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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1999 Commission File No. 001-14625
HOST MARRIOTT CORPORATION
Maryland 53-0085950
(State of Incorporation) (I.R.S. Employer Identification
Number)
10400 Fernwood Road
Bethesda, Maryland 20817
(301) 380-9000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
----------------------------------------- ---------------------------
Common Stock, $.01 par value (221,193,529
shares New York Stock Exchange
outstanding as of March 1, 2000) Chicago Stock Exchange
Purchase Share rights for Series A Junior
Participating Pacific Stock Exchange
Preferred Stock, .01 par value Philadelphia Stock Exchange
Class A Preferred Stock, $.01 par value
(4,160,000 million
shares outstanding as of March 1, 2000)
Class B Preferred Stock, $.01 par value
(4,000,000 million
shares outstanding as of March 1, 2000)
The aggregate market value of shares of common stock held by non-affiliates
at March 1, 2000 was $1,618,000,000.
Indicate by check mark whether the registrant (i) 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 (ii) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Document Incorporated by Reference
Notice of 2000 Annual Meeting and Proxy Statement
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FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K and the information incorporated by
reference into this annual report include forward-looking statements. We have
based these forward-looking statements on our current expectations and
projections about future events. We intend to identify forward-looking
statements in this prospectus and the information incorporated by reference
into this prospectus by using words or phrases such as "anticipate",
"believe", "estimate", "expect", "intend", "may be", "objective", "plan",
"predict", "project" and "will be" and similar words or phrases, or the
negative thereof.
These forward-looking statements are subject to numerous assumptions, risks
and uncertainties. Factors which may cause our actual results, performance or
achievements to be materially different from any future results, performance
or achievements expressed or implied by us in those statements include, among
others, the following:
. national and local economic and business conditions that will affect,
among other things, demand for products and services at our hotels and
other properties, the level of room rates and occupancy that can be
achieved by such properties and the availability and terms of financing;
. our ability to maintain the properties in a first-class manner,
including meeting capital expenditure requirements;
. our ability to compete effectively in areas such as access, location,
quality of accommodations and room rate structures;
. our ability to acquire or develop additional properties and the risk
that potential acquisitions or developments may not perform in
accordance with expectations;
. our degree of leverage which may affect our ability to obtain financing
in the future or compliance with current debt covenants;
. changes in travel patterns, taxes and government regulations which
influence or determine wages, prices, construction procedures and costs;
. government approvals, actions and initiatives including the need for
compliance with environmental and safety requirements, and change in
laws and regulations or the interpretation thereof;
. the effects of tax legislative action, including specified provisions of
the Work Incentives Improvement Act of 1999 as enacted on December 17,
1999 (we refer to this as the "REIT Modernization Act");
. our ability to satisfy complex rules in order to qualify as a REIT for
federal income tax purposes and in order for the operating partnership
to qualify as a partnership for federal income tax purposes, and our
ability to operate effectively within the limitations imposed by these
rules; and
. other factors discussed below under the heading "Risk Factors" and in
other filings with the Securities and Exchange Commission.
Although we believe the expectations reflected in our 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. We disclaim any obligations or undertaking to publicly release any
updates or revisions to any forward-looking statement contained in this annual
report on Form 10-K and the information incorporated by reference herein 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.
Items 1 & 2. Business and Properties
We are a self-managed and self-administered real estate investment trust, or
"REIT," owning full service hotel properties. We were formed as a Maryland
corporation in 1998, under the name HMC Merger Corporation, as a wholly owned
subsidiary of Host Marriott Corporation, a Delaware corporation, in connection
with its efforts to reorganize its business operations to qualify as a REIT
for federal income tax purposes. As part of this
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reorganization, which we refer to as the REIT conversion, and which is
described below in more detail on December 29, 1998, we merged with Host
Marriott and changed our name to Host Marriott Corporation. As a result, we
have succeeded to the hotel ownership business formerly conducted by Host
Marriott. We conduct our business as an umbrella partnership REIT, or UPREIT,
through Host Marriott, L.P., or the "operating partnership", a Delaware
limited partnership, of which we are the sole general partner and in which we
hold approximately 78% of the outstanding partnership interests.
Together with the operating partnership we were formed primarily to
continue, in an UPREIT structure, the full service hotel ownership business
formerly conducted by Host Marriott and its subsidiaries. We use the name Host
Marriott to refer to Host Marriott Corporation, the Delaware corporation,
prior to the REIT conversion and to ourselves on and after the REIT
conversion. Our primary business objective is to provide superior total
returns to our shareholders through a combination of dividends and
appreciation in share price. In addition, we endeavor to:
. achieve long-term sustainable growth in "Funds from Operations" per
share, as defined by the National Association of Real Estate Investment
Trusts (i.e., net income computed in accordance with generally accepted
accounting principles, excluding gains or losses from debt
restructuring, sales of properties and other non-recurring items, plus
real estate-related depreciation and amortization, and after adjustments
for unconsolidated partnerships and joint ventures), and cash flow;
. increase asset values by selectively improving and expanding our hotels;
. acquire additional existing and newly developed upscale and luxury full
service hotels in targeted markets primarily focusing on downtown hotels
in core business districts in major metropolitan markets and select
airport and resort/convention locations;
. develop and construct upscale and luxury full service hotels; and
. opportunistically pursue other real estate investments.
Our operations are conducted solely through the operating partnership and
its subsidiaries. As of March 1, 2000, we own 122 hotels, containing
approximately 58,000 rooms, located throughout the United States and Canada.
The hotels are generally operated under the Marriott, Ritz-Carlton, Four
Seasons, Swissotel and Hyatt brand names. These brand names are among the most
respected and widely recognized brand names in the lodging industry. The
hotels are leased by the operating partnership and its subsidiaries to
lessees, including Crestline and its subsidiaries, and are managed on behalf
of the lessees by subsidiaries of Marriott International and other companies.
We are the sole general partner of the operating partnership and manage all
aspects of the business of the operating partnership. This includes decisions
with respect to:
. sales and purchases of hotels;
. the financing of the hotels;
. the leasing of the hotels; and
. capital expenditures for the hotels subject to the terms of the leases
and the management agreements.
We are managed by our Board of Directors and have no employees who are not
also employees of the operating partnership.
Under current federal income tax law, REITs are restricted in their ability
to derive revenues directly from the operations of hotels. Therefore we,
through the operating partnership and its subsidiaries lease virtually all of
our hotels to the Lessees. See "--The Leases" below. The Lessees pay rent to
the operating partnership and its subsidiaries generally equal to a specified
minimum rent plus percentage rent based on specified percentages of different
categories of aggregate sales at the relevant hotels to the extent such
"percentage rent" would exceed the minimum rent. The Lessees operate the
hotels pursuant to management agreements with the managers. Each of the
management agreements provides for certain base and incentive management fees,
plus reimbursement of specific costs, as further described below. See "--The
Management Agreements." Such fees and cost
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reimbursements are the obligation of the Lessees and not the operating
partnership or its subsidiaries (although the obligation to pay such fees
could adversely affect the ability of the Lessees to pay the required rent to
the operating partnership or its subsidiaries).
The leases, through the sales percentage rent provisions, are designed to
allow us to participate in any growth above specified levels in room sales at
the hotels, which management expects can be achieved through increases in room
rates and occupancy levels. Although the economic trends affecting the hotel
industry will be the major factor in generating growth in lease revenues, the
abilities of the lessees and the managers will also have a material impact on
future sales growth.
In addition to external growth generated by new acquisitions, we intend to
carefully and periodically review our portfolio to identify opportunities to
selectively enhance existing assets to improve operating performance through
major capital improvements. The leases of the operating partnership and its
subsidiaries do provide the operating partnership and its subsidiaries with
the right to approve and finance major capital improvements.
Our primary focus is on the acquisition of upscale and luxury full service
hotel lodging properties. Since the beginning of 1994 through the date hereof,
we have acquired, directly and through our respective subsidiaries, 106 full
service hotels representing more than 48,000 rooms for an aggregate purchase
price of approximately $6.2 billion. Based upon data provided by Smith Travel
Research, we believe that our full service hotels outperform the industry's
average occupancy rate by a significant margin and averaged 77.7% occupancy
for both fiscal years 1999 and 1998 compared to a 69.1% and 69.4% average
occupancy for our competitive set for 1999 and 1998, respectively. "Our
competitive set" refers to hotels in the upscale and luxury full service
segment of the lodging industry, the segment which is most representative of
our full service hotels, and consists of Crowne Plaza; Doubletree; Hyatt;
Hilton; Radisson; Renaissance; Sheraton; Swissotel; Westin and Wyndham.
The relatively high occupancy rates of our hotels, along with increased
demand for full-service hotel rooms, have allowed the managers of our hotels
to increase average daily room rates by selectively raising room rates and by
minimizing, in specified cases, discounted group business, replacing it with
higher-rate group and transient business. As a result, on a comparable basis,
room revenue per available room ("REVPAR") for our full-service properties
increased approximately 4.1% in 1999.
Business Strategy
Our primary business objective is to provide superior total returns to our
shareholders through a combination of dividends and appreciation in share
price. In order to achieve this objective and, therefore, enhance our equity
value, we employ the following strategies:
. Acquire existing upscale and luxury full-service hotels as market
conditions permit, including Marriott and Ritz-Carlton hotels and other
hotels operated by leading management companies such as Four Seasons and
Hyatt which satisfy our investment criteria, which acquisitions may be
completed through various means including by entering into joint
ventures when we believe our return on investment will be maximized by
doing so;
. Develop selected new upscale and luxury full-service hotels, including
Marriott and Ritz-Carlton hotels and other hotels operated by leading
management companies such as Four Seasons and Hyatt which satisfy our
investment criteria and employ transaction structures which mitigate our
risk;
. Participate in the sales growth for each of our hotels through leases
which provide for the payment of rent based upon the lessees' gross
hotel sales in excess of specified thresholds; and
. Enhance existing hotel operations by completing selective capital
improvements which are designed to increase gross hotel sales or improve
operations.
Although competition for acquisitions has remained steady and the
availability of suitable acquisition candidates has been limited recently due
to market conditions, we believe that the upscale and luxury full-service
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segments of the market will continue to offer opportunities over time to
acquire assets at attractive multiples of cash flow and at discounts to
replacement value, including underperforming hotels which can be improved by
conversion to the Marriott, Ritz-Carlton, or other high quality brands. Since
the beginning of fiscal year 1994, we have acquired 14 hotels which we have
converted to the Marriott brand. The vast majority of our hotel properties are
operated under the Marriott and Ritz-Carlton brands. In general, based upon
data provided by Smith Travel Research, we believe that the Marriott brand has
consistently outperformed the industry. Demonstrating the strength of the
Marriott brand name, our comparable properties, consisting of 84 hotels, owned
directly or indirectly by us for the entire 1999 and 1998 fiscal years,
respectively, excluding two properties where significant expansion at the
hotels substantially affected operations during the two fiscal years,
generated a 31% and 29% REVPAR premium over our competitive set for fiscal
years 1999 and 1998, respectively. Accordingly, management anticipates that
any additional full service properties acquired in the future and converted
from other brands to the Marriott brand should achieve higher occupancy rates
and average room rates than has previously been the case for those properties
as the properties begin to benefit from Marriott's brand name recognition,
reservation system and group sales organization.
We have increased our pool of potential acquisition candidates by
considering acquisitions of select non-Marriott and non-Ritz-Carlton hotels
that offer long-term growth potential and are consistent with the overall
quality of our current portfolio. We will focus on upscale and luxury full
service properties in difficult to duplicate locations with high costs to
prospective competitors, such as hotels located in downtown, airport and
resort/convention locations, which are operated by quality managers. For
example, in December 1998, we consummated the Blackstone acquisition for
approximately $1.55 billion in a combination of cash, operating partnership
units, assumed debt and other consideration. The Blackstone acquisition
consisted of two Ritz-Carlton, two Four Seasons, one Grand Hyatt, three Hyatt
Regency and four Swissotel properties. In the future, we may also consider
opportunities to improve property operations by converting certain existing or
acquired hotels to these and other quality national brands. For example, we
are currently converting the resort property in Singer Island, Florida to the
Hilton brand, which is expected to be completed April 1, 2000.
We believe we are well qualified to pursue our acquisition and development
strategy. Management has extensive experience in acquiring and financing
lodging properties and believes its industry knowledge, relationships and
access to market information provide a competitive advantage with respect to
identifying, evaluating and acquiring hotel assets.
In September 1999, our board of directors approved the repurchase, from time
to time on the open market and/or in privately negotiated transactions, of up
to 22 million of the outstanding shares of our common stock, operating
partnership units, or Convertible Preferred Securities convertible into a like
number of shares of common stock. Based on current market conditions, we
believe that the stock repurchase program reflects the best return on
investment for our shareholders. However, we will continue to look at
strategic acquisitions as well as evaluate our stock repurchase program based
on changes in market conditions and our stock price. The stock repurchases may
be financed through cash from operations, assets sales, and other financing
activities, such as the issuances of the Class A and Class B Preferred Stock
made during 1999. Such repurchases will be made at management's discretion,
subject to market conditions and may be suspended at any time at our
discretion. Through March 8, 2000, we spent, in the aggregate, approximately
$149 million to repurchase 10.5 million shares of our common stock, and 1.5
million shares of the Convertible Preferred Securities and 0.6 million
operating partnership units for a total reduction of 16.0 million equivalent
shares on a fully diluted basis.
The REIT Conversion
During 1998, Host Marriott and its subsidiaries and affiliates consummated a
series of transactions intended to enable us to qualify as a REIT for federal
income tax purposes. As a result of these transactions, the hotels formerly
owned by Host Marriott and its subsidiaries and other affiliates are now owned
by the operating partnership and its subsidiaries; the operating partnership
and its subsidiaries lease substantially all of these hotels to Crestline
Capital Corporation, and Marriott International and other hotel operators
conduct the day to day
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management of the hotels pursuant to management agreements with Crestline. We
have elected to be treated as a REIT for federal income tax purposes effective
January 1, 1999. The important transactions comprising the REIT conversion are
summarized below.
During 1998, Host Marriott reorganized its hotels and certain other assets so
that they were owned by the operating partnership and its subsidiaries. Host
Marriott and its subsidiaries received a number of OP Units equal to the number
of then outstanding shares of Host Marriott common stock, and the operating
partnership and its subsidiaries assumed substantially all of the liabilities
of Host Marriott and its subsidiaries. As a result of this reorganization and
the related transactions described below, we are the sole general partner in
the operating partnership and as of December 31, 1999 held approximately 78% of
the outstanding OP Units. The operating partnership and its subsidiaries
conduct our hotel ownership business. 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. However, in lieu of a cash redemption
by the operating partnership, we have the right to acquire any OP Unit offered
for redemption directly from the holder thereof in exchange for either one
share of our common stock or cash in an amount equal to the market value of one
share of our common stock.
In connection with the REIT conversion, two taxable corporations were formed
in which the operating partnership owns approximately 95% of the economic
interest but none of the voting interest. We refer to these two subsidiaries as
the non-controlled subsidiaries. The non-controlled subsidiaries hold various
assets and related liabilities which were originally contributed by Host
Marriott and its subsidiaries to the operating partnership, but whose direct
ownership by the operating partnership or its other subsidiaries generally
would jeopardize our status as a REIT and the operating partnership's status as
a partnership for federal income tax purposes. These assets primarily consist
of interests in partnerships or other interests in three hotels which are not
leased, and specified furniture, fixtures and equipment--also known as FF&E--
used in the hotels. The operating partnership has no control over the operation
or management of the hotels or other assets owned by the non-controlled
subsidiaries. The Host Marriott Statutory Employee/Charitable Trust acquired
all of the voting common stock of each non-controlled subsidiary, representing,
in each case, the remaining approximately 5% of the total economic interests in
each non-controlled subsidiary. The beneficiaries of the Employee/Charitable
Trust are a trust formed for the benefit of specified employees of the
operating partnership and the J. Willard and Alice S. Marriott Foundation.
Under current federal income tax law, REITs are restricted in their ability
to derive revenues from the operation of hotels. However, they can derive
rental income by leasing hotels. Therefore, the operating partnership and its
subsidiaries lease virtually all of their hotel properties to subsidiaries of
Crestline. The lessees pay rent to the operating partnership and its
subsidiaries generally equal to the greater of (1) a specified minimum rent or
(2) rent based on specified percentages of different categories of aggregate
sales at the relevant hotels. Generally, there is a separate lessee for each
hotel property or there is a separate lessee for each group of hotel properties
that has separate mortgage financing or has owners in addition to the operating
partnership and its wholly owned subsidiaries. The lessees for all but four of
our hotels are wholly owned subsidiaries of Crestline, formed as limited
liability companies, each of whose purpose is limited to acting as lessee under
an applicable lease. The limited liability company agreement for each Crestline
lessee provides that Crestline will have full control over the management of
the business of the lessee, except with respect to certain decisions for which
the consent of other members or the hotel manager will be required. In
addition, although the Crestline lessees are wholly owned subsidiaries of
Crestline, Marriott International or its appropriate subsidiary has a non-
economic voting interest on specific matters pertaining to hotels which are
managed by Marriott International or its subsidiaries.
The leases, through the sales percentage rent provisions, are designed to
allow us and our subsidiaries to participate in any growth above specified
levels in room sales at the hotels, which management expects can be achieved
through increases in room rates and occupancy levels. Although the economic
trends affecting the hotel
5
industry will be the major factor in generating growth in lease revenues, the
abilities of the lessees and the managers will also have a material impact on
future sales growth. Our leases have remaining terms ranging from two to ten
years, subject to earlier termination upon the occurrence of contingencies
that are specified in the leases. We may elect to purchase each of the leases
either upon a sale of a hotel to a third party or upon the occurrence of
certain changes in tax law such as those changes included in the REIT
Modernization Act (discussed below), for a purchase price equal to the fair
rental value of the lessee's interest in the lease over the remaining term of
such lease. Effective November 15, 1999, we amended substantially all of our
leases with Crestline to give Crestline the right to renew each of these
leases for up to four additional terms of seven years each at a fair rental
value, to be determined either by agreement between us and Crestline or
through arbitration at the time the renewal option is exercised. Crestline is
under no obligation to exercise these renewal options, and we have the right
to terminate the renewal options during time periods specified in the
amendments. In addition, the amendments provide that the fair rental value
payable by us to Crestline in connection with the purchase of a lease as
described above does not include any amounts relating to any renewal period.
Therefore, the fair rental value of a lease after expiration of the initial
term for such lease would be zero. We have received notices of termination
from Crestline on five leases, with effective dates ranging from March through
June 2000. We are currently negotiating for replacement leases on those five.
We expect to be able to obtain replacement leases for these leases without
material impact to our future operations.
In December 1999, the REIT Modernization Act was passed, with most
provisions effective for taxable years beginning after December 31, 2000,
which significantly amends the REIT laws applicable to us. Among the changes,
the REIT Modernization Act allows a REIT to own up to 100% of the voting stock
of one or more taxable REIT subsidiaries subject to limitations on the value
of those subsidiaries. The rents received from such subsidiaries would not be
disqualified from being "rents from real property" by reason of the operating
partnership's ownership interest in the subsidiary so long as the property is
operated on behalf of the taxable REIT subsidiary by an "eligible independent
contractor." This would enable the operating partnership to lease its hotels
to wholly owned taxable subsidiaries if the hotels are operated and managed on
behalf of such subsidiaries by an independent third party. Under the REIT
Modernization Act, taxable REIT subsidiaries will be subject to federal income
tax. Under the law that is currently in effect, a REIT must satisfy three
tests relating to the nature of its assets:
. First, at least 75% of its total assets must be represented by real
estate assets.
. Second, no more than 25% of total assets may be represented by
securities other than those in the 75% asset class.
. Third, within the 25% assets class, the value of any one issuer's
securities may not exceed 5% of its total assets and a REIT may not own
more than 10% of any one issuer's outstanding voting securities.
The third test will be modified in two respects by the REIT Modernization
Act:
. The 10% voting securities test will be expanded so that we will be
prohibited from owning more than 10% of the value of the outstanding
securities of any one issuer.
. We will be permitted to own securities of a subsidiary that exceed the
5% value test and the new 10% vote or value test if the subsidiary
elects to be a taxable REIT subsidiary.
Under the REIT Modernization Act, beginning January 1, 2001, we could lease
our hotels to a subsidiary of the operating partnership that is a taxable
corporation and that elects to be treated as a "taxable REIT subsidiary". In
addition, as a result of passage of the REIT Modernization Act, we have the
right to purchase the leases from Crestline on or after January 1, 2001, for a
price equal to their fair market value, the amount of which could be
significant. We intend to evaluate our options regarding the Crestline leases
and have not yet made a decision whether or not to purchase those leases.
Finally, under the REIT Modernization Act, beginning January 1, 2001, the
aggregate fair market values of real and personal property will be used for
purposes of determining rents from real property. Currently, the aggregate tax
bases of both real and personal property are used for this purpose.
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Recent Acquisitions, Developments and Dispositions
The pace of acquisitions changed significantly in 1999 from the previous
years. After three years of acquisitions numbering 36, 17, and 24 full service
hotels for 1998, 1997 and 1996, respectively, our 1999 acquisitions were
limited to completing the acquisition of minority interests in two hotels
where we had previously acquired the controlling interests for a total
consideration of approximately $14 million.
During the year we focused our energies on increasing the value of our
current portfolio with selective investments and expansions and new
developments. We plan to selectively develop new upscale and luxury full-
service hotels in major urban markets and convention/resort locations with
strong growth prospects, unique or difficult to duplicate sites, high costs
for prospective competitors for other new hotels and limited new supply. We
intend to target only development projects that show promise of providing
financial returns that represent a premium to acquisitions. The largest of
these projects was the construction of a 717-room full service hotel adjacent
to the convention center in downtown Tampa, Florida. The hotel, which was
completed and opened for business on February 19, 2000, includes 45,000 square
feet of meeting space, three restaurants and a 30 slip marina as well as many
other amenities. The total development cost of the property was approximately
$104 million, not including a $16 million tax subsidy provided by the City of
Tampa.
In April 1999 we completed a 210-room expansion of the Philadelphia
Marriott, through a renovation of the historic railroad headhouse building
adjacent to the property. The project was completed for approximately $37
million including a $7 million tax financing provided by the City of
Philadelphia.
Two other development projects, the Orlando World Center Marriott expansion
and the Ritz-Carlton Naples, Florida spa addition are currently under
construction. At the Orlando Marriott, the addition of a 500-room tower and
15,000 square feet of meeting space will make it the single largest hotel in
the Marriott system at 2000 rooms. We also have renovated the golf course,
added a multi-level parking deck, and upgraded and expanded several
restaurants. The Orlando World Center Marriott construction is expected to be
completed by mid-year 2000. Also under development is a 50,000 square-foot
world-class spa at the Ritz-Carlton, Naples. This project is anticipated to be
completed late in 2000. The combined approximate development cost for these
expansions is estimated to be $107 million.
Two longer-term development projects are currently active with anticipated
completion in 2001. These are the construction of a 295-room Ritz-Carlton,
Naples, Golf Lodge and the 200-room expansion of the Memphis Marriott. The
construction of the Naples Golf Lodge near the 463-room Ritz-Carlton, Naples,
as well as the construction of the new spa facility, will offer travelers an
unmatched resort experience. The Memphis Marriott, which is located adjacent
to a newly-renovated convention center, was converted to the Marriott brand
upon acquisition in 1998 to capitalize on Marriott's brand name recognition.
The combined development cost for these projects is estimated to be
approximately $90 million.
In addition to investments in partnerships in which we already held minority
interests, we have been successful in adding properties to our portfolio
through partnership arrangements with either the seller of the property or the
incoming managers (typically Marriott International or a Marriott franchisee).
We have the financial flexibility and, due to our existing private partnership
investment portfolio, the administrative infrastructure in place to
accommodate such arrangements. We view this ability as a competitive advantage
and expect to enter into similar arrangements to acquire additional properties
in the future.
Through subsidiaries we currently own four Canadian properties, with 1,636
rooms. We intend to continue to evaluate other attractive acquisition
opportunities in Canada. In addition, the overbuilding and economic stress
experienced in some European and Pacific Rim countries may eventually lead to
additional international acquisition opportunities. We will acquire
international properties only when we believe such acquisitions achieve
satisfactory returns after adjustments for currency and country risks.
We will also consider from time to time selling hotels that do not fit our
long-term strategy, or otherwise meet our ongoing investment criteria,
including for example, hotels in some suburban locations, hotels that
7
require significant capital improvement and other underperforming assets. The
net proceeds from these sales will be reinvested in upscale and luxury hotels
more consistent with our strategy or otherwise applied in a manner consistent
with our investment strategy (which may include the purchase of securities) at
the time of sale. The following table summarizes our 1999 dispositions (in
millions):
Pre-tax
Total Gain (Loss)
Property Location Rooms Consideration on Disposal
-------- ---------------- ----- ------------- -----------
Minneapolis/Bloomington
Marriott.................... Bloomington, MN 479 $ 35 $10
Saddle Brook Marriott........ Saddle Brook, NJ 221 15 3
Marriott's Grand Hotel Resort
and Golf Club............... Point Clear, AL 306 28 (2)
The Ritz-Carlton, Boston..... Boston, MA 275 119 15
El Paso Marriott............. El Paso, TX 296 1 (2)
Hotel Lodging Industry
The lodging industry posted moderate gains in 1999 as higher average daily
rates drove strong increases in REVPAR, which measures daily room revenues
generated on a per room basis. This does not include food and beverage or
other ancillary revenues generated by the property. REVPAR represents the
product of the average daily room rate charged and the average daily occupancy
achieved. Previously, the lodging industry benefited from a favorable
supply/demand imbalance, driven in part by low construction levels combined
with high gross domestic product, or GDP, growth. However, during 1999 and
1998 supply moderately outpaced demand, causing slight declines in occupancy
rates in the upscale and luxury full-service segments in which we operate.
According to Smith Travel Research, supply in our brands' competitive set
consisting of Crowne Plaza; Doubletree; Hyatt; Hilton; Radisson; Renaissance;
Sheraton; Westin; Swissotel and Wyndham increased 1.6% for the year ended
December 31, 1999, while demand in our competitive set increased 1.1%. At the
same time, occupancy declined 0.4% in our competitive set for the year ended
December 31, 1999.
These declines in occupancy, however, were more than offset by increases in
average daily rates which generated higher REVPAR. According to Smith Travel
Research, for the year ended December 31, 1999, average daily rate and REVPAR
for our competitive set increased 3.0% and 2.5%, respectively, versus the same
period one year ago. The current amount of excess supply in the upper-upscale
and luxury portions of the full-service segment of the lodging industry is
relatively moderate and much less severe than that experienced in the lodging
industry in other occupancy downturns, in part because of the greater
financial discipline and lending practices imposed by financial institutions
and public markets today relative to those during the late 1980's.
Our hotels have outperformed both the industry as a whole and the upper-
upscale and luxury full service segment. The attractive locations of our
hotels, the limited availability of new building sites for new construction of
competing full service hotels, and the lack of availability of financing for
new full service hotels has allowed us to maintain REVPAR and average daily
rate premiums over our competitors in these service segments. For our
comparable hotels, average daily rates increased 3.8% in 1999. The increase in
average daily rate helped generate a strong increase in comparable hotel
REVPAR of 4.1% for the same period. Furthermore, because our lodging
operations have a high fixed-cost component, increases in REVPAR generally
yield greater percentage increases in our consolidated earnings before
interest expense, income taxes, depreciation, amortization and other non-cash
items or EBITDA. While we do not benefit directly from increases in EBITDA
levels at our properties due to the structure of our leases, we should benefit
from such increases due to expected higher market valuations of our properties
based on such elevated EBITDA levels.
We believe that the current environment of excess new supply will most
likely continue over the next twelve to twenty-four months. However, the
relative balance between supply and demand growth may be influenced by a
number of factors including growth of the economy, interest rates, unique
local considerations and the relatively long lead time to develop urban,
convention and resort hotels. We believe that growth in room supply in upscale
and luxury full-service sub-markets in which we operate will continue to
exceed room demand
8
growth through the year 2001. There can be no assurance that growth in supply
will moderate or that REVPAR and EBITDA will continue to improve.
Hotel Lodging Properties
Our lodging portfolio, as of March 1, 2000, consists of 122 upscale and
luxury full service hotels containing approximately 58,000 rooms. Our hotel
lodging properties represent quality upscale and luxury assets in the full
service. All but thirteen of our hotel properties are currently operated under
the Marriott or Ritz-Carlton brand names.
Our hotels average approximately 474 rooms. Thirteen of our hotels have more
than 750 rooms. Hotel facilities typically include meeting and banquet
facilities, a variety of restaurants and lounges, swimming pools, gift shops
and parking facilities. Our hotels primarily serve business and pleasure
travelers and group meetings at locations in downtown, airport, resort
convention and suburban locations throughout the United States. The properties
are generally well situated in locations where there are significant barriers
to entry by competitors including downtown areas of major metropolitan cities
at airports and resort/convention locations where there are limited or no
development sites. The average age of the properties is 16 years, although
many of the properties have had more recent substantial renovations or major
additions.
To maintain the overall quality of our lodging properties, each property
undergoes refurbishments and capital improvements on a regularly scheduled
basis. Typically, refurbishing has been provided at intervals of five years,
based on an annual review of the condition of each property. For fiscal years
1999, 1998 and 1997 we spent $197 million, $165 million and $129 million,
respectively, on capital improvements to existing properties. As a result of
these expenditures, we expect to maintain high quality rooms at our
properties.
We continue to benefit from our strategic alliance with Marriott
International. Marriott International serves as the manager for 99 of our 122
hotels and all but 13 are part of Marriott International's full-service hotel
system. The Marriott brand name has consistently delivered occupancy and
REVPAR premiums over other brands. Our properties have reported annual
increases in REVPAR since 1993. Based upon data provided by Smith Travel
Research, our comparable properties have more than a 9 percentage point
occupancy premium and approximately 31% REVPAR premium over the competitive
set for 1999.
Comparable properties refer to properties that we owned for the same period
of time in each of the periods covered as adjusted to exclude properties where
significant disruptions to operations occurred due to expansions to the
properties.
The chart below sets forth performance information for our comparable
properties:
1999 1998
------- -------
Comparable Full-Service Hotels(1)
Number of properties.......................................... 84 84
Number of rooms............................................... 40,868 40,868
Average daily rate............................................ $146.74 $141.41
Occupancy percentage.......................................... 78.5% 78.2%
REVPAR........................................................ $115.13 $110.57
REVPAR % change............................................... 4.1% --
- --------
(1) Consists of 84 properties owned, directly or indirectly, by us for the
entire 1999 and 1998 fiscal years, respectively, after giving effect to
adjustments to remove two properties where significant expansion at the
hotels affected operations for the 1999 and 1998 fiscal years. These
properties, for the respective periods, represent the "comparable
properties."
9
The chart below presents some performance information for our hotels:
1999(1) 1998 1997
------- -------- -------
Number of properties................................ 121 126(2) 95
Number of rooms..................................... 57,086 58,445(2) 45,718
Average daily rate.................................. $149.51 $ 140.36 $133.74
Occupancy percentage................................ 77.7% 77.7% 78.4%
REVPAR.............................................. $116.13 $ 109.06 $104.84
- --------
(1) The property statistics and operating results include operations for the
Minneapolis/Bloomington Marriott, the Saddle Brook Marriott, Marriott's
Grand Hotel Resort and Golf Club, the Ritz-Carlton, Boston, and the El
Paso Marriott, which were sold at various times throughout 1999, through
the date of sale.
(2) Number of properties and rooms is as of December 31, 1998 and includes 25
properties (9,965 rooms) acquired in that month.
The following table presents full service hotel information by geographic
region for 1999:
Year Ended December 31,
As of December 31, 1999 1999(1)
------------------------ ---------------------------
Average
Number Average Number Average Daily
Geographic Region of Hotels of Guest Rooms Occupancy Rate REVPAR
- ----------------- --------- -------------- --------- -------- --------
Atlanta.................... 11 486 74.7% $ 148.78 $ 111.12
Florida.................... 12 531 77.1 149.75 115.51
Mid-Atlantic............... 17 364 75.8 132.80 100.69
Midwest.................... 14 358 76.6 132.19 101.24
New York................... 10 716 84.0 203.16 170.70
Northeast.................. 11 390 77.4 140.99 109.07
South Central.............. 19 497 76.2 123.25 93.89
Western.................... 27 491 78.2 154.26 120.60
---
Average--All regions....... 121 472 77.7 149.51 116.13
===
- --------
(1) The property statistics and operating results include operations for the
Minneapolis/Bloomington Marriott, the Saddle Brook Marriott, Marriott's
Grand Hotel Resort and Golf Club, the Ritz-Carlton, Boston, and the El
Paso Marriott, all sold at various times throughout 1999, through the date
of applicable sale.
Prior to 1997, we divested virtually all of our limited-service hotel
properties through the sale and leaseback of 53 Courtyard properties and 18
Residence Inn properties. The Courtyard and Residence Inn properties are
subleased to subsidiaries of Crestline under sublease agreements and are
managed by Marriott International under long-term management agreements.
During 1999, limited-service properties represented less than 1% of our EBITDA
from hotel properties. Lease revenues for the 71 properties that we sub-lease
are reflected in our revenues in 1999, while gross property-level sales were
reflected previous to that.
10
The following table sets forth as of March 1, 2000, the location and number
of rooms relating to each of our 122 hotels. All of the properties are leased
to a subsidiary of Crestline and operated under Marriott brands by Marriott
International, unless otherwise indicated.
Location Rooms
- -------- -----
Arizona
Mountain Shadows Resort.......... 337
Scottsdale Suites................ 251
The Ritz-Carlton, Phoenix........ 281
California
Coronado Island Resort(1)(2)..... 300
Costa Mesa Suites................ 253
Desert Springs Resort and Spa.... 884
Fullerton(2)..................... 224
Hyatt Regency, Burlingame(3)..... 793
Manhattan Beach(1)(2)(4)(6)...... 380
Marina Beach(1)(2)............... 368
Newport Beach.................... 570
Newport Beach Suites............. 250
Ontario Airport(4)(6)............ 299
Sacramento Airport(2)(3)(7)...... 85
San Diego Marriott Hotel and
Marina(2)(6).................... 1,355
San Diego Mission Valley(6)(7)... 350
San Francisco Airport............ 684
San Francisco Fisherman's
Wharf(4)........................ 285
San Francisco Moscone Center(2).. 1,498
San Ramon(2)..................... 368
Santa Clara(2)................... 754
The Ritz-Carlton, Marina del
Rey(2).......................... 306
The Ritz-Carlton, San Francisco.. 336
Torrance......................... 487
Colorado
Denver Southeast(2).............. 595
Denver Tech Center(1)............ 625
Denver West(2)................... 307
Marriott's Mountain Resort at
Vail(1)......................... 349
Connecticut
Hartford/Farmington.............. 380
Hartford/Rocky Hill(2)........... 251
Florida
Fort Lauderdale Marina(2)........ 580
Harbor Beach Resort(2)(5)(6)..... 624
Jacksonville(2)(4)............... 256
Miami Airport(2)................. 782
Miami Biscayne Bay(2)............ 605
Orlando World Center............. 1,503
Palm Beach Gardens(4)............ 279
Singer Island Holiday Inn(3)..... 222
Tampa Airport(2)................. 295
Tampa Waterside.................. 717
Tampa Westshore(2)............... 309
The Ritz-Carlton, Amelia Island.. 449
The Ritz-Carlton, Naples......... 463
Georgia
Atlanta Marriott Marquis(6)...... 1,671
Atlanta Midtown Suites(2)........ 254
Atlanta Norcross................. 222
Atlanta Northwest................ 400
Atlanta Perimeter(2)............. 400
Four Seasons, Atlanta(3)......... 246
Location Rooms
- -------- -----
Georgia (Continued)
Grand Hyatt, Atlanta(3)........... 439
JW Marriott Hotel at Lenox(2)..... 371
Swissotel, Atlanta(3)............. 348
The Ritz-Carlton, Atlanta(2)...... 447
The Ritz-Carlton, Buckhead........ 553
Illinois
Chicago/Deerfield Suites.......... 248
Chicago/Downers Grove Suites...... 254
Chicago/Downtown Courtyard........ 334
Chicago O'Hare(2)................. 681
Chicago O'Hare Suites(2).......... 256
Swissotel, Chicago(3)............. 630
Indiana
South Bend(2)..................... 300
Louisiana
New Orleans....................... 1,290
Maryland
Bethesda(2)....................... 407
Gaithersburg/Washingtonian
Center........................... 284
Massachusetts
Boston/Newton..................... 430
Hyatt Regency, Cambridge(3)....... 469
Swissotel, Boston(3).............. 498
Michigan
The Ritz-Carlton, Dearborn........ 308
Detroit Livonia................... 224
Detroit Romulus................... 245
Detroit Southfield................ 226
Minnesota
Minneapolis City Center(2)........ 583
Minneapolis Southwest(6)(7)....... 320
Missouri
Kansas City Airport(2)............ 382
New Hampshire
Nashua............................ 251
New Jersey
Hanover........................... 353
Newark Airport(2)................. 590
Park Ridge(2)..................... 289
New Mexico
Albuquerque(2).................... 411
New York
Albany(6)(7)...................... 359
New York Marriott Financial
Center........................... 504
New York Marriott Marquis(2)...... 1,919
Marriott World Trade Center
(1)(2)........................... 820
Swissotel, The Drake(3)........... 494
North Carolina
Charlotte Executive Park(4)....... 298
Greensboro/Highpoint(2)........... 299
Raleigh Crabtree Valley........... 375
Research Triangle Park............ 224
Ohio
Dayton............................ 399
Oklahoma
Oklahoma City..................... 354
Oklahoma City Waterford(1)(4)(6).. 197
11
Location Rooms
- -------- -----
Oregon
Portland....................... 503
Pennsylvania
Four Seasons, Philadelphia(3).. 365
Philadelphia Convention
Center(2)(6).................. 1,410
Philadelphia Airport(2)........ 419
Pittsburgh City
Center(1)(2)(4)(6)............ 400
Tennessee
Memphis(1)(2).................. 403
Texas
Dallas/Fort Worth Airport...... 492
Dallas Quorum(2)............... 547
Houston Airport(2)............. 566
Houston Medical Center(2)...... 386
JW Marriott Houston............ 503
Plaza San Antonio(1)(2)(4)..... 252
San Antonio Rivercenter(2)..... 999
San Antonio Riverwalk(2)....... 500
Utah
Salt Lake City(2).............. 510
Location Rooms
- -------- ------
Virginia
Dulles Airport(2)............ 370
Fairview Park(2)............. 395
Hyatt Regency, Reston(3)..... 514
Key Bridge(2)................ 588
Norfolk Waterside(2)(4)...... 404
Pentagon City Residence Inn.. 300
The Ritz-Carlton, Tysons
Corner(2)................... 397
Washington Dulles Suites..... 254
Westfields(1)................ 335
Williamsburg(1).............. 295
Washington
Seattle SeaTac Airport....... 459
Washington, DC
Washington Metro Center(1)... 456
Canada
Calgary(1)................... 380
Toronto Airport(6)........... 423
Toronto Eaton Center(2)...... 459
Toronto Delta Meadowvale(3).. 374
------
TOTAL......................... 57,803
======
- --------
(1) This property was converted to the Marriott brand after acquisition.
(2) The land on which this hotel is built is leased under one or more long-
term lease agreements.
(3) This property is not operated under the Marriott brand and is not managed
by Marriott International.
(4) This property is operated as a Marriott franchised property.
(5) This property is leased to Marriott International.
(6) This property is not wholly owned by the operating partnership.
(7) This property is not leased to Crestline.
Investments in Affiliated Partnerships
The operating partnership and certain of its subsidiaries also manage our
partnership investments and conduct the partnership services business. As
previously discussed, in connection with the REIT conversion, the non-
controlled subsidiaries were formed to hold various assets. The direct
ownership of those assets by us or the operating partnership could jeopardize
our status as a REIT or the operating partnership's treatment as a partnership
for federal income tax purposes. Substantially all our general and limited
partner interests in partnerships owning 209 limited-service hotels were held
by the non-controlled subsidiaries at year end. Additionally, of the 20 full-
service hotels in which we had general and limited partner interests 13 were
acquired by the operating partnership, two were sold, four were transferred to
the non-controlled subsidiary and one was retained. We executed a definitive
agreement regarding litigation for seven of these limited pantherships
subsequent to year end. See "--Legal Proceedings" below.
The managing general partner of the partnership is responsible for the day-
to-day management of the partnership operations, which generally includes
payment of partnership obligations from partnership funds, preparation of
financial reports and tax returns and communications with lenders, limited
partners and regulatory bodies. As the general partner, we are reimbursed for
the cost of providing these services subject to limitations in certain cases.
The partnership hotels are currently operated under management agreements
with Marriott International or its subsidiaries. As the general partner, we
oversee and monitor Marriott International and its subsidiaries' performance
pursuant to these agreements.
Cash distributions provided from these partnerships including distributions
related to partnerships sold, transferred or acquired in 1998 are tied to the
overall performance of the underlying properties and the overall level of
debt. There were no distributions in 1999. Distributions from these
partnerships to us were $2 million in 1998 and $5 million in 1997. All debt of
these partnerships is nonrecourse to us and our subsidiaries, except that we
are contingently liable under various guarantees of debt obligations of
certain of the limited-service partnerships.
12
Marketing
As of March 1, 2000, 99 of our 122 hotel properties were managed by
subsidiaries of Marriott International as Marriott or Ritz-Carlton brand
hotels. Ten of the 23 remaining hotels are operated as Marriott brand hotels
under franchise agreements with Marriott International. The remaining hotels
are managed primarily by Hyatt, Four Seasons, and Swissotel. In addition, we
are currently converting the resort property in Singer Island, Florida to the
Hilton brand, which is expected to be completed April 1, 2000.
We believe that our properties will continue to enjoy competitive advantages
arising from their participation in the Marriott, Ritz-Carlton, Hyatt, Four
Seasons, Swissotel, and Hilton hotel systems. The national marketing programs
and reservation systems of each of these managers, as well as the advantages of
strong customer preference for these upper-upscale and luxury brands should
also help these properties to maintain or increase their premium over
competitors in both occupancy and room rates. Repeat guest business is enhanced
by guest rewards programs offered by Marriott, Hyatt, Swissotel, and Hilton.
For example, the Marriott Rewards program membership includes more than 7.5
million members.
Each of the managers maintain national reservation systems that provide
reservation agents with complete descriptions of the rooms available and up-to-
date rate information from the properties. Marriott's reservation system also
features connectivity to airline reservation systems, providing travel agents
with access to available rooms inventory for all Marriott and Ritz-Carlton
lodging properties. In addition, software at Marriott's centralized
reservations centers enables agents to immediately identify the nearest
Marriott or Ritz-Carlton brand property with available rooms when a caller's
first choice is fully occupied. Our website (www.hostmarriott.com) currently
permits users to connect to the Marriott, Ritz-Carlton, Hyatt, Four Seasons,
and Swissotel reservation systems to reserve rooms in our hotels.
Competition
Our hotels compete with several other major lodging brands in each segment in
which they operate. Competition in the industry is based primarily on the level
of service, quality of accommodations, convenience of locations and room rates.
Although the competitive position of each of our hotel properties differs from
market to market, we believe that our properties compare favorably to their
competitive set in the markets in which they operate on the basis of these
factors. The following table presents key participants in segments of the
lodging industry in which we compete:
Segment Representative Participants
- ------- ---------------------------
Luxury Full-Service Ritz-Carlton; Four Seasons
Upscale Full-Service Crown Plaza; Doubletree; Hyatt; Hilton; Marriott Hotels, Resort and Suites; Radisson;
Renaissance; Sheraton; Swissotel; Westin; Wyndham
Seasonality
Our hotel revenues have traditionally experienced significant seasonality.
Additionally, hotel revenues in the fourth quarter reflect sixteen weeks of
results compared to twelve weeks for the first three quarters of the fiscal
year. Average hotel sales by quarter over the three years 1997 through 1999 for
our lodging properties are as follows:
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
22% 23% 22% 33%
Other Real Estate Investments
We have lease and sublease activity relating primarily to Host Marriott's
former restaurant operations. Additionally, we have lease activity related to
certain office space that we own in Atlanta, Chicago, and San Francisco which
is included in other revenues in our statements of operations. Prior to the
REIT conversion, we
13
owned 12 undeveloped parcels of vacant land, totaling approximately 83 acres,
originally purchased primarily for the development of hotels or senior living
communities. These parcels are now owned by one of the non-controlled
subsidiaries.
Employees
We are managed by our Board of Directors and we have no employees who are not
employees of the operating partnership.
Currently, the operating partnership has approximately 188 management
employees, and approximately 15 other employees which are covered by a
collective bargaining agreement that is subject to review and renewal on a
regular basis. We believe that we and our managers have good relations with
labor unions and have not experienced any material business interruptions as a
result of labor disputes.
Environmental and Regulatory Matters
Under various federal, state and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of hazardous or toxic substances
on, under or in such property. Such laws may impose liability whether or not
the owner or operator knew of, or was responsible for, the presence of such
hazardous or toxic substances. In addition, certain environmental laws and
common law principles could be used to impose liability for release of
asbestos-containing materials, and third parties may seek recovery from owners
or operators of real properties for personal injury associated with exposure to
released asbestos-containing materials. Environmental laws also may impose
restrictions on the manner in which property may be used or business may be
operated, and these restrictions may require expenditures. In connection with
our current or prior ownership or operation of hotels, we may be potentially
liable for any such costs or liabilities. Although we are currently not aware
of any material environmental claims pending or threatened against us, we can
offer no assurance that a material environmental claim will not be asserted
against us.
The Leases
In order for us to qualify as a REIT for federal income tax purposes we may
not operate the hotels or related properties. Accordingly, we lease the hotels
to lessees, which are primarily wholly owned indirect subsidiaries of
Crestline. The following is a brief summary of the general terms of the leases
a form of which has been filed with the Commission.
. Lessees. There generally is a separate lessee for each hotel or group of
hotels that is owned by a separate subsidiary of the operating
partnership. Each lessee is a Delaware limited liability company, whose
purpose is limited to acting as lessee under the applicable lease(s).
For those hotels where it is the manager, Marriott International or a
subsidiary has a noneconomic membership interest in the lessee entitling
it to certain voting rights but no economic rights. The operating
agreements for such lessees provide that the Crestline member of the
lessee has full control over the management of the business of the
lessee, except with respect to specific decisions for which the consent
of both members are required. Upon any termination of the applicable
management agreement, these special voting rights of Marriott
International or its subsidiary will cease.
. Lease Terms. Each lease has a fixed term ranging generally from seven to
ten years (depending upon the lease), subject to earlier termination
upon the occurrence of specified contingencies described in the lease.
Effective November 15, 1999, we amended substantially all of our leases
with Crestline to give Crestline the right to renew each of these leases
for up to four additional terms of seven years each at a fair rental
value, to be determined either by agreement between us and Crestline or
through arbitration at the time the renewal option is exercised.
Crestline is under no obligation to exercise these renewal options, and
we have the right to terminate the renewal options during time periods
specified
14
in the amendments. In addition, the amendments provide that the fair
rental value payable by us to Crestline in connection with the purchase
of a lease as described above does not include any amounts relating to
any renewal period. Therefore, the fair rental value of a lease after
expiration of the initial term for such lease would be zero.
. Termination of the Leases upon Changes in Tax Laws. In the event that
changes in the federal income tax laws such as those included in the
REIT Modernization Act allow the lessors, or subsidiaries or affiliates
of the lessors, to directly operate the hotels without jeopardizing our
status as a REIT, the lessors have the right to terminate all, but not
less than all, of the leases (excluding leases of hotels that must still
be leased following the tax law change) in return for paying the lessees
the fair market value of the remaining terms of the leases.
. Minimum Rent; Percentage Rent. Each lease requires the lessee to pay
minimum rent in a fixed dollar amount specified in each lease per annum
plus to the extent it exceeds minimum rent, percentage rent based upon
specified percentages of aggregate sales from the applicable hotel,
including room sales, food and beverage sales and other income in excess
of specified thresholds. The amount of minimum rent and the percentage
rent thresholds are to be adjusted each year. The annual adjustment with
respect to minimum rent equals a percentage of any increase in the
Consumer Price Index during the previous twelve months. Neither minimum
rent nor percentage rent thresholds will be decreased because of the
annual adjustment.
. Lessee Expenses. Each lessee is responsible for paying all of the
expenses of operating the applicable hotel(s), including all personnel
costs, utility costs and general repair and maintenance of the hotel(s).
The lessee also is responsible for all fees payable to the applicable
manager, including base and incentive management fees, chain services
payments and franchise or system fees, with respect to periods covered
by the term of the lease. The lessee is not obligated to bear the cost
of any capital improvements or capital repairs to the hotels or the
other expenses borne by the lessor, as described below.
. Lessor Expenses. The lessor is responsible for the following expenses:
real estate taxes, personal property taxes, casualty insurance on the
structures, ground lease rent payments, required expenditures for
furniture, fixtures and equipment ("FF&E") and capital expenditures. The
consent of the lessor is required for any capital expenditures or a
change in the amount of the FF&E reserve payment.
. Crestline Guarantee. Crestline and some of its subsidiaries have entered
into a limited guarantee of the lease and management agreement
obligations of each lessee. For each of four identified "pools" of
hotels, the cumulative limit of the guarantee at any time is 10% of the
aggregate rents under all leases in such pool paid with respect to the
preceding thirteen full accounting periods (with an annualized amount
based upon the minimum rent for those leases that have not been in
effect for thirteen full accounting periods). In the event of a payment
default under any lease or failure of Crestline to maintain specified
minimum net worth or debt service coverage ratios, the obligations under
the guarantees of leases in each pool are secured by excess cash flow of
each lessee in such pool. Such excess cash flow will be collected, held
in a cash collateral account, and disbursed in accordance with agreed
cash management procedures.
. Working Capital. Each lessor sold the existing working capital
(including Inventory and Fixed Asset Supplies (as defined in the Uniform
System of Accounts for Hotels) and receivables due from the manager, net
of accounts payable and accrued expenses) to the applicable lessee upon
the commencement of the lease at a price equal to the fair market value
of such assets. The purchase price was represented by a note evidencing
a loan that bears interest at a rate per year equal to the "long-term
applicable federal rate" in effect on the commencement of the lease.
Interest owed on the working capital loan is due simultaneously with
each periodic rent payment and the amount of each payment of interest
will be credited against such rent payment. The principal amount of the
working capital loan will be payable upon termination of the lease.
15
. Termination of Leases upon Disposition of Full Service Hotels. In the
event the applicable lessor enters into an agreement to sell or
otherwise transfer any full-service hotel free and clear of the
applicable lease, the lessor must pay the lessee a termination fee equal
to the fair market value of the lessee's leasehold interest in the
remaining term of the lease. Alternatively, the lessor would be entitled
to substitute a comparable hotel or hotels for any hotel that is sold or
sell the hotel subject to the lease subject to the lessee's reasonable
approval. In addition, the lessors collectively and the lessees
collectively each have the right to terminate up to 12 leases without
being required to pay any fee or other compensation as a result of such
termination, but the lessors are permitted to exercise such right only
in connection with sales of hotels to an unrelated third party or the
transfer of a hotel to a joint venture in which the operating
partnership does not have a two-thirds or greater interest. We have
received notices of termination from Crestline on five leases, with
effective dates ranging from March through June 2000, which we are
currently negotiating. We expect to be able to obtain replacement leases
for these leases without material impact to our future operations.
. Assignment of Lease. A lessee is permitted to sublet all or part of the
hotel or assign its interest under its lease, without the consent of the
lessor, to any wholly owned and controlled single purpose subsidiary of
Crestline, provided that Crestline continues to meet the minimum net
worth test and all other requirements of the lease. Transfers to other
parties are permitted if approved by the lessor.
. Subordination to Qualifying Mortgage Debt. The rights of each lessee are
expressly subordinate to qualifying mortgage debt and any refinancing
thereof.
. Personal Property Limitation. If a lessor reasonably anticipates that
the average tax basis of the items of the lessor's FF&E and other
personal property that are leased to the applicable lessee will exceed
15% of the aggregate average tax basis of the real and personal property
subject to the applicable lease the lessor would acquire any replacement
FF&E that would cause the applicable limits to be exceeded, and
immediately thereafter the lessee would be obligated either to acquire
such excess FF&E from the lessor or to cause a third party to purchase
such FF&E. The annual rent under the applicable lease would then be
reduced in accordance with a formula based on market leasing rates for
the excess FF&E. Beginning January 1, 2001, the average aggregate fair
market values of both real and personal property will be used for
purposes of determining rents from real property as opposed to the
aggregate tax bases.
. Change in Manager. A lessee is permitted to change the manager or the
brand affiliation of a hotel only with the approval of the applicable
lessor, which approval may not be unreasonably withheld.
The Management Agreements
All of our hotels are subject to management agreements for the operation of
the properties. The original terms of the management agreements are generally
15 to 20 years in length with multiple optional renewal terms. The following is
a brief summary of the general terms of the management agreements a form of
which has been filed with the Commission. The lessees lease the hotels from the
operating partnership or its subsidiaries. Upon leasing the hotels, the lessees
assumed substantially all of the obligations of such subsidiaries under the
management agreements between those entities and the subsidiaries of Marriott
International and other companies that currently manage the hotels. As a result
of their assumptions of obligations under the management agreements, the
lessees have substantially all of the rights and obligations of the "owners" of
the hotels under the management agreements for the period during which the
leases are in effect (including the obligation to pay the management and other
fees thereunder) and hold the operating partnership harmless with respect
thereto. The subsidiaries of the operating partnership remain liable for all
obligations under the management agreements.
. General. Under each management agreement related to a Marriott
International-managed hotel, the manager provides complete management
services to the applicable lessees in connection with its management of
such lessee's hotels.
16
. Operational services. The managers have sole responsibility and
exclusive authority for all activities necessary for the day-to-day
operation of the hotels, including establishment of all room rates, the
processing of reservations, procurement of inventories, supplies and
services, periodic inspection and consultation visits to the hotels by
the managers' technical and operational experts and promotion and
publicity of the hotels. The manager receives compensation from the
lessee in the form of a base management fee and an incentive management
fee, which are normally calculated as percentages of gross revenues and
operating profits, respectively.
. Executive supervision and management services. The managers provide all
managerial and other employees for the hotels; review the operation and
maintenance of the hotels; prepare reports, budgets and projections;
provide other administrative and accounting support services, such as
planning and policy services, financial planning, divisional financial
services, risk planning services, product planning and development,
employee planning, corporate executive management, legislative and
governmental representation and certain in-house legal services; and
protect the "Marriott" trademark and other tradenames and service marks.
The manager also provides a national reservations system.
. Chain services. The management agreements require the manager to furnish
chain services that are furnished generally on a central or regional
basis to hotels in the Marriott hotel system. Such services include: (1)
the development and operation of computer systems and reservation
services, (2) regional management and administrative services, regional
marketing and sales services, regional training services, manpower
development and relocation costs of regional personnel and (3) such
additional central or regional services as may from time to time be more
efficiently performed on a regional or group level. Costs and expenses
incurred in providing such services are allocated among all hotels in
the Marriott hotel system managed by the manager or its affiliates and
each applicable lessee is required to reimburse the manager for its
allocable share of such costs and expenses.
. Working capital and fixed asset supplies. The lessee is required to
maintain working capital for each hotel and fund the cost of fixed asset
supplies, which principally consist of linen and similar items. The
applicable lessee also is responsible for providing funds to meet the
cash needs for the operations of the hotels if at any time the funds
available from operations are insufficient to meet the financial
requirements of the hotels.
. Use of affiliates. The manager employs the services of its affiliates to
provide certain services under the management agreements. Certain of the
management agreements provide that the terms of any such employment must
be no less favorable to the applicable lessee, in the reasonable
judgment of the manager, than those that would be available from the
manager.
FF&E replacements. The management agreements generally provide that once each
year the manager will prepare a list of FF&E to be acquired and certain routine
repairs that are normally capitalized to be performed in the next year and an
estimate of the funds necessary therefor. Under the terms of the leases, the
lessor is required to provide to the applicable lessee all necessary FF&E for
the operation of the hotels (including funding any required FF&E replacements).
For purposes of funding the FF&E replacements, a specified percentage
(generally 5%) of the gross revenues of the hotel is deposited by the manager
into a book entry account. These amounts are treated under the leases as paid
by the lessees to the lessor and will be credited against their rental
obligations.
Under each lease, the lessor is responsible for the costs of FF&E
replacements and for decisions with respect thereto (subject to its obligations
to the lessee under the lease).
. Building alterations, improvements and renewals. The management
agreements require the manager to prepare an annual estimate of the
expenditures necessary for major repairs, alterations, improvements,
renewals and replacements to the structural, mechanical, electrical,
heating, ventilating, air conditioning, plumbing and vertical
transportation elements of each hotel. Such estimate must be submitted
to the lessor and the lessee for their approval. In addition to the
foregoing, the management
17
agreements generally provide that the manager may propose such changes,
alterations and improvements to the hotel as are required, in the
manager's reasonable judgment, to keep the hotel in a competitive,
efficient and economical operating condition or in accordance with
Marriott standards. The cost of the foregoing is paid from the FF&E
reserve account; to the extent that there are insufficient funds in such
account, the operating partnership is required to pay any shortfall.
. Service marks. During the term of the management agreements, the service
mark, such as "Marriott" and other symbols, logos and service marks
currently used by the manager and its affiliates, may be used in the
operation of the hotels. Marriott International (or its applicable
affiliates), Hyatt, Swissotel, and Four Seasons intend to retain their
legal ownership of these marks. Any right to use the service marks, logo
and symbols and related trademarks at a hotel will terminate with
respect to that hotel upon termination of the management agreement with
respect to such hotel.
. Termination fee. Certain of the management agreements provide that if
the management agreement is terminated prior to its full term due to
casualty, condemnation or the sale of the hotel, the manager would
receive a termination fee as specified in the specific management
agreement. Under the leases, the responsibility for the payment of any
such termination fee as between the lessee and the lessor depends upon
the cause for such termination.
. Termination for failure to perform. Most of the management agreements
may be terminated based upon a failure to meet certain financial
performance criteria, subject to the manager's right to prevent such
termination by making specified payments to the lessee based upon the
shortfall in such criteria.
Assignment of management agreements. The management agreements applicable to
each hotel have been assigned to the applicable lessee for the term of the
lease of such hotel. The lessee is obligated to perform all of the obligations
of the lessor under the management agreement during the term of its lease,
other than specified retained obligations including, without limitation,
payment of real property taxes, property casualty insurance and ground rent,
and maintaining a reserve fund for FF&E replacements and capital expenditures,
for which the lessor retains responsibility. Although the lessee has assumed
obligations of the lessor under the management agreement, the lessor is not
released from its obligations and, if the lessee fails to perform any
obligations, the manager will be entitled to seek performance by or damages
from the lessor. If the lease is terminated for any reason, any new or
successor lessee must meet certain requirements for an approved lessee or
otherwise be acceptable to Marriott International.
Non-competition agreements
Pursuant to a non-competition agreement entered into in connection with the
leases, Crestline has agreed, among other things, that until the earlier of
December 31, 2008 and the date on which it is no longer a lessee for more than
25% of the number of the hotels owned by us on December 29, 1998, it will not
(1) own, operate or otherwise control (as owner or franchisor) any full-service
hotel brand or franchise, or purchase, finance or otherwise invest in full-
service hotels, or act as an agent or consultant with respect to any of the
foregoing activities, or lease or manage full-service hotels (other than hotels
owned by the operating partnership) if its economic return therefrom would be
more similar to returns derived from ownership interests in such hotels except
for acquisitions of property used in hotels as to which a subsidiary of
Crestline is the lessee, investments in full-service hotels which represent an
immaterial portion of a merger or similar transaction or a minimal portfolio
investment in another entity, limited investments (whether debt or equity) in
full-service hotels as to which a subsidiary of Crestline is the lessee or
activities undertaken with respect to its business of providing asset
management services to hotel owners, or (2) without our consent, manage any of
the hotels owned by the operating partnership, other than to provide asset
management services.
We have agreed with Crestline, among other things, that, (1) until December
31, 2003, we will not purchase, finance or otherwise invest in senior living
communities, or act as an agent or consultant with respect to any of the
foregoing activities (except for acquisitions of communities which represent an
immaterial portion of a
18
merger or similar transaction or for minimal portfolio investments in other
entities) and (2) until the earlier of December 31, 2008 and the date on which
subsidiaries of Crestline are no longer lessees for more than 25% of the
number of the hotels owned by Host Marriott on December 29, 1998, we will not
lease, as tenant or subtenant, limited- or full-service hotel properties from
any "real estate investment trust" within the meaning of Sections 856 through
859 of the Internal Revenue Code where it will not be the operator or manager
of the hotel (other than through a contractual arrangement with a non-
affiliated party) and where its rental payments qualify as "rents from real
property" within the meaning of Section 856(d) of the Internal Revenue Code,
or purchase, finance or otherwise invest in persons or entities which engage
in any of the foregoing activities, or act as an agent or consultant with
respect to any of the foregoing activities (except for acquisitions of
entities which engage in any of the foregoing activities where the prohibited
activities represent an immaterial portion of a merger or similar transaction,
or minimal portfolio investments in other entities which engage in any of the
foregoing activities, or certain leasing arrangements existing on December 29,
1998 or entered into in the future between us and certain other related
parties, or by our management of any hotels in which it has an equity
interest). In addition, both Crestline and we have agreed not to hire or
attempt to hire any of the other company's senior employees at any time prior
to December 31, 2000.
We entered into a noncompetition agreement with Marriott International that
defines our rights and obligations with respect to certain businesses operated
by each of us. Crestline became an additional party to this agreement at the
time its shares were distributed to our stockholders. At that time, we also
entered into an agreement with Crestline under which we agreed with Crestline
about the allocation between us of the rights to engage in certain activities
permitted under the agreement with Marriott International. In general, until
October 8, 2000, we and our subsidiaries are prohibited from entering into or
acquiring any business that competes with the hotel management business (i.e.,
managing, operating or franchising full-service or limited-service hotels) as
conducted by Marriott International. Pursuant to this agreement, we cannot (1)
operate any hotel under a common name with any other hotel we operate or with
any hotel operated by Crestline, (2) have a manager (other than Marriott
International or one of its affiliates) manage any limited-service hotel for
us under a common name with any other limited-service hotel managed by such
manager for use or for Crestline, (3) have a manager (other than Marriott
International or one of affiliates manage more than the greater (a) 10 full-
service hotels under a common name which is a brand other than "Delta," "Four
Seasons," "Holiday Inn," "Hyatt" and Swissotel" (the "Existing Brands") or (b)
25% of any system operated by such manager under a common name which is not an
Existing Brand, (4) have a manager (other than Marriott International or one
of its affiliates) manage more than the greater of (a) 5 full-service hotels
under a common name which is an Existing Brand or (b) 12.5% of any system
operated by such manager under a common name which is an Existing Brand, (5)
franchise as franchisor any limited-service hotel under a common name with any
other limited-service hotel for which we or Crestline is a franchisor or (6)
franchise as franchisor more than 10 full-service hotels under a common name.
Risk Factors
The following risk factors should be considered by prospective investors who
should carefully consider the material described below.
Risks of ownership of our common stock
There are limitations on the acquisition of our common stock and changes in
control. Our charter and bylaws, the partnership agreement of the operating
partnership, our shareholder rights plan and the Maryland General Corporation
Law 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 "--Possible
adverse consequences of limits on ownership of our common stock" below 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 such change in
control would be in the interest of our shareholders, and even if such
change in control would not reasonably jeopardize our REIT status.
19
Staggered board. Our charter provides that our Board of Directors will
consist of eight members and can be increased or decreased after that
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 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
shareholders' ability to effect a change in control of us, even if a change
in control would be in the interest 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 8,160,000
have been issued. 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 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 such business combination must be approved by 80% of
outstanding voting shares, and by two-thirds of 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 such shares previously acquired by the acquiror or in respect of
which the acquiror
20
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. See "Risks of Ownership of
Our Common Stock--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 holding a majority of all
votes entitled to be cast on the merger. Under the Maryland General
Corporation Law, specific mergers without a vote of shareholders and a
share exchange is only required to be approved by a Maryland successor 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 Host Marriott's 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.
Marriott International purchase right. As a result of our spin-off of
Marriott International in 1993, Marriott International has the right to
purchase up to 20% of each class of our outstanding voting shares at the
then fair market value when specific change of control events involving us
occur, subject to specified limitations to protect our REIT status. The
Marriott International purchase right may have the effect of discouraging a
takeover of us, because any person considering acquiring a substantial or
controlling block of our common stock will face the possibility that its
ability to obtain or exercise control would be impaired or made more
expensive by the exercise of the Marriott International purchase right.
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. 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 person 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%
21
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 its qualification as a REIT for federal income tax
purposes, the ownership limit under Host Marriott's charter will prohibit
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 the REIT conversion so long as
the holder would not own more than 9.9% in value of our outstanding shares,
and will prohibit 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 Host Marriott's preferred shares. Together, these limitations are
referred to as the "ownership limit." The 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 it is satisfied, based upon information required
to be provided by the party seeking the waiver and upon an opinion of counsel
satisfactory to the 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 or any of the
partnerships, including Crestline and the lessees, 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 such common stock in violation of the
ownership limit will not be entitled to any distributions thereon, to vote
such shares of common stock or to receive any proceeds from the subsequent
sale thereof in excess of the lesser of the price paid therefor or the amount
realized from such 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. 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 will have to distribute to our shareholders 95% of our
taxable income in order to qualify as a REIT, including taxable income which
does not generate corresponding cash. This distribution requirement will be
reduced to 90% for taxable years after December 31, 2000. Our access to
external capital will depend upon a number of factors, including general
market conditions, the market's perception of our growth potential, our
current and potential future earnings, cash distributions and the market price
of our common stock. Currently, our access to external capital has been
limited to the extent that our common stock is trading at what we believe is a
significant discount to our estimated net asset value.
Shares of our common stock that are or become available for sale could
affect the price for our shares of common stock. Sales of a substantial number
of our shares of common stock, or the perception that sales could occur, could
adversely affect prevailing market prices for our common stock. In addition,
holders of OP Units who redeem their OP Units and receive our common stock
will be able to sell their shares freely after they are received, unless the
person is our affiliate. There are currently approximately 64.0 million OP
Units outstanding, substantially all of which are currently redeemable.
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, the issuance of additional shares of our common stock
by us in the future would be available for sale in the public markets. 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.
22
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. To the extent we retain operating cash flow for
investment purposes, working capital reserves or other purposes rather than
distributing such cash flow to shareholders, these retained funds, while
increasing the value of our underlying assets, may not correspondingly
increase the market price of our common stock. 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.
Market interest rates may affect the price of shares of our common
stock. One of the factors that investors consider important in deciding
whether to buy or sell shares of a REIT is the distribution rate on such
shares, considered as a percentage of the price of such 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
We do not control our hotel operations, and we are dependent on the managers
and lessees of our hotels. Because federal income tax laws currently restrict
REITs and "publicly traded" partnerships from deriving revenues directly from
operating a hotel, we operate none of our hotels. Instead, we lease virtually
all of our hotels to subsidiaries of Crestline which, in turn, retain managers
to manage our hotels pursuant to management agreements. Thus, we are dependent
on the lessees but, under the hotel leases, we have little influence over how
the lessees operate our hotels. Similarly, we are dependent on the managers,
principally Marriott International, but we have little influence over how the
managers manage our hotels. We have very limited recourse if we believe that
the hotel managers do not maximize the revenues from our hotels, which in turn
will maximize the rental payments we receive under the leases. We may seek
redress under most leases only if the lessee violates the terms of the lease
and then only to the extent of the remedies set forth in the lease.
Each lessee's ability to pay rent accrued under its lease depends to a large
extent on the ability of the hotel manager to operate the hotel effectively
and to generate gross sales in excess of its operating expenses. Our rental
income from the hotels may therefore 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. Although
the lessees have primary liability under the management agreements while the
leases are in effect, we remain liable under the management agreements for all
obligations that the lessees do not perform. We may terminate a lease if the
lessee defaults under a management agreement, but terminating the lease could,
unless another suitable lessee is found, impair our ability to qualify as a
REIT for federal income tax purposes and the operating partnership's ability
to qualify as a partnership for federal income tax purposes if it is a
"publicly traded partnership" unless another suitable lessee is found. As
described below, our inability to qualify as a REIT or the operating
partnership's inability to qualify as a partnership for federal income tax
purposes would have a material adverse effect on us.
We do not control the assets held by the non-controlled subsidiaries. The
operating partnership owns economic interests in several taxable corporations,
which we refer to as "non-controlled subsidiaries," that hold various assets
which, under our credit facility may not exceed, in the aggregate, 15% of the
value of our assets. The assets held by the non-controlled subsidiaries
consist primarily of interests in partnerships that own hotels that are not
leased to third parties, hotels that are not leased to third parties, some
FF&E used in our hotels and some international hotels. If the operating
partnership owned these assets, it could jeopardize our REIT status and/or the
status of the operating partnership as a partnership for federal income tax
purposes. Although the operating partnership owns approximately 95% of the
total economic interests of the non-controlled subsidiaries, it owns none of
the voting stock of the non-controlled subsidiaries. The Host Marriott
Statutory
23
Employee/Charitable Trust, the beneficiaries of which are (1) a trust formed
for the benefit of a number of our employees and (2) the J. Willard and Alice
S. Marriott Foundation, owns all of the voting common stock, representing
approximately 5% of the total economic interests in such the controlled
subsidiaries. The Host Marriott Statutory Employee/Charitable Trust elects the
directors who are responsible for overseeing the operations of the non-
controlled subsidiaries. The directors are currently our employees, although
this is not required. As a result, we have no control over the operation or
management of the hotels or other assets owned by the non-controlled
subsidiaries, even though we depend upon the non-controlled subsidiaries for a
portion of our revenues. Also, the activities of the non-controlled
subsidiaries could cause us to be in default under our principal credit
facilities.
We are dependent upon the ability of Crestline and the lessees to meet their
rent obligations. The lessees' rent payments are the primary source of our
revenues. Crestline guarantees the obligations of its subsidiaries under the
hotel leases, but Crestline's liability is limited to a relatively small
portion of the aggregate rent obligation of its subsidiaries. The ability of
Crestline and each of its subsidiaries to meet its obligations under the
leases will determine the amount of our revenue and our ability to meet our
obligations. We have no control over Crestline or any of its subsidiaries and
cannot assure you that Crestline or any of its subsidiaries will have
sufficient assets, income and access to financing to enable them to satisfy
their obligations under the leases or to make payments of fees under the
management agreements. Although the lessees have primary liability under the
management agreements while the leases are in effect, we and our subsidiaries
remain liable under the management agreements for all obligations that the
lessees do not perform. Because of our dependence on Crestline, our credit
rating will be affected by its creditworthiness.
Our relationships with Marriott International and Crestline may result in
conflicts of interest.
Marriott International, a public hotel management company, manages a
significant number of our hotels. In addition, Marriott International manages
hotels that compete with our hotels. As a result, Marriott International may
make decisions regarding competing lodging facilities which it manages that
would not necessarily be in our best interests. J.W. Marriott, Jr. is a member
of our Board of Directors and his brother, Richard E. Marriott, is our
Chairman of the Board. Both J.W. Marriott, Jr. and Richard E. Marriott serve
as directors, and J.W. Marriott, Jr. also serves as an officer, of Marriott
International. J.W. Marriott, Jr. and Richard E. Marriott also beneficially
own, as determined for securities law purposes, as of January 31, 2000,
approximately 10.8% and 10.6%, respectively, of the outstanding shares of
common stock of Marriott International. In addition, J.W. Marriott, Jr. and
Richard E. Marriott own, as of January 31, 2000, approximately 5.1% and 4.8% ,
respectively, of the outstanding shares of common stock of Crestline. Neither
J.W. Marriott, Jr. or Richard E. Marriott serves as an officer or director of
Crestline. As a result, J.W. Marriott, Jr. and Richard E. Marriott have
potential conflicts of interest as our directors when making decisions
regarding Marriott International, including decisions relating to the
management agreements involving the hotels, Marriott International's
management of competing lodging properties and Crestline's leasing and other
businesses.
Both our Board of Directors and the Board of Directors of Marriott
International follow appropriate policies and procedures to limit the
involvement of Messrs. J.W. Marriott, Jr. and Richard E. Marriott in conflict
situations, including requiring them to abstain from voting as directors of
either us or Marriott International or our or their subsidiaries on matters
which present a conflict between the companies. If appropriate, these policies
and procedures will apply to other directors and officers.
When the leases expire or terminate, we might not be able to find other
lessees. Our current hotel leases have terms generally ranging from seven to
ten years. We cannot assure that when our leases expire, our hotels will be
re-leased to the current lessees, or if re-leased, will be re-leased on terms
favorable to us. If our hotels are not re-leased, we will be required to find
other lessees who meet the requirements of the management agreements and of
the federal income tax rules that govern REITs. We have received notices of
termination from Crestline on five leases, with effective dates ranging from
March through June 2000. We are in the process of finding new lessees for
these hotels, and we expect to be able to obtain replacement leases for these
leases
24
without material impact to our future operations. We cannot assure you that we
will be able to find satisfactory lessees or that the terms of any new leases
would be favorable. If we fail to find satisfactory lessees:
. we could lose our REIT status;
. the operating partnership would be taxed as a "C" corporation if it is a
"publicly traded partnership," which would require us and the operating
partnership to pay substantial federal income taxes;
. the operating partnership would be required to distribute more cash to
us and other equity holders to enable us to meet our tax burden; and
. it could adversely affect our and the operating partnership's ability to
raise additional capital.
Failure to enter leases on satisfactory terms could also result in reduced
cash available for debt service and distributions to shareholders.
We have substantial indebtedness. Our degree of leverage could affect our
ability to:
. obtain financing in the future for working capital, capital
expenditures, acquisitions, development or other general business
purposes;
. undertake financings on terms and conditions acceptable to us;
. pursue our acquisition strategy; or
. compete effectively or operate successfully under adverse economic
conditions.
We have a policy of incurring debt only if, immediately following the
incurrence, our debt-to-total market capitalization ratio on a pro forma basis
would be 60% or less. Our debt-to-total market capitalization ratio was
approximately 69% as of December 31, 1999. If our total market capitalization
does not change, we would have to waive or change our debt policy to incur
additional indebtedness. Our debt-to-total market capitalization ratio has
increased primarily because of a general decline in the market valuation of
the stock of lodging companies, including our stock. As a result of this
decline, our Board of Directors may reconsider whether our debt incurrence
policy should be linked to another measure of value instead of total market
capitalization.
If our cash flow and working capital is not sufficient to fund our
expenditures or service our indebtedness, we would have to raise additional
funds through:
. the sale of equity;
. the refinancing of all or part of our indebtedness;
. the incurrence of additional permitted indebtedness; or
. the sale of assets.
We cannot assure you that any of these sources of funds would be available
in amounts sufficient for us to meet our obligations or fulfill our business
plans. Additionally, our debt contains certain performance related covenants
which, if not achieved, could require immediate repayment of the debt or
significantly increase the rate of interest on the debt.
There is no limitation on the amount of debt we may incur. There are no
limitations in our or the operating partnership's 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. Accordingly, our Board of Directors could alter or eliminate our
60% policy without shareholder approval to the extent permitted by our debt
agreements. If this policy were changed, we could become more highly
leveraged, which would increase our debt service payments and adversely affect
our cash flow and our ability to service our debt and make distributions to
our shareholders.
25
Our leases and management agreements could impair the sale or other
disposition of our hotels. Under each lease with a subsidiary of Crestline, we
generally must purchase a lease if we want to terminate the lease prior to the
expiration of its term. We must purchase the lease even if we are terminating
the lease because of a change in the federal income tax laws that either would
make continuation of the lease jeopardize our status as a REIT or would enable
us to operate our hotels directly ourselves. The REIT Modernization Act will
allow us to lease the hotels to a "taxable REIT subsidiary" after December 31,
2000. See "--REIT Modernization Act Changes to REIT asset tests" below. At the
present time, no decision has been made regarding whether a taxable REIT
subsidiary would be formed and, if so, whether it would purchase any of the
leases from a Crestline subsidiary. The purchase price generally will be equal
to the fair market value of the lessee's leasehold interest in the remaining
term of the lease, which could be a significant amount. In addition, if we
decide to sell a hotel, we may be required to terminate its lease, and the
payment of the purchase price under such circumstances could impair our
ability to sell the hotel and would reduce the net proceeds of any sale.
Under the terms of the management agreements, we generally may not sell,
lease or otherwise transfer the hotels unless the transferee assumes the
related management agreements and meets specified other conditions. Our
ability to finance, refinance or sell any of the properties managed by
Marriott International or another manager may, depending upon the structure of
such transactions, require the manager's consent. If Marriott International or
any other manager did not consent, we would be prohibited from financing,
refinancing or selling the property without breaching the management
agreement.
Our rental revenues from hotels are subject to the prior rights of
lenders. The mortgages on some of our hotels require that rent payments under
the leases on the hotels be used first to pay the debt service on the mortgage
loans. Consequently, only the cash flow remaining after debt service on those
mortgage loans will be available to satisfy other obligations, including
property taxes and insurance, FF&E reserves for the hotels and capital
improvements, and to make distributions to our shareholders.
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 owners of some of our 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 rent revenues we
receive on the hotels. As of December 31, 1999, we leased 53 of our hotels
pursuant to ground leases. These ground leases generally require increases in
ground rent payments every five years. Our ability to make distributions to
shareholders could be adversely affected to the extent that the rents payable
by the lessees under the leases 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.
New acquisitions may fail to perform as expected or we may be unable to make
acquisitions on favorable terms. We intend to acquire additional full-service
hotels. Newly acquired properties may fail to perform as expected, which could
adversely affect our financial condition. We may underestimate the costs
necessary to bring an acquired property up to standards established for its
intended market position. We expect to acquire hotels with cash from secured
or unsecured financings and proceeds from offerings of equity or debt, to the
extent available. We may not be in a position or have the opportunity in the
future to make suitable property acquisitions on favorable terms. Competition
for attractive investment opportunities may increase prices for hotel
properties, thereby decreasing the potential return on our investment. In
addition, in order to maintain our status as a REIT, we must lease virtually
all of the properties we acquire. We cannot guarantee that the leases
26
for newly acquired hotels will be as favorable to us as the existing leases.
Under the REIT Modernization Act, however, we would be permitted to lease any
newly acquired hotels to a taxable REIT subsidiary after December 31, 2000.
The seasonality of the hotel industry may affect the ability of the lessees
to make timely rent payments. The seasonality of the hotel industry may, from
time to time, affect either the amount of rent that accrues under the hotel
leases or the ability of the lessees to make timely rent payments under the
leases. A lessee's inability to make timely rent payments to us could
adversely affect our financial condition and our ability to make distributions
to our shareholders.
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 and make distributions to shareholders.
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.
Our revenues and the value of our properties are subject to conditions
affecting the lodging industry. If our assets do not generate income
sufficient to pay our expenses, service our debt and maintain our properties,
we will be unable to make distributions to our shareholders. 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;
. 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,
primarily Marriott International;
. the ability of any hotel lessee to maximize rental payments;
. 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.
Adverse changes in these conditions could adversely affect our financial
performance.
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. If a
property is mortgaged and we are unable to meet the mortgage payments, the
lender could foreclose and take the property. Our financial condition could be
adversely affected by:
. interest rate levels;
. 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.
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. On November 3, 1999, Terence C.
Golden, our President and Chief Executive Officer, announced his resignation
effective in May 2000. Mr. Golden will remain on the Board of Directors. The
Board of Directors has appointed Christopher J. Nassetta, currently our
Executive Vice President and Chief Operating Officer, as our President and
Chief Executive Officer upon the effectiveness of Mr. Golden's resignation.
Mr. Nassetta also became a member of the Board of Directors at the time of the
27
announcement of Mr. Golden's resignation. We do not 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 and the operating
partnership are parties to various lawsuits relating to previous partnership
transactions, including the REIT conversion. 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. In connection with the
REIT conversion, the operating partnership has assumed all liability arising
under legal proceedings filed against us and will indemnify us as to all such
matters. If any of the lawsuits were to be determined adversely to us or
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 announced
that we and Marriott International have executed a definitive settlement
agreement to resolve specific pending litigation involving seven limited
partnerships. The proposed settlement would involve an acquisition of the
limited partner interests in two partnerships by a joint venture between our
non-controlled subsidiary and Marriott International and a resolution of
claims against all defendants in all seven partnerships. Our share of the
payment, including for the acquisition, is expected to be approximately $113
million, not including our existing interests in the partnerships. The
proposed settlement is subject to numerous conditions, including definitive
documentation, court approval and various consents, and we cannot assure you
that the settlement will occur. As a result of the proposed settlement, we
have recorded a one-time, non-recurring, pre-tax charge of $40 million to our
1999 earnings.
We may acquire hotel properties through joint venture 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. Actions by a co-venturer 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-venturers 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.
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, they notify and
train those who may come into contact with asbestos and 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
28
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.
Compliance with other government regulations can also be costly. Our hotels
are subject to various 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 reduce the cash available for
servicing debt and making distributions to our shareholders.
Some potential losses are not covered by insurance. We carry comprehensive
liability, fire, flood, extended coverage and rental loss, for rental losses
extending up to 12 months, insurance with respect to all of our hotels. We
believe the policy specifications and insured limits of these policies are of
the type customarily carried for similar hotels. Some types of losses, such as
from earthquakes and environmental hazards, however, may be either uninsurable
or too expensive to justify insuring against. Should an uninsured loss or a
loss in excess of insured limits occur, we could lose all or a portion of the
capital we have invested in a hotel, 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.
Federal income tax risks.
General. 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. A REIT generally is not taxed
at the corporate level on income it currently distributes to its shareholders
as long as it distributes currently at least 95% of its taxable income,
excluding net capital gain. This distribution requirement will be reduced to
90% in years beginning after December 31, 2000. No assurance can be provided,
however, that we will 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 such qualification.
Required distributions and payments. In order to continue to qualify as a
REIT, we currently are required each year to distribute to our shareholders at
least 95% of our taxable income, excluding net capital gain, and we will be
required to distribute 90% of this amount for years beginning after December
31, 2000. Due to some transactions entered into in years prior to the REIT
conversion, we expect to recognize substantial amounts of "phantom" income,
which is taxable income that is not matched by cash flow or EBITDA to us. In
addition, we will be subject to a 4% nondeductible excise tax on the amount,
if any, by which certain distributions made by us with respect to the calendar
year are less than the sum of 85% of our ordinary income, 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 95% distribution requirement and to avoid the nondeductible excise tax and
will rely for this purpose on distributions from the operating partnership.
However, differences in timing between taxable income and cash available for
distribution due to, among other things, the seasonality of the lodging
industry and the fact that some taxable income will be "phantom" income could
require us to borrow funds or to issue additional equity to enable us to meet
the 95% distribution requirement and, therefore, to maintain our REIT status,
and to avoid the nondeductible excise tax. The operating partnership is
required to pay, or reimburse us, as its general partner, for, some taxes and
other liabilities and expenses that we incur, including all taxes and
liabilities attributable to periods and events prior to the REIT conversion.
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.
29
Adverse consequences of our failure to qualify as a REIT. If we fail to
qualify as a REIT, we will be subject to federal income tax, including any
applicable alternative minimum tax, on our taxable income at regular corporate
rates. In addition, unless entitled to statutory relief, we will 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 to be taxable as
ordinary income to the extent of our current and accumulated E&P. However,
subject to limitations under the Internal Revenue Code, corporate distributees
may be eligible for the dividends received deduction with respect to these
distributions. Our failure to qualify as a REIT also would result in a default
under the senior notes and the credit facility.
Our earnings and profits 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 such 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 there could be uncertainties
relating to the estimate of our non-REIT E&P and the value of the Crestline
stock that we distributed to our shareholders. Therefore, we cannot guarantee
that we met this requirement.
Treatment of leases. 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,
taking into account both the terms of the leases and the expectations that we
and the lessees have with respect to the leases, 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. 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 "--Adverse consequences of our failure to qualify as a REIT,"
above.
Other tax liabilities; our 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 and
local taxes on our income and property. In addition, we will be required to
pay tax at the regular corporate rate, currently 35%, upon our share of any
"built-in gain" recognized as a result of any sale before January 1, 2009, by
the operating partnership 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. We or a
non-controlled subsidiary likely will 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 recognized a
substantial amount of built-in gains and deferred tax liabilities in 1999.
Accordingly, our potential tax exposure on these gains and deferred
liabilities for the future is significantly less than it was at the time of
our REIT conversion. The operating partnership is obligated under its
partnership agreement to pay all such taxes incurred by us, as well as any
liabilities that the IRS may assert against us for corporate income taxes for
taxable years prior to the time we qualified as a REIT. The non-controlled
subsidiaries are fully taxable corporations and will pay federal and state
income tax on their net income at the applicable corporate rates.
30
The operating partnership's failure to qualify as a partnership. We believe
that the operating partnership qualifies to be treated as a partnership for
federal income tax purposes. 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 two of the asset tests applicable to REITs
and, accordingly, cease to qualify as a REIT. See "--Adverse consequences of
our failure to qualify as REIT," above. Also, the imposition of a corporate
tax on the operating partnership would reduce significantly the amount of cash
available for distribution to its limited 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 accounts," and possibly
more, depending upon the circumstances.
REIT Modernization Act changes to the REIT asset tests. Currently, a REIT
may not own securities in any one issuer if 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. As a result of the REIT Modernization Act, after December 31,
2000, the 5% value test and the 10% voting security test will be modified in
two respects. First, the 10% voting securities test will be expanded so that
REITs also will be prohibited from owning more than 10% of the value of the
outstanding securities of any one issuer. Second, an exception to these tests
that will allow a REIT to own securities of a subsidiary that exceed the 5%
value test and the new 10% vote or value test if the subsidiary elects to be a
"taxable REIT subsidiary," which would be a fully taxable corporation. The
expanded 10% vote or value test, however, will not apply to an existing
subsidiary unless it engages in a substantial new line of business or acquires
any substantial asset or the Company acquires any securities in that
subsidiary after July 12, 1999. Under a new asset test, for taxable years
beginning after December 31, 2000, the Company will not be able to own
securities of taxable REIT subsidiaries that represent in the aggregate more
than 20% of the value of the Company's total assets. At the present time, no
decision has been made as to whether any of the non-controlled subsidiaries
will elect to be treated as taxable REIT subsidiaries.
Several provisions of the new law will ensure that a taxable REIT subsidiary
will be subject to an appropriate level of federal income taxation. For
example, a taxable REIT subsidiary will be limited in its ability to deduct
interest payments made to an affiliated REIT. In addition, the REIT will have
to pay a 100% penalty tax on some payments that it receives if the economic
arrangements between the REIT, the REIT's tenants, and the taxable REIT
subsidiary are not comparable to similar arrangements between unrelated
parties.
Item 3. Legal Proceedings
Texas Multi-Partnership Lawsuit. On March 16, 1998, limited partners in
several limited partnerships sponsored by Host Marriott or its subsidiaries
filed a lawsuit, Robert M. Haas, Sr. and Irwin Randolph Joint Tenants, et al.
v. Marriott International, Inc., et al., Case No. 98-CI-04092, in the 57th
Judicial District Court of Bexar County Texas, alleging that the defendants
conspired to sell hotels to the partnerships for inflated prices and that they
charged the partnerships excessive management fees to operate the
partnerships' hotels. A Marriott International subsidiary manages each of the
hotels involved and, as to some properties, Marriott International, or one of
its subsidiaries, is the ground lessor and collects rent. The Company,
Marriott International, several of their subsidiaries, and J.W. Marriott, Jr.
are among the various named defendants. The Haas lawsuit originally involved
the following partnerships:
1.) Courtyard by Marriott Limited Partnership ("CBM I");
2.) Courtyard by Marriott II Limited Partnership ("CBM II");
3.) Marriott Residence Inn Limited Partnership ("Res I");
4.) Marriott Residence Inn II Limited Partnership ("Res II");
31
5.) Fairfield Inn by Marriott Limited Partnership ("Fairfield");
6.) Desert Springs Marriott Limited Partnership ("Desert Springs"); and
7.) Atlanta Marriott Marquis Limited Partnership ("AMMLP").
Those allegations concerning CBM II have been transferred to the CBM II
lawsuit described below.
Courtyard by Marriott II Limited Partnership (CBM II). A group of partners
in CBM II filed a lawsuit, Whitey Ford, et al v. Host Marriott Corporation, et
al., Case No. 96-CI-08327, on June 7, 1996, in the 285th Judicial District
Court of Bexar County, Texas against the Company, Marriott International, and
others alleging breach of fiduciary duty, breach of contract, fraud, negligent
misrepresentation, tortious interference, violation of the Texas Free
Enterprise and Antitrust Act of 1983 and conspiracy in connection with the
formation, operation and management of CBM II and its hotels. The plaintiffs
are seeking unspecified damages. On January 29, 1998, two other limited
partners, A.R. Milkes and D.R. Burklew, filed a petition in intervention
seeking to convert the lawsuit into a class action.
Courtyard by Marriott Limited Partnership (CBM I). Two members of an ad hoc
committee of CBM I limited partners, Marvin Schick and Jack Hirsch, filed a
putative class action lawsuit, Marvin Schick, et al. v. Host Marriott
Corporation, et al., Civil Action No. 15991, in Delaware Chancery Court
against the Company, Marriott International, and others on October 16, 1997,
regarding the 1995 refinancing of CBM I's mortgage debt. The complaint
contains allegations of breach of fiduciary duty, breach of contract, tortious
interference, and aiding and abetting liability in connection with the
refinancing.
Atlanta Marquis. Certain limited partners of AMMLP filed a putative class
action lawsuit, Hiram and Ruth Sturm v. Marriott Marquis Corporation, et al.,
Case No. 97-CV-3706, in the U.S. District Court for the Northern District of
Georgia, on December 12, 1997 against AMMLP's general partner, its directors
and the Company, regarding the merger of AMMLP into a new partnership as part
of the refinancing of AMMLP's debt. The plaintiffs allege that the defendants
misled the limited partners in order to induce them to approve the AMMLP
merger, violated securities regulations and federal roll-up regulations, and
breached their fiduciary duties to the partners. Another limited partner of
AMMLP sought similar relief and filed a separate lawsuit, styled Poorvu v.
Marriott Marquis Corporation, et al., Civil Action No. 16095-NC, on December
19, 1997, in Delaware State Chancery Court.
Partnership Litigation Settlement. On March 9, 2000, we and Marriott
International entered into a definitive settlement agreement that would
resolve the Texas Multi-Partnership, the CBM II (Whitey Ford and Milkes), the
CBM I (Schick), and the Atlanta Marquis (Sturm and Poorvu) litigation. The
settlement, which is still subject to numerous conditions, including
participation in the class action settlement by holders of at least 90 percent
of the units in each partnership, court approval and various consents, was
reached with lead counsel to the plaintiffs in litigation pending in Texas,
Delaware and Georgia. There are two principal features of the proposed
settlement. First, one of our non-controlled subsidiaries and Marriott
International would form a joint venture to acquire the equity interests of
the limited partners in two partnerships, CBM I and CBM II, and to obtain a
full release of all claims for approximately $372 million. These partnerships
own 120 Courtyard hotels. The settlement of litigation concerning these two
partnerships, including the acquisitions and full releases of all claims,
would be financed with approximately $185 million of mezzanine debt loaned to
the joint venture by Marriott International, and equity contributed in equal
shares by our non-controlled subsidiary and Marriott International. Marriott
International would continue to manage these 120 hotels under long-term
agreements. Second, Marriott International and we or our respective affiliates
would each pay approximately $31 million to the limited partners in Res I and
Res II, Fairfield, Desert Springs and Atlanta in exchange for settlement of
the litigation and full releases of claims.
MHP II. Limited partners of Marriott Hotel Properties II Limited Partnership
("MHP II") are asserting putative class claims in lawsuits filed in Palm Beach
County Circuit Court on May 10, 1996, Leonard Rosenblum, as Trustee of the
Sylvia Bernice Rosenblum Trust, et al. v. Marriott MHP Two Corporation, et
al., Case No. CL-96-4087-AD, and, in Delaware State Chancery Court on April
24, 1996, Cary W. Salter, Jr., et al.
32
v. MHP II Acquisition Corp., et al., respectively, against the Company and
certain of its affiliates alleging that the defendants violated their
fiduciary duties and engaged in fraud and coercion in connection with the
tender offer for MHP II units.
The defendants removed the Florida action to the United States District
Court for the Southern District of Florida and, after hearings on various
procedural motions, the District Court remanded the case to state court on
July 25, 1998. The defendants then filed motions to dismiss Rosenblum's fifth
amended complaint or, in the alternative, to deny class certification in the
state court case. The state court held a hearing on these motions on October
27, 1998 but did not issue a ruling at that time. Thereafter, and prior to any
ruling on the defendants' motions, Rosenblum filed a motion seeking leave to
file a sixth amended complaint adding allegations relating to the partnership
merger of MHP II and adding additional plaintiffs. On February 2, 1999, the
court granted Rosenblum's motion to file an amended complaint and denied as
moot the defendants' motion to dismiss the earlier complaint.
On June 12, 1996, the Delaware Chancery Court entered an order denying the
Delaware plaintiffs' application to enjoin the tender offer for MHP II units.
The Delaware plaintiffs subsequently moved to voluntarily dismiss the Delaware
action. The Chancery Court granted this motion, but with the proviso that the
plaintiffs could only refile in the Florida federal action. After the District
Court's remand of the Rosenblum case to Florida state court, two of the three
original Delaware plaintiffs asked the Chancery Court to reconsider its order
granting their voluntary dismissal. The Chancery Court refused to allow the
plaintiffs to join the Rosenblum action in Florida and, instead, reinstated
the Delaware case, now styled In Re Marriott Hotel Properties II Limited
Partnership Unitholders Litigation, Consolidated Civil Action No. 14961. On
January 29, 1999, Cary W. Salter alone filed an Amended Consolidated Class
Action Complaint in the Delaware action, adding allegations relating to the
partnership merger of MHP II. On January 24, 2000, the Delaware Chancery Court
issued a memorandum opinion in which the court dismissed all but one of the
plaintiff's claims.
In light of the Chancery Court's decision, the defendants in the Florida
action filed a supplemental memorandum in support of their motions to dismiss,
and attached a copy of the Delaware opinion to the memorandum. The Florida
court has not yet ruled on the motions.
Potomac Hotel Limited Partnership. On July 15, 1998, one limited partner in
Potomac Hotel Limited Partnership, or PHLP, filed a class action lawsuit
styled Michael C. deBerardinis v. Host Marriott Corporation, Civil Action No.
WMN 98-2263, in the United States District Court for the District of Maryland.
The plaintiff alleged that we misled PHLP's limited partners in order to
induce them into approving the sale of one of PHLP's hotels, violated the
securities regulations by issuing a false and misleading consent solicitation
and breached fiduciary duties and the partnership agreement. The complaint
sought unspecified damages. On February 16, 1999, the District Court dismissed
the federal securities claims with prejudice and the state law claims without
prejudice. On March 9, 1999, the plaintiff filed a class action complaint in
Montgomery County, Maryland Circuit Court in a case styled Michael C.
deBerardinis v. Host Marriott Corporation, Civil No. 197694-V, to further
pursue the state law claims, claims for breach of fiduciary duty and breach of
contract. In support of these claims, the plaintiff asserted that Host
Marriott manipulated certain financial transactions, that the Partnership's
1982 management agreement with Marriott International, Inc. and the 1995
refinancing of the Partnership's debt were unfair, and that Host Marriott
committed misdeeds relating to a loan default and decisions regarding whether
or not to repurchase certain hotels. The state court complaint again sought
unspecified damages. On July 12, 1999, the state court denied Host Marriott's
motion to dismiss. Discovery is currently pending in the case and currently is
scheduled to close on June 30, 2000. All dispositive motions are currently due
no later than July 17, 2000.
Marriott Suites Limited Partnership (MSLP). On December 10, 1999, KSK Hawaii
Co., Ltd. ("KSK"), a limited partner in MSLP, filed a lawsuit, KSK Hawaii Co.,
Ltd. v. Marriott SBM One Corporation, et al., Civil Action No. 17657-NC, in
Delaware State Chancery Court. KSK alleges in its complaint that it suffered
damages due to fraud, breaches of fiduciary duty, breaches of MSLP's
partnership agreement and aiding and abetting in connection with MSLP's 1996
recapitalization and the partnership merger of MSLP in 1998. KSK claims that
it
33
was coerced into selling 19 of its 20 partnership units in the 1996
recapitalization. KSK also maintains that the 1998 merger was a "freeze-out'
merger that was designed solely to eliminate KSK's interest in MSLP. KSK
maintains that it lost slighly more than $15 million as a result of its
investment in MSLP.
Richmond Marriott Partnership. On January 28, 2000, June Schallman and David
Ingall, limited partners in Mutual Benefit/Marriott Hotel Associates-I Limited
Partnership (the "Richmond Partnership"), filed a putative class action
lawsuit, Schallman, et al. v. Host Marriott Corporation and M.B. Investment
Properties, Inc., Civil Action No. 2047 169, in a Montgomery County, Maryland
State Circuit Court. Host Marriott and MB Investment Properties, Inc.
"(MBIP"), who are not affiliated, were the original general partners of the
Richmond Partnership, which was formed in 1985 to own the Richmond, Virginia
Marriott Hotel. The plaintiffs allege that the defendants breached the
partnership agreement and their fiduciary duties thereunder by, among other
things, loaning money to the Richmond Partnership at commercially unreasonable
interest rates, and entering into a management agreement with a subsidiary of
Marriott International which imposes commercially unreasonable fees, does not
disclose profits made from supplying goods and services, and fails to share
rebates provided by suppliers and vendors. The plaintiffs also allege that the
defendants fraudulently concealed this alleged self-dealing. On March 9, 2000,
Host Marriott filed a motion to dismiss for failure to state a claim on which
relief can be granted.
Item 4. Submission of matters to a vote of security holders
None
34
PART II
Item 5. Market for our common stock and related shareholder matters
Our common stock is listed on the New York Stock Exchange, the Chicago Stock
Exchange, the Pacific Stock Exchange and the Philadelphia Stock Exchange and
is traded under the symbol "HMT." The following table sets forth, for the
fiscal periods indicated, the high and low sales prices per share of our
common stock as reported on the New York Stock Exchange Composite Tape.
High Low
-------- ---------
1998
1st Quarter............................................. $20 9/16 $17 1/2
2nd Quarter............................................. 22 1/8 17
3rd Quarter............................................. 19 12 9/16
4th Quarter............................................. 15 7/16 10
1999
1st Quarter............................................. 14 3/4 10 11/16
2nd Quarter............................................. 13 5/16 11 1/16
3rd Quarter............................................. 12 3/16 9 3/16
4th Quarter............................................. 9 1/2 7 13/16
During 1999, a quarterly cash dividend of $0.21 per share of common stock
was declared on March 15, June 15, September 23, and December 20, 1999. The
quarterly dividends were subsequently paid on April 14, July 14, October 15,
1999, and January 17, 2000. Host Marriott declared a special stock and cash
dividend on December 18, 1998, in conjunction with the REIT conversion, which
was paid in 1999 to shareholders of record on December 28, 1998. The 1998
common stock prices listed above have not been adjusted for the special stock
dividend because the effect is immaterial. On December 29, 1998, we spun off
to our shareholders one share of Crestline for every ten shares of our common
stock held. (See Note 2 to the consolidated financial statements).
As a result of the REIT conversion, we are required to pay dividends to the
extent of 95% of our taxable income in order to maintain our REIT
qualification. We intend to pay dividends equal to 100% of our taxable income
for each year. We expect to pay these dividends from distributions to us from
the operating partnership. To the extent that the operating partnership's cash
flow is not sufficient to make distributions to holders of OP Units in an
amount sufficient so that we can pay our dividends, the operating partnership
may be required to borrow money to pay the distributions.
As of March 1, 2000, there were approximately 60,953 holders of record of
common stock and approximately 2,857 holders of record of OP Units, each of
which is convertible into common stock on a one-for-one basis or the cash
equivalent thereof, at our option.
For several technical reasons relating to the federal income tax law, our
ability to qualify as a REIT under the Internal Revenue Code is facilitated by
limiting the number of shares of our stock that a person may own. Primarily
because the Board of Directors believes it is desirable for us to qualify as a
REIT, our Articles of Incorporation provide that, subject to limited
exceptions, no person or persons acting as a group may own, or be deemed to
own by virtue of the attribution provisions of the Internal Revenue Code, more
than 9.8% of the lesser of the number or value of shares of common stock
outstanding; or 9.8% of the lesser of the number or value of the issued and
outstanding preferred or other shares of any class or series of our stock.
The Board of Directors has the authority to increase the ownership limit
from time to time, but does not have the authority to do so to the extent that
after giving effect to such increase, five beneficial owners of capital stock
could beneficially own in the aggregate more than 49.5% of the outstanding
capital stock. These limitations on the ownership of our stock could delay,
defer or prevent a takeover or other transaction in which holders of some, or
a majority, of our common stock might receive a premium for their common stock
over the then prevailing market price or which our shareholders might believe
to be otherwise in their best interest.
35
Item 6. Selected Financial Data
The following table presents selected historical financial data which has
been derived from our audited consolidated financial statements for the five
most recent fiscal years ended December 31, 1999. The 1998 and 1997 financial
information reflects the discontinued operations related to the spin-off of
Crestline in the REIT conversion.
Fiscal Year (1)(2)
-----------------------------------------------
1999 1998(3)(4) 1997(3)(4) 1996 1995(3)(4)
------ ---------- ---------- ------ ----------
(in millions, except per share data)
Income Statement Data:
Revenues(5).................. $1,376 $3,564 $2,875 $2,005 $1,389
Income (loss) from continuing
operations.................. 196 194 47 (13) (62)
Income (loss) before
extraordinary item.......... 196 195 47 (13) (123)
Net income (loss)............ 211 47 50 (13) (143)
Net income (loss) available
to common shareholders...... 216 47 50 (13) (143)
Basic earnings (loss) per
common share:(8)
Income (loss) from
continuing operations..... .89 .90 .22 (.06) (.36)
Income (loss) before
extraordinary items....... .89 .91 .22 (.06) (.72)
Net income (loss).......... .95 .22 .23 (.06) (.84)
Diluted earnings (loss) per
common share:(8)
Income (loss) from
continuing operations..... .87 .84 .22 (.06) (.36)
Income (loss) before
extraordinary items....... .87 .85 .22 (.06) (.72)
Net income (loss).......... .92 .27 .23 (.06) (.84)
Cash dividends declared per
common share(9)............. .84 1.00 -- -- --
Balance Sheet Data:
Total assets(7).............. $8,202 $8,268 $6,141 $5,152 $3,557
Debt(10)..................... 5,069 5,131 3,466 2,647 2,178
Convertible Preferred
Securities.................. 497 550 550 550 --
Other Data:
Ratio of earnings to combined
fixed charges and preferred
stock dividends(6).......... 1.5x 1.5x 1.3x 1.0x --
Deficiency of earnings to
combined fixed charges and
preferred stock
dividends(6)................ -- -- -- -- 70
- --------
(1) The Internal Revenue Code requires REITs to file their income tax return
on a calendar year basis. Accordingly, in 1998 we changed our fiscal year
end to December 31 for both financial and tax reporting requirements.
Previously, our fiscal year ended on the Friday nearest to December 31.
As a result of this change, the results of operations for 15 hotels not
managed by Marriott International were adjusted in 1998 to include 13
months of operations (December 1997 through December 1998) and therefore
are not comparable to fiscal years 1997 and 1996, each of which included
12 months of operations. The additional month of operations in 1998
increased our revenues by $44 million.
(2) Fiscal year 1996 includes 53 weeks. Fiscal years 1995, 1997 and 1998
include 52 weeks.
(3) The historical financial data for fiscal years 1998 and 1997 reflect as
discontinued operations our senior living business that we formerly
conducted but disposed of in the spin-off of Crestline as part of the
REIT conversion. We recorded income from the discontinued operations, net
of taxes, of $6 million in fiscal year 1998. We recorded a loss from
discontinued operations, net of taxes, of $61 million in 1995, as a
result of the spin-off of Host Marriott Services Corporation. The 1995
loss from discontinued operations includes a pre-tax charge of $47
million for the adoption of SFAS No. 121, "Accounting For the Impairment
of Long-Lived Assets and Long-Lived Assets to be Disposed Of," a pretax
$15 million restructuring charge and an extraordinary loss of $10
million, net of taxes, on the extinguishment of debt.
(4) In 1998, we recognized a $148 million extraordinary loss, net of taxes,
on the early extinguishment of debt. In 1997, we recognized a $3 million
extraordinary gain, net of taxes, on the early extinguishment of debt.
Also in 1998, we recognized REIT conversion expenses of $64 million and
recorded a tax benefit of $106 million related to tax liabilities that we
will not recognize as a result of our conversion to a REIT. The loss from
continuing operations for 1995 includes a $10 million pre-tax charge to
write down the carrying value of five limited service properties to their
net
36
realizable value and a $60 million pre-tax charge to write down an
undeveloped land parcel to its estimated sales value. In 1995, we
recognized a $20 million extraordinary loss, net of taxes, on the
extinguishment of debt.
(5) Historical revenue for 1999 primarily represents lease income generated by
our leases with Crestline. Periods prior to 1999 represent gross hotel
sales as our leases were not in effect until January 1, 1999. Revenues for
fiscal years 1998, 1997, 1996 and 1995 have also been adjusted to
reclassify interest income as revenue (previously classified as other
income from operations) in order to be consistent with our 1999 statement
of operations presentation.
(6) The ratio/deficiency of earnings to combined fixed charges and preferred
stock dividends is computed by dividing income from continuing operations
before income taxes, fixed charges and preferred stock dividends by total
fixed charges and preferred stock dividends. Fixed charges represent
interest expense (including capitalized interest), amortization of debt
issuance costs and the portion of rent expense that is deemed to represent
interest. The deficiency of $70 million in 1995 is primarily as a result
of depreciation expense.
(7) Total assets for fiscal year 1997 include $236 million related to net
investment in discontinued operations.
(8) Basic earnings (loss) per common share is computed by dividing net income
(loss) by the weighted average number of shares of common stock
outstanding. Diluted earnings (loss) per share is computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding plus other dilutive securities. Diluted earnings (loss) per
share has not been adjusted for the impact of the Convertible Preferred
Securities for 1999, 1997 and 1996 and for the comprehensive stock plan
for 1995 through 1996, as they are anti-dilutive.
(9) 1999 cash dividends per common share reflect a quarterly cash dividend of
$0.21 per common share declared on March 15, June 15, September 23, and
December 20 of 1999. 1998 cash dividends per common share reflect the cash
portion of a special dividend declared on December 18, 1998. This special
dividend entitled shareholders of record on December 28, 1998 to elect to
receive either $1.00 in cash or .087 of a share of common stock for each
outstanding share of our common stock owned by such shareholder on the
record date. Cash totaling approximately $73 million and approximately
11.6 million shares were subsequently issued during 1999.
(10) Debt consists of long term debt (which includes senior notes, secured
senior notes, mortgage debt, a revolving bank credit facility, and other
notes) and capital lease obligations.
37
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Overview
Host Marriott Corporation a Maryland corporation formerly named HMC Merger
Corporation operating through an umbrella partnership structure, is the owner
of hotel properties. We operate as a self-managed and self-administered REIT
with our operations conducted solely through an operating partnership and its
subsidiaries. Since REITs are not currently permitted to derive revenues
directly from the operations of hotels, we lease substantially all of the
hotels to subsidiaries of Crestline Capital Corporation, Crestline, or the
lessee, and other lessees.
As of December 31, 1999, we owned, or had controlling interests in, 121
upscale and luxury, full-service hotel lodging properties generally located
throughout the United States and operated primarily under the Marriott, Ritz-
Carlton, Four Seasons, Swissotel and Hyatt brand names. Most of these
properties are managed by Marriott International, Inc. or Marriott
International.
During 1999, our basic earnings per share before extraordinary items
decreased 2% to $.89. Our results benefited from increased hotel sales, offset
by the loss on litigation settlement. We refinanced almost $1.2 billion of
debt with long term fixed rate notes, issued 8.16 million shares of preferred
stock, and implemented a stock repurchase program. As of December 31, 1999,
the refinancing of our debt has resulted in an average interest rate of
approximately 8.1% with 96% of the debt at a fixed rate and an average
maturity of approximately eight years with only 4% of our debt maturing in the
next two years. During the third and fourth quarter we received net proceeds
of $196 million as a result of the issuance of perpetual preferred stock.
We are focused on carefully using our capital to improve returns to
shareholder. Currently our primary use of free cash flow and asset sales
proceeds is to repurchase stock under our stock buyback plan, which was
announced during the third quarter of 1999. Based on current market
conditions, we believe that the stock repurchase program reflects the best
return on investment for our shareholders. However, we will continue to look
at strategic acquisitions as well as evaluate our stock repurchase program
based on changes in market conditions and our stock price. Through March 8,
2000, the stock repurchase program has resulted in the retirement of 10.5
million shares of common stock and 1.5 million shares of our Convertible
Preferred Securities and 600,000 operating partnership units, for a total
reduction of 16.0 million equivalent shares on a fully diluted basis for $149
million.
On November 3, 1999, our board of directors announced that Terence C.
Golden, our President and Chief Executive Officer, will retire effective May
18, 2000, the date of our next annual shareholders meeting. The board also
announced that it has named Christopher J. Nassetta, currently our Executive
Vice President and Chief Operating Officer to assume the positions of
President and Chief Executive Officer effective on that date. Mr. Golden will
remain a member of the board of directors and Mr. Nassetta was elected to the
board of directors on November 2, 1999.
In December 1999, the REIT Modernization Act was passed, effective for
taxable years beginning after December 31, 2000, which significantly amends
the REIT laws applicable to us. Under the REIT Modernization Act, beginning
January 1, 2001, we will be able to lease our hotels to a subsidiary of the
operating partnership that is a taxable corporation and that elects to be
treated as a "taxable REIT subsidiary". In addition, as a result of passage of
the REIT Modernization Act, we have the right to purchase the leases from
Crestline on or after January 1, 2001, for a price equal to the fair rental
value of the lessee's interest in the leases over their remaining terms,
excluding any option periods, the amount of which could be significant.
Effective November 15, 1999, we amended substantially all of our leases with
Crestline to give Crestline the right to renew each of these leases for up to
four additional terms of seven years each at a fair rental value, to be
determined either by agreement between us and Crestline or through arbitration
at the time the renewal option is exercised. Crestline is under no obligation
to exercise these renewal options, and we have the right to terminate the
renewal options during time periods specified in the amendments. In addition,
the amendments
38
provide that the fair rental value payable by us to Crestline in connection
with the purchase of a lease as described above does not include any amounts
relating to any renewal period. Therefore, the fair rental value of a lease
after expiration of the initial term for such lease would be zero. We intend
to evaluate our options regarding the Crestline leases and have not yet made a
decision whether or not to purchase those leases.
We announced that we and Marriott International have executed a definitive
settlement agreement to resolve specific pending litigation involving seven
limited partnerships. The proposed settlement would involve an acquisition of
the limited partner interests in two partnerships by a joint venture between
one of our affiliates and Marriott International, and cash payments to
partners in the other five partnerships, in exchange for resolution of claims
against all defendants in all seven partnerships. Our share of the payment,
including the acquisition of two of the partnerships, is expected to be
approximately $113 million, excluding related expenses. The proposed
settlement is subject to numerous conditions, including definitive
documentation, court approval and various consents, and no assurance can be
given that the settlement will occur. As a result of the proposed settlement,
we have recorded a one-time non-recurring, pre-tax charge of $40 million in
the fourth quarter of 1999.
Results of Operations
Our historical revenues have primarily represented gross property-level
sales from hotels, net gains on property transactions, interest income and
equity in earnings of affiliates. Our historical operating costs and expenses
have principally consisted of property-level operating costs, depreciation,
management fees, real and personal property taxes, ground, building and
equipment rent, property insurance and other costs. As of January 1, 1999, we
lease substantially all of our hotels to subsidiaries of Crestline due to the
REIT conversion. As a result of these leases, we no longer record property-
level revenues and operating expenses, rather we recognize rental income on
the leases and specified owner expenses, including real estate and property
taxes, property insurance, and ground and equipment related to the properties.
The comparison of the 1999 results with 1998 and 1997 is also affected by a
change in the reporting period for our hotels not managed by Marriott
International. Thus, 1999 revenues and expenses are not comparable with prior
years.
1999 Compared to 1998
Revenues. Revenues decreased $2.2 billion, or 61%, to $1.4 billion for 1999.
As discussed above, our revenues and operating profit are not comparable to
prior years, primarily due to the leasing of our hotels as a result of the
REIT conversion. However, gross hotel sales, which is used in the
determination of rental income for 1999, increased $836 million or 24% over
1998 amounts as is shown in the following table.
The table below represents gross hotel sales generated by the properties for
1999 and 1998. Rental income for 1999 is computed based on gross hotel sales.
Year Ended
-------------------------
December 31, December 31,
1999 1998
------------ ------------
(in millions)
Hotel Sales(1)
Rooms............................................ $2,725 $2,220
Food and beverage................................ 1,258 984
Other............................................ 295 238
------ ------
Total sales.................................... $4,278 $3,442
====== ======
- --------
(1) 1999 gross hotel sales do not represent our reported revenues for 1999.
Rather, rental income, which is computed based on gross hotel sales,
represents our reported revenues for 1999.
39
Lodging results for 1999 were primarily driven by the addition of 36
properties in 1998. The increase in hotel sales also reflects the growth in
room revenues generated per available room or REVPAR. For comparable
properties, REVPAR increased 4.1%, to $115.13 for 1999. On a comparable basis,
average room rates increased approximately 3.8% for the year, while average
occupancy increased less than one percentage point for the year.
Interest income decreased $12 million or 24% as a result of a lower level of
cash and marketable securities held during 1999 compared to 1998.
The net gain on property transactions for 1999 primarily represents the $24
million recognized on the sale of five properties, including the sale of the
Ritz-Carlton Boston and the El Paso Marriott during the fourth quarter of
1999.
Expenses. As discussed above, hotel revenues and hotel operating costs are
not comparable with the prior year. The lessee pays specified direct property-
level costs including management fees and we receive a rent payment, which is
generally calculated as a percentage of revenue, subject to a minimum level,
net of certain property-level owner costs. All of these costs were our
expenses in 1998. Property-level owner costs which are comparable, including
depreciation, property taxes, property insurance, ground and equipment rent,
increased 8% to $553 million for 1999 versus 1998, primarily reflecting the
depreciation from 36 properties acquired during 1998.
Minority Interest. Minority interest expense increased $30 million to $82
million in 1999, primarily reflecting the impact of the issuance of operating
partnership units for the acquisition of specified hotel properties partially
offset by the consolidation of partnerships which occurred as part of the REIT
conversion.
Interest Expense. Interest expense increased 28% to $430 million in 1999,
primarily due to the issuance of senior notes, establishment of a new credit
facility and additional mortgage debt on properties acquired in 1998.
Corporate Expenses. Corporate expenses decreased $13 million to $37 million
in 1999, resulting primarily from lower staffing levels after the Crestline
spin-off, lower costs associated with reduced acquisition activity and lower
costs related to various stock compensation plans.
Loss on Litigation. In connection with a proposed settlement for litigation
related to seven limited service partnerships we have recorded a one-time,
non-recurring charge of $40 million.
Dividends on Convertible Preferred Securities. The dividends on the
convertible preferred securities reflect the dividends on the $550 million in
6.75% Convertible Preferred Securities issued by a subsidiary in December
1996.
Income from Discontinued Operations. Income from discontinued operations
represents the senior living communities business' results of operations for
1998.
Extraordinary Gain (Loss). In connection with the refinancing of the
mortgage and renegotiation of the management agreement on the New York
Marriott Marquis hotel, we recognized an extraordinary gain of $14 million on
the forgiveness of debt in the form of accrued incentive management fees
during 1999.
An extraordinary loss of $3 million representing the write-off of deferred
financing fees occurred in July 1999 when the mortgage debt for eight
properties was refinanced, including the New York Marriott Marquis hotel. In
connection with this refinancing, the interest rate swap agreements associated
with some of the original debt were terminated and an extraordinary gain of $8
million was recognized.
An extraordinary loss of $2 million representing the write-off of deferred
financing fees occurred during the fourth quarter of 1999 when prepayments
totaling $225 million were made to permanently reduce the outstanding balance
of the term loan portion of the Bank Credit Facility to $125 million.
40
An extraordinary loss of $2 million representing the write-off of deferred
financing fees occurred during the fourth quarter of 1999 when approximately
1.1 million shares of our Convertible Preferred Securities were repurchased
(see Note 7 to the financial statements) and subsequently retired.
In connection with the purchase of the old senior notes, we recognized an
extraordinary loss of $148 million in the third quarter of 1998, which
represents the bond premium and consent payments totaling approximately $175
million and the write-off of deferred financing fees of approximately $52
million related to the old senior notes, net of taxes.
Net Income. Our net income in 1999 was $211 million, compared to $47 million
in 1998. Basic and diluted earnings per common share were $.95 and $.92,
respectively, for 1999, compared to a basic and diluted earnings per common
share of $.22 and $.27, respectively, in 1998.
Net Income Available to Common Shareholders. Our net income available to
common shareholders in 1999 was $216 million, compared to $47 million in 1998,
reflecting dividends of $6 million in 1999 on the Class A and Class B
preferred stock which were issued during 1999, and a gain of $11 million, net
of taxes, on the repurchase of the Convertible Preferred Securities.
1998 Compared to 1997
Revenues. Revenues increased $0.7 billion, or 24%, to $3.6 billion for 1998
from $2.9 billion for 1997. Our revenue and operating profit were impacted by
improved results for comparable full-service hotel properties, the addition of
18 full-service hotel properties during 1997 and 36 full-service hotel
properties during 1998 and the gain on the sale of two hotel properties in
1998.
Hotel sales, which are gross hotel sales, including room sales, food and
beverage sales, and other ancillary sales such as telephone sales, increased
$0.6 billion, or 23%, to over $3.4 billion in 1998, reflecting the REVPAR
increases for comparable units and the addition of full-service hotels in 1997
and 1998. Improved results for our full-service hotels were driven by strong
increases in REVPAR for our 78 comparable units of 7.3% to $112.39 for 1998.
Results were further enhanced by approximately one percentage point increase
in the house profit margin for comparable full-service properties. Average
room rates increased nearly 6.9% for our comparable full-service hotels.
As discussed in Note 2 to the financial statements, we spun off our senior
living communities. We have accounted for these revenues and expenses as
discontinued operations and have shown the amount, net of taxes, below income
from continuing operations. Revenues generated from our 31 senior living
communities totaled $241 million for 1998 compared to $111 million for 1997,
as the assets were purchased in the third quarter of 1997.
Revenues were also impacted by the gains on the sales of two hotels. The New
York East Side Marriott was sold for $191 million resulting in a pre-tax gain
of approximately $40 million. The Napa Valley Marriott was sold for $21
million resulting in a pre-tax gain of approximately $10 million.
Operating Costs and Expenses. Operating costs and expenses principally
consisted of property-level operating costs, depreciation, management fees,
real and personal property taxes, ground, building and equipment rent,
insurance and certain other costs. Operating costs and expenses increased $0.5
billion to $2.9 billion, primarily representing increased hotel operating
costs. Hotel operating costs increased $0.5 billion to $2.8 billion for 1998,
primarily due to the addition of 54 full-service hotel properties during 1997
and 1998 and increased management fees and rentals tied to improved property
results. As a percentage of hotel revenues, hotel operating costs and expenses
decreased slightly to 82% for 1998 from 84% of revenues for 1997, due to the
significant increases in REVPAR discussed above, offset by increases in
management fees and property-level operating costs, including higher labor
costs in certain markets.
41
Minority Interest. Minority interest expense increased $21 million to $52
million for 1998, primarily reflecting the impact of the consolidation of
affiliated partnerships and the acquisition of controlling interests in newly-
formed partnerships during 1997 and 1998.
Corporate Expenses. Corporate expenses increased $5 million to $50 million
for 1998. As a percentage of revenues, corporate expenses decreased to 1.4% of
revenues for 1998 from 1.6% in 1997, reflecting our efforts to control
corporate expenses in spite of the substantial growth in revenues.
REIT Conversion Expenses. REIT conversion expenses reflect the professional
fees, consent fees, and other expenses associated with our conversion to a
REIT and totaled $64 million for 1998. There were no REIT conversion expenses
prior to 1998.
Interest Expense. Interest expense increased 16% to $335 million in 1998,
primarily due to additional debt assumed in connection with the 1997 and 1998
full-service hotel additions as well as the issuance of the senior notes and
establishment of a new credit facility in 1998.
Dividends on Convertible Preferred Securities. The dividends on the
convertible preferred securities reflect the dividends on the $550 million in
6.75% Convertible Preferred Securities issued by a subsidiary trust of Host
Marriott in December 1996.
Interest Income. Interest income decreased $1 million to $51 million for
1998, primarily reflecting the lower level of cash and marketable securities
held in 1998 compared to 1997.
Discontinued Operations. Income from discontinued operations of $6 million
for 1998 represents the senior living communities' business results of
operations for the entire year. The provision for loss on disposal of $5
million for 1998 includes organizational and formation costs related to
Crestline Capital Corporation.
Income before Extraordinary Item. Income before extraordinary item for 1998
was $195 million, compared to $47 million for 1997.
Extraordinary Gain (Loss). In connection with the purchase in August 1998 of
our old senior notes, we recognized an extraordinary loss of $148 million,
which represents the bond premium and consent payments totaling approximately
$175 million and the write-off of deferred financing fees of approximately $52
million related to the old senior notes, net of taxes. In March 1997, we
purchased 100% of the outstanding bonds secured by a first mortgage on the San
Francisco Marriott Hotel. We purchased the bonds for $219 million, which was
an $11 million discount to the face value of $230 million. In connection with
the redemption and defeasance of the bonds, we recognized an extraordinary
gain of $5 million, which represents the $11 million discount and the write-
off of deferred financing fees, net of taxes. In December 1997, we refinanced
the mortgage debt secured by Marriott's Orlando World Center. In connection
with the refinancing, we recognized an extraordinary loss of $2 million, which
represents payment of a prepayment penalty and the write-off of unamortized
deferred financing fees, net of taxes.
Net Income. Net income for 1998 was $47 million compared to net income of
$50 million for 1997. Basic earnings per common share was $.22 and $.23 for
1998 and 1997, respectively. Diluted earnings per common share was $.27 and
$.23 for 1998 and 1997, respectively.
Liquidity and Capital Resources
Cash and cash equivalents were $277 million and $436 million at December 31,
1999 and December 31, 1998, respectively. The decrease in cash is primarily a
result of cash flows used for investing and financing activities, offset by
cash provided by operating activities.
Cash provided by continuing operations increased $7 million to $319 million
during 1999. During 1998, cash from discontinued operations was $29 million;
however, there was no cash activity related to discontinued operations in
1999.
42
Cash used in investing activities from continuing operations was $176
million and $655 million in 1999 and 1998, respectively. Cash used in
investing activities includes capital expenditures of $361 million and $252
million and acquisitions of $29 million and $988 million in 1999 and 1998,
respectively. Significant investing activities during 1999 include:
. Costs associated with the newly constructed 717 room Tampa Waterside
Marriott which opened in February 2000 with over 45,000 square feet of
meeting space. The total cost of the project was over $104 million, of
which $57 million was expended during 1999.
. During 1999 we acquired the remaining minority interests in the two
hotels whose operations we previously consolidated. The acquisition
costs included the issuance of approximately 600,000 preferred OP Units
valued at $8 million and payments of partnership indebtedness of
approximately $6 million.
. In May 1999, we completed a 210-room expansion of the Philadelphia
Marriott for a total cost of approximately $37 million. The project
consisted of a renovation and conversion of the historic railway
terminal directly adjacent to the property.
. Property and equipment balances include $243 million and $78 million for
construction in progress as of December 31, 1999 and December 31, 1998,
respectively. The balance as of December 31, 1999 primarily relates to
the Tampa Waterside Marriott, which was placed in service in February
2000, as well as properties in Orlando, Memphis, Naples, and various
other expansion and development projects.
The cash used for investing activities was partially offset by cash provided
from the net sale of assets of $195 million in 1999, compared to $227 million
in 1998. 1999 property dispositions consisted of the five hotels previously
discussed.
Cash used in investing activities from discontinued operations was $50
million in 1998; however, there was no cash investing activity related to
discontinued operations in 1999.
Cash (used in) provided by financing activities from continuing operations
was ($302) million and $265 million in 1999 and 1998, respectively.
We expect that in 2000 we will make cash payments for certain tax and
litigation contingencies and development projects. Cash payments will be
required for the settlement of litigation related to seven limited
partnerships, the recognition of certain deferred tax items and the settlement
of certain audits of prior years' tax returns with the Internal Revenue
Service and also to fund specific development projects, all of which are
discussed in this report on Form 10-K. The source of future cash outflows are
dependent on cash from operations and the amount of additional debt, if any,
necessary for payment upon the final resolution of these items.
As of December 31, 1999, our total consolidated debt was approximately $5.1
billion. Our debt is comprised of $2.5 billion in unsecured senior notes, $2.3
billion in non-recourse mortgage debt and $125 million outstanding under the
term loan portion of the $1.025 billion bank credit facility. Based on our
total capitalization of approximately $7.7 billion as of December 31, 1999
consisting of long term debt, minority interests, mandatorily redeemable
convertible preferred securities, and shareholder's equity, consolidated debt
represents 69% of our total capitalization, compared to 59% as of December 31,
1998.
Since August 1998, we have issued or refinanced more than $3.4 billion of
debt, as is described below, in order to reduce the risk and volatility in our
capital structure. The net effect of these transactions has been to virtually
eliminate all of our near term maturities, as less than 4% of our debt matures
over the next two years, reduce our average interest rate by approximately 80
basis points, and extend our average maturity by almost one year. As a result,
our average rate is now approximately 8%, and our average maturity is
approximately 8 years, with 96% of our debt having fixed interest rates.
Significant debt transactions include:
. Currently, $125 million is outstanding under the term loan portion of
the bank credit facility, while the available capacity under the
revolving credit portion of the bank credit facility remains at $900
million.
43
The bank credit facility was originally negotiated in August 1998 for
$1.25 billion, and $225 million was subsequently repaid on the term loan
during 1999 to permanently reduce the total bank credit facility to
$1.025 billion. The credit facility has an initial three-year term with
two one-year extension options. Borrowings under the credit facility
generally bear interest at the Eurodollar rate plus 1.65% (7.57%) at
December 31, 1999), and the interest rate and commitment fee on the
unused portion of the facility fluctuate based on specified financial
ratios.
. We issued $300 million of 8 3/8% Series D senior notes due 2006 in
February 1999 and used the proceeds to refinance, or purchase, debt
which had been assumed through the merger of some partnerships or the
purchase of hotel properties in connection with the REIT conversion in
December 1998. We repaid a $40 million variable rate mortgage with a
portion of the proceeds, and terminated the associated swap agreement,
incurring a termination fee of approximately $1 million. In August 1999,
the Series D Senior notes were exchanged on a one-for-one basis for
Series E Senior notes, which are freely transferable by the holders.
. In April 1999, a subsidiary of ours completed the refinancing of the
$245 million mortgage on the New York Marriott Marquis Hotel, maturing
in June 2000. In connection with the refinancing, we renegotiated the
hotel's management agreement and recognized an extraordinary gain of $14
million on the forgiveness of accrued incentive management fees by the
manager. This mortgage was subsequently refinanced as part of the $665
million financing agreement discussed below.
. In June 1999, we refinanced the debt on the San Diego Marriott Hotel and
Marina. The mortgage is for $195 million and a term of 10 years at a
rate of 8.45%. In addition, we entered into a mortgage for the
Philadelphia Marriott expansion in July 1999 for $23 million at an
interest rate of approximately 8.6%, maturing in 2009.
. In July 1999, we entered into a financing agreement pursuant to which we
borrowed $665 million due 2009 at a fixed rate of 7.47%. Eight of our
hotels serve as collateral for the agreement. In connection with this
refinancing, an extraordinary loss of $3 million was recognized,
representing the write-off of deferred financing fees. The proceeds from
this financing were used to refinance existing mortgage indebtedness
maturing at various times through 2000, including approximately $590
million of outstanding variable rate mortgage debt, and to terminate the
related interest rate swap agreements, recognizing an extraordinary gain
of approximately $8 million. As a result of the refinancing we no longer
have any interest rate swap agreements outstanding.
. In August 1999, we made a prepayment of $19 million to pay down in full
the mezzanine mortgage on the Marriott Desert Springs Resort and Spa. In
September 1999, we made a prepayment of $45 million to pay down in full
the mortgage note on the Philadelphia Four Seasons Hotel.
. In August 1998, we purchased substantially all of our then outstanding
senior debt including: (i) $600 million of 9 1/2% senior notes due 2005,
(ii) $350 million of 9% senior notes due 2007 and (iii) $600 million of
8 7/8% senior notes due 2007. We simultaneously issued an aggregate of
$1.7 billion in new senior notes in two series: $500 million of 7 7/8%
Series A notes due in 2005 and $1.2 billion of 7 7/8% Series B notes due
in 2008. In December 1998, we issued $500 million of 8.45% Series C
senior notes due in 2008 under the same indenture and with the same
covenants as the Series A and Series B senior notes.
. In addition to the capital resources provided by our debt financings, in
December 1996, one of our wholly-owned subsidiary trusts, issued 11
million shares of 6 3/4% Convertible Quarterly Income Preferred
Securities, with a liquidation preference of $50 per share for a total
liquidation amount of $550 million. The Convertible Preferred Securities
represent an undivided beneficial interest in the assets of the trust
and, pursuant to various agreements entered into in connection with the
transaction, are fully, irrevocably and unconditionally guaranteed by
us. Proceeds from the issuance of the Convertible Preferred Securities
were invested in 6 3/4% Convertible Subordinated Debentures due December
2, 2026 issued by us, which are the trust's sole assets. Each of the
Convertible Preferred Securities is convertible at the option of the
holder into shares of our common stock at the rate of 3.2537 shares per
Convertible Preferred Security equivalent to a conversion price of
$15.367 per share
44
of our common stock. This conversion ratio includes adjustments to
reflect distributions made to our common stockholders in connection with
the REIT conversion. During 1999, 1998 and 1997, no shares were
converted into common stock. Holders of the Convertible Preferred
Securities are entitled to receive preferential cumulative cash
distributions at an annual rate of 6 3/4% accruing from the original
issue date, commencing March 1, 1997, and payable quarterly in arrears
thereafter. The distribution rate and the distribution and other payment
dates for the Convertible Preferred Securities correspond to the
interest rate and interest and other payment dates on the Convertible
Subordinated Debentures. We may defer interest payments on the
convertible subordinated debentures for a period not to exceed 20
consecutive quarters. If interest payments on the Convertible
Subordinated Debentures are deferred, so too are payments on the
Convertible Preferred Securities. Under this circumstance, we would not
be permitted to declare or pay any cash distributions with respect to
our capital stock or debt securities that rank equal in right of payment
with or junior to the Convertible Subordinated Debentures. Subject to
certain restrictions, the Convertible Preferred Securities are
redeemable at our option upon any redemption of the Convertible
Subordinated Debentures after December 2, 1999. Upon repayment at
maturity or as a result of the acceleration of the Convertible
Subordinated Debentures upon the occurrence of a default, the
Convertible Preferred Securities are subject to mandatory redemption.
During 1999, we repurchased 1.1 million shares of the Convertible
Preferred Securities as part of the stock repurchase plan discussed
below.
Significant equity financings include:
. In September 1999, we announced our intention to repurchase, from time
to time, up to 22 million shares of our common stock, operating
partnership units or an amount of the Convertible Preferred Securities
which are convertible into a like number of shares of our common stock
based upon the specified conversion ratio. As of December 31, 1999, we
had purchased approximately 5.8 million shares of common stock, 1.1
million shares of the Convertible Preferred Securities and 0.3 million
OP Units for an aggregate consideration of approximately $89 million.
Any repurchases of common stock, operating partnership units, or
Convertible Preferred Securities may be effected through open market or
privately negotiated purchases, through a tender offer, or through one
or more combinations of such methods. The repurchase program is on-
going, and through March 8, 2000, approximately 16.0 million common
shares or equivalent were repurchased for $149 million.
. Dividend payments reflect the $73 million in payments for a special
dividend declared in December 1998 as well as the $0.63 dividend per
share of common stock paid as of December 31, 1999. In addition, on
December 20, 1999, the Board of Directors declared a regular cash
dividend of $0.21 per share of common stock to be paid on January 17,
2000.
. In August 1999, we sold 4.16 million shares of 10% Class A preferred
stock. Holders of the stock are entitled to receive cumulative cash
dividends at a rate of 10% per year of the $25.00 per share liquidation
preference. Dividends are payable quarterly in arrears beginning October
15, 1999. After August 3, 2004 we have the option to redeem the Class A
Preferred Stock for $25.00 per share, plus accrued and unpaid dividends
to the date of redemption. The Class A preferred stock ranks senior to
the common stock and the authorized Series A Junior Participating
preferred stock, and on a parity with our Class B preferred stock. The
Class A preferred stockholders generally have no voting rights. We
declared a dividend of $.625 per share on December 20, 1999, which was
paid on January 17, 2000.
. In November 1999, we sold 4.0 million shares of 10% Class B preferred
stock. Holders of the stock are entitled to receive cumulative cash
dividends at a rate of 10% per year of the $25.00 per share liquidation
preference. Dividends are payable quarterly in arrears beginning January
15, 2000. After April 29, 2005 we have the option to redeem the Class B
Preferred Stock for $25.00 per share, plus accrued and unpaid dividends
to the date of redemption. The Class B preferred stock ranks senior to
the common stock and the authorized Series A Junior Participating
preferred stock, and on a parity with our Class A Preferred Stock. The
Class B preferred stockholders generally have no voting rights. We
declared a dividend of $.325 per share on December 20, 1999, which was
paid on January 17, 2000.
45
. In December 1998, we completed the acquisition of, or controlling
interests in, twelve world-class luxury hotels and certain other assets,
including a mortgage note on a thirteenth hotel property from affiliates
of the Blackstone Group. The operating partnership paid approximately
$920 million in cash and assumed debt and issued approximately 47.7
million OP Units, along with other consideration for a total value of
approximately $1.55 billion.
. In December 1998, subsidiaries of the operating partnership merged with
eight public partnerships and acquired limited partnership interests in
four private partnerships, which collectively own or control 28
properties 15 of which were controlled by us and consolidated on our
financial statements prior to December 1998. The operating partnership
issued approximately 25.8 million OP Units, 8.5 million of which were
subsequently converted to our common stock, for interests in these
partnerships valued at approximately $333 million. As a result of these
transactions, the operating partnership increased its ownership of most
of the 28 properties to 100% while consolidating 13 additional hotels
containing 4,445 rooms.
. In connection with our conversion to a REIT, we formed two non-
controlled subsidiaries, which own approximately $325 million in assets
as of December 31, 1999. The ownership of most of these assets by us and
the operating partnership would have jeopardized our status as a REIT
and the operating partnership's status as a partnership for federal
income tax purposes. These assets primarily consist of partnership or
other interests in hotels which are not leased and some furniture,
fixtures and equipment used in the hotels. In exchange for the operating
partnership's contribution of these assets to the non-controlled
subsidiaries, the operating partnership received nonvoting common stock
representing 95% of the total economic interests of the non-controlled
subsidiaries. The Host Marriott Statutory Employee/Charitable Trust, the
beneficiaries of which are 1) a trust formed for the benefit of some
employees of the operating partnership and 2) the J. Willard Marriott
Foundation, acquired all of the voting common stock representing the
remaining 5% of the total economic interests, and reflecting 100% of the
control of each non-controlled subsidiary. As a result, as of December
31, 1998, we did not control the non-controlled subsidiaries.
FFO and EBITDA
We consider Funds from Operations (FFO), which represents FFO as defined by
the National Association of Real Estate Investment Trusts, and our EBITDA to
be indicative measures of our operating performance due to the significance of
our long-lived assets. FFO and EBITDA are also useful in measuring our ability
to service debt, fund capital expenditures and expand our business.
Furthermore, management believes that 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 REITs. However, 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 generally accepted accounting principles. Cash expenditures for various
long-term assets, interest expense (for EBITDA purposes only) and income taxes
have been, and will be incurred which are not reflected in the EBITDA and FFO
presentation.
46
FFO increased $27 million, or 7%, to $429 million in 1999 over 1998. Amounts
for 1998 represent comparative FFO, which equals FFO as defined by NAREIT plus
deferred tax expense. The following is a reconciliation of income from
continuing operations to FFO (in millions):
Year Ended
------------------------------------
December 31, December 31, January 2,
1999 1998 1998
------------ ------------ ----------
Funds from Operations
Income from continuing operations......... $ 196 $194 $ 47
Depreciation and amortization............. 291 243 230
Other real estate activities.............. (28) (57) 5
Partnership adjustments................... 80 (11) (12)
REIT conversion expenses.................. -- 64 --
Loss on litigation settlement............. 40 -- --
Tax adjustments........................... (21) (59) 15
----- ---- ----
Funds from continuing operations.......... 558 374 285
Discontinued operations................... -- 28 10
----- ---- ----
Funds from operations before preferred
stock dividends and minority interest of
Host Marriott, L.P....................... 558 402 295
Dividends on preferred stock.............. (6) -- --
Funds from operations of minority partners
of Host Marriott, L.P. .................. (123) -- --
----- ---- ----
Funds from operations available to common
shareholders............................. $ 429 $402 $295
===== ==== ====
During the REIT conversion, we received a number of units of general and
limited partnership interests in the operating partnership--which we refer to
as OP Units--equal to the number of then outstanding shares of our common
stock, and the operating partnership assumed all of our liabilities. As a
result of this reorganization we are the sole general partner in the operating
partnership and as of December 31, 1999 held approximately 78% of the
outstanding OP Units. The $123 million deducted for 1999 represents the FFO
attributable to the interests in the operating partnership held by those
minority partners. 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.
EBITDA increased $125 million, or 15%, to $953 million in 1999 from $828
million in 1998. Hotel EBITDA increased $162 million, or 19%, to $1,032
million in 1999 from $870 million in 1998, reflecting comparable hotel EBITDA
growth, as well as incremental EBITDA from 1998 acquisitions offset by amounts
representing hotel sales which are retained by Crestline.
47
The following schedule presents our EBITDA as well as a reconciliation of
EBITDA to income from continuing operations (in millions):
Year Ended
------------------------------------
December 31, December 31, January 2,
1999 1998 1998
------------ ------------ ----------
EBITDA
Hotels................................ $1,032 $870 $690
Office buildings...................... 3 1 --
Interest income....................... 39 53 55
Corporate and other expenses.......... (67) (96) (63)
------ ---- ----
EBITDA of Host Marriott, L.P.......... 1,007 828 682
Distributions to minority interest
partners of Host Marriott, L.P....... (54) -- --
------ ---- ----
EBITDA................................ $ 953 $828 $682
====== ==== ====
Year Ended
------------------------------------
December 31, December 31, January 2,
1999 1998 1998
------------ ------------ ----------
EBITDA................................ $ 953 $828 $682
Interest expense...................... (430) (335) (288)
Dividends on Convertible Preferred
Securities........................... (37) (37) (37)
Depreciation and amortization......... (293) (243) (231)
Minority interest expense............. (82) (52) (31)
Income taxes.......................... 16 20 (36)
REIT Conversion expense............... -- (64) --
Distributions to minority interest
partners of Host Marriott, L.P....... 54 -- --
Loss on litigation settlement......... (40) -- --
Other non-cash changes, net........... 55 77 (12)
------ ---- ----
Income from continuing operations..... $ 196 $194 $ 47
====== ==== ====
The $54 million reflects distributions to minority holders of OP Units.
These OP Units are convertible into cash or our common stock at our option.
Approximately $41 million in cash distributions were paid in 1999, and
approximately $13 million in cash distributions were declared in December 1999
and paid on January 17, 2000.
Our interest coverage, defined as EBITDA divided by cash interest expense,
was 2.4 times, 2.7 times, and 2.5 times for 1999, 1998, and 1997,
respectively. The ratio of earnings to fixed charges was 1.5 to 1.0, 1.5 to
1.0, and 1.3 to 1.0 in 1999, 1998, and 1997, respectively.
Partnership Activities. Prior to the REIT conversion, we had general and
limited partner interests in numerous limited partnerships which owned 240
hotels including 20 full-service hotels, managed by Marriott International. As
a result of the REIT conversion, the majority of our interests in the 220
limited-service hotels were transferred to the non-controlled subsidiaries.
Additionally, as part of the REIT conversion, 13 of the 20 full-service hotels
were acquired by the operating partnership, two were sold, four were
transferred to one of the non-controlled subsidiaries and one was retained by
us.
Leases. In addition to our full-service hotels, we also lease some property
and equipment under noncancelable operating leases, including the long-term
ground leases for some of our hotels, generally with multiple renewal options.
The leases related to the 53 Courtyard properties and 18 Residence Inn
properties sold during 1995 and 1996, are nonrecourse to us and contain
provisions for the payment of contingent rentals based
48
on a percentage of sales in excess of stipulated amounts. We remain
contingently liable on some leases related to divested non-lodging properties.
Such contingent liabilities aggregated $80 million at December 31, 1999.
However, management considers the likelihood of any substantial funding
related to these divested properties' leases to be remote.
Inflation. Our hotel lodging properties have been impacted by inflation
through its effect on increasing costs and on the managers' ability to
increase room rates. Unlike other real estate, hotels have the ability to
change room rates on a daily basis, so the impact of higher inflation
generally can be passed on to customers. Our exposure to inflation is less now
that substantially all of our hotels are leased to others.
Almost all of our debt bears interest at fixed rates. This debt structure
largely mitigates the impact of changes in the rate of inflation on future
interest costs. We have some financial instruments that are sensitive to
changes in interest rates. The interest recognized on the debt obligations is
based on various LIBOR terms, which ranged from 5.6% to 5.9% and 5.1% to 5.8%
at December 31, 1999 and December 31, 1998, respectively.
We repaid a $40 million variable rate mortgage with proceeds from the $300
million senior notes offering discussed in Note 5 to the financial statements
during the first quarter of 1999. We terminated the associated swap agreement
incurring a termination fee of approximately $1 million.
In July 1999, we completed the refinancing of approximately $790 million of
outstanding variable rate mortgage debt and terminated the related interest
rate swap agreements. As a result of the refinancing we no longer have any
interest rate swap agreements outstanding. As of December 31, 1999, our
remaining variable debt consists of the credit facility and the mortgage debt
on the Ritz-Carlton Amelia Island property which total $340 million, $50
million of which has been repaid subsequent to year end.
Accounting Standards. As discussed in note 1 to the financial statements, in
December 1999, we changed our method of accounting for contingent rental
revenues to conform to the Commission's Staff Accounting Bulletin (SAB) No.
101. As a result, contingent rental revenue will be deferred on the balance
sheet until certain revenue thresholds are realized. We have adopted SAB No.
101 with retroactive effect beginning January 1, 1999 to conform to the new
presentation. SAB No. 101 has no impact on full-year 1999 revenues, net
income, or earnings per share because all rental revenues considered
contingent under SAB No. 101 were earned as of December 31, 1999. The change
in accounting principle has no effect on prior years because percentage rent
relates to rental income on our leases, which began in 1999.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Statement
establishes accounting and reporting standards requiring that every derivative
instrument (including specified derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at its fair value. The Statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement and requires that a company must formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133 is effective for fiscal years beginning after
June 15, 2000. We have not determined the full impact of SFAS No. 133.
49
Item 7.a Quantitative and Qualitative Disclosures about Market Risk
The table below provides information about our financial instruments that
are sensitive to changes in interest rates. For debt obligations, the table
presents principal cash flows and related weighted average interest rates by
expected maturity dates.
Expected Maturity Date
----------------------------------- Fair
2000 2001 2002 2003 2004 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
($ in millions)
Liabilities
Long-term Debt--variable:
The Ritz-Carlton, Amelia
Island....................... -- -- -- 90 -- -- 90 79
Credit Facility............... -- 125 -- -- -- -- 125 125
Average Interest Rate(1)...... 7.6 7.6 7.6 -- -- -- -- --
- --------
(1) Interest rates are based on various LIBOR terms plus certain basis points
which range from 165 to 200 basis points. The one-month LIBOR rate at
December 31, 1999 was 5.6%. We have assumed for basis of this presentation
that the LIBOR rate remains unchanged. A 100 basis point increase in LIBOR
would increase our interest rate expense by approximately $2 million per
year.
50
Item 8. Financial Statements and Supplementary Data
The following financial information is included on the pages indicated:
Host Marriott Corporation
Page
----
Report of Independent Public Accountants................................. 52
Consolidated Balance Sheets as of December 31, 1999 and 1998............. 53
Consolidated Statements of Operations for the Fiscal Years Ended December
31, 1999 and 1998, and January 2, 1998.................................. 54
Consolidated Statements of Shareholders' Equity and Comprehensive Income
for the Fiscal Years Ended December 31, 1999 and 1998, and January 2,
1998.................................................................... 55
Consolidated Statements of Cash Flows for the Fiscal Years Ended December
31, 1999 and 1998 and January 2, 1998................................... 57
Notes to Consolidated Financial Statements............................... 59
Lease Pool Financial Statements
CCHP I Corporation:
Page
----
Report of Independent Public Accountants................................. 88
Consolidated Balance Sheets as of December 31, 1999...................... 89
Consolidated Statements of Operations for the Fiscal Years Ended December
31, 1999................................................................ 90
Consolidated Statements of Shareholders' Equity for the Fiscal Years
Ended December 31, 1999................................................. 91
Consolidated Statements of Cash Flows for the Fiscal Years Ended December
31, 1999................................................................ 92
Notes to Consolidated Financial Statements............................... 93
CCHP II Corporation:
Page
----
Report of Independent Public Accountants................................. 100
Consolidated Balance Sheets as of December 31, 1999...................... 101
Consolidated Statements of Operations for the Fiscal Years Ended December
31, 1999................................................................ 102
Consolidated Statements of Shareholders' Equity for the Fiscal Years
Ended December 31, 1999................................................. 103
Consolidated Statements of Cash Flows for the Fiscal Years Ended December
31, 1999................................................................ 104
Notes to Consolidated Financial Statements............................... 105
CCHP III Corporation:
Page
----
Report of Independent Public Accountants................................. 112
Consolidated Balance Sheets as of December 31, 1999...................... 113
Consolidated Statements of Operations for the Fiscal Years Ended December
31, 1999................................................................ 114
Consolidated Statements of Shareholders' Equity for the Fiscal Years
Ended December 31, 1999................................................. 115
Consolidated Statements of Cash Flows for the Fiscal Years Ended December
31, 1999................................................................ 116
Notes to Consolidated Financial Statements............................... 117
CCHP IV Corporation:
Page
----
Report of Independent Public Accountants................................. 124
Consolidated Balance Sheets as of December 31, 1999...................... 125
Consolidated Statements of Operations for the Fiscal Years Ended December
31, 1999................................................................ 126
Consolidated Statements of Shareholders' Equity for the Fiscal Years
Ended December 31, 1999................................................. 127
Consolidated Statements of Cash Flows for the Fiscal Years Ended December
31, 1999................................................................ 128
Notes to Consolidated Financial Statements............................... 129
51
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Host Marriott Corporation:
We have audited the accompanying consolidated balance sheets of Host
Marriott Corporation and subsidiaries as of December 31, 1999 and 1998, and
the related consolidated statements of operations, shareholders' equity and
comprehensive income and cash flows for each of the three fiscal years in the
period ended December 31, 1999. These financial statements and the schedule
referred to below are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Host
Marriott Corporation and subsidiaries as of December 31, 1999 and 1998, and
the results of their operations and their cash flows for each of the three
fiscal years in the period ended December 31, 1999, in conformity with
accounting principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index at
Item 14(a)(2) is presented for purposes of complying with the Securities and
Exchange Commission's rules and are not part of the basic financial
statements. This schedule has been subjected to the auditing procedures
applied in the audit of the basic financial statements and, in our opinion,
fairly states in all material respects the financial data required to be set
forth therein in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Vienna, Virginia
March 8, 2000
52
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1999 and 1998
1999 1998
------ ------
(in millions)
ASSETS
Property and equipment, net................................... $7,108 $7,201
Notes and other receivables, net (including amounts due from
affiliates of $127 million and $134 million, respectively)... 175 203
Rent receivable............................................... 72 --
Due from managers............................................. -- 19
Investments in affiliates..................................... 49 33
Other assets.................................................. 521 376
Cash and cash equivalents..................................... 277 436
------ ------
$8,202 $8,268
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Debt
Senior notes................................................ $2,539 $2,246
Mortgage debt............................................... 2,309 2,438
Other....................................................... 221 447
------ ------
5,069 5,131
Accounts payable and accrued expenses......................... 148 204
Deferred income taxes......................................... 49 97
Other liabilities............................................. 426 460
------ ------
Total liabilities......................................... 5,692 5,892
------ ------
Minority interest............................................. 508 515
Company-obligated mandatorily redeemable convertible preferred
securities of a subsidiary whose sole assets are the
convertible subordinated debentures due 2026 ("Convertible
Preferred Securities")....................................... 497 550
Shareholders' equity
Cumulative redeemable preferred stock (liquidation
preference $25.00 per share), 50 million shares authorized;
8.2 million shares and 0 shares issued and outstanding,
respectively............................................... 196 --
Common Stock, 750 million shares authorized; 223.5 million
shares and 225.6 million shares issued and outstanding,
respectively............................................... 2 2
Additional paid-in capital.................................. 1,844 1,867
Accumulated other comprehensive income (loss)............... 2 (4)
Retained deficit............................................ (539) (554)
------ ------
Total shareholders' equity................................ 1,505 1,311
------ ------
$8,202 $8,268
====== ======
See Notes to Consolidated Financial Statements.
53
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal years ended December 31, 1999 and 1998, and January 2, 1998
(in millions, except per common share amounts)
1999 1998 1997
------ ----- -----
REVENUES
Rental income (Note 1)................................. $1,295 $ -- $ --
Hotel sales
Rooms.................................................. -- 2,220 1,850
Food and beverage...................................... -- 984 776
Other.................................................. -- 238 180
------ ----- -----
Total hotel revenues.................................. -- 3,442 2,806
Interest income........................................ 39 51 52
Net gains (losses) on property transactions............ 28 57 (11)
Equity in earnings of affiliates and other............. 14 14 28
------ ----- -----
Total revenues........................................ 1,376 3,564 2,875
------ ----- -----
EXPENSES
Depreciation and amortization.......................... 289 242 231
Property-level expenses................................ 264 271 247
Hotel operating expenses
Rooms................................................. -- 524 428
Food and beverage..................................... -- 731 592
Other department costs and deductions................. -- 843 693
Management fees and other (including Marriott
International management fees of $196 million in
1998, and $162 million in 1997)...................... -- 213 171
Minority interest...................................... 82 52 31
Corporate expenses..................................... 37 50 45
REIT conversion expenses............................... -- 64 --
Loss on litigation settlement.......................... 40 -- --
Interest expense....................................... 430 335 288
Dividends on Convertible Preferred Securities of
subsidiary trust...................................... 37 37 37
Other.................................................. 17 28 29
------ ----- -----
Total expenses........................................ 1,196 3,390 2,792
------ ----- -----
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES... 180 174 83
Benefit (Provision) for income taxes................... 16 (86) (36)
Benefit from change in tax status...................... -- 106 --
------ ----- -----
INCOME FROM CONTINUING OPERATIONS....................... 196 194 47
DISCONTINUED OPERATIONS
Income from discontinued operations (net of income tax
expense of $4 million in 1998)........................ -- 6 --
Provision for loss on disposal (net of income tax
benefit of $3 million in 1998)........................ -- (5) --
------ ----- -----
INCOME BEFORE EXTRAORDINARY ITEMS....................... 196 195 47
Extraordinary gain (loss), net of income tax expense
(benefit) of ($80) million and $1 million in 1998 and
1997, respectively.................................... 15 (148) 3
------ ----- -----
NET INCOME.............................................. $ 211 $ 47 $ 50
====== ===== =====
Less: Dividends on preferred stock..................... (6) -- --
Add: Gain on repurchase of Convertible Preferred
Securities, net of income tax expense of $4 million... 11 -- --
------ ----- -----
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS............. $ 216 $ 47 $ 50
====== ===== =====
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Continuing operations.................................. $ .89 $ .90 $ .22
Discontinued operations (net of income taxes).......... -- .01 --
Extraordinary gain (loss).............................. .06 (.69) .01
------ ----- -----
BASIC EARNINGS PER COMMON SHARE......................... $ .95 $ .22 $ .23
====== ===== =====
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Continuing operations.................................. $ .87 $ .84 $ .22
Discontinued operations (net of income taxes).......... -- .01 --
Extraordinary gain (loss).............................. .05 (.58) .01
------ ----- -----
DILUTED EARNINGS PER COMMON SHARE....................... $ .92 $ .27 $ .23
====== ===== =====
See Notes to Consolidated Financial Statements.
54
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME OF HOST MARRIOTT CORPORATION
Fiscal years ended December 31, 1999 and 1998, and January 2, 1998
(in millions)
Accumulated
Shares Outstanding Additional Retained Other
------------------ Preferred Common Paid-in (Deficit) Comprehensive Comprehensive
Preferred Common Stock Stock Capital Earnings Income (Loss) Income (Loss)
--------- ---------- --------- ------ ---------- --------- ------------- -------------
-- 202.0 Balance, January 3, $-- $ 202 $ 921 $ (1) $ 5
1997.................... $--
-- -- Net income.............. -- -- -- 50 -- 50
-- -- Other comprehensive
income:
-- -- Unrealized gain on HM
Services common stock... -- -- -- -- 7 7
----
-- -- Comprehensive income.... $ 57
====
-- 1.8 Common stock issued for
the comprehensive stock
and employee stock
purchase plans.......... -- 2 14 -- --
- --------------------------------------------------------------------------------------------------------------------
-- 203.8 Balance, January 2, -- 204 935 49 12
1998.................... --
-- -- Net income.............. -- -- -- 47 -- 47
-- -- Other comprehensive
income (loss):
Unrealized loss on HM
Services common stock... -- -- -- -- (5) (5)
Foreign currency
translation adjustment.. -- -- -- -- (9) (9)
Reclassification of gain
realized on HM Services
common stock--net
income.................. -- -- -- -- (2) (2)
----
-- -- Comprehensive income.... $ 31
====
-- 1.4 Common stock issued for
the comprehensive stock
and employee stock
purchase plans.......... -- -- 8 -- --
-- -- Adjustment of stock par
value from $1 to $.01
per share............... -- (202) 202 -- --
-- 11.9 Common stock issued for
Special Dividend........ -- -- 143 (143) --
-- 8.5 Common stock issued for
the REIT roll-up of
partnerships (Note 12).. -- -- 113 -- --
-- -- Increase in Operating
Partnership equity due
to issuance of OP Units
for limited partner
interests (net of $368
million minority
interest of the
Operating Partnership).. -- -- 466 -- --
-- -- Distribution of stock of
Crestline Capital
Corporation............. -- -- -- (438)
-- -- Cash portion of Special
Dividend............... -- -- -- (69) --
- --------------------------------------------------------------------------------------------------------------------
-- 225.6 Balance, December 31,
1998................... $-- $ 2 $1,867 $(554) $(4)
- --------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
55
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME OF HOST MARRIOTT CORPORATION
Fiscal years ended December 31, 1999 and 1998, and January 2, 1998
(in millions)
Accumulated
Shares Outstanding Additional Retained Other
------------------ Preferred Common Paid-in (Deficit) Comprehensive Comprehensive
Preferred Common Stock Stock Capital Earnings Income (Loss) Income (Loss)
--------- ---------- --------- ------ ---------- --------- ------------- -------------
-- 225.6 Balance, December 31, $-- $ 2 $1,867 $(554) $(4)
1998....................
-- -- Net income.............. -- -- -- 211 -- 211
-- -- Other comprehensive
income (loss):..........
Unrealized loss on HM
Services common stock... -- -- -- -- 4 4
Foreign currency
translation adjustment.. -- -- -- -- 3 3
Reclassification of gain
realized on HM Services
common stock............ -- -- -- -- (1) (1)
----
-- -- Comprehensive income.... $217
====
-- 3.6 Common stock issued for
the comprehensive stock
and employee stock
purchase plans.......... -- -- 11 -- --
-- 0.5 Redemptions of limited
partnership interests of
third parties for common
stock................... -- -- 3 -- --
8.2 -- Issuance of preferred 196 -- -- -- --
stock...................
-- -- Dividends on common -- -- -- (191) --
stock...................
-- -- Dividends on preferred -- -- -- (5) --
stock...................
-- (0.4) Adjustment to Special -- -- (4) -- --
Dividend................
-- -- Redemptions of limited
partnership interests
for cash................ -- -- (1) -- --
-- -- Issuance of preferred
limited partnership
interests............... -- -- 3 -- --
-- -- Repurchase of
Convertible Preferred
Securities.............. -- -- 11 -- --
-- (5.8) Repurchases of common -- -- (46) -- --
stock...................
- ---------------------------------------------------------------------------------------------------------------------
8.2 223.5 Balance, December 31, $196 $ 2 $1,844 $(539) $ 2
1999....................
- ---------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
56
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal years ended December 31, 1999 and 1998, and January 2, 1998
1999 1998 1997
------ ------ ------
(in millions)
OPERATING ACTIVITIES
Income from continuing operations...................... $ 196 $ 194 $ 47
Adjustments to reconcile to cash from operations:
Depreciation and amortization......................... 293 243 231
Income taxes.......................................... (66) (103) (20)
Amortization of deferred income....................... (4) (4) (4)
Net (gains) losses on property transactions........... (24) (50) 19
Equity in earnings of affiliates...................... (6) (1) (4)
Other................................................. 46 39 62
Changes in operating accounts:
Other assets.......................................... (55) (56) 57
Other liabilities..................................... (61) 50 44
------ ------ ------
Cash from continuing operations....................... 319 312 432
Cash from discontinued operations..................... -- 29 32
------ ------ ------
Cash from operations.................................. 319 341 464
------ ------ ------
INVESTING ACTIVITIES
Proceeds from sales of assets.......................... 195 227 51
Acquisitions........................................... (29) (988) (359)
Capital expenditures:
Capital expenditures for renewals and replacements.... (197) (165) (129)
New investment capital expenditures................... (150) (87) (29)
Other investments..................................... (14) -- --
Purchases of short-term marketable securities.......... -- (134) (354)
Sales of short-term marketable securities.............. -- 488 --
Notes receivable collections (advances), net........... 19 4 6
Affiliate notes receivable collections (advances),
net................................................... -- (13) (6)
Other.................................................. -- 13 13
------ ------ ------
Cash used in investing activities from continuing
operations........................................... (176) (655) (807)
Cash used in investing activities from discontinued
operations........................................... -- (50) (239)
------ ------ ------
Cash used in investing activities..................... (176) (705) (1,046)
------ ------ ------
FINANCING ACTIVITIES
Issuances of debt...................................... 1,345 2,496 857
Debt prepayments....................................... (1,397) (1,898) (403)
Cash contributed to Crestline at inception............. -- (52) --
Cash contributed to Non-Controlled Subsidiary.......... -- (30) --
Cost of extinguishment of debt......................... (2) (175) --
Scheduled principal repayments......................... (34) (51) (90)
Issuances of common stock.............................. 5 1 6
Issuances of cumulative redeemable preferred stock,
net................................................... 196 -- --
Dividends on common stock.............................. (217) -- --
Dividends on preferred stock........................... (2) -- --
Redemption of outside operating partnership interests
for cash.............................................. (3) -- --
Repurchases of common stock............................ (51) -- --
Repurchases of Convertible Preferred Securities........ (36) -- --
Other.................................................. (106) (26) 22
------ ------ ------
Cash from (used in) financing activities from
continuing operations................................ (302) 265 392
Cash from (used in) financing activities from
discontinued operations.............................. -- 24 (3)
------ ------ ------
Cash from (used in) financing activities.............. (302) 289 389
------ ------ ------
DECREASE IN CASH AND CASH EQUIVALENTS.................. (159) (75) (193)
CASH AND CASH EQUIVALENTS, beginning of year........... 436 511 704
------ ------ ------
CASH AND CASH EQUIVALENTS, end of year................. $ 277 $ 436 $ 511
====== ====== ======
See Notes to Consolidated Financial Statements.
57
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (cont.)
Fiscal years ended December 31, 1999 and 1998, and January 2, 1998
Supplemental schedule of noncash investing and financing activities:
In 1999, approximately 612,000 cumulative redeemable preferred operating
partnership units valued at $7.6 million were issued in connection with the
acquisition of minority interests in two hotels.
Approximately 467,000 shares of common stock were issued during 1999 upon
the conversion of outside Operating Partnership Units valued at $4.9 million.
The Company assumed mortgage debt of $1,215 million and $733 million in 1998
and 1997, respectively, for the acquisition of, or purchase of controlling
interest in, certain hotel properties and senior living communities.
In 1998, the Company distributed $438 million of net assets in connection
with the discontinued operations and contributed $12 million of net assets to
the Non-Controlled Subsidiaries in connection with the REIT Conversion.
See Notes to Consolidated Financial Statements.
58
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description of Business
Host Marriott Corporation a Maryland corporation formerly named HMC Merger
Corporation ("Host REIT"), 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 solely through an operating partnership and its
subsidiaries. As REITs are not currently permitted to derive revenues directly
from the operations of hotels, Host REIT leases all of the hotels to
subsidiaries of Crestline Capital Corporation or other lessees (collectively
the "Lessee") as further discussed at Note 9.
As of December 31, 1999, the Company owned, or had controlling interests in,
121 upscale and luxury, full-service hotel lodging properties generally
located throughout the United States and operated primarily under the
Marriott, Ritz-Carlton, Four Seasons, Hyatt and Swissotel brand names. 108 of
these properties are managed or franchised by Marriott International, Inc.
("Marriott International"). Host REIT also has economic, non-voting interests
in certain Non-Controlled Subsidiaries, whose hotels are also managed by
Marriott International (see Note 4).
Basis of Presentation
On December 15, 1998, shareholders of Host Marriott Corporation, ("Host
Marriott"), a Delaware corporation and the predecessor to Host REIT, approved
a plan to reorganize Host Marriott's business operations through the spin-off
of Host Marriott's senior living business as part of Crestline and the
contribution of Host Marriott's hotels and certain other assets and
liabilities to a newly formed Delaware limited partnership, Host Marriott,
L.P. (the "Operating Partnership"). Host Marriott merged into HMC Merger
Corporation (the "Merger"), a newly formed Maryland corporation (renamed Host
Marriott Corporation) which intends to qualify, effective January 1, 1999, as
a REIT and is the sole general partner of the Operating Partnership. Host
Marriott and its subsidiaries' contribution of its hotels and certain assets
and liabilities to the Operating Partnership and its subsidiaries (the
"Contribution") in exchange for units of partnership interest in the Operating
Partnership ("OP Units") was accounted for at Host Marriott's historical
basis. As of December 31, 1999, Host REIT owned approximately 78% of the
Operating Partnership.
In these consolidated financial statements, the "Company" or "Host Marriott"
refers to Host Marriott Corporation and its consolidated subsidiaries, both
before and after the Merger and its conversion to a REIT (the "REIT
Conversion").
On December 29, 1998, the Company completed the previously discussed spin-
off of Crestline (see Note 2), through a taxable stock dividend to its
shareholders. Each Host Marriott shareholder of record on December 28, 1998
received one share of Crestline for every ten shares of Host Marriott common
stock owned (the "Distribution").
As a result of the Distribution, the Company's financial statements have
been restated to present the senior living communities business results of
operations and cash flows as discontinued operations. See Note 2 for further
discussion of the Distribution. All historical financial statements presented
have been restated to conform to this presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries and controlled affiliates. Investments in affiliates over
which the Company has the ability to exercise significant
59
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
influence, but does not control, are accounted for using the equity method.
All material intercompany transactions and balances have been eliminated.
Fiscal Year End Change
The U.S. Internal Revenue Code of 1986, as amended, requires REITs to file
their U.S. income tax return on a calendar year basis. Accordingly in 1998,
the Company changed its fiscal year-end to December 31 for both financial and
tax reporting requirements. Previously, the Company's fiscal year ended on the
Friday nearest to December 31.
Revenues
The Company's 1999 revenue primarily represents the rental income from its
leased hotels and is not comparable to 1998 hotel revenues which reflect gross
sales generated by the properties. The rent due under each lease is the
greater of base rent or percentage rent, as defined. Percentage rent
applicable to room, food and beverage and other types of hotel revenue varies
by lease and is calculated by multiplying fixed percentages by the total
amounts of such revenues over specified threshold amounts. Both the minimum
rent and the revenue thresholds used in computing percentage rents are subject
to annual adjustments based on increases in the United States Consumer Price
Index and the Labor Index, as defined. As of year end all thresholds have been
achieved.
The comparison of the 1999 results with 1998 and 1997 is also affected by a
change in the reporting period for the Company's hotels not managed by
Marriott International. In prior years, operations for certain of the
Company's hotels were recorded from the beginning of December of the prior
year to November of the current year due to a one-month delay in receiving
results from those hotel properties. Upon conversion to a REIT, operations are
required to be reported on a calendar year basis in accordance with Federal
income tax regulations. As a result, the Company recorded one additional
period of operations in fiscal year 1998 for these properties. The effect on
revenues and net income was to increase revenues by $44 million and net income
by $6 million and diluted earning per share by $0.02 in 1998.
Earnings (Loss) Per Common Share
Basic earnings per common share is computed by dividing net income less
dividends on preferred stock by the weighted average number of shares of
common stock outstanding. Diluted earnings per common share are computed by
dividing net income less dividends on preferred stock 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,
warrants and the Convertible Preferred Securities. Dilutive securities also
include those common and preferred OP Units issuable or outstanding that are
held by minority partners which are assumed to be converted. Diluted earnings
per common share was not adjusted for the impact of the Convertible Preferred
Securities for 1999 and 1997 as they were anti-dilutive. In December 1998, the
Company declared the Special Dividend (Note 2) and, in 1999, the Company
distributed 11.5 million shares to existing shareholders in conjunction with
the Special Dividend. The weighted average number of common shares outstanding
and the basic and diluted earnings per share computations have been restated
to reflect these shares as outstanding for all periods presented.
In February 1999, the Company issued 8.5 million shares in exchange for 8.5
million OP Units issued to certain limited partners in connection with the
Partnership Mergers (see Note 12) which are deemed outstanding at December 31,
1998.
60
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of the number of shares utilized for the calculation of
diluted earnings per common share follows:
Year Ended
----------------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------- -------------------------------- --------------------------------
Per Per Per
Income Shares Share Income Shares Share Income Shares Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- ------ ----------- ------------- ------ ----------- ------------- ------
Net income.......... $211 227.1 $ .93 $ 47 216.3 $ .22 $50 215.0 $.23
Dividends on
preferred stock... (6) -- (.03) -- -- -- -- -- --
Gain on repurchase
of Convertible
Preferred
Securities........ 11 -- .05 -- -- -- -- -- --
---- ----- ----- ---- ----- ----- --- ----- ----
Basic earnings
available to common
shareholders per
share.............. 216 227.1 .95 47 216.3 .22 50 215.0 .23
Assuming
distribution of
common shares
granted under the
comprehensive
stock plan, less
shares assumed
purchased at
average market
price............. -- 5.3 (.02) -- 4.0 (.01) -- 4.8 --
Assuming conversion
of minority OP
Units
outstanding....... 61 64.5 -- -- -- -- -- -- --
Assuming conversion
of preferred OP
Units............. -- 0.3 -- -- -- -- -- -- --
Assuming conversion
of minority OP
Units issuable.... 7 10.9 (.01) -- 0.3 -- -- -- --
Assuming conversion
of Convertible
Preferred
Securities........ -- -- -- 22 35.8 .06 -- -- --
Assuming conversion
of Warrants....... -- -- -- -- -- -- -- 0.3 --
---- ----- ----- ---- ----- ----- --- ----- ----
Diluted Earnings per
Share.............. $284 308.1 $ .92 $ 69 256.4 $ .27 $50 220.1 $.23
==== ===== ===== ==== ===== ===== === ===== ====
International Operations
The consolidated statements of operations include the following amounts
related to non-U.S. subsidiaries and affiliates: revenues of $24 million, $121
million and $105 million, and income (loss) before income taxes of $8 million,
$7 million and ($9 million) in 1999, 1998 and 1997, respectively.
Minority Interest
The 22% of the Operating Partnership equity owned by outside third parties
is presented as minority interest and was $372 million and $368 million as of
December 31, 1999 and 1998, respectively, in the consolidated balance sheets.
Minority interest also includes minority interests in consolidated investments
of Operating Partnership of $136 million and $147 million at December 31, 1999
and 1998, respectively.
Property and Equipment
Property and equipment is recorded at cost. For newly developed properties,
cost includes interest, ground rent and real estate taxes incurred during
development and construction. Replacements and improvements are capitalized.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, generally 40 years for buildings and three to ten
years for furniture and equipment. Leasehold improvements are amortized over
the shorter of the lease term or the useful lives of the related assets.
61
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Gains on sales of properties are recognized at the time of sale or deferred
to the extent required by generally accepted accounting principles. Deferred
gains are recognized as income in subsequent periods as conditions requiring
deferral are satisfied or expire without further cost to the Company.
In cases where management is holding for sale particular hotel properties,
the Company assesses impairment based on whether the estimated sales price
less costs of disposal of each individual property to be sold is less than the
net book value. A property is considered to be held for sale when the Company
has made the decision to dispose of the property. Otherwise, the Company
assesses impairment of its real estate properties based on whether it is
probable that undiscounted future cash flows from each individual property
will be less than its net book value. If a property is impaired, its basis is
adjusted to its fair market value.
Deferred Charges
Financing costs related to long-term debt are deferred and amortized over
the remaining life of the debt.
Cash, Cash Equivalents and Short-term Marketable Securities
The Company considers all highly liquid investments with a maturity of 90
days or less at the date of purchase to be cash equivalents. Cash and cash
equivalents includes approximately $5 million and $22 million at December 31,
1999 and 1998, respectively, of cash related to certain consolidated
partnerships, the use of which is restricted generally for partnership
purposes to the extent it is not distributed to the partners. Short-term
marketable securities include investments with a maturity of 91 days to one
year at the date of purchase. The Company's short-term marketable securities
represent investments in U.S. government agency notes and high quality
commercial paper. The short-term marketable securities are categorized as
available for sale and, as a result, are stated at fair market value.
Unrealized holding gains and losses are included as a separate component of
shareholders' equity until realized.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, cash equivalents
and short-term marketable securities. The Company maintains cash and cash
equivalents and short-term marketable securities with various high credit-
quality financial institutions. The Company performs periodic evaluations of
the relative credit standing of these financial institutions and limits the
amount of credit exposure with any institution.
In addition, on January 1, 1999, subsidiaries of Crestline became the
lessees of virtually all the hotels and, as such, their rent payments are the
primary source of the Company's revenues. The full-service hotel leases are
grouped into four lease pools, with Crestline providing guarantee limited to
the greater of 10% of the aggregate rent payable for the preceding year or 10%
of the aggregate rent payable under all leases in the respective pool.
Additionally, the lessee's obligation under each lease agreement is guaranteed
by all other lessees in the respective lease pool. As a result, the Company
believes that the operating results of each full-service lease pool may be
material to the Company's financial statements. However, management believes
that due to Crestline's substantial assets, net worth and ability to operate
as a separate publicly traded company, Crestline will have the financial
stability and access to capital necessary to meet the substantial obligations
as lessee under the leases. The separate financial statements of each full-
service lease pool are included in this filing. For a more detailed discussion
of the guarantee, see Note 9.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with United States
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets
62
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
REIT Conversion Expenses
The Company incurred certain costs related to the REIT Conversion. These
costs consist of professional fees, printing and filing costs, consent fees
and certain other related fees and are classified as REIT conversion expenses
on the consolidated statement of operations. The Company recognized REIT
conversion expense of $64 million in 1998.
Interest Rate Swap Agreements
In the past, the Company entered into a limited number of interest rate swap
agreements for non-trading purposes. The Company used such agreements to fix
certain of its variable rate debt to a fixed rate basis. The interest rate
differential to be paid or received on interest rate swap agreements is
recognized as an adjustment to interest expense.
Other Comprehensive Income
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" (SFAS 130) which establishes new rules for the reporting
and display of comprehensive income and its components. SFAS 130 requires
unrealized gains or losses on the Company's right to receive Host Marriott
Services stock (see Note 10) and foreign currency translation adjustments, to
be included in other comprehensive income. Prior year financial statements
have been reclassified to conform to the requirements of SFAS 130.
The components of total accumulated other comprehensive income in the
balance sheet are as follows (in millions):
1999 1998
---- ----
Net unrealized gains.............................................. $ 8 $ 5
Foreign currency translation adjustment........................... (6) (9)
--- ---
Total accumulated other comprehensive income (loss)............. $ 2 $(4)
=== ===
Application of New Accounting Standards
On December 3, 1999 the Securities and Exchange Commission staff issued
Staff Accounting Bulletin (SAB) No. 101, which codified the staff's position
on revenue recognition. The Company retroactively changed its method of
accounting for contingent rental revenues to conform to SAB No. 101. As a
result, base rent is recognized as it is earned according to the applicable
lease provisions. Percentage rent is recorded as deferred revenue on the
balance sheet until the applicable hotel revenues exceed the threshold
amounts. The Company has adopted SAB No. 101 with retroactive effect beginning
January 1, 1999.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Statement
establishes accounting and reporting standards requiring that derivative
instruments (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at its fair value. The statement is effective for fiscal years
beginning after June 15, 2000. The Company has not determined the impact of
SFAS No. 133, but management does not believe it will be material.
63
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. Distribution and Special Dividend
In December 1998, the Company distributed to its shareholders through a
taxable distribution the outstanding shares of common stock of Crestline (the
"Distribution"), formerly a wholly owned subsidiary of the Company, which, as
of the date of the Distribution, owned and operated the Company's senior
living communities, owned certain other assets and held leasehold interests in
substantially all of the Company's hotels. The Distribution provided Company
shareholders with one share of Crestline common stock for every ten shares of
Company common stock held by such shareholders on the record date of December
28, 1998. As a result of the Distribution, the Company's financial statements
have been restated to present the senior living communities' business results
of operations and cash flows as discontinued operations. Revenues for the
Company's discontinued operations totaled $241 million and $111 million in
1998 and 1997, respectively. The provision for loss on disposal includes
organizational and formation costs related to Crestline.
For purposes of governing certain of the ongoing relationships between the
Company and Crestline after the Distribution and to provide for an orderly
transition, the Company and Crestline entered into various agreements,
including a Distribution Agreement, an Employee Benefits Allocation Agreement
and a Tax Sharing Agreement. Effective as of December 29, 1998, these
agreements provide, among other things, for the division between the Company
and Crestline of certain assets and liabilities.
On December 18, 1998, the Board of Directors declared a special dividend
which entitled shareholders of record on December 28, 1998 to elect to receive
either $1.00 in cash or .087 of a share of common stock of the Company for
each outstanding share of the Company's common stock owned by such shareholder
on the record date (the "Special Dividend"). Cash totaling $73 million and
11.5 million shares of common stock that were elected in the Special Dividend
were paid and/or issued in 1999.
3. Property and Equipment
Property and equipment consists of the following:
1999 1998
------- ------
(in millions)
Land and land improvements.................................. $ 687 $ 740
Buildings and leasehold improvements........................ 6,687 6,613
Furniture and equipment..................................... 712 740
Construction in progress.................................... 243 78
------- ------
8,329 8,171
Less accumulated depreciation and amortization.............. (1,221) (970)
------- ------
$ 7,108 $7,201
======= ======
Interest cost capitalized in connection with the Company's development and
construction activities totaled $7 million in 1999, $4 million in 1998, and $1
million in 1997.
64
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Investments in and Receivables from Affiliates
Investments in and receivables from affiliates consist of the following:
Ownership
Interests 1999 1998
--------- ---- ----
(in millions)
Equity investments
Rockledge Hotel Properties, Inc....................... 95% $ 47 $ 31
Fernwood Hotel Assets, Inc............................ 95% 2 2
Notes and other receivables from affiliates, net........ -- 127 134
---- ----
$176 $167
==== ====
In connection with the REIT Conversion, Rockledge Hotel Properties, Inc. and
Fernwood Hotel Assets, Inc. (together, the "Non-Controlled Subsidiaries") were
formed to own various assets of approximately $264 million contributed by the
Company to the Operating Partnership, the direct ownership of which by the
Company or the Operating Partnership could jeopardize the Company's status as
a REIT. These assets primarily consist of partnership or other interests in
hotels which are not leased and certain furniture, fixtures and equipment
("FF&E") used in the hotels. In exchange for the contribution of these assets
to the Non-Controlled Subsidiaries, the Operating Partnership received only
non-voting common stock of the Non-Controlled Subsidiaries, representing 95%
of the total economic interests therein. The Host Marriott Statutory
Employee/Charitable Trust, the beneficiaries of which are certain employees of
the Company and the J.W. Marriott Foundation concurrently acquired all of the
voting common stock representing the remaining 5% of the total economic
interest. The Non-Controlled Subsidiaries own three full-service hotels and
interests in partnerships that own an additional two full-service hotels and
209 limited-service hotels.
In connection with the REIT Conversion, the Company completed the
Partnership Mergers and, as a result, investments in affiliates in prior years
include earnings and assets, which are now consolidated. (See Note 12 for
discussion.)
Receivables from affiliates are reported net of reserves of $7 million at
December 31, 1999 and 1998. Net amounts funded by the Company totaled $10
million in 1997, and repayments were $2 million in 1999, $14 million in 1998
and $2 million in 1997. There were no fundings in 1999 and 1998.
The Company's pre-tax income from affiliates includes the following:
1999 1998 1997
---- ---- ----
(in millions)
Interest income............................................... $11 $ 1 $11
Equity in net income.......................................... 6 1 5
--- --- ---
$17 $ 2 $16
=== === ===
65
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Combined summarized balance sheet information for the Company's affiliates
follows:
1999 1998
------ ------
(in millions)
Property and equipment, net................................... $1,556 $1,656
Other assets.................................................. 344 258
------ ------
Total assets................................................ $1,900 $1,914
====== ======
Debt, principally mortgages................................... $1,533 $1,622
Other liabilities............................................. 310 300
Equity (deficit).............................................. 57 (8)
------ ------
Total liabilities and equity................................ $1,900 $1,914
====== ======
Combined summarized operating results for the Company's affiliates follow:
1999 1998 1997
----- ------ -------
(in millions)
Hotel revenues....................................... $ 911 $1,123 $ 1,393
Operating expenses:
Cash charges (including interest).................. (710) (930) (1,166)
Depreciation and other non-cash charges............ (153) (151) (190)
----- ------ -------
Income before extraordinary items.................... 48 42 37
Extraordinary items--forgiveness of debt............. -- 4 40
----- ------ -------
Net income......................................... $ 48 $ 46 $ 77
===== ====== =======
5. Debt
Debt consists of the following:
1999 1998
------ ------
(in millions)
Series A senior notes, with a rate of 7 7/8% due August 2005.. $ 500 $ 500
Series B senior notes, with a rate of 7 7/8% due August 2008.. 1,193 1,192
Series C senior notes, with a rate of 8.45% due December
2008......................................................... 498 498
Series E senior notes, with a rate of 8 3/8% due February
2006......................................................... 300 --
Senior secured notes, with a rate of 9 1/2% due May 2005...... 13 21
Senior notes, with an average rate of 9 3/4% at December 31,
1999, maturing through 2012.................................. 35 35
------ ------
Total senior notes.......................................... 2,539 2,246
------ ------
Mortgage debt (non-recourse) secured by $3.5 billion of real
estate assets, with an average rate of 7.95% at December 31,
1999, maturing through April 2037............................ 2,309 2,438
Line of credit, with a variable rate of Eurodollar plus 1.65%
(7.57% at December 31, 1999)................................. 125 350
Other notes, with an average rate of 7.36% at December 31,
1999, maturing through December 2017......................... 90 90
Capital lease obligations..................................... 6 7
------ ------
Total other................................................. 221 447
------ ------
$5,069 $5,131
====== ======
66
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Public Debt. In February 1999, the Company issued $300 million of 8 3/8%
Series D notes due in 2006 under the same indenture and with the same
covenants as the New Senior Notes (described below). The debt was used to
refinance, or purchase, approximately $299 million of debt acquired in the
Partnership Mergers, including a $40 million variable rate mortgage and
terminate the associated swap agreement, incurring a termination fee of $1
million. The notes were exchanged in August 1999 for Series E Senior notes on
a one-for-one basis, which are freely transferable by the holders.
In December 1998, the Operating Partnership issued $500 million of 8.45%
Series C notes due in 2008 under the same indenture and with the same
covenants as the New Senior Notes (described below).
On August 5, 1998, the Company issued an aggregate of $1.7 billion in new
senior notes (the "New Senior Notes"). The New Senior Notes were issued in two
series, $500 million of 7 7/8% Series A notes due in 2005 and $1.2 billion of
7 7/8% Series B notes due in 2008. The indenture under which the New Senior
Notes were issued contains covenants restricting the ability of the Company
and certain of its subsidiaries to incur indebtedness, grant liens on their
assets, acquire or sell assets or make investments in other entities, and make
certain distributions to equity holders of the Company and the Operating
Partnership. The Company utilized the proceeds from the New Senior Notes to
purchase substantially all of its (i) $600 million in 9 1/2% senior notes due
2005; (ii) $350 million in 9% senior notes due 2007; and (iii) $600 million in
8 7/8% senior notes due 2007 (collectively, the "Old Senior Notes").
Approximately $13 million of the Old Senior Notes remain outstanding. In
connection with the purchase of substantially all of the Old Senior Notes, the
Company recorded a charge of approximately $148 million (net of income tax
benefit of $80 million) as an extraordinary item representing the amount paid
for bond premiums and consent fees, as well as the write-off of deferred
financing fees on the Old Senior Notes.
Concurrently with each offer to purchase, the Company successfully solicited
consents (the "1998 Consent Solicitations") from registered holders of the Old
Senior Notes to certain amendments to eliminate or modify substantially all of
the restrictive covenants and certain other provisions contained in the
indentures pursuant to which the Old Senior Notes were issued.
Bank Credit Facility. In August 1998, the Company entered into a $1.25
billion credit facility (the "Bank Credit Facility") with a group of
commercial banks. The Bank Credit Facility has an initial three-year term with
two one-year extension options. At origination, the facility consisted of a
$350 million term loan and a $900 million revolver. Borrowings under the Bank
Credit Facility bear interest currently at the Eurodollar rate plus 1.65%
(7.57% at December 31, 1999). The interest rate and commitment fee on the
unused portion of the Bank Credit Facility fluctuate based on certain
financial ratios. The New Senior Notes and the Bank Credit Facility were
assumed by the Operating Partnership in connection with the REIT Conversion.
During 1999, the Company repaid $225 million of the outstanding balance on
the $350 million term loan portion of the Bank Credit Facility, permanently
reducing the term loan portion to $125 million. In connection with these
prepayments, an extraordinary loss of $2 million representing the write-off of
deferred financing costs was recognized. As a result of these repayments, the
available capacity under the line of credit balance remains $900 million while
the total line has been permanently reduced to $1.025 billion.
The Bank Credit Facility contains covenants restricting the ability of the
Company and certain of its subsidiaries to incur indebtedness, grant liens on
their assets, acquire or sell assets or make investments in other entities,
and make certain distributions to equity holders of the Company and the
Operating Partnership. The Bank Credit Facility also contains certain
financial covenants relating to, among other things, maintaining certain
levels of tangible net worth and certain ratios of EBITDA to interest and
fixed charges, total debt to EBITDA, unencumbered assets to unsecured debt,
and secured debt to total debt.
67
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Mortgage Debt. In August 1999, the Company made a prepayment of $19 million
to pay down in full the mezzanine mortgage on the Marriott Desert Springs
Resort and Spa. In September 1999, the Company made a prepayment of $45
million to pay down in full the mortgage note on the Philadelphia Four Seasons
Hotel.
In July 1999, the Company entered into a financing agreement pursuant to
which it borrowed $665 million due 2009 at a fixed rate of 7.47% with eight
hotels serving as collateral. In connection with this refinancing, an
extraordinary loss of $3 million was recognized, representing the write-off of
deferred financing fees. The proceeds from this financing were used to
refinance existing mortgage indebtedness maturing at various times through
2000, including approximately $590 million of outstanding variable rate
mortgage debt.
In June 1999, the Company refinanced the debt on the San Diego Marriott
Hotel and Marina. The mortgage is $195 million with a term of 10 years at a
rate of 8.45%. In addition, the Company entered into a mortgage for the
Philadelphia Marriott expansion in July 1999 for $23 million at an interest
rate of approximately 8.6%, maturing in 2009.
In April 1999, a subsidiary of the Company completed the refinancing of the
$245 million mortgage on the New York Marriott Marquis, maturing June 2000.
The Company was required to make a principal payment of $1.25 million on June
30, 1999. In connection with the refinancing, the Company renegotiated the
management agreement and recognized an extraordinary gain of $14 million on
the forgiveness of accrued incentive management fees by the manager. This
mortgage was subsequently refinanced as part of the $665 million financing
agreement discussed above.
In connection with the refinancing of certain mortgage debt for
approximately $152 million in December 1997, the Company recognized an
extraordinary loss of $2 million which represents payment of a prepayment
penalty and the write-off of unamortized deferred financing fees, net of
taxes.
In 1997, the Company purchased 100% of the outstanding bonds secured by a
first mortgage on the San Francisco Marriott for $219 million, an $11 million
discount to the face value of $230 million. An extraordinary gain of $5
million was recognized, which represents the $11 million discount less the
write-off of unamortized deferred financing fees, net of taxes.
Interest Rate swap Agreements. During 1999, the Company terminated its
outstanding interest rate swap agreements recognizing an extraordinary gain of
approximately $8 million. The Company was party to an interest rate swap
agreement with a financial institution with an aggregate notional amount of
$100 million which expired in December 1998. In 1997, the Company was party to
two additional interest rate swap agreements with an aggregate notional amount
of $400 million which expired in May 1997. The Company realized a net
reduction of interest expense of $338 thousand and $1 million in 1999 and
1997, respectively, related to interest rate swap agreements.
The Company's debt balance at December 31, 1999, includes $87 million of
debt that is recourse to the parent company. Aggregate debt maturities at
December 31, 1999 are (in millions):
2000............................................................... $ 180
2001............................................................... 169
2002............................................................... 157
2003............................................................... 132
2004............................................................... 47
Thereafter......................................................... 4,386
------
5,071
Discount on senior notes........................................... (9)
Capital lease obligation........................................... 7
------
$5,069
======
68
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Cash paid for interest for continuing operations, net of amounts
capitalized, was $413 million in 1999, $325 million in 1998, and $278 million
in 1997. Deferred financing costs, which are included in other assets,
amounted to $111 million and $98 million, net of accumulated amortization, as
of December 31, 1999 and 1998, respectively. Amortization of deferred
financing costs totaled $17 million, $10 million, and $7 million in 1999,
1998, and 1997, respectively.
6. Company-obligated Mandatorily Redeemable Convertible Preferred Securities
of a Subsidiary Trust Whose Sole Assets are the Convertible Subordinated
Debentures Due 2026
In December 1996, Host Marriott Financial Trust (the "Issuer"), a wholly-
owned subsidiary trust of the Company, issued 11 million shares of 6 3/4%
convertible quarterly income preferred securities (the "Convertible Preferred
Securities"), with a liquidation preference of $50 per share (for a total
liquidation amount of $550 million). The Convertible Preferred Securities
represent an undivided beneficial interest in the assets of the Issuer. The
payment of distributions out of moneys held by the Issuer and payments on
liquidation of the Issuer or the redemption of the Convertible Preferred
Securities are guaranteed by the Company to the extent the Issuer has funds
available therefor. This guarantee, when taken together with the Company's
obligations under the indenture pursuant to which the Debentures (defined
below) were issued, the Debentures, the Company's obligations under the Trust
Agreement and its obligations under the indenture to pay costs, expenses,
debts and liabilities of the Issuer (other than with respect to the
Convertible Preferred Securities) provides a full and unconditional guarantee
of amounts due on the Convertible Preferred Securities. Proceeds from the
issuance of the Convertible Preferred Securities were invested in 6 3/4%
Convertible Subordinated Debentures (the "Debentures") due December 2, 2026
issued by the Company. The Issuer exists solely to issue the Convertible
Preferred Securities and its own common securities (the "Common Securities")
and invest the proceeds therefrom in the Debentures, which is its sole asset.
Separate financial statements of the Issuer are not presented because of the
Company's guarantee described above; the Company's management has concluded
that such financial statements are not material to investors as the Issuer is
wholly-owned and essentially has no independent operations.
Each of the Convertible Preferred Securities and the related debentures are
convertible at the option of the holder into shares of Company common stock at
the rate of 3.2537 shares per Convertible Preferred Security (equivalent to a
conversion price of $15.367 per share of Company common stock). The Issuer
will only convert Debentures pursuant to a notice of conversion by a holder of
Convertible Preferred Securities. During 1999, 1998 and 1997, no shares were
converted into common stock. The conversion ratio and price were adjusted to
reflect the impact of the Distribution and the Special Dividend.
Holders of the Convertible Preferred Securities are entitled to receive
preferential cumulative cash distributions at an annual rate of 6 3/4%
accruing from the original issue date, commencing March 1, 1997, and payable
quarterly in arrears thereafter. The distribution rate and the distribution
and other payment dates for the Convertible Preferred Securities will
correspond to the interest rate and interest and other payment dates on the
Debentures. The Company may defer interest payments on the Debentures for a
period not to exceed 20 consecutive quarters. If interest payments on the
Debentures are deferred, so too are payments on the Convertible Preferred
Securities. Under this circumstance, the Company will not be permitted to
declare or pay any cash distributions with respect to its capital stock or
debt securities that rank pari passu with or junior to the Debentures.
Subject to certain restrictions, the Convertible Preferred Securities are
redeemable at the Issuer's option upon any redemption by the Company of the
Debentures after December 2, 1999. Upon repayment at maturity or as a result
of the acceleration of the Debentures upon the occurrence of a default, the
Convertible Preferred Securities are subject to mandatory redemption.
69
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In connection with consummation of the REIT Conversion, the Operating
Partnership assumed primary liability for repayment of the Debentures of the
Company underlying the Convertible Preferred Securities. Upon conversion by a
Convertible Preferred Securities holder, the Company will issue shares of
Company common stock, which will be delivered to such holder. Upon the
issuance of such shares by the Company, the Operating Partnership will issue
to the Company a number of OP Units equal to the number of shares of Company
common stock issued in exchange for the Debentures.
The Company repurchased 1.1 million shares of the Convertible Preferred
Securities in 1999 and has repurchased an additional 0.4 million shares
through March 8, 2000 as part of the share repurchase program described below
in Note 7.
7. Shareholders' Equity
Seven hundred fifty million shares of common stock, with a par value of
$0.01 per share, are authorized, of which 223.5 million and 225.6 million were
outstanding as of December 31, 1999 and 1998, respectively. Fifty million
shares of no par value preferred stock are authorized, with 8.16 million
shares outstanding as of December 31, 1999. No shares of preferred stock were
outstanding as of December 31, 1998.
A quarterly dividend of $0.21 per common share was paid on April 14, July
14, and October 15 of 1999. A fourth quarter dividend of $0.21 per common
share was declared on December 20, 1999 and paid on January 17, 2000.
In September 1999, the Board of Directors approved the repurchase, from time
to time on the open market and/or in privately negotiated transactions, of up
to 22 million of the outstanding shares of the Company's common stock,
operating partnership units, or a corresponding amount of Convertible
Preferred Securities, which are convertible into a like number of common
shares. Such repurchases will be made at management's discretion, subject to
market conditions, and may be suspended at any time at the Company's
discretion. For the year ended December 31, 1999, the Company repurchased 5.8
million common shares, 1.1 million shares of the Convertible Preferred
Securities and 0.3 million operating partnership units for a total investment
of $89 million. Through March 8, 2000, the Company repurchased an additional
4.7 million common shares, 0.3 million operating partnership units, and 0.4
million convertible preferred securities for an additional investment of $60
million.
In August 1999, the Company sold 4.16 million shares of 10% Class A
preferred stock ("Class A Preferred Stock"), and in November 1999, the Company
sold 4.0 million shares of 10% Class B preferred stock ("Class B Preferred
Stock"). Holders of both classes of the preferred stock are entitled to
receive cumulative cash dividends at a rate of 10% per annum of the $25.00 per
share liquidation preference. Dividends are payable quarterly in arrears
commencing October 15, 1999 and January 15, 2000 for the Class A Preferred
Stock and Class B Preferred Stock, respectively. After August 3, 2004 and
April 29, 2005, respectively, the Company has the option to redeem the Class A
Preferred Stock and Class B Preferred Stock for $25.00 per share, plus accrued
and unpaid dividends to the date of redemption. The preferred stocks rank
senior to the common stock and the authorized Series A Junior Participating
preferred stock, and on a parity with each other. The preferred stockholders
generally have no voting rights. Accrued dividends at December 31, 1999 were
$4 million.
In conjunction with the Merger, the Blackstone Acquisition and the
Partnership Mergers, the Operating Partnership issued approximately 73.5
million OP Units which are convertible into cash or, at Host Marriott's
option, shares of Host Marriott common stock. Approximately 64.0 million of
the OP Units were outstanding as of December 31, 1999.
The Company issued 11.5 million shares of common stock as part of the
Special Dividend and 8.5 million shares of common stock in exchange for 8.5
million OP Units issued to certain limited partners in connection
70
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
with the Partnership Mergers (Note 12). Also, as part of the REIT Conversion,
the Company changed its par value from $1 to $0.01 per share. The change in
par value did not affect the number of shares outstanding.
In November 1998, the Board of Directors adopted a shareholder rights plan
(as amended December 24, 1998) under which a dividend of one preferred stock
purchase right was distributed for each outstanding share of the Company's
common stock. Each right when exercisable entitles the holder to buy 1/1000th
of a share of a series A junior participating preferred stock of the Company
at an exercise price of $55 per share, subject to adjustment. The rights were
exercisable 10 days after a person or group acquired beneficial ownership of
at least 20%, or began a tender or exchange offer for at least 20%, of the
Company's common stock. Shares owned by a person or group on November 3, 1998
and held continuously thereafter were exempt for purposes of determining
beneficial ownership under the rights plan. The rights are non-voting and
expire on November 22, 2008, unless exercised or previously redeemed by the
Company for $.005 each. If the Company was involved in a merger or certain
other business combinations not approved by the Board of Directors, each right
entitles its holder, other than the acquiring person or group, to purchase
common stock of either the Company or the acquiror having a value of twice the
exercise price of the right.
8. Income Taxes
In December 1998, the Company restructured itself to enable the Company to
qualify for treatment as a REIT, pursuant to the US Internal Revenue Code of
1986, as amended, effective January 1, 1999. In general, a corporation that
elects REIT status and distributes at least 95% of its taxable income to its
shareholders and complies with certain other requirements (relating primarily
to the nature of its assets and the sources of its revenues) is not subject to
Federal income taxation to the extent it distributes its taxable income. In
1999, the Company distributed 100% if its 1999 taxable income which amounted
to $.84 per outstanding common share. Of the total distribution, $.83 per
share was taxable as ordinary income with the remaining $.01 per share taxable
as a capital gain. Management believes that the Company was organized to
qualify as a REIT for 1999 and intends for it to qualify in subsequent years
(including distribution of at least 95% of its REIT taxable income to
shareholders each year). Management expects that the Company will pay taxes on
"built-in gains" on only certain of its assets. Based on these considerations
and the settlement of certain tax contingencies in 1999, management does not
believe that the Company will be liable for income taxes at the federal level
or in most of the states in which it operates in future years, and the Company
eliminated $26 million and $106 million of its net tax liabilities as of
December 31, 1999 and 1998. The Company does not expect to provide for any
material deferred income taxes in future periods except in certain states and
foreign countries. In connection with the Distribution and formation of the
Non-Controlled Subsidiaries, the Company further reduced deferred income tax
liabilities by $102 million in 1998.
In order to qualify as a REIT for federal income tax purposes, among other
things, the Company was required to distribute all of its accumulated earnings
and profits ("E&P") to its stockholders in one or more taxable dividends prior
to December 31, 1999. To accomplish the requisite distributions of accumulated
E&P, Host Marriott made distributions consisting of approximately 20.4 million
shares of Crestline valued at $297 million, $73 million in cash, and
approximately 11.5 million shares of Host Marriott stock valued at $138
million. Management believes it has distributed all required E&P as of
December 31, 1999. The Company's final calculation of E&P and the distribution
thereof is subject to review by the Internal Revenue Service.
Where required, deferred income taxes are accounted for using the asset and
liability method. Under this method, deferred income taxes are recognized for
temporary differences between the financial reporting bases of assets and
liabilities and their respective tax bases and for operating loss and tax
credit carryforwards based on enacted tax rates expected to be in effect when
such amounts are realized or settled. However, deferred tax assets are
recognized only to the extent that it is more likely than not that they will
be realized based on consideration of available evidence, including tax
planning strategies and other factors.
71
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Total deferred tax assets and liabilities at December 31, 1999 and December
31, 1998 were as follows:
1999 1998
------ -------
(in millions)
Deferred tax assets........................................ $ 10 $ 32
Deferred tax liabilities................................... (59) (129)
------ -------
Net deferred income tax liability........................ $ (49) $ (97)
====== =======
The tax effect of each type of temporary difference and carryforward that
gives rise to a significant portion of deferred tax assets and liabilities as
of December 31, 1999 and December 31, 1998 follows:
1999 1998
------ -------
(in millions)
Safe harbor lease investments.............................. $ (24) $ (24)
Deferred tax gain.......................................... (35) (105)
Alternative minimum tax credit carryforwards............... 10 32
------ -------
Net deferred income tax liability........................ $ (49) $ (97)
====== =======
The provision (benefit) for income taxes consists of:
1999 1998 1997
---- ---- ----
(in millions)
Current-- Federal........................................... $ 26 $116 $19
-- State................................................ 3 27 4
-- Foreign.............................................. 3 4 3
---- ---- ---
32 147 26
---- ---- ---
Deferred -- Federal......................................... (37) (49) 8
-- State................................................ (11) (12) 2
---- ---- ---
(48) (61) 10
---- ---- ---
$(16) $ 86 $36
==== ==== ===
At December 31, 1999, the Company had approximately $10 million of
alternative minimum tax credit carryforwards available which do not expire.
As of December 31, 1999, the Company had settled with the Internal Revenue
Service substantially all issues for tax years through 1996. The Company
expects to resolve any remaining issues with no material impact on the
consolidated financial statements. The Company made net payments to the IRS of
approximately $14 million, $27 million, and $10 million in 1999, 1998 and
1997, respectively, related to these settlements.
72
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of the statutory Federal tax rate to the Company's
effective income tax rate follows (excluding the impact of the change in tax
status):
1999 1998 1997
----- ---- ----
Statutory Federal tax rate............................... -- % 35.0% 35.0%
Built-in-gain tax........................................ 2.8 -- --
State income taxes, net of Federal tax benefit........... 1.2 5.8 4.9
Tax credits.............................................. -- (1.7) (2.7)
Tax contingencies........................................ (16.9) -- --
Additional tax on foreign source income.................. 1.6 4.2 6.0
Permanent non-deductible REIT Conversion expenses........ -- 4.6 --
Other permanent items.................................... -- 1.2 .1
Other, net............................................... -- 0.3 .1
----- ---- ----
Effective income tax rate.............................. (11.3)% 49.4% 43.4%
===== ==== ====
Cash paid for income taxes, including IRS settlements, net of refunds
received, was $50 million in 1999, $83 million in 1998 and $56 million in
1997.
9. Leases
Hotel Leases. Due to current federal income tax law restrictions on a REIT's
ability to derive revenues directly from the operation of a hotel, the Company
leases its hotels (the "Leases") to one or more lessees (the "Lessees").
There generally is a separate Lessee for each hotel or group of hotels that
is owned by a separate subsidiary of the Company. The operating agreements for
such Lessees provide that the Crestline member of the Lessee has full control
over the management of the business of the Lessee, subject to blocking rights
by Marriott International, where it is the manager, over certain decisions by
virtue of its non-economic, limited voting interest in the lessee
subsidiaries. Each full-service hotel Lease has a fixed term generally ranging
from seven to ten years, subject to earlier termination upon the occurrence of
certain contingencies as defined in the Leases. Each Lease requires the Lessee
to pay 1) minimum rent in a fixed dollar amount per annum plus 2) to the
extent it exceeds minimum rent, percentage rent based upon specified
percentages of aggregate sales from the applicable hotel, including room
sales, food and beverage sales, and other income in excess of specified
thresholds. The amount of minimum rent and the percentage rent thresholds will
be adjusted each year based upon any increases in the Consumer Price Index and
the Employment Cost Index during the previous 10 months, as well as for
certain capital expenditures and casualty occurrences. The Company has
received notices of termination from Crestline on five leases, with effective
dates ranging from March through June 2000, which we are currently
negotiating. We expect to be able to obtain replacement leases for these
leases without material impact to our future operations.
Effective November 15, 1999, we amended substantially all of our leases with
Crestline to give Crestline the right to renew each of these leases for up to
four additional terms of seven years each at a fair rental value, to be
determined either by agreement between the Company and Crestline or through
arbitration at the time the renewal option is exercised. Crestline is under no
obligation to exercise these renewal options, and we have the right to
terminate the renewal options during certain time periods specified in the
amendments. In addition, the amendments provide that the fair rental value
payable by us to Crestline in connection with the purchase of a lease as
described above does not include any amounts relating to any renewal period.
Therefore, the fair rental value of a lease after expiration of the initial
term for such lease would be zero. The Company intends to evaluate our options
regarding the Crestline leases and have not yet made a decision whether or not
to purchase those leases.
73
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
If the Company anticipates that the average tax basis of the Company's FF&E
and other personal property that are leased by any individual lessor entity
will exceed 15% of the aggregate average tax basis of the fixed assets in that
entity, then the Lessee would be obligated either to acquire such excess FF&E
from the Company or to cause a third party to purchase such FF&E. The Lessee
has agreed to give a right of first opportunity to a Non-Controlled Subsidiary
to acquire the excess FF&E and to lease the excess FF&E to the Lessee.
Each Lessee is responsible for paying all of the expenses of operating the
applicable hotel(s), including all personnel costs, utility costs and general
repair and maintenance of the hotel(s). The Lessee also is responsible for all
fees payable to the applicable manager, including base and incentive
management fees, chain services payments and franchise or system fees, with
respect to periods covered by the term of the Lease. Host Marriott also
remains liable under each management agreement.
The Company is responsible for paying real estate taxes, personal property
taxes (to the extent the Company owns the personal property), casualty
insurance on the structures, ground lease rent payments, required expenditures
for FF&E (including maintaining the FF&E reserve, to the extent such is
required by the applicable management agreement) and other capital
expenditures.
Crestline Guarantees. Crestline and certain of its subsidiaries entered into
limited guarantees of the Lease obligations of each Lessee. The full-service
hotel leases are grouped into four lease pools (determined on the basis of the
term of the particular Lease with all leases having generally the same lease
term placed in the same "pool"). For each of the four identified pools, the
cumulative limit of Crestline's guaranty obligation is the greater of 10% of
the aggregate rent payable for the immediately preceding fiscal year under all
Leases in the pool or 10% of the aggregate rent payable under all Leases in
the pool. For each pool, the subsidiary of Crestline that is the parent of the
Lessees in the pool (a "Pool Parent") also is a party to the guaranty of the
Lease obligations for that pool.
The obligations of the Pool Parent under each guaranty is secured by all
funds received by the applicable Pool Parent from the hotels in the pool, and
the hotels in the pool are required to distribute their excess cash flow to
the Pool Parent for each accounting period, under certain conditions as
described by the guaranty.
As a result of the limited guarantees of the lease obligations of the
lessees, the Company believes that the operating results of each full-service
lease pool may be material to the Company's financial statements. Separate
financial statements for the year ended December 31, 1999 for each of the four
lease pools in which the Company's full-service hotels are organized are
presented in Item 8 of this Annual Report on Form 10-K. Financial information
of certain pools related to the sublease agreements for limited service
properties are not presented, as the Company believes they are not material to
the Company's financial statements. Financial information of Crestline may be
found in its quarterly and annual filings with the Securities and Exchange
Commission.
In the event that Crestline's obligation under a guaranty is reduced to
zero, the applicable Pool Parent can elect to terminate its guaranty and the
pooling agreement for that pool by giving notice to the Operating Partnership.
In that event, subject to certain conditions, the Pool Parent's guaranty will
terminate six months after the effective date of such notice, subject to
reinstatement in certain limited circumstances.
The Operating Partnership sold the existing working capital to the
applicable Lessee upon the commencement of the Lease at a price equal to the
fair market value of such assets. The purchase price is represented by a note
evidencing a loan that bears interest at a rate of 5.12%. Interest accrued on
the working capital loan is due simultaneously with each periodic rent
payment, and the amount of each payment of interest is credited against such
rent payment. The principal amount of the working capital loan is payable upon
termination of the Lease. The Lessee can return the working capital in
satisfaction of the note. As of December 31, 1999, the note receivable from
Crestline for working capital was $90 million.
74
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In the event the Company enters into an agreement to sell or otherwise
transfer any full-service hotel free and clear of the applicable Lease, the
Lessor must pay the Lessee a termination fee equal to the fair market value of
the Lessee's leasehold interest in the remaining term of the Lease using a
discount rate of 12%. Alternatively, the Lessor will be entitled to (i)
substitute a comparable hotel or hotels for any hotel that is sold or (ii)
sell the hotel subject to the Lease and certain conditions without being
required to pay a termination fee.
REIT Modernization Act. Under the REIT Modernization Act, beginning January
1, 2001, we could lease our hotels to a subsidiary of the operating
partnership that is a taxable corporation and that elects to be treated as a
"taxable REIT subsidiary". In addition, as a result of passage of the REIT
Modernization Act, we have the right to purchase the leases from Crestline on
or after January 1, 2001, for a price equal to the fair rental value of the
lessee's interest in the leases over their remaining terms (which could be
significant).
Hospitality Properties Trust Relationship. The Company sold and leased back
37 of its Courtyard properties in 1995 and an additional 16 Courtyard
properties in 1996 to Hospitality Properties Trust ("HPT"). Additionally, in
1996, the Company sold and leased back 18 of its Residence Inns to HPT. These
leases, which are accounted for as operating leases and are included in the
table below, have initial terms expiring through 2012 for the Courtyard
properties and 2010 for the Residence Inn properties, and are renewable at the
option of the Company. Minimum rent payments are $51 million annually for the
Courtyard properties and $17 million annually for the Residence Inn
properties, and additional rent based upon sales levels are payable to the
owner under the terms of the leases.
In connection with the REIT Conversion, the Operating Partnership sublet the
HPT hotels (the "Subleases") to separate indirect sublessee subsidiaries of
Crestline ("Sublessee"), subject to the terms of the applicable HPT Lease. The
term of each Sublease expires simultaneously with the expiration of the
initial term of the HPT lease to which it relates and automatically renews for
the corresponding renewal term under the HPT lease, unless either the HPT
lessee (the "Sublessor") elects not to renew the HPT lease, or the Sublessee
elects not to renew the Sublease at the expiration of the initial term
provided, however, that neither party can elect to terminate fewer than all of
the Subleases in a particular pool of HPT hotels (one for Courtyard by
Marriott hotels and one for Residence Inn hotels). Rent under the Sublease
consists of the Minimum Rent payable under the HPT lease and an additional
percentage rent payable to the Sublessor. The percentage rent is sufficient to
cover the additional rent due under the HPT lease, with any excess being
retained by the Sublessor. The rent payable under the Subleases is guaranteed
by Crestline, up to a maximum amount of $30 million which amount is allocated
between the two pools of HPT hotels.
Other Lease Information. A number of the Company's leased hotel properties
also include long-term ground leases for certain hotels, generally with
multiple renewal options. Certain leases contain provision for the payment of
contingent rentals based on a percentage of sales in excess of stipulated
amounts. Future minimum annual rental commitments for all non-cancelable
leases for which the Company is the lessee are as follows:
Capital Operating
Leases Leases
------- ---------
(in millions)
2000....................................................... $ 2 $ 109
2001....................................................... 1 105
2002....................................................... 1 101
2003....................................................... 1 97
2004....................................................... 1 103
Thereafter................................................. 3 1,236
--- ------
Total minimum lease payments............................... 9 $1,751
======
Less amount representing interest.......................... (3)
---
Present value of minimum lease payments.................... $ 6
===
75
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Certain of the lease payments included in the table above relate to
facilities used in the Company's former restaurant business. Most leases
contain one or more renewal options, generally for five or 10-year periods.
Future rentals on leases have not been reduced by aggregate minimum sublease
rentals from restaurants and HPT subleases of $71 million and $851 million,
respectively, payable to the Company under non-cancellable subleases.
In conjunction with the refinancing of the mortgage of the New York Marriott
Marquis, the Company also renegotiated the terms of the ground lease,
retroactive to 1998. The renegotiated ground lease provides for the payment of
a percentage of the hotel sales (3% in 1998, 4% in 1999 and 5% thereafter)
through 2017, which is to be used to amortize the then existing deferred
ground rent obligation of $116 million. The Company has the right to purchase
the land under certain circumstances. The balance of the deferred ground rent
obligation was $86 million at December 31, 1999.
The Company remains contingently liable at December 31, 1999 on certain
leases relating to divested non-lodging properties. Such contingent
liabilities aggregated $80 million at December 31, 1999. However, management
considers the likelihood of any substantial funding related to these leases to
be remote.
Rent expense consists of:
1999 1998 1997
---- ---- ----
(in millions)
Minimum rentals on operating leases............................. $106 $104 $ 98
Additional rentals based on sales............................... 29 26 20
---- ---- ----
$135 $130 $118
==== ==== ====
10. Employee Stock Plans
At December 31, 1999, the Company maintained two stock-based compensation
plans, including the comprehensive stock plan (the "Comprehensive Plan"),
whereby the Company may award to participating employees (i) options to
purchase the Company's common stock, (ii) deferred shares of the Company's
common stock and (iii) restricted shares of the Company's common stock and the
employee stock purchase plan (the "Employee Stock Purchase Plan"). Total
shares of common stock reserved and available for issuance under the
Comprehensive Plan at December 31, 1999 was 39.6 million.
Employee stock options may be granted to officers and key employees with an
exercise price not less than the fair market value of the common stock on the
date of grant. Non-qualified options generally expire up to 15 years after the
date of grant. Most options vest ratably over each of the first four years
following the date of the grant.
In connection with the Host Marriott Services ("HM Services") spin-off in
1995, outstanding options held by current and former employees of the Company
were redenominated in both Company and HM Services stock and the exercise
prices of the options were adjusted based on the relative trading prices of
shares of the common stock of the two companies. Pursuant to the distribution
agreement between the Company and HM Services, the Company originally had the
right to receive up to 1.4 million shares of HM Services' common stock or an
equivalent cash value subsequent to exercise of the options held by certain
former and current employees of Marriott International. On August 27, 1999,
Autogrill Acquisition Co., a wholly-owned subsidiary of Autogrill SpA of
Italy, acquired Host Marriott Services Corporation. Since Host Marriott
Services is no longer publicly traded, all future payments to the Company will
be made in cash as Host Marriott Services Corporation has indicated that the
receivable will not be settled in Autogrill SpA stock. As of December 31,
1999, the receivable balance is approximately $11.9 million, which is included
in other assets.
76
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Effective December 29, 1998, the Company adjusted the number of outstanding
stock options and the related exercise prices to maintain the intrinsic value
of the options to account for the Special Dividend and the Distribution. The
vesting provisions and option period of the original grant was retained. No
compensation expense was recorded by the Company as a result of these
adjustments. Employee optionholders that remained with the Company received
options only in the Company's stock and those employee optionholders that
became Crestline employees received Crestline options in exchange for the
Company's options.
The Company continues to account for expense under its plans according to
the provisions of Accounting Principle Board Opinion 25 and related
interpretations as permitted under SFAS No. 123. Consequently, no compensation
cost has been recognized for its fixed stock options under the Comprehensive
Plan and its Employee Stock Purchase Plan.
For purposes of the following disclosures required by SFAS No. 123, the fair
value of each option granted has been estimated on the date of grant using an
option-pricing model with the following weighted average assumptions used for
grants in 1999 and 1997, respectively: risk-free interest rates of 6.4% and
6.2%, volatility of 32% and 35%, expected lives of 12 years and 12 years and
dividend yield of $ $0.84 per share and no dividend yield. The weighted
average fair value per option granted during the year was $1.15 in 1999 and
$13.13 in 1997. No options were granted in 1998. Pro forma compensation cost
for 1999, 1998 and 1997 would have reduced net income by approximately
$919,000, $524,000 and $330,000. Basic and diluted earnings per share on a pro
forma basis were not impacted by the pro forma compensation cost in 1999, 1998
and 1997.
The effects of the implementation of SFAS No. 123 are not representative of
the effects on reported net income in future years because only the effects of
stock option awards granted in 1997 and subsequent have been considered.
A summary of the status of the Company's stock option plan for 1999, 1998
and 1997 follows:
1999 1998 1997
---------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
(in millions) Exercise Price (in millions) Exercise Price (in millions) Exercise Price
------------- -------------- ------------- -------------- ------------- --------------
Balance, at beginning of
year................... 5.6 $ 3 6.8 $ 4 8.3 $ 4
Granted................. 0.6 10 -- -- .1 20
Exercised............... (1.3) 3 (1.3) 5 (1.6) 4
Forfeited/Expired....... -- -- (0.6) 4 -- --
Adjustment for
Distribution and
Special Dividend....... -- -- 0.7 3 -- --
---- ---- ----
Balance, at end of
year................... 4.9 4 5.6 3 6.8 4
==== ==== ====
Options exercisable at
year-end............... 4.2 5.5 6.4
==== ==== ====
77
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table summarizes information about stock options at December
31, 1999:
Options Outstanding Options Exercisable
---------------------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Shares Contractual Exercise Shares Exercise
Range of Exercise Prices (in millions) Life Price (in millions) Price
- ------------------------ ------------- ----------- -------- ------------- --------
$ 1 - 3................ 3.4 7 $ 2 3.4 $ 2
4 - 6................ 0.4 9 6 0.4 6
7 - 9................ 0.9 13 9 0.4 8
10 - 12................ 0.2 14 12 -- 12
13 - 15................ -- 13 15 -- 15
16 - 19................ -- 13 18 -- 18
--- ---
4.9 4.2
=== ===
Deferred stock incentive plan shares granted to officers and key employees
after 1990 generally vest over 10 years in annual installments commencing one
year after the date of grant. Certain employees may elect to defer payments
until termination or retirement. The Company accrues compensation expense for
the fair market value of the shares on the date of grant, less estimated
forfeitures. In 1999, 1998 and 1997, 11,000, 12,000 and 14,000 shares were
granted, respectively, under this plan. The compensation cost that has been
charged against income for deferred stock was not material in 1999, 1998 and
1997. The weighted average fair value per share granted during each year was
$14.31 in 1999, $19.21 in 1998 and $15.81 in 1997.
The Company from time to time awards restricted stock plan shares under the
Comprehensive Plan to officers and key executives to be distributed over the
next three to 10 years in annual installments based on continued employment
and the attainment of certain performance criteria. The Company recognizes
compensation expense over the restriction period equal to the fair market
value of the shares on the date of issuance adjusted for forfeitures, and
where appropriate, the level of attainment of performance criteria and
fluctuations in the fair market value of the Company's common stock. In 1999,
1998 and 1997, 3,203,000, 2,900 and 198,000 shares of additional restricted
stock plan shares were granted to certain key employees under these terms and
conditions. Approximately 5,000 and 17,000 shares were forfeited in 1999 and
1998, respectively. There were no forfeitures in 1997. The Company recorded
compensation expense of $7.7 million, $11 million and $13 million 1999, 1998
and 1997, respectively, related to these awards. The weighted average fair
value per share granted during each year was $12.83 in 1999, $18.13 in 1998
and $16.88 in 1997. Under these awards 3,203,000 shares were outstanding at
December 31, 1999.
In 1998, 568,408 stock appreciation rights ("SARs") were issued under the
Comprehensive Plan to certain directors of the Company as a replacement for
previously issued options that were cancelled during the year. The conversion
to SARs was completed in order to comply with ownership limits applicable to
the Company upon conversion to a REIT. The SARs are fully vested and the grant
prices range from $1.20 to $5.13. In 1999 and 1998, the Company recognized
compensation (income) expense of $(2.7) million and $4.8 million,
respectively, related to this grant. Additionally, in future periods, the
Company will recognize compensation expense for outstanding SARs as a result
of fluctuations in the market price of the Company's common stock.
Under the terms of the Employee Stock Purchase Plan, eligible employees may
purchase common stock through payroll deductions at 90% of the lower of market
value at the beginning or market value at the end of the plan year.
78
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Profit Sharing and Postemployment Benefit Plans
The Company contributes to profit sharing and other defined contribution
plans for the benefit of employees meeting certain eligibility requirements
and electing participation in the plans. The amount to be matched by the
Company is determined annually by the Board of Directors. The Company provides
medical benefits to a limited number of retired employees meeting restrictive
eligibility requirements. Amounts for these items were not material in 1997
through 1999.
12. Acquisitions and Dispositions
The Company completed a 210-room expansion of the Philadelphia Marriott in
April 1999 at a cost of approximately $37 million. Additionally, we acquired
the remaining unaffiliated partnership interests in two full-service hotels by
issuing approximately 612,000 cumulative preferred OP Units and paid cash of
approximately $6.8 million.
The Company acquired or gained controlling interest in 36 hotels with 15,166
rooms in 1998 and 18 hotels with 9,128 rooms in 1997. Twenty-five of the 1998
acquisitions, consisting of the Blackstone Acquisition and the Partnership
Mergers, were completed on December 30, 1998 in conjunction with the REIT
Conversion. Additionally, three full-service properties were contributed to
one of the Non-Controlled Subsidiaries (Note 4). These acquisitions are
summarized below.
In December 1998, the Company completed the acquisition of, or controlling
interests in, twelve hotels and one mortgage loan secured by an additional
hotel (the "Blackstone Acquisition") from the Blackstone Group, a Delaware
limited partnership, and a series of funds controlled by affiliates of
Blackstone Real Estate Partners (together, the "Blackstone Entities"). In
addition, the Company acquired a 25% interest in Swissotel Management (USA)
L.L.C., which operates five Swissotel hotels in the United States, which the
Company transferred to Crestline in connection with the Distribution. The
Operating Partnership issued approximately 47.7 million OP Units, which are
redeemable for the Company's common stock (or cash equivalent at Host
Marriott's option) assumed debt and made cash payments totaling approximately
$920 million and distributed 1.4 million of the shares of Crestline common
stock to the Blackstone Entities. During 1999, approximately 467,000 OP Units
were redeemed for common stock and an additional 233,000 OP Units were
redeemed for $2 million in cash. As of December 31, 1999, the Blackstone
Entities own approximately 16% of the outstanding OP Units of the Operating
Partnership.
In December 1998, the Company announced the completion of the Partnership
Mergers which was the roll-up of eight public partnerships and four private
partnerships which own or control 28 properties, 13 of which were already
consolidated (the "Partnership Mergers"). The Operating Partnership issued
approximately 25.8 million OP Units to partners for their interests valued at
approximately $333 million. As of December 31, 1999, approximately 16.8
million OP Units remain outstanding.
As a result of these transactions, the Company increased its ownership of
most of the 28 properties to 100% while consolidating 13 additional hotels
(4,445 rooms).
During 1998, the Company acquired an additional interest in the Atlanta
Marriott Marquis II Limited Partnership, which owns an interest in the 1,671-
room Atlanta Marriott Marquis for approximately $239 million. The Company also
acquired a controlling interest in two partnerships that own four hotels for
approximately $74 million. In addition, the Company acquired four Ritz-Carlton
hotels and two additional hotels totaling over 2,200 rooms for approximately
$465 million.
In 1997, the Company acquired eight full-service hotels totaling 3,600 rooms
for approximately $145 million. In addition, the Company acquired controlling
interests in nine full-service hotels totaling 5,024 rooms
79
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
for approximately $621 million, including the assumption of approximately $418
million of debt. The Company also completed the acquisition of the 504-room
New York Marriott Financial Center, after acquiring the mortgage on the hotel
for $101 million in late 1996.
Also in 1997, the Company acquired the outstanding common stock of the Forum
Group from Marriott Senior Living Services. The Company purchased the Forum
Group portfolio of 29 senior living communities for approximately $460
million, including approximately $270 million in debt. The Company also
acquired 49% of the remaining 50% interest in the partnership which owned the
418-unit Leisure Park retirement community for approximately $23 million,
including the assumption of approximately $15 million of debt. The Company
contributed these assets in conjunction with the Distribution of Crestline.
The following table summarizes property dispositions for 1999 and 1998:
Pre-tax
Total Gain/(Loss)
Consideration on Disposal
Property Location Year Rooms (in millions) (in millions)
- -------- ---------------- ---- ----- ------------- -------------
Minneapolis/Bloomington
Marriott............... Bloomington, MN 1999 479 $ 35 $10
Saddle Brook Marriott... Saddle Brook, NJ 1999 221 15 3
Marriott's Grand Hotel
Resort and Golf Club... Point Clear, AL 1999 306 28 (2)
The Ritz-Carlton,
Boston................. Boston, MA 1999 275 119 15
El Paso Marriott........ El Paso, TX 1999 296 1 (2)
New York Marriott East
Side................... New York, NY 1998 662 191 40
Napa Valley Marriott.... Napa, CA 1998 191 21 10
13. Fair Value of Financial Instruments
The fair values of certain financial assets and liabilities and other
financial instruments are shown below:
1999 1998
--------------- ---------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------ -------- ------
(in millions)
Financial assets
Receivables from affiliates.................. $ 127 $ 133 $ 134 $ 141
Notes receivable............................. 48 48 69 69
Other........................................ 12 12 9 9
Financial liabilities
Debt, net of capital leases.................. 5,063 4,790 5,110 5,125
Other financial instruments
Convertible Preferred Securities............. 497 340 550 449
Short-term marketable securities and Convertible Preferred Securities are
valued based on quoted market prices. Receivables from affiliates, notes and
other financial assets are valued based on the expected future cash flows
discounted at risk-adjusted rates. Valuations for secured debt are determined
based on the expected future payments discounted at risk-adjusted rates. The
fair values of the Bank Credit Facility and other notes are estimated to be
equal to their carrying value. Senior notes are valued based on quoted market
prices.
The fair value of the liability related to the interest rate swap agreements
assumed in the Blackstone Acquisition was $14 million. The fair value is based
on the estimated amount the Company would pay or receive to terminate the swap
agreements. The aggregate notional amount of the agreements was $365 million
at December 31, 1998 and $100 million at January 2, 1998. The Company
terminated all the swap agreements in 1999.
80
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. Marriott International Distribution and Relationship with Marriott
International
The Company and Marriott International (formerly a wholly owned subsidiary,
the common stock of which was distributed to the Company's shareholders on
October 8, 1993) have entered into various agreements in connection with the
Marriott International Distribution and thereafter which provide, among other
things, that (i) the majority of the Company's hotel lodging properties are
managed by Marriott International (see Note 15); (ii) 13 of the Company's
full-service properties are operated under franchise agreements with Marriott
International with terms of 15 to 30 years; (iii) Marriott International
provided the Company with $92 million of financing at an average rate of 9% in
1997 related to the Company's discontinued senior living operations; (iv) the
Company acquired 49% of Marriott International's 50% interest in the Leisure
Park retirement community in 1997 for $23 million, including approximately $15
million of assumed debt; (v) Marriott International guarantees the Company's
performance in connection with certain obligations ($24 million at December
31, 1999); (vi) the Company borrowed and repaid $109 million of first mortgage
financing for construction of the Philadelphia Marriott (see Note 5); (vii)
Marriott International and the Company formed a joint venture and Marriott
International provided the Company with $29 million in debt financing at an
average interest rate of 12.7% and $28 million in preferred equity in 1996 for
the acquisition of two full-service properties in Mexico City, Mexico; and
(viii) Marriott International provides certain limited administrative
services.
In 1998 and 1997, the Company paid to Marriott International $196 million
and $162 million, respectively, in hotel management fees and $9 million and $4
million, respectively, in franchise fees. Beginning in 1999, these fees,
totaling $218 million in 1999, were paid by the lessees (see Note 9). In 1999,
1998 and 1997, the Company paid to Marriott International $0.3 million, $4
million and $13 million, respectively, in interest and commitment fees under
the debt financing and line of credit provided by Marriott International, and
$3 million for each of those years for limited administrative services. In
connection with the discontinued senior living communities' business, the
Company paid Marriott International $13 million and $6 million in management
fees during 1998 and 1997, respectively.
Additionally, Marriott International has the right to purchase up to 20% of
the voting stock of the Company if certain events involving a change in
control of the Company occur.
15. Hotel Management Agreements
Most of the Company's hotels are subject to management agreements (the
"Agreements") under which Marriott International manages the Company's hotels,
generally for an initial term of 15 to 20 years with renewal terms at the
option of Marriott International of up to an additional 16 to 30 years. The
Agreements generally provide for payment of base management fees equal to one
to four percent of sales and incentive management fees generally equal to 20%
to 50% of Operating Profit (as defined in the Agreements) over a priority
return (as defined) to the Company, with total incentive management fees not
to exceed 20% of cumulative Operating Profit, or 20% of current year Operating
Profit. In the event of early termination of the Agreements, Marriott
International will receive additional fees based on the unexpired term and
expected future base and incentive management fees. The Company has the option
to terminate certain management agreements if specified performance thresholds
are not satisfied. No agreement with respect to a single lodging facility is
cross-collateralized or cross-defaulted to any other agreement and a single
agreement may be canceled under certain conditions, although such cancellation
will not trigger the cancellation of any other agreement.
As a result of the REIT Conversion, all fees payable under the Agreements
for subsequent periods are the primary obligations of the Lessees. The
obligations of the Lessees are guaranteed to a limited extent by Crestline.
The Company remains obligated to the managers in case the Lessee fails to pay
these fees (but it would be entitled to reimbursement from the Lessee under
the terms of the Leases).
81
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pursuant to the terms of the Agreements, Marriott International is required
to furnish the hotels with certain services ("Chain Services") which are
generally provided on a central or regional basis to all hotels in the
Marriott International hotel system. Chain Services include central training,
advertising and promotion, a national reservation system, computerized payroll
and accounting services, and such additional services as needed which may be
more efficiently performed on a centralized basis. Costs and expenses incurred
in providing such services are allocated among all domestic hotels managed,
owned or leased by Marriott International or its subsidiaries. In addition,
the Company's hotels also participate in the Marriott Rewards program. The
cost of this program is charged to all hotels in the Marriott hotel system.
Crestline, as the Company's Lessee, is obligated to provide the manager with
sufficient funds to cover the cost of (a) certain non-routine repairs and
maintenance to the hotels which are normally capitalized; and (b) replacements
and renewals to the hotels' property and improvements. Under certain
circumstances, Crestline will be required to establish escrow accounts for
such purposes under terms outlined in the Agreements.
Crestline assumed franchise agreements with Marriott International for 10
hotels. Pursuant to these franchise agreements, Crestline generally pays a
franchise fee based on a percentage of room sales and food and beverage sales
as well as certain other fees for advertising and reservations. Franchise fees
for room sales vary from four to six percent of sales, while fees for food and
beverage sales vary from two to three percent of sales. The terms of the
franchise agreements are from 15 to 30 years.
Crestline assumed management agreements with The Ritz-Carlton Hotel Company,
LLC ("Ritz-Carlton"), an affiliate of Marriott International, to manage ten of
the Company's hotels. These agreements have an initial term of 15 to 25 years
with renewal terms at the option of Ritz-Carlton of up to an additional 10 to
40 years. Base management fees vary from two to five percent of sales and
incentive management fees are generally equal to 20% of available cash flow or
operating profit, as defined in the agreements.
Crestline also assumed management agreements with hotel management companies
other than Marriott International and Ritz-Carlton for 23 of the Company's
hotels (10 of which are franchised under the Marriott brand). These agreements
generally provide for an initial term of 10 to 20 years with renewal terms at
the option of either party or, in some cases, the hotel management company of
up to an additional one to 15 years. The agreements generally provide for
payment of base management fees equal to one to four percent of sales.
Seventeen of the 23 agreements also provide for incentive management fees
generally equal to 10 to 25 percent of available cash flow, operating profit,
or net operating income, as defined in the agreements.
16. Relationship with Crestline Capital Corporation
The Company and Crestline have entered into various agreements in connection
with the Distribution as discussed in Note 2 and further outlined below.
Distribution Agreement
Crestline and the Company entered into a distribution agreement (the
"Distribution Agreement"), which provided for, among other things, (i) the
distribution of shares of Crestline in connection with the Distribution; (ii)
the division between Crestline and the Company of certain assets and
liabilities; (iii) the transfer to Crestline of the 25% interest in the
Swissotel management company acquired in the Blackstone Acquisition and (iv)
certain other agreements governing the relationship between Crestline and the
Company following the Distribution. Crestline also granted the Company a
contingent right to purchase Crestline's interest in Swissotel Management
(USA) L.L.C. at fair market value in the event the tax laws are changed so
that the Company could own such interest without jeopardizing its status as a
REIT.
82
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Subject to certain exceptions, the Distribution Agreement provides for,
among other things, assumptions of liabilities and cross-indemnities designed
to allocate to Crestline, effective as of the date of the Distribution,
financial responsibilities for liabilities arising out of, or in connection
with, the business of the senior living communities.
Asset Management Agreement
The Company and the Non-Controlled Subsidiaries entered into asset
management agreements (the "Asset Management Agreements") with Crestline
whereby Crestline agrees to provide advice on the operation of the hotels and
review financial results, projections, loan documents and hotel management
agreements. Crestline also agrees to consult on market conditions and
competition, as well as monitor and negotiate with governmental agencies,
insurance companies and contractors. Crestline will be paid a fee not to
exceed $4.5 million for each calendar year for its consulting services under
the Asset Management Agreements, which includes $0.25 million related to the
Non-Controlled Subsidiaries. The Asset Management Agreements each have terms
of two years with an automatic one year renewal, unless earlier terminated by
either party in accordance with the terms thereof.
Non-Competition Agreement
Crestline and the Company entered into a non-competition agreement that
limits the respective parties' future business opportunities. Pursuant to this
non-competition agreement, Crestline agrees, among other things, that until
the earlier of December 31, 2008, or the date on which it is no longer a
Lessee of more than 25% of the number of hotels owned by the Company at the
time of the Distribution, it will not own any full service hotel, manage any
limited service or full service hotel owned by the Company, or own or operate
a full service hotel franchise system operating under a common name brand,
subject to certain exceptions. In addition, the Company agrees not to
participate in the business of leasing, operating or franchising limited
service or full service properties, subject to certain exceptions.
1998 Employee Benefits and Other Employment Matters Allocation Agreement
As part of the REIT Conversion, the Company, the Operating Partnership and
Crestline entered into the 1998 Employee Benefits Allocation Agreement
relating to various compensation, benefits and labor matters. Under the
agreement, the Operating Partnership and Crestline each assumed certain
liabilities related to covered benefits and labor matters arising prior to the
effective date of the Distribution and relating to employees of each
organization, respectively, after the Distribution. The agreements also govern
the treatment of awards under the Comprehensive Plan and requires the adoption
of such a plan by Crestline and the Operating Partnership.
17. Litigation
On March 16, 1998, limited partners in several limited partnerships filed a
lawsuit, the Texas Multi-Partnership Lawsuit, naming the Company, Marriott
International and others as defendants and claiming that they conspired to
sell hotels to the partnerships for inflated prices, that they charged the
partnerships excessive management fees to operate the partnerships' hotels and
otherwise breached their fiduciary duties. The lawsuit involved the following
partnerships: Courtyard by Marriott Limited Partnership, Courtyard by Marriott
II Limited Partnership, Marriott Residence Inn Limited Partnership, Marriott
Residence Inn II Limited Partnership, Fairfield Inn by Marriott Limited
Partnership, Desert Springs Marriott Limited Partnership and Atlanta Marriott
Marquis Limited Partnership. Three other lawsuits, collectively, the
Partnership Lawsuits, involving limited partners of some of the aforementioned
partnerships had also been filed, at various dates beginning in June 1996, and
include similar actions naming the Company, Marriott International and others
as defendants.
83
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company and Marriott International announced that we have executed a
definitive settlement agreement to resolve the Texas Multi-Partnership Lawsuit
and the Partnership Lawsuits. The understanding, which is still subject to
numerous conditions, including court approval and various consents, has two
principal features. First, the Company and Marriott International expect,
through a joint venture to be formed between their affiliates, to acquire the
equity interest of the limited partners in the two Courtyard partnerships for
approximately $372 million. The Company's share of the acquisition costs of
the Courtyard partnerships is expected to be $82 million. Second, the Company
and Marriott International will each pay approximately $31 million to the
limited partners of the remaining five partnerships in exchange for settlement
of the litigation and a full release of claims. As a result of the proposed
settlement, the Company has recorded a non-recurring, pre-tax charge of $40
million.
The Company has also been named a defendant in other lawsuits involving
various hotel partnerships. The lawsuits are ongoing, and although the
ultimate resolution of lawsuits is not determinable, the Company does not
believe the outcome will be material to the financial position, statement of
operations or cash flows of the Company.
18. Geographic and Business Segment Information
The Company operates one business segment, hotel ownership. The Company's
hotels are primarily operated under the Marriott or Ritz-Carlton brands,
contain an average of approximately 474 rooms as of March 1, 2000, as well as
supply other amenities such as meeting space and banquet facilities; a variety
of restaurants and lounges; gift shops and swimming pools. They are typically
located in downtown, airport, suburban and resort areas throughout the United
States. During most of 1998, the Company's foreign operations consisted of six
full-service hotel properties located in Mexico and Canada. As of December 31,
1998, the Company's foreign operations had decreased to four Canadian hotel
properties, as the hotels in Mexico were contributed to Rockledge Hotel
Properties, Inc. There were no intercompany sales between the properties and
the Company. The following table presents revenues and long-lived assets for
each of the geographical areas in which the Company operates (in millions):
1999 1998 1997
--------------- --------------- ---------------
Long- Long- Long-
lived lived lived
Revenues Assets Revenues Assets Revenues Assets
-------- ------ -------- ------ -------- ------
United States................... $1,352 $6,987 $3,443 $7,112 $2,770 $4,412
International................... 24 121 121 89 105 222
------ ------ ------ ------ ------ ------
Total......................... $1,376 $7,108 $3,564 $7,201 $2,875 $4,634
====== ====== ====== ====== ====== ======
The long-lived assets for 1997 exclude $583 million of assets related to the
discontinued senior living business.
84
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
19. Quarterly Financial Data (unaudited)
1999
----------------------------------------------------------
First Second Third Fourth Fiscal
Quarter Quarter Quarter Quarter Year
--------- --------- --------- ---------- ----------
(in millions, except per common share amounts)
Revenues................ $ 192 $ 203 $ 203 $ 778 $ 1,376
Income (loss) from
continuing operations
before income taxes.... (44) (44) (32) 300 180
Income (loss) from
continuing operations.. (44) (44) (32) 316 196
Income (loss) before
extraordinary items.... (44) (44) (32) 316 196
Net income (loss)....... (44) (31) (28) 314 211
Net income (loss)
available to common
shareholders........... (44) (31) (29) 320 216
Basic earnings (loss)
per common share:
Income (loss) from
continuing
operations........... (.19) (.19) (.15) 1.43 .89
Income (loss) before
extraordinary items.. (.19) (.19) (.15) 1.43 .89
Net income (loss)..... (.19) (.14) (.13) 1.42 .95
Diluted earnings (loss)
per common share:
Income (loss) from
continuing
operations........... (.19) (.19) (.15) 1.24 .87
Income (loss) before
extraordinary items.. (.19) (.19) (.15) 1.24 .87
Net income (loss)..... (.19) (.14) (.13) 1.24 .92
1998
----------------------------------------------------------
First Second Third Fourth Fiscal
Quarter Quarter Quarter Quarter Year
--------- --------- --------- ---------- ----------
(in millions, except per common share amounts)
Revenues................ $ 805 $ 849 $ 756 $ 1,154 $ 3,564
Income from continuing
operations before
income taxes........... 48 105 8 13 174
Income from continuing
operations............. 28 62 2 102 194
Income before
extraordinary items.... 30 66 4 95 195
Net income (loss)....... 30 66 (144) 95 47
Net income (loss)
available to common
shareholders........... 30 66 (144) 95 47
Basic earnings per
common share:
Income from continuing
operations........... .13 .29 .01 .47 .90
Income before
extraordinary items.. .14 .31 .02 .44 .91
Net income (loss)..... .14 .31 (.67) .44 .22
Diluted earnings per
common share:
Income from continuing
operations........... .13 .26 .01 .43 .84
Income before
extraordinary items.. .14 .28 .02 .40 .85
Net income (loss)..... .14 .28 (.65) .40 .27
In December 1999, the Company retroactively changed its method of accounting
for contingent rental revenues to conform to the Securities and Exchange
Commission's Staff Accounting Bulletin (SAB) No. 101. As a result, contingent
rental revenue is deferred on the balance sheet until certain revenue
thresholds are realized. Amendments to the previously filed quarterly reports
for the first three quarters of 1999 have been filed on Form 10-Q/A to conform
to the new presentation. SAB No. 101 has no impact on full-year 1999 revenues,
net income, or earnings per share because all rental revenues considered
contingent under SAB No. 101 were earned as of December 31, 1999. The change
in accounting principle has no effect on prior years because percentage rent
relates to rental income on our leases, which began in 1999. The quarterly
data in the table above has been restated to reflect the Company's senior
living business as a discontinued operation and the impact of the 1998 stock
portion of the Special Dividend on earnings per share.
85
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The first three quarters consist of 12 weeks each in both 1999 and 1998, and
the fourth quarter includes 16 weeks. The sum of the basic and diluted
earnings (loss) per common share for the four quarters in 1999 and 1998
differs from the annual earnings per common share due to the required method
of computing the weighted average number of shares in the respective periods.
86
CCHP I CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999
With Independent Public Accountants' Report Thereon
87
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To CCHP I Corporation:
We have audited the accompanying consolidated balance sheet of CCHP I
Corporation and its subsidiaries (a Maryland corporation) as of December 31,
1999, and the related consolidated statements of operations, shareholder's
equity and cash flows for the fiscal year ended December 31, 1999. These
consolidated financial statements are the responsibility of CCHP I
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of CCHP I
Corporation and its subsidiaries as of December 31, 1999 and the results of
their operations and their cash flows for the fiscal year then ended in
conformity with accounting principles generally accepted in the United States.
Arthur Andersen LLP
Vienna, Virginia
February 24, 2000
88
CCHP I CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
AS OF DECEMBER 31, 1999
(in thousands, except share data)
ASSETS
Current assets
Cash and cash equivalents............................................ $ 9,467
Due from hotel managers.............................................. 3,890
-------
13,357
Hotel working capital.................................................. 26,011
-------
$39,368
=======
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Lease payable to Host Marriott....................................... $ 5,792
Other................................................................ 3,334
-------
9,126
Hotel working capital notes payable to Host Marriott................... 26,011
Deferred income taxes.................................................. 1,027
-------
Total liabilities.................................................. 36,164
-------
Shareholder's equity
Common stock (100 shares issued at $1.00 par value).................. --
Retained earnings.................................................... 3,204
-------
Total shareholder's equity......................................... 3,204
=======
$39,368
=======
See Notes to Consolidated Financial Statements.
89
CCHP I CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Fiscal Year Ended December 31, 1999
(in thousands)
REVENUES
Rooms............................................................... $585,381
Food and beverage................................................... 277,684
Other............................................................... 65,069
--------
Total revenues.................................................... 928,134
--------
OPERATING COSTS AND EXPENSES
Property-level operating costs and expenses
Rooms............................................................... 141,898
Food and beverage................................................... 211,964
Other............................................................... 241,996
Other operating costs and expenses
Lease expense to Host Marriott...................................... 276,058
Management fees..................................................... 40,659
--------
Total operating costs and expenses................................ 912,575
--------
OPERATING PROFIT BEFORE CORPORATE EXPENSES AND INTEREST............... 15,559
Corporate expenses.................................................... (1,367)
Interest expense...................................................... (1,585)
--------
INCOME BEFORE INCOME TAXES............................................ 12,607
Provision for income taxes............................................ (5,169)
--------
NET INCOME............................................................ $ 7,438
========
See Notes to Consolidated Financial Statements.
90
CCHP I CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
Fiscal Year Ended December 31, 1999
(in thousands)
Common Retained
Stock Earnings Total
------ -------- ------
Balance, January 1, 1999................................ $-- $ -- $ --
Dividend to Crestline Capital......................... -- (4,234) (4,234)
Net income............................................ -- 7,438 7,438
---- ------ ------
Balance, December 31, 1999.............................. $-- $3,204 $3,204
==== ====== ======
See Notes to Consolidated Financial Statements.
91
CCHP I CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Fiscal Year Ended December 31, 1999
(in thousands)
OPERATING ACTIVITIES
Net income............................................................. $ 7,438
Change in amounts due from hotel managers.............................. (678)
Change in lease payable to Host Marriott............................... 5,792
Changes in other operating accounts.................................... 1,149
-------
Cash from operations................................................. 13,701
INVESTING ACTIVITIES................................................... --
-------
FINANCING ACTIVITIES
Dividend to Crestline Capital.......................................... (4,234)
-------
Increase in cash and cash equivalents.................................. 9,467
Cash and cash equivalents, beginning of year........................... --
-------
Cash and cash equivalents, end of year................................. $ 9,467
=======
See Notes to Consolidated Financial Statements.
92
CCHP I CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Organization
CCHP I Corporation (the "Company") was incorporated in the state of Delaware
on November 23, 1998 as a wholly owned subsidiary of Crestline Capital
Corporation ("Crestline"). On December 29, 1998, Crestline became a publicly
traded company when Host Marriott Corporation ("Host Marriott") completed its
plan of reorganizing its business operations by spinning-off Crestline to the
shareholders of Host Marriott as part of a series of transactions pursuant to
which Host Marriott converted into a real estate investment trust ("REIT").
On December 31, 1998, wholly owned subsidiaries of the Company (the "Tenant
Subsidiaries") entered into lease agreements with Host Marriott to lease 35 of
Host Marriott's full-service hotels with the existing management agreements of
the leased hotels assigned to the Tenant Subsidiaries. During 1999, Host
Marriott sold three of the hotels and terminated the leases on those hotels.
As of December 31, 1999, the Company leased 32 full-service hotels from Host
Marriott.
The Company operates as a unit of Crestline, utilizing Crestline's
employees, insurance and administrative services since the Company does not
have any employees. Certain direct expenses are paid by Crestline and charged
directly or allocated to the Company. Certain general and administrative costs
of Crestline are allocated to the Company, using a variety of methods,
principally including Crestline's specific identification of individual costs
and otherwise through allocations based upon estimated levels of effort
devoted by general and administrative departments to the Company or relative
measures of the size of the Company based on revenues. In the opinion of
management, the methods for allocating general and administrative expenses and
other direct costs are reasonable.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All material intercompany transactions and balances
between the Company and its subsidiaries have been eliminated.
Fiscal Year
The Company's fiscal year ends on the Friday nearest December 31.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less at date of purchase as cash equivalents.
Revenues
The Company records the gross property-level revenues generated by the
hotels as revenues.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
93
CCHP I CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 2. Leases
Hotel Leases
The Tenant Subsidiaries entered into leases with Host Marriott effective
January 1, 1999 for 35 full-service hotels. Each hotel lease has an initial
term generally ranging from three to seven years. The hotel leases generally
have four seven-year renewal options at the option of the Company, however,
Host Marriott may terminate any unexercised renewal options. The Tenant
Subsidiaries are required to pay the greater of (i) a minimum rent specified
in each hotel lease or (ii) a percentage rent based upon a specified
percentage of aggregate revenues from the hotel, including room revenues, food
and beverage revenues, and other income, in excess of specified thresholds.
The amount of minimum rent is increased each year based upon 50% of the
increase in CPI during the previous twelve months. Percentage rent thresholds
are increased each year based on a blend of the increases in CPI and the
Employment Cost Index during the previous twelve months. The hotel leases
generally provide for a rent adjustment in the event of damage, destruction,
partial taking or certain capital expenditures. The rent during any renewal
periods will be negotiated at fair market value at the time the renewal option
is exercised.
The Tenant Subsidiaries are responsible for paying all of the expenses of
operating the hotels, including all personnel costs, utility costs, and
general repair and maintenance of the hotels. In addition, the Tenant
Subsidiaries are responsible for all fees payable to the hotel manager,
including base and incentive management fees, chain services payments and
franchise or system fees. Host Marriott is responsible for real estate and
personal property taxes, property casualty insurance, equipment rent, ground
lease rent, maintaining a reserve fund for FF&E replacements and capital
expenditures.
In the event that Host Marriott disposes of a hotel free and clear of the
hotel lease, Host Marriott would generally have to pay a termination fee equal
to the fair market value of the Company's leasehold interest in the remaining
term of the hotel lease using a discount rate of 12%. Alternatively, Host
Marriott would be entitled to (i) substitute a comparable hotel for any hotel
that is sold, with the terms agreed to by the Company, or (ii) sell the hotel
subject to the hotel lease, subject to the Company's approval under certain
circumstances, without having to pay a termination fee. In addition, Host
Marriott also has the right to terminate up to twelve of Crestline's leases
without having to pay a termination fee. During 1999, Host Marriott exercised
its right to terminate three hotel leases of the Company and Crestline without
having to pay a termination fee. Conversely, Crestline may terminate up to
twelve full-service hotel leases without penalty upon 180 days notice to Host
Marriott. During 1999, Crestline exercised its right to terminate two of the
Company's hotel leases as well as three additional Crestline hotel leases.
These hotel leases will terminate in 2000, 180 days after each respective
notification date.
As a result of the recent tax legislation discussed below, Host Marriott may
purchase all, but not less than all, of its hotel leases with Crestline,
beginning January 2, 2001, with the purchase price calculated as discussed
above. The payment of the termination fee will be payable in cash or, subject
to certain conditions, shares of Host Marriott common stock at the election of
Host Marriott.
For those hotels where Marriott International is the manager, it has a
noneconomic membership interest with certain limited voting rights in the
Tenant Subsidiaries.
FF&E Leases
Prior to entering into the hotel leases, if the average tax basis of a
hotel's FF&E and other personal property exceeded 15% of the aggregate average
tax basis of the hotel's real and personal property (the "Excess FF&E"), the
Tenant Subsidiaries and affiliates of Host Marriott entered into lease
agreements (the "FF&E Leases") for the Excess FF&E. The terms of the FF&E
Leases generally range from two to three years and rent under the
94
CCHP I CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
FF&E Leases is a fixed amount. The Company will have the option at the
expiration of the FF&E Lease term to either (i) renew the FF&E Leases for
consecutive one-year renewal terms at fair market rental rate, or (ii)
purchase the Excess FF&E for a price equal to its fair market value. If the
Company does not exercise its purchase or renewal option, the Company is
required to pay a termination fee equal to approximately one month's rent.
Guaranty and Pooling Agreement
In connection with entering into the hotel leases, the Company, Crestline
and Host Marriott, entered into a pool guarantee and a pooling and security
agreement by which the Company provides a full guarantee and Crestline
provides a limited guarantee of all of the hotel lease obligations.
The cumulative limit of Crestline's guarantee obligation is the greater of
ten percent of the aggregate rent payable for the immediately preceding fiscal
year under all of the Company's hotel leases or ten percent of the aggregate
rent payable under all of the Company's hotel leases for 1999. In the event
that Crestline's obligation under the pooling and guarantee agreement is
reduced to zero, the Company can terminate the agreement and Host Marriott can
terminate the Company's hotel leases without penalty.
All of the Company's leases are cross-defaulted and the Company's
obligations under the guaranty are secured by all the funds received from its
Tenant Subsidiaries.
Recent Tax Legislation
On December 17, 1999 President Clinton signed the Work Incentives
Improvement Act of 1999. Included in this legislation are provisions that,
effective January 1, 2001, will allow a REIT to lease hotels to a "taxable
REIT subsidiary" if the hotel is operated and managed on behalf of such
subsidiary by an independent third party. A taxable REIT subsidiary is a
corporation that is owned more than 35 percent by a REIT. This law will enable
Host Marriott, beginning in 2001 to lease its hotels to a taxable REIT
subsidiary. Host Marriott may, at its discretion, elect to terminate the
Company's leases, beginning in 2001, and pay termination fees determined
according to formulas specified in the leases. If Host Marriott elects to
terminate the full-service hotel leases, it would have to terminate all of
Crestline's full-service hotel leases.
Future minimum annual rental commitments for all non-cancelable leases as of
December 31, 1999 are as follows (in thousands):
2000............................................................... $161,094
2001............................................................... 158,406
2002............................................................... 156,630
2003............................................................... 156,630
2004............................................................... 141,614
Thereafter......................................................... 141,614
--------
Total minimum lease payments..................................... $915,988
========
Lease expense for 1999 consisted of the following (in thousands):
Base rent.......................................................... $167,996
Percentage rent.................................................... 108,062
--------
$276,058
========
95
CCHP I CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 3. Working Capital Notes
Upon the commencement of the hotel leases, the Company purchased the working
capital of the leased hotels from Host Marriott for $26,832,000 with the
purchase price evidenced by notes that bear interest at 5.12%. Interest on
each note is due simultaneously with the rent payment of each hotel lease. The
principal amount of each note is due upon the termination of each hotel lease.
Upon termination of the hotel lease, the Company will sell Host Marriott the
existing working capital at its current value. To the extent the working
capital delivered to Host Marriott is less than the value of the note, the
Company will pay Host Marriott the difference in cash. However, to the extent
the working capital delivered to Host Marriott exceeds the value of the note,
Host Marriott will pay the Company the difference in cash. As of December 31,
1999, the outstanding balance of the working capital notes was $26,011,000.
Debt maturities at December 31, 1999 are as follows (in thousands):
2000................................................................. $ 135
2001................................................................. 1,205
2002................................................................. --
2003................................................................. 3,005
2004................................................................. --
Thereafter........................................................... 21,666
-------
$26,011
=======
Cash paid for interest expense in 1999 totaled $1,463,000.
Note 4. Management Agreements
All of the Company's hotels are operated by hotel management companies under
long-term hotel management agreements between Host Marriott and hotel
management companies.
Assignment of Management Agreements
The existing management agreements were assigned to the Tenant Subsidiaries
upon the execution of the hotel leases for the term of each corresponding
hotel lease. The Tenant Subsidiaries are obligated to perform all of the
obligations of Host Marriott under the hotel management agreements including
payment of fees due under the management agreements other than certain
obligations including payment of property taxes, property casualty insurance
and ground rent, maintaining a reserve fund for FF&E replacements and capital
expenditures for which Host Marriott retains responsibility.
Marriott International Management Agreements
Marriott International manages 28 of the 32 hotels under long-term
management agreements assigned to the Tenant Subsidiaries, generally for an
initial term of 15 to 20 years with renewal terms at the option of Marriott
International of up to an additional 16 to 30 years. The management agreements
generally provide for payment of base management fees equal to one to four
percent of revenues and incentive management fees generally equal to 20% to
50% of Operating Profit (as defined in the management agreements) over a
priority return (as defined) to the Tenant Subsidiaries, with total incentive
management fees not to exceed 20% of cumulative Operating Profit, or 20% of
current year Operating Profit.
96
CCHP I CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pursuant to the terms of the management agreements, Marriott International
is required to furnish the hotels with certain services ("Chain Services")
which are generally provided on a central or regional basis to all hotels in
the Marriott International hotel system. Chain Services include central
training, advertising and promotion, a national reservation system,
computerized payroll and accounting services, and such additional services as
needed which may be more efficiently performed on a centralized basis. Costs
and expenses incurred in providing such services are allocated among all
domestic hotels managed, owned or leased by Marriott International or its
subsidiaries. In addition, the Company's hotels also participate in the
Marriott Rewards program. The cost of this program is charged to all hotels in
the Marriott hotel system.
Other Hotel Management Agreements
The Company's remaining four hotels are managed by other hotel management
companies. One of the hotels is managed by Swissotel Management (USA) LLC, one
is managed by Four Seasons Hotel Limited, and the remaining two hotels are
managed by other independent hotel management companies under the "Marriott"
brand pursuant to franchise agreements. The managers of the hotels provide
similar services as Marriott International under its management agreements and
receive base management fees, generally calculated as a percentage of
revenues, and in most cases, incentive management fees, which are generally
calculated as a percentage of operating profits.
The Company has the option to terminate certain management agreements if
specified performance thresholds are not satisfied, with the consent of Host
Marriott under certain conditions. No agreement with respect to a single
lodging facility is cross-collateralized or cross-defaulted to any other
agreement and a single agreement may be canceled under certain conditions,
although such cancellation will not trigger the cancellation of any other
agreement.
Franchise Agreements
Two of the Company's hotels are managed under franchise agreements between
Host Marriott and Marriott International for terms ranging from 15 to 30
years. In connection with the assignment of the corresponding management
agreement, the Tenant Subsidiaries assumed the franchise agreements for these
hotels and will be the franchisee for the term of the corresponding hotel
lease. Pursuant to the franchise agreements, the Tenant Subsidiaries generally
pay a franchise fee based on a percentage of room revenues and food and
beverage revenues as well as certain other fees for advertising and
reservations. Franchise fees for room revenues vary from four to six percent,
while fees for food and beverage revenues vary from two to three percent of
revenues.
Note 5. Income Taxes
The Company is included in the consolidated Federal income tax return of
Crestline and its affiliates (the "Group"). Tax expense is allocated to the
Company as a member of the Group based upon the relative contribution to the
Group's consolidated taxable income/loss and changes in temporary differences.
This allocation method results in Federal and state tax expense allocated for
the period presented that is substantially equal to the expense that would
have been recognized if the Company had filed separate tax returns.
97
CCHP I CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The provision for income taxes for 1999 consists of the following (in
thousands):
Current--Federal...................................................... $3,536
--State........................................................... 606
------
4,142
------
Deferred--Federal..................................................... 877
--State........................................................... 150
------
1,027
------
$5,169
======
A reconciliation of the statutory Federal tax rate to the Company's
effective income tax rate for 1999 follows:
Statutory federal tax rate............................................. 35.0%
State income taxes, net of federal tax benefit......................... 6.0
----
41.0%
====
As of December 31, 1999, the Company had no deferred tax assets. The tax
effect of the temporary difference that gives rise to the Company's deferred
tax liability is attributable to the hotel working capital.
98
CCHP II CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999
With Independent Public Accountants' Report Thereon
99
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To CCHP II Corporation:
We have audited the accompanying consolidated balance sheet of CCHP II
Corporation and its subsidiaries (a Maryland corporation) as of December 31,
1999, and the related consolidated statements of operations, shareholder's
equity and cash flows for the fiscal year ended December 31, 1999. These
consolidated financial statements are the responsibility of CCHP II
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of CCHP II
Corporation and its subsidiaries as of December 31, 1999 and the results of
their operations and their cash flows for the fiscal year then ended in
conformity with accounting principles generally accepted in the United States.
Arthur Andersen LLP
Vienna, Virginia
February 24, 2000
100
CCHP II CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
As of December 31, 1999
(in thousands, except share data)
ASSETS
Current assets
Cash and cash equivalents............................................ $ 8,856
Due from hotel managers.............................................. 10,280
-------
19,136
Hotel working capital.................................................. 18,090
-------
$37,226
=======
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Lease payable to Host Marriott....................................... $16,197
Other................................................................ 1,246
-------
17,443
Hotel working capital notes payable to Host Marriott................... 18,090
Deferred income taxes.................................................. 996
-------
Total liabilities.................................................. 36,529
Shareholder's equity
Common stock (100 shares issued at $1.00 par value).................... --
Retained earnings...................................................... 697
-------
Total shareholder's equity......................................... 697
-------
$37,226
=======
See Notes to Consolidated Financial Statements.
101
CCHP II CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Fiscal Year Ended December 31, 1999
(in thousands)
REVENUES
Rooms.............................................................. $ 646,624
Food and beverage.................................................. 306,320
Other.............................................................. 64,876
---------
Total revenues................................................... 1,017,820
---------
OPERATING COSTS AND EXPENSES
Property-level operating costs and expenses
Rooms.............................................................. 158,279
Food and beverage.................................................. 230,001
Other.............................................................. 231,668
Other operating costs and expenses
Lease expense to Host Marriott..................................... 312,112
Management fees.................................................... 66,672
---------
Total operating costs and expenses............................... 998,732
---------
OPERATING PROFIT BEFORE CORPORATE EXPENSES AND INTEREST.............. 19,088
Corporate expenses................................................... (1,499)
Interest expense..................................................... (928)
---------
INCOME BEFORE INCOME TAXES........................................... 16,661
Provision for income taxes........................................... (6,831)
---------
NET INCOME........................................................... $ 9,830
=========
See Notes to Consolidated Financial Statements.
102
CCHP II CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
Fiscal Year Ended December 31, 1999
(in thousands)
Common Retained
Stock Earnings Total
------ -------- -------
Balance, January 1, 1999.............................. $-- $ -- $ --
Dividend to Crestline Capital....................... -- (9,133) (9,133)
Net income.......................................... -- 9,830 9,830
---- ------- -------
Balance, December 31, 1999............................ $-- $ 697 $ 697
==== ======= =======
See Notes to Consolidated Financial Statements.
103
CCHP II CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Fiscal Year Ended December 31, 1999
(in thousands)
OPERATING ACTIVITIES
Net income............................................................. $ 9,830
Change in amounts due from hotel managers.............................. (9,322)
Change in lease payable to Host Marriott............................... 16,197
Changes in other operating accounts.................................... 1,284
-------
Cash from operations................................................. 17,989
-------
INVESTING ACTIVITIES................................................... --
-------
FINANCING ACTIVITIES
Dividend to Crestline Capital.......................................... (9,133)
-------
Increase in cash and cash equivalents.................................. 8,856
Cash and cash equivalents, beginning of year........................... --
-------
Cash and cash equivalents, end of year................................. $ 8,856
=======
See Notes to Consolidated Financial Statements.
104
CCHP II CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Organization
CCHP II Corporation (the "Company") was incorporated in the state of
Delaware on November 23, 1998 as a wholly owned subsidiary of Crestline
Capital Corporation ("Crestline"). On December 29, 1998, Crestline became a
publicly traded company when Host Marriott Corporation ("Host Marriott")
completed its plan of reorganizing its business operations by spinning-off
Crestline to the shareholders of Host Marriott as part of a series of
transactions pursuant to which Host Marriott converted into a real estate
investment trust ("REIT").
On December 31, 1998, wholly owned subsidiaries of the Company (the "Tenant
Subsidiaries") entered into lease agreements with Host Marriott to lease 28 of
Host Marriott's full-service hotels with the existing management agreements of
the leased hotels assigned to the Tenant Subsidiaries. As of December 31,
1999, the Company leased 28 full-service hotels from Host Marriott.
The Company operates as a unit of Crestline, utilizing Crestline's
employees, insurance and administrative services since the Company does not
have any employees. Certain direct expenses are paid by Crestline and charged
directly or allocated to the Company. Certain general and administrative costs
of Crestline are allocated to the Company, using a variety of methods,
principally including Crestline's specific identification of individual costs
and otherwise through allocations based upon estimated levels of effort
devoted by general and administrative departments to the Company or relative
measures of the size of the Company based on revenues. In the opinion of
management, the methods for allocating general and administrative expenses and
other direct costs are reasonable.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All material intercompany transactions and balances
between the Company and its subsidiaries have been eliminated.
Fiscal Year
The Company's fiscal year ends on the Friday nearest December 31.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less at date of purchase as cash equivalents.
Revenues
The Company records the gross property-level revenues generated by the
hotels as revenues.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
105
CCHP II CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 2. Leases
Hotel Leases
The Tenant Subsidiaries entered into leases with Host Marriott effective
January 1, 1999 for 28 full-service hotels. Each hotel lease has an initial
term of eight years. The hotel leases generally have four seven-year renewal
options at the option of the Company, however, Host Marriott may terminate any
unexercised renewal options. The Tenant Subsidiaries are required to pay the
greater of (i) a minimum rent specified in each hotel lease or (ii) a
percentage rent based upon a specified percentage of aggregate revenues from
the hotel, including room revenues, food and beverage revenues, and other
income, in excess of specified thresholds. The amount of minimum rent is
increased each year based upon 50% of the increase in CPI during the previous
twelve months. Percentage rent thresholds are increased each year based on a
blend of the increases in CPI and the Employment Cost Index during the
previous twelve months. The hotel leases generally provide for a rent
adjustment in the event of damage, destruction, partial taking or certain
capital expenditures. The rent during any renewal periods will be negotiated
at fair market value at the time the renewal option is exercised.
The Tenant Subsidiaries are responsible for paying all of the expenses of
operating the hotels, including all personnel costs, utility costs, and
general repair and maintenance of the hotels. In addition, the Tenant
Subsidiaries are responsible for all fees payable to the hotel manager,
including base and incentive management fees, chain services payments and
franchise or system fees. Host Marriott is responsible for real estate and
personal property taxes, property casualty insurance, equipment rent, ground
lease rent, maintaining a reserve fund for FF&E replacements and capital
expenditures.
In the event that Host Marriott disposes of a hotel free and clear of the
hotel lease, Host Marriott would generally have to pay a termination fee equal
to the fair market value of the Company's leasehold interest in the remaining
term of the hotel lease using a discount rate of 12%. Alternatively, Host
Marriott would be entitled to (i) substitute a comparable hotel for any hotel
that is sold, with the terms agreed to by the Company, or (ii) sell the hotel
subject to the hotel lease, subject to the Company's approval under certain
circumstances, without having to pay a termination fee. In addition, Host
Marriott also has the right to terminate up to twelve of Crestline's leases
without having to pay a termination fee. During 1999, Host Marriott exercised
its right to terminate three of Crestline's hotel leases, however, none of
these were the Company's hotel leases. Conversely, Crestline may terminate up
to twelve full-service hotel leases without penalty upon 180 days notice to
Host Marriott. During 1999, Crestline exercised its right to terminate five of
its hotel leases, however, none of these were the Company's hotel leases.
As a result of the recent tax legislation discussed below, Host Marriott may
purchase all, but not less than all, of its hotel leases with Crestline
beginning January 1, 2001, with the purchase price calculated as discussed
above. The payment of the termination fee will be payable in cash or, subject
to certain conditions, shares of Host Marriott common stock at the election of
Host Marriott.
For those hotels where Marriott International is the manager, it has a
noneconomic membership interest with certain limited voting rights in the
Tenant Subsidiaries.
FF&E Leases
Prior to entering into the hotel leases, if the average tax basis of a
hotel's FF&E and other personal property exceeded 15% of the aggregate average
tax basis of the hotel's real and personal property (the "Excess FF&E"), the
Tenant Subsidiaries and affiliates of Host Marriott entered into lease
agreements (the "FF&E Leases") for the Excess FF&E. The terms of the FF&E
Leases generally range from two to three years and rent under the FF&E Leases
is a fixed amount. The Company will have the option at the expiration of the
FF&E Lease term to
106
CCHP II CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
either (i) renew the FF&E Leases for consecutive one-year renewal terms at
fair market rental rate, or (ii) purchase the Excess FF&E for a price equal to
its fair market value. If the Company does not exercise its purchase or
renewal option, the Company is required to pay a termination fee equal to
approximately one month's rent.
Guaranty and Pooling Agreement
In connection with entering into the hotel leases, the Company, Crestline
and Host Marriott, entered into a pool guarantee and a pooling and security
agreement by which the Company provides a full guarantee and Crestline
provides a limited guarantee of all of the hotel lease obligations.
The cumulative limit of Crestline's guarantee obligation is the greater of
ten percent of the aggregate rent payable for the immediately preceding fiscal
year under all of the Company's hotel leases or ten percent of the aggregate
rent payable under all of the Company's hotel leases for 1999. In the event
that Crestline's obligation under the pooling and guarantee agreement is
reduced to zero, the Company can terminate the agreement and Host Marriott can
terminate the Company's hotel leases without penalty.
All of the Company's leases are cross-defaulted and the Company's
obligations under the guaranty are secured by all the funds received from its
Tenant Subsidiaries.
Recent Tax Legislation
On December 17, 1999 President Clinton signed the Work Incentives
Improvement Act of 1999. Included in this legislation are provisions that,
effective January 1, 2001, will allow a REIT to lease hotels to a "taxable
REIT subsidiary" if the hotel is operated and managed on behalf of such
subsidiary by an independent third party. A taxable REIT subsidiary is a
corporation that is owned more than 35 percent by a REIT. This law will enable
Host Marriott, beginning in 2001 to lease its hotels to a taxable REIT
subsidiary. Host Marriott may, at its discretion, elect to terminate the
Company's leases, beginning in 2001, and pay termination fees determined
according to formulas specified in the leases. If Host Marriott elects to
terminate the full-service hotel leases, it would have to terminate all of
Crestline's full-service hotel leases.
Future minimum annual rental commitments for all non-cancelable leases as of
December 31, 1999 are as follows (in thousands):
2000............................................................ $ 174,747
2001............................................................ 174,747
2002............................................................ 174,747
2003............................................................ 174,747
2004............................................................ 174,747
Thereafter...................................................... 349,493
----------
Total minimum lease payments.................................. $1,223,228
==========
Lease expense for 1999 consisted of the following (in
thousands):
Base rent....................................................... $ 167,755
Percentage rent................................................. 144,357
----------
$ 312,112
==========
107
CCHP II CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 3. Working Capital Notes
Upon the commencement of the hotel leases, the Company purchased the working
capital of the leased hotels from Host Marriott for $18,090,000 with the
purchase price evidenced by notes that bear interest at 5.12%. Interest on
each note is due simultaneously with the rent payment of each hotel lease. The
principal amount of each note is due upon the termination of each hotel lease.
Upon termination of the hotel lease, the Company will sell Host Marriott the
existing working capital at its current value. To the extent the working
capital delivered to Host Marriott is less than the value of the note, the
Company will pay Host Marriott the difference in cash. However, to the extent
the working capital delivered to Host Marriott exceeds the value of the note,
Host Marriott will pay the Company the difference in cash. As of December 31,
1999, the outstanding balance of the working capital notes was $18,090,000.
Debt maturities at December 31, 1999 are as follows (in thousands):
2000............................................................... $ --
2001............................................................... --
2002............................................................... --
2003............................................................... --
2004............................................................... --
Thereafter......................................................... 18,090
-------
$18,090
=======
Cash paid for interest expense in 1999 totaled $856,000.
Note 4. Management Agreements
All of the Company's hotels are operated by hotel management companies under
long-term hotel management agreements between Host Marriott and hotel
management companies.
Assignment of Management Agreements
The existing management agreements were assigned to the Tenant Subsidiaries
upon the execution of the hotel leases for the term of each corresponding
hotel lease. The Tenant Subsidiaries are obligated to perform all of the
obligations of Host Marriott under the hotel management agreements including
payment of fees due under the management agreements other than certain
obligations including payment of property taxes, property casualty insurance
and ground rent, maintaining a reserve fund for FF&E replacements and capital
expenditures for which Host Marriott retains responsibility.
Marriott International Management Agreements
Marriott International manages 20 of the 28 hotels under long-term
management agreements assigned to the Tenant Subsidiaries, generally for an
initial term of 15 to 20 years with renewal terms at the option of Marriott
International of up to an additional 16 to 30 years. The management agreements
generally provide for payment of base management fees equal to one to four
percent of revenues and incentive management fees generally equal to 20% to
50% of Operating Profit (as defined in the management agreements) over a
priority return (as defined) to the Tenant Subsidiaries, with total incentive
management fees not to exceed 20% of cumulative Operating Profit, or 20% of
current year Operating Profit.
108
CCHP II CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Pursuant to the terms of the management agreements, Marriott International
is required to furnish the hotels with certain services ("Chain Services")
which are generally provided on a central or regional basis to all hotels in
the Marriott International hotel system. Chain Services include central
training, advertising and promotion, a national reservation system,
computerized payroll and accounting services, and such additional services as
needed which may be more efficiently performed on a centralized basis. Costs
and expenses incurred in providing such services are allocated among all
domestic hotels managed, owned or leased by Marriott International or its
subsidiaries. In addition, the Company's hotels also participate in the
Marriott Rewards program. The cost of this program is charged to all hotels in
the Marriott hotel system.
Ritz-Carlton Hotel Management Agreements
The Ritz-Carlton Hotel Company, LLC ("Ritz-Carlton"), an affiliate of
Marriott International, manages three of the leased hotels under long-term
Hotel Management Agreements assigned to the Tenant Subsidiaries. These
agreements have an initial term of 15 to 25 years with renewal terms at the
option of Ritz-Carlton of up to an additional 10 to 40 years. Base management
fees vary from two to four percent of revenues and incentive management fees
are generally equal to 20% of available cash flow or operating profit, up to a
maximum of 2.1% of revenues, as defined in the agreements.
Other Hotel Management Agreements
The Company's remaining five hotels are managed by other hotel management
companies. One of the hotels is managed by the Hyatt Corporation and the
remaining four hotels are managed by other independent hotel management
companies under other brands pursuant to franchise agreements. The managers of
the hotels provide similar services as Marriott International under its
management agreements and receive base management fees, generally calculated
as a percentage of revenues, and in most cases, incentive management fees,
which are generally calculated as a percentage of operating profits.
The Company has the option to terminate certain management agreements if
specified performance thresholds are not satisfied, with the consent of Host
Marriott under certain conditions. No agreement with respect to a single
lodging facility is cross-collateralized or cross-defaulted to any other
agreement and a single agreement may be canceled under certain conditions,
although such cancellation will not trigger the cancellation of any other
agreement.
Franchise Agreements
Four of the Company's hotels are managed under franchise agreements between
Host Marriott and other hotel companies for terms ranging from 15 to 30 years.
In connection with the assignment of the corresponding management agreement,
the Tenant Subsidiaries assumed the franchise agreements for these hotels and
will be the franchisee for the term of the corresponding hotel lease. Pursuant
to the franchise agreements, the Tenant Subsidiaries generally pay a franchise
fee based on a percentage of room revenues and food and beverage revenues as
well as certain other fees for advertising and reservations. Franchise fees
for room revenues vary from four to six percent, while fees for food and
beverage revenues vary from two to three percent of revenues.
Note 5. Income Taxes
The Company is included in the consolidated Federal income tax return of
Crestline and its affiliates (the "Group"). Tax expense is allocated to the
Company as a member of the Group based upon the relative contribution to the
Group's consolidated taxable income/loss and changes in temporary differences.
This allocation method results in Federal and net state tax expense allocated
for the period presented that is substantially equal to the expense that would
have been recognized if the Company had filed separate tax returns.
109
CCHP II CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The provision for income taxes for 1999 consists of the following (in
thousands):
Current--Federal..................................................... $4,981
--State.......................................................... 854
------
5,835
------
Deferred--Federal.................................................... 850
--State.......................................................... 146
------
996
------
$6,831
======
A reconciliation of the statutory Federal tax rate to the Company's
effective income tax rate for 1999 follows:
Statutory federal tax rate............................................. 35.0%
State income taxes, net of federal tax benefit......................... 6.0
----
41.0%
====
As of December 31, 1999, the Company had no deferred tax assets. The tax
effect of the temporary differences that gives rise to the Company's federal
deferred tax liability is attributable to the hotel working capital.
110
CCHP III CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999
With Independent Public Accountants' Report Thereon
111
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To CCHP III Corporation:
We have audited the accompanying consolidated balance sheet of CCHP III
Corporation and its subsidiaries (a Maryland corporation) as of December 31,
1999, and the related consolidated statements of operations, shareholder's
equity and cash flows for the fiscal year ended December 31, 1999. These
consolidated financial statements are the responsibility of CCHP III
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of CCHP III
Corporation and its subsidiaries as of December 31, 1999 and the results of
their operations and their cash flows for the fiscal year then ended in
conformity with accounting principles generally accepted in the United States.
Arthur Andersen LLP
Vienna, Virginia
February 24, 2000
112
CCHP III CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
As of December 31, 1999
(in thousands, except share data)
ASSETS
Current assets
Cash and cash equivalents............................................ $ 6,638
Due from hotel managers.............................................. 8,214
Restricted cash...................................................... 4,519
-------
19,371
Hotel working capital.................................................. 21,697
-------
$41,068
=======
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Lease payable to Host Marriott....................................... $13,706
Other................................................................ 4,139
-------
17,845
Hotel working capital notes payable to Host Marriott................... 21,697
Deferred income taxes.................................................. 342
-------
Total liabilities.................................................. 39,884
-------
Shareholder's equity
Common stock (100 shares issued at $1.00 par value).................. --
Retained earnings.................................................... 1,184
-------
Total shareholder's equity......................................... 1,184
-------
$41,068
=======
See Notes to Consolidated Financial Statements.
113
CCHP III CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Fiscal Year Ended December 31, 1999
(in thousands)
REVENUES
Rooms............................................................... $570,611
Food and beverage................................................... 274,233
Other............................................................... 80,149
--------
Total revenues.................................................... 924,993
--------
OPERATING COSTS AND EXPENSES
Property-level operating costs and expenses
Rooms............................................................... 137,338
Food and beverage................................................... 202,181
Other............................................................... 236,721
Other operating costs and expenses
Lease expense to Host Marriott...................................... 295,563
Management fees..................................................... 41,893
--------
Total operating costs and expenses................................ 913,696
--------
OPERATING PROFIT BEFORE CORPORATE EXPENSES AND INTEREST............... 11,297
Corporate expenses.................................................... (1,357)
Interest expense...................................................... (1,129)
--------
INCOME BEFORE INCOME TAXES............................................ 8,811
Provision for income taxes............................................ (3,612)
--------
NET INCOME............................................................ $ 5,199
========
See Notes to Consolidated Financial Statements.
114
CCHP III CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
Fiscal Year Ended December 31, 1999
(in thousands)
Common Retained
Stock Earnings Total
------ -------- -------
Balance, January 1, 1999.............................. $-- $ -- $ --
Dividend to Crestline Capital....................... -- (4,015) (4,015)
Net income.......................................... -- 5,199 5,199
---- ------- -------
Balance, December 31, 1999............................ $-- $ 1,184 $ 1,184
==== ======= =======
See Notes to Consolidated Financial Statements.
115
CCHP III CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Fiscal Year Ended December 31, 1999
(in thousands)
OPERATING ACTIVITIES
Net income.............................................................. $5,199
Change in amounts due from hotel managers............................... (4,084)
Change in lease payable to Host Marriott................................ 13,706
Changes in other operating accounts..................................... (4,168)
------
Cash from operations.................................................. 10,653
INVESTING ACTIVITIES.................................................... --
------
FINANCING ACTIVITIES
Dividend to Crestline Capital........................................... (4,015)
------
Increase in cash and cash equivalents................................... 6,638
Cash and cash equivalents, beginning of year............................ --
------
Cash and cash equivalents, end of year.................................. $6,638
======
See Notes to Consolidated Financial Statements.
116
CCHP III CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Organization
CCHP III Corporation (the "Company") was incorporated in the state of
Delaware on November 23, 1998 as a wholly owned subsidiary of Crestline
Capital Corporation ("Crestline"). On December 29, 1998, Crestline became a
publicly traded company when Host Marriott Corporation ("Host Marriott")
completed its plan of reorganizing its business operations by spinning-off
Crestline to the shareholders of Host Marriott as part of a series of
transactions pursuant to which Host Marriott converted into a real estate
investment trust ("REIT").
On December 31, 1998, wholly owned subsidiaries of the Company (the "Tenant
Subsidiaries") entered into lease agreements with Host Marriott to lease 31 of
Host Marriott's full-service hotels with the existing management agreements of
the leased hotels assigned to the Tenant Subsidiaries. During 1999, Host
Marriott sold two of the hotels and terminated the leases on those hotels. As
of December 31, 1999, the Company leased 29 full-service hotels from Host
Marriott.
The Company operates as a unit of Crestline, utilizing Crestline's
employees, insurance and administrative services since the Company does not
have any employees. Certain direct expenses are paid by Crestline and charged
directly or allocated to the Company. Certain general and administrative costs
of Crestline are allocated to the Company, using a variety of methods,
principally including Crestline's specific identification of individual costs
and otherwise through allocations based upon estimated levels of effort
devoted by general and administrative departments to the Company or relative
measures of the size of the Company based on revenues. In the opinion of
management, the methods for allocating general and administrative expenses and
other direct costs are reasonable.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All material intercompany transactions and balances
between the Company and its subsidiaries have been eliminated.
Fiscal Year
The Company's fiscal year ends on the Friday nearest December 31.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less at date of purchase as cash equivalents.
Restricted Cash
In connection with the lender requirements of one of the leased hotels, the
Company is required to maintain a separate account with the lender on behalf
of the Company for the operating profit and incentive management fees of the
hotel. Following the annual audit, amounts will be distributed to the hotel's
manager and to the Company, in accordance with the loan agreement.
Revenues
The Company records the gross property-level revenues generated by the
hotels as revenues.
117
CCHP III CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Note 2. Leases
Hotel Leases
The Tenant Subsidiaries entered into leases with Host Marriott effective
January 1, 1999 for 31 full-service hotels. Each hotel lease has an initial
term of nine years. The hotel leases generally have four seven-year renewal
options at the option of the Company, however, Host Marriott may terminate any
unexercised renewal options. The Tenant Subsidiaries are required to pay the
greater of (i) a minimum rent specified in each hotel lease or (ii) a
percentage rent based upon a specified percentage of aggregate revenues from
the hotel, including room revenues, food and beverage revenues, and other
income, in excess of specified thresholds. The amount of minimum rent is
increased each year based upon 50% of the increase in CPI during the previous
twelve months. Percentage rent thresholds are increased each year based on a
blend of the increases in CPI and the Employment Cost Index during the
previous twelve months. The hotel leases generally provide for a rent
adjustment in the event of damage, destruction, partial taking or certain
capital expenditures. The rent during any renewal periods will be negotiated
at fair market value at the time the renewal option is exercised.
The Tenant Subsidiaries are responsible for paying all of the expenses of
operating the hotels, including all personnel costs, utility costs, and
general repair and maintenance of the hotels. In addition, the Tenant
Subsidiaries are responsible for all fees payable to the hotel manager,
including base and incentive management fees, chain services payments and
franchise or system fees. Host Marriott is responsible for real estate and
personal property taxes, property casualty insurance, equipment rent, ground
lease rent, maintaining a reserve fund for FF&E replacements and capital
expenditures.
In the event that Host Marriott disposes of a hotel free and clear of the
hotel lease, Host Marriott would generally have to pay a termination fee equal
to the fair market value of the Company's leasehold interest in the remaining
term of the hotel lease using a discount rate of 12%. Alternatively, Host
Marriott would be entitled to (i) substitute a comparable hotel for any hotel
that is sold, with the terms agreed to by the Company, or (ii) sell the hotel
subject to the hotel lease, subject to the Company's approval under certain
circumstances, without having to pay a termination fee. In addition, Host
Marriott also has the right to terminate up to twelve of Crestline's leases
without having to pay a termination fee. During 1999, Host Marriott exercised
its right to terminate three of Crestline's hotel leases, however, none of
these were the Company's hotel leases. Conversely, Crestline may terminate up
to twelve full-service hotel leases without penalty upon 180 days notice to
Host Marriott. During 1999, Crestline exercised its right to terminate three
of the Company's hotel leases, as well as two additional Crestline hotel
leases. These hotel leases will terminate in 2000, 180 days after each
respective notification date. In 1999, Host Marriott terminated two of the
Company's hotel leases with no termination fee as stipulated in those specific
lease agreements.
As a result of the recent tax legislation discussed below, Host Marriott may
purchase all, but not less than all, of its hotel leases with Crestline
beginning January 1, 2001 with the purchase price calculated as discussed
above. The payment of the termination fee will be payable in cash or, subject
to certain conditions, shares of Host Marriott common stock at the election of
Host Marriott.
118
CCHP III CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
For those hotels where Marriott International is the manager, it has a
noneconomic membership interest with certain limited voting rights in the
Tenant Subsidiaries.
FF&E Leases
Prior to entering into the hotel leases, if the average tax basis of a
hotel's FF&E and other personal property exceeded 15% of the aggregate average
tax basis of the hotel's real and personal property (the "Excess FF&E"), the
Tenant Subsidiaries and affiliates of Host Marriott entered into lease
agreements (the "FF&E Leases") for the Excess FF&E. The terms of the FF&E
Leases generally range from two to three years and rent under the FF&E Leases
is a fixed amount. The Company will have the option at the expiration of the
FF&E Lease term to either (i) renew the FF&E Leases for consecutive one-year
renewal terms at fair market rental rate, or (ii) purchase the Excess FF&E for
a price equal to its fair market value. If the Company does not exercise its
purchase or renewal option, the Company is required to pay a termination fee
equal to approximately one month's rent.
Guaranty and Pooling Agreement
In connection with entering into the hotel leases, the Company, Crestline
and Host Marriott, entered into a pool guarantee and a pooling and security
agreement by which the Company provides a full guarantee and Crestline
provides a limited guarantee of all of the hotel lease obligations.
The cumulative limit of Crestline's guarantee obligation is the greater of
ten percent of the aggregate rent payable for the immediately preceding fiscal
year under all of the Company's hotel leases or ten percent of the aggregate
rent payable under all of the Company's hotel leases for 1999. In the event
that Crestline's obligation under the pooling and guarantee agreement is
reduced to zero, the Company can terminate the agreement and Host Marriott can
terminate the Company's hotel leases without penalty.
All of the Company's leases are cross-defaulted and the Company's
obligations under the guaranty are secured by all the funds received from its
Tenant Subsidiaries.
Recent Tax Legislation
On December 17, 1999 President Clinton signed the Work Incentives
Improvement Act of 1999. Included in this legislation are provisions that,
effect January 1, 2001, will allow a REIT to lease hotels to a "taxable REIT
subsidiary" if the hotel is operated and managed on behalf of such subsidiary
by an independent third party. A taxable REIT subsidiary is a corporation that
is owned more than 35 percent by a REIT. This law will enable Host Marriott,
beginning in 2001 to lease its hotels to a taxable REIT subsidiary. Host
Marriott may, at its discretion, elect to terminate the Company's leases,
beginning in 2001, and pay termination fees determined according to formulas
specified in the leases. If Host Marriott elects to terminate the full-service
hotel leases, it would have to terminate all of Crestline's full-service hotel
leases.
119
CCHP III CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Future minimum annual rental commitments for all non-cancelable leases as of
December 31, 1999 are as follows (in thousands):
2000............................................................ $ 162,014
2001............................................................ 155,465
2002............................................................ 155,465
2003............................................................ 155,465
2004............................................................ 155,465
Thereafter...................................................... 466,395
----------
Total minimum lease payments.................................. $1,250,269
==========
Lease expense for 1999 consisted of the following (in
thousands):
Base rent....................................................... $ 168,910
Percentage rent................................................. 126,653
----------
$ 295,563
==========
Note 3. Working Capital Notes
Upon the commencement of the hotel leases, the Company purchased the working
capital of the leased hotels from Host Marriott for $22,046,000 with the
purchase price evidenced by notes that bear interest at 5.12%. Interest on
each note is due simultaneously with the rent payment of each hotel lease. The
principal amount of each note is due upon the termination of each hotel lease.
Upon termination of the hotel lease, the Company will sell Host Marriott the
existing working capital at its current value. To the extent the working
capital delivered to Host Marriott is less than the value of the note, the
Company will pay Host Marriott the difference in cash. However, to the extent
the working capital delivered to Host Marriott exceeds the value of the note,
Host Marriott will pay the Company the difference in cash. As of December 31,
1999, the outstanding balance of the working capital notes was $21,697,000.
Debt maturities at December 31, 1999 are as follows (in thousands):
2000................................................................. $ --
2001................................................................. --
2002................................................................. --
2003................................................................. --
2004................................................................. --
Thereafter........................................................... 21,697
-------
$21,697
=======
Cash paid for interest expense in 1999 totaled $1,042,000.
Note 4. Management Agreements
All of the Company's hotels are operated by hotel management companies under
long-term hotel management agreements between Host Marriott and hotel
management companies.
Assignment of Management Agreements
The existing management agreements were assigned to the Tenant Subsidiaries
upon the execution of the hotel leases for the term of each corresponding
hotel lease. The Tenant Subsidiaries are obligated to perform all of the
obligations of Host Marriott under the hotel management agreements including
payment of fees due under the management agreements other than certain
obligations including payment of property taxes, property casualty
120
CCHP III CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
insurance and ground rent, maintaining a reserve fund for FF&E replacements
and capital expenditures for which Host Marriott retains responsibility.
Marriott International Management Agreements
Marriott International manages 18 of the 29 hotels under long-term
management agreements assigned to the Tenant Subsidiaries, generally for an
initial term of 15 to 20 years with renewal terms at the option of Marriott
International of up to an additional 16 to 30 years. The management agreements
generally provide for payment of base management fees equal to one to four
percent of revenues and incentive management fees generally equal to 20% to
50% of Operating Profit (as defined in the management agreements) over a
priority return (as defined) to the Tenant Subsidiaries, with total incentive
management fees not to exceed 20% of cumulative Operating Profit, or 20% of
current year Operating Profit.
Pursuant to the terms of the management agreements, Marriott International
is required to furnish the hotels with certain services ("Chain Services")
which are generally provided on a central or regional basis to all hotels in
the Marriott International hotel system. Chain Services include central
training, advertising and promotion, a national reservation system,
computerized payroll and accounting services, and such additional services as
needed which may be more efficiently performed on a centralized basis. Costs
and expenses incurred in providing such services are allocated among all
domestic hotels managed, owned or leased by Marriott International or its
subsidiaries. In addition, the Company's hotels also participate in the
Marriott Rewards program. The cost of this program is charged to all hotels in
the Marriott hotel system.
Ritz-Carlton Hotel Management Agreements
The Ritz-Carlton Hotel Company, LLC ("Ritz-Carlton"), an affiliate of
Marriott International, manages three of the leased hotels under long-term
Hotel Management Agreements assigned to the Company. These agreements have an
initial term of 15 to 25 years with renewal terms at the option of Ritz-
Carlton of up to an additional 10 to 40 years. Base Management fees vary from
two to four percent of revenues and incentive management fees are generally
equal to 20% of available cash flow or operating profit, up to a maximum of
2.1% of revenues, as defined in the agreements.
Other Hotel Management Agreements
The Company's remaining eight hotels are managed by other hotel management
companies. Two of the hotels are managed by Swissotel Management (USA) LLC,
one is managed by the Hyatt Corporation, and the remaining five hotels are
managed by other independent hotel management companies under the "Marriott"
brand pursuant to franchise agreements. The managers of the hotels provide
similar services as Marriott International under its management agreements and
receive base management fees, generally calculated as a percentage of
revenues, and in most cases, incentive management fees, which are generally
calculated as a percentage of operating profits.
The Company has the option to terminate certain management agreements if
specified performance thresholds are not satisfied, with the consent of Host
Marriott under certain conditions. No agreement with respect to a single
lodging facility is cross-collateralized or cross-defaulted to any other
agreement and a single agreement may be canceled under certain conditions,
although such cancellation will not trigger the cancellation of any other
agreement.
Franchise Agreements
Five of the Company's hotels are managed under franchise agreements between
Host Marriott and Marriott International for terms ranging from 15 to 30
years. In connection with the assignment of the corresponding
121
CCHP III CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
management agreement, the Tenant Subsidiaries assumed the franchise agreements
for these hotels and will be the franchisee for the term of the corresponding
hotel lease. Pursuant to the franchise agreements, the Tenant Subsidiaries
generally pay a franchise fee based on a percentage of room revenues and food
and beverage revenues as well as certain other fees for advertising and
reservations. Franchise fees for room revenues vary from four to six percent,
while fees for food and beverage revenues vary from two to three percent of
revenues.
Note 5. Income Taxes
The Company is included in the consolidated Federal income tax return of
Crestline and its affiliates (the "Group"). Tax expense is allocated to the
Company as a member of the Group based upon the relative contribution to the
Group's consolidated taxable income/loss and changes in temporary differences.
This allocation method results in Federal and net state tax expense allocated
for the period presented that is substantially equal to the expense that would
have been recognized if the Company had filed separate tax returns.
The provision for income taxes for 1999 consists of the following (in
thousands):
Current--Federal..................................................... $2,792
--State.......................................................... 478
------
3,270
------
Deferred--Federal.................................................... 292
--State.......................................................... 50
------
342
------
$3,612
======
A reconciliation of the statutory Federal tax rate to the Company's
effective income tax rate for 1999 follows:
Statutory federal tax rate............................................. 35.0%
State income taxes, net of federal tax benefit......................... 6.0
----
41.0%
====
As of December 31, 1999, the Company had no deferred tax assets. The tax
effect of the temporary differences that gives rise to the Company's deferred
tax liability is attributable to the hotel working capital.
122
CCHP IV CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999
With Independent Public Accountants' Report Thereon
123
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To CCHP IV Corporation:
We have audited the accompanying consolidated balance sheet of CCHP IV
Corporation and its subsidiaries (a Maryland corporation) as of December 31,
1999, and the related consolidated statements of operations, shareholder's
equity and cash flows for the fiscal year ended December 31, 1999. These
consolidated financial statements are the responsibility of CCHP IV
Corporation's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of CCHP IV
Corporation and its subsidiaries as of December 31, 1999 and the results of
their operations and their cash flows for the fiscal year then ended in
conformity with accounting principles generally accepted in the United States.
Arthur Andersen LLP
Vienna, Virginia
February 24, 2000
124
CCHP IV CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
As Of December 31, 1999
(in thousands, except share data)
ASSETS
Current assets
Cash and cash equivalents............................................ $ 3,487
Due from hotel managers.............................................. 14,571
Due from Crestline Capital........................................... 3,487
-------
21,545
Hotel working capital.................................................. 16,522
-------
$38,067
=======
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Lease payable to Host Marriott....................................... $20,348
Other................................................................ 456
-------
20,804
Hotel working capital notes payable to Host Marriott................... 16,522
Deferred income taxes.................................................. 741
-------
Total liabilities.................................................. 38,067
-------
Shareholder's equity
Common stock (100 shares issued at $1.00 par value).................. --
Retained earnings.................................................... --
Total shareholder's equity......................................... --
-------
$38,067
=======
See Notes to Consolidated Financial Statements.
125
CCHP IV CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Fiscal Year Ended December 31, 1999
(in thousands)
REVENUES
Rooms............................................................... $578,321
Food and beverage................................................... 333,120
Other............................................................... 77,368
--------
Total revenues.................................................... 988,809
--------
OPERATING COSTS AND EXPENSES
Property-level operating costs and expenses
Rooms............................................................... 129,051
Food and beverage................................................... 234,310
Other............................................................... 231,547
Other operating costs and expenses
Lease expense to Host Marriott...................................... 316,654
Management fees..................................................... 66,514
--------
Total operating costs and expenses................................ 978,076
--------
OPERATING PROFIT BEFORE CORPORATE EXPENSES AND INTEREST............... 10,733
Corporate expenses.................................................... (1,449)
Interest expense...................................................... (846)
Interest income....................................................... 16
--------
INCOME BEFORE INCOME TAXES............................................ 8,454
Provision for income taxes............................................ (3,466)
--------
NET INCOME............................................................ $ 4,988
========
See Notes to Consolidated Financial Statements.
126
CCHP IV CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
Fiscal Year Ended December 31, 1999
(in thousands)
Common Retained
Stock Earnings Total
------ -------- ------
Balance, January 1, 1999................................ $-- $ -- $ --
Dividend to Crestline Capital......................... -- (4,988) (4,988)
Net income............................................ -- 4,988 4,988
---- ------ ------
Balance, December 31, 1999.............................. $-- $ -- $ --
==== ====== ======
See Notes to Consolidated Financial Statements.
127
CCHP IV CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Fiscal Year Ended December 31, 1999
(in thousands)
OPERATING ACTIVITIES
Net income............................................................. $ 4,988
Change in amounts due from hotel managers.............................. (14,124)
Change in lease payable to Host Marriott............................... 20,348
Changes in other operating accounts.................................... 750
-------
Cash from operations................................................. 11,962
-------
INVESTING ACTIVITIES................................................... --
-------
FINANCING ACTIVITIES
Amounts advanced to Crestline Capital.................................. (3,487)
Dividend to Crestline Capital.......................................... (4,988)
-------
Cash used in financing activities.................................... (8,475)
-------
Increase in cash and cash equivalents.................................. 3,487
Cash and cash equivalents, beginning of year........................... --
-------
Cash and cash equivalents, end of year................................. $ 3,487
=======
See Notes to Consolidated Financial Statements.
128
CCHP IV CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
Organization
CCHP IV Corporation (the "Company") was incorporated in the state of
Delaware on November 23, 1998 as a wholly owned subsidiary of Crestline
Capital Corporation ("Crestline"). On December 29, 1998, Crestline became a
publicly traded company when Host Marriott Corporation ("Host Marriott")
completed its plan of reorganizing its business operations by spinning-off
Crestline to the shareholders of Host Marriott as part of a series of
transactions pursuant to which Host Marriott converted into a real estate
investment trust ("REIT").
On December 31, 1998, wholly owned subsidiaries of the Company (the "Tenant
Subsidiaries") entered into lease agreements with Host Marriott to lease 27 of
Host Marriott's full-service hotels with the existing management agreements of
the leased hotels assigned to the Tenant Subsidiaries. As of December 31,
1999, the Company leased 27 full-service hotels from Host Marriott.
The Company operates as a unit of Crestline, utilizing Crestline's
employees, insurance and administrative services since the Company does not
have any employees. Certain direct expenses are paid by Crestline and charged
directly or allocated to the Company. Certain general and administrative costs
of Crestline are allocated to the Company, using a variety of methods,
principally including Crestline's specific identification of individual costs
and otherwise through allocations based upon estimated levels of effort
devoted by general and administrative departments to the Company or relative
measures of the size of the Company based on revenues. In the opinion of
management, the methods for allocating general and administrative expenses and
other direct costs are reasonable.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All material intercompany transactions and balances
between the Company and its subsidiaries have been eliminated.
Fiscal Year
The Company's fiscal year ends on the Friday nearest December 31.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less at date of purchase as cash equivalents.
Revenues
The Company records the gross property-level revenues generated by the
hotels as revenues.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
129
CCHP IV CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 2. Leases
Hotel Leases
The Tenant Subsidiaries entered into leases with Host Marriott effective
January 1, 1999 for 27 full-service hotels. Each hotel lease has an initial
term of ten years. The hotel leases generally have four seven-year renewal
options at the option of the Company, however, Host Marriott may terminate any
unexercised renewal options. The Tenant Subsidiaries are required to pay the
greater of (i) a minimum rent specified in each hotel lease or (ii) a
percentage rent based upon a specified percentage of aggregate revenues from
the hotel, including room revenues, food and beverage revenues, and other
income, in excess of specified thresholds. The amount of minimum rent is
increased each year based upon 50% of the increase in CPI during the previous
twelve months. Percentage rent thresholds are increased each year based on a
blend of the increases in CPI and the Employment Cost Index during the
previous twelve months. The hotel leases generally provide for a rent
adjustment in the event of damage, destruction, partial taking or certain
capital expenditures. The rent during any renewal periods will be negotiated
at fair market value at the time this renewal option is exercised.
The Tenant Subsidiaries are responsible for paying all of the expenses of
operating the hotels, including all personnel costs, utility costs, and
general repair and maintenance of the hotels. In addition, the Tenant
Subsidiaries are responsible for all fees payable to the hotel manager,
including base and incentive management fees, chain services payments and
franchise or system fees. Host Marriott is responsible for real estate and
personal property taxes, property casualty insurance, equipment rent, ground
lease rent, maintaining a reserve fund for FF&E replacements and capital
expenditures.
In the event that Host Marriott disposes of a hotel free and clear of the
hotel lease, Host Marriott would generally have to pay a termination fee equal
to the fair market value of the Company's leasehold interest in the remaining
term of the hotel lease using a discount rate of 12%. Alternatively, Host
Marriott would be entitled to (i) substitute a comparable hotel for any hotel
that is sold, with the terms agreed to by the Company, or (ii) sell the hotel
subject to the hotel lease, subject to the Company's approval under certain
circumstances, without having to pay a termination fee. In addition, Host
Marriott also has the right to terminate up to twelve of Crestline's leases
without having to pay a termination fee. During 1999, Host Marriott exercised
its right to terminate three of Crestline's hotel leases, however, none of
these were the Company's hotel leases. Conversely, Crestline may terminate up
to twelve full-service hotel leases without penalty upon 180 days notice to
Host Marriott. During 1999, Crestline exercised its right to terminate five of
its hotel leases, however, none of these were the Company's hotel leases.
As a result of the recent tax legislation discussed below, Host Marriott may
purchase all, but not less than all, of its hotel leases with Crestline
beginning January 1, 2001 with the purchase price calculated as discussed
above. The payment of the termination fee will be payable in cash or, subject
to certain conditions, shares of Host Marriott common stock at the election of
Host Marriott.
For those hotels where Marriott International is the manager, it has a
noneconomic membership interest with certain limited voting rights in the
Tenant Subsidiaries.
FF&E Leases
Prior to entering into the hotel leases, if the average tax basis of a
hotel's FF&E and other personal property exceeded 15% of the aggregate average
tax basis of the hotel's real and personal property (the "Excess FF&E"), the
Tenant Subsidiaries and affiliates of Host Marriott entered into lease
agreements (the "FF&E Leases") for the Excess FF&E. The terms of the FF&E
Leases generally range from two to three years and rent under the FF&E Leases
is a fixed amount. The Company will have the option at the expiration of the
FF&E Lease term to
130
CCHP IV CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
either (i) renew the FF&E Leases for consecutive one-year renewal terms at
fair market rental rate, or (ii) purchase the Excess FF&E for a price equal to
its fair market value. If the Company does not exercise its purchase or
renewal option, the Company is required to pay a termination fee equal to
approximately one month's rent.
Guaranty and Pooling Agreement
In connection with entering into the hotel leases, the Company, Crestline
and Host Marriott, entered into a pool guarantee and a pooling and security
agreement by which the Company provides a full guarantee and Crestline
provides a limited guarantee of all of the hotel lease obligations.
The cumulative limit of Crestline's guarantee obligation is the greater of
ten percent of the aggregate rent payable for the immediately preceding fiscal
year under all of the Company's hotel leases or ten percent of the aggregate
rent payable under all of the Company's hotel leases for 1999. In the event
that Crestline's obligation under the pooling and guarantee agreement is
reduced to zero, the Company can terminate the agreement and Host Marriott can
terminate the Company's hotel leases without penalty.
All of the Company's leases are cross-defaulted and the Company's
obligations under the guaranty are secured by all the funds received from its
Tenant Subsidiaries.
Recent Tax Legislation
On December 17, 1999 President Clinton signed the Work Incentives
Improvement Act of 1999. Included in this legislation are provisions that,
effect January 1, 2001, will allow a REIT to lease hotels to a "taxable REIT
subsidiary" if the hotel is operated and managed on behalf of such subsidiary
by an independent third party. A taxable REIT subsidiary is a corporation that
is owned more than 35 percent by a REIT. This law will enable Host Marriott,
beginning in 2001 to lease its hotels to a taxable REIT subsidiary. Host
Marriott may, at its discretion, elect to terminate the Company's leases,
beginning in 2001, and pay termination fees determined according to formulas
specified in the leases. If Host Marriott elects to terminate the full-service
hotel leases, it would have to terminate all of Crestline's full-service hotel
leases.
Future minimum annual rental commitments for all non-cancelable leases as of
December 31, 1999 are as follows (in thousands):
2000............................................................ $ 186,420
2001............................................................ 186,420
2002............................................................ 186,420
2003............................................................ 186,420
2004............................................................ 186,420
Thereafter...................................................... 745,679
----------
Total minimum lease payments.................................. $1,677,779
==========
Lease expense for 1999 consisted of the following (in
thousands):
Base rent....................................................... $ 183,048
Percentage rent................................................. 133,606
----------
$ 316,654
==========
131
CCHP IV CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Note 3. Working Capital Notes
Upon the commencement of the hotel leases, the Company purchased the working
capital of the leased hotels from Host Marriott for $16,522,000 with the
purchase price evidenced by notes that bear interest at 5.12%. Interest on
each note is due simultaneously with the rent payment of each hotel lease. The
principal amount of each note is due upon the termination of each hotel lease.
Upon termination of the hotel lease, the Company will sell Host Marriott the
existing working capital at its current value. To the extent the working
capital delivered to Host Marriott is less than the value of the note, the
Company will pay Host Marriott the difference in cash. However, to the extent
the working capital delivered to Host Marriott exceeds the value of the note,
Host Marriott will pay the Company the difference in cash. As of December 31,
1999, the outstanding balance of the working capital notes was $16,522,000
Debt maturities at December 31, 1999 are as follows (in thousands):
2000................................................................. $ --
2001................................................................. --
2002................................................................. --
2003................................................................. --
2004................................................................. --
Thereafter........................................................... 16,522
-------
$16,522
=======
Cash paid for interest expense in 1999 totaled $781,000.
Note 4. Management Agreements
All of the Company's hotels are operated by hotel management companies under
long-term hotel management agreements between Host Marriott and hotel
management companies.
Assignment of Management Agreements
The existing management agreements were assigned to the Tenant Subsidiaries
upon the execution of the hotel leases for the term of each corresponding
hotel lease. The Tenant Subsidiaries are obligated to perform all of the
obligations of Host Marriott under the hotel management agreements including
payment of fees due under the management agreements other than certain
obligations including payment of property taxes, property casualty insurance
and ground rent, maintaining a reserve fund for FF&E replacements and capital
expenditures for which Host Marriott retains responsibility.
Marriott International Management Agreements
Marriott International manages 20 of the 27 hotels under long-term
management agreements assigned to the Tenant Subsidiaries, generally for an
initial term of 15 to 20 years with renewal terms at the option of Marriott
International of up to an additional 16 to 30 years. The management agreements
generally provide for payment of base management fees equal to one to four
percent of revenues and incentive management fees generally equal to 20% to
50% of Operating Profit (as defined in the management agreements) over a
priority return (as defined) to the Tenant Subsidiaries, with total incentive
management fees not to exceed 20% of cumulative Operating Profit, or 20% of
current year Operating Profit.
Pursuant to the terms of the management agreements, Marriott International
is required to furnish the hotels with certain services ("Chain Services")
which are generally provided on a central or regional basis to all hotels
132
CCHP IV CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
in the Marriott International hotel system. Chain Services include central
training, advertising and promotion, a national reservation system,
computerized payroll and accounting services, and such additional services as
needed which may be more efficiently performed on a centralized basis. Costs
and expenses incurred in providing such services are allocated among all
domestic hotels managed, owned or leased by Marriott International or its
subsidiaries. In addition, the Company's hotels also participate in the
Marriott Rewards program. The cost of this program is charged to all hotels in
the Marriott hotel system.
Ritz-Carlton Hotel Management Agreements
The Ritz-Carlton Hotel Company, LLC ("Ritz-Carlton"), an affiliate of
Marriott International, manages three of the leased hotels under long-term
Hotel Management Agreements assigned to the Company. These agreements have an
initial term of 15 to 25 years with renewal terms at the option of Ritz-
Carlton of up to an additional 10 to 40 years. Base Management fees vary from
two to four percent of revenues and incentive management fees are generally
equal to 20% of available cash flow or operating profit, as defined in the
agreements.
Other Hotel Management Agreements
The Company's remaining four hotels are managed by other hotel management
companies. Two of the hotels are managed by the Hyatt Corporation, one of the
hotels is managed by Swissotel Management (USA) LLC, and one is managed by
Four Seasons Hotel Limited. The managers of the hotels provide similar
services as Marriott International under its management agreements and receive
base management fees, generally calculated as a percentage of revenues, and in
most cases, incentive management fees, which are generally calculated as a
percentage of operating profits.
The Company has the option to terminate certain management agreements if
specified performance thresholds are not satisfied, with the consent of Host
Marriott under certain conditions. No agreement with respect to a single
lodging facility is cross-collateralized or cross-defaulted to any other
agreement and a single agreement may be canceled under certain conditions,
although such cancellation will not trigger the cancellation of any other
agreement.
Note 5. Income Taxes
The Company is included in the consolidated Federal income tax return of
Crestline and its affiliates (the "Group"). Tax expense is allocated to the
Company as a member of the Group based upon the relative contribution to the
Group's consolidated taxable income/loss and changes in temporary differences.
This allocation method results in Federal and net state tax expense allocated
for the period presented that is substantially equal to the expense that would
have been recognized if the Company had filed separate tax returns.
The provision for income taxes for 1999 consists of the following (in
thousands):
Current--Federal...................................................... $2,326
--State........................................................... 399
------
2,725
------
Deferred--Federal..................................................... 633
--State........................................................... 108
------
741
------
$3,466
======
133
CCHP IV CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A reconciliation of the statutory Federal tax rate to the Company's
effective income tax rate for 1999 follows:
Statutory federal tax rate............................................. 35.0%
State income taxes, net of federal tax benefit......................... 6.0
----
41.0%
====
As of December 31, 1999, the Company had no deferred tax assets. The tax
effect of the temporary differences that gives rise to the Company's deferred
tax liability is attributable to the hotel working capital.
134
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
The information called for by Items 10-13 is incorporated by reference from
our 2000 Annual Meeting of Shareholders Notice and Proxy Statement (to be
filed pursuant to Regulation 14A not later than 120 days after the close of
fiscal year).
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
(i) FINANCIAL STATEMENTS
All financial statements of the registrant as set forth under Item 8 of
this Report on Form 10-K.
(ii) FINANCIAL STATEMENT SCHEDULES
The following financial information is filed herewith on the pages
indicated.
Financial Schedules:
Page
----------
III. Real Estate and Accumulated Depreciation S-1 to S-2
All other schedules are omitted because they are not applicable or the
required information is included in the consolidated financial statements or
notes thereto.
(iii) EXHIBITS
Exhibit
No. Description
------- -----------
2.1 Agreement and Plan of Merger by and among Host Marriott Corporation,
HMC Merger Corporation and Host Marriott L.P. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 333-
64793).
3.3 Bylaws of Host Marriott Corporation dated December 29, 1998
(incorporated by reference to Host Marriott Corporation's Current
Report on Form 8-K (File No. 001-14625) filed with the Commission on
December 30, 1999).
3.4 Articles of Amendment and Restatement of Articles of Incorporation of
Host Marriott Corporation (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
3.5 Articles Supplementary of Host Marriott Corporation Classifying and
Designating a Series of Preferred Stock as Series A Junior
Participating Preferred Stock and Fixing Distribution and Other
Preferences and Rights of Such Series (Incorporated herein by
reference to Exhibit 4.2 to Host Marriott Corporation Registration
Statement on Form 8-A (Registration No. 001-14625) filed with the
Commission on December 11, 1998)
135
Exhibit
No. Description
------- -----------
3.6 Articles Supplementary of Host Marriott Corporation Classifying and
Designating Preferred Stock of the Registrant as 10% Class A
Cumulative Redeemable Preferred Stock (Incorporated by reference to
Exhibit 4.1 to Host Marriott Corporation Registration Statement on
Form 8-A (Registration No. 001-14625) filed with the Commission on
July 30, 1999)
3.7 Articles Supplementary of Host Marriott Corporation Classifying and
Designating Preferred Stock of the Registrant as 10% Class B
Cumulative Redeemable Preferred Stock (Incorporated by reference to
Exhibit 4.1 to Host Marriott Corporation Registration Statement on
Form 8-A (Registration No. 001-14625) filed with the Commission on
November 23, 1999)
4.1 Form of Common Stock Certificate of Host Marriott Corporation
(incorporated by reference to Host Marriott Corporation Registration
Statement No. 333-55807).
4.2 Guarantee Agreement, dated December 2, 1996, between Host Marriott
Corporation and IBJ Schroeder Bank & Trust Company, as Guarantee
Trustee (incorporated by reference to Exhibit 4.6 of Host Marriott
Corporation Registration Statement No. 333-19923).
4.3(i) Rights Agreement between Host Marriott Corporation and The Bank of
New York as Rights Agent dated as of November 23, 1998 (incorporated
by reference to Host Marriott Corporation Current Report on Form 8-K
dated November 23, 1998).
4.3(ii) Amendment No. 1 to Rights Agreement between Host Marriott
Corporation and The Bank of New York as Rights Agent dated as of
December 18, 1998 (incorporated by reference to Host Marriott
Corporation Current Report on Form 8-K dated December 18, 1998).
4.4 Indenture by and among HMC Acquisition Properties, Inc., as Issuer,
HMC SFO, Inc., as Subsidiary Guarantors, and Marine Midland Bank, as
Trustee (incorporated by reference to Host Marriott Corporation
Registration Statement No. 333-00768).
4.5 Indenture by and among HMH Properties, Inc., as Issuer, HMH
Courtyard Properties, Inc., HMC Retirement Properties, Inc.,
Marriott Financial Services, Inc., Marriott SBM Two Corporation, HMH
Pentagon Corporation and Host Airport Hotels, Inc., as Subsidiary
Guarantors, and Marine Midland Bank, as Trustee (incorporated by
reference to Host Marriott Corporation Registration Statement
33-95058).
4.6 Indenture by and among HMH Properties, Inc., as Issuer, and the
Subsidiary Guarantors named therein, and Marine Midland Bank, as
Trustee (incorporated by reference to Host Marriott Corporation
Current Report on Form 8-K dated August 6, 1998).
4.7 Indenture for the 6 3/4% Convertible Debentures, dated December 2,
1996, between Host Marriott Corporation and IBJ Schroeder Bank &
Trust Company, as Indenture Trustee (incorporated by reference to
Exhibit 4.3 of Host Marriott Corporation Registration Statement No.
333-19923).
4.8 Amended and Restated Trust Agreement, dated December 2, 1996, among
Host Marriott Corporation, IBJ Schroeder Bank & Trust Company, as
Property Trustee, Delaware Trust Capital Management, Inc., as
Delaware Trustee, and Robert E. Parsons, Jr., Bruce D. Wardinski and
Christopher G. Townsend, as Administrative Trustees (incorporated by
reference to Exhibit 4.2 of Host Marriott Corporation Registration
Statement No. 333-19923).
4.9 Amended and Restated Trust Agreement, dated as of December 29, 1998,
among HMC Merger Corporation, as Depositor, IBJ Schroder Bank &
Trust Company, as Property Trustee, Delaware Trust Capital
Management, Inc., as Delaware Trustee, and Robert E. Parsons, Jr.,
Ed Walter and Christopher G. Townsend, as Administrative Trustees
(incorporated by reference to Host Marriott Corporation 1998 Annual
Report on Form 10K filed March 26, 1999).
10.1 Second Amended and Restated Agreement of Limited Partnership of Host
Marriott, L.P. (incorporated by reference to Exhibit 3.1 of Host
Marriott Corporation Registration Statement No. 333-55807).
136
Exhibit
No. Description
------- -----------
10.2 Indenture between Host Marriott L.P., as Issuer, and Marine Midland
Bank, as Indenture Trustee, and Form of 6.56% Callable Note due
December 15, 2005 (incorporated by reference to Exhibit 4.1 of Host
Marriott Corporation Registration Statement No. 333-55807).
10.3 Amended and Restated Credit Agreement dated as of June 19, 1997 and
Amended and Restated as of August 5, 1998 among Host Marriott
Corporation, Host Marriott Hospitality, Inc., HMH Properties, Inc.,
Host Marriott, L.P., HMC Capital Resources Corp., Various Banks, Wells
Fargo Bank, National Association, The Bank of Nova Scotia and Credit
Lyonnais New York Branch, as Co-Arrangers, and Bankers Trust Company
as Arranger and Administrative Agent (incorporated by reference to
Host Marriott Corporation Current Report on Form 8-K dated September
11, 1998).
10.4 First Amendment and Waiver of Amended and Restated Credit Agreement
dated as of June 19, 1997 and Amended and Restated as of August 5,
1998, among Host Marriott Corporation, Host Marriott Hospitality Inc.,
HMH Properties, Inc., Host Marriott, L.P., HMC Capital Resources
Corp., Various Banks, Wells Fargo Bank, National Association, The Bank
of Nova Scotia and Credit Lyonnais New York Branch, as Co-Arrangers
and Bankers Trust Company as Arranger and Administrative Agent dated
as of November 25, 1998 (incorporated by reference to Host Marriott
Corporation 1998 Annual Report on Form 10-K filed March 26, 1999).
10.5 Second Amendment and Consent to Credit Agreement of Amended and
Restated Credit Agreement dated as of June 19, 1997 and Amended and
Restated as of August 5, 1998, among Host Marriott Corporation, Host
Marriott Hospitality Inc., HMH Properties, Inc., Host Marriott, L.P.,
HMC Capital Resources Corp., Various Banks, Wells Fargo Bank, National
Association, The Bank of Nova Scotia and Credit Lyonnais New York
Branch, as Co-Arrangers and Bankers Trust Company as Arranger and
Administrative Agent dated as of December 17, 1998 (incorporated by
reference to Host Marriott Corporation 1998 Annual Report on Form 10-K
filed March 26, 1999).
10.6 Third Amendment and Waiver to Credit Agreement Amended and Restated
Credit Agreement dated as of June 19, 1997 and Amended and Restated as
of August 5, 1998, among Host Marriott Corporation, Host Marriott
Hospitality Inc., HMH Properties, Inc., Host Marriott, L.P., HMC
Capital Resources Corp., Various Banks, Wells Fargo Bank, National
Association, The Bank of Nova Scotia and Credit Lyonnais New York
Branch, as Co-Arrangers and Bankers Trust Company as Arranger and
Administrative Agent dated as of March 15, 1999 (incorporated by
reference to Host Marriott Corporation 1998 Annual Report on Form 10-K
filed March 26, 1999).
10.7 Host Marriott Corporation Executive Deferred Compensation Plan
effective as of December 29, 1998 (formerly the Marriott Corporation
Executive Deferred Compensation Plan) (incorporated by reference to
Host Marriott Corporation 1998 Annual Report on Form 10-K filed March
26, 1999).
10.8 Host Marriott Corporation 1997 and Host Marriott, L.P. Comprehensive
Incentive Stock Plan (incorporated by reference to Host Marriott
Corporation's Proxy Statement filed April 3, 1997).
10.9 Distribution Agreement dated as of September 15, 1993 between Marriott
Corporation and Marriott International, Inc. (incorporated by
reference from Host Marriott Corporation Current Report on Form 8-K
dated October 23, 1993).
10.10 Amendment No. 1 to the Distribution Agreement dated December 29, 1995
by and among Host Marriott Corporation, Host Marriott Services
Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Current Report on Form 8-K
dated January 16, 1996).
10.11 Amendment No. 2 to the Distribution Agreement dated June 21, 1997 by
and among Host Marriott Corporation, Host Marriott Services
Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 333-
64793).
10.12 Amendment No. 3 to the Distribution Agreement dated March 3, 1998 by
and among Host Marriott Corporation, Host Marriott Services
Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 333-
64793).
10.13 Amendment No. 4 to the Distribution Agreement by and among Host
Marriott Corporation and Marriott International Inc. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 333-
64793).
137
Exhibit
No. Description
------- -----------
10.14 Amendment No. 5 to the Distribution Agreement dated December 18, 1998
by and among Host Marriott Corporation, Host Marriott Services
Corporation and Marriott International Inc. (incorporated by reference
to Host Marriott Corporation 1998 Annual Report on Form 10-K filed
March 26, 1999).
10.15 Distribution Agreement dated December 22, 1995 by and between Host
Marriott Corporation and Host Marriott Services Corporation
(incorporated by reference to Host Marriott Corporation Current Report
on Form 8-K dated January 16, 1996).
10.16 Amendment to Distribution Agreement dated December 22, 1995 by and
between Host Marriott Corporation and Host Marriott Services
Corporation (incorporated by reference to Host Marriott Corporation
1998 Annual Report on Form 10-K filed March 26, 1999).
10.17 Tax Sharing Agreement dated as of October 5, 1993 by and between
Marriott Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Current Report on Form 8-K
dated October 23, 1993).
10.18 License Agreement dated as of December 29, 1998 by and among Host
Marriott Corporation, Host Marriott, L.P., Marriott International,
Inc. and Marriott Worldwide Corporation (incorporated by reference to
Host Marriott Corporation 1998 Annual Report on Form 10-K filed March
26, 1999).
10.19 Noncompetition Agreement between Host Marriott Corporation, Host
Marriott, L.P. and Crestline Capital Corporation and other parties
named therein (incorporated by reference to Host Marriott Corporation
1998 Annual Report on Form 10-K filed March 26, 1999).
10.20 Tax Administration Agreement dated as of October 8, 1993 by and
between Marriott Corporation and Marriott International, Inc.
(incorporated by reference to Host Marriott Corporation Current Report
on Form 8-K dated October 23, 1993).
10.21 Restated Noncompetition Agreement by and among Host Marriott
Corporation, Marriott International, Inc. and Sodexho Marriott
Services, Inc. (incorporated by reference to Host Marriott Corporation
Registration Statement No. 333-64793).
10.22 First Amendment to Restated Noncompetition Agreement by and among Host
Marriott Corporation, Marriott International, Inc. and Sodexho
Marriott Services, Inc. (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
10.23 Host Marriott Lodging Management Agreement--Marriott Hotels, Resorts
and Hotels dated September 25, 1993 by and between Marriott
Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 33-
51707).
10.24 Employee Benefits and Other Employment Matters Allocation Agreement
dated as of December 29, 1995 by and between Host Marriott Corporation
and Host Marriott Services Corporation (incorporated by reference to
Host Marriott Corporation Current Report on Form 8-K dated January 16,
1996).
10.25 Tax Sharing Agreement dated as of December 29, 1995 by and between
Host Marriott Corporation and Host Marriott Services Corporation
(incorporated by reference to Host Marriott Corporation Current Report
on Form 8-K dated January 16, 1996).
10.26 Host Marriott, L.P. Retirement and Savings Plan and Trust
(incorporated by reference to Host Marriott Corporation 1998 Annual
Report on Form 10-K filed March 26, 1999).
10.27 Contribution Agreement dated as of April 16, 1998 among Host Marriott
Corporation, Host Marriott, L.P. and the contributors named therein,
together with Exhibit B (incorporated by reference to Exhibit 10.18 of
Host Marriott Corporation Registration Statement No. 333-55807).
10.28 Amendment No. 1 to Contribution Agreement dated May 8, 1998 among
Marriott Corporation, Host Marriott, L.P. and the contributors named
therein (incorporated by reference to Exhibit 10.19 of Host Marriott
Corporation Registration Statement No. 333-55807).
10.29 Amendment No. 2 to Contribution Agreement dated May 18, 1998 among
Host Marriott Corporation, Host Marriott, L.P. and the contributors
named therein (incorporated by reference to Exhibit 10.20 of Host
Marriott Corporation Registration Statement No. 333-55807).
#10.30 Form of Lease Agreement (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
138
Exhibit
No. Description
------- -----------
#10.31 Form of Management Agreement for Full-Service Hotels (incorporated by
reference to Host Marriott Corporation Registration Statement No. 33-
51707).
#10.32 Form of Owner's Agreement between Host Marriott Corporation, Marriott
International and Crestline Capital Corporation (incorporated by
reference to Crestline Capital Corporation Registration Statement No.
333-64657).
10.33 Employee Benefits and Other Employment Matters Allocation Agreement
between Host Marriott Corporation, Host Marriott, L.P. and Crestline
Capital Corporation (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
10.34 Amendment to the Employee Benefits and Other Employment Matters
Allocation Agreement effective as of December 29, 1998 by and between
Host Marriott Corporation, Marriott International, Sodexho Marriott
Services, Inc., Crestline Capital Corporation and Host Marriott, L.P.
(incorporated by reference to Host Marriott Corporation 1998 Annual
Report on Form 10-K filed March 26, 1999).
10.35 Pool Guarantee Agreement between Host Marriott Corporation, the
lessees referred to therein and Crestline Capital Corporation
(incorporated by reference to Host Marriott Corporation Registration
Statement No. 333-64793).
10.36 Pooling and Security Agreement by and among Host Marriott Corporation
and Crestline Capital Corporation (incorporated by reference to Host
Marriott Corporation Registration Statement No. 333-64793).
10.37 Amended and Restated Communities Noncompetition Agreement
(incorporated by reference to Host Marriott Corporation Registration
Statement No. 333-64793).
10.38 Asset Management Agreement between Host Marriott Corporation and
Crestline Capital Corporation (incorporated by reference to Crestline
Capital Corporation Registration Statement No. 333-64657).
12.1* Computation of Ratios of Earnings to Fixed Charges.
21* List of Subsidiaries of Host Marriott Corporation.
23.1* Consent of Arthur Andersen LLP.
27.1* Financial Data Schedule.
- --------
# Agreement filed is illustrative of numerous other agreements to which we are
a party.
* Filed herewith.
139
(b) REPORTS ON FORM 8-K
. November 3, 1999--Report of the announcement by Host Marriott
Corporation's Board of Directors that Terence C. Golden, the Company's
President and Chief Executive Officer, has notified the Company of his
intention to retire effective May 18, 2000, the date of the next annual
shareholders meeting. The Board also announced that it has named
Christopher J. Nassetta, the Company's Executive Vice President and Chief
Operating Officer, as President and Chief Executive Officer effective on
that date. Mr. Golden will remain a member of the Board of Directors
after his resignation and Mr. Nassetta was elected to the Board effective
November 2, 1999.
. November 19, 1999--Report on the execution of an Underwriting Agreement
by Host Marriott Corporation and Host Marriott, L.P. to issue and sell
$100,000,000 of 10% Class B Cumulative Redeemable Preferred Stock on
November 29, 1999 at $25.00 per share, with underwriting discounts and
commissions of $.8125 of the principal amount at maturity, generating
expected net proceeds to the Company (after deducting estimated expenses
of the offering) of approximately $96,750,000 before expenses payable by
the Company.
. February 24, 2000--Report that Host Marriott Corporation and Marriott
International have reached a non-binding understanding to resolve
litigation involving six hotel partnerships.
140
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of
Bethesda, State of Maryland, on March 8, 2000.
Host Marriott Corporation
/s/ Robert E. Parsons, Jr.
By: _________________________________
Robert E. Parsons, Jr.
Executive Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures Title Date
---------- ----- ----
/s/ Terence C. Golden President, Chief Executive March 8, 2000
______________________________________ Officer and Director
Terence C. Golden (Principal Executive
Officer)
/s/ Robert E. Parsons, Jr. Executive Vice President March 8, 2000
______________________________________ and Chief Financial
Robert E. Parsons, Jr. Officer (Principal
Financial Officer)
/s/ Donald D. Olinger Senior Vice President and March 8, 2000
______________________________________ Corporate Controller
Donald D. Olinger (Principal Accounting
Officer)
/s/ Richard E. Marriott Chairman of the Board of March 8, 2000
______________________________________ Directors
Richard E. Marriott
/s/ R. Theodore Ammon Director March 8, 2000
______________________________________
R. Theodore Ammon
/s/ Robert M. Baylis Director March 8, 2000
______________________________________
Robert M. Baylis
141
Signatures Title Date
---------- ----- ----
/s/ J.W. Marriott, Jr. Director March 8, 2000
______________________________________
J.W. Marriott, Jr.
/s/ Ann Dore McLaughlin Director March 8, 2000
______________________________________
Ann Dore McLaughlin
/s/ Christopher J. Nassetta Director March 8, 2000
______________________________________
Christopher J. Nassetta
/s/ John G. Schreiber Director March 8, 2000
______________________________________
John G. Schreiber
/s/ Harry L. Vincent, Jr. Director March 8, 2000
______________________________________
Harry L. Vincent, Jr.
142
SCHEDULE III
Page 1 of 3
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1999
(in millions)
Gross Amount at
Initial Costs December 31, 1999
----------------- Subsequent ------------------------ Date of
Buildings & Costs Buildings & Accumulated Completion of Date
Description Debt Land Improvements Capitalized Land Improvements Total Depreciation Construction Acquired
----------- ------ ---- ------------ ----------- ---- ------------ ------ ------------ ------------- --------
Full-service hotels:
New York Marriott
Marquis Hotel,
New York, NY...... $ 269 $-- $ 552 $ 45 $-- $ 597 $ 597 $(162) 1986 n/a
Other full-service
properties, each
less than 5% of
total............. $2,040 $749 $5,510 $505 $687 $6,077 $6,764 $(677) various various
------ ---- ------ ---- ---- ------ ------ -----
Total full-
service......... 2,309 749 6,062 550 687 6,674 7,361 (839)
Other properties,
each less than 5%
of total.......... -- 40 27 (54) -- 13 13 (14) various n/a
------ ---- ------ ---- ---- ------ ------ -----
Total........... $2,309 $789 $6,089 $496 $687 $6,687 $7,374 $(853)
====== ==== ====== ==== ==== ====== ====== =====
Depreciation
Description Life
----------- ------------
Full-service hotels:
New York Marriott
Marquis Hotel,
New York, NY...... 40
Other full-service
properties, each
less than 5% of
total............. 40
Total full-
service.........
Other properties,
each less than 5%
of total.......... various
Total...........
143
SCHEDULE III
Page 2 of 3
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1999
(in millions)
Notes:
(A) The change in total cost of properties for the fiscal years ended December
31, 1999 and 1998, and January 2, 1998 is as follows:
Balance at January 3, 1997........................................... $3,856
Additions:
Acquisitions....................................................... 1,459
Capital expenditures............................................... 117
Transfers from construction-in-progress............................ 30
Deductions:
Dispositions and other............................................. (145)
------
Balance at January 2, 1998......................................... 5,317
Additions:
Acquisitions....................................................... 2,849
Capital Expenditures............................................... 46
Transfers from construction-in-progress............................ 14
Deductions:
Dispositions and other............................................. (91)
Transfers to Non-Controlled Subsidiary............................. (139)
Transfers to Spin-Off (Crestline Capital Corporation).............. (643)
------
Balance at December 31, 1998....................................... 7,353
Additions:
Acquisitions....................................................... 100
Capital expenditures............................................... 69
Transfers from construction-in-progress............................ 7
Other.............................................................. 40
Deductions:
Dispositions....................................................... (195)
------
Balance at December 31, 1999....................................... $7,374
======
144
SCHEDULE III
Page 3 of 3
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1999
(in millions)
(B) The change in accumulated depreciation and amortization of real estate
assets for the fiscal years ended December 31, 1998, January 2, 1998 and
January 3, 1997 is as follows:
Balance at January 3, 1997............................................. $411
Depreciation and amortization.......................................... 126
Dispositions and other................................................. (31)
----
Balance at January 2, 1998............................................. 506
Depreciation and amortization.......................................... 132
Dispositions and other................................................. (13)
Transfers to Non-Controlled Subsidiary................................. (29)
Transfers to Spin-Off (Crestline Capital Corporation).................. (21)
----
Balance at December 31, 1998........................................... 575
Depreciation and amortization.......................................... 243
Dispositions........................................................... (4)
Other.................................................................. 39
----
Balance at December 31, 1999........................................... $853
====
(C) The aggregate cost of properties for Federal income tax purposes is
approximately $5,221 million at December 31, 1999.
(D) The total cost of properties excludes construction-in-progress properties.
145