August 10, 2000
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
MeriStar Hospitality Corporation (the "Company") owns a portfolio of primarily upscale, full-service
hotels, diversified by franchise and brand affiliations, in the United States and Canada. Substantially all of
the Company's hotels are leased to and operated by MeriStar Hotel & Resorts, Inc. ("OpCo"), an affiliated
entity. As of June 30, 2000, the Company owned 114 hotels with 29,090 rooms, 106 of which are leased and operated
by OpCo.
On August 3, 1998, CapStar Hotel Company ("CapStar") merged (the "Merger") with and into American
General Hospitality Corporation ("AGH"), with the surviving entity being named MeriStar Hospitality Corporation.
In conjunction with the Merger, CapStar also distributed on a pro rata basis to its stockholders all of the capital
stock of OpCo, which consisted of CapStar's hotel operations (including leased hotels) and management business
(the "Spin-Off").
In order to maintain its tax status as a Real Estate Investment Trust ("REIT"), the Company has not been
permitted to engage in the operations of its hotel properties. To comply with this requirement, the Company has
leased all of its real property to third-party lessee/managers - OpCo and Prime Hospitality.
In December 1999, the REIT Modernization Act (the "RMA") became law. The RMA will permit the Company
to create a wholly-owned taxable REIT subsidiary (the "TRS"), which will be subject to taxation similar
to a C-Corporation. The TRS will be allowed to lease the real property owned by the Company. Also, although a TRS
can lease real property from a REIT, it will be restricted from being involved in certain activities prohibited
by the RMA. First, a TRS will not be permitted to manage the properties itself; it will need to enter into an "arms
length" management agreement with an independent third-party manager that is actively involved in the trade
or business of hotel management and manages properties on behalf of other owners. Second, a TRS will not be permitted
to lease a property that contains gambling operations. Third, a TRS will be restricted from owning a brand or franchise.
The RMA does not permit a REIT to establish a TRS until January 1, 2001.
The Company believes that establishing a TRS to lease its properties will provide a more efficient alignment of
and ability to capture the economic interests of property ownership. The Company has established a subcommittee
of independent members of the Board of Directors to negotiate the transfer of its existing leases with OpCo to
the Company's TRS. Concurrent with the transfer of the leases to the TRS, the Company expects to enter into management
agreements with OpCo to manage its properties in accordance with the RMA rules described above. The Company and
OpCo are currently in negotiations with regard to the conversion of the leases to management agreements. Neither
the Company nor Opco expect to pay or receive consideration in connection with this transaction. The Company is
aiming to conclude these negotiations during 2000 and transfer those leases to its TRS effective January 1, 2001.
FINANCIAL CONDITION
JUNE 30, 2000 COMPARED WITH DECEMBER 31, 1999
Total assets decreased by $50.6 million to $3,043.6 million at June 30, 2000 from $3,094.2 million at December
31, 1999. This decrease was due mainly to the Company repaying long-term debt from the cash generated from the
sale of the three limited service hotels and OpCo's repayment of the note receivable, partially offset by the purchase
of a full service hotel.
Total liabilities increased by $30.5 million to $1,833.0 million at June 30, 2000 from $1,802.5 million at December
31, 1999. This increase was due to the effect of deferring $59.3 million of revenue under the provisions of Staff
Accounting Bulletin ("SAB") No. 101, an increase in accrued expenses and other liabilities based on the
timing of payments and accruing $8.0 million of deferred purchase price for the hotel acquired by the Company.
This increase was partially offset by $44.3 million in repayments of long-term debt using proceeds from the repayment
of the note receivable and from the sale of the three limited service hotels.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2000 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1999.
Total revenue increased by $7.4 million to $81.5 million in the three months ended June 30, 2000 from $74.1 million
in the three months ended June 30, 1999. This increase was primarily attributable to an increase in participating
lease revenue resulting from an increase in room rates obtained at our hotels under lease. On a pro forma basis
for the quarter, revenue per available room ("RevPAR"), same-store average daily rate ("ADR")
and occupancy were as follows.
2000 1999 Change
---- ---- ------
RevPAR $ 84.44 $ 78.86 7.1%
ADR $109.46 $102.56 6.7%
Occupancy 77.1% 76.9% 0.3%
Net interest expense increased to $29.7 million for the three months ended June 30, 2000 from $26.4 million for
the same period in 1999. This increase was attributable to the increase in interest rates during 1999 and 2000
on the Company's variable rate debt, partially offset by a lower average debt balance during the second quarter
of 2000.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1999.
Total revenue increased by $10.5 million to $148.6 million in the six months ended June 30, 2000 from $138.1 million
in the six months ended June 30, 1999. This increase was primarily attributable to an increase in participating
lease revenue resulting from an increase in room rates obtained at our hotels under lease. On a pro forma basis
for the six-month period, revenue per available room ("RevPAR"), same-store average daily rate ("ADR")
and occupancy were as follows.
2000 1999 Change
---- ---- ------
RevPAR $ 81.59 $ 77.54 5.2%
ADR $110.41 $104.71 5.4%
Occupancy 73.9% 74.0% (0.1)%
Net interest expense increased to $58.4 million for the six months ended June 30, 2000 from $50.5 million for the
same period in 1999. This increase was attributable to the increase in interest rates during 1999 and 2000 on the
Company's variable rate debt, partially offset by a lower average debt balance during the first two quarters of
2000.
The White Paper on Funds From Operations ("FFO") approved by the Board of Governors of the National Association
of Real Estate Investment Trusts ("NAREIT") in October 1999 defines FFO as net income (loss) (computed
in accordance with generally accepted accounting principles ("GAAP")), excluding gains (or losses) from
sales of properties, plus real estate related depreciation and amortization and after comparable adjustments for
the Company's portion of these items related to unconsolidated entities and joint ventures. Extraordinary items
under GAAP are excluded from the calculation of FFO. The Company believes that FFO is helpful to investors as a
measure of the performance of an equity real estate investment trust ("REIT") because, along with cash
flow from operating activities, financing activities and investing activities, it provides investors with an indication
of the ability of the Company to incur and service debt, to make capital expenditures and to fund other cash needs.
FFO does not represent cash generated from operating activities determined by GAAP and should not be considered
as an alternative to net income (determined in accordance with GAAP) as an indication of the Company's financial
performance or to cash flow from operating activities (determined in accordance with GAAP) as a measure of the
Company's liquidity, nor is it indicative of funds available to fund the Company's cash needs, including its ability
to make cash distributions. FFO may include funds that may not be available for management's discretionary use
due to functional requirements to conserve funds for capital expenditures and property acquisitions, and other
commitments and uncertainties.
The following is a reconciliation between net income before the gain on the sale of assets and extraordinary gain
and diluted FFO for the three and six month periods ended June 30, 2000 (in thousands):
Three Months Ended Six Months Ended
June 30, 2000 June 30, 1999
------------------ ----------------
Income before gain on sale of assets and
extraordinary gain $ 6,999 $ 3,573
Minority interest to Common OP Unit Holders 968 964
Interest on convertible debt 1,832 3,823
Hotel depreciation and amortization 27,106 52,804
------- -------
Diluted FFO $36,905 $61,164
======= =======
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No.
101, "Revenue Recognition in Financial Statements". SAB No. 101 addresses lessor revenue recognition
in interim periods related to rental agreements which provide for minimum rental payments, plus contingent rents
based on the lessee's operations, such as a percentage of sales in excess of an annual specified sales target.
SAB No. 101 requires the deferral of contingent rental income until specified targets are met. This accounting
pronouncement relates only to the Company's recognition of lease revenue in interim periods for financial reporting
purposes; it has no effect on the timing of rent payments under the Company's leases. The effect of SAB No. 101
was to defer recognition of contingent rental income of $26,643 and $26,930 for the three months ended June 30,
2000 and 1999, respectively. Contingent rental income of $59,322 and $56,314 was deferred for the six months ended
June 30, 2000 and 1999, respectively. As of June 30, 2000 and 1999, these amounts are included in accounts payable,
accrued expenses and other liabilities on the Company's condensed consolidated balance sheets.
The effect of SAB No. 101 on the Company's financial statements is as follows:
Three Months Ended June 30, 2000
--------------------------------
Prior to Effect Effect After Effect
of of of
SAB No. 101 SAB No. 101 SAB No. 101
---------------- ------------ -------------
Net operating income $ 64,551 $(26,643) $ 37,908
Interest expense (29,657) - (29,657)
Minority interests (3,209) 2,100 (1,109)
Income taxes (634) 491 (143)
Gain on sale of assets, net of tax 3,425 - 3,425
-------- -------- --------
Net income $ 34,476 $(24,052) $ 10,424
======== ======== ========
Diluted funds from operations $ 63,057 $(26,152) $ 36,905
======== ======== ========
Three Months Ended June 30, 1999
--------------------------------
Prior to Effect Effect After Effect
of of of
SAB No. 101 SAB No. 101 SAB No. 101
---------------- ------------- -------------
Net operating income $ 62,298 $(26,930) $ 35,368
Interest expense (26,407) - (26,407)
Minority interests (3,661) 2,023 (1,638)
Income taxes (359) 215 (144)
-------- -------- --------
Net income $ 31,871 $(24,692) $ 7,179
======== ======== ========
Diluted funds from operations $ 61,031 $(26,715) $ 34,316
======== ======== ========
Six Months Ended June 30, 2000
------------------------------
Prior to Effect Effect After Effect
of of of
SAB No. 101 SAB No. 101 SAB No. 101
---------------- ------------- -------------
Net operating income $122,632 $(59,322) $ 63,310
Interest expense (58,417) - (58,417)
Minority interests (6,158) 4,911 (1,247)
Income taxes (1,161) 1,088 (73)
Gain on sale of assets, net of tax 3,425 - 3,425
Extraordinary gain, net of tax 3,054 - 3,054
-------- -------- --------
Net income $ 63,375 $(53,323) $ 10,052
======== ======== ========
Diluted funds from operations $119,398 $(58,234) $ 61,164
======== ======== ========
Retained Earnings $ 29,589 $(53,323) $(24,734)
======== ======== ========
Six Months Ended June 30, 1999
------------------------------
Prior to Effect Effect After Effect
of of of
SAB No. 101 SAB No. 101 SAB No. 101
---------------- ------------- -------------
Net operating income $116,254 $(56,314) $ 59,940
Interest expense (50,496) - (50,496)
Minority interests (6,765) 4,919 (1,846)
Income taxes (1,180) 1,028 (152)
-------- -------- --------
Net income $ 57,813 $(50,367) $ 7,446
======== ======== ========
Diluted funds from operations $115,030 $(55,286) $ 59,744
======== ======== ========
Retained Earnings $ 28,435 $(50,367) $(21,932)
======== ======== ========
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of liquidity are cash on hand, cash generated from operations, and funds from external
borrowings and debt and equity offerings. The Company expects to fund its continuing operations through cash generated
by its participating leases. The Company also expects to finance hotel acquisitions and joint venture investments
through a combination of cash generated from operations, external borrowings, and the issuance of units of the
Company's subsidiary operating partnership and/or common stock. Additionally, the Company must, in order to maintain
favorable tax treatment accorded to a REIT under the Internal Revenue Code, distribute to stockholders at least
95% of its REIT taxable income. The Company expects to fund such distributions through cash generated from operations,
borrowings on the Company's credit facilities or through its preferred return on its investment in MeriStar Investment
Partners.
Operating activities provided $121.1 million of net cash in the six months ended June 30, 2000. Investing activities
provided $13.0 million of cash during the first six months of 2000, primarily due to the Company selling three
hotels and the repayment of the note receivable from OpCo, offset by the purchase of one hotel and other capital
expenditures. Net cash used in financing activities of $136.0 million resulted primarily from dividends paid, repurchase
of Company stock and net repayments on the Company's credit facilities.
At June 30, 2000 and August 8, 2000, the Company had $109.0 million and $99.0 million, respectively, available
under the New Credit Facility.
Capital for renovation work is expected to be provided by a combination of internally generated cash and external
borrowings. Once initial renovation programs for a hotel are completed, the Company expects to spend approximately
4% annually of hotel revenues for ongoing capital expenditure programs, including room and facilities refurbishments,
renovations, and furniture and equipment replacements. During the six months ended June 30, 2000, the Company spent
approximately $38.5 million on capital expenditures.The Company expects to spend approximately $30.0 million during
the remainder of 2000 to complete initial renovation programs and to fund ongoing capital expenditures for its
hotels. The Company also spent $11.4 million to the buy a full-service hotel.
The Company's Board of Directors has authorized the Company to repurchase of up to five million shares of its common
stock from time to time in open market or privately negotiated transactions. Stock repurchases are subject to prevailing
market conditions and other considerations. The Company expects the program to be funded primarily through selected
asset sales. As of June 30, 2000, the Company has repurchased a total of 2,397,576 shares for $40.7 million.
The Company believes cash generated by operations, together with borrowing capacity under its credit facilities
will be sufficient to fund its existing working capital, ongoing capital expenditures, and debt service requirements.
The Company believes, however, that its future capital decisions will also be made in response to specific acquisition
and/or investment opportunities, depending on conditions in the capital and other financial markets. Accordingly,
the Company may consider increasing its borrowing capacity or issuing additional debt or equity securities, the
proceeds of which could be used to finance acquisitions or investments, to refinance existing debt, or repurchase
common stock.
SEASONALITY
Demand in the lodging industry is affected by recurring seasonal patterns. For non-resort properties, demand is
lower in the winter months due to decreased travel and higher in the spring and summer months during peak travel
season. For resort properties, demand is generally higher in winter and early spring. Since the majority of the
Company's hotels are non-resort properties, the Company's operations generally reflect non-resort seasonality patterns.
Excluding the effect of SAB No. 101, the Company has lower revenue, operating income and cash flow in the first
and fourth quarters and higher revenue, operating income and cash flow in the second and third quarters.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates on long- term debt obligations that impact
the fair value of these obligations. The Company's policy is to manage interest rates through the use of a combination
of fixed and variable rate debt. The Company's interest rate risk management objective is to limit the impact of
interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives,
the Company borrows at a combination of fixed and variable rates, and may enter into derivative financial instruments
such as interest rate swaps, caps and treasury locks in order to mitigate its interest rate risk on a related financial
instrument. The Company does not enter into derivative or interest rate transactions for speculative purposes.
The Company has no cash flow exposure due to general interest rate changes for its fixed long-term debt obligations.
The table below presents the principal amounts (in thousands of dollars) for the Company's fixed and variable rate
debt instruments, weighted-average interest rates, and fair values by year of expected maturity to evaluate the
expected cash flows and sensitivity to interest rate changes.
Long-term Debt
-----------------------------------------------------------------------------
Average Average
Expected Maturity Fixed Rate Interest Rate Variable Rate Interest Rate
------------------------ ---------------- ----------------- --------------- --------------
2000 $ 4,459 8.3% $ 1,000 7.3%
2001 11,194 8.4% 17,000 7.3%
2002 15,896 8.5% 32,000 7.3%
2003 8,589 8.1% 648,000 8.0%
2004 171,168 5.1% 190,000 7.3%
Thereafter 533,184 8.2% - N/A
---------------- ----------------- --------------- --------------
Total $744,490 7.5% $888,000 7.8%
================ ================= =============== ==============
Fair Value at 6/30/00 $693,493 $888,000
================ ===============
During June 2000, the Company entered into two separate $100 million swap agreements with financial institutions
in order to hedge against the impact future interest rate fluctuations may have on the Company's existing floating
rate debt instruments. The swap agreement effectively fixes 30-day LIBOR between 7.1% and 7.2%. There were no payments
made during the three and six months ended June 30, 2000 relating to these hedges. The swap agreements will replace
two $100 million swap agreements that are to expire in September 2000. The hedge agreements terminate in June 2002.
In April 2000, the Company entered into a $100 million periodic swap agreement with a financial institution in
order to hedge against the impact future interest rate fluctuations may have on the Company's existing floating
rate debt instruments. The swap agreement effectively fixes 30-day London Interbank Offered Rate ("LIBOR")
at 6.4%. If LIBOR is greater than or equal to 7.5% on the reset date, the amounts paid or received will be zero
for that month. During the three months ended June 30, 2000 the Company has made net payments of $11,000 relating
to this hedge. The amounts are included in interest expense. The hedge agreement expires in April 2003.
During September 1999, the Company entered into two separate $100 million swap agreements with financial institutions
in order to hedge against the impact future interest rate fluctuations may have on the Company's existing floating
rate debt instruments. The swap agreements replaced two $100 million swap agreements that were to expire in November
1999. The swap agreements effectively fix 30-day LIBOR at 6.0%. During the three and six months ended June 30,
2000, the Company received $149,000 and $175,000, respectively, relating to these hedges. These amounts are included
in interest expense. The hedge agreements terminate in September 2001.
In anticipation of the August 1999 completion the New Secured Facility, the Company entered into two separate hedge
transactions during July 1999. Upon completion of the New Secured Facility, the Company terminated the underlying
treasury lock agreements, resulting in a net payment to the Company of $5.1 million. This amount was deferred and
is being recognized as a reduction to interest expense over the life of the underlying debt. As a result, the effective
interest rate on the New Secured Facility is 7.76%.
During 1998, the Company entered into six separate $100 million swap agreements. The swap agreements effectively
fix
30-day LIBOR at between 4.9% and 5.4%. During the three months ended June 30, 2000 and 1999, the Company received
(made) net payments of $770,000 and $(211,000), respectively, relating to these hedges. During the six months ended
June 30, 2000 and 1999, the Company received net payments of $1,445,000 and $22,000, respectively. These amounts
are included in interest expense. The hedge agreements terminate at various times between November 1999 and September
2000. As of June 30, 2000, there are three swap agreeements which have not yet expired.
Additionally, in anticipation of the August 1997 offering of $150 million aggregate principal amount of its 8.75%
senior subordinated notes due 2007 (the "Subordinated Notes"), the Company entered into separate hedge
transactions during June and July 1997. Upon completion of the Subordinated Notes offering, the Company terminated
the underlying swap agreements, resulting in a net payment to the Company of $836,000. This amount was deferred
and is being recognized as a reduction to interest expense over the life of the underlying debt. As a result, the
effective interest rate on the Subordinated Notes is 8.69%.
Although the Company conducts business in Canada, the Canadian operations were not material to the Company's consolidated
financial position, results of operations or cash flows during the three and six months ended June 30, 2000 and
1999. Additionally, foreign currency transaction gains and losses were not material to the Company's results of
operations for the three and six months ended June 30, 2000 and 1999. Accordingly, the Company was not subject
to material foreign currency exchange rate risk from the effects that exchange rate movements of foreign currencies
would have on the Company's future costs or on future cash flows it would receive from its foreign subsidiaries.
To date, the Company has not entered into any significant foreign currency forward exchange contracts or other
derivative financial instruments to hedge the effects of adverse fluctuations in foreign currency exchange rates.