UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-K

 

 

Commission File Number: 001-13957

 

Red Lion Hotels Corporation

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(509) 459-6100

 

Securities registered pursuant to Section 12 (b) of the Act:

 

 

Securities registered pursuant to section 12 (g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

(Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.)

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)  Yes o     No þ

 

The aggregate market value of the registrant’s common stock as of June 30, 2006 was $209.0 million, of which 89.0% or $186.0 million was held by non-affiliates as of that date. As of February 28, 2007, there were 19,136,102 shares of the Registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement for its 2007 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days of the end of the Registrant’s 2006 fiscal year, are incorporated by reference herein in Part III.

 

 

TABLE OF CONTENTS

 

 

This annual report on Form 10-K includes forward-looking statements. We have based these statements on our current expectations and projections about future events. When words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” “should,” “will” and similar expressions or their negatives are used in this annual report, these are forward-looking statements. Many possible events or factors, including those discussed in “Risk Factors” under Item 1A of this annual report, could affect our future financial results and performance, and could cause actual results or performance to differ materially from those expressed. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this annual report.

 

In this report, “we,” “us,” “our,” “our company,” “the company” and “RLH” refer to Red Lion Hotels Corporation and, as the context requires, all of its wholly and partially owned subsidiaries, including its 100% ownership of Red Lion Hotels Holdings, Inc. and Red Lion Hotels Franchising, Inc. and its approximate 99% ownership of Red Lion Hotels Limited Partnership. “Red Lion” refers to the Red Lion brand. The terms “the system,” “system-wide hotels” or “system of hotels” refer to our entire group of owned, leased, managed and franchised hotels.

 

We were incorporated in the state of Washington in April 1978, and operated hotels during that period under various brand names including Cavanaughs Hotels. In 1999, we acquired WestCoast Hotels, Inc., and rebranded our Cavanaughs hotels to the WestCoast brand, changing our name to WestCoast Hospitality Corporation. In 2001, we acquired Red Lion Hotels, Inc. In September 2005, after rebranding most of our WestCoast hotels to the Red Lion name, we changed our name to Red Lion Hotels Corporation.

 

Introduction

 

Red Lion Hotels Corporation is a NYSE-listed hospitality and leisure company primarily engaged in the ownership, operation and franchising of midscale and upscale, full service hotels under our proprietary Red Lion brand. As of December 31, 2006, our system of hotels contained 58 hotels located in nine states and one Canadian province, with 10,167 rooms and 506,629 square feet of meeting space as provided below:

 

 

 

 

Established over 30 years ago, the Red Lion brand today is well recognized, particularly in the western United States, and is typically associated with three- and four-star full-service hotels by our customers. Red Lion is about “Staying Comfortable” and our product and service culture works in both large urban and smaller markets. Each of our hotels reflects its individual local market, rather than a “one-size-fits-all” corporate standard. We believe our adherence to consistent customer service standards and brand touch-points makes guests feel at home no matter where they are. Our hotels are typically classified as upscale and midscale with food and beverage.

 

Our goal is to create the most memorable guest experience possible, allowing us to be the leader in our markets through personalized, exuberant service. To achieve that goal, we have focused our resources — monetary, capital and human — over the past few years in three primary areas:

 

 

 

In 2006, we continued to see the results of our efforts, with marked improvements in room rates at our hotels and strong customer satisfaction results. We also saw growth in our business fundamentals including revenues, operating income and revenue per available room. Significant events throughout 2006 included:

 

 

Hospitality Industry Performance Measures and Definitions

 

We believe that the following performance measures, which are widely used in the hospitality industry and appear throughout this document, are important to our discussion of operating performance:

 

 

Throughout this discussion, unless otherwise stated, RevPAR, ADR and average occupancy statistics are calculated using statistics for comparable hotels. When presented in this discussion, the above performance measures will be identified as belonging to a particular market segment, system-wide, or for continuing operations versus discontinued operations or total combined operations. Also, unless otherwise indicated, industry statistics are from Smith Travel Research, an independent statistical research service that specializes in the lodging industry. Some of the terms used in this report, such as “full service,” “upscale” and “midscale” are consistent with Smith Travel Research terms. We are a full service brand. Smith Travel Research categorizes hotels into seven chain scales. Our hotels are typically classified by Smith Travel Research in the upscale and midscale with food and beverage chain scale.

 

Company Strategy

 

Our strategy is to deliver growth and drive shareholder value through the following key initiatives:

 

 

 

We have dedicated significant resources to these initiatives. We launched an extensive hotel renovation plan, enhanced our technology infrastructure, introduced our revitalized brand image, changed our corporate name and announced an aggressive five-year growth plan to double the number of markets where Red Lion has a presence from 50 to 100. In 2006, we delivered results and built momentum. We completed our room renovation plan, began adjusting our mix of customers to higher rate and higher profit business, and significantly improved our capital structure and financial flexibility by reducing our leverage. In 2007 and beyond, we intend to build on the momentum we have created and complete the implementation of our revitalization plan. We want to ensure that Red Lion remains a preferred hotel brand for guests, owners and investors.

 

Largest renovation program in company history.

 

We are completing the most significant capital investment program in our history in order to improve comfort, freshen décor and upgrade technology at our owned and leased hotels. In 2006 and 2005, we invested almost $30.0 million and $20.0 million, respectively, into our owned and leased hotels. During 2007, we expect to spend an additional $18.0 million on capital improvements primarily for non-room guest contact areas such as lobbies, restaurants, exteriors, banquet rooms and routine capital expenditures. The capital improvements have been funded primarily from existing cash and the net proceeds received from divestiture of non-core assets.

 

We continued to operate our hotels during the renovation process, which limited our ability to maximize occupancy and room rates at these properties during primarily the first and second quarters of 2006. As a result, operating performance at hotels under renovation were negatively impacted. However, as evidenced by average RevPAR growth from continuing operations of 11.0% and 8.1% during the third and fourth quarters of 2006 compared to 2005, we believe the results of this program have been successful and that our capital investment will continue to improve our operating results.

 

Establish brand penetration in a “hub and spoke” pattern.

 

We intend to significantly expand the number of hotels in the Red Lion system through franchises, acquisition and/or joint ventures. We expect to add properties in large, western U.S. urban markets, complemented by leading properties in smaller, secondary cities. This is our “hub and spoke” strategy, where we establish a strong presence in certain major metropolitan cities and expand into adjoining markets. We intend to progressively move east, leveraging the momentum of our growth in the western states. By growing the name recognition of the Red Lion brand and correspondingly increasing our customer base, we believe we can increase RevPAR across our hotel system. We have set forth below our strategy for accomplishing our external growth initiatives.

 

Hotel acquisitions and equity investments.  We intend to selectively make joint venture investments or acquire hotels located in major metropolitan cities. We believe that having equity interests in such hotels will give us operational control of hotels in highly visible markets. The greater San Francisco, Los Angeles, Phoenix and Dallas areas are examples of “hub” markets we are targeting for expansion. We will evaluate investment opportunities based upon a number of factors including price, strategic fit, potential profitability and geographic distribution.

 

Franchise the Red Lion brand.  We expect to leverage our brand awareness in the western United States to expand our presence through franchising in primary and secondary markets. We believe that this strategy will allow us to continue to expand our geographic coverage without requiring significant capital investment, resulting in increased revenues and profitability. We believe our brand represents an attractive conversion opportunity for hotel owners in markets where competing hotel companies have saturated the market with their multiple brands. Our single focus on the Red Lion brand offers potential franchisees a full service brand alternative with a distinctive product, a full range of support services, strong reservation contribution and an attractive fee structure.

 

To facilitate our franchising efforts, in 2006 we named a Vice President of Brand Development to focus solely on expanding the Red Lion brand with high-quality franchisees. We believe we are well positioned to integrate new franchisees into our hotel system with the scalable operational infrastructure we have implemented in recent years.

 

Implementation of new operational and infrastructure initiatives.

 

To accomplish the goals of delivering consistent high-quality service to our guests and establishing a scalable foundation for future growth, we have implemented a number of key initiatives. During the past three to four years, we have (i) enhanced service standards, (ii) developed innovative marketing programs, (iii) implemented state of the art technology and (iv) revitalized our brand image.

 

Enhanced service standards.  We have implemented a new service standard and training program called “The Red Lion Way,” which is designed to provide Red Lion employees more tools to create a positive, memorable guest experience. We believe our enhanced service standards will appeal to our guests and increase brand loyalty, resulting in improved revenues.

 

Innovative marketing programs.

 

 

State of the art technology, including:

 

 

Revitalized brand image.  In September 2005, we introduced a new logo with a contemporary design to better reflect our upgraded hotel product and to position Red Lion as a preferred hotel brand for guests, owners and investors.

 

Maximize the value of our owned hotel and real estate portfolio.

 

We continuously review our owned hotel and real estate portfolio for opportunities to maximize profitability and effectively redeploy capital. In November 2004, we announced our plan to divest eleven of our non-strategic owned hotels, certain commercial office buildings and certain other non-core properties. We completed the sale of

seven of the eleven hotels and one commercial office building in 2005, and three hotels sold in 2006, resulting in gross proceeds of approximately $15.8 million and $52.8 million, respectively. Proceeds from the sales have been used to finance the company-wide renovation program previously discussed. We currently are holding one commercial real estate complex for sale, located in Spokane, Washington, one hotel in Kalispell, Montana and surplus undeveloped land.

 

We also strive to maximize the value of our real estate portfolio through redevelopment. We believe opportunities may exist to redevelop certain of our properties which are located in resort areas and in urban markets that have recently experienced significant growth.

 

Increase flexibility and improve capital markets profile.

 

Our financial strategy is designed to support our business strategy, with the goal of having a flexible capital structure that supports our growth initiatives. During 2006, we completed a public offering of 5.8 million shares of common stock generating gross proceeds of $64.3 million. We believe that through the public offering, we have attracted a significant number of new shareholders and considerably diversified our shareholder base, as well as improved our capital markets profile. This has led to an increase in the financial services community’s familiarity with Red Lion, which we believe will afford us greater financial flexibility in the future.

 

Also during 2006, we reduced our debt by over $59 million primarily from the proceeds from this offering as well as from asset sales. We also obtained a new $50 million revolving credit facility that can be extended to $100 million subject to certain conditions. Through these initiatives during the year, we believe we have increased our financial flexibility to facilitate our future growth.

 

Competitive Strengths

 

Experienced senior management team.

 

We have an experienced senior management team led by our President and Chief Executive Officer, Arthur M. Coffey, who has been with the company for 25 years. Our executive committee members have on average more than 20 years of hospitality industry experience. The balance of our senior management team has strengths in key areas, including hotel development, ownership and management; finance; e-commerce; franchising; sales and marketing; food and beverage management; entertainment and real estate. Their extensive and diverse expertise provides us with a broad perspective from which we can make strategic management and operational decisions.

 

Strong proprietary brand and long operating history.

 

The Red Lion brand, which we believe projects comfort and memorable experiences for our hotel guests, has been well known in the western United States for more than 30 years. As the owner and operator of many of our hotels, we have been able to control brand standards across the system. In addition, as the owner of the Red Lion brand, we have diversified our revenue base by franchising the brand to third-party hotel owners.

 

Strong value proposition.

 

Our Red Lion brand is associated with high-quality lodging, extensive meeting facilities and superior food and beverage operations. Our hotels provide exceptional and friendly service and accommodations at competitive prices within the markets we serve. We seek to ensure consistent quality across our hotel portfolio, offering valuable services such as dining, fitness centers, business services and other ancillary services. In addition, our guest room standards include products that are important to both leisure and business travelers, including free wireless high-speed internet service, comfortable work space and high-quality furnishings, including new pillow-top beds.

 

We believe we are well positioned against other hotel owners and operators in the midscale and upscale full service segments of the lodging industry. In our “hub” markets, we believe our primary competitors include Crowne Plaza^®, Doubletree^®, Four Points^®, Radisson^®, Hilton^® and Marriott^®. In our secondary markets, we believe our competitors include Courtyard^®, Holiday Inn^® and Hilton Garden Inn^®.

 

Attractiveness to franchisees.

 

We offer a strong support system to our franchisees by providing a full suite of franchise services, including (i) central reservations, (ii) revenue management, (iii) national and regional sales, (iv) marketing, (v) systems, operations and customer service training, (vi) corporate purchasing programs and (vii) quality evaluations. As such, our Red Lion brand is attractive to potential franchisees by offering a distinct product valued by customers, backed by a full suite of support services. During 2006, approximately 42% of our system-wide total room revenues were delivered through our reservation channels up from 36% in 2005. We believe that our reservation systems, sales and marketing initiatives and our support services are of value to hotel owners.

 

Strong emphasis on customer service.

 

We continually challenge ourselves to maintain and maximize customer service. We have created a service standard and training program called “The Red Lion Way,” which is designed to provide Red Lion employees more tools to create a positive and memorable guest experience. Through this increased level of personal service, we believe we differentiate Red Lion from our competitors.

 

Well positioned to capitalize on industry-wide growth.

 

We believe we are well positioned to capitalize on the expected continued improvement in lodging industry supply and demand fundamentals. We believe our newly renovated hotel portfolio combined with our enhanced service standards will appeal to our guests and allow us to capture a significant portion of the increasing demand for lodging facilities in our markets. To date, we have been successful in attracting new guests and increasing room rates as evidenced by consistent RevPAR growth from continuing operations.

 

Operations

 

We operate in three reportable segments: hotels; franchise and management; and entertainment.

 

Our “Hotels” reporting segment derives revenue primarily from guest room rentals and food and beverage operations at our owned and leased hotels. As of December 31, 2006, we operated 32 hotels, of which 19 are wholly-owned and 13 are leased. During 2006, our hotel segment accounted for approximately 91% of total revenues, or $154.8 million.

 

Our “Franchise and Management” reporting segment is engaged primarily in licensing our brand to franchisees and managing hotels for third-party owners. The franchise and management segment generates revenue from franchise fees that are typically based on a percent of room revenues and are charged to hotel owners in exchange for the use of our brand. They also receive access to our central services programs, which include the reservation system, guest loyalty program, national and regional sales, revenue management tools, quality inspections, advertising and brand standards. The segment also reflects revenue from management fees charged to the owners of our managed hotels, typically based on a percentage of a hotel’s gross revenues plus an incentive fee based on operating performance. As of December 31, 2006, we managed one hotel owned by a third-party and franchised 25 hotels. During 2006, our franchise and management segment accounted for approximately 1.7% of total revenues, or $2.9 million.

 

A comparative summary of the performance of our hotel system, including all hotels owned, leased, managed and franchised for each of the periods presented, is as follows:

 

 

 

 

Our “Entertainment” segment derives revenues primarily from event ticket distribution and promotion services, and presents a variety of entertainment productions under the operations of TicketsWest and WestCoast Entertainment. We offer ticketing inventory management systems, call center services and outlet/electronic channel distribution for event locations. We have developed an electronic ticketing platform that is integrated with our electronic hotel distribution system. During 2006, our entertainment segment accounted for approximately 6.3% of total revenues, or $10.8 million.

 

None of our remaining activities constitute a reportable segment and have been aggregated into “Other.” Through September 30, 2006, we also reported a “Real Estate” segment that historically included the ownership of commercial real estate properties and the management of commercial and residential projects. During 2006, we divested our real estate management business. Also in association with our divestiture of non-core assets, during the fourth quarter of 2006 we listed one of our two remaining wholly-owned commercial properties for sale and have classified its assets, liabilities and results of operations within discontinued operations for all periods presented. Our remaining office and retail properties no longer constitute a separate reportable segment and their operating results for 2006, 2005 and 2004 have been reclassified to “Other.”

 

A summary of our reporting segment revenues is as follows (in thousands):

 

 

Employees

 

As of December 31, 2006, we employed approximately 3,178 people on a full-time or part-time basis, with 2,867 in hotel operations and the remainder in our administrative office and our entertainment division. At December 31, 2006, approximately 5% of our total workforce was covered by various collective bargaining agreements providing, generally, for basic pay rates, working hours, other conditions of employment and organized settlement of labor disputes. We believe our employee relations are satisfactory.

 

Available Information

 

Through our website (www.redlion.com), we make available our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to these reports and all other reports filed with the U.S. Securities and Exchange Commission (“SEC”), pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. These reports may also be obtained at no cost through the SEC (www.SEC.gov or 800-SEC-0330 or the SEC’s Public Reference Room, 100 F Street, N.E., Washington D.C. 20549).

 

Our internet website also contains our Code of Business Conduct and Ethics, our Corporate Governance Guidelines, Charters for our Audit, Compensation and Nominating and Corporate Governance Committees, Accounting and Audit Complaints and Concerns Procedures and information regarding stockholder communications with our Board of Directors.

 

We are subject to various risks, including those set forth below, that could have a negative effect on our financial condition and could cause results to differ materially from those expressed in forward-looking statements contained in this report or other Red Lion communications.

 

The lodging industry is highly competitive, which may impact our ability to compete successfully with other hospitality and leisure companies in the future.

 

The lodging industry is comprised of numerous national, regional and local hotel companies and is highly competitive. Competition for occupancy is focused on three major segments of travelers: business travelers, convention and group business travelers and leisure travelers. All three segments are significant occupancy drivers for our hotel system and our marketing efforts are geared towards attracting their business.

 

Competition in the industry is primarily based on service quality, range of services, brand name recognition, convenience of location, room rates, guest amenities and quality of accommodations. We compete against national limited and full service hotel brands and companies, as well as various regional and local hotels in the midscale and upscale full-service hotel segments of the industry. Many of our competitors have greater name recognition, a larger network of locations and greater marketing and financial resources than we do. Additionally, new and existing

competitors may offer significantly lower rates, greater convenience, services or amenities or superior facilities, which could attract customers away from our hotels. Our ability to remain competitive and to attract and retain customers depends on our success in differentiating and enhancing the quality, value and efficiency of our product and customer service.

 

We also compete with other hotel brands and management companies for hotels to add to our system, including through management and franchise agreements. Our competitors include management companies as well as large hotel chains that own and operate their hotels and franchise their brands. As a result, the terms of prospective franchise and management agreements may not be as favorable as our current agreements.

 

If we are unable to compete successfully in these areas, our market share and operating results could be diminished, resulting in a decrease in occupancy, ADR and RevPAR for our hotels. Changes in demographics and other changes in our markets may also adversely impact the convenience or desirability of our hotel locations, thereby reducing occupancy, ADR and RevPAR and otherwise adversely impacting our results of operations and financial condition.

 

Our operating results are subject to conditions affecting the lodging industry.

 

Our revenues and operating results may be adversely impacted by a number of factors, including but not limited to:

 

 

Any of these factors could adversely impact hotel room demand and pricing and result in reduced occupancy, ADR and RevPAR, or could otherwise adversely affect our results of operations and financial condition including government imposed fines or private litigants winning damage awards against us.

 

Our hotels may be faced with labor disputes which would harm the operation of our hotels.

 

We rely heavily on our employees to provide high-quality personal service at our hotels, and any labor dispute or stoppage could harm our ability to provide those services, which could reduce occupancy and room revenue, tarnish our reputation and harm our results of operations.

 

Our success depends on the value of our name, image and brand. If demand for our hotels decreases or the value of our name, image or brand diminishes, our business and operations would be harmed.

 

Our success depends, to a large extent, on our ability to shape and stimulate consumer tastes and demands by maintaining innovative, attractive and comfortable properties and services, as well as our ability to remain competitive in the areas of design and quality. If we are unable to anticipate and react to changing consumer tastes and demands in a timely manner, our results of operations and financial condition could be harmed.

 

Our business would be harmed if our public image or reputation were to be diminished by the operations of any of the hotels in our system. Our brand name and trademarks are integral to our marketing efforts. If the value of our name, image or brand were diminished, our business and operations would be harmed.

 

Our business is capital intensive and our hotel acquisition, development, redevelopment and renovation projects might be more costly than we anticipate.

 

We are committed to keeping our properties well maintained and attractive to our customers in order to remain competitive and increase our competitiveness within the industry. This creates an ongoing need for cash, and to the extent we, our franchisees or owners of any hotels we manage cannot fund expenditures from cash generated from operations, funds must be borrowed or otherwise obtained. In addition, we intend to acquire additional hotels in the future, either through direct purchase or joint venture. Hotel redevelopment, renovation and new project development are subject to a number of risks, including:

 

 

As a result, we could incur substantial costs for projects that are never completed. Further, financing for these projects may not be available or, even if available, may not be on terms acceptable to us. Any unanticipated delays or expenses incurred in connection with the acquisition, development, redevelopment or renovation of the hotels in our system could impact expected revenues and availability of funds, negatively affect our reputation among hotel customers, owners and franchisees and otherwise adversely impact our results of operations and financial condition, including the carrying costs of our assets.

 

Our expenses may remain constant or increase even if revenues decline.

 

The expenses of owning property are not necessarily reduced when circumstances such as market factors and competition cause a reduction in revenues to a hotel. Accordingly, a decrease in our revenues could result in a disproportionately higher decrease in our earnings because our expenses are unlikely to decrease proportionately.

 

The increasing use of third-party travel websites by consumers may adversely affect our profitability.

 

Some of our hotel rooms may be booked through third-party travel websites such as Travelocity.com and Expedia.com. If these internet bookings increase, these intermediaries may be able to obtain higher commissions,

reduced room rates or other significant contract concessions from us. Moreover, some of these internet travel intermediaries are attempting to offer hotel rooms as a commodity, by increasing the importance of price and general indicators of quality (such as “three-star downtown hotel”) at the expense of brand identification. We believe that these internet intermediaries hope that consumers will eventually develop brand loyalties to their reservation systems. Although most of the business for our hotels is expected to be derived from traditional channels, if the amount of sales made through internet intermediaries increases significantly, our room revenues may flatten or decrease and our profitability may be adversely affected.

 

Risks associated with real estate ownership may adversely affect revenue or increase expenses.

 

We are subject to varying degrees of risk that generally arise from the ownership of real property. Revenue and cash flow from our hotels and other real estate may be adversely affected by, and costs may increase as a result of, changes beyond our control, including but not limited to:

 

 

These adverse conditions could potentially cause the terms of our borrowings to change unfavorably. In such circumstances, if we were in need of capital to repay indebtedness in accordance with its terms or otherwise, we could be required to sell one or more hotels at times that might not permit realization of the maximum return on our investments. Unfavorable changes in one or more of these conditions could also result in unanticipated expenses and higher operating costs, thereby reducing operating margins and otherwise adversely affecting our results of operations and financial condition.

 

The illiquidity of real estate investments and the lack of alternative uses of hotel properties could significantly limit our ability to respond to adverse changes in the performance of our hotels and harm our financial condition.

 

Real estate investments are relatively illiquid, and therefore our ability to promptly sell one or more of our hotels in response to changing economic, financial or investment conditions is limited. The real estate market, including the market for our hotels, is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control. If we decide to sell one or more of our hotels, we may be unable to do so and, even if we are able to sell the hotels, it may take us a long time to find willing purchasers and the sales may be on unfavorable terms. We also may be required to expend funds to correct defects or to make improvements before a hotel can be sold. If we do not have funds available for such purposes, our ability to sell the hotel could be restricted or the price at which we can sell the hotel may be less than if these improvements were made.

 

In addition, it may be difficult or impossible to convert hotels to alternative uses if they become unprofitable due to competition, age of improvements, decreased demand or other factors. The conversion of a hotel to an alternative use would also generally require substantial capital expenditures.

 

This inability to respond promptly to changes in the performance of our hotels could adversely affect our financial condition and results of operations as well as our ability to service debt, including our debentures. In addition, sales of appreciated real property could generate material adverse tax consequences, which may make it disadvantageous for us to sell certain of our hotels.

 

We may have disputes with the owners of the hotels that we manage or franchise.

 

The nature of our responsibilities under our hotel management agreements, as well as our responsibilities to enforce brand standards under both management and franchise agreements may, in some instances, be subject to interpretation and may give rise to disagreements. We seek to resolve any disagreements in order to develop and maintain positive relations with current and potential franchisees and hotel owners and joint venture partners; however, we may not always be able to do so. Failure to resolve such disagreements may result in litigation, arbitration or other legal actions.

 

Our business is seasonal in nature, and we are likely to experience fluctuations in our results of operations and financial condition.

 

Our business is seasonal in nature, with the period from May through October generally accounting for the greatest portion of our annual revenues. Therefore, our results for any quarter may not be indicative of the results that may be achieved for the full fiscal year. The seasonal nature of our business increases our vulnerability to risks during this period, including labor force shortages, cash flow problems, regional economic downturns, poor weather conditions, actual or threatened terrorist attacks and international conflicts. The adverse impact to our revenues would likely be greater as a result of our seasonal business.

 

Our properties are subject to risks relating to natural disasters, terrorist activity and war and any such event could materially adversely affect our operating results without adequate insurance coverage or preparedness.

 

Our financial and operating performance may be adversely affected by acts of God, such as natural disasters, particularly in locations where we own and/or operate significant properties. We carry comprehensive liability, public area liability, fire, flood, boiler and machinery, extended coverage and rental loss insurance for our properties. However, certain types of catastrophic losses, such as those from earthquake, volcanic activity, terrorism and environmental hazards, may exceed or not be covered by our insurance coverage because it is not economically feasible to insure against such losses. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property. In that event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. Similarly, war and terrorist activity, including the potential for war and threats of terrorist activity, epidemics, travel-related accidents, as well as geopolitical uncertainty and international conflict, which impact domestic and international travel, have caused in the past, and may cause in the future, our results to differ materially from anticipated results. In addition, depending on the severity, a major incident or crisis may prevent operational continuity and consequently impact the value of the brand or the reputation of our business.

 

If we fail to comply with privacy regulations, we could be subject to fines or other restrictions on our business.

 

We collect and maintain information relating to our guests for various business purposes, including maintaining guest preferences to enhance our customer service and for marketing and promotion purposes and credit card information. The collection and use of personal data are governed by privacy laws and regulations enacted in the U.S. and by various contracts under which we operate. Privacy regulation is an evolving area in which different jurisdictions may subject us to inconsistent compliance requirements. Compliance with applicable privacy regulations may increase our operating costs and/or adversely impact our ability to service our guests and market our products, properties and services to our guests. In addition, noncompliance with applicable privacy regulations, either by us or in some circumstances noncompliance by third parties engaged by us, could result in fines or restrictions on our use or transfer of data.

 

Any failure to protect our trademarks could have a negative impact on the value of our brand names.

 

The success of our business depends in part upon our continued ability to use our trademarks, increase brand awareness and further develop our brand. We have registered the following trade names and associated trademarks with the U.S. Patent and Trademark Office: Red Lion, WestCoast, GuestAwards, Net4Guests, Stay Comfortable and

TicketsWest. We have also registered some of these trademarks in Canada and Mexico, and are in the process of obtaining trademark registrations in Asia and Europe. We also own various derivatives of these trademarks, all of which are registered with or have a registration application pending with the U.S. Patent and Trademark Office. We cannot be assured that the measures we have taken to protect our trademarks will be adequate to prevent imitation of our trademarks by others. The unauthorized reproduction of our trademarks could diminish the value of our brand and its market acceptance, competitive advantages or goodwill, which could adversely affect our business.

 

We are subject to environmental regulations.

 

Our operating costs may be affected by the obligation to pay for the cost of complying with existing environmental laws, ordinances and regulations, as well as the cost of compliance with future environmental legislation. Under current federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of contamination from hazardous or toxic substances, or the failure to remediate such contaminated property properly, may adversely affect the ability of the owner of the property to borrow using such property as collateral for a loan or to sell such property. Environmental laws also may impose restrictions on the manner in which a property may be used or transferred or in which businesses may be operated, and may impose remedial or compliance costs. The costs of defending against claims of liability or remediating contaminated property and the cost of complying with environmental laws could have an adverse effect on our results of operations and financial condition.

 

In connection with our acquisition of a hotel, a Phase I environmental assessment is conducted by a qualified independent environmental engineer. A Phase I environmental assessment involves an on-site inspection and researching historical usages of a property and databases containing registered underground storage tanks and other matters to determine whether an environmental issue exists with respect to the property which needs to be addressed. If the results of a Phase I environmental assessment reveal potential issues that warrant further investigation, a Phase II environmental assessment, which may include soil testing, ground water monitoring or borings to locate underground storage tanks, will be ordered. It is possible that Phase I and Phase II environmental assessments will not reveal all environmental liabilities or compliance concerns or that there will be material environmental liabilities or compliance concerns of which we will not be aware. Phase I environmental assessments have been performed on all properties owned by us, although they have not been performed on all of our leased properties.

 

We have not performed Phase II environmental assessments on two of our owned properties for which Phase II assessments were recommended, because we determined that any further investigation was not warranted for materiality reasons. We cannot assure you that these properties do not have any environmental risks associated with them. While we have not been notified by any governmental authority and we have no other knowledge of any material noncompliance, material liability or material claim relating to hazardous or toxic substances or other environmental substances in connection with any of our properties, we cannot assure you that these properties do not have any environmental concerns associated with them. We cannot assure you that we will not discover problems that currently exist, but of which we have no current knowledge that future laws, ordinances or regulations will not impose any material environmental liability, or that the current environmental condition of our existing and future properties will not be affected by the condition of neighboring properties, such as the presence of leaking underground storage tanks, or by third parties unrelated to us.

 

We face risks relating to litigation.

 

At any given time, we are subject to claims and actions incidental to the operation of our business. The outcome of these proceedings cannot be predicted. If a plaintiff were successful in a claim against us, we could be faced with the payment of a material sum of money and we may not be insured for such a loss. If this were to occur, it could have an adverse effect on our financial condition.

 

Due to the geographic concentration of the hotels in our system, our results of operations and financial condition are subject to fluctuations in regional economic conditions.

 

Of the 58 hotels in our system at December 31, 2006, 45 are located in Oregon, Washington, Idaho or Montana. Our results of operations and financial condition may be significantly affected by the economy of the Pacific Northwest, which is dependent in large part on a limited number of major industries, including agriculture, tourism, technology, timber and aerospace. These industries may be affected by:

 

 

In addition, companies in these industries may decide to relocate all or part of their businesses outside the Pacific Northwest. Any of these factors could materially affect the local economies in which these industries operate and where we have a presence. Other adverse events affecting the Pacific Northwest, such as economic recessions or natural disasters, could cause a loss of revenues for our hotels in this region. Our concentration of assets within this region puts us at greater economic risk. In addition, we operate or market multiple hotels within several markets. A downturn in general economic or other relevant conditions in these specific markets or in any other market in which we operate could lead to a decline in demand in these markets and cause a loss of revenues from these hotels.

 

The results of some of our individual hotels are significantly impacted by group contract business and other large customers, and the loss of such customers for any reason could harm our operating results.

 

Group contract business and other large customers, or large events, can significantly impact the results of operations of our hotels. These contracts and customers vary from hotel to hotel and change from time to time. Such contracts are typically for a limited period of time after which they may be eligible for competitive bidding. The impact and timing of large events are not always predictable and are often episodic in nature. The operating results for our hotels can fluctuate as a result of these factors, possibly in adverse ways, and these fluctuations can harm our overall operating results.

 

If our franchisees terminate or fail to renew their relationship with our company, our franchise revenue will decline.

 

As of December 31, 2006, there were 25 hotels in our system that were owned by others and operated under franchise agreements, which generally specify a fixed term and contain various early termination provisions, such as the right to terminate upon notice by paying us a termination fee. We cannot assure shareholders that these agreements will be renewed, or that they will not be terminated prior to the end of their respective terms. If these franchise agreements are not renewed, or are terminated prior to the expiration of their respective terms, the resulting decrease in revenue and loss of market penetration could have an adverse effect on our results of operations and financial condition.

 

We may be unsuccessful in identifying and completing acquisition opportunities, which could limit our ability to implement our long-term growth strategy and result in significant expenses.

 

We intend to pursue a full range of growth opportunities, including identifying hotels for acquisition, development, management, rebranding and franchising. Our ability to make acquisitions is dependent upon, among other things, our relationships with owners of existing hotels and certain major hotel investors, financing acquisitions and renovations and successfully integrating new hotels into our operations. We may be unable to find suitable hotels for acquisition, development, management, rebranding or franchising on acceptable terms, or at all. Competition with other hotel companies may increase the cost of acquiring hotels. Even if suitable hotels are identified for acquisition, we may not be able to find lenders or capital partners willing to finance the acquisition of the hotels on acceptable terms. Further, we may not have adequate cash from operations or from our available debt capacity to pursue such growth opportunities. Our failure to compete successfully for acquisitions, to obtain suitable financing for acquisitions we have identified or to attract and maintain relationships with hotel owners and major

hotel investors could adversely effect our ability to expand our system of hotels. An inability to implement our growth strategy could limit our ability to grow our revenue base and otherwise adversely affect our results of operations.

 

If hotel acquisitions fail to perform in accordance with our expectations or if we are unable to effectively integrate new hotels into our operations, our results of operations and financial condition may suffer.

 

Based on our experience, newly acquired, developed or converted hotels typically begin with lower occupancy and room rates, thereby resulting in lower revenue. Our expansion within our existing markets could adversely affect the financial performance of our existing hotels in those markets and, as a result, negatively impact our overall results of operations. Expansion into new markets may also present operating and marketing challenges that are different from those we currently encounter in our existing markets. Additionally, any new hotels or enhanced or upgraded hotel amenities may fail to achieve revenue and profitability levels comparable to our existing hotels. Our inability to anticipate all of the changing demands that expanding operations will impose on our management and management information and reservation systems, or our failure to quickly adapt our systems and procedures to the new markets could result in lost revenue and increased expenses and otherwise have an adverse effect on our results of operations and financial condition.

 

We rely on our central reservation system for occupancy at our hotels and any failures in such system could negatively affect our revenues and cash flows.

 

We maintain a hotel reservation system that allows us to manage our rooms inventory through various distribution channels, including our websites, and execute rate management strategies. As part of our marketing strategy, we encourage guests to book on our website, which guarantees the lowest rate available compared to third-party travel websites. If our systems fail to operate as anticipated, or we fail to keep up with technological or competitive advances, our revenues and cash flows could suffer.

 

We have incurred debt financing and may incur increased indebtedness in connection with future acquisitions, capital expenditures or for other corporate purposes.

 

A substantial portion of our outstanding indebtedness is secured by individual properties. Neither our Articles of Incorporation nor our Bylaws limit the amount of indebtedness that we may incur. Subject to limitations in our debt instruments, we may incur additional debt in the future to finance acquisitions and renovations and for general corporate purposes. Accordingly, we could become highly leveraged, resulting in an increase in debt service that could adversely affect our operating cash flow. Our continuing indebtedness could increase our vulnerability to general economic and lodging industry conditions, including increases in interest rates, and could impair our ability to obtain additional financing in the future and to take advantage of significant business opportunities that may arise. Our indebtedness is, and will likely continue to be, secured by mortgages on our owned hotels. We cannot assure shareholders that we will be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our assets, including our hotels, to foreclosure.

 

Adverse economic conditions could cause the terms on which borrowings become available to be unfavorable to us. In such circumstances, if we are in need of capital to repay indebtedness in accordance with its terms or otherwise, we could be required to sell one or more of our owned hotels at times that may not permit realization of the maximum potential return on our investments. Economic conditions could result in higher interest rates, which would increase debt service requirements on our variable rate credit facilities and could reduce the amount of cash available for general corporate purposes.

 

Failure to comply with debt covenants could adversely affect our financial results or condition.

 

In September 2006, we entered into a $50 million revolving credit facility that includes customary affirmative and negative covenants, the most restrictive of which are financial covenants dealing with leverage, interest coverage and debt service coverage. At December 31, 2006, we were in compliance with our covenants and had no amounts outstanding under the facility. We believe we will be able to comply with such requirements in the future,

although failure to do so could adversely affect our results or financial condition and may limit our ability to obtain financing. For additional information, see Note 9 of Notes to Consolidated Financial Statements.

 

Our current or future joint venture arrangements may not reflect solely our best interests and may subject these investments to increased risks.

 

We may in the future acquire interests in other properties through joint venture arrangements with other entities. Some of these acquisitions may be financed in whole or in part by loans under which we are jointly and severally liable for the entire loan amount along with the other joint venture partners. The terms of these joint venture arrangements may be more favorable to the other party or parties than to us. In addition, investing in a property through a joint venture arrangement may subject that investment to risks not present with a wholly owned property, including, among others, the following:

 

 

Failure to retain senior management could adversely affect our business.

 

We place substantial reliance on the lodging industry experience and the institutional knowledge of members of our senior management team. Mr. Coffey, Mr. Narayan and Mr. Taffin are particularly important to our future success due to their substantial experience in the lodging industry, with the Red Lion brand and with our company. The loss of the services of one or more of these individuals could hinder our ability to effectively manage our business and implement our growth strategies. Finding suitable replacements for Mr. Coffey, Mr. Narayan or Mr. Taffin could be difficult, and competition for such personnel of similar experience and perspective is intense. We do not carry key person insurance on any of our senior management team.

 

Due to the shareholdings of our Chairman, together with other members of the Barbieri family, we may be limited in our ability to undertake transactions requiring shareholder approval.

 

As of December 31, 2006, Donald K. Barbieri, our Chairman of the Board, had sole voting and investment power with respect to 5.5% of our outstanding shares of common stock. Heather Barbieri, his ex-spouse, had sole voting and investment power with respect to 5.1% of our outstanding shares of common stock. Pursuant to a trust agreement, Donald K. Barbieri and Heather Barbieri share voting and investment power with respect to an additional 3.3% of our outstanding shares of common stock. Richard L. Barbieri, who is also a director and Donald K. Barbieri’s brother, beneficially owned 1.1% of our outstanding shares of common stock as of December 31, 2006. In addition, we believe that other members of the Barbieri family who are not directors, executive officers or 5% shareholders individually hold our outstanding common stock. As such, to the extent they are willing and able to act in concert, they may have the ability as a group to approve or block actions requiring the approval of our shareholders, including a merger or a sale of all of our assets or a transaction that results in a change of control.

 

The performance of our entertainment division is particularly subject to fluctuations in economic conditions.

 

Our entertainment division, which comprised 6.3% of our total revenues from continuing operations in 2006, engages in event ticketing and the presentation of various entertainment productions. Historically, we have attracted additional hotel guests by cross-selling tickets to entertainment events through our TicketsWest subsidiary. Our entertainment division is vulnerable to risks associated with changes in general regional and economic conditions, the potential for significant competition and a change in consumer trends, among other risks. In addition, we face the risk that entertainment productions will not tour the regions in which we operate or that such productions will not choose us as a presenter or promoter.

 

If we are unable to locate lessees for our office and retail space, our revenues and cash flow may be adversely affected.

 

We own and lease to others over 297,000 square feet of office and retail space in Spokane, Washington and Kalispell, Montana. We are subject to the risk that leases for this space might not be renewed upon their expiration, the space may not be relet or the terms of renewal or reletting such space, including the cost of required renovations, might be less favorable to us than current lease terms. Vacancies could result due to the termination of a tenant’s tenancy, the tenant’s financial failure or a breach of the tenant’s obligations. We may be unable to locate tenants for rental spaces vacated in the future or we may be limited to renting space on terms unfavorable to us. Delays or difficulties in attracting tenants and costs incurred in preparing for tenant occupancy could reduce cash flow, decrease the value of a property and jeopardize our ability to pay our expenses.

 

None.

 

Our mix of business is balanced between group, business travelers and leisure travelers with the mix varying by location. It is our mission to provide personalized, exuberant service and to create the most memorable guest experience possible. We strive to provide caring service and comfortable accommodations at our hotels, at competitive prices consistent with the markets we serve, and seek to maintain consistent quality and offer services such as dining, fitness centers, business services or other ancillary services. Most of our hotels offer flexible meeting space to service the group and convention markets. In addition, guest rooms are well equipped with products important to these travelers. We continue to invest in our hotel properties to maintain or improve quality conditions. In focus groups and market research, the Red Lion name is associated with superior service and is consistently identified by consumers when asked about their full service lodging selection and habits.

 

Under the Red Lion name as of December 31, 2006, we owned 19 hotels, leased 13, managed one third-party owned hotel and had 25 franchise arrangements owned and operated by third parties. To support our owned, leased, managed and franchised hotels, we provide all the services typical in our industry: marketing, sales, advertising, frequency program, revenue management, procurement, quality assurance, education and training, design and construction management. We maintain and manage our own central reservation call center with links to various travel agent global distribution systems (“GDS”) and electronic distribution channels on the internet, including our

branded website. The table below reflects our hotel properties and locations, total available rooms per hotel, as well as meeting space availability, as of December 31, 2006.

 

 

 

 

Owned and Leased Hotels

 

Owned hotels are those properties which we operate and manage and have ownership of the hotel facility, equipment, personal property, other structures and in most cases, the land. We recognize revenues and expenses on these properties, including depreciation where appropriate.

 

Leased hotels are those properties which we operate and manage and may have ownership of some or all of the equipment and personal property on site, however, the hotel facility and the underlying land is occupied under an operating lease from a third party. We recognize revenues and expenses on these properties, including lease expense. The most significant leases, with expiration dates ranging from 2020 to 2033 and having renewal provisions, typically require us to pay fixed monthly rent and variable rent based on a percentage of revenue if certain sales thresholds are reached. In addition, we are responsible for repairs and maintenance, operating expenses and management of operations. For additional information on leases, refer to Note 13 of Notes to Consolidated Financial Statements.

 

Managed Hotels

 

As of December 31, 2006, we managed one third-party owned hotel with a total of 254 rooms and 36,000 square feet of meeting space. Under the typical hotel management agreement, we manage virtually all aspects of the hotel’s operations while the hotel owner is responsible for operating and other expenses. Our management fees are based on a percentage of the hotel’s gross revenue plus an incentive fee based on operating performance.

 

Franchised Hotels

 

As of December 31, 2006, we had franchise agreements with 25 hotels that were owned and operated by third parties under our licensed brand name. These hotels had at that date a total of 3,867 rooms and 157,301 square feet of meeting space. Under our franchise agreements, we receive royalties for the use of the Red Lion brand name. We also make available certain services to those hotels including reservation systems, advertising and national sales, our guest loyalty program, revenue management tools, quality inspections and brand standards, as well as administer central services programs for the benefit of our system hotels and franchisees. We do not have management or operational responsibility for these hotels.

 

Discontinued Operations and Assets Held For Sale

 

In November 2004, we announced our plan to divest non-strategic assets, including eleven of our owned hotels, certain commercial office buildings and certain other non-core properties including condominium units and certain parcels of excess land (collectively referred to as “the divestment properties”). The activities of the hotels and commercial office buildings are considered discontinued operations under generally accepted accounting principles. The net impact of the operations of these business units has been segregated and separately disclosed on our consolidated statement of operations, comparative for all periods presented when they existed. Likewise, the assets and liabilities of the business units have been segregated and separately stated on our consolidated balance sheet for all periods presented when they existed. The remaining other real estate has been considered as held for sale under generally accepted accounting principles but does not meet the definition of a discontinued operation.

 

We completed the sale of seven of the eleven hotels and one commercial office building in 2005, and three hotels sold in 2006, resulting in gross proceeds of approximately $15.8 million and $52.8 million, respectively. Proceeds from the sales have been used to finance the company-wide renovation program previously discussed. In the fourth quarter of 2006, we listed for sale another commercial office and retail complex located in Spokane, Washington. In addition, we continue to pursue the divestment of the WestCoast Outlaw Hotel in Kalispell, Montana and we continue to hold as assets held for sale some surplus undeveloped land. For additional information, see Note 3 of Notes to Consolidated Financial Statements.

 

Other Operations

 

In addition to the operations discussed above, we maintain a direct ownership interest in a retail mall in Kalispell, Montana that is attached to our Red Lion hotel and other miscellaneous real estate investments.

 

 

At any given time, we are subject to claims and actions incident to the operation of our business. While the outcome of these proceedings cannot be predicted, it is the opinion of management that none of such proceedings, individually or in the aggregate, will have a material adverse effect on our business, financial condition, cash flows or results of operations.

 

No matters were submitted to a vote of security holders during the fourth quarter of 2006.

 

Set forth below is information regarding our directors, executive officers and certain key employees as of March 15, 2007:

 

 

Donald K. Barbieri.  Mr. Barbieri has been a director since 1978 and Chairman of the Board since 1996. He served as President and Chief Executive Officer from 1978 until April 2003. Mr. Barbieri joined the Company in 1969 and was responsible for its development activities in hotel, entertainment and real estate areas. Mr. Barbieri is a past Trustee of Gonzaga University; Chairman of the Board for the Spokane Regional Chamber of Commerce; served as President of the Spokane Chapter of the Building Owners and Managers Association; as President of the Spokane Regional Convention and Visitors Bureau and as Chairman of the Spokane United Way Campaign. Barbieri chaired the State of Washington’s Quality of Life Task Force. He has served as board Chairman for the Inland Northwest’s largest hospital system, Sacred Heart Medical Center and was founding president of the Physician Hospital Community Organization. He has served three governors on the Washington Economic Development Board and currently chairs the Spokane County Democratic Election Committee after being a candidate for the Fifth District US Congressional Seat from the State of Washington. Mr. Barbieri is brother to director Richard L. Barbieri.

 

Richard L. Barbieri.  Mr. Barbieri has been a director since 1978. From 1994 until he retired in December 2003, he served as the Company’s full-time General Counsel, first as Vice President, then Senior Vice President and Executive Vice President. He currently serves as Chairman of the Board of Puget Sound Neighborhood Health Centers and as a member of the Board of the Pike Market Foundation, both non-profit organizations. From 1978 to 1995, Mr. Barbieri served as legal counsel and Secretary, during which time he was first engaged in the private practice of law at Edwards and Barbieri, a Seattle law firm, and then at Riddell Williams P.S., a Seattle law firm. Mr. Barbieri has also served as chairman of various committees of the Washington State Bar Association and the King County (Washington) Bar Association, and as a member of the governing board of the King County bar

association. He also served as Vice Chairman of the Citizens’ Advisory Committee to the Major League Baseball Stadium Public Facilities District in Seattle in 1996 and 1997. Mr. Barbieri is brother to Donald K. Barbieri.

 

Arthur M. Coffey.  Mr. Coffey has been a director of Red Lion Hotels Corporation since 1990 and has served as its President and Chief Executive Officer since April 2003. Mr. Coffey has over 30 years experience in the hospitality industry and has been with Red Lion Hotels Corporation since 1981. He has held a variety of management positions including Executive Vice President, Chief Financial Officer and Chief Operating Officer. Mr. Coffey played a key role in taking the company public and listing on the NYSE in 1998. He possesses a unique combination of expertise in development, operations and financial disciplines and during his tenure the company has grown from ownership of three hotels into a hospitality company that owns, manages and franchises more than 55 hotels. He previously served as trustee of the Spokane Area Chamber of Commerce, director of the Washington State Hotel Association, and President of the Spokane Hotel Association. He is a past director of the Association of Washington Business. Mr. Coffey is newly appointed to the Board of Trustees of Greater Spokane Incorporated, a non profit economic development organization. He also serves on the board for the Inland Northwest Council, Boy Scouts of America.

 

Ryland P. “Skip” Davis, Mr. Davis has been a director since May 2005. He has served as Chief Executive Officer of Providence Health Care since 1998 and Chief Executive Officer of Sacred Heart Medical Center in Spokane since 1996. From 1993 to 1996, Mr. Davis was Senior Vice President for the Hunter Group, a hospital management firm specializing in healthcare consulting and management nationally. From 1988 to 1993, he was Chairman and CEO of Synergos Neurological Centers, Inc., in Santa Ana and Sacramento, California. From 1987 to 1988, he was President of Diversified Health Group, Inc., of Sacramento. From 1982 to 1987, he worked for American Health Group International as President and CEO of Amerimed in Burbank, California, and as Executive Vice President of Operations. From 1981 to 1982, he worked for Hospital Affiliates International, as Group Vice President in Sacramento, and as CEO of Winona Memorial Hospital in Indianapolis, Indiana. From 1972 to 1975, he was Associate Administrator of San Jose Hospital and Health Care Center in San Jose, California and from 1968 to 1971, Assistant Administrator of Alta Bates Hospital in Berkeley, California. He has done numerous private business ventures related to healthcare. Mr. Davis is a Fellow of the American College of Health Care Executives and has published articles in “Modern Healthcare,” “Health Week,” and other business publications regarding healthcare issues and perspectives. Mr. Davis is currently on the Board and is Chair of the Spokane Area Chamber of Commerce, on the Boy Scouts of America Inland Northwest Council Board, and a member of the Washington State University Advisory Council.

 

Jon E. Eliassen.  Mr. Eliassen has been a director since September 2003. Mr. Eliassen was President and CEO of the Spokane Area Economic Development Council from 2003 until 2007. Mr. Eliassen retired in 2003 from his position as Senior Vice President and Chief Financial Officer of Avista Corp., a publicly-traded diversified utility. Mr. Eliassen spent 33 years at Avista, including the last 16 years as its Chief Financial Officer. While at Avista, Mr. Eliassen was an active participant in development of a number of successful subsidiary company operations including technology related startups Itron, Avista Labs and Avista Advantage. Mr. Eliassen serves on the Board of Directors of Itron Corporation, IT Lifeline, Inc, and is the principal of Terrapin Capital Group, LLC. Mr. Eliassen’s corporate accomplishments are complemented by his extensive service to the community in roles which have included director and President of the Spokane Symphony Endowment Fund, director of The Heart Institute of Spokane, Washington State University Research Foundation, Washington Technology Center, Spokane Intercollegiate Research and Technology Institute and past director of numerous other organizations and energy industry associations.

 

Peter F. Stanton.  Mr. Stanton has been a director since April 1998. Mr. Stanton has served as the Chief Executive Officer of Washington Trust Bank since 1993 and its Chairman since 1997. Mr. Stanton previously served as President of Washington Trust Bank from 1990 to 2000. Mr. Stanton is also Chief Executive Officer, President and Chairman of the Board of Directors of W.T.B. Financial Corporation (a bank holding company). In addition to serving on numerous state and local civic boards, Mr. Stanton was President of the Washington Bankers Association from 1995 to 1996 and served as Washington state chairman of the American Bankers Association in 1997 and 1998. He currently serves as a National Trustee for the Boy’s and Girl’s Club of America. Mr. Stanton is also a

Trustee of Gonzaga University, is on the Board of Trustees of Greater Spokane Incorporated, as well as on the board of the Inland Northwest Council, Boy Scouts of America.

 

Ronald R. Taylor.  Mr. Taylor has been a director since April 1998. Mr. Taylor is President of Tamarack Bay, LLC, a private consulting firm and is currently a director of two other public companies, Watson Pharmaceuticals, Inc. (a pharmaceutical manufacturer) and ResMed, Inc. (a manufacturer of equipment relating to the management of sleep-disordered breathing). At Watson Pharmaceuticals, Inc., Mr. Taylor is a member of the Audit and Nominating and Corporate Governance Committees and is Chairman of the Compensation Committee. At ResMed, Inc., he is a member of the Nominating and Corporate Governance Committees and Chairman of the Compensation Committee. Mr. Taylor is also Chairman of the Board of three privately held companies. From 1998 to 2002, Mr. Taylor was a general partner of Enterprise Partners, a venture capital firm. From 1996 to 1998, Mr. Taylor worked as an independent business consultant. From 1987 to 1996, Mr. Taylor was Chairman, President and Chief Executive Officer of Pyxis Corporation (a health care service provider), which he founded in 1987. Prior to founding Pyxis, he was an executive with both Allergan Pharmaceuticals and Hybritech, Inc.

 

Anupam Narayan.  Mr. Narayan is our Executive Vice President and Chief Investment Officer and Chief Financial Officer. He has been with the company since November 2004 as Executive Vice President and Chief Investment Officer. He was appointed Chief Financial Officer in January, 2005. Mr. Narayan has nearly 25 years of experience in the hospitality industry. From 1998 to March 2004, he served in various capacities as an executive officer of Best Western International Inc., including his most recent position as Senior Vice President, Global Brand Management and Chief Financial Officer and a three-month period as Acting President and Chief Executive Officer during 2002. From 1985 to 1998, Mr. Narayan was employed by Doubletree Corporation and Red Lion Hotels, Inc., serving as Senior Vice President and Treasurer immediately prior to his move to Best Western.

 

John M. Taffin.  Mr. Taffin has been our Executive Vice President, Hotel Operations since September 2003. He originally joined us in 1995 and held the position of Regional Manager from November 1995 to July 1997 and Vice President Hotel Operations from August 1997 to September 2002. From August 2002 to August 2003 he was managing partner of Yogo Inn of Lewistown, Inc., a Montana based hotel company. Mr. Taffin started his hospitality industry career with Red Lion Hotels in 1982. During the period from 1982 to 1986 he held mid-management positions with Red Lion Hotels in Idaho, Washington and Oregon. In 1986 he was promoted to General Manager and during the following nine years managed Red Lion Hotels in Idaho, Washington and Oregon. In 1986 he was promoted to General Manager and during the following nine years managed Red Lion Hotels in Idaho, Washington, Oregon and California. He has served as the President of the Washington State Hotel and Lodging Association and as a board member of the Spokane Public Facilities District, the Spokane Lodging Tax Advisory Committee and the Washington State Tourism Advisory Committee.

 

Thomas L. McKeirnan.  Mr. McKeirnan has been our Senior Vice President, General Counsel and Secretary since February 2005. Prior to that he served as Vice President, General Counsel and Secretary from January 2004 through February 2005 and Vice President, Assistant General Counsel from July 2003 to January 2004. Prior to joining us, Mr. McKeirnan was a partner at the Spokane, Washington law firm of Paine Hamblen Cofflin Brooke & Miller LLP from January 2002 until July 2003 and an associate attorney at the same firm from 1999 to 2001. Mr. McKeirnan was also an associate attorney with the Seattle, Washington law firm of Riddell Williams P.S. from 1995 until 1999. Mr. McKeirnan’s legal practice focused on corporate, transactional, real estate and securities law, with an emphasis on the hospitality industry. While in private practice, Mr. McKeirnan represented us as outside counsel on various strategic and transactional matters and also represented WestCoast Hotels, Inc. prior to our acquisition of that company.

 

Anthony F. Dombrowik.  Mr. Dombrowik serves as our Senior Vice President, Corporate Controller and Principal Accounting Officer. Mr. Dombrowik has been with Red Lion Hotels Corporations since May 2003 and is a member of the senior management team. Mr. Dombrowik was previously employed as senior manager at the public accounting firm of BDO Seidman, LLP, where he served as an auditor, certified public accountant and consultant from 1992 to 2003. Mr. Dombrowik’s public accounting practice focused on auditing and consulting for mid-market public companies, with particular attention to consolidations, capital and debt transactions, mergers and acquisitions, and the hospitality industry.

 

Jack G. Lucas.  Mr. Lucas serves as Vice President of Red Lion Hotels Corporation and President of TicketsWest. He is in charge of overseeing all of the various departments within our entertainment division. He has been President of TicketsWest since February 2006 and Vice President of Red Lion Hotels Corporation since August 1998. Mr. Lucas has approximately 26 years of experience in the entertainment industry, and has been employed by us since 1987. Mr. Lucas previously spent 13 years on the management staff of the City of Spokane Entertainment Facilities, which included a 2,700-seat performing arts center, 30,000-seat stadium, 8,500-seat coliseum, and convention center. Mr. Lucas was awarded the 2004 International Ticketing Professional of the Year award from the International Ticketing Association.

 

(a) Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “RLH”. Prior to September 19, 2005, the stock traded under the symbol “WEH.” The following table sets forth for the periods indicated the high and low closing sale prices for our common stock on the NYSE:

 

 

(b) The last reported sale price of the common stock on the NYSE on February 28, 2007 was $12.25. As of that date, there were approximately 103 shareholders of record of the common stock.

 

(c) We do not anticipate paying any cash dividends on our common stock in the foreseeable future. We intend to retain earnings to provide funds for the continued growth and development of our business. Any determination to pay cash dividends in the future will be at the discretion of our board of directors, who periodically review our dividend policy on common shares.

 

(d) The following information relates to plans under which equity securities may be issued to employees, directors or consultants:

 

 

 

 

(e) The below graph assumes an investment of $100 in our common stock and depicts its price performance relative to the performance of the Russell 2000 Composite Index and the Standard & Poor’s 500 Hotels, Resorts & Cruise Lines Index, assuming a reinvestment of all dividends. The price performance on the graph is not necessarily indicative of future stock price performance.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN

Among Red Lion Hotels Corporation, The Russell 2000 Index

And The S & P Hotels, Resorts & Cruise Lines Index

 

 

The following table sets forth our selected consolidated financial data as of and for the years ended December 31, 2006, 2005, 2004, 2003 and 2002. The selected consolidated statement of operations and balance sheet data are derived from our audited financial statements. The audited consolidated financial statements for certain of these periods are included elsewhere in this annual report. The selected consolidated financial data set forth below should be read in conjunction with, and are qualified in their entirety by, our consolidated financial statements and related notes, Management’s Discussion and Analysis of Financial Condition and Results of Operations and other financial information included elsewhere in this annual report. Operating activities and the balance sheet of discontinued operations have been reflected on a comparable basis for all years presented.

 

 

 

 

 

EBITDA represents net income (loss) before interest expense, income tax benefit (expense) and depreciation and amortization. We utilize EBITDA as a financial measure as management believes investors find it a useful tool to perform more meaningful comparisons of past, present and future operating results and as a means to evaluate the results of core, on-going operations. We believe it is a complement to net income (loss) and other financial performance measures. EBITDA from continuing operations is calculated in the same manner, but excludes the operating activities of business units identified as discontinued. EBITDA is not intended to represent net income (loss) as defined by generally accepted accounting principles in the United States, and such information should not

be considered as an alternative to net income (loss), cash flows from operations or any other measure of performance prescribed by generally accepted accounting principles in the United States (“GAAP”).

 

We use EBITDA to measure the financial performance of our owned and leased hotels because we believe interest, taxes and depreciation and amortization bear little or no relationship to our operating performance. By excluding interest expense, EBITDA measures our financial performance irrespective of our capital structure or how we finance our properties and operations. We generally pay federal and state income taxes on a consolidated basis, taking into account how the applicable taxing laws apply to us in the aggregate. By excluding taxes on income, we believe EBITDA provides a basis for measuring the financial performance of our operations excluding factors that our hotels cannot control. By excluding depreciation and amortization expense, which can vary from hotel to hotel based on historical cost and other factors unrelated to the hotels’ financial performance, EBITDA measures the financial performance of our hotels without regard to their historical cost. For all of these reasons, we believe that EBITDA provides us and investors with information that is relevant and useful in evaluating our business. We believe that the presentation of EBITDA from continuing operations is useful for the same reasons, in addition to using it for comparative purposes for our intended operations going forward.

 

However, because EBITDA excludes depreciation and amortization, it does not measure the capital we require to maintain or preserve our fixed assets. In addition, because EBITDA does not reflect interest expense, it does not take into account the total amount of interest we pay on outstanding debt nor does it show trends in interest costs due to changes in our borrowings or changes in interest rates. EBITDA from continuing operations excludes the activities of operations we have determined to be discontinued and does not reflect the totality of operations as experienced for the periods presented. EBITDA, as defined by us, may not be comparable to EBITDA as reported by other companies that do not define EBITDA exactly as we define the term. Because we use EBITDA to evaluate our financial performance, we reconcile it to net income, which is the most comparable financial measure calculated and presented in accordance with GAAP. EBITDA does not represent cash generated from operating activities determined in accordance with GAAP, and should not be considered as an alternative to operating income or net income (loss) determined in accordance with GAAP as an indicator of performance or as an alternative to cash flows from operating activities as an indicator of liquidity.

 

The following is a reconciliation of EBITDA and EBITDA from continuing operations to net income (loss) for the periods presented (in thousands):

 

 

We are a NYSE-listed hospitality and leisure company (ticker symbols RLH and RLH-pa) primarily engaged in the ownership, operation, development and franchising of midscale and upscale, full service hotels. The Red Lion brand is nationally recognized, particularly in the western United States, and is typically associated with three- and four-star full-service hotels. Our mission is to create the most memorable guest experience possible, allowing us to be the leader in our markets through personalized, exuberant service. As of December 31, 2006, our hotel system contained 58 hotels located in nine states and one Canadian province, with 10,167 rooms and 506,629 square feet of meeting space.

 

We operate in three reportable segments:

 

 

We have historically owned certain commercial real estate properties. We also have engaged in traditional real estate related services, including developing, managing and acting as a broker for sales and leases of commercial and multi-unit residential properties (collectively referred to as the real estate management business). Together, these operations comprised our real estate segment. Effective April 30, 2006, we divested the real estate management business. In addition, consistent with our strategy of divesting non-core assets, during the fourth quarter of 2006, we listed one of our two remaining wholly-owned commercial real estate properties for sale and have classified its results of operations within discontinued operations for all periods presented. Further, the remaining operations of that segment have been reclassified to “Other” for 2006 and for all comparative periods, where appropriate. For additional information, see Note 3 of Notes to Consolidated Financial Statements.

 

Executive Summary

 

During 2006 and 2005, we focused our resources — monetary, capital and human — in three primary areas:

 

 

During 2006, we had growth of 7.7% in hotel room revenues and 16.2% in direct hotel operating profit. We completed extensive room renovations at our hotels and enhanced our capital structure through the combination of successfully completing a follow-on equity offering, and subsequently repaying debt and obtaining a new credit facility. These accomplishments have elevated the Red Lion brand and laid the foundation for our goal of expansion into new markets. As we move into 2007, we will continue to focus on growing our existing operations, expanding

into new markets and taking advantage of opportunities for new franchises, joint ventures and acquisitions. We believe the Red Lion brand and our financial position are both strong.

 

We began our enhancements by initially improving the quality of our existing product in areas where customers’ quality expectations are continuing to grow. This allows us to take advantage of the growth potential in our existing markets, as well as make the Red Lion brand more attractive for franchise opportunities. As of December 31, 2006, we had substantially completed our hotel room renovations, which included new floor and wall coverings, tiled bathroom floors, granite vanities and other bathroom upgrades, enhanced guest room features including new plush pillow top mattresses and upgraded linen and pillow packages, large work desks and ergonomic chairs and amenities such as complimentary wireless internet access.

 

Guest reaction to our renovations has been positive and during 2006, we realized strong increases over prior years in ADR and RevPAR, although we experienced lower occupancy primarily due to the impact of displacement during the implementation of our room renovation plan, as well as our strategy of transitioning to higher rate corporate and group stays, from lower rate promotional and permanent contract business. The lodging industry as a whole also saw improvements in its underlying fundamentals during 2006, which we anticipate will continue during 2007. A comparative summary of the performance of our hotel system, including all hotels owned, leased, managed and franchised for each of the periods presented, is as follows:

 

 

 

 

We continue to increase room bookings as a result of our Red Lion brand strengthening campaign, increased marketing efforts and technological upgrades. Travelers continue to book more reservations through electronic distribution systems like our own branded website and third-party on-line travel agents (“OTA’s,” or also referred to as alternative distribution systems or “ADS”). We have started installing a property management system in our

hotels that shares the same database as our central reservations system, allowing us to improve in delivered rates and availability and helping us take advantage of internet travel bookings. We have also focused on encouraging guests to reserve accommodations on our website through our “We Promise or We Pay” booking initiative. Through this initiative, we guarantee to our guests that our website will provide the best rate available compared to non-opaque OTA channels. As a result, our website is the fastest growing electronic reservation channel, allowing us to maximize our yield on these types of bookings.

 

We intend to grow our hotel operations to 100 markets by the end of 2010, primarily by expanding the number of hotels franchised, managed, joint ventured or owned under the Red Lion brand. We expect to add properties in large, western U.S. urban markets, complemented by leading properties in smaller, secondary cities, and progressively move east, leveraging the momentum of our growth in the western states. Financially, we have a strong balance sheet to advance this growth. In 2006, we reduced our long-term liabilities by over $59.1 million primarily as a result of our second quarter 2006 public offering of 5.8 million shares of Red Lion common stock for net proceeds of approximately $60.4 million. Additionally, during 2006 we added a new revolving credit facility for up to $50 million, which, as of December 31, 2006, had no amounts outstanding. We have the option to increase the facility to $100 million, subject to certain conditions. A summary of our comparative consolidated balance sheet is as follows: