| MERISTAR HOSPITALITY CORP ITEM 1A RISK FACTORS Financing Risks We are highly leveraged; our significant amount of debt could limit our operational flexibility or otherwise adversely affect our financial condition |
| As of December 31, 2005, we had approximately dlra1dtta6 billion of total debt outstanding, or 66dtta5prca of our total capitalization, and approximately dlra25dtta4 million of unrestricted cash and cash equivalents |
| The following details our debt outstanding as of December 31, 2005: (in thousands) _________________________________________________________________ Total _________________________________________________________________ Interest Rate _________________________________________________________________ Maturity _________________________________________________________________ Senior credit facility $ 13cmam128 LIBOR + 350 bps 2006^ ^(a) Secured facility 303cmam217 ^LIBOR + 135 bps ^ 2007^ ^(b) Senior unsecured notes 251cmam326 9dtta00prca 2008 Senior unsecured notes ^^ 205cmam292^^ ^^(c) 10dtta50prca 2009 Convertible subordinated notes 170cmam000 9dtta50prca 2010 Senior unsecured notes 340cmam730 9dtta125prca 2011 Secured facility 97cmam694 6dtta88prca 2013 Mortgage debt 203cmam688 5dtta95prca^ ^(d) Various _________________________________________________________________ _________________________________________________________________ _________________________________________________________________ $ 1cmam585cmam075 _________________________________________________________________ _________________________________________________________________ _________________________________________________________________ Average maturity 4dtta5 years Average interest rate 8dtta12prca ^(a) ^dlra100 million of capacity expires in August 2006, the remainder of the capacity of the senior credit facility expires in December 2006 |
| Repayment of the dlra75 million term loan portion of the senior credit facility has permanently reduced total borrowing capacity to dlra75dtta0 million |
| ^(b) ^The secured facility is due in October 2007, with three one-year extensions at our option |
| ^(c) ^On March 8, 2006, we redeemed dlra100dtta0 million aggregate principal amount of these notes for an aggregate redemption of dlra107dtta7 million, including accrued and unpaid interest |
| On March 27, 2006, we expect to redeem the remaining dlra105dtta9 million of these notes for an aggregate redemption price of dlra114dtta6 million |
| ^(d) ^Weighted-average interest rate for all mortgage debt |
| We are subject to the risks normally associated with significant amounts of debt, including the risks that: • our vulnerability to downturns in our business is increased, requiring us to reduce our capital expenditures as described further in “Operating Risks” and restrict our ability to make acquisitions; • our cash flow from operations may be insufficient to make required payments of principal and interest; • we may be unable to refinance existing indebtedness, including secured indebtedness; • the terms of any refinancing may not be as favorable as the terms of existing indebtedness; and • we currently are, and may in the future be, unable to pay dividends on our common stock due to covenant restrictions, see “Risks Relating to Common Stock |
| ” We may be required to refinance our indebtedness, and the failure to refinance our indebtedness would have an adverse effect on us |
| As of December 31, 2005, we had approximately dlra1dtta6 billion of total debt outstanding with an average maturity of 4dtta5 years |
| In addition, as of March 6, 2006, we may borrow up to dlra75dtta0 million under our senior credit facility that matures in 2006 |
| If we do not have sufficient funds to repay our indebtedness at maturity, we may have to refinance the indebtedness through additional debt financing |
| This additional financing might include private or public offerings of debt securities and additional non-recourse or other collateralized indebtedness |
| If we are unable to refinance our indebtedness on acceptable terms, we might be forced to sell hotels or other assets on disadvantageous terms |
| This could potentially result in losses and impairments and adverse effects on cash flow from operating activities |
| If we are unable to make required payments of principal 15 ______________________________________________________________________ [42]Table of Contents and interest on our indebtedness, our outstanding indebtedness could be accelerated and our properties could be foreclosed upon by the secured lenders with a consequent loss of income and asset value |
| Accordingly, the inability to refinance our indebtedness could adversely impact our ability to make payments on the notes |
| Some of our debt instruments have restrictive covenants that could affect our financial condition |
| All of our senior unsecured notes, but none of our convertible subordinated notes, have either been co-issued or guaranteed by MeriStar Hospitality Operating Partnership, LP, our principal operating subsidiary, and have also been guaranteed by most of our other subsidiaries |
| The collateralized mortgage-backed securities, or CMBS, and mortgage debt and our senior credit facility have been secured by specific properties |
| The indentures relating to some of our outstanding debt contain limitations on our ability to effect mergers and change of control events, as well as other limitations, including limitations on: • incurring additional indebtedness and issuing capital stock; • declaring and paying dividends; • selling our assets and using the proceeds from sales of assets; • conducting transactions with our affiliates; and • incurring liens |
| Senior credit facility |
| As of March 6, 2006, we had no borrowings outstanding under our dlra75dtta0 million senior credit facility |
| Our ability to borrow under this facility is subject to financial covenants, including leverage, fixed charge coverage and interest coverage ratios, and minimum net worth requirements |
| Compliance with these covenants in future periods will depend substantially upon the financial results of our hotels |
| The agreement governing our senior credit facility limits our ability to effect mergers, asset sales and change of control events and limits the payments of dividends other than those required for us to maintain our status as a REIT, and our ability to incur additional secured and total indebtedness |
| The indentures relating to our senior unsecured notes significantly restrict our ability to incur indebtedness and pay dividends, and our ability to acquire or prepay certain of our debt if our fixed charge coverage ratio (as defined in these indentures) is less than 2 to 1 for our most recently ended four fiscal quarters |
| Other secured facilities |
| As of December 31, 2005, our two secured facility loans due in 2007 and 2013 were secured by sixteen and four of our properties, respectively, and contain standard provisions that require the mortgage servicer to maintain in escrow cash balances for certain items such as property taxes and capital expenditures |
| Future debt instruments |
| Debt instruments we issue in future offerings may likely contain similar restrictive covenants |
| These restrictions could limit our ability to finance our future operations or capital needs, make acquisitions or pursue available business opportunities |
| In addition, they may require us to maintain specific financial ratios and to satisfy various financial covenants |
| We may be required to take action to reduce our debt or act in a manner contrary to our business objectives to meet these ratios and satisfy these covenants |
| We may be able to incur substantially more debt, which would increase the risks associated with our substantial leverage |
| Although the terms of our debt instruments restrict our ability to incur additional indebtedness, neither our organizational documents nor those debt instruments prohibit the incurrence of additional indebtedness |
| If we add new debt to our current debt, including CMBS or other debt that we may issue, the related risks we now face could intensify and increase the risk of default on our indebtedness |
| 16 ______________________________________________________________________ [43]Table of Contents Rising interest rates could have an adverse effect on our cash flow and interest expense |
| As of December 31, 2005, all of our debt bore interest at fixed rates with the exception of our senior credit facility, which is the London Interbank Offered Rate, or LIBOR, plus 350 basis points, and our new secured facility, which is LIBOR plus 135 basis points with an interest rate cap of 7dtta10prca through 2007 |
| We may consider opportunities to convert fixed rate debt to floating rate debt in order to take advantage of current low rates for floating rate debt |
| In the future, we may also incur indebtedness, including that under our senior credit facility, bearing interest at a variable rate, or we may be required to refinance our existing indebtedness at higher interest rates |
| Accordingly, increases in interest rates would increase our interest expense and adversely affect our cash flow, reducing the amounts available to make payments on our indebtedness, make acquisitions or pursue other business opportunities |
| Declines in our corporate credit ratings could have an adverse effect on us |
| Credit rating services assign a rating to us based on their perception of our ability to service debt |
| Fluctuations in our operating performance or changes in the amount of our debt may result in a change to our rating and the related costs of financing |
| Operating Risks The possibility of future acts of terrorism and the actual outbreak or escalation of hostilities and international political instability could have a negative effect on our industry and our results of operations |
| A significant number of our hotels are in major metropolitan areas or near airports and therefore may be more at risk of being affected by a terrorist attack |
| Therefore, we believe that any future threats or acts of terrorism and any outbreak or escalation of hostilities and international political instability could have a negative effect on our industry and our results of operations |
| Our hotel assets, revenues and operating results, and liquidity could be negatively affected by weather conditions generally and natural disasters |
| In August and September 2004, Hurricanes Charley and Frances caused substantial damage to a number of our hotels located in Florida |
| The hurricane damage also caused significant business interruption at many of our Florida properties, including the complete closure of certain hotels |
| In August 2005, Hurricane Katrina caused damage to two of our hotels located in Louisiana and one in Florida |
| While we have comprehensive insurance coverage for both property damage and business interruption, we are experiencing a decline in revenues due to the full or partial closure of certain hotels, and we are not able to recognize any income from business interruption insurance or gains, if any, on replacement of damaged property until all contingencies related to the insurance payments have been resolved |
| Such contingencies include the willingness of our insurers to provide recognition of coverage for losses, the timing of any reimbursements once claims are approved, and the amount of any costs we incur to obtain such reimbursements |
| We are liable for any policy deductibles |
| Future property insurance policies, given conditions in the property insurance market, may be less comprehensive, and may have higher deductibles and/or premiums |
| To the extent that the amount of the insurer reimbursements we receive is lower than the amount we have expended to date to repair the properties using cash on hand or asset sale proceeds, we may be required to find other sources of funds, such as borrowings under our credit facilities, to fund future capital expenditures, whether hurricane-related or not |
| ” For information on the settlement of the claim for Hurricane Charley, see Note 17, “Subsequent Events,” included in Item 8 of this Annual Report on Form 10-K We have a number of hotels located in areas that could be affected by severe weather or other natural disasters that occur in the future, including hurricanes and earthquakes |
| Natural disasters that occur in the future could substantially damage our hotel assets and require a significant unreimbursable and unbudgeted cash outlay to repair the damage, and could have a negative impact on revenues, operating results and liquidity |
| Additionally, 17 ______________________________________________________________________ [44]Table of Contents general weather conditions, which may not physically damage our hotel assets, could impact travel patterns and therefore also have a negative impact on revenues, operating results and liquidity |
| In the first quarter of 2006, we sold 11 Florida properties which substantially reduces our exposure to wind loss |
| If our revenues are negatively affected by one or more particular risks, our operating margins could suffer |
| We report operating revenues and expenses from our hotels; therefore, we have sensitivity to changes in operating revenues and are subject to the risk of fluctuating hotel operating margins at those hotels |
| Hotel operating expenses include, but are not limited to, wage and benefit costs, energy costs, supplies, repair and maintenance expenses, utilities, insurance and other operating expenses |
| These operating expenses are more difficult to predict and control than percentage lease revenue, resulting in unpredictability in our operating margins |
| Also, due to the level of fixed costs required to operate full-service hotels, we generally cannot reduce significant expenditures necessary for the operation of hotels when circumstances cause a reduction in revenue |
| Various factors could adversely affect our operating margins, which are subject to all of the operating risks inherent in the lodging industry |
| These risks include the following: • dependence on business and commercial travelers and tourism, which have been affected by the events of September 11, 2001 and threats of further terrorism, or other outbreaks or escalation of hostilities, and may otherwise fluctuate and be seasonal; • other factors that may influence travel, including health and safety concerns; • changes in general and local economic conditions; • weather conditions generally and natural disasters; • cyclical overbuilding in the lodging industry; • varying levels of demand for rooms and related services; • competition from other hotels, motels and recreational properties, some of which may be owned or operated by companies having greater marketing and financial resources than we do; • decreases in air travel; • fluctuations in operating costs; • union contract requirements and limited availability of labor; • the recurring costs of necessary renovations, refurbishments and improvements of hotel properties; • the expanding scope of brand standards and the costs associated with maintaining compliance with those standards; • changes in interest rates and the availability of credit; • reliance on third-party operators to provide timely and accurate financial reporting; and • changes in governmental regulations that influence or determine wages, prices and construction and maintenance costs |
| In addition, demographic, geographic or other changes in one or more of the markets of our hotels could affect the convenience or desirability of the sites of some hotels, which would in turn affect their operations |
| 18 ______________________________________________________________________ [45]Table of Contents The insurance market has been adversely affected |
| The September 11, 2001 terrorist attacks and the recent hurricanes in Florida have resulted in an increase in premiums and reductions in insurance coverage, especially for terrorism and catastrophic risks such as wind, flood and earthquakes |
| If we are unable to maintain insurance that meets the requirements of our lenders and franchisors, and if we are unable to amend or obtain waivers of those requirements, it could have a material adverse effect on our business |
| Our total annual property insurance premiums are approximately dlra23dtta5 million under our current policies |
| We may not receive reimbursements from insurers for our outstanding hurricane claims |
| The hurricanes of 2004 and 2005 caused substantial damage and business disruption to a number of our properties |
| Our insurance policies require us to move expediently to restore properties and mitigate the claims |
| We therefore have had to expend substantial amounts for repairs, often without timely reimbursements by our insurers and often creating a funding gap |
| To date, we have experienced some delays in reimbursement, particularly with respect to claims relating to Hurricane Frances, which damaged several of our properties in September 2004 |
| In addition, we have suffered business interruption and are making claims to our insurance companies relating to the business interruption |
| Our insurers may dispute coverage for certain aspects of the claim or the measurement of replacement cost or lost profits |
| Prolonged disputes or litigation could cause us to have to borrow, sell assets, or seek other sources of liquidity to fund any shortfall in insurance reimbursement |
| We have significant operational relationships with Interstate, and Interstate’s operating or financial difficulties could adversely affect our hotels’ operations or our financial position |
| Interstate currently manages 61 of the 64 hotels we owned as of December 31, 2005 |
| As a result, we depend heavily on Interstate’s ability to provide efficient, effective management services to our hotels |
| Additionally, we rely on the knowledge and experience of certain key personnel of Interstate, and the loss of those personnel, absent suitable replacement, may have an adverse effect on our operations |
| Although we monitor the performance of our properties on an ongoing basis, Interstate is responsible for the day-to-day management of our properties |
| According to Interstate’s public statements, Interstate has earned net income of dlra12dtta9 million for the year ended December 31, 2005, incurred a net loss of dlra5dtta7 million for the year ended December 31, 2004, and on a pro forma basis giving effect to the merger that formed Interstate, incurred a net loss of dlra4dtta5 million for the year ended December 31, 2003 |
| If Interstate were unable to continue in business as a hotel operator, we would have to find a new manager for our hotels |
| This transition could significantly disrupt the operations of our hotels and lead to lower operating results from our properties |
| Interstate is the managing general partner in MeriStar Investment Partners, LP, which we refer to as MIP, a joint venture established to acquire upscale, full-service hotels |
| We have a 12prca (previously 16prca) preferred partnership interest in MIP on our initial investment of dlra40 million |
| We also have a receivable for dlra10dtta0 million in cumulative preferred returns outstanding as of December 31, 2005 |
| Due to MIP’s debt refinancing and partnership restructuring, we received a dlra10 million payment from MIP in December 2004 and a dlra15dtta5 million payment in February 2005, which reduced our cumulative preferred returns receivable |
| We expect MIP to be able to pay our preferred return in the future; however, any adverse changes that affect MIP’s cash flow could negatively impact MIP’s ability to remit the remaining investment balance to us and to pay the preferred return on a current basis |
| If Interstate is unable to continue as the managing general partner of MIP, a liquidation of MIP could occur which could result in an additional impairment of our investment |
| We invest in a single industry |
| Our current strategy is to acquire interests only in hospitality and lodging |
| As a result, we are subject to the risks inherent in investing in a single industry |
| The effects on cash available for distribution resulting from a downturn in the hotel industry may be more pronounced than if we had diversified our investments |
| 19 ______________________________________________________________________ [46]Table of Contents We own investments in hotels of which we are not the controlling entity |
| Through two investments (Radisson Lexington Avenue Hotel and MIP), we own interests in nine hotels, of which we are not the controlling entity |
| While these hotels are not consolidated into our results of operations, we may record equity in the income or realize returns related to these properties |
| Because we are not the controlling entity in these investments, our investments may be adversely impacted by decisions over which we have limited control |
| We have a high concentration of hotels in the upper upscale, full-service segment, which may increase our susceptibility to an economic downturn |
| As of December 31, 2005, most of our hotels were in the upper upscale, full-service segment |
| This hotel segment generally demands higher room rates |
| In an economic downturn, hotels in this segment may be more susceptible to decreases in revenues, as compared to hotels in other segments that have lower room rates |
| This characteristic results from hotels in this segment generally targeting business and high-end leisure travelers |
| In periods of economic difficulties or political instability, business and leisure travelers may seek to reduce travel costs by limiting trips or seeking to reduce costs on their trips |
| This characteristic has had, and could continue to have, a material adverse effect on our revenues and results of operations |
| Generally, our hotel revenues are greater in the second and third calendar quarters than in the first and fourth calendar quarters |
| This may not be true, however, for hotels in major tourist destinations |
| Revenues for hotels in tourist areas generally are substantially greater during tourist season than other times of the year |
| Seasonal variations in revenue at our hotels will cause quarterly fluctuations in our revenues |
| However, due to diversity in the location and types of properties that we own, seasonal variations on revenue have been minimized in the past |
| Events beyond our control, such as extreme weather conditions, economic factors and other considerations affecting travel, may also adversely affect our earnings |
| For example, see “Seasonality” in Item 1 regarding the impact of hurricanes |
| We may be adversely affected by the requirements contained in our franchise and licensing agreements |
| As of December 31, 2005, approximately 84dtta5prca of our hotels were operated under existing franchise or licensing agreements with nationally recognized hotel brands |
| The franchise agreements generally contain specific standards for, and restrictions and limitations on, the operation and maintenance of a hotel in order to maintain uniformity within the franchisor system |
| Those limitations may conflict with our philosophy, shared with Interstate, of creating specific business plans tailored to each hotel and to each market |
| Standards are often subject to change over time, in some cases at the discretion of the franchisor, and may restrict a franchisee’s ability to make improvements or modifications to a hotel without the consent of the franchisor |
| In addition, compliance with standards could require us to incur significant expenses or capital expenditures |
| Our franchisors have the ability to enact heightened operating standards or require additional capital expenditure requirements |
| Action or inaction on our part or by our third-party operator could result in a breach of standards or other terms and conditions of the franchise agreements, and could result in the loss or cancellation of a franchise license |
| Loss of franchise licenses without replacement would likely have an adverse effect on our hotel revenues |
| As brands are differentiating themselves from their competitors, they are increasing standards for the operations and maintenance of the hotels |
| This may result in an increase in our costs of operations |
| If we are unable to raise rates pressure to pay for these enhancements due to competitive pressure, then we may experience a decrease in our profit margin |
| In connection with terminating or changing the franchise affiliation of a currently-owned hotel or a subsequently-acquired hotel, we may be required to incur significant expenses or capital expenditures |
| Moreover, the loss of a franchise license could have a material adverse effect upon the operations or the underlying value of 20 ______________________________________________________________________ [47]Table of Contents the hotel covered by the franchise due to the loss of associated name recognition, marketing support and centralized reservation systems provided by the franchisor |
| The franchise agreements covering the hotels expire or terminate, without specified renewal rights, at various times and have differing remaining terms |
| As a condition to renewal, the franchise agreements frequently contemplate a renewal application process, which may require substantial capital improvements to be made to the hotel |
| We frequently engage in discussions with franchisors regarding both necessary capital as well as service improvements as a condition of maintaining our franchise licenses |
| Generally, the resolution of these issues requires us to commit to achieve or maintain specified improvement milestones over time, which often require additional capital expenditures |
| Unexpected capital expenditures resulting from these discussions could adversely affect our results of operations and our ability to make payments on our indebtedness |
| The lodging industry is highly competitive |
| We have no single competitor or small number of competitors that are considered to be dominant in the industry |
| We operate in areas that contain numerous competitors, some of which may have substantially greater resources than us |
| Competition in the lodging industry is based generally on location, availability, room rates or accommodations, price, range of services and guest amenities offered, and quality of customer service |
| New or existing competitors could significantly lower rates, offer greater conveniences, services or amenities; or significantly expand, improve or introduce new facilities in markets in which we compete |
| Customers may use the Internet to make bookings for some of our brands |
| However, the Internet sales channel, which historically has been a discount sales channel, could be used to wage a price war in a particular market |
| Internet intermediaries may also be able to obtain higher commissions, reduced room rates and other concessions as their percentage of bookings increases |
| All of these factors could adversely affect our operations and the number of suitable business opportunities |
| We rely on the knowledge and experience of some key personnel, and the loss of these personnel may have a material adverse effect on our operations |
| We place substantial reliance on the lodging industry knowledge and experience and the continued services of our senior management, led by Paul W Whetsell |
| While we believe that, if necessary, we could find replacements for these key personnel, the loss of their services could have a material adverse effect on our operations |
| Costs of compliance with environmental laws could adversely affect our operating results |
| See “Item 1—Governmental Regulation—Environmental Laws” for a discussion of the risks related to environmental compliance |
| Aspects of our operations are subject to government regulation, and changes in that regulation may have significant effects on our business |
| A number of states regulate the licensing of hotels and restaurants, including liquor license grants, by requiring registration, disclosure statements and compliance with specific standards of conduct |
| Interstate believes our hotels are substantially in compliance with these requirements or, in the case of liquor licenses that they have or will promptly obtain the appropriate licenses |
| Compliance with, or changes in, these laws could reduce the revenue and profitability of our hotels and could otherwise adversely affect our revenues, results of operations and financial condition |
| Under the Americans with Disabilities Act, or ADA, all public accommodations must meet federal requirements related to access and use by disabled persons |
| These requirements became effective in 1992 |
| Although significant amounts have been, and continue to be, invested in ADA required upgrades to our hotels, a determination that our hotels are not in compliance with the ADA could result in a judicial order requiring compliance, imposition of fines or an award of damages to private litigants |
| 21 ______________________________________________________________________ [48]Table of Contents We may be adversely affected by the limited availability of labor and by union contract requirements |
| Union contracts for hotel employees in several major markets will be up for renewal in 2006 |
| Although all of the employees at our hotels are employed by the hotel managers, under the management contracts we are generally required to pay the costs related to those employees |
| The failure to timely renegotiate the contracts that are expiring could result in labor disruptions, which could adversely affect our revenues and profitability |
| Labor costs could also escalate beyond our expectations and could have a material adverse effect on our margins |
| General risks related to the real estate industry |
| Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our hotels and harm our financial condition |
| Because real estate investments are relatively illiquid, our ability to promptly sell one or more hotels in response to changing economic, financial and investment conditions is limited |
| The real estate market is affected by many factors that are beyond our control, including general economic conditions, availability of financing, interest rates and other factors, such as supply and demand |
| We expect to selectively sell some of our hotels in the future, but we may be unable to sell them on favorable terms |
| It may take an unexpectedly long time to find a willing purchaser and to close the sale of a hotel |
| The sale of some hotels, including any hotel recently acquired, might subject us to significant adverse tax consequences including the loss of our REIT status and may require us to prepay certain long-term debt and certain liquidity facility loans |
| We may also incur prepayment fees in connection with the payoff of some long-term debt |
| Therefore, we may refrain from liquidating those hotels, even if it would otherwise be advisable to do so |
| We may be required to expend funds to correct defects or to make improvements before a hotel can be sold or receive lower proceeds |
| We may not have funds available to correct those defects or to make those improvements |
| In acquiring a hotel, we may agree to lock-out provisions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property |
| These factors and any others that would impede our ability to respond to adverse changes in the performance of our hotels could have a material adverse effect on our business |
| Corporate Structure Risks We have some potential conflicts of interest with Interstate |
| Our Chief Executive Officer and Chairman of the Board of Directors, Paul W Whetsell, is also Chairman of the Board of Directors of Interstate |
| Our relationship with Interstate is governed by management agreements for each managed hotel |
| We may have conflicting views with Interstate on the operation and management of our hotels |
| Potential conflicts of interest may arise in any or all of our numerous transactions with Interstate |
| The terms of our management agreements with Interstate were negotiated when we and Interstate shared one management team (which has since been separated) |
| Therefore, inherent potential conflicts of interest will be present in all of our numerous transactions with Interstate that occurred before the formal separation of our management teams, which was completed in early 2004 |
| In January 2005, we notified Interstate that 11 hotels with 3cmam655 rooms had failed to meet the performance test involving two-year operating results versus budgets for 2003 and 2004 |
| We have reached an agreement with Interstate under which Interstate will continue to manage those hotels, accept a decrease in a one-time incentive fee for 2005, and accelerate our 600-room termination right for the 2007 year so it could be used in 2006 |
| For the two-year period including 2004 and 2005, six hotels with 2cmam208 rooms failed to meet the performance tests specified in the relevant management agreements, of which one hotel was subsequently sold in the first quarter of 2006 |
| We may have conflicts relating to the sale of hotels subject to management agreements |
| Our management agreements with Interstate may require us to pay a termination fee to Interstate if we elect to sell a hotel or if we elect not to restore a hotel after a casualty |
| While we have the right to terminate up to 600 22 ______________________________________________________________________ [49]Table of Contents rooms per year upon the payment of a termination fee equal to 1dtta5 times the fees earned during the preceding 12 months (with the ability to carry over up to 600 rooms for termination in the succeeding year), we must pay a termination fee if we do not replace a sold hotel with another hotel subject to a management agreement with a fair market value equal to the fair market value of Interstate’s remaining management fee due under the management agreement to be terminated |
| Where applicable, the termination fee is equal to the present value of the remaining payments (discounted using a 10prca rate) of the existing term under the agreement, based on the operating results of the hotel for the 12 months preceding the termination |
| Our decision to sell a hotel may, therefore, have significantly different consequences for Interstate and us |
| We may be obligated to pay Interstate termination fees of up to a maximum of approximately dlra11dtta9 million with respect to the 45 properties we have disposed of between January 1, 2003 and December 31, 2005 |
| As we dispose of any additional assets, we may be obligated to pay additional termination fees |
| Therefore, the requirement to pay a termination fee may make a sale transaction less desirable economically |
| Our management agreements with our other hotel managers may require us to transfer the management agreement to the buyer as a condition of the sale, which may make the transaction less desirable to a potential buyer |
| In addition, our management agreements may have restrictions on the credentials and qualifications of potential purchasers, which may limit the sales potential of our hotels |
| We lack control over management and operations of our hotels |
| We depend on the ability of our hotel managers to operate and manage our hotels |
| As a result, we are unable to directly implement strategic business decisions for the operation and marketing of our hotels, such as decisions with respect to the setting of room rates, food and beverage operations and similar matters |
| Our relationship with Interstate could limit our acquisition opportunities in the future |
| While we have successfully acquired investments in three hotels in 2004, it remains possible that our relationship with Interstate could negatively impact our ability to acquire additional hotels because hotel management companies, franchisees and others who would have approached us with acquisition opportunities in hopes of establishing lessee or management relationships may not do so believing that we may rely primarily on Interstate to manage the acquired properties |
| These persons may instead provide acquisition opportunities to other companies or to hotel management companies who choose to own and manage the properties following the sale |
| This could limit our acquisition opportunities in the future |
| Federal Income Tax Risks Requirements imposed on us relating to our REIT status could cause us to operate in a manner that might be disadvantageous to noteholders |
| We have operated and intend to continue to operate in a manner designed to permit us to qualify as a real estate investment trust, or REIT, for federal income tax purposes |
| To obtain the favorable tax treatment accorded to REITs under the Internal Revenue Code, we normally will be required each year to distribute to our stockholders at least 90prca of our real estate investment trust taxable income, determined without regard to the deduction for dividends paid and by excluding net capital gain |
| We will be subject to income tax on undistributed real estate investment trust taxable income and net capital gain, and to a 4prca nondeductible excise tax on the amount, if any, by which distributions we pay with respect to any calendar year are less than the sum of: • 85prca of our ordinary income for the calendar year; • 95prca of our capital gain net income for that year, unless we elect to retain and pay income tax on those gains; and • 100prca of our undistributed income from prior years |
| 23 ______________________________________________________________________ [50]Table of Contents We intend to make distributions to our stockholders to comply with the 90prca distribution requirements described above and generally to avoid federal income taxes and the nondeductible 4prca excise tax |
| Our income will consist primarily of our share of income of our operating partnership and our cash flow will consist primarily of our share of distributions from the operating partnership |
| It is possible that differences in timing between the receipt of income and the payment of expenses in arriving at our taxable income and the effect of nondeductible capital expenditures, the creation of reserves or required debt amortization payments could, in the future, require us to borrow funds on a short- or long-term basis to enable us to continue to qualify as a REIT and avoid federal income taxes and the 4prca nondeductible excise tax |
| In these circumstances, we might need to borrow funds in order to avoid adverse tax consequences even if we believe that the then prevailing market conditions generally are not favorable for those borrowings or that those borrowings are not advisable in the absence of these tax considerations |
| We determine our operating partnership’s distributions |
| The amount of these distributions is dependent on a number of factors, including: • the amount of cash available for distribution; • our financial condition; • our decision to reinvest funds rather than to distribute the funds; • restrictions in our debt agreements; • our capital expenditure requirements; • the annual distribution requirements under the Internal Revenue Code as described above; and • other factors as we deem relevant |
| Although we intend to satisfy the annual distribution requirement to avoid corporate income taxation on the earnings that we distribute, we may not be able to do so |
| If we fail to qualify as a REIT, we will be subject to federal income tax at corporate rates which could adversely affect our operations and our ability to satisfy our obligations |
| Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code for which there are only limited judicial and administrative interpretations |
| The determination of various factual matters and circumstances not entirely within our control may affect our ability to continue to qualify as a REIT The complexity of these provisions and of the applicable income tax regulations that have been promulgated under the Internal Revenue Code is greater in the case of a REIT that holds its assets through a partnership, such as we do |
| Moreover, legislation, new regulations, administrative interpretations, or court decisions might change the tax laws with respect to qualification as a REIT or the federal income tax consequences of that qualification |
| If we fail to qualify as a REIT in any taxable year, we will not be allowed a deduction for distributions to our stockholders in computing our taxable income and we will be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at the applicable corporate rate |
| In addition, unless we were entitled to relief under statutory provisions, we would be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost |
| This disqualification might reduce the funds available to us to satisfy our obligations or make distributions to our stockholders because of the additional tax liability for the year or years involved |
| We would cease to qualify as a REIT if the Internal Revenue Service were successfully to determine that our operating partnership should properly be treated as a corporation for federal income tax purposes and we 24 ______________________________________________________________________ [51]Table of Contents also might cease to qualify as a REIT if the Internal Revenue Service were successfully to determine that any of the other partnerships or the joint ventures or limited liability companies in which we or the operating partnership holds an interest is properly treated as a corporation for federal income tax purposes |
| The imposition of a corporate tax on any of these entities, and any accompanying loss of our real estate investment trust status, could substantially reduce the amount of cash available for payment on our indebtedness |
| If we were to fail to qualify as a REIT, we no longer would be subject to the distribution requirements of the Internal Revenue Code |
| To the extent that distributions to stockholders would have been made in anticipation of our qualifying as a REIT, we might be required to borrow funds or to liquidate assets to pay the applicable corporate income tax |
| Although we currently operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax, or other considerations may cause us to decide to revoke the REIT election |
| In the course of document review with respect to the MIP restructuring, we discovered a potential technical REIT qualification issue relating to a wholly-owned subsidiary of MIP, of which we could be deemed to own a de minimis proportionate share |
| In order to eliminate any uncertainty, in October 2005 we executed a closing agreement with the Internal Revenue Service that resolves all REIT qualification matters with respect to this potential issue |
| As a result of our negotiations with the Internal Revenue Service, we remain qualified as a REIT for all prior years and continued to operate as a REIT during calendar year 2005 |
| Risks Relating to Common Stock Our ability to pay dividends on our common stock is limited, and we expect this to continue for the foreseeable future |
| Furthermore, we may be required to pay dividends in order to maintain REIT status, and the amount of those dividends may exceed our available cash |
| Under the indentures governing our senior unsecured notes, we are currently prohibited from paying any dividends other than those that are necessary to maintain our status as a REIT when we fall below a 2 to 1 fixed charge coverage ratio |
| Also, our senior credit facility contains limitations on our ability to declare and pay dividends, although it will permit us to pay the dividends we are required to pay to maintain our REIT status |
| In order to maintain our qualification as a REIT, we normally are required to make annual distributions to our stockholders of at least 90prca of our taxable income, determined without regard to the deduction for dividends paid and by excluding net capital gains |
| Under certain circumstances, we may be required to make distributions in excess of cash available for distribution in order to meet these distribution requirements |
| In that event, we would seek to borrow funds, or sell assets for cash, to the extent necessary to obtain cash sufficient to make the distributions required to retain our qualification as a REIT for federal income tax purposes |
| Any future distributions will be at the discretion of our Board of Directors and will be determined by factors including our operating results, restrictions imposed by our borrowing agreements, capital expenditure requirements, the economic outlook, the distribution requirements for REITs under the Internal Revenue Code and such other factors as our Board of Directors deems relevant |
| Therefore, we can give no assurance that we will make any such distributions in the future |
| Risks Related to the Blackstone Merger Transaction If the merger transactions with affiliates of The Blackstone Group do not close, there could be a negative impact on the value of our securities |
| The merger transactions are subject to a number of conditions precedent, all of which are described in our proxy statement on Schedule 14A, which has been filed with the SEC, under the caption, “The Merger Agreement--Conditions to the Mergers |
| ” Completion of the mergers is subject to the receipt of the requisite consents with respect to MeriStar Operating Partnership’s 9prca Senior Notes due 2008 and 9^ 1/8prca Senior Notes 25 ______________________________________________________________________ [52]Table of Contents due 2011 and the execution of supplemental indentures to the indentures governing these notes with respect to the amendments described in tender offer and consent solicitation documents to be distributed |
| You should read our proxy statement in its entirety for more details about the merger transactions and the conditions precedent to their completion |
| Many of these conditions precedent are outside of our control |
| We are also required to commenced tender offers and consent solicitations with respect to certain series of our outstanding senior secured notes, all of which are intended to close simultaneously with the merger transactions |
| If the merger transactions do not close, there could be a negative impact on the value of our equity and debt securities |
| While the merger agreement is in effect, we are subject to significant restrictions on our business activities, and activities relating to the merger may divert the attention of our employees |
| While the merger agreement is in effect, we are subject to significant restrictions on our business activities and must generally operate our business in the ordinary course (subject to certain exceptions or the consent of Blackstone) |
| These interim operating covenants are described in our proxy statement under the caption, “The Merger Agreement--Conduct of Our Business Pending the Mergers |
| ” You should read our proxy statement in its entirety for more details about the merger transactions and the interim operating covenants |
| Because of these restrictions on our business activities and because our employees will likely be required to divert significant attention to merger-related activities, our ability to capitalize on growth opportunities and other business opportunities, make other capital expenditures as agreed with Blackstone, sell assets and reduce our indebtedness will be limited, which could have a material adverse effect on our future results of operations or financial condition |