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INTERSTATE HOTELS & RESORTS INC 10-K 2008 Documents found in this filing:
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT
OF 1934
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT
OF 1934
For Fiscal Year Ended December 31, 2007
Commission File Number 1-14331
4501
North Fairfax Drive, Ste 500
Arlington, VA 22203 703-387-3100 www.ihrco.com This Form 10-K can be accessed at no charge through above Web site.
Securities registered pursuant to Section 12(b) of the
Act:
Securities registered pursuant to Section 12(g) of the
Act:
None
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. o Yes þ No
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. o Yes þ No
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 for which
the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past 90 days.
þ
Yes o
No
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to the
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,” “accelerated
filer” and “smaller reporting company” 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 12b-2
of the Securities Exchange Act of
1934). o Yes þ No
The aggregate market value of common stock held by
non-affiliates of the registrant was $112,573,643 (based on the
closing sale price of $5.22 on June 29, 2007 as reported by
the New York Stock Exchange). For this computation, the
registrant has excluded the market value of all shares of its
common stock reported as beneficially owned by executive
officers and directors of the registrant; such exclusion shall
not be deemed to constitute an admission that such person is an
“affiliate” of the registrant. The number of shares of
common stock outstanding at February 27, 2008 was
31,702,017.
Portions of the registrant’s definitive proxy statement
relating to the Registrant’s 2007 Annual Meeting of
Stockholders are incorporated by reference into Part III.
We expect to file our proxy statement on or about April 21,
2008.
INDEX
PART I
We are a leading hotel real estate investor and the
nation’s largest independent operator, as measured by
number of rooms under management and gross annual revenues of
the managed portfolio. We have two reportable operating
segments: hotel ownership (through whole-ownership and joint
ventures) and hotel management. A third reportable segment,
corporate housing, was disposed of on January 26, 2007,
with the sale of BridgeStreet Corporate Housing Worldwide, Inc.
and its affiliated subsidiaries, which we refer to as
“BridgeStreet.” Each segment is reviewed and evaluated
by the company’s senior management. For financial
information about each segment, see Note 10 to our
consolidated financial statements.
Our hotel ownership segment includes our wholly-owned hotels and
our minority interest, joint venture investments in hotel
properties. Hotel ownership allows us to participate in the
potential asset appreciation of the hotel properties, and as of
December 31, 2007, we owned seven hotels and held
non-controlling equity interests in 17 joint ventures, which own
or hold ownership interests in 22 of our managed properties. We
manage all of the properties that are part of our hotel
ownership segment.
In our hotel management segment, we generate revenues from fees
we receive for managing a portfolio of upscale, full-service and
premium, select-service hospitality properties. We also generate
revenues by providing specialized ancillary services in the
hotel, resort, conference center and golf markets, which include
insurance and risk management placed through a licensed broker,
purchasing and project management, information technology and
telecommunications, and centralized accounting functions.
As of December 31, 2007, we and our affiliates managed 191
hotel properties with 42,620 rooms and five ancillary service
centers (which consist of a convention center, conference
center, spa facility and two laundry centers), in
36 states, the District of Columbia, Russia, Mexico,
Canada, Belgium and Ireland. Our portfolio of managed properties
is diversified by location/market, franchise and brand
affiliations, and ownership group. We manage hotels represented
by nearly 30 franchise and brand affiliations in addition
to managing 15 independent hotels. Our managed hotels are owned
by more than 60 different ownership groups, including individual
investors, institutional investors, investment funds, such as
Cornerstone Real Estate, private equity firms, such as The
Blackstone Group, and public real estate investment trusts, or
“REITs”, such as Sunstone Hotel Investors, Inc.
In this report, we use the terms “we”,
“our”, “us”, “Interstate” and the
“Company” to refer to Interstate Hotels &
Resorts, Inc. We were formed on August 3, 1998, as MeriStar
Hotels & Resorts, Inc., when we were spun off by
CapStar Hotel Company, which then changed its name to MeriStar
Hospitality Corporation, which we refer to as
“MeriStar”. We then became the lessee and primary
manager of all of MeriStar’s hotels at the time of the
spin-off. On January 1, 2001, in connection with the
implementation of new REIT tax laws that permit subsidiaries of
a REIT to lease the real estate it owns, we assigned the leases
on each of the properties we were leasing from MeriStar to
taxable REIT subsidiaries of MeriStar and entered into
management contracts with those subsidiaries for each of the
hotels owned by MeriStar.
On July 31, 2002, we merged with Interstate Hotels
Corporation, which we refer to as “Old Interstate,”
and were renamed Interstate Hotels & Resorts, Inc. The
transaction was a stock-for-stock merger of Old Interstate into
us, in which Old Interstate stockholders received
4.6 shares of our common stock for each equivalent share of
Old Interstate. Our stockholders continued to own the same
number of shares in new Interstate following the merger.
Immediately after the merger, we effected a one-for-five reverse
split of our common stock. The merger was accounted for as a
reverse acquisition, with Old Interstate as the accounting
acquirer, and us as the surviving company for legal purposes
under our new name of Interstate Hotels & Resorts, Inc.
Throughout 2007, we focused on the execution of our business
strategy by continuing to build a portfolio of quality
management contracts and investing in hotels through joint
ventures and selective whole-ownership. With the disposition of
our corporate housing business, management was able to focus
solely on the hotel industry. We
believe this strategic focus will enhance our overall long-term
growth by allowing us to deploy all of our resources and
expertise to our core area of operations. Our overall strategy
to grow our core business in the hotel industry is to recruit
and maintain a high quality management team, follow a
disciplined investment philosophy, and provide “best in
class” service to our customers and owner groups. We
believe this strategy will, in turn, provide strong long-term
growth opportunities for our stockholders.
In 2005, we began our expansion into hotel real estate with our
purchase of the 331-room Hilton Concord, located in the
East Bay area of San Francisco, California and the
195-room Hilton Durham, near Duke University, both of which
are full-service hotels. In 2006, we purchased the
131-room Hilton Garden Inn Baton Rouge, a select-service
hotel in Louisiana and the 308-room Hilton Arlington, a
full-service hotel in Texas. In 2007, we acquired the
297-room Hilton Houston Westchase, the 495-room Westin
Atlanta Airport and the 288-room Sheraton Columbia in
Maryland, all full-service hotels.
We believe making investments in hotels through joint ventures
and selective whole-ownership is a key component to our
strategic growth. As of December 31, 2007, we owned six
full-service hotels and one select-service hotel, and held
non-controlling equity interests in 17 joint ventures, 12 of
which own 22 hotels located throughout the United States and
Mexico. As of December 31, 2007, we held investments in two
joint ventures currently developing five hotels, one joint
venture which manages three hotels in Mexico. We also have made
investments in two joint ventures which as of February 27,
2008, had purchased 26 hotel properties.
The following table provides information relating to our joint
venture investments as of December 31, 2007:
Early in 2008, two of our joint ventures acquired a total of 26
hotel properties. One of the joint ventures owns four
full-service properties, three of which we previously managed.
The second joint venture owns 22 select-service properties,
which are additions to our portfolio of managed properties and
offer a strong opportunity for growth through strategic
repositioning with minimal renovation or transition costs.
In February 2008, we realized the successful completion of a
joint venture investment cycle when our joint venture that owned
the Doral Tesoro Hotel & Golf Club, located in Dallas,
Texas, sold the hotel. We expect to recognize a gain in excess
of $2.0 million related to the sale. Proceeds from the sale
of the hotel will be redeployed through additional investment
opportunities during 2008. This transaction highlights the
upside and success we believe exists through our joint venture
investments which range from 10% to 50%. These strategic
partnerships and investments enable us to secure longer term
management contracts, further align our interests in the hotels
that we manage with those of the majority owners and provide us
the opportunity to participate in the potential asset
appreciation of these properties. We pursue whole-ownership
opportunities when we believe our knowledge of the hotel, or the
market in which it operates, will allow us to significantly
increase the current value of the hotel. We accomplish this by
making prudent capital improvements to the hotel and
implementing our management strategies.
Our plan is to continue to expand our portfolio of real estate
investments through the selective whole and joint venture
ownership opportunities of hotels, resorts and conference
centers. Our joint venture investment strategy is designed, in
part, to secure additional full-service and select-service
management contracts. We attempt to identify properties that are
promising acquisition candidates located in markets with
economic, demographic and supply dynamics favorable to hotel
owners. Through our vast network of industry contacts, coupled
with our due diligence process, we seek to select those
acquisition targets where we believe that selected capital
improvements and focused management will increase the
property’s ability to attract key demand segments,
demonstrate better financial performance, and increase long-term
value. In order to evaluate the relative merits of each
investment opportunity,
4
senior management and individual operations teams create
detailed plans covering all areas of renovation and planned
operation. These plans serve as the basis for our expansion
decisions and guide subsequent renovation and operating plans.
We seek to invest in properties that meet the following market
and hotel criteria:
We expect that our reputation as a leading hotel and hospitality
manager combined with our relationships throughout the lodging
industry will continue to provide us with a competitive
advantage in identifying, evaluating and investing in hotels
that meet our criteria. We have a record of successfully
managing the renovation and repositioning of hotels in
situations with varying levels of service, room rates and market
types. We plan to continue to manage such renovation and
repositioning programs as we invest in hotels, resorts and
conference centers.
We believe we can maximize the value of our hotel portfolio
through aggressive asset management. We continue to evaluate key
performance indicators against established benchmarks and
historical performance to ensure that an appropriate level of
assistance is provided to our managers to maximize opportunities
and value for each of our owned and managed owned assets. Areas
of focus include enhancing revenue management for rooms, food
and beverage and other services, reducing operating and overhead
expenses and identifying operating efficiencies
through the benchmarking process, all of which improve the
long-term profitability of the hotel. We also continuously focus
on the guest satisfaction measurement process to ensure that we
maintain a balance of profitability and guest satisfaction,
further enhancing the long-term asset value of our portfolio.
Our asset management and development professionals work closely
with our managers in overseeing capital expenditure budgets to
ensure that our hotels are in good physical condition, highly
competitive in the market and compliant with brand standards. We
also work with our managers to ensure that renewal and
replacement expenditures are efficiently spent to maximize the
profitability of the hotel. In addition, we pursue opportunities
to enhance asset value by completing selective capital
improvements outside the scope of the typical renewal and
replacement capital expenditures. These capital improvements may
include converting under-utilized space to alternative uses,
building additional guest rooms, recreational facilities,
meeting space or exhibit halls, and installing energy management
systems and increasing energy efficiency wherever possible. When
appropriate, we also consider the complete repositioning of a
hotel in a given market, which often includes a complete
renovation of guest rooms, meeting rooms and public space
modifications, and can also include a change in brand and name.
Our portfolio of managed properties is diversified by
location/market, franchise and brand affiliations, and ownership
group. The hotels managed by us and our affiliates are primarily
located throughout the United States, including most major
metropolitan areas and rapidly growing secondary cities. We and
our affiliates also manage eleven international hotels,
including five in Russia, three in Mexico and one each in
Canada, Belgium and Ireland. In addition to geographic and
market diversity, our managed hotels represent nearly 30
nationally and internationally recognized brand names including
Marriott, Hilton, Sheraton, Westin, Renaissance, Radisson,
Doubletree, Embassy Suites, Wyndham, and Hampton Inn, as well as
15 independent hotels. Our managed hotels are owned by more than
60 different ownership groups, including individual investors,
institutional investors, investment funds, such as Cornerstone
Real Estate, private equity firms, such as The Blackstone Group,
and public real estate investment trusts, or “REITS”,
such as Sunstone Hotel Investors, Inc.
We manage properties and provide related management services
primarily within the upscale and mid-priced full-service sectors
and the premium select-service sector. We believe the
combination of these sectors provides us with a balanced mix of
managed assets. The two sectors attract a wide variety of
potential customers, including both business and leisure
travelers. Our size, as the largest independent manager of
hotels in the nation, allows us to provide systems and services
to owners on a broad scale, capitalizing on the extensive
experience of our corporate operations, sales and support
personnel. We believe our independence from any one brand
provides us the opportunity to be more flexible operationally
and to have our interests more closely aligned with those of the
owners of the hotels for which we manage.
Our principal operating objectives in our hotel management
segment are to generate higher revenue per available room, or
RevPAR, control costs and increase the net operating income of
the hotels we manage, while providing our guests with
high-quality service and value. We believe that skilled
management is the most critical element in maximizing revenue
and cash flow in hotel properties. Our senior hotel management
team has successfully managed hotels in all sectors of the
lodging industry. We attribute our management success to our
ability to analyze each hotel as a unique property and to
identify specific opportunities for RevPAR growth, as well as
cash flow growth, available at each hotel. The challenging
operating cycles that the hospitality industry encounters make
our breadth and depth of experience and application of sound
strategies even more valuable to the owners of the hotels we
manage.
Our corporate office associates implement financing and
investment activities and provide services to support and
monitor our
on-site
hotel operations and executives. Each of our disciplines,
including hotel operations, sales and marketing, human
resources, food and beverage, technical services, information
technology, development, risk management, legal and corporate
finance, is staffed by an experienced team with significant
expertise in their respective area. These departments support
the hotel executives in their day-to-day activities by providing
online, real-time financial reporting and review; accounting and
budgeting services; sales and revenue management; cost controls;
property management tools and other resources that we create,
maintain and deliver efficiently and effectively using our
centralized corporate office resources.
Key elements of our management programs include the following:
The following chart summarizes information on the national
franchise affiliations of the properties we and our affiliates
managed as of December 31, 2007:
8
We previously provided short and long-term corporate housing
leases and apartment management within 15 major markets in the
United States, as well as internationally in London and Paris,
through the
BridgeStreet®
brand name in the extended corporate stay industry. On
January 26, 2007, we sold BridgeStreet to an affiliate of
Sorrento Asset Management, an Ireland-based company, for
approximately $42.4 million. We redeployed the proceeds
from this sale into investments in hotel real estate through
wholly-owned acquisitions and joint ventures.
The operations of our corporate housing segment are reported as
discontinued operations in our consolidated statement of
operations for all periods presented, and the assets and
liabilities are presented as held for sale on our consolidated
balance sheet as of December 31, 2006.
MeriStar/Blackstone — On February 21,
2006, MeriStar announced that it had entered into a definitive
agreement to be acquired by The Blackstone Group. The
acquisition closed in May 2006. Our management agreements for
the 44 hotels Blackstone acquired remained in place after the
transaction, although 35 hotels have since been sold, as of
February 27, 2008. The total base management fee for each
of the hotels we manage for Blackstone is 2.5% of total hotel
revenue, however with incentive fees, we have the potential to
earn up to 4% of total revenues. As of February 27, 2008,
we continued to manage nine properties for Blackstone. Of the 35
properties which we no longer manage for Blackstone, we have
individually acquired four properties, entered into joint
ventures to acquire partial ownership of seven properties and
retained the management contracts with the new owners for an
additional two properties. The total management fees related to
all MeriStar/Blackstone properties accounted for
$8.6 million, or 13.4%, of management fees in 2007 and
$20.3 million, or 27.0%, of management fees in 2006 (which
included $3.2 million of business interruption proceeds
from lost management fees that we received associated with eight
MeriStar properties that were damaged or closed due to
hurricanes in 2004).
Under the master management agreement that we entered into in
2004 with MeriStar (which has been assumed by Blackstone), we
are entitled to a termination fee due to a sale of the property.
The termination fees are calculated as the discounted future
cash flows under the management agreement through the end of the
initial contract term. Similar provisions are also in place in
the event the hotel is sold during one of the renewal periods.
The termination fees are paid over 48 months or as a
discounted one-time payment.
MeriStar/Blackstone
may terminate management agreements each year, representing up
to 600 rooms, with the election of a one-time termination fee
payment equal to 18 months of management fees.
MeriStar/Blackstone has the right to terminate a management
agreement, free of any termination fees, if we make an
investment in a hotel that is in the competitive set of any
MeriStar/Blackstone hotel (provided that the termination request
occurs between 12 and 18 months following the date of our
investment). Additionally, Blackstone may also offset any unpaid
termination fees due to us with future management fees earned
from any new management agreement we would enter into with
Blackstone. The remaining life under the master management
agreement is approximately three years.
During August 2006, we entered into an amendment to our master
fee agreement with Blackstone. The amendment allowed Blackstone
to transition three properties from management by us without the
sale of the property. In exchange, we received the right to
preclude Blackstone from substituting any future management
agreements given to us to reduce or offset its currently payable
termination fees for hotels that had been sold as of August
2006. The amendment removed all contingencies related to the
receipt of the agreed upon termination fee payments due from
Blackstone. As a result, we recognized, on a present value
basis, the $15.1 million of termination fees due to us as
of the date of the amendment. During 2007 and 2006, we
recognized $7.2 million and $24.3 million,
respectively, in termination fees related to hotels sold by
either Blackstone or MeriStar during their respective period of
ownership.
See “Risk Factors — Risk Factors Related to Our
Business — Our management agreements may be terminated
or not renewed under various circumstances, including if the
properties to which they relate are sold or otherwise disposed
of by their owners, which may have a material impact on our
results of operations” and “— A large
percentage of our managed properties are owned by a small group
of owners, which could result in the loss of multiple management
agreements in a short period.”
Relationships with Other Significant Owners —
In October 2004, we entered into a stock purchase agreement with
Sunstone Hotel Investors, which we refer to as “Sunstone
REIT,” to acquire Sunstone Hotel Properties, which we refer
to as “Sunstone,” a hotel management company. In
connection with the acquisition, Sunstone entered into new
management contracts with respect to 52 hotels and two ancillary
service centers previously managed by Sunstone, 50 of which were
owned by Sunstone REIT and its affiliates. The management
agreements have an initial term of 20 years, with two
extensions of five years each. As of December 31, 2007, our
Sunstone subsidiary managed 29 hotels and two ancillary
service centers, which accounted for 7,796 rooms, or 18.3% of
our total managed rooms. Management fees related to all Sunstone
properties managed during 2007 were $9.2 million, or 14.5%,
of total management fees. Management fees for all Sunstone
properties managed in 2006 were $10.0 million, or 13.3%, of
total management fees. Under the termination provisions of our
management agreements with Sunstone REIT we would be entitled to
receive a termination fee if a contract is terminated prior to
October 2010.
As of December 31, 2007, we managed five hotels in Moscow
for a single owner, two of which were additions in 2007. The
management agreements for these five properties expire between
2022 and 2024. These hotels accounted for $12.6 million, or
19.8%, of total management fees in 2007 and $9.6 million,
or 12.7%, of total management fees in 2006.
As of December 31, 2007, we managed 38 hotels owned by
Equity Inns, Inc., which accounted for 4,847, or 11.4% of total
managed rooms. The total management fees related to all Equity
Inns, Inc. properties accounted for $3.8 million, or 5.9%,
of total management fees in 2007 and $3.9 million, or 5.2%,
of total management fees in 2006.
As of December 31, 2007, we managed eight hotels for three
separate independent owners which accounted for 4,197, or 9.8%,
of total managed rooms. These properties accounted for
$9.8 million, or 15.3%, of total management fees in 2007,
and $6.8 million, or 9.1%, of total management fees in 2006.
We employ a flexible branding strategy based on each particular
managed hotel’s market environment and other unique
characteristics. Accordingly, a majority of our managed
properties operate under various national trade names pursuant
to licensing arrangements with national franchisors.
Generally, the third-party owners of our managed hotels, rather
than us, are parties to the franchise agreements permitting the
use of the trade names under which the hotels are operated. We
are a party, however, to certain franchise agreements with
Starwood Hotels & Resorts Worldwide, Inc. and Hilton
Hotels Corporation, for the hotels we wholly-own. In the case
where we are not the owner of the hotels, the hotel owners are
required to reimburse us for all costs incurred in connection
with these franchise agreements. Our franchise agreements which
allow us to use these trade names expire at varying times,
generally ranging from 2009 to 2027. We have registered with the
United States Patent and Trademark Office the trademarks
“Colony®”
and
“Doral®”,
which we utilize in connection with managing hotels. We do not
believe that the loss or expiration of any or all of our
trademarks would have a material adverse effect on our business.
The registrations for our marks expire at varying times,
generally ranging from 2008 to 2015.
A number of states regulate the licensing of hospitality
properties and restaurants, including liquor licensing, by
requiring registration, disclosure statements and compliance
with specific standards of conduct. We believe that we are
substantially in compliance with these requirements. Managers of
hospitality properties are also subject to laws governing their
relationship with employees, including minimum wage
requirements, overtime, working conditions and work permit
requirements. Compliance with, or changes in, these laws could
reduce the revenue and profitability of our properties and could
otherwise adversely affect our operations.
We and our affiliates currently manage 11 international
properties and have signed two additional management contracts
for international properties that will commence operations in
the second half of 2008. There are risks inherent in conducting
business internationally. These include: employment laws and
practices in foreign countries; tax laws in foreign countries,
which may provide for tax rates that exceed those of the
U.S. and which may provide that our foreign earnings are
subject to withholding requirements or other restrictions;
unexpected changes in regulatory requirements or monetary
policy; and other potentially adverse tax consequences.
Under the Americans with Disabilities Act, all public
accommodations are required to meet certain requirements related
to access and use by disabled persons. These requirements became
effective in 1992. Although significant amounts of capital have
been and continue to be invested by our owners in federally
required upgrades to our managed hotel properties, a
determination that we or our owners are not in compliance with
the Americans with Disabilities Act could result in a judicial
order requiring compliance, imposition of fines or an award of
damages to private litigants. We or our owners are likely to
incur additional costs of complying with the Americans with
Disabilities Act. However, those costs are not expected to have
a material adverse effect on our results of operations or
financial condition.
Under various federal, state and local and foreign environmental
laws, ordinances and regulations, a current or previous owner or
operator of real property may be liable for noncompliance with
applicable environmental, 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 such hazardous or toxic
substances. The presence of those 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, may adversely
affect the operation of the property or the owner’s ability
to sell or rent the property or to borrow 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 are also regulated by federal and state laws. In
connection with the ownership and operation of hotels, the
operators, such as us, or the owners of those properties, could
be held liable for the costs of remedial action for regulated
substances and storage tanks and related claims. Environmental
laws and common law principles could also be used to impose
liability for releases of hazardous materials, including
asbestos-containing materials, into the environment, and third
parties may seek recovery from owners or operators of real
properties for personal injury associated with exposure to
released asbestos-containing materials or other hazardous
materials. We are not currently aware of any potential material
exposure as a result of any environmental claims.
All of the hotels that we own and the majority of the hotels we
manage have undergone Phase I environmental site assessments,
which generally provide a non-intrusive 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. The Phase I assessments have not revealed, nor are
we aware of, any environmental liability or compliance concerns
that we believe would have a material adverse effect on our
results of operations or financial condition. Nevertheless, it
is possible that these environmental site assessments may not
have revealed all environmental liabilities or compliance
concerns, or that material environmental liabilities or
compliance concerns exist of which we are currently unaware.
In addition, a significant number of the hotels that we own or
manage have been inspected to determine the presence of
asbestos. Federal, state and local environmental laws,
ordinances and regulations require containment, abatement or
removal of asbestos-containing materials and govern emissions of
and exposure to asbestos fibers in the air. Asbestos-containing
materials are present in various building materials such as
sprayed-on ceiling treatments, roofing materials or floor tiles
at some of the hotels. Operations and maintenance programs for
maintaining asbestos-containing materials have been or are in
the process of being designed and implemented, or the
asbestos-containing materials have been scheduled to be or have
been abated at these hotels at which we are aware that
asbestos-containing materials are present. We are not currently
aware of any potential material exposure as a result of any
asbestos-related claims for our owned hotels and we are
indemnified by our hotel owners for any related claims under our
management agreements.
We have also detected the presence of mold at one of our owned
hotels and are evaluating the impact and will take the
appropriate measures to remediate. Many of the costs associated
with remediation of mold may be excluded from coverage under our
property and general liability policies, in which event we would
be required to use our own funds to remediate. Further, in the
event moisture infiltration and resulting mold is pervasive, we
may not be able to rent rooms at that hotel, which could result
in a loss of revenue. Liabilities resulting from moisture
infiltration and the presence of, or exposure to mold, could
have a future material adverse effect on our business, financial
condition, results of operations and ability to make
distributions to our stockholders.
Furthermore, various court decisions have established that third
parties may recover damages for injury caused by property
contamination or exposure to hazardous substances such as
asbestos, lead paint or black mold. In recent years, concern
about indoor exposure to mold has been increasing as such
exposure has been alleged to have a variety of adverse effects
on health. As a result, there has been an increasing number of
lawsuits against owners and managers of real property relating
to the presence of mold. Damages related to the presence of mold
are generally excluded from our insurance coverage. Should an
uninsured loss arise against us, we would be required to use our
own funds to resolve the issue, which could have an adverse
impact on our results of operations or financial condition.
Although we sold BridgeStreet in January 2007, we may be
required to indemnify the purchaser to the extent our policies,
during the time we owned it, are found not to have been in
compliance with local laws. As a former lessee of accommodations
through our corporate housing segment, we believed our employees
were either outside the purview of, exempt from or in compliance
with, laws in the jurisdictions in which we operated, requiring
real estate brokers to hold licenses. There however, can be no
assurance that our position in any jurisdiction would be upheld
if challenged.
We compete primarily in the following segments of the lodging
industry: the upscale and mid-priced sectors of the full-service
segment and the select-service segment and resorts. Other full
and select-service hotels and resorts compete with our
properties in each geographic market in which our properties are
located. Competition in the lodging industry is based on a
number of factors, most notably convenience of location, brand
affiliation, price, range of services and guest amenities or
accommodations offered and quality of customer service and
overall product.
In addition, we compete for hotel management contracts against
numerous competitors, many of which have more financial
resources than us. These competitors include the management arms
of some of the major hotel brands as well as independent,
non-brand- affiliated hotel managers. See “Risk
Factors — Risk Factors Related to Our
Business — We face significant competition in the
lodging industry and in the acquisition of real estate
properties.”
As of December 31, 2007, we employed approximately 19,700
associates, of whom approximately 17,200 were compensated on an
hourly basis. We are reimbursed by the hotel owners for wages,
benefits and other employee related costs directly related to
employees at their respective hotels. Some of the employees at
22 of our hotels are represented by labor unions. We believe
that labor relations with our employees are generally good.
Generally, hotel revenues are greater in the second and third
calendar quarters than in the first and fourth calendar
quarters. Hotels in tourist destinations generate greater
revenue during tourist season than other times of the year.
Seasonal variations in revenue at the hotels we own or manage
will cause quarterly fluctuations in revenues.
We will make available, free of charge, access to our Annual
Report on
Form 10-K,
Proxy Statement, Quarterly Reports on
Form 10-Q,
Current Reports on
Form 8-K
and all amendments to those reports as soon as reasonably
practicable after such reports are electronically filed with or
furnished to the SEC through our home page at www.ihrco.com.
You should carefully consider the risk factors set forth
below as well as the other information contained in this Annual
Report on
Form 10-K
in connection with evaluating us. Additional risks and
uncertainties not currently known to us or that we currently
deem to be immaterial may also materially and adversely affect
our business, results of operations or financial condition.
Certain statements in “Risk Factors” are
forward-looking statements. See “Item 7.
Management’s Discussion and Analysis of Financial Condition
and Results of Operations — Forward-Looking
Statements” for additional information about our business,
results of operations and financial condition.
Risk
Factors Related to Our Business
Various factors could adversely affect our ability to generate
hotel revenues for our owned properties and management fees for
our managed properties, which are based on hotel revenues. Our
business is subject to all of the operating risks inherent in
the lodging industry. These risks include, but are not limited
to, the following:
In addition to the operating risks described above, with respect
to hotels and real estate where we hold an ownership interest,
we have the following additional risks:
Most of these factors are beyond our control. As our company
expands through the acquisition
and/or
development of real estate, the magnitude of these risks may
increase. Any of these factors could have a material and adverse
impact on the value of our assets or on the revenues that can be
generated from those assets. In addition, due to the level of
fixed costs required to operate upscale and select-service
hotels, significant expenditures necessary for the operation of
these properties generally cannot be reduced when circumstances
cause a reduction in revenue. Therefore, if our properties do
not generate revenue sufficient to meet operating expenses,
including debt service and capital expenditures, our income will
be adversely affected. In addition, as we increase our ownership
of hotels, we will be more subject to volatility in our overall
revenues, cash flows from operations and net income, as our
portfolio of owned hotels is currently less diversified across
markets and asset classes than our portfolio of managed hotels,
and the revenues, cash from operations and net income associated
with a single owned hotel will generally be substantially
greater than the same from a single managed hotel.
Increased hotel values in recent years have resulted in an
increased rate of disposition by the owners of hotels we manage,
which has led to the loss of management contracts. The loss of
associated management contracts could have an adverse effect on
our revenues to the extent we do not replace lost management
contracts with new ones. An economic slowdown may lead to an
increased risk of bankruptcy by owners of hotels
and/or
foreclosures on the hotel properties, which may inhibit our
ability to collect fees under our management agreements or may
lead to their termination.
A significant portion of our managed properties and management
fees are derived from seven owners. This group of owners
represents 92, or 48.2%, of our managed properties and 22,453,
or 52.7%, of our managed rooms as of December 31, 2007.
These seven owners also accounted for 69.0% of our base and
incentive management fees in 2007. Our portfolio of managed
properties could be adversely impacted if any of these owners
were acquired by another entity, sold their portfolio or entered
into a property disposition plan. In addition to lost revenues,
the termination of management agreements could result in the
impairment of intangible assets and goodwill. See
“— Our management agreements may be terminated or
not renewed under various circumstances, including if the
properties to which they relate are sold or otherwise disposed
of by their owners, which may have a material impact on our
results of operations.”
We report operating revenues and expenses from our owned hotels;
therefore, we are susceptible to changes in operating revenues
and are subject to the risk of fluctuating hotel operating
margins at those hotels. Hotel operating expenses include, but
are not limited to, wage and benefit costs, energy costs,
supplies, repair and maintenance expenses, utilities, insurance
and other operating expenses. These operating expenses can be
difficult to predict, resulting in unpredictability in our
operating margins. Also, due to the level of fixed costs
required to operate full-service hotels, we are limited in our
ability to reduce significant expenditures when circumstances
cause a reduction in revenue.
If the owner of a property we manage disposes of the property,
or under certain management agreements, if specified performance
standards at the hotel are not met, the owner may cease our
management of the property.
Similarly, if an owner of properties we manage is acquired, the
subsequent owner may have the right to terminate our management
agreements. Although the management agreements with two of our
most significant owners (Blackstone and Sunstone REIT) contain
termination fee provisions, our management agreements with other
owners generally have limited or no termination fees payable to
us if a hotel is sold and the agreement is terminated. The
termination of management contracts as a result of hotel
dispositions or other factors could therefore have an adverse
effect on our revenues. In addition, hotel owners may choose to
allow our management agreements to expire. As of
December 31, 2007, approximately 69 of our management
agreements had current terms scheduled to expire within two
years. In addition, for certain of our owners, we do not have
the right to assign a management contract to an unrelated third
party without prior written consent of the relevant hotel owner.
A change in control of our Company would require the consent of
these owners.
The termination of management contracts may result in the
write-off of management contract intangible assets and require
an evaluation for potential impairment of our goodwill. The
write-off of management contract intangible assets or the
impairment of goodwill could have a material adverse effect on
our statement of operations and earnings per share.
Approximately 80% of the rooms we manage are in hotels that are
classified as upscale or
upper-upscale
hotels. These hotels generally command higher room rates.
However, in an economic downturn, these hotels may be more
susceptible to a decrease in revenues, as compared to hotels in
other categories that have lower room rates. This characteristic
results from hotels in this segment generally targeting business
and high-end leisure travelers. In periods of economic
difficulties, business and leisure travelers may seek to reduce
travel costs by limiting trips or seeking to reduce costs on
their trips. Adverse changes in economic conditions could have a
material adverse effect on our results of operations and
financial condition.
The threat of terrorism could have a negative impact on hotel
operations, causing lower than expected performance,
particularly in weak economic cycles. The threat of terrorism
could cause a significant decrease in hotel occupancy and
average daily rates and result in disruptions in business and
leisure travel patterns due to concerns about travel safety.
Future outbreaks of hostilities could have a material negative
effect on air travel and on our business. In addition, increased
security measures at airports or in major metropolitan areas may
also cause disruptions to our operations.
The uncertainty associated with incidents and threats and the
possibility of future attacks may hamper business and leisure
travel patterns in the future. In addition, potential future
outbreaks of contagious diseases and similar disruptive events
could have a material adverse effect on our revenues and results
of operations due to decreased travel and occupancy, especially
in areas affected by such events.
We incur significant expenditures related to the management of
hotel properties, including salary and other benefit related
costs and business and employee related insurance costs for
which we are reimbursed by the hotel owners. In the normal
course of business, we make every effort to pay these costs only
after receiving payment from an owner for such costs. However,
to the extent an owner would not be able to reimburse these
costs, due to a sudden and unexpected insolvency situation or
otherwise, we would be required to pay these costs directly
until such time as we could make other arrangements. Although we
would make every effort to eliminate these costs prior to the
point at which an owner could not reimburse us and we would
continue to pursue payment through all available legal means,
our results of operations could be adversely affected if we were
forced to bear those costs.
If we are
unable to identify additional appropriate real estate
acquisition or development opportunities and to arrange the
financing necessary to complete these acquisitions or
developments, our continued growth could be impaired.
We continually evaluate potential real estate development and
acquisition opportunities. Any future acquisitions or
developments will be financed through a combination of
internally generated funds, additional bank borrowings from
existing or new credit facilities or mortgages, public offerings
or private placements of equity or debt securities. The nature
of any future financing will depend on factors such as the size
of the particular acquisition or development and our capital
structure at the time of a project. We may not be able to
identify appropriate new acquisition or development
opportunities and necessary financing may not be available on
suitable terms, if at all.
An important part of our growth strategy will be the investment
in, and acquisition of, hotels. Continued industry consolidation
and competition for acquisitions could adversely affect our
growth prospects going forward. We will compete for hotel and
other investment opportunities with other companies, some of
which may have greater financial or other resources than we
have. Competitors may have a lower cost of capital and may be
able to pay higher prices or assume greater risks than would be
prudent for us to pay or assume. If we are unable to make real
estate investments and acquisitions, our continued growth could
be impaired.
Development activities that involve our co-investment with third
parties may further increase completion risk or result in
disputes that could increase project costs or impair project
operations. Partnerships, joint ventures and other business
structures involving our co-investment with third parties
generally include some form of shared control over the
operations of the business and create additional risks,
including the possibility that other investors in such ventures
could become bankrupt or otherwise lack the financial resources
to meet their obligations, or could have or develop business
interests, policies or objectives that are inconsistent with
ours. Although we actively seek to minimize such risks before
investing in partnerships, joint ventures or similar structures,
actions by another investor may present additional risks of
project delay, increased project costs, or operational
difficulties following project completion.
There is no single competitor or small number of competitors
that are dominant either in the hotel management or lodging
business. We operate in areas that attract numerous competitors,
some of which may have substantially greater resources than we
or the owners of the properties that we manage have, including
Marriott International, Inc., Starwood Hotel & Resorts
Worldwide, Inc. and Hilton Hotels Corporation, among others.
Competition in the lodging industry is based generally on
location, brand affiliation, room availability, room rates,
range and quality of services and guest amenities offered. New
or existing competitors could lower rates; offer greater
conveniences, services or amenities; or significantly expand,
improve or introduce new facilities in markets in which we
compete. Any of these factors could adversely affect operations
and the number of suitable business opportunities. In addition,
we compete for hotel management contracts against numerous other
companies, many of which may have greater financial resources
than we have. These competitors include the management divisions
of the major hotel brands as well as independent, non-brand
affiliated hotel managers.
We expect to acquire additional hotel properties from time to
time. The acquisition of properties involves risks, including
the risk that the acquired property will not perform as
anticipated and the risk that any actual costs for
rehabilitating, repositioning, renovating and improving
identified in the pre-acquisition process will exceed estimates.
There is, and it is expected that there will continue to be,
significant competition for acquisitions that meet our
investment criteria as well as risks associated with obtaining
financing for acquisition activities. The continuing
consolidation in the hotel industry may also reduce the
availability of opportunities for us to acquire hotels. Our
failure to make such acquisitions could have a material adverse
effect on our ability to carry out our growth strategy.
In addition to acquiring hotels and resorts directly, we have
invested and expect to continue to invest in joint ventures.
Joint ventures often have shared control over the operation of
the joint venture assets. Consequently, actions by a partner may
subject hotels and resorts owned by the joint venture to
additional risk. As we generally
maintain a minority ownership interest in our joint ventures, we
are usually unable to take action without the approval of our
joint venture partners. Alternatively, our joint venture
partners could take actions binding on the joint venture without
our consent.
Because real estate investments are relatively illiquid, the
ability to promptly sell one or more properties in response to
changing economic, financial and investment conditions is
limited. We cannot predict whether we will be able to sell any
property for the price or on the terms set by us, or whether any
price or other terms offered by a prospective purchaser would be
acceptable to us. We also cannot predict the length of time
needed to find a willing purchaser and to close the sale of a
property. In addition, hotel properties may not readily be
converted to alternative uses if they were to become
unprofitable due to competition, age of improvements, decreased
demand or other factors. The conversion of a hotel to
alternative uses would also generally require substantial
capital expenditures. We may be required to expend funds to
correct defects or to make improvements before a property can be
sold. We may not have funds available to correct those defects
or to make those improvements and as a result our ability to
sell the property would be limited. These factors and any others
that would impede our ability to respond to adverse changes in
the performance of our properties could significantly harm our
financial condition and results of operations.
We maintain insurance coverage at the hotels we manage and are
the named insured on the workers compensation, general
liability, and employment practices insurance policies. We are
reimbursed by the hotel owners for the cost of these insurance
policies as per our management contracts. We place insurance
policies with insurers that are A.M. Best’s rated
“A” or better. We look to maintain adequate coverage
to minimize our overall risk exposure. There are losses that may
not be covered by these policies and in some cases we may, after
reviewing the risks, accept a level of risk on a per claim basis
in order to maintain adequate insurance at appropriate premiums.
We would be indemnified for these losses assuming the owner is
accessible and has the financial ability to compensate us.
Losses incurred under these policies may not be reported or
settled for several years after the original date of loss. If
the insurance company becomes insolvent, we will pursue payment
from the hotel owner but may not be successful. We would be
liable for any amounts we do not collect from an owner and those
amounts could be significant.
We also maintain health and welfare benefit programs for our
associates at the hotels we manage. These programs include
securing fully insured contracts and administrative services
with various carriers for short term disability, medical and
dental insurance coverage. We have decided to retain a portion
of the risk with respect to certain programs based on our belief
that we have a sufficient risk pool to stabilize claim
projections, appropriate claims controls and limited overall
risk. Regarding the short term disability and dental programs,
overall benefit payments are considered low, resulting in
overall limited risk exposure. With regard to the medical
program, we purchase reinsurance on a specific claim basis so
that overall risk is limited on a per occurrence basis. Premiums
for the funding of the risk retention programs are determined by
outside consultants, including Hewitt Associates, after
carefully reviewing past claim patterns, the population of those
we insure both geographically and demographically, as well as
other factors to determine a reasonable level of risk. However,
to the extent we experience significant losses that are not
reimbursed by the hotel owners and exceed our reserves, those
losses could have a material adverse effect on our results of
operations.
Various types of catastrophic losses, such as losses due to
wars, terrorist acts, earthquakes, floods, hurricanes,
pollution, contagious diseases, such as the avian flu and Severe
Acute Respiratory Syndrome (SARS), or environmental matters,
generally are either uninsurable or not economically insurable,
or may be subject to insurance coverage limitations, such as
large deductibles or co-payments. In the event of a catastrophic
loss, our
insurance coverage may not be sufficient to cover the full
current market value or replacement cost of our lost investment.
Should an uninsured loss or a loss in excess of insured limits
occur, we could lose all or a portion of the capital we have
invested in a property, as well as the anticipated future
revenue from the property. In that event, we might nevertheless
remain obligated for any mortgage debt or other financial
obligations related to the property. In the event of a
significant loss that is covered by insurance, our deductible
may be high and, as a consequence, it could materially adversely
affect our financial condition. Inflation, changes in building
codes and ordinances, environmental considerations and other
factors might also keep us from using insurance proceeds to
replace or renovate a hotel after it has been damaged or
destroyed. Under those circumstances, the insurance proceeds we
receive might be inadequate to restore our economic position in
the damaged or destroyed property.
Large scale terrorist attacks and hurricanes could result in an
increase in premiums and reductions in insurance coverage,
especially for terrorism and catastrophic risks such as wind,
flood and earthquakes. If we are unable to maintain
cost-effective insurance that meets the requirements of our
lenders and franchisors, or if we are unable to amend or obtain
waivers of those requirements, it could have a material adverse
effect on our business.
Our current strategy is to acquire interests only in hospitality
and lodging. As a result, we are subject to the risks inherent
in investing in a single industry. The effects on cash available
for distribution resulting from a downturn in the hotel industry
may be more pronounced than if we had diversified our
investments.
Our management fees earned from hotels located outside of the
United States were 21.0%, 13.7% and 11.5% of total management
fees for 2007, 2006 and 2005, respectively. At December 31,
2007, we and our affiliates managed 11 international properties,
an increase from the four international properties we managed at
the end of 2006. In July 2007, we entered into two separate
joint ventures to own and operate hotels in Mexico. We own 15%
of one of the joint ventures, which owns three resort properties
in Mexico, and we own 50% of the other joint venture, which
manages those three hotels and serves to identify other
management opportunities in Mexico and Latin America. We expect
to begin managing our sixth and seventh hotels in Moscow in
2008. We will also continue to actively pursue additional
international opportunities. We have also formed in 2008, a
joint venture management company (of which we hold a 50%
interest) that will begin seeking management opportunities in
India. Simultaneous with the formation of this management
company, we also invested in a related private real estate fund
that will seek opportunities to purchase
and/or
develop hotels in India.
As we continue to grow our international presence, we are
subject to various risks. These risks include tax, environmental
zoning, employment laws, repatriation of money, liquor license,
exposure to currency fluctuations, managing potential
difficulties in enforcing contractual obligations and
intellectual property rights, other laws in the countries in
which we operate, and the effects of potential and actual
international terrorism and hostilities. We are particularly
sensitive to any factors that may influence international
travel. In addition, we cannot be certain of the effect that
changing political and economic conditions could have on our
international hotel operations and on our ability to collect on
loans to third-party owners overseas. Furthermore, the success
of our international operations depends on our ability to
attract and retain qualified management personnel who are
familiar not only with our business and industry but also with
the local commercial practices and economic environment.
As a U.S. company operating internationally, we may be
subject to inconsistencies between U.S. law and the laws of
an international jurisdiction. If taxation authorities in the
countries in which we operate interpret our tax position in a
manner that is materially different than our assumptions, our
tax liabilities could increase which could materially adversely
impact our financial results. Tax laws in foreign countries may
provide for tax rates that exceed those of the U.S. which
may provide that our foreign earnings are subject to withholding
requirements or other restrictions. In addition, sales and
international jurisdictions typically are made in local
currencies, which subject us to risks
associated with currency fluctuations. Currency devaluations and
unfavorable changes in international monetary and tax policies
could have a material adverse effect on our profitability and
financing plans, as could other changes in the international
regulatory climate and international economic conditions.
In addition to traditional hotel management services, we offer
to third-party hotel owners several ancillary services such as
purchasing, project management, self-insurance programs and risk
management, information technology and telecommunication
services, and centralized accounting services. We expect to
derive a portion of our revenues from these services. Our
management contracts do not obligate third-party hotel owners to
utilize these services, and the failure of hotel owners to
utilize these services could adversely affect our overall
revenues.
We are the brand franchisee of record for the hotels we own and
for some of the hotels we have interests in or manage. In
addition, with respect to hotels for which we are not the
franchisee, we may sign a manager acknowledgment agreement with
the franchisor that details some of our rights and obligations
with respect to the hotel and references the hotel’s
franchise agreement. 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’s system. Those
limitations may conflict with our philosophy of creating
specific business plans tailored to each hotel and to each
market. Standards are often subject to change over time, at the
discretion of the franchisor, and may restrict a
franchisee’s ability to make improvements or modifications
to a hotel without the consent of the franchisor. In addition,
compliance with standards could require a hotel owner to incur
significant expenses or capital expenditures. Action or inaction
by us or by the owner of a hotel we manage could result in a
breach of standards or other terms and conditions of the
franchise agreements and could result in the loss or
cancellation of a franchise license.
Loss of franchise licenses without replacement would likely have
an adverse effect on hotel revenues which could result in
adverse affects to our overall revenues. In connection with
terminating or changing the franchise affiliation of a hotel,
the owner of the hotel may be required to incur significant
expenses or capital expenditures. Moreover, the loss of a
franchise license could have a material adverse effect upon the
operation or the underlying value of the hotel covered by the
franchise due to the loss of associated name recognition,
marketing support and centralized reservation systems provided
by the franchisor. Franchise agreements covering the hotels we
manage expire or terminate, without specified renewal rights, at
various times and have differing remaining terms. As a condition
to renewal, these franchise agreements frequently contemplate a
renewal application process. This process may require an owner
to make substantial capital improvements to a hotel. Although
the management agreements generally require owners to make
capital improvements to maintain the quality of a property, we
are not able to directly control the timing or amount of those
expenditures.
Some of the franchise agreements under which we operate and
manage hotels restrict the franchisee’s ability to own or
operate another hotel within a specified territory or with
regard to specific hotels. These limitations, if found to apply
to us, may limit our ability to acquire new management
agreements and potentially impair our continued growth.
Union contracts for hotel employees in several major markets
will be up for renewal between 2008 and 2010. Although under the
terms of the management contracts the employees at our managed
hotels are paid by the hotel owners, they are our employees. In
addition, we have a significant number of employees working at
our owned hotels. The failure to timely renegotiate the
contracts that are expiring could result in labor disruptions,
which could adversely affect our revenues and profitability.
Labor costs could also escalate beyond our expectations and
could have a material adverse effect on our operating margins.
In addition, there are ongoing attempts to unionize at some of
those hotels that we own
and/or
manage which are not currently unionized. To the extent any of
our non-unionized properties become unionized, our labor costs
would most likely increase and have an adverse effect on our
operating margins at our owned hotels.
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 noncompliance with
applicable environmental and health and safety requirements 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, may adversely affect
the operation of the property or the owner’s ability to
sell or rent the property or to borrow 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 are also regulated by federal and
state laws. In connection with the ownership and operation of
hotels, the operators, such as us or the owners of those
properties could be held liable for the costs of remedial action
for regulated substances and storage tanks and related claims.
All of the hotels that we own and the majority of the hotels we
manage have undergone Phase I environmental site assessments,
which generally provide a non-intrusive 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 may be responsible. The
Phase I assessments have not revealed, nor are we aware of, any
environmental liability or compliance concerns that we believe
would have a material adverse effect on our results of
operations or financial condition. Nevertheless, it is possible
that these environmental site 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.
In addition, a significant number of the hotels we own or manage
have been inspected to determine the presence of asbestos.
Federal, state and local environmental laws, ordinances and
regulations also require abatement or removal of
asbestos-containing materials and govern emissions of and
exposure to asbestos fibers in the air. Asbestos-containing
materials are present in various building materials such as
sprayed-on ceiling treatments, roofing materials or floor tiles
at some of the hotels. Operations and maintenance programs for
maintaining asbestos-containing materials have been or are in
the process of being designed and implemented, or the
asbestos-containing materials have been scheduled to be or have
been abated, at those hotels at which we are aware that
asbestos-containing materials are present. Any liability
resulting from non-compliance or other claims relating to
environmental matters could have a material adverse effect on
our results of operations or financial condition.
We have also detected the presence of mold at one of our owned
hotels and are evaluating the impact and will take the
appropriate measures to remediate the situation. Many of the
costs associated with remediation of mold may be excluded from
coverage under our property and general liability policies, in
which event we would be required to use our own funds to
remediate. Further, in the event moisture infiltration and
resulting mold is pervasive, we may not be able to rent rooms at
that hotel, which could result in a loss of revenue. Liabilities
resulting from moisture infiltration and the presence of or
exposure to mold could have a future material adverse effect on
our business, financial condition, results of operations and
ability to make distributions to our stockholders.
Furthermore, various court decisions have established that third
parties may recover damages for injury caused by property
contamination or exposure to hazardous substances such as
asbestos, lead paint or black mold. In recent years, concern
about indoor exposure to mold has been increasing as such
exposure has been alleged to have a variety of adverse effects
on health. As a result, there has been an increasing number of
lawsuits against owners and managers of real property relating
to the presence of mold. Damages related to the presence of mold
are generally excluded from our insurance coverage. Should an
uninsured loss arise against us at one of our owned hotels, we
would be required to use our own funds to resolve the issue,
which could have an adverse impact on our results of operations
or financial condition.
A number of states regulate various aspects of hotels, resorts,
conference centers and restaurants, including liquor licensing,
by requiring registration, disclosure statements and compliance
with specific standards of conduct and timely filing of certain
sales use or property tax forms, which could result in
additional tax payments and fines. Managers of hotels are also
subject to employment laws, including minimum wage requirements,
overtime, working conditions and work permit requirements.
Compliance with, or changes in, these laws could reduce the
revenue and profitability of hotels and could otherwise
adversely affect our results of operations or financial
condition. As an agent for hotels we may be liable for
noncompliance.
Under the Americans with Disabilities Act, or ADA, all public
accommodations in the United States are required to meet federal
requirements related to access and use by disabled persons.
These requirements became effective in 1992. A determination
that the hotels we own are not in compliance with the ADA could
result in a judicial order requiring compliance, imposition of
fines or an award of damages to private litigants.
Generally, hotel revenues are greater in the second and third
calendar quarters than in the first and fourth calendar
quarters, although hotels in tourist destinations generate
greater revenue during tourist season than other times of the
year. Seasonal variations in revenue at the hotels we own or
manage will cause quarterly fluctuations in revenues. Events
beyond our control, such as extreme weather conditions, economic
factors, geopolitical conflicts, actual or potential terrorist
attacks, and other considerations affecting travel may also
adversely affect our earnings.
Our businesses require collection and retention of large volumes
of internal and customer data, including credit card numbers and
other personally identifiable information of our customers as
they are entered into, processed by, summarized by, and reported
by our various information systems. We also maintain personally
identifiable information about our employees. The integrity and
protection of that customer, employee, and company data is
critical to us. If that data is not accurate or complete we
could make faulty decisions. Our customers also have a high
expectation that we will adequately protect their personal
information, and the regulatory environment surrounding
information security and privacy is increasingly demanding, both
in the United States and other international jurisdictions in
which we operate. A significant theft, loss or fraudulent use of
customer, employee or company data could adversely impact our
reputation and could result in remedial and other expenses,
fines and litigation.
If the
material weakness in our internal control over financial
reporting that we have identified is not remedied, it could
result in a material misstatement in our financial statements
not being prevented or detected in a timely manner, could
adversely affect investor confidence in the accuracy and
completeness of our financial statements, and could have an
adverse effect on the trading price of our common
stock.
Through, in part, the documentation, testing and assessment of
our internal control over financial reporting pursuant to the
rules promulgated by the SEC under Section 404 of the
Sarbanes-Oxley Act of 2002 and Item 308 of
Regulation S-K,
management has concluded that we did not maintain effective
controls over a change in accounting for the impairment of
intangible assets related to terminated management contracts.
Management has determined that this control deficiency
represented a material weakness as of December 31, 2007.
This material weakness and our remediation plans are described
further in
Item 9A
“Controls and Procedures” in this Annual Report on
Form 10-K.
Prior to the remediation of this material weakness in 2008,
there remains risk that the controls on which we currently rely
will fail to be sufficiently effective, which could result in a
material misstatement of our financial position or results of
operations and require a restatement of our financial
statements. In addition, even if we are successful in
strengthening our controls and procedures, such controls and
procedures may not be adequate to prevent or identify
irregularities or facilitate the fair presentation of our
financial statements or SEC reporting. Any material weakness or
the unsuccessful remediation thereof could have a material
adverse effect on reported results of operations and financial
condition, as well as impair our ability to meet our quarterly
and annual reporting requirements in a timely manner.
Our ability to maintain our competitive position will depend, to
a significant extent, on the efforts and ability of our senior
management. Our ability to attract and retain highly qualified
personnel is critical to our operations. Competition for
personnel is intense, and we may not be successful in attracting
and retaining our personnel. Our inability to attract and retain
highly qualified personnel may adversely affect our results of
operations and financial condition.
Risk
Factors Related to Our Capital Structure
Restrictions imposed by our debt agreements may limit our
ability to execute our business strategy and increase the risk
of default under our debt obligations.
Our amended and restated senior secured credit facility, which
we entered into in March 2007 (as amended from time to time,
which we refer to as the “Credit Facility”), and our
mortgages contain restrictive covenants. These restrictions
include requirements to maintain financial ratios, which may
significantly limit our ability to, among other things:
A significant decline in our operations could reduce our cash
from operations and cause us to be in default under other
covenants in our debt agreements. A default would leave us
unable to access our Credit Facility, and we depend on our
Credit Facility to supply the necessary liquidity to continue or
to implement new operations and execute on our business strategy.
We will, in the future, be required to repay, refinance or
negotiate an extension of the maturity of our debt agreements.
Our ability to complete the necessary repayments, refinancings
or extensions is subject to a number of conditions, many of
which are beyond our control. For example, if there were a
disruption in the lodging or financial markets as a result of
the occurrence of one of the risks identified above under
“Risk Factors Related to Our Business” or any other
event, we might be unable to access the financial markets.
Failure to complete the necessary repayments, refinancings or
extensions of our agreements would have a material adverse
effect on us.
As of December 31, 2007, we had total indebtedness of
$211.7 million. Our level of indebtedness has important
consequences. It currently requires us to dedicate a portion of
our cash flow from operations to payments of principal and
interest on our indebtedness, which reduces the availability of
our cash flow to fund working capital, capital expenditures and
our business strategy. Additionally, it could:
In addition, despite our current indebtedness levels, we may
still be able to incur substantially more debt. This could
further exacerbate the risks associated with our leverage.
As of December 31, 2007, we had a deficit in working
capital of $12.8 million. A continued deficit in working
capital may require us to make additional borrowings to pay our
current obligations. Such borrowings would serve to reduce
amounts available to us for pursuit of our business strategy of
growing through securing additional management contracts and
acquiring additional hotel, resort and conference center
properties.
Credit rating services assign a rating to us based on their
perception of our ability to service debt. Our current long-term
ratings are ‘B1 Negative’ and ‘B/Stable/-’
from Moody’s and S&P, respectively. Fluctuations in
our operating performance or changes in the amount of our debt
may result in a change to our rating. A negative change in our
ratings could increase the cost of, or prevent us from making
future financings.
We are required to evaluate our assets, including goodwill,
annually or upon certain trigger events in order to ascertain
that the historical carrying value is not less than the fair
market value of the asset. Should we determine that an
asset’s carrying value is less than its fair market value,
the asset would be considered impaired, and we would recognize a
write-down of the asset to its current fair value.
Our current debt covenants require us to maintain certain
ratios, including a minimum net worth. To the extent an
impairment would reduce our asset base, we could fall below that
net worth and fail that test. If we are unable to obtain a
waiver or amendment to the covenant, the resulting default could
adversely affect our liquidity.
In addition, because the impairment of long-lived assets or
goodwill would be recorded as an operating expense, such a
write-down would negatively affect our net income and earnings
per share, which could have a negative impact on our stock price.
Our
stockholder rights plan and the anti-takeover defense provisions
of our charter documents may deter potential acquirers and
depress our stock price.
Under our stockholder rights plan, holders of our common stock
hold one preferred share purchase right for each outstanding
share of common stock they hold, exercisable under defined
circumstances involving a potential change of control. The
preferred share purchase rights have the anti-takeover effect of
causing substantial dilution to a person or group that attempts
to acquire us on terms not approved by our Board of Directors.
Those provisions could have a material adverse effect on the
premium that potential acquirers might be willing to pay in an
acquisition or that investors might be willing to pay in the
future for shares of our common stock.
Provisions of Delaware law and of our charter and bylaws may
have the effect of discouraging a third party from making an
acquisition proposal for us. These provisions could delay, defer
or prevent a transaction or a change in control of us under
circumstances that could otherwise give the holders of our
common stock the opportunity to
realize a premium over the then-prevailing market price of our
common stock. These provisions include the following:
There are currently no unresolved staff comments.
Our corporate headquarters are located in Arlington, Virginia.
In 2007, we established our first international office in
Moscow, Russia to capitalize on the potential growth in the
international markets. In addition, we also maintain corporate
offices in Irving, Texas and San Clemente, California.
Our hotel management segment includes the operations related to
our managed properties, our purchasing, construction and design
subsidiary and our subsidiary that provides self insurance
programs. As of December 31, 2007, we owned
and/or
managed hotels in 36 states, the District of Columbia,
Russia, Mexico, Canada, Belgium and Ireland. The following table
sets forth operating information with respect to the properties
we owned and managed as of December 31,:
Our hotel ownership segment consists of our wholly-owned hotels
and joint venture investments. As of December 31, 2007 we
wholly-owned seven hotels. The following table details our seven
wholly-owned hotels as of December 31, 2007. These
properties have also been included in the table above.
For information on our properties held through joint ventures,
see “Business — Hotel Ownership.”
In the normal course of business activities, various lawsuits,
claims and proceedings have been or may be instituted or
asserted against us. Based on currently available facts, we
believe that the disposition of matters pending or asserted will
not have a material adverse effect on our consolidated financial
position, results of operations or liquidity.
We did not submit any matters to a vote of security holders
during the fourth quarter of 2007.
Our common stock is listed on the NYSE under the ticker-symbol
“IHR.” As of February 27, 2008, there were
31,702,017 shares of our common stock were listed and
outstanding, held by approximately 2,979 record holders.
The following table lists, for the fiscal quarters indicated,
the range of high and low closing prices per share of our common
stock in U.S. dollars, as reported on the NYSE Composite
Transaction Tape.
We have not paid any cash dividends on our common stock, and we
do not anticipate that we will do so in the foreseeable future.
We intend to retain earnings, if any, to provide funds for the
continued growth and development of our business. Any
determination to pay cash dividends in the future will be at the
discretion of the Board of Directors and will be dependent upon
lender approval as well as our results of operations, financial
condition, contractual restrictions and other factors deemed
relevant by the Board of Directors.
Set forth in the following tables are summary historical
consolidated financial and other data as of and for each of the
last five fiscal years.
Selected
Financial and Other Data
(Dollars in Thousands, Except Per Share Data)
Management’s Discussion and Analysis of Financial Condition
and Results of Operations is intended to help the reader
understand Interstate, our operations and our present business
environment. MD&A is provided as a supplement
to — and should be read in conjunction
with — our consolidated financial statements and the
accompanying notes. MD&A is organized into the following
sections:
As previously disclosed in our Current Report on
Form 8-K
dated February 27, 2008, on February 26, 2008, our
Audit Committee determined, after discussions with management,
that our previously-issued financial statements as of and for
the quarters ended March 31, 2007, June 30, 2007 and
September 30, 2007 should no longer be relied upon because
of errors in our calculation of intangible asset impairment
charges that resulted from the termination of certain hotel
management contracts. As a result, we have restated our
unaudited condensed consolidated financial data for the periods
affected by the errors, as set forth in Note 19
“Quarterly Financial Data (Unaudited)” to the
financial statements contained in this Annual Report on
Form 10-K.
The correct method of calculation of intangible asset impairment
charges with respect to terminated hotel management contracts
has been used in the preparation of the financial statements set
forth in this Annual Report on
Form 10-K.
We are a leading hotel real estate investor and the
nation’s largest independent operator, measured by number
of rooms under management and gross annual revenues of the
managed portfolio. We have two reportable operating segments:
hotel ownership (through whole-ownership and joint ventures) and
hotel management. A third reportable segment, corporate housing,
was disposed of on January 26, 2007 with the sale of
BridgeStreet, our corporate housing subsidiary. The results of
this segment are reported as discontinued operations in our
consolidated financial statements for all periods presented.
As of December 31, 2007, we own seven hotels with 2,045
rooms and held non-controlling joint venture equity interests in
17 joint ventures, which hold ownership interests in 22 of our
managed properties.
As of December 31, 2007, we and our affiliates managed 191
hotel properties with 42,620 rooms and five ancillary service
centers, in 36 states, the District of Columbia, Russia,
Mexico, Canada, Belgium and Ireland. Our portfolio of managed
properties is diversified by location/market, franchise and
brand affiliations, and ownership group. We manage hotels
represented by nearly 30 franchise and brand affiliations in
addition to operating 15 independent hotels. Our managed hotels
are owned by more than 60 different ownership groups.
Our revenues consist primarily of the following (percentages do
not include “other revenue from managed properties”):
Our operating expenses consist primarily of the following
(percentages do not include “other expenses from managed
properties”):
We had a successful year in 2007 as a result of the operating
performance at our owned and managed properties as well as the
continued execution of our growth strategy of diversifying our
earnings base through both wholly owned and joint venture real
estate ownership. The Company has redefined itself over the past
two years as we have moved from being primarily a management
company to one with various sources of income. We have executed
on our plan to expand and stabilize our income generating
activities through acquisitions of strategic hospitality
properties. In 2007, a significant portion of our operations
were derived from longer-term real estate ownership, with our
hotel management segment contributing the balance of our income.
We expect this trend to continue in 2008 as a result of our
acquisitions in 2007 being reflected in operations for a full
year and our investment in an additional international joint
venture in the first quarter of 2008.
Hotel Ownership — In 2007, we continued to
expand and stabilize our income generating activities through
our acquisitions of strategic hospitality properties. During the
year, we acquired three full-service hotels with 1,080 rooms for
a total acquisition price of $176.3 million. In addition,
we contributed a total of $17.1 million in 2007 to either
new or existing joint ventures. Our joint venture investments at
year-end also include five properties currently
under development. Early in 2008, two of our joint ventures
closed on the purchases of a four property portfolio and a 22
property portfolio. In addition, we also continue to expand our
international presence through a
50-50 joint
venture partnership with JHM Hotels, one of the nation’s
largest independent hotel owners and developers, to operate and
selectively invest in hotels in India. We committed to fund
$0.5 million towards the working capital of this joint
venture. Concurrently with the creation of our the joint
venture, we committed to invest $6.25 million in a real
estate investment fund dedicated solely to the investment of
hotels in India. This fund has, in turn, committed to let our
Indian management joint venture have the first opportunity to
manage the hotels in which the fund invests.
In addition to increasing our owned hotel portfolio, we also
continued to focus on efficiency and performance at our managed
hotels. Our portfolio of seven wholly-owned hotels performed
very well, with a RevPAR increase of 5.5%. The total operating
income from our owned hotels was $13.3 million in 2007
compared to $4.7 million in 2006, an increase of 183%.
The hotels we acquired in 2007, all of which were purchased from
affiliates of Blackstone, were as follows:
An important part of our ownership strategy is investing capital
to upgrade our hotels, as it allows us to reposition the hotel
and create value. Aside from the comprehensive renovation
programs at our hotels purchased in 2007, we also expect to
invest approximately $7 million on strategic capital
improvements at our four other wholly-owned properties. We also
have renovation programs at 11 hotels owned by our joint
ventures. Our portion of the cost that we expect to fund toward
these programs in 2008 is approximately $1.7 million. With
the completion of these enhancement programs in 2008, we expect
to see significant operating growth in 2009 for these hotels.
Due to the magnitude of the renovations at the Westin Atlanta
Airport and Sheraton Columbia, there will be some renovation
displacement in 2008, however we will continue to manage the
process to minimize any disruption to our guests.
In addition to wholly owned acquisitions, we also continued to
identify joint venture investment opportunities during 2007 and
throughout the early part of 2008. Our joint venture investments
in hotels are designed to enable us to secure longer term
management contracts, further align our interests in the hotels
that we manage with owners, as well as provide us the
opportunity to participate in the potential asset appreciation
of these properties.
The significant joint venture activity in 2007 and early 2008
related to the following investments:
three-property portfolio of
Tesoro®
resorts located in Cabo San Lucas, Manzanillo and Ixtapa,
Mexico. The joint venture plans to invest $10.0 million for
comprehensive renovations and improvements at all three resort
properties in 2008, of which our share is equal to
$1.5 million. We also invested $0.5 million for a 50%
interest in a separate joint venture with Steadfast to manage
hotels. The new management joint venture, which is intended as a
platform for further growth in Mexico, assumed management of the
three-property portfolio of
Tesoro®
resorts upon its formation. This was our first international
joint venture.
Our joint venture with FFC Capital Corporation acquired a
portfolio of 22 properties located throughout the Midwest in
Illinois, Iowa, Michigan, Minnesota, Wisconsin and Texas. We
invested $1.7 million for a 10% equity interest in the
portfolio of hotels. Upon closing, all 22 properties,
representing 2,397 rooms, were converted to various Wyndham
Worldwide brands. The properties are located along major
interstates and proximate to major commercial and leisure demand
generators.
True North Tesoro Property Partners, L.P., in which we
hold a 15.9% equity interest, sold the Doral Tesoro
Hotel & Golf Club located near Dallas, Texas. We
expect to recognize a gain in excess of $2.0 million
related to the sale.
We continued our international expansion by forming a
50-50 joint
venture partnership with JHM Hotels to operate and selectively
invest in hotels in India. We committed to fund
$0.5 million towards the working capital of the joint
venture. The joint venture, named JHM/Interstate Hotels India
(“JHM/Interstate”), will serve as our platform for all
hospitality-related activities in India, primarily focusing on
securing management agreements on existing and to-be-built
hotels. JHM/Interstate is establishing an office in New Delhi,
India. Concurrently with the formation of our management
platform in India, we and our partners each committed to invest
$6.25 million each for a total of $12.5 million in the
Duet Hotel Investment Fund, a U.K.-based, real estate investment
fund dedicated solely to the investment of hotels in India. Duet
has raised approximately $175 million in equity, with
anticipated total equity contributions in excess of
$200 million. Duet’s mission to develop approximately
25 hotels in India in the three- and four-star categories,
targeted at business travelers and located in secondary and
tertiary cities, as well as satellite townships outside major
urban centers. The fund has committed to give JHM/Interstate the
first opportunity to manage the hotels in which it invests.
We have also been active in investing in joint ventures focused
on new development. Throughout 2007, we contributed an
additional $1.7 million to IHR Greenbuck Hotel Venture,
LLC, one of our joint ventures in which we hold a 15% equity
interest that will build approximately five
aloft®
hotels over the next several years, with the potential for
additional development opportunities. Intended to be similar to
the W
Hotel®
brand,
aloft®
is the new premium select-service hotel brand being introduced
by Starwood Hotels & Resorts Worldwide, Inc. Our joint
venture partner is responsible for site selection, construction
and development and management. We will operate the hotels
following completion of construction. The joint venture has
signed long-term franchise agreements for the first two
properties. Construction commenced on the first property located
in Rancho Cucamonga, Californa in January 2007, while the second
location in Cool Springs, Tennessee broke ground in August 2007.
The property in
Rancho Cucamonga is expected to open in May 2008, while the
property in Cool Springs is expected to open in September 2008.
In August 2007, we entered a partnership with Premier Properties
USA to build three hotels. We will operate all three properties
upon the completion of construction and own a 15% equity
interest in the partnership.
Hotel Management — Although the number of hotel
properties we manage decreased during 2007, the operating
performance of our managed properties continued to improve year
over year. RevPAR increased $8.28, or 9.1%, in 2007, compared to
2006. Incentive fees, which are tied directly to the operating
performance of the hotels we manage, were $21.3 million in
2007, an increase of $3.8 million, or 22.0%, compared to
the prior year.
We continued to realize the effects of the significant number of
hotel purchase and sale transactions in the real estate market,
which reduced the number of properties we manage. We ceased
managing a total of 60 hotels during 2007, which included the
loss of 17 properties owned by Blackstone that we ceased
managing. Of the 25 properties sold by Blackstone during 2007,
we acquired whole ownership of three properties, entered into
joint ventures to acquire partial ownership of three properties
and retained the management contracts with the new owners for an
additional two. Additionally, CNL Hotels & Resorts,
Inc. disposed of 22 properties through two portfolio
dispositions, five of which we continue to manage. Sunstone REIT
also disposed of eight non-core hotels during 2007.
In summary, the management fees earned for the 63 management
contracts terminated in 2007 were as follows (in thousands):
While our property count has significantly declined over the
past two years, it has begun to stabilize. In the fourth quarter
of 2007, our property count increased by a net seven properties,
our first quarterly increase in the past 11 quarters. We expect
this trend to continue through the first quarter of 2008.
Throughout 2007, we partially offset the loss of 12,763 rooms
related to the 60 lost management contracts with the addition of
28 management contracts, totaling 5,180 rooms. These additions
include seven international management contracts totaling 1,727
rooms, which demonstrates our focus and ability to expand our
international presence. Also, the merger of Equity Inns, Inc.
was also completed in October 2007 and we continue to manage
this portfolio of 38 hotels, which have 4,847 rooms and
accounted for $3.7 million of management fees in 2007.
Although we lost a net of 32 management contracts during 2007,
our impairment analysis of goodwill related to our hotel
management reporting unit continued to indicate that the
carrying value of goodwill was not impaired. This result is
primarily due to the increase in our operating income from our
portfolio of managed hotels as we, and the hotel industry as a
whole, continue to have strong year-over-year results. In
addition, we have an active pipeline of new management contracts
that were signed in 2007 or expected to be signed in 2008 and
2009. Our goodwill analysis was based on future cash flow
projections. These projections were based on assumptions made by
management, which we believe to be reasonable.
Sale of BridgeStreet Corporate Housing — In
January 2007, we sold BridgeStreet, our corporate housing
subsidiary, for approximately $42.4 million, resulting in a
pre-tax gain on sale of $20.5 million.
Industry Overview — The lodging industry, of
which we are a part, is subject to both national and
international extraordinary events. Over the past several years
we have continued to be impacted by events including the ongoing
war on terrorism, the potential outbreak and epidemic of
infectious disease, natural disasters, the continuing change in
the strength and performance of regional and global economies
and high levels of hotel acquisitions activity by private equity
investors and other acquirers of real estate.
According to Smith Travel Research, in 2006 and 2007, the
significant growth that the lodging industry experienced in 2004
and 2005 began to decelerate. RevPAR growth was 5.7% and 7.8% in
2007 and 2006, respectively. Room demand increased by only 1.2%
in 2007 (against a room supply increase of 1.4%), up from a 0.5%
room demand increase in 2006 (against a room supply increase of
0.2%). The growth in the industry is forecasted to continue in
future years, albeit at a slower pace than recently experienced.
The potential slowdown due to the uncertainty in the economic
conditions and the presidential election will have a greater
impact on lower priced segments. Overall industry RevPAR is
projected to grow an additional 4.4% in 2008. As occupancy is
projected to decrease 0.8% in 2008, nearly all of the growth
will be driven by an increase in ADR of 5.2%. Overall industry
room demand and room supply are both projected to grow by 1.4%
and 2.2% in 2008, respectively.
Financial Targets, Growth Strategy and Operating
Strategy — Over the past five years, with the
increased transaction activity in the hotel real estate market,
we began to see an immediate need for maintaining a diversified
revenue base. In 2006, with Blackstone’s acquisition of
MeriStar, the single largest owner in our management portfolio
at the time, the need for diversity became increasingly
apparent. In 2006, we continued to implement a plan developed by
management in 2005 to expand, diversify and stabilize our
revenue sources through an emphasis on increasing our management
portfolio base and investing in hotel real estate through
wholly-owned acquisitions and joint ventures. In 2007, we took
significant steps toward our vision of diversifying our revenue
sources and increasing shareholder value by recycling assets
through new opportunities that we believe will provide a more
stable long term platform and a greater level of return.
In January 2007, we sold BridgeStreet for approximately
$42.4 million. We immediately began redeploying the
proceeds from this sale into investments in hotel real estate
through both whole-ownership acquisitions and joint ventures.
The impact of our investment activity has been significant, as
evidenced by the increase in lodging revenues in 2007 of
$46.3 million, or 166%, compared to 2006. Additionally, in
2007 we increased our investment in joint ventures by a net
$16.5 million, to $27.6 million as of the end of 2007.
Management contract attrition continued to challenge us in 2007
as it had in 2006. A net loss of management contracts resulted
in a decrease in management fee revenue in 2007 from 2006
(excluding termination fees) of $11.6 million, or 15.4%.
After a steady decline in our management contract portfolio,
precipitated by a strong real estate market and a greater number
of real estate transactions that took place over the past two
years. We began, in the third quarter of 2007, to see a
stabilization of our portfolio and, in the fourth quarter,
realized a net increase of seven management contracts, our first
increase in eleven quarters. This increase continued into 2008
as we added a net additional increase of 29 contracts in January
and February.
Looking forward to 2008, our growth strategy will continue to
focus on expansion through three diverse, yet interrelated areas
of our business. First, to continue as a leader in the hotel
management industry, it is imperative that we continue to build
our core business by securing additional management contracts
for quality properties. We expect that our development pipeline
will continue to produce new management opportunities in 2008.
In addition to our continued pursuit of management opportunities
within the United States, we continue to seek additional growth
through a focus on international management opportunities.
During 2007, we and our affiliates commenced management at seven
new international properties in four countries, bringing our
total international presence to 11 managed properties in five
countries. Furthermore, we have signed agreements to commence
management in 2008 of two additional properties in Russia,
bringing our total presence to seven managed properties in that
country alone. In addition, we opened a regional office in
Moscow to capitalize on our expected growth in the international
markets. In the first quarter of 2008, we continued our
international expansion forming a
50-50 joint
venture partnership with JHM Hotels to operate and invest in
hotels in India. The joint venture will serve as our platform
for expansion for all hospitality related activities in India.
Second, we will continue to remain focused on establishing
strategic partnerships and developing new opportunities through
additional investments in joint ventures. These investments, in
which our ownership interest is typically between 10% and 20%,
provide not only the opportunity to secure new management
agreements, but also the opportunity to participate in the
equity and real estate appreciation of the lodging asset. In
2008, two of our joint ventures, previously formed in 2007,
closed on two separate transactions, acquiring a four hotel
portfolio and a 22 hotel portfolio in addition to the
formation of, and our investment in, the joint venture with JHM
Hotels. As of March 1, 2008, we hold minority ownership
interests in 52 hotel properties currently operating or
currently under development, through 17 real estate partnerships
and limited liability companies. We continue to seek and acquire
ownership interests in upscale, full-service hotels,
select-service hotels, conference centers and resorts where we
believe an opportunity exists to create and increase value
through market recovery, strategic repositioning and our
operating expertise.
Third, we will continue to identify promising whole-ownership
acquisition candidates located in markets with favorable
economic, demographic and supply dynamics. We will select these
acquisition opportunities, when and if our capital resources
allow, and we believe selected capital improvements and focused
management will increase the property’s ability to attract
key demand segments, demonstrate better financial performance,
and increase long-term value. See “Liquidity, Capital
Resources and Financial Position.”
In addition to our expansion strategies we will continue to
implement our operating strategy and emphasize organic growth
for the owners of the properties we manage, building on our
success in the past three years. At our hotel properties, we
have continued to emphasize our dedication to service, through a
commitment to guest satisfaction surveys, improved training of
hotel employees and specialists who focus on improving the
operations of designated brands under our management. Based upon
the operating results and feedback received at our managed
properties, we have seen tangible evidence that this commitment
to superior service has produced positive results. We will also
continue to rely on our ability to identify specific
opportunities to enhance growth at each hotel in order to
generate higher RevPAR, net operating income and overall return
for our owners. In all of our business segments, we will
continue to rely on the experience of our senior management
team, which have successfully managed hotels in all sectors of
the lodging industry. By continuing to execute on our focused
growth and operating strategies in 2008, we anticipate that we
can continue to build a more consistent and long-term stream of
income which will provide for increased value for our
shareholders.
Opportunities, Challenges and Risks — During
the past three years, we have purchased seven hotels and have
planned or completed comprehensive renovations to each of these
properties to reposition them as benchmarks in their respective
markets. We expect these renovations to require a total cash
outlay of approximately $35 million during 2008. Upon the
completion of the comprehensive renovation programs in 2008, we
believe all of our wholly owned properties will be well
positioned to generate greater RevPAR and capitalize on the
markets in which they operate. We believe we have the required
capital resources available to fund the projected cash outlays
under these renovation projects, but the ability of these hotels
to continue to operate and generate an acceptable return on our
investment will depend, to a large extent, on our ability to
avoid any potential delays and complete the renovations on time
and on budget.
Our current debt agreements include restrictions which could
prevent us from raising additional capital needed to take
advantage of desired acquisition and investment opportunities.
Given the current lending environment, our access to additional
funding may be limited. Currently, we see no immediate need to
obtain additional capital to fund our operational and growth
strategies under our 2008 operating projections. However, should
a need arise for us to obtain additional capital funding for
growth opportunities, our ability, or inability to do so, may
require the restructuring of certain debt and the amendment of
certain covenants. Our ability and willingness to accept market
terms may significantly affect our ability to obtain additional
capital funding. Also, an increase in our cost of capital may
cause us to delay, restructure or not commence future
investments, which could limit our ability to grow our business.
In addition, the market value of our common stock could make
financing through an equity offering a less attractive option.
See “Liquidity, Capital Resources and Financial
Position.”
Our ability to achieve our expected financial results through
the implementation of our growth and operating strategies could
be affected by various challenges and risks which include
overall domestic and international economic factors, including
industry-related factors and other factors which are more
specific to us, all of which are discussed in more detail in the
“Risk Factors” section. Our continued growth strategy
through hotel ownership
provides us with more direct exposure to specific hospitality
and lodging economic risk, including but not limited to
reductions in demand. We could also be affected by continued
industry consolidation and competition, which may limit the
amount and nature of opportunities for us to consider.
A significant portion of our managed properties and management
fees are derived from seven owners. This group of owners
represents 92, or 48.2%, of our managed properties as of
December 31, 2007, and 69.0% of our base and incentive
management fees for the year ended December 31, 2007. If
these owners sell their hotels, enter into a property
disposition plan, or are acquired, as we have seen with MeriStar
in 2006 and CNL in 2007, we may be at risk of losing a large
percentage of our management contracts and related revenues. We
would be entitled to receive approximately $9.3 million in
termination fees assuming the twelve remaining Blackstone
properties were terminated on January 1, 2008 in addition
to approximately $16.5 million due from properties
terminated prior to December 31, 2007. If the remaining 29
management contracts with Sunstone REIT were terminated as of
January 1, 2008, we would be entitled to approximately
$9.0 million in termination fees. For the majority of our
other owners, termination fees would not be significant.
The preparation of financial statements in conformity with
U.S. generally accepted accounting principles
(“GAAP”) requires management to make estimates and
assumptions that affect the reported amount of assets and
liabilities at the date of our financial statements and the
reported amounts of revenues and expenses during the reporting
period. Application of these policies involves the exercise of
judgment and the use of assumptions as to future uncertainties
and, as a result, actual results could differ from these
estimates. We evaluate our estimates and judgments on an ongoing
basis. We base our estimates on experience, industry data and
various other assumptions that are believed to be reasonable
under the circumstances. Our significant accounting policies are
disclosed in the notes to our consolidated financial statements.
We believe that the following accounting policies are the most
critical to aid in fully understanding and evaluating our
reported financial results as they require our most difficult,
subjective or complex judgments, resulting from the need to make
estimates about the effect of matters that are inherently
uncertain. Management has discussed the selection of these
critical accounting policies and the effect of estimates with
the Audit Committee of our Board of Directors.
We earn revenue from hotel management contracts and related
services and operations of our wholly owned hotels. Generally,
revenues are recognized when services have been rendered. Given
the nature of our business, revenue recognition practices do not
contain estimates that materially affect results of operations.
Revenues related to our corporate housing segment, which was
sold in January 2007, are included as part of discontinued
operations. The following is a description of the composition of
our revenues:
In accordance with SFAS No. 144, “Accounting
for the Impairment or Disposal of Long Lived Assets,”
whenever events or changes in circumstances indicate that
the carrying values of long-lived assets (which consist of our
owned hotels and intangible assets with determinable useful
lives) may not be recoverable, we perform separate analyses to
determine the recoverability of the related asset’s
carrying value. These events or circumstances may include, but
are not limited to; projected cash flows which are significantly
less than the most recent historical cash flows; a significant
loss of management contracts without the realistic expectation
of a replacement; and economic events which could cause
significant adverse changes and uncertainty in business and
leisure travel patterns.
When evaluating long-lived assets for potential impairment, we
make estimates of the undiscounted cash flows from the expected
future operations of the asset. If the estimated future cash
flows are less than the carrying value of the asset, we
calculate an impairment loss. The impairment calculation
compares the carrying value of the asset to the asset’s
estimated fair value, which may be based on estimated discounted
future cash flows. We recognize an impairment loss if the amount
of the asset’s carrying value exceeds the asset’s
estimated fair value. If we recognize an impairment loss, the
adjusted carrying amount of the asset becomes its new cost basis.
Our impairment evaluations contain uncertainties because they
require management to make assumptions and to apply judgment to
estimate future cash flows and asset fair values, including
forecasting useful lives for the assets and selecting the
discount rate that reflects the risk inherent in future cash
flows. We do not believe there is a reasonable likelihood that
there will be a material change in the estimates or assumptions
we use to evaluate long-lived asset impairment losses. However,
if actual results are not consistent with our estimates and
assumptions used in estimating future cash flows and asset fair
values, we may be exposed to losses that could be material.
We allocate the purchase price of hotels based on the fair value
of the acquired real estate, building, furniture fixture and
equipment, liabilities assumed and identified intangible assets.
The purchase price represents cash and other assets exchanged or
liabilities assumed. The estimates of fair value used to
allocate the purchase price is based upon appraisals and
valuations performed by management and independent third
parties. Property and equipment are carried at cost and are
depreciated using the straight-line method over the expected
useful lives of the assets (generally 40 years for
buildings, seven years for furniture, fixtures and equipment,
and three years for computer equipment). Renovations and
replacements that improve or extend the life of an asset are
capitalized and depreciated over its expected useful life. Our
assessments of the fair value allocated and expected useful life
of assets acquired are subjective. A change in our estimates
will affect depreciation expense and net income.
For properties acquired from Blackstone that we managed prior to
the purchase, we were entitled to termination fees pursuant to
the preexisting management agreements for those properties.
Under Emerging Issues Task Force Issue
04-1,
“Accounting for Preexisting Relationships between the
Parties to a Business Combination”
(“EITF 04-1”),
the settlement of the preexisting management agreements
(including the payment of the termination fees) requires
accounting separate from the acquisition of the properties.
Under
EITF 04-1,
the effective settlement of a management agreement with respect
to an acquired property is required to be measured at the lesser
of (x) the amount by which the agreement is favorable or
unfavorable from our perspective when compared to pricing for
current market transactions for the same or similar management
agreements and, (y) the stated settlement provisions that
are unfavorable to the seller. Therefore, in connection with the
purchase of a hotel being managed by us, we will evaluate the
terms of the contract and record the lesser amount, if any, as
income from the settlement of the management contract and a
corresponding increase in the recorded purchase price.
We evaluate goodwill to assess potential impairments on an
annual basis, or more frequently if events or other
circumstances indicate that the carrying value of goodwill may
not be recoverable. We evaluate the fair value of goodwill at
the reporting unit level and make that determination based upon
future cash flow projections. Assumptions used in these
projections, such as forecasted growth rates, cost of capital
and multiples to determine the terminal value of the reporting
units, are consistent with internal projections and operating
plans. We record an impairment loss when the implied fair value
of the goodwill assigned to the reporting unit is less than the
carrying
value of the reporting unit, including goodwill. In the fourth
quarter of 2007, we completed our annual impairment testing of
goodwill and determined there was no impairment.
We determine fair value using widely accepted valuation
techniques, which contain uncertainties because they require
management to make assumptions and to apply judgment to estimate
industry economic factors and the profitability of future
business strategies. It is our policy to conduct impairment
testing based on our current business strategy in light of
present industry and economic conditions, as well as future
expectations. We have not made any material changes in our
impairment loss assessment methodology during the past three
fiscal years. We do not believe there is a reasonable likelihood
that there will be a material change in the future estimates or
assumptions we use to test for goodwill impairment losses.
However, if actual results are not consistent with our estimates
and assumptions, we may be exposed to an impairment charge that
could be material.
We make certain estimates and judgments in determining our
income tax expense, our deferred tax assets and liabilities, and
any valuation allowance recorded against our deferred tax assets
for financial statement purposes. Deferred tax assets and
liabilities are determined based on temporary differences
between the financial reporting and tax bases of assets and
liabilities. The tax rates used to determine deferred tax assets
or liabilities are the enacted tax rates in effect for the year
in which the differences are expected to reverse. Realization of
certain deferred tax assets is dependent upon generating
sufficient taxable income prior to the expiration of the
carryforward periods. A valuation allowance is required to be
established against deferred tax assets unless we determine that
it is more likely than not that we will ultimately realize the
tax benefit associated with a deferred tax asset.
At December 31, 2007, we have a valuation allowance of
$20.6 million to reduce our deferred tax assets to the
amount that we believe is more likely than not to be realized.
This is an allowance against some, but not all, of our recorded
deferred tax assets. The valuation allowance we recorded
includes the effect of the limitations on our deferred tax
assets arising from net operating loss carryforwards. The
utilization of our net operating loss carryforwards will be
limited by the provisions of the Internal Revenue Code. We have
considered estimated future taxable income and prudent and
feasible ongoing tax planning strategies in assessing the need
for a valuation allowance. Our estimates of taxable income
require us to make assumptions about various factors that affect
our operating results, such as economic conditions, consumer
demand, competition and other factors. Our actual results may
differ from these estimates. Based on actual results or a
revision in future estimates, we may determine that we are not
able to realize additional portions of our net deferred tax
assets in the future; if that occurred, we would record a charge
to the income tax provision in that period.
Depreciation expense is based on the estimated useful lives of
our assets, which are generally the following: buildings and
improvements, 40 years or less; furniture and fixtures,
five to seven years; computer equipment, three years; and
software, five years. If an owned hotel is undergoing a
significant renovation, we will shorten the useful lives of the
assets affected by the renovation to a period which corresponds
to the renovation period.
Amortization expense for our intangible assets is based on the
estimated useful life of the underlying future benefit of the
intangible asset. The lives of our intangible assets are based
upon the length of their related management contracts. These
lives are determined at the onset of the management contract.
However, as certain circumstances arise, such as a disposition
plan by the owner, the estimated future benefit of the contract
may change. At the end of 2006, we revised the remaining useful
life of our management contracts with Blackstone from
approximately 19 years to four years based upon their rate
of dispositions.
While management believes its estimates are reasonable, a change
in circumstances could require us to revise the estimated useful
lives related to our property and equipment and intangible
assets. If we revised the useful lives of these assets, we could
be exposed to material changes in the depreciation and
amortization expense which we record.
Judgment is required with respect to the consolidation of our
joint venture investments in the evaluation of financial
interests and control, including the assessment of the adequacy
of the equity invested in the joint venture, the
proportionality of financial interests and voting interests, as
well as the importance of rights and privileges of the joint
venture partners based on voting rights. Currently, we have
investments in joint ventures that own, operate or develop hotel
properties, which we record using the equity or cost method of
accounting. We are not the primary beneficiary in any variable
interest entities. We do not guarantee debt held by the joint
ventures and the debt is non-recourse to us. While we do not
believe we are required to consolidate any of our current joint
ventures, if we were required to do so, then all of the results
of operations and the assets and liabilities would be included
in our financial statements.
Results
of Operations
Statistics related to our wholly-owned properties and managed
hotel properties include:
Hotels under management decreased by a net of 32 properties as
of December 31, 2007 compared to December 31, 2006,
due to the following:
Hotels under management decreased by a net of 63 properties as
of December 31, 2006 compared to December 31, 2005,
due to the following:
The operating statistics related to our owned hotels on a same
store basis(2) were as follows:
The operating statistics related to our managed hotels on a same
store basis(3) were as follows:
The significant components of total revenue were as follows (in
thousands):
Lodging
Management Fees
The composition of our management and termination fees by
significant owner groups was as follows (in thousands):
Termination fees
Other
Other Revenue from Managed Properties
The significant components of undistributed operating expenses
were as follows (in thousands):
Lodging
Administrative and General
Depreciation and Amortization
Restructuring and Severance Expenses
Asset Impairment and Write-offs
The significant components of other income and expenses, were as
follows (in thousands):
Interest Expense, net of interest income
Equity in Earnings of Affiliates
Gain on Sale of Investments and Extinguishment of
Debt
Income Tax Expense
Income from Discontinued Operations, net of
Tax
Key metrics related to our liquidity, capital resources and
financial position are as follows (in thousands):
The decrease in cash provided by operating activities of
$37.6 million from 2006 to 2007 was primarily driven by the
decrease in management fees, termination fees and other revenue
(primarily accounting fees) of $30.9 million. These
revenues all decreased due to the net loss of properties under
management over the course of 2007 and 2006. In 2007, we also
had an increase in G&A expense of $6.4 million and an
increase in interest expense of $5.2 million due to our
additional ownership of hotel properties. In addition, the net
change in our assets and liabilities resulted in a cash outflow
of $1.2 million in 2007, while in 2006, those changes
resulted in a cash inflow of $10.8 million. These decreases
were offset by an increase in operating income from our owned
hotels of $14.5 million, primarily due to our acquisition
of three additional hotels in 2007 and the full year effect of
our two acquisitions in 2006.
The increase in cash provided by operating activities of
$33.5 million from 2005 to 2006 was primarily driven by the
significant increases in income from operations of
$24.6 million. This increase was primarily due to the
increase in termination fees of $18.7 million, business
interruption proceeds of $3.2 million and stronger
operating results at the hotels with an increase in incentive
fees of $3.1 million. Income from operations also included
an increase in non-cash expenses related to asset impairments
and write-offs of $7.6 million in 2006.
The major components of the increase in cash used in investing
activities from 2006 to 2007 were:
The major components of the increase in cash used in investing
activities from 2005 to 2006 were:
Cash provided by financing activities increased
$121.4 million in 2007 compared to 2006. In 2007, we
borrowed an additional $127.4 million, net of
repayments/extinguishments, to fund the acquisition of three
properties, while in 2006, our long-term debt balance remained
flat compared to 2005. We spent $3.3 million in 2007 in
connection with the refinancing of our long-term debt. We
received $2.8 million of additional proceeds in 2006 from
the issuance of common stock related to the exercise of stock
options.
Cash provided by financing activities increased
$7.3 million in 2006 compared to 2005. In 2006, and 2005,
we borrowed approximately the same amount of total long-term
debt that we repaid, resulting in no substantial net effect on
cash from financing activities. The revolving loan under our
credit facility had a balance of $20.1 million at the end
of 2005 and was repaid in full by the end of 2006 as cash from
operations increased year over year. The change in financing
activities was due to additional financing fees of
$4.0 million incurred in 2005 in connection with the
refinancing of our long-term debt. These cash outflows were
offset by the $2.8 million in additional proceeds from the
issuance of common stock during 2006 compared to 2005, related
to the exercise of stock options.
Liquidity Requirements — Our known short-term
liquidity requirements consist primarily of funds necessary to
pay for operating expenses and other expenditures, including:
corporate expenses, payroll and related benefits, legal costs,
and other costs associated with the management of hotels,
interest and scheduled principal payments on our outstanding
indebtedness and capital expenditures, which include renovations
and maintenance at our owned hotels.
Our long-term liquidity requirements consist primarily of funds
necessary to pay for scheduled debt maturities, capital
improvements at our owned hotels and costs associated with
potential acquisitions. In March 2007, we entered into a new,
senior secured credit facility, as amended from time to time,
which we refer to as the “Credit Facility.” The Credit
Facility matures in March 2010 and consists of a
$115.0 million term loan and an $85.0 million
revolver. As of December 31, 2007, we had
$45.0 million available under our revolver. We also have
two non-recourse mortgage loans for $24.7 million and
$32.8 million, which mature in November 2009 and February
2010, respectively.
We have historically satisfied our short-term liquidity
requirements through cash provided by our operations and
borrowings from our Credit Facility. Our borrowings under our
Credit Facility are subject to certain restrictions under the
Credit Facility agreement. Additionally, we must maintain
compliance with our financial covenants, including an acceptable
degree of leverage, value of unencumbered assets and interest
coverage ratios, in order to continue to have funds available to
borrow under our Credit Facility. We continually monitor our
operating and cash flow models in order to forecast our
compliance with the financial covenants. As of December 31,
2007 we were in compliance with all financial covenants.
Our short-term liquidity could be influenced by various factors
including changes in lodging demand due to seasonality or a
slowdown in the overall economy and RevPAR declines. During the
past three years, we have invested in the ownership of multiple
lodging properties through joint venture partnerships and the
whole ownership acquisition of seven hotels. This degree of
ownership elevates our level of sensitivity to RevPAR
fluctuations, declines in the real estate market and the overall
economy in general, which could have a significant impact on our
earnings and cash flows. Additional factors include increased
operating costs, interest rate changes, natural disasters and
non-specific operational risks.
We have historically satisfied our long-term liquidity
requirements through various sources of capital, including cash
provided by operations, bank credit facilities, long-term
mortgage indebtedness and the issuance of equity. We believe
that these sources of capital will continue to be available to
us in the future to fund our long-term liquidity requirements.
Nevertheless, there are certain factors that may have a material
adverse effect on our access to these capital sources. Our
ability to incur additional debt is dependent upon a number of
factors, including our degree of leverage, the value of our
unencumbered assets (if any), our public debt ratings and
borrowing restrictions imposed by existing lenders. As of
December 31, 2007, our long-term ratings were ‘B1
Negative’ and ‘B/Stable/-’ from Moody’s and
S&P, respectively.
Our continued ability to raise funds through the issuance of
equity securities is dependent upon, among other things, overall
general market conditions, market valuation of our equity and
perceptions about our Company. We will continue to analyze which
sources of capital are most advantageous to us at any particular
point in time, but equity and debt financing may not be
consistently available to us on terms that are financially
viable or at all.
Expectations for 2008 — During 2008, we expect
to fund our operations and growth strategy through cash from
operations, cash on hand and borrowings from our Credit
Facility. Additionally, in early 2008, we are seeking to enter
into a $30.0 million non-recourse mortgage for the Sheraton
Columbia, the proceeds of which we will use to repay our
borrowings under the Credit Facility. We will also seek to have
the right to borrow up to an additional $5.0 million as
needed towards the completion of an estimated $12 million
comprehensive renovation plan which commenced in early 2008. We
expect that our $18.0 million comprehensive renovation plan
at the Westin Atlanta Airport, which began in 2007 and has an
estimated cost of $15 million to complete, will be funded
by cash on hand or borrowings against our Credit Facility. We
also expect to spend approximately $8 million on
renovations at our other wholly owned hotels and approximately
$1.7 million for our share of renovations at 11 of our
joint venture hotels in 2008.
We will continue to focus on our growth strategy of primarily
minority investments in hotels through the formation of
strategic joint venture partnerships. We will also continue to
selectively evaluate whole-ownership opportunities in 2008.
However, opportunities will be considered along with other
factors including but not limited to expected returns on
investment, current capital structure and other potential
investments. Additionally, we expect to use additional cash
flows from operations to pay required debt service, income taxes
and make planned capital purchases, exclusive of the renovation
programs mentioned above for our wholly-owned hotels which
include regular capital expenditures for maintenance. We expect
to continue to seek minority interest ownership in real estate
though joint ventures during 2008. We expect to fund these
investments through cash from operations or borrowings under our
Credit Facility. We also continue to evaluate investment
opportunities to acquire hotel management businesses and
management contracts which may require cash. If none of these
investments become available, we will pay down debt
and/or
invest in short-term securities with excess cash flow until
those investments become available.
Our ability to incur additional debt is dependent upon a number
of factors, including our degree of leverage, the value of our
unencumbered assets (if any), our public debt ratings and
borrowing restrictions imposed by existing lenders. Given the
current lending environment, our access to additional funding
may be limited. In consideration of our current working capital,
projected operations and current capital structure, we do not
foresee a need to seek additional capital to fund our
operational and growth strategies in 2008. Should a need arise
for us to obtain additional capital funding for growth
opportunities, we will first access the available funds under
our Credit Facility. In consideration of our covenants, we would
expect no limitations in accessing the full balance under our
Credit Facility to fund growth operations. If we are required to
obtain additional funds in excess of our current Credit
Facility, our ability or inability to do so, may require the
restructuring of certain debt and the amendment of certain
covenants. Our ability and willingness to accept certain terms
may significantly affect our ability to obtain additional
capital funding. Also, an increase in our cost of capital may
cause us to delay, restructure or not commence future
investments, which could limit our ability to grow our business.
Senior Credit Facility — In March 2007, we
closed on our new $125.0 million Credit Facility, which
replaced our previous $108.0 million credit facility. The
new Credit Facility consisted of a $65.0 million term loan
and a $60.0 million revolving loan. Upon entering into the
new Credit Facility, we borrowed $65.0 million under the
term loan and used a portion of those proceeds to pay off the
remaining obligations under the previous credit facility. In
connection with the purchase of the Westin Atlanta Airport in
May 2007, we amended the new Credit Facility. The amendment
increased our total borrowing capacity to $200.0 million,
consisting of a $115.0 term loan and a $85.0 million
revolving line of credit. We utilized the additional
$50.0 million of borrowings under our term loan to purchase
the Westin Atlanta Airport. As of December 31, 2007,
$45.0 million of capacity was available to us for borrowing
under our revolver. In addition, we have the ability to increase
the revolving Credit Facility
and/or term
loan by up to $75.0 million, in the aggregate, by and after
seeking additional commitments from lenders and
amending certain of our covenants. Under the amended Credit
Facility, we are required to make quarterly payments on the term
loan of approximately $0.3 million.
The actual interest rates on both the revolving loan and term
loan depend on the results of certain financial tests. As of
December 31, 2007, based on those financial tests,
borrowings under the term loan and the revolving loan bore
interest at the
30-day LIBOR
rate plus 275 basis points (a rate of 7.6% per annum). We
incurred interest expense of $7.9 million,
$5.8 million and $6.1 million on the senior credit
facilities for the twelve months ended December 31, 2007,
2006 and 2005, respectively. In January 2008, we entered into an
interest rate collar for a notional amount of $110 million.
The interest rate collar consists of an interest rate cap at
4.0% and an interest rate floor at 2.47% on the
30-day LIBOR
rate.
The debt under the Credit Facility is guaranteed by certain of
our wholly-owned subsidiaries and collateralized by pledges of
ownership interests, owned hospitality properties, and other
collateral that was not previously prohibited from being pledged
by any of our existing contracts or agreements. The Credit
Facility contains covenants that include maintenance of certain
financial ratios at the end of each quarter, compliance
reporting requirements and other customary restrictions. As of
December 31, 2007, we were in compliance with all of these
covenants.
Mortgage Debt — The following table summarizes
our mortgage debt as of December 31, 2007:
We incurred mortgage interest expense of $4.1 million,
$1.8 million and $1.0 million for the twelve months
ended December 31, 2007, 2006 and 2005, respectively. Based
on the terms of these mortgage loans, a prepayment cannot be
made during the first year after it has been entered. After one
year, a penalty of 1% is assessed on any prepayments. The
penalty is reduced ratably over the course of the second year.
There is no penalty for prepayments made in the third year.
Shelf Registration Statement — In August 2004,
we filed a
Form S-3
shelf registration statement registering up to
$150.0 million of debt securities, preferred stock, common
stock and warrants. The registration statement also registered
approximately 6.2 million shares of our common stock held
by CGLH Partners I, LP and CGLH Partners II, LP, which are
beneficially owned by certain of our directors. Of these shares,
at least 4.3 million shares have already been sold by
affiliates of the CGLH partnership in the open market.
Affiliates of the CGLH Partnerships have the right to include
any of their remaining 1.9 million shares they may still
hold in the shelf registration statement pursuant to a
registration rights agreement they executed with us at the time
of our July 2002 merger with Interstate Hotels Corporation.
Contractual Obligations and Off-Balance Sheet
Arrangements — The following table summarizes our
contractual obligations at December 31, 2007, and the
effect that those obligations are expected to have on our
liquidity and cash flows in future periods (in thousands):
We also have the following commitments and off-balance sheet
arrangements currently outstanding:
During 2005, the prior carrier presented invoices to us and
other policy holders related to dividends previously granted to
us and other policy holders with respect to the prior policies.
Based on this information, we have determined that the amount is
probable and estimable and have therefore recorded the
liability. In September 2005, we invoiced the prior carrier for
premium refunds due to us on previous policies. The initial
premiums on these policies were calculated based on estimated
employee payroll expenses and gross hotel revenues. Due to the
September 11th terrorist attacks and the resulting
substantial decline in business and leisure travel in the months
that followed, we reduced hotel level headcount and payroll. The
estimated premiums billed were significantly overstated and as a
result, we are owed refunds on the premiums paid. The amount of
our receivable exceeds the dividend amounts claimed by the prior
carrier. We have reserved the amount of the excess given the
financial condition of the carrier. We believe that we hold the
legal right of offset in regard to this receivable and payable
with the prior insurance carrier. Accordingly, there was no
effect on the statement of operations in 2005, 2006, or 2007. We
will aggressively pursue collection of our receivable and do not
expect to pay any amounts to the prior carrier prior to reaching
an agreement with them regarding the contractual amounts due to
us. To the extent we do not collect sufficiently on our
receivable and pay amounts that we have been invoiced, we will
vigorously attempt to recover any additional amounts from our
owners.
The SEC encourages companies to disclose forward-looking
information so that investors can better understand a
company’s future prospects and make informed investment
decisions. In this Annual Report on
Form 10-K
and the information incorporated by reference herein, we make
“forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995, particularly
statements anticipating future growth in revenues, net income
and cash flow. Any statements in this document about our
expectations, beliefs, plans, objectives, assumptions or future
events or performance are not historical facts and are
forward-looking statements. These statements are often, but not
always, made through the use of words or phrases such as
“will likely result,” “expect,”
“believe,” “will continue,”
“anticipate,” “estimate,”
“intend,” “plan,” “projection,”
“would” and “outlook” and other similar
terms and phrases. Accordingly, these statements involve
estimates, assumptions and uncertainties that are not yet
determinable and could cause actual results to differ materially
from those expressed in the statements. Any forward-looking
statements are qualified in their entirety by reference to the
factors discussed throughout this Annual Report on
Form 10-K
and the documents incorporated by reference herein. In addition
to the risks related to our business, the factors that may cause
actual results to differ materially from those described in the
forward-looking statements include, among others, the following:
These factors and the risk factors referred to above could cause
actual results or outcomes to differ materially from those
expressed in any forward-looking statements made or incorporated
by reference in this Annual Report on
Form 10-K.
You should not place undue reliance on any of these
forward-looking statements. Further, any forward-looking
statement speaks only as of the date on which it is made and we
do not undertake to update any forward-looking statement or
statements to reflect events or circumstances after the date on
which the statement is made or to reflect the occurrence of
unanticipated events. New factors emerge from time to time, and
it is not possible to predict which will arise. In addition, we
cannot assess the impact of each factor on our business or the
extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any
forward-looking statements.
We are exposed to market risk in the form of changes in interest
rates and foreign currency exchange rate fluctuation. In certain
instances, we attempt to reduce volatility in earnings and cash
flow associated with interest rate and foreign exchange rate
risks by entering into derivative arrangements intended to
provide hedges against a portion of the associated risks. We
continue to have exposure to such risks to the extent that they
are not hedged.
Our interest rate risk management objective is to limit the
impact of interest rate changes on earnings and cash flows and
to lower our overall borrowing costs. As of December 31,
2007, all of our debt is at variable rates based on current
LIBOR rates. See “Item 7. Management’s Discussion
and Analysis of Financial Condition and Results of
Operations — Liquidity, Capital Resources and
Financial Position — Long-Term Debt” for more
information regarding our long-term debt.
In an effort to manage interest rate risk covering our
outstanding debt, we have entered into various interest rate cap
agreements. In February 2005, we entered into a
$19.0 million, three-year interest rate cap agreement in
connection with the mortgage loan on the Hilton Concord hotel.
At our option, we cancelled this interest rate cap upon
repayment in full of the Hilton Concord mortgage note in April
2007. In March 2005, we entered into a $55.0 million,
three-year interest rate cap agreement related to our Credit
Facility. The interest rate agreement caps the
30-day LIBOR
at 5.75% matured on January 14, 2008. On January 11,
2008, we entered into an interest rate collar agreement for a
notional amount of $110 million. The interest rate collar
consists of an interest rate cap at 4.0% and an interest rate
floor at 2.47% on the
30-day LIBOR
rate. We receive the difference of the cap rate and
30-day LIBOR
should LIBOR exceed the cap rate. We pay the difference of the
floor rate and
30-day LIBOR
should LIBOR fall below the floor rate. The interest rate collar
became effective January 14, 2008, with monthly settlement
dates on the last day of each month beginning January 31,
2008, and maturing January 31, 2010.
In October 2006, we entered into a $24.7 million,
three-year interest rate cap agreement in conjunction with our
mortgage loan associated with the purchase of the Hilton
Arlington. The interest rate agreement caps the
30-day LIBOR
at 7.25% and is scheduled to mature on November 19, 2009.
In February 2007, we entered into a $32.8 million interest
rate cap agreement in conjunction with our mortgage loan
associated with the purchase of the Hilton Houston Westchase.
The agreement caps the
30-day LIBOR
at 7.25% and is scheduled to mature in February 2010. At
December 31, 2007, the total fair value of these interest
rate cap agreements was approximately $11,100. The change in
fair value for these interest rate cap agreements is recognized
in the consolidated statement of operations.
The 30-day
LIBOR rate, upon which our debt and interest rate cap agreements
are based, decreased from 5.3% per annum as of December 31,
2006, to 5.0% per annum as of December 31, 2007. Giving
effect to our interest rate hedging activities, a 1.0% change in
the 30-day
LIBOR would have changed our interest expense by approximately
$1.5 million, $0.9 million and $0.9 million for
the years ended December 31, 2007, 2006 and 2005,
respectively.
Our international operations are subject to foreign exchange
rate fluctuations. To date, our only foreign currency exposure
are management and incentive fees related to our managed
properties in Russia, which are denominated and paid in Rubles.
Most of our foreign operations have been largely self-contained
or U.S. dollar-denominated and as such, we have not been
exposed to material foreign exchange risk. Therefore, to date,
we have not entered into any currency contracts or other
derivative financial instruments. We continue to monitor and
evaluate our current and future exposure to foreign currency
fluctuation and risk in determining future derivative
arrangements.
We derived approximately 8.6%, 7.4% and 8.8% of our revenues,
excluding reimbursed expenses, from services performed outside
of the United States for the years ended December 31, 2007,
2006 and 2005, respectively. Our foreign currency translation
gains and (losses) of approximately $0.1 million,
$1.1 million and $(0.5) million for the years ended
December 31, 2007, 2006 and 2005, respectively, are
included in accumulated other comprehensive income (loss) in our
statement of operations.
The following Consolidated Financial Statements are filed as
part of this Annual Report of
Form 10-K:
The Board of Directors and Stockholders
Interstate Hotels & Resorts, Inc.:
We have audited the accompanying consolidated balance sheets of
Interstate Hotels & Resorts, Inc. and subsidiaries
(the Company) as of December 31, 2007 and 2006, and the
related consolidated statements of operations and comprehensive
income (loss), stockholders’ equity, and cash flows for
each of the years in the three-year period ended
December 31, 2007. In connection with our audits of the
consolidated financial statements, we also have audited
financial statement schedule III as listed in the index at
item 15. These consolidated financial statements and
financial statement schedule are the responsibility of the
Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Interstate Hotels & Resorts, Inc. and
subsidiaries as of December 31, 2007 and 2006, and the
results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2007, in
conformity with U.S. generally accepted accounting
principles. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
Interstate Hotels & Resorts, Inc. and subsidiaries
internal control over financial reporting as of
December 31, 2007, based on criteria established in
Internal Control — Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated March 17, 2008,
expressed an adverse opinion on the effectiveness of the
Company’s internal control over financial reporting.
KPMG LLP
McLean, Virginia
March 17, 2008
The Board of Directors and Stockholders
Interstate Hotels & Resorts, Inc.:
We have audited the internal control over financial reporting as
of December 31, 2007 for Interstate Hotels &
Resorts, Inc. and subsidiaries (the Company), based on criteria
established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The
Company’s management is responsible for maintaining
effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion
on the effectiveness of the Company’s internal control over
financial reporting based on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the
design and operating effectiveness of internal control based on
the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our
opinion.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s
internal control over financial reporting includes those
policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or a combination of
deficiencies, in internal control over financial reporting, such
that there is a reasonable possibility that a material
misstatement of the company’s annual or interim financial
statements will not be prevented or detected on a timely basis.
The following material weakness has been identified and included
in Management’s Report on Internal Control Over Financial
Reporting. The Company did not have effective policies and
procedures designed either to evaluate or review changes in
accounting principles in accordance with U.S. generally
accepted accounting principles.
In our opinion, because of the effect of the aforementioned
material weakness on the achievement of the objectives of the
control criteria, Interstate Hotels & Resorts, Inc.
and subsidiaries has not maintained effective internal control
over financial reporting as of December 31, 2007, based on
criteria established in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States), the
consolidated financial statements of Interstate
Hotels & Resorts, Inc. and subsidiaries. This material
weakness was considered in determining the nature, timing, and
extent of audit tests applied in our audit of the 2007
consolidated financial statements, and this report does not
affect our report dated March 17, 2008 which expressed an
unqualified opinion on those consolidated financial statements.
KPMG LLP
McLean, Virginia
March 17, 2008
INTERSTATE
HOTELS & RESORTS, INC.
CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts)
The accompanying notes are an integral part of the
consolidated financial statements.
INTERSTATE
HOTELS & RESORTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (In thousands, except per share amounts)
The accompanying notes are an integral part of the
consolidated financial statements.
INTERSTATE
HOTELS & RESORTS,
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (In thousands)
The accompanying notes are an integral part of the
consolidated financial statements.
INTERSTATE
HOTELS & RESORTS, INC
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
The accompanying notes are an integral part of the
consolidated financial statements.
INTERSTATE
HOTELS & RESORTS, INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and per share
amounts)
We are a leading hotel real estate investor and the
nation’s largest independent operator, as measured by
number of rooms under management and gross annual revenues of
the managed portfolio. We have two reportable operating
segments: hotel ownership (through whole-ownership and joint
ventures) and hotel management. A third reportable operating
segment, corporate housing, was disposed of on January 26,
2007 with the sale of BridgeStreet Corporate Housing Worldwide,
Inc. and its affiliated subsidiaries, which we refer to as
“BridgeStreet.” Each segment is reviewed and evaluated
by the company’s senior management. For financial
information about each segment, see Note 10, “Segment
Information.”
Our hotel ownership segment includes our wholly-owned hotels and
our minority interest, joint venture investments in hotel
properties. Hotel ownership allows us to participate in the
potential asset appreciation of the hotel properties, and as of
December 31, 2007, we owned seven hotels and held
non-controlling equity interests in 17 joint ventures, which own
or hold ownership interests in 22 of our managed properties. We
manage all of the properties within our hotel ownership segment.
We manage a portfolio of hospitality properties and provide
related services in the hotel, resort and conference center
markets. Our portfolio is diversified by location/market,
franchise and brand affiliations. The related services provided
include insurance and risk management, purchasing and capital
project management, information technology and
telecommunications and centralized accounting. As of
December 31, 2007, we and our affiliates managed 191 hotel
properties with 42,620 rooms and five ancillary service centers
(which consist of a convention center, conference center, spa
facility and two laundry centers), in 36 states, the
District of Columbia, Russia, Mexico, Canada, Belgium and
Ireland.
Our corporate housing division was disposed of on
January 26, 2007, with the sale of BridgeStreet. It
provided apartment rentals for both individuals and corporations
with a need for temporary housing as an alternative to long-term
apartment rentals or prolonged hotel stays. The assets and
liabilities of our corporate housing division are presented as
held for sale in our consolidated balance sheets as of
December 31, 2006 and as discontinued operations in our
consolidated statement of operations and cash flows for all
periods presented in this report.
Our subsidiary operating partnership, Interstate Operating
Company, L.P, indirectly holds substantially all of our assets.
We are the sole general partner of that operating partnership.
Certain independent third parties and we are limited partners of
the partnership. The interests of those third parties are
reflected in minority interests on our consolidated balance
sheet. The partnership agreement gives the general partner full
control over the business and affairs of the partnership. We own
more than 99% of the subsidiary operating partnership.
Our consolidated financial statements are prepared in accordance
with U.S. generally accepted accounting principles
(“GAAP”). These statements include our accounts and
the accounts of all of our majority owned subsidiaries. If we
determine that we hold an interest in a variable interest entity
(“VIE”) within the meaning of Financial Accounting
Standards Board, or FASB, Interpretation No. 46(R),
“Consolidation of Variable Interest Entities”
(“FIN 46(R)”) and that our variable interest
will absorb a majority of the entities’ expected losses, or
receive a majority of the expected returns, or both to the
extent they occur, then we will consolidate the entity.
If the entity does not meet the definition of a VIE, we evaluate
our voting interest and other indicators of control. We
consolidate entities when we own over 50% of the voting shares
of a company or the majority of the general partner interest of
a partnership, assuming the absence of other factors determining
control. Other control factors we consider include the ability
of minority owners to participate in or block management
decisions. Emerging Issues Task Force
04-5,
“Determining Whether a General Partner, or the General
Partners as a Group, Controls a Limited Partnership or Similar
Entity When the Limited Partners Have Certain Rights,”
(“EITF 04-05”)
addresses the issue
of what rights held by the limited partner(s) preclude
consolidation in circumstances in which the sole general partner
would otherwise consolidate the limited partnership in
accordance with U.S. GAAP. We are not the sole general
partner in any of our joint ventures, nor are we the controlling
general partner for the one joint venture which involves
multiple general partners. We are not the primary beneficiary or
controlling investor in any of these joint ventures, however we
exert significant influence as the manager of the underlying
assets and therefore account for our interests using the equity
method of accounting.
We own 100% of seven hotel properties, the operations of which
are consolidated in our financial statements. We eliminate all
intercompany balances and transactions.
We have reclassified certain immaterial amounts in the prior
years’ consolidated balance sheets within current assets to
conform to the current-year presentation. These classifications
have no effect on net income.
Preparation of financial statements in conformity with
U.S. GAAP requires us to make estimates and assumptions
that affect the amounts reported in the consolidated financial
statements and accompanying disclosures. These estimates are
based on our best knowledge of current events and actions we may
undertake in the future. Actual results may ultimately differ
from those estimates, although management does not believe such
estimates would materially affect the financial statements in
any individual year. Estimates are used in accounting for, among
other things, the impairment of long-lived assets, the
impairment of goodwill, income taxes and useful lives for
depreciation and amortization.
We consider all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
Our insurance captive subsidiary holds short-term liquid
investments. We have classified all short-term investments as
available-for-sale.
The value of unrealized gains and losses on these securities, if
any, are reported as accumulated other comprehensive income,
which is a separate component of stockholders’ equity. The
value of our short term investments was $1.4 million and
$1.3 million as of December 31, 2007 and 2006,
respectively. We periodically evaluate whether any declines in
the fair value of these investments are other than temporary. If
management determines that a decline in fair value is other than
temporary, the carrying value of the investment will be reduced
to the current fair value of the investment and we will
recognize a charge in the consolidated statements of income
equal to the amount of the carrying value reduction. The average
underlying maturities of these investments range from six months
to three years. Despite the long-term nature of the securities
stated contractual maturities, these funds can be readily
liquidated within a short period of time; therefore, these
securities have been classified as short-term and included in
prepaid expenses and other current assets.
Restricted cash primarily consists of cash reserves statutorily
required to be held by our captive insurance subsidiary for
insurance we provide to our managed hotels; escrows required
related to property improvement plans at wholly-owned hotels;
and working capital from our owners to purchase goods for
renovation projects that our purchasing subsidiary oversees.
We provide an allowance for doubtful accounts when we determine
it is more likely than not a specific accounts receivable will
not be collected and provide a general reserve for the
population of our accounts that we believe may become
uncollectible based on current business conditions. Our
allowance for doubtful accounts was $1.9 million and
$1.4 million as of December 31, 2007 and 2006,
respectively.
In January 2007, we were retained as manager for two properties
owned by Capstar Hotel Company, LLC (“New Capstar”), a
newly formed real estate investment company founded by Paul
Whetsell, our current Chairman of the Board. As of
December 31, 2007, balances related to New Capstar have
been included within “Due from related parties” on our
consolidated balance sheet and “Management fees
— related parties” on our consolidated statement
of operations.
In May 2006, The Blackstone Group, which we refer to as
“Blackstone,” acquired MeriStar Hospitality
Corporation, which we refer to as “MeriStar.” MeriStar
had previously been considered a related party, as our Chairman
of the Board, Paul Whetsell, was also the CEO of MeriStar.
Mr. Whetsell did not become part of the Blackstone
management team, and we do not consider Blackstone to be a
related party. As such, the line items “due from related
parties” on our consolidated balance sheet and
“management fees — related parties” on our
consolidated statement of operations do not include any amounts
associated with Blackstone at December 31, 2007 and for the
period from May 2, 2006 through December 31, 2006,
although fees received from Meristar prior to May 2, 2006
continue to be included in “Management fees —
related parties.” See Note 13, “Related-Party
Transactions” for further information on these related
party transactions.
Our managed properties for which we also hold a joint venture
ownership interest continue to be presented as related parties.
See Note 3, “Investments in Joint Ventures” for
further information on these related party amounts.
We provide the benefit of a non-qualified deferred compensation
plan for certain employees, allowing them to make deferrals upon
which we will match up to certain thresholds defined in the
plan. The investments in the plan, which consist primarily of
mutual funds, are classified as available for sale. They are
recorded at fair value with corresponding unrealized gains or
losses reported as accumulated other comprehensive income, which
is a separate component of stockholders’ equity. These
unrealized gains and losses serve to increase or decrease the
corresponding deferred compensation obligation, which is paid to
the employees when they terminate employment with us or reach
the required age for distribution.
Property and equipment are recorded at cost and depreciated over
their estimated useful lives. Costs directly related to an
acquisition are capitalized in accordance with SFAS 141.
All internal costs related to the pursuit of an acquisition are
expensed as incurred. All third-party costs capitalized in
connection with the pursuit of an unsuccessful acquisition are
expensed at the time the pursuit is abandoned. Repairs and
maintenance costs that do not improve service potential or
extend economic life are expensed as incurred.
Depreciation expense is recorded using the straight-line method
over the assets’ estimated useful lives, which generally
have the following ranges: buildings and improvements,
40 years or less; furniture and fixtures, five to seven
years; computer equipment, three years; and software, five
years. Leasehold improvements are depreciated over the shorter
of the lease terms or the estimated useful lives of the
improvements.
Whenever events or changes in circumstances indicate that the
carrying values of property and equipment may be impaired, we
perform an analysis to determine the recoverability of the
asset’s carrying value. We make estimates of the
undiscounted cash flows from the expected future operations of
the asset. If the analysis indicates that the carrying value is
not recoverable from future cash flows, the asset is written
down to estimated fair value and an impairment loss is
recognized.
We account for the majority of our joint venture investments in
limited partnerships and limited liability companies using the
equity method of accounting when we own more than a minimal
investment. We currently employ the cost method on one of our
joint venture ownership interests. At December 31, 2007,
our ownership interest in these joint ventures ranged from 10%
to 50%. We periodically assess the recoverability of our equity
method and cost method investments. If an identified event or
change in circumstances requires an impairment evaluation, we
assess the fair value based on accepted valuation methodologies,
including discounted cash flows, estimates of sales proceeds and
external appraisals, as appropriate. If an investment is
considered to be impaired and the decline is other than
temporary, we will recognize an impairment of the investment to
its fair value. Cash distributions from joint venture
investments are presented as an operating activity on our
statement of cash flows when it is a return on investment and as
an investing activity on our statement of cash flows when it is
a return of investment. See Note 3, “Investments in
Joint Ventures” for additional information on our equity
investments.
We have notes receivable, which are generally issued in
connection with obtaining a management contract, due from
various hotel owners. As of December 31, 2007, we had ten
notes receivable outstanding, for a total of
$5.0 million, net of allowance. We review notes receivable
for potential impairment when events or changes in circumstances
indicate that the carrying value may not be recoverable.
Goodwill represents the excess of the cost to acquire a business
over the estimated fair value of the net identifiable assets of
that business. We estimate the fair value of goodwill to assess
potential impairments on an annual basis, or during the year if
an event or other circumstances indicate that we may not be able
to recover the carrying value amount of the asset. We evaluate
the fair value of goodwill at the reporting unit level and make
that determination based upon internal projections of expected
future cash flows and operating plans. We record an impairment
loss when the implied fair value of the goodwill assigned to the
reporting unit is less than the carrying value of that reporting
unit, including goodwill.
Our intangible assets consist of costs incurred to obtain
management contracts, franchise agreements, and deferred
financing fees. The cost of intangible assets is amortized to
reflect the pattern of economic benefits consumed, principally
on a straight-line basis over the estimated periods benefited.
Management contract and franchise agreement costs are amortized
over the life of the related management contract, unless
circumstances indicate that the useful life is a shorter period.
We currently amortize these costs over periods ranging from one
to 20 years. Deferred financing fees consist of costs
incurred in connection with obtaining various loans and are
amortized to interest expense over the life of the underlying
loan using a method which approximates the effective interest
method.
Costs incurred to obtain a management contract may include
payments to an owner as an incentive. These amounts are also
capitalized as an intangible asset; however, they are amortized
against management fee revenue over the life of the management
contract using the straight-line method.
We test intangible assets with definite lives for impairment
whenever events or changes in circumstances indicate that the
carrying values may not be recoverable. For intangible assets
related to management contracts, this may occur when we are
notified by an owner that we will no longer be managing a
specific property or when a multiple property owner indicates
their intent to dispose of a portion or all of their portfolio.
We make estimates of the undiscounted cash flows from the
expected future operations related to the asset. If the analysis
indicates that the carrying value is not recoverable from future
cash flows, the asset is written down to estimated fair value
and an impairment loss is recognized. When a management contract
is terminated, we write-off the entire value of the intangible
asset related to the terminated management contract as of the
date of termination.
Assets/Liabilities
Held for Sale and Discontinued Operations
Assets and liabilities are classified as held for sale when they
meet the criteria of SFAS No. 144, “Accounting
for the Impairment or Disposal of Long-Lived Assets.”
We believe this criteria includes reclassifying an asset or
business segment as held for sale when management, having the
authority to do so, has initiated an effort to dispose of the
asset or business segment. Assets and liabilities held for sale
consist of the assets and liabilities that will be disposed of
with the sale of our corporate housing subsidiary in January
2007. Included as assets held for sale are net accounts
receivable, prepaid expenses, net fixed assets and goodwill.
Included as liabilities held for sale are accounts payable and
accrued expenses.
We present the results of operations of an entity as
discontinued operations when the operations and cash flows of
the entity have been, or will be, eliminated from our ongoing
operations and the entity will not have any significant
continuing involvement in our operations. Discontinued
operations include the operating results of our corporate
housing subsidiary for the years ended December 31, 2007,
2006 and 2005 and also the operating results of the Residence
Inn Pittsburgh, which was sold in September 2005, for the year
ended December 31, 2005.
Minority interest represents the percentage of our subsidiary
operating partnership, Interstate Operating Company, L.P., which
is owned by third parties. Net income of the subsidiary is
allocated to minority interests based on their weighted average
ownership percentages during the period. At December 31,
2007 and 2006, the redemption value of the outstanding operating
partnership units was $0.2 million and $0.7 million,
respectively.
We earn revenue from our owned hotels and hotel management and
related sources. We recognize revenue from our owned hotels from
rooms, food and beverage, and other operating departments as
earned at the close of each business day. In addition, we
collect sales, occupancy and other similar taxes at our owned
hotels that we remit to the taxing authority, which we present
on a net basis (excluded from revenue) on our statement of
operations. Our hotel management segment earns fees from base
and incentive management fees, termination fees, receivables
from third-party owners of hotel properties and fees for other
related services we provide, primarily centralized accounting
and purchasing. We recognize base fees and fees for other
services as revenue when earned in accordance with the
individual management contracts. Base management fees are
calculated based on a percentage of the total revenue at the
property. We record incentive fees in the period in which they
are earned. As most of our contracts have annual incentive fee
targets, we typically record incentive fees on these contracts
in the last month of the annual contract period when all
contingencies have been met. We record termination fees as
revenue when all contingencies related to the termination fees
have been removed.
These amounts represent expenses incurred in managing the hotel
properties for which we are contractually reimbursed by the
hotel owner and generally include salary and employee benefits
for our employees working in the properties and certain other
insurance costs.
We are involved in various legal proceedings and tax matters.
Due to their nature, such legal proceedings and tax matters
involve inherent uncertainties including, but not limited to,
court rulings, negotiations between affected parties and
governmental actions. We assess the probability of loss for such
contingencies and accrue a liability
and/or
disclose the relevant circumstances, as appropriate. See
Note 15, “Commitments and Contingencies” for
additional information.
On January 1, 2007, we adopted FASB Interpretation
No. 48, “Accounting for Uncertainty in Income
Taxes— an Interpretation of FASB Statement
No. 109” (“FIN 48”). FIN 48
clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in
accordance with SFAS 109. FIN 48 also prescribes a
recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. The
cumulative effect of applying the provisions of FIN 48 are
reported as an adjustment to the opening balance of retained
earnings (or other appropriate components of equity or net
assets in the statement of financial position) for that fiscal
year. See Note 18, “Income Taxes” for additional
information.
We have accounted for income taxes in accordance with
SFAS No. 109, “Accounting for Income
Taxes” (“SFAS 109”). The objectives of
accounting for income taxes are to recognize the amount of taxes
payable or refundable for the current year and deferred tax
assets and liabilities to reflect the tax consequences on future
years of differences between the tax bases of assets and
liabilities and their financial reporting amounts. Deferred tax
assets and liabilities are measured using enacted tax rates in
effect for the year in which those temporary differences are
expected to be recovered or settled. The realization of total
deferred tax assets is contingent upon the generation of future
taxable income. Valuation allowances are provided to reduce such
deferred tax assets to amounts more likely than not to be
ultimately realized.
On January 1, 2006, we adopted SFAS No. 123
(revised 2004), “Share Based Payment”
(“SFAS 123R”) using the modified prospective
method. We have previously and will continue to use the
Black-Scholes pricing model to estimate the value of stock
options granted to employees. The adoption of SFAS 123R did
not have a material impact on our results of operations or
financial position as all of our unvested stock-based awards as
of December 31, 2005 had previously been accounted for
under the fair value method of accounting. See Note 14,
“Stock-Based Compensation,” for additional information.
We maintain the results of operations for our Russian office in
the local currency and translate these results using the average
exchange rates during the period. We translate the assets and
liabilities to U.S. dollars using the exchange
rate in effect at the balance sheet date. We reflect the
resulting translation adjustments in stockholders’ equity
as a cumulative foreign currency translation adjustment, a
component of accumulated other comprehensive (loss) income, net
of tax. To date, our only foreign currency exposure related to
our management contracts are for management and incentive fees
related to our properties in Russia and Belgium, which are
denominated and paid in Rubles and Euros, respectively. Most of
our foreign operations have been largely self-contained or
U.S. dollar-denominated and as such, we have not been
exposed to material foreign exchange risk.
We have entered into three interest rate cap agreements, which
are considered derivative instruments, in order to manage our
interest rate exposure. Our interest rate risk management
objective is to limit the impact of interest rate changes on our
earnings and cash flows. We record these agreements at fair
value as either assets or liabilities. Amounts paid or received
under these agreements are recognized over the life of the
agreements as adjustments to interest expense. If the
requirements for hedge accounting are met, gains and losses from
changes in the fair value of the agreements are recorded as a
component of accumulated other comprehensive (loss) income, net
of tax. Otherwise, we recognize changes in the fair value of the
agreements in the consolidated statement of operations. We do
not enter into derivative financial instruments for trading or
speculative purposes and monitor the financial stability and
credit standing of our counterparties.
The Company considers the recorded cost of its financial assets
and liabilities which consist primarily of cash and cash
equivalents, accounts receivable, marketable securities, notes
receivable, and accounts payable to approximate fair values of
the respective assets and liabilities as of December 31,
2007 and 2006, as they are primarily short-term in nature. Our
long-term debt is primarily variable rate, which is adjusted
quarterly, and therefore, approximated fair value as of
December 31, 2007 and 2006.
We compute basic earnings per share by dividing net income by
the weighted-average number of shares outstanding. Dilutive
earnings per share include the diluted effect of outstanding
stock-based compensation awards and minority interests that have
the option to convert their limited partnership interests to
common stock. No effect is presented for anti-dilutive
securities.
We participate in various vendor rebate and allowance
arrangements as a manager of hotel properties. There are three
types of programs common in the hotel industry that are
sometimes referred to as “rebates” or
“allowances,” including unrestricted rebates,
marketing (restricted) rebates and sponsorships. The primary
business purpose of these arrangements is to secure favorable
pricing for our hotel owners for various products and services
or enhance resources for promotional campaigns co-sponsored by
certain vendors. More specifically, unrestricted rebates are
funds returned to the buyer, generally based upon volumes or
quantities of goods purchased. Marketing (restricted) allowances
are funds allocated by vendor agreements for certain marketing
or other joint promotional initiatives. Sponsorships are funds
paid by vendors, generally used by the vendor to gain exposure
at meetings and events, which are accounted for as a reduction
of the cost of the event.
Unrestricted rebates are refunded back to the properties or
applied towards training programs for the properties. We account
for marketing and sponsorship allowances as adjustments of the
prices of the vendors’ products and services. Vendor
rebates received for unrestricted and marketing allowances are
recorded as accrued expenses on our consolidated balance sheets
until utilized.
In September 2006, FASB Statement No. 157, “Fair
Value Measurements” (“SFAS 157”) was
issued. SFAS 157 defines fair value, establishes a
framework for measuring fair value in accordance with
U.S. GAAP, and expands disclosures about fair value
measurements. SFAS 157 is effective for fiscal years
beginning after November 15, 2007. We are currently
evaluating the impact of the adoption of this statement.
In December 2007, FASB Statement No. 160,
“Noncontrolling Interests in Consolidated Financial
Statements” (“SFAS 160”) was issued.
SFAS 160 establishes a single method of accounting for
changes in a parent’s ownership interest in a subsidiary
that does not result in deconsolidation. The statement also
requires expanded disclosures in
the consolidated financial statements that clearly identify and
distinguish between the interests of the parent’s owners
and the interest of the noncontrolling owners of the subsidiary.
SFAS 160 is effective for fiscal years beginning after
December 15, 2008. We are currently evaluating the impact
of the adoption of this statement.
In December 2007, FASB Statement No. 141(R),
“Business Combinations”
(“SFAS 141(R)”) was issued. SFAS 141(R)
replaces SFAS 141, Business Combinations, however, it
retains the fundamental requirements in SFAS 141.
SFAS 141(R) defines the acquirer and the date of the
combination for each business acquisition. SFAS 141(R),
should be applied prospectively to business combinations for
which the acquisition dates are on or after the start of the
year beginning on or after December 15, 2008.
Our investments in and advances to our joint ventures consist of
the following (in thousands, except number of hotels):
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