ITEM 1. BUSINESS
Business Overview
MeriStar Hospitality Operating Partnership, L.P. (the “Company”) is the subsidiary operating partnership of MeriStar Hospitality Corporation Commission file number 1-11903, (“MeriStar Hospitality,” which is a real estate investment trust, or REIT) and owns a portfolio of primarily upper upscale, full-service hotels and resorts. Our portfolio is diversified geographically as well as by franchise and brand affiliations. As of December 31, 2004, we owned 73 hotels with 20,319 rooms. Our hotels are located in major metropolitan areas, rapidly growing secondary markets or resort locations in the United States. Most of our hotels are operated under internationally recognized brand names such as Hilton®, Sheraton®, Marriott®, The Ritz-Carlton®, Westin®, Doubletree®, Holiday Inn®, Embassy Suites® and Radisson®, although we have 11 hotels with 2,043 rooms that are not operated under any brand.
We believe the upper upscale, full-service segment of the lodging industry offers attractive potential operating results and investment opportunities in the long term. In the recent past, the real estate market experienced a significant slowdown in the construction of upper upscale, full-service hotels. The growth of demand for new rooms continues to exceed the growth in supply of new rooms in this lodging segment and upper upscale, full-service hotels continue to have particular appeal to both business executives and upscale leisure travelers. We believe the combination of these factors offers good long-term potential ownership opportunities for us in this sector of the lodging industry.
We were created on August 3, 1998, when American General Hospitality Corporation (“AGH”), a corporation operating as a real estate investment trust, merged with CapStar Hotel Company (“CapStar”). Prior to the merger, CapStar was required to separate its real estate assets, consisting primarily of hotel assets, from its management business in order for the merged company to continue to operate as a REIT. After the separation, CapStar was merged with AGH to form MeriStar Hospitality Corporation.
The newly separated management business was then named MeriStar Hotels & Resorts, Inc. (“MeriStar Hotels”). MeriStar Hotels was engaged to be the lessee and manager of nearly all of our hotels, as was required by the relevant REIT rules at the time. On July 31, 2002, MeriStar Hotels merged with Interstate Hotels Corporation to form Interstate Hotels & Resorts, Inc. (“Interstate Hotels”). Interstate Hotels currently manages 71 of our hotels. We and Interstate Hotels had previously entered into an intercompany agreement that governed a number of aspects of our relationship. During July 2004, we concluded negotiations with Interstate Hotels to terminate the intercompany agreement (see “The Management Agreements-Interstate Hotels”). Our Chief
Executive Officer and MeriStar Hospitality’s Chief Executive Officer and Chairman of the Board, Paul W. Whetsell, continues to act as the Chairman of the Board of Interstate Hotels, although he is no longer an executive or an employee of Interstate Hotels.
As of December 31, 2004, our general partner, MeriStar Hospitality, in the form of our Common units, directly owned a one percent general partnership interest in us and also indirectly owned an approximately 96% interest in us. Several third parties owned the remaining approximately 3% of our equity interests, in the form of various classes of our partnership units.
Relationship with Interstate Hotels
Since the July 2002 merger that formed Interstate Hotels, we and Interstate Hotels have separated the senior management teams of the two companies in order to allow each senior management team to devote more attention to its respective company’s matters. In December 2003, MeriStar Hospitality’s Board of Directors and that of Interstate Hotels each formed a special committee of independent directors to explore further changes to the relationship between our company and Interstate Hotels, including possible changes to the terms, or complete elimination, of the intercompany agreement.
During July 2004, we concluded negotiations with Interstate Hotels to terminate the intercompany agreement and reached an agreement regarding the calculation of termination fees payable upon a sale. See “The Management Agreements-Interstate Hotels.”
Effective March 31, 2004, our Chief Executive Officer, Paul Whetsell, resigned as CEO of Interstate Hotels, but remains a non-executive Chairman of the Board of Directors of Interstate Hotels. Interstate Hotels is a separate, publicly-traded company.
Portfolio Strategy
At the beginning of 2003, we set out a strategy to position the Company to best take advantage of an expected economic and industry recovery. We believe that we are in the midst of a lodging industry economic recovery. While the recovery is not yet uniform throughout the country, we believe that it will continue to expand and our portfolio performance will benefit as that expansion to additional markets occurs. Our strategy includes the following key initiatives: focus on growth of earnings and cash flow from our existing portfolio using an aggressive asset management program; upgrade our portfolio through extensive renovations; selectively recycle capital from our existing portfolio into higher yielding hotel investments; improve our capital structure; maintain the upside potential of our existing assets, including real estate potential; and maintain liquidity.
Our Asset Management Group, which consists of senior level hotel operators, and construction and engineering experts, concentrates on maximizing all potential revenue management profitability options at our hotels.
We are in the process of upgrading the product quality and growth potential of our hotels through our aggressive capital expenditure program. We have continued to reshape our portfolio through three strategic, high-quality hotel investments, and dispositions of a number of lower yielding properties that did not meet our long-term investment criteria. We have substantially completed our asset disposition program.
We have continued to execute our targeted renovation program using a proprietary program to reduce the time and cost required to renovate hotels, allowing us to improve the quality of our hotels faster to take advantage of the rebound in the economy and better control the level of disruption associated with renovations. We invested approximately $134 million in capital expenditures during 2004, and we expect to invest approximately $100 million in capital expenditures during 2005, including $15 million to complete projects started in 2004 and excluding hurricane-related capital expenditures, to enhance the quality of our portfolio to
meet or exceed the standards of our primary brands-Hilton, Marriott, and Starwood-as well as to improve the competitiveness of these assets in their markets and enable them to more fully participate in the economic recovery. While results are negatively impacted during renovations due to out of service rooms and the negative impact on the ability to sell other hotel services, we expect to have positioned these renovated properties well to be able to benefit from the economic recovery. The amount of hurricane-related capital expenditures has not yet been fully determined, however, we anticipate it to well exceed $100 million, most of which we expect to be reimbursed by our insurance carriers.
Asset Acquisitions
During 2004, we invested in three properties, each of them having exceptional quality and exhibiting superior growth potential, and being located in three of the top performing markets in the country. We believe these factors will enable these investments to produce superior returns for our shareholders. Our two consolidated hotels, and while not consolidated into our results, the hotel for which we record equity in income, realized 2004 (full year) combined RevPAR of $132.74. RevPAR for our entire portfolio during 2004 was $69.82. The higher RevPAR of the acquired hotels is indicative of their overall earnings power.
On May 10, 2004 we acquired the four-star, four-diamond rated Ritz-Carlton, Pentagon City in Arlington, Virginia for a purchase price of $93 million. The 366-room luxury hotel is operated by The Ritz-Carlton Hotel Company, LLC (“Ritz-Carlton”) under a long-term contract. The hotel features nearly 18,000 square feet of meeting space, which can accommodate meetings of up to 900 guests. On June 30, 2004, we partially financed the acquisition through the placement of a $55.8 million fixed-rate mortgage loan, which is secured by this property. The mortgage matures on June 1, 2011 and bears interest at an annual fixed rate of 5.8%. We financed the remainder of the acquisition cost with cash on hand.
Additionally, on June 25, 2004, we acquired the 485-room Marriott Irvine in Orange County, California, for a purchase price of $92.5 million. The hotel is operated by a subsidiary of Marriott International, Inc. (“Marriott”) under a long-term contract. The hotel features 30,000 square feet of meeting space, including a 13,000 square foot ballroom that can accommodate meetings of up to 1,500 guests. To take advantage of the current low interest rate environment, we financed a portion of the acquisition with a $55.5 million fixed-rate mortgage, which is secured by this property, matures on July 1, 2011 and bears interest at an annual fixed rate of 5.69%. We financed the remainder of the acquisition cost with cash on hand.
On October 1, 2004, we acquired a 49.99% interest in the 705-room Radisson Lexington Avenue Hotel in Midtown Manhattan. We made a total investment of $50 million, which includes a $40 million mezzanine loan that matures on October 1, 2014 and yields $5.8 million of cumulative annual interest, and a $10 million equity interest in the hotel. The mezzanine loan is secured by a pledge of the equity interests held by the borrower in an indirect parent of the owner of the hotel, and has a 10-year term. The loan is subordinate to $150 million in senior notes, but has priority over all equity interests.
We will continue to be highly selective with potential acquisitions, focusing primarily on larger properties located in major urban markets or high-end resort destinations with high barriers to new competition, premium brand affiliations, significant meeting space and superior growth potential. We may be somewhat limited by the terms of our note indentures, which limit our ability to obtain debt financing to acquire assets beyond certain limited exceptions (including up to $300 million of mortgage indebtedness, of which $194.5 million was available at December 31, 2004; and $50 million of general indebtedness) as we are below the required fixed charge coverage ratio of 2 to 1, at which level we generally would be permitted to incur debt without restriction.
Asset Dispositions
We have substantially completed our previously announced disposition program that repositioned our portfolio into one generally consisting of larger assets with significant meeting space in urban or high-end resort
locations. Between January 1, 2003 and December 31, 2004, we disposed of 36 hotels with 8,109 rooms for total gross proceeds of $283.6 million in cash and $11.1 million in reduction of debt. Of these 36 hotels, 15 hotels were disposed of in 2003 and 21 hotels were disposed of in 2004.
In addition, we may from time to time receive offers on other assets that we might consider selling. We would consider any opportunities that have the potential to improve our financial condition or results of operations.
Recent Developments
Hurricane Damage to Florida Properties
In August and September 2004, hurricanes caused substantial damage to a number of our hotels located in Florida. The hurricane damage and local evacuation orders also caused significant business interruption at many of our Florida properties, including the complete closure of certain hotels. For more information regarding the impact of these hurricanes, see “-Results Overview.”
Investment in Radisson Lexington Avenue Hotel
On October 1, 2004, we acquired an interest in the landmark, 705-room Radisson Lexington Avenue Hotel in Midtown Manhattan, as described above under “Portfolio Strategy-Asset Acquisitions.”
Investment in MIP
In 1999, we invested $40 million in MeriStar Investment Partners, L.P. (“MIP”), a joint venture established to acquire upscale, full-service hotels. Our cost-basis investment is in the form of a limited partnership interest, in which we earned a 16% cumulative preferred return with outstanding balances compounded quarterly. While the return on this investment was preferred and cumulative, the underlying investment ranked equally with the investments of the other investors in MIP.
In December 2004, MIP’s partnership agreement was amended and restated. In accordance with the amended and restated MIP partnership agreement, MIP’s general partner contributed $10 million to MIP which was then distributed to us, thereby reducing our outstanding preferred return receivable; the return on our investment and on our remaining unpaid accrued preferred return was reduced to a 12% future annual cumulative return rate, and subordinate only to the MIP debt; and $12.5 million of our $40 million investment was upgraded to receive preference over all other investments. As a result of the partnership restructuring, our ability to collect the preferred return improved, and we reassessed the carrying value of our preferred return. During the fourth quarter of 2004, we were able to recognize as income the $4.1 million compounded cumulative preferred return, $1.4 million of which was earned in 2003, but fully reserved.
In February 2005, MIP completed a $175 million commercial mortgage-backed securities financing, secured by its portfolio of eight hotels. Upon the completion of the financing in February 2005, we received an additional $15.5 million, which was applied to reduce our outstanding accrued preferred returns receivable to approximately $4 million.
After the February 2005 receipt of cash, our total MIP carrying value was approximately $19 million, consisting of the $15 million investment and $4 million of accrued preferred returns receivable.
Placement of mortgages
On January 26, 2005, we entered into a $37.7 million mortgage loan on our Hilton Crystal City hotel that bears interest at a fixed rate of 5.84%. The mortgage requires interest payments only for the first three years and then monthly payments of interest and principal over the remaining portion of the ten year term of the loan.
We may look to use additional mortgage capacity permitted under our bond indentures to raise low interest rate, long-term secured debt with the proceeds used to repay more expensive debt and to fund capital investments in new or existing properties.
The Partnership Agreement
The following summary information is qualified in its entirety by the provisions of the Second Amended and Restated Agreement of Limited Partnership of MeriStar Hospitality Operating Partnership, L.P., as amended, a copy of which is incorporated by reference as Exhibit 10.1 to this Form 10-K.
Our partnership agreement gives MeriStar Hospitality full control over our business and affairs. The agreement also gives MeriStar Hospitality the right, in connection with the contribution of property to us or otherwise, to issue additional partnership interests in us in one or more classes or series. These issuances may have such designations, preferences and participating or other special rights and powers (including rights and powers senior to those of the existing partners) as MeriStar Hospitality determines appropriate.
Our partnership agreement currently provides for five classes of partnership interests: Common Operating Partnership (OP) Units, Class B OP Units, Class C OP Units, Class D OP Units and Profits-Only OP Units (POPs). As of March 7, 2005, MeriStar Hospitality and our wholly-owned subsidiaries owned a number of Common OP Units equal to the number of issued and outstanding shares of MeriStar Hospitality’s common stock (87,370,340 shares), par value $0.01. Other ownership interests were as follows:
•
Independent third parties owned 2,297,823 OP Units (consisting of 1,437,481 Common OP Units, 46,628 Class B OP Units, and 813,714 Class C OP Units).
•
There are no Class D OP units or POPs outstanding.
Holders of Common OP Units and Class B OP Units receive distributions for each Common or Class B OP Unit equivalent to the dividend paid on each of MeriStar Hospitality’s common shares. Holders of Class C OP Units receive a non-cumulative, quarterly distribution equal to $0.5575 per Class C OP Unit so long as the Common OP Units and Class B OP Units receive a distribution for such quarter and the dividend rate on MeriStar Hospitality’s common stock has not exceeded $0.5575. Class C OP Units automatically convert into Common OP Units once that dividend rate is exceeded. All net income and capital received by us (after payment of the annual preferred return and, if applicable, the liquidation preference) will be shared by the holders of the Common OP Units in proportion to the number of Common OP Units in the relevant operating partnership owned by each such holder.
Each Common OP Unit, Class B OP Unit and Class C OP Unit held by third-parties is redeemable by the holder for cash in an amount equal to the market value of a share of MeriStar Hospitality’s common stock or, at our option, for one share of MeriStar Hospitality’s common stock, determined in accordance with the terms of our partnership agreement.
On April 9, 2004, in accordance with the terms of the certificate of designation for the outstanding Class D OP Units of our operating partnership, we redeemed all outstanding Class D OP Units plus accrued and unpaid preferential distributions on those units, for an aggregate consideration of approximately $8.7 million. The Class D OP Units had become redeemable at the option of the holder on April 1, 2004.
In July 2004, MeriStar Hospitality’s Board of Directors authorized the elimination of the plan pursuant to which the POPs were issued. In conjunction with the elimination of the plan, we completed the redemption of all outstanding POPs for a total of $4.6 million in cash on December 2, 2004, although 187,500 of those POPs redeemed were not yet exchangeable pursuant to the POPs Plan. See Note 10 to the financial statements.
REIT Modernization Act
On January 1, 2001, changes to the U.S. federal tax laws governing REITs, commonly known as the REIT Modernization Act, or RMA, became effective. As permitted by the RMA, MeriStar Hospitality formed a number of wholly-owned taxable subsidiaries, which are subject to taxation similar to subchapter C-corporations, to lease our real property. Accordingly, a subcommittee of independent members of MeriStar Hospitality’s Board of Directors ratified the transfer of our leases, that were previously with subsidiaries of Interstate Hotels, to our taxable subsidiaries. In connection with the assignment, the taxable subsidiaries executed new management agreements with a subsidiary of Interstate Hotels for each property they previously leased. The management agreements were structured to substantially mirror the economics of the former lease agreements. We believe this structure provides us with the ability to capture the economic interests of property ownership, as well as more efficiently aligning such interests.
Although a taxable subsidiary may lease our real property, it is restricted from being involved in certain activities prohibited by the RMA. First, a taxable subsidiary is not permitted to manage the property itself; it must enter into an “arm’s-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, the taxable subsidiary is not permitted to lease a property that contains gambling operations. Third, the taxable subsidiary is restricted from owning a brand or franchise.
In the course of document review with respect to the MIP restructuring, MeriStar Hospitality discovered a potential technical REIT qualification issue relating to a wholly-owned subsidiary of MIP, of which we are deemed to own a de minimis proportionate share. In order to eliminate any uncertainty, MeriStar Hospitality is currently negotiating a closing agreement with the Internal Revenue Service to resolve all REIT qualification matters with respect to this potential issue. As a partnership for federal income tax purposes, we are not directly affected by the outcome of the discussions by MeriStar Hospitality with the Internal Revenue Service.
The Management Agreements-Interstate Hotels
Management Fees and Performance Standards
Each of our taxable subsidiaries pays a hotel management fee to Interstate Hotels. Under the management agreement, the base management fee is 2.5% of total hotel operating revenue, plus incentive payments based on meeting performance thresholds that could total up to an additional 1.5% of total hotel operating revenue, not to exceed 4.0% of total hotel operating revenue. The incentive payments are calculated as 20% of the difference between: the actual excess of total operating revenues over total operating expenses; and the projected excess of total operating revenues over projected total operating expenses.
Term and Termination
The management agreements with Interstate Hotels generally have initial terms expiring on January 1, 2011 with three renewal periods of five years each. A renewal will not go into effect if a change in the federal tax laws permits us or one of our subsidiaries to operate the hotel directly without adversely affecting MeriStar Hospitality’s ability to qualify as a REIT, or if Interstate Hotels elects not to renew the agreement. We may elect not to renew the management agreements only as provided below.
Our taxable subsidiaries have the right to terminate a management agreement for a hotel upon the sale of the hotel to a third party or if the hotel is not restored after a significant casualty loss. Upon that termination, the relevant taxable subsidiary will be required to pay Interstate Hotels the fair market value of the management agreement. That fair market value will be equal to the present value of the total of the remaining payments (discounted using a 10% rate) of the existing term under the agreement, based on the operating results for the 12 months preceding the termination.
If a hotel’s gross operating profit is less than 85% of the amount projected in the hotel’s budget in any fiscal year and gross operating profit from that hotel is less than 90% of the projected amount in the next fiscal year, our taxable subsidiaries will have the right to terminate the management agreement for the hotel, unless:
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we did not materially comply with the capital expenditures contemplated by the capital budget for either or both of the applicable fiscal years; or
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Interstate Hotels cures the shortfall by agreeing to reduce its management fee for the next fiscal year by the amount of the shortfall between the actual operating profit for the second fiscal year and 90% of the projected gross operating profit for that year.
Interstate Hotels can only use the cure right once during the term of each management agreement.
In January 2005, we notified Interstate Hotels that 11 hotels with 3,655 rooms had apparently failed to meet the performance test involving two year operating results versus budgets for those years. We, MeriStar Hospitality and Interstate Hotels are currently in discussions relating to the apparent shortfall, the reasons for such shortfall, and any remedies that are available to us.
As previously described, in December 2003, MeriStar Hospitality’s Board of Directors and that of Interstate Hotels each formed a special committee of independent directors to explore further changes to the relationship between our company and Interstate Hotels, including possible changes to the terms, or complete elimination, of the intercompany agreement. During July 2004, we concluded negotiations with Interstate Hotels to terminate the intercompany agreement. In exchange for terminating the intercompany agreement, we received, among other things:
•
the right to terminate up to 600 rooms per year upon the payment of a termination fee equal to 1.5 times the fees earned during the preceding 12 months, with the ability to carry over up to 600 rooms for termination in the succeeding year;
•
the right to terminate the management contract of a hotel, where Interstate Hotels invests in a competing hotel, with no termination fee; and
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an extension of the termination fee payment period for terminations related to hotel sales, from 30 months to 48 months.
Separately, we reached an agreement with Interstate Hotels regarding the calculation of termination fees payable upon a sale. Although termination fees for the properties that have been disposed of or were expected to be disposed of under our previously announced disposition program (which includes one of the 73 properties we owned as of December 31, 2004) will be unchanged, we received a $2.5 million credit, which is applicable to fees payable with respect to future dispositions. Of the $2.5 million credit, $2.4 million has been applied to terminations that occurred during 2004.
Assignment
Interstate Hotels does not have the right to assign a management agreement without the prior written consent of the relevant taxable subsidiary. A change in control of Interstate Hotels will require the consent of the relevant taxable subsidiary, and that subsidiary may grant or withhold its consent in its sole discretion.
The Management Agreements-Other
Two of the 73 hotels we owned as of December 31, 2004 were managed by parties other than Interstate Hotels. One hotel was managed by The Ritz-Carlton Hotel Company, LLC (“Ritz-Carlton”), a subsidiary of Marriott International, Inc., and one hotel was managed by another subsidiary of Marriott International, Inc. (“Marriott”).
Each of our taxable subsidiaries pays a hotel management fee to the manager of its hotel. Under the Ritz-Carlton and Marriott management agreements, the base management fee is 3.0% and 2.5% of total hotel revenue,
respectively, through 2005 and 3.0% under both thereafter, plus incentive payments based on meeting performance thresholds that could total up to an additional 2.0% of total revenue and 20% of available cash flow (as defined in the relevant management agreement), respectively. The agreements have initial terms expiring in 2015 and 2024, respectively, with four and three renewal periods of 10 and five years each, respectively, at the option of Ritz-Carlton and Marriott. The Ritz-Carlton and Marriott management agreements include certain limited performance guarantees by the relevant manager which are designed primarily to provide downside performance protection and run through 2005 and up to 2008, respectively. During 2004, we recorded a total amount of $1.0 million under the Ritz-Carlton and Marriott limited performance guarantees, combined. Management, based upon budgets and operating trends, expects payments under these guarantees in the future to be minimal.
Franchises
We employ a flexible strategy in selecting brand names based on each particular hotel’s market environment and other unique characteristics. Accordingly, we use various well-known trade names under licensing arrangements with prominent franchisors. Generally, our franchise fees range from 1.4% to 5.2% of hotel revenues. From time to time, we have conducted negotiations with franchisors to rebrand certain hotels to improve their competitiveness and profitability in light of changing circumstances in the lodging market. We make ongoing capital expenditures in order to keep our hotels competitive and to comply with franchise obligations, as described further in Risk Factors-Operating Risks-“We may be adversely affected by the requirements contained in our franchise and licensing agreements” in Item 1 of this Annual Report on Form 10-K. We have included a listing of all of our properties, along with the affiliated brand names, under Item 2
ITEM 2. PROPERTIES
Our principal executive offices are located in Arlington, Virginia. All of our hotels are currently leased to our taxable subsidiaries and are owned directly by our operating partnership or its subsidiaries. No one hotel property is material to our operations. A typical hotel has meeting and banquet facilities, food and beverage facilities, and guest rooms and suites. Our hotels generally feature comfortable, modern guest rooms, extensive meeting and convention facilities and full-service restaurant and catering facilities. Our hotels are designed to attract meeting, convention, and banquet/reception functions from groups and associations, upscale business and vacation travelers, and the local community.
The following table sets forth certain information with respect to our 73 hotels owned as of December 31, 2004.
Hotel
Location
Guest
Rooms
Arizona
Embassy Suites Tucson
Tucson
California
Courtyard by Marriott, Marina del Rey
Marina Del Rey
Crowne Plaza San Jose
San Jose
Doral Palm Springs(1)
Palm Springs
Hilton Irvine
Irvine
Hilton Monterey
Monterey
Hilton Sacramento
Sacramento
Marina Hotel San Pedro(2)
San Pedro
LA Marriott Downtown
Los Angeles
Marriott Irvine
Irvine
Sheraton Fisherman’s Wharf
San Francisco
Colorado
Embassy Suites Denver
Englewood
Sheraton Colorado Springs
Colorado Springs
Connecticut
Doubletree Hotel Bradley International Airport
Windsor Locks
Florida
Best Western Sanibel Island Resort
Sanibel Island
Doubletree Hotel Westshore
Tampa
Doubletree Universal
Orlando
Hilton Clearwater(2)
Clearwater
Hilton Hotel Cocoa Beach
Cocoa Beach
Holiday Inn Fort Lauderdale Beach
Ft. Lauderdale
Holiday Inn Walt Disney World Village(2)
Lake Buena Vista
Sanibel Inn
Sanibel Island
Seaside Inn
Sanibel Island
Sheraton Beach Resort Key Largo
Key Largo
Sheraton Safari Lake Buena Vista
Lake Buena Vista
Song of the Sea
Sanibel Island
South Seas Plantation Resort & Yacht Harbor
Captiva
Sundial Beach Resort
Sanibel Island
Georgia
Doubletree Atlanta
Atlanta
Westin Atlanta
Atlanta
Wyndham Marietta
Marietta
Illinois
Crowne Plaza Chicago O’Hare
Rosemont
Radisson Chicago
Chicago
Hotel
Location
Guest
Rooms
Indiana
Doubletree Indianapolis
Indianapolis
Kentucky
Hilton Seelbach
Louisville
Radisson Lexington
Lexington
Louisiana
Hilton Lafayette
Lafayette
Holiday Inn Select New Orleans
Kenner
Hotel Maison de Ville(2)
New Orleans
Maryland
Radisson Annapolis
Annapolis
Radisson Cross Keys
Baltimore
Sheraton Columbia
Columbia
Michigan
Hilton Detroit
Romulus
Hilton Hotel Grand Rapids
Grand Rapids
New Jersey
Courtyard by Marriott Secaucus(2)
Secaucus
Doral Forrestal(2)
Princeton
Marriott Somerset
Somerset
Sheraton Crossroads Hotel Mahwah
Mahwah
New Mexico
Doubletree Albuquerque
Albuquerque
Wyndham Albuquerque Airport Hotel(2)
Albuquerque
North Carolina
Courtyard by Marriott Durham
Durham
Hilton Hotel Durham
Durham
Sheraton Charlotte Airport
Charlotte
Oklahoma
Sheraton Oklahoma City
Oklahoma City
Pennsylvania
Embassy Suites Philadelphia
Philadelphia
Sheraton Great Valley
Frazer
Texas
Doubletree Austin
Austin
Doubletree Hotel Dallas Galleria
Dallas
Hilton Arlington
Arlington
Hilton Houston Westchase
Houston
Marriott West Loop Houston
Houston
Utah
Hilton Salt Lake City Airport
Salt Lake City
Virginia
Hilton Arlington
Arlington
Hilton Crystal City
Arlington
Holiday Inn Historic District Alexandria
Alexandria
Radisson Old Town Alexandria
Alexandria
The Ritz-Carlton, Pentagon City(2)
Arlington
Washington
Sheraton Bellevue
Bellevue
Washington, D.C.
Georgetown Inn
Washington, D.C.
Hilton Embassy Row(2)
Washington, D.C.
Latham Georgetown
Washington, D.C.
Hotel
Location
Guest
Rooms
Wisconsin
Crowne Plaza Madison
Madison
Holiday Inn Madison
Madison
Total Rooms
20,319
(1) We lease part of the land on which this hotel was built under one or more long-term lease agreements.
(2) We lease the land on which this hotel was built under one or more long-term lease agreements.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the course of our 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
MeriStar Hospitality held a Special Meeting of Stockholders on September 23, 2004, with a goal to amend and restate its charter. The affirmative vote of over two-thirds of its shares outstanding as of the record date, August 11, 2004, was required for the proposal to pass. The September 23, 2004 meeting was adjourned to December 8, 2004. At the December 8, 2004 meeting, the proposal was withdrawn, as it had not heard from the holders of nearly 19 million shares with respect to the proposal.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
There is not an established public trading market for our OP units. The OP units, however, are redeemable at the option of the holder for a like number of shares of common stock of MeriStar Hospitality, or, at the option of MeriStar Hospitality, for the cash equivalent. The following information is provided regarding the common stock of MeriStar Hospitality. MeriStar Hospitality’s common stock is listed on the New York Stock Exchange (NYSE) under the symbol “MHX.” The following table sets forth for the periods indicated the high and low sales prices for MeriStar Hospitality’s common stock and the cash dividends declared with respect thereto.
(1) MeriStar Hospitality suspended its quarterly dividend payment in the fourth quarter of 2002. At current operating levels, MeriStar Hospitality does not anticipate paying a dividend in 2005.
The last reported sales price of MeriStar Hospitality’s common stock on the NYSE on March 11, 2005 was $7.70. As of March 7, 2005, there were 671 holders of record of MeriStar Hospitality’s common stock.
Based on our current operating levels, MeriStar Hospitality does not expect to pay a dividend in 2005. Any future distributions will be at the discretion of MeriStar Hospitality’s Board of Directors and will be determined by factors including our operating results, capital expenditure requirements, the economic outlook, the distribution requirements for REITs under the Internal Revenue Code and such other factors as MeriStar Hospitality’s Board of Directors deems relevant. Also, our $50 million credit facility and the indentures related to MeriStar Hospitality’s senior unsecured notes and senior subordinated notes contain limitations on the ability to declare and pay dividends. Therefore, MeriStar Hospitality’s can give no assurance that it will make any such distributions in the future.
To obtain the favorable tax treatment accorded to REITs under the Internal Revenue code, MeriStar Hospitality normally is required each year to distribute to its stockholders at least 90% of its REIT taxable income, determined without regard to the deduction for dividends paid and by excluding net capital gains. Under certain circumstances, it may be required to make distributions in excess of available cash in order to meet these distribution requirements. In that event, it would seek to borrow additional funds or sell additional non-core assets, or both, to the extent necessary to obtain cash sufficient to make the dividends required to retain its qualification as a REIT. The restricted payments covenant in the indenture governing its outstanding senior subordinated notes does not permit MeriStar Hospitality to pay any dividends, including those required for it to maintain its REIT status, until it meets a 2.0 to 1.0 fixed charge coverage test. MeriStar Hospitality is currently unable to meet that test.
Recent Sales of Unregistered Securities
None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth summary selected historical consolidated financial data derived from our audited consolidated financial statements and other information as of and for each of the five years presented. The following information should be read in conjunction with our audited consolidated financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Annual Report on Form 10-K.
(A) Until January 1, 2001, Interstate Hotels leased substantially all of our hotels from us, and we received participating lease revenue from Interstate Hotels, which represented a specified percentage of each hotel’s revenue. Under the leases, Interstate Hotels recorded all of the operating revenues and expenses of the hotels in its statements of operations, and we recorded lease revenue earned under the lease agreements in our statement of operations. Effective January 1, 2001, in connection with changes permitted by the REIT
Modernization Act, Interstate Hotels assigned the hotel leases to our newly created, wholly-owned, taxable REIT subsidiaries, and our taxable REIT subsidiaries entered into management arrangements with Interstate Hotels to manage the hotels. As a result of this change, our wholly-owned taxable REIT subsidiaries have assumed the operating risks and rewards of the hotels and now pay Interstate Hotels a management fee to manage the hotels for us. Effective January 1, 2001, we began recording all of the revenues and expenses of the hotels in our statements of operations, including the management fee paid to Interstate Hotels. As a result, our operating results for the years ended after December 31, 2000 are not directly comparable to those for the year ended December 31, 2000.
(B) During 2001, we sold two hotels for a loss. During 2000, we sold three hotels for a gain. We adopted the provisions of Statement of Financial Accounting Standard (SFAS) No. 144 on January 1, 2002. SFAS No. 144 requires the current and prior period operating results of any asset that has been classified as held for sale or has been disposed of on or after January 1, 2002 and where we have no continuing involvement to be recorded as discontinued operations. Any gains or losses on final disposition are also included in discontinued operations. Therefore, any gains or losses on assets sold prior to January 1, 2002 are included in continuing operations.
(C) Continuing operations included losses on asset impairments related to our hotel portfolio of $4.9 million, $27.3 million, $0 and $0 for the years ended December 31, 2004, 2003, 2002 and 2001, respectively. For the year ended December 31, 2003, continuing operations also included an impairment loss of $25 million on our investment in MeriStar Investment Partners, L.P.
We adopted the provisions of SFAS No. 145 on January 1, 2003. Certain provisions require that all gains and losses from extinguishments of debt be classified as extraordinary only if the gains and losses are from unusual or infrequent transactions. Prior period amounts that do not meet this definition are required to be reclassified. Our prior period extraordinary items were reclassified, and in the future we expect any gains and losses from the extinguishment of our debt to be classified as a component of continuing operations. Prior period amounts reclassified to continuing operations were as follows:
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during 2001, we repaid term loans under our previous credit facility and wrote off deferred financing costs associated with this facility totaling $2.7 million, net of tax;
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during 2000, we repurchased some of our 4.75% convertible notes payable to MeriStar Hospitality at a discount, resulting in a $3.1 million gain, net of tax, on the repurchase.
(D) We adopted the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” on January 1, 2002. SFAS 144 requires that current and prior period operating results of any asset that has been classified as held for sale or has been disposed of on or after January 1, 2002, including any gain or loss recognized, to be recorded as discontinued operations. During 2004, we disposed of 21 hotels in separate transactions for an aggregate of $155.7 million in cash and $11.1 million in reduction of debt. As of December 31, 2004, we had no assets classified as held for sale. During 2003, we disposed of 15 hotels in separate transactions for an aggregate of $127.9 million in cash. As of December 31, 2003, we had seven hotels classified as held for sale. During 2002, we disposed of five hotels in separate transactions for an aggregate of $60.7 million in cash. As of December 31, 2002, we had one hotel classified as held for sale. Discontinued operations included losses on asset impairments of $7.4 million, $267.7 million, $78.7 million, and $43.6 million for the years ended December 31, 2004, 2003, 2002, and 2001, respectively.
(E) Includes $51 million and $110 million of assets held for sale as of December 31, 2003 and 2002, respectively.
(F) Total number of rooms occupied by hotel guests on a paid basis, divided by total available rooms. Prior periods have been restated to reflect occupancy data for the 73 hotels included in continuing operations.
(G) Average Daily Rate, or ADR, represents total room revenue divided by total number of rooms occupied by hotel guests on a paid basis. Prior periods have been restated to reflect ADR for the 73 hotels included in continuing operations.
(H) Revenue Per Available Room, or RevPAR, represents total room revenue divided by total available rooms. Prior periods have been restated to reflect RevPAR for the 73 hotels included in continuing operations.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Business Summary
MeriStar Hospitality Operating Partnership, L.P. is the subsidiary operating partnership of MeriStar Hospitality, which is a real estate investment trust, or REIT. We own a portfolio of primarily upper upscale, full-service hotels and resorts. Our portfolio is diversified geographically as well as by franchise and brand affiliations. As of December 31, 2004, we owned 73 hotels with 20,319 rooms. Our hotels are located in major metropolitan areas, rapidly growing secondary markets or resort locations in the United States. All of our hotels are leased by our taxable subsidiaries. As of December 31, 2004, 71 hotels were managed by Interstate Hotels & Resorts (“Interstate Hotels”), which was created on July 31, 2002 through the merger of MeriStar Hotels & Resorts, Inc. and Interstate Hotels Corporation, one hotel was managed by The Ritz-Carlton Hotel Company, LLC (“Ritz-Carlton”), a subsidiary of Marriott International, Inc., and one hotel was managed by another subsidiary of Marriott International, Inc. (“Marriott”) (collectively with Interstate Hotels, the “Managers”).
The Managers operate the 73 hotels we owned as of December 31, 2004 pursuant to management agreements with our taxable subsidiaries. Under these management agreements, each taxable subsidiary pays a management fee for each property to the Manager of its hotels. The taxable subsidiaries in turn make rental payments to our subsidiary operating partnership under the participating leases.
Under the Interstate Hotels management agreements, the base management fee is 2.5% of total hotel revenue, plus incentive payments based on meeting performance thresholds that could total up to an additional 1.5% of total hotel revenue. The agreements have initial terms expiring on January 1, 2011 with three renewal periods of five years each at the option of Interstate Hotels, subject to some exceptions.
Under the Ritz-Carlton and Marriott management agreements, the base management fee is 3.0% and 2.5% of total hotel revenue, respectively, through 2005 and 3.0% under both thereafter, plus incentive payments based on meeting performance thresholds that could total up to an additional 2.0% of total revenue and 20% of available cash flow (as defined in the relevant management agreement), respectively. The agreements have initial terms expiring in 2015 and 2024, respectively, with four and three renewal periods of 10 and five years each, respectively, at the option of Ritz-Carlton and Marriott. The Ritz-Carlton and Marriott management agreements include certain limited performance guarantees by the relevant manager which are designed primarily to provide downside performance protection and run through 2005 and up to 2008, respectively. During 2004, we recorded a total amount of $1.0 million under the Ritz-Carlton and Marriott limited performance guarantees, combined. Management, based upon budgets and operating trends, expects payments under these guarantees in the future to be minimal.
Since the July 2002 merger that formed Interstate Hotels, we and Interstate Hotels have separated the senior management teams of the two companies in order to allow each senior management team to devote more attention to its respective company’s matters. In December 2003, MeriStar Hospitality’s Board of Directors and that of Interstate Hotels each formed a special committee of independent directors to explore further changes to the relationship between our company and Interstate Hotels, including possible changes to the terms, or complete elimination, of the intercompany agreement.
During July 2004, we concluded negotiations with Interstate Hotels to terminate the intercompany agreement. In exchange for terminating the intercompany agreement, we received, among other things:
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the right to terminate up to 600 rooms per year upon the payment of a termination fee equal to 1.5 times the fees earned during the preceding 12 months, with the ability to carry over up to 600 rooms for termination in the succeeding year;
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the right to terminate the management contract of a hotel, where Interstate Hotels invests in a competing hotel, with no termination fee; and
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an extension of the termination fee payment period for terminations related to hotel sales, from 30 months to 48 months.
The termination of the intercompany agreement eliminates the last element of our original “paper clip” relationship with Interstate Hotels.
Separately, we reached an agreement with Interstate Hotels regarding the calculation of termination fees payable upon a sale. Although termination fees for the properties that have been disposed of or were expected to be disposed of under our previously announced disposition program (which includes one of the 73 properties we owned as of December 31, 2004) will be unchanged, we received a $2.5 million credit, which is applicable to fees payable with respect to future dispositions. Of the $2.5 million credit, $2.4 million has been applied to terminations that have occurred during 2004.
Results Overview
General
At the beginning of 2003, we set out a strategy to position our company to best take advantage of an expected economic and industry recovery. This strategy included an asset disposition program, which we had substantially completed from the beginning of 2003 through the end of 2004, having disposed of 36 assets for $283.6 million of gross cash proceeds and $11.0 million in reduction of debt, allowing us to significantly enhance our liquidity while repositioning our portfolio. We believe that we are in the midst of the early stages of a lodging industry economic recovery, however, the recovery is not uniform throughout the country. Certain of our markets are performing well, while others have not yet recovered. Our strategy currently includes the following key initiatives: focus on growth of earnings and cash flow from our existing portfolio using an aggressive asset management program; upgrade our portfolio through extensive renovations; recycle capital into higher yielding hotel investments; improve our capital structure to support internal growth, position the company for external opportunities and increase our fixed charges coverage; maintain upside potential; and maintain liquidity.
We are in the process of upgrading the product quality and growth potential of our hotels through our aggressive capital expenditure program and selective brand conversions. We have continued to reshape our portfolio through three strategic, high-quality acquisitions, including one investment completed in October 2004, and dispositions of a number of lower yielding properties.
We have developed a targeted renovation program that is designed to reduce the time and cost required to renovate hotels, allowing us to improve the quality of our hotels faster to take advantage of the rebound in the economy and better control the level of disruption associated with renovations. During the year, we accelerated our renovation program for certain key assets, which created some short-term disruption, but also positioned us to participate more quickly in the lodging industry recovery. We invested approximately $134 million in capital expenditures during 2004, and we expect to invest approximately $100 million in capital expenditures during 2005, including $15 million to complete projects started in 2004 and excluding hurricane-related capital expenditures, to enhance the quality of our portfolio to meet or exceed the standards of our primary brands-Hilton, Marriott, and Starwood-as well as to improve the competitiveness of these assets in their markets and enable them to more fully participate in the economic recovery. While hotel results are negatively impacted during renovations due to out of service rooms and limitations on the ability to sell other hotel services, we expect to have positioned these renovated properties well to be able to benefit from the economic recovery. The amount of hurricane-related capital expenditures has not yet been fully determined, however, we anticipate it to well exceed $100 million, most of which we expect to be reimbursed by our insurance carriers.
Since the beginning of 2004, we have completed seven brand conversions at the Sheraton Bellevue, Holiday Inn Walt Disney World Village, Doubletree Universal, Doubletree Hotel Dallas Galleria, Sheraton Beach Resort Key Largo, Crowne Plaza Chicago O’Hare, and Sheraton Oklahoma City hotels with 2,626 total rooms. We
experienced short-term negative impacts of these brand conversions during 2004 due to customer displacement, renovation work and initial costs of training and marketing associated with brand conversions. However, we expect the conversions to generate long term positive results at these hotels due to better alignment of hotel characteristics to the brand or a more beneficial cost structure.
The August-September 2004 Hurricanes
In August and September 2004, hurricanes caused substantial damage to a number of our hotels located in Florida. The hurricane damage and local evacuation orders also caused significant business interruption at many of our Florida properties, including the complete closure of certain hotels. As a result, eight of our hotels were closed for an extended period of time, and five others were affected in varying degrees.
We have comprehensive insurance coverage for both property damage and business interruption. Our damage assessment teams, working with the adjusters for our insurance providers, are inspecting each of our affected properties and implementing restoration plans. Some properties will require substantial repair and reconstruction and will remain closed until such repairs are complete. Our recovery effort is extensive and includes replacing portions of buildings, landscaping and furniture, as well as upgrading to comply with changes in building and electrical codes. The net book value of the property damage is currently estimated to be at least $65 million; however, we are still assessing the impact of the hurricanes on our properties, and actual net book value write-offs could vary from this estimate. Changes to this estimate will be recorded in the periods in which they are determined. For the year ended December 31, 2004, we have recorded a net fixed asset write-off and a corresponding insurance claim receivable for this $65 million net book value amount because we believe that it is probable that the insurance recovery, net of deductibles, will significantly exceed the net book value of the damaged portion of these assets. The recovery is based on replacement cost, and we have submitted claims substantially in excess of $65 million.
While we expect the insurance proceeds will be sufficient to cover most of the replacement cost of the restoration of these hotels, certain deductibles (primarily windstorm) and limitations will apply. Moreover, no determination has been made as to the total amount or timing of those insurance payments, and those insurance payments may not be sufficient to cover the costs of all the restoration of the hotels. To the extent that insurance proceeds, which are on a replacement cost basis, ultimately exceed the net book value of the damaged property, a gain will be recorded in the period when all contingencies related to the insurance claim have been resolved.
As of December 31, 2004 and March 7, 2005, seven of our Florida properties remained completely closed due to hurricane damage. Additionally, as of December 31, 2004, four properties that suffered varying amounts of hurricane damage had certain rooms and conference facilities out of service. Where possible and in order to mitigate loss of revenues, some permanent repairs to damaged properties have been deferred during the Florida “high season”, which generally lasts from late December through early April, in order to have facilities available to meet demand. These damaged facilities will be removed from service for permanent repairs at a later date. We have hired consultants to assess our business interruption claims and are currently negotiating with our insurance carriers regarding coverage for income losses sustained. To the extent that we are entitled to a recovery under the insurance policies, we will recognize a receivable when it can be demonstrated that it is probable that such insurance recovery will be realized, and such receivable will then be reflected as a component of operating income. Any gain resulting from business interruption insurance for lost income will not be recognized until the relevant payments have been received and all contingencies related to the insurance recoveries are resolved. This income recognition criteria will result in business interruption insurance recoveries being recorded in a period subsequent to the period that we experience lost income from the affected properties, resulting in fluctuations in our net income that may reduce the comparability of reported quarterly results for some periods into the future.
Under this income recognition criteria, as of December 31, 2004, we have recorded a $107.3 million insurance claim receivable related to both property damage and business interruption recoveries combined, of which $31.3 million in insurance advances had been collected through December 31, 2004. We have collected an
additional $8.8 million in advances from January 1 through March 7, 2005. Of the $107.3 million receivable recorded, $65.5 million represents the write-down of net fixed assets, as discussed above. The remaining $41.8 million represents a probable recovery of costs incurred. The cost recoveries are recorded on the expense line item to which they relate; therefore there is no net impact to any line item or our results.
The following is a summary of hurricane-related activity recorded (in millions):
During the fourth quarter and full year 2003, the nine hotels that have been closed or substantially closed realized $24.1 million and $121.7 million, respectively, in revenues. We recognized $4.4 million of revenues on these hotels during the fourth quarter of 2004, and $94.1 million of revenues during the full year 2004.
Overall Results
Revenues from continuing operations increased to $779.2 million for the year ended December 31, 2004 compared to $757.6 million for the prior year. The revenues increase is primarily due to our acquisition of two hotels in 2004 and the result of a $4.73 increase in ADR at our comparable hotels (see “Results of Operations” for definition of comparable hotels), partially offset by a disruption of revenues at properties impacted by the hurricanes. Net loss for the year ended December 31, 2004 includes hotel and other operating expenses that are 2.9% higher compared to prior year, mainly due to the short-term impact and one-time costs associated with hotel renovations and brand conversions during 2004, the impact in 2003 of aggressive cost-cutting initiatives that were implemented in early 2003 in anticipation of economic impacts associated with the war in Iraq and associated tensions, and a reversal in 2004 of certain 2003 cost reductions, particularly in areas having the most impact on guest satisfaction such as concierge, lounge, restaurant and lounge hours and front desk and bell stand staffing. In addition, we incurred a $7.9 million loss on early extinguishment of debt during the year ended December 31, 2004, as compared to a $4.1 million gain on early extinguishment of debt during the year ended December 31, 2003.
Our December 31, 2004 results include the impact of a $4.0 million adjustment to our previous accounting for Profits-Only OP Units (“POPs”) (equity based compensation awards). Although the adjustment is not material to our financial results taken as a whole, because this adjustment is a one-time compensation expense reduction, our 2004 compensation expense is not fully comparable to our 2003 compensation expense. This adjustment is recorded in the “General and administrative, corporate” line item in our Consolidated Statements of Operations. Had the current accounting been applied originally, our net loss would have been $(103.1) million for the year ended December 31, 2004 (see Note 10 to the financial statements).
Results of Operations
Our revenues are derived from the operations of our hospitality properties, including room, food and beverage revenues, as well as from our leases of office, retail and parking rentals. Included in our operating income (but not in revenues) is our cumulative preferred return on our partnership interest in MIP, the interest income on our mezzanine loan to the Radisson Lexington Avenue Hotel and our equity in the income on our Radisson Lexington Avenue Hotel investment. Operating costs include direct costs to run our hotels, management fees to Interstate Hotels and others for the management of our properties, depreciation of our properties, impairment charges, property tax and insurance, as well as sales, marketing and general and
administrative costs. Our expenses also include interest on our debt, amortization of related debt-issuance costs and minority interest allocations, which represent the allocation of income and losses to outside investors for properties that are not wholly owned.
The provisions of Statement of Financial Accounting Standards (SFAS) No. 144 require that current and prior period operating results of any asset that has been classified as held for sale or has been disposed of on or after January 1, 2002, including any gain or loss recognized on the sale, be recorded as discontinued operations. Accordingly, we have reclassified all prior periods presented to comply with this requirement. See Footnote 16, “Dispositions,” included in Item 8 of this Annual Report on Form 10-K for further information regarding the amounts reclassified.
Summary data for the years ended December 31 were as follows (dollars in thousands, except operating data statistics):
(a) Includes gains or losses on debt extinguishment for the years ended December 2004 and 2003, as well as changes in fair value and losses on fair value of non-hedging derivatives in the year ended December 31, 2002.
(b) Includes loss on asset impairments of $7.4 million, $267.7 million and $78.7 million for the years ended December 31, 2004, 2003, and 2002, respectively. Also includes loss on disposal of $14.1 million, $2.4 million and $21.2 million for the years ended December 31, 2004, 2003, and 2002, respectively.
Year ended December 31, 2004 compared with the year ended December 31, 2003
Continuing Operations Results
Our 73 properties in continuing operations include two properties acquired in 2004, two properties of which we intend to dispose, and nine properties in Florida that were most significantly impacted by a series of four hurricanes in August and September 2004. Operating results have been impacted by these events. For more information regarding the impact of these hurricanes, see “-Results Overview”. In order to provide a useful comparison, where appropriate, this section includes discussion and analysis of our results as a whole and discussion and analysis of results of the 60 comparable hotels that were in normal operations for the current period and the prior year period. The nine Florida hotels impacted by the hurricanes, two hotels of which we intend to dispose, and the two acquired hotels are excluded.
The following table presents operating data for our 60 comparable hotels:
Total revenue. Total revenue increased by $21.6 million or 2.8% in 2004 compared to 2003, primarily due to a $19.0 million increase to $507.9 million in room revenue directly attributable to an increase in ADR, combined with a $10.1 million increase in food revenue. ADR increased 5.4% for the year ended December 31, 2004 when compared with the same period in 2003 due to our two acquired properties as well as the result of the industry benefiting from an increase in travel due to a general strengthening of the economy, partially offset by revenue losses from our hurricane impacted hotels. The decrease in occupancy of 4.2% over the same period was due to rooms out of service as a result of the Florida hurricanes, the impact of having less available rooms due to hotel room renovations, as well as a focus on increasing daily rates, which resulted in lower group, contract, and internet sales. Approximately 2.9% of the 4.2% decrease in occupancy was specifically due to the rooms out of service as a result of the Florida hurricanes.
For the 60 comparable hotels, total revenue increased by $19.5 million or 3.2% from $611.2 million in 2003 to $630.7 million in 2004. The increase in room revenue represents $15.8 million of the total increase which was primarily due to an increase in ADR of $4.73 and RevPAR of $2.37, which resulted from the general strengthening of the economy and lodging industry. Revenue growth was negatively impacted due to the short term effects of brand conversions and rooms out of service during renovations and as a result of the Florida hurricanes. RevPAR increased $4.19 or 6.4% as adjusted for room nights out of service during the period due to renovations and the impact of the Florida hurricanes to our comparable hotels.
Hotel operating expenses. Hotel operating expenses increased $10.6 million or 3.4% in 2004 compared to 2003. The increase was primarily attributable to a $7.5 million or 5.1% increase in food and beverage expense primarily due to the expenses of hotels acquired in 2004. In addition, rooms expense increased by $5.5 million or 4.5% mainly due to the restoration of services with an emphasis on improving guest satisfaction, rising labor and benefits costs, the impact of renovation-related costs, the impact of brand conversion costs and brand initiatives and the effect of expenses of hotels acquired in 2004. Prior period results also reflect aggressive cost reductions in anticipation of economic impacts associated with the war in Iraq and associated tensions.
For the 60 comparable hotels, rooms expense increased by 5.3% from $104.6 million in 2003 to $110.1 million in 2004 with a slight decrease in margin of 0.3% when comparing room revenue to rooms expense, mainly due to the impact of renovation related costs. Food and beverage margins were relatively flat year over year as menu pricing had substantially caught up to increasing food and beverage costs.
Other operating expenses. Other operating expenses include general and administrative expenses, property operating costs, depreciation and amortization, non-income taxes, and insurance. Individual variations in these expenses were as follows:
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Corporate general and administrative expense increased by $2.3 million or 19.3% from 2003 to 2004 reflecting higher corporate operating expenses based on more complete staffing levels after the separation from Interstate Hotels, and higher costs for complying with expanded public company regulatory requirements. This line item also includes a $4.0 million income adjustment to reduce employee compensation costs due to the change in accounting treatment of an equity based compensation plan, a $2.0 million expense adjustment related to prior years’ workers’ compensation claims, a $1.0 million expense for general liability and hurricane insurance claims-related legal costs, and a $1.6 million expense related to incentive plan grants.
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Property operating costs, which consist of repairs and maintenance, energy, franchise and management costs, increased $3.1 million or 2.7% during 2004 as compared to 2003 mainly due to increases in repairs and maintenance of $3.0 million due to a reduction in eligible purchase rebates, and the increased property operating costs associated with the two hotels acquired in 2004. Energy costs decreased by 1.1% due to a strategic program implemented in late 2003, which was designed to help us manage the increasingly volatile energy costs at our hotels.
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Property taxes decreased by $2.8 million primarily due to our efforts to ensure that our properties were accurately valued due to market conditions caused by the economic downturn in specific areas. Insurance expense decreased $1.3 million or 10.2% for the year ended December 31, 2004 as compared to 2003 primarily due to a reduction in property insurance premiums upon renewal which was partially offset by the costs associated with the two hotels acquired in 2004.
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Depreciation and amortization expense increased $5.3 million or 5.6% in 2004. The increase is due to additional depreciation on our properties acquired in 2004, as well as a significant increase in capital expenditures.
Loss on asset impairments. We recognized losses on asset impairments totaling $12.3 million and $295.0 million related to our assets planned for disposition during the years ended December 31, 2004 and 2003, respectively. Of these total asset impairment losses, $7.4 million and $267.7 million for 2004 and 2003, respectively, are included in discontinued operations. The impairment losses recorded during 2004 primarily represent a decrease in estimated proceeds from the sale of our remaining assets planned for disposition. Impairments were significant during 2003 due to our decision during the year to expand our asset disposition program, thereby resulting in a change in our expected holding period for these assets. Impairment charges were lower in 2004, as we did not add a significant number of properties to our disposition program.
Equity in income of and interest earned from unconsolidated affiliates. Equity in income of and interest earned from unconsolidated affiliates consists of income earned from two investments in which we own non-controlling interests and do not consolidate in our financial statements. We recognize a proportionate share of the profit and loss earned by the Radisson Lexington Avenue Hotel, an equity method investment acquired in 2004, as well as interest income on the $40 million loan made to this entity. As of December 31, 2004, we recognized interest income of $1.4 million and equity in income of $0.2 million. In addition, we recognize a preferred return of 16% (12% for the last three weeks of the year) from our investment in MIP, which is accounted for using the cost method. Income of $11.5 million in 2004 from MIP includes a reversal of a $1.4 million reserve due to the favorable change in their collectibility assessment. Our 2003 results include a $25 million impairment charge on MIP, partially offset by $7.4 million of preferred return income on MIP. See “Recent Developments” in Item 1 of this Form 10-K for a discussion of these investments.
Interest expense, net. Net interest expense declined 9.7% or $13.7 million in the year ended December 31, 2004 compared to the year ended December 31, 2003, primarily due to repurchases of higher interest bearing debt, incurrence of lower interest bearing debt, and the effect of the interest rate swap we entered into in April 2004.
Other significant items, net. For the year ended December 31, 2004, we recorded a total loss on early extinguishment of debt of $8.0 of which $6.3 million related to our repurchase of $99.6 million of our senior unsecured notes, and $1.7 million related to our redemption of $49.2 million of our senior subordinated notes. We recognized gains totaling $4.1 million during 2003 related to the early extinguishments of debt. On July 1, 2003, MeriStar Hospitality completed an offering of $170 million aggregate principal amount of 9.5% convertible subordinated notes due 2010. In conjunction with this transaction, we borrowed $170 million from MeriStar Hospitality under terms matching those of the 9.5% convertible subordinated notes. The proceeds from the new borrowing were used to repurchase $150.6 million of the $154.3 million of outstanding 4.75% notes payable to MeriStar Hospitality due 2004, at varying prices, resulting in a $1.4 million gain.
Loss from discontinued operations
During the year ended December 31, 2004, we completed the disposal of 21 hotels in separate transactions for an aggregate of $155.7 million in cash, resulting in loss on disposal of $14.1 million. Loss on disposal resulted primarily from the recognition of $10.9 million in termination fees payable to Interstate Hotels with respect to these hotels’ management contracts. As of December 31, 2004, we had no hotels classified as held for sale. Discontinued operations for the year ended December 31, 2004 included impairment charges totaling $7.4 million related to the assets sold during the year. Discontinued operations for the year ended December 31, 2003 included impairment charges totaling $267.7 million.
Year ended December 31, 2003 compared with the year ended December 31, 2002
Continuing Operations Results
Total revenue. Total revenue decreased by $14.9 million or 1.9% in 2003 compared to 2002, primarily due to a $15.1 million or 3.0% decrease in room revenue directly attributable to a decrease in average daily rate. The average daily rate declined 3.8% for the year ended December 31, 2003 when compared with the same period in 2002 due to the downward pressures on our rates as a result of soft corporate transient and leisure demand throughout the year, coupled with an increase in sales through lower rated group, contract, and internet sales channels. The slight increase in occupancy over the same period did not significantly offset the rate decline.
Hotel operating expenses. Hotel operating expenses increased by $10.1 million or 3.4% from 2002 to 2003 due primarily to increases in food and beverage expenses and other hotel operating costs. These expenses increased mainly due to our focus on improving guest satisfaction, as well as an increase in occupancy in 2003 over 2002.
Other operating expenses. Other operating expenses include general and administrative expenses, property operating costs, depreciation and amortization, and property taxes, insurance and other. The decrease of $3.3 million or 0.8% from 2002 to 2003 was due primarily to a $14.5 million charge incurred related to the settlement of a $42.1 million term loan due from Interstate Hotels during late 2002. Excluding that charge, other variations in these expenses were as follows:
General and administrative expenses at the hotel level decreased by 0.7% or $0.8 million, due to a reduction in selling expenses at the hotels of 2.2%. Property operating costs, which consist of repairs and maintenance, energy, franchise and management costs, increased $1.6 million or 1.4% during 2003 to $114.0 million. Increases in repairs and maintenance expense of $1.6 million and energy costs due to the civil disruptions in Venezuela and the war in Iraq of $2.0 million were partially offset by decreases in franchise and management fees totaling $1.4 million. We began implementing a strategic energy plan across our portfolio during the fourth quarter of 2003, which is designed to aid in the control of volatile energy costs. Depreciation and amortization decreased $3.0 million or 3.1% in 2003 due to the reduction in the book value of our property and equipment stemming from the substantial asset impairment charge in the first half of 2003. Also contributing to the decline were the early extinguishments of debt, thereby reducing on-going amortization of related deferred financing costs.
Loss on asset impairments. We recognized losses on asset impairments totaling $295.0 million and $78.7 million related to our asset disposition program during the years ended December 31, 2003 and 2002, respectively. Of these total asset impairment losses, $267.7 million and $78.7 million for the years ended 2003 and 2002, respectively, are included in discontinued operations.
Equity in income of and interest earned from unconsolidated affiliates. The value of our $40 million investment in MIP, which owns eight hotels and is accounted for on a cost basis, declined during 2003 due to the continued decline in MIP’s cash flow, particularly driven by results in four of its hotel markets. The accounting rules for cost basis investments require that declines in value that are other than temporary be recognized currently. Since the decline in the value of our underlying investment in MIP was other than temporary, we recognized an impairment loss of $25.0 million on this investment during the fourth quarter of 2003.
Interest expense, net Net interest expense increased $4.5 million or 3.3% due primarily to the July 2003 borrowing of 9.5% notes payable from MeriStar Hospitality due 2010 to substantially repurchase our 4.75% notes payable to MeriStar Hospitality (see Note 8 to our Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K).
Other significant items, net. We recognized gains totaling $4.1 million during 2003 related to the early extinguishments of debt. On July 1, 2003, MeriStar Hospitality completed an offering of $170 million aggregate principal amount of 9.5% convertible subordinated notes due 2010. In conjunction with this transaction, we borrowed $170 million from MeriStar Hospitality under terms matching those of the 9.5% convertible subordinated notes. The proceeds from the new borrowing were used to repurchase $150.6 million of the $154.3 million of outstanding 4.75% notes payable to MeriStar Hospitality due 2004, at varying prices, resulting in a $1.4 million gain.
The proceeds from the issuance were also used to repurchase $22.6 million of outstanding 8.75% senior subordinated notes due 2007, at varying prices, resulting in a $1.5 million gain. During 2003, MeriStar Hospitality also repurchased a further $59.8 million of these notes, at varying prices, resulting in an aggregate loss of $0.3 million. In addition, $39.2 million of the senior subordinated notes was redeemed in exchange for 6,669,506 shares of MeriStar Hospitality’s common stock, resulting in a gain of $1.5 million.
We had three swap agreements that did not qualify for treatment as cash-flow hedges under SFAS No. 133, expire, one in December 2002, one in April 2003 and one in July 2003. Results for 2002 included a net expense of $4.4 million related to the swap agreements in place during that time. Results for 2003 were not materially affected by marking to market the swap agreements that expired during 2003. Results for 2002 also included a $4.7 million loss on the fair value of derivatives due to the repayment of debt that was originally hedged.
Loss from discontinued operations
During 2003, we completed the sale of 15 hotels in separate transactions for an aggregate of $127.9 million in cash, resulting in loss on disposal of $2.4 million. As of December 31, 2003, we had seven hotels classified as held for sale, all of which were sold during 2004. Discontinued operations for the year ended December 31, 2003 included impairment charges totaling $276.7 million related to the assets included in our disposition program. Discontinued operations for the year ended December 31, 2002 included impairment charges totaling $78.7 million, and a net loss of $21.2 million related to assets sold that year.
Financial Condition, Liquidity, and Capital Resources
Our principal sources of liquidity are cash generated from operations, funds from borrowings, funds from the sales of assets and existing cash on hand. Our principal uses of cash include the funding of working capital obligations, debt service, debt repurchases, investments in hotels (including capital projects and acquisitions), and escrow requirements. Our debt strategy includes considering opportunities to repay debt and to reduce our
overall cost of borrowing, such as through low interest rate mortgages and interest rate swaps. We believe we currently have sufficient cash on hand, and we expect to have adequate cash flow during the next twelve months in order to fund our operations, capital commitments and debt service obligations. MeriStar Hospitality did not pay a dividend on its common stock during 2004, nor does it expect to pay one in 2005. Our current and future liquidity is, however, greatly dependent upon our operating results, which are driven largely by overall economic conditions, and since September 11, 2001 have been significantly affected by geopolitical concerns and other factors affecting business and leisure travel. If general economic conditions are significantly worse than we expect for an extended period, this will likely have a negative effect on our projections of available cash flow and liquidity.
Factors that may influence our liquidity include:
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Factors that affect our results of operations, including general economic conditions, demand for business and leisure travel, public concerns about travel safety related primarily to terrorism and related concerns, capital investments required to maintain our property’s competitive position, insurance coverage and timing of hurricane-related expenditures and related insurance receipts, and other operating risks described under the caption, “Risk Factors-Operating Risks” in Item 1 of this Annual Report on Form 10-K;
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Factors that affect our access to bank financing and the capital markets, including operational risks, high leverage, covenant compliance, interest rate fluctuations, and other risks described under the caption “Risk Factors-Financing Risks” in Item 1 of this Annual Report on Form 10-K; and
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Other factors described previously under the caption, “Cautionary Statement Regarding Forward-Looking Statements” in this Annual Report on Form 10-K.
We generally intend to hold unrestricted cash balances of $40 million to $50 million in our operating accounts as a hedge against economic and geopolitical uncertainties, as well as to provide for our recurring cash requirements. We established a $50 million secured revolving bank line in December 2003, maturing in December 2006, which is fully available and increases our flexibility in managing our liquidity.
On April 23, 2004, MeriStar Hospitality raised proceeds through the issuance and sale of 12.0 million shares of common stock at a price to the public of $6.25 per share pursuant to its effective shelf registration statement filed under the Securities Act of 1933. The offering closed on April 28, 2004 with net proceeds of approximately $72.3 million. This equity issuance enabled it to raise cash with a deployment strategy to acquire assets with strong brand affiliations and higher growth rate potential in strong markets.
During the year ended December 31, 2004, we disposed of 21 primarily underperforming assets with 5,261 rooms for $155.7 million in cash and $11.1 million in reduction of debt. These assets were largely upscale and midscale assets that do not fit with our upper upscale focus, were located in markets that are not strategically important to us or where we have multiple assets, had significant capital expenditure needs or produced insufficient cash flow or have lower growth opportunities. Proceeds were used to upgrade the existing portfolio through our asset renovation program or acquisition strategy, or to redeem debt.
On May 10, 2004 we acquired the four-star, four-diamond rated Ritz-Carlton, Pentagon City in Arlington, Virginia for a purchase price of $93 million. The 366-room luxury hotel is operated by The Ritz-Carlton Hotel Company, LLC under a long-term contract. The hotel features nearly 18,000 square feet of meeting space, which can accommodate meetings of up to 900 guests. On June 30, 2004, we partially financed the acquisition through closing on a $55.8 million fixed-rate mortgage loan, which is secured by this property, matures on June 1, 2011 and bears interest at an annual fixed rate of 5.8%. We financed the remainder of the acquisition cost with cash on hand.
Additionally, on June 25, 2004, we acquired the 485-room Marriott Irvine in Orange County, California, for a purchase price of $92.5 million. The hotel is operated by a subsidiary of Marriott International, Inc. under a
long-term contract. The hotel features 30,000 square feet of meeting space, including a 13,000 square foot ballroom that can accommodate meetings of up to 1,500 guests. To take advantage of the current low interest rate environment, we financed a portion of the acquisition with a $55.5 million fixed-rate mortgage, which is secured by this property, matures on July 1, 2011 and bears interest at an annual fixed rate of 5.69%. We financed the remainder of the acquisition cost with cash on hand.
On October 1, 2004, we acquired an interest in the 705-room Radisson Lexington Avenue Hotel in Midtown Manhattan. We made a total investment of $50 million, including a loan that matures on October 1, 2014 and yields $5.8 million of cumulative annual interest and a 49.99% equity participation in the income and losses of the hotel. The investment was financed with cash on hand. The loan is secured by a pledge of the equity interests held by the borrower in an indirect parent of the owner of the hotel, and has a 10-year term. The loan is subordinate to a $150 million financial institution loan, but has priority over all equity interests. Our equity investment is accounted for under the equity method of accounting. Under the equity method of accounting, we recognized $0.2 million of equity in the income of our investment during the fourth quarter 2004 and received distributions of $0.8 million. However, due to seasonality of the market, we expect that our equity in the income of the investment could be less in the first three quarters of each year as compared to the last quarter of the year. This seasonality could also impact the timing of distributions received.
Our investment in MIP yielded a payment of $10 million in December 2004 and $15.5 million in February 2005. The payments were applied against our outstanding receivable balance. See “Recent Developments” for further discussion.
During the year ended December 31, 2004, we invested approximately $134 million in our existing assets through our aggressive asset renovation program for our assets. We expect to invest a total of approximately $100 million on capital expenditures in 2005, including $15 million to complete projects started in 2004 and excluding hurricane-related capital expenditures. The amount of hurricane-related capital expenditures has not yet been fully determined, however, we anticipate it to well exceed $100 million, most of which we expect to be reimbursed by our insurance carriers.
As part of our strategy to manage our leverage, we have retired debt with higher interest rates and acquired debt with lower interest rates. During fiscal 2004, we have retired $49.2 million of our 8.75% notes payable to MeriStar Hospitality due 2007 (plus $0.9 million of accrued interest) by issuing 8.1 million common OP Units. In addition, we have purchased from available cash $99.6 million of our senior unsecured notes, including $25.8 million of the 10.5% notes, $29.5 million of the 9% notes and $44.3 million of the 9.125% notes. Following these exchanges and the repurchases, we had $34.2 million of outstanding 8.75% notes payable to MeriStar Hospitality due 2007 and $850.4 million of outstanding senior unsecured notes. These transactions have allowed us to reduce our cost of borrowing and improve our credit statistics.
On January 26, 2005, we entered into a $37.7 million mortgage loan on our Hilton Crystal City hotel that bears interest at a fixed rate of 5.84%. The mortgage requires interest payments only for the first three years and then monthly payments of interest and principal over the remaining portion of the ten year term of the loan.
In August and September 2004, a number of our hotels located in Florida incurred substantial damage and business interruption. While we have comprehensive insurance coverage for both property damage and business interruption, we are experiencing a decline in revenues due to the full or partial closure of certain hotels, and we will not be able to recognize any income from business interruption insurance or gains on replacement of damaged property until all contingencies related to the insurance payments have been resolved. Additionally, we may experience a timing delay between cash outflows and cash inflows, as we may incur costs to rebuild the damaged properties, and temporary negative cash flows associated with affected properties, that may not be reimbursed by the insurance carriers for several periods. Additionally, we are liable for any policy deductibles. While this timing difference may have some impact on our short term liquidity, we believe that we will be able to meet all of our short term cash needs through a variety of means, including reducing capital expenditures, borrowings under our credit facility and the placement of mortgages, if necessary. For more information regarding the impact of these hurricanes, see “-Results Overview.”
As of December 31, 2004, we had $58.4 million of cash held in escrow, which was required by certain debt agreements and the interest rate swap agreement. Our cash balance held in escrow may increase or decrease based upon the performance of our encumbered hotels, our ability to obtain timely capital reimbursements, and the fair value of our interest rate swap. Of the $58.4 million, approximately $25 million was available to fund capital expenditures as of December 31, 2004.
Sources and Uses of Cash
The following table shows our consolidated cash flows, generated by (used in) our various activities, for the years ended December 31 (in thousands):
Our operating results and the amount of cash generated by our hotel operations were adversely affected beginning in late 2001 by a general downturn in the economy compounded by the events of September 11, 2001, and while we are seeing the impacts of a recovering economy, our operating results have continued to be affected by the reduction in travel resulting from economic conditions, geopolitical events, war, the continued threat of domestic terrorism, and other factors affecting business and leisure travel. Cash flow from operations increased in 2004 primarily due to the impact of increased revenues due to the refocusing of our portfolio assets, as well as the generation of new revenues from our hotels acquired in 2004, and as a result of the lodging industry economic recovery.
We used a net $234.5 million of cash from investing activities during the year ended December 31, 2004, primarily due to:
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$182.4 million for acquisition of hotels, net of cash acquired;
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$134.0 million in capital expenditures (including $5.6 million of capitalized interest);
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$50.5 million for an investment in a hotel;
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$15.9 million increase in cash restricted for mortgage escrows and our interest rate swap; and
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$7.5 million in costs associated with our disposition program, partially offset by
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$155.7 million in proceeds from the sale of 21 hotel assets.
Our investing activities provided a net $104.8 million of cash during the year ended December 31, 2003, resulting primarily from:
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$127.9 million in proceeds from the sale of 15 hotel assets; and
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$42.1 million from Interstate Hotels for the repayment of its note receivable; partially offset by
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$36.2 million in capital expenditures (including $3.1 million of capitalized interest);
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$22.2 million increase in cash restricted for mortgage escrows; and
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$6.8 million in costs associated with our disposition program.
Our investing activities provided a net $4.3 million of cash during 2002, resulting primarily from:
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$60.7 million of proceeds from the sale of five hotels; partially offset by
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$47.3 million of hotel capital expenditures (including $4 million of capitalized interest), and
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$7.5 million of advances to Interstate Hotels.
We generated a net $54.6 million of cash from financing activities during the year ended December 31, 2004 due mainly to:
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$109.7 million from the issuance of new debt, net of issuance costs;
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$72.3 million from our issuance of OP units; partially offset by
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$118.4 million in repayments and repurchases of debt; and
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$8.9 million in limited partnership interest purchases.
We generated a net $109.5 million of cash from financing activities during the year ended December 31, 2003 due mainly to:
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$260.5 million from the issuance of new debt, net of issuance costs;
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$95.4 million from our issuance of OP units; partially offset by
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$245.7 million in repayments and repurchases of debt.
We used $51.9 million of cash in financing activities during the year ended December 31, 2002, primarily due to:
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$352.5 million in repayments and repurchases of debt; partially offset by
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$300.5 million from the issuance of new debt, net of issuance costs.
MeriStar Hospitality must distribute to stockholders at least 90% of its REIT taxable income, excluding net capital gains, to preserve the favorable tax treatment accorded to REITs under the Internal Revenue Code. MeriStar Hospitality, as our general partner, must use its best efforts to ensure our partnership distributions meet this requirement. Under certain circumstances, MeriStar Hospitality may be required to make distributions in excess of cash available for distribution in order to meet the Internal Revenue Code requirements. In that event, we and/or MeriStar Hospitality would seek to borrow additional funds or sell additional non-core assets for cash, or both, to the extent necessary to obtain cash sufficient to make the distributions required to retain MeriStar Hospitality’s qualification as a REIT. Any future distributions will be at the discretion of MeriStar Hospitality’s board of directors and will be determined by factors including our operating results, restrictions imposed by our borrowing agreements, capital expenditure requirements, the economic outlook, the distribution requirements for REITs under the Internal Revenue Code and such other factors as MeriStar Hospitality’s board of directors deems relevant. MeriStar Hospitality’s senior unsecured notes indenture permits the payment of dividends in order to maintain REIT qualification if we fall below a 2 to 1 fixed charge coverage ratio. However, MeriStar Hospitality’s senior subordinated notes indenture is more restrictive in that it permits the payment of dividends only if we exceed the 2 to 1 fixed charge coverage ratio. The timing and amount of any future distributions is dependent upon these factors, and we cannot provide assurance that any such distributions will be made in the future.
Long-Term Debt and Notes Payable to MeriStar Hospitality
Long-term debt and Notes Payable to MeriStar Hospitality consisted of the following (in thousands):
As of December 31, 2004, 81% of our debt bore fixed rates of interest, and the remaining 19% bore interest at fixed rates that have been, since April 2, 2004, effectively swapped to a floating rate. Our overall weighted average interest rate was 8.51% after giving effect to the interest rate swap. Based on market prices at December 31, 2004, the fair value of our long-term debt was $1.69 billion.
Credit facility. On December 19, 2003, we entered into a three-year $50 million senior credit facility, secured by six of our hotels, and terminated our previous credit facility. The facility bears interest at an annual rate of the London Interbank Offered Rate, or LIBOR, plus 450 basis points. As of December 31, 2004 and 2003, we had no outstanding borrowings under this facility.
The facility contains financial and other restrictive covenants. Our ability to borrow under this facility is subject to compliance with financial covenants, including leverage, fixed charge coverage and interest coverage ratios and minimum net worth requirements. Our compliance with these covenants in future periods will depend substantially upon the financial results of our hotels. The agreement governing our senior credit facility limits our ability to effect mergers, asset sales and change of control events and limits the payments of dividends other than those required for MeriStar Hospitality to maintain its status as a REIT and our ability to incur additional secured and total indebtedness. There are no ratings-based covenants in the facility.
Senior unsecured notes. During the year ended December 31, 2004, we repurchased, using available cash, $99.6 million of our senior unsecured notes, including $29.5 million of the 9.0% notes due 2008, $44.3 million of the 9.125% notes due 2011, and $25.8 million of the 10.5% notes due 2009. We recorded a loss on early extinguishment of debt of $6.2 million and wrote off deferred financing costs of $1.2 million related to these repurchases which is included in depreciation and amortization expense on the accompanying consolidated statements of operations.
These senior unsecured notes are general, unsecured obligations of us and certain subsidiaries of ours, and MeriStar Hospitality guarantees payment of principal and interest on the notes. These notes contain various restrictive covenants, limiting our ability to initiate or transact certain business activities if specific financial thresholds are not achieved. One of those thresholds is having a 2 to 1 fixed charge coverage ratio (as defined in the indentures, fixed charges only include interest on debt obligations and preferred equity) in order to enter into
certain types of transactions, including the repurchase of our common OP units, the issuance of any preferred equity, the payment of certain distributions, the incurrence of any additional debt, or the repayment of certain outstanding debt before it comes due. As of December 31, 2004, our fixed charge coverage ratio was significantly below 2 to 1, and therefore we were not permitted generally to enter into those transactions, except as noted below.
There are certain exceptions with respect to the incurrence of additional debt and early repayment of debt features in the indentures. We have the ability to incur up to $300 million of secured financing within restricted subsidiaries, subject to meeting other maintenance tests under the indentures, of which $194.5 million was available at December 31, 2004. We also have a general carve-out to incur $50 million of unspecified borrowings within a restricted subsidiary, of which the full amount was available at December 31, 2004. We have the ability to incur debt financing within an unrestricted subsidiary, such as the $55.5 million mortgage financing related to the acquisition of Marriott Irvine. Additionally, we are permitted to repay subordinated debt prior to its maturity from the proceeds of an equal or junior financing with a longer term than the debt refinanced, an equity offering, or a financing within an unrestricted subsidiary.
Secured facilities. We completed a $330 million non-recourse financing secured by a portfolio of 19 hotels in 1999. The loan bears a fixed annual interest rate of 8.01% and matures in 2009. The secured facility contains standard provisions that require the servicer to maintain in escrow cash balances for certain items such as property taxes and insurance. In addition, the facility contains a provision that requires our mortgage servicer to retain in escrow the excess cash from the encumbered hotels after payment of debt service (“Excess Cash”), if net hotel operating income (“NOI”) for the trailing twelve months declines below $57 million. This provision was triggered in October 2002 and will be effective until the hotels generate the minimum cash flow required for two consecutive quarters, at which time the cash being held in escrow will be released to us. In July 2003, we signed an amendment to the loan agreement that permits the release of cash placed in escrow for all capital expenditures incurred on the 19 encumbered properties on or after April 1, 2003. Although the servicer will continue to retain in escrow any excess cash from the encumbered hotels during the low NOI period, they will release cash for all capital expenditures on the 19 encumbered properties beginning April 1, 2003, subject to the servicer’s review and approval. As of December 31, 2004 and December 31, 2003, $29.9 million and $27.2 million, respectively, of cash was held in escrow under this provision. Escrowed funds totaling $21.0 million were available to fund capital expenditures under this provision as of December 31, 2004. From January 1, 2005 through March 7, 2005, we have received cash reimbursements of $6.2 million from the servicer related to capital expenditures incurred on the 19 encumbered properties.
The fair value adjustments for the interest rate swap agreement of net $(4.7) million that are discussed in further detail below are related to the outstanding secured facility balance of $303.0 million as of December 31, 2004.
On September 26, 2003, as permitted by the indentures governing our senior unsecured notes and senior subordinated notes, we completed a $101 million commercial mortgage-backed securities financing, secured by a portfolio of four hotels. The loan carries a fixed annual interest rate of 6.88% and matures in 2013.
Notes payable to MeriStar Hospitality. On July 1, 2003, MeriStar Hospitality completed an offering of $170 million aggregate principal amount of 9.5% convertible subordinated notes due 2010. In conjunction with this transaction, we borrowed $170 million from MeriStar Hospitality under terms matching those of the 9.5% convertible subordinated notes.
The proceeds from the borrowing were used to repurchase $150.6 million of our $154.3 million 4.75% notes payable to MeriStar Hospitality due 2004, at varying prices, resulting in an aggregate discount of approximately $1.4 million. On October 15, 2004, the remaining $3.7 million balance of 4.75% notes payable to MeriStar Hospitality were repaid at maturity. The remaining proceeds from the issuance were also used to repurchase a portion of our 8.75% notes payable to MeriStar Hospitality due 2007.
In conjunction with MeriStar Hospitality’s issuance of senior subordinated notes due in 2007, we borrowed a total amount of $205.0 million, of which $34.2 million was outstanding as of December 31, 2004, under terms matching those of MeriStar Hospitality’s senior subordinated notes. The 8.75% notes payable to MeriStar Hospitality due 2007 are unsecured obligations, and provide for semi-annual payments of interest each February 15 and August 15. The related indenture contains various restrictive covenants, which are similar to those in our senior unsecured notes.
During the year ended December 31, 2004, we retired $49.2 million of our 8.75% notes payable to MeriStar Hospitality due 2007 (plus $0.9 million of accrued interest) through the issuance of 8,138,728 common OP units. We recorded a loss on early extinguishment of debt of $1.7 million. In February 2005, we retired an additional $1.49 million of our notes payable to MeriStar Hospitality.
Mortgage and other debt. As of December 31, 2004, we had three mortgage loans, two of which were incurred during the second quarter of 2004.
We financed a portion of the Marriott Irvine acquisition (see “Asset Acquisitions” below) with a $55.5 million fixed-rate mortgage loan effective June 25, 2004, which matures on July 1, 2011 and bears interest at an annual fixed rate of 5.69%. On June 30, 2004, in connection with The Ritz-Carlton, Pentagon City acquisition (see “Asset Acquisitions” below), we entered into a $55.8 million fixed-rate mortgage loan, which matures on June 1, 2011 and bears interest at an annual fixed rate of 5.8%.
We had a mortgage loan on a hotel property that was to mature in 2011 and carried an interest rate of 8.8%; however, the lender, with our acquiescence, initiated foreclosure proceedings on the property which were completed on September 7, 2004, and we relinquished the property to the bank. The carrying value of the mortgage loan and the fair value of the property both approximated $11 million. This property is included in discontinued operations.
Our other individual mortgage matures in 2011 and carries a fixed interest rate of 9.0% with an initial principal amount of $17.0 million.
On January 26, 2005, we entered into a $37.7 million mortgage loan on our Hilton Crystal City hotel that bears interest at a fixed rate of 5.84%. The mortgage requires interest payments only for the first three years and then monthly payments of interest and principal over the remaining portion of the ten year term of the loan.
Derivatives. On April 2, 2004, we entered into an interest rate swap arrangement with a third party to manage our interest rate risk related to our secured facility due 2009, effectively converting the interest the facility bears from a fixed rate to a floating rate. Under the swap, we receive fixed-rate payments of 8.01% and pay floating rate payments based on a one month LIBOR plus 444 basis points on an initial $307 million notional amount. We do not use derivative instruments for speculative purposes. Due to the fact that the notional amount of the swap matches the principal amount of the underlying debt and other hedge accounting criteria were met, the swap was designated as highly effective at the inception of the swap arrangement and designated as a fair value hedge. We continue to evaluate the effectiveness of the hedge and believe that the hedge continues to be highly effective.
For a derivative qualifying as a fair value hedge, the change in net unrealized gain or loss upon measuring the fair value hedge and the fair value of the debt instrument is recorded in our consolidated statements of operations. These amounts offset each other as there was no ineffective portion and therefore had no impact on our net loss for the year ended December 31, 2004. The fair value of the swap is recorded as either an asset or liability, with a corresponding increase or decrease to the carrying value of the debt instrument being hedged on our consolidated balance sheets. The fair value of our hedge was approximately a $4.7 million liability as of December 31, 2004. This amount is recorded on our consolidated balance sheet in the other liabilities line item with a corresponding debit recorded to long-term debt. During the year ended December 31, 2004, we earned
cash payments of $4.2 million under the swap, which were recorded as a reduction in interest expense. In conjunction with the interest rate swap, we have posted collateral of $12.0 million as of December 31, 2004. The required collateral amount fluctuates based on the changes in the swap rate and the amount of time left to maturity. During 2004, our posted collateral ranged from $8.0 million to $20.9 million. However, due to the terms of the swap agreement, our posted collateral must be a minimum amount calculated per the agreement, which was $6.7 million as of December 31, 2004. We will receive all remaining collateral upon maturity of the swap.
During 2003, our only derivative instruments consisted of two swap agreements that did not qualify for treatment as hedges under SFAS No. 133, which expired in April 2003 and July 2003. During the year ended December 31, 2003, we recognized $4.0 million of income related to the decrease in fair value of the liability recorded for the interest rate swaps in place in that time period. For the year ended December 31, 2003, we made cash payments on those swaps of $4.0 million. The change in fair value and the swap payments are netted together on our consolidated statement of operations, thus resulting in no impact on consolidated net loss.
During the year ended December 31, 2002, we recognized $7.6 million of income related to the decrease in fair value of the liability recorded for the interest rate swaps in place in that time period. For the year ended December 31, 2002, we made cash payments on those swaps of $12.1 million. The change in fair value and the swap payments are netted together on our consolidated statement of operations. During the year ended December 31, 2002, we also recognized a $4.7 million loss on the fair value of derivatives no longer providing a hedge due to the repayment of the hedged debt.
Asset Acquisitions
During 2004, we invested in three properties, each of them having exceptional quality and exhibiting superior growth potential, and being located in three of the top performing markets in the country. We believe these factors will enable these investments to produce superior returns for our shareholders. Our two consolidated hotels, and while not consolidated into our results, the hotel for which we record equity in income, realized 2004 (full year) combined RevPAR of $132.74. RevPAR for our entire portfolio during 2004 was $69.82. The higher RevPAR of the acquired hotels is indicative of their overall earnings power.
On May 10, 2004 we acquired the four-star, four-diamond rated Ritz-Carlton, Pentagon City in Arlington, Virginia for a purchase price of $93 million. The 366-room luxury hotel is operated by The Ritz-Carlton Hotel Company, LLC under a long-term contract. The hotel features nearly 18,000 square feet of meeting space, which can accommodate meetings of up to 900 guests. On June 30, 2004, we partially financed the acquisition through the placement of a $55.8 million fixed-rate mortgage loan, which is secured by this property. The mortgage matures on June 1, 2011 and bears interest at an annual fixed rate of 5.8%. We financed the remainder of the acquisition cost with cash on hand.
Additionally, on June 25, 2004, we acquired the 485-room Marriott Irvine in Orange County, California, for a purchase price of $92.5 million. The hotel is operated by a subsidiary of Marriott International, Inc. under a long-term contract. The hotel features 30,000 square feet of meeting space, including a 13,000 square foot ballroom that can accommodate meetings of up to 1,500 guests. To take advantage of the current low interest rate environment, we financed a portion of the acquisition with a $55.5 million fixed-rate mortgage, which is secured by this property, matures on July 1, 2011 and bears interest at an annual fixed rate of 5.69%. We financed the remainder of the acquisition cost with cash on hand.
On October 1, 2004, we acquired a 49.99% interest in the 705-room Radisson Lexington Avenue Hotel in Midtown Manhattan. We made a total investment of $50 million, which includes a $40 million mezzanine loan that matures on October 1, 2014 and yields $5.8 million of cumulative annual interest, and a $10 million equity interest in the hotel. The mezzanine loan is secured by a pledge of the equity interests held by the borrower in an indirect parent of the owner of the hotel, and has a 10-year term. The loan is subordinate to $150 million in senior notes, but has priority over all equity interests.
We will continue to be highly selective with potential acquisitions, focusing primarily on larger properties located in major urban markets or high-end resort destinations with high barriers to new competition, premium brand affiliations, significant meeting space and superior growth potential. The terms of our senior note indentures may limit our ability to obtain financing to acquire assets beyond certain limited exceptions (including up to $300 million of mortgage indebtedness, of which $194.5 million was available at December 31, 2004, and $50 million of general indebtedness) as we are below the required fixed charge coverage ratio of 2 to 1, at which level we would be permitted to generally incur debt without restriction.
Asset Dispositions
We have substantially completed our previously announced disposition program that repositioned our portfolio into one generally consisting of larger assets with significant meeting space in urban or high-end resort locations. Between January 1, 2003 and December 31, 2004, we disposed of 36 hotels with 8,109 rooms for total gross proceeds of $283.6 million in cash and $11.1 million in reduction of debt. Of these 36 hotels, 15 hotels were disposed of in 2003 and 21 hotels were disposed of in 2004. The reshaping of our portfolio has contributed to an increase in RevPAR, which, for our entire portfolio of properties (excludes nine properties affected by hurricanes in 2004), increased to $69.56 from $59.64 for the years ended December 31, 2004 and 2003, respectively.
In addition, we may from time to time receive offers on other assets that we might consider selling. We would consider any opportunities that have the potential to improve our financial condition or results of operations.
Capital Expenditures
We have developed a targeted renovation program that is designed to reduce the time and cost required to renovate hotels, allowing us to improve the quality of our hotels faster to take advantage of the rebound in the economy and better control the level of disruption associated with renovations. During the year, we accelerated our renovation program for certain key assets, which created some short-term disruption, but also positioned us to participate more quickly in the lodging industry recovery. We make ongoing capital expenditures in order to keep our hotels competitive in their markets and to comply with franchise obligations, as described further in “Operating Risks” (the potential adverse impact of our failure to meet the requirements contained in our franchise and licensing agreements) included in Item 1 - Risk Factors of this Annual Report on Form 10-K. Additionally, certain of our hotels’ management contracts and franchise agreements contain reserve requirements for property improvements. We fund our capital expenditures primarily from cash generated from operations and existing cash on hand and intend to use a portion of the proceeds from the sales of assets to provide capital for renovation work. We initiated an aggressive renovation program for our assets in the beginning of 2004, and invested a total of $134 million on capital expenditures in 2004. We anticipate investing a total of approximately $100 million in 2005, including $15 million to complete projects started in 2004 and excluding hurricane-related capital expenditures. The emphasis is on completing these projects on budget with minimal disruptions to operations. We focus on complete room and facility renovations, eliminating to the degree possible, piecemeal work where the typical consumer might not ascribe value to the improvements. We believe we are timing this work appropriately to take full advantage of the economic recovery. The amount of hurricane-related capital expenditures has not yet been fully determined, however, we anticipate it to well exceed $100 million, most of which we expect to be reimbursed by our insurance carriers.
Other Financial Information
Critical Accounting Policies and Estimates
Our consolidated financial statements include the accounts of all wholly-owned and majority-owned subsidiaries. Preparing financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and judgments, including those related to the impairment of long-lived assets and the recording of certain accrued liabilities. We base our estimates and judgments on historical experience and other factors we believe to be reasonable under the circumstances. Some of our estimates are material to the financial statements. These estimates are therefore particularly sensitive as future events could cause the actual results to be significantly different from our estimates.
We believe that the following critical accounting policies, among others, affect our more significant estimates and assumptions used in preparing our consolidated financial statements:
Accounting for the impairment or disposal of long-lived assets
We are required by GAAP to perform an analysis to determine the recoverability of an asset’s carrying value whenever events or changes in circumstances indicate that a long-lived asset may be impaired. We make estimates of the undiscounted cash flows from the expected future operations or potential sale of the asset using the best information available at that time. If our analysis indicates that the carrying value is not recoverable from these estimates of cash flows, we write down the asset to estimated fair value and recognize an impairment loss. In conducting these analyses, we may also make assumptions about the asset’s expected useful life, future capital expenditures, and fair market value. Due to future changes in market or economic conditions and our continuing forecast and outlooks for future periods, we may need to revise our estimates of fair value and recognize additional impairment charges in future periods if circumstances indicate at that time that the carrying value of the assets may be impaired. In the past, market conditions have changed, causing additional impairment to be recognized due to a reduction in estimated sales price of our assets stemming from market forces.
We apply the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. Hotels of which we dispose may be managed under agreements that require payments to the hotel management company as a result of termination. Any such liability will be recognized at the time the asset disposition is complete and a termination notice is provided to the hotel management company. At that time, the recognition of the termination obligation will be included in the calculation of the final gain or loss on sale and will be included in discontinued operations.
Classification of properties as held for sale
Our hotel properties generally fall into two categories, held for use and held for sale. Our held for use properties may include those that we are actively marketing. Until such time as our criteria for held for sale are met, as described below in further detail, we maintain classification as an operational asset. At the time we determine an asset to meet the criteria noted below, we reclassify the asset and its operations to discontinued operations.
Held-for-sale classification requires that the sale be probable and that the transfer of the asset is expected to be completed within one year, among other criteria. Assessing the probability of the sale requires significant judgment due to the uncertainty surrounding completing the transaction, and as a result, we have the following policy in aiding in assessing probability. We classify the properties we are actively marketing as held for sale once all of these conditions are met:
•
Our board has approved the sale,
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We have a fully executed agreement with a qualified buyer which provides for no significant outstanding or continuing obligations with the property after sale, and
•
We have a significant non-refundable deposit.
We carry properties held for sale at the lower of their carrying values or estimated fair values less costs to sell. If our estimates of fair value are incorrect, the carrying values may not be accurately reflected. We cease depreciation at the time the asset is classified as held for sale. If material to our total portfolio, we segregate the assets and liabilities relating to our held for sale properties on our consolidated balance sheet. We also reclassify the operating results of properties held for sale as discontinued operations for all periods presented.
Depreciation and Amortization Expense
We estimate the useful lives of property and equipment in order to determine the amount of depreciation and amortization expense to be recorded during any reporting period. We depreciate the majority of our buildings and improvements over an estimated useful life of 20 to 40 years, or the remaining terms of a ground lease, if shorter. We depreciate furniture, fixtures and equipment over lives ranging from five to seven years, and computers over three to five years. The estimated useful lives are based on our historical experience with similar assets, as well as our taking into account current market and economic conditions. While management believes its estimates are reasonable, a change in the estimated lives would affect depreciation expense and net income, as well as the gain or loss on the sale of any of our hotels.
Hurricane Related Insurance Recoveries
We have comprehensive insurance coverage for both property damage and business interruption relating to the properties affected by the August and September 2004 hurricanes. Our damage assessment teams, working with the adjusters for our insurance providers, are inspecting each of our affected properties and implementing restoration plans. The net book value of the property damage is currently estimated to be at least $65 million; however, we are still assessing the impact of the hurricanes on our properties, and actual net book value write-offs could vary from this estimate. Changes to this estimate will be recorded in the periods in which they are determined. For the year ended December 31, 2004, we have recorded a net fixed asset write-off and a corresponding insurance claim receivable for this $65 million net book value amount because we believe that it is probable that the insurance recovery, net of deductibles, will significantly exceed the net book value of the damaged portion of these assets. The recovery is based on replacement cost, and we have submitted claims substantially in excess of $65 million.
While we expect the insurance proceeds will be sufficient to cover most of the replacement cost of the restoration of these hotels, certain deductibles (primarily windstorm) and limitations will apply. Moreover, no determination has been made as to the total amount or timing of those insurance payments, and those insurance payments may not be sufficient to cover the costs of all the restoration of the hotels. To the extent that insurance proceeds, which are on a replacement cost basis, ultimately exceed the net book value of the damaged property, a gain will be recorded in the period when all contingencies related to the insurance claim have been resolved.
As a result of the damage caused by the hurricanes, our properties experienced varying periods of business interruption and impacts on operations, including closure of certain hotels. Where possible and in order to mitigate loss of revenues, some permanent repairs to damaged properties have been deferred during the Florida “high season”, which generally lasts from late December through early April, in order to have facilities available to meet demand. These damaged facilities will be removed from service for permanent repairs at a later date. We have hired consultants to assess our business interruption claims and are currently negotiating with our insurance carriers regarding coverage for income losses sustained. To the extent that we are entitled to a recovery under the insurance policies, we will recognize a receivable when it can be demonstrated that it is probable that such insurance recovery will be realized, and such receivable will then be reflected as a component of operating income. Any gain resulting from business interruption insurance for lost income will not be recognized until the relevant payments have been received and all contingencies related to the insurance recoveries are resolved. This income recognition criteria will result in business interruption insurance recoveries being recorded in a period subsequent to the period that we experience lost income from the affected properties, resulting in fluctuations in our net income that may reduce the comparability of reported quarterly results for some periods into the future.
New Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which requires companies to recognize compensation cost relating to share-based payment transactions, and measure that cost based on the fair value of the equity or liability instruments issued. We are required to comply with the provisions of this statement beginning with the third quarter of 2005. We do not expect the adoption of this revised standard to have a material effect on our accounting treatment for share-based payments, as we adopted the transition provisions of SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” on January 1, 2003 and elected to recognize compensation expense for options granted subsequent to December 31, 2002 under the fair-value-based method.
The FASB issued SFAS No. 152 “Accounting for Real Estate Time-Sharing Transactions-an amendment of FASB Statements No. 66 and 67” in December 2004, which amends current guidance to state that the rules for (a) incidental operations and (b) costs incurred to sell real estate projects do not apply to real estate time-sharing transactions. We are required to comply with the provisions of this statement for the third quarter of 2005. We do not expect the effect of this statement to be material.
The FASB issued Statement No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions” in December 2004. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. We are required to comply with the provisions of this statement for the third quarter of 2005. We have not entered into or modified any transactions within the scope of this standard, nor do we have any existing transactions that fall within the scope of SFAS No. 153.
Off-Balance Sheet Arrangements
We have future ground lease obligations related to our consolidated entities and properties. The ground leases are accounted for as operating leases, and are expensed evenly over the lives of the leases. These leases exist at properties where we do not own the land associated with our hotel. As of December 31, 2004, other than our equity method investment, we were not involved in any off-balance sheet arrangements.
Aggregate Contractual Obligations
The following table summarizes our aggregate contractual obligations as of December 31, 2004 (in thousands):
(a) The amounts shown include amortization of principal and maturities on our debt as well as discounts of $4.0 million on our senior notes. For a description of the material terms of our long-term debt, see “Financial Condition, Liquidity and Capital Resources-Long-Term Debt” section above.
(b) Includes ground and building operating types of leases, which are shown net of $0.1 million of sublease receipts.
(c) Our purchase obligations consist of commitments for capital expenditures at our hotels, which include $14.3 million in hurricane related commitments (most of which we expect to be reimbursed by our insurance carriers) and $48.0 million in non-hurricane related commitments. Under our contracts, we have the ability to defer some of these expenditures into later years and some of the current year amount reflects prior year contracts that were deferred or not completed.
(d) Termination fees related to the sale of our hotels, see “The Management Agreements-Interstate Hotels.”
(e) Represents fixed interest payments on our debt.
The Managers operate our 73 hotels pursuant to management agreements with our taxable subsidiaries. Under these management agreements, the taxable subsidiaries pay a management fee for each property to the Manager of their hotels. The taxable subsidiaries in turn make rental payments to our subsidiary operating partnership under the participating leases.
Under the Interstate Hotels management agreements, the base management fee is 2.5% of total hotel revenue, plus incentive payments based on meeting performance thresholds that could total up to an additional 1.5% of total hotel revenue. The agreements generally have initial terms expiring on January 1, 2011 with three renewal periods of five years each at the option of Interstate Hotels, subject to some exceptions. We may be obligated to pay Interstate Hotels termination fees with respect to properties that we sell. See “Financial Condition, Liquidity and Capital Resources-Asset Dispositions.”
Under the Ritz-Carlton and Marriott management agreements, the base management fee is 3.0% and 2.5% of total hotel revenue, respectively, through 2005 and 3.0% under both thereafter, plus incentive payments based on meeting performance thresholds that could total up to an additional 2.0% of total hotel revenue and 20% of available cash flow (as defined), respectively. The agreements have initial terms expiring in 2015 and 2024, respectively, with four and three renewal periods of 10 and five years each, respectively, at the option of Ritz-Carlton and Marriott, subject to some exceptions.
As part of our overall executive compensation, certain senior executives are employed under contracts as described in our proxy statements, and incorporated by reference as exhibits to this Form 10-K.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our interest rate risk management objective is to manage the effect of interest rate changes on earnings and cash flows. We look to manage interest rates through the use of a combination of fixed and variable rate debt. To achieve our objectives, we may borrow 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 our interest rate risk on a related financial instrument. We only enter into derivative or interest rate transactions for hedging purposes, and not for trading purposes. We do not engage in speculative transactions.
On April 2, 2004, we entered into an interest rate swap on our secured facility due 2009, effectively converting the interest the facility bears from a fixed rate to a floating rate. Under the swap, we receive fixed-rate payments of 8.01% and pay floating rate payments based on a one month LIBOR plus 444 basis points on an initial $307 million notional amount.
We have designated the interest rate swap as a fair value hedge for financial reporting purposes and the amounts paid or received under the swap agreement will be recognized over the life of the agreement as an adjustment to interest expense. Changes in the fair value of the swap and the secured facilities are reflected in the balance sheet as offsetting changes and have no income statement effect. The fair value of the interest rate swap at December 31, 2004 was a liability of approximately $4.7 million, which is included in the other liabilities line item on our consolidated balance sheet.
In conjunction with the interest rate swap, we have posted collateral of $12.0 million as of December 31, 2004. The required collateral amount fluctuates based on the changes in the swap rate and the amount of time left to maturity. During 2004, our posted collateral ranged from $8.0 million to $20.9 million. However, due to the terms of the swap agreement, our posted collateral must be a minimum amount calculated per the agreement, which was $6.7 million as of December 31, 2004. We will receive all remaining collateral upon maturity of the swap.
The table below provides information about our derivative financial instrument that is sensitive to changes in interest rates. The table presents contractual payments to be exchanged under the contract and weighted average interest rates by expected (contractual) maturity dates for our interest rate swap. Weighted average interest rates and notional amounts are used to calculate the contractual payments to be exchanged under the contract. Weighted average interest rates are based on implied forward rates in the yield curve as of December 31, 2004. The interest rate swap that we have entered into is strictly to hedge interest rate risk and not for trading purposes.
As a result of our interest rate swap, we are exposed to market risks related to changes in interest rates. In the future, we intend to manage our interest rate exposure using a mix of fixed and floating interest rate debt. A change in one month LIBOR of 50 basis points would result in an increase or decrease in current annual interest expense of approximately $1.5 million.
As of December 31, 2004, approximately 19% of our outstanding debt bears fixed rates of interest that have been effectively swapped from a fixed rate to a floating rate, with the remaining 81% of debt bearing fixed rates of interest. Before the effect of the swap, all of our debt bears fixed rates of interest as follows (in millions):
Exchange Rate Risk
As of December 31, 2004, we had no foreign operations. We had previously owned four Canadian hotels, but our last property in Canada was sold in 2004. Our Canadian operations were not material to our consolidated financial position as of December 31, 2004 and 2003, or our consolidated results of operations and cash flows for each of the years in the three-year period ended December 31, 2004. Accordingly, we were not subject to material foreign currency exchange rate risk from the effects that exchange rate movements of foreign currencies would have on our future costs or on our future cash flows we would receive from our foreign subsidiaries. Foreign currency transaction gains and losses were not material to our results of operations for the same periods. Additionally, we did not enter into any foreign currency forward exchange contracts or other derivative financial instruments to hedge the effects of adverse fluctuations in foreign currency exchange rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following Consolidated Financial Statements, Supplementary Data and Financial Statement Schedules are filed as part of this Annual Report on Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Partner’s Capital for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
Notes to the Consolidated Financial Statements
Schedule III-Real Estate and Accumulated Depreciation as of December 31, 2004
All other schedules are omitted because they are not applicable or the required information is included in the Consolidated Financial Statements or the Notes thereto.
Report of Independent Registered Public Accounting Firm
The Partners
MeriStar Hospitality Operating Partnership, L.P.:
We have audited the accompanying consolidated financial statements of MeriStar Hospitality Operating Partnership, L.P. and subsidiaries (the Partnership) as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and the financial statement schedule are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MeriStar Hospitality Operating Partnership, L.P. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Partnership’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 15, 2005, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
/s/ KPMG LLP
KPMG LLP
McLean, VA
March 15, 2005
MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
(Dollars and units in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands, except per unit amounts)
The accompanying notes are an integral part of these consolidated financial statements.
MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004, 2003 AND 2002
1. Organization
MeriStar Hospitality Operating Partnership, L.P. is the subsidiary operating partnership of MeriStar Hospitality Corporation, which is a real estate investment trust, or REIT. We own a portfolio of primarily upper upscale, full-service hotels and resorts in the United States. Our portfolio is diversified geographically as well as by franchise and brand affiliations. As of December 31, 2004, we owned 73 hotels with 20,319 rooms, all of which were leased by our taxable subsidiaries. As of December 31, 2004, 71 hotels were managed by Interstate Hotels & Resorts (“Interstate Hotels”), which was created on July 31, 2002 through the merger of MeriStar Hotels & Resorts, Inc. and Interstate Hotels Corporation, one hotel was managed by The Ritz-Carlton Hotel Company, LLC (“Ritz-Carlton”), a subsidiary of Marriott International, Inc., and one hotel was managed by another subsidiary of Marriott International, Inc. (“Marriott”) (collectively with Interstate Hotels, the “Managers”).
On January 1, 2001, changes to the federal tax laws governing REITs, commonly known as the REIT Modernization Act, or RMA, became effective. As permitted by the RMA, we formed a number of wholly-owned taxable subsidiaries to lease our real property. The RMA prohibits our taxable subsidiaries from engaging in the following activities:
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Managing the properties they lease (our taxable subsidiaries must enter into an “arm’s-length” management agreement with an independent third-party manager actively involved in the trade or business of hotel management and manages properties on behalf of other owners);
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Leasing a property that contains gambling operations; and
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Owning a brand or franchise.
The Managers operate the 73 hotels we owned as of December 31, 2004 pursuant to management agreements with our taxable subsidiaries. Under these management agreements, each taxable subsidiary pays a management fee for each property to the Manager of its hotels. The taxable subsidiaries in turn make rental payments to our subsidiary operating partnership under the participating leases.
Under the Interstate Hotels management agreements, the base management fee is 2.5% of total hotel revenue, plus incentive payments based on meeting performance thresholds that could total up to an additional 1.5% of total hotel revenue. The agreements have initial terms expiring on January 1, 2011 with three renewal periods of five years each at the option of Interstate Hotels, subject to some exceptions.
Under the Ritz-Carlton and Marriott management agreements, the base management fee is 3.0% and 2.5% of total hotel revenue, respectively, through 2005 and 3.0% under both thereafter, plus incentive payments based on meeting performance thresholds that could total up to an additional 2.0% of total revenue and 20% of available cash flow (as defined in the relevant management agreement), respectively. The agreements have initial terms expiring in 2015 and 2024, respectively, with four and three renewal periods of 10 and five years each, respectively, at the option of Ritz-Carlton and Marriott. The Ritz-Carlton and Marriott management agreements include certain limited performance guarantees by the relevant manager which are designed primarily to provide downside performance protection and run through 2005 and up to 2008, respectively. During 2004, we recorded a total amount of $1.0 million under the Ritz-Carlton and Marriott limited performance guarantees, combined. Management, based upon budgets and operating trends, expects payments under these guarantees in the future to be minimal.
2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation. The accompanying consolidated financial statements include the accounts of the Company, its subsidiaries and its controlled affiliates. We consolidate entities (in the
absence of other factors when determining control) when we own over 50% of the voting shares of another company or, in the case of partnership investments, when we own a majority of the general partnership interest. Additionally, if we determine that we are an owner in a variable interest entity within the meaning of the Financial Accounting Standards Board, or FASB, revision to Interpretation No. 46, “Consolidation of Variable Interest Entities” and that our variable interest will absorb a majority of the entity’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both, then we will consolidate the entity. All material intercompany transactions and balances have been eliminated in consolidation. One of our properties reports results over 13 four week periods each year. We include 12 weeks of results in each of quarters one through three and 16 weeks of results in quarter four.
Use of Estimates. Preparing financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from these estimates.
Property and Equipment. We record our property and equipment at cost or at fair value at the time of contribution for contributed property. We use the straight-line method for depreciation. We depreciate the majority of our buildings and improvements over an estimated useful life of 20 to 40 years, or the remaining terms of a ground lease, if shorter. We depreciate furniture, fixtures and equipment over lives ranging from five to seven years, and computers over three to five years. During the years ended December 31, 2004, 2003, and 2002, we recognized depreciation expense of $95.3 million, $105.7 million, and $115.4 million, respectively. For the years ended December 31, 2004, 2003 and 2002, we capitalized interest of $5.6 million, $3.1 million, and $4 million, respectively.
Held for Sale Properties. Held-for-sale classification requires that the sale be probable and that the transfer of the asset is expected to be completed within one year, among other criteria. Assessing the probability of the sale requires significant judgment due to the uncertainty surrounding completing the transaction, and as a result, we have the following policy in aiding in assessing probability. We classify the properties we are actively marketing as held for sale once all of the following conditions are met:
•
Our board has approved the sale,
•
We have a fully executed agreement with a qualified buyer which provides for no significant outstanding or continuing obligations with the property after sale, and
•
We have a significant non-refundable deposit.
We carry properties held for sale at the lower of their carrying values or estimated fair values less costs to sell. We cease depreciation at the time the asset is classified as held for sale. If material to our total portfolio, we segregate the assets and liabilities relating to our held for sale properties on our consolidated balance sheet.
Intangible Assets. Intangible assets, which are included in prepaid expenses and other assets, consist primarily of deferred financing fees. We amortize, to amortization expense, the deferred financing fees on a straight-line basis (which approximates the interest method) over the lives of the related borrowings. As of December 31, 2004, 2003 and 2002, we had recorded gross deferred financing fees of $34.8 million, $34.9 million, and $27.3 million; these intangibles were $19.0 million, $23.4 million and $19.1 million, respectively, net of accumulated amortization. Related amortization expense was $4.6 million, $3.9 million and $3.5 million for the years ended December 31, 2004, 2003 and 2002, respectively. We estimate related amortization expense to remain approximately $5.0 million each of the next five years.
Cash Equivalents and Restricted Cash. We classify investments with original maturities of three months or less as cash equivalents. Our cash equivalents include investments in debt securities, including commercial
paper, overnight repurchase agreements and money market funds. Restricted cash represents amounts held in escrow in accordance with the requirements of certain of our credit facilities.
Revenue Recognition. Substantially all of our revenues are derived from the operations of our hospitality properties, including room, food and beverage revenues. We recognize hotel operational revenues as hotel services are delivered.
Impairment or Disposal of Long-Lived Assets. We apply the provisions of Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which require the current and prior period operating results of any asset that has been classified as held for sale or has been disposed of and where we have no continuing involvement to be recorded as discontinued operations. Any gains or losses on final disposition are also included in discontinued operations.
The provisions of SFAS No. 144 also require that whenever events or changes in circumstances indicate that the carrying value of a long-lived asset may be impaired that an analysis be performed to determine the recoverability of the asset’s carrying value. When we conclude that we expect to sell or otherwise dispose of an asset significantly before the end of its previously estimated useful life, we perform an impairment analysis on that asset (as is the case for assets we are considering for disposition). We make estimates of the undiscounted cash flows from the expected future operations or potential sale of the asset. If the analysis indicates that the carrying value is not recoverable from these estimates of cash flows, we write down the asset to estimated fair value and recognize an impairment loss. Any impairment losses we recognize on assets held for use are recorded as operating expenses. We record any impairment losses on assets held for sale as a component of discontinued operations.
Accounting for Costs Associated with Exit or Disposal Activities. We apply the provisions of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” which require that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. Our strategy includes the disposition of certain hotel assets, all of which are managed under agreements that typically require payments as a result of termination. Any such liability will be recognized at the time the asset disposition is complete and a termination notice is provided. At that time, the recognition of the termination obligation will be included in the calculation of the final gain or loss on sale. To date, we have not incurred any management agreement termination obligations other than in connection with sales of hotels. For further discussion of potential termination obligations, see Note 15.
Gains and Losses From Extinguishments of Debt. We apply the provisions of SFAS No. 145, “Rescission of FASB Statements No. 4, No. 44 and No. 64, Amendment of SFAS No. 13, and Technical Corrections.” The rescission of SFAS No. 4 and No. 64 requires that all gains and losses from extinguishments of debt be classified as extraordinary only if the gains and losses are from unusual or infrequent transactions. It also requires prior period gains or losses that are not from unusual and infrequent transactions to be reclassified. See Note 8 for details on the early extinguishment of certain debt during the years ended December 31, 2004 and 2003.
Stock-Based Compensation. We apply the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, for new stock options issued under compensation programs sponsored by MeriStar Hospitality. As permitted by SFAS No. 148, we elected to apply the provisions prospectively, which includes recognizing compensation expense for only those stock options issued in 2003 and after. We grant options with an exercise price equal to the price of MeriStar Hospitality’s common stock on grant date. Compensation costs related to stock options are included in general and administrative expenses on the accompanying consolidated statement of operations. We apply the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for stock options issued by MeriStar Hospitality under compensation programs prior to January 1, 2003. As MeriStar Hospitality granted these stock options at fair market value, no compensation cost has been recognized. For other equity-based compensation plans, we recognize compensation expense over the vesting period based on the fair market value of the award at
the date of grant for fixed plan awards, while variable plan awards are re-measured based upon the intrinsic value of the award at each balance sheet date.
Pro forma information regarding net loss and loss per unit is required by SFAS No. 123, and has been determined as if we had accounted for all of MeriStar Hospitality’s employee stock options under the fair value method. We estimated the fair value for these options at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
Had compensation cost been determined based on fair value at the grant date for awards granted prior to our adoption of the fair value method, our net loss and per unit amounts would have been adjusted to the pro forma amounts indicated as follows (in thousands, except per unit amounts):
These pro forma compensation costs may not be representative of the actual effects on reported net loss and loss per share in future years. Additionally, the adjustment related to the POPs accounting is not included in the stock-based employee compensation expense amounts in the schedule above (see Note 10).
Income Taxes. We account for income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes.” Deferred income taxes reflect the tax consequences on future years of differences between the tax and financial reporting bases of assets and liabilities. As a partnership, we are not subject to federal income taxes. We are subject to state and local taxes in certain jurisdictions.
Foreign Currency Translation. We sold three of our four Canadian hotels in December 2003 and the fourth Canadian hotel in 2004. We maintained the results of operations for our Canadian hotels in Canadian dollars and translated those results to U.S. dollars using the average exchange rates for each period. We translated assets and liabilities using the exchange rate in effect at the balance sheet date. We reflected any resulting translation adjustments in accumulated other comprehensive loss. Our cumulative translation adjustment included in accumulated other comprehensive loss at December 31, 2004 was zero.
Derivative Instruments and Hedging Activities. Our interest rate risk management objective is to manage the effect of interest rate changes on earnings and cash flows. We look to manage interest rates through the use of a combination of fixed and variable rate debt. We only enter into derivative or interest rate transactions for hedging
purposes. We recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income based on the derivative’s effectiveness and whether the derivative has been designated as a cash flow or fair value hedge. SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” became effective on July 1, 2003. The statement clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying derivative, and amends certain other provisions. This statement applies to any freestanding financial derivative instruments entered into or modified after June 30, 2003. This standard did not affect our results of operations or financial condition as we have properly classified our interest rate swap as a fair value hedge, and have not entered into any other transactions within the scope of SFAS No. 149.
Acquisition of Hotels. Our hotel acquisitions consist almost exclusively of land, building, furniture, fixtures and equipment. We allocate the purchase price among these asset classes and any acquired intangible assets based upon their respective fair values as required by SFAS No. 141, “Business Combinations.”
Investments in Unconsolidated Affiliates. We have non-controlling interests in two entities which we carry at cost, plus any equity in net earnings or losses on our equity method investment, less distributions received since the date of acquisition, less any adjustment for impairment, in a separate line item on our Consolidated Balance Sheets. Our cost method investment is a limited partner interest with no participation rights in the management, affairs or operations of the entity. On one investment, we recognize our preferred return quarterly as it becomes due to us. Our other investment is accounted for using the equity method, since we are presumed to exert significant influence on this entity due to our ownership percentage of 49.99%. Accordingly, we recognize 49.99% of the profit and loss of the investee. Our investments in unconsolidated affiliates are periodically reviewed for other than temporary declines in market value. An impairment is recorded as a reduction to the carrying value of the investment for any declines which are determined to be other than temporary.
Accounting for the Impact of the Hurricane Damage to Florida Properties. In August and September 2004, hurricanes caused substantial damage to a number of our hotels located in Florida. The hurricane damage and local evacuation orders also caused significant business interruption at many of our Florida properties, including the complete closure of certain hotels. As a result, eight of our hotels were closed for an extended period of time, and five others were affected in varying degrees.
We have comprehensive insurance coverage for both property damage and business interruption. Our damage assessment teams, working with the adjusters for our insurance providers, are inspecting each of our affected properties and implementing restoration plans. Some properties will require substantial repair and reconstruction and will remain closed until such repairs are complete. Our recovery effort is extensive and includes replacing portions of buildings, landscaping and furniture, as well as upgrading to comply with changes in building and electrical codes. The net book value of the property damage is currently estimated to be at least $65 million; however, we are still assessing the impact of the hurricanes on our properties, and actual net book value write-offs could vary from this estimate. Changes to this estimate will be recorded in the periods in which they are determined. For the year ended December 31, 2004, we have recorded a net fixed asset write-off and a corresponding insurance claim receivable for this $65 million net book value amount because we believe that it is probable that the insurance recovery, net of deductibles, will significantly exceed the net book value of the damaged portion of these assets. The recovery is based on replacement cost, and we have submitted claims substantially in excess of $65 million.
While we expect the insurance proceeds will be sufficient to cover most of the replacement cost of the restoration of these hotels, certain deductibles (primarily windstorm) and limitations will apply. Moreover, no determination has been made as to the total amount or timing of those insurance payments, and those insurance payments may not be sufficient to cover the costs of all the restoration of the hotels. To the extent that insurance
proceeds, which are on a replacement cost basis, ultimately exceed the net book value of the damaged property, a gain will be recorded in the period when all contingencies related to the insurance claim have been resolved.
As of December 31, 2004, seven of our Florida properties remained completely closed due to hurricane damage. Additionally, as of December 31, 2004, four properties that suffered varying amounts of hurricane damage had certain rooms and conference facilities out of service. Where possible and in order to mitigate loss of revenues, some permanent repairs to damaged properties have been deferred during the Florida “high season”, which generally lasts from late December through early April, in order to have facilities available to meet demand. These damaged facilities will be removed from service for permanent repairs at a later date. We have hired consultants to assess our business interruption claims and are currently negotiating with our insurance carriers regarding coverage for these income losses sustained. To the extent that we are entitled to a recovery under the insurance policies, we will recognize a receivable when it can be demonstrated that it is probable that such insurance recovery will be realized, and such receivable will then be reflected as a component of operating income. Any gain resulting from business interruption insurance for lost income will not be recognized until the relevant payments have been received and all contingencies related to the insurance recoveries are resolved. This income recognition criteria will likely often result in business interruption insurance recoveries being recorded in a period subsequent to the period that we experience lost income from the affected properties, resulting in fluctuations in our net income that may reduce the comparability of reported quarterly results for some periods into the future.
Under this income recognition criteria, as of December 31, 2004, we have recorded a $107.3 million insurance claim receivable related to both property damage and business interruption recoveries combined, of which $31.3 million in insurance advances had been collected through December 31, 2004. We have collected an additional $8.8 million in advances from January 1 through March 7, 2005. Of the $107.3 million receivable recorded, $65.5 million represents the write-down of net fixed assets, as discussed above. The remaining $41.8 million represents a probable recovery of costs incurred. The cost recoveries are recorded on the expense line item to which they relate; therefore there is no net impact to any line item or our results.
The following is a summary of hurricane-related activity recorded (in millions):
New Accounting Pronouncements. In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which requires companies to recognize compensation cost relating to share-based payment transactions, and measure that cost based on the fair value of the equity or liability instruments issued. We are required to comply with the provisions of this statement beginning with the third quarter of 2005. We do not expect the adoption of this revised standard to have a material effect on our accounting treatment for share-based payments as we adopted the transition provisions of SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” on January 1, 2003 and elected to recognize compensation expense for options granted subsequent to December 31, 2002 under the fair-value-based method.
The FASB issued SFAS No. 152 “Accounting for Real Estate Time-Sharing Transactions-an amendment of FASB Statements No. 66 and 67” in December 2004, which amends current guidance to state that the rules for (a) incidental operations and (b) costs incurred to sell real estate projects do not apply to real estate time-sharing transactions. We are required to comply with the provisions of this statement for the third quarter of 2005. We do not expect the effect of this statement to be material.
The FASB issued Statement No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions” in December 2004. This Statement amends Opinion 29 to
eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. We are required to comply with the provisions of this statement for the third quarter of 2005. We have not entered into or modified any transactions within the scope of this standard, nor do we have any existing transactions that fall within the scope of SFAS No. 153.
Reclassifications. Certain prior year information has been reclassified to conform to the current year presentation. These reclassifications have no impact on consolidated net loss.
3. Comprehensive Loss
Comprehensive loss was $98.2 million for the year ended December 31, 2004, which consisted of net loss ($99.1 million) and foreign currency translation adjustments.
Comprehensive loss was $398.3 million for the year ended December 31, 2003, which consisted of net loss ($404.4 million) and foreign currency translation adjustments.
Comprehensive loss was $165.4 million for the year ended December 31, 2002, which consisted of net loss ($170.8 million), partially offset by foreign currency translation adjustments ($0.2 million), change in valuation of hedging derivative instruments ($0.5 million), and a reclassification of loss on derivatives due to repayment of hedged debt ($4.7 million).
4. Acquisitions
On May 10, 2004 and June 25, 2004, we acquired the 366-room Ritz-Carlton, Pentagon City in Arlington, Virginia and the 485-room Marriott Irvine in Orange County, California, respectively, for a total purchase price of $185.5 million, plus net acquisition costs and adjustments of $0.9 million.
The Ritz-Carlton, Pentagon City luxury hotel is operated by The Ritz-Carlton Hotel Company, LLC under a long-term contract. On June 30, 2004, we partially financed the acquisition through a $55.8 million fixed-rate mortgage loan, which is secured by this property, matures on June 1, 2011 and bears interest at an annual fixed rate of 5.8%. We financed the remainder of the acquisition cost with cash on hand.
The Marriott Irvine is operated by a subsidiary of Marriott International, Inc. under a long-term contract. We financed a portion of the acquisition with a $55.5 million fixed-rate mortgage loan, which is secured by this property, matures on July 1, 2011 and bears interest at an annual fixed rate of 5.69%. We financed the remainder of the acquisition cost with cash on hand. Because Marriott International, Inc. reports results in 13 four-week periods during the year rather than the 12 monthly periods that we employ, we will include 12 weeks of results in each of quarters one through three and 16 weeks of results in quarter four.
The acquisitions were accounted for under the purchase method of accounting, and the assets and liabilities and results of operations of the hotels have been consolidated in our financial statements since the date of purchase. On an unaudited pro forma basis, revenues, net income and basic and diluted loss per share for the years ended December 31, 2004 and 2003 would have been reported as follows if the acquisitions had occurred at the beginning of each of the respective periods (in thousands):
The following is a summary of the combined allocation of the purchase price based on estimates of fair value as determined by an appraiser (in thousands).
On October 1, 2004, we acquired an interest in the 705-room Radisson Lexington Avenue Hotel in Midtown Manhattan (see Note 7).
5. Property and Equipment
Property and equipment consisted of the following (in thousands):
For the years ended December 31, 2004 and 2003, we capitalized interest of $5.6 million and $3.1 million, respectively.
During the years ended December 31, 2004, 2003 and 2002 we recognized impairment losses of $12.3 million, $295.0 million, and $78.7 million respectively, of which $7.4 million, $267.7 million, and $78.7 million, respectively, are recorded in discontinued operations as of December 31, 2004 (see Note 16). There are no properties classified as held for sale as of December 31, 2004.
The impairment charges recorded during 2004, 2003 and 2002 were triggered by an expectation that a property would be sold significantly before the end of its estimated useful life. The impairment charges were based on our estimates of the fair value of the properties we were actively marketing based on available market data. As we received updated market data on the estimated sales proceeds of these assets, we recalculated estimated fair values, and re-assessed impairment based on the updated estimated fair values. We recorded additional impairments, as necessary, based upon the estimated fair values. The estimates of fair values required us to make assumptions about the sales prices that we expected to realize for each property as well as the timing of a potential sale. In making these estimates, we considered the operating results of the assets, the market for comparable properties, and quotes from brokers, among other information. In nearly all cases, our estimates reflected the results of an extensive marketing effort and negotiations with prospective buyers. Actual fair values, or realized proceeds, could differ materially from these estimates.
On September 7, 2004, we relinquished a property to a mortgage lender upon the completion of a foreclosure proceeding initiated by the lender with our acquiescence (see Note 8). The property and the mortgage loan had a fair value and carrying value of approximately $11 million.
6. Assets Held for Sale
At December 31, 2004, none of our 73 properties met the probability criteria as prescribed by SFAS No. 144 to classify them as held for sale. As of December 31, 2003, seven assets were classified as held for sale. All seven of these assets were disposed of during the first six months of 2004.
Assets held for sale consisted of the following (in thousands).
7. Investments in Unconsolidated Affiliates
Investment in Radisson Lexington Avenue Hotel. On October 1, 2004, we acquired a 49.99% interest in the 705-room Radisson Lexington Avenue Hotel in Midtown Manhattan. We made a total investment of $50 million, which includes a $40 million mezzanine loan that matures on October 1, 2014 and yields $5.8 million of cumulative annual interest, and a $10 million equity interest in the hotel. The mezzanine loan is secured by a pledge of the equity interests held by the borrower in an indirect parent of the owner of the hotel, and has a 10-year term. The loan is subordinate to $150 million in senior notes, but has priority over all equity interests.
Our equity investment is accounted for under the equity method of accounting, in accordance with our accounting policies as described in Note 2 to the Consolidated Financial Statements. The interest income from the loan, as well as the income related to the 49.99% share in profits and losses, is recorded in a separate line item “equity in income of and interest earned from unconsolidated affiliates” within operating activities as the operations of this investment are integral to our operations. As of December 31, 2004, we recognized interest income of $1.4 million on the mezzanine loan, which is recognized as earned. Our outstanding loan balance of $40.4 million includes $0.4 million origination costs associated with the loan. Our initial equity investment balance of $10.1 million includes $0.1 million of external costs incurred. During 2004, we recognized $0.2 million of income on our equity investment.
Investment in MIP. In 1999, we invested $40 million in MeriStar Investment Partners, L.P. (“MIP”), a joint venture established to acquire upscale, full-service hotels. Our cost-basis investment is in the form of a limited partnership interest, in which we earned a 16% cumulative preferred return with outstanding balances compounded quarterly. While the return on this investment was preferred and cumulative, the underlying investment ranked equally with the investments of the other investors in MIP.
In December 2004, MIP’s partnership agreement was amended and restated. In accordance with the amended and restated MIP partnership agreement, MIP’s general partner contributed $10 million to MIP which was then distributed to us, thereby reducing our outstanding preferred return receivable; the return on our investment and on our remaining unpaid accrued preferred return was reduced to a 12% future annual cumulative return rate, and subordinate only to the MIP debt; and $12.5 million of our $40 million investment was upgraded to receive preference over all other investments. As a result of the partnership restructuring, our ability to collect the preferred return improved, and we reassessed the carrying value of our preferred return. During the fourth quarter of 2004, we were able to recognize as income the $4.1 million compounded cumulative preferred return, $1.4 million of which was earned in 2003, but fully reserved.
In February 2005, MIP completed a $175 million commercial mortgage-backed securities financing, secured by its portfolio of eight hotels. Upon the completion of the financing in February 2005, we received an additional $15.5 million, which was applied to reduce our outstanding accrued preferred returns receivable to approximately $4 million.
After the February 2005 receipt of cash, our total MIP carrying value was approximately $19 million, consisting of the $15 million investment and $4 million of accrued preferred returns receivable.
We recognize our preferred return quarterly as it becomes due to us. The income, net of related expense, is recorded in the “Equity in income of and interest earned from unconsolidated affiliates” line within operating activities as the operations of this investment are integral to our operations. For the years ended December 31, 2004 and 2003, we recognized a preferred return of $11.5 million and $7.4 million, respectively, from this investment. Additionally, the $10 million contribution that we received in December reduced our outstanding preferred return receivable balance. As of December 31, 2004 and 2003, cumulative preferred returns of $19.7 million and $19.6 million, respectively, were due from MIP. We had reserved a portion of this balance and have included the net $19.7 million and $18.2 million in the “Investments in and advances to unconsolidated affiliates” line on the accompanying consolidated balance sheets as of December 31, 2004 and 2003, respectively. We expect that any cumulative unpaid preferred returns will be paid in the future from excess cash flow above our current return, from potential partnership hotel disposition proceeds in excess of debt allocated to individual assets, and from contributions to MIP from other partner contributions. We evaluate the collectibility of our preferred return based on our preference to distributions and the underlying value of the hotel properties.
While we believe that our current and cumulative returns continue to be fully collectible, during 2003, the value of our underlying investment declined due to the decline in MIP’s cash flow, particularly driven by results in four of its hotel markets. While we believe that the cash flow, and thus the value of our investment in MIP, will be recoverable over time, we expect that any such recovery will take a number of years to achieve. The accounting rules for cost basis investments require that declines in value that are other than temporary be recognized currently. Since the decline in the value of our underlying investment in MIP was other than temporary, we recognized a $25.0 million impairment loss on this investment during the fourth quarter of 2003. There have been no adverse changes in circumstances in 2004 that would require an additional impairment.
8. Long-Term Debt and Notes Payable to MeriStar Hospitality
Long-term debt and notes payable to MeriStar Hospitality consisted of the following (in thousands):
Aggregate future maturities as of December 31, 2004 were as follows (in thousands):
As of December 31, 2004, 81% of our debt bore fixed rates of interest, and the remaining 19% bore interest at fixed rates that have been, since April 2, 2004, effectively swapped to a floating rate. Our overall weighted average interest rate was 8.51% after giving effect to the interest rate swap. Based on market prices at December 31, 2004, the fair value of our long-term debt was $1.69 billion.
Credit facility. On December 19, 2003, we entered into a three-year $50 million senior credit facility, secured by six of our hotels, and terminated our previous credit facility. The facility bears interest at an annual rate of the London Interbank Offered Rate, or LIBOR, plus 450 basis points. As of December 31, 2004 and 2003, we had no outstanding borrowings under this facility.
The facility contains financial and other restrictive covenants. Our ability to borrow under this facility is subject to compliance with financial covenants, including leverage, fixed charge coverage and interest coverage ratios and minimum net worth requirements. Our compliance with these covenants in future periods will depend substantially upon the financial results of our hotels. The agreement governing our senior credit facility limits our ability to effect mergers, asset sales and change of control events and limits the payments of dividends other than those required for MeriStar Hospitality to maintain its status as a REIT and our ability to incur additional secured and total indebtedness. There are no ratings-based covenants in the facility.
Senior unsecured notes. During the year ended December 31, 2004, we repurchased, using, from available cash, $99.6 million of our senior unsecured notes, including $29.5 million of the 9.0% notes due 2008, $44.3 million of the 9.125% notes due 2011, and $25.8 million of the 10.5% notes due 2009. We recorded a loss on early extinguishment of debt of $6.2 million and wrote off deferred financing costs of $1.2 million related to these repurchases which is included in depreciation and amortization expense on the accompanying consolidated statements of operations.
These senior unsecured notes are general, unsecured obligations of us and certain subsidiaries of ours, and MeriStar Hospitality guarantees payment of principal and interest on the notes. These notes contain various restrictive covenants, limiting our ability to initiate or transact certain business activities if specific financial thresholds are not achieved. One of those thresholds is having a 2 to 1 fixed charge coverage ratio (as defined in the indentures, fixed charges only include interest on debt obligations and preferred equity) in order to enter into certain types of transactions, including the repurchase of our common OP units, the issuance of any preferred equity, the payment of certain distributions, the incurrence of any additional debt, or the repayment of certain outstanding debt before it comes due. As of December 31, 2004, our fixed charge coverage ratio was significantly below 2 to 1, and therefore we were not permitted generally to enter into those transactions, except as noted below.
There are certain exceptions with respect to the incurrence of additional debt and early repayment of debt features in the indentures. We have the ability to incur up to $300 million of secured financing within restricted subsidiaries, subject to meeting other maintenance tests under the indentures, of which $194.5 million was
available at December 31, 2004. We also have a general carve-out to incur $50 million of unspecified borrowings within a restricted subsidiary, of which the full amount was available at December 31, 2004. We have the ability to incur debt financing within an unrestricted subsidiary, such as the $55.5 million mortgage financing related to the acquisition of Marriott Irvine. Additionally, we are permitted to repay subordinated debt prior to its maturity from the proceeds of an equal or junior financing with a longer term than the debt refinanced, an equity offering, or a financing within an unrestricted subsidiary.
Secured facilities. We completed a $330 million non-recourse financing secured by a portfolio of 19 hotels in 1999. The loan bears a fixed annual interest rate of 8.01% and matures in 2009. The secured facility contains standard provisions that require the servicer to maintain in escrow cash balances for certain items such as property taxes and insurance. In addition, the facility contains a provision that requires our mortgage servicer to retain in escrow the excess cash from the encumbered hotels after payment of debt service (“Excess Cash”), if net hotel operating income (“NOI”) for the trailing twelve months declines below $57 million. This provision was triggered in October 2002 and will be effective until the hotels generate the minimum cash flow required for two consecutive quarters, at which time the cash being held in escrow will be released to us. In July 2003, we signed an amendment to the loan agreement that permits the release of cash placed in escrow for all capital expenditures incurred on the 19 encumbered properties on or after April 1, 2003. Although the servicer will continue to retain in escrow any excess cash from the encumbered hotels during the low NOI period, they will release cash for all capital expenditures on the 19 encumbered properties beginning April 1, 2003, subject to the servicer’s review and approval. As of December 31, 2004 and December 31, 2003, $29.9 million and $27.2 million, respectively, of cash was held in escrow under this provision. Escrowed funds totaling $21.0 million were available to fund capital expenditures under this provision as of December 31, 2004. From January 1, 2005 through March 7, 2005, we have received cash reimbursements of $6.2 million from the servicer related to capital expenditures incurred on the 19 encumbered properties.
The fair value adjustments for the interest rate swap agreement of net $(4.7) million that are discussed in further detail below are related to the outstanding secured facility balance of $303.0 million as of December 31, 2004.
On September 26, 2003, as permitted by the indentures governing our senior unsecured notes and senior subordinated notes, we completed a $101 million commercial mortgage-backed securities financing, secured by a portfolio of four hotels. The loan carries a fixed annual interest rate of 6.88% and matures in 2013.
Notes payable to MeriStar Hospitality. On July 1, 2003, MeriStar Hospitality completed an offering of $170 million aggregate principal amount of 9.5% convertible subordinated notes due 2010. In conjunction with this transaction, we borrowed $170 million from MeriStar Hospitality under terms matching those of the 9.5% convertible subordinated notes.
The proceeds from the borrowing were used to repurchase $150.6 million of our $154.3 million 4.75% notes payable to MeriStar Hospitality due 2004, at varying prices, resulting in an aggregate discount of approximately $1.4 million. On October 15, 2004, the remaining $3.7 million balance of 4.75% notes payable to MeriStar Hospitality were repaid at maturity. The remaining proceeds from the issuance were also used to repurchase a portion of our 8.75% notes payable to MeriStar Hospitality due 2007.
In conjunction with MeriStar Hospitality’s issuance of senior subordinated notes due in 2007, we borrowed a total amount of $205.0 million, of which $34.2 million was outstanding as of December 31, 2004, under terms matching those of MeriStar Hospitality’s senior subordinated notes. The 8.75% notes payable to MeriStar Hospitality due 2007 are unsecured obligations, and provide for semi-annual payments of interest each February 15 and August 15. The related indenture contains various restrictive covenants, which are similar to those in our senior unsecured notes.
During the year ended December 31, 2004, we retired $49.2 million of our 8.75% notes payable to MeriStar Hospitality due 2007 (plus $0.9 million of accrued interest) through the issuance of 8,138,728 common OP units.
We recorded a loss on early extinguishment of debt of $1.7 million. In February 2005, we retired an additional $1.49 million of our notes payable to MeriStar Hospitality.
Mortgage and other debt. As of December 31, 2004, we had three mortgage loans, two of which were incurred during the second quarter of 2004.
We financed a portion of the Marriott Irvine acquisition (see Note 4) with a $55.5 million fixed-rate mortgage loan effective June 25, 2004, which matures on July 1, 2011 and bears interest at an annual fixed rate of 5.69%. On June 30, 2004, in connection with The Ritz-Carlton, Pentagon City acquisition (see Note 4), we entered into a $55.8 million fixed-rate mortgage loan, which matures on June 1, 2011 and bears interest at an annual fixed rate of 5.8%.
We had a mortgage loan on a hotel property that was to mature in 2011 and carried an interest rate of 8.8%; however, the lender, with our acquiescence, initiated foreclosure proceedings on the property which were completed on September 7, 2004, and we relinquished the property to the bank. The carrying value of the mortgage loan and the fair value of the property both approximated $11 million. This property is included in discontinued operations.
Our other individual mortgage matures in 2011 and carries a fixed interest rate of 9.0% with an initial principal amount of $17.0 million.
On January 26, 2005, we entered into a $37.7 million mortgage loan on our Hilton Crystal City hotel that bears interest at a fixed rate of 5.84%. The mortgage requires interest payments only for the first three years and then monthly payments of interest and principal over the remaining portion of the ten year term of the loan.
Derivatives. On April 2, 2004, we entered into an interest rate swap arrangement with a third party to manage our interest rate risk related to our secured facility due 2009, effectively converting the interest the facility bears from a fixed rate to a floating rate. Under the swap, we receive fixed-rate payments of 8.01% and pay floating rate payments based on a one month LIBOR plus 444 basis points on an initial $307 million notional amount. We do not use derivative instruments for speculative purposes. Due to the fact that the notional amount of the swap matches the principal amount of the underlying debt and other hedge accounting criteria were met, the swap was designated as highly effective at the inception of the swap arrangement and designated as a fair value hedge. We continue to evaluate the effectiveness of the hedge and believe that the hedge continues to be highly effective.
For a derivative qualifying as a fair value hedge, the change in net unrealized gain or loss upon measuring the fair value hedge and the fair value of the debt instrument is recorded in our consolidated statements of operations. These amounts offset each other as there was no ineffective portion and therefore had no impact on our net loss for the year ended December 31, 2004. The fair value of the swap is recorded as either an asset or liability, with a corresponding increase or decrease to the carrying value of the debt instrument being hedged on our consolidated balance sheets. The fair value of our hedge was approximately a $4.7 million liability as of December 31, 2004. This amount is recorded on our consolidated balance sheet in the other liabilities line item with a corresponding debit recorded to long-term debt. During the year ended December 31, 2004, we earned cash payments of $4.2 million under the swap, which were recorded as a reduction in interest expense. In conjunction with the interest rate swap, we have posted collateral of $12.0 million as of December 31, 2004. The required collateral amount fluctuates based on the changes in the swap rate and the amount of time left to maturity. During 2004, our posted collateral ranged from $8.0 million to $20.9 million. However, due to the terms of the swap agreement, our posted collateral must be a minimum amount calculated per the agreement, which was $6.7 million as of December 31, 2004. We will receive all remaining collateral upon maturity of the swap.
During 2003, our only derivative instruments consisted of two swap agreements that did not qualify for treatment as hedges under SFAS No. 133, which expired in April 2003 and July 2003. During the year ended
December 31, 2003, we recognized $4.0 million of income related to the decrease in fair value of the liability recorded for the interest rate swaps in place in that time period. For the year ended December 31, 2003, we made cash payments on those swaps of $4.0 million. The change in fair value and the swap payments are netted together on our consolidated statement of operations, thus resulting in no impact on consolidated net loss.
During the year ended December 31, 2002, we recognized $7.6 million of income related to the decrease in fair value of the liability recorded for the interest rate swaps in place in that time period. For the year ended December 31, 2002, we made cash payments on those swaps of $12.1 million. The change in fair value and the swap payments are netted together on our consolidated statement of operations. During the year ended December 31, 2002, we also recognized a $4.7 million loss on the fair value of derivatives no longer providing a hedge due to the repayment of the hedged debt.
9. Income Taxes
We file as a partnership for federal income tax purposes. As a partnership, we are not subject to federal income tax but are responsible for certain state and local income taxes. When the RMA became effective on January 1, 2001, MeriStar Hospitality formed taxable subsidiaries to lease certain of our properties. These subsidiaries are subject to taxation similar to subchapter C-corporations. The income of these taxable subsidiaries is subject to federal and state income taxes. In addition, the partnership is also subject to income taxes in certain state and local jurisdictions.
Our income taxes were allocated as follows (in thousands):
Our effective income tax rate differs from the federal statutory income tax rate as follows:
The components of income tax (benefit) expense were as follows as of December 31 (in thousands):
The tax effects of the principal temporary differences that give rise to our net deferred tax liability (asset) were as follows (in thousands):
For state income tax purposes, the aggregate net operating loss (NOL) carryforward, prior to apportionment, for the partnership was $280.5 million and $130.8 million as of December 31, 2004 and 2003, respectively. These NOLs expire through 2024. The net operating loss for any jurisdiction, state or local, is subject to the laws of that jurisdiction and may differ from the aggregate NOL carryforward noted above for reasons other than apportionment. Such differences in NOL characteristics may arise from, but are not limited to, carry over period limitations and asset recovery methods that are different from the federal income tax rules. We have recorded a deferred tax asset relating to the NOL carryovers for states where we are subject to corporate level tax, based on our ability to use the losses against future income and as an offset to our net deferred tax liability relating to such state taxes.
As a result of our cumulative recognized losses, the Company has placed a valuation allowance against a portion of the deferred tax asset created by the net operating loss. The valuation allowance is sufficient to prevent our net operating loss from creating a net deferred tax asset for the Company. In future periods, we will review our ability to utilize our net operating loss carryforwards based on changes in economic conditions and operation results, and we will adjust the valuation allowance accordingly. At December 31, 2004, the valuation allowance for the partnership was $1.1 million.
For federal income tax purposes, the NOL carryforward for our taxable subsidiaries was $153.9 million and $63.7 million as of December 31, 2004 and 2003, respectively. These NOLs expire through 2024. Based on our projections of the taxable subsidiaries’ ability to utilize the NOL carryforward, we have recorded valuation allowances for the taxable subsidiaries of $61.1 million and $25.8 million, respectively, to reduce the carrying value of the NOL carryforward deferred tax asset to zero at both December 31, 2004 and 2003.
Our total valuation allowance was $62.2 million, $25.8 million and $10.5 million at December 31, 2004, 2003, and 2002, respectively.
A significant component of our deferred tax liability continues to be the basis difference in our fixed assets. At the time of the merger between CapStar Hotel Company and American General Hospitality Corporation in 1998, we established a new basis for the acquired assets and assumed liabilities based on their fair values at the
time of the merger. We established a net deferred income tax liability for the estimated future state and local income tax effect for differences between the accounting and tax bases of these assets and liabilities. As of December 31, 2004, this component of the deferred tax liability was $4.3 million.
In the course of document review with respect to the MIP restructuring, MeriStar Hospitality discovered a potential technical REIT qualification issue relating to a wholly-owned subsidiary of MIP, of which MeriStar Hospitality is deemed to own a de minimis proportionate share. For further discussion, see Note 15.
10. Partnership Units and Minority Interests
OP Units. Our operating partnership agreement provides for five classes of partnership interests: Common OP Units, Class B OP Units, Class C OP Units, Class D OP Units and Profits-Only OP Units, or POPs.
During the year ended December 31, 2004, we issued 8,138,728 Common OP units in exchange for the redemption of $49.2 million of our 8.75% notes payable to MeriStar Hospitality due 2007 (plus $0.9 million of accrued interest) (see Note 8).
Common OP Unit holders converted 133,000 and 885,000 of their OP Units, with a value of $0.6 million and $21.8 million, respectively, into MeriStar Hospitality’s common stock during the years ended December 31, 2004 and 2003, respectively.
On April 9, 2004, in accordance with the terms of the certificate of designation for the outstanding Class D OP Units of our operating partnership, we redeemed all outstanding Class D OP Units plus accrued and unpaid preferential distributions on those units, for an aggregate consideration of approximately $8.7 million. The Class D OP Units had become redeemable at the option of the holder on April 1, 2004.
On April 23, 2004, MeriStar Hospitality issued and sold 12.0 million shares of common stock at a price to the public of $6.25 per share pursuant to its effective shelf registration statement filed under the Securities Act of 1933. In connection with this transaction, MeriStar L.P. Inc., a wholly-owned subsidiary of MeriStar Hospitality, contributed the net proceeds to us in exchange for the same number of Common OP units. The offering closed on April 28, 2004 with net proceeds of $72.2 million.
In July 2004, MeriStar Hospitality’s Board of Directors authorized the elimination of the plan pursuant to which the POPs were issued. In conjunction with the elimination of the plan, we completed the redemption of all outstanding POPs for a total of $4.6 million in cash on December 2, 2004, although 187,500 of those POPs redeemed were not yet exchangeable pursuant to the POPs Plan. The POPs plan had been accounted for under APB 25, “Accounting for Stock Issued to Employees” as a fixed plan since December 11, 2001. Under fixed plan accounting, compensation expense is measured on the intrinsic value of the award on the grant date and amortized on a straight line basis over the vesting period. As a result of an accounting analysis performed in conjunction with the elimination of the POPs plan, we have determined that these awards should have been accounted for using variable plan accounting instead of fixed plan accounting. Under variable plan accounting, compensation expense is re-measured based upon the intrinsic value of the award at each balance sheet date and amortized to expense using a ratable vesting formula. Had variable plan accounting been applied from December 11, 2001, compensation expense for each of the years ended December 31, 2001, 2002 and 2003 would have been increased (reduced) by $0.5 million, $(3.7) million, and $(2.7) million, respectively. In order to correct this error, an adjustment of $4.5 million, net of forfeitures, was recorded during the third quarter of 2004 to reduce compensation expense; $4.0 million of this amount relates to 2003 and prior periods while $0.2 million and $0.3 million relate to the first and second quarters of 2004, respectively. This adjustment is included in the “General and administrative, corporate” line in our Consolidated Statements of Operations. In addition, the accrual for our liability under this plan, which was $3.6 million at September 30, 2004, was reclassified from redeemable OP units to accrued liabilities as of September 30, 2004. With the redemption of all outstanding POPs, this liability is zero at December 31, 2004. We have determined that the adjustments related to correction of this error are immaterial on both a quantitative and qualitative basis to the financial statements for all periods affected. Accordingly, the correction has been made in the current period financial statements.
11. Loss Per Unit
The following table presents the computation of basic and diluted loss per unit:
12. Related-Party Transactions
Due to/from Interstate Hotels & Resorts
Effective March 31, 2004, our Chief Executive Officer, and MeriStar Hospitality’s Chairman and Chief Executive Officer, Paul Whetsell, resigned as CEO of Interstate Hotels, but remains a non-executive Chairman of the Board of Directors of Interstate Hotels. In the normal course of managing our hotel properties, Interstate Hotels incurs day-to-day operating costs which are reimbursed by us. The balance due to Interstate Hotels of $21.8 million at December 31, 2004 and $16.4 million at December 31, 2003, respectively, included management fees due for each hotel, and reimbursements due for insurance, employee benefits, sales and marketing expenses, and other miscellaneous operating expenses. These amounts are normally paid within 30 days. The balance also included accrued termination obligations related to our asset dispositions. During the years ended December 31, 2004, 2003 and 2002, we paid Interstate Hotels a total of $25.9 million, $23.3 million, and $30.4 million, respectively, for termination fees, management fees, and miscellaneous operating expenses.
Pursuant to an intercompany agreement effective as of August 3, 1998, we and Interstate Hotels provided each other with, among other things, reciprocal rights to participate in certain transactions entered into by each party. In particular, until July 1, 2004, Interstate Hotels had the right of first refusal, under certain circumstances, to become the manager of any real property we acquired, and we and Interstate Hotels also may have provided each other with certain services from time to time. Although the intercompany agreement is no longer in effect, we and Interstate Hotels may continue to provide each other with services from time to time; certain of these services are required by the management agreements. These services may have included administrative, renovation supervision, corporate, accounting, finance, risk management, legal, tax, information technology, human resources, acquisition identification and due diligence, and operational services, for which Interstate Hotels was compensated in an amount that we would have been charged by a third party for comparable services. During the years ended December 31, 2004, 2003 and 2002, we paid Interstate Hotels a net amount of $0.05 million, $0.07 million, and $0.5 million, respectively, for such services. In July 2004, we concluded negotiations with Interstate Hotels to terminate the intercompany agreement, eliminating the last element of our original “paper clip” relationship with Interstate Hotels.
Note Receivable from Interstate Hotels & Resorts
Under a revolving credit agreement with Interstate Hotels through July 31, 2002, we had the ability to lend Interstate Hotels up to $50 million for general corporate purposes. As of December 31, 2001, Interstate Hotels owed us $36 million under this agreement. Effective January 1, 2002, Interstate Hotels issued us a term note for $13.1 million, which refinanced outstanding accounts payable owed to us.
In connection with the merger that created Interstate Hotels on July 31, 2002, we amended the terms of certain loans outstanding to Interstate Hotels, combining them into a term loan agreement with a principal
balance of $56.1 million and a maturity date of July 31, 2007. The interest rate was 650 basis points over the 30-day LIBOR. This term loan was subordinate to Interstate Hotels’ bank credit agreement.
In late December 2002, we reached an agreement to settle the term loan with Interstate Hotels for $42.1 million, plus accrued interest, which was paid in January 2003. We incurred a $14.5 million charge in 2002, including expenses of the transaction, related to this settlement.
During 2002, we earned interest of $4.8 million from these lending arrangements.
Senior Unsecured Notes held by Oak Hill Capital Partners
One non-executive director of MeriStar Hospitality Corporation’s Board of Directors is a Managing Partner of Oak Hill Capital Management, Inc, and Oak Hill Capital Management II, LLC and another non-executive director of MeriStar Hospitality Corporation’s Board of Directors oversees an entity related to Oak Hill Capital Partners, LP and Oak Hill Capital Partners II, LP.
Of the $300 million aggregate principal amount of 9.0% senior unsecured notes due in 2008 we issued in January 2001, $30 million principal amount was issued at a price of 99.688% to an affiliate of Oak Hill Capital Partners.
Of the total $400 million aggregate principal amount of 9.125% senior unsecured notes due in 2011 we issued in 2001 and 2002, $20 million principal amount was issued at a price of 99.603% to an affiliate of Oak Hill Capital Partners.
Of the $250 million aggregate principal amount of 10.5% senior unsecured notes due in 2009 we issued in December 2001, $23 million principal amount was issued at a price of 99.368% to an affiliate of Oak Hill Capital Partners.
Note Receivable from Radisson Lexington
Our outstanding note receivable from Radisson Lexington, an equity method investment, was $40 million as of December 31, 2004, which is due in full in 2014. This loan yields $5.8 million of cumulative annual interest, for which we recognized interest income of $1.4 million in 2004. See Note 7 “Investment in Unconsolidated Affiliates” for information about this investment.
Relationship with MIP
Oak Hill Capital Partners, and Interstate Hotels, both related-parties to MeriStar Hospitality Corporation are partners in the joint venture that forms the General Partner of MIP, a joint venture established in 1999 to acquire upscale, full-service hotels. We earn a cumulative preferred return on our $40 million investment with outstanding balances compounded quarterly, which we recognize quarterly as it becomes due to us. For the years ended December 31, 2004, 2003, and 2002, we recognized a preferred return of $11.5 million, $7.4 million, and $7.6 million respectively, from this investment. As of December 31, 2004 and 2003, cumulative preferred returns of $19.7 million, and $19.6 million, respectively, were due from MIP. See Note 7 “Investment in Unconsolidated Affiliates” for information about this investment.
13. Incentive Compensation
MeriStar Hospitality sponsors an incentive compensation plan in which employees of the operating partnership participate. Under the plan, MeriStar Hospitality is authorized to award up to a maximum of 12.5% of its outstanding shares of common stock to officers or other key employees. These awards may be granted in cash, restricted shares of common stock or options to purchase common stock. Upon issuance of any restricted stock or stock options under the plan, MeriStar Hospitality is obligated to contribute the proceeds to us in
exchange for an equal number of OP units. As of December 31, 2004, up to a maximum of 10,920,864 shares of common stock were authorized to be awarded, of which 7,879,774 shares remain available for award.
Under the incentive plan for non-employee directors, MeriStar Hospitality is authorized to award up to 500,000 options to purchase common stock to our non-employee directors. As of December 31, 2004, 148,050 shares remain available for award.
Stock Options
Stock options to officers, other key employees or directors are exercisable in three annual installments and expire ten years from the grant date.
Stock option activity for 2004, 2003 and 2002 was as follows:
The following table summarizes information about stock options outstanding and exercisable at December 31, 2004:
Other Stock-Based Compensation
In 2004, MeriStar Hospitality’s Board of Directors authorized it to grant certain long term incentive stock awards (the “awards”) under its incentive plan, pursuant to criteria to be established by the Compensation Committee of our Board of Directors (the “Committee”). In March 2005, the Committee finalized the service and performance criteria pursuant to which these awards will be issued, effective for the three year period ending December 31, 2006. We recorded $1.6 million compensation expense related to these awards during the year ended December 31, 2004. The awards will be paid to the extent they are earned in the form of MeriStar Hospitality’s common stock during 2007, and the number of shares will be determined based on the stock price at the time at which they are paid.
During the years ended December 31, 2004 and 2003, MeriStar Hospitality has issued 310,000 and 231,721 shares of restricted stock, net of forfeitures, to our employees. This restricted stock generally vests ratably over three-year periods. The weighted average grant-date fair value of restricted stock issued during 2004 and 2003 was $5.93 and $4.99, respectively.
During the years ended December 31, 2000, 2001 and 2002, we granted a total of 1,000,000 Profits-Only OP Units, or POPs, to some of our employees pursuant to our POPs Plan. These POPs were subject to vesting requirements and the incurrence of a “book-up” event, and were exchangeable for common stock or cash based on the market value of our common stock. During the years ended December 31, 2002 and 2003, 50,000 and 187,500, respectively, POPs were surrendered in exchange for the same number of shares of common stock. In July 2004, MeriStar Hospitality’s Board of Directors authorized the redemption of all outstanding POPs. On December 2, 2004, we completed the redemption of all 701,250 outstanding POPS (net of forfeitures) for a total of $4.6 million in cash, although 187,500 of those POPs redeemed were not yet exchangeable pursuant to the POPs Plan. See Note 10 to the financial statements.
In 2004, MeriStar Hospitality’s Board of Directors authorized us to grant certain long term incentive stock awards (the “awards”) under our incentive plan, pursuant to criteria to be established by the Committee. In March 2005, the Committee finalized the service and performance criteria pursuant to which these awards will be issued, effective for the three year period ending December 31, 2006. The awards will be paid to the extent they are earned in the form of MeriStar Hospitality’s common stock during 2007, and the number of shares will be determined based on the stock price at the time at which they are paid.
14. Separation and Restructuring Charges
In 2002, we incurred $3.2 million of costs related to the formal separation of management functions from Interstate Hotels. The costs are included in the line item “general and administrative, corporate” on our income statement.
15. Commitments and Contingencies
Litigation. In the course of our 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 that are pending or asserted will not have a material adverse effect on our financial position, results of operations or liquidity.
Minimum Lease Payments. We lease the land at certain of our hotels under long-term arrangements from third parties. These agreements are accounted for as operating leases and are expensed evenly over the life of the lease. Certain leases contain contingent rent features based on gross revenues at the respective property. Future minimum lease payments, including fixed escalations, required under these operating leases as of December 31, 2004 were as follows (in thousands):
Our obligations under other operating lease commitments, primarily for equipment, are not significant.
Rent expense consists of:
Termination Fees. We may be obligated to pay Interstate Hotels termination fees of up to a maximum of approximately $13.1 million with respect to the 36 properties we have disposed of between January 1, 2003 and December 31, 2004. As we dispose of any additional assets, we may be obligated to pay additional termination fees. Any obligations due under the termination provisions of the applicable contracts will be payable over a period of 48 months after termination. Termination fees payable to Interstate Hotels may be reduced by amounts paid under replacement management contracts.
During July 2004, we concluded negotiations with Interstate Hotels to terminate the intercompany agreement. In exchange for terminating the intercompany agreement, we received, among other things:
•
the right to terminate up to 600 rooms per year upon the payment of a termination fee equal to 1.5 times the fees earned during the preceding 12 months, with the ability to carry over up to 600 rooms for termination in the succeeding year;
•
the right to terminate the management contract of a hotel, where Interstate Hotels invests in a competing hotel, with no termination fee; and
•
an extension of the termination fee payment period for terminations related to hotel sales, from 30 months to 48 months.
Separately, we reached an agreement with Interstate Hotels regarding the calculation of termination fees payable upon a sale. Although termination fees for the properties that have been disposed of or were expected to be disposed of under our previously announced disposition program (which includes one of the 73 properties we owned as of December 31, 2004) will be unchanged, we received a $2.5 million credit, which is applicable to fees payable with respect to future dispositions. Of the $2.5 million credit, $2.4 million has been applied to terminations that occurred during 2004.
Hurricane recoveries. Recoveries expected to be received for insured claims are included in the insurance claim receivable. Additional liabilities, if any, that may result from these matters are not expected to have a material adverse effect on our financial position or results from operations.
Other commitments and contingencies. We maintain reserves for commitments and contingencies that arise in the normal course of business based on the existing facts and circumstances. As of December 31, 2004 and 2003, we carried a $5.1 million and $3.1 million, respectively, reserve related to workers’ compensation insurance claims related to periods prior to January 31, 2003. This reserve was increased $2.0 million during 2004 due to a change in estimate regarding insurance payments covered by a third party. Future changes related to the facts and circumstances of our reserves could necessitate additional, or a reduction of, reserves in the future.
As part of our asset renovation program, we have entered into contractual obligations with vendors to acquire capital assets and perform renovations totaling approximately $48.0 million over the next 12 months. As of December 31, 2004, we have entered into contractual obligations related to capital expenditures as a result of the hurricanes in the amount of $14.3 million over the next 12 months, most of which we expect to be reimbursed by our insurance carriers.
In the course of document review with respect to the MIP restructuring, MeriStar Hostpiality discovered a potential technical REIT qualification issue relating to a wholly-owned subsidiary of MIP, of which we are deemed to own a de minimis proportionate share. In order to eliminate any uncertainty, MeriStar Hospitality is currently negotiating a closing agreement with the Internal Revenue Service to resolve all REIT qualification matters with respect to this potential issue. As a partnership for federal income tax purposes, we are not directly affected by the outcome of the discussions by MeriStar Hospitality with the Internal Revenue Service.
16. Dispositions
Between January 1, 2003 and December 31, 2004, we disposed of 36 hotels with 8,109 rooms for total gross proceeds of $283.6 million in cash and $11.1 million in reduction of debt. Of these 36 hotels, 15 hotels were disposed of in 2003 and 21 hotels were disposed of in 2004. As of December 31, 2004, none of our hotels met our criteria for held-for-sale classification (see Note 6). Operating results for the sold hotels, and where applicable, the gain or loss on final disposition, are included in discontinued operations.
Summary financial information included in discontinued operations for these hotels were as follows (in thousands):
Loss on disposal resulted primarily from the recognition of termination fees payable to Interstate Hotels with respect to these hotels’ management contracts.
17. Segment Information
SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires public entities to report selected information about operating segments. Based on the guidance provided in the standard, we have determined that our business is conducted in one reportable segment, hotel ownership.
The following summarizes certain geographic information required under the standard (in thousands):
(1) We sold three of the four Canadian hotels in December 2003 and the other in 2004.
18. Quarterly Financial Information (Unaudited)
Quarterly information has been restated to conform to the current presentation of discontinued operations as of December 31, 2004 (in thousands).
19. Consolidating Financial Statements
Certain of our subsidiaries and MeriStar Hospitality are guarantors of our senior unsecured notes. Certain of our subsidiaries are guarantors of MeriStar Hospitality’s unsecured subordinated notes. All guarantees are full and unconditional, and joint and several. Exhibit 99.1 to this Annual Report on Form 10-K presents supplementary consolidating financial statements for us, including each of our guarantor subsidiaries. This exhibit presents our consolidating balance sheets as of December 31, 2004 and 2003, consolidating statements of operations for the years ended December 31, 2004, 2003, and 2002, and consolidating statements of cash flows for the years ended December 31, 2004, 2003 and 2002.
MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2004
(1) These properties secure the secured facility due 2009, which, as of December 31, 2004, had an outstanding balance of $302,979.
(2) These properties secure the secured facility due 2013, which, as of December 31, 2004, had an outstanding balance of $99,293.
(3) Subsequent mortgage placed on property of $37,650 on January 26, 2005.
MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2004
(in thousands)
The components of our property and equipment are as follows:
A reconciliation of our property and equipment and related accumulated depreciation is as follows:
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this annual report.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2004.
Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein.
Report of Independent Registered Public Accounting Firm
The Partners
MeriStar Hospitality Operating Partnership, L.P.:
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that MeriStar Hospitality Operating Partnership, L.P and subsidiaries (the Partnership) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Partnership’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Partnership’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Partnership maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by COSO. Also, in our opinion, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of MeriStar Hospitality Operating Partnership, L.P. as of December 31, 2004 and 2003, and the related consolidated statements of operations, partners’ capital, and cash flows for each of the years in the three-year period ended December 31, 2004, and the related financial statement schedule of real estate and accumulated depreciation, and our report dated March 15, 2005, expressed an unqualified opinion on the consolidated financial statements and related financial statement schedule.
/s/ KPMG LLP
KPMG LLP
McLean, VA
March 15, 2005
ITEM 9B.
ITEM 9B. OTHER INFORMATION
ITEM 1.01 ENTRY INTO A MATERIAL DEFINITIVE AGREEMENT
Under MeriStar Hospitality’s incentive plan, as amended May 24, 2001 (the “incentive plan”), our employees, including executive officers, may be granted incentive awards based upon our financial performance and the individual performance of each employee. The amount of each award may be based upon the achievement of predefined performance goals and other criteria established by the Compensation Committee of MeriStar Hospitality’s Board of Directors (the “Committee”).
In 2004, MeriStar Hospitality’s Board of Directors authorized us to grant certain long term incentive stock awards (the “awards”) under our incentive plan, pursuant to criteria to be established by the Committee. In March 2005, the Committee finalized the service and performance criteria pursuant to which these awards will be issued, effective for the three year period ending December 31, 2006. The awards will be paid to the extent they are earned in the form of MeriStar Hospitality’s common stock during 2007, and the number of shares will be determined based on the stock price at the time at which they are paid.
The table below reflects the maximum value of the awards to be paid to each of our named executive officers for the three year period ending December 31, 2006 (in thousands):
* Maximum amount is based upon meeting the maximum performance criteria, and is estimated using 2004 salaries, as adjusted for expected future increases.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated herein by reference to MeriStar Hospitality’s 2005 Annual Stockholder Meeting proxy statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to MeriStar Hospitality’s 2005 Annual Stockholder Meeting proxy statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference to MeriStar Hospitality’s 2005 Annual Stockholder Meeting proxy statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated herein by reference to MeriStar Hospitality’s 2005 Annual Stockholder Meeting proxy statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated herein by reference to MeriStar Hospitality’s 2005 Annual Stockholder Meeting proxy statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following documents are filed as a part of this Annual Report on Form 10-K:
1. Financial Statements
The Independent Auditors’ Report and Consolidated Financial Statements are provided under Item 8.
2. Financial Statement Schedules
Schedule III, Real Estate and Accumulated Depreciation as of December 31, 2004 is provided under Item 8. No other schedules are submitted because they are either not applicable or not required, or because the required information is included in the Consolidated Financial Statements or the Notes thereto, which are provided in Item 8 of this Annual Report on Form 10-K.
3. Exhibits
See Index on pages 92 through 96 of this Annual Report on Form 10-K.
INDEX TO EXHIBITS-MERISTAR HOSPITALITY CORPORATION
COMMISSION FILE NO. 1-11903
Exhibits listed below, which have been filed with the Commission pursuant to the Securities Act of 1933 or the Securities Exchange Act of 1934, and which were filed as noted below, are hereby incorporated by reference and made a part of this report with the same effect as if filed herewith.
* Indicates a management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c) of Form 10-K.
** Filed as part of MeriStar Hospitality Corporation’s Annual Report on Form 10-K for the year ended December 31, 2004 (Commission file number 1-11903).
*** Filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
MERISTAR HOSPITALITY OPERATING PARTNERSHIP, L.P.
MERISTAR HOSPITALITY FINANCE CORP.
MERISTAR HOSPITALITY FINANCE CORP. II
MERISTAR HOSPITALITY FINANCE CORP. III
BY:
MERISTAR HOSPITALITY CORPORATION,
ITS GENERAL PARTNER
BY:
/s/ PAUL W. WHETSELL
Paul W. Whetsell
Chief Executive Officer and
Chairman of the Board
Dated: March 16, 2005
KNOW ALL MEN BY THESE PRESENT, that each person whose signature appears below constitutes and appoints Paul W. Whetsell, Bruce G. Wiles, Donald D. Olinger and Jerome J. Kraisinger, such person’s true and lawful attorneys-in-fact and agents, with full power of substitution and revocation, for such person and in such person’s name, place and stead, in any and all capacities to sign any and all amendments to this report filed pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, and to file the same with all exhibits thereto, and the other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and things requisite and necessary to be done, as fully to all intents and purposes as such person might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report and the foregoing Power of Attorney have been signed by the following persons in the capacities and on the dates indicated.
Signature
Title
Date
/S/ PAUL W. WHETSELL
Paul W. Whetsell
Chief Executive Officer and Chairman of the Board of Directors (Principal Executive Officer) of MeriStar Hospitality Corporation
March 16, 2005
/S/ BRUCE G. WILES
Bruce G. Wiles
President, Chief Operating Officer and Director of MeriStar Hospitality Corporation
March 14, 2005
/S/ DONALD D. OLINGER
Donald D. Olinger
Executive Vice President and Chief Financial Officer of MeriStar Hospitality Corporation
March 11, 2005
/S/ BRENDAN J. KEATING
Brendan J. Keating
Senior Vice President, Chief Accounting Officer and Corporate Controller of MeriStar Hospitality Corporation
March 14, 2005