MERISTAR HOSPITALITY CORP (MHX) Quarterly Report (SEC form 10-Q)
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, 1999, the Company owned 117 hotels with 29,468 rooms, 109 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").

The Merger was accounted for as a purchase for financial reporting purposes. In accordance with the provisions of Accounting Principles Board Opinion No. 16, "Business Combinations," CapStar was considered the acquiring enterprise for financial reporting purposes. The Company established a new accounting basis for AGH's assets and liabilities based on their fair values. For financial reporting purposes, the results of operations of AGH were included in the Company's statement of operations from August 3, 1998.

Prior to August 3, 1998, the Company's consolidated financial statements included the operating results for the owned and leased hotels as well as management fees from hotels managed for third-party owners. Subsequent to August 3, 1998, the Company owns certain hotels which are leased to hotel operators and no longer manages hotels. Therefore, the financial statements for the periods ended June 30, 1999 and 1998 reflect differing numbers of owned, leased, and managed hotels throughout the periods. The following table outlines the Company's portfolio of owned, leased and managed hotels:

	OWNED		LEASED		MANAGED		TOTAL
	HOTELS	ROOMS	HOTELS	ROOMS	HOTELS	ROOMS	HOTELS	ROOMS
June 30, 1999	117	29,468	---	---	---	---	117	29,468
December 31, 1998	117	29,351	---	---	---	---	117	29,351
June 30, 1998	56	15,155	48	6,819	41	7,018	145	28,992
December 31, 1997	47	12,019	40	5,687	27	4,631	114	22,337

FINANCIAL CONDITION


JUNE 30, 1999 COMPARED WITH DECEMBER 31, 1998

Total assets increased by $98.2 million to $3,096.7 million at June 30, 1999 from $2,998.5 million at December 31, 1998. This growth was due mainly to the Company's investment of $40.5 million in MeriStar Investment Partners, LP and net additional investment in hotel properties.

Total liabilities increased by $138.7 million to $1,847.6 million at June 30, 1999 from $1,708.9 million at December 31, 1998 due mainly to an increase in long-term debt and the effect of deferring $56.3 million of revenue under the Emerging Issues Task Force ("EITF") Issue No. 98-9. Long-term debt increased by $79.7 million to $1,682.1 million at June 30, 1999 from $1,602.4 million at December 31, 1998 as a result of borrowings under the New Credit Facility and the issuance of $55 million of new subordinated notes.


RESULTS OF OPERATIONS


THREE MONTHS ENDED JUNE 30, 1999 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1998

Total revenue decreased by $110.8 million from $184.9 million in the three-month period ended June 30, 1998 to $74.1 million in the three-month period ended June 30, 1999. This decrease was primarily attributable to the change in the types of revenues recorded in the Company's financial statements in periods before and after the Merger. On a pro forma basis for the quarter, revenue per available room ("RevPAR") increased 3.5 percent to $79.73 compared to $77.05 in 1998. Same-store average daily rate ("ADR") for such hotels rose 0.7 percent from $102.91 on a pro forma basis in 1998 to $103.62 in 1999, and occupancy increased to 77.0 percent, compared to 74.9 percent on a pro forma basis in the same period in 1998.

Hotel department and other operating expenses decreased in 1999 because after August 3, 1998, in conjunction with the Merger and Spin-Off, all then-existing hotel operations were leased to OpCo.

Net interest expense increased to $26.4 million for the three months ended June 30, 1999 from $12.1 million for the same period in 1998. This increase was attributable to the borrowings made to finance the acquisition of hotels during 1998 and the new debt associated with the Merger, offset by a lower average interest rate.


SIX MONTHS ENDED JUNE 30, 1999 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1998


Total revenue decreased by $190.4 million from $328.5 million in the six-month period ended June 30, 1998 to $138.1 million in the six-month period ended June 30, 1999. This decrease was primarily attributable to the change in the types of revenues recorded in the Company's financial statements in periods before and after the Merger. On a pro forma basis, revenue per available room ("RevPAR") increased 3.8 percent to $78.16 compared to $75.27 in 1998. Same-store average daily rate ("ADR") for such hotels rose 1.0 percent from $104.51 on a pro forma basis in 1998 to $105.54 in 1999, and occupancy increased to 74.1 percent, compared to 72.0 percent on a pro forma basis in the same period in 1998.

Hotel department and other operating expenses decreased in 1999 because after August 3, 1998, in conjunction with the Merger and Spin-Off, all then-existing hotel operations were leased to OpCo.

Net interest expense increased to $50.5 million for the six months ended June 30, 1999 from $22.1 million for the same period in 1998. This increase was attributable to the borrowings made to finance the acquisition of hotels during 1998 and the new debt associated with the Merger, offset by a lower average interest rate.

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 March 1995 defines FFO as net income (loss) (computed in accordance with generally accepted accounting principles ("GAAP")), excluding gains (or losses) from debt restructuring and 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. 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. The Company computes FFO in accordance with standards established by NAREIT which may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than the Company. 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. In addition, the Company includes the effect of adding back deferred revenue resulting from EITF Issue No. 98-9, "Accounting for Contingent Rent in Interim Financial Periods," in the calculation of FFO.


The following is a reconciliation between net income and FFO for the three and six months ended June 30, 1999 (in thousands):

	Three Months Ended June 30, 1999	Six Months Ended June 30, 1999
Net income	$ 7,179	$ 7,446
Effect of EITF No. 98-9 (net of income taxes)	26,715	55,286
Minority interest to Common OP Unit Holders	1,518	1,563
Interest on convertible debt	2,026	4,119
Hotel depreciation and amortization	23,593	46,616
Diluted FFO	$61,031	$115,030

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 internally generated cash, external borrowings, and the issuance of units of the Company's subsidiary operating partnership and/or common stock. Additionally, the Company will be required, in order to maintain favorable tax treatment accorded to a REIT under the Internal Revenue Code, to distribute to stockholders at least 95% of its REIT taxable income. The Company expects to fund such distributions through cash generated from operations or borrowings on the Company's credit facilities.

Operating activities provided $105.9 million of net cash in the six-month period ended June 30, 1999 mainly due to higher levels of depreciation and amortization and accrued expenses and other liabilities. The Company used $106.0 million of cash in investing activities for the first six months of 1999, primarily for capital expenditures and the investment in MeriStar Investment Partners. Net cash provided by financing activities of $27.5 million resulted primarily from net borrowings under the Company's credit facilities, offset partially by dividends paid.

On March 18, 1999, the Company sold $55.0 million aggregate principal amount (issue price of $51.9 million, net of discount) of 8.75% senior subordinated notes due 2007, generating net proceeds of $51.2 million to the Company. The Company used the net proceeds to repay indebtedness under its New Credit Facility and to invest in real estate ventures.

At June 30, 1999, the Company had available $61.0 million under the New Credit Facility and $47.2 million under the non-recourse facility. As of August 4, 1999, the Company has available $60.0 million under the New Credit Facility and $47.2 million under the non-recourse facility.

The Company is in the process of refinancing its $250.0 million Secured Facility and $52.8 million Non-Recourse Facility. The refinanced notes are expected to have a maturity of August 2009. The transaction is expected to close in August 1999.

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-month period ended June 30, 1999, the Company spent approximately $93.2 million on capital expenditures. The Company expects to spend approximately $81.8 million during the remainder of 1999 to complete initial renovation programs and to fund ongoing capital expenditures for its owned hotels.

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, or to refinance existing debt.


SEASONALITY

Demand in the lodging industry is affected by recurring seasonal patterns. Excluding resort hotel properties, demand is lower in the winter months due to decreased travel and higher in the spring and summer months during peak travel season. The majority of the properties operated by the Company are non-resort properties. Therefore, the Company's operations are seasonal in nature. Assuming other factors remain constant and excluding resort hotel properties and the effect of EITF 98-9 on reporting in interim periods, 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.


YEAR 2000 CONVERSION

The Company has reviewed its computer systems to identify the systems that could be affected by the "Year 2000" problem and has initiated an implementation plan to address the problem. The Year 2000 problem is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. If not corrected, this could result in a major systems failure or miscalculations.

The Company's hotel properties contain various information technology and embedded technology systems. Both types of systems contain microprocessors and microcontrollers that must be assessed for Year 2000 compliance. The Company has developed a comprehensive implementation plan to address the potential Year 2000 problems caused by such systems. This plan involves six stages: increase awareness of issue; assign responsibility for coordinating response to issue; information collection; analysis; modification, repair or replacement; and testing. The Company is currently in its modification, repair or replacement stage, and expects to complete this stage and testing in October 1999.

As an additional part of its implementation plan to address the Year 2000 problem, the Company has also initiated communications with third parties with which it has material relationships to determine the extent of potential Year 2000 problems with these parties' services provided to the Company.

The most critical of these services involve such items as reservations systems for the Company's hotels. Without such systems, the Company could suffer a material decline in business at many of its properties. The Company expects to complete its communications and assessment of these outside parties' services in September 1999. Also, the Company expects to review and update its contingency plans in 1999 to allow for manual or other alternative operation of certain computerized systems, in the event that modification, repair, and replacement efforts are not completed timely.

The Company anticipates completing its Year 2000 implementation plan no later than October 31, 1999, which is prior to any anticipated impact on its operating systems. As of June 30, 1999 historical costs incurred to address the Year 2000 problem approximate $1.0 million. The Company's current estimate of these remediation costs to fix Year 2000 issues is $7-9 million. This cost estimate is based on the Company's current assessment, and will be refined and adjusted as the Company continues to complete the stages of its implementation plan to address the potential Year 2000 problems.

Based on its preliminary assessment, the Company believes that its risks of Year 2000 non-compliance (that is, its "most reasonably likely worst case scenario"), with modifications to existing software and converting to new software, will not pose significant operational problems for the Company's computer systems as so modified and converted. If, however, such modifications and conversions are not completed timely, the Year 2000 problem could have a material impact on the Company's financial position and operations. The Company's operations are highly dependent upon participating lease revenue earned from the lessees of its properties. These participating lease revenue amounts are based upon revenues generated at the leased properties. To the extent that the Year 2000 problems materially affect the conduct of operations at those properties, it is likely that those lessees' revenues would be affected, and that the Company's participating lease revenues would ultimately be affected.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes since the Company filed the Form 10-Q/A on May 20, 1999.