<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 31, 1998
REGISTRATION NO. 333-
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
INNSUITES HOSPITALITY TRUST
(Exact name of registrant as specified in its Declaration)
------------------------
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OHIO 34-6647590
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification Number)
organization)
1750 HUNTINGTON BUILDING GREGORY D. BRUHN
925 EUCLID AVENUE EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL
CLEVELAND, OHIO 44115 OFFICER
(216) 622-0046 1750 HUNTINGTON BUILDING
(Address, including zip code, and telephone number, 925 EUCLID AVENUE
including area code, of registrant's principal CLEVELAND, OHIO 44115
executive offices) (216) 622-0046
(Name, address, including zip code, and
telephone number, including area code, of agent for
service)
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COPIES TO:
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JAMES B. ARONOFF, ESQ. CHRISTOPHER D. JOHNSON, ESQ.
THOMPSON HINE & FLORY LLP SQUIRE, SANDERS & DEMPSEY L.L.P.
3900 KEY CENTER TWO RENAISSANCE SQUARE, SUITE 2700
127 PUBLIC SQUARE 40 NORTH CENTRAL AVENUE
CLEVELAND, OHIO 44114 PHOENIX, ARIZONA 85004
(216) 566-5500 (602) 528-4000
</TABLE>
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this 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 the registrant elects to deliver its latest annual report to security
holders, or a complete and legible facsimile thereof, pursuant to Item 11(a)(l)
of this form, 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, please 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, check
the following box: [ ]
CALCULATION OF REGISTRATION FEE
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- --------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM
TITLE OF SECURITIES AMOUNT TO BE OFFERING PRICE PER PROPOSED MAXIMUM AMOUNT OF
TO BE REGISTERED REGISTERED(1) SHARE(2) AGGREGATE OFFERING PRICE(2) REGISTRATION FEE
- --------------------------------------------------------------------------------------------------------------------
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Shares of Beneficial Interest,
without par value............ 2,300,000 $15.00 $34,500,000.00 $9,591.00
- --------------------------------------------------------------------------------------------------------------------
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(1) Includes up to 300,000 shares which may be purchased by the Underwriter to
cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c)
- ------------------------
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, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(A), MAY DETERMINE.
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SUBJECT TO COMPLETION, DATED 1999
PROSPECTUS
INNSUITES HOSPITALITY TRUST LOGO
INNSUITES HOSPITALITY TRUST
2,000,000 SHARES OF BENEFICIAL INTEREST
WITHOUT PAR VALUE
$15.00 PER SHARE
INNSUITES HOTELS LOGO
INNSUITES INNTERNATIONAL HOTELS, INC.
3,627,279 REDEEMABLE COMMON STOCK PURCHASE WARRANTS
- --------------------------------------------------------------------------------
We operate a real estate investment trust ("REIT") that owns, directly or
indirectly, ten hotels with 1,665 suites in Arizona and southern California. Our
hotels operate as InnSuites Hotels(R).
When we complete this offering, our shareholders will receive a right, known as
a warrant, to purchase the common stock of InnSuites Innternational Hotels,
Inc., a related management company further described in this prospectus. For
each of our shares, our shareholders will receive one warrant to purchase one
share of InnSuites Innternational Hotels, Inc. common stock. Our shareholders
may exercise their warrants after one year following the completion of this
offering at a purchase price of $2.50 per share. The warrants will expire after
seven years following the completion of this offering. Ownership of our shares
and the common stock of InnSuites Innternational Hotels, Inc. will provide our
shareholders with the benefits of a "paper-clipped" REIT structure.
Our shares are listed on the New York Stock Exchange under the symbol "IHT". Our
shares offered by this offering will represent 73.02% of the total shares held
by the public. Neither the warrants nor the shares of InnSuites Innternational
Hotels, Inc. are listed on any exchange.
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THIS OFFERING: PER SHARE TOTAL
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PRICE TO PUBLIC........ $ $
UNDERWRITING
DISCOUNTS............ $ $
PROCEEDS TO IHT........ $ $
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Sutro & Co., Inc. will act as our underwriter for this offering. They will offer
our shares in a firm offering and have the option within 45 days of this date to
purchase up to 15% additional shares to cover over-allotments. They also reserve
the right to withdraw, cancel or modify its offers and to reject orders in whole
or in part. We expect that certificates for the shares of this offering will be
available for delivery to you on or about , 1999 at the offices of
Sutro & Co., Inc., . Payment for these shares will be due at the
time of delivery, in cash or other immediately available funds.
Read this prospectus and any supplements carefully before you invest. The "Risk
Factors Related To The Trust" beginning on page 18 discuss many factors relevant
to your ownership of our shares. The "Risk Factors Related To The Management
Company" beginning on page 31 discuss many factors relevant to your ownership of
the warrants.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
SUTRO & CO., INC.
, 1999
THE INFORMATION CONTAINED IN THIS 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 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
[INSIDE FRONT COVER]
[RESERVED FOR PHOTOS]
<PAGE> 4
TABLE OF CONTENTS
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PROSPECTUS SUMMARY................. 1
Our Company...................... 1
Our Business Strategy............ 3
Formation Transactions........... 4
Corporate Structure
Transactions.................. 4
Ownership activities integrated
into the Trust................ 5
Management related activities
integrated into the Management
Company....................... 5
The Management Company........... 6
Intercompany Agreement........... 7
The Hotel Industry............... 9
Warrant Distribution............. 9
Federal Income Tax Consequences
of the Warrant Distribution... 10
Trading Market................... 10
Dividend Policies................ 11
Risk Factors..................... 11
Tax Status of The Trust.......... 11
This Offering.................... 12
Summary Financial Information.... 12
RISK FACTORS RELATED TO THE
TRUST............................ 18
General Operating Risks.......... 18
Our recent organization and
limited operating history..... 18
Lack of control over the
operations and management of
the hotels.................... 18
Dependence on the Initial Lessee
and the Management Company for
rent payments under the
Percentage Leases............. 18
Year 2000 Compliance............. 19
Real estate investment risks..... 19
General risks of owning real
property investments.......... 19
Illiquidity of real estate
investments................... 20
Uninsured and underinsured
losses........................ 20
Potential costs of complying with
environmental laws............ 20
Our hotels' compliance with
public access laws............ 21
Increases in property taxes...... 21
Hotel ownership risks............ 22
General operating risks.......... 22
Competition in hotel industry.... 22
Seasonal revenue fluctuations of
hotel business................ 23
Investment concentration in
single industry............... 23
Emphasis on marketing InnSuites
Hotels and concentration of
hotel locations............... 23
Risks of operating hotels under
franchise agreements.......... 23
Constraints on continued
acquisitions and
improvements.................. 24
Risk of Conflicts of Interest.... 24
General conflict between the
Management Company and the
Trust......................... 24
No arms-length bargaining on
Percentage Leases and
compensation arrangements for
officers and trustees......... 25
Differing tax consequences to
certain affiliates on sale or
financing of certain hotels... 25
Risks of debt obligations and
variable rate debt............ 26
Tax risks........................ 27
Failure to maintain the Trust's
REIT qualification............ 27
Requirement that the Trust
maintain REIT minimum
distributions................. 27
Ownership limitation............. 28
Failure of the Operating
Partnership to be classified
as a partnership for federal
income tax purposes and impact
on the Trust's REIT status.... 29
Effect of interest rates on
market price of your shares... 29
Limitations on control,
acquisition and changes in
control....................... 30
Reliance on key personnel and the
Board of Trustees............. 30
Ownership limitation............. 30
Classification of Board of
Trustees into three classes... 30
Effect on market price of shares
available for future sale..... 30
Risks of not meeting or
maintaining our estimated
distribution rates............ 31
RISK FACTORS RELATED TO THE
MANAGEMENT COMPANY............... 31
General operating risks.......... 31
Recent organization and limited
operating history............. 31
Restrictions on corporate purpose
and business opportunities.... 31
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Dependence upon the Trust and the Operating
Partnership for business
opportunities........................... 32
Year 2000 Compliance....................... 33
Risk of Real Estate Operations............. 33
General real estate operations............. 33
Seasonal revenue fluctuations of hotel
business................................ 34
Potential costs of complying with
environmental laws...................... 34
Risk of Conflicts of Interest.............. 35
General conflict between the Management
Company and the Trust................... 35
Risks of potential investments and ability
to manage those investments............. 35
Limited Financial Resources................ 36
Absence of a public market for the
Management Company's shares............. 36
Absence of dividends on the Management
Company's shares........................ 37
Reliance on key personnel and the Board of
Directors............................... 37
Potential anti-takeover effects of certain
laws.................................... 37
THE TRUST.................................... 37
Formation Transactions..................... 37
The Current Trust.......................... 38
Business Objectives........................ 39
Business Strategy.......................... 40
Financing Strategy......................... 40
Corporate Structure Transactions........... 41
THE HOTEL INDUSTRY........................... 43
Hotel Demand............................... 43
The Company's Segment of the Hotel
Industry................................ 44
Stability of the Hotels Market Segment..... 44
USE OF PROCEEDS BY THE TRUST................. 45
DILUTION..................................... 46
DIVIDEND POLICY OF THE TRUST................. 46
SELECTED HISTORICAL AND PRO FORMA FINANCIAL
INFORMATION AND OPERATING DATA OF THE TRUST
AND THE INITIAL LESSEE..................... 49
NOTES TO PRO FORMA CONDENSED CONSOLIDATED
STATEMENTS OF INCOME....................... 54
NOTES TO PRO FORMA CONDENSED STATEMENTS OF
OPERATIONS................................. 59
SELECTED FINANCIAL DATA...................... 60
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE TRUST.................... 61
Overview................................... 61
General.................................... 62
Pro Forma Results of Operations for the
Trust................................... 62
Pro Forma Results of Operations of the
Initial Lessee.......................... 64
Results of Operations of the Hotels........ 66
Liquidity and Capital Resources............ 68
Inflation.................................. 69
Seasonality................................ 70
Year 2000 Compliance....................... 70
BUSINESS AND PROPERTIES OF THE TRUST......... 71
The Properties............................. 71
Leasing and Operation of the Properties.... 76
Employees.................................. 81
Legal Proceedings.......................... 81
DESCRIPTION OF CAPITAL STOCK OF THE TRUST.... 81
Common Shares.............................. 81
Market for the Company's Common Stock and
Related Security Holder Matters......... 83
Restrictions on Ownership and Transfer..... 83
Exchange Listing........................... 83
Transfer Agent............................. 83
MANAGEMENT OF THE TRUST...................... 83
Trustees and Executive Officers............ 83
Audit Committee............................ 84
Compensation Committee..................... 84
Executive Compensation..................... 85
Compensation of Trustees................... 85
Stock Incentive and Option Plan............ 85
CERTAIN TRANSACTIONS BY THE TRUST............ 86
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CERTAIN DECLARATION OF TRUST AND STATUTORY
PROVISIONS................................. 87
Restrictions on Ownership and Transfer..... 87
Number of Trustees; Removal; Filling
Vacancies............................... 88
Limitation of Liability.................... 89
Indemnification of Trustees and Officers... 89
Amendment.................................. 89
PARTNERSHIP AGREEMENT........................ 89
Management................................. 89
Transferability of Interests............... 90
Capital Contributions...................... 90
Conversion Rights.......................... 90
Tax Matters................................ 91
Operations................................. 91
Distributions.............................. 91
Term....................................... 92
POLICIES AND OBJECTIVES WITH RESPECT TO
CERTAIN ACTIVITIES BY THE TRUST............ 92
Investment Policies........................ 92
Financing.................................. 93
Policies with Respect to Certain Other
Activities.............................. 94
Conflict of Interest Policy................ 94
SHARES AVAILABLE FOR FUTURE SALE BY THE
TRUST...................................... 94
General.................................... 94
FEDERAL INCOME TAX CONSIDERATIONS RELATED TO
THE TRUST.................................. 95
Taxation of the Trust...................... 95
Requirements for Qualification............. 97
Income Tests............................... 98
Asset Tests................................ 105
Distribution Requirements.................. 106
Recordkeeping Requirement.................. 107
Partnership Anti-Abuse Rule................ 107
Failure to Qualify......................... 108
Taxation of Taxable Domestic
Shareholders............................ 108
Backup Withholding......................... 109
Taxation of Tax-Exempt Shareholders........ 109
Taxation of Foreign Shareholders........... 110
Other Tax Consequences..................... 112
TAX ASPECTS OF THE OPERATING PARTNERSHIP..... 113
Classification as a Partnership............ 113
Effect of Failure to Qualify as a
Partnership............................. 114
Income Taxation of the Operating
Partnership, the Subsidiary Partnerships
and their Partners...................... 114
Sale of the Operating Partnership's
Property................................ 117
ERISA CONSIDERATIONS......................... 117
Employee Benefit Plans, Tax-Qualified
Retirement Plans and IRAs............... 118
Status of the Trust and the Operating
Partnership Under ERISA................. 119
INNSUITES INNTERNATIONAL HOTELS, INC......... 121
Business And Properties Of The Management
Company................................. 121
Intercompany Agreement..................... 123
THE WARRANT DISTRIBUTION..................... 125
DESCRIPTION OF WARRANTS...................... 125
Adjustments................................ 126
Reservation of Shares...................... 128
Amendment.................................. 128
Delivery and Form.......................... 128
USE OF PROCEEDS BY THE MANAGEMENT COMPANY.... 128
FEDERAL INCOME TAX CONSEQUENCES OF WARRANT
DISTRIBUTION AND EXERCISE.................. 129
Income Recognition by the Trust as a Result
of the Warrant Distribution............. 129
Taxation of Taxable Domestic Shareholders
of the Trust as a Result of the Warrant
Distribution............................ 129
Taxation of Tax-Exempt Shareholders of the
Trust as a Result of the Warrant
Distribution............................ 130
Taxation of Foreign Stockholders of the
Trust as a Result of the Warrant
Distribution............................ 130
Taxation of Limited Partners as a Result of
the Warrant Distribution................ 131
Tax Consequences of Warrant Exercise....... 132
SELECTED HISTORICAL AND PRO FORMA FINANCIAL
INFORMATION AND OPERATING DATA OF THE
MANAGEMENT COMPANY......................... 132
NOTES TO PROFORMA CONDENSED FINANCIAL
INFORMATION................................ 138
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE MANAGEMENT COMPANY....... 139
DESCRIPTION OF CAPITAL STOCK OF THE
MANAGEMENT COMPANY......................... 141
Authorized Capital Stock................... 141
Management Company Common Stock............ 141
Management Company Preferred Stock......... 142
MANAGEMENT OF THE MANAGEMENT COMPANY......... 142
Directors and Officers of the Management
Company................................. 142
Committees of the Board of Directors of the
Management Company...................... 143
Compensation of Directors.................. 143
Executive Compensation..................... 143
BENEFICIAL OWNERSHIP OF MANAGEMENT COMPANY
COMMON STOCK............................... 143
DIVIDEND POLICY OF THE MANAGEMENT COMPANY.... 144
CERTAIN TRANSACTIONS BY THE MANAGEMENT
COMPANY.................................... 144
CERTAIN CHARTER AND STATUTORY PROVISIONS..... 145
General.................................... 145
Control Share Acquisitions................. 145
Certain Business Combinations.............. 145
Directors' Duties.......................... 146
SHARES AVAILABLE FOR FUTURE SALE BY THE
MANAGEMENT COMPANY......................... 146
WHERE YOU CAN FIND MORE INFORMATION.......... 147
INCORPORATION OF CERTAIN DOCUMENTS BY
REFERENCE.................................. 148
FORWARD-LOOKING STATEMENTS................... 148
UNDERWRITING................................. 149
LEGAL MATTERS................................ 151
EXPERTS...................................... 151
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PROSPECTUS SUMMARY
The following discussion summarizes information further explained in this
prospectus. Since the following summary discussion relates to tax matters,
financial information, financial statements and the notes to the financial
statements, you should always consult the detailed information contained in the
later parts of this prospectus. To understand this offering fully you should
read the entire prospectus carefully, including the risk factors and the
financial statements and its notes.
This prospectus contains certain statements that relate to our future
expectations. While we gave considered thought to all estimations, those
statements involve risks and uncertainties. Actual results may differ
significantly from the results discussed in our estimates and expectations. The
"Risk Factors Related To The Trust" beginning on page 18 of this prospectus and
the "Risk Factors Related To The Management Company" beginning on page 31 of
this prospectus describe possible causes of any differences between our
estimates and actual results. See also "FORWARD-LOOKING STATEMENTS" for a
discussion of our estimates and expectations.
To prepare the pro forma financial statements and other information in
this prospectus, we assumed that:
- we would receive $15.00 per share from this offering;
- we completed the transactions that restructure our operations on February
1, 1997;
- our underwriters would not exercise their option to purchase additional
shares from this offering;
- all holders of units of limited partnership interest in the Operating
Partnership exchanged their units for Trust shares on a one-for-one basis;
and
- our trustees and officers would not exercise their options to purchase our
shares.
OUR COMPANY
We operate a self-administered, unincorporated Ohio real estate investment
trust, also known as a REIT, and the rules governing REITs require us to closely
associate with other companies and partnerships. The following descriptions
should help you understand our organization's complex structure for purposes of
this summary and throughout the prospectus. Our organizational chart on page 8
of this prospectus may also assist you with this understanding.
- - WE, US OR TRUST -- our company, InnSuites Hospitality Trust (formerly known as
Realty ReFund Trust), which owns all of the general partnership interests in
the Operating Partnership. Unless otherwise stated, this prospectus refers to
the Trust and the Operating Partnership together.
- - OPERATING PARTNERSHIP -- RRF Limited Partnership, the Delaware limited
partnership that directly or indirectly owns the ten InnSuites Hotels.
- - MANAGEMENT COMPANY -- InnSuites Innternational Hotels, Inc., the Nevada
corporation that help to manage our existing hotels and will lease from us
hotels we acquire after February 1, 2000. The Management Company will also
manage the day-to-day operations of our newly acquired hotels.
1
<PAGE> 9
- - INITIAL LESSEE -- InnSuites Hotels, Inc. (formerly known as Realty Hotel
Lessee Corp.), the Nevada corporation that currently leases 10 hotels from us
and will lease from us newly acquired hotels we acquire before February 1,
2000.
- - MANAGEMENT GROUP -- the Management Company, the Initial Lessee, and their
affiliates and predecessors, including InnSuites Licensing Corp., the current
holder of InnSuites(R) trademark and franchise agreements.
Through our ownership and control of the Operating Partnership, we own and
operate ten InnSuites Hotels(R) in Flagstaff, Phoenix, Scottsdale, Tempe, Tucson
(2) and Yuma, Arizona and Buena Park (Anaheim), Ontario (Los Angeles) and San
Diego, California with a total of 1,665 suites. Our hotels offer studio and two
room suites offering "Your Suite Choice(R)" of a one-room "Studio InnSuite," a
two-room "Executive/Family Suite," a multi-purpose "Boardroom Meeting Suite," or
a "Presidential Jacuzzi Suite." InnSuites Hotels operate as moderate and full
service hotels near many of the country's premier vacation attractions and
business centers. Three of the hotels are also marketed as "Best Western(R)
InnSuites Hotels(R)" and another is primarily marketed as a "Holiday Inn(R)
Hotel and Suites, an InnSuites Hotel." As previously noted, this summary and the
remainder of this prospectus often refer to the Operating Partnership and the
Trust together.
In addition to owning our shares, you will also have the opportunity to own
stock in the Management Company. All of our shareholders will receive the right
to purchase the common stock of the Management Company for a purchase price of
$2.50 per share. This right is called a warrant. The warrants you receive may be
exercised after one year following the completion of this offering but must be
exercised within seven years of this offering. If you exercise your warrants and
hold your Management Company stock together with your Trust shares, you will
participate in a "paper-clipped" REIT structure. As further described in this
prospectus, a "paper-clipped" REIT structure permits you to benefit from both
the real estate operations of the Trust (including the ownership of real estate
assets) and the management operations of the Management Company (including the
ownership of non-real estate assets). This structure also offers you
flexibility, as our "paper-clipped" REIT structure will not require you to own
the shares of both the Trust and the Management Company, unlike investments in
traditional "paired-share" REITs.
When we complete this offering we will own 49% of the Operating Partnership as
its sole general partner, allowing us to control the operations of the Operating
Partnership. The limited partners of the Operating Partnership will own the
remaining 51% of the Operating Partnership. Limited partners hold either Class A
Units, which are freely convertible into Trust shares, or Class B Units, which
are convertible into Trust shares only with the approval of the Trust's Board of
Trustees. The ownership limitations discussed on page 28 of this prospectus may
also restrict the conversion of limited partnership interests in the Operating
Partnership.
The Initial Lessee leases our current hotels from the Operating Partnership
through substantially identical percentage leases. The Percentage Leases require
the Initial Lessee to pay the higher of a minimum base or a percentage rent
based on gross room revenues. The Management Company assists with the operations
of the hotels under management contracts with the Initial Lessee. As described
below, we expect the Management Company to lease any hotels acquired after
February 1, 2000 through similar lease arrangements pursuant to an Intercompany
Agreement between the Trust, the Operating Partnership and the Management
Company.
2
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OUR BUSINESS STRATEGY
We intend to maximize the current returns to our shareholders through increased
cash distributions and to increase the long-term total returns to our
shareholders through appreciation in the value of our hotel assets and our
shares. To achieve these objectives we will seek to participate in increased
revenues from the hotels through our receipts under Percentage Leases with the
Initial Lessee and selectively acquire, redevelop, reposition and expand
existing and future hotel properties.
We will give particular consideration to investment opportunities in properties
where we expect our affiliated trademark acceptance, established industry and
marketing expertise and other management resources to produce improved operating
results. Our recent acquisitions include a full-service hotel in Tucson (St.
Mary's), Arizona, a full-service hotel in San Diego, California and a
moderate-service hotel in Buena Park, California. In April 1998, we obtained a
$12 million revolving credit facility with Pacific Century Bank to provide us
with interim financing to facilitate property acquisitions and capital
improvements.
To date, our fully refurbished and repositioned hotels have performed well in
comparison to their competitors. For the twelve months ended October 31, 1998,
those hotels achieved an average occupancy rate of 75.4%, produced an average
daily room rate (known as "ADR") of $71.56 and earned an average room revenue
per available room night (known as "REVPAR") of $53.96. During the one-year
period ended October 31, 1997, those hotels' REVPAR compared favorably with the
REVPAR of local competing hotels (as consistently defined by management for
performance evaluation purposes). We attribute the excellent performance of our
hotels to the successful implementation of our asset positioning and operating
strategy.
We believe that a regular program of capital improvements at our hotels,
including the replacement and refurbishment of furniture, fixtures and
equipment, has enhanced and will continue to enhance our competitiveness and
maximize revenue growth under the Percentage Leases. As part of our ongoing
renovation and capital expenditures program, we expect to spend approximately
$1,200,000 on capital improvements at our current hotels during the current
fiscal year ending January 31, 1999. To stay competitive, we expect to spend
about 4% of annual gross room revenues for renovation each year.
Our management team and the Management Group have substantial hotel operating,
development, acquisition and transaction experience. Founded in 1980, the
Management Group has developed six hotels with a total of 902 studio and
two-room suites and has owned or managed 11 properties with a total of 1,767
studio and two-room suites. James F. Wirth, our President and Chief Executive
Officer and Chairman of the Board of the Management Company, has more than 27
years of experience in the hotel and real estate industries, our senior
management team has an average of over 20 years of experience in the hotel and
real estate industries, and our Board of Trustees has a combined 165 years of
business experience.
The Management Group will continue applying its active asset management
strategies to maximize cash flow from our current and future hotels, especially
newly acquired hotels with below market average occupancy and room rates. These
strategies include adding the InnSuites trademark, providing "Your Suite
Choice(R)" of suite types and providing extra guest value with the "InnSuites
Extras" of free breakfast, free social hour, in-room refrigerator, microwave
oven, coffee maker, hair dryer and more. In addition, the
3
<PAGE> 11
Management Company will participate in repositioning acquired hotels that do not
immediately meet the strict earnings requirements of the Trust.
The Management Company will develop two Internet-based reservation systems, one
solely for InnSuites Hotels and the other for industry-wide reservations, to
sell excess room inventory at discount prices. The first system will be managed
by the Management Company through its currently operating InnSuites Reservation
Center. The second system will be operated as discountsuites.com, Inc., a ninety
percent (90%) owned subsidiary of the Management Company. The Management Company
expects to expand this subsidiary to become a profit center that significantly
contributes to its growth. Both systems should be fully operational by April
1999.
FORMATION TRANSACTIONS
At the 1997 annual shareholders' meeting held on January 28, 1998, the
shareholders of the Trust approved the Formation Agreement. By the terms of the
Formation Agreement, the previous trustees and executive officers of the Trust
resigned effective January 30, 1998. James F. Wirth, Gregory D. Bruhn, Marc E.
Berg, Mark J. Nasca, Lee J. Flory and Edward G. Hill were appointed the new
trustees of the Trust effective January 30, 1998. Mr. Wirth was also appointed
Chairman, President and Chief Executive Officer of the Trust and Mr. Bruhn was
also appointed Executive Vice President, Chief Financial Officer, Treasurer and
Secretary of the Trust.
On January 30, 1998, in furtherance of the Formation Agreement, the Trust
entered into the "Formation Transactions". In general terms, the Formation
Transactions resulted in the formation of the Operating Partnership by the Trust
and Hospitality Corporation International ("HCI"), a privately-held Arizona
corporation. HCI and its principal, James F. Wirth, through affiliated entities,
controlled seven all-suite hotel properties, comprising 1,036 hotel studio and
two-room suites, in Arizona and southern California, which were owned by five
partnerships and two corporations. The Trust was the 13.6% general partner, and
the investors in the partnerships and one of the corporations were the 86.4%
limited partners, in the newly-formed Operating Partnership. The Operating
Partnership then acquired substantial interests in the partnerships and the one
corporation. The investors (including Messrs. Wirth, Berg and Flory) received
Operating Partnership units in exchange for their interests in the partnerships
and the one corporation. The remaining corporation, which was owned by Mr. Wirth
and his wife, was acquired directly by RRF Sub Corp., a wholly-owned subsidiary
of the Trust, in a stock-for-stock exchange. The effect of the Formation
Transactions was to re-direct the investment focus of the Trust from making
wrap-around mortgage loans to the equity ownership of hotel properties,
initially located in the southwestern United States.
Following the Formation Transactions, the Trust acquired three additional hotels
in Tucson (St. Mary's), Arizona and San Diego and Buena Park, California.
CORPORATE STRUCTURE TRANSACTIONS
In an effort to streamline the ownership activities and management related
activities of the Trust and the Management Company for more efficient results
and maximum shareholder value, we and the Management Company are taking steps to
integrate ownership activities into the Trust and management related activities
into the Management Company. Prior to the
4
<PAGE> 12
completion of this offering, the Trust or the Management Company will have
completed the following corporate structure transactions:
Ownership activities integrated into the Trust:
- combined the Trust with the InnSuites Hotels System on January 30, 1998;
- added Gregory Bruhn, Executive Vice President and CFO and Bob Conaway as
Vice President and Controller of the Trust;
- hired Marc Berg as Vice President-Acquisitions for the Trust;
- changed our name from Realty ReFund Trust to InnSuites Hospitality Trust;
- issued one new Trust share for three existing Trust shares in a reverse
stock split;
- terminated our agreement with our external advisor (Mid-America ReaFund
Advisors, Inc.) and eliminated their advisory fees through the issuance of
Class B units to its Shareholders;
- reinstated quarterly dividends, payable at the rate of $0.30 per share
($1.20 per share annual rate, post-reverse stock split);
- established a $12 million line of credit to assist in acquisitions and to
refinance current debt and refinanced the Tucson St. Mary hotel's
mortgage; and
- transferred ownership of the InnSuites Hotels in Scottsdale to the
Operating Partnership. This hotel was owned by RRF Sub Corp., our
wholly-owned subsidiary.
Management related activities integrated into the Management Company:
- added William Kidwell, former Vice President Operations of Starwood
Lodging Corp. (a real estate investment trust), as President of the
Management Company;
- entered into an Intercompany Agreement between the Management Company, the
Trust and the Operating Partnership;
- acquired InnSuites Licensing Corp. and obtained full ownership of the
InnSuites Hotels tradename and trademarks and acquired the InnSuites
trademark licensing/franchise agreements;
- developed two Internet-based reservation systems to sell excess room
capacity and increase InnSuites brand awareness; and
- created warrants to be distributed to the Trust's shareholders at the
conclusion of this offering. The ability to own both Trust and Management
Company shares creates a "paper-clipped" REIT structure.
As a result of the contemplated corporate structure transactions and this
offering, all existing external affiliates (other than the Initial Lessee) will
have become part of the Trust or the Management Company. We believe that these
transactions should:
- reduce or eliminate potential conflicts of interest between us and our
external affiliates;
- allow investors greater participation in the results of our hotels and the
Management Company;
5
<PAGE> 13
- terminate the fees and payments made to external advisors and affiliates;
- reorganize the Management Company to undertake redevelopment or
construction projects of future hotels formerly impermissible or
impracticable because of our restrictive REIT status;
- build the size of the InnSuites Hotels system to benefit our existing
hotels with systems of cross-referrals and reservations and to add
recognition and value to the InnSuites Hotels(R) trademark; and
- provide an alternative to recently restricted "paired-share" REIT
structures by forming a "paper-clipped" REIT structure, permitting our
shareholders to enjoy the benefits of both Trust and Management Company
operations, while allowing separate transfer of Trust and Management
Company shares, not otherwise offered by "paired-share" REITs.
THE MANAGEMENT COMPANY
The Management Company began operations in February 1998 and was organized to
provide hotel management services to the Initial Lessee. The Management
Company's predecessors, InnSuites Hotels, LLC and Hospitality Corporation
International, began operations in 1980. The Management Company will continue to
provide hotel management services to the Initial Lessee pursuant to the current
management service agreements. Under those management service agreements, the
Initial Lessee pays the Management Company annual management fees of 2.5% of
gross room revenues for each hotel it manages.
By acquiring InnSuites Licensing Corp. as a part of the corporate structure
transactions described above, the Management Company has obtained full ownership
of the InnSuites(R) trademark and tradename. As a result, the Management Company
has acquired the current trademark and license agreements with the Initial
Lessee. The Management Company will continue to provide the Initial Lessee with
trademark and licensing services pursuant to the current trademark and licensing
agreements. For these trademark and licensing services, the Initial Lessee will
pay the Management Company 2.5% of gross room revenues (1.25% for those hotel
properties which also carry a third-party franchise, such as Best Western(R) or
Holiday Inn(R)).
The combination of the Management Company and InnSuites Licensing Corp. will
integrate the lease, management, and trademark and franchise licensing
activities into the Management Company. Ownership of the InnSuites(R) trademark
and tradename will allow the Management Company to save the costs it would
otherwise incur to operate under the InnSuites(R) trademark and tradename.
Owning the trademark also provides the Management Company the opportunity to
seek licensing arrangements with unrelated third-parties.
Additionally, the Management Company will own assets that the Trust cannot own
and conduct activities the Trust cannot conduct. For example, the Management
Company will own assets and conduct activities that are closely associated with
the operation of the hotels but that could otherwise cause the Trust to violate
the strict asset ownership and income tests applied to REITs. The Management
Company will function as an operating company, providing property-level
managerial services for the hotels, whereas the Trust focuses on investment in
real estate. While the Management Company has not identified specific operating
assets or operations that it will acquire, it is expected to become the lessee
and operator of new hotel properties acquired by the Operating Partnership after
February 1, 2000, as contemplated by the Intercompany Agreement described below.
6
<PAGE> 14
The Management Company expects its activities to relate primarily to the Trust
and the Operating Partnership and their real estate investments rather than to
unrelated businesses. In addition to its leasing operations pursuant to the
Intercompany Agreement described below, the Management Company may acquire hotel
properties that do not immediately meet the earnings requirements of the Trust
and the Operating Partnership. As the owner of these hotel properties, the
Management Company would implement its management strategies to improve the
property's operations and earnings. At a later date, if the Management Company
chose to sell such properties, they would be required to offer the Trust or the
Operating Partnership a right of first refusal to purchase the property.
For Internet consumers, the Management Company will provide the InnSuites
reservation system over the world wide web at www.innsuites.com which will offer
reduced rates for all InnSuites Hotels locations. The Management Company may
profit from its 90% ownership of the www.discountsuites.com reservation system.
These Internet-based reservation systems, will utilize InnSuites' excess
capacities to support overall hotel profitability and build InnSuites Hotels'
name recognition. As InnSuites Hotels profits increase, the Management Company
will profit from increased management services fees, trademark and licensing
fees and, eventually, as the lessee of newly acquired hotel properties.
INTERCOMPANY AGREEMENT
When we complete this offering and the distribution of the warrants, the Trust,
the Operating Partnership and the Management Company will enter into an
Intercompany Agreement. This agreement will provide, subject to certain terms,
that the Operating Partnership will grant the Management Company a right of
first refusal to lease any real property acquired by the Operating Partnership
or the Trust after February 1, 2000. If the Management Company accepts, the
Operating Partnership, or the Trust, and the Management Company will then
negotiate a mutually satisfactory percentage lease arrangement if the Operating
Partnership determines that the Management Company is qualified to be the lessee
of the newly acquired property. The Management Company will not invest in real
estate we could own unless we decide not to pursue that investment opportunity.
The Management Company will also provide the Trust with (a) trademark and
licensing services for newly acquired hotels and (b) a right of first refusal
for real property it has refurbished and repositioned.
7
<PAGE> 15
ORGANIZATION CHART
As a result of this offering and the corporate structure transactions,
the relationships among the Trust, the Operating Partnership, the hotels, the
Initial Lessee and the Management Company will be as follows:
-----------
| | ___________________
| Trust | |
--------- |
| |
GP(51%) | |
| |
--------- |
|Operating| |
|Partner- |____________________|
|ship | |
--------- |Intercompany
(100%) | | |Agreement
___________________| |--------------- |
| | |
| | |
---------- --------- |
| Current | | Future | |
| Hotels | | Hotels | |
---------- --------- |
| | |
|Percentage Percentage | |
|Leases Leases | |
| | |
| | |
| Trademark and License | |
---------- Agreements ---------------
| Initial |___________________________| Management |
| Lessee | Management Agreements | Company |
---------- ---------------
|
|
-----------------------
discountsuites.com,Inc.
-----------------------
8
<PAGE> 16
THE HOTEL INDUSTRY
According to Smith Travel Research, the United States hotel industry continues
to experience a strong recovery from an extended downturn in the late 1980's and
early 1990's. We believe that this broad industry recovery may contribute to the
growth in total revenues and REVPAR at our existing hotels (and at hotels we may
subsequently acquire), which, through the Percentage Leases, may increase the
cash we have available for distribution to our shareholders.
As reflected in the chart below, the hotel industry continues to experience
strong demand growth. Despite improved economic conditions and increased
consumer spending since 1995, demand for mid-scale hotels with food and beverage
operations declined from year to year, and the compounded 10-year growth rate
for such hotels was stagnated at 0.2%. On the other hand, demand for mid-scale
hotels without food and beverage operations, the sector currently targeted by
our InnSuites Hotels, grew at a rate of 6.4% compounded over the past 10 years.
We believe this difference in growth reflects changes in consumer preferences
toward the quality hotel accommodations and affordable prices offered by the
mid-scale market segment in which the InnSuites Hotels participate.
PERCENTAGE CHANGE IN DEMAND OVER PRIOR YEAR
<TABLE>
<CAPTION>
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
All U.S. Hotels....... 4.2% 4.9% 2.0% (1.4)% 2.0% 1.7% 3.0% 1.8% 2.2% 2.6%
Mid-scale with Food &
Beverage............ 1.8 1.6 (1.1) (2.6) (2.1) 1.3 1.7 (0.7) (1.3) (0.9)
Mid-scale without Food
& Beverage.......... 28.1 21.7 15.3 12.9 11.1 10.2 13.5 12.9 12.9 14.4
</TABLE>
- ---------------
Source: Smith Travel Research
As a result of strong demand growth since 1988, the Midscale without Food and
Beverage sector has enjoyed annual increases in ADR and REVPAR and occupancy
levels have remained above 65%. As a result of these strong operating
statistics, this sector has achieved gross operating profits of 40% or more
since 1990. (Source: Smith Travel Research). We believe these favorable
operating indicators, results and profitability support our investment strategy
of continuing to expand in this market segment.
Smith Travel Research has not provided any form of consultation, advice or
counsel regarding any aspects of, and is in no way whatsoever associated with,
this offering.
WARRANT DISTRIBUTION
A small number of existing REITs, operating under federal income tax provisions
no longer available to other REITs, "pair" or "staple" their shares with the
shares of a separate but related operating management company. Recent changes in
the tax law have limited growth opportunities for these companies. As the shares
of these two companies are "paired" or "stapled" together, they cannot be owned
or transferred separately. The ownership of both companies allow the
shareholders to enjoy the economic benefits of both the profits from the lease
payments received by the REIT and the operating profits realized by the
operating management company, while maintaining the tax benefits of REIT status.
Our "paper-clipped" structure (discussed below) offers these benefits, with free
transferability and without the new tax restrictions on growth.
9
<PAGE> 17
The Management Company will initially issue the warrants to Mr. and Mrs. Wirth
who will then contribute the warrants to the Operating Partnership. The
Operating Partnership will distribute some of the warrants to the Trust, who
will, in turn, distribute those warrants to its shareholders. The Operating
Partnership will distribute the remainder of the warrants to its Class A limited
partners.
In order to create a "paper-clipped" REIT structure, every shareholder of the
Trust will receive a right, known as a warrant, to purchase shares of Management
Company stock. For every Trust share you hold upon completion of this offering,
you will receive one warrant to purchase one Management Company share. Class A
limited partners of the Operating Partnership will also receive one warrant for
Management Company stock for every limited partnership unit they hold. Each
warrant will be exercisable after one year following the completion of this
offering at a price of $2.50 per share. Each warrant must be exercised within
seven years of the completion of this offering.
Shares of the Trust and the Management Company can be owned and transferred
separately and independently of each other and will not be formally paired or
stapled. Therefore, shares of the Trust and the Management Company will not
provide a "paired" investment to those shareholders who choose to purchase or
hold the shares of only one company. Shareholders who choose to purchase and
hold shares of both companies will, however, participate in the benefits of both
the real estate ownership and leasing activities of the Trust and the management
operations and ownership of non-real estate assets by the Management Company,
similar to shareholders of "paired-share" REITs.
FEDERAL INCOME TAX CONSEQUENCES OF THE WARRANT DISTRIBUTION
The Trust's distribution of the warrants for Management Company stock will be
treated as a taxable dividend to our shareholders to the extent that the
distribution is treated as made out of our current or accumulated earnings and
profits (as determined for federal income tax purposes). To the extent that the
fair market value of the distributed warrants exceeds our earnings and profits
allocated to the distribution, such excess will be treated first as a return of
a shareholder's basis in its Trust shares, and thereafter as gain on a deemed
disposition of Trust shares. We will recognize gain in connection with the
distribution of the warrants to the extent that the fair market value of the
distributed warrants exceeds our adjusted tax basis in such warrants. Gain we
recognize will give rise to additional taxable income for our shareholders as
such gain will result in an increase in our current earnings and profits. Our
shareholders will receive a tax basis in the warrants equal to the fair market
value of the warrants at the time of distribution. If the warrants are treated
as marketable securities, a limited partner of the Operating Partnership will
generally recognize gain in connection with the distribution to the extent that
the fair market value of the warrants received by the limited partner exceeds
the limited partner's basis in the limited partner's partnership interest.
TRADING MARKET
There is currently no public market for the Management Company's warrants or
common stock and its shares have not yet been approved for listing on any
national securities exchange, automated quotation system or over-the-counter
market. We cannot provide any assurance that a market will develop for the
Management Company's warrants or common stock.
10
<PAGE> 18
DIVIDEND POLICIES
We intend to make regular quarterly distributions to our shareholders and
limited partners of the Operating Partnership initially equal to $0.30 per share
($1.20 per share on an annual basis), which would represent approximately 122%
of our pro forma Cash Available for Distribution and 94% of our pro forma Funds
From Operations for the year ending January 31, 1998. The distribution for the
period commencing on the completion of this offering and ending April 30, 1999
is expected to be a pro rata portion of the applicable quarterly distribution.
We do not intend to change our estimate of dividend distributions if the
underwriters exercise their over-allotment option. Our ability to make
distributions depends on our receipt of distributions from the Operating
Partnership. The Operating Partnership's principal source of revenue initially
will be payments of rent by the Initial Lessee under the percentage leases.
It is anticipated that the Management Company will not pay any dividends in the
foreseeable future.
RISK FACTORS
Investments in the Trust and in the Management Company involve various risks,
and prospective shareholders should carefully consider the matters discussed
under "RISK FACTORS RELATED TO THE TRUST," which begin on page 18 of this
prospectus, and under "RISK FACTORS RELATED TO THE MANAGEMENT COMPANY," which
begin on page 31 of this prospectus.
TAX STATUS OF THE TRUST
We intend to continue our election to be taxed as a REIT under Sections 856
through 860 of the Internal Revenue Code. Under current federal income tax laws,
we do not pay federal income tax on our income as long as we currently
distribute at least 95% of our REIT taxable income to our shareholders and
satisfy a number of organizational and operational requirements. If we fail to
qualify as a REIT in any taxable year, we would be subject to federal income tax
(including any applicable alternative minimum tax) on our taxable income at
regular corporate rates. Even if we continue our REIT qualification, we would
owe federal income taxes, and possibly additional state and local income,
property and excise taxes, on REIT taxable income we do not distribute.
11
<PAGE> 19
THIS OFFERING
Trust:
Trust shares offered............ 2,000,000 shares(1)
Over-allotment option........... Up to 300,000 common shares. If the
over-allotment option is exercised in full
by the underwriters, the total public price,
underwriting discounts and proceeds to the
Trust would be $ , $ and
$ respectively.
Trust shares and Class A limited
partnership units to be
outstanding after this
offering...................... 3,627,279 shares(2)
Use of proceeds................. Debt reduction; contribution to capital
expenditures fund; working capital; and
general purposes.
New York Stock Exchange
symbol.......................... IHT
Management Company:
Management Company Warrants
offered....................... 3,627,279 warrants
Management Company shares to be
outstanding after this
offering...................... 100 shares
Use of proceeds................. working capital
Public Trading.................. none
- ---------------
(1) Assumes the underwriters' over-allotment option is not exercised. All shares
are offered by the Trust.
(2) Includes 888,311 shares issuable on exchange of 888,311 Class A limited
partnership units of the Operating Partnership. See "PARTNERSHIP
AGREEMENT -- CONVERSION RIGHTS." Does not give effect to any shares issuable
under the Trust's Stock Incentive and Option Plan. See "MANAGEMENT OF THE
TRUST -- STOCK INCENTIVE AND OPTION PLAN."
SUMMARY FINANCIAL INFORMATION
The following tables set forth unaudited summary pro forma consolidated
financial information for the Trust, unaudited summary pro forma financial
information for the Management Company and summary combined historical financial
information for all ten hotels. This information should be read with the
financial statements and notes appearing later in this prospectus. The pro forma
operating information for the Trust and for the Management Company is presented
as if this offering, the corporate structure transactions, the acquisitions of
all ten hotels and the beginning of the relevant lease years, occurred on
February 1, 1997. The pro forma balance sheet data is presented as if this
offering and the corporate structure transactions had occurred on October 31,
1998.
12
<PAGE> 20
INNSUITES HOSPITALITY TRUST
SUMMARY CONSOLIDATED PRO FORMA FINANCIAL DATA (1)
UNAUDITED (DOLLAR AMOUNT IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
JANUARY 31, 1998 OCTOBER 31, 1998
---------------- ----------------
<S> <C> <C>
OPERATING DATA:
Percentage lease revenue....................... $ 9,897 $ 7,975
Interest income................................ 55 20
--------- ---------
Total revenue........................ 9,952 7,995
--------- ---------
Depreciation................................... 2,438 1,971
Real estate and personal property taxes,
property and casualty insurance and ground
rent......................................... 1,149 884
General and administrative..................... 968 1,220
Interest expense............................... 954 919
Minority interest.............................. 2,266 1,519
--------- ---------
Total expenses and minority
interest.......................... 7,775 6,513
--------- ---------
Net income attributable to common shares....... 2,177 1,482
========= =========
Net Income per common share.................... $ .85 $ .57
Weighted average number of common shares
outstanding.................................. 2,555,939 2,604,521
OTHER DATA:
Funds From Operations(2)....................... $ 6,881 $ 4,972
Net Cash Provided by Operating Activities(3)... 6,939 5,015
Net Cash Used for Investing Activities(4)...... 1,050 852
Net Cash Used for Financing Activities(5)...... 6,265 6,331
</TABLE>
<TABLE>
<CAPTION>
AT OCTOBER 31, 1998
-------------------
<S> <C>
BALANCE SHEET DATA:
Investment in hotel properties, net...................... $58,935
Total assets............................................. 62,193
Total debt............................................... 10,088
Minority interest in Partnership......................... 15,476
Shareholders' equity..................................... 34,855
</TABLE>
- ---------------
1. The pro forma operating information for the Trust is presented as if the
Formation Transactions, the acquisitions of the San Diego, Buena Park and
Tucson (St. Mary's) hotels and the beginning of the relevant lease years, the
corporate structure transactions and this offering had all occurred as of
February 1, 1997. The pro forma balance sheet data is presented as if the
corporate structure transactions and this offering had occurred as of October
31, 1998.
2. The White Paper on funds from operations ("FFO") approved by the Board of
Governors of the National Association of Real Estate Investment Trusts
("NAREIT") in March 1995 defines FFO as net income (loss)(computed in
accordance with GAAP), excluding gains
13
<PAGE> 21
(losses) from debt restructuring and sales of properties, plus real estate
related depreciation and amortization and after comparable adjustments for
the Trust's portion of these items related to unconsolidated entities and
joint ventures. The Trust believes that FFO is helpful to investors as a
measure of the performance of an equity REIT because, along with cash flow
from operating activities, financing activities and investing activities, it
provides investors with an indication of the ability of the Trust to incur
and service debt, to make capital expenditures and to fund other cash needs.
The Trust computes FFO in accordance with standards established by NAREIT,
which may not be comparable to funds form operations reported by other REITs
that do not define the term in accordance with the current NAREIT definition,
or that interpret the current NAREIT definition differently from the Trust.
Funds from operations does not represent cash generated from operating
activities determined in accordance with GAAP and should not be considered as
an alternative to net income (determined in accordance with GAAP) as an
indication of the Trust's financial performance, or to cash flow from
operating activities (determined in accordance with GAAP) as a measure of the
Trust's liquidity, nor is it indicative of funds available to fund the
Trust's cash needs, including its ability to make cash distributions. FFO may
include funds that may not be available for management's discretionary use
due to functional requirements to conserve funds for capital expenditures and
property acquisitions, and other commitments and uncertainties. The following
is a reconciliation between pro forma net income (loss) and FFO.
<TABLE>
<CAPTION>
YEAR
ENDED NINE MONTHS ENDED
JANUARY 31, OCTOBER 31,
1998 1998
----------- -----------------
<S> <C> <C>
Pro forma net income................... $ 2,177 $ 1,482
Real estate related depreciation and
amortization......................... 2,438 1,971
Minority interest...................... 2,266 1,519
-------- --------
Funds from operations.................. $ 6,881 $ 4,972
======== ========
Pro forma net income per common share
and unit............................. $ .85 $ .57
</TABLE>
3. For pro forma purposes, net cash provided by operating activities represents
net income before depreciation of real estate assets, amortization of
deferred financing costs and minority interest. For pro forma purposes, no
effect has been given to changes in working capital assets and liabilities.
4. For pro forma purposes, net cash used for investing activities represents 4%
of hotel revenue for the applicable period.
5. For pro forma purposes, net cash used for financing activities represents
estimated dividends and distributions based upon the Trust's intended annual
dividend rate of $1.20 per share and the weighted average number of shares
and units (2,664,576 for year ended January 31, 1998 and 2,671,098 for nine
months ended October 31, 1998) outstanding during the applicable period.
14
<PAGE> 22
INNSUITES INNTERNATIONAL HOTELS, INC.
(THE MANAGEMENT COMPANY)
SUMMARY PRO FORMA FINANCIAL DATA (1)
UNAUDITED (AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE DATA)
<TABLE>
<CAPTION>
PREDECESSORS
INNSUITES HOTELS, LLC
AND HOSP. CORP. INTN'L
YEAR ENDED NINE MONTHS
DECEMBER 31, 1997 ENDED SEPTEMBER 30, 1998
---------------------- ------------------------
<S> <C> <C>
OPERATING DATA:
Revenues:
Management fees.................. $ 848 $ 405
Trademark fees................... 529 397
Other revenue.................... -- 2
------ ------
Total revenues........... 1,377 804
Operating expenses................. 222 214
------ ------
Total expenses........... 222 214
------ ------
Net income (loss).................. $1,155 $ 590
====== ======
</TABLE>
<TABLE>
<CAPTION>
AT SEPTEMBER 30, 1998
------------------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.......... $ 35
Total assets....................... $1,168
Total liabilities.................. 763
Shareholders' equity............... $ 405
</TABLE>
15
<PAGE> 23
INNSUITES HOTELS, INC.
(THE INITIAL LESSEE)
SUMMARY PRO FORMA FINANCIAL DATA (1)
UNAUDITED (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
DECEMBER 31, 1997 ENDED SEPTEMBER 30, 1998
----------------- ------------------------
<S> <C> <C>
OPERATING DATA:
Room revenue.......................... $23,901 $19,090
Food and beverage revenue............. 1,463 985
Other revenue......................... 898 1,225
------- -------
Total revenues.............. 26,262 21,300
------- -------
Operating expenses.................... 20,744 16,375
Percentage Lease payments............. 9,897 7,975
------- -------
Total expenses.............. 30,641 24,350
------- -------
Net income (loss)..................... $(4,379) $(3,050)
======= =======
</TABLE>
<TABLE>
<CAPTION>
AT SEPTEMBER 30, 1998
------------------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.......... $ 558
Total assets....................... 5,950
Total liabilities.................. 6,876
Shareholders' equity (deficit)..... (926)
</TABLE>
- ---------------
1. The pro forma operating information for the Initial Lessee is presented as if
the Formation Transactions, the Trust's acquisitions of the San Diego, Buena
Park and Tucson (St. Mary's) hotels and the beginning of the relevant lease
years, the corporate structure transactions and this offering had all
occurred as of January 1, 1997. The pro forma balance sheet data is presented
as if the corporate structure transactions and this offering had occurred as
of September 30, 1998.
16
<PAGE> 24
HOTELS
SUMMARY COMBINED HISTORICAL FINANCIAL DATA(1)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------- NINE MONTHS ENDED NINE MONTHS ENDED
1993 1994 1995 1996 1997 SEPTEMBER 30, 1997 SEPTEMBER 30, 1998
------- ------- ------- ------- ------- ------------------ ------------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Room revenue................ $11,689 $13,572 $15,367 $17,613 $18,801 $14,166 $16,113
Other revenue............... 464 476 576 710 1,110 829 1,921
------- ------- ------- ------- ------- ------- -------
Total revenues........ $12,153 $14,048 $15,943 $18,323 $19,911 $14,995 $18,034
------- ------- ------- ------- ------- ------- -------
Departmental and other
expenses.................. 8,967 10,101 11,090 12,857 14,585 9,953 12,232
Real estate and personal
property taxes, insurance
and rent.................. 697 592 656 877 912 593 --
Percentage rent............. -- -- -- -- -- -- 6,808
Depreciation and
amortization.............. 1,388 1,163 1,058 1,147 1,226 823 --
Interest expense............ 1,859 1,460 1,990 1,570 1,854 1,292 --
------- ------- ------- ------- ------- ------- -------
Total expenses........ 12,911 13,316 14,794 16,451 18,577 12,661 19,040
------- ------- ------- ------- ------- ------- -------
Income (loss) before
extraordinary items....... (758) 732 1,149 1,872 1,334 2,334 (1,006)
Extraordinary Items, gain on
early extinguishment of
debt...................... -- 133 6,465 307 -- -- --
------- ------- ------- ------- ------- ------- -------
Net Income (loss)........... $ (758) $ 865 $ 7,614 $ 2,179 $ 1,334 $ 2,334 $(1,006)
======= ======= ======= ======= ======= ======= =======
BALANCE SHEET DATA:
Investment in hotel
properties, net........... $27,166 $26,201 $25,309 $26,488 $26,933 $26,885 $ --
Total assets................ $28,982 $28,687 $28,398 $29,214 $28,893 $30,478 $ 5,950
Mortgage notes payable(2)... $26,419 $24,667 $17,028 $16,406 $17,777 $17,963 $ --
Total partners' capital
(deficit)................. $(1,803) $ (937) $ 6,827 $ 8,407 $ 5,034 $ 7,582 $ (926)
CASH FLOW DATA:
Net cash provided by (used
for) operating
activities................ $ 1,243 $ 1,435 $ 2,108 $ 2,643 $ 3,915 $ 2,684 $(1,521)
Net cash provided by (used
for) investing
activities................ $ (94) $ (112) $ (406) $(2,004) $(1,670) $(1,224) $ 712
Net cash provided by (used
for) financing
activities................ $ (860) $ (828) $(1,891) $(1,176) $(2,744) $(1,262) $ 984
OTHER DATA:
EBITDA(3)................... $ 2,489 $ 3,355 $ 4,197 $ 4,589 $ 4,414 $ 4,449 $(1,006)
</TABLE>
- ---------------
(1) For all periods prior to 1998, represents the combined historical financial
data of the hotels prior to the consummation of the Formation Transactions
and includes the acquisition of Flagstaff Hotel in 1996 which was accounted
for as a purchase. For the nine month period ended September 30, 1998,
represents the historical financial data of the Initial Lessee, and includes
the operating results of the San Diego (acquired April 29, 1998), Buena Park
(acquired June 1, 1998) and Tucson (St. Mary's) (acquired February 1, 1998)
hotels since their respective dates of acquisition by, and commencement of
Percentage Leases with, the Operating Partnership.
(2) The reductions of mortgage notes payable in 1995 and 1996 were caused by the
early extinguishments of debt in those years.
(3) Represents income (loss) before unusual and extraordinary items, excluding
depreciation, amortization and interest expense. The Initial Lessee believes
that EBITDA provides a good indicator of the entity's ability to incur and
service debt, to make capital expenditures and to fund other cash needs.
EBITDA does not represent cash generated from operating activities
determined in accordance with GAAP and should not be considered as an
alternative to net income (determined in accordance with GAAP) as an
indication of the entity's financial performance, or to cash flow from
operating activities (determined in accordance with GAAP) as a measure of
liquidity, nor is it indicative of funds available to fund cash needs,
including the ability to make cash distributions.
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<PAGE> 25
RISK FACTORS RELATED TO THE TRUST
BEFORE YOU INVEST, YOU SHOULD BE AWARE OF THE RISKS ASSOCIATED WITH OWNING OUR
SHARES, INCLUDING THOSE DESCRIBED BELOW. PROSPECTIVE SHAREHOLDERS SHOULD
CONSIDER CAREFULLY THE FOLLOWING FACTORS WHEN EVALUATING THEIR INVESTMENT IN OUR
SHARES.
GENERAL OPERATING RISKS
OUR RECENT ORGANIZATION AND LIMITED OPERATING HISTORY
As a result of the Formation Transactions, we reorganized the Trust and
organized the Operating Partnership and the Management Company in January 1998
and, therefore, have limited operating histories and limited assets. Although
our management has substantial experience in developing, financing and operating
hotel properties, they have limited experience operating as a REIT. The Trust's
ability to maintain its REIT qualification depends upon compliance with many
technical tax and operational requirements. Our management's limited experience
with these requirements could, therefore, subject the Trust to adverse
consequences if the Trust lost its REIT qualification.
LACK OF CONTROL OVER THE OPERATIONS AND MANAGEMENT OF THE HOTELS
To maintain the Trust's status as a REIT, we cannot operate our existing hotels
or any acquired hotels. Therefore, we lease our existing hotels to the Initial
Lessee, a separate company. The Initial Lessee operates and manages the hotels
and relies on the Management Company, also a separate company, to help manage
the hotels. Pursuant to the Intercompany Agreement, on or after February 1,
2000, we will lease any newly acquired hotels to the Management Company pursuant
to Percentage Leases. Most of the Initial Lessee's and the Management Company's
Board of Directors and executive officers, however, have no affiliation with the
Trust. Therefore, we cannot directly carry out our strategic business decisions
related to operating and marketing our hotels. For example, the Management
Company, in consultation with the Initial Lessee, determines the suite rates
and, if applicable, manages the food and beverage operations of our hotels.
While we have entered into the Intercompany Agreement with the Management
Company, we cannot guaranty that the Management Company will effectively apply
our management and marketing ideas for the hotels.
DEPENDENCE ON THE INITIAL LESSEE AND THE MANAGEMENT COMPANY FOR RENT PAYMENTS
UNDER THE PERCENTAGE LEASES
Our ability to distribute cash to our shareholders depends primarily upon the
Initial Lessee's, and eventually upon the Management Company's, ability to meet
their rent payment obligations under the Percentage Leases. Their ability to
make rent payments depends primarily on generating cash flows from the hotels
sufficient to exceed hotel operating expenses. For the year ended December 31,
1997 and the nine months ended September 30, 1998, the Initial Lessee had pro
forma net losses of approximately $4,379,000 and $3,050,000, respectively. Any
failure or delay by the Initial Lessee or the Management Company to meet their
rent payment obligations under the Percentage Leases could adversely affect our
ability to distribute cash to our shareholders.
Additionally, their rent payment obligations under the Percentage Leases are
unsecured. The Initial Lessee's only assets are cash, receivables, inventory,
supplies and prepaid expenses,
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<PAGE> 26
the franchise licenses for the hotels, and its rights and benefits under the
Percentage Leases. At September 30, 1998, the Initial Lessee had a total
shareholders' deficit of approximately $926,000. The Management Company's only
assets are cash, receivables, the trademark and licensing agreements for the
hotels, and its rights and benefits under the Intercompany Agreement. At
September 30, 1998, the Management Company had total shareholders' equity of
approximately $405,000. See "THE TRUST," "PARTNERSHIP AGREEMENT," AND "INNSUITES
INNTERNATIONAL HOTELS, INC."
Material failure by the Initial Lessee or the Management Company to comply with
the terms of a Percentage Lease (including the failure to pay rent when due)
gives us the right to terminate that Percentage Lease, repossess the applicable
property and enforce the delinquent payment obligations. Exercising that right,
however, would force us to find another suitable operator and manager for that
hotel. We cannot guarantee that we could find another suitable lessee or, if
another suitable lessee were found, that we could enter into a new lease with
favorable terms.
YEAR 2000
The Year 2000 problem results from computer programs having been written using
two digits instead of four digits to define the applicable year. Any of our
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could potentially result
in a system failure or miscalculations, causing disruptions of operations and
normal business activity. Continuing system failure or miscalculations could
substantially affect our ability to schedule reservations and could
significantly affect our profitability.
We cannot predict the effect of the Year 2000 problem on vendors, customers and
other entities with which we transact business, and there can be no assurance
that the effect of the Year 2000 problem on such entities will not adversely
affect our Company's operations.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE TRUST -- YEAR 2000 COMPLIANCE."
REAL ESTATE INVESTMENT RISKS
GENERAL RISKS OF OWNING REAL PROPERTY INVESTMENTS
Our investment in hotel properties subjects us to the risks generally incident
to the ownership of real property. The yields available from real estate
investments depend upon the amount of revenues generated and expenses incurred.
We cannot guarantee that our hotel properties will generate revenues sufficient
to meet operating expenses, including debt service and capital expenditures, in
order for us to make expected cash distributions to our shareholders. We also
cannot assure you that any of our hotels will not decrease in value, as real
estate assets particularly reflect adverse changes in local and national
economic conditions. Other factors may adversely affect our business. These
factors include:
- increasing labor and supplies costs;
- restrictive zoning laws;
- unproductive traffic patterns;
- adverse neighborhood characteristics;
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<PAGE> 27
- increasing tax rates;
- restrictive government rules and fiscal policies; and
- civil unrest, acts of war and other adverse factors beyond our control.
ILLIQUIDITY OF REAL ESTATE INVESTMENTS
Investments in real estate are not easily convertible into cash. That quality
limits our ability to alter our investment portfolio in response to
unanticipated changes in economic and social conditions. We cannot guarantee
that, if required, we could effectively sell any of our investments in an
advantageous time-frame or at a sale price that recovers or exceeds the money we
have invested.
UNINSURED AND UNDERINSURED LOSSES
Each of our hotels maintains comprehensive insurance policies, including
liability, fire and extended coverage. We can not guaranty that insurance
companies will continue offering us similar coverage with similar cost.
Additionally, insurance companies may not insure certain losses, generally of a
catastrophic nature, such as earthquakes, hurricanes and floods. Even if
insurance were available to cover these risks, the insurance premiums may be too
expensive for us to afford. Our three California hotels bear higher seismic
risks than our other hotel properties. Although one of our California hotels was
constructed after 1984 under more stringent building codes intended to reduce
the likelihood or extent of damage from seismic activity, we can give no
assurances that an earthquake would not cause substantial damage and losses to
that hotel or any other of our hotels.
Our Board of Trustees exercises its discretion when determining the amounts,
coverage limits and deductibility provisions of our insurance policies. They
review these matters to maintain appropriate insurance coverage on our
investments at reasonable costs and on suitable terms. Applying these
considerations, however, may cause us to purchase insurance coverages that would
not cover sufficiently the full current market value or current replacement cost
of a lost hotel property. Inflation, changes in building codes and ordinances,
environmental considerations and other factors might also make it impractical to
rely on insurance proceeds to replace fully any damaged or destroyed property.
An uninsured or underinsured loss may require us to use our own funds to restore
or replace the damaged or lost hotel property. This may reduce our ability to
pay our debts or distribute cash to our shareholders.
POTENTIAL COSTS OF COMPLYING WITH ENVIRONMENTAL LAWS
Various federal, state and local environmental laws, ordinances and regulations,
subject current or previous owners or operators of real property to liability
for the removal or remediation of hazardous or toxic substances on, under,
around or in the property. These laws often impose liability whether or not the
owner or operator knew of, or was responsible for, the presence of the hazardous
or toxic substances. Under certain limited circumstances, liability also may
extend to persons who hold a security interest in the property. Additionally,
the presence of hazardous or toxic contamination, or failing to properly
remediate contaminated property, may adversely affect an owner's ability to
dispose of its property, to fully utilize its property without restriction or to
use the property as collateral for borrowing. These restrictions and liabilities
may require unanticipated expenditures.
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<PAGE> 28
Other environmental laws and common law principles may impose liability for the
release of hazardous or toxic substances. These laws also regulate the release
of asbestos-containing materials into the air. Third parties may seek recovery
from real property owners or operators for personal injury or property damage
related to these regulated releases.
As owners and operators of hotel properties, we could incur liability for such
costs. The cost to defend against claims of liability, to comply with
environmental regulatory requirements or to remediate contaminated property
could materially and adversely affect our business, assets and profits. Similar
liability and costs could befall the Operating Partnership.
Independent environmental engineers conducted Phase I environmental site
assessments on each of the hotels prior to our acquisition. The Phase I site
assessments identified potential environmental contamination and, secondarily,
assessed, the potential for required regulatory compliance. The environmental
engineers designed the Phase I site assessments to meet the requirements of our
lenders and the then-current industry standards governing Phase I site
assessments. Consistent with those requirements, none of the site assessments
involved the testing of groundwater, soil or air. Accordingly, the assessments
did not evaluate site conditions that would be revealed only through the testing
of groundwater, soil or air. We cannot give you any assurance that the site
assessments revealed all potential environmental liabilities. The environmental
regulatory compliance assessment was general in scope and was not a detailed
determination of each hotel's complete compliance. Similarly, the environmental
engineers did not analyze comprehensively potential off-site liabilities. Our
current insurance policies do not cover environmental liabilities.
The Phase I reports issued by the environmental engineers did not reveal any
environmental liabilities that our management believes would materially and
adversely effect our business, assets or results of operations. Neither are we
aware of any such liabilities. Nevertheless, it is possible that these reports
and our knowledge do not reveal all material environmental conditions.
Still other environmental laws impose liability on previous owners of real
property to the extent hazardous or toxic substances were present during the
prior ownership period. As transfers of the subject property do not relieve the
previous owner, we may be liable with respect to properties we have sold or will
sell.
OUR HOTELS' COMPLIANCE WITH PUBLIC ACCESS LAWS
The Americans with Disabilities Act of 1990 ("ADA") and other state and local
laws require that all public accommodations meet certain access and use
requirements to assist disabled members of the public. If our hotels do not
comply with current laws, we could face additional expenses, fines and/or an
award of damages from private lawsuits. Any requirements to make substantial
modifications to our hotels to comply with these laws could adversely affect our
ability to pay our debts or to distribute cash to our shareholders. Future
legislation could impose further access requirements, requiring substantial
renovation of our hotels. These requirements could affect our profitability and
hinder our acquisition options.
INCREASES IN PROPERTY TAXES
Each of our hotels is subject to real and personal property taxes. These real
and personal property taxes may increase as property tax rates change, as we
improve our hotels or as local taxing authorities assess or reassess the values
of our hotels. Increases in property taxes could adversely affect our ability to
pay our debts or to distribute cash to our shareholders.
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HOTEL OWNERSHIP RISKS
GENERAL OPERATING RISKS
Our hotels endure operating risks common to the hotel industry. While we strive
to have our hotels managed and operated to the fullest economic potential,
events and conditions beyond our control may adversely affect our profitability.
Some of these risks include the following:
- intense and increased competition from other hotels;
- potential overbuilding in the hotel industry, which has adversely affected
occupancy rates, ADR and REVPAR in the past;
- increases in the costs of necessary renovation and capital improvement
projects;
- increases in operating costs due to inflation and other economic factors,
which have not always been, and may not always be, offset by increased
suite rates;
- dependence on cyclical business travel and tourism;
- increases in energy costs and other expenses of travel; and
- the effects of general and local economic conditions.
These factors, with others, could adversely affect the Initial Lessee's and the
Management Company's ability to fulfill their lease payment obligations under
the Percentage Leases, ultimately affecting our ability to pay our debts and
distribute cash to our shareholders. Further, annual adjustments to the base
rent charges and percentage rent thresholds under the Percentage Leases will
reflect adverse changes in key economic indicators such as the U.S. Consumer
Price Index. Without offsetting increases in suite revenues, or upon decreases
in suite revenues for any reasons, these formulas could result in decreased
Percentage Lease rents, also adversely affecting our ability to pay our debts
and distribute cash to our shareholders.
COMPETITION IN HOTEL INDUSTRY
The hotel industry is highly competitive. Each of our hotels experiences
competition primarily from other mid-market hotels in its immediate vicinity,
but they also compete with hotel properties in other geographic markets. Some of
those competitors have much greater marketing and financial resources and, as a
result, may more effectively or more often advertise in our hotel markets. Our
competitors also have added, are currently developing, or have announced the
addition of hotel rooms in several of our hotel markets. They may also develop
and market additional hotel rooms in the future. The addition of hotel rooms by
our competitors has had, and may continue to have, an adverse effect on the
revenues of our hotels.
We may also compete for investment opportunities with competitors that have much
greater financial resources. These competitors may accept riskier transactions
than we could prudently manage, generally reducing the number of suitable
investment opportunities and increasing the bargaining power of sellers. Without
suitable investment options, we cannot meet our growth strategy.
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<PAGE> 30
SEASONAL REVENUE FLUCTUATIONS OF HOTEL BUSINESS
Our operating results reflect the seasonality of the hotel business. Most of our
hotels experience historically higher occupancy rates during the first and, to a
lesser extent, the fourth quarters of each fiscal year and encounter the lowest
occupancy rates during the second quarter of each fiscal year. Our southern
Arizona hotels are historically most profitable in the winter season, whereas
our northern Arizona and southern California hotels are historically most
profitable during the summer season, providing some balance to the seasonal
fluctuations of the hotel business. Despite this balance, we expect seasonality
to continue causing significant quarterly fluctuations in our revenues.
INVESTMENT CONCENTRATION IN SINGLE INDUSTRY
Our current investment and operating strategies focus on owning and managing
hotel properties. We will not seek to diversify our investments to reduce the
risks associated with our exclusive investment in the hotel industry. If we do
not vary our investments, any substantial downturn in the hotel industry may
significantly affect our lease revenues, scheduled debt payments or cash
distributions to our shareholders.
EMPHASIS ON MARKETING INNSUITES HOTELS AND CONCENTRATION OF HOTEL LOCATIONS
We market nine of our hotels primarily as InnSuites Hotels (three of which are
also marketed as Best Western(R) hotels), while modestly marketing our tenth
Holiday Inn(R) hotel as an InnSuites affiliate. Concentrating our investments in
the InnSuites Hotels brand subjects us to additional investment risks. For
example, adverse publicity related to the InnSuites brand could reduce hotel
business, adversely affecting our lease revenues, scheduled debt payments, or
cash distributions to our shareholders.
All of our current hotels are located in Arizona and southern California.
Adverse events or conditions that affect particularly those areas (such as
localized natural disasters or adverse changes in local economic conditions)
could negatively impact our hotel operations and our lease revenues, scheduled
debt payments, and cash distributions to our shareholders. Concentrating our
properties in a few markets subjects us to more risks than if we had properties
in diverse locations. To the extent conditions in these areas deteriorate
significantly, the economic value of our hotel investments could also materially
decline.
RISKS OF OPERATING HOTELS UNDER FRANCHISE AGREEMENTS
Obtaining or maintaining our franchise and/or trademark licenses may require
significant additional improvement to our hotels. If we fail to complete
improvements in a manner satisfactory to the franchise owner, they might refuse
to issue or cancel our franchise licenses. Franchise owners may also require
significant capital expenditures and upgrades for newly acquired hotels we wish
to add to our existing franchise arrangements. The failure to meet the standards
imposed by our franchise owner(s) could result in the loss or cancellation of a
franchise agreement. The loss of a franchise agreement could have a material
adverse effect on our operations or on the value of our hotels. Any additional
financial commitments could also adversely affect our ability to pay our debts
or distribute cash to our shareholders.
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<PAGE> 31
CONSTRAINTS ON CONTINUED ACQUISITIONS AND IMPROVEMENTS
To pursue our growth strategy, we intend to develop and improve currently owned
and newly and to be acquired hotel properties. Risks generally associated with
our acquisition and improvement strategies may include the following:
- expenditure of funds and management time on failed acquisitions;
- failure of or delay in an acquisition to meet our profitability
expectations;
- inaccurate cost estimates for necessary improvements and renovations;
- decreases in property values following an acquisition;
- increased government regulation of real estate expansion; and
- insufficient financing or unfavorable financing terms.
To maintain the Trust's REIT qualification, we must distribute at least 95% of
our REIT taxable income annually. This means that we generally cannot retain
cash generated by our operating activities. Therefore, we have obtained
commitments, such as our $12 million credit facility, to assist with financing
our growth strategy. Our current credit facility, however, expires in 2001.
After 2001, our ability to continue our growth strategy will depend primarily on
our ability to obtain additional financing, because we generally cannot retain
earnings.
We incur similar risks if we exhaust the available credit under the current
credit facility. We might persuade hotel property sellers to accept Trust shares
or Operating Partnership units instead of cash or debt. Using equity rather than
debt to finance our business, however, could dilute your investment. In any
case, if debt or equity financing were unavailable to us on favorable terms,
then further acquisitions and growth might cease or our profitability might
suffer. We cannot give you any assurance that favorable debt or equity financing
will be available to make future investments.
While we anticipate growing in a controlled manner, the addition of hotel
properties to our investment portfolio may increase the demands placed on our
management. Although our management has significant experience in acquiring
hotel properties, we cannot guarantee that our management can continue
successfully to integrate new acquisitions into our management and operational
systems. For example, we must unify the accounting systems, management
information systems, guest registration, reservation systems and asset
management systems for each and every acquisition with our existing procedures
and systems. Failure to quickly and fully integrate the acquired properties'
operations and employees could adversely affect our operations or the
implementation of our management strategies.
RISK OF CONFLICTS OF INTEREST
GENERAL CONFLICT BETWEEN THE MANAGEMENT COMPANY AND THE TRUST
Certain of our trustees and executive officers also have important positions
with our affiliates. As trustees and executive officers, they owe fiduciary
duties to each and every company they represent. Those fiduciary duties might
compete in transactions they initiate and approve. For example, their attempts
to maximize Management Company profits may conflict with the best interests of
the Trust. A number of our prior transactions have involved dealings with our
affiliates, executive officers, trustees, and major shareholders.
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<PAGE> 32
Our executive officers and trustees might also experience competing monetary
interests from their ownership of Trust and Management Company shares. While the
Trust does not directly own Management Company shares, our executive officers
and trustees own controlling interests in the Management Company.
Accordingly, our management may have considered their own interests above the
interests of our other shareholders while negotiating the Intercompany
Agreement. Similar risks may arise in future negotiations with our affiliates.
Except as specifically provided in the Intercompany Agreement, in our governing
documents or in certain provisions of Ohio law, nothing prohibits our officers
and trustees from engaging in business activities for their own account. As a
general principle of law, however, officers and trustees owe fiduciary duties to
the shareholders of each company they represent. Those duties require them to
deal with each company fairly. Additionally, all decisions involving the
potential for conflict must be approved by a majority of trustees who do not
have an interest in the transaction. We cannot guarantee, however, that the
independent trustees will resolve all decisions involving conflict in favor of
the Trust. This prospectus further describes the relationships between our
management and our affiliates in the prospectus section labeled "MANAGEMENT OF
THE TRUST -- TRUSTEES AND EXECUTIVE OFFICERS."
NO ARMS-LENGTH BARGAINING ON PERCENTAGE LEASES AND COMPENSATION ARRANGEMENTS FOR
OFFICERS AND TRUSTEES
The terms of the current Percentage Leases and the initial compensation
arrangements for our officers and trustees were not negotiated on an arm's
length basis. We believe, however, that the terms of these agreements are fair
to all the parties, including the Trust and the Initial Lessee. For example, the
Percentage Leases base the required lease payments on references to objective
historical financial data and the projected operating and financial performance
of the hotels. Our management believes that terms of the Percentage Leases are
typical of provisions found in similar lease transactions and that future
Percentage Leases with the Management Company will also be fair and contain
typical lease provisions.
We also believe that the initial and current compensation arrangements for our
officers and trustees, coupled with their substantial ownership interests,
provide strong incentives for our officers and trustees to maximize shareholder
value. As an additional safeguard to officer and trustee fiduciary duties, our
governing documents and Ohio laws require that only those trustees without an
interest in particular transactions may vote to approve or disapprove certain
transactions. The Trust's independent trustees so approved the Percentage Leases
and compensation plans. We cannot guaranty, however, that these safeguards will
curtail self-dealing or self-motivated decisions.
DIFFERING TAX CONSEQUENCES TO CERTAIN AFFILIATES ON SALE OR FINANCING OF CERTAIN
HOTELS
Certain of our affiliates may have unrealized gains from hotels they contributed
to the Operating Partnership and the subsequent sale of these hotels may cause
them different or adverse tax consequences. Therefore, the interests of the
Trust could conflict with the interests of certain affiliates. These affiliates
may seek to influence the disposition decisions of the Trust, even when that
sale might otherwise benefit the Trust and the other shareholders.
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<PAGE> 33
Additional conflicts may arise from financing decisions. Certain affiliates may
recognize gain upon hotel debt repayments or payments of expenditures
attributable to specific hotels they contributed to the Operating Partnership.
To reduce or eliminate these gains, limited partners of the Operating
Partnership generally have the right to guarantee other loans on other hotel
properties. These guarantees might, under certain circumstances, reduce
depreciation or other deductions available to the Trust for tax purposes.
Reducing these deductions may increase taxable income to the Trust and increase
the required proportionate distributions to Trust shareholders. The shareholders
would then pay ordinary income taxes on these increased distributions. If the
Trust claimed these deductions, the shareholders could report those deductions
as reductions to the basis in their shares, or if the deductions exceeded basis,
as a capital gain. The significance of these tax effects may create conflicts
between the Trust and its affiliates, as these affiliates may attempt to
influence financing decisions for their benefit.
RISKS OF DEBT OBLIGATIONS AND VARIABLE RATE DEBT
At October 31, 1998, on a consolidated pro forma basis, our outstanding debt
principal and capital lease obligations consisted of approximately $10.0
million. Our governing documents do not limit the amount of debt we may incur.
Accordingly, we may become increasingly leveraged, resulting in increased
interest costs which could have a material adverse effect on our profitability.
We may borrow additional funds to pursue our growth and operating strategies of
acquiring additional hotels. We may also borrow additional funds to fulfill REIT
guidelines which require us to distribute annually at least 95% of our REIT
taxable income. For present purposes, we have obtained a $12 million credit
facility to provide, as necessary, funds for investments in additional hotel
properties, working capital and cash distributions. This credit facility bears
interest at a variable rate of the 30-day London Interbank Offered Rate
("LIBOR") plus 2.75%. Changes in economic conditions could increase variable
interest rates, increasing our interest costs and adversely affecting our
profitability. First mortgages on three of our hotels secure our current credit
facility.
Certain risks may apply to debt financing, including the following:
- adverse effects of economic downturns on financing terms;
- insufficient cash flow to meet debt payment obligations;
- failure to meet payment obligations resulting in foreclosure; and
- inability to renew or refinance debt financing or renewal on unfavorable
terms.
Also, as lenders continue to require additional collateral to secure their
loans, the risk increases that defaults on particular loan agreements could
cause foreclosures on multiple properties. Unfavorable borrowing terms may force
us to liquidate one or more of our investments in our hotels to meet our
existing debt obligations. Liquidating our investments in such a manner may not
permit us to realize the maximum return on our hotel properties.
To counteract the adverse effects of increasing interest rates and generally
unfavorable economic conditions, we may employ hedging strategies. Our
strategies to offset such adverse effects may include interest rate swaps, caps,
floors and other interest rate exchange contracts. The use of these devices to
neutralize our exposure to financial risks involves additional risks. For
example, losses from unsuccessful hedge investments might reduce cash
distributions to our shareholders and may also exceed the amount we invested in
such instruments. Moreover,
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the parties who currently engage in hedging transactions may stop trading or
quoting prices in such instruments, rendering us unable to complete our hedging
transactions.
TAX RISKS
FAILURE TO MAINTAIN THE TRUST'S REIT QUALIFICATION
We operate our business in a manner intended to qualify the Trust as a REIT for
federal income tax purposes. We have not requested, and do not expect to
request, a ruling from the Internal Revenue Service that the Trust qualifies as
a REIT. We have received, however, an opinion of our counsel that, based on
certain representations made by us to our counsel and assumptions, the Trust
qualifies as a REIT. You should be aware that the opinion of our counsel does
not control determinations of courts or the Internal Revenue Service. The REIT
qualification opinion only represents our counsel's view based on their review
and analysis of existing law. Additionally, the validity of the REIT
qualification opinion and the Trust's continued qualification as a REIT directly
depends on our continuing ability to meet various technical requirements. Those
requirements affect, among other things, the amounts we distribute to our
shareholders, the ownership of our shares, the nature of our assets, and the
sources of our income.
If the Trust were to fail to qualify as a REIT in any taxable year, we could not
deduct distributions to our shareholders in computing our taxable income.
Failure to qualify would also subject us to federal income tax (including any
applicable alternative minimum tax) on all of our taxable income at regular
corporate rates. Unless entitled to relief under certain provisions of the
Internal Revenue Code, we would lose REIT treatment for an additional four
taxable years following the year of our actual disqualification. Loss of REIT
status would reduce our ability to pay our debts and to distribute cash to our
shareholders for each year involved.
Although we intend to operate the Trust in a manner designed to continue REIT
qualification, future economic, market, legal, tax or other considerations may
cause the Board of Trustees to revoke the Trust's REIT election. See "FEDERAL
INCOME TAX CONSIDERATIONS RELATED TO THE TRUST" for a more thorough discussion
of tax issues.
REQUIREMENT THAT THE TRUST MAINTAIN REIT MINIMUM DISTRIBUTIONS
To maintain the Trust's REIT qualification, we generally must distribute at
least 95% of our REIT taxable income (excluding any net capital gains) and 95%
of our net income from foreclosure property (less any tax thereon) to our
shareholders. Additionally, to avoid a 4% nondeductible excise tax, during all
calendar years we must also distribute more than the sum of:
- 85% of our ordinary income for that year;
- 95% of our capital gain net income for that year; and
- 100% of our undistributed taxable income from prior years.
If we elect to retain and pay income tax on our capital gain net income, we
could treat those amounts as distributed for purposes of the nondeductible 4%
excise tax. We intend to observe the 95% distribution requirement and to avoid
the nondeductible 4% excise tax for all periods, but we cannot guaranty
compliance.
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The income we must distribute to our shareholders consists primarily of income
from the Operating Partnership. Cash for our shareholders consists primarily of
cash we receive from the Operating Partnership distributions. Timing differences
between income reporting and cash distribution could force us to borrow funds on
a short-term basis to meet the 95% distribution requirement and to avoid the
nondeductible 4% excise tax. A portion of that timing difference may result from
the effects of hotel industry seasonality on the Operating Partnership
distributions.
As the Trust controls the activities of the Operating Partnership, our Board of
Trustees determines the timing and amounts of the Operating Partnership
distributions. The Board of Trustees considers many factors, including the
following:
- cash available for distribution;
- the Operating Partnership's financial condition and cash-flow needs;
- reinvestment options other than distributing funds;
- annual Internal Revenue Code REIT distribution requirements; and
- such other factors as the Board of Trustees deem relevant.
See also "FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE TRUST -- REQUIREMENTS
FOR QUALIFICATION and -- DISTRIBUTION REQUIREMENTS."
OWNERSHIP LIMITATION
The tax rules governing the Trust's continued qualification as a REIT require
that we impose certain limitations upon the ownership and transfer of Trust
shares. For example, our top five individual shareholders (as defined to include
certain entities) may collectively own only up to 50% of the value of the
Trust's outstanding shares during the last half of any taxable year (other than
in our first taxable year). We calculate the ownership of these five individuals
by including shares they actually own and shares they are considered to
constructively own due to their relationship with other shareholders or
entities. Additionally, the Trust must have 100 or more shareholders during at
least 335 days of any taxable year (other than in our first taxable year) or
during a proportionate part of a shorter taxable year. These additional
requirements add additional risks that the Trust may not qualify as a REIT.
To preserve its REIT qualification, the Trust's Second Amended and Restated
Declaration of Trust dictates limitations on the ownership and transfer of Trust
shares. These include:
- prohibiting any shareholder from owning (after applying the constructive
ownership rules mentioned above) more than 4.9% of any class of the
Trust's shares; and
- subject to exceptions for Board of Trustee approval, prohibiting transfers
resulting in:
(a) any shareholder violating the 4.9% ownership limit;
(b) fewer than 100 shareholders owning Trust shares (determined
without constructive ownership);
(c) the Trust being "closely held" as defined by the Internal
Revenue Code;
(d) otherwise failing to qualify as a REIT under the Internal
Revenue Code; or
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(e) the Trust owning (after applying the constructive ownership
rules) 10% or more of the Management Company, the Initial Lessee or any
other lessee or sublessee.
Any attempt to transfer our shares in violation of any one or more of the above
restrictions would render that transfer void and of no force or effect for the
amount of shares in excess of the allowable ownership limits. Any such excess
shares will be transferred automatically to a trust whose beneficiary is a
qualified charitable organization. Transfers that would violate the 100
shareholder requirement are considered void and of no force or effect,
regardless of the number of shares involved. We may also take any lawful action
we deem necessary or advisable to ensure compliance with these restrictive
provisions and to preserve the Trust's REIT status. Our actions may include,
without limiting our available options, refusing to recognize or record any
transfer in violation of these restrictions.
Any individual who acquires shares in violation of the restrictions, therefore,
bears the risk of losing
- voting control over certain of those shares;
- the ability to freely transfer certain of those shares; and
- dividends paid on certain of those shares.
FAILURE OF THE OPERATING PARTNERSHIP TO BE CLASSIFIED AS A PARTNERSHIP FOR
FEDERAL INCOME TAX PURPOSES AND IMPACT ON THE TRUST'S REIT STATUS
We have not requested, and do not expect to request, a ruling from the Internal
Revenue Service that it will classify the Operating Partnership as a partnership
for federal income tax purposes. We will, however, receive at the closing of
this offering an opinion of our counsel stating that, based on certain
representations made by us to our counsel and assumptions, the Operating
Partnership should be classified as a partnership. You should be aware that the
opinion of our counsel does not control determinations of courts or the Internal
Revenue Service. The partnership classification opinion only represents our
counsel's view based on their review and analysis of existing law. Successful
challenge by the Internal Revenue Service of the Operating Partnership's federal
income tax treatment would subject the Operating Partnership to corporate
taxation, requiring it to pay federal income taxes on its taxable income at
regular corporate rates. In such event, the Trust would likely cease to qualify
as a REIT since the value of the Trust's ownership interest in the Operating
Partnership makes up more than 10% of the Operating Partnership's voting
securities and exceeds 5% of the Trust's assets. Furthermore, the imposition of
a corporate tax on the Operating Partnership would substantially reduce the
Operating Partnership's cash distributions to the Trust and, therefore, reduce
the Trust's cash distributions to its shareholders.
EFFECT OF INTEREST RATES ON MARKET PRICE OF YOUR SHARES
The annual yield from Trust distributions, as compared with yields from other
financial instruments, may influence the market price of your shares in the
public trading markets. For example, an increase in market interest rates will
result in higher yields on other financial instruments, which could adversely
affect the market price of your shares. Moreover, adverse changes and
fluctuations in the public securities markets may have a material and adverse
affect on the market value of your shares.
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LIMITATIONS ON CONTROL, ACQUISITION AND CHANGES IN CONTROL
RELIANCE ON KEY PERSONNEL AND THE BOARD OF TRUSTEES
As a shareholder, you would not have the right or the power to manage the Trust
except through the election of trustees and the exercise of voting rights on
certain specified matters. Instead, our Board of Trustees and officers manage
the Trust. Our future success, including particularly the implementation of our
acquisition growth strategy, substantially depends on the active participation
of our executive officers, Mr. James F. Wirth, our President and Chief Executive
Officer, and Mr. Gregory D. Bruhn, our Executive Vice President and Chief
Financial Officer, and other important employees, such as Mr. Marc E. Berg, our
Vice President-Acquisitions, and Mr. Robert Conaway, our Controller. With the
Board of Trustees, they direct our day-to-day operations, in addition to
identifying and negotiating our most important transactions. The loss of any of
these individuals could have a material adverse effect on the Trust. The Trust
does not maintain "key-man" life insurance on any of these individuals.
OWNERSHIP LIMITATION
The ownership limitation forbidding any shareholder from owning more than 4.9%
in value of the Trust's shares may discourage third party attempts to acquire
control of the Trust without the approval of the Board of Trustees. Such a
barrier to a change in control may exist even if a change in control were in our
shareholders' best interests.
CLASSIFICATION OF BOARD OF TRUSTEES INTO THREE CLASSES
Our Board of Trustees consists of three classes, each class having two trustees.
Our shareholders elect each of the trustees to three year terms at each annual
meeting of the shareholders. We stagger the election of our trustee so that only
one class of trustees is elected in any particular year. This prevents any
changes in the majority of our trustees in less than two years. Subject to any
rights of preferred shareholders, if any, and unless the Board of Trustees
otherwise determines, the affirmative vote of a majority of the remaining
trustees will fill vacancies in the Board of Trustees, even if such a vote were
made by less than a quorum of the trustees. Accordingly, our current Board of
Trustees could temporarily prevent any shareholder from enlarging the Board of
Trustees and filling the new trustee positions with outside nominees. These
restrictions may further discourage third parties from making offers to purchase
your shares or from attempting to change control of the Trust, even if such
offers or changes in control were in the best interest of our shareholders.
EFFECT ON MARKET PRICE OF SHARES AVAILABLE FOR FUTURE SALE
We cannot predict the effect on the market price of our shares if the Trust or
its executive officers sell their shares. Substantial sales of our shares
(including shares issued on the exercise of options), or the perception that
such sales might occur, could adversely affect the market prices for your
shares. See "SHARES AVAILABLE FOR FUTURE SALE" and "UNDERWRITING."
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RISKS OF NOT MEETING OR MAINTAINING OUR ESTIMATED DISTRIBUTION RATES
We estimate an annual distribution rate of 8% per share for the twelve months
ending January 31, 2000. This estimate assumes a public offering price of $15.00
per share. The Board of Trustees exercises limited discretion when declaring
shareholder distributions, depending upon a number of factors, including:
- the Trust's available cash;
- the Trust's financial condition;
- decisions to reinvest rather than distribute funds;
- the actual or projected capital expenditures relating to the hotels;
- the annual distribution requirements under the Internal Revenue Code; and
- such other factors as the Board of Trustees deems relevant.
An annual distribution of $1.20 per share would exceed the annual distribution
requirements for REITs, and would also represent 122% of the Trust's pro forma
cash available for distribution, therefore, we cannot assure you that the Trust
will actually distribute the estimated annual distribution set forth above.
Accordingly, we cannot assure you that the Trust will distribute sufficient cash
to its shareholders to maintain its REIT status.
RISK FACTORS RELATED TO THE MANAGEMENT COMPANY
BEFORE YOU INVEST, YOU SHOULD BE AWARE OF THE RISKS ASSOCIATED WITH OWNING
MANAGEMENT COMPANY SHARES, INCLUDING THOSE DESCRIBED BELOW. PROSPECTIVE
SHAREHOLDERS SHOULD CONSIDER CAREFULLY THE FOLLOWING FACTORS WHEN EVALUATING
THEIR INVESTMENT.
The Management Company is described beginning on page 121.
GENERAL OPERATING RISKS
RECENT ORGANIZATION AND LIMITED OPERATING HISTORY
The Management Company began operating in February of 1998, following the
formation of the Operating Partnership and the restructuring of the Trust into
an "umbrella partnership REIT." As a result, the Management Company has a
limited operating history and limited operating results upon which it may
estimate future performance. Additionally, the Trust depends upon the operations
of its affiliates, including the Management Company, to maintain its REIT
qualification. That REIT qualification depends upon compliance with many
technical tax and operational requirements and our management has limited
experience with these requirements. Any Management Company action violating
these requirements could have adverse tax consequences to the Trust.
RESTRICTIONS ON CORPORATE PURPOSE AND BUSINESS OPPORTUNITIES
The Intercompany Agreement limits, for as long as it remains in effect, the
Management Company's ability to invest in real estate or other investments that
the Trust (as a REIT) may use. The Management Company must first offer the
investment to the Trust and the Trust must reject that opportunity. If the Trust
elects to pursue an offered opportunity, the Management Company must then assist
the Trust in structuring and consummating the
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transaction. While these restrictions support the Trust's REIT qualification,
they severely restrict the business and available opportunities of the
Management Company. These restrictions may affect the Management Company's
financial condition and its profitability. See "INNSUITES INNTERNATIONAL HOTEL,
INC. -- INTERCOMPANY AGREEMENT."
DEPENDENCE UPON THE TRUST AND THE OPERATING PARTNERSHIP FOR BUSINESS
OPPORTUNITIES
The terms of the Intercompany Agreement may cause uncertainty in the Management
Company's business. Those terms cause the Management Company to rely
significantly on the Trust and the Operating Partnership to identify its
business opportunities. Those opportunities will likely involve the operation
and management of hotels pursuant to Percentage Leases. Future opportunities are
also likely to relate to the Trust and its real estate investments, rather than
to unrelated businesses. There is no guaranty, however, that the Trust or the
Operating Partnership will identify opportunities for the Management Company or
that any identified opportunities will fall within its financial, operational or
management constraints.
Additionally, although the Intercompany Agreement obligates the Operating
Partnership to give the Management Company the first opportunity, after February
1, 2000, to lease any newly-acquired real property, that opportunity remains
subject to the Operating Partnership's sole discretion. For each newly acquired
property, the Operating Partnership must determine that, consistent with the
Trust's REIT status, the new property requires a Percentage Lease and that the
Management Company would qualify as the lessee. Moreover, the Management Company
can enter into a new Percentage Lease only if it agrees with the Operating
Partnership on mutually satisfactory lease terms. Without the Trust and the
Operating Partnership continuing to offer new Percentage Lease opportunities,
the Management Company has limited prospects for further developing its
business. See "INTERCOMPANY AGREEMENT."
The Trust's failure to qualify as a REIT could materially and adversely affect
the Management Company's business. For example, under the Intercompany
Agreement, if the Trust cannot maintain its REIT qualification it may choose to
lease new properties to any person or entity under any form of lease (including
a master lease arrangement). It may also choose to operate the new property
itself. In either case, the Trust is not required to offer the lease opportunity
to the Management Company. The Management Company would, however, remain subject
to all of the operational limitations and restrictions contained in the
Intercompany Agreement.
If the Trust sold any property leased to the Management Company, the new owner
may refuse to renew the applicable Percentage Lease upon the expiration of its
term. Although the Management Company anticipates that the Percentage Leases
will generally allow the Management Company to retain its renewal rights
following a sale of a property or an assignment of a Percentage Lease, the
Management Company could lose those rights upon expiration of the Percentage
Leases. The likelihood of a sale or assignment of a Percentage Lease increases
if the Trust fails to qualify as a REIT. Therefore, the Management Company's
operations depend on the Trust's continued REIT qualification. As its business
is uncertain due to dependence on the Trust and the Operating Partnership, the
Management Company cannot guaranty that its profits will support distributions
to its shareholders.
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YEAR 2000
The Year 2000 problem results from computer programs having been written using
two digits instead of four digits to define the applicable year. Any of the
Management Company's computer programs that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could potentially result in a system failure or miscalculations, causing
disruptions of operations and normal business activity. Continuing system
failure or miscalculations could substantially affect the Management Company's
ability to manage hotel properties and could significantly affect the Management
Company's profitability.
The Management Company cannot predict the effect of the Year 2000 problem on
vendors, customers and other entities with which it transacts business, and
there can be no assurance that the effect of the Year 2000 problem on such
entities will not adversely affect the Management Company's operations.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE MANAGEMENT COMPANY -- YEAR 2000 COMPLIANCE."
RISK OF REAL ESTATE OPERATIONS
GENERAL REAL ESTATE OPERATIONS
The inability of the Management Company to diversify its operations without the
action of the Trust or the Operating Partnership subjects it to risks related to
the Trust's ownership of the hotels. While it will strive to manage and operate
the hotels to their fullest economic potential, events and conditions beyond the
control of the Management Company may adversely affect its profitability. Some
of these risks include the following:
- intense and increased competition from other hotels;
- potential overbuilding in the hotel industry, which has adversely affected
occupancy rates and revenues in the past;
- increases in the costs of necessary renovation and capital improvement
projects;
- increases in operating costs due to inflation and other economic factors,
which have not always been, and may not always be, offset by increased
suite rates;
- dependence on cyclical business travel and tourism;
- increases in energy costs and other expenses of travel; and
- the effects of general and local economic conditions.
These factors, with others, could also adversely affect the Management Company's
ability to fulfill its lease payment obligations to the Operating Partnership
under the Percentage Leases. As the Percentage Leases may require substantial
payments of base rent or percentage rent, declining hotel profitability could
significantly affect the Management Company's ability to pay the Operating
Partnership. Defaults on the Percentage Leases may subject the hotels to the
Trust's foreclosure and repossession. Failure to maintain the Percentage Leases
may have a material adverse effect on the Management Company's financial
condition and operating
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results. See also See "RISK FACTORS RELATED TO THE TRUST -- HOTEL OWNERSHIP
RISKS."
SEASONAL REVENUE FLUCTUATIONS OF HOTEL BUSINESS
Revenue retained under the Percentage Leases may determine the Management
Company's overall profitability. Decreases in hotel profits would decrease its
revenues. Therefore, the Management Company's operating results may reflect
particularly the seasonality of the hotel business. Most of the hotels in the
Management Company's geographic regions experience historically higher occupancy
rates during the first and, to a lesser extent, the fourth quarters of each
fiscal year and encounter the lowest occupancy rates during the second quarter
of each fiscal year. Southern Arizona hotels are historically most profitable in
the winter season, whereas northern Arizona and California hotels are
historically most profitable during the summer season, providing some balance to
the seasonal fluctuations of the hotel business. As hotel profits fluctuate, so
will the Management Company's operating results. Therefore, the Management
Company expects seasonality to cause significant quarterly fluctuations in
Management Company revenues.
POTENTIAL COSTS OF COMPLYING WITH ENVIRONMENTAL LAWS
Various federal, state and local environmental laws, ordinances and regulations,
subject current or previous owners or operators of real property to liability
for the removal or remediation of hazardous or toxic substances on, under,
around or in the property. These laws often impose liability whether or not the
owner or operator knew of, or was responsible for, the presence of the hazardous
or toxic substances. Under certain limited circumstances, liability also may
extend to persons who hold a security interest in the property. Additionally,
the presence of hazardous or toxic contamination, or failing to properly
remediate contaminated property, may adversely affect an owner's ability to
dispose of its property, to use fully its property without restriction or to use
the property as collateral for borrowing. These restrictions and liabilities may
require unanticipated expenditures by the Management Company.
Other environmental laws and common law principles may impose liability on the
Management Company for the release of hazardous or toxic substances. These laws
also regulate the release of asbestos-containing materials into the air. Third
parties may seek recovery from real property owners or operators for personal
injury or property damage related to these regulated releases.
As operators of hotel properties, the Management Company could incur liability
for such costs. The cost to defend against claims of liability, to comply with
environmental regulatory requirements or to remediate contaminated property
could materially and adversely affect the business, assets and profits of the
Management Company.
Independent environmental engineers will conduct Phase I environmental site
assessments on each hotel prior to the Trust's acquisition. The Phase I site
assessments should identify potential environmental contamination and,
secondarily, assess, the potential for required regulatory compliance.
Environmental engineers will design the Phase I site assessments to meet the
requirements of the Trust's lenders and the then-current industry standards
governing Phase I site assessments. Consistent with those requirements, none of
the site assessments would involve the testing of groundwater, soil or air.
Accordingly, the assessments would not evaluate site conditions revealed only
through the testing of
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groundwater, soil or air. The Management Company cannot assure that future site
assessments will reveal all potential environmental liabilities. Environmental
regulatory compliance assessments are general in scope and are not a detailed
determination of each hotel's complete compliance. Similarly, the environmental
engineers will not analyze comprehensively potential off-site liabilities. Our
current insurance policies do not cover environmental liabilities.
The Phase I reports issued by the environmental engineers did not reveal any
environmental liabilities that the Management Company believes would materially
and adversely affect its business, assets or results of operations. Neither is
it aware of any such liabilities. Nevertheless, it is possible that these
reports and its knowledge do not reveal all material environmental conditions.
RISK OF CONFLICTS OF INTEREST
GENERAL CONFLICT BETWEEN THE MANAGEMENT COMPANY AND THE TRUST
Certain Management Company directors will also serve as trustees and executive
officers of its affiliates. For example, James F. Wirth will serve as a director
of the Management Company and as a trustee, and executive officer of the Trust.
Mr. Wirth serves as Chairman of both Boards. This commonality of management may
cause conflicts of interest in transactions between the companies. As a general
principle of law, however, directors and trustees owe fiduciary duties to the
shareholders of each company they represent. Those duties require them to deal
with each company fairly. Additionally, our directors who do not have an
interest in the transaction must approve all decisions involving the potential
for conflict. We cannot guaranty, however, that our independent directors will
resolve all decisions involving conflict in favor of the Management Company.
The management and directors of the Management Company might also experience
competing financial interests due to their ownership of both Management Company
shares and Trust shares. The management and directors of the Management Company
own controlling interests in the Management Company and own shares of its
affiliates, including the Trust. Accordingly, the Management Company's
management may have considered their own interests while negotiating the
Intercompany Agreement. Similar risks may arise in future negotiations with
affiliates. Except as specifically provided in the Intercompany Agreement, in
its governing documents or in certain provisions of Nevada law, nothing
prohibits the Management Company's officers and directors from engaging in
business activities for their own account.
RISKS OF POTENTIAL INVESTMENTS AND ABILITY TO MANAGE THOSE INVESTMENTS
While managing the hotels and pursuing its business strategy and corporate
purpose, the Management Company may pursue a variety of opportunities. Although
the Management Company intends to acquire and operate a complementary group of
businesses, it may commit resources to different businesses. Any commitment to a
new business may require a wide range of skills and qualifications. The
Management Company cannot guarantee that its management or employees will have,
or that it could hire and retain employees with, the necessary skills and
qualifications. The Management Company also cannot guarantee that the business
opportunities it pursues will perform as expected or contribute significant
revenues
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or profits. Pursued business opportunities may lose money, affecting
significantly the Management Company's financial condition and profitability.
LIMITED FINANCIAL RESOURCES
The Management Company expects to have access to the capital markets and to
other financing opportunities, including financing from the Trust. We cannot
guarantee, however, that we could secure financing in amounts or on terms
acceptable to us. The Management Company and the Trust may deem it desirable,
under certain circumstances, to further offer and sell their shares under a
common plan of distribution. In that case, the Management Company cannot assure
you that the timing, terms and manner of such an offering will be as favorable
to the Management Company as the timing, terms and manner of an independent
Management Company offering. Neither the Trust, nor any other person or entity,
is obligated to provide any additional funds to the Management Company, to offer
securities under a common plan of distribution or to assist the Management
Company in obtaining additional financing.
ABSENCE OF A PUBLIC MARKET FOR THE MANAGEMENT COMPANY'S SHARES
There are no public markets currently for the Management Company's warrants or
shares. The Management Company cannot guarantee that active trading markets will
develop or will continue into the future. Until orderly trading markets for them
develop, the trading prices of its warrants and shares may fluctuate
significantly. If no active trading markets develop, Management Company
shareholders may not promptly find buyers for their Management Company warrants
or shares or find buyers willing to pay a reasonable price. Accordingly,
Management Company shareholders should consider an investment in the Management
Company as an illiquid, long-term investment.
Many factors may influence the trading prices of Management Company warrants or
shares. Those factors include:
- financial performance and prospects;
- the depth and liquidity of the market for the shares;
- investor perception of the Management Company and of its industry;
- general economic conditions;
- the Management Company's dividend policy; and
- general financial and other market conditions.
Additionally, the recent price and volume fluctuations experienced in the
financial markets may affect the market price of the Management Company's
warrants or shares. General uncertainty in the financial markets could
disproportionately affect the Management Company's warrants or shares, while
having no relation to its operating performance. These market fluctuations may
also disproportionately affect the Management Company as a new public issuer.
Without a strong market history, the market price for the Management Company's
warrants or shares may suffer from adverse general market conditions.
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ABSENCE OF DIVIDENDS ON THE MANAGEMENT COMPANY'S SHARES
The Management Company intends to use its available funds to pursue investment
and business opportunities and, therefore, it does not anticipate the payment of
any cash dividends on its shares in the immediate future. The lack of dividends
on our shares could adversely and significantly affect the market value of our
shares.
RELIANCE ON KEY PERSONNEL AND THE BOARD OF DIRECTORS
The Management Company's success depends significantly upon the contribution of
its executives and key personnel. In particular, it will rely upon the
management and operational skills of William Kidwell, as President, James Wirth,
as Chairman, and Gregory Bruhn, as Chief Financial Officer. While the Management
Company believes that it could find replacements for these key personnel, the
loss of their services could have an adverse effect on its operations.
As a shareholder of the Management Company, you would have no right or power to
manage the Management Company except through the election of directors and the
exercise of voting rights on certain specified matters. Instead, the Management
Company's Board of Directors and officers will manage its operations. The future
success of the Management Company, including particularly its operations under
the Intercompany Agreement and the Percentage Leases, depends substantially on
the active participation of its executive officers. With the Board of Directors,
the executive officers will direct the day-to-day operations, in addition to
identifying and negotiating the most important transactions. The Management
Company does not maintain "key-man" life insurance on any of these individuals.
POTENTIAL ANTI-TAKEOVER EFFECTS OF CERTAIN LAWS
Applicable sections of the Nevada General Corporation Law contain provisions
that may discourage acquiring control of the Management Company without the
approval of the Management Company's Board of Directors. See "CERTAIN CHARTER
AND STATUTORY PROVISIONS."
THE TRUST
FORMATION TRANSACTIONS
In accordance with the terms of the Formation Agreement approved at the 1997
annual shareholders' meeting held on January 28, 1998, the previous trustees
(Alan M. Krause, James H. Berick, Alvin M. Kendis, Frank L. Kennard and Samuel
S. Pearlman) and executive officers (Alan M. Krause, Chairman and Co-Chief
Executive Officer, and James H. Berick, President, Co-Chief Executive Officer
and Treasurer) of the Trust resigned effective January 30, 1998. James F. Wirth,
Gregory D. Bruhn, Marc E. Berg, Mark J. Nasca, Lee J. Flory and Edward G. Hill
were appointed the new trustees of the Trust effective January 30, 1998. Mr.
Wirth was also appointed Chairman, President and Chief Executive Officer of the
Trust and Mr. Bruhn was also appointed Executive Vice President, Chief Financial
Officer, Treasurer and Secretary of the Trust.
On January 30, 1998, the "Formation Transactions" were entered into by the Trust
in accordance with the terms of the Formation Agreement. In general terms, the
Formation
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Transactions resulted in the formation of the Operating Partnership by the Trust
and Hospitality Corporation International ("HCI"), a privately-held Arizona
corporation. HCI and its principal, James F. Wirth, through affiliated entities,
controlled seven all-suite hotel properties, comprising 1,036 hotel studio and
two-room suites, in Flagstaff, Phoenix (2), Scottsdale, Tucson, and Yuma,
Arizona and in Ontario, California, five of which were owned by partnerships and
two of which were owned by corporations. The Trust was the 13.6% general
partner, and the investors in the five partnerships and one of the corporations
were the 86.4% limited partners, in the newly-formed Operating Partnership. The
Operating Partnership then acquired substantial interests in the five
partnerships and the one corporation. The investors (including Messrs. Wirth,
Berg and Flory) received Operating Partnership units in exchange for their
interests in the five partnerships and the one corporation. The remaining
corporation, which was owned by Mr. Wirth and his wife, was acquired directly by
RRF Sub Corp., a wholly-owned subsidiary of the Trust, in a stock-for-stock
exchange. The Operating Partnership units and Trust Common Shares issued in
exchange for the seven hotel properties had an approximate aggregate value of
$35,608,000, which represents the appraised value (as determined by independent
appraisals) of the seven hotel properties less outstanding debt assumed. That
value was determined in arms-length negotiations between HCI and the Trust prior
to the change in control described above. The effect of the Formation
Transactions was to re-direct the investment focus of the Trust from its prior
investment strategy of making wrap-around mortgage loans to the equity ownership
of hotel properties, initially located in the southwestern United States.
Following the Formation Transactions, the Trust acquired three additional hotels
in Tucson (St. Mary's), Arizona and San Diego and Buena Park, California.
THE CURRENT TRUST
The Trust is a self-administered equity REIT that, at October 31, 1998, after
giving effect to this offering, owned an approximate 49% general partner
interest in the Operating Partnership. The Operating Partnership presently owns
directly or indirectly, together with RRF Sub Corp., a wholly-owned subsidiary
of the Trust, interests in ten hotels with an aggregate of 1,665 suites in
Arizona and southern California (collectively, the "Hotels"). The Hotels are
operated as InnSuites Hotels(R). Three of the Hotels are also marketed as "Best
Western(R)" and one primarily as a "Holiday Inn(R) Hotel and Suites." Unless the
context otherwise requires, all references herein to the business and assets of
the Trust refer to InnSuites Hospitality Trust, the Operating Partnership, RRF
Sub Corp. and their respective subsidiaries on a consolidated basis and all
references herein to the Operating Partnership include RRF Sub Corp.
To maintain the Trust's REIT qualification, the Operating Partnership leases the
Hotels to the Initial Lessee and expects to lease any additional hotels to the
Management Company, or a wholly-owned subsidiary thereof, pursuant to leases
providing for the payment of rent based primarily upon the gross room revenues
of such Hotels ("Percentage Leases"). The Initial Lessee pays, and the
Management Company will pay, rent to the Operating Partnership under the
Percentage Leases and, in addition, pays all franchise fees, management fees and
other operating expenses of the Hotels leased by it. The Operating Partnership,
in turn, distributes such rental payments, less expenses, to the Trust.
The Initial Lessee currently operates and manages, with the assistance of the
Management Company, all of the Hotels. The Initial Lessee pays the Management
Company an annual management fee of 2.5% of gross room revenues for its property
management services and
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an annual licensing fee of 2.5% of gross room revenues (1.25% for hotel
properties with third-party franchises) for its trademark and licensing
services.
The Trust was formed as an unincorporated Ohio real estate investment trust on
April 28, 1971. The Trust's executive offices are located at 1750 Huntington
Building, 925 Euclid Avenue, Cleveland, Ohio 44115 and its telephone number is
(216) 622-0046. The Trust is managed and directed by its trustees and officers,
who collectively have over 165 years of experience in managing and operating
real estate related businesses. James F. Wirth, Trustee, Chairman, Chief
Executive Officer and President of the Trust, has been engaged in the hotel
business for approximately 27 years, including serving as Assistant to the
President and Division President of Ramada Inns, where he started in 1970.
BUSINESS OBJECTIVES
The Trust believes that, while the lodging industry as a whole has benefitted
from increased demand for hotel accommodations, the greatest opportunities for
revenue growth and profitability will arise from the skillful acquisition,
management, refurbishment and repositioning of hotel properties. The Trust
believes that InnSuites Hotels are particularly attractive investments because
of the following factors:
- - the favorable recognition of the InnSuites Hotels brand among consumers in the
southwest and western regions of the United States;
- - the leadership position of InnSuites Hotels within the market niche of middle
market moderate and full service studio and two-room suite hotels and the
relative strength of that market within the hotel industry; and
- - the Trust's positive experience and expertise with InnSuites Hotels.
The Trust believes that a substantial number of hotels meeting its investment
criteria remain to be acquired and repositioned at attractive prices. An
integral element of the Trust's business objectives is the continuous evaluation
of each Hotel's position in its market and the implementation, as necessary, of
changes in rates, amenities and customer focus. By focusing on these business
objectives, the Trust will attempt to maximize the profitability of the Hotels.
Through the Percentage Leases, the Trust will participate in any increases in
Hotel revenues, thereby improving its operating cash flow. The Trust attributes
the historical performance of the Hotels to the implementation of this asset
management strategy. In addition, the Trust may expand certain of its Hotel
properties by constructing additional "extended-stay" suites with meeting space,
if market and other conditions warrant.
The Trust's primary business objectives are to maximize current returns to its
shareholders through increases in cash flow available for distribution and to
increase long-term total returns to shareholders through appreciation in the
value of the Hotel assets and Common Shares. The Trust will seek to achieve
these objectives by participating in increased revenues from the Hotels pursuant
to the Percentage Leases and by selective acquisition, ownership, redevelopment,
repositioning and expansion of hotel properties. The Trust will seek to continue
to invest in properties where the Trust's established industry and marketing
expertise and other resources will enable it to improve the acquired hotel's
performance.
39
<PAGE> 47
BUSINESS STRATEGY
The Trust's strategies to meet its objectives include the following:
Cash Flow Growth. The Trust believes that, based on historical operating results
and the strength of InnSuites Hotels' management team, portfolio and markets,
the Hotels should provide the Trust with cash flow growth through the Percentage
Leases. The Trust believes that the Hotels' revenue and cash flows will be
maximized by intensive management and marketing. The Trust believes that the
Management Group's continued commitment to customer service and the experience
of its management team should allow the Trust to capitalize on expected economic
growth and on improvements in the U.S. hotel market. The Trust will also attempt
to enhance its competitive market position by continuing a regular program of
renovation, capital improvement and niche marketing.
Acquisitions. The Trust believes that attractive opportunities exist to acquire
additional hotel properties now serving, or able to serve, the market segment
served currently by the Hotels. The Trust plans to expand the InnSuites Hotels
system in southern California and other markets in the southwestern United
States where it believes strategically acquired properties will, at
stabilization, add to earnings. The Trust believes it has the capacity to
acquire additional hotels without significantly increasing management and
overhead expenses.
Renovation and Development. Land for the addition of "extended-stay" suites may
be available adjacent to four of the Hotels. These additional suites may enable
the Trust to avoid the duplication of overhead and capitalize on InnSuites
Hotels' past success by broadening services to include weekly and/or monthly
"extended-stay" guests while retaining the ability to offer the additional
suites on a daily basis during peak travel season.
The Trust believes that a regular program of capital improvements at the Hotels,
including replacement and refurbishment of furniture, fixtures and equipment,
will enhance its competitiveness and maximize revenue growth under the
Percentage Leases. As part of its ongoing renovation and capital expenditures
program, the Trust expects to spend approximately $1,200,000 on capital
improvements at the Hotels during the fiscal year ending January 31, 1999. These
expenditures for capital repairs, replacements and improvements approved by the
Trust, will be funded from Trust contributions to a capital expenditures fund
established by the Trust pursuant to the Percentage Leases (currently 4% of the
Hotels' gross room revenues). The Initial Lessee administers expenditures from
the fund subject to the Trust's review and approval.
The Trust may also develop additional moderate-service or "extended-stay" hotels
elsewhere in its current geographic markets. The Trust believes that selective
development of hotels in or near its existing geographic markets will enable it
to utilize operating and marketing efficiencies to generate attractive returns
on investment.
FINANCING STRATEGY
As of October 31, 1998, the Trust, on a consolidated pro forma basis, had an
aggregate of approximately $10,088,000 of outstanding debt. While its
organizational documents contain no limitation on the amount of debt it may
incur, the Trust intends to achieve a debt to total market capitalization ratio
or debt to appraised value of real estate ratio (measured at the time debt is
incurred) of not more than 50% to 55%. The Trust may from time to time re-
evaluate its debt capitalization policy in light of economic conditions,
relative costs of debt
40
<PAGE> 48
and equity capital, market values of its properties, acquisition, development
and expansion opportunities, and other factors.
Any indebtedness may be incurred by the Trust or the Operating Partnership.
Indebtedness incurred by the Trust may be in the form of bank borrowings,
secured or unsecured, and publicly or privately placed debt instruments, the
proceeds of which would be loaned or contributed to the Operating Partnership.
Indebtedness incurred by the Operating Partnership may be in the form of
purchase money obligations to the sellers of properties, publicly or privately
placed debt instruments, further borrowings from the Trust, or financing from
banks, institutional investors or other lenders, any of which indebtedness may
be unsecured or may be secured by mortgages or other interests in the property
owned by the Operating Partnership. This indebtedness may be with recourse to
all or any part of the property of the Trust or the Operating Partnership, or
recourse may be limited to the specific property to which the indebtedness
relates. The proceeds from any borrowings by the Trust or the Operating
Partnership may be used for the payment of distributions or dividends, for
working capital, or to refinance existing indebtedness or to finance
acquisitions or expansions of properties. See "FEDERAL INCOME TAX CONSIDERATIONS
RELATED TO THE TRUST -- REQUIREMENTS FOR QUALIFICATION" and " -- DISTRIBUTION
REQUIREMENTS."
The Trust has entered into a $12,000,000 senior secured revolving credit
facility with Pacific Century Bank. The Trust intends to use the credit facility
to provide interim financing for property acquisitions and capital improvements
in anticipation of long-term financing and to fund working capital requirements.
The credit facility is secured by first mortgages on three of the Hotels.
The Operating Partnership may also issue additional limited partnership units in
exchange for hotel properties. Such additional limited partnership units may
reduce distributions to, and, if convertible into Common Shares, dilute the
voting power of, the Trust's shareholders. Such additional limited partnership
units may also reduce distributions to and the ownership interests of the
partners in the Operating Partnership.
CORPORATE STRUCTURE TRANSACTIONS
In an effort to streamline the ownership activities and management related
activities of the Trust and the Management Company for more efficient results
and maximum shareholder value, the Trust and the Management Company are taking
steps towards certain corporate structure transactions (the "Corporate Structure
Transactions"). Prior to the completion of this offering, the Trust or
Management Company will have completed the following Corporate Structure
Transactions:
Ownership activities integrated into the Trust:
- combined the Trust with the InnSuites Hotels System on January 30, 1998
and elected James F. Wirth, founder of InnSuites Hotels, as President and
CEO of the Trust to add entrepreneurial leadership;
- added Gregory Bruhn, Executive Vice President and CFO and Bob Conaway as
Vice President and Controller of the Trust to strengthen financial
capabilities and controls;
- hired Marc Berg as Vice President-Acquisitions for the Trust, reflecting
major emphasis on acquisitions of hotels below replacement cost to be
upgraded and
41
<PAGE> 49
repositioned to become InnSuites Hotels to produce higher rates, occupancy, and
profits;
- changed our name from Realty ReFund Trust to InnSuites Hospitality Trust,
reflecting our concentration on mid-market moderate and full service
studio and two-room suite hotels;
- issued one new Trust Common Share for three existing Trust Common Shares
in a reverse stock split to bring the Trust into a more preferable trading
range for individuals and institutions;
- terminated our agreement with our external advisor (Mid-America ReaFund
Advisors, Inc.) and eliminated their advisory fees;
- reinstated quarterly dividends, continuing 28 consecutive years of
dividends, payable quarterly at the rate of $0.30 per share ($1.20 per
share annual rate, post-reverse stock split);
- established a $12 million line of credit to assist in acquisitions and to
refinance current debt. We also refinanced the Tucson (St. Mary's),
Arizona hotel's assumed mortgage to reduce the interest rate from a
floating 14% per annum to a floating approximately 8.3% per annum, saving
us approximately $350,000 per year in reduced interest expense; and
- transferred ownership of the InnSuites Hotel in Scottsdale hotel to the
Operating Partnership. This hotel was owned by RRF Sub Corp., our
wholly-owned subsidiary. We received additional general partnership units
from the Operating Partnership in return for our additional contribution.
Management related activities integrated into the Management Company:
- added Bill Kidwell, former Vice President Operations of Starwood Lodging
Corp., as President of the Management Company to provide additional depth
to our management team;
- entered into an Intercompany Agreement between the Management Company, the
Trust and the Operating Partnership giving the Management Company the
right of first refusal to eventually lease newly acquired hotels from the
Operating Partnership to take advantage of future growth opportunities;
- acquired InnSuites Licensing Corp. and obtained full ownership of the
InnSuites Hotels trademarks and tradename and acquired the InnSuites
trademark licensing/franchise agreements to control a recognized hotel
franchise;
- developed Internet-based reservation systems to offer discounted excess
room capacity to Internet consumers and travel industry professionals to
provide an additional source of profit from the growing internet segment
of the industry; and
- created warrants to be distributed to the Trust's shareholders at the
conclusion of this offering. The ability to own both Trust and Management
Company shares creates a "paper-clipped" REIT structure to benefit the
shareholders of the Trust and the Management Company.
42
<PAGE> 50
As a result of the Corporate Structure Transactions and this offering, all
existing external affiliates (other than the Initial Lessee) will become part of
the Trust or the Management Company. As a result of the Corporate Structure
Transactions, we should:
- reduce or eliminate potential conflicts of interest between us and our
external affiliates;
- allow investors greater participation in the results of our hotels and the
Management Company;
- terminate the fees and payments made to external advisors and affiliates;
- reorganize the Management Company to undertake redevelopment or
construction projects of future hotels impermissible or impracticable to
the Trust because of our restrictive REIT status;
- build the size of the InnSuites Hotels system to benefit our existing
hotels with systems of cross-referrals and reservations and to add
recognition and value to the InnSuites Hotels(R) trademark; and
- provide an alternative to recently restricted "paired-share" REIT
structures by forming a "paper-clipped" REIT structure, allowing separate
transfer of Trust and Management Company shares, not otherwise offered by
"paired-share" REITs, while enjoying the benefits of Trust and Management
Company operations.
THE HOTEL INDUSTRY
According to Smith Travel Research, the United States hotel industry continues
to experience a strong recovery from an extended downturn in the late 1980's and
early 1990's. We believe that this broad industry recovery may contribute to the
growth in total revenues and REVPAR at the Hotels (and at hotels we may
subsequently acquire), which, through the Percentage Leases, may increase the
cash we have available for distribution to our shareholders.
HOTEL DEMAND
As reflected in the chart below, the hotel industry continues to experience
strong demand growth. Despite improved economic conditions and increased
consumer spending since 1995, demand for mid-scale hotels with food and beverage
operations declined from year to year, and the 10-year growth rate for such
hotels stagnated at 0.2%. On the other hand, demand for mid-scale hotels without
food and beverage services, the sector currently targeted by our InnSuites
Hotels, grew at a rate of 6.4% compounded over the past 10 years. We believe
this difference in growth reflects changes in consumer preferences toward the
quality hotel accommodations and affordable prices offered by the mid-scale
market of the InnSuites Hotels.
<TABLE>
<CAPTION>
DEMAND CHANGE OVER PRIOR YEAR
-------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
All U.S. Hotels......... 4.2% 4.9% 2.0% (1.4)% 2.0% 1.7% 3.0% 1.8% 2.2% 2.6%
Mid-scale with
Food &
Beverage.............. 1.8 1.6 (1.1) (2.6) (2.1) 1.3 1.7 (0.7) (1.3) (0.9)
Mid-scale without Food &
Beverage.............. 28.1 21.7 15.3 12.9 11.1 10.2 13.5 12.9 12.9 14.4
</TABLE>
43
<PAGE> 51
- ---------------
Source: Smith Travel Research
THE COMPANY'S SEGMENT OF THE HOTEL INDUSTRY
From 1991 through 1997, the number of rooms available at upper upscale,
mid-scale with food and beverage, budget chain and independent hotels decreased
compared to the total number of rooms available at all hotels. On the other
hand, the number of rooms available at mid-scale chain hotels without food and
beverage services increased significantly compared to the total number of rooms
available at all hotels. Increasing demand has allowed the entire hotel industry
to maintain positive ADR and REVPAR growth. According to Smith Travel Research,
the average annual increase in room rates for mid-scale hotels without food and
beverage during the period was 4.8%.
Demand and Operating Statistics of Mid-scale Hotels Without Food & Beverage
<TABLE>
<CAPTION>
DEMAND OCCUPANCY
% % ADR REVPAR
-------- ----------- ----- ------
<S> <C> <C> <C> <C>
1988............................... 28.1% 65.3 39.46 25.76
1989............................... 21.7 66.5 41.45 27.55
1990............................... 15.3 66.2 43.39 28.75
1991............................... 12.9 66.4 44.68 29.66
1992............................... 11.1 67.8 45.75 31.02
1993............................... 10.2 69.0 47.31 32.63
1994............................... 13.5 70.6 49.32 34.81
1995............................... 12.9 70.2 52.57 36.91
1996............................... 12.9 68.5 55.92 38.32
1997............................... 14.4 67.5 58.88 39.73
</TABLE>
- ---------------
Source: Smith Travel Research
Mid-scale limited service hotels like the InnSuites Hotels generally operate
with lower fixed costs. As a result, limited service hotels generally have
higher gross operating profit margins than full service hotels that must support
food and beverage and banquet operations. Our management believes that higher
profit margins and management control of variable expenses may make our
InnSuites Hotels properties consistently more profitable despite industry and
economic downturns.
STABILITY OF THE HOTELS MARKET SEGMENT
Our management also believes that changes and trends in occupancy, ADR and
REVPAR reflect the recovery in the hotel industry. Since 1990, despite
relatively stagnant occupancy rates, due to the increased supply of hotel rooms
without a corresponding increase in demand, the hotel industry has enjoyed
growth in ADR, resulting in consistent REVPAR growth for seven of the past eight
years. The following table sets forth REVPAR growth of all U.S. hotels and
mid-scale hotels without food and beverage and percentage changes in the
44
<PAGE> 52
CPI. This chart demonstrates real growth in the entire hotel industry and
particularly describes even greater real growth in our limited service segment
of the market.
Growth in REVPAR and CPI
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1990 1991 1992 1993 1994 1995 1996 1997
---- ----- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
All U.S. Hotels(1).......... 2.0% (2.6)% 2.7% 4.2% 5.8% 5.4% 6.4% 5.2%
Mid-scale without Food &
Beverage(1)............... 4.4 3.2 4.6 5.2 6.7 6.0 3.8 3.7
Consumer Price Index(2)..... 5.4 4.2 3.0 3.0 2.6 2.8 3.0 2.3
</TABLE>
- ---------------
(1) Source: Smith Travel Research. Reflects percentage increase in REVPAR over
prior year.
(2) Source: U.S. Department of Labor Bureau of Labor Statistics. Reflects
percentage increases in CPI over prior year.
Other than during the industry's downturn from 1990 through 1992, hotel industry
REVPAR growth exceeded inflation. In 1991, REVPAR for the industry declined.
However, REVPAR growth for mid-scale hotels without food and beverage remained
positive even during the downturn years of 1990 and 1991. From 1992 to 1995, the
mid-scale hotel without food and beverage sector grew faster than the industry.
Our management believes that REVPAR growth at hotels in the mid-scale without
food and beverage sector stabilized in 1996 and 1997. Our management also
believes that limited service hotel property REVPAR growth is supporting the
current industry-wide growth. Additionally, our management believes that the
operating efficiencies of the InnSuites Hotels, as well as overall consumer
demand for limited service hotels, make the Hotels a more stable hotel
investment through industry and economic downturns.
USE OF PROCEEDS BY THE TRUST
We estimate that the net proceeds to the Trust from this offering, after payment
of expenses incurred in connection with this offering, will be approximately
$27.0 million ($31.0 million if the over-allotment option is exercised in full),
based on an assumed public offering price of $15.00 per Common Share. We will
contribute all of the net proceeds of this offering to the Operating Partnership
in exchange for an approximately 35% additional equity interest in the Operating
Partnership (38% if the over-allotment option is exercised in full).
The Operating Partnership expects to use the amounts contributed to it as
follows:
<TABLE>
<S> <C>
Repayment of third party mortgage indebtedness and
borrowings under the line of credit (including
certain prepayment penalties)........................ $24,667,000
Repayment of loans payable to the Management Group..... 645,000
Repayment of other note payable and accrued interest... 473,000
Deposit to Capital Expenditures Fund................... 1,215,000
-----------
Total uses of proceeds....................... $27,000,000
===========
</TABLE>
The mortgage indebtedness to be paid out of the net proceeds of this offering
matures at various times from April 29, 1999, through August 1, 2011 and bears
interest at effective rates varying from 8.50% to 9.75% per year.
45
<PAGE> 53
If the Underwriters exercise the over-allotment option in full, the additional
net proceeds will be used for general purposes, including possible future
acquisitions of additional hotel properties. Pending use as described above, the
net proceeds may be invested in interest-bearing accounts and short-term
interest-bearing securities that are consistent with the Trust's intention to
qualify for taxation as a REIT. These investments may include, for example,
government and government agency securities, certificates of deposit,
interest-bearing bank deposits, mortgage loan participations and shares of other
real estate investment trusts.
DILUTION
The net tangible book value of the Trust at October 31, 1998 was $8.0 million,
or $10.77 per Common Share, after giving effect to the one-for-three reverse
stock split which will be effected prior to the completion of this offering. Net
tangible book value per Common Share is equal to the Trust's total tangible
assets less total tangible liabilities, divided by the total number of shares of
Common Shares outstanding. Net tangible book value dilution per Common Share
represents the difference between the amount per Common Share paid by purchasers
in this offering and the net tangible book value per Common Share immediately
after the completion of this offering. After giving effect to the sale by the
Trust of the 2,000,000 Common Shares offered hereby at an initial public
offering price of $15.00 per Common Share and after deducting the underwriting
discount and estimated offering expenses, the pro forma net tangible book value
of the Trust as of October 31, 1998 would have been $34.5 million, or $12.60 per
Common Share. This represents an immediate increase in pro forma net tangible
book value of $1.83 per Common Share to the Trust's existing shareholders and an
immediate dilution of $2.40 per Common Share to new investors purchasing Common
Shares in this offering. The following table illustrates this per share
dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per Common Share.... $15.00
------
Net tangible book value per Common Share
as of October 31, 1998............... $10.77
------
Increase per Common Share attributable
to new investors..................... $ 1.83
------
Pro forma net tangible book value per Common Share
as of October 31, 1998.......................... $12.60
------
Net tangible book value dilution per Common Share
to new investors................................ $ 2.40
======
</TABLE>
DIVIDEND POLICY OF THE TRUST
The Trust intends to make regular quarterly distributions to its shareholders
and limited partners of the Operating Partnership initially equal to $0.30 per
share, which on an annual basis would equal $1.20 per share. These distributions
would represent approximately 122% of the Trust's pro forma Cash Available for
Distribution and 94% of its pro forma Funds From Operations for the year ended
January 31, 1998. The distribution for the period commencing on the completion
of this offering and ending April 30, 1999 is expected to be a pro rata portion
of the initial quarterly distribution. The Trust intends to maintain its initial
dividend rate for the first 12 months following the completion of this offering,
unless actual results of operations, economic conditions or other factors differ
from the assumptions used
46
<PAGE> 54
in its estimate. The Trust does not expect to change its estimated dividend rate
per share if the Underwriter's over-allotment option is exercised.
For federal income tax purposes, distributions paid to shareholders may consist
of ordinary income, capital gains, nontaxable returns of capital, or a
combination thereof. Aggregate distributions for the 12 months following the
completion of this offering are expected to be greater than 95% of the Trust's
REIT taxable income. Distributions in excess of earnings and profits generally
will be treated as nontaxable return of capital to a shareholder and, therefore,
will result in a reduction of a shareholder's basis in their Common Shares, to
the extent of such basis, and thereafter as taxable gain. Return of capital
distributions will have the effect of deferring taxation until the sale of the
shareholder's Common Shares.
The following table sets forth certain pro forma financial information for the
Trust for the twelve months ended January 31, 1998, which was used to establish
the expected distribution per share. The following table is presented as if the
acquisition of the Hotels, the Corporate Structure Transactions and this
offering had occurred on February 1, 1997.
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED
JANUARY 31, 1998
-----------------------------
(DOLLAR AMOUNTS IN
THOUSANDS, EXCEPT PER
SHARE DATA)
<S> <C>
Pro forma net income.................................. $2,177
Add: Minority interest................................ 2,266
Depreciation of real estate assets.................. 2,438
Amortization of deferred financing fees............. 58
Less: Additions to Capital Expenditures Fund.......... (1,050)
Scheduled principal amortization of long-term
debt............................................. (591)
------
Estimated cash available for distributions(1)......... 5,298
Estimated initial annual distribution(2).............. 6,487
Estimated initial annual distribution to Trust's
shareholders(3)..................................... 3,287
Estimated initial annual distribution per
share/unit(4)....................................... $ 1.20
Estimated payout ratio of cash available for
distribution(5)..................................... 1.22
</TABLE>
(1) If the Operating Partnership received only the minimum rent under the
Percentage Leases, the estimated cash available for distribution would be
$ .
(2) Based on 2,738,968 Common Shares, 888,311 Class A Units and 1,765,947 Class
B Units outstanding, and the equivalent of 13,015 Class A Units held by
non-exchanging minority partners.
(3) Based on 2,738,968 Common Shares outstanding and an initial annual
distribution rate of $1.20 per share.
(4) An equivalent annual distribution will be made to each Common Share and each
Class A Unit and Class B Unit, irrespective of whether or not a Class A Unit
or Class B Unit has been converted or is convertible.
(5) Represents the anticipated aggregate annual distribution divided by
estimated cash available for distribution.
The primary source of proceeds to be used for distributions to shareholders is
the Trust's share of the rents due pursuant to the Percentage Leases. The
anticipated revenue may or
47
<PAGE> 55
may not be realized or collected. Accordingly, the statements set forth above
with regard to distributions are forward-looking statements involving certain
risks and uncertainties that could cause actual results to differ materially
from those expressed in such statements. Important factors that could cause such
different results include, but are not limited to, competition from other
hotels, increases in operating costs, seasonality effects in hotel occupancy and
revenues, and the potential loss of a franchise or liquor license in respect of
any Hotel or acquired hotel. See "FORWARD-LOOKING STATEMENTS."
48
<PAGE> 56
SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
AND OPERATING DATA OF THE TRUST AND THE INITIAL LESSEE
The following tables set forth (a) selected unaudited pro forma condensed
consolidated financial information for the Trust for the year ended January 31,
1998 and the nine months ended October 31, 1998 and (b) selected unaudited pro
forma condensed financial information for the Initial Lessee for the year ended
December 31, 1997 and the nine months ended September 30, 1998.
The Pro Forma Condensed Consolidated Balance Sheet of the Trust is presented as
if the transactions reflected, including (i) the reverse stock split, (ii) the
purchase of Mid-America Reafund Advisors, Inc. ("MARA"), (iii) the transfer of
the InnSuites Hotel in Scottsdale, and (iv) the completion of this offering and
the sale of 2,000,000 Common Shares at an assumed price of $15.00 per Common
Share, and the use of the net proceeds therefrom as described under "USE OF
PROCEEDS BY THE TRUST", all had occurred as of October 31, 1998.
The Pro Forma Condensed Consolidated Statements of Income for the year ended
January 31, 1998 and for the nine months ended October 31, 1998 are presented as
if the transactions reflected, including (i) the Formation Transactions, (ii)
the acquisitions of the hotel properties located in Tucson, Arizona, and in San
Diego and Buena Park, California, (iii) the reverse stock split, (iv) the
purchase of Mid-America Reafund Advisors, Inc., (v) the transfer of the
InnSuites Hotel in Scottsdale, and (vi) the consummation of the Offering and the
sale of 2,000,000 Common Shares at an assumed price of $15.00 per Common Share,
and the use of the net proceeds therefrom as described under "USE OF PROCEEDS BY
THE TRUST", all had occurred as of February 1, 1997.
The Pro Forma Condensed Statements of Operations of the Initial Lessee for the
year ended December 31, 1997 and for the nine months ended September 30, 1998
are presented as if the acquisitions of the Hotels and the beginning of the
relevant lease years had occurred on January 1, 1997, and therefore incorporates
certain assumptions that are included in the Notes to the Pro Forma Condensed
Statements of Operations. The pro forma operating information for the Initial
Lessee is presented to reflect the pro forma operations of the Initial Lessee
for 1997 and for the first nine months of 1998, which operations are the source
of funds for the Percentage Lease payments to the Operating Partnership.
The following selected financial information and the financial statements
contained in the Trust's Form 10-K for the year ended January 31, 1998, Form
10-Q for the quarter ended April 30, 1998, Form 10-Q for the quarter ended July
31, 1998 and Form 10-Q for the quarter ended October 31, 1998 should be read in
conjunction with "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF THE TRUST" and all other historical financial
statements and notes included elsewhere in this Prospectus. See pages F-1
through F-38 for certain historical financial statements and "INCORPORATION OF
CERTAIN DOCUMENTS BY REFERENCE."
49
<PAGE> 57
INNSUITES HOSPITALITY TRUST
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF 10/31/98
UNAUDITED (DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
HISTORICAL MARA PRO ADJUSTED
10/31/98 ACQUISITION FORMA OFFERING PRO FORMA
---------- ----------- ------- -------- ---------
(A) (B) (C)
<S> <C> <C> <C> <C> <C>
Net Investment in hotel
properties........... $58,935 $ -- $58,935 $ -- $58,935
Cash and cash
equivalents.......... 809 -- 809 -- 809
Percentage rent
receivable........... 430 -- 430 -- 430
Prepaids and other
assets............... 804 -- 804 1,215 2,019
------- ----- ------- -------- -------
Total
Assets.... $60,978 -- 60,978 1,215 $62,193
======= ===== ======= ======== =======
Mortgage notes
payable.............. $23,359 $ -- $23,359 $(13,271) $10,088
Lines of credit........ 10,955 -- 10,955 (10,955) --
Loans from affiliates
and other notes
payable.............. 645 450 1,095 (1,095) --
Accrued expenses and
other liabilities.... 1,774 23 1,797 (23) 1,774
Minority interest...... 15,949 (473) 15,476 -- 15,476
------- ----- ------- -------- -------
Total
Liabilities.. 52,682 -- 52,682 (25,344) 27,338
Shareholders'
equity.......... 8,296 -- 8,296 26,559 34,855
------- ----- ------- -------- -------
Total
liabilities
and
shareholders'
equity... $60,978 $ -- $60,978 $ 1,215 $62,193
======= ===== ======= ======== =======
</TABLE>
50
<PAGE> 58
INNSUITES HOSPITALITY TRUST
NOTES TO PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
AS OF OCTOBER 31, 1998
(DOLLARS IN THOUSANDS)
(A) Derived from the historical condensed consolidated balance sheet of the
Trust as of October 31, 1998.
(B) Represents the acquisition and termination of the MARA Advisory Agreement
from James and Gail Wirth in exchange for 118,479 Class B Partnership Units
in RRF Limited Partnership. Due to the related party nature of the
transaction, the purchase is recorded at carryover basis for financial
reporting purposes. After elimination of intercompany amounts due between
RRF Limited Partnership and MARA, the only balance sheet accounts to be
assumed by RRF Limited Partnership are a $450, 7% note payable obligation to
the former owners of MARA, together with $23 of accrued interest. The offset
to these assumed balances is minority interest due to the issuance of
limited partnership units as consideration.
(C) Represents the proceeds from the offering, net of offering costs, and the
use of such proceeds as described in "USE OF PROCEEDS BY THE TRUST".
<TABLE>
<S> <C>
Gross proceeds from Offering................................ $ 30,000
Offering costs.............................................. (3,000)
--------
Net proceeds................................................ 27,000(a)
Retirement of mortgage debt on the San Diego, St. Mary's,
Buena Park and Tempe hotel properties..................... (13,271)
Prepayment penalties on the early retirement of the above
mortgage debt............................................. (441)(a)
Pay down of outstanding borrowings against line of credit... (10,955)
Retirement of loans from affiliates and other notes
payable................................................... (1,095)
Payment of accrued interest................................. (23)
--------
Deposit of remaining funds to the Capital Expenditures
Fund...................................................... $ 1,215
========
</TABLE>
- ---------------
(a) Net increase in shareholders' equity is $26,559.
51
<PAGE> 59
INNSUITES HOSPITALITY TRUST
PRO FORMA CONSOLIDATED INCOME STATEMENT
FOR THE TWELVE MONTH PERIOD ENDED 1/31/98
UNAUDITED (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
YEAR END FORMATION MARA PRO ADJUSTED
1/31/98 TRANSACTIONS ACQUISITIONS ACQUISITION FORMA OFFERING PRO FORMA
---------- ------------ ------------ ----------- ------- -------- ----------
(A) (B) (C) (D) (E)
<S> <C> <C> <C> <C> <C> <C> <C>
Percentage lease
revenue............ $ -- $ 7,902 $ 1,995 $ -- $ 9,897 $ -- $ 9,897
Other rental
revenue............ 1,367 (1,367) -- -- -- -- --
Interest income...... 55 -- -- -- 55 -- 55
-------- ------- ------- ----- ------- -------- ----------
Total
revenues..... 1,422 6,535 1,995 -- 9,952 -- 9,952
-------- ------- ------- ----- ------- -------- ----------
Loss on sale of real
estate............. 36 (36) -- -- -- -- --
Interest expense on
mortgage and other
notes payable...... 118 1,550 1,390 32 3,090 (2,136) 954
Advisory fee to
related party
advisor............ -- 576 242 (818) -- -- --
Operating expense of
real estate held
for sale........... 1,379 (1,379) -- -- -- -- --
Depreciation and
amortization....... 21 1,679 738 -- 2,438 -- 2,438
General and
administrative..... 441 137 230 160 968 -- 968
Real estate and
personal property
taxes, casualty
insurance and
ground rent........ -- 820 329 -- 1,149 -- 1,149
-------- ------- ------- ----- ------- -------- ----------
Total
expenses..... 1,995 3,347 2,929 (626) 7,645 (2,136) 5,509
-------- ------- ------- ----- ------- -------- ----------
Income (loss)
before minority
interest....... (573) 3,188 (934) 626 2,307 2,136 4,443
Minority
interest....... -- (2,320) 828 (555) (2,047) (219) (2,266)
-------- ------- ------- ----- ------- -------- ----------
Net income
(loss)......... $ (573) $ 868 $ (106) $ 71 $ 260 $ 1,917 $ 2,177
======== ======= ======= ===== ======= ======== ==========
Earnings per share:
Basic............ $ (1.68) $ .47 $ .85
Diluted.......... (1.68) .47 .85
Weighted average
number of shares
outstanding........ 340,786 555,939 2,555,939
</TABLE>
52
<PAGE> 60
INNSUITES HOSPITALITY TRUST
PRO FORMA CONSOLIDATED INCOME STATEMENT
FOR THE NINE MONTH PERIOD ENDED 10/31/98
UNAUDITED (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
HISTORICAL
NINE
MONTHS
ENDED MARA PRO ADJUSTED
10/31/98 ACQUISITIONS ACQUISITION FORMA OFFERING PRO FORMA
---------- ------------ ----------- -------- -------- -----------
(A) (C) (D) (E)
<S> <C> <C> <C> <C> <C> <C>
Percentage lease revenue... $ 7,668 $ 307 $ -- $ 7,975 $ -- $ 7,975
Interest income............ 20 -- -- 20 -- 20
-------- ----- ----- -------- ------- -----------
Total revenues....... 7,688 307 -- 7,995 -- 7,995
-------- ----- ----- -------- ------- -----------
Interest expense on
mortgage and other notes
payable.................. 1,944 379 24 2,347 (1,428) 919
Advisory fee to related
party advisor............ 488 68 (556) -- -- --
Depreciation and
amortization............. 1,854 117 -- 1,971 -- 1,971
General and
administrative........... 1,024 76 120 1,220 -- 1,220
Real estate and personal
property taxes, casualty
insurance and ground
rent..................... 834 50 -- 884 -- 884
-------- ----- ----- -------- ------- -----------
Total expenses....... 6,144 690 (412) 6,422 (1,428) 4,994
-------- ----- ----- -------- ------- -----------
Income before minority
interest............. 1,544 (383) 412 1,573 1,428 3,001
Minority interest...... (1,423) 334 (360) (1,449) (70) (1,519)
-------- ----- ----- -------- ------- -----------
Net income............. $ 121 $ (49) $ 52 $ 124 $ 1,358 $ 1,482
======== ===== ===== ======== ======= ===========
Earnings per share:
Basic.................. $ .20 $ .21 $ .57
Diluted................ .20 .21 .57
Weighted average number of
shares................... 604,521 604,521 2,604,521
</TABLE>
53
<PAGE> 61
INNSUITES HOSPITALITY TRUST
NOTES TO PRO FORMA CONDENSED CONSOLIDATED
STATEMENTS OF INCOME
FOR THE YEAR ENDED JANUARY 31, 1998 AND
THE NINE MONTHS ENDED OCTOBER 31, 1998
(DOLLAR AMOUNTS IN THOUSANDS)
(A) Derived from the historical statement of operations for the Trust for the
applicable period. All historical and pro forma share and per share data
reflect the effects of the 1:3 reverse stock split.
(B) Reflects the assumption that the Formation Transactions occurred on February
1, 1997. The pro forma adjustments include the following:
1. Pro forma Percentage Lease revenue based upon the historical revenues of
the Hotels and the terms of the Percentage Leases.
2. Assumes the sale of the Carbon & Carbide Building as of February 1,
1997, thereby eliminating historical rental revenue and operating
expenses of the real estate held for sale. The building was sold on
September 4, 1997 for $6,000.
3. Elimination of interest expense on a $2,300 related party loan retired
with the proceeds from the sale of the Carbon & Carbide building.
4. Interest expense on (i) existing mortgage indebtedness of the Hotels
assumed by the Operating Partnership, and (ii) pro forma borrowings
against the Credit Facility. The interest rates on the mortgage debt
ranged from 8.5% to 9.75%.
5. Increase in the advisory fee to MARA (equal to 1% of invested assets)
related to the increase in assets under management.
6. The elimination of historical amortization of the Trust related to real
estate held for sale.
7. Pro forma depreciation of the investment in hotel properties, computed
using the straight-line method and useful lives of 40 years for
buildings and improvements and 7 years for furniture and equipment.
These estimated lives are based upon management's knowledge of the
properties and the hotel industry in general. The Trust's pro forma
investment in hotel properties acquired in the Formation Transactions,
at cost, consisted of the following:
<TABLE>
<S> <C>
Land........................................... $ 3,440
Buildings and improvements..................... 31,395
Furniture and equipment........................ 6,406
-------
$41,241
=======
</TABLE>
54
<PAGE> 62
8. Increase in general and administrative expenses comprised of the
following
<TABLE>
<CAPTION>
FULL NINE
YEAR MONTHS
--------- -----------
<S> <C> <C>
Salaries and wages..................... $ 94 $ --
Professional fees...................... 17 --
Other operating expenses............... 26 --
---- ----
$137 $ --
==== ====
</TABLE>
9. Represents real estate and personal property taxes, property and
casualty insurance and ground rent expense which became the
responsibility of the Trust upon completion of the Formation
Transactions. Such amounts were derived from the historical amounts paid
by the Hotels.
10. Represents the amortization of $175 of deferred loan fees and costs over
the initial 3-year term of the Credit Facility.
11. Represents 88.7% of net income of the Operating Partnership attributable
to minority interest holders. For the year ended January 31, 1998, the
historical operating results of the Trust are assumed to have been
conducted within the Operating Partnership as such is the case after
consummation of the Formation Transactions, the acquisitions and the
offering.
(C) Represents pro forma revenues and expenses associated with the San Diego,
Buena Park and Tucson (St. Mary's) hotel properties acquired by the
Operating Partnership in the months indicated below, assuming all such
acquisitions had been consummated on February 1, 1997. Following is the
composition of the pro forma adjustment by property.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED JANUARY 31, 1998
-----------------------------------------------------------------------------------------------
1998 TAXES, GENERAL
MONTH LEASE INSURANCE AND ADVISORY INTEREST MINORITY
ACQUIRED REVENUE DEPRECIATION AND RENT ADMINISTRATIVE FEE EXPENSE INTEREST
-------- ------- ------------ --------- -------------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
San Diego................ April $ 500 $164 $ 49 $ 90 $ 59 $ 413 $244
Buena Park............... June 500 227 50 70 71 347 235
Tucson (St. Mary's)...... February 995 347 230 70 112 630 349
------ ---- ---- ---- ---- ------ ----
$1,995 $738 $329 $230 $242 $1,390 $828
====== ==== ==== ==== ==== ====== ====
</TABLE>
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED OCTOBER 31, 1998
------------------------------------------------------------------------------------
TAXES, GENERAL
LEASE INSURANCE AND ADVISORY INTEREST MINORITY
REVENUE DEPRECIATION AND RENT ADMINISTRATIVE FEE EXPENSE INTEREST
------- ------------ --------- -------------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
San Diego.................. $ 115 $ 41 $ 12 $ 23 $ 15 $ 95 $ 62
Buena Park................. 192 76 38 53 53 284 272
------ ---- ---- ---- ---- ------ ----
$ 307 $117 $ 50 $ 76 $ 68 $ 379 $334
====== ==== ==== ==== ==== ====== ====
</TABLE>
The pro forma adjustments reflected above represent the following:
1. Pro forma lease payments to the Operating Partnership calculated on a pro
forma basis by applying the rent provisions of the Percentage Lease
agreements to the historical revenues of the acquired hotels for the
applicable period.
2. Pro forma depreciation of buildings, improvements, furniture and
equipment computed on the straight-line method and based upon estimated
useful lives of 40 years for buildings and improvements and 7 years for
furniture and equipment. The purchase
55
<PAGE> 63
price allocations related to the acquired properties, including related
transaction costs, were as follows:
<TABLE>
<CAPTION>
BUILDINGS FURNITURE
AND AND
LAND IMPROVEMENTS EQUIPMENT TOTALS
------ ------------- ------------- -------
<S> <C> <C> <C> <C>
San Diego........................ $ 700 $ 3,973 $ 468 $ 5,141
Buena Park....................... 646 4,336 833 5,815
Tucson (St. Mary's).............. 900 3,615 1,800 6,315
------ ------- ------ -------
$2,246 $11,924 $3,101 $17,271
====== ======= ====== =======
</TABLE>
3. Historical amounts of real estate and personal property taxes, property
and casualty insurance related to the acquired properties which become
the responsibility of the Operating Partnership.
4. Incremental general and administrative expenses of the Operating
Partnership associated with the acquired properties.
<TABLE>
<CAPTION>
FULL NINE
YEAR MONTHS
--------- -----------
<S> <C> <C>
Salaries and wages..................... $155 $51
Professional fees...................... 31 10
Other operating expenses............... 44 15
---- ---
$230 $76
==== ===
</TABLE>
5. Increase in advisory fee due to MARA attributable to each acquisition as
a result of the increase in assets under management.
6. Pro forma interest expense associated with debt assumed or incurred in
connection with each acquisition.
7. Minority interest related to the pro forma adjustments, calculated at
approximately 88.7% and 87.3% for the year ended January 31, 1998 and for
the nine months ended October 31, 1998, respectively.
(D) Reflects the elimination of the historical and pro forma advisory fees
payable to MARA by the Operating Partnership, general and administrative
expenses of MARA to be incurred by the Operating Partnership after the
termination of the advisory agreement with MARA and interest expense at 7%
on $450 of MARA debt to be assumed by the Operating Partnership.
(E) Reflects (i) the consummation of the offering and the use of the net
proceeds therefrom to retire debt, thereby reducing interest expense, and
(ii) the contribution by the Trust of the Scottsdale hotel property to the
Operating Partnership in exchange for 215,744 general partnership units. As
a result of these transactions, the minority interest percentage in the
Operating Partnership decreases to 51.0% and 50.6% for the year ended
January 31, 1998 and for the nine months ended October 31, 1998,
respectively.
56
<PAGE> 64
INNSUITES HOTELS, INC.
PRO FORMA INCOME STATEMENT
FOR THE TWELVE MONTH PERIOD ENDED 12/31/97
UNAUDITED (DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
HISTORICAL
YEAR END PRO
12/31/97 ACQUISITIONS ADJUSTMENTS FORMA
---------- ------------ ----------- -------
(A) (B)
<S> <C> <C> <C> <C>
REVENUES:
Room revenue.................... $18,801 $ 5,100 $ -- $23,901
Food and beverage revenue....... 519 944 -- 1,463
Other revenue................... 591 307 -- 898
------- ------- ------- -------
Total revenue......... 19,911 6,351 -- 26,262
------- ------- ------- -------
EXPENSES:
Departmental expenses of hotels:
Rooms...................... 4,915 2,433 -- 7,348
Food and beverage.......... 921 693 -- 1,614
General and administrative...... 3,056 479 180(C) 3,715
Advertising and promotion....... 871 294 -- 1,165
Utilities....................... 934 555 -- 1,489
Management fees................. 833 125 (302)(D) 656
Franchisor royalties and other
charges....................... 582 254 265(E) 1,101
Repairs and maintenance......... 2,473 1,056 -- 3,529
Real estate and personal
property taxes, insurance, and
ground rent................... 912 364 (1,149)(F) 127
Interest expense................ 1,854 1,114 (2,968)(G) --
Depreciation and amortization... 1,226 617 (1,843)(H) --
Percentage rent expense......... -- -- 9,897(I) 9,897
------- ------- ------- -------
Total expenses........ 18,577 7,984 4,080 30,641
------- ------- ------- -------
Net Income (Loss).......... $ 1,334 $(1,633) $(4,080) $(4,379)
======= ======= ======= =======
</TABLE>
57
<PAGE> 65
INNSUITES HOTELS, INC.
PRO FORMA INCOME STATEMENT
FOR THE NINE MONTH PERIOD ENDING 9/30/98
UNAUDITED (DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
HISTORICAL HISTORICAL
8 MONTHS 1 MONTH
9/30/98 1/31/98 ACQUISITIONS ADJUSTMENTS PRO FORMA
---------- ---------- ------------ ----------- ---------
(A) (A) (B) (C)
<S> <C> <C> <C> <C> <C>
REVENUES:
Room revenue.......... $16,113 $1,833 $1,144 $ -- $19,090
Food and beverage
revenue............. 823 62 100 -- 985
Other revenue......... 1,098 61 66 -- 1,225
------- ------ ------ ------- -------
Total
revenue... 18,034 1,956 1,310 -- 21,300
------- ------ ------ ------- -------
EXPENSES:
Departmental expenses
of hotels:
Rooms............ 5,555 668 663 -- 6,886
Food and
beverage....... 670 85 79 -- 834
General and
administrative...... 1,800 1,250 137 30(C) 3,217
Advertising and
promotion........... 1,408 77 89 -- 1,574
Utilities............. 984 90 99 -- 1,173
Management fees....... 307 90 46 90(D) 533
Franchisor royalties
and other charges... 490 53 38 23(E) 604
Repairs and
maintenance......... 1,018 234 302 -- 1,554
Real estate and
personal property
taxes, insurance,
and ground rent..... -- 94 56 (150)(F) --
Interest expense...... -- 138 254 (392)(G) --
Depreciation and
amortization........ -- 110 161 (271)(H) --
Percentage rent
expense............. 6,808 -- -- 1,167(I) 7,975
------- ------ ------ ------- -------
Total
expense... 19,040 2,889 1,924 497 24,350
------- ------ ------ ------- -------
Net Income
(Loss)......... $(1,006) $ (933) $ (614) $ (497) $(3,050)
======= ====== ====== ======= =======
</TABLE>
58
<PAGE> 66
INNSUITES HOTELS, INC.
NOTES TO PRO FORMA CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(DOLLAR AMOUNTS IN THOUSANDS)
(A) Derived from the historical financial statements of the Hotels for the
applicable period, including for the nine month period ended September 30,
1998, and the operating results of the San Diego, Buena Park and Tucson (St.
Mary's) Hotels since their respective dates of acquisition by the Operating
Partnership.
(B) Represents the pro forma revenues and expenses associated with hotel
properties acquired by the Operating Partnership in 1998 and leased to the
Initial Lessee, assuming that the Initial Lessee leased and operated such
properties commencing January 1, 1997. Following is the composition of the
pro forma adjustments by hotel property.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997 NINE MONTHS ENDED SEPTEMBER 30, 1998
------------------------------------------ ------------------------------------------
BUENA TUCSON BUENA TUCSON
SAN DIEGO PARK (ST. MARY'S) TOTAL SAN DIEGO PARK (ST. MARY'S) TOTAL
--------- ------ ------------ ------ --------- ------ ------------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Room revenue.................. $1,398 $1,140 $2,562 $5,100 $327 $ 556 $261 $1,144
Food and beverage revenue..... 130 -- 814 944 31 -- 69 100
Other revenue................. 80 61 166 307 25 29 12 66
------ ------ ------ ------ ---- ------ ---- ------
Total revenue......... $1,608 $1,201 $3,542 $6,351 $383 $ 585 $342 $1,310
====== ====== ====== ====== ==== ====== ==== ======
Departmental expenses:
Rooms..................... $ 716 $ 598 $1,119 2,433 $143 $ 367 $153 $ 663
Food and beverage......... 82 -- 611 693 18 -- 61 79
General and Administrative.... 91 220 168 479 19 106 12 137
Advertising and promotion..... 93 81 120 294 16 55 18 89
Utilities..................... 119 86 350 555 26 40 33 99
Management fees............... 48 18 59 125 14 15 17 46
Franchise royalties and other
charges..................... 93 60 101 254 23 15 -- 38
Repairs and maintenance....... 82 517 457 1,056 32 228 42 302
Real estate and personal
property taxes, insurance
and ground rent............. 49 111 204 364 15 25 16 56
Interest expense.............. 229 329 556 1,114 57 122 75 254
Depreciation and
amortization................ 165 204 248 617 41 85 35 161
------ ------ ------ ------ ---- ------ ---- ------
Total expenses........ $1,767 $2,224 $3,993 $7,984 $404 $1,058 $462 $1,924
====== ====== ====== ====== ==== ====== ==== ======
</TABLE>
(C) Increase reflects the estimated incremental expenses expected to be incurred
by the Initial Lessee in connection with administrative salaries and
occupancy expenses.
(D) Reflects the adjustment of management fees paid by the Hotels to a standard
2.5% of revenues per year pursuant to the management agreements.
(E) Reflects the adjustment of franchise fees paid to InnSuites Licensing Corp.
to a standard 2.5% of revenues per year (1.25% at the four properties
having dual franchises).
(F) Reflects the elimination of real estate and personal property taxes,
property and casualty insurance and ground rent expense to be paid by the
Operating Partnership.
(G) Reflects the elimination of interest expense related to debt assumed by the
Operating Partnership.
(H) Reflects the elimination of depreciation expense related to the investments
in hotel properties which were acquired by the Operating Partnership.
59
<PAGE> 67
(I) Represents lease payments calculated on a pro forma basis by applying the
rent provisions of the Percentage Leases to the pro forma room and other
revenues of the Hotels.
SELECTED FINANCIAL DATA
The following selected financial data of the Trust for the five fiscal years
ended January 31, 1998 have been derived from the audited financial statements
of the Trust, which have been audited by Arthur Andersen LLP, independent public
accountants. The following selected financial data of the Trust for the nine
months ended October 31, 1997 and 1998 have been derived from the unaudited
financial statements of the Trust. All of the data should be read in conjunction
with the respective financial statements and related notes included therein.
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
OCTOBER 31, OCTOBER 31,
1998 1997 1998 1997 1996 1995 1994
----------- ----------- ----------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Total revenues....... $ 7,687,766 $1,367,366 $ 1,421,979 $3,915,506 $ 5,430,006 $ 6,592,051 $ 7,645,790
=========== ========== =========== ========== =========== =========== ===========
Net income (loss).... $ 120,507 $ (386,062) $ (573,509) $ (888,365) $(7,554,351) $ 670,945 $ 955,121
=========== ========== =========== ========== =========== =========== ===========
Earnings (loss) per
share -- basic and
diluted............ $ .07 $ (.38) $ (.56) $ (.87) $ (7.40) $ .66 $ .94
=========== ========== =========== ========== =========== =========== ===========
Cash dividends paid
and declared per
share.............. $ .10 $ .05 $ .15 $ .40 $ .50 $ .80 $ .86
=========== ========== =========== ========== =========== =========== ===========
Total assets......... $60,978,512 $2,279,881 $43,619,639 $6,416,123 $24,555,330 $45,165,356 $65,264,638
=========== ========== =========== ========== =========== =========== ===========
Bank and other
borrowings......... $34,959,447 $ 0 $22,428,880 $2,300,000 $10,795,000 $16,810,000 $24,575,000
=========== ========== =========== ========== =========== =========== ===========
</TABLE>
60
<PAGE> 68
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS OF THE TRUST
OVERVIEW
On January 31, 1998, the Trust contributed $2,081,000 to the Operating
Partnership in exchange for a 13.6% general partner interest therein. The Trust
is the sole general partner of the Operating Partnership. The Operating
Partnership issued limited partnership interests representing 86.4% of the
Operating Partnership to acquire six hotel properties from various entities. In
addition, through RRF Sub Corp., the Trust issued 647,231 Common Shares in
exchange for all of the outstanding shares of a corporation which owned a hotel
located in Scottsdale, Arizona. On February 1, 1998, the Operating Partnership
acquired 100% of the ownership interests in the Tucson (St. Mary's) hotel for
$10,820,000. The Operating Partnership assumed $7,803,000 in mortgage debt and
other obligations and issued 669,933 limited partnership units to James and Gail
Wirth (of which 28,800 units were subsequently paid to third parties as advisory
fees), who each held a 50% equity ownership interest in the Tucson St. Mary's
hotel. On April 29, 1998, the Operating Partnership acquired 100% of the
ownership of the InnSuites Hotel San Diego for $5,148,000. The Operating
Partnership invested $1,448,000 in cash (of which $1,348,000 was drawn under the
Credit Facility) and became obligated for $3,700,000 in seller financing in the
form of two promissory notes secured by mortgage trust deeds on the property. On
June 1, 1998, the Operating Partnership acquired 100% of the ownership of the
InnSuites Hotel Buena Park for $7,100,000. The Operating Partnership assumed
$4,116,754 in mortgage debt and other obligations and issued 681,739 limited
partnership units to James Wirth and Steven Robson (of which 13,034 units were
subsequently paid to a third party as an advisory fee) who each held a 50%
equity ownership interest in the Buena Park hotel. On August 11, 1998, the
Company satisfied a $2.65 million participating mortgage obligation related to
the Ontario hotel through the issuance of 423,687 Common Shares to former
partners in Ontario Hospitality Properties Limited Partnership and 133,492 Class
B Units in the Operating Partnership to James Wirth and his affiliates for their
respective interests.
Having completed the acquisitions of the Hotels and having satisfied the Ontario
participating mortgage, the Trust now owns a 16.61% interest in nine of the
Hotels through its interest in the Operating Partnership and 100% of the
Scottsdale hotel through RRF Sub Corp. In order for the Trust to qualify as a
REIT, neither the Trust nor the Operating Partnership can operate the Hotels.
Therefore, each of the Hotels are leased to the Initial Lessee pursuant to a
Percentage Lease. The Trust and the Operating Partnership expect to lease all
newly acquired hotels to the Management Company pursuant to the Intercompany
Agreement described on page 122 of this prospectus. Each Percentage Lease
obligates the Initial Lessee, and will obligate the Management Company, to pay
rent equal to the greater of the minimum rent or a percentage rent based on the
gross revenues of each Hotel. Following the completion of this offering, the
Management Company will hold the franchise agreement for each Hotel. The Initial
Lessee is owned 9.8% by the Management Company, an entity owned by Mr. Wirth and
his wife. The Trust's principal source of revenue is lease payments pursuant to
the Percentage Leases. Lease revenue is based upon the room and other revenues
of the Hotels. The Initial Lessee's ability to make payments to the Operating
Partnership pursuant to the Percentage Leases is dependent primarily upon the
operations of the Hotels. Therefore, management believes that a discussion of
the pro forma operating results of the Initial Lessee
61
<PAGE> 69
and the historical operating results of the Hotels are important to an
understanding of the business of the Trust. The following discusses (i) the
Trust's pro forma results of operations for the years ended January 31, 1997 and
January 31, 1998 and the nine-month periods ended October 31, 1997 and October
31, 1998; (ii) the Initial Lessee's pro forma results of operations for the year
ended December 31, 1997 and the nine-month periods ended September 30, 1997 and
September 30, 1998; and (iii) the historical results of the Hotels for the years
ended December 31, 1997, 1996 and 1995 and the nine-month period ended September
30, 1998.
GENERAL
Results of operations are best explained by three key performance indicators:
occupancy, ADR and REVPAR. Increases in REVPAR attributable to increases in
occupancy are accompanied by increases in most categories of variable operating
costs. Increases in REVPAR attributable to increases in ADR are accompanied by
increases in limited categories of operating costs, such as management fees and
franchise and licenses fees.
PRO FORMA RESULTS OF OPERATIONS FOR THE TRUST
The following tables set forth key indicators for (i) all of the Hotels
combined, and (ii) all fully operational Hotels (which excludes the Flagstaff,
Tucson (St. Mary's), Buena Park and San Diego hotels, which were under
renovation), and are useful in understanding the underlying changes in the
percentage rent during the Trust's pro forma years ended January 31, 1997 and
January 31, 1998.
<TABLE>
<CAPTION>
ALL FULLY-OPERATIONAL HOTELS ALL HOTELS
(EXCLUDES HOTELS (INCLUDES HOTELS
UNDER RENOVATION) UNDER RENOVATION)
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
------------------------------ ------------------------
KEY FACTORS 1997 1996 1995 1997 1996 1995
----------- -------- -------- -------- ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Occupancy................... 73.1% 70.5% 70.3% 59.0% 57.0% 55.9%
ADR......................... $72.25 $70.60 $65.39 $64.87 $63.13 $59.39
REVPAR...................... $52.84 $49.76 $45.98 $38.24 $35.96 $33.22
</TABLE>
The following tables set forth key indicators for (i) all of the Hotels
combined, and (ii) all fully-operational Hotels (which excludes the Flagstaff,
Tucson (St. Mary's), Buena Park and San Diego hotels, which were under
renovation), and are useful in understanding the underlying changes in the
percentage rent during the Trust's pro forma nine-month periods ended October
31, 1997 and October 31, 1998.
<TABLE>
<CAPTION>
ALL FULLY-
OPERATIONAL HOTELS ALL HOTELS
(EXCLUDES HOTELS (INCLUDES HOTELS
UNDER RENOVATION) UNDER RENOVATION)
NINE-MONTHS ENDED NINE-MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
KEY FACTORS 1998 1997 1998 1997
----------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
Occupancy................................. 75.21% 72.69% 63.17% 60.18%
ADR....................................... $72.08 $73.55 $65.18 $62.54
REVPAR.................................... $54.38 $53.51 $42.15 $39.23
</TABLE>
62
<PAGE> 70
The pro forma financial information set forth below is presented as if the
acquisitions of the Hotels had been consummated as of February 1, 1997. The pro
forma financial information is not necessarily indicative of what actual results
of operations of the Trust would have been assuming the acquisitions of the
Hotels had been consummated as of February 1, 1997, nor does it purport to
represent the results of operations for future periods.
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
JANUARY 31, OCTOBER 31,
------------------ ------------------
1998 1997 1998 1997
------ -------- ------ --------
(UNAUDITED, IN (UNAUDITED, IN
THOUSANDS) THOUSANDS)
<S> <C> <C> <C> <C>
Percentage Lease Revenue.................. $9,897 $ 9,371 $7,975 $ 7,519
Interest Income........................... 55 1,638 20 --
------ -------- ------ --------
Total Revenues.................. $9,952 $ 11,009 $7,995 $ 7,519
Provision for Writedown of Loan
Receivables............................. -- 111 -- 111
Interest Expense on Mortgage and Other
Notes Payable........................... 954 1,454 919 1,118
Depreciation and Amortization............. 2,438 2,115 1,971 1,772
General and Administrative................ 968 968 1,220 593
Operating Expenses of Real Estate Held For
Sale.................................... -- -- --
Real Estate and Personal Property Taxes
and Casualty Insurance and Ground
Rent.................................... 1,149 1,271 884 941
------ -------- ------ --------
Total Expenses.................. $5,509 $ 5,919 $4,994 4,535
Minority Interest......................... 2,266 2,704 1,519 1,492
------ -------- ------ --------
Total Expenses and Minority
Interest...................... $7,775 $ 8,623 $6,513 $ 6,027
Net Income Attributable to Shares of
Beneficial Interest..................... $2,177 $ 2,386 $1,482 $ 1,492
====== ======== ====== ========
Net Income Per Share -- basic and
diluted................................. $ .85 $ .93 $ .57 $ .58
====== ======== ====== ========
</TABLE>
For the year ended January 31, 1998, the Trust had pro forma revenues of $9.9
million from the Percentage Leases that would have been in place at the Hotels.
The Trust had only $.06 million in interest income compared to $1.6 million in
interest income from mortgage investments in 1997 due to loan repayments during
fiscal 1997. Other rental revenue of $1.4 million and operating expenses of $1.4
million and amortization of $.02 million related to the Carbon & Carbide
Building (the sale of which closed on September 4, 1997) have been eliminated.
Net income to shareholders (after minority interest) declined to $2.2 million
from $2.4 million due to the elimination of the positive spread on the mortgage
investments and presentation of $3.3 million in cash realized from the sale of
the Carbon & Carbide Building without reflecting any pro forma income or return
from investment of that cash.
For the year ended January 31, 1997, the Trust had pro forma revenues of $9.4
million from the Percentage Leases that would have been in place at the Hotels.
The Trust also had $1.6 million in interest income from mortgage investments
which were repaid during fiscal 1997. Expenses included interest expense related
to the mortgage investments and a note payable to an affiliated party. Other
rental revenue of $2.3 million and operating expenses of $2.1 million and
amortization of $.04 million related to the Carbon & Carbide Building (the sale
of which closed on September 4, 1997) have been eliminated.
63
<PAGE> 71
For the nine months ended October 31, 1998, the Trust had pro forma revenues of
$8.0 million from the Percentage Leases that would have been in place at the
Hotels. The Trust had $.02 million in interest income compared to no interest
income from mortgage investments in 1997. There was no other rental revenue or
operating expenses related to the Carbon & Carbide Building (the sale of which
closed on September 4, 1997). Net income to shareholders (after minority
interest) is comparable at $1.5 million.
For the nine months ended October 31, 1997, the Trust had pro forma revenues of
$7.5 million from the Percentage Leases that would have been in place at the
Hotels. The Trust had no interest income from mortgage investments which were
repaid during fiscal 1997. Expenses included interest expense investments and a
note payable to an affiliated party. Other rental revenue of $1.4 million and
operating expenses of $1.4 million and amortization of $.02 million related to
the Carbon & Carbide Building (the sale of which closed on September 4, 1997)
have been eliminated.
PRO FORMA RESULTS OF OPERATIONS OF THE INITIAL LESSEE
For the year ended December 31, 1997, the Initial Lessee had pro forma revenues
of $26.2 million compared to $18.3 million for the year ended December 31, 1996,
an increase of $7.9 million (43.1%). This was due to the inclusion of Tucson
(St. Mary's), San Diego's and Buena Park's revenue in 1997 and increases in
occupancy at all fully-operational hotels from 70.5% in 1996 to 73.1% in 1997
and ADR at the same hotels from $70.60 in 1996 to $72.25 in 1997. Total expenses
increased $10.4 million from $20.2 million in the year ended December 31, 1996
to $30.6 million in the year ended December 31, 1997 primarily due to the
inclusion of expenses of Tucson (St. Mary's), San Diego and Buena Park in 1997
and increased general and administrative expenses related to the formation of
the Operating Partnership. Increases of $1.5 million in general and
administrative expenses, and $2.5 million in Percentage Lease payments were also
consistent with increased occupancy and revenues and, in the case of general and
administrative expenses, due to increased legal and accounting and advisory
expenses. Repairs and maintenance of $3.5 million in 1997 remained high due to
costs of the ongoing refurbishment program which was substantially completed by
December 31, 1997 and the inclusion of expenses from Tucson (St. Mary's), San
Diego and Buena Park. The larger increase in expenses ($10.4 million) as
compared to the $7.9 million increase in revenues resulted in a $2.6 million
increased loss to $4.38 million in the year ended December 31, 1997 as compared
to the $1.84 million loss for the year ended December 31, 1996.
The pro forma net loss of the Initial Lessee for 1997 was $4.38 million,
primarily due to having incurred $3.53 million of maintenance expense as part of
a multi-year refurbishment program. The refurbishment program was substantially
completed as of December 31, 1997. Mr. and Mrs. Wirth's management and trademark
corporations have agreed to subordinate their receipt of management fees and
trademark fees from the Initial Lessee, to the extent that the Flagstaff hotel
has not generated sufficient operating cash flow to meet its $250,000 minimum
annual rent payment, until the Flagstaff hotel has generated sufficient
operating cash flow to meet its $250,000 minimum annual rent payment in two
consecutive years. The elimination of the maintenance expense associated with
refurbishment and Mr. Wirth's subsidy of the Flagstaff hotel should enable the
Initial Lessee to generate a positive cash flow.
For the nine months ended September 30, 1998, the Initial Lessee had a pro forma
net loss of $3.05 million, an increase of $.55 million as compared to the $2.5
million net loss for the
64
<PAGE> 72
nine months ended September 30, 1997. Total pro forma revenues of $21.3 million
represented an increase of $1.5 million (7.6%) as compared to total revenues of
$19.8 for the same period in 1997. This was due primarily to an increase of $1.1
million (6%) in pro forma room revenues from $18.0 million in 1997 to $19.1
million in 1998. Food and beverage revenues remained constant between the
periods. Total pro forma expenses of $24.4 million for the nine months ended
September 30, 1998 represented a $2.1 million (9%) increase as compared to total
expenses of $22.3 million for the nine months ended September 30, 1997. Pro
forma room departmental expenses increased $1.4 million (25%) from $5.5 million
in 1997 to $6.9 million in 1998 due to increased wages and costs of supplies.
General and administrative expenses increased to $3.2 million in 1998 compared
to $2.8 million in 1997, a $.4 million (14%) increase due to increased legal and
accounting costs relating to the Formation Transactions and increased costs of
administrative salaries and benefits. Advertising and promotion expenses for the
nine months ended September 30, 1998 increased $.7 million (78%) to $1.6 million
as compared to $.9 million for the same period in 1997 due to increased
promotions for acquisitions in new markets. Pro forma repairs and maintenance
expenses declined $.3 million (16%) to $1.6 million in 1998 due to the
substantial completion of improvement programs at several hotels during 1998.
Percentage rent expenses for the nine months ended September 30, 1998 increased
to $8.0 million as compared to $7.5 million for the nine months ended September
30, 1997, a $.5 million (6.6%) increase due to increased occupancy and average
daily rates.
65
<PAGE> 73
RESULTS OF OPERATIONS OF THE HOTELS
The following table sets forth certain combined historical financial information
for the Hotels, as a percentage of revenues, for the periods indicated.
<TABLE>
<CAPTION>
NINE-MONTHS NINE-MONTHS
YEAR ENDED DECEMBER 31, ENDED ENDED
--------------------------- SEPTEMBER 30, SEPTEMBER 30,
1997 1996 1995 1998 1997
------- ------- ------- ------------- -------------
<S> <C> <C> <C> <C> <C>
FINANCIAL DATA
Room revenue....................... 94.4% 96.1% 96.4% 89.6% 90%
Food and beverage revenue.......... 2.6 1.1 0.8 8.2 6.0
Other revenue...................... 3.0 2.8 2.8 2.2 3.0
------- ------- ------- ------- -------
Total revenue............ 100.0 100.0 100.00 100.00 100.00
------- ------- ------- ------- -------
Departmental and other expenses.... 73.2 70.1 69.6 68.8 68.8
Real estate and personal property
taxes, insurance and rent........ 4.6 4.8 4.1 -- --
Depreciation and amortization...... 6.2 6.3 6.6 -- --
Interest expense................... 9.3 8.6 12.5 -- --
------- ------- ------- ------- -------
Income before extraordinary
items............................ 6.7 10.2 7.2 31.2 31.2
Extraordinary item -- gain on early
extinguishment of debt........... -- 1.7 40.6 -- --
------- ------- ------- ------- -------
Net income......................... 6.7% 11.9% 47.8% 31.2% 31.2%
======= ======= ======= ======= =======
OTHER DATA
EBITDA(1), as a % of revenue....... 22.2% 25.0% 26.3% 31.2% 31.2%
Cash Flow from Operating
Activities....................... $ 3,915 $ 2,642 $ 2,108 $(1,521) $ 2,744
Cash Flow from Investing
Activities....................... $(1,670) $(2,004) $ (406) $ 712 $ (205)
Cash Flow from Financing
Activities....................... $(2,744) $(1,175) $(1,891) $ 984 $(2,341)
KEY FACTORS(2)
Occupancy.......................... 70.6% 68.4% 67.6% 63.2% 60.2%
ADR................................ $ 68.73 $ 65.71 $ 62.80 $ 66.74 $ 65.19
REVPAR............................. $ 48.62 $ 45.79 $ 42.45 $ 42.16 $ 39.23
</TABLE>
- ---------------
(1) Represents income (loss) before extraordinary items, excluding interest
expense, depreciation and amortization. The Trust believes that EBITDA,
defined as net income before interest, depreciation, amortization, taxes and
extraordinary items, provides a good indicator of the financial performance
of the Hotels and will be a significant factor in determining the Initial
Lessee's ability to make lease payments to the Operating Partnership. This
indicator should not, however, be considered as an alternative to net income
as an indication of the Initial Lessee's performance or to cash flow as a
measure of liquidity.
(2) No assurance can be given that the trends reflected in this data will
continue or that occupancy, ADR and REVPAR will not decrease as a result of
changes in national or local economic or hospitality industry conditions.
These figures include the Flagstaff hotel, acquired in June 1996 and under
renovation during the remainder of 1996 and the first half of 1997. The
renovation was substantially completed as of October 15, 1997.
66
<PAGE> 74
Comparison of the year ended December 31, 1997 with 1996 for the Hotels
Room revenues increased $1.19 million, or 6.7%, from 1996 to 1997. This was
driven by increases in ADR at almost all of the Hotels, along with an increase
in occupancy of 3.0%. These were attributable to the general improvement in the
business travel and tourism industries, lack of any new competition in the
markets where the Hotels operate and the InnSuites' refurbishment program. Food
and beverage revenue grew $.32 million or 163.5% from 1996 to 1997, relating to
the increase in occupancy and expansion of food service, including room service
at two of the Hotels. The composition of revenue remained consistent between the
periods, with only a slight increase in food and beverage revenues, from 1.1% of
the total to 2.6%, which reflects that most of the gains in revenue occurred in
occupancy and room rates during this period.
Departmental and other expenses grew by $1.73 million, or 13.4%, between the
years because of expansion of food service, increased payroll costs, general
inflationary pressures and increased occupancy. These costs increased as a
percentage of revenues from 70.1% in 1996 to 73.2% in 1997, as expenses grew
faster than revenues, primarily through increased payroll. Depreciation and
amortization increased slightly between 1996 and 1997.
Interest expense increased by $.28 million in 1997 compared to 1996 due to
refinancing costs of capital improvements.
Income before extraordinary items decreased $.54 million primarily due to
increased expenses discussed above.
A gain on early extinguishment of debt of $.3 million recorded in May 1996
related to the extinguishment of debt at the Flagstaff property. No gains or
losses related to the extinguishment of debt were realized in 1997.
Net income declined $.85 million due to the extinguishment of debt income
realized in 1996 and increased expenses in 1997.
EBITDA declined $.17 million, or 3.8%, from 1996 to 1997. This decline is
attributable to the increase in expenses during the periods.
Comparison of the year ended December 31, 1996 with 1995 for the Hotels
Total revenues increased $2.38 million, or 14.9%, from 1995 to 1996. Room
revenues increased $2.2 million, or 14.6%, from 1995 to 1996. As can be seen by
the growth of REVPAR, revenues as reported were driven by increases in the ADR
which occurred at five of the Hotels, while occupancy increased 1.4% overall.
This was attributable in part to the general improvement in the business travel
and tourism industries as well as to InnSuites' refurbishment program which was
substantially completed at all the Hotels by the end of calendar 1997. The
continuation of InnSuites' focus on maximizing REVPAR by focusing on increasing
ADR while maintaining stable occupancy during this period had significant
effects. Food and beverage revenue grew $.066 million, or 50.8%, from 1995 to
1996. The composition of revenue stayed consistent between the periods, with
only a slight increase in food and beverage revenues, from .8% of the total to
1.1%.
Departmental and other expenses increased by $1.77 million, or 16.0%, between
the years substantially because of a $.68 million increase in maintenance
associated with the refurbishment program, the inclusion of the operating
results of the Flagstaff hotel from January 1, 1996, increases in management and
franchise fees due to increased revenues and
67
<PAGE> 75
general inflationary pressures. These costs increased slightly as a percentage
of revenues from 69.6% in 1995 to 70.1% in 1996, due to the effect of expenses
growing at a faster pace than revenues, in particular maintenance expenses, and
the less-profitable operating results of the Flagstaff hotel acquired in 1996.
In addition, management fees increased from 3.8% of revenues in 1995 to 4.6% of
revenues in 1996 because of higher revenues and increases in the management fee
rate implemented in the second quarter of 1996 at four of the Hotels. Real
estate and personal property taxes, insurance and rent increased 33.6% from 1995
to 1996. This is primarily attributable to real estate taxes which increased
40.3% due to increased property valuations based on improved revenues.
Depreciation and amortization expense increased by $.088 million, or 8.3%,
primarily due to the additional depreciation associated with the increased rate
of refurbishment at the Hotels.
Interest expense decreased $0.42 million, or 21.1%, in 1996 due to (i) principal
payments on mortgage notes payable of $2.2 million in 1995 and $.62 million in
1996, net of new mortgage debt of $.99 million in 1996.
Income before extraordinary items increased $.72 million primarily due to
increases in ADR at the Hotels and decreased interest expense.
The gain on early extinguishment of debt of $.3 million recorded in May 1996
related to the extinguishment of debt in Hulsey Hotels (the Flagstaff property)
in the form of forgiveness of advances from affiliates and was substantially
less than the $6.5 million gain recorded in May 1995 related to the
extinguishment of debt at the Ontario property in the form of forgiveness of
mortgage debt.
Net income declined $5.44 million due to substantially larger forgiveness of
debt income in 1995, which was offset partially by the improvement in ADR and
reduced interest expense in 1996.
EDITDA grew $.39 million or 9.3% from 1995 to 1996. This improvement was
attributable to the increase in revenues due to growth in ADR during the periods
which was partially offset by increases in franchise and management fees.
LIQUIDITY AND CAPITAL RESOURCES
The Trust, through its ownership interest in the Operating Partnership, will
have its proportionate share of the benefits and obligations of the Operating
Partnership's ownership interests in the Hotels. The Trust's principal sources
of cash to meet its cash requirements, including distributions to shareholders,
will be its share of the Operating Partnership's cash flow. The Operating
Partnership's principal source of revenue will be rent payments under the
Percentage Leases. The Initial Lessee's obligations under the Percentage Leases
are, and the Management Company's obligations will be, unsecured and their
ability to make rent payments to the Operating Partnership under the Percentage
Leases, and the Trust's liquidity, including its ability to make distributions
to stockholders, will be dependent on their ability to generate sufficient cash
flow from hotel operations.
For a discussion of the abatement of management and trademark fees at the
Flagstaff property, see " -- PRO FORMA RESULTS OF OPERATIONS OF THE INITIAL
LESSEE" above. Beyond the 4% reserve for refurbishment and replacements set
aside annually, and $450,000 in anticipated refurbishing costs at the recently
acquired InnSuites Hotel San Diego, the Trust has no present commitments for
extraordinary capital expenditures.
68
<PAGE> 76
Outstanding mortgage debt will be reduced from $23.4 million on a pro forma
basis at January 31, 1998 to $10.1 million by application of the proceeds of
this offering. Borrowings of $11 million under the line of credit will be fully
repaid with the proceeds of this offering. The Trust intends to acquire and
develop additional hotels and will incur indebtedness to fund those acquisitions
and developments. The Trust may also incur indebtedness to meet distribution
requirements imposed on a REIT under the Code to the extent that working capital
and cash flow from the Trust's investments are insufficient to make the required
distributions. The terms of the line of credit discussed below permit borrowings
for that purpose, but impose certain limitations on the Trust's ability to
engage in other borrowings.
On April 16, 1998, the Trust obtained the $12 million Credit Facility to assist
it in its funding of acquisition and development of additional hotels and for
certain other business purposes. Borrowings under the Credit Facility are
secured by first mortgages on three of the Hotels. The Trust may seek to
increase the amount of its Credit Facility, negotiate additional credit
facilities, or issue debt instruments. Any debt incurred or issued by the Trust
may be secured or unsecured, long-term, medium-term or short-term, bear interest
at a fixed or variable rate, and be subject to such other terms as the Trust
considers prudent.
The Trust will acquire or develop additional hotels only as suitable
opportunities arise, and the Trust will not undertake acquisition or
redevelopment of properties unless adequate sources of financing are available.
Funds for future acquisitions or development of hotels are expected to be
derived, in whole or in part, from borrowings under the Credit Facility or other
borrowings or from the proceeds of additional issuances of Common Shares or
other securities. There is no agreement or understanding to invest in any other
properties, and there can be no assurance that the Trust will successfully
acquire or develop additional hotels.
The Operating Partnership will contribute to a Capital Expenditures Fund on a
continuing basis, from the rent paid under the Percentage Leases, an amount
equal to 4% of the Initial Lessee's revenues from operation of the Hotels. The
Capital Expenditures Fund is intended to be used for capital improvements to the
Hotels and refurbishment and replacement of furniture, fixtures and equipment,
in addition to other uses of amounts in the Fund considered appropriate from
time to time. The Operating Partnership anticipates making similar arrangements
with respect to future hotels that it may acquire or develop. During the period
from January 1, 1995 through December 31, 1997, the Hotels spent approximately
$2.0 million for capital expenditures, excluding hotel acquisitions. The Trust
considers the majority of these improvements to be revenue producing and
therefor these amounts have been capitalized and are being depreciated over
their estimated useful lives. The Hotels also spent $7.0 million during the
period from January 1, 1995 through December 31, 1997 on repairs and maintenance
and these amounts have been charged to expense as incurred.
INFLATION
The Trust's revenues initially will be based on the Percentage Leases which will
result in changes in the Trust's revenues based on changes in the underlying
Hotel revenues. Therefore, the Trust initially will be relying entirely on the
performance of the Hotels and the Initial Lessee's and the Management Company's
abilities to increase revenues to keep pace with inflation. Operators of hotels
in general, and the Initial Lessee in particular, can change room rates quickly,
but competitive pressures may limit the Initial Lessee's ability to raise rates
faster than inflation.
69
<PAGE> 77
The Trust's largest fixed expense is the depreciation of the investment in Hotel
properties. The Trust's variable expenses, which are subject to inflation,
represented approximately 26.3% of pro forma revenues in fiscal 1998. These
variable expenses (general and administrative costs, as well as real estate and
personal property taxes, property and casualty insurance and ground rent) are
expected to grow with the general rate of inflation.
SEASONALITY
The Hotels' operations historically have been seasonal. The six southern Arizona
hotels experience their highest occupancy in the first fiscal quarter and, to a
lesser extent, the fourth fiscal quarter. The second fiscal quarter tends to be
the lowest occupancy period at those six southern Arizona hotels. This
seasonality pattern can be expected to cause fluctuations in the Trust's
quarterly lease revenue under the Percentage Leases. The Trust anticipates that
its cash flow from the Initial Lessee's and the Management Company's hotel
operations will be sufficient to enable the Trust to make quarterly
distributions at the rate of $0.30 per Common Share for at least the next twelve
months. To the extent that cash flow from operations is insufficient during any
quarter, because of temporary or seasonal fluctuations in lease revenue, the
Trust expects to utilize other cash on hand or borrowings to make those
distributions. No assurance can be given that the Trust will make distributions
in the future at the initially estimated rate, or at all.
YEAR 2000 COMPLIANCE
The Year 2000 problem is the result of computer programs having been written
using two digits instead of four digits to define the applicable year. Any of
the Trust's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could
potentially result in a system failure or miscalculations, causing disruptions
of operations and normal business activity.
The Trust is currently in the process of upgrading its computer accounting
programs and has commenced installing a new property management system along
with necessary hardware. These new systems have been warranted to be Year 2000
compliant. The Trust has estimated the total cost which will be incurred in
connection with these installations to be approximately $400,000, which will be
capitalized and amortized over seven years. The Trust believes that such costs
will not result in a material adverse effect on its financial condition or
results of operations.
These new systems represent virtually all of the Trust's computer systems,
however, the Trust cannot predict the effect of the Year 2000 problem on
vendors, customers and other entities with which the Trust transacts business,
and there can be no assurance that the effect of the Year 2000 problem on such
entities will not adversely affect the Trust's operations.
In the event of the failure of any of the Trust's computer systems, the Trust
intends to perform necessary functions without the aid of the affected computer
systems until any Year 2000 problems are resolved.
70
<PAGE> 78
BUSINESS AND PROPERTIES OF THE TRUST
THE PROPERTIES.
The following table sets forth certain information in respect of each of the
Hotels:
<TABLE>
<CAPTION>
NUMBER
NUMBER OF YEAR OF MOST NUMBER OF
OF PARKING BUILDING CONSTRUCTION/ RECENT RESTAURANTS/ MEETING FITNESS POOL/
PROPERTY SUITES SPACES STRUCTURE ADDITION RENOVATION LOUNGES ROOMS CENTER JACUZZI
-------- ------ ------- ------------- ------------- ---------- ------------ --------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
InnSuites 123 153 Metal stud 1980 1995/1996 0 2-total Yes Yes
Hotel Phoenix construction of 1,000
Best Western......... with stucco sq. ft.
exterior
InnSuites Hotel 170 200 Metal stud 1982/1985 1995/1996 1 6-total Yes Yes
Tempe/Phoenix construction of 4,065
Airport/South with stucco sq. ft.
Mountain............. exterior
InnSuites Hotel 159 189 Metal stud 1981/1983 1995/1996 1 10-total Yes Yes
Tucson, Catalina construction of 4,500
Foothills with stucco sq. ft.
Best Western......... exterior
InnSuites Hotel 166 196 Metal stud 1982/1984 1995/1996 1 11-total Yes Yes
Yuma Best Western.... construction of 8,900
with stucco sq. ft.
exterior
Holiday Inn Airport 150 180 Wood 1990 1995/1996 1 9-total Yes Yes
Hotel and construction, of 5,850
Suites/Ontario....... stucco sq. ft.
exterior,
concrete
floors
InnSuites Hotel 134 158 Masonry 1966-67/ 1972 1996/1997 1 3-total Yes Yes
Flagstaff/ construction of 1,111
Grand Canyon......... sq. ft.
InnSuites Hotel 134 163 Metal stud 1980 1995/1996 1 2-total Yes Yes
Scottsdale El construction of 1,424
Dorado Park Resort... with stucco sq. ft.
exterior
InnSuites Hotel 297 352 Concrete 1960/1966 1997 2 10-total Yes Yes
Tucson block 1971 of 14,252
(St. Mary's)......... construction sq. ft.
with stucco
exterior
InnSuites Hotel 147 129 Wood 1946/1989 1996 1 7-total Yes Yes
San Diego............ construction of 12,000
with stucco sq. ft.
exterior
InnSuites Hotel 185 214 Wood 1972/1980 1997/1998 1 3-total Yes Yes
Buena Park........... construction Of 1,941
with Stucco Sq. Ft.
exterior
-----
Total Suites......... 1,665
=====
<CAPTION>
PROPERTY OTHER
-------- ----------
<S> <C>
InnSuites
Hotel Phoenix
Best Western.........
InnSuites Hotel 2 tennis
Tempe/Phoenix courts
Airport/South
Mountain.............
InnSuites Hotel 2 tennis
Tucson, Catalina courts
Foothills
Best Western.........
InnSuites Hotel 2 tennis
Yuma Best Western.... courts
Holiday Inn Airport basketball
Hotel and court
Suites/Ontario.......
InnSuites Hotel
Flagstaff/
Grand Canyon.........
InnSuites Hotel
Scottsdale El
Dorado Park Resort...
InnSuites Hotel
Tucson
(St. Mary's).........
InnSuites Hotel
San Diego............
InnSuites Hotel
Buena Park...........
Total Suites.........
</TABLE>
General. Each of the Hotels is under the direction of a general manager and an
executive committee, who are accountable for, and compensated in part based on,
the property's performance. This group oversees day-to-day operations and
develops annual budgets and long-term capital and human resource development
plans for the respective Hotel. Each Hotel is also responsible for developing
its own comprehensive marketing plan, which analyzes local market conditions and
the Hotel's competition, determines Hotel positioning, identifies consumer
needs, and outlines marketing objectives and strategies. Each plan will continue
to be evaluated quarterly by the Initial Lessee to maintain effectiveness under
changing market conditions.
71
<PAGE> 79
The Initial Lessee and the Management Company stress comprehensive financial
management and revenue reporting and believe their management teams are skilled
at anticipating business needs and changes. All Hotel departments, including
rooms, food and beverage, accounting, sales and marketing, and maintenance, will
continue to receive regular on-site performance reviews and benefit from open
lines of communication directly to the Initial Lessee's and the Management
Company's management. These performance reviews will enable the Initial Lessee
and the Management Company to maintain an in-depth understanding of each Hotel's
marketing opportunities and to insure that the Trust's properties receive the
direction necessary to enable on-site management to maximize profits. The
Management Company will continue to utilize similar management techniques in
connection with the management of newly acquired hotels.
The following table sets forth the occupancy, average daily rate and revenue per
available room for each of the Hotels for the years ended December 31, 1996 and
1997 and the nine months ended September 30, 1998.
<TABLE>
<CAPTION>
REVENUE PER
AVERAGE DAILY RATE AVAILABLE ROOM
OCCUPANCY(1) FOR THE NINE (ADR)(2) FOR THE NINE (REVPAR)(3) FOR THE NINE
------------ MONTHS ------------------ MONTHS ---------------- MONTHS
PROPERTY 1996 1997 ENDED 9/30/98 1996 1997 ENDED 9/30/98 1996 1997 ENDED 9/30/98
-------- ---- ---- ------------- ------- ------- ------------- ------ ------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
InnSuites............ 72.3% 68.2% 72.3% $76.04 $78.57 $77.12 $54.97 $53.57 $55.75
Hotel Phoenix
Best Western
InnSuites Hotel...... 73.1% 76.0% 75.6% $68.43 $69.43 $71.18 $49.99 $52.74 $53.79
Tempe/Phoenix
Airport/South
Mountain
InnSuites Hotel...... 84.4% 81.5% 82.8% $73.87 $76.42 $77.42 $62.33 $62.32 $64.07
Tucson, Catalina
Foothills
Best Western
InnSuites Hotel...... 73.7% 75.1% 79.3% $62.12 $64.24 $64.94 $45.81 $48.28 $51.52
Yuma Best Western
Holiday Inn
Airport.............. 66.2% 76.6% 74.8% $68.35 $76.20 $80.55 $45.28 $56.57 $60.25
Hotel and
Suites/Ontario
InnSuites Hotel...... 59.0% 65.3% 63.6% $67.89 $67.53 $61.64 $39.58 $40.68 $39.33
Scottsdale El
Dorado Park Resort
InnSuites Hotel...... 45.2% 45.9% 54.3% $42.40 $48.07 $51.97 $19.14 $22.08 $28.20
Flagstaff/
Grand Canyon
InnSuites Hotel...... 37.3% 38.1% 45.4% $45.99 $56.67 $62.54 $17.16 $21.59 $28.37
Tucson
(St. Mary's)(4)
InnSuites Hotel...... 51.2% 51.8% 48.1% $45.54 $50.24 $64.47 $23.32 $26.02 $31.04
San Diego(5)
InnSuites Hotel...... 36.4% 38.6% 51.4% $38.39 $42.84 $45.94 $13.96 $16.52 $23.60
Buena Park(6)
</TABLE>
- ---------------
(1) Occupancy is calculated by dividing the actual number of rooms rented by the
actual number of rooms available for rent and is expressed as a percentage.
(2) Average Daily Rate is calculated by dividing actual room revenues by the
actual number of rooms rented.
(3) Revenue Per Available Room is calculated by dividing actual room revenues by
the actual number of rooms available for rent.
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(4) Occupancy, ADR and REVPAR for the InnSuites Hotel Tucson (St. Mary's) in
1996 are based on partial year data (June through December).
(5) Occupancy, ADR and REVPAR for the InnSuites Hotel San Diego in 1996 are
based on partial year data (May through December).
(6) Occupancy, ADR and REVPAR for the InnSuites Hotel Buena Park in 1996 are
based on partial year data (August through December).
To the knowledge of the Trust, the Hotels are in compliance with all relevant
environmental regulations. The Trust is unaware of any specific fuel or energy
requirements with which the Hotels must comply. Finally, the Hotels are not
subject to rent control regulations.
The following discussion sets forth additional information for each Hotel.
InnSuites Hotels Phoenix Best Western
This property is located just off the Squaw Peak Parkway, in the North Phoenix
resort area, convenient to Phoenix Sky Harbor International Airport and downtown
central Phoenix. The resort area offers golf, tennis, jogging and Squaw Peak
hiking trails as well as a variety of restaurants. Nearby attractions include
Turf Paradise Racing and shopping at the Biltmore Fashion Park, Metro Center and
Paradise Valley Mall.
Within the Phoenix, Arizona submarket there are several new hotels that have
either been completed or are under construction, including one or more
properties that will be directly competitive with the Hotel. As an offset to the
increase in supply, the general Arizona marketplace has experienced renewed
economic strength during the past several years, generally boosting lodging
demand throughout the state. This Hotel was acquired as part of the Formation
Transactions.
InnSuites Hotels Tempe/Phoenix Airport
This Hotel is located on Baseline Road at I-10, less than eight minutes from
Phoenix Sky Harbor International Airport with easy access to the Phoenix East
Valley and the Tempe/ Mesa/Chandler area. Area attractions include spring
training baseball, Arizona State University, Firebird Raceway, Old Towne Mill
Avenue shopping and dining and South Mountain Resort golf.
Within the Tempe, Arizona submarket there are several new hotels that have
either been completed or are under construction, including one or more
properties that will be directly competitive with the Hotel. As an offset to the
increase in supply, the general Arizona marketplace has experienced renewed
economic strength during the past several years, generally boosting lodging
demand throughout the state. Additionally, within this specific submarket, a
large outlet shopping mall was opened across the street from this Hotel in 1997,
which the Trust expects will further enhance this submarket's lodging demand.
This Hotel was acquired as part of the Formation Transactions.
InnSuites Hotels Tucson/Catalina Foothills Best Western
This Hotel is located in northwest Tucson's Catalina Foothills resort area, five
miles east of I-10, convenient to downtown and the Tucson International Airport.
The Tucson Mall and Foothills Mall and a variety of restaurants and golf courses
are within minutes of the property. Many Tucson attractions, including Biosphere
II, the Old Tucson movie studio, the
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<PAGE> 81
Arizona Sonora Desert Museum, the arts district and the University of Arizona
are conveniently located for access by the Hotel's guests.
Within the Tucson, Arizona submarket there are several new hotels that have
either been completed or are under construction. The additional supply has or
will create moderate competitive pressure as one or more of these properties are
expected to be directly competitive with the Hotel. As an offset to the increase
in supply, the general Arizona marketplace has experienced renewed economic
strength during the past several years, generally boosting lodging demand
throughout the state. This Hotel was acquired as part of the Formation
Transactions.
InnSuites Hotels Yuma Best Western
This Hotel is located on Castle Dome Avenue, just off the 16th Street exit of
I-8, convenient to the Yuma International Airport, restaurants, golf, shopping
and boating on the nearby Colorado River. Many attractions of Yuma and the
Colorado River Park, including Fort Yuma, the Yuma Art Center, Yuma Territorial
Prison Park and Martinez Lake, are convenient to this property.
Within the Yuma, Arizona submarket, although there have not been in recent years
any new hotels added to the supply of lodging, all hotels within the submarket,
including the Hotel, are dependent to some extent upon demand from surrounding
U.S. military facilities. With no supply growth and only modest demand
expansion, the Trust has worked to gain market share for this Hotel. This Hotel
was acquired as part of the Formation Transactions.
Holiday Inn Hotel and Suites Airport Ontario, an InnSuites Hotel
Located at the foot of California's San Gabriel Mountains and Mt. Baldy, this
Hotel is situated minutes from the Ontario, California International Airport and
the newly-opened Ontario Mills Mall. Dining and entertainment are centered
around P.J.'s Winery Cafe and Lounge, serving breakfast, lunch and dinner, with
a complimentary breakfast buffet and a free daily afternoon social hour. On
Wednesdays, guests are treated to a complimentary manager's barbeque.
Within the Ontario, California submarket there are several new hotels that have
either been completed or are under construction. The additional supply has or
will create moderate competitive pressure as one or more of these properties are
expected to be directly competitive with the Hotel. Concurrently, southern
California is experiencing an increase in general economic activity which has
served to enhance lodging demand in this submarket. This Hotel was acquired as
part of the Formation Transactions.
InnSuites Hotels Flagstaff/Grand Canyon
This Hotel's hillside location in Arizona Mountain Country is located 90 minutes
southeast of the Grand Canyon. Situated on historic Route 66, hotel guests can
conveniently visit downtown Flagstaff's restaurants and pubs, as well as many
Native American shops. Other attractions include the Snow Bowl ski resort, the
cliffs of Walnut Canyon, the Lowell Observatory and Oak Creek Canyon.
Within the Flagstaff, Arizona submarket there is an abundance of hospitality
capacity attempting to capture the Grand Canyon visitor demand. There are also
several new hotels that have either been completed or are under construction,
including one or more properties
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that will be directly competitive with the Hotel. As an offset to the increase
in supply, the general Arizona marketplace has experienced renewed economic
strength during the past several years, generally boosting lodging demand
throughout the state. That factor is, however, less relevant to this Hotel than
to other of the Hotels, as this Hotel relies more heavily on the tourist trade
than on the business traveler. This Hotel was acquired as part of the Formation
Transactions and had been under renovation for most of 1997.
InnSuites Hotels Scottsdale El Dorado Park Resort
This Hotel is located in the heart of Scottsdale, adjacent to El Dorado Park and
15 minutes from Phoenix Sky Harbor International Airport. Due to its location
next to El Dorado Park, guests of this Hotel are offered many attractions,
including paddle boats, hiking, golf, and walking and jogging trails. Other
nearby attractions include the Island of Big Surf, the Phoenix Zoo, the Desert
Botanical Gardens, Papago Park Golf and the Scottsdale Art Galleries. The Fiesta
Bowl, Arizona State University's Sun Devil Stadium and the homes of football's
Arizona Cardinals and baseball's San Francisco Giants and Chicago Cubs (spring
training) are also easily accessible.
Within the Scottsdale, Arizona submarket there are several new hotels that have
either been completed or are under construction, including one or more
properties that will be directly competitive with the Hotel. These new
properties could significantly enhance this submarket's lodging capacity,
creating an increase in competitive pressure. As an offset to the increase in
supply, the general Arizona marketplace has experienced renewed economic
strength during the past several years, generally boosting lodging demand
throughout the state. This Hotel was acquired as part of the Formation
Transactions.
InnSuites Hotels & Resort/Tucson (St. Mary's)
Conveniently located off of I-10 at the St. Mary's Road exit, this 297-suite
property occupies 11 acres and is centrally located in the heart of Tucson's art
and historic downtown district. Attractions include the Tucson Mall, the Tucson
Convention Center, the Old Tucson movie studio, the Arizona Sonora Desert
Museum, Biosphere II and golfing, and is minutes away from the University of
Arizona.
Within the Tucson, Arizona submarket there are several new hotels that have
either been completed or are under construction. The additional supply has or
will create moderate competitive pressure as one or more of these properties are
expected to be directly competitive with the Hotel. As an offset to the increase
in supply, the general Arizona marketplace has experienced renewed economic
strength during the past several years, generally boosting lodging demand
throughout the state. Finally, the State of Arizona plans, in late 1999, to
relocate an interchange of I-10 that was in close proximity to this Hotel. This
change is expected to have only a minimal impact since freeway impulse business
does not comprise a material part of the Hotel's business. This Hotel was
acquired on February 1, 1998 and was under renovation from acquisition to
December 31, 1998.
InnSuites Hotels San Diego Balboa Park Suite Resort
Located in San Diego, California, this Hotel is conveniently located near many
major attractions in San Diego, including Balboa Park, the San Diego Zoo, the
Convention Center, Sea World, Old Town and beaches. The elegant, colonial style
mansion has 147-suites, many
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<PAGE> 83
of which have fireplaces. Additional amenities include an Olympic-size, terrazzo
tile swimming pool and a choice of studio, one, two and three bedroom suites.
Within the San Diego, California submarket there are several new hotels that
have either been completed or are under construction. The additional supply has
or will create moderate competitive pressure as one or more of these properties
are expected to be directly competitive with the Hotel. Concurrently, southern
California is experiencing an increase in general economic activity which has
served to enhance lodging demand in this submarket. This Hotel was acquired on
April 29, 1998 and is currently undergoing renovations which are expected to be
completed in the first quarter of 1999.
InnSuites Hotels Buena Park
Located in northern Orange County, this Hotel is situated only minutes from
major attractions, such as Disneyland, Knott's Berry Farm, Movieland Wax Museum,
Ripley's Believe It or Not, Wild Bill's and Medieval Times. The Hotel is also a
short drive from southern California's beaches. Dining and entertainment for the
area begin with PJ's Cafe where a deluxe breakfast buffet is served every
morning, as well as a social hour every afternoon and the manager's barbeque
every Wednesday night.
Within the Buena Park, California submarket there is only one hotel planned to
begin construction within the next year. This additional hotel, as well as a
franchise change for another, will create moderate competitive pressure as these
properties are expected to be directly competitive with this Hotel.
Concurrently, Orange County is experiencing an increase in general economic
activity, which has served to enhance lodging demand in this submarket. The
expansion of Disneyland and the renovation of the Anaheim Convention Center will
cause a further increase in this area's activity and will enhance lodging demand
in this submarket. This Hotel was acquired on June 1, 1998 and was under
renovation from acquisition to December 31, 1998.
LEASING AND OPERATION OF THE PROPERTIES
The Initial Lessee entered into substantially identical Percentage Leases for
each Hotel with the Operating Partnership. The Trust and the Operating
Partnership anticipate that the Management Company will enter into substantially
identical Percentage Leases for each newly acquired hotel. Additional
information regarding the Percentage Leases is set forth below.
The following table sets forth (i) the quarterly percentage rent formulas, (ii)
the annual minimum rent, and (iii) the pro forma percentage rent and total rent
that would have been paid for each Hotel pursuant to the terms of the Percentage
Leases based upon historical revenues for the twelve months ended January 31,
1998 and the nine months ended
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<PAGE> 84
October 31, 1998 as if the Operating Partnership had owned the Hotels and the
Percentage Leases had been in effect since February 1, 1997.
<TABLE>
<CAPTION>
FOR THE 12 MONTHS
ENDED 1/31/98
------------------------
FRANCHISE HISTORICAL
LEASE RENEWAL ANNUAL QUARTERLY ROOMS & PRO FORMA
EXPIRATION EXPIRATION MINIMUM PERCENTAGE OTHER ANNUAL
HOTEL DATE DATE RENT RENT FORMULA(1) REVENUE RENT(2)
----- ---------- ---------- ------- --------------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
InnSuites Hotel 1/31/08 12/31/99 $ 800,000 37.5% under $600, $ 2,480,300 $ 982,519
Phoenix Best Western 50% from $600 to $1,000,
68% over
InnSuites Hotel 1/31/08 1/31/02 $1,000,000 37.5% under $600, $ 3,447,904 $1,480,268
Tempe/Phoenix 50% from $600 to $1,000,
Airport/South Mountain 70% over $1,000
InnSuites Hotel
Tucson, 1/31/08 12/31/99 $1,000,000 37.5% under $600, $ 3,701,411 $1,604,564
Catalina Foothills 50% from $600 to $1,000,
Best Western 70% over $1,000
InnSuites Hotel Yuma 1/31/08 12/31/99 $ 800,000 32% under $600, $ 3,017,388 $1,077,322
Best Western 50% from $600 to $1,000,
68% over $1,000
Holiday Inn Airport 1/31/08 6/30/04 $ 600,000 34% under $1,000, $ 3,335,105 $1,140,753
Hotel and
Suites/Ontario 50% from $1,000 to $1,300,
68% over $1,300
InnSuites Hotel 1/31/08 1/31/02 $ 250,000 25% under $600, $ 1,130,898 $ 282,725
Flagstaff/Grand Canyon 40% from $600 to $1,000,
58% over $1,000
InnSuites Hotel 1/31/08 1/31/02 $ 600,000 35% under $800, $ 2,006,330 $ 713,653
Scottsdale El Dorado 50% from $800 to $1,100,
Park Resort 68% over $1,100
InnSuites Hotel Tucson 1/31/08 1/31/02 $ 800,000 35% under $1,400, $ 2,528,824 $ 914,710
(St. Mary's) 50% from $1,400 to $1,800,
68% over $1,800
InnSuites Hotel 1/31/08 1/31/02 $ 500,000 35% under $800, $ 1,585,561 $ 554,946
San Diego 50% from $800 to $1,100,
70% over $1,100
InnSuites Hotel 1/31/08 1/31/02 $ 500,000 37.5% under $700 $ 1,181,246 $ 442,987
---------- ----------- ----------
Buena Park 50% from $700 to $1,000
70% over $1,000
Total $6,850,000 $24,414,967 $9,194,447
========== =========== ==========
<CAPTION>
FOR THE NINE MONTHS
ENDED 10/31
-----------------------
HOTEL 1997 1998
----- ---------- ----------
<S> <C> <C>
InnSuites Hotel $ 715,351 $ 761,448
Phoenix Best Western
InnSuites Hotel $1,101,218 $1,073,860
Tempe/Phoenix
Airport/South Mountain
InnSuites Hotel
Tucson, $1,209,762 $1,205,646
Catalina Foothills
Best Western
InnSuites Hotel Yuma $ 814,919 $ 910,606
Best Western
Holiday Inn Airport $ 863,972 $ 897,182
Hotel and
Suites/Ontario
InnSuites Hotel $ 236,864 $ 275,797
Flagstaff/Grand Canyon
InnSuites Hotel $ 527,710 $ 497,735
Scottsdale El Dorado
Park Resort
InnSuites Hotel Tucson $ 704,022 $ 844,256
(St. Mary's)
InnSuites Hotel $ 442,017 $ 548,779
San Diego
InnSuites Hotel $ 355,742 $ 510,736
---------- ----------
Buena Park
Total $6,971,577 $7,526,045
========== ==========
</TABLE>
- ---------------
(1) Shown as a percentage of revenues (amounts in thousands).
(2) Calculated on a pro forma basis by applying the rent provisions in the
Percentage Leases to historical revenues of the properties for the
twelve-month period as if February 1, 1997 was the beginning of the lease
year.
The following summary of the Percentage Leases, and the descriptions of certain
provisions thereof set forth herein, are qualified in their entirety by
reference to the form of Percentage Lease, which is an exhibit to the
Registration Statement of which this Prospectus is a part.
Duration. The current Percentage Leases have initial terms ending on January 31,
2008, subject to earlier termination on the occurrence of certain contingencies
described in the Percentage Leases (including, particularly, the provisions
described herein under "-- DAMAGE TO PROPERTIES," "-- CONDEMNATION OF
PROPERTIES" AND "-- TERMINATION OF PERCENTAGE LEASES ON DISPOSITION OF THE
HOTELS").
Amounts Payable Under the Percentage Leases. The Initial Lessee is obligated to
pay (i) the higher of minimum rent or percentage rent and (ii) certain other
amounts, including interest accrued on any late payment or charge. Minimum rent
is a fixed amount determined by negotiation between the Operating Partnership
and the Initial Lessee. Percentage rent is calculated by multiplying fixed
percentages by gross room and other revenues exceeding
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<PAGE> 85
specified threshold amounts. Minimum rent is payable monthly in advance, and
percentage rent is payable for each quarter within 30 days after the end of the
quarter.
Both minimum rent and the threshold gross room and other revenue amounts used in
computing percentage rent will be adjusted for changes in the CPI. The changes
will be calculated at the beginning of each calendar year beginning with 1999,
based on the average annual change in the CPI during the prior 12 months.
Each Percentage Lease requires the Initial Lessee to pay rent, all costs and
expenses, and all utility and other charges incurred in the operation of the
respective Hotel. All capital expenditures (as defined in the Percentage Lease)
will be the responsibility of the Operating Partnership. Each Percentage Lease
also provides for rent reductions and abatements in the event of damage or
destruction or a partial taking of the Hotel as described under "-- DAMAGE TO
PROPERTIES" and "-- CONDEMNATION OF PROPERTIES." The Initial Lessee is required
to carry insurance to cover rental interruption for a period of up to one year.
Maintenance and Modifications. The Operating Partnership is required to maintain
the underground utilities and the structural elements, including exterior walls
(excluding plate glass) and the roof, of the Hotels. The Operating Partnership
will also fund the repair, replacement and refurbishment of furniture, fixtures
and equipment in the Hotels, when and as it considers necessary, and will
maintain a Capital Expenditures Fund to help provide funds to cover such
expenses. See "THE TRUST -- BUSINESS OBJECTIVES -- BUSINESS STRATEGY." The
Operating Partnership must make a quarterly contribution to the Capital
Expenditures Fund in an amount equal to 4% of the Initial Lessee's aggregate
gross revenues generated from the Hotels. The Initial Lessee will be required,
at its expense, to maintain the Hotels in good order and repair, except for
ordinary wear and tear, and to make nonstructural, foreseen and unforeseen, and
ordinary and extraordinary, repairs which may be necessary and appropriate to
keep the Hotels in good order and repair. Capital expenses and furniture,
fixture and equipment replacements will be paid for by the Operating Partnership
generally out of the Capital Expenditures Fund. The Operating Partnership and
the Initial Lessee will agree on an annual budget for each Hotel.
The Initial Lessee, at its expense, may make noncapital and capital additions,
modifications or improvements to the Hotels, so long as doing so does not
significantly alter the character or purposes of the Hotels or significantly
detract from their value or operating efficiencies. All such additions,
modifications and improvements will be subject to all of the terms of the
Percentage Leases and will become the property of the Operating Partnership upon
termination of the Percentage Leases. The Operating Partnership will own the
furniture, fixtures and equipment, except in limited circumstances under which
the Operating Partnership may require the Initial Lessee to purchase certain
furniture, fixtures and equipment. The Initial Lessee will own substantially all
other personal property not affixed to, or considered a part of, the real estate
or improvements thereon. Any required purchase of furniture, fixtures and
equipment by the Initial Lessee will be made on terms negotiated between the
Operating Partnership and the Initial Lessee.
Insurance and Property Taxes. The Operating Partnership is responsible for
paying real estate and personal property taxes on the Hotels and for maintaining
property insurance, including casualty insurance. The Initial Lessee is required
to maintain comprehensive general public liability, workers' compensation,
12-month rental interruption insurance and any other insurance customary for
properties similar to the Hotels or required by any relevant franchisor. The
Operating Partnership is to be named as an additional insured of any
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<PAGE> 86
insurance. The Operating Partnership believes that the insurance coverage
carried by each Hotel is adequate in scope and amount.
Indemnification. Under each Percentage Lease, the Initial Lessee must indemnify
the Operating Partnership against all liabilities, costs and expenses (including
reasonable attorneys' fees and disbursements) incurred by, imposed on or
asserted against the Operating Partnership on account of, among other things,
(i) any accident or injury to person or property on or about a Hotel; (ii) any
negligence by the Initial Lessee or any of its agents as to the leased property;
(iii) any environmental liability resulting from conditions caused or resulting
thereafter from any action, inaction or negligence of the Initial Lessee; (iv)
taxes and assessments in respect of a Hotel (other than real estate taxes and
income taxes of the Operating Partnership on income attributable to a Hotel);
(v) the sale or consumption of alcoholic beverages on or in the real property or
improvements thereon; or (vi) any breach of the Percentage Lease by the Initial
Lessee. The Initial Lessee is not required, however, to indemnify the Operating
Partnership against the Operating Partnership's gross negligence or willful
misconduct.
Assignment and Subleasing. The Initial Lessee is not permitted to sublet all or
any part of a Hotel or assign its interest under a Percentage Lease, other than
to an affiliate of the Initial Lessee, without the prior written consent of the
Operating Partnership. No assignment, subletting or management agreement will
release the Initial Lessee from any of its obligations under the Percentage
Leases.
Damage to Properties. If damage to or destruction of any Hotel renders such
Hotel unsuitable for the Initial Lessee's use and occupancy and is covered by
insurance, the Operating Partnership will be obligated to repair, rebuild or
restore such Hotel, but only to the extent of available insurance proceeds. The
Percentage Lease will remain in full force and effect during the first 12 months
of any period required to repair or restore a Hotel, after which time rent will
be equitably abated.
Condemnation of Properties. In the event of a total condemnation of a Hotel,
each of the Operating Partnership and the Initial Lessee will be entitled to
terminate the Percentage Lease as of the date of the condemnation. The resulting
condemnation award will be allocated between the Operating Partnership and the
Initial Lessee as set forth in the Percentage Lease. In the event of a partial
taking that does not render a Hotel unsuitable for the Initial Lessee's use, the
Initial Lessee must restore the untaken portion of such Hotel to a complete
architectural unit. In such a case, the Operating Partnership must provide the
required funds to cover the cost of that restoration, which may include that
part of the condemnation award specified for restoration.
Events of Default. Events of Default under each Percentage Lease include, among
others, the following:
- - the failure by the Initial Lessee to pay minimum rent when due and the
continuation of such failure for a period of 10 days;
- - the failure by the Initial Lessee to pay the percentage rent for any quarter
within 10 days after the end of such quarter;
- - the failure by the Initial Lessee to observe or perform any other term of the
Percentage Lease and the continuation of such failure beyond any applicable
cure period;
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<PAGE> 87
- - an Event of Default under any other Percentage Lease;
- - if the Initial Lessee files a petition in bankruptcy or reorganization under
any federal or state bankruptcy law or any similar federal or state law, or is
adjudicated a bankrupt or makes an assignment for the benefit of creditors or
admits in writing its inability to pay its debts generally as they become due,
or if a petition or answer proposing the adjudication of the Initial Lessee as
a bankrupt or its reorganization pursuant to any federal or state bankruptcy
law or any similar federal or state law is filed in any court and the Initial
Lessee is adjudicated a bankrupt and that adjudication is not vacated or set
aside or stayed within sixty (60) days after the entry of an order in respect
thereof, or if a receiver of the Initial Lessee, or of the whole or
substantially all of the assets of the Initial Lessee is appointed in any
proceeding brought by the Initial Lessee, or any such receiver, trustee or
liquidator is appointed in any proceeding brought against the Initial Lessee
and that appointment is not vacated or set aside or stayed within sixty (60)
days after that appointment is made;
- - if the Initial Lessee voluntarily discontinues operations of a Hotel for more
than thirty (30) days, except as a result of damage, destruction or
condemnation; or
- - if the franchise agreement in respect of any Hotel is terminated by the
franchisor as a result of any action or failure to act by the Initial Lessee
or its agents and is not replaced within ninety (90) days after the date of
termination by a new franchise agreement that is acceptable to the Operating
Partnership acting in its reasonable discretion.
If an Event of Default occurs and continues beyond any curative period, the
Operating Partnership may terminate the Percentage Lease and any or all of the
other Percentage Leases by giving the Initial Lessee thirty (30) days' written
notice of the date for termination thereof and, unless that Event of Default is
cured prior to that termination date, the specified Percentage Leases will
terminate on that date and the Initial Lessee will be required to surrender
possession of the affected Hotels.
Termination of Percentage Leases on Disposition of the Hotels. If the Operating
Partnership enters into an agreement to transfer a Hotel to a non-affiliate, the
Operating Partnership may terminate that Hotel's Percentage Lease by giving the
Initial Lessee 30 days' prior notice and paying it the fair market value of its
leasehold interest in the remaining term of that Percentage Lease.
Franchise Agreements. The Initial Lessee and/or the relevant Hotel are the
franchisee under the franchise agreements for the Hotels. The current franchise
agreements for the three Best Western(R) Hotels (located in Phoenix, Tucson
(Oracle) and Yuma, Arizona), which are renewable annually, expire on December
31, 1999. The current franchise agreement for the Holiday Inn(R) Hotel (located
in Ontario, California) expires on June 30, 2004. There can be no assurance that
such franchise agreements will be renewed upon their expiration or as to the
effect on the Trust of any non-renewal. The current franchise agreements for the
InnSuites Hotels(R) (located in Tempe, Flagstaff, Scottsdale and Tucson (St.
Mary's), Arizona and San Diego and Buena Park, California) expire on January 31,
2002.
Inventory. All working capital assets required in the operation of the Hotels
will be purchased by the Initial Lessee at its expense.
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EMPLOYEES
The Trust has 4 employees. These employees will perform, directly or through the
Operating Partnership, various acquisition, development, redevelopment and
management functions. The Initial Lessee has approximately 490 employees engaged
in operating the Hotels. The Management Company has 3 employees engaged in
managing the Hotels. The Initial Lessee and the Management Company will continue
the Management Group's ongoing recruiting efforts to attract quality talent at
all levels of sales and management.
None of the persons employed by the Trust, the Initial Lessee or the Management
Company are represented by a union. The Trust believes that its, the Initial
Lessee's and the Management Company's relations with their respective employees
are excellent.
LEGAL PROCEEDINGS
None of the Trust, the Initial Lessee, the Management Company or the Operating
Partnership are currently involved in any material litigation nor, to the
Trust's knowledge, is any material litigation currently threatened against them.
DESCRIPTION OF CAPITAL STOCK OF THE TRUST
The authorized capital stock of the Trust consists of an unlimited number of
Common Shares. The following summary description does not purport to be complete
and is qualified in its entirety by reference to the Trust's Declaration. See
"CERTAIN DECLARATION OF TRUST AND STATUTORY PROVISIONS."
COMMON SHARES
Under the Declaration, the Trust has authority to issue an unlimited number of
Common Shares. Under Ohio law, shareholders generally are not responsible for a
corporation's debts or obligations. At October 31, 1998, the Trust had
outstanding 2,216,905 Common Shares. In addition, 2,664,933 Common Shares are
issuable upon conversion of outstanding Class A Units of the Operating
Partnership. Upon completion of this offering and giving effect to the Corporate
Structure Transactions, the Trust will have 2,738,968 Common Shares issued and
outstanding (3,038,968 if the Underwriter fully exercises its over-allotment
option).
Shareholders are entitled to one vote per share on all matters subject to a vote
of the shareholders, including the election of Trustees. The Trust's Declaration
does not provide for cumulative voting in the election of Trustees. Matters
subject to a vote by the shareholders, including the election of Trustees,
generally require the affirmative vote of a majority of the outstanding Common
Shares present in person or by proxy at a stockholder's meeting. Amendments to
the Declaration require the affirmative vote of two-thirds of the outstanding
Common Shares whether or not present in person or by proxy at a stockholder's
meeting. Except as otherwise required by law, the holders of Common Shares
exclusively possess all voting power.
The Company's Board of Trustees is divided into three classes, comprised of two
Trustees each, which have staggered three-year terms. At least two years would
be required in order to change the membership of a majority of the Board of
Trustees.
In order to maintain its REIT qualification, the Trust must make annual
distributions to shareholders of at least 95% of its REIT taxable income (which
does not include net capital
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gains). For the year ended January 31, 1998, the Trust had distributions
totaling $.15 per share, none of which was required to satisfy the 95% REIT
distribution test. Under certain circumstances, the Trust may be required to
make distributions in excess of cash available for distribution in order to meet
such REIT distribution requirements. In such event, the Trust presently would
expect to borrow funds, or to sell assets for cash, to the extent necessary to
obtain cash sufficient to make the distributions required to retain its
qualification as a REIT for federal income tax purposes.
On July 10, 1998, the Trust declared a dividend of $0.10 per Common Share paid
on August 31, 1998 to shareholders of record on August 10, 1998. After the
one-for-three reverse stock split, the Trust anticipates that it will maintain
at least a dividend rate of $1.20 per Common Share per year or $0.30 per Common
Share per quarter for the immediate future.
To the extent that cash flow from operations is insufficient during any quarter,
due to temporary or seasonal fluctuations in Percentage Lease revenue, the Trust
expects to utilize other cash on hand or borrowings under the credit facility to
make such distributions. No assurance can be given, however, that the Trust will
make distributions in the future at the current rate, or at all.
The timing and amount of future distributions, if any, made by the Trust will be
determined by the Board of Trustees and will depend on a number of factors,
including the amount of cash available for distribution, funds available from
operations, the Trust's financial condition, capital expenditure requirements
for the Trust's properties, the annual distribution requirements under the REIT
provisions of the Code and such other factors as the Board of Trustees may deem
relevant.
Shareholders are entitled to such dividends, if any, as may be declared from
time to time by the Board of Trustees from funds legally available therefor and,
upon liquidation, are entitled to receive, pro rata, all assets of the Trust
available for distribution to such shareholders. All Common Shares are or, when
issued upon conversion of Units, will be fully paid and nonassessable and will
have no preemptive rights.
The primary source of proceeds to be used for distributions to shareholders is
the Trust's share of the rents due pursuant to the Percentage Leases. The
anticipated revenue may or may not be realized or collected. Accordingly, the
statements set forth above with regard to distributions are forward-looking
statements involving certain risks and uncertainties that could cause actual
results to differ materially from those expressed in such statements. Important
factors that could cause such different results include, but are not limited to,
competition from other hotels, increases in operating costs, seasonality effects
in hotel occupancy and revenues, and the potential loss of a franchise or liquor
license in respect of any Hotel or acquired hotel. See "FORWARD-LOOKING
STATEMENTS."
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MARKET FOR THE TRUST'S COMMON SHARES AND RELATED SECURITY HOLDER MATTERS
The following table sets forth, for the periods indicated, the high and low
sales prices of the Trust's Common Shares, as quoted by the NYSE, as well as
dividends declared thereon:
<TABLE>
<CAPTION>
HIGH LOW DIVIDENDS
---- ---- ---------
<S> <C> <C> <C>
FISCAL YEAR 1999
First Quarter.......................................... 4 3/8 4 1/8 --
Second Quarter......................................... 5 3/16 4 1/4 .10
Third Quarter.......................................... 5 1/2 3 3/4 --
FISCAL YEAR 1998
First Quarter.......................................... 5 3/8 4 1/2 .10
Second Quarter......................................... 4 7/8 4 3/8 .05
Third Quarter.......................................... 5 4 5/8 --
Fourth Quarter......................................... 4 11/16 4 1/4 --
FISCAL YEAR 1997
First Quarter.......................................... 7 1/4 5 3/4 .10
Second Quarter......................................... 6 5 3/8 .10
Third Quarter.......................................... 6 5 3/8 .10
Fourth Quarter......................................... 5 5/8 4 7/8 .10
</TABLE>
RESTRICTIONS ON OWNERSHIP AND TRANSFER
The Common Shares are subject to certain restrictions upon the ownership and
transfer thereof that were adopted for the purpose of enabling the Trust to
preserve its REIT status. For a description of such restrictions, see "CERTAIN
DECLARATION OF TRUST AND STATUTORY PROVISIONS."
EXCHANGE LISTING
The Trust's Common Shares are listed on the NYSE under the symbol "IHT."
TRANSFER AGENT
The transfer agent and registrar for the Common Shares is National City Bank,
Cleveland, Ohio.
MANAGEMENT OF THE TRUST
TRUSTEES AND EXECUTIVE OFFICERS
The Board of Trustees of the Trust currently consists of six members, three of
whom are independent Trustees.
The Board of Trustees is presently divided into three classes, comprised of two
Trustees each. Trustees are elected to staggered three year terms. The
Declaration provides that, subject to any rights of holders of preferred stock,
if any, and unless the Board of Trustees otherwise determines, any vacancies
will be filled by the affirmative vote of a majority of the remaining Trustees,
though less than a quorum. Accordingly, the Board of Trustees could temporarily
prevent any stockholder from enlarging the Board of Trustees and filling the new
Trusteeships with such stockholder's own nominees. Any Trustee so elected shall
hold office until the next annual meeting of shareholders.
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Executive officers of the Trust are elected and serve at the discretion of the
Board of Trustees until their successors are duly chosen and qualified.
The following table sets forth certain information concerning the individuals
who are Trustees and executive officers of the Trust.
<TABLE>
<CAPTION>
POSITION AND PRINCIPAL OCCUPATIONS
NAME DURING PAST FIVE YEARS
---- ------------------------------------------------------------
<S> <C>
James F. Trustee, Chairman, President and Chief Executive Officer of
Wirth........... the Trust since January 30, 1998. Chairman and President of
InnSuites Hotels, L.L.C., and affiliated entities, owners
and operators of hotels since 1980; Chairman and President
of Rare Earth Development Company, a real estate development
and investment company, since 1973. Age: 52.
Gregory D. Trustee, Executive Vice President, Chief Financial Officer,
Bruhn........... Treasurer and Secretary of the Trust since January 30, 1998.
Executive Vice President and Chief Financial Officer of
First Union Real Estate Mortgage and Equity Investments, a
real estate investment trust, from 1994 through 1996;
Executive Vice President, Real Estate Industries Division,
Bank of America from 1992 through 1994. Age: 50.
Marc E. Berg.... Trustee since January 30, 1998. Vice
President -- Acquisitions for the Trust since December 16,
1998. Vice President of the Initial Lessee since May 1,
1998. Self-employed as a registered investment advisor since
1985. Age: 46
Lee J. Flory.... Trustee since January 30, 1998. Vice President, Secretary
and Director of The Grainger Foundation, Inc., a private
charitable organization, since 1972. From 1969 until his
retirement in 1991, Vice President and Secretary of W.W.
Grainger, Inc., the leading North American distributor of
maintenance, repair and operating supplies. Age: 72.
Edward G. Trustee since January 30, 1998. President of ABCO Foods, a
Hill............ division of Fleming Companies, Inc., an owner and operator
of grocery stores, since 1984. Mr. Hill retired from this
position on April 30, 1998. Age: 54.
Steven S. Trustee since June 16, 1998. President of Robson Communities
Robson.......... and President of Scott Homes and Scott Homes Multifamily,
Inc., residential real estate developers, since 1979. Age:
42.
</TABLE>
AUDIT COMMITTEE
The Audit Committee consists of the three independent Trustees, Messrs. Flory,
Hill and Robson. The Audit Committee makes recommendations concerning the
engagement of independent public accountants, approves professional services
provided by the Trust's independent public accountants, and reviews, with the
independent public accountants, the plans and results of the audit engagement,
the independent public accountants' letter of comments and management's
responses, the adequacy of the Trust's internal accounting controls and major
accounting or reporting changes.
COMPENSATION COMMITTEE
The Compensation Committee consists of the three independent Trustees, Messrs.
Flory, Hill and Robson. The Compensation Committee determines the compensation
of senior management, advises the Board of Trustees on the adoption and
administration of employee
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benefit and compensation plans, and administers the Trust's 1997 Stock Incentive
and Option Plan.
EXECUTIVE COMPENSATION
The following table sets forth the annual base compensation expected to be paid
for the fiscal year ending January 31, 2000, to the Chief Executive Officer and
to each of the other executive officers or significant employees of the Trust
whose annual salary will exceed $100,000.
<TABLE>
<CAPTION>
NAME POSITION SALARY
- ---- ---------------------------------- ----------
<S> <C> <C>
James F. Wirth.................... Chairman, President and Chief $160,000
Executive Officer
Gregory D. Bruhn.................. Executive Vice President, Chief $160,000
Financial Officer, Treasurer and
Secretary
</TABLE>
The Trust will pay Gregory D. Bruhn a "termination fee" of $50,000 upon the
termination of his employment for any reason. This fee is to be paid to Mr.
Bruhn over 10 months at $5,000 per month following his termination. The
termination fee expires following his 12th year of service. Mr. Bruhn would also
receive one month's salary for each full and partial year of service up to a
maximum of 12 months salary for 12 years of service.
COMPENSATION OF TRUSTEES
The Trust pays Trustee's fees to each Trustee, other than Messrs. Wirth, Bruhn
and Berg, in the amount of $12,000 per year.
STOCK INCENTIVE AND OPTION PLAN
The shareholders of the Trust have adopted the 1997 Stock Incentive and Option
Plan (the "Plan"). The objective of the Plan is to reward performance and build
each participant's equity interest in the stock of the Trust by providing long
term incentives and rewards to Trustees and officers and other key employees,
consultants and advisers of the Trust and its subsidiaries and affiliates who
contribute to its continuing success by their innovation, ability, industry,
loyalty and exceptional service. The Plan provides for the grant of options
(which may be "incentive stock options", within the meaning of Section 422 of
the Code, or non-qualified stock options), stock appreciation rights, restricted
stock and performance awards.
The Plan is administered by the Compensation Committee, which determines the
participants to whom stock incentives will be granted, the type and amount of
stock incentives to be granted and the terms and conditions of stock incentives
under the Plan, including any applicable performance goals. The Committee
interprets the Plan and is authorized to make all determinations and decisions
thereunder.
The Plan limits the total number of Common Shares as to which options, stock
appreciation rights, restricted stock and performance awards may be granted
under the Plan in any calendar year to 10% of the total outstanding Common
Shares and Units (Class A and Class B) as of the first day of such year.
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CERTAIN TRANSACTIONS BY THE TRUST
Mr. Wirth derives, and in the future will derive, benefits from the operation of
the Trust's hotel properties by the Initial Lessee and the Management Company,
and the management of the Trust's hotel properties by, and the license
agreements with, the Management Company. Mr. and Mrs. Wirth are 100% owners of
the Management Company, which is, in turn, the owner of 9.8% of the outstanding
common stock of the Initial Lessee. The Trust has leased each of its hotel
properties to the Initial Lessee under the Percentage Leases. The Initial Lessee
has contracted for certain property management services and certain trademark
and licensing services with the Management Company. The Management Company will
receive an annual management fee of 2.5% of gross room revenues for its property
management services and an annual licensing fee of 2.5% of gross room revenues
(1.25% for those hotel properties which also carry a third-party franchise, such
as Best Western or Holiday Inn) for its trademark and licensing services. Such
fees were determined through arms-length negotiations between the Trust and the
Initial Lessee and the Management Company. The Trust believes that such fees are
commercially reasonable.
The Operating Partnership will use approximately $645,000 of the net proceeds of
this offering to repay loans made to the Operating Partnership by the Management
Group.
Approximately $5.9 million of the mortgage indebtedness to be paid by the
Operating Partnership from the net proceeds of this offering is guaranteed by
Mr. Wirth.
The Operating Partnership will issue limited partnership units to the Trust in
exchange for the contribution by the Trust of the Scottsdale Hotel to the
Operating Partnership. See "THE TRUST -- CORPORATE STRUCTURE TRANSACTIONS".
Certain Trustees also hold both Class A and Class B limited partner Units in the
Operating Partnership, and, as a result, may personally, as limited partners,
benefit from the less than market consideration having been furnished to the
Trust by the Operating Partnership. The Trust believes that the consideration
furnished for such contribution was fair. This transaction was approved by the
independent Trustees.
The Operating Partnership will issue 118,479 Class B Units and assume
approximately $.45 million in debt in connection with the termination of the
advisory agreement with MARA. Mr. and Mrs. Wirth are 100% owners of MARA. The
Trust believes that the total consideration for the transaction was fair. This
transaction was approved by the independent Trustees.
The Intercompany Agreement between the Trust, Operating Partnership and
Management Company provides certain rights to the Management Company, including
a right of first refusal to lease future hotels acquired by the Trust. See
"INNSUITES INNTERNATIONAL HOTELS, INC. -- INTERCOMPANY AGREEMENT". Mr. and Mrs.
Wirth are 100% owners of the Management Company. The Trust believes that the
terms of the Intercompany Agreement are commercially reasonable. The
Intercompany Agreement was approved by the independent Trustees.
The Percentage Leases between the Operating Partnership and the Initial Lessee
were not negotiated in arms-length transactions. Mr. and Mrs. Wirth are the
indirect owners of 9.8% of the common stock of the Initial Lessee. The Trust
believes that the Percentage Leases are commercially reasonable. The Percentage
Leases were approved by the independent Trustees.
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<PAGE> 94
CERTAIN DECLARATION OF TRUST AND STATUTORY PROVISIONS
RESTRICTIONS ON OWNERSHIP AND TRANSFER
For the Trust to qualify as a REIT under the Code, it must meet certain
requirements concerning the ownership of its outstanding capital stock.
Specifically, not more than 50% in value of the Trust's outstanding capital
stock may be owned, actually and constructively under the applicable attribution
provisions of the Code, by five or fewer individuals (as defined in the Code to
include certain entities) during the last half of a taxable year (other than the
first year), and the Trust must be beneficially owned by 100 or more persons
during at least 335 days of a taxable year (other than the first year) or during
a proportionate part of a shorter taxable year. See "FEDERAL INCOME TAX
CONSIDERATIONS RELATED TO THE TRUST -- REQUIREMENTS FOR QUALIFICATION." For the
purpose of preserving the Trust's REIT qualification, the Trust's Declaration
contains the "Ownership Limitation Provisions," which restrict the ownership and
transfer of the Trust's capital stock under certain circumstances.
The Ownership Limitation Provisions provide that, subject to certain exceptions
specified in the Declaration, no person may own, or be deemed to own by virtue
of the applicable attribution provisions of the Code, more than 4.9% of any
class of the Trust's outstanding capital stock. The Board of Trustees may, but
in no event will be required to, waive the Ownership Limit if it determines that
such ownership will not jeopardize the Trust's REIT status. As a condition of
such waiver, the Board of Trustees may require opinions of counsel satisfactory
to it and/or undertakings or representations from the applicant with respect to
preserving the Trust's REIT status. The Ownership Limitation Provisions will not
apply if the Board of Trustees determines that it is no longer in the best
interests of the Trust to attempt to qualify, or to continue to qualify, as a
REIT.
Any purported transfer of capital stock of the Trust and any other event that
would otherwise result in any person or entity violating the Ownership Limit
will be void and of no force or effect as to that number of shares in excess of
the Ownership Limit. In addition, if any purported transfer of capital stock of
the Trust or any other event otherwise would cause the Trust to become "closely
held" under the Code or otherwise fail to qualify as a REIT under the Code
(other than as a result of a violation of the requirement that a REIT have at
least 100 shareholders), then any such purported transfer will be void and of no
force or effect as to that number of shares in excess of the number that could
have been transferred without such result. Also, if any purported transfer of
capital stock of the Trust or any other event would otherwise cause the Trust to
own, or be deemed to own by virtue of the applicable attribution provisions of
the Code, 10% or more of the ownership interests in the Initial Lessee, the
Management Company or in any sublessee, then any such purported transfer will be
void and of no force or effect as to that number of shares in excess of the
number that could have been transferred without such result. In each of those
cases, the prohibited transferee shall acquire no right or interest (or, in the
case of any event other than a purported transfer, the person or entity holding
record title to any such shares in excess of the Ownership Limit shall cease to
own any right or interest) in such excess shares.
Any such excess shares described above will be transferred automatically, by
operation of law, to a trust, the beneficiary of which will be a qualified
charitable organization selected by the Trust ("Beneficiary"). The trustee of
the trust, who shall be designated by the Trust and be unaffiliated with the
Trust and any prohibited transferee, will be empowered to sell such excess
shares to a qualified person or entity and distribute to the prohibited
transferee an
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amount equal to the lesser of the price paid by the prohibited transferee for
such excess shares or the sales proceeds received by the trust for such excess
shares. In the case of any excess shares resulting from any event other than a
transfer, or from a transfer for no consideration, the trustee will be empowered
to sell such excess shares to a qualified person or entity and distribute to the
prohibited transferee an amount equal to the lesser of the fair market value of
such excess shares on the date of such event or the sales proceeds received by
the trust for such excess shares. Prior to a sale of any such excess shares by
the trust, the trustee will be entitled to receive, in trust for the benefit of
the Beneficiary, all dividends and other distributions paid by the Trust with
respect to such excess shares, and also will be entitled to exercise all voting
rights with respect to such excess shares.
Any purported transfer of capital stock of the Trust that would otherwise cause
the Trust to be beneficially owned by fewer than 100 persons will be null and
void in its entirety, without regard to the number of shares, and the intended
transferee will acquire no rights in such shares.
All certificates representing shares of capital stock will bear a legend
referring to the restrictions described above.
Every owner of more than 4.9% (or such lower percentage as may be required by
the Code or Treasury Regulations) of the outstanding shares of capital stock of
the Trust must file a written notice with the Trust containing the information
specified in the Declaration no later than January 30 of each year. In addition,
each shareholder shall upon demand be required to disclose to the Trust in
writing such information as the Trust may request in order to determine the
effect on the Trust's REIT status, if any, of such shareholder's actual and
constructive ownership and to ensure compliance with the Ownership Limit.
The Ownership Limitation Provisions may have the effect of precluding an
acquisition of control of the Trust without approval of the Board of Trustees.
NUMBER OF TRUSTEES; REMOVAL; FILLING VACANCIES
The Declaration provides that the Board of Trustees consist of not less than
five persons, subject to increase by the affirmative vote of a majority of the
members of the entire Board of Trustees. At all times a majority of the Trustees
shall be independent Trustees, except that upon the death, removal or
resignation of an independent Trustee, such requirement shall not be applicable
for sixty (60) days. Currently, there are six Trustees, three of whom are
independent Trustees. The shareholders shall be entitled to vote on the election
of Trustees, with each share entitled to one vote. The Board of Trustees is
presently divided into three classes, comprised of two Trustees each. Trustees
are elected to staggered three year terms. Any Trustee may be removed for cause
by the vote of two-thirds of the remaining Trustees. The Declaration provides
that, subject to any rights of holders of preferred stock, if any, and unless
the Board of Trustees otherwise determines, any vacancies will be filled by the
affirmative vote of a majority of the remaining Trustees, though less than a
quorum. Any Trustee so elected may qualify as an independent Trustee only if he
has received the affirmative vote of at least a majority of the remaining
independent Trustees, if any. Accordingly, the Board of Trustees could
temporarily prevent any shareholder from enlarging the Board of Trustees and
filling the new Trusteeships with such shareholder's own nominees. Any Trustee
so elected shall hold office until the next annual meeting of shareholders.
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<PAGE> 96
LIMITATION OF LIABILITY
The Declaration provides that to the maximum extent that Ohio law in effect from
time to time permits the limitation of liability of Trustees and officers, no
Trustee or officer of the Trust shall be liable to the Trust or its shareholders
for money damages.
INDEMNIFICATION OF TRUSTEES AND OFFICERS
The Declaration and Bylaws require the Trust to indemnify its Trustees,
officers, employees and agents to the fullest extent permitted from time to time
by Ohio law. Ohio law permits a corporation to indemnify its trustees, officers,
employees and agents against judgments, penalties, fines, settlements and
reasonable expenses (including attorneys fees) actually incurred by them in
connection with any proceeding to which they may be made a party by reason of
their service to or at the request of the corporation, unless it is established
that (i) the act or omission of the indemnified party was material to the matter
giving rise to the proceeding and the act or omission was committed in bad faith
or was the result of active and deliberate dishonesty, (ii) the indemnified
party actually received an improper personal benefit in money, property or
services, or (iii) in the case of any criminal proceeding, the indemnified party
had reasonable cause to believe that the act or omission was unlawful.
Indemnification is mandatory if the indemnified party has been successful on the
merits or otherwise in the defense of any proceeding unless such indemnification
is not otherwise permitted as provided in the preceding sentence. In addition to
the foregoing, a court of competent jurisdiction, under certain circumstances,
may order indemnification if it determines that the indemnified party is fairly
and reasonably entitled thereto in view of all the relevant circumstances,
unless the proceeding was an action by or in the right of the corporation or
involved a determination that the indemnified party received an improper
personal benefit.
AMENDMENT
The Declaration may be amended by the affirmative vote of the holders of
two-thirds of the outstanding Common Shares, with the shareholders voting as a
class with one vote per share.
PARTNERSHIP AGREEMENT
The following summary of the Partnership Agreement, and the descriptions of
certain provisions thereof set forth herein, are qualified in their entirety by
reference to the Partnership Agreement, which is an exhibit to the Registration
Statement of which this Prospectus is a part.
MANAGEMENT
The Operating Partnership is a Delaware limited partnership and was formed
pursuant to the terms of the Partnership Agreement. Pursuant to the Partnership
Agreement, the Trust, as the sole general partner of the Operating Partnership,
has full, exclusive and complete responsibility and discretion in the management
and control of the Operating Partnership, and the limited partners of the
Operating Partnership have no authority to transact business for, or participate
in the management activities or decisions of, the Operating Partnership.
However, any amendment to the Partnership Agreement that would (i) affect the
conversion rights described under "-- CONVERSION RIGHTS" below, (ii) adversely
affect the limited partners' rights to receive cash distributions, (iii) alter
the Operating Partnership's allocations of
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income, or (iv) impose on the limited partners any obligations to make
additional contributions to the capital of the Operating Partnership, requires
the consent of the limited partners holding at least a majority of the Class A
and Class B Units.
TRANSFERABILITY OF INTERESTS
The Trust may not voluntarily withdraw from the Operating Partnership or
transfer or assign its interest in the Operating Partnership unless the
transaction in which such withdrawal or transfer occurs results in the limited
partners receiving property in an amount equal to the amount they would have
received had they exercised their conversion rights immediately prior to such
transaction, or unless the successor to the Trust contributes substantially all
of its assets to the Operating Partnership in return for an interest in the
Operating Partnership. The limited partners may not transfer their interests in
the Operating Partnership without the consent of the Trust, which the Trust may
withhold in its sole discretion. The Trust may not consent to any transfer that
would cause the Operating Partnership to be treated as a separate corporation
for federal income tax purposes.
CAPITAL CONTRIBUTIONS
The Trust and the limited partners contributed cash or interests in certain of
the Hotels to the Operating Partnership in exchange for partnership interests in
the Operating Partnership. As required by the Partnership Agreement, immediately
prior to a capital contribution by the Trust, all partners' capital accounts and
the carrying value of the Operating Partnership property shall be adjusted to
reflect the unrealized gain or loss attributable to the Operating Partnership
property as if such gain or loss had actually been recognized immediately prior
to such contribution and had been allocated to the partners at such time.
The Partnership Agreement provides that if the Operating Partnership requires
additional funds at any time or from time to time in excess of funds available
to the Operating Partnership from borrowing or capital contributions, the Trust
may borrow such funds from a financial institution or other lender and lend such
funds to the Operating Partnership on the same terms and conditions as are
applicable to the Trust's borrowing of such funds. As an alternative to
borrowing funds required by the Operating Partnership, the Trust may contribute
the amount of such required funds as an additional capital contribution to the
Operating Partnership. If the Trust so contributes additional capital to the
Operating Partnership, the Trust will receive additional partnership interests
in the Operating Partnership. As a result, the Trust's percentage interest in
the Operating Partnership will be increased on a proportionate basis with the
amount of such additional capital contributions and the value of the Operating
Partnership at the time of such contributions. Conversely, the percentage
interests of the limited partners will be decreased on a proportionate basis in
the event of additional capital contributions by the Trust.
The Operating Partnership may also issue additional limited partnership units in
exchange for hotel properties. Such additional limited partnership units may
reduce distributions to and the ownership interests of the partners in the
Operating Partnership.
CONVERSION RIGHTS
Pursuant to the Partnership Agreement, the limited partners holding Class A
Units may cause the Operating Partnership to convert their interests in the
Operating Partnership (subject to certain restrictions) into Common Shares. To
the extent that the "Ownership Limit"
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contained in the Trust's Declaration is reached, the Trust may elect to purchase
any Class A Units in excess of the Ownership Limit for cash. The conversion
rights may not be exercised if the issuance of Common Shares by the Trust, as
general partner, for any part of the interest in the Operating Partnership
sought to be converted would (i) result in any person violating the Ownership
Limit, (ii) cause the Trust to be "closely held" within the meaning of the Code,
(iii) cause the Trust to be treated as owning 10% or more of the Initial Lessee,
the Management Company or any sublessee within the meaning of the Code, or (iv)
otherwise cause the Trust to fail to qualify as a REIT; unless, in any case, the
Operating Partnership or the Trust (as the case may be) elects, in its sole and
absolute discretion, to pay the conversion amount in cash.
The conversion rights may be exercised by the limited partners, in whole or in
part (in either case, subject to the above restrictions), at any time or from
time to time, following the satisfaction of any applicable holding period
requirements. At October 31, 1998, the aggregate number of Common Shares
issuable upon exercise of the conversion rights by the limited partners was
888,311. The number of shares issuable upon the exercise of the conversion
rights will be adjusted upon the occurrence of stock splits, mergers,
consolidations or similar pro rata share transactions, which otherwise would
dilute the ownership interests of the limited partners or the shareholders of
the Trust. Class B Units are convertible only upon the approval of the Trust's
Board of Trustees.
TAX MATTERS
Pursuant to the Partnership Agreement, the Trust is the tax matters partner of
the Operating Partnership and, as such, has authority to make tax elections
under the Code on behalf of the Operating Partnership.
Profit and loss of the Operating Partnership generally are allocated among the
partners in accordance with their respective interests in the Operating
Partnership based on the number of partnership interests held by the partners.
OPERATIONS
The Partnership Agreement requires the Operating Partnership to operate in a
manner that enables the Trust to satisfy the REIT classification requirements
and to avoid any federal income tax liability.
DISTRIBUTIONS
The Partnership Agreement provides that the Operating Partnership will
distribute cash from operations (including net sale or refinancing proceeds, but
excluding net proceeds from the sale of the Operating Partnership's property in
connection with the liquidation of the Operating Partnership) quarterly, in
amounts determined by the Trust in its sole discretion, to the Partners in
accordance with their respective percentage interests in the Operating
Partnership. Upon liquidation of the Operating Partnership, and after payment
of, or adequate provision for, debts and obligations of the Operating
Partnership, including any partner loans, any remaining assets of the Operating
Partnership will be distributed to all partners with positive capital account
balances in accordance with those balances.
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TERM
The Operating Partnership will continue until December 31, 2047, or until sooner
dissolved upon (i) the bankruptcy, dissolution or withdrawal of the Trust as
general partner (unless the limited partners elect to continue the Operating
Partnership), (ii) the sale or other disposition of all or substantially all the
assets of the Operating Partnership, (iii) the conversion of all limited
partnership interests in the Operating Partnership (other than those held by the
Trust, if any), or (iv) the election of the general partner.
POLICIES AND OBJECTIVES WITH RESPECT
TO CERTAIN ACTIVITIES BY THE TRUST
The following supplements the discussion of the Trust's growth, acquisition,
development and financing strategies under the heading "THE TRUST." The Trust's
policies with respect to those activities and the matters discussed below have
been established by the Board of Trustees of the Trust and may be amended or
revised from time to time at the discretion of the Board of Trustees without a
vote of the shareholders of the Trust, except that changes in certain policies
with respect to conflicts of interest must be consistent with legal
requirements.
INVESTMENT POLICIES
Short-Term Investments. Prior to making any acquisitions and during the periods
between the receipt of revenues and their distribution to you, we will invest
our liquid assets, including any unused proceeds of this offering, in certain
short-term investments. These may include:
- - interest-bearing bank accounts;
- - certificates of deposit;
- - short-term money-market securities;
- - short-term government securities;
- - mortgage-backed securities guaranteed by the Government National Mortgage
Association;
- - mortgages insured by the Federal Housing Administration or guaranteed by the
Veterans Administration; or
- - mortgage loan participations purchased from banks or other financial
institutions.
We may also invest in other similar types of instruments. While we reserve the
right to invest in these types of securities, we have no immediate plans to do
so.
Investments in Real Estate. The Trust may acquire equity interests in hotel
properties other than the Hotels through the Operating Partnership or other
entities controlled by the Operating Partnership, or through joint ventures or
other types of co-ownership. These investments may be subject to existing
mortgage financing and other indebtedness that may have priority over the equity
interest of the Trust.
The Trust's current policy is to not invest more than 25% of its total assets
(at the time of the investment) in any one property.
Investments in Real Estate Mortgages. While the Trust will continue to emphasize
equity real estate investments, it may invest in mortgage and other real estate
interests, including
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securities of other REITs, and in nonperforming mortgages in order to acquire
the underlying property. The Trust may invest in participating or convertible
mortgages (which are similar to equity participation) if it may benefit from the
cash flow or any appreciation in the value of the subject property. The Trust
does not currently intend to invest in mortgages or securities of other REITs.
FINANCING
While its organizational documents do not contain limitations on the amount of
debt it may incur, the Trust, subject to the discretion of the Board of
Trustees, intends to maintain a debt to total market capitalization ratio or
debt to appraised value of real estate ratio (measured at the time the debt is
incurred) of not more than 50% to 55%. The Trust may from time to time
re-evaluate its debt capitalization policy in light of economic conditions,
relative costs of debt and equity capital, market value of its properties,
acquisition, development and expansion opportunities, and other factors.
Any indebtedness may be incurred by the Operating Partnership or the Trust.
Indebtedness incurred by the Trust may be in the form of bank borrowings,
secured or unsecured, and publicly or privately placed debt instruments, the
proceeds of which would be loaned or contributed to the Operating Partnership.
Indebtedness incurred by the Operating Partnership may be in the form of
purchase money obligations to the sellers of properties, publicly or privately
placed debt instruments, further borrowings from the Trust, or financing from
banks, institutional investors or other lenders, any of which indebtedness may
be unsecured or may be secured by mortgages or other interests in the property
owned by the Operating Partnership. This indebtedness may be recourse to all or
any part of the property of the Trust or the Operating Partnership, or may be
limited to the specific property to which the indebtedness relates. The proceeds
from any borrowings by the Trust or the Operating Partnership may be used for
the payment of distributions or dividends, for working capital, or to refinance
existing indebtedness or to finance acquisitions or expansions of properties.
See "FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE TRUST -- REQUIREMENTS FOR
QUALIFICATION" and "-- DISTRIBUTION REQUIREMENTS."
If the Board of Trustees determines to raise additional equity capital, the
Board has the authority, without shareholder approval, to issue additional
Common Shares or other capital stock, including preferred stock, of the Trust in
any manner and on such terms and for such consideration it deems appropriate,
including in exchange for hotels or other assets, provided that the Trust
contributes the consideration received by it to the Operating Partnership in
exchange for units or other comparable securities of the Operating Partnership.
Holders of Common Shares issued in this offering will not have any preemptive
right to purchase Common Shares or other securities issued in any such
additional offering, and any such offering would cause a dilution of a
shareholder's investment in the Trust. See "DESCRIPTION OF CAPITAL STOCK OF THE
TRUST." The Trust may also cause the Operating Partnership to issue additional
Class A Units or other partnership interests, including in exchange for hotels
or other assets. These Class A Units or other interests may also be exchangeable
into Common Shares or preferred stock of the Trust, further diluting a
shareholder's investment in the Trust.
See "THE TRUST -- BUSINESS STRATEGY -- FINANCING STRATEGY" for a description of
the terms of the Trust's credit facility.
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POLICIES WITH RESPECT TO CERTAIN OTHER ACTIVITIES
The Trust has authority to offer capital shares or other securities and to
repurchase or otherwise reacquire its shares or any other securities, and may
engage in such activities in the future. The Trust has no outstanding loans to
other entities or persons, including its officers and directors, and except as
described above under " -- INVESTMENT POLICIES," does not currently intend to
make loans to other entities. The Trust has not engaged, and does not currently
intend to engage, in trading, underwriting or agency distribution or sale of
securities of other issuers, and has not invested, and does not currently intend
to invest, in the securities of other issuers (other than the Operating
Partnership or in connection with the acquisition of hotel properties) for the
purpose of exercising control. The Trust intends to make investments in such a
way that it will not be treated as an investment company under the Investment
Company Act of 1940.
The Trust intends to make investments at all times in a manner consistent with
the requirements of the Code in order for the Trust to maintain its REIT
qualification unless, because of changing circumstances or changes in the Code,
in Treasury Regulations or in the interpretations of either, the Trust's Board
of Trustees determines that it is no longer in the best interests of the Trust
and its shareholders to qualify as a REIT.
CONFLICT OF INTEREST POLICY
Neither the Trust's governing instruments nor Trust policy prohibit any Trustee,
officer, shareholder or affiliate from having a pecuniary interest in any
investment to be acquired or disposed of by the Trust or in any transaction to
which the Trust is a party or in which it has an interest.
Determinations to be made on behalf of the Trust with respect to relationships
or opportunities that represent a conflict of interest for any officer or
Trustee as such will be subject to the approval of the independent Trustees. See
"RISK FACTORS RELATED TO THE TRUST -- RISK OF CONFLICTS OF INTEREST." In
addition, Mr. Wirth and the other affiliates of InnSuites Hotels have agreed
that they will conduct all of their hotel ownership, development and acquisition
activities through the Trust.
The Partnership Agreement requires the Trust to resolve in favor of the Trust's
shareholders any conflict of interest between those shareholders, on the one
hand, and the limited partners of the Operating Partnership, on the other hand,
if the conflict cannot be resolved in a manner not adverse to the interests of
either group. The Partnership Agreement also exonerates the Trust from monetary
damages for losses sustained, liabilities incurred or benefits not derived by
limited partners in connection with any such resolution, so long as the Trust
has acted in good faith.
SHARES AVAILABLE FOR FUTURE SALE BY THE TRUST
GENERAL
Upon completion of this offering, the Trust will have outstanding 2,738,968
Common Shares (3,038,968 if the Underwriter fully exercises its over-allotment
option). The Common Shares issued in this offering will be freely tradeable by
persons other than "affiliates" of the Trust, as that term is defined under the
Securities Act, subject to the limitations on ownership set
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forth in the Declaration. See "CERTAIN DECLARATION OF TRUST AND STATUTORY
PROVISIONS -- RESTRICTIONS ON OWNERSHIP AND TRANSFER."
The Trust has filed, and the Securities and Exchange Commission ("SEC") has
declared effective, a registration statement with respect to 2,771,443 Class A
Units of the Operating Partnership, which are convertible, at the option of the
holders thereof, into Common Shares. In addition, there are 1,765,947 Class B
units of the Operating Partnership outstanding. Such Class B units are
convertible into Common Shares only with the approval of the Trust's Board of
Trustees.
No prediction can be made as to the effect, if any, that future sales of Common
Shares, or the availability of Common Shares for future sale, will have on the
market price prevailing from time to time. Sales of substantial amounts of
Common Shares (including Common Shares issued upon the exercise of stock
options), or the perception that such sales may occur, could adversely affect
prevailing market prices of the Common Shares. See "RISK FACTORS RELATED TO THE
MANAGEMENT COMPANY -- ABSENCE OF A PUBLIC MARKET FOR SHARES."
Pursuant to the Underwriting Agreement between the Trust and the Underwriter,
the Trust has agreed, subject to certain limited exceptions, not to offer, sell,
contract to sell, pledge or otherwise transfer any Common Shares (or any
convertible securities or interests convertible into or exercisable or
exchangeable for Common Shares) for a period of [180] days after this offering
without the prior written consent of the Underwriter.
For a description of certain restrictions on transfers of Common Shares held by
certain shareholders of the Trust, see "UNDERWRITING."
FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE TRUST
The following is a summary of the material federal income tax considerations
relevant to a prospective shareholder. The partnerships in which the Operating
Partnership has made an investment are collectively referred to herein as the
"Subsidiary Partnerships." The discussion does not purport to deal with all
aspects of taxation that may be relevant to a shareholder in light of their
personal investment or tax circumstances, or to certain types of shareholders
(including insurance companies, tax-exempt organizations, financial institutions
or broker-dealers, foreign corporations, and persons who are not citizens or
residents of the United States) subject to special treatment under the federal
income tax laws.
YOU ARE ADVISED TO CONSULT YOUR OWN TAX ADVISOR REGARDING THE SPECIFIC TAX
CONSEQUENCES TO YOU OF THE PURCHASE, OWNERSHIP AND SALE OF COMMON SHARES AND OF
THE TRUST'S ELECTION TO BE TAXED AS A REIT, INCLUDING THE FEDERAL, STATE, LOCAL,
FOREIGN AND OTHER TAX CONSEQUENCES OF SUCH PURCHASE, OWNERSHIP, SALE AND
ELECTION, AND OF POTENTIAL CHANGES IN APPLICABLE TAX LAWS.
TAXATION OF THE TRUST
The Trust has made an election to be taxed as a REIT under Sections 856 through
860 of the Code. The Trust currently qualifies as a REIT and intends to continue
to operate in such manner, but no assurance can be given that the Trust will
continue to operate in a manner so as to remain qualified as a REIT.
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The sections of the Code relating to REIT qualification and operation are highly
technical and complex. The following discussion sets forth the material aspects
of the Code sections that govern the federal income tax treatment of a REIT and
its shareholders. The discussion is qualified in its entirety by the applicable
Code provisions, rules and regulations promulgated thereunder ("Treasury
Regulations"), and administrative and judicial interpretations thereof, all of
which are subject to change prospectively or retrospectively. Thompson Hine &
Flory LLP has acted as counsel to the Trust commencing January 30, 1998.
The Trust believes that it will continue qualifying as a REIT for its taxable
year ended January 31, 1998, and that its organization and current and proposed
operations will enable it to continue qualifying as a REIT for its taxable year
ended January 31, 1999 and in the future. The Trust has obtained an opinion of
Thompson Hine & Flory LLP as to its REIT qualifications beginning with its
fiscal year ended January 31, 1999. Investors should be aware, however, that
opinions of counsel are not binding upon the Service or any court. It must be
emphasized that the opinion of Thompson Hine & Flory LLP is based on various
assumptions and is conditioned upon certain representations made by the Trust as
to factual matters. These representations include the nature of the Trust's
properties and the future conduct of its business. Such factual assumptions and
representations are described below. Moreover, continued REIT qualification and
taxation depend upon the Trust's continuing ability to meet on a continuing
basis, through actual annual operating results, distribution levels, and stock
ownership, the various qualification tests imposed under the Code. These tests
are described below in further detail. Thompson Hine & Flory LLP will not review
the Trust's compliance with those tests on a continuing basis. Accordingly, no
assurance can be given that the actual results of the Trust's operation for any
particular taxable year will satisfy such requirements. For a discussion of the
tax consequences of failure to qualify as a REIT, see " -- FAILURE TO QUALIFY."
If the Trust continues to qualify for taxation as a REIT, it generally will not
be subject to federal corporate income taxes on its net income that is
distributed currently to the shareholders. That treatment substantially
eliminates the "double taxation" (i.e., taxation at both the corporate and
shareholder levels) that generally results from investment in a corporation.
However, the Trust will incur federal income tax in the following circumstances:
- - the Trust will be taxed at regular corporate rates on any undistributed REIT
taxable income, including undistributed net capital gains;
- - under certain circumstances, the Trust may be subject to the "alternative
minimum tax" under Section 55 of the Code;
- - if the Trust has (i) net income from the sale or other disposition of
"foreclosure property" that is held primarily for sale to customers in the
ordinary course of business or (ii) other nonqualifying income from
foreclosure property, it will be subject to tax at the highest corporate rate
on such income;
- - if the Trust has net income from prohibited transactions (generally, certain
sales or other dispositions of property (other than foreclosure property) held
primarily for sale to customers in the ordinary course of business), such
income will be subject to a 100% tax;
- - if the Trust should fail the 75% or 95% gross income tests (as discussed
below), and it nonetheless maintains its REIT qualification because certain
other requirements have been met, it will be subject to a 100% tax on the
greater of the amount by which the Trust fails the 75% or 95% gross income
tests;
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- - if the Trust fails to distribute during each calendar year at least the sum of
(i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT
capital gain net income for such year, and (iii) any undistributed taxable
income from prior periods, the Trust would be subject to a 4% excise tax on
the excess of such required distribution over the amounts actually
distributed; and
- - if the Trust makes an election pursuant to IRS Notice 88-19 and it acquires
any asset from a C corporation (i.e., a corporation generally subject to full
corporate-level tax) in a transaction in which the basis of the asset in the
Trust's hands is determined by reference to the basis of the asset (or any
other asset) in the hands of the C corporation and the Trust recognizes gain
on the disposition of that asset during the next ten years, then to the extent
of such asset's built-in gain (i.e., the excess of the fair market value of
such asset at the time of acquisition by the Trust over the adjusted tax basis
in such asset at such time), such gain will be subject to tax at the highest
regular corporate rate applicable (as provided in Treasury Regulations that
have not yet been promulgated).
REQUIREMENTS FOR QUALIFICATION
The Code defines a REIT as a corporation, trust or association:
- - that is managed by one or more trustees or directors;
- - the beneficial ownership of which is evidenced by transferable shares or by
transferable certificates of beneficial interest;
- - that would be taxable as a domestic corporation, but for Sections 856 through
860 of the Code;
- - that is neither a financial institution nor an insurance company subject to
certain provisions of the Code;
- - the beneficial ownership of which is held by 100 or more persons;
- - not more than 50% in value of the outstanding stock of which is owned,
directly or indirectly, by five or fewer individuals (as defined in the Code
to include certain entities) during the last half of each taxable year ("5/50
Rule");
- - that makes an election to be a REIT (or has made such election for a previous
taxable year) and satisfies all relevant filing and other administrative
requirements established by the Service that must be met in order to elect and
to maintain REIT status;
- - that uses a calendar year for federal income tax purposes unless the REIT
(such as the Trust) uses a fiscal year and was in existence as a REIT for any
taxable year beginning on or before October 4, 1976, and complies with the
recordkeeping requirements of the Code and Treasury Regulations promulgated
thereunder; and
- - that meets certain other tests, described below, regarding the nature of its
income and assets.
The Code provides that the first four requirements must be met during the entire
taxable year and that the fifth requirement must be met during at least 335 days
of a 12 month taxable year, or during a proportionate part of a shorter taxable
year. Moreover, the fifth and sixth requirements will not apply until after the
first taxable year a REIT election is made. The Trust has issued and will issue
sufficient Common Shares in sufficient diversity of ownership to allow it to
satisfy the fifth and sixth requirements. In addition, the Trust's Declaration
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provides for restrictions regarding transfer of its Common Shares to assist the
Trust in continuing to satisfy the share ownership requirements described in the
fifth and sixth requirements above. See "CERTAIN DECLARATION OF TRUST AND
STATUTORY PROVISIONS -- RESTRICTIONS ON OWNERSHIP AND TRANSFER."
For purposes of determining stock ownership under the 5/50 Rule, (i) a
supplemental unemployment compensation benefits plan, a private foundation, or a
portion of a trust permanently set aside or used exclusively for charitable
purposes generally is considered to be an individual shareholder, and (ii) stock
held by a trust that is a qualified trust under Section 401(a) of the Code is
treated as held by each of the Trust's beneficiaries in proportion to their
actuarial interests in the pension trust for purposes of the 5/50 Rule.
The Trust owns a corporate subsidiary, RRF Sub Corp., which the Trust believes
to be a "qualified REIT subsidiary." (A qualified REIT subsidiary is any
corporation wholly-owned by a REIT.) As such, RRF Sub Corp. is disregarded for
federal income tax purposes and all assets, liabilities and items of income,
deduction and credit of RRF Sub Corp. are treated as assets, liabilities and
items of the Trust itself.
If a REIT is a partner in a partnership, then the Treasury Regulations provide
that the REIT will be deemed to own its proportionate share of the partnership's
assets and will be deemed to be entitled to its proportionate share of the
partnership's gross income. In addition, the character of the partnership's
assets and gross income will retain the same character in the hands of the REIT
for purposes of the gross income and asset tests of Section 856 of the Code,
described below. Thus, the Trust's proportionate share of the Operating
Partnership's assets, liabilities and items of income (and of any lower tier
partnership) will be treated as the Trust's assets and gross income for purposes
of applying the requirements described herein.
INCOME TESTS
In order for the Trust to maintain its REIT qualification, there are two gross
income requirements that must be satisfied annually. First, at least 75% of the
Trust's gross income (excluding gross income from prohibited transactions) for
each taxable year must be income derived directly or indirectly from investments
relating to real property or mortgages on real property (including "rents from
real property" and, in certain circumstances, interest) or temporary investment
income. Second, at least 95% of the Trust's gross income (excluding gross income
from prohibited transactions) for each taxable year must be derived from such
real property or temporary investments, and from dividends, other types of
interest, and gain from the sale or disposition of stock, securities and real
property that do not constitute dealer property, or from any combination of the
foregoing.
Rents received by the Trust will qualify as "rents from real property" and
satisfy the gross income requirements described above only if the following
conditions are met:
- - the amount of rent must not be based in whole or in part on the income or
profits of any person; however, an amount generally will not be excluded from
"rents from real property" solely for being based on a fixed percentage or a
percentage of receipts or sales.
- - the Code provides that rents received from a tenant will not qualify as "rents
from real property" if the Trust, or an owner of 10% or more of the Trust,
directly or constructively owns 10% or more of such tenant; included in the
10% ownership calculation is the attribution of certain interests held by
family members, corporations (if such owner owns
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more than 10% of the value of the outstanding shares), partnerships (if such
person owns 25% or more of the capital or profits) or certain partners of any
such person.
- - if rent attributable to personal property, leased in connection with a lease
of real property, exceeds 15% of the total rent received under the lease, then
the portion of the rent attributable to such personal property will not
qualify as "rents from real property"; and
- - for rents received to qualify as "rents from real property," the Trust
generally must not operate or manage the leased property or furnish or render
more than a de minimis amount of services to the tenants of such property,
other than through an "independent contractor" from whom the Trust derives no
revenue. The "independent contractor" requirement, however, does not apply if
the services provided by the Trust are "usually or customarily rendered" in
connection with the rental of space for occupancy only and are not otherwise
considered "rendered to the occupant."
Pursuant to the current Percentage Leases, the Initial Lessee leases from the
Operating Partnership and the Subsidiary Partnerships (as defined below) and RRF
Sub Corp. the land, buildings, improvements, furnishings, and equipment
comprising the Hotels for a ten-year period. These Percentage Leases provide
that the Initial Lessee is obligated to pay the Operating Partnership or RRF Sub
Corp., as the case may be, (i) the greater of a fixed base rent or a percentage
rent (collectively, "Rents") and (ii) certain other amounts, including interest
accrued on any late payments or charges ("Additional Charges"). The percentage
rent is calculated by multiplying fixed percentages by the gross room revenues
and food and beverage revenues for each of the Hotels in excess of certain
levels. The base rent accrues and is required to be paid monthly without regard
to Hotel revenues. For purposes of this section, the term "Operating
Partnership" includes the Subsidiary Partnerships and RRF Sub Corp. when the
context requires.
In order for the Rents and the Additional Charges to constitute "rents from real
property," the Percentage Leases must be respected as true leases for federal
income tax purposes and not treated as service contracts, joint ventures or some
other type of arrangement. The determination of whether the Percentage Leases
are true leases depends on an analysis of all the surrounding facts and
circumstances. In making such a determination, courts have considered a variety
of factors, including:
- - the intent of the parties;
- - the form of the agreement;
- - the degree of control the property owner retains over the property (e.g.,
whether the lessee has substantial control over the operation of the property
or whether the lessee is required simply to use its best efforts to perform
its obligations under the agreement); and
- - the extent to which the property owner retains the risk of loss with respect
to the property (e.g., whether the lessee bears the risk of increases in
operating expenses or the risk of damage to the property).
In addition, Section 7701(e) of the Code provides that a contract that purports
to be a service contract (or a partnership agreement) is treated instead as a
lease of property if the contract is properly treated as such, taking into
account all relevant factors, including whether or not:
- - the service recipient is in physical possession of the property;
- - the service recipient controls the property;
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- - the service recipient has a significant economic or possessory interest in the
property (e.g., the property's use is likely to be dedicated to the service
recipient for a substantial portion of the useful life of the property, the
service recipient shares the risk that the property will decline in value, the
service recipient shares in any appreciation in the value of the property, the
service recipient shares in savings in the property's operating costs, or the
service recipient bears the risk of damage to or loss of the property);
- - the service provider does not bear any risk of substantially diminished
receipts or substantially increased expenditures if there is nonperformance
under the contract;
- - the service provider does not use the property concurrently to provide
significant services to entities unrelated to the service recipient; and
- - the total contract price does not substantially exceed the rental value of the
property for the contract period.
Since the determination whether a service contract should be treated as a lease
is inherently factual, the presence or absence of any single factor may not be
dispositive in every case.
The Trust believes that the Percentage Leases will be treated as true leases for
federal income tax purposes. Such belief is based, in part, on the following
facts:
- - the Operating Partnership and the Initial Lessee intend for their relationship
to be that of a lessor and lessee and such relationship will be documented by
lease agreements;
- - the Initial Lessee has the right to exclusive possession and use and quiet
enjoyment of the Hotels during the term of the Percentage Leases;
- - the Initial Lessee bears the cost of, and will be responsible for, day-to-day
maintenance and repair of the Hotels, other than the cost of maintaining
underground utilities and structural elements, and will dictate how the Hotels
are operated, maintained and improved;
- - the Initial Lessee bears all of the costs and expenses of operating the Hotels
(including the cost of any inventory and supplies used in their operation)
during the term of the Percentage Leases (other than real and personal
property taxes, and the cost of replacement or refurbishment of furniture,
fixtures and equipment, to the extent such costs do not exceed the allowance
for such costs provided by the Operating Partnership under each Percentage
Lease);
- - the Initial Lessee benefits from any savings in the costs of operating the
Hotels during the term of the Percentage Leases;
- - in the event of damage or destruction to a Hotel, the Initial Lessee will be
at economic risk as it will be obligated to either (i) restore the property to
its prior condition, in which event it will bear all costs of such restoration
or (ii) purchase the Hotel for an amount generally equal to the Operating
Partnership's investment in the property;
- - the Initial Lessee will indemnify the Operating Partnership against all
liabilities imposed on the Operating Partnership during the term of the
Percentage Leases by reason of (i) injury to persons or damage to property
occurring at the Hotels or (ii) the Initial Lessee's use, management,
maintenance or repair of the Hotels;
- - the Initial Lessee is obligated to pay substantial fixed rent for the period
it uses the Hotels; and
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- - the Initial Lessee stands to incur substantial losses (or reap substantial
gains) depending on how successfully it operates the Hotels.
INVESTORS SHOULD BE AWARE THAT THERE ARE NO CONTROLLING TREASURY REGULATIONS,
PUBLISHED RULINGS, OR JUDICIAL DECISIONS INVOLVING LEASES WITH TERMS
SUBSTANTIALLY THE SAME AS THE PERCENTAGE LEASES THAT DISCUSS WHETHER SUCH LEASES
CONSTITUTE TRUE LEASES FOR FEDERAL INCOME TAX PURPOSES. THEREFORE, THE
RELATIONSHIP BETWEEN THE OPERATING PARTNERSHIP AND THE INITIAL LESSEE IS BASED
UPON ALL OF THE FACTS AND CIRCUMSTANCES AND UPON RULINGS AND JUDICIAL DECISIONS
INVOLVING SITUATIONS THAT ARE CONSIDERED TO BE ANALOGOUS. THERE CAN BE NO
COMPLETE ASSURANCE THAT THE SERVICE WILL NOT ASSERT SUCCESSFULLY A CONTRARY
POSITION. If the Percentage Leases were recharacterized as service contracts or
partnership agreements, rather than true leases, part or all of the payments
that the Operating Partnership receives from the Initial Lessee may not be
considered rent or may not otherwise qualify as "rents from real property." In
that case, the Trust likely would not be able to satisfy either the 75% or 95%
gross income tests and, as a result, would lose its REIT status.
In order for the Rents to constitute "rents from real property," several other
requirements also must be satisfied. Rents attributable to personal property
leased in connection with the lease of the real property must not exceed 15% of
the total Rents received under the Percentage Lease. For purposes of this
calculation, Rents attributable to the personal property in a Hotel is the
amount that bears the same ratio to total rent for the taxable year as the
average of the adjusted bases of the personal property in the Hotel at the
beginning and at the end of the taxable year bears to the average of the
aggregate adjusted bases of both the real and personal property comprising the
Hotel at the beginning and at the end of the such taxable year. The Trust
believes that the initial adjusted basis of the personal property in each Hotel
was less than 15% of the initial adjusted bases of both the real and personal
property comprising such hotel. There can be no assurance, however, that the
Service would not challenge this determination. If such a challenge were
successfully asserted, the Trust could fail this 15% test for one or more of the
Percentage Leases, which in turn potentially could cause it to fail to satisfy
the 95% or 75% gross income tests and thus lose its REIT status.
Another requirement for qualification of the Rents as "rents from real property"
is that the percentage rent must not be based in whole or in part on the income
or profits of any person. The percentage rent, however, will qualify as "rents
from real property" if it is based on a percentage of receipts or sales and the
percentages (i) are fixed at the time the Percentage Leases are entered into,
(ii) are not renegotiated during the term of the Percentage Leases in a manner
that has the effect of basing percentage rent on income or profits, and (iii)
conform with normal business practice. More generally, the percentage rent will
not qualify as "rents from real property" if, considering the Percentage Leases
and all the surrounding circumstances, the arrangement does not conform with
normal business practice but is instead used as a means of basing the percentage
rent on income or profits.
Since percentage rent is based on fixed percentages of the gross revenues from
the Hotels that are established in the Percentage Leases and the Trust
represents that the percentages (i) will not be renegotiated during the terms of
the Percentage Leases in a manner that has the effect of basing the percentage
rent on income or profits and (ii) conform with normal business practice,
percentage rent paid to the Operating Partnership should not be considered based
in whole or in part on the income or profits of any person. Furthermore, the
Trust represents that, with respect to other hotel properties that it acquires
in the future, it will not charge rent for any property that is based in whole
or in part on the income or profits of any
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person (except by reason of being based on a fixed percentage of gross revenues,
as described above).
A third requirement to qualify the Rents as "rents from real property" is that
the Trust must not own, directly or constructively, 10% or more of the Initial
Lessee, the Management Company (as a future lessee of hotels), or any sublessee.
The constructive ownership rules generally provide that, if 10% or more in value
of the shares of the Trust are owned, directly or indirectly, by or for any
person, the Trust deemed to own the ownership interests in any lessee that are
owned, directly or indirectly, by or for such person. In other words, if any
person, directly or indirectly, owns 10% or more in value of the Trust's shares
and owns 10% or more of the shares of the Initial Lessee, the Management Company
or any sublessee, the Trust will be deemed to own 10% or more of the Initial
Lessee, the Management Company or the sublessee. The Trust does not currently
own, directly or constructively, any ownership interest in the Initial Lessee,
the Management Company or any sublessee. In addition, the Partnership Agreement
provides that a limited partner will not be permitted to convert his or her
Operating Partnership units into Trust Common Shares (unless the Trust elects,
in its sole discretion, to pay cash in lieu of Common Shares) to the extent that
his or her conversion would result in the Trust being treated as owning,
directly or constructively, 10% or more of the ownership interests of the
Initial Lessee, the Management Company or any sublessee. Thus, the Trust should
never own, directly or constructively, 10% or more of the Initial Lessee, the
Management Company or any sublessee. Furthermore, the Trust represents that,
with respect to other hotel properties that it acquires in the future, it will
not rent any property to a related party. However, because the Code's
constructive ownership rules are broad and it is not practicable to monitor
continually direct and indirect transfers of Common Shares, no absolute
assurance can be given that such transfers or other events of which the Trust
has no knowledge will not cause the Trust to own constructively 10% or more of
the Initial Lessee, the Management Company or a sublessee at some future date.
A fourth requirement to qualify the Rents as "rents from real property" is that
the Trust cannot furnish or render (i) impermissible services to the Initial
Lessee, the Management Company or the tenants of the Hotels, or manage or
operate the Hotels, other than through an independent contractor from whom the
Trust itself does not derive or receive any income, or (ii) impermissible
services to the Initial Lessee or the Management Company, except in either case
to a de minimis extent. Provided that the Percentage Leases are respected as
true leases, the Trust should satisfy this requirement as the Operating
Partnership does not and will not perform any services other than customary ones
for the Initial Lessee or the Management Company. Furthermore, the Trust
represents that, with respect to other hotel properties that it acquires in the
future, it will not perform noncustomary services with respect to any tenant. As
described above, however, if the Percentage Leases are recharacterized as
service contracts or partnership agreements, the Rents likely would be
disqualified as "rents from real property" as the Trust would be considered to
furnish or render services to the occupants of the Hotels, and to manage or
operate the Hotels other than through an independent contractor who is
adequately compensated and from whom the Trust derives or receives no income.
If the Rents do not qualify as "rents from real property" because the rents
attributable to personal property exceed 15% of the total Rents for a taxable
year, the portion of the Rents attributable to personal property will not be
qualifying income for either the 75% or 95% gross income tests. Thus, if the
Rents attributable to personal property, plus any other nonqualifying income,
during a taxable year exceed 5% of the Trust's gross income during
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the year, the Trust would lose its REIT status. If, however, the Rents do not
qualify as "rents from real property" because (i) the Percentage Rent is
considered based on income or profits of the Initial Lessee or the Management
Company, (ii) the Trust owns, directly or constructively, 10% or more of the
Initial Lessee or the Management Company, or (iii) the Trust furnishes
noncustomary services to the Initial Lessee or the Management Company (other
than to a de minimis extent) or manages or operates the Hotels, none of the
Rents would qualify as "rents from real property." In that case, the Trust
likely would lose its REIT status because it would be unable to satisfy either
the 75% or 95% gross income tests.
In addition to the Rents, the Initial Lessee is and the Management Company will
be required to pay to the Operating Partnership the Additional Charges. To the
extent that the Additional Charges represent either (i) reimbursements of
amounts that the Initial Lessee is and the Management Company will be obligated
to pay to third parties or (ii) penalties for nonpayment or late payment of such
amounts, the Additional Charges should qualify as "rents from real property."
If, however, the Additional Charges represent interest that is accrued on the
late payment of the Rents or the Additional Charges, the Additional Charges
should not qualify as "rents from real property," but should be treated as
interest that qualifies for the 95% gross income test.
The Trust believes that the Rents and the Additional Charges will qualify as
"rents from real property" for purposes of the 75% and 95% gross income tests,
except to the extent that the Additional Charges represent interest that is
accrued on the late payment of the Rents or the Additional Charges (which will
be qualifying gross income for the 95% test, but not the 75% test). However,
there can be no complete assurance that the Internal Revenue Service will not
assert successfully a contrary position and, therefore, if successful, would
prevent the Trust from qualifying as a REIT.
The term "interest," as defined for purposes of the 75% gross income test,
generally does not include any amount received or accrued (directly or
indirectly) which is based in whole or in part on the income or profits of any
person. However, an amount received or accrued generally will not be excluded
from the term "interest" solely by reason of being based on a fixed percentage
or percentages of receipts or sales. Furthermore, to the extent that interest
from a loan is based on the residual cash proceeds from sale of the property
securing the loan and the loan contains a "shared appreciation provision" (as
defined in the Code), income attributable to such participation feature will be
treated as gain from the sale of the secured property and not as qualifying
interest.
The net income from any prohibited transaction entered into by the Trust is
subject to a 100% tax. The term "prohibited transaction" generally includes a
sale or other disposition of property (other than foreclosure property) that is
held primarily for sale to customers in the ordinary course of a trade or
business. All inventory required to operate of the Hotels will be purchased by
the Initial Lessee or the Management Company or their designees as required by
the terms of the Percentage Leases. Accordingly, the Trust and the Operating
Partnership believe that no asset owned by the Trust or the Operating
Partnership is held for sale to customers and that a sale of any such asset will
not be in the ordinary course of business of the Trust or the Operating
Partnership. Whether property is held "primarily for sale to customers in the
ordinary course of a trade or business" depends, however, on the facts and
circumstances in effect from time to time, including those related to the
particular property. Nevertheless, the Trust and the Operating Partnership will
attempt to comply with the terms of safe-harbor provisions in the Code
prescribing when asset sales will not be characterized
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as prohibited transactions. Complete assurance cannot be given, however, that
the Trust or the Operating Partnership can comply with the safe-harbor
provisions of the Code or avoid owning property that may be characterized as
property held "primarily for sale to customers in the ordinary course of a trade
or business."
The Trust will be subject to tax at the maximum corporate rate on any income
from foreclosure property (other than income that would be qualified income
under the 75% gross income test), less expenses directly connected with the
production of such income. However, gross income from such foreclosure property
will qualify under the 75% and 95% gross income tests. "Foreclosure property" is
defined as any real property (including interests in real property) and any
personal property incident to such real property (i) that is acquired by a REIT
having bid on such property at foreclosure, or having otherwise reduced such
property to ownership or possession by agreement or process of law, after there
was a default (or default was imminent) on a lease of such property or on an
indebtedness that such property secured and (ii) for which such REIT makes a
proper election to treat such property as foreclosure property. However, a REIT
will not be considered to have foreclosed on a property where such REIT takes
control of the property as a mortgagee-in-possession and cannot receive any
profit or sustain any loss except as a creditor of the mortgagor.
Under the Code, property generally ceases to be foreclosure property as of the
close of the third taxable year following the taxable year in which the REIT
acquired such property (or longer if an extension is granted by the Secretary of
the Treasury). The foregoing grace period is terminated and foreclosure property
ceases to be foreclosure property on the first day (i) on which a lease is
entered into with respect to such property that, by its terms, will give rise to
income that does not qualify under the 75% gross income test or any amount is
received or accrued, directly or indirectly, pursuant to a lease entered into on
or after such day that will give rise to income that does not qualify under the
75% gross income test, (ii) on which any construction takes place on such
property (other than completion of a building, or any other improvement, where
more than 10% of the construction of such building or other improvement was
completed before default became imminent) or (iii) which is more than 90 days
after the day on which such property was acquired by the REIT and the property
is used in a trade or business that is conducted by the REIT (other than through
an independent contractor from whom the REIT itself does not derive or receive
any income). As a result of the foreclosure property rules, if the Initial
Lessee or the Management Company would default on their obligations under a
Percentage Lease for a hotel, the Trust terminates the leasehold interest, and
the Trust is unable to find a replacement lessee for such hotel within 90 days
of such foreclosure, gross income from hotel operations conducted by the Trust
from such hotel would cease to qualify for the 75% and 95% gross income tests.
In such event, the Trust likely would be unable to satisfy the 75% and 95% gross
income tests and, thus, would fail to qualify as a REIT.
It is possible that, from time to time, the Trust or the Operating Partnership
will enter into hedging transactions with respect to one or more of its assets
or liabilities. Any such hedging transactions could take a variety of forms,
including interest rate swap contracts, interest rate cap or floor contracts,
futures or forward contracts and options. To the extent that the Trust or the
Operating Partnership enters into an interest rate swap, cap, or other contract
to hedge any interest rate risk with respect to indebtedness incurred to acquire
or carry real estate assets, any periodic income or gain from the disposition of
such contract should be qualifying income for purposes of the 95% gross income
test. To the extent that the Trust or the Operating Partnership hedges with
other types of financial instruments or in other situations,
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it is unclear how income from those transactions will be treated for purposes of
the various REIT income tests. The Trust intends to structure any hedging
transactions in a manner that does not jeopardize its status as a REIT.
If the Trust fails to satisfy one or both of the 75% or 95% gross income tests
for any taxable year, it may nevertheless qualify as a REIT for such year if it
is entitled to relief under certain provisions of the Code. Those relief
provisions will be generally available if the Trust's failure to meet such tests
is due to (i) reasonable cause and not due to willful neglect, (ii) the Trust
attaches a schedule of the sources of its income to its return, and (iii) any
incorrect information on the schedule was not due to fraud with intent to evade
tax. It is not possible, however, to state whether in all circumstances the
Trust would be entitled to the benefit of those relief provisions. As discussed
above in " -- TAXATION OF THE TRUST," even if those relief provisions apply, a
tax would be imposed with respect to the net income attributable to the excess
of 75% or 95% of the Trust's gross income over its qualifying income in the
relevant category, whichever is greater.
ASSET TESTS
The Trust, at the close of each quarter of its tax year, also must satisfy two
tests relating to the nature of its assets. First, at least 75% of the value of
the Trust's total assets must be cash or cash items (including certain
receivables), government securities, "real estate assets" and, in cases in which
the Trust raises new capital through stock or long-term (at least five-year)
debt offerings, temporary investments in stock or debt instruments during the
one-year period following the Trust's receipt of such capital. The term "real
estate assets" includes interests in real property, interests in mortgages on
real property (to the extent the mortgage balance does not exceed the value of
the associated real property), and shares of other REITs. For purposes of the
75% asset requirement, the term "interest in real property" includes an interest
in land and improvements thereon, such as buildings or other inherently
permanent structures (including items that are structural components of such
buildings or structures), a leasehold in real property and an option to acquire
real property (or a leasehold in real property). Second, of the investments not
included in the 75% asset class, the value of any one issuer's securities owned
by the Trust may not exceed 5% of the value of the Trust's total assets, and the
Trust may not own more than 10% of any one issuer's outstanding voting
securities (except for its ownership interest in the Operating Partnership and
Subsidiary Partnership or the stock of a subsidiary with respect to which it has
held 100% of the stock at all times during the subsidiary's existence).
For purposes of the asset requirements, the Trust will be deemed to own its
proportionate share of the assets of the Operating Partnership (and any
Subsidiary Partnership), rather than its general partnership interest in the
Operating Partnership. The Trust represents that, at all relevant times, (i) at
least 75% of the value of its total assets will be represented by real estate
assets, cash and cash items (including receivables), or government securities
and (ii) it will not own any securities that do not satisfy the 75% asset
requirement (except for the stock of subsidiaries with respect to which it has
held 100% of the stock at all times during the subsidiary's existence). In
addition, the Trust represents that it will not acquire or dispose, or cause the
Operating Partnership to acquire or dispose, of assets in a way that would cause
it to violate either asset requirement. The Trust believes that it currently
satisfies both asset requirements.
If the Trust should fail inadvertently to satisfy the asset requirements at the
end of a calendar quarter, such a failure would not cause it to lose its REIT
status if (i) it satisfied all of the
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asset tests at the close of the preceding calendar quarter and (ii) the
discrepancy between the value of the Trust's assets and the standards imposed by
the asset requirements either did not exist immediately after the acquisition of
any particular asset or was not wholly or partly caused by such an acquisition
(i.e., the discrepancy arose from changes in the market values of its assets).
If the condition described in clause (ii) of the preceding sentence were not
satisfied, the Trust still could avoid disqualification by eliminating any
discrepancy within 30 days after the close of the calendar quarter in which it
arose.
DISTRIBUTION REQUIREMENTS
The Trust, in order to maintain its REIT qualification, must distribute
dividends (other than capital gain dividends) to its shareholders in an amount
at least equal to (i) the sum of (A) 95% of its REIT taxable income (computed
without regard to the dividends paid deduction and its net capital gain) and (B)
95% of the net income (after tax), if any, from foreclosure property, minus (ii)
the sum of certain items of noncash income. Such dividends must be paid in the
tax year to which they relate, or in the following tax year if declared before
the Trust timely files its tax return for such year and if paid on or before the
first regular dividend payment after such declaration. To the extent that the
Trust does not distribute all of its net capital gain or distributes at least
95%, but less than 100%, of its "REIT taxable income," as adjusted, it will be
subject to tax thereon at regular ordinary and capital gains corporate tax rates
(in the case of capital gains taxes paid by the Trust, each shareholder shall be
entitled to claim a tax credit based on the amount of such taxes. See "TAXATION
OF TAXABLE DOMESTIC SHAREHOLDERS"). Furthermore, if the Trust should fail to
distribute during each calendar year at least the sum of (i) 85% of its REIT
ordinary income for such year, (ii) 95% of its REIT capital gain income for such
year, and (iii) any undistributed taxable income from prior periods, the Trust
would be subject to a 4% nondeductible excise tax on undistributed amounts. The
Trust has made, and intends to continue to make, timely distributions sufficient
to satisfy all annual distribution requirements.
It is possible that, from time to time, the Trust may experience timing
differences between (i) the actual receipt of income and actual payment of
deductible expenses and (ii) the inclusion of that income and deduction of those
expenses in arriving at its REIT taxable income. For example, under the
Percentage Leases, the Initial Lessee may defer payment of the excess of the
percentage rent over the base rent for a period of up to 90 days after the end
of the calendar year in which such payment was due. In that case, the Operating
Partnership still would be required to recognize as income the excess of the
percentage rent over the base rent in the calendar quarter to which it relates.
Further, it is possible that, from time to time, the Trust may be allocated a
share of net capital gain attributable to the sale of depreciated property which
exceeds its allocable share of cash attributable to that sale. Therefore, the
Trust may have less cash available for distribution than is necessary to meet
its annual distribution requirements to avoid corporate income tax or the excise
tax. In such a situation, the Trust may find it necessary to arrange for
short-term (or possibly long-term) borrowings or to raise funds through the
issuance of additional shares of common or preferred stock.
Under certain circumstances, the Trust may be able to rectify a failure to meet
the distribution requirements for a year by paying "deficiency dividends" to its
shareholders in a later year, which may be included in the Trust's deduction for
dividends paid for the earlier year. Although the Trust may be able to avoid
being taxed on amounts distributed as
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deficiency dividends, it will be required to pay interest based upon the amount
of any deduction taken for deficiency dividends.
RECORDKEEPING REQUIREMENT
For tax years beginning before August 6, 1997, in order to maintain its REIT
qualification, the Trust must maintain certain records and request on an annual
basis certain information from its shareholders designed to disclose the actual
ownership of its outstanding capital stock. For tax years beginning after August
5, 1997, the Trust must satisfy these rules to prevent a penalty. The Trust
intends to comply with such requirements.
PARTNERSHIP ANTI-ABUSE RULE
The Treasury Department has issued a final regulation ("Anti-Abuse Rule"), under
the partnership provisions of the Code, that would authorize the Service, in
certain abusive transactions involving partnerships, to disregard the form of
the transaction and recast it for federal tax purposes as it deems appropriate.
The Anti-Abuse Rule would apply where a partnership is formed or availed of in
connection with a transaction (or series of related transactions), a principal
purpose of which is to reduce substantially the present value of the partners'
aggregate federal tax liability in a manner inconsistent with the intent of the
Code's partnership provisions. The Anti-Abuse Rule states that the Code's
partnership provisions are intended to permit taxpayers to conduct joint
business (including investment) activities through a flexible economic
arrangement that accurately reflects the partners' economic agreement and
clearly reflects the partners' income, without incurring an entity-level tax.
The purposes for structuring a transaction involving a partnership are
determined based on all of the facts and circumstances, including a comparison
of the purported business purpose for the transaction and the claimed tax
benefits resulting from the transaction. A reduction in the present value of the
partners' aggregate federal tax liability through the use of a partnership does
not, by itself, establish inconsistency with the intent of the Code's
partnership provisions. The Anti-Abuse Rule is generally effective for all
transactions relating to a partnership occurring on and after May 12, 1994.
The Anti-Abuse Rule contains an example in which a corporation that elects to be
treated as a REIT contributes substantially all of the proceeds from a public
offering to a partnership in exchange for a general partner interest. The
limited partners of the partnership contribute real property assets to the
partnership, subject to liabilities that exceed their respective aggregate bases
in such property. In addition, some of the limited partners have the right,
beginning two years after the formation of the partnership, to require the
redemption of their limited partnership interests in exchange for cash or REIT
stock (at the REIT's option) equal to the fair market value of their respective
interests in the partnership at the time of the redemption. The example
concludes that the use of the partnership is not inconsistent with the intent of
the Code's partnership provisions and, thus, cannot be recast by the Service.
The Trust believes that the Anti-Abuse Rule will not have any adverse impact on
its ability to qualify as a REIT. However, because the Anti-Abuse Rule is
extraordinarily broad in scope and is applied based on an analysis of all of the
facts and circumstances, there can be no assurance that the Service will not
attempt to apply the Anti-Abuse Rule to the Trust. If the conditions of the
Anti-Abuse Rule are met, the Service is authorized to take appropriate
enforcement action, which includes disregarding the Operating Partnership for
federal tax purposes or treating one or more of its partners as nonpartners. Any
such action potentially could jeopardize the Trust's status as a REIT.
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FAILURE TO QUALIFY
If the Trust fails to qualify as a REIT in any taxable year, and the relief
provisions do not apply, the Trust would be subject to tax (including any
applicable alternative minimum tax) on its taxable income at regular corporate
income tax rates. Dividends to the shareholders in any year in which the Trust
fails to qualify would not be deductible by the Trust, or required to be made.
In such event, to the extent of current and accumulated earnings and profits,
all dividends to shareholders, if any, would be taxable as ordinary income and,
subject to certain limitations of the Code, corporate shareholders may be
eligible for the dividends received deduction. Unless entitled to relief under
specific statutory provisions, the Trust also would be disqualified from
taxation as a REIT for the four taxable years following the year during which
the Trust ceased to qualify as a REIT, unless the Trust would be entitled to
such statutory relief.
TAXATION OF TAXABLE DOMESTIC SHAREHOLDERS
Provided the Trust continues to qualify as a REIT, distributions made to the
Trust's taxable U.S. shareholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends) will be considered as
ordinary income to those U.S. shareholders and will not be eligible for the
dividends received deduction for corporate shareholders. Each year the Trust
will designate a certain amount of its dividends as capital gain dividends. Such
amount will be taxed as long-term capital gains (to the extent they do not
exceed the Trust's actual net capital gain for the taxable year) without regard
to the shareholder's holding period for its Common Shares and will be subject to
a credit if it is not currently distributed to such shareholder. Corporate
shareholders, however, may be required to treat up to 20% of certain capital
gain dividends as ordinary income.
Distributions in excess of current and accumulated earnings and profits will not
be taxable to a shareholder to the extent that they do not exceed the adjusted
tax basis of the shareholder's Common Shares, but rather such distributions will
reduce the adjusted tax basis of such Common Shares. To the extent that
distributions in excess of current and accumulated earnings and profits exceed
the adjusted tax basis of a shareholder's Common Shares, they will be included
in income as long-term capital gain (or short-term capital gain if the Common
Shares have been held for one year or less). Any dividend declared by the Trust
in October, November, or December of any year payable to a shareholder of record
on a specified date in any such month shall be treated as both paid by the Trust
and received by the shareholder on December 31 of such year, provided that the
dividend is actually paid by the Trust during January of the following calendar
year. Shareholders may not include in their individual income tax returns any
net operating losses or capital losses of the Trust.
The Trust may elect under the Code to retain and pay income tax on its net
capital gain for any taxable year. Under the Taxpayer Relief Act of 1997 (the
"1997 Act"), however, if the Trust so elects, a shareholder must include in
income such shareholder's proportionate share of the Trust's undistributed
capital gain for the taxable year and will be deemed to have paid such
shareholder's proportionate share of the income tax paid by the Trust with
respect to such undistributed capital gain. This deemed tax payment would be
credited against the shareholder's tax liability and subject to normal refund
procedures. In addition, each shareholder's tax basis in its Common Shares would
be increased by the amount of undistributed capital gain (less the tax paid by
the Trust) included in the shareholder's income.
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The 1997 Act, the IRS Restructuring and Reform Act of 1998 (the "1998 Act") and
the Tax and Trade Relief Act of 1998 also altered the taxation of capital gain
income for individuals (and for certain trusts and estates). Gain from the sale
or exchange of certain investments held for more than 12 months will be taxed at
a maximum capital gain rate of 20% if such sale or exchange occurred either (i)
after May 6, 1997 and before July 29, 1997, or (ii) in tax years ending after
December 31, 1997. Gain from the sale or exchange of certain investments held
for 18 months or less, but for more than one year, will be taxed at a maximum
capital gain rate of 28% if such sale or exchange occurred either (i) before May
7, 1997, or (ii) after July 28, 1997 and before January 1, 1998. The 1997 Act
also provides a maximum rate of 25% for "unrecaptured Section 1250 gain"
recognized on the sale or exchange of certain real estate assets, introduces
special rules for "qualified 5-year gain," and makes certain other changes to
prior law. The Tax and Trade Relief Act of 1998 generally provides that the 20%
capital gains tax rate applies to capital gain dividends made after December 31,
1997 even though the underlying property (i) was sold or exchanged by the REIT
after July 28, 1997 and before January 1, 1998 and (ii) such property was held
by the REIT more than one year but less than 18 months on the date of sale or
exchange.
In general, any loss upon a sale or exchange of Common Shares held for six
months or less (after applying certain holding period rules) will be treated as
a long-term capital loss to the extent of distributions from the Trust required
to be treated by that shareholder as long-term capital gain.
BACKUP WITHHOLDING
The Trust will report to its U.S. shareholders and the Service the amount of
distributions paid during each calendar year and the amount of tax withheld, if
any. Under the backup withholding rules, a shareholder may be subject to backup
withholding at the rate of 31% with respect to distributions paid unless the
shareholder (a) is a corporation or comes within certain other exempt categories
and, when required, demonstrates this fact, or (b) provides a taxpayer
identification number, certifies as to no loss of exemption from backup
withholding, and otherwise complies with applicable requirements of the backup
withholding rules. A stockholder that does not provide the Trust with its
correct taxpayer identification number may also be subject to penalties imposed
by the Service. Any amount paid as backup withholding will be creditable against
the stockholder's income tax liability.
TAXATION OF TAX-EXEMPT SHAREHOLDERS
The Service has ruled that dividends of a qualified REIT do not constitute
unrelated business taxable income ("UBTI") when received by certain tax-exempt
entities. Based on that ruling, provided that a tax-exempt shareholder (except
certain tax-exempt shareholders described below) has not held its REIT shares as
"debt financed property" within the meaning of the Code (generally shares of
common stock, the acquisition of which was financed through a borrowing by the
tax-exempt shareholder) and such shares are not otherwise used in a trade or
business, dividend income from the Trust will not be UBTI to such tax-exempt
shareholder. Similarly, income from the sale of REIT shares will not constitute
UBTI unless such tax-exempt shareholder has held such shares as "debt financed
property" within the meaning of the Code or has used the shares in a trade or
business.
For tax-exempt shareholders that are social clubs, voluntary employee benefit
associations, supplemental unemployment benefit trusts, and qualified group
legal services plans exempt from federal income taxation under Code Sections
501(c)(7), (c)(9), (c)(17) and (c)(20),
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respectively, income from an investment in the Trust will constitute UBTI unless
the organization is able to properly deduct amounts set aside or placed in
reserve for certain purposes so as to offset the income generated by its
investment in the Trust. Such prospective investors should consult their own tax
advisors concerning these set aside and reserve requirements.
Notwithstanding the above, however, a portion of the dividends paid by a
"pension held REIT" shall be treated as UBTI as to any trust which (i) is
described in Section 401(a) of the Code, (ii) is tax-exempt under Section 501(a)
of the Code, and (iii) holds more than 10% (by value) of the interests in the
REIT. Tax-exempt pension funds that are described in Section 401(a) of the Code
are referred to below as "qualified trusts."
A REIT is a "pension held REIT" if (i) it would not have qualified as a REIT but
for the fact that Section 856(h)(3) of the Code provides that stock owned by
qualified trusts shall be treated, for purposes of the "not closely held"
requirement, as owned by the beneficiaries of the trust (rather than by the
trust itself), and (ii) either (a) at least one such qualified trust holds more
than 25% (by value) of the interests in the REIT, or (b) one or more such
qualified trusts, each of which owns more than 10% (by value) of the interests
in the REIT, hold in the aggregate more than 50% (by value) of the interests in
the REIT. The percentage of any REIT dividend treated as UBTI is equal to the
ratio of (i) the UBTI earned by the REIT (treating the REIT as if it were a
qualified trust and therefore subject to tax on UBTI) to (ii) the total gross
income of the REIT. A de minimis exception applies if the percentage is less
than 5% for any year. The provisions requiring qualified trusts to treat a
portion of REIT distributions as UBTI will not apply if the REIT is able to
satisfy the "not closely held" requirement without relying upon the
"look-through" exception with respect to qualified trusts. In order to
facilitate the Trust's qualification as a REIT and to avoid the Trust being
treated as a pension-held REIT under Section 856(h)(3)(D) of the Code, all
entities (other than members of the Wirth Family), including trusts to which the
provisions of Section 856(h)(3)(A)(i) of the Code apply, are prohibited by the
Declaration from owning, either directly or under the applicable attribution
rules, more than 4.9% of the value of the Trust's outstanding Common Shares.
TAXATION OF FOREIGN SHAREHOLDERS
THE RULES GOVERNING UNITED STATES FEDERAL INCOME TAXATION OF NONRESIDENT ALIEN
INDIVIDUALS, FOREIGN CORPORATIONS, FOREIGN PARTNERSHIPS, AND OTHER FOREIGN
SHAREHOLDERS (COLLECTIVELY, "NON-U.S. SHAREHOLDERS") ARE COMPLEX, AND NO ATTEMPT
WILL BE MADE HEREIN TO PROVIDE MORE THAN A SUMMARY OF THESE RULES. PROSPECTIVE
NON-U.S. SHAREHOLDERS SHOULD CONSULT WITH THEIR OWN TAX ADVISORS TO DETERMINE
THE IMPACT OF FEDERAL, STATE, AND LOCAL INCOME TAX LAWS WITH REGARD TO AN
INVESTMENT IN SHARES, INCLUDING ANY REPORTING REQUIREMENTS, AS WELL AS THE TAX
TREATMENT OF SUCH INVESTMENT UNDER THEIR HOME COUNTRY LAWS.
Distributions that are not attributable to gain from sales or exchanges by the
Trust of United States real property interests and are not designated by the
Trust as capital gain dividends will be treated as ordinary dividends to the
extent that they are made out of current or accumulated earnings and profits of
the Trust. These distributions will ordinarily be subject to a withholding tax
equal to 30% of the gross amount of the distribution unless an applicable tax
treaty reduces or eliminates that tax. If income from the investment in the
Trust's Common Shares is treated as "effectively connected" with the Non-U.S.
Shareholder's conduct of a United States trade or business, however, the
Non-U.S. Shareholder generally
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will be subject to a tax at graduated rates, in the same manner as U.S.
shareholders are taxed with respect to these distributions (and may also be
subject to the 30% branch profits tax in the case of a shareholder that is a
foreign corporation). The Trust expects to withhold United States income tax at
the rate of 30% on the gross amount of any such distributions made to a Non-U.S.
Shareholder unless (a) a lower treaty rate applies and the Non-U.S. Shareholder
files certain information evidencing its entitlement to such lower treaty rate
or (b) the Non-U.S. Shareholder files an IRS Form 4224 with the Trust claiming
that the distribution is "effectively connected" income.
Distributions in excess of current and accumulated earnings and profits of the
Trust will not be taxable to a Non-U.S. Shareholder to the extent that these
distributions do not exceed the adjusted tax basis of the shareholder's Common
Shares, but rather such distributions will reduce its adjusted tax basis. To the
extent that distributions in excess of current and accumulated earnings and
profits exceed the adjusted tax basis of a Non-U.S. Shareholder's shares, they
will give rise to tax liability if the Non-U.S. Shareholder would otherwise be
subject to tax on any gain from the sale or disposition of its Common Shares, as
described below. The Trust may not be able to determine at the time a
distribution is made to what extent such distribution will exceed current and
accumulated earnings and profits. Therefore, such distributions will be subject
to withholding at the same rate as ordinary dividends if such determination
cannot be made. Amounts thus withheld are refundable, however, if it is
subsequently determined that the distribution was, in fact, in excess of current
and accumulated earnings and profits of the Trust.
For any year in which the Trust qualifies as a REIT, distributions that are
attributable to gain from sales or exchanges by the Trust of United States real
property interests will be taxed to a Non-U.S. Shareholder under the provisions
of the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA"). Under
FIRPTA, distributions attributable to gain from sales of United States real
property interests are taxed to a Non-U.S. Shareholder as if the gain were
"effectively connected" with a United States business. Non-U.S. Shareholders
would therefore be taxed at the normal capital gain rates applicable to U.S.
shareholders (subject to applicable alternative minimum tax and a special
alternative minimum tax in the case of nonresident alien individuals). Also,
distributions subject to FIRPTA may be subject to a 30% branch profits tax in
the hands of a corporate Non-U.S. Shareholder not entitled to treaty exemption.
The Trust is required by applicable Treasury Regulations to withhold 35% of any
distribution that could be designated by the Trust as a capital gain dividend.
This amount is creditable against the Non-U.S. Shareholder FIRPTA tax liability
and a refund may be obtained if the amount withheld exceeds the Non-U.S.
Shareholder's U.S. tax liability.
Gain recognized by a Non-U.S. Shareholder upon a sale of shares generally will
not be taxed under FIRPTA if the Trust is a REIT in which at all times during a
specified testing period less than 50% in value of its Common Shares were held
directly or indirectly by foreign persons (a "domestically controlled Trust").
It is currently anticipated that the Trust will be a domestically controlled
REIT, and therefore the sale of Common Shares will not be subject to taxation
under FIRPTA. Gain not subject to FIRPTA, however, will be taxable to a Non-
U.S. Shareholder if (a) investment in the Common Shares is "effectively
connected" with the Non-U.S. Shareholder's United States trade or business, in
which case the Non-U.S. Shareholder will be subject to the same treatment as
U.S. shareholders with respect to the gain, or (b) the Non-U.S. Shareholder is a
nonresident alien individual who was present in the United States for 183 days
or more during the taxable year, in which case the nonresident alien individual
will be subject to a 30% tax on the individual's capital gains.
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If the proceeds of a disposition of Common Shares are paid by or through a
United States office of a broker, the payment is subject to information
reporting and backup withholding unless the disposing Non-U.S. Shareholder
certifies as to his or her name, address and non-United States status or
otherwise establishes an exemption. Generally, United States information
reporting and backup withholding will not apply to a payment of disposition
proceeds made outside of the United States through a non-United States office of
a non-United States broker. United States information reporting requirements
(but not backup withholding) will apply, however, to a payment of disposition
proceeds outside the United States if (a) the payment is made through an office
outside the United States of a broker that is either (i) a United States
citizen, (ii) a foreign person that derives 50% or more of its gross income for
certain periods from the conduct of a trade or business in the United States or
(iii) a "controlled foreign corporation" for United States federal income tax
purposes, and (b) the broker fails to initiate documentary evidence that the
shareholder is a Non-U.S. Shareholder and that certain conditions are met or
that the Non-U.S. Shareholder otherwise is entitled to an exemption.
OTHER TAX CONSEQUENCES
The 1997 Act modifies many of the provisions relating to the requirements for
qualification as, and the taxation of, a REIT. Among other things, the 1997 Act
(i) replaces the rule disqualifying a REIT for any year in which the REIT fails
to comply with Treasury Regulations that are intended to enable a REIT to
ascertain its ownership, with an intermediate penalty for failing to do so; (ii)
permits a REIT to render a de minimis amount of impermissible services to
tenants, or in connection with the management or operation of property, and
still treat amounts received with respect to that property as "rents from real
property"; (iii) permits a REIT to elect to retain and pay income tax on net
long-term capital gains; (iv) repeals a rule requiring that less than 30% of a
REIT's gross income be derived from gain from the sale or other disposition of
stock or securities held for less than one year, certain real property held for
less than four years, and property that is sold or disposed of in a prohibited
transaction; (v) lengthens the original grace period for foreclosure property
from two years after the REIT's acquisition to a period ending on the last day
of the third full tax year following the tax year in which the property was
acquired; (vi) considers income from all hedges that reduce the interest rate
risk of REIT liabilities, not just interest rate swaps and caps, as qualifying
income under the 95% gross income test; and (vii) permits any corporation
wholly-owned by a REIT to be treated as a qualified subsidiary, regardless of
whether the corporation has always been owned by a REIT. The modifications are
effective for taxable years beginning after August 5, 1997. Thus, these changes
will apply to the operation of the Trust.
Prospective shareholders should recognize that the present federal income tax
treatment of the Trust may be modified by future legislative, judicial or
administrative actions or decisions at any time, which may be retroactive in
effect. As a result, any such action or decision may affect investments and
commitments previously made. The rules dealing with federal income taxation are
constantly under review by persons involved in the legislative process and by
the Service and the Treasury Department, resulting in statutory changes as well
as promulgation of new, or revisions to existing Treasury Regulations and
revised interpretations of established concepts. No prediction can be made as to
the likelihood of passage of any new tax legislation or other provisions either
directly or indirectly affecting the Trust or its
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shareholders. Revisions in federal income tax laws and interpretations thereof
could adversely affect the tax consequences of an investment in the Trust.
The Trust and its shareholders may be subject to state or local taxation in
various state or local jurisdictions, including those in which it or they
transact business or reside. The state and local tax treatment of the Trust and
its shareholders may not conform to the federal income tax consequences
discussed above. CONSEQUENTLY, YOU SHOULD CONSULT YOUR OWN TAX ADVISORS
REGARDING THE EFFECT OF STATE AND LOCAL TAX LAWS ON AN INVESTMENT IN THE TRUST.
TAX ASPECTS OF THE OPERATING PARTNERSHIP
The following discussion summarizes certain federal income tax considerations
applicable to the Trust's investment in the Operating Partnership. The
discussion does not cover state or local tax laws or any federal tax laws other
than income tax laws.
CLASSIFICATION AS A PARTNERSHIP
The Trust is entitled to include in its income its distributive share of the
Operating Partnership's income (including the Operating Partnership's
distributive share of Subsidiary Partnership income) and to deduct its
distributive share of the Operating Partnership's losses (including the
Operating Partnership's distributive share of Subsidiary Partnership losses)
only if the Operating Partnership (and each Subsidiary Partnership) is
classified for federal income tax purposes as a partnership rather than as an
association taxable as a corporation. An organization formed as a partnership
will be treated as a partnership if it (i) is organized under state law as a
partnership and (ii) is not a "publicly traded" partnership. The Operating
Partnership is organized under Delaware limited partnership law. A publicly
traded partnership is a partnership whose interests are traded on an established
securities market or are readily tradable on a secondary market (or the
substantial equivalent thereof). A publicly traded partnership will not,
however, be taxed as a corporation for any taxable year if 90% or more of the
partnership's gross income for such year consists of certain passive-type
income, including real property rents, gains from the sale or other disposition
of real property, interest, and dividends. Whether, for any particular period,
the Operating Partnership or a Subsidiary Partnership will satisfy this passive
income exception will depend upon the facts and circumstances applicable to the
Operating Partnership or the Subsidiary Partnership for such period.
The Service has issued Notice 88-75, providing limited safe harbors from the
definition of a publicly traded partnership in advance of the issuance of
Treasury Regulations. Pursuant to one of those safe harbors (the "Private
Placement Exclusion"), interests in a partnership will not be treated as readily
tradeable on a secondary market or the substantial equivalent thereof if (i) all
of the partnership interests are issued in a transaction that is not registered
under the Securities Act of 1933, as amended, and (ii) the partnership does not
have more than 500 partners (taking into account as a partner each person who
indirectly owns an interest in the partnership through a partnership, grantor
trust, or S corporation). The Operating Partnership and each Subsidiary
Partnership satisfy the Private Placement Exclusion.
The Treasury Department recently issued regulations ("PTP Regulations") that
limit the Private Placement Exclusion to partnerships that have no more than 100
partners at any time during the taxable year. The Operating Partnership and the
Subsidiary Partnerships do not have more than 100 partners (taking into account
indirect ownership of such partnerships through partnerships, grantor trusts,
and S corporations). Thus, the Operating Partnership and
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each Subsidiary Partnership should satisfy the Private Placement Exclusion, as
modified by the PTP Regulations. If, however, the Operating Partnership or any
Subsidiary Partnership were treated as publicly traded and the 90% passive
income exception did not apply, the Trust would not be able to satisfy the
income and assets requirements for REIT status.
The Trust believes that the Operating Partnership and each Subsidiary
Partnership are properly treated as partnerships for federal income tax purposes
and are not associations taxable as corporations. The Operating Partnership has
not requested, and does not intend to request, a ruling from the Service that it
or any of the Subsidiary Partnerships will be classified as a partnership for
federal income tax purposes.
EFFECT OF FAILURE TO QUALIFY AS A PARTNERSHIP
If for any reason the Operating Partnership or a Subsidiary Partnership were
taxed as a corporation, rather than as a partnership, for federal income tax
purposes, the Trust would not be able to satisfy the income and asset
requirements for REIT status. See "FEDERAL INCOME TAX CONSIDERATIONS RELATED TO
THE TRUST -- INCOME TESTS" AND "FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE
TRUST -- ASSET TESTS." In addition, any change in the Operating Partnership's or
a Subsidiary Partnership's status for tax purposes might be treated as a taxable
event, in which case the Trust might incur a tax liability without any related
cash distribution. See "FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE TRUST
-- DISTRIBUTION REQUIREMENTS." Further, items of income and deduction of the
Operating Partnership and the Subsidiary Partnerships would not pass through to
its partners, and its partners would be treated as shareholders for tax
purposes. Consequently, the Operating Partnership or a Subsidiary Partnership
would be required to pay income tax at corporate tax rates on its net income,
and distributions to its partners would constitute distributions that would not
be deductible in computing the Operating Partnership's or a Subsidiary
Partnership's taxable income.
INCOME TAXATION OF THE OPERATING PARTNERSHIP, THE SUBSIDIARY PARTNERSHIPS AND
THEIR PARTNERS
Partners, Not the Operating Partnership, Subject to Tax. The Operating
Partnership is not a taxable entity for federal income tax purposes. Rather, the
Trust is required to take into account its allocable share of the Operating
Partnership's income, gains, losses, deductions, and credits for any Operating
Partnership tax year ending within or with the tax year of the Trust, without
regard to whether the Trust has received or will receive any distribution of the
Operating Partnership. Such items will include the Operating Partnership's
available share of income, gain, loss, deductions and credits of the Subsidiary
Partnerships.
Partnership Allocations. Although a partnership agreement generally will
determine the allocation of income and losses among partners, such allocations
will be disregarded for tax purposes under Section 704(b) of the Code if they do
not comply with the provisions of that Section and the Treasury Regulations
promulgated thereunder. If an allocation is not recognized for federal income
tax purposes, the item subject to the allocation will be reallocated in
accordance with the partners' interests in the partnership, which will be based
on all of the facts and circumstances relating to the economic arrangement of
the partners with respect to such item. The Operating Partnership's allocations
of taxable income and loss of the Operating Partnership and the Subsidiary
Partnerships are intended to comply with the
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requirements of Section 704(b) of the Code and the Treasury Regulations
promulgated thereunder.
Tax Allocations With Respect to Contributed Properties. Pursuant to Section
704(c) of the Code, income, gain, loss and deduction attributable to appreciated
or depreciated property that is contributed to a partnership in exchange for an
interest in the partnership must be allocated for federal income tax purposes in
a manner such that the contributor is charged with, or benefits from, the
unrealized gain or unrealized loss associated with the property at the time of
the contribution. The amount of such unrealized gain or unrealized loss is
generally equal to the difference between the fair market value of the
contributed property at the time of contribution and the adjusted tax basis of
such property at the time of contribution. The Treasury Department recently
issued regulations requiring partnerships to use a "reasonable method" for
allocating items affected by Section 704(c) of the Code and outlining certain
reasonable allocation methods.
The Operating Partnership intends to use the "traditional method" of allocation
under Section 704(c) of the Code. The traditional method is the least favorable
method for the Trust due to certain technical limitations. Under the traditional
method, depreciation with respect to a contributed property for which there is a
difference between the property's book value and adjusted tax basis ("Book-Tax
Difference") at the time of contribution will be first allocated to the Trust
and other partners who did not have an interest in such property. These
allocations will continue until they have been allocated an amount of
depreciation equal to what they would have been allocated if the Operating
Partnership had purchased such property for its fair market value at the time of
contribution. In addition, if such a property is sold, gain equal to the
Book-Tax Difference at the time of sale will be specially allocated to the
partner who contributed the property. These allocations will tend to eliminate
the Book-Tax Differences with respect to the contributed hotels over the life of
the Operating Partnership. However, they may not always entirely eliminate the
Book-Tax Difference on an annual basis or with respect to a specific taxable
transaction such as a sale. Book-Tax Differences could cause the Trust to be
allocated (i) lower amounts of depreciation deduction for tax purposes than if
each contributed hotel were to have a tax basis equal to its fair market value
at the time of contribution and (ii) lower amounts of taxable loss in the event
of a sale of a contributed hotel at a book loss than the economic or book loss
allocated to the Trust as a result of such sale, with converse benefits to the
other partners in the Operating Partnership. These allocations might adversely
affect the Trust's ability to comply with REIT distribution requirements,
although the Trust does not anticipate that this will occur. These allocations
may also affect the earnings and profits of the Trust for purposes of
determining the portion of distributions taxable as dividend income. See
"FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE TRUST -- TAXATION OF TAXABLE
DOMESTIC SHAREHOLDERS". The application of these rules over time may result in a
higher portion of distributions being taxed as dividends than would have
occurred had the Trust purchased its interests in the Hotels at their agreed
values.
Under the Partnership Agreement, depreciation or amortization deductions of the
Operating Partnership generally will be allocated among its partners in
accordance with their respective interests in the Operating Partnership, except
to the extent that Section 704(c) of the Code requires that the Trust receive a
disproportionately large share of such deductions. In addition, gain on sale of
a hotel will be specially allocated to the limited partners of the Operating
Partnership to the extent of any built-in gain with respect to such hotel for
federal income tax purposes. The application of Section 704(c) of the Code to
the Operating
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Partnership is not entirely clear, however, and may be affected by Treasury
Regulations promulgated in the future. Similar provisions are included in the
partnership agreements of the Subsidiary Partnerships.
Basis in Partnership Interest. The Trust's adjusted tax basis in its partnership
interest in the Operating Partnership generally (i) equals the amount of cash
and the tax basis of any other property contributed to the Operating Partnership
by the Trust, (ii) is increased by (A) its allocable share of the Operating
Partnership's income and (B) its allocable share of indebtedness of the
Operating Partnership and (iii) is reduced, but not below zero, by the Trust's
allocable share of (A) the Operating Partnership's loss and (B) the amount of
cash distributed to the Trust and by constructive distributions resulting from a
reduction in the Trust's share of indebtedness of the Operating Partnership.
Similar rules apply to the Operating Partnership's tax basis in the Subsidiary
Partnerships.
If the allocation of the Trust's distributive share of the Operating
Partnership's loss would reduce the adjusted tax basis of the Trust's
partnership interest in the Operating Partnership below zero, the recognition of
such loss will be deferred until the recognition of such loss would not reduce
the Trust's adjusted tax basis below zero. To the extent that the Operating
Partnership's distributions, or any decrease in the Trust's share of the
indebtedness of the Operating Partnership (such decrease being considered a
constructive cash distribution to the partners), would reduce the Trust's
adjusted tax basis below zero, such distributions (including such constructive
distributions) constitute taxable income to the Trust. Taxable distributions and
constructive distributions normally will be characterized as capital gain, and,
if the Trust's partnership interest in the Operating Partnership has been held
for longer than the long-term capital gain holding periods, the distributions
and constructive distributions will be subject to favorable capital gains tax
rates. See "FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE TRUST -- TAXATION
OF TAXABLE DOMESTIC SHAREHOLDERS".
Depreciation Deductions Available to the Operating Partnership. Immediately
after the acquisition of the Hotels, the Trust made a cash contribution to the
Operating Partnership in exchange for a general partner interest in the
Operating Partnership. The Operating Partnership's initial basis in the Hotels
for federal income tax purposes generally is a carryover of the basis of the
previous ownership entities on the date that the Hotels were contributed to the
Operating Partnership. Although the law is not entirely clear, the Operating
Partnership has depreciated such depreciable hotel property for federal income
tax purposes under the same methods used by the transferors. The Operating
Partnership's tax depreciation deductions will be allocated among its partners
in accordance with their respective interests in the Operating Partnership,
except to the extent that Section 704(c) of the Code requires that the Trust
receive a disproportionately large share of such deductions. The Operating
Partnership plans to depreciate, for federal income tax purposes, any
depreciable hotel property which it may acquire for cash in the future under
either the modified accelerated cost recovery system of depreciation ("MACRS")
or the alternative depreciation system of depreciation ("ADS"). The Operating
Partnership plans to use MACRS for subsequently acquired furnishings and
equipment. Under MACRS, the Operating Partnership generally will depreciate
furnishings and equipment over a seven-year recovery period using a 200%
declining balance method and a half-year convention. If, however, the Operating
Partnership places more than 40% of its furnishings and equipment in service
during the last three months of a taxable year, a mid-quarter depreciation
convention must be used for the
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furnishings and equipment placed in service during that year. The Operating
Partnership plans to use ADS to depreciate subsequently acquired buildings and
improvements. Under ADS, the Operating Partnership generally will depreciate
such buildings and improvements over a 40-year recovery period using a straight
line method and a mid-month convention.
To the extent that the Operating Partnership acquires additional hotels in
exchange for Operating Partnership units, the Operating Partnership's initial
basis in each such hotel, for federal income tax purposes, should be the same as
the transferor's basis in that hotel on the date of acquisition.
SALE OF THE OPERATING PARTNERSHIP'S PROPERTY
Generally, any gain realized by the Operating Partnership or the Subsidiary
Partnerships on the sale of property held for more than the applicable holding
period will be subject to favorable capital gains tax rates (See "FEDERAL INCOME
TAX CONSIDERATIONS RELATED TO THE TRUST -- TAXATION OF TAXABLE DOMESTIC
SHAREHOLDERS"), except for any portion of such gain that is treated as
depreciation or cost recovery recapture. Any gain recognized by the Operating
Partnership on the disposition of the Hotels will be allocated first to its
limited partners under Section 704(c) of the Code to the extent of the limited
partners' built-in gain on those Hotels. The limited partners' built-in gain on
the Hotels sold will equal the excess of the limited partners' proportionate
share of the book value of those Hotels over the limited partners' tax basis
allocable to those Hotels at the time of sale. Any remaining gain recognized by
the Operating Partnership on the disposition of the Hotels will be allocated
among all its partners in accordance with their respective percentage interests
in the Operating Partnership. The Board of Trustees has adopted a policy
requiring that any decision to sell the Hotels will be made by a vote of a
majority of the independent Trustees.
The Trust's share of any gain realized by the Operating Partnership or a
Subsidiary Partnership on the sale of any property held as inventory or other
property held primarily for sale to customers in the ordinary course of the
Operating Partnership's or a Subsidiary Partnership's trade or business,
however, will be treated as income from a prohibited transaction that is subject
to a 100% penalty tax. Such prohibited transaction income also may have an
adverse effect upon the Trust's ability to satisfy the income test for REIT
status. See "FEDERAL INCOME TAX CONSIDERATIONS RELATED TO THE TRUST -- INCOME
TESTS" ABOVE.
ERISA CONSIDERATIONS
The following is a summary of material considerations arising under the Employee
Retirement Income Security Act of 1974, as amended ("ERISA"), and the prohibited
transactions provisions of Section 4975 of the Code that may be relevant to a
prospective purchaser (including, with respect to the discussion contained in
" -- Status of the Trust and the Operating Partnership under ERISA," to a
prospective purchaser that is not an employee benefit plan, another
tax-qualified retirement plan, or an individual retirement account ("IRA")).
This discussion does not purport to deal with all aspects of ERISA or Section
4975 of the Code that may be relevant to particular shareholders (including
plans subject to Title I of ERISA, other retirement plans and IRAs subject to
the prohibited transaction provisions of Section 4975 of the Code, and
governmental plans or church plans that are exempt from ERISA and Section 4975
of the Code but that may be subject to state law requirements) in
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light of their particular circumstances. The statements in this discussion are
based on current provisions of ERISA and the Code, existing regulations under
ERISA and the Code, the legislative history of ERISA and the Code, existing
administrative rulings of the Department of Labor (the "DOL") and reported
judicial decisions. No assurance can be given that legislative, judicial, or
administrative changes will not affect the accuracy of any statements in this
Prospectus with respect to transactions entered into or contemplated prior to
the effective date of such changes.
A FIDUCIARY MAKING THE DECISION TO INVEST IN THE TRUST AND MANAGEMENT COMPANY ON
BEHALF OF A PROSPECTIVE PURCHASER THAT IS AN EMPLOYEE BENEFIT PLAN, A
TAX-QUALIFIED RETIREMENT PLAN OR AN IRA IS ADVISED TO CONSULT ITS OWN LEGAL
ADVISOR REGARDING THE SPECIFIC CONSIDERATIONS ARISING UNDER ERISA, SECTION 4975
OF THE CODE AND STATE LAW WITH RESPECT TO THE PURCHASE, OWNERSHIP OR SALE OF THE
SHARES BY SUCH PLAN OR IRA.
EMPLOYEE BENEFIT PLANS, TAX-QUALIFIED RETIREMENT PLANS AND IRAS
Each fiduciary of a pension, profit-sharing or other employee benefit plan
subject to Title I of ERISA (an "ERISA Plan") should carefully consider whether
an investment in the Common Shares and the Warrants are consistent with that
person's fiduciary responsibilities under ERISA. In particular, the fiduciary
requirements of Part 4 of Title I of ERISA require an ERISA Plan's investments
to be (a) prudent and in the best interests of the ERISA Plan, its participants
and its beneficiaries, (b) diversified in order to reduce the risk of large
losses, unless it is clearly prudent not to do so, and (c) authorized under the
terms of the governing documents of the ERISA Plan. In determining whether
investments in the Common Shares and Warrants are prudent for purposes of ERISA,
the appropriate fiduciary of an ERISA Plan should consider all of the facts and
circumstances, including whether the investments are reasonably designed, as a
part of the ERISA Plan's portfolio for which the fiduciary has investment
responsibility, to meet the objectives of the ERISA Plan, taking into
consideration the risk of loss and opportunity for gain (or other return) from
the investments, the diversification, the cash flow and funding requirements of
the ERISA Plan and the liquidity and current return of the ERISA Plan's
portfolio. A fiduciary should also take into account the nature of the Trust's
and the Management Company's businesses, the length of the Trust's and the
Management Company's operating histories, the terms of the management agreements
between the Initial Lessee and the Management Company, the fact that certain
investment properties may not yet have been identified and the possibility of
UBTI.
The fiduciary of an IRA or of a qualified retirement plan not subject to Title I
of ERISA because it is a governmental or church plan or because it does not
cover common law associates or U.S. persons (a "Non-ERISA Plan") should consider
that such an IRA or Non-ERISA plan may only make investments that are authorized
by the appropriate governing documents and under applicable state law.
In addition, ERISA and the corresponding provisions of the Code prohibit a wide
range of transactions involving the assets of an ERISA Plan or an IRA, and
persons who have certain specified relationships to these plans ("parties in
interest" within the meaning of ERISA; "disqualified persons" within the meaning
of the Code). Thus, a designated plan fiduciary considering investments in the
Common Shares and the Warrants should also consider whether the acquisition or
the continued holding of the Common Shares and Warrants might constitute or give
rise to a direct or indirect prohibited transaction.
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STATUS OF THE TRUST AND THE OPERATING PARTNERSHIP UNDER ERISA
The following section discusses certain principles that apply in determining
whether the fiduciary requirements of ERISA and the prohibited transaction
provisions of ERISA and the Code apply to an entity because one or more
investors in the entity's equity interests is an ERISA Plan or is a Non-ERISA
Plan or IRA subject to Section 4975 of the Code. An ERISA Plan fiduciary should
also consider the relevance of these principles to ERISA's prohibition on
improper delegation of control over or responsibility for "plan assets" and
ERISA's imposition of co-fiduciary liability on a fiduciary who participates in,
permits (by action or inaction) the occurrence of, or fails to remedy a known
breach by another fiduciary.
The DOL, which has certain administrative responsibility over ERISA Plans as
well as over IRAs and other Non-ERISA Plans, has issued a regulation defining
"plan assets" (the "DOL Regulation"). The DOL Regulation generally provides that
when an ERISA or Non-ERISA Plan or IRA acquires a security that is an equity
interest in an entity, and that security is neither a "publicly-offered
security" nor a security issued by an investment company registered under the
Investment Trust Act of 1940, the ERISA or Non-ERISA Plan's or IRA's assets
include both the equity interest and an undivided interest in each of the
underlying assets of the entity, unless it is established either that the entity
is an operating company or that equity participation in the entity by benefit
plan investors is not significant.
The DOL Regulation defines a publicly-offered security as a security that is
"widely held," "freely transferable" and either part of a class of securities
registered under the Exchange Act or sold pursuant to an effective registration
statement under the Securities Act (provided the securities are registered under
the Exchange Act within 120 days after the end of the fiscal year of the issuer
during which the offering occurred). The Common Shares and Warrants are being
sold in an offering registered under the Securities Act and are being registered
under the Exchange Act.
The DOL Regulation provides that a security is "widely held" only if it is part
of a class of securities that is owned by 100 or more investors independent of
the issuer and of one another. A security will not fail to be "widely held"
because the number of independent investors falls below 100 subsequent to the
initial public offering as a result of event beyond the issuer's control. The
Trust and the Management Company expect the Common Shares and Warrants to be
"widely held" upon completion of this offering.
The DOL Regulation provides that whether a security is "freely transferable" is
a factual question to be determined on the basis of all relevant facts and
circumstances. The DOL Regulation further provides that, where a security is
part of an offering in which the minimum investment is $10,000 or less (as is
the case with this offering), certain restrictions ordinarily will not, alone or
in combination, affect a finding that such securities are freely transferable.
The restrictions on transfer enumerated in the DOL Regulation as not affecting
that finding include: (i) any restriction on or prohibition against any transfer
or assignment that would result in a termination or reclassification of the
Trust for federal or state tax purposes, or that would otherwise violate any
state or federal law or court order, (ii) any requirement that advance notice of
a transfer or assignment be given to the Trust, (iii) any requirement that
either the transferor or transferee, or both, execute documentation setting
forth representations as to compliance with any restrictions on transfer that
are among those enumerated in the final DOL Regulation as not affecting free
transferability, (iv) any administrative procedure that establishes an effective
date or an event (such as completion of the Offering) prior to which a transfer
or assignment will not be effective and (v) any
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limitation or restriction on transfer or assignment that is not imposed by the
issuer or a person acting for or on behalf of the issuer. The Trust believes
that the restrictions imposed under the Declaration on the transfer of shares
are limited to the restrictions on transfer generally permitted under the DOL
Regulation and are unlikely to result in the failure of the shares to be "freely
transferable." See "DESCRIPTION OF CAPITAL STOCK OF THE TRUST -- RESTRICTIONS ON
OWNERSHIP AND TRANSFER." The Trust also believes that certain restrictions that
apply to the Common Shares that derive from the securities laws and from
contractual arrangements requested by the Underwriters in connection with this
offering are unlikely to result in the failure of the Common Shares to be
"freely transferable." See "DESCRIPTION OF CAPITAL STOCK OF THE
TRUST -- RESTRICTIONS ON OWNERSHIP AND TRANSFER." "SHARES AVAILABLE FOR FUTURE
SALE BY THE TRUST" and "UNDERWRITING." Furthermore, the Trust is not aware of
any other facts or circumstances limiting the transferability of the Common
Shares that are not included among those enumerated as not affecting their free
transferability under the DOL Regulation, and the Trust does not expect or
intend to impose in the future (or to permit any person to impose on its behalf)
any limitations or restrictions on transfer that would not be among the
enumerated permissible limitations or restrictions. Accordingly, it is expected
that the assets of the Trust will not be deemed to be "plan assets" of any ERISA
Plan, Non-ERISA Plan or IRA that invests in the shares. The DOL Regulation only
establishes a presumption in favor of a finding of free transferability,
however, and no assurance can be given that the DOL or the Treasury Department
will not reach a contrary conclusion.
If the assets of the Trust were deemed to be "plan assets" under ERISA, (i) the
prudence standards and other provisions of Part 4 of Title I of ERISA would be
applicable to any transactions involving the Trust's assets, (ii) persons who
exercise any authority or control over the Trust's assets, or who provide
investment advice to the Trust, would (for purposes of the fiduciary
responsibility provisions of ERISA) be fiduciaries of each ERISA Plan that
acquires shares, and transactions involving the Trust's assets undertaken at
their direction or pursuant to their advice might violate their fiduciary
responsibilities under ERISA, especially with regard to conflicts of interest,
(iii) a fiduciary exercising its investment discretion over the assets of an
ERISA Plan to cause it to acquire or hold the shares could be liable under the
aforementioned Part 4 of Title I of ERISA for transactions entered into by the
Trust that do not conform to ERISA standards of prudence and fiduciary
responsibility and (iv) certain transactions that the Trust might enter into in
the ordinary course of its business and operations might constitute a
"prohibited transaction" under ERISA and the Code.
The DOL Regulation will also apply in determining whether the assets of the
Operating Partnership will be deemed to be "plan assets." The DOL Regulation
provides that the assets of an entity will not be treated as "plan assets" if
equity participation by benefit plan investors in the entity is not significant.
Participation by benefit plan investors would not be significant if less than
25% of the value of each class of equity interests were held by benefit plan
investors, which are defined as ERISA Plans, IRAs, Non-ERISA Plans and any
entity whose underlying assets include plan assets by reason of a plan's
investment in the entity. The investment of the Trust in the Operating
Partnership, which is expected to be approximately 49% following this offering,
will not be treated as an investment by a benefit plan investor if the assets of
the Trust are not treated as "plan assets" under the analysis set forth above.
For purposes of determining whether participation by benefit plan investors is
significant, the value of any equity interests held by a person (other than a
benefit plan investor) who has discretionary authority or control, with respect
to the assets of the entity,
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shall be disregarded. The Trust may be considered to have discretionary
authority or control with respect to the assets of the Operating Partnership; as
a result, the value of the Trust's equity interest in the Operating Partnership
might be disregarded for purposes of calculating whether participation by
benefit plan investors is significant. It is expected that participation by
benefit plan investors in the Operating Partnership will not be significant and
that the assets of the Operating Partnership will therefore not be treated as
"plan assets." In any event, it is expected that the Operating Partnership will
qualify as an operating company under the DOL Regulation, in which case its
assets will not be treated as "plan assets." If the assets of the Operating
Partnership were treated as "plan assets," certain adverse consequences could
occur, including the applicability of the prudence standards and other
provisions of Part 4 of Title I of ERISA to any transactions involving the
assets of the Operating Partnership.
ANY ERISA PLAN OR BENEFIT PLAN INVESTOR PROPOSING TO PURCHASE SHARES SHOULD
CONSULT WITH ITS COUNSEL.
INNSUITES INNTERNATIONAL HOTELS, INC.
THE BUSINESS AND PROPERTIES OF THE MANAGEMENT COMPANY
The Management Company began operations in February 1998 as a Nevada corporation
and was organized to provide hotel management services to the Initial Lessee.
The Management Company's predecessors, InnSuites Hotels, LLC and Hospitality
Corporation International, began operations in 1980. The Management Company has
provided and will continue to provide hotel management services to the Initial
Lessee pursuant to management service agreements with the Initial Lessee.
Specifically, the Management Company provides property-level management support
for each of the current hotel properties. For these services, the Management
Company receives annual management fees of 2.5% of gross room revenues for each
hotel it manages. The Management Company will also provide hotel management
services for any new hotel properties leased by the Initial Lessee and will
receive additional management fees for those services.
In the past, the Initial Lessee has received trademark and licensing services
from InnSuites Licensing Corp. The Initial Lessee paid InnSuites Licensing Corp.
an annual licensing fee of 2.5% of gross room revenues (1.25% for those hotel
properties which also carry a third-party franchise, such as Best Western(R) or
Holiday Inn(R)). As further described in this prospectus, the Management Company
has acquired InnSuites Licensing Corp., obtaining full ownership of the
InnSuites(R) trademark and tradename and acquired the trademark
licensing/franchise agreements with the Initial Lessee. The Management Company
will provide trademark and licensing services to and receive fees from the
Initial Lessee pursuant to the terms of the current trademark and license
agreements.
The combination of the Management Company and InnSuites Licensing Corp. will
integrate into the Management Company lease, management, and trademark and
franchise licensing activities. Owning the rights to the InnSuites(R) trademark
will provide the Management Company with the potential for trademark licensing
or franchising to third parties or trademark licensing in conjunction with
management contracts to third parties. Ownership of the trademark/franchise by
the Management Company distinguishes it from, and provides certain advantages
over, other hotel operators who must pay fees to third-parties for the right to
operate under a franchise. Instead, the Management Company, as both the hotel
operator
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and the franchise owner saves the costs otherwise associated with franchise fee
payments. This advantage is particularly important during economic downturns
since franchise fees are generally based upon gross, rather than net, receipts
and therefore impose a greater burden than that borne by hotels owned by a
franchisor. If the Management Company does not lease a newly acquired hotel
property of the Trust, the Management Company would still benefit from trademark
and franchise licensing of the InnSuites brand to the third-party lessee. The
Management Company may also consider licensing the InnSuites(R) trademark to
third-parties and seek management opportunities in connection with such
licensing independent of the Trust's new acquisitions.
While continuing to provide these services to the Initial Lessee, future
Management Company activities will include their execution and performance of an
Intercompany Agreement described on page 122 of this prospectus. Through the
Intercompany Agreement, the Management Company will have the opportunity to
manage and lease newly acquired hotels from the Operating Partnership and to
enter into certain businesses related to the hotels after February 1, 2000. The
Intercompany Agreement will permit those Trust's shareholders and those limited
partners who elect to exercise the Warrants to participate in the benefits of
the real estate operations of the Trust (including ownership of real property)
and the management, trademarking, reservations and leasing operations of, and
ownership of non-real estate assets by, the Management Company.
Due to limitations imposed by the Internal Revenue Code on REIT operations, the
Trust cannot directly manage or operate the hotel properties. The Internal
Revenue Code also restricts the types of assets the Trust may own. Therefore,
the Management Company will own assets that the Trust itself could not own and
conduct activities that the Trust itself could not conduct. For example, many
operations and assets that are closely associated with the operation of the
hotels could cause the Trust to violate the strict asset and income tests
applied to REITs. Those tests are further described elsewhere in this
prospectus. The Management Company is intended to function principally as a
service and operating company, in contrast to the Trust's principal focus on
investment in real estate assets. The Management Company will seek to implement
its investment and operating strategies by acquiring and operating a
complementary group of businesses aligned with certain investments and
businesses of the Trust. To pursue such opportunities, the Management Company
plans to further capitalize on its relationship with the Trust. The additional
opportunities the Management Company may pursue are expected to be varied and
may be unrelated to any current or future business of the Management Company.
The Management Company will primarily focus on increasing net income through
efficient operations and expense control.
An additional focus of the Management Company will be to assist in locating
properties that could be purchased below replacement cost, providing a right of
first refusal to the Trust to purchase such properties and providing the
Management Company the opportunity to obtain a fair lease arrangement for such
properties. This focus could allow the Management Company to benefit from the
renovation and repositioning of such hotels leading to higher overall Management
Company profitability. The Management Company would receive a portion of these
increased profits through future Percentage Leases. If the Trust does not
exercise its right of first refusal, the Management Company may purchase and
reposition such properties. The Management Company may also consider building
and developing new hotels or resorts as the principals of the Management Company
have expertise in new construction and
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development. Pursuant to the Intercompany Agreement, the Management Company will
provide the Trust with a right of first refusal for real property it refurbishes
and repositions.
The Management Company also operates the InnSuites Reservation Center in Tempe,
Arizona. From this centralized location, the Management Company offers toll-free
InnSuites Hotels reservation services to the United States, Canada, Mexico,
Great Britain, the Netherlands, and Germany. The Management Company will also
develop Internet-based reservation services. For Internet consumers, the
Management Company will provide the InnSuites Reservation system over the world
wide web at www.innsuites.com and offer rack, corporate and discount rates for
all InnSuites Hotels' locations. For travel industry professionals and other
Internet consumers, www.discountsuites.com will provide wholesale discount rates
for excess lodging capacities at InnSuites and non-affiliated hotels. Based on
projected availabilities, the second system will utilize InnSuites' excess
capacities to support overall hotel profitability and build InnSuites Hotels'
name recognition within the travel industry. This industry-oriented system will
be owned and operated by discountsuites.com, Inc., a subsidiary of the
Management Company, owned 90% by the Management Company and 10% by certain
officers of the Trust, officers of the Management Company and Internet
consultants. The Management Company estimates that both Internet reservation
systems will be fully operational by April 1999.
The Management Company's principal executive offices are located at 1625 E.
Northern Avenue, Suite 201, Phoenix, Arizona 85020 and its telephone number is
(602) 944-1500.
INTERCOMPANY AGREEMENT
Upon completion of this offering, the Management Company, the Trust and the
Operating Partnership will enter into the Intercompany Agreement which will
provide each other with rights to participate in certain transactions. The
Intercompany Agreement is designed to permit investors who purchase and retain
equity interests in both the Trust and the Management Company to participate in
the benefits of investing in both companies in a manner similar to holders of
shares in "paired share" REITs. Holders of both Trust and Management Company
shares will enjoy the economic benefits of both the profits from lease payments
received by the Trust and the operating profits realized by the Management
Company, while maintaining the tax benefits of the Trust's REIT status. The
Trust and the Management Company believe that their operating and growth
strategies will benefit from this alliance.
In order to maintain its REIT qualification, the Trust anticipates leasing
hotels acquired after February 1, 2000 to the Management Company pursuant to
Percentage Leases in accordance with the terms of the Intercompany Agreement.
The Intercompany Agreement provides, subject to certain terms, that the
Operating Partnership or the Trust will provide the Management Company with a
right of first refusal to become the lessee of any real property acquired by the
Operating Partnership or the Trust after February 1, 2000 upon a determination
that, consistent with the Trust's status as a REIT, it is required to enter into
a lease arrangement, provided that the Management Company and the Operating
Partnership or the Trust negotiate a mutually satisfactory lease arrangement and
the Operating Partnership or the Trust determines, in its sole discretion, that
the Management Company is qualified to be the lessee. For example, the Operating
Partnership or the Trust generally would be required, consistent with the
Trust's status as a REIT, to enter into a lease arrangement as to its hotels
under which an entire property or project (or a group of related properties or
projects) are leased to a single lessee. The Intercompany Agreement provides
that the Operating
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Partnership or the Trust must provide the Management Company with written notice
of all opportunities for the Management Company to become the lessee under a
lease arrangement. The Trust presently intends to lease newly acquired hotels to
the Initial Lessee until February 1, 2000.
The Intercompany Agreement requires the Management Company to provide licensing
and trademark services to the Operating Partnership or the Trust for newly
acquired hotels, provided such hotels meet certain franchise standards similar
to those now in place at the Hotels.
Under the Intercompany Agreement, the Management Company has agreed not to
acquire or make (i) investments in real estate which, for purposes of the
Intercompany Agreement, include the provision of services related to real estate
and investments in hotel properties, real estate mortgages, real estate
derivatives or entities that invest in real estate assets or (ii) any other
investments that may be structured in a manner that qualifies under the federal
income tax requirements applicable to REITs unless it has provided written
notice to the Trust of the material terms and conditions of the acquisition or
investment opportunity and the Trust has determined not to pursue such
acquisitions or investments either by providing written notice to the Management
Company rejecting the opportunity within ten days or by allowing such ten-day
period to lapse. The Management Company also has agreed to assist the Trust in
structuring and consummating any such acquisition or investment which the Trust
elects to pursue, on terms determined by the Trust.
The Management Company has agreed to provide the Trust with a right of first
refusal with respect to any real property which it has decided to sell. Finally,
the Management Company has agreed to notify the Trust of, and make available to
the Trust, investment opportunities developed by the Management Company or of
which the Management Company becomes aware but is unable or unwilling to pursue.
LEGAL PROCEEDINGS
The Management Company is not currently involved in any material litigation nor,
to the Management Company's knowledge, is any material litigation currently
threatened against it.
EMPLOYEES
The Management Company has 3 employees which assist the Initial Lessee in
managing the Hotels. The Management Company will continue the Management Group's
ongoing recruiting efforts to attract quality talent at all levels. None of the
persons employed by the Management Company are represented by a union. The
Management Company believes that its relations with its employees are excellent.
SEASONAL HOTEL OPERATIONS
The Management Company depends on hotel operations for its income. Hotel
operations are subject to seasonality. See "RISK FACTORS RELATED TO THE
MANAGEMENT COMPANY -- SEASONAL REVENUE FLUCTUATIONS OF HOTEL BUSINESS."
ENVIRONMENTAL COMPLIANCE
As an operator of hotel properties, the Management Company could incur liability
for costs associated with compliance with environmental claims and regulations.
See "RISK
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FACTORS RELATED TO THE MANAGEMENT COMPANY -- POTENTIAL COSTS OF COMPLYING WITH
ENVIRONMENTAL LAWS."
THE WARRANT DISTRIBUTION
The Management Company will initially issue the Warrants to Mr. Wirth who will
then contribute the Warrants to the Operating Partnership. The Operating
Partnership will distribute some of the Warrants to the Trust.
The Warrants will then be distributed to each holder of Trust Common Shares or
Operating Partnership Class A Units immediately following the completion of this
offering. At the time of the Warrant distribution, certificates representing the
Warrants will be delivered to the shareholders and unitholders of record. The
Warrant distribution will be made on the basis of one Warrant for every Common
Share or Class A Unit held on the record date. As of the record date ( ,
1999) there were Common Shares and Class A Units outstanding. All
Warrants will be fully paid and nonassessable. See "DESCRIPTION OF WARRANTS."
NO HOLDER OF COMMON SHARES OR OPERATING PARTNERSHIP UNITS WILL BE REQUIRED TO
MAKE ANY PAYMENT FOR THE WARRANTS TO BE RECEIVED IN THE DISTRIBUTION OR TO
SURRENDER OR EXCHANGE COMMON SHARES OR UNITS OR TO TAKE ANY OTHER ACTION IN
ORDER TO RECEIVE WARRANTS TO WHICH THE HOLDER IS ENTITLED IN THE DISTRIBUTION.
DESCRIPTION OF WARRANTS
The Warrants will be issued pursuant to a Warrant Agreement (the "Warrant
Agreement") between the Management Company and National City Bank, as Warrant
Agent (the "Warrant Agent"). The following summary of the material provisions of
the Warrant Agreement does not purport to be complete and is qualified in its
entirety by reference to the Warrant Agreement, including the definitions
therein of certain terms used below, a copy of which is filed as an exhibit to
the Registration Statement of which this Prospectus forms a part.
Each Warrant, when exercised, will entitle the holder thereof (a "Warrant
Holder") to receive one fully paid and non-assessable share of Management
Company Common Stock (the "Warrant Shares"), at an exercise price of $2.50 per
share (the "Exercise Price"). The Exercise Price and the number of Warrant
Shares are both subject to adjustment in certain cases referred to below. The
Warrants will be exercisable beginning on the first anniversary of the
completion of this offering of Common Shares. Unless exercised, the Warrants
will automatically expire on , 2006 (the "Expiration Date").
There is no public market for the Management Company Common Stock. The exercise
price for the shares of Management Company Common Stock offered hereby has been
determined by negotiations among the Management Company and the Underwriter.
Among the factors considered in determining the exercise price were prevailing
market and general economic conditions, the revenues and earnings of the
Management Company in recent periods, the current financial condition of the
Management Company, estimates of the business potential and earnings prospects
of the Management Company, the present state of the Management Company's
development, and other factors deemed relevant. Additionally, consideration was
given to the general status of the securities market, market conditions for new
issues of
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securities, and the demand for securities of comparable companies at the time of
this offering.
The Warrants may be exercised by surrendering to the Management Company the
warrant certificate, evidencing the Warrants to be exercised, with the
accompanying form of election to purchase properly completed and executed,
together with payment of the Exercise Price. Payment of the Exercise Price shall
be made in cash in United States dollars by wire transfer or by certified or
official bank check to the order of the Management Company. Upon surrender of
the warrant certificate and payment of the Exercise Price, the Company will
deliver or cause to be delivered, to or upon the written order of such Warrant
Holder, stock certificates representing the number of whole Warrant Shares to
which the Warrant Holder is entitled. If less than all of the Warrants evidenced
by a warrant certificate are to be exercised, a new warrant certificate will be
issued for the remaining number of Warrants. Warrant Holders will be able to
exercise their Warrants for cash so long as the Registration Statement is then
in effect, or the exercise of such Warrants is exempt from the registration
requirements of the Securities Act, and such securities are qualified for sale
or exempt from qualification under the applicable securities laws of the states
in which the various Warrant Holders, or other persons to whom it is proposed
that Warrant Shares be issued on exercise of the Warrants, reside.
The Warrant Holders will have no right to vote on matters submitted to the
stockholders of the Management Company and will have no right to receive
dividends. The Warrant Holders will not be entitled to share in the assets of
the Management Company in the event of liquidation, dissolution or the winding
up of the Management Company. In the event a bankruptcy or reorganization is
commenced by or against the Management Company, a bankruptcy court could
determine that unexercised Warrants are executory contracts, and therefore
subject to rejection by the Management Company with approval of the bankruptcy
court, and the Warrant Holders may, even if sufficient funds are available,
receive nothing or a lesser amount as a result of any such bankruptcy case than
they would be entitled to if they had exercised their Warrants prior to the
commencement of any such case.
In the event of a taxable distribution to holders of Management Company Common
Stock that results in an adjustment to the number of Warrant Shares or other
consideration for which a Warrant may be exercised, the Warrant Holders may, in
certain circumstances, be deemed to have received a distribution subject to
United States federal income tax as a dividend.
ADJUSTMENTS
Subject to certain exceptions, the number of Warrant Shares purchasable upon
exercise of Warrants and the Exercise Price will be subject to adjustment,
including, but not limited to, the occurrence of the following events:
- - the payment by the Management Company in its Common Stock of dividends and
other distributions on its Common Stock;
- - subdivisions, combinations and reclassification of Management Company Common
Stock;
- - the issuance to all holders of Management Company Common Stock of certain
rights, options or warrants entitling them to subscribe for Management Company
Common Stock or securities convertible into, or exchangeable or exercisable
for, Management Company
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Common Stock at a price which is less than the Fair Value per share (as
defined) of Management Company Common Stock;
- - certain distributions to all holders of Management Company Common Stock of any
of the Management Company's assets, debt securities, other securities or any
rights or warrants to purchase any such securities (excluding those rights and
warrants referred to in the third clause above);
- - the issuance of shares of Management Company Common Stock for consideration
per share less than the then Fair Value per share of Management Company Common
Stock (excluding securities issued in transactions referred to in the first
four clauses above and certain other issuances);
- - the issuance of securities convertible into or exchangeable for Management
Company Common Stock for a conversion or exchange price plus consideration
received upon issuance less than the then Fair Value per share of Management
Company Common Stock (excluding securities issued in transactions referred to
in the first four clauses above); and
- - certain other events that could have the effect of depriving Warrant Holders
of the benefit of all or a portion of the purchase rights evidenced by the
Warrants.
Adjustments to the Exercise Price per share will be calculated to the nearest
cent. No adjustment need be made for any of the foregoing transactions if
Warrant Holders are to participate in the transaction on a basis and with notice
that the Board of Directors determines to be fair and appropriate in light of
the basis and notice on which holders of Management Company Common Stock
participate in the transaction.
"Fair Value" per security at any date of determination shall be (1) in
connection with a sale to a party that is not an affiliate of the Management
Company in an arm's-length transaction (a "Non-Affiliate Sale"), the price per
security at which such security is sold and (2) in connection with any sale to
an affiliate of the Management Company, (a) the last price per security at which
such security was sold in a Non-Affiliate Sale within the three-month period
preceding such date of determination or (b) if clause (a) is not applicable, the
fair market value of such security determined in good faith by (i) a majority of
the Board of Directors of the Management Company, including a majority of the
Disinterested Directors, and approved in a board resolution delivered to the
Warrant Agent or (ii) a nationally recognized investment banking, appraisal or
valuation firm, which is not an affiliate of the Management Company, in each
case, taking into account, among all other factors deemed relevant by the Board
of Directors of the Management Company or such investment banking, appraisal or
valuation firm, the trading price and volume of such security on any national
securities exchange or automated quotation system on which such security is
traded. Notwithstanding the foregoing, any sale pursuant to an underwritten
public offering registered under the Securities Act shall be deemed to be and
treated as a Non-Affiliate Sale.
"Disinterested Director" means, in connection with any issuance of securities
that gives rise to a determination of the Fair Value thereof, each member of the
Board of Directors of the Management Company who is not an officer, employee,
director or other affiliate of the party to whom the Management Company is
proposing to issue the securities giving rise to such determination.
No adjustment in the Exercise Price will be required unless such adjustment
would require an increase or decrease of at least one percent (1.0%) in the
Exercise Price, provided however,
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that any adjustment that is not made will be carried forward and taken into
account in any subsequent adjustment.
In the case of certain consolidations or mergers of the Management Company, or
the sale of all or substantially all of the assets of the Management Company to
another corporation, (i) each Warrant will thereafter be exercisable for the
right to receive the kind and amount of shares of stock or other securities or
property to which such Warrant Holder would have been entitled as a result of
such consolidation, merger or sale had the Warrants been exercised immediately
prior thereto and (ii) the entity formed by or surviving any such consolidation
or merger (if other than the Management Company) or to which such sale shall
have been made will assume the obligations of the Management Company under the
Warrant Agreement.
RESERVATION OF SHARES
The Management Company will at all times reserve and keep available such number
of shares of Management Company Common Stock as will be issuable upon the
exercise of all outstanding Warrants. Such shares of Management Company Common
Stock, when paid for and issued, will be duly and validly issued, fully paid and
non-assessable, free of preemptive rights and free from all taxes, liens,
charges and security interests with respect to the issuance thereof.
AMENDMENT
From time to time, the Management Company and the Warrant Agent, without the
consent of the Warrant Holders, may amend or supplement the Warrant Agreement
for certain purposes, including curing defects or inconsistencies or making any
change that does not adversely affect the legal rights of any Warrant Holder.
Any amendment or supplement to the Warrant Agreement that adversely affects the
legal rights of the Warrant Holders will require the written consent of the
Warrant Holders owning a majority of the then outstanding Warrants (excluding
Warrants held by the Management Company or any of its affiliates). The consent
of each Warrant Holder affected will be required for any amendment pursuant to
which the Exercise Price would be increased or the number of Warrant Shares
purchasable upon exercise of Warrants would be decreased (other than pursuant to
adjustments provided in the Warrant Agreement).
DELIVERY AND FORM
The Warrants will be in the form of registered, certificated warrants.
USE OF PROCEEDS BY THE MANAGEMENT COMPANY
The net proceeds to the Management Company from the exercise of the Warrants are
estimated to be $9,068,198 if all Warrants are exercised. The Management Company
anticipates that all of the proceeds will be added to the Management Company's
working capital and will be used for general corporate purposes which may
include acquisition of hotel properties not acquired by the Trust.
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FEDERAL INCOME TAX CONSEQUENCES OF
WARRANT DISTRIBUTION AND EXERCISE
INCOME RECOGNITION BY THE TRUST AS A RESULT OF THE WARRANT DISTRIBUTION
The Trust will recognize gain in connection with the distribution of the
Warrants to the extent that the fair market value of the Warrants distributed by
the Trust exceeds the Trust's adjusted tax basis in such Warrants. This gain, if
any, should be treated as qualifying for the 95% gross income test but not as
qualifying for the 75% gross income test. Based upon representations made by the
Trust, any gain recognized by the Trust on the distribution of Warrants when
combined with all other non-qualifying income will not cause the Trust to fail
either the 95% or 75% gross income tests. See "FEDERAL INCOME TAX CONSIDERATIONS
RELATED TO THE TRUST -- INCOME TESTS." The amount of such gain, if any, will
generally increase the Trust's current earnings and profits for its taxable year
ending January 31, 2000. Such increase in the Trust's current earnings and
profits will result in taxable income to the Trust's shareholders by increasing
the portion of the Trust's distributions that are treated as made out of current
earnings and profits for federal income tax purposes. The Trust's current
earnings and profits for its taxable year ending January 31, 2000 will generally
be allocated, for purposes of determining which portions of the Trust's
distributions made or deemed made in such fiscal year, including the
distribution of Warrants, were attributable to the Trust's earnings and profits,
in proportion to the relative size of such distributions on the Common Shares.
For purposes of allocating the Trust's earnings and profits among distributions
on the Common Shares, any distribution declared by the Trust in October,
November or December of any year payable to a shareholder of record on a
specified date in any such month shall be treated as both paid by the Trust and
received by the shareholder on December 31 of such year provided that such
distribution is actually paid by the Trust during January of the following
taxable year.
TAXATION OF TAXABLE DOMESTIC SHAREHOLDERS OF THE TRUST AS A RESULT OF THE
WARRANT DISTRIBUTION
The distribution of Warrants by the Trust will be treated as a taxable dividend
to Trust shareholders to the extent that it is treated as made out of the
Trust's current or accumulated earnings and profits (as determined for federal
income tax purposes). To the extent that the fair market value of the Warrants
distributed to a Trust shareholder exceeds the earnings and profits of the Trust
allocated to such distribution of the Warrants, such excess will be treated
first as a return of such shareholder's basis in its Common Shares to the extent
thereof and thereafter as capital gain on a deemed disposition of Common Shares
assuming the Common Shares are a capital asset in the hands of the shareholder.
Any such capital gain will be short-term capital gain if the Common Shares have
been held for one year or less by the shareholder. A shareholder's holding
period in the Warrants distributed by the Trust will not include any period
during which such Warrants were held by the Trust. As long as the Trust
qualifies as a REIT, the portion of the distribution of Warrants to the Trust's
taxable U.S. shareholders out of the Trust's current or accumulated earnings and
profits (and not designated as capital gain dividends) will be taken into
account by such U.S. shareholders as ordinary income and, for corporate
shareholders, will not be eligible for the dividends received deduction.
To the extent that the Trust designates a portion of the distribution as a
capital gain dividend, such portion will be taxable to Trust shareholders as
gain from the sale or exchange of a
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capital asset held for more than one year, without regard to the period for
which the shareholder has held its Common Shares. U.S. shareholders that are
corporations may, however, be required to treat up to 20% of certain capital
gain dividends as ordinary income.
TAXATION OF TAX-EXEMPT SHAREHOLDERS OF THE TRUST AS A RESULT OF THE WARRANT
DISTRIBUTION
Most tax-exempt employees' pension trusts are not subject to federal income tax
except to the extent of their receipt of "unrelated business taxable income" as
defined in Section 512(a) of the Code ("UBTI"). The distribution of Warrants
should not result in UBTI to a shareholder that is a tax-exempt entity, provided
that the tax-exempt entity has not financed the acquisition of its Common Shares
with "acquisition indebtedness" within the meaning of the Code and the Common
Shares are not otherwise used in an unrelated trade or business of the
tax-exempt entity. In addition, certain pension trusts that own more than 10% of
a "pension-held REIT" must report a portion of the dividends that they receive
from such a REIT as UBTI. The Trust has not been and does not expect to be
treated as a pension-held REIT for purposes of this rule.
TAXATION OF FOREIGN STOCKHOLDERS OF THE TRUST AS A RESULT OF THE WARRANT
DISTRIBUTION
The rules governing United States federal income taxation of nonresident alien
individuals, foreign corporations, foreign partnerships and other foreign
stockholders (collectively, "Non-U.S. Stockholders") are complex, and no attempt
will be made in this prospectus to provide more than a summary of such rules.
Non-U.S. Stockholders should consult with their own tax advisors to determine
the impact of federal, state and local tax laws with regard to the distribution
of Warrants, including any reporting requirements. In general, as is the case
with domestic taxable Trust shareholders, the distribution of Warrants is
treated as a distribution in an amount equal to the fair market value of the
Warrants distributed. Trust shareholders will receive a basis in the Warrants
equal to the fair market value thereof at the time of the distribution.
The distribution of Warrants will be treated as a dividend taxed as ordinary
income to the extent that it is treated as made out of the Trust's current or
accumulated earnings and profits, (under the rules described above under the
heading "--TAXATION OF TAXABLE DOMESTIC SHAREHOLDERS OF THE TRUST AS A RESULT OF
THE WARRANT DISTRIBUTION") and is not (i) designated by the Trust as a capital
gain dividend or (ii) attributable to gain recognized by the Trust in connection
with the disposition of a "United States real property interest". The Trust does
not anticipate that a significant portion of the distribution of Warrants will
be treated as attributable to a disposition by the Trust of a "United States
real property interest". The portion of the distribution of Warrants that is
treated as such an ordinary income dividend ordinarily will be subject to a
withholding tax equal to 30% of the gross amount of such portion, unless an
applicable tax treaty reduces or eliminates that tax. The Trust expects to
withhold U.S. income tax at the rate of 30% on the gross amount of the
distribution of Warrants made to a Non-U.S. Stockholder unless (i) a lower
treaty rate applies and the Non-U.S. Stockholder has filed the required IRS Form
1001 with the Trust or (ii) the Non-U.S. Stockholder files an IRS Form 4224 with
the Trust claiming that the distribution is effectively connected with the
Non-U.S. Stockholder's conduct of a U.S. trade or business. The portion of the
distribution of Warrants that is in excess of the Trust's current and
accumulated earnings and profits allocated to the distribution of Warrants will
be subject to a
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10% withholding requirement but will not be taxable to a shareholder to the
extent that such portion does not exceed the adjusted tax basis of the
shareholder's Common Shares, but rather will reduce the adjusted tax basis of
such shares. To the extent that the portion of the distribution of Warrants in
excess of the Trust's current and accumulated earnings and profits allocated to
such distribution exceeds the adjusted tax basis of a Non-U.S. Stockholder's
Common Shares, such excess will give rise to tax liability if the Non-U.S.
Stockholder would otherwise be subject to tax on any gain from the sale or
disposition of the Trust Shares. Any portion of the distribution of Warrants
which is treated as a capital gain dividend and is not attributable to a
disposition by the Trust of a United States real property interest shall be
subject to a similar rule. Provided that the Trust is a "domestically controlled
REIT" for federal income tax purposes, a Non-U.S. Stockholder would be subject
to taxation on gain from a sale or disposition of Common Shares only if (i) the
investment in the Trust Shares were treated as effectively connected with such
Non-U.S. Stockholder's U.S. trade or business, in which case the Non-U.S.
Stockholder would be subject to the same treatment as U.S. shareholders with
respect to such gain or (ii) the Non-U.S. Stockholder is a nonresident alien
individual who was present in the United States for 183 days or more during the
taxable year of the sale or disposition and either the individual has a "tax
home" in the United States or the gain is attributable to an office or other
fixed place of business maintained by the individual in the United States, in
which case the gain will be subject to a 30% tax. It is believed that the Trust
is and will continue to be a "domestically controlled REIT" for federal income
tax purposes.
As the Trust will not be able to determine, at the time that the distribution of
Warrants is made, the portion of such distribution, if any, that will be in
excess of the current and accumulated earnings and profits allocated to the
distribution, the distribution of Warrants will be subject to withholding as
though the entire distribution (apart from any portion designated as a capital
gain dividend) were an ordinary income dividend. However, a Non-U.S. Stockholder
may seek a refund of such amounts from the Service if it is subsequently
determined that a portion of the distribution of Warrants was, in fact, in
excess of the Trust's current and accumulated earnings and profits allocable to
such distribution.
It is not anticipated that a significant portion of the distribution of Warrants
will be treated as attributable to the Trust's disposition of a United States
real property interest. To the extent that a portion of the distribution of
Warrants were to be treated as attributable to the disposition of a United
States real property interest, a Non-U.S. Stockholder would be subject to tax on
such portion as though it were gain that was effectively connected with a United
States trade or business of such Non-U.S. Stockholder. Thus, Non-U.S.
Stockholders would be taxed on such portion of the distribution of Warrants at
the normal capital gain rates applicable to U.S. shareholders. The Trust is
required under applicable Treasury Regulations to withhold 35% of any
distribution to a Non-U.S. Stockholder that could be designated by the Trust as
a capital gain dividend. The amount so withheld is creditable against the Non-
U.S. Stockholder's U.S. tax liability.
Amounts required to be withheld from payments to Non-U.S. Stockholders will be
collected by converting a portion of the Warrants to be distributed into cash.
TAXATION OF LIMITED PARTNERS AS A RESULT OF THE WARRANT DISTRIBUTION
If the Warrants are treated as marketable securities as defined in the Code, the
distribution of Warrants to a limited partner of the Operating Partnership will
generally result in the recognition of gain by such limited partner to the
extent that the fair market value of the
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<PAGE> 139
Warrant distributed exceeds such limited partner's basis in his partnership
interest. A marketable security as defined in the Code includes personal
property (such as the Warrants) which may be traded on a national securities
exchange or through an interdealer market.
TAX CONSEQUENCES OF WARRANT EXERCISE
A Warrant Holder's tax basis in the Warrants will be equal to the fair market
value of such Warrants on the date of distribution. The Warrant Holder's holding
period for such Warrants will begin on the day following the date of
distribution. The Trust believes that the Warrants are noncompensatory in which
case a Warrant Holder generally will not recognize gain or loss upon exercise of
a Warrant. The Warrant Holder's federal income tax basis in the Warrant Shares
received upon exercise of the Warrant will be equal to the holder's federal
income tax basis in the Warrant immediately prior to exercise (the cost of the
Warrant), plus the amount of cash paid upon exercise. The holding period of the
Warrant Shares acquired upon exercise of the Warrant will begin on the day after
the date of exercise of the Warrant and will not include the period during which
the Warrant was held.
SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
AND OPERATING DATA OF THE MANAGEMENT COMPANY
The following tables set forth selected unaudited pro forma condensed financial
information for the Management Company for the year ended December 31, 1997 and
the nine months ended September 30, 1998.
The Pro Forma Condensed Balance Sheet of the Management Company is presented as
if the transactions reflected all had occurred as of September 30, 1998.
The Pro Forma Condensed Statements of Operations of the Management Company for
the year ended December 31, 1997 and for the nine months ended September 30,
1998 are presented as if the acquisitions of the Hotels and the beginning of the
relevant lease years had occurred on January 1, 1997, and therefore incorporates
certain assumptions that are included in the Notes to the Pro Forma Condensed
Statements of Operations.
The following selected financial information should be read in conjunction with
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE MANAGEMENT COMPANY" and all other historical financial
statements and notes included elsewhere in this Prospectus.
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INNSUITES INNTERNATIONAL HOTELS, INC.(1)
(THE MANAGEMENT COMPANY)
PRO FORMA BALANCE SHEET
(AS OF SEPTEMBER 30, 1998)
UNAUDITED (AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ACTUAL AT PRO FORMA
SEPTEMBER 30, 1998 ADJUSTMENTS(2) PRO FORMA
------------------ -------------- ---------
<S> <C> <C> <C>
ASSETS:
Cash.............................. $ 15 $ 20 $ 35
Loans Receivable.................. 675 400 1,075
Investments....................... -- -- --
Fixed Assets...................... 8 50 58
==== ====== ======
Total Assets.............. $698 470 $1,168
==== ====== ======
LIABILITIES:
Accounts Payable.................. $ -- -- $ --
Loans Payable..................... 650 107 757
Accrued Expenses.................. 5 -- 5
Other............................. 1 -- 1
---- ------ ------
Total Liabilities......... $656 107 $ 763
==== ====== ======
EQUITY:
Paid in Capital................... $ 1 $ 1 $ 2
Retained Earnings 41 362 403
==== ====== ======
Total Equity.............. $ 42 $ 363 $ 405
==== ====== ======
Total Liabilities and Equity........ $698 470 $1,168
==== ====== ======
</TABLE>
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<PAGE> 141
INNSUITES INNTERNATIONAL HOTELS, INC.(1)
(THE MANAGEMENT COMPANY)
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
UNAUDITED (AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED PRO FORMA
DECEMBER 31, 1997 ADJUSTMENTS(2) PRO FORMA
----------------- -------------- ---------
<S> <C> <C> <C>
REVENUES:
Management Fees.................. $848 $ 848
Trademark/Licensing Fees......... -- $529 $ 529
Other Income..................... -- $ 0
---- ---- ------
Total Revenue............ $848 $529 $1,377
OPERATING EXPENSES:
Payroll and Benefits............. $ 24 $ 90 $ 114
Professional Fees................ 4 7 $ 11
Travel and Entertainment......... 1 15 $ 16
General and Administration....... 19 27 $ 46
Other............................ 31 4 $ 35
==== ==== ======
Total Expenses........... $ 79 $143 $ 222
==== ==== ======
Net Income (Loss).................. $769 $386 $1,155
==== ==== ======
</TABLE>
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<PAGE> 142
INNSUITES INNTERNATIONAL HOTELS, INC.(1)
(THE MANAGEMENT COMPANY)
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
UNAUDITED (AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS PRO FORMA
ENDED SEPTEMBER 30, 1998 ADJUSTMENTS(2) PRO FORMA
------------------------ -------------- ---------
<S> <C> <C> <C>
REVENUE:
Management Fees.............. $405 -- $405
Trademark/Licensing Fees..... 0 $397 $397
Other Income................. 2 -- $ 2
==== ==== ====
Total Revenue........ $407 $397 $804
OPERATING EXPENSES:
Payroll and Benefits......... $ 55 $ 68 $123
Professional Fees............ 5 5 10
Travel and Entertainment..... 8 12 20
General and Administrative... 42 15 57
Other........................ 2 2 4
==== ==== ====
Total Expenses....... $112 $106 $214
==== ==== ====
Net Income (Loss).............. $295 $295 $590
==== ==== ====
</TABLE>
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<PAGE> 143
INNSUITES INNTERNATIONAL HOTELS, INC.(1)
(THE MANAGEMENT COMPANY)
SELECTED FINANCIAL DATA
UNAUDITED (AMOUNTS IN THOUSANDS)
The following selected financial data for the five years ended December 31, 1997
have been derived from the audited financial statements of InnSuites Hotels, LLC
and Hospitality Corporation International (predecessors to the Management
Company, the "Predecessors"), which have been audited by Michael Maastricht,
C.P.A., independent public accountants. The following selected financial data of
the Management Company for the nine months ended September 30, 1998 have been
derived from the unaudited financial statements of the Management Company. The
selected financial data of the Predecessors for the nine months ended September
30, 1997 have been derived from the unaudited financial statements of the
Predecessors. All of the data should be read in conjunction with the respective
financial statements and related notes included therein.
<TABLE>
<CAPTION>
MANAGEMENT
COMPANY PREDECESSORS
NINE MONTHS NINE MONTHS
ENDED ENDED PREDECESSORS
SEPTEMBER 30, SEPTEMBER 30, ------------------------------------
1998 1997 1997 1996 1995 1994 1993
------------- ------------- ---- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
REVENUES:
Management Fees............ $405 $824 $848 $ 68 $ 410 $ 517 $ 488
Trademark/Licensing Fees... 0 92 0 107 77 87 30
Other Income............... 2 -- -- -- 3 5 --
---- ---- ---- ----- ----- ----- -----
Total Revenue....... $407 $916 $848 $ 175 $ 490 $ 609 $ 518
OPERATING EXPENSES:
Payroll and Benefits....... $ 55 $ 45 $ 25 $ 74 $ 4 $ 21 $ 35
Professional Fees.......... 5 59 4 79 12 97 2
Travel and Entertainment... 8 886 5 12 17 20 18
General and
Administration........... 42 104 14 15 27 284 125
Other...................... 2 23 23 4 16 23 9
---- ---- ---- ----- ----- ----- -----
Total Expenses...... $112 $231 $ 71 $ 184 $ 85 $ 445 $ 189
---- ---- ---- ----- ----- ----- -----
Income (Loss) From
Operations............... 295 685 777 (9) 404 163 329
Partners Share of
Partnership Operations... -- -- -- 254 (402) 14 (853)
Gain (Loss) on Sale of
Investments.............. -- -- (7) (180) 434 (150) (119)
---- ---- ---- ----- ----- ----- -----
Net Income (Loss) Before
Income Taxes............. 295 (7) 770 65 436 27 (643)
Income Taxes............... -- -- -- 7 150 -- --
Net Income (Loss)............ $295 $677 $770 $ 57 $ 286 $ 27 $(643)
==== ==== ==== ===== ===== ===== =====
</TABLE>
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<PAGE> 144
INNSUITES INNTERNATIONAL HOTELS, INC.(1)
(THE MANAGEMENT COMPANY)
SELECTED FINANCIAL DATA
UNAUDITED (AMOUNTS IN THOUSANDS)
The following selected financial data for the five years ended December 31, 1997
have been derived from the audited financial statements of the InnSuites Hotels,
LLC and Hospitality Corporation International (predecessors to the Management
Company, the "Predecessors"), which have been audited by Michael Maastricht,
C.P.A., independent public accountants. The following selected financial data of
the Management Company for the nine months ended September 30, 1998 have been
derived from the unaudited financial statements of the Management Company. The
selected financial data of the Predecessors for the nine months ended September
30, 1997 have been derived from the unaudited financial statements of the
Predecessors. All of the data should be read in conjunction with the respective
financial statements and related notes included therein.
<TABLE>
<CAPTION>
MANAGEMENT
COMPANY PREDECESSORS
NINE MONTHS NINE MONTHS
ENDED ENDED PREDECESSORS
SEPTEMBER 30, SEPTEMBER 30, ------------------------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
------------- ------------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Cash................ $ 15 $ 124 $ 5 $ 8 $ 9 $ 39 $ 9
Loans Receivable.... 675 1,549 649 166 349 165 41
Investments......... -- 47 404 430 531 190 (209)
Fixed Assets........ 7 70 60 -- 20 162 28
---- ------ ------ ---- ---- ------ -----
Total
Assets..... $697 $1,789 $1,118 $604 $908 $ 556 (131)
==== ====== ====== ==== ==== ====== =====
LIABILITIES:
Accounts Payable.... $ -- $ -- $ -- $ -- $ 34 $ -- $ --
Loans Payable
Affiliates........ 650 440 794 473 835 867 300
Accrued Expenses.... 6 39 -- 79 -- 141 34
Other............... -- 572 -- 5 50 6 17
==== ====== ====== ==== ==== ====== =====
Total
Liabilities.. $656 $1,050 $ 794 $557 $919 $1,014 $ 350
EQUITY:
Paid in Capital..... $ 1 $ 15 $ 2 $ 2 $ 13 $ 13 $ 13
Retained Earnings 41 724 322 45 (24) (471) (495)
==== ====== ====== ==== ==== ====== =====
Total
Equity..... $ 42 739 $ 324 $ 47 $(11) $ (458) $(482)
==== ====== ====== ==== ==== ====== =====
Total Liabilities and
Equity.............. $698 $1,789 $1,118 $604 $908 $ 556 $(131)
==== ====== ====== ==== ==== ====== =====
</TABLE>
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INNSUITES INNTERNATIONAL HOTELS, INC.
(THE MANAGEMENT COMPANY)
NOTES TO PRO FORMA CONDENSED FINANCIAL INFORMATION
1. Management services, pursuant to the management agreements, were provided by
InnSuites Innternational Hotels, Inc. for the nine months ended September 30,
1998, by InnSuites Hotels, L.L.C. during 1997, and by Hospitality Corporation
International during 1996 and 1995. All of these entities are/were owned by
James F. Wirth or his affiliates.
2. Pro forma adjustments reflect the acquisitions of the InnSuites trademark and
licensing rights, related income and estimated operating expenses related to
the trademark and licensing activities.
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<PAGE> 146
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF
THE MANAGEMENT COMPANY
OVERVIEW
The Management Company was organized in February 1998 to provide management
services to the Initial Lessee. Therefore, the Management Company has a limited
operating history and limited financial results relating to these management
services.
Prior to completing this offering, the Management Company will acquire InnSuites
Licensing Corp. as part of the Corporate Structure Transactions. As a result,
the Management Company will acquire full ownership to the InnSuites(R) trademark
and tradename and acquire the trademark and licensing agreements with the
Initial Lessee. Pursuant to those agreements, the Management Company will
receive licensing fees equal to 2.5% of gross room revenues (1.25% for those
properties that also carry a third-party franchise, such as Best Western(R) or
Holiday Inn(R)). This acquisition will provide additional revenues for the
Management Company and will enhance overall profitability.
The Management Company will also enter into the Intercompany Agreement with the
Trust and the Operating Partnership. Pursuant to this agreement, the Trust and
the Operating Partnership will provide the Management Company with a right of
first refusal to lease any real property acquired by the Trust or the Operating
Partnership after February 1, 2000, subject to certain terms and conditions.
While this agreement will provide additional opportunities to increase the
Management Company's profitability through hotel leasing activities, such
opportunities will be available only after February 1, 2000.
GENERAL
To date, the Management Company has had limited operations. Since its
organization in February 1998, the Management Company has provided
property-level management services to the Initial Lessee for the Hotels. For
these services, the Management Company receives 2.5% of gross room revenues for
each of the hotels it manages.
The pro forma financial information for the Management Company reflects receipts
for the management services provided by the Management Company from February
1998 through September 30, 1998. They also reflect the acquisition of the
InnSuites(R) trademark and licensing rights and include related income and
estimated operating expenses related to trademark and licensing activities
conducted by InnSuites Licensing Corp.
PRO FORMA RESULTS OF OPERATIONS OF THE MANAGEMENT COMPANY
For the year ended December 31, 1997, the Management Company had pro forma total
revenue of $1.38 million consisting of $.85 million from management fees and
$.53 million from trademark and licensing fees. After total expenses of $.22
million consisting largely of payroll and benefits expenses of $.11 million and
general and administrative expenses of $.46 million, the Management Company
realized pro forma net income of $1.16 million.
For the nine months ended September 30, 1998, the Management Company had pro
forma revenues of $.80 million consisting of $.41 from management service fees
and $.40 million from trademark and licensing fees. After total expenses of $.21
million consisting largely of
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<PAGE> 147
payroll and benefits expenses of $.12 million and general and administrative
expenses of $.57 million, the Management Company realized pro forma net income
of $.59 million.
At September 30, 1998, the Management Company's pro forma balance sheet
reflected total assets of $1.17 million comprised of $1.08 million of loans
receivable, $.58 million of fixed assets and $.35 million of cash, total
liabilities of $.76 million consisting primarily of $.76 million of loans
payable, and total equity was $.41 million.
ACTUAL RESULTS OF THE MANAGEMENT COMPANY
For the year ended December 31, 1998, the Management Company had revenues of
$.85 million from management service fees. After total expenses of $.71 million,
including $.25 million of payroll and benefits expenses and $.14 million of
general and administrative expenses, the Management Company had net income of
$.77 million.
For the nine months ended September 30, 1998, the Management Company had total
revenues of $.41 million in management service fees. After total expenses of
$.11 million, including $.55 million of payroll and benefits expenses and $.42
million of general and administrative expenses, the Management Company had net
income of $.30 million for the nine month period. At September 30, 1998, the
Management Company had total assets of $.70 million consisting of $.68 million
of loans receivable and $.15 million in cash, total liabilities of $.66 million
including $.65 million of loans payable, and total equity of $.04 million.
LIQUIDITY AND CAPITAL RESOURCES
The Management Company's current principal sources of cash are the hotel
management fees and trademark and licensing fees from the Initial Lessee. The
Initial Lessee's obligations for these fees are unsecured and its ability to pay
the Management Company, and the Management Company's liquidity, will depend on
its ability to generate sufficient cash flow from Hotel operations. The
Management Company has no present commitments for extraordinary capital
expenditures.
INFLATION
The Management Company's revenues initially will be based on the management
service agreements and the trademark and licensing agreements with the Initial
Lessee which will result in changes in the Management Company's revenues based
on changes in the underlying Hotel revenues. Therefore, the Management Company
initially will rely entirely on the performance of the Hotels and the Initial
Lessee's ability to increase revenues to keep pace with inflation. Hotel
operators in general, and the Initial Lessee in particular, can alter room rates
quickly, but competitive pressures may limit the Initial Lessee's ability to
raise rates faster than increases in inflation.
SEASONALITY
The Hotels' operations historically have been seasonal. The six southern Arizona
hotels experience their highest occupancy in the first fiscal quarter and, to a
lesser extent, the fourth fiscal quarter. The second fiscal quarter tends to be
the lowest occupancy period at those six southern Arizona hotels. This
seasonality pattern can be expected to cause fluctuations in the Management
Company's hotel management service and trademark and licensing fee revenues.
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YEAR 2000 COMPLIANCE
The Year 2000 problem is the result of computer programs having been written
using two digits instead of four digits to define the applicable year. Any of
the Management Company's computer programs that have date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could potentially result in a system failure or miscalculations, causing
disruptions of operations and normal business activity.
The Management Company does not rely heavily on computer systems for its
operations and does not own significant computer systems, but does believe that
its systems are Year 2000 compliant. The Management Company estimates its total
costs to be incurred in connection with the Year 2000 problem to be minimal.
The Management Company cannot predict the effect of the Year 2000 problem on
vendors, customers and other entities with which the Management Company
transacts business, and there can be no assurance that the effect of the Year
2000 problem on such entities will not adversely affect the Management Company's
operations.
In the event of the failure of any of the Management Company's computer systems,
the Management Company intends to perform necessary functions without the aid of
the affected computer systems until any Year 2000 problems are resolved.
DESCRIPTION OF CAPITAL STOCK OF
THE MANAGEMENT COMPANY
AUTHORIZED CAPITAL STOCK
The Charter of the Management Company authorizes the issuance of up to
11,000,000 shares, consisting of 10,000,000 shares of common stock, without par
value (the "Management Company Common Stock"), and 1,000,000 shares of preferred
stock, par value $1.00 per share (the "Management Company Preferred Stock"). 100
shares of Management Company Common Stock are currently outstanding and held of
record by two shareholders. No shares of Management Company Preferred Stock have
been issued or are outstanding. All of the shares of Management Company Common
Stock that are currently outstanding are validly issued, fully paid and
nonassessable.
MANAGEMENT COMPANY COMMON STOCK
The holders of Management Company Common Stock will be entitled to one vote for
each share held of record on all matters subject to a vote of the shareholders,
including the election of directors, and, except as otherwise required by law or
provided in any resolution adopted by the Management Company's Board with
respect to any series of Management Company Preferred Stock, the holders of such
shares will possess all voting power with respect to the Management Company. The
Charter does not provide for cumulative voting in the election of directors.
Subject to any preferential rights of any outstanding series of Management
Company Preferred Stock created by the Management Company Board from time to
time, the holders of Management Company Common Stock will be entitled to such
dividends as may be declared from time to time by the Management Company Board
from funds available therefor, and upon liquidation will be entitled to receive
pro rata all assets of the Management Company available for distribution to such
holders.
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<PAGE> 149
MANAGEMENT COMPANY PREFERRED STOCK
The Charter provides that shares of Management Company Preferred Stock may be
issued in one or more series from time to time by the Management Company Board,
and the Management Company Board is expressly authorized to fix the designations
and the powers, preferences and rights, and the qualifications, limitations and
restrictions thereof, of the shares of each series of Management Company
Preferred Stock.
MANAGEMENT OF THE MANAGEMENT COMPANY
DIRECTORS AND OFFICERS OF THE MANAGEMENT COMPANY
The following table sets forth certain information concerning those persons who
are directors and officers of the Management Company:
<TABLE>
<CAPTION>
POSITION AND PRINCIPAL
NAME OCCUPATIONS DURING PAST FIVE YEARS
---- ----------------------------------
<S> <C>
James F. Wirth........ Chairman of the Board of Directors of the Management
Company since April, 1997. Trustee, Chairman, President
and Chief Executive Officer of the Trust since January 30,
1998. Chairman and President of InnSuites Hotels, L.L.C.,
and affiliated entities, owners and operators of hotels,
since 1980; Chairman and President of Rare Earth
Development Company, a real estate development and
investment company, since 1973. Age: 52.
William A. Kidwell.... Director and President of the Management Company since
December 1, 1998. Vice President Operations of Starwood
Lodging Corp. from 1995 to 1997. Senior Vice President of
Richfield Management from 1986 to 1995. Age: 54.
Gregory D. Bruhn...... Executive Vice President, Chief Financial Officer and
Treasurer of the Management Company since December 1,
1998. Trustee, Executive Vice President, Chief Financial
Officer, Treasurer and Secretary of the Trust since
January 30, 1998. Executive Vice President and Chief
Financial Officer of First Union Real Estate Mortgage and
Equity Investments, a real estate investment trust, from
1994 through 1996; Executive Vice President, Real Estate
Industries Division, Bank of America from 1992 through
1994. Age: 50.
J. R. Chase........... Director and Secretary of the Management Company since
December, 1, 1998. Secretary and Treasurer of Rare Earth
Development Company from 1993 to present. Director of
Hospitality Corporation International, an affiliate and
predecessor to InnSuites Hotels since 1992. Senior
engineer technical writer with Hughes Aircraft Company,
Missile and Space Division prior to 1992. Age: 48.
</TABLE>
The officers of the Management Company are elected by and serve at the
discretion of the Board of Directors of the Management Company.
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<PAGE> 150
COMMITTEES OF THE BOARD OF DIRECTORS OF THE MANAGEMENT COMPANY
The Management Company Board has established an Audit Committee and a
Compensation Committee. Audit Committee functions include reviewing reports sent
to shareholders, recommending to the Management Company Board the engagement of
the independent auditors, reviewing the independent auditors' plan of audit and
the results of the auditors' engagement, and reviewing the effectiveness of the
Management Company's internal controls and the results of its operations. The
Audit Committee consists of two members, Messrs. Chase and Kidwell. Mr. Chase is
the Chairman of the Audit Committee.
The Compensation Committee is responsible for establishing the terms of
compensation for the executive officers of the Management Company, including
their salaries, bonuses and other compensation. The Compensation Committee
consists of two members, Messrs. Chase and Wirth. Mr. Chase is the Chairman of
the Compensation Committee.
COMPENSATION OF DIRECTORS
Each member of the Management Company Board who is not otherwise an employee of
the Management Company will receive from the Management Company an annual fee of
$12,000 per year for serving as a director of the Management Company and will be
reimbursed for expenses incurred to attend meetings.
EXECUTIVE COMPENSATION
James F. Wirth served as the chief executive officer of the Management Company
during the fiscal year ended December 31, 1997 and received no compensation. In
addition to salaries, the Management Company's executive officers may earn an
annual bonus, payable during the first calendar quarter of the year based on the
prior year's results. In addition, a stock option program for key company
personnel and a stock appreciation program for the employees of InnSuites Hotels
and its affiliates is provided.
The Management Company will pay William A. Kidwell $50,000 upon the termination
of his employment and directorships other than for cause. This separation
payment is payable, at the option of the Management Company, in equal monthly
installments over the six months following his departure from all officer and
director positions with the Management Company.
BENEFICIAL OWNERSHIP OF MANAGEMENT COMPANY
COMMON STOCK
As of January 1, 1999, the Management Company had 100 outstanding shares of
Common Stock, held of record by two stockholders. The outstanding Management
Company Common Stock is owned by affiliates of the Management Company and can
only be sold pursuant to an exemption from the registration requirements of the
Securities Act of 1933. The following table sets forth certain information
concerning the beneficial ownership of shares of Common Stock by each
stockholder who is known by the Management Company to own beneficially in excess
of 5% of the outstanding shares of Common Stock, by each director, by each named
executive officer, and by all directors and executive officers as a group, as of
January 1, 1999. Except as otherwise indicated, all persons listed below have
(i) sole voting power and investment power in respect of their shares of Common
Stock, except to the extent
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<PAGE> 151
that authority is shared by spouses under applicable law, and (ii) record and
beneficial ownership in respect of their shares of Management Company Common
Stock.
<TABLE>
<CAPTION>
NAME OF FULLY-DILUTED FULLY-DILUTED PRE-OFFERING PRE-OFFERING
BENEFICIAL OWNER NO. OF SHARES(A) PERCENTAGE NO. OF SHARES(B) PERCENTAGE
---------------- ---------------- ------------- ---------------- ------------
<S> <C> <C> <C> <C>
James F. Wirth(c)..... 50 50%
Gail J. Wirth(c)...... 50 50%
William A. Kidwell.... 0 0%
Gregory D. Bruhn...... 0 0%
J.R. Chase............ 0 0%
All Executive Officers
and Directors as a
Group (four
persons)............ 50 50%
</TABLE>
- ---------------
(a) Assumes that all Warrants are exercised and converted into shares of Common
Stock.
(b) Assumes that no Warrants are exercised and converted into shares of Common
Stock.
(c) Mr. and Mrs. Wirth have a business address at 1625 E. Northern Ave., Suite
201, Phoenix, Arizona 85020.
DIVIDEND POLICY OF THE MANAGEMENT COMPANY
Since its inception, the Management Company has not paid cash dividends to its
stockholders. The Management Company intends to use its available funds to
pursue investment and business opportunities and, therefore, does not anticipate
the payment of any cash dividends on the Management Company Common Stock in the
foreseeable future.
CERTAIN TRANSACTIONS BY THE MANAGEMENT COMPANY
The Intercompany Agreement between the Trust, the Operating Partnership and the
Management Company provides certain rights to the Operating Partnership and the
Trust, including a right of first refusal to acquire any real property that a
REIT may own before the Management Company could acquire such property for its
own account. Mr. and Mrs. Wirth own significant percentages of both the Trust
and the Operating Partnership and, as such, may not have acted in the best
interests of the Management Company in agreeing to the terms of the Intercompany
Agreement. The Management Company believes that the terms of the Intercompany
Agreement are both fair and commercially reasonable. The Intercompany Agreement
was approved by the independent directors of the Management Company.
Due to Mr. Wirth's significant ownership interest in the Operating Partnership
and the Trust, future Percentage Leases between the Operating Partnership or the
Trust and the Management Company may not be structured in the best interests of
the Management Company. Such Percentage Leases will be approved by the
independent directors of the Management Company.
The terms of the acquisition of the InnSuites Hotels trademarks and tradenames
from InnSuites Licensing Corp. may not have been determined in the best
interests of the Management Company due to Mr. and Mrs. Wirth's 100% ownership
of InnSuites Licensing Corp. The Management Company believes that the terms of
the acquisition were fair. This transaction was approved by the independent
directors of the Management Company.
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<PAGE> 152
CERTAIN CHARTER AND STATUTORY PROVISIONS
GENERAL
The terms of Chapter 78 of the Nevada Revised Statutes (the "NRS") apply to the
Management Company. Under certain circumstances, the provisions of the NRS
described in the following paragraphs may delay or make more difficult
acquisitions or changes of control of the Management Company. The Management
Company's Charter and Bylaws do not exclude the Management Company from such
provisions of the NRS. Such NRS provisions may make it more difficult to
accomplish transactions that shareholders may believe are in their best
interests and may also have the effect of preventing changes in the Management
Company's management.
CONTROL SHARE ACQUISITIONS
Under the NRS, any person who, individually or in association with others,
acquires or offers to acquire, directly or indirectly, a "controlling interest"
in an "issuing corporation" may exercise voting rights on any "control shares"
only if such voting rights are conferred by a majority vote of the disinterested
shareholders of the issuing corporation at a special meeting of such
shareholders. If the control shares are accorded full voting rights and
represent a majority of all the voting power, any shareholder, other than the
acquiring person, who does not vote for authorizing voting rights for the
control shares, may demand payment for the fair value of their shares, and the
corporation must comply with their demand.
For the above provisions, "controlling interest" means the ownership of
outstanding voting shares of an issuing corporation sufficient to enable the
acquiring person, individually or in association with others, directly or
indirectly, to exercise (i) one fifth or more, but less than one third, (ii) one
third or more, but less than a majority, and/or (iii) a majority of the voting
power of the issuing corporation in the election of directors. Voting rights
must be conferred by a majority of the disinterested shareholders as each
threshold is reached and/or exceeded. "Control shares" mean those outstanding
voting shares of an issuing corporation which an acquiring person acquires or
offers to acquire in an acquisition or within 90 days immediately preceding the
date when the acquiring person became an acquiring person. "Issuing corporation"
means a corporation that is organized in Nevada, has 200 or more shareholders
(at least 100 of whom are shareholders of record and residents of Nevada) and
conducts business in Nevada directly or though an affiliated corporation. The
above does not apply if the articles of incorporation or bylaws of the
corporation in effect on the 10th day following the acquisition of a controlling
interest by an acquiring person provide that said provisions do not apply.
CERTAIN BUSINESS COMBINATIONS
Unless previously approved by the resident domestic corporation's board of
directors, the NRS restricts the ability of a "resident domestic corporation" to
engage in any combination with an "interested stockholder" for three years
following the date the interested stockholder acquired the shares causing such
stockholder to become an interested stockholder. If the combination was not
previously approved, the interested stockholder may effect a combination after
the three year period only if such stockholder receives approval from a majority
of the disinterested shares or the offer meets certain fair price criteria.
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<PAGE> 153
For the above provisions, "resident domestic corporation" means a Nevada
corporation that has 200 or more shareholders. These provisions of the NRS do
not apply, however, to any combination of a resident domestic corporation which
does not, as of the date of acquiring shares, have a class of voting shares
registered with the Securities and Exchange Commission under Section 12 of the
Exchange Act, unless the corporation's original articles of incorporation
provide otherwise. "Interested stockholder", when used with reference to any
resident domestic corporation, means any person, or its subsidiaries, who is (i)
the beneficial owner, directly or indirectly, of 10% or more of the voting power
of the outstanding voting shares of the resident domestic corporation or (ii) an
affiliate or associate of the resident domestic corporation and, at any time
within three years immediately before the date in question, was the beneficial
owner, directly or indirectly, of 10% or more of the voting power of the then
outstanding shares of the resident domestic corporation. The above provisions do
not apply to corporations that elect in a charter amendment approved by a
majority of the disinterested shares. Such a charter amendment, however, would
not become effective for 18 months after its passage and would apply only to
stock acquisitions occurring after its effective date.
DIRECTORS' DUTIES
The NRS allows directors and officers, in exercising their respective powers
with a view toward the interest of a company, to consider the interests of a
company's employees, suppliers, creditors and customers, the economy of the
state and the nation, the interests of the community and of society and the long
and short term interests of a company and its shareholders, including the
possibility these interests may be best served by the continued independence of
a company in the case of an acquisition offer. Directors may resist a change or
potential change in control if the directors, by a majority vote of a quorum,
determine that the change or potential change is opposed to or not in the best
interest of the company upon consideration of the interests set forth above.
Changes in control may also be resisted if the directors have reasonable grounds
to believe that, within a reasonable time, the debt created as a result of the
change in control would cause the liabilities of the company or any successor to
exceed its assets, would render the company or any successor insolvent or would
lead to bankruptcy proceedings.
SHARES AVAILABLE FOR FUTURE SALE BY
THE MANAGEMENT COMPANY
Management Company Common Stock distributed upon the exercise of the Warrants
will be freely transferable, except for securities received by persons who may
be deemed to be "affiliates" of the Management Company under the Securities Act.
Persons deemed to be affiliates of the Management Company generally include
individuals or entities that control, are controlled by, or are under common
control with, the Management Company and may include certain officers and
directors of the Management Company as well as principal shareholders of the
Management Company. Persons who are affiliates of the Management Company will be
permitted to sell their shares of Management Company Common Stock only pursuant
to an effective registration statement under the Securities Act or an exemption
from the registration requirements of the Securities Act, such as the exemption
afforded by Section 4(2) of the Securities Act (relating to private sales) or by
Rule 144 under the Securities Act. Neither the Trust nor the Management Company
is able to predict when the Warrants will be exercised and when substantial
amounts of Management Company Common
146
<PAGE> 154
Stock will be sold in the open market following this offering. The sale of
substantial amounts of Management Company Common Stock in the public market, or
the perception that such sales might occur, could adversely affect the market
price of Management Company Common Stock.
WHERE YOU CAN FIND MORE INFORMATION
The Trust has filed with the SEC a Registration Statement on Form S-2
("Registration Statement") under the Securities Act with respect to the Common
Shares offered by this Prospectus. This Prospectus, which constitutes part of
the Registration Statement, omits certain of the information contained in the
Registration Statement and the exhibits thereto on file with the SEC pursuant to
the Securities Act and the rules and regulations of the SEC thereunder. The
Registration Statement, including the exhibits thereto, may be inspected and
copied at the Public Reference Room maintained by the SEC at 450 Fifth Street,
N.W., Washington, D.C. 20549, and at the SEC's Regional Offices at 7 World Trade
Center, Suite 1300, New York, New York 10048, and Citicorp Center, 500 W.
Madison Street, Suite 1400, Chicago, Illinois 60661, and copies may be obtained
by mail, at prescribed rates, from the Public Reference Room of the SEC at its
principal office in Washington, D.C. Statements contained in this Prospectus as
to the contents of any contract or other document referred to are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement,
each such statement being qualified in all respects by such reference.
The Trust is subject to the informational requirements of the Exchange Act and,
in accordance therewith, files reports and proxy statements and other
information with the SEC. Such reports, proxy statements and other information
can be inspected and copied at the locations described above. Copies of such
materials can be obtained by mail from the Public Reference Room of the SEC at
450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. Further
information on the operation of the SEC's Public Reference Room in Washington,
D.C. can be obtained by calling the SEC at 1-800-SEC-0330. In addition, certain
of such materials can be inspected at the New York Stock Exchange, Inc., 20
Broad Street, New York, New York. Further, the SEC maintains a World Wide Web
site that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the Commission,
including the Trust. The address of such Web site is http://www.sec.gov.
No person is authorized to give any information or to make any representations,
other than those contained or incorporated by reference in this Prospectus, in
connection with the offering of Shares described herein and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Trust. This Prospectus does not constitute an offer to sell,
or the solicitation of an offer to buy, nor shall there be any sale of the
Shares by any person in any jurisdiction in which it is unlawful for such person
to make such offer, solicitation or sale. Neither the delivery of this
Prospectus nor any sale made hereunder shall under any circumstances create an
implication that the information contained herein is correct as of any time
subsequent to the date hereof.
The Management Company does not currently file reports with the Securities and
Exchange Commission.
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<PAGE> 155
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents, which have been previously filed by the Trust with the
SEC under the Exchange Act (File No. 1-7062) are incorporated herein by
reference:
1. Annual Report on Form 10-K for the year ended January 31, 1998, filed on
May 18,1998;
2. Quarterly Report on Form 10-Q/A for the quarter ended April 30, 1998,
filed on June 24, 1998;
3. Quarterly Report on Form 10-Q for the quarter ended July 31, 1998, filed
on September 18, 1998;
4. Quarterly Report on Form 10-Q for the quarter ended October 31, 1998,
filed on December 15, 1998;
5. Current Report on Form 8-K dated February 17, 1998, as amended by Form
8-K/A filed on April 20, 1998;
6. Current Report on Form 8-K dated March 16, 1998, as amended by Form 8-K/A
filed on May 15, 1998, as further amended by Form 8-K/A filed on June 30,
1998;
7. Current Report on Form 8-K dated May 14, 1998, as amended by Form 8-K/A
filed on May 27, 1998;
8. Current Report on Form 8-K dated June 24, 1998; and
9. Current Report on Form 8-K dated September 2, 1998.
All documents filed by the Trust pursuant to Sections 13(a), 13(c), 14 or 15(d)
of the Exchange Act after the date of this prospectus and prior to the
termination of this offering of Common Shares made hereby shall be deemed to be
incorporated by reference in this prospectus and to be a part hereof from the
date of filing such documents.
Any statement contained herein, or in any document incorporated or deemed to be
incorporated by reference herein, shall be deemed to be modified or superseded
for purposes of this prospectus to the extent that a statement contained herein
or in any subsequently filed document that also is or is deemed to be
incorporated by reference herein, modifies or supersedes such statement. Any
such statement so modified or superseded shall not be deemed, except as so
modified or superseded, to constitute a part of this prospectus.
The Trust will provide, without charge, to each person, including any beneficial
owner, to whom a copy of this prospectus is delivered, on the written or oral
request of any such person, a copy of any or all of the documents incorporated
herein by reference, except the exhibits to such documents (unless such exhibits
are specifically incorporated by reference in such documents). Requests for such
copies should be directed to the Trust at 1750 Huntington Building, 925 Euclid
Avenue, Cleveland, Ohio 44115, Attention: Investor Relations; (216) 622-0046.
FORWARD-LOOKING STATEMENTS
Certain statements in this prospectus constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act and Section 21E of the
Exchange Act. The Trust and the Management Company intend that such
forward-looking statements be subject
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<PAGE> 156
to the safe harbors created by such Acts. Those forward-looking statements
relating to the Trust include statements regarding the intent, belief or current
expectations of the Trust, its Trustees or its officers in respect of (i) the
declaration or payment of dividends; (ii) the leasing, management or operation
of the Hotels; (iii) the adequacy of reserves for renovation and refurbishment;
(iv) the Trust's financing plans; (v) the Trust's position regarding
investments, acquisitions, financings, conflicts of interest and other matters;
(vi) the Trust's continued REIT qualification; and (vii) trends affecting the
Trust's or any Hotel's financial condition or results of operations. Those
forward-looking statements relating to the Management Company include statements
regarding the intent, belief or current expectations of the Management Company,
its directors or its officers in respect of (i) the declaration or payment of
dividends; (ii) the leasing, management or operation of the Hotels; (iii) the
Management Company's financing plans; (iv) the Management Company's position
regarding investments, acquisitions, financings, conflicts of interest and other
matters; and (v) trends, affecting the Management Company's financial condition
or results of operations. The words and phrases "looking ahead", "we are
confident", "should be", "will be", "predicted", "believe", "expect",
"anticipate" and similar expressions identify forward-looking statements.
These forward-looking statements reflect the Trust's and the Management
Company's current views in respect of future events and financial performance,
but are subject to many uncertainties and factors relating to the operations and
business environment of the Hotels which may cause the actual results of the
Trust and the Management Company to differ materially from any future results
expressed or implied by such forward-looking statements. Examples of such
uncertainties include, but are not limited to: fluctuations in hotel occupancy
rates; changes in room rental rates which may be charged by the Initial Lessee
and the Management Company in response to market rental rate changes or
otherwise; interest rate fluctuations; changes in federal income tax laws and
regulations; competition; any changes in the Trust's or the Management Company's
financial condition or operating results due to acquisitions or dispositions of
hotel properties; real estate and hospitality market conditions; and local or
national economic and business conditions, including, without limitation,
conditions which may affect public securities markets generally, the hospitality
industry, or the markets in which the Trust or the Management Company operates
or will operate. Neither the Trust nor the Management Company undertakes any
obligation to update publicly or revise any forward-looking statements, whether
as a result of new information, future events or otherwise. Pursuant to Section
21E(b)(2)(E) of the Exchange Act, the qualifications set forth hereinabove are
inapplicable to any forward-looking statements in this prospectus relating to
the operations of the Operating Partnership.
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement among the
Trust, the Operating Partnership and the representatives of the Underwriters
named below (the "Underwriting Agreement"), the Trust has agreed to sell to each
of the Underwriters named below (the "Underwriters"), and each of the
Underwriters, for whom Sutro & Co., Inc. are
149
<PAGE> 157
acting as representatives, has severally agreed to purchase from the Trust the
respective number of Common Shares set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER COMMON SHARES
----------- -------------
<S> <C>
-------
TOTAL
=======
</TABLE>
Under the terms of the Underwriting Agreement, the Underwriters are committed to
take and to pay for all of the Common Shares offered hereby, if any are taken.
The Underwriters propose initially to offer the Common Shares in part directly
to the public at the public offering price set forth on the cover page of this
prospectus, and in part to certain securities dealers at such price less a
concession of $ per share. The Underwriters may allow, and such dealers may
reallow, a concession not in excess of $ per share to certain brokers and
dealers. After the Common Shares are released for sale to the public, the
offering price and other selling terms may from time to time be varied by the
representatives.
The Trust has granted the Underwriters an option, exercisable for 45 days after
the date of this prospectus, to purchase up to an aggregate of 300,000
additional Common Shares at the public offering price less the underwriting
discount as set forth on the cover page of this prospectus to cover
over-allotments, if any. If the Underwriters exercise their over-allotment
option, the Underwriters have severally agreed, subject to certain conditions,
to purchase approximately the same percentage thereof that the number of Common
Shares to be purchased by each of them, as shown in the foregoing table, bears
to the Common Shares offered hereby.
Pursuant to the Underwriting Agreement, the Trust has agreed, subject to certain
limited exceptions, that it shall not, without the prior written consent of the
representatives, sell, contract to sell, pledge or otherwise dispose of any
Common Shares (or any securities or other interests convertible into or
exercisable or exchangeable for Common Shares) for a period of 180 days after
the date of this prospectus.
At the request of the Trust, up to Common Shares offered in this
offering are being reserved for sale to Trustees and certain associates and
certain other persons who have relationships with the Trust and its
predecessors, at the offering price less the Underwriters' discount set forth on
the cover page of this prospectus. This discount per share reduces the
Underwriters' underwriting discount.
The representatives have informed the Trust that they do not expect sales to
discretionary accounts by the Underwriters to exceed percent of
the total number of Common Shares offered by them.
The public offering price has been determined by negotiations between the Trust
and the representatives of the Underwriters. Among the factors considered in
determining the public offering price of the Common Shares, in addition to
prevailing market conditions, were the Cash Available for Distribution from the
Hotels, the current financial position of the Trust, estimates of the business
potential and earnings prospects of the Trust, an assessment of
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<PAGE> 158
management and of the Trust's position in its industry and consideration of the
above factors in relation to market prices of and demand for similar securities
of comparable companies in recent periods.
The Common Shares have been approved for listing on the NYSE, subject to notice
of issuance. There can be no assurance, however, that the Trust will be able to
maintain the listing of the Common Shares on the NYSE.
The Trust and the Operating Partnership, jointly and severally, have agreed to
indemnify the Underwriters against certain civil liabilities, including
liabilities under the Securities Act, and to contribute to payments that the
Underwriters may be required to make in respect thereof.
During and after completion of this offering, the Underwriters may purchase and
sell the Common Shares in the open market. These transactions may include
over-allotment and stabilizing transactions and purchases to cover syndicate
short positions created in connection with this offering. The Underwriters also
may impose a penalty bid, whereby selling concessions allowed to syndicate
members or other broker-dealers in respect of the Common Shares sold in this
offering for their account may be reclaimed by the syndicate if such securities
are repurchased by the syndicate in stabilizing or covering transactions. These
activities may stabilize, maintain or otherwise affect the market price of the
Common Shares which may be higher than the price that might otherwise prevail in
the open market. These transactions may be effected on the NYSE or otherwise,
and these activities, if commenced, may be discontinued at any time.
LEGAL MATTERS
The validity of the Common Shares will be passed upon for the Trust by Thompson
Hine & Flory LLP, Cleveland, Ohio. In addition, the description of federal
income tax consequences contained in the Prospectus under the caption "FEDERAL
INCOME TAX CONSIDERATIONS RELATED TO THE TRUST" is based upon the opinion of
Thompson Hine & Flory LLP. Squire, Sanders & Dempsey L.L.P., Phoenix, Arizona,
will pass upon certain legal matters for the Underwriter.
EXPERTS
The audited Consolidated Financial Statements and schedule of InnSuites
Hospitality Trust (formerly Realty ReFund Trust) incorporated by reference in
this prospectus and elsewhere in the Registration Statement have been audited by
Arthur Andersen LLP, independent public accountants, as indicated in their
report with respect thereto, and are incorporated by reference herein upon the
authority of said firm as experts in giving said reports.
The audited Combined Financial Statements of InnSuites Hotels, Inc. incorporated
by reference in this prospectus and elsewhere in the Registration Statement
included in this prospectus have been audited by Michael Maastricht, C.P.A.,
independent public accountants, as indicated in their report with respect
thereto, and are incorporated by reference herein upon the authority of said
firm as experts in giving said reports.
Any financial statements and schedules hereafter filed by the Trust pursuant to
Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act and incorporated by
reference in the registration statement, of which this prospectus is a part,
that have been examined and are the subject of a report by independent
accountants will be so incorporated by reference in reliance upon such reports
given and upon the authority of such firms as experts in accounting and auditing
to the extent covered by consents filed with the Securities and Exchange
Commission.
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<PAGE> 159
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To InnSuites Innternational Hotels, Inc.:
We have audited the accompanying combined balance sheets of the InnSuites
Hotels System as defined in Note 1 to the combined financial statements, as of
December 31, 1996 and 1997 and January 30, 1998, and the related combined
statements of operations, equity and cash flows for each of the three years in
the period ended December 31, 1997 and the thirty days ended January 30, 1998.
These combined financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined financial position of the InnSuites
Hotels System as of December 31, 1996 and 1997 and January 30, 1998, and the
combined results of their operations, equity, and cash flows for each of the
three years in the period ended December 31, 1997 and the thirty days ended
January 30, 1998, in conformity with generally accepted accounting principles.
MICHAEL MAASTRICHT, CPA
February 19, 1998
Phoenix, Arizona
F-1
<PAGE> 160
INNSUITES HOTELS
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JANUARY 30,
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
ASSETS
INVESTMENT IN HOTEL PROPERTIES, at cost:
Land.............................................. $ 3,439,738 $ 3,439,738 $ 3,439,738
Buildings and improvements........................ 24,831,670 24,831,670 24,831,670
Furniture and equipment........................... 9,175,834 10,845,586 10,958,829
----------- ----------- -----------
37,447,242 39,116,994 39,230,237
Less- Accumulated depreciation.................... 10,958,581 12,184,479 12,322,787
----------- ----------- -----------
Net investment in hotel properties................ 26,488,661 26,932,515 26,907,450
CASH AND CASH EQUIVALENTS........................... 628,797 129,871 322,095
ACCOUNTS RECEIVABLE................................. 344,882 571,301 591,869
INVENTORIES......................................... 347,252 415,575 397,807
OTHER ASSETS........................................ 638,265 295,440 121,691
CASH HELD IN ESCROW................................. 253,056 296,099 297,811
DEFERRED EXPENSES, net.............................. 513,610 252,430 248,227
----------- ----------- -----------
$29,214,523 $28,893,231 $28,886,950
=========== =========== ===========
LIABILITIES AND COMBINED EQUITY
MORTGAGE NOTES PAYABLE.............................. $16,405,945 $17,776,627 $17,709,589
ACCOUNTS PAYABLE:
Trade............................................. 357,089 678,637 621,073
Affiliates........................................ 582,145 1,260,601 1,699,601
Bank overdrafts................................... 149,372 121,052 409,196
PARTNERS' CAPITAL PURCHASES PAYABLE................. -- 275,366 218,063
LINES OF CREDIT..................................... 100,000 131,000 155,000
CAPITAL LEASE OBLIGATION............................ 71,707 22,437 20,226
LAND LEASE PAYABLE.................................. 75,842 80,441 88,286
ACCRUED EXPENSES AND OTHER LIABILITIES.............. 418,596 867,267 1,622,317
PARTICIPATION INVESTORS CONTINGENT LIABILITY........ 2,646,627 2,646,627 2,646,627
----------- ----------- -----------
20,807,323 23,860,055 25,189,978
COMMITMENTS AND CONTINGENCIES
COMBINED EQUITY:
General Partners'................................. 56,032 (43,823) (113,338)
Limited Partners'................................. 8,049,434 7,337,403 6,276,374
Corporate......................................... 301,734 (2,260,404) (2,466,064)
----------- ----------- -----------
8,407,200 5,033,176 3,696,972
----------- ----------- -----------
$29,214,523 $28,893,231 $28,886,950
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-2
<PAGE> 161
INNSUITES HOTELS
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
DECEMBER 31, JANUARY 30,
1995 1996 1997 1998
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
REVENUES FROM HOTEL OPERATIONS:
Room revenue......................... $15,366,788 $17,613,618 $18,800,566 $1,833,441
Food and beverage revenue............ 130,708 197,064 519,440 61,623
Other revenue........................ 445,761 513,143 591,135 60,999
----------- ----------- ----------- ----------
Total revenues....................... 15,943,257 18,323,825 19,911,141 1,956,063
EXPENSES:
Departmental expenses:
Rooms............................. 4,193,048 4,629,652 4,915,019 667,892
Food and beverage................. 349,981 487,367 921,514 84,590
General and administrative........... 3,134,257 3,500,161 4,470,820 1,393,290
Advertising and promotion............ 706,372 724,887 870,732 76,619
Utilities............................ 765,721 894,121 933,994 90,416
Repairs and maintenance.............. 1,938,523 2,621,472 2,473,074 233,804
Real estate, personal property taxes,
and insurance..................... 656,544 876,816 911,870 79,518
Interest expense..................... 1,990,762 1,569,850 1,853,800 137,580
Depreciation......................... 1,058,931 1,147,326 1,225,898 110,155
Other -- land lease.................. -- -- -- 13,678
----------- ----------- ----------- ----------
Total expenses....................... 14,794,139 16,451,652 18,576,721 2,887,542
Income before extraordinary items...... 1,149,118 1,872,173 1,334,420 (931,479)
EXTRAORDINARY ITEMS
Gain on early extinguishment of
debt.............................. 6,465,305 307,000 -- --
----------- ----------- ----------- ----------
NET INCOME............................. $ 7,614,423 $ 2,179,173 $ 1,334,420 $ (931,479)
=========== =========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-3
<PAGE> 162
INNSUITES HOTELS
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
DECEMBER 31, JANUARY 30,
1995 1996 1997 1998
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income............................ $ 7,614,424 $ 2,179,173 $ 1,334,420 $(931,479)
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization...... 1,084,325 1,175,804 1,264,424 114,361
Gain on early extinguishment of
debt............................. (6,465,305) (307,000) -- --
(Increase) decrease in:
Accounts receivable................ (113) 56,431 (226,419) (20,568)
Inventories........................ (53,014) (17,610) (68,323) 17,768
Cash held in escrow................ -- -- (30,039) (1,712)
Other assets....................... (376,921) (231,090) 581,474 173,749
Increase (decrease) in:
Accounts payable................... (191,596) 38,764 321,975 (57,564)
Bank overdraft..................... -- -- -- 288,144
Accrued expenses................... 496,240 (251,944) 737,618 791,045
----------- ----------- ----------- ---------
Net cash provided by operating
activities....................... 2,108,040 2,642,528 3,915,130 373,744
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of furniture, fixtures,
and equipment.................... (406,289) (753,741) (281,998) (113,243)
Acquisition of land, building and
equipment........................ -- (1,250,000) (79,707) --
Guest room remodeling.............. -- -- (565,471) --
Capitalization of partners'
capital.......................... -- -- (742,576) --
----------- ----------- ----------- ---------
Net cash used by investing
activities....................... (406,289) (2,003,741) (1,669,752) (113,243)
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of mortgage notes
payable.......................... (2,185,926) (1,612,687) (636,524) (60,147)
Refinancing of mortgage notes
payable.......................... -- -- (5,017,226) --
Increase in loans from
affiliates....................... (91,500) 587,853 (115,000) 439,000
Increase in loans to affiliates.... -- (87,500) 793,456 --
Increase of mortgage notes
payable.......................... -- 990,000 7,000,000 --
Increase in bank overdrafts........ -- -- -- --
Partners' contributions............ 266,000 -- -- --
Purchases of partners' capital..... -- -- 157,907 (57,303)
Distributions...................... (120,000) (969,375) (4,866,351) --
Distribution of REIT shares........ -- -- -- (404,725)
Lines of credit.................... -- -- (6,728) 24,000
Loan fees.......................... (139,279) (251,711) (29,000) --
Other.............................. 275,584 (31,715) -- --
Capital lease obligations.......... 103,742 (24,838) (9,102)
Capitalization of common stock..... -- 200,000 -- --
----------- ----------- ----------- ---------
Net cash (used) by financing
activities....................... (1,891,379) (1,175,135) (2,744,304) (68,277)
NET CHANGE IN CASH AND CASH
EQUIVALENTS........................... (189,628) (536,348) (498,926) 192,224
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR............................... 1,354,773 1,165,145 628,797 129,871
----------- ----------- ----------- ---------
CASH AND CASH EQUIVALENTS AT END OF
YEAR.................................. $ 1,165,145 $ 628,797 $ 129,871 $ 322,095
=========== =========== =========== =========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-4
<PAGE> 163
INNSUITES HOTELS
COMBINED STATEMENTS OF EQUITY
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNERS' PARTNERS' COMMON RETAINED COMBINED
CAPITAL CAPITAL STOCK(1) EARNINGS EQUITY
--------- ---------- -------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995.... $ (2,525) $6,766,832 $ 5,000 $ 58,095 $ 6,827,402
NET INCOME.................... 107,025 2,033,509 -- 38,639 2,179,173
CONTRIBUTIONS................. -- 170,000 -- -- 170,000
ISSUANCE OF COMMON STOCK...... -- -- 200,000 -- 200,000
DISTRIBUTIONS................. (48,468) (920,907) -- -- (969,375)
--------- ---------- -------- ----------- -----------
BALANCE, December 31, 1996.... 56,032 8,049,434 205,000 96,734 8,407,200
NET INCOME.................... 117,283 1,829,275 -- (612,138) 1,334,420
DISTRIBUTIONS................. (217,138) (2,699,213) -- (1,950,000) (4,866,351)
PARTNERS' CAPITAL PURCHASES... -- 157,907 -- -- 157,907
--------- ---------- -------- ----------- -----------
BALANCE, December 31, 1997.... (43,823) 7,337,403 205,000 (2,465,404) 5,033,176
NET INCOME.................... (46,304) (722,215) -- (162,960) (931,479)
DISTRIBUTIONS................. (23,211) (338,814) -- (42,700) (404,725)
--------- ---------- -------- ----------- -----------
BALANCE, January 30, 1998..... $(113,338) $6,276,374 $205,000 $(2,671,064) $ 3,696,972
========= ========== ======== =========== ===========
</TABLE>
- ---------------
(1) Hulsey Hotels Corporation -- Common stock, no par value, 1,000,000 shares
authorized, 1,000,000 issued and outstanding
(1) Buenaventura Properties, Inc. -- Common stock, no par value, 10,000,000
shares authorized, 1,000,000 issued and outstanding
The accompanying notes are an integral part of these combined financial
statements.
F-5
<PAGE> 164
INNSUITES HOTELS SYSTEM
NOTES TO COMBINED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The InnSuites Hotels System consists of the following full-service hotels:
<TABLE>
<CAPTION>
NUMBER OF
PROPERTY NAME LOCATION SUITES
- ------------- -------- ---------
<S> <C> <C>
InnSuites Phoenix Best Western ("Phoenix")............ Phoenix, Arizona 123
InnSuites Tempe/Airport ("Tempe")..................... Tempe, Arizona 170
InnSuites Tucson Best Western ("Tucson").............. Tucson, Arizona 159
InnSuites Yuma Best Western ("Yuma").................. Yuma, Arizona 166
Holiday Inn Airport InnSuites Ontario ("Ontario")..... Ontario, California 150
InnSuites Flagstaff Grand Canyon ("Flagstaff")........ Flagstaff, Arizona 134
InnSuites Scottsdale ("Scottsdale")................... Scottsdale, Arizona 134
</TABLE>
InnSuites International Hotels, Inc., ("InnSuites") and its affiliates,
officers and employees were involved in the development of each of the above
hotels, except Flagstaff which was purchased January 1, 1996, and have managed
all of the InnSuites Hotels since their respective inceptions. The hotels with
two exceptions, are owned by partnerships ("InnSuites Partnerships") in which
the shareholders of InnSuites and certain officers of InnSuites (collectively,
InnSuites Affiliates) have significant direct and indirect ownership interests.
Flagstaff and Scottsdale are owned by corporations controlled by principals of
InnSuites. The partnerships and corporations are referred to collectively as the
InnSuites System Entities.
As of December 31, 1997, the InnSuites System Entities are owned as
follows:
<TABLE>
<CAPTION>
ENTITY INTEREST
-------------------
INNSUITES THIRD
AFFILIATES PARTY
---------- -----
<S> <C> <C>
InnSuites Phoenix Best Western.............................. 96% 4%
InnSuites Tempe/Airport..................................... 46% 54%
InnSuites Tucson Best Western............................... 28% 72%
InnSuites Yuma Best Western................................. 33% 67%
Holiday Inn Airport InnSuites Ontario....................... 100% 0%
InnSuites Flagstaff Grand Canyon............................ 100% 0%
InnSuites Scottsdale........................................ 100% 0%
</TABLE>
Realty ReFund Trust is an unincorporated Ohio real estate investment trust
("REIT") which agreed to acquire equity interests in existing hotel properties
on January 31, 1998 and to consider selectively the purchase or development of
additional hotels. The REIT acquired the general partnership interest,
representing a 13.6% equity interest in RRF Limited Partnership, a Delaware
limited partnership (the Partnership), as of January 31, 1998. The partners and
shareholders of the entities owning the InnSuites Hotels contributed their
respective partnership and corporate interests to the Partnership, or a
subsidiary of the REIT in exchange for cash, partnership interests or REIT stock
on January 31, 1998. All of the InnSuites Hotels will be leased to Realty Hotel
Lessee Corporation (the InnSuites Lessee) pursuant to operating leases which
contain provisions for rent based on the revenues of the InnSuites Hotels. The
Lessee is an affiliate of InnSuites.
Management believes that these combined financial statements result in a
more meaningful presentation of the InnSuites Hotel System businesses acquired
by the Partnership or REIT and thus appropriately reflect the historical
financial position and results of operations of the predecessor of the Lessee.
All significant intercompany balances and transactions have been eliminated.
F-6
<PAGE> 165
INNSUITES HOTELS SYSTEM
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Accounting Periods
For annual reporting purposes, all of the InnSuites System Entities have
been included in the accompanying combined financial statements based on a
December 31 year-end.
Hotel Properties
Hotel properties are stated at cost. Depreciation is computed using
primarily the straight-line method based upon estimated useful lives, 40 years
for buildings and improvements, 7 years for furniture and equipment.
The partners and management of the InnSuites System Entities review the
hotel properties for impairment when events or changes in circumstances indicate
the carrying amounts of the hotel properties may not be recoverable. When such
conditions exist, management estimates the future cash flows from operations and
disposition of the hotel properties. If the estimated undiscounted future cash
flows from operations and disposition of the hotel properties are less than the
carrying amount of the asset, an adjustment to reduce the carrying amount to the
related hotel property's estimated fair market value would be recorded and an
impairment loss would be recognized. No such impairment losses have been
recognized.
Deferred Expenses
Deferred expenses consist principally of deferred loan costs. Deferred loan
costs are amortized over the terms of the related loan agreements. The
amortization of deferred loan costs of $51,377, $42,187, and $37,925, and $4,203
for the years ended December 31, 1995, 1996, and 1997, and the month ended
January 30, 1998 is included in interest expense in the accompanying combined
statements of operations. Accumulated amortization of deferred expenses was
$385,651 and $258,673 at December 31, 1996 and 1997, respectively, and $262,876
at January 30, 1998.
Concentration of Credit Risk
Financial instruments which potentially subject the InnSuites System
Entities to credit risk consist primarily of trade receivables. Credit
evaluations of guest's accounts are performed regularly. The receivables are
unsecured.
Revenue Recognition
Revenue is recognized as earned. Ongoing credit evaluations are performed
and credit losses are charged off when deemed to be uncollectible. Such losses
have been minimal and within management's expectations.
Income Taxes
The InnSuites Partnerships, Scottsdale and Flagstaff (S-Corporations in
1997) are not subject to federal or state income taxes; however, they must file
informational income tax returns and the partners and stockholders must take
income or loss of the InnSuites Partnerships and S-Corporations into
consideration when filing their respective tax returns. Flagstaff, was a
C-Corporation in 1996, and had no income tax liability for that year.
Management's Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-7
<PAGE> 166
INNSUITES HOTELS SYSTEM
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Maintenance and Repairs
Maintenance and repairs are charged to operations as incurred; major
renewals and betterments are capitalized. The hotel properties have scheduled
guest room refurbishing programs, the cost of which is expensed as incurred.
Upon the sale or disposition of a fixed asset, the asset and related accumulated
depreciation are removed from the accounts, and the gain or loss is included in
the determination of net income or loss.
Advertising and Promotion
The Innsuites System Entities expense the cost of advertising and promotion
as incurred which approximates the time such advertising takes place. There are
no capitalized advertising costs.
Cash and Cash Equivalents
All highly liquid investments with an original maturity date of three
months or less when purchased are considered to be cash equivalents. Management
believes that the fair value of cash equivalents approximates carrying value due
to the relatively short maturity of these instruments.
Inventories
Inventories consisting primarily of linen, food, and beverages and gift
store merchandise are stated at the lower of first-in, first-out cost or market.
Cash Held in Escrow
Cash held in escrow consists of amounts for real estate taxes and property
insurance remitted to the lenders which hold the mortgages on the hotel
properties and amounts deposited for the replacement of hotel real and personal
property pursuant to the terms of certain mortgage and franchise agreements.
F-8
<PAGE> 167
INNSUITES HOTELS SYSTEM
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
3. MORTGAGE NOTES PAYABLE:
Mortgage notes payable consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- JANUARY 30,
1996 1997 1998
----------- ---------- -----------
<S> <C> <C> <C>
Mortgage note payable to a bank in aggregate monthly
installments of principal and interest of $38,436 at
rate of 8.5%; the unpaid principal matures with a
balloon payment due in March 2007; collateralized by
real and personal property having a net book value
of $2,766,938 at December 31,1997. ................. $3,152,590 2,947,434 2,929,875
Mortgage note payable to a bank in aggregate
installments of principal and interest of $27,572 at
a rate of 8.5%; the unpaid principal is due January
2006; collateralized by real and personal property
having a net book value of $3,816,504 at December
31, 1997. .......................................... 2,711,786 2,607,412 2,598,308
Mortgage note payable to a finance company in
aggregate monthly installments of principal and
interest of $41,168 at a rate of 9.25%; the unpaid
principal is due August 2011; collateralized by real
and personal property having a net book value of
$3,094,443 at December 31, 1997. ................... 3,958,182 3,824,738 3,812,963
Mortgage note payable to a bank in aggregate monthly
installments of principal and interest of $33,581 at
a rate of 8.75%; the unpaid principal due March
2011, collateralized by real and personal property
having a net book value of $6,834,154 at December
31, 1997; requires an escrow reserve of 4% of
revenues for the replacement or refurbishing of
furniture, fixtures and equipment. ................. 3,739,308 3,653,520 3,646,629
Mortgage note payable to a bank in aggregate monthly
installments of principal and interest of $12,919 at
a rate of 9.75%; the unpaid principal due June 2001;
collateralized by real and personal property having
a net book value of $2,122,233 at December 31,
1997. .............................................. 956,612 891,983 886,524
Mortgage note payable to a finance company in
aggregate monthly installments of principal of
$45,701 plus interest at a rate of 9%; the unpaid
principal due February 1998; collateralized by real
and personal property having a net book value of
$1,920,889 at December 31, 1997. ................... 1,887,467 3,851,540 3,835,290
----------- ---------- ----------
$16,405,945 17,776,627 17,709,589
=========== ========== ==========
</TABLE>
Aggregate scheduled annual principal payments for the above mortgage notes
payable at December 31, 1997 are as follows:
<TABLE>
<CAPTION>
YEAR AMOUNT
---------------------------------------------------- -----------
<S> <C>
1998................................................ $ 4,504,838
1999................................................ 723,492
2000................................................ 779,853
2001................................................ 1,321,003
2002................................................ 799,639
Thereafter.......................................... 9,647,802
-----------
$17,776,627
===========
</TABLE>
F-9
<PAGE> 168
INNSUITES HOTELS SYSTEM
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Debt Extinguishment
In 1995 Tempe and Ontario realized net extraordinary gains of $5,994,473 on
early extinguishment of debt and Scottsdale realized an extraordinary gain
related to the forgiveness of principal on debt of $470,832 due to a related
party. In 1996 Flagstaff refinanced its existing mortgage indebtedness,
realizing a net extraordinary gain of $112,780 and an extraordinary gain related
to the forgiveness of debt of $194,220 due to a related party.
4. RELATED PARTY TRANSACTIONS:
A substantial portion of the hotels' management functions are performed by
two InnSuites management companies for a fee computed as specified in each
hotel's management agreement. The management fee is based on a percentage of
hotel revenues of 4.5%.
In addition, InnSuites has trademark license agreements with the hotels,
excluding Ontario which operates under licensing with Holiday Inns, for which
the fees are .5% of revenues. InnSuites also operates an advertising trust to
which the hotels contribute 1% of revenues, 1.9% for a portion of 1995. Certain
properties paid different rates or no fees during certain periods. All
agreements expire in 2000. The payable to affiliates represents amounts due
primarily for working capital advances. There are no terms or covenants
connected with the advances.
The InnSuites System Entities paid fees to InnSuites affiliates for various
services as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------ JANUARY 30,
1995 1996 1997 1998
-------- ------- ------- -----------
<S> <C> <C> <C> <C>
Management fees
(4.5% of total revenues)............... $611,421 840,518 902,938 90,051
Trademark license fees
(0.5% of total revenues)............... 66,246 80,596 81,935 9,785
Advertising trust fees
(1% of total revenues)................. 232,023 189,231 201,296 16,594
</TABLE>
5. CHANGES IN OWNERSHIP:
On January 1, 1996 the principals of InnSuites became sole shareholders of
Hulsey Hotels Corporation (Flagstaff) and purchased the hotel from a
sole-proprietorship for the assumption of $200,000 of outstanding debt, certain
other considerations plus the outstanding mortgage indebtedness. The property
was refinanced on June 19, 1996 in the amount of $1,004,000.
The purchase accounting adjustment recorded was an aggregate increase in
the carrying value of the investments in hotel property was as follows:
<TABLE>
<S> <C>
Land, buildings and improvements............................ $1,050,000
Furniture and equipment..................................... 200,000
----------
$1,250,000
==========
</TABLE>
6. COMMITMENTS AND CONTINGENCIES:
Claims and Legal Matters
Certain of the hotels are involved in claims and legal matters incidental
to their business. In the opinion of management, the ultimate resolution of
these matters will not have a material impact on the financial position or the
results of operations of the hotels.
F-10
<PAGE> 169
INNSUITES HOTELS SYSTEM
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Trademark License Agreements
Under the terms of hotel trademark license agreements, annual payments for
trademark royalties and reservation and advertising services are due from the
hotels. Fees are computed based upon a percentage of total revenues. At December
31, 1997, the trademark license royalty fees are payable by the hotels at .5% of
revenues to InnSuites affiliates while the fees for advertising services are 1%
of revenues. The franchise agreements expire in 2000. The Best Western and
Holiday Inn hotels have additional franchise agreements in which fees are
charged on a per room basis and generally approximate 3% of revenues for Best
Western and 9% for Holiday Inn.
Other
The land on which the Tucson Hotel is located is leased under an operating
lease agreement expiring in 2010 which can be extended to 2051. The lease
requires minimum annual rentals of $70,000 for 1997-2000, $75,000 through 2002,
plus percentage rentals based on hotel revenues. Tucson is responsible for all
taxes, insurance and maintenance on the property. Rental expense charged to
operations for the land lease were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------ JANUARY 30,
1995 1996 1997 1998
-------- ------- ------- -----------
<S> <C> <C> <C> <C>
Minimum rent............................. $ 60,000 70,000 70,000 5,833
Percentage rent.......................... 70,689 74,632 80,437 7,845
-------- ------- ------- ------
$130,689 144,632 150,437 13,678
======== ======= ======= ======
</TABLE>
7. FAIR VALUE OF FINANCIAL INSTRUMENTS:
Statement of Financial Accounting Standards No. 107 requires disclosure
about fair value for all financial instruments, whether or not recognized for
financial statement purposes. Disclosure about fair value of financial
instruments is based on pertinent information available to management as of
December 31, 1997 and January 30, 1998. Considerable judgment is necessary to
interpret market data and develop estimated fair value. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts which
could be realized on disposition of the financial instruments. The use of
different market assumptions and/or estimation methodologies may have a material
effect on the estimated fair value amounts.
Long-Term Debt
Management estimates that the fair values of mortgage and other long-term
debt approximate carrying values based upon the hotels' effective borrowing rate
for issuance of debt with similar terms and remaining maturities.
8. PARTICIPATION INVESTORS CONTINGENT LIABILITY:
For the Ontario property, participation investors rights to repayment were
converted to the right to receive forty-five percent of the profits from any
future sale of the hotel property, over a fixed base amount of approximately
$4,100,000, after payment of all outstanding liabilities. The contingent
liability approximates the participants original investment plus certain accrued
interest and management's estimate of the potential liability upon a future sale
of the hotel property. The balance consists of the original $1,950,000 of loan
participation units subscribed to by investors, plus $745,035 of accrued but
unpaid interest during the construction period, as defined. During 1996 the
Partnership purchased units from participation investors for $48,408.
F-11
<PAGE> 170
INNSUITES HOTELS SYSTEM
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
9. LINES OF CREDIT:
Flagstaff, Scottsdale, Ontario and Tucson each carried an unsecured line of
credit of $50,000 at December 31, 1997. Interest rates are 10% to 10.25%; and
due dates are March 1 to April 30, 1998. The lines of credit are guaranteed by a
principal of InnSuites.
10. CAPITAL LEASE OBLIGATION:
Ontario owns equipment under a capital lease arrangement for $39,752. The
lease liability carries interest at a rate of 10.5% and is payable through
October 1999 with monthly payments of $1,433. Future payments required by the
lease as of December 31, 1997 follow:
<TABLE>
<S> <C>
1998....................................................... 14,438
1999....................................................... 7,999
-------
$22,437
=======
</TABLE>
11. PARTNERS' CAPITAL PURCHASES PAYABLE:
Certain partners of entities owning the InnSuites Hotels are redeeming
their interests for cash in lieu of exchanging their interests for partnership
interests or REIT stock. Three properties purchased such interests effective
January 1, 1997 aggregating $584,669. The purchases are payable monthly through
December 1998.
12. PREACQUISITION COSTS:
On January 31, 1998 the InnSuites System Entities were acquired by RRF
Limited Partnership, the general partner of which is Realty ReFund Trust, an
unincorporated Ohio real estate investment trust ("REIT"). In accordance with
the acquisition agreements the InnSuites System Entities are bearing certain
preacquisition costs, primarily professional fees, which will not be reimbursed
by the REIT and will not be a part of the purchase price. These costs of
$445,414 in 1997 and $651,198 in January 1998 are expensed and included in
professional services. As part of the acquisition, the InnSuites System Entities
purchased for $950,000 certain shares from the REIT's prior owners. It then
distributed $404,725 in shares to the partners of RRF Limited Partnership and
$545,275 in shares to certain employees which is included in wages and salaries.
F-12
<PAGE> 171
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Trustees,
Realty ReFund Trust:
We have audited the accompanying consolidated balance sheets of Realty
ReFund Trust (an Ohio unincorporated business trust) and subsidiaries as of
January 31, 1998 and 1997, and the related consolidated statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended January 31, 1998. These financial statements and the schedule
referred to below are the responsibility of the Trust's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Realty ReFund Trust as of
January 31, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended January 31, 1998 in conformity
with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in Item 14(a)1. of
this Form 10-K is the responsibility of the Trust's management and is presented
for purposes of complying with the Securities and Exchange Commission's rules
and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Cleveland, Ohio,
May 13, 1998.
F-13
<PAGE> 172
REALTY REFUND TRUST
CONSOLIDATED BALANCE SHEETS
JANUARY 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
ASSETS
INVESTMENTS IN HOTEL PROPERTIES, net........................ $41,241,241 $ --
CASH AND CASH EQUIVALENTS................................... 2,378,398 531,997
INTEREST RECEIVABLE AND OTHER ASSETS........................ -- 285,004
REAL ESTATE HELD FOR SALE, net of $4,085,000 valuation
allowance................................................. -- 5,599,122
----------- ----------
TOTAL ASSETS................................................ $43,619,639 $6,416,123
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
MORTGAGE NOTES PAYABLE...................................... $17,709,589 $ --
NOTES PAYABLE TO BANKS...................................... 155,000 --
OTHER NOTES PAYABLE......................................... 2,864,690 --
ADVANCES PAYABLE TO RELATED PARTIES......................... 1,699,601 2,300,000
DUE TO LESSEE............................................... 944,234 --
ACCOUNTS PAYABLE AND ACCRUED EXPENSES....................... 572,031 864,903
MINORITY INTEREST IN PARTNERSHIP............................ 14,075,523 --
SHAREHOLDERS' EQUITY:
Shares of beneficial interest without par value; unlimited
authorization; 1,667,817 and 1,020,586 shares issued
and outstanding in 1998 and 1997, respectively......... 5,598,971 3,251,220
----------- ----------
$43,619,639 $6,416,123
=========== ==========
</TABLE>
The accompanying notes to financial statements are an integral part of these
balance sheets.
F-14
<PAGE> 173
REALTY REFUND TRUST
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JANUARY 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- -----------
<S> <C> <C> <C>
REVENUES:
Interest income from loans receivable............... $ -- $1,077,757 $ 2,199,600
Interest income from loan receivable from related
party............................................ -- 560,139 932,605
Rental revenue from real estate held for sale....... 1,367,366 2,277,610 2,297,801
Interest income..................................... 54,613 -- --
---------- ---------- -----------
1,421,979 3,915,506 5,430,006
---------- ---------- -----------
EXPENSES:
Provision for writedown of loan receivable from
related party.................................... -- 111,498 5,000,000
Provision for writedown of real estate held for
sale............................................. -- 1,085,000 3,000,000
Loss on sale of real estate......................... 35,620 -- --
Interest on loans underlying wrap-around
mortgages........................................ -- 150,184 617,123
Interest on loan underlying wrap-around mortgage to
related party.................................... -- 89,223 209,872
Interest on note payable to bank.................... -- 381,368 717,550
Interest on note payable to related party........... 118,082 332,308 427,445
Fee to related party investment advisor............. -- 169,961 223,278
Legal expense to related party...................... 84,000 56,000 20,000
Operating expenses of real estate held for sale..... 1,379,389 2,085,807 2,144,150
Depreciation of building held for sale.............. -- -- 264,873
Amortization of tenant improvements and deferred
leasing commissions.............................. 21,724 43,080 192,719
Other operating expenses............................ 356,673 299,442 167,347
---------- ---------- -----------
1,995,488 4,803,871 12,984,357
---------- ---------- -----------
NET LOSS.............................................. $ (573,509) $ (888,365) $(7,554,351)
========== ========== ===========
LOSS PER SHARE -- Basic and diluted................... $ (.56) $ (.87) $ (7.40)
========== ========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING......................................... 1,022,359 1,020,586 1,020,586
CASH DIVIDENDS PER SHARE:
Paid................................................ $ .15 $ .30 $ .40
Declared............................................ .00 .10 .10
---------- ---------- -----------
$ .15 $ .40 $ .50
========== ========== ===========
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
F-15
<PAGE> 174
REALTY REFUND TRUST
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED JANUARY 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
TOTAL
SHAREHOLDERS'
EQUITY
-------------
<S> <C>
BALANCE, JANUARY 31, 1995................................... $12,714,542
Net loss.................................................. (7,554,351)
Cash dividends paid....................................... (612,372)
-----------
BALANCE, JANUARY 31, 1996................................... 4,547,819
Net loss.................................................. (888,365)
Cash dividends paid....................................... (408,234)
-----------
BALANCE, JANUARY 31, 1997................................... 3,251,220
Issuance of shares........................................ 3,074,348
Net loss.................................................. (573,509)
Cash dividends paid....................................... (153,088)
-----------
BALANCE, JANUARY 31, 1998................................... $ 5,598,971
===========
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
F-16
<PAGE> 175
REALTY REFUND TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JANUARY 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................... $ (573,509) $ (888,365) $(7,554,351)
Adjustments to reconcile net loss to net cash
(used for) provided by operating activities --
Provision for writedown of loan receivable
from related party........................ -- 111,498 5,000,000
Provision for writedown of real estate held
for sale.................................. -- 1,085,000 3,000,000
Depreciation of building held for sale....... -- -- 264,873
Amortization of tenant improvements and
deferred leasing commissions.............. 21,724 43,080 192,719
Amortization of deferred loan fees........... -- (15,000) (18,000)
Decrease in interest receivable and other
assets.................................... 263,280 392,587 220,781
Decrease in accounts payable and accrued
expenses.................................. (676,274) (600,158) (45,767)
----------- ----------- -----------
Net cash (used for) provided by operating
activities.............................. (964,779) 128,642 1,060,255
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Principal collected on mortgage loans
receivable..................................... -- 14,569,483 13,087,769
Principal payments on mortgage loans payable...... -- (4,991,421) (6,364,536)
Payments for tenant and building improvements..... -- -- (1,178,904)
Payment of transaction costs...................... (334,854) -- --
Proceeds from sale of real estate, net............ 5,599,122 -- --
Purchase of fee interest in land.................. -- (287,758) --
----------- ----------- -----------
Net cash provided by investing
activities.............................. 5,264,268 9,290,304 5,544,329
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Bank borrowings................................... -- 625,000 2,550,000
Bank repayments................................... -- (6,920,000) (8,065,000)
Payment of cash dividends......................... (153,088) (408,234) (612,372)
Principal payments on note payable to related
party.......................................... (2,300,000) (2,200,000) (500,000)
----------- ----------- -----------
Net cash used for financing activities.... (2,453,088) (8,903,234) (6,627,372)
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH..................... 1,846,401 515,712 (22,788)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR...... 531,997 16,285 39,073
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR............ $ 2,378,398 $ 531,997 $ 16,285
=========== =========== ===========
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
F-17
<PAGE> 176
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1998, 1997 AND 1996
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION:
Prior to fiscal 1998, Realty ReFund Trust (the Trust) specialized in
mortgage financing as its investment vehicle, refinancing existing
income-producing commercial, industrial and multi-unit residential real property
by supplementing or replacing existing financing. The primary refinancing
technique which the Trust employed was wrap-around mortgage lending, which is
discussed in Note 2. As of January 31, 1997, the Trust's remaining real estate
asset was a wholly owned commercial office building in Chicago, which was sold
in September 1997.
On January 31, 1998, the Trust contributed $2,081,000 to RRF Limited
Partnership (the Partnership), a Delaware limited partnership, in exchange for a
13.6% general partnership interest therein. The Trust is the sole general
partner of the Partnership. The Partnership issued limited partnership interests
representing 86.4% of the Partnership to acquire six hotel properties from
various entities. In addition, through a wholly-owned subsidiary, the Trust
issued 647,231 shares of beneficial interest in exchange for all of the
outstanding shares of Buenaventura Properties, Inc. (BPI), which owned a hotel
located in Scottsdale, Arizona. The Scottsdale, Arizona hotel together with the
six hotel properties acquired by the Partnership, are the Initial Hotels. The
Initial Hotels are leased to Realty Hotel Lessee Corp. (the Lessee) pursuant to
leases which contain provisions for rent based on revenues of the Initial Hotels
(the Percentage Leases). Each Percentage Lease obligates the Lessee to pay rent
equal to the greater of the minimum rent or a percentage rent based on the gross
revenues of each hotel. The Lessee holds the franchise agreement for each hotel.
The Lessee is owned 9.8% by InnSuites Innternational Hotels, Inc. an entity
owned by James F. Wirth, Chairman, President and Chief Executive Officer of the
Trust, (Wirth) and his spouse.
Partnership Agreement
Pursuant to the Partnership Agreement, the partners in five partnerships
(the Exchanging Partners) exchanged their respective partnership interests for
limited partnership interests in the Partnership. The corporation which owned a
hotel property in Flagstaff, Arizona (one of the Initial Hotels) contributed the
hotel to the Partnership in exchange for limited partnership interests therein.
The Partnership Agreement provides for the issuance of two classes of limited
partnership units, Class A and Class B. Such Classes are identical in all
respects, except that each Class A limited partnership unit in the Partnership
shall be convertible into a like number of shares of beneficial interest of the
Trust, at any time at the option of the particular limited partner, if the Trust
determines that such conversion would not cause the Trust to fail to qualify as
a REIT. A total of 2,174,931 Class A limited partnership units were issued to
the Exchanging Partners. Additionally, 299,622 Class A partnership units were
reserved for issuance to those partners who did not accept the formation
exchange offer. A total of 4,017,361 Class B limited partnership units were
issued to Wirth and his affiliates, in lieu of the issuance of Class A limited
partnership units. If all of the Class A limited partnership units were to be
converted, the limited partners in the Partnership would hold 2,174,931 shares
of beneficial interest of the Trust. The Class B limited partnership units may
be converted at the discretion of the Board of Trustees provided that such
conversion would not cause the Trust to fail to qualify as a REIT.
Basis of Presentation
As general partner, the Trust exercises unilateral control over the
Partnership. Therefore, the financial statements of the Trust, its wholly-owned
subsidiaries and the Partnership are consolidated. All significant intercompany
transactions and balances have been eliminated.
F-18
<PAGE> 177
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Investments in Hotel Properties
Hotel properties are stated at cost and are depreciated using the
straight-line method over estimated lives of 40 years for buildings and
improvements and 7 years for furniture and equipment.
In accounting for the acquisitions of the Initial Hotels discussed in Note
1, purchase accounting was applied. The historical carrying values of the assets
and liabilities of BPI were adjusted to their respective fair market values
based upon the aggregate fair market value of shares of beneficial interest
issued to acquire the outstanding shares of BPI. The Trust's purchase of its
13.6% general partnership interest in the Partnership and the Partnership's
acquisition of interests in the Initial Hotels other than BPI held by Exchanging
Partners other than Wirth and his affiliates resulted in adjustments to the
historical net carrying values of such hotel properties in amounts equal to 34%
of the difference between the fair market values and the historical net carrying
values of the respective hotel properties. The Partnership's acquisition of
interests in the Initial Hotels other than BPI held by Wirth and his affiliates
did not result in purchase accounting adjustments to historical net carrying
values as such transactions were between entities under common control. The
purchase price allocation resulting from the formation transactions remains
preliminary as of January 31, 1998 pending final determination of assumed
liabilities and allocation of cost among categories of investments in hotel
properties.
The Trust does not believe that there are any factors or circumstances
indicating impairment of any of its investments in hotel properties at January
31, 1998.
In the first quarter of fiscal 1997, the Trust adopted FAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." Pursuant to this standard, long-lived assets to be disposed of
are to be reported at the lower of carrying amount or fair value less
incremental direct costs to sell. Long-lived assets to be disposed of shall not
be depreciated while being held for disposal. The Trust's real estate held for
sale was within the scope of FAS No. 121. As the Trust established a $3,000,000
valuation allowance at January 31, 1997 to reduce the carrying value of the real
estate held for sale to its estimated net realizable value, adoption of FAS No.
121 did not have a material impact on the Trust's financial position or results
of operations except that no depreciation expense was recorded on the real
estate held for sale during fiscal 1998 and 1997. Accumulated depreciation and
amortization of the real estate held for sale at January 31, 1996 was $793,000.
Interest Receivable and Other Assets
Included in interest receivable and other assets at January 31, 1997 were
deferred leasing commissions related to the Chicago office building of $312,000,
which were being amortized on a straight-line basis over the related lease
terms. Accumulated amortization of such deferred costs at January 31, 1997 was
$74,000.
Investments in Wrap-Around Mortgages and Related Underlying Loans
In a wrap-around mortgage structure, the principal amount secured by the
mortgage note held by the Trust was equal to the outstanding balance under the
prior mortgage loan plus the amount of funds advanced by the Trust. The notes
held by the Trust were subordinate to the underlying prior indebtedness. The
Trust agreed with the borrower to make principal and interest payments to the
holder of the existing prior mortgage, but only to the extent scheduled payments
were received from the borrower and no other default existed. Generally, the
Trust had the right to pay off the prior indebtedness and succeed to its
priority.
In May 1993, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (FAS) No. 114, "Accounting by Creditors for
Impairment of a Loan." This standard allows a creditor to measure the impairment
of a loan based on the fair value of the collateral if a loan is collateral
dependent. FAS No. 118 "Accounting by Creditors for Impairment of a
Loan -- Income Recognition and Disclosures," issued in October 1994, amended FAS
No. 114 to allow a creditor to use existing methods for recognizing interest
income
F-19
<PAGE> 178
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
on impaired loans. The Trust adopted the provisions of FAS Nos. 114 and 118 in
fiscal 1996. See Note 4 for a discussion of the impairment of the Trust's loan
on the Toledo, Ohio property.
Dividends/Distributions
The Trust expects to pays dividends which will be dependant upon the
receipt of distributions from the Partnership.
Revenue Recognition
The Trust recognizes lease revenue on a accrual basis over the terms of the
respective Percentage Leases. No percentage rent was earned in fiscal 1998 from
the Initial Hotels.
Minority Interest
Minority interest in the Partnership represents the limited partners'
actual proportionate share of the equity in the Partnership. Income will be
allocated to minority interest based on the weighted average limited partnership
percentage ownership throughout the period.
Fair Value of Financial Instruments
For disclosure purposes, fair value is determined by using available market
information and appropriate valuation methodologies. Cash and cash equivalents,
due to their short maturities, are carried at amounts which reasonably
approximate fair value.
For mortgage notes payable, notes payable to banks, other note payables and
advances to related parties, the fair value is estimated by discounting the
future cash flows using the current rates which would be available for similar
loans having the same remaining maturities.
Earnings Per Share
In February 1997, FAS No. 128, "Earnings per Share" was issued which
eliminated the concept of common stock equivalents and replaces "primary" and
"fully diluted" earnings per share with "basic" and "diluted" earnings per
share. For all periods presented there were no dilutive securities.
Basic earnings per share has been computed based on the weighted average
number of shares outstanding during the periods. The calculation of basic
earnings per share for 1998 was based upon 1,022,359 shares and in 1997 and 1996
was based upon 1,020,586 shares.
Statements of Cash Flows
The Trust considers all highly liquid short-term investments with original
maturities of three months or less to be cash equivalents. Interest paid
amounted to $118,000, $995,000 and $2,018,000 for fiscal years 1998, 1997 and
1996, respectively.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
In July 1995, the Trust established a valuation allowance of $5,000,000 on
its investment in the Toledo, Ohio wrap-around mortgage loan. The loan was
retired in fiscal 1997 and an additional loss of $111,000 was recorded.
F-20
<PAGE> 179
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the fourth quarter of fiscal 1996, the Trust established a valuation
allowance of $3,000,000 to writedown the Chicago real estate held for sale to
its estimated net realizable value. The Trust recorded an additional valuation
allowance of $1,085,000 at January 31, 1997 to further reduce the real estate
held for sale to its estimated net realizable value. The building was sold
during fiscal 1998.
3. INVESTMENT IN HOTEL PROPERTIES:
Investment in hotel properties as of January 31, 1998 consist of the
following:
<TABLE>
<S> <C>
Land........................................................ $ 3,439,738
Building and improvements................................... 31,395,305
Furniture and equipment..................................... 6,406,198
-----------
41,241,241
Less-Accumulated depreciation............................... --
-----------
$41,241,241
===========
</TABLE>
The Initial Hotels are located in Arizona (6) and California (1) and are
subject to Percentage Leases as described in Note 11.
4. LOAN IMPAIRMENT:
In July 1995, the Trust recorded a $5,000,000 loss provision on its
investment in the Toledo, Ohio wrap-around mortgage loan. The owner of the
property was pursuing, among other things, the sale of the property. As the
Trust's loan was made on a nonrecourse basis, the Trust had written down its
investment to reflect the estimated sale price of the property and the estimated
net proceeds to be received by the Trust as repayment of its loan as of January
31, 1996.
The commercial building that secured the loan was owned by a partnership of
which a corporation owned by the former Chairman of the Trust was the general
partner. The building was sold by the partnership in fiscal 1997. In connection
with that sale, the Trust was released by the new owner from any claims or
liabilities relating to that property, and the Trust released its rights to any
obligations from the partnership. As a result, in the fourth quarter of fiscal
1997, the Trust recorded a $111,000 loss provision on the Toledo, Ohio loan
based on its final actual net realized value.
5. REAL ESTATE HELD FOR SALE:
In July 1992, the Trust accepted title in lieu of foreclosure on a
commercial building in Chicago, Illinois. At the time of title acceptance, the
Trust recorded a provision to write down its investment to estimated net
realizable value as it was the Trust's intention to sell the real estate. The
carrying value of the investment increased as a result of considerable
investment in building and tenant improvements.
Based on both market conditions for similar commercial property in Chicago
and the operating performance of the property, the Trust recorded a $3,000,000
provision in the fourth quarter of fiscal 1996 to reduce the carrying value of
the property to its then estimated net realizable value. The amount of the
writedown was based upon the Trust's best estimate at January 31, 1996 of the
amount of net proceeds which would be realized upon sale of the real estate in
the near term future.
In the fourth quarter of fiscal 1997, the Trust entered into a contract to
sell the Chicago building for $6,000,000. Accordingly, the Trust recorded an
additional provision of $1,085,000 to reduce the carrying value of the real
estate held for sale to its estimated net realizable value based upon a pending
contract price and estimated costs associated with the potential sale.
F-21
<PAGE> 180
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the third quarter of fiscal 1998, the Trust sold the Chicago building
and received approximately $6,000,000 before consideration of closing and other
costs related to the sale. A loss of approximately $36,000 was recorded as a
result of the sale.
6. MORTGAGE NOTES PAYABLE:
At January 31, 1998, the Trust had mortgage notes payable outstanding with
respect to six of the Initial Hotels. The mortgage notes payable have various
repayment terms and have scheduled maturity dates ranging from fiscal 1999 to
2012. Interest rates on the mortgage notes range from 8.50% to 9.75%. The
mortgage notes payable are guaranteed by Wirth and certain of his affiliates.
The net book value of properties securing the mortgage notes payable at January
31, 1998 was $35,179,000.
Scheduled minimum payments of mortgage notes payable as of January 31, 1998
are as follows:
<TABLE>
<CAPTION>
YEAR AMOUNT
- ---- -----------
<S> <C>
1999.................................................... $ 4,496,000
2000.................................................... 729,000
2001.................................................... 785,000
2002.................................................... 1,317,000
2003.................................................... 781,000
Thereafter.............................................. 9,602,000
-----------
$17,710,000
===========
</TABLE>
7. NOTE PAYABLE TO BANKS:
At January 31, 1998, the Trust had various lines of credit totaling
$350,000 with outstanding balances totaling $155,000 at interest rates floating
with the banks' respective reference rates plus 1.5% to 3.0%.
Prior to January 31, 1997, the Trust had a separate bank credit facility.
During fiscal 1997, the proceeds from the repayment of the Forth Worth, Texas
loan were utilized, in part, to retire all outstanding borrowings under the
Trust's bank credit agreement. Upon retirement of all outstanding borrowings
thereunder, the Trust's former bank credit agreement expired.
For the years ended January 31, 1997 and 1996, the average daily bank
borrowings were $5,519,000 and $9,431,000, respectively, with a weighted average
interest rate (actual interest expense divided by average daily borrowings) of
6.9% and 7.6%, respectively.
8. OTHER NOTES PAYABLE:
For one of the Initial Hotels, participation investors' rights to repayment
were converted into the right to receive forty-five percent of the profits from
any future sale of that hotel property, over a fixed base amount of
approximately $4,100,000 and after payment of all outstanding liabilities. Other
notes payable at January 31, 1998 includes a contingent liability of $2,647,000
which represents the participants' original investment plus certain accrued
interest and management's estimate of the potential liability upon a future sale
of the hotel property. The balance consists of the original $1,950,000 of loan
participation units subscribed to by investors, plus $745,000 of accrued but
unpaid interest during the construction period, as defined. During 1996 certain
units were purchased from participation investors for $48,000.
Prior to the formation transactions, certain partners of the partnerships
that previously owned the Initial Hotels sold their interests therein in
exchange for notes. These notes are payable over 2 years. At January 31, 1998
$218,000 principal amounts of such notes is outstanding.
F-22
<PAGE> 181
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. ADVANCES PAYABLE TO RELATED PARTIES:
Advances payable to related parties at January 31, 1998 consists of funds
provided to fund working capital and capital improvement needs. The aggregate
amount outstanding was approximately $1,700,000 as of January 31, 1998.
In March 1993, the Trust sold a $5,000,000 secured note to the former
Chairman of the Trust, at par. The note bore interest at the prime lending rate
and had a stated maturity date of August 1994. The Trust exercised its option to
extend the maturity of the note. Pursuant to the terms of the note, the Trust
made scheduled principal payments of $500,000 for each of the years ended
January 31, 1997 and 1996. In addition, $1,700,000 of the proceeds from the
repayment of the Fort Worth, Texas loan was utilized to reduce the note. The
remaining $2,300,000 of the note was retired with proceeds from the sale of the
Chicago property.
10. DESCRIPTION OF CAPITAL STOCK:
Holders of the Trust's shares are entitled to receive dividends when, as
and if declared by the Board of Directors of the Trust out of funds legally
available therefor. The holders of shares, upon any liquidation, dissolution or
winding-up of the Trust, are entitled to share ratably in any assets remaining
after payment in full of all liabilities of the Trust. The shares possess
ordinary voting rights, each share entitling the holder thereof to one vote.
Holders of shares do not have cumulative voting rights in the election of
directors and do not have preemptive rights.
11. PERCENTAGE LEASE AGREEMENTS:
The Percentage Leases have noncancellable terms which expire at various
dates through May 31, 2007, subject to earlier termination on the occurrence of
certain contingencies, as defined. The rent due under each Percentage Lease is
the greater of minimum rent, as defined, or percentage rent. Percentage rent
applicable to room and other hotel revenue varies by lease and is calculated by
multiplying fixed percentages by the total amounts of such gross revenues in
excess of specified threshold amounts. Both the minimum rent and the revenue
thresholds used in computing percentage rents are subject to annual adjustments
beginning January 1, 1999, based on increases in the United States Consumer
Price Index. Percentage rent applicable to food and beverage revenues is
calculated as 5% of such revenues over a minimum threshold.
Future minimum rentals (ignoring CPI increases) to be received by the Trust
from the Lessee pursuant to the Percentage Leases for each of the next five
years and in total thereafter are as follows:
<TABLE>
<S> <C>
1999....................................................... $ 5,850
2000....................................................... 5,850
2001....................................................... 5,850
2002....................................................... 5,850
2003....................................................... 5,850
Thereafter................................................. 25,347
-------
$54,597
=======
</TABLE>
12. FEDERAL INCOME TAXES:
No provision for current or deferred income taxes has been made by the
Trust. The Trust has elected to be a real estate investment trust (REIT) and is
therefore subject to the requirements of Sections 856-860 of the Internal
Revenue Code, all of the requirements of which management believes have been met
for the year ended January 31, 1998. As a REIT, the Trust normally distributes
all of its taxable income to its shareholders. For the year ended January 31,
1998, the Trust had a taxable loss of approximately $4,000,000. The primary
difference
F-23
<PAGE> 182
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
between the timing of book provisions for write downs and when such amounts are
allowed as deductions for Federal income tax purposes is attributable to the
foreclosure property described in Note 5. In fiscal 1998, the net tax deductions
related to such property were $3,570,000 that related primarily to amounts that
had been expensed in previous years for book purposes.
The total dividends per share applicable to operating results for the year
ended January 31, 1998, amount to $.15 per share, totaling $153,088.
An income tax net operating loss of approximately $9,533,000 of which
$4,476,000, originated in fiscal 1993 and $5,057,000 originated in fiscal 1997,
is available for carryforward to fiscal 2008 and fiscal 2012, respectively. In
addition, the taxable loss for fiscal 1998 of $4,000,000 will be available for
carryforward to fiscal 2013. The calendar 1997 dividends were 100% return of
capital due to the fiscal 1998 taxable loss. The quarterly allocation of cash
dividends paid per share for individual shareholders' income tax purposes was as
follows:
<TABLE>
<CAPTION>
CALENDAR 1997 CALENDAR 1996 CALENDAR 1995
----------------------------- ----------------------------- -----------------------------
ORDINARY RETURN TOTAL ORDINARY RETURN TOTAL ORDINARY RETURN TOTAL
MONTH PAID INCOME OF CAPITAL PAID INCOME OF CAPITAL PAID INCOME OF CAPITAL PAID
- ---------- -------- ---------- ----- -------- ---------- ----- -------- ---------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
March............................. $-- $.10 $.10 $-- $.10 $.10 $.195 $.005 $.20
June.............................. -- .05 .05 -- .10 .10 .195 .005 .20
September......................... -- -- -- -- .10 .10 .097 .003 .10
December.......................... -- -- -- -- .10 .10 .097 .003 .10
-- ---- ---- -- ---- ---- ----- ----- ----
$-- $.15 $.15 $-- $.40 $.40 $.584 $.016 $.60
== ==== ==== == ==== ==== ===== ===== ====
</TABLE>
The tax status of distributions to shareholders in calendar 1998 will be
dependent on the level of the Trust's earnings in that year. If taxable income
of the Trust exceeds dividends paid in calendar 1998, such dividends will
represent ordinary income to the recipients irrespective of the net operating
loss carryforward.
13. ADVISORY AGREEMENT/EMPLOYMENT AGREEMENTS:
On January 31, 1998, Wirth and his spouse purchased the stock of
Mid-America ReaFund Advisors, Inc. (the Advisor) which provides the
administration of the day-to-day investment operations of the Trust and the
Partnership. The Advisor was formerly owned by the former Chairman and President
of the Trust. Under the terms of the advisory agreement, the Advisor is to
receive, subject to certain limitations, a monthly fee equal to 1/12 of 1% of
invested assets, as defined in the advisory agreement, and an annual incentive
fee equal to (a) 10% of the amount by which the net income of the Trust exceeds
8% of the average net worth for the year and (b) 10% of the difference between
net realized capital gains less accumulated net realized capital losses, as
defined. For any fiscal year in which operating expenses of the Trust exceed
certain thresholds specified in the advisory agreement, the Advisor is required
to refund to the Trust the amount of such excess. For fiscal years 1997 and
1996, operating expenses exceeded the specified thresholds by approximately
$6,000 and $18,000, respectively. There was no fee to the Advisor during fiscal
year 1998 due to the reduction in the Trust's investment in mortgage loans.
Wirth has an employment agreement with the Trust which expires in December
2007. The employment agreement provides that Wirth will receive no compensation
from the Trust as long as the advisory agreement is in effect. However, pursuant
to the terms of the employment agreement, should the Advisor no longer provide
services to the Trust, Wirth will then be compensated, upon the same annual
basis as the Advisor would have been compensated under the current terms of the
advisory agreement had it remained in effect.
Certain employment agreements with the former Chairman and President of the
Trust were terminated at January 30, 1998.
F-24
<PAGE> 183
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. INVESTMENTS IN LOANS RECEIVABLE:
RECONCILIATION OF MORTGAGE LOANS RECEIVABLE
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
BALANCE, beginning of period.............................. $17,422,010 $35,509,779
----------- -----------
COLLECTIONS OF PRINCIPAL:
Office buildings........................................ 14,569,483 7,255,186
Shopping centers........................................ -- 2,029,068
Motels.................................................. -- 3,803,515
Apartments.............................................. -- --
----------- -----------
14,569,483 13,087,769
----------- -----------
ELIMINATION OF UNDERLYING MORTGAGE (Note 15).............. 2,741,029 --
WRITEDOWN OF LOAN RECEIVABLE FROM RELATED PARTY (Note
4)...................................................... 111,498 5,000,000
----------- -----------
BALANCE, end of period.................................. $ -- $17,422,010
=========== ===========
</TABLE>
15. OTHER RELATED PARTY TRANSACTIONS:
Wirth is a 9.8% shareholder of the Lessee. At January 31, 1998, the Trust
has a payable to the Lessee of $944,000 primarily for the reimbursement of costs
and expenses incurred on behalf of the Trust.
The Initial Hotels were acquired by the Partnership from entities in which
Wirth and his affiliates had substantial ownership interests. Wirth and his
affiliates received 4,017,361 Class B limited partnership units and 647,231
shares of beneficial interest in the Trust in exchange for their interests in
the Initial Hotels.
The Trust recorded provisions of approximately $84,000, $56,000 and $20,000
in fiscal years 1998, 1997 and 1996, respectively, for legal services provided
by a law firm of which the former President of the Trust and another former
Trustee are principals.
The Toledo, Ohio loan investment was secured by a commercial building owned
by a partnership of which the former Chairman of the Trust was the general
partner. In September 1996, the Toledo, Ohio loan investment was converted from
a wrap-around mortgage loan to a junior mortgage loan. Accordingly, the Trust's
loan receivable from related party and loan payable underlying mortgage to
related party were reduced by approximately $2,741,000, representing the balance
of the underlying mortgage loan at the time the status of the Toledo loan was
changed. In addition, a principal prepayment of $600,000 was received and
approximately $401,000 of escrow funds held by the Trust was applied against the
mortgage loan receivable balance. The remaining portion ($111,498) of the loan
was written off in the fourth quarter of fiscal 1997.
In the years ended January 31, 1997 and 1996, the Trust earned
approximately $560,000 and $933,000 of interest income on this loan,
respectively. The Trust incurred interest expense of approximately $89,000 and
$210,000 in connection with the related underlying loan payable for the years
ended January 31, 1997 and 1996, respectively.
F-25
<PAGE> 184
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying amounts and fair values of the Trust's significant financial
instruments at January 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------- ----------------------------
CARRYING AMOUNT FAIR VALUE CARRYING AMOUNT FAIR VALUE
--------------- ----------- --------------- ----------
<S> <C> <C> <C> <C>
Mortgage notes payable.......... $17,709,589 $18,103,824 $ -- $ --
Notes payable to banks.......... 155,000 155,000 -- --
Other notes payable............. 2,864,690 2,864,690 -- --
Advances payable to related
parties....................... 1,699,601 1,699,601 2,300,000 2,300,000
</TABLE>
17. STATEMENT OF CASH FLOWS, SUPPLEMENTAL DISCLOSURES:
In connection with the formation of the Partnership, approximately
$24,899,000 of historical net book value in hotel properties was contributed to
the Partnership in exchange for Partnership units and the Partnership assumed
approximately $16,844,000 of debt.
The Trust acquired all of the outstanding shares of BPI in exchange for
647,231 shares of beneficial interest having an aggregate value of $3,074,000.
18. PRO FORMA FINANCIAL INFORMATION (UNAUDITED):
The pro forma financial information set forth below is presented as if the
formation transactions had been consummated as of February 1, 1996. The pro
forma financial information is not necessarily indicative of what actual results
of operations of the Trust would have been assuming the formation transactions
had been consummated as of February 1, 1996 nor does it purport to represent the
results of operations for future periods.
<TABLE>
<CAPTION>
YEAR ENDED
JANUARY 31,
----------------
1998 1997
------ ------
(UNAUDITED, IN
THOUSANDS)
<S> <C> <C>
PERCENTAGE LEASE REVENUE.................................... $7,902 $7,376
INTEREST INCOME............................................. 55 1,638
------ ------
TOTAL REVENUES.................................... 7,957 9,014
------ ------
PROVISION FOR WRITEDOWNS OF LOAN RECEIVABLE................. -- 111
INTEREST ON LOANS UNDERLYING WRAP MORTGAGES................. -- 239
INTEREST EXPENSE ON MORTGAGE AND OTHER NOTES PAYABLE........ $1,668 $1,929
ADVISORY FEE TO RELATED PARTY ADVISOR....................... 576 576
DEPRECIATION AND AMORTIZATION............................... 1,710 1,710
GENERAL AND ADMINISTRATIVE.................................. 578 578
REAL ESTATE AND PERSONAL PROPERTY TAXES AND CASUALTY
INSURANCE AND GROUND RENT................................. 820 942
MINORITY INTEREST........................................... 2,314 1,625
------ ------
TOTAL EXPENSES AND MINORITY INTEREST.............. 7,666 7,360
------ ------
NET INCOME ATTRIBUTABLE TO SHARES OF BENEFICIAL INTEREST.... $ 291 $1,304
====== ======
NET INCOME PER SHARE -- basic and diluted................... $ .17 $ .78
====== ======
</TABLE>
F-26
<PAGE> 185
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
19. SUBSEQUENT EVENTS:
In the first quarter of fiscal 1999, the Partnership completed the
acquisition of the InnSuites Hotel Tucson/ St. Mary's located in Tucson,
Arizona, and the acquisition of the Lafayette Hotel Ramada Inn and Conference
Center located in San Diego, California. Total consideration for the
acquisitions were $10,820,000 and $5,148,000, respectively.
In the first quarter of fiscal 1999, the Trust established a $12,000,000
secured revolving line of credit with Pacific Century Bank. The credit facility
will require, among other things, the Trust to maintain a minimum net worth, a
specified coverage ratio of EBITDA to debt service, and a specified coverage
ratio of EBITDA to debt service and fixed charges. Further, the Trust will be
required to maintain its franchise agreement at each of the hotel properties and
to maintain its REIT status.
20. NEW ACCOUNTING PRONOUNCEMENTS:
In March 1998, the AICPA issued Statement of Position (SOP) 98-1,
"Accounting for the Costs of Computer Software Development or Obtained for
Internal Use," which is effective for the Trust as of February 1, 1999. This SOP
requires capitalization of the development costs of software to be used
internally. The Trust plans to adopt this SOP as of February 1, 1999. The effect
of adopting this SOP will not be material.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities," which is effective for the Trust as of February 1, 1999.
This SOP requires start-up and organization costs to be expensed as incurred and
also requires previously deferred start-up costs to be recognized as a
cumulative effect adjustment in the statement of income. The Trust will adopt
this SOP when required, but the effect of adoption will not be material.
21. QUARTERLY RESULTS (UNAUDITED):
The following is an unaudited summary of the results of operations, by
quarter, for the fiscal years ended January 31, 1998 and 1997. Management
believes that all adjustments (consisting of normal recurring accruals)
necessary for a fair presentation of such interim results have been included.
The results of operations for any interim period are not necessarily indicative
of those for the entire fiscal year.
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------
FISCAL 1998 APRIL 30 JULY 31 OCTOBER 31 JANUARY 31
----------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Total revenues........................... $ 558,933 $ 545,926 $ 262,507 $ 54,613
========== ========== ========== ===========
Total revenues less interest expense on
mortgage loans and operating expenses,
and amortization expense of real estate
held for sale.......................... $ 14,423 $ 55,036 $ (127,379) $ (187,447)
========== ========== ========== ===========
Net loss................................. $ (90,973) $ (48,889) $ (246,200) $ (187,447)
========== ========== ========== ===========
Loss per share -- basic and diluted...... $ (.09) $ (.05) $ (.24) $ (.18)
========== ========== ========== ===========
Dividends declared per share............. $ .05 $ .00 $ .00 $ .00
========== ========== ========== ===========
</TABLE>
F-27
<PAGE> 186
REALTY REFUND TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
QUARTER ENDED
-----------------------------------------------------
FISCAL 1997 APRIL 30 JULY 31 OCTOBER 31 JANUARY 31
----------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Total revenues........................... $1,082,334 $1,107,406 $1,064,527 $ 661,239
========== ========== ========== ===========
Total revenues less interest expense on
mortgage loans and operating expenses,
depreciation and amortization expense
of real estate held for sale........... $ 408,457 $ 445,805 $ 529,278 $ 163,671
========== ========== ========== ===========
Provision for writedown of loan
receivable from related party.......... $ -- $ -- $ -- $ (111,498)
========== ========== ========== ===========
Provision for writedown of real estate
held for sale.......................... $ -- $ -- $ -- $(1,085,000)
========== ========== ========== ===========
Net income (loss)........................ $ 101,775 $ 98,464 $ 102,258 $(1,190,862)
========== ========== ========== ===========
Earnings (loss) per share -- basic and
diluted................................ $ .10 $ .10 $ .10 $ (1.17)
========== ========== ========== ===========
Dividends declared per share............. $ .10 $ .10 $ .10 $ .10
========== ========== ========== ===========
</TABLE>
F-28
<PAGE> 187
SCHEDULE III
REALTY REFUND TRUST
REAL ESTATE AND ACCUMULATED DEPRECIATION
AS OF JANUARY 31, 1998
<TABLE>
<CAPTION>
COST CAPITALIZED
SUBSEQUENT TO
INITIAL COST TO TRUST ACQUISITION
-------------------------- -------------------
BUILDINGS AND BUILDING AND
ENCUMBRANCES LAND IMPROVEMENTS LAND IMPROVEMENTS
------------ ---------- ------------- ---- ------------
<S> <C> <C> <C> <C> <C>
InnSuites Hotels
Phoenix Best Western
Phoenix, Arizona..................... $ 2,929,875 $ 418,219 $ 2,922,884 $-- $--
InnSuites Hotels
Tempe/Phoenix Airport/South Mountain
Tempe, Arizona....................... 2,598,308 686,806 6,548,348 -- --
InnSuites Hotels Tucson,
Catalina Foothills Best Western
Tucson, Arizona...................... -- -- 4,220,820 -- --
InnSuites Hotels Yuma Best Western
Yuma, Arizona........................ 3,812,963 251,649 4,983,292 -- --
Holiday Inn Airport
Ontario Hotel and Suites
Ontario, California.................. 6,293,256 1,633,064 5,450,872 -- --
InnSuites Hotels
Flagstaff/Grand Canyon
Flagstaff, Arizona................... 886,524 100,000 1,194,691 -- --
InnSuites Hotels Scottsdale/
El Dorado Park Resort
Scottsdale, Arizona.................. 3,835,290 350,000 6,074,398 -- --
----------- ---------- ----------- -- --
$20,356,216 $3,439,738 $31,395,305 $-- $--
=========== ========== =========== == ==
</TABLE>
F-29
<PAGE> 188
<TABLE>
<CAPTION>
GROSS AMOUNTS AT
WHICH CARRIED AT
CLOSE OF PERIOD
--------------------------- NET BOOK VALUE
BUILDINGS AND ACCUMULATED LAND AND BUILDINGS
LAND IMPROVEMENTS TOTAL (A) DEPRECIATION AND IMPROVEMENTS
---------- ------------- ----------- ------------ ------------------
<S> <C> <C> <C> <C> <C>
InnSuites Hotels
Phoenix Best Western
Phoenix, Arizona............ $ 418,219 $ 2,922,884 $ 3,341,103 $-- $ 3,341,103
InnSuites Hotels
Tempe/Phoenix Airport/South
Mountain
Tempe, Arizona.............. 686,806 6,548,348 7,235,154 -- 7,235,154
InnSuites Hotels Tucson,
Catalina Foothills Best
Western
Tucson, Arizona............. -- 4,220,820 4,220,820 -- 4,220,820
InnSuites Hotels Yuma Best
Western
Yuma, Arizona............... 251,649 4,983,292 5,234,941 -- 5,234,941
Holiday Inn Airport
Ontario Hotel and Suites
Ontario, California......... 1,633,064 5,450,872 7,083,936 -- 7,083,936
InnSuites Hotels
Flagstaff/Grand Canyon
Flagstaff, Arizona.......... 100,000 1,194,691 1,294,691 -- 1,294,691
InnSuites Hotels Scottsdale/El
Dorado Park Resort
Scottsdale, Arizona......... 350,000 6,074,398 6,424,398 -- 6,424,398
---------- ----------- ----------- -- -----------
$3,439,738 $31,395,305 $34,835,043 $-- $34,835,043
========== =========== =========== == ===========
</TABLE>
- ---------------
(A) Aggregate cost for federal income tax reporting purposes at January 31, 1998
is as follows:
<TABLE>
<S> <C>
Land.................................................... $ 3,439,738
Building and improvements............................... 10,026,664
-----------
$13,466,402
===========
</TABLE>
F-30
<PAGE> 189
<TABLE>
<CAPTION>
DEPRECIATION IN
DATE OF DATE OF INCOME STATEMENT IS
CONSTRUCTION ACQUISITION COMPUTED
------------ ----------- -------------------
<S> <C> <C> <C>
InnSuites Hotels
Phoenix Best Western
Phoenix, Arizona................................. 6/1/84 1998 40 years
InnSuites Hotels
Tempe/Phoenix Airport/South Mountain
Tempe, Arizona................................... 12/1/82 1998 40 years
InnSuites Hotels Tucson, Catalina Foothills Best
Western
Tucson, Arizona.................................. 11/1/81 1998 40 years
InnSuites Hotels Yuma Best Western
Yuma, Arizona.................................... 4/1/82 1998 40 years
Holiday Inn Airport
Ontario Hotel and Suites
Ontario, California.............................. 12/1/90 1998 40 years
InnSuites Hotels
Flagstaff/Grand Canyon
Flagstaff, Arizona............................... 1966(1) 1998 40 years
InnSuites Hotels Scottsdale/
El Dorado Park Resort
Scottsdale, Arizona.............................. 12/1/80 1998 40 years
</TABLE>
- ---------------
(1) Purchased by InnSuites 1/1/96
F-31
<PAGE> 190
INDEPENDENT AUDITOR'S REPORT
The Members
Tucson Saint Mary's Suite Hospitality, LLC:
We have audited the accompanying balance sheet of Tucson Saint Mary's Suite
Hospitality, LLC (An Arizona Limited Liability Company) as of December 31, 1997,
and the related statements of operations and members' deficit and cash flows for
the year ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Tucson Saint Mary's Suite
Hospitality, LLC as of December 31, 1997, and the results of its operations and
cash flows for the year ended in conformity with generally accepted accounting
principles.
February 27, 1998 Michael Maastricht, C.P.A.
Phoenix, Arizona
F-32
<PAGE> 191
TUCSON SAINT MARY'S SUITE HOSPITALITY, LLC
BALANCE SHEET
DECEMBER 31, 1997
<TABLE>
<S> <C>
ASSETS
Cash........................................................ $ 16,617
Accounts receivable......................................... 51,999
Inventory................................................... 95,643
Land........................................................ 900,000
Buildings and equipment pledged, at cost, net of accumulated
depreciation.............................................. 5,415,062
Deferred loan fees, net of accumulated amortization......... 85,000
Cash held in escrow......................................... 90,452
Other assets................................................ 11,277
----------
$6,666,050
==========
LIABILITIES AND MEMBERS' DEFICIT
Accounts payable............................................ $ 391,484
Accrued expenses............................................ 298,403
Deed of trust............................................... 6,000,000
Line of credit.............................................. 50,000
Advances from affiliates.................................... 1,140,428
----------
7,880,315
----------
Members' deficit:
Members' capital.......................................... 25,000
Distributions to prior owners............................. (788,256)
Accumulated losses........................................ (451,009)
----------
(1,214,265)
----------
$6,666,050
==========
</TABLE>
See accompanying notes to financial statements
F-33
<PAGE> 192
TUCSON SAINT MARY'S SUITE HOSPITALITY, LLC
STATEMENTS OF OPERATIONS AND MEMBERS' DEFICIT
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
Revenues:
Room rentals.............................................. $2,562,155
Restaurant and banquet.................................... 813,651
Telephone................................................. 100,698
Other..................................................... 65,144
----------
3,541,648
----------
Department costs:
Wages and salaries:
Salaries.................................................. 206,457
Front desk................................................ 139,182
Housekeeping.............................................. 224,374
Laundry and houseman...................................... 85,297
Maintenance and other..................................... 146,069
Taxes and benefits........................................ 129,684
----------
931,063
----------
Rooms department:
Guest supplies............................................ 60,305
Complimentary items....................................... 92,692
Telephone................................................. 65,824
Cleaning supplies......................................... 36,776
Office and desk supplies.................................. 11,707
Linen..................................................... 18,952
Travel agent commissions.................................. 25,217
Reservations.............................................. 4,147
Other rooms department.................................... 18,357
----------
334,157
----------
Other operating expenses:
Administrative and general:
Professional services..................................... 83,054
Licenses, dues and subscriptions.......................... 12,274
Bank charges and credit card discount..................... 51,045
Management fees........................................... 58,372
Trademark license fees.................................... 100,414
Other administrative...................................... 21,767
----------
326,926
----------
Advertising and sales promotion:
Travel and promotion...................................... 18,434
Advertising trust fees.................................... 14,189
Publications and newspapers............................... 48,458
Billboards................................................ 18,949
Guest mail and postage.................................... 6,685
Supplies and sales printing............................... 13,608
----------
120,323
----------
</TABLE>
(continued)
F-34
<PAGE> 193
TUCSON SAINT MARY'S SUITE HOSPITALITY, LLC
STATEMENTS OF OPERATIONS AND MEMBERS' DEFICIT
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
Repairs and maintenance:
Landscaping and pool...................................... $ 55,229
Mechanical and electrical................................. 42,611
Supplies.................................................. 31,544
Refurbishing.............................................. 181,658
-----------
311,042
-----------
Restaurant and banquet:
Food and beverage......................................... 224,016
Wages..................................................... 292,261
Benefits and taxes........................................ 51,500
Supplies.................................................. 28,893
Other..................................................... 14,404
-----------
611,074
-----------
Utilities:
Electric.................................................. 242,926
Gas....................................................... 35,433
Water and sewer........................................... 71,940
-----------
350,299
-----------
Other fixed charges:
Property insurance........................................ 35,165
Property taxes............................................ 168,872
Depreciation.............................................. 247,548
Interest.................................................. 556,188
-----------
1,007,773
-----------
Total expenses.................................... $ 3,992,657
-----------
Net loss.................................................... (451,009)
Members' capital contributions.............................. 25,000
Distributions to prior owners............................... (788,256)
Members' deficit, beginning of year......................... --
-----------
Members' deficit, end of year............................... $(1,214,265)
===========
</TABLE>
See accompanying notes to financial statements.
F-35
<PAGE> 194
TUCSON SAINT MARY'S SUITE HOSPITALITY, LLC
STATEMENTS OF OPERATIONS AND MEMBERS' DEFICIT
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
Cash flows from operating activities:
Net income................................................ $ (451,009)
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation......................................... 247,548
Amortization......................................... 35,000
(Increase) decrease in:
Accounts receivable.................................. (51,999)
Inventories.......................................... (95,643)
Cash held in escrow.................................. (90,452)
Other assets......................................... (11,277)
Increase (decrease) in:
Accounts payable..................................... 391,484
Accrued expenses..................................... 298,403
-----------
Net cash provided by operating activities......... 272,055
-----------
Cash flows from investing activities:
Acquisition of land, buildings and equipment.............. (6,562,610)
-----------
Net cash used by investing activities............. (6,562,610)
-----------
Cash flows from financing activities:
Deferred loan fees........................................ (120,000)
Increase in line of credit................................ 50,000
Increase in advances from affiliates...................... 1,140,428
Addition of deed of trust: payable........................ 6,000,000
Members' capital contributions............................ 25,000
Distributions to prior owners............................. (788,256)
-----------
Net cash provided by financing activities......... 6,307,172
-----------
Net increase in cash.............................. 16,617
Cash, beginning of period................................. --
-----------
Cash, end of period....................................... $ 16,617
===========
</TABLE>
See accompanying notes to financial statements.
F-36
<PAGE> 195
NOTES TO FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997
1. OPERATIONS AND SUMMARY OF SIGNIFICANT POLICIES:
Tucson Saint Mary's Suite Hospitality, LLC ("The Company") (An Arizona
Limited Liability Company) was organized in May 1997 to purchase and operate a
hotel property in Tucson, Arizona. The financial statements are presented for
the purpose of presenting the property's operations for a full year and include
operations of the prior owners for the period January 1 to May 20, 1997. The
property is operated under the InnSuites trademark ("InnSuites") of Hospitality
Corporation International ("Hospitality"). An affiliate, InnSuites Hotels, LLC
provides management services to the Company. The property is located in a
developed area that includes other hotel properties some of which may have
greater financial resources than the Company.
Significant accounting policies of the Company follow:
Property and Equipment. Buildings and equipment are stated at cost.
Depreciation is provided principally using the straight-line method for
financial reporting and income tax purposes over the estimated useful lives of
the assets which range from 7 years for equipment to 40 years for the buildings.
Expenditures for major renewals and betterments that extend the useful lives of
property and equipment are capitalized. Expenditures for maintenance and repairs
are charged to expense including regular guest room refurbishing. Loan fees are
amortized over the term of the note. Property accounts consist of the following:
<TABLE>
<S> <C>
Buildings................................................... $3,780,087
Equipment and furnishings................................... 1,882,523
----------
5,662,610
Accumulated depreciation.................................... 247,548
----------
$5,415,062
==========
</TABLE>
Management of the Company reviews the hotel property for impairment when
events or changes in circumstances indicate the carrying amounts of the hotel
properties may not be recoverable. When such conditions exist, management
estimates the future cash flows from operations and disposition of the hotel
property. If the estimated undiscounted future cash flows from operations and
disposition of the hotel property are less than the carrying amount of the
asset, an adjustment to reduce the carrying amount to the related hotel
property's estimated fair market value would be recorded and an impairment loss
would be recognized. No such impairment losses have been recognized.
Cash and Cash Equivalents. All highly liquid investments with an original
maturity date of three months or less when purchased are considered to be cash
equivalents.
Cash Held in Escrow. Cash held in escrow consists of amounts for real
estate taxes remitted to the lender which holds the deed of trust on the hotel
property and amounts deposited for the replacement of hotel real and personal
property pursuant to the terms of the loan agreement.
Deferred Loan Fees. Deferred loan fees are amortized over the terms of the
related loan agreement. Amortization expense of $35,000 for the period ended
December 31, 1997 is included in interest expense in the accompanying statements
of operations. Accumulated amortization of deferred expenses was $35,000 at
December 31, 1997.
Revenue Recognition. Revenue is recognized as earned. Ongoing credit
evaluations are performed and credit losses are charged off when deemed to be
uncollectible. Such losses have been minimal and within management's
expectations.
Inventories. Inventories, which consist primarily of linen, operating
supplies, and food and beverage, are stated at the lower of cost or market. Cost
is determined by the first in, first out method.
F-37
<PAGE> 196
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
YEAR ENDED DECEMBER 31, 1997
Income Taxes. All income and expense is passed through the Company for tax
purposes and reported on the income tax returns of the individual members.
Accordingly, the financial statements include no provision or liabilities for
income taxes.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the reporting period. Actual results could differ from those estimates.
2. RELATED PARTY TRANSACTIONS:
The Company, Hospitality and its affiliates are related through common
ownership and management. The Company accrued fees to Hospitality or its
affiliates during 1997 for services rendered as follows (fees in excess of these
amounts were paid by the property to the prior management company and trademark
owner):
<TABLE>
<S> <C>
Management fees (2.5% of total revenues).................... $ 35,472
Trademark license fees (2.5% of total revenues)............. 35,472
InnSuites Trust -- advertising (1% of total revenues)....... 14,189
Advances from affiliates are as follows:
Hospitality Corporation International....................... $ 825,000
Rare Earth Development Company.............................. 52,500
Managing member............................................. 262,928
----------
$1,140,428
==========
</TABLE>
Advances from affiliates are working capital advances generally advanced
during slower periods and repaid by the property during the busy season and
advances connected with guest room refurbishing and improvements. There are no
terms or covenants connected with the advances.
3. DEED OF TRUST:
The deed of trust payable matures in May of 1999. Monthly payments of
interest only of $70,000 are at a rate of 14%. The note is secured by all
property and equipment of the Company and collateral assignment of all operating
agreements. Interest paid in 1997 was $521,188. Annual principal payment
requirements of the mortgage are as follows:
<TABLE>
<S> <C>
1998........................................................ $ --
1999........................................................ 6,000,000
----------
$6,000,000
==========
</TABLE>
F-38
<PAGE> 197
- ---------------------------------------------------------
- ---------------------------------------------------------
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED OR
INCORPORATED BY REFERENCE IN THIS PROSPECTUS IN CONNECTION WITH THE OFFER MADE
HEREBY AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. NEITHER THE DELIVERY OF
THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCE,
CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE FACTS SET FORTH IN
THIS PROSPECTUS OR IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER OR SOLICITATION BY ANYONE IN ANY STATE
IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON
MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANYONE TO WHOM
IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary............................... 1
Risk Factors Related to the Trust................ 18
Risk Factors Related to the Management Company... 31
The Trust........................................ 37
Corporate Structure Transactions................. 41
Use of Proceeds by the Trust..................... 45
Dividend Policy of the Trust..................... 46
Selected Historical and Pro Forma Financial
Information and Operating Data of the Trust and
the Initial Lessee............................. 49
Notes to Pro Forma Condensed Consolidated
Statements of Income........................... 54
Notes to Pro Forma Condensed Statements of
Operations..................................... 59
Management's Discussion and Analysis of Financial
Condition and Results of Operations of the
Trust.......................................... 61
Business and Properties of the Trust............. 71
Description of Capital Stock of the Trust........ 81
Management of the Trust.......................... 83
Certain Transactions by the Trust................ 86
Certain Declaration of Trust and Statutory
Provisions..................................... 87
Partnership Agreement............................ 89
Policies and Objectives with Respect to Certain
Activities by the Trust........................ 92
Shares Available for Future Sale by the Trust.... 94
Federal Income Tax Considerations Related to the
Trust.......................................... 95
Tax Aspects of the Operating Partnership......... 113
Erisa Considerations............................. 117
Innsuites Innternational Hotels, Inc............. 121
Business and Properties of the Management
Company........................................ 121
Intercompany Agreement........................... 123
The Warrant Distribution......................... 125
Description of Warrants.......................... 125
Use of Proceeds by the Management Company........ 128
Federal Income Tax Consequences of Warrant
Distribution and Exercise...................... 129
Selected Historical and Pro Forma Financial
Information and Operating Data of the
Management Company............................. 132
Management's Discussion and Analysis of Financial
Condition and Results of Operations of the
Management Company............................. 139
Description of Capital Stock of the Management
Company........................................ 141
Management of the Management Company............. 142
Beneficial Ownership of Management Company Common
Stock.......................................... 143
Dividend Policy of the Management Company........ 144
Certain Transactions By The Management Company... 144
Certain Charter and Statutory Provisions......... 145
Shares Available for Future Sale by the
Management Company............................. 146
Where You Can Find More Information.............. 147
Incorporation of Certain Documents by
Reference...................................... 148
Forward-Looking Statements....................... 148
Underwriting..................................... 149
Legal Matters.................................... 151
Experts.......................................... 151
Financial Statements.............................
</TABLE>
- ---------------------------------------------------------
- ---------------------------------------------------------
- ---------------------------------------------------------
- ---------------------------------------------------------
2,000,000 SHARES
INNSUITES HOSPITALITY TRUST LOGO
INNSUITES HOSPITALITY TRUST
SHARES OF BENEFICIAL INTEREST,
WITHOUT PAR VALUE
INNSUITES HOTELS LOGO
INNSUITES INNTERNATIONAL HOTELS, INC.
3,627,279 REDEEMABLE COMMON
STOCK PURCHASE WARRANTS
------------------------
PROSPECTUS
------------------------
- ---------------------------------------------------------
- ---------------------------------------------------------
<PAGE> 198
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Set forth below is an estimate of the approximate amount of the fees and
expenses (other than underwriting discounts and commissions) payable by the
Registrant in connection with the issuance and distribution of the Shares.
<TABLE>
<S> <C>
Securities and Exchange Commission, registration
fee............................................ $ 9,591.00
Printing and mailing............................. *
Blue Sky fees and expenses....................... *
Accountant's fees and expenses................... *
Legal fees and expenses.......................... *
Miscellaneous.................................... *
------------
Total.................................. $ *
============
</TABLE>
- ---------------
* To be provided by amendment.
ITEM 15. INDEMNIFICATION OF TRUSTEES AND OFFICERS
The Declaration of the Trust generally limits the liability for money damages of
the Trust's Trustees and officers to the Trust and its shareholders to the
fullest extent permitted from time to time by the laws of the State of Ohio. The
Declaration also provides generally for the indemnification of Trustees and
officers, among others, against judgments, settlements, penalties, fines and
reasonable expenses actually incurred by them in connection with any proceeding
to which they have been made a party by reason of their service in those or
other capacities except in respect of any matter as to which they shall have
been adjudicated to have acted in bad faith or with willful misconduct or
reckless disregard of their duties or gross negligence or not to have acted in
good faith in the reasonable belief that their action was in the best interests
of the Trust. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to Trustees and officers of the Trust pursuant
to the foregoing provisions or otherwise, the Trust 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.
The Trust may purchase Trustee and officer liability insurance for the purpose
of providing a source of funds to pay any indemnification described above.
ITEM 16. EXHIBITS
<TABLE>
<C> <S>
1.1 -- Form of Underwriting Agreement between the Trust and the
Underwriters*
4.1 -- Second Amended and Restated Declaration of Trust
(incorporated by reference to Annex A of the Registrant's
definitive Proxy Statement, filed with the Securities and
Exchange Commission on May 15, 1998).
4.2 -- Form of Certificate for Common Shares of the Trust
(incorporated by reference to Exhibit 4.1 of the
Registrant's Form S-2 filed with the Securities and
Exchange Commission on September 8, 1998, bearing
Registration No. 333-56301).
5.1 -- Opinion of Thompson Hine & Flory LLP regarding legality.*
</TABLE>
II-1
<PAGE> 199
<TABLE>
<C> <S>
8.1 -- Opinion of Thompson Hine & Flory LLP regarding tax
matters.*
10.1 -- First Amended and Restated Agreement of Limited
Partnership of RRF Limited Partnership dated January 31,
1998 (incorporated by reference to Exhibit 10.1 of the
Registrant's Form S-2 filed with the Securities and
Exchange Commission on September 8, 1998, bearing
Registration No. 333-56301).
10.2 -- Formation Agreement among the Trust, Mid-America ReaFund
Advisors, Inc., Alan M. Krause, James H. Berick, Hospitality
Corporation International, InnSuites Hotels, L.L.C.,
James F. Wirth, Tucson Hospitality Properties, Ltd., Yuma
Hospitality Properties, Ltd., Baseline Hospitality
Properties, Ltd., Northern Phoenix Investment Limited
Partnership, Ontario Hospitality Properties Limited
Partnership, Hulsey Hotels Corporation and Buenaventura
Properties, Inc. (incorporated by reference to Exhibit
2.1 of the Registrant's Form 8-K, filed with the
Securities and Exchange Commission on February 17, 1998).
10.3 -- Contribution Agreement dated as of February 1, 1998,
between James F. Wirth, Gail J. Wirth and the Operating
Partnership (incorporated by reference to Exhibit 2.1 of
the Registrant's Form 8-K, filed with the Securities and
Exchange Commission on March 16, 1998).
10.4 -- Agreement of Purchase and Sale and Joint Escrow
Instructions dated March 20, 1998, between Lafayette Hotel,
LLC and the Operating Partnership (incorporated by
reference to Exhibit 2.1 of the Registrant's Form 8-K/A,
filed with the Securities and Exchange Commission on May
27, 1998).
10.5 -- Contribution Agreement dated as of June 1, 1998, among
James F. Wirth, Steven S. Robson and the Operating
Partnership (incorporated by reference to Exhibit 2.1 of
the Registrant's Form 8-K filed with the Securities and
Exchange Commission on September 2, 1998).
10.6 -- Intercompany Agreement among the Trust, the Operating
Partnership and the Management Company.*
23.1 -- Consent of Thompson Hine & Flory LLP (included in
Exhibits 5.1 and 8.1).*
23.2 -- Consent of Arthur Andersen LLP.
23.3 -- Consent of Michael Maestricht, CPA.
24.1 -- Powers of Attorney.
99.1 -- Form of Percentage Lease.*
</TABLE>
- ---------------
* To be filed by amendment.
ITEM 17. UNDERTAKINGS.
Rule 415 Offering. The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which,
II-2
<PAGE> 200
individually or in the aggregate, represent a fundamental change in the
information set forth in the registration statement. Notwithstanding the
foregoing, any increase or decrease in volume of securities offered (if the
total dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than 20 percent change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the Securities Act
of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any of
the securities being registered which remain unsold at the termination of the
offering.
Filings Incorporating Subsequent Exchange Act Documents by Reference. The
undersigned Registrant hereby undertakes that, for purposes of determining any
liability under the Securities Act of 1933, each filing of the Registrant's
annual report pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934 (and, where applicable, each filing of an employee benefit plan's annual
report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is
incorporated by reference in the registration statement shall be deemed to be a
new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
Request For Acceleration of Effective Date. Insofar as indemnification for
liabilities arising under the Securities Act of 1933 may be permitted to
trustees, officers and controlling persons of the Registrant pursuant to the
provisions referred to in Item 15 of this registration statement, or otherwise,
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 of 1933 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 trustee, officer or
controlling person of the Registrant in the successful defense of any action,
suit or proceeding) is asserted by such trustee, 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 whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933 and will be governed by the final adjudication of such
issue.
II-3
<PAGE> 201
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Cleveland, State of Ohio, on the 31st day of
December, 1998.
INNSUITES HOSPITALITY TRUST
an unincorporated Ohio real estate
investment trust (Registrant)
By: *
--------------------------------------
James F. Wirth
Chairman, President and
Chief Executive Officer
By: /s/ GREGORY D. BRUHN
--------------------------------------
Gregory D. Bruhn
Executive Vice President
Chief Financial Officer, Treasurer
and Secretary
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed by the following persons in the capacities and on the
dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
* Trustee, Chairman, President December 31, 1998
- ------------------------------- and Chief Executive Officer
James F. Wirth
/s/ GREGORY D. BRUHN Trustee, Executive Vice December 31, 1998
- ------------------------------- President, Chief Financial
Gregory D. Bruhn Officer, Treasurer and
Secretary
* Trustee December 31, 1998
- -------------------------------
Marc E. Berg
* Trustee December 31, 1998
- -------------------------------
Lee J. Flory
* Trustee December 31, 1998
- -------------------------------
Edward G. Hill
* Trustee December 31, 1998
- -------------------------------
Steven S. Robson
* Signature by Gregory D. Bruhn Attorney-in-Fact under Power of
as Attorney-in-Fact under Power Attorney
of Attorney
/s/ GREGORY D. BRUHN
- -------------------------------
Gregory D. Bruhn
</TABLE>
II-4
<PAGE> 202
INDEX TO EXHIBITS
<TABLE>
EXHIBIT
NUMBER DESCRIPTION
---- ------------------------------------------------------------
<C> <S>
1.1 -- Form of Underwriting Agreement between the Trust and the
Underwriters*
4.1 -- Second Amended and Restated Declaration of Trust
(incorporated by reference to Annex A of the Registrant's
definitive Proxy Statement, filed with the Securities and
Exchange Commission on May 15, 1998).
4.2 -- Form of Certificate for Common Shares of the Trust
(incorporated by reference to Exhibit 4.1 of the
Registrant's Form S-2 filed with the Securities and
Exchange Commission on September 8, 1998, bearing
Registration No. 333-56301).
5.1 -- Opinion of Thompson Hine & Flory LLP regarding legality.*
8.1 -- Opinion of Thompson Hine & Flory LLP regarding tax
matters.*
10.1 -- First Amended and Restated Agreement of Limited
Partnership of RRF Limited Partnership dated January 31,
1998 (incorporated by reference to Exhibit 10.1 of the
Registrant's Form S-2 filed with the Securities and
Exchange Commission on September 8, 1998, bearing
Registration No. 333-56301).
10.2 -- Formation Agreement among the Trust, Mid-America ReaFund
Advisors, Inc., Alan M. Krause, James H. Berick, Hospitality
Corporation International, InnSuites Hotels, L.L.C.,
James F. Wirth, Tucson Hospitality Properties, Ltd., Yuma
Hospitality Properties, Ltd., Baseline Hospitality
Properties, Ltd., Northern Phoenix Investment Limited
Partnership, Ontario Hospitality Properties Limited
Partnership, Hulsey Hotels Corporation and Buenaventura
Properties, Inc. (incorporated by reference to Exhibit
2.1 of the Registrant's Form 8-K, filed with the
Securities and Exchange Commission on February 17, 1998).
10.3 -- Contribution Agreement dated as of February 1, 1998,
between James F. Wirth, Gail J. Wirth and the Operating
Partnership (incorporated by reference to Exhibit 2.1 of
the Registrant's Form 8-K, filed with the Securities and
Exchange Commission on March 16, 1998).
10.4 -- Agreement of Purchase and Sale and Joint Escrow
Instructions dated March 20, 1998, between Lafayette Hotel,
LLC and the Operating Partnership (incorporated by
reference to Exhibit 2.1 of the Registrant's Form 8-K/A,
filed with the Securities and Exchange Commission on May
27, 1998).
10.5 -- Contribution Agreement dated as of June 1, 1998, among
James F. Wirth, Steven S. Robson and the Operating
Partnership (incorporated by reference to Exhibit 2.1 of
the Registrant's Form 8-K filed with the Securities and
Exchange Commission on September 2, 1998).
10.6 -- Intercompany Agreement among the Trust, the Operating
Partnership and the Management Company.*
23.1 -- Consent of Thompson Hine & Flory LLP (included in
Exhibits 5.1 and 8.1).*
23.2 -- Consent of Arthur Andersen LLP.
23.3 -- Consent of Michael Maestricht, CPA.
24.1 -- Powers of Attorney.
99.1 -- Form of Percentage Lease.*
</TABLE>
- ---------------
* To be filed by amendment.
II-5
<PAGE> 1
Exhibit 23.2
Consent of Independent Public Accountants
-----------------------------------------
As independent public accountants, we hereby consent to the incorporation by
reference in this Registration Statement of our report dated May 13, 1998
included in InnSuites Hospitality Trust's (formerly Realty ReFund Trust) Form
10-K for the year ended January 31, 1998 and to all references to our Firm
included in this Registration Statement.
ARTHUR ANDERSEN LLP
Cleveland, Ohio,
December 30, 1998.
<PAGE> 1
Exhibit 23.3
[Michael Maastricht, C.P.A. letterhead]
Consent of Independent Public Accountants
-----------------------------------------
As independent public accountants, we hereby consent to the inclusion in this
Registration Statement of our report dated February 19, 1998 included in Realty
ReFund Trust's Form 10-K for the year ended January 31, 1998 and our report
dated February 27, 1998 included In Realty ReFund Trust's Form 8-K filed June
30, 1998, and to all references to our Firm in this Registration Statement.
Michael Maastricht, CPA
Phoenix, Arizona
December 30 1998
MEMBER
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTINGS
ARIZONA SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS
<PAGE> 1
Exhibit 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints each of James F. Wirth and
Gregory D. Bruhn, with full power to act without the other, his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities (until
revoked in writing) to sign any and all amendments (including post-effective
amendments) to this Registration Statement, to file the same, together with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, to sign any and all applications,
registration statements, notices and other documents necessary or advisable to
comply with the applicable state securities laws, and to file the same, together
with all other documents in connection therewith, with the appropriate state
securities authorities, granting unto said attorneys-in-fact and agents or any
of them, or their or his substitutes or substitute, full power and authority to
perform and do each and every act and thing necessary and advisable as fully to
all intents and purposes as he might or could perform and do in person, thereby
ratifying and confirming all that said attorneys-in-fact and agents or any of
them or their or his substitutes or substitute, may lawfully do or cause to be
done by virtue hereof.
Date: December 21, 1998 /s/ James F. Wirth
---------------------------------------------
Name: James F. Wirth
Title: Trustee, Chairman, President and Chief
Executive Officer
<PAGE> 2
Exhibit 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints each of James F. Wirth and
Gregory D. Bruhn, with full power to act without the other, his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities (until
revoked in writing) to sign any and all amendments (including post-effective
amendments) to this Registration Statement, to file the same, together with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, to sign any and all applications,
registration statements, notices and other documents necessary or advisable to
comply with the applicable state securities laws, and to file the same, together
with all other documents in connection therewith, with the appropriate state
securities authorities, granting unto said attorneys-in-fact and agents or any
of them, or their or his substitutes or substitute, full power and authority to
perform and do each and every act and thing necessary and advisable as fully to
all intents and purposes as he might or could perform and do in person, thereby
ratifying and confirming all that said attorneys-in-fact and agents or any of
them or their or his substitutes or substitute, may lawfully do or cause to be
done by virtue hereof.
Date: December 21, 1998 /s/ Gregory D. Bruhn
-----------------------------------------------
Name: Gregory D. Bruhn
Title: Trustee, Executive Vice President,
Chief Financial Officer, Treasurer
and Secretary
<PAGE> 3
Exhibit 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints each of James F. Wirth and
Gregory D. Bruhn, with full power to act without the other, his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities (until
revoked in writing) to sign any and all amendments (including post-effective
amendments) to this Registration Statement, to file the same, together with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, to sign any and all applications,
registration statements, notices and other documents necessary or advisable to
comply with the applicable state securities laws, and to file the same, together
with all other documents in connection therewith, with the appropriate state
securities authorities, granting unto said attorneys-in-fact and agents or any
of them, or their or his substitutes or substitute, full power and authority to
perform and do each and every act and thing necessary and advisable as fully to
all intents and purposes as he might or could perform and do in person, thereby
ratifying and confirming all that said attorneys-in-fact and agents or any of
them or their or his substitutes or substitute, may lawfully do or cause to be
done by virtue hereof.
Date: December 21, 1998 /s/ Marc E. Berg
-------------------
Name: Marc E. Berg
Title: Trustee
<PAGE> 4
Exhibit 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints each of James F. Wirth and
Gregory D. Bruhn, with full power to act without the other, his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities (until
revoked in writing) to sign any and all amendments (including post-effective
amendments) to this Registration Statement, to file the same, together with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, to sign any and all applications,
registration statements, notices and other documents necessary or advisable to
comply with the applicable state securities laws, and to file the same, together
with all other documents in connection therewith, with the appropriate state
securities authorities, granting unto said attorneys-in-fact and agents or any
of them, or their or his substitutes or substitute, full power and authority to
perform and do each and every act and thing necessary and advisable as fully to
all intents and purposes as he might or could perform and do in person, thereby
ratifying and confirming all that said attorneys-in-fact and agents or any of
them or their or his substitutes or substitute, may lawfully do or cause to be
done by virtue hereof.
Date: December 21, 1998 /s/ Lee J. Flory
-------------------
Name: Lee J. Flory
Title: Trustee
<PAGE> 5
Exhibit 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints each of James F. Wirth and
Gregory D. Bruhn, with full power to act without the other, his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities (until
revoked in writing) to sign any and all amendments (including post-effective
amendments) to this Registration Statement, to file the same, together with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, to sign any and all applications,
registration statements, notices and other documents necessary or advisable to
comply with the applicable state securities laws, and to file the same, together
with all other documents in connection therewith, with the appropriate state
securities authorities, granting unto said attorneys-in-fact and agents or any
of them, or their or his substitutes or substitute, full power and authority to
perform and do each and every act and thing necessary and advisable as fully to
all intents and purposes as he might or could perform and do in person, thereby
ratifying and confirming all that said attorneys-in-fact and agents or any of
them or their or his substitutes or substitute, may lawfully do or cause to be
done by virtue hereof.
Date: December 21, 1998 /s/ Edward G. Hill
--------------------
Name: Edward G. Hill
Title: Trustee
<PAGE> 6
Exhibit 24.1
POWER OF ATTORNEY
The undersigned hereby constitutes and appoints each of James F. Wirth and
Gregory D. Bruhn, with full power to act without the other, his true and lawful
attorney-in-fact and agent, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities (until
revoked in writing) to sign any and all amendments (including post-effective
amendments) to this Registration Statement, to file the same, together with all
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, to sign any and all applications,
registration statements, notices and other documents necessary or advisable to
comply with the applicable state securities laws, and to file the same, together
with all other documents in connection therewith, with the appropriate state
securities authorities, granting unto said attorneys-in-fact and agents or any
of them, or their or his substitutes or substitute, full power and authority to
perform and do each and every act and thing necessary and advisable as fully to
all intents and purposes as he might or could perform and do in person, thereby
ratifying and confirming all that said attorneys-in-fact and agents or any of
them or their or his substitutes or substitute, may lawfully do or cause to be
done by virtue hereof.
Date: December 21, 1998 /s/ Steven S. Robson
-----------------------
Name: Steven S. Robson
Title: Trustee
