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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 MARCH 31, 2002
------------------------
INTERSTATE HOTELS CORPORATION
FOSTER PLAZA TEN
680 ANDERSEN DRIVE
PITTSBURGH, PENNSYLVANIA 15220
(412) 937-0600
<Table>
MARYLAND 0-26805 75-2767215
(State of Incorporation) (Commission File No.) (I.R.S. Employer
Identification Number)
</Table>
The Company (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and
(2) has been subject to such filing requirements for the past 90 days.
The total number of shares of the Company's Common Stock, par value $0.01
per share, outstanding at May 10, 2002 was as follows: Class A shares 5,487,885
and Class B shares 242,555.
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INDEX
INTERSTATE HOTELS CORPORATION
<Table>
<Caption>
PAGE NO.
--------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)............................ 2
Condensed Consolidated Balance Sheets - December 31, 2001
and March 31, 2002.......................................... 2
Condensed Consolidated Statements of Operations - Three
Months Ended March 31, 2001 and March 31, 2002.............. 3
Condensed Consolidated Statements of Cash Flows - Three
Months Ended March 31, 2001 and March 31, 2002.............. 4
Notes to Consolidated Financial Statements.................. 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 13
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................... 14
Item 6. Exhibits and Reports on Form 8-K............................ 14
</Table>
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED).
INTERSTATE HOTELS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
DECEMBER 31, MARCH 31,
2001 2002
------------ -----------
(A) (UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 39,040 $ 35,325
Accounts receivable, net of allowance for doubtful
accounts of $227 in 2001 and
$169 in 2002............................................ 9,080 11,836
Deferred income taxes..................................... 2,204 1,787
Prepaid expenses and other assets......................... 1,941 1,773
-------- --------
Total current assets.................................. 52,265 50,721
Restricted cash............................................. 1,348 1,082
Marketable securities....................................... 2,548 2,842
Property and equipment, net................................. 14,390 14,103
Officers and employees notes receivable..................... 2,028 2,143
Affiliates notes receivable, net of reserve for
uncollectible notes receivable of $666.................... 1,718 2,074
Equity investments in hotel real estate..................... 11,220 10,944
Deferred income taxes....................................... 5,479 6,396
Intangible and other assets................................. 17,673 15,717
-------- --------
Total assets.......................................... $108,669 $106,022
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable -- trade................................. 1,038 285
Accounts payable -- health trust.......................... 4,424 4,823
Accrued payroll and related benefits...................... 5,092 2,072
Other accrued liabilities................................. 7,048 8,296
Current portion of long-term debt......................... 1,601 7,353
-------- --------
Total current liabilities............................. 19,203 22,829
Deferred compensation....................................... 2,548 2,842
Long-term debt.............................................. 39,380 32,852
-------- --------
Total liabilities..................................... 61,131 58,523
Minority interest........................................... 433 433
Mandatorily redeemable preferred stock...................... 5,070 5,272
Commitments and contingencies............................... -- --
Stockholders' equity:
Preferred stock, $.01 par value; 10,000,000 shares
authorized; 725,000 shares issued and outstanding and
classified as mandatorily redeemable preferred stock at
December 31, 2001 and March 31, 2002.................... -- --
Common stock, $.01 par value; 64,939,361 shares
authorized; 5,730,440 shares issued and outstanding at
December 31, 2001 and March 31, 2002.................... 57 57
Common stock options/warrants............................. -- 48
Paid-in capital........................................... 64,955 64,955
Retained deficit.......................................... (22,977) (23,266)
-------- --------
Total stockholders' equity............................ 42,035 41,794
-------- --------
Total liabilities and stockholders' equity............ $108,669 $106,022
======== ========
</Table>
- ---------------
(A) The year-end balance sheet information was derived from audited financial
statements, but does not include all disclosures required by generally
accepted accounting principles.
The accompanying notes are an integral part of the consolidated financial
statements.
2
INTERSTATE HOTELS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
------------------------
2001 2002
---------- ----------
Lodging revenues............................................ $ 1,101 $ 676
Net management fees......................................... 6,476 5,658
Other fees.................................................. 3,508 4,013
---------- ----------
11,085 10,347
Other revenues from managed hotels (Note 2)................. 69,405 62,441
---------- ----------
80,490 72,788
---------- ----------
Lodging expenses............................................ 779 481
General and administrative.................................. 2,837 1,943
Payroll and related benefits................................ 5,357 4,243
Tender Offer costs (Note 6)................................. -- 119
Depreciation and amortization............................... 2,706 2,528
---------- ----------
11,679 9,314
Other expenses from managed hotels (Note 2)................. 69,405 62,441
---------- ----------
81,084 71,755
---------- ----------
Operating (loss) income..................................... (594) 1,033
Other (expense) income:
Interest, net............................................. (67) (975)
Earnings (losses) from equity investments in hotel real
estate................................................. 177 (180)
---------- ----------
Loss before income tax benefit.............................. (484) (122)
Income tax benefit.......................................... (208) (71)
---------- ----------
Loss before minority interest............................... (276) (51)
Minority interest........................................... 36 64
---------- ----------
Net loss.................................................... (312) (115)
Mandatorily redeemable preferred stock:
Dividends................................................. 159 159
Accretion................................................. 15 15
---------- ----------
Net loss available to common stockholders................... $ (486) $ (289)
========== ==========
Earnings per common share and common share equivalent:
Basic..................................................... $ (.07) $ (.05)
========== ==========
Diluted................................................... $ (.07) $ (.05)
========== ==========
Weighted average number of common share and common share
equivalents outstanding:
Basic..................................................... 6,481,182 5,730,440
========== ==========
Diluted................................................... 6,481,182 5,730,440
========== ==========
</Table>
The accompanying notes are an integral part of the consolidated financial
statements.
3
INTERSTATE HOTELS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
----------------------------
2001 2002
------------ ------------
Cash flows from operating activities:
Net loss.................................................. $ (312) $ (115)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 2,706 2,528
(Earnings) losses from equity investments in hotel real
estate................................................ (177) 180
Minority interest...................................... 36 64
Deferred income taxes.................................. (701) (500)
Amortization of mandatorily redeemable preferred
stock................................................. 188 188
Other.................................................. 145 381
Cash (used in) provided by assets and liabilities:
Accounts receivable, net............................... (34) (3,038)
Prepaid expenses and other assets...................... 79 142
Accounts payable....................................... (7,416) (3,374)
Accrued liabilities.................................... (7,243) 1,479
-------- -------
Net cash used in operating activities................ (12,729) (2,065)
-------- -------
Cash flows from investing activities:
Change in restricted cash................................. 525 266
Purchases of property and equipment, net.................. (308) (4)
Purchases of marketable securities........................ (220) (1,110)
Proceeds from sale of marketable securities............... 368 755
Net cash (invested for) received from equity investments
in hotel and real estate............................... (8,314) 96
Change in officers and employees notes receivable, net.... 528 (115)
Net investment in management agreements................... (141) --
Change in affiliates notes receivable, net................ (283) (74)
Merger-related acquisition costs.......................... -- (422)
Deposits and other........................................ (119) (63)
-------- -------
Net cash used in investing activities................ (7,964) (671)
-------- -------
Cash flows from financing activities:
Proceeds from long-term debt.............................. 4,169 --
Repayment of long-term debt............................... (24) (776)
Financing fees paid....................................... (105) (42)
Proceeds from issuance of common stock.................... 215 --
Dividends paid on mandatorily redeemable preferred
stock.................................................. (159) (159)
Other..................................................... (1) (2)
-------- -------
Net cash provided by (used in) financing
activities.......................................... 4,095 (979)
-------- -------
Net decrease in cash and cash equivalents................... (16,598) (3,715)
Cash and cash equivalents at beginning of period............ 51,327 39,040
-------- -------
Cash and cash equivalents at end of period.................. $ 34,729 $35,325
======== =======
</Table>
The accompanying notes are an integral part of the consolidated financial
statements.
4
INTERSTATE HOTELS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION AND BASIS OF PRESENTATION:
Interstate Hotels Corporation and its subsidiaries (the "Company") is one
of the largest independent hotel management companies in the United States based
on number of properties, number of rooms and total revenues produced for owners.
At March 31, 2002, the Company managed or performed related services, including
insurance and risk management services, purchasing and project management
services and centralized accounting services, for 135 hotels with a total of
28,480 rooms in 36 states in the United States, the District of Columbia, as
well as Canada and Russia. The Company wholly owns one of these properties, the
156-suite Pittsburgh Airport Residence Inn by Marriott (the "Owned Hotel"),
which it acquired in 1999, and has non-controlling equity interests in 12 of
these hotels.
The Company, together with its subsidiaries and predecessors, was formed on
June 18, 1999, pursuant to a series of events culminating in the spin-off of the
Company's operations from Wyndham International, Inc. ("Wyndham") (the
"Spin-off").
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. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to such
rules and regulations. These consolidated interim financial statements should be
read in conjunction with the consolidated financial statements, notes thereto
and other information included in the Company's Annual Report on Form 10-K/A for
the year ended December 31, 2001.
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.
2. CHANGE IN ACCOUNTING:
Effective January 1, 2002, the Company adopted the provisions of Emerging
Issues Task Force ("EITF") Issue No. 01-14 "Income Statement Characterization of
Reimbursements Received for Out-of-Pocket Expenses Incurred." This issue
establishes standards for accounting for reimbursements received for
out-of-pocket expenses incurred and the characterization as revenue and expense
in the statement of operations. In accordance with EITF Issue No. 01-14, the
Company has included in operating revenues and expenses the reimbursement of
costs incurred on behalf of the third-party owners of the Company's managed
hotels. These costs relate primarily to payroll and benefit costs at managed
hotels where the Company is the employer. These reimbursements are received
based upon the costs incurred by the Company with no added margin. Therefore,
the adoption of EITF Issue No. 01-14 did not impact operating income, earnings
per share, cash flows or the financial position of the Company.
The effect of adopting EITF Issue No. 01-14, which was retroactively
applied for all periods presented, was an increase in operating revenues and
expenses of $69,405 and $62,441 for the three-month periods ended March 31, 2001
and 2002, respectively.
3. EARNINGS PER SHARE:
Basic earnings per common share was calculated by dividing net loss
available to common stockholders by the weighted average number of shares of
common stock outstanding. Diluted earnings per common share assumes the issuance
of common stock for all potentially dilutive equivalents outstanding. The effect
of the
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
3. EARNINGS PER SHARE--CONTINUED:
conversion of the Company's Subordinated Convertible Notes and the Series B
Convertible Preferred Stock into Class A Common Stock and the Class A shares
issuable upon the exercise of outstanding stock options are considered to be
anti-dilutive. The details of basic and diluted earnings per common share for
the three-month periods ended March 31, 2001 and 2002 were as follows:
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
------------------------
2001 2002
---------- ----------
Net loss available to common stockholders................... $ (486) $ (289)
---------- ----------
Weighted average number of common shares outstanding........ 6,481,182 5,730,440
---------- ----------
Basic earnings per common share............................. $ (.07) $ (.05)
---------- ----------
Shares issuable upon exercise of dilutive outstanding stock
options................................................... -- --
---------- ----------
Weighted average number of diluted common shares
outstanding............................................... 6,481,182 5,730,440
---------- ----------
Diluted earnings per common share........................... $ (.07) $ (.05)
========== ==========
</Table>
4. COMMITMENTS AND CONTINGENCIES:
The Company has committed to invest $25,000 into a joint venture with
entities affiliated with Lehman Brothers Holdings Inc. Such amount is expected
to be invested incrementally, concurrently with the closings of hotel property
acquisitions by the joint venture (see Note 6).
5. SEGMENT INFORMATION:
The Company's reportable segments are: (i) operations of luxury and upscale
hotels, and (ii) operations of mid-scale, upper economy and budget hotels. The
luxury and upscale hotels segment derives revenues from management fees,
reimbursements received for out-of-pocket expenses incurred and other services
which directly relate to providing management services, including insurance and
risk management services, purchasing and project management services, IT
support, training and relocation programs and equipment leasing. The mid-scale,
upper economy and budget hotels segment derives revenues from management fees,
reimbursements received for out-of-pocket expenses incurred and certain
specialized support services, such as centralized accounting services, as well
as the operating revenues from the Owned Hotel.
The table below presents revenue and operating income (loss) information
for each reportable segment for the three-month periods ended March 31, 2001 and
2002.
<Table>
<Caption>
THREE MONTHS ENDED
MARCH 31,
------------------
2001 2002
------- -------
REVENUES(1):
Luxury and Upscale Hotels................................... $62,756 $55,482
Mid-Scale, Upper Economy and Budget Hotels.................. 17,734 17,306
------- -------
Consolidated totals....................................... $80,490 $72,788
======= =======
OPERATING INCOME (LOSS):
Luxury and Upscale Hotels................................... $ (729) $ 852
Mid-Scale, Upper Economy and Budget Hotels.................. 135 181
------- -------
Consolidated totals....................................... $ (594) $ 1,033
======= =======
</Table>
- ---------------
(1) Includes other revenues from managed hotels in accordance with EITF Issue
No. 01-14, which was retroactively applied for all periods presented.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
5. SEGMENT INFORMATION--CONTINUED:
Depreciation and amortization included in segment operating income (loss)
information for the three-month periods ended March 31, 2001 and 2002 were as
follows:
<Table>
<Caption>
THREE MONTHS
ENDED
MARCH 31,
---------------
2001 2002
------ ------
Luxury and Upscale Hotels................................... $2,211 $2,015
Mid-Scale, Upper Economy and Budget Hotels.................. 495 513
------ ------
Consolidated totals....................................... $2,706 $2,528
====== ======
</Table>
The net book value of intangible and other assets and equity investments in
hotel real estate by segment consisted of the following as of December 31, 2001
and March 31, 2002:
<Table>
<Caption>
DECEMBER 31, MARCH 31,
2001 2002
------------ ---------
Luxury and Upscale Hotels................................... $14,383 $12,388
Mid-Scale, Upper Economy and Budget Hotels.................. 14,510 14,273
------- -------
Consolidated totals....................................... $28,893 $26,661
======= =======
</Table>
The following table reconciles the Company's measure of operating income
(loss) to consolidated net loss for the three-month periods ended March 31, 2001
and 2002.
<Table>
<Caption>
THREE MONTHS
ENDED
MARCH 31,
-------------
2001 2002
----- -----
Total after-tax operating income (loss)..................... $(357) $ 640
Unallocated amounts, net of tax:
Interest, net............................................. (40) (604)
Earnings (losses) from equity investments in hotel real
estate................................................. 106 (112)
Minority interest......................................... (21) (39)
----- -----
Consolidated net loss....................................... $(312) $(115)
===== =====
</Table>
6. SUBSEQUENT EVENTS:
Tender Offer:
On April 11, 2002, Shaner Hotel Group Limited Partnership ("Shaner")
commenced an unsolicited partial tender offer to purchase 2,465,322 shares of
the Company's Class A Common Stock for $3.00 per share (as subsequently amended,
the "Tender Offer"). The Tender Offer is scheduled to expire on May 31, 2002
unless otherwise extended by Shaner. The Tender Offer is subject to various
conditions including the redemption of the Company's preferred stock purchase
rights, pursuant to the Company's Shareholder Rights Agreement, or Shaner being
satisfied that those rights do not apply to the Tender Offer.
On April 24, 2002, the Company's full board of directors and a Special
Committee of its independent directors concluded that the Tender Offer was
financially inadequate and was not in the best interests of the Company's
stockholders. Therefore, they unanimously recommended that the Company's
stockholders reject the Tender Offer and not tender their shares pursuant to the
Tender Offer.
In the first quarter of 2002 and prior to the commencement of the Tender
Offer, the Company received unsolicited proposals from Shaner to combine the
operations of the Company with Shaner, which proposals
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
6. SUBSEQUENT EVENTS--CONTINUED:
also provided for the purchase of a portion of shares of the Company's common
stock by Shaner. The board of directors unanimously voted to reject the
proposals.
The Company incurred approximately $119 of costs related to the Tender
Offer and the unsolicited proposals for the three months ended March 31, 2002.
These costs were incurred for legal and other professional fees and are recorded
in the accompanying consolidated statement of operations for the three months
ended March 31, 2002.
Merger with MeriStar Hotels & Resorts, Inc.:
On May 1, 2002, the Company entered into an Agreement and Plan of Merger
(the "Merger Agreement") with MeriStar Hotels & Resorts, Inc. ("MeriStar")
pursuant to which the Company would be merged with and into MeriStar, with
MeriStar being the surviving company (the "Merger"). The combined company will
be named Interstate Hotels Corporation. Pursuant to the Merger Agreement, each
share of the Company's common stock will be converted into 4.6 shares of
MeriStar common stock. The completion of the Merger is subject to various
conditions including the approval of the stockholders of the Company and
MeriStar and United States antitrust clearance. The special stockholders
meetings and the closing are expected to occur in the third quarter of 2002. The
Company may receive from or be required to pay to MeriStar a termination fee of
$2,000 plus up to $500 in expenses if the Merger Agreement is terminated under
certain circumstances.
In connection with the execution of the Merger Agreement, CGLH Partners I
LP and CGLH Partners II LP (collectively, the "Investor") has agreed to convert
its Subordinated Convertible Notes and Series B Convertible Preferred Stock into
Class A Common Stock, subject to the restrictions on conversion set forth in the
terms of those securities and the agreements to convert those securities. The
Investor will receive a payment of $9,250 from the Company as an inducement to
such conversion. Members of senior management have also agreed to convert their
Series B Convertible Preferred Stock into Class A Common Stock in connection
with the Merger, and each of those members of senior management and the Investor
has committed to vote in favor of the Merger. Stockholders of MeriStar that
represent approximately 22% of MeriStar's common stock have also agreed to vote
their shares in favor of the Merger.
As an inducement for MeriStar to enter into the Merger Agreement, the
managing general partner of the Company's joint venture with entities affiliated
with Lehman Brothers Holdings Inc. has confirmed that, if the Merger is
consummated, the surviving company will not be required to invest $25,000 into
the joint venture.
Prior to entering into the Merger Agreement, an affiliate of Wyndham, the
holder of a 1.6627% non-controlling economic interest (the "Wyndham Interest")
in Interstate Hotels, LLC ("IH LLC"), the Company's principal operating
subsidiary, agreed to permit the Company to cause IH LLC, or its subsidiaries,
to provide a guaranty and pledge of assets of IH LLC, or its subsidiaries, under
the terms of a proposed credit facility for the combined company following the
Merger. In consideration for this agreement, the Company repaid a promissory
note to Wyndham on May 2, 2002 in the outstanding principal amount of $750 and
agreed to pay to Wyndham the outstanding principal amount of $3,682 under a
second promissory note prior to IH LLC, or its subsidiaries, providing such
guarantee and pledge of any of its or their assets. In addition, the Company
accelerated the timing of Wyndham's right to require the Company to redeem the
Wyndham Interest to be the earlier of (i) the date on which the Company repays
the second promissory note to Wyndham and (ii) July 1, 2004.
The merger will be accounted for as a reverse acquisition under the
provisions of Statement of Financial Accounting Standards ("SFAS") No. 141,
"Business Combinations," with the Company as acquiror. As of March 31, 2002, the
Company incurred Merger-related acquisition costs of approximately $422, which
are recorded in the accompanying consolidated balance sheet. These costs were
incurred for legal and other professional fees in connection with the proposed
Merger.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
The events of September 11, 2001 and the aftermath of the terrorist attacks
on the United States adversely affected the Company during 2001 and the
lingering economic effects continued into 2002. Since the tragic events of
September 11th, the Company's managed hotels have experienced significant
short-term declines in occupancy. At present, it is not possible to predict
either the severity or duration of such declines in the near- or long-term or
the potential impact on the Company's results of operations, financial condition
or cash flows. Weaker hotel performance would reduce management fees and could
give rise to additional losses under minority investments that were made in
connection with hotels that the Company manages, which could, in turn, have an
adverse impact on the Company's financial performance. The Company's management
is currently unable to estimate the extent of the impact that the terrorist
attacks could have on the Company's operations, liquidity or capital resources.
Lodging revenues consist of rooms, food and beverage and other departmental
revenues from the Pittsburgh Airport Residence Inn by Marriott ("the Owned
Hotel"). Lodging revenues decreased by $0.4 million, or 38.6%, from $1.1 million
in the three months ended March 31, 2001 (the "2001 Three Months") to $0.7
million in the three months ended March 31, 2002 (the "2002 Three Months"). The
average daily room rate for the Owned Hotel decreased from $85.69 during the
2001 Three Months to $69.89 during the 2002 Three Months, and the average
occupancy rate decreased to 66.2% during the 2002 Three Months from 73.4% during
the 2001 Three Months. This resulted in a decrease in room revenue per available
room of 26.5% to $46.23 during the 2002 Three Months from $62.86 during the 2001
Three Months.
Net management fees decreased by $0.8 million, or 12.6%, from $6.5 million
in the 2001 Three Months to $5.7 million in the 2002 Three Months. During the
2002 Three Months, the Company earned lower base and incentive management fee
revenue on its hotels in the luxury and upscale hotels segment. Net management
fees earned from hotels in this segment decreased by $0.7 million during the
2002 Three Months as compared to the 2001 Three Months. Lower incentive
management fee revenue was earned from hotels in this segment due to the
weakness in the U.S. economy during 2001 and continuing into 2002 and
significant declines in occupancy following the events of September 11th.
Net management fees earned from hotels in the mid-scale, upper economy and
budget hotels segment decreased slightly during the 2002 Months compared to the
2001 Three Months.
In accordance with Staff Accounting Bulletin No. 101, "Revenue Recognition
in Financial Statements," and Securities and Exchange Commission ("SEC") Topic
No. D-96, "Accounting for Management Fees Based on a Formula" (Method No. 2),
base and incentive management fees are accrued as earned based on the
profitability of the hotel, subject to the specific terms of each individual
management agreement.
Other fees increased by $0.5 million, or 14.4%, from $3.5 million in the
2001 Three Months to $4.0 million the 2002 Three Months. This increase was due
to an increase of $0.4 million in income earned on national purchasing contracts
during the 2002 Three Months compared to the 2001 Three Months.
Lodging expenses consist of rooms, food and beverage, property costs and
other departmental expenses from the Owned Hotel. Lodging expenses decreased by
$0.3 million, or 38.3%, from $0.8 million in the 2001 Three Months to $0.5
million in the 2002 Three Months. This decrease resulted primarily from a
reduction in hotel staff personnel in accordance with the Company's cost
containment initiatives.
Effective January 1, 2002, the Company adopted the provisions of Emerging
Issues Task Force ("EITF") Issue No. 01-14 "Income Statement Characterization of
Reimbursements Received for Out-of-Pocket Expenses Incurred." This issue
establishes standards for accounting for reimbursements received for
out-of-pocket expenses incurred and the characterization as revenue and expense
in the statement of operations. In accordance with EITF Issue No. 01-14, the
Company has included in operating revenues and expenses the reimbursement of
costs incurred on behalf of the third-party owners of the Company's managed
hotels. These costs relate primarily to payroll and benefit costs at managed
hotels where the Company is the employer. These reimbursements are received
based upon the costs incurred by the Company with no added
9
margin. Therefore, the adoption of EITF Issue No. 01-14 did not impact operating
income, earnings per share, cash flows or the financial position of the Company.
Other revenues and expenses from managed hotels decreased by $7.0 million,
or 10.0%, from $69.4 million in the 2001 Three Months to $62.4 million in the
2002 Three Months. This decrease relates primarily to a decrease in payroll and
related benefit costs at managed hotels, which resulted from the Company's
overall cost containment initiatives implemented at its managed hotels.
General and administrative expenses are associated with the management of
hotels and consist primarily of centralized management expenses such as
operations management, sales and marketing, finance and other hotel support
services, as well as general corporate expenses. General and administrative
expenses decreased by $0.9 million, or 31.5%, from $2.8 million in the 2001
Three Months to $1.9 million in the 2002 Three Months. Overall as a result of
cost containment initiatives, the Company incurred lower general and
administrative expenses relating to business travel and relocation.
Specifically, during the 2002 Three Months the Company positively adjusted the
accrual for deficiencies between the amount of premiums received as compared to
actual and estimated claims incurred under the Company's self-insured health and
welfare plan in the amount of $0.3 million. In addition, the Company's incurred
insurance losses decreased by $0.3 million during the 2002 Three Months compared
to the 2001 Three Months. General and administrative expenses as a percentage of
revenues decreased to 2.7% during the 2002 Three Months compared to 3.5% during
the 2001 Three Months.
Payroll and related benefits decreased by $1.2 million, or 20.8%, from $5.4
million in the 2001 Three Months to $4.2 million in the 2002 Three Months.
Overall, corporate salaries and wages decreased due to temporary pay reductions
and the elimination of salaries and benefits of approximately 20 employees who
were terminated following the events of September 11th, as well as a wage freeze
until the fourth quarter of 2002. Specifically, during the 2002 Three Months the
Company revised its estimate for compensation accruals related to future
termination benefits reducing expense by $0.6 million. Payroll and related
benefits as a percentage of revenues decreased to 5.8% during the 2002 Three
Months compared to 6.7% during the 2001 Three Months.
Tender Offer costs represents costs related to the commencement of a
partial tender offer to purchase 2,465,322 shares of the Company's Class A
Common Stock by Shaner Hotel Group Limited Partnership ("Shaner") and Shaner's
unsolicited proposals to combine the operations of the Company with Shaner
during the 2002 Three Months. These costs were incurred for legal and other
professional fees. The Company expects to incur additional costs of at least
$0.7 million related to the Tender Offer in the second quarter of 2002.
Depreciation and amortization decreased by $0.2 million, or 6.6%, from $2.7
million in the 2001 Three Months to $2.5 million in the 2002 Three Months.
Depreciation and amortization during the 2002 Three Months includes $2.1 million
of amortization related to long-term intangible assets that existed at the date
of the Spin-off from Wyndham International, Inc. ("Wyndham") in 1999. These
costs will be fully amortized in the second quarter of 2003.
As a result of the changes noted above, operating income of $1.0 million
was earned in the 2002 Three Months compared to an operating loss of $0.6
million in the 2001 Three Months.
Net interest expense increased from $0.1 million in the 2001 Three Months
to $1.0 million in the 2002 Three Months. During the 2002 Three Months, the
Company's investment earnings on its cash balances decreased by approximately
$0.4 million due to lower interest rates and the Company incurred incremental
interest expense of approximately $0.3 million related to its long-term debt and
amortization of financing fees.
Earnings from equity investments in hotel real estate were $0.2 million in
the 2001 Three Months compared to losses from equity investments in hotel real
estate of $0.2 million in the 2002 Three Months. These earnings (losses)
consisted of the Company's proportionate share of the losses incurred by four
non-controlling equity investments in 12 hotels. These losses were incurred by
the hotels due to the weakness in the U.S. economy during 2001 and continuing
into 2002, and significant declines in occupancy following the events of
September 11th. Future adverse changes in the hospitality and lodging industry
market conditions or
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poor operating results of the underlying investments could result in future
losses or an inability to recover the carrying value of these investments.
Income tax benefit for the 2001 Three Months was computed based on an
effective tax rate of 40% after reduction of minority interest. Income tax
benefit for the 2002 Three Months was computed based on an effective tax rate of
38% after reduction of minority interest.
Minority interest reflects Wyndham's 1.6627% non-controlling economic
interest in Interstate Hotels, LLC ("IH LLC"), the Company's principal operating
subsidiary.
As a result of the changes noted above, a net loss of $0.1 million was
incurred in the 2002 Three Months compared to a net loss of $0.3 million in the
2001 Three Months.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Other than the adoption of EITF Issue No. 01-14 and other estimate changes
noted above, there have been no material changes in the Company's critical
accounting policies and estimates during the three months ended March 31, 2002.
A complete description of the Company's critical accounting policies and
estimates is included in Part II, Item 7, "Management's Discussion and Analysis
of Financial Condition and Results of Operations," in the Company's Annual
Report on Form 10K/A for the year ended December 31, 2001.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalent assets were $35.3 million at March
31, 2002 compared to $39.0 million at December 31, 2001, and current assets
exceeded current liabilities by $27.9 million at March 31, 2002 compared to
$33.1 million at December 31, 2001. This decrease in working capital of $5.2
million resulted from the re-classification of the $6.6 million mortgage note to
current portion of long-term debt, as discussed below. The Company has committed
to invest $25.0 million of its cash and cash equivalents into a joint venture
with entities affiliated with Lehman Brothers Holdings Inc. (the "Joint
Venture").
Net cash used in operating activities was $2.1 million during the 2002
Three Months compared to net cash used in operating activities of $12.7 million
during the 2001 Three Months. The increase of $10.6 million during the 2002
Three Months resulted primarily from an increase in operating income (adjusted
for non-cash items) of $0.8 million and an increase of $9.8 million in cash used
in changes in assets and liabilities, primarily as a result of the payment of
accrued rent and other current liabilities in the 2001 Three Months associated
with 75 hotels that were previously leased from Equity Inns, Inc. and terminated
on January 1, 2001.
If the Company's managed hotels continue to experience declines in
occupancy and weaker hotel operating performance in the future, the Company's
management fee revenues could decrease and additional losses from the Company's
minority investments may arise, which could negatively impact the Company's cash
flows from operations and net income.
Net cash used in investing activities was $0.7 million during the 2002
Three Months compared to net cash used in investing activities of $8.0 million
during the 2001 Three Months. During the 2002 Three Months, the Company incurred
merger-related acquisition costs of approximately $0.4 million. On May 1, 2002,
the Company entered into an Agreement and Plan of Merger (the "Merger
Agreement") with MeriStar Hotels & Resorts, Inc. ("MeriStar") pursuant to which
the Company would be merged with and into MeriStar, with MeriStar being the
surviving company (the "Merger"). During the 2001 Three Months, the Company
invested $8.7 million for a 50% non-controlling equity interest in eight hotels.
The Company's capital expenditure budget for the year ending December 31,
2002 is approximately $0.5 million consisting primarily of expenditures for
computer and systems-related equipment. In addition, the Company has committed
to invest $25.0 million into the Joint Venture. The Company is required to
maintain, and does maintain, sufficient liquidity for this investment, which may
be accomplished through lines of credit or other means. Such amount is expected
to be invested incrementally, concurrently with the closings of hotel property
acquisitions by the Joint Venture. As of May 10, 2002, no funds have been
invested.
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On February 21, 2002, the ownership and financing for the Renaissance
Worldgate Hotel in Kissimmee, Florida were restructured in order to address
financial difficulties of the hotel. As part of this restructuring, the
Company's 20% non-controlling equity interest was redeemed in exchange for
mutual releases with respect to the obligations of the hotel, and the Company
received a $0.9 million cash payment towards the accounts receivable owed to the
Company by the hotel. The hotel owner also issued a promissory note to the
Company in the amount of approximately $0.3 million for the remaining accounts
receivable, which note bears interest at the rate of nine percent per annum and
is payable in equal quarterly installments beginning January 1, 2003 and ending
December 31, 2003. In addition, the hotel owner and the Company amended the
management agreement for the hotel, pursuant to which, among other things, the
Company waived its management fees for the period from July 1, 2001 through
February 21, 2002 and agreed to reduce its base management fee for periods
following February 21, 2002. The majority owners and the principal lender for
the hotel have representation on the Company's board of directors and are
affiliated with the Investor.
The Company's management currently believes that the remaining accounts and
note receivable will be collected, however, there can be no assurance that the
amounts will be collected or, if so, the timing or terms thereof. The Company's
management will continue to evaluate the collectibility of the accounts
receivable on a quarterly basis.
Net cash used in financing activities was $1.0 million during the 2002
Three Months compared to net cash provided by financing activities of $4.1
million during the 2001 Three Months. In February 2002, the Company made a $0.8
million payment on its limited-recourse mortgage note that is collateralized by
the Owned Hotel in connection with an extension of the term of the mortgage note
until February 2003. Therefore, the entire principal balance of the mortgage
note of $6.6 million is included in current portion of long-term debt as of
March 31, 2002. Management of the Company is currently assessing plans for
refinancing this mortgage note. During the 2001 Three Months, the Company
entered into a $4.2 million promissory note to fund the acquisition of a 50%
non-controlling equity interest in eight hotels.
The Company is required to distribute 1.6627% of cash flows from the
operations of IH LLC to Wyndham based on Wyndham's common interest in IH LLC.
The net distribution payable to Wyndham through March 31, 2002 approximated
$88,000.
During the third quarter of 2001, the Company entered into a $40.0 million
senior secured credit facility co-arranged by Lehman Brothers Holdings Inc.,
d/b/a Lehman Capital, and Credit Lyonnais New York Branch. The credit facility,
which may be used to obtain management agreements for hotel properties and to
finance the acquisition of hotel properties, has a two-year term, carries
varying rates of interest and contains restrictive covenants. Transaction costs
of approximately $1.5 million were incurred in connection with the credit
facility during 2001. These costs were deferred and are being amortized over a
two-year period. In addition, a nonrefundable commitment fee ranging from 0.375%
to 0.5% of the unused portion of the credit facility is payable quarterly.
During the 2002 Three Months, the Company incurred $50,000 of interest expense
related to the commitment fee. As of May 10, 2002, there were no borrowings
against the credit facility and the Company was in compliance with all of the
restrictive covenants.
A complete description of the Company's contractual obligations is included
in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition
and Results of Operations," in the Company's Annual Report on Form 10K/A for the
year ended December 31, 2001. In addition and in connection with the proposed
Merger, the Company may receive from or be required to pay to MeriStar a
termination fee of $2.0 million plus up to $0.5 million in expenses if the
Merger Agreement is terminated under certain circumstances.
In connection with the execution of the Merger Agreement, CGLH Partners I
LP and CGLH Partners II LP (collectively, the "Investor") has agreed to convert
its Subordinated Convertible Notes and Series B Convertible Preferred Stock into
Class A Common Stock, subject to the restrictions on conversion set forth in the
terms of those securities and the agreements to convert those securities. The
Investor will receive a payment of $9.25 million from the Company as an
inducement to such conversion. As an inducement for MeriStar to enter into the
Merger Agreement, the managing general partner of the Joint Venture confirmed
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that, if the Merger is consummated, the surviving company will not be required
to invest $25.0 million into the Joint Venture.
Prior to entering into the Merger Agreement, an affiliate of Wyndham, the
holder of a 1.6627% non-controlling economic interest (the "Wyndham Interest")
in IH LLC, agreed to permit the Company to cause IH LLC, or its subsidiaries, to
provide a guaranty and pledge of assets of IH LLC, or its subsidiaries, under
the terms of a proposed credit facility for the combined company following the
Merger. In consideration for this agreement, the Company repaid a promissory
note to Wyndham on May 2, 2002 in the outstanding principal amount of $0.7
million and agreed to pay to Wyndham the outstanding principal amount of $3.7
million under a second promissory note prior to IH LLC, or its subsidiaries,
providing such guarantee and pledge of any of its or their assets. In addition,
the Company accelerated the timing of Wyndham's right to require the Company to
redeem the Wyndham Interest to be the earlier of (i) the date on which the
Company repays the second promissory note to Wyndham and (ii) July 1, 2004.
The proposed Merger discussed above, or any other change in control
transaction, may give rise to termination rights on the part of the lenders of
the Company's $40.0 million credit facility and $6.6 million mortgage note. As
such, any outstanding amounts under these facilities would become due and
payable immediately. As of May 10, 2002, there were no borrowings against the
credit facility.
The Company intends to pursue future opportunities to manage hotels on
behalf of third-party owners, including through the Joint Venture, as well as
pursue other business opportunities, such as selective hotel investments and the
execution of the Merger Agreement. Such opportunities may require capital
investments by the Company. The Company believes that the cash on hand, together
with the credit facility and future cash flows from operations, will be
sufficient to pursue its business strategy and to fund its presently foreseeable
capital requirements.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Report contains forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 and information based on the beliefs of the Company's management, as well
as assumptions made by and information currently available to the Company's
management. When used herein, words or phrases such as "will likely result,"
"are expected to," "will continue," "anticipates," "believes," "estimates,"
"expects," "intends" or 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 risks and uncertainties that could
cause the Company's business and results of operations to differ materially from
those reflected in the Company's forward-looking statements.
Forward-looking statements are not guarantees of future performance. The
Company's forward-looking statements are based on trends that the Company's
management anticipates in the lodging industry and the effect on those trends by
such factors as industry capacity, the seasonal nature of the lodging industry,
the impact of the events of September 11, 2001, changes in local or national
economic conditions and product demand and pricing.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The quantitative and qualitative disclosures required by this item and by
Rule 305 of SEC Regulation S-K are not material to the Company at this time. The
Company does not have any foreign currency or commodities contracts. Interest
rates governing the majority of the Company's debt are fixed and therefore not
subject to market risk.
The Company's current investment policy is to invest in highly liquid
investments with a maturity of 90 days or less. Such financial instruments
consist of cash and cash equivalents, individual municipal bonds and corporate
government bonds. The Company believes it minimizes its risk through proper
diversification along with the requirements that the securities must be of
investment grade with an average rating of "A" or better by Standard and Poor's.
The Company believes that earnings and cash flows are not materially affected by
changes in interest rates, due to the nature and short-term investment horizon
for which these securities are invested.
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On January 26, 2001, Columbus Hotels Properties, LLC ("Columbus") sought
termination of eight hotel management agreements and a master agreement between
it and a subsidiary of the Company on the basis of gross negligence and failure
to achieve the performance standards set forth in the management agreements. In
response to this attempt to terminate the agreements, the Company filed a demand
for arbitration with the American Arbitration Association. Following the
Company's demand for arbitration, Columbus and Corporate Capital, LLC commenced
an action against Interstate Hotels Company, Crossroads Hospitality Company
(sic) and Crossroads Hospitality Management Company, which are subsidiaries of
the Company, on March 22, 2001 in the Civil District Court for the Parish of
Orleans in the State of Louisiana. The action alleges, among other things,
fraudulent misrepresentations inducing the plaintiffs to enter into a master
agreement and certain hotel management agreements and to purchase the Company's
common stock. In addition, the action alleges gross negligence in defendants'
performance under those agreements and breach of the agreements and fiduciary
duties to the plaintiffs. The action seeks, among other things, compensatory and
consequential damages in such amounts as may be determined by a jury,
termination of the agreements and a rescission of certain transactions between
the parties. After several procedural rulings against Columbus by the federal
court to which the Company removed the case, Columbus has agreed to arbitrate
all claims outstanding among the parties and place the lawsuit on the inactive
docket.
On September 30, 1999, Chisholm Properties South Beach, Inc. ("Chisholm")
terminated the management agreement between it and Crossroads Hospitality
Company, L.L.C., a subsidiary of the Company, relating to the Surfcomber Hampton
Inn in Miami Beach, Florida. Subsequently, Chisholm filed a demand for
arbitration with the American Arbitration Association alleging breach of
contract. Specifically, the arbitration demand alleges, among other things,
failure to adequately market the hotel, commission of accounting and management
errors and wrongful retention of a contractually agreed-upon termination fee.
Chisholm's claim seeks compensatory and consequential lost profits damages in
such amounts as may be determined by the panel of arbitrators. The parties
completed approximately six weeks of arbitration hearings in 2001 and 2002, and
closing arguments are scheduled for June 2002.
The Company's management believes that the legal proceedings to which it is
subject will not have a material effect on the Company's financial condition or
results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
10.1 Amended and Restated Employment Agreement, dated as of February
12, 2002, by and between the Company and Thomas F. Hewitt(1)
10.2 Amended and Restated Employment Agreement, dated as of March 1,
2002, by and between the Company and Henry L. Ciaffone(1)
- ---------------------
(1) Filed previously as an exhibit to the Company's Solicitation/Recommendation
Statement on Schedule 14D-9, dated April 24, 2002, and incorporated herein
by reference.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which this
Report is filed.
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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: May 15, 2002 By: /s/ J. WILLIAM RICHARDSON
------------------------------------
J. William Richardson
Vice Chairman and Chief Financial
Officer
(Principal Financial Officer)
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