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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 quarter ended June 14, 2002.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 001-14625
HOST MARRIOTT CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Maryland 53-0085950
(State of Incorporation) (I.R.S. Employer Identification No.)
10400 Fernwood Road, Bethesda, Maryland 20817
(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, including area code) (301) 380-9000
(Former name, former address and former fiscal year, if changed since last
report) Not Applicable
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, and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [_] No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
The registrant had 264,908,016 shares of its $0.01 par value common stock
outstanding as of July 15, 2002.
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INDEX
Page No.
--------
Part I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets-
June 14, 2002 and December 31, 2001 ...................................... 3
Condensed Consolidated Statements of Operations-
Twelve Weeks and Twenty-four Weeks Ended
June 14, 2002 and June 15, 2001 .......................................... 4
Condensed Consolidated Statements of Cash Flows-
Twenty-four Weeks Ended June 14, 2002 and June 15, 2001 .................. 6
Notes to Condensed Consolidated Financial Statements ........................ 8
ITEM 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition ....................................... 12
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk. ................. 22
PART II. OTHER INFORMATION AND SIGNATURE
ITEM 1. Legal Proceedings ........................................................... 23
ITEM 4. Submission of Matters to a Vote of Security Holders ......................... 23
ITEM 5. Other Items ................................................................. 24
ITEM 6. Exhibits and Reports on Form 8-K ............................................ 41
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
June 14, December 31,
2002 2001
----------- ------------
(unaudited)
ASSETS
------
Property and equipment, net .............................................................. $ 7,159 $ 6,999
Notes and other receivables (including amounts due from affiliates of $6 million and
$6 million, respectively) ............................................................. 54 54
Due from Managers ........................................................................ 150 141
Investments in affiliates ................................................................ 143 142
Other assets ............................................................................. 586 536
Restricted cash .......................................................................... 124 114
Cash and cash equivalents ................................................................ 243 352
----------- -----------
$ 8,459 $ 8,338
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Debt
Senior notes .......................................................................... $ 3,232 $ 3,235
Mortgage debt ......................................................................... 2,313 2,261
Other ................................................................................. 105 106
----------- -----------
5,650 5,602
Accounts payable and accrued expenses .................................................... 115 121
Other liabilities ........................................................................ 310 321
----------- -----------
Total liabilities ................................................................... 6,075 6,044
----------- -----------
Minority interest ........................................................................ 247 210
Company-obligated mandatorily redeemable convertible preferred securities of a
subsidiary whose sole assets are convertible subordinated debentures due 2026
("Convertible Preferred Securities") .................................................. 475 475
Shareholders' equity
Cumulative redeemable preferred stock (liquidation preference $354 million),
50 million shares authorized; 14.1 million shares issued and outstanding .............. 339 339
Common stock, par value $.01, 750 million shares authorized; 264.8 million shares
and 263.2 million shares issued and outstanding, respectively ......................... 3 3
Additional paid-in capital ............................................................... 2,095 2,051
Accumulated other comprehensive loss ..................................................... (2) (5)
Deficit .................................................................................. (773) (779)
----------- -----------
Total shareholders' equity .......................................................... 1,662 1,609
----------- -----------
$ 8,459 $ 8,338
=========== ===========
See Notes to Condensed Consolidated Statements
-3-
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Twelve and Twenty-four Weeks Ended June 14, 2002 and June 15, 2001
(unaudited, in millions, except per share amounts)
Twelve Weeks Ended Twenty-four Weeks Ended
------------------------ ------------------------
June 14, June 15, June 14, June 15,
2002 2001 2002 2001
---------- ---------- ---------- ----------
REVENUES
Rooms .................................................. $ 543 $ 590 $ 1,008 $ 1,112
Food and beverage ...................................... 288 295 532 548
Other .................................................. 65 73 120 137
---------- ---------- ---------- ----------
Total hotel sales .................................... 896 958 1,660 1,797
Rental income .......................................... 24 36 50 70
---------- ---------- ---------- ----------
Total revenues ....................................... 920 994 1,710 1,867
---------- ---------- ---------- ----------
OPERATING COSTS AND EXPENSES
Rooms .................................................. 129 135 240 256
Food and beverage ...................................... 205 208 380 399
Hotel departmental costs and deductions ................ 225 232 421 440
Management fees ........................................ 44 54 80 106
Taxes, insurance, and other property-level expenses .... 72 75 134 140
Depreciation and amortization .......................... 84 100 168 177
Corporate expenses ..................................... 7 9 20 17
Other expenses ......................................... 5 5 9 7
Lease repurchase expense ............................... -- 5 -- 5
---------- ---------- ---------- ----------
OPERATING PROFIT ......................................... 149 171 258 320
Minority interest expense .............................. (6) (11) (11) (26)
Interest income ........................................ 4 12 7 20
Interest expense ....................................... (106) (104) (211) (207)
Net gains on property transactions ..................... 1 -- 2 1
Equity in earnings (losses) of affiliates .............. 1 2 (3) 4
Dividends on Convertible Preferred Securities .......... (8) (8) (15) (15)
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES ............................... 35 62 27 97
Provision for income taxes ............................... (11) (12) (15) (15)
---------- ---------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS ........................ 24 50 12 82
DISCONTINUED OPERATIONS
Income (loss) from operations ............................ -- (1) 7 (1)
---------- ---------- ---------- ----------
INCOME BEFORE EXTRAORDINARY ITEMS ........................ 24 49 19 81
Extraordinary gain on the extinguishment of debt ......... -- -- 6 --
---------- ---------- ---------- ----------
NET INCOME ............................................... $ 24 $ 49 $ 25 $ 81
========== ========== ========== ==========
Less: Dividends on Preferred Stock ....................... (9) (9) (18) (14)
---------- ---------- ---------- ----------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS .............. $ 15 $ 40 $ 7 $ 67
========== ========== ========== ==========
See Notes to Condensed Consolidated Statements
-4-
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
Twelve and Twenty-four Weeks Ended June 14, 2002 and June 15, 2001
(unaudited, in millions, except per share amounts)
Twelve Weeks Ended Twenty-four Weeks Ended
------------------------ -----------------------
June 14, June 15, June 14, June 15,
2002 2001 2002 2001
---------- ---------- ---------- ---------
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Continuing operations ................................. $ .06 $ .17 $ (.02) $ .28
Discontinued operations ............................... -- -- .03 --
Extraordinary gain .................................... -- -- .02 --
---------- ---------- ---------- ---------
BASIC EARNINGS PER COMMON SHARE ......................... $ .06 $ .17 $ .03 $ .28
========== ========== ========== =========
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Continuing operations ................................. $ .06 $ .16 $ (.02) $ .28
Discontinued operations ............................... -- -- .03 --
Extraordinary gain .................................... -- -- .02 --
---------- ---------- ---------- ---------
DILUTED EARNINGS PER COMMON SHARE ....................... $ .06 $ .16 $ .03 $ .28
========== ========== ========== =========
See Notes to Condensed Consolidated Statements
-5-
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Twenty-four Weeks Ended June 14, 2002 and June 15, 2001
(unaudited, in millions)
2002 2001
----------- -----------
OPERATING ACTIVITIES
Net income from continuing operations ............................ $ 12 $ 82
Adjustments to reconcile to cash from operations:
Depreciation and amortization ................................ 168 177
Deferred income taxes ........................................ 5 (11)
Deferred contingent rental income ............................ 2 15
Net gains on property transactions ........................... (2) (1)
Equity in earnings of affiliates ............................. 3 (4)
Purchase of Crestline leases ................................. -- (204)
Changes in other operating accounts .......................... (23) 10
Other ........................................................ 11 (15)
----------- -----------
Cash provided by operations ............................. 176 49
----------- -----------
INVESTING ACTIVITIES
Acquisitions ..................................................... (117) (2)
Capital expenditures:
Capital expenditures for renewals and replacements ........... (80) (102)
New investment capital expenditures .......................... (10) (30)
Other investments ............................................ (6) (12)
Note receivable collections, net ................................. -- 10
----------- -----------
Cash used in investing activities ....................... (213) (136)
----------- -----------
FINANCING ACTIVITIES
Issuances of debt, net of financing costs ........................ (7) 121
Scheduled principal repayments ................................... (36) (23)
Debt prepayments ................................................. -- (115)
Issuances of common stock ........................................ 1 2
Issuances of cumulative redeemable preferred stock, net .......... -- 144
Dividends ........................................................ (18) (130)
Other ............................................................ (12) (8)
----------- -----------
Cash used in financing activities ....................... (72) (9)
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS ............................ $ (109) $ (96)
=========== ===========
See Notes to Condensed Consolidated Statements
-6-
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Twenty-four Weeks Ended June 14, 2002 and June 15, 2001
(unaudited, in millions)
Supplemental schedule of noncash investing and financing activities:
During the twenty-four weeks ended June 14, 2002 and June 15, 2001, we issued
1.6 million and 42.8 million common shares, respectively. Of the shares issued,
approximately 353,000 shares and 41.4 million shares of common stock were held
by minority partners issued upon the conversion of operating partnership units
(OP Units) held by minority partners valued at $3.9 million and $540.8 million,
respectively.
Included in the 1.6 million common shares issued during 2002, 1.1 million shares
were issued to acquire minority interests in the partnership owning the San
Diego Marina Marriott hotel. This transaction resulted in an increase to
property and equipment of $10.5 million to reflect the fair value of the
interest acquired. During April 2002, the Company increased its ownership
percentage in the partnership that owns the hotel to 90% as a result of the
exchange by the minority partners in San Diego of partnership units in the hotel
for approximately 6.9 million OP Units. The Company has agreed to promptly
register approximately 6.9 million shares of its common stock for resale by such
holders upon their conversion of the OP Units. The transaction resulted in an
increase in property and equipment of $56.1 million and a corresponding increase
in minority interest and equity to reflect the fair value of the interest
acquired.
During January 2002, the Company transferred the St. Louis Marriott Pavilion to
the mortgage lender. The Company recorded the difference between the debt
extinguished and the fair value of the assets surrendered of $9.6 million, net
of tax expense of $3.6 million, as a $6 million extraordinary item. The Company
also recorded the operations of the hotel transferred, net of tax, as income
from discontinued operations.
On June 14, 2002, the Company acquired the Boston Marriott Copley Place in
Boston, Massachusetts for a cash purchase price of $117 million and an
assumption of $97 million of mortgage debt.
See Notes to Condensed Consolidated Statements
-7-
HOST MARRIOTT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization
Host Marriott Corporation ("Host REIT" or the "Company"), a Maryland
corporation operating through an umbrella partnership structure, is
primarily the owner of hotel properties. Host REIT operates as a
self-managed and self-administered real estate investment trust ("REIT")
with its operations conducted through an operating partnership, Host
Marriott, L.P. (the "Operating Partnership" or "Host LP"), and its
subsidiaries, which issues units of partnership interest ("OP Units").
Host REIT is the sole general partner of the Operating Partnership and as
of June 14, 2002, owns approximately 90% of the Operating Partnership.
2. Summary of Significant Accounting Policies
The accompanying condensed consolidated financial statements of the
Company and its subsidiaries have been prepared without audit. Certain
information and footnote disclosures normally included in financial
statements presented in accordance with accounting principles generally
accepted in the United States have been condensed or omitted. The Company
believes the disclosures made are adequate to make the information
presented not misleading. However, the unaudited condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's annual
report on Form 10-K for the fiscal year ended December 31, 2001.
In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments necessary to
present fairly the financial position of the Company as of June 14, 2002,
the results of its operations for the twelve and twenty-four weeks ended
June 14, 2002 and June 15, 2001, and cash flows for the twenty-four weeks
ended June 14, 2002 and June 15, 2001. Interim results are not necessarily
indicative of fiscal year performance because of the impact of seasonal
and short-term variations.
Certain reclassifications have been made to the prior year financial
statements to conform to the current presentation.
The Company consolidates entities in which it owns a controlling financial
interest (generally, when it owns over 50% of the voting shares of another
company or, in the case of partnership investments, when the Company owns
the general partnership interest). In all cases, the Company considers the
impact on the Company's financial control of the ability of minority
shareholders or other partners to participate in or block management
decisions. All material intercompany transactions and balances have been
eliminated.
Revenue from operations of the Company's hotels not leased to third
parties is recognized when the services are provided. For the Company's
hotels leased to third parties, rental income is recorded when due and is
the greater of base rent or percentage rent, as defined. Percentage rent
received pursuant to the leases, but not recognized as revenue until all
contingencies have been met is deferred and included on the balance sheet
in other liabilities. Contingent rental revenue of $1 million and $8
million for the twelve weeks ended June 14, 2002 and June 15, 2001,
respectively, and $2 million and $15 million for the twenty-four weeks
ended June 14, 2002 and June 15, 2001, respectively, has been deferred.
Contingent rent in the first and second quarters of 2001 related to four
full-service and certain limited service hotel leases. Effective June 16,
2001, the Company purchased the four full service hotel leases and,
accordingly, all contingent rent subsequently recorded has been for the
limited service hotel leases.
-8-
HOST MARRIOTT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. Earnings Per Share
Basic earnings per common share is computed by dividing net income
available to common shareholders by the weighted average number of shares
of common stock outstanding. Diluted earnings per share is computed by
dividing net income available to common shareholders as adjusted for
potentially dilutive securities, by the weighted average number of shares
of common stock outstanding plus other potentially dilutive securities.
Dilutive securities may include shares granted under comprehensive stock
plans, common and preferred OP Units held by minority partners, minority
interests that have the option to convert their limited partnership
interest to common OP Units and the Convertible Preferred Securities. No
effect is shown for securities if they are anti-dilutive.
Twelve weeks ended
------------------------------------------------------------------------
June 14, 2002 June 15, 2001
----------------------------------- ----------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------------------------------- -----------------------------------
(in millions, except per share amount)
Net income ....................................... $ 24 264.7 $ .09 $ 49 241.0 $ .20
Dividends on preferred stock .................... (9) -- (.03) (9) -- (.03)
--------- --------- --------- --------- --------- ---------
Basic income available to common
shareholders .................................... 15 264.7 .06 40 241.0 .17
Assuming distribution of common shares
granted under the comprehensive stock
plan, less shares assumed purchased at
average market price .......................... -- 3.2 -- -- 3.8 --
Assuming conversion of minority OP Units
issuable ...................................... -- -- -- 1 9.3 (.01)
--------- --------- --------- --------- --------- ---------
Diluted earnings ................................. $ 15 267.9 $ .06 $ 41 254.1 $ .16
========= ========= ========= ========= ========= =========
Twenty-four weeks ended
------------------------------------------------------------------------
June 14, 2002 June 15, 2001
----------------------------------- ----------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------------------------------- -----------------------------------
(in millions, except per share amount)
Net income ....................................... $ 25 264.1 $ .09 $ 81 235.1 $ .34
Dividends on preferred stock .................... (18) -- (.06) (14) -- (.06)
--------- --------- --------- --------- --------- ---------
Basic income available to common
shareholders .................................... 7 264.1 .03 67 235.1 .28
Assuming distribution of common shares
granted under the comprehensive stock
plan, less shares assumed purchased at
average market price .......................... -- -- -- -- 4.2 --
--------- --------- --------- --------- --------- ---------
Diluted earnings ................................. $ 7 264.1 $ .03 $ 67 239.3 $ .28
========= ========= ========= ========= ========= =========
4. Equity Transactions
During February 2002, the Company filed a shelf registration statement for
1.1 million shares of its common stock to be issued in exchange for
partnership interests held by the minority partners in the partnership
that owns the San Diego Marina Marriott hotel. On March 15, 2002, the
minority partners sold the 1.1 million common shares to an underwriter for
resale on the open market.
-9-
HOST MARRIOTT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Concurrent with the issuance of the common shares, the Operating
Partnership issued to the Company an equivalent number of OP Units. Also,
in April 2002, the Company acquired an additional interest in the San
Diego Marina Marriott hotel through the issuance of 6.9 million OP Units
to certain minority partners in exchange for their partnership interests.
These transactions reduced the Company's ownership percentage in the
Operating Partnership to 90% and resulted in an increase to property and
equipment of $66.6 million to reflect the fair value of the interest
acquired. As a result of the acquisition, the Company now owns
approximately 90% of the interests in the partnership that owns the hotel.
The minority partner continues to receive fees for marketing and other
services, which totaled $1.7 million and $2.0 million for the twenty-four
weeks ended June 14, 2002 and June 15, 2001, respectively.
5. Debt
Effective June 6, 2002, the Company completed negotiations on a new
credit facility with an aggregate revolving commitment of up to $400
million. The credit facility has an initial three-year term with an
option to extend for an additional year if certain conditions are met.
Interest on borrowings under the credit facility will be calculated
based on a spread over LIBOR that will vary based on the Company's
leverage ratio. The Company is required to pay a quarterly commitment
fee that will vary based on the amount of unused capacity under the
credit facility. Currently, the commitment fee is .55%. As of June 14,
2002 no amounts have been drawn on the credit facility.
The new credit facility establishes financial covenants for leverage,
interest coverage, fixed charge coverage and unsecured interest coverage
at levels that are generally less stringent than those that would have
been applicable under the prior facility. The new credit facility also
imposes other customary covenants and restrictions. In many cases, the
covenants have been modified to be comparable with the requirements under
the senior note indenture.
In the event we do not satisfy a minimum interest coverage ratio and
certain other conditions both the new credit facility and the senior note
indenture restrict the Company's ability to incur debt, except debt
incurred under the credit facility or in connection with a refinancing of
existing debt. In addition, failure to satisfy this ratio will restrict
the Company's ability to declare and pay dividends, except dividends
necessary to maintain its status as a REIT. As a result of the effect on
our business of the September 11 terrorist attacks and the 2001 recession
we did not meet our specified minimum interest coverage ratio beginning in
the third quarter. Accordingly, we are subject to the restrictions
discussed above, although we may take certain actions to achieve
compliance on a pro forma basis.
In connection with its acquisition of Boston Marriott Copley Place
discussed below, on June 14, 2002 the Company assumed $97 million of
mortgage debt. The mortgage bears interest at a fixed rate of 8.39% and is
due on June 1, 2006.
6. Acquisitions
Effective June 14, 2002, the Company completed the acquisition of the
1,139-room Boston Marriott Copley Place. The $214 million purchase price
consisted of a $117 million cash payment and the assumption of $97 million
in mortgage debt.
7. Dividends
On June 17, 2002, the Company announced that the Board of Directors had
declared a quarterly cash dividend of $0.625 per share for each class of
preferred stock. The second quarter preferred stock dividend was paid on
July 15, 2002 to shareholders of record on June 28, 2002.
-10-
HOST MARRIOTT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. Geographic Information
The Company's foreign operations consist of four hotel properties located
in Canada and two hotel properties located in Mexico. The hotels in Mexico
were acquired in the second quarter of 2001 as a result of the purchase of
the remaining outside interests in Rockledge Hotel Properties, Inc. There
were no intercompany sales between the properties and the Company. The
following table presents revenues (in millions) for each of the
geographical areas in which the Company owns hotels.
Twelve Weeks Ended Twenty-four Weeks Ended
---------------------------------- ----------------------------------
June 14, 2002 June 15, 2001 June 14, 2002 June 15, 2001
-------------- -------------- -------------- --------------
United States .................. $ 891 $ 962 $ 1,660 $ 1,820
International .................. 29 32 50 47
-------------- -------------- -------------- --------------
Total ...................... $ 920 $ 994 $ 1,710 $ 1,867
============== ============== ============== ==============
9. Comprehensive Income
The Company's other comprehensive income consists of unrealized gains and
losses on foreign currency translation adjustments and the right to
receive cash from HMSHost Corporation subsequent to the exercise of the
options held by certain former and current employees of Marriott
International, pursuant to the distribution agreement between the Company
and HMSHost Corporation. For the twelve weeks and twenty-four weeks ended
June 14, 2002, comprehensive income totaled $25 million and $28 million,
respectively. Comprehensive income was $54 million and $83 million for the
twelve and twenty-four weeks ended June 15, 2001, respectively. As of June
14, 2002, the Company's accumulated other comprehensive loss was $2
million compared to a cumulative loss of $5 million as of December 31,
2001.
10. Subsequent Events
On July 25, 2002, we completed our negotiations with Marriott
International of changes to the management and other agreements for
substantially all of our Marriott- and Ritz-Carlton-managed hotels. We
believe that these changes, which are effective as of December 29,
2001, will provide meaningful benefits to us. We estimate that the
cash flow benefit from these modifications will be approximately $8
million in 2002 and increase to approximately $25 million by 2006, of
which approximately two-thirds is related to cost reductions and other
benefits and one-third is related to reduction in incentive management
fees. The management contract changes include the following:
. Providing additional approval rights over hotel operating budgets,
capital budgets, shared service programs, and changes to certain
system wide programs;
. Reducing the amount of working capital requirements, and expanding an
existing agreement that allows us to fund FF&E expenditures as
incurred from a consolidated account rather than escrowing funds
at the hotel level, which collectively increases cash available to
us for general corporate purposes by approximately $125 million;
. Reducing incentive management fees payable on Marriott-managed hotels;
. Reducing the amount we pay related to frequent guest programs;
. Gradually reducing the amounts payable with respect to various
centrally administered programs; and,
. Providing additional territorial restrictions for certain hotels in 10
markets.
In addition to these modifications, we have expanded the pool of hotels
subject to an existing agreement that allows us to sell assets
unencumbered by a Marriott management agreement without the payment of
termination fees. The revised pool will include forty-six assets, 75%
(measured by EBITDA) of which may be sold over approximately a ten year or
greater period. This flexibility will enhance the value of these assets
and our ability to recycle capital.
We have also agreed to terminate Marriott International's right to
purchase up to 20% of each class of our outstanding voting shares upon
certain changes of control and to clarify existing provisions in the
management agreements that limit our ability to sell a hotel or our
company to a competitor of Marriott International.
-11-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Forward-looking Statements
Certain Statements contained in this report constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. We have based these forward-looking statements on our current expectations
and projections about future events. We identify forward-looking statements in
this Report by using words or phrases such as "believe," "expect," "may be,"
"intend," "predict," "project," "plan," "objective," "will be," "should,"
"estimate," or "anticipate," or the negative thereof or other variations thereof
or comparable terminology. All forward-looking statements are not guarantees of
future performance and involve known and unknown risks, uncertainties and other
factors which may cause our actual transactions, results, performance or
achievements to be materially different from any future transactions, results,
performance or achievements expressed or implied by such forward-looking
statements. These risks and uncertainties include the risks discussed elsewhere
in this Report. Although we believe the expectations reflected in such
forward-looking statements are based upon reasonable assumptions, we can give no
assurance that we will attain these expectations or that any deviations will not
be material. Except as otherwise required by the federal securities laws, we
disclaim any obligations or undertaking to publicly release any updates or
revisions to any forward-looking statement contained in this Report to reflect
any change in our expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based.
Recent Events
Credit Facility and Senior Notes. On June 6, 2002, we entered into a new credit
facility that provides an aggregate revolving loan commitment amount of up to
$400 million ($300 million of which is available initially, with up to an
additional $100 million becoming available to the extent that our leverage ratio
falls below certain specified levels). The new credit facility also includes
subcommitments for the issuance of letters of credit and loans to certain of our
Canadian subsidiaries in Canadian Dollars, in each case in an amount of up to
$100 million. The new credit facility replaces the prior credit facility. The
new credit facility has an initial scheduled maturity in June 2005. We have an
option to extend the maturity for an additional year if certain conditions are
met at the time of the initial scheduled maturity.
As with the prior facility, the debt under the new credit facility is guaranteed
by certain of our existing subsidiaries and is currently secured by pledges of
equity interests in many of our subsidiaries. Unlike the prior facility, all or
a portion of the pledges can be released in the event that our pro forma
leverage ratio, as defined in the credit facility, falls below a certain level
for two consecutive fiscal quarters. The spread we pay over LIBOR on borrowings
under the new credit facility will adjust based on our leverage ratio. We also
will pay a quarterly commitment fee of .55% on the unused portion of the
available loan commitment. Currently, we have no amounts outstanding under the
credit facility.
The new credit facility establishes financial covenants for leverage, interest
coverage, fixed charge coverage and unsecured interest coverage at levels that
are generally less stringent than those that would have been applicable under
the prior facility. The new credit facility also imposes other customary
covenants and restrictions. In many cases, the covenants have been modified to
be comparable with the requirements under our senior note indenture.
In the event we do not satisfy a minimum interest coverage ratio and certain
other conditions, both the new credit facility and our senior note indenture
restrict our ability to incur debt, except debt incurred under our new credit
facility or in connection with a refinancing of existing debt. In addition,
failure to satisfy this ratio will restrict our ability to declare and pay
dividends, except dividends necessary to maintain our status as a REIT. As a
result of the effect on our business of the September 11 terrorist attacks and
the 2001 recession we did not meet our specified minimum interest coverage ratio
beginning in the third quarter. Accordingly, we are subject to the restrictions
discussed
-12-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
above, although we may take certain actions to achieve compliance on a pro forma
basis. These actions include, among others, retiring existing debt, swapping
certain of our fixed interest rate debt for lower floating interest rate debt or
the acquisition of less leveraged properties. While we believe that we have the
ability to complete these actions, there can be no assurance that these options
will be available to us later in the year, or if available, that these options
would be at a price that would be acceptable.
We have $3.2 billion of senior notes outstanding as of June 14, 2002. On June
25, 2002, the $450 million of outstanding 9 1/2% Series H notes were exchanged
for 9 1/2% Series I notes. The terms of the Series I notes are substantially
identical to the terms of the Series H notes except that the Series I notes are
registered under the Securities Act of 1933 and are, therefore, freely
transferable.
Hotel Acquisition. Effective June 14, 2002 we completed the acquisition of the
1,139-room Boston Marriott Copley Place for $214 million consisting of a $117
million cash payment and the assumption of $97 million in mortgage debt. The
property is located in downtown Boston, Massachusetts and is part of a 3.7
million square foot high-end mixed use development, which includes 200 upscale
retail shops and restaurants and is adjacent to the Hynes Convention Center. The
acquisition is consistent with our strategy of buying upper-upscale properties
in hard to duplicate urban, convention and resort locations. We believe that the
Boston market has been particularly hard hit by the slowdown in the economy in
recent years and that, as a result, should benefit from an eventual improvement
in business in this market.
Insurance Coverage. The insurance markets nationwide were significantly affected
by the terrorist attacks on September 11, 2001 and as a result it has become
more difficult and more expensive to obtain adequate insurance coverage. We
recently obtained new comprehensive insurance policies including general
liability, property, business interruption and other risks with respect to all
of our properties. We believe our insurance coverage is appropriate to protect
our properties. However, the terrorism coverage we have obtained excludes
various risks such as nuclear or biological acts, and is subject to annual
aggregate limits. For our Marriott-operated properties, these aggregate limits
are shared among various properties including other properties managed by
Marriott International that are not owned by us. The insurance on our
Non-Marriott branded properties has been renewed under similar terms, except
that this coverage is not shared among other owners. Additionally, our new
policies have significantly higher premiums, although these costs should remain
at less than 0.1% of our annual revenues. We estimate that insurance costs for
these hotel-related property and terrorism insurance policies will increase
approximately $13 million to $25 million in 2002.
In addition, our debt agreements typically require us to maintain a minimum
rating of our insurance carrier from Standard & Poors, A.M. Best or other rating
agencies. Currently, we do not satisfy the requirement for a minimum Standard &
Poors rating of AA for seven of our properties subject to approximately $739
million of indebtedness. We have notified our lenders regarding this situation,
and we have obtained, for certain of our Marriott-managed properties that have
mortgage debt, insurance coverage provided by a carrier with a rating from
Standard & Poors of AA- and a rating from A.M. Best of A+XV. However, we cannot
assure you that each of our lenders will be satisfied with the AA- rating level
of our current carrier. If the lenders are unwilling or unable to amend or waive
these covenants, or if we are unable to obtain insurance coverage that complies
with the covenants in these loan agreements the lenders may determine that we
are out of compliance with the terms of the relevant debt agreement in which
case to the extent the lenders chose to pursue their remedies and we were unable
to prevent this course of action we may be required to refinance the debt, with
debt carrying different insurance requirements. There can be no assurances that
we will be able to complete such a refinancing on terms acceptable to us or at
all. We describe changes to our insurance coverage and the risks related thereto
in Part II, Item 5 of this report.
Management and Other Agreements. On July 25, 2002, we completed our negotiations
with Marriott International of changes to the management and other agreements
for substantially all of our Marriott- and Ritz-Carlton-managed hotels. We
believe that these changes, which are effective as of December 29, 2001, will
provide meaningful benefits to us. We estimate that the cash flow benefit from
these modifications will be approximately $8 million in 2002 and increase to
approximately $25 million by 2006, of which approximately two-thirds is related
to cost reductions and other benefits and one-third is related to reduction in
incentive management fees. The management contract changes include the
following:
. Providing additional approval rights over hotel operating budgets,
capital budgets, shared service programs, and changes to certain
system wide programs;
. Reducing the amount of working capital requirements, and expanding an
existing agreement that allows us to fund FF&E expenditures as
incurred from a consolidated account rather than escrowing funds
at the hotel level, which collectively increases cash available to
us for general corporate purposes by approximately $125 million;
. Reducing incentive management fees payable on Marriott-managed hotels;
. Reducing the amount we pay related to frequent guest programs;
. Gradually reducing the amounts payable with respect to various
centrally administered programs; and,
. Providing additional territorial restrictions for certain hotels in 10
markets.
In addition to these modifications, we have expanded the pool of hotels
subject to an existing agreement that allows us to sell assets
unencumbered by a Marriott management agreement without the payment of
termination fees. The revised pool will include forty-six assets, 75%
(measured by EBITDA) of which may be sold over approximately a ten year or
greater period. This flexibility will enhance the value of these assets
and our ability to recycle capital.
We have also agreed to terminate Marriott International's right to
purchase up to 20% of each class of our outstanding voting shares upon
certain changes of control and to clarify existing provisions in the
management agreements that limit our ability to sell a hotel or our
company to a competitor of Marriott International.
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HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Change in Certifying Accountant. On May 22, 2002, upon the recommendation of our
Audit Committee, the Board of Directors dismissed Arthur Andersen LLP as the
Company's independent auditors and appointed KPMG LLP to serve as Host
Marriott's independent auditors for the current fiscal year, which ends on
December 31, 2002. The change in auditors was effective on May 22, 2002.
Increase in Ownership of San Diego Marina Hotel. We own our interest in the San
Diego Marriott Marina hotel through a partnership with outside investors. These
outside investors have a right to exchange their hotel partnership interests for
OP Units. In April 2002, the investors elected to exchange 6,875,844 partnership
units for OP Units, which increased our ownership in the partnership that owns
the hotel from a 51% interest to a 90% interest. The minority partner continues
to receive fees for marketing and other services, which totaled $1.7 million and
$2.0 million for the twenty-four weeks ended June 14, 2002 and June 15, 2001,
respectively. We have agreed to promptly register the equivalent shares of
common stock with the SEC for resale by such investors upon conversion of their
OP Units. We would receive no proceeds from the sale of these shares.
Lodging Performance
For the second quarter of 2002, RevPAR for comparable hotels decreased
approximately 9.8% when compared to the same period in 2001. The decline is the
result of a decrease in average occupancy of 1.6 percentage points and the
decline of average room rates of 7.9%. Also, year-to-date RevPAR decreased
11.0%, as occupancy decreased 1.9 percentage points and room rates declined by
8.6%. A significant portion of the decline in room rate is a result of the
change in the mix of business to lower rated group and transient segments rather
than simply a reduction in room rate. If the rate of economic growth continues
to improve and airline travel increases, we expect it to create a rising demand
for our properties, particularly amongst individual business travelers, a
segment which typically pays a higher rate.
-14-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The changes in our RevPAR reflect a decline in operations in every region for
the quarter and year-to-date; however, the decreases in RevPAR varied across the
country. For example, our hotels in the Pacific region had a significant decline
as a result of a weakened technology industry, declining attendance at citywide
events and significant reductions in airline travel to the San Francisco
Airport. RevPAR for the twenty-four weeks ended June 14, 2002 at our hotels in
San Francisco and Los Angeles declined 27.3% and 19.3%, respectively, when
compared to the same period in 2001. However, our performance in other cities
was much better. For example, our three hotels in Philadelphia and three hotels
in San Antonio had RevPAR improvements of 4.0% and 7.1%, respectively, for the
twenty-four week period ended June 14, 2002. These cities were able to take
advantage of strong convention sales to generate an increase in RevPAR.
The charts below set forth performance information for our comparable
properties as of June 14, 2002:
Comparable by Region
Twelve Weeks Ended
As of June 14, 2002 June 14, 2002 June 15, 2001
----------------------- -------------------------------- ---------------------------------
Average Average Percent
No. of No. of Average Occupancy Average Occupancy Change in
Properties (1) Rooms Daily Rate Percentages RevPAR Daily Rate Percentages RevPAR RevPAR
-------------- ------ -------------------------------- --------------------------------- ---------
Atlanta ................ 15 6,563 $ 147.85 69.0% $ 101.99 $ 159.06 70.5% $ 112.08 (9.0)%
DC Metro ............... 13 4,998 144.63 76.9 111.17 160.41 75.0 120.26 (7.6)
Florida ................ 13 7,581 163.43 73.4 119.95 173.42 74.4 129.00 (7.0)
International .......... 4 1,641 97.90 72.9 71.37 105.21 77.1 81.11 (12.0)
Mid-Atlantic ........... 9 6,222 191.15 79.0 150.93 200.35 81.4 163.18 (7.5)
Mountain ............... 8 3,313 107.90 69.3 74.79 116.10 70.6 81.91 (8.7)
New England ............ 6 2,277 134.37 69.1 92.91 158.15 71.7 113.38 (18.1)
North Central .......... 15 5,395 122.52 69.3 84.87 138.57 70.9 98.31 (13.7)
Pacific ................ 23 11,817 155.81 70.2 109.33 173.57 74.5 129.43 (15.5)
South Central .......... 12 6,515 134.14 81.0 108.66 140.18 79.1 110.86 (2.0)
------- -------
All Regions ....... 118 56,322 148.17 73.2 108.42 160.94 74.8 120.26 (9.8)
======= =======
Comparable by Region
Twenty-four Weeks Ended
As of June 14, 2002 June 14, 2002 June 15, 2001
----------------------- -------------------------------- ---------------------------------
Average Average Percent
No. of No. of Average Occupancy Average Occupancy Change in
Properties (1) Rooms Daily Rate Percentages RevPAR Daily Rate Percentages RevPAR RevPAR
-------------- ------ -------------------------------- --------------------------------- ---------
Atlanta ................ 15 6,563 $ 145.52 69.1% $ 100.50 $ 158.25 71.6% $ 113.25 (11.3)%
DC Metro ............... 13 4,998 140.51 70.2 98.66 159.82 70.3 112.35 (12.2)
Florida ................ 13 7,581 168.41 76.4 128.65 182.96 77.4 141.60 (9.1)
International .......... 4 1,641 96.26 68.7 66.09 103.36 73.3 75.73 (12.7)
Mid-Atlantic ........... 9 6,222 184.29 77.6 143.03 195.91 78.6 153.94 (7.1)
Mountain ............... 8 3,313 117.82 68.9 81.21 120.16 71.9 86.43 (6.0)
New England ............ 6 2,277 127.21 64.0 81.46 148.00 66.8 98.83 (17.6)
North Central .......... 15 5,395 117.92 65.7 77.52 133.45 67.8 90.41 (14.3)
Pacific ................ 23 11,817 156.51 70.3 110.08 177.35 74.5 132.14 (16.7)
South Central .......... 12 6,515 137.17 79.9 109.57 143.53 79.2 113.68 (3.6)
------- -------
All Regions ....... 118 56,322 148.15 72.1 106.81 162.15 74.0 120.06 (11.0)
======= =======
____________
(1) Consists of 118 properties owned, directly or indirectly, by us for the
entire first and second quarters of 2002 and 2001, respectively, excluding
properties with non-comparable operating environments as a result of
acquisitions, dispositions, property damage and expansions and development
projects during the periods being compared.
-15-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The charts below set forth performance information for our entire portfolio as
of June 14, 2002:
All Properties by Region
Twelve Weeks Ended
As of June 14, 2002 June 14, 2002 June 15, 2001
----------------------- -------------------------------- ---------------------------------
Average Average Percent
No. of No. of Average Occupancy Average Occupancy Change in
Properties(1) Rooms(1) Daily Rate Percentages RevPAR Daily Rate Percentages RevPAR RevPAR
---------- ----- -------------------------------- --------------------------------- ---------
Atlanta ................ 15 6,563 $ 147.85 69.0% $ 101.99 $ 159.06 70.5% $ 112.08 (9.0)%
DC Metro ............... 13 4,998 144.63 76.9 111.17 160.41 75.0 120.26 (7.6)
Florida ................ 14 7,876 167.10 72.9 121.78 173.42 74.4 129.00 (5.6)
International .......... 6 2,553 109.88 72.2 79.38 119.09 75.0 89.27 (11.1)
Mid-Atlantic ........... 10 6,726 190.62 78.8 150.14 200.33 81.5 163.35 (8.1)
Mountain ............... 8 3,313 107.87 69.3 74.77 116.60 69.1 80.56 (7.2)
New England ............ 7 3,416 134.85 69.2 93.33 158.15 71.7 113.38 (17.7)
North Central .......... 15 5,395 122.52 69.3 84.87 138.57 70.9 98.31 (13.7)
Pacific ................ 23 11,817 155.81 70.2 109.33 173.75 74.5 129.43 (15.5)
South Central .......... 12 6,515 134.14 81.0 108.66 137.76 78.6 108.34 0.3
------- -------
All Regions ....... 123 59,172 148.78 73.1 108.75 161.31 74.8 120.62 (9.8)
======= =======
All Properties by Region
Twenty-four Weeks Ended
As of June 14, 2002 June 14, 2002 June 15, 2001
----------------------- -------------------------------- ---------------------------------
Average Average Percent
No. of No. of Average Occupancy Average Occupancy Change in
Properties(1) Rooms(1) Daily Rate Percentages RevPAR Daily Rate Percentages RevPAR RevPAR
---------- ----- -------------------------------- --------------------------------- ---------
Atlanta ................ 15 6,563 $ 145.52 69.1% $ 100.50 $ 158.25 71.6% $ 113.25 (11.3)%
DC Metro ............... 13 4,998 140.51 70.2 98.66 159.82 70.3 112.35 (12.2)
Florida ................ 14 7,876 171.79 75.9 130.39 182.96 77.4 141.60 (7.9)
International .......... 6 2,553 109.61 69.2 75.83 112.88 72.8 82.20 (7.8)
Mid-Atlantic ........... 10 6,726 183.48 77.1 141.50 198.51 78.5 155.82 (9.2)
Mountain ............... 8 3,313 117.77 68.9 81.18 125.34 71.4 89.55 (9.4)
New England ............ 7 3,416 127.52 64.1 81.72 148.00 66.8 98.83 (17.3)
North Central .......... 15 5,395 117.92 65.7 77.52 133.45 67.8 90.41 (14.3)
Pacific ................ 23 11,817 156.51 70.3 110.08 177.35 74.5 132.14 (16.7)
South Central .......... 12 6,515 136.78 79.2 108.36 142.10 79.0 112.20 (3.4)
------- -------
All Regions ....... 123 59,172 148.67 72.0 106.97 163.28 74.1 121.00 (11.6)
======= =======
(1) For 2001, the results of operations represent 125 hotels with 60,080 rooms.
During the second quarter of 2001, we began to work with our managers to control
operating costs at our hotels through eliminating management positions, closing
unprofitable operations and other cost control measures. We continued these
measures during the first two quarters of 2002, which resulted in a decrease in
labor costs at the hotels, productivity improvements and lower utility costs.
Additionally, decreases in our hotel margins were partially offset by reduced
incentive management fees and relatively stronger food and beverage results.
However, our ability to achieve significant additional reductions in variable
costs is limited. We believe that we will see less of a year-over-year decline
in margins in the third quarter of 2002 than we saw in the second quarter of
2002. Furthermore, during the fourth quarter we expect margins to improve when
compared to the fourth quarter of 2001 as we experience significant increases in
RevPAR over the exceptionally depressed levels in 2001. For the full year of
2002, we expect an overall decline in comparable property-level operating
margins of 75 to 150 basis points when compared to 2001.
We continue to work with the Port Authority of New York and New Jersey and the
Lower Manhattan Development Corporation to determine how the World Trade Center
site in New York will be redeveloped. We anticipate that it will be several
years before these issues are resolved. We are also working closely with our
insurance companies to resolve our claims related to the destruction of the
-16-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Marriott World Trade Center and the damage to the New York Marriott Financial
Center, including negotiating insurance payments for property damage as well as
business interruption. We reopened the New York Marriott Financial Center on
January 7, 2002. We have received no insurance proceeds for property damage at
the World Trade Center. To the extent that we do, it will be held in escrow by a
trustee until a final resolution on the site is determined.
During 2002, we expect to receive additional business interruption proceeds for
what we believe our operating results would have been absent the terrorist
attacks, although the actual receipt of some of these proceeds may not happen
before December 31, 2002. In addition, special restrictive accounting rules
developed for the events of September 11, 2001 may delay our ability to
recognize a portion of the business interruption advances as income until we
resolve certain contingencies with our insurance providers. Since September 11,
2001, the Company has received $40 million in insurance proceeds with respect to
the two hotels, $10 million of which was received subsequent to June 14, 2002.
Of the $40 million received, we have offset $13 million of operating expenses at
the properties and spent an additional $5 million in building repairs.
Results of Operations
2002 Compared to 2001
Revenues. Hotel sales decreased $62 million, or 6.5%, to $896 million for the
twelve weeks ended June 14, 2002 and decreased $137 million, or 7.6%, to $1,660
million for the twenty-four weeks ended June 14, 2002. This decline reflects the
continued weakness in the lodging industry, primarily as a result of reduced
business travel. We have adjusted our rooms sales mix to reflect this trend and,
as a result, have increased the amount of group business at our properties.
Although group business typically has a lower rate as compared to individual
business travelers, the difference has been mitigated by greater occupancy
levels and additional food and beverage revenues.
Rental income decreased $12 million, or 33.3%, to $24 million for the second
quarter of 2002 compared to the second quarter of 2001 and decreased $20
million, or 28.6% to $50 million for the twenty-four weeks ended June 14, 2002,
when compared to the same period in 2001. Rental income for the twenty-four
weeks ended June 14, 2002 and June 15, 2001 includes: 1) lease income from our
limited service hotel leases of $31 million for both periods, 2) lease income
from full-service hotel leases of $17 million and $37 million, respectively, and
3) office space rental income of $2 million for both periods. We repurchased the
lessee entities with respect to four of the five full-service hotels leased to
third parties effective June 16, 2001, terminating those leases for financial
reporting purposes. As a result, we currently record rental income with respect
to only one full-service hotel.
Operating Costs and Expenses. Operating costs and expenses decreased $52
million, or 6.4%, to $771 million for the second quarter of 2002 compared to the
second quarter of 2001. For the twenty-four weeks ended June 14, 2002, operating
costs and expenses decreased $95 million, or 6.2%, to $1.45 billion from the
same period in 2001. This decline is the result of our efforts to control
operating costs at the hotels and the overall decline in demand. Rental and
other expense for the twenty-four weeks ended June 14, 2002 and June 15, 2001,
includes expense for our limited service hotel leases of $32 million and $33
million, respectively, and office building expenses of $1 million for both
periods. These expenses are included in taxes, insurance and other
property-level expenses on the consolidated statements of operations.
-17-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Depreciation and Amortization. Depreciation and amortization expense decreased
$16 million or 16.0% for the second quarter of 2002 versus the second quarter of
2001, and decreased $9 million or 5.1% year-to-date. The decline in depreciation
expense reflects a $13 million impairment charge due to the reclassification of
certain hotels from held-for-use to held-for-sale recorded during the second
quarter of 2001, the sale of three hotels during the second half of 2001, and
the loss of the Marriott World Trade Center as a result of the September 11th
terrorist attacks. These declines were partially offset by the increased
depreciation related to the opening of the Ritz-Carlton, Naples Golf Resort in
January, 2002 and the consolidation of three hotels and other equipment as a
result of the acquisition of the voting interests in Rockledge Hotel Properties,
Inc. during April 2001.
Corporate Expenses. For the twenty-four weeks ended June 14, 2002, corporate
expenses increased $3 million, primarily as a result of an increase in
stock-based compensation expense related to the increase in the Company's stock
price since year-end.
Minority Interest Expense. The variance in minority interest expense is due in
part to the decrease in the weighted average minority interest ownership in the
Operating Partnership from 17% as of June 15, 2001 to 8% as of June 14, 2002.
The decline is also a reflection of the decrease in our results of operations as
described above.
Equity in Earnings (Losses) of Affiliates. For the twenty-four weeks ended June
14, 2002, equity in losses of affiliates was $3 million compared to equity in
earnings of affiliates of $4 million during the twenty-four weeks ended June 15,
2001. The decrease primarily reflects our share of operating losses on
investments in CBM Joint Venture LLC and JWDC Limited Partnership.
Discontinued Operations. During January of 2002, we transferred the St. Louis
Marriott Pavilion to the mortgage lender in a non-cash transaction. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," which we adopted January 1, 2002, the hotel's income from
operations, net of tax, of $7 million was recorded as discontinued operations.
Additionally, the standard requires the reclassification of the previously
reported earnings of the discontinued hotel to discontinued operations. As a
result, for the first two quarters of 2001, we recorded a loss from discontinued
operations of $1 million, net of taxes, for the operations of the St. Louis
Marriott Pavilion.
Extraordinary Gain. During the twenty-four weeks ended June 14, 2002, we
recorded an extraordinary gain, net of tax, of $6 million representing the
extinguishment of debt on the St. Louis Marriott Pavilion, which we transferred
to the lender.
Net Income Available to Common Shareholders. The decrease reflects the
previously discussed changes in operations as well as the increase in dividends
on preferred stock due to the issuance of $144 million Class C preferred stock
during the second quarter of 2001.
Liquidity and Capital Resources
Our principal sources of cash are cash from operations, borrowings under our
revolving credit facility and our ability to obtain additional financing through
various financial markets. In addition, as a result of the recently completed
agreement with Marriott International, we will be receiving approximately $125
million in cash which will be available for general corporate purposes. Our
principal uses of cash are capital expenditures at our properties and payments
on debt and distributions to our equityholders and minority owners of the
operating partnership. We believe our sources of cash will be sufficient to meet
our liquidity needs.
During the twenty-four weeks ended June 14, 2002, we reported a decrease in cash
and cash equivalents of $109 million, primarily a result of $117 million of cash
used for the purchase of the Boston Marriott Copley Place. At June 14, 2002, we
maintained $243 million of cash on hand, no outstanding debt on our
-18-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
credit facility and no significant debt maturities until 2005. Our new long-term
credit facility, which we negotiated during the second quarter, is smaller but
contains less restrictive covenants than our previous facility. We do not
believe we will need to access the credit facility during 2002.
In addition to the recent acquisition of the Boston Marriott Copley, we remain
interested in both single asset and portfolio transactions and expect that over
the next couple of years there will be more opportunities to acquire assets that
are consistent with our target profile. On the disposition front, we are
continuing our efforts to sell non-core assets in slower growth markets that are
not consistent with our preferred portfolio. We are currently forecasting
dispositions of $75 to $100 million this year.
Cash from Operations. During 2002, our cash provided by operations increased by
$127 when compared to the same period in 2001. The increase over prior year is
primarily due to $204 million of operating cash used in the first half of 2001
for the purchase of the Crestline lessee entities, which was offset by the
declining cash from operations at the hotels.
Cash from/used in Investing Activities. Based on our assessment of the current
operating environment and to conserve capital, we have continued our disciplined
approach to capital expenditures during 2002. As a result, capital expenditures
at our properties have decreased by $48 million, or 33.3%, when compared to the
same period in 2001. We have achieved these decreases while focusing on property
maintenance and selected improvements to maintain high quality standards. We
anticipate spending approximately $185 million on capital expenditures in 2002.
As a result of the changes in the management agreements with Marriott
International discussed above, approximately $75 million of funds previously
held in escrow accounts for capital expenditures at certain properties will be
returned to us. While we continue to be obligated to fund capital expenditures
at these properties as such expenditures are approved by us, this modification
will enable us to use the available funds for general corporate purposes on an
ongoing basis. Other investing activity included the purchase of the Boston
Marriott Copley Place for $117 million of cash. The acquisition is consistent
with our strategy of buying upper-upscale properties in hard to duplicate urban,
convention and resort locations.
Cash from/used in Financing Activities. During 2002, the cash used in financing
activities primarily consisted of principal repayments on debt of $36 million
and preferred stock dividend payments of $18 million. On June 17, 2002, the
Company announced that the Board of Directors had declared a dividend of $0.625
per share of Preferred Stock, which was paid on July 15, 2002 to shareholders of
record on June 28, 2002. We have not declared a dividend on our common stock
during 2002. Our policy on paying common dividends has been to distribute the
minimum amount necessary to maintain REIT status, which is generally an amount
equal to our taxable income. We expect to be able to reinstate a minimal
dividend on our common stock during the fourth quarter of 2002 if we continue to
see improvement in our operations. It is our intention to continue to pay
dividends on our QUIPs and preferred stock.
-19-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Aggregate Debt Maturities and Minimum Annual Rental Commitments on
Non-Cancelable Leases. The table below summarizes our obligations for principal
payments on our debt and the minimum lease payments due on our operating leases.
Operating
Senior Notes Mortgage Debt Other Leases /(2)/
-------------- --------------- --------------- ---------------
2002/(1)/ .............. -- 26 -- 58
2003 ................... -- 136 -- 104
2004 ................... -- 83 -- 101
2005 ................... 513 57 3 97
2006 ................... 300 441 -- 95
Thereafter ............. 2,419 1,570 102 1,164
------------- -------------- --------------- ---------------
Total .............. 3,232 2,313 105 1,619
============= ============== =============== ===============
__________
/(1)/ Amounts shown for payments and minimum lease payments due on our
operating leases for 2002 are for the third and fourth quarters of 2002
only.
/(2)/ $839 million of the total operating lease expenditures is for ground
leases on our properties. $693 million of the total operating lease
expenditures above relate to our sale-leaseback relationships with
Hospitality Properties Trust (HPT) with regards to 53 Courtyard
properties and 18 Residence Inn properties. In connection with the
REIT conversion, we sublet the hotels to subsidiaries of Crestline
Capital Corporation (Crestline), now a subsidiary of Barcelo Hotels
and Resorts. Rent due to us under the non- cancelable sublease is
equal to the minimum rent payable by us under the lease with HPT and
includes an additional percentage rent payable to us. The percentage
rent payable under the subleases is sufficient to cover any additional
rent due under the non-recourse HPT lease, which is calculated based on
the hotel sales, and is guaranteed by Crestline, up to a maximum amount
of $30 million. Additionally, $41 million is due under the sublease with
regard to our former restaurant business. None of the $734 million of
rent due us under the subleases is included in the table above.
FFO and EBITDA
We consider Comparative Funds From Operations ("Comparative FFO"), which
consists of Funds From Operations, as defined by the National Association of
Real Estate Investment Trusts, adjusted for significant non-recurring items
detailed in the chart below, and our consolidated earnings before interest
expense, income taxes, depreciation, amortization and other non-cash items
(including contingent rent) ("EBITDA") to be indicative measures of our
operating performance due to the significance of our long-lived assets.
Comparative FFO and EBITDA are also useful in measuring our ability to service
debt, fund capital expenditures and expand our business. Furthermore, management
believes that Comparative FFO and EBITDA are meaningful disclosures that will
help shareholders and the investment community to better understand our
financial performance, including comparing our performance to other real estate
investment trusts. However, Comparative FFO and EBITDA as presented may not be
comparable to amounts calculated by other companies. This information should not
be considered as an alternative to net income, operating profit, cash from
operations, or any other operating or liquidity performance measure prescribed
by accounting principles generally accepted in the United States. Cash
expenditures for various long-term assets, interest expense (for EBITDA purposes
only) and other items have been, and will be incurred which are not reflected in
the EBITDA and Comparative FFO presentations.
We are the sole general partner in the Operating Partnership and as of June 14,
2002 and June 15, 2001 held approximately 90% and 92%, respectively, of the
outstanding OP Units. The $10 million and $26 million deducted from the
Comparative FFO for the twelve weeks ended June 14, 2002 and June 15, 2001,
respectively, and $16 million and $51 million for the twenty-four weeks ended
June 14, 2002 and June 15, 2001, respectively, represent the Comparative FFO
attributable to the interests in the Operating Partnership of those minority
partners. Additionally, the $30 million deducted from the EBITDA of Host
-20-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
LP for the twenty-four week period ended June 15, 2001 represents the
distributions made by the Company to the outside holders of the OP Units. No
distributions have been made during 2002. OP Units owned by holders other than
us are redeemable at the option of the holder, generally commencing one year
after the issuance of their OP Units. Upon redemption of an OP Unit, the holder
would receive from the Operating Partnership cash in an amount equal to the
market value of one share of our common stock, or at our option, a share of our
common stock.
Twelve Weeks Ended Twenty-four Weeks Ended
------------------------ ------------------------
June 14, June 15, June 14, June 15,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Income from continuing operations ............................ $ 24 $ 50 $ 12 $ 82
Effect on revenue of SAB 101 ............................... 1 8 2 15
Interest expense ........................................... 106 104 211 207
Dividends on Convertible Preferred Securities .............. 8 8 15 15
Depreciation and amortization .............................. 84 100 168 177
Minority interest expense .................................. 6 11 11 26
Income taxes ............................................... 11 12 15 15
Equity in (earnings) losses of affiliates .................. (1) (2) 3 (4)
Lease repurchase expense ................................... -- 5 -- 5
Other non-cash changes, net ................................ (1) 8 6 4
---------- ---------- ---------- ----------
EBITDA of Host LP ............................................ 238 304 443 542
Distributions to minority interest partners of Host LP .... -- (13) -- (30)
---------- ---------- ---------- ----------
EBITDA of Host REIT .......................................... $ 238 $ 291 $ 443 $ 512
========== ========== ========== ==========
EBITDA of Host LP ............................................ 238 304 443 542
Interest expense .......................................... (106) (104) (211) (207)
Dividends on convertible preferred securities ............. (8) (8) (15) (15)
Dividends on preferred stock .............................. (9) (9) (18) (14)
Income tax expense ........................................ (11) (12) (15) (15)
Effective impact of lease repurchase ...................... 3 3 6 3
Partnership adjustments and other ......................... 3 (6) (8) --
---------- ---------- ---------- ----------
Comparative Funds From Operations of Host LP
available to common unitholders ........................... 110 168 182 294
Comparative Funds From Operations of minority
partners of Host LP ..................................... (10) (26) (16) (51)
---------- ---------- ---------- ----------
Comparative Funds From Operations available to
common shareholders of Host REIT .......................... $ 100 $ 142 $ 166 $ 243
========== ========== ========== ==========
Our interest coverage ratio, defined as EBITDA divided by cash interest expense,
was 2.2 times and 2.5 times for the 2002 and 2001 twenty-four week periods,
respectively, and 2.0 times for full year 2001. The ratio of earnings to fixed
charges and preferred dividends was 1.2 to 1.0 in the second quarter of 2002
versus 1.5 to 1.0 in the second quarter of 2001. We reported a ratio of earnings
to fixed charges of 1.2 to 1.0 for the full year 2001.
-21-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Sensitivity
Historically, our debt has primarily been fixed rate, including all of our
outstanding senior notes. However, certain of our financial instruments are
sensitive to changes in interest rates, including our credit facility and the
mortgage debt on our Canadian properties. There were no amounts outstanding on
the credit facility during the second quarter and as of June 14, 2002. The
spread we pay over LIBOR on borrowings under the new credit facility will adjust
based on our leverage ratio. The Canadian mortgage debt, which is denominated in
US dollars and had a balance of $96.6 million at June 14, 2002, has an interest
rate based on LIBOR plus 275 basis points. The weighted average interest rate
for this mortgage debt was 4.7% for the twenty-four weeks ended June 14, 2002
and 5.5% for the year ended December 31, 2001.
Subsequent to the Series H senior note offering in December 2001, we entered
into an interest rate swap agreement that effectively converts our obligation
under the $450 million of indebtedness from a fixed rate to a floating rate
based on 30 day LIBOR plus 450 basis points. The swap became effective on
January 15, 2002 and matures in January 2007. A change in the LIBOR rate of 100
basis points will result in $4.5 million increase or decrease in interest
expense. The swap has been designated as a fair value hedge and changes in the
interest rate over the life of the agreement are recorded as an adjustment to
interest expense. Changes in the fair value of the swap and the notes are
reflected on the balance sheet as offsetting changes and have no income
statement effect.
During January of 2002, we purchased, for $3.5 million, a 5-year interest rate
cap with a notional amount of $450 million. The interest rate cap limits our
exposure under the Series H interest rate swap to the extent that the floating
rate we are required to pay under that agreement exceeds 14%. Changes in
interest rates will affect the fair value of the cap. The gains or losses from
the changes in the market value of the cap will be recorded in other income or
expense in the current period. The fair value of this cap has decreased during
2002 and we have recorded expenses of $2.2 million and $1.1 million for the
twenty-four weeks and twelve weeks ended June 14, 2002, respectively.
Exchange Rate Sensitivity
In connection with the mortgage debt discussed above, our Canadian subsidiaries
entered into currency forward contracts to hedge the currency exposure of
converting Canadian dollars to US dollars on a monthly basis to cover debt
service payments on the mortgage debt. This swap has been designated as a cash
flow hedge of the principal payments, and the forward contracts are recorded at
fair value on the balance sheet with offsetting changes recorded in accumulated
other comprehensive income. The fair value of the forward contracts was ($55)
thousand at June 14, 2002 and $1.5 million at December 31, 2001.
In addition, our hotels in Mexico have earnings that are denominated in pesos
while the debt obligations on these properties are denominated in dollars. We
have not hedged our currency risk in Mexico, however the peso has appreciated
significantly since our original investment in these hotels. To the extent that
the peso declines in value versus the dollar, some or all of the benefit due to
the appreciation of the peso may be offset. We are exploring refinancing the
debt on our hotels in Mexico, with the intent of replacing the current debt with
peso denominated debt. However, there can be no assurance that we be successful
in completing such a refinancing.
-22-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We believe all of the lawsuits in which we are a defendant are without
merit and we intend to defend vigorously against such claims; however, no
assurance can be given as to the outcome of any of the lawsuits. We do not
believe the outcome of any of the current lawsuits will materially effect our
financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Company held its Annual Meeting of Shareholders on May 16, 2002.
(c) (i) Votes regarding the election of one Director for a term expiring in
2005 were as follows:
Term expiring in 2005 FOR AGAINST WITHHELD
------------- ------- ---------
John G. Schreiber 226,010,422 0 1,793,223
(ii) Votes on a shareholder proposal that the Board of Directors take
the necessary steps to reinstate the election of all directors annually, instead
of the election of staggered classes were as follows:
ABSTENTIONS AND
FOR AGAINST BROKER NONVOTES
- ---------- ----------- ---------------
71,4455 123,037,013 1,324,039
(iii) Votes on a shareholder proposal that the Board of Directors take
the necessary steps to nominate at least two candidates for each open board
position were as follows:
FOR AGAINST ABSTENTIONS AND
- ---------- ----------- BROKER NONVOTES
---------------
5,491,772 187,678,919 2,683,816
(iv) Votes on a shareholder proposal that the Board of Directors take
the measures necessary to change the Company's jurisdiction of incorporation
from Maryland to Delaware were as follows:
FOR AGAINST ABSTENTIONS AND
- ---------- ----------- BROKER NONVOTES
---------------
38,659,040 155,675,350 1,520,117
-23-
Item 5. Other Items
RISK FACTORS
Risks of Ownership of Our Common Stock
There are limitations on the ability of investors to acquire our common stock
and to effect a change in control. Our charter and bylaws, the partnership
agreement of the Operating Partnership, our shareholder rights plan, the
Maryland General Corporation Law and certain contracts contain a number of
provisions that could delay, defer or prevent a transaction or a change in
control of us that might involve a premium price for our shareholders or
otherwise be in their best interests, including the following:
. Ownership limit. The 9.8% ownership limit described under "Risk
Factors--Risks of Ownership of Our Common Stock--There are possible
adverse consequences of limits on ownership of our common stock" may have
the effect of precluding a change in control of us by a third party
without the consent of our Board of Directors, even if the change in
control would be in the interests of our shareholders, and even if the
change in control would not reasonably jeopardize our REIT status.
. Staggered board. Our Board of Directors consists of seven director
positions, one of which is currently vacant, but our charter provides
that the number of our directors may be increased or decreased according
to our bylaws, provided that the total number of directors is not less
than three nor more than 13. Pursuant to our bylaws, the number of
directors will be fixed by our Board of Directors within the limits set
forth in our charter. Our Board of Directors is divided into three
classes of directors. Directors for each class are chosen for a
three-year term when the term of the current class expires. The staggered
terms for directors may affect our shareholders' ability to effect a
change in control of us, even if a change in control would be in the
interests of our shareholders.
. Removal of Board of Directors. Our charter provides that, except for any
directors who may be elected by holders of a class or series of shares of
capital stock other than our common stock, directors may be removed only
for cause and only by the affirmative vote of shareholders holding at
least two-thirds of our outstanding shares entitled to be cast for the
election of directors. Vacancies on the Board of Directors may be filled
by the concurring vote of a majority of the remaining directors and, in
the case of a vacancy resulting from the removal of a director by the
shareholders, by at least two-thirds of all the votes entitled to be cast
in the election of directors.
. Preferred shares; classification or reclassification of unissued shares
of capital stock without shareholder approval. Our charter provides that
the total number of shares of stock of all classes which we have
authority to issue is 800,000,000, initially consisting of 750,000,000
shares of common stock and 50,000,000 shares of preferred stock, of which
14,140,000 shares of preferred stock were issued and outstanding as of
July 15, 2002. Our Board of Directors has the authority, without a vote
of shareholders, to classify or reclassify any unissued shares of stock,
including common stock, into preferred stock, or vice versa, and to
establish the preferences and rights of any preferred or other class or
series of shares to be issued. The issuance of preferred shares or other
shares having special preferences or rights could delay or prevent a
change in control even if a change in control would be in the interests
of our shareholders. Because our Board of Directors has the power to
establish the preferences and rights of additional classes or series of
shares without a shareholder vote, our Board of Directors may give the
holders of any
-24-
class or series preferences, powers and rights, including voting rights,
senior to the rights of holders of our common stock.
. Consent rights of the limited partners. Under the partnership agreement
of the Operating Partnership, we generally will be able to merge or
consolidate with another entity with the consent of partners holding
percentage interests that are more than 50% of the aggregate percentage
interests of the outstanding limited partnership interests entitled to
vote on the merger or consolidation, including any limited partnership
interests held by us, as long as the holders of limited partnership
interests either receive or have the right to receive the same
consideration as our shareholders. We, as holder of a majority of the
limited partnership interests, would be able to control the vote. Under
our charter, holders of at least two-thirds of our outstanding shares of
common stock generally must approve the merger or consolidation.
. Maryland business combination law. Under the Maryland General Corporation
Law, specified "business combinations," including specified issuances of
equity securities, between a Maryland corporation and any person who owns
10% or more of the voting power of the corporation's then outstanding
shares, or an "interested shareholder," or an affiliate of the interested
shareholder are prohibited for five years after the most recent date in
which the interested shareholder becomes an interested shareholder.
Thereafter, any of these specified business combinations must be approved
by 80% of the outstanding voting shares, and by two-thirds of the voting
shares other than voting shares held by an interested shareholder unless,
among other conditions, the corporation's common shareholders receive a
minimum price, as defined in the Maryland General Corporation Law, for
their shares and the consideration is received in cash or in the same
form as previously paid by the interested shareholder. We are subject to
the Maryland business combination statute.
. Maryland control share acquisition law. Under the Maryland General
Corporation Law, "control shares" acquired in a "control share
acquisition" have no voting rights except to the extent approved by a
vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares owned by the acquiror and by officers or directors who
are employees of the corporation. "Control shares" are voting shares
which, if aggregated with all other voting shares previously acquired by
the acquiror or over which the acquiror is able to exercise or direct the
exercise of voting power (except solely by virtue of a revocable proxy),
would entitle the acquiror to exercise voting power in electing directors
within one of the following ranges of voting power: (1) one-fifth or more
but less than one-third, (2) one-third or more but less than a majority
or (3) a majority or more of the voting power. Control shares do not
include shares the acquiring person is then entitled to vote as a result
of having previously obtained shareholder approval. A "control share
acquisition" means the acquisition of control shares, subject to
specified exceptions. We are subject to these control share provisions of
Maryland law, subject to an exemption for Marriott International pursuant
to its purchase right discussed below. See "Risk Factors--Risks of
Ownership of Our Common Stock--There are limitations on the ability of
investors to acquire our common stock and to effect a change in
control--Marriott International purchase right".
. Merger, consolidation, share exchange and transfer of our assets.
Pursuant to our charter, subject to the terms of any outstanding class or
series of capital stock, we can merge with or into another entity,
consolidate with one or more other entities, participate in a share
exchange or transfer our assets within the meaning of the Maryland
General Corporation Law if approved (1) by our Board of Directors in the
manner provided in the Maryland General Corporation Law and (2) by our
shareholders holding two-thirds of all the votes entitled to be cast on
the matter, except that any merger of us with or into a trust organized
for the purpose of changing our form of organization from a corporation
to a trust requires only the approval of our shareholders
-25-
holding a majority of all votes entitled to be cast on the merger. Under
the Maryland General Corporation Law, specified mergers may be approved
without a vote of shareholders and a share exchange is only required to
be approved by a Maryland corporation by its Board of Directors. Our
voluntary dissolution also would require approval of shareholders holding
two-thirds of all the votes entitled to be cast on the matter.
. Amendments to our charter and bylaws. Our charter contains provisions
relating to restrictions on transferability of our common stock, the
classified Board of Directors, fixing the size of our Board of Directors
within the range set forth in our charter, removal of directors and the
filling of vacancies, all of which may be amended only by a resolution
adopted by the Board of Directors and approved by our shareholders
holding two-thirds of the votes entitled to be cast on the matter. As
permitted under the Maryland General Corporation Law, our charter and
bylaws provide that directors have the exclusive right to amend our
bylaws. Amendments of this provision of our charter also would require
action of our Board of Directors and approval by shareholders holding
two-thirds of all the votes entitled to be cast on the matter.
. Shareholder rights plan. We adopted a shareholder rights plan which
provides, among other things, that when specified events occur, our
shareholders will be entitled to purchase from us a newly created series
of junior preferred shares, subject to our ownership limit described
below. The preferred share purchase rights are triggered by the earlier
to occur of (1) ten days after the date of a public announcement that a
person or group acting in concert has acquired, or obtained the right to
acquire, beneficial ownership of 20% or more of our outstanding shares of
common stock or (2) ten business days after the commencement of or
announcement of an intention to make a tender offer or exchange offer,
the consummation of which would result in the acquiring persons becoming
the beneficial owner of 20% or more of our outstanding common stock. The
preferred share purchase rights would cause substantial dilution to a
person or group that attempts to acquire us on terms not approved by our
Board of Directors.
There are possible adverse consequences of limits on ownership of our common
stock. To maintain our qualification as a REIT for federal income tax purposes,
not more than 50% in value of our outstanding shares of capital stock may be
owned, directly or indirectly, by five or fewer individuals, as defined in the
Internal Revenue Code to include some entities. In addition, a person who owns,
directly or by attribution, 10% or more of an interest in a tenant of ours, or a
tenant of any partnership in which we are a partner, cannot own, directly or by
attribution, 10% or more of our shares without jeopardizing our qualification as
a REIT. Primarily to facilitate maintenance of our qualification as a REIT for
federal income tax purposes, the ownership limit under our charter prohibits
ownership, directly or by virtue of the attribution provisions of the Internal
Revenue Code, by any person or persons acting as a group, of more than 9.8% of
the issued and outstanding shares of our common stock, subject to an exception
for shares of our common stock held prior to our conversion into a REIT
(referred to as the "REIT
-26-
conversion") so long as the holder would not own more than 9.9% in value of our
outstanding shares after the REIT conversion, and prohibits ownership, directly
or by virtue of the attribution provisions of the Internal Revenue Code, by any
person, or persons acting as a group, of more than 9.8% of the issued and
outstanding shares of any class or series of our preferred shares. Together,
these limitations are referred to as the "ownership limit". Our Board of
Directors, in its sole and absolute discretion, may waive or modify the
ownership limit with respect to one or more persons who would not be treated as
"individuals" for purposes of the Internal Revenue Code if the Board of
Directors is satisfied, based upon information required to be provided by the
party seeking the waiver and, if it determines necessary or advisable, upon an
opinion of counsel satisfactory to our Board of Directors, that ownership in
excess of this limit will not cause a person who is an individual to be treated
as owning shares in excess of the ownership limit, applying the applicable
constructive ownership rules, and will not otherwise jeopardize our status as a
REIT for federal income tax purposes (for example, by causing any of our tenants
to be considered a "related party tenant" for purposes of the REIT qualification
rules). Common stock acquired or held in violation of the ownership limit will
be transferred automatically to a trust for the benefit of a designated
charitable beneficiary, and the person who acquired the common stock in
violation of the ownership limit will not be entitled to any distributions
thereon, to vote those shares of common stock or to receive any proceeds from
the subsequent sale of the common stock in excess of the lesser of the price
paid for the common stock or the amount realized from the sale. A transfer of
shares of our common stock to a person who, as a result of the transfer,
violates the ownership limit may be void under certain circumstances, and, in
any event, would deny that person any of the economic benefits of owning shares
of our common stock in excess of the ownership limit. The ownership limit may
have the effect of delaying, deferring or preventing a change in control and,
therefore, could adversely affect the shareholders' ability to realize a premium
over the then-prevailing market price for our common stock in connection with
such transaction.
We depend on external sources of capital for future growth and we may be unable
to access capital when necessary. As with other REITs, but unlike corporations
generally, our ability to reduce our debt and finance our growth largely must be
funded by external sources of capital because we generally are required to
distribute to our shareholders at least 90% of our taxable income in order to
qualify as a REIT, including taxable income we recognize for tax purposes but
with regard to which we do not receive corresponding cash. Our ability to access
the external capital we require could be hampered by a number of factors many of
which are outside of our control, including, without limitation, declining
general market conditions, unfavorable market perception of our growth
potential, decreases in our current and estimated future earnings, excessive
cash distributions or decreases in the market price of our common stock. In
addition, our ability to access additional capital may also be limited by the
terms of our existing indebtedness, which, among other things, restricts our
incurrence of debt and the payment of dividends. The occurrence of any of these
above-mentioned factors, individually or in combination, could prevent us from
being able to obtain the external capital we require on terms that are
acceptable to us or at all and the failure to obtain necessary external capital
could materially adversely affect our future growth.
Sales of shares of our common stock that are, or become, available for sale,
could adversely affect the price for shares of our common stock. Sales of a
substantial number of shares of our common stock, or the perception that sales
could occur, could adversely affect prevailing market prices for our common
stock. Holders of units of limited partnership interest in the Operating
Partnership (referred to as "OP Units") may redeem their OP Units for cash, or
at our discretion, for shares of our common stock. Holders who redeem their OP
Units and receive common stock upon redemption will be able to sell those shares
freely, unless the person is our affiliate and resale of the affiliate's shares
is not covered by an effective registration statement. As of July 15, 2002,
there were approximately 28.1 million OP Units outstanding (not including OP
Units held directly or indirectly by us), all of which are currently
-27-
redeemable by the holder for cash or, at our election, for an equivalent number
of shares of common stock. Further, a substantial number of shares of our common
stock have been and will be issued or reserved for issuance from time to time
under our employee benefit plans, including shares of our common stock reserved
for options, and these shares of common stock would be available for sale in the
public markets from time to time pursuant to exemptions from registration or
upon registration. Moreover, we may issue additional shares of our common stock
in the future. We can make no prediction about the effect that future sales of
our common stock would have on the market price of our common stock.
Our earnings and cash distributions will affect the market price of shares of
our common stock. We believe that the market value of a REIT's equity securities
is based primarily upon the market's perception of the REIT's growth potential
and its current and potential future cash distributions, whether from
operations, sales, acquisitions, development or refinancings, and is secondarily
based upon the value of the underlying assets. For that reason, shares of our
common stock may trade at prices that are higher or lower than the net asset
value per share. Our failure to meet the market's expectation with regard to
future earnings and cash distributions would likely adversely affect the market
price of our common stock.
Our future cash distributions on common stock may be limited by the terms of our
indebtedness and the terms of our preferred stock. In order to maintain our
status as a REIT, we are required to distribute to our stockholders at least 90%
of our taxable income. We may be limited in our ability to pay dividends on our
common stock in excess of the minimum amount necessary to maintain our REIT
status because of restrictions contained in our new bank credit facility and the
indenture governing substantially all of our senior notes. Under the terms of
our new bank credit facility and the senior notes indenture, distributions to us
by the Operating Partnership, which we depend upon in order to obtain the cash
necessary to pay dividends, are permitted only to the extent that, at the time
of the distributions, the Operating Partnership can satisfy certain financial
covenant tests and meet other requirements. For example, to make distributions
to us, the Operating Partnership must in general have a consolidated coverage
ratio (measuring the pro forma ratio of its consolidated EBITDA to its
consolidated interest expense over a trailing four-quarter period) of greater
than 2.0 to 1.0 in addition to satisfying other requirements. If it fails to
meet this requirement, the Operating Partnership will only be able to make
distributions to us, subject to compliance with certain other requirements, in
the amounts we need to pay to our stockholders in order to maintain our
qualification as a REIT. As of the beginning of the third quarter of 2002 we had
a consolidated coverage ratio of less than 2.0 to 1.0. As a result, until we
increase our ratio, and assuming it otherwise complies with the other terms of
our indebtedness, the Operating Partnership will only be able to distribute to
us enough cash to enable us to maintain our qualifications as a REIT.
Our ability to pay dividends on our common stock may be further limited by the
terms of our preferred stock. Under the terms of each of our class A, class B
and class C cumulative redeemable preferred stock, we are not permitted to pay
dividends on our common stock unless full cumulative dividends have been paid
(or funds for payment have been set apart for payment) on each such class of
preferred stock for all past dividend periods. Therefore, our ability to pay a
dividend on our common stock is subject to our having previously paid all
cumulative dividends accrued on our outstanding classes of preferred stock.
Since the issuance of each of our classes of preferred stock, all dividends on
our preferred stock have been paid when due and there are no dividends accrued
for prior quarters at this time.
In December 2001, in order to preserve cash flow and due to the uncertain
economic environment, our Board of Directors decided to temporarily suspend the
payment of dividends on our common stock, although we have continued to pay the
regular quarterly dividend on our preferred stock. Because we currently fail to
meet the consolidated coverage ratio discussed above under our new bank credit
facility and the senior notes indenture, we will be able to reinstate the
payment of dividends on our common stock only to the extent that the
distributions we are required to make to maintain our status as a REIT exceed
the cumulative dividends we are required to pay on our outstanding preferred
stock. If we continue to experience improvement in our operations, we expect to
be able to reinstate a minimal dividend on our common stock during the fourth
quarter of 2002. However, we cannot provide assurance that we will be able to
reinstate even a minimal dividend on our common stock and, when reinstated, we
expect
-28-
the amount of any such dividends to be meaningfully lower than the dividends we
have previously paid to holders of our common stock prior to the suspension of
such dividend payments.
Market interest rates may affect the price of shares of our common stock. We
believe that one of the factors that investors consider important in deciding
whether to buy or sell shares of a REIT is the distribution rate on the shares,
considered as a percentage of the price of the shares, relative to market
interest rates. If market interest rates increase, prospective purchasers of
REIT shares may expect a higher distribution rate. Thus, higher market interest
rates could cause the market price of our shares to go down.
Risks of Operation
Our revenues and the value of our properties are subject to conditions affecting
the lodging industry. Our revenues and the value of our properties are subject
to conditions affecting the lodging industry. These include:
. changes in the national, regional and local economic climate;
. reduced demand and increased operating costs and other conditions
resulting from recent terrorist attacks;
. changes in business and pleasure travel;
. local conditions such as an oversupply of hotel properties or a reduction
in demand for hotel rooms;
. the attractiveness of our hotels to consumers and competition from
comparable hotels;
. the quality, philosophy and performance of the managers of our hotels;
. changes in room rates and increases in operating costs due to inflation
and other factors; and
. the need to periodically repair and renovate our hotels.
As a result of continuing weak economic conditions resulting from the effects of
the September 11, 2001 terrorist attacks and the 2001 economic recession, the
lodging industry has experienced a significant decline in business caused by a
reduction in travel, particularly in the business transient segment. As a
result, room revenues of our hotels continued to decrease during the first and
second quarters of 2002 compared to the prior year results. For the twenty-four
weeks ended June 14, 2002, our comparable RevPAR decreased 11.0% from the same
period in 2001 due to a decrease in occupancy of 1.9 percentage points to 72.1%
combined with a decline in the average room rate of 8.6% to $148.15. We
currently expect that reduced operating levels, as compared with 2001, will
continue in the third quarter of 2002. We expect that fourth quarter operations
will improve when compared to prior year, as fourth quarter 2001 operations were
down significantly. There can be no assurance that the current weak economic
conditions will not continue for an extended period of time and that they will
not significantly affect our operations.
If, as a result of conditions such as those referenced above affecting the
lodging industry, our assets do not generate income sufficient to pay our
expenses, we will be unable to service our debt and maintain our properties.
-29-
Thirty of our hotels and assets related thereto are subject to various mortgages
in an aggregate amount of approximately $2.3 billion. Although generally the
debt is non-recourse to us and the Operating Partnership, if these hotels do not
produce adequate cash flow to service the debt secured by such mortgages, the
mortgage lenders could foreclose on such assets and we would lose such assets.
If the cash flow on such properties were not sufficient to provide us with an
adequate return, we could opt to allow such foreclosure rather than make
necessary mortgage payments with funds from other sources. However, we cannot
assure you that permitting any such foreclosure would not adversely affect our
long-term business prospects.
Our expenses may remain constant even if our revenue drops. The expenses of
owning property are not necessarily reduced when circumstances like market
factors and competition cause a reduction in income from the property. Because
of the current weak economic condition and continuing effects of the September
11, 2001 terrorist attacks, we have been working with our managers to
substantially reduce the operating costs of our hotels. While we have achieved
significant reductions in operating costs as a result of these efforts,
additional cost reductions could be difficult to achieve if operating levels
continue to decline, and some of the cost reductions achieved may eventually
need to be restored even if operations remain at reduced levels. In addition,
based on our assessment of the current operating environment, and in order to
conserve capital, we have reduced overall capital expenditure projects to levels
substantially lower than budgeted. Despite our efforts to reduce our expenses
and conserve our cash, our financial condition could be adversely affected by
the following costs:
. interest rate levels;
. debt service levels (including on loans secured by mortgages);
. the availability of financing;
. the cost of compliance with government regulation, including zoning and
tax laws; and
. changes in governmental regulations, including those governing usage,
zoning and taxes.
If we are unable to reduce our expenses to reflect our current reduction in
revenue and the reduction that we expect in the future, our business will be
adversely affected. Additionally, our efforts to reduce operating costs and our
failure to make scheduled capital expenditures could adversely affect the growth
of our business and the value of our hotel properties.
We do not control our hotel operations, and we are dependent on the managers of
our hotels. Because federal income tax laws restrict REITs and their
subsidiaries from operating a hotel, we do not manage our hotels. Instead, we
retain third-party managers including, among others, Marriott International,
Hyatt, Four Seasons and Swissotel, to manage our hotels pursuant to management
agreements. Our income from the hotels may be adversely affected if the managers
fail to provide quality services and amenities and competitive room rates at our
hotels or fail to maintain the quality of the hotel brand names. While HMT
Lessee LLC, a taxable REIT subsidiary of ours that is the lessee of
substantially all of our full-service properties, monitors the hotel managers'
performance, we have limited specific recourse if we believe that the hotel
managers are not performing adequately. Underperformance by our hotel managers
could adversely affect our results of operations.
Our relationships with our hotel managers are primarily contractual in nature,
although certain of our managers owe fiduciary duties to us under applicable
law. We are in discussions with various managers of our hotels regarding their
performance under management agreements for our hotels. We have had, and
continue to have, differences with the managers of our hotels over their
performance and compliance with the terms of our agreements. We generally
resolve issues with our managers through discussions
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and negotiations. However, if we are unable to reach satisfactory results
through discussions and negotiations, we also occasionally may engage in
litigation with our managers. For example, we are currently engaged in
litigation with Swissotel, the manager of four of our hotels. If we fail to
reach satisfactory resolution with respect to any disputes, the operation of our
hotels could be adversely affected.
On July 25, 2002, we finalized negotiations with Marriott International
concerning certain changes to the management and other agreements for our
Marriott-managed hotels. See "Management Discussion and Analysis of Results of
Operations and Financial Condition -- Recent Events" for additional disclosure.
Our relationship with Marriott International may result in conflicts of
interest. Marriott International, a public hotel management company, and its
affiliates, manages or franchises 110 of our 123 hotels. In addition, Marriott
International manages and in some cases may own or be invested in hotels that
compete with our hotels. As a result, Marriott International may make decisions
regarding competing lodging facilities that it manages that would not
necessarily be in our best interests. Prior to the departure of J. W. Marriott,
Jr. from our board at the end of his term in May of 2002 and Richard E.
Marriott's resignation from the board of Marriott International in May of 2002
and during the period that we entered into most of our management agreements and
other arrangements with Marriott International, Richard E. Marriott was our
Chairman of the Board and a director of Marriott International and his brother,
J. W. Marriott, Jr., was a member of our Board of Directors and served as a
director and executive officer of Marriott International, and as a result, both
had potential conflicts of interest as our directors when making decisions
regarding Marriott International, including decisions relating to the management
agreements involving our hotels and Marriott International's management of
competing lodging properties. J. W. Marriott, Jr. and Richard E. Marriott
beneficially owned, as determined for securities law purposes, as of January 31,
2002, approximately 12.7% and 12.3%, respectively, of the outstanding shares of
common stock of Marriott International. During this period, our Board of
Directors followed policies and procedures intended to limit the involvement of
J. W. Marriott, Jr. and Richard E. Marriott in conflict situations, including
requiring them to abstain from voting as directors in matters that presented a
conflict between the companies.
We have substantial leverage. We have a significant amount of indebtedness,
which could have important consequences. It currently requires us to dedicate a
substantial portion of our cash flow from operations to payments on our
indebtedness, which reduces the availability of our cash flow to fund working
capital, capital expenditures, expansion efforts, distributions to our
shareholders and other general purposes. Additionally, it could:
. limit our ability in the future to undertake refinancings of our debt or
obtain financing for expenditures, acquisitions, development or other
general business purposes on terms and conditions acceptable to us, if at
all; or
. affect adversely our ability to compete effectively or operate
successfully under adverse economic conditions.
If our cash flow and working capital were not sufficient to fund our
expenditures or service our indebtedness, we would have to raise additional
funds through:
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. the sale of our equity;
. the incurrence of additional permitted indebtedness; or
. the sale of our assets.
We cannot assure you that any of these sources of funds would be available to us
or, if available, would be on terms that we would find acceptable or in amounts
sufficient for us to meet our obligations or fulfill our business plan.
There is no charter or bylaw restriction on the amount of debt we may incur.
There are no restrictions in our organizational documents that limit the amount
of indebtedness that we may incur. However, our existing debt instruments
contain restrictions on the amount of indebtedness that we may incur. If we
became more highly leveraged, our debt service payments would increase and our
cash flow and our ability to service our debt and other obligations might be
adversely affected.
The terms of our debt place restrictions on us and our subsidiaries, reducing
operational flexibility and creating default risks. The documents governing the
terms of our senior notes and new bank credit facility contain covenants that
place restrictions on us and our subsidiaries. The activities upon which such
restrictions exist include, but are not limited to:
. acquisitions, merger and consolidations;
. the incurrence of additional debt;
. the creation of liens;
. the sale of assets;
. capital expenditures;
. the payment of dividends; and
. transactions with affiliates.
In addition, certain covenants in our new bank credit facility and the senior
notes indenture require us and our subsidiaries, as a condition to engaging in
certain activities, to meet financial performance tests. These restrictive
covenants, together with other restrictive covenants in the documents governing
our other debt (including our mortgage debt), will reduce our flexibility in
conducting our operations and will limit our ability to engage in activities
that may be in our long-term best interest. In addition, certain covenants in
our new bank credit facility and the senior notes indenture require us to meet
financial performance tests at all times without regard to the activities in
which we engage. Our failure to comply with these restrictive covenants could
result in an event of default that, if not cured or waived, could result in the
acceleration of all or a substantial portion of our debt or a significant
increase in the interest rates on our debt, either of which could adversely
affect our operations and ability to maintain adequate liquidity.
Certain financial covenants under the documents governing our indebtedness limit
our ability to engage in activities that may be in our long-term best interest.
Under the terms of our new bank credit facility and the indenture pursuant to
which nearly all of our outstanding senior notes were issued, we and our
subsidiaries are generally prohibited from incurring additional indebtedness
unless, at the time of such incurrence, we would satisfy certain requirements
set
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forth therein, including the consolidated coverage ratio as discussed above. As
a result of the effects on our business of the 2001 economic recession and the
September 11, 2001 terrorist attacks and the continuing weak economic climate,
our consolidated coverage ratio calculated beginning in the third quarter was
less than 2.0 to 1.0. Because our consolidated coverage ratio is below this
level, the terms of our indebtedness will prohibit us from incurring
indebtedness other than the incurrence of amounts under our credit facility and
the incurrence of debt in connection with refinancings. Our failure to maintain
a consolidated coverage ratio that is greater than 2.0 to 1.0 also limits our
ability to reinstate the payment of dividends on our common stock as described
in "Risk Factors -- Risks of Ownership of Our Common Stock: Our future cash
distributions may be limited by the terms of our indebtedness and the terms of
our preferred stock." The restriction imposed by this covenant may limit our
ability to engage in activities that may be in our long-term best interest.
Our management agreements could impair the sale or financing of our hotels.
Under the terms of the management agreements, we generally may not sell, lease
or otherwise transfer the hotels unless the transferee is not a competitor of
the manager, and the transferee assumes the related management agreements and
meets specified other conditions. Our ability to finance, refinance or sell any
of the properties may, depending upon the structure of such transactions,
require the manager's consent. If the manager does not consent, we would be
prohibited from financing, refinancing or selling the property without breaching
the management agreement.
The acquisition contracts relating to some hotels limit our ability to sell or
refinance those hotels. For reasons relating to federal income tax
considerations of the former and current owners of approximately 20 of our
full-service hotels, we agreed to restrictions on selling some hotels or
repaying or refinancing the mortgage debt on those hotels for varying periods
depending on the hotel. We anticipate that, in specified circumstances, we may
agree to similar restrictions in connection with future hotel acquisitions. As a
result, even if it were in our best interests to sell or refinance the mortgage
debt on these hotels, it may be difficult or impossible to do so during their
respective lock-out periods.
Our ground lease payments may increase faster than the revenues we receive on
the hotels. As of June 1, 2002, 45 of our hotels are subject to ground leases
(including the New York World Trade Center Marriott hotel ground lease which is
still in effect). These ground leases generally require increases in ground rent
payments every five years. Our ability to service our debt could be adversely
affected to the extent that our revenues do not increase at the same or a
greater rate as the increases under the ground leases. In addition, if we were
to sell a hotel encumbered by a ground lease, the buyer would have to assume the
ground lease, which could result in a lower sales price. Moreover, to the extent
that such ground leases are not renewed at their expiration, our revenues could
be adversely affected.
We may be unable to sell properties when appropriate because real estate
investments are illiquid. Real estate investments generally cannot be sold
quickly. We may not be able to vary our portfolio promptly in response to
economic or other conditions. The inability to respond promptly to changes in
the performance of our investments could adversely affect our financial
condition and ability to service debt. In addition, there are limitations under
the federal tax laws applicable to REITs and agreements that we have entered
into when we acquired some of our properties that may limit our ability to
recognize the full economic benefit from a sale of our assets.
We depend on our key personnel. We depend on the efforts of our executive
officers and other key personnel. While we believe that we could find
replacements for these key personnel, the loss of their services could have a
significant adverse effect on our operations. None of our key personnel have
employment agreements. We do not have or intend to obtain key-man life insurance
with respect to any of our personnel.
Partnership and other litigation judgments or settlements could have a material
adverse effect on our financial condition. We are a party to various lawsuits
relating to previous partnership transactions,
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including transactions relating to our conversion into a REIT. While we and the
other defendants to such lawsuits believe all of the lawsuits in which we are a
defendant are without merit and we are vigorously defending against such claims,
we can give no assurance as to the outcome of any of the lawsuits. If any of the
lawsuits were to be determined adversely to us or a settlement involving a
payment of a material sum of money were to occur, there could be a material
adverse effect on our financial condition.
We may acquire hotel properties through joint ventures with third parties that
could result in conflicts. Instead of purchasing hotel properties directly, we
may invest as a co-venturer. Joint venturers often share control over the
operation of the joint venture assets. For example, through our subsidiary
Rockledge, we entered into a joint venture with Marriott International that owns
two limited partnerships holding, in the aggregate, 120 Courtyard by Marriott
hotels. Subsidiaries of Marriott International manage these Courtyard by
Marriott hotels. Actions by a co-venturer, particularly Marriott International,
could subject the assets to additional risk, including:
. our co-venturer in an investment might have economic or business
interests or goals that are inconsistent with our interests or goals;
. our co-venturer may be in a position to take action contrary to our
instructions or requests or contrary to our policies or objectives; or
. a joint venture partner could go bankrupt, leaving us liable for its
share of joint venture liabilities.
Although we generally will seek to maintain sufficient control of any joint
venture to permit our objectives to be achieved, we might not be able to take
action without the approval of our joint venture partners. Also, our joint
venture partners could take actions binding on the joint venture without our
consent. For further discussion of the risks associated with entering into a
joint venture with Marriott International, see the discussion above under "Our
relationship with Marriott International may result in conflicts of interest."
Environmental problems are possible and can be costly. We believe that our
properties are in compliance in all material respects with applicable
environmental laws. Unidentified environmental liabilities could arise, however,
and could have a material adverse effect on our financial condition and
performance. Federal, state and local laws and regulations relating to the
protection of the environment may require a current or previous owner or
operator of real estate to investigate and clean up hazardous or toxic
substances or petroleum product releases at the property. The owner or operator
may have to pay a governmental entity or third parties for property damage and
for investigation and clean-up costs incurred by the parties in connection with
the contamination. These laws typically impose clean-up responsibility and
liability without regard to whether the owner or operator knew of or caused the
presence of the contaminants. Even if more than one person may have been
responsible for the contamination, each person covered by the environmental laws
may be held responsible for all of the clean-up costs incurred. In addition,
third parties may sue the owner or operator of a site for damages and costs
resulting from environmental contamination emanating from that site.
Environmental laws also govern the presence, maintenance and removal of
asbestos. These laws require that owners or operators of buildings containing
asbestos properly manage and maintain the asbestos, that they notify and train
those who may come into contact with asbestos and that they undertake special
precautions, including removal or other abatement, if asbestos would be
disturbed during renovation or demolition of a building. These laws may impose
fines and penalties on building owners or operators who fail to comply with
these requirements and may allow third parties to seek recovery from owners or
operators for personal injury associated with exposure to asbestos fibers.
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Compliance with other government regulations can be costly. Our hotels are
subject to various other forms of regulation, including Title III of the
Americans with Disabilities Act, building codes and regulations pertaining to
fire safety. Compliance with those laws and regulations could require
substantial capital expenditures. These regulations may be changed from time to
time, or new regulations adopted, resulting in additional or unexpected costs of
compliance. Any increased costs could have a material adverse effect on our
business, financial condition or results of operations.
Recent or future terrorist attacks could adversely affect us. On September 11,
2001, several aircraft that were hijacked by terrorists destroyed the World
Trade Center Towers in New York City and damaged the Pentagon in northern
Virginia. As a result of the attacks and the collapse of the World Trade Center
Towers, our New York World Trade Center Marriott hotel was destroyed and we
sustained considerable damage to our New York Marriott Financial Center hotel.
Subsequent to the attacks, the Federal Aviation Administration closed United
States airspace to commercial traffic for several days. The aftermath of these
events, together with an economic recession, has adversely affected the travel
and hospitality industries, including the full-service hotel industry. The
impact which these terrorist attacks, or future events such as military or
police activities in the United States or foreign countries, future terrorist
activities or threats of such activities, biological or chemical weapons
attacks, political unrest and instability, interruptions in transportation
infrastructure, riots and protests, could have on our business in particular and
the United States economy, the global economy, and global financial markets in
general cannot presently be determined. It is possible that these factors could
have a material adverse effect on our business, our ability to finance our
business, our ability to insure our properties (see "We may not be able to
recover fully under our prior terrorism insurance or be able maintain terrorism
insurance in adequate amounts or at acceptable premium levels" below), and on
our financial condition and results of operations as a whole.
Some potential losses are not covered by insurance. We carry comprehensive
insurance coverage for general liability, property, business interruption and
other risks with respect to all of our hotels and other properties. These
policies offer coverage features and insured limits that we believe are
customary for similar type properties. Generally, our policies provide that
coverage is available on a per occurrence basis and that for each occurrence
there is an overall limit as well as various sub-limits on the amount of
insurance proceeds we can receive. Sub-limits exist for certain types of claims
such as service interruption, abatement, expediting costs or landscaping
replacement, and the dollar amounts of these sub-limits are significantly lower
than the dollar amounts of the overall coverage limit. Our policies also provide
that all of the claims from each of our properties resulting from a particular
insurable event, must be combined together for purposes of evaluating whether
the aggregate limits and sub-limits contained in our policies have been exceeded
and, in the case of our Marriott-managed hotels, any such claims will also be
combined with the claims of other owners of Marriott-managed hotels for the same
purpose. That means that if an insurable event occurs that affects more than one
of our hotels, or in the case of Marriott-managed hotels, affects other
Marriott-managed hotels, the claims from each affected hotel will be added
together to determine whether the aggregate limit or sub-limits, depending on
the type of claim, have been reached and each affected hotel will only receive
its share of the amount of insurance proceeds provided for under the policy. We
may incur losses in excess of insured limits and, as a result of shared limits,
we may be even less likely to receive sufficient coverage for risks that affect
multiple properties such as earthquakes or certain types of terrorism. In
addition, there are other risks such as war, some other forms of terrorism such
as nuclear or biological terrorism and some environmental hazards that may be
deemed to fall completely outside the general coverage limits of our policies or
may be uninsurable or may be too expensive to justify insuring against. If any
such risk were to materialize and materially adversely affect one or more of our
properties, we would not be able to recover any of our losses.
We may also encounter challenges with our insurance provider regarding whether a
particular claim is covered under our policy. Should a loss in excess of insured
limits or an uninsured loss occur or should
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we be unsuccessful in obtaining coverage from an insurance carrier, 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 hotel. In that event, we might
nevertheless remain obligated for any mortgage debt or other financial
obligations related to the property.
We may not be able to recover fully under our prior terrorism insurance or be
able to maintain terrorism insurance in adequate amounts or at acceptable
premium levels in the future. As discussed above in "Recent or future terrorist
attacks could adversely affect us," on September 11, 2001, terrorist attacks on
the World Trade Center Towers in New York City resulted in the destruction of
our New York World Trade Center Marriott hotel and caused considerable damage to
our New York Marriott Financial Center hotel. Although we had, through our
manager Marriott International, both property and business interruption
insurance with a major insurer for our two affected hotels from which we expect
to receive proceeds to cover all or a substantial portion of the losses at both
hotels, we cannot currently determine the amount or timing of those payments.
Under the terms of the New York World Trade Center Marriott ground lease, any
proceeds from the property portion of the hotel claim are required to be placed
in an insurance trust for the exclusive purpose of rebuilding the hotel. As of
July 1, 2002, we had received business interruption and property advances from
our insurers in an aggregate amount of $40 million of which approximately $5
million was for property insurance proceeds relating to the two hotels. If the
amount of such insurance proceeds is substantially less than our actual losses
or if the payments are substantially delayed, it could have a material adverse
effect on our business.
In addition, as a result of the September 11, 2001 terrorist attacks, most
insurers have ceased offering terrorism coverage in conjunction with "all-risk"
property policies (described below), and separate terrorism insurance policies
are available only in limited coverage amounts and at expensive premium levels.
We have procured terrorism coverage that excludes various risks, such as nuclear
or biological acts, and is subject to annual aggregate limits which are shared
among various hotels as described above. Because we have only been able to
obtain limited amounts of terrorism insurance and due to the shared limits with
other owners, we may be exposed to reduced coverage levels in the event another
owner experiences a catastrophic loss. Furthermore, for a limited number of our
properties, the terrorism coverage we have procured is limited to less than full
replacement costs, even if the full coverage is available. As a result, there
can be no assurance that we would receive full replacement value for any of our
properties damaged or destroyed in future terrorist attacks.
We may be unable to satisfy the insurance requirements of our lenders given the
changes in the insurance industry after the terrorist attacks of September 11,
2001. Pursuant to the terms of many of our mortgage agreements, we have been and
are required to maintain adequate or full replacement cost "all-risk" property
insurance and, in some instances, terrorism insurance. In the months following
the terrorist attacks of September 11, 2001, our policies in effect during the
time of the terrorist attacks expired and we recently completed renewals of the
all-risk property insurance policies for nearly all of our hotels. However,
because of the terrorist attacks, most insurers have ceased offering terrorism
coverage in conjunction with "all-risk" property policies. As a result, the
"all-risk" property insurance on our properties may not be considered acceptable
to mortgage lenders. While these policies generally provide full replacement
cost and full business interruption coverage for our properties, our new
coverage is subject to substantial limits on a per-occurrence basis and other
exclusions, including certain risks of terrorism. Should our lenders or mortgage
servicers deem our insurance coverage to be inadequate, we could be forced to
procure additional insurance, if available, at cost levels that might be
unacceptable to us, and to the extent that insurance premiums remain at their
current levels and/or coverage remains limited, it could become more difficult
or more expensive to obtain similar financing in the future.
In addition, our debt agreements typically require us to maintain a minimum
rating of our insurance carrier from Standard & Poors, A.M. Best or other rating
agencies. Currently, we do not satisfy the requirement for a minimum Standard &
Poors rating of AA for seven of our properties subject to approximately $739
million of indebtedness. We have notified our lenders regarding this situation,
and we have obtained, for certain of our Marriott-managed properties that have
mortgage debt, insurance coverage provided by a carrier with a rating from
Standard & Poors of AA- and a rating from A.M. Best of A+XV. However, we cannot
assure you that each of our lenders will be satisfied with the AA- rating level
of our current carrier. If the lenders are unwilling or unable to amend or waive
these covenants, or if we are unable to obtain insurance coverage that complies
with the covenants in these loan agreements the lenders may determine that we
are out of compliance with the terms of the relevant debt agreement in which
case to the extent the lenders chose to pursue their remedies and we were unable
to prevent this course of action we may be required to refinance the debt, with
debt carrying different insurance requirements. There can be no assurances that
we will be able to complete such a refinancing on terms acceptable to us or at
all.
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Our former independent public accountant Arthur Andersen LLP is likely to cease
operating after having been found guilty of federal obstruction of justice
charges arising from the government's investigation of Enron Corporation and, as
a result, it is unlikely that you will be able to exercise effective remedies
against them in any future legal action. Our consolidated financial statements
as of and for each of the three years in the period ended December 31, 2001 were
audited by Arthur Andersen LLP. On March 14, 2002, Andersen was indicted on
federal obstruction of justice charges arising from the government's
investigation of Enron Corporation. On June 15, 2002, a jury in Houston, Texas
found Arthur Andersen LLP guilty of federal obstruction of justice charges
arising from the federal government's investigation of Enron Corp. In light of
the jury verdict and the underlying events, Arthur Andersen LLP has informed the
Securities and Exchange Commission that it will cease practicing before the SEC
by August 31, 2002, unless the SEC determines another date is appropriate. A
substantial number of Arthur Andersen LLP's personnel have already left the
firm, and substantially all remaining personnel are expected to do so in the
near future. Because of the significant decline in their size and the
possibility that they will cease to operate, you are unlikely to be able to
exercise effective remedies or collect judgments against them.
Moreover, as a public company, we are required to file with the SEC periodic
financial statements audited or reviewed by an independent public accountant.
The SEC has said that it will continue accepting financial statements audited by
Arthur Andersen LLP on an interim basis if Arthur Andersen LLP is able to make
certain representations to its clients concerning audit quality controls. Arthur
Andersen LLP has made such representations to us. However, for the reasons noted
above, Arthur Andersen LLP may be unable to make these representations in the
future or to provide other information or documents that would customarily be
received by us or the underwriters in connection with this offering, including
consents and "comfort letters". In addition, Arthur Andersen LLP may be unable
to perform procedures to assure the continued accuracy of its report on our
audited financial statements included in this prospectus. Arthur Andersen LLP
will be unable to provide such information and documents and perform such
procedures in future financings and other transactions. As a result, we may
encounter delays, additional expense and other difficulties in this offering,
future financings or other transactions.
Federal Income Tax Risks
We are required to make certain distributions to qualify as a REIT but may not
have sufficient cash available for distribution from operations. To continue to
qualify as a REIT, we currently are required to distribute to our shareholders
with respect to each year at least 90% of our taxable income, excluding net
capital gain, irrespective of our available cash or outstanding obligations. In
addition, we will be subject to a 4% nondeductible excise tax on the amount, if
any, by which distributions made by us with respect to the calendar year are
less than the sum of 85% of our ordinary income and 95% of our capital gain net
income for that year and any undistributed taxable income from prior periods. We
intend to make distributions to our shareholders to comply with the distribution
requirement and to avoid the nondeductible excise tax and will rely for this
purpose on distributions from the Operating Partnership. However, there are
differences in timing between our recognition of taxable income and our receipt
of cash available for distribution due to, among other things, the seasonality
of the lodging industry and the
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fact that some taxable income will be "phantom" income, which is taxable income
that is not matched by cash flow, or EBITDA, to us. Due to some transactions
entered into in years prior to the REIT conversion, we expect to recognize
substantial amounts of "phantom" income. There is a distinct possibility that
these timing differences could require us to borrow funds or to issue additional
equity to enable us to meet the distribution requirement and, therefore, to
maintain our REIT status, and to avoid the nondeductible excise tax. In
addition, because the REIT distribution requirements prevent us from retaining
earnings, we will generally be required to refinance debt that matures with
additional debt or equity. We cannot assure you that any of these sources of
funds, if available at all, would be sufficient to meet our distribution and tax
obligations.
Adverse tax consequences would apply if we failed to qualify as a REIT. We
believe that we have been organized and have operated in such a manner so as to
qualify as a REIT under the Internal Revenue Code, commencing with our taxable
year beginning January 1, 1999, and we currently intend to continue to operate
as a REIT during future years. No assurance can be provided, however, that we
qualify as a REIT or that new legislation, Treasury Regulations, administrative
interpretations or court decisions will not significantly change the tax laws
with respect to our qualification as a REIT or the federal income tax
consequences of our REIT qualification. If we fail to qualify as a REIT, we will
be subject to federal and state income tax, including any applicable alternative
minimum tax, on our taxable income at regular corporate rates. In addition,
unless entitled to statutory relief, we would not qualify as a REIT for the four
taxable years following the year during which REIT qualification is lost. The
additional tax burden on us would significantly reduce the cash available for
distribution by us to our shareholders, and we would no longer be required to
make any distributions to shareholders. Our failure to qualify as a REIT could
reduce materially the value of our common stock and would cause any
distributions to shareholders that otherwise would have been subject to tax as
capital gain dividends to be taxable as ordinary income to the extent of our
current and accumulated earnings and profits, or "E&P". However, subject to
limitations under the Internal Revenue Code, corporate distributees may be
eligible for the dividends received deduction with respect to our distributions.
Our failure to qualify as a REIT also would cause an event of default under our
new bank credit facility that could lead to an acceleration of the amounts due
under the new bank credit facility, which, in turn, would constitute an event of
default under our outstanding debt securities.
We will be disqualified as a REIT at least for taxable year 1999 if we failed to
distribute all of our E&P attributable to our non-REIT taxable years. In order
to qualify as a REIT, we cannot have at the end of any taxable year any
undistributed E&P that is attributable to one of our non-REIT taxable years. A
REIT has until the close of its first taxable year as a REIT in which it has
non-REIT E&P to distribute its accumulated E&P. We were required to have
distributed this E&P prior to the end of 1999, the first taxable year for which
our REIT election was effective. If we failed to do this, we will be
disqualified as a REIT at least for taxable year 1999. We believe that
distributions of non-REIT E&P that we made were sufficient to distribute all of
the non-REIT E&P as of December 31, 1999, but we cannot guarantee that we met
this requirement.
If our leases are not respected as true leases for federal income tax purposes,
we would fail to qualify as a REIT. To qualify as a REIT, we must satisfy two
gross income tests, under which specified percentages of our gross income must
be passive income, like rent. For the rent paid pursuant to the leases, which
constitutes substantially all of our gross income, to qualify for purposes of
the gross income tests, the leases must be respected as true leases for federal
income tax purposes and not be treated as service contracts, joint ventures or
some other type of arrangement. In addition, the lessees must not be regarded as
"related party tenants," as defined in the Internal Revenue Code. We believe
that the leases will be respected as true leases for federal income tax
purposes. There can be no assurance, however, that the IRS will agree with this
view. We also believe that Crestline Capital Corporation, the lessee of
substantially all of our full-service hotels prior to January 1, 2001, was not a
"related party
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tenant" and, as a result of changes in the tax laws effective January 1, 2001,
HMT Lessee will not be treated as a "related party tenant" so long as it
qualifies as a "taxable REIT subsidiary". If the leases were not respected as
true leases for federal income tax purposes or if the lessees were regarded as
"related party tenants," we would not be able to satisfy either of the two gross
income tests applicable to REITs and we would lose our REIT status. See "Risk
Factors--Federal Income Tax Risks--Adverse tax consequences would apply if we
failed to qualify as a REIT" above.
If HMT Lessee fails to qualify as a taxable REIT subsidiary, we would fail to
qualify as a REIT. For our taxable years beginning on and after January 1, 2001,
as a result of REIT tax law changes under the specific provisions of the Ticket
to Work and Work Incentives Improvement Act of 1999 relating to REITs (we refer
to those provisions as the "REIT Modernization Act"), we are permitted to lease
our hotels to a subsidiary of the Operating Partnership that is taxable as a
corporation and that elects to be treated as a "taxable REIT subsidiary."
Accordingly, as of July 1, 2002, HMT Lessee has directly or indirectly acquired
all the full-service hotel leasehold interests from third parties. So long as
HMT Lessee and other affiliated lessees qualify as taxable REIT subsidiaries of
ours, they will not be treated as "related party tenants." We believe that HMT
Lessee qualifies to be treated as a taxable REIT subsidiary for federal income
tax purposes. We cannot assure you, however, that the IRS will not challenge its
status as a taxable REIT subsidiary for federal income tax purposes, or that a
court would not sustain such a challenge. If the IRS were successful in
disqualifying HMT Lessee from treatment as a taxable REIT subsidiary, we would
fail to meet the asset tests applicable to REITs and substantially all of our
income would fail to qualify for the gross income tests and, accordingly, we
would cease to qualify as a REIT. See "Risk Factors--Federal Income Tax
Risks--Adverse tax consequences would apply if we failed to qualify as a REIT"
above.
Despite our REIT status, we remain subject to various taxes, including
substantial deferred and contingent tax liabilities. Notwithstanding our status
as a REIT, we are subject, through our ownership interest in the Operating
Partnership, to certain federal, state, local and foreign taxes on our income
and property. In addition, we will be required to pay federal tax at the highest
regular corporate rate upon our share of any "built-in gain" recognized as a
result of any sale before January 1, 2009, by the Operating Partnership and its
non-corporate subsidiaries of assets, including the hotels, in which interests
were acquired by the Operating Partnership from our predecessor and its
subsidiaries as part of the REIT conversion. Built-in gain is the amount by
which an asset's fair market value exceeded our adjusted basis in the asset on
January 1, 1999, the first day of our first taxable year as a REIT. The total
amount of gain on which we would be subject to corporate income tax if the
assets that we held at the time of the REIT conversion were sold in a taxable
transaction prior to January 1, 2009 would be material to us. In addition, at
the time of the REIT conversion, we expected that we or Rockledge Hotel
Properties, Inc. or Fernwood Hotel Assets, Inc. (each of which is a taxable
corporation in which the Operating Partnership owned a 95% nonvoting interest
and, as of April, 2001, acquired the remaining 5% voting interest) likely would
recognize substantial built-in gain and deferred tax liabilities in the next ten
years without any corresponding receipt of cash by us or the Operating
Partnership. We may have to pay certain state income taxes because not all
states treat REITs the same as they are treated for federal income tax purposes.
We may also have to pay certain foreign taxes to the extent we own assets or
conduct operations in foreign jurisdictions. The Operating Partnership is
obligated under its partnership agreement to pay all such taxes (and any related
interest and penalties) incurred by us, as well as any liabilities that the IRS
successfully may assert against us for corporate income taxes for taxable years
prior to the time we qualified as a REIT. Our taxable REIT subsidiaries,
including Rockledge, Fernwood and HMT Lessee, are taxable as corporations and
will pay federal, state and local income tax on their net income at the
applicable corporate rates, and foreign taxes to the extent they own assets or
conduct operations in foreign jurisdictions.
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If the IRS were to challenge successfully the Operating Partnership's status as
a partnership for federal income tax purposes, we would cease to qualify as a
REIT and suffer other adverse consequences. We believe that the Operating
Partnership qualifies to be treated as a partnership for federal income tax
purposes. As a partnership, it is not subject to federal income tax on its
income. Instead, each of its partners, including us, is required to recognize
its allocable share of the Operating Partnership's income. No assurance can be
provided, however, that the IRS will not challenge its status as a partnership
for federal income tax purposes, or that a court would not sustain such a
challenge. If the IRS were successful in treating the Operating Partnership as a
corporation for tax purposes, we would fail to meet the income tests and certain
of the asset tests applicable to REITs and, accordingly, cease to qualify as a
REIT. If we fail to qualify as a REIT, such failure would cause an event of
default under our new bank credit facility that, in turn, could constitute an
event of default under our outstanding debt securities. Also, the failure of the
Operating Partnership to qualify as a partnership would cause it to become
subject to federal and state corporate income tax, which would reduce
significantly the amount of cash available for debt service and for distribution
to its partners, including us. Finally, the classification of the Operating
Partnership as a corporation would cause us to recognize gain at least equal to
our "negative capital account," if any.
As a REIT, we are subject to limitations on our ownership of debt and equity
securities. Subject to the exceptions discussed in this paragraph, a REIT is
prohibited from owning securities in any one issuer to the extent that the value
of those securities exceeds 5% of the value of the REIT's total assets, or the
securities owned by the REIT represent more than 10% of the issuer's outstanding
voting securities or more than 10% of the value of the issuer's outstanding
securities. A REIT is permitted to own securities of a subsidiary in an amount
that exceeds the 5% value test and the 10% vote or value test if the subsidiary
elects to be a "taxable REIT subsidiary," which is taxable as a corporation.
However, a REIT may not own securities of taxable REIT subsidiaries that
represent in the aggregate more than 20% of the value of the REIT's total
assets. Effective January 1, 2001, each of Fernwood, Rockledge and HMT Lessee
elected to be treated as a taxable REIT subsidiary.
Our taxable REIT subsidiaries are subject to special rules that may result in
increased taxes. Several Internal Revenue Code provisions ensure that a taxable
REIT subsidiary is subject to an appropriate level of federal income taxation.
For example, a taxable REIT subsidiary is limited in its ability to deduct
interest payments made to an affiliated REIT. In addition, the REIT has to pay a
100% penalty tax on some payments that it receives if the economic arrangements
between the REIT and the taxable REIT subsidiary are not comparable to similar
arrangements between unrelated parties.
We may be required to pay a penalty tax upon the sale of a hotel. The federal
income tax provisions applicable to REITs provide that any gain realized by a
REIT on the sale of property held as inventory or other property held primarily
for sale to customers in the ordinary course of business is treated as income
from a "prohibited transaction" that is subject to a 100% penalty tax. Under
existing law, whether property, including hotels, is held as inventory or
primarily for sale to customers in the ordinary course of business is a question
of fact that depends upon all of the facts and circumstances with respect to the
particular transaction. The Operating Partnership intends that it and its
subsidiaries will hold the hotels for investment with a view to long-term
appreciation, to engage in the business of acquiring and owning hotels and to
make occasional sales of hotels as are consistent with the Operating
Partnership's investment objectives. We cannot assure you, however, that the IRS
might not contend that one or more of these sales is subject to the 100% penalty
tax.
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Item 6b. Reports on Form 8-K
(b) Reports on Form 8-K.
.. February 8, 2002 - The Company updated its disclosure relating to real
estate investment trusts federal tax considerations.
.. May 24, 2002 - The Company announced that upon the recommendation of its
Audit Committee, the Board of Directors had dismissed Arthur Andersen LLP
as its independent auditor and appointed KPMG, LLP to serve as the
independent auditor for the fiscal year ending December 31, 2002.
.. June 14, 2002 - The Company announced that Host Marriott, L.P., the
Delaware partnership of which the Company is the sole general partner,
entered into a new credit facility with Deutsche Bank Trust Company
Americas, as Administrative Agent, Bank of America, N.A., as syndication
agent and certain other agents and lenders.
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SIGNATURE
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.
HOST MARRIOTT CORPORATION
July 29, 2002 /s/ Donald D. Olinger
---------------------
Donald D. Olinger
Senior Vice President and
Corporate Controller
(Chief Accounting Officer)
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