FILED PURSUANT TO RULE 424(B)(1)
FILE NUMBER 333-48581
1,000,000 Shares
HUMPHREY HOSPITALITY TRUST, INC. [Logo]
Common Stock
Humphrey Hospitality Trust, Inc. (the "Company") is a self-administered
equity real estate investment trust ("REIT") that, through Humphrey Hospitality
Limited Partnership (the "Partnership"), owns interests in 20 existing
limited-service hotels (the "Hotels"). The Hotels include twelve Comfort Inn(R)
hotels, three Holiday Inn Express(R) hotels, one Best Western(R) hotel, one Best
Western Suites(R) hotel, one Comfort Suites(R) hotel, one Days Inn(R) hotel and
one Rodeway Inn(R) hotel, with an aggregate of 1,312 rooms. The Hotels are
located in nine states in the eastern United States.
All of the shares of the Company's common stock, $.01 par value per
share (the "Common Stock"), offered hereby are being sold by the Company. The
last reported sales price of the Common Stock, which is quoted under the symbol
"HUMP" on The Nasdaq National Market, was $10.00 per share on April 17, 1998. To
ensure compliance with certain rules relating to the Company's qualification as
a REIT, the Company's Articles of Incorporation generally prohibit direct or
indirect ownership of more than 9.9% of the outstanding shares of Common Stock
by any person. See "Description of Capital Stock - Restrictions on Ownership and
Transfer."
The public offering price of the shares of Common Stock offered hereby
is $10.50 per share (the "Offering Price"). The net proceeds to the Company from
this offering will be approximately $9.5 million, after deducting expenses
payable by the Company estimated at $210,000. The Company will contribute all of
the net proceeds of this offering to the Partnership and, after such
contribution, will own an approximately 87.21% interest in the Partnership. The
Partnership will use the net proceeds of this offering to repay certain
indebtedness.
SEE "RISK FACTORS" BEGINNING ON PAGE 14 OF THIS PROSPECTUS FOR A
DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE
PURCHASERS OF THE SHARES OF COMMON STOCK OFFERED HEREBY.
---------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
==================================================================================================================================
Price to Selling Proceeds to
Public Commission(1) Company(2)
- ----------------------------------------------------------------------------------------------------------------------------------
<S><C>
Per Share............................... $10.50 $.802 $9.698
Total(3) ............................... $10,500,000 $801,777 $9,698,223
==================================================================================================================================
</TABLE>
(1) See "Underwriting" for information concerning indemnification of the
Underwriter and other matters.
(2) Before deducting expenses payable by the Company, estimated at $210,000.
(3) The Company has granted the Underwriter an option for 30 days to purchase up
to an additional 150,000 shares at the public offering price per share, less
the underwriting discount, solely to cover over-allotments. If such option is
exercised in full, the total Price to Public, Selling Commission and Proceeds
to Company will be $12,075,000, $910,058 and $11,164,942, respectively. See
"Underwriting".
The shares of Common Stock offered hereby are being offered by Anderson
& Strudwick Incorporated (the "Underwriter"), as and if delivered to and
accepted by it, and subject to the right of the Underwriter to reject any order
in whole or in part. It is expected that the delivery of the Common Shares will
be made in New York, New York on or about April 24, 1998.
---------------
Anderson & Strudwick
Incorporated
April 21, 1998
<PAGE>
[COLOR PHOTOS AND ART WORK TO COME]
<PAGE>
THE PROSPECTUS CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING
OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS CONTAINING THE
WORDS "BELIEVES," "ANTICIPATES," "EXPECTS" AND WORDS OF SIMILAR IMPORT. SUCH
FORWARD-LOOKING STATEMENTS RELATE TO FUTURE EVENTS, THE FUTURE FINANCIAL
PERFORMANCE OF THE COMPANY, AND INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES
AND OTHER FACTORS THAT MAY CAUSE THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS
OF THE COMPANY OR INDUSTRY RESULTS TO BE MATERIALLY DIFFERENT FROM ANY FUTURE
RESULTS, PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH
FORWARD-LOOKING STATEMENTS. PROSPECTIVE INVESTORS SHOULD SPECIFICALLY CONSIDER
THE VARIOUS FACTORS IDENTIFIED IN THE PROSPECTUS THAT COULD CAUSE ACTUAL RESULTS
TO DIFFER, INCLUDING, WITHOUT LIMITATION, THOSE DISCUSSED IN THE SECTIONS
ENTITLED "PROSPECTUS SUMMARY" AND "RISK FACTORS."
AVAILABLE INFORMATION
The Company is subject to the information requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith files reports, proxy statements and other information with
the Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information filed by the Company can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at
regional offices of the Commission located at 7 World Trade Center, 13th Floor,
New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661-2511. Copies of such material can be obtained by
mail from the Public Reference Section of the Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549, at prescribed rates. The Commission maintains a
Web site at http://www.sec.gov, and reports, proxy and information statements
and other information regarding registrants that file electronically with the
Commission (including the Company) can be obtained from that site. The Common
Stock of the Company is traded on The Nasdaq National Market and such reports,
proxy and information statements and other information concerning the Company
can be inspected and copied at The Nasdaq Stock Market, 1735 K Street, N.W.,
Washington, D.C. 20006-1506.
The Company has filed with the Commission, 450 Fifth Street, N.W.,
Washington, D.C. 20549, a Registration Statement on Form S-11 under the
Securities Act of 1933, as amended (the "Securities Act"), and the rules and
regulations promulgated thereunder, with respect to the Common Shares offered
pursuant to this Prospectus. This Prospectus, which is part of the Registration
Statement, does not contain all of the information set forth in the Registration
Statement and the exhibits thereto. For further information concerning the
Company and the Common Shares offered hereby, reference is made to the
Registration Statement and the exhibits and schedules filed therewith, which may
be examined without charge at, or copies obtained upon payment of prescribed
fees from, the Commission and its regional offices at the locations listed
above. Any statements contained herein concerning the provisions of any document
are not necessarily complete, and in each instance, reference is made to the
copy of such document filed as an exhibit to the Registration Statement or
otherwise filed with the Commission. Each such statement is qualified in its
entirety by such reference.
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR
EFFECT TRANSACTIONS THAT STABILIZE OR MAINTAIN THE MARKET PRICE OF THE
COMMON STOCK AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, IN
THE OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZATION, IF COMMENCED,
MAY BE DISCONTINUED AT ANY TIME. SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER (AND SELLING GROUP
MEMBERS, IF ANY) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE
COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF
REGULATION M. SEE "UNDERWRITING."
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S><C>
PROSPECTUS SUMMARY....................................................................................... 1
The Company............................................................................................ 1
Risk Factors........................................................................................... 1
Recent Developments.................................................................................... 3
The Hotels............................................................................................. 5
Growth Strategy........................................................................................ 6
Distribution Policy.................................................................................... 9
Tax Status............................................................................................. 9
The Offering........................................................................................... 10
Summary Financial Data................................................................................. 11
RISK FACTORS............................................................................................. 14
Conflicts of Interest.................................................................................. 14
Risks of Leverage...................................................................................... 15
Dependence on the Lessee............................................................................... 15
Tax Risks.............................................................................................. 16
Risks of Mr. Humphrey's Personal Bankruptcy............................................................ 17
Risks Associated with Development...................................................................... 17
Inability to Operate the Properties.................................................................... 17
Growth Strategy........................................................................................ 17
Limited Number of Hotels............................................................................... 18
Emphasis on Comfort Inn Hotels......................................................................... 18
Dilution............................................................................................... 18
Cross-Collateralized Debt.............................................................................. 18
No Assurance of Return on Property Investments......................................................... 19
Effect of Market Interest Rates on Price of the Common Stock........................................... 19
Reliance on Board of Directors and Management.......................................................... 19
Limitation on Liability of Officers and Directors...................................................... 19
Limitation on Acquisition and Change in Control........................................................ 19
Ability of Board of Directors to Change Certain Policies............................................... 20
Hotel Industry Risks................................................................................... 20
Real Estate Investment Risks........................................................................... 22
THE COMPANY.............................................................................................. 23
GROWTH STRATEGY.......................................................................................... 24
Acquisition Strategy................................................................................... 24
Development Strategy................................................................................... 25
Internal Growth Strategy............................................................................... 25
USE OF PROCEEDS.......................................................................................... 27
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS............................................................ 28
CAPITALIZATION........................................................................................... 29
DILUTION................................................................................................. 30
SELECTED FINANCIAL INFORMATION........................................................................... 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS...................................................................... 36
Overview............................................................................................... 36
Results of Operations.................................................................................. 36
Liquidity and Capital Resources........................................................................ 37
Inflation.............................................................................................. 40
Seasonality of Hotel Business and the Hotels........................................................... 40
Year 2000.............................................................................................. 40
BUSINESS AND PROPERTIES.................................................................................. 40
Comfort Inn and Comfort Suites Hotels and Rodeway Inn Hotels........................................... 40
Best Western Hotels and Best Western Suites............................................................ 40
Days Inn Hotels........................................................................................ 40
Holiday Inn Express Hotels............................................................................. 40
The Hotels............................................................................................. 41
The Fixed Lease........................................................................................ 44
The Percentage Leases.................................................................................. 44
Franchise Licenses..................................................................................... 50
Operating Practices.................................................................................... 51
Employees.............................................................................................. 51
Environmental Matters.................................................................................. 52
Competition............................................................................................ 52
Depreciation........................................................................................... 53
Legal Proceedings...................................................................................... 53
POLICIES AND OBJECTIVES WITH RESPECT TO CERTAIN
ACTIVITIES............................................................................................. 53
Investment Policies.................................................................................... 54
Financing.............................................................................................. 54
Conflict of Interest Policies.......................................................................... 54
Provisions of Virginia Law............................................................................. 56
Policies with Respect to Other Activities.............................................................. 56
MANAGEMENT............................................................................................... 57
Directors and Executive Officers....................................................................... 57
Acquisition Committee.................................................................................. 58
Audit Committee........................................................................................ 58
Executive Compensation................................................................................. 58
Compensation of Directors.............................................................................. 58
Exculpation and Indemnification........................................................................ 59
CERTAIN RELATIONSHIPS AND TRANSACTIONS................................................................... 59
Revised Services Agreement............................................................................. 59
Credit Facility........................................................................................ 59
Development Agreement.................................................................................. 60
Acquisition of Certain Hotels from Humphrey Affiliates................................................. 60
Guarantees by Mr. Humphrey and His Affiliates.......................................................... 60
Leases................................................................................................. 60
Franchise Licenses..................................................................................... 61
Non-Competition Agreement and Option Agreement......................................................... 61
Other.................................................................................................. 61
THE LESSEE............................................................................................... 61
OWNERSHIP OF THE COMPANY'S COMMON STOCK.................................................................. 63
DESCRIPTION OF CAPITAL STOCK............................................................................. 64
General................................................................................................ 64
Common Stock........................................................................................... 64
Preferred Stock........................................................................................ 65
Restrictions on Ownership and Transfer................................................................. 65
Other Matters.......................................................................................... 67
CERTAIN PROVISIONS OF VIRGINIA LAW AND
OF THE COMPANY'S ARTICLES OF INCORPORATION AND
BYLAWS................................................................................................... 67
Board of Directors..................................................................................... 67
Amendment.............................................................................................. 68
Business Combinations.................................................................................. 68
Control Share Acquisitions............................................................................. 69
Operations............................................................................................. 69
Advance Notice of Director Nominations and New Business................................................ 69
SHARES AVAILABLE FOR FUTURE SALE......................................................................... 69
PARTNERSHIP AGREEMENT.................................................................................... 70
Management............................................................................................. 70
Transferability of Interests........................................................................... 70
Capital Contribution................................................................................... 71
Redemption Rights...................................................................................... 71
Operations............................................................................................. 72
Distributions.......................................................................................... 72
Allocations............................................................................................ 72
Term................................................................................................... 72
Tax Matters............................................................................................ 72
FEDERAL INCOME TAX CONSIDERATIONS........................................................................ 73
Taxation of the Company................................................................................ 73
Requirements for Qualification......................................................................... 74
Failure to Qualify..................................................................................... 82
Taxation of Taxable U.S. Shareholders.................................................................. 82
Taxation of Shareholders on the Disposition of the Common Stock........................................ 83
Capital Gains and Losses............................................................................... 83
Information Reporting Requirements and Backup Withholding.............................................. 83
Taxation of Tax-Exempt Shareholders.................................................................... 84
Taxation of Non-U.S. Shareholders...................................................................... 84
Proposed Tax Legislation............................................................................... 86
Other Tax Consequences................................................................................. 86
Tax Aspects of the Partnership and the Subsidiary Partnership.......................................... 86
Sale of a Hotel Partnership's Property................................................................. 89
UNDERWRITING............................................................................................. 89
EXPERTS.................................................................................................. 91
REPORTS TO SHAREHOLDERS.................................................................................. 91
LEGAL MATTERS............................................................................................ 91
GLOSSARY................................................................................................. 92
</TABLE>
(i)
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and the notes thereto appearing elsewhere
in this Prospectus. Unless otherwise indicated, the information contained in
this Prospectus assumes that the Underwriter's over-allotment option is not
exercised. Unless the context otherwise indicates, all references herein to the
"Company" include Humphrey Hospitality Trust, Inc., Humphrey Hospitality REIT
Trust, Humphrey Hospitality Limited Partnership and Solomons Beacon Inn Limited
Partnership. Unless the context otherwise indicates, all references herein to
the "Partnership" include Humphrey Hospitality Limited Partnership and Solomons
Beacon Inn Limited Partnership. The offering of 1,000,000 shares of the
Company's Common Stock pursuant to this Prospectus is referred to herein as the
"Offering." The Company's Common Stock, par value $.01 per share, is referenced
herein as the "Common Stock," and the shares of the Company's Common Stock that
are offered hereby are referenced herein as the "Common Shares." See "Glossary"
for the definitions of certain additional terms used in this Prospectus.
The Company
The Company is a self-administered REIT that, through the Partnership,
owns interests in twenty existing limited-service Hotels with an aggregate of
1,312 rooms and an average age of approximately nine years as of December 31,
1997. The Hotels include twelve Hotels operated as Comfort Inn hotels, three
Hotels operated as Holiday Inn Express hotels, one Hotel operated as a Best
Western hotel, one Hotel operated as a Best Western Suites hotel, one Hotel
operated as a Comfort Suites hotel, one Hotel operated as a Days Inn hotel and
one Hotel operated as a Rodeway Inn hotel. The Hotels are located in nine states
in the eastern United States. Ten of the Hotels were purchased from Affiliates
(as defined herein) of James I. Humphrey, Jr., the Company's Chairman and
President.
The Company will contribute all of the proceeds from the Offering, net
of all Offering expenses and fees to the Underwriter ("Net Proceeds"), to the
Partnership in exchange for 1,000,000 units of limited partnership interest in
the Partnership ("Units"). After the closing of the Offering (the "Closing"),
the Company will own an 87.21% partnership interest, and Mr. Humphrey and his
Affiliates (collectively, the "Humphrey Affiliates") will own a 12.79% limited
partnership interest in the Partnership. Humphrey Hospitality REIT Trust, a
Maryland real estate investment trust and wholly owned subsidiary of the Company
(the "General Partner"), will remain the sole general partner of the
Partnership. The Net Proceeds will be approximately $9.5 million. The
Partnership will use the Net Proceeds to repay approximately $9.5 million of
outstanding debt on a credit facility (the "Credit Facility"), which is secured
by 17 of the Hotels. Upon the application of the Net Proceeds, the Company will
have approximately $21.5 million of total indebtedness outstanding (the
"Remaining Indebtedness"), all of which debt will be secured by one or more of
the Hotels.
In order to qualify as a REIT, the Company cannot operate hotels.
Therefore, the Hotels are leased to, and operated by, Humphrey Hospitality
Management, Inc. (the "Lessee"). The leases relating to the Hotels (the
"Percentage Leases"), with the exception of the Comfort Suites-Dover, Delaware
Hotel, are designed to allow the Company to participate in growth in revenues of
the Hotels by providing that percentages of such revenues are paid by the Lessee
as rent. The Comfort Suites-Dover, Delaware Hotel is leased pursuant to a lease
that provides for fixed rent payments (the "Fixed Lease"). Mr. Humphrey is the
sole shareholder of the Lessee.
Risk Factors
An investment in the Common Shares involves various risks, and
investors should carefully consider the matters discussed under "Risk Factors,"
including the following:
o Conflicts of interest between the Company, the limited
partners of the Partnership (the "Limited Partners"), which
consist of Mr. Humphrey and certain Humphrey Affiliates, and
the Lessee, including:
o conflicts related to the adverse tax consequences to
the Limited Partners upon a sale of any Hotel in
which they once owned an interest, or the refinancing
or prepayment of any principal on any of the
Remaining Indebtedness related to such a Hotel and
the related
<PAGE>
risk that Mr. Humphrey's personal interests with
regard to a sale of a Hotel or refinancing or
prepayment of any of the Remaining Indebtedness could
be adverse to those of the Company and its
shareholders;
o lack of arm's-length negotiations with respect to the
terms of the Leases (as defined herein), the purchase
agreements for the Hotels, the Non-Competition
Agreement (as defined herein) and the Option
Agreement (as defined herein) and Mr. Humphrey's
conflicts relating to enforcing these agreements; and
o conflicts relating to competing demands on Mr.
Humphrey's and the Lessee's time.
o George R. Whittemore, a Director of the Company, is a
consultant to Mills Management II, Inc., which is the manager
and a member of a privately-held limited liability company
that was formed to, among other things, acquire hotels that
are substantially similar to the Hotels. Mr. Whittemore may
experience conflicts between his obligations as a consultant
to Mills Management II, Inc. and his duties to the Company in
the event that investment opportunities arise that meet both
companies' investment criteria.
o Risks associated with the dependence of the Company on the
Lessee's ability to generate revenue and to control operating
costs at the Hotels and to make payments under the Leases, as
the principal source of the Company's revenues, in amounts
sufficient to permit the Company to make the anticipated
distributions to shareholders.
o Risks associated with distributing substantially all Cash
Available for Distribution to Shareholders (as defined
herein), including the risk that future Cash Available for
Distribution to Shareholders will be insufficient to permit
the Company to maintain its current distribution rate.
o Tax risks, including taxation of the Company as a regular
corporation if it fails to qualify as a REIT, taxation of the
Partnership as a corporation if it were deemed not to be a
partnership, and the Company's liability for federal and state
taxes on its income as a result of either such event, which
would materially adversely affect Cash Available for
Distribution to Shareholders.
o Mr. Humphrey personally guarantees, jointly and severally with
the Company, a portion of the Remaining Indebtedness, and his
personal bankruptcy would constitute a default under the
related loan documents.
o Risks associated with the Company's (and the Company's
shareholders') lack of control over the daily operation of the
Hotels due to federal income tax law prohibitions on a REIT
operating hotels.
o Risks that the Company's growth through acquisitions and
development will be constrained (i) because a REIT generally
cannot retain earnings for acquisitions and development and
(ii) by the limitation on the amount of indebtedness that the
Company can incur under its Debt Policy (as defined herein).
Consequently, the Company's ability to grow through additional
acquisitions and development of hotels will likely depend on
its ability to obtain additional equity financing.
o The number of the Hotels is limited and, therefore, adverse
changes in the operations of any Hotel could reduce Cash
Available for Distribution to Shareholders.
o Twelve of the Hotels are licensed under one franchise brand
and any adverse developments to that franchise brand could
reduce amounts available for distribution to the holders of
Common Stock.
o Purchasers of the Common Shares sold in the Offering will
experience immediate and substantial dilution of $4.52 or
43.1% of the Offering Price in the net tangible book value per
Common Share.
2
<PAGE>
o Although the Company has adopted policies and has made
covenants to lenders and the Underwriter limiting its level of
indebtedness, there is no provision in the Company's Articles
of Incorporation or Bylaws that limits the amount of debt that
the Company may incur, and consequently, the Company could
become highly leveraged, which in turn could adversely affect
the Company's ability to make distributions to its
shareholders and increase the risk of default under its
indebtedness.
o Risks associated with the Company's potential development of
hotels, including the risk of abandonment of development,
unexpected construction costs or delays, newly developed
hotels' failure to perform as expected, and failure to obtain,
or delays in obtaining, governmental permits and
authorizations.
Recent Developments
Acquisitions
The following table shows Hotels that have been acquired by the Company
since its most recent public offering of Common Stock, which was completed in
December 1996. Each Hotel, with the exception of the Comfort Suites-Dover,
Delaware Hotel, is leased pursuant to a Percentage Lease. The Comfort
Suites-Dover, Delaware Hotel is leased pursuant to a Fixed Lease.
<TABLE>
<CAPTION>
Contract
Date Number of Purchase
Acquired Rooms Price
-------- --------- --------
<S><C>
Comfort Inns:
Chambersburg, Pennsylvania............ May 29, 1997 65 $ 2,600,000
Culpeper, Virginia.................... February 26, 1997 49 1,900,000
Gettysburg, Pennsylvania(1)........... May 23, 1997 81 4,325,000
Murphy, North Carolina................ April 25, 1997 56 1,975,000
New Castle, Pennsylvania.............. March 17, 1997 79 3,000,000
Comfort Suites:
Dover, Delaware....................... January 22, 1997 64 2,795,210
Best Western and Best Western Suites:
Harlan, Kentucky(1)................... April 17, 1997 63 2,625,000
Key Largo, Florida.................... September 2, 1997 40 2,960,000(2)
Holiday Inn Express:
Allentown, Pennsylvania............... June 10, 1997 83 3,750,000
Danville, Kentucky.................... April 23, 1997 62 2,716,000
Gettysburg, Pennsylvania.............. May 23, 1997 51 2,725,000
---- ----------
Totals............................ 693 $31,371,210
=== ===========
</TABLE>
- -------------------------
(1) The Company is the lessee under land leases on the parcels underlying the
Comfort Inn-Gettysburg, Pennsylvania and the Best Western-Harlan, Kentucky
Hotels that expire in 2096 and 2091, respectively. The rent on the
Gettysburg land lease is $35,000 per year, payable in equal monthly
installments, and the rent on the Harlan land lease is $2,000 per month or
5% of room sales, whichever is greater.
(2) Purchased at a contract purchase price of $2,590,000 from an unaffiliated
seller pursuant to a purchase agreement that was assigned to the
Partnership by Humphrey-Key Largo Associates, L.P. ("Humphrey-Key Largo"),
a partnership substantially owned by Mr. Humphrey. Pursuant to the
assignment of the purchase agreement, Humphrey-Key Largo received as
compensation 34,023 Units of limited partnership interest in the
Partnership, valued at $370,000 based on an average price of $10.875 per
share of Common Stock for the ten
3
<PAGE>
trading days prior to September 2, 1997. The acquisition of the Hotel has
been recorded by the Company at the contract purchase price of $2,590,000,
which excludes the value of the Units issued to Humphrey-Key Largo.
Resignation of Executive Officer and Director of the Company
Effective March 17, 1998, Charles A. Mills, III, resigned from his
positions as Vice President, Treasurer and Director of the Company. Mr. Mills is
the Senior Vice President, Chairman and largest shareholder of the Underwriter
and has served on the Company's Board of Directors since its IPO on November 29,
1994. Simultaneously with the completion of the Offering, the Company will enter
into a Capital Consulting Agreement with Mr. Mills, who will continue to provide
the Company with advice as to future equity offerings and access to capital
markets generally. Under the terms of the Capital Consulting Agreement, which
has a one year term, the Company will pay Mr. Mills $20,000 plus .25% of the net
proceeds from public equity offerings over the next twelve months.
Directors Fees
On May 22, 1997, the Board of Directors unanimously voted to increase
the annual fees paid to them by the Company for serving on the Board of
Directors from $10,000 per year to $15,000 per year. On September 9, 1997, the
Board of Directors voted to utilize their full annual fees, with the exception
of the fees received by Mr. Humphrey, to purchase Common Stock on the open
market, and to exercise their reasonable best efforts to do so within ten days
of the receipt of such fees.
Credit Facility and Debt Policy
Since February 1997, the Company has increased the maximum amount that
it may borrow pursuant to its credit agreement with Mercantile Safe Deposit and
Trust Company ("Mercantile") from $6.5 million to $25.5 million (the "Credit
Facility"), primarily in order to acquire additional hotels. The Credit Facility
is secured by 17 of the Hotels. The interest rate under the Credit Facility is
equal to the prime rate as published in the "Money Rates" section of The Wall
Street Journal plus .25%, which, as of March 20, 1998, was equal to 8.75%. The
Credit Facility matures on April 10, 1999 and is subject to 2 one year
extensions, which are exercisable at Mercantile's option. Upon completion of the
Offering, the Company expects to increase the maximum amount that it may borrow
pursuant to the Credit Facility to $40 million at an interest rate equal to the
30 day London Interbank Offered Rate (which was 5.68% as of March 20, 1998),
plus 250 basis points.
As of May 22, 1997, the Board of Directors voted to increase the amount
of consolidated indebtedness that the Company may incur from 50% to 55% of the
aggregate purchase price of the hotels in which it has invested.
Capital Expenditure Reserves Policy
Although the Company believes that 4% of room revenue is generally an
appropriate capital reserve to maintain the condition and viability of its
Hotels, the Company will increase its capital reserves set-aside from 4% to 6%
of room revenue upon completion of the Offering. The additional 2% of room
revenue will be held in a special reserve fund (the "Additional Reserve Fund")
that will be deployed at the Hotels primarily to enhance their competitive
position. To ensure that the Company receives additional annual income that is
at least equal to 12% of the amount of funds invested by the Company from the
Additional Reserve Fund, the Company and the Lessee have agreed to amend the
Leases for the Hotels that receive capital from the Additional Reserve Fund to
provide that each such Hotel will increase its annual Base Rent payment by 7%
per annum of the capital received from the Additional Reserve Fund. The Company
expects that it will receive additional amounts under the terms of the
Percentage Leases equal to at least 5% per annum of the amount invested from the
Additional Reserve Fund through its participation in increased room revenue
resulting from such additional investments.
4
<PAGE>
The Hotels
The following table sets forth certain information with respect to the
Hotels for the twelve months ended December 31, 1997 (or such shorter period
commencing on the date of acquisition, if applicable):
<TABLE>
<CAPTION>
Average
Year Number of Average Daily Lease
HOTELS Opened Rooms Occupancy Rate REVPAR(1) Payments
------ --------- --------- ------- --------- --------
<S><C>
Comfort Inns & Suites:
Chambersburg, Pennsylvania(2)...... 1993 65 68.0% $55.24 $37.57 $ 228,806
Culpeper, Virginia(3).............. 1986 49 83.8% 50.71 42.48 254,646
Dahlgren, Virginia................. 1989 59 82.5% 49.53 40.85 388,044
Dover, Delaware(4)................. 1997 64 67.8% 64.42 43.68 357,649
Dublin, Virginia................... 1986 100 73.4% 52.95 38.87 689,691
Elizabethton, Tennessee............ 1987 58 57.8% 44.94 25.98 219,273
Farmville, Virginia................ 1985 51 79.5% 49.80 39.57 347,681
Gettysburg, Pennsylvania(5)........ 1996 81 74.1% 74.37 55.11 424,239
Morgantown, West Virginia.......... 1986 80 79.6% 55.12 43.85 644,049
Murphy, North Carolina(6).......... 1989 56 73.7% 56.10 41.32 219,165
New Castle, Pennsylvania(7)........ 1987 79 71.9% 56.40 40.57 381,810
Princeton, West Virginia........... 1985 51 80.0% 50.06 40.05 411,982
Beacon Marina,
Solomons, Maryland............... 1986 60 79.3% 65.07 51.57 851,070
Best Western and Best Western Suites:
Harlan, Kentucky(8)................ 1993 63 72.5% 51.93 37.66 304,284
Key Largo, Florida(9).............. 1987 40 71.4% 88.30 63.06 147,017
Days Inn:
Farmville, Virginia................ 1989 60 62.5% 47.55 29.73 292,875
Holiday Inn Express:
Allentown, Pennsylvania(10)........ 1978 83 65.5% 65.13 42.68 311,753
Danville, Kentucky(11)............. 1994 62 80.1% 55.89 44.77 295,851
Gettysburg, Pennsylvania(5)........ 1990 51 73.3% 77.01 56.43 267,764
Rodeway Inn:
Wytheville, Virginia............... 1985 100 32.8% 48.23 15.83 288,544
----- ----------
Consolidated Total/Weighted
Average for all Hotels............ 1,312 $7,326,193
===== ==========
</TABLE>
- -------------------------
(1) "REVPAR" means room revenue per available room, and is determined by
dividing room revenue by available rooms for the applicable period.
(2) Acquired May 29, 1997.
(3) Acquired February 26, 1997.
(4) Opened January 22, 1997.
(5) Acquired May 23, 1997.
(6) Acquired April 25, 1997.
(7) Acquired March 17, 1997.
(8) Acquired April 17, 1997.
(9) Acquired September 2, 1997.
(10) Acquired June 10, 1997.
(11) Acquired April 23, 1997.
5
<PAGE>
For further information regarding the Hotels, see "Business and Properties - The
Hotels." For further information regarding the Lessee, see "Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Overview."
Growth Strategy
The Company seeks to enhance shareholder value by increasing Cash
Available for Distribution to Shareholders by acquiring and developing
additional hotels that meet the Company's investment criteria and by
participating in increased revenue from the Hotels through Percentage Leases.
"Cash Available for Distribution to Shareholders" means net income, or loss, of
the Company plus depreciation and amortization minus capital expenditures or
reserves and scheduled principal payments on indebtedness.
Acquisition Strategy
The Company intends to acquire equity interests in additional operating
hotels that meet its investment criteria as described below. The Company will
emphasize limited service hotels with strong, national franchise affiliations in
the upper economy and mid-scale market segments, or hotels with the potential to
obtain such franchises. In particular, the Company will consider acquiring
limited service hotels such as Comfort Inn, Comfort Suites, Best Western, Best
Western Suites, Days Inn, Fairfield Inn(R), Hampton Inn(R), Holiday Inn Express
and Rodeway Inn hotels, limited service extended-stay hotels such as Hampton Inn
and Suites(R), Homewood Suites(R) and Residence Inn(R) hotels and full service
hotels such as Holiday Inns(R). Under the Company's Bylaws, any transaction to
acquire any additional properties must be approved by a majority of the members
of the Company's Board of Directors, including a majority of the Independent
Directors. As defined in the Company's Articles of Incorporation, "Independent
Directors" means Directors of the Company who within the last two years have not
(i) owned an interest in any Humphrey Affiliates or certain other entities, (ii)
been employed by Mr. Humphrey or any Humphrey Affiliates or certain other
entities, (iii) been an officer or director of any Humphrey Affiliates or
certain other entities, (iv) performed services for the Company, (v) been a
director for more than three REITs organized by Mr. Humphrey or any of his
Affiliates or certain other entities or (vi) had any material business or
professional relationship with Mr. Humphrey or any of his Affiliates or certain
other entities. See "Certain Provisions of Virginia Law and of the Company's
Articles of Incorporation and Bylaws -- Board of Directors."
Under the Investment Policy, the Company will only acquire an operating
hotel for which it expects to receive, based on prior operating history, annual
rental income in an amount greater than or equal to 12% of the total purchase
price paid by the Company for such hotel, net of (i) insurance premiums paid by
the Company, (ii) the FFE Reserves of 4% of room revenue ("FFE Reserves") and
(iii) real estate and personal property taxes. See "Risk Factors -- No Assurance
of Return on Property Investments." The Company's additional investments in
hotels may be financed, in whole or in part, with undistributed cash, net
proceeds from subsequent issuances of capital stock or other securities or
borrowings. The Company's policy is to limit consolidated indebtedness to less
than 55% of the aggregate purchase price paid by the Company for the Hotels in
which it has invested (the "Debt Policy"). The aggregate purchase price paid by
the Company for the Hotels is currently approximately $58.4 million. After the
Company has applied the Net Proceeds as set forth herein, the Remaining
Indebtedness (approximately $21.5 million) will represent approximately 36.8% of
the aggregate purchase price paid by the Company for the Hotels. See "- Recent
Developments," "Risk Factors - Risks of Leverage" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources." The Company has an option to acquire additional hotels
acquired or developed by Mr. Humphrey or his Affiliates. See "Policies and
Objectives with Respect to Certain Activities - Conflict of Interest Policies --
The Non-Competition Agreement and Option Agreement."
Development Strategy
The Company intends to grow through the development of new hotels as
well as from the acquisition of existing hotels. The Company intends to develop
limited-service hotels in secondary and tertiary markets, typically with under
150 rooms, that are similar to the Company's present Hotels. The Company is
interested in sites that offer the potential to attract a diverse mix of
potential market segments.
6
<PAGE>
The Company's development site selection criteria is expected to
include some or all of the following characteristics:
o Relatively low land costs, particularly as compared with major
metropolitan areas.
o Sites that exist on or near major highways.
o Areas that have strong industrial bases with the potential for
future growth.
o Communities with state or federal installations, colleges or
universities.
o Areas with older existing hotel properties.
These criteria describe the basic characteristics that the Company
looks for prior to committing to the development of a new hotel. Sites that are
selected may have some or all of the market characteristics as described above,
as well as characteristics that are not specifically described herein. It is not
anticipated that all sites selected by the Company will possess all of the
characteristics described herein.
Because a development project has no prior revenues on which the
Company's Investment Policy can be tested, the Company intends to invest only in
developments where it reasonably believes it will receive Rent (as defined
herein) payments from the Lessee that are consistent with the Investment Policy.
See "Risk Factors - No Assurance of Return on Property Investments."
Internal Growth Strategy
The Percentage Leases relating to the Hotels are designed to allow the
Company to participate in growth in revenues at the Hotels. The Company intends
to use Percentage Leases substantially similar to those applicable to the Hotels
with respect to any additional existing hotels it may acquire and Fixed Leases
substantially similar to the lease on the Comfort Suites-Dover, Delaware Hotel
with respect to hotels the Company may develop on its own. The Company believes
that there is less startup risk associated with acquisitions of existing hotels
than with the Company's development of new hotels. See "Business and Properties
- - The Percentage Leases." The Percentage Leases provide for the Lessee to pay
monthly base rent ("Base Rent") plus percentage rent ("Percentage Rent"). The
Percentage Rent for each Hotel consists of (i) a set percentage of quarterly and
semi-annual room revenues, which is payable quarterly and semi-annually,
respectively, (ii) a set percentage of annual room revenues in excess of a
threshold amount ("Threshold"), which is payable annually, and (iii) 8% of
monthly revenues other than room revenues (including, but not limited to,
telephone charges, movie rental fees and rental payments under any third-party
leases), which is payable monthly. The portion of Percentage Rent that is based
on annual room revenues does not apply to amounts under the Threshold and is
designed to allow the Company to participate in any increases in room revenues
occurring after the acquisition of a Hotel. See "Business and Properties - The
Hotels" and "The Percentage Leases - Amounts Payable Under the Percentage
Leases." The Base Rent, Percentage Rents and rent payments pursuant to the Fixed
Lease are hereinafter referred to collectively as "Rent."
7
<PAGE>
Following the Closing of the Offering, the structure and relationships
of the Company, the Partnership, the Hotels and the Lessee will be as follows:
----
[WORD CHART APPEARS BELOW]
<TABLE>
<S><C>
----------------------
Holders of
Common Stock
----------------------
---------------------- -------------------
Humphrey Hospitality Mr. Humphrey
Trust, Inc. and
The "Company" Affiliates
---------------------- -------------------
100%
1% Equity Interest 12.79%
Limited Partnership Partnership Interest
Interest ---------------------- and limited partners
Humphrey Hospitality
REIT Trust
The "General Partner"
----------------------
87.21%
Partnership Interest
- ------------------ ---------------------- ----------------------
Solomons 99% Humphrey Hospitality Humphrey Hospitality
Beacon Inn Limited General Limited Leases Management, Inc.
Partnership Partnership Partnership (solely owned by
The "Subsidiary Interest The "Partnership" Mr. Humphrey)
Partnership" ---------------------- The "Lessee"
- ------------------ ----------------------
100% 100%
Equity Interest Equity Interest
- ---------------------- ----------------------
One Nineteen
Hotel Hotels
- ---------------------- ----------------------
</TABLE>
8
<PAGE>
Distribution Policy
The following table sets forth the cash distributions declared per
share for each of the periods indicated.
1995
First Quarter............................................. .15
Second Quarter............................................ .15
Third Quarter............................................. .181(1)
Fourth Quarter............................................ .19
1996
First Quarter............................................. .19
Second Quarter............................................ .19
Third Quarter............................................. .19
Fourth Quarter............................................ .19
1997
First Quarter............................................. .19
Second Quarter............................................ .19
Third Quarter............................................. .19
Fourth Quarter............................................ .2025(2)
1998
First Quarter (through February 28, 1998)................. .135(2)
- ----------------------------
(1) Pro rata distribution for the period July 21, 1995, the closing of the
Company's second public offering of Common Stock, through September 30,
1995 based on a quarterly distribution of $.19 per share.
(2) Although presented on a quarterly basis, the Company began making monthly
distributions to its Common Shareholders commencing with the Company's
distribution declared in October 1997.
Future distributions will depend on the Company's actual results of
operations, Cash Available for Distribution to Shareholders, cash flows from
operations, economic conditions and other factors, such as working capital, cash
requirements to fund investing and financing activities such as debt service
requirements, including the repayment or refinancing of indebtedness, capital
expenditure requirements, including improvements to and expansions of existing
properties, and the acquisition or development of additional hotel properties,
as well as the distribution requirements under federal income tax provisions for
qualification as a REIT, which require that a REIT distribute at least 95% of
its annual taxable income. None of the distributions paid to the Common
Shareholders during 1997 represented a return of capital for federal income tax
purposes. There are no assurances that Cash Available for Distribution to
Shareholders will be sufficient for the Company to maintain its current
distribution rate in the future. See "Partnership Agreement."
Tax Status
The Company elected to be taxed as a REIT under Sections 856-860 of the
Internal Revenue Code of 1986, as amended, effective for its short taxable year
ended December 31, 1994. As long as the Company qualifies for taxation as a
REIT, with certain exceptions, the Company will not be subject to federal
corporate income tax on its taxable income that is distributed to its
shareholders. A REIT is subject to a number of organizational and operational
requirements, including a requirement that it currently distribute at least 95%
of its annual taxable income, excluding net capital gains. Although the Company
does not intend to request a ruling from the Internal Revenue Service (the
"Service") as to its REIT status, the Company will obtain, at the closing of the
Offering, the opinion of its legal counsel as to its REIT status, which opinion
will be based on certain assumptions and representations and will not be binding
on the Service or any court. Even if the Company qualifies for taxation as a
REIT, the Company, the Partnership or the Subsidiary Partnership may be subject
to certain state and local taxes
9
<PAGE>
on its income and property. In connection with the Company's election to be
taxed as a REIT, the Company's Articles of Incorporation impose restrictions on
the ownership and transfer of shares of Common Stock. The Company has adopted
the calendar year as its taxable year. Failure to qualify as a REIT will render
the Company subject to federal income tax (including any applicable alternative
minimum tax) on its taxable income at regular corporate rates and distributions
to the Common Shareholders in any such year will not be deductible by the
Company. See "Risk Factors - Tax Risks," "Federal Income Tax Considerations -
Taxation of the Company" and "Description of Capital Stock - Restrictions on
Ownership and Transfer."
The Offering
<TABLE>
<S><C>
Common Shares offered by the Company...................... 1,000,000
Shares of Common Stock and Units to be outstanding
after the Offering..................................... 5,139,073(1)
Use of Net Proceeds....................................... To repay a portion of the outstanding borrowings
under the Credit Facility.
Symbol on The Nasdaq National Market...................... HUMP
</TABLE>
- ---------------
(1) Includes 657,373 Units that are redeemable, at the option of the holder, on
a one-for-one basis for shares of Common Stock at any time or, at the Company's
option, an equivalent amount of cash.
10
<PAGE>
Summary Financial Data
The following table sets forth audited historical financial information
for the Company and the Lessee. Such data should be read in conjunction with the
applicable financial statements and the notes thereto, which are contained
elsewhere in this Prospectus.
HUMPHREY HOSPITALITY TRUST, INC. (THE COMPANY)
Summary Historical
Revenue and Expenses and Financial Data
(in thousands, except per share data)
<TABLE>
<CAPTION>
Period from
November 29, 1994
(Date of IPO)
through Year Ended Year Ended Year Ended
December 31, December 31, December 31, December 31,
1994 1995 1996 1997
---- ---- ---- ----
<S><C>
Operating Data:
Revenue:
Lease revenue ...................... $ 273 $ 3,750 $ 3,958 $ 7,326
Other income........................ - 21 47 106
---------- ---------- --------- ----------
Total revenue....................... 273 3,771 4,005 7,432
---------- ---------- --------- ----------
Expenses:
Depreciation and amortization....... 42 680 736 1,633
Interest expense.................... 97 1,011 493 1,764
Real estate and personal
property taxes and insurance...... 18 196 252 476
General and administrative.......... 15 238 411 537
---------- ---------- ---------- ----------
Total expenses.................... 172 2,125 1,892 4,410
---------- ---------- ---------- ----------
Income before
minority interest................. 101 1,646 2,113 3,022
Minority interest................... 29 396 435 465
---------- ---------- ---------- ----------
Net income applicable
to Common Shareholders............ $ 72 $ 1,250 $ 1,678 $ 2,557
========== ========== ========== ==========
Basic earnings per common share (1) $ 0.05 $ 0.72 $ 0.70 $ 0.73
Diluted earnings per common share (1) $ 0.05 $ 0.70 $ 0.70 $ 0.73
Other Data:
Weighted average shares:
Basic............................. 1,321,800 1,742,533 2,410,252 3,481,700
Diluted........................... 1,849,666 2,365,883 3,033,602 4,139,073
Funds from operations (2)........... $ 139 $ 2,132 $ 2,723 $ 4,548
Net cash provided by operating
activities........................ $ 170 $ 1,334 $ 2,751 $ 3,680
Net cash used in
investing activities.............. $ (4,840) $ (619) $ (1,967) $ (29,406)
Net cash provided by (used in)
financing activities.............. $ 5,223 $ (1,100) $ 6,148 $ 18,829
</TABLE>
HUMPHREY HOSPITALITY TRUST, INC.
Summary Historical Balance Sheet Data
(in thousands)
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1997
----------------- -----------------
(Audited) (Audited)
--------- ---------
<S><C>
Balance Sheet Data:
Net investment in hotel properties........................... $21,405 $50,476
Minority interest in Partnership............................. 3,247 3,370
Shareholders' equity......................................... 18,145 17,852
Total assets................................................. 30,221 53,799
Total debt................................................... 8,185 31,755
</TABLE>
11
<PAGE>
HUMPHREY HOSPITALITY MANAGEMENT, INC.
Summary Historical Revenue and Expenses
(in thousands)
<TABLE>
<CAPTION>
Period from
November 29, 1994 Year Year Year
(Date of IPO) Ended Ended Ended
through December 31, December 31, December 31, December 31,
1994 1995 1996 1997
(Audited) (Audited) (Audited) (Audited)
--------- --------- --------- ---------
<S><C>
Room revenue........................... $ 459 $ 7,499 $ 7,942 $ 15,581
Other revenue (3)...................... 38 556 637 871
----- ------- ------- --------
Total revenue........................ 497 8,055 8,579 16,452
Hotel operating expenses............... 314 4,167 4,590 8,716
Percentage Lease payments.............. 273 3,750 3,958 7,326
----- ------- ------- --------
Net income............................. $ (90) $ 138 $ 31 $ 410
===== ====== ======= ========
</TABLE>
- -------------------
(1) Represents basic and diluted earnings per share computed in accordance
with Statement of Financial Accounting Standards No. 128, Earnings Per
Share ("FAS No. 128"), adopted by the Company during 1997. Basic earnings
per share is computed as net income available to common shareholders
divided by the weighted average common shares outstanding and diluted
earnings per share is computed as income before minority interest divided
by the weighted average common shares outstanding plus the assumed
conversion of the units held by minority interests. See Note 6, Earnings
Per Share of the consolidated financial statements of Humphrey Hospitality
Trust, Inc. at page F-19 for a reconciliation of the income (numerator)
and weighted average shares (denominator) used in the calculation of basic
and diluted earnings per share. The adoption of FAS No. 128 did not have
a material effect on prior years.
(2) Management considers Funds From Operations ("FFO") to be a market accepted
measure of an equity REIT's cash flow, which management believes reflects
on the value of real estate companies such as the Company, in connection
with the evaluation of other measures of operating performances. All
REITs do not calculate FFO in the same manner, therefore, the Company's
calculation may not be the same as the calculation of FFO for similar
REITs. Beginning with the year ended December 31, 1997, the Company
changed the way it computes FFO. The Company believes that its new method
of computing FFO is more consistent with the guidelines established by
NAREIT for calculating FFO. FFO, as defined under the NAREIT standard,
consists of net income, computed in accordance with generally accepted
accounting principles ("GAAP"), excluding gains or losses from debt
restructuring and sales of properties, plus depreciation and amortization
and after adjustments for unconsolidated partnerships and joint ventures.
The following table computes FFO under both the new method and the method
formerly utilized by the Company:
12
<PAGE>
The computation of historical FFO is as follows (in thousands):
<TABLE>
<CAPTION>
Period from
November 29, 1994
(Date of IPO) Year Year Year
through Ended Ended Ended
December 31, December 31, December 31, December 31,
1994 1995 1996 1997
(Audited) (Audited) (Audited) (Audited)
--------- --------- --------- ---------
<S><C>
Net income before minority
interests $ 101 $ 1,646 $ 2,113 $ 3,022
Depreciation 38 486 610 1,502
Amortization of initial
franchise costs - - - 24
--------- ---------- --------- ---------
Funds From Operations 139 2,132 2,723 4,548
(new method)
Amortization of loan costs 4 194 126 107
--------- ---------- --------- ---------
Funds From Operations
(former method) $ 143 $ 2,326 $ 2,849 $ 4,655
========= ========== ========= =========
</TABLE>
Industry analysts generally consider FFO to be an appropriate measure of
the performance of an equity REIT. FFO should not be considered as an
alternative to net income or other measurements under GAAP as an indicator
of operating performance or to cash flows from operating, investing or
financing activities as a measure of liquidity. FFO does not reflect
working capital changes, cash expenditures for capital improvements or
debt service with respect to the Hotels.
(3) Represents marina revenue (for the Comfort Inn-Beacon Marina, Solomons,
Maryland and the Best Western Suites-Key Largo, Florida Hotels only),
telephone revenue, restaurant revenue and other revenue.
13
<PAGE>
RISK FACTORS
In evaluating the Company's business, prospective investors should
carefully consider the following risk factors in addition to the other
information contained in this Prospectus.
Conflicts of Interest
Because of Mr. Humphrey's ownership in and/or positions with the
Company, the Partnership, and the Lessee, there are inherent conflicts of
interest in the disposition and operation of the Hotels. Consequently, the
interests of shareholders may not have been, and in the future may not be,
reflected fully in all decisions made or actions taken by officers and the Board
of Directors of the Company. See "Policies and Objectives with Respect to
Certain Activities - Conflict of Interest Policies."
Conflicts Relating to Sales or Refinancing of Hotels
Certain of the Limited Partners, which are Humphrey Affiliates, have
unrealized gain in their interests in the Partnership. A sale of certain of the
Hotels or refinancing or prepayment of principal on the Remaining Indebtedness
by the Company may cause adverse tax consequences to certain of the Limited
Partners. Therefore, the interests of the Company and certain of the Limited
Partners could be different in connection with the disposition or refinancing of
a Hotel. Decisions with respect to the disposition of any Hotel or refinancing
or prepayment of principal on the Remaining Indebtedness will be made by a
majority of the Directors, including a majority of the Independent Directors.
See "Certain Relationships and Transactions - Acquisition of Certain Hotels from
Humphrey Affiliates."
No Arm's-Length Bargaining on the Percentage Leases, the Fixed Lease, the
Development Agreement, the Services Agreement, the Hotel Purchase Agreements,
the Non-Competition Agreement and the Option Agreement
The terms of the Percentage Leases, the Fixed Lease, the Development
Agreement, the Services Agreement, the agreements pursuant to which the
Partnership acquired certain of the Hotels, the Non-Competition Agreement and
the Option Agreement were not negotiated on an arm's-length basis. See
"Business and Properties - The Percentage Leases," and "- The Fixed Lease and
"Certain Relationships and Transactions." The Company does not own any interest
in the Lessee. Mr. Humphrey is a Director and officer of the Company and the
sole shareholder of the Lessee. Consequently, he has a conflict of interest
regarding the enforcement of the Leases, the Services Agreement, the
Non-Competition Agreement and the Option Agreement. See "The Lessee."
Competing Hotels to be Acquired by Affiliates of Mr. Humphrey
The Humphrey Affiliates may develop or acquire new hotels, subject to
certain limitations, which may materially affect the amount of time Mr. Humphrey
has to devote to the affairs of the Company. The Humphrey Affiliates, including
the Lessee, may operate hotels that are not owned by the Company, subject to
certain restrictions, which may materially affect the amount of time that Mr.
Humphrey or the Lessee has to devote to managing the Hotels. See "Policies and
Objectives with Respect to Certain Activities - Conflict of Interest Policies --
The Non-Competition Agreement and Option Agreement."
Competing Companies to be Advised by an Affiliate of the Company
George R. Whittemore, a Director of the Company, is a consultant to
Mills Management II, Inc., which is the manager and a member of a privately-held
limited liability company that was formed to, among other things, acquire hotels
that are substantially similar to the Hotels. Mr. Whittemore may experience
conflicts between his obligations as a consultant to Mills Management II, Inc.
and his duties to the Company in the event that investment opportunities arise
that meet both companies' investment criteria.
14
<PAGE>
Risk of High Distribution Payout Percentage
The Company's distribution rate to stockholders was approximately
84.43% of the Company's Cash Available for Distribution to Shareholders for the
fiscal year ended December 31, 1997. See "Price Range of Common Stock and
Distributions." Should the Company's Cash Available for Distribution to
Shareholders decrease, the Company may not be able to maintain its current level
of distributions.
Risks of Leverage
Upon completion of the Offering and the application of the Net Proceeds
as set forth herein, the Company will have Remaining Indebtedness of
approximately $21.5 million. All of the Remaining Indebtedness will be secured
by one or more of the Hotels. Approximately 70.8% ($15.2 million) of the
Remaining Indebtedness will be due or callable by the lender in April 1999, and
approximately 8.0% ($1.7 million) of the Remaining Indebtedness will be due or
callable by the lender in November 1999. Because there is no assurance that the
Company will be able to repay or refinance its debt when due or called, one or
more of the Hotels may be lost to foreclosure. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations Liquidity and Capital
Resources."
Although the Company has adopted the Debt Policy and has made covenants
to lenders and the Underwriter limiting its level of indebtedness, there is no
limit on the Company's ability to incur debt contained in the Articles of
Incorporation or Bylaws. The Company may borrow additional amounts from the same
or other lenders in the future, or may issue corporate debt securities in public
or private offerings. Certain of such additional borrowings may be secured by
the Hotels. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources" and "Policies and
Objectives with Respect to Certain Activities - Financing."
There can be no assurance that the Company will be able to meet its
debt service obligations and, to the extent that it cannot, the Company risks
the loss of some or all of its assets, including the Hotels, to foreclosure.
There also can be no assurance that the Company will be able to adhere to its
Debt Policy and such policy may be changed by the Board of Directors without
shareholder approval. The aggregate purchase price paid by the Company for the
Hotels is currently approximately $58.4 million. After the Company has applied
the Net Proceeds as set forth herein, the Company's total outstanding
indebtedness will represent approximately 36.8% of the aggregate purchase price
paid by the Company for the Hotels, thereby giving the Company additional
borrowing capacity of up to approximately $10.6 million under the Debt Policy.
The amount of the Company's outstanding indebtedness could limit the Company's
ability to acquire additional hotels without issuing equity securities. See
"Risk Factors - Growth Strategy - Constraints on Acquisitions."
Dependence on the Lessee
In order to generate revenues to enable it to make distributions to
shareholders, the Company relies on the Lessee to make Rent payments. Reductions
in revenues from the Hotels or in the net operating income of the Lessee may
adversely affect the ability of the Lessee to make such Rent payments and thus
the Company's ability to make anticipated distributions to its shareholders.
Although failure on the part of the Lessee to comply materially with the terms
of a Lease would give the Company the right to terminate any or all of the
Leases, to repossess the applicable properties and to enforce the payment
obligations under the Leases, the Company would then be required to find another
lessee. There can be no assurance that the Company would be able to find another
lessee or that, if another lessee were found, the Company would be able to enter
into a lease on terms as favorable as the Leases. See "Business and Properties -
The Percentage Leases" and "- The Fixed Lease."
The Lessee has only nominal assets (other than its leasehold interests
in the Hotels and the working capital necessary to operate the Hotels) and,
therefore, is dependent on the operation of the Hotels to fund its Rent payments
to the Partnership under the Leases. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Results of Operations."
15
<PAGE>
Tax Risks
Failure to Qualify as a REIT
The Company has operated and intends to continue to operate so as to
qualify as a REIT for federal income tax purposes. Although the Company has not
requested, and does not expect to request, a ruling from the Service that it
qualifies as a REIT, the Company will receive at the Closing an opinion of its
counsel that, based on certain assumptions and representations, it so qualifies.
Investors should be aware, however, that opinions of counsel are not binding on
the Service or any court. The REIT qualification opinion only represents the
view of counsel to the Company based on counsel's review and analysis of
existing law, which includes no controlling precedent. Furthermore, both the
validity of the opinion and the continued qualification of the Company as a REIT
will depend on the Company's continuing ability to meet various requirements
concerning, among other things, the ownership of its outstanding shares, the
nature of its assets, the sources of its income, and the amount of its
distributions to its shareholders. See "Federal Income Tax Considerations -
Taxation of the Company."
If the Company were to fail to qualify as a REIT in any taxable year,
the Company would not be allowed a deduction for distributions to its
shareholders in computing its taxable income and would be subject to federal
income tax (including any applicable alternative minimum tax) on its taxable
income at regular corporate rates. Unless entitled to relief under certain Code
provisions, the Company also would be disqualified from treatment as a REIT for
the four taxable years following the year during which qualification was lost.
As a result, Cash Available for Distribution to Shareholders would be reduced
for each of the years involved. Although the Company currently conducts its
operations in a manner designed to qualify as a REIT, it is possible that future
economic, market, legal, tax or other considerations may cause the Board of
Directors, with the consent of two-thirds of the shareholders, to revoke the
REIT election. See "Federal Income Tax Considerations."
REIT Minimum Distribution Requirements
In order to qualify as a REIT, the Company generally is required each
year to distribute to its shareholders at least 95% of its net taxable income
(excluding any net capital gain). In addition, the Company will be subject to a
4% nondeductible excise tax on the amount, if any, by which certain
distributions paid by it with respect to any calendar year are less than the sum
of (i) 85% of its ordinary income for that year, (ii) 95% of its capital gain
net income for that year, and (iii) 100% of its undistributed taxable income
from prior years. To the extent that the Company elects to retain and pay income
tax on its net capital gain, such retained amounts will be treated as having
been distributed for purposes of the 4% excise tax.
The Company has made and will continue to make distributions to its
shareholders to comply with the 95% distribution requirement and to avoid the
nondeductible excise tax. The Company's income consists primarily of its share
of the income of the Partnership and the Subsidiary Partnership, and the
Company's Cash Available for Distribution to Shareholders consists primarily of
its share of cash distributions from the Partnership and the Subsidiary
Partnership. Differences in timing between the recognition of taxable income and
the receipt of Cash Available for Distribution to Shareholders due to the
seasonality of the hotel industry could require the Company, through the
Partnership, to borrow funds on a short-term basis to meet the 95% distribution
requirement and to avoid the nondeductible excise tax. See "Risk Factors -- Risk
of Leverage." For federal income tax purposes, distributions paid to
shareholders may consist of ordinary income, capital gains, nontaxable return of
capital, or a combination thereof. The Company will provide its shareholders
with an annual statement as to its designation of the taxability of
distributions.
Distributions by the Partnership will be determined by the Company's
Board of Directors and will be dependent on a number of factors, including the
amount of the Partnership's distributable cash, the Partnership's financial
condition, any decision by the Board of Directors to reinvest funds rather than
to distribute such funds, the Partnership's capital expenditures, the annual
distribution requirements under the REIT provisions of the Code and such other
factors as the Board of Directors deems relevant. See "Federal Income Tax
Considerations - Requirements for Qualification - Distribution Requirements."
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Failure of the Partnership or the Subsidiary Partnership to be Classified as a
Partnership for Federal Income Tax Purposes; Impact on REIT Status
Although the Company has not requested, and does not expect to request,
a ruling from the Service that the Partnership and the Subsidiary Partnership
will be classified as partnerships for federal income tax purposes, the Company
will receive at the Closing an opinion of its counsel stating that the
Partnership and the Subsidiary Partnership will be classified as partnerships
and not as corporations or associations taxable as corporations for federal
income tax purposes. If the Service were to challenge successfully the tax
status of the Partnership and the Subsidiary Partnership as a partnership for
federal income tax purposes, the Partnership or the Subsidiary Partnership, as
applicable, would be taxable as a corporation. In such event, the Company likely
would cease to qualify as a REIT for a variety of reasons. Furthermore, the
imposition of corporate income tax on the Partnership or the Subsidiary
Partnership would substantially reduce the amount of Cash Available for
Distribution to Shareholders. See "Federal Income Tax Considerations - Tax
Aspects of the Partnership and the Subsidiary Partnership."
Risks of Mr. Humphrey's Personal Bankruptcy
Mr. Humphrey currently personally guarantees, jointly and severally
with the Company, 18.7% ($5.9 million) of the Company's indebtedness. In the
event of his personal bankruptcy, the lenders would have the right to call all
such indebtedness due. Because there is no assurance that the Company would be
able to repay or refinance such debt if called, one or more of the Hotels could
be lost to foreclosure.
Risks Associated with Development
The Company developed one of its Hotels and may develop other hotel
properties in the future. Risks associated with hotel development include:
abandonment of development opportunities; construction costs exceeding estimates
and possibly making the hotel uneconomical; occupancy and room rates at newly
completed hotels may not be sufficient to make the hotel profitable; financing
may not be available on favorable terms to replace a short-term construction
loan; and construction may not be completed on time resulting in increased debt
service expenses and/or a longer time before income is produced. Development
projects are also subject to risks relating to the inability to obtain, or
delays in obtaining, all necessary land-use, building, occupancy and other
required governmental permits and authorizations.
Inability to Operate the Properties
In order to qualify as a REIT, the Company cannot operate any hotels.
As a result, the Company is unable to make and implement strategic business
decisions with respect to its properties, such as decisions with respect to the
choice of franchise affiliation, redevelopment of food and beverage operations
and other similar decisions. Although the Company consults with the Lessee on
such matters, the Lessee is under no obligation to implement any recommendations
of the Company. Accordingly, there can be no assurance that the Lessee will
operate the Hotels in a manner that is in the best interests of the Company. See
"The Lessee."
Growth Strategy
Constraints on Acquisitions
The Company's growth strategy includes acquiring existing hotel
properties, which will be dependent on its access to cash. The Company generally
cannot retain cash from operating activities because in order to qualify as a
REIT, the Company must distribute at least 95% of its annual taxable income. See
"Federal Income Tax Considerations -- Requirements for Qualification --
Distribution Requirements." In addition, the Company's ability to borrow funds
is limited by covenants made to lenders and its Debt Policy. Because the Company
cannot retain earnings, to the extent that covenants made to lenders and its
Debt Policy limit its ability to incur additional indebtedness, the Company's
ability to continue to make acquisitions may depend on its ability to obtain
additional
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equity financings. See "Growth Strategy - Acquisition Strategy." There is no
assurance that such financing will be available.
Competition for Acquisitions
There will be competition for investment opportunities in upper-economy
and mid-scale hotels from entities organized for purposes substantially similar
to the Company's objectives, as well as other purchasers of hotels. The Company
will be competing for such investment opportunities with entities that have
substantially greater financial resources than the Company, including access to
capital or better relationships with franchisors, sellers or lenders. The
Company's competitors may generally be able to accept more risk than the Company
can manage prudently and may be able to borrow the funds needed to acquire
hotels. Competition may generally reduce the number of suitable investment
opportunities offered to the Company and increase the bargaining power of
property owners seeking to sell. See "Business and Properties - Competition."
Acquisition Risks
The Company intends to pursue acquisitions of additional hotel
properties. Acquisitions entail risks that investments will fail to perform in
accordance with expectations and that estimates of the cost of improvements
necessary to market and acquire properties will prove inaccurate, as well as
general investment risks associated with any new real estate investment. The
fact that the Company must distribute 95% of its annual net taxable income in
order to maintain its qualification as a REIT may limit the ability of the
Company to rely upon rental income from the Leases or subsequently acquired
properties to finance acquisitions. As a result, if debt or equity financing is
not available on acceptable terms, further acquisition activities might be
curtailed or Cash Available for Distribution to Shareholders might be adversely
affected. See "Growth Strategy - Acquisition Strategy."
Limited Number of Hotels
The Company currently owns only twenty Hotels, twelve of which are
operated as Comfort Inn hotels, three of which are operated as Holiday Inn
Express hotels, one of which is operated as a Best Western hotel, one of which
is operated as a Best Western Suites hotel, one of which is operated as a
Comfort Suites hotel, one of which is operated as a Days Inn hotel and one of
which is operated as a Rodeway Inn hotel. Significant adverse changes in the
operations of any Hotel could have a material adverse effect on the Lessee's
ability to make Rent payments and, accordingly, on the Company's ability to make
expected distributions to its shareholders. See "Business and Properties."
Emphasis on Comfort Inn Hotels
The Company's acquisition and development strategies emphasize hotels
with franchise affiliations similar to those of the Hotels. The Company is
subject to risks inherent in concentrating investments in any franchise brand,
in particular the Comfort Inn brand, which could have an adverse effect on the
Company's lease revenues and Cash Available for Distribution to Shareholders.
These risks include, among others, the risk of a reduction in hotel revenues
following any adverse publicity related to the Comfort Inn brand. See "Business
and Properties - Comfort Inn and Comfort Suites Hotels and Rodeway Inn Hotels"
and "- Franchise Licenses."
Dilution
Purchasers of the Common Shares sold in the Offering will experience
immediate and substantial dilution of $4.52 or 43.1% of the Offering Price in
the net tangible book value per Common Share. See "Dilution."
Cross-Collateralized Debt
Approximately $3.9 million of the Remaining Indebtedness is secured by
liens on the Comfort Inn- Morgantown, West Virginia and the Rodeway
Inn-Wytheville, Virginia Hotels and the notes related to such debt are
cross-collateralized and cross-defaulted so that the Company will be subject to
a risk of loss to foreclosure of
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one or both of such Hotels upon a default on either of such notes. Approximately
$15.2 million of the Remaining Indebtedness, consisting of borrowings under the
Credit Facility, is secured by and cross-collateralized and cross- defaulted on
17 Hotels. Therefore, the Company will be subject to a risk of loss to
foreclosure of all 17 Hotels upon an event of default under the Credit Facility.
The remainder of the Remaining Indebtedness is secured by a lien on the Comfort
Inn-Dublin, Virginia Hotel.
No Assurance of Return on Property Investments
The Company's Investment Policy will be applied to a hotel property
prior to its acquisition or development by the Company, and therefore, there can
be no assurance that increases in insurance rates, real estate or personal
property tax rates or FFE Reserves, which are based on room revenues, will not
decrease the Company's annual return on its investments in any hotel property to
a level below that set out in the Investment Policy. See "Business and
Properties - the Percentage Leases - Maintenance and Modifications."
Effect of Market Interest Rates on Price of the Common Stock
One of the factors that may influence the price of the Common Stock in
public trading markets will be the annual yield from distributions by the
Company on the Common Stock as compared to yields on other financial
instruments. Thus, an increase in market interest rates will result in higher
yields on other financial instruments, which could adversely affect the market
price of the Common Stock.
Reliance on Board of Directors and Management
Common Shareholders have no right or power to take part in the
management of the Company except through the exercise of voting rights on
certain specified matters and the annual election of Directors. See "Description
of Capital Stock - Common Stock" and "Certain Provisions of Virginia Law and of
the Company's Articles of Incorporation and Bylaws." The Board of Directors is
responsible for managing the Company. The Company relies upon the services and
expertise of its Directors for strategic business direction. An Acquisition
Committee, consisting of three Directors, including Mr. Humphrey, reviews
potential hotel acquisitions and developments, visits proposed hotel sites,
reviews the terms of proposed leases for proposed hotel acquisitions and
development, and makes recommendations to the full Board of Directors with
respect to proposed hotel acquisitions. See "Management."
In addition, there may be conflicting demands on Mr. Humphrey caused by
his overlapping management of the Company and Humphrey Associates, Inc.
("Humphrey Associates"), a Maryland corporation that is wholly-owned by Mr.
Humphrey. Humphrey Associates is one of the Limited Partners. Because Humphrey
Associates owns and operates properties other than the Hotels, and Mr. Humphrey
serves as President of the Company and Humphrey Associates, Mr. Humphrey may
experience a conflict in allocating his time between such entities. See
"Policies and Objectives with Respect to Certain Activities - Conflict of
Interest Policies."
Limitation on Liability of Officers and Directors
The Articles of Incorporation of the Company contain a provision which,
subject to certain exceptions, eliminates the liability of a Director or officer
to the Company or its shareholders for monetary damages for any breach of duty
as a Director or officer. This provision does not eliminate such liability to
the extent that it is proved that the Director or officer engaged in willful
misconduct or a knowing violation of criminal law or of any federal or state
securities law. See "Management - Exculpation and Indemnification."
Limitation on Acquisition and Change in Control
Ownership Limitation
In order for the Company to maintain its qualification as a REIT, not
more than 50% in value of its outstanding shares of capital stock may be owned,
directly or indirectly, by five or fewer individuals (as defined
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in the Code to include certain entities) during the last half of any taxable
year. Furthermore, if the Company owns, actually or constructively, 10% or more
of the ownership interests in the Lessee, the Rents received from the Lessee
will not qualify as rents from real property, which would result in loss of REIT
status for the Company. For the purpose of preserving the Company's REIT
qualification, the Articles of Incorporation generally prohibit direct or
indirect ownership of more than 9.9% of the number of outstanding shares of
Common Stock or 9.9% of the number of outstanding shares of preferred stock of
any class or series by any person (the "Ownership Limitation"). The Ownership
Limitation could have the effect of discouraging a takeover or other transaction
in which holders of some, or a majority, of the shares of Common Stock might
receive a premium for their shares of Common Stock over the then prevailing
market price or which such holders might believe to be otherwise in their best
interests. See "Description of Capital Stock - Restrictions on Ownership and
Transfer" and "Federal Income Tax Considerations - Requirements for
Qualification."
Authority to Issue Preferred Stock
The Articles of Incorporation authorize the Board of Directors to issue
up to 10,000,000 shares of preferred stock and to establish the preferences and
rights of any shares of preferred stock issued. Although the Company has no
current intention to issue any series of preferred stock in the foreseeable
future, the issuance of any series of preferred stock could have the effect of
delaying or preventing a change in control of the Company even if a change in
control were in the interests of the Common Shareholders. See "Description of
Capital Stock - Preferred Stock."
Virginia Anti-Takeover Statutes
As a Virginia corporation, the Company is subject to various provisions
of the Virginia Stock Corporation Act, which impose certain restrictions and
require certain procedures with respect to certain takeover offers and business
combinations, including, but not limited to, combinations with interested
holders and share repurchases from certain holders. See "Certain Provisions of
Virginia Law and the Company's Articles of Incorporation and Bylaws - Business
Combinations" and "- Control Share Acquisitions."
Ability of Board of Directors to Change Certain Policies
The major policies of the Company, including its Investment Policy,
Debt Policy and other policies with respect to acquisitions, financing, growth,
operations, debt and distributions, are determined by its Board of Directors.
The Board of Directors may amend or revise, and has, in the past, amended and
revised, these and other policies from time to time without a vote of the Common
Shareholders. The effect of any such changes may be positive or negative. Under
the Company's Bylaws, the Company cannot acquire any property, sell any of the
Hotels, prepay or refinance the Remaining Indebtedness, or decrease the expected
distributions to shareholders (assuming the Company has sufficient revenues),
without the approval of a majority of the Directors, including a majority of the
Independent Directors. The Company cannot change these provisions of its Bylaws
without the approval of either 80% of the entire Board of Directors, including a
majority of the Independent Directors, or the holders of two-thirds of the
outstanding shares of Common Stock. The Company cannot change its policy of
seeking to maintain its qualification as a REIT without the approval of the
holders of two-thirds of the outstanding shares of Common Stock. See "Policies
and Objectives with Respect to Certain Activities" and "Certain Provisions of
Virginia Law and of the Company's Articles of Incorporation and Bylaws."
Hotel Industry Risks
Operating Risks
The Hotels are subject to all operating risks common to the hotel
industry. The hotel industry has experienced volatility in the past, as have the
Hotels, and there can be no assurance that such volatility will not occur in the
future. These risks include, among other things, competition from other hotels,
over-building in the hotel industry that could adversely affect hotel revenues,
increases in operating costs due to inflation and other factors, which increases
may not be offset by increased room rates, dependence on business and commercial
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travelers and tourism, strikes and other labor disturbances of hotel employees,
increases in energy costs and other expenses of travel and adverse effects of
general and local economic conditions. These factors could reduce revenues of
the Hotels and adversely affect the Lessee's ability to make Rent payments, and
therefore, the Company's ability to make expected distributions to its
shareholders.
Competition for Guests
The hotel industry is highly competitive. The Hotels will compete with
other existing and new hotels in their geographic markets. Many of the Company's
competitors have substantially greater marketing and financial resources than
the Company and the Lessee. See "Business and Properties - Competition."
Investment Concentration in Single Industry
The Company's current growth strategy is to acquire and develop hotels.
The Company will not seek to invest in assets outside the hotel industry, and
will therefore be subject to the risks created by concentrating its investments
in a single industry. Therefore, the adverse effect on Rent and Cash Available
for Distribution to Shareholders resulting from a downturn in the hotel industry
will be more pronounced than if the Company had diversified its investments
outside of the hotel industry.
Seasonality of Hotel Business and the Hotels
The hotel industry is seasonal in nature. Generally, hotel revenues for
hotels operating in the geographic areas in which the Hotels operate are greater
in the second and third quarters than in the first and fourth quarters. The
Hotels' operations historically reflect this trend. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Seasonality of
Hotel Business and the Hotels."
Risks of Operating Hotels under Franchise Licenses
The continuation of the franchise licenses applicable to the Hotels
(the "Franchise Licenses") is subject to specified operating standards and other
terms and conditions. Choice Hotels International, Inc. ("Choice Hotels"), the
franchisor of Comfort Inns, Comfort Suites and Rodeway Inns; Best Western
International, Inc. ("Best Western"); Days Inns of America, Inc. ("Days Inn")
and Holiday Hospitality Corporation ("Holiday Hospitality"), the franchisor of
Holiday Inn Express, periodically inspect their licensed properties to confirm
adherence to their operating standards. The failure of the Partnership or the
Lessee to maintain such standards respecting the Hotels or to adhere to such
other terms and conditions could result in the loss or cancellation of the
applicable Franchise License. It is possible that a franchisor could condition
the continuation of a Franchise License on the completion of capital
improvements that the Board of Directors determines are too expensive or
otherwise not economically feasible in light of general economic conditions or
the operating results or prospects of the affected Hotel. In that event, the
Board of Directors may elect to allow the Franchise License to lapse or be
terminated. Under the Franchise License with Choice Hotels, the franchisor may
terminate the Franchise License without cause for the Comfort Inn-Dahlgren,
Virginia on April 1, 1999. Under the Franchise Licenses with Best Western, the
franchisee and franchisor each has the option to terminate each Franchise
License every year. There can be no assurance that a franchisor will not
exercise a termination right or renew a Franchise License at the expiration of
the current terms. If a Franchise License is terminated, the Partnership and the
Lessee may seek to obtain a suitable replacement franchise, or to operate the
Hotel without a franchise affiliation. The loss of a Franchise License could
have a material adverse effect upon the operations or the underlying value of
the related Hotel because of the loss of associated name recognition, marketing
support and centralized reservation systems provided by the franchisor. Although
the Leases require the Lessee to maintain the Franchise Licenses for each Hotel,
the Lessee's loss of a Franchise License for one or more of the Hotels could
have a material adverse effect on the Partnership's revenues under the Leases
and the Company's Cash Available for Distribution to Shareholders. See "Business
and Properties - Franchise Licenses."
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Operating Costs and Capital Expenditures; Hotel Renovation
Hotels generally have an ongoing need for renovations and other capital
improvements, particularly in older structures, including periodic replacement
of furniture, fixtures and equipment. Under the terms of the Leases, the
Partnership is obligated to pay the cost of (i) expenditures for items that are
classified as capital items under generally accepted accounting principles and
which are necessary for the continued operation of the Hotels and (ii)
replacement or refurbishment of furniture, fixtures and equipment in the Hotels,
to the extent such costs do not exceed the allowance for such costs provided by
the Partnership under each Lease. If these expenses exceed the Company's
estimate, the additional cost could have an adverse effect on Cash Available for
Distribution to Shareholders. In addition, the Company may acquire hotels in the
future that require significant renovation. Renovation of hotels involves
certain risks, including the possibility of environmental problems, construction
cost overruns and delays, uncertainties as to market demand or deterioration in
market demand after commencement of renovation, and the emergence of
unanticipated competition from hotels. See "Business and the Properties - The
Percentage Leases" and - "The Fixed Lease."
Real Estate Investment Risks
General Risks of Investing in Real Estate
The Hotels are subject to varying degrees of risk generally incident to
the ownership of real property. The underlying value of the Hotels and the
Company's income and ability to make distributions to its shareholders are
dependent upon the ability of the Lessee to operate the Hotels in a manner
sufficient to maintain or increase revenues in excess of operating expenses to
enable the Lessee to make Rent payments. Hotel revenues may be adversely
affected by adverse changes in national economic conditions, adverse changes in
local market conditions due to changes in general or local economic conditions
and neighborhood characteristics, competition from other hotels, changes in
interest rates and in the availability, cost and terms of mortgage funds, the
impact of present or future environmental legislation and compliance with
environmental laws, the ongoing need for capital improvements (particularly in
older structures), changes in real estate tax rates and other operating
expenses, adverse changes in governmental rules and fiscal policies, civil
unrest, acts of God, including earthquakes, hurricanes and other natural
disasters (which may result in uninsured losses), acts of war, adverse changes
in zoning laws, and other factors that are beyond the control of the Company.
See "Business and Properties."
Illiquidity of Real Estate
Real estate investments are relatively illiquid. The ability of the
Company to vary its portfolio in response to changes in economic and other
conditions will be limited. No assurance can be given that the fair market value
of any of the Hotels will not decrease in the future.
Uninsured and Underinsured Losses
Each Lease requires that comprehensive insurance be maintained on each
of the Hotels, including liability and fire and extended coverage, in amounts
sufficient to permit the replacement of the Hotels in the event of a total loss,
subject to applicable deductibles. Management believes that such specified
coverage is of the type and amount customarily obtained by owners of hotels
similar to the Hotels. Leases for hotels acquired or developed by the Company in
the future may contain similar provisions. However, there are certain types of
losses, generally of a catastrophic nature, such as earthquakes, floods and
hurricanes, that may be uninsurable or not economically insurable. Inflation,
changes in building codes and ordinances, environmental considerations and other
factors also might make it infeasible to use insurance proceeds to replace a
Hotel if it is damaged or destroyed. Under such circumstances, the insurance
proceeds received by the Company might not be adequate to restore its economic
position with respect to the affected Hotel. See "Business and Properties - The
Percentage Leases" and - "The Fixed Lease."
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Property Taxes
Each Hotel is subject to real and personal property taxes. The real and
personal property taxes on hotel properties in which the Company invests may
increase or decrease as property tax rates change and as the properties are
assessed or reassessed by taxing authorities. If property taxes increase, the
Company's ability to make expected distributions to its shareholders could be
adversely affected.
Environmental Matters
Operating costs and the value of the Hotels may be affected by the
obligation to pay for the cost of complying with existing environmental laws,
ordinances and regulations, as well as the cost of future legislation. Under
various federal, state, and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of hazardous or toxic substances
on, under or in such property. Such laws often impose liability whether or not
the owner or operator knew of, or was responsible for, the presence of such
hazardous or toxic substances. Therefore, an environmental liability could have
a material adverse effect on the underlying value of the Hotels, the Company's
income and Cash Available for Distribution to Shareholders. Phase I
environmental assessments were obtained on all of the Hotels prior to their
acquisition or development by the Company. The purpose of Phase I environmental
assessments is to identify potential environmental contamination that is made
apparent from historical reviews of the Hotels, reviews of certain public
records, preliminary investigations of the sites and surrounding properties, and
screening for the presence of hazardous substances, toxic substances and
underground storage tanks. The Phase I environmental assessment reports have not
revealed any environmental contamination that the Company believes would have a
material adverse effect on the Company's business, assets, results of operations
or liquidity, nor is the Company aware of any such liability. Nevertheless, it
is possible that these reports do not reveal all environmental liabilities or
that there are material environmental liabilities of which the Company is
unaware. Because the Comfort Inn-Beacon Marina Solomons, Maryland Hotel is
located on a tributary of the Chesapeake Bay, the Company's ability to expand
any facilities at this Hotel will be limited by state and federal environmental
regulations. See "Business and Properties - Environmental Matters."
Compliance with Americans with Disabilities Act
and other Changes in Governmental Rules and Regulations
Under the Americans with Disabilities Act of 1990 (the "ADA"), all
public accommodations are required to meet certain federal requirements related
to access and use by disabled persons. While the Company believes that the
Hotels are substantially in compliance with these requirements, a determination
that the Company is not in compliance with the ADA could result in imposition of
fines or an award of damages to private litigants. In addition, changes in
governmental rules and regulations or enforcement policies affecting the use and
operation of the Hotels, including changes to building codes and fire and
life-safety codes, may occur. If the Company were required to make substantial
modifications at the Hotels to comply with the ADA or other changes in
governmental rules and regulations, the Company's ability to make expected
distributions to its shareholders could be adversely affected.
THE COMPANY
The Company is a self-administered REIT that, through the Partnership,
owns interests in twenty existing limited-service Hotels with an aggregate of
1,312 rooms and an average age of approximately nine years as of December 31,
1997. The Hotels include twelve Hotels operated as Comfort Inns, three Hotels
operated as Holiday Inn Express hotels, one Hotel operated as a Best Western,
one Hotel operated as a Best Western Suites, one Hotel operated as a Comfort
Suites, one Hotel operated as a Days Inn and one Hotel operated as a Rodeway
Inn. The Hotels are located in nine states in the eastern United States. The
Company is a corporation that was incorporated under the laws of Virginia on
August 23, 1994.
The Partnership will use the Net Proceeds to repay approximately $9.5
million of outstanding debt on the Credit Facility, which is secured by 17 of
the Hotels. Upon the application of the Net Proceeds, the Company will
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have the Remaining Indebtedness (approximately $21.5 million) outstanding, all
of which debt shall be secured by one or more of the Hotels.
In order to qualify as a REIT, the Company cannot operate hotels.
Therefore, the Hotels are leased to and operated by the Lessee. The Percentage
Leases, which relate to each Hotel with the exception of the Comfort
Suites-Dover, Delaware Hotel, are designed to allow the Company to participate
in growth in revenues of the Hotels by providing that percentages of such
revenues are paid by the Lessee as Rent. The Comfort Suites-Dover, Delaware
Hotel is leased pursuant to a Fixed Lease. Mr. Humphrey is the sole shareholder
of the Lessee.
The Company's executive offices are located at 12301 Old Columbia Pike,
Silver Spring, Maryland 20904 and its telephone number is (301) 680-4343.
GROWTH STRATEGY
The Company seeks to enhance shareholder value by increasing Cash
Available for Distribution to Shareholders by acquiring additional operating
hotels and developing hotels that meet the Company's investment criteria and by
participating in increased revenues from the Hotels through the Percentage Rents
provided under the Percentage Leases. Therefore, the Company has developed a
growth strategy that management of the Company believes will capitalize on
attractive acquisition and development opportunities.
Acquisition Strategy
The Company intends to acquire equity interests in additional operating
hotels that meet its investment criteria as described below. The Company will
place particular emphasis on limited service hotels with strong, national
franchise affiliations in the upper economy and mid-scale market segments, or
hotels with potential to obtain such franchises. In particular, the Company will
consider acquiring limited service hotels such as Best Western, Best Western
Suites, Comfort Inn, Comfort Suites, Days Inn, Hampton Inn, Fairfield Inn,
Holiday Inn Express and Rodeway Inn hotels, limited service extended-stay hotels
such as Hampton Inn and Suites, Homewood Suites and Residence Inn hotels and
full service hotels such as Holiday Inns. Under the Company's Bylaws, any
transaction to acquire any additional properties must be approved by a majority
of the Directors, including a majority of the Independent Directors.
The Company believes that there are existing hotels that meet its
investment criteria because of the adverse impact of high leverage on the
profitability and operations of many hotels, and the over-building of hotels
from 1980 through 1991. The Company also believes that the management,
development and construction experience of Mr. Humphrey will enable the Company
to identify underperforming hotels that would benefit substantially from
renovation, implementation of quality management and, in some instances, a new
Franchise License. The Company has an option to acquire any hotel acquired or
developed by Mr. Humphrey or his Affiliates within 12 months after the
acquisition or opening of such hotel. See "Policies and Objectives with Respect
to Certain Activities - Conflict of Interest Policies - The Non-Competition
Agreement and Option Agreement."
Investment Criteria and Financing
The Company considers investments in operating hotels, primarily
limited service hotels, that meet one or more of the following criteria:
o nationally franchised hotels in locations with relatively high
demand for rooms, relatively low supply of competing hotels and
significant barriers to entry into the hotel business, such as a
scarcity of suitable hotel sites or zoning restrictions;
o poorly managed hotels, which could benefit from new management,
new marketing strategy and/or association with a national
franchisor;
o hotels in a deteriorated physical condition, which could benefit
significantly from renovations; and
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o hotels in attractive locations that the Company believes could
benefit significantly by changing franchises to a brand the
Company believes is superior.
Under the Investment Policy, the Company will only acquire those hotels
for which it reasonably believes that it will receive annual Rent (net of
insurance paid by the Company, real estate and personal property taxes and the
FFE Reserves of 4% of room revenues) in an amount greater than or equal to 12%
of the total purchase price to be paid by the Company for such hotels. Under the
Bylaws, the approval of a majority of the Board of Directors, including a
majority of the Independent Directors, is required for the Company to acquire
any property. Such hotel investments may be financed, in whole or in part, with
undistributed cash, subsequent issuances of shares of Common Stock or other
securities or borrowings. The Company's Debt Policy limits its consolidated
indebtedness to less than 55% of the aggregate purchase price of the hotels in
which it has invested. The aggregate purchase price paid by the Company for the
Hotels is approximately $58.4 million. After the Company has applied the Net
Proceeds (approximately $9.5 million) as set forth herein, the Company's total
outstanding indebtedness will represent approximately 36.8% of the aggregate
amount paid by the Company for the Hotels. To the extent that the Company's Debt
Policy or covenants it has made to lenders limit its ability to incur additional
indebtedness, the success of the Company's acquisition strategy will likely
depend on its ability to access additional capital through issuances of equity
securities. See "Risk Factors - Risks of Leverage" and "-- Growth Strategy,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources," "Policies and Objectives with
Respect to Certain Activities - Investment Policies" and "- Financing."
Development Strategy
The Company intends to grow through the development of new hotels as
well as from the acquisition of existing hotels. The Company intends to develop
limited-service hotels in secondary and tertiary markets, typically with under
150 rooms, that are similar to the Company's present hotels. The Company is
interested in sites that offer the potential to attract a diverse mix of
potential market segments.
The Company's development site selection criteria is expected to
include some or all of the following characteristics:
o Relatively low land costs, particularly as compared with major
metropolitan areas.
o Sites that exist on or near major highways.
o Areas that have strong industrial bases with the potential for
future growth.
o Communities with state or federal installations, colleges or
universities.
o Areas that currently have an aging hotel presence.
These criteria describe the basic characteristics that the Company
looks for prior to committing to the development of a new hotel. Sites that are
selected may have some or all of the market characteristics as described above,
as well as characteristics that are not specifically described herein. It is not
anticipated that all sites selected by the Company will possess all of the
characteristics described herein.
Because a development project has no prior revenues on which the
Company's Investment Policy can be tested, the Company intends to invest only in
developments where it reasonably believes it will receive Rent payments that are
consistent with the Investment Policy.
Internal Growth Strategy
The Percentage Leases are designed to allow the Company to participate
in growth in room revenues at the Hotels because it mitigates the risks
associated with the initial startup of a hotel such as low occupancy rates or
low room rates. The Company intends to use Percentage Leases substantially
similar to those applicable to the Hotels with respect to any additional
existing hotels it may acquire because the Company believes that there are
25
<PAGE>
fewer startup risks associated with acquiring an existing operating hotel than
with hotel developments. Under each Percentage Lease, the Partnership receives
Percentage Rents. The Percentage Rent for each Hotel is comprised of (i) a set
percentage of quarterly and semi-annual room revenues, which is payable
quarterly and semi-annually, respectively, (ii) a set percentage of annual room
revenues in excess of the Threshold, which is payable annually, and (iii) 8% of
monthly revenues other than room revenues (including, but not limited to,
telephone charges, movie rental fees and rental payments under any third party
leases), which is payable monthly. The portion of Percentage Rent that is based
on annual room revenues does not apply to amounts under the Threshold and is
designed to allow the Company to participate in any future increases in room
revenues. See "Business and Properties - The Hotels" and "- The Percentage
Leases - Amounts Payable Under the Percentage Leases."
26
<PAGE>
USE OF PROCEEDS
The Net Proceeds (after deducting underwriting discounts and offering
expenses of approximately $210,000) will be approximately $9.5 million based on
the Offering Price ($11 million if the over-allotment option is fully
exercised). The Company will contribute all of the Net Proceeds to the
Partnership and after such contribution will own an 87.21% interest in the
Partnership (87.57% if the over-allotment option is fully exercised). The
Partnership will use the Net Proceeds of the Offering to repay certain amounts
under the Credit Facility, which amounts have been borrowed over the past year
principally to purchase certain of the Hotels. See "Prospectus Summary--Recent
Developments--Acquisitions."
The following describes the amounts under the Credit Facility to be
repaid with the Net Proceeds:
<TABLE>
<CAPTION>
Amount Interest Rate Maturity Date
------ ------------- -------------
<S><C>
Amounts Payable to Mercantile
under the Credit Facility............... $9,500,000 8.75%(1) April 10, 1999
</TABLE>
- ----------------------
(1) The interest rate is equal to the prime rate as published in the "Money
Rates" section of The Wall Street Journal (8.5% as of March 20, 1998) plus
.25%.
After the application of the Net Proceeds, the Company's total
outstanding indebtedness will represent approximately 36.8% of the aggregate
purchase price of the Hotels, thereby giving the Company additional borrowing
capacity pursuant to the Debt Policy of up to approximately $10.6 million, which
will be available for future acquisitions or development.
To the extent that the Underwriter's over-allotment option to purchase
up to 150,000 Common Shares is exercised in full, the Company expects to use the
additional net proceeds to repay $1.5 million under the Credit Facility.
27
<PAGE>
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS
The Common Stock currently trades on The Nasdaq National Market under
the symbol "HUMP." The following table sets forth for the indicated periods the
high and low bid prices, and the cash distributions declared, per share for the
Common Stock. Prior to October 30, 1996, the Common Stock traded through the
facilities of The Nasdaq SmallCap Market. Beginning October 30, 1996, the Common
Stock began trading on The Nasdaq National Market.
<TABLE>
<CAPTION>
Price Range
---------------- Cash Distributions
High Low Declared Per Share
---- --- ------------------
<S><C>
1995
First Quarter................................. $7.75 $6.25 $.15
Second Quarter................................ $7.75 $7.50 $.15
Third Quarter ................................ $8.75 $7.50 $.181(1)
Fourth Quarter................................ $8.375 $7.75 $.19
1996
First Quarter................................. $9.125 $8.00 $.19
Second Quarter................................ $9.375 $8.4375 $.19
Third Quarter................................. $9.25 $8.25 $.19
Fourth Quarter ............................... $8.25 $8.25 $.19
1997
First Quarter................................. $10.50 $8.00 $.19
Second Quarter................................ $11.125 $8.75 $.19
Third Quarter................................. $11.875 $10.50 $.19(2)
Fourth Quarter................................ $13.00 $10.4375 $.2025(2)
1998
First Quarter (through March 20, 1998)........ $12.375 $11.00 $.135(3)
</TABLE>
- ------------------
(1) Pro rata distribution for the period July 21, 1995, the closing of the
Company's second public offering of Common Stock, through September 30,
1995 based on a quarterly distribution of $.19 per share.
(2) Although presented on a quarterly basis, the Company began making monthly
distributions to its Common Shareholders commencing with the Company's
distribution declared in October 1997.
(3) Based on monthly distributions for January and February of .0675 per share
per month and not including any portion of any potential March
distribution.
On April 17, 1998, the last reported bid price of the Common Stock on
The Nasdaq National Market was $10.00 per share, the Company had approximately
110 shareholders of record, and there were approximately 1,097 beneficial owners
of the Common Stock.
Although the declaration of distributions is within the discretion of
the Board of Directors and depends on the Company's results of operations, Cash
Available for Distribution to Shareholders, the financial condition of the
Company, tax considerations (including those related to REITs) and other factors
considered important by the Board of Directors, the Company's policy is to make
regular monthly distributions to its shareholders. The Company's ability to make
distributions will depend on the receipt of distributions from the Partnership.
The Company has caused and intends to cause the Partnership to distribute to its
partners substantially all of its Cash Available for Distribution to
Shareholders. The Company's distributions to holders of Common Stock represented
approximately 84.43% of the Company's Cash Available for Distribution to
Shareholders in the fiscal year ended December 31, 1997. The Partnership's
primary source of revenue is Rent payments from the Lessee under the Leases for
the Hotels. The Company must rely on the operation of the Hotels to generate
sufficient cash flow from the operation
28
<PAGE>
of the Hotels to permit the Lessee to meet its Rent obligations under the
Leases. The Lessee has nominal assets and its obligations under the Leases are
unsecured. See "The Lessee."
Under the federal income tax provisions affecting REITs, the Company
must distribute at least 95% of its annual taxable income in order to avoid
taxation as a regular corporation. Moreover, the Company must distribute at
least 85% of its ordinary income and 95% of its capital gain net income (plus
any undistributed income from the prior year) to avoid certain excise taxes
applicable to REITs. Under certain circumstances, the Company may be required to
make distributions in excess of Cash Available for Distribution to Shareholders
in order to meet such distribution requirements. In such event, the Company
would seek to borrow the amount of the deficiency or sell assets to obtain the
cash necessary to make distributions to retain its qualification as a REIT. The
Company expects that a portion of its future distributions to Common
Shareholders may constitute a return of capital. A return of capital generally
is not subject to federal income tax under current law. There can be no
assurance that the portion of the distributions estimated to be a return of
capital based on pro forma results is indicative of the actual return of capital
for any future period.
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1997, as adjusted to give effect to the Offering and the use of the
Net Proceeds as described under "Use of Proceeds."
<TABLE>
<CAPTION>
December 31, 1997
-----------------------
Actual As Adjusted
------ -----------
(In thousands)
<S><C>
Short-term debt............................................... $ 822 $ 822
Long-term debt................................................ 31,755 22,267
Minority interest............................................. 3,370 3,928
Shareholders' Equity:
Preferred Stock, $.01 par value,
10,000,000 shares authorized,
no shares issued and outstanding .......................... - -
Common Stock, $.01 par value,
25,000,000 shares authorized, 3,481,700 shares
issued and outstanding(1) and 4,481,700, as adjusted(1).... 35 45
Additional paid-in capital................................... 18,042 26,962
Distributions in excess of net earnings...................... (225) (225)
------- -------
Total shareholders' equity.................................... 17,852 26,782
------- -------
Total capitalization.......................................... $53,799 $53,799
======= =======
</TABLE>
- ---------------------
(1) Excludes 657,373 shares of Common Stock issuable upon redemption of Units.
29
<PAGE>
DILUTION
The Offering Price per share to the public of the Common Shares offered
hereby exceeds the pro forma net tangible book value per share of Common Stock
or Unit after the Offering. Therefore, the holders of Units will realize an
immediate increase in the net tangible book value of their Units of $.85, while
purchasers of Common Shares in the Offering will realize an immediate and
substantial dilution of $4.52 or 43.1% of the Offering Price in the net tangible
book value of their shares. Pro forma net tangible book value per share is
determined by subtracting total liabilities from total tangible assets and
dividing the remainder by the number of shares of Common Stock and Units that
will be outstanding after the Offering. The following table illustrates the
dilution to purchasers of Common Shares in the Offering, based on the assumed
Offering Price.
<TABLE>
<S><C>
Offering Price per Common Share(1)....................................................... $10.50
Pro forma net tangible book value per Unit
(which may be redeemed for Common Stock on
a one-for-one basis in certain circumstances)
as of December 31, 1997, prior to the Offering,
applicable to the minority interest in the
Partnership(2)....................................................... $ 5.13
Reduction in minority interest prior to the
Offering(3).......................................................... (1.00)
Increase in net tangible book value per share
attributable to payments by purchasers of
shares in the Offering(4)............................................ 1.85
Pro forma net tangible book value per share or Unit
after the Offering..................................................................... $ 5.98
------
Dilution per share to purchasers of Common Shares........................................ $ 4.52
======
</TABLE>
- ---------------------
(1) Before deducting underwriting discounts and estimated expenses of
the Offering.
(2) Represents the minority interest at December 31, 1997, before the
Offering, divided by the Units outstanding (657,373 Units).
(3) Represents the percentage reduction in minority Unit holders' interest
from 15.88% prior to the Offering to 12.79% after the Offering or 3.1%
times shareholders' equity at December 31, 1997 ($17.9 million), plus
minority interest ($3.4 million) divided by the Units outstanding (657,373
Units).
(4) Net proceeds of the Offering (approximately $9.5 million) divided by
5,139,073 shares of Common Stock and Units.
30
<PAGE>
SELECTED FINANCIAL INFORMATION
The following tables set forth (i) audited historical revenue and
expenses and financial data for the Company and the Lessee for the period from
November 29, 1994 (date of IPO) through December 31, 1994 and for each of the
years in the three year period ended December 31, 1997, (ii) audited selected
historical balance sheet data for the Company as of December 31, 1996 and 1997,
and (iii) selected combined historical operating and financial data for the
Combined Selling Partnerships-Initial Hotels (the "Initial Hotels") purchased by
the Company in connection with the Company's IPO for the year ended December 31,
1993 and the eleven month period ended November 29, 1994, and pro forma
operating and financial data for the year ended December 31, 1994. The selected
historical balance sheet data of the Company as of December 31, 1996 and 1997,
the selected historical operating and financial data of the Company and the
Lessee for the period from November 29, 1994 through December 31, 1994 and for
each of the years in the three year period ended December 31, 1997, and the
selected combined historical operating and financial data for the Initial Hotels
for the year ended December 31, 1993 and the period from January 1, 1994 through
November 29, 1994 have been derived from the historical financial statements of
the Company, the Lessee and the Initial Hotels audited by Reznick Fedder &
Silverman, independent public accountants.
The following selected financial information should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements and notes thereto
included elsewhere in this Prospectus.
31
<PAGE>
HUMPHREY HOSPITALITY TRUST, INC. (THE COMPANY)
Selected Historical
Revenue and Expenses and Financial Data
(in thousands, except per share data)
<TABLE>
<CAPTION>
Period from
November 29, 1994
(Date of IPO) Year Year Year
through Ended Ended Ended
December 31, December 31, December 31, December 31,
1994 1995 1996 1997
(Audited) (Audited) (Audited) (Audited)
--------- --------- --------- ---------
<S><C>
Operating Data:
Revenue:
Lease revenue .............................. $273 $ 3,750 $ 3,958 $ 7,326
Other income................................ - 21 47 106
---- ------- ------- --------
Total revenue............................... 273 3,771 4,005 7,432
---- ------- ------- --------
Expenses:
Depreciation and amortization............... 42 680 736 1,633
Interest expense............................ 97 1,011 493 1,764
Real estate and personal
property taxes and insurance.............. 18 196 252 476
General and administrative.................. 15 238 411 537
---- ------- ------- --------
Total expenses............................ 172 2,125 1,892 4,410
---- ------- ------- --------
Income before
minority interest......................... 101 1,646 2,113 3,022
Minority interest........................... 29 396 435 465
---- ------- ------- --------
Net income applicable
to Common Shareholders.................... $ 72 $ 1,250 $ 1,678 $ 2,557
==== ======= ======= ========
Basic earnings per common share (1)......... $.05 $.72 $.70 $.73
Diluted earnings per common share (1)....... $.05 $.70 $.70 $.73
Other Data:
Weighted average shares:
Basic..................................... 1,321,800 1,742,533 2,410,252 3,481,700
Diluted................................... 1,849,666 2,365,883 3,033,602 4,139,073
Funds from operations (2)................... $ 139 $ 2,132 $ 2,723 $ 4,548
Net cash provided by operating
activities................................ $ 170 $ 1,334 $ 2,751 $ 3,680
Net cash used in
investing activities...................... $(4,840) $ (619) $(1,967) $(29,406)
Net cash provided by (used in)
financing activities...................... $ 5,223 $(1,100) $ 6,148 $ 18,829
</TABLE>
32
<PAGE>
HUMPHREY HOSPITALITY TRUST, INC.
Selected Historical Balance Sheet Data
(in thousands)
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1997
----------------- -----------------
(Audited) (Audited)
--------- ---------
<S><C>
Balance Sheet Data:
Net investment in hotel properties........................... $21,405 $50,476
Minority interest in Partnership............................. 3,247 3,370
Shareholders' equity......................................... 18,145 17,852
Total assets................................................. 30,221 53,799
Total debt................................................... 8,185 31,755
</TABLE>
HUMPHREY HOSPITALITY MANAGEMENT, INC.
Selected Historical Revenue and Expenses
(in thousands)
<TABLE>
<CAPTION>
Period from
November 29, 1994 Year Year Year
(Date of IPO) Ended Ended Ended
through December 31, December 31, December 31, December 31,
1994 1995 1996 1997
(Audited) (Audited) (Audited) (Audited)
--------- --------- --------- ---------
<S><C>
Room revenue.................................... $ 459 $ 7,499 $ 7,942 $15,581
Other revenue (3)............................... 38 556 637 871
----- ------- ------- -------
Total revenue................................. 497 8,055 8,579 16,452
Hotel operating expenses........................ 314 4,167 4,590 8,716
Percentage Lease payments....................... 273 3,750 3,958 7,326
----- ------- ------- -------
Net income (loss)............................... $ (90) $ 138 $ 31 $ 410
===== ======= ======= =======
</TABLE>
33
<PAGE>
COMBINED SELLING PARTNERSHIPS - INITIAL HOTELS
Selected Combined Historical Operating and Financial Data
(In thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
Historical Pro Forma
1993 1994(4) 1994(4)
------ ------- -------
<S><C>
Statement of Operations Data:
Room revenue............................. $ 6,627 $6,583 $7,042
Other revenue ........................... 704 715 752
------- ------ ------
Total revenue............................ 7,331 7,298 7,794
Hotel operating expenses ................ 4,603 4,513 4,827
------- ------ ------
Operating income before interest,
depreciation, and amortization........... 2,728 2,785 2,967
Interest................................. 1,272 1,062 1,159
Depreciation and amortization............ 776 690 732
------- ------ ------
Net income............................... $ 680 $1,033 $1,076
======= ====== ======
Other Data
Net cash provided by
operating activities................. $ 1,503 $1,698 $1,896
Net cash used in
investing activities................. $ (40) $ (373) $ (373)
Net cash used in
financing activities................. $(1,275) $ (985) $ (985)
</TABLE>
- -----------------------
(1) Represents basic and diluted earnings per share computed in accordance
with FAS No. 128, adopted by the Company during 1997. Basic earnings per
share is computed as net income available to common shareholders divided
by the weighted average common shares outstanding and diluted earnings per
share is computed as income before minority interest divided by the
weighted average common shares outstanding plus the assumed conversion of
the Units held by minority interests. See Note 6, Earnings Per Share of
the consolidated financial statements of Humphrey Hospitality Trust, Inc.
at page F-19 for a reconciliation of the income (numerator) and weighted
average shares (denominator) used in the calculation of basic and diluted
earnings per share. The adoption of FAS No. 128 did not have a material
effect on prior years.
(2) Management considers FFO to be a market accepted measure of an equity
REIT's cash flow, which management believes reflects on the value of real
estate companies such as the Company, in connection with the evaluation of
other measures of operating performances. All REITs do not calculate FFO
in the same manner, therefore, the Company's calculation may not be the
same as the calculation of FFO for similar REITs. Beginning with the year
ended December 31, 1997, the Company changed the way it computes FFO. The
Company believes that its new method of computing FFO is more consistent
with the guidelines established by NAREIT for calculating FFO. FFO, as
defined under the NAREIT standard, consists of net income, computed in
accordance with generally accepted accounting principles, excluding gains
or losses from debt restructuring and sales of properties, plus
depreciation and amortization and after adjustments for unconsolidated
partnerships and joint ventures.
34
<PAGE>
The following table computes FFO under both the new method and the method
formerly utilized by the Company (in thousands):
<TABLE>
<CAPTION>
Period from
November 29, 1994
(Date of IPO) Year Year Year
through Ended Ended Ended
December 31, December 31, December 31, December 31,
1994 1995 1996 1997
(Audited) (Audited) (Audited) (Audited)
--------- --------- --------- ---------
<S><C>
Net income before minority interests......... $101 $1,646 $2,113 $3,022
Depreciation................................. 38 486 610 1,502
Amortization of initial franchise costs...... - - - 24
---- ------ ------ ------
Funds From Operations (new method)........... 139 2,132 2,723 4,548
Amortization of loan costs................... 4 194 126 107
Funds From Operations (former method)........ $143 $2,326 $2,849 $4,655
</TABLE>
Industry analysts generally consider FFO to be an appropriate measure of
the performance of an equity REIT. FFO should not be considered as an
alternative to net income or other measures under GAAP as an indicator of
operating performance or to cash flows from operating, investing or
financing activities as a measure of liquidity. FFO does not reflect
working capital changes, cash expenditures for capital improvements or
debt service with respect to the Hotels.
(3) Represents marina revenue (for the Comfort Inn-Beacon Marina, Solomons,
Maryland and the Best Western Suites-Key Largo, Florida Hotels only),
telephone revenue, restaurant revenue and other revenue.
(4) The historical 1994 operating data of the Combined Selling Partnerships -
Initial Hotels is for the period January 1, 1994 through November 29,
1994. The pro forma 1994 operating data for the Combined Selling
Partnerships - Initial Hotels represents the historical operating data of
the Initial Hotels for the period January 1, 1994 through November 29,
1994 and the Lessee for the period November 29, 1994 through December 31,
1994.
35
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview
The Company currently owns, through the General Partner, an 84.12%
interest in the Partnership. After the Closing, the Company will own, through
the General Partner, an 87.21% partnership interest in the Partnership. In order
for the Company to qualify as a REIT, neither the Company nor the Partnership
may operate hotels. Therefore, the Partnership leases the Hotels to the Lessee.
The Company's principal source of revenue is derived from payments by the Lessee
under the Leases. The principal determinants of Percentage Rent are the Hotels'
room revenue, and to a lesser extent, other revenue. The Lessee's ability to
make payments to the Partnership under the Leases is dependent on the operations
of the Hotels.
Results of Operations
The following is a discussion of the results of operations for the Company, the
Lessee and the Hotels.
Comparison of year ended December 31, 1997 to year ended December 31, 1996
The Company
The Company's total revenues for the twelve month period ended December
31, 1997 consisted substantially of Percentage Lease revenue recognized pursuant
to the Percentage Leases, as well as Fixed Lease revenue related to the Comfort
Suites-Dover, Delaware Hotel. The Company's revenue was approximately
$7,432,000, an increase of 85.6% compared to revenue of $4,005,000 for the year
ended December 31, 1996. Net income for the period was approximately $2,557,000,
an increase of 52.4% compared to 1996 net income of approximately $1,678,000.
The increase in both revenue and net income is attributable to the acquisition
of ten hotels and the completion of the Comfort Suites-Dover, Delaware Hotel.
Interest expense increased as a result of increased borrowings under the Credit
Facility. These funds were utilized to acquire and develop the above noted
Hotels in 1997. General and administrative expenses increased as the result of
fees incurred from auditing the financial performance of the Hotels acquired and
from the land leases associated with the purchase of the Comfort Inn-Gettysburg,
Pennsylvania and the Best Western-Harlan, Kentucky Hotels.
The Lessee
The Lessee's revenues increased by $7,874,000, or 92%, to $16,452,000
for the year ended December 31, 1997, as compared to $8,579,000 of revenue for
the year ended 1996. The Lessee's net income for the year ended December 31,
1997 increased approximately $379,000 to $410,000 compared to net income of
approximately $31,000 for the year ended December 31, 1996. Average occupancy
for the Hotels remained at 70% for the year ended December 31, 1997, unchanged
from the year ended December 31, 1996. The average daily rate at the Hotels
increased to $56.21 for the year ended December 31, 1997 or 12% compared to
$50.27 for the same period in 1996. The increases in revenue and net income are
the result of the addition of eleven new Hotels to the portfolio in 1997. The
increase in average daily rate resulted from the addition of the Comfort
Suites-Dover, Delaware Hotel and the Best Western Suites-Key Largo, Florida
Hotel during 1997. These Hotels generated a greater average daily rate than the
remainder of the Hotels.
Comparison of year ended December 31, 1996 to year ended December 31, 1995
The Company
The Company's total revenues for the twelve month period ended December
31, 1996 substantially consisted of Percentage Lease revenue recognized pursuant
to the Percentage Leases. The Company's revenue was approximately $4,005,000, up
6.2% as compared to revenue of $3,771,000 for the period ended December 31,
1995. Net income for the period was approximately $1,678,000, improving 34.2% as
compared to net income of $1,250,000 for the period ended December 31, 1995. The
improvement in revenue is attributed to the addition of
36
<PAGE>
the Days Inn-Farmville, Virginia Hotel, which substantially strengthened the
Company's market position for the Hotels located in Farmville, Virginia. The
improvement in net income is attributed to the additional revenue from the Days
Inn-Farmville, Virginia Hotel and the refinancing and/or retirement of Company
debt on the Hotels located in Solomons, Maryland; Dahlgren, Virginia;
Elizabethton, Tennessee; Princeton, West Virginia and Farmville, Virginia in
connection with the acquisition of the Credit Facility.
The Lessee
The Lessee's net income for the period ended December 31, 1996 was
approximately $31,000. The Lessee's revenues increased by approximately
$524,000, or 6.5%, to $8,579,000 for the twelve months ended December 31, 1996,
as compared to $8,055,000 of revenue for the same period of 1995. Occupancy for
the Hotels decreased from 71.6% for the year ended 1995, to 70% for the year
ended 1996. The decrease in occupancy is attributed to decreased business
activity near the Hotels located in Dublin, Virginia and Elizabethton, Tennessee
and to record snowfall in the first quarter of 1996. In 1995, the Company's
Hotels in Dublin, Virginia and Elizabethton, Tennessee received business from
nearby industrial construction projects. The construction projects were
substantially completed during 1995. The Days Inn-Farmville, Virginia Hotel has
an annual occupancy below the average for the Company; accordingly, its
inclusion for 1996's occupancy lowers the average occupancy for all the Hotels.
The average daily rate at the Hotels increased to $50.27 for the year ended
December 31, 1996, or 3.6%, as compared to $48.53 for the same period of 1995.
Revenue per available room ("REVPAR") increased to $35.17 for 1996, from $34.74
for the same period in 1995. Lessee operating expenses increased by
approximately $424,000, or 10.2%, for the twelve months ended December 31, 1996
as compared to operating expenses for the same period in 1995. Operating
expenses increased in 1996 due to the consolidation of the Lessee and the
Operator, and the addition of management personnel, which were hired to
accommodate anticipated additional hotel acquisitions.
Liquidity and Capital Resources
The Company's principal source of cash to meet its cash requirements,
including distributions to shareholders, is its share of the Partnership's cash
flow. The Partnership's principal source of revenue is Rent payments received
from the Lessee. The Lessee's obligations under the Leases are unsecured. The
Lessee's ability to make Rent payments, and the Company's liquidity, including
its ability to make distributions to Common Shareholders, is dependent on the
Lessee's ability to generate sufficient cash flow from the operation of the
Hotels.
The hotel business is seasonal, with hotel revenue generally greater in
the second and third quarters than in the first and fourth quarters, with the
exception of the Best Western Suites-Key Largo, Florida. The Best Western
Suites-Key Largo Hotel is busiest in the first and fourth quarters of the year.
To the extent that cash flow from operating activities is insufficient to
provide all of the estimated monthly distributions (particularly in the first
quarter), the Company anticipates that it will be able to fund any such deficit
from future working capital. As of December 31, 1997, the Company's cash and
current accounts receivable balances exceed the current obligations by $1,239.
The Company's FFO was $4,548,000 in the year ended December 31, 1997,
which is an increase of $1,825,000, or 67%, over FFO in the comparable period in
1996, which was $2,723,000. Most of the improvements in FFO can be attributed to
the completion and opening of the Comfort Suites-Dover, Delaware Hotel and the
acquisition of ten Hotels between February 1997 and September 1997. The Company
considers FFO to be a market-accepted measure of an equity REIT's cash flow,
which the Company believes reflects on the value of real estate companies such
as the Company in connection with the evaluation of other measures of operating
performances. Beginning with the year ended December 31, 1997, the Company
changed the way it computes FFO. The Company believes that its new method of
computing FFO is more consistent with the guidelines established by the National
Association of Real Estate Investment Trusts ("NAREIT") for calculating FFO.
FFO, as defined under the NAREIT standard, consists of net income, computed in
accordance with GAAP, excluding gains or losses from debt restructuring and
sales of properties, plus depreciation and amortization of real estate assets
and after adjustments for unconsolidated partnerships and joint ventures. For
the periods presented, depreciation and amortization and minority interest were
the only non-cash adjustments. FFO should not be considered as an alternative to
net income or other measurements under GAAP as an indicator of operating
performance or to cash
37
<PAGE>
flows from operating, investing or financing activities as a measure of
liquidity. FFO does not reflect working capital changes, cash expenditures for
capital improvements or debt service with respect to the hotel properties. FFO
may not be comparable to similarly titled measures of operating performance
disclosed by other REITs.
The computation of historical FFO is as follows (in thousands):
<TABLE>
<CAPTION>
Historical Twelve Historical Twelve
Month Period Ended Month Period Ended
December 31, 1996 December 31, 1997
----------------- -----------------
<S><C>
Net income before minority interests..................... $ 2,113 $ 3,022
Depreciation............................................. 610 1,502
Amortization of initial franchise costs.................. - 24
---------- ----------
Funds From Operations (new method)....................... 2,723 4,548
Amortization of loan costs............................... 126 107
---------- ----------
Funds From Operations (former method).................... $ 2,849 $ 4,655
========== ==========
</TABLE>
The aggregate annual principal payments and payments to bond sinking
funds for the three years following December 31, 1997 are approximately as
follows:
1998 $ 195,000
1999 $25,661,000
2000 $ 225,000
Long-term debt as of December 31, 1997 of approximately $31.7 million consisted
of:
Approximately $25.5 million from the Credit Facility, which is secured
by and cross-collateralized and cross-defaulted on the Hotels located
in Solomons, Maryland; Farmville, Virginia (2 Hotels); Elizabethton,
Tennessee; Dahlgren, Virginia; Princeton, West Virginia; Dover,
Delaware; Culpeper, Virginia; New Castle, Pennsylvania; Harlan,
Kentucky; Danville, Kentucky; Murphy, North Carolina; Chambersburg,
Pennsylvania; Allentown, Pennsylvania; Gettysburg, Pennsylvania (2
Hotels) and Key Largo, Florida. The interest rate on the Credit
Facility is variable at 25 basis points above the prime rate, presently
at a rate of 8.75% per annum.
Approximately $3.9 million, secured by first deeds of trust on the
Hotels located in Wytheville, Virginia, and Morgantown, West Virginia.
Interest accrues at the rate necessary to remarket bonds at a price
equal to 100% of the outstanding principal balance. The interest rate
is approximately half of the prime rate, which is adjusted weekly and
is not to exceed 15% and 11.3636% for Wytheville and Morgantown,
respectively. At December 31, 1997, the interest rate was approximately
4.15% for both. In addition, letter of credit fees, trustee fees and
financing fees increased the effective rate on the bonds.
Approximately $2.3 million, secured by a first deed of trust on the
Comfort Inn-Dublin, Virginia. The outstanding balance bears interest at
a rate equal to 7.75% per annum with additional underwriters' fees
increasing the interest rate to 8%. The loan matures in November 2005.
Upon completion of the Offering and the application of the Net
Proceeds, the Company will have Remaining Indebtedness in the aggregate
principal amount of approximately $21.5 million outstanding. All of the
Remaining Indebtedness is secured by one or more Hotels.
Effective April 3, 1997, the Company's Board of Directors adopted a
resolution increasing the Company's limit on consolidated indebtedness from 50%
to 55% of the aggregate purchase price of the Hotels in which it has invested.
The aggregate purchase price paid by the Company for the Hotels as of December
31, 1997 is approximately $58.4 million. As of December 31, 1997, the Company's
total outstanding indebtedness represents approximately 54.8% of the aggregate
amount paid by the Company for the Hotels.
38
<PAGE>
The Board of Directors has adopted the Investment Policy, which governs
all of the Company's investments in hotel properties, including the acquisition
of existing hotels and the development of hotels until such time as the Board
amends such policy. Under the Investment Policy, the Company will only acquire
an operating hotel for which it expects to receive, based on prior operating
history, annual rental income in an amount greater than or equal to 12% of the
total purchase price paid by the Company for such hotel, net of (i) insurance
premiums paid by the Company, (ii) the FFE Reserves of 4% of room revenue and
(iii) real estate and personal property taxes. Under the Bylaws, the approval of
a majority of the Board of Directors, including a majority of the Independent
Directors, is required for the Company to acquire any property. In addition, the
Investment Policy will be applied to a hotel property prior to its acquisition
or development by the Company, and therefore, there can be no assurances that
increases in insurance rates, real estate or personal property tax rates or FFE
Reserves, which are based on room revenues, will not decrease the Company's
annual return on its investments in any hotel property to a level below that set
out in the Investment Policy. Because a development project has no prior
revenues on which the Company's Investment Policy can be tested, the Company
intends to invest only in developments where it reasonably believes it will
receive an annual return on its investment that is consistent with the
Investment Policy.
Pursuant to the Leases, the Partnership is required to make available
to the Lessee 4% of room revenue per quarter, on a cumulative basis, for capital
improvements and periodic replacement or refurbishment of furniture, fixtures
and equipment at each of the Hotels. Although the Company believes that 4% of
room revenue is generally an appropriate capital reserve to maintain the
condition and viability of its Hotels, the Company will increase its capital
reserves set-aside from 4% to 6% of room revenue upon completion of the
Offering. The additional 2% of room revenue will be held in the Additional
Reserve Fund that will be deployed at the Hotels primarily to enhance their
competitive position. To ensure that the Company receives additional annual
income that is at least equal to 12% of the amount of funds invested by the
Company from the Additional Reserve Fund, the Company and the Lessee have agreed
to amend the Leases for the Hotels that receive capital from the Additional
Reserve Fund to provide that each such Hotel will increase its annual Base Rent
payment by 7% per annum of the capital received from the Additional Reserve
Fund. The Company expects that it will receive additional amounts under the
terms of the Percentage Leases equal to at least 5% per annum of the amount
invested from the Additional Reserve Fund through its participation in increased
room revenue resulting from such additional investments. The Company intends to
cause the Partnership to spend amounts in excess of the obligated amounts if
necessary to comply with the reasonable requirements of any Franchise License
and otherwise to the extent that the Company deems such expenditures to be in
the best interests of the Company. The Partnership is obligated to fund the cost
of certain capital improvements to the operations and any furniture, fixture and
equipment requirements in excess of the above. See "Business and Properties --
The Percentage Leases" and " -- The Fixed Lease."
The Company has elected to be taxed as a REIT under Sections 856
through 860 of the Code, commencing with its initial taxable year ended December
31, 1994, and, as such, the Company generally is not subject to federal income
tax on its net income. REITs are subject to a number of organizational and
operational requirements. See "Risk Factors - Tax Risks." For example, a REIT,
and therefore the Company, is required to distribute to its shareholders at
least 95% of its annual taxable income. The Company intends to make those
distributions from operating cash flows. The Company intends to retain as a
reserve such amounts as it considers necessary for the acquisition, expansion
and renovation of hotel properties consistent with continuing to distribute to
its shareholders amounts sufficient to maintain the Company's qualification as a
REIT.
The Company expects to meet its short-term liquidity requirements
generally through net cash provided by operations and existing cash balances.
The Company believes that its net cash provided by operations will be adequate
to fund both operating requirements and payments of dividends by the Company in
accordance with REIT requirements.
The Company expects to meet its long-term liquidity requirements, such
as scheduled debt maturities and property acquisitions, through long-term
secured and unsecured borrowings, the issuance of additional equity securities
of the Company, or, in connection with acquisitions of hotel properties, the
issuance of Units.
39
<PAGE>
Inflation
Operators of hotels in general possess the ability to adjust room rates
quickly. However, competitive pressures have limited and may, in the future,
limit the Lessee's ability to raise room rates in the face of inflation.
Seasonality of Hotel Business and the Hotels
The hotel industry is seasonal in nature. Generally, hotel revenues for
hotels operating in the geographic areas in which the Hotels operate are greater
in the second and third quarters than in the first and fourth quarters, with the
exception of the Best Western Suites-Key Largo, Florida, which is busiest in the
first and fourth quarters of the year. The Hotels' operations historically
reflect this trend. Although the hotel business is seasonal in nature, the
Company believes that it generally will be able to make its expected
distributions by using undistributed cash from the second and third quarters to
fund any shortfall in cash flow from operating activities from the Hotels in the
first and fourth quarters.
Year 2000
In response to the Year 2000 issue, the Company modified its existing
information systems in order to make them Year 2000 compliant. The Company
believes that it has made all necessary modifications to its existing systems
and does not expect that additional costs associated with Year 2000 compliance,
if any, will be material to the Company's results of operations or financial
position.
BUSINESS AND PROPERTIES
Comfort Inn and Comfort Suites Hotels and Rodeway Inn Hotels
Twelve of the Hotels operate as Comfort Inn hotels, one Hotel operates
as a Comfort Suites hotel and one Hotel operates as a Rodeway Inn hotel. Since
the inception of the Comfort Inn brand in 1981, the number of hotels licensed
under that brand has grown to approximately 1,500 inns, hotels, and suites
worldwide. Comfort Inn, Comfort Suites and Rodeway Inns are part of the
worldwide Choice Hotels System of over 3,200 Sleep Inns, Comfort Inn, Comfort
Suites, Mainstay, Quality, Clarion, Econo Lodge, Rodeway and Friendship Inns,
hotels, suites and resorts.
Best Western Hotels and Best Western Suites
One of the Hotels operates as a Best Western hotel and one of the
Hotels operates as a Best Western Suites hotel. Best Western was established in
1946 as a reservation referral system by hoteliers and has developed into the
world's largest hotel chain. As of December 31, 1997, Best Western had 3,614
properties worldwide, with hotels located in 68 countries and 2,150 member
properties located in North America.
Days Inn Hotels
One of the Hotels operates as a Days Inn hotel. Days Inn has been
operating for more than 20 years and presently has more than 150,000 rooms and
1,600 properties worldwide. Days Inn is part of HFS Incorporated's blend of
hotel brands which includes Ramada, Howard Johnson, Super 8, Park Inns, Villager
and Travelodge.
Holiday Inn Express Hotels
Three of the Hotels operate as Holiday Inn Express hotels. Since the
inception of the Holiday Inn Express brand in 1990, the number of hotels
licensed under that brand has grown to over 650 hotels worldwide. Holiday Inn
Express is part of the worldwide Holiday Inn system of over 2,500 Holiday Inns,
Holiday Inn Garden Court, Holiday Inn Crowne Plaza, Holiday Inn Express, Holiday
Inn Select, Holiday Inn Sunspree and Resort Crowne Plaza Hotels, Suites and
Resorts.
40
<PAGE>
The Hotels
Set forth below is certain information regarding the Hotels for the
twelve months ended December 31, 1997 (or such shorter period commencing on the
date of acquisition, if applicable).
<TABLE>
<CAPTION>
Year Number of Room Other Lease Average
HOTELS Opened Rooms Revenue Revenue(1) Payment Occupancy ADR REVPAR
------ ----- ------- ---------- ------- --------- --- ------
<S><C>
Comfort Inn:
Chambersburg, Pennsylvania(2) . 1993 65 $ 529,983 $ 10,470 $ 228,806 68.0% $55.24 $37.57
Culpeper, Virginia(3).......... 1986 49 643,124 15,401 254,646 83.8% 50.71 42.48
Dahlgren, Virginia............. 1989 59 879,714 27,406 388,044 82.5% 49.53 40.85
Dublin, Virginia............... 1986 100 1,418,609 39,257 689,691 73.4% 52.95 38.87
Elizabethton, Tennessee........ 1987 58 549,938 16,709 219,273 57.8% 44.94 25.98
Farmville, Virginia............ 1985 51 736,511 18,570 347,681 79.5% 49.80 39.57
Gettysburg, Pennsylvania(5).... 1990 81 995,498 15,625 424,239 74.1% 74.37 55.11
Morgantown, West Virginia...... 1986 80 1,280,380 68,673 644,049 79.6% 55.12 43.85
Murphy, North Carolina(6)...... 1989 56 585,372 13,006 219,165 73.7% 56.10 41.32
New Castle, Pennsylvania(7).... 1987 79 926,194 21,902 381,810 71.9% 56.40 40.57
Princeton, West Virginia....... 1985 51 745,468 16,872 411,982 80.0% 50.06 40.05
Beacon Marina,
Solomons, Maryland........... 1986 60 1,129,361 299,947 851,070 79.3% 65.07 51.57
Comfort Suites
Dover, Delaware(4)............. 1997 64 945,723 14,156 357,649 67.8% 64.42 43.68
Best Western and Best Western Suites:
Harlan, Kentucky(8)............ 1993 63 604,703 29,947 304,284 72.5% 51.93 37.66
Key Largo, Florida(9).......... 1987 40 302,690 14,846 147,017 71.4% 88.30 63.06
Days Inn:
Farmville, Virginia............ 1989 60 651,155 18,184 292,875 62.5% 47.55 29.73
Holiday Inn Express:
Allentown, Pennsylvania(10).... 1978 83 723,662 14,113 311,753 65.5% 65.13 42.68
Danville, Kentucky(11)......... 1994 62 713,659 31,285 295,851 80.1% 55.89 44.77
Gettysburg, Pennsylvania(5).... 1990 51 641,741 12,255 267,764 73.3% 77.01 56.43
Rodeway Inn:
Wytheville, Virginia.......... 1985 100 577,813 6,750 288,544 32.8% 48.23 15.83
----- ----------- -------- ---------- ----- ------ ------
Consolidated Total/Weighted
Average for all Hotels........ 1,312 $15,581,298 $705,374 $7,326,193
===== =========== ======== ==========
</TABLE>
- -------------------------
(1) Represents recurring marina rental revenue (for the Comfort Inn-Beacon
Marina, Solomons, Maryland and the Best Western Suites-Key Largo, Florida
Hotels only), telephone revenue, restaurant revenue and other
miscellaneous service revenue.
(2) Acquired May 29, 1997.
(3) Acquired February 26, 1997.
(4) Opened January 22, 1997.
(5) Acquired May 23, 1997.
(6) Acquired April 25, 1997.
(7) Acquired March 17, 1997.
(8) Acquired April 17, 1997.
(9) Acquired September 2, 1997.
(10) Acquired June 10, 1997.
(11) Acquired April 23, 1997.
41
<PAGE>
The following table sets forth certain information with respect to each
Hotel:
<TABLE>
<CAPTION>
Twelve Months Ended December 31,
------------------------------------------------
The Hotels 1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S><C>
Comfort Inn-Chambersburg, Pennsylvania
Occupancy N/A N/A 80.9% 75.5% 65.8%
ADR $54.28 $54.61 $54.62
REVPAR $43.92 $40.13 $35.94
Comfort Inn-Culpeper, Virginia
Occupancy 73.1% 80.3% 80.4% 80.1% 80.6%
ADR $44.01 $45.37 $46.44 $47.51 $50.24
REVPAR $32.18 $36.42 $37.34 $38.07 $40.52
Comfort Inn-Dahlgren, Virginia
Occupancy 74.4% 70.3% 76.2% 76.4% 82.5%
ADR $42.66 $43.55 $42.89 $43.23 $49.53
REVPAR $31.76 $30.70 $32.68 $33.02 $40.85
Comfort Inn-Dublin, Virginia
Occupancy 74.6% 80.7% 80.1% 72.9% 73.4%
ADR $42.80 $45.97 $49.51 $52.32 $52.95
REVPAR $31.94 $37.08 $39.65 $38.16 $38.87
Comfort Inn-Elizabethton, Tennessee
Occupancy 74.6% 68.8% 74.2% 60.4% 57.8%
ADR $39.43 $39.98 $40.17 $44.44 $44.94
REVPAR $26.82 $27.52 $29.80 $26.83 $25.98
Comfort Inn-Farmville, Virginia
Occupancy 80.7% 84.3% 75.9% 81.0% 79.5%
ADR $40.10 $41.81 $47.22 $48.43 $49.80
REVPAR $32.38 $35.24 $35.83 $39.22 $39.57
Comfort Inn-Gettysburg, Pennsylvania
Occupancy N/A N/A 72.9% 69.2% 65.0%
ADR $64.69 $66.66 $69.37
REVPAR $47.18 $46.12 $45.07
Comfort Inn-Morgantown, West Virginia
Occupancy 81.9% 81.8% 77.3% 77.7% 79.6%
ADR $46.28 $49.00 $50.78 $52.44 $55.12
REVPAR $37.88 $40.10 $39.26 $40.76 $43.85
Comfort Inn-Murphy, North Carolina
Occupancy 71.1% 71.4% 74.7% 66.6% 68.1%
ADR $45.43 $46.21 $46.22 $53.51 $53.87
REVPAR $32.29 $32.98 $34.51 $35.61 $36.70
Comfort Inn-New Castle, Pennsylvania
Occupancy N/A 64.4% 66.4% 66.8% 67.0%
ADR $47.90 $48.70 $53.09 $55.59
REVPAR $30.84 $32.32 $35.46 $37.29
Comfort Inn-Princeton, West Virginia
Occupancy 93.9% 95.8% 95.5% 88.5% 80.0%
ADR $48.08 $50.37 $53.78 $54.73 $50.06
REVPAR $45.16 $48.31 $51.35 $48.45 $40.05
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
Twelve Months Ended December 31,
-----------------------------------------------
The Hotels 1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S><C>
Comfort Inn-Beacon Marina,
Solomons, Maryland
Occupancy 72.5% 78.6% 67.1% 76.6% 79.3%
ADR $53.49 $55.37 $58.86 $58.55 $65.07
REVPAR $38.79 $43.50 $39.48 $44.16 $51.57
Comfort Suites-Dover, Delaware
Occupancy N/A N/A N/A N/A 67.8%
ADR $64.42
REVPAR $43.68
Best Western-Harlan, Kentucky
Occupancy N/A 72.0% 74.8% 70.4% 68.0%
ADR $44.45 $47.10 $48.97 $51.50
REVPAR $32.00 $35.20 $34.47 $35.00
Best Western Suites-Key Largo, Florida
Occupancy 80.8% 73.3% 79.7% 84.2% 79.9%
ADR $102.56 $93.59 $93.91 $96.68 $101.78
REVPAR $82.82 $68.55 $74.85 $81.39 $81.31
Days Inn-Farmville, Virginia
Occupancy 64.2% 60.1% 62.7% 69.1% 62.5%
ADR $38.10 $42.55 $44.27 $45.53 $47.55
REVPAR $24.48 $24.68 $27.78 $31.47 $29.73
Holiday Inn Express-Allentown, Pennsylvania
Occupancy N/A N/A 60.3% 67.0% 65.2%
ADR $59.61 $62.05 $65.59
REVPAR $35.96 $41.54 $41.43
Holiday Inn Express-Danville, Kentucky
Occupancy N/A 69.5% 72.2% 72.0% 75.3%
ADR $49.17 $49.74 $52.04 $55.23
REVPAR $34.16 $35.92 $37.47 $41.62
Holiday Inn Express-Gettysburg, Pennsylvania
Occupancy N/A N/A 72.1% 66.6% 65.1%
ADR $69.76 $72.24 $70.69
REVPAR $50.29 $48.13 $45.99
Rodeway Inn-Wytheville, Virginia
Occupancy 61.4% 48.8% 47.9% 44.7% 32.8%
ADR $38.08 $45.12 $47.23 $48.85 $48.23
REVPAR $23.39 $22.07 $22.64 $21.85 $15.83
</TABLE>
Occupancy and REVPAR for the Rodeway Inn-Wytheville, Virginia declined
from 1993 to 1994. The Company believes that the decline in occupancy and REVPAR
is a result of the loss of a year-to-year contract pursuant to which a trucking
firm reserved at least ten rooms daily at rates significantly below quoted
market rates. In 1993, the contract was awarded to another hotel that submitted
a lower bid. The Company believes that the effects of the loss of such contract
have been partially offset by increases in ADR, as shown in the table above.
There can be no assurance, however, that the increase in ADR can return REVPAR
at this Hotel to the historical levels achieved prior to the termination of the
contract. The decrease in occupancy in 1994 compared to 1993 at the Comfort
Inn-Dahlgren, Virginia was primarily due to a higher than normal occupancy in
1993 that was attributable to an increase in construction at the adjacent Naval
Surface Warfare Center during that year. The occupancy of many of the Hotels
decreased in 1996 as compared to 1995 due to the record snowfall in the first
quarter of 1996. Occupancy and REVPAR at the Comfort Inn-Morgantown, West
Virginia, declined in 1994 from 1993 due to the bankruptcy of the lessee of the
restaurant at that hotel. The Company executed a new lease for this restaurant
in early 1996. The decrease in occupancy and REVPAR at the Comfort Inn-Beacon
Marina, Solomons, Maryland, was primarily attributable to the fact that in 1995
a nearby nuclear power station dramatically curtailed
43
<PAGE>
the amount of specialized maintenance work it historically had performed in the
first quarter of each year. During 1996, the unusual weather was great enough to
negatively impact REVPAR at the Comfort Inn-Dahlgren, Virginia and the Rodeway
Inn-Wytheville, Virginia. In addition, the Comfort Inn-Dublin, Virginia and the
Comfort Inn- Elizabethton, Tennessee both experienced a slowdown in
construction-related business in 1996 which had a negative impact on occupancy
and REVPAR. The Comfort Inn-Chambersburg, Pennsylvania and the Comfort Inn-
Gettysburg, Pennsylvania Hotels experienced a drop in occupancy in each of 1996
and 1997 due to increased competition in their respective markets. The Company
took into account the new competition in these markets prior to their purchase
and adjusted its purchase price to accommodate the anticipated impact of the
competition. The Comfort Inn-Princeton, West Virginia and the Rodeway
Inn-Wytheville, Virginia Hotels both experienced new competition in 1997 with
the addition of two new hotels in each respective market. During 1996, the
Comfort Inn- Farmville, Virginia and Days Inn-Farmville Hotels' market area
experienced an unusual level of occupancy due to significant construction
activity in the area. During 1997, the construction activity abated
significantly, which resulted in a reduction in occupancy.
The Fixed Lease
Because development projects have no prior income to which the Company
can apply the Investment Policy, the Company intends to invest in developments
only where it reasonably believes it will receive rent payments from the Lessee
consistent with the Investment Policy. The lease for the Comfort Suites-Dover,
Delaware is a Fixed Lease pursuant to which the Lessee leases the Hotel for a
fixed rent payment, which is payable in equal monthly installments. So long as
the Investment Policy remains in effect, the Company intends to enter into
similar Fixed Leases on any new hotel developments because the Company believes
that this type of lease mitigates the risks associated with the initial startup
of a hotel, such as low occupancy rates or low room rates. All material terms of
the Fixed Leases, except for the payment terms, are substantially similar to the
terms of the Percentage Leases described below.
The Percentage Leases
The Percentage Leases provide for both Base Rent and Percentage Rents.
The Company intends to use similar leases with respect to additional existing
hotels it may acquire because the Company believes that there are fewer startup
risks associated with acquiring an existing operating hotel than with hotel
developments. The Board of Directors may, however, in its discretion, alter any
of these provisions with respect to any proposed Percentage Lease, depending on
the purchase price paid, economic conditions and other factors deemed relevant
at the time. The following summary is qualified in its entirety by the
Percentage Leases, which have been filed as an exhibit to the Registration
Statement of which this Prospectus is a part.
Percentage Lease Terms. Each Percentage Lease has a non-cancelable term
of ten years, which may be renewed for an additional term of five years at the
Lessee's option, subject to earlier termination upon the occurrence of defaults
thereunder and certain other events described therein (including, particularly,
the provisions described herein under "Damage to Hotels," "Condemnation of
Hotels" and "Termination of Percentage Leases on Disposition of the Hotels").
Amounts Payable Under the Percentage Leases. During the term of each
Percentage Lease, the Lessee is obligated to pay (i) the Base Rent and
Percentage Rents and (ii) certain other amounts, including interest accrued on
any late payments or charges (the "Additional Charges"). Base Rent accrues and
is required to be paid monthly. The Percentage Rent for each Hotel is comprised
of (i) a set percentage of quarterly and semi-annual room revenues, which is
payable quarterly and semi-annually, respectively, (ii) a set percentage of
annual room revenues in excess of the Threshold, which is payable annually, and
(iii) 8% of monthly revenues other than room revenues (including, but not
limited to, telephone charges, movie rental fees and rental payments under any
third-party leases), which is payable monthly. Annual Percentage Rent does not
apply to amounts under the Threshold. The portion of Percentage Rent that is
based on annual room revenues is designed to allow the Company to participate in
any future increases in room revenues. All Percentage Rents are due 30 days
after the end of the applicable calendar period.
44
<PAGE>
The following table sets forth (i) the annual Base Rent, (ii)
Percentage Rents formulas and (iii) the Rent that was paid for each Hotel
pursuant to the terms of the Percentage Leases in 1997. With respect to the
Hotels acquired in 1997, the information presented relates to the period from
the date of acquisition to December 31, 1997.
<TABLE>
<CAPTION>
Aggregate
Aggregate Percentage
Annual Percentage Hotel Percentage Rent Plus
Hotels Base Rent Rent Formula Revenues Rent Base Rent
------ --------- ------------ -------- ---- ---------
<S><C>
Comfort Inns $107,663 14.2% of quarterly room revenues Rooms - $ 529,983 $120,306 $228,806
Chambersburg, up to $960,000 per year, plus 8.5% Other - $ 10,470 837
Pennsylvania of semi-annual room revenues up to --------
$960,000 per year plus 35% of $121,143
annual room revenues in excess of --------
$960,000, plus 8% of monthly other
revenue
Culpeper, Virginia 111,926 11% of quarterly room revenue up Rooms - $ 643,124 $141,487 $254,646
to $675,000 per year, plus 11% of Other - $ 15,401 1,233
semi-annual revenues up to --------
$675,000 per year, plus 35% of $142,720
annual room revenues in excess of --------
$675,000, plus 8% of monthly other
revenues
Dahlgren, Virginia 153,096 14.0% of quarterly room revenues, Rooms - $ 879,714 $232,756 $388,044
plus 6.5% of semi-annual room Other - $ 27,406 2,192
revenues, plus 30% of annual room --------
revenues in excess of $705,000, $234,948
plus 8% of monthly other revenues --------
Dublin, Virginia 253,350 17.5% of quarterly room revenues, Rooms - $1,418,609 $433,200 $689,691
plus 10.0% of semi-annual room Other - $ 39,257 3,141
revenues, plus 30% of annual room --------
revenues in excess of $1,275,000, $436,341
plus 8% of monthly other revenues --------
Elizabethton, 96,950 14.5% of quarterly room revenues, Rooms - $ 549,938 $120,986 $219,273
Tennessee plus 7.5% of semi-annual room Other - $ 16,709 1,337
revenues, plus 30% of annual room --------
revenues in excess of $560,000, $122,323
plus 8% of monthly other revenues --------
Farmville, Virginia 132,432 16.0% of quarterly room revenues, Rooms - $ 736,511 $213,763 $347,681
plus 9.5% of semi-annual room Other - $ 18,750 1,486
revenues, plus 30% of annual room --------
revenues in excess of $650,000 plus $215,249
8% of monthly other revenues --------
Gettysburg, 184,069 14.5% of quarterly room revenues Rooms - $ 995,498 $238,920 $424,239
Pennsylvania up to $1,400,000 per year, plus Other - $ 15,625 1,250
9.5% of semi-annual room revenues --------
up to $1,400,000 per year plus 35% $240,170
of room revenues in excess of --------
$1,400,000, plus 8% of total other
revenues
Morgantown, 210,136 6.5% of quarterly room revenues, Rooms - $1,280,380 $428,420 $644,049
West Virginia plus 24.0% of semi-annual room Other - $ 68,673 5,493
revenues, plus 33% of annual room --------
revenues in excess of $1,150,000, $433,913
plus 8% of monthly other revenues --------
Murphy, 95,197 11% of quarterly room revenues up, Rooms - $ 585,372 $122,928 $219,165
North Carolina to $740,000 per year plus 10% of Other - $ 13,006 1,040
semi annual room revenues up to --------
$740,000 per year, plus 35% of annual $123,968
room revenues in excess of $740,000, --------
plus 8% of monthly other revenues
45
<PAGE>
New Castle, 171,665 7.5% of quarterly room revenues up Rooms - $ 926,164 $208,394 $381,810
Pennsylvania to $1,000,000 per year, plus 15% Other - $ 21,902 1,751
of semi-annual room revenues up to --------
$1,000,000 per year, plus 35% of $210,145
annual room revenues in excess of --------
$1,000,000 plus 8% of monthly
other revenues
Princeton, 208,610 11.1% of quarterly room revenues, Rooms - $ 745,468 $202,022 $411,982
West Virginia plus 16.0% of semi-annual room Other - $ 16,872 1,350
revenues, plus 33% of annual room --------
revenues in excess of $875,000, $203,372
plus 8% of monthly other revenues --------
Beacon Marina, 288,397 17.6% of quarterly room revenues, Rooms - $1,129,361 $538,677 $851,070
Solomons, plus 25.0% of semi-annual room Other - $ 299,947 23,996
Maryland revenues, plus 25.1% of annual --------
room revenues in excess of $562,673
$900,000, plus 8% of monthly other --------
revenues
Comfort Suites 357,649 Fixed Lease - Not Applicable Not Not $357,649
Dover, Delaware Applic- Applicable
able
Best Western 129,548 14.5% of quarterly room revenues, Rooms - $ 604,703 $172,340 $304,284
Harlan, Kentucky up to $800,000 per year, plus 14% Other - $ 29,947 2,396
of semi-annual room revenues up to --------
$800,000 per year, plus 35% of $174,736
room revenues in excess of --------
$800,000, plus 8% of monthly other
revenues
Best Western Suites 73,184 14% of quarterly room revenues up Rooms - $ 302,690 $ 72,646 $147,017
Key Largo, Florida to $1,225,000 per year, plus 10% Other - $ 14,846 1,187
of semi-annual revenues up to --------
$1,225,000 per year, plus 35% of $ 73,833
annual room revenues in excess of --------
$1,225,000, plus 8% of monthly
other revenues
Days Inn 125,376 16% of quarterly room revenues, Rooms - $ 651,155 $166,044 $292,875
Farmville, Virginia plus 9.5% of semi-annual room Other - $ 18,184 1,455
revenues plus 30.0% annual room --------
revenues in excess of $760,000, $167,499
plus 8% of other revenue --------
Holiday Inn Express
Allentown, PA 146,353 14.2% of quarterly room revenues Rooms - $ 723,662 $164,271 $311,753
up to $1,250,000 per year, plus Other - $ 14,113 1,129
8.5% of semi-annual room revenues --------
up to $1,250,000 per year, plus $165,400
35% of annual room revenues in --------
excess of $1,250,000, plus 8% of
monthly other revenues.
Danville, Kentucky 131,347 14.2% of quarterly room revenues Rooms - $ 713,659 $162,001 $295,851
up to $900,000 per year, plus 8.5% Other - $ 31,285 2,503
of semi-annual room revenues up to --------
$900,000 per year, plus 35% of $164,504
annual room revenues in excess of --------
$900,000, plus 8% of monthly other
revenues
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
Aggregate
Aggregate Percentage
Annual Percentage Hotel Percentage Rent Plus
Hotels Base Rent Rent Formula Revenues Rent Base Rent
------ --------- ------------ -------- ---- ---------
<S><C>
Gettysburg, 115,974 14.5% of quarterly room revenues Rooms - $ 641,741 $ 150,809 $ 267,764
Pennsylvania up to $940,000 per year, plus 9% Other - $ 12,255 981
of semi-annual room revenues up to ----------
$940,000 per year, plus 35% of $ 151,790
annual room revenues in excess of ----------
$940,000, plus 8% of monthly other
revenues
Rodeway Inn 210,000 6.5% of quarterly room revenues, Rooms - $ 577,813 $ 78,004 $ 288,544
Wytheville, Virginia ---------- plus 7.0% of semi-annual room Other - $ 6,750 540 ----------
revenues, plus 30.0% of annual ----------
room revenues in excess of $ 78,544
$815,000, plus 8% of monthly other ----------
revenues
Total $3,302,922 $4,023,271 $7,326,193
========== ========== ==========
</TABLE>
Other than real estate and personal property taxes, ground lease rent
(where applicable), the cost of certain furniture, fixtures and equipment,
expenditures for items that are classified as capital items under GAAP which are
necessary for the continued operation of the Hotels, and property and casualty
insurance premiums, which are obligations of the Partnership, the Percentage
Leases require the Lessee to pay Base Rent, Percentage Rents, Additional Charges
and the operating expenses of the Hotels (including insurance, other than
property and casualty insurance, all costs and expenses and all utility and
other charges incurred in the operation of the Hotels) during the term of the
Percentage Leases. The Percentage Leases also provide for rent reductions and
abatements in the event of damage to or destruction or a partial taking of any
Hotel as described under "Damage to Hotels" and "Condemnation of Hotels."
Maintenance and Modifications. Under the Percentage Leases, the
Partnership is required to maintain structural elements and underground
utilities and to pay for certain expenditures for items that are classified as
capital items under GAAP and which are necessary for the continued operation of
the Hotels. In addition, the Partnership will make available to the Lessee for
the repair, replacement and refurbishment of furniture, fixtures and equipment
in the Hotels, when and as deemed necessary by the Lessee, the FFE Reserves,
which is an amount equal to 4% of room revenues per quarter on a cumulative
basis. Although the Company believes that 4% of room revenue is generally an
appropriate capital reserve to maintain the condition and viability of its
Hotels, the Company will increase its capital reserves set-aside from 4% to 6%
of room revenue upon completion of the Offering. The additional 2% of room
revenue will be held in the Additional Reserve Fund, which will be deployed at
the Hotels primarily to enhance their competitive position. To ensure that the
Company receives additional annual income that is at least equal to 12% of the
amount of funds invested by the Company from the Additional Reserve Fund, the
Company and the Lessee have agreed to amend the Leases for the Hotels that
receive capital from the Additional Reserve Fund to provide that each such Hotel
will increase its annual Base Rent payment by 7% per annum of the capital
received from the Additional Reserve Fund. The Company expects that it will
receive additional amounts under the terms of the Percentages Leases equal to at
least 5% per annum of the amount invested from the Additional Reserve Fund
through its participation in increased room revenue resulting from such
additional investments. The Partnership's obligation will be carried forward to
the extent that the Lessee has not expended such amount, and any unexpended
amounts will remain the property of the Partnership upon termination of the
Percentage Leases. Other than as described above, the Lessee is responsible for
all repair and maintenance of the Hotels.
The Lessee, at its expense, may make non-capital and capital additions,
modifications or improvements to the Hotels, provided that such action does not
significantly alter the character or purposes of the Hotels or significantly
detract from the value or operating efficiencies of the Hotels. All such
alterations, replacements and improvements shall be subject to all the terms and
provisions of the Percentage Leases and will become the property of the
Partnership upon termination of the Percentage Leases. The Partnership owns
substantially all personal property (other than inventory, linens, and other
nondepreciable personal property) not affixed to, or deemed a part
47
<PAGE>
of, the real estate or improvements on the Hotels, except to the extent that
ownership of such personal property would cause the Rent under a Percentage
Lease not to qualify as "rents from real property" for REIT income test
purposes. See "Federal Income Tax Considerations - Requirements for
Qualification - Income Tests."
Insurance and Property Taxes. The Partnership is responsible for paying
real estate and personal property taxes on the Hotels (except to the extent that
personal property associated with the Hotels is owned by the Lessee), and all
premiums for property and casualty insurance. The Lessee is required to pay or
reimburse the Partnership for all other insurance on the Hotels, including
comprehensive general public liability, workers' compensation and other
insurance appropriate and customary for properties similar to the Hotels and
naming the Partnership as an additional named insured.
Assignment and Subleasing. The Lessee is not permitted to sublet all or
any part of the Hotels or assign its interest under any of the Percentage Leases
without the prior written consent of the Partnership. No assignment or
subletting will release the Lessee from any of its obligations under the
Percentage Leases.
Damage to Hotels. In the event of damage to or destruction of any Hotel
covered by insurance which renders the Hotel unsuitable for the Lessee's use and
occupancy, the Lessee is obligated to repair, rebuild, or restore the Hotel,
except as to structural elements of such hotel and underground utilities, or
offer to acquire the Hotel on the terms set forth in the applicable Percentage
Lease. If the Lessee rebuilds the Hotel, the Partnership is obligated to
disburse to the Lessee, from time to time and upon satisfaction of certain
conditions, any insurance proceeds actually received by the Partnership as a
result of such damage or destruction, and any excess costs of repair or
restoration will be paid by the Lessee. If the Lessee decides not to rebuild and
the Partnership exercises its right to reject the Lessee's mandatory offer to
purchase the Hotel on the terms set forth in the Percentage Lease, the
Percentage Lease will terminate and the insurance proceeds will be retained by
the Partnership. If the Partnership accepts the Lessee's offer to purchase the
Hotel, the Percentage Lease will terminate and the Lessee will be entitled to
the insurance proceeds. In the event that damage to or destruction of a Hotel
that is covered by insurance does not render the Hotel wholly unsuitable for the
Lessee's use and occupancy, the Lessee generally will be obligated to repair or
restore the Hotel. The Percentage Lease shall remain in full force and effect
during any period required for repair or restoration of any damaged or destroyed
Hotel except that if damage to the Hotel renders the Hotel wholly unsuitable for
Lessee's use and occupancy within the final 24 months of the term of the
Percentage Lease, either the Partnership or the Lessee may terminate the
Percentage Lease on the terms set forth therein.
Condemnation of Hotel. In the event of a total condemnation of any
Hotel, the relevant Percentage Lease will terminate with respect to such Hotel
as of the date of taking, and the Partnership and the Lessee will be entitled to
their shares of the condemnation award in accordance with the provisions of the
Percentage Lease. In the event of a partial taking that does not render the
Hotel unsuitable for the Lessee's use, the Lessee will restore the untaken
portion of the Hotel to a complete architectural unit and the Partnership shall
contribute the cost of such restoration in accordance with the provisions of the
Percentage Lease.
Events of Default. Events of Default under the Percentage Leases
include, among others, the following:
(i) the occurrence of an Event of Default under any other
Percentage Lease between the Partnership and the Lessee;
(ii) the failure by the Lessee to pay Base Rent when due and
the continuation of such failure for a period of ten days thereafter;
(iii) the failure by the Lessee to pay Percentage Rent when
due and the continuation of such failure for a period of 20 days
thereafter;
(iv) the failure by the Lessee to observe or perform any other
term of a Percentage Lease and the continuation of such failure for a
period of 30 days after receipt by the Lessee of notice from the
Partnership thereof, unless such failure cannot be cured within such
period and the Lessee commences appropriate action to cure such failure
within such 30 day period and thereafter acts, with diligence, to
48
<PAGE>
correct such failure within such time as is necessary, provided in no
event shall such period exceed 90 days;
(v) if the Lessee shall file a petition in bankruptcy or
reorganization pursuant to any federal or state bankruptcy law or any
similar federal or state law, or shall be adjudicated a bankrupt or
shall make an assignment for the benefit of creditors or shall admit in
writing its inability to pay its debts generally as they become due, or
if a petition or answer proposing the adjudication of the Lessee as a
bankrupt or its reorganization pursuant to any federal or state
bankruptcy law or any similar federal or state law shall be filed in
any court and the Lessee shall be adjudicated a bankrupt and such
adjudication shall not be vacated or set aside or stayed within 60 days
after the entry of an order in respect thereof, or if a receiver of the
Lessee or of the whole or substantially all of the assets of the Lessee
shall be appointed in any proceeding brought by the Lessee or if any
such receiver, trustee or liquidator shall be appointed in any
proceeding brought against the Lessee and shall not be vacated or set
aside or stayed within 60 days after such appointment;
(vi) if the Lessee voluntarily discontinues operations of any
Hotel except as a result of damage, destruction, or condemnation; or
(vii) if the Franchise License with respect to a Hotel is
terminated by the franchisor as a result of any action or failure to
act by the Lessee or its agents, other than the failure to complete
improvements required by a franchisor because the Partnership fails to
pay the costs of such improvements.
If an Event of Default occurs and continues beyond any curative period,
the Partnership has the option of terminating the Percentage Lease or any or all
other Percentage Leases by giving the Lessee ten days' written notice of the
date for termination of the Percentage Leases and, unless such Event of Default
is cured prior to the termination date set forth in such notice, the Percentage
Leases shall terminate on the date specified in the Partnership's notice and the
Lessee shall be required to surrender possession of the affected Hotel.
Termination of Percentage Leases on Disposition of the Hotels. In the
event the Partnership enters into an agreement to sell or otherwise transfer a
Hotel, the Partnership has the right to terminate the Percentage Lease with
respect to such Hotel if within six months of the termination the Partnership
either (i) pays the Lessee the fair market value of the Lessee's leasehold
interest in the remaining term of the Percentage Lease to be terminated, or (ii)
offers to lease to the Lessee one or more substitute hotels on terms that would
create a leasehold interest in such hotels with a fair market value equal to or
exceeding the fair market value of the Lessee's remaining leasehold interest
under the Percentage Lease to be terminated.
Franchise License. The Lessee is the licensee under the Franchise
Licenses on the Hotels. See "Business and Properties - Franchise Licenses."
Other Lease Covenants. The Lessee has agreed that during the term of
the Percentage Leases it will maintain a ratio of total debt to consolidated net
worth (as defined in the Percentage Leases) of less than or equal to 25%,
exclusive of capitalized leases.
Breach by Partnership. Upon notice from the Lessee that the Partnership
has breached the Lease, the Partnership will have 30 days to cure the breach or
proceed to cure the breach, which period may be extended in the event of certain
specified, unavoidable delays.
Inventory. All inventory required in the operation of the Hotels is
owned by the Lessee at its expense. The Partnership has the option to purchase
all inventory related to a particular Hotel at fair market value upon
termination of the Percentage Lease for that Hotel.
49
<PAGE>
Franchise Licenses
Comfort Inn,(R) Comfort Suites(R) and Rodeway Inn(R) are registered
trademarks of Choice Hotels. Best Western(R) and Best Western Suites(R) are
registered trademarks of Best Western. Days Inn(R) is a registered trademark of
Days Inn. Holiday Inn Express(R) is a registered trademark of Holiday
Hospitality.
The Company anticipates that most of the additional hotels in which it
invests will be operated under similar franchise licenses. The Company believes
that the public's perception of quality associated with a franchisor is an
important feature in the operation of a hotel. Franchisors provide a variety of
benefits for franchisees which include national advertising, publicity and other
marketing programs designed to increase brand awareness, training of personnel,
continuous review of quality standards and centralized reservation systems.
The Franchise Licenses generally specify certain management,
operational, recordkeeping, accounting, reporting and marketing standards and
procedures with which the franchisee must comply. The Franchise Licenses
obligate the Lessee to comply with the franchisors' standards and requirements
with respect to training of operational personnel, safety, maintaining specified
insurance, the types of services and products ancillary to guest room services
that may be provided by the Lessee, display of signage, and the type, quality
and age of furniture, fixtures and equipment included in guest rooms, lobbies
and other common areas.
With the exception of the Franchise Licenses noted below, all Franchise
Licenses from Choice Hotels will terminate on November 29, 2014. The Franchise
License for the Comfort Suites-Dover, Delaware will terminate in early 2017. The
Franchise Licenses for the Comfort Inns located in Culpeper, Virginia; New
Castle, Pennsylvania; Murphy, North Carolina; Gettysburg, Pennsylvania and
Chambersburg, Pennsylvania will terminate in 2017. Further, the Franchise
License from Choice Hotels for the Comfort Inn-Dahlgren, Virginia may be
terminated without cause by the franchisor on April 1, 1999 upon three months
written notice. The Franchise License from Choice Hotels for the Rodeway
Inn-Wytheville, Virginia will terminate in 2017; however, the Company has the
option to terminate this Franchise License in July 1998 and July 1999.
Otherwise, these Franchise Licenses may be terminated by the franchisor only
upon a violation of their terms.
The Franchise Licenses from Best Western may be terminated by the
franchisor or franchisee on each annual anniversary upon 90 days notice to the
other party.
The Franchise License from Days Inn expires on October 31, 2009. During
the term of that Franchise License, Days Inn may terminate the license only for
a violation of its terms.
The Franchise Licenses from Holiday Hospitality for the Holiday Inn
Express Hotels will terminate in 2007.
Under the Franchise Licenses from Choice Hotels relating to the Comfort
Inn Hotels located in Dahlgren, Virginia; Dublin, Virginia; Elizabethton,
Tennessee; Farmville, Virginia; Morgantown, West Virginia; Princeton, West
Virginia and Solomons, Maryland, the Lessee currently pays fees of approximately
6% of monthly room revenue. Under the Franchise Licenses from Choice Hotels
relating to the Comfort Inn Hotels located in Chambersburg, Pennsylvania;
Culpeper, Virginia; Gettysburg, Pennsylvania; Murphy, North Carolina and New
Castle, Pennsylvania, the Lessee currently pays fees of approximately 8.85% of
monthly room revenue. Under the Franchise License from Choice Hotels relating to
the Comfort Suites-Dover, Delaware, the Lessee pays a franchise fee of 8.05% of
monthly room revenue. Under the Best Western-Harlan, Kentucky Franchise License,
the Lessee currently pays a franchise fee of $1,935 per month and annual dues of
$2,654. Under the Best Western Suites-Key Largo, Florida Franchise License, the
Lessee currently pays a franchise fee of $2,012 per month and annual dues of
$2,050. Under the Rodeway Inn Franchise License, the Lessee pays franchise and
reservation fees equal to 8.8% of monthly room revenue. Under the Franchise
Licenses from Holiday Hospitality relating to the Holiday Inn Express Hotels,
the Lessee currently pays fees of approximately 8% of monthly room revenue plus
$6.43 per room per month. In addition, the Days Inn Franchise License requires
the Lessee to pay to any travel agent arranging a reservation for a room, 10% of
the gross room revenues generated by such reservation.
50
<PAGE>
Although management of the Company believes that each of the Hotels is
currently in compliance with the terms of the related Franchise License, there
can be no assurance that a franchisor will not exercise its option to terminate
a Franchise License at the designated anniversary. The Franchise Licenses also
provide for termination at the franchisor's option upon the occurrence of
certain events, including the Lessee's failure to pay royalties and fees or
perform its other covenants under the Franchise License, bankruptcy, abandonment
of the franchise or material breach of any term of a mortgage or lease relating
to the related Hotel. The Lessee is responsible for making all payments under
the Franchise Licenses to the franchisors.
COMFORT INN(R), COMFORT SUITES(R) AND RODEWAY INN(R) ARE REGISTERED
TRADEMARKS OF CHOICE HOTELS. CHOICE HOTELS HAS NOT ENDORSED OR APPROVED THE
OFFERING. A GRANT OF A COMFORT INN, COMFORT SUITES OR RODEWAY INN FRANCHISE
LICENSE FOR CERTAIN OF THE HOTELS IS NOT INTENDED AS, AND SHOULD NOT BE
INTERPRETED AS, AN EXPRESS OR IMPLIED APPROVAL OR ENDORSEMENT BY CHOICE HOTELS
(OR ANY OF ITS AFFILIATES, SUBSIDIARIES OR DIVISIONS) OF THE COMPANY, THE
PARTNERSHIP OR THE COMMON SHARES OFFERED HEREBY.
BEST WESTERN(R) AND BEST WESTERN SUITES(R) ARE REGISTERED TRADEMARKS OF
BEST WESTERN. BEST WESTERN HAS NOT ENDORSED OR APPROVED THE OFFERING. A GRANT OF
A BEST WESTERN FRANCHISE LICENSE FOR CERTAIN OF THE HOTELS IS NOT INTENDED AS,
AND SHOULD NOT BE INTERPRETED AS, AN EXPRESS OR IMPLIED APPROVAL OR ENDORSEMENT
BY BEST WESTERN (OR ANY OF ITS AFFILIATES, SUBSIDIARIES OR DIVISIONS) OF THE
COMPANY, THE PARTNERSHIP OR THE COMMON SHARES OFFERED HEREBY.
DAYS INN(R) IS A REGISTERED TRADEMARK OF DAYS INN. DAYS INN HAS NOT
ENDORSED OR APPROVED THE OFFERING. A GRANT OF A DAYS INN FRANCHISE LICENSE FOR A
HOTEL IS NOT INTENDED AS, AND SHOULD NOT BE INTERPRETED AS, AN EXPRESS OR
IMPLIED APPROVAL OR ENDORSEMENT BY DAYS INN HOTELS (OR ANY OF ITS AFFILIATES,
SUBSIDIARIES OR DIVISIONS) OF THE COMPANY, THE PARTNERSHIP OR THE COMMON SHARES
OFFERED HEREBY.
HOLIDAY INN EXPRESS(R) IS A REGISTERED TRADEMARK OF HOLIDAY HOSPITALITY
CORPORATION. HOLIDAY HOSPITALITY CORPORATION HAS NOT ENDORSED OR APPROVED THE
OFFERING. A GRANT OF A HOLIDAY INN EXPRESS FRANCHISE LICENSE FOR CERTAIN OF THE
HOTELS IS NOT INTENDED AS, AND SHOULD NOT BE INTERPRETED AS, AN EXPRESS OR
IMPLIED APPROVAL OR ENDORSEMENT BY HOLIDAY HOSPITALITY CORPORATION (OR ANY OF
ITS AFFILIATES, SUBSIDIARIES OR DIVISIONS) OF THE COMPANY, THE PARTNERSHIP OR
THE COMMON SHARES OFFERED HEREBY.
Operating Practices
The Company's management recognizes the need for aggressive, market
driven, creative management given the competition in the hospitality industry.
Each of the Hotels is managed by the Lessee. The Lessee intends to continue the
management systems developed by it and its Affiliates. The Lessee currently
manages the Hotels and has experience satisfying the requirements imposed by the
Choice Hotels, Best Western, Days Inn and Holiday Hospitality Franchise
Licenses.
Employees
The Company is self-advised and thus utilizes the services of its
officers and Directors rather than retaining an advisor. See "Management -
Directors and Executive Officers." In addition, the Lessee provides the Company
with accounting and securities reporting services pursuant to the terms of the
amended Services Agreement. The Lessee employs approximately 400 people in
operating the Hotels and has advised the Company that its relationship with its
employees is good.
51
<PAGE>
Environmental Matters
Under various federal, state and local laws and regulations, an owner
or operator of real estate may be liable for the costs of removal or remediation
of certain hazardous or toxic substances on such property. Such laws often
impose such liability without regard to whether the owner knew of, or was
responsible for, the presence of hazardous or toxic substances. Furthermore, a
person that arranges for the disposal or transports for disposal or treatment a
hazardous substance at a property owned by another party may be liable for the
costs of removal or remediation of hazardous substances released into the
environment at that property. The costs of remediation or removal of such
substances may be substantial, and the presence of such substances, or the
failure to promptly remediate such substances, may adversely affect the owner's
ability to sell such real estate or to borrow using such real estate as
collateral. In connection with the ownership and operation of the Hotels, the
Company, the Partnership, or the Lessee, as the case may be, may be potentially
liable for any such costs.
Phase I environmental assessments were obtained on all of the Hotels
prior to their acquisition or development by the Company. The Phase I
environmental assessments were intended to identify potential environmental
contamination for which the Hotels may be responsible. The Phase I environmental
assessments included historical reviews of the Hotels, reviews of certain public
records, preliminary investigations of the sites and surrounding properties,
screening for the presence of hazardous substances, toxic substances and
underground storage tanks, and the preparation and issuance of a written report.
The Phase I environmental assessments did not include invasive procedures, such
as soil sampling or ground water analysis.
The Phase I environmental assessments have not revealed any
environmental liability that the Company believes would have a material adverse
effect on the Company's business, assets, results of operations or liquidity,
nor is the Company aware of any such liability. Nevertheless, it is possible
that these environmental assessments do not reveal all environmental liabilities
or that there are material environmental liabilities of which the Company is
unaware. Moreover, no assurance can be given that (i) future laws, ordinances or
regulations will not impose any material environmental liability or (ii) the
current environmental condition of the Hotels will not be affected by the
condition of the properties in the vicinity of the Hotels (such as the presence
of leaking underground storage tanks) or by third parties unrelated to the
Company, the Partnership, or the Lessee.
The Company believes that the Hotels are in compliance in all material
respects with all federal, state and local ordinances and regulations regarding
hazardous or toxic substances and other environmental matters. Neither the
Company nor, to the knowledge of the Company, the Selling Partnerships, the LLC
or the LLC's predecessor in interest with regard to any of the former owners of
the Hotels, have been notified by any governmental authority of any material
noncompliance, liability or claim relating to hazardous or toxic substances or
other environmental matters in connection with any of the Hotels.
Competition
The hotel industry is highly competitive. Each of the Hotels is located
in a developed area that includes other hotels, many of which are competitive
with the Hotels in their locality. The number of competitive hotels in a
particular area could have a material adverse effect on revenues of the Hotels
or hotels acquired in the future. See "Business and Properties - The Hotels."
There will be competition for investment opportunities in upper-economy
and mid-scale hotels from entities organized for purposes substantially similar
to the Company's objectives as well as other purchasers of hotels, including the
entity managed by Mills Management II, Inc., to which George R. Whittemore, a
Director of the Company, is a consultant. The Company will be competing for such
investment opportunities with entities that have substantially greater financial
resources than the Company, including access to capital or better relationships
with franchisors, lenders and sellers. The Company's Debt Policy limits its
consolidated indebtedness to less than 55% of the aggregate purchase price of
the hotels in which it has invested. The aggregate amount paid by the Company
for the Hotels is currently approximately $58.4 million. After the Company has
applied the Net Proceeds as set forth herein, the Company's Remaining
Indebtedness ($21.5 million) will represent approximately 36.8% of the aggregate
amount paid by the Company for the Hotels. To the extent that the Company's Debt
Policy limits its access to debt financing, the success of the Company's
acquisition strategy will likely depend on its ability to access
52
<PAGE>
additional capital through issuances of equity securities. The Company's
competitors may generally be able to accept more risk than the Company can
manage prudently and may be able to borrow the funds needed to acquire hotels.
Competition may generally reduce the number of suitable investment opportunities
offered to the Company and increase the bargaining power of property owners
seeking to sell. See "Risk Factors - Conflicts of Interest - Competing Hotels to
be Acquired by Affiliates of Mr. Humphrey" and "-- Growth Strategy."
Depreciation
To the extent that the Partnership has acquired, or will acquire,
equity interests in the Hotels for cash, the Partnership's initial basis in the
Hotels for federal income tax purposes generally equals, or will equal, the
purchase price paid by the Partnership. The Partnership plans to depreciate such
depreciable hotel property for federal income tax purposes under either the
modified accelerated cost recovery system of depreciation ("MACRS") or the
alternative depreciation system of depreciation ("ADS"). The Partnership uses
MACRS for furnishings and equipment. Under MACRS, the Partnership generally
depreciates such furnishings and equipment over a five-year recovery period
using a 200% declining balance method and a half-year convention. If, however,
the 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 furnishings and equipment placed in service
during that year. The Partnership uses ADS for buildings and improvements. Under
ADS, the Partnership generally depreciates 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 Partnership has acquired, or will acquire,
equity interests in the Hotels in exchange for Units, the Partnership's initial
basis in each Hotel for federal income tax purposes should be the same as the
transferor's basis in such Hotel on the date of acquisition. Although the law is
not entirely clear, the Partnership intends to depreciate such depreciable hotel
property for federal income tax purposes under MACRS with respect to furnishings
and equipment and under ADS with respect to buildings and improvements. The
Partnership's tax depreciation deductions will be allocated among the partners
in accordance with their respective interests in the Partnership (except to the
extent that the Partnership is required under Code Section 704(c) to use a
method for allocating depreciation deductions attributable to the Hotels or
other contributed properties that results in the Company receiving a
disproportionately larger share of such deductions). The Partnership generally
has elected to use the "traditional method" for allocating Code Section 704(c)
items with respect to Hotels that it acquires in exchange for Units. Because the
Partnership's initial basis in the Initial Hotels acquired in exchange for Units
was less than the fair market value of those hotels on the date of acquisition,
the Company's depreciation deductions may be less than they otherwise would have
been if the Partnership had purchased the partnership interests in the
partnerships that sold the Company the Initial Hotels ("Selling Partnerships")
entirely for cash.
Legal Proceedings
The Company is not currently involved in any material litigation nor,
to the Company's knowledge, is any material litigation currently threatened
against the Company or any of the Hotels. The Lessee has advised the Company
that it currently is not involved in any material litigation.
POLICIES AND OBJECTIVES WITH RESPECT TO CERTAIN ACTIVITIES
The following is a discussion of the Company's policies with respect to
investment, financing, conflicts of interest and certain other activities that
have not been discussed elsewhere. The policies with respect to these activities
have been determined by the Board of Directors of the Company and may be amended
or revised from time to time at the discretion of the Board of Directors without
a vote of the shareholders of the Company, except that (i) changes in certain
policies with respect to conflicts of interest must be consistent with legal
requirements, (ii) certain policies with respect to competition are imposed
pursuant to contracts that cannot be amended without the consent of all parties
thereto, and (iii) the Company cannot take any action intended to terminate its
qualification as a REIT without the approval of the holders of two-thirds of the
outstanding shares of Common Stock.
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Investment Policies
The Company's investment objective is to acquire and develop hotels
that meet its investment criteria. The Company's business is focused solely on
hotels. See "Growth Strategy" and "Risk Factors - Growth Strategy." Under the
Investment Policy, the Company intends to acquire only those hotels for which it
expects to receive annual Rent (net of insurance paid by the Company, the FFE
Reserves of 4% of room revenue and real estate and personal property taxes) in
an amount greater than or equal to 12% of the total purchase price paid by the
Company for such hotels. Under the Bylaws, the approval of a majority of the
Board of Directors, including a majority of the Independent Directors, is
required for the Company to acquire any property. Although the Company intends
primarily to acquire hotels, it also may participate with other entities in
property ownership, through joint ventures or other types of co-ownership.
Equity investments may be subject to existing mortgage financing and other
indebtedness that may have priority over the equity interest of the Company.
While the Company will emphasize equity investments in hotels, it may,
in its discretion, invest in mortgages and other real estate interests,
including securities of other REITs. The Company may invest in participating,
convertible or other types of mortgages if it concludes that by doing so it may
benefit from the cash flow or any appreciation in the value of the subject
property. Such mortgages are similar to equity participation, because they
permit the lender to either participate in increasing revenues from the property
or convert some or all of that mortgage to equity ownership interest. The
Company does not presently intend to invest in mortgages or real estate
interests other than hotels.
Financing
The Company intends to make additional investments in operating hotels
and may incur additional indebtedness to make such investments or to meet the
distribution requirements imposed by the REIT provisions of the Code, to the
extent that cash flow from the Company's investments and working capital is
insufficient. The proceeds of any borrowing by the Partnership may be used for
the payment of distributions or dividends, working capital or to finance
acquisitions, expansions, additions or renovations of operating hotels. Under
the Bylaws, any refinancing of or prepayment of principal on the Remaining
Indebtedness must be approved by a majority of the Directors, including a
majority of the Independent Directors. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Liquidity and Capital
Resources" and "Federal Income Tax Considerations - Requirements for
Qualification - Distribution Requirements."
The Company's Debt Policy presently limits its consolidated
indebtedness to less than 55% of the aggregate purchase price of the hotels in
which it has invested. The aggregate purchase price of the Hotels is currently
approximately $58.4 million. After the Company has applied the Net Proceeds, as
set forth herein, the Company's total outstanding indebtedness will represent
approximately 36.8% of the aggregate purchase price of the Hotels.
The Company will invest in additional hotels only as suitable
opportunities arise. The Company will not undertake investments in such hotels
unless adequate sources of financing are available. The Bylaws require the
approval of a majority of the Directors, including a majority of the Independent
Directors, to acquire any additional hotel. It is expected that future
investments in hotels will be dependent on and financed by the proceeds from
additional issuances of Common Stock or other securities or borrowings. If the
Board of Directors determines to raise additional equity capital, the Board has
the authority, without shareholder approval, to issue additional Common Stock or
other capital shares of the Company in any manner (and on such terms and for
such consideration) as it deems appropriate, including in exchange for property.
Common Shareholders have no preemptive right to purchase shares issued in any
offering, and any such offering might cause a dilution of a shareholder's
investment in the Company.
Conflict of Interest Policies
The Company has adopted certain policies and entered into certain
agreements designed to minimize the effects of potential conflicts of interest.
The Company's Board of Directors is subject to certain provisions of Virginia
law, which are designed to eliminate or minimize certain potential conflicts of
interest. However, there
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can be no assurance that these policies always will be successful in eliminating
the influence of such conflicts, and if they are not successful, decisions could
be made that might fail to reflect fully the interests of all shareholders.
Articles of Incorporation and Bylaw Provisions
The Company's Articles of Incorporation, with limited exceptions,
require that a majority of the Company's Board of Directors be comprised of
Independent Directors, persons who, within the last two years, have not (i)
owned an interest in any Humphrey Affiliates, (ii) been employed by Mr. Humphrey
or any of Humphrey Affiliates, (iii) been an officer or director of any of
Humphrey Affiliates, (iv) performed services for the Company, (v) been a
director for more than three REITs organized by Mr. Humphrey or any of his
Affiliates or (vi) had any material business or professional relationship with
Mr. Humphrey or any of his Affiliates. Currently, four of the seven Directors of
the Company are Independent Directors. The Articles of Incorporation provide
that the Independent Director requirement may not be amended, altered, changed
or repealed without the affirmative vote of at least 80% of the members of the
Board of Directors or the affirmative vote of the holders of not less than
two-thirds of the outstanding shares of Common Stock (and other shares of
capital stock of the Company entitled to vote, if any exist). In addition, the
Company's Bylaws provide that any action pertaining to any transaction in which
the Company is purchasing, selling, leasing or mortgaging any real estate asset
or engaging in any other transaction in which an advisor, director or officer of
the Company, any lessee or contract manager of any property of the Company or
any Affiliate of the foregoing, has any direct or indirect interest, must be
approved by a majority of the Directors, including a majority of the Independent
Directors. This provision of the Bylaws may not be amended, altered, changed or
repealed without the affirmative vote of at least 80% of the members of the
Board of Directors including a majority of the Independent Directors or the
affirmative vote of the holders of not less than two-thirds of the outstanding
shares of Common Stock (and other shares of capital stock of the Company
entitled to vote, if any exist).
The Non-Competition Agreement and Option Agreement
Pursuant to the Non-Competition Agreement among Mr. Humphrey, Humphrey
Associates, a Maryland corporation wholly-owned by Mr. Humphrey, and the
Company, while Mr. Humphrey is an officer or Director of the Company or owns any
ownership interest in the Company, and for five years thereafter, neither Mr.
Humphrey nor any Humphrey Affiliate, will acquire, develop, own, operate, manage
or have any interest in any hotel that is within 20 miles of a hotel in which
the Company or the Partnership has invested. The 20-mile prohibition may be
waived by the Independent Directors if they determine that such development,
ownership, management, or operation will not have a material adverse affect on
the operations of one or more of the Hotels. In addition, Mr. Humphrey has
agreed that neither he nor any of his Affiliates will receive any brokerage
commissions or other fees with respect to hotels purchased by the Company. The
Non-Competition Agreement was executed by the parties in connection with the
IPO.
Pursuant to the Option Agreement among Mr. Humphrey, Humphrey
Associates and the Company, the Company has an option to acquire any hotels
acquired or developed by Mr. Humphrey or any of his Affiliates. At any time
during twelve months after a hotel is acquired, or after the opening of a hotel
developed, by Mr. Humphrey or any of his Affiliates, the Company may purchase
the applicable hotel under the option for a price equal to the fair market value
of the hotel, as determined by independent third-party appraisal, but in no
event less than the sum of the following: (i) acquisition or development costs
paid to unaffiliated third parties, (ii) capitalized interest expense, (iii) the
amount of equity investment in the hotel, including the cash investment or
advances of Mr. Humphrey and his Affiliates, if any (to the extent not covered
in sections (i) and (ii)), and (iv) a cumulative, non-compounded return on the
equity investment not to exceed the prime rate, as reported by The Wall Street
Journal, Eastern Edition, plus five percent (less any net cash flow received by
Mr. Humphrey or any of his Affiliates with respect to such equity investment).
All transactions to acquire additional properties and all and any transactions
between the Company or the Partnership and Mr. Humphrey or his Affiliates must
be approved by a majority of the Directors, including a majority of the
Independent Directors. In addition, the Option Agreement provides that in the
event the Company acquires a hotel from Mr. Humphrey or any of his Affiliates in
connection with the Company's issuance of additional securities, Mr. Humphrey or
any of his Affiliates may receive consideration for such property in additional
Units, provided that his and his Affiliates' interests in the Partnership
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shall not exceed 28.54% of the total partnership interests in the Partnership.
The Option Agreement was executed by the parties in connection with the IPO.
The Partnership
Because some of the Limited Partners have unrealized taxable gain
associated with their interests in the Hotels that were contributed to the
Partnership, the Limited Partners may suffer different and more adverse tax
consequences than the Company upon the sale of such a Hotel or refinancing or
prepayment of principal on any of the Remaining Indebtedness. Consequently, a
conflict of interest may arise between the Company, as General Partner of the
Partnership, and certain of the Limited Partners. The Company's Bylaws provide
that the Company's decisions with respect to the sale of a Hotel must be
approved by a majority of the Directors, including a majority of the Independent
Directors. This provision of the Bylaws may not be amended, altered, changed or
repealed without the affirmative vote of at least 80% of the members of the
Board of Directors, including the Independent Directors, or the affirmative vote
of the holders of not less than two-thirds of the outstanding shares of Common
Stock (and other shares of capital stock of the Company entitled to vote, if any
exist). The Partnership Agreement gives the Company, as General Partner of the
Partnership, full, complete and exclusive discretion in managing and controlling
the business of the Partnership and in making all decisions affecting the
business and assets of the Partnership.
Provisions of Virginia Law
Pursuant to the Virginia Stock Corporation Act, each Director is
required to discharge his or her duties in accordance with his or her good faith
business judgment of the best interest of the Company. In addition, Virginia law
provides that a transaction with the Company in which a Director or officer of
the Company has a direct or indirect interest is not voidable by the Company
solely because of any Director's or officer's interest in the transaction if (i)
the material facts of the transaction and interest are disclosed to or known by
the Directors and the transaction is authorized, approved or ratified by the
disinterested Directors, (ii) the material facts of the transaction and interest
are disclosed to or known by the shareholders and the transaction is authorized,
approved or ratified by the disinterested shareholders, or (iii) the transaction
is established to have been fair to the Company.
Policies with Respect to Other Activities
The Company has authority to offer shares of Common Stock or other
securities and to repurchase or otherwise reacquire its Common Stock or any
other securities and may engage in such activities in the future. As described
under "Shares Available for Future Sale," the Company may issue shares of Common
Stock to holders of Units upon exercise of their Redemption Rights (as defined
herein). The Company has no outstanding loans to other entities or persons,
including its officers and Directors. The Company has not engaged in trading,
underwriting or agency distribution or sale of securities of other issuers, nor
has the Company invested in the securities of other issuers other than the
Partnership for the purpose of exercising control. The Company 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.
At all times, the Company intends to make investments in such a manner
consistent with the requirements of the Code for the Company to qualify as a
REIT unless, because of changing circumstances or changes in the Code (or in the
Treasury Regulations), the Company's Board of Directors, with the consent of the
holders of two-thirds of the outstanding shares of Common Stock, determines that
it is no longer in the best interests of the Company to qualify as a REIT.
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MANAGEMENT
Directors and Executive Officers
The Board of Directors consists of six members, four of whom are
Independent Directors. All of the Directors are serving one-year terms that will
expire at the Company's 1998 annual meeting of shareholders. Mr. Humphrey is
serving as the Company's Chairman of the Board, President and Secretary.
Certain information regarding the directors and executive officers of
the Company is set forth below.
Name Age Position
---- --- --------
James I. Humphrey, Jr. 56 Chairman of the Board,
President and Secretary
Margaret Allen 52 Director
Andrew A. Mayer, M.D. 63 Director
Dr. Leah T. Robinson 66 Director
George R. Whittemore 48 Director
Jeffrey M. Zwerdling 53 Director
- ------------------------
James I. Humphrey, Jr. is the President and Chairman of Humphrey
Associates and has held that position since 1978. Humphrey Associates, formerly
Harkins-Humphrey Associates, Inc., is a full service real estate corporation.
Mr. Humphrey also served as President of the Operator from 1989 to 1994. He
currently serves on the Credit Assurance Review Committee of the Maryland
Housing Fund. Mr. Humphrey served on the governor's Housing Task Force in
Maryland, the Maryland Housing Policy Commission and the Maryland International
Division Private Sector Advisory Council. Mr. Humphrey is a graduate of the
University of Maryland and obtained an M.B.A. degree from Loyola College.
Margaret Allen is Chief Executive Officer and 50% owner of AGM
Financial Services, Inc. ("AGM"), which she co-founded in 1990. AGM is a
mortgagee licensed by the Federal Housing Authority (the "FHA"), a division of
the United States Department of Housing and Urban Development. As a licensed
mortgagee, AGM represents borrowers who wish to obtain mortgage insurance from
the FHA for multifamily housing, assisted living facilities and nursing homes.
Prior to 1990, Ms. Allen was a Regional Vice President for ABG Financial
Services, Inc., a FHA licensed mortgagee. Ms. Allen currently serves on the
Credit Assurance Review Committee of the Maryland Department of Housing and
Community Development, the Board of Directors of the Baltimore City Chapter of
the Home Builders Association of Maryland and the Insured Projects Committee of
the Mortgage Bankers Association. She has served on the Maryland Housing Policy
Commission and chaired that commission from 1991-1992. Ms. Allen is a graduate
of the University of California, Berkeley.
Dr. Leah T. Robinson is a clinical psychologist in a part-time private
practice. She was a member of the faculty of Virginia Commonwealth University
until 1973 when she joined Psychiatric Associates of Tidewater, remaining with
this group until it dissolved in 1989.
Andrew A. Mayer, M.D., is presently retired. He was a partner of
Medical Center Radiologists from 1965 to 1992 and served as a Director and
Treasurer until 1991. Dr. Mayer was also Chief of Radiology at Leigh Memorial
Hospital, Norfolk, Virginia. Dr. Mayer served as a Director of Mills Value
Fund, a mutual fund, from July 1988 to December 1991, and has served as managing
partner for partnerships formed to develop and own residential and commercial
property.
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George R. Whittemore served as director and President and Managing
Officer of Pioneer Federal Savings Bank and its parent Pioneer Financial
Corporation from September 1982 until these institutions were acquired in a
merger with Signet Banking Corporation in August 1994. Mr. Whittemore joined
Pioneer Federal Savings Bank in 1975 as Treasurer and was made Executive Vice
President in March 1982. Mr. Whittemore was appointed President of Mills Value
Advisor, Inc., a registered investment adviser, in April 1996. In October 1996,
he was named a Senior Vice President of Anderson & Strudwick Incorporated, the
Underwriter of the Common Shares offered by this Prospectus. Mr. Whittemore is
also a consultant to Mills Management II, Inc., which is the manager and a
member of a privately-held limited liability company that was formed to, among
other things, acquire hotels that are substantially similar to the Hotels. Mr.
Whittemore is a graduate of the University of Richmond.
Jeffrey M. Zwerdling, Esq. is Managing Partner at the law firm of
Zwerdling and Oppleman located in Richmond, Virginia. Mr. Zwerdling specializes
in commercial real estate law and general litigation. He is presently Vice
President and Director of The Corporate Center, the owner of a 225,000 square
foot office park complex located in Richmond, Virginia, and serves as a trustee
of three pension plans. Mr. Zwerdling is a graduate of Virginia Commonwealth
University and obtained his J.D. degree from William & Mary Law School.
Acquisition Committee
The Board of Directors has appointed an Acquisition Committee
consisting of Ms. Allen, Mr. Humphrey and Mr. Zwerdling. The Acquisition
Committee reviews potential hotel acquisitions and developments, visits the
sites of proposed hotel acquisitions or developments, reviews the terms of
proposed leases for proposed hotel acquisitions or developments and makes
recommendations to the full Board of Directors with respect to proposed hotel
acquisitions or developments. Under the Bylaws, the approval of a majority of
the Board of Directors, including a majority of the Independent Directors, is
required for the Company to acquire any property. The Company's Independent
Directors consist of Drs. Mayer and Robinson, Ms. Allen and Mr. Zwerdling.
Audit Committee
The Audit Committee consists of three Independent Directors, Ms. Allen,
Dr. Mayer and Mr. Zwerdling. The Audit Committee makes recommendations
concerning the engagement of independent public accountants, reviews with the
independent public accountants the plans and results of the audit engagement,
approves professional services provided by the independent public accountants,
reviews the independence of the independent public accountants, considers the
range of audit and non-audit fees and reviews the adequacy of the Company's
internal accounting controls. The Audit Committee, with advice from the
Company's attorneys and independent public accountants, will establish
procedures to monitor compliance with the REIT provisions of the Code and the
Exchange Act, and such other laws and regulations applicable to the Company.
Executive Compensation
The Company does not pay its executives any salary above and beyond the
compensation that they receive as Directors.
Compensation of Directors
On May 22, 1997, the Board of Directors unanimously voted to increase
the annual fees paid to them by the Company for serving on the Board of
Directors from $10,000 per year to $15,000 per year effective for the last two
quarters of 1997. The Board's action was designed to make their fees more
comparable to those of other public companies (including REITs) that are of a
similar size to the Company. On September 9, 1997, the Board of Directors voted
to utilize their full annual fees, with the exception of the fees received by
Mr. Humphrey, to purchase Common Stock on the open market, and to exercise their
reasonable best efforts to do so within ten days of receipt of such fees.
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Exculpation and Indemnification
The Articles of Incorporation of the Company contain a provision which,
subject to certain exceptions described below, eliminates the liability of a
Director or officer to the Company or its shareholders for monetary damages for
any breach of duty as a Director or officer. This provision does not eliminate
such liability to the extent that it is proved that the Director or officer
engaged in willful misconduct or a knowing violation of criminal law or of any
federal or state securities law.
The Company's Articles of Incorporation also require the Company to
indemnify any Director or officer who is or was a party to a proceeding,
including a proceeding by or in the right of the Company, by reason of the fact
that he is or was such a Director or officer or is or was serving at the request
of the Company as a director, officer, employee or agent of another entity
provided that the Board of Directors determines that the conduct in question was
in the best interest of the Company and such person was acting on behalf of the
Company. A Director or officer of the Company is entitled to be indemnified
against all liabilities and expenses incurred by the Director or officer in the
proceeding, except such liabilities and expenses as are incurred (i) if such
person is an Independent Director or officer, because of his or her gross
negligence, willful misconduct or knowing violation of the criminal law or (ii)
in the case of the Director other than the Independent Directors, because of his
or her negligence or misconduct. Unless a determination has been made that
indemnification is not permissible, a Director or officer also is entitled to
have the Company make advances and reimbursement for expenses prior to final
disposition of the proceeding upon receipt of a written undertaking from the
Director or officer to repay the amounts advanced or reimbursed if it is
ultimately determined that he or she is not entitled to indemnification. Such
advances shall be permissible when the proceeding has been initiated by a
shareholder of the Company only if such advance is approved by a court of
competent jurisdiction. The Board of Directors of the Company also has the
authority to extend to any person who is an employee or agent of the Company, or
who is or was serving at the request of the Company as a director, officer,
employee or agent of another entity, the same indemnification rights held by
Directors and officers, subject to all of the accompanying conditions and
obligations.
The Virginia Stock Corporation Act permits a court, upon application of
a Director or officer, to review the Company's determination as to a Director's
or officer's request for advances, reimbursement or indemnification. If it
determines that the Director or officer is entitled to such advances,
reimbursement or indemnification, the court may order the Company to make
advances and/or reimbursement for expenses or to provide indemnification.
CERTAIN RELATIONSHIPS AND TRANSACTIONS
The Company and the Partnership have entered into a number of
transactions with Mr. Humphrey and his Affiliates in connection with the
organization of the Company and the acquisition of the Hotels. Mr. Humphrey, the
Chairman of the Board of Directors and the President of the Company, is the sole
shareholder of the Lessee.
Revised Services Agreement
The Company amended the terms of the Services Agreement between it and
the Lessee to provide accounting and securities reporting services for the
Company. The initial Services Agreement provided that these services would be
provided to the Company for a fixed fee of $80,000 notwithstanding the size of
the Company's portfolio. The Company amended the agreement to provide for such
services for an initial annual fee of $30,000 for so long as the Company's
portfolio includes the Initial Hotels, the Days Inn-Farmville, Virginia Hotel
and the the Comfort Suites-Dover, Delaware Hotel. The amended Services Agreement
provides that the fee for such services will increase $10,000 per year (prorated
for the time of acquisition) for each additional hotel added to the Company's
portfolio. Under the terms of the amended Services Agreement, the services fee
cannot exceed $100,000 in any year.
Credit Facility
On April 15, 1996, the Company entered into a credit agreement with
Mercantile for a $6.5 million Credit Facility. Effective as of September 30,
1997, the maximum amount that the Company may borrow under the Credit
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Facility was increased to $25.5 million. The amount outstanding under the Credit
Facility as of February 28, 1998 was $24.5 million. Upon completion of the
Offering, the Company expects to increase the maximum amount that it may borrow
pursuant to the Credit Facility to $40 million at an interest rate equal to the
30 day London Interbank Offered Rate (which was 5.68% as of March 20, 1998),
plus 250 basis points. The Credit Facility is secured by 17 Hotels.
Development Agreement
Pursuant to the Development Agreement, Humphrey Development holds the
right to purchase the Comfort Suites-Dover, Delaware Hotel from the Company in
January 2002 for $2,795,910.
Acquisition of Certain Hotels from Humphrey Affiliates
The Initial Hotels were acquired, directly and indirectly, by the
Partnership from limited partnerships in which Mr. Humphrey was a limited
partner and one of his affiliates was the general partner. The Partnership's
interests in the Initial Hotels and the Subsidiary Partnership were acquired in
exchange for (i) the assumption of approximately $13.4 million of outstanding
indebtedness of the sellers of the Initial Hotels, most of which was guaranteed
by Mr. Humphrey and one of his Affiliates and secured by the Initial Hotels,
(ii) the issuance of an aggregate of 527,866 Units to the Humphrey Affiliates,
(iii) the assumption and repayment of approximately $2.1 million of outstanding
indebtedness of the sellers of the Initial Hotels (in addition to the
indebtedness in clause (i) above) of which approximately $1.2 million was repaid
to a Humphrey Affiliate, (iv) the payment of $247,000 in cash to satisfy the
obligations of Humphrey Associates to restore its negative capital account in
one of the limited partnerships selling an Initial Hotel, and (v) the payment of
approximately $4.6 million in cash to persons not affiliated with Mr. Humphrey.
The Partnership acquired the Days Inn-Farmville, Virginia Hotel in
exchange for (i) 95,484 Units, which are redeemable, subject to certain
limitations, for an aggregate of approximately 95,484 shares of Common Stock and
(ii) the assumption of approximately $1.2 million of debt secured by that Hotel,
which was repaid immediately with proceeds from the Company's second public
stock offering.
The Partnership acquired the Best Western Suites-Key Largo, Florida
Hotel pursuant to a purchase agreement that was assigned to the Partnership by
Humphrey Key Largo. Pursuant to the assignment of the purchase agreement,
Humphrey Key Largo received 34,023 Units.
The Humphrey Affiliates own 657,373 Units with a value of approximately
$7.2 million based on the Offering Price. Upon exercise of the Redemption
Rights, which are currently all exercisable, such Units will be redeemed on a
one-for-one basis for shares of Common Stock or for an equivalent amount of
cash, at the sole election of the Company or if the issuance of shares of Common
Stock would result in any person owning more than 9.9% of the outstanding shares
of Common Stock.
Guarantees by Mr. Humphrey and His Affiliates
Mr. Humphrey, jointly and severally with the Company, currently
guarantees the payment of interest and principal on approximately $5.9 million
of the Company's long-term debt. The debt is secured by 19 of the Hotels.
Leases
During 1997, the Partnership and the Lessee were parties to Percentage
Leases with respect to each Hotel, with the exception of the Comfort
Suites-Dover, Delaware, which is subject to a Fixed Lease. Each Lease has or
will have a non-cancelable term of ten years, which may be renewed for an
additional term of five years at the Lessee's option, subject to earlier
termination upon the occurrence of defaults thereunder and certain other events
described therein. Pursuant to the terms of the Leases, the Lessee is required
to pay rent and certain other additional charges and is entitled to all profits
from the operations of the Hotels after the payment of Rent, operating and other
expenses. Payments of Rent under the Percentage Leases and the Fixed Lease have
constituted all of the
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Partnership's and the Company's revenue since their respective inceptions. For
the period January 1, 1997 through December 31, 1997, the Lessee paid an
aggregate of $7,326,193 in Rent under the Leases.
Franchise Licenses
The Lessee, which is owned by Mr. Humphrey, holds all of the Franchise
Licenses for the hotels currently owned by the Partnership and is expected to
hold all of the Franchise Licenses for any subsequently acquired hotel
properties. During 1997, the Lessee paid franchise fees in the aggregate amount
of $875,104.
Non-Competition Agreement and Option Agreement
Mr. Humphrey, certain Humphrey Affiliates and the Company entered into
the Non-Competition Agreement and the Option Agreement in connection with the
IPO. See "Risk Factors - Conflicts of Interest" and "Policies and Objectives
with Respect to Certain Activities - Conflict of Interest Policies - The
Non-Competition Agreement and Option Agreement."
Other
Mr. Whittemore, who is a Director of the Company, is Senior Vice
President of the Underwriter. The Underwriter will receive $801,777 in fees in
connection with this Offering. The Underwriter was the underwriter of the
Company's previous three public stock offerings. The Underwriter also served as
underwriter for $2,460,000 principal amount fixed rate first mortgage refunding
revenue bonds, series 1995 issued by the Industrial Development Authority of
Pulaski County, which are secured by the Comfort Inn-Dublin, Virginia Hotel. The
Underwriter and one of its senior officers (who is not affiliated with the
Company) together receive an ongoing annual fee equal to .25% of the outstanding
principal of those bonds.
Simultaneously with the Offering, the Company will enter into a Capital
Consulting Agreement with Charles A. Mills, III, who will provide the Company
with advice as to future equity offerings and access to capital markets
generally. Mr. Mills is the Senior Vice President, Chairman and largest
shareholder of the Underwriter and served on the Company's Board of Directors
from its IPO on November 29, 1994 to March 17, 1998. Under the terms of the
Capital Consulting Agreement, which has a one year term, the Company will pay
Mr. Mills $20,000 plus .25% of the net proceeds (but not to exceed $100,000)
from public equity offerings over the next twelve months.
THE LESSEE
The Lessee is a Maryland corporation. The Lessee currently leases each
Hotel from the Partnership pursuant to individual Leases relating to each Hotel.
The Partnership intends to lease to the Lessee (i) additional existing hotels
acquired by the Partnership on terms and conditions substantially similar to the
Percentage Leases applicable to the Hotels, and (ii) hotels developed by the
Partnership pursuant to Fixed Leases, which will provide for the payment of a
fixed monthly Rent and otherwise have terms and conditions substantially similar
to the Percentage Leases applicable to the Hotels. The Lessee's ability to
perform its obligations, including making Rent payments under the Leases, is
dependent on the Lessee's ability to generate sufficient net cash flow from the
operation of the Hotels and any other hotels leased to the Lessee by the
Partnership. The Lessee's obligations under the Leases are and will be
unsecured. Mr. Humphrey does not guarantee the Lessee's obligations under the
Percentage Leases, but the Percentage Leases currently contain cross-default
provisions. Accordingly, the Lessee's failure to make required payments under
any Percentage Lease will allow the Company to terminate any or all of the
Percentage Leases. See "Risk Factors - Dependence on the Lessee." The Percentage
Leases have terms of ten years and are renewable for an additional term of five
years at the option of the Lessee, but are subject to earlier termination upon
the occurrence of certain events. Under the Percentage Leases, the Partnership
is entitled to receive from the Lessee Base and Percentage Rents. Mr. Humphrey
is the sole shareholder of the Lessee and President and Chairman of the Board of
the Company. Consequently, he has a conflict of interest regarding the
enforcement of the Percentage Leases. See "Risk Factors - Conflicts of Interest
- - No Arm's Length Bargaining
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on the Percentage Leases, the Development Agreement, the Services Agreement, the
Hotel Purchase Agreements, the Non-Competition Agreements and Option Agreement"
and "Business and Properties."
The Operator, an affiliate of the Lessee, managed the Initial Hotels
from 1989 to 1996 and managed the Days Inn-Farmville, Virginia Hotel since it
was acquired by a Humphrey Affiliate in November 1994 until the Operator
combined its operations with the Lessee effective January 1, 1996. The Lessee
provides all employees and performs all marketing, accounting and management
functions necessary to operate the Hotels. The Lessee has in-house programs for
accounting and the management and marketing of the Hotels. The Lessee utilizes
its sales management program to coordinate, direct and manage the sales
activities of personnel located at the Hotels.
The Lessee's primary philosophy for each hotel it operates is to
provide the best service and cleanest setting for the most value in the market
that the hotel serves. In 1990, the Operator, an affiliate of the Lessee,
received the first Choice Hotels Gold Award ever presented by Choice Hotels for
its operation of the Comfort Inn-Farmville, Virginia. The Choice Hotels Gold
Award is presented annually to those hotels that have excelled in service,
appearance, housekeeping and employee training. The Operator received three
additional Choice Hotels Gold Awards for its operation of the Comfort
Inn-Elizabethton, Tennessee and two Choice Hotels Gold Awards for its operation
of the Comfort Inn-Beacon Marina, Solomons, Maryland. An affiliate of the
Operator has also received four nominations for Comfort Inn's Inn of the Year
for its operation of the Comfort Inns-Dublin, Virginia, -Elizabethton,
Tennessee, -Farmville, Virginia and -Solomons, Maryland. Choice Hotels awards
the "Inn of the Year" to one hotel, which is chosen from the approximately 35
hotels nominated for that Award. The Operator has received one Choice Hotels
Gold Award and two Choice Hotels Silver Awards for excellence in service and
housekeeping for its operation of the Comfort Inn-Morgantown, West Virginia and
one Choice Hotels Gold Award for its operation of the Comfort Inn-New Castle,
Pennsylvania.
The Lessee believes that in order to carry out its philosophy, it must
allow its managers the flexibility to quickly meet the needs and desires of
customers of an individual hotel. The Lessee monitors the performance of its
managers by conducting frequent on-site reviews and by closely reviewing and
controlling expenditures and cash flows at individual hotels.
The Lessee's President, Randy P. Smith, has been employed in the hotel
business since 1978 and has operated a variety of hotels under many franchise
brands. He joined the Operator in 1989 as Director of Operations and in 1991 he
was appointed Vice President of Operations. He was appointed President of the
Lessee in 1994. He has been appointed to the Comfort Inn Advisory Council, the
International Operators Council for Choice Hotels ("IOC") National Marketing
Committee, the IOC National Operations and Standards Committee, the IOC National
Awards Committee, the Region 4 (Virginia) Regional Advisory Board for Choice
Hotels and numerous boards for the IOC. Mr. Smith received an M.B.A. degree from
Loyola College in 1995.
The Lessee's Chief Financial Officer, William F. Goodrick, joined the
Lessee in January 1998. Mr. Goodrick has over thirty years experience in the
public and private sector of the accounting and financial field. Prior to
joining the Lessee, Mr. Goodrick was Vice President, Asset Management for NHP,
Inc., the nation's second largest manager of multi-family housing. Prior to
that, he owned his own business providing accounting and financial services to
the private sector of the business community, including two medium sized hotel
management and development companies. Prior to that, he was Senior Vice
President of Finance for C.R.I., Inc., a multi-billion dollar real estate
syndication firm. He is a certified public accountant and received his B.S.B.A.
from Georgetown University in 1967.
The Lessee's Vice President, Bethany H. Hooper, joined Humphrey
Associates in 1988 after working for the accounting firm of Reznick Fedder &
Silverman as a certified public accountant. In 1991, she was appointed Vice
President of Accounting and Administration of Humphrey Associates and the
Operator. Ms. Hooper continues to work for both the Lessee and Humphrey
Associates. She received a B.S. degree in Business Administration from Lewis and
Clark College in 1986 and an M.B.A. degree in Finance from Loyola College in
1991.
The Lessee's Senior Director of Operations, Dave Yakes, has been
employed in the hotel business since 1985. He has an extensive background in
hotel operations and joined the Lessee in 1995. Prior to his current position,
Mr. Yakes was a Regional Director of Operations as well as the General Manager
of the Comfort Inn-
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Beacon Marina, Solomons, Maryland. Before joining the Lessee, Mr. Yakes worked
several years for Winegardner and Hammons, Inc., a Cincinnati, Ohio based hotel
management company. He received a B.S. degree in Hospitality and Tourism
Management from Grand Valley State University in 1991.
OWNERSHIP OF THE COMPANY'S COMMON STOCK
Security Ownership of Certain Beneficial Owners
The following table sets forth as of December 31, 1997 each person
known by the Company to be a beneficial owner of more than five percent (5%) of
its Common Stock. The Company has no other class of equity securities
outstanding. Unless otherwise indicated, said shares are owned directly and the
indicated person has sole voting and investment power.
<TABLE>
<CAPTION>
Name and Address Amount and Nature
of Beneficial of Beneficial Percent
Owner Ownership of Class
- ---------------- ----------------- --------
<S><C>
James I. Humphrey, Jr. 657,373(1) 15.9%(1)
The Humphrey Companies
12301 Old Columbia Pike, Suite 300
Silver Spring, MD 20904
James T. Martin 322,547(2) 9.3%
Odyssey Capital Reg.
6 Front Street
Hamilton, HMII, Bermuda
Equitable Companies, Inc. 321,300(3) 9.2%
787 Seventh Avenue
New York, NY 10019
Smith Barney Mutual 191,300(4) 5.5%
Funds Management Inc.
338 Greenwich Street
New York, NY 10013
</TABLE>
- ---------------------
(1) Assumes that all Units held by James I. Humphrey and his Affiliates are
redeemed for shares of Common Stock.
(2) Based upon information contained in Schedule 13D/A, dated April 28, 1997,
and filed with the Commission on May 1, 1997.
(3) Based upon information contained in Schedule 13G/A, dated February 10,
1998, and filed with the Commission on February 17, 1998.
(4) Based upon information contained in Schedule 13D, dated February 5, 1997,
and filed with the Commission on February 6, 1997.
Security Ownership by Management
The following table sets forth certain information as of February 1,
1998 regarding the beneficial ownership of Common Stock by (i) each Director of
the Company, (ii) each executive officer of the Company, and (iii) by all
Directors and executive officers of the Company as a group. Unless otherwise
indicated, all shares are owned directly and the indicated person has sole
voting and investment power.
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<TABLE>
<CAPTION>
Shares of Common Stock Percent of
Name of Beneficial Owner Beneficially Owned Class
- ------------------------ ---------------------- -------------------------------------
Before Offering After Offering(5)
--------------- -----------------
<S><C>
Margaret Allen 3,846 * *
James I. Humphrey, Jr. 657,373(1) 15.9% 12.8%
Andrew A. Mayer, M.D. 90,552 2.6% 2.0%
Dr. Leah T. Robinson 86,165 2.5% 1.9%
George R. Whittemore 92,652 2.7% 2.1%
Jeffrey M. Zwerdling 59,062(2) 1.7% 1.5%
------- ---- ----
Total 989,650(3) 23.9%(4) 19.5%(4)
</TABLE>
- ---------------------
* Represents less than 1% of the outstanding shares of Common Stock.
(1) Represents 657,373 shares of Common Stock issuable to Mr. Humphrey,
Humphrey Associates, Farmville Lodging Associates, or Humphrey Key Largo
upon redemption of their Units. Mr. Humphrey is the sole shareholder of
Humphrey Associates and owns a 98% interest in Farmville Lodging
Associates and a 73% interest in Humphrey Key Largo. The redemption rights
are exercisable at any time subject to certain conditions.
(2) Includes 33,087 shares of Common Stock owned by Mr. Zwerdling and 25,975
shares of Common Stock over which Mr. Zwerdling has dispositive power.
(3) Does not include 300 shares acquired by Mr. Whittemore on February 13,
1998. At the Closing, officers and Directors of the Company will acquire a
total of 10,000 Common Shares and thereafter, will own 999,950 shares of
Common Stock, assuming that all Units held by Mr. Humphrey, Humphrey
Associates, Farmville Lodging Associates and Humphrey Key Largo are
redeemed for shares of Common Stock.
(4) Assumes that all Units held by Mr. Humphrey, Humphrey Associates,
Farmville Lodging Associates and Humphrey Key Largo are redeemed for
shares of Common Stock.
(5) Includes 300 Common Shares that Mr. Whittemore acquired on February 13,
1998, and 10,000 Common Shares that Mr. Zwerdling intends to acquire in
the Offering.
DESCRIPTION OF CAPITAL STOCK
General
The Articles of Incorporation of the Company provide that the Company
may issue up to 35,000,000 shares of capital stock, consisting of 25,000,000
shares of Common Stock, $0.01 par value per share, and 10,000,000 shares of
preferred stock, $0.01 par value per share ("Preferred Stock"). Upon completion
of the Offering, 4,481,700 shares of Common Stock will be issued and
outstanding, 657,373 shares of Common Stock will be reserved for issuance upon
redemption of Units and no Preferred Stock will be issued and outstanding.
Common Stock
All shares of Common Stock are duly authorized, fully paid and
nonassessable. Subject to the preferential rights of any other shares or series
of shares of capital stock, Common Shareholders are entitled to receive
dividends if and when authorized and declared by the Board of Directors of the
Company out of assets legally available therefor and to share ratably in the
assets of the Company legally available for distribution to its shareholders in
the event of its liquidation, dissolution or winding-up after payment of, or
adequate provision for, all known debts and liabilities of the Company.
Commencing with the dividend declared in October 1997, the Company began paying
monthly dividends. For the period beginning November 29, 1994, the closing date
of the IPO, and ending
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December 31, 1994, the Company made a distribution of $.044 per share to the
Common Shareholders, which is the equivalent of a $.125 quarterly or a $.50
annual distribution. For each of the quarters ended March 31, 1995, and June 30,
1995, the Company made a distribution of $.15 per share, which is the equivalent
of a $.60 annual distribution. For the quarter ended September 30, 1995, the
Company made a distribution of $.181 per share, which represents a pro rata
distribution of $.19 per share from the closing date of the Company's second
public stock offering to the end of the quarter. For each of the quarters ended
December 31, 1995; March 31, 1996; June 30, 1996; September 30, 1996; December
31, 1996; March 31, 1997; June 30, 1997; and September 30, 1997, the Company
made a distribution of $.19 per share, which is the equivalent of a $.76 annual
distribution. During the quarter ended December 31, 1997, the Company made
monthly distributions of $.0675 per share, which is the equivalent of an $.81
annual distribution. See "Price Range of Common Stock and Distributions."
Each outstanding share of Common Stock entitles the holder to one vote
on all matters submitted to a vote of shareholders, including the election of
Directors, and, except as otherwise required by law or except as provided with
respect to any other class or series of shares of capital stock, the Common
Shareholders will possess the exclusive voting power. There is no cumulative
voting in the election of Directors, which means in all elections of Directors,
each Common Shareholder has the right to cast one vote for each share of stock
for each candidate.
Preferred Stock
Shares of Preferred Stock may be issued from time to time, in one or
more series, as authorized by the Board of Directors. Because the Board of
Directors has the power to establish the preferences and rights of each class or
series of Preferred Stock, the Board of Directors may afford the holders of any
series or class of Preferred Stock preferences, powers and rights, voting or
otherwise, senior to the rights of Common Shareholders. The Board could
authorize the issuance of Preferred Stock with terms and conditions which could
have the effect of discouraging a takeover or other transaction which holders of
some, or a majority, of the shares of Common Stock might believe to be in their
best interests or in which holders of some, or a majority, of the shares of
Common Stock might receive a premium for their shares of Common Stock over the
then market price of such shares of Common Stock. As of the date hereof, no
shares of Preferred Stock are outstanding and the Company has no present plans
to issue any Preferred Stock.
Restrictions on Ownership and Transfer
For the Company to qualify as a REIT under the Code, it must meet
certain requirements concerning the ownership of its outstanding shares of
capital stock. Specifically, not more than 50% in value of the Company's
outstanding capital stock may be owned, directly or indirectly, by five or fewer
individuals (as defined in the Code to include certain entities) during the last
half of a taxable year, and the Company must be beneficially owned by 100 or
more persons during at least 335 days of a taxable year of twelve months or
during a proportionate part of a shorter taxable year. See "Federal Income Tax
Considerations - Requirements for Qualification." In addition, the Company must
meet certain requirements regarding the nature of its gross income in order to
qualify as a REIT. One such requirement is that at least 75% of the Company's
gross income for each year must consist of rents from real property and income
from certain other real property investments. The rents received by the
Partnership from the Lessee will not qualify as rents from real property, which
likely would result in loss of REIT status for the Company, if the Company were
to own, actually or constructively, 10% or more of the ownership interests in
the Lessee within the meaning of Section 856(d)(2)(B) of the Code. See "Federal
Income Tax Considerations Requirements for Qualification - Income Tests."
Because the Board of Directors believes it is essential for the Company
to continue to qualify as a REIT, the Articles of Incorporation, subject to
certain exceptions described below, provide that no person may own, or be deemed
to own by virtue of the attribution provisions of the Code, more than 9.9% of
(i) the number of outstanding shares of Common Stock or (ii) the number of
outstanding shares of Preferred Stock of any class or series (the "Ownership
Limitation"). Any transfer of shares of Common Stock or Preferred Stock that
would (i) result in any person owning, directly or indirectly, shares of Common
Stock or Preferred Stock in excess of the Ownership Limitation, (ii) result in
the shares of Common Stock and Preferred Stock being owned by fewer than 100
persons (determined without reference to any rules of attribution), (iii) result
in the Company being "closely held" within the meaning of Section 856(h) of the
Code, or (iv) cause the Company to own, actually or
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<PAGE>
constructively, 10% or more of the ownership interests in a tenant of the
Company's, the Partnership's or the Subsidiary Partnership's real property,
within the meaning of Section 856(d)(2)(B) of the Code, will be null and void,
and the intended transferee will acquire no rights in such shares of Common
Stock or Preferred Stock.
Subject to certain exceptions described below, any purported transfer
of shares of Common Stock or Preferred Stock that would (i) result in any person
owning, directly or indirectly, shares of Common Stock or Preferred Stock in
excess of the Ownership Limitation, (ii) result in the shares of Common Stock
and Preferred Stock being owned by fewer than 100 persons (determined without
reference to any rules of attribution), (iii) result in the Company being
"closely held" within the meaning of Section 856(h) of the Code, or (iv) cause
the Company to own, actually or constructively, 10% or more of the ownership
interests in a tenant of the Company's, the Partnership's or the Subsidiary
Partnership's real property, within the meaning of Section 856(d)(2)(B) of the
Code, will be designated as "Shares-in-Trust" and transferred automatically to a
trust (the "Trust") effective on the day before the purported transfer of such
shares of Common Stock or Preferred Stock. The record holder of the shares of
Common Stock or Preferred Stock that are designated as Shares-in-Trust (the
"Prohibited Owner") will be required to submit such number of shares of Common
Stock or Preferred Stock to the Company for registration in the name of the
Trust (the "Trustee"). The Trustee will be designated by the Company, but will
not be affiliated with the Company. The beneficiary of the Trust (the
"Beneficiary") will be one or more charitable organizations that are named by
the Company.
Shares-in-Trust will remain issued and outstanding shares of Common
Stock or Preferred Stock and will be entitled to the same rights and privileges
as all other shares of the same class or series. The Trustee will receive all
dividends and distributions on the Shares-in-Trust and will hold such dividends
or distributions in trust for the benefit of the Beneficiary. The Trustee will
vote all Shares-in-Trust. The Trustee will designate a permitted transferee of
the Shares-in-Trust, provided that the permitted transferee (i) purchases such
Shares-in-Trust for valuable consideration and (ii) acquires such
Shares-in-Trust without such acquisition resulting in a transfer to another
Trust.
The Prohibited Owner with respect to Shares-in-Trust will be required
to repay to the Trustee the amount of any dividends or distributions received by
the Prohibited Owner (i) that are attributable to any Shares-in-Trust and (ii)
the record date of which was on or after the date that such shares became
Shares-in-Trust. The Prohibited Owner generally will receive from the Trustee
the lesser of (i) the price per share such Prohibited Owner paid for the shares
of Common Stock or Preferred Stock that were designated as Shares-in-Trust (or,
in the case of a gift or devise, the Market Price (as defined below) per share
on the date of such transfer) or (ii) the price per share received by the
Trustee from the sale of such Shares-in-Trust. Any amounts received by the
Trustee in excess of the amounts to be paid to the Prohibited Owner will be
distributed to the Beneficiary.
The Shares-in-Trust will be deemed to have been offered for sale to the
Company, or its designee, at a price per share equal to the lesser of (i) the
price per share in the transaction that created such Shares-in-Trust (or, in the
case of a gift or devise, the Market Price per share on the date of such
transfer) or (ii) the Market Price per share on the date that the Company, or
its designee, accepts such offer. The Company will have the right to accept such
offer for a period of 90 days after the later of (i) the date of the purported
transfer which resulted in such Shares-in-Trust or (ii) the date the Company
determines in good faith that a transfer resulting in such Shares-in-Trust
occurred.
"Market Price" on any date shall mean the average of the Closing Price
(as defined below) for the five consecutive Trading Days (as defined below)
ending on such date. The "Closing Price" on any date shall mean the last quoted
price as reported by The Nasdaq National Market. "Trading Day" shall mean a day
on which the principal national securities exchange on which the shares of
Common Stock or Preferred Stock are listed or admitted to trading is open for
the transaction of business or, if the shares of Common Stock or Preferred Stock
are not listed or admitted to trading on any national securities exchange, shall
mean any day other than a Saturday, a Sunday or a day on which banking
institutions in the State of New York are authorized or obligated by law or
executive order to close.
Any person who acquires or attempts to acquire shares of Common Stock
or Preferred Stock in violation of the foregoing restrictions, or any person who
owned shares of Common Stock or Preferred Stock that were
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<PAGE>
transferred to a Trust, will be required (i) to immediately give written notice
to the Company of such event and (ii) to provide to the Company such other
information as the Company may request in order to determine the effect, if any,
of such transfer on the Company's status as a REIT.
All persons who own, directly or indirectly, more than 5% (or such
lower percentages as required pursuant to regulations under the Code) of the
outstanding shares of Common Stock and Preferred Stock must, within 30 days
after January 1 of each year, provide to the Company a written statement or
affidavit stating the name and address of such direct or indirect owner, the
number of shares of Common Stock and Preferred Stock owned directly or
indirectly, and a description of how such shares are held. In addition, each
direct or indirect shareholder shall provide to the Company such additional
information as the Company may request in order to determine the effect, if any,
of such ownership on the Company's status as a REIT and to ensure compliance
with the Ownership Limitation.
The Ownership Limitation generally will not apply to the acquisition of
shares of Common Stock or Preferred Stock by an underwriter that participates in
a public offering of such shares. In addition, the Board of Directors, upon
receipt of a ruling from the Service or an opinion of counsel and upon such
other conditions as the Board of Directors may direct, may exempt a person from
the Ownership Limitation under certain circumstances. The foregoing restrictions
will continue to apply until (i) the Board of Directors determines that it is no
longer in the best interests of the Company to attempt to qualify, or to
continue to qualify, as a REIT and (ii) there is an affirmative vote of
two-thirds of the number of shares of Common Stock and Preferred Stock entitled
to vote on such matter at a regular or special meeting of the shareholders of
the Company.
All certificates representing shares of Common Stock or Preferred Stock
will bear a legend referring to the restrictions described above.
The Ownership Limitation could have the effect of discouraging a
takeover or other transaction in which holders of some, or a majority, of shares
of Common Stock might receive a premium for their shares of Common Stock over
the then prevailing market price or which such holders might believe to be
otherwise in their best interest.
Other Matters
The transfer agent and registrar for the Common Stock is First Union
National Bank of North Carolina.
CERTAIN PROVISIONS OF VIRGINIA LAW AND
OF THE COMPANY'S ARTICLES OF INCORPORATION AND BYLAWS
The following summary of certain provisions of Virginia law and of the
Articles of Incorporation and Bylaws of the Company does not purport to be
complete and is subject to and qualified in its entirety by reference to
Virginia law and the Articles of Incorporation and Bylaws of the Company.
Certain provisions of Virginia law and the Articles of Incorporation and Bylaws
are described elsewhere in this Prospectus.
Board of Directors
The Bylaws provide that the number of Directors of the Company may be
established by the Board of Directors but may not be fewer than three nor more
than nine. Any vacancy will be filled, at any regular meeting or at any special
meeting called for that purpose, by a majority of the remaining Directors,
except that a vacancy resulting from an increase in the number of Directors must
be filled by a majority of the entire Board of Directors.
The Company's Bylaws also provide that a Director may be removed with
or without cause with the affirmative vote of at least two-thirds of the votes
entitled to be cast in the election of Directors. This provision, when coupled
with the provisions of the Bylaws authorizing the Board of Directors to fill
vacant directorships, precludes the Company's shareholders from removing
incumbent Directors, except upon the existence of a substantial affirmative
vote, and filling the vacancies created by such removal with their own nominees.
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Amendment
The Articles of Incorporation may be amended by the affirmative vote of
the holders of a majority of the outstanding shares of Common Stock, with the
shareholders voting as a class with one vote per share; provided, that the
Articles of Incorporation provision relating to the Company's election to be
taxed as a REIT shall not be amended, altered, changed or repealed without the
affirmative vote of at least 80% of the members of the Board of Directors or the
affirmative vote of holders of two-thirds of the outstanding shares of Common
Stock and any other shares of capital stock entitled to vote generally in the
election of Directors voting as a class. The Company's Bylaws may be amended by
the Board of Directors or by vote of the holders of a majority of the
outstanding shares of Common Stock, provided that provisions with respect to
removal of Directors, quorum requirements and approval of certain matters by a
majority of the Directors, cannot be amended without the affirmative vote of 80%
of the members of the entire Board of Directors, including a majority of the
Independent Directors, or the holders of two-thirds of the outstanding shares of
Common Stock and any other shares of capital stock entitled to vote generally in
the election of Directors.
Business Combinations
The Virginia Stock Corporation Act contains provisions restricting
"Affiliated Transactions." These provisions, with several exceptions discussed
below, require approval of material acquisition transactions between a Virginia
corporation having more than 300 shareholders of record and any holder of more
than 10% of any class of its outstanding voting shares (an "Interested
Shareholder") by the holders of at least two-thirds of the remaining voting
shares. Affiliated Transactions subject to this approval requirement include
mergers, share exchanges, material dispositions of corporate assets not in the
ordinary course of business, any dissolution of the corporation proposed by or
on behalf of an Interested Shareholder, or any reclassification, including, a
reverse stock split, a recapitalization or a merger of the corporation with its
subsidiaries that increases the percentage of voting shares owned beneficially
by an Interested Shareholder by more than 5%.
For three years following the time that an Interested Shareholder
becomes an owner of 10% of the outstanding voting shares, a Virginia corporation
cannot engage in an Affiliated Transaction with such Interested Shareholder
without approval of two-thirds of the voting shares other than those shares
beneficially owned by the Interested Shareholder, and majority approval of the
"Disinterested Directors." A Disinterested Director means, with respect to a
particular Interested Shareholder, a member of the Company's Board of Directors
who was (i) a Director on the date on which an Interested Shareholder became an
Interested Shareholder and (ii) recommended for election by, or was elected to
fill a vacancy and received the affirmative vote of, a majority of the
Disinterested Directors then on the Board. At the expiration of the three year
period, the statute requires approval of Affiliated Transactions by two-thirds
of the voting shares other than those beneficially owned by the Interested
Shareholder.
The principal exceptions to the special voting requirement apply to
transactions proposed after the three year period has expired and require either
that the transaction be approved by a majority of the corporation's
Disinterested Directors or that the transaction satisfy the fair-price
requirements of the statute. In general, the fair-price requirement provides
that in a two-step acquisition transaction, the Interested Shareholder must pay
the shareholders in the second step either the same amount of cash or the same
amount and type of consideration paid to acquire the Virginia corporation's
shares in the first step.
None of the foregoing limitations and special voting requirements
applies to a transaction with an Interested Shareholder whose acquisition of
shares making such person an Interested Shareholder was approved by a majority
of the Virginia corporation's Disinterested Directors.
These provisions were designed to deter certain takeovers of Virginia
corporations. In addition, the statute provides that, by affirmative vote of a
majority of the voting shares other than shares owned by any Interested
Shareholder, a corporation can adopt an amendment to its Articles of
Incorporation or Bylaws providing that the Affiliated Transactions provisions
shall not apply to the corporation. The Company has not "opted out" of the
Affiliated Transactions provisions.
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Control Share Acquisitions
The Virginia Stock Corporation Act also contains provisions regulating
certain "Control Share Acquisitions," which are transactions causing the voting
strength of any person acquiring beneficial ownership of shares of a public
corporation in Virginia to meet or exceed certain threshold percentages (20%,
331/3% or 50%) of the total votes entitled to be cast for the election of
Directors. Shares acquired in a control share acquisition have no voting rights
unless: (i) the voting rights are granted by a majority vote of all outstanding
shares other than those held by the acquiring person or any officer or employee
Director of the corporation, or (ii) the Articles of Incorporation or Bylaws of
the corporation provide that these Virginia law provisions do not apply to
acquisitions of its shares. The acquiring person may require that a special
meeting of the shareholders be held to consider the grant of voting rights to
the shares acquired in the control share acquisition. These provisions were
designed to deter certain takeovers of Virginia public corporations. Under
Virginia law, a corporation may "opt out" of the Control Share Acquisitions
provisions in its Articles of Incorporation or Bylaws. The Company has not
"opted out" of the Control Share Acquisitions provisions.
Operations
The Company is generally prohibited from engaging in certain activities
and acquiring or holding property or engaging in any activity that would cause
the Company to fail to qualify as a REIT.
Advance Notice of Director Nominations and New Business
The Bylaws of the Company provide (a) with respect to an annual meeting
of shareholders, nominations of persons for election to the Board of Directors
and the proposal of business to be considered by such shareholders may be made
only (i) pursuant to the Company's notice of the meeting, (ii) by the Board of
Directors or (iii) by a shareholder who is entitled to vote at the meeting and
has complied with the advance notice procedures set forth in the Bylaws and (b)
with respect to special meetings of shareholders, nominations of persons for
election to the Board of Directors may be made only (i) pursuant to the
Company's notice of meeting, (ii) by the Board of Directors or (iii) provided
that the Board of Directors has determined that Directors shall be elected at
such meeting, by a shareholder who is entitled to vote at the meeting and has
complied with the advance notice provisions set forth in the Bylaws.
SHARES AVAILABLE FOR FUTURE SALE
Upon the completion of the Offering, the Company will have 4,481,700
shares of Common Stock outstanding, 657,373 shares of Common Stock reserved for
issuance upon redemption of Units and no shares of Preferred Stock outstanding.
After the Closing Date, all shares of Common Stock will be freely tradeable by
persons other than "Affiliates" of the Company without restriction under the
Securities Act, subject to certain limitations on ownership set forth in the
Articles of Incorporation. See "Description of Capital Stock - Restrictions on
Transfer."
Pursuant to the Partnership Agreement, the Limited Partners, which are
Mr. Humphrey and three of his Affiliates, have the right to redeem their Units
in exchange for shares of Common Stock (the "Redemption Rights") on a
one-for-one basis (or for cash, at the election of the Company or if the
issuance of shares of Common Stock would result in any person owning, directly
or indirectly, more than 9.9% of the shares of Common Stock). The Redemption
Rights relating to all outstanding Units currently are exercisable at any time.
See "Partnership Agreement - Redemption Rights." Any amendment to the
Partnership Agreement that would affect the Redemption Rights requires the
consent of Limited Partners holding more than 50% of the Units held by all
Limited Partners (except the Company).
Shares of Common Stock issued to holders of Units upon exercise of the
Redemption Rights will be "restricted" securities under the meaning of Rule 144
promulgated under the Securities Act ("Rule 144") and may not be sold in the
absence of registration under the Securities Act unless an exemption from
registration is available, including exemptions contained in Rule 144.
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In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who beneficially owned shares for at least one
year, including any person who may be deemed an "affiliate" of the Company,
would be entitled to sell within any three-month period a number of such shares
that does not exceed the greater of 1% of the then outstanding shares of Common
Stock or the average weekly trading volume in the Common Stock during the four
calendar weeks preceding the date on which notice of the sale is filed with the
Commission. A person who is not deemed to have been an "affiliate" of the
Company at any time during the three months immediately preceding a sale and who
has beneficially owned shares for at least two years would be entitled to sell
such shares under Rule 144 without regard to the volume limitation described
above.
The Company has agreed to file a registration statement with the
Commission covering the resale of any shares of Common Stock issued to a Limited
Partner upon redemption of Units. Upon request from a Limited Partner at any
time, the Company will file such registration statement and use its best efforts
to have the registration statement declared effective and to keep it effective
for a period of two years. Upon effectiveness of such registration statement,
those persons who receive shares of Common Stock upon redemption of Units may
sell such shares in the secondary market without being subject to the volume
limitations or other requirements of Rule 144. The Company will bear expenses
incident to its registration requirements, except that such expenses shall not
include any selling commissions, the Commission or state securities registration
fees, transfer taxes or certain other fees or taxes relating to such shares.
Registration rights may be granted to future sellers of hotels to the
Partnership who may receive, in lieu of cash, shares of Common Stock, Units, or
other securities convertible into shares of Common Stock.
The Common Stock trades on The Nasdaq National Market under the symbol
"HUMP." See "Underwriting." No prediction can be made as to the effect, if
any, that the Offering or the availability of shares for future sale, will have
on the market price for shares of Common Stock or Preferred Stock prevailing
from time to time. Sales of substantial amounts of shares of Common Stock, or
the perception that such sales could occur, may affect adversely prevailing
market prices of the shares of Common Stock. See "Risk Factors - and
"Partnership Agreement - Transferability of Interests."
PARTNERSHIP AGREEMENT
The following summary of the Partnership Agreement, and the
descriptions of certain provisions thereof set forth elsewhere in this
Prospectus, is qualified in its entirety by reference to the Partnership
Agreement, which is filed as an exhibit to the Registration Statement of which
this Prospectus is a part.
Management
The Partnership has been organized as a Virginia limited partnership
pursuant to the terms of the Partnership Agreement. Pursuant to the Partnership
Agreement, the General Partner as the sole general partner of the Partnership,
has full, exclusive and complete responsibility and discretion in the management
and control of the Partnership. All of the outstanding shares of beneficial
interest of the General Partner are held by the Company. The Limited Partners
have no authority in their capacity as Limited Partners to transact business
for, or participate in the management activities or decisions of, the
Partnership. The General Partner, without the consent of the Limited Partners,
may amend the Partnership Agreement in any respect to the benefit of and not
adverse to the interests of the Limited Partners; provided, however, that any
other amendments to the Partnership Agreement requires the consent of Limited
Partners (other than the General Partner) holding more than 50% of the
percentage interests of the Limited Partners (other than the General Partner).
Transferability of Interests
The General Partner may not voluntarily withdraw from the Partnership,
and the Company may not transfer or assign its interest in the General Partner.
In addition, the General Partner may not transfer or assign its interest in the
Partnership unless (i) 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 Redemption Rights
immediately prior to such transaction, or (ii) the successor to the Company
contributes
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substantially all of its assets to the Partnership in return for an interest in
the Partnership. With certain limited exceptions, the Limited Partners may not
transfer their interests in the Partnership, in whole or in part, without the
written consent of the Company, which consent the Company may withhold in its
sole discretion. The Company may not consent to any transfer that would cause
the Partnership to be treated as a corporation for federal income tax purposes.
Capital Contribution
The Company will contribute to the Partnership substantially all the
Net Proceeds of the Offering in exchange for 1,000,000 Units. After the Closing
Date, the Company will own an 87.21% partnership interest in the Partnership,
and the Limited Partners will collectively own a 12.79% limited partnership
interest in the Partnership. Upon the Company's contribution of the Net Proceeds
to the Partnership, the property of the Partnership will be revalued to its fair
market value (based on the Offering Price of the Common Shares), and the capital
accounts of the partners will be adjusted to reflect the manner in which the
unrealized gain or loss inherent in such property would be allocated among the
partners under the terms of the Partnership Agreement if there were a taxable
disposition of such property for such fair market value on the date of the
revaluation. The Partnership Agreement provides that if the Partnership requires
additional funds at any time or from time to time in excess of funds available
to the Partnership from borrowing or capital contributions, the Company may
borrow such funds from a financial institution or other lender and lend such
funds to the Partnership on the same terms and conditions as are applicable to
the Company's borrowing of such funds. Under the Partnership Agreement, the
Company generally is obligated to contribute the proceeds of a share offering as
additional capital to the Partnership. Moreover, the Company is authorized to
cause the Partnership to issue partnership interests for less than fair market
value if the Company has concluded in good faith that such issuance is in the
best interests of the Company and the Partnership. If the Company so contributes
additional capital to the Partnership, the Company will receive additional Units
and the Company's percentage interest in the Partnership will be increased on a
proportionate basis based upon the amount of such additional capital
contributions and the value of the 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 Company. In addition, if the Company contributes additional
capital to the Partnership, the Company will revalue the property of the
Partnership to its fair market value (as determined by the Company) and the
capital accounts of the partners will be adjusted to reflect the manner in which
the unrealized gain or loss inherent in such property (that has not been
reflected in the capital accounts previously) would be allocated among the
partners under the terms of the Partnership Agreement if there were a taxable
disposition of such property for such fair market value on the date of the
revaluation.
Redemption Rights
Pursuant to the Partnership Agreement, the Limited Partners have the
Redemption Rights, which enable them to cause the Partnership to redeem their
interests in the Partnership in exchange for cash or, at the Company's option,
shares of Common Stock on a one-for-one basis. The redemption price will be paid
in cash in the discretion of the Company or in the event that the issuance of
shares of Common Stock to the redeeming Limited Partner would (i) result in any
person owning, directly or indirectly, shares of Common Stock in excess of the
Ownership Limitation, (ii) result in shares of capital stock of the Company
being owned by fewer than 100 persons (determined without reference to any rules
of attribution), (iii) result in the Company being "closely held" within the
meaning of Section 856(h) of the Code, (iv) cause the Company to own, actually
or constructively, 10% or more of the ownership interests in a tenant of the
Company's or the Partnership's real property, within the meaning of Section
856(d)(2)(B) of the Code, or (v) cause the acquisition of shares of Common Stock
by such redeeming Limited Partner to be "integrated" with any other distribution
of shares of Common Stock for purposes of complying with the Securities Act. The
Redemption Rights currently are exercisable at any time, provided that (i) no
Limited Partner may exercise the Redemption Right for less than 1,000 Units or,
if such Limited Partner holds less than 1,000 Units, less than all of the Units
held by such Limited Partner and (ii) no Limited Partner may exercise the
Redemption Rights if, as a result, such partner or any other person would, upon
redemption, own, directly or indirectly, shares of Common Stock in excess of the
Ownership Limitation. The aggregate number of shares of Common Stock issuable
upon exercise of the Redemption Rights is 657,373. The number of shares of
Common Stock issuable upon exercise of the Redemption Rights will be adjusted
upon the occurrence of share splits, mergers,
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consolidations or similar pro rata share transactions, which otherwise would
have the effect of diluting or increasing the ownership interests of the Limited
Partners or the shareholders of the Company.
Operations
The Partnership Agreement requires that the Partnership be operated in
a manner that will enable the Company to satisfy the requirements for being
classified as a REIT, to use reasonable efforts to avoid any federal income or
excise tax liability imposed by the Code, and to ensure that the Partnership
will not be classified as a "publicly traded partnership" for purposes of
Section 7704 of the Code.
In addition to the administrative and operating costs and expenses
incurred by the Partnership, the Partnership pays all administrative costs and
expenses of the Company (the "Company Expenses") and the Company Expenses are
treated as expenses of the Partnership. The Company Expenses generally include
(i) all expenses relating to the formation and continuity of existence of the
Company, (ii) all expenses relating to the registration of securities by the
Company, (iii) all expenses associated with the preparation and filing of any
periodic reports by the Company under federal, state or local laws or
regulations, (iv) all expenses associated with compliance by the Company with
laws, rules and regulations promulgated by any regulatory body and (v) all other
operating or administrative costs of the Company incurred in the ordinary course
of its business on behalf of the Partnership. The Company Expenses, however, do
not include any administrative and operating costs and expenses incurred by the
Company that are attributable to hotel properties or partnership interests in
the Subsidiary Partnership that are owned by the Company directly. The Company
currently does not own any Hotel directly.
Distributions
The Partnership Agreement provides that the Partnership will distribute
cash from operations (including net sale or refinancing proceeds, but excluding
net proceeds from the sale of the Partnership's property in connection with the
liquidation of the Partnership) on a quarterly (or, at the election of the
Company, more frequent) basis, in amounts determined by the Company in its sole
discretion, to the partners in accordance with their respective percentage
interests in the Partnership. Upon liquidation of the Partnership, after payment
of, or adequate provision for, debts and obligations of the Partnership,
including any partner loans, any remaining assets of the Partnership will be
distributed to all partners with positive capital accounts in accordance with
their respective positive capital account balances. If the Company has a
negative balance in its capital account following a liquidation of the
Partnership, it will be obligated to contribute cash to the Partnership equal to
the negative balance in its capital account.
Allocations
Income, gain and loss of the Partnership for each fiscal year generally
are allocated among the partners in accordance with their respective interests
in the Partnership, subject to compliance with the provisions of Code Sections
704(b) and 704(c) and Treasury Regulations promulgated thereunder.
Term
The Partnership will continue until December 31, 2050, or until sooner
dissolved upon (i) the bankruptcy, dissolution or withdrawal of the Company
(unless the Limited Partners elect to continue the Partnership), (ii) the sale
or other disposition of all or substantially all the assets of the Partnership,
(iii) the redemption of all Units (other than those held by the Company, if
any), or (iv) the election of the General Partner and approval of the holders of
75% of the Percentage Interests of the Limited Partners (excluding the General
Partner).
Tax Matters
Pursuant to the Partnership Agreement, the General Partner is the tax
matters partner of the Partnership and, as such, will have authority to handle
tax audits and to make tax elections under the Code on behalf of the
Partnership.
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FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of material federal income tax
considerations that may be relevant to a prospective holder of Common Stock.
Hunton & Williams has acted as counsel to the Company and has reviewed this
summary and is of the opinion that the discussion contained herein fairly
summarizes the federal income tax considerations that are likely to be material
to a Common Shareholder. The discussion does not address all aspects of taxation
that may be relevant to particular shareholders in light of their personal
investment or tax circumstances, or to certain types of shareholders (including
insurance companies, tax-exempt organizations (except as described below),
financial institutions or broker-dealers, and, except as described below,
foreign corporations and persons who are not citizens or residents of the United
States) subject to special treatment under the federal income tax laws.
The statements in this discussion and the opinion of Hunton & Williams
are based on current provisions of the Code, existing, temporary, and currently
proposed Treasury Regulations, the legislative history of the Code, existing
administrative rulings and practices of the Service, and judicial decisions. No
assurance can be given that future legislative, judicial, or administrative
actions or decisions, which may be retroactive in effect, will not affect the
accuracy of any statements in this Prospectus with respect to the transactions
entered into or contemplated prior to the effective date of such changes.
EACH PROSPECTIVE PURCHASER SHOULD CONSULT HIS OWN TAX ADVISOR REGARDING
THE SPECIFIC TAX CONSEQUENCES TO HIM OF THE PURCHASE, OWNERSHIP, AND SALE OF
COMMON STOCK AND OF THE COMPANY'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 Company
The Company elected to be taxed as a REIT under Sections 856 through
860 of the Code, effective for its short taxable year ended December 31, 1994.
The Company believes that, commencing with such taxable year, it has been
organized and has operated in such a manner as to qualify for taxation as a REIT
under the Code, and the Company intends to continue to operate in such a manner,
but no assurance can be given that the Company will operate in a manner so as to
qualify or remain qualified as a REIT.
The sections of the Code relating to qualification and operation as a
REIT 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, Treasury Regulations promulgated
thereunder, and administrative and judicial interpretations thereof, all of
which are subject to change prospectively or retrospectively.
Hunton & Williams has acted as counsel to the Company in connection
with the IPO, the Company's secondary public stock offerings, the Offering and
the Company's election to be taxed as a REIT. In the opinion of Hunton &
Williams, the Company qualified to be taxed as a REIT for its taxable years
ended December 31, 1994 through December 31, 1997, and the Company's
organization and current and proposed method of operation will enable it to
continue to qualify as a REIT for its taxable year ended December 31, 1998 and
in the future. Investors should be aware, however, that opinions of counsel are
not binding upon the Service or any court. It must be emphasized that Hunton &
Williams' opinion is based on various assumptions and is conditioned upon
certain representations made by the Company as to factual matters, including
representations regarding the nature of the Company's properties, the Percentage
Leases, and the future conduct of the Company's business. Such factual
assumptions and representations are described below in this discussion of
"Federal Income Tax Considerations" and are set out in the federal income tax
opinion that will be delivered by Hunton & Williams at the closing of the
Offering. Moreover, such qualification and taxation as a REIT depend upon the
Company's ability to meet on a continuing basis, through actual annual operating
results, distribution levels, and share ownership, the various qualification
tests imposed under the Code discussed below. Hunton & Williams will not review
the Company's compliance with those tests on a continuing basis. Accordingly, no
assurance can be given that the actual results
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of the Company'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 "Federal Income Tax Considerations - Failure to Qualify."
If the Company qualifies for taxation as a REIT, it generally will not
be subject to federal corporate income tax on its net income that is distributed
currently to its shareholders. That treatment substantially eliminates the
"double taxation" of income (i.e., taxation at both the corporate and
shareholder levels) that generally results from an investment in a corporation.
However, the Company will be subject to federal income tax in the following
circumstances. First, the Company will be taxed at regular corporate rates on
any undistributed REIT taxable income, including undistributed net capital
gains. Second, under certain circumstances, the Company may be subject to the
"alternative minimum tax" on its undistributed items of tax preference. Third,
if the Company 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. Fourth, if the Company has net income from prohibited transactions
(which are, in general, 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. Fifth, if the
Company should fail to satisfy the 75% gross income test or the 95% gross income
test (as discussed below), and has nonetheless maintained its qualification as a
REIT because certain other requirements have been met, it will be subject to a
100% tax on the gross income attributable to the greater of the amount by which
the Company fails the 75% or 95% gross income test, multiplied by a fraction
intended to reflect the Company's profitability. Sixth, if the Company 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 net income
for such year, and (iii) any undistributed taxable income from prior periods,
the Company will be subject to a 4% excise tax on the excess of such required
distribution over the amounts actually distributed. Seventh, beginning with its
1998 taxable year, the Company may elect to retain and pay income tax on the
long-term capital gain it received during a taxable year. Any such retained
amounts would be treated as having been distributed by the Company for purposes
of the 4% excise tax described above. Finally, if the Company 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
Company'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 Company recognizes gain
on the disposition of such asset during the 10-year period beginning on the date
on which such asset was acquired by the Company, 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 Company over the adjusted 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). The results described above with respect to the recognition of
"built-in gain" assume that the Company would make an election pursuant to IRS
Notice 88-19 if it were to make any such acquisition. See "Proposed Tax
Legislation."
Requirements for Qualification
The Code defines a REIT as a corporation, trust or association (i) that
is managed by one or more trustees or directors; (ii) the beneficial ownership
of which is evidenced by transferable shares, or by transferable certificates of
beneficial interest; (iii) that would be taxable as a domestic corporation, but
for Sections 856 through 860 of the Code; (iv) that is neither a financial
institution nor an insurance company subject to certain provisions of the Code;
(v) the beneficial ownership of which is held by 100 or more persons; (vi) 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 (the "5/50 Rule");
(vii) 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; (viii) that uses a calendar year for
federal income tax purposes and complies with the recordkeeping requirements of
the Code and Treasury Regulations; and (ix) that meets certain other tests,
described below, regarding the nature of its income and assets. The Code
provides that conditions (i) to (iv), inclusive, must be met during the entire
taxable year and that condition (v) must be met during at least 335 days of a
taxable year of 12 months, or during a proportionate part of a taxable year of
less than 12 months. Conditions (v) and (vi) did not apply until after the first
taxable year for which an election was made by the Company to be taxed as a
REIT. For purposes of determining share ownership under the 5/50 Rule, a
supplemental unemployment compensation benefits plan, a private foundation, or a
portion of a trust permanently set aside or used exclusively for charitable
purposes
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generally is considered an individual, although a trust that is a qualified
trust under Code Section 401(a) generally is not considered an individual and
the beneficiaries of such trust are treated as holding shares of a REIT in
proportion to their actuarial interests in the trust for purposes of the 5/50
Rule.
The Company has issued sufficient shares of Common Stock with
sufficient diversity of ownership to allow it to satisfy requirements (v) and
(vi). In addition, the Company's Articles of Incorporation restrict the
ownership and transfer of shares of Common Stock in a manner intended to assist
the Company in continuing to satisfy the share ownership requirements described
in (v) and (vi) above. Such transfer restrictions are described in "Description
of Capital Stock - Restrictions on Ownership and Transfer."
The Company does not currently have any corporate subsidiaries, nor
will it have any corporate subsidiaries immediately after completion of the
Offering, although it may have corporate subsidiaries in the future. Code
Section 856(i) provides that a corporation that is a "qualified REIT subsidiary"
shall not be treated as a separate corporation, and all assets, liabilities, and
items of income, deduction, and credit of a "qualified REIT subsidiary" shall be
treated as assets, liabilities, and items of income, deduction, and credit of
the REIT. A "qualified REIT subsidiary" is a corporation, all of the capital
stock of which is owned by the REIT. Thus, in applying the requirements
described herein, any "qualified REIT subsidiaries" acquired or formed by the
Company will be ignored, and all assets, liabilities, and items of income,
deduction, and credit of such subsidiaries will be treated as assets,
liabilities and items of income, deduction, and credit of the Company.
In the case of a REIT that is a partner in a partnership, Treasury
Regulations provide that the REIT will be deemed to own its proportionate share
of the assets of the partnership and will be deemed to be entitled to the gross
income of the partnership attributable to such share. In addition, the assets
and gross income of the partnership will retain the same character in the hands
of the REIT for purposes of Section 856 of the Code, including satisfying the
gross income and asset tests, described below. Thus, the Company's proportionate
share of the assets, liabilities and items of income of the Partnership are
treated as assets and gross income of the Company for purposes of applying the
requirements described herein.
Income Tests
In order for the Company to maintain its qualification as a REIT, there
are two requirements relating to the Company's gross income that must be
satisfied annually. First, at least 75% of the Company's gross income (excluding
gross income from prohibited transactions) for each taxable year must consist of
defined types of 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 Company'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 or securities, or from
any combination of the foregoing. The specific application of these tests to the
Company is discussed below.
Rents received by the Company will qualify as "rents from real
property" for purposes of the gross income requirements for a REIT described
above only if several conditions are met. First, the amount of rent must not be
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 "rents
from real property" solely by reason of being based on a fixed percentage or
percentages of receipts or sales. Second, the Code provides that rents received
from a tenant will not qualify as "rents from real property" for purposes of the
gross income tests if the Company, or an owner of 10% or more of the Company,
directly or constructively owns 10% or more of the ownership interests in such
tenant (a "Related Party Tenant"). Third, if rent attributable to personal
property, leased in connection with a lease of real property, is greater than
15% of the total rent received under the lease, then the portion of rent
attributable to such personal property will not qualify as "rents from real
property." Finally, for rents received to qualify as "rents from real property,"
the Company generally must not operate or manage the property or furnish or
render services to the tenants of such property, other than through an
"independent contractor" who is adequately compensated and from whom the Company
derives no revenue. The "independent contractor" requirement, however, does not
apply to the extent the services provided by the Company are "usually or
customarily rendered"
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in connection with the rental of space for occupancy only and are not otherwise
considered "rendered to the occupant." In addition, beginning with its 1998
taxable year, the Company may furnish or render a de minimis amount of
"noncustomary services" to the tenants of a property other than through an
independent contractor as long as the amount that the Company receives that is
attributable to such services does not exceed 1% of its total receipts from the
property. For that purpose, the amount attributable to the Company's
noncustomary services will be at least equal to 150% of the Company's cost of
providing the services.
Pursuant to the Percentage Leases, the Lessee leases from the
Partnership the land, buildings, improvements, furnishings and equipment
comprising the Hotels for a 10-year period. The Percentage Leases provide that
the Lessee is obligated to pay to the Partnership (i) the Base Rent and the
Percentage Rent (collectively, the "Rents") and (ii) certain other Additional
Charges. The Percentage Rent is calculated by multiplying fixed percentages by
the gross room and other revenues for each of the Hotels. The Base Rent accrues
and is required to be paid monthly and the Percentage Rent accrues and is
required to be paid monthly, quarterly, semi-annually and annually (if
applicable).
In order for the Base Rent, the Percentage Rent, 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
following: (i) the intent of the parties, (ii) the form of the agreement, (iii)
the degree of control over the property that is retained by the property owner
(e.g., whether the lessee has substantial control over the operation of the
property or whether the lessee was required simply to use its best efforts to
perform its obligations under the agreement), and (iv) 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) or the potential for economic gain (e.g.,
appreciation) with respect to the property.
In addition, Code Section 7701(e) 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: (i) the
service recipient is in physical possession of the property, (ii) the service
recipient controls the property, (iii) 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 recipient shares the risk that the property
will decline in value, the recipient shares in any appreciation in the value of
the property, the recipient shares in savings in the property's operating costs,
or the recipient bears the risk of damage to or loss of the property), (iv) the
service provider does not bear any risk of substantially diminished receipts or
substantially increased expenditures if there is nonperformance under the
contract, (v) the service provider does not use the property concurrently to
provide significant services to entities unrelated to the service recipient, and
(vi) 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 Company 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: (i) the Partnership and the Lessee intend for their
relationship to be that of a lessor and lessee and such relationship is
documented by lease agreements, (ii) the Lessee has the right to exclusive
possession and use and quiet enjoyment of the Hotels during the term of the
Percentage Leases, (iii) the Lessee bears the cost of, and is responsible for,
day-to-day maintenance and repair of the Hotels, other than the cost of capital
expenditures that are classified as capital items under generally accepted
accounting principles which are necessary for the continued operation of the
Hotels, and dictates how the Hotels are operated, maintained, and improved, (iv)
the Lessee bears all of the costs and expenses of operating the Hotels
(including the cost of any inventory used in their operation) during the term of
the Percentage Leases (other than real and personal property taxes, property and
casualty insurance, 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 Partnership under each Percentage Lease), (v) the
Lessee benefits from any savings in the costs of operating the Hotels during the
term of the Percentage Leases, (vi) in the event of damage to or destruction of
a Hotel, the Lessee is at
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economic risk because it generally is obligated either (A) to restore the
property to its prior condition, in which event it will bear all costs of such
restoration in excess of any insurance proceeds or (B) to purchase the Hotel for
an amount generally equal to the fair market value of the property, less any
insurance proceeds, (vii) the Lessee has indemnified the Partnership against all
liabilities imposed on the Partnership during the term of the Percentage Leases
by reason of (A) injury to persons or damage to property occurring at the Hotels
or (B) the Lessee's use, management, maintenance or repair of the Hotels, (viii)
the Lessee is obligated to pay substantial fixed rent for the period of use of
the Hotels, and (ix) the 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. If the Percentage
Leases are recharacterized as service contracts or partnership agreements,
rather than true leases, part or all of the payments that the Partnership
receives from the Lessee may not be considered rent or may not otherwise satisfy
the various requirements for qualification as "rents from real property." In
that case, the Company likely would not be able to satisfy either the 75% or 95%
gross income test 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. One requirement is that the
Rents attributable to personal property leased in connection with the lease of
the real property comprising a Hotel must not be greater than 15% of the Rents
received under the Percentage Lease. The 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 basis 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 basis of both the real and personal property
comprising the Hotel at the beginning and at the end of such taxable year (the
"Adjusted Basis Ratio"). With respect to each Hotel that the Partnership has
acquired, or will acquire, in exchange for Units, the initial adjusted basis of
the personal property in such hotel was, or will be, less than 15% of the
initial adjusted basis of both the real and personal property comprising such
Hotel. In addition, the Company obtained an appraisal of the personal property
at each Initial Hotel acquired for cash that indicates that the fair market
value of the personal property was less than 15% of the purchase price of such
Hotel. Further, in no event will the Partnership acquire additional personal
property for a Hotel to the extent that such acquisition would cause the
Adjusted Basis Ratio for that hotel to exceed 15%. There can be no assurance,
however, that the Service would not assert that the personal property acquired
by the Partnership had a value in excess of the appraised value, or that a court
would not uphold such assertion. If such a challenge were successfully asserted,
the Company could fail the Adjusted Basis Ratio as to one or more of the Hotels,
which in turn potentially could cause the Company to fail to satisfy the 95% or
75% gross income test 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 percentages 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 in reality used as a means of basing the
Percentage Rent on income or profits. Since the Percentage Rent is based on
fixed percentages of the gross revenues from the Hotels that are established in
the Percentage Leases, and the Company has represented 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, the Percentage Rent should not be
considered based in whole or in part on the income or profits of any person.
Furthermore, the Company has represented that, with respect to other hotels 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 person (except by
reason of being based on a fixed percentage of gross revenues, as described
above).
A third requirement for qualification of the Rents as "rents from real
property" is that the Company must not own, actually or constructively, 10% or
more of the Lessee. The constructive ownership rules generally provide
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that, if 10% or more in value of the shares of the Company is owned, directly or
indirectly, by or for any person, the Company is considered as owning the shares
owned, actually or indirectly, by or for such person. The Company does not own
directly any stock of the Lessee. The Limited Partners, including Mr. Humphrey,
who is the sole shareholder of the Lessee, may acquire shares of Common Stock by
exercising their Redemption Rights. The Partnership Agreement, however, provides
that a redeeming Limited Partner will receive cash, rather than shares of Common
Stock, if the Company so elects or if the acquisition of shares of Common Stock
by such partner would cause the Company to own, actually or constructively, 10%
or more of the ownership interests in a tenant of the Company's or the
Partnership's real property, within the meaning of Section 856(d)(2)(B) of the
Code. The Articles of Incorporation likewise prohibit transfers of Common Stock
that would cause the Company to own, actually or constructively, 10% or more of
the ownership interests in a tenant of the Company's real property, within the
meaning of Section 856(d)(2)(B) of the Code. Thus, the Company should never own,
actually or constructively, 10% of more of the Lessee. Furthermore, the Company
has represented that, with respect to other hotels that it acquires in the
future, it will not rent any property to a Related Party Tenant. However,
because the Code's constructive ownership rules for purposes of the Related
Party Tenant rules are broad and it is not possible to monitor continually
direct and indirect transfers of shares of Common Stock, no absolute assurance
can be given that such transfers or other events of which the Company has no
knowledge will not cause the Company to own constructively 10% or more of the
Lessee at some future date.
A fourth requirement for qualification of the Rents as "rents from real
property" is that other than pursuant to the 1% de minimis exception described
above, the Company cannot furnish or render noncustomary services to the tenants
of the Hotels, or manage or operate the Hotels, other than through an
independent contractor who is adequately compensated and from whom the Company
does not derive or receive any income. Provided that the Percentage Leases are
respected as true leases, the Company should satisfy that requirement because
the Partnership is not performing any services other than customary ones for the
Lessee. Furthermore, the Company has represented that, with respect to other
hotels that it acquires in the future, it will not perform noncustomary services
with respect to the tenant of the property. 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"
because the Company 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
Company 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 that is attributable to personal property
will not be qualifying income for purposes of either the 75% or 95% gross income
test. Thus, if the Rents attributable to personal property, plus any other
income that is nonqualifying income for purposes of the 95% gross income test,
during a taxable year exceed 5% of the Company's gross income during the year,
the Company would lose its REIT status. If, however, the Rents do not qualify as
"rents from real property" because either (i) the Percentage Rent is considered
based on income or profits of the Lessee, (ii) the Company owns, actually or
constructively, 10% or more of the Lessee, or (iii) the Company furnishes
noncustomary services to the tenants of the Hotels, or manages or operates the
Hotels, other than through a qualifying independent contractor (other than
pursuant to the 1% de minimis exception described above), none of the Rents
would qualify as "rents from real property." In that case, the Company likely
would lose its REIT status because it would be unable to satisfy either the 75%
or 95% gross income test.
In addition to the Rents, the Lessee is required to pay the Additional
Charges to the Partnership. To the extent that the Additional Charges represent
either (i) reimbursements of amounts that the Lessee is 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." To the
extent, however, that 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 instead should be
treated as interest that qualifies for the 95% gross income test.
The term "interest" generally does not include any amount received or
accrued (directly or indirectly) if the determination of such amount depends 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
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that is based on the residual cash proceeds from the sale of the property
securing the loan constitutes 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.
The net income derived from any prohibited transaction 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 in the operation of the Hotels has been and will be purchased
by the Lessee or its designee as required by the terms of the Percentage Leases.
Accordingly, the Company believes that no asset owned by the Company or the
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 Company or the 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 a particular property.
Nevertheless, the Company and the Partnership will attempt to comply with the
terms of safe-harbor provisions in the Code prescribing when asset sales will
not be characterized as prohibited transactions. Complete assurance cannot be
given, however, that the Company or the 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 Company will be subject to tax at the maximum corporate rate on any
income from foreclosure property (other than income that would be qualifying
income for purposes of the 75% gross income test), less expenses directly
connected with the production of such income. "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 as the
result of such REIT having bid in 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 with respect to a REIT on the last day 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 for purposes of 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 for purposes of 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 rules with respect to foreclosure property, if
the Lessee defaults on its obligations under a Percentage Lease for a Hotel, the
Company terminates the Lessee's leasehold interest, and the Company is unable to
find a replacement Lessee for such Hotel within 90 days of such foreclosure,
gross income from hotel operations conducted by the Company from such Hotel
would cease to qualify for the 75% and 95% gross income tests. In such event,
the Company 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 Company or the 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 Company or the
Partnership enters into an interest rate swap or cap contract, option, futures
contract, forward rate agreement, or similar financial instrument to reduce the
interest rate risk with respect to indebtedness incurred or to be 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, but not the 75% gross income test. To the extent that the
Company or the Partnership hedges with other types of financial instruments or
in other situations, it may not be entirely clear how the income from those
transactions will be treated
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for purposes of the various income tests that apply to REITs under the Code. The
Company intends to structure any hedging transactions in a manner that does not
jeopardize its status as a REIT.
If the Company 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 generally will be available if the Company's failure to
meet such tests is due to reasonable cause and not due to willful neglect, the
Company attaches a schedule of the sources of its income to its return, and 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
Company would be entitled to the benefit of those relief provisions. As
discussed above in "Federal Income Tax Considerations - Taxation of the
Company," even if those relief provisions apply, a 100% tax would be imposed
with respect to the gross income attributable to the greater of the amount by
which the Company fails the 75% or 95% gross income test, multiplied by a
fraction intended to reflect the Company's profitability.
Asset Tests
The Company, at the close of each quarter of its taxable year, also
must satisfy two tests relating to the nature of its assets. First, at least 75%
of the value of the Company's total assets must be represented by cash or cash
items (including certain receivables), government securities, "real estate
assets," or, in cases where the Company raises new capital through share or
long-term (at least five-year) debt offerings, temporary investments in stock or
debt instruments during the one-year period following the Company'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 test, 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 Company may not exceed 5% of the value of the
Company's total assets and the Company may not own more than 10% of any one
issuer's outstanding voting securities (except for its ownership interest in the
Partnership or a qualified REIT subsidiary). See "Proposed Tax Legislation."
For purposes of the asset tests, the Company will be deemed to own its
proportionate share of the assets of the Partnership, rather than its
partnership interest in the Partnership. The Company has represented that, at
all relevant times (including the taxable periods preceding the Offering), (i)
at least 75% of the value of its total assets has been and will be represented
by real estate assets, cash and cash items (including receivables), and
government securities and (ii) it has not owned and will not own any securities
that do not satisfy the 75% asset requirement (except for the stock of qualified
REIT subsidiaries). In addition, the Company has represented that it will not
acquire or dispose, or cause the Partnership to acquire or dispose, of assets in
the future in a way that would cause it to violate either asset test.
If the Company should fail to satisfy the asset tests 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 asset tests at the close of the preceding calendar
quarter and (ii) the discrepancy between the value of the Company's assets and
the asset test requirements arose from changes in the market values of its
assets and was not wholly or partly caused by an acquisition of one or more
nonqualifying assets. If the condition described in clause (ii) of the preceding
sentence were not satisfied, the Company still could avoid disqualification by
eliminating any discrepancy within 30 days after the close of the quarter in
which it arose.
Distribution Requirements
The Company, in order to avoid corporate income taxation of its
earnings, is required each taxable year to distribute dividends (other than
capital gain dividends and retained capital gains) 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,
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minus (ii) the sum of certain items of noncash income. Such distributions must
be paid in the taxable year to which they relate, or in the following taxable
year if declared before the Company timely files its tax return for such year
and if paid on or before the first regular dividend payment date after such
declaration. To the extent that the Company 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. Furthermore, if the Company
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 Company would be subject to a 4% nondeductible excise tax on the
excess of such required distribution over the amounts actually distributed. To
the extent that the Company elects to retain and pay income tax on its net
capital gain, such retained amounts will be treated as having been distributed
for purposes of the excise tax. The Company has made, and has represented that
it will continue to make, timely distributions sufficient to satisfy all annual
distribution requirements.
It is possible that, from time to time, the Company 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
such expenses in arriving at its REIT taxable income. For example, under the
Percentage Leases, the 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 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 Company may be allocated a share of net
capital gain attributable to the sale of depreciated property that exceeds its
allocable share of cash attributable to that sale. Therefore, the Company may
have less Cash Available for Distribution to Shareholders than is necessary to
meet its annual 95% distribution requirement or to avoid corporate income tax or
the excise tax imposed on certain undistributed income. In such a situation, the
Company may find it necessary to arrange for short-term (or possibly long-term)
borrowings or to raise funds through the issuance of additional common or
preferred shares.
Under certain circumstances, the Company may be able to rectify a
failure to meet the distribution requirement for a year by paying "deficiency
dividends" to its shareholders in a later year, which may be included in the
Company's deduction for dividends paid for the earlier year. Although the
Company may be able to avoid being taxed on amounts distributed as deficiency
dividends, it will be required to pay to the Service interest based upon the
amount of any deduction taken for deficiency dividends.
Recordkeeping Requirement
Pursuant to applicable Treasury Regulations, the Company must maintain
certain records and request on an annual basis certain information from its
shareholders designed to disclose the actual ownership of its outstanding
shares. The Company has complied, and represents that it will continue to
comply, with such requirements.
Partnership Anti-Abuse Rule
The U.S. Department of Treasury has issued a final regulation (the
"Anti-Abuse Rule") under the partnership provisions of the Code (the
"Partnership Provisions") that authorizes the Service, in certain "abusive"
transactions involving partnerships, to disregard the form of the transaction
and recast it for federal tax purposes as the Service deems appropriate. The
Anti-Abuse Rule applies 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
Partnership Provisions. The Anti-Abuse Rule states that the 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 a
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 Partnership Provisions.
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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 partnership
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 Partnership Provisions and, thus, cannot be recast by the Service.
The Redemption Rights do not conform in all respects to the redemption rights
described in the foregoing example. Moreover, the Anti-Abuse Rule is
extraordinarily broad in scope and is applied based on an analysis of all of the
facts and circumstances. As a result, there can be no assurance that the Service
will not attempt to apply the Anti-Abuse Rule to the Company. If the conditions
of the Anti-Abuse Rule are met, the Service is authorized to take appropriate
enforcement action, including disregarding the Partnership for federal tax
purposes or treating one or more of its partners as nonpartners. Any such action
potentially could jeopardize the Company's status as a REIT.
Failure to Qualify
If the Company fails to qualify for taxation as a REIT in any taxable
year, and the relief provisions do not apply, the Company will be subject to tax
(including any applicable alternative minimum tax) on its taxable income at
regular corporate rates. Distributions to the shareholders in any year in which
the Company fails to qualify will not be deductible by the Company nor will they
be required to be made. In such event, to the extent of current and accumulated
earnings and profits, all distributions to shareholders will be taxable as
ordinary income and, subject to certain limitations of the Code, corporate
distributees may be eligible for the dividends received deduction. Unless
entitled to relief under specific statutory provisions, the Company also will be
disqualified from taxation as a REIT for the four taxable years following the
year during which the Company ceased to qualify as a REIT. It is not possible to
state whether in all circumstances the Company would be entitled to such
statutory relief.
Taxation of Taxable U.S. Shareholders
As long as the Company qualifies as a REIT, distributions made to the
Company's taxable U.S. shareholders out of current or accumulated earnings and
profits (and not designated as capital gain dividends or retained capital gains)
will be taken into account by such U.S. shareholders as ordinary income and will
not be eligible for the dividends received deduction generally available to
corporations. As used herein, the term "U.S. shareholder" means a Common
Shareholder that for U.S. federal income tax purposes is (i) a citizen or
resident of the United States, (ii) a corporation, partnership, or other entity
created or organized in or under the laws of the United States or of any
political subdivision thereof, (iii) an estate whose income from sources without
the United States is includible in gross income for U.S. federal income tax
purposes regardless of its connection with the conduct of a trade or business
within the United States, or (iv) any trust with respect to which (A) a U.S.
court is able to exercise primary supervision over the administration of such
trust and (B) one or more U.S. fiduciaries have the authority to control all
substantial decisions of the trust.
Distributions that are designated as capital gain dividends will be
taxed as long-term capital gains (to the extent they do not exceed the Company's
actual net capital gain for the taxable year) without regard to the period for
which the shareholder has held his shares of Common Stock. However, corporate
shareholders may be required to treat up to 20% of certain capital gain
dividends as ordinary income. Beginning with its 1998 taxable year, the Company
may elect to retain and pay income tax on its net long-term capital gains. In
that case, the Company's shareholders would include in income their
proportionate share of the Company's undistributed long-term capital gains. In
addition, the shareholders would be deemed to have paid their proportionate
share of the tax paid by the Company, which would be credited or refunded to the
shareholders. Each shareholder's basis in his shares would be increased by the
amount of the undistributed long-term capital gain included in the shareholder's
income, less the shareholder's share of the tax paid by the Company.
Distributions in excess of current and accumulated earnings and profits
will not be taxable to a Common Shareholder to the extent that they do not
exceed the adjusted basis of the Common Shareholder's shares, but rather
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will reduce the adjusted basis of such shares. To the extent that distributions
in excess of current and accumulated earnings and profits exceed the adjusted
basis of a Common Shareholder's shares, such distributions will be included in
income as long-term capital gain (or short-term capital gain if the shares of
Common Stock have been held for one year or less) assuming the shares of Common
Stock are capital assets in the hands of the Common Shareholder. In addition,
any distribution declared by the Company in October, November, or December of
any year and payable to a Common Shareholder of record on a specified date in
any such month shall be treated as both paid by the Company and received by the
Common Shareholder on December 31 of such year, provided that the distribution
is actually paid by the Company during January of the following calendar year.
Common Shareholders may not include in their individual income tax
returns any net operating losses or capital losses of the Company. Instead, such
losses would be carried over by the Company for potential offset against its
future income (subject to certain limitations). Taxable distributions from the
Company and gain from the disposition of shares of Common Stock will not be
treated as passive activity income and, therefore, shareholders generally will
not be able to apply any "passive activity losses" (such as losses from certain
types of limited partnerships in which the shareholder is a limited partner)
against such income. In addition, taxable distributions from the Company and
gain from the disposition of shares of Common Stock generally will be treated as
investment income for purposes of the investment interest limitations. The
Company will notify shareholders after the close of the Company's taxable year
as to the portions of the distributions attributable to that year that
constitute ordinary income, return of capital, and capital gain.
Taxation of Shareholders on the Disposition of the Common Stock
In general, any gain or loss realized upon a taxable disposition of the
Common Stock by a shareholder who is not a dealer in securities will be treated
as long-term capital gain or loss if the Common Stock has been held for more
than one year and otherwise as short-term capital gain or loss. However, any
loss upon a sale or exchange of Common Stock by a shareholder who has held such
shares 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
Company required to be treated by such shareholder as long-term capital gain.
All or a portion of any loss realized upon a taxable disposition of the Common
Stock may be disallowed if other shares of Common Stock are purchased within 30
days before or after the disposition.
Capital Gains and Losses
The highest marginal individual income tax rate is 39.6%. The maximum
tax rate on net capital gains applicable to noncorporate taxpayers is 28% for
sales and exchanges of assets held for more than one year but not more than 18
months, and 20% for sales and exchanges of assets held for more than 18 months.
The maximum tax rate on long-term capital gain from the sale or exchange of
"section 1250 property" (i.e., depreciable real property) held for more than 18
months is 25% to the extent that such gain would have been treated as ordinary
income if the property were "section 1245 property." With respect to
distributions designated by the Company as capital gain dividends and any
retained capital gains that the Company is deemed to distribute, the Company may
designate (subject to certain limits) whether such a distribution is taxable to
its noncorporate stockholders at a 20%, 25%, or 28% rate. Thus, the tax rate
differential between capital gain and ordinary income for individuals may be
significant. In addition, the characterization of income as capital or ordinary
may affect the deductibility of capital losses. Capital losses not offset by
capital gains may be deducted against an individual's ordinary income only up to
a maximum annual amount of $3,000. Unused capital losses may be carried forward.
All net capital gain of a corporate taxpayer is subject to tax at ordinary
corporate rates. A corporate taxpayer can deduct capital losses only to the
extent of capital gains, with unused losses being carried back three years and
forward five years.
Information Reporting Requirements and Backup Withholding
The Company 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 such holder (i) is a corporation or comes within certain other
exempt categories and, when required, demonstrates this fact or (ii) provides a
taxpayer identification number, certifies as to no loss of exemption from backup
withholding, and
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otherwise complies with the applicable requirements of the backup withholding
rules. A shareholder who does not provide the Company with his correct taxpayer
identification number also may be subject to penalties imposed by the Service.
Any amount paid as backup withholding will be creditable against the
shareholder's income tax liability. In addition, the Company may be required to
withhold a portion of capital gain distributions to any shareholders who fail to
certify their nonforeign status to the Company. The Service has issued final
regulations regarding the backup withholding rules as applied to Non-U.S.
Shareholders. The regulations alter the technical requirements relating to
backup withholding compliance and will be effective for distributions made after
December 31, 1998 See "Federal Income Tax Considerations - Taxation of Non-U.S.
Shareholders."
Taxation of Tax-Exempt Shareholders
Tax-exempt entities, including qualified employee pension and profit
sharing trusts and individual retirement accounts ("Exempt Organizations"),
generally are exempt from federal income taxation. However, they are subject to
taxation on their unrelated business taxable income ("UBTI"). While many
investments in real estate generate UBTI, the Service has issued a published
ruling that dividend distributions by a REIT to an exempt employee pension trust
do not constitute UBTI, provided that the shares of the REIT are not otherwise
used in an unrelated trade or business of the exempt employee pension trust.
Based on that ruling and on the intention of the Company to invest its assets in
a manner that will avoid the recognition of UBTI by the Company, amounts
distributed by the Company to Exempt Organizations generally should not
constitute UBTI. However, if an Exempt Organization finances its acquisition of
shares of Common Stock with debt, a portion of its income from the Company will
constitute UBTI pursuant to the "debt-financed property" rules. Furthermore,
social clubs, voluntary employee benefit associations, supplemental unemployment
benefit trusts, and qualified group legal services plans that are exempt from
taxation under paragraphs (7), (9), (17), and (20), respectively, of Code
Section 501(c) are subject to different UBTI rules, which generally will require
them to characterize distributions from the Company as UBTI. In addition, in
certain circumstances, a pension trust that owns more than 10% of the Company's
shares of capital stock is required to treat a percentage of the dividends from
the Company as UBTI (the "UBTI Percentage"). The UBTI Percentage is the gross
income derived by the Company from an unrelated trade or business (determined as
if the Company were a pension trust) divided by the gross income of the Company
for the year in which the dividends are paid. The UBTI rule applies to a pension
trust holding more than 10% of the Company's shares of capital stock only if (i)
the UBTI Percentage is at least 5%, (ii) the Company qualifies as a REIT by
reason of the modification of the 5/50 Rule that allows the beneficiaries of the
pension trust to be treated as holding shares of the Company in proportion to
their actuarial interests in the pension trust, and (iii) either (A) one pension
trust owns more than 25% of the value of the Company's shares of capital stock
or (B) a group of pension trusts individually holding more than 10% of the value
of the Company's shares of capital stock collectively owns more than 50% of the
value of the Company's shares of capital stock. Because the Ownership Limitation
prohibits any pension trust from owning more than 9.9% of the number of
outstanding shares of Common Stock or the outstanding shares of Preferred Stock
of any class or series, no pension trust should recognize UBTI as a result of
its investment in the Company.
Taxation of Non-U.S. Shareholders
The rules governing U.S. 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 such 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 THE COMMON STOCK, INCLUDING ANY REPORTING REQUIREMENTS.
Distributions to Non-U.S. Shareholders that are not attributable to
gain from sales or exchanges by the Company of U.S. real property interests and
are not designated by the Company as capital gains dividends or retained capital
gains will be treated as dividends of ordinary income to the extent that they
are made out of current or accumulated earnings and profits of the Company. Such
distributions ordinarily will 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. However, if income from the investment in shares of Common
Stock is treated as effectively connected with the Non-U.S. Shareholder's
conduct of a U.S. trade or business, the Non-U.S. Shareholder generally will be
subject
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to federal income tax at graduated rates, in the same manner as U.S.
shareholders are taxed with respect to such distributions (and also may be
subject to the 30% branch profits tax in the case of a Non-U.S. Shareholder that
is a foreign corporation). The Company expects to withhold U.S. income tax at
the rate of 30% on the gross amount of any such distributions made to a Non-U.S.
Shareholder unless (i) a lower treaty rate applies and any required form
evidencing eligibility for that reduced rate is filed with the Company or (ii)
the Non-U.S. Shareholder files an IRS Form 4224 with the Company claiming that
the distribution is effectively connected income. The Service has issued final
regulations. Those regulations are effective for distributions made after
December 31, 1998 that modify the manner in which the Company complies with the
withholding requirements.
Distributions in excess of current and accumulated earnings and profits
of the Company will not be taxable to a shareholder to the extent that such
distributions do not exceed the adjusted basis of the shareholder's shares of
Common Stock, but rather will reduce the adjusted basis of such shares. To the
extent that distributions in excess of current and accumulated earnings and
profits exceed the adjusted basis of a Non-U.S. Shareholder's shares of Common
Stock, such distributions 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 his shares of Common Stock, as described below. Because it
generally cannot be determined at the time a distribution is made whether or not
such distribution will be in excess of current and accumulated earnings and
profits, the entire amount of any distribution normally will be subject to
withholding at the same rate as a dividend. However, amounts so withheld are
refundable to the extent it is determined subsequently that such distribution
was, in fact, in excess of the current and accumulated earnings and profits of
the Company. The Company is required to withhold 10% of any distribution in
excess of the Company's current and accumulated earnings and profits.
Consequently, although the Company intends to withhold at a rate of 30% on the
entire amount of any distribution, to the extent that the Company does not do
so, any portion of a distribution not subject to withholding at a rate of 30%
will be subject to withholding at a rate of 10%.
For any year in which the Company qualifies as a REIT, distributions
that are attributable to gain from sales or exchanges by the Company of U.S.
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 U.S.
real property interests are taxed to a Non-U.S. Shareholder as if such gain were
effectively connected with a U.S. business. Non-U.S. Shareholders thus would 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). Distributions subject to FIRPTA also
may be subject to a 30% branch profits tax in the hands of a foreign corporate
shareholder not entitled to treaty relief or exemption. The Company is required
to withhold 35% of any distribution that is designated by the Company as a
capital gains dividend. The amount withheld is creditable against the Non-U.S.
Shareholder's FIRPTA tax liability.
Gain recognized by a Non-U.S. Shareholder upon a sale of his shares of
Common Stock generally will not be taxed under FIRPTA if the Company is a
"domestically controlled REIT," defined generally as a REIT in which at all
times during a specified testing period less than 50% in value of the stock was
held directly or indirectly by foreign persons. However, because the shares of
Common Stock are publicly traded, no assurance can be given that the Company is
or will continue to be a "domestically controlled REIT." A Non-U.S. Shareholder
that owned, actually or constructively, 5% or less of the Common Stock at all
times during a specified testing period will not be subject to tax under FIRPTA
if the Common Stock is "regularly traded" on an established securities market.
Furthermore, gain not subject to FIRPTA will be taxable to a Non-U.S.
Shareholder if (i) investment in the shares of Common Stock is effectively
connected with the Non-U.S. Shareholder's U.S. 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 such gain, or (ii) 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 and certain other conditions apply, in which
case the nonresident alien individual will be subject to a 30% tax on the
individual's capital gains. If the gain on the sale of the shares of Common
Stock were to be subject to taxation under FIRPTA, the Non-U.S. Shareholder will
be subject to the same treatment as U.S. shareholders with respect to such gain
(subject to applicable alternative minimum tax, a special alternative minimum
tax in the case of nonresident alien individuals, and the possible application
of the 30% branch profits tax in the case of non-U.S. corporations).
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Proposed Tax Legislation
On February 2, 1998, President Clinton released his budget proposal for
fiscal year 1999 (the "Proposal"). Two provisions contained in the Proposal
could affect the Company if enacted in final form. First, the Proposal would
prohibit a REIT from owning, directly or indirectly, more than 10% of the voting
power or value of all classes of a C corporation's stock (other than the stock
of a qualified REIT subsidiary). Currently, a REIT may own no more than 10% of
the voting stock of a C corporation (other than a qualified REIT subsidiary),
but its ownership of the nonvoting stock of a C corporation is not limited
(other than by the rule that the value of a REIT's combined equity and debt
interest in a C corporation may not exceed 5% of the value of a REIT's total
assets). That provision is proposed to be effective with respect to stock in a C
corporation acquired by a REIT on or after the date of "first committee action"
(i.e., first action by the House Ways and Means with respect to the provision)
("First Committee Action"). A REIT that owns stock in a C corporation in excess
of the new ownership limit prior to First Committee Action would be
"grandfathered," but only to the extent that the C corporation does not engage
in a new trade or business or acquire substantial new assets on or after the
date of First Committee Action. If enacted as presently written, that provision
would severely limit the use by a REIT of taxable subsidiaries to conduct
businesses the income from which would be nonqualifying income if received by
the REIT. Currently, the Company has no such taxable subsidiaries. Second, the
Proposal would require recognition of any built-in gain associated with the
assets of a "large" C corporation (i.e., a C corporation whose stock has a fair
market value of more than $5 million) upon its conversion to REIT status or
merger into a REIT. That provision is proposed to be effective for conversions
to REIT status effective for taxable years beginning after January 1, 1999 and
mergers of C corporations into REITs that occur after December 31, 1998. The
Company currently believes that the Proposal, if enacted in final form, would
not have a material adverse effect on the Company's business or operations, as
currently conducted.
Other Tax Consequences
The Company, the Partnership or the Company's shareholders may be
subject to state or local taxation in various state or local jurisdictions,
including those in which it or they own property, transact business, or reside.
The state and local tax treatment of the Company and its shareholders may not
conform to the federal income tax consequences discussed above. CONSEQUENTLY,
PROSPECTIVE SHAREHOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS REGARDING THE
EFFECT OF STATE AND LOCAL TAX LAWS ON AN INVESTMENT IN THE COMPANY.
Tax Aspects of the Partnership and the Subsidiary Partnership
The following discussion summarizes certain federal income tax
considerations applicable to the Company's direct or indirect investment in the
Partnership and the Subsidiary Partnership (each, a "Hotel 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 Company will be entitled to include in its income its distributive
share of each Hotel Partnership's income and to deduct its distributive share of
each Hotel Partnership's losses only if each Hotel Partnership is classified for
federal income tax purposes as a partnership rather than as a corporation or an
association taxable as a corporation. An entity will be classified as a
partnership rather than as a corporation for federal income tax purposes if the
entity (i) is treated as a partnership under Treasury regulations, effective
January 1, 1997, relating to entity classification (the "Check-the-Box
Regulations") and (ii) is not a "publicly traded" partnership. In general, under
the Check-the-Box Regulations, an unincorporated entity with at least two
members may elect to be classified as an association taxable as a corporation or
as a partnership. If such an entity fails to make an election, it generally will
be treated as a partnership for federal income tax purposes. The federal income
tax classification of an entity that was in existence prior to January 1, 1997
will be respected for all periods prior to January 1, 1997 if (i) the entity had
a reasonable basis for its claimed classification, (ii) the entity and all
members of the entity recognized the federal tax consequences of any changes in
the entity's classification within the 60 months prior to January 1, 1997, and
(iii) neither the entity nor any of its members was notified in writing by a
taxing authority on or before
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May 8, 1996 that the classification of the entity was under examination. Each
Hotel Partnership in existence on January 1, 1997 reasonably claimed partnership
classification under the Treasury Regulations relating to entity classification
in effect prior to January 1, 1997, and such classification should be respected
for federal income tax purposes. In addition, no Hotel Partnership was notified
by a taxing authority on or before May 8, 1996 that its classification was under
examination. The Hotel Partnerships intend to continue to be classified as
partnerships and the Company has represented that no Hotel Partnership will
elect to be treated as an association taxable as a corporation for federal
income tax purposes under the Check-the-Box Regulations.
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 be treated as a corporation for federal income tax purposes
unless at least 90% of such partnership's gross income for a taxable year
consists of "qualifying income" under section 7704(d) of the Code, which
generally includes any income that is qualifying income for purposes of the 95%
gross income test applicable to REITs (the "90% Passive-Type Income Exception").
See "-- Requirements for Qualification--Income Tests." The U.S. Treasury
Department has issued regulations effective for taxable years beginning after
December 31, 1995 (the "PTP Regulations") that provide limited safe harbors from
the definition of a publicly traded partnership. Pursuant to one of those safe
harbors (the "Private Placement Exclusion"), interests in a partnership will not
be treated as readily tradable on a secondary market or the substantial
equivalent thereof if (i) all interests in the partnership were issued in a
transaction (or transactions) that was not required to be registered under the
Securities Act of 1933, as amended, and (ii) the partnership does not have more
than 100 partners at any time during the partnership's taxable year. In
determining the number of partners in a partnership, a person owning an interest
in a flow-through entity (i.e., a partnership, grantor trust, or S corporation)
that owns an interest in the partnership is treated as a partner in such
partnership only if (a) substantially all of the value of the owner's interest
in the flow-through entity is attributable to the flow-through entity's interest
(direct or indirect) in the partnership and (b) a principal purpose of the use
of the flow-through entity is to permit the partnership to satisfy the
100-partner limitation. Each Hotel Partnership qualifies for the Private
Placement Exclusion. If a Hotel Partnership is considered to be a publicly
traded partnership under the PTP Regulations because it is deemed to have more
than 100 partners, such Hotel Partnership should not be treated as a corporation
because it should be eligible for the 90% Passive-Type Income Exception.
Each Hotel Partnership has not requested, and does not intend to
request, a ruling from the Service that it will be classified as a partnership
for federal income tax purposes. Instead, Hunton & Williams is of the opinion
that, based on the provisions of the partnership agreement of each Hotel
Partnership, certain factual assumptions, and certain representations described
in the opinion, each Hotel Partnership will be treated for federal income tax
purposes as a partnership and not as a corporation or an association taxable as
a corporation or as a publicly traded partnership. Unlike a tax ruling, an
opinion of counsel is not binding upon the Service, and no assurance can be
given that the Service will not challenge the status of each Hotel Partnership
as a partnership for federal income tax purposes. If such challenge were
sustained by a court, each Hotel Partnership would be treated as a corporation
for federal income tax purposes, as described below. The opinion of Hunton &
Williams is based on existing law, which is to a great extent the result of
administrative and judicial interpretation. No assurance can be given that
administrative or judicial changes would not modify the conclusions expressed in
the opinion.
If for any reason either Hotel Partnership were taxable as a
corporation, rather than as a partnership, for federal income tax purposes, the
Company would not be able to qualify as a REIT. See "Federal Income Tax
Considerations - Requirements for Qualification - Income Tests" and "-
Requirements for Qualification - Asset Tests." In addition, any change in either
Hotel Partnership's status for tax purposes might be treated as a taxable event,
in which case the Company might incur a tax liability without any related cash
distribution. See "Federal Income Tax Considerations - Requirements for
Qualification - Distribution Requirements." Further, items of income and
deduction of such Hotel Partnership would not pass through to its partners, and
its partners would be treated as shareholders for tax purposes. Consequently,
such Hotel Partnership would be required to pay income tax at corporate tax
rates on its net income, and distributions to its partners would constitute
dividends that would not be deductible in computing such Hotel Partnership's
taxable income.
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Income Taxation of Each Hotel Partnership and its Partners
Partners, Not the Hotel Partnership, Subject to Tax. A partnership is
not a taxable entity for federal income tax purposes. Rather, the Company is
required to take into account its allocable share of each Hotel Partnership's
income, gains, losses, deductions, and credits for any taxable year of such
Hotel Partnership ending within or with the taxable year of the Company, without
regard to whether the Company has received or will receive any distribution from
such Hotel Partnership.
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 Section 704(b) of the Code 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 determined by taking into account all of the facts
and circumstances relating to the economic arrangement of the partners with
respect to such item. Each Hotel Partnership's allocations of taxable income,
gain and loss are intended to comply with the 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 U.S. Department of Treasury has
issued regulations requiring partnerships to use a "reasonable method" for
allocating items affected by Section 704(c) of the Code and outlining several
reasonable allocation methods. The application of Section 704(c) to the
Partnership is not entirely clear, however, and may be affected by Treasury
Regulations promulgated in the future.
Under the Partnership Agreement, depreciation or amortization
deductions of the Partnership generally will be allocated among the partners in
accordance with their respective interests in the Partnership, except to the
extent that the Partnership is required under Code Section 704(c) to use a
method for allocating tax depreciation deductions attributable to the Hotels or
other contributed properties that results in the Company receiving a
disproportionately large share of such deductions. In addition, gain on the sale
of an Hotel will be specially allocated to the Limited Partners to the extent of
any "built-in" gain with respect to such Hotel for federal income tax purposes.
The Partnership generally has elected to use the "traditional method" for
allocating items of income, gain, and expense as required by Section 704(c) of
the Code with respect to Hotels that it acquires in exchange for Units.
Basis in Partnership Interest. The Company's adjusted tax basis in its
partnership interest in the Partnership generally is equal to (i) the amount of
cash and the basis of any other property contributed to the Partnership by the
Company, (ii) increased by (A) its allocable share of the Partnership's income
and (B) its allocable share of indebtedness of the Partnership, and (iii)
reduced, but not below zero, by (A) the Company's allocable share of the
Partnership's loss and (B) the amount of cash distributed to the Company, and by
constructive distributions resulting from a reduction in the Company's share of
indebtedness of the Partnership.
If the allocation of the Company's distributive share of the
Partnership's loss would reduce the adjusted tax basis of the Company's
partnership interest in the Partnership below zero, the recognition of such loss
will be deferred until such time as the recognition of such loss would not
reduce the Company's adjusted tax basis below zero. To the extent that the
Partnership's distributions, or any decrease in the Company's share of the
indebtedness of the Partnership (such decrease being considered a constructive
cash distribution to the partners), would reduce the Company's adjusted tax
basis below zero, such distributions (including such constructive distributions)
will constitute taxable income to the Company. Such distributions and
constructive distributions normally will be characterized as capital gain, and,
if the Company's partnership interest in the Partnership has been held for
longer than the long-term capital gain holding period (currently one year), the
distributions and constructive distributions will constitute long-term capital
gain.
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Depreciation Deductions Available to the Partnership. To the extent
that a Hotel Partnership has acquired, or will acquire, equity interests in the
Hotels for cash, the Hotel Partnership's initial basis in the Hotels for federal
income tax purposes generally equals or will equal the purchase price paid by
the Hotel Partnership. The Hotel Partnerships generally depreciate such
depreciable hotel property for federal income tax purposes under either MACRS or
ADS. The Hotel Partnerships generally use MACRS for furnishings and equipment.
Under MACRS, the Hotel Partnerships generally depreciate such furnishings and
equipment over a seven-year recovery period using a 200% declining balance
method and a half-year convention. If, however, a Hotel 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 furnishings and equipment placed in service during that year. The Hotel
Partnerships generally use ADS for buildings and improvements. Under ADS, the
Hotel Partnerships generally depreciate such buildings and improvements over a
40-year recovery period using a straight line method and a mid-month convention.
However, to the extent that a Hotel Partnership has acquired, or will acquire,
equity interests in the Hotels in exchange for Units, the Hotel Partnership's
initial basis in each Hotel for federal income tax purposes should be the same
as the transferor's basis in such Hotel on the date of acquisition. Although the
law is not entirely clear, the Hotel Partnerships generally depreciate such
depreciable hotel property for federal income tax purposes over the same
remaining useful lives and using the same methods used by the transferors. A
Hotel Partnership's tax depreciation deductions will be allocated among its
partners in accordance with their respective interests in the partnership
(except to the extent that the Hotel Partnership is required under Code Section
704(c) to use a method for allocating depreciation deductions attributable to
the Hotels or other contributed properties that results in the Company receiving
a disproportionately large share of such deductions).
Sale of a Hotel Partnership's Property
Generally, any gain realized by a Hotel Partnership on the sale of
property by the Hotel Partnership held for more than one year will be long-term
capital gain, except for any portion of such gain that is treated as
depreciation or cost recovery recapture. Any gain recognized by a Hotel
Partnership on the disposition of the Hotels will be allocated first to the
Limited Partners under Section 704(c) of the Code to the extent of their
"built-in gain" on those hotels for federal income tax purposes. 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 the Hotels over the
Limited Partners' tax basis allocable to the Hotels at the time of the sale. Any
remaining gain recognized by the Hotel Partnership on the disposition of the
Hotels will be allocated among the partners in accordance with their respective
percentage interests in the Hotel Partnership. The Board of Directors has
adopted a policy that any decision to sell a Hotel will be made by a majority of
the Directors, including a majority of the Independent Directors. See "Risk
Factors Conflicts of Interest - Conflicts Relating to Sales or Refinancings of
Hotels."
The Company's share of any gain realized by a Hotel Partnership on the
sale of any property held by the partnership as inventory or other property held
primarily for sale to customers in the ordinary course of the partnership's
trade or business will be treated as income from a prohibited transaction that
is subject to a 100% penalty tax. See "Federal Income Tax Considerations -
Requirements for Qualification - Income Tests." Such prohibited transaction
income also may have an adverse effect upon the Company's ability to satisfy the
income tests for REIT status. See "Federal Income Tax Considerations -
Requirements For Qualification - Income Tests" above. The Company, however, does
not presently intend to acquire or hold or allow a Hotel Partnership to acquire
or hold any property that represents inventory or other property held primarily
for sale to customers in the ordinary course of the Company's or the Hotel
Partnerships' trade or business.
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Company has agreed to sell to the Underwriter, and the Underwriter has agreed to
take and pay for, all 1,000,000 Common Shares offered hereby, if any are taken.
The Underwriter proposes to offer the Common Shares in part directly to
the public at the Offering Price set forth on the cover page of this Prospectus
and in part to certain securities dealers at such prices less a concession
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of $.42 per share. After the Common Stock is released for sale to the public,
the Offering Price and other selling terms may from time to time be varied by
the Underwriter.
The Company has granted the Underwriter an option exercisable for 30
days after the date of this Prospectus to purchase up to an aggregate of 150,000
additional shares of Common Stock solely to cover over-allotments, if any.
In connection with the IPO, the Company also granted the Underwriter a
right of first refusal, expiring November 29, 1999, to act as underwriter or
sales agent with respect to any future offering by the Company or the
Partnership of any debt or equity securities, or the placement of any long-term
debt by the Company or the Partnership. In connection with this Offering, the
Underwriter will permanently waive this right of first refusal with respect to
any future offerings by the Company.
Mr. Whittemore, a Senior Vice President of the Underwriter, serves as a
Director of the Company and, as of March 1, 1998, owned directly and indirectly
92,952 shares of Common Stock. Mr. Whittemore received $12,500 in 1997 for
serving as a Director of the Company, which he used to purchase Common Stock in
open market transactions. See "Certain Relationships and Transactions --
Other."
Simultaneously with the closing of the Offering, the Company will enter
into a Capital Consulting Agreement with Charles A. Mills, III, the Senior Vice
President, Chairman and largest shareholder of the Underwriter. Pursuant to such
Agreement, Mr. Mills will provide the Company with advice with respect to future
equity offerings and access to capital markets generally. Under the terms of the
Capital Consulting Agreement, which has a one year term, Mr. Mills will receive
$20,000 plus .25% of the net proceeds (but not to exceed $100,000) of any future
public equity offerings over the next twelve months.
The Company and the Partnership have agreed to indemnify the
Underwriter or to contribute to losses arising out of certain liabilities,
including liabilities under the Securities Act.
The Underwriter may engage in passive market making transactions in the
Common Stock in accordance with Rule 103 of Regulation M promulgated by the
Securities and Exchange Commission. In general, a passive market maker may not
bid for, or purchase, the Common Stock at a price that exceeds the highest
independent bid. In addition, the net daily purchases made by any passive market
maker generally may not exceed the greater of 30% of its average daily trading
volume in the Common Stock during a specified two month prior period, or 200
shares. A passive market maker must identify passive market making bids as such
on the Nasdaq electronic inter-dealer reporting system. Passive market making
may stabilize or maintain the market price of the Common Stock above independent
market levels. The Underwriter is not required to engage in passive market
making and may end passive market making activities at any time.
In order to facilitate the offering of the Common Stock, the
Underwriter may engage in transactions that stabilize, maintain or otherwise
affect the price of the Common Stock. Specifically, the Underwriter may
overallot in connection with the offering, creating a short position in the
Common Stock for its own account. In addition, to cover overallotments or to
stabilize the price of the Common Stock, the Underwriters may bid for, and
purchase, shares of Common Stock in the open market. Any of these activities may
stabilize or maintain the market price of the Common Stock above independent
market levels. The Underwriter is not required to engage in these activities,
and may end any of these activities at any time.
The Underwriter does not intend to sell the Common Stock offered hereby
to any accounts over which it is exercising discretionary authority.
The Company's Directors will each agree, subject to certain limited
exceptions, not to offer, sell, contract to sell or otherwise dispose of any
Common Stock (or any securities convertible into, or exercisable or exchangeable
for shares in the Company) for a period of 90 days after the date of this
Prospectus, without the prior written consent of the Underwriter.
The Common Stock trades on The Nasdaq National Market under the symbol
"HUMP."
90
<PAGE>
EXPERTS
The consolidated financial statements of the Company as of December 31,
1996 and 1997 and for each of the years in the three year period ended December
31, 1997 and the financial statement schedule of the Company as of December 31,
1997 included in this Prospectus; the financial statements of the Lessee as of
December 31, 1996 and 1997 and for each of the years in the three year period
ended December 31, 1997 included in this Prospectus; the financial statements of
the Gateway Acquisition Hotel as of and for the year ended December 31, 1996;
and the combined financial statements as of and for the year ended December 31,
1996 for the H&W Acquisition Hotels, the BCL Acquisition Hotel, and the HERSHA
Acquisition Hotels included in this Prospectus, have been audited by Reznick
Fedder & Silverman, independent public accountants, as set forth in their
reports thereon included elsewhere herein and in the Registration Statement.
Such consolidated financial statements, financial statements, and combined
financial statements, are included in reliance upon such reports given on their
authority as experts in accounting and auditing.
REPORTS TO SHAREHOLDERS
The Company intends to furnish its shareholders with annual reports
containing consolidated financial statements audited by its independent
certified public accountants and with quarterly reports containing unaudited
condensed consolidated financial statements for each of the first three quarters
of each fiscal year.
LEGAL MATTERS
The validity of the Common Shares offered hereby will be passed upon
for the Company by Hunton & Williams. In addition, the description of federal
income tax consequences contained in the section of the Prospectus entitled
"Federal Income Tax Considerations" is based on the opinion of Hunton &
Williams. Certain legal matters related to this Offering will be passed upon for
the Underwriter by Willcox & Savage, P.C. Hunton & Williams will rely on
Gallagher, Evelius & Jones, LLP, Baltimore, Maryland as to certain matters of
Maryland law.
91
<PAGE>
GLOSSARY
Unless the context otherwise requires, the following capitalized terms
shall have the meanings set forth below for the purposes of this Prospectus.
"ADA" means the Americans with Disabilities Act of 1990.
"Additional Charges" means certain amounts payable under the Percentage
Leases other than Rent, including interest on any late payments or charges.
"Additional Reserve Fund" means the additional capital reserve
set-aside, equal to 2% of room revenue, to be used at the Hotels to enhance
their competitive position.
"ADR" means average daily room rate.
"ADS" means the alternative depreciation system of depreciation.
"Affiliate" means (i) any person directly or indirectly owning,
controlling, or holding, with power to vote ten percent or more of the
outstanding voting securities of such other person, (ii) any person ten percent
or more of whose outstanding voting securities are directly or indirectly owned,
controlled, or held, with power to vote, by such other person, (iii) any person
directly or indirectly controlling, controlled by, or under common control with
such other person, (iv) any executive officer, director, trustee or general
partner of such other person, and (v) any legal entity for which such person
acts as an executive officer, director, trustee or general partner. The term
"person" means and includes any natural person, corporation, partnership,
association, limited liability company or any other legal entity. An indirect
relationship shall include circumstances in which a person's spouse, children,
parents, siblings or mothers-, fathers-, sisters- or brothers-in-law is or has
been associated with a person.
"Affiliated Transaction" means any material acquisition transaction
between a Virginia corporation having more than 300 holders of record and any
Interested Shareholder.
"Articles of Incorporation" means the Articles of Incorporation of the
Company.
"Base Rent" means the fixed obligation of the Lessee to pay a sum
certain in monthly Rent under each of the Percentage Leases.
"Beneficiary" means the beneficiary of the Trust.
"Best Western" means Best Western International, Inc.
"Board of Directors" means the Board of Directors of the Company.
"Bylaws" means the Bylaws of the Company.
"Capital Reserves Lease Amendment" means each amendment to a Lease that
provides for additional rent payments to the Company in the event that a Hotel
receives funds from the Additional Reserve Fund.
"Cash Available for Distribution to Shareholders" means net income, or
loss, plus depreciation and amortization and minority interest, minus capital
expenditures or reserves therefor and principal payments on indebtedness.
"Choice Hotels" means Choice Hotels International, Inc.
"Closing" means the closing of the Offering.
92
<PAGE>
"Closing Price" means on any date, the last quoted price as reported by
The Nasdaq National Market.
"Code" means the Internal Revenue Code of 1986, as amended.
"Commission" means the United States Securities and Exchange
Commission.
"Common Shares" means 1,000,000 shares of Common Stock to be issued in
connection with the Offering.
"Common Shareholders" means the holders of shares of Common Stock.
"Common Stock" means the common stock, par value $.01 per share, of the
Company.
"Company" means Humphrey Hospitality Trust, Inc., a Virginia
corporation.
"Company Expenses" means all administrative costs and expenses of the
Company.
"Control Share Acquisitions" means transactions causing the voting
strength of any person acquiring beneficial ownership of shares of a public
corporation in Virginia to meet or exceed certain threshold percentages (20%,
33 1/3% or 50%) of the total votes entitled to be cast for the election
of directors.
"Credit Facility" means the $25.5 million secured line of credit that
Mercantile Safe Deposit and Trust Company has extended to the Partnership.
"Days Inn" means Days Inn of America, Inc.
"Debt Policy" means the policy adopted by the Board of Directors
limiting the Company's consolidated indebtedness to less than 55% of the
aggregate purchase price paid by the Company for the Hotels in which it has
invested.
"Development Agreement" means the amended development services
agreement, as amended, between the Company and Humphrey Development.
"Directors" means the members of the Company's Board of Directors.
"Disinterested Director" means with respect to a particular Interested
Shareholder, a member of the Company's Board of Directors who was (i) a Director
on the date on which an Interested Shareholder became an Interested Shareholder
and (ii) recommended for election by, or was elected to fill a vacancy and
received the affirmative vote of, a majority of the Disinterested Directors then
on the Board.
"Event of Default" means an Event of Default as provided in the
Percentage Leases.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"FFE Reserves" means the reserves for furniture, fixtures and capital
expenditures equal to 4% of room revenues per quarter on a cumulative basis that
the Company sets aside for the Lessee to use on the Hotels. Upon completion of
the Offering, the Company will increase its FFE Reserves from 4% to 6% of room
revenue. The additional 2% will be held in the Additional Reserve Fund and will
be used pursuant to the Capital Reserves Lease Amendment.
"Fixed Lease" means the operating lease between the Partnership and the
Lessee pursuant to which the Lessee leases the Comfort Suites-Dover, Delaware
Hotel and any additional hotels developed by the Company in the future from the
Partnership, for a fixed amount of rent.
"Franchise Licenses" means the franchise licenses held by the Lessee
for the Hotels.
93
<PAGE>
"Funds From Operations" represents net income (computed in accordance
with GAAP) excluding gains (or losses) from debt restructuring or sales of
property, plus depreciation and amortization on real estate assets, other than
amortization of loan fees, and after adjustments for unconsolidated partnerships
and joint ventures.
"GAAP" means generally accepted accounting principles.
"General Partner" means Humphrey Hospitality REIT Trust, a Maryland
real estate investment trust, as the sole general partner of the Partnership.
"Hotel Partnership" means either the Partnership or the Subsidiary
Partnership.
"Hotels" means the twenty existing limited service hotels in which the
Company through the Partnership owns interests.
"Humphrey Affiliates" means Mr. Humphrey and his Affiliates.
"Humphrey Associates" means Humphrey Associates, Inc., a Maryland
corporation.
"Humphrey Development" means Humphrey Development, Inc., a Maryland
corporation.
"Humphrey Key Largo" means Humphrey-Key Largo Associates, L.P., a
Maryland limited partnership, which assigned its interest in the purchase
agreement for the Best Western Suites-Key Largo, Florida Hotel to the Company.
"Independent Director" means a Director of the Company who within the
last two years, has not (i) owned an interest in any Humphrey Affiliates, (ii)
been employed by Mr. Humphrey or any Humphrey Affiliates, (iii) been an officer
or director of any Humphrey Affiliates, (iv) performed services for the Company,
(v) been a director for more than three REITs organized by Mr. Humphrey or any
of his Affiliates or (vi) had any material business or professional relationship
with Mr. Humphrey or any of his Affiliates.
"Initial Hotels" means the eight hotels acquired directly or indirectly
by the Partnership in connection with the IPO, which hotels include seven
Comfort Inn hotels and one Rodeway Inn hotel.
"Interested Shareholder" means any holder of more than 10% of any class
of outstanding voting shares of a Virginia corporation having more than 300
shareholders of record.
"Investment Policy" means the policy of the Board of Directors limiting
the Company's investments in hotel properties, including the acquisition of
existing hotels and development of hotels to properties that the Company can
reasonably demonstrate will yield an annual return on its investment in such
property, after deducting insurance, real estate and personal property taxes and
FFE Reserves of 4% of room revenues that is greater than or equal to 12% of the
total purchase price to be paid by the Company for such Property.
"IOC" means the International Operators Council for Choice Hotels.
"IPO" means the initial public offering of Common Stock of the Company,
which closed on November 29, 1994.
"Leases" means Fixed Leases and/or Percentage Leases.
"Lessee" means Humphrey Hospitality Management, Inc., a Maryland
corporation, which leases the Hotels from the Partnership pursuant to the
Leases.
"Limited Partners" means the limited partners of the Partnership.
94
<PAGE>
"LLC" means Farmville Lodging Associates, LLC, a Maryland limited
liability company, which sold the Days Inn-Farmville, Virginia Hotel to the
Company.
"MACRS" means the modified accelerated cost recovery system of
depreciation.
"Market Price" means, on any date, the average of the Closing Price for
the five consecutive Trading Days ending on such date.
"Mercantile" means Mercantile Safe Deposit and Trust Company, as lender
under the Credit Facility.
"NAREIT" means the National Association of Real Estate Investment
Trusts, Inc.
"Net Proceeds" means the proceeds of the Offering to be received by the
Company net of all Offering expenses and fees to the Underwriter.
"Non-Competition Agreement" means the acquisition agreement and
covenant not to compete between Mr. Humphrey, his Affiliates and the Company
pursuant to which Mr. Humphrey and his Affiliates agreed that none of them will
compete with the Company for hotel acquisition, development and management
opportunities within 20 miles of the Hotels or any other hotel acquired by the
Company.
"Offering" means the offering of Common Shares hereby.
"Offering Price" means the offering price of $10.50 per Common Share
offered hereby.
"Operator" means Humphrey Hotels, Inc., a Maryland corporation, which
operated the Hotels for the Lessee.
"Option Agreement" means the option agreement to be executed by the
Company and Mr. Humphrey and granting the Company certain rights in any hotels
to be developed or acquired by Mr. Humphrey or of any Affiliate of Mr. Humphrey
within the United States.
"Ownership Limitation" means the restriction on ownership (or deemed
ownership by virtue of the attribution provisions of the Code) of more than 9.9%
of the outstanding Common Shares or any other class of outstanding shares of
capital stock.
"Partnership" means Humphrey Hospitality Limited Partnership, a limited
partnership organized under the laws of the State of Virginia.
"Partnership Agreement" means the partnership agreement of the
Partnership, as amended and restated.
"Percentage Leases" means operating leases between the Lessee and the
Partnership pursuant to which the Lessee leases the Hotels from the Partnership
and any additional existing hotels acquired by the Company after the date of the
Offering.
"Percentage Rents" means Rent based on percentages of revenues payable
by the Lessee pursuant to the Percentage Leases.
"Preferred Stock" means the preferred stock, par value $.01 per share,
of the Company.
"Prohibited Owner" means the record holder of shares of Common Stock or
Preferred Stock that are designated as Shares-in-Trust.
95
<PAGE>
"Redemption Right" means the right of the persons receiving Units to
cause the redemption of Units in exchange for Common Shares on a one-for-one
basis (or for cash at the election of the Company or in certain other
circumstances).
"REIT" means real estate investment trust, as defined in Section 856 of
the Code.
"Remaining Indebtedness" means that certain indebtedness in the
aggregate approximate principal amount of $21 million to remain outstanding
after the application of the Net Proceeds.
"Rent" means the Base Rent and the Percentage Rents and rent payments
under the Fixed Lease.
"REVPAR" means revenue per available room for the applicable period.
"Rule 144" means the rule promulgated under the Securities Act that
permits holders of restricted securities as well as affiliates of an issuer of
the securities, pursuant to certain conditions and subject to certain
restrictions, to sell their securities publicly without registration under the
Securities Act.
"Securities Act" means the Securities Act of 1933, as amended.
"Selling Partnerships" means the limited partnerships that sold the
Initial Hotels to the Company in connection with the IPO.
"Service" means the Internal Revenue Service.
"Services Agreement" means the amended and restated services agreement
between the Lessee and the Company.
"Shares-in-Trust" means those shares transferred to the Trust in the
event of any purported transfer of shares of Common Stock or Preferred Stock
that would (i) result in any person owning, directly or indirectly, shares of
Common Stock or Preferred Stock in excess of the Ownership Limitation, (ii)
result in the shares of Common Stock or Preferred Stock being owned by fewer
than 100 persons (determined without reference to any rules of attribution),
(iii) result in the Company being "closely held" within the meaning of Section
856(h) of the Code, or (iv) cause the Company to own, actually or
constructively, 10% of more of the ownership interests in a tenant of the
Company's, the Partnership's or the Subsidiary Partnership's real property,
within the meaning of Section 856(d)(2)(B) of the Code.
"Subsidiary Partnership" means the Solomons Beacon Inn Limited
Partnership, a Maryland limited partnership, which owns the Comfort Inn-Beacon
Marina, Solomons, Maryland Hotel.
"Trading Day" means a day on which the principal national securities
exchange on which the shares of Common Stock or Preferred Stock are listed or
admitted to trading is open for the transaction of business or, if the shares of
Common Stock or Preferred Stock are not listed or admitted to trading on any
national securities exchange, any day other than a Saturday, a Sunday or a day
on which banking institutions in the State of New York are authorized or
obligated by law or executive order to close.
"Threshold" means the amount of annual room revenues set out in each
Percentage Lease above which the Lessee will pay the Partnership or Subsidiary
Partnership, as applicable, a Percentage Rent relating to annual room revenues
above that Threshold.
"Treasury Regulations" means the final, temporary and proposed tax
regulations promulgated under the Code.
"Trust" means the record holder of Shares-in-Trust.
96
<PAGE>
"Trustee" means the trustee of the Trust.
"Underwriter" means Anderson & Strudwick Incorporated.
"Units" means units of partnership interest in the Partnership.
97
<PAGE>
INDEX TO FINANCIAL STATEMENTS
HUMPHREY HOSPITALITY TRUST, INC.
INDEPENDENT AUDITOR'S REPORT F-4
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1996
AND 1997 F-5
CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED
DECEMBER 31, 1995, 1996 AND 1997 F-6
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR
THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F-10
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION F-25
NOTES TO SCHEDULE III - REAL ESTATE AND ACCUMULATED
DEPRECIATION F-26
HUMPHREY HOSPITALITY MANAGEMENT, INC.
INDEPENDENT AUDITOR'S REPORT F-27
BALANCE SHEETS AS OF DECEMBER 31, 1996 AND 1997 F-28
STATEMENTS OF INCOME FOR THE YEARS ENDED
DECEMBER 31, 1995, 1996 AND 1997 F-29
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) FOR THE
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 F-30
STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED
DECEMBER 31, 1995, 1996 AND 1997 F-31
NOTES TO FINANCIAL STATEMENTS F-32
HERSHA ACQUISITION HOTELS
INDEPENDENT AUDITORS' REPORT F-35
COMBINED BALANCE SHEET AS OF DECEMBER 31, 1996 F-36
COMBINED STATEMENT OF INCOME AND RETAINED EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 1996 F-37
F-1
<PAGE>
INDEX TO FINANCIAL STATEMENTS
COMBINED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996 F-38
NOTES TO COMBINED FINANCIAL STATEMENTS F-39
H&W ACQUISITION HOTELS
INDEPENDENT AUDITORS' REPORT F-41
COMBINED BALANCE SHEET AS OF DECEMBER 31, 1996 F-42
COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996 F-43
COMBINED STATEMENT OF EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1996 F-44
COMBINED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996 F-45
NOTES TO COMBINED FINANCIAL STATEMENTS F-46
GATEWAY ACQUISITION HOTEL
INDEPENDENT AUDITORS' REPORT F-50
BALANCE SHEET AS OF DECEMBER 31, 1996 F-51
STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996 F-52
STATEMENT OF PARTNERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1996 F-53
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996 F-54
NOTES TO FINANCIAL STATEMENTS F-55
BCL ACQUISITION HOTEL
INDEPENDENT AUDITORS' REPORT F-57
COMBINED BALANCE SHEET AS OF DECEMBER 31, 1996 F-58
COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996 F-59
F-2
<PAGE>
INDEX TO FINANCIAL STATEMENTS
COMBINED STATEMENT OF EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1996 F-60
COMBINED STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 1996 F-61
NOTES TO COMBINED FINANCIAL STATEMENTS F-62
F-3
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors
Humphrey Hospitality Trust, Inc.
We have audited the accompanying consolidated balance sheets of
Humphrey Hospitality Trust, Inc. and Subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1997, and the financial statement schedule as of December 31,1997. These
consolidated financial statements and the financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on the consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Humphrey
Hospitality Trust, Inc. and Subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1997, in conformity with generally accepted
accounting principles. The financial statement schedule referred to above, when
considered in relation to the consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information required to be
included therein.
As described in Notes 1 and 6 to the consolidated financial statements,
the Company adopted Statement of Financial Accounting Standards No. 128,
Earnings Per Share, in 1997.
/s/ REZNICK FEDDER & SILVERMAN
Baltimore, Maryland
February 4, 1998
F - 4
<PAGE>
Humphrey Hospitality Trust, Inc.
CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, 1996 and 1997
<TABLE>
<CAPTION>
1996 1997
----------------- -----------------
<S> <C>
ASSETS
Investment in hotel properties, net of accumulated depreciation
of $1,134 and $2,636 $ 21,405 $ 50,476
Cash and cash equivalents 7,101 204
Accounts receivable from lessee 1,067 1,857
Reserve for replacements 68 149
Deferred expenses, net of accumulated amortization
of $76 and $207 373 904
Other assets 207 209
-------------- -------------
Total assets $ 30,221 $ 53,799
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Mortgages and bonds payable $ 8,151 $ 31,721
Obligations under capital leases 34 34
Dividends payable 561 559
Accounts payable and accrued expenses 83 263
-------------- -------------
Total liabilities 8,829 32,577
-------------- -------------
MINORITY INTEREST 3,247 3,370
-------------- -------------
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' EQUITY
Preferred stock, $.01 par value, 10,000,000 shares authorized;
no shares issued and outstanding - -
Common stock, $.01 par value, 25,000,000 shares authorized;
3,481,700 shares issued and outstanding 35 35
Additional paid-in capital 18,202 18,042
Distributions in excess of net earnings (92) (225)
-------------- -------------
18,145 17,852
-------------- -------------
Total liabilities and shareholders' equity $ 30,221 $ 53,799
============== =============
</TABLE>
See notes to consolidated financial statements
F - 5
<PAGE>
Humphrey Hospitality Trust, Inc.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
1995 1996 1997
----------------- ----------------- ----------------
<S> <C>
Revenue
Percentage lease revenue $ 3,750 $ 3,958 $ 7,326
Other revenue 21 47 106
-------------- -------------- -------------
Total revenue 3,771 4,005 7,432
-------------- -------------- -------------
Expenses
Interest 1,011 493 1,764
Real estate and personal property taxes and
property insurance 196 252 476
General and administrative 238 411 537
Depreciation and amortization 680 736 1,633
-------------- -------------- -------------
Total expenses 2,125 1,892 4,410
-------------- -------------- -------------
Income before allocation to minority
interest 1,646 2,113 3,022
Income allocated to minority interest 396 435 465
-------------- -------------- -------------
NET INCOME $ 1,250 $ 1,678 $ 2,557
============== ============== =============
Basic earnings per common share $ .72 $ .70 $ .73
============== ============== =============
Diluted earnings per common share $ .70 $ .70 $ .73
============== ============== =============
</TABLE>
See notes to consolidated financial statements
F - 6
<PAGE>
Humphrey Hospitality Trust, Inc.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
Common Stock Additional Distributions
--------------------------- Paid-In in excess of
Shares Dollars Capital net earnings Total
------------ ------------ -------------- --------------- -------------
<S> <C>
Balance, December 31, 1994 1,321,800 $ 13 $ 4,338 $ 14 $ 4,365
Redemption of shares (100) - (1) - (1)
Issuance of shares, net of offering expenses 1,010,000 10 6,947 - 6,957
Minority interest in the proceeds from the
common stock offering - - (1,467) - (1,467)
Net increase resulting from the acquisition of
Farmville, LLC - - 448 - 448
Dividends declared - - - (1,262) (1,262)
Net income - - - 1,250 1,250
------------ ---------- ------------ ------------ ----------
Balance, December 31, 1995 2,331,700 23 10,265 2 10,290
Issuance of shares, net of offering
expenses 1,150,000 12 8,633 - 8,645
Minority interest in the proceeds from the
common stock offering - - (696) - (696)
Dividends declared - - - (1,772) (1,772)
Net income - - - 1,678 1,678
------------ ---------- ------------ ------------ ----------
Balance, December 31, 1996 3,481,700 35 18,202 (92) 18,145
Offering expenses - - (7) - (7)
Minority interest issued in connection with the
acquisition of the Best Western Key Largo - - (153) - (153)
Dividends declared - - - (2,690) (2,690)
Net income - - - 2,557 2,557
------------ ---------- ------------ ------------ ----------
Balance, December 31, 1997 3,481,700 35 18,042 $ (225) $ 17,852
============ ========== ============ ============ ==========
</TABLE>
See notes to consolidated financial statements
F - 7
<PAGE>
Humphrey Hospitality Trust, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
1995 1996 1997
---------------- ---------------- ----------------
<S> <C>
Cash flows from operating activities
Net income $ 1,250 $ 1,678 $ 2,557
Adjustments to reconcile net income to net cash provided by
operating activities
Depreciation and amortization 680 736 1,633
Income allocated to minority interests 396 435 465
Changes in assets and liabilities
Deferred franchise fees paid - - (363)
Increase in accounts receivable (881) (42) (790)
Increase in other assets (43) (64) (2)
(Decrease) increase in accounts payable and accrued expenses (68) 8 180
------------- ------------- -------------
Net cash provided by operating activities 1,334 2,751 3,680
------------- ------------- -------------
Cash flows from investing activities
Investment in hotel properties (212) (2,306) (29,325)
Deposits to reserve for replacements (407) - (776)
Withdrawals from reserve for replacements - 339 695
------------- ------------- -------------
Net cash used in investing activities (619) (1,967) (29,406)
------------- ------------- -------------
Cash flows from financing activities
Proceeds from sale of stock 6,957 8,645 -
Stock issuance costs - - (7)
Proceeds from mortgages and bonds payable 1,283 - -
Principal payments on mortgages and bonds payable (7,930) (3,175) (1,400)
Proceeds from line of credit 600 2,999 23,750
Repayment of line of credit (600) - -
Financing costs paid (221) (53) (299)
Dividends paid (1,172) (2,246) (3,187)
Principal payments on capital leases (16) (22) (28)
Redemption of common stock (1) - -
------------- ------------- -------------
Net cash (used in) provided by financing activities (1,100) 6,148 18,829
------------- ------------- -------------
(DECREASE) INCREASE IN CASH (385) 6,932 (6,897)
Cash and cash equivalents, beginning 554 169 7,101
------------- ------------- -------------
Cash and cash equivalents, ending $ 169 $ 7,101 $ 204
============= ============= =============
</TABLE>
See notes to consolidated financial statements
F - 8
<PAGE>
Humphrey Hospitality Trust, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(in thousands)
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
1995 1996 1997
---------------- -------------- ---------------
<S> <C>
Supplemental disclosures of cash flow information
Cash paid during the period for interest $ 1,074 $ 495 $ 1,582
============= =========== ==============
</TABLE>
Supplemental disclosures of non-cash investing and financing activities
During 1995, the Partnership acquired the Days Inn Hotel in Farmville,
Virginia, in exchange for units of limited partnership interest to Farmville
Lodging Associates, LLC, which are redeemable for an aggregate of 95,484
common shares with a value of approximately $740 based on the offering price
of $7.75 per common share, and the assumption of approximately $1,231 of
indebtedness. The assets acquired and the liabilities assumed consisted of:
Investment in hotel properties $ 1,800
Deferred expenses 24
Mortgages payable (1,231)
Obligations under capital leases (20)
Accounts payable and accrued expenses (6)
Minority interest (119)
Net increase in additional paid-in capital resulting from
acquisition of Farmville Lodging Associates, LLC (448)
-------
$ -
=======
During 1997, the Partnership issued units of limited partnership interest to
Humphrey-Key Largo Associates, L.P., which are redeemable for an aggregate
of 34,023 common shares, with a value of approximately $370 based on an
average price of $10.875 per share in connection with the acquisition of the
Best Western Suites Hotel in Key Largo, Florida. The recording of the
increase in minority interest resulted in a $153 reduction in additional
paid in capital.
During 1997, the Company acquired the Culpeper Comfort Inn Hotel for $1,900
of which $1,220 represented debt assumed.
During 1997, the Company acquired equipment subject to capital leases
totalling $28.
Dividends declared on December 1, 1996, and on November 28, 1997 and
December 31, 1997, are payable as of December 31, 1996 and 1997, in the
amounts of $561 and $559, respectively. Dividends declared during 1996 and
1997 included $474 and $495, respectively, to the minority interests which
have been deducted from the minority interest on the balance sheets as of
December 31, 1996 and 1997, respectively.
See notes to consolidated financial statements
F - 9
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 1. Organization and Summary of Significant Accounting Policies
Humphrey Hospitality Trust, Inc. was incorporated on August 23, 1994.
The Company is a self-administered real estate investment trust (REIT) for
Federal income tax purposes. Humphrey Hospitality Trust, Inc., through its
wholly-owned subsidiary Humphrey Hospitality REIT Trust (collectively, the
Company) owns a controlling partnership interest in Humphrey Hospitality Limited
Partnership (the Partnership) and through the Partnership owns interests in
twenty existing limited - service Hotels (including ten hotel properties
acquired during 1997) as of December 31, 1997. The Partnership owns a 99%
general partnership interest and the Company owns a 1% limited partnership
interest in Solomons Beacon Inn Limited Partnership (the Subsidiary
Partnership). As of December 31, 1997, the Company owns a 84.12% interest in the
Partnership. The Company began operations on November 29, 1994.
Since inception, the Partnership has leased all of its hotel facilities
to Humphrey Hospitality Management, Inc. (the Lessee), a corporation wholly
owned by James I. Humphrey, Jr., the President and Chairman of the Board of the
Company. The Lessee operates and leases the hotel properties pursuant to
separate percentage and fixed lease agreements (the Percentage Leases and the
Fixed Lease) which provide for both fixed base rents and percentage rents based
on the revenues of the hotels.
As of December 31, 1997, James I. Humphrey, Jr., Humphrey Associates,
Inc., Farmville Lodging Associates, LLC and Humphrey-Key Largo Associates, L.P.
(collectively, the Humphrey Affiliates) own a combined total of 657,373 units of
limited partnership interests, representing a 15.88% interest in the
Partnership.
The Company has completed the following public offerings since its
incorporation:
<TABLE>
<CAPTION>
Offering price per Shares sold Net proceeds
Offering Date completed share (in thousands)
- ------------------------- ---------------------- ------------------- -------------- ------------------
<S> <C>
Initial public offering November 29, 1994 $ 6.00 1,321,700 $ 6,950
Second offering July 21, 1995 $ 7.75 1,010,000 $ 6,957
Third offering December 6, 1996 $ 8.25 1,150,000 $ 8,645
</TABLE>
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company, the Partnership and the Subsidiary Partnership. All significant
intercompany balances and transactions have been eliminated.
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.
F - 10
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 1. Organization and Summary of Significant Accounting Policies (Continued)
Investment in Hotel Properties
The hotel properties are recorded at cost. Depreciation is computed
using the straight-line method over estimated useful lives of the assets which
range from 31 to 40 years for buildings and 5 to 12 years for furniture and
equipment. Maintenance and repairs are generally the responsibility of the
Lessee and are charged to the Lessee's operations as incurred; major
replacements, renewals and improvements are capitalized. Upon disposition, both
the asset and accumulated depreciation accounts are relieved and the related
gain or loss is credited or charged to the statement of income.
The Company reviews the carrying value of each hotel property in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 121 to
determine if circumstances exist indicating an impairment in the carrying value
of the investment in the hotel property or that depreciation periods should be
modified. If facts or circumstances support the possibility of impairment, the
Company will prepare a projection of the undiscounted future cash flows of the
specific hotel property and determine if the investment in the hotel property is
recoverable based on the undiscounted future cash flows. If impairment is
indicated, an adjustment will be made to the carrying value of the hotel
property based on the discounted future cash flows. The Company does not believe
that there are any current facts or circumstances indicating impairment of any
of its investment in hotel properties.
Cash and Cash Equivalents
Cash and cash equivalents includes cash, a repurchase agreement, a
certificate of deposit, and an investment in commercial paper, all with original
maturities of three months or less when acquired, carried at cost which
approximates fair value.
Deferred Expenses
Deferred expenses are recorded at cost and consist of the following at
December 31, 1996 and 1997:
1996 1997
---------------- --------------
(in thousands)
Initial franchise fees $ - $ 378
Computer software costs - 27
Loan costs 449 706
------------- -----------
449 1,111
Less accumulated amortization 76 207
------------- -----------
$ 373 $ 904
============= ===========
F - 11
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 1. Organization and Summary of Significant Accounting Policies (Continued)
Amortization of loan costs is computed using the straight-line method
over the terms of the loan agreements. The unamortized balance of loan costs
associated with retired debt is expensed upon repayment of the related debt.
Amortization of initial franchise fees is computed using the straight-line
method over the remaining lives of the franchise agreements, which range up to
20 years. Amortization of computer software costs is computed using the
straight-line method over three years.
Revenue Recognition
Lease income is recognized when earned from the Lessee under the lease
agreements from the date of acquisition of each hotel property (see Note 7).
Earnings Per Common Share
During 1997, the Company adopted Statement of Financial Accounting
Standards No. 128, Earnings Per Share. Basic and diluted earnings per share
have been calculated in accordance therewith for 1995, 1996 and 1997 (see Note
6).
Distributions
The Company intends to pay regular monthly dividends which are
dependent upon the receipt of distributions from the Partnership.
Minority Interest
Minority interest in the Partnership represents the limited partners'
proportionate share of the equity of the Partnership. The limited partnership
interests are owned by the Humphrey Affiliates as of December 31, 1997. Income
is allocated to minority interest based on weighted average percentage ownership
throughout the year.
Income Taxes
The Company intends to continue to qualify as a REIT under Sections 856
and 860 of the Internal Revenue Code effective with its taxable period ended
December 31, 1994. Accordingly, no provision for Federal income taxes has been
reflected in the financial statements.
Earnings and profits, which will determine the taxability of dividends
to shareholders, will differ from net income reported for financial reporting
purposes due to the differences for Federal tax purposes in the estimated useful
lives and methods used to compute depreciation. Distributions made in 1996 are
considered to be 5.7% return of capital for Federal income tax purposes. During
1997, none of the distributions are considered to be return of capital.
F - 12
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 1. Organization and Summary of Significant Accounting Policies (Continued)
Concentration of Credit Risk
The Company maintains its deposits, including its repurchase agreements
and investment in commercial paper, with three major banks. At December 31,
1997, the balances reported by the banks, exceeded the federal depository
insurance limit, however, management believes that no significant concentration
of credit risk exists with respect to these uninsured cash balances.
Note 2. Investment in Hotel Properties
Investment in hotel properties consist of the following at December 31,
1996 and 1997:
1996 1997
-------------- --------------
(in thousands)
-----------------------------
Land $ 3,048 $ 4,455
Buildings and improvements 16,140 43,595
Furniture and equipment 1,631 4,937
Leased equipment 100 125
Construction-in-progress 1,620 -
----------- -----------
22,539 53,112
Less accumulated depreciation 1,134 2,636
----------- -----------
$ 21,405 $ 50,476
=========== ===========
Depreciation expense was $486, $610 and $1,502 for the years ended
December 31, 1995, 1996 and 1997, respectively.
The twenty hotel properties owned at December 31, 1997 (including the
10 hotels acquired during 1997) are all limited service hotels located in nine
states in the eastern United States and are subject to leases as described in
Note 7. During 1997, the Company also completed the development of a Comfort
Suites Hotel located in Dover, Delaware (the Dover Hotel) at a cost of
approximately $2,688 (see Note 7).
F - 13
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 2. Investment in Hotel Properties (Continued)
During 1997, the Company acquired the following hotels for the
approximate amounts indicated:
Contract Purchase
Price
Location Number of hotels (in thousands)
- ---------------------- ------------------ --------------------
Florida 1 $ 2,590
Kentucky 2 5,341
North Carolina 1 1,975
Pennsylvania 5 16,400
Virginia 1 1,900
------------
$ 28,206
============
The above acquisitions were accounted for as purchases, and the results
of such acquisitions are included in the Company's consolidated statements of
income from the date of acquisition. The hotel property in Key Largo, Florida,
was acquired pursuant to an assignment of a purchase contract from Humphrey-Key
Largo Associates, L.P. (the Affiliate), a partnership substantially owned by Mr.
Humphrey. Pursuant to the assignment of the contract, the Affiliate received as
compensation 34,023 units of limited partnership interest in the Partnership,
valued at $370 based on an average price of $10.875 per share of common stock
for the ten trading days prior to September 2, 1997. The acquisition of the
hotel has been recorded by the Company at its acquisition cost ($2,590) which
excludes the value of the units issued to the Affiliate ($370) and is less than
or equal to net realizable value.
Note 3. Dividends Payable
On December 1, 1996, the Company declared a $.19 dividend on each share
of common stock and on each unit of interest outstanding on December 1, 1996.
The dividend (including the distribution to minority interests) was paid on
January 31, 1997.
On November 28, 1997 and December 31, 1997, the Company declared a
$.0675 dividend on each share of common stock and on each unit of interest
outstanding on November 28, 1997 and December 31, 1997, respectively. The
dividends (including the distributions to minority interest) were paid on
January 9, 1998 and January 30, 1998, respectively.
F - 14
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 4. Mortgages and Bonds Payable
Mortgages and bonds payable at December 31, 1996 and 1997, consisted of
the following:
<TABLE>
<CAPTION>
1996 1997
----------------- -----------------
(in thousands)
<S> <C>
Comfort Inn - Morgantown, West Virginia
Bonds payable; see (a) below for repayment terms, interest rates, and maturity;
collateralized by a first mortgage on the hotel facility and equipment with a
net book value of $3,064,725 and $3,133,740 at December 31, 1996 and 1997,
respectively, and secured by a letter of credit issued by Crestar Bank in the
amount of $2,281,104 expiring in April 2000. The outstanding principal and
interest are guaranteed jointly and severally by the Company and James I.
Humphrey, Jr. $ 2,275 $ 2,230
Comfort Inn - Dublin, Virginia
Bonds payable; see (b) below for repayment terms, interest rates, and maturity;
collateralized by a first mortgage on the hotel facility and equipment with a
net book value of $2,920,557 and $2,741,938 at December 31, 1996
and 1997, respectively. 2,375 2,325
Rodeway Inn - Wytheville, Virginia
Bonds payable; see (c) below for repayment terms, interest rates, and maturity;
collateralized by a first mortgage on the hotel facility and equipment with a
net book value of $2,133,880 and $2,071,272 at December 31, 1996 and 1997,
respectively, and secured by a letter of credit issued by Crestar Bank in the
amount of $1,749,188 which expires November 1, 1999. The outstanding principal
and accrued interest are guaranteed jointly and severally by the Company
and James I. Humphrey, Jr. 1,795 1,710
</TABLE>
F - 15
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 4. Mortgage and Bonds Payable (Continued)
<TABLE>
<CAPTION>
1996 1997
----------- -----------
(in thousands)
<S> <C>
Mortgage payable to Mercantile Safe Deposit and Trust Company under the terms of
a $25.5 million line of credit, collateralized by 17 of the hotel properties
(see (d) below). The terms of the line of credit require monthly installments of
interest only at the prime rate plus .25% (8.75% per annum as of December 31,
1997). The outstanding principal balance plus any accrued interest are payable
in full in April 1999, with two one year extensions at the option of the bank.
The mortgage is collateralized by hotel facilities and equipment having a
combined net book value of $6,567,156 and $42,381,185 at December 31, 1996 and
1997, respectively. The first $2 million outstanding on the line is guaranteed
jointly and severally by the Company and James I. Humphrey, Jr. 1,706 25,456
-------------- -------------
$ 8,151 $ 31,721
============== =============
</TABLE>
- --------------
(a) The bonds are Monongalia County, West Virginia, Commercial Development
Variable Rate Demand Refunding Revenue Bonds, Series 1988 issued through
Crestar Bank in the amount of $2,500,000. Interest is accrued at the rate
necessary to remarket the bonds at a price equal to 100% of the
outstanding principal balance. The rate is adjusted weekly and is not to
exceed 11.3636%. At December 31, 1997, the interest rate was 4.15% . In
addition, letter of credit fees and financing fees increase the effective
rate on the bonds. The bonds may be redeemed at the option of the
Partnership in denominations greater than $25,000. Mandatory redemptions
are pursuant to a sinking fund redemption schedule which began on April
1, 1989, in the amount of $15,000 increasing annually until April 1,
2017, when the payment equals $140,000. The Partnership is required to
fund a principal reserve fund monthly equal to one-twelfth of the
mandatory sinking fund redemption. In addition, the Partnership is
required to fund an interest reserve fund. All principal and interest
payments will be automatically deducted by the trustee. Any deficiencies
will be drawn down under the letter of credit.
(b) On October 14, 1992, $2,528,000 of Variable Rate First Mortgage Refunding
Revenue Bonds were issued by the Industrial Development Authority of
Pulaski County, Virginia. Crestar Bank is the trustee. In August 1995,
the bonds were refinanced with approximately $2,460,000 of 1995 First
Mortgage Refunding Revenue Bonds bearing interest at 8% per annum. The
agreement establishes a sinking fund from which principal payments on the
bonds will be made. The bonds mature in varying amounts November 1, 1995
through November 1, 2005.
(c) The original $2,600,000 bond issue financing of 1984 was refunded with
$2,270,000, 1993 Series Industrial Development Revenue Bonds on December
21, 1993. Crestar Bank is the lender and bond
F - 16
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 4. Mortgage and Bonds Payable (Continued)
trustee. Interest is accrued at the rate necessary to remarket
the bonds at a price equal to 100% of the outstanding principal
balance. The rate is adjusted weekly and is not to exceed 15%. At
December 31, 1997, the interest rate was 4.15%. The bonds are
subject to mandatory redemption at a redemption price equal to
the principal amount thereof plus all unpaid accrued interest
thereon, pursuant to the sinking fund installments beginning on
November 1, 1994, in the amount of $65,000 increasing annually
until November 1, 2009, when the payment equals $300,000. The
Partnership is required to fund a principal reserve monthly equal
to one-twelfth of the mandatory sinking fund redemption. In
addition, the Partnership is required to fund an interest reserve
fund. All principal and interest payments will be automatically
deducted by the trustee. Any deficiencies will be drawn under the
letter of credit described above.
(d) As of December 31, 1997, the line of credit is secured by the
Company's hotels located in Solomons, MD; Farmville, VA (2
hotels); Elizabethton, TN; Dahlgren, VA; Princeton, WV; Dover,
DE; Culpeper, VA; New Castle, PA; Harlan, KY; Danville, KY;
Murphy, NC; Chambersburg, PA; Allentown, PA; Gettysburg, PA (2
hotels); and Key Largo, FL.
Aggregate annual principal payments and payments to bond sinking funds
for the five years following December 31, 1997, and thereafter are as follows:
(in thousands)
----------------
December 31, 1998 $ 195
1999 25,661
2000 225
2001 245
2002 265
Thereafter 5,130
------
$31,721
=======
Bond sinking funds and escrows for taxes and insurance in the amounts
of approximately $114 and $198 are included in other assets at December 31, 1996
and 1997, respectively.
Management believes that the carrying amounts of the Company's
mortgages and bonds payable approximate fair value at December 31, 1997, as
there were no significant changes in the market rate of interest between that
date and the dates of the respective mortgages and bonds.
F - 17
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 5. Obligations Under Capital Lease
Certain of the hotel properties lease equipment under noncancellable
capital leases expiring at various intervals through 1999. The leases provide
for bargain purchase options at the end of the respective terms. Future minimum
lease payments under the capital leases, together with the present value of the
net minimum lease payments are as follows:
(in thousands)
---------------
Years ended December 31, 1998 $25
1999 8
2000 6
2001 3
--
42
Less amount representing interest 8
---
Present value of net minimum lease
payments $34
===
F - 18
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 6. Earnings Per Share
The following is a reconciliation of the income (numerator) and
weighted average shares (denominator) used in the calculation of basic earnings
per common share and diluted earnings per common share in accordance with
Statement of Financial Accounting Standards No. 128, Earnings Per Share:
<TABLE>
<CAPTION>
Year ended December 31, 1995 Year ended December 31, 1996
------------------------------------ -----------------------------------------
Income Income
(Numerator) (Numerator)
(In Shares Per Share (In Shares Per Share
thousands) (Denominator) Amount thousands) (Denominator) Amount
----------- -------------- --------- ------------- --------------- ----------
<S> <C>
Basic earnings per share
Income available to common $1,250 1,742,533 $0.72 $1,678 2,410,252 $0.70
==== ====
Effect of diluted securities
Units held by minority interests 396 623,350 435 623,350
------ --------- ------ ---------
Income available to common shareholders
plus assumed conversion $1,646 2,365,883 $0.70 $2,113 3,033,602 $0.70
====== ========= ==== ====== ========= ====
</TABLE>
Year ended December 31, 1997
-------------------------------------
Income
(Numerator)
(In Shares Per Share
thousands) (Denominator) Amount
------------ ------------- ---------
Basic earnings per share
Income available to common $2,557 3,481,700 $0.73
====
Effect of diluted securities
Units held by minority interests 465 657,373
------ ---------
Income available to common shareholders
plus assumed conversion $3,022 4,139,073 $0.73
====== ========= ====
F - 19
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 7. Commitments and Contingencies and Related Party Transactions
Pursuant to the Humphrey Hospitality Limited Partnership Agreement (the
Partnership Agreement), the Humphrey Affiliates have received redemption rights,
which will enable them to cause the Partnership to redeem their interests in the
Partnership in exchange for shares of common stock or for cash at the election
of the Company. The redemption rights may be exercised by the Humphrey
Affiliates, excluding Humphrey - Key Largo Associates, L.P., at any time.
Humphrey - Key Largo Associates, L.P. may redeem its units at any time after
March 3, 1998. At December 31, 1997, the number of shares of common stock
issuable to the Humphrey Affiliates upon exercise of the redemption rights is
657,373. The number of shares issuable upon exercise of the redemption rights
will be adjusted upon the occurrence of stock splits, mergers, consolidations or
similar pro rata share transactions, which otherwise would have the effect of
diluting the ownership interests of the Humphrey Affiliates or the shareholders
of the Company.
The Company acts as the general partner of the Partnership, which acts
as a general partner of the Subsidiary Partnership and as such, is liable for
all recourse debt of the partnerships to the extent not paid by the
partnerships. In the opinion of management, the Company does not anticipate any
losses as a result of its general partner obligations.
The Company has entered into percentage leases relating to nineteen of
its twenty Hotels, and a fixed lease relating to the Dover Hotel, with Humphrey
Hospitality Management, Inc. (the "Lessee"). Each such lease (the Percentage
Leases and the Fixed Lease) has a term of 10 years, with a five year renewal
option at the option of the Lessee. Pursuant to the terms of the Percentage
Leases, the Lessee is required to pay a fixed rent and certain other additional
charges and is entitled to all profits from the operations of the Hotel after
the payment of certain specified operating expenses. The percentage rents are
based on a percentage of gross room revenue and other revenue. Also pursuant to
the terms of the Percentage Leases and the Fixed Lease, the Company is required
to make available to the Lessee an amount equal to 4% (increased to 6% upon
completion of the Offering) of room revenue on a quarterly, cumulative basis for
capital improvements and refurbishments. The Company has future lease
commitments from the Lessee through August 2007. Minimum future rental income
under these noncancelable operating leases at December 31, 1997, is as follows:
Years (in thousands)
---------------- ------------------------
1998 $ 4,082
1999 4,082
2000 4,082
2001 4,082
2002 4,082
Thereafter 13,693
-------
$34,103
=======
The Company earned base rents of $1,609, $1,679 and $3,303 and
percentage rents of $2,141, $2,279 and $4,023 for the years ended December 31,
1995, 1996 and 1997, respectively. As of December 31, 1996 and 1997, $1,067 and
$1,857, respectively, of lease revenue was due from the Lessee.
F - 20
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
Note 7. Commitments and Contingencies and Related Party Transactions
(Continued)
On January 1, 1996, the Company executed an agreement with the Lessee
to provide accounting and securities reporting services for the Company. The
initial terms of the agreement provided for a fixed fee of $80,000 per year. On
October 1, 1996, the Company amended the Agreement reducing the initial annual
fee to $30,000 per year, with an increase of $10,000 per year (prorated from the
time of acquisition) for each hotel added to the Company's portfolio (excluding
the Dover Hotel). Under the terms of the amended agreement, the service fee
cannot exceed $100,000 in any year. As of December 31, 1996 and 1997, $67,503
and $79,388, respectively, has been charged to operations.
During 1996, the Company executed a Development Agreement with Humphrey
Development, Inc., a Humphrey Affiliate, pursuant to which Humphrey Development,
Inc. provided construction supervision services for the Dover Hotel and agreed
to pay any development costs in excess of $2,796 in exchange for a right to
purchase the Dover Hotel from the Company on the sixth anniversary of its
commencement of operations for $2,796. The development costs incurred in
connection with the Dover Hotel totaled approximately $2,794 of which $2,688 was
recorded as investment in hotel properties and $106 as deferred loan costs.
The hotel properties are operated under franchise agreements by the
Lessee that may be terminated by either party on certain anniversary dates
specified in the agreements. The agreements require annual payments for
franchise royalties, reservation and advertising services which are based upon
percentages of gross room revenue.
These fees are paid by the Lessee.
On April 17, 1997, the Company assumed a land lease agreement in
conjunction with the purchase of the Best Western, Harlan, Kentucky. The lease
requires monthly payments of the greater of $2 or 5% of room revenue through
November 2091. On May 23, 1997, the Company assumed a land lease agreement in
conjunction with the purchase of the Comfort Inn, Gettysburg, Pennsylvania. The
lease requires an annual payment of $35 through May 2025. For the year ended
December 31, 1997, land lease expense totalled approximately $52 and is included
in the general and administrative expense line item.
As of December 31, 1997, the future minimum lease payments applicable
to noncancellable land leases are as follows:
(in thousands)
----------------
December 31, 1998 $ 59
1999 59
2000 59
2001 59
2002 59
Thereafter 2,919
Total minimum lease payments $ 3,214
========
F - 21
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
In response to the year 2000 issue, the Company modified its existing
information systems in order to make them year 2000 compliant. The Company
believes that it has made all necessary modifications to its existing systems
and does not expect that additional costs associated with year 2000 compliance,
if any, will be material to the Company's results of operations or financial
position.
Note 8. Capital Stock
The Company's common stock is duly authorized, fully paid and
nonassessable. Subject to preferential rights of any other shares or series of
shares of capital stock, common shareholders are entitled to receive dividends
if and when authorized and declared by the Board of Directors of the Company out
of assets legally available therefor and to share ratably in the assets of the
Company legally available for distribution to its shareholders in the event of
its liquidation, dissolution or winding up after payment of, or adequate
provision for, all known debts and liabilities of the Company. Each outstanding
share of common stock entitles the holder to one vote on all matters submitted
to a vote of shareholders. See Notes 2 and 7 for a discussion of the units
issued during 1997 and the redemption rights of Humphrey Affiliates with respect
to 657,373 units that are redeemable on a one-for-one basis for shares of common
stock at any time. None of the units discussed in Notes 2 and 7 have been
redeemed.
The Board of Directors is authorized to provide for the issuance of ten
million shares of preferred stock in one or more series, to establish the number
of shares in each series and to fix the designation, powers, preferences and
rights of each such series and the qualifications, limitations or restriction
thereof. As of December 31, 1996 and 1997, no preferred stock was issued.
The Board of Directors, excluding the Chairman, unanimously agreed on
September 9, 1997, to utilize their Directors fees to purchase the Company's
Common Stock on the open market effective immediately. Presently, members of the
Board of Directors own approximately 9.5% of the Company's outstanding shares of
stock.
Note 9. Pro Forma Financial Information (Unaudited)
Due to the impact of the acquisitions discussed in Notes 1 and 2,
historical operations may not be indicative of future results of operations and
net income per common share.
F - 22
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(Amounts in thousands, except per share data)
December 31, 1995, 1996 and 1997
The following unaudited Pro Forma Consolidated Statements of Income for
the years ended December 31, 1996 and 1997, are presented as if the acquisition
of all 20 hotels owned at December 31, 1997 had occurred on January 1, 1996, and
all of the hotels had been leased to the Lessee pursuant to the Percentage and
Fixed Leases Agreements. The Pro Forma Consolidated Statements of Income do not
purport to present what actual results of operations would have been if the
acquisitions had occurred and the leases executed on such date or to project
results for any future period.
<TABLE>
<CAPTION>
Pro Forma (Unaudited)
--------------------------------
(in thousands)
--------------------------------
1996 1997
-------------- ----------
<S> <C>
Revenue
Lease revenue $ 8,298 $ 8,827
Other revenue 47 106
----------- ----------
Total revenue 8,345 8,933
----------- ----------
Expense
Real estate and personal property taxes and insurance 554 592
Depreciation and amortization 1,735 2,040
Interest expense 2,549 2,582
General and administrative 521 568
Minority interest 474 504
----------- ----------
Total expense 5,833 6,286
----------- ----------
Net income applicable to common shareholders $ 2,512 $ 2,647
=========== ==========
</TABLE>
Note 10. Subsequent Events
On February 3, 1998, the Company exercised its option to pay off
various capital leases for a total of $39.
F - 23
<PAGE>
Humphrey Hospitality Trust, Inc.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1997
(in thousands)
<TABLE>
<CAPTION>
Gross Amounts at which
Costs Capitalized Carried at
Initial Costs Subsequent to Acquisition Close of Period
--------------------- ------------------------- -----------------------
Encum- Buildings and Buildings and Buildings and
Description brances Land Improvements Land Improvements Land Improvements Total
- ------------------------ ------------ ------ ------------- --------- ------------ ----- ------------- -----------
<S> <C>
Comfort Inn Hotel
Morgantown,
West Virginia $2,230 $277 $2,574 - $120 $277 $2,694 $2,971
Comfort Inn Hotel
Dublin, Virginia 2,335 118 2,611 - 44 118 2,655 2,773
Best Western Hotel
Wytheville, Virginia 1,710 137 1,737 - 73 137 1,810 1,947
Solomons Beacon Inn
Solomons Island, (e) 1,354 2,012 - 155 1,354 2,167 3,521
Maryland
Comfort Inn Hotel
Elizabethton, Tennessee (e) 156 1,040 - 47 156 1,087 1,243
Comfort Inn Hotel
Farmville, Virginia (e) 148 1,201 - 17 148 1,218 1,366
Comfort Inn Hotel
Dahlgren, Virginia (e) 205 1,546 - 55 205 1,601 1,806
Comfort Inn Hotel
Princeton, West Virginia (e) 363 1,600 - 43 363 1,643 2,006
Days Inn Hotel
Farmville, Virginia (e) 290 1,389 - 29 290 1,418 1,708
Holiday Inn Express
Allentown, Pennsylvania (e) 139 3,360 - - 139 3,360 3,499
</TABLE>
<TABLE>
<CAPTION>
Life Upon
Which
Accumulated Net Book Depreciation
Depreciation Value in Latest Income
Buildings and Buildings and Year of Statement is
Description Improvements Improvements Acquisition Computed
- ------------------------ --------------- ------------- ----------- ---------------
<S> <C>
Comfort Inn Hotel
Morgantown,
West Virginia $140 $2,831 1994 (d)
Comfort Inn Hotel
Dublin, Virginia 156 2,617 1994 (d)
Best Western Hotel
Wytheville, Virginia 94 1,853 1994 (d)
Solomons Beacon Inn
Solomons Island, 116 3,405 1994 (d)
Maryland
Comfort Inn Hotel
Elizabethton, Tennessee 63 1,180 1994 (d)
Comfort Inn Hotel
Farmville, Virginia 74 1,292 1994 (d)
Comfort Inn Hotel
Dahlgren, Virginia 84 1,722 1994 (d)
Comfort Inn Hotel
Princeton, West Virginia 86 1,920 1994 (d)
Days Inn Hotel
Farmville, Virginia 54 1,654 1994 (d)
Holiday Inn Express
Allentown, Pennsylvania 49 3,450 1997 (d)
</TABLE>
F - 24
<PAGE>
<TABLE>
<CAPTION>
Gross Amounts at which
Costs Capitalized Carried at
Initial Costs Subsequent to Acquisition Close of Period
--------------------- ------------------------- -----------------------
Encum- Buildings and Buildings and Buildings and
Description brances Land Improvements Land Improvements Land Improvements Total
- ------------------------ ------------ ------ ------------- --------- ------------ ----- ------------- -----------
<S> <C>
Comfort Inn Hotel
Chambersburg,
Pennsylvania (e) 97 2,343 - - 97 2,343 2,440
Comfort Inn Hotel
Culpeper, Virginia (e) 97 2,343 - - 146 1,705 1,851
Holiday Inn Hotel Express
Danville, Kentucky (e) 140 2,366 - - 140 2,366 2,606
Comfort Suites
Dover, Delaware (e) 200 2,090 - - 200 2,090 2,290
Comfort Inn Hotel
Gettysburg,
Pennsylvania (e) - 4,036 - - - 4,036 4,036
Holiday Inn Express
Gettysburg,
Pennsylvania (e) 101 2,450 - - 101 2,450 2,551
Best Western Hotel
Harlan, Kentucky (e) - 2,395 - - - 2,395 2,395
Best Western Suites
Key Largo, Florida (e) 269 2,237 - - 269 2,237 2,506
Comfort Inn Hotel
Murphy, North
Carolina (e) 276 1,569 - - 276 1,569 1,845
Comfort Inn Hotel
New Castle, (e) 39 2,751 - - 39 2,751 2,790
Pennsylvania
---------- ------ ------------- --------- ------------ -------------------- -----------
$ 6,275 $4,455 $ 43,012 - $ 583 $ 4,455 $ 43,595 $ 48,050
========== ====== ============= ========= ============ ==================== ===========
</TABLE>
<TABLE>
<CAPTION>
Life Upon
Which
Accumulated Net Book Depreciation
Depreciation Value in Latest Income
Buildings and Buildings and Year of Statement is
Description Improvements Improvements Acquisition Computed
- ------------------------ --------------- ------------- ----------- ---------------
<S> <C>
Comfort Inn Hotel
Chambersburg,
Pennsylvania 34 2,406 1997 (d)
Comfort Inn Hotel
Culpeper, Virginia 36 1,815 1997 (d)
Holiday Inn Hotel Express
Danville, Kentucky 39 2,467 1997 (d)
Comfort Suites
Dover, Delaware 48 2,242 1997 (d)
Comfort Inn Hotel
Gettysburg,
Pennsylvania 59 3,977 1977 (d)
Holiday Inn Express
Gettysburg,
Pennsylvania 36 2,515 1997 (d)
Best Western Hotel
Harlan, Kentucky 45 2,350 1997 (d)
Best Western Suites
Key Largo, Florida 18 2,488 1997 (d)
Comfort Inn Hotel
Murphy, North
Carolina 26 1,819 1997 (d)
Comfort Inn Hotel
New Castle, 51 2,739 1997 (d)
Pennsylvania
---------- ---------------
$1,308 $ 46,742
========== ===============
</TABLE>
F-25
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1997
(in thousands)
<TABLE>
<S> <C>
(a) Reconciliation of real estate:
Balance at December 31, 1995 $15,809
Additions to building and improvements 331
------
Balance at December 31, 1996 16,140
Acquisition of building and improvements 27,302
Additions to building and improvements 153
------
Balance at December 31, 1997 $43,595
======
(b) Reconciliation of accumulated depreciation:
Balance at December 31, 1995 $ 406
Depreciation for the period ended December 31, 1996 405
------
Balance at December 31, 1996 811
Depreciation for the period ended December 31, 1997 497
------
Balance at December 31, 1997 $ 1,308
======
</TABLE>
(c) The aggregate cost of land, buildings, furniture and
equipment for Federal income tax purposes is
approximately $48,807.
(d) Depreciation is computed based upon the following useful lives:
Buildings and improvements 31 - 40 years
Furniture and equipment 5 - 12 years
(e) The Company has a mortgage payable with a bank which is
collateralized by 17 of the hotels. The outstanding
balance at December 31, 1997, was $25,456.
F - 26
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholder
Humphrey Hospitality Management, Inc.
We have audited the accompanying balance sheets of Humphrey Hospitality
Management, Inc. as of December 31, 1997 and 1996, and the related statements of
income, shareholder's equity and cash flows for each of the three years in the
period ended December 31,1997. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Humphrey Hospitality
Management, Inc. as of December 31, 1997 and 1996, and the results of its
operations, the changes in shareholder's equity and its cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
/s/ REZNICK FEDDER & SILVERMAN
Baltimore, Maryland
January 19, 1998
F - 27
<PAGE>
Humphrey Hospitality Management, Inc.
BALANCE SHEETS
December 31, 1996 and 1997
<TABLE>
<CAPTION>
1996 1997
---------------- ----------------
<S> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,127,573 $ 2,483,403
Accounts receivable 89,060 224,201
Accounts receivable - shareholder 51,250 -
Prepaid expenses 36,282 66,862
Other assets 818 60,377
------------- -------------
Total current assets $ 1,304,983 $ 2,834,843
============= =============
LIABILITIES AND SHAREHOLDER'S EQUITY
CURRENT LIABILITIES
Accounts payable $ 107,845 $ 402,188
Accrued expenses 67,328 346,744
Advanced deposits 1,730 12,031
Prepaid slip rentals - Marina 31,203 31,914
Due to affiliates 1,066,996 1,857,021
------------- -------------
Total current liabilities 1,275,102 2,649,898
------------- -------------
COMMITMENTS - -
SHAREHOLDER'S EQUITY
Common stock, $.01 par value, 1,000 shares authorized; 100
shares issued and outstanding 1 1
Retained earnings 29,880 184,944
------------- -------------
Total shareholder's equity 29,881 184,945
------------- -------------
Total liabilities and shareholder's equity $ 1,304,983 $ 2,834,843
============= =============
</TABLE>
See notes to financial statements
F - 28
<PAGE>
Humphrey Hospitality Management, Inc.
STATEMENTS OF INCOME
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
1995 1996 1997
----------------- --------------- ----------------
<S> <C>
Revenue from hotel operations
Room revenue $ 7,499,245 $ 7,941,875 $ 15,581,298
Telephone revenue 168,385 173,743 273,256
Slip revenue 262,113 243,725 252,481
Other revenue 104,137 192,147 313,316
Interest revenue 20,972 27,422 32,131
-------------- ------------ -------------
Total revenue 8,054,852 8,578,912 16,452,482
-------------- ------------ -------------
Expenses
Salaries and wages 1,737,805 2,062,594 3,849,840
Room expense 407,335 433,870 950,239
Telephone 145,777 182,735 258,926
Marina expense 33,822 42,925 34,821
General and administrative 299,591 386,670 729,163
Marketing and promotion 240,438 254,205 621,067
Utilities 390,894 429,608 768,138
Repairs and maintenance 150,932 227,200 384,050
Taxes and insurance 130,544 149,811 244,877
Management fees 241,010 - -
Franchise fees 387,853 420,809 875,104
Lease payments 3,750,456 3,957,401 7,326,193
-------------- ------------ -------------
Total expenses 7,916,457 8,547,828 16,042,418
-------------- ------------ -------------
NET INCOME $ 138,395 $ 31,084 $ 410,064
============== ============ =============
</TABLE>
See notes to financial statements
F - 29
<PAGE>
Humphrey Hospitality Management, Inc.
STATEMENTS OF SHAREHOLDER'S EQUITY
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
Common Stock Retained
----------------- Earnings
Shares Amount (Deficit) Total
------- ------ ------------ ----------
<S> <C>
Balance, December 31, 1994 100 $ 1 $ (89,599) $(89,598)
Net income - - 138,395 138,395
------- ---- --------- --------
Balance, December 31, 1995 100 1 48,796 48,797
Distributions - - (50,000) (50,000)
Net income - - 31,084 31,084
------- ---- --------- --------
Balance, December 31, 1996 100 1 29,880 29,881
Distributions - - (255,000) 255,000)
Net income - - 410,064 410,064
------- ---- --------- --------
Balance, December 31, 1997 100 $ 1 $ 184,944 $ 184,945
======= ==== ======== ========
</TABLE>
See notes to financial statements
F - 30
<PAGE>
Humphrey Hospitality Management, Inc.
STATEMENTS OF CASH FLOWS
Years ended December 31, 1995, 1996 and 1997
<TABLE>
<CAPTION>
1995 1996 1997
---------- ---------- ----------
<S> <C>
Cash flow from operating activities
Net income $ 138,395 $ 31,084 $ 410,064
Adjustments to reconcile net income to net
cash provided by (used in) operating activities
Changes in assets and liabilities
Decrease (increase) in accounts receivable 8,971 (10,475) (135,141)
Increase in prepaid expenses (368) (18,306) (30,580)
Increase in other assets - (818) (59,559)
Increase (decrease) in accounts payable 29,998 (62,610) 294,343
(Decrease) increase in prepaid slip rentals -
Marina (10,531) (6,862) 711
Increase (decrease) in due to affiliates 889,166 (25,477) 790,025
Increase in accrued expenses - 67,328 279,416
Increase in advanced deposits - 1,730 10,301
---------- ---------- ----------
Net cash provided by (used in)
operating activities 1,055,631 (24,406) 1,559,580
---------- ---------- ----------
Cash flows from financing activities
Distributions paid - (50,000) (255,000)
Advances to (from) shareholder - (51,250) 51,250
---------- ---------- ----------
Net cash used in financing activities - (101,250) (203,750)
---------- ---------- ----------
NET INCREASE (DECREASE) IN
CASH AND CASH EQUIVALENTS 1,055,631 (125,656) 1,355,830
Cash and cash equivalents, beginning of year 197,598 1,253,229 1,127,573
---------- ---------- ----------
Cash and cash equivalents, end of year $1,253,229 $ 1,127,573 $2,483,403
========== ========== ==========
</TABLE>
See notes to financial statements
F - 31
<PAGE>
Humphrey Hospitality Trust, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996 and 1997
Note 1. Organization and Summary of Significant Accounting Policies
Humphrey Hospitality Management, Inc. (the Lessee) was incorporated
under the laws of the State of Maryland on August 18, 1994, to lease and operate
hotel properties from Humphrey Hospitality Limited Partnership (the
Partnership). James I. Humphrey, Jr. is the sole shareholder of the Lessee.
The Lessee began operations on November 29, 1994. As of December 31, 1997, the
Lessee leases 20 hotel properties from the Partnership.
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.
Accounts Receivable
The Lessee considers accounts receivable to be fully collectible;
accordingly, no allowance for doubtful accounts is required. If amounts become
uncollectible, they will be charged to operations when that determination is
made.
Income Taxes
The Lessee has elected to be treated as an S Corporation for Federal
and state income tax purposes. Therefore, no provision or benefit for income
taxes has been included in these financial statements since taxable income or
loss passes through to, and is reportable by, the stockholder individually.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and a repurchase agreement
with a bank with an original maturity of three months or less when acquired,
carried at cost, which approximates fair value.
Concentration of Credit Risk
The Lessee places cash deposits with major banks. The Company has not
experienced any losses with respect to bank balances in excess of government
provided insurance. As of December 31, 1997, management believes that no
significant concentration of credit risk exists with respect to these cash
balances.
Note 2. Related Party Transactions
Management Fees and Payroll Reimbursements
The Lessee entered into separate management agreements, relating to
each of the Initial Hotels, with Humphrey Hotels, Inc. (the Operator), an
affiliate. Pursuant to the management agreements, a fee equal to 3% of total
revenue was payable to Humphrey Hotels, Inc. and was subordinate, in all
respects, to the Lessee's obligations under the percentage leases. For the year
ended December 31, 1995, management fees of $241,010 were accrued and charged to
operations.
F - 32
<PAGE>
Humphrey Hospitality Management, Inc.
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1996 and 1997
Note 2. Related Party Transactions (Continued)
The Operator provided all site employees for the Lessee and was
reimbursed for the salaries and related costs. During the year ended December
31, 1995, the Lessee incurred charges of $1,737,805 for such payroll
reimbursements.
On February 9, 1996, the Lessee announced the termination of its
operating agreements with the Operator effective January 1, 1996. The Lessee
immediately began operating all of the hotels that it leases from the
Partnership. All personnel from the Operator were hired in identical capacities
by the Lessee. The Lessee intends to operate the hotels throughout the lease
term.
Shared Expenses
Humphrey Associates, Inc., and HAI Management, Inc., affiliates of the
Lessee, share certain operating expenses with the Lessee. Expenditures are
allocated based on each entity's pro rata share of the expense.
Percentage Lease Payment
The Lessee has entered into percentage leases, with the Partnership
relating to nineteen of its Hotels (including ten hotels acquired in 1997) and a
fixed lease relating to the Dover Hotel (collectively , the Acquired Hotels).
Each such lease (the "Percentage Leases" and the "Fixed Lease") has a term of 10
years. Pursuant to the terms of the Percentage Leases, the Lessee is required to
pay both base rent and percentage rent and certain other additional charges.
Pursuant to the terms of the Fixed Lease, the Lessee is required to pay a fixed
rent and certain other additional charges. The Lessee has future lease
commitments through August 2007. Minimum future lease payments due under these
noncancellable operating leases as of December 31, 1997 are as follows:
Year Amount
---- ------
1998 $ 4,081,920
1999 4,081,920
2000 4,081,920
2001 4,081,920
2002 4,081,920
Thereafter 13,693,746
--------------
$ 34,103,346
==============
The Lessee has incurred base rents of $1,608,976, $1,678,347 and
$3,302,922 and percentage rents of $2,141,480, $2,279,054 and $4,023,271 for the
years ended December 31, 1995, 1996 and 1997, respectively. As of December 31,
1996 and 1997, the amount due Humphrey Hospitality Limited Partnership and
Solomons Beacon Inn Limited Partnership for lease payments totalled $1,066,996
and $1,857,021, respectively, and is included in due to affiliates on the
balance sheets.
F - 33
<PAGE>
Humphrey Hospitality Management, Inc.
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1996 and 1997
Note 2. Related Party Transactions (Continued)
During 1996, the Lessee made a loan to its shareholder in the amount of
$51,250 which is unsecured and non-interest bearing. The amount was repaid in
January 1997.
Services Agreement
On January 1, 1996, the Lessee executed an Agreement with Humphrey
Hospitality Trust, Inc., to provide accounting and securities reporting
services. The initial terms of the Agreement provided for a fixed fee of $80,000
per year. On October 1, 1996, the Agreement was amended reducing the initial
annual fee to $30,000 per year with an increase of $10,000 per year (prorated
from the time of acquisition) for each hotel acquired by Humphrey Hospitality
Trust, Inc. (excluding the hotel property in Dover, DE). Under the terms of the
amendment, the service fee cannot exceed $100,000 in any year. As of December
31, 1996 and 1997, the Lessee received $67,503 and $79,388, respectively, for
the services provided in accordance with the Agreement, which is included in
other revenue.
Note 3. Commitments
Franchise Agreements
The Lessee operates the hotels owned by the Partnership and the
Subsidiary Partnership under the terms of existing franchise agreements. The
franchise licenses generally specify certain management, operational,
accounting, reporting and marketing standards and procedures with which the
franchisee must comply and provide for annual franchise fees based upon
percentages of gross room revenue. During the years ended December 31, 1995,
1996 and 1997, $387,853, $420,809 and $875,104, respectively, of franchise fees
were charged to operations.
Restaurant Leases
Three of the eight Initial Hotels have executed lease agreements for
the hotel's restaurant facilities with varying expiration dates, including
renewal periods, through December 1, 2023. Monthly rent is payable during the
terms of the leases at 3% to 8% of the previous month's gross receipts.
Note 4. Economic Dependency
The Lessee receives the majority of its income from related hotel
entities. The related hotels are primarily located in the Mid-Atlantic region of
the United States.
F - 34
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors
Humphrey Hospitality Trust, Inc.
We have audited the accompanying combined balance sheet of the HERSHA
Acquisition Hotels as of December 31, 1996, and the related combined statements
of income and retained earnings and cash flows for the year then ended. These
financial statements are the responsibility of the management of the HERSHA
Acquisition Hotels. 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 combined financial statements referred to above
present fairly, in all material respects, the combined financial position of the
HERSHA Acquisition Hotels as of December 31, 1996, the combined results of their
operations and their combined cash flows for the year then ended in conformity
with generally accepted accounting principles.
/s/ REZNICK FEDDER & SILVERMAN
Baltimore, Maryland
May 17, 1997
F - 35
<PAGE>
HERSHA Acquisition Hotels
COMBINED BALANCE SHEET
December 31, 1996
<TABLE>
<S> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 448,111
Accounts receivable 48,817
Prepaid expenses and other assets 6,901
Due from shareholders and affiliates 799,528
----------
Total current assets 1,303,357
Furniture and equipment, net of
accumulated depreciation of $55,575 238,166
Franchise costs, net of
accumulated amortization of $6,252 18,748
----------
$1,560,271
==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 88,635
Advances deposits 2,600
Income taxes payable 37,990
----------
Total current liabilities 129,225
SHAREHOLDERS' EQUITY
Common stock, $1 par value, 3,000 shares
authorized; 1,200 shares issued and outstanding 1,200
Retained earnings 1,429,846
----------
$1,560,271
==========
</TABLE>
F - 36
<PAGE>
HERSHA Acquisition Hotels
COMBINED STATEMENT OF INCOME AND RETAINED EARNINGS
Year ended December 31, 1996
<TABLE>
<S> <C>
REVENUES
Room revenue $4,484,652
Telephone revenue 50,861
Other revenue 110,836
----------
Total revenue 4,646,349
----------
EXPENSES
Salaries and wages 1,011,779
Room expense 279,495
Telephone 52,426
General and administrative 139,809
Marketing and promotion 227,898
Utilities 230,477
Repairs and maintenance 111,125
Taxes and insurance 188,634
Franchise fees 376,766
Rent 1,791,089
Land lease 35,000
Depreciation and amortization 31,964
----------
Total expenses 4,476,462
----------
INCOME BEFORE TAXES 169,887
INCOME TAXES, CURRENTLY PAYABLE 49,506
----------
NET INCOME 120,381
RETAINED EARNINGS, BEGINNING 1,309,465
----------
RETAINED EARNINGS, ENDING $1,429,846
==========
</TABLE>
F - 37
<PAGE>
HERSHA Acquisition Hotels
COMBINED STATEMENT OF CASH FLOWS
Year ended December 31, 1996
<TABLE>
<S> <C>
Cash flows from operating activities
Net Income $ 120,381
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 29,046
Amortization 2,918
Changes in assets and liabilities
Decrease in accounts receivable 1,832
Decrease in prepaid expenses 4,793
Decrease in other assets 3,297
Decrease in accounts payable and accrued expenses (110,608)
Increase in income taxes payable 37,990
----------
Net cash provided by operating activities 89,649
----------
Cash flow from investing activities
Investment in furniture and equipment (177,608)
Advances to shareholders and affiliates, net (276,648)
----------
Net cash used in investing activities (454,256)
----------
NET DECREASE IN CASH (364,607)
Cash and cash equivalents, beginning 812,718
----------
Cash and cash equivalents, ending $ 448,111
==========
Supplemental disclosures of cash flow information
Cash paid during the year for income taxes $ 11,516
==========
</TABLE>
F - 38
<PAGE>
HERSHA Acquisition Hotels
NOTES TO COMBINED FINANCIAL STATEMENTS
December 31, 1996
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The HERSHA Acquisition Hotels combined financial statements are a
combination of the balance sheets and statements of income, retained
earnings and cash flows of three corporations (collectively, the Companies).
The Companies are related through common control and management. Each
company operates under a lease arrangement hotel properties which are owned
by an affiliated entity.
The Companies combined in these financial statements consist of the
following hotel properties:
<TABLE>
<CAPTION>
Company Hotel Location
- ----------------- ------------------------ -----------------------------
<S> <C>
Chambersburg Comfort Inn - 65 Chambersburg, Pennsylvania
Lodging, Inc. rooms
Gettysburg Comfort Inn - 81 Gettysburg, Pennsylvania
Lodging, Inc. rooms
Allentown Holiday Inn Express - Allentown, Pennsylvania
Lodging, Inc. 83 rooms
Gettysburg Holiday Inn Express - Gettysburg, Pennsylvania
Lodging, Inc. 51 rooms
</TABLE>
During 1997, the HERSHA group sold the hotel properties to Humphrey
Hospitality Limited Partnership. The sales agreements did not extend to any
other assets or liabilities of the Companies or their affiliates.
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
disclosures of contingent assets and liabilities at the date of the
financial statements and the reporting amounts and revenue and expenses
during the reporting period. Actual results could differ from those
estimates.
Furniture and Equipment
Furniture and equipment is stated at cost. Depreciation is provided for in
amount sufficient to relate the cost of depreciable assets to operations
over their estimated services lives using accelerated methods.
Franchise Fees
The Comfort Inn hotels are operated under franchise agreements with Choice
Hotels International. The Holiday Inn Express hotels are operated under
franchise agreements with Holiday Hospitality Corporation. Franchise fees
are being amortized over the term of the franchise agreements using the
straight-line method.
F - 39
<PAGE>
HERSHA Acquisition Hotels
NOTES TO COMBINED FINANCIAL STATEMENTS - CONTINUED
December 31, 1996
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNT POLICIES
(Continued)
Revenue Recognition
Room and other revenue is recognized as earned. Ongoing credit evaluations
are performed and accounts deemed uncollectible are charged to operations.
Income Taxes
Income tax expense includes federal and state taxes currently payable. For
the year ended December 31, 1996, there were no differences between income
for financial reporting and income tax purposes resulting in deferred taxes.
NOTE B - RELATED PARTY TRANSACTIONS
Operating Leases
The Companies lease the hotel properties from an affiliated partnership of a
shareholder under noncancellable operating leases. The lease for the
Allentown Holiday Inn Express calls for an annual rent of $120,000 through
the year 2000. The other HERSHA hotels are operated under month-to-month
leases which provide for rent payment based on a percentage of net operating
income. For the year ended December 31, 1997, lease expense totaled
$1,791,089.
Due From Shareholders and Affiliates
The Companies make advances to and from shareholders and entities related to
the Companies through common ownership. Amounts due from shareholders and
affiliates as of December 31, 1996 are unsecured, non-interest bearing and
payable on demand.
NOTE C - COMMITMENTS
Franchise costs represent the annual expense for franchise royalties,
reservation and advertising services under the terms of the hotel franchise
agreements. The payments are based upon percentages of gross room revenue.
For the year ended December 31, 1997, franchise fees totaled $376,766.
The Company has a land lease on the Comfort-Inn Gettysburg, PA, which
requires an annual payment of $35,000 through May 31, 2025.
F - 40
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors
Humphrey Hospitality Trust, Inc.
We have audited the accompanying combined balance sheet of the H&W
Acquisition Hotels as of December 31, 1996, and the related combined statements
of income, equity, and cash flows for the year then ended. These financial
statements are the responsibility of the management of the H&W Acquisition
Hotels. 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 combined financial statements referred to above present
fairly, in all material respects, the combined financial position of the H&W
Acquisition Hotels as of December 31, 1996, the combined results of its
operations and its combined cash flows for the year then ended in conformity
with generally accepted accounting principles.
/s/ REZNICK FEDDER & SILVERMAN
Baltimore, Maryland
March 26, 1997
F - 41
<PAGE>
H&W Acquisition Hotels
COMBINED BALANCE SHEET
December 31, 1996
<TABLE>
<S> <C>
ASSETS
INVESTMENT IN HOTEL PROPERTIES
Land $ 425,000
Buildings and improvements 3,862,686
Furniture and equipment 514,855
---------
4,802,541
Less accumulated depreciation 448,942
---------
Net investment in hotel properties 4,353,599
Cash and cash equivalents 144,669
Accounts receivable 42,064
Supplies inventory 5,892
Franchise costs, net of accumulated amortization of $16,338 77,962
Mortgage costs, net of accumulated amortization of $9,477 41,718
Goodwill, net of accumulated amortization of $20,000 180,000
----------
$4,845,904
==========
LIABILITIES AND EQUITY
Long-term debt $4,152,923
Accounts payable and accrued expenses 103,214
Accrued interest payable 21,192
Obligation under capital lease 12,870
---------
4,290,199
Equity 555,705
----------
$4,845,904
==========
</TABLE>
See notes to financial statement
F - 42
<PAGE>
H&W Acquisition Hotels
COMBINED STATEMENT OF INCOME
Year ended December 31, 1996
<TABLE>
<S> <C>
REVENUES
Room revenue $2,375,857
Telephone revenue 53,873
Other revenue 48,570
----------
Total revenue 2,478,300
----------
EXPENSES
Salaries and wages 483,323
Room expense 208,129
Telephone 31,131
General and administrative 133,690
Marketing and promotion 97,301
Utilities 114,979
Repairs and maintenance 66,035
Taxes and insurance 49,344
Management fees 137,577
Real estate taxes 56,519
Franchise fees 104,241
Land lease 38,990
Interest expense 404,370
Depreciation and amortization 202,155
----------
Total expenses 2,127,784
----------
NET INCOME $ 350,516
==========
</TABLE>
See notes to financial statement
F - 43
<PAGE>
H&W Acquisition Hotels
COMBINED STATEMENT OF EQUITY
Year ended December 31, 1996
<TABLE>
<CAPTION>
Common Retained Partners'
stock earnings equity Total
------------- ------------- ------------ ------------
<S> <C>
Balance, December 31, 1995
$ 100 $ 232,657 $ 322,432 $ 555,189
Net income - 306,112 44,404 350,516
Distributions - (350,000) - (350,000)
---- --------- -------- ---------
Balance, December 31, 1996 $ 100 $ 188,769 $ 366,836 $ 555,705
==== ========= ======== =========
</TABLE>
See notes to financial statement
F - 44
<PAGE>
H&W Acquisition Hotels
COMBINED STATEMENT OF CASH FLOWS
Year ended December 31, 1996
<TABLE>
<S> <C>
Cash flows from operating activities
Net Income $ 350,516
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 175,437
Amortization 26,718
Changes in assets and liabilities
Decrease in accounts receivable 11,713
Increase in inventory (1,231)
Decrease in accounts payable and accrued expenses (16,545)
------------
Net cash provided by operating activities 546,608
------------
Cash flow from investing activities
Investment in hotel property (37,125)
------------
Net cash used in investing activities (37,125)
------------
Cash flow from financing activities
Repayment of mortgage payable (1,196,760)
Proceeds from mortgage payable 1,345,870
Principal payments on mortgage (147,298)
Principal payments on notes payable (148,437)
Payment on loan fees (25,000)
Distribution to shareholders (350,000)
------------
Net cash used in financing activities (521,625)
------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (12,142)
Cash and cash equivalents, beginning 156,811
------------
Cash and cash equivalents, ending $ 144,669
============
Supplemental disclosures of cash flow information
Cash paid during the year for interest $ 404,370
============
</TABLE>
See notes to financial statement
F - 45
<PAGE>
H&W Acquisition Hotels
NOTES TO COMBINED FINANCIAL STATEMENTS
December 31, 1996
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The H&W Acquisition Hotels combined financial statements are a combination
of the balance sheets and statements of income, equity and cash flows of one
limited liability company and two "Subchapter S" corporations (collectively
the Companies) The Companies are related through common control and
management. Each company owns and operates one hotel property.
The Companies combined in these financial statements consist of the
following hotel properties:
<TABLE>
<CAPTION>
Companies Hotel Location
- ------------------------ ---------------------------------- ------------------------
<S> <C>
H&W Wheeling Inn, Comfort Inn - 56 rooms Murphy, North
LLC Best Western - 63 rooms Carolina
Harlan Hotel Corp. Holiday Inn Express - 62 rooms Harlan, Kentucky
Danville Hotel Corp. Danville, Kentucky
</TABLE>
In April 1997, the Companies sold their hotel properties to Humphrey
Hospitality Limited Partnership. The sales agreements did not extend to any
other assets or liabilities of the Companies. The Companies plan to
liquidate their remaining assets, satisfy their liabilities and make final
distributions to their owners.
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
disclosures of contingent assets and liabilities at the date of the
financial statements and the reporting amounts and revenue and expenses
during the reporting period. Actual results could differ from those
estimates.
Investment in Hotel Properties
The hotel properties are stated at cost. Depreciation is provided for in
amounts sufficient to relate the cost of depreciable assets to operations
over their estimated service lives. Depreciation is provided by the use of
the straight-line and accelerated methods on the following estimated useful
lives:
Buildings and improvements 15 - 40 years
Property and equipment 5 - 7 years
Maintenance and repairs are charged to operations as incurred. Additions and
major improvements are capitalized. Upon sale or disposition, both the asset
and related accumulated depreciation are relieved and the related gain or
loss is included in operations.
The Companies evaluate long-lived assets for potential impairment by
analyzing the operating results, trends and prospects for the Company and
considering any other events and circumstances which might indicate
potential impairment.
F - 46
<PAGE>
H&W Acquisition Hotels
NOTES TO COMBINED FINANCIAL STATEMENTS - CONTINUED
December 31, 1996
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNT POLICIES
(Continued)
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and all highly liquid investments
with original maturities of three months or less when acquired, carried at
cost which approximates fair value.
Franchise Fees
The Comfort Inn hotel is operated under a franchise agreement with Choice
Hotels International. The Best Western hotel is operated under a franchise
agreement with Best Western. The Holiday Inn Express hotel is operated under
a franchise agreement with Holiday Hospitality Corporation. Franchise fees
are being amortized over the term of the franchise agreement using the
straight-line method.
Mortgage Costs
Mortgage costs are amortized over the term of the mortgage using the
straight-line method.
Goodwill
Goodwill, which represents the excess of the cost of purchased hotel
properties over the fair value of their net assets at the date of
acquisition, is being amortized using the straight-line method of 10 years.
Revenue Recognition
Room and other revenue is recognized as earned.
Income Taxes
No provision or benefit for income taxes has been included in the financial
statement for the Companies since taxable income or loss passes through to,
and is reportable by, the owners individually.
F - 47
<PAGE>
H&W Acquisition Hotels
NOTES TO COMBINED FINANCIAL STATEMENTS - CONTINUED
December 31, 1996
NOTE B - LONG-TERM DEBT
At December 31, 1996, long-term debt consists of the following:
<TABLE>
<S> <C>
Note payable in equal monthly installments of principal and interest
of $15,124 bearing interest at 8.75%, due August 2008. $ 1,318,929
Note payable in equal monthly installments of principal and interest
of $13,400 bearing interest at 7.8%, due August 2012. 1,448,816
Note payable in equal monthly installments of principal and interest
of $16,029 bearing interest at 10.5%, due May 2010. 1,385,178
----------
$ 4,152,923
==========
</TABLE>
The debt is collateralized by the investments in hotel properties.
Aggregate annual principal payments for long-term debt at December 31, 1996,
are as follows:
December 31, 1997 $ 170,745
1998 $ 186,552
1999 $ 203,848
2000 $ 222,778
2001 $ 243,495
NOTE C - OBLIGATION UNDER CAPITAL LEASE
The Companies lease certain equipment under capital leases expiring in 2001.
Future minimum lease payments under these capital leases, together with the
present value of the net minimum lease payments are as follows:
Years ended December 31, 1997 $ 4,175
1998 4,175
1999 4,175
2000 4,175
2001 3,131
-------
19,831
Less amount representing interest 6,961
-------
Present value of net minimum lease payments $ 12,870
=========
F - 48
<PAGE>
H&W Acquisition Hotels
NOTES TO COMBINED FINANCIAL STATEMENTS - CONTINUED
December 31, 1996
NOTE D - RELATED PARTY TRANSACTIONS
Management Fees
The Partnerships' hotel properties were managed by an affiliate of the
general partner. The management agreement called for percentage fees of 2%
of gross sales plus 8.5% of net operating income. As of December 31, 1996,
management fees totaled $137,577.
NOTE E - COMMITMENTS
Franchise costs represent the annual expense for franchise royalties,
reservation and advertising services under the terms of the hotel franchise
agreements. The payments are based upon percentages of gross room revenue.
As of December 31, 1996, franchise fees totaled, $104,241.
The Company has executed a land lease related to the Holiday Inn Express,
Harlan, Kentucky, which requires monthly payments of the greater of $2,000
or 5% of room revenue through November 2091. For the year ended December 31,
1996, land lease expense totaled $38,990.
F - 49
<PAGE>
INDEPENDENT AUDITORS' REPORT
To The Shareholders and
Board of Directors
Humphrey Hospitality Trust, Inc.
We have audited the accompanying balance sheet of the Gateway Acquisition
Hotel, as of December 31, 1996, and the related statements of income, partners'
equity, and cash flows for the year then 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 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 The Gateway Acquisition
Hotel as of December 31, 1996, and the results of its operations and its cash
flows for the year then ended in conformity with generally accepted accounting
principles.
/s/ REZNICK FEDDER & SILVERMAN
Baltimore, Maryland
March 26, 1997
F - 50
<PAGE>
Gateway Acquisition Hotels
BALANCE SHEET
December 31, 1996
<TABLE>
<S> <C>
ASSETS
INVESTMENT IN HOTEL PROPERTIES
Land $ 144,875
Building and improvements 1,257,413
Furniture and equipment 211,996
-----------
1,614,284
Less accumulated depreciation (494,968)
-----------
Net investment in hotel properties 1,119,316
Cash and cash equivalents 89,659
Accounts receivable 8,108
Prepaid expenses and other assets 3,725
Bond escrows 50,341
Mortgage costs net of accumulated amortization of $34,734 90,311
-----------
$ 1,361,460
===========
LIABILITIES AND PARTNERS' EQUITY
Bond payable $ 1,245,000
Accounts payable and accrued expenses 18,475
Accrued interest payable 8,995
-----------
1,272,470
Partners' equity 88,990
-----------
$ 1,361,460
===========
</TABLE>
See notes to financial statement
F - 51
<PAGE>
Gateway Acquisition Hotels
STATEMENT OF INCOME
Year ended December 31, 1996
<TABLE>
<S> <C>
Revenue
Room revenue $ 682,885
Telephone revenue 20,243
Other revenue 9,912
---------
Total revenue 713,040
Expenses
Salaries and wages 146,125
Room expense 42,515
Telephone 8,878
General and administrative 41,832
Marketing and promotion 7,035
Utilities 37,177
Repairs and maintenance 46,604
Taxes and insurance 18,413
Management fees 37,743
Real estate taxes 13,052
Franchise fees 47,391
Interest expense 115,215
Depreciation and amortization 56,174
---------
Total expense 618,154
---------
NET INCOME $ 94,886
=========
</TABLE>
See notes to financial statement
F - 52
<PAGE>
Gateway Acquisition Hotels
STATEMENT OF PARTNERS' EQUITY
Year ended December 31, 1996
Partners' equity, beginning $ 24,104
Net income 94,886
Distributions (30,000)
--------
Partners' equity, ending $ 88,990
========
See notes to financial statement
F - 53
<PAGE>
Gateway Acquisition Hotels
STATEMENT OF CASH FLOW
Year ended December 31, 1996
<TABLE>
<S> <C>
Cash flow from operating activities
Net income $ 94,886
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation 47,838
Amortization 8,336
Changes in assets and liabilities
Decrease in accounts receivable 11,498
Increase in prepaid expenses and other assets (2,645)
Increase in bond escrow (2,309)
Decrease in accounts payable and accrued expenses (7,524)
--------
Net cash provided by operating activities 150,080
--------
Cash flows from investing activities
Investment in hotel property (38,007)
--------
Net cash used in investing activities (38,007)
--------
Cash flows from financing activities
Principal payments on mortgage (65,000)
Distributions to shareholders (30,000)
--------
Net cash used in financing activities (95,000)
--------
NET INCREASE IN CASH 17,073
Cash and cash equivalents, beginning 72,586
--------
Cash and cash equivalents, ending $ 89,659
========
Supplemental disclosures of cash flow information
Cash paid during the year for interest $ 115,215
========
</TABLE>
See notes to financial statement
F - 54
<PAGE>
Gateway Acquisition Hotels
NOTES TO FINANCIAL STATEMENTS
December 31, 1996
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Gateway Partnership I (the Partnership) was formed to own and operate a
Comfort Inn in Culpeper, Virginia. In February 1997, the Partnership sold
its hotel property to Humphrey Hospitality Limited Partnership. The sales
agreements did not extend to any other assets or liabilities of the
Partnership. The Partnership plans to liquidate its remaining assets,
satisfy its liabilities and make final distributions to its owners.
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
disclosures 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.
Investment in Hotel Property
The hotel property is stated at cost. Depreciation is provided for in
amounts sufficient to relate the cost of depreciable assets to operations
over their estimated services lives. Depreciation is provided by the use of
the straight-line method over estimated useful lives of 5 and 40 years for
furniture and equipment and buildings and improvements, respectively.
Maintenance and repairs are charged to operations as incurred. Additions and
major improvements are capitalized. Upon sale or disposition, both the asset
and related accumulated depreciation are relieved and the related gain or
loss is included in operations.
The Partnership evaluates long-lived assets for potential impairment by
analyzing the operating results, trends and prospects for the Partnership
and considering any other events and circumstances which might indicate
potential impairment.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and all highly liquid investments
with original maturities of three months or less when acquired, carried at
cost which approximates fair value.
Financing Costs
Financing costs are amortized over the term of the bonds using the
straight-line method.
Revenue Recognition
Room and other revenue is recognized as earned. Room payments received in
advance are deferred until earned.
Income Taxes
No provision or benefit for income taxes has been included in the financial
statement for the Partnership since taxable income or loss passes through to
and is reportable by the partners individually.
F - 55
<PAGE>
Gateway Acquisition Hotels
NOTES TO FINANCIAL STATEMENTS - CONTINUED
December 31, 1997
NOTE B - BOND PAYABLE
Bond payable consists of First Mortgage Revenue Refunding Bonds issued by
the Virginia Small Business Financing Authority in the original amount of
$1,465,000. Crestar Bank is the trustee. The bonds bear interest at 10% per
annum, which is subject to adjustment on November 1, 1997 to equal the then
current yield on five year Treasury Bonds plus 4%, with a minimum interest
rate of 10% and a maximum rate of 14%. The agreement established a sinking
fund from which principal payments on the bonds will be made. The bonds
mature in varying amounts through November 2002. The bonds are secured by
the investment in hotel property.
Aggregate annual payments to the bond sinking fund for the five years of
following December 31, 1996 are as follows:
December 31, 1997 $ 75,000
1998 $ 80,000
1999 $ 95,000
2000 $ 100,000
2001 $ 100,000
NOTE C - RELATED PARTY TRANSACTIONS
Management Fees
The hotel property is managed by an affiliate of the general partner. The
management agreement called for percentage fees of 2% of gross sales plus
$4,800 per annum.
NOTE D - COMMITMENTS
The Comfort Inn Hotel is operated under a franchise agreement with Choice
Hotels International. Franchise fees represent the annual expense for
franchise royalties, reservation and advertising services under the terms of
the hotel franchise agreements. The payments are based upon percentages of
gross room revenue.
F - 56
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors
Humphrey Hospitality Trust, Inc.
We have audited the accompanying combined balance sheet of the BCL
Acquisition Hotel as of December 31, 1996, and the related combined statements
of income, equity and cash flows for the year then ended. These financial
statements are the responsibility of the management of the BCL Acquisition
Hotel. 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 combined financial statements referred to above present
fairly, in all material respects, the combined financial position of the BCL
Acquisition Hotel as of December 31, 1996, the combined results of its
operations and its combined cash flows for the year then ended in conformity
with generally accepted accounting principles.
/s/ REZNICK FEDDER & SILVERMAN
Baltimore, Maryland
March 26, 1997
F - 57
<PAGE>
BCL Acquisition Hotel
COMBINED BALANCE SHEET
December 31, 1996
<TABLE>
<S> <C>
ASSETS
INVESTMENT IN HOTEL PROPERTIES
Land $ 50,000
Buildings and improvements 2,535,970
Furniture and equipment 786,051
-----------
3,372,021
Less accumulated depreciation 1,592,462
-----------
Net investment in hotel properties 1,779,559
Cash and cash equivalents 569,675
Accounts receivable 62,366
Supplies inventory 10,969
Prepaid expenses and other assets 6,030
Mortgage costs, net of accumulated amortization of $32,000 6,404
-----------
$ 2,435,003
===========
LIABILITIES AND EQUITY
LIABILITIES
Long-term debt $ 1,615,589
Accounts payable and accrued expenses 38,205
Due from affiliates 459,901
-----------
2,113,695
EQUITY 321,308
-----------
$ 2,435,003
===========
</TABLE>
See notes to financial statement
F - 58
<PAGE>
BCL Acquisition Hotel
COMBINED STATEMENT OF INCOME
Year ended December 31, 1996
<TABLE>
<S> <C>
Revenue
Room revenue $1,024,143
Telephone revenue 13,992
Other revenue 21,101
Restaurant revenue 478,244
----------
Total revenue 1,537,480
----------
Expenses
Salaries and wages 209,838
Room expense 62,646
Restaurant expense 350,687
Telephone 13,136
General and administrative 40,195
Marketing and promotion 14,637
Utilities 95,325
Repairs and maintenance 38,691
Taxes and insurance 25,132
Real estate taxes 52,859
Franchise fees 49,210
Interest expense 164,498
Depreciation and amortization 165,035
----------
Total expenses 1,281,889
----------
NET INCOME $ 255,591
==========
</TABLE>
See notes to financial statement
F - 59
<PAGE>
BCL Acquisition Hotel
COMBINED STATEMENT OF EQUITY
Year ended December 31, 1996
<TABLE>
<CAPTION>
Common Retained Partners'
stock earnings deficit Total
-------------- ---------------- --------------- ---------------
<S> <C>
Balance, December 31, 1995 $ 15,000 $ 159,532 $ (108,815) $ 65,717
Net income (loss) - 688,342 (432,751) 255,591
------- -------- ---------- --------
Balance, December 31, 1996 $ 15,000 $ 847,874 $ (541,566) $ 321,308
======= ======== ========== ========
</TABLE>
See notes to financial statement
F - 60
<PAGE>
BCL Acquisition Hotel
COMBINED STATEMENT OF CASH FLOWS
Year ended December 31, 1996
<TABLE>
<S> <C>
Cash flows from operating activities
Net income $ 255,591
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 161,605
Amortization 3,430
Changes in assets and liabilities
Decrease in accounts receivable 8,052
Increase in prepaid expenses and other assets (4,664)
Increase in supplies inventory (2,314)
Increase in accounts payable and accrued expenses 4,515
----------
Net cash provided by operating activities 426,215
----------
Cash flow from investing activities
Investment in hotel property (25,475)
----------
Net cash used in investing activities (25,475)
----------
Cash flow from financing activities
Principal payments on long-term debt (194,577)
----------
Net cash used in financing activities (194,577)
----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 206,163
Cash and cash equivalents, beginning 363,512
----------
Cash and cash equivalents, ending $ 569,675
==========
Supplemental disclosures of cash flow information
Cash paid during the year for interest $ 164,498
==========
</TABLE>
See notes to financial statement
F - 61
<PAGE>
BCL Acquisition Hotel
NOTES TO COMBINED FINANCIAL STATEMENTS
December 31, 1996
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The BCL Acquisition Hotel (BCL) combined financial statements are a
combination of the balance sheets and statements of income, equity and cash
flows of BCL Management, Inc., a "Subchapter S" corporation and BCL
Properties, L.P., a limited partnership. BCL owns and operates a Comfort Inn
located in New Castle, Pennsylvania. On March 17, 1997, BCL sold the hotel
property to Humphrey Hospitality Limited Partnership. The sales agreement
did not extend to any other assets or liabilities of BCL. BCL plans to
liquidate its remaining assets, satisfy its liabilities and make final
distributions to its owners.
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
disclosures of contingent assets and liabilities at the date of the
financial statements and the reporting amounts and revenue and expenses
during the reporting period. Actual results could differ from those
estimates.
Investment in Hotel Properties
The hotel property is stated at cost. Depreciation is provided for in
amounts sufficient to relate the cost of depreciable assets to operations
over their estimated services lives. Depreciation is provided for by use of
the straight-line method over estimated useful lives of 5 and 40 years for
furniture and equipment and buildings and improvements, respectively.
Maintenance and repairs are charged to operations as incurred. Additions and
major improvements are capitalized. Upon sale or disposition, both the asset
and related accumulated depreciation are relieved and the related gain or
loss is included in operations.
BCL evaluates long-lived assets for potential impairment by analyzing the
operating results, trends and prospects for BCL and considering any other
events and circumstances which might indicate potential impairment.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and all highly liquid investments
with original maturities of three months or less when acquired, carried at
cost which approximates fair value.
Mortgage Costs
Mortgage costs are amortized over the term of the debt using the
straight-line method.
Revenue Recognition
Room and other revenue is recognized as earned. Ongoing credit evaluations
are performed and accounts deemed uncollectible are charged to operations.
F - 62
<PAGE>
BCL Acquisition Hotel
NOTES TO COMBINED FINANCIAL STATEMENTS - CONTINUED
December 31, 1996
NOTE A - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNT POLICIES
(Continued)
Income Taxes
No provision or benefit for income taxes has been included in the financial
statement for BCL because taxable income or loss passes through to, and is
reportable by, the owners individually.
NOTE B - LONG-TERM DEBT
Mortgage payable in equal monthly principal payments of $6,000 plus interest
at the prime rate plus 1% per annum (9.75% at December 31, 1996) through
December 2006, at which time the remaining outstanding balance is due in
full. The mortgage is secured by the investment in hotel property. As of
December 31, 1996, the outstanding mortgage balance was $1,601,500.
Note payable in equal monthly installments of principal and interest of $337
bearing interest at 7.85%, due December 2000. The note payable is secured by
a vehicle having a net book value of approximately $9,500 at December 31,
1996. As of December 31, 1996, the outstanding note payable balance was
$14,089.
Aggregate annual principal payments on the mortgage and note payable to the
bond sinking fund for the five years following December 31, 1996, are as
follows:
December 31, 1997 $ 9,045
1998 $ 9,293
1999 $ 9,561
2000 $ 10,179
2001 $ 6,000
NOTE C - COMMITMENTS
The Comfort Inn hotel is operated under a franchise agreement with Choice
Hotel International. Franchise fees represent the annual expense for
franchise royalties, reservation and advertising services under the terms of
the hotel franchise agreements. The payments are based upon percentages of
gross room revenue. As of December 31, 1996, the franchise fees totaled
$49,210.
F - 63
<PAGE>
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No dealer, salesperson or other individual has been authorized to give any
information or to make any representations other than those contained in this
Prospectus in connection with the offer made by this Prospectus and, if given or
made, such information or representations must not be relied upon as having been
authorized by the Company or the Underwriter. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any securities
in any jurisdiction 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 any person to whom it is unlawful to make such offer or solicitation. Neither
the delivery of this Prospectus nor any sale made hereunder shall, under any
circumstances, create any implication that there has been no change in the
affairs of the Company or that information contained herein is correct as of any
time subsequent to the date hereof.
TABLE OF CONTENTS
Page
----
PROSPECTUS SUMMARY............................................... 1
RISK FACTORS..................................................... 14
THE COMPANY...................................................... 23
GROWTH STRATEGY.................................................. 24
USE OF PROCEEDS.................................................. 27
PRICE RANGE OF COMMON STOCK AND DISTRIBUTIONS.................... 28
CAPITALIZATION................................................... 29
DILUTION......................................................... 30
SELECTED FINANCIAL INFORMATION................................... 31
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.................................................. 36
BUSINESS AND PROPERTIES.......................................... 40
POLICIES AND OBJECTIVES WITH RESPECT
TO CERTAIN ACTIVITIES.......................................... 53
MANAGEMENT....................................................... 57
CERTAIN RELATIONSHIPS AND TRANSACTIONS........................... 59
THE LESSEE....................................................... 61
OWNERSHIP OF THE COMPANY'S COMMON STOCK.......................... 63
DESCRIPTION OF CAPITAL STOCK..................................... 64
CERTAIN PROVISIONS OF VIRGINIA LAW AND
OF THE COMPANY'S ARTICLES OF
INCORPORATION AND BYLAWS....................................... 67
SHARES AVAILABLE FOR FUTURE SALE................................. 69
PARTNERSHIP AGREEMENT............................................ 70
FEDERAL INCOME TAX CONSIDERATIONS................................ 73
UNDERWRITING..................................................... 89
EXPERTS.......................................................... 91
REPORTS TO SHAREHOLDERS.......................................... 91
LEGAL MATTERS.................................................... 91
GLOSSARY......................................................... 92
INDEX TO FINANCIAL STATEMENTS....................................F-1
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1,000,000 Shares
HUMPHREY HOSPITALITY
TRUST, INC.
Common Stock
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PROSPECTUS
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Anderson & Strudwick
Incorporated
April 21, 1998
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