10-Q 1 0001.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ______________ FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from __________ to __________ Commission File Number 0-27360 _____________ EXTENDED STAY AMERICA, INC. (Exact name of Registrant as specified in its charter) Delaware 36-3996573 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 450 EAST LAS OLAS BOULEVARD, FORT LAUDERDALE, FL 33301 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (954) 713-1600 _____________ Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- ---- At November 3, 2000, the registrant had issued and outstanding an aggregate of 95,352,454 shares of Common Stock. PART I FINANCIAL INFORMATION Item 1. Financial Statements EXTENDED STAY AMERICA, INC. Condensed Consolidated Balance Sheets (Unaudited) (In thousands, except share data)
ASSETS ------ September 30, December 31, 2000 1999(1) ------------- ------------ Current assets: Cash and cash equivalents............................................................ $ 8,490 $ 6,449 Accounts receivable.................................................................. 7,880 6,094 Prepaid expenses..................................................................... 2,900 2,810 Deferred income taxes................................................................ 49,850 39,053 Other current assets................................................................. 27 27 ---------- ---------- Total current assets............................................................. 69,147 54,433 Property and equipment, net........................................................... 1,987,161 1,856,517 Deferred loan costs, net.............................................................. 18,203 15,746 Other assets.......................................................................... 792 553 ---------- ---------- $2,075,303 $1,927,249 ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------
Current liabilities: Accounts payable..................................................................... $ 32,592 $ 34,020 Income taxes payable................................................................. 10,900 2,888 Accrued retainage.................................................................... 8,640 8,834 Accrued property taxes............................................................... 15,997 8,871 Accrued salaries and related expenses................................................ 5,075 2,633 Accrued interest..................................................................... 2,071 7,059 Other accrued expenses............................................................... 16,686 14,187 Current portion of long-term debt.................................................... 3,000 3,000 ---------- ---------- Total current liabilities........................................................ 94,961 81,492 ---------- ---------- Deferred income taxes................................................................. 95,561 77,167 ---------- ---------- Long-term debt........................................................................ 917,000 853,000 ---------- ---------- Commitments Stockholders' equity: Preferred stock, $.01 par value, 10,000,000 shares authorized, no shares issued and outstanding........................................................................ Common stock, $.01 par value, 500,000,000 shares authorized, 95,456,578 and 95,996,884 shares issued and outstanding, respectively............................. 955 960 Additional paid-in capital........................................................... 825,659 828,724 Retained earnings.................................................................... 141,167 85,906 ---------- ---------- Total stockholders' equity............................................................ 967,781 915,590 ---------- ---------- $2,075,303 $1,927,249 ========== ==========
------------------- (1) Derived from audited financial statements See notes to the unaudited condensed consolidated financial statements 1 EXTENDED STAY AMERICA, INC. Condensed Consolidated Statements of Income (Unaudited) (In thousands, except per share data)
Three Months Ended Nine Months Ended ---------------------------- ---------------------------- September 30, September 30, September 30, September 30, 2000 1999 2000 1999 ------------- ------------- ------------- ------------- Revenue........................................................ $142,162 $116,491 $389,338 $312,397 Property operating expenses.................................... 56,081 48,231 158,984 133,277 Corporate operating and property management expenses.......................................... 11,171 10,589 33,153 31,335 Increase (decrease) in valuation allowance..................... (1,079) Depreciation and amortization.................................. 16,643 15,637 49,150 44,464 -------- -------- -------- -------- Total costs and expenses.................................. 83,895 74,457 241,287 207,997 -------- -------- -------- -------- Income from operations before interest, income taxes and cumulative effect of accounting change...................... 58,267 42,034 148,051 104,400 Interest expense, net.......................................... 20,385 14,942 55,949 40,210 -------- -------- -------- -------- Income before income taxes and cumulative effect of accounting change........................................... 37,882 27,092 92,102 64,190 Provision for income taxes..................................... 15,151 10,837 36,840 25,677 -------- -------- -------- -------- Net income before cumulative effect of accounting change....... 22,731 16,255 55,262 38,513 Cumulative effect of change in accounting for start-up activities, net of income tax benefit of $520............... 779 -------- -------- -------- -------- Net income..................................................... $ 22,731 $ 16,255 $ 55,262 $ 37,734 ======== ======== ======== ======== Net income per common share- Basic: Net income before cumulative effect of accounting change.. $ 0.24 $ 0.17 $ 0.58 $ 0.40 Cumulative effect of accounting change.................... (0.01) -------- -------- -------- -------- Net income..................................................... $ 0.24 $ 0.17 $ 0.58 $ 0.39 ======== ======== ======== ======== Net income per common share- Diluted: Net income before cumulative effect of accounting change.... $ 0.23 $ 0.17 $ 0.57 $ 0.40 Cumulative effect of accounting change...................... (0.01) -------- -------- -------- -------- Net income..................................................... $ 0.23 $ 0.17 $ 0.57 $ 0.39 ======== ======== ======== ======== Weighted average shares: Basic....................................................... 95,192 96,523 95,351 96,260 Effect of dilutive options.................................. 2,164 712 971 778 -------- -------- -------- -------- Diluted..................................................... 97,356 97,235 96,322 97,038 ======== ======== ======== ========
See notes to the unaudited condensed consolidated financial statements 2 EXTENDED STAY AMERICA, INC. Condensed Consolidated Statements of Cash Flows (Unaudited) (In thousands)
Nine Months Ended ----------------------------- September 30, September 30, 2000 1999 ------------- ------------- Cash flows from operating activities: Net income................................................................ $ 55,262 $ 37,734 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization........................................ 49,150 44,464 Amortization of deferred loan costs included in interest expense..... 3,428 2,894 Deferred income taxes................................................ 7,597 16,404 Cumulative effect of accounting change, net.......................... 779 Changes in operating assets and liabilities.......................... 15,947 (12,753) --------- --------- Net cash provided by operating activities......................... 131,384 89,522 --------- --------- Cash flows from investing activities: Additions to property and equipment....................................... (183,033) (251,622) Other assets.............................................................. (239) 121 --------- --------- Net cash used in investing activities............................. (183,272) (251,501) --------- --------- Cash flows from financing activities: Proceeds from long-term debt.............................................. 313,000 315,000 Repayments of revolving credit facility................................... (249,000) (150,000) Proceeds from issuance of common stock.................................... 4,268 5,489 Repurchases of Company common stock....................................... (8,578) Additions to deferred loan costs.......................................... (5,761) (345) --------- --------- Net cash provided by financing activities......................... 53,929 170,144 --------- --------- Increase in cash and cash equivalents........................................ 2,041 8,165 Cash and cash equivalents at beginning of period............................. 6,449 623 --------- --------- Cash and cash equivalents at end of period................................... $ 8,490 $ 8,788 ========= ========= Noncash investing and financing transactions: Capitalized or deferred items included in accounts payable and accrued liabilities................................................. $ 26,053 $ 26,882 ========= ========= Supplemental cash flow disclosures: Cash paid for: Income taxes............................................................ $ 19,883 $ 15,402 ========= ========= Interest expense, net of amounts capitalized............................ $ 64,942 $ 42,588 ========= =========
See notes to the unaudited condensed consolidated financial statements 3 EXTENDED STAY AMERICA, INC. NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 2000 NOTE 1 -- BASIS OF PRESENTATION The accompanying condensed consolidated financial statements are unaudited and include the accounts of Extended Stay America, Inc. and subsidiaries (the "Company"). All significant intercompany accounts and transactions have been eliminated in consolidation. These financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The condensed consolidated balance sheet data at December 31, 1999 was derived from audited financial statements of the Company but does not include all disclosures required by generally accepted accounting principles. Operating results for the three-month and nine-month periods ended September 30, 2000 are not necessarily indicative of the results that may be expected for the year ended December 31, 2000. For further information, refer to the financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. Derivative Financial Instruments: The Company does not enter into financial instruments for trading or speculative purposes. The Company uses interest rate cap contracts to hedge its exposure on variable rate debt. The cost of the caps is included in prepaid expenses and is amortized to interest expense over the life of the cap contract. The interest differential to be received under the related cap is recognized as a reduction in interest expense in the period earned. Changes in the fair value of cap contracts that do not qualify as hedges are recognized in income when they occur. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 was amended in June 2000 by SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment to FASB Statement No. 133." SFAS No. 133, as amended, requires all derivatives to be carried on the balance sheet at fair value. SFAS No. 133, as amended, is effective for financial statements issued for periods beginning after December 15, 2000. Upon adoption of SFAS No. 133, as amended, all hedging relationships must be designated and documented pursuant to the provisions of the statement. The Company intends to designate its interest rate cap contracts as cash-flow hedges. Accordingly, the difference, net of taxes, between the fair value of the caps and their carrying value on the balance sheet under previous hedge-accounting rules will be charged to other comprehensive income in stockholders' equity. The Company has evaluated the impact of SFAS No. 133 on the financial statements and does not anticipate that adoption will have a material impact or that it will create a violation of the Company's debt covenant agreements. At September 30, 2000, the fair value of the caps was $130,000 and their carrying value was $1.2 million. Pursuant to the Statement of Position 98-5, "Reporting on the Costs of Start-up Activities" issued by the Accounting Standards Executive Committee, effective January 1, 1999, the Company changed its method of accounting for start-up activities, including pre-opening and organizational costs, to expense them as they are incurred. Accordingly, the Company recorded an expense of $779,000, net of income tax benefit of $520,000, as the cumulative effect of this change in accounting. 4 In the quarter ended September 30, 1998, unfavorable capital market conditions resulted in a reduction in the Company's development plans for 1999 and 2000. As a result, a valuation allowance of $12.0 million was established for the write-off of costs related to sites that would not be developed. This valuation allowance was reduced by $1.1 million in the quarter ended June 30, 1999 due to the renegotiation of the terms of a number of the optioned sites. The computation of diluted earnings per share for the three months ended September 30, 2000 and 1999 does not include approximately 3.6 million and 7.4 million weighted average shares, respectively, and for the nine months ended September 30, 2000 and 1999 does not include approximately 6.3 million and 7.9 million weighted average shares, respectively, of common stock represented by outstanding options because the exercise price of the options for the periods was greater than the average market price of common stock during the periods. Certain previously reported amounts have been reclassified to conform with the current period's presentation. NOTE 2 -- PROPERTY AND EQUIPMENT Property and equipment consist of the following:
(000's Omitted) September 30, December 31, 2000 1999 ------------- ------------ Operating Facilities: Land and improvements.......................................... $ 467,040 $ 425,098 Buildings and improvements..................................... 1,288,036 1,194,789 Furniture, fixtures, equipment and supplies.................... 251,637 237,218 ---------- ---------- Total Operating Facilities................................. 2,006,713 1,857,105 Office furniture, fixtures and equipment........................... 8,218 8,270 Facilities under development, including land and improvements...... 152,718 122,611 ---------- ---------- 2,167,649 1,987,986 Less: Accumulated depreciation.................................... (180,488) (131,469) ---------- ---------- Total property and equipment....................................... $1,987,161 $1,856,517 ========== ==========
NOTE 3 -- LONG - TERM DEBT AND DERIVATIVE FINANCIAL INSTRUMENTS In June 2000, the Company increased availability under its bank credit facility from $800 million to $1 billion with the addition of a $200 million Tranche D term loan that matures on June 30, 2007. The proceeds from the new term loan were used to reduce amounts outstanding under the Company's revolving loan facility. In addition to increasing aggregate borrowings and availability under the credit facility from $800 million to $1 billion, certain other terms of the credit facility were modified in connection with an amendment and restatement of the credit facility. The credit facility was amended to allow the Company to purchase up to an additional $75 million of its common stock and/or subordinated notes, with a sub-limit of $25 million for the subordinated notes. The credit facility was also amended to expand the Company's ability to issue its common stock to effect certain investments. In addition, certain conditions to each borrowing of revolving loans were eliminated and the permitted ratio of senior debt to earnings before interest, taxes, depreciation and amortization was increased to 4.25:1.00 through September 2001 and to 4.00:1.00 thereafter. Interest on the new Tranche D term loan will be calculated, at the Company's option, using either the prime rate plus 2.5% or the LIBOR rate plus 3.5%. In connection with the issuance of the new Tranche D term loan and the amendments discussed above, the interest rate on the revolving loans and the Tranche A term loan, which previously varied based on the amount of loans outstanding relative to earnings before interest, taxes, depreciation and amortization, are now calculated, at the Company's option, using either the prime rate plus 1.0% or the LIBOR rate plus 2.0%. The commitment fee on the unused revolving loan capacity is 0.5% per annum on the unused amount. 5 In connection with these revisions to the credit facility, the Company has also acquired interest rate cap contracts with a financial institution that limit the Company's exposure to future increases in the LIBOR rate. These contracts relate to a total of $800 million and limit the Company's exposure to a maximum LIBOR rate of 7.88% from June 16, 2000 through June 16, 2001 and to a maximum LIBOR rate of 8.88% from June 17, 2001 through June 16, 2002. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General We own and operate three brands in the extended stay lodging market-- StudioPLUS/TM/ Deluxe Studios ("StudioPLUS"), EXTENDED STAYAMERICA Efficiency Studios ("EXTENDED STAY"), and Crossland Economy Studios/SM/ ("Crossland"). Each brand is designed to appeal to different price points below $500 per week. All three brands offer the same core components: a living/sleeping area; a fully- equipped kitchen or kitchenette; and a bathroom. StudioPLUS facilities serve the mid-price category and generally feature guest rooms that are larger than those in our other brands, an exercise facility, and a swimming pool. EXTENDED STAY rooms are designed to compete in the economy category. Crossland rooms are typically smaller than EXTENDED STAY rooms and are targeted for the budget category. In this Quarterly Report on Form 10-Q, the words "Extended Stay America", "Company", "we", "our", "ours", and "us" refer to Extended Stay America, Inc. and its subsidiaries unless the context suggests otherwise. The table below provides a summary of our selected development and operational results for the three months and nine months ended September 30, 2000 and 1999.
Three Months Nine Months Ended September 30, Ended September 30, --------------------- --------------------- 2000 1999 2000 1999 ---- ---- ---- ---- Total Facilities Open (at period end).. 383 356 383 356 Total Facilities Developed............. 5 9 21 51 Average Occupancy Rate................. 85% 79% 81% 75% Average Weekly Room Rate............... $ 307 $ 296 $ 303 $ 292
Average occupancy rates are determined by dividing the rooms occupied on a daily basis by the total number of rooms. Due to our rapid expansion, our overall average occupancy rate has been negatively impacted by the lower occupancy typically experienced during the pre-stabilization period for newly- opened facilities. We expect the negative impact on overall average occupancy to decline as the ratio of newly-opened properties to total properties in operation declines. Average weekly room rates are determined by dividing room revenue by the number of rooms occupied on a daily basis for the applicable period and multiplying by seven. The average weekly room rates generally will be greater than standard room rates because of (i) stays of less than one week, which are charged at a higher nightly rate, (ii) higher weekly rates for rooms that are larger than the standard rooms, and (iii) additional charges for more than one person per room. We expect that our future occupancy and room rates will be impacted by a number of factors, including the number and geographic location of new facilities as well as the season in which we open those facilities. We also cannot assure you that we can maintain our occupancy and room rates. At September 30, 2000, we had 383 operating facilities (39 Crossland, 252 EXTENDED STAY, and 92 StudioPLUS ) and had 23 facilities under construction (21 EXTENDED STAY and 2 StudioPLUS). We expect to complete the construction of the facilities currently under construction generally within the next twelve months, however, we cannot assure you that we will complete construction within the time periods we have historically experienced. Our ability to complete construction may be materially impacted by various factors including final permitting and obtaining certificates of occupancy, as well as weather-induced construction delays. 6 Results of Operations For the Three Months Ended September 30, 2000 and 1999 Property Operations The following is a summary of the properties in operation at the end of each period along with the related average occupancy rates and average weekly room rates during each period:
For the Three Months Ended ----------------------------------------------------------------------------- September 30, 2000 September 30, 1999 ----------------------------------- ----------------------------------- Average Average Average Average Facilities Occupancy Weekly Room Facilities Occupancy Weekly Room Open Rate Rate Open Rate Rate ---------- ---------- ----------- ---------- ---------- ----------- Crossland............. 39 85% $215 39 75% $214 EXTENDED STAY......... 252 86 315 228 80 301 StudioPLUS............ 92 82 343 89 77 338 --- -- ---- --- -- ---- Total............... 383 85% $307 356 79% $296 === == ==== === == ====
Because newly opened properties typically experience lower occupancies during their pre-stabilization period, average occupancy rates are impacted by the ratio of newly opened properties to total properties. Each of our brands experienced a decline in the ratio of newly opened properties to total properties for the third quarter of 2000 as compared to the third quarter of 1999. The impact of this decline in the ratio of newly opened properties, along with increases in occupancy at our mature properties, resulted in an increase in our overall average occupancy rate to 85% for the third quarter of 2000 compared to 79% for the third quarter of 1999. The average occupancy rate in the third quarter of 2000 for the 347 properties we owned and operated as of June 30, 1999 was 86%. Similarly, the average occupancy rate in the third quarter of 1999 for the 239 properties we owned and operated as of June 30, 1998 was 81%. We believe that the increase in the average occupancy rate for properties open for at least one year at the beginning of the quarter of each year reflects, primarily, increases in the overall demand for lodging products in various markets in which we operate. In addition, we believe that our occupancies benefited from a strategy implemented at the beginning of 2000 to establish a more competitive pricing structure for our products. The increase in overall average weekly room rates for the third quarter of 2000 as compared to the third quarter of 1999 reflects, primarily, the geographic dispersion of properties opened since September 30, 1999 and the higher standard weekly room rates in certain of those markets. The increase also is due in part to increases in rates charged at previously opened properties. The average weekly room rate for the 347 properties that we owned and operated throughout both periods increased by 1% in the third quarter of 2000. We believe that the average weekly room rate for these properties was impacted by a strategy implemented at the beginning of 2000 to establish a more competitive pricing structure. We believe that this pricing strategy contributed to an increase in the occupancy at these properties. We recognized total revenue of $142.2 million for the third quarter of 2000 and $116.5 million for the third quarter of 1999. This is an increase of $25.7 million, or 22%. Approximately $14.9 million of the increased revenue was attributable to properties opened subsequent to June 30, 1999 and approximately $10.8 million was attributable to an increase in revenue for the 347 properties that we owned and operated throughout both periods. Property operating expenses, consisting of all expenses directly allocable to the operation of the facilities but excluding any allocation of corporate operating and property management expenses, depreciation, or interest were $56.1 million (39% of total revenue) for the third quarter of 2000, as compared to $48.2 million (41% of total revenue) for the third quarter of 1999. We expect the ratio of property operating expenses to total revenue to generally fluctuate inversely relative to occupancy rate increases or decreases because the majority of these expenses do not vary based on occupancy. Our overall occupancy rates were 85% for the third quarter of 2000 and 79% for the third quarter of 1999 and our property operating margins were 61% for the third quarter of 2000 and 59% for the third quarter of 1999. The provisions for depreciation and amortization for our lodging facilities were $16.3 million for the third quarter of 2000 and $15.2 million for the third quarter of 1999. These provisions were computed using the straight- 7 line method over the estimated useful lives of the assets. These provisions reflect a pro rata allocation of the annual depreciation and amortization charge for the periods for which the facilities were in operation. Depreciation and amortization for the third quarter of 2000 increased compared to the third quarter of 1999 because we operated 27 additional facilities in 2000 and because we operated for a full quarter the 9 properties that were opened in the third quarter of 1999. Corporate Operations Corporate operating and property management expenses include all expenses not directly related to the development or operation of lodging facilities. These expenses consist primarily of personnel and certain marketing costs, as well as development costs that are not directly related to a site that we will develop. We incurred corporate operating and property management expenses of $11.2 million (8% of total revenue) in the third quarter of 2000 and $10.6 million (9% of total revenue) in the third quarter of 1999. The increase in the amount of these expenses for the third quarter of 2000 as compared to the same period in 1999 reflects the impact of additional personnel and related expenses in connection with the increased number of facilities we operated. We expect these expenses will continue to increase in total amount but decline moderately as a percentage of revenue as we develop and operate additional facilities in the future. Depreciation and amortization was $335,000 for the quarter ended September 30, 2000 and $419,000 for the comparable period in 1999. These provisions were computed using the straight-line method over the estimated useful lives of the assets for assets not directly related to the operation of our facilities. These assets were primarily office furniture and equipment. We realized $95,000 of interest income in the third quarter of 2000 and $143,000 in the third quarter of 1999. This interest income was primarily attributable to the temporary investment of funds drawn under our credit facilities. We incurred interest charges of $23.5 million during the third quarter of 2000 and $17.2 million in the third quarter of 1999. Of these amounts, $3.0 million in the third quarter of 2000 and $2.1 million in the third quarter of 1999 were capitalized and included in the cost of buildings and improvements. We recognized income tax expense of $15.2 million and $10.8 million (40% of income before income taxes and the cumulative effect of an accounting change, in both periods) for the third quarter of 2000 and 1999, respectively. Our income tax expense differs from the federal income tax rate of 35% primarily due to state and local income taxes. We expect the annualized effective income tax rate for 2000 will be approximately 40%. For the Nine Months Ended September 30, 2000 and 1999 Property Operations The following is a summary of the number of properties in operation at the end of each period along with the related average occupancy rates and average weekly room rates during each period:
For the Nine Months Ended ------------------------------------------------------------------------------ September 30, 2000 September 30, 1999 ----------------------------------- ----------------------------------- Average Average Average Average Facilities Occupancy Weekly Room Facilities Occupancy Weekly Room Open Rate Rate Open Rate Rate ---------- ---------- ----------- ---------- ---------- ----------- Crossland...... 39 80% $213 39 68% $210 EXTENDED STAY.. 252 81 310 228 77 296 StudioPLUS..... 92 79 342 89 74 334 --- -- ---- --- -- ---- Total........ 383 81% $303 356 75% $292 === == ==== === == ====
Average occupancy rates for each of the brands increased for the nine-month period ended September 30, 2000 as compared to the same period in 1999 primarily due to a decrease in the ratio of newly opened properties to total properties for those brands. In addition, we believe that our occupancies have benefited from a strategy implemented at the beginning of 2000 to establish a more competitive pricing structure for our products. The average occupancy rate in the nine months ended September 30, 2000 for the 305 properties that we owned and operated as of December 31, 1998 was 81%. Similarly, the average occupancy rate in the nine months ended September 30, 1999 for the 185 properties that we owned and operated as of December 31, 1997 was 79%. 8 The increase in average weekly room rates for the nine months ended September 30, 2000 as compared to the same period of 1999 reflects, primarily, the geographic dispersion of properties opened since September 30, 1999 and the higher standard weekly room rates in certain of those markets. The increase also is due in part to increases in rates charged at previously opened properties. The average weekly room rate for the 305 properties that we owned and operated throughout both periods increased 1% in the first nine months of 2000. We believe that the average weekly room rate for these properties was impacted by a strategy implemented at the beginning of 2000 to establish a more competitive pricing structure. We believe that this pricing strategy contributed to an increase in the occupancy at these properties. We recognized total revenue of $389.3 million for the nine months ended September 30, 2000 and $312.4 million for the nine months ended September 30, 1999. This is an increase of $76.9 million, or 25%. Approximately $55.7 million of the increased revenue was attributable to properties opened subsequent to December 31, 1998 and approximately $21.2 million was attributable to an increase in revenue for the 305 properties that were owned and operated throughout both periods. Property operating expenses were $159.0 million (41% of total revenue) for the nine months ended September 30, 2000 as compared to $133.3 million (43% of total revenue) for the nine months ended September 30 1999. We expect the ratio of property operating expenses to total revenue to generally fluctuate inversely relative to occupancy rate increases or decreases because the majority of these expenses do not vary based on occupancy. Our overall occupancy rates were 81% for the nine months ended September 30, 2000 and 75% for the nine months ended September 30, 1999 and our property operating margins were 59% for the nine months ended September 30, 2000 and 57% for the nine months ended September 30, 1999. The provisions for depreciation and amortization for the lodging facilities were $48.2 million for the nine months ended September 30, 2000 and $43.4 million for the nine months ended September 30, 1999. Depreciation and amortization for the nine months ended September 30, 2000 increased compared to the nine months ended September 30, 1999 because we operated 27 additional facilities in 2000 and because we operated for a full nine months the 51 properties that were opened in the first nine months of 1999. Corporate Operations We incurred corporate operating and property management expenses of $33.2 million (9% of total revenue) in the nine months ended September 30, 2000 and $31.3 million (10% of total revenue) in the nine months ended September 30, 1999. The increase in the amount of these expenses for the nine-month period ended September 30, 2000 as compared to the same period of 1999 reflects the impact of additional personnel and related expenses in connection with the increased number of facilities we operated. We expect these expenses will continue to increase in total amount but decline moderately as a percentage of revenue as we develop and operate additional facilities in the future. Depreciation and amortization for assets not directly related to operation of our facilities was $1.0 million for the nine months ended September 30, 2000 and $1.1 million for the comparable period in 1999. We realized $431,000 of interest income in the nine months ended September 30, 2000 and $544,000 in the nine months ended September 30, 1999. This interest income was attributable to the temporary investment of funds drawn under our credit facilities. We incurred interest charges of $63.9 million in the nine months ended September 30, 2000 and $48.8 million in the nine months ended September 30, 1999. Of these amounts, $7.5 million in the nine months ended September 30, 2000 and $8.0 million in the nine months ended September 30, 1999 were capitalized and included in the cost of buildings and improvements. We recognized income tax expense of $36.8 million for the nine-month period ended September 30, 2000 and $25.7 million for the nine-month period ended September 30, 1999 (40% of income before income taxes and the cumulative effect of an accounting change, in both periods). Income tax expense differs from the federal income tax rate of 35% primarily due to state and local income taxes. 9 Reduction in Valuation Allowance In the quarter ended September 30, 1998, unfavorable capital market conditions resulted in a reduction in our development plans for 1999 and 2000. As a result, a valuation allowance of $12.0 million was established for the write-off of costs related to sites that would not be developed. This valuation allowance was reduced by $1.1 million in the quarter ended June 30, 1999 due to the renegotiation of the terms of a number of the optioned sites. Cumulative Effect of a Change in Accounting Pursuant to the Statement of Position 98-5, "Reporting on the Costs of Start-up Activities" issued by the Accounting Standards Executive Committee, effective January 1, 1999, we changed our method of accounting for start-up activities, including pre-opening and organizational costs, to expense them as they are incurred. Accordingly, in the first quarter of 1999 we recorded an expense of $779,000, net of income tax benefit of $520,000, as the cumulative effect of this change in accounting. Liquidity and Capital Resources We had net cash and cash equivalents of $8.5 million as of September 30, 2000 and $6.4 million as of December 31, 1999. At September 30, 2000 we had approximately $7.9 million, and at December 31, 1999 we had approximately $45,000, invested in short-term demand notes having credit ratings of A1/P1 or equivalent utilizing domestic commercial banks and other financial institutions. We also deposited excess funds during these periods in an overnight sweep account with a commercial bank which in turn invested these funds in short-term, interest-bearing reverse repurchase agreements. Due to the short-term nature of these investments, we did not take possession of the securities, which were instead held by the financial institutions. The market value of the securities held pursuant to these arrangements approximates the carrying amount. Deposits in excess of $100,000 are not insured by the Federal Deposit Insurance Corporation. Our operating activities generated cash of $131.4 million during the nine months ended September 30, 2000 and $89.5 million during the nine months ended September 30, 1999. We used $183.0 million to acquire land, develop, or furnish a total of 44 sites opened or under construction in the nine months ended September 30, 2000 and $251.6 million for 74 sites in the nine months ended September 30, 1999. Our cost to develop a property varies significantly by brand and by geographic location due to differences in land and labor costs. Similarly, the average weekly rate charged and the resultant cash flow from these properties will vary significantly but generally are expected to be in proportion to the development costs. For the 329 properties we opened from January 1, 1996 through December 31, 1999, the average development cost was approximately $5.3 million with an average of 107 rooms. In 2000, we expect to open a number of properties in the Northeast and West where average development costs are higher. Accordingly, we expect our average development cost for 2000 to increase to approximately $8.3 million per property. We made open market repurchases of 1,092,900 shares of common stock for approximately $8.6 million in the nine months ended September 30, 2000. We received net proceeds from the exercise of options to purchase common stock totaling $4.3 million in the nine months ended September 30, 2000 and $5.5 million in the nine months ended September 30, 1999. We have $200 million of 9.15% Senior Subordinated Notes due 2008 (the "Notes"). In June 2000, we increased availability under our bank credit facility from $800 million to $1.0 billion with the addition of a $200 million Tranche D term loan that matures on June 30, 2007. The amended $1.0 billion credit facility (the "Credit Facility") provides for a $350 million revolving loan facility (the "Revolving Facility"), a $150 million term loan facility (the "Tranche A Facility"), a $198 million (net of scheduled principal repayments of $2 million made in 1999) term loan facility (the "Tranche B Facility"), a $100 million term loan facility (the "Tranche C Facility"), and a $200 million term loan facility (the "Tranche D Facility"). The proceeds from the Tranche D Facility were used to 10 reduce amounts outstanding under the Revolving Facility. As of September 30, 2000, we had outstanding loans of $72 million under the Revolving Facility and $648 million under the term loans, leaving $278 million available and committed under the Credit Facility. In addition to increasing aggregate borrowings and availability under the Credit Facility from $800 million to $1.0 billion, certain other terms of the Credit Facility were modified in connection with an amendment and restatement of the Credit Facility. The Credit Facility was amended to allow us to purchase up to an additional $75 million of our common stock and/or subordinated notes, with a sub-limit of $25 million for the subordinated notes. The Credit Facility also was amended to expand our ability to issue common stock to effect certain investments. In addition, certain conditions to borrowings of revolving loans were eliminated and the permitted ratio of senior debt to earnings before interest, taxes, depreciation, and amortization was increased to 4.25:1.00 through September 2001 and to 4.00:1.00 thereafter. Loans under the Credit Facility bear interest, at our option, at either a variable prime-based rate or a variable LIBOR-based rate, plus an applicable margin. Interest rates on the Tranche B Facility and Tranche C Facility were not affected by the amendment. Interest on the Tranche D Facility is calculated, at our option, using either the prime rate plus 2.5% or the LIBOR rate plus 3.5%. In connection with the issuance of the new Tranche D Facility and the amendments discussed above, the interest rate on loans under the Revolving Facility and the Tranche A Facility, which previously varied based on the amount of loans outstanding relative to earnings before interest, taxes, depreciation, and amortization, are now calculated, at our option, using either the prime rate plus 1.0% or the LIBOR rate plus 2.0%. The commitment fee on the unused revolving loan capacity is 0.5% per annum on the unused amount. Our primary market risk exposures result from the variable nature of the interest rates on borrowings under the Credit Facility. We entered into the Credit Facility for purposes other than trading. Based on the levels of borrowings under the Credit Facility at September 30, 2000, if interest rates changed by 1.0%, our annual cash flow and net income would change by $4.3 million. We manage our market risk exposures by periodic evaluation of such exposures relative to the costs of reducing the exposures by entering into interest rate swap or cap agreements or by refinancing the underlying obligations with longer term fixed rate debt obligations. We do not own derivative financial instruments or derivative commodity instruments other than interest rate cap contracts on a total of $800 million that limit our exposure to LIBOR increases to a maximum LIBOR rate of 7.88% from June 16, 2000 through June 16, 2001 and to a maximum LIBOR rate of 8.88% from June 17, 2001 through June 16, 2002. At September 30, 2000 the fair value of the interest rate cap contracts was $130,000 and their carrying value was $1.2 million. In connection with the Credit Facility, we incurred additions to deferred loan costs of $5.8 million during the nine months ended September 30, 2000 and $345,000 during the nine months ended September 30, 1999. We plan to develop approximately 30 properties with total costs of approximately $250 million in each of 2000 and 2001. We will seek to increase our annual investment in extended-stay properties to $350 million for 2002. We had commitments not reflected in our financial statements at September 30, 2000 totaling approximately $95 million to complete construction of extended-stay properties. We believe that the remaining availability under the Credit Facility, together with cash on hand and cash flows from operations, will provide sufficient funds to continue our expansion as presently planned and to fund our operating expenses through 2002. We may need additional capital depending on a number of factors, including the number of properties we construct or acquire, the timing of that development, the cash flow generated by our properties, and the amount of open market repurchases we make of our common stock. Also, if capital markets provide favorable opportunities, our plans or assumptions change or prove to be inaccurate, our existing sources of funds prove to be insufficient to fund our growth and operations, or if we consummate acquisitions, we may seek additional capital sooner than currently anticipated. In the event we obtain additional capital, we may seek to increase property openings in future years. Sources of capital may include public or private debt or equity financing. We cannot assure you that we will be able to obtain additional financing on acceptable terms, if at all. Our failure to raise additional capital could result in the delay or abandonment of some or all of our development and expansion plans, and could have a material adverse effect on us. 11 New Accounting Releases In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 was amended in June 2000 by SFAS No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an amendment to FASB Statement No. 133." SFAS No. 133, as amended, requires all derivatives to be carried on our balance sheet at fair value. SFAS No. 133, as amended, is effective for financial statements issued for periods beginning after December 15, 2000. Upon adoption of SFAS No. 133, as amended, all hedging relationships must be designated and documented pursuant to the provisions of the statement. We intend to designate our interest rate cap contracts as cash-flow hedges. Accordingly, the difference, net of taxes, between the fair value of the caps and their carrying value on our balance sheet under previous hedge-accounting rules will be charged to other comprehensive income in stockholders' equity. We have evaluated the impact of SFAS No. 133 on our financial statements and do not anticipate that adoption will have a material impact or that it will create a violation of our debt covenant agreements. At September 30, 2000, the fair value of the interest rate cap contracts was $130,000 and their carrying value was $1.2 million. Seasonality and Inflation Based upon the operating history of our facilities, we believe that extended stay lodging facilities are not as seasonal in nature as the overall lodging industry. We do expect, however, that our occupancy rates and revenues will be lower than average during the first and fourth quarters of each calendar year. Because many of our expenses do not fluctuate with changes in occupancy rates, declines in occupancy rates may cause fluctuations or decreases in our quarterly earnings. The rate of inflation as measured by changes in the average consumer price index has not had a material effect on our revenue or operating results during any of the periods presented. We cannot assure you, however, that inflation will not affect our future operating or construction costs. Special Note on Forward-Looking Statements This Quarterly Report on Form 10-Q includes forward-looking statements. Words such as "expects", "intends", "plans", "projects", "believes", "estimates", and similar expressions are used to identify these forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. However, these forward-looking statements are subject to risks, uncertainties, assumptions, and other factors which may cause our actual results, performance, or achievements to be materially different. These factors include, among other things: . our limited operating history and uncertainty as to our future profitability; . our ability to meet construction and development schedules and budgets; . our ability to develop and implement the operational and financial systems needed to manage rapidly growing operations; . uncertainty as to the consumer demand for extended stay lodging; . increasing competition in the extended stay lodging market; . our ability to integrate and successfully operate acquired properties and the risks associated with such properties; . our ability to obtain financing on acceptable terms to finance our growth; and . our ability to operate within the limitations imposed by financing arrangements. 12 Other matters set forth in this Quarterly Report may also cause our actual future results to differ materially from these forward-looking statements. We cannot assure you that our expectations will prove to be correct. In addition, all subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements mentioned above. You should not place undue reliance on these forward-looking statements. All of these forward-looking statements are based on our expectations as of the date of this Quarterly Report. We do not intend to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Item 3. Quantitative and Qualitative Disclosures About Market Risk See Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." 13 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit Number Description of Exhibit ------ ---------------------- 27.1 Financial Data Schedule (for EDGAR filings only) (b) Reports on Form 8-K None 14 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 13, 2000. EXTENDED STAY AMERICA, INC. /s/ Gregory R. Moxley ---------------------------- Gregory R. Moxley Chief Financial Officer (Principal Financial Officer) /s/ Patricia K. Tatham ----------------------------- Patricia K. Tatham Vice President - Corporate Controller (Principal Accounting Officer) 15