Lodgian 10-K 2007
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file no. 1-14537
Registrants telephone number, including area code:
Title of Each Class
Class A warrants
Class B warrants
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b-2 of the Act). Yes o No þ
The aggregate market value of Common Stock, par value $.01 per share, held by non-affiliates of the registrant as of June 30, 2006, was $351,829,935 based on the closing price of $14.25 per share on the American Stock Exchange on such date. For purposes of this computation, all directors, executive officers and 10% shareholders are treated as affiliates of the registrant.
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes þ No o
The registrant had 24,647,826 shares of Common Stock, par value $.01, outstanding as of March 1, 2007.
Portions of the proxy statement for the 2007 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III of this Form 10-K.
When we use the terms Lodgian, we, our, and us, we mean Lodgian, Inc. and its subsidiaries.
We are one of the largest independent owners and operators of full-service hotels in the United States in terms of our number of guest rooms, as reported by Hotel Business in the 2007 Green Book published in December 2006. We are considered an independent owner and operator because we do not operate our hotels under our own name. We operate substantially all of our hotels under nationally recognized brands, such as Crowne Plaza, Holiday Inn, Marriott and Hilton. As of March 1, 2007, we operated 68 hotels with an aggregate of 12,353 rooms, located in 28 states and Canada. Of the 68 hotels we operated as of March 1, 2007, 44 hotels, with an aggregate of 8,116 rooms, are part of our continuing operations, while 24 hotels, with an aggregate of 4,237 rooms, were held for sale and classified in discontinued operations. Our portfolio of hotels, all of which we consolidate in our financial statements, consists of:
Our hotels are primarily full-service properties that offer food and beverage services, meeting space and banquet facilities and compete in the midscale and upscale market segments of the lodging industry. We operate all but two of our hotels under franchises obtained from nationally recognized hospitality franchisors. We operate 42 of our hotels under franchises obtained from InterContinental Hotels Group as franchisor of the Crowne Plaza, Holiday Inn, Holiday Inn Select and Holiday Inn Express brands. We operate 13 of our hotels under franchises from Marriott International as franchisor of the Marriott, Courtyard by Marriott, Fairfield Inn by Marriott, Residence Inn by Marriott, and SpringHill Suites by Marriott brands. We operate another 11 hotels under other nationally recognized brands and two hotels are non-branded. We believe that franchising under strong national brands affords us many benefits such as guest loyalty and market share premiums.
Our management consists of an experienced team of professionals with extensive lodging industry experience led by our President and Chief Executive Officer, Edward J. Rohling, who has been in the lodging industry for over twenty-four years. In addition, our Vice President of Hotel Operations and our Senior Vice President of Capital Investment have been in the hospitality industry for over twenty years each.
Our operations team is responsible for the management of our properties. We have aligned our operations team into two divisions. Our core operating division is responsible for the operations of our held for use hotels, while our held for sale division is responsible for the operations of our held for sale hotels. This structure allows our core operating division to concentrate on the creation of long-term value while our held for sale division is simultaneously focused on maximizing hotel performance through the date of sale and accelerating the sales process in an effort to optimize selling prices. Our vice president of hotel operations oversees our core operating division. He is assisted by our director of regional operations, who is responsible for the supervision of our regional operating managers, who support our general managers in the day-to-day operations of our hotels. Our vice president of asset management is responsible for managing our held for sale properties. Our corporate office is located in Atlanta, Georgia. The centralized management services provided by our corporate office include sales and marketing, purchasing, finance and accounting, information technology, renovations, human resources, legal services, and quality programs.
Our corporate finance and accounting team coordinates the financial and accounting functions of our business. These functions include internal audit, insurance, payroll and accounts payable processing, credit, tax, property accounting and financial reporting services. The corporate operations team oversees the budgeting and forecasting for our hotels and also identifies new systems and procedures to employ within our hotels to improve efficiency and
profitability. The capital investment process includes scoping, budgeting, return on investment analysis, design, procurement, and construction. Capital investment projects are approved when management determines that the appropriate return on investment will be achieved, following thorough planning, diligence, and analysis. The corporate sales and marketing team coordinates the sales forces for our hotels, designs sales training programs, tracks future business under contract and identifies, employs and monitors marketing programs aimed at specific target markets. The corporate capital investment team oversees the interior design and renovation of all our hotels. Each hotels product quality and the refurbishment of existing properties are also managed from our corporate headquarters. The legal team coordinates all contract reviews and provides the hotels with legal support as needed.
Our information technology team maintains our computer systems, which provide real-time tracking of each hotels daily occupancy, average daily rate (ADR), room, food, beverage and other revenues, revenue per available room (RevPAR) and all hotel expenses. By having current information available, we are better able to respond to changes in each market by focusing sales efforts and we are able to make appropriate adjustments to control expenses and maximize profitability as new current information becomes available.
Creating cost and guest service efficiencies in each hotel is a top priority. Our centralized purchasing team is able to realize significant cost savings by securing volume pricing from our vendors.
Our corporate human resources staff works closely with management and employees throughout the Company to ensure compliance with employment laws and related government filings, counsel management on employee relations and labor relations matters, design and administer benefit programs, and develop recruiting and retention strategies.
The foundation of the hospitality industry is managing and leading people as they serve our guests. Our guest satisfaction and training group supports our general managers and regional teams in this effort by monitoring and communicating our successes and opportunities for improvement. We provide our guests with a direct link to our corporate office via a dedicated toll-free phone number whereby guests can provide feedback regarding their stay. This provides the Company with an additional opportunity to recognize associates that have provided exemplary service to our guests as well as to ensure our guests had a pleasant and memorable experience at our hotels. When areas for improvement are identified, additional support is provided to the hotels through training and enhanced property visits. This support assists the propertys leadership team to realize their service potential and provide value to our guests that will make them return time and time again.
Lodgian, Inc. was formed as a new parent company in a merger of Servico, Inc. and Impac Hotel Group, LLC in December 1998. Servico was incorporated in Delaware in 1956 and was an owner and operator of hotels under a series of different entities. Impac was a private hotel ownership, management and development company organized in Georgia in 1997 through a reorganization of predecessor entities. After the effective date of the merger, our portfolio consisted of 142 hotels.
Between December 1998 and the end of 2001, a number of factors, including our heavy debt load, lack of available funds to maintain the quality of our hotels, a weakening U.S. economy, and the severe decline in travel in the aftermath of the terrorist attacks of September 11, 2001, combined to place adverse pressure on our cash flow and liquidity. As a result, on December 20, 2001, Lodgian and substantially all of our subsidiaries that owned hotels filed for voluntary reorganization under Chapter 11 of the Bankruptcy Code. At the time of the Chapter 11 filing, our portfolio consisted of 106 hotels. Following the effective date of our reorganization, we emerged from Chapter 11 with 97 hotels after eight of our hotels were conveyed to a lender in satisfaction of outstanding debt obligations and one hotel was returned to the lessor of a capital lease of the property. Of the 97 hotels, 78 hotels emerged from Chapter 11 on November 25, 2002, 18 hotels emerged from Chapter 11 on May 22, 2003 and one property never filed under Chapter 11. Effective November 22, 2002, the Company adopted fresh start reporting. As a result, all assets and liabilities were restated to reflect their estimated fair values at that time.
During 2003, we identified 19 hotels, one office building and three land parcels for sale as part of our portfolio improvement strategy and our efforts to reduce debt and interest costs. During 2003, we sold one hotel and the office
building. During 2004, we sold 11 hotels and two land parcels. During 2005, we identified an additional five hotels for sale and sold eight hotels.
In the first 10 months of 2006, we identified 15 additional hotels for sale, and sold four hotels and one land parcel. We also surrendered two Holiday Inn hotels, located in Lawrence and Manhattan, KS, to a bond trustee pursuant to the settlement agreement entered into in August 2005. Further, a venture in which we own a minority interest and which owned the Holiday Inn City Center Columbus, OH transferred the hotel to the lender.
On November 2, 2006, we announced a major strategic initiative to reconfigure our hotel portfolio. We redefined our continuing operations portfolio, which contains 44 hotels with 8,116 rooms (including the Holiday Inn Marietta, GA hotel, which is currently closed following a fire). We plan to sell our non-strategic properties, which will allow us to concentrate on operating those hotels that we expect will generate the highest returns and produce long-term growth. The proceeds we receive from the sale of our non-strategic properties will give us greater flexibility to respond to current and future industry trends. In accordance with this new initiative, we sold two hotels and identified 12 additional hotels for sale in November and December 2006. In January 2007, we sold the University Plaza Hotel in Bloomington, IN for a gross sales price of $2.4 million. As of March 1, 2007, we owned 68 hotels, of which 24 were held for sale.
Our business is conducted in one reportable segment, which is the hospitality segment. During 2006, we derived approximately 98% of our revenues from hotels located within the United States and the balance from our one hotel located in Windsor, Canada.
We operate substantially all of our hotels under nationally recognized brands. In addition to benefits in terms of guest loyalty and market share premiums, our hotels benefit from franchisors central reservation systems, their global distribution systems and their brand Internet booking sites. Reservations made by means of these franchisor facilities generally accounted for approximately 39% of our total reservations in 2006.
We enter into franchise agreements, generally for terms of 10 years, with hotel franchisors. The franchise agreements typically authorize us to operate the hotel under the franchise name, at a specific location or within a specified area, and require that we operate the hotel in accordance with the standards specified by the franchisor. As part of our franchise agreements, we are generally required to pay a royalty fee, an advertising/marketing fee, a fee for the use of the franchisors nationwide reservation system and certain other ancillary charges. Royalty fees range from 2.0% to 6.0% of gross room revenues, advertising/marketing fees range from 1.0% to 2.5%, reservation system fees range from 0.8% to 2.3%, and club and restaurant fees from 0.01% to 4.0%. In the aggregate, royalty fees, advertising/marketing fees, reservation fees and other ancillary fees for the various brands under which we operate our hotels range from 5.2% to 11.5% of gross room revenues. In 2006, franchise fees for our continuing operations were 9.4% of room revenues.
Set forth below is a summary of our franchise affiliations as of March 1, 2007, along with the brands associated with each hotel and number of hotels and rooms represented by each franchisor, in continuing operations and discontinued operations:
During 2004, we entered into new franchise agreements for all 15 of our Marriott-branded hotels owned at that time and we agreed to pay a fee aggregating approximately $0.5 million, of which $0.1 million has been paid, and $0.4 million is payable in 2007, subject to offsets.
During the term of our franchise agreements, the franchisors may require us to upgrade facilities to comply with their current standards. Our current franchise agreements terminate at various times and have differing remaining terms. As franchise agreements expire, we may apply for franchise renewals. In connection with a
renewal, a franchisor may require payment of a renewal fee, increased royalty and other recurring fees and substantial renovation of the facility, or the franchisor may elect at its sole discretion, not to renew the franchise.
If we do not comply with the terms of a franchise agreement, following a notice and an opportunity to cure, the franchisor has the right to terminate the agreement, which could lead to a default and acceleration under one or more of our loan agreements, which would materially and adversely affect us. In the past, we have been able to cure most cases of non-compliance and most defaults within the cure periods. If we perform an economic analysis of a hotel and determine it is not economically justifiable to comply with a franchisors requirements, we will either select an alternative franchisor, operate the hotel without a franchise affiliation, or sell the hotel. Generally, under the terms of our loan agreements, we are not permitted to operate hotels without an approved franchise affiliation. See Risk Factors Risks Related to Our Business.
When a hotel does not meet the terms of its franchise license agreement, a franchisor reserves the right to issue a notice of non-compliance to the licensee. This notice of non-compliance provides the franchisee with a cure period which typically ranges from 3-24 months. At the end of the cure period, the franchisor will review the criteria for which the non-compliance notice was issued and either cure the franchise agreement, returning to good standing, or issue a notice of default and termination, giving the franchisee another opportunity to cure the non-compliant issue. At the end of the default and termination period, the franchisor will review the criteria for which the non-compliance notice was issued and either cure the default, issue an extension which will grant the franchisee additional time to cure, or terminate the franchise agreement.
As of March 1, 2007, we have been or expect to be notified that we are not in compliance with some of the terms of the franchise agreements at two hotels, we have received default and termination notices from franchisors with respect to the agreements at eight hotels, and we are awaiting cure letters from the franchisor for an additional three hotels, summarized as follows:
The corporate operations team, as well as each propertys general manager and associates, have focused their efforts to cure each of these non-compliance, or default issues through enhanced service, increased cleanliness, and product improvements by the required cure date.
We believe that we will cure the non-compliance and defaults as to which our franchisors have given us notice before the applicable termination dates or receive default extensions, but we cannot provide assurance that we will be able to complete our action plans (which we estimate will cost approximately $4.2 million) to cure the alleged defaults of noncompliance and default prior to the termination dates or be granted additional time in which to cure any defaults or noncompliance. If a franchise agreement is terminated, we will either select an alternative franchisor, operate the hotel independently of any franchisor or sell the hotel. However, terminating or changing the franchise affiliation of a hotel could require us to incur significant expenses, including franchise termination payments and capital expenditures, and in certain circumstances could lead to acceleration of some of our indebtedness. This could adversely affect us.
In addition, as part of our bankruptcy reorganization proceedings, we entered into stipulations with each of our major franchisors setting forth a timeline for completion of capital expenditures for some of our hotels. As of March 1, 2007, we have not completed the required capital expenditures for seven hotels (six of which are held for sale and one of which is held for use). However, we have sufficient escrow reserves with our lenders to fund the related capital expenditures, pursuant to the terms of the respective loan agreements. A franchisor could, nonetheless, seek to declare its franchise agreement in default of the stipulations and could seek to terminate the franchise agreement.
Also, our loan agreements generally prohibit a hotel from operating without a national franchise affiliation, and the loss of such an affiliation could trigger a default under one or more such agreements. The 10 hotels that are in default or non-compliance under their respective franchise agreements are part of the collateral security for an aggregate of $285.5 million of mortgage debt as of March 1, 2007.
We have developed a unique sales and marketing culture that is focused on revenue generation and long term profitability. We developed several key components that we believe set us apart from a typical brand or independent management approach.
The hotel sales effort is supported by a core of seasoned hotel sales veterans. The Regional Directors of Sales are strategically aligned and assigned to support property-level sales and company wide revenue generation. These efforts include direct sales as well as support and direction to the property sales teams. Every hotel sales associate is armed with a series of sales training completed by a lodging industry sales training company. The Regional Directors of Sales are able to further leverage the global brand initiatives but more importantly Company-specific initiatives, customized for each hotels needs. This structure provides a distinct advantage as the hotels proactively adjust the hotel specific marketing plans and business strategies as market conditions change.
In collaboration with the Regional Directors of Sales, the Regional Revenue Managers steer the efforts of the property-level teams, ensuring the appropriate mix of business for each hotel. We have developed an industry-leading forecasting tool that provides history by day of week and segment of business. This customized tool provides each hotel with a means to analyze trends from previous years as well as changes in market conditions to forecast day by day rooms sold and ADR by segment of business. The forecast is then used to identify the types of business and periods of time where the sales effort will result in the greatest revenue gains and where changes in current strategy are not necessary.
In 2000, we developed a centrally-housed Area Revenue Office (ARO) that is tasked with providing high quality reservation service by trained reservation sales associates to maximize revenue and relieve on-site associates of reservations responsibilities, thereby allowing the on-site front office teams to maximize guest service. The ARO, based in Strongsville, OH, houses a staff of 35-50 reservation sales agents (depending on seasonal demands). The ARO handles approximately half a million calls per year. The ARO is scaleable, and has in the past handled up to a million calls per year. The ARO handles reservations for all of our InterContinental (IHG) branded hotels including Crowne Plaza, Holiday Inn Select, Holiday Inn, and Holiday Inn Express. Incoming calls are answered with a
distinct greeting for the destination hotel and customers are under the assumption that the call is being handled by an on-property hotel associate.
While the IHG brand provides a similar reservation solution, the ARO has several key advantages including lower overhead costs (the ARO is located inside one of our hotels and shares hotel support staff), opportunities for cross-selling among our portfolio of hotels, the ability to promote Company strategies for revenue maximization, and an intimate knowledge of our hotel portfolio.
As of March 1, 2007, we operate three hotels in joint ventures in which we have a 50% or greater voting equity interest and exercise control. In each joint venture, we share decision making authority with our joint venture partner and may not have sole discretion with respect to a hotels disposition.
On April 18, 2005, we acquired for $0.7 million our joint venture partners 40% interest in the Ramada Plaza hotel located in Macon, Georgia, which is now consolidated as a wholly-owned subsidiary.
Through a partnership, we owned a 30% interest in the Holiday Inn City Center located in Columbus, OH. Because the debt on the hotel exceeded the fair value of the hotel, the partnership ceased making regular debt service payments to the lender in August 2005 but made interest payments to the lender as cash flow was available to do so. The lender filed a foreclosure petition on September 7, 2005. On November 15, 2005, the hotel was surrendered to a receiver and on February 3, 2006 the hotel was deeded to the lender. We accounted for our interest in the hotel using the equity method of accounting. The receivable to Lodgian from this entity was fully reserved and the investment in this subsidiary was written off in 2005 for a total expense of $0.9 million.
On January 22, 2007, we initiated a review of strategic alternatives to enhance shareholder value. We retained Goldman, Sachs & Co. and Genesis Capital, L.L.C. to assist us with the review. There can be no assurance that the review will result in any specific strategic or financial transaction.
The hotel business is highly competitive. Each of our hotels competes in its market area with numerous other hotel properties operating under various lodging brands. National chains, including in many instances chains from which we obtain franchises, may compete with us in various markets. Our competition is comprised of public companies, privately-held equity fund companies, and small independent owners and operators. Competitive factors in the lodging industry include, among others, room rates, quality of accommodation, service levels, convenience of locations and amenities customarily offered to the traveling public. In addition, the development of travel-related Internet websites has increased price awareness among travelers and price competition among similarly located, comparable hotels.
Demand for accommodations, and the resulting revenues, varies seasonally. The high season tends to be the summer months for hotels located in colder climates and the winter months for hotels located in warmer climates. Aggregate demand for accommodations in our portfolio is lowest during the winter months. Levels of demand are also dependent upon many factors that are beyond our control, including national and local economic conditions and changes in levels of leisure and business-related travel. In addition, the lodging industry in the U.S. has benefited from robust demand and a reduction in supply following Hurricane Katrina. This temporary market dynamic has begun to shift as the rebuilding efforts in the Gulf Coast region are underway and displaced residents have begun to move into permanent housing. Our hotels depend on both business and leisure travelers for revenue.
We also compete with other hotel owners and operators with respect to acquiring hotels and obtaining desirable franchises for upscale and midscale hotels in targeted markets.
The lodging industry has shown signs of recovery since 2004. Full-year RevPAR growth has been 7.8%, 8.4% and 7.5%, for years 2004, 2005 and 2006, respectively, according to Smith Travel Research as reported in January 2007.
The U.S. lodging industry enjoyed nine consecutive years of positive RevPAR growth from 1992 through 2000 after the economic recession of 1991. The periods of greatest RevPAR growth over this time period generally occurred when growth in room demand exceeded new room supply growth. Smith Travel Research recently predicted annual U.S. lodging industry RevPAR growth of 5.8% in 2007 with an annual increase in supply of 1.6%, slightly ahead of the annual net change in demand of 0.8%. As a result, industry occupancy is expected to decline 0.8% and ADR is expected to increase 6.5%.
Smith Travel Research classifies the lodging industry into six chain scale segments by brand according to their respective national average daily rate or ADR. The six segments are defined as: luxury, upper upscale, upscale, midscale with food and beverage, midscale without food and beverage and economy. We operate hotel brands in the following five chain scale segments:
We believe that our hotels and brands will perform competitively with the U.S. lodging industry as occupancy remains generally flat and ADR continues to increase. The table below illustrates the 2006 actual RevPAR growth of the chain segments represented by our brands as compared to the U.S. lodging industry averages as reported by Smith Travel Research. Lodgians RevPAR for continuing operations hotels increased 13.4% as compared to 7.5% for the industry as a whole.
Source: Smith Travel Research
Smith Travel Research is forecasting a U.S. average 5.8% RevPAR growth in 2007. These industry forecasts may not necessarily reflect our portfolio of hotels. We believe this continued upturn in the lodging business cycle will allow us to enhance our growth by focusing on our portfolio improvement strategy.
We own and manage our hotels. Accordingly, we retain responsibility for all aspects of the day-to-day management for each of our hotels. We establish and implement standards for hiring, training and supervising staff, creating and maintaining financial controls, complying with laws and regulations related to hotel operations, and
providing for the repair and maintenance of the hotels. Because we own and manage our hotels, we are able to directly control our labor costs, we can negotiate purchasing arrangements without fees to third parties, and as an owner and operator, we are motivated to focus our results on bottom-line profit performance instead of solely on top-line revenue growth. Accordingly, we are focused on maximizing returns for our shareholders.
Our hotel portfolio, as of March 1, 2007, by franchisor, is set forth below:
A summary of our disposition activity is as follows:
Hotel data by market segment and region
The following four tables exclude four of our hotels as noted below:
The two tables below present data on occupancy, ADR and RevPAR for the hotels in our portfolio for the years ended December 31, 2006, December 31, 2005 and December 31, 2004 by chain scale segment with four hotels excluded as noted above. The chain scale segments are defined on page 8.
The two tables below present data on occupancy, ADR and RevPAR for the hotels in our portfolio for the years ended December 31, 2006, December 31, 2005 and December 31, 2004 by geographic region with four hotels excluded as previously noted.
The regions in the two tables above are defined as:
Northeast: Canada, Connecticut, Massachusetts, Maryland, New Hampshire, New York, Ohio, Pennsylvania, Vermont, West Virginia;
Southeast: Alabama, Florida, Georgia, Kentucky, Louisiana, South Carolina, Tennessee;
Midwest: Arkansas, Iowa, Indiana, Kansas, Michigan, Minnesota, Oklahoma, Texas; and
West: Arizona, California, Colorado, New Mexico.
Of the 69 hotels that we consolidate as of December 31, 2006, 61 hotels were pledged as collateral to secure long-term debt. Refer to the table in Item 7, Managements Discussion and Analysis of Financial Condition and Results of operation, Liquidity and Capital Resources.
We maintain the following types of insurance:
We are self-insured up to certain amounts with respect to our insurance coverages. We establish liabilities for these self-insured obligations annually, based on actuarial valuations and our history of claims. If these claims exceed our estimates, our future financial condition and results of operations would be adversely affected. As of December 31, 2006, we had accrued $11.5 million for these costs (including employee medical and dental coverage).
There are other types of losses for which we cannot obtain insurance at all or at a reasonable cost, including losses caused by acts of war. If an uninsured loss or a loss that exceeds our insurance limits were to occur, we could lose both the revenues generated from the affected property and the capital that we have invested. We also could be liable for any outstanding mortgage indebtedness or other obligations related to the hotel. Any such loss could materially and adversely affect our financial condition and results of operations.
We believe that we have adequate reserves and sufficient insurance coverage for our business.
Our hotels are subject to certain federal, state and local regulations which require us to obtain and maintain various licenses and permits. These licenses and permits must be periodically renewed and may be revoked or suspended for cause at any time.
Occupancy licenses are obtained prior to the opening of a hotel and may require renewal if there has been a major renovation. The loss of the occupancy license for any of the larger hotels in our portfolio could have a material adverse effect on our financial condition and results of operations. Liquor licenses are required for hotels to be able to serve alcoholic beverages and are generally renewable annually. We believe that the loss of a liquor license for an individual hotel would not have a material effect on our financial condition and results of operations. We are not aware of any reason why we should not be in a position to maintain our licenses.
We are subject to certain federal and state labor laws and regulations such as minimum wage requirements, regulations relating to working conditions, laws restricting the employment of illegal aliens, and the Americans with Disabilities Act (ADA). As a provider of restaurant services, we are subject to certain federal, state and local health laws and regulations. We believe that we comply in all material respects with these laws and regulations. We are also subject in certain states to dramshop statutes, which may give an injured person the right to recover damages from us if we wrongfully serve alcoholic beverages to an intoxicated person who causes an injury. We believe that our insurance coverage relating to contingent losses in these areas is adequate.
Our hotels are also subject to environmental regulations under federal, state and local laws. These environmental regulations have not had a material adverse effect on our operations. However, such regulations potentially impose liability on property owners for cleanup costs for hazardous waste contamination. If material hazardous
waste contamination problems exist on any of our properties, we would be exposed to liability for the costs associated with the cleanup of those sites.
At December 31, 2006, we had 3,534 full-time and 1,402 part-time employees. We had 119 full-time employees engaged in administrative and executive activities and the balance of our employees manage, operate and maintain our properties. At December 31, 2006, 402 of our full, part-time and on call employees located at six hotels were covered by seven collective bargaining agreements. These seven agreements expire between 2007 and 2010. We consider relations with our employees to be good.
From time to time, as we conduct our business, legal actions and claims are brought against us. The outcome of these matters is uncertain. However, we believe that all currently pending matters will be resolved without a material adverse effect on our results of operations or financial condition. Claims relating to the period before we filed for Chapter 11 protection are limited to the amounts approved by the Bankruptcy Court for settlement of such claims and were payable out of the disputed claims reserves provided for by the Bankruptcy Court. On July 26, 2004, all remaining shares of mandatory redeemable 12.25% cumulative Preferred Stock (Preferred Stock) were redeemed and a liability of $2.2 million replaced the Preferred Stock shares that were previously held in the disputed claims reserve for the Joint Plan of Reorganization. Accordingly, when this liability was established it reduced additional paid-in capital and did not flow through our consolidated statement of operations. On June 30, 2005, we completed the final distribution for our bankruptcy claims and released the remaining unused accrual balance of $1.3 million with a corresponding adjustment to additional paid-in capital in our consolidated statement of stockholders equity.
This Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and our Proxy Statement on Schedule 14A, and amendments to those reports are available free of charge on our website (www.Lodgian.com) as soon as practicable after they are submitted to the Securities and Exchange Commission (SEC).
You may read and copy any materials the Company files with the SEC at the SECs Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information about us.
Financial information about our revenues and expenses for the last three fiscal years and assets and liabilities for the last two years may be found in the Consolidated Financial Statements, beginning on page F-1.
We make forward looking statements in this report and other reports we file with the SEC. In addition, management may make oral forward-looking statements in discussions with analysts, the media, investors and others. These statements include statements relating to our plans, strategies, objectives, expectations, intentions and adequacy of resources, and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words believes, anticipates, expects, intends, plans, estimates, projects, and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect our current views with respect to future events and the impact of these events on our business, financial condition, results of operations and prospects. Our business is exposed to many risks, difficulties and uncertainties, including the following:
Any of these risks and uncertainties could cause actual results to differ materially from historical results or those anticipated. Although we believe the expectations reflected in our forward-looking statements are based upon reasonable assumptions, we can give no assurance that our expectations will be attained and caution you not to place undue reliance on such statements. We undertake no obligation to publicly update or revise any forward-looking statements to reflect current or future events or circumstances or their impact on our business, financial condition, results of operations and prospects.
The following represents risks and uncertainties which could either individually or together cause actual results to differ materially from those described in the forward-looking statements. If any of the following risks actually occur, our business, financial condition, results of operations, cash flow, liquidity and prospects could be adversely affected. In that case, the market price of our common stock could decline and you may lose all or part of your investment in our common stock.
Risks Related to Our Business
We may not be able to meet the requirements imposed by our franchisors in our franchise agreements and therefore could lose the right to operate one or more hotels under a national brand.
We operate substantially all of our hotels pursuant to franchise agreements for nationally recognized hotel brands. The franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of a hotel in order to maintain uniformity within the franchisor system. The standards are also subject to change over time. Compliance with any new and existing standards could cause us to incur significant expenses and investment in capital expenditures.
If we do not comply with standards or terms of any of our franchise agreements, those franchise agreements may be terminated after we have been given notice and an opportunity to cure the non-compliance or default. As of March 1, 2007, we have been or expect to be notified that we were not in compliance with some of the terms of two
of our franchise agreements and have received default and termination notices from franchisors with respect to an additional eight hotels. We cannot assure you that we will be able to complete our action plans (which we estimate will cost approximately $4.2 million) to cure the alleged defaults of noncompliance and default prior to the termination dates or be granted additional time in which to cure any defaults or noncompliance.
In addition, as part of our bankruptcy reorganization proceedings, we entered into stipulations with each of our major franchisors setting forth a timeline for completion of capital expenditures for some of our hotels. As of March 1, 2007, we have not completed the required capital expenditures for seven hotels (one of which is held for use). However, we have sufficient escrow reserves with our lenders to fund the related capital expenditures, pursuant to the terms of the respective loan agreements. A franchisor could, nonetheless, seek to declare its franchise agreement in default of the stipulations and could seek to terminate the franchise agreement.
If a franchise agreement is terminated, we will either select an alternative franchisor or operate the hotel independently of any franchisor. However, terminating or changing the franchise affiliation of a hotel could require us to incur significant expenses, including franchise termination payments and capital expenditures associated with the change of a brand. Moreover, the loss of a franchise agreement could have a material adverse effect upon the operations or the underlying value of the hotel covered by the franchise because of the loss of associated guest loyalty, name recognition, marketing support and centralized reservation systems provided by the franchisor. Loss of a franchise agreement may result in a default under, and acceleration of, the related mortgage debt. In particular, we would be in default under the Refinancing Debt (comprised of the Merrill Lynch Mortgage fixed rate refinancing debt and the Merrill Lynch Mortgage floating rate refinancing debt) if we experience either:
A single franchise agreement termination could materially and adversely affect our revenues, cash flow and liquidity.
Also, our loan agreements generally prohibit a hotel from operating without a national franchise affiliation, and the loss of such an affiliation could trigger a default under one or more such agreements. The 10 hotels that are in default or non-compliance under their respective franchise agreements are part of the collateral security for an aggregate of $285.5 million of mortgage debt as of March 1, 2007.
In connection with our equity offering in June 2004, we entered into new franchise agreements for all 15 of our Marriott-branded hotels at that time and agreed to pay a fee aggregating approximately $0.5 million, of which $0.1 million has been paid, and $0.4 million is payable in 2007, subject to offsets.
Our current franchise agreements, generally for terms of 10 years, terminate at various times and have differing remaining terms. As a condition to renewal of the franchise agreements, franchisors frequently contemplate a renewal application process, which may require substantial capital improvements to be made to the hotel and increases in franchise fees. A significant increase in unexpected capital expenditures and franchise fees would adversely affect us.
Hotels typically require a higher level of capital expenditures, maintenance and repairs than other building types. If we are not able to meet the requirements of our hotels appropriately, our business and operating results will suffer.
In order to maintain our hotels in good condition and attractive appearance, it is necessary to replace furnishings, fixtures and equipment periodically, generally every five to seven years, and to maintain and repair public areas and exteriors on an ongoing basis. When we make needed capital improvements, we can be more competitive in the market and our hotel occupancy and room rate can grow accordingly. Further, the process of renovating a hotel has the potential to be disruptive to operations. It is vital that we properly plan and execute renovations during lower occupancy and/or lower rated months in order to avoid displacement, an industry term for a temporary loss of revenue caused by rooms being out of service during a renovation. Additionally, if capital improvements are not made, franchise agreements could be at risk.
Most of our hotels are pledged as collateral for mortgage loans, and we have a significant amount of debt that could limit our operational flexibility or otherwise adversely affect our financial condition.
As of December 31, 2006, we had $399.1 million of total long-term debt outstanding (including the current portion) including both continuing and discontinued operations, $338.9 million of which is associated with our continuing operations. We are subject to the risks normally associated with significant amounts of debt, such as:
The terms of our debt instruments place many restrictions on us, which reduce operational flexibility and create default risks.
Our outstanding debt instruments subject us to financial covenants, including leverage and coverage ratios. Our compliance with these covenants depends substantially upon the financial results of our hotels. The restrictive covenants in our debt documents may reduce our flexibility in conducting our operations and may limit our ability to engage in activities that may be in our long-term best interest. Our failure to comply with our debt agreements, including these restrictive covenants, may result in additional interest being due and would constitute an event of default, and in some cases with notice or the lapse of time, if not cured or waived, could result in the acceleration of the defaulted debt and the sale or foreclosure of the affected hotels. Under certain circumstances the termination of a hotel franchise agreement could also result in the same effects. A foreclosure would result in a loss of any anticipated income and cash flow from, and our invested capital in, the affected hotel. No assurance can be given
that we will be able to repay, through financings or otherwise, any accelerated indebtedness or that we will not lose all or a portion of our invested capital in any hotels that we sell in such circumstances.
As of December 31, 2006 the Company was not in compliance with the debt yield ratio requirement of one of the Merrill Lynch fixed rate loans. This loan is secured by nine properties. Under the terms of the loan agreement, until the required ratio is met, the lender may require the Company to deposit all revenues from the mortgaged properties into a restricted cash account controlled by the lender. The revenues would then be disbursed to fund property-related expenditures, including debt service payments and capital expenditures, in accordance with the loan agreement. The net cash flow as defined by the loan agreement, after debt service payment, for the nine properties which secure the loan was $1.7 million for the trailing 12 months ended December 31, 2006. As of March 1, 2007, the lender has not exercised its right to require the use of a restricted cash account.
A significant portion of our capital needs are fulfilled by borrowings, of which $98.6 million was variable rate debt at December 31, 2006. In the future, we may incur additional indebtedness bearing interest at a variable rate, or we may be required to refinance our existing fixed-rate indebtedness at higher interest rates. Accordingly, increases in interest rates will increase our interest expense and adversely affect our cash flow, reducing the amounts available to make payments on our indebtedness, fund our operations and our capital expenditure program, make acquisitions or pursue other business opportunities. We have reduced the risk of rising interest rates by entering into interest rate cap agreements for all our variable interest rate debt.
To service our indebtedness, we require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control and a cash shortfall could adversely affect our ability to fund our operations, planned capital expenditures and other needs.
Our ability to make payments on and to refinance our indebtedness and to fund our operations, planned capital expenditures and other needs will depend on our ability to generate cash in the future. Various factors could adversely affect our ability to meet operating cash requirements, many of which are subject to the operating risks inherent in the lodging industry and, therefore, are beyond our control. These risks include the following:
The value of our hotels and our ability to repay or refinance our debt are dependent upon the successful operation and cash flows of the hotels.
The value of our hotels is heavily dependent on their cash flows. If cash flow declines, the hotel values may also decline and the ability to repay or refinance our debt could also be adversely affected. Factors affecting the performance of our hotels include, but are not limited to, construction of competing hotels in the markets served by our hotels, loss of franchise affiliations, the need for renovations, the effectiveness of renovations or repositioning in attracting customers, changes in travel patterns and adverse economic conditions.
We may not be able to fund our future capital needs, including necessary working capital, funds for capital expenditures or acquisition financing from operating cash flow. Consequently, we may have to rely on third-party sources to fund our capital needs. We may not be able to obtain the financing on favorable terms or at all, which could materially and adversely affect our operating results, cash flow and liquidity. Any additional debt would increase our leverage, which would reduce our operational flexibility and increase our risk exposure. Our access to third-party sources of capital depends, in part, on:
If we are not able to execute our strategic initiative, we may not be able to improve our financial performance.
Our strategic initiative is focused on improving the operations of our continuing operations hotels with improved product quality, improved services levels, and disciplined capital investment in our hotels, including repositionings and renovations, that will earn a sufficient return on the capital invested. The execution of this initiative is dependent upon a number of factors, including but not limited to, our ability to dispose of the assets that do not fit into our core portfolio in a timely manner and at the desired selling prices. Additionally, we periodically evaluate our portfolio of hotels to identify underperforming hotels that should be sold. We cannot assure you that the execution of our strategic initiative will produce improved financial performance at the affected hotels. We compete for growth opportunities with national and regional hospitality companies, many of which have greater name recognition, marketing support and financial resources than we do. An inability to implement our strategic initiative successfully could limit our ability to grow our revenue, net income and cash flow.
Our current joint venture investments could be adversely affected by our lack of sole decision-making authority, our reliance on joint venture partners financial condition and performance, and any disputes that may arise between us and our joint venture partners.
We currently have an ownership interest in three of our hotels through joint ventures. We generally will not be in a position to exercise sole decision-making authority regarding the hotels owned through such joint ventures. Investments in joint ventures may, under certain circumstances, involve risks not present when a third party is not involved, including the possibility that joint venture partners might become bankrupt or fail to fund their share of required capital contributions. Joint venture partners may have business interests, strategies or goals that are inconsistent with our business interests, strategies or goals. Joint venture investments also entail a risk of impasse on decisions, such as acquisitions or sales. Any disputes that may arise between us and our joint venture partners may result in litigation or arbitration that could increase our expenses and could prevent our officers and/or directors from focusing their time and effort exclusively on our business strategies. Consequently, actions by or disputes with our joint venture partners might result in subjecting hotels owned by the joint venture to additional risks. In addition, we may in certain circumstances be liable for the actions of our third-party joint venture partners.
We have a history of significant losses and we may not be able to successfully improve our performance to achieve profitability.
We incurred cumulative net losses of $363.9 million from January 1, 1999 through December 31, 2006 and had an accumulated deficit of $84.8 million as of December 31, 2006. Our ability to improve our performance to achieve profitability is dependent upon a recovery in the general economy, combined with an improvement in the lodging industry specifically, and the successful implementation of our business strategy. Our failure to improve our performance could have a material adverse effect on our business, results of operations, financial condition, cash flow, liquidity and prospects. Although Smith Travel Research recently forecasted RevPAR growth for the U.S. lodging industry in 2007 due to increased average daily rates and an improving economy, this forecast does not necessarily reflect to our portfolio of hotels. Additionally, rising interest rates and energy costs, the troubled airline industry and continued threats to national security or air travel safety could adversely affect the industry, resulting in our inability to meet our profit expectations.
Force majeure events, including natural disasters, acts and threats of terrorism, the ongoing war against terrorism, military conflicts and other factors have had and may continue to have a negative effect on the lodging industry and our results of operations.
Force majeure events, including natural disasters, such as Hurricane Katrina that affected the Gulf Coast in August 2005, the terrorist attacks of September 11, 2001 and the continued threat of terrorism, including changing threat levels announced by the U.S. Department of Homeland Security, have had a negative impact on the lodging industry and on our hotel operations. These events can cause a significant decrease in occupancy and ADR due to disruptions in business and leisure travel patterns and concerns about travel safety. In particular, as it relates to terrorism, major metropolitan areas and airport hotels can be adversely affected by concerns about air travel safety and may see an overall decrease in the amount of air travel. We believe that uncertainty associated with natural disasters, subsequent terrorist threats and incidents, military conflicts and the possibility of hostilities with other countries may continue to hamper business and leisure travel patterns and our hotel operations.
Certain expenses associated with owning and operating a hotel are relatively fixed and do not proportionately reduce with a drop in revenues. Consequently, during periods when revenues drop, we would be compelled to continue to incur certain expenses which are fixed in nature. Moreover, we could be adversely affected by:
We may make acquisitions or investments that are not successful and that adversely affect our ongoing operations.
We may acquire or make investments in hotel companies or groups of hotels that we believe complement our business. If we fail to properly evaluate and execute acquisitions or investments, it may have a material adverse effect on our results of operations. In making or attempting to make acquisitions or investments, we face a number of risks, including:
Losses may exceed our insurance coverage or estimated reserves, which could impair our results of operations, financial condition and liquidity.
We are self-insured up to certain amounts with respect to our insurance coverages. Various types of catastrophic losses, including those related to environmental, health and safety matters may not be insurable or may not be economically insurable. In the event of a substantial loss, our insurance coverage may not cover the full current market value or replacement cost of our lost investment or building code upgrades associated with such an occurrence. Inflation, changes in building codes and ordinances, environmental considerations and other factors might cause insurance proceeds to be insufficient to fully replace or renovate a hotel after it has been damaged or destroyed.
We cannot assure you that:
Should a material uninsured loss or a loss in excess of insured limits occur with respect to any particular property, we could lose our capital invested in the property, as well as the anticipated income and cash flow from the property. Any such loss would have an adverse effect on our results of operations, financial condition and liquidity. In addition, if we are unable to maintain insurance that meets our debt and franchise agreement requirements, and if we are unable to amend or waive those requirements, it could result in an acceleration of that debt and impair our ability to maintain franchise affiliations.
Competition in the lodging industry could have a material adverse effect on our business and results of operations.
The lodging industry is highly competitive. No single competitor or small number of competitors dominates the industry. We generally operate in areas that contain numerous other competitors, some of which may have substantially greater resources than we have. Competitive factors in the lodging industry include, among others, oversupply in a particular market, franchise affiliation, reasonableness of room rates, quality of accommodations, service levels, convenience of locations and amenities customarily offered to the traveling public. There can be no assurance that demographic, geographic or other changes in markets will not adversely affect the future demand for our hotels, or that the competing and new hotels will not pose a greater threat to our business. Any of these adverse factors could materially and adversely affect us.
Adverse conditions in major metropolitan markets in which we do substantial business could negatively affect our results of operations.
Adverse economic conditions in markets in which the Company has multiple hotels, such as Pittsburgh, Baltimore/Washington, D.C. and Phoenix, could significantly and negatively affect the Companys revenue and results of operations. The 12 continuing operations hotels in these areas provided approximately 32% of the Companys 2006 continuing operations revenue and approximately 30% of the Companys 2006 continuing operations total available rooms. In 2005, these 12 hotels provided approximately 33% of the Companys continuing operations revenue and approximately 32% of the Companys continuing operations total available
rooms. In 2004, these 12 hotels provided approximately 34% of the Companys continuing operations revenue and approximately 31% of the Companys continuing operations total available rooms. As a result of the geographic concentration of these hotels, the Company is particularly exposed to the risks of downturns in these markets, which could have a major adverse effect on the Companys profitability.
Demand for accommodations varies seasonally. The high season tends to be the summer months for hotels located in colder climates and the winter months for hotels located in warmer climates. Aggregate demand for accommodations at the hotels in our portfolio is lowest during the winter months. We generate substantial cash flow in the summer months compared to the slower winter months. If adverse factors affect our ability to generate cash in the summer months, the impact on our profitability is much greater than if similar factors were to occur during the winter months.
As of March 1, 2007, we operate approximately 81% of our hotels under the InterContinental Hotels Group and Marriott flags, and therefore, are subject to potential risks associated with the concentration of our hotels under limited brand names. If either of these brands suffered a major decline in popularity with the traveling public, it could adversely affect our revenue and profitability.
There have been a number of changes in our senior management team during the last two years and since our emergence from bankruptcy. Our new chief executive officer was hired in July 2005, our chief operating officer resigned in September 2005 and our chief financial officer resigned in December 2005. On March 1, 2006, we hired James MacLennan as our new chief financial officer and on June 8, 2006, we hired Mark Linch as our new senior vice president of capital investment. If our management team is unable to develop successful business strategies, achieve our business objectives or maintain effective relationships with employees, suppliers, creditors and customers, our ability to grow our business and successfully meet operational challenges could be impaired.
Our future success and our ability to manage future growth will depend in large part on our ability to attract and retain other highly qualified personnel. Competition for personnel is intense, and we may not be successful in attracting and retaining our personnel. The inability to attract and retain highly qualified personnel could hinder our business.
The increasing use of third-party travel websites by consumers may adversely affect our profitability.
Some of our hotel rooms are booked through third-party travel websites such as Travelocity.com, Expedia.com, Priceline.com and Hotels.com. If these Internet bookings increase, these intermediaries may be in a position to demand higher commissions, reduced room rates or induce other significant contract concessions from us. Moreover, some of these Internet travel intermediaries are attempting to offer hotel rooms as a commodity, by increasing the importance of price and general indicators of quality (such as three-star downtown hotel) at the expense of brand identification. Although we expect to continue to derive most of our business through the traditional channels, if the revenue generated through Internet intermediaries increases significantly, room revenues may flatten or decrease and our profitability may be adversely affected.
As of December 31, 2006, we had approximately $318.9 million of net operating loss carryforwards available for federal income tax purposes, which includes the utilization of an estimated $20.3 million of net operating losses to offset the December 31, 2006 taxable income. To the extent that we do not have sufficient future taxable income to be offset by these net operating loss carryforwards, any unused losses will expire between 2019 and 2025. Our ability to use these net operating loss carryforwards to offset future income is also subject to annual limitations. An
audit or review by the Internal Revenue Service could result in a reduction in the net operating loss carryforwards available to us.
Many aspects of our operations are subject to government regulations, and changes in these regulations may adversely affect our results of operations and financial condition.
A number of states and local governments regulate the licensing of hotels and restaurants, including occupancy and liquor license grants, by requiring registration, disclosure statements and compliance with specific standards of conduct. Operators of hotels are also subject to the Americans with Disabilities Act, and various employment laws, which regulate minimum wage requirements, overtime, working conditions and work permit requirements. Compliance with, or changes in, these laws could increase our operating costs and reduce profitability.
Costs of compliance with environmental laws and regulations could adversely affect operating results.
Under various federal, state, local and foreign environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for non-compliance with applicable environmental and health and safety requirements and for the costs of investigation, monitoring, removal or remediation of hazardous or toxic substances. These laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of hazardous or toxic substances.
The presence of these hazardous or toxic substances on a property could also result in personal injury or property damage or similar claims by private parties. In addition, the presence of contamination, or the failure to report, investigate or properly remediate contaminated property, could adversely affect the operation of the property or the owners ability to sell or rent the property or to borrow funds using the property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances may also be liable for the costs of removal or remediation of those substances at the disposal or treatment facility, whether or not that facility is or ever was owned or operated by that person.
The operation and removal of underground storage tanks is also regulated by federal, state and local laws. In connection with the ownership and operation of our hotels, we could be held liable for the costs of remedial action for regulated substances and storage tanks and related claims.
Some of our hotels contain asbestos-containing building materials (ACBMs). Environmental laws require that ACBMs be properly managed and maintained, and may impose fines and penalties on building owners or operators for failure to comply with these requirements. Third parties may be permitted by law to seek recovery from owners or operators for personal injury associated with exposure to contaminants, including, but not limited to, ACBMs. Operation and maintenance programs have been developed for those hotels which are known to contain ACBMs.
Many, but not all, of our hotels have undergone Phase I environmental site assessments, which generally provide a nonintrusive physical inspection and database search, but not soil or groundwater analyses, by a qualified independent environmental consultant. The purpose of a Phase I assessment is to identify potential sources of contamination for which the hotel owner or others may be responsible. None of the Phase I environment site assessments revealed any past or present environmental liability that we believe would have a material adverse effect on us. Nevertheless, it is possible that these assessments did not reveal all environmental liabilities or compliance concerns or that material environmental liabilities or compliance concerns exist of which we are currently unaware.
Some of our hotels may contain microbial matter such as mold, mildew and viruses, whose presence could adversely affect our results of operations. Phase I assessments performed on certain of our hotels in connection with our refinancing completed at the time of our Chapter 11 bankruptcy emergence identified mold in four of our hotels. We have completed all necessary remediation for these properties. In addition, if any hotel in our portfolio is not properly connected to a water or sewer system, or if the integrity of such systems are breached, microbial matter or other contamination might develop. If this were to occur, we would incur significant remedial costs and we might also be subject to private damage claims and awards.
Any liability resulting from noncompliance or other claims relating to environmental matters would have a material adverse effect on us and our insurability for such matters in the future and on our results of operations, financial condition, liquidity and prospects.
A downturn in the economy due to high energy costs and gasoline prices could negatively impact our financial performance, our customer guest satisfaction scores and customer service levels.
We use significant amounts of electricity, gasoline, natural gas and other forms of energy to operate our hotels. A shortage in supply or a period of sustained high energy costs could negatively affect our results of operations. Additionally, a shortage of supply could impact our ability to operate our hotels and could adversely impact our guests experience at our hotels, and ultimately, our guest satisfaction scores and potentially our franchisor affiliations.
The market price of our common stock could decline or fluctuate significantly in response to various factors, including:
We may never pay dividends on our common stock, in which event our stockholders only return on their investment, if any, will occur on the sale of our common stock.
We have not yet paid any dividends on our common stock, and we do not intend to do so in the foreseeable future. As a result, a stockholders only return on their investment, if any, will occur on the sale of our common stock.
Our charter documents, employment contracts and Delaware law may impede attempts to replace or remove our management or inhibit a takeover, which could adversely affect the value of our common stock.
Our certificate of incorporation and bylaws, as well as Delaware corporate law, contain provisions that could delay or prevent changes in our management or a change of control that you might consider favorable and may prevent you from receiving a takeover premium for your shares. These provisions include, for example:
In addition, we have entered into, and could enter into in the future, employment contracts with certain of our employees that contain change of control provisions.
We have no unresolved staff comments.
The information required to be presented in this section is presented in Item 1. Business.
The information required to be presented in this section is presented in Item 1. Business.
No matters were submitted to a vote of security holders during the fourth quarter of 2006.
On April 27, 2004, our Board of Directors authorized a reverse stock split of our Companys common stock in a ratio of one-for-three (1:3) with resulting fractional shares paid in cash. The reverse split affected all our issued and outstanding common shares, warrants, stock options, and restricted stock. The record date for the reverse split was April 29, 2004 and our new common stock began trading under the split adjustment on April 30, 2004. All stock information has been retroactively restated to reflect the 1:3 reverse stock split.
Our common stock is traded on the American Stock Exchange under the symbol LGN. Prior to November 21, 2001, our common stock traded on the New York Stock Exchange under the symbol LOD. Subsequent to November 21, 2001, our common stock traded on the Over-the-Counter Bulletin Board under the trading symbol LODN.OB. Subsequent to November 25, 2002, the common stock traded on the Over-the-Counter Bulletin Board under the symbol LDGIV.OB until January 28, 2003, when it began trading on the American Stock Exchange under the symbol LGN. The following table sets forth the high and low closing prices of our common stock on a quarterly basis for the past two years:
At March 1, 2007, we had approximately 2,774 holders of record of our common stock.
We have not declared or paid any dividends on our common stock, and our board of directors does not anticipate declaring or paying any cash dividends in the foreseeable future. We anticipate that all of our earnings, if any, and other cash resources will be retained to fund our business and build cash reserves and will be available for other strategic opportunities that may develop. Future dividend policy will be subject to the discretion of our board of directors, and will be contingent upon our results of operations, financial position, cash flow, liquidity, capital expenditure plan and requirements, general business conditions, restrictions imposed by financing arrangements, if any, legal and regulatory restrictions on the payment of dividends and other factors that our board of directors deems relevant.
The Preferred Stock issued on November 25, 2002 (the date on which the first of the plans of reorganization became effective) accrued dividends at the rate of 12.25% per annum. As required by the Preferred Stock agreement, we paid the dividend due on November 21, 2003 by issuing additional shares of Preferred Stock, except for fractional shares, which we paid in cash. Immediately following the effective date of our equity offering on June 25, 2004, we exchanged 3,941,115 shares of our common stock for 1,483,558 shares of Preferred Stock (the Preferred Share Exchange) held by (1) certain affiliates of, and investment accounts managed by, Oaktree Capital Management (Oaktree), LLC, (2) BRE/HY Funding LLC (BRE/HY), and (3) Merrill Lynch, Pierce, Fenner & Smith Incorporated (Merrill Lynch), based on a common stock price of $10.50 per share. In the Preferred Share Exchange, Oaktree, BRE/HY and Merrill Lynch received 2,262,661, 1,049,034 and 629,420 shares of our common stock, respectively. As part of the Preferred Share Exchange, we recorded a $1.6 million loss on preferred stock redemption for the 4% prepayment premium on the shares of Preferred Stock that were exchanged for common stock. Also, from the proceeds of the public equity offering, on July 26, 2004, we redeemed all 4,048,183 remaining shares of our Preferred Stock for approximately $114.0 million. The 79,278 shares of Preferred Stock that were part of the disputed claims reserve were replaced with a liability of approximately $2.2 million on our consolidated balance sheet. Approximately $4.5 million was paid for the 4% prepayment premium on the Preferred Stock when all remaining outstanding shares were redeemed on July 26, 2004. On June 30, 2005, we completed the final distribution of our bankruptcy claims and released the remaining unused accrual balance of $1.3 million with a corresponding adjustment to Additional paid-in capital in our Consolidated Statement of Stockholders Equity.
On July 15, 2004, July 15, 2005 and September 8, 2005, a total of 66,666 restricted stock units previously issued to our former chief executive officer Thomas Parrington, vested in three installments of 22,222 shares. Mr. Parrington, pursuant to the restricted unit award agreement with the Company, elected to have the Company withhold 21,633 shares to satisfy the employment tax withholding requirements associated with the vested shares. The shares were deemed repurchased by the Company and are shown as treasury stock on our balance sheet.
On January 31, 2006, we granted 12,413 shares of restricted stock to certain employees, of which 4,719 shares were withheld to satisfy tax obligations and were included in the treasury stock balance on our balance sheet. The aggregate cost of these shares was approximately $61,000.
Also on January 31, 2006, we granted 3,884 shares of nonvested stock to certain employees. The shares vest in equal annual installments on the next two anniversary dates. The shares were valued at $12.88, the average of the high and low market prices of the Companys common stock on the date of the grant. The aggregate value of the grant is being recorded as compensation expense over the two-year vesting period.
On March 1, 2006, we granted 35,000 shares of nonvested stock to James MacLennan, our executive vice president and chief financial officer. The shares vest in equal annual installments on the next three anniversary dates. The shares were valued at $12.77, the average of the high and low market prices of the Companys common stock on the date of the grant. The aggregate value of the grant is being recorded as compensation expense over the three-year vesting period.
On June 8, 2006, we granted 7,000 shares of nonvested stock to Mark Linch, our new senior vice president of capital investment. The shares vest in equal annual installments on the next three anniversary dates. The shares were valued at $11.78, the average of the high and low market prices of the Companys common stock on the date of the grant. The aggregate value of the grant is being recorded as compensation expense over the three-year vesting period.
In May 2006, the Board of Directors approved a $15 million share repurchase program. As of December 31, 2006, we had repurchased 225,267 shares at an aggregate cost of $2.8 million under this program. From January 1 to March 1, 2007, we repurchased 146,625 shares at an aggregate cost of $1.9 million, bringing the remaining repurchase authority to $10.4 million.
Subsequent to December 31, 2006, the following awards were granted:
The tables below summarize certain information with respect to our equity compensation plan as of December 31, 2006:
On November 25, 2002, the Company adopted a stock incentive plan (Stock Incentive Plan) which replaced the stock option plan previously in place. The Stock Incentive Plan, prior to the completion of the secondary stock offering on June 25, 2004, authorized the Company to award its directors, officers, or other key employees or consultants as determined by a committee appointed by the Board of Directors, options to acquire and other equity incentives up to 353,333 shares of common stock. With the completion of the secondary stock offering on June 25, 2004, the total number of shares available for issuance under our stock incentive plan increased to 3,301,058 shares. As of December 31, 2006, we have issued options to acquire 981,332 shares (422,472 of which were forfeited), 12,413 shares of restricted stock (of which 4,719 shares were withheld to satisfy tax obligations), 66,666 shares of restricted stock units (of which 21,633 were withheld to satisfy tax obligations) and 122,266 shares of nonvested stock (of which 777 shares were forfeited ).
Awards made during 2006 pursuant to the Stock Incentive Plan are summarized below:
The following table presents information with respect to the Companys purchases of common stock made during the three months ended December 31, 2006:
We emerged from reorganization proceedings under Chapter 11 bankruptcy on November 25, 2002. Pursuant to the Joint Plan of Reorganization approved by the Bankruptcy Court, the previous common stock was cancelled and new common stock became available for issuance. The new common stock began trading on AMEX on January 28, 2003, under the symbol LGN. There is no meaningful market information relating to the price of the common stock from November 25, 2002 until the new common stock was listed on AMEX on January 28, 2003. Accordingly, performance information with respect to the Companys common stock before January 28, 2003 is not presented below.
The following stock performance graph compares the cumulative total stockholder return of our common stock between January 28, 2003 and December 31, 2005, against the cumulative stockholder return during such period achieved by the Dow Jones Lodging Index and the Wilshire 5000 Total Market Index. The graph assumes that $100 was invested on January 28, 2003 in each of the comparison indices and in our common stock. The chart is adjusted to reflect a 1 for 3 reverse stock split which was effective on April 30, 2004.
Graph produced by Research Data Group, Inc.
Selected Consolidated Financial Data
We present, in the table below, selected financial data derived from our historical financial statements for the five years ended December 31, 2006. On November 22, 2002, in connection with our emergence from Chapter 11 and in accordance with generally accepted accounting principles, we restated our assets and liabilities to reflect their estimated fair values at that date, referred to as fresh start reporting. As a result, our financial statements for the period subsequent to November 22, 2002 are those of a new reporting entity, and are not comparable with the financial statements for the period prior to November 22, 2002. For this reason, we use the term Successor when we refer to periods subsequent to November 22, 2002 and the term Predecessor when we refer to the periods prior to November 22, 2002.
In addition, in accordance with generally accepted accounting principles, our results of operations distinguish between the results of operations of those properties which we plan to retain in our portfolio for the foreseeable future, referred to as continuing operations, and the results of operations of those properties which have been sold or have been identified for sale, referred to as discontinued operations. The historical income statements have been reclassified based on the assets sold or held for sale as of December 31, 2006.
You should read the financial data below in conjunction with Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data included in this Form 10-K.
The income statement financial data for the years ended December 31, 2006, December 31, 2005, and December 31, 2004, and selected balance sheet data for the years ended December 31, 2006 and December 31, 2005, were extracted from the audited financial statements included in this Form 10-K, which commences on page F-1.
You should read the discussion below in conjunction with the consolidated financial statements and accompanying notes. Also, the discussion which follows contains forward-looking statements which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed above under the caption Risk Factors.
We are one of the largest independent owners and operators of full-service hotels in the United States in terms of our number of guest rooms, as reported by Hotel Business in the 2007 Green Book published in December 2006. We are considered an independent owner and operator because we do not operate our hotels under our own name. We operate substantially all of our hotels under nationally recognized brands, such as Crowne Plaza, Holiday Inn, Marriott and Hilton. As of March 1, 2007, we operated 68 hotels with an aggregate of 12,353 rooms, located in 28 states and Canada. Of the 68 hotels we operated as of March 1, 2007, 44 hotels, with an aggregate of 8,116 rooms, are part of our continuing operations, while 24 hotels, with an aggregate of 4,237 rooms, were held for sale and classified in discontinued operations.
Below is a summary of our results of continuing operations, presented in more detail in Results of Operations-Continuing Operations:
The consolidated statements of operations for discontinued operations for the years ended 2006, 2005 and 2004 includes the results of operations for the 25 hotels held for sale at December 31, 2006, as well as all properties that have been sold.
The assets and liabilities related to these held for sale assets are separately disclosed in our consolidated balance sheet based on the assets held for sale at the balance sheet date.
Where the carrying values of the assets held for sale exceeded their estimated fair values, net of selling costs, we reduced the carrying values and recorded non-cash impairment charges. Fair values were determined using market prices and where the estimated selling prices, net of selling costs, exceeded the carrying values, no adjustments were recorded. We classify an asset as held for sale when management approves and commits to a formal plan to actively market a property for sale. While we believe the completion of these dispositions is probable, the sale of these assets is subject to market conditions and we cannot provide assurance that we will finalize the sale of all or any of these assets on favorable terms or at all. In 2006, we recorded impairment charges of $23.1 million in discontinued operations of which $13.1 million was recognized in the fourth quarter of 2006 largely as a result of our strategic initiative to dispose of non-core hotels announced on November 2, 2006.
For the six hotels and one land parcel sold in 2006, the total revenues for the year ended December 31, 2006 were $9.8 million, the direct operating expenses were $3.5 million, and the other hotel operating expenses were $6.6 million.
Our financial statements are prepared in accordance with generally accepted accounting principles (GAAP). As we prepare our financial statements, we make estimates and assumptions which affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from our estimates. A summary of our significant accounting policies is included in Note 1 of the notes to our consolidated financial statements. We consider the following to be our critical accounting policies and estimates:
Consolidation policy All of our hotels are owned by operating subsidiaries. We consolidate the assets, liabilities and results of operations of those hotels where we own at least 50% of the voting equity interest and we exercise control. All of the subsidiaries are wholly-owned except for three joint ventures.
When we consolidate hotels in which we own less than 100% of the voting equity interest, we include the assets and liabilities of these hotels in our consolidated balance sheet. The third party interests in the net assets of these hotels are reported as minority interest on our consolidated balance sheet. In addition, our consolidated statement of operations reflects the full revenues and expenses of these hotels and the third party portion of the net income or loss is reported as minority interest in our consolidated statements of operations. If the loss applicable to the minority interest exceeds the minoritys equity, we report the entire loss in our consolidated statement of operations.
Deferral policy We defer franchise application fees on the acquisition or renewal of a franchise as well as loan origination costs related to new or renewed loan financing arrangements. Deferrals relating to the acquisition or renewal of a franchise are amortized on a straight-line basis over the period of the franchise agreement. We amortize deferred financing costs over the term of the loan using the effective interest method. The effective interest method incorporates the present values of future cash outflows and the effective yield on the debt in determining the amortization of loan fees. At December 31, 2006, these deferrals totaled $4.6 million for our continuing operations hotels. If we were to write these expenses off in the year of payment, our operating expenses in those years would be significantly higher and lower in other years covered in the related agreement.
Asset impairment We invest significantly in real estate assets. Property and equipment for held for use assets represent 69.7% of the total assets on our consolidated balance sheet at December 31, 2006. Accordingly, our policy on asset impairment is considered a critical accounting estimate. Management periodically evaluates the Companys property and equipment to determine whether events or changes in circumstances indicate that a
possible impairment in the carrying values of the assets has occurred. As part of this evaluation, and in accordance with Statement of Financial Accounting Standard (SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No. 144), we classify our properties into two categories, assets held for sale and assets held for use.
We consider an asset held for sale when the following criteria per SFAS No. 144 are met:
1. Management commits to a plan to sell the asset;
2. The asset is available for immediate sale in its present condition;
3. An active marketing plan to sell the asset has been initiated at a reasonable price;
4. The sale of the asset is probable within one year; and
5. It is unlikely that significant changes to the plan to sell the asset will be made.
Upon designation of an asset as held for sale, we record the carrying value of the asset at the lower of its carrying value or its estimated fair value (which is determined after consultation with independent real estate brokers) less estimated selling costs, and we cease depreciation of the asset. The fair values of the assets held for sale are based on the estimated selling prices. We determine the estimated selling prices with the assistance of independent real estate brokers. The estimated selling costs are based on our experience with similar asset sales. We record impairment charges and write down respective hotel assets if their carrying values exceed the estimated selling prices less costs to sell. During 2006, we recorded $23.1 million of impairment losses on 16 hotels held for sale. $13.1 million of the 2006 impairment charge was recorded in the fourth quarter and was largely the result of our strategic initiative to dispose of non-core hotels as announced on November 2, 2006. During 2005, we recorded $11.1 million of impairment losses on 10 hotels and one land parcel held for sale.
With respect to assets held for use, we estimate the undiscounted cash flows to be generated by these assets. We then compare the estimated undiscounted cash flows for each hotel with their respective carrying values to determine if there are indicators of impairment. The carrying value of a long-lived asset is considered for impairment when the estimated undiscounted cash flows to be generated by the asset over its estimated useful life is less than the assets carrying value. For those assets where there are indicators of impairment, we determine the estimated fair values of these assets using broker valuations or appraisals. The broker valuations of fair value normally use the cap rate approach of estimated cash flows, a per key approach or a room revenue multiplier approach for determining fair value. If the projected future cash flow exceeds the assets carrying value, no adjustment is recorded. Additionally, if an asset is replaced prior to the end of its useful life, the remaining net book value is recorded as impairment expense. During 2006, we recorded $0.8 million of impairment losses for net book value write-offs for assets that were replaced in 2006 that had remaining book value. The impairment of long-lived assets of $1.2 million recorded during 2005 represents $1.0 million in adjustments made to the carrying value of one held for use hotel, to reduce it to its estimated fair value, and $0.2 million for furniture, fixtures and equipment net book value write-offs for items that were replaced in 2005.
Accrual of self-insured obligations We are self-insured up to certain amounts with respect to employee medical, employee dental, property insurance, general liability insurance, personal injury claims, workers compensation, automobile liability and other coverages. We establish reserves for our estimates of the loss that we will ultimately incur on reported claims as well as estimates for claims that have been incurred but not yet reported. Our reserves, which are reflected in other accrued liabilities on our consolidated balance sheet, are based on actuarial valuations and our history of claims. Our actuaries incorporate historical loss experience and judgments about the present and expected levels of costs per claim. Trends in actual experience are an important factor in the determination of these estimates. We believe that our estimated reserves for such claims are adequate; however, actual experience in claim frequency and amount could materially differ from our estimates and adversely affect our results of operations, cash flow, liquidity and financial condition. As of December 31, 2006, we had an accrued balance of $11.5 million for these expenses.
The discussion below focuses primarily on our continuing operations. In the continuing operations discussions, we compare the results of operations for the last three years for the 44 consolidated hotels that, as of December 31, 2006, are classified as assets held for use.
We categorize our revenues into the following three categories:
Transient revenues, which accounted for approximately 71% of our 2006 room revenues, are revenues derived from individual guests who stay only for brief periods of time without a long-term contract. Demand from groups made up approximately 23% of our 2006 room revenues while our contract revenues (such as contracts with airlines for crew rooms) accounted for the remaining 6%.
We believe revenues in the hotel industry are best explained by the following four key performance indicators:
To obtain available room nights for a year, we multiply the number of rooms in our portfolio by the number of days the hotel was open during the year. We have adjusted available rooms accordingly, for the Holiday Inn Marietta, GA hotel, which closed following a fire in January 2006, the Crowne Plaza Melbourne, FL hotel, which was closed throughout 2005 due to hurricane renovations, and the Crowne Plaza West Palm Beach, FL hotel which reopened December 29, 2005 after the completion of its hurricane repairs.
These measures are influenced by a variety of factors including national, regional and local economic conditions, the degree of competition with other hotels in the area and changes in travel patterns. The demand for accommodations is also affected by normally recurring seasonal patterns and most of our hotels experience lower occupancy levels in the fall and winter months, November through February, which generally results in lower revenues, lower net income and less cash flow during these months.
Operating expenses fall into the following categories:
We use certain non-GAAP financial measures, which are measures of our historical financial performance that are not calculated and presented in accordance with GAAP, within the meaning of applicable SEC rules. For instance, we use the term direct operating margin to mean revenues less direct operating expenses as presented in the consolidated statement of operations. We assess profitability by measuring changes in our direct operating margin and direct operating margin percentage, which is direct operating margin as a percentage of the applicable revenue source. These measures assist management in distinguishing whether increases or decreases in revenues and/or expenses are due to growth or decline of operations or from other factors. We believe that direct operating margin, when combined with the presentation of GAAP operating profit, revenues and expenses, provide useful information to management.
Non-operating items include:
Results of Operations Continuing Operations
Results of operations for the twelve months ended December 31, 2006 and December 31, 2005
Room revenues increased $29.7 million, or 17.7% due to higher rooms sold (up 6.1%) and ADR (up 10.9%). The increase in rooms sold was driven by a 2.4% increase in occupancy (rooms sold as a percentage of available rooms) and a 3.7% increase in available rooms. The increase in available rooms was due to the reopening of two hotels. Our Crowne Plaza Hotels in West Palm Beach and Melbourne, FL, which were closed due to hurricane damage, reopened in late December 2005 and January 2006, respectively. The increase in occupancy was attributable in part to lowered occupancy in 2005 caused by displacement. In addition to the two hotels in Florida, eight other continuing operations hotels underwent major renovations in 2005. For the year ended December 31, 2005, room revenue displacement for the 10 hotels was $15.9 million and total revenue displacement was $21.1 million. Excluding the impact of 2005 displacement, room revenues increased $13.8 million, or 7.5%. The growth in ADR and occupancy were partially offset by the closure of one hotel in January 2006 due to a fire.
Revenue is considered displaced only when a hotel has sold all available rooms and denies additional reservations due to rooms being out of order. We feel this method is conservative, as it does not include estimated other or soft displacement associated with a renovation; for example, guests who depart earlier than planned due to the disruption caused by the renovation work, local customers or frequent guests who may choose an alternative hotel during the renovation, or local groups that may not choose to use the hotel to house their groups during renovations.
Food and beverage revenues increased $8.9 million, or 19.0% due largely to the reopening of the Crowne Plaza hotels in West Palm Beach and Melbourne, FL. Excluding these two hotels, food and beverage revenues increased $4.2 million, or 8.9%, driven by initiatives to improve our food and beverage operations.
Other revenues increased $0.4 million due to the reopening of our two Crowne Plaza hotels in Florida. Excluding these two hotels, other revenues remained constant year over year.
The table below shows our occupancy, ADR, RevPAR and RevPAR Index (market share) for our continuing operations hotels for the twelve months ended December 31, 2006 and 2005. To illustrate the impact of the two hotels closed throughout most of 2005 due to hurricane damage, the impact of renovations underway and completed, and the impact of rebranding, we have presented this information in eight different subsets. These subsets indicate that where we have recently completed a major renovation, on an annual basis we saw an increase in RevPAR that is greater than the average increase for all of our continuing operations hotels.
(A) Other Brands and Independent Hotels include the Radisson New Orleans Airport Hotel in Kenner, LA which experienced dramatic increases in Occupancy and ADR as a result of Hurricane Katrina.
Direct operating expenses Continuing Operations
Room expenses increased $6.2 million, or 13.9%. Room expenses on a cost per occupied room basis increased from $24.52 in 2005 to $26.31 in 2006, an increase of 7.3%, primarily as a result of higher travel agent and credit card commissions driven by the increase in room revenue. Additionally, payroll costs on a per occupied room basis increased 4.9%, driven largely by higher rooms sold. Direct operating margin for rooms increased $23.4 million, a growth rate of 19.1%. Direct operating rooms margin as a percentage of revenue increased from 73.2% to 74.1%, an increase of 90 basis points.
Food and beverage expenses increased $6.5 million, or 19.7%, driven primarily by higher food and beverage revenues. The food and beverage direct operating margin declined 30 basis points from 29.3% in 2005 to 29.0% in 2006 as a result of ramp-up expenses at our Crowne Plaza hotels in West Palm Beach and Melbourne, FL and the closure of one hotel due to a fire. Excluding these three hotels, food and beverage direct operating margin as a percentage of food and beverage revenue remained unchanged at 30.1%.
Total direct operating expenses increased $12.9 million, while total revenues increased $39.0 million. Direct operating margin increased $26.1 million, or 18.9%. Total direct operating margin as a percentage of total revenues improved from 62.2% in 2005 to 62.9% in 2006.
Other operating expenses Continuing Operations
Other hotel operating costs increased $7.5 million, or 11.1%, but declined as a percentage of revenue. The increase is a result of the following:
Property and other taxes, insurance and leases increased $4.0 million, or 24.1%. Higher property insurance premiums accounted for $3.5 million of this increase. If our insurance costs had remained constant, property and other taxes, insurance and leases would have increased $0.6 million, or 3.4%.
Corporate and other expenses increased $0.7 million, or 3.7%, due mainly to the adoption of SFAS No. 123(R), Share Based Payment, on January 1, 2006. SFAS No. 123(R) requires grants of employee stock options to be recognized as expense in the statement of operations. Prior to January 1, 2006, stock option expense was accounted for using the intrinsic method under APB Opinion No. 25 Accounting for Stock Issued to Employees and thus was excluded from our statement of operations. Stock option expense of $0.8 million was recorded in Corporate and other expenses in 2006. In addition, we incurred costs during 2006 associated with the restructuring of several departments in the corporate office, including severance, relocation, signing bonuses, nonvested stock grants, and recruiting fees. However, similar costs were incurred in 2005 due to the resignations of several executives and the hiring costs for our new president and chief executive officer.
Casualty (gains) losses, net represent costs related to hurricane and other property damage, offset by gains related to the final settlement of the related property damage claims. In 2006, we recognized a net casualty gain of $2.9 million associated with the final settlement of property damage claims at the Crowne Plaza hotels in West Palm Beach and Melbourne, FL. In 2005, we recognized a net casualty gain of $28.5 million on the settlement of property damage claims for the Crowne Plaza hotels in West Palm Beach and Melbourne, FL which was offset by related repair expenses.
Depreciation and amortization expenses increased $8.7 million, or 39.4% due to the completion of several renovation projects. In accordance with generally accepted accounting principles, we begin recognizing depreciation expense when the asset is placed in service.
The impairment of long-lived assets of $0.8 million recorded during 2006 represents the write-off of the net book value of disposed assets.
Business interruption proceeds represent funds received or amounts for which proofs of loss have been signed. Business interruption proceeds in 2006 were recorded for the Crowne Plaza hotels in West Palm Beach and Melbourne, FL that were closed as a result of damage sustained in the 2004 hurricanes, and the Holiday Inn Marietta, GA which was closed in January 2006 as the result of a fire. In 2005, business interruption proceeds were recorded for Crowne Plaza hotels in West Palm Beach and Melbourne, FL.
Interest income and other increased $1.8 million due to higher balances in our interest-bearing and escrow accounts as well as higher interest rates.
Interest expense increased $4.0 million, or 18.7% as a result of prepayment penalties and higher amortization of deferred loans costs associated with debt refinancings which occurred in the first quarter of 2006, lower capitalized interest due to fewer construction projects, and higher interest rates on our variable rate debt. We have interest rate caps for all our variable rate debt to manage our exposure to increases in interest rates.
Minority interests represent the third party owners share of the net income (losses) of the joint ventures in which we have a controlling interest. The $9.8 million decrease in minority interest is primarily due to the large casualty gains and business interruption proceeds realized in 2005.
Results of operations for the twelve months ended December 31, 2005 and December 31, 2004
The $7.2 million, or 4.5%, increase in room revenues resulted from increases in both occupancy and ADR. Occupancy increased 1.7% and ADR increased 6.5%. While occupancy increased 1.7% from 2004, it was negatively impacted by renovations at eight hotels during 2005, and the closure of the West Palm Beach and Melbourne, FL Crowne Plaza hotels. We made substantial progress on our renovation program in 2005, but with many rooms out of service while under renovation, we experienced substantial room revenue displacement. The increase in ADR was a result of increasing demand and improved yield management strategies as the economy improved as well as a shift away from Internet sales that involve more heavily discounted room rates.
Food and beverage revenues decreased $1.4 million, or 2.9% due to the continued closure of our Crowne Plaza hotels in West Palm Beach and Melbourne, FL. Other revenues, which decreased by 2.5%, were affected by these closures as well as a decline in telephone revenues as a result of the increased usage of cell phones by our guests and the availability of free high speed internet access at many of our hotels.
Direct operating expenses Continuing Operations
Direct operating expenses increased $1.2 million, or 1.4% due to higher occupancy. Total direct operating margin improved from 61.8% in 2004 to 62.2% in 2005.
Room expenses on a cost per occupied room basis increased from $23.26 in 2004 to $24.52 in 2005, an increase of 5.4%. Payroll and benefits increased 3.6% and other expenses increased 8.4%. Additionally, travel agent, credit card and other commissions increased due to higher revenues.
Food and beverage expenses decreased $0.5 million, or 1.6% compared with 2004 primarily as a result of lower volume. Food and beverage margin declined 100 basis points as a result of the displaced ala carte and banquet revenues due to the ongoing property renovations, as well as higher health insurance costs.
Other operating expenses Continuing Operations
Other hotel operating costs increased $4.9 million, or 7.9% compared with 2004 as a result of the following factors:
Property and other taxes, insurance and leases increased $1.2 million, or 7.4%. In 2004, expenses were reduced by the settlement of a deferred ground rent obligation for $1.0 million less than the amount that had been previously recorded.
Corporate and other expenses increased $3.1 million, or 18.5%, primarily due to $0.6 million in severance costs related to the resignations of our former CEO, COO, and CFO including the acceleration of the unvested portion of our former CEOs nonvested stock, $1.1 million of expenses related to hiring costs including a signing bonus, nonvested stock grants and a relocation allowance for our new president and chief executive officer, a $0.9 million write-off of the receivable from and the investment in the 30% minority-owned Holiday Inn City Center Columbus, OH (which has since been deeded to the lender). Additionally, expenses were higher because in 2004, we recorded a reduction in our sales and use tax audit reserve which resulted in a $1.5 million reduction our 2004 expenses. These increases were partially offset by lower Directors & Officers (D&O) premiums due to favorable trends in the D&O markets, lower post-emergence Chapter 11 expenses due to the completion of the bankruptcy claims distribution process, lower audit fees as a result of the second year of Sarbanes-Oxley (SOX), and lower costs related to SOX compliance.
Casualty (gains) losses, net represent costs related to hurricane damage sustained in the 2004 and 2005 hurricane seasons offset by gains related to the final settlement of the related property damage claims. In 2005, we recognized a net casualty gain of $28.5 million. We recorded $28.7 million in casualty gains on the settlement of property damage claims for the Crowne Plaza West hotels in Palm Beach and Melbourne, FL.
Depreciation and amortization expenses increased $3.1 million, or 16.3%, due to the completion of numerous renovation projects.
The impairment of long-lived assets of $1.2 million recorded during 2005 represents $1.0 million in adjustments made to the carrying value of the Fairfield Inn Merrimack, NH, to reduce the carrying value to its estimated fair value, and $0.2 million for write-offs of assets that were replaced in 2005. The impairment of long-lived assets of $0.4 million recorded during 2004 represents write-offs of assets that were replaced in 2004.