UNITED STATES
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, 2004 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: (1) 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.
X Yes 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 4, 2004 was 45,450,477.
1 of 41
EQUITY INNS, INC.
INDEX
PAGE
----
PART I. Financial Information
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets - June 30, 2004 and
December 31, 2003 3
Condensed Consolidated Statements of Operations - For the
three and six months ended June 30, 2004 and 2003 4
Condensed Consolidated Statements of Cash Flows - For the
six months ended June 30, 2004 and 2003 5
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures About Market Risk 37
Item 4. Controls and Procedures 39
PART II. Other Information
Item 1. Legal Proceedings 40
Item 6. Exhibits and Reports on Form 8-K 40
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EQUITY INNS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
June 30, December 31,
2004 2003
-------- ------------
ASSETS
Investment in hotel properties, net $744,167 $681,478
Assets held for sale - 10,242
Cash and cash equivalents 11,560 8,201
Accounts receivable, net of doubtful accounts
of $200 and $200, respectively 8,693 5,069
Interest rate swap 43 -
Notes receivable, net 5,428 4,917
Deferred expenses, net 8,504 8,291
Deposits and other assets, net 9,865 6,083
-------- --------
Total assets $788,260 $724,281
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Long-term debt $378,510 $329,774
Accounts payable and accrued expenses 27,830 22,913
Distributions payable 7,329 6,939
Interest rate swap - 931
Minority interests in Partnership 7,827 7,338
-------- --------
Total liabilities 421,496 367,895
-------- --------
Commitments and Contingencies
Shareholders' equity:
Preferred stock (Series B), $.01 par value, 10,000,000
shares authorized, 3,450,000 shares issued and outstanding 83,524 83,524
Common stock, $.01 par value, 100,000,000
shares authorized, 46,195,827 and 43,305,827
shares issued and outstanding 462 433
Additional paid-in capital 487,837 463,691
Treasury stock, at cost, 747,600 shares (5,173) (5,173)
Unearned directors' and officers' compensation (1,740) (123)
Distributions in excess of net earnings (198,189) (185,035)
Unrealized income (loss) on interest rate swap 43 (931)
-------- --------
Total shareholders' equity 366,764 356,386
-------- --------
Total liabilities and shareholders' equity $788,260 $724,281
======== ========
The accompanying notes are an integral
part of these condensed consolidated financial statements.
3
EQUITY INNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------- -------------------------
2004 2003 2004 2003
------- ------- -------- --------
Revenue:
Room revenue $63,132 $58,560 $115,024 $108,211
Other hotel revenue 3,102 2,932 5,687 5,451
Other revenue 109 257 208 363
------- ------- -------- --------
Total revenues 66,343 61,749 120,919 114,025
------- ------- -------- --------
Operating expenses:
Direct hotel expenses 36,505 33,683 68,146 64,036
Other hotel expenses 2,346 2,143 4,341 4,055
Depreciation 9,842 9,583 19,334 19,169
Property taxes, rental expense and insurance 4,111 4,413 8,541 9,138
General and administrative expenses:
Non-cash stock-based compensation 164 133 323 265
Other general and administrative expenses 1,871 1,655 3,878 3,562
------- ------- -------- --------
Total operating expenses 54,839 51,610 104,563 100,225
------- ------- -------- --------
Operating income 11,504 10,139 16,356 13,800
Interest expense, net 7,154 7,875 13,894 15,324
------- ------- -------- --------
Income (loss) from continuing operations
before minority interest and income taxes 4,350 2,264 2,462 (1,524)
Minority interests expense (income) 62 51 (44) 2
Deferred income tax benefit - (960) - (3,302)
------- ------- --------- --------
Loss from continuing operations 4,288 3,173 2,506 1,776
Discontinued operations:
Gain (loss) on sale of hotel properties - - (320) 1,275
Loss on impairment of hotels held for sale - (3,556) - (3,556)
Income (loss) from operations of
discontinued operations (19) 212 (116) 293
------- ------- -------- --------
Loss from discontinued operations (19) (3,344) (436) (1,988)
------- ------- -------- --------
Net income (loss) 4,269 (171) 2,070 (212)
Preferred stock dividends 1,887 1,633 3,773 3,266
------- ------- -------- --------
Net income (loss) applicable to common
shareholders $ 2,382 $(1,804) $(1,703) $(3,478)
======= ======= ======= =======
Net income (loss) per share data: Basic and diluted income (loss) per share:
Continuing operations $ 0.05 $ 0.04 $ (0.03) $ (0.04)
Discontinued operations 0.00 (0.08) (0.01) (0.05)
------- ------- -------- --------
Net income (loss) per common share $ 0.05 $ (0.04) $ (0.04) $ (0.09)
======= ======= ======== ========
Weighted average number of common
shares outstanding - basic and diluted 45,104 40,549 43,990 40,531
======= ======= ======== ========
The accompanying notes are an integral
part of these consolidated financial statements.
4
EQUITY INNS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Six Months Ended
June 30,
----------------------------
2004 2003
------- --------
Cash flows from operating activities:
Net income (loss) $ 2,070 $ (212)
Adjustments to net income (loss) provided by operating activities:
Loss (gain) on sale of hotel properties 320 (1,275)
Loss on impairment of hotels held for sale - 3,556
Depreciation 19,334 19,169
Amortization of loan costs and franchise fees 953 2,296
Stock-based or non-cash compensation 323 265
Income tax benefit - (3,490)
Minority interests (44) 2
Changes in assets and liabilities:
Accounts receivable (3,624) (1,955)
Distributions payable 53 -
Deposits and other assets (3,782) (2,425)
Accounts payable and accrued expenses 5,358 (2,806)
------- --------
Net cash provided by operating activities 20,961 13,125
------- --------
Cash flows from investing activities:
Improvements and additions to hotel properties (8,234) (6,162)
Acquisition of hotel properties (32,529) -
Cash paid for franchise applications (275) -
Net proceeds from sale of hotel properties 9,122 10,358
Proceeds from principal payments on notes receivable 289 -
------- --------
Net cash provided by (used in) investing activities (31,627) 4,196
------- --------
Cash flows from financing activities:
Gross proceeds from public offering of common stock 21,720 -
Payment of offering expenses (359) -
Distributions paid (15,195) (14,103)
Cash paid for loan costs (892) (1,719)
Proceeds from borrowings 59,815 28,125
Payments on long-term debt (51,064) (26,868)
------- --------
Net cash provided by (used in) financing activities 14,025 (14,565)
------- --------
Net increase in cash 3,359 2,756
Cash and cash equivalents at beginning of period 8,201 5,916
------- --------
Cash and cash equivalents at end of period $11,560 $ 8,672
======= ========
The accompanying notes are an integral
part of these condensed consolidated financial statements.
5
Supplemental disclosure of non-cash investing and financing activities:
For all stock issuances below, we value the stock award based on the shares of
common stock times the closing price of our common stock on the date earned.
2004
During January 2004, we issued to two of our officers, 47,535 shares of common
stock at $9.26 per share under the 1994 Stock Incentive Plan in lieu of cash as
a performance bonus.
During January 2004, we sold one hotel in Jacksonville, Florida for $5.0
million, including the assumption of a non-cash note receivable for $800,000.
During February 2004, we issued to several key officers 405,233 shares of
restricted common stock at $9.45 per share under the 1994 Stock Incentive Plan
as part of management's long-term incentive compensation.
During the six months ended June 30, 2004, we issued 36,113 shares of common
stock upon redemption of Partnership units.
During the six months ended June 30, 2004, we completed the purchase of nine
hotels and assumed approximately $40.0 million in secured long-term debt,
including approximately $3.7 million of a mortgage note premium. We also issued
$1.3 million in Partnership units in conjunction with these acquisitions.
During the six months ended June 30, 2004, we issued 6,919 shares of common
stock at prices ranging from $8.73 to $9.20 per share to our independent
directors in lieu of cash as compensation.
During the quarter ended June 30, 2004, we declared approximately $6.1 million
in common stock and unit dividends. We paid these dividends on August 2, 2004.
During the quarter ended June 30, 2004, we had approximately $1.2 million in
declared but unpaid preferred stock dividends. We paid these dividends on July
30, 2004.
2003
During January 2003, we issued to one of our 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, we issued 51,521 shares of common
stock upon redemption of Partnership units.
During the six months ended June 30, 2003, we issued 8,724 shares of common
stock at prices ranging from $5.82 to $7.20 per share to our independent
directors in lieu of cash as compensation.
During the quarter ended June 30, 2003, we declared approximately $5.4 million
in common stock and unit dividends. We paid these dividends on August 1, 2003.
During the quarter ended June 30, 2004, we had approximately $1.1 million in
declared but unpaid preferred stock dividends. We paid these dividends on July
31, 2003.
The accompanying notes are an integral
part of these condensed consolidated financial statements.
6
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
Throughout this Form 10-Q, the words "Company", "Equity Inns", "we", "our", and
"us" refer to Equity Inns, Inc., a Tennessee corporation, and its consolidated
subsidiaries, unless otherwise stated or the context requires otherwise.
1. Organization
Equity Inns 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, 2004 owned an
approximate 97.3% interest in the Partnership.
Our hotel properties are leased to our wholly-owned taxable REIT
subsidiaries (the "TRS Lessees"). Our hotel properties are managed by
independent third parties. At June 30, 2004, the independent managers of
our hotels are as follows:
Number of Hotels
----------------
Interstate Hotels & Resorts, Inc. 48
Hilton Hotels Corporation 17
Prime Hospitality Corporation 18
Other (3) 16
--
99
==
Our management agreements with Prime are structured to provide the TRS
Lessees minimum net operating income at each of our 18 AmeriSuites
hotels. In addition, the management agreements specify a net operating
income threshold for each of our 18 AmeriSuites hotels. As the manager,
the Prime subsidiaries can earn an incentive management fee of 25% of
hotel net operating income above the threshold, as defined, to a maximum
of 6.5% of gross hotel revenues. If the management fee calculation would
have exceeded 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 the greater of
a predetermined minimum return or the net operating income plus 25% of
the shortfall between the threshold amount and the net operating income
of the hotel. We record all shortfall contributions as a reduction of
base management fees which are included as a component of direct hotel
expenses in our accompanying condensed consolidated statements of
operations when all contingencies related to such amounts have been
resolved. In May 2003, we updated our current franchise contracts and
management agreements with Prime on all of our AmeriSuites hotels. The
minimum net operating income guarantee agreements were not extended
beyond their original terms and are set to expire in 2007 and 2008. Under
the new agreements, we extended the existing franchise agreements with
7
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
1. Organization, Continued
Prime to 2028 and the management agreements to 2010, as long as Prime
continues to be in compliance with the minimum net operating income
guarantees in the original agreements. For the three months ended
June 30, 2004 and 2003, we recorded approximately $815,000 and $750,000,
respectively, in minimum income guarantees from Prime as a reduction of
our base management fee expense in the accompanying condensed
consolidated statements of operations. For the six months ended June 30,
2004 and 2003, we recorded approximately $2.6 million and $2.5 million,
respectively, in minimum income guarantees from Prime as a reduction of
our base management fee expense in the accompanying condensed
consolidated statements of operations. The management contracts for our
remaining hotels have terms ranging from one to ten years and generally
provide for payment of management fees ranging from 1.5% to 3.0% of hotel
revenues and an incentive fee consisting of a percentage of gross
operating profits in excess of budget, as defined by the management
agreements.
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 our
financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2003. The
accompanying unaudited condensed consolidated financial statements
reflect, in the opinion of management, all adjustments necessary for a
fair presentation of the interim financial statements. All such
adjustments are of a normal and recurring nature. The results of our
operations for the current three-month and six-month periods are not
necessarily indicative of the results to be expected for the full year.
Certain prior period amounts have been reclassified to conform to the
current year presentation.
2. Summary of Significant Accounting Policies
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers and other borrowers to make
required payments. The allowance for doubtful accounts is maintained at a
level believed adequate by us to absorb estimated probable receivable
losses. Our periodic evaluation of the adequacy of the allowance is
primarily based on past receivable loss experience, known and inherent
credit risks, current economic conditions, and other relevant factors.
This evaluation is inherently subjective as it requires estimates
including the amounts and timing of future collections. If the financial
condition of our customers or other borrowers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.
8
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
2. Summary of Significant Accounting Policies, Continued
Net Income Per Common Share
Basic earnings per common share from continuing operations are computed
by dividing income (loss) from continuing operations as adjusted for
gains or losses on the sale of hotel properties not included in
discontinued operations, for losses on redemptions of preferred stock,
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 (loss) from
continuing operations as adjusted for gains or losses on the sale of
hotel properties not included in discontinued operations 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. The majority of the options to purchase shares of our common
stock that were outstanding during the three and six months ended June
30, 2004 and 2003 were not included in the computation of diluted EPS
because their effect would have been anti-dilutive.
Distributions
With the exception of the fourth quarter 2001, we have paid regular
quarterly cash distributions to shareholders. These distributions are
determined quarterly by our Board based on our operating results,
economic conditions, capital expenditure requirements, the Internal
Revenue Code's REIT annual distribution requirements, leverage
restrictions imposed by our Line of Credit and other debt documents, and
any other matters that our Board deems relevant.
Stock-Based Compensation
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("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. We have
adopted a policy that applies the estimated fair value based method of
accounting for stock-based employee compensation prospectively to all
awards granted, modified or settled.
In January 2004, we issued 405,233 shares of restricted common stock to
certain key executives of our Company. These grants vest between three
and five years after the date of issuance, if certain performance
measures have been achieved by the Company. The vesting
9
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
2. Summary of Significant Accounting Policies, Continued
of the restricted stock is based on cumulative funds from operations
("FFO") and total shareholder return targets as determined by our Board.
The executives will be entitled to vote these restricted stock shares and
will also receive dividends on the common shares over the vesting period.
Based on management's estimated fair value of these restricted stock
grants, we record compensation expense ratably over the respective
vesting periods.
Segment Reporting
We consider each of our hotels to be an operating segment, none of which
meets the threshold for a reportable segment as prescribed by SFAS No.
131, "Disclosures about Segments of an Enterprise and Related
Information." We allocate resources and assess operating performance
based on each individual hotel. Additionally, we aggregate these
individually immaterial operating segments into one segment using the
criteria established by SFAS No. 131, including the similarities of our
product offering, types of customers and method of providing service.
3. Investment in Hotel Properties
During the six months ended June 30, 2004, we invested approximately
$73.7 million related to nine previously announced acquisitions that were
completed during the period. We funded these acquisitions primarily
through a 2.4 million share common stock offering, borrowings under our
Line of Credit and the assumption of approximately $40.0 million in
secured long-term debt, including approximately $3.7 million of a
mortgage note premium. Based on our estimate of fair value, we allocated
the purchase price of these hotels as follows (in thousands):
Amount
--------
Land $ 3,766
Buildings and improvements 61,842
Furniture and equipment 8,135
-------
$73,743
=======
10
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
3. Investment in Hotel Properties, Continued
We noted the following pro forma results assuming these acquisitions had
occurred on January 1, 2003 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ------------------------
2004 2003 2004 2003
------- ------- -------- --------
Revenues
Equity Inns, as reported $66,343 $61,749 $120,919 $114,025
Acquisitions 2,370 5,388 6,853 10,295
------- ------- -------- --------
Pro forma combined revenues $68,713 $67,137 $127,772 $124,320
======= ======= ======== ========
Net income (loss) applicable to
common shareholders
Equity Inns, as reported $ 2,382 $(1,804) $ (1,703) $ (3,478)
Acquisitions 200 669 465 1,107
------- ------- -------- --------
Pro forma combined net income (loss) $ 2,582 $(1,135) $ (1,238) $ (2,371)
======= ======= ======== ========
Pro forma basic and diluted income (loss)
per share $ 0.06 $ (0.03) $ (0.03) $ (0.06)
======= ======= ======== ========
Pro forma weighted average number of common
shares outstanding - basic and diluted 45,448 42,949 45,362 42,931
======= ======== ======= =======
Note: These unaudited pro forma results are presented for comparative
purposes only. The pro forma results are not necessarily indicative of
what our actual results would have been had these acquisitions been
completed on January 1, 2003, or of future results.
During the six months ended June 30, 2004, we invested $8.2 million to
fund capital improvements in our hotels, including replacement of
carpets, drapes, furniture and equipment, renovation of common areas and
improvements of hotel exteriors. We expect to fund an aggregate of
approximately $17.0 million throughout 2004 for capital improvements with
$3.5 million representing one-time upgrades, related to brand
initiatives, to certain of our hotel properties. We intend to fund such
improvements out of our cash flows from operations, current cash balances
and borrowings under our Line of Credit.
During the six months ended June 30, 2004, we sold three hotels for
approximately $10.9 million, including approximately $9.1 million in cash
(after selling costs of approximately $980,000) and an increase to an
existing note receivable of $800,000. We utilized the net proceeds to pay
down existing long-term debt. In conjunction with these sales, we
recorded a loss of approximately $320,000 as part of discontinued
operations in our accompanying condensed consolidated statement of
operations.
11
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
3. Investment in Hotel Properties, Continued
We classify 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 we identify an asset as held for sale, we estimate the net
realizable value of such asset. If the net realizable value of the asset
is less than the carrying amount of the asset, we establish a reserve for
the estimated loss. Depreciation is no longer recorded once we have
identified an asset as held for sale. Net realizable value is estimated
as the amount at which the asset could be sold (fair value) less costs to
sell. We have determined fair value by using prevailing market
conditions, appraisals or current estimated net sales proceeds from
pending offers, as appropriate. We only allocate to discontinued
operations 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.
4. Notes Receivable
Notes receivable consist of the following at June 30, 2004 and December
31, 2003 (in thousands):
2004 2003
------ ------
HM-NM, Inc. $4,333 $3,582
Officers of the Company 1,095 1,335
------ ------
$5,428 $4,917
====== ======
In 2003, we sold our AmeriSuites hotel in Jacksonville, Florida to HM-NM,
Inc. for a purchase price of approximately $6.0 million, $4.0 million of
which was in the form of a 15-month note receivable bearing interest at
7.75% per annum. Additionally, in 2004 we sold a Hampton Inn hotel
located in Jacksonville, Florida to HM-NM, Inc. for a purchase price of
approximately $5.0 million, including an additional $800,000 increase to
the note receivable discussed above. The entire note is secured by the
land, building and furniture and fixtures of the AmeriSuites hotel
located at 8277 Western Way Circle, Jacksonville, Florida. Accordingly,
as the sale of both hotels was negotiated concurrently, coupled with the
initial minimum investment required by SFAS No. 66, "Accounting for Sales
of Real Estate," we had deferred a gain of approximately $420,000 until
we collect the note receivable.
At various times from January 1998 to July 2002, we advanced loans to our
executive officers for income taxes relating to annual bonuses taken in
shares of our common stock and income taxes related to the taxable value
of vested restricted stock. At June 30, 2004, the aggregate amount of
notes receivable from our officers is approximately $1.1 million. All
notes are
12
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
4. Notes Receivable, Continued
collateralized by the applicable shares of common stock held by each
officer and are non- interest bearing. All notes were paid in full by
July 23, 2004 in accordance with their stated terms. We no longer provide
loans to officers.
5. Debt
The following details our debt outstanding at June 30, 2004 and December
31, 2003 (in thousands):
Principal Balance
---------------------- Interest
6/30/04 12/31/03 Rate Maturity
-------- -------- ------------------- --------
Commercial Mortgage Bonds
Class A $ - $ 4,061 6.83% Fixed Nov 2006
Class B 47,172 50,600 7.37% Fixed Dec 2015
Class C 10,000 10,000 7.58% Fixed Feb 2017
-------- --------
57,172 64,661
Line of Credit 62,200 50,000 LIBOR plus Variable June 2006
Percentage
Mortgage 90,182 91,009 8.37% Fixed July 2009
Mortgage 66,368 66,891 8.25% Fixed Nov 2010
Mortgage 34,356 34,612 8.25% Fixed Nov 2010
Mortgage 10,750 10,750 LIBOR plus
285 pts. Variable Aug 2008
Mortgage 2,862 2,912 6.00% Fixed May 2008
Mortgage 5,306 5,431 10.00% Fixed Sept 2005
Mortgage 3,415 3,508 6.37% Fixed Nov 2016
Mortgage 6,322 - 8.70% Fixed Nov 2010
Mortgage 4,315 - 7.97% Fixed Oct 2007
Mortgage 5,317 - 7.97% Fixed Oct 2007
Mortgage 4,508 - 7.10% Fixed Sept 2008
Mortgage 3,828 - 8.04% Fixed Nov 2007
Mortgage 5,334 - 8.04% Fixed Nov 2007
Mortgage 3,189 - 9.375% Fixed April 2007
Mortgage 3,408 - 9.375% Fixed April 2007
Mortgage 6,000 - 5.83% Fixed July 2014
-------- --------
374,832 329,774
Unamortized Mortgage
Note Premium 3,678 -
-------- --------
$378,510 $329,774
======== ========
Related to our hotel acquisitions completed during the six months ended
June 30, 2004, we assumed approximately $36.3 million of principal with
various interest rates and maturities through 2010. In accounting for
these acquisitions at estimated fair value, including the corresponding
long-term debt assumed, we recorded approximately $3.7 million of a
mortgage
13
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
5. Debt, Continued
note premium in the accompanying balance sheet. This premium will be
amortized using the interest method over the remaining lives of the
assumed debt as a reduction of interest expense.
We entered into a collateralized Line of Credit in June 2003 for $110.0
million, subject to certain restrictions. The Line of Credit bears
interest at LIBOR plus 2.25% to 3.0% per annum as determined by our
quarterly leverage and the facility matures in June 2006 but may be
extended at our option for an additional year. At June 30, 2004, the
interest rate on our Line of Credit was LIBOR (1.34% at June 30, 2004)
plus 2.75%. Fees ranging from .45% to .60% per annum, as determined by
our ratio of total indebtedness to EBITDA, are paid quarterly on the
unused portion of our Line of Credit. The Line of Credit maintains
certain restrictions regarding capital expenditures and other quarterly
financial covenants, including a test for cash available for dividend
payouts, a fixed charge test and a leverage test, among other covenants.
At June 30, 2004, we were in compliance with all covenants required by
our Line of Credit.
All of our debt is secured by first mortgages on our hotels. Our debt has
maturity dates that range from September 2005 to February 2017 with
certain debt requiring annual principal payments and certain debt
representing term maturities. The terms of our debt generally require
prepayment penalties if repaid prior to maturity.
Certain of our loan agreements require quarterly deposits into separate
room renovation accounts for the amount by which 4% of revenues at our
hotels exceeds the amount expended by us during the year for replacement
of furniture and equipment, maintenance, and capital improvements for our
hotels. For 2004, we expect that amounts expended will exceed, in the
aggregate, the amounts required under the loan covenants. If, for any
reason, we do not meet the renovation requirements at the individual
hotel level, we could be required to fund such shortfalls into cash
escrow accounts.
Our Line of Credit has a stated borrowing capacity of $110.0 million.
This capacity is further limited to a stated percentage of the appraised
value of the assets pledged as collateral. Additionally, since the
completion of our Line of Credit, we have sold certain of our hotels that
served as collateral under this facility. Accordingly, at June 30, 2004,
we now have a borrowing capacity of $100.6 million under our Line of
Credit.
6. Interest Rate Swap Contracts
In 2003, we entered into an interest rate swap agreement with a financial
institution on a notional amount of $25.0 million. The agreement expires
in November 2008. The agreement effectively fixes the interest rate on
the first $25.0 million of floating rate debt outstanding under the Line
of Credit at a rate of 3.875% per annum plus the interest rate spread on
the Line
14
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
6. Interest Rate Swap Contracts, Continued
of Credit, thus reducing our 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 us. The differences to be paid or
received by us 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.
In 2003, we entered into an additional interest rate swap agreement with
a financial institution on a notional amount of $25.0 million. The
agreement expires in November 2006. The agreement effectively fixes the
interest rate on the second $25.0 million of floating rate debt
outstanding under the Line of Credit at a rate of 3.22% per annum plus
the interest rate spread on the Line of Credit, thus reducing our
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 us. The differences to be paid or received by us 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.
7. 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, 2004, we recorded comprehensive income of
approximately $3.1 million, comprised of net income of approximately $2.1
million and an unrealized gain on our interest rate swap of approximately
$974,000.
15
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
8. Income Taxes
The Company's income tax benefit related to our TRS Lessees consists of
the following for the three and six months ended June 30 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------- ----------------------
2004 2003 2004 2003
----- ------ ------- ------
Deferred tax benefit:
Federal $ 647 $1,027 $ 2,027 $3,122
State 76 121 238 368
----- ------ ------- ------
723 1,148 2,265 3,490
Less valuation allowance (723) - (2,265) -
----- ------ ------- ------
Total $ - $1,148 $ - $3,490
===== ====== ======= ======
The TRS Lessees' deferred income tax asset of approximately $19.1 million
is comprised primarily of the benefit of net operating loss carryforwards
that expire beginning in December 2021. At year-end 2003, we determined
that a valuation allowance was necessary for the entire deferred income
tax asset. We continue to believe that it is more likely than not that
the Company will not be able to realize our deferred income tax asset,
and thus we have recorded a valuation allowance for the current balance.
If we determine that the Company will be able to realize all or part of
our net deferred tax asset in the future, an adjustment to the valuation
allowance would be charged to income in the periods such determination
was made.
9. Discontinued Operations
In 2002, we adopted the provisions of SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 established
criteria beyond that previously specified in SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of," 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 No. 144, we now report as
discontinued operations any assets held for sale (as defined by SFAS No.
144), and assets sold during the periods presented. We identify and
assess discontinued operations at the individual hotel operating level
because we can identify cash flows at this level. All results of these
discontinued operations, less applicable income taxes, are included as a
separate component of income in our accompanying condensed consolidated
statements of operations. This change has resulted in certain
reclassifications of the previously reported statements of operations for
the three and six months ended June 30, 2003.
16
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
9. Discontinued Operations, Continued
We classify 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 we
identify an asset held for sale, we estimate the net realizable value of
such asset. If the net realizable value of the asset is less than the
carrying amount of the asset, we establish a reserve for the estimated
loss. Depreciation is no longer recorded once we have identified an asset
as held for sale. Net realizable value is estimated as the amount at
which the asset could be bought or sold (fair value) less costs to sell.
We have determined fair value by using prevailing market conditions,
appraisals or current estimated net sales proceeds from pending offers,
as appropriate. We only allocate to discontinued operations 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.
During the first quarter, we sold three hotels for approximately $10.9
million, including approximately $9.1 million in cash (after selling
costs of approximately $980,000) and an increase to an existing note
receivable of $800,000. The hotels sold were a 97-room Hampton Inn
located in Sarasota, Florida, a 122-room Hampton Inn located in
Jacksonville, Florida, and a 141-room Comfort Inn located in Arlington,
Texas. The average age of these hotels was approximately 17 years old. We
utilized the net proceeds to pay down existing long-term debt. These
sales represent the last of our hotels that were classified as
discontinued operations. The operations of these hotels are included in
the statement of operations under the heading, "Loss
17
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
from discontinued operations." The components of income (loss) from discontinued
operations are as follows for the three and six months ended June 30, 2004 and
2003 (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- -----------------------
2004 2003 2004 2003
---- ------- ----- -------
Revenue:
Room revenue $ 2 $ 2,004 $ 324 $ 4,248
Other hotel revenue 3 82 14 161
Operating Costs:
Direct hotel expenses (29) (1,301) (381) (2,761)
Other hotel expenses (1) (71) (26) (147)
Depreciation - (368) - (736)
Property taxes, rental expense
and insurance 6 (142) (28) (301)
Amortization of franchise fees - (3) - (6)
Interest - (177) (19) (353)
Deferred income tax benefit - 188 - 188
---- ------- ----- -------
Income (loss) from operations
of discontinued operations (19) 212 (116) 293
Gain (loss) on sale of hotel properties (320) 1,275
Loss on impairment of hotels held
for sale - (3,556) - (3,556)
---- ------- ----- -------
Income (loss) from discontinued
operations $(19) $(3,344) $(436) $(1,988)
==== ======= ===== =======
In 2003, we sold our AmeriSuites hotel in Jacksonville, Florida for $6.0
million, including the assumption of a $4.0 million 15-month note
receivable bearing interest at 7.75% per annum. This sale was negotiated
concurrently with the sale of our Hampton Inn hotel in Jacksonville,
Florida, as discussed above. As part of the Hampton Inn sale, we
increased our note receivable to $4.8 million. The entire $4.8 million
note receivable is collateralized by the AmeriSuites hotel sold. Given
the initial minimum investment required by SFAS No. 66, "Accounting for
Sales of Real Estate," we have deferred a gain of approximately $420,000
until we collect the note receivable under the cost recovery method of
income recognition.
10. Commitments and Contingencies
Under our franchise agreements, we are periodically required to make
capital improvements in order to maintain our brand standards.
Additionally, under certain of our loan covenants, we are generally
obligated to fund 4% of total hotel revenues per quarter on a cumulative
basis, to a separate room renovation account for the ongoing replacement
or refurbishment of
18
EQUITY INNS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
----------------
10. Commitments and Contingencies, Continued
furniture, fixtures and equipment at our hotels. For 2004, we expect that
amounts expended will exceed, in the aggregate, the amount required under
the loan covenants. If, for any reason, we do not meet the renovation
requirements at the individual hotel level, we could be required to fund
such shortfalls into cash escrow accounts. We currently have one lender
that could require us to deposit approximately $1.0 million into an
escrow account, but the lender has thus far decided not to trigger the
escrow funding based on our future capital improvement plans for the
individual hotels.
We maintain agreements with certain senior officers that provide for
severance payments in the event of a change in control of Equity Inns. At
June 30, 2004, the maximum amount of compensation that would be payable
under all agreements, if a change of control occurred, would be
approximately $7.0 million.
We are involved in various legal actions arising in the ordinary course
of business. We do not believe that any of the pending actions will have
a material adverse effect on our business, financial condition or results
of operations.
11. Shareholders' Equity
On April 7, 2004, we completed an offering of 2.4 million shares of
common stock that resulted in net proceeds of approximately $21.4
million. The proceeds were used to fund approximately $13.3 million in
previously announced acquisitions, with the remaining funds being
utilized to pay down our Line of Credit.
12. Subsequent Events
In July 2004, we entered into two agreements to purchase seven hotels.
These hotels represent five upscale Hampton Inns (including a Hampton Inn
& Suites) in Southern Florida, a Courtyard by Marriott in Georgia and our
first Hilton Garden Inn in Kentucky. The total purchase price is
approximately $88.0 million and the transactions are expected to close
before the end of 2004.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This report contains or incorporates by reference 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",
"intends", "will", "anticipates", "expects" and words of similar import. Such
forward- looking statements relate to future events, the future financial
performance of our Company, and involve known and unknown risks, uncertainties
and other factors which may cause the actual results, performance or
achievements of the Company or industry results to be materially different from
any future results, performance or achievements expressed or implied by such
forward-looking statements. Such risks and uncertainties include, but are not
limited to, the 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; risk associated
with debt financing; hotel operating risks; the ability of the Company to
successfully implement our operating strategy; changes in economic cycles;
competition from other hospitality companies; and changes in the laws and
government regulations applicable to us. Readers should specifically consider
the various factors identified, or incorporated by reference in this report
including, but not limited to those discussed in the sections entitled "Growth
Strategy" and "Management's Discussion and Analysis of Financial Conditions and
Results of Operations," certain risk factors as discussed in our Current Report
on Form 8-K filed March 11, 2004, and in any other documents filed by us with
the Securities and Exchange Commission that could cause actual results to differ
from those implied by the forward-looking statements. We disclaim any obligation
to update any such factors or to publicly announce the result of any revisions
to any of the forward-looking statements contained herein to reflect future
events or developments.
BACKGROUND
Equity Inns is a Memphis-based, self-advised hotel real estate investment trust
("REIT") primarily focused on the upscale extended stay, all-suite and upscale
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, 2004 owned
an approximate 97.3% interest in the Partnership. The Partnership and its
affiliates lease all of our hotels to wholly-owned taxable REIT subsidiaries of
the Company (the "TRS Lessees").
We commenced operations on March 1, 1994 upon completion of our initial public
offering and the simultaneous acquisition of eight Hampton Inn hotels with 995
rooms. Over the next ten years, we grew with a focus on both geographic and
brand diversity. We believe that diversity in our asset portfolio reduces
operational variance from year-to-year and results in less volatility as
compared to the overall hotel industry.
20
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
The following table illustrates our geographic presence by the number of hotels
and rooms at June 30, 2004.
Region Hotels Rooms/Suites
------------------ ------ ------------
East North Central 14 1,889
East South Central 15 1,702
Middle Atlantic 6 827
Mountain 10 1,285
New England 5 605
Pacific Northwest 2 329
South Atlantic 30 3,526
West North Central 7 830
West South Central 10 1,401
-- -------
99 12,394
== ======
We believe that geographic diversity helps to limit our exposure to any one
market. At June 30, 2004, we owned a geographically diverse portfolio of 99
hotels with 12,394 rooms located in 34 states. Additionally, our property mix is
spread between suburban and urban locations, helping to insulate us from various
economic climates, including a depressed business travel climate.
Our hotel portfolio includes midscale limited service hotels, all-suite hotels,
upscale extended stay hotels, and full service hotels. This array of product
offering allows us to diversify the asset portfolio in an effort to reduce risk
in various economic environments.
21
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
The following chart summarizes information regarding our franchise diversity at
June 30, 2004:
Number of Number of
Franchise Affiliation Hotel Properties Rooms/Suites
--------------------- ---------------- ------------
Midscale Limited Service Hotels:
Hampton Inn 45 5,686
Comfort Inn 1 104
-- ------
Sub-total 46 5,790
All-Suite Hotels:
AmeriSuites 18 2,291
Upscale Extended Stay Hotels:
Residence Inn 16 1,751
Homewood Suites 9 1,295
-- ------
Sub-total 25 3,046
Full Service Hotels:
Holiday Inn 4 557
Comfort Inn 1 177
Courtyard by Marriott 5 533
-- ------
Sub-total 10 1,267
-- ------
Total 99 12,394
== ======
22
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
The following table sets forth certain information for the six months ended June
30, 2004 and June 30, 2003 with respect to our hotels:
Three Months Ended June 30, 2004 (1) Three Months Ended June 30, 2003 (1)
-------------------------------------------------- ------------------------------------
Revenue Revenue
Number Number Average Per Average Per
of of Daily Available Daily Available
Brand Hotels Rooms Occupancy Rate Room (2) Occupancy Rate Room (2)
- ----- -------- ------- --------- -------- --------- --------- ------- ---------
Hampton Inn 45 5,686 67.6% $72.44 $48.93 67.9% $70.66 $47.96
AmeriSuites 18 2,291 71.1% $72.33 $51.43 74.4% $67.49 $50.19
Residence Inn 16 1,751 81.9% $92.00 $75.38 81.7% $89.61 $73.24
Homewood Suites 9 1,295 80.9% $104.28 $84.36 79.5% $102.44 $81.43
Courtyard by Marriott 5 533 77.8% $92.46 $71.92 80.4% $89.52 $72.00
Holiday Inn 4 557 65.9% $69.97 $46.12 57.3% $72.82 $41.75
Comfort Inn 2 281 76.2% $89.23 $67.95 73.9% $88.38 $65.31
-- ------ ----- ------ ------ ----- ------ ------
99 12,394 72.2% $80.53 $58.14 72.5% $78.12 $56.60
== ====== ===== ====== ====== ===== ====== ======
Six Months Ended June 30, 2004 (1) Six Months Ended June 30, 2003 (1)
------------------------------------------------- ----------------------------------
Revenue Revenue
Number Number Average Per Average Per
of of Daily Available Daily Available
Brand Hotels Rooms Occupancy Rate Room (2) Occupancy Rate Room (2)
- ----- -------- ------- --------- ------- --------- --------- ------- --------
Hampton Inn 45 5,686 63.2% $71.24 $45.02 62.9% $70.18 $44.16
AmeriSuites 18 2,291 66.4% $73.06 $48.53 69.4% $69.35 $48.14
Residence Inn 16 1,751 78.2% $90.24 $70.55 78.0% $88.89 $69.35
Homewood Suites 9 1,295 76.9% $102.66 $78.97 75.5% $99.87 $75.41
Courtyard by Marriott 5 533 75.1% $92.79 $69.71 76.0% $88.10 $66.98
Holiday Inn 4 557 59.1% $65.86 $38.93 52.6% $67.66 $35.60
Comfort Inn 2 281 73.8% $87.20 $64.32 69.3% $88.19 $61.12
-- ------ ----- ------ ------ ----- ------ ------
99 12,394 67.9% $79.61 $54.09 67.8% $77.72 $52.71
== ====== ===== ====== ====== ===== ====== ======
Notes
(1) Represents "all comparable" statistics for hotels owned by us at quarter end
as if we had owned the hotels for both periods presented. (2) Determined by
multiplying occupancy times the average daily rate.
Approximately 94% of our hotel portfolio is comprised of the following leading
franchise brands: Homewood Suites and Hampton Inn by Hilton, Residence Inn and
Courtyard by Marriott and AmeriSuites by Prime Hospitality. We believe that
multiple brands at the midscale and upscale levels, without food and beverage,
help to insulate our asset portfolio against the volatility of individual brand
results relative to industry revenue per available room ("RevPAR") performance.
Descriptions of each of our major brands are as follows:
23
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
Homewood Suites by Hilton:
A premier upscale extended stay hotel, focusing on extended stay, corporate
transient and family travelers. Rated the #1 extended stay hotel brand by JD
Powers in 2003.
Hampton Inn by Hilton:
A premier midscale without food and beverage hotel chain with over 1,000
locations.
Residence Inn by Marriott:
A premier upscale extended stay hotel, focusing on extended stay, corporate
transient and family travelers. Rated the #2 extended stay hotel brand by JD
Powers in 2003.
Courtyard by Marriott:
An upscale full service hotel designated as the hotel designed by business
travelers for business travelers.
AmeriSuites by Prime Hospitality:
An upscale all-suite hotel, billed as America's most affordable all-suite
hotel.
Approximately 76% of our hotels are branded by Hilton and Marriott, which both
provide national marketing support and frequent stay programs that continue to
drive additional revenue. We believe that better brands generate premium RevPAR
over their peers and focusing on these premium generating brands is another
factor in our strategy to limit risk in the volatility of our hotel portfolio.
In order to qualify as a REIT, we cannot operate hotels and, consequently, we
outsource the management of our hotels to leading independent management
companies. By utilizing third-party managers with relatively short-term
contracts providing for strong operating incentive management fees, we believe
that we have better control over the operating results of our hotels. At June
30, 2004, our hotel managers are as follows:
Number of Hotels
----------------
Interstate Hotels & Resorts, Inc. 48
Hilton Hotels Corporation 17
Prime Hospitality Corporation 18
Others 16
--
99
==
24
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
GROWTH STRATEGY
The Company's business objectives are to increase funds from operations and
dividends, while enhancing shareholder value primarily through (i) aggressive
asset management and the strategic investment of capital in its diversified
hotel portfolio, primarily with mid-scale and upscale properties in urban and
suburban areas, (ii) selectively acquiring hotels that have been underperforming
due to the lack of sufficient capital improvements, poor management or franchise
affiliation, and (iii) selectively disposing of hotels that have reached their
earnings potential or may, in management's judgment, suffer adverse changes in
their local market, or require large capital outlays. This process is ongoing,
and activity could potentially increase given a more fluid marketplace.
COMPETITION
The hotel industry is highly competitive with various participants competing on
the basis of price, level of service and geographic location. Each of our hotels
is located in a developed area that includes other hotel properties. The number
of competitive hotel properties in a particular area could have a material
adverse effect on the occupancy, average daily rate ("ADR") and RevPAR of our
hotels or at hotel properties acquired in the future. We believe that brand
recognition, location, the quality of the hotel, consistency of services
provided, and price are the principal competitive factors affecting our hotels.
To the extent that cash flows from our hotel operations are insufficient to fund
our operating or investing requirements, we may fund seasonal-related shortfalls
with borrowings under our Line of Credit.
SEASONALITY
Our operations historically have been seasonal in nature, generally reflecting
higher occupancy rates and RevPAR during the second and third quarters. This
seasonality can be expected to cause fluctuations in our quarterly operating
results.
INFLATION
Operators of hotels in general have the ability to adjust room rates quickly.
However, competitive pressures may limit our ability to raise room rates in the
face of inflation.
TAX STATUS
We intend to operate so as to be taxed as a REIT under Sections 856-860 of the
Internal Revenue Code of 1986, as amended. As long as we qualify for taxation as
a REIT, with certain exceptions, we will not be taxed at the corporate level on
our taxable income that is distributed to our shareholders. A REIT is subject to
a number of organizational and operational requirements,
25
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
BACKGROUND, Continued
including a requirement that it must distribute annually at least 90% of its
taxable income in the form of dividends to its shareholders. Failure to qualify
as a REIT will render us subject to tax (including any applicable alternative
minimum tax) on our taxable income at regular corporate rates and distributions
to the shareholders in any such year will not be deductible by us. Even if we
qualify for taxation as a REIT, we may be subject to certain state and local
taxes on our income and property. In connection with our election to be taxed as
a REIT, our Company charter imposes certain restrictions on the transfer of
shares of our common stock and preferred stock. We have adopted the calendar
year as our taxable year.
AVAILABLE INFORMATION
Our Internet website address is: www.equityinns.com. We also make available free
of charge through our website our annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange
Act of 1934, as amended, as soon as reasonably practicable after such documents
are electronically filed with, or furnished to, the Securities and Exchange
Commission ("SEC").
We have also made available our Corporate Governance Guidelines and the charters
of the Audit Committee, Compensation Committee and Corporate Governance and
Nomination Committee on our website under "Corporate Governance." We have also
adopted a Code of Ethics that applies to our chief executive officer, our
president and chief operating officer, our chief financial officer, our
controller, and all other employees and have posted this Code of Ethics, along
with our Whistleblower policy, on our website. We intend to satisfy the
disclosure requirements under Item 10 of Form 8-K relating to amendments to or
waivers from any provision of the Code of Ethics by posting such information on
our website. Our corporate governance documents are also available in print upon
written shareholder request to our Secretary, J. Mitchell Collins, at 7700 Wolf
River Boulevard, Germantown, Tennessee 38138, or by filling out an information
request on our website under "Information Requests."
The information on our website is not, and shall not be deemed to be, a part of
this report or incorporated into any other filings that we make with the SEC.
26
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS
For the Three Months Ended For the Six Months Ended
--------------------------------------- -------------------------------------
June 30, June 30, June 30, June 30,
(in thousands) 2004 % 2003 % 2004 % 2003 %
------- ----- ------- ----- -------- ----- -------- -----
Hotel revenues $66,234 99.8 $61,492 99.6 $120,711 99.8 $113,662 99.7
Other revenue 109 .2 257 .4 208 .2 363 .3
------- ----- ------- ----- -------- ----- -------- -----
Total revenues 66,343 100.0 61,749 100.0 120,919 100.0 114,025 100.0
Hotel expenses 38,851 58.6 35,826 58.0 72,487 60.0 68,091 59.7
Depreciation 9,842 14.8 9,583 15.5 19,334 16.0 19,169 16.8
Property taxes, rental expense
and insurance 4,111 6.2 4,413 7.2 8,541 7.0 9,138 8.0
General and
administrative 2,035 3.1 1,788 2.9 4,201 3.5 3,827 3.4
------- ----- ------- ----- -------- ----- -------- -----
Operating income $11,504 17.3 $10,139 16.4 $ 16,356 13.5 $ 13,800 12.1
======= ===== ======= ===== ======== ===== ======== =====
Comparison of the Company's operating results for the three months ended June
30, 2004 and 2003.
Revenues
Our hotel revenues of approximately $66.2 million in 2004 increased
approximately $4.7 million, or 7.6%, as compared to approximately $61.5 million
in 2003. After eliminating revenues of approximately $3.2 million related to our
hotel acquisitions for 2004, our same-store hotel revenues increased by
approximately $1.5 million in 2004 as compared to 2003. This increase was
primarily due to a RevPAR increase of 2.6%, driven by an increase in our ADR
from $77.20 to $79.57, partially offset by a decrease of 32 basis points in
occupancy to 71.48%.
Other revenue of $109,000 in 2004 decreased $148,000, or 57.6%, as compared to
$257,000 in 2003, primarily due to a decrease in joint venture income, travel
agent rebates and interest income.
Operating Expenses
Hotel expenses of approximately $38.9 million in 2004 increased approximately
$3.1 million, or 8.7%, as compared to approximately $35.8 million in 2003. After
eliminating expenses of approximately $1.7 million related to our hotel
acquisitions for 2004, our same-store hotel expenses increased by approximately
$1.4 million in 2004 as compared to 2003, primarily due to an increase in
payroll and related benefits of approximately $920,000, an increase in franchise
fees and loyalty programs of approximately $230,000, an increase in enhanced
brand free breakfasts of approximately $145,000 and an increase in utility costs
of approximately $130,000. Hotel expenses as a percentage of hotel revenues were
58.7% in 2004 and 58.3% in 2003.
Depreciation expense of approximately $9.8 million in 2004 increased
approximately $200,000, or 2.1%, as compared to approximately $9.6 million in
2003, primarily due to increased depreciation expense related to our hotel
acquisitions.
27
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS, Continued
Property taxes, rental expense and insurance of approximately $4.1 million in
2004 decreased approximately $300,000, or 6.8%, as compared to approximately
$4.4 million in 2003, primarily due to a decrease in a real estate tax reserve
related to one of our hotels.
General and administrative expenses of approximately $2.0 million in 2004
increased approximately $200,000, or 11.1%, as compared to approximately $1.8
million in 2003. This increase was primarily due to an increase in professional
fees of approximately $125,000, an increase in franchise taxes of approximately
$50,000, an increase in non-cash stock-based compensation of approximately
$30,000 and an increase in travel expenses of approximately $25,000.
Operating Income
For 2004, we recorded operating income of approximately $11.5 million as
compared to operating income of approximately $10.1 million in 2003. The
principal components of the change in operating income for 2004 as compared to
2003 was an increase in same-store revenues of approximately $1.5 million, an
increase in net operating income related to our hotel acquisitions of
approximately $885,000, a decrease in property taxes, rental expense and
insurance of approximately $300,000, partially offset by an increase in
same-store hotel expenses of approximately $1.4 million and an increase in
general and administrative expenses of approximately $200,000.
Comparison of the Company's operating results for the six months ended June 30,
2004 and 2003.
Revenues
Our hotel revenues of approximately $120.7 million in 2004 increased
approximately $7.0 million, or 6.2%, as compared to approximately $113.7 million
in 2003. After eliminating revenues of approximately $3.9 million related to our
hotel acquisitions in 2004, our same-store hotel revenues increased by
approximately $3.2 million in 2004 as compared to 2003. This increase was
primarily due to a RevPAR increase of 2.5%, driven by an increase in our ADR
from $76.81 to $78.53 and an increase of 14 basis points in occupancy to 67.16%,
and also includes approximately $500,000 of increased hotel revenues due to the
effect of the 2004 leap year as compared to 2003.
Other revenue of $208,000 in 2004 decreased $155,000, or 42.7%, as compared to
$363,000 in 2003, primarily due to a decrease in joint venture income, travel
agent rebates and interest income.
28
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
RESULTS OF OPERATIONS, Continued
Operating Expenses
Hotel expenses of approximately $72.5 million in 2004 increased approximately
$4.4 million, or 6.5%, as compared to approximately $68.1 million in 2003. After
eliminating expenses of approximately $1.9 million related to our hotel
acquisitions in 2004, our same-store hotel expenses increased by approximately
$2.5 million in 2004 as compared to 2003, primarily due to an increase in
payroll and related benefits of approximately $1.4 million, an increase in
franchise fees and loyalty programs of approximately $430,000, an increase in
enhanced brand free breakfasts of approximately $240,000 and an increase in
utility costs of approximately $275,000. Hotel expenses as a percentage of hotel
revenues were 60.1% in 2004 and 59.9% in 2003.
Depreciation expense of approximately $19.3 million in 2004 was relatively flat
as compared to 2003.
Property taxes, rental expense and insurance of approximately $8.5 million in
2004 decreased approximately $600,000, or 6.6%, as compared to approximately
$9.1 million in 2003, primarily due to a reduction in insurance premiums and a
decrease in a real estate tax reserve related to one of our hotels.
General and administrative expenses of approximately $4.2 million in 2004
increased approximately $400,000, or 10.5%, as compared to approximately $3.8
million in 2003. This increase was primarily due to severance and relocation
costs of approximately $155,000, an increase in payroll and related benefits of
approximately $110,000, an increase in public company expenses of approximately
$40,000, an increase in non-cash stock-based compensation of approximately
$55,000, a write-off of telephone equipment of approximately $60,000, offset by
a decrease in professional fees of approximately $100,000.
Operating Income
For 2004, we recorded operating income of approximately $16.4 million as
compared to operating income of approximately $13.8 million in 2003. The
principal components of the change in operating income for 2004 as compared to
2003 was an increase in same-store revenues of approximately $3.2 million, an
increase of approximately $1.1 million in net operating income related to our
hotel acquisitions, a decrease in property taxes, rental expense and insurance
of approximately $600,000, partially offset by an increase in same-store hotel
expenses of approximately $2.5 million and an increase in general and
administrative expenses of approximately $400,000.
29
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES
Equity Inns' principal source of cash to meet our operating requirements,
including distributions to our shareholders and repayments of indebtedness, is
from our hotels' results of operations. For the six months ended June 30, 2004,
net cash flows provided by our operating activities was approximately $21.0
million. We currently expect that our operating cash flows will be sufficient to
fund our continuing operations, including our required debt service obligations
and distributions to shareholders required to maintain our REIT status. We
expect to fund any short-term liquidity requirements above our operating cash
flows through short-term borrowings under our Line of Credit. In 2003, we
entered into our collateralized Line of Credit for $110.0 million, subject to
certain restrictions. Borrowings under the Line of Credit bear interest at LIBOR
plus 2.25% to 3.0% per annum as determined by our quarterly leverage, and this
facility matures in June 2006 but may be extended at our option for an
additional year. The Line of Credit maintains certain restrictions regarding
capital expenditures and other quarterly financial covenants, including a test
for cash available for dividend payouts, a fixed charge test and a leverage
test, among other covenants. At June 30, 2004, we had the ability to borrow over
$37.8 million under our Line of Credit. At June 30, 2004, we had approximately
$11.6 million of cash and cash equivalents.
We may make additional investments in hotel properties and may incur
indebtedness to make such investments or to meet distribution requirements
imposed on a REIT under the Internal Revenue Code of 1986 to the extent that
working capital and cash flows from our investments are insufficient to make
such distributions. Our Board has adopted a policy limiting aggregate
indebtedness to 45% of our investment in hotel properties, at cost, after giving
effect to our use of proceeds from any indebtedness. This policy may be amended
at any time by the Board without shareholder vote. Our consolidated indebtedness
was 37.8% of our investments in hotels, at original cost, at June 30, 2004.
On January 21, 2004 and March 26, 2004, we amended our Line of Credit to provide
for more flexibility regarding our financial covenants through June 2006,
including the redefining of our cash available for dividend payouts to exclude
certain non-cash operating items, including the deferred income tax benefit that
we will no longer record due to losses from our TRS Lessees. We incurred total
amendment fees of approximately $120,000.
30
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
The following details our debt outstanding at June 30, 2004 and December 31,
2003 (in thousands):
Principal Balance
---------------------- Interest
6/30/04 12/31/03 Rate Maturity
------- -------- ------------------- --------
Commercial Mortgage Bonds
Class A $ - $ 4,061 6.83% Fixed Nov 2006
Class B 47,172 50,600 7.37% Fixed Dec 2015
Class C 10,000 10,000 7.58% Fixed Feb 2017
-------- --------
57,172 64,661
Line of Credit 62,200 50,000 LIBOR plus Variable June 2006
Percentage
Mortgage 90,182 91,009 8.37% Fixed July 2009
Mortgage 66,368 66,891 8.25% Fixed Nov 2010
Mortgage 34,356 34,612 8.25% Fixed Nov 2010
Mortgage 10,750 10,750 LIBOR plus
285 pts. Variable Aug 2008
Mortgage 2,862 2,912 6.00% Fixed May 2008
Mortgage 5,306 5,431 10.00% Fixed Sept 2005
Mortgage 3,415 3,508 6.37% Fixed Nov 2016
Mortgage 6,322 - 8.70% Fixed Nov 2010
Mortgage 4,315 - 7.97% Fixed Oct 2007
Mortgage 5,317 - 7.97% Fixed Oct 2007
Mortgage 4,508 - 7.10% Fixed Sept 2008
Mortgage 3,828 - 8.04% Fixed Nov 2007
Mortgage 5,334 - 8.04% Fixed Nov 2007
Mortgage 3,189 - 9.375% Fixed April 2007
Mortgage 3,408 - 9.375% Fixed April 2007
Mortgage 6,000 - 5.83% Fixed July 2014
-------- --------
374,832 329,774
Unamortized Mortgage
Note Premium 3,678 -
-------- --------
$378,510 $329,774
======== ========
In 2003, we entered into an interest rate swap agreement with a financial
institution on a notional amount of $25.0 million. The agreement expires in
November 2008. The agreement effectively fixes the interest rate on the first
$25.0 million of floating rate debt outstanding under our Line of Credit at a
rate of 3.875% per annum plus the interest rate spread on our Line of Credit, or
6.63% at June 30, 2004, thus reducing our 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 us. The differences to be paid
or received by us 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.
In 2003, we entered into an additional interest rate swap agreement with a
financial institution on a notional amount of $25.0 million. The agreement
expires in November 2006. The agreement effectively fixes the interest rate on
the second $25.0 million of floating rate debt outstanding under
31
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
our Line of Credit at a rate of 3.22% per annum plus the interest rate spread on
our Line of Credit, or 5.97% at June 30, 2004, thus reducing our 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 us. The
differences to be paid or received by us 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, 2004, we purchased nine hotels for
approximately $73.7 million related to previously announced acquisitions. We
funded these acquisitions primarily through a 2.4 million share common stock
offering, our Line of Credit and the assumption of approximately $40.0 million
in secured long-term debt. Included in our debt assumption is a mortgage note
premium of approximately $3.7 million to record the debt at its estimated fair
value. This premium will be amortized using the interest method over the
remaining lives of the assumed debt as a reduction of interest expense.
During the six months ended June 30, 2004, we invested $8.2 million to fund
capital improvements in our hotels, including replacement of carpets, drapes,
furniture and equipment, renovation of common areas and improvements of hotel
exteriors. We expect to fund an aggregate of approximately $17.0 million
throughout 2004 for capital improvements with $3.5 million representing one-time
upgrades, related to brand initiatives, to certain of our hotel properties. We
intend to fund such improvements out of our cash flows from operations, current
cash balances and borrowings under our Line of Credit. Under our franchise
agreements, we are periodically required to make capital improvements in order
to maintain our brand standards. Additionally, under certain of our loan
covenants, we are generally obligated to fund 4% of total hotel revenues per
quarter on a cumulative basis, to a separate room renovation account for
replacement of furniture, fixtures and equipment, maintenance, and capital
improvements for our hotels. For 2004, we expect that amounts expended will
exceed, in the aggregate, the amount required under the loan covenants. If, for
any reason, we do not meet the renovation requirements at the individual hotel
level, we could be required to fund such shortfalls into cash escrow accounts.
We currently have one lender that could require us to deposit approximately $1.0
million into an escrow account, but the lender has thus far decided not to
trigger the escrow funding based on our future capital improvement plans for the
individual hotels.
During the six months ended June 30, 2004, we sold three hotels for
approximately $10.9 million, including approximately $9.1 million in cash (after
selling costs of approximately $980,000) and an increase to an existing note
receivable of $800,000. We utilized the net proceeds to pay down existing
long-term debt.
32
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
LIQUIDITY AND CAPITAL RESOURCES, Continued
REITs are subject to a number of organizational and operational requirements.
For example, for federal income tax purposes, a REIT, and therefore the Company,
is required to pay distributions of at least 90% of its taxable income to our
shareholders. We intend to pay these distributions from operating cash flows.
During the six months ended June 30, 2004, our Partnership distributed an
aggregate of $11.8 million to its limited partners, or $.13 per unit (including
$11.5 million of distributions to the Company to fund distributions to our
shareholders of $.13 per share). We expect to make future quarterly
distributions to our shareholders. The amount of our future distributions will
be based upon quarterly operating results, economic conditions, capital
requirements, the Internal Revenue Code's annual distribution requirements,
leverage restrictions imposed by our Line of Credit and other factors which our
Board deems relevant.
We expect to meet our 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 our Partnership's limited partnership agreement, subject to certain
holding period requirements, holders of units in our Partnership have the right
to require the Partnership to redeem their units. Under the Partnership
agreement, we have 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. We anticipate that we will acquire any units tendered for redemption in
the foreseeable future in exchange for shares of common stock and, to date, have
registered such shares so as to be freely tradeable by the recipient.
FUNDS FROM OPERATIONS
The National Association of Real Estate Investment Trusts, or NAREIT, defines
Funds From Operations, or FFO, as net income (loss) applicable to common
shareholders excluding gains (or losses) from sales of real estate, the
cumulative effect of changes in accounting principles, real estate-related
depreciation and amortization, and after adjustments for unconsolidated
partnerships and joint ventures. FFO does not include the cost of capital
improvements and any related capitalized interest. FFO is presented on a per
share basis, including the assumed conversion of all Partnership units, and
after making adjustments for the effects of dilutive securities. We use FFO per
share as a measure of performance to adjust for certain non-cash expenses such
as depreciation and amortization because historical cost accounting for real
estate assets implicitly assumes that the value of real estate assets diminishes
predictably over time.
Because real estate values have historically risen or fallen with market
conditions, many industry investors have considered presentation of operating
results for real estate companies that use historical cost accounting to be less
informative. NAREIT adopted the definition of FFO in order
33
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
FUNDS FROM OPERATIONS, Continued
to promote an industry-wide standard measure of REIT operating performance.
Accordingly, as a member of NAREIT, Equity Inns adopted FFO as a measure to
evaluate performance and facilitate comparisons between the Company and other
REITs, although our FFO and FFO per share may not be comparable to FFO measures
reported by other companies.
The following reconciliation of net income to FFO, applicable to common
shareholders, illustrates the difference in these measures of operating
performance (in thousands):
For the Three Months For the Six Months
Ended June 30, Ended June 30,
-------------------- --------------------
2004 2003 2004 2003
------- ------- ------- -------
Net income (loss) applicable to common shareholders $ 2,382 $(1,804) $(1,703) $(3,478)
Add:
(Gain) loss on sale of hotel properties - - 320 (1,275)
Minority interests 62 51 (44) 2
Depreciation 9,842 9,583 19,334 19,169
Depreciation from discontinued operations - 368 - 736
------- ------- ------- -------
Funds From Operations (FFO) (1) $12,286 $ 8,198 $17,907 $15,154
======= ======= ======= =======
Weighted average number of diluted common
shares and Partnership units outstanding 46,269 41,696 45,133 41,691
======= ======= ======= =======
(1) For the three months ended June 30, 2003, FFO includes a non-cash deferred
income tax benefit of approximately $1.1 million. For the six months ended June
30, 2003, FFO includes a non-cash deferred income tax benefit of approximately
$3.5 million and a non-cash loss on impairment of hotels held for sale of
approximately $3.6 million.
34
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's discussion and analysis of our financial condition and results of
operations are based upon our 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
our 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.
On an on-going basis, all estimates are evaluated by our 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.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
We maintain allowances for doubtful accounts for estimated losses resulting
from the inability of our customers and other borrowers to make required
payments. The allowance for doubtful accounts is maintained at a level
believed adequate by us to absorb estimated probable receivable losses. Our
periodic evaluation of the adequacy of the allowance is primarily based on
past receivable loss experience, known and inherent credit risks, current
economic conditions, and other relevant factors. This evaluation is
inherently subjective as it requires estimates including the amounts and
timing of future collections. If the financial condition of our customers or
other borrowers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required.
We record an impairment charge when we believe 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. For 2003, we
noted continued softness in the lodging industry primarily due to an
economic recession in the United States and the lagging aftermath effects of
the events of September 11, 2001. Additionally, the RevPAR results of our
hotels for 2003 were not what we had initially anticipated at the beginning
of the year. At year-end 2003, we were still uncertain as to when the
lodging industry would begin to fully recover from the effects of the
aforementioned matters. We performed internal cash flow tests that
considered the current industry downturn and also included moderate RevPAR
growth assumptions into the future.
35
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
CRITICAL ACCOUNTING POLICIES AND ESTIMATES, Continued
Based upon our internal cash flow tests that followed the criteria
prescribed by SFAS No. 144, there were no impairments noted for our hotel
properties.
We record a valuation allowance to reduce our deferred income tax asset to
the amount that is more likely than not to be realized. We have considered
future taxable income and ongoing prudent and feasible tax planning
strategies in assessing the need for a valuation allowance. At year-end
2003, we determined, it was more likely than not, that we would not be able
to realize our $16.8 million deferred income tax asset. During the last
three years, our TRS Lessees had continued to accumulate net operating
losses primarily due to the lease payments that our TRS Lessees paid to
their parent company, Equity Inns, in conjunction with our assumption of the
operating leases from several of our independent property management
companies in 2001. As a result of these losses, the continued softness in
the lodging industry and the uncertainty associated with its future
recovery, at year-end we recorded a valuation allowance for the full amount
of our deferred income tax asset. Additionally, we will not record a
deferred income tax benefit until it is more likely than not that such
benefit will be realized.
OTHER DEVELOPMENTS
Acquisitions
In late 2003 and early 2004, we announced our intent to purchase nine hotels
from the McKibbon Hotel Group. All of these transactions closed by June 30,
2004. The total purchase price for the nine hotels was approximately $73.7
million, including the assumption of approximately $40.0 million in secured
long-term debt, and we funded approximately $33.7 million of the purchase price
through borrowings under our Line of Credit and the additional issuance of 2.4
million shares of our common stock. The average age of these nine hotels is
seven years.
The acquisitions that we completed are as follows for the six months ended June
30, 2004:
Hotel Location Rooms Date Acquired
------------------------- ------------------------- ----- --------------------
Courtyard by Marriott Tallahassee, Florida 93 January 26, 2004
Residence Inn by Marriott Tampa, Florida 102 March 25, 2004
Courtyard by Marriott Gainesville, Georgia 81 April 29, 2004
Residence Inn by Marriott Tallahassee, Florida 78 April 29, 2004
Residence Inn by Marriott Knoxville, Tennessee 78 May 10, 2004
Courtyard by Marriott Asheville, North Carolina 78 May 28, 2004
Residence Inn by Marriott Chattanooga, Tennessee 76 May 28, 2004
Courtyard by Marriott Athens, Georgia 105 June 16, 2004
Residence Inn by Marriott Savannah, Georgia 66 June 29, 2004
36
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
OTHER DEVELOPMENTS, Continued
In July 2004, we entered into two agreements to purchase seven hotels. These
hotels represent five upscale Hampton Inns (including a Hampton Inn & Suites) in
Southern Florida, a Courtyard by Marriott in Georgia and our first Hilton Garden
Inn in Kentucky. The total purchase price is approximately $88 million and the
transactions are expected to close before year-end. We intend to fund these
acquisitions through a combination of secured long-term debt, our Line of Credit
and additional debt or equity securities.
Common Stock Offering
On April 7, 2004, we completed an offering of 2.4 million shares of common stock
that resulted in net proceeds of approximately $21.4 million. The proceeds were
used to fund approximately $13.3 million of our acquisitions discussed above,
with the remaining funds being utilized to pay down our Line of Credit.
Hotel Sales
During the first quarter, we sold three hotels for approximately $10.9 million,
including $9.1 million of cash (after selling costs of approximately $980,000)
and an increase to an existing note receivable of approximately $800,000. The
hotels sold were a 97-room Hampton Inn located in Sarasota, Florida, a 122-room
Hampton Inn located in Jacksonville, Florida, and a 141-room Comfort Inn located
in Arlington, Texas. The average age of these hotels was approximately 17 years.
We utilized the net proceeds to pay down existing long-term debt. These sales
represent the last of our hotels that were previously classified as discontinued
operations.
Hotel Development
We intend to develop a 200-room, full service Marriott hotel in Sandy, Utah, a
suburb of Salt Lake City, Utah. We estimate that the development cost of this
hotel will be approximately $24.0 million, including approximately $2.2 million
in land previously purchased by us, and the hotel should be completed by
mid-2006. For 2004, we expect to fund up to $5.0 million related to the
development of this hotel, principally through borrowings under our Line of
Credit. We plan to obtain additional financing sources to complete the
development of this hotel.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain financial market risks, the most predominant of which
is the fluctuation in interest rates. At June 30, 2004, our exposure to market
risk for a change in interest rates is related to our debt outstanding under the
Line of Credit and certain hotel secured debt. Total debt outstanding under
these two debentures totaled approximately $73.0 million at June 30, 2004.
37
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, Continued
Our Line of Credit bears interest at a variable rate of LIBOR plus 2.25% to 3.0%
per annum as determined by our quarterly leverage. At June 30, 2004, our
interest rate on our Line of Credit was LIBOR (1.34% at June 30, 2004) plus
2.75%. Our interest rate risk objective is to limit the impact of interest rate
fluctuations on earnings and cash flows and to lower our overall borrowing
costs. To achieve this objective, we manage our exposure to fluctuations in
market interest rates for our 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 our variable rate
debt. We do not enter into derivative or interest rate transactions for
speculative purposes. We also regularly review interest rate exposure on our
outstanding borrowings in an effort to minimize the risk of interest rate
fluctuation.
In 2003, we entered into an interest rate swap agreement with a financial
institution on a notional amount of $25.0 million. The agreement expires in
November 2008. The agreement effectively fixes the interest rate on the first
$25.0 million of floating rate debt outstanding under our Line of Credit at a
rate of 3.875% per annum plus the interest rate spread on our Line of Credit,
thus reducing our 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 us. The differences to be paid or received by us 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.
In 2003, we entered into an interest rate swap agreement with a financial
institution on a notional amount of $25.0 million. The agreement expires in
November 2006. The agreement effectively fixes the interest rate on the second
$25.0 million of floating rate debt outstanding under our Line of Credit at a
rate of 3.22% per annum plus the interest rate spread on our Line of Credit,
thus reducing our 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 us. The differences to be paid or received by us 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.
Our Line of Credit matures in June 2006. As discussed above, our Line of Credit
bears interest at variable rates, and therefore, cost approximates market value.
At June 30, 2004, the fair value of our interest rate swaps was an asset of
approximately $43,000.
Our operating results are affected by changes in interest rates, primarily as a
result of our borrowings under the Line of Credit. If interest rates increased
by 25 basis points, our interest expense would have increased by approximately
$28,000, based on balances outstanding during the six months ended June 30,
2004.
38
Management's Discussion and Analysis of
Financial Condition and Results of Operations, Continued
ITEM 4. CONTROLS AND PROCEDURES
Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, we 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 J.
Mitchell Collins, 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, 2004 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
39
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in various legal actions arising in the ordinary course of
business. Management does not believe that any of the pending actions will have
a material adverse effect on our business, financial condition or results of
operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -- The following exhibits were filed with this Quarterly Report on
Form 10-Q:
31.1 -- Rule 13a-14(a) Certification of Phillip H. McNeill, Sr.
31.2 -- Rule 13a-14(a) Certification of J. Mitchell Collins
32.1 -- Section 1350 Certification of Phillip H. McNeill, Sr.
32.2 -- Section 1350 Certification of J. Mitchell Collins
(b) Reports on Form 8-K -- During the period covered by this Quarterly Report on
Form 10-Q, the Company filed the following Current Reports on Form 8-K:
(1) Current Report on From 8-K dated January 20, 2004 and filed on
January 20, 2004 (Items 5 and 12) announcing the resignation of Donald H.
Dempsey as Executive Vice President, Chief Financial Officer, Secretary and
Treasurer and director of the Company, as well as the hiring of J. Mitchell
Collins as Executive Vice President, Chief Financial Officer, Secretary and
Treasurer of the Company.
(2) Current Report on Form 8-K dated February 17, 2004 and filed on
February 17, 2004, (Items 7 and 12) announcing the Company's issuance of its
earnings press release for the three and twelve months ended December 31, 2003.
(3) Current Report on Form 8-K dated March 11, 2004 and filed on March
11, 2004, (Item 5) disclosing the Company's annual updated material risk factors
(no financial information required).
(4) Current Report on Form 8-K dated March 18, 2004 and filed on March
18, 2004 (Items 5 and 7) announcing the nomination of Robert P. Bowen as a new
board member to be voted on by shareholders at the Company's May 13, 2004 annual
meeting, and the resignation of William W. Deupree, Jr. as a director of the
Company.
(5) Current Report on Form 8-K dated May 6, 2004 and filed on May 6,
2004 (Items 7 and 12) announcing the Company's issuance of its earnings press
release for the three months ended March 31, 2004.
(6) Current Report on Form 8-K dated May 13, 2004 and filed on May 13,
2004 (Item 5) announcing the voting results of its annual election of board
members.
40
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 9, 2004 By: /s/J. Mitchell Collins
- -------------- -------------------------------------------------
Date J. Mitchell Collins
Executive Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer),
Secretary and Treasurer
41