ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
Winston Hotels, Inc. ("WHI") operates so as to qualify as a real estate investment trust ("REIT") for federal income tax purposes. During 1994, WHI completed an initial public offering ("IPO") of $0.01 par value common stock ("Common Stock"), utilizing the majority of the proceeds to acquire one hotel and a general partnership interest (as the sole general partner) in WINN Limited Partnership (the "Partnership"). The Partnership used a substantial portion of the proceeds to acquire nine hotel properties (collectively the ten hotels are the "Initial Hotels"). WHI and the Partnership (collectively the "Company") began operations as a REIT on June 2, 1994.
During 1995 and 1996, WHI completed follow-on Common Stock offerings, as well as a Preferred Stock offering in September 1997, and invested the net proceeds from these offerings in the Partnership. The Partnership utilized the proceeds to acquire 28 additional hotel properties. During 1998, the Company added 13 additional properties to its portfolio, five of which were internally developed. As of December 31, 1999, WHI's ownership in the Partnership was 92.83%. As of December 31, 1999, the Company owned 51 hotel properties (the "Current Hotels"), having an aggregate of 6,904 rooms.
Under the REIT qualification requirements of the Internal Revenue Code, REITs generally must lease their hotels to third party operators. Therefore, as of December 31, 1999, the Company leased 49 of the 51 Current Hotels to CapStar Winston Company, L.L.C. ("CapStar Winston"), a wholly owned subsidiary of MeriStar Hotels and Resorts, Inc. ("MeriStar"), one of the Current Hotels to Bristol Hotels & Resorts, Inc. ("Bristol") and one of the Current Hotels to Prime Hospitality Corp. ("Prime"). All 51 of the Current Hotels were leased pursuant to leases that provide for rent payments based, in part, on revenues from the Current Hotels (the "Percentage Leases"). Under the terms of the Percentage Leases, the lessees are obligated to pay the Company the greater of base rent or percentage rent ("Percentage Rent"). The Percentage Leases are designed to allow the Company to participate in the growth in revenues at the Current Hotels by providing that a portion of each Current Hotel's room revenues in excess of specified amounts will be paid to the Company as Percentage Rent.
NARRATIVE DESCRIPTION OF BUSINESS
Growth Strategy
The Company's growth strategy is to enhance shareholder value by increasing cash available for distribution per share of Common Stock through: (i) participating in any increased room revenue from the Current Hotels and any subsequently acquired or developed hotels through Percentage Leases; (ii) acquiring additional hotels, or ownership interests in hotels, that meet the Company's investment criteria; (iii) selectively developing hotels and hotel additions as market conditions warrant; and (iv) leveraging off of its management team's expertise.
Internal Growth Strategy
The Company participates in any increased room revenue from the Current Hotels through Percentage Leases. The Company believes that internal growth, through increases in Percentage Rent has and, in the future, may result from: (i) continued sales and marketing programs by the lessees and operators; (ii) completion of refurbishment projects as needed at the Current Hotels; (iii) maintaining hotel franchises with demonstrated market acceptance and national reservation systems; and (iv) continuation of the industry-wide trend of increasing average daily room rate ("ADR") and revenue per available room ("REVPAR").
The Percentage Leases provide that a percentage of room revenues in specified ranges is paid as Percentage Rent. For most leases, the percentage of room revenues paid as Percentage Rent increases as a higher specified level of room revenues is achieved. Pursuant to each Percentage Lease, base rent and the ranges of room revenues specified for purposes of calculating Percentage Rent are adjusted on a quarterly or annual basis for inflation beginning on the first day after the first full fiscal year of the Percentage Lease, based on changes in the United States Consumer Price Index ("CPI").
Acquisition Strategy
The Company intends to acquire additional hotel properties with strong national franchise affiliations in the mid-scale and upscale market segments, or hotel properties with the potential to obtain such franchise affiliations. In particular, the Company will consider acquiring limited-service hotels such as Hampton Inn and Fairfield Inn by Marriott hotels; full-service hotels such as Hilton Garden Inn, Courtyard by Marriott and Holiday Inn hotels; and extended-stay hotel properties such as Homewood Suites by Hilton, Hampton
Inn and Suites, Residence Inn by Marriott and Staybridge by Holiday Inn (see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Forward Looking Statements").
The Company intends to consider investments in hotel properties that meet one or more of the following criteria: (i) properties in locations with relatively high demand for rooms, a relatively low supply of hotel properties and barriers to easy entry into the hotel business, such as a scarcity of suitable sites or zoning restrictions; (ii) successful hotels available at favorable prices; and (iii) newly developed hotels that the developer does not intend to own. The Company believes its relationship with each lessee and franchisor will provide additional potential investment opportunities.
Additional investments in hotel properties may be made through the Partnership, directly by WHI or with entities affiliated with the Company. The Company's ability to acquire additional hotel properties and develop hotels depends primarily on its ability to obtain additional debt financing, proceeds from subsequent issuances of Common Stock or other securities, proceeds from the sale of hotel properties or co-investments from other investors.
Development Strategy
The Company intends to pursue hotel development as suitable opportunities arise. The Company may finance 100% of such development or seek partners who would co-invest in development or rehabilitation joint ventures. The Company intends to consider development of hotels with strong national franchise affiliations in markets where the Company believes that carefully timed and managed development will yield returns to the Company that exceed returns from any available hotels in those markets that meet the Company's acquisition criteria (see "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Forward Looking Statements"). The Company earns certain fees from its joint venture development activity and also is exploring other opportunities to use management's expertise to earn additional fees through third party development.
In June 1999, the Company entered into a joint venture agreement to develop upscale hotels with Regent Partners, Inc., a leading real estate development, investment and services firm and a wholly owned subsidiary of J.A. Jones, Inc. ("Regent"). By combining Regent's expertise in hotel development with the Company's, this approach offers each organization the potential for attractive financial returns. Under the terms of the joint venture (the "Joint Venture"), Regent and the Company will co-develop the hotels and receive fees for their respective services including development, asset management and purchasing. The Company is expected to have an ownership level of up to 49 percent in each project. The Company also has the right to acquire Regent's interests subject to the provisions of the joint venture agreement.
The Joint Venture's initial project is a $16.5 million, full-service 158-room Hilton Garden Inn in Windsor, Connecticut, which is scheduled to open in the second half of 2000. Construction also is scheduled to begin this spring on the Joint Venture's second project: a $20 million, 177-room Hilton Garden Inn in the Chicago suburb of Evanston, which is scheduled to open before the holiday season in 2001. The Company is considering other possible joint ventures and also is investigating providing hotel development financing services as well. In addition to generating development, asset management, and purchasing fee income and thus enhancing the Company's revenues and cash flow; other benefits include expanding our affiliations with leading upscale brands and the potential addition of new hotels to our portfolio, despite the external capital constraints prevalent in today's real estate market.
Operations and Property Management
As of December 31, 1999, CapStar Winston leased 49 of the Current Hotels, 39 of which they also operated. Interstate Management and Investment Corporation ("IMIC") managed nine of the Current Hotels and Promus Hotels, Inc. ("Promus") managed one of the Current Hotels (collectively the "Property Managers") pursuant to management agreements with CapStar Winston with respect to each of such hotels. Bristol and Prime each leased and operated one of the Current Hotels. The lessees and the Property Managers seek to increase revenues at the Current Hotels by using established systems to manage the Current Hotels for marketing, rate achievement, expense management, physical facility maintenance, human resources, accounting and internal auditing. They are trained in all aspects of hotel operations, including negotiation of prices with corporate and other clients and responsiveness to marketing requirements in their particular markets, with particular emphasis placed on customer service. The lessees and the Property Managers employ a mix of marketing techniques designed for each specific Current Hotel, which include individual toll-free lines, cross-marketing of the Current Hotels' billboards and direct marketing, as well as taking advantage of national advertising by the franchisors of the Current Hotels.
The lessees lease the Current Hotels pursuant to the Percentage Leases. Under the Percentage Leases, the lessees, or the Property Managers, generally are required to perform all operational and management functions necessary to operate the Current Hotels. The lessees are entitled to all profits and cash flow from the Current Hotels after payment of rent under the Percentage Leases and other operating expenses, including, in the case of the ten Current Hotels managed by the Property Managers, the management fee payable to the Property Managers. The lessees, their affiliates and the Property Managers may manage other hotel properties in addition to hotels owned by the Company, however, the lessees and their affiliates may not build or develop a hotel or motel within five miles of a hotel owned by the Company and leased by the lessee.
CapStar Winston is a wholly owned subsidiary of MeriStar, a New York Stock Exchange company. As of December 31, 1999, MeriStar, the nation's largest independent hotel management company, leased or managed 225 hotels with 47,046 rooms in 35 states, the District of Columbia, Canada and the U.S. Virgin Islands.
IMIC, a hotel development and management company, operates nine of the Current Hotels under separate management agreements with CapStar Winston. Each year, CapStar Winston pays IMIC a base management fee for each Current Hotel managed by IMIC based on a percentage of the budgeted gross operating profit for that year with incentive amounts based on actual gross operating profits if they exceed budgeted amounts. IMIC has agreed that each year it will spend a specified percentage of the gross revenues of each Current Hotel managed by IMIC on repairs and maintenance of the hotel. CapStar Winston and the Company have retained the right to control the expenditure of funds budgeted for capital and non-routine items, including, at their discretion, approving plans and selecting and overseeing contractors and other vendors. IMIC currently operates 28 hotels in six states, including 24 limited-service hotels and four full-service, convention or resort hotels.
Promus manages one of the Current Hotels under a management agreement with CapStar Winston. Each year, CapStar Winston pays Promus a management fee based on a percentage of the gross operating profit for the hotel managed by Promus with certain incentive amounts.
Bristol, a New York Stock Exchange company, is one of the leading independent hotel operating companies in the United States. As of December 31, 1999, Bristol operated 110 primarily full-service hotels in the upscale and midscale segments of the hotel industry containing more than 30,000 rooms. Bristol is the largest franchisee of Bass Hotels & Resorts (formerly Holiday Hospitality) branded hotels including Crowne Plaza, Holiday Inn, Holiday Inn Select and Holiday Inn Express hotels.
Prime, a New York Stock Exchange company, is one of the nation's premier lodging companies. Prime operates three proprietary brands, AmeriSuites (all-suites), HomeGate Studios & Suites (extended-stay) and Wellesley Inns (limited-service). It also owns and/or manages hotels operated under franchise agreements with national hotel chains. As of December 31, 1999, Prime Hospitality Corporation owned 172 hotels, operated 28 hotels under lease agreements with REITs and managed 10 hotels from third parties.
Franchise Agreements
The Company anticipates that most of the additional hotel properties in which it invests will be operated under franchise licenses. Franchisors provide a variety of benefits for franchisees which include national advertising, publicity and other marketing programs designed to increase brand awareness, training of personnel, continuous review of quality standards and centralized reservation systems.
The hotel franchise licenses generally specify certain management, operational recordkeeping, accounting, reporting and marketing standards and procedures with which the lessees must comply. The franchise licenses obligate the lessees to comply with the franchisors' standards and requirements with respect to training of operational personnel, safety, maintaining specified insurance, the types of services and products ancillary to guest room services that may be provided, display of signs, and the type, quality and age of furniture, fixtures and equipment included in guest rooms, lobbies and other common areas.
Of the Current Hotels' franchise licenses, one expires in 2003, two expire in 2006, two expire in 2007, three expire in 2008, three expire in 2009, two expire in 2010, three expire in 2011, two expire in 2014, one expires in 2015, three expire in 2016, 19 expire in 2017 and 10 expire in 2018. The franchise agreements provide for termination at the franchisor's option upon the occurrence of certain events, including the lessees' failure to pay royalties and fees or perform its other covenants under the franchise agreement, bankruptcy, abandonment of the franchise, commission of a felony, assignment of the franchise without the consent of the franchisor, or failure to comply with applicable law in the operation of the relevant Current Hotel. The lessees are entitled to terminate the franchise license only by giving at least 12 months' notice and paying a specified amount of liquidated damages. The franchise agreements will not renew automatically upon expiration. The lessees are responsible for making all payments under the franchise agreements to the franchisors. Under the franchise agreements, the lessees pay a franchise fee of an aggregate of between 3% and 5% of room revenues, plus additional fees that amount to between 3% and 4% of room revenues from the Current Hotels.
Although CapStar Winston entered into new 10-year franchise agreements for the operation of three Holiday Inn hotels, the Company remains obligated to Holiday Inn for certain liquidated damages in the event of a termination of the Holiday Inn franchise agreements prior to the expiration of the 10-year term. CapStar Winston and its affiliates shall indemnify the Company for certain obligations arising from CapStar Winston or its affiliates' failure to satisfy certain conditions in its franchise agreements with Holiday Inn.
Competition
The hotel industry is highly competitive with various participants competing on the bases of price, level of service and geographic location. The Current Hotels compete with other hotel properties in their geographic markets. Some of the Company's competitors may have greater marketing and financial resources than the Company, the lessees, and the Property Managers. Several of the Current Hotels are located in areas in which they may compete with other Current Hotels for business. The Company competes for acquisition opportunities with entities that may have greater financial resources than the Company. These entities may generally be able to accept more risk than the Company can prudently manage, including risks with respect to the creditworthiness of a hotel operator.
Employees
The Company had 27 employees as of February 28, 2000.
Environmental Matters
Under various federal, state and local laws and regulations, an owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on such property. Such laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of hazardous or toxic substances. Furthermore, a person that arranges for the disposal or transports for disposal or treatment of a hazardous substance at another property may be liable for the costs of removal or remediation of hazardous substances released into the environment at that property. The costs of remediation or removal of such substances may be substantial, and the presence of such substances, or the failure to promptly remediate such substances, may adversely affect the owner's ability to use or sell such real estate or to borrow using such real estate as collateral. Certain environmental laws and common law principles could be used to impose liability for the release of and exposure to hazardous substances, including asbestos-containing materials ("ACMs") into the air, and third parties may seek recovery from owners or operators of real properties for personal injury or property damage associated with exposure to released hazardous substances, including ACMs. In connection with the ownership and operation of the Current Hotels, the Company, the lessees, or the Property Managers, as the case may be, may be potentially liable for such costs.
Phase I environmental site assessments ("ESAs") were obtained on all of the Current Hotels. The Phase I ESAs were intended to identify potential sources of contamination for which the Current Hotels may be responsible and to assess the status of environmental regulatory compliance. The Phase I ESAs included historical reviews of the Current Hotels, reviews of certain public records, preliminary investigations of the sites and surrounding properties, screening for the presence of asbestos, PCBs and underground storage tanks, and the preparation and issuance of a written report. The Phase I ESAs did not include invasive procedures, such as soil sampling or ground water analysis. The Phase I ESA reports have not revealed any environmental condition, liability or compliance concern that the Company believes would have a material adverse effect on the Company's business, assets or results of operations, nor is the Company aware of any such condition, liability or compliance concern. Nevertheless, it is possible that these reports do not reveal all environmental conditions, liabilities or compliance concerns or that there are material environmental conditions, liabilities or compliance concerns that arose at a Current Hotel after the related Phase I ESA report was completed of which the Company is unaware. Moreover, no assurances can be given that (i) future laws, ordinances or regulations will not impose any material environmental liability, or (ii) the current environmental condition of the Current Hotels will not be affected by the condition of the properties in the vicinity of the Current Hotels (such as the presence of leaking underground storage tanks) or by third parties unrelated to the Company.
The Company believes that the Current Hotels are in compliance in all material respects with all federal, state and local laws, ordinances and regulations regarding hazardous or toxic substances and other environmental matters. The Company has not been notified by any governmental authority of any material noncompliance, liability or claim relating to hazardous or toxic substance or other environmental substances in connection with any of its properties.
Tax Status
The Company elected to be taxed as a REIT under Sections 856-860 of the Internal Revenue Code of 1986, as amended, effective for its short taxable year ended December 31, 1994. The Company believes that it qualifies for taxation as a REIT, and with certain exceptions, the Company will not be subject to tax at the corporate level on its taxable income that is distributed to the shareholders of the Company. A REIT is subject to a number of organizational and operational requirements, including a requirement that it currently distribute at least 95% of its annual taxable income. For taxable years beginning after December 31, 2000, the annual taxable income
distribution requirement has been lowered to 90%. Failure to qualify as a REIT will render the Company subject to federal income tax (including any applicable minimum tax) on its taxable income at regular corporate rates and distributions to the shareholders in any such year will not be deductible by the Company. Although the Company does not intend to request a ruling from the Internal Revenue Service (the "Service") as to its REIT status, the Company has obtained the opinion of its legal counsel that the Company qualifies as a REIT, which opinion is based on certain assumptions and representations and is not binding on the Service or any court. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and properties.
Seasonality
The Current Hotels' operations historically have been seasonal in nature, reflecting higher REVPAR during the second and third quarters. This seasonality and the structure of the Percentage Leases, which provide for a higher percentage of room revenues above stated equal quarterly levels to be paid as Percentage Rent, can be expected to cause fluctuations in the Company's quarterly lease revenue under the Percentage Leases.
Investments by Executive Management and Board of Directors
On October 29, 1999, the Company's Chief Executive Officer, Robert W. Winston, III, and several members of WHI's Board of Directors, purchased an aggregate of 594,950 shares of WHI's Common Stock, or approximately 3.5% of the total shares outstanding as of December 31, 1999.
Executive Officers of the Registrant
The following table lists the executive officers of the Company:
CHARLES M. WINSTON. Charles Winston has served as Chairman of the Board of Directors since March 15, 1994. Mr. Winston is a native of North Carolina and a graduate of the University of North Carolina at Chapel Hill with an A.B. degree. Mr. Winston has more than 36 years of experience in developing and operating full service restaurants. Mr. Winston is Robert Winston's father and brother of James Winston, a director.
ROBERT W. WINSTON, III. Robert Winston has served as Chief Executive Officer and Director of the Company since March 15, 1994. Mr. Winston served as the Company's President from March 15, 1994 through January 14, 1999 and as Secretary for the periods from March 1994 through May 1995 and from October 1997 until May 5, 1998. Mr. Winston is a native of North Carolina and a graduate of the University of North Carolina at Chapel Hill with a B.A. degree in economics. Mr. Winston is Charles Winston's son and James Winston's nephew.
JAMES D. ROSENBERG. Mr. Rosenberg assumed the title of President on January 14, 1999. Mr. Rosenberg has also served as Chief Operating Officer since January 5, 1998, Secretary since May 5, 1998, and served as Chief Financial Officer from January 5, 1998 through May 18, 1999. Mr. Rosenberg is a CPA and a graduate of Presbyterian College and received an MBA from the University of South Carolina. Prior to joining the Company, Mr. Rosenberg held the position of Senior Vice President with Holiday Inn Worldwide since 1994 where he was responsible for managing 85 hotels in seven countries. Prior to joining the Holiday Inn organization, Mr. Rosenberg was a partner in Sage Hospitality Resources and served as Executive Vice President and Chief Financial Officer of the Denver-based hospitality firm.
JOSEPH V. GREEN. Mr. Green assumed the title of Executive Vice President, Chief Financial Officer on May 18, 1999. Mr. Green has also served as Executive Vice President - Acquisitions and Finance from January 1, 1998 through May 18, 1999, after having advised Winston Hospitality, Inc. on matters regarding hotel acquisitions and finance since 1993, including the initial public offering of WHI. Mr. Green is a graduate of East Carolina University, was awarded his J.D. degree from Wake Forest University School of Law and received a Master of Laws in Taxation from Georgetown University.
KENNETH R. CROCKETT. Mr. Crockett was appointed Senior Vice President of Development of the Company in September 1995 and Executive Vice President of Development in January 1998. Mr. Crockett is a graduate of the University of North Carolina at Chapel Hill with a B.S. degree in Business Administration. Prior to joining the Company, Mr. Crockett was an Associate Partner for project development in commercial real estate at Capital Associates, a real estate development firm located in the Raleigh, North Carolina area.
ITEM 2.
ITEM 2. PROPERTIES
The following table sets forth certain unaudited pro forma information with respect to the Current Hotels:
* Hotel opened during 1998. # Hotel acquired during 1998.
THE PERCENTAGE LEASES
In order for the Company to qualify as a REIT, the Partnership cannot operate hotels. Therefore, the Partnership leases the Current Hotels for terms of 10 or 15 years pursuant to Percentage Leases, which provide for rent equal to the greater of Base Rent or Percentage Rent. The Percentage Leases for the Current Hotels contain the provisions described below. The Company intends that future leases with respect to its hotel property investments will contain substantially similar provisions, although the Company may, in its discretion, alter any of these provisions with respect to any particular lease, depending on the purchase price paid, economic conditions and other factors deemed relevant at the time.
Percentage Lease Terms
Each Percentage Lease for the Current Hotels has a non-cancelable term of 10 or 15 years, subject to earlier termination upon the occurrence of certain contingencies described in the Percentage Lease.
Amounts Payable under the Percentage Leases
During the term of each Percentage Lease, the lessees are or will be obligated to pay (i) the greater of Base Rent or Percentage Rent and (ii) certain other additional charges. Base Rent accrues and is required to be paid monthly. Percentage Rent consists of minimum percentage rent and excess percentage rent, if any. Minimum percentage rent is calculated based primarily on the amount of room revenue up to a predetermined threshold per the lease. The percentage, which differs by hotel, is multiplied by this amount to calculate minimum percentage rent. These percentages range from 23% to 81%. Excess percentage rent is calculated based primarily on the amount of any room revenue in excess of the predetermined threshold mentioned above. The percentage, which differs by hotel, is multiplied by this amount to calculate excess percentage rent. These percentages range from 5% to 80%. For most leases, the percentage used to calculate excess percentage rent exceeds the percentage used to calculate the minimum percentage rent. Percentage Rent is due either monthly or quarterly.
Beginning in the fiscal year following the year in which most Percentage Leases commence, and for each fiscal year thereafter, (i) the annual Base Rent and (ii) the Percentage Rent formulas will be adjusted on a quarterly or annual basis for inflation, based on changes in the CPI. The adjustment in any quarter may not exceed 2%, which may be less than the change in CPI for the quarter.
Other than real estate and personal property taxes, casualty insurance, capital improvements and maintenance of underground utilities and structural elements, which are obligations of the Company, the Percentage Leases require the lessees to pay rent, insurance, all costs and expenses and all utility and other charges incurred in the operation of the Current Hotels. The Percentage Leases also provide for rent reductions and abatements in the event of damage to, destruction of or a partial taking of any Current Hotel.
Maintenance and Modifications
Under the Percentage Leases, the Company is required to maintain the underground utilities and the structural elements of the improvements, including exterior walls (excluding plate glass) and the roof of such Current Hotel. In addition, the Percentage Leases obligate the Company to fund periodic capital improvements (in addition to maintenance of underground utilities and structural elements) to the buildings and grounds comprising their respective Current Hotels, and the periodic repair, replacement and refurbishment of furniture, fixtures and equipment in their respective Current Hotels, up to an amount equal to 5% of room revenues (7% of room revenues and food and beverage revenue for one of its full-service hotels). These obligations will be carried forward to the extent that the lessees have not expended such amounts, and any unexpended amounts will remain the property of the Company upon termination of the Percentage Leases. Except for capital improvements and maintenance of structural elements and underground utilities, the lessees are required, at their expense, to maintain the Current Hotels in good order and repair, except for ordinary wear and tear, and to make non-structural, foreseen and unforeseen, and ordinary and extraordinary repairs which may be necessary and appropriate to keep the Current Hotels in good order and repair.
The lessees are not obligated to bear the cost of capital improvements to the Current Hotels. With the consent of the Company, however, the lessees, at their expense, may make non-capital and capital additions, modifications or improvements to the Current Hotels, provided that such action does not significantly alter the character or purposes of the Current Hotels or significantly detract from the value or operating efficiencies of the Current Hotels. All such alterations, replacements and improvements shall be subject to all the terms and provisions of the Percentage Leases and will become the property of the Company upon termination of the Percentage Leases. The Company owns or will own substantially all personal property not affixed to, or deemed a part of, the real estate or improvements thereon comprising the Current Hotels, except to the extent that ownership of such personal property would cause the rents under the Percentage Leases not to qualify as "rents from real property" for REIT income test purposes.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Other than the matter described below, the Company currently is not involved in any pending legal proceedings, other than ordinary routine litigation incidental to the business, nor are any such proceedings known to be contemplated by governmental authorities. The lessees have advised the Company that they currently are not involved in any material pending litigation, other than routine litigation arising in the ordinary course of business, substantially all of which is expected to be covered by liability insurance.
On July 16, 1999, Walton Construction Company, Inc. ("Walton") filed a civil lawsuit in the State Court of Fulton County Georgia naming the Partnership as defendant. The Partnership removed the action to the United States District Court for the Northern District of Georgia on August 30, 1999. The complaint alleges that the Partnership has not paid approximately $2,500,000 due under a contract entered into by the parties in connection with the construction of the Partnership's Alpharetta, Georgia Homewood Suites Hotel. The Partnership disputes that such monies are due to Walton based upon Walton's alleged inability to complete construction on the hotel within the time set out in the construction contract. The Partnership has also filed counterclaims against Walton arising out of the construction delays and construction deficiencies allegedly caused by Walton. On August 2, 1999, Walton initiated a virtually identical action in the United States District Court for the Eastern District of North Carolina. On February 29, 2000, the Partnership answered Walton's complaint and counterclaimed for recovery of damages due to the construction delays and construction deficiencies allegedly caused by Walton. Simultaneously, the Partnership also filed a third party action against Walton's surety for recovery on a performance bond.
The Partnership believes that it has substantial and meritorious defenses against the claims alleged against it, and the Partnership intends to vigorously defend against these claims and pursue its own claims.
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 ended December 31, 1999.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY
WHI's Common Stock trades on the New York Stock Exchange ("NYSE") under the symbol "WXH." As of March 15, 2000, WHI had approximately 11,700 common shareholders based on the number of shareholders of record and an estimate of the number of participants represented by security position listings. The following table sets forth, for the indicated periods, the high and low closing prices for the Common Stock and the cash distributions declared per share:
Although the declaration of distributions is within the discretion of the Board of Directors and depends on the Company's results of operations, cash available for distribution, the financial condition of the Company, tax considerations (including those related to REITs) and other factors considered important by the Board of Directors, the Company's policy is to make regular quarterly distributions to its shareholders.
RECENT SALES OF UNREGISTERED SECURITIES
On October 2, 1999, WHI issued 440,100 shares of WHI Common Stock to Quantum Realty Partners, II, L.P. in exchange for 440,100 units of limited partnership in the Partnership. The WHI Common Stock was issued in reliance on a claim of exemption pursuant to Section 4(2) of the Securities Act of 1933, as amended.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial information for the Company for the years ended December 31, 1999, 1998, 1997, 1996, and 1995 and selected historical balance sheet data as of December 31, 1999, 1998, 1997, 1996, and 1995. This information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included elsewhere in this report.
WINSTON HOTELS, INC. SELECTED HISTORICAL FINANCIAL AND OTHER DATA FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, 1997, 1996 AND 1995 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(1) Funds from operations, as defined by the National Association of Real Estate Investment Trusts, is income (loss) before minority interest (determined in accordance with generally accepted accounting principles), excluding gains (losses) from debt restructuring and sales of properties, plus real estate-related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures.
The following table sets forth selected financial information for CapStar Winston for the years ended December 31, 1999 and 1998 and the period October 15, 1997 (date of inception) through December 31, 1997. This information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto included elsewhere in this report.
CAPSTAR WINSTON COMPANY, L.L.C. SELECTED HISTORICAL FINANCIAL DATA FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 AND THE PERIOD OCTOBER 15, 1997 (DATE OF INCEPTION) THROUGH DECEMBER 31, 1997 (IN THOUSANDS)
The following table sets forth selected financial information for Winston Hospitality, Inc. for the ten months ended October 31, 1997 and 1996 and the years ended December 31, 1996 and 1995. This information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto included elsewhere in this report.
WINSTON HOSPITALITY, INC. SELECTED HISTORICAL FINANCIAL DATA FOR THE TEN-MONTHS ENDED OCTOBER 31, 1997 AND 1996 AND THE YEARS ENDED DECEMBER 31, 1996 AND 1995 (IN THOUSANDS)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Winston Hotels, Inc. ("WHI") operates so as to qualify as a real estate investment trust ("REIT") for federal income tax purposes. During 1994, WHI completed an initial public offering of $0.01 par value common stock ("Common Stock"), utilizing the majority of the proceeds to acquire one hotel and a general partnership interest (as the sole general partner) in WINN Limited Partnership (the "Partnership"). The Partnership used a substantial portion of the proceeds to acquire nine hotel properties (collectively the ten hotels are the "Initial Hotels"). The Initial Hotels were acquired from affiliates of WHI. WHI and the Partnership (collectively the "Company") began operations as a REIT on June 2, 1994.
During 1995 and 1996, WHI completed follow-on Common Stock offerings, as well as a Preferred Stock offering in September 1997, and invested the net proceeds from these offerings in the Partnership. The Partnership utilized the proceeds to acquire 28 additional hotel properties. The Company owned 31 hotels as of December 31, 1996 and acquired seven hotels in 1997 (the "1997 Hotels"). During 1998, the Company added 13 additional properties to its portfolio, five of which were internally developed (the "1998 Hotels") (see Note 4 to the consolidated financial statements). As of December 31, 1999, WHI's ownership in the Partnership was 92.83% (see Note 7 to the consolidated financial statements). As of December 31, 1999, the Company owned 51 hotel properties (the "Current Hotels"), in 13 states, having an aggregate of 6,904 rooms. Forty-nine of the Current Hotels were leased, pursuant to separate percentage operating lease agreements (the "Percentage Leases"), to CapStar Winston Company, L.L.C. ("CapStar Winston"), one was leased to Bristol Hotels and Resorts, Inc. and one was leased to Prime Hospitality Corp.
Prior to November 17, 1997, the Current Hotels were leased pursuant to the Percentage Leases to Winston Hospitality, Inc. On November 17, 1997 and November 24, 1997, CapStar Management Company, L.P. purchased substantially all of the assets and assumed certain liabilities of Winston Hospitality, Inc., including all 38 of the then existing Current Hotels' leases. Concurrent with this transaction, the leases were assigned to CapStar Winston, an affiliate of CapStar Management Company, L.P., and the terms of the leases were extended to 15 years from the date of the transaction.
CapStar Winston is a wholly owned subsidiary of MeriStar Hotels and Resorts, Inc. ("MeriStar"). As of December 31, 1999, MeriStar, the nation's largest independent hotel management company, leased or managed 225 hotels with 47,046 rooms in 35 states, the District of Columbia, Canada and the U.S. Virgin Islands.
RESULTS OF OPERATIONS
For the periods ended December 31, 1999, 1998, and 1997, the differences in operating results are primarily attributable to the stabilization of the 1998 Hotels and the full year of operations of those hotels in 1999 versus the partial year of operations in 1998. The table below outlines the Company's hotel properties owned as of December 31, 1999, 1998 and 1997:
* Five of the total 13 hotels added in 1998 were internally developed properties.
In order to present a more meaningful comparison of operations, the following comparisons are presented:
THE COMPANY: - actual operating results for the year ended December 31, 1999 versus actual operating results for the year ended December 31, 1998; - actual operating results for the year ended December 31, 1998 versus actual operating results for the year ended December 31, 1997; - actual operating results for the year ended December 31, 1999 versus pro forma operating results for the year ended December 31, 1998, as if the addition of the 1998 Hotels occurred on the later of January 1, 1998 or the hotel opening date (the Company made no acquisitions in 1999, therefore the pro forma 1999 results of operations would be identical to the actual 1999 results of operations); - pro forma operating results for the year ended December 31, 1998 versus pro forma operating results for the year ended December 31, 1997, as if the Preferred Stock offering and the addition of the 1998 Hotels and 1997 Hotels occurred on the later of January 1, 1997 or the hotel opening date.
CAPSTAR WINSTON COMPANY, L.L.C.: - actual operating results for the year ended December 31, 1999 versus actual operating results for the year ended December 31, 1998; - Since CapStar Winston operated for a partial year in 1997 (November and December) and for a full year in 1998, the operating results of these two periods are very different and difficult to compare. Thus, no management discussion and analysis will be included herein. (See Item 14 for CapStar Winston's financial statement disclosure.)
THE COMPANY
ACTUAL - YEAR ENDED DECEMBER 31, 1999 VERSUS ACTUAL - YEAR ENDED DECEMBER 31,
The Company had revenues of $62,310 in 1999, consisting of $61,877 of Percentage Lease revenues and $433 of interest and other income. Percentage Lease revenues increased $7,177, or 13%, in 1999 from $54,700 in 1998. This increase was primarily attributable to an increase in lease revenues from the 1998 Hotels due to a full year of operations in 1999 versus a partial year of operations in 1998, partially offset by a decrease of $1,160 in lease revenue generated from the hotels owned as of December 31, 1997, which decrease was primarily attributable to competitive pressures.
Real estate taxes and property and casualty insurance expenses incurred in 1999 were $5,996, an increase of $979 from $5,017 in 1998. The increase was primarily attributable to a full year of operations for the 1998 Hotels in 1999 versus a partial year in 1998. General and administrative expenses increased $347 to $4,236 in 1999 from $3,889 in 1998. The increase was primarily attributable to an increase in the number of employees and related compensation expense throughout the year, costs associated with efforts to form joint ventures and costs associated with efforts to sell certain hotels. Interest expense increased $4,199 to $12,513 in 1999 from $8,314 in 1998, primarily due to an increase in weighted-average outstanding borrowings from $127,776 in 1998 to $178,038 in 1999, and a decrease of capitalized interest of $1,350 from $1,513 in 1998 to $163 in 1999. Annual weighted-average interest rates decreased 0.58% from 7.63% in 1998 to 7.05% in 1999. Depreciation expense increased $4,176 to $20,565 in 1999 from $16,389 in 1998, primarily due to depreciation related to the 1998 Hotels and renovations completed during 1999 and 1998. Amortization expense increased $369 to $834 in 1999 from $465 in 1998. The increase is primarily attributable to an increase in amortization of deferred financing costs associated with the Company's new $140,000 line of credit, which originated in February 1999, and the Company's $71,000 GE Capital Corporation loan which originated in November 1998.
ACTUAL - YEAR ENDED DECEMBER 31, 1998 VERSUS ACTUAL - YEAR ENDED DECEMBER 31,
The Company had revenues of $54,949 in 1998, consisting of $54,700 of Percentage Lease revenues and $249 of interest and other income. Percentage Lease revenues increased $18,832, or 53%, in 1998 from $35,868 in 1997. This increase was attributable to (i) $12,132 related to the 1998 Hotels; (ii) $6,479 related to the 1997 Hotels owned for the entire 12-month period in 1998; and (iii) $221 in lease revenues generated from the hotels owned as of December 31, 1996.
Real estate taxes and property and casualty insurance expenses incurred in 1998 were $5,017, an increase of $2,315 from $2,702 in 1997. $940 of this increase was attributable to the 1998 Hotels and $813 was due to the 1997 Hotels that were owned for the entire 12-month period in 1998. The remaining increase was due to an increase in assessed values and rates. General and administrative expenses increased $1,794 to $3,889 in 1998 from $2,095 in 1997. The increase was primarily attributable to (i) an increase in the number of employees and related compensation expense throughout the year; (ii) costs related to the increase in size and activities of the Company in 1998 over 1997; as well as (iii) advertising costs associated with the opening of five internally developed hotels during 1998. Interest expense increased $5,666 to $8,314 in 1998 from $2,648 in 1997, primarily due to an increase in weighted-average outstanding borrowings from $48,842 in 1997 to $127,776 in 1998. This increase was due to the borrowings necessary to acquire and develop the 1998 Hotels as well as an increase in renovation activity in 1998. Interest rates remained relatively flat from 1997 to 1998. Depreciation expense increased $6,325 to $16,389 in 1998 from $10,064 in 1997, primarily due to depreciation related to the 1998 Hotels, the 1997 Hotels and renovations completed during 1998 and 1997.
ACTUAL - YEAR ENDED DECEMBER 31, 1999 VERSUS PRO FORMA - YEAR ENDED DECEMBER 31, 1998
The Company had revenues of $62,310 for the year ended December 31, 1999, consisting of $61,877 of Percentage Lease revenues and $433 of interest and other income. Percentage Lease revenues increased $5,476, or 10%, to $61,877 in 1999 from $56,401 in 1998. This increase was primarily attributable to the opening of 10 hotel properties in 1998 (the "1998 New Hotels"), partially offset by a decrease of $935 in lease revenue generated from the hotels owned as of December 31, 1997, which decrease was primarily attributable to competitive pressures.
Real estate taxes and property and casualty insurance expenses incurred in 1999 were $5,996, an increase of $739 from $5,257 in 1998. The increase was primarily attributable to the 1998 New Hotels and an increase in tax rates and assessed values in 1999. General and administrative expenses increased $338 to $4,236 in 1999 from $3,898 in 1998. The increase was primarily attributable to an increase in the number of employees and related compensation expense throughout the year, costs associated with efforts to form joint ventures and costs associated with efforts to sell certain hotels. Interest expense increased $3,602 to $12,513 in 1999 from $8,911 in 1998. The increase was primarily due to an increase in weighted-average borrowings from $137,932 in 1998 to $178,038 in 1999, offset by a decrease of capitalized interest of $1,350 from $1,513 in 1998 to $163 in 1999. Interest rates decreased 0.58% from 7.63% in 1998 to 7.05% in 1999. Depreciation expense increased $3,845 to $20,565 in 1999 from $16,720 in 1998, primarily due to additional depreciation related to the 1998 New Hotels and renovations completed during 1999 and 1998. Amortization expense increased $372 to $834 in 1999 from $462 in 1998. The increase is primarily attributable to an increase in amortization of deferred financing costs associated with the Company's new $140,000 line of credit, which originated in February 1999, and the Company's $71,000 GE Capital Corporation loan, which originated in November 1998.
PRO FORMA - YEAR ENDED DECEMBER 31, 1998 VERSUS PRO FORMA - YEAR ENDED DECEMBER 31, 1997
The Company had pro forma revenues of $56,650 for the year ended December 31, 1998, consisting of $56,401 of pro forma Percentage Lease revenues and $249 of pro forma interest and other income. Pro forma Percentage Lease revenues increased $8,781, or 18%, to $56,401 in 1998 from $47,620 in 1997. Of this increase, $7,667 was attributable to the 1998 New Hotels and the remaining increase of $1,114 was primarily due to an increase in room rates in 1998 from 1997.
Pro forma real estate taxes and property and casualty insurance expenses incurred in 1998 were $5,257, an increase of $1,163 from $4,094 in 1997. This increase was primarily attributable to the 1998 New Hotels and an increase in tax rates and assessed values in 1998. Pro forma general and administrative expenses increased $1,730 to $3,898 in 1998 from $2,168 in 1997. The increase was primarily attributable to (i) an increase in the number of employees and related compensation expense throughout the year; (ii) costs related to the increase in size and activities of the Company in 1998 over 1997; as well as (iii) pre-opening advertising costs associated with the opening of five internally developed hotels during 1998. Pro forma interest expense increased $5,269 to $8,911 in 1998 from $3,642 in 1997. The increase was primarily due to an increase in weighted average borrowings from $68,957 in 1997 to $137,932 in 1998, which resulted from borrowings made to acquire and develop the 1998 New Hotels. Interest rates remained flat from 1997 to 1998. Pro forma depreciation expense increased $4,262 to $16,720 in 1998 from $12,458 in 1997, primarily due to additional depreciation related to the 1998 New Hotels and renovations completed during 1998 and 1997.
CAPSTAR WINSTON COMPANY, L.L.C.
ACTUAL - YEAR ENDED DECEMBER 31, 1999 VERSUS ACTUAL - YEAR ENDED DECEMBER 31,
Total revenue increased $16,082 or 12.8%, to $141,715 from $125,633. This increase was primarily related to an increase in room revenues of $14,120 or 12.4%, to $127,571 from $113,451. The increase in room revenues was due to an increase of $14,058 for the 1998 Hotels and an increase of $62 for all other hotels. Food and beverage revenue increased $1,939 to $8,732 in 1999 from $6,793 in 1998, primarily due to increased revenue from the 1998 Hotels.
Total expenses increased $15,791 or 12.6%, to $140,828 from $125,037. This increase was primarily related to increased expenses generated by the 1998 Hotels.
Net income increased $291, to $887 from $596, primarily driven by the operating results of the 1998 Hotels.
REVENUE RECOGNITION AND IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS TO BE ADOPTED IN 2000
In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101") which provides guidance on revenue recognition. SAB 101 is effective for fiscal years beginning after December 15, 1999. SAB 101 requires that a lessor not recognize contingent rental income until annual specified hurdles have been achieved by the lessee. During 1999 and prior years, the Company has recognized contingent rentals throughout the year since it was considered probable that the lessee would exceed the annual specified hurdles. The Company has reviewed the terms of its Percentage Leases and has determined that the provisions of SAB 101 materially impact the Company's revenue recognition on an interim basis, effectively deferring the recognition of revenue from its Percentage Leases from the first and second quarters of the calendar year to the third and fourth quarters. SAB 101 will impact the Company's revenue recognition on an annual basis, although to a much lesser degree, as seven of the Company's Percentage Leases have fiscal year ends which differ from the Company's calendar year end. SAB 101 will have no impact on the Company's interim or annual cash flow from its third party lessees, and therefore on its ability to pay dividends. The Company will account for SAB 101 as a change in accounting principle effective January 1, 2000.
LIQUIDITY AND CAPITAL RESOURCES
The Company finances its operations from operating cash flow, which is principally derived from Percentage Leases. For the year ended December 31, 1999, cash flow provided by operating activities was $39,952 and funds from operations, which is equal to net income before allocation to minority interest (excluding gains/losses on sales of property), plus depreciation, less preferred share distributions, was $31,793. Under federal income tax law provisions applicable to REITs, the Company is required to distribute at least 95% of its taxable income to maintain its tax status as a REIT. For taxable years beginning after December 31, 2000, the taxable income distribution requirement has been lowered to 90%. In 1999, the Company declared distributions of $25,388 to its shareholders. Because the Company's cash flow from operating activities is expected to exceed its taxable income due to depreciation and amortization expenses, the Company expects to be able to meet its distribution requirements out of cash flow from operating activities.
The Company's net cash used in investing activities during the year ended December 31, 1999 totaled $12,658, primarily relating to capital expenditures and renovation of hotels. During 1999, the Company spent $16,179 or 12.0% of the lessees' room revenue, in connection with the renovation of its Current Hotels. These capital expenditures were well in excess of the 5% of room revenues for its hotels (7% of room revenues and food and beverage revenues for one of its full service hotels) which the Company is required to spend under its Percentage Leases for periodic capital improvements and the refurbishment and replacement of furniture, fixtures and equipment at its Current Hotels. These capital expenditures are funded from operating cash flow, and possibly from borrowings under the Company's $140,000 line of credit, sources which are expected to be adequate to fund such capital requirements. These capital expenditures are in addition to amounts spent on normal repairs and maintenance which have approximated 5.5% and 5.3% of room revenues in 1999 and 1998, respectively, and are paid by the lessees.
During 1999, the Company sold two land parcels previously held for development. Total proceeds received were $3,789, resulting in a loss of $239. Also during 1999, the Company entered into a joint venture agreement with Regent Partners, Inc. (the "Joint Venture") to jointly develop hotel properties. As of December 31, 1999, the Company had invested $183 in the Joint Venture. The first hotel to be developed by the Joint Venture, a full service 158-room Hilton Garden Inn at Windsor, CT, is scheduled to open during the third quarter of 2000. The second hotel to be developed by the Joint Venture, a full-service 177-room Hilton Garden Inn in the Chicago suburb of Evanston, is scheduled to open before the holiday season in 2001. The Company continues to seek additional joint venture opportunities with other business partners.
On February 15, 2000, the Company sold its Comfort Suites hotel in London, KY. Sales proceeds received by the Company totaled $2,497, resulting in a net loss of $265. The Company also is considering the sale of certain other non-core hotels that lie outside the Company's upscale segment focus and plans to use the proceeds to reduce debt.
The Company's net cash used in financing activities during the year ended December 31, 1999 totaled $27,299. This net use of cash was primarily due to the payment of distributions to shareholders of $25,248 and the payment of distributions to the Partnership's minority interest of $1,947. This amount also includes payments for financing fees totaling $1,445 primarily related to the Company's $140,000 line of credit, principal payments totaling $1,025 related to the Company's $71,000 fixed rate note, and $49 to register additional common shares. These payments were offset by a net increase in amounts outstanding under the $140,000 line of credit of $2,415.
On February 1, 1999, the Company entered into a new three-year, $140,000 line of credit agreement with a group of four banks led by Wachovia Bank, N.A. The Company has collateralized the line of credit with 29 of its Current Hotels. The line of credit bears interest generally at rates from LIBOR plus 1.45% to LIBOR plus 1.70%, based primarily upon the Company's level of total indebtedness. The Company's current rate is LIBOR plus 1.45%. As of December 31, 1999, total outstanding debt under the line of credit was $104,500.
The Line is used primarily to fund the Company's hotel acquisitions, development and major renovations. Pursuant to the Company's operating strategies, it maintains minimal cash balances and is substantially dependent upon, among other things, the availability of adequate financing to support hotel acquisitions, development and major renovations.
The Company had $69,975 in debt at December 31, 1999 that was subject to a fixed interest rate and fixed monthly payments. This debt, a ten-year loan with a 25-year amortization period, with GE Capital Corporation, carries an interest rate of 7.375% for the first 10 years. All unpaid principal and interest are due on December 1, 2008. The GE Capital loan is collateralized with 14 of the Company's Current Hotels.
On May 18, 1999, at the Annual Meeting of Shareholders, the Company's shareholders approved an amendment to the Company's Articles of Incorporation to increase the limit of its level of permitted indebtedness from 45% to 60% of investments in hotel properties, at cost. This change should provide the Company with greater financial flexibility and should allow the Company to be better positioned to acquire or develop hotel properties when attractive opportunities are available.
The Company intends to acquire and develop additional hotel properties that meet its investment criteria and is continually evaluating acquisition opportunities. It is expected that future hotel acquisitions will be financed, in whole or in part, from additional follow-on offerings, from borrowings under the line of credit, from joint venture agreements, from the sale of hotel properties and/or from the issuance of other debt or equity securities. There can be no assurances that the Company will make an investment in any additional hotel properties that meet its investment criteria.
SEASONALITY
The Company's operations historically have been seasonal in nature, reflecting higher REVPAR during the second and third quarters. This seasonality and the structure of the Percentage Leases, which provide for a higher percentage of room revenues above the minimum equal quarterly levels to be paid as Percentage Rent, can be expected to cause fluctuations in the Company's quarterly lease revenue under the Percentage Leases.
FORWARD LOOKING STATEMENTS
This report contains certain "forward looking" statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. You can identify these statements by use of words like "may," "will," "expect," "anticipate," "estimate," or "continue" or similar expressions. These statements represent the Company's judgment and are subject to risks and uncertainties that could cause actual operating results to differ materially from those expressed or implied in the forward looking statements, including but not limited to the risk that properties held for sale will not sell, financing risks, development risks including risk of construction delay, cost overruns, occupancy rates, average daily rates, governmental permits, zoning, the increase of development costs in connection with projects that are not pursued to completion, and the other risk factors described in Exhibit 99.1 attached to this report.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 1999, the Company's exposure to market risk for a change in interest rates related solely to debt outstanding under its $140,000 line of credit (the "Line"). Debt outstanding under the Line totaled $104,500 at December 31, 1999. The Line, which expires in February 2002, bears interest generally at rates from LIBOR plus 1.45% to LIBOR plus 1.70%, based, in part, on the Company's level of total indebtedness. The Company's current interest rate is LIBOR plus 1.45%. During 1999, the Company entered into an interest rate cap agreement to eliminate the exposure to increases in 30-day LIBOR over 7.50%, and therefore from its exposure to interest rate increases over 8.95% under the Line on a principal balance of $25,000 for the period of March 23, 1999 through March 25, 2002. The weighted average interest rate on the Line for 1999 was 6.84%. (See Note 6 to the consolidated financial statements.) The definitive extent of the Company's interest rate risk under the Line is not quantifiable or predictable because of the variability of future interest rates and business financing requirements. The Line, combined with the fixed-rate $71,000 loan with GE Capital Corporation, provides the Company with a maximum borrowing capacity of $211,000. The Company does not enter into derivative or interest rate transactions for speculative purposes.
The following table presents the aggregate maturities and historical cost amounts of the fixed debt principal and interest rates by maturity dates at December 31, 1999:
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required by this Item 8 are filed with this report on Form 10-K immediately following the signature page and are listed in Item 14 of this report on Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information on the Company's directors is incorporated by reference from pages 5 and 6, "Proposal 1 - Election of Directors", in the Company's Proxy Statement to be filed with respect to the Annual Meeting of Shareholders to be held May 9, 2000. Information on the Company's executive officers is included under the caption "Executive Officers of the Registrant" on pages 7 and 8 of this report on Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
This information is incorporated by reference from pages 8 through 12, "Executive Compensation", in the Company's Proxy Statement to be filed with respect to the Annual Meeting of Shareholders to be held May 9, 2000.
ITEM 12.
ITEM 12. SHARE OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS
This information is incorporated by reference from pages 2 through 4, "Share Ownership of Management and Certain Beneficial Owners", in the Company's Proxy Statement to be filed with respect to the Annual Meeting of Shareholders to be held May 9, 2000.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is incorporated by reference from page 14, "Certain Relationships and Related Transactions", in the Company's Proxy Statement to be filed with respect to the Annual Meeting of Shareholders to be held May 9, 2000.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K
(a) FINANCIAL STATEMENTS AND SCHEDULES. The financial statements and schedules listed below are included in this report.
(B) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the fourth quarter of 1999.
(c) EXHIBITS. The exhibits required by Item 601 of Regulation S-K are listed below. Management contracts or compensatory plans are filed as Exhibits 10.9, 10.12, 10.13 and 10.16.
(1) Exhibits to the Company's Registration Statement on Form S-11 as filed with the Securities and Exchange Commission (Registration No. 33-76602) effective May 25, 1994 and incorporated herein by reference.
(2) Exhibits to the Company's Registration Statement on Form S-11 as filed with the Securities and Exchange Commission (Registration No. 33-91230) effective May 11, 1995 and incorporated herein by reference.
(3) Exhibit to the Company's report on Form 8-K as filed with the Securities and Exchange Commission on July 24, 1997 and incorporated herein by reference.
(4) Exhibits to the Company's report on Form 8-K as filed with the Securities and Exchange Commission on September 15, 1997 and incorporated herein by reference.
(5) Exhibits to the Company's report on Form 8-K as filed with the Securities and Exchange Commission on December 10, 1997 and incorporated herein by reference.
(6) Exhibits to the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 27, 1998 and as amended by Form 10-K/A filed with the Securities and Exchange Commission on April 1, 1998.
(7) Exhibit to the Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on July 29, 1998 (Registration No. 333-60079) and incorporated herein by reference.
(8) Exhibits to the Company's Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on November 16, 1998 and as amended on Form 10-Q/A filed with the Securities and Exchange Commission on February 23, 1999 and incorporated herein by reference.
(9) Exhibits to the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 25, 1999 and incorporated herein by reference.
(10) Exhibit to the Company's Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on August 4, 1999 and incorporated herein by reference.
(11) Exhibit to the Company's Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on November 13, 1999 and incorporated herein by reference.
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.
WINSTON HOTELS, INC.
By: /s/ Robert W. Winston, III --------------------------- Robert W. Winston, III Chief Executive Officer
Date: March 17, 2000
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 the capacities and on the dates indicated.
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders Winston Hotels, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of shareholders' equity and of cash flows present fairly, in all material respects, the consolidated financial position of Winston Hotels, Inc. as of December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedule of Winston Hotels, Inc. as listed on the index and included in this Form 10-K, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP Raleigh, North Carolina
January 21, 2000
WINSTON HOTELS, INC. CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1999 AND 1998 ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The accompanying notes are an integral part of the financial statements.
WINSTON HOTELS, INC. CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The accompanying notes are an integral part of the financial statements.
WINSTON HOTELS, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The accompanying notes are an integral part of the financial statements.
WINSTON HOTELS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 ($ IN THOUSANDS)
The accompanying notes are an integral part of the financial statements.
WINSTON HOTELS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. ORGANIZATION:
Winston Hotels, Inc. ("WHI") operates so as to qualify as a real estate investment trust ("REIT") for federal income tax purposes. During 1994, WHI completed an initial public offering ("IPO") of $0.01 par value common stock ("Common Stock"), utilizing the majority of the proceeds to acquire one hotel and a general partnership interest (as the sole general partner) in WINN Limited Partnership (the "Partnership"). The Partnership used a substantial portion of the proceeds to acquire nine hotel properties (collectively the ten hotels are the "Initial Hotels"). The Initial Hotels were acquired from affiliates of WHI. WHI and the Partnership (collectively the "Company") began operations as a REIT on June 2, 1994.
During 1995 and 1996, WHI completed follow-on Common Stock offerings, as well as a Preferred Stock offering in September 1997, and invested the net proceeds from these offerings in the Partnership. The Partnership utilized the proceeds to acquire 28 additional hotel properties. During 1998, the Company added 13 additional properties to its portfolio, five of which were internally developed (see Note 4). As of December 31, 1999, WHI's ownership in the Partnership was 92.83% (see Note 7). As of December 31, 1999, the Company owned 51 hotel properties (the "Current Hotels"), in 13 states, having an aggregate of 6,904 rooms. 49 of the Current Hotels were leased, pursuant to separate percentage operating lease agreements (the "Percentage Leases"), to CapStar Winston Company, L.L.C. ("CapStar Winston"), one was leased to Bristol Hotels and Resorts, Inc. and one was leased to Prime Hospitality Corp.
Prior to November 17, 1997, 38 of the Current Hotels were leased pursuant to the Percentage Leases to Winston Hospitality, Inc. On November 17, 1997 and November 24, 1997, CapStar Management Company, L.P. purchased substantially all of the assets and assumed certain liabilities of Winston Hospitality, Inc., including the 38 then existing leases. Concurrent with this transaction, the leases were assigned to CapStar Winston, an affiliate of CapStar Management Company, L.P., and the terms of the leases were extended to 15 years from the date of the transaction.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation. The consolidated financial statements include the accounts of WHI and the Partnership. All significant inter-company balances and transactions have been eliminated.
Investment in Hotel Properties. Hotel properties are recorded at cost and are depreciated using the straight-line method over estimated useful lives of the assets of 5 and 30 years for furniture, fixtures and equipment, and buildings and improvements, respectively. Upon disposition, both the assets and accumulated depreciation accounts are relieved and the related gain or loss is credited or charged to the income statement. Repairs and maintenance of hotel properties are paid by the lessees.
The Company evaluates long-lived assets for potential impairment by analyzing the operating results, trends and prospects for the Company and considering any other events and circumstances which might indicate potential impairment.
Cash and Cash Equivalents. All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents.
Revenue Recognition and Impact of Recently Issued Accounting Standards to be Adopted in 2000. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101") which provides guidance on revenue recognition. SAB 101 is effective for fiscal years beginning after December 15, 1999. SAB 101 requires that a lessor not recognize contingent rental income until annual specified hurdles have been achieved by the lessee. During 1999 and prior years, the Company has recognized contingent rentals throughout the year since it was considered probable that the lessee would exceed the annual specified hurdles. The Company has reviewed the terms of its Percentage Leases and has determined that the provisions of SAB 101 materially impact the Company's revenue recognition on an interim basis, effectively deferring the recognition of revenue from its Percentage Leases from the first and second quarters of the calendar year to the third and fourth quarters. SAB 101 will impact the Company's revenue recognition on an annual basis, although to a much lesser degree, as seven of the Company's Percentage Leases have fiscal year ends which differ from the Company's calendar year end. SAB 101 will have no impact on the Company's interim or annual cash flow from its third party lessees, and therefore on its ability to pay dividends. The Company will account for SAB 101 as a change in accounting principle effective January 1, 2000.
Deferred Expenses. Included in deferred expenses are franchise fees, loan costs, acquisition costs and disposition costs which are
recorded at cost. Amortization of franchise fees is computed using the straight-line method over ten years. Amortization of loan costs is computed using the straight-line method over the period of the related debt facility. Acquisition costs are either capitalized to properties when purchased, or expensed. Disposition costs are netted against the proceeds from the sale of properties to determine gain or loss on the sale.
Minority Interest in Partnership. Certain hotel properties have been acquired, in part, by the Partnership, through the issuance of limited partnership units of the Partnership. The equity interest in the Partnership created by these transactions represents the Company's minority interest liability. The Company's minority interest liability is: (i) increased or decreased by its pro-rata share of the net income or net loss, respectively, of the Partnership; (ii) decreased by distributions; (iii) decreased by redemption of partnership units for WHI's Common Stock; and (iv) adjusted to equal the net equity of the Partnership multiplied by the limited partners' ownership percentage immediately after each issuance of units of the Partnership and/or Common Stock of the Company through an adjustment to additional paid-in capital.
Earnings Per Share. Net income per common share is computed by dividing net income applicable to common shareholders by the weighted-average number of common shares outstanding during the period. Net income per common share assuming dilution is computed by dividing net income applicable to common shareholders plus income allocated to minority interest by the weighted-average number of common shares assuming dilution during the period. Weighted average number of common shares assuming dilution includes common shares and dilutive common share equivalents, primarily redeemable limited partnership units and stock options (see Notes 7 and 9).
Distributions. WHI's ability to pay regular quarterly distributions is dependent upon receipt of distributions from the Partnership, which in turn is dependent upon the results of operations of the Company's properties. Distributions declared on WHI's Common Stock in 1999, 1998 and 1997 are considered to be approximately 10%, 2%, and 4% return of capital, respectively, for federal income tax purposes.
Income Taxes. The Company qualifies as a REIT under Sections 856 to 860 of the Internal Revenue Code and therefore no provision for federal income taxes has been reflected in the financial statements.
Earnings and profits, which determine the taxability of distributions to shareholders, differ from net income reported for financial reporting purposes due to the differences for federal tax purposes in the estimated useful lives used to compute depreciation and the carrying value (basis) of the investment in hotel properties. Additionally, certain costs associated with the Company's equity offerings are treated differently for federal tax purposes than for financial reporting purposes. At December 31, 1999, the net tax basis of the Company's assets and liabilities was approximately $11,196 less than the amounts reported in the accompanying consolidated financial statements.
For federal income tax purposes, 1999 distributions amounted to $1.12 per common share, ten percent of which is considered a return of capital.
Concentration of Credit Risk. The Company places cash deposits at federally insured depository institutions. At December 31, 1999, bank account balances exceeded federal depository insurance limits by approximately $1,139.
Reclassifications. Certain reclassifications have been made to the 1998 and 1997 financial statements to conform with the 1999 presentation. These reclassifications have no effect on net income or shareholders' equity previously reported.
Estimates. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the balance sheet dates and the reported amounts of revenues and expenses during the periods reported. Actual results could differ from those estimates.
3. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
The estimated fair values of the Company's financial instruments are as follows:
4. HOTEL PROPERTIES:
The Company owned 51 hotels, consisting of 6,904 rooms, as of December 31, 1999. The Company's acquisition of hotel properties for the years 1999, 1998, and 1997 are summarized as follows:
* Five of the total 13 hotels added in 1998 were internally developed properties.
All acquisitions were accounted for by the purchase method of accounting and results of operations for these hotels are included in the Consolidated Statements of Income for the period in which they were owned by the Company. The Company made no acquisitions in 1999; therefore the pro forma 1999 results of operations are identical to the actual 1999 results of operations. The following unaudited pro forma 1998 financial information assumes the hotels were acquired as of the later of January 1, 1998 or their date of opening:
5. DEFERRED EXPENSES:
At December 31, 1999 and 1998 deferred expenses consisted of:
6. DEBT:
The Company's outstanding debt balance as of December 31, 1999 consisted of amounts due under two separate debt facilities.
On February 1, 1999, the Company entered into a new three-year $140,000 line of credit agreement (the "New Line") with a group of banks led by Wachovia Bank, N.A. This New Line replaces the Company's previous $125,000 line of credit (the "Previous Line"). The New Line bears interest at rates from LIBOR plus 1.45% to 1.70%, based on the Company's level of total indebtedness. The Company's current rate is LIBOR plus 1.45%. A commitment fee of 0.05% is also payable quarterly on the unused portion of the New Line. The Company used the proceeds from the New Line to pay off the outstanding balances under the Previous Line and under the $45,000 revolving demand note discussed below. The Company has collateralized the New Line with 29 of its Current Hotels, with a carrying value of $219,512 as of December 31, 1999. The New Line requires the Company to maintain certain financial ratios including maximum leverage, minimum interest coverage and minimum fixed charge coverage, as well as certain levels of unsecured and secured debt and tangible net worth.
On November 3, 1998, the Company closed a $71,000 loan with GE Capital Corporation. The ten-year loan with a 25-year amortization period, bears interest at a fixed rate of 7.375%. Fourteen of the Company's Current Hotels, with a carrying value of $124,407 as of December 31, 1999, serve as collateral for the loan. The Company used the net proceeds from the loan to pay down the then existing line of credit balance. As of December 31, 1999, $69,975 was outstanding. All unpaid principal and interest are due on December 1, 2008. The loan agreement with GE Capital Corporation requires the Company to establish escrow reserves for the purposes of debt service, capital improvements and property taxes and insurance. These reserves, which are held by GE Capital Corporation, totaled $2,523 as of December 31, 1999 and are included in prepaid expenses and other assets on the accompanying consolidated balance sheets.
On October 30, 1998, the Company signed a $45,000 revolving demand note with Wachovia Bank, N.A. Interest accrued on the note at the prime rate (7.75% as of December 31, 1998). As of December 31, 1998, the Company's outstanding debt balance under its $45,000 revolving demand note totaled $34,385. Six of the Company's Current Hotels served as collateral for the note. The note was paid off in February 1999 with the proceeds from the above mentioned New Line.
As of December 31, 1999 and 1998 the Company's outstanding debt balance under its New Line and Previous Line totaled $104,500 and $67,700, respectively. Interest on borrowings was generally at LIBOR plus 1.45% and LIBOR plus 1.75% for the two
years respectively, and were payable monthly in arrears. As of December 31, 1999 and 1998 the weighted average interest rate on the outstanding balance under the New Line and the Previous Line was 6.84% and 7.56%, respectively. A commitment fee of 0.05% was also paid quarterly on the unused portion of the New Line, and 0.0625% on the unused portion of the Previous Line. During the years ended December 31, 1999, 1998 and 1997, the Company capitalized interest of $163, $1,513 and $1,284 respectively, related to hotels under development or major renovation.
During 1999, the Company entered into an interest rate cap agreement to eliminate the exposure to increases in 30-day LIBOR over 7.50%, and therefore from its exposure to interest rate increases over 8.95% under its $140,000 line of credit on a principal balance of $25,000 for the period of March 23, 1999 through March 25, 2002. During 1997, the Company entered into an interest rate cap agreement to eliminate the exposure to increases in 90-day LIBOR over 6.25%, and therefore from its exposure to interest rate increases over 8.00% under its previous $125,000 line of credit, on a principal balance of $40,000 for the period June 4, 1997 through June 4, 1998.
7. CAPITAL STOCK:
On September 11, 1997, WHI issued 3,000,000 shares of 9.25% Series A Cumulative Preferred Stock. Except in the event of certain occurrences, the preferred shares are not redeemable prior to September 28, 2001. On and after such date, the preferred shares will be redeemable for cash at the option of the Company, in whole or in part, at a redemption price of $25 per share, plus unpaid cumulative distributions.
Pursuant to the Partnership Agreement of the Partnership, the holders of limited partnership units have certain redemption rights (the "Redemption Rights") which enable them to cause the Partnership to redeem their units in the Partnership in exchange for shares of Common Stock on a one-for-one basis or, in certain circumstances, for cash. The number of shares issuable upon exercise of the Redemption Rights will be adjusted upon the occurrence of stock splits, mergers, consolidations or similar pro-rata share transactions, which otherwise would have the effect of diluting the ownership interests of the limited partners or the shareholders of WHI. During 1999, the Partnership redeemed 440,100 units in exchange for 440,100 shares of WHI's Common Stock. As of December 31, 1999, the Partnership had 18,112,303 units outstanding, of which 16,813,823 units were held by WHI.
On October 29, 1999, the Company's Chief Executive Officer, Robert W. Winston, III, and several members of the Company's Board of Directors purchased an aggregate of 594,950 shares of WHI's Common Stock, or approximately 3.5% of the total shares outstanding as of December 31, 1999.
8. EARNINGS PER SHARE:
The following is a reconciliation of the net income applicable to common shareholders used in the net income per common share calculation to the net income assuming dilution used in the net income per common share assuming dilution calculation:
The following is a reconciliation of the weighted average shares used in net income per common share to the weighted average shares used in net income per common share - assuming dilution:
9. STOCK INCENTIVE PLAN:
During 1998, the Company amended the Winston Hotels, Inc. Stock Incentive Plan (the "Plan"). The amendment increased the number of shares of Common Stock that may be issued under the Plan to 1,600,000 shares plus an annual increase to be added as of January 1 of each year, beginning January 1, 1999, equal to the lesser of (i) 500,000 shares; (ii) 8.5% of any increase in the number of authorized and issued shares (on a fully diluted basis) since the immediately preceding January 1; or (iii) a lesser number determined by the Board of Directors. The Plan permits the grant of incentive or nonqualified stock options, stock appreciation rights, stock awards and performance shares to participants. Under the Plan, the exercise price of an option is determined by the Compensation Committee of the Company. In the case of incentive stock options, the exercise price is no less than the market price of the Company's Common Stock on the date of grant and the maximum term of an incentive stock option is ten years. Stock options and stock awards are granted upon approval of the Compensation Committee and generally are subject to vesting over a period of years.
During 1999 and 1998, the Company granted awards of Common Stock to certain executive officers. The total numbers of shares granted were 20,000 and 25,000, respectively. These shares vest either (i) 25% on the anniversary date over each of the next four years, or (ii) 20% immediately and 20% on the anniversary date over each of the next four years.
On May 18, 1999, WHI issued 42,000 shares, 7,000 shares each, to six of its Directors. These shares vested 20% immediately and will vest 20% on the anniversary date over each of the next four years. Upon issuing these shares, WHI terminated 3,412 unvested shares previously granted to a then new independent director on January 2, 1998. On May 18, 1999, WHI also issued options to purchase 2,000 shares of WHI Common Stock to six of its Directors. These options were 100% vested on May 18, 1999.
On June 2, 1994, WHI issued 7,500 shares to each of its five initial independent directors which shares vested at a rate of 1,500 shares per year beginning on June 2, 1994. These shares became fully vested on May 5, 1998. WHI also issued 5,687 shares to a new independent director on January 2, 1998. As noted above, 3,412 unvested shares were terminated on May 18, 1999. Any unvested shares are subject to forfeiture if the director does not remain a director of WHI. Each director is entitled to vote and receive distributions paid on such shares prior to vesting.
On January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS 123"). As permitted by SFAS 123, no compensation cost has been recognized for options granted under the Plan. Had the fair value method been used to determine compensation cost, the impact on the Company's 1999, 1998 and 1997 net income would have been a decrease of $181, $171, and $57, and a corresponding decrease in net income per Common Share of $0.01, $0.01 and $0.01, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants in 1999, 1998 and 1997: dividend of $1.12, $1.09 and $1.08; expected volatility of 27.8%, 26.2% and 20.8%; risk-free interest rate of 6.5%, 5.5% and 5.5%, respectively, and an expected life of five years for all options. The estimated weighted average fair value per share of the options granted in 1999, 1998 and 1997 were $0.93, $1.21 and $0.31, respectively.
A summary of the status of stock options granted under the Plan as of December 31, 1999, 1998 and 1997, and changes during the years ended on those dates, is presented below:
The following table summarizes information about the Plan at December 31, 1999:
10. COMMITMENTS:
The Company leases its corporate office under a non-cancellable lease. Under the terms of the lease, the Company makes lease payments through February 2005. Commitments for minimum rental payments are as follows:
Rental expense for the years ended December 31, 1999, 1998 and 1997 was $177, $102 and $51, respectively.
The Company has future lease commitments from the lessees through 2013. Minimum future rental payments contractually due to the Company under these non-cancelable operating leases are as follows:
Under the terms of the Percentage Leases, the lessees are obligated to pay the Company the greater of base rents or percentage rents. The Company earned minimum base rents of $32,353, $28,033 and $16,114 for the years ended December 31, 1999, 1998, and 1997, respectively, and percentage rents of $29,882, $26,667 and $19,754 for the years ended December 31, 1999, 1998, and 1997, respectively. The percentage rents are based on percentages of gross room revenue and certain food and beverage revenues of the lessees. MeriStar Hospitality Corporation, an affiliate of CapStar Winston, has guaranteed amounts due and payable to the Company under the 49 properties leased by CapStar Winston up to $20,000. The lessees operate the hotel properties pursuant to franchise agreements, which require the payment of fees based on a percentage of hotel revenue. These fees are paid by the lessees.
Pursuant to the Percentage Leases, the Company reserves 5% of room revenues (7% of gross room, food and beverage revenues from one of its full-service hotels) to fund periodic improvements to the buildings and grounds, and the periodic replacement and refurbishment of furniture, fixtures and equipment.
For one of the Current Hotels, the Company leases the land under an operating lease which expires on December 31, 2062. Expenses incurred in 1999 related to this land lease totaled $358. Minimum future rental payments contractually due by the Company under this lease are as follows: 2000 - $110, 2001 - $110, 2002 - $110, 2003 - $110, 2004 - $110, 2005 and thereafter - $6,930.
In June 1999, the Company entered into a joint venture agreement with Regent Partners, Inc. to jointly develop and own hotel properties. The first hotel to be developed by the joint venture, a full-service 158-room Hilton Garden Inn in Windsor, CT, is scheduled to open during the third quarter of 2000. The Company will own a 49% interest in this joint venture. On June 25, 1999, the Company purchased an irrevocable standby letter of credit from Wachovia Bank, N.A. totaling $3,298, which approximates the Company's future equity investment in the joint venture. The letter of credit is for the benefit of Compass Bank, the construction lender, and can be drawn upon after the earliest to occur of either January 24, 2001 or 30 days after the date of issuance of the certificate of occupancy. The Company paid $73 to obtain the letter of credit, which expires on March 25, 2001. The Company's total investment in this joint venture as of December 31, 1999 was $183, which is included in prepaid expenses and other assets in the accompanying consolidated balance sheets.
11. SUBSEQUENT EVENT:
On February 15, 2000, the Company sold its Comfort Suites hotel in London, KY. Sales proceeds received by the Company totaled $2,497, resulting in a net loss of $265.
12. QUARTERLY FINANCIAL DATA (UNAUDITED):
Summarized unaudited quarterly results of operations for the years ended December 31, 1999 and 1998 are as follows:
WINSTON HOTELS, INC. SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 1999 ($ IN THOUSANDS)
*Property serves as collateral for the $140,000 line of credit which closed on February 1, 1999 (see Note 6). # Property serves as collateral for the $71,000 note through GE Capital Corporation (see Note 6).
WINSTON HOTELS, INC. NOTES TO SCHEDULE III
(c) The aggregate cost of land, buildings and improvements for federal income tax purposes is approximately $391,658.
(d) Refer to Note 1 to the consolidated financial statements of Winston Hotels, Inc. for transactions with affiliates
INDEPENDENT AUDITORS' REPORT
The Members CapStar Winston Company, L.L.C.:
We have audited the accompanying balance sheets of CapStar Winston Company, L.L.C. (the "Company") as of December 31, 1999 and 1998 and the related statements of operations, members' capital, and cash flows for the years ended December 31, 1999 and 1998 and the period from October 15, 1997 (date of inception) through December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CapStar Winston Company, L.L.C. as of December 31, 1999 and 1998, and the results of its operations and its cash flows for the years ended December 31, 1999 and 1998 and the period from October 15, 1997 (date of inception) through December 31, 1997, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Washington, D.C. January 28, 2000, except for note 8 which is as of February 14, 2000
CAPSTAR WINSTON COMPANY, L.L.C. BALANCE SHEETS AS OF DECEMBER 31, 1999 AND 1998 ($ IN THOUSANDS)
See accompanying notes to financial statements.
CAPSTAR WINSTON COMPANY, L.L.C. STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1999 AND 1998 AND THE PERIOD FROM OCTOBER 15, 1997 (DATE OF INCEPTION) THROUGH DECEMBER 31, 1997 ($ IN THOUSANDS)
See accompanying notes to financial statements.
CAPSTAR WINSTON COMPANY, L.L.C. STATEMENTS OF MEMBERS' CAPITAL YEARS ENDED DECEMBER 31, 1999 AND 1998 AND THE PERIOD FROM OCTOBER 15, 1997 (DATE OF INCEPTION) THROUGH DECEMBER 31, 1997 ($ IN THOUSANDS)
See accompanying notes to financial statements.
CAPSTAR WINSTON COMPANY, L.L.C. STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999 AND 1998 AND THE PERIOD FROM OCTOBER 15, 1997 (DATE OF INCEPTION) THROUGH DECEMBER 31, 1997 ($ IN THOUSANDS)
See accompanying notes to financial statements.
CAPSTAR WINSTON COMPANY, L.L.C. NOTES TO FINANCIAL STATEMENTS ($ IN THOUSANDS)
1. ORGANIZATION:
CapStar Winston Company, L.L.C. (the "Company") was formed on October 15, 1997, pursuant to a limited liability company agreement ("Agreement"), subject to the Limited Liability Act of the State of Delaware, between CapStar Management Company, L.P. ("CMC") and EquiStar Acquisition Corporation ("EquiStar"), both wholly owned subsidiaries of CapStar Hotel Company ("CapStar"), to lease and operate certain hotels owned by WINN Limited Partnership and Winston Hotels, Inc. (collectively, "Winston"). Generally, members of a limited liability company are not personally responsible for debts, obligations and other liabilities of the Company. The Agreement provides for the termination of the Company as upon the consent of the members.
In November 1997, CMC purchased substantially all of the assets and assumed certain liabilities of Winston Hospitality, Inc. ("WHI"), including 38 hotel leases, certain operating assets and liabilities, and goodwill and other intangible assets. Concurrent with the purchase, CMC contributed the assets purchased and liabilities assumed in the transaction to the Company.
On August 3, 1998, MeriStar Hotels & Resorts, Inc. ("MeriStar") was spun off from CapStar (the "Spin-Off") to become the lessee, manager and operator of various hotel assets, including those previously owned, leased and managed by CapStar and certain of its affiliates. Pursuant to the Spin-Off, CMC and Equistar transferred their capital and interests in the Company to MeriStar H&R Operating Company, L.P. ("MHOC") and MeriStar, respectively. The transfer was recorded at its net book value.
As of December 31, 1999, the Company leased 49 Winston-owned hotels, which included 28 limited-service hotels, 11 extended-stay hotels and ten full-service hotels. The hotels have 6,616 rooms, are operated under various franchise agreements, and are located in Arizona, Florida, Georgia, Kentucky, Massachusetts, Michigan, North Carolina, New Jersey, New York, South Carolina, Texas and Virginia.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Cash Equivalents. The Company considers all highly liquid instruments with original maturities of three months or less to be cash equivalents.
Restricted Cash. Restricted cash represents amounts required to be maintained in escrow to comply with terms of certain state beverage licensing agreements.
Furniture, Fixtures and Equipment. Furniture, fixtures and equipment are recorded at cost and are depreciated using the straight-line method over estimated useful lives ranging from five to seven years.
Intangible Assets. Intangible assets consist of goodwill and hotel lease contracts purchased and beverage licensing costs incurred.
Hotel lease contracts represent the estimated present value of net cash flows expected to be received from the hotel leases originally acquired. Hotel lease contracts are amortized on a straight-line basis over 30 years.
Goodwill represents the excess of the cost over the net tangible and identifiable intangible assets originally acquired. Goodwill is amortized on a straight-line basis over 40 years.
Licensing costs represent the cost of beverage licenses mandated by state statutes. Licensing costs are amortized on a straight-line basis over five years.
The Company reviews intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Recoverability is measured by comparing the carrying amount of the intangible assets to the projected future cash flows of the Company. If such assets are considered to be impaired, the impairment to be recognized is the amount by which the carrying amounts of the intangible assets exceed their fair value. No impairment loss was recorded in 1999, 1998 or 1997.
Deferred Franchise Costs. Franchise costs are deferred and amortized on a straight-line basis over the terms of the franchise agreements, which range from 18 months to 20 years.
Members' Capital and Allocation of Profits and Losses. Prior to the Spin-Off, CMC had a 99% ownership interest and EquiStar had a 1% ownership interest in the Company. Subsequent to the Spin-Off, MHOC has a 99% ownership interest and MeriStar has a 1% ownership interest in the Company. In general, the allocation of income and losses and contributions and distributions were made to the members in proportion to their respective ownership interest.
Income Taxes. No provision has been made for income taxes since any such amount is the liability of the individual members.
Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses recognized during the reporting period. Actual results could differ from those estimates.
3. INTANGIBLE ASSETS:
Intangible assets consist of the following:
4. MANAGEMENT AGREEMENTS:
As of December 31, 1999, the Company managed 39 of the 49 leased hotels and had separate management agreements with third parties to manage the remaining 10 hotels. The terms of these third-party management agreements provide for management fees to be paid on a monthly basis based on budgeted gross operating profit, as defined in the agreements, with year-end adjustments, for actual operating results. The term of nine of the management agreements extends to 2006 and one extends to 2012. The agreements are cancelable before expiration under certain circumstances. Management fees incurred during 1999, 1998 and 1997 were $886, $1,001 and $17, respectively and are included in other expenses.
5. TRANSACTIONS WITH RELATED PARTIES:
The Company and MHOC advanced amounts to each other in the normal course of business. At December 31, 1999 and 1998, MHOC owed the Company $8,667 and $5,392, respectively.
6. COMMITMENTS:
Each of the Company's hotels is leased under a separate participating lease agreement. The leases in existence at the date CMC purchased the initial 38 hotel leases expire on November 30, 2012; subsequent leases extend through December 31, 2013. The leases require monthly minimum base rental payments to Winston and additional quarterly payments of percentage rent, based on revenues generated by the hotels in excess of specified amounts. The leases are non-cancelable except upon sale of a hotel. Winston is
required to make a termination payment to the Company, as defined in the lease agreements, upon cancellation of a lease. MeriStar Hospitality Corporation, an affiliate of the Company, has guaranteed amounts due and payable by the Company under the leases up to $20,000. Future minimum base rental payments under these non-cancelable operating leases as of December 31, 1999 are as follows:
The Company incurred minimum base rents of $30,676, $26,378 and $2,731, and additional percentage rents of $27,875, $26,342 and $511 during 1999, 1998 and 1997, respectively.
7. BUSINESS CONCENTRATION:
Winston owns all of the Company's leased hotels. Therefore, the Company's financial position and results of operations would be adversely and materially impacted if Winston sells the hotels and terminates the leases. Management believes that Winston has no intention of selling hotels which would, individually or in the aggregate, have a material impact on the operations of the Company.
8. SUBSEQUENT EVENT:
On February 14, 2000, Winston sold the Comfort Suites hotel in London, Kentucky. As a result, the Company's lease for that hotel was terminated.
REPORT OF INDEPENDENT ACCOUNTANTS
The Shareholders Winston Hospitality, Inc.
We have audited the accompanying statements of income, shareholders' equity and cash flows for the ten months ended October 31, 1997. These financial statements are the responsibility of the Company'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 results of operations and cash flows of Winston Hospitality, Inc. for the ten months ended October 31, 1997, in conformity with accounting principles generally accepted in the United States.
/s/ PricewaterhouseCoopers LLP
Raleigh, North Carolina February 6, 1998
WINSTON HOSPITALITY, INC. STATEMENT OF INCOME FOR THE TEN MONTHS ENDED OCTOBER 31, 1997 ($ IN THOUSANDS)
WINSTON HOSPITALITY, INC. STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE TEN MONTHS ENDED OCTOBER 31, 1997 ($ IN THOUSANDS)
The accompanying notes are an integral part of the financial statements.
WINSTON HOSPITALITY, INC. STATEMENT OF CASH FLOWS FOR THE TEN MONTHS ENDED OCTOBER 31, 1997 ($ IN THOUSANDS)
The accompanying notes are an integral part of the financial statements.
WINSTON HOSPITALITY, INC. NOTES TO FINANCIAL STATEMENTS ($ IN THOUSANDS)
1. ORGANIZATION:
Winston Hospitality, Inc. ("Hospitality") was formed to lease and operate hotels owned by WINN Limited Partnership (the "Partnership") and Winston Hotels, Inc. ("WHI") (collectively, the "Company). The two shareholders of Hospitality (Robert W. Winston, III and John B. Harris, Jr.) are also shareholders of WHI and/or partners in the Partnership. The Company owned 38 hotels as of October 31, 1997.
Each hotel was separately leased by the Company to Hospitality under a Percentage Lease Agreement. These leases required minimum base rental payments to be made to the Company on a monthly basis and additional quarterly payments to be made based on a percentage of gross room revenue and certain food and beverage revenues.
Twenty-eight of the 38 hotels are limited-service hotels, five are extended-stay hotels and five are full-service hotels. All 38 hotels are operated under franchise agreements with Promus Hotels, Inc., Choice Hotels International, Inc., Holiday Inns Franchising, Inc. and Marriott International, Inc. The cost of obtaining the franchise licenses was paid by the Company and the on-going franchise fees were paid by Hospitality.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Revenue Recognition. Revenue is recognized as earned. Ongoing credit evaluations are performed and an allowance for potential credit losses is provided against the portion of accounts receivable which is estimated to be uncollectible.
Cash Equivalents. All highly liquid investments with a maturity date of three months or less when purchased are considered to be cash equivalents. At October 31, 1997, bank account balances exceeded federal depository insurance limits by approximately $6,252.
Fair Value of Financial Instruments. Hospitality's financial instruments consist of cash and cash equivalents whose carrying value approximates fair value because of their short maturity.
Furniture, Fixtures and Equipment. Furniture and equipment are recorded at cost and are depreciated using the straight-line method over estimated useful lives of the assets of five and seven years. Leasehold improvements are being amortized using the straight-line method over the terms of the related leases. Upon disposition, both the asset and accumulated depreciation accounts are relieved and the related gain or loss is credited or charged to the income statement. Repairs and maintenance of hotel properties owned by the Company are paid by Hospitality and are charged to expense as incurred.
Income Taxes. Hospitality has made an election under Subchapter S of the Internal Revenue Code of 1986, as amended. Any taxable income or loss is recognized by the shareholders and, therefore, no provision for income taxes has been provided in the accompanying financial statements.
3. COMMITMENTS:
Under the terms of the Percentage Lease Agreements, Hospitality had future lease commitments to the Company through 2006. As disclosed in Note 6 below, all Percentage Leases were sold as of November 24, 1997.
Hospitality incurred minimum base rents of $13,535 as well as percentage rents of $17,445 for the ten months ended October 31, 1997.
Hospitality had entered into separate contracts with unrelated parties for the management of 10 of the hotels. The terms of these agreements provided for management fees to be paid based on predetermined formulas for a period of ten years through 2006. The contracts were cancelable under certain circumstances as outlined in the agreements. As disclosed in Note 6 below, all such contracts were sold as of November 24, 1997.
Various legal proceedings against Hospitality have arisen from time to time in the normal course of business. Management believes liabilities arising from these proceedings, if any, will have no material adverse effect on the financial positions or results of operations of Hospitality.
4. DISTRIBUTIONS:
Beginning with the year ended December 31, 1996, the shareholders agreed to limit distributions by Hospitality to amounts necessary to pay their income taxes on the net income derived from Hospitality until such time as the tangible net worth of Hospitality reached $4,000. Thereafter, they agreed to invest at least 75% of their after-tax distributions of net income from Hospitality in Common Stock of the Company. These agreements terminated effective November 24, 1997, due to the sale of the leases to CapStar.
5. PROFIT SHARING PLAN:
On January 1, 1996, Hospitality adopted the Winston 401(k) Plan (the "Plan") for substantially all employees, (except any highly compensated employee, as defined in the Plan), who had attained the age of 21 and completed one year of service. Under the Plan, employees were able to contribute from 1% to 15% of compensation, subject to an annual maximum as determined under the Internal Revenue Code. Hospitality made matching contributions of a specified percentage of the employee's contribution. Hospitality contributed $54 during the 10-month period ended October 31, 1997.
6. SUBSEQUENT EVENT:
On November 24, 1997, Hospitality completed the sale of substantially all of its assets and all 38 existing Percentage Leases to CapStar Management Company, L.P. ("CMC") for total consideration of $34,000. The $34,000 sale price consisted of $10,000 in cash and 674,236 CMC Partnership Units.
INDEX TO EXHIBITS
(1) Exhibits to the Company's Registration Statement on Form S-11 as filed with the Securities and Exchange Commission (Registration No. 33-76602) effective May 25, 1994 and incorporated herein by reference.
(2) Exhibits to the Company's Registration Statement on Form S-11 as filed with the Securities and Exchange Commission (Registration No. 33-91230) effective May 11, 1995 and incorporated herein by reference.
(3) Exhibit to the Company's report on Form 8-K as filed with the Securities and Exchange Commission on July 24, 1997 and incorporated herein by reference.
(4) Exhibits to the Company's report on Form 8-K as filed with the Securities and Exchange Commission on September 15, 1997 and incorporated herein by reference.
(5) Exhibits to the Company's report on Form 8-K as filed with the Securities and Exchange Commission on December 10, 1997 and incorporated herein by reference.
(6) Exhibits to the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 27, 1998 and as amended by Form 10-K/A filed with the Securities and Exchange Commission on April 1, 1998.
(7) Exhibit to the Company's Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on July 29, 1998. (Registration No. 333-60079) and incorporated herein by reference.
(8) Exhibits to the Company's Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on November 16, 1998 and as amended on Form 10-Q/A filed with the Securities and Exchange Commission on February 23, 1999 and incorporated herein by reference.
(9) Exhibits to the Company's Annual Report on Form 10-K as filed with the Securities and Exchange Commission on March 25, 1999 and incorporated herein by reference.
(10) Exhibit to the Company's Quarterly Report on Form 10-Q or filed with the Securities and Exchange Commission on August 4, 1999 and incorporated herein by reference.
(11) Exhibit to the Company's Quarterly Report on Form 10-Q as filed with the Securities and Exchange Commission on November 12, 1999 and incorporated herein by reference.