10-Q 1 a32381q602.txt JUNE 30, 2002 ================================================================================ 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 JUNE 30, 2002 --------------------- OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File No. 0-15291 ------- ARLINGTON HOSPITALITY, INC. --------------------------- (Exact name of Registrant as specified in its charter) DELAWARE 36-3312434 -------- ---------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2355 S. ARLINGTON HEIGHTS ROAD, SUITE 400, ARLINGTON HEIGHTS, ILLINOIS 60005 ---------------------------------------------------------------------- ----- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (847) 228-5400 -------------- 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 -- -- As of August 13, 2002, 4,958,056 shares of the Registrant's Common Stock were outstanding. ================================================================================ ARLINGTON HOSPITALITY, INC. FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 2002 INDEX PART I: Financial Information Page ----------------------------- ---- Item 1. Financial Statements Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001 4 Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2002 and 2001 6 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2001 7 Notes to Consolidated Financial Statements 9 Item 2. Management's Discussion and Analysis 15 Item 3. Quantitative and Qualitative Disclosures About Market Risk 23 PART II: Other Information -------------------------- Item 6. Exhibits and Reports on Form 8-K 24 Signatures 24 Page 2 PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ---------------------------- Page 3 ARLINGTON HOSPITALITY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED)
================================================================================================================== June 30, December 31, 2002 2001 --------------- ---------------- ASSETS Current assets: Cash and cash equivalents $ 3,415,730 $ 4,748,156 Accounts receivable, less an allowance of $150,000 at June 30, 2002 and December 31, 2001 (including approximately $106,000 and $126,000 from related parties) 1,975,083 2,343,423 Notes receivable, current portion 518,499 518,499 Prepaid expenses and other current assets 454,277 998,559 Refundable income taxes 1,122,853 - Costs and estimated earnings in excess of billings on uncompleted contracts with related parties 1,738,937 1,079,137 --------------- -------------- Total current assets 9,225,379 9,687,774 --------------- -------------- Investments in and advances to unconsolidated hotel joint ventures (Note 8) 5,849,430 5,404,744 --------------- -------------- Property and equipment: Land 13,911,841 12,454,360 Buildings 81,589,861 68,095,453 Furniture, fixtures and equipment 26,247,133 24,189,969 Construction in progress 2,286,988 5,973,890 Leasehold improvements 2,772,836 2,899,179 Assets held for sale - 2,187,822 --------------- -------------- 126,808,659 115,800,673 Less accumulated depreciation and amortization 25,407,549 22,905,635 --------------- -------------- 101,401,110 92,895,038 --------------- -------------- Notes receivable, less current portion 993,279 1,000,000 Deferred income taxes (Note 5) 2,302,000 3,247,000 Other assets, net of accumulated amortization of $1,072,000 and $986,000 2,782,243 2,939,900 --------------- -------------- 6,077,522 7,186,900 $ 122,553,441 $ 115,174,456 =============== ============== (continued) Page 4 ARLINGTON HOSPITALITY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) ================================================================================================================== June 30, December 31, 2002 2001 --------------- ---------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,941,621 $ 2,467,704 Bank line-of-credit 7,156,287 6,793,702 Accrued payroll and related expenses 786,717 784,533 Accrued real estate and other taxes 2,384,376 1,952,875 Other accrued expenses and current liabilities 352,924 452,086 Current portion of long-term debt 6,382,654 2,110,652 Income taxes payable - 286,670 --------------- -------------- Total current liabilities 20,004,579 14,848,222 --------------- -------------- Long-term debt, net of current portion 73,289,190 70,088,269 --------------- -------------- Deferred income (Note 9) 10,335,945 10,714,735 --------------- -------------- Commitments and contingencies Minority interests 380,933 456,631 --------------- -------------- Shareholders' equity: Preferred stock, no par value; authorized 100,000 shares; none issued - - Common stock, $.005 par value; authorized 25,000,000 shares; issued and outstanding 4,958,056 shares at June 30, 2002 and 4,958,081 shares at December 31, 2001 24,790 24,790 Additional paid-in capital 13,171,030 13,171,151 Retained earnings 5,783,849 6,307,533 --------------- -------------- 18,979,669 19,503,474 Less: Stock subscriptions receivable (436,875) (436,875) --------------- -------------- 18,542,794 19,066,599 --------------- -------------- $ 122,553,441 $ 115,174,456 =============== ============== See notes to consolidated financial statements.
Page 5 ARLINGTON HOSPITALITY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, (UNAUDITED)
================================================================================================================== Three Months Ended June 30, Six Months Ended June 30, ---------------------------------- ---------------------------------- 2002 2001 2002 2001 --------------- ---------------- --------------- ---------------- Revenue: Hotel operations: AmeriHost Inn hotels $ 11,685,235 $ 12,251,152 $ 20,845,162 $ 22,117,815 Other hotels 2,976,625 2,963,923 5,233,178 5,138,261 Development and construction 3,154,027 42,018 5,219,310 107,175 Hotel sales and commissions 1,540,451 93,373 4,748,348 5,858,068 Management services 262,772 242,090 496,709 471,898 Employee leasing 867,814 1,370,134 1,720,175 2,730,016 Other 156,318 - 317,988 - --------------- --------------- --------------- --------------- 20,643,242 16,962,690 38,580,870 36,423,233 --------------- --------------- --------------- --------------- Operating costs and expenses: Hotel operations: AmeriHost Inn hotels 7,824,102 8,507,534 15,403,551 16,692,558 Other hotels 2,504,103 2,098,862 5,099,282 4,274,177 Development and construction 2,626,326 211,256 4,623,893 587,424 Hotel sales and commissions 1,497,732 - 3,528,680 3,717,468 Management services 184,297 159,455 338,827 351,912 Employee leasing 856,165 1,341,867 1,676,802 2,696,781 Other 28,798 - 45,621 - --------------- --------------- --------------- --------------- 15,521,523 12,318,974 30,716,656 28,320,320 --------------- --------------- --------------- --------------- 5,121,719 4,643,716 7,864,214 8,102,913 Depreciation and amortization 1,406,141 1,148,002 2,729,830 2,269,348 Leasehold rents - hotels 1,336,840 1,705,280 2,818,652 3,461,139 Corporate general and administrative 386,435 411,804 773,594 1,025,432 --------------- --------------- --------------- --------------- Operating income 1,992,303 1,378,630 1,542,138 1,346,994 Other income (expense): Interest expense (1,451,102) (1,389,474) (2,874,776) (2,797,047) Interest income 134,392 122,163 258,222 270,029 Other income (22,650) 63,143 37,360 106,388 Gain on sale of property - 275,207 327,076 590,445 Equity in net income and (losses) of affiliates (208,551) (159,767) (121,583) (272,540) --------------- --------------- --------------- --------------- Income (loss) before minority interests and income taxes 444,392 289,902 (831,563) (755,731) Minority interests in (income) loss of consolidated subsidiaries and partnerships (50,324) (34,306) (37,121) (30,791) --------------- --------------- --------------- --------------- Income (loss) before income taxes 394,068 255,596 (868,684) (786,522) Income tax expense (benefit) 160,000 103,000 (345,000) (319,000) --------------- --------------- --------------- --------------- Net income (loss) $ 234,068 $ 152,596 $ (523,684) $ (467,522) =============== =============== =============== =============== Net income (loss) per share - Basic $ 0.05 $ 0.03 $ (0.11) $ (0.09) Net income (loss) per share - Diluted $ 0.05 $ 0.03 $ (0.11) $ (0.10) See notes to consolidated financial statements.
Page 6 ARLINGTON HOSPITALITY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, (UNAUDITED)
================================================================================================================= 2002 2001 --------------- --------------- Cash flows from operating activities: Cash received from customers $ 39,145,568 $ 37,508,895 Cash paid to suppliers and employees (30,134,918) (28,816,393) Interest received 281,545 101,262 Interest paid (2,893,044) (2,798,308) Income taxes paid (119,523) (276,353) --------------- --------------- Net cash provided by operating activities 6,279,628 5,719,103 --------------- --------------- Cash flows from investing activities: Distributions, and collections on advances, from affiliates 263,836 475,409 Purchase of property and equipment (12,066,782) (5,569,952) Purchase of investments in, and advances to, minority owned affiliates (1,268,212) (1,847,326) Acquisitions of partnership interests, net of cash acquired (Note 7) (796,786) (795,384) Collections on notes receivable 6,721 13,089 Proceeds from sale of assets (6,700) - --------------- --------------- Net cash used in investing activities (13,867,923) (7,724,164) --------------- --------------- Cash flows from financing activities: Proceeds from issuance of long-term debt 9,660,858 3,500,162 Principal payments on long-term debt (3,654,444) (4,266,789) Net proceeds from line of credit 362,585 3,185,569 Distributions to minority interest (112,819) - (Purchase) issuance of common stock (311) 13,711 Other - 117,000 --------------- --------------- Net cash provided by financing activities 6,255,869 2,549,653 --------------- --------------- Net increase (decrease) in cash (1,332,426) 544,592 Cash and cash equivalents, beginning of year 4,748,156 1,728,869 --------------- --------------- Cash and cash equivalents, end of period $ 3,415,730 $ 2,273,461 =============== =============== (continued) Page 7 ARLINGTON HOSPITALITY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, (UNAUDITED) ================================================================================================================= 2002 2001 --------------- --------------- Reconciliation of net loss to net cash provided by operating activities: Net loss $ (523,684) $ (467,522) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 2,729,830 2,269,348 Equity in net (income) loss of affiliates and amortization of deferred income 121,583 272,540 Interest from unconsolidated joint ventures (43,053) - Minority interests in net income of subsidiaries 37,121 30,791 Amortization of deferred gain (527,304) (431,588) Deferred income taxes 360,000 314,000 Issuance of common stock 190 - Gain on sale of property and equipment (327,076) (590,445) Proceeds from sale of hotels 4,456,081 4,724,468 Income from sale of hotels (927,401) (986,189) Changes in assets and liabilities, net of effects of acquisition: Decrease (increase) in accounts receivable 366,110 (255,169) Decrease (increase) in prepaid expenses and other current assets 570,756 (23,008) Increase in refundable income taxes (824,523) (909,353) (Increase) decrease in costs and estimated earnings in excess of billings (659,800) 286,057 Increase in other assets (141,615) (292,228) Increase in accounts payable 450,277 569,250 Increase in accrued payroll and other accrued expenses and current liabilities 322,016 261,026 Decrease in accrued interest (18,268) (1,261) Increase in deferred income 858,388 948,386 --------------- --------------- Net cash provided by operating activities $ 6,279,628 $ 5,719,103 =============== ================ See notes to consolidated financial statements.
Page 8 ARLINGTON HOSPITALITY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 ================================================================================ 1. BASIS OF PREPARATION: --------------------- The financial statements included herein have been prepared by the Company, without audit. In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments, which consist only of recurring adjustments necessary to present fairly the financial position of Arlington Hospitality, Inc. and subsidiaries as of June 30, 2002 and December 31, 2001, and the results of its operations for the three and six months ended June 30, 2002 and 2001, and cash flows for the six months ended June 30, 2002. The results of operations for the three and six months ended June 30, 2002, are not necessarily indicative of the results to be expected for the full year. It is suggested that the accompanying consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's 2001 Annual Report on Form 10-K. Certain reclassifications have been made to the 2001 financial statements in order to conform with the 2002 presentation. 2. PRINCIPLES OF CONSOLIDATION: ---------------------------- The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and entities in which the Company has a majority ownership interest. Significant intercompany accounts and transactions have been eliminated. 3. CRITICAL ACCOUNTING POLICIES: ----------------------------- We defined critical accounting policies as those accounting policies that require our management to exercise subjective and complex judgment. Our critical accounting policies are described in our 2001 Form 10-K. On January 1, 2002 we adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 requires a long-lived asset to be sold to be classified as "held for sale" in the period in which certain criteria are met, including that the sale of the asset within one year is probable. Based on historical experience and our business strategy, we generally do not assess a sale as probable before the transaction closes. We do not believe any of our properties meet all of the criteria necessary to classify assets as held for sale as of June 30, 2002. SFAS 144 also requires that the results of operations of a component of an entity that either has been disposed of or is classified as held for sale be reported in discontinued operations if the operations and cash flows of the component have been or will be eliminated from our ongoing operations. We do not include the sales or operations of AmeriHost Inn hotels in discontinued operations because we retain ongoing royalty fees from those hotels after their sale. The operations of all other long-lived assets sold or classified as held for sale are reflected as discontinued operations. As of June 30, 2002, we have no identifiable discontinued operations. 4. EARNINGS (LOSS) PER SHARE: -------------------------- Basic earnings per share ("EPS") is calculated by dividing the income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period, without consideration of common stock equivalents. Diluted EPS gives effect to all dilutive potential common shares outstanding for the period. The Company excluded stock options which had an anti-dilution effect on the EPS computations in all periods presented and excluded the impact of a convertible partnership interest for the three months ended June 30, 2002 as its effect was also anti-dilutive. The calculations of basic and diluted earnings (loss) per share are as follows: Page 9 ARLINGTON HOSPITALITY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 ================================================================================ 4. EARNINGS (LOSS) PER SHARE (CONTINUED): -------------------------------------- Three Months Ended June 30, Six Months Ended June 30, ---------------------------- ------------------------------- 2002 2001 2002 2001 ------------- ------------- -------------- --------------- Net income (loss) $ 234,068 $ 152,596 $ (523,684) $ (467,522) Impact of convertible partnership interests - (18,391) (15,943) (58,681) ------------- ------------- -------------- -------------- Net income (loss) available to common shareholders $ 234,068 $ 134,205 $ (539,627) $ (526,203) ============= ============= ============== ============== Weighted average common shares outstanding 4,958,077 4,980,484 4,958,079 4,979,953 Dilutive effect of convertible partnership interests and common stock equivalents 75,514 248,771 84,975 168,100 ------------- ------------- -------------- -------------- Dilutive common shares outstanding 5,033,591 5,229,255 5,043,054 5,148,053 ============= ============= ============== ============== Net income (loss) per share - Basic $ 0.05 $ 0.03 $ (0.11) $ (0.09) ============= ============= ============== ============== Net income (loss) per share - Diluted $ 0.05 $ 0.03 $ (0.11) $ (0.10) ============= ============= ============== ==============
5. INCOME TAXES: ------------- Deferred income taxes are provided on the differences in the bases of the Company's assets and liabilities determined for tax and financial reporting purposes and relate principally to depreciation of property and equipment and deferred income. A valuation allowance has not been recorded to reduce the deferred tax assets, as the Company expects to realize all components of the deferred tax asset in future periods. Approximately $595,000 was reclassified into refundable income taxes from deferred income taxes at June 30, 2002, based on the final determination of the appropriate tax treatment for certain fees. The income tax expense (benefit) for the three and six months ended June 30, 2002 and 2001 was based on the Company's estimate of the effective tax rate expected to be applicable for the full year. The Company expects the effective tax rate to approximate the Federal and state statutory rates. 6. HOTEL LEASES: ------------- The Company leases 24 hotels as of June 30, 2002 (including 22 sale/leaseback hotels - Note 9), the operations of which are included in the Company's consolidated financial statements. All of these leases are triple net and provide for monthly base rent payments ranging from $14,000 to $27,000. The leases expire through March 2014. Two of these leases provide for an option to purchase the hotel. The purchase prices are based upon a fixed amount approximating the fair value at the lease commencement, subject to increases in the CPI index. During the three months ended June 30, 2002, the Company exercised its option to purchase one leased hotel from a partnership in which the Company has an ownership interest for $4.5 million. The aggregate purchase price for the remaining two leased hotels was approximately $7,000,000 as of June 30, 2002. Page 10 ARLINGTON HOSPITALITY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 ================================================================================ 7. LIMITED PARTNERSHIP GUARANTEED DISTRIBUTIONS: --------------------------------------------- The Company was a general partner in two partnerships where the Company had guaranteed minimum annual distributions to the limited partners, including a Director of the Company, in the amount of 10% of their original capital contributions. On May 10, 2002, the Company acquired the remaining ownership interest in one of the joint ventures for $815,000 and anticipates completing the acquisition of the second joint venture on or before December 31, 2002. 8. INVESTMENTS: ------------ Effective January 1, 2001, the Company acquired the remaining ownership interest in one hotel joint venture. Effective May 1, 2002, the Company acquired the remaining ownership interest in another hotel joint venture. The following is a summary of these acquisitions: 2002 2001 ------------- ------------- Property and equipment acquired $ 2,279,309 2,100,058 Other assets acquired 38,400 37,023 Long-term debt assumed (1,466,510) (1,238,763) Other liabilities assumed (54,413) (102,934) ------------- ------------- Cash paid, net of cash acquired $ 796,786 $ 795,384 ============= ============= During the second quarter of 2002, one of the Company's hotel joint ventures wrote down its hotel asset by $100,000 based upon its estimated realized value. This adjustment was included in equity in net income and (losses) of affiliates in the accompanying consolidated financial statements. 9. SALE/LEASEBACK OF HOTELS: ------------------------- In 1998 and 1999, the Company completed the sale of 30 AmeriHost Inn hotels to a Real Estate Investment Trust ("REIT") for $73 million. Upon the sales to the REIT, the Company entered into agreements to lease back the hotels for an initial term of ten years, with two five year renewal options. The lease payments are fixed at 10% of the sale price for the first three years. Thereafter, the lease payments are subject to a CPI increase with a 2% annual maximum. The Company has deferred the gain on the sale of these hotels pursuant to sale/leaseback accounting. The deferred gain is being recognized on a straight-line basis over the remaining term of the lease, as extended, as a reduction of leasehold rent expense. In January 2001, the Company amended the master lease with the REIT to provide for the sale of eight hotels by the lessor under specified terms, and to extend the initial lease term by five years. The amendment provides for four increases in rent payments of 0.25% each, if these hotels are not sold to an unrelated third party or to the Company by the dates specified. As of June 30, 2002, the Company is obligated under the terms of the amendment to either facilitate the sale to a third party, or purchase from the REIT, one hotel prior to June 5, 2003, or the 0.25% rent increase becomes effective. The REIT sold one of its hotels to an unrelated third party during the six months ended June 30, 2002. Consequently, the Company has terminated the lease with the REIT for this hotel and recognized a commission from the sale of this hotel, which is classified as hotel sales and commissions in the accompanying consolidated financial statements. The unamortized deferred gain related to the initial sale of this hotel was recognized upon termination of the respective lease. Page 11 ARLINGTON HOSPITALITY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 ================================================================================ 10. BUSINESS SEGMENTS: ------------------ The Company's business is primarily involved in five segments: (1) hotel operations, consisting of the operations of all hotels in which the Company has a 100% or controlling ownership or leasehold interest, (2) hotel development and construction, consisting of development, construction and renovation of hotels for unconsolidated joint ventures and unrelated third parties, (3) hotel sales and commissions, resulting from the sale of AmeriHost Inn hotels, (4) hotel management, consisting of hotel management activities and (5) employee leasing, consisting of the leasing of employees to various hotels. Results of operations of the Company's business segments are reported in the consolidated statements of operations. The following represents revenues, operating costs and expenses, operating income, identifiable assets, capital expenditures and depreciation and amortization, as of and for the six months ended June 30, 2002 and 2001, for each business segment, which is the information utilized by the Company's decision makers in managing the business: Revenues 2002 2001 -------- ------------- ------------- Hotel operations $ 26,078,340 $ 27,256,076 Hotel development and construction 5,219,310 107,175 Hotel sales and commissions 4,748,348 5,858,068 Hotel management 496,709 471,898 Employee leasing 1,720,175 2,730,016 Other (office building) 317,988 - ------------- ------------- $ 38,580,870 $ 36,423,233 ============= ============= Operating costs and expenses ---------------------------- Hotel operations $ 20,502,833 $ 20,966,735 Hotel development and construction 4,623,893 587,424 Hotel sales and commissions 3,528,680 3,717,468 Hotel management 338,827 351,912 Employee leasing 1,676,802 2,696,781 Other (office building) 45,621 - ------------- ------------- $ 30,716,656 $ 28,320,320 ============= ============= Operating income ---------------- Hotel operations $ 204,643 $ 635,297 Hotel development and construction 592,411 (493,034) Hotel sales and commissions 1,219,668 2,140,600 Hotel management 131,292 91,185 Employee leasing 42,190 31,641 Other (office building) 194,747 - Corporate (842,813) (1,058,695) ------------- ------------- $ 1,542,138 $ 1,346,994 ============= ============= Page 12 ARLINGTON HOSPITALITY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 ================================================================================ 10. BUSINESS SEGMENTS (CONTINUED): ------------------------------ Identifiable assets 2002 2001 ------------------- ------------- ------------- Hotel operations $ 105,567,673 $ 96,073,082 Hotel development and construction 2,176,523 534,644 Hotel management 52,689 (167,925) Employee leasing (99,161) 176,593 Other (office building) 6,694,182 - Corporate 8,161,535 5,463,475 ------------- ------------- $ 122,553,441 $ 102,079,869 ============= ============= Capital expenditures -------------------- Hotel operations $ 11,788,467 $ 5,474,253 Hotel development and construction - 5,975 Hotel management 7,998 43,722 Employee leasing - - Other (office building) 255,672 - Corporate 14,645 46,002 ------------- ------------- $ 12,066,782 $ 5,569,952 ============= ============= Depreciation/Amortization ------------------------- Hotel operations $ 2,552,212 $ 2,192,905 Hotel development and construction 3,005 12,786 Hotel management 26,590 28,800 Employee leasing 1,184 1,594 Other (office building) 77,620 - Corporate 69,219 33,263 ------------- ------------- $ 2,729,830 $ 2,269,348 ============= =============
11. BANK LINE OF CREDIT: --------------------- At December 31, 2001, the Company had a $7,500,000 bank operating line-of-credit. The operating line-of-credit was collateralized by a security interest in certain of the Company's assets, including its interests in various joint ventures, was subject to interest at an annual rate equal to the bank's base lending rate plus one-half of one percent, and matured February 28, 2002. Prior to its expiration in February 2002, the Company replaced its line-of-credit with another lender. The new operating line-of-credit has a limit of $8.5 million, is collateralized by substantially all the assets of the Company, subject to first mortgages from other lenders on hotel assets, bears interest at a rate based on either the prime rate or LIBOR as chosen quarterly by the Company, plus a spread adjusted quarterly based on the Company's leverage ratio, ranging from zero to 0.5% (if Prime based) or 3.0% (if LIBOR based), and matures February 19, 2003. The new line-of-credit agreement also provides for the maintenance of certain financial covenants, including minimum tangible net worth, a maximum leverage ratio, and a minimum debt service coverage ratio. The Company was not in compliance with the maximum leverage ratio covenant as of June 30, 2002; however, the lender has waived this violation and adjusted the covenant for future periods. Page 13 ARLINGTON HOSPITALITY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 ================================================================================ 12. SUBSEQUENT EVENT: ----------------- The Company anticipates exchanging a note receivable from the principals of Diversified Innkeepers, Inc. in the amount of $1,136,779 at June 30, 2002, for a 50% ownership interest in a hotel joint venture. The remaining 50% ownership interest will be held by the principals of Diversified Innkeepers, Inc. Under the terms of the partnership agreement, the Company is entitled to preferred operating distributions, as well as a preferred distribution upon the sale or refinancing of the hotel. Page 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- GENERAL The Company is engaged in the development and sale of AmeriHost Inn hotels, and the ownership, operation and management of AmeriHost Inn hotels and other mid-price hotels. Since the Company's inception, the Company has constructed over 100 hotels. In addition, the Company has acquired other brand hotels, or has formed joint ventures to acquire other brand hotels. As of June 30, 2002, the Company had 65 AmeriHost Inn hotels open, of which 53 were wholly-owned or leased, one was majority-owned, and 11 were minority-owned. The Company opened four AmeriHost Inn hotels during the past twelve months. The Company intends to use the AmeriHost Inn brand when expanding its hotel operations segment. As of June 30, 2002, three wholly-owned AmeriHost Inn hotels were under construction. Same room revenues for all AmeriHost Inn hotels owned and operated by the Company, including minority owned hotels, increased approximately 5.3% during the second quarter of 2002, compared to the second quarter of 2001, attributable to a 9.5% increase in occupancy, partially offset by a decrease of $2.24 in average daily rate. These results relate to the 60 AmeriHost Inn hotels that were operating for at least thirteen full months during the six months ended June 30, 2002. Revenues from hotel operations consist of the revenues from all hotels in which the Company has a 100% or controlling ownership or leasehold interest ("Consolidated" hotels). Development and construction revenues consist of fees for new construction and renovation activities performed by the Company for unconsolidated minority-owned hotels and unrelated third parties. The Company records commissions and revenue from the sale of its Consolidated AmeriHost Inn hotels, based upon the net sale price, as these sales are considered part of the Company's strategy of building and selling hotels, and therefore expanding the AmeriHost Inn brand. The Company also receives revenue from management and employee leasing services provided to unconsolidated minority-owned hotels and unrelated third parties. Revenues from Consolidated AmeriHost Inn hotels decreased 4.6% and 5.8% to $11.7 million and $20.8 million during the three and six months ended June 30, 2002, from revenues of $12.3 million and $22.1 million during the three and six months ended June 30, 2001, respectively, due primarily to the sale of hotels. Revenues from the development segment increased to $3.2 million and $5.2 million during the three and six months ended June 30, 2002, from $42,018 and $107,175 for the three and six months ended June 30, 2001, respectively, due to the increase in hotel development activity for minority-owned and third party entities. Revenues from hotel sales and commissions decreased 18.9% to $4.7 million during the six months ended June 30, 2002, from $5.9 million for the six months ended June 30, 2001, as a result of the sale of three AmeriHost Inn hotels during the first six months of 2002, including one in the second quarter, versus the sale of five AmeriHost Inn hotels during the first six months of 2001. Revenues from hotel management and employee leasing segments decreased by 29.9% and 30.8% in total during the three and six months ended June 30, 2002, respectively, due primarily to the sale or termination of hotels under management contracts. Revenues from Consolidated non-AmeriHost Inn hotels increased 0.4% and 1.8% during the three and six months ended June 30, 2002, respectively, compared to 2001, as a result primarily of the acquisition of one non-AmeriHost Inn hotel during December 2001. Total revenues increased 21.7% and 5.9% to $20.6 million and $38.6 million during the three and six months ended June 30, 2002, from $17.0 million and $36.4 million during the three and six months ended June 30, 2001. The Company recorded net income of $234,068 for the second quarter of 2002, or $0.05 per diluted share, compared to net income of $152,596 or $0.03 per diluted share in 2001. The Company recorded a net loss of ($523,684) for the six months ended June 30, 2002, or ($0.11) per diluted share, compared to net loss of ($467,522), or ($0.10) per diluted share, for the six months ended June 30, 2001. On September 30, 2000, the Company sold the AmeriHost Inn and AmeriHost Inn & Suites brand names and franchising rights to Cendant Corporation. The agreement with Cendant provides for favorable royalty payment terms and additional long-term incentives to the Company as the AmeriHost Inn brands are expanded, including royalty sharing and a hotel development incentive fee each time a hotel owned by the Company is sold to an operator who becomes a Cendant franchisee. The Company uses Cash Flow, defined as net income plus depreciation and amortization, as a supplemental performance measure, along with net income, to report its operating results. Net income plus depreciation and amortization is not defined by Generally Accepted Accounting Principles ("GAAP"), however the Company believes it provides relevant information about its operations and is Page 15 necessary for an understanding of the Company's operations, given its significant investment in real estate. Cash Flow, as defined, should not be considered as an alternative to operating income (as determined in accordance with GAAP) as an indicator of the Company's operating performance or to cash flows from operating activities (as determined in accordance with GAAP) as a measure of liquidity. Cash Flow, as defined, increased 26.1% and 22.4% to $1.6 million and $2.2 million during the three and six months ended June 30, 2002, from $1.3 million and $1.8 million during the three and six months ended June 30, 2001. Excluding hotels under construction, the Company had an ownership interest in 75 hotels at June 30, 2002, versus 77 hotels at June 30, 2001. The increased ownership from the development of AmeriHost Inn hotels for the Company's own account and the acquisition of a non-AmeriHost Inn hotel was offset by the sale of AmeriHost Inn hotels to Cendant franchisees. Total Consolidated hotels decreased slightly to 62 hotels at June 30, 2002, versus 63 hotels at June 30, 2001. CRITICAL ACCOUNTING POLICIES We define critical accounting policies as those accounting policies that require our management to exercise subjective and complex judgment. Our critical accounting policies are described in our 2001 Form 10-K. In addition, on January 1, 2002 we adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). The statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 requires a long-lived asset to be sold to be classified as "held for sale" in the period in which certain criteria are met, including that the sale of the asset within one year is probable. Based on historical experience and our business strategy, we generally do not assess a sale as probable before the transaction closes. We do not believe any of our properties meet all of the criteria necessary to classify assets as held for sale as of June 30, 2002. SFAS 144 also requires that the results of operations of a component of an entity that either has been disposed of or is classified as held for sale be reported in discontinued operations if the operations and cash flows of the component have been or will be eliminated from our ongoing operations. We do not include the sales or operations of AmeriHost Inn hotels in discontinued operations because we retain ongoing royalty fees from those hotels after their sale. The operations of all other long-lived assets sold or classified as held for sale are reflected as discontinued operations. As of June 30, 2002, we have no identifiable discontinued operations. RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO THE THREE AND SIX MONTHS ENDED JUNE 30, 2001 Revenues increased 21.7% and 5.9% to $20.6 million and $38.6 million during the three and six months ended June 30, 2002, respectively, from $17.0 million and $36.4 million during the three and six months ended June 30, 2001. The increase in revenue was primarily due to increases in hotel development revenues during 2002 and hotel sales and commissions during the three months ended June 30, 2002. Hotel operations revenue decreased 3.6% and 4.3% to $14.7 million and $26.1 million during the three and six months ended June 30, 2002, respectively, from $15.2 million and $27.3 million during the three and six months ended June 30, 2001. Revenues from Consolidated AmeriHost Inn hotels decreased 4.6% and 5.8% to $11.7 million and $20.8 million during the three and six months ended June 30, 2002, respectively, from $12.3 million and $22.1 million during the three and six months ended June 30, 2001. These decreases were attributable primarily to the sale of seven Consolidated AmeriHost Inn hotels to Cendant franchisees, partially offset by the opening of four newly constructed AmeriHost Inn hotels. Revenues from Consolidated other brand hotels increased 0.4% and 1.8% to $3.0 million and $5.2 million during the three and six months ended June 30, 2002, respectively. These increases were primarily the result of the acquisition of one non-AmeriHost Inn Consolidated hotel during December 2001. The hotel operations segment included the operations of 62 Consolidated hotels (including 54 AmeriHost Inn hotels) comprising 4,535 rooms at June 30, 2002, compared to 63 Consolidated hotels (including 57 AmeriHost Inn hotels) comprising 4,446 rooms at June 30, 2001. The Company has experienced an increase in competition in certain markets, primarily from newly constructed hotels. As a result, there is increased downward pressure on occupancy levels and average daily rates. The Company believes that as the number of AmeriHost Inn hotels increases, the greater the benefits will be at all locations from marketplace recognition and Page 16 repeat business. In addition, the Company typically builds new hotels in growing markets where it anticipates a certain level of additional hotel development. Hotel development revenue increased to $3.2 million and $5.2 million during the three and six months ended June 30, 2002, respectively, from $42,018 and $107,175 during the three and six months ended June 30, 2001. Hotel development revenues are directly related to the number of hotels being developed and constructed for minority-owned entities or unrelated third parties. The Company was constructing two hotels for minority-owned entities or unrelated third parties during the first six months of 2002, compared to none during the first six months of 2001. However, the Company also had several additional projects in various stages of pre-construction development during both six-month periods. In addition, Cendant pays the Company a development incentive fee every time the Company sells one of its existing AmeriHost Inn hotels to a buyer who executes an AmeriHost Inn franchise agreement with Cendant. The Company received approximately $535,000 and $771,000 in development incentive fees from the sale of AmeriHost Inn hotels during the second quarter and first six months of 2002, respectively. These fees are deferred and recognized as revenue over a 76-month period. Approximately $91,000 and $162,000 was recognized as hotel development revenue in the second quarter and first six months of 2002. Cendant also pays the Company a portion of all royalty fees Cendant receives from all of its AmeriHost Inn franchisees. Generally, Cendant receives royalty fees from each of their franchisees based upon a percentage of guest room revenue, ranging from 4% to 5%. In turn, Cendant will pay the Company a portion of this fee as stipulated in the agreement. The Company recorded approximately $50,000 and $87,000 in royalty sharing payments during the second quarter and first six months of 2002, respectively. The Company generally records this royalty sharing fee as hotel development segment revenue when the related royalty fee is received. The Company recorded $1.5 million and $4.7 million in hotel sales and commission revenue during the three and six months ended June 30, 2002, respectively, compared to $93,373 and $5.9 million during the three and six months ended June 30, 2001. The Company and the REIT which owns certain of the Company's leased hotels, closed on the sale of three AmeriHost Inn hotels during the first six months of 2002, including one in the second quarter of 2002, versus five AmeriHost inn hotels during the first six months of 2001, including one during the second quarter of 2001. The Company intends to continue to build and sell AmeriHost Inn hotels in order to maximize the value inherent in the Cendant transaction while enhancing net income and cash flow. The AmeriHost Inn hotel that was sold during the second quarter of 2001 was owned by the REIT; therefore, the revenues from this segment only included a commission on the sale of this hotel. Hotel management revenue increased 8.5% and 5.3% to $262,772 and $496,709 during the three and six months ended June 30, 2002, respectively, from $242,090 and $471,898 during the three and six months ended June 30, 2001. The number of hotels managed for third parties and minority-owned entities was 15 hotels, representing 1,212 rooms, at June 30, 2002, versus 16 hotels, representing 1,318 rooms, at June 30, 2001. The decrease from the elimination of management fees from a minority-owned hotel upon its consolidation during the fourth quarter of 2001, was offset by the increase in same room revenues, which is the basis for the management fee revenue. Employee leasing revenue decreased 36.7% and 37.0% to $867,814 and $1.7 million during the three and six months ended June 30, 2002, respectively, from $1.4 million and $2.7 million during the three and six months ended June 30, 2001, due primarily to the reduction in rooms managed for minority-owned entities and unrelated third parties as described above, a concerted effort to decrease payroll costs which is the basis for the employee leasing revenue, and the treatment of workers compensation insurance cost in 2002. Other revenue, consisting of leasing revenue from the Company's office building was $156,318 and $317,988 during the three and six months ended June 30, 2002. On October 1, 2001, the Company purchased the office building in which its headquarters is located. The building contains approximately 50,000 rentable square feet, of which the Company occupies approximately 19,000 square feet. Nearly all of the remaining space is leased to unrelated third parties pursuant to long-term leases. Total operating costs and expenses increased 26.0% and 8.5% to $15.5 million (75.2% of total revenues) and $30.7 million (79.6% of total revenues) during the three and six months ended June 30, 2002, respectively, from $12.3 million (72.6% of total revenues) and $28.3 million (77.8% of total revenues) during the three and six months ended June 30, 2001, primarily due to increases in operating costs and expenses from the hotel development and sale of hotel segments as described below. Operating costs and expenses in the hotel operations segment decreased 2.6% and 2.2% to $10.3 million and $20.5 million during the three and six months ended June 30, 2002, respectively. A decrease in Page 17 operating costs associated with the fewer number of hotels included in this segment (62 hotels at June 30, 2002, versus 63 hotels at June 30, 2001), and the decrease in energy costs during the first six months of 2002 compared to 2001, were partially offset by the acquisition of one non-AmeriHost Inn hotel and the consolidation of another non-AmeriHost Inn hotel which was previously accounted for by the equity method. Hotel operations segment operating costs and expenses as a percentage of segment revenue increased to 70.4% and 78.6% during the three and six months ended June 30, 2002, from 69.7% and 76.9% during the three and six months ended June 30, 2001. Operating costs and expenses as a percentage of revenues for the Consolidated AmeriHost Inn hotels decreased to 67.0% and 73.9% during the three and six months ended June 30, 2002, from 69.4% and 75.5% during the three and six months ended June 30, 2001. Operating costs and expenses as a percentage of revenues from the other Consolidated hotels increased to 84.1% and 97.4% during the three and six months ended June 30, 2002, from 70.8% and 83.2% during the three and six months ended June 30, 2001, due primarily to the acquisition and consolidation of the two non-AmeriHost Inn hotels and the associated operating costs therefrom. Operating costs and expenses for the hotel development segment increased to $2.6 million and $4.6 million during the three and six months ended June 30, 2002, from $211,256 and $587,424 during the three and six months ended June 30, 2001, consistent with increase in hotel development revenues for the three and six months ended June 30, 2002. Operating costs and expenses in the hotel development segment as a percentage of segment revenue decreased during the three and six month periods ended June 30, 2002 due to the increase in hotel construction activity from third parties and minority-owned entities. Hotel management segment operating costs and expenses increased 15.6% and decreased 3.7% to $184,297 and $338,827 during the three and six months ended June 30, 2002, respectively, from $159,445 and $351,912 during the three and six months ended June 30, 2001. These decreases were primarily due to the decrease in the number of hotel rooms operated and managed for unrelated third parties and minority-owned entities. Employee leasing operating costs and expenses decreased 36.2% and 37.8% to $856,165 and $1.7 million during the three and six months ended June 30, 2002, respectively, from $1.3 million and $2.7 million during the three and six months ended June 30, 2001, which is consistent with the 36.7% and 37.0% decrease in segment revenue for the three and six months ended June 30, 2002. Other operating costs and expenses of $28,798 and $45,621 during the three and six months ended June 30, 2002, consisted of expenses related to the management of the Company's office building. On October 1, 2001, the Company purchased the office building in which its headquarters is located and assumed the landlord duties for the other tenants. Depreciation and amortization expense increased 22.5% and 20.3% to $1.4 million and $2.7 million during the three and six months ended June 30, 2002, respectively, from $1.1 million and $2.3 million during the three and six months ended June 30, 2001. The increases were primarily attributable to the acquisition of the office building, the opening of newly constructed hotels, and the acquisition or consolidation of existing hotels, offset by the sale of consolidated hotels during the last twelve months. Leasehold rents - hotels decreased 21.6% and 18.6% to $1.3 million and $2.8 million during the three and six months ended June 30, 2002, respectively, compared to $1.7 million and $3.5 million during the three and six months ended June 30, 2001. The decrease was due to the sale of five leased AmeriHost Inn hotels during the last 18 months, and the acquisition of three hotels pursuant to lease-purchase options during the past twelve months. Corporate general and administrative expense decreased 6.2% and 24.6% to $386,435 and $773,594 during the three and six months ended June 30, 2002, respectively, from $411,804 and $1.0 million during the three and six months ended June 30, 2001, and can be attributed primarily to the expense related to stock options issued to consultants and transitional accounting fees incurred during the first quarter of 2001. The Company's operating income increased 44.5% and 14.5% to $2.0 million and $1.5 million during the three and six months ended June 30, 2002, respectively, from $1.4 million and $1.3 million during the three and six months ended June 30, 2001. The following discussion of operating income by segment is exclusive of any corporate general and administrative expense. Operating income from Consolidated AmeriHost Inn hotels increased 19.8% and 48.3% to $1.7 million and $1.2 million during the three and six months ended June 30, 2002, respectively, from $1.5 million and $782,398 during the three and six months ended June 30, 2001. These increases in operating income were due to the increase in same room revenues and decreases in certain hotel operating expenses including energy Page 18 costs. Operating income from the hotel development segment increased to $526,343 and $592,411 during the three and six months ended June 30, 2002, from ($175,630) and ($493,034) during the three months ended June 30, 2001. The increases in hotel development operating income were due to the increase in hotels developed and constructed for third parties and minority-owned entities during the second quarter and first six months of 2002, compared with the second quarter and first six months of 2001. Operating income from hotel sales and commissions decreased to $42,719 and $1.2 million during the three and six months ended June 30, 2002, from $93,373 and $2.1 million during the three and six months ended June 30, 2001. These decreases were due to the sale of three AmeriHost Inn hotels during the first six months of 2002, versus the sale of five during the six months ended June 30, 2001. The hotel management segment had operating income of $65,394 and $131,292 during the three and six months ended June 30, 2002, compared to operating income of $68,235 and $91,185 during the three and six months ended June 30, 2001. The increase during the six months ended June 30, 2002, was due primarily to a reduction in hotel management operating expenses. Employee leasing operating income decreased to $11,081 during the three months ended June 20, 2002, from $27,470 during the three months ended June 30, 2001, and increased to $42,190 during the six months ended June 30, 2002, from $31,641 during the six months ended June 30, 2001, due primarily to the decrease in employee leasing operating expenses. Other operating income of $86,465 and $194,747 during the three and six months ended June 30, 2002, was attributable to the acquisition in 2001 of the office building in which the Company's headquarters is located. Interest expense increased slightly to $1.5 million and $2.9 million during the three and six months ended June 30, 2002, respectively, from $1.4 million and $2.8 million during the three and six months ended June 30, 2001. The decrease attributable to sale of AmeriHost Inn hotels, whereby the Company does not incur any interest expense on sold hotels after the sale dates, the decrease from lower interest on floating rate debt, and the reduction of fixed interest rates pursuant to loan modifications executed in 2001, was offset by the mortgage financing of newly constructed or acquired Consolidated hotels. The Company capitalizes interest expense incurred during the pre-opening construction period of a Consolidated hotel project, as part of the total development cost. The amount capitalized includes both interest charges from a direct construction loan, plus interest computed at the Company's incremental borrowing rate on the total costs incurred to date in excess of the construction loan funding. The Company's share of equity in income (loss) of affiliates decreased to ($208,551) during the three months ended June 30, 2002, from ($159,767) during the three months ended June 30, 2001. The Company's share of equity in income (loss) of affiliates increased to ($121,583) during the six months ended June 30, 2002, from ($272,540) during the six months ended June 30, 2001. The fluctuations in equity of affiliates during the second quarter and first six months of 2002, compared to 2001, were primarily attributable to the write down to net realizable value of property in a hotel partnership by $100,000 during the second quarter of 2002, and the recognition of the Company's share of the operations in excess of the Company's ownership interest as a result of its position as general partner. Distributions from affiliates were $10,310 during the six months ended June 30, 2002, compared to $10,059 during the six months ended June 30, 2001. The Company anticipates exchanging a note receivable from the principals of Diversified Innkeepers, Inc. in the amount of $1,136,779 at June 30, 2002, for a 50% ownership interest in a hotel joint venture. The remaining 50% ownership interest will be held by the principals of Diversified Innkeepers, Inc. Under the terms of the partnership agreement, the Company is entitled to preferred operating distributions, as well as a preferred distribution upon the sale or refinancing of the hotel. The Company recorded gains from the sale of assets of $0 and $327,076 during the three and six months ended June 30, 2002, compared to $275,207 and $590,445 during the three and six months ended June 30, 2001. These gains were comprised primarily of the unamortized deferred gains remaining from the original sale of these hotels to the REIT, which were recognized upon the consummation of the sales of these hotels by the REIT to unrelated third parties and the simultaneous termination of the Company's leases with the REIT. Two hotels were sold by the REIT during the first six months of 2001, and one hotel was sold by the REIT during the first six months of 2002. The Company expects to continue recognizing the unamortized deferred gain from the future sale of REIT owned hotels. The Company recorded income tax expense of $160,000 and $103,000 during the three and six months ended June 30, 2002 and 2001, respectively, and an income tax benefit of $345,000 and $319,000 during the three and six months ended June 30, 2002 and 2001, respectively, which are directly related to the pre-tax income during the second quarter of 2002 and 2001, and the pre-tax losses incurred during the first six months of 2002 and 2001. Page 19 The Company reported a net income of $234,068 and $152,596 during the three months ended June 30, 2002 and 2001, respectively, and a net loss of ($523,684) and ($467,522) during the first six months of 2002 and 2001, primarily due to the factors discussed above. LIQUIDITY AND CAPITAL RESOURCES The Company has five main sources of cash from operating activities: (i) revenues from hotel operations; (ii) fees from development, construction and renovation projects, including hotel development incentive fees and royalty sharing pursuant to the Cendant transaction, (iii) revenues from the sale of hotel assets; (iv) fees from management contracts; and (v) fees from employee leasing services. Cash from hotel operations is typically received at the time the guest checks out of the hotel. Approximately 10% of the Company's hotel operations revenues is generated through other businesses and contracts and is usually paid within 30 to 45 days from billing. Fees from development, construction and renovation projects are typically received within 15 to 45 days from billing. Due to the procedures in place for processing its construction draws, the Company typically does not pay its contractors until the Company receives its draw from the equity or lending source. Management fee revenues typically are received by the Company within five working days from the end of each month. Cash from the Company's employee leasing segment typically is received as of or prior to the pay date. The Company typically receives an earnest money deposit from the buyer of a hotel when a sales contract is executed. The remaining proceeds from the sale of hotel assets are received at the time of closing. The development incentive fee from Cendant is typically received within 20 days of the closing. Royalty sharing payments from Cendant are received quarterly, based on the actual royalty payments received by Cendant from the AmeriHost Inn franchisees. During the first six months of 2002, the Company provided cash from operations of $6.3 million, compared to $5.7 million the first six months of 2001, or an increase in cash provided by operations of approximately $560,000. The increase in cash flow from operations during the first six months of 2002, when compared to 2001, can be attributed primarily to the increase in hotel development activity for a third party and a minority-owned entity and the increase in operating income from AmeriHost Inn hotels. The Company invests cash in three principal areas: (i) the purchase of property and equipment through the construction and renovation of Consolidated hotels; (ii) the purchase of equity interests in hotels; and (iii) the making of loans to affiliated and non-affiliated hotels for the purpose of construction, renovation and working capital. From time to time, the Company may also utilize cash to purchase its own common stock. Pursuant to an amendment to the Master lease agreement with the REIT, the Company can facilitate the sale of up to eight leased hotels by the REIT. When the REIT sells a leased hotel to a buyer who becomes an AmeriHost Inn franchisee of Cendant, the Company receives: (i) a commission from the REIT for facilitating the transaction which is based upon the sale price, (ii) an incremental fee from Cendant, and (iii) long-term royalty sharing fees from Cendant from the future royalties paid to Cendant. Both the Company and the REIT choose which properties are sold. For each hotel chosen by the Company, one hotel is also chosen by the REIT. The Company's choice is final when the sale transaction closes. The REIT makes their corresponding choice at this time. If the Company and the REIT are not successful in selling the REIT's choice, then the Company is obligated under the agreement to purchase the hotel from the REIT. If the Company does not complete the purchase of the hotel within the specified time period, then the Company's rent payment shall be increased by 0.25% each time. The Company cannot close on the sale of its third and fourth choice until the first and second REIT choices have been sold (or purchased by the Company), respectively. During 2001, the Company facilitated the sale of two hotels by the REIT (the Company's first and second choices), and purchased one hotel from the REIT (the REIT's first choice). The Company purchased the REIT's second choice during the second quarter of 2002, using approximately $700,000 in cash, plus mortgage financing already committed from an affiliate of the REIT. The Company must facilitate the sale or purchase the REIT's third choice by June 5, 2003. On September 18, 2000, the Company finalized the terms of an agreement to purchase the remaining ownership interests in three existing joint ventures at a specified price. One of these acquisitions was completed in 2001, one was completed during the second quarter of 2002 using approximately $800,000, and the remaining one must be completed before December 31, 2002. The Company expects to use approximately $800,000 for the purchase of the remaining joint venture interests. Page 20 During the first six months of 2002, the Company used $13.9 million in investing activities compared to using $7.7 million during the first six months of 2001. During the first six months of 2002, the Company bought out the partners' interests in one joint venture for $796,786, used $12.1 million to purchase property and equipment for Consolidated AmeriHost Inn hotels, and used $1.0 million for investments in and advances to affiliates, net of distributions and collections on advances from affiliates. During the first six months of 2001, the Company bought out the partners' interests in one joint venture for $795,384, used $5.6 million to purchase property and equipment for Consolidated AmeriHost Inn hotels, and used $1.4 million for investments in and advances to affiliates, net of distributions and collections on advances from affiliates. Cash provided by financing activities was $6.3 million during the first six months of 2002 compared to $2.5 million during the first six months of 2001. In 2002, the primary factors were $9.7 million in proceeds from the mortgage financing of Consolidated hotels and net proceeds of $362,585 on the Company's operating line-of-credit, offset by principal repayments of $3.7 million on the mortgage financing of Consolidated hotels, including the repayment of mortgages in connection with the sale of hotels. In 2001, the contributing factors were $3.5 million in proceeds from the issuance of long-term debt, and $3.2 million in net proceeds from the Company's operating line-of-credit, offset by principal repayments of $4.3 million on the mortgage financing of Consolidated hotels, including the repayment of mortgages in connection with the sale of hotels. Approximately $6.4 million is classified as current portion of long-term debt, including two mortgages which are due within the next twelve months. The Company expects these loans to be repaid through the sale of the hotels or refinanced prior to maturity. The Company, through wholly-owned subsidiaries, is a general partner or managing member in 18 joint ventures. As such, the Company is secondarily liable for the obligations and liabilities of these joint ventures. As of June 30, 2002, these joint ventures had $32.5 million outstanding under mortgage loan agreements. Approximately $7.5 million of this amount has been included in the Company's consolidated financial statements as of June 30, 2002 since it is from joint ventures in which the Company has a majority or controlling ownership interest, leaving approximately $24.9 million in off balance sheet mortgage debt with unconsolidated joint ventures. Of this amount, the Company has also provided approximately $13.9 million in guarantees to the lenders. Other partners have also guaranteed portions of this amount. One unconsolidated joint venture mortgage loan in the amount of $1.6 million at June 30, 2002, matures in 2002. The hotel owned by this joint venture is currently under contract for sale. The Company expects this loan to be repaid from the sale proceeds or refinanced prior to its maturity. One unconsolidated joint venture mortgage loan in the amount of $1.8 million at June 30, 2002 matures in 2003. The Company expects this loan to be extended or refinanced prior to its maturity. The remaining joint venture mortgage loans mature after 2003. From time to time, the Company advances funds to joint ventures for working capital and renovation projects. The Company has also provided the mortgage financing for one unconsolidated joint venture. The advances, including the mortgage note, bear interest at rates ranging from prime to 10% per annum and are due upon demand. The advances were $7.2 million at June 30, 2002, and are included in investments in and advances to unconsolidated hotel joint ventures in the Company's consolidated financial statements. The Company expects the joint ventures to repay these advances through cash flow generated from hotel operations, mortgage financing, and/or the sale of the hotel. Certain of the Company's hotel mortgage notes and the Company's office building mortgage note contain financial covenants, principally minimum net worth requirements, debt to equity ratios, and minimum debt service coverage ratios. These financial covenants are typically measured annually, based upon the Company's fiscal year end. The Company is not aware of any covenant violations as of June 30, 2002. At June 30, 2002, the Company had $7.2 million outstanding under its operating line-of-credit. The operating line-of-credit has a limit of $8.5 million, is collateralized by substantially all the assets of the Company subject to first mortgages from other lenders on hotel assets, bears interest at a rate based on either the prime rate or LIBOR, plus a spread adjusted quarterly based on the Company' leverage ratio, ranging from zero to 0.5% (if prime based) or 3.0% (if LIBOR based), and matures February 19, 2003. The line-of-credit agreement also provides for the maintenance of certain financial covenants, including minimum tangible net worth, a maximum leverage ratio, and a minimum debt service coverage ratio. The Company was not in compliance with the maximum leverage ratio covenant as of June 30, 2002; however, the lender has waived this violation and adjusted the covenant for future periods. Page 21 The Company expects cash from operations, including proceeds from the sale of hotels, to be sufficient to pay all operating and interest expenses in 2002, as well as commitments to purchase hotel assets. SEASONALITY The lodging industry, in general, is seasonal by nature. The Company's hotel revenues are generally greater in the second and third calendar quarters than in the first and fourth quarters due to weather conditions in the markets in which the Company's hotels are located, as well as general business and leisure travel trends. This seasonality can be expected to continue to cause quarterly fluctuations in the Company's revenues, and is expected to have a greater impact as the number of Consolidated hotels increases. Quarterly earnings may also be adversely affected by events beyond the Company's control, such as extreme weather conditions, economic factors and other general factors affecting travel. In addition, hotel construction is seasonal, depending upon the geographic location of the construction projects. Construction activity in the Midwest may be slower in the first and fourth calendar quarters due to weather conditions. INFLATION Management does not believe that inflation has had, or is expected to have, any significant adverse impact on the Company's financial condition or results of operations for the periods presented. RECENTLY ISSUED ACCOUNTING STANDARDS On April 30, 2002, the FASB issued Statement of Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections." The rescission of SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt," and SFAS no. 64 "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements," which amended SFAS No. 4, will affect income statement classification of gains and losses from extinguishment of debt. SFAS No. 4 requires that gains and losses from extinguishment of debt be classified as an extraordinary item, if material. Under SFAS No. 145, extinguishment of debt is now considered a risk management strategy by the reporting enterprise and the FASB does not believe it should be considered extraordinary under the criteria in AP B Opinion No. 30, "Reporting the Results of Operations-Reporting he Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," unless the debt extinguishment meets the unusual in nature and infrequency of occurrence criteria in APB Opinion No. 30. SFAS 145 will be effective for fiscal years beginning after May 15, 2002. Upon adoption extinguishments of debt shall be classified under the criteria in APB Opinion No. 30. The Company does not believe the adoption of SFAS 145 will have a material effect on its financial statements. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 All statements contained herein that are not historical facts, including, but not limited to, statements regarding the Company's hotels under construction and the operation of AmeriHost Inn hotels are based on current expectations. These statements are forward looking in nature and involve a number of risks and uncertainties. Actual results may differ materially. Among the factors that could cause actual results to differ materially are the following: the availability of sufficient capital to finance the Company's business plan on terms satisfactory to the Company; competitive factors, such as the introduction of new hotels or renovation of existing hotels in the same markets; changes in travel patterns which could affect demand for the Company's hotels; changes in development and operating costs, including labor, construction, land, equipment, and capital costs; general business and economic conditions; and other risk factors described from time to time in the Company's reports filed with the Securities and Exchange Commission. The Company wishes to caution readers not to place undue reliance on any such forward looking statements, which statements are made pursuant to the Private Securities Litigation Reform Act of 1995 and, as such, speak only as of the date made. Page 22 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ------ The Company's exposure to market risk for changes in interest rates relates primarily to the Company's long-term debt obligations. The Company has some cash flow exposure on its long-term debt obligations to changes in market interest rates. The Company primarily enters into long-term debt obligations in connection with the development and financing of hotels. The Company maintains a mix of fixed and floating debt to mitigate its exposure to interest rate fluctuations. The Company's management believes that fluctuations in interest rates in the near term would not materially affect the Company's consolidated operating results, financial position or cash flows as the Company has limited risks related to interest rate fluctuations. The table below provides information about financial instruments that are sensitive to changes in interest rates, for each interest rate sensitive asset or liability as of June 30, 2002. The carrying amounts reflected approximate the estimated fair values. As the table incorporates only those exposures that existed as of June 30, 2002, it does not consider those exposures or positions which could arise after that date. Moreover, the information presented therein is merely an estimate and has limited predictive value. As a result, the ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during future periods, hedging strategies and prevailing interest rates at the time. Average Nominal Carrying Value Interest Rate -------------- ------------- Operating line of credit - variable rate $ 7,156,287 5.50% Mortgage debt - fixed rate $ 34,074,599 7.55% Mortgage debt - variable rate $ 45,597,246 6.38% Page 23 PART II: OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ----------------------------------------- (a) Reports on Form 8-K: There were no reports on Form 8-K filed during this period covered by this report. (b) Exhibits: The following are included as exhibits to this report on Form 10-Q: Exhibit No. Description ----------- ----------- 3.2 By-laws of Arlington Hospitality, Inc. (as amended June 27, 2002) 99.1 Certification pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 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. ARLINGTON HOSPITALITY, INC. --------------------------- Registrant Date: August 13, 2002 By: /s/ James B. Dale ----------------------------- James B. Dale Chief Financial Officer Page 24