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 March 31, 2005 Commission File Number 01-12073
EQUITY INNS, INC.
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(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
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(Address of Principal Executive Office) (Zip Code)
(901) 754-7774
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(Registrant's Telephone Number, Including Area Code)
Not Applicable
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(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.
Yes X 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 May 5, 2005 was 53,970,066.
1 of 39
EQUITY INNS, INC.
INDEX
PAGE
PART I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - March 31, 2005
(unaudited) and December 31, 2004 3
Condensed Consolidated Statements of Operations
(unaudited) - For the three months ended March 31,
2005 and 2004 4
Condensed Consolidated Statements of Cash Flows
(unaudited) - For the three months ended March 31,
2005 and 2004 5
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 35
Item 4. Controls and Procedures 36
PART II. Other Information
Item 1. Legal Proceedings 37
Item 6. Exhibits 37
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EQUITY INNS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31, December 31,
2005 2004
----------- ------------
(unaudited)
ASSETS
Investment in hotel properties, net $868,386 $852,755
Assets held for sale - 3,849
Cash and cash equivalents 10,403 6,991
Accounts receivable, net of doubtful
accounts of $225 and $225, respectively 9,259 7,543
Interest rate swaps 662 -
Deferred expenses, net 8,309 8,679
Deposits and other assets, net 12,979 13,437
-------- --------
Total Assets $909,998 $893,254
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Long-term debt $428,966 $439,183
Accounts payable and accrued expenses 32,099 30,366
Distributions payable 9,568 8,090
Interest rate swaps - 119
Minority interests in Partnership 9,197 9,064
-------- --------
Total Liabilities 479,830 486,822
-------- --------
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, 54,715,041 and 51,872,460
shares issued and outstanding 547 519
Additional paid-in capital 572,404 542,397
Treasury stock, at cost, 747,600 shares (5,173) (5,173)
Unearned directors' and officers' compensation (2,980) (2,211)
Distributions in excess of net earnings (218,816) (212,505)
Unrealized gain (loss) on interest rate swaps 662 (119)
-------- --------
Total Shareholders' Equity 430,168 406,432
-------- --------
Total Liabilities and Shareholders' Equity $909,998 $893,254
======== ========
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 Ended
March 31,
-----------------------------
2005 2004
------- -------
Revenue:
Room revenue $71,919 $51,492
Other hotel revenue 3,121 2,572
Other revenue 106 99
------- -------
Total revenue 75,146 54,163
Operating expenses:
Direct hotel expenses 41,436 31,387
Other hotel expenses 2,430 1,971
Depreciation 11,400 9,403
Property taxes, rental expense and insurance 5,403 4,437
General and administrative expenses:
Non-cash stock-based compensation 435 159
Other general and administrative expenses 2,132 1,968
------- -------
Total operating expenses 63,236 49,325
------- -------
Operating income 11,910 4,838
Interest expense, net 8,178 6,740
------- -------
Income (loss) from continuing operations
before minority interests and income taxes 3,732 (1,902)
Minority interests income (expense) (49) 107
Deferred income tax benefit (expense) - -
------- -------
Income (loss) from continuing operations 3,683 (1,795)
Discontinued operations:
Gain (loss) on sale of hotel properties - (320)
Loss on impairment of hotels held for sale - -
Income (loss) from operations of discontinued operations (30) (83)
------- -------
Income (loss) from discontinued operations (30) (403)
------- -------
Net income (loss) 3,653 (2,198)
Preferred stock dividends (1,887) (1,887)
------- -------
Net income (loss) applicable to common shareholders $ 1,766 $(4,085)
======= =======
Net income (loss) per share data: Basic and diluted income (loss)
per share:
Continuing operations $ 0.03 $ (0.09)
Discontinued operations (0.00) (0.01)
------- -------
Net income (loss) per common share $ 0.03 $ (0.10)
======= =======
Weighted average number of common
shares outstanding, basic and diluted 52,070 42,881
======= =======
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 Three Months Ended
March 31,
-----------------------------
2005 2004
-------- --------
Cash flows from operating activities:
Net income (loss) $ 3,653 $ (2,198)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
(Gain) loss on sale of hotel properties - 320
Depreciation 11,400 9,403
Depreciation of discontinued operations - 88
Amortization of loan costs and franchise fees 547 445
Amortization of mortgage note premium (341) -
Non-cash stock-based compensation 435 159
Minority interests (income) expense 49 (107)
Changes in operating assets and liabilities:
Accounts receivable (1,716) (1,637)
Deposits and other assets 458 (1,207)
Accounts payable and accrued expenses 2,286 133
Other (19) 26
-------- --------
Net cash provided by (used in) operating activities 16,752 5,425
-------- --------
Cash flows from investing activities:
Improvements and additions to hotel properties (6,405) (3,292)
Acquisition of hotel properties (20,607) (13,229)
Payments for franchise applications (150) (25)
Proceeds from principal payments on notes receivable - 24
Net proceeds from sale of hotel properties 3,849 9,122
-------- --------
Net cash provided by (used in) investing activities (23,313) (7,400)
-------- --------
Cash flows from financing activities:
Gross proceeds from public offering of common stock 29,835 -
Payment of offering expenses (1,258) -
Distributions paid (8,701) (7,568)
Payments for loan costs (28) (264)
Proceeds from borrowings 32,400 22,000
Payments on long-term debt (42,275) (10,279)
-------- --------
Net cash provided by (used in) financing activities 9,973 3,889
-------- --------
Net increase (decrease) in cash 3,412 1,914
Cash and cash equivalents at beginning of period 6,991 8,201
-------- --------
Cash and cash equivalents at end of period $ 10,403 $ 10,115
======== ========
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 anticipated award based on the
shares of common stock times the closing price of our common stock on date of
issuance.
Three Months Ended March 31, 2005
During January 2005, we issued to several key officers, 83,850 shares of
restricted common stock at prices ranging from $10.90 to $11.74 per share under
the 1994 Stock Incentive Plan as part of management's long-term incentive
compensation.
During February 2005, we issued to three of our officers, 49,445 shares of
common stock at $11.20 per share under the 1994 Stock Incentive Plan in lieu of
cash as a performance bonus.
During February 2005, we issued to one of our outside directors, 5,000 shares of
restricted common stock at $11.12 per share under the 1994 Stock Incentive Plan.
During the three months ended March 31, 2005, we declared approximately $8.3
million in common stock and unit dividends. We paid these dividends on May 2,
2005.
During the three months ended March 31, 2005, we issued 4,286 shares of common
stock at prices ranging from $10.86 to $11.74 per share to our independent
directors in lieu of cash as compensation.
Three Months Ended March 31, 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 March 2004, we completed the purchase of a Marriott Residence Inn hotel
and assumed $6.3 million in long-term debt.
During the three months ended March 31, 2004, we declared approximately $5.7
million in common stock and unit dividends. We paid these dividends on May 3,
2004.
During the three months ended March 31, 2004, we issued 36,113 shares of common
stock upon redemption of Partnership units.
During the three months ended March 31, 2004, we issued 3,142 shares of common
stock at prices ranging from $9.05 to $9.17 per share to our independent
directors in lieu of cash as compensation.
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 March 31, 2005 owned an
approximate 97.4% 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 March 31, 2005, the independent managers of
our hotels are as follows:
Number of Hotels
----------------
Interstate Hotels & Resorts, Inc. 48
Hilton Hotels Corporation 16
Hyatt Corporation 18
McKibbon Hotel Group 14
Other (5) 15
---
111
===
Our management agreements with Hyatt, which purchased the AmeriSuites
brand in January 2005 from the Blackstone Group, which purchased the
brand from Prime Hospitality Corporation in October 2004, 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, Hyatt's 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 exceeds 6.5% of gross hotel revenue, Hyatt's 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, Hyatt'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 Hyatt's subsidiaries for 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 existing
franchise agreements to 2028 and the management agreements to 2010, as
long as Hyatt continues to be in compliance with the minimum net
7
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
1. Organization, Continued
operating income guarantees in the original agreements. For the three
months ended March 31, 2005 and 2004, we recorded approximately $1.5
million and $1.6 million, respectively, in minimum income guarantees from
Hyatt 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 four 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, 2004. 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 period(s) are not necessarily indicative of
the results to be expected for the full year.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its consolidated subsidiaries. All significant intercompany balances
and transactions have been eliminated.
Certain prior period amounts have been reclassified to conform to the
current year presentation.
Use of Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires us
to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
8
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
2. Summary of Significant Accounting Policies, Continued
Investment in Hotel Properties
Our hotel properties are recorded at cost. We compute depreciation using
the straight-line method over the estimated useful lives of the assets
which range from 5 to 40 years for buildings and components and 5 to 7
years for furniture and equipment.
We record maintenance and repairs expense as incurred, and major renewals
and improvements are capitalized. Upon disposition, both the asset and
accumulated depreciation accounts are relieved, and the related gain or
loss is credited or charged to the statement of operations.
We record an impairment charge when we believe an investment in a hotel
has been impaired such that future undiscounted cash flows would not
recover the book basis of the hotel property, or the hotel is being held
for sale. 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.
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 the
Company identifies 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 record an impairment charge for
the estimated loss. We no longer record depreciation expense once we
identify an asset as held for sale. Net realizable value is estimated as
the amount at which we believe the asset could be bought or sold (fair
value) less costs to sell. We estimate the fair value by determining
prevailing market conditions, appraisals or current estimated net sales
proceeds from pending offers, if appropriate. We record operations for
hotels designated as held for sale and hotels which have been sold as
part of discontinued operations for all periods presented. We also
allocate to discontinued operations the estimated 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. For the three months
ended March 31, 2005 and 2004, we did not realize any losses on
impairments of hotels held for sale. Impairments recorded, if any, are
reflected as a component of discontinued operations for the respective
periods in the accompanying condensed consolidated statements of
operations.
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.
9
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
2. Summary of Significant Accounting Policies, Continued
Distributions
We pay 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 covenants imposed by our Line of Credit and other debt
documents, and any other matters that our Board deems relevant.
Net Income Per Common Share
We compute basic earnings per common share from continuing operations by
taking our income (loss) from continuing operations as adjusted for gains
or losses on the sale of hotel properties not included in discontinued
operations and dividends on our preferred stock, divided by the weighted
average number of shares of our common stock outstanding. We compute
diluted earnings per common share from continuing operations by taking
our income (loss) from continuing operations as adjusted for gains or
losses on the sale of hotel properties not included in discontinued
operations and dividends on our preferred stock, divided by the weighted
average number of shares of our common stock outstanding plus other
potentially dilutive securities.
Potential dilutive securities included in our 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 months ended March 31, 2005
and 2004 were not included in the computation of diluted earnings per
share because their effect would have been anti-dilutive.
Stock-Based Compensation
At March 31, 2005, we have two stock-based employee and director
compensation plans. Prior to January 1, 2003, we accounted for these
plans under the recognition and measurement provisions of APB No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
In December of 2002, the Financial Accounting Standards Board ("FASB")
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 elected to adopt the recognition
provisions of SFAS No. 123 under the prospective method as defined in
SFAS No. 148 on January 1, 2003. Under the prospective method, we will
apply the fair value based method of accounting for stock-based employee
compensation prospectively to all awards granted, modified or settled
beginning January 1, 2003. There were no material grants, modifications
or settlements of options to purchase shares of our common stock made
during the three months ended March 31, 2005 and 2004.
10
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
2. Summary of Significant Accounting Policies, Continued
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.
Concentration of Credit Risk
At March 31, 2005, we own 4,576 hotel rooms or approximately 34% of our
total hotel rooms in the South Atlantic region of the United States,
which includes 1,893 hotel rooms or approximately 13.9% of our total
hotel rooms in the state of Florida.
3. Investment in Hotel Properties
During the three months ended March 31, 2005, we purchased two hotels for
approximately $20.6 million related to previously announced acquisitions.
The hotels were purchased from two hotel developers. These hotels
represent a combined 204 rooms and have an average age of approximately
five years. We funded these acquisitions primarily through borrowings
under our Line of Credit.
The hotel acquisitions that we completed for the three months ended March
31, 2005 are as follows:
Hotel Location Rooms Date Acquired
------------------------- --------------------- ----- -------------
Hilton Garden Inn Fort Myers, Florida 126 March 1, 2005
Residence Inn by Marriott Jacksonville, Florida 78 March 9, 2005
Based on our estimate of fair value, we allocated the purchase price of
these hotels at March 31, 2005 as follows (in thousands):
Land $ 2,025
Buildings and improvements 16,623
Furniture and equipment 1,959
-------
$20,607
=======
During 2004, we purchased 20 hotels for approximately $192.9 million
related to previously announced acquisitions. The hotels were purchased
from three hotel developers. These hotels represent a combined 1,871
rooms and have an average age of approximately five years. Of the 20
hotels purchased, 13 hotels are managed by McKibbon Hotel Management,
Inc., five hotels are managed by Hospitality Group, Inc. and two hotels
are managed by Gateway Lodging Company, Inc. We funded these acquisitions
primarily
11
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
3. Investment in Hotel Properties, Continued
through $74.6 million in net cash proceeds from April 2004 and October
2004 issuances of our common stock, the issuance of approximately 325,000
Partnership units valued at approximately $3.2 million, the assumption of
approximately $54.1 million in secured long-term debt, the issuance of
approximately $40.6 million in secured long-term debt and approximately
$20.4 million in borrowings under our Line of Credit. Included in our
debt assumption is a mortgage note premium of approximately $4.9 million
to record the debt at its estimated fair value. This premium is being
amortized using the interest method over the remaining lives of the
assumed debt as a reduction of interest expense.
The following unaudited pro forma results are presented as if all
acquisitions for the year ended December 31, 2004 and the three months
ended March 31, 2005 had occurred on January 1, 2004 (in thousands,
except per share data):
Three Months Ended
March 31,
-----------------------------
2005 2004
------- -------
Revenues
Equity Inns, as reported $75,146 $54,163
Acquisitions 1,316 15,612
------- -------
Pro forma combined revenues $76,462 $69,775
======= =======
Net income (loss) applicable to
common shareholders
Equity Inns, as reported $ 1,766 $(4,085)
Acquisitions 441 3,481
------- -------
Pro forma combined net income (loss) $ 2,207 $ (604)
======= =======
Pro forma basic and diluted income (loss)
per share $ 0.04 $ (0.01)
======= =======
Pro forma weighted average number of
common shares outstanding - basic and
diluted 52,070 42,881
======= =======
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, 2004, or of future results.
During the three months ended March 31, 2005 and 2004, we invested
approximately $6.4 million and $3.3 million, respectively, 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 $25.0 million in 2005 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.
12
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
3. Investment in Hotel Properties, Continued
During late 2004, we recorded a charge for impairment of approximately
$1.9 million in accordance with SFAS No. 144, "Accounting For Impairment
or Disposal of Long-Lived Assets," based on the estimated net realizable
value of a hotel held for sale. This hotel was subsequently sold in
January 2005 for its approximate carrying value of $3.8 million. The
hotel sold was a 123-room Hampton Inn located in Birmingham, Alabama. The
age of the hotel was approximately 18 years.
During late 2004, we experienced significant hurricane damage at one of
our hotels located in Jacksonville Beach, Florida. This hotel was
subsequently repaired and became operational in late January 2005. The
total cost of the hurricane loss is estimated to be approximately $4.1
million, and we are currently working with our insurance carrier in
processing this claim. Based on the total estimated project cost, the
estimated net insurance proceeds and the estimated net book value of the
assets destroyed, we expect to record a net gain on insurance proceeds
upon the conclusion of the processed claim. This gain will be recorded
upon receipt of the net insurance proceeds and closure of the insurance
claim.
During the three months ended March 31, 2004, we sold three hotels
previously classified as held for sale 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. In
conjunction with these sales, we recorded a loss of approximately
$320,000 as part of discontinued operations in the accompanying condensed
consolidated statement of operations.
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 the
Company identifies 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 record an impairment charge for
the estimated loss. We no longer record depreciation expense once we
identify an asset as held for sale. Net realizable value is estimated as
the amount at which we believe the asset could be bought or sold (fair
value) less costs to sell. We estimate the fair value by determining
prevailing market conditions, appraisals or current estimated net sales
proceeds from pending offers, if appropriate. We record operations for
hotels designated as held for sale and hotels which have been sold as
part of discontinued operations for all periods presented. We also
allocate to discontinued operations the estimated 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. For the three months
ended March 31, 2005 and 2004, we did not realize any losses on
impairments of hotels held for sale. Impairments recorded, if any, are
reflected as a component of discontinued operations for the respective
periods in the accompanying condensed consolidated statements of
operations.
13
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
4. Long-Term Debt
The following details our debt outstanding at March 31, 2005 and December
31, 2004 (dollars in thousands):
Principal Balance Collateral Net Book
------------------------- Interest # of Value at
3/31/05 12/31/04 Rate Maturity Hotels 12/31/04
-------- -------- --------------------- ----------- ---------- --------
Commercial Mortgage
Bonds
Class A $ - $ - 6.83% Fixed Nov 2006
Class B 45,099 45,802 7.37% Fixed Dec 2015
Class C 10,000 10,000 7.58% Fixed Feb 2017
-------- --------
q 55,099 55,802 18 $ 98,167
Line of Credit 64,500 72,000 LIBOR plus
Percentage Variable June 2006 25 218,863
Mortgage 88,841 89,318 8.37% Fixed July 2009 19 151,967
Mortgage 65,519 65,823 8.25% Fixed Nov 2010 16 101,659
Mortgage 33,939 34,089 8.25% Fixed Nov 2010 8 53,625
Mortgage 10,578 10,652 LIBOR plus
285 pts. Variable Aug 2008 1 14,656
Mortgage 2,785 2,811 6.00% Fixed May 2008 1 6,625
Mortgage 3,271 3,320 6.37% Fixed Nov 2016 1 7,783
Mortgage 6,250 6,276 8.70% Fixed Nov 2010 1 10,607
Mortgage 4,241 4,268 7.97% Fixed Oct 2007 1 7,180
Mortgage 5,226 5,258 7.97% Fixed Oct 2007 1 8,002
Mortgage 4,429 4,457 7.10% Fixed Sept 2008 1 9,020
Mortgage 3,765 3,787 8.04% Fixed Nov 2007 1 6,802
Mortgage 5,245 5,276 8.04% Fixed Nov 2007 1 7,861
Mortgage 3,143 3,160 9.375% Fixed April 2007 1 6,396
Mortgage 3,363 3,381 9.375% Fixed April 2007 1 6,599
Mortgage 5,114 5,145 8.04% Fixed Nov 2007 1 6,529
Mortgage 3,923 3,938 9.375% Fixed April 2007 1 7,338
Mortgage 3,839 3,854 9.05% Fixed May 2007 1 9,364
Mortgage 5,931 5,958 5.83% Fixed July 2014 1 9,502
Mortgage 40,231 40,508 5.64% Fixed Nov 2014 5 73,805
Mortgage 5,673 5,700 5.39% Fixed Dec 2014 1 10,763
-------- -------- --- --------
424,905 434,781 107 $833,113
=== ========
Unamortized Mortgage
Note Premium 4,061 4,402
-------- --------
$428,966 $439,183
======== ========
Our hotel acquisitions completed during the three months ended March 31,
2005 were funded primarily through borrowings under our Line of Credit.
Our hotel acquisitions completed during the three months ended March 31,
2004 were funded primarily through borrowings under our Line of Credit
and the assumption of approximately $6.3 million in secured long-term
debt.
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 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 March 31, 2005, the
interest rate on our Line of Credit was LIBOR (2.85% at March 31, 2005)
plus 2.50%. Fees ranging from .45% to .60% per annum, as determined by
our ratio
14
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
4. Long-Term Debt, Continued
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 March 31, 2005, 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. At March 31,
2005, our debt has maturity dates that range from June 2006 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 2005, 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 March 31, 2005,
we had an additional borrowing capacity of approximately $42.2 million
under our Line of Credit.
5. 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. 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.
15
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
6. Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income," requires the disclosure
of the components included in comprehensive income (loss). For the three
months ended March 31, 2005, we recorded comprehensive income of
approximately $4.5 million, comprised of net income of approximately $3.7
million and the change in unrealized loss on our interest rate swap of
approximately $780,000.
7. Income Taxes
The components of our deferred income tax benefit (expense) related to
our TRS Lessees for the three months ended March 31 are as follows (in
thousands):
2005 2004
------- -------
Deferred:
Federal $ 1,362 $ 1,419
State 118 123
Valuation allowance (1,480) (1,542)
------- ------
Deferred income tax benefit
(expense), net $ - $ -
======= =======
The deferred income tax benefit (expense) and related deferred tax asset
was historically calculated using a statutory tax rate of 38% applied to
the losses of our TRS Lessees. In 2003, we determined that a valuation
allowance was necessary for the entire deferred income tax asset due to
the continued softness in the lodging industry and the uncertainty
associated with its future recovery. Additionally, we discontinued
recording a deferred income tax benefit beginning in 2004. At March 31,
2005, we have a valuation allowance for a deferred income tax asset of
approximately $22.4 million that is comprised of the tax effect of net
operating loss carryforwards that will expire in years beginning after
2021.
8. 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
2004.
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
16
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
8. Discontinued Operations, Continued
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 record an impairment charge 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 late 2004, we recorded a charge for impairment of approximately
$1.9 million based on the estimated net realizable value of a hotel held
for sale. This hotel was subsequently sold in January 2005 for its
approximate carrying value of $3.8 million. The hotel sold was a 123-room
Hampton Inn located in Birmingham, Alabama. The age of the hotel was
approximately 18 years.
During the three months ended March 31, 2004, we sold three hotels
previously classified as held for sale 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. In
conjunction with these sales, we recorded a loss of approximately
$320,000 as part of discontinued operations in the accompanying condensed
consolidated statement of operations.
17
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
8. Discontinued Operations, Continued
For all periods presented, the operations of all of our hotels classified
as held for sale are included in the accompanying condensed consolidated
statements of operations under the heading "Income (loss) from
discontinued operations." The components of income (loss) from
discontinued operations for the three months ended March 31 are shown
below (in thousands):
2005 2004
------ ------
Revenue:
Room revenue $ 93 $ 722
Other hotel revenue 5 24
Operating costs:
Direct hotel expenses 66 607
Other hotel expenses 4 49
Depreciation - 88
Property taxes, rental expense
and insurance 58 63
Amortization of franchise fees - 3
Interest expense - 19
---- -----
Income (loss) from operations of
discontinued operations (30) (83)
Gain (loss) on sale of hotel properties - (320)
Loss on impairment of hotels held for sale - -
---- -----
Income (loss) from discontinued
operations $(30) $(403)
==== =====
9. Commitments and Contingencies
At March 31, 2005, all of our hotels are operated under franchise
agreements and are licensed as Hampton Inn (48), AmeriSuites (18),
Residence Inn (18), Homewood Suites (9), Courtyard by Marriott (8),
Holiday Inn (4), Comfort Inn (2), Hilton Garden Inn (2), Hampton Inn &
Suites (1) and SpringHill Suites (1). The TRS Lessees hold the
franchise licenses for our hotels. The franchise agreements generally
require the payment of fees based on a percentage of hotel room
revenue.
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 2005, we expect that amounts expended will exceed, in
the aggregate, the amounts
18
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
9. Commitments and Contingencies, Continued
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.
Our Partnership is obligated to pay the costs of real estate and
personal property taxes and to maintain underground utilities and
structural elements of our hotels. In addition, the Partnership is
obligated to fund the cost of periodic repair and the replacement and
refurbishment of furniture, fixtures and equipment in our hotels. We
also may be required by our franchisors to fund certain capital
improvements to our hotels, which we fund from borrowings under our
Line of Credit, operating cash flows, or the room renovation accounts.
For the three months ended March 31, 2005 and 2004, capital
improvements of approximately $6.4 million and $3.3 million,
respectively, were made to our 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 March 31, 2005, the maximum amount of cash compensation that would
be payable under all agreements, if a change of control occurred, would
be approximately $8.0 million. Additionally, vesting of certain
restricted stock held by our senior officers would accelerate under a
change of control.
We are also 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.
10. Capital Stock
On March 4, 2005, we completed an offering of approximately 2.7 million
shares of common stock for net proceeds of approximately $28.5 million.
The proceeds will be used for identified acquisitions and to repay
indebtedness under our Line of Credit.
11. Subsequent Events
On April 29, 2005, we completed the acquisition of a 93-room Marriott
Courtyard hotel located in Bowling Green, Kentucky, for approximately
$6.9 million, including the assumption approximately of $3.2 million in
secured long-term debt.
On May 2, 2005, we completed the acquisition of an 81-room Marriott
Courtyard hotel located in Jacksonville, Florida, for approximately
$6.4 million, including the assumption of approximately $4.0 million in
secured long-term debt.
19
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; risks 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 16, 2005, 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 intend 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
March 31, 2005 owned an approximate 97.4% 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. Since then, we have grown with a focus on both geographic and brand
diversity. We believe that diversity in our asset portfolio reduces operational
variances from year-to-year and results in less volatility as compared to the
overall hotel industry.
At March 31, 2005, we owned 111 hotel properties with a total of 13,589 rooms
located in 34 states. In order to qualify as a REIT, we cannot operate hotels.
Therefore, our hotels are leased to our TRS Lessees and are managed by unrelated
third parties. By maintaining these leases through our TRS Lessees, we realize
the economic benefits and risks of operating these hotels and report all hotel
revenues and expenses in the accompanying condensed consolidated statements of
operations.
We maintain management agreements with unrelated third parties for our hotels
that range in remaining terms from one to four years. The majority of our
management contracts renew annually. The management fees consist of a base fee
ranging from 1.5% to 3.0% of hotel revenues and an incentive fee consisting of a
20
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
percentage of gross operating profits in excess of budget, as defined by the
management agreements. These fees are recorded by us as a component of direct
hotel expenses in our accompanying condensed consolidated statements of
operations.
The diversity of our portfolio is such that, at March 31, 2005, no individual
hotel exceeded 1.9% of the total rooms in the portfolio. Our geographical
distribution and franchise diversity is illustrated by the following charts.
Brand Diversity
Number of Number of
Brand Affiliation Hotel Properties Rooms/Suites
----------------- ---------------- ------------
Midscale Limited Service Hotels:
Hampton Inn (1) 48 5,989
Comfort Inn (4) 1 104
--- ------
Sub-total 49 6,093
All-Suite Hotels:
AmeriSuites (3) 18 2,291
Hampton Inn & Suites (1) 1 161
SpringHill Suites (2) 1 88
--- ------
Sub-total 20 2,540
Upscale Extended Stay Hotels:
Residence Inn (2) 18 1,907
Homewood Suites (1) 9 1,295
--- ------
Sub-total 27 3,202
Full Service Hotels:
Courtyard (2) 8 782
Hilton Garden Inn (1) 2 238
Comfort Inn (4) 1 177
Holiday Inn (5) 4 557
--- ------
Sub-total 15 1,754
--- ------
Total 111 13,589
=== ======
Franchise Affiliation
(1) Hilton Hotels Corporation
(2) Marriott International, Inc.
(3) Hyatt Corporation, which purchased the AmeriSuites brand from the
Blackstone Group in January 2005, which purchased the brand from Prime
Hospitality Corporation in October 2004
(4) Choice Hotels International, Inc.
(5) Intercontinental Hotels Group, PLC
21
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
We believe that geographic diversity helps to limit our exposure to any one
market. The following table illustrates our geographic presence by the number of
rooms at March 31, 2005:
Region
------------------
East North Central 13.9%
East South Central 13.6%
Middle Atlantic 6.1%
Mountain 9.5%
New England 4.4%
Pacific Northwest 2.4%
South Atlantic 33.7%
West North Central 6.1%
West South Central 10.3%
Our hotel portfolio includes upscale extended stay hotels, all-suite hotels,
midscale limited service hotels and full service hotels. This array of product
offerings coupled with a property mix that is spread between suburban and urban
locations helps to insulate us from various economic climates, including a
depressed business travel climate.
The following table sets forth certain information for the three months ended
March 31, 2005 and 2004 with respect to our hotels:
Three Months Ended March 31, 2005 (1) Three Months Ended March 31, 2004 (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 48 5,989 64.0% $83.29 $53.26 60.8% $76.60 $46.56
AmeriSuites 18 2,291 65.1% $77.96 $50.73 61.8% $73.89 $45.64
Residence Inn 18 1,907 73.9% $95.29 $70.45 74.5% $88.43 $65.90
Homewood Suites 9 1,295 75.1% $106.47 $80.01 73.0% $100.87 $73.59
Courtyard 8 782 77.1% $92.57 $71.64 75.0% $91.04 $68.25
Holiday Inn 4 557 55.7% $59.66 $33.23 51.0% $60.24 $30.74
Comfort Inn 2 281 66.3% $99.92 $66.25 71.4% $85.03 $60.70
Hilton Garden Inn 2 238 75.0% $128.38 $96.34 75.7% $110.42 $83.54
Hampton Inn & Suites 1 161 91.3% $154.70 $141.25 91.9% $125.81 $115.62
SpringHill Suites 1 88 59.0% $67.13 $40.15 62.9% $61.50 $38.68
---- -------- ----- ------ ------ ----- ------ ------
111 13,589 67.6% $88.81 $60.01 65.3% $82.68 $54.01
=== ====== ===== ====== ====== ===== ====== ======
Notes
(1) Represents "all comparable" statistics for hotels owned by us at the latest
period end as if we had owned the hotels for both periods presented. (2)
Determined by multiplying occupancy times the average daily rate.
22
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
Approximately 95% of our hotel portfolio is comprised of the following leading
franchise brands: Homewood Suites, Hilton Garden Inn, Hampton Inn & Suites and
Hampton Inn by Hilton, Residence Inn, Courtyard and SpringHill Suites by
Marriott and AmeriSuites by Hyatt. We believe that multiple brands at the
midscale, upscale extended stay and all-suite levels 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 significant brands are as follows:
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
Business Travel News in 2005.
Hampton Inn by Hilton:
A premier midscale without food and beverage hotel chain with over 1,000
locations. Rated the #1 midprice without food and beverage by Business Travel
News in 2005.
Residence Inn by Marriott:
A premier upscale extended stay hotel, focusing on extended stay, corporate
transient and family travelers. Rated the #2 extended stay hotel brand by
Business Travel News in 2005.
Courtyard by Marriott:
An upscale full service hotel designated as the hotel designed by business
travelers for business travelers. Rated the #1 midprice with food and
beverage by Business Travel News in 2005.
AmeriSuites by Hyatt:
An upscale all-suite hotel, billed as America's most affordable all-suite
hotel.
Approximately 95% of our hotels are branded by Marriott, Hilton and Hyatt, which
provide national marketing support and frequent stay programs that continue to
drive additional revenue. We believe that better brands generate RevPAR premiums
over their peers and focusing on these premium 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 that provide for strong operating incentive management fees, we
believe that we have better control over the operating results of our hotels. At
March 31, 2005, our hotel managers are as follows:
Number of Hotels
----------------
Interstate Hotels & Resorts, Inc. 48
Hilton Hotels Corporation 16
Hyatt Corporation 18
McKibbon Hotel Group 14
Other (5) 15
---
111
===
23
Management's Discussion and Analysis of
Financial Condition and Results of Operations, 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, supply of rooms in the market and price are the principal competitive
factors affecting our hotels.
FRANCHISE AGREEMENTS
A part of our asset management program is the licensing of all of our hotels
under nationally franchised brands. We believe that the public's perception of
quality associated with a franchisor is an important feature in the operation of
a hotel. We also believe that franchised properties generally have higher levels
of RevPAR than unfranchised properties due to access to national reservation
systems and advertising and marketing programs provided by franchisors. Our
franchise agreements generally have initial terms ranging from 10 to 25 years
and expire beginning in 2005 through 2028. Franchise renewal procedures are
currently underway for several of our hotels.
We are also committed to franchisors to make certain capital improvements to our
hotel properties, which will be funded primarily through our operating cash
flows. In 2005, we expect to fund approximately $25.0 million of capital
improvements to our hotels, with approximately $13.0 million representing major
refurbishment projects to six hotels.
SEASONALITY
Our operations historically have been seasonal in nature, generally reflecting
higher 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.
24
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
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, 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.
The REIT Modernization Act ("RMA"), which generally took effect on January 1,
2001, includes several REIT provisions which revised extensively the tax rules
applicable to our TRS Lessees. Under the RMA provisions, we are allowed to own
all of the stock in our TRS Lessees. In addition, our TRS Lessees are allowed to
perform "non-customary" services for hotel guests and are permitted to enter
into many new businesses. However, our TRS Lessees are not allowed to manage
hotels. Instead, our TRS Lessees are required to enter into management contracts
for our hotels with independent management companies. The use of TRS Lessees,
however, is subject to certain restrictions, including the following:
o no more than 20% of our assets may consist of securities of our TRS
Lessees;
o the tax deductibility of interest paid or accrued by our TRS Lessees to
us is limited; and
o a 100% excise tax is imposed on non-arm's length transactions between
TRS Lessees and us or our tenants.
ENVIRONMENTAL MATTERS
In connection with most of our acquisitions, Phase I environmental site
assessments were obtained for our hotels. These assessments included historical
reviews of the hotels, reviews of certain public records, preliminary
investigations of the sites and surrounding properties, screenings for hazardous
and toxic substances and underground storage tanks, and the preparation and
issuance of a written report. These assessments did not include invasive
procedures to detect contaminants from former operations of our hotels or
migrating from neighbors or caused by third parties. These assessments have not
revealed any environmental liability that we believe would have a material
adverse effect on our business, assets, results of operations or liquidity, nor
are we aware of any such liability or material environmental issues.
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").
25
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
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 president and chief executive
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.
26
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS
For the Three Months Ended March 31,
-----------------------------------------------
(in thousands) 2005 % 2004 %
------- ----- ------- -----
Hotel revenues $75,040 99.9 $54,064 99.8
Other revenue 106 .1 99 .2
------- ----- ------- -----
Total revenues 75,146 100.0 54,163 100.0
Hotel expenses 43,866 58.4 33,358 61.6
Depreciation 11,400 15.2 9,403 17.4
Property taxes, rental expense
and insurance 5,403 7.2 4,437 8.2
General and
administrative 2,567 3.4 2,127 3.9
------- ----- ------- -----
Operating income $11,910 15.8 $ 4,838 8.9
======= ===== ======= =====
Comparison of the Company's operating results for the three months ended March
31, 2005 and 2004.
Revenues
Hotel revenues of approximately $75.0 million in 2005 increased approximately
$20.9 million, or 38.6%, as compared to approximately $54.1 million in 2004.
After eliminating net revenues of approximately $16.5 million related to our
hotel acquisitions for 2005 and 2004, our same-store hotel revenues increased by
approximately $4.4 million in 2005 as compared to 2004. This increase was
primarily due to a same-store RevPAR increase of 9.9%, driven by a 6.1% increase
in our ADR from $77.42 to $82.11, and an increase of 230 basis points in
occupancy to 65.2%.
Other revenue of $106,000 in 2005 was relatively flat as compared to 2004.
Operating Expenses
Hotel expenses of approximately $43.9 million in 2005 increased approximately
$10.5 million, or 31.4%, as compared to approximately $33.4 million in 2004.
After eliminating net expenses of approximately $7.8 million related to our
hotel acquisitions for 2005 and 2004, our same-store hotel expenses increased by
approximately $2.7 million in 2005 as compared to 2004. This increase was
primarily due to an increase in payroll and related benefits of approximately
$740,000, an increase in franchise fees, management fees and loyalty programs of
approximately $720,000, an increase in enhanced complimentary hot breakfasts of
approximately $355,000, an increase in travel agent commissions and credit card
fees of approximately $250,000, an increase in maintenance costs of
approximately $155,000 and an increase in utility costs of approximately
$330,000. Hotel expenses as a percentage of hotel revenues were 58.4% in 2005
and 61.6% in 2004.
Depreciation expense of approximately $11.4 million in 2005 increased
approximately $2.0 million, or 21.3%, as compared to approximately $9.4 million
in 2004, primarily due to an increase in depreciation expense related to our
hotel acquisitions.
27
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
Property taxes, rental expense and insurance of approximately $5.4 million in
2005 increased approximately $1.0 million, or 22.7%, as compared to
approximately $4.4 million in 2004, primarily due to an increase in property
taxes, rental expense and insurance of approximately $825,000 related to our
hotel acquisitions, partially offset by a net increase in same-store property
taxes, rental expense and insurance of approximately $165,000.
General and administrative expenses of approximately $2.6 million in 2005
increased approximately $500,000, or 23.8%, as compared to $2.1 million in 2004,
primarily due to an increase of approximately $275,000 in non- cash stock-based
compensation, an increase of approximately $75,000 in professional fees and an
increase of approximately $95,000 related to payroll and related benefits.
Operating Income
For 2005, we recorded operating income of approximately $11.9 million as
compared to operating income of approximately $4.8 million in 2004. The
principal components of the change in operating income for 2005 as compared to
2004 was an increase in same-store revenues of approximately $4.4 million, an
increase in operating income related to our hotel acquisitions of approximately
$5.8 million, partially offset by an increase in same-store hotel expenses of
approximately $2.7 million, an increase in same-store property taxes, rental
expense and insurance of approximately $165,000 and an increase in general and
administrative expenses of approximately $500,000.
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 three months ended March 31,
2005, net cash flows provided by our operating activities were approximately
$16.8 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 our 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 March 31, 2005, we were in
compliance with all covenants required by our Line of Credit. At March 31, 2005,
we had the ability to borrow an additional $42.2 million under our Line of
Credit. At March 31, 2005, we had approximately $10.4 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 37.8% of our investment in hotels, at original cost, at March 31, 2005.
28
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
The following details our debt outstanding at March 31, 2005 and December 31,
2004 (dollars in thousands):
Principal Balance Collateral Net Book
--------------------- Interest # of Value at
3/31/05 12/31/04 Rate Maturity Hotels 12/31/04
---------- --------- ------------------ ---------- ---------- --------
Commercial Mortgage
Bonds
Class A $ - $ - 6.83% Fixed Nov 2006
Class B 45,099 45,802 7.37% Fixed Dec 2015
Class C 10,000 10,000 7.58% Fixed Feb 2017
-------- --------
55,099 55,802 18 $ 98,167
Line of Credit 64,500 72,000 LIBOR plus
Percentage Variable June 2006 25 218,863
Mortgage 88,841 89,318 8.37% Fixed July 2009 19 151,967
Mortgage 65,519 65,823 8.25% Fixed Nov 2010 16 101,659
Mortgage 33,939 34,089 8.25% Fixed Nov 2010 8 53,625
Mortgage 10,578 10,652 LIBOR plus
285 pts. Variable Aug 2008 1 14,656
Mortgage 2,785 2,811 6.00% Fixed May 2008 1 6,625
Mortgage 3,271 3,320 6.37% Fixed Nov 2016 1 7,783
Mortgage 6,250 6,276 8.70% Fixed Nov 2010 1 10,607
Mortgage 4,241 4,268 7.97% Fixed Oct 2007 1 7,180
Mortgage 5,226 5,258 7.97% Fixed Oct 2007 1 8,002
Mortgage 4,429 4,457 7.10% Fixed Sept 2008 1 9,020
Mortgage 3,765 3,787 8.04% Fixed Nov 2007 1 6,802
Mortgage 5,245 5,276 8.04% Fixed Nov 2007 1 7,861
Mortgage 3,143 3,160 9.375% Fixed April 2007 1 6,396
Mortgage 3,363 3,381 9.375% Fixed April 2007 1 6,599
Mortgage 5,114 5,145 8.04% Fixed Nov 2007 1 6,529
Mortgage 3,923 3,938 9.375% Fixed April 2007 1 7,338
Mortgage 3,839 3,854 9.05% Fixed May 2007 1 9,364
Mortgage 5,931 5,958 5.83% Fixed July 2014 1 9,502
Mortgage 40,231 40,508 5.64% Fixed Nov 2014 5 73,805
Mortgage 5,673 5,700 5.39% Fixed Dec 2014 1 10,763
-------- -------- --- --------
424,905 434,781 107 $833,113
=== ========
Unamortized Mortgage
Note Premium 4,061 4,402
-------- --------
$428,966 $439,183
======== ========
For the three months ended March 31, 2005 and 2004, interest expense, net of
approximately $8.2 million in 2005 increased approximately $1.5 million, or
22.5%, as compared to approximately $6.7 million in 2004. This increase was
primarily due to an increase in average borrowings from $338.5 million to $440.3
million related to borrowings for our hotel acquisitions, partially offset by a
reduction in the weighted average interest rate from 7.71% to 7.11%. At March
31, 2005, our debt maturities have an average life of 4.4 years and a weighted
average interest rate of 7.04%.
During the three months ended March 31, 2005, we purchased two hotels for
approximately $20.6 million related to previously announced acquisitions. The
hotels were purchased from two hotel developers. These hotels represent a
combined 204 rooms and have an average age of approximately five years. We
funded these acquisitions primarily through borrowings under our Line of Credit.
During the three months ended March 31, 2005, we sold one hotel for
approximately $3.8 million. We utilized the net proceeds to pay down existing
long-term debt.
29
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
For the three months ended March 31, 2005, we invested approximately $6.4
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
$25.0 million in 2005 for capital improvements, with approximately $13.0 million
representing major refurbishment projects to six hotels. 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 2005, we expect that amounts expended will exceed, in the aggregate,
the amounts required under our 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 late 2004, we experienced significant hurricane damage at one of our
hotels located in Jacksonville Beach, Florida. This hotel was subsequently
repaired and became operational in late January 2005. The total cost of the
hurricane loss is estimated to be approximately $4.1 million, and we are
currently working with our insurance carrier in processing this claim. Based on
the total estimated project cost, the estimated net insurance proceeds and the
estimated net book value of the assets destroyed, we expect to record a net gain
on insurance proceeds upon the conclusion of the processed claim. This gain will
be recorded upon receipt of the net insurance proceeds and closure of the
insurance claim.
During 2004, we purchased 20 hotels for approximately $192.9 million related to
previously announced acquisitions. The hotels were purchased from three hotel
developers. These hotels represent a combined 1,871 rooms and have an average
age of approximately five years. Of the 20 hotels purchased, 13 hotels are
managed by McKibbon Hotel Management, Inc., five hotels are managed by
Hospitality Group, Inc. and two hotels are managed by Gateway Lodging Company,
Inc. We funded these acquisitions primarily through $74.6 million in net cash
proceeds from April 2004 and October 2004 issuances of our common stock, the
issuance of approximately 325,000 Partnership units valued at approximately $3.2
million, the assumption of approximately $54.1 million in secured long-term
debt, the issuance of approximately $40.6 million in secured long-term debt and
approximately $20.4 million in borrowings under our Line of Credit. Included in
our debt assumption is a mortgage note premium of approximately $4.9 million to
record the debt at its estimated fair value. This premium is being amortized
using the interest method over the remaining lives of the assumed debt as a
reduction of interest expense.
During the three months ended March 31, 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.
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
6.38% at March 31, 2005, thus reducing our exposure to interest rate
fluctuations. The notional amount does not represent amounts exchanged by the
parties, and thus
30
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
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 2008. 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, or 5.72% at March 31, 2005, 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.
REITs are subject to a number of organizational and operational requirements.
For example, for federal income tax purposes, we are required to pay
distributions of at least 90% of our taxable income to shareholders. We intend
to pay these distributions from operating cash flows. During the three months
ended March 31, 2005, our Partnership distributed an aggregate of approximately
$6.8 million to its limited partners, or $.13 per unit per quarter (including
approximately $6.6 million of distributions to the Company to fund distributions
to our shareholders of $.13 per share per quarter). We also announced that our
first quarter 2005 dividend, payable in May 2005, would be increased to $.15 per
unit and common share. Additionally, during the three months ended March 31,
2005, we distributed approximately $1.9 million in dividends related to our
8.75% Series B preferred stock. 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 debt and 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.
During the three months ended March 31, 2005, there were no units tendered for
redemption. 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.
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 or any related
capitalized interest. We use FFO as a measure of performance to adjust for
certain non-cash expenses such as depreciation and amortization because
historical cost accounting for real estate assets implicitly assumes that the
value of real estate assets diminishes predictably over time.
31
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
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
may not be comparable to FFO measures reported by other companies. Additionally,
FFO is also used by management in the annual budget process.
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 Ended
March 31,
--------------------------
2005 2004
------- -------
Net income (loss) applicable to common
shareholders $ 1,766 $(4,085)
Add (subtract):
(Gain) loss on sale of hotel properties - 320
Minority interests (income) expense 49 (107)
Depreciation 11,400 9,403
Depreciation from discontinued operations - 88
------- -------
Funds From Operations (FFO) $13,215 $ 5,619
======= =======
Weighted average number of diluted common
shares and Partnership units outstanding 53,503 44,004
======= =======
MANAGEMENT CONTRACTS
Our management agreements with Hyatt, which purchased the AmeriSuites brand in
January 2005 from the Blackstone Group, which purchased the brand from Prime
Hospitality Corporation in October 2004, 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, Hyatt's 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 exceeds 6.5% of gross hotel revenue, Hyatt's
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, Hyatt'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 Hyatt's
subsidiaries for 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 existing
franchise agreements to 2028 and the management agreements to 2010, as long as
Hyatt continues to be in compliance
32
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
with the minimum net operating income guarantees in the original agreements. For
the three months ended March 31, 2005 and 2004, we recorded approximately $1.5
million and $1.6 million, respectively, in minimum income guarantees from Hyatt
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 four 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.
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
us 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:
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.
Investment in Hotel Properties
We record an impairment charge when we believe an investment in a hotel has
been impaired such that future undiscounted cash flows would not recover
the book basis of the hotel property, or the hotel is being held for sale.
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.
33
Management's Discussion and Analysis of
Financial Condition and Results of 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 the Company identifies 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 record an impairment charge for the estimated loss. We no
longer record depreciation expense once we identify an asset as held for
sale. Net realizable value is estimated as the amount at which we believe
the asset could be bought or sold (fair value) less costs to sell. We
estimate the fair value by determining prevailing market conditions,
appraisals or current estimated net sales proceeds from pending offers, if
appropriate. We record operations for hotels designated as held for sale
and hotels which have been sold as part of discontinued operations for all
periods presented. We also allocate to discontinued operations the
estimated 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. For the three months ended March 31, 2005 and 2004, we did not
realize any losses on impairments of hotels held for sale. Impairments
recorded, if any, are reflected as a component of discontinued operations
for the respective periods in the accompanying condensed consolidated
statements of operations.
Income Taxes
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. In 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, and we recorded a full
valuation allowance for this asset. Our TRS Lessees continue to accumulate
net operating losses primarily due to the lease payments that our TRS
Lessees pay to their respective lessors, in conjunction with our assumption
of the operating leases from several of our independent management
companies in 2001. As a result of these continued losses, we continue to
record 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
During the three months ended March 31, 2005, we purchased two hotels for
approximately $20.6 million related to previously announced acquisitions. The
hotels were purchased from two hotel developers. These hotels represent a
combined 204 rooms and have an average age of approximately five years. We
funded these acquisitions primarily through borrowings under our Line of Credit.
The hotel acquisitions that we completed for the three months ended March 31,
2005 are as follows:
Hotel Location Rooms Date Acquired
----- -------- ----- -------------
Hilton Garden Inn Fort Myers, Florida 126 March 1, 2005
Residence Inn by Marriott Jacksonville, Florida 78 March 9, 2005
34
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
Common Stock Offerings
On March 4, 2005, we completed an offering of approximately 2.7 million shares
of common stock for net proceeds of approximately $28.5 million. The proceeds
will be used for identified acquisitions and to repay indebtedness under our
Line of Credit.
Hotel Development
We may 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. If we decide to develop this hotel, we plan to
obtain additional financing sources to complete the construction of this hotel.
Long-Lived Asset Impairments and Hotel Sales
During late 2004, we recorded a charge for impairment of approximately $1.9
million in accordance with SFAS No. 144, "Accounting For Impairment or Disposal
of Long-Lived Assets," based on the estimated net realizable value of a hotel
held for sale. This hotel was subsequently sold in January 2005 for its
approximate carrying value of $3.8 million. The hotel sold was a 123-room
Hampton Inn located in Birmingham, Alabama. The age of the hotel was
approximately 18 years.
Subsequent Events
On April 29, 2005, we completed the acquisition of a 93-room Marriott Courtyard
hotel located in Bowling Green, Kentucky, for approximately $6.9 million,
including the assumption approximately of $3.2 million in secured long-term
debt.
On May 2, 2005, we completed the acquisition of an 81-room Marriott Courtyard
hotel located in Jacksonville, Florida, for approximately $6.4 million,
including the assumption of approximately $4.0 million in secured long-term
debt.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We are exposed to certain financial market risks, the most predominant of which
is the fluctuation in interest rates. At March 31, 2005, 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 $75.1 million at March 31, 2005. As
discussed below, we do maintain two interest rate swap agreements for a combined
notional amount of $50.0 million.
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 March 31, 2005, our
interest rate on our Line of Credit was LIBOR (2.85% at March 31, 2005) plus
2.50%. 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
35
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
exposure to fluctuations in market interest rates for borrowings under our Line
of Credit through the use of interest rate swaps, in order 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 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, but may be extended at our option for
an additional year. As discussed above, our Line of Credit bears interest at
variable rates, and therefore, cost approximates market value. At March 31,
2005, the fair value of our interest rate swaps was an asset of approximately
$662,000.
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
$21,000, based on balances outstanding during the three months ended March 31,
2005.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation with the participation of the Company's
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the Company's disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended
(the "Exchange Act")) as of the end of the period covered by this report. Based
upon that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective to ensure that information required to be disclosed by the Company in
the reports that the Company files, or submits under the Exchange Act, is
recorded, processed, summarized and reported, within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to the Company's management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.
There has been no change in the Company's internal control over financial
reporting during the quarter ended March 31, 2005 that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
36
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
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
(a) Exhibits:
12.1 -- Statement Regarding Computation of Ratios
31.1 -- Rule 13a-14(a) Certification of Howard A. Silver
31.2 -- Rule 13a-14(a) Certification of J. Mitchell Collins
32.1 -- Section 1350 Certification of Howard A. Silver
32.2 -- Section 1350 Certification of J. Mitchell Collins
37
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.
May 10, 2005 By: /s/J. Mitchell Collins
- ------------ -------------------------------------------------
Date J. Mitchell Collins
Executive Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer),
Secretary and Treasurer
38
INDEX OF EXHIBITS
Exhibits
Number Description
- ------ -----------
12.1 Statement Regarding Computation of Ratios
31.1 Rule 13a-14(a) Certification of Howard A. Silver
31.2 Rule 13a-14(a) Certification of J. Mitchell Collins
32.1 Section 1350 Certification of Howard A. Silver
32.2 Section 1350 Certification of J. Mitchell Collins
39