UNITED STATES
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 Commission File Number
- ------------------------------ ----------------------
September 30, 2004 01-12073
EQUITY INNS, INC.
------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Tennessee 62-1550848
- ------------------------------- --------------------
(State or Other Jurisdiction of (I.R.S. Employer)
Incorporation or Organization Identification No.)
7700 Wolf River Boulevard, Germantown, TN 38138
--------------------------------------------------
(Address of Principal Executive Office) (Zip Code)
(901) 754-7774
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Not Applicable
----------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
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.
X Yes No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No .
----- -----
The number of shares of the Registrant's Common Stock, $.01 par value,
outstanding on November 4, 2004 was 50,707,972.
1 of 43
EQUITY INNS, INC.
INDEX
PAGE
PART I. Financial Information
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - September 30, 2004
and December 31, 2003 3
Condensed Consolidated Statements of Operations - For the
three and nine months ended September 30, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows - For the
nine months ended September 30, 2004 and 2003 5
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 40
Item 4. Controls and Procedures 41
PART II. Other Information
Item 1. Legal Proceedings 42
Item 6. Exhibits and Reports on Form 8-K 42
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EQUITY INNS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
September 30, December 31,
2004 2003
------------- ------------
ASSETS
Investment in hotel properties, net $741,241 $681,478
Assets held for sale - 10,242
Cash and cash equivalents 10,764 8,201
Accounts receivable, net of doubtful accounts
of $225 and $200, respectively 8,300 5,069
Notes receivable, net 4,306 4,917
Deferred expenses, net 8,983 8,291
Deposits and other assets, net 11,510 6,083
-------- --------
Total assets $785,104 $724,281
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Long-term debt $375,248 $329,774
Accounts payable and accrued expenses 31,245 22,913
Distributions payable 7,330 6,939
Interest rate swaps 566 931
Minority interests in Partnership 7,761 7,338
-------- --------
Total liabilities 422,150 367,895
-------- --------
Commitments and Contingencies
Shareholders' equity:
Preferred stock (Series B), 8.75%, $.01 par value, 10,000,000
shares authorized, 3,450,000 shares issued and outstanding 83,524 83,524
Common stock, $.01 par value, 100,000,000
shares authorized, 46,199,162 and 43,305,827
shares issued and outstanding 462 433
Additional paid-in capital 487,868 463,691
Treasury stock, at cost, 747,600 shares (5,173) (5,173)
Unearned directors' and officers' compensation (1,610) (123)
Distributions in excess of net earnings (201,551) (185,035)
Unrealized income (loss) on interest rate swaps (566) (931)
-------- --------
Total shareholders' equity 362,954 356,386
-------- --------
Total liabilities and shareholders' equity $785,104 $724,281
======== ========
The accompanying notes are an integral
part of these condensed consolidated financial statements.
3
EQUITY INNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------- --------------------------
2004 2003 2004 2003
------- ------- -------- --------
Revenue:
Room revenue $67,809 $60,191 $182,832 $168,401
Other hotel revenue 3,289 2,934 8,976 8,385
Other revenue 119 120 327 483
------- ------- -------- --------
Total revenues 71,217 63,245 192,135 177,269
------- ------- -------- --------
Operating expenses:
Direct hotel expenses 40,403 34,846 108,552 98,882
Other hotel expenses 2,392 2,175 6,733 6,230
Depreciation 10,263 9,583 29,596 28,751
Property taxes, rental expense and insurance 4,412 4,589 13,131 13,817
General and administrative expenses:
Non-cash stock-based compensation 162 128 484 393
Other general and administrative expenses 1,669 1,756 5,368 5,228
------- ------- -------- --------
Total operating expenses 59,301 53,077 163,864 153,301
------- ------- -------- --------
Operating income 11,916 10,168 28,271 23,968
Interest expense, net 7,391 7,343 21,285 22,666
------- ------- -------- --------
Income from continuing operations before
minority interests and income taxes 4,525 2,825 6,986 1,302
Minority interests expense (97) (7) (52) (9)
Deferred income tax benefit - 1,454 - 4,755
------- ------- -------- --------
Income from continuing operations 4,428 4,272 6,934 6,048
Discontinued operations:
Gain (loss) on sale of hotel properties - (53) (320) 1,222
Loss on impairment of hotels held for sale - - - (3,556)
Income (loss) from operations of
discontinued operations (20) 132 (136) 425
------- ------- -------- --------
Income (loss) from discontinued operations (20) 79 (456) (1,909)
------- ------- -------- --------
Net income 4,408 4,351 6,478 4,139
Loss on redemption of Series A preferred stock - 2,408 - 2,408
Preferred stock dividends 1,887 1,687 5,660 4,953
------- ------- -------- --------
Net income (loss) applicable to common
shareholders $ 2,521 $ 256 $ 818 $ (3,222)
======= ======= ======== ========
Net income (loss) per share data: Basic and
diluted income (loss) per share:
Continuing operations $ 0.06 $ 0.01 $ 0.03 $ (0.03)
Discontinued operations 0.00 0.00 (0.01) (0.05)
------- ------- -------- --------
Net income (loss) per common share $ 0.06 $ 0.01 $ 0.02 $ (0.08)
======= ======= ======== ========
Weighted average number of common
shares outstanding - basic and diluted 45,453 40,555 44,482 40,539
======= ======= ======== ========
The accompanying notes are an integral
part of these consolidated financial statements.
4
EQUITY INNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Nine Months Ended
September 30,
-----------------------------
2004 2003
------- -------
Cash flows from operating activities:
Net income $ 6,478 $ 4,139
Adjustments to net income provided by operating activities:
(Gain) loss on sale of hotel properties 320 (1,222)
Loss on impairment of hotels held for sale - 3,556
Depreciation 29,596 29,566
Amortization of loan costs and franchise fees 1,464 2,013
Amortization of mortgage premium (228) -
Stock-based or non-cash compensation 484 393
Deferred income tax benefit - (5,089)
Minority interests 52 9
Provision for doubtful accounts 25 -
Changes in operating assets and liabilities:
Accounts receivable (3,256) (2,212)
Distributions payable 26 -
Deposits and other assets (5,427) (2,453)
Accounts payable and accrued expenses 8,774 (799)
------- -------
Net cash provided by operating activities 38,308 27,901
------- -------
Cash flows from investing activities:
Improvements and additions to hotel properties (15,393) (10,094)
Acquisition of hotel properties (32,726) -
Payments for franchise applications (275) -
Net proceeds from sale of hotel properties 9,141 13,625
Proceeds from principal payments on notes receivable 1,411 -
------- -------
Net cash provided by (used in) investing activities (37,842) 3,531
------- -------
Cash flows from financing activities:
Gross proceeds from public offering of common stock 21,720 -
Gross proceeds from public offering of Series B preferred stock - 79,063
Payment of offering expenses (359) (2,680)
Redemption of Series A preferred stock - (68,750)
Distributions paid (23,100) (21,337)
Payments for loan costs (1,881) (2,048)
Proceeds from borrowings 69,615 43,875
Payments on long-term debt (63,898) (54,041)
------- -------
Net cash provided by (used in) financing activities 2,097 (25,918)
------- -------
Net increase in cash 2,563 5,514
Cash and cash equivalents at beginning of period 8,201 5,916
------- -------
Cash and cash equivalents at end of period $10,764 $11,430
======= =======
The accompanying notes are an integral
part of these condensed consolidated financial statements.
5
Supplemental disclosure of non-cash investing and financing activities:
For all stock issuances below, we value the stock award based on the shares of
common stock times the closing price of our common stock on the date earned.
2004
During January 2004, we issued to two of our officers, 47,535 shares of common
stock at $9.26 per share under the 1994 Stock Incentive Plan in lieu of cash as
a performance bonus.
During January 2004, we sold one hotel in Jacksonville, Florida for $5.0
million, including the assumption of a non-cash note receivable for $800,000.
During February 2004, we issued to several key officers 405,233 shares of
restricted common stock at $9.45 per share under the 1994 Stock Incentive Plan
as part of management's long-term incentive compensation.
During the nine months ended September 30, 2004, we issued 36,113 shares of
common stock upon redemption of Partnership units.
During the nine months ended September 30, 2004, we completed the purchase of
nine hotels and assumed approximately $40.0 million in secured long-term debt,
including approximately $3.7 million of a mortgage note premium. We also issued
$1.3 million in Partnership units in conjunction with these acquisitions.
During the nine months ended September 30, 2004, we issued 10,254 shares of
common stock at prices ranging from $8.73 to $9.95 per share to our independent
directors in lieu of cash as compensation.
During the quarter ended September 30, 2004, we declared approximately $6.1
million in common stock and unit dividends. We paid these dividends on November
1, 2004. During the quarter ended September 30, 2004, we had approximately $1.3
million in declared but unpaid preferred stock dividends. We paid these
dividends on October 29, 2004.
2003
During January 2003, we issued to one of our officers, 19,081 shares of common
stock at $5.88 per share under the 1994 Stock Incentive Plan in lieu of cash as
a performance bonus.
During the nine months ended September 30, 2003, we issued 51,521 shares of
common stock upon redemption of Partnership units.
During the nine months ended September 30, 2003, we issued 11,823 shares of
common stock at prices ranging from $5.82 to $7.53 per share to our independent
directors in lieu of cash as compensation.
During the quarter ended September 30, 2003, we declared approximately $5.4
million in common stock and unit dividends. We paid these dividends on November
3, 2003. During the quarter ended September 30, 2003, we had approximately $1.0
million in declared but unpaid preferred stock dividends. We paid these
dividends on October 31, 2003.
The accompanying notes are an integral
part of these condensed consolidated financial statements.
6
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
Throughout this Form 10-Q, the words "Company", "Equity Inns", "we", "our", and
"us" refer to Equity Inns, Inc., a Tennessee corporation, and its consolidated
subsidiaries, unless otherwise stated or the context requires otherwise.
1. Organization
Equity Inns is a hotel real estate investment trust ("REIT") for federal
income tax purposes. The Company, through its wholly owned subsidiary,
Equity Inns Trust (the "Trust"), is the sole general partner of Equity
Inns Partnership, L.P. (the "Partnership") and at September 30, 2004
owned an approximate 97.3% interest in the Partnership.
Our hotel properties are leased to our wholly-owned taxable REIT
subsidiaries (the "TRS Lessees"). Our hotel properties are managed by
independent third parties. At September 30, 2004, the independent
managers of our hotels are as follows:
Number of Hotels
----------------
Interstate Hotels & Resorts, Inc. 48
Hilton Hotels Corporation 17
Prime Hospitality Corporation 18
Other (3) 16
--
99
==
Our management agreements with Prime are structured to provide the TRS
Lessees minimum net operating income at each of our 18 AmeriSuites
hotels. In addition, the management agreements specify a net operating
income threshold for each of our 18 AmeriSuites hotels. As the manager,
the Prime subsidiaries can earn an incentive management fee of 25% of
hotel net operating income above the threshold, as defined, to a maximum
of 6.5% of gross hotel revenues. If the management fee calculation would
have exceeded 6.5% of gross hotel revenue, the Prime subsidiaries may
earn an additional fee of 10% on any additional net operating income. If
a hotel fails to generate net operating income sufficient to reach the
threshold, Prime's subsidiaries are required to contribute the greater of
a predetermined minimum return or the net operating income plus 25% of
the shortfall between the threshold amount and the net operating income
of the hotel. We record all shortfall contributions as a reduction of
base management fees which are included as a component of direct hotel
expenses in our accompanying condensed consolidated statements of
operations when all contingencies related to such amounts have been
resolved. In May 2003, we updated our current franchise contracts and
management agreements with Prime on all of our AmeriSuites hotels. The
minimum net operating income guarantee agreements were not extended
beyond their original terms and are set to expire in 2007 and 2008. Under
the new agreements, we extended the
7
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
1. Organization, Continued
existing franchise agreements with Prime to 2028 and the management
agreements to 2010, as long as Prime continues to be in compliance with
the minimum net operating income guarantees in the original agreements.
For the three months ended September 30, 2004 and 2003, we recorded
approximately $625,000 and $545,000, respectively, in minimum income
guarantees from Prime as a reduction of our base management fee expense
in the accompanying condensed consolidated statements of operations. For
the nine months ended September 30, 2004 and 2003, we recorded
approximately $3.2 million and $3.1 million, respectively, in minimum
income guarantees from Prime as a reduction of our base management fee
expense in the accompanying condensed consolidated statements of
operations. The management contracts for our remaining hotels have terms
ranging from one to ten years and generally provide for payment of
management fees ranging from 1.5% to 3.0% of hotel revenues and an
incentive fee consisting of a percentage of gross operating profits in
excess of budget, as defined by the management agreements.
These unaudited condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") and should be read in conjunction with our
financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2003. The
accompanying unaudited condensed consolidated financial statements
reflect, in the opinion of management, all adjustments necessary for a
fair presentation of the interim financial statements. All such
adjustments are of a normal and recurring nature. The results of our
operations for the current interim periods are not necessarily indicative
of the results to be expected for the full year.
Certain prior period amounts have been reclassified to conform to the
current year presentation.
2. Summary of Significant Accounting Policies
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers and other borrowers to make
required payments. The allowance for doubtful accounts is maintained at a
level believed adequate by us to absorb estimated probable receivable
losses. Our periodic evaluation of the adequacy of the allowance is
primarily based on past receivable loss experience, known and inherent
credit risks, current economic conditions, and other relevant factors.
This evaluation is inherently subjective as it requires estimates
including the amounts and timing of future collections. If the financial
condition of our customers or other borrowers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.
8
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
2. Summary of Significant Accounting Policies, Continued
Net Income Per Common Share
Basic earnings per common share from continuing operations are computed
by dividing income (loss) from continuing operations as adjusted for
gains or losses on the sale of hotel properties not included in
discontinued operations, for losses on redemptions of preferred stock,
and for dividends on preferred stock by the weighted average number of
shares of common stock outstanding. Diluted earnings per common share
from continuing operations are computed by dividing income (loss) from
continuing operations as adjusted for gains or losses on the sale of
hotel properties not included in discontinued operations and for
dividends on preferred stock by the weighted average number of shares of
common stock outstanding plus other potentially dilutive securities.
Potential dilutive securities included in the Company's calculation of
diluted earnings per share include shares issuable upon exercise of stock
options. The majority of the options to purchase shares of our common
stock that were outstanding during the three and nine months ended
September 30, 2004 and 2003 were not included in the computation of
diluted EPS because their effect would have been anti-dilutive.
Distributions
With the exception of the fourth quarter 2001, we have paid regular
quarterly cash distributions to shareholders. These distributions are
determined quarterly by our Board based on our operating results,
economic conditions, capital expenditure requirements, the Internal
Revenue Code's REIT annual distribution requirements, leverage
restrictions imposed by our Line of Credit and other debt documents, and
any other matters that our Board deems relevant.
Stock-Based Compensation
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure." SFAS No. 148 amends SFAS No.
123, "Accounting for Stock-Based Compensation," to provide alternative
methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. We have
adopted a policy that applies the estimated fair value based method of
accounting for stock-based employee compensation prospectively to all
awards granted, modified or settled.
In January 2004, we issued 405,233 shares of restricted common stock to
certain key executives of our Company. These grants vest between three
and five years after the date of issuance, if certain performance
measures have been achieved by the Company. The vesting
9
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
2. Summary of Significant Accounting Policies, Continued
of the restricted stock is based on cumulative funds from operations
("FFO") and total shareholder return targets as determined by our Board.
The executives will be entitled to vote these restricted stock shares and
will also receive dividends on the common shares over the vesting period.
Based on management's estimated fair value of these restricted stock
grants, we record compensation expense ratably over the respective
vesting periods.
Segment Reporting
We consider each of our hotels to be an operating segment, none of which
meets the threshold for a reportable segment as prescribed by SFAS No.
131, "Disclosures about Segments of an Enterprise and Related
Information." We allocate resources and assess operating performance
based on each individual hotel. Additionally, we aggregate these
individually immaterial operating segments into one segment using the
criteria established by SFAS No. 131, including the similarities of our
product offering, types of customers and method of providing service.
3. Investment in Hotel Properties
During the nine months ended September 30, 2004, we invested
approximately $74.0 million related to nine previously announced hotel
acquisitions that were completed during the period. These hotels were
developed by the McKibbon Hotel Group. We funded these acquisitions
primarily through $21.4 million in net cash proceeds from an April 2004
issuance of 2.4 million shares of our common stock, the issuance of
approximately 150,000 Partnership units valued at approximately $1.3
million, borrowings under our Line of Credit and the assumption of
approximately $40.0 million in secured long-term debt, including
approximately $3.7 million of a mortgage note premium as described in
Note 5.
The results of operations of these hotels were included in the Company's
statement of operations from the respective dates acquired. The
acquisitions that we completed are as follows for the nine months ended
September 30, 2004:
Hotel Location Rooms Date Acquired
------------------------- -------------------------- ----- ----------------
Courtyard by Marriott Tallahassee, Florida 93 January 26, 2004
Residence Inn by Marriott Tampa, Florida 102 March 25, 2004
Courtyard by Marriott Gainesville, Georgia 81 April 29, 2004
Residence Inn by Marriott Tallahassee, Florida 78 April 29, 2004
Residence Inn by Marriott Knoxville, Tennessee 78 May 10, 2004
Courtyard by Marriott Asheville, North Carolina 78 May 28, 2004
Residence Inn by Marriott Chattanooga, Tennessee 76 May 28, 2004
Courtyard by Marriott Athens, Georgia 105 June 16, 2004
Residence Inn by Marriott Savannah, Georgia 66 June 29, 2004
10
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
3. Investment in Hotel Properties, Continued
Based on our estimate of fair value, we allocated the purchase price of
these hotels as follows (in thousands):
Amount
-------
Land $ 7,767
Buildings and improvements 58,084
Furniture and equipment 8,135
-------
$73,986
=======
We noted the following pro forma results assuming these acquisitions had
occurred on January 1, 2003 (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -----------------------
2004 2003 2004 2003
------- ------- -------- --------
Revenues
Equity Inns, as reported $71,217 $63,245 $192,135 $177,269
Acquisitions - 5,402 6,867 15,697
------- ------- -------- --------
Pro forma combined revenues $71,217 $68,647 $199,002 $192,966
======= ======= ======== ========
Net income (loss) applicable to
common shareholders
Equity Inns, as reported $ 2,521 $ 256 $ 818 $ (3,222)
Acquisitions - 752 237 1,859
------- ------- -------- --------
Pro forma combined net income (loss) $ 2,521 $ 1,008 $ 1,055 $ (1,363)
======= ======= ======== ========
Pro forma basic and diluted income (loss)
per share $ 0.06 $ 0.02 $ 0.02 $ (0.03)
======= ======= ======== ========
Pro forma weighted average number of
common shares outstanding - basic and
diluted 45,453 42,955 45,393 42,939
======= ======== ======== ========
Note: These unaudited pro forma results are presented for comparative
purposes only. The pro forma results are not necessarily indicative of
what our actual results would have been had these acquisitions been
completed on January 1, 2003, or of future results.
During the nine months ended September 30, 2004, we invested $15.4
million to fund capital improvements in our hotels, including replacement
of carpets, drapes, furniture and equipment, renovation of common areas
and improvements of hotel exteriors. We expect to fund an aggregate of
approximately $18.0 to $20.0 million throughout 2004 for capital
improvements.
11
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
3. Investment in Hotel Properties, Continued
We intend to fund such improvements out of our cash flows from
operations, current cash balances and borrowings under our Line of
Credit.
During the nine months ended September 30, 2004, we sold three hotels for
approximately $10.9 million, including approximately $9.1 million in cash
(after selling costs of approximately $980,000) and an increase to an
existing note receivable of $800,000. We utilized the net proceeds from
these dispositions to pay down existing long-term debt. In conjunction
with these sales, we recorded a loss of approximately $320,000 as part of
discontinued operations in our accompanying condensed consolidated
statement of operations.
During the three months ended September 30, 2004, we experienced
significant hurricane damage at one of our hotels, located in
Jacksonville Beach, Florida. We are currently in the process of
evaluating the cost to repair the hotel. We are also working with our
insurer to determine the level of coverage that we are due under our
insurance policy. Based on our current evaluation of the situation, we
have not incurred a casualty loss as a result of this event. A gain, if
any, as a result of this event will be recognized in our financial
statements when realized.
We classify certain assets as held for sale based on management having
the authority and intent of entering into commitments for sale
transactions expected to close in the next twelve months.
When we identify an asset as held for sale, we estimate the net
realizable value of such asset. If the net realizable value of the asset
is less than the carrying amount of the asset, we establish a reserve for
the estimated loss. Depreciation is no longer recorded once we have
identified an asset as held for sale. Net realizable value is estimated
as the amount at which the asset could be sold (fair value) less costs to
sell. We have determined fair value by using prevailing market
conditions, appraisals or current estimated net sales proceeds from
pending offers, as appropriate. We only allocate to discontinued
operations interest on debt that is to be assumed by the buyer and
interest on debt that is required to be repaid as a result of the
disposal transaction.
4. Notes Receivable
Notes receivable consist of the following at September 30, 2004 and
December 31, 2003 (in thousands):
2004 2003
------ ------
HM-NM, Inc. $4,306 $3,582
Officers of the Company - 1,335
------ ------
$4,306 $4,917
====== ======
12
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
4. Notes Receivable, Continued
In November 2003, we sold our AmeriSuites hotel in Jacksonville, Florida
to HM-NM, Inc. for a purchase price of approximately $6.0 million, $4.0
million of which was in the form of a 15-month note receivable bearing
interest at 7.75% per annum. Additionally, in January 2004 we sold a
Hampton Inn hotel located in Jacksonville, Florida to HM-NM, Inc. for a
purchase price of approximately $5.0 million, including an additional
$800,000 increase to the note receivable discussed above. The entire note
is secured by the land, building and furniture and fixtures of the
AmeriSuites hotel located at 8277 Western Way Circle, Jacksonville,
Florida. Accordingly, as the sale of both hotels was negotiated
concurrently, coupled with the initial minimum investment required by
SFAS No. 66, "Accounting for Sales of Real Estate," we have deferred a
gain of approximately $420,000 until we collect the note receivable.
At various times from January 1998 to July 2002, we advanced loans to our
executive officers for income taxes relating to annual bonuses taken in
shares of our common stock and income taxes related to the taxable value
of vested restricted stock. All notes were paid in full in July 2004 in
accordance with their stated terms. We no longer provide loans to
officers.
13
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
5. Debt
The following details our debt outstanding at September 30, 2004 and
December 31, 2003 (in thousands):
Principal Balance
---------------------- Interest
9/30/04 12/31/03 Rate Maturity
------- -------- ------------------- --------
Commercial Mortgage Bonds
Class A $ - $ 4,061 6.83% Fixed Nov 2006
Class B 46,493 50,600 7.37% Fixed Dec 2015
Class C 10,000 10,000 7.58% Fixed Feb 2017
-------- --------
56,493 64,661
Line of Credit 61,000 50,000 LIBOR plus Variable June 2006
Percentage
Mortgage 89,765 91,009 8.37% Fixed July 2009
Mortgage 66,106 66,891 8.25% Fixed Nov 2010
Mortgage 34,228 34,612 8.25% Fixed Nov 2010
Mortgage 10,725 10,750 LIBOR plus
285 pts. Variable Aug 2008
Mortgage 2,837 2,912 6.00% Fixed May 2008
Mortgage 5,241 5,431 10.00% Fixed Sept 2005
Mortgage 3,367 3,508 6.37% Fixed Nov 2016
Mortgage 6,299 - 8.70% Fixed Nov 2010
Mortgage 4,292 - 7.97% Fixed Oct 2007
Mortgage 5,289 - 7.97% Fixed Oct 2007
Mortgage 4,483 - 7.10% Fixed Sept 2008
Mortgage 3,809 - 8.04% Fixed Nov 2007
Mortgage 5,306 - 8.04% Fixed Nov 2007
Mortgage 3,175 - 9.375% Fixed April 2007
Mortgage 3,398 - 9.375% Fixed April 2007
Mortgage 5,984 - 5.83% Fixed July 2014
-------- --------
371,797 329,774
Unamortized Mortgage
Note Premium 3,451 -
-------- --------
$375,248 $329,774
======== ========
Related to our hotel acquisitions completed during the nine months ended
September 30, 2004, we assumed approximately $36.3 million of long-term
debt with various interest rates and maturities through 2010. In
accounting for these acquisitions at estimated fair value, including the
corresponding long-term debt assumed, we recorded approximately $3.7
million of a mortgage note premium in the accompanying balance sheet.
This premium will be amortized using the interest method over the
remaining lives of the assumed debt as a reduction of interest expense.
We entered into a collateralized Line of Credit in June 2003 for $110.0
million, subject to certain restrictions. The Line of Credit bears
interest at LIBOR plus 2.25% to 3.0% per annum
14
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
5. Debt, Continued
as determined by our quarterly leverage and the facility matures in June
2006 but may be extended at our option for an additional year. At
September 30, 2004, the interest rate on our Line of Credit was LIBOR
(1.84% at September 30, 2004) plus 2.75%. Fees ranging from .45% to .60%
per annum, as determined by our ratio of total indebtedness to EBITDA,
are paid quarterly on the unused portion of our Line of Credit. The Line
of Credit maintains certain restrictions regarding capital expenditures
and other quarterly financial covenants, including a test for cash
available for dividend payouts, a fixed charge test and a leverage test,
among other covenants. At September 30, 2004, we were in compliance with
all covenants required by our Line of Credit.
All of our debt is secured by first mortgages on our hotels. Our debt has
maturity dates that range from September 2005 to February 2017 with
certain debt requiring annual principal payments and certain debt
representing term maturities. The terms of our debt generally require
prepayment penalties if repaid prior to maturity.
Certain of our loan agreements require quarterly deposits into separate
room renovation accounts for the amount by which 4% of revenues at our
hotels exceeds the amount expended by us during the year for replacement
of furniture and equipment, maintenance, and capital improvements for our
hotels. For 2004, we expect that amounts expended will exceed, in the
aggregate, the amounts required under the loan covenants. If, for any
reason, we do not meet the renovation requirements at the individual
hotel level, we could be required to fund such shortfalls into cash
escrow accounts.
Our Line of Credit has a stated borrowing capacity of $110.0 million.
This capacity is further limited to a stated percentage of the appraised
value of the assets pledged as collateral. Additionally, since the
completion of our Line of Credit, we have sold certain of our hotels that
served as collateral under this facility. Accordingly, at September 30,
2004, we had a borrowing capacity of $100.6 million under our Line of
Credit.
6. Interest Rate Swap Contracts
In 2003, we entered into an interest rate swap agreement with a financial
institution on a notional amount of $25.0 million. The agreement expires
in November 2008. The agreement effectively fixes the interest rate on
the first $25.0 million of floating rate debt outstanding under the Line
of Credit at a rate of 3.875% per annum plus the interest rate spread on
the Line of Credit, thus reducing our exposure to interest rate
fluctuations. The notional amount does not represent amounts exchanged by
the parties, and thus is not a measure of exposure to us.
15
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
6. Interest Rate Swap Contracts, Continued
The differences to be paid or received by us under the interest rate swap
agreement are recognized as an adjustment to interest expense. The
agreement is with a major financial institution, which is expected to
fully perform under the terms of the agreement.
In 2003, we entered into an additional interest rate swap agreement with
a financial institution on a notional amount of $25.0 million. The
agreement expires in November 2006. The agreement effectively fixes the
interest rate on the second $25.0 million of floating rate debt
outstanding under the Line of Credit at a rate of 3.22% per annum plus
the interest rate spread on the Line of Credit, thus reducing our
exposure to interest rate fluctuations. The notional amount does not
represent amounts exchanged by the parties, and thus is not a measure of
exposure to us. The differences to be paid or received by us under the
interest rate swap agreement are recognized as an adjustment to interest
expense. The agreement is with a major financial institution, which is
expected to fully perform under the terms of the agreement.
7. Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income," requires the disclosure
of the components included in comprehensive income (loss). For the nine
months ended September 30, 2004, we recorded comprehensive income of
approximately $6.9 million, comprised of net income of approximately $6.5
million and an unrealized gain on our interest rate swap of approximately
$365,000.
16
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
8. Income Taxes
The Company's income tax benefit related to our TRS Lessees consists of
the following for the three and nine months ended September 30 (in
thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -------------------
2004 2003 2004 2003
---- ------ ------ ------
Deferred tax benefit:
Federal $796 $1,431 $2,823 $4,553
State 94 168 332 536
---- ------ ------ ------
890 1,599 3,155 5,089
Less valuation allowance (890) - (3,155) -
---- ------ ------ ------
Total $ - $1,599 $ - $5,089
==== ====== ====== ======
The TRS Lessees' deferred income tax asset of approximately $19.9 million
is comprised primarily of the benefit of net operating loss carryforwards
that expire beginning in December 2021. At year-end 2003, we determined
that a valuation allowance was necessary for the entire deferred income
tax asset. We continue to believe that it is more likely than not that
the Company will not be able to realize our deferred income tax asset,
and thus we have recorded a valuation allowance for the current balance.
If we determine that the Company will be able to realize all or part of
our net deferred tax asset in the future, an adjustment to the valuation
allowance would be charged to income in the periods such determination
was made.
9. Discontinued Operations
In 2002, we adopted the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 established
criteria beyond that previously specified in SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of," to determine when a long-lived asset is classified as held
for sale, and it provides a single accounting model for the disposal of
long-lived assets. Due to the adoption of SFAS No. 144, we now report as
discontinued operations any assets held for sale (as defined by SFAS No.
144), and assets sold during the periods presented. We identify and
assess discontinued operations at the individual hotel operating level
because we can identify cash flows at this level. All results of these
discontinued operations, less applicable income taxes, are included as a
separate component of income in our accompanying condensed consolidated
statements of operations. This change has resulted in certain
reclassifications of the previously reported statements of operations for
the three and nine months ended September 30, 2003.
17
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
9. Discontinued Operations, Continued
We classify certain assets as held for sale based on management having
the authority and intent of entering into commitments for sale
transactions expected to close in the next twelve months. When we
identify an asset held for sale, we estimate the net realizable value of
such asset. If the net realizable value of the asset is less than the
carrying amount of the asset, we establish a reserve for the estimated
loss. Depreciation is no longer recorded once we have identified an asset
as held for sale. Net realizable value is estimated as the amount at
which the asset could be bought or sold (fair value) less costs to sell.
We have determined fair value by using prevailing market conditions,
appraisals or current estimated net sales proceeds from pending offers,
as appropriate. We only allocate to discontinued operations interest on
debt that is to be assumed by the buyer and interest on debt that is
required to be repaid as a result of the disposal transaction.
During the nine months ended September 30, 2004, we sold three hotels for
approximately $10.9 million, including approximately $9.1 million in cash
(after selling costs of approximately $980,000) and an increase to an
existing note receivable of $800,000. The hotels sold were a 97-room
Hampton Inn located in Sarasota, Florida, a 122-room Hampton Inn located
in Jacksonville, Florida, and a 141-room Comfort Inn located in
Arlington, Texas. The average age of these hotels was approximately 17
years. We utilized the net proceeds from these dispositions to pay down
existing long-term debt.
These sales represent the last of our hotels that were classified as
discontinued operations. The operations of these hotels are included in
the statement of operations under the heading, "Loss from discontinued
operations." The components of income (loss) from discontinued
18
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
9. Discontinued Operations, Continued
operations are as follows for the three and nine months ended September
30, 2004 and 2003 (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2004 2003 2004 2003
----- ------ ----- -------
Revenue:
Room revenue $ - $1,603 $ 324 $ 5,851
Other hotel revenue - 67 14 228
Operating Costs:
Direct hotel expenses (18) (1,227) (399) (3,988)
Other hotel expenses (2) (54) (28) (201)
Depreciation - (79) - (815)
Property taxes, rental expense
and insurance - (146) (28) (448)
Amortization of franchise fees - - - (6)
Interest expense - (177) (19) (530)
Deferred income tax benefit - 145 - 334
---- ------ ----- -------
Income (loss) from operations
of discontinued operations (20) 132 (136) 425
Gain (loss) on sale of hotel properties - (53) (320) 1,222
Loss on impairment of hotels held
for sale - - - (3,556)
---- ------ ----- -------
Income (loss) from discontinued
operations $(20) $ 79 $(456) $(1,909)
==== ====== ===== =======
In November 2003, we sold our AmeriSuites hotel in Jacksonville, Florida
for $6.0 million, including the assumption of a $4.0 million 15-month
note receivable bearing interest at 7.75% per annum. This sale was
negotiated concurrently with the January 2004 sale of our Hampton Inn
hotel in Jacksonville, Florida, as discussed above. As part of the
Hampton Inn sale, we increased our note receivable to $4.8 million. The
entire $4.8 million note receivable is collateralized by the AmeriSuites
hotel sold. Given the initial minimum investment required by SFAS No. 66,
"Accounting for Sales of Real Estate," we have deferred a gain of
approximately $420,000 until we collect the note receivable under the
cost recovery method of income recognition.
19
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
10. Commitments and Contingencies
Under our franchise agreements, we are periodically required to make
capital improvements in order to maintain our brand standards.
Additionally, under certain of our loan covenants, we are generally
obligated to fund 4% of total hotel revenues per quarter on a cumulative
basis, to a separate room renovation account for the ongoing replacement
or refurbishment of furniture, fixtures and equipment at our hotels. For
2004, we expect that amounts expended will exceed, in the aggregate, the
amount required under the loan covenants. If, for any reason, we do not
meet the renovation requirements at the individual hotel level, we could
be required to fund such shortfalls into cash escrow accounts. We
currently have one lender that could require us to deposit approximately
$1.0 million into an escrow account, but the lender has thus far decided
not to trigger the escrow funding based on our future capital improvement
plans for the individual hotels.
We maintain agreements with certain senior officers that provide for
severance payments in the event of a change in control of Equity Inns. At
September 30, 2004, the maximum amount that would be payable under all
agreements, if a change of control occurred, would be approximately $7.0
million.
We are involved in various legal actions arising in the ordinary course
of business. We do not believe that any of the pending actions will have
a material adverse effect on our business, financial condition or results
of operations.
11. Shareholders' Equity
On April 7, 2004, we completed an offering of 2.4 million shares of
common stock that resulted in net proceeds of approximately $21.4
million. The proceeds were used to fund approximately $13.3 million in
previously announced acquisitions, with the remaining funds being
utilized to pay down our Line of Credit.
12. Subsequent Events
On October 19, 2004, we completed an offering of approximately 5.3
million shares of common stock that resulted in net proceeds of
approximately $49.5 million. The proceeds were used to partially fund the
previously announced acquisitions of five hotels in southern Florida,
with the remaining proceeds being utilized for general corporate
purposes, further acquisitions and to pay down our Line of Credit.
Additionally, the offering is subject to an underwriters' 30-day
over-allotment of an additional 787,500 shares of common stock.
20
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
12. Subsequent Events, Continued
On October 21, 2004, we completed an acquisition of five hotels in
southern Florida. These hotels have an average age of five years and
contain an aggregate of 587 rooms. These properties consist of a 94-room
Hampton Inn in Boca Raton, a 106-room Hampton Inn in Deerfield Beach, a
116-room Hampton Inn in Palm Beach Gardens, a 161-room Hampton Inn &
Suites in Boynton Beach and a 110-room Hampton Inn in West Palm Beach.
The total purchase price for these five hotels is approximately $73.9
million, which we funded through a fixed rate mortgage loan in the amount
of $40.6 million and proceeds from our October 2004 common stock offering
discussed above. The loan bears interest at an annual rate of 5.64%.
Under the terms of the loan, the promissory note matures on November 1,
2024, although the lender has a call option on November 1, 2014 and
November 1, 2019, at which time all outstanding principal and interest
would be due in full.
On October 28, 2004, we announced an agreement to purchase four
additional hotels from the McKibbon Hotel Group. These hotels represent
two Courtyards by Marriott in Knoxville, Tennessee and Mobile, Alabama, a
Residence Inn by Marriott in Macon, Georgia and our first Springhill
Suites by Marriott in Asheville, North Carolina. The hotels represent 322
rooms and have an average age of seven years. The total purchase price is
approximately $28.5 million and the transaction, subject to the
completion of our customary due diligence, is expected to close by March
31, 2005. We plan to fund these acquisitions through the assumption of
$13.0 million in long-term secured debt and borrowings under our Line of
Credit.
On November 1, 2004, we completed our acquisition of two additional
hotels. These properties consist of a 93-room Courtyard by Marriott in
Dalton, Georgia and our first 112- room Hilton Garden Inn in Louisville,
Kentucky. The hotels represent 205 rooms and have an average age of five
years. The total purchase price for these hotels is $14.4 million, which
we funded through proceeds from our October 2004 common stock offering.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains or incorporates by reference forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, including,
without limitation, statements containing the words, "may", "believes",
"estimates", "projects", "plans", "intends", "will", "anticipates", "expects"
and words of similar import. Such forward-looking statements relate to future
events, the future financial performance of our Company, and involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of the Company or industry results to be
materially different from any future results, performance or achievements
expressed or implied by such forward-looking statements. Such risks and
uncertainties include, but are not limited to, the following: the ability of the
Company to cope with domestic economic and political disruption and Federal and
state governmental regulations or war, terrorism, states of emergency or similar
activities; risk associated with debt financing; risks associated with the hotel
and hospitality industry; the ability of the Company to successfully implement
our operating strategy; availability of capital; changes in economic cycles;
competition from other hospitality companies; and changes in the laws and
government regulations applicable to us. Readers should specifically consider
the various factors identified, or incorporated by reference in this report
including, but not limited to those discussed in our Current Report on Form 8-K
filed March 11, 2004, and in any other documents filed by us with the Securities
and Exchange Commission that could cause actual results to differ from those
implied by the forward-looking statements. We undertake no obligation and do not
intent to publicly update or revise any forward-looking statements contained
herein to reflect future events or developments, whether as a result of new
information, future events or otherwise.
BACKGROUND
Equity Inns is a Memphis-based, self-advised hotel real estate investment trust
("REIT") primarily focused on the upscale extended stay, all-suite, midscale
limited-service and full service segments of the hotel industry. The Company,
through its wholly owned subsidiary, Equity Inns Trust (the "Trust"), is the
sole general partner of Equity Inns Partnership, L.P. (the "Partnership") and at
September 30, 2004 owned an approximate 97.3% interest in the Partnership. The
Partnership and its affiliates lease all of our hotels to wholly-owned taxable
REIT subsidiaries of the Company (the "TRS Lessees").
We commenced operations on March 1, 1994 upon completion of our initial public
offering and the simultaneous acquisition of eight Hampton Inn hotels with 995
rooms. Over the past ten years, we have grown with a focus on both geographic
and brand diversity. We believe that diversity in our asset portfolio reduces
operational variance from year-to-year and results in less volatility as
compared to the overall hotel industry.
22
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
The following table illustrates our geographic presence by the number of hotels
and rooms at September 30, 2004.
Region Hotels Rooms/Suites
------------------ ------ ------------
East North Central 14 1,889
East South Central 15 1,702
Middle Atlantic 6 827
Mountain 10 1,285
New England 5 605
Pacific Northwest 2 329
South Atlantic 30 3,526
West North Central 7 830
West South Central 10 1,401
-- ------
99 12,394
== ======
We believe that geographic diversity helps to limit our exposure to any one
market. At September 30, 2004, we owned a geographically diverse portfolio of 99
hotels with 12,394 rooms located in 34 states. Additionally, our property mix is
spread between suburban and urban locations, helping to insulate us from various
economic climates, including a depressed business travel climate.
Our hotel portfolio includes midscale limited service hotels, all-suite hotels,
upscale extended stay hotels, and full service hotels. This array of product
offering allows us to diversify the asset portfolio in an effort to reduce risk
in various economic environments.
23
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
The following chart summarizes information regarding our franchise diversity at
September 30, 2004:
Number of Number of
Franchise Affiliation Hotel Properties Rooms/Suites
--------------------- ---------------- ------------
Midscale Limited Service Hotels:
Hampton Inn 45 5,686
Comfort Inn 1 104
-- ------
Sub-total 46 5,790
All-Suite Hotels:
AmeriSuites 18 2,291
Upscale Extended Stay Hotels:
Residence Inn 16 1,751
Homewood Suites 9 1,295
-- ------
Sub-total 25 3,046
Full Service Hotels:
Holiday Inn 4 557
Comfort Inn 1 177
Courtyard by Marriott 5 533
-- ------
Sub-total 10 1,267
-- ------
Total 99 12,394
== ======
24
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
The following table sets forth certain information for the three and nine months
ended September 30, 2004 and September 30, 2003 with respect to our hotels:
Three Months Ended September 30, 2004 (1) Three Months Ended September 30, 2003 (1)
----------------------------------------- -------------------------------------------
Revenue Revenue
Number Number Average Per Average Per
of of Daily Available Daily Available
Brand Hotels Rooms Occupancy Rate Room (2) Occupancy Rate Room (2)
- ----- -------- ------- --------- ------- --------- --------- ------- ---------
Hampton Inn 45 5,686 69.0% $73.25 $50.51 68.3% $71.25 $48.67
AmeriSuites 18 2,291 73.5% $72.79 $53.53 73.9% $69.79 $51.59
Residence Inn 16 1,751 84.2% $96.58 $81.29 84.5% $93.82 $79.25
Homewood Suites 9 1,295 81.5% $100.81 $82.20 77.8% $98.69 $76.73
Courtyard by Marriott 5 533 75.2% $95.74 $72.00 73.1% $93.82 $68.57
Holiday Inn 4 557 65.3% $67.07 $43.77 63.1% $67.05 $42.30
Comfort Inn 2 281 70.1% $87.39 $61.22 78.3% $84.67 $66.32
--- ------ ----- ------ ------ ----- ------ ------
99 12,394 73.4% $81.21 $59.61 72.8% $78.89 $57.45
== ====== ===== ====== ====== ===== ====== ======
Nine Months Ended September 30, 2004 (1) Nine Months Ended September 30, 2003 (1)
--------------------------------------- -------------------------------------------
Revenue Revenue
Number Number Average Per Average Per
of of Daily Available Daily Available
Brand Hotels Rooms Occupancy Rate Room (2) Occupancy Rate Room (2)
- ----- -------- ------- --------- ------- --------- --------- ------- ---------
Hampton Inn 45 5,686 65.1% $71.96 $46.86 64.7% $70.56 $45.68
AmeriSuites 18 2,291 68.8% $72.96 $50.21 70.9% $69.51 $49.31
Residence Inn 16 1,751 80.2% $92.47 $74.16 80.2% $90.64 $72.69
Homewood Suites 9 1,295 78.5% $102.02 $80.06 76.3% $99.46 $75.85
Courtyard by Marriott 5 533 75.2% $93.78 $70.48 75.0% $89.98 $67.52
Holiday Inn 4 557 60.8% $66.21 $40.22 56.2% $67.43 $37.86
Comfort Inn 2 281 72.5% $87.26 $63.28 72.4% $86.90 $62.87
-- ------ ----- ------ ------ ----- ------ ------
99 12,394 69.8% $80.17 $55.92 69.5% $78.13 $54.31
== ====== ===== ====== ====== ===== ====== ======
Notes
(1) Represents "all comparable" statistics for hotels owned by us at quarter end
as if we had owned the hotels for both periods presented. (2) Determined by
multiplying occupancy times the average daily rate.
Approximately 94% of our hotel portfolio is comprised of the following leading
franchise brands: Homewood Suites and Hampton Inn by Hilton, Residence Inn and
Courtyard by Marriott and AmeriSuites by Prime Hospitality. We believe that
multiple brands at the midscale and upscale levels, without food and beverage,
help to insulate our asset portfolio against the volatility of individual brand
results relative to industry revenue per available room ("RevPAR") performance.
Descriptions of each of our major brands are as follows:
25
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
Homewood Suites by Hilton:
A premier upscale extended stay hotel, focusing on extended stay, corporate
transient and family travelers. Rated the #1 extended stay hotel brand by JD
Powers in 2004.
Hampton Inn by Hilton:
A premier midscale without food and beverage hotel chain with over 1,000
locations.
Residence Inn by Marriott:
A premier upscale extended stay hotel, focusing on extended stay, corporate
transient and family travelers. Rated the #3 extended stay hotel brand by JD
Powers in 2004.
Courtyard by Marriott:
An upscale full service hotel designated as the hotel designed by business
travelers for business travelers.
AmeriSuites by Prime Hospitality:
An upscale all-suite hotel, billed as America's most affordable all-suite
hotel.
Approximately 76% of our hotels are branded by Hilton and Marriott, which both
provide national marketing support and frequent stay programs that continue to
drive additional revenue. We believe that better brands generate premium RevPAR
over their peers and focusing on these premium generating brands is another
factor in our strategy to limit risk in the volatility of our hotel portfolio.
In order to qualify as a REIT, we cannot operate hotels and, consequently, we
outsource the management of our hotels to leading independent management
companies. By utilizing third-party managers with relatively short-term
contracts providing for strong operating incentive management fees, we believe
that we have better control over the operating results of our hotels. At
September 30, 2004, our hotel managers are as follows:
Number of Hotels
----------------
Interstate Hotels & Resorts, Inc. 48
Hilton Hotels Corporation 17
Prime Hospitality Corporation 18
Others 16
--
99
==
26
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
GROWTH STRATEGY
The Company's business objectives are to increase funds from operations and
dividends, while enhancing shareholder value primarily through (i) aggressive
asset management and the strategic investment of capital in its diversified
hotel portfolio, primarily with mid-scale and upscale properties in strategic
urban and suburban areas, (ii) selectively acquiring hotels that have been
underperforming due to the lack of sufficient capital improvements, poor
management or franchise affiliation, and (iii) selectively disposing of hotels
that have reached their earnings potential or may, in management's judgment,
suffer adverse changes in their local market, or require large capital outlays.
This process is ongoing, and activity could potentially increase given a more
fluid marketplace.
COMPETITION
The hotel industry is highly competitive with various participants competing on
the basis of price, level of service and geographic location. Each of our hotels
is located in a developed area that includes other hotel properties. The number
of competitive hotel properties in a particular area could have a material
adverse effect on the occupancy, average daily rate ("ADR") and RevPAR of our
hotels or at hotel properties acquired in the future. We believe that brand
recognition, location, the quality of the hotel, consistency of services
provided, and price are the principal competitive factors affecting our hotels.
SEASONALITY
Our operations historically have been seasonal in nature, generally reflecting
higher occupancy rates and RevPAR during the second and third quarters. This
seasonality can be expected to cause fluctuations in our quarterly operating
results. To the extent that cash flows from our hotel operations are
insufficient to fund our operating or investing requirements or dividend
distributions, we may fund seasonal-related shortfalls with borrowings under our
Line of Credit.
INFLATION
Operators of hotels in general have the ability to adjust room rates quickly.
However, competitive pressures may limit our ability to raise room rates in the
face of inflation.
TAX STATUS
We intend to operate so as to be taxed as a REIT under Sections 856-860 of the
Internal Revenue Code of 1986, as amended. As long as we qualify for taxation as
a REIT, with certain exceptions, we will not be taxed at the corporate level on
our taxable income that is distributed to our shareholders. A REIT is subject to
a number of organizational and operational requirements,
27
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
including a requirement that it must distribute annually at least 90% of its
taxable income in the form of dividends to its shareholders. Failure to qualify
as a REIT will render us subject to tax (including any applicable alternative
minimum tax) on our taxable income at regular corporate rates and distributions
to the shareholders in any such year will not be deductible by us. Even if we
qualify for taxation as a REIT, we may be subject to certain state and local
taxes on our income and property. In connection with our election to be taxed as
a REIT, our Company charter imposes certain restrictions on the transfer of
shares of our common stock and preferred stock. We have adopted the calendar
year as our taxable year.
AVAILABLE INFORMATION
Our Internet website address is: www.equityinns.com. We also make available free
of charge through our website our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange
Act of 1934, as amended, as soon as reasonably practicable after such documents
are electronically filed with, or furnished to, the Securities and Exchange
Commission ("SEC").
We have also made available our Corporate Governance Guidelines and the charters
of the Audit Committee, Compensation Committee and Corporate Governance and
Nomination Committee on our website under "Corporate Governance." We have also
adopted a Code of Ethics that applies to our chief executive officer, our
president and chief operating officer, our chief financial officer, our
controller, and all other employees and have posted this Code of Ethics, along
with our Whistleblower policy, on our website. We intend to satisfy the
disclosure requirements under Item 10 of Form 8-K relating to amendments to or
waivers from any provision of the Code of Ethics by posting such information on
our website. Our corporate governance documents are also available in print upon
written shareholder request to our Secretary, J. Mitchell Collins, at 7700 Wolf
River Boulevard, Germantown, Tennessee 38138, or by filling out an information
request on our website under "Information Requests."
The information on our website is not, and shall not be deemed to be, a part of
this report or incorporated into any other filings that we make with the SEC.
28
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS
For the Three Months Ended For the Nine Months Ended
------------------------------------------- -------------------------------------------
September 30, September 30, September 30, September 30,
(in thousands) 2004 % 2003 % 2004 % 2003 %
------------- ---- ------------- ----- ------------- ---- ------------- ----
Hotel revenues $71,098 99.8 $63,125 99.8 $191,808 99.8 $176,786 99.7
Other revenue 119 .2 120 .2 327 .2 483 .3
-------- ---- ------- ---- -------- ---- -------- ----
Total revenues 71,217 100.0 63,245 100.0 192,135 100.0 177,269 100.0
Hotel expenses 42,795 60.1 37,021 58.5 115,285 60.0 105,112 59.3
Depreciation 10,263 14.4 9,583 15.1 29,596 15.4 28,751 16.2
Property taxes, rental expense
and insurance 4,412 6.2 4,589 7.3 13,131 6.8 13,817 7.8
General and
administrative 1,831 2.6 1,884 3.0 5,852 3.1 5,621 3.2
------- ------- ------- ---- -------- ----- --------- ----
Operating income $11,916 16.7 $10,168 16.1 $ 28,271 14.7 $ 23,968 13.5
======= ====== ======= ==== ======== ===== ======== ====
Comparison of the Company's operating results for the three months ended
September 30, 2004 and 2003.
Revenues
Our hotel revenues of approximately $71.1 million in 2004 increased
approximately $8.0 million, or 12.7%, as compared to approximately $63.1 million
in 2003. After eliminating revenues of approximately $5.8 million related to our
hotel acquisitions for 2004, our same-store hotel revenues increased by
approximately $2.2 million in 2004 as compared to 2003. This increase was
primarily due to a RevPAR increase of 3.4%, driven by an increase in our ADR
from $77.76 to $80.17, and an increase of 28 basis points in occupancy to 72.7%.
Other revenue of $119,000 in 2004 was relatively flat as compared to 2003.
Operating Expenses
Hotel expenses of approximately $42.8 million in 2004 increased approximately
$5.8 million, or 15.7%, as compared to approximately $37.0 million in 2003.
After eliminating expenses of approximately $3.2 million related to our hotel
acquisitions for 2004, our same-store hotel expenses increased by approximately
$2.6 million in 2004 as compared to 2003, primarily due to an increase in
payroll and related benefits of approximately $1.0 million, an increase in
franchise fees, management fees and loyalty programs of approximately $400,000,
an increase in enhanced complimentary hot breakfasts of approximately $260,000,
an increase in expenses related to high speed internet access of approximately
$100,000, an increase in travel agent commissions and credit card fees of
approximately $290,000, an increase in maintenance costs of approximately
$190,000 and an increase in utility costs of approximately $210,000. Hotel
expenses as a percentage of hotel revenues were 60.2% in 2004 and 58.6% in 2003.
29
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS, Continued
Depreciation expense of approximately $10.3 million in 2004 increased
approximately $700,000, or 7.3%, as compared to approximately $9.6 million in
2003, primarily due to increased depreciation expense related to our hotel
acquisitions.
Property taxes, rental expense and insurance of approximately $4.4 million in
2004 decreased approximately $200,000, or 4.4%, as compared to approximately
$4.6 million in 2003, primarily due to a decrease in same-store property taxes
of approximately $530,000, partially offset by an increase in property taxes of
approximately $185,000 related to our hotel acquisitions and an increase in
overall insurance costs of approximately $155,000.
General and administrative expenses of approximately $1.8 million in 2004 were
relatively flat as compared to 2003.
Operating Income
For 2004, we recorded operating income of approximately $11.9 million as
compared to operating income of approximately $10.2 million in 2003. The
principal components of the change in operating income for 2004 as compared to
2003 was an increase in same-store revenues of approximately $2.2 million, an
increase in net operating income related to our hotel acquisitions of
approximately $1.5 million, a decrease in same-store property taxes, rental
expense and insurance of approximately $460,000, partially offset by an increase
in same-store hotel expenses of approximately $2.6 million.
Comparison of the Company's operating results for the nine months ended
September 30, 2004 and 2003.
Revenues
Our hotel revenues of approximately $191.8 million in 2004 increased
approximately $15.0 million, or 8.5%, as compared to approximately $176.8
million in 2003. After eliminating revenues of approximately $9.7 million
related to our hotel acquisitions in 2004, our same-store hotel revenues
increased by approximately $5.3 million in 2004 as compared to 2003. This
increase was primarily due to a RevPAR increase of 2.7%, driven by an increase
in our ADR from $77.17 to $79.10 and an increase of 16 basis points in occupancy
to 69.0%, and also includes approximately $500,000 of increased hotel revenues
due to the effect of the 2004 leap year as compared to 2003.
Other revenue of $327,000 in 2004 decreased $156,000, or 32.3%, as compared to
$483,000 in 2003, primarily due to a decrease in joint venture income, travel
agent rebates and interest income.
30
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS, Continued
Operating Expenses
Hotel expenses of approximately $115.3 million in 2004 increased approximately
$10.2 million, or 9.7%, as compared to approximately $105.1 million in 2003.
After eliminating expenses of approximately $5.1 million related to our hotel
acquisitions in 2004, our same-store hotel expenses increased by approximately
$5.1 million in 2004 as compared to 2003, primarily due to an increase in
payroll and related benefits of approximately $2.5 million, an increase in
loyalty programs of approximately $330,000, an increase in enhanced
complimentary hot breakfasts of approximately $500,000, an increase in expenses
related to high speed internet access of approximately $200,000, an increase in
travel agent commissions and credit card fees of approximately $410,000 and an
increase in utility costs of approximately $485,000. Hotel expenses as a
percentage of hotel revenues were 60.1% in 2004 and 59.5% in 2003.
Depreciation expense of approximately $29.6 million in 2004 increased
approximately $800,000, or 2.8%, as compared to approximately $28.8 million in
2003, primarily due to increased depreciation expense related to our hotel
acquisitions.
Property taxes, rental expense and insurance of approximately $13.1 million in
2004 decreased approximately $700,000, or 5.1%, as compared to approximately
$13.8 million in 2003, primarily due to lower same-store property taxes of
approximately $1.1 million, partially offset by an increase in property taxes of
approximately $320,000 related to our hotel acquisitions.
General and administrative expenses of approximately $5.9 million in 2004
increased approximately $300,000, or 5.4%, as compared to approximately $5.6
million in 2003. This increase was primarily due to severance and relocation
costs of approximately $155,000, an increase in travel expenses of approximately
$75,000, an increase in non-cash stock-based compensation of approximately
$90,000 and a write-off of telephone equipment of approximately $60,000, offset
by a decrease in professional fees of approximately $90,000.
Operating Income
For 2004, we recorded operating income of approximately $28.3 million as
compared to operating income of approximately $24.0 million in 2003. The
principal components of the change in operating income for 2004 as compared to
2003 was an increase in same-store revenues of approximately $5.3 million, an
increase of approximately $2.6 million in net operating income related to our
hotel acquisitions, a decrease in same-store property taxes, rental expense and
insurance of approximately $1.2 million, partially offset by an increase in
same-store hotel expenses of approximately $5.1 million and an increase in
general and administrative expenses of approximately $225,000.
31
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES
Equity Inns' principal source of cash to meet our operating requirements,
including distributions to our shareholders and repayments of indebtedness, is
from our hotels' results of operations. For the nine months ended September 30,
2004, net cash flows provided by our operating activities was approximately
$38.3 million. We currently expect that our operating cash flows will be
sufficient to fund our continuing operations, including our required debt
service obligations and distributions to shareholders required to maintain our
REIT status. We expect to fund any short-term liquidity requirements above our
operating cash flows through short-term borrowings under our Line of Credit. In
2003, we entered into our collateralized Line of Credit for $110.0 million,
subject to certain restrictions. Borrowings under the Line of Credit bear
interest at LIBOR plus 2.25% to 3.0% per annum as determined by our quarterly
leverage, and this facility matures in June 2006 but may be extended at our
option for an additional year. The Line of Credit maintains certain restrictions
regarding capital expenditures and other quarterly financial covenants,
including a test for cash available for dividend payouts, a fixed charge test
and a leverage test, among other covenants. At September 30, 2004, we had the
ability to borrow an additional $39.0 million under our Line of Credit. At
September 30, 2004, we had approximately $10.8 million of cash and cash
equivalents.
We may make additional investments in hotel properties and may incur
indebtedness to make such investments or to meet distribution requirements
imposed on a REIT under the Internal Revenue Code of 1986 to the extent that
working capital and cash flows from our investments are insufficient to make
such distributions. Our Board has adopted a policy limiting aggregate
indebtedness to 45% of our investment in hotel properties, at cost, after giving
effect to our use of proceeds from any indebtedness. This policy may be amended
at any time by the Board without shareholder vote. Our consolidated indebtedness
was 37.5% of our investments in hotels, at original cost, at September 30, 2004.
On January 21, 2004 and March 26, 2004, we amended our Line of Credit to provide
for more flexibility regarding our financial covenants through June 2006,
including the redefining of our cash available for dividend payouts to exclude
certain non-cash operating items, including the deferred income tax benefit that
we will no longer record due to losses from our TRS Lessees. We incurred total
amendment fees of approximately $120,000.
32
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
The following details our debt outstanding at September 30, 2004 and December
31, 2003 (in thousands):
Principal Balance
---------------------- Interest
9/30/04 12/31/03 Rate Maturity
-------- -------- ------------------- --------
Commercial Mortgage Bonds
Class A $ - $ 4,061 6.83% Fixed Nov 2006
Class B 46,493 50,600 7.37% Fixed Dec 2015
Class C 10,000 10,000 7.58% Fixed Feb 2017
-------- --------
56,493 64,661
Line of Credit 61,000 50,000 LIBOR plus Variable June 2006
Percentage
Mortgage 89,765 91,009 8.37% Fixed July 2009
Mortgage 66,106 66,891 8.25% Fixed Nov 2010
Mortgage 34,228 34,612 8.25% Fixed Nov 2010
Mortgage 10,725 10,750 LIBOR plus
285 pts. Variable Aug 2008
Mortgage 2,837 2,912 6.00% Fixed May 2008
Mortgage 5,241 5,431 10.00% Fixed Sept 2005
Mortgage 3,367 3,508 6.37% Fixed Nov 2016
Mortgage 6,299 - 8.70% Fixed Nov 2010
Mortgage 4,292 - 7.97% Fixed Oct 2007
Mortgage 5,289 - 7.97% Fixed Oct 2007
Mortgage 4,483 - 7.10% Fixed Sept 2008
Mortgage 3,809 - 8.04% Fixed Nov 2007
Mortgage 5,306 - 8.04% Fixed Nov 2007
Mortgage 3,175 - 9.375% Fixed April 2007
Mortgage 3,398 - 9.375% Fixed April 2007
Mortgage 5.984 - 5.83% Fixed July 2014
-------- --------
371,797 329,774
Unamortized Mortgage
Note Premium 3,451 -
-------- --------
$375,248 $329,774
======== ========
In 2003, we entered into an interest rate swap agreement with a financial
institution on a notional amount of $25.0 million. The agreement expires in
November 2008. The agreement effectively fixes the interest rate on the first
$25.0 million of floating rate debt outstanding under our Line of Credit at a
rate of 3.875% per annum plus the interest rate spread on our Line of Credit, or
6.63% at September 30, 2004, thus reducing our exposure to interest rate
fluctuations. The notional amount does not represent amounts exchanged by the
parties, and thus is not a measure of exposure to us. The differences to be paid
or received by us under the interest rate swap agreement are recognized as an
adjustment to interest expense. The agreement is with a major financial
institution, which is expected to fully perform under the terms of the
agreement.
In 2003, we entered into an additional interest rate swap agreement with a
financial institution on a notional amount of $25.0 million. The agreement
expires in November 2006. The agreement effectively fixes the interest rate on
the second $25.0 million of floating rate debt outstanding under
33
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
our Line of Credit at a rate of 3.22% per annum plus the interest rate spread on
our Line of Credit, or 5.97% at September 30, 2004, thus reducing our exposure
to interest rate fluctuations. The notional amount does not represent amounts
exchanged by the parties, and thus is not a measure of exposure to us. The
differences to be paid or received by us under the interest rate swap agreement
are recognized as an adjustment to interest expense. The agreement is with a
major financial institution, which is expected to fully perform under the terms
of the agreement.
During the nine months ended September 30, 2004, we purchased nine hotels for
approximately $74.0 million related to previously announced acquisitions. We
funded these acquisitions primarily through $21.4 million in net cash proceeds
from an April 2004 issuance of 2.4 million shares of our common stock, the
issuance of approximately 150,000 Partnership units valued at approximately $1.3
million, our Line of Credit and the assumption of approximately $40.0 million in
secured long- term debt. Included in our debt assumption is a mortgage note
premium of approximately $3.7 million to record the debt at its estimated fair
value. This premium will be amortized using the interest method over the
remaining lives of the assumed debt as a reduction of interest expense.
During the nine months ended September 30, 2004, we invested $15.4 million to
fund capital improvements in our hotels, including replacement of carpets,
drapes, furniture and equipment, renovation of common areas and improvements of
hotel exteriors. We expect to fund an aggregate of approximately $18.0 to $20.0
million throughout 2004 for capital improvements. We intend to fund such
improvements out of our cash flows from operations, current cash balances and
borrowings under our Line of Credit. Under our franchise agreements, we are
periodically required to make capital improvements in order to maintain our
brand standards. Additionally, under certain of our loan covenants, we are
generally obligated to fund 4% of total hotel revenues per quarter on a
cumulative basis, to a separate room renovation account for replacement of
furniture, fixtures and equipment, maintenance, and capital improvements for our
hotels. For 2004, we expect that amounts expended will exceed, in the aggregate,
the amount required under the loan covenants. If, for any reason, we do not meet
the renovation requirements at the individual hotel level, we could be required
to fund such shortfalls into cash escrow accounts. We currently have one lender
that could require us to deposit approximately $1.0 million into an escrow
account, but the lender has thus far decided not to trigger the escrow funding
based on our future capital improvement plans for the individual hotels.
During the nine months ended September 30, 2004, we sold three hotels for
approximately $10.9 million, including approximately $9.1 million in cash (after
selling costs of approximately $980,000) and an increase to an existing note
receivable of $800,000. We utilized the net proceeds to pay down existing
long-term debt.
34
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
During the three months ended September 30, 2004, we experienced significant
hurricane damage at one of our hotels, located in Jacksonville Beach, Florida.
We are currently in the process of evaluating the cost to repair the hotel. We
are also working with our insurer to determine the level of coverage that we are
due under our insurance policy. Based on our current evaluation of the
situation, we have not incurred a casualty loss as a result of this event. A
gain, if any, as a result of this event will be recognized in our financial
statements when realized.
REITs are subject to a number of organizational and operational requirements.
For example, for federal income tax purposes, a REIT, and therefore the Company,
is required to pay distributions of at least 90% of its taxable income to our
shareholders. We intend to pay these distributions from operating cash flows.
During the nine months ended September 30, 2004, our Partnership distributed an
aggregate of $17.9 million to its limited partners, or $.13 per unit per quarter
(including $17.4 million of distributions to the Company to fund distributions
to our shareholders of $.13 per share per quarter). We expect to make future
quarterly distributions to our shareholders. The amount of our future
distributions will be based upon quarterly operating results, economic
conditions, capital requirements, the Internal Revenue Code's annual
distribution requirements, leverage restrictions imposed by our Line of Credit
and other factors which our Board deems relevant.
We expect to meet our long-term liquidity requirements, such as scheduled debt
maturities and property acquisitions, through long-term secured and unsecured
borrowings, the issuance of additional equity securities of the Company or, in
connection with acquisitions of hotel properties, the issuance of Partnership
units. Under our Partnership's limited partnership agreement, subject to certain
holding period requirements, holders of units in our Partnership have the right
to require the Partnership to redeem their units. Under the Partnership
agreement, we have the option to redeem units tendered for redemption on a
one-for-one basis for shares of common stock or for an equivalent amount of
cash. We anticipate that we will acquire any units tendered for redemption in
the foreseeable future in exchange for shares of common stock and, to date, have
registered such shares so as to be freely tradeable by the recipient.
FUNDS FROM OPERATIONS
The National Association of Real Estate Investment Trusts, or NAREIT, defines
Funds From Operations, or FFO, as net income (loss) applicable to common
shareholders excluding gains (or losses) from sales of real estate, the
cumulative effect of changes in accounting principles, real estate-related
depreciation and amortization, and after adjustments for unconsolidated
partnerships and joint ventures. FFO does not include the cost of capital
improvements and any related capitalized interest. FFO is presented on a per
share basis, including the assumed conversion of all Partnership units, and
after making adjustments for the effects of dilutive securities. We use FFO per
share as a measure of performance to adjust for certain non-cash expenses such
as depreciation
35
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
FUNDS FROM OPERATIONS, Continued
and amortization because historical cost accounting for real estate assets
implicitly assumes that the value of real estate assets diminishes predictably
over time.
Because real estate values have historically risen or fallen with market
conditions, many industry investors have considered presentation of operating
results for real estate companies that use historical cost accounting to be less
informative. NAREIT adopted the definition of FFO in order to promote an
industry-wide standard measure of REIT operating performance. Accordingly, as a
member of NAREIT, Equity Inns adopted FFO as a measure to evaluate performance
and facilitate comparisons between the Company and other REITs, although our FFO
and FFO per share may not be comparable to FFO measures reported by other
companies.
The following reconciliation of net income to FFO, applicable to common
shareholders, illustrates the difference in these measures of operating
performance (in thousands):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
--------------------- -------------------
2004 2003 2004 2003
------- ------ ------- -------
Net income (loss) applicable to common shareholders $ 2,521 $ 256 $ 818 $(3,222)
Add:
(Gain) loss on sale of hotel properties - 53 320 (1,222)
Minority interests expense 97 7 52 9
Depreciation 10,263 9,583 29,596 28,751
Depreciation from discontinued operations - 79 - 815
------- ------ ------- -------
Funds From Operations (FFO) (1) $12,881 $9,978 $30,786 $25,131
======= ====== ======= =======
Weighted average number of diluted common
shares and Partnership units outstanding 46,709 41,699 45,663 41,694
======= ====== ======= =======
(1) For the three months ended September 30, 2003, FFO includes a non-cash
deferred income tax benefit of approximately $1.6 million and a loss on
redemption of Series A preferred stock of approximately $2.4 million. For the
nine months ended September 30, 2003, FFO includes a non-cash deferred income
tax benefit of approximately $5.1 million and a non-cash loss on impairment of
hotels held for sale of approximately $3.6 million and a loss on redemption of
Series A preferred stock of approximately $2.4 million.
36
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
our management to make estimates and judgments that affect the reported amount
of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities.
On an on-going basis, all estimates are evaluated by our management, including
those related to bad debts, carrying value of investments in hotel properties,
income taxes, contingencies and litigation. All estimates are based upon
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers and other borrowers to make required
payments. The allowance for doubtful accounts is maintained at a level
believed adequate by us to absorb estimated probable receivable losses. Our
periodic evaluation of the adequacy of the allowance is primarily based on
past receivable loss experience, known and inherent credit risks, current
economic conditions, and other relevant factors. This evaluation is
inherently subjective as it requires estimates including the amounts and
timing of future collections. If the financial condition of our customers or
other borrowers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.
We record an impairment charge when we believe an investment in hotels has
been impaired such that future undiscounted cash flows would not recover the
book basis of the investment in the hotel property. Future adverse changes
in market conditions or poor operating results of underlying investments
could result in losses or an inability to recover the carrying value of the
investments that may not be reflected in an investment's carrying value,
thereby possibly requiring an impairment charge in the future. For 2003, we
noted continued softness in the lodging industry primarily due to an
economic recession in the United States and the lagging aftermath effects of
the events of September 11, 2001. Additionally, the RevPAR results of our
hotels for 2003 were not what we had initially anticipated at the beginning
of the year. At year-end 2003, we were still uncertain as to when the
lodging industry would begin to fully recover from the effects of the
aforementioned matters. We performed internal cash flow tests that
considered the current industry downturn and also included moderate RevPAR
growth assumptions into the future.
37
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
CRITICAL ACCOUNTING POLICIES AND ESTIMATES, Continued
Based upon our internal cash flow tests that followed the criteria
prescribed by SFAS No. 144, there were no impairments noted for our hotel
properties.
We record a valuation allowance to reduce our deferred income tax asset to
the amount that is more likely than not to be realized. We have considered
future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for a valuation allowance. At year-end
2003, we determined, it was more likely than not, that we would not be able
to realize our $16.8 million deferred income tax asset. During the last
three years, our TRS Lessees had continued to accumulate net operating
losses primarily due to the lease payments that our TRS Lessees paid to
their parent company, Equity Inns, in conjunction with our assumption of the
operating leases from several of our independent property management
companies in 2001. As a result of these losses, the continued softness in
the lodging industry and the uncertainty associated with its future
recovery, at year-end we recorded a valuation allowance for the full amount
of our deferred income tax asset. Additionally, we will not record a
deferred income tax benefit until it is more likely than not that such
benefit will be realized.
OTHER DEVELOPMENTS
Acquisitions
In late 2003 and early 2004, we announced our intent to purchase nine hotels
from the McKibbon Hotel Group. All of these transactions closed by June 30,
2004. The total purchase price for the nine hotels was approximately $74.0
million, including the assumption of approximately $40.0 million in secured
long-term debt, and we funded approximately $34.0 million of the purchase price
through borrowings under our Line of Credit, the net cash proceeds from an April
2004 issuance of 2.4 million shares of our common stock and the issuance of
approximately 150,000 Partnership units. The average age of these nine hotels is
seven years.
The acquisitions that we completed are as follows for the nine months ended
September 30, 2004:
Hotel Location Rooms Date Acquired
------------------------- ------------------------- ----- ----------------
Courtyard by Marriott Tallahassee, Florida 93 January 26, 2004
Residence Inn by Marriott Tampa, Florida 102 March 25, 2004
Courtyard by Marriott Gainesville, Georgia 81 April 29, 2004
Residence Inn by Marriott Tallahassee, Florida 78 April 29, 2004
Residence Inn by Marriott Knoxville, Tennessee 78 May 10, 2004
Courtyard by Marriott Asheville, North Carolina 78 May 28, 2004
Residence Inn by Marriott Chattanooga, Tennessee 76 May 28, 2004
Courtyard by Marriott Athens, Georgia 105 June 16, 2004
Residence Inn by Marriott Savannah, Georgia 66 June 29, 2004
38
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
OTHER DEVELOPMENTS, Continued
In July 2004, we entered into two agreements to purchase seven hotels. These
hotels represent five upscale Hampton Inns (including a Hampton Inn & Suites) in
southern Florida, a Courtyard by Marriott in Georgia and our first Hilton Garden
Inn in Kentucky. The total purchase price is approximately $88.3 million.
On October 21, 2004, we completed our acquisition of the five hotels in southern
Florida. These hotels have an average age of five years and contain an aggregate
of 587 rooms. These properties consist of a 94-room Hampton Inn in Boca Raton, a
106-room Hampton Inn in Deerfield Beach, a 116-room Hampton Inn in Palm Beach
Gardens, a 161-room Hampton Inn & Suites in Boynton Beach and a 110-room Hampton
Inn in West Palm Beach. The total purchase price for these five hotels is
approximately $73.9 million, which we funded through a fixed rate mortgage loan
in the amount of $40.6 million and proceeds from our October 2004 common stock
offering. The loan bears interest at an annual rate of 5.64%. Under the terms of
the loan, the promissory note matures on November 1, 2024, although the lender
has a call option on November 1, 2014 and November 1, 2019, at which time all
outstanding principal and interest would be due in full.
On October 28, 2004, we announced an agreement to purchase four additional
hotels from the McKibbon Hotel Group. These hotels represent two Courtyards by
Marriott in Knoxville, Tennessee and Mobile, Alabama, a Residence Inn by
Marriott in Macon, Georgia and our first Springhill Suites by Marriott in
Asheville, North Carolina. The hotels represent 322 rooms and have an average
age of seven years. The total purchase price is approximately $28.5 million and
the transaction, subject to the completion of our customary due diligence, is
expected to close by March 31, 2005. We plan to fund these acquisitions through
the assumption of $13.0 million in long-term secured debt and borrowings under
our Line of Credit.
On November 1, 2004, we completed our acquisition of the remaining two hotels.
These properties consist of a 93-room Courtyard by Marriott in Dalton, Georgia
and a 112-room Hilton Garden Inn in Louisville, Kentucky. These hotels represent
205 rooms and have an average age of five years. The total purchase price for
these hotels is $14.4 million, which we funded through proceeds from our October
2004 common stock offering.
Common Stock Offering
On April 7, 2004, we completed an offering of 2.4 million shares of common stock
that resulted in net proceeds of approximately $21.4 million. The proceeds were
used to fund approximately $13.3 million of our acquisitions discussed above,
with the remaining funds being utilized to pay down our Line of Credit.
On October 19, 2004, we completed an offering of approximately 5.3 million
shares of common stock that resulted in net proceeds of approximately $49.5
million. The proceeds were used to partially fund the previously announced
acquisitions of five hotels in southern Florida, with the remaining proceeds
being utilized for general corporate purposes, further acquisitions and to pay
down our Line of Credit. Additionally, the offering is subject to an
underwriters' 30-day over- allotment of an additional 787,500 shares of common
stock.
39
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
OTHER DEVELOPMENTS, Continued
Hotel Sales
During the first quarter of 2004, we sold three hotels for approximately $10.9
million, including $9.1 million of cash (after selling costs of approximately
$980,000) and an increase to an existing note receivable of approximately
$800,000. The hotels sold were a 97-room Hampton Inn located in Sarasota,
Florida, a 122-room Hampton Inn located in Jacksonville, Florida, and a 141-room
Comfort Inn located in Arlington, Texas. The average age of these hotels was
approximately 17 years. We utilized the net proceeds from the dispositions to
pay down existing long-term debt. These sales represent the last of our hotels
that were previously classified as discontinued operations.
Hotel Development
We intend to develop a 200-room, full service Marriott hotel in Sandy, Utah, a
suburb of Salt Lake City, Utah. We estimate that the development cost of this
hotel will be approximately $24.0 million, including approximately $2.2 million
in land previously purchased by us, and the hotel should be completed by
mid-2007. For 2004, we expect to fund up to $500,000 related to the development
of this hotel, principally through borrowings under our Line of Credit. We plan
to obtain additional financing sources to complete the development of this
hotel.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain financial market risks, the most predominant of which
is the fluctuation in interest rates. At September 30, 2004, our exposure to
market risk for a change in interest rates is related to our debt outstanding
under the Line of Credit and certain hotel secured debt. Total debt outstanding
under these two debentures totaled approximately $71.7 million at September 30,
2004.
Our Line of Credit bears interest at a variable rate of LIBOR plus 2.25% to 3.0%
per annum as determined by our quarterly leverage. At September 30, 2004, our
interest rate on our Line of Credit was LIBOR (1.84% at September 30, 2004) plus
2.75%. Our interest rate risk objective is to limit the impact of interest rate
fluctuations on earnings and cash flows and to lower our overall borrowing
costs. To achieve this objective, we manage our exposure to fluctuations in
market interest rates for our borrowings through the use of fixed-rate debt
instruments to the extent that reasonably favorable rates are obtainable through
such arrangements and derivative financial instruments such as interest rate
swaps, to effectively lock the interest rate on a portion of our variable rate
debt. We do not enter into derivative or interest rate transactions for
speculative purposes. We also regularly review interest rate exposure on our
outstanding borrowings in an effort to minimize the risk of interest rate
fluctuation.
In 2003, we entered into an interest rate swap agreement with a financial
institution on a notional amount of $25.0 million. The agreement expires in
November 2008. The agreement effectively fixes the interest rate on the first
$25.0 million of floating rate debt outstanding under our Line of
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Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, Continued
Credit at a rate of 3.875% per annum plus the interest rate spread on our Line
of Credit, thus reducing our exposure to interest rate fluctuations. The
notional amount does not represent amounts exchanged by the parties, and thus is
not a measure of exposure to us. The differences to be paid or received by us
under the interest rate swap agreement are recognized as an adjustment to
interest expense. The agreement is with a major financial institution, which is
expected to fully perform under the terms of the agreement.
In 2003, we entered into an interest rate swap agreement with a financial
institution on a notional amount of $25.0 million. The agreement expires in
November 2006. The agreement effectively fixes the interest rate on the second
$25.0 million of floating rate debt outstanding under our Line of Credit at a
rate of 3.22% per annum plus the interest rate spread on our Line of Credit,
thus reducing our exposure to interest rate fluctuations. The notional amount
does not represent amounts exchanged by the parties, and thus is not a measure
of exposure to us. The differences to be paid or received by us under the
interest rate swap agreement are recognized as an adjustment to interest
expense. The agreement is with a major financial institution, which is expected
to fully perform under the terms of the agreement.
Our Line of Credit matures in June 2006. As discussed above, our Line of Credit
bears interest at variable rates, and therefore, cost approximates market value.
At September 30, 2004, the fair value of our interest rate swaps was a liability
of approximately $566,000.
Our operating results are affected by changes in interest rates, primarily as a
result of our borrowings under the Line of Credit. If interest rates increased
by 25 basis points, our interest expense would have increased by approximately
$40,000, based on balances outstanding during the nine months ended September
30, 2004.
ITEM 4. CONTROLS AND PROCEDURES
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, we carried
out an evaluation, with the participation of the Company's management, including
Phillip H. McNeill, Sr., the Company's Chief Executive Officer ("CEO") and J.
Mitchell Collins, the Company's Chief Financial Officer ("CFO"). Based upon that
evaluation, the Company's CEO and CFO concluded that the Company's disclosure
controls and procedures are effective in timely alerting them to material
information relating to the Company required to be included in the Company's
periodic SEC filings. There has been no change in the Company's internal control
over financial reporting during the quarter ended September 30, 2004 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in various legal actions arising in the ordinary course of
business. Management does not believe that any of the pending actions will have
a material adverse effect on our business, financial condition or results of
operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -- The following exhibits were filed with this Quarterly Report on
Form 10-Q:
31.1 -- Rule 13a-14(a) Certification of Phillip H. McNeill, Sr.
31.2 -- Rule 13a-14(a) Certification of J. Mitchell Collins
32.1 -- Section 1350 Certification of Phillip H. McNeill, Sr.
32.2 -- Section 1350 Certification of J. Mitchell Collins
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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.
Equity Inns, Inc.
November 9, 2004 By: /s/J. Mitchell Collins
- ---------------------- -------------------------------------------------
Date J. Mitchell Collins
Executive Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer),
Secretary and Treasurer
43