1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 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, and (2) has been subject to such filing
requirements for the past 90 days.
The total number of shares of the Company's Common Stock, par value $0.01
per share, outstanding at November 4, 1999 was 6,394,996.
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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
September 30, 1999.......................................... 2
Consolidated Statements of Operations - Historical Three
Months Ended September 30, 1998 and September 30, 1999...... 3
Consolidated Statements of Operations - Historical Periods
from January 1, 1998 to June 1, 1998 and from June 2, 1998
to September 30, 1998, Combined Nine Months Ended September
30, 1998 and Historical Nine Months Ended September 30,
1999........................................................ 4
Consolidated Statements of Cash Flows - Historical Periods
from January 1, 1998 to June 1, 1998 and from June 2, 1998
to September 30, 1998, Combined Nine Months Ended September
30, 1998 and Historical Nine Months Ended September 30,
1999........................................................ 5
Consolidated Statements of Operations - Pro Forma Three
Months and Nine Months Ended September 30, 1998 and
September 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 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, SEPTEMBER 30,
1998 1999
------------ -------------
(A) (UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,652 $ 37,032
Accounts receivable, net.................................. 16,816 18,039
Deferred income taxes..................................... 615 1,741
Net investment in direct financing leases................. 827 578
Prepaid expenses and other assets......................... 741 1,724
Related party receivables--management contracts........... 1,085 421
-------- --------
Total current assets.................................... 21,736 59,535
Restricted cash............................................. 2,201 1,646
Marketable securities....................................... 2,609 2,138
Property and equipment, net................................. 4,076 3,677
Officers and employees notes receivable..................... 2,803 3,573
Affiliate receivables....................................... 3,381 9,263
Net investment in direct financing leases................... 1,680 1,122
Investment in hotel real estate............................. 22,150 300
Intangibles and other assets................................ 100,521 86,878
-------- --------
Total assets............................................ $161,157 $168,132
======== ========
LIABILITIES AND OWNERS' EQUITY
Current liabilities:
Accounts payable--trade................................... 2,413 2,060
Accounts payable--health trust............................ 1,785 3,762
Accounts payable--related parties......................... 18,597 --
Accrued payroll and related benefits...................... 6,120 6,981
Accrued rent.............................................. 5,043 10,617
Accrued merger costs...................................... 9,344 404
Other accrued liabilities................................. 9,236 15,794
-------- --------
Total current liabilities............................... 52,538 39,618
Deferred income taxes....................................... 11,053 6,108
Deferred compensation....................................... 2,609 2,138
-------- --------
Total liabilities....................................... 66,200 47,864
Minority interest........................................... 2,350 55,477
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 September 30,
1999.................................................... -- 61
Paid-in capital........................................... -- 65,630
Retained deficit.......................................... -- (900)
Owners' equity............................................ 92,607 --
-------- --------
Total owners' equity.................................... 92,607 64,791
-------- --------
Total liabilities and owners' equity.................... $161,157 $168,132
======== ========
- - ---------------
(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, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
SEPTEMBER 30,
---------------------
1998 1999
--------- ---------
Lodging revenues:
Rooms..................................................... $ 51,109 $ 52,013
Other departmental........................................ 2,875 2,899
Net management fees......................................... 9,504 7,535
Other fees.................................................. 5,482 3,114
--------- ---------
68,970 65,561
--------- ---------
Lodging expenses:
Rooms..................................................... 11,131 12,075
Other departmental........................................ 1,745 1,919
Property costs............................................ 14,422 15,141
General and administrative.................................. 2,664 3,765
Payroll and related benefits................................ 5,527 4,935
Lease expense............................................... 24,773 25,595
Depreciation and amortization............................... 4,568 4,620
--------- ---------
64,830 68,050
--------- ---------
Operating income (loss)..................................... 4,140 (2,489)
Other income:
Interest, net............................................. 280 517
Other, net................................................ 413 --
--------- ---------
Income (loss) before income tax expense (benefit)........... 4,833 (1,972)
Income tax expense (benefit)................................ 1,912 (376)
--------- ---------
Income (loss) before minority interest...................... 2,921 (1,596)
Minority interest........................................... 54 (1,031)
--------- ---------
Net income (loss)........................................... $ 2,867 $ (565)
========= =========
Earnings per common share and common share equivalent
(Note 4):
Basic..................................................... $ -- $ (.09)
========= =========
Diluted................................................... $ -- $ (.09)
========= =========
Weighted average number of common share and common share
equivalents outstanding:
Basic..................................................... -- 6,063,079
========= =========
Diluted................................................... -- 6,063,079
========= =========
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
------------------------------------ NINE MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 SEPTEMBER 30,
TO TO --------------------
JUNE 1, 1998 SEPTEMBER 30, 1998 1998 1999
--------------- ------------------ -------- ---------
Lodging revenues:
Rooms................................... $74,265 $68,311 $142,576 $141,137
Other departmental...................... 4,504 3,806 8,310 7,958
Net management fees....................... 18,018 13,385 31,403 24,857
Other fees................................ 9,976 7,305 17,281 9,294
------- ------- -------- --------
106,763 92,807 199,570 183,246
------- ------- -------- --------
Lodging expenses:
Rooms................................... 16,115 14,750 30,865 32,895
Other departmental...................... 2,674 2,308 4,982 5,194
Property costs.......................... 21,045 18,904 39,949 41,863
General and administrative................ 6,115 3,435 9,550 11,353
Payroll and related benefits.............. 10,982 6,939 17,921 14,891
Lease expense............................. 34,515 33,197 67,712 70,104
Depreciation and amortization............. 2,152 6,123 8,275 14,712
------- ------- -------- --------
93,598 85,656 179,254 191,012
------- ------- -------- --------
Operating income (loss)................... 13,165 7,151 20,316 (7,766)
Other income (expense):
Interest, net........................... 204 315 519 672
Other, net.............................. 474 514 988 1,563
Loss on sale of investment in hotel real
estate............................... -- -- -- (876)
------- ------- -------- --------
Income (loss) before income tax expense
(benefit)............................... 13,843 7,980 21,823 (6,407)
Income tax expense (benefit).............. 5,528 3,168 8,696 (1,752)
------- ------- -------- --------
Income (loss) before minority interest.... 8,315 4,812 13,127 (4,655)
Minority interest......................... 24 59 83 (2,027)
------- ------- -------- --------
Net income (loss)......................... $ 8,291 $ 4,753 $ 13,044 $ (2,628)
======= ======= ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
4
6
INTERSTATE HOTELS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
PREDECESSOR SUCCESSOR COMBINED SUCCESSOR
--------------- ------------------ -------- ---------
PERIOD FROM
------------------------------------ NINE MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 SEPTEMBER 30,
TO TO --------------------
JUNE 1, 1998 SEPTEMBER 30, 1998 1998 1999
--------------- ------------------ -------- ---------
Cash flows from operating activities:
Net income (loss)........................... $ 8,291 $ 4,753 $13,044 $ (2,628)
Adjustments to reconcile net income (loss)
to net cash provided by operating
activities:
Depreciation and amortization............. 2,152 6,123 8,275 14,712
Equity in earnings from unconsolidated
subsidiaries........................... (513) (515) (1,028) (1,525)
Deferred income taxes..................... (1,555) 6,119 4,564 (782)
Other..................................... 200 123 323 (1,191)
Cash (used) provided by assets and
liabilities:
Accounts receivable, net.................. (3,661) (675) (4,336) (1,223)
Prepaid expenses and other assets......... 307 366 673 (983)
Related party receivables................. (341) 558 217 664
Accounts payable.......................... 1,053 (2,771) (1,718) 2,485
Accrued liabilities....................... 12,426 (1,017) 11,409 13,495
-------- -------- -------- --------
Net cash provided by operating
activities........................... 18,359 13,064 31,423 23,024
-------- -------- -------- --------
Cash flows from investing activities:
Net investment in direct financing leases... 145 (693) (548) 807
Change in restricted cash................... 540 (714) (174) 555
Purchase of property and equipment, net..... (709) (32) (741) (302)
Purchases of marketable securities.......... -- -- -- (2,030)
Proceeds from sale of marketable
securities................................ -- -- -- 1,941
Proceeds from sale of investment in hotel
real estate............................... -- -- -- 13,654
Net cash received from unconsolidated
subsidiaries.............................. 1,085 (2,793) (1,708) 1,176
Net investment in management contracts...... (666) (78) (744) (352)
Merger-related acquisition costs............ -- (21,538) (21,538) (8,941)
Change in affiliate receivables, net........ 2,043 372 2,415 (482)
Other....................................... 236 779 1,015 (786)
-------- -------- -------- --------
Net cash provided by (used in)
investing activities................. 2,674 (24,697) (22,023) 5,240
-------- -------- -------- --------
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) 12 (32) 6,934
Related party payables...................... (9,234) 3,591 (5,643) (18,597)
Net (distributions to) contributions from
owners.................................... (9,840) 7,043 (2,797) 16,659
-------- -------- -------- --------
Net cash (used in) provided by
financing activities................. (19,298) 10,646 (8,652) 7,116
-------- -------- -------- --------
Net increase (decrease) in cash and cash
equivalents................................. 1,735 (987) 748 35,380
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 $ 3,180 $ 3,180 $ 37,032
======== ======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
5
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ --------------------
1998 1999 1998 1999
------- ------- -------- --------
Lodging revenues:
Rooms..................................... $51,109 $52,013 $142,576 $141,137
Other departmental........................ 2,875 2,899 8,310 7,958
Net management fees......................... 7,884 6,847 23,050 20,549
Other fees.................................. 4,390 3,087 13,627 8,637
------- ------- -------- --------
66,258 64,846 187,563 178,281
------- ------- -------- --------
Lodging expenses:
Rooms..................................... 11,131 12,075 30,865 32,895
Other departmental........................ 1,745 1,919 4,982 5,194
Property costs............................ 14,422 15,141 39,949 41,863
General and administrative.................. 2,914 3,765 9,772 11,797
Payroll and related benefits................ 5,115 5,085 15,402 15,341
Lease expense............................... 24,773 25,595 67,712 68,104
Depreciation and amortization............... 4,562 4,620 13,648 14,712
------- ------- -------- --------
64,662 68,200 182,330 189,906
------- ------- -------- --------
Operating income (loss)..................... 1,596 (3,354) 5,233 (11,625)
Other income (expense):
Interest, net............................. 423 512 950 934
Other, net................................ -- -- (40) 38
------- ------- -------- --------
Income (loss) before income tax expense
(benefit)................................. 2,019 (2,842) 6,143 (10,653)
Income tax expense (benefit)................ 394 (534) 1,200 (1,877)
------- ------- -------- --------
Income (loss) before minority interest...... 1,625 (2,308) 4,943 (8,776)
Minority interest........................... 1,032 (1,506) 3,142 (5,960)
------- ------- -------- --------
Net income (loss)........................... $ 593 $ (802) $ 1,801 $ (2,816)
======= ======= ======== ========
Pro forma earnings per common share and
common share equivalent:
Basic..................................... $ .09 $ (.13) $ .28 $ (.44)
======= ======= ======== ========
Diluted................................... $ .09 $ (.13) $ .28 $ (.44)
======= ======= ======== ========
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 nine months ended September
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 the 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 retained
by the Company in connection with the Spin-off. 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 nine-month periods ended September 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 nine-month periods ended September 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 period between the date
of the Spin-off through September 30, 1999 is meaningful. Rather, historical
three-month period ended September 30, 1999 earnings per share and pro forma
earnings per share are a more meaningful measure of the Company's results of
operations for the periods presented.
The historical earnings per share for the three-month period ended
September 30, 1999 has been calculated by dividing net income by the weighted
average number of shares of common stock deemed to be outstanding. The pro forma
earnings per share for the three and nine-month periods ended September 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 were issued in October 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. 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.
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.
6. SUPPLEMENTAL CASH FLOW INFORMATION:
In connection with the Merger, in the period from June 2, 1998 to September
30, 1998, the Company excluded from the consolidated statements of cash flows a
non-cash step-up in basis of $40,886 arising from the allocation of Merger
consideration, which includes an increase to management contract costs of
$48,586, 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
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS)
7. SEGMENT INFORMATION:
The Company's reportable segments historically were: (i) operations of
luxury and upscale hotels, (ii) operations of mid-scale, upper economy and
budget hotels and (iii) 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.
The table below presents revenue and operating income information for each
reportable segment for the three and nine-month periods ended September 30, 1998
and 1999.
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------
1998 1999
-------- --------
Revenues:
Luxury and Upscale Hotels................................... $ 13,993 $ 9,519
Mid-Scale, Upper Economy and Budget Hotels.................. 54,977 56,042
-------- --------
Consolidated totals......................................... $ 68,970 $ 65,561
======== ========
Operating income (loss):
Luxury and Upscale Hotels................................... 4,272 (207)
Mid-Scale, Upper Economy and Budget Hotels.................. (132) (2,282)
-------- --------
Consolidated totals......................................... $ 4,140 $ (2,489)
======== ========
PERIOD FROM
------------------------------------ NINE MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 SEPTEMBER 30,
TO TO -------------------
JUNE 1, 1998 SEPTEMBER 30, 1998 1998 1999
--------------- ------------------ -------- --------
Revenues:
Luxury and Upscale Hotels................. $ 26,010 $19,251 $ 45,261 $ 31,137
Mid-Scale, Upper Economy and Budget
Hotels.................................. 80,753 73,556 154,309 152,109
-------- ------- -------- --------
Consolidated totals....................... $106,763 $92,807 $199,570 $183,246
======== ======= ======== ========
Operating income (loss):
Luxury and Upscale Hotels................. 11,887 6,823 18,710 557
Mid-Scale, Upper Economy and Budget
Hotels*................................. 1,278 328 1,606 (8,323)
-------- ------- -------- --------
Consolidated totals....................... $ 13,165 $ 7,151 $ 20,316 $ (7,766)
======== ======= ======== ========
- - ---------------
* 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.
10
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS)
7. SEGMENT INFORMATION--CONTINUED
Depreciation and amortization included in segment operating income for the
three and nine-month periods ended September 30, 1998 and 1999 were as follows:
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
1998 1999
------- -------
Luxury and Upscale Hotels................................... $3,355 $3,343
Mid-Scale, Upper Economy and Budget Hotels.................. 1,213 1,277
------ ------
Consolidated totals......................................... $4,568 $4,620
====== ======
PERIOD FROM
------------------------------------ NINE MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 SEPTEMBER 30,
TO TO ------------------
JUNE 1, 1998 SEPTEMBER 30, 1998 1998 1999
--------------- ------------------ ------- --------
Luxury and Upscale Hotels.................... $ 776 $4,450 $5,226 $10,844
Mid-Scale, Upper Economy and Budget Hotels... 1,376 1,673 3,049 3,868
------ ------ ------ -------
Consolidated totals.......................... $2,152 $6,123 $8,275 $14,712
====== ====== ====== =======
The net book value of intangible and other assets by segment as of December
31, 1998 and September 30, 1999 were as follows:
DECEMBER 31, 1998 SEPTEMBER 30, 1999
----------------- ------------------
Luxury and Upscale Hotels................................. $ 55,487 $45,472
Mid-Scale, Upper Economy and Budget Hotels................ 45,034 41,406
-------- -------
Consolidated totals....................................... $100,521 $86,878
======== =======
The following table reconciles the Company's measure of segment profit to
consolidated net income for the three and nine-month periods ended September 30,
1998 and 1999.
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
1998 1999
------ -------
Total after-tax operating income (loss)..................... $2,483 $(1,494)
Unallocated amounts, net of tax:
Interest, net............................................. 168 310
Other, net................................................ 248 --
Minority interest......................................... (32) 619
------ -------
Consolidated net income (loss).............................. $2,867 $ (565)
====== =======
PERIOD FROM
------------------------------------ NINE MONTHS ENDED
JANUARY 1, 1998 JUNE 2, 1998 SEPTEMBER 30,
TO TO -----------------
JUNE 1, 1998 SEPTEMBER 30, 1998 1998 1999
--------------- ------------------ ------- -------
Total after-tax operating income (loss)...... $7,899 $4,291 $12,190 $(4,659)
Unallocated amounts, net of tax:
Interest, net.............................. 122 189 311 403
Other, net................................. 284 309 593 412
Minority interest.......................... (14) (36) (50) 1,216
------ ------ ------- -------
Consolidated net income (loss)............... $8,291 $4,753 $13,044 $(2,628)
====== ====== ======= =======
11
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS)
8. SUBSEQUENT EVENT:
In November 1999, the Company acquired one hotel with 156 rooms for a total
acquisition cost, including closing costs, of approximately $12,700. This
acquisition was accounted for using the purchase method of accounting. The
operating results of this hotel have not been included in the pro forma
financial results of the Company.
12
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
PRO FORMA THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO PRO FORMA
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999
Pro forma total revenues decreased by $1.5 million, or 2.1%, from $66.3
million in the three months ended September 30, 1998 (the "1998 Three Months")
to $64.8 million in the three months ended September 30, 1999 (the "1999 Three
Months") and by $9.3 million, or 4.9%, from $187.6 million in the nine months
ended September 30, 1998 (the "1998 Nine Months") to $178.3 million in the nine
months ended September 30, 1999 (the "1999 Nine 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 increased by $0.9 million, or 1.7%, from $54.0 million in the 1998
Three Months to $54.9 million in the 1999 Three Months and decreased by $1.8
million, or 1.2%, from $150.9 million in the 1998 Nine Months to $149.1 million
in the 1999 Nine Months. This decrease was due to the net loss of four hotel
operating leases since January 1, 1998 due primarily 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 6.0%, from
$74.66 during the 1998 Three Months to $79.17 during the 1999 Three Months, and
the average occupancy rate decreased to 70.0% during the 1999 Three Months from
73.9% during the 1998 Three Months. This resulted in a slight increase in room
revenue per available room of 0.4% to $55.40 during the 1999 Three Months.
During the nine-month periods, the average daily room rate for the leased hotels
increased by 6.0%, from $72.40 during the 1998 Nine Months to $76.73 during the
1999 Nine Months, and the average occupancy rate decreased to 67.2% during the
1999 Nine Months from 70.4% during the 1998 Nine Months. This resulted in an
increase in room revenue per available room of 1.1% to $51.56 during the 1999
Nine 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 inflationary rate increases 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 13.2%, from
$7.9 million in the 1998 Three Months to $6.8 million in the 1999 Three Months
and by $2.5 million, or 10.9%, from $23.0 million in the 1998 Nine Months to
$20.5 million in the 1999 Nine Months. This decrease was due to the net loss of
25 management contracts since January 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 $1.3 million, or 29.7%,
from $4.4 million in the 1998 Three Months to $3.1 million in the 1999 Three
Months and by $5.0 million, or 36.6%, from $13.6 million in the 1998 Nine Months
to $8.6 million in the 1999 Nine 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 $0.9 million from the 1998 Three
Months to the 1999 Three Months and by $2.7 million from the 1998 Nine Months to
the 1999 Nine 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 $1.8 million, or 6.7%, from $27.3 million in the 1998 Three Months
to $29.1 million in the 1999 Three Months and by $4.2 million, or 5.5%, from
$75.8 million in the 1998 Nine Months to $80.0 million in the 1999 Nine 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 49.4% during the 1998 Three Months to
46.9% during the 1999 Three Months and from 49.8% during the 1998 Nine Months to
46.4% during the 1999 Nine 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 $0.9 million, or 29.2%, from $2.9 million in the 1998 Three Months to $3.8
million in the 1999 Three Months and by $2.0 million, or 20.7%, from $9.8
million in the 1998 Nine Months to $11.8 million in the 1999 Nine Months. This
increase resulted from increased costs of $2.0 million during the 1999 Nine
Months associated with a deficiency between the amount of premiums received as
compared to actual and estimated claims incurred under the Company's
self-insured health and welfare plan. Pro forma general and administrative
expenses as a percentage of pro forma revenues increased to 5.8% during the 1999
Three Months compared to 4.4% during the 1998 Three Months and to 6.6% during
the 1999 Nine Months compared to 5.2% during the 1998 Nine 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 $5.0 million from $1.6 million in
the 1998 Three Months to a pro forma operating loss of $3.4 million in the 1999
Three Months. For the nine-month periods, pro forma operating income decreased
by $16.8 million from $5.2 million in 1998 to a pro forma operating loss of
$11.6 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 $0.6 million in the 1998 Three Months. For the nine-month periods, a
pro forma net loss of $2.8 million was incurred in 1999 as compared to pro forma
net income of $1.8 million in 1998.
HISTORICAL THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO HISTORICAL
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999
Total revenues decreased by $3.4 million, or 4.9%, from $69.0 million in
the 1998 Three Months to $65.6 million in the 1999 Three Months and by $16.4
million, or 8.2%, from $199.6 million in the 1998 Nine Months to $183.2 million
in the 1999 Nine Months. A portion of this decrease related to lodging revenues.
Lodging revenues increased by $0.9 million, or 1.7%, from $54.0 million in the
1998 Three Months to $54.9 million in the 1999 Three Months and decreased by
$1.8 million, or 1.2%, from $150.9 million in the 1998 Nine Months to $149.1
million in the 1999 Nine Months. This decrease was due to the net loss of four
hotel operating leases since January 1, 1998 due primarily 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 $2.0 million, or 20.7%, from $9.5 million
in the 1998 Three Months to $7.5 million in the 1999 Three Months and by $6.5
million, or 20.9%, from $31.4 million in the 1998 Nine Months to $24.9 million
in the 1999 Nine Months. This decrease was due to the net loss of 54 management
contracts since January 1, 1998, which includes 29 hotels whose management was
transferred to either Wyndham or Marriott resulting from to the Merger and
Spin-off. 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 $2.4 million, or 43.2%, from $5.5 million in the 1998 Three
Months to $3.1 million in the 1999 Three Months and by $8.0 million, or 46.2%,
from $17.3 million in the 1998 Nine Months to $9.3 million in the 1999 Nine
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 $1.6 million from the 1998 Three Months to the 1999 Three Months
and by $4.5 million from the 1998 Nine Months to the 1999 Nine Months. This
decrease is primarily due to the decrease in the total number of hotels operated
in 1999 compared to
14
16
1998 and a reduction in the amount of financial indemnity for the Company's
self-insured health and welfare plan.
Lodging expenses increased by $1.8 million, or 6.7%, from $27.3 million in
the 1998 Three Months to $29.1 million in the 1999 Three Months and by $4.2
million, or 5.5%, from $75.8 million in the 1998 Nine Months to $80.0 million in
the 1999 Nine 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 49.4% during
the 1998 Three Months to 46.9% during the 1999 Three Months and from 49.8%
during the 1998 Nine Months to 46.4% during the 1999 Nine Months.
General and administrative expenses increased by $1.1 million, or 41.3%,
from $2.7 million in the 1998 Three Months to $3.8 million in the 1999 Three
Months and by $1.8 million, or 18.9%, from $9.6 million in the 1998 Nine Months
to $11.4 million in the 1999 Nine Months. This increase resulted from increased
costs of $2.0 million during the 1999 Nine Months associated with a deficiency
between the amount of premiums received as compared to actual and estimated
claims incurred under the Company's self-insured health and welfare plan.
General and administrative expenses as a percentage of revenues increased to
5.7% during the 1999 Three Months compared to 3.9% during the 1998 Three Months
and to 6.2% during the 1999 Nine Months compared to 4.8% during the 1998 Nine
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 $0.6 million, or 10.7%, from $5.5
million in the 1998 Three Months to $4.9 million in the 1999 Three Months and by
$3.0 million, or 16.9%, from $17.9 million in the 1998 Nine Months to $14.9
million in the 1999 Nine 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 to 7.5% during the 1999 Three Months compared
to 8.0% during the 1998 Three Months and decreased to 8.1% during the 1999 Nine
Months compared to 9.0% during the 1998 Nine Months.
Lease expense represents base rent and participating rent that is based on
a percentage of rooms and food and beverage revenues from the leased hotels.
Lease expense increased by $0.8 million, or 3.3%, from $24.8 million in the 1998
Three Months to $25.6 million in the 1999 Three Months due to a slight increase
in lodging revenues from 1998 to 1999. Lease expense increased by $2.4 million,
or 3.5%, from $67.7 million in the 1998 Nine Months to $70.1 million in the 1999
Nine 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 the Merger.
Depreciation and amortization increased by $6.4 million from $8.3 million
in the 1998 Nine Months to $14.7 million in the 1999 Nine 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 $6.6 million from $4.1 million in the 1998
Three Months to an operating loss of $2.5 million in the 1999 Three Months. For
the nine-month periods, operating income decreased by $28.1 million from $20.3
million in 1998 to an operating loss of $7.8 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 nine-month periods increased 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, a net loss of $0.6 million was
incurred in the 1999 Three Months as compared to net income of $2.9 million in
the 1998 Three Months. For the nine-month periods, a net loss of $2.6 million
was incurred in 1999 as compared to net income of $13.0 million in 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalent assets were $37.0 million at
September 30, 1999 compared to $1.7 million at December 31, 1998, and current
assets exceeded current liabilities by $19.9 million at September 30, 1999. In
connection with the Spin-off, Wyndham provided working capital to the Company in
the amount of $16.3 million, less positive working capital, of IH LLC. 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 Nine Months was
cash from operations. Net cash provided by operating activities was $23.0
million during the 1999 Nine Months compared to $31.4 million during the 1998
Nine Months. The increase primarily resulted from higher earnings and lower
amortization in the 1998 Nine Months compared to lower earnings with higher
amortization in the 1999 Nine Months. Net cash of $5.2 million was provided from
investing activities during the 1999 Nine Months compared to net cash of $22.0
million used in investing activities during the 1998 Nine 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 Nine Months and
a decrease of $12.6 million in amounts paid in connection with the Merger during
the 1999 Nine Months compared to the 1998 Nine 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 $7.1 million was provided by financing activities during the 1999
Nine Months compared to net cash of $8.7 million used in financing activities
during the 1998 Nine Months. During the 1999 Nine Months, $32.0 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 $11.6 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.
In November 1999, the Company acquired one hotel with 156 rooms for a total
acquisition cost, including closing costs, of approximately $12.7 million. This
acquisition was funded with cash received from Wyndham in connection with the
Spin-off. The Company is currently seeking financing for this property.
16
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.
Management developed and implemented a comprehensive plan (i) to address
potential year 2000 problems both at the Company's corporate offices and at the
hotels managed and leased by the Company, and (ii) to minimize the impact on
operations to the extent possible. Management's 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
The Company engaged a consultant to complete Steps 1 and 2, at an estimated
cost of $13,500 per hotel for upscale hotels and $7,500 per hotel for midscale
and economy hotels. Management instructed the hotels operated by the Company to
increase their capital budgets for 1999 to accommodate this cost. The
inventories at the hotels and the corporate offices have been completed. In
addition, management has catalogued the responses to the year 2000 readiness
questionnaires that were sent out to the Company's and the hotels' third-party
vendors, and distributed those responses to each of the hotels.
Step 3 was performed through a joint effort between management and hotel
owner representatives and a year 2000 consultant. The Company's management and
information systems department completed the written assessments, which
prioritized the corporate and hotel year 2000 compliance plans for remediation
and estimated the costs of such remediation. Once each written assessment was
finalized, management furnished the assessment to each hotel for review and
implementation by hotel personnel. On the corporate level, the implementation
process described in Step 4 above is nearly complete and management is
developing a contingency plan in the event unforeseen problems arise. In
addition, the hotels are also in the process of implementing their remediation
and testing plans, as well as developing their individual contingency plans
based on the guidelines provided to them. Because Step 3 was performed primarily
utilizing internal resources, the costs incurred were minimal. The costs
incurred or to be incurred in implementing Step 4 vary from hotel to hotel,
depending upon the extent of remediation necessary. At this time, the Company
cannot identify the total costs that will be incurred to complete Step 4.
Management believes that the expenses incurred to complete the year 2000
compliance program at each managed hotel are the responsibility of the hotel
owner, and management believes that the terms of the 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 the Company, management also believes that the expenses associated
with year 2000 compliance with respect to the 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 the Company's
responsibility. To date, the Company has incurred and expensed approximately
$0.6 million in such costs. Further, the Company will be responsible for funding
the year 2000
17
19
compliance expenses for corporate operations. Management has provided for
approximately $2.7 million in capital expenditures in the Company's 1999
management and information systems capital budget, approximately $2.4 million of
which is expected to be spent addressing year 2000 issues. To date, the Company
has incurred approximately $1.1 million in such costs.
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 the Company is responsible for any year 2000 compliance related
expenses with respect to the leased hotels, Wyndham is obligated to indemnify
the Company for up to $1.2 million of such expenses. Any remaining expenses not
funded by Wyndham will be funded by the Company through operating cash flow.
Management's 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 the Company's and the hotels' third-party vendors.
Management believes the most likely "worst-case" scenario is that the Company's
and the hotels' 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 the Company's 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. Based
on the information management has received from third-party vendors in those
countries, management does not currently anticipate any material disruptions to
the life safety systems (i.e. electrical power, water, fire safety, etc.) at
those hotels. Nonetheless, such failures of the third-party vendors, both within
and outside the United States, to be year 2000 compliant could affect critical
operations at the hotels in a significant manner, and management 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 finalized to address these failures, using existing disaster
contingency plans in place at the hotels. In addition, while management believes
the indemnification provisions in the Company's 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.
18
20
PART II--OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
10.1 Employment Agreement, dated June 18, 1999, between the
Company and Kevin P. Kilkeary
27.1 Financial Data Schedule
(b) Reports on Form 8-K.
During the three months ended September 30, 1999, the Company filed the
following:
1. Current Report on Form 8-K, dated June 18, 1999, under Item 2, which
reported the sale by the Company of substantially all of its equity
interests in The Charles Hotel Complex for $19.25 million.
2. Current Report on Form 8-K, dated July 8, 1999, under Item 5, which
reported the Company's adoption of a Shareholder Rights Agreement.
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SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
INTERSTATE HOTELS CORPORATION
Date: November 15, 1999 By: /s/ J. WILLIAM RICHARDSON
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J. William Richardson
Vice Chairman and Chief Financial
Officer
(Principal Financial Officer)
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