification of $4,478 between partners' capital and paid-in
capital.
In March 1996, the Company made a capital distribution by issuing notes
payable to the shareholders of IHC in the aggregate amount of $30,000. Such
notes were repaid in June 1996 with the proceeds from the Initial Offering.
F-18
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
---------
19. EARNINGS PER SHARE:
Prior to the consummation of the Company's Initial Offering, the
predecessors of the Company were organized as S corporations, partnerships and
limited liability companies. Accordingly, the Company believes that the earnings
per share calculations required to be presented are not meaningful for periods
prior to the Initial Offering and, therefore, have not been provided. As such,
earnings per share for the three-month periods ended September 30, 1996 and
December 31, 1996 and pro forma earnings per share for the years ended December
31, 1995 and 1996 are a more meaningful measure of the Company's results of
operations (see Notes 5 and 20).
20. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
The following table sets forth certain items included in the Company's
unaudited consolidated financial statements for each quarter of fiscal 1996 and
1995:
FIRST SECOND THIRD FOURTH
------- -------- ----------- -----------
FISCAL 1996:
Total revenues.................................. $12,295 $ 15,946 $ 65,530 $ 96,614
Operating income (loss)......................... 4,607 (5,775) 16,602 18,699
Income (loss) before extraordinary items........ 4,236 (12,299) 7,366 6,814
Net income (loss)............................... 4,236 (19,942) 7,366 6,724
Earnings per common share and common share
equivalent (Note 19).......................... -- -- .26 .22
Weighted average common shares and common share
equivalents................................... -- -- 28,664,549 30,586,186
FISCAL 1995:
Total revenues.................................. $10,249 $ 11,403 $ 11,236 $ 12,130
Operating income................................ 3,293 4,636 4,409 3,199
Net income...................................... 3,345 4,712 4,472 3,310
21. SUBSEQUENT EVENTS:
As of March 19, 1997, the Company had acquired a majority equity interest
in one hotel, a 50% equity interest in another hotel and a minority equity
interest in two other hotels through four separate transactions. The total
aggregate purchase price of these acquisitions was approximately $31,359, which
includes a $2,000 contribution for future capital expenditures. A portion of one
of the acquisitions was purchased for $300 from an entity partially owned by a
significant shareholder of the Company. These acquisitions have not been
included in the pro forma financial information in Note 5.
The Company has also entered into a definitive agreement to purchase a
hotel for an expected purchase price of approximately $63,000.
22. NEW ACCOUNTING PRONOUNCEMENT:
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128 "Earnings Per Share." The new standard, which is effective for fiscal year
1997, revises the disclosure requirements and simplifies the computation of
earnings per share. Management has not yet determined the impact of this
standard.
F-19
35
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- - ----------- -------------------------------------------------------------------------------
2.1 Formation Agreement, dated as of June 25, 1996, among the Company and the
parties identified on the signature page thereof(1)
3.1 Amended and Restated Articles of Incorporation of the Company(1)
3.2 Amended and Restated Bylaws of the Company(1)
4.1 Specimen Common Stock Certificate(2)
4.2(a) Credit Agreement, dated as of June 25, 1996, among Interstate Hotels
Corporation, Credit Lyonnais and the other parties signatory thereto(1)
4.2(b) First Amendment to Credit Agreement, dated as of October 21, 1996, among
Interstate Hotels Corporation, Credit Lyonnais and the other parties signatory
thereto(2)
10.1 Agreement of Purchase and Sale, dated as of March 29, 1996, among the Sellers
named therein and IHC Member Corporation(3)
10.2 Contribution Agreement, dated as of March 29, 1996, among Interstate Hotels
Corporation and the other persons signatory thereto(3)
10.3 Stockholders Agreement, dated as of June 25, 1996, among the Company,
Blackstone Real Estate Advisors L.P. and the shareholders named therein(1)
10.4 Registration Rights Agreement, dated as of June 25, 1996, among the Company and
the shareholders named therein(1)
10.5 Master Agreement, dated as of April 1, 1996, among Host Funding, Inc.,
Crossroads Hospitality Tenant Company, L.L.C. and Crossroads Hospitality
Company, L.L.C.(3)
10.6 Interstate Hotels Company Executive Retirement Plan(3)
10.7 Interstate Hotels Company Equity Incentive Plan(3)
10.8 Interstate Hotels Company Stock Purchase Plan(3)
10.9 Interstate Hotels Company Management Bonus Plan(3)
10.10 Interstate Hotels Company Stock Option Plan for Non-Employee Directors(3)
10.11(a) Employment Agreement between the Company and Milton Fine(3)
10.11(b) Employment Agreement between the Company and W. Thomas Parrington, Jr.(3)
10.11(c) Employment Agreement between the Company and J. William Richardson(3)
10.11(d) Employment Agreement between the Company and Robert L. Froman(3)
10.11(e) Employment Agreement between the Company and Marvin I. Droz(3)
10.11(f) Employment Agreement between the Company and Thomas D. Reese(2)
10.12 Form of Severance Agreement between the Company and each of Milton Fine, W.
Thomas Parrington, Jr., J. William Richardson, Robert L. Froman and Marvin I.
Droz(3)
10.13 Form of Indemnification Agreement between the Company and each of its
directors(3)
10.14(a) Interstate Hotels Company Supplemental Deferred Compensation Plan(3)
10.14(b) Deferred Compensation Agreement between the Company and W. Thomas Parrington,
Jr.(3)
10.14(c) Deferred Compensation Agreement between the Company and J. William
Richardson(3)
10.15(a) Contribution Agreement, dated as of October 4, 1996, as amended, among Trust
Leasing, Inc., Trust Management, Inc., Phillip H. McNeill, Sr.,
Crossroads/Memphis Company, L.L.C. and Crossroads/Memphis Partnership, L.P.(2)
10.15(b) Master Agreement, dated as of November 4, 1996, as amended, among Equity Inns
Partnership, L.P., Interstate Hotels Corporation, Equity Inns, Inc.,
Crossroads/Memphis Partnership, L.P. and Crossroads Future Company, L.L.C.(2)
36
EXHIBIT NO. DESCRIPTION
- - ----------- -------------------------------------------------------------------------------
10.16(a) Contribution Agreement, dated as of December 19, 1996, among Casa Marina Ltd.,
Casa Marina Realty Corporation, Interstone Partners I, L.P. and Casa Marina
Realty Partnership, L.P.(4)
10.16(b) Contribution Agreement and Agreement to Assign Partnership Interests and Enter
into First Amended and Restated Limited Partnership Agreement, dated as of
December 19, 1996, among IHC Reach Corporation, Reach Resort Investment
Corporation, Interstone Partners I, L.P. and The Key West Reach Limited
Partnership(4)
21.1 List of Subsidiaries of the Company
23.1 Consent of Coopers & Lybrand L.L.P.
24.1 Powers of Attorney executed by the Company, Michael J. Aranson, David J. Fine,
Milton Fine, R. Michael McCullough, W. Thomas Parrington, Jr., J. William
Richardson, Thomas J. Saylak and Steven J. Smith
27.1 Financial Data Schedule
- - ---------
(1) Filed previously as an exhibit to the Company's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1996 and incorporated herein by
reference.
(2) Filed previously as an exhibit to the Company's Registration Statement on
Form S-1, as amended (Registration. No. 333-15507), and incorporated herein
by reference.
(3) Filed previously as an exhibit to the Company's Registration Statement on
Form S-1, as amended (Registration. No. 333-3958), and incorporated herein
by reference.
(4) Filed previously as an exhibit to the Company's Current Report on Form 8-K
dated December 27, 1997 and incorporated herein by reference.