SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
- -----
X Quarterly Report Pursuant to Section 13 or 15(d) of
- ----- The Securities Exchange Act of 1934
For The Quarterly Period Ended June 30, 2003 Commission File Number 01-12073
EQUITY INNS, INC.
(Exact Name of Registrant as Specified in its Charter)
Tennessee 62-1550848
- ------------------------------- -------------------
(State or Other Jurisdiction of (I.R.S. Employer)
Incorporation or Organization Identification No.)
7700 Wolf River Boulevard, Germantown, TN 38138
--------------------------------------------------
(Address of Principal Executive Office) (Zip Code)
(901) 754-7774
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Not Applicable
--------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check mark whether the Registrant: (i) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes X No
----- -----
The number of shares of the Registrant's Common Stock, $.01 par value,
outstanding on August 8, 2003 was 40,554,718.
1 of 32
EQUITY INNS, INC.
INDEX
PAGE
PART I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - June 30, 2003 (unaudited)
and December 31, 2002 3
Condensed Consolidated Statements of Operations (unaudited) -
For the three and six months ended June 30, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows (unaudited) -
For the three and six months ended June 30, 2003 and 2002 5
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 28
Item 4. Controls and Procedures 29
PART II. Other Information
Item 5. Submission of Matters to a Vote of Security Holders 30
Item 6. Exhibits and Reports on Form 8-K 30
2
PART I. Financial Information
Item 1. Financial Statements
EQUITY INNS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2003 2002
------------ ------------
(unaudited)
ASSETS
Investment in hotel properties, net $699,282,187 $740,145,842
Assets held for sale 14,522,502
Cash and cash equivalents 8,672,181 5,916,209
Accounts receivable, net 6,098,027 4,142,901
Notes receivable, net 1,335,025 1,335,025
Deferred expenses, net 8,670,681 8,743,477
Deferred tax asset 13,267,000 9,777,000
Deposits and other assets 6,817,859 4,391,484
------------ ------------
Total assets $758,665,462 $774,451,938
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Debt $364,138,594 $362,881,131
Accounts payable and accrued expenses 24,809,230 27,817,365
Distributions payable 6,509,142 6,505,528
Interest rate swap 2,958,786 2,198,809
Minority interest in Partnership 8,011,763 8,781,685
------------ ------------
Total liabilities 406,427,515 408,184,518
------------ ------------
Commitments and Contingencies
Shareholders' equity:
Preferred Stock, $.01 par value, 10,000,000 shares
authorized, 2,750,000 shares issued and outstanding 68,750,000 68,750,000
Common Stock, $.01 par value, 100,000,000
shares authorized, 41,299,965 and 41,220,639
shares issued and outstanding 413,000 412,206
Additional paid-in capital 446,328,565 445,793,107
Treasury stock, at cost, 747,600 shares (5,173,110) (5,173,110)
Unearned directors' and officers' compensation (334,148) (545,528)
Distributions in excess of net earnings (154,787,574) (140,770,446)
Accumulated other comprehensive income:
Unrealized loss on interest rate swap (2,958,786) (2,198,809)
------------ ------------
Total shareholders' equity 352,237,947 366,267,420
------------ ------------
Total liabilities and shareholders' equity $758,665,462 $774,451,938
============ ============
The accompanying notes are an integral
part of these condensed consolidated financial statements.
3
EQUITY INNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -------------------------------
2003 2002 2003 2002
----------- ----------- ------------ ------------
Revenue:
Rooms $58,998,404 $59,126,062 $109,121,227 $109,312,144
Other operating departments 2,940,777 2,914,687 5,465,056 5,397,616
Other revenue 256,714 309,245 363,177 507,214
----------- ----------- ------------ ------------
Total revenue 62,195,895 62,349,994 114,949,460 115,216,974
----------- ----------- ------------ ------------
Operating costs and other expenses:
Property operating costs 33,924,089 34,349,272 64,547,666 64,251,979
Other operating departments 2,153,738 1,987,477 4,076,054 3,698,236
Property taxes and insurance 4,222,088 4,484,897 8,757,615 8,641,547
Depreciation 9,662,676 9,739,989 19,328,552 19,510,654
Amortization of franchise fees 72,783 85,379 145,566 168,758
General and administration expenses:
Stock based or non-cash compensation 133,293 172,727 265,028 344,236
Other general and administrative expenses 1,581,812 1,288,956 3,416,818 2,824,577
Rental expense 223,638 330,566 446,425 660,284
----------- ----------- ------------ ------------
Total operating expenses 51,974,117 52,439,263 100,983,724 100,100,271
----------- ----------- ------------ ------------
Operating income 10,221,778 9,910,731 13,965,736 15,116,703
Amortization of debt costs 903,264 511,035 1,408,839 1,022,070
Interest 6,971,405 7,057,885 13,914,516 14,324,421
----------- ----------- ------------ ------------
Income (loss) from continuing operations before
minority interest and income taxes 2,347,109 2,341,811 (1,357,619) (229,788)
Minority interest 50,714 68,359 2,245 (5,022)
Income tax benefit 1,079,417 1,278,617 3,307,194 2,968,191
----------- ----------- ------------ ------------
Income from continuing operations 3,375,812 3,552,069 1,947,330 2,743,425
------------ ----------- ------------- ------------
Discontinued operations:
Gain on sale of hotel properties 1,274,544
Loss on impairment of hotels held for sale (3,556,067) (3,556,067)
Income from operations of discontinued
operations 8,949 186,171 122,172 359,950
----------- ----------- ------------ ------------
Income (loss) from discontinued operations (3,547,118) 186,171 (2,159,351) 359,950
---------- ----------- ------------ ------------
Net income (loss) (171,306) 3,738,240 (212,021) 3,103,375
Preferred stock dividends 1,632,813 1,632,813 3,265,626 3,265,626
----------- ----------- ------------- ------------
Net income (loss) applicable to common
shareholders $(1,804,119) $ 2,105,427 $ (3,477,647) $ (162,251)
=========== =========== ============ ============
Net income (loss) share data:
Basic and diluted income (loss) per share
from continuing operations $ 0.05 $ 0.05 $ (0.03) $ (0.01)
Discontinued operations (0.09) 0.00 (0.06) 0.01
=========== =========== ============ ============
Net income (loss) per common share $ (0.04) $ 0.05 $ (0.09) $ 0.00
=========== =========== ============ ============
Weighted average number of common shares
outstanding, diluted 40,548,562 40,468,528 40,530,671 38,770,884
=========== =========== ============ ============
The accompanying notes are an integral
part of these condensed consolidated financial statements.
4
EQUITY INNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
For the Six Months Ended
June 30,
---------------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net income (loss) $ (212,021) $ 3,103,375
Adjustments to net income provided by operating activities:
Gain on sale of hotel properties (1,274,544)
Loss on impairment of hotels held for sale 3,556,067
Depreciation and amortization 20,056,538 20,673,424
Amortization of loan costs 1,408,839 1,022,070
Amortization of unearned directors' and officers' compensation 211,380 298,710
Directors' stock-based compensation 53,648 45,527
Income tax benefit (3,490,000) (3,175,000)
Minority interest 2,245 (5,021)
Changes in assets and liabilities:
Accounts receivable (1,955,126) (3,365,626)
Due from Lessees 162,265
Notes receivable (407,633)
Deposits and other assets (2,426,375) (2,460,251)
Accounts payable and accrued expenses (2,805,939) 4,262,752
----------- -----------
Net cash provided from operating activities 13,124,712 20,154,592
----------- -----------
Cash flows from investing activities:
Improvements and additions to hotel properties (6,162,364) (3,005,706)
Cash paid for franchise applications (116,601)
Proceeds from sale of hotel properties 10,358,577
----------- -----------
Net cash provided by (used in) investing activities 4,196,213 (3,122,307)
----------- -----------
Cash flows from financing activities:
Gross proceeds from public offering of common stock 28,520,000
Payment of offering expenses (1,599,381)
Distributions paid (14,102,647) (8,265,128)
Cash paid for loan costs (1,719,769) (124,913)
Proceeds from borrowings 28,125,000 9,578,885
Payments on debt (26,867,537) (41,601,483)
----------- -----------
Net cash used in financing activities (14,564,953) (13,492,020)
----------- -----------
Net increase in cash 2,755,972 3,540,265
Cash and cash equivalents at beginning of period 5,916,209 4,358,787
----------- -----------
Cash and cash equivalents at end of period $ 8,672,181 $ 7,899,052
=========== ===========
The accompanying notes are an integral
part of these condensed consolidated financial statements.
5
Supplemental disclosure of noncash investing and financing activities:
During January 2003, the Company issued to one of its officers, 19,081 shares of
common stock at $5.88 per share under the 1994 Stock Incentive Plan in lieu of
cash as a performance bonus.
During the six months ended June 30, 2003, the Company issued 51,521 shares of
common stock in exchange for 51,521 units of limited partnership interest in the
partnership ("Units").
During the six months ended June 30, 2003, the Company issued 11,077 shares of
common stock at prices ranging from $5.82 to $7.20 per share to its independent
directors in lieu of cash as compensation.
During January 2002, the Company issued to certain officers 51,704 shares of
common stock at $6.62 per share under the 1994 Stock Incentive Plan in lieu of
cash as a performance bonus.
During the six months ended June 30, 2002, the Company recorded $4 million of
investment in hotel properties and a liability related to the purchase of a
hotel property.
During the six months ended June 30, 2002, the Company issued 2,566 shares of
common stock in exchange for 2,566 units of limited partnership interest in the
partnership.
During the six months ended June 30, 2002, the Company issued 6,105 shares of
common stock at prices ranging from $6.62 to $8.19 per share to its independent
directors in lieu of cash as compensation.
The accompanying notes are an integral
part of these condensed consolidated financial statements.
6
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
-----------------------
1. Organization
------------
Equity Inns, Inc. (the "Company") is a hotel real estate investment trust
("REIT") for federal income tax purposes. The Company, through its wholly
owned subsidiary, Equity Inns Trust (the "Trust"), is the sole general
partner of Equity Inns Partnership, L.P. (the "Partnership") and at June
30, 2003 owned an approximate 97.3% interest in the Partnership.
The Company's hotel properties are managed by unrelated third parties. At
June 30, 2003, the managers of the Company's hotels were as follows:
Number of Hotels
----------------
Interstate Hotels & Resorts, Inc. 52
Hilton Hotels Corporation 18
Prime Hospitality Corporation 19
Other 6
--
95
==
The management agreements with Prime's subsidiaries are structured to
provide the TRS Lessees minimum net operating income at each of the 19
AmeriSuites hotels. In addition, the management agreements specify a net
operating income threshold for each of the 19 AmeriSuites hotels. As the
manager, the Prime subsidiaries can earn an incentive management fee of
25% of hotel net operating income above the threshold, to a maximum of
6.5% of gross hotel revenues. If the management fee exceeds 6.5% of gross
hotel revenue, the Prime subsidiaries may earn an additional fee of 10%
on any additional net operating income. If a hotel fails to generate net
operating income sufficient to reach the threshold, Prime's subsidiaries
are required to contribute 25% of the shortfall in net operating income
to the Company. Management records such shortfall contributions as
revenue when all contingencies related to such amounts have been
resolved.
During the quarter ended June 30, 2003, the Company updated its current
franchise contracts and management agreements with Prime on its 19
AmeriSuites hotels. The minimum net operating income guarantee agreements
were not extended beyond their original terms and are set to expire
between 2007 and 2008. Under the new agreements, Prime and the Company
extended the existing franchise agreements to 2028 and the management
agreements were extended to 2010 as long as Prime continues to be in
compliance with the minimum net operating income guarantees previously
agreed to in the original agreements.
The management contracts for the Company's remaining 76 hotels have terms
ranging up to five years and generally provide for payment of management
fees equal to a percentage of hotel
7
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(unaudited)
-----------------------
1. Organization, Continued
-----------------------
revenues and an incentive fee consisting of a percentage of gross
operating profits in excess of budget.
These unaudited condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and
Exchange Commission ("SEC") and should be read in conjunction with the
financial statements and notes thereto of the Company included in the
Company's Annual Report on Form 10-K for the year ended December 31,
2002. The accompanying unaudited condensed consolidated financial
statements reflect, in the opinion of the Company's management, all
adjustments necessary for a fair presentation of the interim financial
statements. All such adjustments are of a normal and recurring nature.
2. Summary of Significant Accounting Policies
------------------------------------------
Net Income Per Common Share
Basic earnings per common share from continuing operations are computed
by dividing income from continuing operations as adjusted for gains or
losses on the sale of hotel properties and for dividends on preferred
stock by the weighted average number of shares of common stock
outstanding. Diluted earnings per common share from continuing operations
are computed by dividing income from continuing operations as adjusted
for gains or losses on the sale of hotel properties and for dividends on
preferred stock by the weighted average number of shares of common stock
outstanding plus other potentially dilutive securities.
Potential dilutive securities included in the Company's calculation of
diluted earnings per share include shares issuable upon exercise of stock
options. None of the options to purchase shares of the Company's common
stock that were outstanding during the six months ended June 30, 2003 and
2002 were included in the computation of diluted EPS because their effect
would have been anti-dilutive.
Stock-Based Compensation
The FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation --
Transition and Disclosure." SFAS No. 148 amends SFAS No. 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. The Company will apply
the fair value based method of accounting for stock-based employee
compensation prospectively to all awards granted, modified or settled
beginning January 1, 2003.
8
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(unaudited)
-----------------------
2. Summary of Significant Accounting Policies, Continued
-----------------------------------------------------
There were no grants of options to purchase shares of common stock or
units made during the six months ended June 30, 2003. Had compensation
costs for the Company's grants for stock- based compensation plans prior
to January 1, 2003 been determined consistent with SFAS 123, the
Company's pro forma net income and net income per common share for the
six months ended June 30, 2003 and 2002 would have decreased by an
insignificant amount.
3. Investment in Hotel Properties
------------------------------
Management classifies certain assets as held for sale based on management
having the authority and intent of entering into commitments for sale
transactions expected to close in the next twelve months. When management
identifies an asset held for sale, the Company estimates the net selling
price of such asset. If the net selling price of the asset is less than
the carrying amount of the asset, a reserve for loss is established.
Depreciation is no longer recorded once management has identified an
asset held for sale. Net selling price is estimated as the amount at
which the asset could be bought or sold (fair value) less costs to sell.
Fair value is determined at prevailing market conditions, appraisals or
current estimated net sales proceeds from pending offers, if appropriate.
Only interest on debt that is to be assumed by the buyer and interest on
debt that is required to be repaid as a result of the disposal
transaction is allocated to discontinued operations. The company recorded
impairment of $3,556,067 for the six month period ended June 30, 2003 to
write the assets held for sale down to their fair value less cost to
sell.
4. Debt
----
The following details the Company's debt outstanding at June 30, 2003:
Interest
Rate Maturity
-------------------- --------
Commercial Mortgage Bonds
Class A $ 4,680,764 6.83% Fixed Nov 2006
Class B 50,600,000 7.37% Fixed Dec 2015
Class C 10,000,000 7.58% Fixed Feb 2017
------------
65,280,764
Line of Credit 92,700,000 LIBOR plus Variable June 2006
Percentage
Mortgage 91,802,534 8.37% Fixed July 2009
Mortgage 67,393,132 8.25% Fixed Nov 2010
Mortgage 34,857,051 8.25% Fixed Nov 2010
Mortgage 2,957,903 6.00% Fixed May 2008
Mortgage 5,549,514 10.00% Fixed Sept 2005
Mortgage 3,597,696 6.37% Fixed Nov 2016
------------
$364,138,594
============
9
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(unaudited)
-----------------------
4. Debt, Continued
---------------
On June 11, 2003, the Company repaid the remaining outstanding balance
under its prior collateralized line of credit with Bank One, NA with
borrowings under a new $110 million collateralized line of credit with
Bank One, NA (the "Line of Credit"). The Line of Credit has an initial
term of three years, with a one-year extension option, subject to certain
conditions.
The Line of Credit has a stated borrowing capacity of $110 million. This
capacity is further limited to a stated percentage of the appraised value
of the assets pledged as collateral. The borrowing capacity of the Line
of Credit based on these appraised values is approximately $102 million
as of June 30, 2003.
The Line of Credit bears interest at a variable rate of LIBOR plus 2.25%,
2.50%, 2.75% or 3.00% as determined by the Company's percentage of total
debt to adjusted earnings before interest, taxes, depreciation and
amortization ("EBITDA"), as defined in the loan agreement (the
"Percentage"). The Percentage is adjusted quarterly. At June 30, 2003,
the interest rate on the Line of Credit was LIBOR (1.14% at June 30,
2003) plus 2.75%. Fees ranging from .45% to .60%, as determined by the
Company's ratio of total indebtedness to EBITDA, are paid quarterly on
the unused portion of the Line of Credit. The Line of Credit contains
various covenants, including the maintenance of a minimum net worth,
minimum debt coverage and interest coverage ratios, and total
indebtedness limitations. At June 30, 2003, the Company was in compliance
with all covenants contained in the Line of Credit.
5. Interest Rate Swap Contracts
----------------------------
Effective January 16, 2001, the Company entered into an interest rate
swap agreement with a financial institution on a notional amount of $50
million. The agreement effectively fixes the interest rate on the first
$50 million of floating rate debt outstanding under the Line of Credit at
a rate of 6.4275% plus the Percentage, thus reducing exposure to interest
rate fluctuations. The notional amount does not represent amounts
exchanged by the parties, and thus is not a measure of exposure to the
Company. The term of the interest rate swap agreement is through November
2003. The differences to be paid or received by the Company under the
interest rate swap agreement are recognized as an adjustment to interest
expense. The agreement is with a major financial institution, which is
expected to fully perform under the terms of the agreement.
On March 20, 2003, the Company entered into an interest rate swap
agreement with a financial institution on a notional amount of $25
million. The agreement becomes effective November 2003 and expires in
10
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(unaudited)
-----------------------
5. Interest Rate Swap Contracts, Continued
---------------------------------------
November 2008. The agreement effectively fixes the interest rate on the
first $25 million of floating rate debt outstanding under the Line of
Credit at a rate of 3.875% plus the interest rate spread on the Line of
Credit, thus reducing exposure to interest rate fluctuations. The
notional amount does not represent amounts exchanged by the parties, and
thus is not a measure of exposure to the Company. The differences to be
paid or received by the Company under the interest rate swap agreement
are recognized as an adjustment to interest expense. The agreement is
with a major financial institution, which is expected to fully perform
under the terms of the agreement.
On March 20, 2003, the Company entered into an interest rate swap
agreement with a financial institution on a notional amount of $25
million. The agreement becomes effective in November 2003 and expires in
November 2006. The agreement effectively fixes the interest rate on the
second $25 million of floating rate debt outstanding under the Line of
Credit at a rate of 3.22% plus the interest rate spread on the Line of
Credit, thus reducing exposure to interest rate fluctuations. The
notional amount does not represent amounts exchanged by the parties, and
thus is not a measure of exposure to the Company. The differences to be
paid or received by the Company under the interest rate swap agreement
are recognized as an adjustment to interest expense. The agreement is
with a major financial institution, which is expected to fully perform
under the terms of the agreement.
6. Comprehensive Income
--------------------
SFAS No. 130, "Reporting Comprehensive Income", requires the disclosure
of the components included in comprehensive income (loss). For the six
months ended June 30, 2003, the Company's comprehensive loss was
$971,998, comprised of a net loss of $212,021 and the change in the
unrealized loss on its interest rate swap of $759,977. For the six months
ended June 30, 2002, the Company's comprehensive income was $3,412,256,
comprised of a net income of $3,103,375 and the change in the unrealized
loss on its interest rate swap of $308,881.
11
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(unaudited)
-----------------------
7. Income Taxes
------------
The Company's income tax benefit related to its TRS Lessee subsidiaries
consists of the following for the six months ended June 30:
2003 2002
----------- -----------
Deferred:
Federal $(3,122,000) $(2,840,000)
State (368,000) (335,000)
----------- -----------
(3,490,000) (3,175,000)
Included in discontinued operations 182,806 206,809
----------- -----------
Total $(3,307,194) $(2,968,191)
=========== ===========
The TRS Lessees' net deferred tax asset of $13,267,000 is comprised of
net operating loss carry-forwards which expire beginning on December 31,
2021. The Company believes that the TRS Lessees will generate sufficient
future taxable income to realize this deferred tax asset in full.
Accordingly, no valuation allowance has been recorded at June 30, 2003.
The difference between the TRS Lessees' effective income tax rate and the
statutory Federal income tax rate is as follows as follows for the six
months ended June 30:
2003 2002
---- ----
Statutory Federal rate 34.0% 34.0%
State income taxes 4.0% 4.0%
---- ----
Effective tax rate 38.0% 38.0%
==== ====
8. Discontinued Operations
-----------------------
In 2002, the Company adopted the provisions of Financial Accounting
Standard No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144"). SFAS 144 established criteria beyond
that previously specified in Statement of Financial Accounting Standard
No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" ("SFAS 121"), to determine when a
long-lived asset is classified as held for sale, and it provides a single
accounting model for the disposal of long-lived assets. Due to the
adoption of SFAS 144, the Company now reports as discontinued operations
any
12
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(unaudited)
-----------------------
8. Discontinued Operations, Continued
----------------------------------
assets held for sale (as defined by SFAS 144), and assets sold in the
current period. All results of these discontinued operations, less
applicable income taxes, are included in a separate component of income
on the consolidated statement of operations under the heading, "income
from discontinued operations." This change has resulted in certain
reclassifications of the previously reported 2002 statements of
operations.
In 2003, the Company sold its Hampton Inn in Ft. Worth, Texas and its
Hampton Inn & Suites in Bartlett, Tennessee for an aggregate cash price
of $10.7 million, resulting in a gain on the sales of approximately $1.3
million. The operations of these hotels, plus the operations of four
other hotels classified as held for sale effective June 30, 2003 are
included in the statement of operations under the heading, "Income (loss)
from discontinued operations." The components of income (loss) from
discontinued operations for the three and six months ended June 30, 2003
and 2002 are shown below:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- -----------------------------
2003 2002 2003 2002
---------- ---------- ----------- ----------
Revenue:
Room revenue $1,565,705 $2,734,059 $ 3,336,557 $5,293,729
Other operating departments 72,488 107,983 147,102 212,991
Operating Costs:
Property operating costs (1,060,332) (1,730,056) (2,248,523) (3,364,045)
Other operating departments (59,938) (125,092) (125,730) (255,053)
Property taxes and insurance (109,809) (197,267) (234,543) (387,392)
Depreciation (288,030) (517,506) (576,060) (988,422)
Amortization of franchise fees (3,180) (1,795) (6,360) (5,590)
Interest (176,538) (176,538) (353,077) (353,077)
Income tax benefit 68,583 92,383 182,806 206,809
---------- ---------- ----------- ----------
Income from operations of
discontinued operations 8,949 186,171 122,172 359,950
---------- ---------- ----------- ----------
Gain on sale of hotel properties, net of
minority interest 1,274,544
Loss on impairment of hotels held
for sale, net of minority interest (3,556,067) (3,556,067)
---------- ---------- ----------- ----------
Income (loss) from discontinued
operations $3,547,118 $ 186,171 $(2,159,351) $ 359,950
========== ========== =========== ==========
13
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(unaudited)
-----------------------
9. Recent Accounting Pronouncements
--------------------------------
In May 2003, FAS 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity," was issued. FAS 150
establishes standards for how a company classifies and measures certain
financial instruments with characteristics of both liabilities and
equity. It requires that a company classify a financial instrument that
is within its scope as a lability (or an asset in some instances). Many
of those instruments were previously classified as equity. This
statements is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective for the first
fiscal period beginning after December 15, 2003. We have not yet
determined the effect of the adoption of FAS 150 on our results of
operations or financial position.
10. Subsequent Events
-----------------
On August 11, 2003, the Company completed its offering of 8.75% Series B
Cumulative Preferred Stock, selling 3 million shares. The offering price
was $25 per share, resulting in gross proceeds of $75 million. The
Company received approximately $72.4 million after underwriters' discount
and offering expenses were paid. At the discretion of the underwriters,
an additional 450,000 shares may be sold at $25 per share as a part of
this offering, resulting in an additional $11.2 million in gross
proceeds. If this option is exercised in full, the Company will receive
additional proceeds of approximately $10.5 million after underwriters'
discount and offering expenses are paid.
On August 11, 2003, the Company redeemed all of its outstanding 9 1/2%
Series A Cumulative Preferred Stock at a redemption price of $25, plus
accrued dividends. The cost of the redemption of the 9 1/2% Series A
Cumulative Preferred Stock was approximately $68.8 million.
On August 11, 2003, the Partnership sold its Holiday Inn Express hotel in
Wilkesboro, North Carolina to a third party for approximately $3.4
million in cash. The Company realized a loss of approximately $52,000 as
a result of the sale.
14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
BACKGROUND
Equity Inns, Inc. (the "Company") is a Memphis-based, self-advised hotel real
estate investment trust ("REIT") focused on the upscale extended stay, all-suite
and midscale limited-service segments of the hotel industry. The Company,
through its wholly owned subsidiary, Equity Inns Trust (the "Trust"), is the
sole general partner of Equity Inns Partnership, L.P. (the "Partnership") and at
June 30, 2003 owned an approximate 97.3% interest in the Partnership.
The Company commenced operations on March 1, 1994 upon completion of its initial
public offering and the simultaneous acquisition of eight Hampton Inn hotels
with 995 rooms. Over the next nine years, the Company grew with a focus on
geographic and brand diversity. The Company believes that diversity in its asset
portfolio reduces operational variance from year to year and results in less
volatility relative to the overall hotel industry. Management believes that this
diversity provides minimal operational variances in comparison to industry
norms.
The following table illustrates the Company's geographic presence by the number
of hotels as of June 30, 2003.
Region
------------------
East North Central 14.7%
East South Central 13.7%
Middle Atlantic 6.3%
Mountain 10.5%
New England 5.3%
Pacific Northwest 2.1%
South Atlantic 28.4%
West North Central 7.4%
West South Central 11.6%
Management believes that geographic diversity helps to limit its exposure to any
one market. At June 30, 2003, the Company owned a geographically diverse
portfolio of 95 hotels with 12,210 rooms, located in 34 states with eight
national brands. Additionally, this property mix is spread between suburban and
urban locations, helping to insulate the Company from various economic climates,
including a depressed business travel climate.
The Company's hotel portfolio includes premium limited service hotels, all-suite
hotels, premium extended stay hotels, and full service hotels. This array of
product allows management to diversify the asset portfolio so as to minimize
risk in various economic environments.
15
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
The following chart summarizes information regarding the Company's franchise
diversity at June 30, 2003:
Number of Number of
Franchise Affiliation Hotel Properties Rooms/Suites
--------------------- ---------------- ------------
Premium Limited Service Hotels:
Hampton Inn 47 5,905
Holiday Inn Express 1 101
Comfort Inn 2 245
-- ------
Sub-total 50 6,251
-- -------
All-Suite Hotels:
AmeriSuites 19 2,403
Premium Extended Stay Hotels:
Residence Inn 11 1,351
Homewood Suites 9 1,295
-- ------
Sub-total 20 2,646
-- ------
Full Service Hotels:
Holiday Inn 4 557
Comfort Inn 1 177
Courtyard by Marriott 1 176
-- ------
Sub-total 6 910
-- ------
Total 95 12,210
== ======
Ninety-two percent of the hotel portfolio is comprised of the following leading
franchise brands: Homewood Suites and Hampton Inn by Hilton, Residence Inn by
Marriott, Courtyard by Marriott and AmeriSuites by Prime Hospitality. The focus
on multiple brands at the midscale level, excluding food and beverage costs,
better insulates the asset portfolio against the volatility of results relative
to industry revenue per available room ("RevPAR") performance. Descriptions of
each of the Company's brands are as follows:
Homewood Suites by Hilton:
A premier upscale extended stay hotel, focusing on extended stay,
corporate transient and family travelers. Voted the #2 extended stay
hotel brand by JD Powers in 2002.
16
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
Hampton Inn by Hilton:
A premier midscale without food and beverage hotel chain with over
1,000 locations. Voted the #2 midscale without food and beverage
hotel chain by JD Powers in 2002.
Residence Inn by Marriott:
A premier upscale extended stay hotel, focusing on extended stay,
corporate transient and family travelers. Voted the #1 extended stay
hotel brand by JD Powers in 2002.
AmeriSuites by Prime Hospitality:
An upscale all-suite hotel, billed as America's most affordable
all-suite hotel.
Approximately 72% of the Company's hotels are branded by Marriott and Hilton,
which both provide national marketing support and frequent stay programs that
continue to drive additional revenue. The fact that better brands generate
premium RevPAR over their peers is another factor in Equity Inns limiting its
risk and the volatility of the portfolio. The chart below illustrates the 2002
RevPAR premium for the Company's premier brands.
Chain
Brand Segment
RevPAR RevPAR Premium % Premium
------ ------ ------- ---------
Hampton Inn (Hilton) $51.66 $42.34 $9.32 22%
Residence Inn (Marriott) $73.47 $60.36 $13.11 22%
Homewood Suites (Hilton) $68.53 $60.36 $8.17 14%
(Sources: Brand RevPAR -- Hilton and Marriott press releases; Chain Segment
RevPAR -- Smith Travel)
Effective January 1, 2002, the Company, through its TRSs, outsourced the
management of its hotels to leading management companies. By utilizing third
party managers with contracts providing for relatively short-term incentives,
the Company is able to better control the results the third party management
companies produce. The managers of the Company's hotels are as follows:
Number of Hotels
----------------
Interstate Hotels & Resorts, Inc. 52
Hilton Hotels Corporation 18
Prime Hospitality Corporation 19
Others 6
--
95
==
17
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
The Company pursues an active asset acquisition strategy and constantly seeks
opportunities through the purchase of assets in strategic locations or by the
sale of assets when they no longer fit the Company's long-term goals. This
process is ongoing, and activity could potentially increase given a more fluid
marketplace.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2003 and 2002
Hotel revenue for the current period, including revenue from the Company's most
recent acquisition acquired in December 2002, totaled $61.9 million. Hotel
revenue for the same period of the prior year totaled $62.0 million. This
represents a decrease in hotel revenues, after adjustment for the recent
acquisition, of approximately $1.4 million. For the quarter, revenue per
available room declined 2.2% as compared to the same period last year, due
primarily to a decline in average daily rates from $55.55 to $54.32.
Other revenue decreased by approximately $53,000 as compared to the same period
last year, due primarily to a decrease in the income received from the provision
of certain management services to the Company's joint venture partner, GHII,
LLC.
Property operating costs and other operating department expenses decreased by
approximately $259,000 as compared to the same period last year. The decrease
was due primarily to a decrease in repair and maintenance expenses.
Property taxes and insurance decreased by approximately $263,000 due primarily
to decreases in property taxes, resulting from lower assessed values at many of
the Company's hotels.
Depreciation expense decreased slightly as compared to the same period last
year, due primarily to certain components becoming fully depreciated in prior
periods.
Amortization of franchise fees decreased by approximately $13,000 due primarily
to extensions of certain of the Company's hotel franchise licenses for extended
periods.
General and administrative expenses, including non-cash compensation, increased
approximately $253,000 over the prior quarter, due primarily to increased
professional fees and increased franchise taxes.
Rental expense decreased by approximately $107,000, as compared to the prior
quarter, due to the recording of non-recurring adjustments in the prior period.
18
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS, Continued
Amortization of debt costs increased by approximately $390,000, as compared to
the prior quarter, due to the write-off of debt costs as a result of the early
replacement of the Company's line of credit, which was originally scheduled to
expire in October 2003.
Interest expense decreased by approximately $86,000, as compared to the prior
quarter, due to a decrease in the weighted average interest rate from 8.11% to
7.71%, offset by an increase in average borrowings outstanding from $357.0
million to $366.0 million.
Income tax benefit increased $199,000 over the prior quarter as taxable REIT
subsidiaries incurred larger losses.
Loss on impairment of hotels held for sale represents the anticipated losses on
the sale of three hotels that the Company expects to sell in the next year, at a
combined loss of approximately $3.6 million.
Income from operations of discontinued operations represents the operating
results of two hotels sold by the Company in January 2003 and four hotels which
the Company expects to sell in the next year. Statement of Financial Accounting
Standard No. 144, Accounting for the Impairment of Long-Lived Assets, requires
the results of operations of both sold hotels and hotels held for sale to be
reported as discontinued operations.
Six Months Ended June 30, 2003 and 2002
Hotel revenue for the current period, including revenue from the Company's most
recent acquisition acquired in December 2002, totaled $114.6 million. Hotel
revenue for the same period of the prior year totaled $114.7 million. This
represents a decrease in hotel revenues, after adjustment for the recent
acquisition, of approximately $2.8 million. For the period, revenue per
available room declined 2.2% as compared to the same period last year, due
primarily to a decline in average daily rate from $51.76 to $50.62.
Other revenue decreased by approximately $144,000 as compared to the same period
last year, due primarily to a decrease in the income received from the provision
of certain management services to the Company's joint venture partner, GHII,
LLC.
Property operating costs and other operating department expenses increased by
approximately $674,000, as compared to the same period last year, due primarily
to an increase in the cost of utilities and insurance.
Property taxes and insurance increased over the comparable period last year by
approximately $116,000 due primarily to increases in the cost of insurance,
which has risen significantly following September 11, 2001.
19
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS, Continued
Depreciation expense decreased slightly as compared to the same period last
year, due primarily to certain components being fully depreciated in prior
periods.
Amortization of franchise fees decreased by approximately $23,000 due primarily
to extensions of certain of the Company's hotel franchise licenses for extended
periods and the sale of two hotels in January 2003.
General and administrative expenses, including non-cash compensation, increased
approximately $513,000 over the comparable period last year, due primarily to
increased professional fees and increased franchise taxes.
Rental expense decreased by approximately $214,000, as compared to the prior
quarter, due to the recording of non-recurring adjustments in the prior period.
Amortization of debt costs increased by approximately $387,000, as compared to
the same period last year, due to the write-off of debt costs as a result of the
early replacement of the Company's line of credit, which was originally
scheduled to expire in October 2003.
Interest expense decreased by approximately $410,000 as compared to the prior
quarter, due to a decrease in the weighted average interest rate from $7.96% to
7.84%, and by a decrease in average borrowings outstanding from $371.4 million
to $363.8 million.
Income tax benefit increased $339,000 over the prior quarter as taxable REIT
subsidiaries incurred larger losses.
Gain on the sale of hotel properties relates to the sale of two hotels in
January 2003.
Loss on impairment of hotels held for sale represents the anticipated losses on
the sale of three hotels that the Company expects to sell in the next year, at a
combined loss of approximately $3.6 million.
Income from operations of discontinued operations represents the operating
results of two hotels sold by the Company in January 2003 and four hotels which
the Company expects to sell in the next year. Statement of Financial Accounting
Standard No. 144, Accounting for the Impairment of Long-Lived Assets, requires
the results of operations of both sold hotels and hotels held for sale to be
reported as discontinued operations.
20
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal source of cash to meet its cash requirements, including
distributions to its shareholders and repayments of indebtedness, is from the
results of operations of its hotels. For the six months ended June 30, 2003, net
cash flow provided by operating activities was $13.1 million and FFO was $18.7
million. The Company currently expects that its operating cash flow will be
sufficient to fund its continuing operations, including its required debt
service obligations and distributions to shareholders required to maintain its
status as a REIT. The Company expects to fund any short-term liquidity
requirements above its operating cash flows through short-term borrowings under
its Line of Credit.
The Company is currently negotiating a mortgage on its Houston Courtyard by
Marriott hotel for approximately $10.7 million. These funds are expected to be
available in late August. The Company is expecting to complete the sale of an
unencumbered hotel in Wilkesboro, North Carolina in late August. The net
proceeds from the sale are expected to be approximately $3.2 million. The
Company is also expected to receive approximately $3.7 million from the
completion of its Series B Cumulative Preferred Stock offering on August 11,
2003. The Company has granted a 30-day overallotment option to its underwriters,
which would result in approximately $10.5 million of additional proceeds if
fully exercised. All of these funds will be used to reduce the balance
outstanding on the Company's Line of Credit.
The Company may make additional investments in hotel properties and may incur,
or cause the Partnership to incur, indebtedness to make such investments or to
meet distribution requirements imposed on a REIT under the Internal Revenue Code
of 1986 (the "Code") to the extent that working capital and cash flow from the
Company's investments are insufficient to make such distributions. The Company's
Board of Directors has adopted a policy limiting aggregate indebtedness to 45%
of the Company's investment in hotel properties, at cost, after giving effect to
the Company's use of proceeds from any indebtedness. This policy may be amended
at any time by the Board of Directors without a shareholder vote.
At June 30, 2003, the Company had outstanding debt of approximately $364.1
million, including $92.7 million under the Line of Credit, leaving approximately
$8.7 million available for borrowings under the Line of Credit, after
consideration of outstanding letters of credit. The Company's consolidated
indebtedness was 38.7% of its investment in hotels, at cost, at June 30, 2003.
21
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
The following details the Company's debt outstanding at June 30, 2003:
Interest
Rate Maturity
-------------------- --------
Commercial Mortgage Bonds
Class A $ 4,680,764 6.83% Fixed Nov 2006
Class B 50,600,000 7.37% Fixed Dec 2015
Class C 10,000,000 7.58% Fixed Feb 2017
------------
65,280,764
Line of Credit 92,700,000 LIBOR plus Variable June 2006
Percentage
Mortgage 91,802,534 8.37% Fixed July 2009
Mortgage 67,393,132 8.25% Fixed Nov 2010
Mortgage 34,857,051 8.25% Fixed Nov 2010
Mortgage 2,957,903 6.00% Fixed May 2008
Mortgage 5,549,514 10.00% Fixed Sept 2005
Mortgage 3,597,696 6.37% Fixed Nov 2016
------------
$364,138,594
============
At June 30, 2003, the Line of Credit had a borrowing capacity of approximately
$102 million. The weighted average interest rate incurred by the Company during
the six months ended June 30, 2003 was 7.84%. Payment of outstanding
indebtedness under the Line of Credit is due at maturity in June 2006.
Effective January 16, 2001, the Company entered into an interest rate swap
agreement with a financial institution on a notional amount of $50 million. The
agreement effectively fixes the interest rate on the first $50 million of
floating rate debt outstanding under the Line of Credit at a rate of 6.4275%
plus the Percentage, thus reducing exposure to interest rate fluctuations. The
notional amount does not represent amounts exchanged by the parties, and thus is
not a measure of exposure to the Company. The term of the interest rate swap
agreement is through November 2003. The differences to be paid or received by
the Company under the interest rate swap agreement are recognized as an
adjustment to interest expense. The agreement is with a major financial
institution, which is expected to fully perform under the terms of the
agreement.
On March 20, 2003, the Company entered into an interest rate swap agreement with
a financial institution on a notional amount of $25 million. The agreement
becomes effective November 2003 and expires in November 2008. The agreement
effectively fixes the interest rate on the first $25 million of floating rate
debt outstanding under the Line of Credit at a rate of 3.875% plus the interest
rate spread on the Line of Credit, thus reducing exposure to interest rate
fluctuations. The notional
22
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
amount does not represent amounts exchanged by the parties, and thus is not a
measure of exposure to the Company. The differences to be paid or received by
the Company under the interest rate swap agreement are recognized as an
adjustment to interest expense. The agreement is with a major financial
institution, which is expected to fully perform under the terms of the
agreement.
On March 20, 2003, the Company entered into an interest rate swap agreement with
a financial institution on a notional amount of $25 million. The agreement
becomes effective in November 2003 and expires in November 2006. The agreement
effectively fixes the interest rate on the second $25 million of floating rate
debt outstanding under the Line of Credit at a rate of 3.22% plus the interest
rate spread on the Line of Credit, thus reducing exposure to interest rate
fluctuations. The notional amount does not represent amounts exchanged by the
parties, and thus is not a measure of exposure to the Company. The differences
to be paid or received by the Company under the interest rate swap agreement are
recognized as an adjustment to interest expense. The agreement is with a major
financial institution, which is expected to fully perform under the terms of the
agreement.
During the six months ended June 30, 2003, the Company invested $6.2 million to
fund capital improvements to its hotels, including replacement of carpets,
drapes, renovation of common areas and improvements of hotel exteriors. In
addition, the Company expects to fund an additional $9.8 million during the
remainder of 2003 for capital improvements. The Company intends to fund such
improvements out of future cash from operations, present cash balances and
borrowings under the Line of Credit. Under certain of its loan agreements, the
Partnership is obligated to fund 4% of room revenues per quarter, on a
cumulative basis, to a separate room renovation account for the ongoing
replacement or refurbishment of furniture, fixtures and equipment at the Hotels.
The Company intends to fund cash distributions to shareholders and limited
partners principally out of cash generated from operations. The Company may
incur, or cause its subsidiaries to incur, indebtedness to meet distribution
requirements imposed on a REIT under the Internal Revenue Code including the
requirement that a REIT distribute to its shareholders annually at least 90% of
its taxable income to the extent that working capital and cash flow from the
Company's investments are insufficient to make such distributions. The Company's
decision to pay a quarterly common dividend will be determined each quarter, at
the discretion of the Board of Directors, based upon the operating results of
that quarter, economic conditions and other operating trends.
The Company expects to meet its long-term liquidity requirements, such as
scheduled debt maturities and property acquisitions, through long-term secured
and unsecured borrowings, the issuance of additional equity securities of the
Company or, in connection with acquisitions of hotel properties, the issuance of
Partnership Units. Under the Partnership's limited partnership agreement (the
23
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
"Partnership Agreement"), subject to certain holding period requirements,
holders of Units in the Partnership have the right to require the Partnership to
redeem their Units. During the six months ended June 30, 2003, 51,521 Units were
tendered for redemption. Under the Partnership Agreement, the Company has the
option to redeem Units tendered for redemption on a one-for-one basis for shares
of Common Stock or for an equivalent amount of cash. The Company anticipates
that it will acquire any Units tendered for redemption in the foreseeable future
in exchange for shares of Common Stock and, to date, has registered such shares
so as to be freely tradeable by the recipient.
FUNDS FROM OPERATIONS
The Company generally considers Funds from Operations ("FFO") to be an
appropriate measure of the performance of an equity REIT. In accordance with the
resolution adopted by the Board of Governors of the National Association of Real
Estate Investment Trusts ("NAREIT"), FFO represents net income (loss) (computed
in accordance with generally accepted accounting principles), excluding gains
(or losses) from sales of property, losses on impairment, plus depreciation, and
after adjustments for unconsolidated partnerships and joint ventures. For the
periods presented, depreciation, gains and losses from sales of property, losses
on impairment, and minority interest were the Company's only adjustments to net
income for the definition of FFO. FFO should not be considered an alternative to
net income or other measurements under generally accepted accounting principles
as an indicator of operating performance or to cash flows from operating,
investing or financing activities as a measure of liquidity. FFO does not
reflect working capital changes, cash expenditures for capital improvements or
principal payments with respect to indebtedness on the hotels.
24
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
FUNDS FROM OPERATIONS, Continued
The following reconciliation of net income (loss) to FFO illustrates the
difference in the two measures of operating performance:
For the Three Months Ended For the Six Months Ended
June 30, June 30,
----------------------------- ----------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net income (loss) $ (171,306) $ 3,738,240 $ (212,021) $ 3,103,375
Less:
Preferred stock dividends (1,632,813) (1,632,813) (3,265,626) (3,265,626)
Gain on sale of hotel properties (1,274,544)
Add:
Minority interest 50,714 68,359 2,245 (5,022)
Loss on impairment of hotels held for sale 3,556,067 3,556,067
Depreciation 9,662,676 9,739,989 19,328,552 19,510,654
Depreciation from discontinued operations 288,030 517,506 576,060 988,422
----------- ----------- ----------- -----------
Funds From Operations $11,753,368 $12,431,281 $18,710,733 $20,331,803
=========== =========== =========== ===========
Weighted average number of outstanding
share of Common Stock and Units of
Partnership 41,695,661 41,665,063 41,690,821 39,968,470
=========== =========== =========== ===========
Funds From Operations per Share and Unit $ 0.28 $ 0.30 $ 0.45 $ 0.51
=========== =========== =========== ===========
INFLATION
Operators of hotels, including third-party managers retained by the TRS Lessees,
in general possess the ability to adjust room rates quickly. However,
competitive pressures and a slow economy have limited and may in the future
limit the ability of the third-party managers retained by the TRS Lessees to
raise room rates in response to inflation.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of its financial condition and results of
operations are based upon its consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
the Company's management to make estimates and judgments that affect the
reported amount of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities.
25
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
CRITICAL ACCOUNTING POLICIES AND ESTIMATES, Continued
On an on-going basis, all estimates are evaluated by the Company's management,
including those related to bad debts, carrying value of investments in hotel
properties, income taxes, contingencies and litigation. All estimates are based
upon historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements:
o The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers and other borrowers to make
required payments. If the financial condition of its customers or other
borrowers were to deteriorate, resulting in an impairment of their ability
to make payments, additional allowances may be required.
o The Company records an impairment charge when it believes an investment in
hotels has been impaired such that future undiscounted cash flows would not
recover the book basis of the investment in the hotel property. Future
adverse changes in market conditions or poor operating results of underlying
investments could result in losses or an inability to recover the carrying
value of the investments that may not be reflected in an investment's
carrying value, thereby possibly requiring an impairment charge in the
future.
o The Company records a valuation allowance to reduce its deferred tax assets
to the amount that is more likely than not to be realized. The Company's
management has considered future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for a valuation
allowance. If management determines that the Company will not be able to
realize all or part of its net deferred tax asset in the future, an
adjustment to the deferred tax asset will be charged to income in the
periods such determination was made.
FORWARD-LOOKING STATEMENTS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations contains 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, including without limitation, statements
containing the words "believes", "estimates", "projects", "anticipates",
"intends," "expects" and words of similar import. Such forward-looking
statements relate to future events and the future financial performance of the
Company, and involve known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the Company
to be materially different from the results or achievement expressed or implied
by such forward-looking statements. Such risks and uncertainties include, but
are not limited to, the
26
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
FORWARD-LOOKING STATEMENTS, Continued
following: the ability of the Company to cope with domestic economic and
political disruption and Federal and state governmental regulations or war,
terrorism, states of emergency or similar activities such as those resulting
from the terrorist attacks occurring on September 11, 2001; risks associated
with debt financing; hotel operating risks; the ability of the Company to
successfully implement its operating strategy; changes in economic cycles;
competition from other hospitality companies; and changes in the laws and
government regulations applicable to the Company. Risk factors relating to such
forward-looking statements are contained from time to time in the Company's
filings with the SEC, including the Company's Current Report on Form 8-K dated
March 27, 2003 filed under the Securities Exchange Act of 1934, as amended. The
Company is not obligated to update any such forward-looking statements or risk
factors.
SEASONALITY
The hotel industry is seasonal in nature. The Company's hotel operations
historically reflect higher occupancy rates and average daily rates during the
second and third quarters. This seasonality can be expected to cause
fluctuations in quarterly operating income. To the extent that cash flow from
the hotels for a quarter is insufficient to fund all of the distributions for
such quarter, the Company may fund seasonal-related shortfalls with available
cash or borrowing under the Line of Credit.
27
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to certain financial market risks, the most predominant
of which is the fluctuation in interest rates. At June 30, 2003, the Company's
exposure to market risk for a change in interest rates is related solely to its
debt outstanding under the Line of Credit. Total debt outstanding under the Line
of Credit totaled $92.7 million at June 30, 2003.
The Company's Line of Credit bears interest at a variable rate of LIBOR plus
2.25%, 2.5%, 2.75% or 3.0% as determined by the Company's percentage of total
debt to earnings before interest, taxes, depreciation and amortization, as
defined in the loan agreement (the "Percentage"). At June 30, 2003, the interest
rate on the line of credit was LIBOR (1.14% at June 30, 2003) plus 2.75%. The
Company's interest rate risk objective is to limit the impact of interest rate
fluctuations on earnings and cash flows and to lower its overall borrowing
costs. To achieve this objective, the Company manages its exposure to
fluctuations in market interest rates for its borrowings through the use of
fixed rate debt instruments to the extent that reasonably favorable rates are
obtainable through such arrangements and derivative financial instruments such
as interest rate swaps, to effectively lock the interest rate on a portion of
its variable rate debt. The Company does not enter into derivative or interest
rate transactions for speculative purposes. The Company regularly reviews
interest rate exposure on its outstanding borrowings in an effort to minimize
the risk of interest rate fluctuations.
Effective January 16, 2001, the Company entered into an interest rate swap
agreement with a financial institution on a notional amount of $50 million. The
agreement effectively fixes the interest rate on the first $50 million of
floating rate debt outstanding under the Line of Credit at a rate of 6.4275%
plus the Percentage, thus reducing exposure to interest rate fluctuations. The
notional amount does not represent amounts exchanged by the parties, and thus is
not a measure of exposure to the Company. The term of the interest rate swap
agreement is through November 2003. The differences to be paid or received by
the Company under the interest rate swap agreement are recognized as an
adjustment to interest expense. The agreement is with a major financial
institution, which is expected to fully perform under the terms of the
agreement.
On March 20, 2003, the Company entered into an interest rate swap agreement with
a financial institution on a notional amount of $25 million. The agreement
becomes effective November 2003 and expires in November 2008. The agreement
effectively fixes the interest rate on the first $25 million of floating rate
debt outstanding under the Line of Credit at a rate of 3.875% plus the interest
rate spread on the Line of Credit, thus reducing exposure to interest rate
fluctuations. The notional amount does not represent amounts exchanged by the
parties, and thus is not a measure of exposure to the Company. The differences
to be paid or received by the Company under the interest rate swap agreement are
recognized as an adjustment to interest expense. The agreement is with a major
financial institution, which is expected to fully perform under the terms of the
agreement.
On March 20, 2003, the Company entered into an interest rate swap agreement with
a financial institution on a notional amount of $25 million. The agreement
becomes effective in November 2003
28
and expires in November 2006. The agreement effectively fixes the interest rate
on the second $25 million of floating rate debt outstanding under the Line of
Credit at a rate of 3.22% plus the interest rate spread on the Line of Credit,
thus reducing exposure to interest rate fluctuations. The notional amount does
not represent amounts exchanged by the parties, and thus is not a measure of
exposure to the Company. The differences to be paid or received by the Company
under the interest rate swap agreement are recognized as an adjustment to
interest expense. The agreement is with a major financial institution, which is
expected to fully perform under the terms of the agreement.
Thus, at June 30, 2003, the Company has $42.7 million of variable rate debt
outstanding under the Line of Credit that was exposed to fluctuations in the
market rate of interest.
The Company's Line of Credit matures in June 2006. As discussed above, the
Company's Line of Credit bears interest at variable rates, and therefore, cost
approximates market value. As of June 30, 2003, the fair value liability of the
Company's interest rate swaps was approximately $3.0 million.
The Company's operating results are affected by changes in interest rates,
primarily as a result of its borrowing under the Line of Credit. If interest
rates increased by 25 basis points, the Company's interest expense for the six
months ended June 30, 2003 would have increased by approximately $53,400, based
on balances outstanding during the period ended June 30, 2003.
Item 4. Controls and Procedures
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, the
Company carried out an evaluation, with the participation of the Company's
management, including Phillip H. McNeill, Sr., the Company's chief executive
officer ("CEO") and Donald H. Dempsey, the Company's chief financial officer
("CFO"). Based upon that evaluation, the Company's CEO and CFO concluded that
the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company required to be
included in the Company's periodic SEC filings. There has been no change in the
Company's internal control over financial reporting during the quarter ended
June 30, 2003 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
29
PART II - OTHER INFORMATION
Item 5. Submission of Matters to a Vote of Security Holders
The 2003 annual meeting of shareholders (the "2003 Annual Meeting") of Equity
Inns, Inc. (the "Company") was held on May 8, 2003.
At the 2003 Annual Meeting, the Company's shareholders of record on March 14,
2003 were asked to take action to elect two nominees as Class III directors,
Joseph W. McLeary and Donald H. Dempsey, each to serve on the Board of Directors
until the Company's annual meeting of shareholders in 2006 or until their
successors have been duly elected and qualified (the "Proposal"). Both nominees
for Class III directors were nominated by the Board of Directors on March 20,
2003.
With respect to the Proposal, a plurality of the votes cast in favor of each
nominee was required for the election of each nominee as director. Both of
Messrs. McLeary and Dempsey received the required plurality of the votes, and
each was elected as a Class III director.
The breakdown of the votes cast by the shareholders at the 2003 Annual Meeting
was as follows:
Withheld/ Broker
For Against Abstain Non-Votes Total
---------- ---------- ------- --------- ----------
Mr. McLeary (Class III) 36,072,678 1,560,2763 N/A 37,632,951
Mr. Dempsey (Class III) 37,279,086 353,865 N/A 37,632,951
Phillip H. McNeill, Sr., Raymond E. Schultz, Howard A. Silver, William W.
Deupree, Jr. and Harry S. Hays will continue to serve as directors.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits -- The following exhibits were filed with this Quarterly Report on
Form 10-Q:
10.1 -- Amended and Restated Secured Revolving Credit Agreement dated
as of June 11, 2003, by and among Equity Inns Partnership, L.P., Equity
Inns/West Virginia Partnership, L.P. and Equity Inns Partnership II,
L.P. as Borrowers, Bank One, NA, Credit Lyonnais New York Branch, Fleet
National Bank, National Bank of Commerce, AmSouth Bank and Union
Planters Bank, National Associations as Lenders, Bone One, NA as
Administrative Agent, Banc One Capital Markets, Inc. as Co-Lead
Arranger/Sole Book Manager, Credit Lyonnais New York Branch as
Syndication Agent and Co-Lead Arranger and Fleet National Bank as
Documentation Agent (incorporated by reference to Exhibit 10.0 to Form
8-K dated June 11, 2003 and filed July 2, 2003).
30
31.1 -- Rule 13a-14(a) Certification of Phillip H. McNeill, Sr.
31.2 -- Rule 13a-14(a) Certification of Donald H. Dempsey
32.1 -- Section 1350 Certification of Phillip H. McNeill, Sr.
32.2 -- Section 1350 Certification of Donald H. Dempsey
(b) Reports on Form 8-K -- During the period covered by this Quarterly
Report on Form 10-Q, the Company filed the following two (2) Current
Reports on Form 8-K:
(1) Current Report on Form 8-K dated May 8, 2003 and filed on May 9,
2003, reporting the issuance of a press release reporting the
Company's first quarter results for 2003 (no financial
information required).
(2) Current Report on Form 8-K dated May 8, 2003 and filed on May 9,
2003, disclosing the results of the Company's annual meeting of
shareholders held May 8, 2003 (no financial information
required).
31
SIGNATURES
Pursuant to the requirements 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.
Equity Inns, Inc.
August 13, 2003 By: /s/Donald H. Dempsey
- --------------------- -----------------------------------------------
Date Donald H. Dempsey
Executive Vice President, Secretary, Treasurer,
and Chief Financial Officer (Principal
Financial and Accounting Officer)
32