Back to GetFilings.com
1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
[NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996]
For the fiscal year ended December 31, 1996 Commission File Number 34-0-23290
EQUITY INNS, INC.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Tennessee 62-1550848
- ------------------------------- ---------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
4735 Spottswood, Suite 102, Memphis, Tennessee 38117
- --------------------------------------------------------------------------------
(Address of Registrant's Principal Executive Office) (Zip Code)
(901) 761-9651
- --------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
----------------------------
(Title of Class)
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 proceeding 12 months and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in the definitive proxy statement or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Aggregate market value of voting stock held by nonaffiliates of the Registrant
as of March 13, 1997: $328,744,232.
Number of shares of Common Stock, $.01 par value, outstanding as of March 13,
1997: 23,693,278
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Shareholders to be held April 29, 1997 (the "Proxy Statement") are incorporated
by reference into Part III of this Report. Portions of the Registrant's
Registration Statements on Form S-11 (No. 33-73304 and No. 33-80318) and
Registration Statements on Form S-3 (No. 33-90364 and No. 33-93158) are
incorporated by reference into Part IV of this report.
Exhibit Index beginning on Page 57.
Page 1 of 60
2
EQUITY INNS, INC
ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 1996
TABLE OF CONTENTS
PART I
Page
Item 1. Business 3
Item 2. Properties 21
Item 3. Legal Proceedings 22
Item 4. Submission of Matters to a Vote of Security Holders 22
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 23
Item 6. Selected Financial Data 24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 27
Item 8. Financial Statements and Supplementary Data 35
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 55
PART III
Item 10. Directors and Executive Officers of the Registrant 55
Item 11. Executive Compensation 55
Item 12. Security Ownership of Certain Beneficial Owners and
Management 55
Item 13. Certain Relationships and Related Transactions 55
PART IV
Item 14. Exhibits, Financial Statements, Schedules, and Reports on
Form 8-K 56
2
3
PART I
ITEM 1. BUSINESS
(a) General Development of Business
Equity Inns, Inc. (the "Company") was incorporated on November 24, 1993. The
Company is a real estate investment trust ("REIT") for federal income tax
purposes. On March 1, 1994, the Company completed an initial public offering
(the "IPO") of 5,117,500 shares of common stock, $.01 par value (the "Common
Stock") (including the underwriters' over-allotment option). The offering price
per share was $10.00 resulting in gross proceeds of $51.2 million. Net of
underwriters' discount and offering expenses, the Company received approximately
$46.2 million. Additionally, the Company issued 72,500 shares of common stock in
a private placement at a price of $10.00 per share resulting in proceeds of
$725,000. There were no operations from November 24, 1993 to February 28, 1994.
Upon completion of the IPO, the Company contributed substantially all of the net
proceeds of the IPO to Equity Inns Partnership, L.P. (the "Partnership") in
exchange for an approximately 86.5% sole general partnership interest in the
Partnership. The Partnership used the proceeds to acquire eight Hampton Inn
hotels (the "Initial Hotels") from various partnerships (the "Selling
Partnerships") free of debt, to finance certain capital improvements to the
Initial Hotels, including improvements required by franchisors, to pay franchise
fees and for general working capital. Rather than receiving cash for their
interest in the Selling Partnerships, upon the sale of the Initial Hotels,
certain partners in the Selling Partnerships, including affiliates of the
Company, elected to receive limited partnership interests in the Partnership
aggregating an approximately 13.5% equity interest in the Partnership.
Since the IPO, the Company has completed additional underwritten public
offerings and private placements of approximately totaling 18.3 million shares
of Common Stock at prices ranging from $10.75 to $12.50 per share, the proceeds
from which were contributed to the Partnership, and the Partnership has issued
additional limited partnership interests to third parties in exchange for
interests in hotel properties. The Company through its wholly-owned subsidiary,
Equity Inns Trust (the "Trust"), is the sole general partner of the Partnership
and at December 31, 1996, owned an approximately 96.7% interest in the
Partnership.
(b) Financial Information About Industry Segment
The Company is in the business of acquiring equity interests in hotel
properties. See the Consolidated Financial Statements and notes thereto included
in Item 8 of this Annual Report on Form 10-K for certain financial information
required in Item 1.
(c) Narrative Description of Business
In order to qualify as a REIT, neither the Company nor the Partnership can
operate hotels. From its inception through November 14, 1996, the Partnership
leased all of its hotels to Trust Leasing, Inc., formerly McNeill Hotel Co.,
Inc. (the "Former Lessee"), pursuant to percentage leases ("Percentage Leases")
which provide for rent based, in part, on the revenues from the hotels and which
are designed to allow the Company to participate in the growth of room revenues,
and where applicable, food and beverage revenue.
The Former Lessee is principally owned by Phillip H. McNeill, Sr., Chairman of
the Board and Chief Executive Officer of the Company.
3
4
Effective November 15, 1996, the Former Lessee, as the lessee of the 47 hotels
owned at such date by the Partnership, transferred and assigned its assets,
including all Percentage Leases between the Former Lessee and the Partnership,
pursuant to a Contribution Agreement dated October 4, 1996 (the "Contribution
Agreement") to Crossroads/Memphis Partnership, L.P. (the "Lessee") and
Crossroads/Memphis Company, L.L.C. in exchange for units of limited partnership
interest in the Lessee. The sole general partner of the Lessee is a wholly-owned
subsidiary of Interstate Hotels Corporation ("Interstate"). The Company also
entered a Master Agreement providing Crossroads Future Company, L.L.C. (the
"Future Lessee"), an affiliate of Interstate, a right of first offer to lease
hotels acquired by the Company in the future, subject to certain limitations.
See "Master Agreement--Future Lessee Right of First Offer" below.
The Former Lessee and Trust Management, Inc. ("Trust Management") are the only
limited partners of the Lessee. With limited exceptions, the sole general
partner of the Lessee exercises full, complete and exclusive discretion in
management and control of the Lessee, with the Former Lessee and Trust
Management having no participation or control over the business of the Lessee.
Trust Management is wholly-owned by Phillip McNeill, Sr. and the Former Lessee
is majority-owned by Mr. McNeill. Messrs. David Levine, Howard Silver and
Phillip McNeill, Jr., officers of the Company, own only minority interests in
the Former Lessee. The term "Lessees" is used herein to refer collectively to
the Lessee and the Future Lessee.
At December 31, 1996, the Partnership owned 48 hotel properties, with a total of
5,811 rooms in 24 states ("Current Hotels"). This geographical distribution and
franchise diversity is further illustrated by the following chart.
% Of
Franchise Total Date
State/City Affiliation Rooms Rooms Opened
- ------------ --------------- ----- ----- ---------------
ALABAMA:
ENTERPRISE Comfort Inn 78 1.3% May 1987
ARIZONA:
SCOTTSDALE Hampton Inn 126 2.2% January 1996
PHOENIX Homewood Suites 124 2.1% September 1996
ARKANSAS:
LITTLE ROCK Hampton Inn 122 2.1% September 1985
CONNECTICUT:
MILFORD Hampton Inn 148 2.5% August 1986
MERIDEN Hampton Inn 126 2.2% May 1988
HARTFORD Homewood Suites 132 2.3% May 1990
FLORIDA:
SARASOTA Hampton Inn 97 1.7% March 1987
JACKSONVILLE Hampton Inn 122 2.1% November 1986
JACKSONVILLE BEACH Comfort Inn 180 3.1% October 1973
GEORGIA:
COLUMBUS Hampton Inn 119 2.0% September 1986
4
5
% Of
Franchise Total Date
State/City Affiliation Rooms Rooms Opened
- ------------ ------------- ----- ----- ---------------
KENTUCKY:
LOUISVILLE Hampton Inn 119 2.6% December 1986
ILLINOIS:
GURNEE (Chicago) Hampton Inn 134 2.3% June 1988
NAPERVILLE (Chicago) Hampton Inn 130 2.2% October 1987
INDIANA:
INDIANAPOLIS Hampton Inn 129 2.2% March 1987
MARYLAND:
GLEN BURNIE (Baltimore) Hampton Inn 116 2.0% December 1989
MICHIGAN:
ANN ARBOR Hampton Inn 153 2.6% November 1986
TRAVERSE CITY Hampton Inn 127 2.2% January 1987
DETROIT Hampton Inn 125 2.2% August 1989
MINNESOTA:
EAGAN (Minneapolis) Residence Inn 120 2.1% January 1988
NEBRASKA:
OMAHA Residence Inn 80 1.4% January 1981
NEW JERSEY:
TINTON FALLS Residence Inn 96 1.7% June 1988
NEW YORK:
ALBANY Hampton Inn 155 2.7% July 1986
NORTH CAROLINA:
WILKESBORO Holiday Inn Express 101 1.7% August 1985
SHELBY Hampton Inn 78 1.3% February 1989
GASTONIA Hampton Inn 109 1.9% February 1989
FAYETTEVILLE Hampton Inn 122 2.1% May 1986
WINSTON-SALEM Holiday Inn 160 2.8% October 1969
OHIO:
CLEVELAND Hampton Inn 123 2.1% January 1987
PENNSYLVANIA:
STATE COLLEGE Hampton Inn 121 2.1% January 1987
SCRANTON Hampton Inn 129 2.2% February 1994
SOUTH CAROLINA:
MT. PLEASANT (Charleston) Holiday Inn 158 2.7% May 1988
5
6
% Of
Franchise Total Date
State/City Affiliation Rooms Rooms Opened
- ------------ ------------- ----- ----- ---------------
TENNESSEE
CLEVELAND Hampton Inn 60 1.0% March 1993
KNOXVILLE Hampton Inn 118 2.0% February 1991
CHATTANOOGA Hampton Inn 167 2.9% April 1988
TEXAS:
ARLINGTON (Dallas) Hampton Inn 142 2.4% December 1985
FT. WORTH Hampton Inn 125 2.2% February 1987
COLLEGE STATION Hampton Inn 135 2.3% May 1986
AUSTIN Hampton Inn 121 2.1% July 1987
GARLAND (Dallas) Hampton Inn 125 2.2% October 1986
SAN ANTONIO Homewood Suites 123 2.1% August 1996
VERMONT:
RUTLAND Comfort Inn 104 1.8% August 1985
BURLINGTON Residence Inn 96 1.7% November 1988
WEST VIRGINIA:
BECKLEY Hampton Inn 109 1.9% March 1992
BLUEFIELD Holiday Inn 120 2.1% May 1980
MORGANTOWN Hampton Inn 108 1.9% June 1991
OAK HILL Holiday Inn 119 2.0% August 1983
WISCONSIN:
MADISON Residence Inn 80 1.3% January 1988
----- -----
TOTAL ROOMS 5,811 100.0%
===== =====
Since December 31, 1996, the Partnership has acquired seven additional hotel
properties: a 96-room Residence Inn hotel in Colorado Springs, Colorado; a
135-room Residence Inn hotel in Oklahoma City, Oklahoma; a 128-room Residence
Inn hotel in Tucson, Arizona; a 129-room Hampton Inn hotel in Savannah, Georgia;
a 119-room Hampton Inn hotel in Norfolk, Virginia; a 50-room Hampton Inn hotel
in Pickwick, Tennessee; and a 86-room Hampton Inn hotel in Southaven (Memphis),
Mississippi. The 55 hotels owned and contracted to own by the Company at March
13, 1997 are herein referred to as the "Hotels."
The Company has contracted to acquire a 135-room Hampton Inn hotel in Overland
Park, Kansas, and has announced that it has entered into agreements to acquire
28 Hampton Inn hotels with an aggregate of 3,487 rooms in 14 states from a
series of partnerships controlled by Growth Hotel Investors ("GHI") and Growth
Hotel Investors II ("GHI II") for purchase prices aggregating approximately $182
million which includes franchisor required renovations and franchise fees. The
GHI and GHI II hotels are located principally in the southeastern and midwestern
United States in major urban and suburban markets. The GHI and GHI II agreements
provide for a due diligence period which expires on April 28, 1997, during which
time the Company may terminate the agreements for any reason. In connection with
this transaction, the Company has placed a $10 million refundable security
deposit with an escrow agent. The deposit is refundable through April 28, 1997
if the Company chooses to terminate the agreement. The purchase and sale of the
hotels are subject to the requisite approvals of the limited partners of GHI and
GHI II, which those
6
7
partnership must obtain through a proxy solicitation, as well as customary real
estate closing conditions.
BUSINESS STRATEGY
The Company has developed a growth strategy which management believes
capitalizes on attractive acquisition opportunities and improving industry
conditions. The Company's primary objective is to increase funds from operations
and enhance shareholder value by participating in increased revenues from the
Hotels through leases which provide for rent payments based on the revenues from
the Hotels and by acquiring equity interests in additional hotels that meet the
Company's investment criteria.
ACQUISITION STRATEGY
The Company intends to acquire additional existing hotel properties that meet
its investment criteria. While the Company has placed particular emphasis on
Hampton Inn hotels, it also considers acquisitions of other premium limited
service and extended stay hotel properties in the mid-price segment.
The Company considers investment in hotel properties which meet some or all of
the following criteria:
Particular emphasis is given to premium limited service hotels in the
mid-price segment, such as Hampton Inn(R), Comfort Inn(R), Holiday Inn
Express(R) and Marriott Courtyard(R) and premium extended stay
properties such as Hampton Inn & Suites(R), Homewood Suites(R) and
Residence Inn(R), with major franchisors such as Promus Hotel
Corporation and Marriott Corporation;
Properties in attractive locations which may be underperforming due to
poor management, weak franchise affiliation or a need for renovation;
Properties in attractive locations that the Company believes could
benefit significantly by changing franchise affiliations to a brand the
Company believes will strengthen the acquired hotel's competitive
position or by converting hotel properties from full service to limited
service;
Properties with relatively stable operating histories; and
Properties with purchase prices which, coupled with the elimination or
significant reduction of debt, may allow the Company to realize a
favorable return on its investment.
The Company has a right of first refusal to acquire from Affiliates of Mr.
McNeill, a Homewood Suites hotel in Germantown, Tennessee, and three Hampton Inn
hotels in Destin, Florida, San Antonio, Texas and Highlands, North Carolina. The
rights of first refusal require that before a property is sold to a person or
entity other than the Partnership, the seller must first offer the property to
the Partnership on the same terms and conditions as the proposed sale to a third
party. Mr. McNeill also has agreed to grant a similar right of first refusal, as
well as an option, on any future hotel developments controlled by Mr. McNeill or
his Affiliates, including a Hampton Inn hotel in Collierville, Tennessee and a
Hampton Inn hotel proposed for development in White River Junction, Vermont. The
option provides that the Company or Partnership may purchase any such hotel at
any time twelve months after the opening of the hotel for a price determined by
appraisal. Management currently anticipates that a property will have achieved
stabilized operating performance and cash flows prior to the Partnership
considering the purchase of such property. All investment decisions relating to
transactions between the Company or the Partnership, and Mr. McNeill or his
Affiliates, must be approved by a majority of the Independent Directors.
7
8
The Company intends to consider selective development of hotel properties,
principally in the premium extended stay and limited service segment of the
market. At December 31, 1996, the Company had a 125-room Hampton Inn & Suites
hotel under construction in Bartlett (Memphis), Tennessee. The hotel is expected
to open in the fall of 1997.
INTERNAL GROWTH STRATEGY
The Percentage Leases are designed to allow the Company to participate in any
growth in room revenues at the Hotels and to a lesser extent, food and beverage
revenue, if any. The Percentage Leases provide for rent equal to the greater of
(i) a fixed Base Rent or (ii) Percentage Rent. The Percentage Leases provide
that the Base Rent and the thresholds for the payment of Percentage Rent will be
adjusted annually (subject to an annual cap of 7%) based on changes in the
United States Consumer Price Index ("CPI").
EMPLOYEES
Effective January 1, 1995, the Company's three executive officers became
employees of a wholly-owned subsidiary of the Company. At December 31, 1996, the
Company had a total of three employees. Effective January 1, 1997, certain
employees of the Former Lessee became employees of the Company. At March 1,
1997, the Company had 14 employees.
COMPETITION
The hotel industry is highly competitive. Each of the 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
occupancy, ADR and Revenue Per Available Room ("REVPAR") of the Hotels or at
hotel properties acquired in the future.
The Company may be competing for investment opportunities with entities which
have substantially greater financial resources than the Company. These entities
generally may be able to accept more risk than the Company prudently can manage.
Competition generally may reduce the number of suitable investment opportunities
available to the Company and increase the bargaining power of property owners
seeking to sell. Further, the Company believes that competition from entities
organized for purposes substantially similar to the Company's objectives will
increase significantly.
FRANCHISE AGREEMENTS
The Lessees hold or will hold the franchise license for each of the Hotels.
Thirty-seven of the fifty-six Hotels currently owned and contracted to own by
the Partnership are licensed as Hampton Inn hotels. Hampton Inn(R) is a
registered trademark of Promus Hotels, Inc. ("Promus"). Promus approved the
transfer of the franchise license to the Lessee when the Partnership acquired
each Hotel that is operated as a Hampton Inn hotel. Three of the Hotels are
licensed as Comfort Inn hotels. Comfort Inn(R) is a registered trademark of
Choice Hotels International, Inc., ("Choice"). Choice approved the transfer of
the franchise license to the Lessee when the Partnership acquired each Hotel
that is operated as a Comfort Inn. Five of the Hotels are licensed as Holiday
Inn hotels or Holiday Inn Express hotels. Holiday Inn(R) and Holiday Inn
Express(R) are registered trademarks of Holiday Inns, Inc., ("Holiday Inn").
Holiday Inn approved the transfer of the franchise license to the Lessee when
the Partnership acquired each Hotel that is operated as a Holiday Inn or Holiday
Inn Express. Eight of the Hotels are licensed as Residence Inn hotels. Residence
Inn(R) is a registered trademark of Marriott Corporation ("Marriott"). Marriott
approved the transfer of the franchise license to the Lessee when the
Partnership acquired each Hotel that is operated as a Residence Inn hotel. Three
of the Hotels are licensed as Homewood Suites hotels. Homewood
8
9
Suites(R) is a registered trademark of Promus Hotel Corporation. The Company
intends to maintain the existing franchise affiliations of all the hotels.
The Company anticipates that most of the additional hotel properties in which it
invests will be operated under franchise licenses. The Company believes that the
public's perception of quality associated with a franchisor is an important
feature in the operation of a hotel. Franchisors provide a variety of benefits
for franchisees which include national advertising, publicity and other
marketing programs designed to increase brand awareness, training of personnel,
continuous review of quality standards and centralized reservation systems.
The Hampton Inn, Homewood Suites, Comfort Inn, Residence Inn and Holiday Inn
franchise licenses generally specify certain management, operational,
recordkeeping, accounting, reporting and marketing standards and procedures with
which the Lessee must comply. Such franchise licenses obligate the Lessee to
comply with the franchisors' standards and requirements with respect to training
of operation personnel, safety, maintaining specified insurance, the types of
services and products ancillary to guest room services that may be provided by
the Lessee, display of signage, and the type, quality and age of furniture,
fixtures and equipment included in guest rooms, lobbies and other common areas.
Each new franchise license generally gives the Lessee the right to operate the
particular Hotel under a franchise license for periods ranging up to 20 years.
The franchise agreements provide for termination at the franchisor's option upon
the occurrence of certain events, including the Lessee's failure to pay
royalties and fees or perform its other covenants under the license agreement,
bankruptcy, abandonment of the franchise, commission of a felony, assignment of
the license without the consent of the franchisor, or failure to comply with
applicable law in the operation of the relevant Hotel. The Lessee will be
entitled to terminate the franchise license only by giving at least 12 months'
notice and paying a specific amount of liquidated damages. The license
agreements will not renew automatically upon expiration. The Partnership made
franchise transfer payments to franchisors aggregating $340,400 in 1996. The
Partnership is also committed to franchisors to fund certain capital
improvements to hotel properties when acquired, which are funded from
borrowings, working capital, or the room renovation accounts. The Partnership
made capital improvements of approximately $19.4 million to its hotel properties
in 1996, including approximately $10.6 million in renovations required by
franchisors. In 1997, the Partnership expects to fund approximately $11.1
million of capital improvements, approximately $5.9 million of which is
renovation required by franchisors, for the hotel properties owned and
contracted to own at December 31, 1996. The Lessee is responsible for making
royalty payments under the franchise agreements to the franchisors. Under the
Hampton Inn franchise agreements, the Lessee pays a franchise fee of 8% of room
revenue (plus additional fees). One half of such fee is designated for a
marketing and reservation fund for the benefit of Hampton Inn hotels systemwide.
Under the Homewood Suites franchise agreements, the Lessee pays a franchise fee
of 4% of room revenue, of which 4% is designated for a marketing and
reservations fund. Under the Comfort Inn franchise agreements, the Lessee pays a
franchise fee of 8.05% of room revenue, of which 3.05 % (plus additional fees)
is designated for a marketing and reservations fund. Under the Holiday Inn
franchise agreements, the Lessee pays a franchise fee of 7% of room revenue, of
which 3% (plus additional fees) is designated for a marketing and reservations
fund. Under the Residence Inn franchise agreements, the Lessee pays a franchise
fee of 6.5% of room revenue, of which 2.5% (plus additional fees) is designated
for a marketing and reservations fund. Promus has agreed that in the event of a
default by the Lessee under a franchise agreement for the Hampton Inn hotels or
the Partnership's termination of a Percentage Lease for a Hampton Inn hotel,
upon request by the Partnership and the curing of any event of default, Promus
will allow that hotel to be operated by a designee of the Partnership acceptable
to Promus for a reasonable period of time, not to exceed twelve (12) months, to
allow the designee of the Partnership to apply for a new franchise license. The
Partnership will be
9
10
obligated to pay Promus' actual costs of investigating the Partnership's
designee. In addition, Promus requires that normal change of ownership
commitment fees be paid when a designee applies for a new franchise license.
MASTER AGREEMENT
Future Lessee Right of First Offer
Pursuant to a Master Agreement dated as of November 4, 1996 (the "Master
Agreement") among the Company, the Partnership, Interstate, the Lessee, and the
Future Lessee, the Company and the Partnership granted to the Future Lessee a
right of first offer (the "Future Lessee Right of First Offer") to lease hotels
acquired or developed by the Partnership or the Company prior to November 15,
2001 (the "Term"), subject to certain exceptions described below.
During the Term, the Partnership and any affiliates must deliver to the Future
Lessee a notice (a) specifying the proposed rent terms upon which the
Partnership would be willing to lease a proposed acquisition or development
hotel to the Future Lessee and (b) providing certain additional items of
information to the Future Lessee. For any single acquisition or development
hotel or for any portfolio of up to four such hotels, the Future Lessee shall
have 21 days following receipt of the notice to agree to the Partnership's
proposed terms or propose alternative rent terms and reach an agreement with the
Partnership as to such terms and execute a percentage lease agreement
incorporating such terms. In the event the Future Lessee does not agree within
21 days to lease the particular hotel(s) pursuant to the rent terms set forth in
the notice, the Partnership may lease the hotel(s) to a non-affiliated lessee
(an "Alternative Lessee"); provided, however, that the rent terms of such lease
are no more favorable to the Alternative Lessee than the rent terms rejected by
the Future Lessee. For any portfolio of five or more acquisition or development
hotels, the Future Lessee shall have 25 days following receipt of the notice to
agree to the Partnership's proposed terms, execute leases incorporating such
terms. If the Partnership does not enter into a lease with an Alternative Lessee
for any acquisition or development hotel or any hotel portfolio within 60 days,
the Partnership must again send a notice to the Future Lessee setting forth
proposed rent terms of the proposed lease for such hotel or hotel portfolio. The
Future Lessee will then have 21 or 25 days, as applicable, to elect to lease the
hotel or hotel portfolio from the Partnership upon the terms set forth in the
second notice.
The Future Lessee Right of First Offer does not apply to (i) hotels acquired or
developed by the Partnership where the seller requires, as a condition of sale,
that the seller or an affiliate of the seller be the lessee or manager of the
hotel following acquisition by the Partnership, (ii) any acquisition hotel which
is subject to a hotel lease which cannot be terminated without the payment of
liquidated damages or other financial penalties and the Future Lessee does not
agree to pay such damages, and (iii) any hotels currently subject to the
Company's agreements with Promus Hotels, Inc.
The Partnership may terminate the Future Lessee Right of First Offer upon
termination of the Company's status as a REIT for federal income tax purposes
and subject to the satisfaction of termination obligations under the Percentage
Leases. The Partnership may also terminate the Future Lessee Right of First
Offer: (i) upon the occurrence under a lease of an event of default by the
Lessee or the Future Lessee; (ii) in the event of a default under the Master
Agreement; or (iii) in the event of a default under the Lease Guaranties.
Interstate and its parent, Interstate Hotels Company, each executed a Lease
Guaranty guaranteeing the prompt and full payment of rent and all other amounts
due to the Partnership and the prompt and complete performance of all
obligations by the Lessee to the Partnership under the Consolidated Lease
Amendment and will guarantee all obligations under future leases between the
Company and the Partnership and any affiliate of Interstate.
10
11
Development Option in Favor of the Partnership
During the Term, Interstate has granted to the Partnership, a development option
(the "Development Option") to purchase certain brand name midscale, upper
economy, economy and budget hotels which Interstate plans to develop (the
"Interstate Development Hotels") and which Interstate notifies the Partnership
prior to commencement of construction that Interstate plans to sell after
completion of construction for a purchase price equal to the greater of 105% of
Interstate's budgeted development costs or such budgeted development costs plus
cost overruns, with the right to terminate in the event of overruns.
Interstate must deliver to the Partnership a notice specifying the proposed
development cost budget for each such Interstate Development Hotel and providing
certain additional items of information to the Partnership. Within 21 days
following receipt of the notice, the Partnership may exercise its Development
Option to purchase such hotel, and the Future Lessee shall have the right to
lease any Interstate Development Hotel sold to the Partnership pursuant to its
exercise of the Development Option. The Future Lessee shall have 15 days
following receipt of the Partnership's proposed rent terms to (i) agree to the
Partnership's proposed terms and execute a Percentage Lease thereto or (ii)
propose alternative rental terms, reach an agreement with the Partnership as to
such terms and execute a Percentage Lease incorporating such terms. In the event
that (a) the Partnership does not provide notice of its intent to exercise its
Development Option within 21 days or (b) the Partnership and the Future Lessee
do not agree within 21 days to rent terms for the particular hotel, the
Partnership shall have waived its rights under the Development Option and
Interstate may retain or sell the hotel in its sole discretion.
In the event Interstate's actual development costs exceed budgeted development
costs for any such Interstate Development Hotel, the Partnership shall have the
right to purchase such hotel for a purchase price equal to (1) 105% of the
budgeted development costs plus (2) the amount by which the actual costs exceed
the budgeted costs of such hotel, with the parties to renegotiate in good faith
the rent terms for such hotel to reflect the increased purchase price. If the
Partnership does not elect to so purchase the hotel, then Interstate shall have
the right to sell such hotel to the Partnership for a purchase price equal to
105% of its budgeted development costs. In the event that, during the Term,
Interstate has not offered to the Partnership at least five Interstate
Development Hotels, the term of the Development Option shall be extended until
such time as Interstate has offered five Interstate Development Hotels to the
Partnership in accordance with the Development Option.
Partnership Right of First Offer
During the Term, Interstate has granted the Partnership a right of first offer
(the "Partnership Right of First Offer") to acquire midscale, upper economy, and
budget hotels which Interstate or any affiliate of Interstate owned at November
15, 1996 or acquires or develops during the Term (the "Interstate First Offer
Hotels").
Prior to offering an Interstate First Offer Hotel for sale, Interstate shall
deliver to the Partnership a notice of its intent to sell such hotel and stating
Interstate's proposed cash purchase price. Within 21 days following receipt of
the notice, the Partnership may elect to purchase the Interstate First Offer
Hotel for Interstate's proposed purchase price by delivering a notice to
Interstate of its intent to purchase such hotel, and Future Lessee shall have
the right to lease any Interstate First Option Hotel sold to the Partnership
pursuant to its exercise of the Partnership Right of First Offer. The Future
Lessee shall have 15 days following receipt of the Partnership's proposed rent
terms to agree to the Partnership's proposed terms and execute a Percentage
Lease thereto or propose alternative rental terms, reach an agreement with the
Partnership as to such terms and execute a Percentage
11
12
Lease incorporating such terms. In the event that (a) the Partnership does not
provide notice of its intent to exercise its Partnership Right of First Offer
within 21 days or (b) the Partnership and the Future Lessee do not agree within
21 days to rent terms for the particular hotel, (1) the Partnership shall have
waived its rights under the Partnership Right of First Offer, and (2) Interstate
may sell such Interstate First Offer Hotel at any time within 195 days from the
date of its notice of sale to the Partnership, for a purchase price equal to or
greater than 95% of the price listed in such notice. In the event that
Interstate desires to sell such Interstate First Offer Hotel for a price less
than 95% of the price listed in such notice, Interstate must again comply with
its notice requirements to the Partnership prior to marketing or soliciting for
sale such hotel.
THE PERCENTAGE LEASES
Each hotel owned by the Partnership is separately leased to the Lessee or, with
respect to all Hotels acquired since November 15, 1996, the Future Lessee, under
a Percentage Lease. Effective November 15, 1996, each of the existing Percentage
Leases was amended and restated in a Consolidated Lease Amendment between the
Partnership and the Lessee (the "Consolidated Lease Amendment"). The principal
amendments were as follows: (i) the term of each Percentage Lease was increased
to 15 years from the date of closing, with rent for the final five years of the
term to be re-negotiated after ten years, and, if the parties cannot agree to
new rent terms, the new rent terms will be determined by arbitration; (ii) the
non-compete provision precluding the Lessee or its affiliates from owning,
leasing, operating, managing or franchising any hotel or motel within a 20-mile
radius of any hotel in which the Partnership or an affiliate of the Partnership
has an interest, was deleted; (iii) events of default shall include, among
others, (a) the failure of the Lessee to make Base Rent or Percentage Rent
payments when due and payable and continuing for a 10-day period after receipt
of notice from the Partnership, as compared to the previous 90-day period for
non-payment of Percentage Rent and (b) occurrence of a breach of any
representation or warranty under the Lease Guaranties; (iv) the Lessee shall be
required, not later than 30 days prior to the commencement or each lease year,
to prepare and submit to the Partnership for its approval a capital budget; (v)
prohibitions on payment of fees to any affiliate of the Lessee were deleted;
(vi) the Partnership has the right to approve any manager of its hotels that is
not an affiliate of the Lessee; (vii) the Lessee will have an extended period
(up to 30 days) to cure defaults under the franchise agreements; (viii) certain
amendments were made in the casualty restoration and condemnation provisions;
(ix) the respective obligations of the parties relating to franchise agreements,
capital expenditures and repairs and maintenance were amended; (x) the
Partnership has the right to terminate the lease (a) upon a sale of the
property, provided that the Partnership either (1) offers the Lessee a
substitute lease or leases creating for the Lessee a leasehold estate having
substantially the same fair market value as the Percentage Lease for the
property being sold or (2) pays the Lessee a termination payment equal to the
net present value of the property's cash flow to the Lessee, and (b) in the
event that the Company terminates its REIT status and the Partnership makes the
applicable lease termination payment; and (xi) the Lessee has a right of first
offer to acquire hotels subject to the Percentage Leases. Future leases between
the Partnership and the Future Lessee will contain provisions substantially
similar to the Consolidated Lease Amendment.
Each Percentage Lease has a non-cancelable initial term of fifteen (15) years,
subject to earlier termination upon the occurrence of certain contingencies
described in the Percentage Leases. During the term of each Percentage Lease,
the Lessee is obligated to pay (i) the greater of Base Rent or Percentage Rent
and (ii) certain other amounts, including interest accrued on any late payments
or charges. Base Rent accrues and is required to be paid monthly. Percentage
Rent is based on percentages of room revenues and to a lesser extent, food and
beverage revenues, if any, for each of the Hotels. Both the Base Rent and the
threshold room revenue amount in each Percentage Rent formula will be adjusted
for changes in the CPI. The adjustment is calculated at the beginning of each
lease year based upon the average change in the CPI during the prior 24 months.
The adjustment in any lease year may not exceed 7% of the Base Rent and
threshold room
12
13
revenue amounts for the prior fiscal year. Percentage Rent is payable quarterly,
on or before the 30th day following the end of each of the calendar quarters in
each fiscal year.
The following table summarizes the percentages of room revenues in excess of
certain levels payable as Percentage Rent under the Percentage Leases as of
January 1, 1997.
Range of Percentages of Room Revenue
------------------------------------
First Tier Top Tier
---------- --------
Full Service (1) 28% to 38% 65% to 77%
Extended Stay 27% to 37% 65% to 75%
Limited Service 22% to 37% 62% to 74%
(1) Percentage Rent formula also includes 15%-30% of beverage revenue and 5%-15%
of food revenue.
Other than real estate and personal property taxes and maintenance of
underground utilities and structural elements, which are obligations of the
Partnership, the Percentage Leases require the Lessee to pay insurance,
utilities and all other costs and expenses incurred in the operation of the
Hotels. The Percentage Leases also provide for rent reductions and abatements in
the event of damage or destruction or a partial taking of any Hotel.
Maintenance and Modifications. Under the Percentage Leases, the Partnership is
required to maintain the underground utilities and the structural elements of
the improvements, including exterior and interior load bearing walls (excluding
plate glass) and the roof of each Hotel. In addition, the Percentage Leases
obligate the Partnership to fund certain capital expenditures in the Hotels
pursuant to the capital budgets approved by the Partnership, when and as deemed
necessary by the Lessee, up to an amount equal to 4% of annual room revenue, net
of amounts actually expended for capital expenditures for each Hotel during any
fiscal year. The Partnership's obligation will be carried forward to the extent
that the Lessee has not expended such amount, and any unexpended amounts will
remain the property of the Partnership upon termination of the Percentage
Leases. Otherwise, the Lessee is required, at its expense, to maintain the
Hotels in good order and repair, except for ordinary wear and tear, and to make
non-structural, foreseen and unforeseen, and ordinary and extraordinary, repairs
which may be necessary and appropriate to keep the Hotels in good order and
repair.
The Lessee, at its expense and with the Partnership's approval, may make
non-capital and capital additions, modifications or improvements to the Hotels,
provided that such action does not significantly alter the character or purposes
of the Hotels or significantly detract from the value or operating efficiencies
of the Hotels. All such alterations, replacements and improvements shall be
subject to all the terms and provisions of the Percentage Leases and will become
the property of the Partnership upon termination of the Percentage Leases. The
Partnership owns substantially all personal property (other than inventory,
linens and other nondepreciable personal property) not affixed to, or deemed a
part of, the real estate or improvements thereon, except to the extent that
ownership of such personal property would cause the rents under a Percentage
Lease not to qualify as "rents from real property" for REIT income test
purposes.
Insurance and Property Taxes. The Partnership is responsible for paying real
estate and personal property taxes on the Hotels (except to the extent that
personal property associated with the Hotels is owned by the Lessee). The Lessee
is required to keep in force and pay or reimburse the
13
14
Partnership for all insurance on the Hotels, with extended coverage, including
casualty, comprehensive general public liability, workers' compensation,
earthquake, flood and other insurance appropriate and customary for properties
similar to the Hotels and naming the Partnership as an additional named insured.
Indemnification. Under each of the Percentage Leases, the Lessee is obligated to
indemnify, and is obligated to hold harmless, the Partnership from and against
liabilities, costs and expenses (including reasonable attorneys' fees and
expenses) incurred by, imposed upon or asserted against the Partnership on
account of, among other things, (i) any accident or injury to person or property
on or about the Hotels, (ii) any misuse by the Lessee or any of its agents of
the leased property, (iii) any environmental liability resulting from any action
or negligence of the Lessee, (iv) taxes and assessments in respect of the Hotels
(other than real estate and personal property taxes and income taxes of the
Partnership on income attributable to the Hotels), (v) the sale or consumption
of alcoholic beverages on or in the real property or improvements thereon, or
(vi) any breach of the Percentage Leases by Lessee; provided, however, that such
indemnification will not be construed to require the Lessee to indemnify the
Partnership against the Partnership's own grossly negligent acts or omissions or
willful misconduct or third-party contractual liabilities arising from
termination of the Percentage Leases due to an event of default by the
Partnership thereunder.
Assignment and Subleasing. The Lessee is not permitted to sublet all or any part
of the Hotels or assign its interest under any of the Percentage Leases, other
than to an Affiliate of the Lessee, without the prior written consent of the
Partnership. No assignment or subletting will release the Lessee from any of its
obligations under the Percentage Leases.
Damage to Hotels. In the event of damage to or destruction of any hotel covered
by insurance which renders the Hotel unsuitable for the Lessee's use and
occupancy, the Lessee, at its option, will be obligated to (i) repair, rebuild,
or restore the Hotel or (ii) offer to acquire the Hotel on the terms set forth
in the applicable Percentage Lease. If the Lessee rebuilds the Hotel, the
Partnership is obligated to disburse to the Lessee, from time to time and upon
satisfaction of certain conditions, any insurance proceeds actually received by
the Partnership as a result of such damage or destruction, and any excess costs
of repair or restoration will be paid by the Lessee. If the Lessee decides not
to rebuild and the Partnership exercises its right to reject the Lessee's
mandatory offer to purchase the Hotel on the terms set forth in the Percentage
Lease, the Percentage Lease will terminate and the insurance proceeds will be
retained by the Partnership. If the Partnership accepts the Lessee's offer to
purchase the Hotel, the Percentage Lease will terminate and the Lessee will be
entitled to the insurance proceeds. In the event that damage to or destruction
of a Hotel which is covered by insurance does not render the Hotel wholly
unsuitable for the Lessee's use and occupancy, the Lessee generally will be
obligated to repair or restore the Hotel. In the event of damage to or
destruction of any Hotel which is not covered by insurance, the Lessee will be
obligated to either repair, rebuild, or restore the Hotel or offer to purchase
the Hotel on the terms and conditions set forth in the Percentage Lease. The
Percentage Lease shall remain in full force and effect during the period
required for repair or restoration of any damaged or destroyed Hotel, with the
Lessee to receive a credit against rental payments and other charges in an
amount equal to any loss-of-income insurance proceeds actually received by the
Partnership.
Condemnation of Hotel. In the event of a total condemnation of a Hotel , the
relevant Percentage Lease will terminate with respect to such Hotel as of the
date of taking, and the Partnership and the Lessee will be entitled to their
shares of the condemnation award in accordance with the provisions of the
Percentage Lease. In the event of a partial taking which does not render the
Hotel unsuitable for the Lessee's use, the Lessee shall restore the untaken
portion of the Hotel to a complete architectural unit and the Partnership shall
contribute to the cost of such restoration that part of the condemnation award
specified for restoration, provided that if the condemnation awards are
14
15
inadequate to restore the affected Hotel to a complete architectural unit,
either the Partnership or the Lessee shall have the right to terminate the
applicable Percentage Lease.
Events of Default. Events of Default under the Percentage Leases include, among
others, the following:
(i) the occurrence of an Event of Default under any other lease between
the Partnership and the Lessee or any Affiliate of the Lessee (including the
Consolidated Lease Amendment);
(ii) the failure by the Lessee to pay Base Rent, Percentage Rent or any
additional charges within 10 days after written notice from the Partnership that
such has become due and payable;
(iii) the failure by the Lessee to observe or perform any other term of
a Percentage Lease and the continuation of such failure for a period of 30 days
after receipt by the Lessee of notice from the Partnership thereof, unless such
failure cannot be cured within such period and the Lessee commences appropriate
action to cure such failure within said 30 days and thereafter acts, with
diligence, to correct such failure within such time as is necessary;
(iv) if the Lessee or a guarantor of the Percentage Leases shall file a
petition in bankruptcy or reorganization pursuant to any federal or state
bankruptcy law or any similar federal or state law, or shall be adjudicated a
bankrupt or shall make an assignment for the benefit of creditors or shall admit
in writing its inability to pay its debts generally as they become due, or if a
petition or answer proposing the adjudication of the Lessee or a guarantor of
the Percentage Leases as bankrupt or its reorganization pursuant to any federal
or state bankruptcy law or any similar federal or state law shall be filed in
any court and the Lessee or a guarantor of the Percentage Leases shall be
adjudicated a bankrupt and such adjudication shall not be vacated or set aside
or stayed within 60 days after the entry of an order in respect thereof, or if a
receiver of the Lessee or a guarantor of the Percentage Leases or of the whole
or substantially all of the assets of the Lessee shall be appointed in any
proceeding brought by the Lessee or a guarantor of the Percentage Leases or if
any such receiver, trustee or liquidator shall be appointed in any proceeding
brought against the Lessee or any guarantor of the Percentage Leases and shall
not be vacated or set aside or stayed within 60 days after such appointment;
(v) if the Lessee voluntarily discontinues operations of a Hotel for
more than 30 days, except as a result of damage, destruction, or condemnation;
(vi) if the franchise agreement with respect to a Hotel is terminated
as a result of any action or failure to act by the Lessee or its agents (other
than a failure to complete a capital improvement required by the franchisor
resulting from the Partnership's failure to fund such capital improvements); or
(vii) the occurrence of an event of default under either of the Lease
Guaranties.
If an Event of Default occurs and continues beyond any curative period, the
Partnership will have the option of terminating the Percentage Lease or any or
all other Percentage Leases between the Partnership and the Lessee and the
Consolidated Lease Amendment and, unless such Event of Default is cured, the
Percentage Leases shall terminate and the Lessee will be required to surrender
possession of the affected Hotels.
Right of First Offer. In the event that the Partnership desires to sell its
interest in a Hotel, the Partnership shall first offer to Lessee by written
notice the opportunity to acquire the Hotel at the price at which the
partnership intends to offer the Hotel (the "Offer Price"). In the event that
the Lessee elects within 15 days after receipt of such notice to acquire the
Hotel at the Offer Price, the
15
16
Partnership will be obligated to sell the Hotel to the Lessee or its nominee at
the Offer Price, and upon such sale, the applicable Percentage Lease shall
terminate with respect to the Hotel. Such provisions shall not apply to any
sale, transfer or conveyance by the Partnership of any interest in the Hotels to
any affiliate of the Partnership.
Termination of Percentage Leases on Disposition of the Hotels. In the event the
Partnership enters into an agreement to sell or otherwise transfer a Hotel and
the Lessee does not elect to acquire the Hotel in accordance with the right of
first offer described above, the Partnership shall be permitted to sell the
Hotel to a third party at a price equal to or greater than 95% of the Offer
Price. As compensation for the early termination of the Lessee's leasehold
estate, the Partnership will have the right to terminate the Percentage Lease
with respect to such Hotel upon either (i) paying the Lessee the net present
value of the Lessee's leasehold interest in the remaining term of the Percentage
Lease to be terminated or (ii) offering to lease to the Lessee one or more
substitute hotels on terms that would create a leasehold interest in such hotels
with a fair market value equal to or exceeding the fair market value of the
Lessee's remaining leasehold interest under the Percentage Lease to be
terminated.
Termination of Percentage Leases on Company's Termination of REIT Status. In the
event that the Company terminates its REIT status or the Code provisions are
amended so that REITs are permitted to operate hotels, the Partnership may elect
to terminate the Percentage Leases. In such event, the Partnership shall be
obligated to pay to the Lessee the termination payment calculated as set forth
in "The Percentage Leases-Termination of Percentage Leases on Disposition of the
Hotels."
Other Lease Covenants. The Lessee has agreed that it will not make any payments
to any Affiliate of the Lessee in connection with the Hotels as gross operating
expenses unless expressly set forth in the operating budget or an approved
capital budget or otherwise agreed to by the Partnership. The Lessee shall be
permitted to contract with its Affiliates for management and other services and
pay fees for such services, provided that such contracts and fees (i) are
disclosed in writing to the Partnership and (ii) shall not be included in gross
operating expenses. The Lessee's obligation to pay such fees shall be
subordinated to its obligation to pay Base Rent, Percentage Rent and additional
charges to the Partnership pursuant to the Percentage Leases.
Approval of Management Agreement. The Partnership shall have the right in its
sole and absolute discretion to approve in advance any manager or proposed
manager of a Hotel which is not an Affiliate of the Lessee or is not controlled
by Interstate or its senior management, as well as any agreement relating to the
management or operation of the Hotel (a "Management Agreement") by a manager
which is not an Affiliate of the Lessee, and the Lessee will provide the
Partnership with an executed copy of any Management Agreement so approved by the
Partnership. Any Management Agreement (whether or not with a manager which is an
Affiliate of the Lessee) must provide that (i) upon termination of the
applicable Percentage Lease or termination of the Partnership's or the Lessee's
right to possession of the Hotel for any reason, the Management Agreement may be
terminated by the Partnership without liability for any payment due or to become
due to the manager thereunder; (ii) any management fees shall be subordinated to
payments of rent to the Partnership; and (iii) in the event that the Lessee is
in default, the manager shall, at the election of the Partnership and provided
the manager continues to be paid, continue to perform under the terms of the
Management Agreement for a period not to exceed 90 days. No fees or other
amounts payable by the Lessee to any manager shall excuse the Lessee from its
obligations to pay rent and other amounts payable by Lessee to the Partnership
under the applicable Percentage Lease.
16
17
Breach by Partnership. If the Partnership fails to cure a breach by it under a
Percentage Lease, the Lessee may purchase the relevant Hotel from the
Partnership for a purchase price equal to that Hotel's then fair market value.
Upon notice from Lessee that the Partnership has breached the Lease, the
Partnership has 30 days to cure the breach or proceed to cure the breach, which
period may be extended in the event of certain specified, unavoidable delays
with such extension not to exceed 90 days after the notice of breach from the
Lessee.
Inventory. All inventory required in the operation of the Hotels is purchased
and owned by the Lessee at its expense. The Company has the option to purchase
all inventory related to a particular hotel at fair market value upon
termination of the related Percentage Lease.
SEASONALITY
The Hotels' operations historically have been seasonal in nature, generally
reflecting higher occupancy rates during the second and third quarters. This
seasonality can be expected to cause fluctuations in the Company's quarterly
lease revenue to the extent that it receives Percentage Rent.
TAX STATUS
The Company intends to operate so as to be taxed as a REIT under Sections
856-860 of the Internal Revenue Code of 1986, as amended (the "Code"). As long
as the Company qualifies for taxation as a REIT, with certain exceptions, the
Company will not be taxed at the corporate level on its taxable income that is
distributed to its shareholders. A REIT is subject to a number of organizational
and operational requirements, including a requirement that it distribute
annually at least 95% of its taxable income. Failure to qualify as a REIT will
render the Company subject to tax (including any applicable minimum tax) on its
taxable income at regular corporate rates and distributions to the shareholders
in any such year will not be deductible by the Company. Even if the Company
qualifies for taxation as a REIT, the Company may be subject to certain state
and local taxes on its income and property. In connection with the Company's
election to be taxed as a REIT, the Company's Charter imposes restrictions on
the transfer of shares of Common Stock. The Company has adopted the calendar
year as its taxable year.
In order for the Company to maintain its qualification as a REIT, not more than
50% in value of its outstanding stock may be owned, directly or indirectly, by
five or fewer individuals (as defined in the Code to include certain entities).
Furthermore, if any shareholder or group of shareholders of the Lessee owns,
actually or constructively, 10% or more of the stock of the Company, the Lessee
could become a related party tenant of the Partnership, which likely would
result in loss of REIT status for the Company. For the purpose of preserving the
Company's REIT qualification, the Company's Charter prohibits direct or indirect
ownership of more than 9.9% of the outstanding shares of any class of the
Company's stock by any person or group (the "Ownership Limitation"). Generally,
the capital stock owned by affiliated owners will be aggregated for purposes of
the Ownership Limitation.
Any transfer of shares that would prevent the Company from continuing to qualify
as a REIT under the Code will be void ab initio, and the intended transferee of
such shares will be deemed never to have had an interest in such shares.
Further, if, in the opinion of the Board of Directors, (i) a transfer of shares
would result in any shareholder or group of shareholders acting together owning
in excess of the Ownership Limitation or (ii) a proposed transfer of shares may
jeopardize the qualification of the Company as a REIT under the Code, the Board
of Directors may, in its sole discretion, refuse to allow the shares to be
transferred to the proposed transferee. Finally, the Company may, in the
discretion of the Board of Directors, redeem any stock held of record by any
shareholder in excess of the Ownership Limitation.
17
18
ENVIRONMENTAL MATTERS
Under various federal, state and local laws and regulations, an owner or
operator of real estate may be liable for the costs of removal or remediation of
certain hazardous or toxic substances on such property. Such laws often impose
such liability without regard to whether the owner knew of, or was responsible
for, the presence of hazardous or toxic substances. Furthermore, a person that
arranges for the disposal or transports for disposal or treatment a hazardous
substance at a property owned by another may be liable for the costs of removal
or remediation of hazardous substances released into the environment at that
property. The costs of remediation or removal of such substances may be
substantial and the presence of such substances, or the failure to promptly
remediate such substances, may adversely affect the owner's ability to sell such
real estate or to use such real estate as collateral for borrowings. In
connection with the ownership and operation of the Hotels, the Company, the
Partnership or the Lessee, as the case may be, may be potentially liable for any
such costs.
In connection with the Partnership's acquisition of the Hotels, Phase I
environmental site assessments ("ESAs") were obtained on all of the Hotels from
various independent environmental engineers. The Phase I ESAs were intended to
identify potential environmental contamination for which the Hotels may be
responsible and the potential for environmental regulatory compliance
liabilities. The Phase I ESAs included historical review of the Hotels, reviews
of certain public records, preliminary investigations of the sites and
surrounding properties, screening for the presence of hazardous substances,
toxic substances and underground storage tanks, and the preparation and issuance
of a written report. The Phase I ESAs did not include invasive procedures, such
as soil sampling or ground water analysis.
The Phase I ESAs have not revealed any environmental liability that the Company
believes would have a material adverse effect on the Company's business, assets,
results of operations or liquidity, nor is the Company aware of any such
liability or that there are material environmental liabilities of which the
Company is unaware. Nevertheless, no assurances can be given that (i) future
laws, ordinances or regulations will not impose any material environmental
liability or (ii) the current environmental condition of the Hotels will not be
affected by the condition of the properties in the vicinity of Hotels (such as
the presence of leaking underground storage tanks) or by third parties unrelated
to the Partnership or the Company.
The Company believes that its Hotels are in compliance in all material respects
with all federal, state and local statutes, ordinances and regulations regarding
hazardous or toxic substances and other environmental matters. Neither the
Company nor, to the knowledge of the Company, any of the most recent owners of
the Hotels prior to the Partnership's acquisition of the Hotels has been
notified by any governmental authority of any material noncompliance, liability
or claim relating to hazardous or toxic substances or other environmental matter
in connection with any of its present or former properties.
DEPRECIATION
In exchange for cash, the Partnership acquired 44 hotels in addition to a
portion of the ownership interest in the four hotels acquired from Phillip H.
McNeill, Sr. or certain of his affiliates (the "McNeill Initial Hotels"). To
that extent, the Partnership's initial basis in such hotels for federal income
tax purposes generally is equal to the purchase price paid by the Partnership.
The Partnership depreciates such hotel property for federal income tax purposes
under either the modified accelerated cost recovery system of depreciation
("MACRS") or the alternative depreciation system of depreciation ("ADS"). The
Partnership uses MACRS for furnishings and equipment. Under MACRS, the
Partnership depreciates such furnishings and equipment over a five-year recovery
18
19
period using a 200% declining balance method and a half-year convention. If,
however, the Partnership places more than 40% of its furnishings and equipment
in service during the last three months of a taxable year, a mid-quarter
depreciation convention must be used for the furnishings and equipment placed in
service during that year. The Partnership uses ADS for buildings and
improvements. Under ADS, the Partnership generally will depreciate such
buildings and improvements over a 40-year recovery period using a straight line
method and a mid-month convention.
To the extent that the Partnership acquired the McNeill Initial Hotels in
exchange for Partnership Units, the Partnership's initial basis in each McNeill
Initial Hotel for federal income tax purposes should be the same as the
transferor's basis in that McNeill Initial Hotel on the date of acquisition.
Although the law is not entirely clear, the Partnership depreciates such hotel
property for federal income tax purposes over the same remaining useful lives
and under the same methods used by the transferors. The Partnership's tax
depreciation deductions are allocated among the partners in accordance with
their respective interest in the Partnership (except to the extent that the
Partnership is required under Code Section 704 (c) to use a method for
allocating depreciation deductions attributable to the McNeill Initial Hotels or
other contributed properties that results in the Company receiving a
disproportionately large share of such deductions). Because the Partnership's
initial basis in the McNeill Initial Hotels is less than the fair market value
of those hotels on the date of acquisition, the Company's depreciation
deductions may be less than they otherwise would have been if the Partnership
had purchased the McNeill Initial Hotels entirely for cash.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company, listed below, serve in their respective
capacities for approximate one year terms and are subject to re-election
annually by the Board of Directors, normally in May of each year.
NAME POSITION
---- --------
Phillip H. McNeill, Sr. Chairman of the Board, Chief Executive Officer
and Director
David L. Levine President and Chief Operating Officer
Howard A. Silver Vice President of Finance, Secretary, Treasurer
and Chief Financial Officer
Phillip H. McNeill, Jr. (1) Vice President of Development
J. Ronald Cooper (1) Assistant Secretary and Controller
(1) Effective January 1, 1997, certain employees of the Former Lessee joined the
Company.
Phillip H. McNeill, Sr. (age 58) is Chief Executive Officer of the Company and
has been Chairman of McNeill Hospitality Corporation since 1984. From 1963 to
1977, he served in various capacities, including President and Chief Executive
Officer, with Schumacher Mortgage Company, Inc., a mortgage banking firm and
subsidiary of Time, Inc. Mr. McNeill has served as President and Director of the
Memphis Mortgage Bankers Association and the Tennessee State Mortgage Bankers
Association. He has served as a member of the Board of Trustees of the
University of Memphis Foundation and as a Director of First Commercial Bank of
Memphis. Mr. McNeill holds both a B.S. and a J.D. degree from the University of
Memphis and is a graduate of the Northwestern School of Mortgage Banking.
19
20
David L. Levine (age 49) is President and Chief Operating Officer of the Company
and joined the Company in June 1994. Mr. Levine entered the hospitality industry
in 1969 with the E.F. McDonald Incentive Travel Company, an incentive and
corporate travel arrangement company. In 1974 Mr. Levine was made director of
the Corporate Travel Division of the E.F. McDonald Incentive Travel Company. In
1975 Mr. Levine joined Intercontinental Hotels Corporation to direct their
Midwest Travel Industry Sales Department. From 1977 to 1981, Mr. Levine held
various positions with Holiday Inns, Inc. including Director of Worldwide Sales
- - USA and Canada, and National Sales Director and in 1982 became the Director of
Corporate and Franchise Hotel Operations for its Chicago district. From 1984 to
1985 Mr. Levine was Vice President of Operations of a regional Holiday Inn hotel
operator. In 1985, Mr. Levine formed North American Hospitality, Inc. and served
as its President before joining the Company. North American Hospitality, Inc.
operates Hampton Inn hotels and other properties for financial institutions and
private developers.
Howard A. Silver (age 42) is Vice President of Finance, Secretary, Treasurer and
Chief Financial Officer of the Company and has been a certified public
accountant since 1980. Mr. Silver joined the Company in May 1994. From 1992
until joining the Company, Mr. Silver served as Chief Financial Officer of
Alabaster Originals, L.P., Memphis, Tennessee, a fashion jewelry wholesaler.
From 1978 to 1985, Mr. Silver was a certified public accountant with the
national accounting firm of Coopers & Lybrand L.L.P., and from 1987 to 1992 Mr.
Silver was employed as a certified public accountant with the national
accounting firm of Ernst & Young. Mr. Silver holds a B.S. in Accounting from the
University of Memphis.
Phillip H. McNeill, Jr. (age 35) is Vice President of Development of the
Company. From 1994 to 1996, he served as President of the Former Lessee and from
1984 to 1996 served as Vice President of Trust Management, Inc., formerly
McNeill Hospitality Corporation, an Affiliate of the Former Lessee. Mr. McNeill
is the son of Phillip H. McNeill, Sr. and holds a B.B.A. from the University of
Memphis and is a graduate of the Northwestern School of Mortgage Banking.
J. Ronald Cooper (age 48) is Assistant Secretary and Controller of the Company.
From 1994 to 1996, he was Controller and Director of Financial Reporting for the
Former Lessee and joined the Former Lessee in October 1994. Mr. Cooper has been
a certified public accountant since 1972. From 1978 until joining the Former
Lessee, Mr. Cooper was employed as Secretary, Treasurer and Controller of Wall
Street Deli, Inc., a publicly-owned delicatessen company. Prior to that, Mr.
Cooper was a certified public accountant with the national accounting firm of
Coopers & Lybrand L.L.P. from 1970 to 1976. Mr. Cooper holds a B.S. degree in
accounting from Murray State University.
20
21
ITEM 2. PROPERTIES
The following table sets forth certain information with respect to the Current
Hotels on a pro forma basis:
Year Ended December 31, 1996
---------------------------- Revenue
Number Pro Forma Average Per
Date Of Room Lease Daily Available
Opened Rooms Revenue(3) Payment(1)(3) Occupancy Rate Room(2)
------ ----- ---------- ------------- --------- ---- -------
Hampton Inn:
Albany, NY 1986 155 $3,004 $1,419 73.9% $72.15 $53.30
Ann Arbor, MI 1986 153 2,501 1,128 70.6% $64.53 $45.55
Arlington, TX 1985 142 2,075 875 62.9% $63.94 $40.22
Austin, TX 1987 121 2,136 1,033 73.0% $65.49 $47.83
Beckley, WV 1992 109 2,156 1,168 86.3% $63.19 $54.54
Chattanooga, TN 1988 167 2,438 928 74.0% $60.68 $44.90
Cleveland, OH 1987 123 1,895 937 71.7% $58.45 $41.90
Cleveland, TN 1993 60 889 367 73.7% $54.86 $40.45
College Station, TX 1986 135 1,933 869 70.3% $55.62 $39.12
Columbus, GA 1986 119 1,934 934 82.6% $53.78 $44.42
Detroit, MI 1989 125 2,255 1,078 80.3% $61.39 $49.30
Fayetteville, NC 1986 122 1,574 656 69.7% $50.58 $35.25
Fort Worth, TX 1987 125 1,801 742 70.4% $55.94 $39.38
Glen Burnie, MD 1989 116 2,120 907 77.9% $64.09 $49.93
Garland, TX 1987 125 1,598 660 63.6% $54.79 $34.85
Gastonia, NC 1989 109 1,961 1,040 80.9% $60.75 $49.16
Gurnee, IL 1988 134 2,197 981 68.0% $65.87 $44.79
Indianapolis, IN 1987 129 2,056 924 66.3% $65.64 $43.55
Jacksonville, FL 1986 122 1,645 629 69.7% $52.86 $36.83
Knoxville, TN 1991 118 1,561 580 65.7% $54.99 $36.15
Little Rock, AR 1985 122 1,363 454 57.4% $53.16 $30.52
Louisville, Ky 1986 119 1,766 794 71.0% $57.09 $40.55
Meriden, CT 1988 126 1,702 772 63.5% $58.56 $37.21
Milford, CT 1986 148 2,615 1,236 77.7% $62.16 $48.28
Morgantown, WV 1991 108 1,809 896 75.1% $60.91 $45.76
Naperville, IL 1987 130 2,172 975 73.2% $62.37 $45.64
Sarasota, FL 1987 97 1,495 594 70.0% $60.20 $42.12
Scottsdale, AZ (4) 1996 126 780
Scranton, PA 1994 129 2,675 1,314 85.6% $66.23 $56.66
Shelby, NC 1989 78 935 412 65.4% $50.12 $32.76
State College, PA 1987 121 2,149 1,053 73.6% $65.94 $48.53
Traverse City, MI 1987 127 1,855 834 55.3% $72.22 $39.91
Comfort Inn:
Enterprise, AL 1987 78 950 402 74.0% $44.97 $33.29
Jacksonville Beach, FL 1973 180 3,273 1,536 69.1% $73.11 $50.53
Rutland, VT 1985 104 1.618 678 73.1% $58.18 $42.51
Residence Inn:
Burlington, VT 1988 96 2,582 1,282 87.9% $83.62 $73.47
Eagan, MN 1988 120 2,746 1,333 76.3% $81.93 $62.52
Madison, WI 1988 80 1,377 364 66.2% $71.07 $47.05
Omaha, NC 1981 80 1,834 724 78.6% $79.70 $62.62
Tinton Falls, NJ 1988 96 2,645 1,229 83.3% $89.91 $74.90
Holiday Inn:
Bluefield, WV 1980 120 1,974 1,111 70.9% $64.50 $45.70
Mt. Pleasant, SC 1988 158 3,122 1,665 73.0% $74.01 $53.99
Oak Hill, WV 1983 119 1,204 550 43.8% $63.12 $27.65
Winston-Salem, NC 1969 160 2,152 913 67.3% $54.65 $36.75
Holiday Inn Express:
Wilkesboro, NC 1985 101 1,285 661 58.7% $59.25 $34.75
21
22
Year Ended December 31, 1996
---------------------------- Revenue
Number Pro Forma Average Per
Date Of Room Lease Daily Available
Opened Rooms Revenue(3) Payment(1)(3) Occupancy Rate Room(2)
------ ----- ---------- ------------- --------- ---- -------
Homewood Suites:
Hartford, CT 1990 132 3,231 1,477 78.0% $85.74 $66.88
Phoenix, AZ (4) 1996 124 1,032
San Antonio, TX (4) 1996 123 854
----- ------- ------- ---- ------ ------
Consolidated Totals/Weighted
Average for all hotels 5,811 $90,258 $43,780 71.4% $63.89 $45.59
===== ======= ======= ==== ====== ======
- ------------------------
(1) Represents lease payments calculated on a pro forma basis by applying
the rent provisions in the Percentage Leases using historical room
revenues of the hotels as if January 1, 1996 was the beginning of the
lease year.
(2) Determined by multiplying occupancy and the average daily rate.
(3) Amounts in thousands.
(4) Hotel was not open for the entire period; therefore, pro forma results
are not available, minimum rent has been assumed.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Partnership currently is involved in any material
litigation nor, to the Company's knowledge, is any material litigation currently
threatened against the Company or the Partnership. The Lessee has advised the
Company that it currently is not involved in any litigation, other than routine
litigation arising in the ordinary course of business. The Lessee has advised
the Company that none of such litigation is material and substantially all of
any liability is expected to be covered by liability insurance.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company shareholders during the
fourth quarter of 1996, through the solicitation of proxies or otherwise.
22
23
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
(1) Market Information
The Company's Common Stock is traded on the New York Stock Exchange (the "NYSE")
under the symbol "ENN." The following table sets forth for the indicated periods
the high and low closing prices for the Common Stock, as traded through the
facilities of the NYSE and, prior to September 9, 1996, the Nasdaq Stock Market
and the cash dividends declared per share:
Distributions
Price Range Declared
----------- Per Share Record
High Low and Unit Date
---- --- -------- ----
Year Ended December 31, 1995:
First Quarter 11 1/8 9 1/2 $0.24 March 31, 1995
Second Quarter 12 10 3/8 0.24 June 16, 1995
Third Quarter 12 1/2 10 3/8 0.26 October 2, 1995
Fourth Quarter 12 10 3/4 0.26 December 29, 1995
Year Ended December 31, 1996:
First Quarter 13 1/4 11 1/2 0.28 March 29, 1996
Second Quarter 12 3/4 11 1/4 0.28 June 28, 1996
Third Quarter 13 11 0.28 September 30, 1996
Fourth Quarter 13 1/8 11 1/8 0.28 December 31, 1996
On March 1, 1997, there were 661 record holders of the Company's Common Stock,
including shares held in "street name" by nominees who are record holders, and
approximately 15,400 beneficial owners.
(c) Distributions
The Company intends to make regular quarterly distributions to its shareholders.
The Company's ability to make distributions is dependent on the receipt of
distributions from the Partnership. In order to qualify as a REIT for federal
income tax purposes, the Company must distribute to shareholders annually at
least 95% of its taxable income. The Company, as general partner of the
Partnership through a wholly-owned subsidiary, intends to cause the Partnership
to distribute to its partners sufficient amounts to permit the Company to make
regular quarterly distributions to its shareholders. The Partnership's primary
source of revenue consists of rent payments from the Lessee under the Percentage
Leases.
A portion of the distribution to shareholders is expected to represent a return
of capital for federal income tax purposes which generally will not be subject
to federal income tax under current law. The Company's distributions made in
1996 and 1995 are considered to be 29% and 22% return of capital for federal
income tax purposes.
Future distributions paid by the Company will be at the discretion of the board
of directors of the Company and will depend on the actual cash flow of the
Company, its financial condition, capital requirements, the annual distribution
requirements under the REIT provisions of the Code and such other factors as the
directors of the Company deem relevant.
23
24
ITEM 6. SELECTED FINANCIAL DATA
The following tables set forth selected historical financial information for the
Company and the McNeill Initial Hotels, which are deemed under the rules of the
Securities and Exchange Commission to be the predecessor of the Company.
With respect to the Company, the following tables set forth (i) selected
historical operating and other financial information for the years ended
December 31, 1996 and 1995, and the period March 1, 1994 (inception of
operations) through December 31, 1994, and (ii) selected historical balance
sheet data as of December 31, 1996 and 1995. The selected historical financial
information has been derived from the historical financial statements of the
Company audited by Coopers & Lybrand L.L.P., independent accountants, whose
report with respect thereto is included in this report.
With respect to the McNeill Initial Hotels, the following tables set forth
selected combined historical financial data for the period January 1, 1994
through February 28, 1994, and for the two years ended December 31, 1993. The
selected combined historical financial information for the McNeill Initial
Hotels for each of the two years ended December 31, 1993, have been derived from
the historical combined financial statements.
The following selected financial information should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and all of the financial statements and notes thereto included
elsewhere in this report.
24
25
EQUITY INNS, INC
SELECTED FINANCIAL DATA
(in thousands, Except Per Share Data)
March 1, 1994
(inception of operations)
Year Ended December 31, through
1996 1995 December 31, 1994
------- ------- -----------------
Operating Data:
Revenue $38,430 $24,145 $9,798
Net income 14,473 8,511 4,620
Net income per common share .69 .70 .60
Distributions declared per
common share and Unit 1.12 1.00 .703
Funds from operations (1) 26,397 15,804 7,611
Funds from operations per
common share and Unit 1.22 1.22 .89
Weighted average number of
common shares and Units
outstanding 21,652 12,920 8,551
Balance Sheet Data:
Investments in hotel properties, net $309,202 $218,429 $140,970
Total assets 317,880 225,067 145,555
Debt 77,399 74,939 45,838
Minority interest in partnership 7,728 6,073 6,081
Shareholders' equity 222,951 137,493 89,802
(1) Represents Funds from Operations of the Company on a consolidated
basis. Industry analysts generally consider Funds from Operations to be
an appropriate measure of the performance of an equity REIT. In
accordance with the resolution adopted by the Board of Governors of
NAREIT, Funds from Operations represent net income (loss) (computed in
accordance with generally accepted accounting principles), excluding
gains (or losses) from debt restructuring or sales of property, plus
depreciation, and after adjustments for unconsolidated partnerships and
joint ventures. For the periods presented, depreciation and minority
interest were the only non-cash adjustments. Funds from Operations
should not be considered an alternative to net income or other
measurements under generally accepted accounting principles as an
indicator of operating performance or to cash flows from operating,
investing or financing activities as a measure of liquidity. Funds from
Operations does not reflect working capital changes, cash expenditures
for capital improvements and debt service on the hotels.
25
26
The following information reflects the combined selected financial data for four
hotels acquired from affiliates of the Company's Chairman of the Board and Chief
Executive Officer in connection with the Company's IPO. Under the rules of the
Securities and Exchange Commission, such combined hotels are deemed to be the
predecessor of the Company.
MCNEILL INITIAL HOTELS
SELECTED FINANCIAL DATA
(in thousands)
January 1, 1994
to Year Ended December 31,
February 28, 1994 1993 1992
----------------- -------- -------
Operating Data:
Room revenue $ 1,026 $ 6,052 $ 4,798
Other revenue 46 286 223
------- ------- -------
Total revenue 1,072 6,338 5,021
Hotel operating expenses 657 3,628 2,948
Depreciation and amortization 116 699 606
Interest 218 1,036 889
Other corporate expenses 82 614 410
------- ------- -------
Net income (loss) $ (1) $ 361 $ 168
======= ======= =======
26
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORMATION OF THE COMPANY, INITIAL PUBLIC OFFERING AND FOLLOW-ON OFFERINGS
Equity Inns, Inc. (the "Company") is a self-advised real estate investment trust
("REIT") which was incorporated on November 24, 1993 but did not commence
operations until March 1, 1994. The Company has completed the following public
offerings (collectively, the "Offerings") and private placements since
inception:
Offering Price
Offering Date Completed Per Share Shares Sold Net Proceeds
- ----------------------- -------------- -------------- ----------- -------------
Initial Public Offering March 1, 1994 $10.00 5,190,000 $46.9 million
Second Offering July 13, 1994 $12.50 4,410,000 51.2 million
Third Offering July 6, 1995 $10.75 5,125,000 52.0 million
Fourth Offering April 16, 1996 $11.50 7,947,000 86.0 million
Trust Leasing, Inc.
(Units) April 16, 1996 $11.50 250,000 2.9 million
Promus Hotels, Inc.
Private Placement May 31, 1996 $11.50 347,826 4.0 million
Promus Hotels, Inc.
Private Placement September 27, 1996 $12.42 123,822 1.5 million
Promus Hotels, Inc.
Private Placement November 5, 1996 $11.52 134,584 1.6 million
The Company contributed all of the net proceeds of the Offerings and private
placements to Equity Inns Partnership, L.P. (the "Partnership") in exchange for
an equity interest in the Partnership. At December 31, 1996, 1995 and 1994, the
Company owned an approximately 96.7%, 95.8% and 92.3% equity interest in the
Partnership, respectively. Equity Inns Trust, a wholly-owned subsidiary of the
Company, is the sole general partner of the Partnership.
In order to qualify as a REIT, neither the Company nor the Partnership can
operate hotels. Therefore, prior to November 15, 1996, all of the Company's
hotels were leased to Trust Leasing, Inc., the Former Lessee ("Former Lessee"),
which was owned by Phillip H. McNeill, Sr., the Chairman of the Company.
Effective November 15, 1996, the Former Lessee assigned all of its interest in
the Leases to Crossroads/Memphis Partnership, L.P. (the "Lessee"). All of the
hotels are leased pursuant to the Percentage Leases (the "Percentage Leases")
which provide for the greater of (i) fixed annual base rent ("Base Rent") or
(ii) rent based, in part, on the revenue of the hotels ("Percentage Rent"). The
Partnership's, and therefore the Company's, principal source of revenue is lease
payments made by the Lessee under the Percentage Leases. Percentage Rent is
based primarily upon the hotels' room revenues and, to a lesser extent, food and
beverage revenues.
1996 HIGHLIGHTS
Since its inception, the Company and its officers have taken steps to position
the Company for growth and stability. Several changes occurred in 1996 which
have significantly added to these efforts. These events are as follows:
FORMATION OF STRATEGIC ALLIANCE WITH PROMUS HOTELS
On March 15, 1996, the Company entered into a strategic alliance with
Promus Hotels, Inc. ("Promus"), the exclusive franchisor of Hampton
Inn, Homewood Suites, Hampton Inn &
27
28
Suites and Embassy Suites. Under the agreement, Promus will invest over
time up to a maximum of $15 million, $7 million of which was invested
in 1996, in newly issued shares of the Company, as it purchases or
develops Promus brand hotel properties. Promus has agreed to offer at
least three development opportunities each year for the next four
years. Promus will manage all hotels acquired through this alliance.
LISTING OF COMMON STOCK ON NYSE
On September 9, 1996, the Company, formerly listed on the Nasdaq Stock
Market, listed its Common Stock on the New York Stock Exchange ("NYSE")
under the symbol "ENN." Management believes that this change will
improve the liquidity of the shares of Common Stock and will provide
greater access to investors.
SALE OF TRUST LEASING, INC. AND ALLIANCE WITH INTERSTATE HOTELS COMPANY
Effective November 15, 1996, the Former Lessee assigned all of its
interest in the Percentage Leases to the Lessee, a partnership
controlled by Interstate Hotels Corporation ("Interstate"), an
affiliate of Interstate Hotels Company, a NYSE-listed corporation with
a market cap of $979 million at December 31, 1996. In management's
opinion, this was a major step in eliminating the perceived conflicts
of interest.
Interstate Hotels Company, the nation's largest hotel management
company, and Interstate have each guaranteed the Lessee's obligations
under the Percentage Leases. The Company granted Interstate a right of
first refusal, subject to certain limitations, to lease and manage
hotels acquired or developed by the Company over the next five years.
Under the agreement, the Company has the option over the same period to
acquire certain limited-service, extended-stay, upper economy or
midmarket hotels developed or owned by Interstate.
Since the IPO, the Company has actively implemented its acquisition strategy.
The following chart summarizes information regarding the 48 hotels (the "Current
Hotels") owned at December 31, 1996:
# of Hotel # of Rooms/
Franchise Affiliation Properties Suites
- --------------------- ---------- -----------
Premium Limited Service Hotels:
Hampton Inn 32 3,940
Comfort Inn 2 182
Holiday Inn Express 1 101
-- -----
Sub-total 35 4,223
-- -----
Premium Extended Stay Hotels:
Residence Inn 5 472
Homewood Suites 3 379
-- -----
Sub-total 8 851
-- -----
Full Service Hotels:
Holiday Inn 4 557
Comfort Inn 1 180
-- -----
Sub-total 5 737
-- -----
Total 48 5,811
== =====
28
29
The Current Hotels are located in 24 states. Management believes it is prudent
to diversify geographically, by market segment and among franchise brands.
During 1996 and 1995, the Company acquired the following types of hotels at
advantageous capitalization rates for the approximate amounts indicated:
1996 1995
---------------------------------- ----------------------------------
No. of Hotels Purchase Price No. of Hotels Purchase Price
------------- -------------- ------------- --------------
(in thousands) (in thousands)
Premium Limited service 5 $36,200 9 $55,100
Premium Extended stay 5 41,300 1 3,700
Full service 1 5,100 2 17,800
------- ------- ------- -------
11 $82,600 12 $76,600
======= ======= ======= =======
RESULTS OF OPERATIONS
Comparison of the Company's operating results for the year ended December 31,
1996 with the year ended December 31, 1995.
For the year ended December 31, 1996, the Company had total revenues of $38.4
million, consisting substantially of Percentage Lease revenue. This compares
with total revenues of $24.1 million for the year ended December 31, 1995.
Increases in revenue from hotel operations for the year ended December 31, 1996
as compared to 1995 are due to (i) an increased number of hotels being owned and
leased by the Partnership throughout 1996, (ii) increase in ADR and/or occupancy
at many of the hotels leased during both years and, (iii) a full year of
operation in 1996 of hotels acquired in 1995. Assuming all hotels which were in
operation a full year in both 1996 and 1995 had been owned and leased as of
January 1, 1995, revenue per available room ("REVPAR") (on a pro forma basis)
would have increased 2.8% over 1995.
Real estate and personal property taxes and general and administrative expenses
in the aggregate remained fairly constant in 1996 and 1995 as a percentage of
total revenue. Interest expense increased to $4.4 million from $3.7 million in
1995 due primarily to borrowings incurred to finance the Company's acquisitions
subsequent to the Fourth Offering. The Company's weighted average interest rate
on outstanding borrowings at December 31, 1996 was 7.33%. Net income for 1996
was $14.5 million or $0.69 per share, compared to $8.5 million or $0.70 per
share for 1995. Funds from Operations ("FFO"), as defined below, for 1996 was
$26.4 million or $1.22 per share and Unit, compared to $15.8 million or $1.22
per share and Unit for 1995. FFO for 1996 compared to 1995 remained flat, due to
an unanticipated delay in the Company's acquisition program, and a follow-on
stock offering in April 1996 that greatly increased the Company's weighted
number of shares outstanding.
Comparison of the Company's operating results for the year ended December 31,
1995 with the period March 1, 1994 (inception of operations) through December
31, 1994.
For the year ended December 31, 1995, the Company had total revenues of $24.1
million, consisting substantially of Percentage Lease revenue. This compares
with total revenues of $9.8 million for the period March 1, 1994 (inception of
operations) to December 31, 1994. Real estate and personal property taxes and
general and administrative expenses in the aggregate remained fairly constant in
1995 and 1994 as a percentage of total revenue. Interest expense increased to
$3.7 million in
29
30
1995 from $390,000 in 1994 due primarily to the Company's acquisitions
subsequent to the Third Offering. The Company's weighted average interest rate
on outstanding borrowings at December 31, 1995 was 7.6%. Net income for 1995 was
$8.5 million or $0.70 per share, compared to $4.6 million or $0.60 per share for
1994. FFO for 1995 was $15.8 million or $1.22 per share and Unit, compared to
$7.6 million or $0.89 per share and Unit for 1994.
THE CURRENT HOTELS - ACTUAL
The following discussion and room revenue data reflect the actual operations of
the Current Hotels which were in operation a full year in both 1996 and 1995 and
is independent of ownership and other pro forma consideration. The following
table sets forth historical room revenue for the Current Hotels and the
percentage change between the periods indicated.
ROOM REVENUE
(in thousands)
Year Ended December 31, Percent
1996 1995 Change
------ ------ ------
Hampton Inn
Albany, New York $ 3,004 $ 2,990 0.5 %
Ann Arbor, Michigan 2,501 2,245 11.4 %
Arlington (Dallas), Texas 2,075 2,380 (12.8)%
Austin, Texas 2,136 2,255 (5.3)%
Beckley, West Virginia 2,156 1,999 7.9 %
Chattanooga, Tennessee 2,438 2,213 10.2 %
Cleveland, Ohio 1,895 1,807 4.9 %
Cleveland, Tennessee 889 726 22.5 %
College Station, Texas 1,933 1,836 5.3 %
Columbus, Georgia 1,934 1,721 12.4 %
Detroit, Michigan 2,255 2,004 12.5 %
Fayetteville, North Carolina 1,574 1,546 1.8 %
Fort Worth, Texas 1,801 1,762 2.2 %
Glen Burnie (Baltimore), Maryland 2,120 2,039 4.0 %
Garland (Dallas), Texas 1,598 1,841 (13.2)%
Gastonia, North Carolina 1,961 1,781 10.1 %
Gurnee (Chicago), Illinois 2,197 1,891 16.2 %
Indianapolis, Indiana 2,056 2,157 (4.7)%
Jacksonville, Florida 1,645 1,658 (0.8)%
Knoxville, Tennessee 1,561 1,587 (1.6)%
Little Rock, Arkansas 1,363 1,438 (5.2)%
Louisville, Kentucky 1,766 1,663 6.2 %
Meriden, Connecticut 1,702 1,550 9.8 %
Milford, Connecticut 2,615 2,264 15.5 %
Morgantown, West Virginia 1,809 1,683 7.5 %
Naperville (Chicago), Illinois 2,172 2,058 5.5 %
Sarasota, Florida 1,495 1,468 1.8 %
Scottsdale, Arizona (1)
Scranton, Pennsylvania 2,675 2,643 1.2 %
Shelby, North Carolina 935 931 0.4 %
State College, Pennsylvania 2,149 2,097 2.5 %
Traverse City, Michigan 1,855 1,865 (0.5)%
30
31
Year Ended December 31, Percent
1996 1995 Change
------ ------ ------
Comfort Inn
Enterprise, Alabama 950 974 (2.5)%
Jacksonville Beach, Florida 3,273 3,365 (2.7)%
Rutland, Vermont 1,618 1,672 (3.2)%
Residence Inn
Burlington, Vermont 2,582 2,405 7.4 %
Minneapolis (Eagan), Minnesota 2,746 2,893 (5.1)%
Madison, Wisconsin 1,377 1,400 (1.6)%
Omaha, Nebraska 1,834 1,935 (5.2)%
Tinton Falls, New Jersey 2,645 2,618 1.0 %
Holiday Inn
Bluefield, West Virginia 1,974 1,996 (1.1)%
Charleston (Mt. Pleasant), South Carolina 3,122 2,748 13.6 %
Oak Hill, West Virginia 1,204 1,109 8.6 %
Winston-Salem, North Carolina 2,152 2,016 6.7 %
Holiday Inn Express
Wilkesboro, North Carolina 1,285 1,138 12.9 %
Homewood Suites
Hartford, Connecticut 3,231 3,026 6.8 %
Phoenix, Arizona (1)
San Antonio, Texas (1)
------- ------- ----
$90,258 $87,393 3.3 %
======= ======= ====
(1) Hotel was not open for the full year; therefore, revenues are not available.
As shown above, room revenues for the Current Hotels increased 3.3%. For the
Current Hotels, average daily rate increased an average of 6.7% from $59.86 to
$63.89 with occupancy experiencing a decrease from 74.1% in 1995 to 71.4% in
1996, due to (i) decreases in certain of the Company's hotels where major
renovations significantly reduced the number of available rooms, (ii) regional
weakness in the South-Central region of the United States where the Company has
six hotels, and (iii) through the focus on room rate increases to increase
revenues.
FUNDS FROM OPERATIONS
Industry analysts generally consider Funds from Operations to be an appropriate
measure of the performance of an equity REIT. In accordance with the resolution
adopted by the Board of Governors of the National Association of Real Estate
Investment Trusts, Funds from Operations represent net income (loss) (computed
in accordance with generally accepted accounting principles), excluding gains
(or losses) from debt restructuring or sales of property, plus depreciation, and
after adjustments for unconsolidated partnerships and joint ventures. For the
periods presented, depreciation and minority interest were the only non-cash
adjustments. Funds from Operations should not be considered an alternative to
net income or other measurements under generally accepted accounting principles
as an indicator of operating performance or to cash flows from operating,
investing or financing activities as a measure of liquidity. Funds from
Operations does
31
32
not reflect working capital changes, cash expenditures for capital improvements
and debt service on the hotels.
The following reconciliation of income before minority interest to Funds from
Operations illustrates the difference in the two measures of operating
performance:
For the Year For the Year
Ended Ended
December 31, 1996 December 31, 1995
----------------- -----------------
(in thousands, except per share and Unit data)
Income before minority interest $14,933 $ 9,013
Add:
Depreciation of buildings,
furniture and fixtures 11,464 6,791
------- -------
Funds from Operations $26,397 $15,804
======= =======
Weighted average number of
common shares and Units
outstanding 21,652 12,920
======= =======
Funds from Operations per share and Unit $ 1.22 $ 1.22
======= =======
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of cash to meet its cash requirements, including
distributions to its shareholders, is its cash distributions from the
Partnership. The Partnership receives cash payments from the Lessee pursuant to
the Percentage Leases. The Lessee's obligations under the Percentage Leases are
guaranteed by Interstate. The Company's liquidity, including its ability to make
distributions to shareholders, is dependent upon the Lessee's ability to make
payments under the Percentage Leases.
Cash and cash equivalents were $129,000 at December 31, 1996, compared to
$133,000 at December 31, 1995. Excess cash balances are used to reduce the
Company's outstanding debt. For the year ended December 31, 1996, cash flow
provided by operating activities, consisting primarily of Percentage Lease
revenue, was $26.2 million, and funds from operations, which is the sum of net
income, minority interest and depreciation were $26.4 million.
At its annual meeting of shareholders on April 18, 1995, the Company's
shareholders voted to amend the Company's Charter to increase the Charter's debt
limitation from 35% to 45% of the Company's investment in hotel properties, at
cost. In December 1995, the Company increased the principal amount of its Line
of Credit from $69 million to $130 million. The increased facility bears
interest, at the Company's option, at 1.75% over 30, 60, or 90-day LIBOR. At
December 31, 1996, the Company had outstanding debt of approximately $77 million
under the Line of Credit, leaving approximately $53 million available for future
acquisitions. At December 31, 1996, the Line of Credit was collateralized by
first mortgages on 35 of the 48 hotels owned by the Partnership and will be
collateralized by additional hotels acquired in the future using proceeds from
the Line of Credit. The Line of Credit has been extended through November 1998,
with an additional one-year option.
32
33
In January 1997, the Company established EQI Financing Partnership I, L.P. ("EQI
Finance"), an indirect, wholly-owned subsidiary of the Company. EQI Finance was
established for the purpose of issuing $88 million of fixed rate collateralized
mortgage bonds in a private placement transaction.
On February 10, 1997, EQI Finance issued $88 million of rated Commercial
Mortgage Bonds ("Bonds"), as follows:
Initial
Principal Interest Stated
Class Amount Rate Maturity Rating
----- ------------- -------- ----------------- ------
A $27.4 million 6.825% November 20, 2006 AA
B $50.6 million 7.370% December 20, 2015 A
C $10.0 million 7.580% February 20, 2017 BBB
The combined interest rate for all three issues of Bonds is fixed at 7.22%.
Proceeds from the issuance of these Bonds were used to repay existing debt under
the Line of Credit of approximately $85.6 million and expenses of approximately
$2.4 million. Principal payments are to be applied to each class of Bonds in
order of their respective maturities with no principal payment on any Bond until
all Bonds in a bond class with an earlier stated maturity have been paid in
full. The Company expects to repay these bonds in full within 10 years.
In connection with these transactions, the Partnership transferred twenty-three
of its hotel properties and their respective leases to EQI Finance as a capital
contribution in return for a 99% limited partnership interest. The remaining 1%
interest is owned by EQI Financing Corporation, the sole general partner of EQI
Finance and a wholly-owned subsidiary of the Company. The mortgage properties
will secure the Bonds.
During 1996, the Company spent $19.4 million, including $10.6 million in
renovations required by franchisors, to fund capital improvements to its
pro