<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 9, 1999
REGISTRATION STATEMENT NO. 333-67065
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
INTERSTATE HOTELS MANAGEMENT, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
MARYLAND 7011 75-2767215
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or Classification Code Number) Identification No.)
organization)
</TABLE>
680 ANDERSEN DRIVE, FOSTER PLAZA TEN
PITTSBURGH, PENNSYLVANIA 15220
(412) 937-0600
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)
THOMAS F. HEWITT
INTERSTATE HOTELS MANAGEMENT, INC.
680 ANDERSEN DRIVE, FOSTER PLAZA TEN
PITTSBURGH, PENNSYLVANIA 15220
(412) 937-0600
(Name, address including zip code, and telephone number,
including area code, of agent for service)
-------------------------
COPIES TO:
CARLA S. MORELAND, ESQ.
JOHN P. BOHLMANN, ESQ.
C/O PATRIOT AMERICAN HOSPITALITY, INC.
1950 STEMMONS FREEWAY
SUITE 6001 DALLAS, TEXAS 75207
(214) 863-1000
TIMOTHY Q. HUDAK, ESQ.
INTERSTATE HOTELS MANAGEMENT, INC.
680 ANDERSEN DRIVE, FOSTER PLAZA TEN
PITTSBURGH, PENNSYLVANIA 15220
(412) 937-0600
-------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS
PRACTICABLE AFTER THE REGISTRATION STATEMENT BECOMES EFFECTIVE.
-------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
-------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
SUBJECT TO COMPLETION, DATED MARCH , 1999
9,221,743 SHARES
INTERSTATE HOTELS MANAGEMENT, INC.
DISTRIBUTION BY
PATRIOT AMERICAN HOSPITALITY, INC.
TO ITS SHAREHOLDERS OF UP TO
9,221,743 SHARES OF COMMON STOCK
OF INTERSTATE HOTELS MANAGEMENT, INC.
-------------------------
We are sending you this Information Statement/Prospectus to describe the
spin-off of 92% of Interstate Hotels Management, Inc. from Patriot American
Hospitality, Inc., and the business and financial condition of Interstate
Management following the spin-off. When the spin-off is accomplished, you will
receive one share of common stock of Interstate Management for every 19.57
shares of Patriot common stock, Patriot Series A Preferred Stock, Wyndham
International, Inc. Series A and Series B Preferred Stock and Wyndham
International Operating Partnership, L.P. Class A and Class C preferred limited
partnership units you own.
Patriot signed a merger agreement on December 2, 1997 pursuant to which it
was to acquire Interstate Hotels Company. In March 1998, prior to the closing of
the merger, Marriott International, Inc. sued IHC seeking to block the
transaction, and the merger was preliminarily enjoined in April 1998 pending a
trial on the merits of Marriott's claims. On May 27, 1998, Patriot/Wyndham, IHC
and Marriott reached a settlement allowing the Patriot/IHC merger to close on
June 2, 1998. As part of the settlement agreement, Patriot agreed to effect the
spin-off of Interstate Management, which operates and has a 45% managing member
interest in the third-party hotel management business Patriot acquired from IHC.
Interstate Management has been a subsidiary of Patriot since the IHC
acquisition. The spin-off achieves two goals: you will continue to own an equity
stake in IHC's third-party hotel management business, but Wyndham, shares of
which are paired and trade together as a single unit with Patriot's shares and
which is a major competitor of Marriott's, will not have a direct operational
relationship with Marriott or any Marriott hotels. If you are a holder of record
of Patriot securities on March , 1999, you will receive your Interstate
Management shares automatically. You do not need to take any further action. We
intend to apply to have the Interstate Management shares listed on the New York
Stock Exchange under the trading symbol "IHM."
-------------------------
WE URGE YOU TO READ THIS INFORMATION STATEMENT/PROSPECTUS CAREFULLY SINCE IT
CONTAINS INFORMATION THAT IS IMPORTANT TO YOU. PLEASE PAY PARTICULAR ATTENTION
TO THE "RISK FACTORS" BEGINNING ON PAGE 9.
-------------------------
NO VOTE OF STOCKHOLDERS IS REQUIRED IN CONNECTION WITH THIS DISTRIBUTION. WE ARE
NOT ASKING YOU FOR A PROXY AND YOU ARE REQUESTED NOT TO SEND US A PROXY.
-------------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
INFORMATION STATEMENT/PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
-------------------------
THIS INFORMATION STATEMENT/PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY ANY SECURITIES.
-------------------------
The date of this Information Statement/Prospectus is March , 1999.
THE INFORMATION IN THIS INFORMATION STATEMENT/PROSPECTUS IS NOT COMPLETE
AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE
REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
IS EFFECTIVE. THIS INFORMATION STATEMENT/PROSPECTUS IS NOT AN OFFER TO
SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Questions and Answers about the Spin-off and Interstate
Management................................................ 1
Summary..................................................... 3
Summary Financial and Other Data............................ 7
Risk Factors................................................ 9
The Spin-off................................................ 15
Business.................................................... 19
Selected Financial and Other Data........................... 30
Pro Forma Financial Data.................................... 32
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 39
Management.................................................. 47
Certain Relationships and Related Transactions.............. 55
Security Ownership of Certain Beneficial Owners and
Management................................................ 56
Description of Capital Stock................................ 56
Where You Can Find More Information......................... 60
Index to Combined Financial Information..................... F-1
</TABLE>
This Information Statement/Prospectus contains trademarks and trade names of
companies other than Interstate Hotels Management, Inc.
<PAGE> 4
QUESTIONS AND ANSWERS ABOUT THE SPIN-OFF AND INTERSTATE MANAGEMENT
These questions and answers are qualified by the more detailed information and
the financial statements and notes thereto appearing elsewhere in this
Information Statement/Prospectus. References to "we," "us," and "Interstate
Management" mean Interstate Hotels Management, Inc. and its subsidiaries,
references to "Interstate Hotels, LLC" mean Interstate Hotels, LLC and its
subsidiaries, references to "Patriot" mean Patriot American Hospitality, Inc.
and its subsidiaries, references to "Wyndham" mean Wyndham International, Inc.
and its subsidiaries, references to "Patriot/Wyndham" mean Patriot and its
subsidiaries together with Wyndham and its subsidiaries, references to "IHC"
mean Interstate Hotels Company, references to "Interstate Management stock" and
"Interstate Management shares" mean the common stock of Interstate Management,
and references to "Patriot securities" mean common stock and Series A Preferred
Stock of Patriot, Series A and Series B Preferred Stock of Wyndham and Class A
and Class C Preferred limited partnership units of Wyndham International
Operating Partnership, L.P. In addition, all statistics are as of December 31,
1998 and relate to Interstate Management's portfolio of hotels for which
management contracts or leases were in place as of March 1, 1999 and/or which we
expect to be operated by Interstate Management following the spin-off.
Q: What will happen in the spin-off?
A: In the spin-off, Patriot/Wyndham will separate from its hotel business IHC's
third-party hotel management business, as well as equity interests
representing in the aggregate an approximate 50.3% interest in The Charles
Hotel Complex, a hotel, retail and office complex located in Cambridge,
Massachusetts, all of which it acquired from IHC through Patriot's merger
with IHC, to create a separate publicly traded company. ("Third-party hotel
management business" refers to the management, leasing and related services
we perform for hotels that we do not own.)
Q: What will I receive in the spin-off?
A: You will receive one Interstate Management share for every 19.57 Patriot
securities you own on March , 1999, the record date for the spin-off. We
will not issue any fractional shares. Instead, you will receive cash based on
the market value of any fractional shares.
Example: If you own 100 Patriot securities, then after the spin-off you will
receive five Interstate Management shares and a check for the market value of
the fractional interest.
Q: What do I have to do to participate in the spin-off?
A: Nothing. No proxy or vote is necessary for the spin-off. If you own Patriot
securities as of the close of business on March , 1999, Interstate
Management shares will be mailed to you or credited to your brokerage
account. You do not need to mail in any stock certificates.
Q: What will my spin-off shares be worth?
A: Based on information we have received from Patriot, we have estimated the
initial value of the Interstate Management shares to be per share. The
actual trading value of the Interstate Management shares may be higher or
lower than the estimated value and will depend on many factors. Until an
orderly trading market develops, the market price for the Interstate
Management shares may fluctuate significantly. Please obtain current
quotations prior to deciding whether to purchase or sell Interstate
Management shares.
Q: Will I have to pay taxes on the shares I receive in the spin-off?
A: Yes. The fair market value at the time of the spin-off of the Interstate
Management shares you receive in the spin-off (and the cash you receive in
lieu of fractional shares) will be taxable to you. The distribution will be
treated as a dividend and taxable as ordinary income if it is paid out of
Patriot's
1
<PAGE> 5
earnings and profits. Any amount of the distribution in excess of earnings
and profits will first reduce your tax basis in your Patriot securities and
then will be taxable to you as capital gain. We have assigned an estimated
value of per share to the Interstate Management shares, but the actual
value of the spin-off distribution could be between and per
share. The final value of the spin-off distribution cannot be determined
until after the distribution is completed. We will make a public announcement
of the amount of the distribution promptly after it is determined and will
furnish to you the required IRS information as promptly as we can. For a more
detailed description of the tax consequences to you of the spin-off, see page
16.
Q: When will I receive my Interstate Management shares?
A: Patriot will deliver the Interstate Management shares to which you are
entitled as promptly as it can following the spin-off. Patriot will either
mail a stock certificate to you or arrange for your shares to be credited
electronically to your brokerage account.
Q: When will I be able to buy and sell Interstate Management shares?
A: You may buy and sell Interstate Management shares once the spin-off occurs.
Q: Where will the Interstate Management shares trade?
A: Interstate Management intends to apply to have its shares listed on the New
York Stock Exchange under the trading symbol "IHM."
Q: Will dividends be paid on the Interstate Management shares?
A: We do not plan to pay dividends on the Interstate Management shares in the
foreseeable future. Unlike Patriot, we are not a REIT and thus are not
required to pay any dividends. We plan to retain our earnings to fund the
development of our business.
Q: Whom should I call with questions about the spin-off and Interstate
Management?
A: If you have questions about the spin-off or Interstate Management or if you
would like additional copies of this Information Statement/Prospectus or any
document we refer to in this Information Statement/ Prospectus, you should
contact Lisa O'Connor at Interstate Management at (412) 937-0600.
2
<PAGE> 6
SUMMARY
This summary highlights selected information from this Information
Statement/Prospectus and does not contain all of the information that may be
important to you. For a more complete description of the spin-off, you should
read this entire Information Statement/Prospectus as well as the additional
documents we refer to under the heading "Where You Can Find More Information."
THE SPIN-OFF
When the spin-off is consummated, Patriot will distribute to you one Interstate
Management share for every 19.57 Patriot securities you own on March , 1999,
the record date for the spin-off. At the time of the spin-off, Marriott will
also purchase four percent of the outstanding Interstate Management shares for
approximately $2.3 million. We expect the spin-off to occur on March , 1999.
REASONS FOR THE SPIN-OFF
Before Patriot/Wyndham agreed to acquire IHC in December 1997, Patriot/Wyndham
negotiated a non-binding letter of intent with Marriott to address Marriott's
concerns regarding the acquisition of IHC, their largest franchisee, by a
competitor, Patriot/Wyndham. Despite lengthy and intensive negotiations,
Patriot/ Wyndham and Marriott were unable to reach a definitive agreement prior
to the planned closing of the IHC merger and Marriott filed suit in March 1998
seeking to block the merger. Patriot/Wyndham, IHC and Marriott reached a
settlement on May 27, 1998 which allowed the IHC merger to close on June 2,
1998. A major component of the settlement agreement was the transfer of certain
operations, principally IHC's third-party hotel management business, to a newly
created subsidiary of Patriot/Wyndham, Interstate Management, and the subsequent
spin-off of Interstate Management from Patriot/Wyndham.
OWNERSHIP OF INTERSTATE MANAGEMENT FOLLOWING THE SPIN-OFF
At the time of the spin-off, Marriott will purchase four percent of our
outstanding shares for approximately $2.3 million. Following the spin-off, in
order to reduce the percentage of Interstate Management shares owned by
affiliates of Patriot/Wyndham, we will redeem the 248,385 Interstate Management
shares which are to be distributed in the spin-off to the holders of Series A
Preferred Stock of Patriot. Following the spin-off and these transactions,
holders of Patriot securities will own 92% of our shares, Marriott will own four
percent of our shares and Patriot/Wyndham will own four percent of our shares.
This ownership structure was a negotiated part of the settlement agreement
reached with Marriott and will allow each of Patriot/Wyndham and Marriott to
maintain an equal interest in Interstate Management. This structure, in addition
to certain rights to elect directors held by Wyndham and Marriott, will allow
both Patriot/Wyndham and Marriott to have an influence on the management of our
affairs.
OUR CORPORATE STRUCTURE
After the spin-off, we will initially have two principal subsidiaries,
Interstate Hotels, LLC and IHC II, LLC. We will own a 45% managing member
interest in Interstate Hotels, LLC and a 99.99% interest in IHC II, LLC. Patriot
will retain a 55% non-controlling ownership interest in Interstate Hotels, LLC
and Marriott will own the remaining .01% interest in IHC II, LLC. Interstate
Hotels, LLC is the entity that will operate the third-party hotel management
business that Patriot/Wyndham acquired from IHC, as well as own equity interests
representing in the aggregate an approximate 50.3% interest in The Charles Hotel
Complex. IHC II, LLC will enter into arrangements under which Marriott will
submanage eleven Marriott hotels acquired by Patriot/Wyndham from IHC. IHC II,
LLC is not expected to make a profit on these arrangements, but rather will
serve to insulate Patriot/Wyndham and Marriott from having a direct operational
relationship with each other. Summary diagrams of our structure both prior to
and immediately following the spin-off are set forth below.
3
<PAGE> 7
Included here in the printed version of this Information
Statement/Prospectus are two graphics which depict, using boxes to
represent entities and arrows to represent ownership interests, the
ownership structure of Interstate Management immediately prior to and
immediately following the spin-off.
The first graphic, which depicts the ownership structure of Interstate
Management immediately prior to the spin-off, shows that:
o Patriot will own 99% of Interstate Management and PAH-Interstate
Holdings, Inc., a subsidiary owned 99% by Patriot and one percent
by Wyndham Operating Partnership (itself a subsidiary of which
Wyndham owns at least 85%), will own one percent of Interstate
Management.
o Interstate Management will own 100% of IHC II, LLC.
o Interstate Management will own 99.99% of IHC II, LLC and Marriott will
own .01% of IHC II, LLC;
o Interstate Management will own 45% of Interstate Hotels, LLC and
PAH-Interstate Holdings, Inc. will own 55% of Interstate Hotels,
LLC;
o Interstate Hotels, LLC will own 99% of both Crossroads Hospitality
Company, L.L.C. and Hilltop Equipment Leasing Company, L.P., and
PAH-Interstate Member, Inc., a wholly-owned subsidiary of
PAH-Interstate Holdings, Inc., will own 1% of both Crossroads
Hospitality Company, L.L.C. and Hilltop Equipment Leasing
Company L.P.;
o Interstate Hotels, LLC will own 100% of Colony Hotels and Resort,
Company, Northridge Insurance Company, Continental Design and
Supplies Company, L.L.C., and several entities owning interests
in leaseholds; and
o Interstate Hotels, LLC will own 50.3% in the aggregate of several
entities owning equity interests in The Charles Hotel Complex.
4
<PAGE> 8
The second graphic, which depicts the ownership structure of Interstate
Management immediately following the spin-off, shows that:
o Marriott will own four percent of Interstate Management, the
holders of Patriot securities will own 92% of Interstate
Management, Patriot will own three percent of Interstate
Management and PAH-Interstate Holdings, Inc., a subsidiary
company owned 99% by Patriot and one percent by Wyndham Operating
Partnership (itself a subsidiary of which Wyndham owns at least
85%), will own one percent of Interstate Management;
o Interstate Management will own 99.99% of IHC II, LLC and Marriott will
own .01% of IHC II, LLC;
o Interstate Management will own 45% of Interstate Hotels, LLC and
PAH-Interstate Holdings, Inc. will own 55% of Interstate Hotels,
LLC;
o Interstate Hotels, LLC will own 99% of both Crossroads Hospitality
Company, L.L.C. and Hilltop Equipment Leasing Company, L.P., and
PAH-Interstate Member, Inc., a wholly-owned subsidiary of
PAH-Interstate Holdings, Inc., will own 1% of both Crossroads
Hospitality Company, L.L.C.;
o Interstate Hotels, LLC will own 100% of Colony Hotels and Resort,
Company, Northridge Insurance Company, Continental Design and
Supplies Company, L.L.C., and several entities owning interests
in leaseholds; and
o Interstate Hotels, LLC will own 50.3% in the aggregate of several
entities owning equity interests in The Charles Hotel Complex.
5
<PAGE> 9
MANAGEMENT
There initially will be five persons on our Board of Directors, one of whom
( ) was selected by Marriott. Thomas F. Hewitt is our Chief Executive
Officer and the Chairman of our Board of Directors.
Our principal executive offices are located at 680 Andersen Drive, Foster Plaza
Ten, Pittsburgh, Pennsylvania 15220. Our telephone number is (412) 937-0600.
6
<PAGE> 10
SUMMARY FINANCIAL AND OTHER DATA
We are providing the following summary financial information to aid you in your
analysis of the financial aspects of the spin-off. The table sets forth summary
historical financial data for Interstate Management, prior to the merger of IHC
with Patriot, as the predecessor, as of and for the years ended December 31,
1994, 1995, 1996 and 1997 and for the period from January 1, 1998 to June 1,
1998, and for Interstate Management, subsequent to the merger of IHC with
Patriot, as the successor, as of December 31, 1998 and for the period from June
2, 1998 to December 31, 1998. In addition, we have provided a combined 1998
column which combines the predecessor for the period from January 1, 1998 to
June 1, 1998 and the successor for the period from June 2, 1998 to December 31,
1998. We believe that this presentation is informative to the reader. In
addition, summary pro forma financial data for the year ended December 31, 1998
is presented.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND HOTEL DATA)
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR YEAR ENDED
-------------------------------------------------------------- ------------- DECEMBER 31,
YEAR ENDED DECEMBER 31, JAN. 1, 1998 JUNE 2, 1998 -----------------------
----------------------------------------------- THROUGH THROUGH COMBINED PRO FORMA
1994 1995 1996 1997 JUNE 1, 1998 DEC. 31, 1998 1998 1998(1)
-------- ---------- ---------- ---------- ------------ ------------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME
DATA:
Revenues:
Lodging revenues..... -- -- $ 9,979 $ 167,855 $ 78,769 $ 115,153 $ 193,922 $ 193,922
Management and
related fees....... $ 36,726 $ 45,018 53,733 62,562 27,994 33,241 61,235 46,716
-------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total revenues... 36,726 45,018 63,712 230,417 106,763 148,394 255,157 240,638
Expenses:
Lodging expenses..... -- -- 6,126 85,631 39,834 60,790 100,624 100,624
Operating expenses
and other(2)....... 20,708 24,934 39,931 34,673 16,623 14,870 31,493 27,736
Lease expense........ -- -- 3,477 73,283 34,515 51,165 85,680 85,680
Depreciation and
amortization....... 3,659 4,188 4,385 4,845 2,152 10,659 12,811 18,184
Interest, net........ (30) (146) (501) (498) (204) (390) (594) (594)
-------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before income
tax expense.......... 12,389 16,042 10,294 32,483 13,843 11,300 25,143 9,008
Income tax expense(3).. -- -- 4,117 12,986 5,528 4,436 9,964 1,564
-------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Income before minority
interest............. 12,389 16,042 6,177 19,497 8,315 6,864 15,179 7,444
Minority interest...... -- -- -- 18 24 209 233 5,098
-------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income............. $ 12,389 $ 16,042 $ 6,177 $ 19,479 $ 8,291 $ 6,655 $ 14,946 $ 2,346
======== ========== ========== ========== ========== ========== ========== ==========
Pro forma net income
per common share(4):
Basic................ $ 0.23
Diluted.............. $ 0.23
BALANCE SHEET DATA
(AT YEAR END):
Cash and cash
equivalents.......... $ 6,702 $ 14,035 $ 11,168 $ 2,432 $ 1,652 $ 1,652 $ 29,942
Total assets........... 30,741 38,420 88,204 118,185 161,157 161,157 188,362
Long-term debt......... 3,890 1,270 541 370 -- -- --
Total equity........... 18,858 24,345 56,886 80,730 92,607 92,607 70,534
OTHER FINANCIAL DATA:
EBITDA (5)............. $ 16,018 $ 20,084 $ 14,178 $ 36,812 $ 15,767 $ 21,360 $ 37,127 $ 21,500
Net cash provided by
operating
activities........... 15,331 12,517 18,359 9,593 27,952
Net cash (used in)
provided by investing
activities........... (4,338) (35,707) 2,674 (27,707) (25,033)
Net cash (used in)
provided by financing
activities........... (13,860) 14,454 (19,298) 15,599 (3,699)
TOTAL HOTEL DATA (6)
Total hotel revenues... $858,986 $1,056,279 $1,326,581 $1,600,958 $1,546,926 $1,065,030
Number of hotels (7)... 136 150 212 223 176 165
Number of rooms (7).... 31,502 35,044 43,178 45,329 35,214 30,644
</TABLE>
7
<PAGE> 11
- -------------------------
(1) Reflects the spin-off and other adjustments described in "Pro Forma
Financial Data."
(2) Includes a non-recurring expense of $11,896 for the year ended December 31,
1996, relating to the issuance of 785,533 shares of common stock to certain
executives and key employees of IHC in consideration for the cancellation of
stock options issued by one of IHC's predecessors, Interstate Hotels
Corporation, in 1995.
(3) Prior to 1996, IHC and its predecessors were organized as S corporations,
partnerships and limited liability companies and, accordingly, were not
subject to federal and certain state income taxes.
(4) Based on 10,002,035 shares of common stock outstanding on a pro forma basis
on the spin-off date.
(5) EBITDA represents earnings before interest, income tax expense, depreciation
and amortization. Management believes that EBITDA is a useful measure of
operating performance because it is industry practice to evaluate hotel
properties based on operating income before interest, taxes, depreciation
and amortization, which is generally equivalent to EBITDA, and EBITDA is
unaffected by the debt and equity structure of the property owner. EBITDA,
as calculated by Interstate Management, may not be consistent with
computations of EBITDA by other companies. EBITDA does not represent cash
flow from operations as defined by generally accepted accounting principles
("GAAP"), is not necessarily indicative of cash available to fund all cash
flow needs and should not be considered as an alternative to net income
under GAAP for purposes of evaluating Interstate Management's results of
operations.
(6) Represents all hotels, including the leased hotels, which Interstate
Management operates.
(7) As of the end of the periods presented. The 1998 pro forma number of hotels
and number of rooms excludes ten hotels with 1,725 rooms under construction
that are scheduled to open in 1999 that are expected to be managed by
Interstate Hotels, LLC.
8
<PAGE> 12
RISK FACTORS
You should carefully read and evaluate the risk factors listed below as well as
the other information contained in this Information Statement/Prospectus.
TERMINATION AND EXPIRATION OF OUR MANAGEMENT AGREEMENTS
Almost all of our revenues for the foreseeable future will come from the
operation of hotels for third-party owners. Hotel management agreements will
expire and be acquired, terminated and renegotiated in the ordinary course of
our business. Typically, our hotel management agreements may be terminated for
many reasons, including default by us or sale of or foreclosure on the
underlying property.
- - In addition, 23 of our management agreements (which generated 10.8 percent of
our 1998 pro forma net management fees) may be terminated without cause and
without the payment of a penalty by either party upon ten to ninety days'
notice.
- - An additional 18 management agreements (which generated 14.6 percent of our
1998 pro forma net management fees) may be terminated without cause upon
thirty to ninety days' notice with the payment of a termination fee.
- - We have been notified by third-party owners of seven hotels (which generated
17.0 percent of our 1998 pro forma net management fees) that such hotels are
currently for sale.
- - Twenty-one of our management agreements (which generated 25.2 percent of our
1998 pro forma net management fees) expire by the end of 1999, 17 agreements
(which generated 14.1 percent of our 1998 pro forma net management fees)
expire by the end of 2000, and seven agreements (which generated 7.2 percent
of our 1998 pro forma net management fees) expire by the end of 2001.
In aggregate, we estimate the average remaining life of our hotel management
agreements to be approximately five years. We cannot be sure that any of these
management agreements will be renewed or extended or that the terms of any
renewals or extensions will be as favorable to us as the terms of the existing
agreements. We also cannot be sure that we will be able to obtain new
third-party hotel management agreements or that the terms of any new management
agreements will be as favorable to us as the typical terms of our existing
agreements. Please see "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Background and General" for a more detailed
discussion.
BUSINESS DISRUPTION DUE TO IHC MERGER AND THE SPIN-OFF
There has been a disruption to our business caused by the IHC merger with
Patriot, the lengthy and intensive negotiations regarding the Marriott
settlement, the consideration of possible alternatives to the spin-off
(including the private sale of Interstate Management to a third party), and the
spin-off. In addition, IHC's operations were required to be divided between
those to be retained by Patriot/Wyndham and those which would be contributed to
us in connection with the spin-off. We were required to expend a substantial
amount of resources, particularly the time and attention of senior management,
in order to achieve that division of operations. The diversion of senior
management's attention and the uncertainty with respect to our future operations
caused by these distractions has disrupted our relationships with hotel owners
and resulted in other negative effects, including reduced employee morale,
increased employee turnover and an inability to actively pursue new business. If
we are unable following the spin-off to rectify the disruption in our
relationships with hotel owners and successfully address the other issues
described above, our business will continue to be negatively affected.
9
<PAGE> 13
DISPUTE AND POTENTIAL LITIGATION REGARDING LEASED HOTEL PORTFOLIO
We are engaged in a dispute with Equity Inns Partnership, L.P. regarding, among
other matters, the status of leases for 80 hotels we lease from Equity Inns or
its affiliates. We received approximately 13.9% of our 1998 pro forma EBITDA
from these 80 hotels. The principal issue in the dispute is whether we or Equity
Inns are responsible for funding property improvement plans ("PIPs") which were
issued by certain franchisors under whose brand names we operate the leased
hotels. Although franchise agreements generally provide to franchisors the right
to require PIPs at any time, these PIPs were issued as a result of Patriot's
merger with IHC. The total amount required to be funded under the PIPs is
approximately $6.0 million.
Generally, the leases require Equity Inns to satisfy any capital obligations
relating to the leased hotels. In this case, however, Equity Inns is claiming
that because certain franchisors issued the new PIPs as a result of the
franchisee change in control provisions of the franchises triggered by the
Patriot/IHC merger and the new franchise applications Patriot has been required
to submit as a result of the merger, Patriot should be responsible for paying
the costs necessary to satisfy them. In addition, Equity Inns claims that it had
the right under the leases to consent in advance to Patriot's application for
new franchise agreements and has demanded that we pay the costs necessary to
satisfy the PIPs as a condition to continuation of the leases. We are vigorously
disputing Equity Inns' claims, but we cannot be sure that we will prevail. The
Equity Inns leaseholds represent a significant portion of our current business
and if we are not able to resolve this dispute with Equity Inns and the leases
are terminated, our results will be negatively affected.
We are currently a party to management contracts with Equity Inns for two
Residence Inn by Marriott hotels, which opened in 1998, and two Homewood Suites
hotels, which Equity Inns plans to purchase upon completion of construction. The
two franchisors of the hotels, Marriott and Promus Hotels, refused to enter into
franchise agreements with us until Patriot completed its ongoing negotiations
with them in connection with the merger of IHC into Patriot and until the
corporate structure of Interstate Management was finalized. As a result, we were
prevented from entering into long-term leases for these hotels. At this point,
Marriott and Promus Hotels have approved us as operators of such hotels only
under short-term management agreements. Equity Inns recently notified us of
their intent to terminate all four agreements in order to lease the two
Residence Inns to a third-party operator and to enter into management agreements
for the two Homewood Suites with such operator. We informed Equity Inns that we
believe that all four hotels are subject to our right of first offer to lease
hotels pursuant to the master agreement entered into between Equity Inns and IHC
in November 1996. Equity Inns maintains, however, that we waived our right of
first offer with respect to the two Residence Inns and that, because Equity Inns
is not entering into leases for the two Homewood Suites, our right of first
offer does not apply to those hotels. While we are currently negotiating with
Equity Inns to resolve this dispute, we cannot be sure that we will prevail. If
we cannot maintain the right to operate the four hotels, the loss of revenues
from the operation of the hotels would negatively affect our operating results.
The two Residence Inns generated less than one percent of our 1998 pro forma net
management fees.
POTENTIAL SALE OF LEASED HOTELS
Equity Inns, the owner of substantially all of our 81 leased hotels, has the
right under our lease agreements to sell any or all of the leased hotels from
time to time without our consent. Our leases and management agreements with
respect to these hotels could be terminated upon such a sale. If Equity Inns
were to sell a substantial number of the leased hotels and the new owners did
not continue our management agreements, our results would be negatively
affected. Equity Inns has advised us that it is currently marketing certain of
the leased hotels for sale. Equity Inns has entered into sale agreements with
respect to certain of the leased hotels, and the potential purchasers are
currently conducting due diligence reviews. If these sales are consummated, our
leases and management contracts for the hotels are likely to be terminated.
10
<PAGE> 14
POTENTIAL VOLATILITY OF OUR STOCK PRICE
POTENTIAL EFFECT OF FORWARD EQUITY TRANSACTIONS. Patriot and Wyndham are parties
to forward equity contracts with NationsBanc Capital Corporation, PaineWebber
Financial Products, Inc. and UBS AG, London Branch which Patriot/Wyndham are
required to settle by returning to the counterparties their original investment
plus a return, either in cash or by issuing to the counterparties a sufficient
number of paired shares of their common stock to be sold for cash. The forward
equity contracts were structured as the sale of an aggregate of approximately
13.3 million paired shares to the counterparties (currently reduced to
approximately 12.5 million due to the sale by one of the counterparties of a
portion of its shares). If the forward equity contracts are settled in cash, the
paired shares issued to the counterparties will be returned to Patriot/Wyndham
and cancelled. The forward equity contracts require Patriot/Wyndham to issue
additional paired shares as collateral if the market price of the paired shares
falls below certain levels. As of March 8, 1999, as a result of decreases in the
market price of the paired shares, Patriot/Wyndham have issued an aggregate of
64.8 million additional paired shares as collateral.
The counterparties have entered into standstill agreements with Patriot/Wyndham
pursuant to which they have agreed, subject to certain exceptions, not to sell
the paired shares they hold until June 30, 1999. Patriot/ Wyndham expect to
close a private equity investment of up to $1.0 billion prior to that date and
to use a portion of the proceeds to settle the forward equity transactions in
cash. In that event, the paired shares held by the counterparties, as well as
the paired shares and other collateral being held on behalf of the
counterparties, will be returned to Patriot/Wyndham and the paired shares will
be cancelled. The closing of the private investment is subject to a number of
conditions, including stockholder approval. We cannot assure you that the
closing will occur or that the forward equity transactions will be settled for
cash as contemplated.
In the spin-off, NationsBanc, PaineWebber and UBS will receive a distribution of
Interstate Management shares in respect of both the paired shares originally
purchased by them, as well as on the paired shares held by them as collateral.
As a result, the counterparties will initially own approximately % of the
outstanding Interstate Management shares and may seek to sell all or a portion
of these shares at the time the shares are issued, or at any time thereafter. In
addition, the Interstate Management shares held by them as collateral will
represent an additional % of the outstanding Interstate Management shares.
If the private investment described above does not close, or the standstill
agreements are otherwise terminated, the counterparties may seek to sell these
shares as well. Any such sales may cause volatility in the prevailing market
price for Interstate Management shares and, potentially, a decline in such
price.
Patriot/Wyndham are currently negotiating with the counterparties to exchange at
the time of the spin-off the Interstate Management shares distributed to the
counterparties for paired shares of equivalent value, to be held by them as
additional collateral for the obligations under the forward equity contracts. In
that event, Patriot/Wyndham would return the Interstate Management shares to
Interstate Management for no consideration, and the shares would be cancelled.
Any such transaction would require the agreement of the counterparties and the
consent of the group which is expected to make the investment in
Patriot/Wyndham. We cannot assure you that the agreement of the counterparties
or the consent of the investor group will be obtained.
ABSENCE OF PRIOR TRADING MARKET FOR OUR SHARES. There is currently no public
trading market for our shares. We cannot predict what the market price for our
shares might be. Until an orderly trading market develops, the market price for
our shares may fluctuate significantly. You should not view historical trading
prices of shares of IHC's (or Patriot/Wyndham's) stock as a reflection of what
the trading price of our shares might be. Following the spin-off, we will be
significantly smaller than IHC was prior to its merger with Patriot.
11
<PAGE> 15
Some of the Patriot securityholders who receive Interstate Management shares in
the spin-off may decide that they do not want to own these shares, and may sell
their shares. We believe that some Patriot shareholders may not be interested in
owning the stock of a comparatively smaller company which does not own a
substantial amount of real estate. Additionally, we believe that a number of
Patriot's current shareholders may be arbitrageurs or other short-term investors
who do not intend to hold shares of a lodging company for the long term. Some of
our larger stockholders will be contractually bound, under a Voting Agreement,
to sell portions of their Interstate Management shares within one year after the
spin-off in an attempt to reduce the holdings of Interstate Management shares by
affiliates of Patriot/Wyndham to less than 9.9% of the outstanding Interstate
Management shares by the first anniversary of the spin-off. These mandatory
sales may depress the trading price of Interstate Management shares. The Voting
Agreement is discussed in more detail on page 55.
COMPETITION FOR THIRD-PARTY HOTEL MANAGEMENT AGREEMENTS AND RELATED BUSINESS
We compete for third-party hotel management agreements with international,
national, regional and local hotel management and franchise companies. We
compete with these companies on factors such as relationships with hotel owners
and investors, access to capital, financial performance, contract terms, name
recognition, marketing support and the willingness to provide funds in
connection with new management arrangements. Many of our competitors have
substantially greater financial resources than we do. In order for us to expand
our hotel management business, we may be required to offer more attractive terms
to hotel owners than those contained in our existing management agreements and
we may be required to make investments (in the form of equity or debt) in hotel
properties. We currently have limited capital available to make such investments
and, therefore, we may be required to obtain financing to provide the necessary
funds. We cannot assure you that we could obtain such financing on commercially
reasonable terms.
OPTIONAL NATURE OF ANCILLARY SERVICES
In addition to traditional hotel management services, we offer to third-party
hotel owners several ancillary services such as purchasing, project management,
insurance and risk management. We received approximately 35.8% of our 1998 pro
forma management and related fees from the provision of these services. Our
management contracts do not obligate third-party hotel owners to utilize these
services, and the failure of a substantial number of third-party hotel owners to
utilize these services could adversely affect our overall revenues.
DEPENDENCE ON SMALL NUMBER OF HOTEL OWNERS
We derived 54.6% of our 1998 pro forma net management fees from hotels owned by
seven owners, none of which contributed more than 10% individually. Should any
of these owners decide to terminate their relationship with us, our financial
results would be negatively affected.
HOTEL INDUSTRY RISKS
OPERATING RISKS. The hotels we operate are subject to all of the operating
risks common to the hotel industry, such as:
- overbuilding of hotels, and the corresponding oversupply of hotel rooms,
in a particular geographic area;
- changes in travel patterns due to increases in travel expenses and other
factors; and
- changes in general, regional and local economic conditions.
12
<PAGE> 16
All of these risks could adversely affect our average occupancy and average
daily room rates ("ADR"). Such effects on average occupancy and ADR could reduce
our revenues since our management fees are calculated as a percentage of
revenues and profits of hotels.
COMPETITION. Each of the hotels that we manage or lease competes with the other
hotels in its geographic area. Additional hotel rooms have been or may be built
in many of the geographic areas in which we manage or lease hotels, which could
adversely affect our average occupancy and ADR in these areas. In addition, the
overall supply of hotel rooms in the United States as a whole has increased
substantially over the past several years. All of the hotels that we operate
face competition on factors such as room rates, quality of accommodations, name
recognition, service levels, convenience of location and the quality and scope
of other amenities including food and beverage facilities.
GOVERNMENT REGULATION. As a hotel management company, we are subject to
extensive governmental regulation, including laws which relate to the licensing
of hotels and restaurants, the preparation and sale of food and beverages, the
adaptation of public accommodations for use by the disabled, general building
and zoning requirements and the disposal of hazardous waste. We are also subject
to laws relating to our relationship with our employees, including minimum wage,
overtime, working conditions and work permit requirements. Although third-party
hotel owners are generally responsible for paying all costs, expenses and
liabilities incurred in the operation of the hotels we manage, including
compliance with laws (including environmental laws), we may be contingently
liable for certain liabilities for which we do not maintain insurance, including
certain claims arising under the Americans With Disabilities Act of 1990.
FOREIGN HOTEL RISKS
Five of the hotels we manage are located in Canada and Russia. These hotels
accounted for 11.1% of 1998 pro forma net management fees. In addition, pursuant
to the management contracts for the three hotels located in Russia, Interstate
Hotels, LLC agreed to fund loans to the hotel owners. Interstate Hotels, LLC has
loaned $2.7 million to these owners and currently is obligated to fund up to an
additional $750,000 in aggregate. We cannot be certain of the effect that
changing political climates and economic conditions could have on hotel
operations in such countries and on our ability to collect on our loans to
third-party owners in Russia.
DEPENDENCE ON FRANCHISORS
Most of the hotels we manage, lease or for which we perform related services are
operated under franchise licenses, including franchise licenses for the
AmeriSuites, Colony, Comfort Inn, Courtyard by Marriott, Embassy Suites,
Fairfield Inn by Marriott, Hampton Inn, Hilton, Holiday Inn, Homewood Suites,
Marriott, Radisson, Residence Inn by Marriott, Sheraton and Westin brands. Any
significant decline in the reputation of any of our franchisors could adversely
affect our results of operations.
CONCENTRATION IN SINGLE INDUSTRY
Our business is almost entirely hotel related. In the event of a general
downturn in the hotel industry, the adverse effect on us may be greater than on
a more diversified company with assets or activities outside of the hotel
industry.
LIMITED FINANCIAL RESOURCES
Following the spin-off, we may have difficulty obtaining financing on favorable
terms because our asset base will be smaller than IHC's was prior to its merger
into Patriot and we will not initially own any hotels to provide collateral for
such financing. Accordingly, we will not necessarily be able to rely on IHC's or
Patriot's prior relationships with lenders.
13
<PAGE> 17
SUBSTANTIAL RELIANCE ON KEY PERSONNEL
We will be dependent on the efforts of our senior management team. Our future
success and our ability to manage future growth depends in large part on the
efforts of our senior management and on our ability to attract and retain these
key executives and other qualified personnel. Competition for such personnel is
intense, and we cannot assure you that we will succeed in attracting and
retaining such personnel.
HOTEL INVESTMENT AND DEVELOPMENT RISKS
We expect to make investments in hotels in the future, and these hotels may fail
to perform in accordance with our expectations. We also may develop new hotels
selectively. New project development is subject to risks such as market or site
deterioration after acquisition and the possibility that regulatory approvals,
inclement weather, labor or material shortages, work stoppages and the lack of
continued availability of construction or permanent financing may lead to
construction delays or cost overruns. We cannot be sure that we will be able to
successfully integrate these new hotels into our existing operations or that
these new hotels will achieve revenue and profitability levels comparable to our
existing hotels.
GROWTH RISKS
We intend to pursue a growth-oriented business strategy focusing primarily on
adding significantly to our hotel portfolio. Our ability to pursue new growth
opportunities successfully will depend on a number of factors, including, among
others: our ability to identify suitable growth opportunities, finance
acquisitions, integrate new contracts into our operations, adapt to competition,
and access sufficient capital on commercially reasonable terms. We cannot assure
you that our systems, procedures and controls, and management, financial and
other resources will be adequate to support such expansion.
REAL ESTATE OWNERSHIP, LEASING AND INVESTMENT RISKS
At March 1, 1999, we operated 81 hotels under leases, 80 of which were long-term
leases. As of the spin-off, we will own equity interests representing in the
aggregate an approximate 50.3% interest in The Charles Hotel Complex. We also
intend to make investments in hotels, which will subject us to risks generally
related to owning or leasing real estate, such as changes in national, regional
and local economic conditions, local real estate market conditions, changes in
interest rates and in the availability, cost and terms of financing, liability
for long-term lease obligations, the potential for uninsured casualty and other
losses, the impact of environmental legislation and compliance with
environmental laws and adverse changes in zoning laws and other regulations. In
addition, real estate investments in general are relatively illiquid, which
could limit our ability to adapt the portfolio of hotels we may own or lease in
response to changes in economic and other conditions.
14
<PAGE> 18
THE SPIN-OFF
BACKGROUND OF THE SPIN-OFF
On December 2, 1997, Patriot/Wyndham and IHC entered into a merger agreement
providing for the acquisition of IHC by Patriot/Wyndham. Before signing the IHC
merger agreement, Patriot negotiated with Marriott a non-binding letter of
intent which outlined the terms of a proposed agreement which was intended to
address Marriott's concerns regarding the acquisition of their largest
franchisee by a competitor, Patriot/Wyndham. Despite lengthy and intensive
negotiations, Patriot/Wyndham and Marriott were not able to reach a definitive
agreement prior to the planned closing of the IHC merger and Marriott filed suit
seeking to block the merger. Marriott obtained a preliminary injunction against
the merger pending a trial on its claims.
Following entry of the preliminary injunction against the IHC merger, the
parties began simultaneously to prepare for trial and to negotiate a settlement.
An agreement for settlement was reached on May 27, 1998, allowing the IHC merger
to close on June 2, 1998.
The principal focus of the settlement agreement is a set of arrangements
designed to prevent Patriot/ Wyndham from having a direct operational
relationship with Marriott or any Marriott branded hotels. For example, the
settlement agreement provides that ten of the Marriott hotels which were owned
by IHC will be converted to the Wyndham brand and ten other Marriotts previously
owned by IHC will convert to Marriott management. The other major component of
the settlement agreement is the spin-off, which addresses the Marriott hotels
and other hotels which were managed or leased by IHC on behalf of their
third-party owners. Patriot/Wyndham agreed to separate this business from the
rest of IHC's hotel operations and spin it off as a new, publicly traded
company. Patriot/Wyndham agreed with Marriott that each would initially own four
percent of the outstanding shares of the new company and that the remaining 92%
would be distributed to Patriot's shareholders.
The settlement agreement, including the terms of the spin-off, was approved by
special committees of the Boards of Directors of Patriot and Wyndham. The
special committees recognized that the spin-off would be taxable to you based on
the fair market value of the Interstate Management shares distributed to you on
the date of the spin-off. However, the special committees believed that the
benefits of the spin-off, and the related closing of the IHC merger, outweighed
any negative tax consequences to you from the spin-off.
Based on information we have received from Patriot, we have estimated the value
of the Interstate Management shares you will receive in the spin-off to be
per share. The final value of the spin-off distribution cannot be
determined until after the distribution is completed. We will make a public
announcement of the amount of the distribution promptly after it is determined
and will furnish to you the required IRS information as early as we can so that
you can complete your tax returns.
The actual trading value of the Interstate Management shares may be higher or
lower than the estimated value and will depend on many factors. Until an orderly
trading market develops, the market price for the Interstate Management shares
may fluctuate significantly. Please obtain current market quotations prior to
deciding whether to purchase or sell Interstate Management shares.
DISTRIBUTION OF INTERSTATE MANAGEMENT SHARES
Each holder of Patriot securities as of the close of business on
, 1999 will receive one Interstate Management share for every
19.57 Patriot securities he or she owns.
In anticipation of the spin-off, immediately following the IHC merger
Patriot/Wyndham contributed to Interstate Management a 35% interest in
Interstate Hotels, LLC, the entity holding IHC's third-party hotel management
business. The remaining 65% interest was contributed to a subsidiary owned 99%
by Patriot
15
<PAGE> 19
and 1% by Wyndham. Patriot and Interstate Management have since adjusted their
respective ownership percentages to the current 55% and 45% levels.
As of December 31, 1998, Patriot's preferred stockholders owned approximately
% of Patriot's shares and these stockholders will participate proportionately
in the spin-off. Following the spin-off, we will redeem for cash all of the
Interstate Management shares which are distributed to Patriot's preferred
stockholders. The purchase price for the redemption will be the average closing
price of the Interstate Management shares for the first five days on which they
are traded. In addition, limited partners in Patriot's operating partnership
will receive an equivalent cash payment in lieu of receiving Interstate
Management shares.
We will not issue fractional shares in the spin-off. The distribution agent will
distribute cash to you in lieu of such fractional shares.
DISTRIBUTION AGREEMENT
We intend to enter into a Distribution Agreement with Patriot on or before the
date of the spin-off. The Distribution Agreement is intended to allocate certain
assets and liabilities between Interstate Management and Patriot and to ease our
transition from a subsidiary of Patriot to an independent publicly traded
company.
The Distribution Agreement will outline the principal arrangements between
Interstate Management and Patriot related to the spin-off. The Distribution
Agreement will obligate us to indemnify Patriot for liabilities arising out of
or related to our assets (including assets to be contributed to us by Patriot).
This indemnification will apply to liabilities arising both before and after the
spin-off. Patriot will provide similar indemnification to us in respect of
liabilities arising out of the assets which it retains.
The Distribution Agreement will also contain provisions allocating certain
assets and liabilities relating to employee benefits between Patriot's employee
benefit plans and Interstate Management's employee benefit plans, and will
provide that Patriot will generally be responsible for the tax liabilities and
be the beneficiary of the tax benefits arising out of our operations prior to
the spin-off. Each of Interstate Management and Patriot will be responsible for
the tax liabilities and the beneficiary of the tax benefits arising out of their
respective operations after the spin-off.
DISTRIBUTION AGENT
The distribution agent for the spin-off will be American Stock Transfer & Trust
Company, 40 Wall Street, 46th Floor, New York, New York 10005 (Telephone: (800)
937-5449). You may contact them if you have any questions regarding delivery of
your Interstate Management shares and cash in lieu of fractional shares in the
spin-off.
FEDERAL INCOME TAX CONSEQUENCES OF THE SPIN-OFF
The following discussion summarizes the material United States federal income
tax consequences of the spin-off to you. We have not attempted to comment on all
United States federal income tax consequences of the spin-off that may be
relevant to you. We based this summary upon current provisions of the tax code,
existing temporary and final treasury regulations, and current administrative
rulings and court decisions, all of which are subject to change, possibly on a
retroactive basis. The IRS could disagree with our summary of these provisions.
We do not intend to obtain a private letter ruling regarding the spin-off from
the IRS or any other taxing authority.
Our discussion below is for general information only, and is not intended to
provide legal or tax advice to any particular holder of Interstate Management
shares. The discussion may not apply to particular
16
<PAGE> 20
stockholders who are subject to special treatment under the tax code, such as
insurance companies, financial institutions, broker-dealers, tax-exempt
organizations and non-U.S. stockholders. You should consult your personal tax
advisor to determine the specific tax consequences to you of the spin-off,
including any state, local or other tax consequences, in light of your
particular investment circumstances.
PATRIOT'S STATUS AS A REIT. Patriot has conducted business and continues to
conduct business in a manner designed to permit it to qualify as a REIT under
the Internal Revenue Code of 1986, as amended. On March 1, 1999, Patriot
announced that it had signed an agreement with an investor group, including
affiliates of Thomas H. Lee Company, Apollo Real Estate Advisors, L.P., Apollo
Management, L.P., Beacon Capital Partners, Inc., and Rosen Consulting Group,
providing for an equity investment of up to $1 billion in Patriot. In connection
with this investment, Patriot would become a subsidiary of Wyndham, and convert
from a REIT to a C corporation. Since this investment would occur after the date
of the spin-off, the spin-off related transactions are being accounted for
assuming Patriot qualifies as a REIT. However, if the investment is subsequently
consummated, Patriot's REIT status would be terminated retroactively effective
January 1, 1999. The consummation of this investment is subject to numerous
conditions, including approval by Patriot shareholders. Therefore, the following
discussion describes the federal income tax consequences of the spin-off in both
scenarios, i.e., assuming that Patriot is a C corporation at the time of the
spin-off and assuming that Patriot qualifies as a REIT at the time of the
spin-off, in which case the consequences of the spin-off are evaluated in light
of the special rules applicable to a corporation that intends to qualify as a
REIT.
TAX CONSEQUENCES OF THE SPIN-OFF TO PATRIOT. Upon consummation of the spin-off,
Patriot will recognize taxable gain equal to the difference between the fair
market value of the Interstate Management shares distributed and Patriot's tax
basis in such shares. Based on information provided by Patriot, we currently
estimate that the amount of gain will be approximately $ million, based
on an estimate that the fair market value of the Interstate Management shares
distributed will be $ per share, or $ million in the aggregate.
However, the final value of the Interstate Management shares cannot be
determined until after the spin-off is completed. In addition, the determination
of the amount of gain is a factual issue that is subject to challenge by the
IRS.
Patriot will recognize this taxable gain regardless of whether it is a C
corporation or a REIT as of the date of the spin-off. If Patriot qualifies as a
REIT as of such date, Patriot will be subject to tax at the highest regular
corporate rate applicable, pursuant to Treasury Regulations not yet promulgated,
to the extent of the "built-in-gain" of Interstate Management's assets at the
time of the IHC merger. Such tax will apply to Patriot as a REIT because the
assets of Interstate Management were acquired on a tax-free basis by a REIT from
a C corporation. In determining the amount Patriot must distribute annually to
shareholders in order to maintain REIT qualification, Patriot will take into
account the excess of the amount of recognized built-in-gain over the amount of
tax paid. The value of the Interstate Management shares distributed to Patriot
shareholders will apply towards the annual distribution requirement.
RECEIPT OF INTERSTATE MANAGEMENT SHARES. The spin-off will be taxable to you
for federal income tax purposes based on the fair market value of the Interstate
Management shares (and cash in lieu of fractional shares) you receive as of the
date of the spin-off. You will acquire an initial tax basis in your Interstate
Management shares equal to their value on the date of the spin-off, and your
holding period for such shares will begin on such date.
Assuming that Patriot qualifies as a REIT, distributions such as the spin-off
made to Patriot's shareholders out of Patriot's current or accumulated earnings
and profits (and not designated as capital gain dividends) will be taken into
account as ordinary income. If Patriot is a C corporation as of the date of the
spin-off, these distributions made to Patriot's corporate shareholders may be
eligible for the dividends received deduction. However, if Patriot qualifies as
a REIT as of such date, such distributions made to Patriot's
17
<PAGE> 21
corporate shareholders will not be eligible for the dividends received
deduction. Regardless of whether Patriot is a C corporation or a REIT as of the
date of the spin-off, any amount of the distribution in excess of earnings and
profits will first reduce your tax basis in your Patriot securities and then
will be taxable to you as capital gain. The characterization of the distribution
as a dividend will depend on the amount of Patriot's current and accumulated
earnings and profits allocable to the distribution, which cannot be determined
with certainty at this time. However, we expect that a portion of the
distribution may be in excess of earnings and profits. If Patriot qualifies as a
REIT as of the date of the spin-off, Patriot's ability to designate the
distribution of Interstate Management shares as a capital gain distribution may
be limited and will depend on a variety of factors, and we cannot be sure that
the distribution will be so designated.
After the spin-off, Patriot will determine the fair market value of the shares
distributed based on a number of factors. Patriot will provide to you the
information necessary to determine the amount and character of the distribution
to you, and Patriot will report the amount received by you to the IRS. We cannot
be sure that the IRS or any court will agree that the amount received by you is
equal to the amount determined by Patriot. If the IRS were to challenge the
value or character of the distribution reportable by you on your federal income
tax return, you would have to bear the expense and effort of defending against
or otherwise resolving such challenge.
BACKUP WITHHOLDING. Patriot generally will be required to withhold 31% of the
Interstate Management shares to be distributed to you if (i) you fail to furnish
or certify a taxpayer identification number to Patriot, (ii) the IRS notifies
Patriot that the taxpayer identification number furnished by you is incorrect,
(iii) the IRS notifies Patriot that you have underreported interest and/or
dividend income, or (iv) you fail to certify to Patriot that you are not subject
to withholding for underreporting interest or dividend income. Any amounts
withheld from you under these backup withholding rules will be allowed as a
credit against your federal income tax liability or as a refund.
18
<PAGE> 22
BUSINESS
GENERAL
We are one of the largest independent hotel management companies in the United
States based on total portfolio hotel revenues, number of guestrooms and number
of properties managed. Following the spin-off, we will control and have a 45%
economic interest in Interstate Hotels, LLC, the successor to the third-party
hotel management business conducted by IHC prior to its merger into Patriot. As
the managing member of Interstate Hotels, LLC, we expect to operate 175 hotels
containing approximately 32,400 rooms. We manage, lease or perform related
services for hotels in all market segments, which are geographically dispersed
in 38 states in the United States, and in Canada, the Caribbean and Russia. We
operate these hotels under a variety of major brand names, including
AmeriSuites, Colony, Comfort Inn, Courtyard by Marriott, Embassy Suites,
Fairfield Inn by Marriott, Hampton Inn, Hilton, Holiday Inn, Homewood Suites,
Marriott, Radisson, Residence Inn by Marriott, Sheraton and Westin. To
facilitate the management of our diverse portfolio of hotels, we have divided
the hotels into two separate operating divisions--Interstate, which operates
luxury and upscale hotels, and Crossroads, which operates mid-scale, upper
economy and budget hotels.
Following the spin-off, in addition to conducting IHC's former third-party hotel
management business through Interstate Hotels, LLC, we will own an equity
interest in The Charles Hotel Complex. As part of our business strategy, we plan
to pursue future opportunities to manage or lease hotels on behalf of third-
party owners as well as other business opportunities, such as selective hotel
investments and the formation of strategic alliances. Any new business will be
managed, leased or owned directly by us, not through Interstate Hotels, LLC.
Because we have an agreement with Interstate Hotels, LLC that prevents it from
expanding its business beyond its existing contracts, you will have the full
economic benefit of any new business we acquire, even business we obtain through
relationships with the owners of hotels currently managed by Interstate Hotels,
LLC. We intend to attract future business both through our existing
relationships with third-party owners and through the development of
relationships with additional third-party owners.
Our senior management team consists of our Chief Executive Officer Thomas F.
Hewitt, who has more than 30 years of experience in the hospitality industry,
and former IHC executive officers who, together with Mr. Hewitt, have an average
of 24 years of experience in the hospitality industry. In addition, we employ
substantially all of IHC's employees who were a part of IHC's third-party hotel
management business. We intend to capitalize on this extensive experience,
together with our corporate infrastructure and the diversity of our portfolio of
hotels, to obtain future third-party hotel management contracts and take
advantage of other hotel-related opportunities.
BACKGROUND
IHC was founded in 1961 to own and operate a single motor lodge in northwestern
Pennsylvania. Throughout the 1960s and 1970s, IHC built a portfolio of hotel
management contracts and developed its reputation as an experienced hotel
management company. In the late 1980s and early 1990s, IHC continued to
aggressively pursue third-party hotel management opportunities at a time when
financial distress existed within the hotel industry. By providing experienced
hotel management to hotel owners, many of which were financial institutions
which had assumed ownership of hotels through foreclosure, IHC was able to
rapidly expand its portfolio of managed hotels during this time period. During
the past five years, IHC continued to expand its management portfolio while it
pursued a growth strategy focused largely on acquiring and investing in hotels
and hotel leaseholds, as a result of management's belief that the real estate
market was appreciating rapidly and that significant value could be created
through the ownership of hotel assets. During this time period, IHC completed an
initial public offering, the acquisition of controlling
19
<PAGE> 23
interests in 40 hotels, the development and construction of four limited-service
hotels and the acquisition of the hotel management and leasing business
affiliated with Equity Inns, Inc.
BUSINESS AND GROWTH STRATEGY
We believe that there are current trends in the industry, including a
significant increase in new hotel construction activity, particularly by
institutions and entrepreneurs who lack hotel management expertise, that will
provide us with new third-party hotel management opportunities. We intend to
pursue two core business strategies to take advantage of these opportunities in
the lodging industry: (i) improving investment value for hotel owners by
increasing the revenues and the profitability of the hotels we operate for them;
and (ii) expanding our hotel portfolio by adding new management contracts and
long-term hotel operating leases, selectively investing in hotels and forming
strategic alliances with real estate partners to increase the range of hotel
investment and management opportunities available to us.
IMPROVING INVESTMENT VALUE FOR HOTEL OWNERS. Because our profits from hotel
management contracts and leases are generally based on the revenues and
profitability of our hotels, our financial interests are aligned with those of
the owners of the hotels we operate. Our ongoing system of investigation,
prioritization and immediate action is designed to ensure that we maintain high
quality facilities and customer service at the hotels we operate while
implementing effective cost controls. In addition, we provide incentives to
regional and general managers to achieve revenue and operating goals at the
hotels for which they are responsible. We believe these measures, in turn, will
lead to increased revenue and operating cash flow and, ultimately, greater value
for our hotel owners.
EXPANDING HOTEL PORTFOLIO. We plan to expand our hotel portfolio through
implementing the following principal strategies:
ADDITION OF NEW HOTEL MANAGEMENT AGREEMENTS AND LONG-TERM OPERATING
LEASES. Through the efforts of our business development staff, we seek to add
new hotel management agreements and long-term hotel operating leases that are
suitable for integration into our portfolios. We believe that we will continue
to win new hotel management agreements and long-term hotel operating leases by
capitalizing on IHC's reputation for integrity, its track record of delivering
superior financial returns for hotel owners and investors and its willingness to
structure key terms of hotel management agreements and leases to satisfy hotel
owner objectives. In particular, we believe that IHC's historic relationships
with institutional hotel investors and franchisors will facilitate our growth by
generating new hotel management agreements and long-term hotel operating leases.
We intend to continue to operate hotels in multiple segments of the lodging
industry, which we believe will increase our opportunities to compete for new
hotel management agreements and long-term operating leases. While we will
participate in each segment of the lodging industry, we believe that the
greatest opportunities for expansion exist in the luxury and upscale segment.
We expect that our existing relationships with owners outside the United States
and our experience in managing their hotels will lead to other international
management opportunities. We believe that our international management
experience will position us to take advantage of growing opportunities in the
international hotel market and enhance our reputation both internationally and
domestically.
SELECTIVE HOTEL INVESTMENTS. We intend to make strategic investments in
hotel properties with business partners or through equity contributions or
secured loans. We may selectively make strategic investments in order to achieve
high returns on capital and to secure new management contracts. We believe that
our in-house management expertise, as well as our extensive hotel, real estate
and finance industry contacts will facilitate our ability to identify, evaluate
and negotiate potential hotel investment opportunities. We may selectively
participate in the development of new hotels in the future when we believe the
20
<PAGE> 24
competitive environment favors such development, based on factors such as
average occupancy and ADR, site location and marketing, financial and operating
issues.
STRATEGIC ALLIANCES. In the past, IHC aligned itself with institutional
investors, such as Blackstone Real Estate Advisors, L.P., and REITs, such as
Equity Inns. These strategic alliances provided IHC opportunities to acquire and
invest in hotels and hotel leaseholds, obtain new management contracts and
acquire small hotel management companies with proportionally smaller capital
investments. In light of IHC's success with these alliances and our belief that
we can significantly grow our management business through hotel and real estate
investments, we will seek to form these types of alliances in the future.
COMPETITIVE ADVANTAGES
We believe that our prospects for growth are enhanced by a number of competitive
advantages, including (i) the opportunity to capitalize on our existing
relationships with hotel investors and owners that IHC developed through its
management experience and its track record of improving the profitability of the
hotels it operated; (ii) the opportunity to source management contract and
investment opportunities resulting from our large and geographically diverse
hotel portfolio, as well as the experience and talents of our management team;
(iii) our flexible branding strategy, which permits us to operate multiple
hotels under different brands within the same geographic market and to operate
more opportunistically within existing and new markets than hotel companies
committed to particular flags; (iv) our corporate and operational
infrastructure, which permits us to lower the unit costs of our services and
assure the implementation of quality management systems on a company-wide basis;
and (v) the strength and depth of our management team, the executive officers of
which have an average tenure of 24 years in the lodging industry and 11 years
with Interstate Management and its predecessors.
RELATIONSHIPS WITH HOTEL INVESTORS AND OWNERS. We intend to foster and
capitalize on the relationships that IHC developed with hotel investors and
owners due to its management experience and track record of improving the
profitability of the hotels it operated. We intend to maintain these
relationships to help us renew our existing management contracts and to utilize
them as a source of new management contracts and investment opportunities
OPPORTUNITY TO SOURCE MANAGEMENT CONTRACTS AND INVESTMENTS. As a result of the
size and geographic diversity of our hotel portfolio and the experience and
talents of our management team, as well as our knowledge of individual markets,
we believe we will have access to management and investment opportunities not
available to all of our competitors. We obtain information about management and
investment opportunities through contacts at every level of our company,
including hotel general managers, regional managers and members of senior
management. Industry association contacts also provide us with information about
potential management and investment opportunities. In addition, our management's
knowledge of existing hotels and our personal relationships with numerous hotel
owners and operators provide us with extensive information regarding management
and investment opportunities.
FLEXIBILITY AFFORDED BY MULTIPLE BRANDING. We currently operate hotels under
more than 20 brand names, which affords us the flexibility to operate multiple
hotels under different brands within the same geographic market. It also
provides us with competitive and economic advantages, such as the ability to
position hotels optimally within their local markets, to provide access to a
broad base of national reservation and marketing systems and to pursue new
business more freely than many of our competitors.
CORPORATE AND OPERATIONAL INFRASTRUCTURE. By virtue of providing management and
related services to 175 hotels, we believe we can achieve significant economies
of scale not available to all of our competitors. Our management seeks to
maintain a blend of centralized control over strategic issues while encouraging
decentralized decision-making with respect to appropriate operational issues.
All personnel, marketing, cash management and other policies are formulated at
our corporate offices and are provided to our hotels.
21
<PAGE> 25
Our corporate offices also provide accounting, legal, insurance and finance
functions, institute management information systems and coordinate the
preparation of budgets. This centralization of control over strategic matters
allows us to operate our hotels with fewer employees and enables hotel
management personnel to focus on matters having the greatest impact on the
performance of the particular hotel and on the quality of its guests' hotel
experiences.
MANAGEMENT TEAM. Collectively, our executive officers have an average of 24
years of experience in the lodging industry and an average of 11 years with
Interstate Management and its predecessors. Several of these executive officers
were instrumental in developing or maintaining IHC's relationships with hotel
investors and owners and growing IHC from a medium-sized privately held hotel
operator into a large publicly traded hotel owner, operator and developer. We
believe their continued efforts will help us maintain and capitalize on these
valuable contacts.
COMPETITION
The hotel management industry is highly competitive. We compete for both
limited-service and full-service third-party hotel management contracts and
leaseholds with several hundred companies, including international, national,
regional and local franchise companies and independent hotel management
companies. Within the highly fragmented limited-service hotel management
industry, we compete with a large and diverse group of competitors including
hotel franchise companies, owner-operators, and a number of independent
operators. Within the full-service hotel management industry we compete with a
smaller number of more experienced competitors, primarily consisting of
franchise companies and independent full-service operators. In both industries,
we compete on such factors as relationships with hotel owners and investors,
access to capital, financial performance, contract terms, brand name
recognition, marketing support and the willingness to provide funds (in the form
of debt or equity investments) in connection with new management arrangements.
In addition, strategic alliances between hotel owners, including REITs, and our
competitors within the hotel management industry limit the number of management
contracts available to us.
Each of the hotels we operate competes with other hotels in its geographic area.
Like the hotel management business, the lodging industry, in general, is highly
competitive. The supply of hotel rooms in the United States has increased
substantially over the past several years, and we expect that it will continue
to grow. The hotels we operate will compete with other hotels on factors such as
room rates, quality of accommodations, name recognition, service levels,
convenience of location and the quality and scope of other amenities including
food and beverage facilities.
In addition to the factors on which we compete discussed above, we encounter
certain competitive disadvantages, including the facts that (i) our
relationships with hotel owners have been disrupted by IHC's merger with
Patriot, the lengthy and intensive negotiations regarding the Marriott
settlement, the consideration of possible alternatives to the spin-off
(including the private sale of Interstate Management to a third party), and the
spin-off; (ii) unlike hotels operated by most of the franchisors with whom we
compete, the branded hotels we operate must pay a franchise fee in addition to
our management fee; and (iii) we generally will have less access to capital than
larger companies and companies that own a substantial amount of real estate.
OPERATIONS
We provide a wide variety of services to our hotels. We offer specialized
support services, such as purchasing, project management and insurance and risk
management services as well as those services traditionally provided by other
major hotel operating companies, such as sales and marketing support,
22
<PAGE> 26
rooms services, food and beverage services, human resources and training
programs, financial planning and reporting, management information systems,
engineering services and legal support.
Our services are provided by hotel associates who we employ and who are trained
and supported by our experienced corporate personnel. We provide most of these
services in consideration of the management fees payable to us, which are based
upon a percentage of gross revenues and/or operating profits. Hotel owners are
generally responsible for all operating expenses, capital expenditures and
working capital requirements related to the hotels we manage. We earn
incremental revenues from third-party owners for certain services, such as
providing purchasing, project management and insurance and risk management
services. The following is a brief description of the services we generally
provide to our hotels:
PURCHASING. We assist our hotels with purchases of a wide variety of goods and
services, including perishable food, consumable supplies, dry goods, linens,
cable television systems, audio-visual services, telephone systems, advertising
agency services, independent marketing services, consulting services, printing
services, furniture, fixtures and equipment. Our purchasing service is a key
element of our operating system and our ability to improve the profitability of
our hotels. As one of the largest independent hotel management companies in the
United States, we have significant leverage to negotiate competitive prices on
goods and services from both local and national vendors. As a result, we are
able to pass along substantial savings to our hotels. We offer our purchasing
services at a fee based on merchandise value.
PROJECT MANAGEMENT. We assist and advise our hotels on all aspects of
renovation and construction projects, including design, budgeting, scheduling,
purchasing, systems, materials and contracting. We are actively involved in each
stage of a project, from planning through completion of construction. The
project management services we provide are offered on a contracted fee basis.
INSURANCE AND RISK MANAGEMENT. Through our subsidiary, Northridge Insurance
Company, we offer our hotels reinsurance and risk management services. We
purchase insurance from major insurance carriers at attractive rates due to our
high volume purchasing and the excellent claims history we inherited from IHC.
We then provide our hotels the opportunity to participate in the policy at
prices and coverages that we believe are more advantageous than third-party
hotel owners could otherwise obtain. Northridge also provides direct insurance
coverage to Interstate Management in connection with its self-insured health
care program. In conjunction with our risk management services and in order to
minimize our operating liabilities, we set policies regarding the standards of
operation to which all of our hotels and their employees must adhere.
SALES AND MARKETING SUPPORT. We provide our hotels with traditional sales and
marketing support, as well as customized assistance, to identify and attract
potential business, leisure and convention guests. We employ a systematic
approach toward identifying and targeting segments of demand for our hotels in
order to maximize market penetration. We support the local sales efforts of our
hotels with corporate sales executives who develop new marketing concepts and
monitor and respond to specific market needs and preferences. We employ revenue
yield management systems to manage our hotels' use of the various distribution
channels in the lodging industry.
ROOMS SERVICES. We assist our hotels in developing quality standard and
operating procedures for room operations, while focusing on controlling expenses
and maximizing profits. Such assistance includes:
- Developing the concept, design and staffing requirements for the front
office, housekeeping, property maintenance, laundry, valet,
telecommunications, garage and other guest services departments;
- Establishing quality standards for products and services and evaluating
performance against these standards;
- Conducting training conferences and workshops for rooms department
employees at all levels;
23
<PAGE> 27
- Creating operating procedures, training manuals, training programs and
reference guides;
- Developing, maintaining and auditing front office software applications
and training staff in their proper usage; and
- Selecting equipment and supplies such as linens, guest room amenities and
uniforms.
FOOD AND BEVERAGE SERVICES. We assist our hotels in developing high quality,
profitable food and beverage operations as well as innovative approaches to food
and beverage concepts and designs. Such assistance includes:
- Providing educational and technical training materials and seminars to
improve the skills of our employees;
- Establishing quality levels and management guidelines for new and
existing food and beverage facilities in accordance with area market
expectations;
- Providing ongoing research and development of systems and equipment;
- Creating and implementing system-wide promotional programs to enhance
hotel revenues;
- Conducting business audits that analyze current financial performance
against industry norms, providing a detailed review of existing
procedures and programs and setting a plan for achieving goals in
business growth and cost containment; and
- Providing low cost access to the freshest and highest quality food
products and beverages available in the market through contracts with
national and regional vendors.
HUMAN RESOURCES AND TRAINING PROGRAMS. Our human resources department is
responsible for designing the employee selection process, creating competitive
compensation programs and developing appropriate training programs at all
levels. Our human resources department has developed approximately 25 training
programs to introduce new employees to our methods of operation and to augment
their skills. The training programs focus on such areas as supervisory
development, middle management training, career planning, technical training and
executive development. In addition, our employees are required to attend outside
courses developed by a variety of managerial and technical organizations both
within and outside the industry.
FINANCIAL PLANNING AND REPORTING. We provide to our hotels a wide variety of
accounting, financial reporting and financial planning services that assist the
hotel owners in making informed decisions.
MANAGEMENT INFORMATION SYSTEMS. We provide to our hotels access to key
operating information and technologies as well as on-going systems support.
Access to key information enables our hotels to set operating objectives and
measure their operating performance on a daily basis.
ENGINEERING SERVICES. We provide to our hotels expertise in physical plant
systems such as mechanical, plumbing, electrical, fire and life safety and
swimming pools.
LEGAL SUPPORT. Our in-house legal department provides to our hotels legal
support with respect to employment law issues, liquor licensing and various
vendor and service contract negotiations.
LODGING INDUSTRY
The hotel industry has experienced profitability gains over the past several
years following a strong recovery from the industry slowdown in the late 1980s
and early 1990s. Moderate growth in the national economy, increased travel and
tourism, a low interest rate environment and improved hotel operating
efficiencies have contributed to increased profitability. According to
PricewaterhouseCoopers Hospitality Directions (February 1999), 1998 is estimated
to have surpassed 1997 as the hotel industry's most profitable year with
aggregate industry profits at $18.9 billion. PricewaterhouseCoopers predicts
industry profits will continue to climb each year to a total of $23.7 billion in
the year 2001.
24
<PAGE> 28
Hotel industry profits have resulted, in part, from increased room revenue per
available room ("REVPAR") over the last several years. According to Smith Travel
Research, REVPAR for the industry grew 5.3% and 7.4% in 1997 and 1996,
respectively. PricewaterhouseCoopers estimates that REVPAR grew in 1998 by 3.7%
and will continue to grow through 2001, but at a slower rate due to slower
growth in ADR and a continued decline in occupancy. According to Smith Travel
Research, ADR increased 6.1% and 7.6% in 1997 and 1996, respectively.
PricewaterhouseCoopers estimates ADR increased 4.5% in 1998 and predicts that it
will increase 3.9% in 1999. Despite the trend in ADR, occupancy rates have
declined each year since achieving a peak of 65.1% in 1995. According to Smith
Travel Research, occupancy percentage declined 0.8% and 0.2% in 1997 and 1996,
respectively. PricewaterhouseCoopers estimates the occupancy rate declined 0.6%
in 1998 and predicts that it will decline 0.9% in 1999. This decline is largely
attributed to an increase in new construction projects during 1997 and 1998.
PricewaterhouseCoopers expects occupancy to remain steady at current rates or
continue to decline depending on the price segment. PricewaterhouseCoopers
predicts that by year 2001, a positive combination of ADR growth and a
stabilizing occupancy rate will allow REVPAR to recover strength and post an
increase in its rate of growth for the first time in five years.
We believe that slower growth prospects in the hotel industry will increase
competition, causing less sophisticated owners to realize financial results
below their expectations. As a result, hotel owners may increasingly turn to
professional, independent management companies in order to improve their hotels
financial performance.
HOTEL PORTFOLIO
The following tables set forth certain information as of December 31, 1998 with
respect to management contracts and leases of the two operating divisions of
Interstate Hotels, LLC in effect as of March 1, 1999 and/or expected to be
operated by Interstate Hotels, LLC following the spin-off.
INTERSTATE DIVISION
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE AVERAGE
HOTEL BRAND HOTELS NUMBER OF ROOMS OCCUPANCY(1) ADR(1) REVPAR(1)(2)
----------- --------- --------------- ------------ ------- ------------
<S> <C> <C> <C> <C> <C>
Marriott(3)(4) 19 6,410 73.5% $124.03 $ 91.16
Independent(5) 9 2,281 76.8% $154.36 $118.63
Westin 1 1,354 67.6% $ 92.43 $ 62.47
Hilton(5) 3 1,116 65.4% $107.79 $ 70.50
Embassy Suites 4 1,101 75.0% $134.19 $100.64
Colony 2 888 78.2% $ 92.66 $ 72.41
Radisson 3 795 69.2% $ 93.39 $ 64.62
Sheraton 1 598 87.8% $ 85.17 $ 74.77
Holiday Inn 1 498 84.0% $ 99.72 $ 83.73
Crowne Plaza 1 415 83.7% $113.20 $ 94.79
Delta 1 374 76.9% $120.18 $ 92.36
AmeriSuites(6) 1 128 0.0% $ 0.00 $ 0.00
--- ------
Total 46 15,958 74.2% $119.69 $ 88.85
=== ======
</TABLE>
- -------------------------
(1) Operating statistics represent results for the year ended December 31, 1998
for the hotels that were open in 1998.
(2) REVPAR represents total room revenues divided by total available rooms.
(3) Includes one hotel currently managed by Wyndham.
(4) Includes five hotels which owners have notified us are for sale.
(5) Includes one hotel currently under a letter of intent to be sold.
(6) Represents one hotel with respect to which there is insufficient data
because it opened in December 1998.
25
<PAGE> 29
CROSSROADS DIVISION
<TABLE>
<CAPTION>
NUMBER OF AGGREGATE AVERAGE
HOTEL BRAND HOTELS NUMBER OF ROOMS OCCUPANCY(1) ADR(1) REVPAR(1)(2)
- ----------- --------- --------------- ------------ ------- ------------
<S> <C> <C> <C> <C> <C>
Hampton Inn(3)(4) 66 8,210 67.0% $ 69.31 $ 46.43
Residence Inn by
Marriott(5) 13 1,643 78.3% $ 91.76 $ 71.84
Homewood Suites(6) 9 1,293 72.8% $ 91.53 $ 66.59
Holiday Inn(7) 7 1,100 64.8% $ 71.32 $ 46.20
Courtyard by
Marriott(8) 7 868 70.1% $ 98.47 $ 69.03
Independent 6 762 53.2% $ 67.82 $ 36.11
Comfort Inn 4 487 74.4% $ 87.32 $ 64.95
Colony 4 409 42.8% $113.85 $ 48.72
Hilton Garden Inn(9) 1 357 0.0% $ 0.00 $ 0.00
Fairfield Inn by
Marriott(10) 4 355 75.2% $ 55.61 $ 41.83
Radisson(11) 2 236 25.0% $ 95.01 $ 23.75
Doubletree 1 155 55.8% $ 86.11 $ 48.07
Days Inn 1 148 56.6% $ 41.59 $ 23.55
Country Inn and
Suites(12) 1 120 0.0% $ 0.00 $ 0.00
Best Western 1 102 68.7% $ 58.13 $ 39.95
Super 8 1 86 70.5% $ 51.47 $ 36.30
Sleep Inn 1 80 57.0% $ 54.75 $ 31.22
--- ------
Total 129 16,411 67.4% $ 75.53 $ 50.88
=== ======
</TABLE>
- -------------------------
(1) Operating statistics represent results for the year ended December 31, 1998
for the hotels that were open in 1998.
(2) REVPAR represents total room revenues divided by total available rooms.
(3) Includes three hotels with scheduled openings of April 15, 1999, May 15,
1999 and July 1, 1999.
(4) Includes two hotels that are currently under contract to be sold.
(5) Includes one hotel with a scheduled opening of November 1, 1999.
(6) Includes two hotels with scheduled openings of June 1, 1999.
(7) Includes one hotel currently under contract to be sold.
(8) Includes one hotel currently managed by Wyndham.
(9) Represents one hotel with a scheduled opening of November 15, 1999.
(10) Includes one hotel with a scheduled opening of March 15, 1999.
(11) Includes one hotel with a scheduled opening of September 1, 1999.
(12) Represents one hotel with a scheduled opening of October 1, 1999.
26
<PAGE> 30
The geographic diversification of our hotel portfolio reflects our belief that
such diversification helps to insulate the portfolio from local market
fluctuations that are typical for the lodging industry. The following table sets
forth the geographic distribution of our hotel portfolio.
<TABLE>
<CAPTION>
NUMBER OF NUMBER
STATE HOTELS OF ROOMS
- ----- --------- --------
<S> <C> <C>
California(1)(2) 13 4,357
Florida(3)(4) 17 4,088
New York 10 2,236
Pennsylvania(5)(6) 10 2,012
Illinois(7) 7 1,663
Tennessee(2) 11 1,440
Texas 10 1,384
Canada 2 1,091
North Carolina 7 982
Arizona 6 958
New Jersey 4 958
Connecticut(6) 6 925
Ohio(8) 6 884
Michigan(8) 5 876
Russia 3 746
Colorado 4 661
Vermont 6 595
Washington 2 576
Massachusetts 4 571
West Virginia(2) 4 455
Mississippi(2)(9) 5 447
Georgia 4 443
</TABLE>
<TABLE>
<CAPTION>
NUMBER OF NUMBER
STATE HOTELS OF ROOMS
- ----- --------- --------
<S> <C> <C>
Alabama 4 424
Maryland(2) 2 416
South Carolina 3 404
Rhode Island(6) 1 345
Oklahoma 2 332
Virginia 2 267
Kansas 2 254
Missouri 2 244
Hawaii 1 171
Oregon 1 168
New Mexico(10) 1 131
Indiana 1 129
Arkansas 1 123
Minnesota 1 120
Kentucky 1 119
Virgin Islands 1 110
Idaho 1 104
Nebraska 1 80
Wisconsin 1 80
--- ------
Total 175 32,369
=== ======
</TABLE>
- -------------------------
(1) Includes two hotels with scheduled openings of April 15, 1999 and May 15,
1999.
(2) Includes one hotel under contract to be sold.
(3) Includes three hotels with scheduled openings of June 1, 1999, September 1,
1999 and October 1, 1999.
(4) Includes two hotels which owners have notified us are for sale.
(5) Includes one hotel with a scheduled opening of November 1, 1999.
(6) Represents one hotel which the owner has notified us is for sale.
(7) Includes two hotels with scheduled openings of June 1, 1999 and November
15, 1999.
(8) Includes one hotel currently managed by Wyndham.
(9) Includes one hotel with a scheduled opening of March 15, 1999.
(10) Represents one hotel with a scheduled opening of July 1, 1999.
EMPLOYEES
Most of the employees at our leased and managed hotels, as well as those at our
corporate offices, will be employed by either Interstate Hotels, LLC or
Crossroads Hospitality; however, third-party hotel owners
27
<PAGE> 31
reimburse us or incur the expense for all of the wages and benefits for all the
employees in their hotels. Following the spin-off, we will have approximately
13,500 employees, approximately 13,300 of whom will be employees of specific
hotels.
Currently, eight of the properties in our hotel portfolio employ approximately
1,500 workers in the aggregate who are subject to labor union contracts. We have
not experienced any union strikes or other material labor disruptions.
GOVERNMENT REGULATION
The lodging industry is subject to extensive government regulation, including
laws which regulate the licensing of hotels and restaurants, the sale of food
and liquor and the disposal of hazardous waste. We are also subject to laws
regarding our relationship with our employees, including minimum wage, overtime,
working conditions and work permit requirements. Under the ADA, all public
accommodations are required to meet certain federal requirements relating to
access and use by disabled persons. We believe that our hotels are substantially
in compliance with the requirements of the ADA. However, a determination that
our hotels are not in compliance with the ADA could result in liability for
fines and damages. Third-party hotel owners are generally responsible for paying
all costs, expenses and liabilities incurred in the operation of our managed
hotels, including compliance with laws (including the ADA and environmental
laws), although we could be contingently liable for certain liabilities for
which we do not maintain insurance, including certain claims arising under the
ADA.
ENVIRONMENTAL MATTERS
Various laws impose liability for the costs of removal or remediation of
hazardous or toxic substances on the properties we operate, regardless of
whether or not we knew of or were responsible for the presence of such hazardous
or toxic substances. Depending on the circumstances, we could also be liable for
personal injury associated with exposure to asbestos-containing materials
("ACMs"). Environmental laws also may restrict the manner in which property may
be used or businesses may be operated, and these restrictions may result in
expenditures and require interruption of such businesses. Equity Inns, the owner
of substantially all of our leased hotels, has agreed to indemnify us from
environmental liabilities relating to the leased hotels except to the extent
caused by our gross negligence. In addition, most of our currently leased and
managed hotels have been inspected to determine the presence of ACMs. While ACMs
are present in certain of the properties, operations and maintenance programs
for maintaining such ACMs have been or are in the process of being designed and
implemented, or the ACMs have been scheduled to be or have been abated at such
hotels. We believe that the presence of ACMs in our leased and managed hotels
will not have a material adverse effect on our financial condition or results of
operations, but we cannot be sure that this will be the case.
LEGAL PROCEEDINGS
In the ordinary course of our business, we are named as a defendant in legal
proceedings resulting from incidents at the hotels we operate. In order to limit
our exposure in such matters, we maintain liability insurance, require hotel
owners to maintain adequate insurance coverages and are generally entitled to
indemnity from third-party hotel owners for lawsuits and damages against us in
our capacity as a hotel manager.
FACILITIES
Our principal executive offices in Pittsburgh, Pennsylvania are under a lease
expiring December 31, 2003. In addition, we maintain offices in Orlando, Florida
under a lease expiring July 31, 2005 and Scottsdale, Arizona under a lease
expiring July 31, 2000.
28
<PAGE> 32
INTELLECTUAL PROPERTY
Generally, the third-party owners of our hotels, rather than Interstate
Management, are parties to the franchise agreements to use the trade names under
which the hotels are operated. We are a party, however, to franchise agreements
with Bass Hotels & Resorts, Inc., Choice Hotels International, Inc., Marriott
and Promus Hotels, Inc. Our franchise agreements to use these trade names expire
at varying times generally ranging from 2000 to 2015. The franchisors under
whose brand names we operate hotels have not endorsed or approved the spin-off
or any of the financial results of the hotels set forth in this Information
Statement/ Prospectus. A grant of franchise licenses for our hotels is not
intended as, and should not be interpreted as, an express or implied approval or
endorsement by any such franchisor or licensor (or any of their respective
affiliates, subsidiaries or divisions) of Interstate Management or its stock.
We have registered, or have applied with the United States Patent Office for
registration of, a number of trademarks and service marks incorporating the word
"Colony," as well as many other trademarks and service marks used in our
business. While we utilize our trademarks and service marks (including "Colony"
marks) in connection with managing and leasing hotels, we do not believe that
the loss or expiration of any or all of our marks would have a material adverse
effect on our business. The registrations for our marks expire at varying times,
generally ranging from to .
29
<PAGE> 33
SELECTED FINANCIAL AND OTHER DATA
We are providing the following selected financial information to aid you in your
analysis of the financial aspects of the spin-off. The table sets forth selected
historical financial data for Interstate Management, prior to the merger of IHC
with Patriot, as the predecessor, as of and for the years ended December 31,
1994, 1995, 1996 and 1997 and for the period from January 1, 1998 to June 1,
1998, and for Interstate Management, subsequent to the merger of IHC with
Patriot, as the successor, as of December 31, 1998 and for the period from June
2, 1998 to December 31, 1998. In addition, we have provided a combined 1998
column which combines the predecessor for the period from January 1, 1998 to
June 1, 1998 and the successor for the period from June 2, 1998 to December 31,
1998. We believe that this presentation is informative to the reader. In
addition, selected pro forma financial data for the year ended December 31, 1998
is presented.
(Dollars in Thousands, Except Per Share and Hotel Data)
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
-------------------------------------------------------------- -------------
YEAR ENDED DECEMBER 31, JAN. 1, 1998 JUNE 2, 1998
----------------------------------------------- THROUGH THROUGH
1994 1995 1996 1997 JUNE 1, 1998 DEC. 31, 1998
-------- ---------- ---------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Lodging revenues:
Rooms........................ -- -- $ 9,258 $ 158,343 $ 74,265 $ 108,698
Other departmental........... -- -- 721 9,512 4,504 6,455
Net management fees............ $ 22,284 $ 27,022 33,023 39,136 18,018 22,763
Other fees..................... 14,442 17,996 20,710 23,426 9,976 10,478
-------- ---------- ---------- ---------- ---------- ----------
Total revenues........... 36,726 45,018 63,712 230,417 106,763 148,394
Lodging expenses:
Rooms........................ -- -- 2,334 36,919 17,173 26,567
Other departmental........... -- -- 591 5,487 2,674 3,962
Property costs............... -- -- 3,201 43,225 19,987 30,261
General and administrative..... 8,302 9,811 10,369 13,212 6,115 5,822
Payroll and related benefits... 12,420 15,469 17,666 21,892 10,982 10,439
Non-cash compensation (2)...... -- -- 11,896 -- -- --
Lease expense.................. -- -- 3,477 73,283 34,515 51,165
Depreciation and
amortization................. 3,659 4,188 4,385 4,845 2,152 10,659
-------- ---------- ---------- ---------- ---------- ----------
Operating income............... 12,345 15,550 9,793 31,554 13,165 9,519
Other income (expense):
Interest, net................ 30 146 501 498 204 390
Other, net................... 14 346 -- 431 474 1,391
-------- ---------- ---------- ---------- ---------- ----------
Income before income tax
expense...................... 12,389 16,042 10,294 32,483 13,843 11,300
Income tax expense (3)......... -- -- 4,117 12,986 5,528 4,436
-------- ---------- ---------- ---------- ---------- ----------
Income before minority
interest..................... 12,389 16,042 6,177 19,497 8,315 6,864
Minority interest.............. -- -- -- 18 24 209
-------- ---------- ---------- ---------- ---------- ----------
Net income..................... $ 12,389 $ 16,042 $ 6,177 $ 19,479 $ 8,291 $ 6,655
======== ========== ========== ========== ========== ==========
Pro forma net income per common
share(4):
Basic........................
Diluted......................
BALANCE SHEET DATA
(AT YEAR END):
Cash and cash equivalents...... $ 6,702 $ 14,035 $ 11,168 $ 2,432 $ 1,652
Total assets................... 30,741 38,420 88,204 118,185 161,157
Long-term debt................. 3,890 1,270 541 370 --
Total equity................... 18,858 24,345 56,886 80,730 92,607
OTHER FINANCIAL DATA:
EBITDA (5)..................... $ 16,018 $ 20,084 $ 14,178 $ 36,812 $ 15,767 $ 21,360
Net cash provided by operating
activities................... 15,331 12,517 18,359 9,593
Net cash (used in) provided by
investing activities......... (4,338) (35,707) 2,674 (27,707)
Net cash (used in) provided by
financing activities......... (13,860) 14,454 (19,298) 15,599
TOTAL HOTEL DATA (6)
Total hotel revenues........... $858,986 $1,056,279 $1,326,581 $1,600,958
Number of hotels (7)........... 136 150 212 223
Number of rooms (7)............ 31,502 35,044 43,178 45,329
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------------
COMBINED PRO FORMA
1998 1998(1)
---------- ----------
<S> <C> <C>
STATEMENT OF INCOME DATA:
Lodging revenues:
Rooms........................ $ 182,963 $ 182,963
Other departmental........... 10,959 10,959
Net management fees............ 40,781 29,987
Other fees..................... 20,454 16,729
---------- ----------
Total revenues........... 255,157 240,638
Lodging expenses:
Rooms........................ 43,740 43,740
Other departmental........... 6,636 6,636
Property costs............... 50,248 50,248
General and administrative..... 11,937 12,437
Payroll and related benefits... 21,421 17,450
Non-cash compensation (2)...... -- --
Lease expense.................. 85,680 85,680
Depreciation and
amortization................. 12,811 18,184
---------- ----------
Operating income............... 22,684 6,263
Other income (expense):
Interest, net................ 594 594
Other, net................... 1,865 2,151
---------- ----------
Income before income tax
expense...................... 25,143 9,008
Income tax expense (3)......... 9,964 1,564
---------- ----------
Income before minority
interest..................... 15,179 7,444
Minority interest.............. 233 5,098
---------- ----------
Net income..................... $ 14,946 $ 2,346
========== ==========
Pro forma net income per common
share(4):
Basic........................ $ 0.23
Diluted...................... $ 0.23
BALANCE SHEET DATA
(AT YEAR END):
Cash and cash equivalents...... $ 1,652 $ 29,942
Total assets................... 161,157 188,362
Long-term debt................. -- --
Total equity................... 92,607 70,534
OTHER FINANCIAL DATA:
EBITDA (5)..................... $ 37,127 $ 21,500
Net cash provided by operating
activities................... 27,952
Net cash (used in) provided by
investing activities......... (25,033)
Net cash (used in) provided by
financing activities......... (3,699)
TOTAL HOTEL DATA (6)
Total hotel revenues........... $1,546,926 $1,065,030
Number of hotels (7)........... 176 165
Number of rooms (7)............ 35,214 30,644
</TABLE>
30
<PAGE> 34
- -------------------------
(1) Reflects the spin-off and other adjustments described in "Pro Forma
Financial Data."
(2) Represents a non-recurring expense relating to the issuance of 785,533
shares of common stock to certain executives and key employees of IHC in
consideration for the cancellation of stock options issued by one of IHC's
predecessors, Interstate Hotels Corporation, in 1995.
(3) Prior to 1996, IHC and its predecessors were organized as S corporations,
partnerships and limited liability companies and, accordingly, were not
subject to federal and certain state income taxes.
(4) Based on 10,002,035 shares of Common Stock outstanding on a pro forma basis
on the spin-off date.
(5) EBITDA represents earnings before interest, income tax expense, depreciation
and amortization. Management believes that EBITDA is a useful measure of
operating performance because it is industry practice to evaluate hotel
properties based on operating income before interest, taxes, depreciation
and amortization, which is generally equivalent to EBITDA, and EBITDA is
unaffected by the debt and equity structure of the property owner. EBITDA,
as calculated by Interstate Management, may not be consistent with
computations of EBITDA by other companies. EBITDA does not represent cash
flow from operations as defined by GAAP, is not necessarily indicative of
cash available to fund all cash flow needs and should not be considered as
an alternative to net income under GAAP for purposes of evaluating
Interstate Management's results of operations.
(6) Represents all hotels, including the leased hotels, which Interstate
Management operates.
(7) As of the end of the periods presented. The 1998 pro forma number of hotels
and number of rooms excludes ten hotels with 1,725 rooms under construction
that are scheduled to open in 1999 that are expected to be managed by
Interstate Hotels, LLC.
31
<PAGE> 35
PRO FORMA FINANCIAL DATA
The following unaudited pro forma financial data of Interstate Management
assumes that Patriot/Wyndham has separated the third-party hotel management
business they acquired through the merger of IHC into Patriot to create
Interstate Management. The Unaudited Pro Forma Combined Balance Sheet as of
December 31, 1998, is presented as if this spin-off had occurred on that date.
The Unaudited Pro Forma Combined Statement of Operations for the year ended
December 31, 1998 is presented as if the spin-off had occurred on January 1,
1998. The adjustments required to reflect the spin-off and related transactions
are discussed in the accompanying notes. In management's opinion, all material
adjustments necessary to reflect the effect of these transactions have been
made.
The following unaudited pro forma financial data and notes thereto of Interstate
Management have been derived from and should be read in conjunction with the
historical combined financial statements and notes thereto of Interstate
Management contained elsewhere in this Information Statement/Prospectus. The
historical combined financial statements of Interstate Management have been
carved out of IHC and Patriot and principally include those historical assets,
liabilities, revenues and expenses directly attributable to the third-party
hotel management business of IHC that will succeed to Interstate Management. The
unaudited pro forma financial data is presented for informational purposes only
and may not reflect the future results of operations and financial position, or
be necessarily indicative of what the actual results of operations and financial
position of Interstate Management would have been had the spin-off occurred as
of the dates indicated.
32
<PAGE> 36
INTERSTATE HOTELS MANAGEMENT, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL (A) ADJUSTMENTS PRO FORMA
-------------- ----------- ---------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 1,652 $ 28,290(B) $ 29,942
Accounts receivable, net........................... 16,816 -- 16,816
Deferred income taxes.............................. 615 -- 615
Net investment in direct financing leases.......... 827 -- 827
Prepaid expenses and other assets.................. 741 -- 741
Related party receivables -- management
contracts....................................... 1,085 (1,085)(C) --
-------- -------- --------
Total current assets....................... 21,736 27,205 48,941
Restricted cash...................................... 2,201 -- 2,201
Marketable securities................................ 2,609 -- 2,609
Property and equipment, net.......................... 4,076 -- 4,076
Officers and employees notes receivable.............. 2,803 -- 2,803
Affiliate receivables................................ 3,381 -- 3,381
Net investment in direct financing leases............ 1,680 -- 1,680
Investment in hotel real estate...................... 22,150 -- 22,150
Intangibles and other assets......................... 100,521 -- 100,521
-------- -------- --------
Total assets............................... $161,157 $ 27,205 $188,362
======== ======== ========
LIABILITIES AND OWNERS' EQUITY
Current liabilities:
Accounts payable -- trade.......................... 2,413 -- 2,413
Accounts payable -- health trust................... 1,785 -- 1,785
Accounts payable -- related parties................ 18,597 (18,597)(B) --
Accrued payroll and related benefits............... 6,120 -- 6,120
Accrued rent....................................... 5,043 -- 5,043
Accrued merger costs............................... 9,344 -- 9,344
Other accrued liabilities.......................... 9,236 -- 9,236
-------- -------- --------
Total current liabilities.................. 52,538 (18,597) 33,941
Deferred income taxes................................ 11,053 -- 11,053
Deferred compensation................................ 2,609 -- 2,609
-------- -------- --------
Total liabilities.......................... 66,200 (18,597) 47,603
-------- -------- --------
Minority interest.................................... 2,350 67,875(D) 70,225
Commitments and contingencies........................ -- -- --
Owners' equity:
Common stock, $0.01 par value...................... -- 100(E) 100
Paid-in capital.................................... -- 70,434(E) 70,434
Owners' equity..................................... 92,607 (92,607)(E) --
-------- -------- --------
Total owners' equity....................... 92,607 (22,073) 70,534
-------- -------- --------
Total liabilities and owners' equity....... $161,157 $ 27,205 $188,362
======== ======== ========
</TABLE>
The accompanying notes are an integral part of this Pro Forma Combined Balance
Sheet.
33
<PAGE> 37
INTERSTATE HOTELS MANAGEMENT, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PERIOD FROM
----------------------------
JAN. 1, 1998 JUNE 2, 1998 COMBINED PRO FORMA
TO TO YEAR ENDED YEAR ENDED
JUNE 1, 1998 DEC. 31, 1998 DECEMBER 31, PRO FORMA DECEMBER 31,
(A) (A) 1998 ADJUSTMENTS 1998
------------ ------------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C>
Lodging revenues:
Rooms.................... $ 74,265 $108,698 $182,963 -- $182,963
Other departmental....... 4,504 6,455 10,959 -- 10,959
Net management fees........ 18,018 22,763 40,781 $(10,794)(B) 29,987
Other fees................. 9,976 10,478 20,454 (3,725)(C) 16,729
-------- -------- -------- -------- --------
106,763 148,394 255,157 (14,519) 240,638
Lodging expenses:
Rooms.................... 17,173 26,567 43,740 -- 43,740
Other departmental....... 2,674 3,962 6,636 -- 6,636
Property costs........... 19,987 30,261 50,248 -- 50,248
General and
administrative........... 6,115 5,822 11,937 500(D) 12,437
Payroll and related
benefits................. 10,982 10,439 21,421 (3,971)(E) 17,450
Lease expense.............. 34,515 51,165 85,680 -- 85,680
Depreciation and
amortization............. 2,152 10,659 12,811 5,373(F) 18,184
-------- -------- -------- -------- --------
Operating income........... 13,165 9,519 22,684 (16,421) 6,263
Other income:
Interest, net............ 204 390 594 -- 594
Other, net............... 474 1,391 1,865 286(G) 2,151
-------- -------- -------- -------- --------
Income before income tax
expense.................. 13,843 11,300 25,143 (16,135) 9,008
Income tax expense......... 5,528 4,436 9,964 (8,400)(H) 1,564
-------- -------- -------- -------- --------
Income before minority
interest................. 8,315 6,864 15,179 (7,735) 7,444
Minority interest.......... 24 209 233 4,865(I) 5,098
-------- -------- -------- -------- --------
Net income................. $ 8,291 $ 6,655 $ 14,946 $(12,600) $ 2,346
======== ======== ======== ======== ========
Basic net income per common
share.................... $ 0.23(J)
========
Diluted net income per
common share............. $ 0.23(J)
========
</TABLE>
- -------------------------
The accompanying notes are an integral part of this Pro Forma Combined Statement
of Operations.
34
<PAGE> 38
INTERSTATE HOTELS MANAGEMENT, INC.
NOTES TO UNAUDITED PRO FORMA FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
------------------
NOTE 1 -- PRO FORMA BALANCE SHEET ADJUSTMENTS:
(A) Reflects the historical combined balance sheet of Interstate Management as
of December 31, 1998. The historical balance sheet reflects the historical
carrying amounts recorded on the books of Patriot.
(B) Adjustments to reflect the net increase in cash and cash equivalents as
follows:
<TABLE>
<S> <C>
Cash contribution from Patriot to Interstate Hotels, LLC to
fund working capital...................................... $ 31,887
Repayment of amounts owed to Wyndham to meet Interstate
Management's short-term cash requirements................. (18,597)
Cash proceeds of Marriott's purchase of a 4% ownership
interest in Interstate Management......................... 2,314
Cash contribution from Patriot to Interstate Management to
provide $15.0 million of working capital at the spin-off
date...................................................... 12,686
--------
$ 28,290
========
</TABLE>
(C) Represents adjustments to eliminate management fees and other fee income
receivables related to management contracts for the hotels formerly owned by
IHC. Interstate Management will not hold the management contracts for these
hotels subsequent to the spin-off.
(D) Represents Patriot's 55% non-controlling ownership interest in Interstate
Hotels, LLC, based on 55% of the historical recorded carrying amount of
Interstate Management on the books of Patriot. Subsequent to the spin-off,
Interstate Management will have two principal subsidiaries. Interstate
Hotels, LLC, the successor to the third-party hotel management business
conducted by IHC prior to its merger into Patriot, will own substantially
all of the assets of Interstate Management immediately after the spin-off.
Interstate Management will own a 45% managing member interest in Interstate
Hotels, LLC, and therefore will control Interstate Hotels, LLC. Interstate
Management's second subsidiary, IHC II, LLC, will contract with Wyndham to
manage ten Marriott franchise hotels that were owned and managed by IHC, and
one hotel that was owned by IHC and managed by Marriott, prior to the merger
with Patriot. Marriott will submanage these hotels for IHC II, LLC.
<TABLE>
<S> <C>
Historical book value of owners' equity..................... $ 92,607
Adjustment to eliminate management fees and other fee income
receivable related to management contracts formerly owned
by IHC that will not be held by Interstate Hotels, LLC,
(as discussed in Note (C) above).......................... (1,085)
Funding of working capital by Patriot....................... 31,887
--------
123,409
Minority interest ownership percentage...................... 55%
--------
Minority interest........................................... $ 67,875
========
</TABLE>
35
<PAGE> 39
INTERSTATE HOTELS MANAGEMENT, INC.
NOTES TO UNAUDITED PRO FORMA FINANCIAL DATA--(CONTINUED)
------------------
NOTE 1 -- PRO FORMA BALANCE SHEET ADJUSTMENTS--(CONTINUED)
(E) Represents adjustments to reflect the issuance of shares of common stock,
par value $0.01, of Interstate Management in connection with the spin-off as
follows:
<TABLE>
<CAPTION>
NUMBER OF COMMON PAID-IN OWNERS'
SHARES STOCK CAPITAL EQUITY
---------- ------ -------- --------
<S> <C> <C> <C> <C>
Shares distributed to
Patriot's shareholders... 9,221,743 $ 92 $ 65,286 $ --
Shares retained by
Patriot.................. 390,146 4 2,838 --
Shares purchased by
Marriott................. 390,146 4 2,310 --
Eliminate historical
owners' equity........... -- -- -- (92,607)
---------- ---- -------- --------
Total............ 10,002,035 $100 $ 70,434 $(92,607)
========== ==== ======== ========
</TABLE>
In connection with the merger of IHC into Patriot, certain operations,
principally, the third-party hotel management business, along with certain
assets and liabilities will be transferred to Interstate Management.
Ninety-two percent of the shares of Interstate Management will be
distributed to Patriot's shareholders. Patriot will retain a 4% ownership
interest in Interstate Management's common stock after the redemption
discussed in Note 2.
In connection with the spin-off of Interstate Management from Patriot,
Marriott will purchase a 4% ownership interest in Interstate Management's
common stock, after the redemption discussed in Note 2, for $2,314 in cash.
NOTE 2 -- STOCK REDEMPTION:
Following the spin-off, Interstate Management will redeem the 248,385 Interstate
Management shares which are to be distributed in the spin-off to the holders of
Series A Preferred Stock of Patriot. The purchase price for the shares to be
redeemed will be the average trading price of Interstate Management shares over
their first five trading days. Since this transaction will occur subsequent to
the spin-off, it has been excluded from the Unaudited Pro Forma Combined Balance
Sheet. If this transaction had been included in the Unaudited Pro Forma Combined
Balance Sheet, assuming a $5.23 per share redemption price, the effect would
have been to decrease the pro forma amounts to the following balances:
<TABLE>
<S> <C>
Cash........................................................ $17,283
Total current assets........................................ 47,642
Total assets................................................ 187,063
Paid-in capital............................................. 69,135
Total owners' equity........................................ 69,235
Total liabilities and owners' equity........................ 187,063
</TABLE>
36
<PAGE> 40
INTERSTATE HOTELS MANAGEMENT, INC.
NOTES TO UNAUDITED PRO FORMA FINANCIAL DATA--(CONTINUED)
------------------
NOTE 3 -- PRO FORMA STATEMENTS OF OPERATIONS ADJUSTMENTS:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1998
------------
<S> <C>
(A) Reflects the historical combined statements of
operations of Interstate Management for the indicated
period.
(B) Adjustments to reflect the net decrease in net
management fees:
The elimination of management fee revenues related to
ten Patriot-owned hotels that will be submanaged by
Marriott pursuant to an arrangement with IHC II, LLC, to
ten hotels that will be leased to Wyndham, converted to
the Wyndham brand and managed by Wyndham, and to other
hotels that will be leased by Patriot to Wyndham and
will be managed by Wyndham. Prior to the merger of IHC
into Patriot, these hotels were owned and managed by
subsidiaries of IHC..................................... $(13,116)
The addition of management fee revenues related to seven
Patriot-owned hotels that will be managed by Interstate
Management.............................................. 2,322
--------
$(10,794)
========
(C) Adjustments to reflect the net decrease in other fees:
The elimination of fees for insurance services,
purchasing, leasing and other ancillary services that
Interstate Management provided to the hotels that were
owned and managed by subsidiaries of IHC and are
currently owned by Patriot, as discussed in Note (B)
above. Interstate Management will not provide such
services to these hotels subsequent to the spin-off..... $ (4,610)
The addition of fees for insurance services, purchasing,
leasing and other ancillary services that Interstate
Management will provide to seven Patriot-owned hotels,
as discussed in Note (B) above.......................... 885
--------
$ (3,725)
========
(D) Adjustment to general and administrative expense to
reflect costs related to managing and administering a
publicly held company................................... $ 500
========
(E) Adjustment to payroll and related benefits expense to
reflect the elimination of salaries and related benefits
of employees who were terminated subsequent to the
merger of IHC into Patriot and whose positions have been
eliminated. The reduction in employees relates
principally to the reduction in the size of Interstate
Management subsequent to the merger..................... $ (3,971)
========
(F) Adjustments to depreciation and amortization to reflect
the net increase in amortization of management and lease
contract costs associated with the step-up in basis
arising from the allocation of purchase price resulting
from the merger of IHC into Patriot. The management and
lease contract costs have been stated at their estimated
fair market values and are being amortized using the
straight-line method over five years for the management
contracts and 11 and 13.5 years for the lease contracts.
The management contracts' amortization period was
determined using the average remaining life of the
original contract terms, and the amortization period of
the lease contracts is based on the remaining original
lease life.............................................. $ 5,373
========
</TABLE>
37
<PAGE> 41
INTERSTATE HOTELS MANAGEMENT, INC.
NOTES TO UNAUDITED PRO FORMA FINANCIAL DATA--(CONTINUED)
------------------
NOTE 3 -- PRO FORMA STATEMENTS OF OPERATIONS ADJUSTMENTS--(CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1998
------------
<S> <C>
(G) Adjustment to other income to reflect the addition of
equity in earnings for The Charles Hotel Complex for the
period prior to Interstate Management's acquisition of
additional interests in 1998 in The Charles Hotel
Complex................................................. $ 286
========
(H) Adjustment reflects the provision for income tax expense
based on Interstate Management's estimated effective
income tax rate of 40% after reduction of minority
interests............................................... $ (8,400)
========
(I) Adjustment to minority interest to reflect Patriot's
55% non-controlling interest in Interstate Hotels,
LLC..................................................... $ 4,865
========
(J) Pro forma basic and diluted net income per common share
has been calculated using 10,002,035 shares of Common
Stock. The historical combined financial statements of
Interstate Management have been carved out of IHC and
Patriot, and principally include those historical
assets, liabilities, revenues and expenses directly
attributable to the third-party hotel management
business to be conducted by Interstate Management.
Historical earnings per share information for the carved
out company has not been presented because management
believes it is not meaningful.
</TABLE>
38
<PAGE> 42
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In addition to historical information, this Information Statement/Prospectus
contains forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 and information based on our current views of our
business and our assumptions concerning future events. The words or phrases
"will likely result," "are expected to," "will continue," "is anticipated,"
"believes," "estimates," "projects" or similar expressions are intended to
identify these forward-looking statements. These statements are subject to risks
and uncertainties that could cause our actual operations and results of
operations to differ materially from those reflected in our forward-looking
statements.
Forward-looking statements are not guarantees of future performance. They are
subject to Interstate Management successfully implementing its business
strategy, limiting the costs and realizing the expected benefits of that
strategy and generating sufficient cash flow to fund its lease payments, debt
service requirements, working capital needs and other significant expenditures.
Our forward-looking statements are based on certain trends which we anticipate
in the lodging industry and the effect on those trends of such factors as
industry capacity, the seasonal nature of the lodging industry, product demand
and pricing and the other matters referred to in the "Risk Factors" section of
this document. Accordingly, you are cautioned not to place undue reliance on our
forward-looking statements.
BACKGROUND AND GENERAL
Interstate Management provides a wide variety of management and other services
to hotels that Interstate Management operates on behalf of third-party owners.
Additionally, Interstate Management holds leasehold interests of certain hotels
which are primarily owned by Equity Inns. The management agreements generally
provide for payment of a base management fee which ranges from 1% to 4% of the
hotel's gross revenues. In addition, some of the management agreements provide
for payment of an incentive management fee, which generally ranges from 10% to
20% of the excess of operating profits or net operating cash flow over a defined
threshold level. Interstate Management also earns incremental revenues from
third-party owners for certain services, such as purchasing, project management
and insurance and risk management services. At December 31, 1998, Interstate
Management managed, leased or performed related services for 176 hotels with
35,214 rooms, compared to 223 hotels with 45,329 rooms at December 31, 1997.
Interstate Management's management agreements have initial terms that range from
one month to 49 years expiring through 2044, and Interstate Management's lease
agreements have initial terms of 11 to 15 years expiring through 2013.
The following table sets forth the expiration dates and corresponding percentage
of pro forma net management fees for the year ended December 31, 1998 for the
hotels expected to be managed (excluding the leaseholds) by Interstate Hotels,
LLC following the spinoff:
<TABLE>
<CAPTION>
PERCENTAGE OF PRO FORMA
NET MANAGEMENT FEES FOR
THE YEAR ENDED
YEAR OF EXPIRATION NO. OF HOTELS DECEMBER 31, 1998
------------------ ------------- -----------------------
<S> <C> <C>
1999.............................. 21 25.2%
2000.............................. 17 14.1%
2001.............................. 7 7.2%
2002.............................. 8 3.9%
2003.............................. 8 7.7%
Thereafter 33 34.1%
</TABLE>
39
<PAGE> 43
In addition, Interstate Management entered into long-term operating leases for
81 of these hotels with 9,929 rooms at December 31, 1998, compared to 89 hotels
with 10,258 rooms at December 31, 1997.
We have been notified by third-party owners of seven of our managed hotels that
such hotels are currently for sale. These three hotels generated $5.1 million,
or 17.0%, of our pro forma net management fees for the year ended December 31,
1998. Equity Inns has entered into sale agreements with respect to certain of
the leased hotels.
The historical combined financial statements of Interstate Management presented
elsewhere in this Information Statement/Prospectus have been carved out of the
historical consolidated financial statements of IHC and its subsidiaries and
predecessors, and include only those historical assets, liabilities, revenues
and expenses directly attributable to the third-party hotel management business
("third-party hotel management business" refers to the management, leasing and
related services we perform for hotels that we do not own). The working capital
and operating results of the leased hotels are included in the historical
combined financial statements because the operating performance associated with
such hotels is guaranteed by Interstate Management. These financial statements
have been prepared as if Interstate Management had operated as a free-standing
entity for all periods presented. All investments in, associated debt and
results of operations of the hotels that were owned by subsidiaries of IHC prior
to the merger of IHC into Patriot, as well as certain other operating
subsidiaries that are not included in the continuing business of Interstate
Management have been carved out of the historical combined financial statements
of Interstate Management.
The following discussion and analysis includes discussion and analysis of
Interstate Management's pro forma financial position and results of operations
in addition to its historical data, and should be read in conjunction with the
pro forma financial information included elsewhere in this Information
Statement/ Prospectus. The pro forma adjustments described below result
primarily from the merger of IHC into Patriot on June 2, 1998 and the spin-off
of Interstate Management, and consist primarily of the elimination of costs and
revenues associated with the hotels that were owned and managed by IHC that will
be retained by Patriot, and therefore will not be included in Interstate
Management after the spin-off. In connection with the merger, an intangible
asset related to the estimated fair market value of management contract costs of
$69.9 million and a deferred tax liability of $5.5 million were recorded, as of
June 2, 1998, and will be amortized over five years.
RESULTS OF OPERATIONS
Pro Forma Year Ended December 31, 1998 Compared to Historical Year Ended
December 31, 1998
Pro forma net management fees include adjustments to eliminate $9.7 million of
management fee revenues related to ten Patriot-owned hotels that will be
submanaged by Marriott pursuant to an arrangement with IHC II, LLC and ten
hotels that will be leased to Wyndham, converted to the Wyndham brand and
managed by Wyndham. Prior to the merger of IHC into Patriot, these hotels were
owned and managed by subsidiaries of IHC. The remaining hotels that were owned
and managed by subsidiaries of IHC prior to the merger have also been leased by
Patriot to Wyndham and will be managed by Wyndham, resulting in an elimination
of $3.4 million of management fee revenues. These elimination adjustments are
offset by the addition of $2.3 million of management fee revenues related to
seven Patriot-owned hotels that will be managed by Interstate Management.
Pro forma other fees include adjustments to eliminate $3.3 million of fees for
insurance services and $1.3 million of fees for purchasing and other services
that Interstate Management provided to the hotels that were owned and managed by
subsidiaries of IHC and are currently owned by Patriot. Interstate Management
will not provide such services to these hotels subsequent to the spin-off. These
elimination
40
<PAGE> 44
adjustments are offset by the addition of $0.9 million of other fee revenues
related to seven Patriot-owned hotels that will be managed by Interstate
Management.
Pro forma general and administrative expense includes an adjustment to reflect
costs of $0.5 million of costs related to managing and administering a publicly
held company.
Pro forma payroll and related benefits expense includes an adjustment to
eliminate $4.0 million of salaries and related benefits of employees who were
terminated subsequent to the merger of IHC into Patriot and whose positions have
been eliminated.
Pro forma depreciation and amortization primarily represents $16.9 million of
amortization of management and lease contract costs associated with the step-up
in basis arising from the allocation of purchase price resulting from the merger
of IHC into Patriot. The management and lease contract costs have been stated at
their estimated fair market values and are being amortized using the
straight-line method over five years for the management contracts and 11 and
13.5 years for the lease contracts. The management contracts' amortization
period was determined using the average remaining life of the original contract
terms, and the amortization period of the lease contracts is based on the
remaining original lease life.
Pro forma income tax expense was computed based on Interstate Management's
estimated effective tax rate of 40% after reduction of minority interests.
Pro forma minority interest reflects Patriot's 55% non-controlling interest, or
$4.8 million, in Interstate Hotels, LLC, the successor to the third-party hotel
management business conducted by IHC prior the merger of IHC into Patriot.
Historical Year Ended December 31, 1998 Compared to Historical Year Ended
December 31, 1997
Total revenues increased by $24.8 million, or 10.7%, from $230.4 million in 1997
to $255.2 million in 1998. The most significant portion of this increase related
to lodging revenues, which consist of rooms, food and beverage and other
departmental revenues from leased hotels. Lodging revenues increased by $26.0
million, or 15.5%, from $167.9 million in 1997 to $193.9 million in 1998. This
increase was due to the operations of the leased hotels since their respective
inception dates.
The average daily room rate ("ADR") for the leased hotels increased by 6.0%,
from $67.93 during 1997 to $71.98 during 1998, and the average occupancy rate
decreased to 68.2% during 1998 from 71.1% during 1997. This resulted in an
increase in room revenue per available room ("REVPAR") of 1.7% to $49.08 during
1998. The statistical results of our leased hotels reflect the current trends
within the lodging industry, as reported by Smith Travel Research. As such, the
increase in ADR resulted from inflation and improvement resulting from our
management expertise. The decrease in the average occupancy rate resulted from
an increase of new supply within the lodging industry.
Net management fees increased by $1.7 million, or 4.2%, from $39.1 million in
1997 to $40.8 million in 1998 due to increased revenues associated with
incentive management fees earned as a result of the performance improvement of
certain existing managed hotels. Other fees decreased by $2.9 million, or 12.7%,
from $23.4 million in 1997 to $20.5 million in 1998 due to a decrease in the
total number of hotels operated in 1998 as compared to 1997. Other fees also
include insurance revenues of $8.4 million in 1998 compared to $9.1 million in
1997.
Lodging expenses, which consist of rooms, food and beverage, property costs and
other departmental expenses from leased hotels, increased by $15.0 million, or
17.5%, from $85.6 million in 1997 to $100.6 million in 1998. This increase was
due to the addition of the operations of the leased hotels since
41
<PAGE> 45
their respective inception dates. The operating margin of the leased hotels
decreased from 49.0% during 1997 to 48.1% during 1998.
General and administrative expenses are associated with the management of hotels
and consist primarily of centralized management expenses such as operations
management, sales and marketing, finance and other hotel support services, as
well as general corporate expenses. General and administrative expenses
decreased by $1.3 million, or 9.7%, from $13.2 million in 1997 to $11.9 million
in 1998. This decrease was primarily due to a reduction in development
activities and legal and accounting costs. General and administrative expenses
as a percentage of revenues decreased to 4.7% during 1998 compared to 5.7%
during 1997, primarily due to the increase in lodging revenues resulting from
the inclusion of the operations of the leased hotels since their respective
inception dates.
Payroll and related benefits decreased slightly by $0.5 million, or 2.2%, from
$21.9 million in 1997 to $21.4 million in 1998. Payroll and related benefits as
a percentage of revenues decreased to 8.4% during 1998 compared to 9.5% during
1997, primarily due to the increase in lodging revenues resulting from the
inclusion of the operations of the leased hotels since their respective
inception dates.
Lease expense represents base rent and participating rent that is based on a
percentage of rooms and food and beverage revenues from the leased hotels. Lease
expense increased by $12.4 million, or 16.9%, from $73.3 million in 1997 to
$85.7 million in 1998. This increase was due to the addition of the operations
of the leased hotels since their respective inception dates.
Depreciation and amortization increased by $8.0 million from $4.8 million in
1997 to $12.8 million in 1998. This increase was due to incremental amortization
of management contract costs associated with the step-up in basis arising from
the allocation of purchase price resulting from the merger of IHC into Patriot.
The management contract costs have been stated at their estimated fair market
values and are being amortized using the straight-line method over five years.
Operating income decreased by $8.9 million, or 28.1%, from $31.6 million in 1997
to $22.7 million in 1998. The operating margin decreased from 13.7% during 1997
to 8.9% during 1998. This decrease in operating income and in the operating
margin reflects the inclusion of the operating results of the leased hotels
since their respective inception dates and the increase in depreciation and
amortization during 1998.
Other income increased by $1.5 million from $0.4 million in 1997 to $1.9 million
in 1998 primarily due to an increase in equity in earnings from The Charles
Hotel Complex, which resulted from Interstate Management's acquisition of
additional interests in The Charles Hotel Complex.
Income tax expense in 1997 and 1998 was computed based on an effective tax rate
of 40%.
As a result of the changes noted above, net income decreased by $4.5 million, or
23.3%, from $19.5 million in 1997 to $14.9 million in 1998. The net income
margin decreased from 8.5% during 1997 to 5.9% during 1998, reflecting the
inclusion of the operating results of the leased hotels since their respective
inception dates and the increase in depreciation and amortization during 1998.
Historical Year Ended December 31, 1997 Compared to Historical Year Ended
December 31, 1996
Total revenues increased by $166.7 million from $63.7 million in 1996 to $230.4
million in 1997. The most significant portion of this increase related to
lodging revenues which increased by $157.9 million during 1997. This increase
was due to the addition of the operations of 89 leased hotels commencing in
November 1996 and continuing during 1997. The ADR for the leased hotels
increased by 23.7%, from $54.93 during 1996 to $67.93 during 1997, and the
average occupancy rate increased to 71.1% during 1997 from 58.4% during 1996.
This resulted in an increase in REVPAR of 50.5% to $48.27 during 1997. The
42
<PAGE> 46
variance of the operating results is primarily due to the leased hotels being
operated by Interstate Management for only two months in 1996 as compared to the
entire year of 1997.
Net management fees increased by $6.1 million, or 18.5%, from $33.0 million in
1996 to $39.1 million in 1997 due to the net addition of 11 new management
contracts and increased revenues associated with the performance improvement of
certain existing managed hotels, which resulted in increased incentive
management fees. Other fees increased by $2.7 million, or 13.1%, from $20.7
million in 1996 to $23.4 million in 1997 due to incremental revenues associated
with the net addition of new hotels during 1996 and 1997, many of which utilize
Interstate Management's ancillary services. Other fees also include insurance
revenues of $9.1 million in 1997 compared to $8.1 million in 1996.
Lodging expenses increased by $79.5 million from $6.1 million in 1996 to $85.6
million in 1997 due to the addition of the operations of 89 leased hotels
commencing in November 1996 and continuing during 1997. The operating margin of
the leased hotels increased from 38.6% during 1996 to 49.0% during 1997. This
increase in operating margin is primarily due to the leased hotels being
operated by Interstate Management for only two months in 1996 as compared to the
entire year of 1997.
General and administrative expenses increased by $2.8 million, or 27.4%, from
$10.4 million in 1996 to $13.2 million in 1997. This increase was primarily due
to incremental expenses associated with the growth of Interstate Management's
business. General and administrative expenses as a percentage of revenues
decreased to 5.7% during 1997 compared to 16.3% during 1996 as a result of the
addition of the operations of 89 leased hotels commencing in November 1996 and
continuing during 1997.
Payroll and related benefits increased by $4.2 million, or 23.9%, from $17.7
million in 1996 to $21.9 million in 1997. This increase was related to the
addition of corporate management and staff personnel as Interstate Management's
hotels for which it provides management and other services grew, primarily
resulting from the addition of the leased hotels for which Interstate Management
provides centralized accounting services. Payroll and related benefits as a
percentage of revenues decreased to 9.5% during 1997 compared to 27.7% during
1996 as a result of the addition of the operations of 89 leased hotels
commencing in November 1996 and continuing during 1997.
Non-cash compensation of $11.9 million in 1996 resulted from the issuance of
785,533 shares of common stock to certain executives and key employees of IHC in
consideration for the cancellation of stock options issued by one of IHC's
predecessors, Interstate Hotels Corporation, in 1995.
Lease expense increased by $69.8 million from $3.5 million in 1996 to $73.3
million in 1997 due to the addition of 89 leased hotels commencing in November
1996 and continuing during 1997.
Depreciation and amortization increased by $0.4 million, or 10.5%, from $4.4
million in 1996 to $4.8 million in 1997. This increase is due to incremental
amortization of $3.2 million during 1997 related to goodwill and the cost of
lease contracts associated with Interstate Management's acquisition of the
management and leasing businesses affiliated with Equity Inns in November 1996.
This increase was offset by decreased amortization of $2.5 million associated
with investments in management contracts that became fully amortized during
1996.
Operating income (exclusive of non-cash compensation) increased by $9.9 million,
or 45.5%, from $21.7 million in 1996 to $31.6 million in 1997. The operating
margin decreased from 34.0% during 1996 to 13.7% during 1997. This increase in
operating income and decrease in the operating margin reflects the inclusion of
the operating results of the leased hotels commencing in November 1996 and
continuing during 1997, and the increase in general and administrative and
payroll and related benefits expenses.
Income tax expense in 1996 and 1997 was computed based on an effective tax rate
of 40%.
43
<PAGE> 47
As a result of the changes noted above, net income increased by $13.3 million
from $6.2 million in 1996 to $19.5 million in 1996.
LIQUIDITY AND CAPITAL RESOURCES
Interstate Management's cash and cash equivalent assets were $1.7 million at
December 31, 1998 compared to $2.4 million at December 31, 1997. At December 31,
1998, current liabilities exceeded current assets by $30.8 million partially as
a result of $18.6 million of amounts owed to Wyndham to meet short-term cash
requirements. As part of the spin-off, Patriot has agreed to contribute cash to
Interstate Management so that, at the time of the spin-off, Interstate
Management's current assets will equal current liabilities. Patriot has
committed to infuse $15.0 million of additional capital into Interstate
Management. Interstate Management's pro forma cash and cash equivalents after
giving effect to such capital infusions were $29.9 million at December 31, 1998.
In addition, in connection with approximately $5.7 million of potential
expenditures arising from such issues as the dispute with Equity Inns, year 2000
compliance and loan forgiveness, among others, Patriot has agreed to fund 50% of
these potential expenditures into an escrow account and indemnify Interstate
Management against the remaining 50%. Patriot has also agreed to fund the
payment of cash in lieu of fractional shares in the spin-off and the cash
required to redeem the Interstate Management shares which are to be distributed
in the spin-off to the holders of Series A Preferred Stock of Patriot.
Interstate Management's principal source of liquidity during 1998 was cash from
operations. Net cash provided by operating activities was $28.0 million during
1998 compared to $12.5 million during 1997. The increase was primarily related
to a decrease in accounts receivable during 1998 compared to 1997 and lower
income taxes due for 1998 resulting from accelerated deductions recognized for
income tax purposes. Interstate Management used cash in investing activities of
$25.0 million during 1998, which primarily related to amounts paid in connection
with the merger of IHC into Patriot. During 1997, Interstate Management used
cash of $35.7 million in investing activities consisting primarily of $16.1
million in connection with its acquisition of interests in The Charles Hotel
Complex and $7.6 million due to increases in notes and other receivables.
Interstate Management's capital expenditure budget through December 31, 1999
relating to current operations is approximately $2.7 million, consisting
primarily of expenditures for computer and related equipment. Interstate
Management intends to fund these expenditures from its pro forma cash and cash
equivalents and from the escrow account and indemnity from Patriot, as discussed
above. Net cash used in financing activities of $3.7 million during 1998
resulted primarily from $11.6 million used for distributions to Patriot, offset
by $8.3 million of amounts borrowed from related entities to meet short-term
cash requirements. During 1997, cash provided by financing activities of $14.5
million resulted from $10.3 million of amounts borrowed from related entities to
meet short-term cash requirements, offset by $4.4 million used for distributions
to related entities.
Interstate Management intends to pursue future opportunities to manage or lease
hotels on behalf of third-party owners, as well as pursue other business
opportunities, such as selective hotel investments and the formation of
strategic alliances. Interstate Management believes that the cash provided by
Patriot at the time of the spin-off and future cash flow provided by operations
may be insufficient to fully fund the execution of its business and growth
strategy, and Interstate Management may be required to obtain debt or equity
financing to achieve its business plan. Interstate Management plans to obtain a
line of credit from a lending institution in order to partially finance its
business and growth strategy; however, negotiations to obtain such line of
credit have not commenced at this time and are not expected to be completed by
the time of the spin-off. Additionally, there is no assurance that the line of
credit or any other form of financing will be available to Interstate Management
on commercially reasonable terms, or at all. If Interstate Management does not
obtain additional financing, its pursuit of its business strategy and growth may
be impaired.
44
<PAGE> 48
YEAR 2000 COMPLIANCE
The year 2000 issue relates to computer programs written using two digits rather
than four to define the applicable year. Computer programs written this way may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in systems failures or miscalculations causing disruptions of hotel
operations or a temporary inability to process transactions, prepare financial
statements or engage in similar normal business activities.
We have developed and begun implementing a comprehensive plan to address
potential year 2000 problems at the hotels we manage and lease, as well as at
our corporate offices, and to minimize the impact on operations to the extent
possible. Our plan, which is designed to identify and address potential problems
in the most critical operational systems first in order to minimize any
disruption in service to hotel guests, consists of the following four steps:
Step 1 -- Inventory: Conduct an inventory to identify (a) all
computer hardware and software systems and
building systems in use and (b) any potential
year 2000 problems that may exist in such
systems.
Step 2 -- Vendor Survey: Identify and contact third-party vendors to
determine whether their systems or services
are or will be made year 2000 compliant. We
are conducting Step 2 simultaneously with
Step 1.
Step 3 -- Planning and Cost
Estimation: Prepare a prioritized year 2000 compliance
plan for remediation or replacement of
non-compliant systems. Step 3 will be
performed through a joint effort between
management representatives and a year 2000
consultant.
Step 4 -- Implementation and
Testing: Implement the year 2000 compliance plan
prepared in Step 3 and test all systems to
ensure maximum possible compliance and
develop contingency plans for continuing
operations in the event problems arise.
We have engaged a consultant to complete Steps 1 and 2, at an estimated cost of
$13,500 per hotel for upscale hotels and $7,500 for midscale and economy hotels.
We have instructed the hotels that we operate to increase their capital budgets
for 1999 to accommodate this cost. The end product of Steps 1 and 2 is a written
assessment which identifies the potential problems and estimates the costs of
remediating such problems. The inventories at the hotels and our corporate
offices have been substantially completed and we expect that the assessments are
currently being completed.
At this time, we cannot identify the total costs that will be incurred to
complete Steps 3 and 4. However, once each written assessment described above is
finalized, we will be able to provide an estimate of those costs. We have
instructed all hotels that we manage and lease to include in their 1999 capital
budgets a minimal amount (ranging from $10,000 to $50,000, depending on the size
of the hotel) to be utilized for these purposes. As specific costs become known,
our budgets will be adjusted as necessary.
We believe that the expenses incurred to complete the year 2000 compliance
program at each managed hotel are the responsibility of the hotel owner, and we
believe that the terms of our management contracts provide adequate basis for
this position. Nonetheless, it is possible that some third-party hotel owners
may challenge this position. With respect to the hotels leased by us, we also
believe that the expenses associated with year 2000 compliance with respect to
our leased hotels are the responsibility of the hotel owner. To the extent that
such expense is not considered a capital expenditure, however, it may be deemed
to be our responsibility. Further, we will be responsible for funding the year
2000 compliance expenses for corporate
45
<PAGE> 49
operations. These expenses, which will cover both updating and replacing system
components, will be funded through operating cash flow. The costs incurred to
date have not been material. We have provided for approximately $2.7 million in
capital expenditures in our 1999 management and information systems capital
budget, approximately $2.4 million of which is expected to be spent addressing
our year 2000 issues.
Our time and cost estimates for year 2000 compliance are based on currently
available information. These estimates could be affected by unforeseen
developments including, but not limited to, the availability and cost of trained
personnel; the ability to locate and correct problems in all relevant systems;
and the year 2000 compliance efforts of our third-party vendors. Currently, we
believe the most likely "worst-case" scenario is that our third-party vendors
may not be year 2000 compliant, which could potentially cause disruptions in
operations at hotels which use the services of such third-party vendors. In
addition, operations at our hotels outside the United States may be adversely
affected by failures of businesses in those countries to take adequate steps to
address the year 2000 problem. While such failures could affect critical
operations at our hotels in a significant manner, we cannot at present estimate
either the likelihood or the potential cost of such failures. The contingency
plans for continuing operations referenced in Step 4 described above are being
developed to address these failures, using existing disaster contingency plans
in place at our hotels. In addition, while we believe the indemnification
provisions in our management contracts and leases provide adequate protection
from liability that may arise from a failure to be year 2000 compliant, such
failure could result in lower hotel revenues (and, as a result, lower management
fee revenues) because of general adverse economic conditions and lower profits
caused by expenses incurred with contingency plans.
46
<PAGE> 50
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information regarding our directors and
executive officers. The Board will in general be classified into three classes,
with the initial members to serve for the periods identified below.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Thomas F. Hewitt 55 Chief Executive Officer and Chairman of the
Board of Directors (term on Board of Directors
expiring 2002)
J. William Richardson 51 Chief Financial Officer and Executive Vice
President, Finance and Administration
Kevin P. Kilkeary 46 Executive Vice President, and President and
Chief Operating Officer, Crossroads Hospitality
Henry L. Ciaffone 58 Executive Vice President, International
Operations and Development
Charles R. Tomb 44 Senior Vice President, Development
Timothy Q. Hudak 36 Senior Vice President, General Counsel
William W. Evans III 46 Director (term expiring 2000)
- ------------------------------------- -- Director (term expiring 2001)
- ------------------------------------- -- Director (term expiring 2001)
- ------------------------------------- -- Director (term expiring 2000)
</TABLE>
THOMAS F. HEWITT became our Chief Executive Officer and the Chairman of our
Board of Directors in March 1999. Mr. Hewitt previously was President and Chief
Operating Officer of Carnival Resorts & Casinos, where he headed all hotel and
resort operations. At Carnival Resorts & Casinos, Mr. Hewitt was responsible for
over 80 hotels and 17,000 employees in the United States, South America, the
Caribbean and Mexico. Mr. Hewitt joined Carnival Resorts & Casinos in 1985 (when
it was known as The Continental Companies) after a career spanning more than 20
years with Sheraton Corporation, most recently as the President of its North
American division from 1983 to 1985.
J. WILLIAM RICHARDSON was IHC's Chief Financial Officer and Executive Vice
President of Finance and Administration from 1994 until its merger with Patriot,
and has served in the same capacities for us since the merger. Mr. Richardson
previously served as Controller and Treasurer of IHC since 1988. Previously, Mr.
Richardson was Vice President and a partner in an Atlanta based hotel management
and development company and worked with Marriott Corporation prior thereto. His
experience in the hospitality industry spans over a period of approximately 28
years. He served as our acting President and Chief Executive Officer from
January to March of 1999.
KEVIN P. KILKEARY serves as our Executive Vice President, and as President and
Chief Operating Officer, Crossroads Hospitality. Mr. Kilkeary joined IHC in 1972
and held a variety of positions in hotels and at the corporate office, including
executive positions as General Manager, Regional Vice President of Operations,
Vice President of Sales and Marketing and Vice President of Staff Operations.
HENRY L. CIAFFONE is our Executive Vice President, International Operations and
Development, a position he has held since January 1999. Mr. Ciaffone, who joined
IHC in 1989, previously served as our Senior Vice President and Treasurer. Prior
to joining IHC, Mr. Ciaffone held positions in hotel finance and real estate
development at Koala Inns of America, Sheraton Corporation and the Howard
Johnson Company.
47
<PAGE> 51
CHARLES R. TOMB is our Senior Vice President of Development. He joined IHC in
1992, and most recently, he oversaw IHC's development activities in the Western
Region as Vice President of Development. Mr. Tomb has approximately 20 years of
experience in the hotel industry, including prior positions with Holiday Inns
Worldwide, Americana Hotels & Resorts and Hyatt Hotels.
TIMOTHY Q. HUDAK joined IHC in 1992 as Assistant General Counsel and now serves
as our Senior Vice President and General Counsel. Prior to joining IHC, Mr.
Hudak held the position of Associate General Counsel for Cyclops Industries,
Inc. and, prior to that, practiced law at the firm of Tucker Arensberg.
WILLIAM W. EVANS III joined our Board of Directors in January 1999. Mr. Evans
serves as President and Chief Operating Officer and a member of the Board of
Directors of Patriot and as an Executive Vice President of Wyndham. Prior to
joining Patriot in March 1997, Mr. Evans was a Managing Director in
PaineWebber's Real Estate Group with responsibility primarily for the
origination and structuring of principal transactions. He joined PaineWebber as
a result of the firm's acquisition of Kidder, Peabody & Co. in December 1994.
Prior to joining Kidder, Peabody in 1992, Mr. Evans was a First Vice President
and head of the Real Estate Financing Division of Swiss Bank Corporation, where
he was responsible for all U.S. real estate activities.
DIRECTOR COMPENSATION
Directors who are not employees of Interstate Management are paid an annual
retainer fee of $15,000 in quarterly installments of $3,750. In addition, each
such director will be paid $1,000 for attendance at each meeting of our Board of
Directors and $750 for attendance at each meeting of a committee of our Board of
Directors of which such director is a member held on a date other than a date on
which a full Board of Directors meeting is held. The annual retainer fee and
meeting fees will be paid in cash, but the directors will be entitled to elect
in advance to receive all or part of the fees in the form of Interstate
Management shares. Directors who are employees of ours will not receive any fees
for their service on the Board of Directors or a committee thereof. In addition,
we will reimburse directors for their out-of-pocket expenses incurred in
connection with their service on the Board of Directors.
48
<PAGE> 52
EXECUTIVE COMPENSATION
Interstate Management was incorporated in May 1998. The following table sets
forth certain information regarding (i) the compensation paid or accrued in 1998
by IHC and Interstate Management, as well as (ii) the expected compensation to
be paid in 1999 by Interstate Management, to IHC's (and Interstate Management's)
former Chief Executive Officer, Interstate Management's new Chief Executive
Officer and each of the four other most highly compensated executive officers of
IHC and Interstate Management who are expected to be executive officers of
Interstate Management during 1999 and who earned at least $100,000 in total
salary and bonus from IHC and Interstate Management in 1998. The executive
officers listed in the table below (other than Mr. Parrington, who resigned
effective December 31, 1998) are sometimes referred to elsewhere in this
Information Statement/Prospectus as the "Named Executive Officers."
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
EXPECTED 1999
1998 COMPENSATION LONG-TERM COMPENSATION COMPENSATION(1)
------------------- ----------------------- -------------------
SECURITIES
UNDERLYING LTIP ALL OTHER 1998
NAME AND PRINCIPAL POSITION SALARY BONUS OPTIONS PAYOUTS COMPENSATION SALARY BONUS
- --------------------------- -------- -------- ------------ -------- -------------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Thomas F. Hewitt(2)........... -- -- 400,000 800,000
Chief Executive Officer and
Chairman of the Board
W. Thomas Parrington, Jr. .... 380,173 565,000 6,994,688(3) -- --
Former President and Chief
Executive Officer
J. William Richardson......... 265,123 397,684 4,145,690(4) 265,000 530,000
Chief Financial Officer and
Executive Vice President,
Finance and Administration
Kevin P. Kilkeary............. 242,844 273,199 2,346,519(5) 250,000 375,000
Executive Vice President,
President and Chief
Operating Officer of
Crossroads Hospitality
Henry L. Ciaffone............. 181,610 187,567 2,016,934(6) 200,000 240,000
Executive Vice President,
International Operations and
Development
Charles R. Tomb............... 160,284 75,000 1,113,663(7) 190,000 237,500
Senior Vice President,
Development
</TABLE>
- -------------------------
(1) The amounts listed under "Expected 1999 Compensation" represent the expected
salary and the maximum bonus possible.
(2) Mr. Hewitt became our Chief Executive Officer and the Chairman of our Board
of Directors in March 1999.
(3) Consists of a change in control payment of $12,561, stock option proceeds of
$3,800,000, special bonus of $430,000, loan forgiveness of $2,048,436,
Executive Retirement Plan contribution of $49,400, and deferred compensation
payment of $654,291.
(4) Consists of a change in control payment of $9,690, stock option proceeds of
$1,921,875, special bonus of $300,000, loan forgiveness of $1,060,920,
Executive Retirement Plan contribution of $34,466, and deferred compensation
payment of $818,739.
(5) Consists of stock option proceeds of $1,070,125, loan forgiveness of
$90,000, and a change in control payment of $1,186,394.
(6) Consists of stock option proceeds of $412,500, loan forgiveness of $170,000,
and a change in control payment of $955,314 with a tax gross up of $479,120.
(7) Consists of stock option proceeds of $155,000, deal commission of $11,134,
relocation expenses of $111,212, restricted stock of $79,844, a change in
control payment of $747,713, and a car allowance of $8,760.
COMPENSATION PLANS AND ARRANGEMENTS
MANAGEMENT BONUS PLAN. We have established a Management Bonus Plan under which
all key management employees who are directly involved in our growth and success
(other than Messrs. Hewitt and
49
<PAGE> 53
Richardson, whose bonuses are determined pursuant to their employment
agreements) are eligible to receive bonuses based upon the achievement of
specified targets and goals for Interstate Management and the individual
employee. Awards under the Management Bonus Plan are made by the Compensation
Committee of the Board of Directors and range from zero to specified levels
depending on the position of the individual. Currently, approximately 80
employees are eligible for awards under the Management Bonus Plan, with
approximately 40 of such employees eligible to receive up to 45% of their base
salaries, approximately ten of such employees eligible to receive up to 55% of
their base salaries, four of such employees eligible to receive up to 125% of
their base salaries and one such employee eligible to receive up to 150% of his
base salary.
EXECUTIVE RETIREMENT PLAN. Our employees holding job classifications of Vice
President or above, including the Named Executive Officers, will be eligible to
participate in our Executive Retirement Plan. The plan is intended to be a
non-qualified and unfunded plan maintained primarily for the purpose of
providing deferred compensation for a select group of management or highly
compensated employees. Actual participation in the plan will be determined by
the Board or a committee of the Board.
We plan to contribute 8.0% of each participant's base salary to the plan and we
may make discretionary contributions of up to an additional 5.0% of each
participant's base salary. These discretionary contributions will be based on
our net increase in earnings per share in a given year. In addition, plan
participants will be eligible to designate a portion (to be specified by the
Board or the committee administering the plan) of their cash bonus to be
contributed to the plan.
The funds contributed by Interstate Management or participants will be held in a
grantor "rabbi" trust established by Interstate Management. Unless the Board or
the committee administering the plan determines that the amounts contributed to
the plan on behalf of a participant are payable earlier, in general, a
participant in the plan will receive his plan benefits one year after his
retirement or termination of employment. Plan benefits are paid out in a lump
sum and are taxable to the plan participant as ordinary income upon receipt.
STOCK PURCHASE PLAN. We plan to establish a Stock Purchase Plan, under which
each full-time employee who has completed 12 consecutive months of employment
with Interstate Management or a predecessor, excluding any employee whose
customary employment is not for more than 20 hours per week or more than five
months per calendar year, is eligible to participate. Under the Stock Purchase
Plan, participating employees may elect to authorize us to withhold a maximum of
8.0% of the participating employee's salary, which amounts will be held in the
participating employee's account and used to purchase Interstate Management
shares on a semi-annual basis at a price equal to a designated percentage from
85% to 100% of the average closing sales price for Interstate Management shares
as reported by the New York Stock Exchange (except as otherwise described
below). The designated percentage will be established semi-annually by the Board
or the administrator of the plan.
The price paid by a participating employee under the Stock Purchase Plan for
Interstate Management shares may not be less than the lesser of (i) 85% of the
fair market value of such shares on the date of the regular offering of the
right to participate in such plan and (ii) 85% of the fair market value of such
shares on the date the shares are purchased. The fair market value of the shares
available for purchase by a participating employee (determined as of the
offering date) generally may not exceed $25,000 per calendar year.
Employees may generally resell Interstate Management shares acquired under the
Stock Purchase Plan without restrictions; however, any "affiliate" who acquires
Interstate Management shares under the Stock Purchase Plan may resell only upon
compliance with Rule 144 under the Securities Act, except that the one-year
holding period requirement of Rule 144 will not apply. For this purpose, the
term "affiliate" includes any participating employee who directly, or indirectly
through one or more intermediaries, controls, or is controlled by, or is under
common control with, Interstate Management.
50
<PAGE> 54
We expect to reserve 400,000 authorized but unissued Interstate Management
shares for purchase under the Stock Purchase Plan. The Stock Purchase Plan will
remain in effect until terminated at any time by the Board, except that such
termination will be subject to employees' rights to purchase shares in any
outstanding semi-annual offering period.
The Stock Purchase Plan may be amended from time to time by the Board. No
amendment will increase the aggregate number of Interstate Management shares
that may be issued and sold under the Stock Purchase Plan (except for
authorizations pursuant to the antidilution provisions of the Stock Purchase
Plan) without further approval by our shareholders. Furthermore, no amendment
that would cause the Stock Purchase Plan to fail to meet the requirements of
Section 423 of the Code will be adopted without shareholder approval.
EQUITY INCENTIVE PLAN. Our Equity Incentive Plan is designed to attract and
retain qualified officers and other key employees. The Equity Incentive Plan
authorizes the grant of (i) options to purchase Interstate Management shares,
(ii) restricted shares, (iii) unrestricted shares and (iv) deferred shares. The
Board or a committee of the Board will administer the Equity Incentive Plan and
determine to whom grants will be made and the terms and conditions, including
the number of shares and the period of exercisability, thereof.
The number of Interstate Management shares that may be issued or transferred and
covered by outstanding awards granted under the Equity Incentive Plan shall at
all times equal 20% of the outstanding Interstate Management shares, which may
be shares of original issuance or treasury shares or a combination of both.
Officers, including officers who are members of the Board, and our key employees
and consultants and those of our subsidiaries may be selected to receive
benefits under the Equity Incentive Plan. As of the date of the spin-off,
options to purchase Interstate Management shares will have been granted to
Interstate Management employees and shares will be available for additional
awards under the Equity Incentive Plan.
The Board or the committee administering the plan may grant stock options that
entitle the optionee to purchase Interstate Management shares at a price equal
to or greater or less than market value on the date of grant, and the
exercisability of stock options may be conditioned on the achievement of
specified performance objectives. Subject to adjustment as provided in the
Equity Incentive Plan, no participant shall be granted stock options, in the
aggregate, for more than 100,000 shares during any calendar year.
An award of restricted shares involves the immediate transfer by us to a
participant of ownership of a specific number of Interstate Management shares in
consideration of the performance of services. The participant is entitled
immediately to voting, dividend and other ownership rights in the shares. The
transfer may be made without additional consideration or for consideration in an
amount that is less than the market value of the shares on the date of grant, as
the Board or the committee administering the plan may determine. Restricted
shares must be subject to a "substantial risk of forfeiture" within the meaning
of Section 83 of the Code for a period to be determined by the Board or the
committee administering the plan, such as a provision that the restricted shares
would be forfeited if the participant ceased to serve for us as an officer or
other salaried employee during a specified number of years. The Board or the
committee administering the plan may provide for a shorter period during which
the forfeiture provisions are to apply in the event of a change in control of
Interstate Management or other similar transaction or event.
Like restricted shares, an award of unrestricted shares (i) involves the
immediate transfer by us to a participant of ownership of a specific number of
Interstate Management shares in consideration of the performance of services,
(ii) entitles the participant immediately to voting, dividend and other
ownership rights in the shares, and (iii) may be made without additional
consideration or for consideration in an amount that is less than the market
value of the shares on the date of grant. Unlike unrestricted shares, however,
unrestricted shares are not subject to forfeiture.
51
<PAGE> 55
An award of deferred shares constitutes an agreement by us to deliver Interstate
Management shares to the participant in the future in consideration of the
performance of services, subject to the fulfillment of such conditions during a
deferral period as the Board or the committee administering the plan may
specify. During the deferral period, the participant has no right to transfer
any rights covered by the award and no right to vote the shares covered by the
award. On or after the date of any grant of deferred shares, the Board or the
committee administering the plan may authorize the payment of dividend
equivalents thereon on a current, deferred or contingent basis in either cash or
additional Interstate Management shares. Grants of deferred shares may be made
without additional consideration or for consideration in an amount that is less
than the market value of the shares on the date of grant. Deferred shares must
be subject to a deferral period, as determined by the Board or the committee
administering the plan on the date of grant, except that the Board or the
committee administering the plan may provide for a shorter deferral period in
the event of a change in control of Interstate Management or other similar
transaction or event.
With limited exceptions, no stock option or other "derivative security" within
the meaning of Rule 16b-3 under the Exchange Act is transferable by a
participant except by will or the laws of descent and distribution. Stock
options generally may not be exercised during a participant's lifetime except by
the participant or, in the event of the participant's incapacity, by the
participant's guardian or legal representative acting in a fiduciary capacity on
behalf of the participant under state law and court supervision. Notwithstanding
the foregoing, the Board or the committee administering the plan, in its sole
discretion, may provide for the transferability of the particular awards under
the Equity Incentive Plan so long as such provisions will not disqualify the
exemption for other awards under Rule 16b-3 under the Exchange Act if such rule
is then applicable to awards under the plan.
The maximum number of shares that may be issued or transferred under the Equity
Incentive Plan, the number of shares covered by outstanding stock options and
the option prices or base prices per share applicable thereto, are subject to
adjustment in the event of stock dividends, stock splits, combinations of
shares, recapitalizations, mergers, consolidations, spin-offs, reorganizations,
liquidations, issuances of rights or warrants and similar transactions or
events. In the event of any such transaction or event, the Board or the
committee administering the plan may provide in substitution for any or all
outstanding awards under the Equity Incentive Plan such alternative
consideration as it may in good faith determine to be equitable in the
circumstances and may require the surrender of all awards so replaced. The Board
or the committee administering the plan may also, as it determines to be
appropriate in order to reflect any such transaction or event, make or provide
for such adjustments in the number of shares that may be issued or transferred
and covered by outstanding awards granted under the Equity Incentive Plan and
the number of shares permitted to be covered by stock options granted to any one
participant during any calendar year.
The Equity Incentive Plan may be amended from time to time by the Board or the
committee administering the plan but, without further approval by shareholders,
no such amendment may (i) increase the aggregate number of Interstate Management
shares that may be issued or transferred and covered by outstanding awards or
increase the number of shares which may be granted to any participant in any
calendar year or (ii) otherwise cause Rule 16b-3 under the Exchange Act to cease
to be applicable to the Equity Incentive Plan.
To the extent that a participant in any of our plans recognizes ordinary income
by virtue of his participation in such plan, we or the subsidiary for which the
participant performs services will be entitled to a corresponding deduction
provided that, among other things, (i) the income meets the test of
reasonableness, is an ordinary and necessary business expense and is not an
"excess parachute payment" within the meaning of Section 280G of the Code and is
not disallowed by the $1.0 million limitation on certain executive compensation
and (ii) any applicable reporting obligations are satisfied.
52
<PAGE> 56
EMPLOYMENT AND CHANGE-IN-CONTROL AGREEMENTS
We have entered into an employment agreement with Mr. Hewitt pursuant to which:
- - He shall serve as Chief Executive Officer and Chairman of the Board of
Interstate Management.
- - He shall be employed for a term beginning March 1, 1999 and ending February
28, 2003 subject to, on the second anniversary of the date of his employment
and every even-numbered anniversary thereafter, automatic two year extensions,
unless either party gives 90 days prior written notice otherwise.
- - With respect to termination of Mr. Hewitt's employment, he shall be entitled
to receive: his minimum bonus, if he is terminated for cause or resigns
without good reason; (i) his minimum bonus, (ii) an amount equal to twice his
base pay and minimum bonus, (iii) continuation for 24 months of his employee
benefits, and (iv) acceleration of his restricted stock grant, if his
employment is terminated for any reason other than cause or disability; (i)
his minimum bonus for the year of termination of his employment, (ii) his base
pay and minimum bonus for a period of 12 months following the termination of
his employment, and (iii) acceleration of his restricted stock grant, if his
employment is terminated as a result of his death or disability.
- - In the event of a change in control of Interstate Management, Mr. Hewitt shall
be entitled to: (i) a $2 million cash payment, (ii) acceleration of his
restricted stock grant, and (iii) benefits continuation, in the event that his
employment is terminated without cause or he resigns for good reason within 36
months of the change in control; the compensation in the foregoing clause of
this sentence, in the event that he terminates his employment for any reason
within the first 24 months immediately following the change in control; and a
gross-up of his compensation under this section if he incurs the tax on
"excess parachute payments" under the Code.
- - Mr. Hewitt has agreed that, during the term of his employment and the period
ending one year following the termination of his employment, he will not
engage in any business which competes with Interstate Management, solicit any
employee of Interstate Management to leave his employment or otherwise
interfere with the employment of any such employee, or solicit any agent of
Interstate Management to terminate, reduce or modify its agency relationship
with us.
- - Mr. Hewitt is obligated to keep in strict confidence any trade secrets and
confidential business and technical information of Interstate Management.
- - Mr. Hewitt is entitled to have his legal fees and related expenses paid by us
in connection with interpretation, enforcement or defense of his rights under
the employment agreement.
We have also entered into employment agreements with Mr. Ciaffone and Mr. Tomb.
Pursuant to the terms of Mr. Ciaffone's employment agreement:
- - In the event of the termination of Mr. Ciaffone's employment for any reason
other than cause or disability, he shall be entitled to the greater of either
(i) his salary and bonus for the immediately preceding six months or (ii) his
salary and bonus for the remainder of the term of the agreement, plus the
continuation of health and other welfare benefits for six months following
termination of employment.
- - Mr. Ciaffone has agreed that, during the term of his employment and the period
ending six months following the termination of his employment, he will not
engage in any business which competes with Interstate Management, solicit any
employee of Interstate Management to leave his employment or otherwise
interfere with the employment of any such employee, or solicit any agent of
Interstate Management to terminate, reduce or modify its agency relationship
with us.
53
<PAGE> 57
- - Mr. Ciaffone is obligated to keep in strict confidence any trade secrets and
confidential business and technical information of Interstate Management.
- - Mr. Ciaffone is entitled to have his legal fees and related expenses paid by
us in connection with enforcing or defending his rights under the employment
agreement.
Pursuant to the terms of Mr. Tomb's employment agreement:
- - As a result of the change in control triggered by the merger of IHC into
Patriot, Mr. Tomb has received 50% of the severance compensation he was
entitled to receive under his severance agreement with IHC in place at the
time of the merger.
- - Mr. Tomb has received a loan in an amount equal to the remaining 50% of such
severance compensation, which amortizes over a 30-month period.
- - At any time prior to the date that is 30 days following the effective date of
the spin-off, Mr. Tomb may elect to terminate his employment with or without
cause, and the entire severance loan will be forgiven.
- - After such date, if Mr. Tomb terminates his employment for reasons other than
a change in control or a material change in his job responsibilities, he is
required to repay the unamortized portion of the severance loan.
- - In the event we terminate Mr. Tomb without cause or either Mr. Tomb or we
terminate his employment as the result of a change in control or a material
change in his job responsibilities during the initial three year term of his
employment, he is entitled to (i) have the severance loan forgiven and (ii)
continue health and other welfare benefits for the greater of 18 months or the
remainder of the term of the agreement.
- - If we terminate Mr. Tomb without cause or he terminates his employment as a
result of a change in control or a material change in his job responsibilities
after the expiration of the initial three year term of his employment, he is
entitled to an amount equal to his salary and bonus for up to a maximum of six
months.
- - Mr. Tomb has agreed that, during the term of his employment and the period
ending six months following the termination of his employment, he will not
engage in any business which competes with Interstate Management, solicit any
employee of Interstate Management to leave his employment or otherwise
interfere with the employment of any such employee, or solicit any agent of
Interstate Management to terminate, reduce or modify its agency relationship
with us.
- - Mr. Tomb is obligated to keep in strict confidence any trade secrets and
confidential business and technical information of Interstate Management.
- - Mr. Tomb is entitled to have his legal fees and related expenses paid by us in
connection with interpretation, enforcement or defense of his rights under the
employment agreement.
We are currently negotiating the terms of employment agreements with the other
Named Executive Officers.
54
<PAGE> 58
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
EXECUTIVE LOANS
In 1996, Interstate Management's predecessor loaned $2.0 million and $1.0
million to Messrs. Parrington and Richardson, respectively. The remaining unpaid
balances of these loans, along with additional loans of $165,850 and $120,000,
respectively, were forgiven as of June 2, 1998 in connection with IHC's merger
into Patriot and in accordance with the change of control provisions of their
respective severance agreements with IHC. Interstate Management also loaned an
additional $100,000 and $357,317 to Messrs. Parrington and Richardson,
respectively, as advances against their 1998 bonuses.
On June 2, 1998, in connection with IHC's merger into Patriot and in accordance
with the change of control provisions of their respective severance agreements
with IHC, Interstate Management forgave loans in the amount of $90,000 and
$170,000 to Messrs. Kilkeary and Ciaffone, respectively. Interstate Management
loaned Mr. Ciaffone an additional $232,200, which was repaid in full on October
29, 1998.
Interstate Management has also loaned $238,000 to Mr. Tomb to cover expenses
incurred in his relocation to Pittsburgh, as well as $29,774 as an advance
against his 1998 bonus.
VOTING AGREEMENT
GENERAL. Upon consummation of the spin-off, three directors and/or executive
officers of Patriot/Wyndham and certain entities with which the directors
and/or officers are affiliated (with such directors, officers and affiliated
entities being referred to in this section as the "Shareholders") will enter
into a Voting Agreement with Interstate Management.
VOTING PROVISIONS. The Voting Agreement will provide that on all shareholder
votes taken at any time when the Shareholders, together with Patriot/Wyndham and
certain other directors and executive officers of Patriot/Wyndham (collectively
referred to in this section as the "Affiliated Shareholders"), collectively own
greater than 9.9% of the outstanding Interstate Management shares, the
Shareholders will vote their Interstate Management shares in proportion with the
results of voting on the particular matter by all Interstate Management
shareholders other than the Shareholders and the Affiliated Shareholders. This
will have the effect of nullifying the impact of voting by the Shareholders on
the particular matter and reducing the impact of voting by the Affiliated
Shareholders on such matter.
DIVESTITURE PROVISIONS. The Voting Agreement will also provide that the
Shareholders will use reasonable efforts to sell or otherwise dispose of the
number of Interstate Management shares necessary so that the Shareholders and
the Affiliated Shareholders will collectively own 9.9% or less of the
outstanding Interstate Management shares by the first anniversary of the
spin-off. Based on their holdings of Patriot securities on , 1999, we
currently estimate that the Shareholders and the Affiliated Shareholders will
collectively own Interstate Management shares, or % of the outstanding
Interstate Management shares, upon consummation of the spin-off. The
Shareholders will thus be obligated under the Voting Agreement to sell an
aggregate of Interstate Management shares, or % of the outstanding
Interstate Management shares, by the first anniversary of the spin-off.
Thereafter, the Shareholders' selling obligations will become effective again at
any time within five years after the spin-off that the Shareholders are informed
by Interstate Management that the Shareholders and the Affiliated Shareholders
collectively own greater than 9.9% of the outstanding Interstate Management
shares.
INTERSTATE MANAGEMENT CALL RIGHT. In the event that the Shareholders fail to
comply with their obligations to sell Interstate Management shares as described
above within five years after the spin-off, Interstate Management will have a
call right to purchase from the Shareholders for fair market value the number of
Interstate Management shares the Shareholders were obligated to sell. Marriott
will have the right to compel Interstate Management to exercise its call right
if Interstate Management fails to do so.
55
<PAGE> 59
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth the number of Interstate Management shares that
will be beneficially owned immediately following the spin-off and the related
redemption transactions by each person or "group" known to us to be the
beneficial owner of more than 5% of Interstate Management shares, each of our
directors and Named Executive Officers and all of our directors and executive
officers as a group. Unless indicated otherwise, the address for each of the
persons named in the table is c/o Interstate Hotels Management, Inc., 680
Andersen Drive, Foster Plaza Ten, Pittsburgh, Pennsylvania 15220. For purposes
of the table, a person or group of persons is deemed to have "beneficial
ownership" of any shares as of a given date which such person has the right to
acquire within 60 days after such date.
<TABLE>
<CAPTION>
NUMBER OF PERCENTAGE OF
NAME SHARES OWNED SHARES OWNED
- ---- ------------ -------------
<S> <C> <C>
Thomas F. Hewitt........................................... [ ] [ ]%
J. William Richardson...................................... 879(1) *%
Kevin P. Kilkeary.......................................... 255 *%
Henry L. Ciaffone.......................................... 0 0%
Charles R. Tomb............................................ 189 %
William W. Evans III.......................................
Director................................................... %
Director................................................... %
Director................................................... %
All directors and executive officers as a group
( persons)............................................. %
</TABLE>
- -------------------------
* Less than 1%
(1) Includes shares held by Mr. Richardson's daughter.
DESCRIPTION OF CAPITAL STOCK
We have summarized below the material provisions of our Articles of
Incorporation and Bylaws as they are contemplated to be in effect at the time of
the spin-off. Our summary may not contain all of the information that is
important to you. See "Where You Can Find More Information" for information
about how to obtain a copy of the documents we refer to in this section.
CAPITAL STOCK
Under the Articles of Incorporation, we are authorized to issue up to
million shares of stock, consisting of:
- million shares of Class A common stock,
- million shares of Class B common stock,
- million shares of Class C common stock, and
- million shares of preferred stock.
COMMON STOCK. Each holder of Class A shares, Class B shares and Class C shares
shall be entitled to one vote for each share held by such holder and no
shareholders shall have cumulative voting rights. The three classes shall vote
separately for the election of Interstate Management's Board of Directors as
explained in detail under "Additional Corporate Governance and Takeover-related
Matters -- Board of Directors."
56
<PAGE> 60
If Marriott and its affiliates own in the aggregate at least two percent of our
outstanding stock, then we are prohibited from entering into various
transactions with any of Patriot/Wyndham or its affiliates unless the holders of
the Class B shares (Marriott) give their approval. If Patriot/Wyndham and its
affiliates own in the aggregate at least two percent of our outstanding stock,
then we are prohibited from entering into various transactions with any of
Marriott or its affiliates unless the holders of the Class C shares (Wyndham)
give their approval. Except as required by law, the holders of common stock
shall vote together as a single class on all other matters submitted to
stockholders for a vote. In all respects other than those mentioned above, each
class of common stock shall be identical and shall entitle its holders to
identical rights and privileges. We will be distributing Class A shares in the
spin-off. The Class B shares will be held by Marriott and the Class C shares
will be held by Wyndham.
Holders of shares of common stock have no preemptive, subscription or redemption
rights, and no liability exists for further calls or assessments. Holders of
Class B and Class C shares may, at their discretion, convert their respective
shares into Class A shares, and the Class B shares and Class C shares will
automatically convert into Class A shares upon the occurrence of certain events
(including, among other things, upon the transfer of Class B or Class C shares
from Marriott or Wyndham, as the case may be, to an unaffiliated entity).
Holders of shares of common stock are entitled to receive such dividends as may
be declared by our Board out of funds legally available for the payment of
dividends. Upon the liquidation, dissolution or winding up of Interstate
Management, holders of shares of common stock share ratably in the assets of
Interstate Management available for distribution to stockholders generally,
subject to the preferential rights of any then outstanding shares of preferred
stock. No shares of preferred stock are currently outstanding.
PREFERRED STOCK. The preferred shares may be issued in one or more series, with
such rights and qualifications as our Board may determine before such shares are
issued. Our Board could, without the approval of stockholders, issue preferred
shares having voting or conversion rights that could adversely affect the voting
power of the holders of common stock and the issuance of preferred shares could
be used, under certain circumstances, to render more difficult or discourage a
hostile takeover of Interstate Management.
STOCK EXCHANGE LISTING
We intend to apply to list our common stock for trading on the New York Stock
Exchange.
There is currently no trading market for our shares. The price at which our
shares will trade after the spin-off cannot be predicted. Until our shares are
fully distributed and an orderly market develops, the prices at which trading in
our shares occurs may fluctuate significantly. The price at which our stock
trades will be determined by the marketplace and may be influenced by many
factors, including, among other things, the depth and liquidity of the market
for our stock, investor perception of Interstate Management and our business,
our dividend policy, interest rates, and general economic and market conditions.
SHARES AVAILABLE FOR RESALE
Interstate Management shares distributed to you in the spin-off may be traded
freely and without restriction if you are not deemed to be an "affiliate" of
Interstate Management under the rules of the SEC. Persons who may be deemed to
be affiliates of Interstate Management after the spin-off include individuals or
entities that control, are controlled by or are under common control with
Interstate Management, and may include certain officers and directors of
Interstate Management as well as certain principal stockholders of Interstate
Management. Persons who are affiliates of Interstate Management will be
permitted to sell their Interstate Management shares only pursuant to an
effective registration statement or an exemption from the registration
requirements of the securities laws.
57
<PAGE> 61
ADDITIONAL CORPORATE GOVERNANCE AND TAKEOVER-RELATED MATTERS
The Articles of Incorporation and Bylaws provide for the following:
ACTIONS OF STOCKHOLDERS. Subject to certain exceptions for holders of Class B
shares and Class C shares, our Articles of Incorporation do not permit actions
to be taken by written consent. Stockholder actions may only be taken at annual
or special meetings of the stockholders called in accordance with our Articles
of Incorporation and Bylaws. Special meetings of stockholders may only be called
by (i) the vote of a majority of directors then in office, (ii) by the Chairman
of the Board, if one is elected, or by the Chief Executive Officer or, if none,
the President and (iii) by the Secretary of Interstate Management upon the
written request of the holders of a majority of all shares entitled to vote at
such meeting. Only business that is specified in the notice of the annual or
special meeting or properly brought before the meeting may be discussed at any
meeting. The first annual meeting of our stockholders will be held in 2000, on a
date and at a time designated by the Board.
BOARD OF DIRECTORS. Our business and affairs are managed under the direction of
our Board, which initially shall consist of five members. The holders of Class A
shares will be entitled to elect four directors and the holders of Class B
shares will be entitled to elect one director. At the first annual meeting of
stockholders (expected to be held in 2000), the holders of Class C shares
(Wyndham) shall be entitled to elect one director to the Board. If at the time
of this election Patriot is no longer a REIT, the size of the Board shall be
fixed at seven, and the number of directors which the holders of Class A shares
are entitled to elect shall be increased to five. If at the time of this
election Patriot is still a REIT, the size of the Board shall be fixed at
eleven, and the number of directors which the holders of Class A shares are
entitled to elect shall be increased to nine. On March 1, 1999, Patriot/Wyndham
publicly announced that it plans to merge Patriot into a subsidiary of Wyndham
and, in so doing, relinquish its REIT status. After September 30, 2003, or prior
to such date upon the occurrence of certain events, the size of the Board may be
fixed by a resolution adopted by the Board.
Class A directors are elected by the holders of the outstanding Class A shares.
Class A directors are classified into three classes, as nearly equal in number
as possible, designated Class A-I, Class A-II and Class A-III. The term of the
director(s) first appointed to Class A-I will expire at the annual meeting of
stockholders to be held in 2000. The term of the director(s) first appointed to
Class A-II will expire at the annual meeting of stockholders to be held in 2001.
The term of the director(s) first appointed to Class A-III will expire at the
annual meeting of stockholders to be held in 2002. Class A directors are elected
for three-year terms by a plurality of votes cast by holders of Class A shares
at each annual meeting.
The Class B director will be elected by the holders of Class B shares (Marriott)
within ten days after the initial issuance of Class B shares. The term for the
initial Class B director will expire at the annual meeting of stockholders to be
held in 2002. Thereafter, the Class B director will serve one-year terms
expiring at each subsequent annual meeting of stockholders. Class B directors
are elected by a plurality of all votes cast by holders of Class B shares at
such annual meeting or by unanimous written consent. If each of the Class B
shares automatically convert into Class A shares, which will happen upon the
occurrence of certain events, the Class B director then in office will be
removed, the number of Class A directors will automatically be increased by one
and the resulting vacancy will be filled by either the remaining directors or
the holders of Class A shares.
The Class C director will be elected by the holders of Class C shares (Wyndham)
as provided above. The term for the initial Class C director will expire at the
annual meeting of stockholders to be held in 2002. Thereafter, the Class C
director will serve one-year terms expiring at each subsequent annual meeting of
stockholders. Class C directors are elected by a plurality of all votes cast by
holders of Class C shares at such annual meeting or by unanimous written
consent. If each of the Class C shares automatically convert into Class A
shares, which will happen upon the occurrence of certain events, the Class C
director then in
58
<PAGE> 62
office will be removed, the number of Class A directors will automatically be
increased by one and the resulting vacancy will be filled by either the
remaining directors or the holders of Class A shares.
The Bylaws provide that directors may only be nominated by the Board or by any
stockholder who has delivered notice of his or her nominees not less than 75
days nor more than 120 days prior to any annual meeting. The stockholder's
notice must contain certain information concerning the stockholder and the
stockholder's nominees, including:
- their names and addresses,
- proof that the stockholder is a stockholder of record and plans to
appear in person at the annual meeting,
- the class and number of shares of Interstate Management stock owned
by such stockholder and the stockholder's nominees,
- any agreements between the relevant parties pursuant to which the
nomination is to be made, and
- the signed consent of each nominee to serve as a director of
Interstate Management, if elected.
The presiding officer of the annual meeting may refuse to acknowledge the
nomination of any person not made in compliance with these requirements or the
requirements of the securities laws.
Any vacancy that occurs on the Board will be filled by first giving effect to
the respective rights of holders of Class B shares and Class C shares to replace
Class B directors and Class C directors. Otherwise a majority of the votes cast
by the holders of Class A shares will fill vacancies due to removal for cause
and the majority vote of the remaining directors will generally fill vacancies
which occur for any other reason.
Any director may be removed from office for cause by the affirmative vote of the
holders of at least 75% of the shares then entitled to vote at a meeting of
stockholders called for that purpose. Additionally, any Class B director or
Class C director may be removed from office with or without cause by the
affirmative vote of a majority of the holders of Class B shares or the holders
of Class C shares, respectively, at a meeting of such stockholders called for
the purpose. Class B and Class C directors may also be removed by unanimous
written consent of their respective class of stockholders.
INDEMNIFICATION OF OFFICERS AND DIRECTORS. We have agreed to indemnify our
officers and directors to the maximum extent authorized or permitted under
applicable law. Maryland's corporation law generally permits the liability of
directors and officers to a corporation for monetary damages to be limited,
unless it is proven that (i)(a) the director or officer actually received an
improper personal benefit in money, property or services, (b) the director or
officer acted in bad faith, or (c) the director's or officer's act or omission
was the result of active and deliberate dishonesty, and (ii) the director's or
officer's act or omission was material to the matter giving rise to the
proceeding. However, in the case of a suit by or in the right of Interstate
Management, a director or officer may not be indemnified in respect of any
proceeding in which he shall have been adjudged liable to Interstate Management,
unless and only to the extent that a court of appropriate jurisdiction
determines that such person is fairly and reasonably entitled to indemnity for
such expenses as such court may deem proper. Any amendment or repeal of our
Articles of Incorporation may not adversely affect the rights of any person
entitled to indemnification for any event occurring prior to such amendment or
repeal.
AMENDMENT OF THE BYLAWS. Except as provided by law, the Board has the exclusive
power to alter or repeal the Bylaws by the affirmative vote of a majority of the
directors then in office. In certain limited circumstances, as more fully
described in the Bylaws, a bylaw may only be amended by (i) the affirmative
59
<PAGE> 63
vote of a majority of the directors than in office and each of the Class B and
Class C directors or (ii) by the holders of a majority of the outstanding shares
entitled to vote on the matter.
SHAREHOLDER RIGHTS PLAN
We intend to adopt a shareholder rights plan. In connection with the adoption of
the rights plan, we will declare a dividend distribution of one preferred stock
purchase right (a "Right") for each outstanding Interstate Management share to
stockholders of record as of a specified date. Each Right will entitle its
holder to purchase from Interstate Management a unit consisting of a specified
number of shares of Preferred Stock of Interstate Management at a specified cash
exercise price per unit, subject to adjustment.
Initially, the Rights will not be exercisable and will attach to and trade with
all Interstate Management shares outstanding as of, or issued subsequent to, the
record date. The Rights will separate from Interstate Management shares and will
become exercisable upon the earlier of (i) the close of business on the tenth
calendar day following the first public announcement that a person or group of
affiliated or associated persons has acquired beneficial ownership of 10% or
more of the outstanding Interstate Management shares (an "Acquiring Person"), or
(ii) the close of business on the tenth business day following the commencement
of a tender offer or exchange offer that would result upon its consummation in a
person or group becoming the beneficial owner of 10% or more of the outstanding
Interstate Management shares.
In the case of certain stockholders of Interstate Management who beneficially
own 10% or more of the outstanding Interstate Management shares as of a
specified date, (such stockholders are referred to in the rights agreement as
"grandfathered persons"), the Rights generally will be distributed only if any
such stockholder acquires or proposes to acquire additional Interstate
Management shares. In addition, a "grandfathered person" generally will become
an Acquiring Person only if such person acquires additional Interstate
Management shares.
The shareholder rights agreement will effectively prevent any person or group
from acquiring more than 10% of our shares without our Board's approval.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1 in connection
with the spin-off. As permitted by SEC rules, this Information
Statement/Prospectus does not contain all of the information contained in the
registration statement or in the exhibits to the registration statement. For
further information you may read and copy documents at the public reference room
of the SEC at 450 5th Street, N.W., Washington, D.C. 20549, and at the regional
offices of the SEC at 7 World Trade Center, Suite 1300, New York, New York 10048
and at Citicorp Center, Suite 1400 and 500 West Madison Street, Chicago,
Illinois 60661. Please call the SEC at 1-800-SEC-0330 for further information on
the public reference rooms. The SEC charges a fee for copies. Copies of this
material should also be available through the Internet at the SEC EDGAR Archive,
the address of which is http://www.sec.gov. In addition, our filings may be
inspected at the offices of the New York Stock Exchange, 20 Broad Street, New
York, New York 10005.
Following the spin-off, we will be required to file annual, quarterly and other
reports with the SEC. We will also be subject to the proxy rules and,
accordingly, will furnish audited financial statements to you in connection with
our annual meetings of stockholders.
No person is authorized by Patriot or Interstate Management to give any
information or to make any representations other than those contained in this
Information Statement/Prospectus, and, if given or made, you should not rely
upon such information.
60
<PAGE> 64
INTERSTATE HOTELS MANAGEMENT, INC.
INDEX TO COMBINED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
-------
<S> <C>
Report of Independent Accountants........................... F-2
Combined Balance Sheets as of December 31, 1997 and 1998.... F-3
Combined Statements of Operations and Owners' Equity for the
years ended December 31, 1996 and 1997 and for the period
from January 1, 1998 to June 1, 1998 and for the period
from June 2, 1998 to December 31, 1998.................... F-4
Combined Statements of Cash Flows for the years ended
December 31, 1996 and 1997 and for the period from January
1, 1998 to June 1, 1998 and for the period from June 2,
1998 to December 31, 1998................................. F-5
Notes to Combined Financial Statements...................... F-6-19
</TABLE>
F-1
<PAGE> 65
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors of Patriot American Hospitality,
Inc.:
We have audited the accompanying combined balance sheets of Interstate Hotels
Management, Inc. (Interstate Management), comprised of businesses of Interstate
Hotels Company, which was acquired by Patriot American Hospitality, Inc., as
described in Note 1 of the combined financial statements, as of December 31,
1997 and 1998, and the related combined statements of operations and owners'
equity and cash flows for the period from January 1, 1998 to June 1, 1998 and
for the period from June 2, 1998 to December 31, 1998 and for each of the two
years in the period ended December 31, 1997. These combined financial statements
are the responsibility of Interstate Management's management. Our responsibility
is to express an opinion on these combined financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1, Interstate Management was not a separate legal entity
during the periods presented. The accompanying combined financial statements
have been prepared for the purpose of complying with the rules and regulations
of the Securities and Exchange Commission and are not intended to be a complete
presentation of the combined financial statements of Interstate Hotels Company
or its affiliates.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the combined financial position of Interstate
Management as of December 31, 1997 and 1998, and the combined results of its
operations, owners' equity and cash flows for the period from January 1, 1998 to
June 1, 1998 and for the period from June 2, 1998 to December 31, 1998 and for
each of the two years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
As discussed in Note 3, Interstate Management adopted the provisions of Emerging
Issues Task Force Issue 97-14 effective September 30, 1998.
/s/ PricewaterhouseCoopers LLP
600 Grant Street
Pittsburgh, Pennsylvania
March 5, 1999
F-2
<PAGE> 66
INTERSTATE HOTELS MANAGEMENT, INC.
COMBINED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
-------- --------
DECEMBER 31,
------------------------
1997 1998
----------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 2,432 $ 1,652
Accounts receivable, net.................................. 15,707 16,816
Deferred income taxes..................................... 1,151 615
Net investment in direct financing leases................. 751 827
Prepaid expenses and other assets......................... 3,613 741
Related party receivables -- management contracts......... 1,761 1,085
-------- --------
Total current assets................................. 25,415 21,736
Restricted cash............................................. 2,324 2,201
Marketable securities....................................... -- 2,609
Property and equipment, net................................. 3,639 4,076
Officers and employees notes receivable..................... 12,157 2,803
Affiliate receivables....................................... 5,113 3,381
Net investment in direct financing leases................... 1,524 1,680
Investment in hotel real estate............................. 17,042 22,150
Deferred income taxes....................................... 660 --
Intangible and other assets................................. 50,311 100,521
-------- --------
Total assets......................................... $118,185 $161,157
======== ========
Current liabilities:
Accounts payable -- trade................................. 3,478 2,413
Accounts payable -- health trust.......................... 1,382 1,785
Accounts payable -- related parties....................... 10,260 18,597
Accrued payroll and related benefits...................... 9,586 6,120
Accrued rent.............................................. 5,875 5,043
Accrued merger costs...................................... -- 9,344
Other accrued liabilities................................. 6,501 9,236
Current portion of long-term debt......................... 180 --
-------- --------
Total current liabilities............................ 37,262 52,538
Long-term debt.............................................. 190 --
Deferred income taxes....................................... -- 11,053
Deferred compensation....................................... -- 2,609
-------- --------
Total liabilities.................................... 37,452 66,200
Minority interest........................................... 3 2,350
Commitments and contingencies............................... -- --
Owners' equity.............................................. 80,730 92,607
-------- --------
Total liabilities and owners' equity................. $118,185 $161,157
======== ========
</TABLE>
The accompanying notes are an integral part of the combined financial
statements.
F-3
<PAGE> 67
INTERSTATE HOTELS MANAGEMENT, INC.
COMBINED STATEMENTS OF OPERATIONS AND OWNERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
----------------------------------------- -----------------
PERIOD FROM
YEAR ENDED DECEMBER -------------------------------------
31, JANUARY 1, 1998 JUNE 2, 1998
--------------------- TO TO
1996 1997 JUNE 1, 1998 DECEMBER 31, 1998
-------- -------- --------------- -----------------
<S> <C> <C> <C> <C>
Lodging revenues:
Rooms....................... $ 9,258 $158,343 $ 74,265 $108,698
Other departmental.......... 721 9,512 4,504 6,455
Net management fees........... 33,023 39,136 18,018 22,763
Other fees (Note 13).......... 20,710 23,426 9,976 10,478
-------- -------- -------- --------
63,712 230,417 106,763 148,394
-------- -------- -------- --------
Lodging expenses:
Rooms....................... 2,334 36,919 17,173 26,567
Other departmental.......... 591 5,487 2,674 3,962
Property costs.............. 3,201 43,225 19,987 30,261
General and administrative.... 10,369 13,212 6,115 5,822
Payroll and related
benefits.................... 17,666 21,892 10,982 10,439
Non-cash compensation......... 11,896 -- -- --
Lease expense................. 3,477 73,283 34,515 51,165
Depreciation and
amortization................ 4,385 4,845 2,152 10,659
-------- -------- -------- --------
53,919 198,863 93,598 138,875
-------- -------- -------- --------
Operating income.............. 9,793 31,554 13,165 9,519
Other income:
Interest, net............... 501 498 204 390
Other, net.................. -- 431 474 1,391
-------- -------- -------- --------
Income before income tax
expense..................... 10,294 32,483 13,843 11,300
Income tax expense.......... 4,117 12,986 5,528 4,436
-------- -------- -------- --------
Income before minority
interest.................... 6,177 19,497 8,315 6,864
Minority interest............. -- 18 24 209
-------- -------- -------- --------
Net income.................... $ 6,177 $ 19,479 $ 8,291 $ 6,655
======== ======== ======== ========
Owners' equity:
Beginning of period......... 63,840 56,886 80,730 79,181
Net income.................. 6,177 19,479 8,291 6,655
Net capital distributions... (60,548) 4,365 (9,840) (49,981)
Change in Basis (Note 3).... -- -- -- 56,752
Acquisition of hotel leases
for stock................ 47,417 -- -- --
-------- -------- -------- --------
End of period............... $ 56,886 $ 80,730 $ 79,181 $ 92,607
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of the combined financial
statements.
F-4
<PAGE> 68
INTERSTATE HOTELS MANAGEMENT, INC.
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
PREDECESSOR SUCCESSOR
----------------------------------------- -----------------
PERIOD FROM
YEAR ENDED ------------------------------------
DECEMBER 31, JANUARY 1, 1998 JUNE 2, 1998
---------------------- TO TO
1996 1997 JUNE 1, 1998 DECEMBER 31, 1998
-------- -------- --------------- -----------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income........................... $ 6,177 $ 19,479 8,291 6,655
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization...... 4,385 4,845 2,152 10,659
Equity in earnings from
unconsolidated subsidiaries...... -- (373) (513) (1,526)
Deferred income taxes.............. (1,644) 167 (1,555) 8,346
Other.............................. -- 18 200 344
Cash (used) provided by assets and
liabilities:
Accounts receivable, net........... 2,848 (8,158) (3,661) 2,552
Prepaid expenses and other
assets........................... (3,033) (267) 307 1,092
Related party receivables.......... (2,912) 1,312 (341) 1,017
Accounts payable................... 9,096 (2,572) 1,053 (5,181)
Accrued liabilities................ 414 (1,934) 12,426 (14,365)
-------- -------- -------- --------
Net cash provided by operating
activities.................... 15,331 12,517 18,359 9,593
-------- -------- -------- --------
Cash flows from investing activities:
Net investment in direct financing
leases............................. (1,007) (33) 145 (377)
Change in restricted cash............ (9) (219) 540 (417)
Purchase of property and equipment,
net................................ (695) (2,170) (709) (487)
Purchases of marketable securities... -- -- -- (10,725)
Proceeds from sale of marketable
securities......................... -- -- -- 14,567
Net cash invested in unconsolidated
subsidiaries....................... -- (16,147) 1,085 (2,327)
Change in notes receivable, net...... (3,384) (7,554) (2) (989)
Net investment in management
contracts.......................... -- (2,116) (666) (548)
Merger related acquisition costs..... -- -- -- (26,484)
Change in affiliate receivables...... 751 (5,071) 2,043 (311)
Acquisitions of leases............... -- (2,500) -- --
Other................................ 6 103 238 391
-------- -------- -------- --------
Net cash (used in) provided by
investing activities.......... (4,338) (35,707) 2,674 (27,707)
-------- -------- -------- --------
Cash flows from financing activities:
Repayment of long-term debt.......... (729) (171) (180) (190)
Net distributions to minority
interest........................... -- -- (44) (55)
Related party payables............... -- 10,260 (9,234) 17,571
Net (distributions) contributions to
owners............................. (13,131) 4,365 (9,840) (1,727)
-------- -------- -------- --------
Net cash (used in) provided by
financing activities.......... (13,860) 14,454 (19,298) 15,599
-------- -------- -------- --------
Net (decrease) increase in cash and
cash equivalents..................... (2,867) (8,736) 1,735 (2,515)
Cash and cash equivalents at beginning
of period............................ 14,035 11,168 2,432 4,167
-------- -------- -------- --------
Cash and cash equivalents at end of
period............................... $ 11,168 $ 2,432 $ 4,167 $ 1,652
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of the combined financial
statements.
F-5
<PAGE> 69
INTERSTATE HOTELS MANAGEMENT, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(IN THOUSANDS)
1. ORGANIZATION AND BASIS OF PRESENTATION:
Interstate Hotels Company and Subsidiaries (Interstate or the Predecessor) was
merged into Patriot American Hospitality, Inc. (Patriot) on June 2, 1998.
Interstate owned 23 hotels and had a controlling interest in 17 other hotels
(collectively, the Owned Hotels), held long-term leasehold interests in 89
hotels (the Leased Hotels), and provided management and other related services
to 94 hotels (the Managed Hotels) owned by third parties as of December 31,
1997. The Owned Hotels, the Leased Hotels and the Managed Hotels (collectively,
the Hotels) were located in 35 states and the District of Columbia, Canada, the
Caribbean, and Russia, with the largest concentration in the states of Florida
and California. The Hotels were operated under a number of franchise agreements,
with the largest franchisors being Marriott International, Inc. (Marriott) and
Promus Hotels, Inc. The Hotels were all subject to management agreements with
Interstate Hotels Corporation (IHC), Crossroads Hospitality Company, L.L.C.
(Crossroads) or Colony Hotels and Resorts Company (Colony), all wholly-owned
subsidiaries of Interstate.
Prior to the consummation of the merger of Interstate into Patriot (the
"Merger"), Marriott filed a lawsuit to stop the closing of the transaction as a
result of a dispute over certain franchise agreements Marriott had with
Interstate. On May 27, 1998, and pursuant to a settlement agreement with
Marriott, Patriot and Interstate announced a plan to transfer certain
operations, principally the third-party hotel management business, an ownership
interest in the Charles Hotel and the Leased Hotels, and certain assets and
liabilities of Interstate to a new entity, Interstate Hotels Management, Inc.
(the Company). The Company is expected to be spun-off from Patriot (the
Spin-off) prior to March 31, 1999, which will result in the Company operating as
an independent entity with publicly traded common stock. Ninety-two percent of
the shares of the Company will be distributed to Patriot's shareholders. Patriot
and Marriott will each hold a 4% ownership interest in the Company's common
stock after the Spin-off.
These financial statements, prior to the Merger, have been prepared using the
predecessor basis of accounting for the years ended December 31, 1996 and 1997
and for the period from January 1, 1998 to June 1, 1998 (June 1998 period) and
have been prepared using the successor basis of accounting for the period June
2, 1998 to December 31, 1998 (December 1998 period) to coincide with the periods
before and after the Merger. The Merger was accounted for using the purchase
method of accounting and Patriot allocated the purchase price to the fair market
value of the assets acquired. The spin-off will be accounted for using this
historical basis of accounting. All references as of and for the two years in
the period ended December 31, 1997 and for the June 1998 period relate to the
predecessor and all references to December 31, 1998 and the December 1998 period
relate to the successor.
The Company was not a separate legal entity during the periods presented in
these financial statements. The accompanying combined financial statements of
the Company have been carved out of Interstate using the predecessor basis of
accounting and subsequent to the merger with Patriot include the successor's
basis of accounting which considers the effect of the purchase price allocation.
The financial statements include only those assets, liabilities, revenues and
expenses directly attributable to the third-party hotel management business, the
ownership interest in the Charles Hotel, the Leased Hotels and other services
described in the paragraph above which will succeed to the Company. These
activities were conducted primarily by IHC, Crossroads and Colony. These
combined financial statements have been prepared for the purpose of complying
with the rules and regulations of the Securities and Exchange Commission, and as
if the Company had operated as a free-standing entity for all periods presented.
All investments in, associated debt, and results of operations of the Owned
Hotels, as well as certain other operating subsidiaries (see Note
F-6
<PAGE> 70
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
1. ORGANIZATION AND BASIS OF PRESENTATION, CONTINUED:
13) that will not be included in the continuing business of the Company, have
been carved out of the historical combined financial statements.
The Company will have two principal subsidiaries. One subsidiary will assume
management of the Managed Hotels and will hold the ownership interest in the
Charles Hotel and the leasehold interests of the Leased Hotels as well as
provide ancillary services previously provided by Interstate, primarily
centralized purchasing, equipment leasing and insurance services. The Company
will own a 45% managing member interest in this subsidiary and Patriot will
retain a 55% non-controlling ownership interest. The other subsidiary will enter
into management contracts to manage eleven Owned Hotels with the tenant of such
Owned Hotels, Wyndham International Operating Partnership, L.P., and will then
subcontract the management to Marriott. The Company will retain a controlling
99.99% interest in this subsidiary and Marriott will own a .01% interest in this
subsidiary.
The Company includes the revenues and expenses and assets and liabilities of the
Leased Hotels in the financial statements since the risk of operating these
hotels is borne by the Company, as lessee, under the terms of the lease. As a
result of the terms of the management contracts, the revenues and expenses from
operations of the Managed Hotels are not included in the financial statements
since the contracts are generally cancellable, not transferable and do not shift
risks of operations to the Company. Accordingly, the Company records revenues
from management fees for the Managed Hotels.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Combination and Consolidation:
The combined financial statements include the accounts of the entities described
in Note 1. All significant intercompany transactions and balances have been
eliminated.
Cash and Cash Equivalents:
All unrestricted, highly liquid investments purchased with a remaining maturity
of three months or less are considered to be cash equivalents. The Company
maintains cash and cash equivalents with various financial institutions in
excess of the amount insured by the Federal Deposit Insurance Corporation.
Management believes the credit risk related to these cash and cash equivalents
is minimal. Beginning in 1997, certain cash of the Company was swept from
individual accounts and combined with Interstate's cash in a central account.
Amounts owed to related entities to meet short-term cash requirements in
connection with Interstate's centralized cash account are recorded as Accounts
payable -- related parties.
Restricted Cash:
Capital restricted under applicable government insurance regulations is included
in restricted cash, and represents approximately 20% of the annual insurance
premiums written by the Company (See Note 13).
Direct Financing Leases:
Equipment acquired and subsequently leased to hotels under capital leases is
recorded at the net investment in direct financing leases, which represents the
total future minimum lease payments receivable net of
F-7
<PAGE> 71
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
unearned income. When payments are received, the receivable is reduced and the
unearned income is recognized on a pro-rata basis over the life of the lease.
Property and Equipment:
Property and equipment are recorded at cost, and are depreciated on the
straight-line method over their estimated useful lives. Expenditures for repairs
and maintenance are expensed as incurred. Expenditures for major renewals and
betterments that significantly extend the useful life of existing property and
equipment are capitalized and depreciated. The cost and the related accumulated
depreciation applicable to property no longer in service are eliminated from the
accounts and any gain or loss thereon is included in operations.
Officers and Employees Notes Receivable:
Officers notes receivable consist principally of the advances on expected
severance payments and notes from two executives at December 31, 1997. The notes
from the two executives and the advances were forgiven effective with the
Merger. The Company also makes loans from time to time to other employees, which
are payable upon demand and generally do not bear interest until such demand is
made. Certain notes may be forgiven and expensed provided certain conditions are
satisfied. Officers and employees notes receivable also include a note with a
former officer and significant shareholder of Interstate (see Note 15).
Intangible and Other Assets:
Intangible and other assets consist of the amounts paid to obtain management and
lease contracts including the allocation of the Interstate purchase price paid
by Patriot. Goodwill is also included in intangible and other assets through
December 31, 1997, and represents the excess of the purchase price over the book
value of the net assets of businesses acquired. Intangibles and other assets are
amortized on the straight-line method over the life of the underlying contracts
or estimated useful lives.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of:
The carrying values of long-lived assets, which include property and equipment
and all intangible assets, are evaluated periodically in relation to the
operating performance and future undiscounted cash flows of the underlying
assets. Adjustments are made if the sum of expected future net cash flows is
less than book value. No adjustments to the carrying values of long-lived assets
have been recorded to date.
Deferred Income Taxes:
Deferred income taxes are recorded in the combined financial statements of
Interstate Management using the liability method. Under this method, deferred
tax assets and liabilities are provided for the differences between the
financial statement and the tax basis of assets and liabilities using enacted
tax rates in effect for the years in which the differences are expected to
reverse.
Income Tax Status:
The entities that comprised Interstate Management were included in the
consolidated federal income tax return of Interstate and all tax liabilities
were paid by Interstate or Patriot. The income tax provision for each period
presented in these combined financial statements has been calculated as if
Interstate Management had prepared and filed a separate income tax return for
those periods. Accordingly, the effective tax rate for
F-8
<PAGE> 72
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
Interstate Management in future years could vary from historical effective rates
depending on Interstate Management's future legal and tax elections. The income
tax liability for all current income taxes for purposes of these combined
financial statements have been settled with Interstate or Patriot through
owners' equity.
Insurance:
Insurance revenues are earned through reinsurance premiums, direct premiums
written and reinsurance premiums ceded. Reinsurance premiums are recognized when
policies are written and any unearned portion of the premium is recognized to
account for the unexpired term of the policy (as-reported basis). Direct
premiums written are recognized pursuant to the underlying policy and
reinsurance premiums ceded are recognized on a pro-rata basis over the life of
the related policies. Unearned premiums represent the portion of premiums
applicable to the unexpired term of policies in force. Losses are provided for
reported claims, claims incurred but not reported and claims settlement expense
at each balance sheet date. Such losses are based on management's estimate of
the ultimate cost of settlement of claims and historical loss rates. Accrued
claims liabilities are carried at present value without discounting since the
contracts are of a short duration and discounting would not be significant.
Actual liabilities may differ from estimated amounts. Any changes in estimated
losses and settlements are reflected in current earnings.
Owners' Equity:
Owners' equity represents the net equity of Interstate and Patriot in Interstate
Management. Net contributions/distributions from owners represent non-operating
transfers to and from Interstate and Patriot.
Revenue Recognition:
The Leased Hotels recognize revenue from their rooms, food and beverage and
other departments as earned on the close of each business day. Management and
other related fees are recognized when earned.
Reimbursable Expenses:
Interstate Management is reimbursed for costs associated with providing certain
insurance and risk management services, purchasing and project management
services, MIS and legal support, centralized accounting, training and relocation
programs to the Managed and Leased Hotels. These revenues are included in other
fees and the corresponding costs are included in general and administrative and
payroll and related benefits in the combined statements of operations and
owners' equity.
Financial Instruments:
As a policy, Interstate Management does not engage in speculative or leveraged
transactions, nor does Interstate Management hold or issue financial instruments
for trading purposes.
Earnings Per Share:
Because the accompanying combined financial statements have been carved out of
Interstate and Patriot and certain of its subsidiaries, some of which are/were
corporations and some of which are/were partnerships, Interstate Management
believes that the earnings per share calculations required to be presented are
not meaningful for periods presented herein and, therefore, have not been
provided. In conjunction with the
F-9
<PAGE> 73
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
Spin-off the Company will distribute common stock which will be accounted for in
a manner similar to a recapitalization or stock split. Accordingly, after the
Spin-off, the Company will provide earnings per share based on the then
outstanding shares.
Use of Estimates:
The preparation of the combined financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions. These may affect the reported amounts of assets and liabilities
and the disclosure of contingent assets and liabilities at the date of the
combined financial statements. They may also affect the reported amounts of
revenues and expenses during the reporting periods. Actual results could differ
from those estimates.
3. MERGER:
In connection with the Merger, Patriot allocated the purchase price to the
estimated fair market value of the assets acquired. The fair market value of the
assets held by Interstate Management were determined using historical and
projected cash flow and earnings at then current market multiples. As a result,
on June 2, 1998, Interstate Management recorded an additional intangible asset
related to management contracts of $69,862, a net decrease in other assets of
$7,652 related to hotel leases and a deferred tax liability of $5,458, resulting
in a net increase to owners' equity of $56,752 (Change in Basis). The intangible
asset related to the management contacts will amortize over five years, based on
the average remaining contract term, and the intangible asset related to the
Leased Hotels will be amortized over the remaining periods of the leases of 11
and 13.5 years beginning June 2, 1998.
Prior to the Merger, merger-related costs incurred by Interstate and were not
reflected in the accompanying combined statement of operations for the June 1998
period, as they did not relate specifically to the ongoing business of
Interstate Management. In connection with the Merger, severance payments and
other merger-related costs were incurred by Patriot and capitalized as part of
the purchase price of Interstate. Certain of these costs were paid by Interstate
in the December 1998 period and certain remain unpaid at December 31, 1998.
These remaining merger-related costs, amounting to $9,344 at December 31, 1998,
have been accrued by Interstate Management and consist principally of unpaid
severance and professional fees.
4. CHANGE IN ACCOUNTING:
Effective September 30, 1998, the Company adopted the provisions of Emerging
Issues Task Force Issue 97-14 "Accounting for Deferred Compensation Arrangements
Where Amounts Earned are Held in a Rabbi Trust and Invested" (EITF 97-14). The
issue requires that the accounts of the rabbi trust (Trust) be consolidated with
the accounts of the employer. Previously the accounts of the Trust were not
consolidated.
The Company provides deferred compensation for certain executives and hotel
general managers by depositing amounts into a Trust for the benefit of the
participating employees. Deposits into the Trust are expensed under both
accounting methods and amounted to $331, $662, $178 and $250 for the years ended
December 31, 1996 and 1997 and for the June 1998 and December 1998 periods,
respectively. Amounts in the Trust earn investment income, which serves to
increase the corresponding deferred compensation obligation. Amounts in the
Trust are always fully vested.
F-10
<PAGE> 74
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
4. CHANGE IN ACCOUNTING, CONTINUED:
The effect of adopting EITF 97-14 as of September 30, 1998 was an increase in
investments and deferred compensation of $6,451. Investments are recorded at
market value, which approximates cost, are directed by the Company, and consist
principally of mutual funds. The adoption did not have any effect on net income
in the December 1998 period and is not expected to significantly impact net
income in future periods.
In October 1998 Interstate Management paid $4,213 in deferred compensation to
certain executives from the Trust.
5. PROPERTY AND EQUIPMENT:
Property and equipment consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Leasehold improvements (10 years)........................... $ 1,345 $ 1,000
Furniture, fixtures and equipment (5 to 20 years)........... 6,021 3,522
------- -------
7,366 4,522
Less accumulated depreciation............................... (3,727) (446)
------- -------
$ 3,639 $ 4,076
======= =======
</TABLE>
Depreciation expense was approximately $523, $666, $313 and $446 for the years
ended December 31, 1996 and 1997 and for the June 1998 and December 1998
periods, respectively.
6. NET INVESTMENT IN DIRECT FINANCING LEASES:
The Company leases office, computer and telephone equipment to managed hotels
under capital leases. The following represents the components of the net
investment in direct financing leases at December 31:
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Total future minimum lease payments receivable.............. $ 2,918 $ 3,118
Less unearned income........................................ 643 611
------- -------
2,275 2,507
------- -------
Less current portion........................................ 751 827
------- -------
$ 1,524 $ 1,680
======= =======
</TABLE>
Future minimum lease payments to be received under these leases for each of the
years ending December 31 are as follows:
<TABLE>
<S> <C>
1999........................................................ $ 1,297
2000........................................................ 846
2001........................................................ 630
2002........................................................ 262
2003........................................................ 83
-------
$ 3,118
=======
</TABLE>
Included in the direct financing leases is $1,015 and $1,122 of leases due from
the Owned Hotels as of December 31, 1997 and 1998, respectively.
F-11
<PAGE> 75
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
7. INTANGIBLE AND OTHER ASSETS:
Intangible and other assets consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
------- --------
<S> <C> <C>
Management contracts (3 to 6 years through June 1998, 5
years in December 1998)................................ $ 8,568 $ 74,109
Lease contracts (15 and 11 years through June 1998, 13.5
and 11 years in December 1998)......................... 24,284 36,832
Goodwill (25 years)...................................... 21,725 --
Other.................................................... 2,056 --
------- --------
56,633 110,941
Less accumulated amortization............................ (6,322) (10,420)
------- --------
$50,311 $100,521
======= ========
</TABLE>
8. COMMITMENTS AND CONTINGENCIES:
Leases, entered into by the Leased Hotels, have initial terms of 10 to 15 years
expiring through 2012, and provide for fixed base rent and variable components
based on a percentage of hotel revenues. Future fixed minimum lease payments are
computed based on the base rent of each lease, as defined, and are as follows:
<TABLE>
<S> <C>
1999........................................................ $ 49,901
2000........................................................ 49,901
2001........................................................ 49,901
2002........................................................ 49,901
2003........................................................ 49,901
Thereafter.................................................. 364,814
--------
$614,319
========
</TABLE>
Interstate Management accounts for the leases of office space (the office leases
expire at varying times through 2005) and certain office equipment (the
equipment leases expire at varying times through 2003) as operating leases.
Total rent expense amounted to approximately $1,020, $1,571, $911 and $1,305 for
the years ended December 31, 1996 and 1997 and for the June, 1998 and December
1998 periods, respectively. The following is a schedule of future minimum lease
payments under these leases:
<TABLE>
<S> <C>
1999........................................................ $ 2,170
2000........................................................ 1,923
2001........................................................ 1,849
2002........................................................ 1,337
2003........................................................ 1,331
Thereafter.................................................. 408
-------
$ 9,018
=======
</TABLE>
Interstate Management, pursuant to certain management contracts, has agreed to
provide additional loans of up to $750, in the aggregate, to the owner of a
hotel located in Russia.
F-12
<PAGE> 76
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
8. COMMITMENTS AND CONTINGENCIES, CONTINUED:
In the ordinary course of business, various lawsuits, claims and proceedings
have been or may be instituted or asserted against Interstate. Interstate
Management will be held liable for certain of the lawsuits, claims and
proceedings instituted or asserted against Interstate to the extent that the
claim relates to operations of Interstate Management. Based on currently
available facts, management believes that the disposition of matters that are
pending or asserted against Interstate Management will not have a material
adverse effect on the combined financial position, results of operations or
liquidity of Interstate Management.
Risk Related to Dispute Over Leased Hotel Portfolio:
Interstate Management is engaged in a dispute with Equity Inns Partnership, L.P.
(Equity Inns) regarding the status of leases for 80 hotels Interstate Management
leases from Equity Inns or its affiliates. The principal issue in the dispute is
whether Interstate Management or Equity Inns is responsible for funding property
improvement plans (PIPs) which were issued by certain franchisors under whose
brand names Interstate Management operates the Leased Hotels. Although franchise
agreements generally provide to franchisors the right to require PIPs at any
time, these PIPs were issued as a result of Patriot's merger with Interstate.
The total amount required to be funded under the PIPs is approximately $6.0
million.
Generally, the leases require Equity Inns to satisfy any capital obligations
relating to the Leased Hotels, including any PIPs issued from time to time by
franchisors. In this case, however, Equity Inns is claiming that because certain
franchisors issued the new PIPs as a result of the franchisee change in control
provisions of the franchises triggered by Merger and the new franchise
applications Patriot has been required to submit as a result of the Merger,
Patriot should be responsible for paying the costs necessary to satisfy them. In
addition, Equity Inns claims that it had the right under the leases to consent
in advance to Patriot's application for new franchise agreements and has
demanded that Interstate Management pay the costs necessary to satisfy the PIPs
as a condition to continuation of the leases. Management is vigorously disputing
Equity Inns' claims, but they cannot be sure that they will prevail. The Equity
Inns leaseholds represent a significant portion of Interstate Management's
current business and if management is not able to resolve this dispute with
Equity Inns and the leases are terminated, Interstate Management's results will
be negatively affected.
9. NET MANAGEMENT FEES:
Interstate Management's management agreements have initial terms that range from
one month to 22 years, expire through the year 2019 and are generally cancelable
under certain conditions, including the sale of the hotel. In addition, certain
agreements are renewable for successive terms of one to ten years.
The management agreements specify the base management fees to be earned, which
are generally based on percentages of gross revenues. In certain cases,
incentive management fees are earned based on the hotels'
F-13
<PAGE> 77
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
9. NET MANAGEMENT FEES, CONTINUED:
profitability as defined by the management agreements. The net management fees
earned for the years ended December 31 and the June 1998 and December 1998
periods were as follows:
<TABLE>
<CAPTION>
JUNE DECEMBER
1996 1997 1998 1998
------- ------- ------- --------
<S> <C> <C> <C> <C>
Base management fees................. $27,802 $32,220 $14,435 $16,108
Incentive management fees............ 5,766 7,238 3,882 7,096
------- ------- ------- -------
33,568 39,458 18,317 23,204
Less:
Administrative fees................ 545 322 299 441
------- ------- ------- -------
$33,023 $39,136 $18,018 $22,763
======= ======= ======= =======
</TABLE>
10. NON-CASH COMPENSATION:
Prior to an initial public offering of Interstate's common stock in 1996,
Interstate issued 785,533 shares of common stock to certain employees in
consideration for the cancellation of certain stock options issued by IHC in
1995. The shares were valued based on the estimated value of the common stock at
the time the shares were issued. As a result of the cancellation of the stock
options issued by IHC in 1995 and the issuance of the common stock at no cost to
the recipients, Interstate Management recorded non-cash compensation expense of
$11,896.
11. INCOME TAXES:
Income tax expense consisted of the following for the years ended December 31
and for the June 1998 period and the December 1998 period:
<TABLE>
<CAPTION>
JUNE DECEMBER
1996 1997 1998 1998
------- ------- ------- --------
<S> <C> <C> <C> <C>
Current:
Federal................................ $ 5,041 $11,217 $ 6,198 $(3,421)
State.................................. 720 1,602 885 (489)
------- ------- ------- -------
5,761 12,819 7,083 (3,910)
------- ------- ------- -------
Deferred:
Federal................................ (1,438) 146 (1,360) 7,303
State.................................. (206) 21 (195) 1,043
------- ------- ------- -------
(1,644) 167 (1,555) 8,346
------- ------- ------- -------
Income tax expense..................... $ 4,117 $12,986 $ 5,528 $ 4,436
======= ======= ======= =======
</TABLE>
The provision for income tax was recorded based on the federal statutory rate of
35% plus the state tax rate, net of federal income tax benefit of 5% after
consideration of minority interests in passthrough tax entities. These rates
approximate Interstate's historical rates.
F-14
<PAGE> 78
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
11. INCOME TAXES, CONTINUED:
The components of net deferred tax assets and liabilities consisted of the
following at December 31:
<TABLE>
<CAPTION>
1997 1998
--------------------- ---------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Depreciation and amortization................... $ 410 $ -- $ -- $11,749
Payroll and related benefits.................... 121 -- 139 --
Self-insured health trust....................... 36 -- 614 --
Retirement plan................................. 1,356 -- -- 90
Other........................................... -- 362 -- 48
Investment in Hotel real estate................. 250 -- 696 --
------ ---- ------ -------
$2,173 $362 $1,449 $11,887
====== ==== ====== =======
</TABLE>
12. SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest amounted to $274, $29, $20 and $10 for the years ended
December 31, 1996, and 1997 and for the June 1998 and December 1998 period,
respectively. Non-cash, equity-related compensation of $11,896 was excluded from
the combined statement of cash flows in 1996. Additionally, stock valued at
$47,417 was used to purchase certain hotel leases and was also excluded from the
combined statement of cash flows in 1996.
In connection with the Merger, in the December 1998 period, Interstate
Management excluded a non-cash step-up of $30,268 which includes an increase to
the management contract intangible of $43,378, a decrease in other assets
related to hotel leases of $7,652 and a deferred tax liability of $5,458, from
the December 1998 period statement of cash flows. In addition, as a result of
the change in accounting discussed in Note 4, the Company recorded marketable
securities and deferred compensation in the amount of $6,451 as of September 30,
1998 which was also excluded from the December 1998 period statement of cash
flows.
13. INSURANCE:
Interstate Management provides certain insurance coverage to hotels under the
terms of the various management and lease contracts. This insurance is generally
arranged through third-party carriers. Northridge Insurance Company
(Northridge), a subsidiary of Interstate Management, reinsures a portion of the
coverage from these third-party primary insurers. The policies provide for
layers of coverage with minimum deductibles and annual aggregate limits. The
policies are for coverage relating to innkeepers' losses (general/comprehensive
liability), wrongful employment practices, garagekeeper's legal liability,
replacement cost automobile losses and real and personal property insurance.
Interstate Management is liable for any deficiencies in the IHC Employee Health
and Welfare Plan (and related Health Trust), which provides employees of
Interstate Management with group health insurance benefits. Interstate
Management has a financial indemnity liability policy with Northridge which
indemnifies Interstate Management for certain obligations for the deficiency in
the related Health Trust. The premiums for this coverage received from the
properties managed by Interstate Management, net of intercompany amounts paid
for employees at Interstate Management's corporate offices and Leased Hotels,
are recorded as direct premiums written. There was a deficiency of $1,451 in the
related Health Trust as of December 31, 1998, which was recorded as a liability
of Interstate Management on the accompanying combined balance sheet.
F-15
<PAGE> 79
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
13. INSURANCE, CONTINUED:
All accounts of Northridge are classified with assets and liabilities of a
similar nature in the combined balance sheets. Amounts restricted due to
statutory requirements consist of cash and cash equivalents of $1,762 and $1,610
at December 31, 1997 and 1998, respectively. These amounts are included in
restricted cash in the accompanying balance sheets. The combined statements of
operations and owners' equity include the insurance income earned and related
insurance expenses incurred. The insurance income earned has been included in
other fees in the consolidated statements of operations and owners' equity and
is comprised of the following for the years ended December 31, 1996 and 1997 and
the June 1998 period and the December 1998 period:
<TABLE>
<CAPTION>
JUNE DECEMBER
1996 1997 1998 1998
------ ------ ------ --------
<S> <C> <C> <C> <C>
Reinsurance premiums written................ $5,245 $5,811 $3,191 $2,585
Direct premiums written..................... 2,032 2,221 625 875
Reinsurance premiums ceded.................. (414) (544) (130) (170)
Change in unearned premiums reserve......... 158 (55) (87) (103)
Loss sharing premiums....................... 1,101 1,687 702 926
------ ------ ------ ------
Insurance income............................ $8,122 $9,120 $4,301 $4,113
====== ====== ====== ======
</TABLE>
14. FINANCIAL INSTRUMENTS:
The carrying values and fair values of Interstate Management's financial
instruments consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1998
------------------- -------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Cash and cash equivalents.............. $ 2,432 $ 2,432 $ 1,652 $ 1,652
Restricted cash........................ 2,324 2,324 2,201 2,201
Officers and employees notes
receivable........................... 12,157 12,157 2,803 2,803
Marketable securities.................. -- -- 2,609 2,609
Long-term debt, including current
portion.............................. 370 370 -- --
</TABLE>
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Cash and cash equivalents and restricted cash: The carrying amounts approximate
fair value because of the short maturity of these investments.
Officers and employees notes receivable: The fair value of officers and
employees notes receivable is based on anticipated cash flows and approximates
carrying value.
Long-term debt: The fair value of long-term debt is based on interest rates
that are currently available to Interstate Management for issuance of debt with
similar terms and remaining maturities.
Marketable securities: The fair value of marketable securities is based
principally on the quoted market prices of the underlying security.
F-16
<PAGE> 80
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
15. RELATED PARTY TRANSACTIONS:
Transactions with Significant Related Parties:
Included in net management fees are management fees earned pursuant to
management agreements between Interstate Management and the affiliates of
Interstate or Patriot that owned the Owned Hotels. In addition, certain of the
Owned Hotels were subject to management agreements between Interstate Management
and the third-party owners of these hotels prior to the Owned Hotels'
acquisition by Interstate. Included in net management fee revenue in the
accompanying combined statements of operations are fees related to the Owned
Hotels (including periods prior to their acquisition by Interstate, if
applicable) amounting to $11,726, $15,752, $6,987, and $6,129 for the years
ended December 31, 1996 and 1997 and the June 1998 and December 1998 periods,
respectively. Receivables from management fee revenues from the Owned Hotels
comprise the Related Party Receivables -- management contracts in the
accompanying combined balance sheets and amount to $1,260 and $705 at December
31, 1997 and 1998, respectively.
Revenues from other fees include primarily insurance revenues and purchasing
fees. Insurance revenues, which are described in Note 13, from Owned Hotels
amounted to $2,521, $2,842, $1,378 and $1,929 for the years ended December 31,
1996 and 1997 and the June 1998 and December 1998 periods, respectively.
Purchasing fees from Owned Hotels amounted to $969, $1,574, $616 and $552 for
the years ended December 31, 1996 and 1997 and the June 1998 and December 1998
periods, respectively.
Included in accounts receivable is approximately $302 and $548 at December 31,
1997 and 1998, respectively, due from hotels that Milton Fine, former Chairman
of the Interstate Board of Directors and significant shareholder of Interstate,
has an ownership interest. Interstate Management has waived the management fees
for one of these hotels through November 1998.
Affiliate Receivables:
Affiliate receivables consist principally of short-term interest bearing loans
to third-party owners.
Concentration of Risk:
Interstate Management manages three hotels located in Russia, one of which opens
in December 1998. As of December 31, 1997 and 1998, receivables from these
hotels amounted to $3,471 and $3,677, respectively. The Company currently
estimates the receivables as collectable, however, actual collections could
differ from current estimates.
16. INVESTMENT IN HOTEL REAL ESTATE
On October 2, 1997, the Company, through a 95% owned subsidiary, Intercarp
Limited Partnership (Intercarp), purchased a 55% non-controlling general
partnership interest in Charles Square Associates (CSA), a joint venture general
partnership, which serves as the managing general partner of CH&S Limited
Partnership (CHS), and a 25% interest in Cambridge Hotel Associates (CHA) from
an unrelated third party for approximately $13,000. CH&S owns The Charles Hotel
Complex, which includes the hotel and related offices and retail space in
Cambridge, Massachusetts. CHA manages The Charles Hotel.
On October 10, 1997, Intercarp purchased 7.5 limited partnership units of CHS
for $150. During 1998, Intercarp purchased an additional 99.25 limited partner
units for $2,948 and exchanged an 11.68% interest in Intercarp in exchange for
an additional 66.25 units. As of December 31, 1998 Intercarp holds 173 of the
289 outstanding limited partnership units of CHS.
F-17
<PAGE> 81
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
16. INVESTMENT IN HOTEL REAL ESTATE, CONTINUED:
In connection with the purchase of the interests in CSA and CHA, Intercarp is
party to certain put/call rights (P/C Options) with certain affiliates of the
45% general partnership interest in CSA and the 25% limited partnership interest
in CHA. The P/C Options allow Intercarp to acquire the interests in both CSA and
CHA anytime prior to December 31, 2000 for a price equal to approximately
$11,625. The Partnership may be required to buy the interest at the Option Price
upon the earlier of the completion of certain events, as defined, or October 2,
1999. As of December 31, 1998, neither party has exercised its rights under the
P/C Options.
The Company, accounts for its investment in CSA and CHA using the equity method
of accounting. Equity in earnings are included in other net in the statement of
income and the investments are included in Investment in Hotel Real Estate on
the balance sheet. The Company recognized equity in earnings from CHA of $136,
$146 and $123 for the year ended December 31, 1997 and the periods from January
1, 1998 to June 1, 1998 and June 2, 1998 to December 31, 1998, respectively.
Selected financial information of CSA consolidated with CHS as of and for the
year ended December 31, 1997 and as of December 31, 1998 and for the period from
January 1, 1998 to June 1, 1998 and for the period June 2, 1998 to December 31,
1998 is as follows:
<TABLE>
<CAPTION>
DECEMBER 31
------------------
1997 1998
------- -------
<S> <C> <C>
Assets $67,453 $79,321
Liabilities $59,580 56,947
------- -------
Total net equity 7,873 22,374
Net equity-others (8,292) 670
------- -------
Net equity-Intercarp $16,165 $21,704
======= =======
</TABLE>
<TABLE>
<CAPTION>
PERIOD FROM
----------------------------------
YEAR ENDED JANUARY 1, TO JUNE 2, TO
1997 JUNE 1, 1998 DECEMBER 31, 1998
---------- ------------- -----------------
<S> <C> <C> <C>
Revenues $ 40,924 17,052 23,873
Expenses (37,054) (15,426) (21,597)
-------- -------- -------
Net income 3,870 1,626 2,276
Income allocated to others 3,633 1,259 963
Income allocated to Intercarp 237 367 1,313
</TABLE>
17. SEGMENT INFORMATION
Interstate Management adopted the provisions of Statement of Financial
Accounting Standards Board No. 131 "Disclosures about Segments of an Enterprise
and Related Information," effective December 31, 1998. The statement requires
disclosure of segment information for all periods presented. As discussed in
Note 1, during the periods of these financial statements, Interstate Management
was carved out of Interstate and Patriot. The manner of determining the segment
information presented below may be modified in future periods as the Company
finalizes the Spin-off and becomes a stand alone entity. In that event the
Company will restate all amounts to conform to the modification of the segment
information.
The Company determined that its reportable segments are those that are based on
the Company's method of internal reporting, which disaggregates its business by
operating entities which provide differing services.
F-18
<PAGE> 82
NOTES TO COMBINED FINANCIAL STATEMENTS, CONTINUED
(IN THOUSANDS)
17. SEGMENT INFORMATION, CONTINUED:
The Company's reportable segments are: operations of luxury and upscale hotels,
operations of mid-scale, upper economy and budget, and the Charles Hotel. The
luxury and upscale hotels segment derives revenues from management fees and
other products which directly relate to providing management services including
revenues from insurance, purchasing and equipment leasing. The mid-scale, upper
economy and budget segment derives revenues from managing and leasing hotels and
certain specialized support services. The Charles Hotel segment is an equity
investment which is described in note 16. The operations of this segment differ
from those of the other segments and the results are separately reviewed by the
Company's chief operating decision maker.
The accounting policies of the segment are the same as those described in Note
2. The Company evaluates the performance of its segments and allocates resources
to them based on operating income.
The table below presents information about operating income and segment assets
as of and for the three years in the period ended December 31, 1998:
<TABLE>
<CAPTION>
JUNE DECEMBER
1996 1997 1998 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
REVENUES
Luxury and Upscale Hotels 49,131 57,961 26,010 30,745
Mid-Scale, Upper Economy
and Budget Hotels 14,581 172,456 80,753 117,649
-------- -------- -------- --------
Consolidated Totals 63,712 230,417 106,763 148,394
======== ======== ======== ========
OPERATING INCOME
Luxury and Upscale Hotels 8,675 28,322 11,887 10,134
Mid-Scale, Upper Economy
and Budget Hotels 1,118 3,232 1,278 (615)
-------- -------- -------- --------
Consolidated Totals 9,793 31,554 13,165 9,519
======== ======== ======== ========
</TABLE>
Depreciation and amortization included in segment operating income for the three
years in the period ended December 31, 1998 are as follows:
<TABLE>
<CAPTION>
JUNE DECEMBER
1996 1997 1998 1998
------- ------- ------- --------
<S> <C> <C> <C> <C>
Luxury and Upscale Hotels 4,141 1,646 776 8,437
Mid-Scale, Upper Economy and
Budget Hotels 244 3,199 1,376 2,222
------- ------- ------- --------
Consolidated Totals 4,385 4,845 2,152 10,659
======= ======= ======= ========
</TABLE>
Intangible and other assets by segment are as follows as of December 31:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
<S> <C> <C> <C> <C>
Luxury and Upscale Hotels 3,817 4,909 60,823
Mid-Scale, Upper Economy and
Budget Hotels 48,075 45,402 39,698
------- ------- -------
Consolidated Totals 51,892 50,311 100,521
======= ======= =======
</TABLE>
F-19
<PAGE> 83
- ---------------------------------------------------------
- ---------------------------------------------------------
WE HAVE NOT AUTHORIZED ANYONE TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS IN CONNECTION WITH THE SPIN-OFF. IF ANYONE GIVES YOU ANY SUCH
INFORMATION OR MAKES ANY SUCH REPRESENTATIONS, YOU SHOULD NOT RELY ON IT OR THEM
AS HAVING BEEN AUTHORIZED BY INTERSTATE MANAGEMENT. THE AFFAIRS OF INTERSTATE
MANAGEMENT MAY CHANGE AND YOU SHOULD NOT ASSUME THAT THE INFORMATION IN THIS
INFORMATION STATEMENT/PROSPECTUS IS CORRECT AS OF ANY TIME SUBSEQUENT TO THIS
DATE. THIS INFORMATION STATEMENT/PROSPECTUS IS NOT AN OFFER TO SELL THESE
SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY
STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Questions and Answers about the Spin-
off and Interstate Management....... 1
Summary............................... 3
Summary Financial and Other Data...... 7
Risk Factors.......................... 9
The Spin-off.......................... 15
Business.............................. 19
Selected Financial and Other Data..... 30
Pro Forma Financial Data.............. 32
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 39
Management............................ 47
Certain Relationships and Related
Transactions........................ 55
Security Ownership of Certain
Beneficial Owners and Management.... 56
Description of Capital Stock.......... 56
Where You Can Find More Information... 60
Index to Combined Financial
Information......................... F-1
</TABLE>
UNTIL , 1999, ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE
SECURITIES MAY BE REQUIRED TO DELIVER THIS INFORMATION STATEMENT/PROSPECTUS.
- ---------------------------------------------------------
- ---------------------------------------------------------
- ---------------------------------------------------------
- ---------------------------------------------------------
9,221,743 SHARES
INTERSTATE HOTELS
MANAGEMENT, INC.
COMMON STOCK
--------------------------------------------------
INFORMATION STATEMENT/PROSPECTUS
--------------------------------------------------
MARCH , 1999
- ---------------------------------------------------------
- ---------------------------------------------------------
<PAGE> 84
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION (1)
The following table sets forth the estimated expenses payable by Interstate
Management in connection with the spin-off:
<TABLE>
<CAPTION>
NATURE OF EXPENSE AMOUNT
- ----------------- -------
<S> <C>
SEC Registration Fee........................................ $13,408
New York Stock Exchange Filing Fee.......................... *
Accounting Fees and Expenses................................ *
Legal Fees and Expenses..................................... *
Printing Expenses........................................... *
Blue Sky Qualification Fees and Expenses.................... *
Distribution Agent's Fee.................................... *
Miscellaneous............................................... *
-------
Total.................................................. $ *
=======
</TABLE>
- ---------------
(1) The amounts set forth above, except for the SEC and New York Stock Exchange
fees, are in each case estimated.
* To be completed by Amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Interstate Management's officers and directors are indemnified to the maximum
extent authorized or permitted under applicable law. Maryland's corporation law
generally permits the liability of directors and officers to a corporation for
monetary damages to be limited, unless it is proven that (i)(a) the director or
officer actually received an improper personal benefit in money, property or
services, (b) the director or officer acted in bad faith, or (c) the director's
or officer's act or omission was the result of active and deliberate dishonesty,
and (ii) the director's or officer's act or omission was material to the matter
giving rise to the proceeding. However, in the case of a suit by or in the right
of Interstate Management, a director or officer may not be indemnified in
respect of any proceeding in which he shall have been adjudged liable to
Interstate Management, unless and only to the extent a court of appropriate
jurisdiction determines that such person is fairly and reasonably entitled to
indemnity for such expenses as such court may deem proper. Any amendment or
repeal of Interstate Management's Articles of Incorporation may not adversely
affect the rights of any person entitled to indemnification for any event
occurring prior to such amendment or repeal.
Interstate Management's Bylaws provide for indemnification by Interstate
Management of its officers and certain non-officer employees under certain
circumstances against expenses (including attorneys' fees, judgments, fines and
amounts paid in settlement) reasonably incurred in connection with the defense
or settlement of any threatened, pending or completed legal proceeding in which
any such person is involved by reason of the fact that such person is or was an
officer or employee of Interstate Management if such person acted in good faith
and in a manner he or she reasonably believed to be in or not opposed to the
best interests of Interstate Management, and, with respect to criminal actions
or proceedings, if such person had no reasonable cause to believe his or her
conduct was unlawful.
II-1
<PAGE> 85
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Interstate Management has issued unregistered securities to a limited number of
persons, as described below. No underwriters or underwriting discounts or
commissions were involved. There was no public offering in any such transaction,
and Interstate Management believes that each transaction was exempt from the
registration requirements of the Securities Act of 1933, as amended, by reason
of Section 4(2) thereof, based on the private nature of the transactions and the
financial sophistication of the purchasers, all of whom had access to complete
information concerning Interstate Management and acquired the securities for
investment and not with a view to the distribution thereof.
(1) On June 2, 1998, Interstate Management issued an aggregate of 9,900
shares of Interstate Management's Class B Non-Voting Common Stock to
Patriot American Hospitality, Inc. in exchange for (i) a 35% managing
membership interest in Interstate Hotels, LLC; (ii) Patriot's rights under
its contract with Interstate Hotels, LLC pursuant to which Interstate
Hotels, LLC agreed not to pursue or conduct any third-party hotel
management business other than that in existence on June 2, 1998 (including
any renewals or extensions of management contracts in existence on such
date); and (iii) Patriot's rights under its contract with Interstate
Hotels, LLC pursuant to which Interstate Hotels, LLC agreed that it would
cease to manage certain identified hotels upon consummation of the
spin-off.
(2) On June 2, 1998, Interstate Management issued an aggregate of 100
shares of Interstate Management's Class A Voting Common Stock to
PAH-Interstate Holdings, Inc. for an aggregate purchase price of $478,836.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits. The following is a complete list of Exhibits filed as part of this
Registration Statement.
2.1* Form of Distribution Agreement by and among Patriot American Hospitality,
Inc. and Interstate Hotels Management, Inc.
3.1* Form of Articles of Amendment and Restatement of Interstate Management
3.2+ Form of Amended and Restated Bylaws of Interstate Management
3.3* Form of Shareholder Rights Plan of Interstate Management
5.1* Opinion of Goodwin, Procter & Hoar LLP
10.1+ Form of Limited Liability Company Agreement of IHC II, LLC
10.2+ Form of Amended and Restated Limited Liability Company Agreement of
Interstate Hotels, LLC
10.3+ Form of Voting Agreement among Interstate Management and the identified
stockholders of Interstate Management
10.4* Form of Owner Agreement by and between Patriot American Hospitality
Partnership, L.P., Wyndham International Operating Partnership, L.P., IHC
II, LLC and [Marriott International, Inc./ Marriott Hotel Services, Inc.]
10.5* Form of Lease Agreement
10.6* Form of Management Agreement by and between Wyndham International
Operating Partnership, L.P. and IHC II, LLC
10.7* Form of Submanagement Agreement by and between [Marriott International,
Inc./Marriott Hotel Services, Inc.] and IHC II, LLC
10.8* Form of Interstate Hotels Management, Inc. Guaranty
II-2
<PAGE> 86
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES, CONTINUED
10.9* Settlement Agreement dated as of May 27, 1998 by and among Marriott
International, Inc., Interstate Hotels Corporation, Interstate Hotels
Company, Patriot American Hospitality, Inc. and Wyndham International,
Inc.
10.10* Employment Agreement by and between Interstate Hotels Management, Inc.
and Thomas F. Hewitt
10.11* Employment Agreement by and between Interstate Hotels Management, Inc.
and J. William Richardson
10.12* Employment Agreement by and between Interstate Hotels Management, Inc.
and Henry L. Ciaffone
21.1* List of Subsidiaries of Interstate Management
23.1 Consent of PricewaterhouseCoopers, LLC
23.2* Consent of Goodwin, Procter & Hoar LLP (to be included in Exhibit 5.1)
27.1 Financial Data Schedule
- ---------------
* To be filed by amendment.
+ Previously filed.
(b) All applicable required schedules are included in the Information
Statement/Prospectus and are therefore omitted from this section.
ITEM 17. UNDERTAKINGS
(a) -- (g) Not applicable.
(h) Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of
the registrant, the registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities
(other than the payment by the registrant of expenses incurred or paid by a
director, officer or controlling person of the registrant in the successful
defense of any action, suit or proceeding) is asserted by such director,
officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question of whether such indemnification by it
is against public policy as expressed in the Securities Act and will be
governed by the final adjudication of such issue.
(i) -- (j) Not applicable.
II-3
<PAGE> 87
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant has
duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Pittsburgh, Commonwealth
of Pennsylvania, on March 8, 1999.
Interstate Hotels Management, Inc.
By: /s/ THOMAS F. HEWITT
-----------------------------------
Thomas F. Hewitt
Chief Executive Officer
KNOW ALL MEN BY THESE PRESENTS that each individual whose signature appears
below constitutes and appoints Thomas F. Hewitt and J. William Richardson such
person's true and lawful attorney-in-fact and agent with full power of
substitution and resubstitution, for such person and in such person's name,
place and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this Registration Statement and to file
the same, with all exhibits thereto, and all documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as such person might or could do
in person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or any substitute, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed below by the following persons in the capacities and
on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<C> <S> <C>
/s/ THOMAS F. HEWITT Chief Executive Officer and March 8, 1999
- ---------------------------------- Chairman of the Board of Directors
Thomas F. Hewitt (Principal Executive Officer)
/s/ J. WILLIAM RICHARDSON Chief Financial Officer and March 8, 1999
- ---------------------------------- Executive Vice President, Finance
J. William Richardson and Administration (Principal
Financial Officer and Principal
Accounting Officer)
/s/ WILLIAM W. EVANS III Director March 8, 1999
- ----------------------------------
William W. Evans III
</TABLE>
II-4
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Amendment No. 1 to registration statement on
Form S-1 of our report dated March 5, 1999, on our audits of the combined
financial statements as of December 31, 1997 and 1998 and for the period from
January 1, 1998 to June 1, 1998 and for the period from June 2, 1998 to
December 31, 1998 and for each of the two years in the period ended December
31, 1997 of Interstate Hotels Management, Inc.
/s/ PricewaterhouseCoopers LLP
Pittsburgh, Pennsylvania
March 8, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMBINED
BALANCE SHEET AS OF DECEMBER 31, 1998 AND THE COMBINED STATEMENTS OF OPERATIONS
AND OWNERS' EQUITY FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 1,652
<SECURITIES> 0
<RECEIVABLES> 16,816
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 21,736
<PP&E> 4,522
<DEPRECIATION> 446
<TOTAL-ASSETS> 161,157
<CURRENT-LIABILITIES> 52,538
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 92,607
<TOTAL-LIABILITY-AND-EQUITY> 161,157
<SALES> 0
<TOTAL-REVENUES> 255,157
<CGS> 0
<TOTAL-COSTS> 232,473
<OTHER-EXPENSES> (1,865)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (594)
<INCOME-PRETAX> 25,143
<INCOME-TAX> 9,964
<INCOME-CONTINUING> 15,179
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 14,946
<EPS-PRIMARY> 0<F1>
<EPS-DILUTED> 0<F1>
<FN>
<F1>THE ACCOMPANYING COMBINED FINANCIAL STATEMENTS HAVE BEEN CARVED OUT OF
FINANCIAL STATEMENTS OF THE COMPANY'S PREDECESSORS. THEREFORE, THE COMPANY
BELIEVES THAT EARNINGS PER SHARE CALCULATIONS REQUIRED TO BE PRESENTED ARE NOT
MEANINGFUL FOR THE PERIOD PRESENTED AND HAVE NOT BEEN PROVIDED.
</FN>
</TABLE>
