SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from __________ to __________
Commission File Number 0-27360
_____________
EXTENDED STAY AMERICA, INC.
(Exact name of Registrant as specified in its charter)
Delaware 36-3996573
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
450 EAST LAS OLAS BOULEVARD, FORT LAUDERDALE, FL 33301
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (954) 713-1600
_____________
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
At November 4, 1998, the registrant had issued and outstanding an aggregate of
95,942,768 shares of Common Stock.
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
EXTENDED STAY AMERICA, INC.
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except share data)
ASSETS
------
September 30, December 31,
1998 1997(1)
------------- ------------
Current assets:
Cash and cash equivalents........................ $ 27,121 $ 3,213
Accounts receivable.............................. 9,719 3,651
Prepaid expenses................................. 2,702 3,869
Deferred income taxes............................ 18,629 6,895
Other current assets............................. 716 866
---------- ----------
Total current assets......................... 58,887 18,494
Property and equipment, net....................... 1,487,038 1,042,741
Deferred loan costs............................... 17,225 8,167
Other assets...................................... 1,526 1,489
---------- ----------
$1,564,676 $1,070,891
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable................................. $ 55,627 $ 51,309
Accrued retainage................................ 21,276 19,951
Accrued property taxes........................... 8,978 3,417
Accrued interest................................. 2,037 356
Accrued salaries and related expenses............ 3,062 2,707
Income taxes payable............................. 5,779
Other accrued expenses........................... 25,318 5,099
---------- ----------
Total current liabilities.................... 122,077 82,839
---------- ----------
Deferred income taxes............................. 33,738 18,393
---------- ----------
Long-term debt.................................... 550,000 135,000
---------- ----------
Commitments
Stockholders' equity:
Preferred stock, $.01 par value, 10,000,000
shares authorized; no shares issued and
outstanding.....................................
Common stock, $.01 par value, 500,000,000 shares
authorized; 95,921,558 and 95,604,208 shares
issued and outstanding, respectively............ 959 956
Additional paid-in capital....................... 826,850 823,060
Retained earnings................................ 31,052 10,643
---------- ----------
Total stockholders' equity................... 858,861 834,659
---------- ----------
$1,564,676 $1,070,891
========== ==========
_____________________
(1) Derived from audited financial statements
See notes to the unaudited condensed consolidated financial statements
1
EXTENDED STAY AMERICA, INC.
Condensed Consolidated Statements of Income (Unaudited)
(In thousands, except per share data)
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
September 30, September 30, September 30, September 30,
1998 1997 1998 1997
------------- -------------- ------------- --------------
Revenue............................................ $81,006 $38,773 $205,280 $87,564
------- ------- -------- -------
Property operating expenses........................ 32,593 17,436 87,767 39,923
Corporate operating and property
management expenses............................... 9,966 8,102 29,078 20,846
Merger, financing and other non-recurring charges.. 12,000 12,000 19,895
Depreciation and amortization...................... 10,865 5,274 30,308 13,344
------- ------- -------- -------
Total costs and expenses......................... 65,424 30,812 159,153 94,008
------- ------- -------- -------
Income (loss) from operations...................... 15,582 7,961 46,127 (6,444)
Interest expense (income), net..................... 6,429 (1,446) 12,111 (8,880)
------- ------- -------- -------
Income before income taxes......................... 9,153 9,407 34,016 2,436
Provision for income taxes......................... 3,661 3,763 13,607 3,415
------- ------- -------- -------
Net income (loss).................................. $ 5,492 $ 5,644 $ 20,409 $ (979)
======= ======= ======== =======
Net income (loss) per common share:
Basic............................................. $ 0.06 $ 0.06 $ 0.21 $ (0.01)
======= ======= ======== =======
Diluted........................................... $ 0.06 $ 0.06 $ 0.21 $ (0.01)
======= ======= ======== =======
Weighted average shares:
Basic............................................. 96,033 95,349 95,878 93,786
Effect of dilutive options........................ 690 1,444 998
------- ------- -------- -------
Diluted........................................... 96,723 96,793 96,876 93,786
======= ======= ======== =======
See notes to the unaudited condensed consolidated financial statements
2
EXTENDED STAY AMERICA, INC.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
Nine Months Ended
-----------------------------
September 30, September 30,
1998 1997
------------- -------------
Cash flows from operating activities:
Net income (loss)................................................... $ 20,409 $ (979)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization..................................... 30,308 13,344
Merger expenses................................................... 485
Deferred loan costs............................................... 1,701 9,667
Unsuccessful development costs.................................... 14,388 2,363
Deferred income taxes............................................. 5,300 4,531
Changes in operating assets and liabilities....................... 450 (4,361)
--------- ---------
Net cash provided by operating activities..................... 72,556 25,050
--------- ---------
Cash flows from investing activities:
Additions to property and equipment................................. (455,409) (409,650)
Other assets........................................................ (37)
---------
Net cash used in investing activities......................... (455,446) (409,650)
--------- ---------
Cash flows from financing activities:
Proceeds from long-term debt........................................ 443,500
Repayments of revolving credit facility............................. (28,500)
Proceeds from issuance of common stock.............................. 3,126 200,775
Additions to deferred loan costs.................................... (11,328) (7,652)
--------- ---------
Net cash provided by financing activities..................... 406,798 193,123
--------- ---------
Increase (decrease) in cash and cash equivalents..................... 23,908 (191,477)
Cash and cash equivalents at beginning of period..................... 3,213 224,325
--------- ---------
Cash and cash equivalents at end of period........................... $ 27,121 $ 32,848
========= =========
Noncash investing and financing transactions:
Capitalized or deferred items included in accounts payable
and accrued liabilities............................................ $ 70,185 $ 39,655
========= =========
Conversion of amounts due under revolving credit facility
to term loan....................................................... $ 100,000 $
========= =========
Capitalization of amortized deferred loan costs..................... $ 511 $
========= =========
Supplemental cash flow disclosures:
Cash paid for:
Income taxes, net of refunds of $411 in 1998....................... $ 2,672 $ 1,129
========= =========
Interest expense, net of amounts capitalized....................... $ 14,703 $
========= =========
See notes to the unaudited condensed consolidated financial statements
3
EXTENDED STAY AMERICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
NOTE 1 -- BASIS OF PRESENTATION
Extended Stay America, Inc. ("ESA") was organized on January 9, 1995 as a
Delaware corporation to develop, own and manage extended stay lodging
facilities.
On April 11, 1997, ESA, ESA Merger Sub, Inc. ("Merger Sub"), a wholly-owned
subsidiary of ESA, and Studio Plus Hotels, Inc. ("SPH") consummated a merger
(the "Merger") pursuant to which SPH was merged with and into Merger Sub and the
12,557,786 shares of SPH common stock issued and outstanding on such date were
converted into 15,410,915 shares of common stock, par value $.01 per share, of
ESA ("Common Stock") and options to purchase 1,072,565 shares of SPH common
stock were converted into options to purchase 1,316,252 shares of Common Stock.
The Merger was accounted for using the pooling of interests method of
accounting. The accompanying unaudited condensed consolidated financial
statements of ESA and SPH (together, the "Company") give effect to the Merger as
if it had been consummated as of the beginning of the periods presented. All
significant intercompany accounts and transactions have been eliminated in
consolidation. These financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information and
the instructions of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included.
The condensed consolidated balance sheet data at December 31, 1997 was
derived from audited financial statements of the Company but does not include
all disclosures required by generally accepted accounting principles.
Operating results for the three-month and nine-month periods ended
September 30, 1998 are not necessarily indicative of the results that may be
expected for the year ended December 31, 1998. For further information, refer to
the financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
In April 1998, the Accounting Standards Executive Committee released
Statement of Position 98-5, "Reporting on the Costs of Start-up Activities"
("SOP 98-5"). SOP 98-5 requires that start-up costs, including pre-opening and
organizational costs be expensed as incurred and is effective for financial
statements issued for periods beginning after December 15, 1998. At September
30, 1998, the Company had unamortized pre-opening and organization costs of
approximately $1.1 million. Under SOP 98-5, the Company would have reported a
reduction of expenses of approximately $174,000 for the nine months ended
September 30, 1998.
For the nine months ended September 30, 1998 and 1997, the computation of
diluted earnings per share does not include approximately 6,287,000 and
3,075,000 weighted average shares, respectively, of Common Stock represented by
outstanding options because the exercise price of the options was greater than
the average market price of Common Stock during the period.
Certain previously reported amounts have been reclassified to conform with
the current period's presentation.
4
NOTE 2 -- INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
bases and for operating loss and tax carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Income tax expense for the three-month and nine-month periods ended
September 30, 1998 and 1997 differed from the amounts computed by applying the
U.S. Federal income tax rate of 35% primarily as a result of the impact of state
and local income taxes and as a result of nondeductible expenses associated with
the Merger recognized in the second quarter of 1997.
NOTE 3 -- LONG-TERM DEBT
Effective March 10, 1998, the Company issued $200 million aggregate
principal amount of Senior Subordinated Notes (the "Notes"). The Notes contain
certain redemption features, bear interest at an annual rate of 9.15% and mature
on March 15, 2008. The Notes are uncollateralized and are subordinated to all
senior indebtedness of the Company and contain certain covenants for the benefit
of the holders of the Notes. These convenants, among other things, restrict
under certain circumstances the Company's ability to incur additional
indebtedness, pay dividends and make investments and other restricted payments,
enter into transactions with 5% stockholders or affiliates, create liens, and
sell assets.
Effective March 10, 1998, the Company amended its existing credit facility
("the Amended Credit Facility"). The Amended Credit Facility provides for $350
million in term loans (the "Term Loans") and $350 million in a revolving loan
facility (the "Revolving Facility"). The Revolving Facility and $150 million of
the Term Loans mature December 31, 2002 and bear interest, at the Company's
option, at either the Base Rate (as defined) or the Eurodollar rate, plus an
applicable margin which will be between .875% and 0% for Base Rate loans and
1.875% and 1% for Eurodollar loans. Term Loans of $200 million mature December
31, 2003, subject to maximum principal amortization of 1% in each of the years
1999 through 2002 and payment of the balance in four equal quarterly payments in
2003, and bear interest, at the Company's option, at either the Base Rate plus
1.75% or the Eurodollar rate plus 2.75%. At September 30, 1998, the Term Loans
were borrowed and the Revolving Facility remained available and committed under
the Amended Credit Facility. Availability of the Revolving Facility is
dependent, however, upon the Company satisfying certain financial ratios of debt
and interest compared to earnings before interest, taxes, depreciation and
amortization, with such amounts being calculated pursuant to definitions
contained in the Amended Credit Facility.
The Amended Credit Facility contains a number of covenants, including,
among others, covenants limiting under certain circumstances the ability of the
Company and its subsidiaries to incur debt, make investments, pay dividends,
prepay other indebtedness, engage in transactions with affiliates, enter into
sale-leaseback transactions, create liens, make capital expenditures, acquire or
dispose of assets, or engage in mergers or acquisitions. In addition, the
Amended Credit Facility contains affirmative covenants, including, among others,
covenants requiring maintenance of corporate existence, compliance with laws,
maintenance of properties and insurance, and the delivery of financial and other
information. The Amended Credit Facility also specifies events of default,
including a change of control, and requires the Company to comply with certain
financial tests and to maintain certain financial ratios on a consolidated
basis. The Company's obligations under the Amended Credit Facility are
guaranteed by each of the Company's subsidiaries and are collateralized by a
first priority lien on all stock of such subsidiaries owned by the Company and
all other current and future assets of the Company and its subsidiaries (other
than mortgages on the Company's and its subsidiaries' real property).
5
NOTE 4 -- MERGER, FINANCING AND OTHER NON-RECURRING CHARGES
The Company, consistent with its normal operating procedures, invests
varying amounts in the sites under option in terms of (1) earnest money which
would be applied to the purchase of the site but that in many cases may not be
refundable, (2) legal, environmental, engineering, and architectural outlays
necessary to determine the feasibility of acquiring the site and constructing a
hotel on such site, and (3) salaries, wages, and travel costs of the Company's
personnel related to the sites which are capitalized in accordance with
generally accepted accounting principles. In the quarter ended September 30,
1998, the Company announced a reduction in its development plans for 1999 and
2000 as a result of capital market conditions. Accordingly, certain sites under
option would not be developed. As a result, the Company established a valuation
allowance of $12.0 million which resulted in a corresponding expense during the
period ended September 30, 1998.
During the three months ended June 30, 1997, the Company recorded merger,
financing, and other charges totaling $19.9 million. These one-time, pre-tax
charges consisted of (i) $9.7 million of merger expenses and costs associated
with the integration of SPH's operations following the Merger, (ii) the write-
off of $9.7 million of deferred costs associated with the Company's $400 million
mortgage facilities which were terminated upon execution of a revolving credit
agreement with various banks, and (iii) a charge of $500,000 in connection with
moving the listing of the Company's Common Stock to the New York Stock Exchange,
Inc. from The Nasdaq National Market.
6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
General
Extended Stay America, Inc. ("ESA"), was organized on January 9, 1995, as a
Delaware corporation to develop, own, and manage extended stay lodging
facilities. Studio Plus Hotels, Inc. ("SPH") was formed in December 1994 and
acquired (through merger and exchange of SPH common stock for partnership
interests immediately prior to completion of the SPH initial public offering in
June 1995) all of the assets of Studio Plus, Inc. and the SPH predecessor
entities, which owned and operated StudioPLUS(TM) extended stay facilities since
1986. The acquisition of the interests of the controlling shareholder or
partner and affiliates of the predecessor entities was accounted for as a
pooling of interests.
On April 11, 1997, ESA, ESA Merger Sub, Inc. ("Merger Sub"), a wholly-owned
subsidiary of ESA, and SPH consummated a merger pursuant to which SPH was merged
with and into Merger Sub (the "Merger") and the 12,557,786 shares of SPH common
stock that were outstanding on the closing date were converted into 15,410,915
shares of common stock, par value $.01 per share, of ESA ("Common Stock") and
options to purchase 1,072,565 shares of SPH common stock were converted into
options to purchase 1,316,252 shares of Common Stock. The Merger was accounted
for using the pooling of interests method of accounting. The accompanying
unaudited condensed consolidated financial statements of ESA and SPH (together,
the "Company") give effect to the Merger as if it had been consummated at the
beginning of the periods presented.
The Company owns and operates three brands in the extended stay lodging
market--StudioPLUSTM Deluxe Studios ("StudioPLUS"), EXTENDED STAYAMERICA
Efficiency Studios ("EXTENDED STAY"), and Crossland Economy StudiosSM
("Crossland"), each designed to appeal to different price points below $500 per
week. All three brands offer the same core components: a living/sleeping area; a
fully-equipped kitchen or kitchenette; and a bathroom. EXTENDED STAY rooms are
designed to compete in the economy category. Crossland guestrooms are typically
smaller than EXTENDED STAY rooms and are targeted for the budget category, while
StudioPLUS facilities serve the mid-price category and generally feature larger
guestrooms, an exercise facility, and a swimming pool.
The following is a summary of the Company's selected development and
operational results for the three months and nine months ended September 30,
1998 and 1997.
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
Total Facilities Open (at Period End)........ 269 151 269 151
Total Facilities Developed................... 30 35 84 76
Average Occupancy Rate....................... 78% 80% 74% 75%
Average Weekly Room Rate..................... $ 290 $ 264 $ 286 $ 262
Average occupancy rates are determined by dividing the guestrooms occupied
on a daily basis by the total number of guestrooms. Due to the Company's rapid
expansion, its overall average occupancy rate has been negatively impacted by
the lower occupancy typically experienced during the pre-stabilization period
for newly opened facilities. This negative impact on overall average occupancy
is expected to diminish as the ratio of newly opened facilities to total
facilities in operation at the end of the period decreases. Average weekly room
rates are determined by dividing room revenue by the number of rooms occupied on
a daily basis for the applicable period and multiplying by seven. The average
weekly room rates vary from standard room rates due primarily to (i) stays of
less than one week, which are charged at a higher nightly rate, (ii) higher
weekly rates for rooms which are larger than the standard rooms, and (iii)
additional charges for more than one person per room. Future occupancy and room
rates may be impacted by a number of factors including the number and geographic
location of new facilities as well as the season in which such facilities
commence operations. There can be no assurance that the foregoing occupancy and
room rates can be maintained.
7
The following is a summary of the Company's development status as of
September 30, 1998, by brand. The Company expects to complete the construction
of the facilities currently under construction generally within the next twelve
months. There can be no assurance, however, that the Company will complete
construction within time periods historically experienced by the Company. The
Company's ability to complete construction may be materially impacted by various
factors including final permitting and obtaining certificates of occupancy as
well as weather-induced construction delays.
EXTENDED
Crossland STAY StudioPLUS Total
--------- -------- ---------- -----
Operating Facilities................... 21 163 85 269
Facilities Under Construction.......... 18 46 17 81
Results of Operations
For the Three Months Ended September 30, 1998 and 1997
Property Operations
The following is a summary of the properties operated during the specified
periods and the related average occupancy and weekly room rates:
For the Three Months Ended
------------------------------------------------------------------------
September 30, 1998 September 30, 1997
----------------------------------- -----------------------------------
Average Average Average Average
Facilities Occupancy Weekly Room Facilities Occupancy Weekly Room
Open Rate Rate Open Rate Rate
---------- ---------- ----------- ---------- ---------- -----------
Crossland...... 21 66% $198 3 72% $183
EXTENDED STAY.. 163 81 286 99 79 251
StudioPLUS..... 85 76 328 49 84 308
--- -- ---- --- -- ----
Total........ 269 78% $290 151 80% $264
=== == ==== === == ====
Because newly opened properties typically experience lower occupancies
during their pre-stabilization period, average occupancy rates are impacted by
the ratio of newly opened properties to total properties. For the EXTENDED STAY
brand, occupancy rates increased for the third quarter of 1998 as compared to
the third quarter of 1997 primarily due to a decrease in the ratio of newly
opened properties to total properties for that brand. Occupancy rates decreased
for the Crossland and StudioPLUS brands primarily due to an increase in the
number of newly opened properties for these brands. The average occupancy rate
in the third quarter of 1998 for the 116 properties that were owned and operated
by the Company as of June 30, 1997 was 85%.
The increase in overall average weekly room rates for the third quarter of
1998 as compared to the third quarter of 1997 reflects the geographic dispersion
of properties opened since September 30, 1997 and the higher standard weekly
room rates in certain of those markets, in addition to increases in rates
charged at previously opened properties. The Company expects that its average
weekly room rate will continue to be impacted as the lower priced EXTENDED STAY
and Crossland facilities increase as a percentage of the Company's total
facilities. The average weekly room rate for the 116 properties that were owned
and operated throughout both periods increased by 5% in the third quarter of
1998.
The Company recognized total revenues for the three months ended September
30, 1998 and 1997 of $81.0 million and $38.8 million, respectively, an increase
of $42.2 million. Approximately $40.0 million of the increased revenue was
attributable to properties opened subsequent to June 30, 1997 and approximately
$2.2 million was attributable to an increase in revenue for the 116 properties
that were owned and operated throughout both periods.
Property operating expenses, consisting of all expenses directly allocable
to the operation of the facilities but excluding any allocation of corporate
operating and property management expenses, depreciation or interest were $32.6
million (40% of total revenue) for the third quarter of 1998, compared to $17.4
million (45% of total revenue) for the third quarter of 1997. The decrease in
property operating expenses as a percentage of total revenue for the third
quarter of 1998 as compared to the third quarter of 1997 was primarily a result
of a decrease in the ratio of
8
newly opened properties to total properties. In addition, the increase in
revenues of previously opened properties resulted in a decrease in property
operating expenses as a percentage of total revenue for those sites. As a result
of the foregoing, the Company realized property operating margins of 60% and 55%
for the third quarter of 1998 and 1997, respectively.
The provision for depreciation and amortization for the lodging facilities
of $10.5 million and $5.1 million for the third quarter of 1998 and 1997,
respectively, was provided using the straight-line method over the estimated
useful lives of the assets. These provisions reflect a pro rata allocation of
the annual depreciation and amortization charge for the periods for which the
facilities were in operation. The increase in depreciation and amortization for
the third quarter of 1998 as compared to the third quarter of 1997 is due to the
operation of 118 additional facilities in 1998.
Corporate Operations
Corporate operating and property management expenses include all expenses
not directly related to the development or operation of lodging facilities.
These expenses consist primarily of personnel expenses, professional and
consulting fees, and related travel expenses including costs that are not
directly related to a site that will be developed by the Company. The Company
incurred corporate operating and property management expenses of $10.0 million
(12% of total revenue) and $8.1 million (21% of total revenue) in the third
quarter of 1998 and 1997, respectively. The increase in the amount of these
expenses for the third quarter of 1998 as compared to 1997 reflects the impact
of additional personnel and related expenses in connection with the Company's
increased level of operating facilities and site development. Management expects
these expenses to increase in total amount but to continue to decline as a
percentage of revenue with the development of additional facilities in the
future.
Depreciation and amortization in the amount of $333,000 and $200,000 for
the third quarter of 1998 and 1997, respectively, were provided using the
straight-line method over the estimated useful lives of the assets for assets
not directly related to the operation of the facilities, including primarily
office furniture and equipment.
The Company realized $1.4 million of interest income during the third
quarter of 1997, which was primarily attributable to the investment of funds
received from an offering of Common Stock. Approximately $1.2 million of
interest income was realized in the third quarter of 1998 primarily resulting
from the temporary investment of funds drawn under the Company's credit
facilities. The Company incurred interest charges of $12.5 million during the
third quarter of 1998, $4.9 million of which was capitalized and included in the
cost of buildings and improvements.
The Company recognized income tax expense of $3.7 million and $3.8 million
for the third quarter of 1998 and 1997, respectively. Income tax expense for
these periods differs from the federal income tax rate of 35% primarily due to
state and local income taxes.
Non-Recurring Charges
The Company, consistent with its normal operating procedures, invests
varying amounts in the sites under option in terms of (1) earnest money which
would be applied to the purchase of the site but that in many cases may not be
refundable, (2) legal, environmental, engineering, and architectural outlays
necessary to determine the feasibility of acquiring the site and constructing a
hotel on such site, and (3) salaries, wages, and travel costs of the Company's
personnel related to the sites which are capitalized in accordance with
generally accepted accounting principles. In the quarter ended September 30,
1998, the Company announced a reduction in its development plans for 1999 and
2000 as a result of capital market conditions. Accordingly, certain sites under
option would not be developed. As a result, the Company established a valuation
allowance of $12.0 million which resulted in a corresponding expense during the
period ended September 30, 1998.
9
For the Nine Months Ended September 30, 1998 and 1997
Property Operations
The following is a summary of the properties operated during the specified
periods and the related average occupancy and weekly room rates:
For the Nine Months Ended
------------------------------------------------------------------------
September 30, 1998 September 30, 1997
----------------------------------- ------------------------------------
Average Average Average Average
Facilities Occupancy Weekly Room Facilities Occupancy Weekly Room
Open Rate Rate Open Rate Rate
---------- ---------- ----------- ---------- ---------- -----------
Crossland...... 21 63% $196 3 79% $179
EXTENDED STAY.. 163 76 281 99 73 248
StudioPLUS..... 85 72 322 49 82 303
--- -- ---- --- -- ----
Total........ 269 74% $286 151 75% $262
=== == ==== === == ====
For the EXTENDED STAY brand, occupancy rates increased for the nine-month
period ended September 30, 1998 as compared to the same period in 1997 primarily
due to a decrease in the ratio of newly opened properties to total properties
for that brand. Occupancy rates decreased for the Crossland and StudioPLUS
brands primarily due to an increase in the number of newly opened properties for
these brands. The average occupancy rate in the nine months ended September 30,
1998 for the 75 properties that were owned and operated by the Company as of
December 31, 1996 was 82%.
The increase in average weekly room rates for the nine months ended
September 30, 1998 as compared to the same period of 1997 reflects the
geographic dispersion of properties opened since September 30, 1997 and the
higher standard weekly room rates in certain of those markets, in addition to
increases in rates charged at previously opened properties. The average weekly
room rate for the 75 properties that were owned and operated throughout both
periods increased 1% in the first nine months of 1998.
The Company recognized total revenues for the nine months ended September
30, 1998 and 1997 of $205.3 million and $87.6 million, respectively, an increase
of $117.7 million. Approximately $115.1 million of the increased revenue was
attributable to properties opened subsequent to December 31, 1996 and
approximately $2.6 million was attributable to an increase in revenue for the 75
properties that were owned and operated throughout both periods.
Property operating expenses for the nine months ended September 30, 1998
were $87.8 million (43% of total revenue) compared to $39.9 million (46% of
total revenue) for the nine months ended September 30 1997. The decrease in
property operating expenses as a percentage of total revenue for the nine months
ended September 30, 1998 as compared to the same period of 1997 was primarily a
result of improved occupancies and revenues for the facilities that were in
their pre-stabilization periods during the first nine months of 1997. As a
result of the foregoing, the Company realized property operating margins of 57%
and 54% for the nine months ended September 30, 1998 and 1997, respectively.
The provision for depreciation and amortization for the lodging facilities
was $29.3 million and $12.7 million for the nine months ended September 30, 1998
and 1997, respectively. The increase in depreciation and amortization for the
nine months ended September 30, 1998 as compared to the same period in 1997 is
due to the operation of 118 additional facilities in 1998.
Corporate Operations
Corporate operating and property management expenses for the nine months
ended September 30, 1998 and 1997 were $29.1 million and $20.8 million,
respectively, or 14% and 24% of total revenue, respectively. The increases in
the amount of these expenses for the nine-month period ended September 30, 1998
as compared to the same period of 1997 reflect the impact of additional
personnel and related expenses in connection with the Company's increased level
of operating facilities and site development. Management expects these expenses
to increase in total amount but to continue to decline as a percentage of
revenue with the development of additional facilities in the future.
10
Depreciation and amortization for assets not directly related to operation
of the facilities was $1.1 million and $640,000 for the nine months ended
September 30, 1998 and 1997, respectively.
The Company realized $8.9 million of interest income during the nine-month
period ended September 30, 1997, which was primarily attributable to the
investment of funds received from an offering of Common Stock. Approximately
$2.6 million of interest income was realized in the nine-month period ended
September 30, 1998 primarily resulting from the temporary investment of funds
drawn under the Company's credit facilities. The Company incurred interest
charges of $27.5 million during the nine-month period ended September 30, 1998,
$12.8 million of which was capitalized and included in the cost of buildings and
improvements.
The Company recognized income tax expense of $13.6 million and $3.4 million
for the nine-month periods ended September 30, 1998 and 1997 respectively.
Income tax expense for these periods differs from the federal income tax rate of
35% primarily due to state and local income taxes and, in 1997, due to permanent
tax differences relating to non-deductible merger expenses. Management expects
that the annualized effective income tax rate for 1998 will be approximately
40%.
In the quarter ended September 30, 1998, the Company announced a reduction
in its development plans for 1999 and 2000 as a result of capital market
conditions. Accordingly, certain sites under option would not be developed. As a
result, the Company established a valuation allowance of $12.0 million which
resulted in a corresponding expense during the period ended September 30, 1998.
During the three months ended June 30, 1997, the Company recorded merger,
financing, and other charges totaling $19.9 million. These one-time, pre-tax
charges consisted of (i) $9.7 million of merger expenses and costs associated
with the integration of SPH's operations following the Merger, (ii) the write-
off of $9.7 million of deferred costs associated with the Company's $400 million
mortgage facilities which were terminated upon execution of a revolving credit
agreement with various banks, and (iii) a charge of $500,000 in connection with
moving the listing of the Company's Common Stock to the New York Stock Exchange,
Inc. from the Nasdaq National Market.
Liquidity and Capital Resources
The Company had cash and cash equivalents of $27.1 million and $3.2 million
as of September 30, 1998 and December 31, 1997, respectively. At September 30,
1998, substantially all of the cash balances were invested, utilizing domestic
commercial banks and other financial institutions, in short-term commercial
paper and other securities having credit ratings of A1/P1 or equivalent. The
market value of the securities held approximates the carrying amount. In
addition, at September 30, 1998 and December 31, 1997, the Company invested
excess funds in an overnight sweep account with a commercial bank which invested
in short-term, interest-bearing reverse repurchase agreements. Due to the short-
term nature of these investments, the Company did not take possession of the
securities, which were instead held by the financial institution. The market
value of the securities held pursuant to the agreements approximates the
carrying amount. Deposits in excess of $100,000 are not insured by the Federal
Deposit Insurance Corporation.
During the nine months ended September 30, 1998, and 1997 the Company
generated cash from operating activities of $72.6 million and $25.1 million,
respectively.
The Company used $455.4 million and $409.7 million to acquire land and
develop and furnish a total of 166 and 155 sites, respectively, in the nine
months ended September 30, 1998 and 1997.
On February 6, 1997, the Company completed a private placement of 11.5
million shares of its Common Stock at a purchase price of $17.625 per share, for
an aggregate amount of approximately $203 million. Net proceeds received by the
Company from that private placement were approximately $198 million.
Effective September 26, 1997, the Company executed an agreement with
various banks establishing a revolving credit facility (the "Credit Facility")
for $500 million to be used for general corporate purposes, including the
construction and acquisition of extended stay hotel properties. The Credit
Facility had a maturity of December 31, 2002. Upon execution of the agreement
establishing the Credit Facility, the Company terminated two mortgage loan
facilities, which provided for an aggregate of $400 million in available
mortgage loans.
On March 10, 1998 (the "Effective Date"), the Company amended the Credit
Facility (the "Amended Credit Facility"). The Amended Credit Facility converted
$150 million of the amounts available under the Credit Facility into a term loan
facility (the "Converted Term Loans"), with the $350 million balance of the
amounts available under the Credit Facility remaining as a revolving loan
facility (the "Revolving Facility" and, together with the Converted Term Loans,
the "Converted Facilities"). With respect to the Converted Term Loans, $100
million was drawn on the Effective Date and the balance was drawn on July 31,
1998.
11
The Amended Credit Facility also provides for up to $300 million in
additional term loans (the "Additional Term Loans"), $200 million of which were
committed as of the Effective Date and have been drawn (the "Committed Loans").
Additional Term Loans in excess of Committed Loans may be borrowed after
December 31, 1998 provided that at least $275 million must be outstanding under
the Revolving Facility on the date such loans are incurred.
The Company is required to repay indebtedness outstanding under the Amended
Credit Facility with the net cash proceeds from certain sales of assets, from
certain issuances of debt or equity by the Company, and from certain insurance
recovery events (subject to certain reinvestment rights). The Company is also
required to repay indebtedness outstanding under the Amended Credit Facility
annually in an amount equal to 50% of the Company's excess cash flow (as
defined).
Amounts drawn under the Converted Facilities bear interest, at the
Company's option, at either the Base Rate (as defined) or the Eurodollar rate,
plus an applicable margin. The applicable margin is an annual rate which
fluctuates based on the Company's ratio of consolidated debt to consolidated
EBITDA and which will be between .875% and 0% for Base Rate loans and 1.875% and
1% for Eurodollar loans.
Committed Loans bear interest, at the Company's option, at either the
Base Rate plus 1.75% or the Eurodollar rate plus 2.75%. Additional Term Loans
that are not Committed Loans will bear interest at rates to be agreed upon.
The Converted Facilities mature on December 31, 2002. Additional Term Loans
will mature no earlier than December 31, 2003, subject to maximum principal
amortization of 1% of the initially funded amounts in each of the years 1999
through 2002 and payment of the balance due in four equal quarterly payments in
2003.
The Company's obligations under the Converted Facilities are guaranteed by
each of the Company's subsidiaries (the "Guarantors") and are collateralized by
a first priority lien on all stock owned by the Company and the Guarantors and
all other current and future assets of the Company and the Guarantors (other
than mortgages on the Company's and the Guarantors' real property). The
obligations of the Company and the Guarantors under the Additional Term Loans
are collateralized on a pari passu basis by way of perfected first priority
security interests in the assets securing the Converted Facilities.
The Amended Credit Facility contains a number of covenants, including,
among others, covenants limiting under certain circumstances the ability of the
Company and its subsidiaries to incur debt, make investments, pay dividends,
prepay other indebtedness, engage in transactions with affiliates, enter into
sale-leaseback transactions, create liens, make capital expenditures, acquire or
dispose of assets, or engage in mergers or acquisitions. In addition, the
Amended Credit Facility contains affirmative covenants, including, among others,
covenants requiring maintenance of corporate existence, compliance with laws,
maintenance of properties and insurance, and the delivery of financial and other
information. The Amended Credit Facility also specifies events of default,
including a change of control, and requires the Company to comply with certain
financial tests and to maintain certain financial ratios on a consolidated
basis.
At September 30, 1998, the Company had drawn the Converted Term Loans and
the Committed Loans and $350 million remained available and committed under the
Revolving Facility. Availability under the Revolving Facility is dependent upon
the Company satisfying certain financial ratios of debt and interest compared to
earnings before interest, taxes, depreciation, and amortization, with such
amounts being calculated pursuant to definitions contained in the Amended Credit
Facility.
Effective March 10, 1998, the Company issued $200 million aggregate
principal amount of Senior Subordinated Notes, (the "Notes"). The Notes bear
interest at an annual rate of 9.15%, payable semiannually on March 15 and
September 15 of each year, commencing September 15, 1998, and mature on March
15, 2008. The Notes are redeemable, in whole or in part, any time on or after
March 15, 2003, initially at 104.575% of their principal amount, plus accrued
interest, declining ratably to 100% of their principal amount, plus accrued
interest, on or after March 15, 2006. Additionally, at any time prior to March
15, 2001, the Company may redeem up to 35% of the principal amount of the Notes
with the proceeds of one or more public equity offerings by the Company of its
Common Stock, at a redemption price of
12
109.15% of their principal amount, plus accrued interest, provided that at least
$130 million aggregate principal amount of Notes remains outstanding after each
such redemption.
The Notes are uncollateralized and are subordinated to all senior
indebtedness of the Company and contain certain covenants for the benefit of the
holders of the Notes. These covenants, among other things, restrict under
certain circumstances the Company's ability to incur additional indebtedness,
pay dividends and make investments and other restricted payments, enter into
transactions with 5% stockholders or affiliates, create liens, and sell assets.
In connection with the Amended Credit Facility and the Notes, the Company
incurred additions to deferred loan costs of $11.3 million during the nine
months ended September 30, 1998.
The Company had commitments totaling approximately $225 million to complete
construction of extended stay properties at September 30, 1998. The Company
believes that the remaining availability under the Amended Credit Facility,
together with cash on hand and cash flows from operations, will provide
sufficient funds for the Company to develop the properties currently planned to
open in 1998 and to fund its operating expenses through 1998. The Company
expects to continue to rapidly expand its operations. Beginning in 1999, the
Company plans to open 50 to 70 properties annually with total development costs
of approximately $350 million per year. The Company expects to finance this
development with internally generated cash flows and increases in its debt
facilities. The timing and amount of financing needed will depend on a number
of factors, including the number of properties the Company constructs or
acquires, the timing of such development, and the cash flow generated by its
properties. In the event that the capital markets provide favorable
opportunities, the Company's plans or assumptions change or prove to be
inaccurate, or the foregoing sources of funds prove to be insufficient to fund
the Company's growth and operations, or if the Company consummates acquisitions,
the Company may seek additional capital sooner than currently anticipated.
Sources of financing may include public or private debt or equity financing.
There can be no assurance that such additional financing will be available to
the Company or, if available, that it can be obtained on acceptable terms or
within the limitations contained in the Company's financing arrangements.
Failure to obtain such financing could result in the delay or abandonment of
some or all of the Company's development and expansion plans and expenditures
and could have a material adverse effect on the Company.
Impact of the Year 2000 Issue and Accounting Releases
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Based on its
assessment, management of the Company does not anticipate that any significant
modification or replacement of the Company's software will be necessary for its
computer systems to properly utilize dates beyond December 31, 1999 or that the
Company will incur significant operating expenses to make any such computer
system improvements. The Company is undertaking an assessment as to whether any
of its significant suppliers, lenders, or service providers will need to make
any such software modifications or replacements. Management does not expect the
failure of any of such third parties to address the Year 2000 Issue to have a
material adverse effect on the Company's business, operations, or financial
condition, although there can be no assurance to that effect.
In April 1998, the Accounting Standards Executive Committee released
Statement of Position 98-5, "Reporting on the Costs of Start-up Activities"
("SOP 98-5"). SOP 98-5 requires that start-up costs, including pre-opening and
organizational costs be expensed as incurred and is effective for financial
statements issued for periods beginning after December 15, 1998. At September
30, 1998, the Company had unamortized pre-opening and organization costs of
approximately $1.1 million. Under SOP 98-5, the Company would have reported a
reduction of expenses of approximately $174,000 for the nine months ended
September 30, 1998.
Seasonality and Inflation
Based upon the operating history of the Company's facilities, management
believes that extended stay lodging facilities are not as seasonal in nature as
the overall lodging industry. Management does expect, however, that occupancy
and revenues may be lower than average during the first and fourth quarters of
each calendar year. Because many of the Company's expenses do not fluctuate
with occupancy, such declines in occupancy may cause fluctuations or decreases
in the Company's quarterly earnings.
13
The rate of inflation as measured by changes in the average consumer price
index has not had a material effect on the revenue or operating results of the
Company during any of the periods presented. There can be no assurance,
however, that inflation will not affect future operating or construction costs.
Special Note on Forward-Looking Statements
Certain statements in this Form 10-Q constitute "forward-looking
statements." Such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual results, performance,
or achievements of the Company to be materially different from any future
results, performance, or achievements expressed or implied by such forward-
looking statements. Such factors include, among other things, the Company's
limited operating history and uncertainty as to the Company's future
profitability; the ability to meet construction and development schedules and
budgets; the ability to develop and implement operational and financial systems
to manage rapidly growing operations; the uncertainty as to the consumer demand
for extended stay lodging; increasing competition in the extended stay lodging
market; the ability to integrate and successfully operate acquired properties
and the risks associated with such properties; the ability to obtain financing
on acceptable terms to finance the Company's growth strategy; the ability of the
Company to operate within the limitations imposed by financing arrangements; and
general economic conditions as they may impact the overall lodging industry.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of their dates. The Company undertakes no
obligations to publicly update or revise any forward-looking statements, whether
as a result of new information, future events, or otherwise.
14
PART II
OTHER INFORMATION
Item 5. Other Information
On August 13, 1998, the Company exchanged all $200 million aggregate
principal amount of its outstanding 9.15% Senior Subordinated Notes due 2008
(the "Old Notes") for an equal principal amount of newly-issued 9.15% Senior
Subordinated Notes due 2008 (the "New Notes"). The form and terms of the New
Notes are the same in all material respects as the form and terms of the Old
Notes except that the New Notes were registered under the Securities Act of
1933, as amended, and do not bear legends restricting the transfer thereof. The
New Notes evidence the same indebtedness as the Old Notes (which they replace)
and are entitled to the benefits of the Indenture, dated as of March 10, 1998,
between the Company and Manufacturers and Traders Trust Company, as Trustee.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description of Exhibit
------ ----------------------
10.1 Amendment, dated as of September 18, 1998, to Credit Agreement,
dated as of September 26, 1997 and Amended and Restated as of March
10, 1998, by and among the Company and Morgan Stanley Senior
Funding, Inc. as Syndication Agent and Arranger, The Industrial Bank
of Japan, Limited, as Administrative Agent, and various banks
10.2 Pro Player Stadium Executive Suite License Agreement, dated as of
July 16, 1998, by and between South Florida Stadium Corporation
d/b/a Pro Player Stadium and the Company
10.3 Broward County Arena Executive Suite License Agreement, by and
between Arena Operating Company, Ltd. and the Company
27.1 Financial Data Schedule (for EDGAR filings only)
(b) Reports on Form 8-K
None
15
SIGNATURES
Pursuant to the requirements 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, on November 10, 1998.
EXTENDED STAY AMERICA, INC.
/s/ Robert A. Brannon
------------------------------------------------------
Robert A. Brannon
Senior Vice President, Chief Financial Officer,
Secretary, and Treasurer
(Principal Financial Officer)
/s/ Gregory R. Moxley
------------------------------------------------------
Gregory R. Moxley
Vice President Finance
(Principal Accounting Officer)
16