1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
------------------------
INTERSTATE HOTELS CORPORATION
FOSTER PLAZA TEN
680 ANDERSEN DRIVE
PITTSBURGH, PENNSYLVANIA 15220
(412) 937-0600
MARYLAND 0-26805 75-2767215
(State of Incorporation) (Commission File No.) (I.R.S. Employer
Identification Number)
The Company (1) has filed all reports to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the period that the Company was
required to file such reports, but (2) has not been subject to such filing
requirements for the past 90 days.
The total number of shares of the Company's Common Stock, par value $0.01
per share, outstanding at August 5, 1999 was 6,063,079.
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2
INDEX
INTERSTATE HOTELS CORPORATION
PAGE NO.
--------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)............................ 2
Consolidated Balance Sheets - December 31, 1998 and June 30,
1999........................................................ 2
Consolidated Statements of Operations - Historical Periods
from April 1, 1998 to June 1, 1998 and from June 2, 1998 to
June 30, 1998, Combined Three Months Ended June 30, 1998 and
Historical Three Months Ended June 30, 1999................. 3
Consolidated Statements of Operations - Historical Periods
from January 1, 1998 to June 1, 1998 and from June 2, 1998
to June 30, 1998, Combined Six Months Ended June 30, 1998
and Historical Six Months Ended June 30, 1999............... 4
Consolidated Statements of Cash Flows - Historical Periods
from January 1, 1998 to June 1, 1998 and from June 2, 1998
to June 30, 1998, Combined Six Months Ended June 30, 1998
and Historical Six Months Ended June 30, 1999............... 5
Consolidated Statements of Operations - Pro Forma Three
Months and Six Months Ended June 30, 1998 and June 30,
1999........................................................ 6
Notes to Consolidated Financial Statements.................. 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 13
PART II OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds................... 19
Item 6. Exhibits and Reports on Form 8-K............................ 19
3
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED).
INTERSTATE HOTELS CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31, JUNE 30,
1998 1999
------------ -----------
(A) (UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,652 $ 38,164
Accounts receivable, net.................................. 16,816 16,990
Deferred income taxes..................................... 615 1,562
Net investment in direct financing leases................. 827 671
Prepaid expenses and other assets......................... 741 1,664
Related party receivables--management contracts........... 1,085 790
-------- --------
Total current assets.................................... 21,736 59,841
Restricted cash............................................. 2,201 1,639
Marketable securities....................................... 2,609 2,880
Property and equipment, net................................. 4,076 3,673
Officers and employees notes receivable..................... 2,803 2,691
Affiliate receivables....................................... 3,381 9,404
Net investment in direct financing leases................... 1,680 1,302
Investment in hotel real estate............................. 22,150 300
Intangibles and other assets................................ 100,521 91,099
-------- --------
Total assets............................................ $161,157 $172,829
======== ========
LIABILITIES AND OWNERS' EQUITY
Current liabilities:
Accounts payable--trade................................... 2,413 1,534
Accounts payable--health trust............................ 1,785 4,505
Accounts payable--related parties......................... 18,597 3,462
Accrued payroll and related benefits...................... 6,120 5,911
Accrued rent.............................................. 5,043 9,970
Accrued merger costs...................................... 9,344 1,042
Other accrued liabilities................................. 9,236 15,003
-------- --------
Total current liabilities............................... 52,538 41,427
Deferred income taxes....................................... 11,053 6,659
Deferred compensation....................................... 2,609 2,880
-------- --------
Total liabilities....................................... 66,200 50,966
Minority interest........................................... 2,350 56,508
Commitments and contingencies............................... -- --
Owners' equity:
Preferred stock, $.01 par value; 10,000,000 shares
authorized; no shares
issued or outstanding................................... -- --
Common stock, $.01 par value; 65,000,000 shares
authorized; 6,063,079
shares issued and outstanding as of June 30, 1999....... -- 61
Paid-in capital........................................... -- 65,630
Retained deficit.......................................... -- (336)
Owners' equity............................................ 92,607 --
-------- --------
Total owners' equity.................................... 92,607 65,355
-------- --------
Total liabilities and owners' equity.................... $161,157 $172,829
======== ========
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(A) The year-end balance sheet information was derived from audited financial
statements, but does not include all disclosures required by generally
accepted accounting principles.
The accompanying notes are an integral part of the consolidated financial
statements.
2
4
INTERSTATE HOTELS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS)
PREDECESSOR SUCCESSOR COMBINED SUCCESSOR
------------- ------------- -------- ---------
PERIOD FROM
----------------------------- THREE MONTHS ENDED
APRIL 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO --------------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
------------- ------------- -------- ---------
Lodging revenues:
Rooms........................................... $32,896 $17,202 $50,098 $48,854
Other departmental.............................. 1,981 931 2,912 2,734
Net management fees............................... 7,684 3,881 11,565 8,753
Other fees........................................ 4,442 1,823 6,265 3,200
------- ------- ------- -------
47,003 23,837 70,840 63,541
------- ------- ------- -------
Lodging expenses:
Rooms........................................... 7,435 3,831 11,266 11,085
Other departmental.............................. 1,196 563 1,759 1,769
Property costs.................................. 8,371 4,270 12,641 13,905
General and administrative........................ 2,105 771 2,876 3,510
Payroll and related benefits...................... 4,239 1,412 5,651 5,048
Lease expense..................................... 15,744 8,424 24,168 23,612
Depreciation and amortization..................... 841 1,555 2,396 5,434
------- ------- ------- -------
39,931 20,826 60,757 64,363
------- ------- ------- -------
Operating income (loss)........................... 7,072 3,011 10,083 (822)
Other income (expense):
Interest, net................................... 80 35 115 96
Other, net...................................... 172 101 273 1,181
Loss on sale of investment in hotel real
estate....................................... -- -- -- (876)
------- ------- ------- -------
Income (loss) before income tax expense........... 7,324 3,147 10,471 (421)
Income tax expense................................ 2,926 1,256 4,182 249
------- ------- ------- -------
Income (loss) before minority interest............ 4,398 1,891 6,289 (670)
Minority interest................................. 10 5 15 (1,045)
------- ------- ------- -------
Net income........................................ $ 4,388 $ 1,886 $ 6,274 $ 375
======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
3
5
INTERSTATE HOTELS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS)
PREDECESSOR SUCCESSOR COMBINED SUCCESSOR
--------------- ------------- -------- ---------
PERIOD FROM
------------------------------- SIX MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO --------------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
--------------- ------------- -------- ---------
Lodging revenues:
Rooms......................................... $74,265 $17,202 $91,467 $89,124
Other departmental............................ 4,504 931 5,435 5,059
Net management fees............................. 18,018 3,881 21,899 17,322
Other fees...................................... 9,976 1,823 11,799 6,180
------- ------- ------- -------
106,763 23,837 130,600 117,685
------- ------- ------- -------
Lodging expenses:
Rooms......................................... 17,173 3,831 21,004 20,820
Other departmental............................ 2,674 563 3,237 3,275
Property costs................................ 19,987 4,270 24,257 26,722
General and administrative...................... 6,115 771 6,886 7,588
Payroll and related benefits.................... 10,982 1,412 12,394 9,956
Lease expense................................... 34,515 8,424 42,939 44,509
Depreciation and amortization................... 2,152 1,555 3,707 10,092
------- ------- ------- -------
93,598 20,826 114,424 122,962
------- ------- ------- -------
Operating income (loss)......................... 13,165 3,011 16,176 (5,277)
Other income (expense):
Interest, net................................. 204 35 239 155
Other, net.................................... 474 101 575 1,563
Loss on sale of investment in hotel real
estate..................................... -- -- -- (876)
------- ------- ------- -------
Income (loss) before income tax expense
(benefit)..................................... 13,843 3,147 16,990 (4,435)
Income tax expense (benefit).................... 5,528 1,256 6,784 (1,376)
------- ------- ------- -------
Income (loss) before minority interest.......... 8,315 1,891 10,206 (3,059)
Minority interest............................... 24 5 29 (996)
------- ------- ------- -------
Net income (loss)............................... $ 8,291 $ 1,886 $10,177 $(2,063)
======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
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6
INTERSTATE HOTELS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
PREDECESSOR SUCCESSOR COMBINED SUCCESSOR
--------------- ------------- -------- ---------
PERIOD FROM
------------------------------- SIX MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO --------------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
--------------- ------------- -------- ---------
Cash flows from operating activities:
Net income (loss)............................... $ 8,291 $ 1,886 $10,177 $ (2,063)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization................. 2,152 1,555 3,707 10,092
Equity in earnings from unconsolidated
subsidiaries............................... (513) (101) (614) (1,525)
Deferred income taxes......................... (1,555) 1,106 (449) (52)
Other......................................... 200 32 232 (160)
Cash (used) provided by assets and liabilities:
Accounts receivable, net...................... (3,661) (3,100) (6,761) (174)
Prepaid expenses and other assets............. 307 (609) (302) (923)
Related party receivables..................... (341) (44) (385) 295
Accounts payable.............................. 1,053 (3,226) (2,173) 1,632
Accrued liabilities........................... 12,426 814 13,240 12,178
-------- -------- ------- --------
Net cash provided by (used in) operating
activities............................... 18,359 (1,687) 16,672 19,300
-------- -------- ------- --------
Cash flows from investing activities:
Net investment in direct financing leases....... 145 (797) (652) 534
Change in restricted cash....................... 540 (576) (36) 562
Purchase of property and equipment, net......... (709) (19) (728) (75)
Purchases of marketable securities.............. -- -- -- (1,324)
Proceeds from sale of marketable securities..... -- -- -- 1,113
Proceeds from sale of investment in hotel real
estate........................................ -- -- -- 13,654
Net cash received from unconsolidated
subsidiaries.................................. 1,085 67 1,152 1,176
Net investment in management contracts.......... (666) (27) (693) (176)
Merger-related acquisition costs................ -- (10,159) (10,159) (8,303)
Change in affiliate receivables, net............ 2,043 231 2,274 (623)
Other........................................... 236 (141) 95 96
-------- -------- ------- --------
Net cash provided by (used in) investing
activities................................. 2,674 (11,421) (8,747) 6,634
-------- -------- ------- --------
Cash flows from financing activities:
Repayment of long-term debt..................... (180) -- (180) --
Proceeds from sale of common stock.............. -- -- -- 2,120
Net (distributions to) contributions from
minority interests............................ (44) 15 (29) 6,934
Related party payables.......................... (9,234) 5,290 (3,944) (15,135)
Net (distributions to) contributions from
owners........................................ (9,840) 8,473 (1,367) 16,659
-------- -------- ------- --------
Net cash (used in) provided by financing
activities............................... (19,298) 13,778 (5,520) 10,578
-------- -------- ------- --------
Net increase in cash and cash equivalents......... 1,735 670 2,405 36,512
Cash and cash equivalents at beginning of
period.......................................... 2,432 4,167 2,432 1,652
-------- -------- ------- --------
Cash and cash equivalents at end of period........ $ 4,167 $ 4,837 $ 4,837 $ 38,164
======== ======== ======= ========
The accompanying notes are an integral part of the consolidated financial
statements.
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7
INTERSTATE HOTELS CORPORATION
PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
PRO FORMA (NOTE 3)
--------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
1998 1999 1998 1999
------- ------- ------- -------
Lodging revenues:
Rooms....................................... $50,098 $48,854 $91,467 $89,124
Other departmental.......................... 2,912 2,734 5,435 5,059
Net management fees........................... 8,122 7,014 15,166 13,702
Other fees.................................... 4,977 2,776 9,237 5,550
------- ------- ------- -------
66,109 61,378 121,305 113,435
------- ------- ------- -------
Lodging expenses:
Rooms....................................... 11,266 11,085 21,004 20,820
Other departmental.......................... 1,759 1,769 3,237 3,275
Property costs.............................. 12,641 13,905 24,257 26,722
General and administrative.................... 2,859 3,704 6,858 8,032
Payroll and related benefits.................. 4,645 5,198 10,287 10,256
Lease expense................................. 24,168 23,612 42,939 42,509
Depreciation and amortization................. 4,532 5,434 9,086 10,092
------- ------- ------- -------
61,870 64,707 117,668 121,706
------- ------- ------- -------
Operating income (loss)....................... 4,239 (3,329) 3,637 (8,271)
Other income (expense):
Interest, net............................... 259 219 527 422
Other, net.................................. (40) 38 (40) 38
------- ------- ------- -------
Income (loss) before income tax expense
(benefit)................................... 4,458 (3,072) 4,124 (7,811)
Income tax expense (benefit).................. 835 (522) 806 (1,343)
------- ------- ------- -------
Income (loss) before minority interest........ 3,623 (2,550) 3,318 (6,468)
Minority interest............................. 2,373 (1,768) 2,110 (4,454)
------- ------- ------- -------
Net income (loss)............................. $ 1,250 $ (782) $ 1,208 $(2,014)
======= ======= ======= =======
Pro forma earnings per common share and common
share equivalent:
Basic....................................... $ .20 $ (.12) $ .19 $ (.31)
======= ======= ======= =======
Diluted..................................... $ .20 $ (.12) $ .19 $ (.31)
======= ======= ======= =======
Pro forma weighted average number of common
share and common share equivalents
outstanding:
Basic....................................... 6,394,996 6,394,996 6,394,996 6,394,996
========= ========= ========= =========
Diluted..................................... 6,394,996 6,394,996 6,394,996 6,394,996
========= ========= ========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
6
8
INTERSTATE HOTELS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED, DOLLARS IN THOUSANDS)
1. ORGANIZATION AND BASIS OF PRESENTATION:
Interstate Hotels Company (together with its subsidiaries, "Old
Interstate") was merged into Wyndham International, Inc., formerly Patriot
American Hospitality, Inc. ("Wyndham"), on June 2, 1998 (the "Merger"). Prior to
the Merger, Marriott International, Inc. ("Marriott") filed a lawsuit to stop
the closing of the Merger as a result of a dispute over certain franchise
agreements between Marriott and Old Interstate. On June 18, 1999, pursuant to a
settlement agreement with Marriott with respect to the lawsuit, Wyndham
transferred the third-party hotel management business of Old Interstate, equity
interests in The Charles Hotel Complex, a hotel, retail and office complex
located in Cambridge, Massachusetts, and long-term leasehold interests in
hotels, as well as certain other assets and liabilities of Old Interstate, to a
new entity, Interstate Hotels Corporation (together with its subsidiaries, the
"Company"), which Wyndham then spun-off to its shareholders (the "Spin-off"). As
a result of the Spin-off, 92% of the common shares of the Company were
distributed to Wyndham's shareholders, Marriott was issued a 4% ownership
interest in the Company's common stock and Wyndham retained a 4% interest in the
Company's common stock.
The financial statements have been prepared using the predecessor basis of
accounting for the period from January 1, 1998 to June 1, 1998, and the
successor basis of accounting for the period from June 2, 1998 to December 31,
1998, as well as for the periods presented in 1999, to coincide with the periods
before and after the Merger. The Merger was accounted for using the purchase
method of accounting, and the Merger consideration was allocated by Wyndham on
the basis of the fair market value of the assets of Old Interstate. The Spin-off
was accounted for using the historical basis of accounting. The statements of
operations and cash flows contain columns for the three and six months ended
June 30, 1998 that combine the predecessor and successor periods, as the Company
deems this presentation to be informative to the reader of such financial
statements. When used herein, "consolidated financial statements" refers to the
historical combined financial statements of the Company prior to the Spin-off
and the historical consolidated financial statements of the Company thereafter.
Prior to the Spin-off, the Company was not a separate legal entity.
Therefore, the accompanying consolidated financial statements of the Company
have been carved out of Old Interstate's financial statements prior to the
Merger using the predecessor basis of accounting, and from Wyndham's financial
statements subsequent to the Merger using the successor basis of accounting,
which gives effect to the allocation of Merger consideration. The financial
statements include only those assets, liabilities, revenues and expenses
directly attributable to the third-party hotel management business, the equity
interests in The Charles Hotel Complex and the leased hotels which were spun-off
with the Company. These consolidated financial statements have been prepared as
if the Company had operated as a separate entity for all periods presented.
The Company has two principal subsidiaries. Interstate Hotels, LLC ("IH
LLC") has assumed the third-party hotel management business previously conducted
by Old Interstate and holds the leasehold interests in the Company's leased
hotels, as well as provides ancillary services such as centralized purchasing,
equipment leasing and insurance services. The Company owns a 45% managing member
interest and Wyndham owns a 55% non-controlling ownership interest in IH LLC.
The other subsidiary, IHC II, LLC, has entered into management contracts to
manage eleven Wyndham-owned hotels and subcontracted the management under these
contracts to Marriott. The Company owns a 99.99% interest and Marriott owns a
.01% interest in this subsidiary.
In accordance with IH LLC's limited liability company agreement, the
Company is required to distribute 55% of IH LLC's cash flows from operations to
Wyndham and allocate between IH LLC and the Company the costs and expenses
relating to services provided by one party for the benefit of the other in
accordance with generally accepted accounting principles, on the basis of which
party benefited from the expenditure. To the extent that the allocation of any
such costs and expenses, including general and administrative expenses, cannot
be fairly apportioned, IH LLC and the Company will allocate such costs and
expenses based upon their respective gross revenues, so that each party's profit
margins are substantially the same for similar services.
7
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS)
1. ORGANIZATION AND BASIS OF PRESENTATION--CONTINUED
The Company includes the revenues and expenses and assets and liabilities
of leased hotels in the financial statements because the risk of operating these
hotels is borne by the Company, as lessee, under the terms of the leases.
Revenues and expenses from the operation of managed hotels are not included in
the financial statements because the hotel management contracts are generally
cancellable, not transferable and do not shift the risks of operation to the
Company. Therefore, the Company records revenues from management fees only for
its managed hotels.
2. INTERIM FINANCIAL STATEMENTS:
The accompanying consolidated interim financial statements have been
prepared by the Company, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission (the "SEC"). Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations. These consolidated interim financial
statements should be read in conjunction with the financial statements, notes
thereto and other information included in the Company's Registration Statement
on Form S-1 (No. 333-67065) filed with the SEC on November 10, 1998, as amended
(the "Registration Statement").
The accompanying consolidated interim financial statements reflect, in the
opinion of management, all adjustments necessary for a fair presentation, in all
material respects, of the financial position and results of operations for the
periods presented. The preparation of financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The results
of operations for the interim periods are not necessarily indicative of the
results for the entire year.
3. PRO FORMA INFORMATION:
The unaudited pro forma consolidated statements of operations for the three
and six-month periods ended June 30, 1998 and 1999 include the effects of the
Spin-off, the sale of equity interests in The Charles Hotel Complex and certain
other adjustments as if all of the transactions had occurred on January 1, 1998.
Such other adjustments principally include the elimination and addition of
certain management fee and other fee revenues related to Wyndham-owned hotels,
the management of which was transferred to Wyndham, Marriott or the Company as a
result of the Spin-off. The adjustments also include the elimination of a $2,000
one-time charge for additional incentive lease expense for 1999 resulting from
the settlement of a dispute with Equity Inns, Inc. resulting from the Merger,
and the addition of minority interest to reflect Wyndham's 55% non-controlling
interest in IH LLC prior to the Spin-off. The Company has elected to present
comparative pro forma consolidated statements of operations for the three and
six-month periods ended June 30, 1998 and 1999 due to the significance of the
pro forma adjustments on the historical operating results.
The pro forma information is based in part upon information contained in,
and should be read in conjunction with, the Company's Registration Statement. In
management's opinion, all material pro forma adjustments necessary to reflect
the effects of these transactions have been made. The pro forma information does
not include earnings on the Company's pro forma cash and cash equivalents or
certain one-time charges to income, and does not purport to present what the
actual results of operations of the Company would have been if the previously
mentioned transactions had occurred on such dates or to project what the results
of operations of the Company will be for any future period.
8
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS)
4. EARNINGS PER SHARE:
Prior to the Spin-off, the Company was not a separate legal entity.
Therefore, the accompanying consolidated financial statements of the Company
have been carved out of the financial statements of Old Interstate and Wyndham,
and principally include those assets, liabilities, revenues and expenses
directly attributable to the third-party hotel management and leasing businesses
conducted by the Company. The Company believes that the historical earnings per
share calculations required in accordance with Statement of Financial Accounting
Standard No. 128 are not meaningful for periods prior to the Spin-off and,
therefore, have not been provided. In addition, the Company does not believe
that a historical earnings per share calculation for the partial 12-day period
between the date of the Spin-off through June 30, 1999 is meaningful. Rather,
pro forma earnings per share is a more meaningful measure of the Company's
results of operations for the periods presented.
The pro forma earnings per share for the three and six-month periods ended
June 30, 1998 and 1999 have been calculated by dividing pro forma net income by
the pro forma weighted average number of common shares deemed to be outstanding,
which includes certain restricted common shares that are expected to be issued
in the third quarter of 1999, pursuant to employment agreements that were
entered into during the first half of 1999. Pro forma net income reflects the
transactions discussed in Note 1 and other required adjustments discussed in
Note 3 as if all of the transactions had occurred on January 1, 1998.
5. PREFERRED AND COMMON STOCK:
The Company has the authority to issue up to 10,000,000 shares of preferred
stock having such rights, preferences and privileges as designated by the Board
of Directors of the Company without shareholder approval. The rights of the
holders of the Company's common stock will be subject to, and may be affected
by, the rights of the holders of any such preferred stock that may be issued in
the future.
The following table represents the number of shares of common stock
authorized, issued and outstanding as of June 30, 1999.
ISSUED AND
PAR VALUE AUTHORIZED OUTSTANDING
--------- ---------- -----------
Class A common stock..................................... $.01 62,000,000 5,759,885
Class B common stock..................................... $.01 1,500,000 242,555
Class C common stock..................................... $.01 1,500,000 60,639
---------- ---------
65,000,000 6,063,079
========== =========
6. SALE OF INVESTMENT IN HOTEL REAL ESTATE:
On June 18, 1999, the Company completed the previously announced sale of
substantially all of its equity interests in The Charles Hotel Complex. The
Company sold a 1% general partnership interest and an 82.9% limited partnership
interest in Intercarp Limited Partnership, which is a general partner in Charles
Square Associates, the managing partner in CH&S Limited Partnership, which is
the owner of The Charles Hotel Complex. The Company, through IH LLC, received
$13,500 in cash and a $5,750 secured non-recourse promissory note in connection
with the sale. The promissory note pays quarterly interest only, at a rate of
10% per annum, until maturity in 2002. The loss of $876 on the sale is included
in "loss on sale of investment in hotel real estate" in the consolidated
statements of operations and is allocated 100% to Wyndham in "minority interest"
in the consolidated statements of operations in accordance with IH LLC's limited
liability company agreement. This agreement also requires that the proceeds and
interest from the promissory note be allocated entirely to the Company.
The Company is the sole general partner of Cambridge Hotel Associates, the
manager of The Charles Hotel. The management contract for The Charles Hotel was
amended in connection with the sale to provide for a
9
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS)
6. SALE OF INVESTMENT IN HOTEL REAL ESTATE--CONTINUED
reduction in management fees payable to the Company in exchange for an extension
of the term of the management contract to ten years and IH LLC's agreement to
cause the Company to loan the owner of the hotel up to $2,500.
7. INCOME TAXES:
Prior to the Spin-off, the entities that comprised the Company were
included in the consolidated federal income tax returns of Old Interstate or
Wyndham and all tax liabilities were paid by either Old Interstate or Wyndham.
The income tax provision presented in the consolidated financial statements
through the Spin-off date has been calculated as if the Company had prepared and
filed separate income tax returns for those periods. The income tax liability
for all current income taxes for purposes of these consolidated financial
statements through the Spin-off date have been settled with either Old
Interstate or Wyndham through owners' equity. Effective with the Spin-off, the
Company will file a separate tax return. Such return will include an allocation
of the operating results of IH LLC based on its 45% share of the taxable
operating results of IH LLC, except for the loss on the sale of equity interests
in The Charles Hotel Complex, which is allocated 100% to Wyndham, as discussed
in Note 6.
The effective tax rate used after the Spin-off is based on the Company's
expected effective tax rate for the period ended December 31, 1999, and varies
from the statutory tax rate as a result of the allocations of the taxable
operating results of IH LLC to minority interests, as discussed above.
8. SUPPLEMENTAL CASH FLOW INFORMATION:
In connection with the Merger, in the period from June 2, 1998 to June 30,
1998, the Company excluded from the consolidated statements of cash flows a
non-cash step-up in basis of $52,002 arising from the allocation of Merger
consideration, which includes an increase to management contract costs of
$59,702, a decrease in other assets related to hotel leases of $7,700 and a
deferred tax liability of $5,458.
In 1999, as a result of the Spin-off, the Company excluded from the
consolidated statements of cash flows non-cash equity transfers of $57,614 to
minority interests, representing the net book value of Wyndham's 55%
non-controlling ownership interest in IH LLC, a transfer of Wyndham's share of
the net deferred tax liability of $5,289, and the net book value of the common
stock distributed to the shareholders of the Company of $65,456. Prior to the
Spin-off, the Company excluded from the consolidated statements of cash flows
the contribution of Wyndham stock valued at $2,172 that was used to reduce
accrued liabilities recorded in connection with the Merger. In addition, as a
result of the sale of the equity interests in The Charles Hotel Complex, the
Company excluded from the consolidated statements of cash flows the receipt of a
$5,750 secured non-recourse promissory note, which were received as proceeds
from the sale, and the elimination of $2,409 of third-party minority interests
of Intercarp Limited Partnership.
9. SEGMENT INFORMATION:
The Company's reportable segments are: operations of luxury and upscale
hotels, operations of mid-scale, upper economy and budget hotels and The Charles
Hotel (hotel ownership). The luxury and upscale hotels segment derives revenues
from management fees and other services which directly relate to providing
management services, including revenues from insurance, purchasing and equipment
leasing. The mid-scale, upper economy and budget segment derives revenues from
managing and leasing hotels and certain specialized support services. The
Charles Hotel segment consisted principally of an equity investment in The
Charles Hotel Complex, which was sold during the second quarter, as discussed in
Note 6. The operations of this segment differ from those of the other segments
and the results are separately reviewed by the Company's chief operating
decision maker.
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12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS)
9. SEGMENT INFORMATION--CONTINUED
The table below presents revenue and operating income information for each
reportable segment for the three and six-month periods ended June 30, 1998 and
1999.
PERIOD FROM
----------------------------- THREE MONTHS ENDED
APRIL 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO -------------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
------------- ------------- -------- --------
Revenues:
Luxury and Upscale Hotels......................... $11,256 $ 5,258 $16,514 $10,909
Mid-Scale, Upper Economy and Budget Hotels........ 35,747 18,579 54,326 52,632
------- ------- ------- -------
Consolidated totals............................... $47,003 $23,837 $70,840 $63,541
======= ======= ======= =======
Operating income (loss):
Luxury and Upscale Hotels......................... 5,947 2,551 8,498 279
Mid-Scale, Upper Economy and Budget Hotels........ 1,125 460 1,585 (1,101)
------- ------- ------- -------
Consolidated totals............................... $ 7,072 $ 3,011 $10,083 $ (822)
======= ======= ======= =======
PERIOD FROM
------------------------------- SIX MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO -------------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
--------------- ------------- -------- --------
Revenues:
Luxury and Upscale Hotels..................... $ 26,010 $ 5,258 $ 31,268 $ 21,618
Mid-Scale, Upper Economy and Budget Hotels.... 80,753 18,579 99,332 96,067
-------- ------- -------- --------
Consolidated totals........................... $106,763 $23,837 $130,600 $117,685
======== ======= ======== ========
Operating income (loss):
Luxury and Upscale Hotels..................... 11,887 2,551 14,438 764
Mid-Scale, Upper Economy and Budget Hotels*... 1,278 460 1,738 (6,041)
-------- ------- -------- --------
Consolidated totals........................... $ 13,165 $ 3,011 $ 16,176 $ (5,277)
======== ======= ======== ========
- - ---------------
* The 1999 amount includes a $2,000 one-time charge in the first quarter of 1999
for additional incentive rent resulting from the settlement of a dispute with
Equity Inns, Inc. resulting from the Merger.
Depreciation and amortization included in segment operating income for the
three and six-month periods ended June 30, 1998 and 1999 were as follows:
PERIOD FROM THREE MONTHS
----------------------------- ENDED
APRIL 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO ---------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
------------- ------------- ------ ------
Luxury and Upscale Hotels........................... $291 $1,096 $1,387 $4,157
Mid-Scale, Upper Economy and Budget Hotels.......... 550 459 1,009 1,277
---- ------ ------ ------
Consolidated totals................................. $841 $1,555 $2,396 $5,434
==== ====== ====== ======
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13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS)
9. SEGMENT INFORMATION--CONTINUED
PERIOD FROM
------------------------------- SIX MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO ----------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
--------------- ------------- ------ -------
Luxury and Upscale Hotels........................ $ 776 $1,096 $1,872 $ 7,502
Mid-Scale, Upper Economy and Budget Hotels....... 1,376 459 1,835 2,590
------ ------ ------ -------
Consolidated totals.............................. $2,152 $1,555 $3,707 $10,092
====== ====== ====== =======
The net book value of intangible and other assets by segment as of June 30,
1998 and 1999 were as follows:
JUNE 30, 1998 JUNE 30, 1999
------------- -------------
Luxury and Upscale Hotels................................... $ 61,425 $49,751
Mid-Scale, Upper Economy and Budget Hotels.................. 47,597 41,348
-------- -------
Consolidated totals......................................... $109,022 $91,099
======== =======
The following table reconciles the Company's measure of segment profit to
consolidated net income for the three and six-month periods ended June 30, 1998
and 1999.
PERIOD FROM
----------------------------- THREE MONTHS ENDED
APRIL 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO -------------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
------------- ------------- -------- --------
Total after-tax operating income (loss)............ $4,243 $1,807 $ 6,050 $ (341)
Unallocated amounts, net of tax:
Interest, net.................................... 48 21 69 44
Other, net....................................... 103 61 164 709
Minority interest................................ (6) (3) (9) (37)
------ ------ ------- -------
Consolidated net income............................ $4,388 $1,886 $ 6,274 $ 375
====== ====== ======= =======
PERIOD FROM
------------------------------- SIX MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 JUNE 30,
TO TO -----------------
JUNE 1, 1998 JUNE 30, 1998 1998 1999
--------------- ------------- ------- -------
Total after-tax operating income (loss).......... $7,899 $1,807 $ 9,706 $(3,014)
Unallocated amounts, net of tax:
Interest, net.................................. 122 21 143 79
Other, net..................................... 284 61 345 938
Minority interest.............................. (14) (3) (17) (66)
------ ------ ------- -------
Consolidated net income (loss)................... $8,291 $1,886 $10,177 $(2,063)
====== ====== ======= =======
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
PRO FORMA THREE AND SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO PRO FORMA THREE
AND SIX MONTHS ENDED JUNE 30, 1999
Pro forma total revenues decreased by $4.7 million, or 7.2%, from $66.1
million in the three months ended June 30, 1998 (the "1998 Three Months") to
$61.4 million in the three months ended June 30, 1999 (the "1999 Three Months")
and by $7.9 million, or 6.5%, from $121.3 million in the six months ended June
30, 1998 (the "1998 Six Months") to $113.4 million in the six months ended June
30, 1999 (the "1999 Six Months"). A portion of this decrease related to lodging
revenues, which consist of rooms, food and beverage and other departmental
revenues from the leased hotels. Pro forma lodging revenues decreased by $1.4
million, or 2.7%, from $53.0 million in the 1998 Three Months to $51.6 million
in the 1999 Three Months and by $2.7 million, or 2.8%, from $96.9 million in the
1998 Six Months to $94.2 million in the 1999 Six Months. This decrease was due
to the net loss of nine hotel operating leases since April 1, 1998 due to the
divestiture of these hotels by Equity Inns, Inc., increased competition and the
general negative trends in the limited-service hotel sector. In addition, some
of the Company's leased hotels have been undergoing renovations which reduced
rooms available and impacted operating results negatively.
The average daily room rate for the leased hotels increased by 7.3%, from
$72.15 during the 1998 Three Months to $77.44 during the 1999 Three Months, and
the average occupancy rate decreased to 69.8% during the 1999 Three Months from
73.3% during the 1998 Three Months. This resulted in an increase in room revenue
per available room of 2.2% to $54.08 during the 1999 Three Months. During the
six-month periods, the average daily room rate for the leased hotels increased
by 6.3%, from $71.11 during the 1998 Six Months to $75.56 during the 1999 Six
Months, and the average occupancy rate decreased to 65.6% during the 1999 Six
Months from 68.9% during the 1998 Six Months. This resulted in an increase in
room revenue per available room of 1.2% to $49.59 during the 1999 Six Months.
The statistical results of our leased hotels reflect the current trends within
the lodging industry. As such, the increase in the average daily room rate
resulted from inflation and improvement resulting from our management expertise.
The decrease in the average occupancy rate resulted from both an increase of new
supply within the lodging industry and the renovations noted above.
Pro forma net management fees decreased by $1.1 million, or 13.6%, from
$8.1 million in the 1998 Three Months to $7.0 million in the 1999 Three Months
and by $1.5 million, or 9.7%, from $15.2 million in the 1998 Six Months to $13.7
million in the 1999 Six Months. This decrease was due to the net loss of 14
management contracts since April 1, 1998, primarily due to the divestiture of
hotels by third-party owners. Contributing to the net loss of management
contracts was the uncertainty surrounding the timing and completion of the
Merger and subsequent Spin-off, which impaired the Company from adding new
management contracts. Pro forma other fees decreased by $2.2 million, or 44.2%,
from $5.0 million in the 1998 Three Months to $2.8 million in the 1999 Three
Months and by $3.6 million, or 39.9%, from $9.2 million in the 1998 Six Months
to $5.6 million in the 1999 Six Months. This decrease was due to a decrease in
the total number of hotels operated in the 1999 periods as compared to the 1998
periods. A significant portion of this decrease resulted from a decrease in pro
forma insurance revenues, which decreased by $1.0 million from the 1998 Three
Months to the 1999 Three Months and by $1.8 million from the 1998 Six Months to
the 1999 Six Months. This decrease is primarily due to the decrease in the total
number of hotels operated in 1999 compared to 1998 and a reduction in the amount
of financial indemnity for the Company's self-insured health and welfare plan.
Lodging expenses consist of rooms, food and beverage, property costs and
other departmental expenses from the leased hotels. Pro forma lodging expenses
increased by $1.1 million, or 4.3%, from $25.7 million in the 1998 Three Months
to $26.8 million in the 1999 Three Months and by $2.3 million, or 4.8%, from
$48.5 million in the 1998 Six Months to $50.8 million in the 1999 Six Months.
This increase was partially due to increased costs associated with the
third-party reservation system for many of the leased hotels. The operating
margin of the leased hotels decreased from 51.6% during the 1998 Three Months to
48.1% during the 1999 Three Months and from 50.0% during the 1998 Six Months to
46.0% during the 1999 Six Months.
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 increased
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15
by $0.8 million, or 29.6%, from $2.9 million in the 1998 Three Months to $3.7
million in the 1999 Three Months and by $1.1 million, or 17.1%, from $6.9
million in the 1998 Six Months to $8.0 million in the 1999 Six Months. This
increase resulted from increased costs of $1.4 million during the 1999 Six
Months associated with a deficiency between actual claims and the amount of
premiums received under the Company's self-insured health and welfare plan,
offset by reductions in development expenses and legal and accounting costs. Pro
forma general and administrative expenses as a percentage of pro forma revenues
increased to 6.0% during the 1999 Three Months compared to 4.3% during the 1998
Three Months and to 7.1% during the 1999 Six Months compared to 5.7% during the
1998 Six Months. This increase was primarily due to the decrease in total
revenues and the increase in general and administrative expenses.
Pro forma operating income decreased by $7.5 million from $4.2 million in
the 1998 Three Months to a pro forma operating loss of $3.3 million in the 1999
Three Months. For the six-month periods, pro forma operating income decreased by
$11.9 million from $3.6 million in 1998 to a pro forma operating loss of $8.3
million in 1999. This decrease is primarily due to the decrease in total
revenues and constant or increased operating expenses from 1998 to 1999.
Pro forma income tax expense (benefit) for both 1998 and 1999 was computed
based on an effective tax rate of 40% after reduction of minority interest.
Pro forma minority interest reflects Wyndham's 55% non-controlling interest
in IH LLC, the successor to the third-party hotel management and leasing
businesses previously conducted by Old Interstate prior to the Merger.
As a result of the changes noted above, a pro forma net loss of $0.8
million was incurred in the 1999 Three Months as compared to pro forma net
income of $1.3 million in the 1998 Three Months. For the six-month periods, a
pro forma net loss of $2.0 million was incurred in 1999 as compared to pro forma
net income of $1.2 million in 1998.
HISTORICAL THREE AND SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO HISTORICAL THREE
AND SIX MONTHS ENDED JUNE 30, 1999
Total revenues decreased by $7.3 million, or 10.3%, from $70.8 million in
the 1998 Three Months to $63.5 million in the 1999 Three Months and by $12.9
million, or 9.9%, from $130.6 million in the 1998 Six Months to $117.7 million
in the 1999 Six Months. A portion of this decrease related to lodging revenues.
Lodging revenues decreased by $1.4 million, or 2.7%, from $53.0 million in the
1998 Three Months to $51.6 million in the 1999 Three Months and by $2.7 million,
or 2.8%, from $96.9 million in the 1998 Six Months to $94.2 million in the 1999
Six Months. This decrease was due to the net loss of nine hotel operating leases
since April 1, 1998 due to the divestiture of these hotels by Equity Inns, Inc.,
increased competition and the general negative trends in the limited-service
hotel sector. In addition, some of the Company's leased hotels have been
undergoing renovations which reduced rooms available and impacted operating
results negatively.
Net management fees decreased by $2.8 million, or 24.3%, from $11.6 million
in the 1998 Three Months to $8.8 million in the 1999 Three Months and by $4.6
million, or 20.9%, from $21.9 million in the 1998 Six Months to $17.3 million in
the 1999 Six Months. This decrease was due to the net loss of 31 management
contracts since April 1, 1998, which includes 18 hotels whose management was
transferred to a subsidiary of Wyndham subsequent to the Merger. Contributing to
the net loss of management contracts was the uncertainty surrounding the timing
and completion of the Merger and subsequent Spin-off, which impaired the Company
from adding new management contracts. Other fees decreased by $3.1 million, or
48.9%, from $6.3 million in the 1998 Three Months to $3.2 million in the 1999
Three Months and by $5.6 million, or 47.6%, from $11.8 million in the 1998 Six
Months to $6.2 million in the 1999 Six Months. This decrease was due to a
decrease in the total number of hotels operated in the 1999 periods as compared
to the 1998 periods. A significant portion of this decrease resulted from a
decrease in insurance revenues, which decreased by $1.4 million from the 1998
Three Months to the 1999 Three Months and by $2.8 million from the 1998 Six
Months to the 1999 Six Months. This decrease is primarily due to the decrease in
the total number of hotels operated in 1999 compared to 1998 and a reduction in
the amount of financial indemnity for the Company's self-insured health and
welfare plan.
14
16
Lodging expenses increased by $1.1 million, or 4.3%, from $25.7 million in
the 1998 Three Months to $26.8 million in the 1999 Three Months and by $2.3
million, or 4.8%, from $48.5 million in the 1998 Six Months to $50.8 million in
the 1999 Six Months. This increase was partially due to increased costs
associated with the third-party reservation system for many of the leased
hotels. The operating margin of the leased hotels decreased from 51.6% during
the 1998 Three Months to 48.1% during the 1999 Three Months and from 50.0%
during the 1998 Six Months to 46.0% during the 1999 Six Months.
General and administrative expenses increased by $0.6 million, or 22.0%,
from $2.9 million in the 1998 Three Months to $3.5 million in the 1999 Three
Months and by $0.7 million, or 10.2%, from $6.9 million in the 1998 Six Months
to $7.6 million in the 1999 Six Months. This increase resulted from increased
costs of $1.4 million during the 1999 Six Months associated with a deficiency
between actual claims and the amount of premiums received under the Company's
self-insured health and welfare plan, offset by reductions in development
expenses and legal and accounting costs. General and administrative expenses as
a percentage of revenues increased to 5.5% during the 1999 Three Months compared
to 4.1% during the 1998 Three Months and to 6.4% during the 1999 Six Months
compared to 5.3% during the 1998 Six Months. This increase was primarily due to
the decrease in total revenues and the increase in general and administrative
expenses.
Payroll and related benefits decreased by $0.7 million, or 10.7%, from $5.7
million in the 1998 Three Months to $5.0 million in the 1999 Three Months and by
$2.4 million, or 19.7%, from $12.4 million in the 1998 Six Months to $10.0
million in the 1999 Six Months. This decrease was due to elimination of salaries
and related benefits of employees who were terminated subsequent to the Merger
and whose positions have been eliminated. Payroll and related benefits as a
percentage of revenues decreased slightly to 7.9% during the 1999 Three Months
compared to 8.0% during the 1998 Three Months and decreased to 8.5% during the
1999 Six Months compared to 9.5% during the 1998 Six Months.
Lease expense represents base rent and participating rent that is based on
a percentage of rooms and food and beverage revenues from the leased hotels.
Lease expense decreased by $0.6 million, or 2.3%, from $24.2 million in the 1998
Three Months to $23.6 million in the 1999 Three Months due to a decrease in
lodging revenues from 1998 to 1999. However, lease expense increased by $1.6
million, or 3.7%, from $42.9 million in the 1998 Six Months to $44.5 million in
the 1999 Six Months. This increase resulted from a $2.0 million one-time charge
in the first quarter for additional incentive rent for 1999 resulting from the
settlement of a dispute with Equity Inns, Inc. resulting from to the Merger.
Depreciation and amortization increased by $3.0 million from $2.4 million
in the 1998 Three Months to $5.4 million in the 1999 Three Months and by $6.4
million from $3.7 million in the 1998 Six Months to $10.1 million in the 1999
Six Months. This increase was due to incremental amortization of management
contract costs associated with the step-up in basis arising from the allocation
of Merger consideration. The management contract costs have been stated at their
estimated fair market values and are being amortized using the straight-line
method over five years.
Operating income decreased by $10.9 million from $10.1 million in the 1998
Three Months to an operating loss of $0.8 million in the 1999 Three Months. For
the six-month periods, operating income decreased by $21.5 million from $16.2
million in 1998 to an operating loss of $5.3 million in 1999. This decrease is
primarily due to the decrease in total revenues and the increase in depreciation
and amortization from 1998 to 1999.
Other income in the three and six-month periods increased by approximately
$1.0 million from 1998 to 1999 primarily due to an increase in equity in
earnings from The Charles Hotel Complex, which resulted from the Company's
acquisition of additional equity interests in The Charles Hotel Complex during
the latter half of 1998.
Loss on sale of investment in hotel real estate resulted from the sale of
the Company's equity interests in The Charles Hotel Complex on June 18, 1999.
Income tax expense (benefit) for both 1998 and 1999 was computed based on
an effective tax rate of 40% after reduction of minority interest, except for
the $0.9 million loss on the sale of equity interests in The Charles Hotel
Complex in 1999, which was allocated 100% to Wyndham.
15
17
Minority interest in 1999 primarily reflects Wyndham's 55% non-controlling
interest in IH LLC retained in the Spin-off. In addition, the $0.9 million loss
on the sale of equity interests in The Charles Hotel Complex was allocated 100%
to Wyndham.
As a result of the changes noted above, net income decreased by $5.9
million from $6.3 million in the 1998 Three Months to $0.4 million in the 1999
Three Months. For the six-month periods, a net loss of $2.1 million was incurred
in 1999 as compared to net income of $10.2 million in 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalent assets were $38.2 million at June
30, 1999 compared to $1.7 million at December 31, 1998, and current assets
exceeded current liabilities by $18.4 million at June 30, 1999. In connection
with the Spin-off, Wyndham agreed to ensure that IH LLC did not have a working
capital deficit as of April 30, 1999. In addition, Wyndham agreed to provide
working capital to the Company in the amount of $16.3 million, less positive
working capital, if any, of IH LLC. Currently, the Company and Wyndham have not
finalized the reconciliation of the working capital, as well as other related
matters. In addition, Wyndham agreed to reimburse the Company for potential
expenditures relating to such things as year 2000 compliance, loan forgiveness
and pending litigation, which are expected to approximate $5.7 million.
The Company's principal source of liquidity during the 1999 Six Months was
cash from operations. Net cash provided by operating activities was $19.3
million during the 1999 Six Months compared to $16.7 million during the 1998 Six
Months. The increase primarily resulted from higher earnings and lower
amortization in the 1998 Six Months compared to lower earnings with higher
amortization in the 1999 Six Months, as well as an increase in accounts
receivable of $6.8 million during the 1998 Six Months with a corresponding
increase of only $0.2 million during the 1999 Six Months. Net cash of $6.6
million was provided from investing activities during the 1999 Six Months
compared to net cash of $8.7 million used in investing activities during the
1998 Six Months. The increase was primarily related to the receipt of $13.5
million of proceeds from the sale of equity interests in The Charles Hotel
Complex during the 1999 Six Months and a decrease of $1.9 million in amounts
paid in connection with the Merger during the 1999 Six Months compared to the
1998 Six Months. The Company's capital expenditure budget through December 31,
1999 relating to current operations is approximately $2.7 million, consisting
primarily of expenditures for computer and related equipment. The Company
intends to fund these expenditures from its cash and cash equivalents and from
payments from Wyndham, as discussed above. Net cash of $10.6 million was
provided by financing activities during the 1999 Six Months compared to net cash
of $5.5 million used in financing activities during the 1998 Six Months. During
the 1999 Six Months, $35.5 million was received from Wyndham in connection with
the Spin-off and $2.1 million was received from Marriott in exchange for a 4%
ownership interest in the Company. These amounts were offset by the use of $11.9
million for net distributions to Wyndham and the repayment of $15.1 million that
was borrowed from related entities to meet short-term cash requirements.
In accordance with IH LLC's limited liability company agreement, the
Company is required to distribute 55% of IH LLC's cash flows from operations to
Wyndham and allocate between IH LLC and the Company the costs and expenses
relating to services provided by one party for the benefit of the other in
accordance with generally accepted accounting principles, on the basis of which
party benefited from the expenditure. To the extent that the allocation of any
such costs and expenses, including general and administrative expenses, cannot
be fairly apportioned, IH LLC and the Company will allocate such costs and
expenses based upon their respective gross revenues, so that each party's profit
margins are substantially the same for similar services.
The Company intends to pursue future opportunities to manage or lease
hotels on behalf of third-party owners, as well as pursue other business
opportunities, such as selective hotel investments and the formation of
strategic alliances. The Company believes that the cash that was provided by
Wyndham at the time of the Spin-off and future cash flow provided by operations
may be insufficient to fully fund the execution of its business and growth
strategy. As a result, the Company will be required to obtain debt or equity
financing or modify its business plan. While the Company presently intends to
seek to obtain additional debt or equity financing, there can be no assurance
that any such financing will be available to the Company on acceptable terms, or
at all. If the Company does not obtain additional financing, its pursuit of its
business strategy and growth may be impaired.
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18
YEAR 2000 COMPLIANCE
The year 2000 issue relates to computer programs written using two digits
rather than four to define the applicable year. Computer programs written this
way may recognize a date using "00" as the year 1900 rather than the year 2000.
This could result in systems failures or miscalculations causing disruptions of
hotel operations or a temporary inability to process transactions, prepare
financial statements or engage in similar normal business activities.
We have developed and begun implementing a comprehensive plan (i) to
address potential year 2000 problems both at our corporate offices and at the
hotels we manage and lease, and (ii) to minimize the impact on operations to the
extent possible. Our plan, which is designed to identify and address potential
problems in the most critical operational systems first in order to minimize any
disruption in service to hotel guests, consists of the following four steps:
Step 1 - Inventory: Conduct an inventory to identify (a) all computer
hardware and software systems and building systems in
use and (b) any potential year 2000 problems that may
exist in such systems
Step 2 - Vendor Survey: Identify and contact third-party vendors to determine
whether their systems or services are or will be made
year 2000 compliant
Step 3 - Planning and Cost Estimation: Prepare a prioritized year 2000 compliance plan for
remediation or replacement of non-compliance systems
Step 4 - Implementation and Testing: Implement the year 2000 compliance plan prepared in
Step 3 and test all systems to ensure maximum possible
compliance and develop contingency plans for
continuing operations in the event problems arise
We engaged a consultant to complete Steps 1 and 2, at an estimated cost of
$13,500 per hotel for upscale hotels and $7,500 for midscale and economy hotels.
We have instructed the hotels that we operate to increase their capital budgets
for 1999 to accommodate this cost. The inventories at the hotels and our
corporate offices have been completed. In addition, we are currently reviewing
and cataloguing the responses to the year 2000 readiness questionnaires that we
sent out to our third-party vendors.
Step 3 is being performed through a joint effort between management and
hotel owner representatives and a year 2000 consultant. At this time, we cannot
identify the total costs that will be incurred to complete Steps 3 and 4. Our
management and information systems department has substantially completed the
written assessments, however, which prioritize the corporate and hotel year 2000
compliance plans for remediation and estimate the costs of such remediation.
Once each written assessment is finalized, we are able to provide an estimate of
those costs for each hotel. On the corporate level, the implementation process
described in Step 4 above is already in progress based on the completed
inventory and written assessment. In addition, many of the hotels we manage are
also in the process of implementing their remediation and testing plans. We have
instructed all hotels that we manage and lease to include in their capital
budgets an amount ranging from $10,000 to $50,000, depending on the size of the
hotel, to be utilized for these purposes. As specific costs become known, the
budgets will be adjusted as necessary.
We believe that the expenses incurred to complete the year 2000 compliance
program at each managed hotel are the responsibility of the hotel owner, and we
believe that the terms of our management contracts provide adequate basis for
this position. Nonetheless, it is possible that some third-party hotel owners
may challenge this position. With respect to the hotels leased by us, we also
believe that the expenses associated with year 2000 compliance with respect to
our leased hotels are the responsibility of the hotel owner. To the extent that
such expense is not considered a capital expenditure, however, it may be deemed
to be our responsibility. Further, we will be responsible for funding the year
2000 compliance expenses for corporate operations. The costs incurred to date
have not been material. We have provided for approximately $2.7 million in
capital expenditures in our 1999 management and information systems capital
budget, approximately $2.4 million of which is expected to be spent addressing
our year 2000 issues.
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In connection with the Spin-off, Wyndham agreed to pay up to $929,000 of
the corporate level year 2000 compliance related expenses, and this amount was
funded into an escrow account at the time of the Spin-off. In addition, to the
extent that we are responsible for any year 2000 compliance related expenses
with respect to our leased hotels, Wyndham is obligated to indemnify us for up
to $1.2 million of such expenses. Any remaining expenses not funded by Wyndham
will be funded by us through operating cash flow.
Our time and cost estimates for year 2000 compliance are based on currently
available information. These estimates could be affected by unforeseen
developments including the availability and cost of trained personnel, the
ability to locate and correct problems in all relevant systems, and the year
2000 compliance efforts of our third-party vendors. We believe the most likely
"worst-case" scenario is that our third-party vendors may not be year 2000
compliant, which could potentially cause disruptions in operations at hotels
which use the services of such third-party vendors. In addition, operations at
our hotels outside the United States may be adversely affected by failures of
businesses in those countries to take adequate steps to address the year 2000
problem. While such failures could affect critical operations at our hotels in a
significant manner, we cannot at present estimate either the likelihood or the
potential cost of such failures. The contingency plans for continuing operations
referenced in Step 4 described above are being developed to address these
failures, using existing disaster contingency plans in place at our hotels. In
addition, while we believe the indemnification provisions in our management
contracts and leases provide adequate protection from liability that may arise
from a failure to be year 2000 compliant, such failure could result in lower
hotel revenues (and, as a result, lower management fee revenues) because of
general adverse economic conditions and lower profits caused by expenses
incurred with contingency plans.
FORWARD-LOOKING STATEMENTS
This Report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995 and information based on the
beliefs of the Company's management, as well as assumptions made by and
information currently available to the Company's management. When used herein,
words such as "anticipate," "believe," "estimate," "expect," "intend" and
similar expressions, as they relate to the Company or the Company's management,
are intended to identify these forward-looking statements. Such statements are
subject to certain risks and uncertainties that could cause the Company's
business and results of operations to differ materially from those reflected in
the Company's forward-looking statements.
Forward-looking statements are not guarantees of future performance. The
Company's forward-looking statements are based on trends that the Company's
management anticipates in the lodging industry and the effect on those trends of
such factors as industry capacity, the seasonal nature of the lodging industry
and product demand and pricing. In addition, such forward-looking statements are
subject to the Company's reversing the current negative trend in its business
and financial results.
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PART II--OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(c) In connection with the Spin-off, on June 18, 1999 the Company issued
242,555 shares of Class B common stock, par value $0.01 per share, to Marriott
in consideration for $2.1 million and 181,916 shares of Class A common stock and
60,639 shares of Class C common stock, each with a par value $0.01 per share, to
Wyndham in exchange for the cancellation of 100 shares of Class C common stock
and 9,900 shares of Class B common stock of the Company held by Wyndham. The
shares were issued without registration under the Securities Act of 1933
pursuant to the exemption afforded by Section 4(2) thereof.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
2.1 Distribution Agreement, dated June 18, 1999, among Patriot
American Hospitality, Inc., Wyndham International, Inc., the
Company and Interstate Hotels, LLC
3.1 Articles of Amendment and Restatement
3.2 Articles Supplementary Classifying and Designating Series A
Junior Participating Cumulative Preferred Stock
3.3 Amended and Restated Bylaws
10.1 Amended and Restated Limited Liability Company Agreement,
dated June 18, 1999, of Interstate Hotels, LLC
10.2 Voting Agreement, dated June 18, 1999, among the Company and
the identified stockholders of the Company
10.3 Fifth Amendment, dated April 23, 1999, to the Settlement
Agreement, dated May 27, 1998, among Marriott International,
Inc., Interstate Hotels Corporation, Interstate Hotels
Company, Patriot American Hospitality, Inc. and Wyndham
International, Inc. (the "Settlement Agreement")(1)
10.4 Sixth Amendment, dated May 14, 1999, to the Settlement
Agreement(1)
10.5 Asset Purchase Agreement, dated May 7, 1999, among IHC/Chaz
Corporation, PAH-Management Corporation and F&H Realty,
LLC(2)
10.6 Instrument of Assignment and Assumption, dated June 18,
1999, made by IHC/Chaz Corporation and PAH-Management
Corporation in favor of Interstate Hotels, LLC(2)
10.7 Instrument of Assignment and Assumption, dated June 18,
1999, made by F&H Realty, LLC in favor of F&H GP
Corporation(2)
10.8 Employment Agreement, dated June 18, 1999, between the
Company and J. William Richardson
10.9 Interstate Hotels Corporation 1999 Equity Incentive Plan
10.9.1 Form of Standard Stock Option Agreement
10.9.2 Form of Stock Option Agreement for certain employees with
employment agreements
10.10 Interstate Hotels Corporation Stock Purchase Plan
27.1 Financial Data Schedule
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which this
Report is filed.
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(1) Previously filed as an exhibit to the Company's Registration Statement on
Form S-1 (No. 333-67065) and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Current Report on Form 8-K
dated June 18, 1999 and incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
INTERSTATE HOTELS CORPORATION
Date: August 16, 1999 By: /s/ J. WILLIAM RICHARDSON
-----------------------------------
J. William Richardson
Vice Chairman and Chief Financial
Officer
(Principal Financial Officer)
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