ITEM 1. BUSINESS
General
Fairfield Inn by Marriott Limited Partnership (the "Partnership"), a Delaware limited partnership, was formed on August 23, 1989 to acquire, own and operate 50 Fairfield Inn by Marriott properties (the "Inns"), which compete in the economy segment of the lodging industry. Effective August 16, 2001, AP-Fairfield GP LLC, a Delaware limited liability company, became the general partner of the Partnership. See "Restructuring Plan" below. During the year ended December 31, 2002, the Partnership sold four of its Inns, two of which leased their underlying land from Marriott International, Inc. ("Marriott International"), and retains an interest in 46 Inns. These sales are discussed further below.
The Partnership has experienced declining operations in 2002 and, as a result, failed to meet its debt service payments on its loan encumbering its properties since November 11, 2002. As such, the Partnership is in default on its mortgage loan and is currently negotiating with the lender to restructure the loan terms. If operating results do not significantly improve or a restructuring of the loan cannot be negotiated, the lender may or could seek to foreclose on the Inns. Further, it is expected that the Partnership will not be able to comply with the terms of the Restructuring Plan and make the $23 million in capital improvements by November 30, 2003, thereby creating a default under the Franchise Agreement and Ground Lease. On March 26, 2003, the Partnership received notice from Marriott International that it was in default under the ground lease agreements, due to its failure to pay the full amount due of minimum rentals owed under the Ground Leases beginning in January 2003. As a result of the current loan default and the possible future defaults, the Partnership may seek to protect its interest in the Inns by filing for bankruptcy protection. See "Restructuring Plan", "Ground Leases" and "Mortgage Debt" below.
As of December 31, 2002, the Partnership leases the land underlying 30 of its Inns from Marriott International and some of its affiliates. The Partnership's 46 Inns are located in sixteen states. See "Item 2.
ITEM 2. PROPERTIES
The Partnership's portfolio consists of 46 Fairfield Inn by Marriott properties as of March 31, 2003. The Inns, which range in age between 13 and 16 years, are geographically diversified among 16 states.
The following table presents the location and number of rooms for each of the Inns. All of the Inns are managed by Sage. See Item 1. Business. The land on which the Inns are located is either owned by us or leased under a long-term agreement.
(1) The land on which the Inn is located is leased by the Partnership from Marriott International under a long-term lease agreement. See "Item 1. Business-Ground Lease."
Schedule of Properties
The following table sets forth as of December 31, 2002, the gross carrying value, accumulated depreciation and federal tax basis for each of the Inns. The rate and method of depreciation varies at each property. See, "Item 8. Financial Statements and Supplementing Data, Notes 2 and 3" for additional information.
Occupancy
The following table sets forth the average occupancy rates at the Inns for the years ended December 31, 2002, 2001 and 2000
Room Rates
The following table sets forth the average daily room rates at the Inns for the years ended December 31, 2002, 2001 and 2000. Average daily room rate is the annual room revenue divided by the number of paid occupied rooms for the year.
Real Estate Taxes
Real estate taxes billed and rates in 2002 for each of the Inns were:
(1) The real estate tax rates calculated by dividing the 2002 tax liability by the 2002 assessed value of the property.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
None
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S SECURITIES AND RELATED SECURITY HOLDER MATTERS
Units of the Partnership are not publicly traded. There are certain restrictions set forth in the Partnership's amended limited partnership agreement (the "Limited Partnership Agreement") that may limit the ability of a limited partner to transfer Units. Such restrictions could impair the ability of a limited partner to liquidate its investment in the event of an emergency or for any other reason.
As of March 1, 2003, there were 2,484 holders of Units of the Partnership, owning an aggregate of 83,337 Units.
The Partnership made a distribution of $2.4 million during the year ended December 31, 2002 and none during the year ended December 31, 2001. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", for a discussion of additional factors which may affect the Partnership's ability to pay distributions.
Over the past few years, many companies have begun making "mini-tenders" (offers to purchase an aggregate of less than 5% of the total outstanding Units) for Units. Pursuant to the rules of the Securities and Exchange Commission, when a tender offer is commenced for Units, the Partnership is required to provide limited partners with a statement setting forth whether it believes limited partners should tender or whether it is remaining neutral with respect to the offer. Unfortunately, the rules of the Securities and Exchange Commission do not require that the bidders in certain tender offers provide the Partnership with a copy of their offer. As a result, the general partner often does not become aware of such offers until shortly before they are scheduled to expire or even after they have expired. Accordingly, the general partner does not have sufficient time to advise limited partners of its position on the tender. In this regard, please be advised that pursuant to the discretionary right granted to the general partner of the Partnership in the Limited Partnership Agreement to reject any transfers of Units, the general partner will not permit the transfer of any Unit in connection with a tender offer unless: (i) the Partnership is provided with a copy of the bidder's offering materials, including amendments thereto, simultaneously with their distribution to the limited partners; (ii) the offer provides for withdrawal rights at any time prior to the expiration date of the offer and, if payment is not made by the bidder within 60 days of the date of the offer, after such 60 day period; and (iii) the offer must be open for at least 20 business days and, if a material change is made to the offer, for at least 10 business days following such change.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected historical financial data for each of the five years in the period ended December 31, 2002, which data has been derived from our audited financial statements for those years. You should read the following selected financial data together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our audited financial statements included herein.
Selected Financial Data (in thousands, except per unit amounts and ratio data)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain matters discussed herein are forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward-looking terminology, such as "believes," "expects," "may," "will," "should," "estimates," or "anticipates," or the negative thereof or other variations thereof or comparable terminology. All forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual transactions, results, performance or achievements to be materially different from any future transactions, results, performance or achievements expressed or implied by such forward- looking statements. Although we believe the expectations reflected in such forward-looking statements are based upon reasonable assumptions, we can give no assurance that our expectations will be attained or that any deviations will not be material. We disclaim any obligations or undertaking to publicly release any updates or revisions to any forward-looking statement contained in this report on Form 10-K to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
GENERAL
The Partnership is the owner of 46 limited service Inns, which are operated as part of the Fairfield Inn by Marriott system, and until November 30, 2001, managed by Fairfield FMC Corporation. Beginning November 30, 2001, Sage began providing management at the properties. Under Sage the Inns continue to be operated under the Fairfield Inn by Marriott system.
During the period from 2000 through 2002, the Partnership's revenues declined from $91.5 million to $78.8 million. The Partnership's revenues are primarily a function of room revenues generated per available room or "RevPAR." RevPAR represents the combination of the average daily room rate charged and the average daily occupancy achieved and is a commonly used indicator of hotel performance. During the period from 2000 through 2002, the Partnership's combined RevPAR decreased approximately 13% from $36.76 to $32.15.
As a result of the decline in the economy, combined with the effect of the September 11, 2001 terrorist attacks, the hospitality and travel industry experienced a significant decrease in operations beginning in the second half of 2001 and throughout 2002. Further exacerbating this decrease is the age of the Partnership's Inns (between 13 and 16 years old) that causes disadvantages when competing with newer limited service hotels. The Partnership's revenues decreased $5.1 million, or 6.0%, to $78.8 million in 2002 from $83.9 million in 2001, primarily as a result of decreases in occupancy, which had been flat or decreasing throughout 2002.
The Partnership's operating costs and expenses are, to a great extent, fixed. Therefore, the Partnership derives substantial operating leverage from increases in revenue. Operating leverage is offset primarily by certain variable expenses, including base and incentive management fees which are calculated based on Inn sales.
The table below presents performance information for the Inns for the indicated periods:
RESULTS OF OPERATIONS
The following discussion and analysis addresses results of operations for the three years ended December 31, 2002 and should be read together with the "Selected Financial Data" and historical financial statements and related notes included elsewhere herein.
2002 compared to 2001
Rooms Revenues: Rooms revenues decreased $4.8 million, or approximately 5.9% to $76.7 million in 2002 from $81.5 million in 2001, reflecting a 2.8 percentage point decrease in average occupancy to 59.2%. The decrease in average occupancy was primarily the result of the increased competition in the economy segment which was exacerbated by the general downturn in the economy experienced during 2002, which hurt the hospitality industry in general. Revenues also declined due to the sale of four of the Partnership's hotels during 2002. Excluding the effect on revenues of the sale of these four hotels, rooms revenues for the remaining 46 inns decreased $3.0 million, or approximately 3.9% to $73.0 million in 2002 from $76.0 million in 2001. In 2002, total Inn revenues decreased $5.1 million, or 6.0%, to $78.8 million when compared to $83.9 million in 2001.
Operating Expenses: Operating expenses decreased $4.6 million, or 5.5%, to $78.8 million when compared to 2001. The individual components are discussed below.
Room Costs: In 2002, rooms costs decreased $1.1 million, or 4.2%, to $25.3 million when compared to 2001. The overall decrease in controllable room costs is a result of the occupancy decreases at the Inns. Room costs in 2002 were also lower due to the sale of four of the hotels during 2002.
Selling, Administrative and other: Selling, administrative and other expenses decreased by $1.3 million in 2002 to $25.8 million, or a 4.8% decrease when compared to 2001. The decrease in expenses was due to a decrease in repairs and maintenance expenses.
Fairfield Inn system fee: In connection with the Partnership's termination of the management agreement with Fairfield FMC Corporation on November 30, 2001, the Partnership's obligation to pay system fees is now included in its franchise fees paid to Marriott International. In 2001, the Partnership recognized $2.4 million in Fairfield Inn system fee expenses.
Insurance and other: Insurance and other expenses decreased by $1.1 million in 2002 to $3.0 million, or a 26% decrease when compared to 2001. The decrease in expense is primarily due the following expenses incurred in 2001: the payment of a franchise application fee of $500,000 to Marriott International in connection with the new franchise agreement, legal expenses incurred in connection with the restructuring, and expenses associated with the transition of the management of the Inns from Marriott International to Sage.
Termination of management agreement: In connection with the termination of the Management Agreement with Fairfield FMC Corporation, the Partnership paid Marriott International $500,000 and wrote off deferred incentive fees of $2.8 million as the fees were no longer due.
Loss on impairment of long-lived assets: In 2002, the Partnership recorded impairment of long-lived assets of $5.3 million related to its Inns located in Atlanta (Northlake), Georgia; Birmingham, Alabama; Detroit (Warren), Michigan; St. Louis (Hazelwood), Missouri; Greenville, South Carolina; and Orlando (South), Florida. The Partnership recorded an impairment charge of $3.8 million in 2001 related to the Inns located in Greenville, South Carolina; Charlotte (Northeast), North Carolina; Charlotte (Airport), North Carolina; Chicago (Lansing), Illinois; Atlanta (Southlake), Georgia; and Atlanta (Peachtree Corners), Georgia.
Operating (Loss) Profit: As a result of the changes in revenues and operating expenses discussed above, operating loss increased by $499,000, resulting in an operating loss of $3,000 in 2002 compared to operating profit of $496,000 in 2001.
Interest Expense: Interest expense decreased by $530,000 to $12.3 million in 2002 when compared to 2001. This decrease is due to the payment of $11.4 million of principal on the mortgage debt.
Gain on Disposition of Properties: During 2002, the Partnership recorded gain on disposition of properties of $3.5 million related to the sale of its Inns located in Montgomery, Alabama; Charlotte-Airport, North Carolina; Atlanta-Southlake, Georgia; and Chicago-Lansing, Illinois.
Net Loss: Net loss for 2002 was $8.5 million compared to net loss of $11.5 million for 2001. The decrease is primarily due to the $3.5 million gain on disposition of four of the Partnership's properties and decreases in operating expenses, offset by the decrease in revenues.
2001 compared to 2000
Rooms Revenues: Rooms revenues decreased $7.8 million, or approximately 8.7%, to $81.5 million in 2001 from $89.3 million in 2000, reflecting a 6.0 percentage point decrease in average occupancy to 62.0% and the $0.58 decrease in the average daily room rate to $53.48. The decrease in average occupancy was primarily the result of increased competition in the economy segment and exacerbated by the September 11, 2001 terrorist attacks, which hurt the hospitality industry in general. In 2001, total Inn revenues decreased $7.6 million, or 8.3%, to $83.9 million when compared to 2000.
Operating Expenses: Operating expenses decreased $11 million, or 11.6%, to $83.4 million when compared to 2000. The individual components are discussed below.
Rooms Costs: In 2001, rooms costs decreased $1.5 million, or 5.5%, to $26.4 million when compared to 2000. The overall decrease in controllable room costs is a result of the occupancy decreases at the Inns. Room costs in 2001 were also lower due to the implementation of the Guestview reservation system in 2000.
Selling, Administrative and other: Selling, administrative and other expenses decreased by $0.6 million in 2001 to $27.1 million, or a 2.0% decrease when compared to 2000. The decrease in expenses was due to a decrease in labor costs, repairs and maintenance expenses.
Insurance and other: Insurance and other expenses increased $2.9 million in 2001 as compared to 2000. This increase is primarily due to the payment of a franchise application fee of $500,000 to Marriott International in connection with the new franchise agreement, legal expenses incurred in connection with the restructuring, expenses associated with the transition of the management of the Inns from Marriott International to Sage and payments to the special servicer on the loan and the rating agencies relating to the loan modifications.
Termination of Management Agreement: In connection with the termination of the Management Agreement with Fairfield FMC Corporation, $2.0 million and $2.8 million of incentive fees earned in 2001 and 2000, respectively, were no longer due under the terms of the Management Agreement. Deferred incentive fees of $2.8 million related to 2000, net of a $500,000 payment to the Manager, have been reflected in the 2001 statement of operations in the line titled Termination of Management Agreement. Incentive fees for 2001 were not recognized in the 2001 statement of operations due to the termination of the Management Agreement with Fairfield FMC Corporation.
Loss on impairment of long-lived assets: In 2001, the Partnership recorded impairment of long-lived assets of $3.8 million related to our Inns located in Greenville, South Carolina; Charlotte-Northeast, North Carolina; Charlotte Airport, North Carolina; Chicago-Lansing, Illinois; Atlanta-Southlake, Georgia; and Atlanta-Peachtree Corners, Georgia. The Partnership recorded an impairment charge of $8.1 million in 2000 related to the Inns located in Johnson City, Tennessee; Raleigh and Charlotte Airport, North Carolina; and Columbus North, Ohio.
Operating Profit (Loss): As a result of the changes in revenues and operating expenses discussed above, operating loss decreased by $3.3 million, resulting in operating income of $496,000 for 2001, when compared to an operating loss of $2.8 million in 2000.
Interest Expense: Interest expense decreased by $0.4 million to $12.8 million in 2001 when compared to 2000. This decrease is due to the payment of $4.4 million of principal on the mortgage debt.
Loss Before Extraordinary Item: The Partnership generated a net loss of $11.5 million in 2001 compared to a loss before extraordinary item of $14.8 million in 2000. This decreased loss is primarily due to the gain on forgiveness of incentive management fees and decreases in operating expenses which were partially offset by the decrease in revenues discussed above.
Extraordinary Gain: In connection with the class action litigation settlement agreement that became effective in 2000, Fairfield FMC Corporation, the previous manager of all our Inns, waived $23.5 million of deferred incentive management fees.
Net Income (Loss): Net loss for 2001 was $11.5 million compared to net income of $8.7 million for 2000. The decrease is primarily due to the $23.5 million of deferred management fees waived in 2000 and lower revenues in 2001, offset by the gain on termination of the incentive management fees in 2001 and decreases in operating expenses.
LIQUIDITY AND CAPITAL RESOURCES
GOING CONCERN AND OTHER IMPORTANT RISK FACTORS: Adequate liquidity and capital are critical to the Partnership's ability to continue as a going concern. The Partnership's Inns have experienced a substantial decline in operating results over the past several years. Since 1998, the Partnership's annual revenues have declined each year, from $94.4 million in 1996 to $78.8 million in 2002. The Partnership did not have sufficient cash flow from current operations to make its required debt service payment in November 2002, nor did it have sufficient cash flow to make its property improvement fund contributions beginning in September 2002. These factors and those discussed below raise substantial doubt about the Partnership's ability to continue as a going concern.
The Partnership has faced increasing needs to make substantial capital improvements to its Inns to enable it to compete more effectively in the markets and to satisfy standards for the Fairfield Inn brand, as required by the franchise agreements. The Partnership had approximately $5.9 million of unrestricted cash as of December 31, 2002. In addition, the Partnership had approximately $2.8 million in its property improvement fund as of December 31, 2002.
Further to the slowdown in the hotel industry (due to softness in the economy), the September 11th terrorist attacks have caused general travel in the United States to significantly decline, thereby further exacerbating the Partnership's financial difficulties. The Partnership had significant declines in occupancy levels and RevPAR in the fourth quarter of 2001 as a result. While the Partnership is working with Sage to attempt to offset this trend, the Partnership's results in 2002 were also below historical levels.
The Partnership had $135.7 million of mortgage debt outstanding as of December 31, 2002. The annual principal and interest debt service requirements are approximately $17 million. As of November 11, 2002, the Partnership is in default under the mortgage loan agreement due to its failure to pay the regularly scheduled debt service payment due on that date. The Partnership is also in default under the franchise agreements with Marriott International due to its failure to make its property improvement fund contributions beginning in September 2002, also resulting in technical default under the mortgage loan agreement. The Partnership has requested from the lender further modifications to the mortgage loan agreement. These modifications included paying debt service solely from available cash flow, selling certain of the Partnership's properties and applying the proceeds from the sales toward replenishing reserves held by the lender. If the lender is unwilling to grant the requested modifications the Partnership may be required to seek protection by filing for bankruptcy or the Partnership's properties may be lost through foreclosure.
There can be no assurances that the Partnership will be able to improve operations, or obtain the additional financing that may be required to meet operating needs in the future, and make the necessary PIPs to avoid default under the Partnership's franchise agreements with Marriott International. The above factors raise substantial doubt about the Partnership's ability to continue as a going concern.
PRINCIPAL SOURCES AND USES OF CASH: The Partnership's principal source of cash has been cash from operations. The Partnership's principal uses of cash are to make debt service payments, fund the property improvement fund and maintain reserves required pursuant to the terms of the mortgage debt.
The Partnership's cash and cash equivalents increased to $5.9 million at December 31, 2002 compared to $5.4 million at December 31, 2001. The increase from the prior year is due to $6.5 million of cash provided by operating activities and $8.7 million of cash provided by investing activities, which were partially offset by $14.6 million of cash used in financing activities. Cash provided by investing activities consisted of the proceeds from the sales of four of the Partnership's inns, offset by contributions to the property improvement fund and capital improvements and equipment purchases. Cash used in financing activities consisted of principal payments on the Partnership's mortgage loan, a distribution to partners, and changes to the restricted cash reserves as required under the terms of the mortgage debt.
SALES OF PROPERTIES. On July 29, 2002, the Partnership sold its Inn located in Montgomery, Alabama (classified as property held for sale on the accompanying balance sheet) for $3.1 million. The net proceeds from the sale of approximately $2.9 million were applied toward the Partnership's mortgage debt, in accordance with the terms of the loan agreement. The Partnership recognized a gain on the sale of approximately $2.1 million.
On August 12, 2002, the Partnership sold its Inn located in Charlotte (Airport), North Carolina (classified as property held for sale on the accompanying balance sheet) for $2.5 million. The net proceeds from the sale of approximately $300,000, which is net of approximately $1.9 million attributed to the ground lease buyout, were applied toward the Partnership's mortgage debt, in accordance with the terms of the loan agreement. The Partnership recognized a gain on the sale of approximately $200,000.
On August 14, 2002, the Partnership sold its Inn located in Atlanta (Southlake), Georgia (classified as property held for sale on the accompanying balance sheet) for $3.0 million. The net proceeds from the sale of approximately $2.8 million were applied toward the Partnership's mortgage debt, in accordance with the terms of the loan agreement. The Partnership recognized a gain on the sale of approximately $200,000.
On October 9, 2002, the Partnership sold its Inn located in Chicago (Lansing), Illinois (classified as property held for sale on the accompanying balance sheet) for $2.3 million. The net proceeds from the sale of approximately $1.4 million, which is net of approximately $700,000 attributed to the ground lease buyout, were applied toward the Partnership's mortgage debt, in accordance with the terms of the loan agreement. The Partnership recognized a gain on the sale of approximately $1.1 million.
In addition, the Partnership had been marketing its Inns located in Charlotte (Northeast), North Carolina, Columbus, Ohio, Raleigh (Northeast), North Carolina and Orlando (South), Florida, all classified as properties held for sale on the accompanying balance sheet. These properties had been marketed with the consent of the Partnership's lender. However, the consent may not be valid if an event of default exists. As described above, the Partnership is in default and as such, lender's consent to a sale may be withheld. There can be no assurance that any of these Inns will ultimately be sold. Therefore, the Partnership reclassified these Inns from properties held for sale and began depreciating their net book values in the first quarter of 2003, after the Partnership determined to no longer market these Inns for sale.
SHORTFALL IN FUNDS AVAILABLE FOR CAPITAL EXPENDITURES: In light of the age of the Partnership's Inns, which range from 13 to 16 years, major capital expenditures are required over the next several years in an effort to remain competitive in the markets where the Partnership operates and to satisfy brand standards required by the franchise agreement. These capital expenditures include room refurbishments planned for 22 of the Inns over the next several years and the replacement of roofs, facades, carpets, wall vinyl and furniture. The capital expenditure needs for the Partnership's Inns for 2002 and 2003 are estimated to total approximately $19 million.
The cost of future capital expenditures for the Partnership's inns is estimated to exceed available funds. The Partnership's property improvement fund became insufficient to meet anticipated capital expenditures in 1999 and continued to be insufficient through 2002. To address this shortfall, the Partnership deposited an additional $2.4 million into the property improvement fund during 1999 from its Partnership cash beyond the required contributions. In addition, the contribution rate to the property improvement fund was increased to 7% of gross sales for 1997 and thereafter. The Partnership contributed $3.5 million and $5.8 million during 2002 and 2001, respectively, to the property improvement fund.
Based upon information provided by Sage, the estimated property improvement fund shortfall is expected to be $6.2 million of projected capital expenditure requirements by the end of 2003. Until the Partnership reaches a resolution concerning funding of the Partnership's operating and capital expenditure shortfalls, any proposed capital expenditures exceeding the amount available in the property improvement fund will be deferred.
In 2002, the Partnership received a private complaint with respect to its Birmingham, Alabama property that it was not ADA compliant. The Partnership negotiated a settlement agreement which provided for the scope of work to be complete. It is believed that the cost of such work will not exceed $125,000.
In accordance with the property improvement plan with Marriott International, the Partnership is required to provide evidence by no later than November 30, 2003 that at least $23 million has been set aside to complete a portion of these capital improvements. If the capital improvements are not completed, the Franchise Agreement could be terminated and the Inns could not be operated as a "Fairfield Inn by Marriott". However, given the partnership's current financial condition, the partnership may be unable to bear the costs associated with becoming part of a nationally recognized hotel system. If this were to occur, which is likely, the Partnership would seek to become part of a comparable, nationally recognized hotel system in order to continue to comply with the obligations under its loan documents. However, given the Partnership's current financial condition, the Partnership may be unable to bear the costs associated with becoming part of a nationally recognized hotel system. If the Partnership is unable to retain another nationally recognized manager, it could significantly impair its revenues and cash flow.
Recently Issued Accounting Standards
Financial Accounting Standards Board ("FASB") SFAS No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets" supersedes SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The standard provides guidance beyond that previously specified in Statement 121 to determine when a long-lived asset should be classified as held for sale, among other things. This Statement was adopted by the Partnership effective January 1, 2002. Implementation of the statement did not have a material effect on the Partnership.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of SFAS No. 13 and Technical Corrections," updates, clarifies and simplifies existing accounting pronouncements. In part, this statement rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt." SFAS No. 145 will be effective for fiscal years beginning after May 15, 2002. Upon adoption, enterprises must reclassify prior period items that do not meet the extraordinary item classification criteria in APB Opinion No. 30. The Partnership does not expect that this statement will have a material effect on its financial statements.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing or other exit or disposal activity. SFAS No. 146 is effective prospectively for exit and disposal activities initiated after December 31, 2002, with earlier adoption encouraged. The Partnership does not expect that this statement will have a material effect on its financial statements.
FASB Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This Interpretation does not prescribe a specific approach for subsequently measuring the guarantor's recognized liability over the term of the related guarantee. The disclosure provisions of this Interpretation are effective for the Partnership's December 31, 2002 financial statements. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. This Interpretation had no effect on the Partnership's financial statements.
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" clarifies the application of existing accounting pronouncements to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of the Interpretation will be immediately effective for all variable interests in variable interest entities created after January 31, 2003, and the Partnership will need to apply its provisions to any existing variable interests in variable interest entities by no later than December 31, 2004. The Partnership does not expect that this will have an impact on its financial statements.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related footnotes. In preparing these financial statements, management has made its best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. The Partnership does not believe there is a great likelihood that materially different amounts would be reported related to the accounting policies described below. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates.
Impairment of long-lived assets: At December 31, 2002 and 2001, the Partnership had $99.6 million and $110.0 million of property and equipment (net), and $1.1 million and $5.7 million of properties held for sale, accounting for approximately 88% and 85%, respectively, of the Partnership's total assets. Property and equipment is carried at cost but is adjusted to fair value if there is an impairment loss.
During the years ended December 31, 2002, 2001, and 2000, the Partnership recognized $5.2 million, $3.8 million, and $8.1 million, respectively, of impairment losses related to its property and equipment. An impairment loss must be recorded for an Inn if estimated undiscounted future cash flows are less than the book value of the Inn. Impairment losses are measured based on the estimated fair value of the Inn. The Partnership bases its estimates of fair values primarily upon tax assessments and sales comparisons. In assessing the recoverability of the Partnership's property and equipment the Partnership must consider the forecasted financial performance of its properties. If these estimates or their related assumptions change in the future, the Partnership may be required to record additional impairment charges.
Useful lives of long-lived assets: Property and equipment, and certain other long-lived assets, are amortized over their useful lives. Useful lives are based on management's estimates of the period that the assets will generate revenue.
Deferred ground rent: Deferred ground rent payable to Marriott International and its affiliates at December 31, 2002 and 2001 was $4.7 million and $2.2 million, respectively, and is included in Due to Marriott International, Inc., affiliates and other on the accompanying balance sheet. The Partnership's deferred ground rent of $2.2 million that remained payable at November 30, 2001 was waived in accordance with the amended lease agreement that was entered between the Partnership and Marriott International and its affiliates. The amount of deferred ground rent waived as a result of the ground lease amendment will be recognized as a reduction in ground rent expense over the remaining life of the new lease term, which has been extended to November 30, 2098, since it represents a new operating lease as of November 30, 2001, for accounting purposes. Ground rent expense is recognized on a straight-line basis over the term of the lease. The excess of ground rent expense recognized over rental payments required by the lease agreement of $2.5 million is deferred at December 31, 2002.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The Partnership is not subject to market risk with respect to interest rates, foreign currency exchanges or other market rate or price risk, and we do not hold any financial instruments for trading purposes. As of December 31, 2002, all of the Partnership's debt has a fixed interest rate.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
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Report of Independent Auditors........................................... 28
Report of Independent Public Accountants................................. 30
Balance Sheets as of December 31, 2002 and 2001.......................... 31
Statements of Operations for the years ended December 31, 2002, 2001 and 2000........................................ 32
Statements of Changes in Partners' Capital (Deficit) for the years ended December 31, 2002, 2001 and 2000............................ 33
Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000........................................ 34
Notes to Financial Statements............................................ 35
Report of Independent Auditors
To the Partners Fairfield Inn by Marriott Limited Partnership
We have audited the accompanying balance sheet of Fairfield Inn by Marriott Limited Partnership as of December 31, 2002, and the related statements of operations, changes in partners' capital (deficit), and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. The financial statements and schedule of Fairfield Inn by Marriott Limited Partnership for the years ended December 31, 2001 and 2000, were audited by other auditors who have ceased operations and whose report dated March 18, 2002, included an explanatory paragraph that raised substantial doubt about the Partnership's ability to continue as a going concern. The financial statements on which they reported were before giving effect to the revision adjustments and disclosures described in Note 9.
We conducted our audit in accordance with auditing standards generally accepted in the 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 audit provides a reasonable basis for our opinion.
In our opinion, the 2002 financial statements referred to above present fairly, in all material respects, the financial position of Fairfield Inn by Marriott Limited Partnership at December 31, 2002, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule as of and for the year ended December 31, 2002, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying financial statements have been prepared assuming that Fairfield Inn by Marriott Limited Partnership will continue as a going concern. As more fully described in Note 1, the Partnership has incurred recurring operating losses, has a partners' deficit and is in default on its mortgage loan, and its ground leases and franchise agreements with Marriott International, Inc. These conditions raise substantial doubt about the Partnership's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
As discussed above, the financial statements of Fairfield Inn by Marriott Limited Partnership as of December 31, 2001, and for the year then ended, were audited by other auditors who have ceased operations. As described in Note 9, these financial statements have been revised to reflect the components of working capital on the balance sheet. We audited the adjustments in Note 9 that were applied to revise the balance sheet as of December 31, 2001 and the statement of cash flows for the year ended December 31, 2001. Our procedures included (a) agreeing the adjusted amounts for cash, accounts receivable, prepaid expenses and other current assets, and accounts payable to the Partnership's underlying trial balances obtained from Management and (b) testing the mathematical accuracy of the financial statements. In our opinion, such adjustments and disclosures are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of the Partnership other than with respect to such adjustments and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole.
/s/ Ernst & Young LLP
Boston, Massachusetts March 14, 2003, except for Notes 1 and 7 as to which the date is March 26, 2003
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE PARTNERS OF FAIRFIELD INN BY MARRIOTT LIMITED PARTNERSHIP:
We have audited the accompanying balance sheets of Fairfield Inn by Marriott Limited Partnership (a Delaware limited partnership) as of December 31, 2001 and 2000, and the related statements of operations, changes in partners' capital (deficit) and cash flows for the three years in the period ended December 31, 2001. These financial statements are the responsibility of the General Partner's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the 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 financial statements referred to above present fairly, in all material respects, the financial position of Fairfield Inn by Marriott Limited Partnership as of December 31, 2001 and 2000, and the results of its operations and its cash flows for the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming that the partnership will continue as a going concern. As discussed in Note 1 to the financial statements, the partnership has suffered recurring operating losses, has a net capital deficiency, and the partnership may not be able to meet its 2002 debt obligations. These factors raise substantial doubt about the partnership's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments relating to recoverability of asset carrying amounts or the amount of liabilities that might result should the partnership be unable to continue as a going concern.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index at Item 14(a)(2) is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Vienna, Virginia March 18, 2002
Note: This is a copy of the audit report previously issued by Arthur Andersen LLP in connection with Fairfield Inn by Marriott Limited Partnership's Annual Report on Form 10-K for the year ended December 31, 2001. This report has not been reissued by Arthur Andersen LLP in connection with this filing on Form 10-K.
FAIRFIELD INN BY MARRIOTT LIMITED PARTNERSHIP
BALANCE SHEETS December 31, 2002 and 2001 (in thousands)
The accompanying notes are an integral part of these financial statements.
FAIRFIELD INN BY MARRIOTT LIMITED PARTNERSHIP
STATEMENTS OF OPERATIONS Years ended December 31, 2002, 2001 and 2000 (in thousands, except Unit and per Unit amounts)
The accompanying notes are an integral part of these financial statements.
FAIRFIELD INN BY MARRIOTT LIMITED PARTNERSHIP
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) Years ended December 31, 2002, 2001 and 2000 (in thousands)
The accompanying notes are an integral part of these financial statements.
FAIRFIELD INN BY MARRIOTT LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS Years ended December 31, 2002, 2001 and 2000 (in thousands)
The accompanying notes are an integral part of these financial statements.
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Fairfield Inn by Marriott Limited Partnership (the "Partnership"), a Delaware limited partnership, was formed on August 23, 1989, to acquire, own and operate 50 Fairfield Inn by Marriott properties (the "Inns"), which compete in the economy segment of the lodging industry. Effective August 16, 2001, AP-Fairfield GP LLC, a Delaware limited liability company, became the general partner of the Partnership. See "Restructuring Plan" below. During the year ended December 31, 2002, the Partnership sold four of its Inns, two of which leased underlying land from Marriott International, Inc. ("Marriott International"). See Note 4 "Sale of Inns" below.
As of December 31, 2002, the Partnership leased the land underlying 30 of the Inns from Marriott International and certain of its affiliates (the "Ground Leases"). Of the Partnership's 46 Inns, six are located in each of Georgia, North Carolina and Michigan; four in each of Florida and Ohio; and three or less in each of Alabama, California, Illinois, Iowa, Indiana, Kansas, Missouri, South Carolina, Tennessee, Virginia and Wisconsin. Effective November 30, 2001, Sage Management Resources III, LLC ("Sage" or "New Manager"), an affiliate of Sage Hospitality Resources, LLC, began providing management at the properties. See "Restructuring Plan" below. Prior to such date the Inns were managed by Fairfield FMC Corporation (the "Former Manager"), a wholly-owned subsidiary of Marriott International, as part of the Fairfield Inn by Marriott hotel system under a long-term management agreement. Under Sage, the Inns continue to be operated under the Fairfield Inn by Marriott system.
Inn operations commenced on July 31, 1990 (the "Closing Date") after 83,337 limited partnership interests (the "Units") were sold in a public offering for $1,000 per Unit. Marriott FIBM One Corporation ("FIBM One") contributed $841,788 for a 1% general partnership interest and $1.1 million to establish the initial working capital reserve of the Partnership at $1.5 million. In addition, FIBM One had a 10% limited partnership interest in the Partnership while the remaining 90% of the limited partnership interest is owned by outside parties.
Restructuring Plan
As a result of the Partnership's continued decline in operating results, which is discussed below, the prior general partner, FIBM One LLC, developed a restructuring plan for the Partnership. In connection with this plan, the consent of limited partners of the Partnership was sought for the transfer of FIBM One LLC's general partner interest in the Partnership to the current general partner. Effective August 16, 2001, following the receipt of the necessary consent to the transfer of the general partner interest, FIBM One LLC, transferred its general partner interest in the Partnership to AP-Fairfield GP, LLC (the "New General Partner"), which is affiliated with Apollo Real Estate Advisors, L.P. and Winthrop Financial Associates.
Also, as part of the restructuring plan, the Partnership filed a Registration Statement on Form S-1, in which the Partnership sought to offer its limited partners the right to purchase $23 million in subordinated notes due in 2007 (the "Offering"). The proceeds of the Offering, were to be utilized for capital improvements at the Inns. On January 6, 2003, the Partnership withdrew its Form S-1 Registration Statement.
On November 30, 2001, the Restructuring Plan was implemented as the Partnership (i) replaced the Former Manager at the Partnership's Inns with Sage, (ii) entered into new Franchise Agreements with Marriott International, (iii) entered into Ground Lease modifications which provide for substantially reduced rent for the year 2002, and an extension of the term to November 30, 2098, and (iv) agreed to complete the property improvement plans ("PIPs") required by Marriott International at the Inns by no later than November 30, 2003.
Partnership Allocations and Distributions
Partnership allocations and distributions are generally made as follows:
a. Cash available for distribution for each fiscal year will be distributed quarterly as follows: (i) 99% to the limited partners and 1% to the General Partner (collectively, the "Partners") until the Partners have received, with respect to such fiscal year, an amount equal to the Partners' Preferred Distribution (10% of the excess of original cash contributions over cumulative distributions of net refinancing and sales proceeds ("Capital Receipts") on an annualized basis); and (ii) remaining cash available for distribution will be distributed as follows, depending on the amount of Capital Receipts previously distributed:
(1) 99% to the limited partners and 1% to the General Partner, if the Partners have received aggregate cumulative distributions of Capital Receipts of less than 50% of their original capital contributions; or
(2) 90% to the limited partners and 10% to the General Partner, if the Partners have received aggregate cumulative distributions of Capital Receipts equal to or greater than 50% but less than 100% of their original capital contributions; or
(3) 80% to the limited partners and 20% to the General Partner, if the Partners have received aggregate cumulative distributions of Capital Receipts equal to 100% or more of their original capital contributions.
b. Refinancing proceeds and sale proceeds from the sale or other disposition of less than substantially all of the assets of the Partnership will be distributed (i) 99% to the limited partners and 1% to the General Partner until the Partners have received the then outstanding Partners' 12% Preferred Distribution, as defined, and cumulative distributions of Capital Receipts equal to 100% of their original capital contributions; and (ii) thereafter, 80% to the limited partners and 20% to the General Partner.
c. Sale proceeds from the sale of substantially all of the assets of the Partnership will be distributed to the Partners pro-rata in accordance with their capital account balances as adjusted to take into account gain or loss resulting from such sale.
d. Net profits for each fiscal year generally will be allocated in the same manner in which cash available for distribution is distributed. Net losses for each fiscal year generally will be allocated 99% to the limited partners and 1% to the General Partner.
e. Gains recognized by the Partnership generally will be allocated in the following order of priority: (i) to those Partners whose capital accounts have negative balances until such negative balances are brought to zero; (ii) to all Partners up to the amount necessary to bring the Partners' capital account balances to an amount equal to their pro-rata share of the Partners' 12% Preferred Distribution, as defined, plus their Net Invested Capital, as defined; and (iii) thereafter, 80% to the limited partners and 20% to the General Partner.
f. For financial reporting purposes, profits and losses are allocated among the Partners based on their stated interests in cash available for distribution.
Going Concern Uncertainty, Liquidity and Financing Requirements
Adequate liquidity and capital are critical to the ability of the Partnership to continue as a going concern. Annual revenues have declined each year, from $94.4 million in 1998 to $78.8 million in 2002. The decline in Inn operations is primarily due to increased competition, over-supply of limited service hotels in the markets where the Partnership's Inns operate, increased pressure on room rates, lack of funds for capital improvements needed to make the Inns more competitive in their marketplaces, and a slowdown in the economy resulting in a softness in the lodging industry as a whole. Exacerbating this trend was the impact of the events of September 11, 2001 which have had a significant detrimental effect on the hospitality industry in general and the Inns in particular as travel nationwide has severely decreased. The Partnership did not have sufficient cash flow from current operations to make its required debt service payments beginning in November 2002, nor did it have sufficient cash flow to make its property improvement fund contributions beginning in September 2002.
The Partnership is not projecting improved results for 2003 over 2002. Partnership cash, including $8,000 and $3.1 million held in lender reserve accounts at December 31, 2002 and 2001, respectively, totaled $5.9 million and $8.5 million at December 31, 2002 and 2001, respectively. As of November 11, 2002, the Partnership is in default under the mortgage loan agreement due to its failure to pay the regularly scheduled debt service payment due on that date. The Partnership is also in default under the Franchise Agreements with Marriott International due to its failure to make its property improvement fund contributions beginning in September 2002, also resulting in technical default under the mortgage loan agreement. The Partnership has requested from the lender further modifications to the mortgage loan agreement. These modifications include paying debt service solely from available cash flow, selling certain of the Partnership's properties and applying the proceeds from the sales toward replenishing reserves held by the lender. If the lender is unwilling to grant the requested modifications the Partnership may be required to seek protection by filing for bankruptcy or the Partnership's properties may be lost through foreclosure.
The lack of available funds from operations over the past several years has also delayed room refurbishments at the Inns. Based upon information provided by Sage, the capital expenditure needs for 2002 and 2003 for the Inns are estimated to total approximately $19 million. As of March 1, 2003, the Partnership has spent approximately $4.9 million toward the completion of the property improvements plans ("PIPs") required under the Franchise Agreements with Marriott International. As indicated above, the Partnership is required to provide evidence by no later than November 30, 2003 that at least $23 million has been set aside to complete a portion of these capital improvements. If the capital improvements are not completed, the Franchise Agreement could be terminated and the Inns could be prohibited from operating as "Fairfield Inn by Marriott". If this were to occur, which is likely, the Partnership would seek to become part of a comparable, nationally recognized hotel system in order to continue to comply with the obligations under its loan documents. If the Partnership is unable to retain another nationally recognized brand, it could significantly impair its revenues and cash flow. The Partnership estimates that the shortfall in available funds for capital expenditures will be approximately $6.2 million by the end of 2003.
For the years ended December 31, 2002, 2001 and 2000, the Partnership contributed $3.5 million, $5.8 million, $6.0 million, respectively, to the property improvement fund. In 2001 and 2000 the Partnership deposited an additional $2.5 million and $2.4 million, respectively to the property improvement fund to cover the capital expenditure shortfall which began in 1999. No deposits were made in 2002. The shortfall is primarily due to room refurbishments, which are planned for a majority of the Partnership's Inns in the next several years. The Partnership had insufficient cash flow from operations beginning in September 2002 to make its property improvement fund contributions. This resulted in a default under the Partnership's Franchise Agreements with Marriott International, and thus a technical default under the mortgage loan agreement. If the lender is unwilling to grant the requested modifications the Partnership may be required to seek protection by filing for bankruptcy or the Partnership's properties may be lost through foreclosure.
On March 26, 2003, the Partnership received notice from Marriott International that it was in default under the ground lease agreements, due to its failure to pay the full amount due of minimum rentals owed under the Ground Leases beginning in January 2003.
All of the above mentioned factors raise substantial doubt about the Partnership's ability to continue as a going concern. These financial statements have been prepared on a going concern basis. In the event of liquidation, the carrying values as presented in the accompanying financial
statements could be materially different and the accompanying financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Partnership records are maintained on the accrual basis of accounting.
Use of Estimates in the Preparation of Financial Statements
The preparation of 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 from those estimates.
Revenue Recognition
Revenue is generally recognized as services are performed.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which is generally 30 years for building, leasehold and land improvements, and 4 to 10 years for furniture and equipment. All property and equipment is pledged as security for the mortgage debt.
The Partnership assesses impairment of its real estate properties based on whether estimated undiscounted future cash flows from such properties will be less than their net book value. If a property is impaired, its basis is adjusted to its estimated fair value. In 2002, Inns located in Atlanta, Georgia; Birmingham, Alabama; Detroit, Michigan; and St. Louis, Missouri also experienced declining cash flows due to additional competition in their local markets. An additional impairment charge was also taken in 2002 on the inn located in Greenville, South Carolina. An impairment charge was also taken on one of the Inns currently held for sale, located in Orlando, Florida, based on the most recent sales offer. In 2000 and 2001, the Inns located in Johnson City, Tennessee; Raleigh and Charlotte, North Carolina; Columbus, Ohio; Greenville, South Carolina; Atlanta, Georgia experienced declining cash flows, primarily due to additional competition in their local markets. As a result, during 2002, 2001 and 2000, the Partnership concluded that these Inns were impaired and adjusted their basis to their estimated fair market value. The Partnership recorded an impairment charge of $5.3 million, $3.8 million, and $8.1 million in 2002, 2001, and 2000, respectively.
Deferred Financing Costs
Deferred financing costs represent the costs incurred in connection with the mortgage debt refinancing and are amortized over the term of the Mortgage Debt. The Partnership incurred $4.9 million of financing costs in connection with the Mortgage Debt. The financing costs are being amortized using the straight-line method, which approximates the effective interest method, over the ten year term of the Mortgage Debt. The Partnership recognized an additional $89,000 of amortization expense as a result of certain prepayments that were made to the principal balance from proceeds of the sale of four of the Partnership's hotels (see Note 4). At December 31, 2002 and 2001, accumulated amortization of deferred financing costs totaled $3.0 million and $2.4 million, respectively.
Restricted Cash
The Partnership was required to establish certain reserves pursuant to the terms of the mortgage debt (see Note 6).
Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of three months or less at date of purchase to be cash equivalents.
Inventory
Inventory consists primarily of linen, which is stated at the lower of cost or market.
Ground Rent
Certain Inns are subject to Ground Leases with Marriott International that provide for annual minimum rents. The Ground Leases include scheduled increases in minimum rents per property. These scheduled rent increases, which were included in minimum lease payments, were recognized by the Partnership on a straight-line basis over the first ten years of the leases. The adjustment included in ground rent expense and Due to Marriott International, Inc. and affiliates to reflect minimum lease payments on a straight-line basis was a decrease of $12,000 for the year ended December 31, 2000. At year end 2000, all deferred straight-line ground rent had been recognized. For the remaining life of the leases, the minimum rentals are adjusted every five years based on changes in the Consumer Price Index, and are expensed as incurred.
Upon modification of the ground lease with Marriott International effective November 30, 2001, ground rent of $2.2 million was forgiven and minimum rentals for 2002 were reduced to $100,000. The excess of ground rent expense recognized over the 2002 rental payments of $100,000 required by the lease agreement of $2.5 million is deferred at December 31, 2002. These amounts are being amortized on a straight line basis over the terms of the ground lease.
Income Taxes
Provision for Federal and state income taxes has not been made in the accompanying financial statements since the Partnership does not pay income taxes, but rather, allocates profits and losses to the individual Partners. Significant differences exist between the net loss for financial reporting purposes and the net loss as reported in the Partnership's tax return.
Recently Issued Accounting Standards
Financial Accounting Standards Board ("FASB") SFAS No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets" supersedes SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." The standard provides guidance beyond that previously specified in Statement 121 to determine when a long-lived asset should be classified as held for sale, among other things. This Statement was adopted by the Partnership effective January 1, 2002. Implementation of the statement did not have a material effect on the Partnership.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of SFAS No. 13 and Technical Corrections," updates, clarifies and simplifies existing accounting pronouncements. In part, this statement rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt." SFAS No. 145 will be effective for fiscal years beginning after May 15, 2002. Upon adoption, enterprises must reclassify prior period items that do not meet the extraordinary item classification criteria in APB Opinion No. 30. The Partnership does not expect that this statement will have a material effect on its financial statements.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Examples of costs covered by the standard include lease termination costs and certain employee severance costs that are associated with a restructuring, discontinued operation, plant closing or other exit or disposal activity. SFAS No. 146 is effective prospectively for exit and disposal activities initiated after December 31, 2002, with earlier adoption encouraged. The Partnership does not expect that this statement will have a material effect on its financial statements.
FASB Interpretation No. 45, "Guarantors' Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" elaborates on the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This Interpretation does not prescribe a specific approach for subsequently measuring the guarantor's recognized liability over the term of the related guarantee. The disclosure provisions of this Interpretation are effective for the Partnership's December 31, 2002 financial statements. The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. This Interpretation had no effect on the Partnership's financial statements.
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" clarifies the application of existing accounting pronouncements to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of the Interpretation will be immediately effective for all variable interests in variable interest entities created after January 31, 2003, and the Partnership will need to apply its provisions to any existing variable interests in variable interest entities by no later than December 31, 2004. The Partnership does not expect that this will have an impact on its financial statements.
NOTE 3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in thousands):
In December 2001, the Partnership committed to a plan with the approval of its mortgage lender to place eight Inns on the market for potential sale. The eight Inns are located in Montgomery, Alabama; Orlando, Florida; Atlanta, Georgia; Chicago, Illinois; Charlotte, North Carolina; Raleigh, North Carolina; and Columbus, Ohio. Each of these Inns is carried at the lower of cost or fair value less cost to sell and have been classified as held for sale on the accompanying balance sheet. No depreciation expense has been taken on these Inns since they were classified as held for sale. During 2002, the Partnership sold four of the Inns, located in Montgomery, Alabama; Atlanta, Georgia; Chicago, Illinois; and Charlotte, North Carolina.
The Partnership's mortgage debt permits sales of Inns only if U.S. government securities in specified amounts are substituted as collateral for the benefit of the mortgage lender. The Partnership's loan agreement was amended to waive this provision in order to allow proceeds, if any, from the sale of certain inns to be applied to reduce the outstanding balance on the mortgage loans, which will reduce debt service commensurately. However, the proceeds of sales may not be sufficient to satisfy required prepayment minimums. There can be no assurance that any of the remaining Inns held for sale will ultimately be sold. These properties have been marketed with the consent of the Partnership's lender. However, the consent may not be valid if an event of default exists. As described above, the Partnership is in default and as such, lender's consent to a sale may be withheld.
The net book value of the four Inns remaining at December 31, 2002 of $1.1 million and the eight Inns at December 31, 2001 of $5.7 million has been classified as "Properties Held for Sale" in the accompanying balance sheet. However, in the first quarter of 2003, the Partnership reclassified these Inns from properties held for sale and began depreciating their net book values, after the Partnership determined to no longer market these Inns for sale.
NOTE 4. SALE OF INNS
On July 29, 2002, the Partnership sold one of its Inns located in Montgomery, Alabama (classified as property held for sale on the accompanying balance sheet) for $3.1 million. The net proceeds from the sale of approximately $2.9 million were applied toward the Partnership's mortgage debt, in accordance with the terms of the loan agreement. The Partnership recognized a gain on the sale of approximately $2.1 million.
On August 12, 2002, the Partnership sold its Inn located in Charlotte, North Carolina (classified as property held for sale on the accompanying balance sheet) for $2.5 million. The net proceeds from the sale of approximately $300,000, which is net of approximately $1.9 million attributed to the ground lease buyout, were applied toward the Partnership's mortgage debt, in accordance with the terms of the loan agreement. The Partnership recognized a gain on the sale of approximately $200,000.
On August 14, 2002, the Partnership sold its Inn located in Atlanta, Georgia (classified as property held for sale on the accompanying balance sheet) for $3.0 million. The net proceeds from the sale of approximately $2.8 million were applied toward the Partnership's mortgage debt, in accordance with the terms of the loan agreement. The Partnership recognized a gain on the sale of approximately $200,000.
On October 9, 2002, the Partnership sold its Inn located in Chicago, Illinois (classified as property held for sale on the accompanying balance sheet) for $2.3 million. The net proceeds from the sale of approximately $1.4 million, which is net of approximately $700,000 attributed to the ground lease buyout, were applied toward the Partnership's mortgage debt, in accordance with the terms of the loan agreement. The Partnership recognized a gain on the sale of approximately $1.1 million.
NOTE 5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The Partnership is currently in default under its mortgage loan agreement. Therefore, the fair value of the Partnership's mortgage debt cannot be reasonably estimated due to uncertainties related to ongoing operations. The fair value of the Partnership's cash and cash equivalents, restricted cash, property improvement fund, accounts receivable, and accounts payable equals carrying value as presented in the accompanying balance sheets.
NOTE 6. DEBT
Mortgage Debt In Default
As of November 11, 2002, the Partnership is in default under the mortgage loan agreement due to its failure to pay the regularly scheduled debt service payment due on that date. In 1997, the Partnership's mortgage debt was refinanced and increased to $165.4 million. The mortgage debt is non-recourse, bears interest at a fixed rate of 8.40% and requires monthly payments of $1.4 million of principal and interest based upon a 20-year amortization schedule for a 10-year term expiring January 11, 2007. Thereafter, until the final maturity date of January 11, 2017, interest is payable at an adjusted rate, and all excess cash flow is applied toward principal amortization. The lender securitized the loan through the issuance and sale of commercial mortgage backed securities.
The Partnership is also in default under the Franchise Agreements with Marriott International due to its failure to make its property improvement fund contributions beginning in September 2002, also resulting in technical default under the mortgage loan agreement. The Partnership has requested from the lender further modifications to the mortgage loan agreement. These modifications included paying debt service solely from available cash flow, selling certain of the Partnership's Inns and applying the proceeds from the sales toward replenishing reserves held by the lender. If the lender is unwilling to grant the requested modifications the Partnership may be required to seek protection by filing for bankruptcy or the Partnership's properties may be lost through foreclosure.
The mortgage premium of $3.5 million is being amortized based on a 20-year amortization schedule for a 10-year term, subject to adjustments for Inn sales, expiring January 11, 2007. Accumulated amortization of the mortgage premium at
December 31, 2002 and 2001 was $2.1 million and $1.7 million, respectively, resulting in an unamortized balance of $1.4 million and $1.8 million, respectively.
The mortgage debt is secured by first mortgages on all of the Inns, the land on which they are located, or an assignment of the Partnership's interest under the Ground Leases, including ownership interest in all improvements thereon, fixtures and personal property related thereto.
Reserves
The Partnership was required by the lender to establish various reserves for capital expenditures, working capital, debt service and insurance needs.
The balances in those reserves as of December 31 are as follows (in thousands):
The Partnership is required to deposit two months' debt service payments, or $2.9 million, into a debt service reserve. The Partnership was also required to establish a ground rent reserve, which is adjusted annually to equal one month's anticipated ground rent. The Partnership's loan agreement requires that if a single downgrade of Marriott International's debt occurs, the Partnership is required to contribute an additional month's debt service payment to the debt service reserve which was under funded in 2002 and 2001 by $2.9 million and $2.5 million, respectively. In addition, pursuant to the terms of the mortgage debt subsequent to a downgrade of Marriott International's debt, the Partnership is required to establish with the lender a separate escrow account for payments of insurance premiums and real estate taxes (the "Tax and Insurance Escrow Reserve") for each mortgaged property. During 1998, Orange County in Florida (the "County") paid the Partnership $197,000 for a portion of the land in front of the Orlando South Fairfield Inn in Orlando, Florida. The funds were placed in an escrow account and shown as the condemnation reserve. During 2001, the County made its final resolution on the value of the land. The Partnership received an additional $150,000, which was initially placed into the condemnation reserve. The entire balance of the condemnation reserve account was then transferred into the debt reserve account in accordance with the terms of the Amended Loan Agreement.
In addition, the Partnership entered into a Working Capital Maintenance and Supplemental Debt Service Agreement ("Working Capital Agreement") with the Former Manager, effective January 13, 1997. As part of the Working Capital Agreement, the Partnership agreed to furnish the Former Manager additional working capital to be deposited into a segregated interest bearing account (the "Working Capital Reserve"). The Working Capital Reserve was to be funded from Operating Profit, as defined, retained by or distributed to the Partnership as such amounts became available, until the Working Capital Reserve reached $670,000. The Working Capital Agreement also required the funding of another segregated account for debt service shortfalls (the "Supplemental Debt Service Reserve"). This reserve was also to be funded out of Operating Profit, as defined, retained or distributed to the Partnership as such amounts became available, until the Supplemental Debt Service Reserve reached $1.4 million. Interest earned on these reserve accounts was transferred to the Partnership during first quarter 2001. The balance of the supplemental Debt Service Reserve was used to fund debt service during 2001. The Working Capital Agreement was terminated effective November 30, 2001, along with the termination of the Management Agreement with Fairfield FMC Corporation.
NOTE 7. GROUND LEASES
The land on which 30 of the Inns are located is leased from Marriott International or its affiliates. The Ground Leases, prior to the amendment discussed below, expired on November 30, 2088 and provide that, other than in 2002, the Partnership will pay annual rents equal to the greater of a specified minimum rent for each property or a percentage rent
based on gross revenues of the Inn operated thereon. The minimum rentals are adjusted at various anniversary dates through 2000, as defined in the agreements. The minimum rentals are adjusted every five years for the remaining life of the leases based on changes in the Consumer Price Index. The percentage rent, which also varies from property to property, is fixed at predetermined percentages of gross revenues that increase over time.
On November 30, 2001, the Partnership executed a ground lease amendment, which cancels the Partnership's obligation to pay unpaid deferred ground rent for 2000 and 2001 in the amount of $2.2 million, reduces the minimum ground rent from $2.7 million to $100,000 for 2002, and extends the term of the lease to November 30, 2098. The forgiveness of deferred ground rent and reduction of 2002 minimum rentals due to the lease modification are being amortized on a straight-line basis over the amended ground lease terms. If by November 30, 2003 the Partnership (i) receives a capital infusion (either by way of loan or otherwise) of not less than $23 million in order to fund the completion of the PIPs, (ii) is diligently pursuing completion of the PIPs, and (iii) satisfies certain other conditions, the ground rent will be reduced through 2004 and the Partnership will have an option to acquire the fee interest in the land for a price equal to $45.8 million. If the Partnership does not meet these conditions, it will be a default under the Franchise Agreements, which would also constitute a default under the Ground Leases. Accordingly, if the Partnership does not meet these conditions, not only could it lose the right to operate its Inns as a "Fairfield Inn by Marriott", but the 30 Inns subject to a Ground Lease could be lost to the ground lessor.
Minimum future rental payments during the term of the Ground Leases as of December 31, 2002 are as follows (in thousands):
Total rental expense on the Ground Leases was $2.6 million, $2.7 million, and $3.0 million for 2002, 2001 and 2000, respectively.
In connection with the refinancing, beginning in 1997 until the Mortgage Debt is repaid, the payment of rental expense exceeding 3% of gross revenues from the 30 leased Inns in the aggregate shall be deferred in any fiscal year that cash flow is less than the regularly scheduled principal and interest payments on the Mortgage Debt. The deferral shall then be payable in the following year if cash flow is sufficient to pay the regularly scheduled principal and interest payments for the Mortgage Debt. Deferred ground rent payable to Marriott International and its affiliates at December 31, 2002 and 2001 was $4.7 million and $2.2 million, respectively, and is included in Due to Marriott International, Inc. and affiliates on the accompanying balance sheet. The amount of deferred ground rent waived as a result of the ground lease amendment of $2.2 million is recognized as a reduction in ground rent expense over the remaining life of the new lease term, since it represents a new operating lease as of November 30, 2001, for accounting purposes. Ground rent expense is recognized on a straight-line basis over the term of the lease. The excess of ground rent expense recognized over rental payments required by the lease agreement of $2.5 million is deferred at December 31, 2002 and is also being recognized on a straight-line basis over the term of the lease.
Under the leases, the Partnership pays all costs, expenses, taxes and assessments relating to the Inns and the underlying land, including real estate taxes. Each Ground Lease provides that the Partnership has a first right of refusal in the event the applicable ground lessor decides to sell the leased premises. Upon expiration or termination of a Ground Lease, title to the applicable Inn and all improvements reverts to the ground lessor.
On March 26, 2003, the Partnership received notice from Marriott International that it was in default under the ground lease agreements, due to its failure to pay the full amount due of minimum rentals owed under the Ground Leases beginning in January 2003.
NOTE 8. FORMER MANAGEMENT AGREEMENT
Through November 30, 2001, the Partnership was a party to a long-term management agreement (the "Management Agreement") with the Former Manager. This agreement was terminated and Sage Management Resources III, LLC ("Sage"), an affiliate of Sage Hospitality Resources, LLC, was retained as the New Manager effective November 30, 2001. See discussion of new management agreement below.
In conjunction with the 1997 mortgage refinancing, the initial term of the Management Agreement was extended ten years to December 31, 2019. The Former Manager had the option to renew the Management Agreement as to one or more of the Inns at its option, for up to four additional 10-year terms plus one five-year term. The Former Manager was paid a base management fee equal to 2% of gross Inn revenues and a Fairfield Inn system fee equal to 3% of gross Inn revenues. In addition, the Former Manager was entitled to an incentive management fee equal to 15% of Operating Profit as defined, increasing to 20% after the Inns had achieved total Operating Profit during any 12 month period equal to or greater than $33.9 million. As of December 31, 2001, operating profit did not exceed $33.9 million. The incentive management fee with respect to each Inn was payable out of 50% of cash flow from operations remaining after payment of ground rent, debt service, Partnership administrative expenses and the owner's priority return, as defined.
In accordance with the Management Agreement, incentive management fees earned through 1992 were waived by the Former Manager. Incentive management fees earned after 1992 accrued and were payable as outlined above or from Capital Receipts. Due to the litigation settlement agreement (see Note 13), $23.5 million of deferred incentive management fees were waived by the Former Manager in 2000. As a result, the Partnership recognized an extraordinary gain for this amount in 2000. During 2001 and 2000, the Former Manager deferred $2.0 million and $2.8 million of incentive management fees, respectively. In connection with the termination of the Management Agreement with Fairfield FMC Corporation, $2.0 million and $2.8 million of incentive fees earned in 2001 and 2000, respectively, were no longer due under the terms of the Management Agreement. Deferred incentive fees of $2.8 million related to 2000, net of a $500,000 payment to the Former Manager, have been reflected in the 2001 statement of operations in the line titled Termination of Management Agreement. Incentive fees for 2001 were not recognized in the 2001 statement of operations due to the termination of the Management Agreement with Fairfield FMC Corporation.
The Former Manager was required to furnish certain services ("Chain Services") which are furnished generally on a central or regional basis to all managed or owned Inns in the Fairfield Inn by Marriott hotel system. Costs and expenses incurred in providing such services were allocated among all domestic Fairfield Inn by Marriott hotels managed, owned or leased by Marriott International or its subsidiaries, based upon one or a combination of the following: (i) percent of revenues, (ii) total number of hotel rooms, (iii) total number of reservations booked, and (iv) total number of management employees. The Inns also participated in Marriott International's Marriott Rewards Program ("MRP"). The cost of this program was charged to all hotels in the full-service, Residence Inn by Marriott, Courtyard by Marriott and Fairfield Inn by Marriott systems based upon the MRP revenues at each hotel. The total amount of chain services and MRP costs allocated to the Partnership for the years ended December 31, 2002, 2001 and 2000 was $5.0 million, $1.7 million, and $1.7 million, respectively. In addition, Marriott International maintains a marketing fund to pay the costs associated with certain system-wide advertising, marketing, sales, promotional and public relations materials and programs. Each Inn within the system contributes approximately 2.5% (for 2002) and 2.4% (for 2001 and prior) of gross Inn revenues to the marketing fund. For the years ended December 31, 2002, 2001 and 2000, the Partnership contributed $1.9 million, $1.9 million, and $2.5 million, respectively, to the marketing fund.
Pursuant to the terms of the Management Agreement, the Partnership was required to provide the Former Manager with working capital and supplies to meet the operating needs of the Inns. The Former Manager converted cash advanced by the Partnership into other forms of working capital consisting primarily of operating cash, inventories, and trade receivables and payables which were maintained and controlled by the Former Manager. This advance earned no interest and remained the property of the Partnership throughout the term of the Management Agreement. The Partnership was required to advance upon request of the Former Manager any additional funds necessary to satisfy the needs of the Inns as their operations required from time to time. Upon termination of the Management Agreement, the Former Manager returned to the Partnership all unused working capital and supplies. At the inception of the Partnership, $1 million was advanced to the Former Manager for working capital and supplies which was included in Due from Marriott
International, Inc. and affiliates in the accompanying balance sheet. Effective with the termination of the Management Agreement, the working capital was turned over to the new manager and represents inventory.
The Management Agreement provided for the establishment of a property improvement fund for the Inns to cover (a) the cost of certain non-routine repairs and maintenance to the Inns, which are normally capitalized; and (b) the cost of replacements and renewals to the Inns' property and improvements. Contributions to the property improvement fund were based on a percentage of gross revenues of each Inn equal to 7%. During 2000, $416,000 of these contributions were reallocated to pay for debt service. For the years ended December 31, 2002, 2001 and 2000, the Partnership contributed $3.5 million, $5.8 million, and $6.0 million, respectively, to the property improvement fund. However, if the Former Manager determined 7% exceeded the amount needed for making capital expenditures, then the Former Manager could adjust the incentive management fee calculation to exclude as a deduction in calculating incentive management fees up to one percentage point of contributions to the property improvement fund. No adjustment was necessary for 2001 and 2000.
NOTE 9. NEW MANAGEMENT AGREEMENT
Effective November 30, 2001, the Partnership retained Sage, an independent hotel management company, to manage its Inns under separate management agreements for each Inn.
The management agreements have a term of five years and provide that the Inns will be operated as part of the Fairfield Inn by Marriott franchise system and that Sage will be responsible for the day-to-day operation of the Inns. The Partnership has the right to terminate a management agreement under certain circumstances, including a change in control of Sage, the sale of all the Inns (in which event a termination fee may be payable) or Sage's failure to achieve certain performance levels during the third year of the agreement, unless such failure is due to circumstances beyond Sage's control. Sage may terminate a management agreement under certain circumstances, including the Partnership's failure to provide sufficient working capital for the operation of an Inn.
Sage receives a base management fee under the management agreements in the aggregate equal to 3% of adjusted gross revenue, and an incentive management fee equal to 10% of the excess of earnings before interest, taxes, depreciation and amortization of all the Inns during the applicable fiscal year ("EBITDA") over (i) $25 million, to be adjusted if an Inn is no longer managed by Sage (during the first three years of the management agreements) and (ii) 107.5% of the greater of (x) $25,000,000 and (y) the prior year's EBITDA (during the last two years of the management agreements). The right to continue to manage and operate the Inns shall be subordinate to the mortgage. The incentive management fee shall be subordinate in payment to the mortgage debt. The total fees and expenses payable by the Partnership under the new franchise agreements and the new management agreements, exclusive of the incentive management fee payable to Sage, will not exceed the amount that was paid to the Former Manager under the previous management agreement.
During 2001, the Partnership advanced to Sage amounts totaling $868,000 in order to fund expenses incurred related to Sage's transition as the new manager. The Partnership and Sage entered into a Promissory Note Agreement ("Note") whereby these advances would be repaid by Sage on a monthly basis beginning February 1, 2002 in an amount equal to 50% of the previous months management fees until the Note is paid in full. The advances accrued interest at a rate of 12%. Interest income on these advances was $49,000 and $23,000 for the years ending December 31, 2002 and 2001, respectively. This Note was paid in full during the year ended December 31, 2002.
The Partnership is required to establish a reserve account to cover expenditures for capital improvements and replacement of furniture, fixtures and equipment for the Inns. Contributions to the account will be made on a monthly basis in an amount equal to 7% of gross monthly revenues for the Inns. If funds are insufficient to meet required monthly contributions to the reserve account, the Partnership is required to provide additional funds.
The Partnership is also required to provide Sage with working capital sufficient to meet all disbursements and operating expenses necessary to permit the uninterrupted and efficient operation of the Inns. Sage may request additional contributions to working capital if any additional funds are necessary to satisfy the needs of the Inns as their operations may require from time to time.
If the Partnership's earnings before interest, taxes, depreciation, and amortization is not at least $25 million for the calendar year 2004 (subject to certain exceptions), the Partnership has the right to terminate Sage.
The Partnership has historically presented the working capital advanced to the Former Manager in a single line item on the balance sheet. In 2001, the Partnership presented the working capital advanced to Sage in a single line item on the balance sheet to be consistent with prior year presentation.
In 2002, the Partnership concluded that the components of the working capital managed by Sage should be consolidated with the working capital of the Partnership. Previously reported financial statements have been revised to reflect this accounting presentation.
This revision did not impact the statement of operations, partners' deficit or the net operating, investing and financing cash flows, but did affect the comparability of the components of the operating cash flows for 2002 to 2001 and 2000.
Following is a summary of the working capital components affected by the revision at December 31, 2001 (in thousands):
NOTE 10. FRANCHISE AGREEMENTS
Effective November 30, 2001, the Partnership entered into Franchise Agreements with Marriott International for each Inn, which permitted the Partnership to continue to use the Fairfield Inn by Marriott brand.
Under the new Franchise Agreements, the Partnership will pay the following fees for each Inn:
o a $10,000 non-refundable application fee per inn to cover Marriott International's application processing expenses;
o a royalty fee of 4% of gross room revenue;
o a marketing fund contribution of 2.5% of gross room revenue;
o a reservation system fee equal to 1% of gross room revenue, plus $3.50 for each reservation confirmed and a communications support fee of $379 per month for each inn;
o a property management system fee of $323 per month for each inn plus an additional $30 per month for each inn to access the Marriott intranet site; and
o training and software charges.
In addition, the Partnership is required to deposit 7% of each Inn's gross monthly revenues into an escrow account to be applied towards capital improvements. The Partnership is currently in default under the franchise agreements with MII
due to its failure to make its property improvement fund contributions beginning in September 2002, also resulting in technical default under the mortgage loan agreement.
Each new franchise agreement includes a termination fee to Marriott International if the franchise for a particular Inn is terminated. To facilitate a potential sale, the Partnership will not be required to pay the termination fee on five of eight specified inns if the Inns are sold within 18 months of the date of the franchise agreements. Each franchise agreement has a 10-year term. The Partnership has the option to renew each agreement for two additional five-year periods subject to its successful maintenance of brand standards and compliance with all of the material terms of the agreement.
Marriott International may terminate the franchise agreements under certain circumstances, including the Partnership's failure to operate an inn under the Fairfield Inn by Marriott brand, certain transfers of an interest in the Partnership and the Partnership's failure to complete required upgrading and remodeling of the Inns.
As noted above, the Partnership is currently in default under the franchise agreements. If the Property Improvement Plans required by Marriott International are not completed by November 30, 2003, which is likely, it will also be considered an event of default under the franchise agreements.
As a condition to entering into the franchise agreements, an affiliate of the Partnership's general partner has guaranteed the Partnership's obligations to pay the termination fees under certain circumstances that may come due under the agreements up to a maximum of $25 million, and up to a maximum of $10 million on the Partnership's other obligations under the agreements.
NOTE 11. TAXABLE LOSS
The Partnership's taxable loss differs from the net income (loss) for financial reporting purposes for the years ended December 31, 2002, 2001 and 2000, as follows (in thousands):
NOTE 12. RELATED PARTY TRANSACTIONS
The Partnership pays Winthrop Financial Associates, an affiliate of the general partner, a monthly fee of $30,000 to cover various administrative services provided on the Partnership's behalf. For the years ended December 31, 2002 and 2001, $360,000 and $120,000 were expensed for these services, respectively.
NOTE 13. LITIGATION
In March 2000, Marriott International, Inc., Host Marriott, various of their subsidiaries, J.W. Marriott, Jr., Stephen Rushmore, and Hospitality Valuation Services, Inc. (collectively, the "Defendants") entered into a settlement agreement with counsel for the plaintiffs to resolve litigation in seven partnerships, including the Partnership. Under the terms of the settlement, the Defendants paid $18.8 million in cash in exchange for dismissal of the litigation and a complete release of all claims in October 2000. Each limited partner received $152 per Unit. In addition to the Defendants' cash payments, Fairfield FMC Corporation forgave $23.5 million of deferred management fees.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Effective May 17, 2002, the Partnership dismissed Arthur Andersen LLP ("Arthur Andersen") as its independent auditors. Arthur Andersen's report on the Partnership's financial statements for the year ended December 31, 2001 contained a modification raising substantial doubt about the Partnership's ability to continue as a going concern due to recurring operating losses, a net capital deficiency, and doubt about the Partnership's ability to meet its 2002 debt obligations. Arthur Andersen's report on the Partnership's financial statements for the year ended December 31, 2000 did not contain an adverse opinion or disclaimer of opinion, nor was such report qualified or modified as to uncertainty, audit scope or accounting principles.
For the years ended December 31, 2001 and 2000, there were: (i) no disagreements with Arthur Andersen on any matter of accounting principle or practice, financial statement disclosure, or auditing scope or procedure which disagreements if not resolved to Arthur Andersen's satisfaction, would have caused them to make reference to the subject matter in connection with their report on our financial statements for such years; and (ii) there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.
Effective September 13, 2002, the Partnership engaged Ernst & Young, LLP ("Ernst & Young") as its independent auditors. For the year ended December 31, 2002, there are (i) no disagreements with Ernst & Young on any matter of accounting principle or practice, financial statement disclosure, or auditing scope or procedure which disagreements if not resolved to Ernst & Young's satisfaction, would have caused them to make reference to the subject matter in connection with their report on our financial statements for such year; and (ii) there were no reportable events as defined in Item 304(a)(1)(v) of Regulation S-K.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE PARTNERSHIP
The Partnership has no directors or executive officers. The general partner of the Partnership is AP-Fairfield GP LLC, a Delaware limited liability company. The general partner manages and controls substantially all of the Partnership's affairs and has general responsibility and ultimate authority in all matters affecting its business. As of March 1, 2003, the names of the executive officers of manager of the general partner and the position held by each of them, are as follows:
Michael L. Ashner, age 50, has been the Chief Executive Officer of Winthrop Financial Associates, A Limited Partnership ("WFA") and the Managing General Partner since January 15, 1996. Since August 19, 2002, Mr. Ashner has also served as the Chief Executive Officer of Fairfield Inn By Marriott Limited Partnership, Shelbourne Properties II Inc. and Shelbourne Properties III Inc. (collectively, the "Shelbourne REITs"), three publicly traded real estate investment trusts. Mr. Ashner currently serves as a director of each of the Shelbourne REITs, Great Bay Hotel and Casino Inc., and NBTY, Inc.
Thomas C. Staples, age 47, has been the Chief Financial Officer of WFA since January 1, 1999. From March 1996 through December 1998, Mr. Staples was Vice President/Corporate Controller of WFA.
Peter Braverman, age 51, has been a Vice President of WFA and the Managing General Partner since January 1996. Since August 19, 2002, Mr. Braverman has also served as the Executive Vice President of each of the Shelbourne REITs. Mr. Braverman serves as a director of the Shelbourne REITs.
Carolyn Tiffany, age 36, has been employed with WFA since January 1993. Since December 1997, Ms. Tiffany has served as the Chief Operating Officer of WFA. In addition, since August 19, 2002, Ms. Tiffany has served as the Chief Financial Officer of each of the Shelbourne REITs.
One or more of the above persons are also directors or officers of a general partner (or general partner of a general partner) of a number of limited partnerships which either have a class of securities registered pursuant to Section 12(g) of the Securities and Exchange Act of 1934, or are subject to the reporting requirements of Section 15(d) of such Act. In addition, each of the foregoing officers and directors hold similar positions with Newkirk MLP Corp., GFB-AS Manager Corp. and AP-PCC III, L.P., entities that through one or more subsidiaries manage over 200 limited partnerships that hold title to real property including, commercial properties, residential properties and assisted living facilities.
Except as indicated above, neither the Partnership nor the general partner has any significant employees within the meaning of Item 401(c) of Regulation S-K. There are no family relationships among the officers and directors of the general partner.
Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to the Partnership under Rule 16a-3(e) during the Partnership's most recent fiscal year and Forms 5 and amendments thereto furnished to the Partnership with respect to its most recent fiscal year, the Partnership is not aware of any director, officer, beneficial owner of more than ten percent of the units of limited partnership interest in the Registrant that failed to file on a timely
basis, as disclosed in the above Forms, reports required by section 16(a) of the Exchange Act during the most recent fiscal year or prior fiscal years.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The Partnership is not required to and did not pay remuneration to the officers and directors of its general partner. Certain officers and directors of the general partner receive compensation from the general partner and/or its affiliates (but not from the Partnership) for services performed for various affiliated entities, which may include services performed for the Partnership; however, the general partner believes that any compensation attributable to services performed for the Partnership are immaterial. See also "Item 13. Certain Relationships and Related Transactions."
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) Security Ownership of Certain Beneficial Owners.
Except as set forth below, no person or group is known by the Partnership to be the beneficial owner of more than 5% of the outstanding Units at March 1, 2003:
(1) The principal business address of the listed entity, which is an affiliate of the general partner, is 7 Bulfinch Place, Suite 500, Boston, Massachusetts 02114.
(b) Security Ownership of Management.
At March 1, 2003, AP-Fairfield LP, LLC, an affiliate of the general partner, owned 18,459 Units representing approximately 22.15% of the total number of Units outstanding. Neither the general partner, nor any officer, director, manager or member thereof, or any of their affiliates owned any Units.
(c) Changes in Control.
There exists no arrangement known to the Partnership the operation of which may at a subsequent date result in a change in control of the Partnership.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Partnership pays Winthrop Financial Associates, an affiliate of the general partner, a monthly fee of $30,000 to cover various administrative services provided on the Partnership's behalf. For the year ended December 31, 2002, $360,000 was expensed for these services.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
The general partner's principal executive officer and principal financial officer have, within 90 days of the filing date of this annual report, evaluated the effectiveness of the Partnership's disclosure controls and procedures (as defined in Exchange Act Rules 13a - 14(c) and have determined that such disclosure controls and procedures are adequate. There have been no significant changes in the Partnership's internal controls or in other factors that could significantly affect such internal controls since the date of evaluation. Accordingly, no corrective actions have been taken with regard to significant deficiencies or material weaknesses.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements: see Index to Financial Statements in Item 8.
(a) (2) Financial Statement Schedule:
Schedule III - Real Estate and Accumulated Depreciation
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
(a) (3) Exhibits:
See Exhibit Index
(b) Reports on Form 8-K:
The Partnership filed the following reports on Form 8-K during the last quarter of the fiscal year:
No Current Reports on Form 8-K were filed by the Partnership during the three month period ended December 31, 2002.
SCHEDULE III Fairfield Inn by Marriott Limited Partnership Real Estate and Accumulated Depreciation As of December 31, 2002 (in thousands)
Notes:
(c) The aggregate cost of land, buildings, improvements and properties held for sale for Federal income tax purposes is approximately $188.9 million at December 31, 2002.
(d) 46 Fairfield Inns, limited service hotels, located throughout the United States
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.
FAIRFIELD INN BY MARRIOTT LIMITED PARTNERSHIP
By: AP-Fairfield GP LLC General Partner
By: AP-Fairfield Manager Corp. Manager
Dated: April 1, 2003 By: /s/ Michael L. Ashner --------------------------------- Michael L. Ashner President and Director (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, This report has been signed below by the following persons on behalf of the registrant and in their capacities on the dates indicated.
Dated: April 1, 2003 By: /s/ Michael L. Ashner ------------------------------------- Michael L. Ashner President and Director (Principal Executive Officer)
Dated: April 1, 2003 By: /s/ Thomas Staples ------------------------------------- Thomas Staples Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)
CERTIFICATIONS
I, THOMAS C. STAPLES, certify that:
1. I have reviewed this annual report on Form 10-K of Fairfield Inn by Marriott Limited Partnership;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant is made known to us, particularly during the period in which this annual report is being prepared:
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: April 1, 2003 /s/ Thomas Staples ----------------------------------------- Thomas C. Staples Chief Financial Officer
CERTIFICATIONS
I, MICHAEL L. ASHNER, certify that:
1. I have reviewed this annual report on Form 10-K of Fairfield Inn by Marriott Limited Partnership;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant is made known to us, particularly during the period in which this annual report is being prepared:
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: April 1, 2003 /s/ Michael L. Ashner ----------------------------------------- Michael L. Ashner Chief Executive Officer
EXHIBIT INDEX
No. Exhibit Page --- ------- ---- 2.1 Amended and Restated Agreement of Limited Partnership of (1) Fairfield Inn by Marriott Limited Partnership by and among Marriott FIBM One Corporation (General Partner), Christopher, G. Townsend (Organizational Limited Partner), and those persons who become Limited Partners (Limited Partners) dated July 31, 1990.
2.2 First Amendment to Amended and Restated Agreement of Limited (2) Partnership dated as of December 28, 1998.
10.1 Loan Agreement between Fairfield Inn by Marriott Limited (1) Partnership and Nomura Asset Capital Corporation dated January 13, 1997.
10.2 Secured Promissory Note made by Fairfield Inn by Marriott (1) Limited Partnership (the "Maker") to Nomura Asset Capital Corporation (the "Payee") dated January 13, 1997.
10.3 Form of Ground Lease (1)
12.1 Statements re: Computation of Ratio of Earnings to Fixed 59 Charges
16 Letter from Arthur Andersen LLP to the Securities and (4) Exchange Commission dated May 20, 2002.
99.1 Confirmation of Receipt of Assurances from Arthur Anderson LLP (3)
99.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley 60 Act of 2002
(1) Incorporated by reference to the Registrant's Form 10 filed on January 29, 1998.
(2) Incorporated by reference to the Registrant's Form 10/A filed on April 11, 2001
(3) Incorporated by reference to the Registrant's Annual Report on Form 10K filed for the year ended December 31, 2001.
(4) Incorporated by reference to the Registrant's Current Report on Form 8K filed May 20, 2002.