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INTERSTATE HOTELS & RESORTS INC 10-Q 2007

Documents found in this filing:

  1. 10-Q
  2. Ex-10.5.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32
  6.  
e10vq
 

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
     
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended June 30, 2007
or
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to
 
 
Commission File Number 1-14331
 
 
 
 
     
Delaware
(State of Incorporation)
  52-2101815
(IRS Employer Identification No.)
4501 North Fairfax Drive, Ste 500
Arlington, VA
(Address of Principal Executive Offices)
  22203
(Zip Code)
 
 
www.ihrco.com
This Form 10-Q can be accessed at no charge through above website.
 
 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  þ  Yes     o No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
The number of shares of Common Stock, par value $0.01 per share, outstanding at August 1, 2007 was 31,678,569.
 


 

 
INTERSTATE HOTELS & RESORTS, INC.
 
 
 
                 
        Page
 
             
  Financial Statements (Unaudited):   2
             
    Consolidated Balance Sheets — June 30, 2007 and December 31, 2006   2
             
    Consolidated Statements of Operations and Comprehensive Income — Three and six months ended June 30, 2007 and 2006   3
             
    Consolidated Statements of Cash Flows — Six months ended June 30, 2007 and 2006   4
             
    Notes to Consolidated Financial Statements   5
             
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   21
             
  Quantitative and Qualitative Disclosures About Market Risk   35
             
  Controls and Procedures   35
 
             
  Legal Proceedings   37
             
  Submission of Matters to a Vote of Security Holders   37
             
  Exhibits   38


1


 

 
PART I. FINANCIAL INFORMATION
 
Item 1:   Financial Statements
 
INTERSTATE HOTELS & RESORTS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
 
                 
    June 30,
    December 31,
 
    2007     2006  
    (Unaudited)        
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 27,380     $ 25,308  
Restricted cash
    8,086       6,485  
Accounts receivable, net of allowance for doubtful accounts of $373 and $253, respectively
    27,398       31,511  
Due from related parties, net of allowance for doubtful accounts of $1,110 and $1,110, respectively
    944       1,469  
Prepaid expenses and other current assets
    4,056       2,592  
Assets held for sale
          28,383  
                 
Total current assets
    67,864       95,748  
Marketable securities
    1,919       1,610  
Property and equipment, net
    230,522       103,895  
Investments in affiliates
    11,220       11,144  
Notes receivable
    4,289       4,962  
Deferred income taxes
    12,067       12,451  
Goodwill
    73,672       73,672  
Intangible assets, net
    29,886       30,208  
                 
Total assets
  $ 431,439     $ 333,690  
                 
 
LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 1,958     $ 2,053  
Accrued expenses
    70,506       68,395  
Liabilities related to assets held for sale
          10,263  
Current portion of long-term debt
    862       3,750  
                 
Total current liabilities
    73,326       84,461  
Deferred compensation
    1,914       1,541  
Long-term debt
    171,375       80,476  
                 
Total liabilities
    246,615       166,478  
Minority interest
    519       516  
Commitments and contingencies
               
Stockholders’ equity:
               
Preferred stock, $.01 par value; 5,000,000 shares authorized, no shares issued
           
Common stock, $.01 par value; 250,000,000 shares authorized; 31,678,569, and 31,540,926 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively
    317       316  
Treasury stock
    (69 )     (69 )
Paid-in capital
    194,929       194,460  
Accumulated other comprehensive (loss) income
    (464 )     1,201  
Accumulated deficit
    (10,408 )     (29,212 )
                 
Total stockholders’ equity
    184,305       166,696  
                 
Total liabilities, minority interest and stockholders’ equity
  $ 431,439     $ 333,690  
                 
 
The accompanying notes are an integral part of the consolidated financial statements.


2


 

 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2007     2006     2007     2006  
 
Revenue:
                               
Lodging
  $ 18,621     $ 6,418     $ 31,697     $ 11,455  
Management fees
    10,728       12,422       21,350       21,625  
Management fees-related parties
    852       2,765       1,699       10,725  
Termination fees
    2,418       1,494       3,993       1,779  
Termination fees-related parties
          702             6,117  
Other
    2,763       2,718       5,032       6,429  
                                 
      35,382       26,519       63,771       58,130  
Other revenue from managed properties
    164,793       217,824       341,163       442,773  
                                 
Total revenue
    200,175       244,343       404,934       500,903  
Expenses:
                               
Lodging
    12,667       4,572       22,039       8,460  
Administrative and general
    14,575       15,385       27,890       29,030  
Depreciation and amortization
    3,684       1,546       6,977       3,089  
Asset impairments and write-offs
    1,047       92       1,155       8,642  
                                 
      31,973       21,595       58,061       49,221  
Other expenses from managed properties
    164,793       217,824       341,163       442,773  
                                 
Total operating expenses
    196,766       239,419       399,224       491,994  
                                 
OPERATING INCOME
    3,409       4,924       5,710       8,909  
Interest income
    721       545       1,157       931  
Interest expense
    (3,276 )     (1,970 )     (6,009 )     (4,025 )
Equity in earnings (losses) of affiliates
    854       123       1,255       (434 )
                                 
INCOME BEFORE MINORITY INTEREST AND INCOME TAXES
    1,708       3,622       2,113       5,381  
Income tax expense
    (708 )     (1,611 )     (855 )     (2,280 )
Minority interest expense
    (9 )     (31 )     (62 )     (49 )
                                 
INCOME FROM CONTINUING OPERATIONS
    991       1,980       1,196       3,052  
Income from discontinued operations, net of tax
    607       1,029       17,608       703  
                                 
NET INCOME
  $ 1,598     $ 3,009     $ 18,804     $ 3,755  
                                 
Other comprehensive income, net of tax:
                               
Foreign currency translation (loss) gain
    (18 )     418       (23 )     671  
Unrealized gain on investments
    1       24       18       12  
                                 
COMPREHENSIVE INCOME
  $ 1,581     $ 3,451     $ 18,799     $ 4,438  
                                 
BASIC EARNINGS PER SHARE:
                               
Continuing operations
  $ 0.03     $ 0.07     $ 0.04     $ 0.10  
Discontinued operations
    0.02       0.03       0.56       0.02  
                                 
Basic earnings per share
  $ 0.05     $ 0.10     $ 0.60     $ 0.12  
                                 
DILUTIVE EARNINGS PER SHARE:
                               
Continuing operations
  $ 0.03     $ 0.07     $ 0.04     $ 0.10  
Discontinued operations
    0.02       0.03       0.55       0.02  
                                 
Dilutive earnings per share
  $ 0.05     $ 0.10     $ 0.59     $ 0.12  
                                 
 
The accompanying notes are an integral part of the consolidated financial statements.


3


 

INTERSTATE HOTELS & RESORTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
                 
    Six Months Ended
 
    June 30,  
    2007     2006  
 
OPERATING ACTIVITIES:
               
Net income
  $ 18,804     $ 3,755  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    6,977       3,089  
Amortization of deferred financing fees
    1,113       387  
Stock compensation expense
    553       598  
Bad debt expense
    46       759  
Asset impairments and write-offs
    1,155       8,642  
Equity in (earnings) losses of affiliates
    (1,255 )     434  
Operating distributions from unconsolidated affiliates
    221       186  
Minority interest
    62       49  
Deferred income taxes
    384       1,033  
Excess tax benefits from share-based payment arrangements
    (87 )     (558 )
Discontinued operations:
               
Depreciation and amortization
          897  
Gain on sale
    (18,131 )      
Changes in assets and liabilities:
               
Accounts receivable
    4,640       (1,453 )
Due from related parties
    525       4,563  
Prepaid expenses and other current assets
    (1,088 )     (3,024 )
Accounts payable and accrued expenses
    1,227       (2,787 )
Changes in asset and liability accounts held for sale
    93        
Other changes in asset and liability accounts
    180       357  
                 
Cash provided by operations
    15,419       16,927  
                 
INVESTING ACTIVITIES:
               
Proceeds from the sale of discontinued operations
    34,966        
Change in restricted cash
    (1,601 )     4  
Acquisition of hotels
    (127,958 )     (14,528 )
Purchases related to discontinued operations
    (68 )     (1,516 )
Purchases of property and equipment
    (4,027 )     (2,947 )
Additions to intangible assets
    (1,740 )     (804 )
Contributions to unconsolidated affiliates
    (1,377 )     (6,248 )
Distributions from unconsolidated affiliates
    2,759        
Changes in notes receivable
    746       60  
                 
Cash used in investing activities
    (98,300 )     (25,979 )
                 
FINANCING ACTIVITIES:
               
Proceeds from borrowings
    147,825       9,000  
Repayment of borrowings
    (59,814 )     (12,500 )
Excess tax benefits from share-based payments
    87       558  
Proceeds from issuance of common stock
    190       2,201  
Financing fees paid
    (3,317 )      
                 
Cash provided by (used in) financing activities
    84,971       (741 )
                 
Effect of exchange rate on cash
    (18 )     187  
Net increase (decrease) in cash and cash equivalents
    2,072       (9,606 )
CASH AND CASH EQUIVALENTS, beginning of period
    25,308       12,929  
                 
CASH AND CASH EQUIVALENTS, end of period
  $ 27,380     $ 3,323  
                 
SUPPLEMENTAL CASH FLOW INFORMATION
               
Cash paid for interest and income taxes:
               
Interest
  $ 4,577     $ 3,676  
Income taxes
    1,894       1,364  
 
The accompanying notes are an integral part of the consolidated financial statements.


4


 

INTERSTATE HOTELS & RESORTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.   BUSINESS SUMMARY
 
We are one of the largest independent U.S. hotel management companies not affiliated with a hotel brand, measured by number of rooms under management. We derive our earnings from a diversified portfolio of hotel management agreements and ownership of select hotel properties. While we continue to focus on our core business as a leading provider of hospitality management services, we continue to expand our portfolio of owned hotels in an effort to diversify and enhance our earnings. In 2007, a significant portion of our operating income will be related to owned hotels. We have two reportable operating segments: hotel management and hotel ownership (through whole-ownership and joint ventures). A third reportable segment, corporate housing, was disposed of on January 26, 2007 with the sale of BridgeStreet, our corporate housing division.
 
Our management portfolio is diversified by brand, franchise and ownership group to which we provide related services in the hotel, resort and conference center markets. These services include insurance and risk management, purchasing and capital project management, information technology and telecommunications, and centralized accounting services. As of June 30, 2007, we managed 187 hotel properties and five ancillary service centers (which consist of two laundry centers, two conference centers, and a spa facility), with 42,760 rooms in 36 states, the District of Columbia, Canada, Russia, Belgium and Ireland. We also owned six hotel properties, with 1,755 rooms, and held non-controlling joint venture equity interests in 11 joint ventures, which own or hold ownership interests in 17 of our managed properties.
 
Our corporate housing division 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 as minority interest 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.
 
2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 
We have prepared these unaudited consolidated interim financial statements according to the rules and regulations of the Securities and Exchange Commission. Accordingly, we have omitted certain information and footnote disclosures that are normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). These interim financial statements should be read in conjunction with the financial statements, accompanying notes and other information included in our Annual Report on Form 10-K, for the year ended December 31, 2006.
 
In our opinion, the accompanying unaudited consolidated interim financial statements reflect all normal and recurring adjustments necessary for a fair presentation of the financial condition and results of operations and cash flows for the periods presented. The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities, as well as the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Our actual results could differ from those estimates. The results of operations for the interim periods are not necessarily indicative of our results for the entire year.


5


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

These consolidated financial statements include our accounts and the accounts for all of our majority owned subsidiaries. We eliminate all significant intercompany balances and transactions. Certain reclassifications have been made to our prior year financial statements to conform to our current presentation.
 
 
As we have existing management agreements with Blackstone, the owner of multiple hotels which we have purchased, we evaluate the impact of EITF Issue No. 04-1, “Accounting for Preexisting Relationships between the Parties to a Business Combination” (“EITF 04-1”) on the purchase accounting for these acquisitions. Our agreements with Blackstone have provisions which require the payment of termination fees if Blackstone elects to terminate the management contract or sells the hotel to any buyer, including us. We determine the amount by which the pricing of these contracts is favorable when compared to the pricing we have negotiated with owners for recently executed management contracts for comparable hotel properties and compare this amount to the amount of the required termination fee due from Blackstone. EITF 04-1 requires that we recognize the lesser of the amounts as a gain on the settlement of the executory contract and as part of the acquisition cost of the hotel. For the Hilton Houston Westchase and Westin Atlanta Airport acquisitions, the amount by which the pricing of the Blackstone contracts are favorable to us exceeded the stated termination fees due to us from Blackstone. Accordingly, we recorded the stated termination fees for the Hilton Houston Westchase and the Westin Atlanta Airport of $1.0 million and $1.4 million, respectively, at the time of acquisition.
 
 
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 June 30, 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 Mr. Whetsell was also the CEO of MeriStar. Mr. Whetsell did not become part of the Blackstone management team and accordingly, we no longer 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, 2006 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.”
 
Our managed properties for which we also hold a joint venture ownership interest continue to be included in “management fees — related parties.” See Note 4, “Investments in Affiliates” for further information on these related party amounts.
 
 
On January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share Based Payment” (“SFAS 123R”) using the modified prospective method. Beginning January 1, 2003, we have used 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 13, “Stock-Based Compensation,” 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


6


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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. See Note 14, “FIN 48 — Recognition and Measurement of Tax Positions and Benefits,” for additional information.
 
 
In June 2006, EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement, That Is, Gross versus Net Presentation” (“EITF 06-3”) was ratified. EITF 06-3, which is effective for periods beginning after December 15, 2006, requires the disclosure of the accounting policy for any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction on a gross (included in revenues and costs) or net (excluded from revenues) basis. We have reported revenues from our owned-hotels, which are subject to various taxes assessed by government authorities, including sales and use taxes, on a net basis.
 
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 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 February 2007, FASB Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities (as amended)” (“SFAS 159”) was issued. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. It provides entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of the adoption of this statement.
 
3.   EARNINGS PER SHARE
 
We calculate our basic earnings per common share by dividing net income by the weighted average number of shares of common stock outstanding. Our diluted earnings per common share assume the issuance of common stock for all potentially dilutive stock equivalents outstanding. Potentially dilutive shares include restricted stock, stock options granted under our various stock compensation plans and operating partnership units held by minority partners. In periods in which there is a loss, diluted shares outstanding will equal basic shares outstanding to prevent anti-dilution.
 
Basic and diluted earnings per common share are as follows (in thousands, except per share amounts):
 
                                                 
    Three Months Ended  
    June 30, 2007     June 30, 2006  
    Income/
          Per Share
    Income/
          Per Share
 
    (Loss)     Shares     Amount     (Loss)     Shares     Amount  
 
Income from continuing operations
  $ 991       31,642     $ 0.03     $ 1,980       30,890     $ 0.07  
Income from discontinued operations, net of tax
    607             0.02       1,029             0.03  
                                                 
Basic net income
  $ 1,598       31,642     $ 0.05     $ 3,009       30,890     $ 0.10  
Assuming exercise of outstanding employee stock options less shares repurchased at average market price
          41                   212        
Assuming vesting of outstanding restricted stock
          306                   174        
                                                 
Diluted net income
  $ 1,598       31,989     $ 0.05     $ 3,009       31,276     $ 0.10  
                                                 
 


7


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                                 
    Six Months Ended  
    June 30, 2007     June 30, 2006  
    Income/
          Per Share
    Income/
          Per Share
 
    (Loss)     Shares     Amount     (Loss)     Shares     Amount  
 
Income from continuing operations
  $ 1,196       31,602     $ 0.04     $ 3,052       30,788     $ 0.10  
Income from discontinued operations, net of tax
    17,608             0.56       703             0.02  
                                                 
Basic net income
  $ 18,804       31,602     $ 0.60     $ 3,755       30,788     $ 0.12  
Assuming exercise of outstanding employee stock options less shares repurchased at average market price
          65                   157        
Assuming vesting of outstanding restricted stock
          227       (0.01 )           144        
                                                 
Diluted net income
  $ 18,804       31,894     $ 0.59     $ 3,755       31,089     $ 0.12  
                                                 
 
4.   INVESTMENTS IN AFFILIATES
 
Our investments and advances to our joint ventures and affiliated companies consist of the following (in thousands, except number of hotels):
 
                             
          Our Equity
  June 30,
    December 31,
 
Joint Venture
  Number of Hotels     Participation   2007     2006  
 
CNL/IHC Partners, L.P. 
    3     15.0%   $ 2,698     $ 2,625  
RQB Resort/Development Investors, LLC
    1     10.0%     913       447  
True North Tesoro Property Partners, L.P. 
    1     15.9%     29       1,381  
Amitel Holdings, LLC
    6     15.0%     3,909       3,903  
Cameron S-Sixteen Hospitality, LLC
    1     10.9%     451       487  
Cameron S-Sixteen Broadway, LLC
    1     15.7%     1,085       1,136  
IHR Greenbuck Hotel Venture, LLC(1)
        15.0%     1,074       362  
Interstate Cross Keys, LLC
    1     15.0%     572        
Other
    3     12.5%-50.0%     489       803  
                             
Total
    17         $ 11,220     $ 11,144  
                             
 
 
(1) Hotel number is not listed since this joint venture is in the process of developing hotels.
 
In March 2007, we invested $0.5 million to acquire a 15% interest in the 147-room Radisson Cross Keys hotel in Baltimore, Maryland. We plan to invest an additional $0.3 million for future capital improvements.
 
In April 2007, the joint venture which owns the Doral Tesoro Hotel and Golf Club made a distribution to us of $1.8 million, which included the return of our initial investment of $1.5 million and a return on investment. As the distribution received was greater than our investment balance at the time of the distribution, the investment balance was reduced to zero with the remainder recorded as a deferred gain in our consolidated balance sheets. The distribution in excess of our investment will be deferred until such time as the assets in the venture are sold or another such event has occurred, resulting in the culmination of the earnings process. The distribution did not impact our percentage investment ownership interest in the joint venture. Also in April 2007, our joint venture Orchard Park Associates, L.P., in which we hold a 5% ownership interest, sold the Comfort Suites Norwich. We received a $0.1 million distribution as a result of the sale.

8


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During 2007, we invested an additional $0.7 million in our joint venture, IHR Greenbuck Hotel Venture, LLC, to build as many as five to ten aloft® hotels over the next several years.
 
We had related party accounts receivable from our joint venture ownership interests of $0.9 million and $1.4 million as of June 30, 2007 and December 31, 2006. We had related party management fees from these joint ventures of $0.9 million and $1.7 million for the three and six months ended June 30, 2007, respectively and $0.8 million and $2.2 million for the three and six months ended June 30, 2006, respectively.
 
The recoverability of the carrying values of our investments and advances to our investees is dependent upon the operating results of the underlying real estate investments. Future adverse changes in the hospitality and lodging industry, market conditions or poor operating results of the underlying investments could result in future impairment losses or the inability to recover the carrying value of these long-lived assets. The debt of all investees is non-recourse to us and we do not guarantee any of our investees’ obligations. We are not the primary beneficiary or controlling investor in any of these joint ventures however, do exert significant influence as the manager of the underlying assets, and therefore account for our interests under the equity method.
 
5.   PROPERTY AND EQUIPMENT
 
Property and equipment consist of the following (in thousands):
 
                 
    June 30,
    December 31,
 
    2007     2006  
 
Land
  $ 19,547     $ 10,269  
Furniture and fixtures
    25,964       17,437  
Building and improvements
    187,234       75,566  
Leasehold improvements
    5,695       5,889  
Computer equipment
    6,414       4,978  
Software
    11,883       12,244  
                 
Total
    256,737       126,383  
Less accumulated depreciation
    (26,215 )     (22,488 )
                 
Property and equipment, net
  $ 230,522     $ 103,895  
                 
 
6.   INTANGIBLE ASSETS
 
Intangible assets consist of the following (in thousands):
 
                 
    June 30,
    December 31,
 
    2007     2006  
 
Management contracts
  $ 35,382     $ 35,940  
Franchise fees
    1,814       1,620  
Deferred financing fees
    3,635       2,538  
                 
Total cost
    40,831       40,098  
Less accumulated amortization
    (10,945 )     (9,890 )
                 
Intangible assets, net
  $ 29,886     $ 30,208  
                 
 
We amortize the value of our intangible assets, which all have definite useful lives, over their estimated useful lives, which generally correspond with the expected terms of the associated management, franchise, or financing agreements. For the six months ended June 30, 2007, we recognized management contract impairment charges of $1.2 million, including $0.7 million for the Westin Atlanta Airport which we purchased from Blackstone in May 2007, $0.4 million associated with seven properties sold by Sunstone Hotels Investors, Inc. (“Sunstone REIT”) and $0.1 million related to other terminated or lost management contracts. For the six months ended June 30, 2006, the


9


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

management contract impairment losses of $8.6 million primarily consisted of $8.3 million for the termination of management contracts related to 18 MeriStar/Blackstone properties.
 
We incurred scheduled amortization expense on our remaining management contracts and franchise fees of $1.4 million and $2.7 million for the three and six months ended June 30, 2007, respectively, and $0.6 million and $1.5 million for the three and six months ended June 30, 2006, respectively. We also incurred amortization expense related to deferred financing fees of $0.4 million and $1.1 million for the three and six months ended June 30, 2007, respectively, and $0.2 million and $0.4 million for the three and six months ended June 30, 2006, respectively. During the first quarter of 2007, $0.5 million of deferred financing fees related to our old senior credit facility was amortized in connection with our entrance into a new $125.0 million senior secured credit facility (the “Credit Facility”) and the related payoff of our old senior credit facility and subordinated term loan. Amortization of deferred financing fees are included in interest expense.
 
In connection with the new Credit Facility, we recorded $2.2 million of financing fees which will be amortized over the term of the Credit Facility. During the second quarter of 2007, we recorded an additional $0.8 million of financing fees in connection to the amendment of our Credit Facility. See Note 8, “Long-Term Debt,” for additional information related to the Credit Facility.
 
We evaluate our capitalized management contracts for impairment when circumstances warrant. When we receive notification that a management contract will be terminated early, we evaluate when, or if, amortization should be accelerated or if any remaining management contract costs should be impaired. We have revised the estimated economic lives of the underlying management contracts for the remaining Blackstone properties from 25 years to approximately four years as Blackstone has initiated plans to sell most of the portfolio of hotels within four years and had taken over management or executed sales of seven hotels as of December 31, 2006. The change in estimate occurred in December 2006 and was applied as of January 1, 2007. As of June 30, 2007, we do not believe the carrying value of $25.6 million associated with the remaining management contracts is impaired. We will continue to assess the recorded value of our management contracts and their related amortization periods as circumstances warrant.
 
We evaluate goodwill annually for impairment during the fourth quarter; however, when circumstances warrant, we will assess the valuation of our goodwill more frequently. During the six months ended June 30, 2007, no material transactions occurred which were not already considered in our analysis during the fourth quarter of 2006. As such, we did not re-evaluate our goodwill in the second quarter of 2007.
 
7.   ACCRUED EXPENSES
 
Accrued expenses consist of the following (in thousands):
 
                 
    June 30,
    December 31,
 
    2007     2006  
 
Salaries and employee related benefits
  $ 22,831     $ 24,895  
Deferred revenue
    4,862       561  
Other
    42,813       42,939  
                 
Total
  $ 70,506     $ 68,395  
                 
 
“Other” consists of legal expenses, sales and use tax accruals, property tax accruals, owners insurance for our managed hotels, general and administrative costs of managing our business and various other items. No individual amounts in “Other” represent more than 5% of current liabilities.


10


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

8.   LONG-TERM DEBT
 
Our long-term debt consists of the following (in thousands):
 
                 
    June 30,
    December 31,
 
    2007     2006  
 
Senior credit facility — term loan
  $ 114,712     $ 40,526  
Mortgage debt
    57,525       43,700  
                 
Total long-term debt
    172,237       84,226  
Less current portion
    (862 )     (3,750 )
                 
Long-term debt, net of current portion
  $ 171,375     $ 80,476  
                 
 
 
In March 2007, we entered into a new senior secured Credit Facility with various lenders. The Credit Facility consisted of a $65.0 million term loan and a $60.0 million revolving loan. Upon entering into the Credit Facility, we borrowed $65.0 million under the term loan, using a portion of it to pay off the remaining obligations under our previous credit facility. In May 2007, we amended the Credit Facility to increase the borrowings under our term loan by $50.0 million, resulting in a total of $115.0 million outstanding under the term loan, and increased the availability under our revolving loan to $85.0 million. 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 seeking additional commitments from lenders. Simultaneously with the amendment, we used the additional $50.0 million under the term loan, along with cash on hand, to purchase the 495-room Westin Atlanta Airport. See Note 12, “Acquisitions and Dispositions,” for additional information.
 
The actual interest rates on both the revolving loan and term loan depend on the results of certain financial tests. As of June 30, 2007, based on those financial tests, borrowings under the term and revolving loan bore interest at the 30-day LIBOR rate plus 275 basis points (a rate of 8.07% per annum). We incurred interest expense of $1.9 million and $2.7 million on the senior credit facilities for the three and six months ended June 30, 2007, respectively, and $1.4 million and $3.0 million for the three and six months ended June 30, 2006, respectively.
 
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. At June 30, 2007, we were in compliance with the loan covenants of the Credit Facility.
 
 
The following table summarizes our mortgage debt as of June 30, 2007:
 
                                 
    Principal
  Maturity
  Spread Over
  Interest Rate as of
    Amount   Date(1)   30-Day LIBOR   June 30, 2007
 
Hilton Arlington
  $ 24.7 million       November 2009       135 bps       6.7 %
Hilton Houston Westchase
  $ 32.8 million       February 2010       135 bps       6.7 %
 
 
(1) We are required to make interest-only payments until these loans mature, with two optional one-year extensions.
 
In April 2007, we repaid in full, $19.0 million of mortgage debt relating to the Hilton Concord. We incurred no prepayment penalties in connection with the early repayment.
 
We incurred interest expense on these mortgage loans of $1.0 million and $2.1 million for the three and six months ended June 30, 2007, respectively, and $0.3 million and $0.7 million for the three and six months ended June 30, 2006, respectively. Based on the terms of these mortgage loans, a prepayment cannot be made during the


11


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

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.
 
 
We have entered into three interest rate cap agreements in order to provide an economic hedge against the potential effect of future interest rate fluctuations. The following table summarizes our interest rate cap agreements as of June 30, 2007:
 
                         
          Maturity
    30-Day LIBOR
 
    Amount     Date     Cap Rate  
 
March 2005 (Credit Facility)
  $ 55.0 million       January 2008       5.75 %
October 2006 (Hilton Arlington mortgage loan)
  $ 24.7 million       November 2009       7.25 %
February 2007 (Hilton Westchase mortgage loan)
  $ 32.8 million       February 2010       7.25 %
 
At June 30, 2007, the total fair value of these interest rate cap agreements was approximately $19,000. The change in fair value for these interest rate cap agreements was de minimus and was recognized in the consolidated statement of operations.
 
9.   SEGMENT INFORMATION
 
We are organized into two reportable segments: hotel management and hotel ownership (through whole-ownership and joint ventures). A third reportable segment, corporate housing, was disposed of on January 26, 2007 with the sale of BridgeStreet and its affiliated subsidiaries. Each segment is managed separately because of its distinctive economic characteristics. Reimbursable expenses, classified as “other revenue and expenses from managed properties” on the statement of operations, are not included as part of this segment analysis. These reimbursable expenses are all part of the hotel management segment.
 
Hotel management includes the operations related to our managed properties, our purchasing, construction and design subsidiary and our insurance subsidiary. Revenue for this segment consists of “management fees” (which includes $3.2 million of business interruption proceeds received during the first quarter of 2006), “termination fees” and “other” from our consolidated statement of operations. Our insurance subsidiary, as part of the hotel management segment, provides a layer of reinsurance for property, casualty, and auto and employment practices liability coverage to our hotel owners.
 
Hotel ownership includes our wholly-owned hotels and joint venture investments. For the hotel ownership segment presentation, we have allocated internal management fee expense of $0.4 million and $0.8 million for the three and six months ended June 30, 2007, respectively, and $0.2 million and $0.4 million for the three and six months ended June 30, 2006, respectively. These fees are eliminated in consolidation but are presented as part of the segment to present their operations on a stand-alone basis. Interest expense related to hotel mortgages and other debt drawn specifically to finance the hotels is included in the hotel ownership segment. As of January 1, 2007, our entire debt balance relates to our hotel ownership segment.
 
Corporate is not actually a reportable segment but rather includes costs that do not specifically relate to any other single segment of our business. Corporate includes expenses related to our public company structure, certain restructuring charges, Board of Directors costs, audit fees, unallocated corporate interest expense and an allocation for rent and legal expenses. Corporate assets include the Company’s cash accounts, deferred tax assets, deferred financing fees and various other corporate assets.
 
Due to the sale of our third reportable segment, corporate housing, in January 2007, the operations of this segment are included as part of discontinued operations on the consolidated statement of operations for all periods presented. The assets related to this segment have been presented as assets held for sale on the consolidated balance sheet as of December 31, 2006. The assets of our corporate housing segment of $35.3 million as of June 30, 2006 are separately included within the corporate assets in the segment presentation below. As the corporate housing


12


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

segment was sold, we have not presented its operations within the following segment presentation. See Note 12, “Acquisitions and Dispositions” for more information on the disposition of the segment.
 
Capital expenditures includes the “acquisition of hotels” and “purchases of property and equipment” line items from our cash flow statement. All amounts presented are in thousands.
 
                                 
    Hotel
    Hotel
             
    Management     Ownership     Corporate     Consolidated  
 
Three months ended June 30, 2007
                               
Revenue
  $ 16,761     $ 18,621     $     $ 35,382  
Depreciation and amortization
    1,782       1,790       112       3,684  
Operating expense
    13,079       13,129       2,081       28,289  
                                 
Operating income (loss)
    1,900       3,702       (2,193 )     3,409  
Interest expense, net
          (2,915 )     360       (2,555 )
Equity in earnings of affiliates
          854             854  
                                 
Income (loss) before minority interests and income taxes
  $ 1,900     $ 1,641     $ (1,833 )   $ 1,708  
                                 
Capital expenditures
  $ 46     $ 78,256     $ 11     $ 78,313  
Three months ended June 30, 2006
                               
Revenue
  $ 20,101     $ 6,418     $     $ 26,519  
Depreciation and amortization
    973       457       116       1,546  
Operating expense
    13,926       4,783       1,340       20,049  
                                 
Operating income (loss)
    5,202       1,178       (1,456 )     4,924  
Interest expense, net
          (514 )     (911 )     (1,425 )
Equity in earnings of affiliates
          123             123  
                                 
Income (loss) before minority interests and income taxes
  $ 5,202     $ 787     $ (2,367 )   $ 3,622  
                                 
Capital expenditures
  $ 792     $ 15,387     $ 247     $ 16,426  
 


13


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                 
    Hotel
    Hotel
             
    Management     Ownership     Corporate     Consolidated  
 
Six months ended June 30, 2007
                               
Revenue
  $ 32,074     $ 31,697     $     $ 63,771  
Depreciation and amortization
    3,545       3,216       216       6,977  
Operating expense
    25,189       22,865       3,030       51,084  
                                 
Operating income (loss)
    3,340       5,616       (3,246 )     5,710  
Interest expense, net
          (4,871 )     19       (4,852 )
Equity in earnings of affiliates
          1,255             1,255  
                                 
Income (loss) before minority interests and income taxes
  $ 3,340     $ 2,000     $ (3,227 )   $ 2,113  
                                 
Total assets
  $ 138,951     $ 246,914     $ 45,574     $ 431,439  
Capital expenditures
  $ 633     $ 131,194     $ 158     $ 131,985  
Six months ended June 30, 2006
                               
Revenue
  $ 46,675     $ 11,455     $     $ 58,130  
Depreciation and amortization
    1,967       899       223       3,089  
Operating expense
    34,560       8,816       2,756       46,132  
                                 
Operating income (loss)
    10,148       1,740       (2,979 )     8,909  
Interest expense, net
          (1,002 )     (2,092 )     (3,094 )
Equity in earnings of affiliates
          (434 )           (434 )
                                 
Income (loss) before minority interests and income taxes
  $ 10,148     $ 304     $ (5,071 )   $ 5,381  
                                 
Total assets
  $ 156,255     $ 76,229     $ 64,370     $ 296,824  
Capital expenditures
  $ 1,394     $ 15,684     $ 397     $ 17,475  
 
Revenues from foreign operations, excluding reimbursable expenses, were as follows (in thousands)(1):
 
                                 
    Three Months
    Six Months
 
    Ended June 30,     Ended June 30,  
    2007     2006     2007     2006  
 
Canada
  $ 69     $ 124     $ 130     $ 197  
Russia
  $ 180     $ 375     $ 360     $ 750  
Belgium
  $ 28     $     $ 28     $  
Ireland
  $ 60     $     $ 60     $  
 
 
(1) BridgeStreet revenues from the United Kingdom and France were $2.8 million and $0.2 million, respectively, for the six month period ended June 30, 2007. Revenues from the United Kingdom and France were $8.5 million and $0.7 million for the three months ended June 30, 2006, respectively, and $15.5 million and $1.1 million for the six month period ended June 30, 2006, respectively. These revenues have been classified as discontinued operations on the consolidated statement of operations for the related periods.
 
A significant portion of our management fees for the three and six month periods ended June 30, 2007 were derived from Blackstone and Sunstone REIT. These owners represented 31% of our managed properties through the six months ended June 30, 2007 which contributed 44% and 43% of our base and incentive management fees for the three and six months ended June 30, 2007, respectively. As of June 30, 2007, we managed 19 hotels for Blackstone and 30 hotels and two ancillary service centers for Sunstone REIT. The total management fees for all Blackstone properties accounted for $2.2 million, or 19%, of management fees for the three months ended June 30, 2007, and $5.3 million, or 23%, of management fees for the six month period ended June 30, 2007. The

14


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Sunstone REIT properties accounted for $2.6 million, or 23%, of management fees for the three months ended June 30, 2007 and $4.9 million, or 21%, of management fees for the six month period ended June 30, 2007.
 
10.   OTHER TRANSACTIONS
 
We managed eight properties that were damaged or closed due to hurricanes in 2004. In March 2006, we settled our claim for lost management fees and received approximately $3.2 million in business interruption proceeds. This recovery is recorded in management fees on the income statement.
 
11.   COMMITMENTS AND CONTINGENCIES
 
 
As part of our management services to hotel owners, we generally obtain casualty (workers’ compensation and general liability) insurance coverage for our managed hotels. In December 2002, one of the carriers we used to obtain casualty insurance coverage was downgraded significantly by rating agencies. In January 2003, we negotiated a transfer of that carrier’s current policies to a new carrier. We have been working with the prior carrier to facilitate a timely and efficient settlement of the original 1,213 claims outstanding under the prior carrier’s casualty policies. The prior carrier has primary responsibility for settling these claims from its assets. As of June 30, 2007, 48 claims remained outstanding. If the prior carrier’s assets are not sufficient to settle these outstanding claims, and the claims exceed amounts available under state guaranty funds, we may be required to settle those claims. We are indemnified under our management agreements for such amounts, except for periods prior to January 2001, when we leased certain hotels from owners. Based on currently available information, we believe the ultimate resolution of these claims will not have a material adverse effect on our consolidated financial position, results of operations or liquidity.
 
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 hold the legal right of offset in regard to this receivable and payable with the prior insurance carrier. We will continue to pursue collection of our receivable and do not expect to pay any amounts to the prior carrier prior to reaching an agreement with it 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.
 
 
With the sale of BridgeStreet, we no longer lease apartments for our corporate housing division. As of June 30, 2007, our lease obligations consist of only office space for our corporate offices. Future minimum lease payments required under these operating leases as of June 30, 2007 were as follows (in thousands):
 
         
June 30, 2007-2008
  $ 3,563  
June 30, 2008-2009
    2,928  
June 30, 2009-2010
    3,262  
June 30, 2010-2011
    2,841  
June 30, 2011-2012
    3,179  
Thereafter
    3,817  
         
Total
  $ 19,590  
         


15


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The operating lease obligations shown in the table above have not been reduced by a non-cancelable sublease related to our former corporate office space. We remain secondarily liable under this lease in the event that the sub-lessee defaults under the sublease terms. Given the size and financial stability of the sub-lessee, we do not believe that any payments will be required as a result of the secondary liability provisions of the primary lease agreements. We expect to receive minimum payments under this sublease as follows (in thousands):
 
         
June 30, 2007-2008
  $ 1,112  
June 30, 2008-2009
    1,156  
June 30, 2009-2010
    1,202  
June 30, 2010-2011
    1,250  
June 30, 2011-2012
    1,300  
Thereafter
    1,581  
         
Total
  $ 7,601  
         
 
 
Under the provisions of management agreements with certain hotel owners, we are obligated to provide an aggregate of $3.0 million to these hotel owners in the form of investments or loans. The timing of future investments or working capital loans to hotel owners is not currently known as these advances are at the hotel owner’s discretion. We are also required to fund up to $0.6 million in the event of cost overruns in excess of 110% of the projected budgeted costs, as defined in the relevant management agreement, for the development of certain hotels related to one of our joint venture interests.
 
In connection with our owned hotels, we have committed to provide certain funds for property improvements as required by the respective brand franchise agreements. As of June 30, 2007, we had ongoing improvement projects in effect with remaining expected costs to complete of approximately $8.6 million for five of our owned hotels and $18.0 million for Westin Atlanta Airport.
 
 
As of June 30, 2007, we had a $1.5 million letter of credit outstanding from Northridge Insurance Company in favor of our property insurance carrier. The letter of credit expires on April 4, 2008. We are required by the property insurance carrier to deliver the letter of credit to cover its losses in the event we default on payments to the carrier. Accordingly, the lender has required us to restrict a portion of our cash equal to the amount of the letter of credit, which we present as restricted cash on the consolidated balance sheet. We also have a $0.8 million letter of credit outstanding from Bank of America in favor of the insurance carrier that issues surety bonds on behalf of the properties we manage. The letter of credit expires on March 31, 2008. We are required by the insurance carrier to deliver the letter of credit to cover its risk in the event the properties default on their required payments related to the surety bonds.
 
 
We own interests in several partnerships and other joint ventures. To the extent that any of these partnerships or joint ventures become unable to pay its obligations, those obligations would become obligations of the general partners. We are not the sole general partner of any of our joint ventures. While we believe we are protected from any risk of liability because our investments in these partnerships as a general partner were conducted through the use of single-purpose entities, to the extent any debtors pursue payment from us, it is possible that we could be held liable for those liabilities, and those amounts could be material.


16


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

12.   ACQUISITIONS AND DISPOSITIONS
 
 
In May 2007, we acquired the 495-room Westin Atlanta Airport in Georgia, from an affiliate of Blackstone, for a total acquisition cost of $76.1 million, including normal and customary closing costs. We funded the acquisition through a combination of borrowings on our Credit Facility and cash on hand. From May 24, 2007 to June 30, 2007, hotel revenues and operating income of $2.4 million and $0.6 million, respectively, have been included in our consolidated statement of operations. The acquisition cost of the hotel was allocated as follows (in thousands):
 
         
Land
  $ 4,419  
Buildings and improvements
    66,243  
Furniture and fixtures
    4,945  
Working capital
    474  
         
Total
  $ 76,081  
         
 
As the purchase of the Westin Atlanta Airport was a material acquisition, we are providing the pro forma financial information set forth below (dollars in thousands), which represents the combined results as if the acquisition had occurred on January 1, 2006. This pro forma information is not necessarily indicative of the results that actually would have occurred nor does it intend to indicate future operating results.
 
                 
    Six Months
 
    Ended June 30,  
    2007     2006  
 
Pro forma lodging revenues
  $ 42,016     $ 24,264  
Pro forma net income
  $ 20,354     $ 5,690  
Pro forma diluted earnings per share
  $ 0.64     $ 0.18  
 
In February 2007, we acquired the 297-room Hilton Houston Westchase in Texas, from an affiliate of Blackstone, for a total acquisition cost of $51.9 million, including normal and customary closing costs. We financed the acquisition through a non-recourse mortgage loan of $32.8 million and the remainder with a combination of cash on hand and borrowings on our previous credit facility. From February 8, 2007 to June 30, 2007, hotel revenues and operating income of $7.8 million and $2.0 million, respectively, have been included in our consolidated statement of operations. The acquisition cost of the hotel was allocated as follows (in thousands):
 
         
Land
  $ 4,860  
Buildings and improvements
    43,422  
Furniture and fixtures
    3,411  
Working capital
    184  
         
Total
  $ 51,877  
         


17


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

On June 27, 2006, we acquired the 131-room Hilton Garden Inn Baton Rouge Airport in Louisiana. The acquisition cost was $14.5 million, including normal and customary closings costs. We financed the purchase through borrowings on our previous credit facility and available cash. The acquisition cost of the hotel was allocated as follows (in thousands):
 
         
Land
  $ 1,375  
Buildings and improvements
    12,087  
Furniture and fixtures
    1,022  
Working Capital
    44  
         
Total
  $ 14,528  
         
 
Dispositions — On January 26, 2007, we sold our BridgeStreet corporate housing subsidiary for total proceeds of approximately $40.5 million in cash, resulting in a gain on sale of approximately $18.1 million. This gain has been recorded as part of discontinued operations for the six months ended June 30, 2007. Our corporate housing business had been classified as its own reportable segment. We classified the assets and liabilities relating to this subsidiary as held for sale in our consolidated balance sheet at December 31, 2006 as detailed in the following table (in thousands):
 
         
    December 31,
 
    2006  
 
Accounts receivable, net
  $ 8,064  
Prepaid expenses and other current assets
    8,247  
Property and equipment, net
    2,214  
Goodwill
    9,858  
         
Total assets held for sale
  $ 28,383  
         
Accounts payable
  $ 2,498  
Accrued expenses
    7,765  
         
Total liabilities held for sale
  $ 10,263  
         
 
The operations of the corporate housing subsidiary have been classified as discontinued operations in our consolidated statement of operations for all periods presented. The following table summarizes operating results, the gain on the sale, and our segment reporting of our corporate housing subsidiary (in thousands):
 
                 
    Six Months
 
    Ended June 30,  
    2007     2006  
 
Revenue
  $ 8,500     $ 61,052  
Depreciation and amortization
          897  
Operating expense
    8,969       59,112  
                 
Operating (loss) income
  $ (469 )   $ 1,043  
Gain on sale
    18,131        
Interest expense
          16  
                 
Income before minority interest and taxes
  $ 17,662     $ 1,027  
Income tax expense
    (175 )     (324 )
                 
Income from discontinued operations, net of taxes
  $ 17,487     $ 703  
                 


18


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The disposition of our corporate housing subsidiary triggered the recognition of significant differences in the carrying values between tax basis and GAAP basis. As the tax basis was significantly higher, the gain realized for tax purposes was significantly lower than the $18.1 million gain recognized in our statement of operations for the six month period ended June 30, 2006, resulting in an effective tax rate of 1%.
 
In September 2005, we sold the Pittsburgh Airport Residence Inn by Marriott for $11.0 million and recognized a gain on sale of $2.5 million. We received an additional distribution of $0.2 million during the second quarter of 2007 that had been held in escrow for any contingent liabilities. The resulting adjustment to our gain on sale of $0.1 million (net of tax) has been recorded as part of discontinued operations.
 
13.   STOCK-BASED COMPENSATION
 
On January 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share Based Payment” (“SFAS No. 123R”) using the modified prospective method. Since January 1, 2003, we have used the Black-Scholes pricing model to estimate the value of stock options granted to employees. The adoption of SFAS No. 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.
 
A summary of option activity under the equity-based compensation plans as of June 30, 2007, and changes during the six months then ended is as follows:
 
                         
                Aggregate
 
    Number of
    Weighted Average
    Intrinsic
 
    Shares     Exercise Price/Share     Value  
 
Options outstanding at December 31, 2006
    495,413     $ 6.81          
Granted
    40,000     $ 5.99          
Exercised
    (48,141 )   $ 3.94          
Forfeited
    (33,700 )   $ 10.92          
                         
Options outstanding at June 30, 2007
    453,572     $ 6.47     $ 240,462  
                         
Options exercisable at June 30, 2007
    340,246     $ 6.59     $ 224,514  
 
A summary of the restricted stock activity under the equity-based compensation plans as of June 30, 2007, and changes during the six months then ended is as follows:
 
                 
          Weighted
 
          Average
 
    Number of
    Grant-
 
    Restricted
    Date Fair
 
    Shares     Value  
 
Unvested at December 31, 2006
    326,577     $ 5.40  
Granted
    279,200     $ 6.04  
Vested
    (134,579 )   $ 5.31  
Forfeited
           
                 
Unvested at June 30, 2007
    471,198     $ 5.78  
                 
 
The total intrinsic value of restricted stock which vested during the six months ended June 30, 2007 was approximately $0.8 million.
 
The restricted stock awards granted in 2007 vest ratably over four years, except for one employee whose awards vest over three years based on his employment agreement. All restricted stock awards granted in prior years vest ratably over three years.
 
The compensation expense related to stock options and restricted stock awards was $0.3 million and $0.6 million for each of the three and six month periods ended June 30, 2007 and 2006, respectively. As of


19


 

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

June 30, 2007, there was $2.5 million and $0.2 million of total unrecognized compensation cost related to unvested restricted stock and unvested stock options, respectively.
 
14.   FIN 48 — RECOGNITION AND MEASUREMENT OF TAX POSITIONS AND BENEFITS
 
We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we made a comprehensive review of our tax positions in accordance with the more-likely-than-not standard established by FIN 48. The result of the implementation of FIN 48 did not have a material effect on our consolidated financial position or results of operations.
 
The Company does not believe there will be any material changes in our unrecognized tax positions over the next 12 months.
 
We will recognize interest and penalties accrued related to any unrecognized tax benefits in income tax expense. For the six months ended June 30, 2007, we did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense or penalties recognized during the quarter.
 
We file income tax returns in the U.S. federal jurisdiction, various state and local jurisdictions, and several foreign jurisdictions in which we operate. As of January 1 and June 30, 2007, our open tax years for U.S., state and local jurisdictions that remain subject to examination range from 2001 through 2006.
 
15.   SUBSEQUENT EVENT
 
In July 2007, we formed a strategic partnership with Steadfast Resorts International (“SRI”) to own and operate hotels in Mexico. We invested $5.7 million through a convertible debt instrument in a three-property portfolio of Tesoro Resorts in Mexico, currently owned by affiliates of SRI. Our investment is expected to convert to a 15% equity interest in a joint venture with SRI in the near future. A $10 million capital plan will be initiated to make improvements at all three resorts, with the primary concentration on redeveloping the Cabo San Lucas property. The three properties included in this joint venture are:
 
             
Hotel
 
Rooms
 
Location
 
Tesoro Los Cabos
  286   Cabo San Lucas, Mexico
Tesoro Manzanillo
  331   Manzanillo, Mexico
Tesoro Ixtapa
  203   Ixtapa, Mexico
         
Total rooms:
  820    
         
 
We also invested $0.5 million for a 50% interest in a separate joint venture with SRI, named Interstate de Mexico, to manage hotels. We are the managing member of this joint venture. The joint venture, which is a platform for further growth in Mexico, took over management of the three-property portfolio immediately upon its formation.


20


 

 
ITEM 2:   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations, which we refer to as MD&A, is intended to help the reader understand Interstate Hotels & Resorts Inc., our operations and our present business environment. MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated interim financial statements and the accompanying notes.
 
 
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 Quarterly Report on Form 10-Q and the information incorporated by reference herein, we make some “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are often, but not always, made through the use of words or phrases such as “will likely result,” “expect,” “will continue,” “anticipate,” “estimate,” “intend,” “plan,” “projection,” “would”, “outlook” and other similar terms and phrases. 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. Forward-looking statements are based on management’s current expectations and assumptions and are not guarantees of future performance that involve known and unknown risks, uncertainties and other factors which may cause our actual results to differ materially from those anticipated at the time the forward-looking statements are made. These risks and uncertainties include those risk factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2006.
 
Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this Quarterly Report on Form 10-Q, our most recent Annual Report on Form 10-K, and the documents incorporated by reference herein. 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.
 
 
Our Business — We are one of the largest independent U.S. hotel management companies not affiliated with a hotel brand, measured by number of rooms under management. We derive our earnings from a diversified portfolio of hotel management agreements and ownership of a group of select hotel properties. While we continue to focus on our core business as a premier provider of hospitality management services, we are also expanding our portfolio of owned hotels in an effort to diversify and enhance our earnings. In 2007, a significant portion of our operating income will be related to owned hotels. We have two reportable operating segments: hotel management and hotel ownership (through whole-ownership and joint ventures). A third reportable segment, corporate housing, was disposed of on January 26, 2007 with the sale of BridgeStreet, our corporate housing subsidiary, and the results of this segment are reported as discontinued operations in our consolidated financial statements for all periods presented.
 
Our portfolio of managed properties is diversified by brand, franchise and ownership group. We manage hotels representing more than 30 franchise and brand affiliations and also operate 15 independent hotels. Our managed hotels are owned by more than 60 different ownership groups. As of June 30, 2007, we managed 187 properties, with 42,760 rooms in 36 states, the District of Columbia, Canada, Russia, Belgium, and Ireland. We also owned six hotels with 1,755 rooms and held non-controlling joint venture equity interests in 11 joint ventures, which hold ownership interests in 17 of our managed properties.
 
Financial Highlights — Our operating results for the first half of 2007 reflect tangible results of our strategy to diversify and stabilize our income streams through the increase of hotel ownership, through wholly-owned


21


 

acquisitions and joint venture investments. In January 2007, we were able to capitalize on the earnings growth of our corporate housing subsidiary with the sale of BridgeStreet for $40.5 million, resulting in a gain on sale of $18.1 million. This additional capital was beneficial as we purchased our fifth wholly-owned property, the Hilton Houston Westchase, in February 2007 for a total acquisition cost of $51.9 million. In May 2007, we purchased the Westin Atlanta Airport, our largest wholly-owned acquisition to date, for a total acquisition cost of $76.1 million. For the six months ended June 30, 2007, revenues from our owned-hotels were $31.7 million, an increase of $20.2 million compared to the same period in 2006. In addition, operating income from owned-hotels increased by $6.7 million, while gross margins increased from 26% in the first half of 2006, to 30% in the first half of 2007.
 
While our operations have benefited from the acquisitions of wholly-owned real estate, we also continue to experience the effects of the significant number of management contracts lost during 2006 and the first half of 2007. Total management fees were $23.0 million in the first half of 2007, a decrease of $6.1 million from the first half of 2006 (after removing the effect of $3.2 million of business interruption proceeds received in the first quarter of 2006). Although our management contract losses have been significant, we have effectively managed to replace the majority of the earnings from these contracts by executing our ownership growth strategy.
 
Investments in, and Acquisitions of Real Estate — In February 2007, we acquired the 297-room Hilton Houston Westchase from affiliates of Blackstone, for a total acquisition price of $52.2 million. We financed part of the acquisition through a non-recourse mortgage loan of $32.8 million and the remainder with a combination of cash on hand and borrowings on our old credit facility. The hotel is currently undergoing the final phase of an $11 million comprehensive renovation program, of which $8.5 million was completed by the previous owner.
 
In May 2007, we acquired the 495-room Westin Atlanta Airport for a total purchase price of $76.1 million, representing our largest hotel acquisition to date. Simultaneous to amending the new Credit Facility (“Credit Facility”), we borrowed a further $50.0 million of term loans to finance part of the purchase price, with the remainder paid from cash on hand. The hotel is set to begin a comprehensive $18.0 million renovation program designed to provide all of the full-service features and amenities that travelers have come to expect at a Westin property.
 
We have also been actively seeking joint venture investment opportunities during the first half of 2007. In March 2007, we continued to grow our portfolio of joint ventures by investing $0.5 million to acquire a 15% interest in the Radisson Hotel Cross Keys in Baltimore, Maryland. We also contributed an additional $0.7 million in an existing joint venture which will build five to ten aloft® hotels over the next several years. 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 management, while we will operate the hotels. The joint venture has signed long-term franchise agreements for the first two properties. Construction commenced on the first property located in Rancho Cucamonga, CA in January 2007, with the second location in Cool Springs, TN expected to begin construction later in 2007.
 
In April 2007, the joint venture which owns the Doral Tesoro Hotel and Golf Club made a distribution to us of $1.8 million, which included the return of our initial investment of $1.5 million and a return on investment. As the distribution received was greater than our investment balance at the time of the distribution, the investment balance was reduced to zero with the remainder recorded as a deferred gain in our consolidated balance sheets. The distribution in excess of our investment will be deferred until such time as the assets in the venture are sold or another such event has occurred, resulting in the culmination of the earnings process. The distribution did not impact our percentage investment ownership interest in the joint venture.
 
In July 2007, we formed a strategic partnership with Steadfast Resorts International (“SRI”) to own and operate hotels in Mexico. We invested $5.7 million through a convertible debt instrument in a three-property portfolio of Tesoro Resorts in Mexico, currently owned by affiliates of SRI. Our investment is expected to convert to a 15% equity interest in a joint venture with SRI in the near future. A $10 million capital plan will be initiated to make improvements at all three resorts. We also invested $0.5 million for a 50% interest in a separate joint venture with SRI to manage hotels. The joint venture, which is a platform for further growth in Mexico, took over management of the three-property portfolio immediately upon its formation.


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Increase in our Borrowing Capacity — In March 2007, we closed on our Credit Facility. The Credit Facility consisted of a $65.0 million term loan and a $60.0 million revolving loan. Upon entering into the Credit Facility, we borrowed $65.0 million under the term loan using a portion of it to pay off the remaining obligation under the old credit facility. In May 2007, we amended the Credit Facility to borrow a further $50.0 million of term loans, resulting in a total of $115.0 million of term loans outstanding under the facility, and increased the availability under our revolving loan to $85.0 million. The proceeds from the additional $50.0 million of term loans was used to purchase the 495-room Westin Atlanta Airport. The Credit Facility provides for $200.0 million of total borrowing capacity, compared to $108.0 million under the previous credit facility. 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 seeking additional commitments from lenders.
 
Turnover of Management Contracts — 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 49 hotels during the first half of 2007, including the loss of 17 properties owned by CNL Hotels & Resorts, Inc. which were sold as a portfolio of hotels. As a result, we were terminated as the manager of those properties. In addition, Sunstone REIT sold seven hotels, which resulted in the termination of our management contracts for those properties.
 
During the first six months of 2007, Blackstone sold 18 hotels, including the Hilton Houston Westchase and Westin Atlanta Airport, which we purchased in February 2007 and May 2007, respectively, and three hotels which we continued to manage as of June 30, 2007 for the new owner. The 19 Blackstone properties which we continued to manage at June 30, 2007 accounted for $3.7 million in management fees for the six months ended June 30, 2007. Termination fees due to us as of June 30, 2007 for hotels previously sold by Blackstone are $15.1 million (assuming Blackstone does not replace the lost management contracts).
 
In summary, the impact on our financial results for the 49 management contracts terminated in the first half of 2007 is as follows:
 
                                 
    Number of
    Number of
    Six Months
    Six Months
 
Owner Group
  Properties     Rooms     Ended 6/30/2007     Ended 6/30/2006  
 
Blackstone
    15 (1)     4,314     $ 1.6 million     $ 2.5 million  
Sunstone REIT
    7       1,492       0.4 million       0.5 million  
CNL
    17       2,999       0.6 million       1.5 million  
Others
    12       2,322       0.5 million       0.9 million  
                                 
Total
    51       11,127     $ 3.1 million     $ 5.4 million  
                                 
 
 
(1) As we will no longer be recording management fees for the 297-room Hilton Houston Westchase and the 495-room Westin Atlanta Airport, we have included them in this analysis. In 2007, there were 13 Blackstone properties sold which we no longer manage.
 
We partially offset the loss of 10,335 rooms related to the 49 management contracts with the addition of 13 management contracts, totaling nearly 2,900 rooms.
 
In June 2007, Equity Inns announced that it was being acquired in a transaction that is expected to close in the fourth quarter of 2007. At June 30, 2007, we managed 39 properties for Equity Inns, consisting of 4,917 rooms. We anticipate entering into discussions with the new owner as to its future plans for those 39 properties. The management contracts for the Equity Inns properties have minimal termination fee provisions. For the six months ended June 30, 2007, we received approximately $1.3 million in management fees from the Equity Inns properties.
 
Industry Overview — The lodging industry, of which we are a part, is subject to international and national events. We have been impacted by several events over the previous several years, including the ongoing threat of terrorism and other hostilities, the potential outbreak of infectious disease and natural disasters. As we conduct our business on a national and international level, our activities are also affected by changes in the performance of regional and global economies.


23


 

In the second half of 2006 and the first half of 2007, the lodging industry experienced a substantial slowdown in room demand growth as compared to prior periods. This slowdown is partially due to the impact of Hurricane Katrina in the previous periods and also a slowdown in disposable income and consumption expenditures. However, the growth in the industry is forecasted to continue in future years, albeit at a slower pace than recently experienced. Overall, industry RevPAR is projected to grow an additional 5.3% in 2007. The entire RevPAR increase is projected to be a result of growth in ADR, as occupancy is forecasted to decrease by 0.6% in 2007. The decrease in occupancy is driven by room supply growth outpacing room demand growth in 2007 by 1.1%.
 
 
The preparation of financial statements in conformity with 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, including those related to the impairment of long-lived assets, on an ongoing basis. We base our estimates on experience and on various other assumptions that are believed to be reasonable under the circumstances.
 
We have discussed those policies that we believe are critical and require judgment in their application in our Annual Report on Form 10-K, for the year ending December 31, 2006. We also believe that the following are critical accounting policies:
 
 
We adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) on January 1, 2007. FIN 48 is an interpretation of FASB Statement No. 109, “Accounting for Income Taxes,” and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 prescribes a recognition threshold and measurement requirement for the financial statement recognition of a tax position that we have taken or expect to take on a tax return. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Under FIN 48, we may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold. See Note 14, “FIN 48 — Recognition and Measurement of Tax Positions and Benefits” for additional information.
 
 
As we have existing management agreements with Blackstone, the owner of multiple hotels which we have purchased, we evaluate the impact of EITF Issue No. 04-1,Accounting for Preexisting Relationships between the Parties to a Business Combination(“EITF 04-1”) on the purchase accounting for these acquisitions. Our agreements with Blackstone have provisions which require the payment of termination fees if Blackstone elects to terminate the management contract or sells the hotel to any buyer, including us. We determine the amount by which the pricing of these contracts is favorable when compared to the pricing we have negotiated with owners for recently executed management contracts for comparable hotel properties and compare this amount to the amount of required termination fee due from Blackstone. EITF 04-1 requires that we recognize the lesser of these amounts as a gain on the settlement of the executory contract and as part of the acquisition cost of the hotel.


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Results of Operations
 
 
Statistics related to our managed hotel properties (including wholly-owned hotels) are set forth below:
 
                         
    As of June 30,     Percent Change
 
    2007     2006     ’07 vs.’06  
 
Hotel Management
                       
Properties managed
    187       262       (28.6 )%
Number of rooms
    42,760       59,020       (27.5 )%
Hotel Ownership
                       
Number of properties
    6       3       100.0 %
Number of rooms
    1,755       655       167.9 %
 
Hotels under management decreased by a net of 75 properties as of June 30, 2007 compared to June 30, 2006, due to the following:
 
  •  We acquired 16 additional management contracts from various owners.
 
  •  28 properties owned by Meristar/Blackstone were transitioned out of our system.
 
  •  Sunstone REIT sold 22 properties which we no longer manage.
 
  •  CNL sold 17 properties which we no longer manage.
 
  •  24 properties owned by other owners were transitioned out of our system.
 
The operating statistics related to our managed hotels, including wholly-owned hotels, on a same-store basis(1) were as follows:
 
                         
    Three Months
       
    Ended June 30,     Percent Change
 
    2007     2006     ’07 vs. ’06  
 
Hotel Management
                       
RevPAR
  $ 104.61     $ 96.85       8.0 %
ADR
  $ 135.43     $ 126.00       7.5 %
Occupancy
    77.2 %     76.9 %     0.4 %
 
                         
    Six Months
       
    Ended June 30,     Percent Change
 
    2007     2006     ’07 vs. ’06  
 
Hotel Management
                       
RevPAR
  $ 98.75     $ 90.98       8.5 %
ADR
  $ 132.80     $ 123.46       7.6 %
Occupancy
    74.4 %     73.7 %     0.9 %
 
 
(1) We present these operating statistics for the periods included in this report on a same-store basis. We define our same-store hotels as those which (i) are managed or owned by us for the entirety of the reporting periods being compared or have been managed by us for part of the reporting periods compared and we have been able to obtain operating statistics for the period of time in which we did not manage the hotel and (ii) have not sustained substantial property damage, business interruption or undergone large-scale capital projects during the periods being reported. In addition, the operating results of hotels for which we no longer manage as of June 30, 2007 are not included in same-store hotel results for the periods presented herein. Of the 187 properties that we managed as of June 30, 2007, 165 properties have been classified as same-store hotels.


25


 

Three months ended June 30, 2007 compared to three months ended June 30, 2006
 
 
Revenue consisted of the following (in thousands):
 
                         
    Three Months
       
    Ended June 30,     Percent Change
 
    2007     2006     ’07 vs. ’06  
 
Lodging
  $ 18,621     $ 6,418       >100 %
Management fees
    11,580       15,187       (23.8 )%
Termination fees
    2,418       2,196       10.1 %
Other
    2,763       2,718       1.7 %
Other revenue from managed properties
    164,793       217,824       (24.3 )%
                         
Total revenue
  $ 200,175     $ 244,343       (18.1 )%
                         
 
The increase in lodging revenue is primarily due to the inclusion of $12.0 million of revenues in the three months ended June 30, 2007 from the Westin Atlanta Airport (acquired in May 2007), the Hilton Houston Westchase (acquired in February 2007), the Hilton Arlington (acquired in October 2006) and the Hilton Garden Inn Baton Rouge Airport (acquired in June 2006). RevPAR at the two hotels we owned during both three month periods increased by 5.6%.
 
The decrease in management fee revenue is a result of a decrease in the average number of managed properties of approximately 28%. However, due to the strength of the lodging industry and improved operating efficiencies at our managed properties, we were able to partially offset the loss of management contracts by increasing RevPAR by 8.0% during the quarter.
 
Termination fees for the three months ended June 30, 2007 were due to the recognition of $1.4 million of termination fees from Blackstone on the sale of the Westin Atlanta Airport, $0.5 million from sales of other Blackstone properties and $0.5 million from termination by various other owners. For the three months ended June 30, 2006, we recognized $1.9 million in termination fees from MeriStar/Blackstone, and $0.3 million from various other owners.


26


 

The composition of our management and termination fees by significant owner groups was as follows:
 
                         
    Number of
             
    Properties @
    Three Months
    Three Months
 
Owner Group
  6/30/2007     Ended 6/30/2007     Ended 6/30/2006  
 
MANAGEMENT FEES:
                       
Blackstone
    19     $ 1.9 million     $ 1.9 million  
Sunstone REIT
    30       2.2 million       2.1 million  
Equity Inns REIT
    39       0.7 million       0.5 million  
CNL/Ashford
    5       0.2 million       0.1 million  
International(1)
    8       0.3 million       0.4 million  
Other
    86       5.3 million       4.8 million  
                         
Hotels terminated during 2007
            1.0 million       2.9 million  
Hotels terminated during 2006
                  2.5 million  
                         
Total management fees
    187     $ 11.6 million     $ 15.2 million  
                         
TERMINATION FEES:
                       
Blackstone
          $ 1.9 million     $ 1.9 million  
Sunstone REIT
            0.2 million        
Other
            0.3 million       0.3 million  
                         
Total termination fees
          $ 2.4 million     $ 2.2 million  
                         
 
 
(1) We also expect to earn incentive fees related to the international properties. We record incentive management fees in the period that it is certain these fees will be earned, which for annual incentive fee measurements is typically in the last month of the annual contract period. At June 30, 2007, we recorded deferred revenue of $4.1 related to the international properties. We expect to recognize this deferred revenue in the fourth quarter.
 
Other revenues increased as a result of miscellaneous incentives from vendor contracts. The increase was completely offset by a decrease in operating activity in our purchasing and capital project management subsidiary and a decrease in accounting fees of $0.6 million as a result of managing fewer properties.
 
These amounts represent the reimbursement of payroll and related costs, and certain other costs of the hotel’s operations that are contractually reimbursed to us by the hotel owners, the payments of which are recorded as “other expenses from managed properties.” The decrease of $53.0 million in other revenue from managed properties is primarily due to the decrease in the number of managed hotels and a corresponding decrease in the number of hotel employees and related reimbursable salaries, benefits and other expenses.


27


 

 
Operating expenses consisted of the following (in thousands):
 
                         
    Three Months
       
    Ended June 30,     Percent Change  
    2007     2006     ’07 vs. ’06  
 
Lodging
  $ 12,667     $ 4,572       >100 %
Administrative and general
    14,575       15,385       (5.3 )%
Depreciation and amortization
    3,684       1,546       >100 %
Asset impairments and write-offs
    1,047       92       >100 %
Other expenses from managed properties
    164,793       217,824       (24.3 )%
                         
Total operating expenses
  $ 196,766     $ 239,419       (17.8 )%
                         
 
The increase in lodging expense is primarily due to the inclusion of $8.1 million of expenses in the three months ended June 30, 2007 from the Westin Atlanta Airport (acquired in May 2007), the Hilton Houston Westchase (acquired in February 2007), the Hilton Arlington (acquired in October 2006) and the Hilton Garden Inn Baton Rouge Airport (acquired in June 2006). Operating margins for our owned hotels increased to 32% from 29%.
 
These expenses consist of payroll and related benefits for employees in operations management, sales and marketing, finance, legal, human resources and other support services, as well as general corporate and public company expenses. Administrative and general expenses showed a decrease between periods, primarily due to a reduction in employee compensation of $1.2 million and expenses in our insurance subsidiary of $0.6 million. These savings have been partially offset by general and administrative expenses of $0.9 million relating to our new international office in Moscow, Russia.
 
We had a significant increase in depreciable assets due to the presence of six wholly-owned hotels during the three months ended June 30, 2007. The Westin Atlanta Airport, Hilton Houston Westchase, Hilton Arlington and Hilton Garden Inn Baton Rouge Airport, all of which were acquired in or subsequent to the second quarter of 2006, resulted in additional depreciation expense of $1.3 million. In addition, scheduled amortization expense for our management contracts increased by approximately $0.8 million as a result of revising the estimated economic lives of the management contracts for the remaining Blackstone properties from 25 years to approximately four years, due to Blackstone’s plans to sell most of the portfolio within four years.
 
When we receive notification that a management contract will be terminated early, we evaluate when or if amortization should be accelerated or if any remaining management contract costs should be impaired. For the three months ended June 30, 2007, we recognized impairment losses of $1.1 million, related to seven properties that were sold in the second quarter.
 
These expenses represent the payroll and related costs, and certain other costs of the hotel’s operations that are contractually reimbursed to us by the hotel owners and are also recorded as “other expenses from managed properties.” The decrease of $53.0 million in other revenue from managed properties is primarily due to the decrease in the number of managed hotels and a corresponding decrease in the number of hotel employees and related reimbursable salaries, benefits and other expenses.


28


 

Other income and expenses consisted of the following (in thousands):
 
                         
    Three Months
       
    Ended June 30,     Percent Change  
    2007     2006     ’07 vs. ’06  
 
Interest expense, net
  $ 2,555     $ 1,425       79.3 %
Equity in earnings of affiliates
    854       123       >100 %
Income tax expense
    708       1,611       (56.1 )%
Minority interest expense
    9       31       (71.0 )%
Income from discontinued operations, net of tax
    607       1,029       (41.0 )%
 
The majority of the increase in interest expense of $1.1 million was due to interest expense of $1.0 million incurred associated with our mortgage debt from the purchase of the Hilton Arlington and the Hilton Houston Westchase. In addition, we recorded additional interest expense of $0.4 million associated with our credit facility due to the higher average outstanding debt balance as a result of borrowing $50.0 million for the purchase of the Westin Atlanta Airport in May 2007. These increases were offset by $0.3 million in lower interest expense related to the $19.0 million of mortgage debt on the Hilton Concord, which was repaid in April 2007.
 
Equity in earnings of affiliates increased $0.7 million, primarily related to $0.6 million in additional gain related to the settlement of working capital and purchase price true-ups from the sale of the Sawgrass Marriott Resort & Spa, which our joint venture sold in July 2006.
 
The change in income tax expense is driven by the decrease in income from continuing operations.
 
Income from discontinued operations, net of tax
Income from discontinued operations for the three months ended June 30, 2007 was primarily due to an additional gain recognized on the sale of BridgeStreet of $0.5 million as well as an additional $0.1 million net gain related to true-ups on the September 2005 sale of the Pittsburgh Airport Residence Inn by Marriott. The 2006 discontinued operations relate to the operations of BridgeStreet.
 
Six months ended June 30, 2007 compared to six months ended June 30, 2006
 
 
Revenue consisted of the following (in thousands):
 
                         
    Six Months
       
    Ended June 30,     Percent Change  
    2007     2006     ’07 vs. ’06  
 
Lodging
  $ 31,697     $ 11,455       >100 %
Management fees
    23,049       32,350       (28.8 )%
Termination fees
    3,993       7,896       (49.4 )%
Other
    5,032       6,429       (21.7 )%
Other revenue from managed properties
    341,163       442,773       (22.9 )%
                         
Total revenue
  $ 404,934     $ 500,903       (19.2 )%
                         


29


 

The increase in lodging revenue is primarily due to the inclusion of $19.2 million of revenues in the six months ended June 30, 2007 from the Westin Atlanta Airport (acquired in May 2007), the Hilton Houston Westchase (acquired in February 2007), the Hilton Arlington (acquired in October 2006) and the Hilton Garden Inn Baton Rouge Airport (acquired in June 2006). RevPAR at hotels we owned during both six month periods increased by 9.1%.
 
The decrease in management fee revenue is partially due to the non-recurrence in 2007 of business interruption proceeds of $3.2 million that we received in the first quarter of 2006 associated with eight properties that were damaged or closed due to hurricanes in 2004. The remaining change is a result of a decrease in the average number of managed properties of approximately 25%. However, due to the strength of the lodging industry and improved operating efficiencies at our managed properties, we were able to partially offset the loss of management contracts by increasing RevPAR by 8.5% for the six month period ended June 30, 2007 compared to prior year.
 
Termination fees for the six months ended June 30, 2007 were due to the recognition of $1.4 million of termination fees from Blackstone on the sale of the Westin Atlanta Airport, $1.0 million from the sale of Hilton Houston Westchase, $0.5 million from sales of other Blackstone properties and $1.1 million related to the loss of management contracts from other owners. For the six months ended June 30, 2006, we recognized $7.3 million in termination fees from MeriStar/Blackstone, including one-time termination fees of $4.1 million due to the sale of ten properties and subsequent loss of these management contracts. The remaining $0.6 million in termination fees were from various other owners.
 
The composition of our management and termination fees by significant owner groups was as follows:
 
                         
    Number of
             
    Properties @
    Six Months
    Six Months
 
Owner Group
  6/30/2007     Ended 6/30/2007     Ended 6/30/2006  
 
MANAGEMENT FEES:
                       
Blackstone
    19     $ 3.7 million     $ 3.6 million  
Sunstone REIT
    30       4.3 million       3.8 million  
Equity Inns
    39       1.3 million       0.9 million  
CNL/Ashford
    5       0.3 million       0.3 million  
International(1)
    8       0.6 million       0.9 million  
Other
    86       9.7 million       9.0 million  
                         
Hotels terminated during 2007
            3.1 million       5.4 million  
Hotels terminated during 2006
                  5.3 million  
Business interruption proceeds
                  3.2 million  
                         
Total management fees
    187     $ 23.0 million     $ 32.4 million  
                         
TERMINATION FEES:
                       
Blackstone
          $ 3.0 million     $ 7.3 million  
Sunstone REIT
            0.2 million        
Other
            0.8 million       0.6 million  
                         
Total termination fees
          $ 4.0 million     $ 7.9 million  
                         
 
 
(1) We also expect to earn incentive fees related to the international properties. We record incentive management fees in the period that it is certain these fees will be earned, which for annual incentive fee measurements is typically in the last month of the annual contract period. At June 30, 2007, we recorded deferred revenue of $4.1 related to the international properties. We expect to recognize this deferred revenue in the fourth quarter.


30


 

 
Other revenues decreased $1.4 million due to a decrease in operating activity generated by our purchasing and capital project management subsidiary and our accounting fees as a result of managing fewer properties.
 
These amounts represent the reimbursement of payroll and related costs, and certain other costs of the hotel’s operations that are contractually reimbursed to us by the hotel owners, the payment of which are recorded as “other expenses from managed properties.” The decrease of $101.6 million in other revenue from managed properties is primarily due to the decrease in the number of managed hotels and a corresponding decrease in the number of hotel employees and related reimbursable salaries, benefits and other expenses.
 
Operating expenses consisted of the following (in thousands):
 
                         
    Six Months
       
    Ended June 30,     Percent Change  
    2007     2006     ’07 vs. ’06  
 
Lodging
  $ 22,039     $ 8,460       >100 %
Administrative and general
    27,890       29,030       (3.9 )%
Depreciation and amortization
    6,977       3,089       >100 %
Asset impairments and write-offs
    1,155       8,642       (86.6 )%
Other expenses from managed properties
    341,163       442,773       (22.9 )%
                         
Total operating expenses
  $ 399,224     $ 491,994       (18.9 )%
                         
 
The increase in lodging expense is primarily due to the inclusion of $13.1 million of expenses in the six months ended June 30, 2007 from the Westin Atlanta Airport (acquired in May 2007), the Hilton Houston Westchase (acquired in February 2007), the Hilton Arlington (acquired in October 2006) and the Hilton Garden Inn Baton Rouge Airport (acquired in June 2006). Operating margins for our owned hotels increased from 26% to 30%.
 
These expenses consist of payroll and related benefits for employees in operations management, sales and marketing, finance, legal, human resources and other support services, as well as general corporate and public company expenses. Administrative and general expenses decreased between periods primarily due to a reduction in employee compensation of $2.8 million as overall headcount was lower. These savings have been partially offset by various general and administrative expenses totaling $1.6 million during the six month period ended June 30, 2007 relating to our new international office in Moscow, Russia and costs related to executing our growth strategy.
 
We had a significant increase in depreciable assets due to the presence of six wholly-owned hotels during the six months ended June 30, 2007. The Westin Atlanta Airport, Hilton Houston Westchase, Hilton Arlington and Hilton Garden Inn Baton Rouge Airport, all of which were acquired in or subsequent to the second quarter of 2006, resulted in additional depreciation expense of $2.2 million. In addition, scheduled amortization expense for our management contracts increased by approximately $1.6 million as a result of revising the estimated economic lives of the management contracts for the remaining Blackstone properties from 25 years to approximately four years, due to their plans to sell most of the portfolio within four years.
 
When we receive notification that a management contract will be terminated early, we evaluate when or if amortization should be accelerated or if any remaining management contract costs should be impaired. For the six months ended June 30, 2007, we recognized impairment losses of $1.2 million, related to properties that


31


 

were sold in 2007. For the six months ended June 30, 2006, $8.3 million of asset impairments were recorded as a result of the termination of management contracts related to the sale of 18 MeriStar/Blackstone properties.
 
These expenses represent the payroll and related costs, and certain other costs of the hotel’s operations that are contractually reimbursed to us by the hotel owners and are also recorded as “other expenses from managed properties.” The decrease of $101.6 million in other revenue from managed properties is primarily due to the decrease in the number of managed hotels and a corresponding decrease in the number of hotel employees and related reimbursable salaries, benefits and other expenses.
 
Other income and expenses consisted of the following (in thousands):
 
                         
    Six Months
       
    Ended June 30,     Percent Change  
    2007     2006     ’07 vs. ’06  
 
Interest expense, net
  $ 4,852     $ 3,094       56.8 %
Equity in earnings (losses) of affiliates
    1,255       (434 )     >100 %
Income tax expense
    855       2,280       (62.5 )%
Minority interest expense
    62       49       26.5 %
Income from discontinued operations, net of tax
    17,608       703       >100 %
 
The majority of the increase in interest expense of $1.8 million was due to interest expense incurred associated with our mortgage debt from the purchase of the Hilton Arlington and the Hilton Houston Westchase. In addition, we recorded additional amortization expense of $0.6 million for deferred financing fees related to the extinguishment of our old credit facility in March 2007. The increase was offset by $0.5 million in lower interest expense on our old credit facility due to a lower average outstanding debt balance during 2007 and the early repayment of the $19.0 million of mortgage debt on the Hilton Concord in April 2007.
 
Equity in earnings of affiliates increased $1.7 million, primarily related to $0.6 million in additional gain related to the settlement of working capital and other purchase price true-ups from the sale of the Sawgrass Marriott Resort & Spa in July 2006 by a joint venture in which we previously had an ownership interest, which our joint venture sold in July 2006. In addition, we recorded $0.5 million in earnings in 2007 from our interest in the new joint venture which owns the Sawgrass Marriott Resort & Spa. In 2006, one of our joint ventures, which was sold in December 2006, contributed losses of $0.5 million.
 
The change in income tax expense is driven by the decrease in income from continuing operations.
 
Income from discontinued operations, net of tax
Discontinued operations represents the operations of our corporate housing subsidiary (disposed in January 2007) and the gain on sale of this subsidiary of $18.1 million. The disposition of our corporate housing subsidiary triggered the recognition of significant differences in the carrying values between tax basis and GAAP basis. As the tax basis was significantly higher, the gain realized for tax purposes was significantly lower than the $18.1 million gain recognized in our statement of operations for the six month period ended June 30, 2006, resulting in an effective tax rate of 1%.
 
In September 2005, we sold Pittsburgh Airport Residence Inn by Marriott. We recognized an additional net gain on sale of $0.1 million in 2007 related to true-ups finalizing the sale.


32


 

 
Key metrics related to our liquidity, capital resources and financial position were as follows (in thousands):
 
                         
    Six Months
       
    Ended June 30,     Percent Change  
    2007     2006     ’07 vs. ’06  
 
Cash provided by operating activities
  $ 15,419     $ 16,927       (8.9 )%
Cash used in investing activities
    (98,300 )     (25,979 )     >100 %
Cash provided by (used in) financing activities
    84,971       (741 )     >100 %
Working capital
    (5,462 )     (14,324 )     61.9 %
Cash interest expense
    4,577       3,676       24.5 %
Debt balance
    172,237       81,552       >100 %
 
 
The decrease in cash provided by operating activities is primarily due to marginal changes in working capital assets and liabilities. This was partially offset by a change in net income, which increased by $0.8 million, after adjusting for the $18.1 million gain on sale of our corporate housing subsidiary, as well as termination fees for both periods totaling $4.0 million and $7.9 million for the six month periods ended June 30, 2007 and 2006, respectively.
 
 
The major components of the increase in cash used in investing activities during the six month period ended June 30, 2007 compared to the six month period ended June 30, 2006 were:
 
  •  The purchase of two wholly-owned properties in 2007 compared to one in 2006. In February 2007, we purchased the Hilton Houston Westchase for $51.9 million followed by the purchase of the Westin Atlanta Airport in May 2007 for $76.1 million. In 2006 we purchased the Hilton Garden Inn Baton Rouge for $14.5 million.
 
  •  In 2007, we invested a total of $1.2 million in two new joint ventures while receiving distributions totaling $2.8 million from four joint ventures. In 2006, we invested $6.0 million in three new joint ventures and made an additional contribution to an existing joint ventures of $0.2 million. Distributions which are a return of our investment in the joint venture are recorded as investing cash flows while distributions which are a return on our investment are recorded as operating cash flows.
 
  •  We spent an additional $1.1 million on property and equipment during the six month period ended June 30, 2007, which is primarily related to improvements at our owned hotels and general corporate additions.
 
  •  The cash expenditures above were offset by proceeds of $35.0 million from the sale of our corporate housing subsidiary.
 
 
The increase in cash provided by financing activities is primarily due to net borrowings on long-term debt of $88.0 million during 2007, compared to net repayments on long-term debt of $3.5 million during 2006. Borrowings in 2007 are primarily related to the $32.8 million and $50.0 million used for the purchase of the Hilton Westchase and Westin Atlanta Airport, respectively. Our hotel acquisition in 2006 was paid for with cash on hand. Repayments of principal in 2006 were made from cash provided by operating activities.
 
We incurred total financing fees of $3.3 million in connection with the new Credit Facility entered in March 2007 and the amendment to the Credit Facility in May 2007. In addition, during 2007, we received proceeds of $0.2 million in connection with the issuance of common stock related to equity based compensation, compared to $2.2 million during 2006.


33


 

 
Liquidity Requirements — Our known short-term liquidity requirements consist primarily of funds necessary to pay for operating expenses and other expenditures. 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 and continuing our growth strategy. We continually monitor our operating and cash flow models in order to forecast our compliance with the financial covenants. As of June 30, 2007, we were in compliance with all financial covenants under our Credit Facility.
 
We continue to implement our growth strategy, which involves the acquisition of whole ownership and joint venture interests in hotel properties. In February 2007, we acquired our fifth wholly-owned property, the Hilton Houston Westchase. We financed the purchase through a $32.8 million, non-recourse mortgage loan. In May 2007, we acquired our sixth wholly-owned property, the Westin Atlanta Airport. We financed the acquisition through cash on hand and borrowings of $50.0 million from our amended Credit Facility. Joint ventures also continue to play a strategic and vital role in the continued growth strategy of the Company. In March, we entered into another joint venture with a $0.5 million investment for a 15% ownership interest in the Radisson Cross Keys in Baltimore, Maryland.
 
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. In addition, we have certain limitations under our Credit Facility that could limit our ability to make future investments without the consent of our lenders. We expect to use additional cash flows from operations and amounts available under the Credit Facility to pay required debt service, income taxes and make planned capital purchases for our wholly-owned hotels. In May 2007, we amended our Credit Facility to expand our availability under our revolving loan from $65.0 million to $85.0 million. As of June 30, 2007, all $85.0 million of capacity was available to us for borrowing. We may also seek to raise additional funding for future investments and growth opportunities by raising additional debt or equity from time to time based on the specific needs of those future investments.
 
 
Senior Credit Facility — In March 2007, we closed on our new $125.0 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 obligation under the old credit facility. In connection with the purchase of the Westin Atlanta Airport in May 2007, we amended the 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 credit facility. 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 seeking additional commitments from lenders. 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 June 30, 2007, based on those financial tests, borrowings under the term and revolving loan bore interest at the 30-day LIBOR rate plus 275 basis points (a rate of 8.07% per annum). We incurred interest expense of $1.9 million and $2.7 million on the senior credit facilities for the three and six month periods ended June 30, 2007, respectively, and $1.4 million and $3.0 million for the three and six month periods ended June 30, 2006, respectively.
 
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 June 30, 2007, we were in compliance with all of these covenants.


34


 

Mortgage Debt — The following table summarizes our mortgage debt as of June 30, 2007:
 
                                 
    Principal
    Maturity
    Spread Over
    Interest Rate as of
 
    Amount     Date(1)     30-Day LIBOR     June 30, 2007  
 
Hilton Arlington
  $ 24.7 million       November 2009       135 bps       6.7 %
Hilton Houston Westchase
  $ 32.8 million       February 2010       135 bps       6.7 %
 
 
(1) We are required to make interest-only payments until these loans mature, with two optional one-year extensions.
 
In April 2007, we repaid, in full, $19.0 million of mortgage debt relating to the Hilton Concord. Due to the structure of the loan agreement, we incurred no prepayment penalties in connection with the early repayment.
 
We incurred interest expense on the mortgage loans of $1.0 million and $2.1 million for the three and six month periods ended June 30, 2007, respectively, and $0.3 million and $0.7 million for the three and six month periods ended June 30, 2006, 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.
 
Item 3.   Quantitative and Qualitative Disclosures About Market Risk
 
 
In February 2007, we entered into an interest rate cap agreement in connection with the purchase of the Hilton Houston Westchase. The $32.8 million, three-year interest rate cap agreement is designed to protect against the potential effect of future interest rate fluctuations. The interest rate agreement caps the 30-day LIBOR at 7.25% and is scheduled to mature on February 9, 2010. In April 2007, we repaid the Hilton Concord $19.0 million mortgage loan and have cancelled the related interest rate cap agreement. The 30-day LIBOR rate, upon which our debt and interest rate cap agreements are based on, decreased from 5.4% per annum, as of December 31, 2006, to 5.3% per annum, as of June 30, 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 $0.4 million and $0.2 million for the three months ended June 30, 2007 and 2006, respectively, and by $0.6 million and $0.4 million for the six months ended June 30, 2007 and 2006, respectively.
 
Beyond those stated above, there were no other material changes to the information provided in Item 7A in our Annual Report on Form 10-K regarding our market risk.
 
Item 4.   Controls and Procedures
 
 
We maintain disclosure controls and procedures that are designed to ensure that information that is required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that the information is accumulated and communicated to our management, including our chief executive officer, chief financial officer, and chief accounting officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of “disclosure controls and procedures” (as defined in Exchange Act Rules 13a-15(e) and 15-d — 15(e)).
 
We carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, we concluded that our disclosure controls and procedures were effective as of June 30, 2007.


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There has not been any change in our internal control over financial reporting during the second quarter of 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there is only reasonable assurance that our controls will succeed in achieving their stated goals under all potential future conditions. Also, we have investments in certain unconsolidated entities. As we do not control or manage these entities, our disclosure controls and procedures with respect to these entities are substantially more limited than those we maintain with respect to our consolidated subsidiaries.


36


 

 
 
Item 1.   Legal Proceedings
 
In the course of normal 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.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
Our annual meeting of stockholders was held on May 31, 2007.
 
At that meeting, the following matters were submitted to a vote of our stockholders:
 
Item No. 1
 
To approve the adoption of the Interstate Hotels & Resorts, Inc. 2007 Equity Award Plan.
 
         
For
    18,059,727  
Against
    5,752,421  
Abstain
    40,924  
 
Item No. 2
 
To consider and vote upon ratification of the appointment of KPMG LLP as our independent Registered Public Accounting Firm for the fiscal year ending December 31, 2007.
 
         
For
    28,422,120  
Against
    185,602  
Abstain
    19,331  
 
Item No. 3
 
To approve the election or re-election as directors of the Company to serve terms expiring at the Annual Meeting in the year set forth and in accordance with their respective classes, and until their successors are duly elected and qualified.
 
                         
    For     Against     Withheld  
 
Class III: (term to expire at the Annual Meeting in 2008)
                       
James F. Dannhauser
    25,899,597       2,689,668       37,787  
Class II: (term to expire at the Annual Meeting in 2009)
                       
Ronald W. Allen
    26,389,881       2,217,416       19,755  
Class I: (term to expire at the Annual Meeting in 2010)
                       
Leslie R. Doggett(1)
    423,968              
James B. McCurry
    25,891,641       2,694,207       41,204  
John J. Russell, Jr. 
    26,368,342       2,217,486       41,224  
 
 
(1) Due to ministerial proxy card error, the shares voted “For” Ms. Doggett are only those shares voted in person at the Annual Meeting.


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(a) Exhibits
 
         
Exhibit No.
 
Description of Document
 
  3 .1   Amended and Restated Certificate of Incorporation of the Company, formerly MeriStar Hotels & Resorts, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Form S-1/A filed with the Securities and Exchange Commission on July 23, 1998 (Registration No. 333-49881)).
  3 .1.1   Certificate of Amendment of the Restated Certificate of Incorporation of the Company dated June 30, 2001 (incorporated by reference to Exhibit 3.1.1 to the Company’s Form 10-K filed with the Securities and Exchange Commission on April 15, 2002).
  3 .1.2   Certificate of Merger of Interstate Hotels Corporation into MeriStar Hotels & Resorts, Inc. (incorporated by reference to Exhibit 3.1.2 to the Company’s Form 8-A/A filed with the Securities and Exchange Commission on August 2, 2002).
  3 .1.3   Certificate of Amendment of the Restated Certificate of Incorporation of the Company dated July 31, 2002 (incorporated by reference to Exhibit 3.1.3 to the Company’s Form 8-A/A filed with the Securities and Exchange Commission on August 2, 2002).
  3 .2   By-laws of the Company, formerly MeriStar Hotels & Resorts, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Form S-1/A filed with the Securities and Exchange Commission on July 23, 1998 (Registration No. 333-49881)).
  3 .2.1   Amendment to the By-laws of the Company (incorporated by reference to Exhibit 3.3 to the Company’s Form 8-A/A filed with the Securities and Exchange Commission on August 2, 2002).
  4 .1   Form of Common Stock Certificate of the Company (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-A/A filed with the Securities and Exchange Commission on August 2, 2002).
  4 .2   Preferred Share Purchase Rights Agreement, dated July 23, 1998, between the Company, formerly MeriStar Hotels & Resorts, Inc., and the Rights Agent (incorporated by reference to Exhibit 4.4 to the Company’s Form S-1/A filed with the Securities and Exchange Commission on July 23, 1998(Registration No. 333-49881)).
  4 .2.1   Amendment to Rights Agreement, dated December 8, 2000, between the Company, formerly MeriStar Hotels & Resorts, Inc., and the Rights Agent (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on December 12, 2000).
  4 .2.2   Second Amendment to Rights Agreement, dated May 1, 2002, between the Company, formerly MeriStar Hotels & Resorts, Inc., and the Rights Agent (incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on May 3, 2002).
  4 .3   Form of Rights Certificate (incorporated by reference to Exhibit 4.3 to the Company’s Form S-1/A filed with the Securities and Exchange Commission on July 23, 1998 (Registration No. 333-49881)).
  4 .4   Registration Rights Agreement, dated June 30, 1999, between the Company (formerly MeriStar Hotels & Resorts, Inc.), Oak Hill Capital Partners, L.P. and Oak Hill Capital Management Partners, L.P. (incorporated by reference to Exhibit 4.7 to the Company’s Form 10-Q filed with the Securities and Exchange Commission for the three months ended June 30, 1999).
  10 .5.1*   First Amendment to the Senior Secured Credit Facility, dated May 24, 2007, among Interstate Operating Company, LP, Lehman Brothers Inc. and various other lenders.
  10 .6   Agreement of Purchase and Sale between Lepercq Atlanta Renaissance Partners, L.P., and affiliate of the Blackstone Group, and Interstate Atlanta Airport, LLC, dated May 4, 2007, for the purchase of the Westin Atlanta Airport (incorporated by reference to Exhibit 10.6 to the Company’s Form 10-Q filed with the Securities and Exchange Commission on May 10, 2007).
  10 .7   Interstate Hotels & Resorts, Inc., 2007 Equity Award Plan (incorporated by reference to Annex A to the Company’s Form Def 14A filed with the Securities and Exchange Commission on April 24, 2007).
  31 .1*   Sarbanes-Oxley Act Section 302 Certifications of the Chief Executive Officer.
  31 .2*   Sarbanes-Oxley Act Section 302 Certifications of the Chief Financial Officer
  32 *   Sarbanes-Oxley Act Section 906 Certifications of Chief Executive Officer and Chief Financial Officer
 
 
* Filed herewith


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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
Interstate Hotels & Resorts, Inc.
 
  By: 
/s/  Denis S. McCarthy
Denis S. McCarthy
Chief Accounting Officer
 
Dated: August 9, 2007


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