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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarter ended June 14, 2002.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 001-14625
HOST MARRIOTT CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
Maryland 53-0085950
(State of Incorporation) (I.R.S. Employer Identification No.)
10400 Fernwood Road, Bethesda, Maryland 20817
(Address of Principal Executive Offices) (Zip Code)
(Registrant's telephone number, including area code) (301) 380-9000
(Former name, former address and former fiscal year, if changed since last
report) Not Applicable
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [_] No
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
The registrant had 264,908,016 shares of its $0.01 par value common stock
outstanding as of July 15, 2002.
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INDEX
Page No.
--------
Part I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets-
June 14, 2002 and December 31, 2001 ...................................... 3
Condensed Consolidated Statements of Operations-
Twelve Weeks and Twenty-four Weeks Ended
June 14, 2002 and June 15, 2001 .......................................... 4
Condensed Consolidated Statements of Cash Flows-
Twenty-four Weeks Ended June 14, 2002 and June 15, 2001 .................. 6
Notes to Condensed Consolidated Financial Statements ........................ 8
ITEM 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition ....................................... 12
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk. ................. 22
PART II. OTHER INFORMATION AND SIGNATURE
ITEM 1. Legal Proceedings ........................................................... 23
ITEM 4. Submission of Matters to a Vote of Security Holders ......................... 23
ITEM 5. Other Items ................................................................. 24
ITEM 6. Exhibits and Reports on Form 8-K ............................................ 41
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
June 14, December 31,
2002 2001
----------- ------------
(unaudited)
ASSETS
------
Property and equipment, net .............................................................. $ 7,159 $ 6,999
Notes and other receivables (including amounts due from affiliates of $6 million and
$6 million, respectively) ............................................................. 54 54
Due from Managers ........................................................................ 150 141
Investments in affiliates ................................................................ 143 142
Other assets ............................................................................. 586 536
Restricted cash .......................................................................... 124 114
Cash and cash equivalents ................................................................ 243 352
----------- -----------
$ 8,459 $ 8,338
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Debt
Senior notes .......................................................................... $ 3,232 $ 3,235
Mortgage debt ......................................................................... 2,313 2,261
Other ................................................................................. 105 106
----------- -----------
5,650 5,602
Accounts payable and accrued expenses .................................................... 115 121
Other liabilities ........................................................................ 310 321
----------- -----------
Total liabilities ................................................................... 6,075 6,044
----------- -----------
Minority interest ........................................................................ 247 210
Company-obligated mandatorily redeemable convertible preferred securities of a
subsidiary whose sole assets are convertible subordinated debentures due 2026
("Convertible Preferred Securities") .................................................. 475 475
Shareholders' equity
Cumulative redeemable preferred stock (liquidation preference $354 million),
50 million shares authorized; 14.1 million shares issued and outstanding .............. 339 339
Common stock, par value $.01, 750 million shares authorized; 264.8 million shares
and 263.2 million shares issued and outstanding, respectively ......................... 3 3
Additional paid-in capital ............................................................... 2,095 2,051
Accumulated other comprehensive loss ..................................................... (2) (5)
Deficit .................................................................................. (773) (779)
----------- -----------
Total shareholders' equity .......................................................... 1,662 1,609
----------- -----------
$ 8,459 $ 8,338
=========== ===========
See Notes to Condensed Consolidated Statements
-3-
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Twelve and Twenty-four Weeks Ended June 14, 2002 and June 15, 2001
(unaudited, in millions, except per share amounts)
Twelve Weeks Ended Twenty-four Weeks Ended
------------------------ ------------------------
June 14, June 15, June 14, June 15,
2002 2001 2002 2001
---------- ---------- ---------- ----------
REVENUES
Rooms .................................................. $ 543 $ 590 $ 1,008 $ 1,112
Food and beverage ...................................... 288 295 532 548
Other .................................................. 65 73 120 137
---------- ---------- ---------- ----------
Total hotel sales .................................... 896 958 1,660 1,797
Rental income .......................................... 24 36 50 70
---------- ---------- ---------- ----------
Total revenues ....................................... 920 994 1,710 1,867
---------- ---------- ---------- ----------
OPERATING COSTS AND EXPENSES
Rooms .................................................. 129 135 240 256
Food and beverage ...................................... 205 208 380 399
Hotel departmental costs and deductions ................ 225 232 421 440
Management fees ........................................ 44 54 80 106
Taxes, insurance, and other property-level expenses .... 72 75 134 140
Depreciation and amortization .......................... 84 100 168 177
Corporate expenses ..................................... 7 9 20 17
Other expenses ......................................... 5 5 9 7
Lease repurchase expense ............................... -- 5 -- 5
---------- ---------- ---------- ----------
OPERATING PROFIT ......................................... 149 171 258 320
Minority interest expense .............................. (6) (11) (11) (26)
Interest income ........................................ 4 12 7 20
Interest expense ....................................... (106) (104) (211) (207)
Net gains on property transactions ..................... 1 -- 2 1
Equity in earnings (losses) of affiliates .............. 1 2 (3) 4
Dividends on Convertible Preferred Securities .......... (8) (8) (15) (15)
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES ............................... 35 62 27 97
Provision for income taxes ............................... (11) (12) (15) (15)
---------- ---------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS ........................ 24 50 12 82
DISCONTINUED OPERATIONS
Income (loss) from operations ............................ -- (1) 7 (1)
---------- ---------- ---------- ----------
INCOME BEFORE EXTRAORDINARY ITEMS ........................ 24 49 19 81
Extraordinary gain on the extinguishment of debt ......... -- -- 6 --
---------- ---------- ---------- ----------
NET INCOME ............................................... $ 24 $ 49 $ 25 $ 81
========== ========== ========== ==========
Less: Dividends on Preferred Stock ....................... (9) (9) (18) (14)
---------- ---------- ---------- ----------
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS .............. $ 15 $ 40 $ 7 $ 67
========== ========== ========== ==========
See Notes to Condensed Consolidated Statements
-4-
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
Twelve and Twenty-four Weeks Ended June 14, 2002 and June 15, 2001
(unaudited, in millions, except per share amounts)
Twelve Weeks Ended Twenty-four Weeks Ended
------------------------ -----------------------
June 14, June 15, June 14, June 15,
2002 2001 2002 2001
---------- ---------- ---------- ---------
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Continuing operations ................................. $ .06 $ .17 $ (.02) $ .28
Discontinued operations ............................... -- -- .03 --
Extraordinary gain .................................... -- -- .02 --
---------- ---------- ---------- ---------
BASIC EARNINGS PER COMMON SHARE ......................... $ .06 $ .17 $ .03 $ .28
========== ========== ========== =========
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Continuing operations ................................. $ .06 $ .16 $ (.02) $ .28
Discontinued operations ............................... -- -- .03 --
Extraordinary gain .................................... -- -- .02 --
---------- ---------- ---------- ---------
DILUTED EARNINGS PER COMMON SHARE ....................... $ .06 $ .16 $ .03 $ .28
========== ========== ========== =========
See Notes to Condensed Consolidated Statements
-5-
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Twenty-four Weeks Ended June 14, 2002 and June 15, 2001
(unaudited, in millions)
2002 2001
----------- -----------
OPERATING ACTIVITIES
Net income from continuing operations ............................ $ 12 $ 82
Adjustments to reconcile to cash from operations:
Depreciation and amortization ................................ 168 177
Deferred income taxes ........................................ 5 (11)
Deferred contingent rental income ............................ 2 15
Net gains on property transactions ........................... (2) (1)
Equity in earnings of affiliates ............................. 3 (4)
Purchase of Crestline leases ................................. -- (204)
Changes in other operating accounts .......................... (23) 10
Other ........................................................ 11 (15)
----------- -----------
Cash provided by operations ............................. 176 49
----------- -----------
INVESTING ACTIVITIES
Acquisitions ..................................................... (117) (2)
Capital expenditures:
Capital expenditures for renewals and replacements ........... (80) (102)
New investment capital expenditures .......................... (10) (30)
Other investments ............................................ (6) (12)
Note receivable collections, net ................................. -- 10
----------- -----------
Cash used in investing activities ....................... (213) (136)
----------- -----------
FINANCING ACTIVITIES
Issuances of debt, net of financing costs ........................ (7) 121
Scheduled principal repayments ................................... (36) (23)
Debt prepayments ................................................. -- (115)
Issuances of common stock ........................................ 1 2
Issuances of cumulative redeemable preferred stock, net .......... -- 144
Dividends ........................................................ (18) (130)
Other ............................................................ (12) (8)
----------- -----------
Cash used in financing activities ....................... (72) (9)
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS ............................ $ (109) $ (96)
=========== ===========
See Notes to Condensed Consolidated Statements
-6-
HOST MARRIOTT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Twenty-four Weeks Ended June 14, 2002 and June 15, 2001
(unaudited, in millions)
Supplemental schedule of noncash investing and financing activities:
During the twenty-four weeks ended June 14, 2002 and June 15, 2001, we issued
1.6 million and 42.8 million common shares, respectively. Of the shares issued,
approximately 353,000 shares and 41.4 million shares of common stock were held
by minority partners issued upon the conversion of operating partnership units
(OP Units) held by minority partners valued at $3.9 million and $540.8 million,
respectively.
Included in the 1.6 million common shares issued during 2002, 1.1 million shares
were issued to acquire minority interests in the partnership owning the San
Diego Marina Marriott hotel. This transaction resulted in an increase to
property and equipment of $10.5 million to reflect the fair value of the
interest acquired. During April 2002, the Company increased its ownership
percentage in the partnership that owns the hotel to 90% as a result of the
exchange by the minority partners in San Diego of partnership units in the hotel
for approximately 6.9 million OP Units. The Company has agreed to promptly
register approximately 6.9 million shares of its common stock for resale by such
holders upon their conversion of the OP Units. The transaction resulted in an
increase in property and equipment of $56.1 million and a corresponding increase
in minority interest and equity to reflect the fair value of the interest
acquired.
During January 2002, the Company transferred the St. Louis Marriott Pavilion to
the mortgage lender. The Company recorded the difference between the debt
extinguished and the fair value of the assets surrendered of $9.6 million, net
of tax expense of $3.6 million, as a $6 million extraordinary item. The Company
also recorded the operations of the hotel transferred, net of tax, as income
from discontinued operations.
On June 14, 2002, the Company acquired the Boston Marriott Copley Place in
Boston, Massachusetts for a cash purchase price of $117 million and an
assumption of $97 million of mortgage debt.
See Notes to Condensed Consolidated Statements
-7-
HOST MARRIOTT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Organization
Host Marriott Corporation ("Host REIT" or the "Company"), a Maryland
corporation operating through an umbrella partnership structure, is
primarily the owner of hotel properties. Host REIT operates as a
self-managed and self-administered real estate investment trust ("REIT")
with its operations conducted through an operating partnership, Host
Marriott, L.P. (the "Operating Partnership" or "Host LP"), and its
subsidiaries, which issues units of partnership interest ("OP Units").
Host REIT is the sole general partner of the Operating Partnership and as
of June 14, 2002, owns approximately 90% of the Operating Partnership.
2. Summary of Significant Accounting Policies
The accompanying condensed consolidated financial statements of the
Company and its subsidiaries have been prepared without audit. Certain
information and footnote disclosures normally included in financial
statements presented in accordance with accounting principles generally
accepted in the United States have been condensed or omitted. The Company
believes the disclosures made are adequate to make the information
presented not misleading. However, the unaudited condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's annual
report on Form 10-K for the fiscal year ended December 31, 2001.
In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments necessary to
present fairly the financial position of the Company as of June 14, 2002,
the results of its operations for the twelve and twenty-four weeks ended
June 14, 2002 and June 15, 2001, and cash flows for the twenty-four weeks
ended June 14, 2002 and June 15, 2001. Interim results are not necessarily
indicative of fiscal year performance because of the impact of seasonal
and short-term variations.
Certain reclassifications have been made to the prior year financial
statements to conform to the current presentation.
The Company consolidates entities in which it owns a controlling financial
interest (generally, when it owns over 50% of the voting shares of another
company or, in the case of partnership investments, when the Company owns
the general partnership interest). In all cases, the Company considers the
impact on the Company's financial control of the ability of minority
shareholders or other partners to participate in or block management
decisions. All material intercompany transactions and balances have been
eliminated.
Revenue from operations of the Company's hotels not leased to third
parties is recognized when the services are provided. For the Company's
hotels leased to third parties, rental income is recorded when due and is
the greater of base rent or percentage rent, as defined. Percentage rent
received pursuant to the leases, but not recognized as revenue until all
contingencies have been met is deferred and included on the balance sheet
in other liabilities. Contingent rental revenue of $1 million and $8
million for the twelve weeks ended June 14, 2002 and June 15, 2001,
respectively, and $2 million and $15 million for the twenty-four weeks
ended June 14, 2002 and June 15, 2001, respectively, has been deferred.
Contingent rent in the first and second quarters of 2001 related to four
full-service and certain limited service hotel leases. Effective June 16,
2001, the Company purchased the four full service hotel leases and,
accordingly, all contingent rent subsequently recorded has been for the
limited service hotel leases.
-8-
HOST MARRIOTT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. Earnings Per Share
Basic earnings per common share is computed by dividing net income
available to common shareholders by the weighted average number of shares
of common stock outstanding. Diluted earnings per share is computed by
dividing net income available to common shareholders as adjusted for
potentially dilutive securities, by the weighted average number of shares
of common stock outstanding plus other potentially dilutive securities.
Dilutive securities may include shares granted under comprehensive stock
plans, common and preferred OP Units held by minority partners, minority
interests that have the option to convert their limited partnership
interest to common OP Units and the Convertible Preferred Securities. No
effect is shown for securities if they are anti-dilutive.
Twelve weeks ended
------------------------------------------------------------------------
June 14, 2002 June 15, 2001
----------------------------------- ----------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------------------------------- -----------------------------------
(in millions, except per share amount)
Net income ....................................... $ 24 264.7 $ .09 $ 49 241.0 $ .20
Dividends on preferred stock .................... (9) -- (.03) (9) -- (.03)
--------- --------- --------- --------- --------- ---------
Basic income available to common
shareholders .................................... 15 264.7 .06 40 241.0 .17
Assuming distribution of common shares
granted under the comprehensive stock
plan, less shares assumed purchased at
average market price .......................... -- 3.2 -- -- 3.8 --
Assuming conversion of minority OP Units
issuable ...................................... -- -- -- 1 9.3 (.01)
--------- --------- --------- --------- --------- ---------
Diluted earnings ................................. $ 15 267.9 $ .06 $ 41 254.1 $ .16
========= ========= ========= ========= ========= =========
Twenty-four weeks ended
------------------------------------------------------------------------
June 14, 2002 June 15, 2001
----------------------------------- ----------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------------------------------- -----------------------------------
(in millions, except per share amount)
Net income ....................................... $ 25 264.1 $ .09 $ 81 235.1 $ .34
Dividends on preferred stock .................... (18) -- (.06) (14) -- (.06)
--------- --------- --------- --------- --------- ---------
Basic income available to common
shareholders .................................... 7 264.1 .03 67 235.1 .28
Assuming distribution of common shares
granted under the comprehensive stock
plan, less shares assumed purchased at
average market price .......................... -- -- -- -- 4.2 --
--------- --------- --------- --------- --------- ---------
Diluted earnings ................................. $ 7 264.1 $ .03 $ 67 239.3 $ .28
========= ========= ========= ========= ========= =========
4. Equity Transactions
During February 2002, the Company filed a shelf registration statement for
1.1 million shares of its common stock to be issued in exchange for
partnership interests held by the minority partners in the partnership
that owns the San Diego Marina Marriott hotel. On March 15, 2002, the
minority partners sold the 1.1 million common shares to an underwriter for
resale on the open market.
-9-
HOST MARRIOTT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Concurrent with the issuance of the common shares, the Operating
Partnership issued to the Company an equivalent number of OP Units. Also,
in April 2002, the Company acquired an additional interest in the San
Diego Marina Marriott hotel through the issuance of 6.9 million OP Units
to certain minority partners in exchange for their partnership interests.
These transactions reduced the Company's ownership percentage in the
Operating Partnership to 90% and resulted in an increase to property and
equipment of $66.6 million to reflect the fair value of the interest
acquired. As a result of the acquisition, the Company now owns
approximately 90% of the interests in the partnership that owns the hotel.
The minority partner continues to receive fees for marketing and other
services, which totaled $1.7 million and $2.0 million for the twenty-four
weeks ended June 14, 2002 and June 15, 2001, respectively.
5. Debt
Effective June 6, 2002, the Company completed negotiations on a new
credit facility with an aggregate revolving commitment of up to $400
million. The credit facility has an initial three-year term with an
option to extend for an additional year if certain conditions are met.
Interest on borrowings under the credit facility will be calculated
based on a spread over LIBOR that will vary based on the Company's
leverage ratio. The Company is required to pay a quarterly commitment
fee that will vary based on the amount of unused capacity under the
credit facility. Currently, the commitment fee is .55%. As of June 14,
2002 no amounts have been drawn on the credit facility.
The new credit facility establishes financial covenants for leverage,
interest coverage, fixed charge coverage and unsecured interest coverage
at levels that are generally less stringent than those that would have
been applicable under the prior facility. The new credit facility also
imposes other customary covenants and restrictions. In many cases, the
covenants have been modified to be comparable with the requirements under
the senior note indenture.
In the event we do not satisfy a minimum interest coverage ratio and
certain other conditions both the new credit facility and the senior note
indenture restrict the Company's ability to incur debt, except debt
incurred under the credit facility or in connection with a refinancing of
existing debt. In addition, failure to satisfy this ratio will restrict
the Company's ability to declare and pay dividends, except dividends
necessary to maintain its status as a REIT. As a result of the effect on
our business of the September 11 terrorist attacks and the 2001 recession
we did not meet our specified minimum interest coverage ratio beginning in
the third quarter. Accordingly, we are subject to the restrictions
discussed above, although we may take certain actions to achieve
compliance on a pro forma basis.
In connection with its acquisition of Boston Marriott Copley Place
discussed below, on June 14, 2002 the Company assumed $97 million of
mortgage debt. The mortgage bears interest at a fixed rate of 8.39% and is
due on June 1, 2006.
6. Acquisitions
Effective June 14, 2002, the Company completed the acquisition of the
1,139-room Boston Marriott Copley Place. The $214 million purchase price
consisted of a $117 million cash payment and the assumption of $97 million
in mortgage debt.
7. Dividends
On June 17, 2002, the Company announced that the Board of Directors had
declared a quarterly cash dividend of $0.625 per share for each class of
preferred stock. The second quarter preferred stock dividend was paid on
July 15, 2002 to shareholders of record on June 28, 2002.
-10-
HOST MARRIOTT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
8. Geographic Information
The Company's foreign operations consist of four hotel properties located
in Canada and two hotel properties located in Mexico. The hotels in Mexico
were acquired in the second quarter of 2001 as a result of the purchase of
the remaining outside interests in Rockledge Hotel Properties, Inc. There
were no intercompany sales between the properties and the Company. The
following table presents revenues (in millions) for each of the
geographical areas in which the Company owns hotels.
Twelve Weeks Ended Twenty-four Weeks Ended
---------------------------------- ----------------------------------
June 14, 2002 June 15, 2001 June 14, 2002 June 15, 2001
-------------- -------------- -------------- --------------
United States .................. $ 891 $ 962 $ 1,660 $ 1,820
International .................. 29 32 50 47
-------------- -------------- -------------- --------------
Total ...................... $ 920 $ 994 $ 1,710 $ 1,867
============== ============== ============== ==============
9. Comprehensive Income
The Company's other comprehensive income consists of unrealized gains and
losses on foreign currency translation adjustments and the right to
receive cash from HMSHost Corporation subsequent to the exercise of the
options held by certain former and current employees of Marriott
International, pursuant to the distribution agreement between the Company
and HMSHost Corporation. For the twelve weeks and twenty-four weeks ended
June 14, 2002, comprehensive income totaled $25 million and $28 million,
respectively. Comprehensive income was $54 million and $83 million for the
twelve and twenty-four weeks ended June 15, 2001, respectively. As of June
14, 2002, the Company's accumulated other comprehensive loss was $2
million compared to a cumulative loss of $5 million as of December 31,
2001.
10. Subsequent Events
On July 25, 2002, we completed our negotiations with Marriott
International of changes to the management and other agreements for
substantially all of our Marriott- and Ritz-Carlton-managed hotels. We
believe that these changes, which are effective as of December 29,
2001, will provide meaningful benefits to us. We estimate that the
cash flow benefit from these modifications will be approximately $8
million in 2002 and increase to approximately $25 million by 2006, of
which approximately two-thirds is related to cost reductions and other
benefits and one-third is related to reduction in incentive management
fees. The management contract changes include the following:
. Providing additional approval rights over hotel operating budgets,
capital budgets, shared service programs, and changes to certain
system wide programs;
. Reducing the amount of working capital requirements, and expanding an
existing agreement that allows us to fund FF&E expenditures as
incurred from a consolidated account rather than escrowing funds
at the hotel level, which collectively increases cash available to
us for general corporate purposes by approximately $125 million;
. Reducing incentive management fees payable on Marriott-managed hotels;
. Reducing the amount we pay related to frequent guest programs;
. Gradually reducing the amounts payable with respect to various
centrally administered programs; and,
. Providing additional territorial restrictions for certain hotels in 10
markets.
In addition to these modifications, we have expanded the pool of hotels
subject to an existing agreement that allows us to sell assets
unencumbered by a Marriott management agreement without the payment of
termination fees. The revised pool will include forty-six assets, 75%
(measured by EBITDA) of which may be sold over approximately a ten year or
greater period. This flexibility will enhance the value of these assets
and our ability to recycle capital.
We have also agreed to terminate Marriott International's right to
purchase up to 20% of each class of our outstanding voting shares upon
certain changes of control and to clarify existing provisions in the
management agreements that limit our ability to sell a hotel or our
company to a competitor of Marriott International.
-11-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Forward-looking Statements
Certain Statements contained in this report constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. We have based these forward-looking statements on our current expectations
and projections about future events. We identify forward-looking statements in
this Report by using words or phrases such as "believe," "expect," "may be,"
"intend," "predict," "project," "plan," "objective," "will be," "should,"
"estimate," or "anticipate," or the negative thereof or other variations thereof
or comparable terminology. All forward-looking statements are not guarantees of
future performance and involve known and unknown risks, uncertainties and other
factors which may cause our actual transactions, results, performance or
achievements to be materially different from any future transactions, results,
performance or achievements expressed or implied by such forward-looking
statements. These risks and uncertainties include the risks discussed elsewhere
in this Report. Although we believe the expectations reflected in such
forward-looking statements are based upon reasonable assumptions, we can give no
assurance that we will attain these expectations or that any deviations will not
be material. Except as otherwise required by the federal securities laws, we
disclaim any obligations or undertaking to publicly release any updates or
revisions to any forward-looking statement contained in this Report to reflect
any change in our expectations with regard thereto or any change in events,
conditions or circumstances on which any such statement is based.
Recent Events
Credit Facility and Senior Notes. On June 6, 2002, we entered into a new credit
facility that provides an aggregate revolving loan commitment amount of up to
$400 million ($300 million of which is available initially, with up to an
additional $100 million becoming available to the extent that our leverage ratio
falls below certain specified levels). The new credit facility also includes
subcommitments for the issuance of letters of credit and loans to certain of our
Canadian subsidiaries in Canadian Dollars, in each case in an amount of up to
$100 million. The new credit facility replaces the prior credit facility. The
new credit facility has an initial scheduled maturity in June 2005. We have an
option to extend the maturity for an additional year if certain conditions are
met at the time of the initial scheduled maturity.
As with the prior facility, the debt under the new credit facility is guaranteed
by certain of our existing subsidiaries and is currently secured by pledges of
equity interests in many of our subsidiaries. Unlike the prior facility, all or
a portion of the pledges can be released in the event that our pro forma
leverage ratio, as defined in the credit facility, falls below a certain level
for two consecutive fiscal quarters. The spread we pay over LIBOR on borrowings
under the new credit facility will adjust based on our leverage ratio. We also
will pay a quarterly commitment fee of .55% on the unused portion of the
available loan commitment. Currently, we have no amounts outstanding under the
credit facility.
The new credit facility establishes financial covenants for leverage, interest
coverage, fixed charge coverage and unsecured interest coverage at levels that
are generally less stringent than those that would have been applicable under
the prior facility. The new credit facility also imposes other customary
covenants and restrictions. In many cases, the covenants have been modified to
be comparable with the requirements under our senior note indenture.
In the event we do not satisfy a minimum interest coverage ratio and certain
other conditions, both the new credit facility and our senior note indenture
restrict our ability to incur debt, except debt incurred under our new credit
facility or in connection with a refinancing of existing debt. In addition,
failure to satisfy this ratio will restrict our ability to declare and pay
dividends, except dividends necessary to maintain our status as a REIT. As a
result of the effect on our business of the September 11 terrorist attacks and
the 2001 recession we did not meet our specified minimum interest coverage ratio
beginning in the third quarter. Accordingly, we are subject to the restrictions
discussed
-12-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
above, although we may take certain actions to achieve compliance on a pro forma
basis. These actions include, among others, retiring existing debt, swapping
certain of our fixed interest rate debt for lower floating interest rate debt or
the acquisition of less leveraged properties. While we believe that we have the
ability to complete these actions, there can be no assurance that these options
will be available to us later in the year, or if available, that these options
would be at a price that would be acceptable.
We have $3.2 billion of senior notes outstanding as of June 14, 2002. On June
25, 2002, the $450 million of outstanding 9 1/2% Series H notes were exchanged
for 9 1/2% Series I notes. The terms of the Series I notes are substantially
identical to the terms of the Series H notes except that the Series I notes are
registered under the Securities Act of 1933 and are, therefore, freely
transferable.
Hotel Acquisition. Effective June 14, 2002 we completed the acquisition of the
1,139-room Boston Marriott Copley Place for $214 million consisting of a $117
million cash payment and the assumption of $97 million in mortgage debt. The
property is located in downtown Boston, Massachusetts and is part of a 3.7
million square foot high-end mixed use development, which includes 200 upscale
retail shops and restaurants and is adjacent to the Hynes Convention Center. The
acquisition is consistent with our strategy of buying upper-upscale properties
in hard to duplicate urban, convention and resort locations. We believe that the
Boston market has been particularly hard hit by the slowdown in the economy in
recent years and that, as a result, should benefit from an eventual improvement
in business in this market.
Insurance Coverage. The insurance markets nationwide were significantly affected
by the terrorist attacks on September 11, 2001 and as a result it has become
more difficult and more expensive to obtain adequate insurance coverage. We
recently obtained new comprehensive insurance policies including general
liability, property, business interruption and other risks with respect to all
of our properties. We believe our insurance coverage is appropriate to protect
our properties. However, the terrorism coverage we have obtained excludes
various risks such as nuclear or biological acts, and is subject to annual
aggregate limits. For our Marriott-operated properties, these aggregate limits
are shared among various properties including other properties managed by
Marriott International that are not owned by us. The insurance on our
Non-Marriott branded properties has been renewed under similar terms, except
that this coverage is not shared among other owners. Additionally, our new
policies have significantly higher premiums, although these costs should remain
at less than 0.1% of our annual revenues. We estimate that insurance costs for
these hotel-related property and terrorism insurance policies will increase
approximately $13 million to $25 million in 2002.
In addition, our debt agreements typically require us to maintain a minimum
rating of our insurance carrier from Standard & Poors, A.M. Best or other rating
agencies. Currently, we do not satisfy the requirement for a minimum Standard &
Poors rating of AA for seven of our properties subject to approximately $739
million of indebtedness. We have notified our lenders regarding this situation,
and we have obtained, for certain of our Marriott-managed properties that have
mortgage debt, insurance coverage provided by a carrier with a rating from
Standard & Poors of AA- and a rating from A.M. Best of A+XV. However, we cannot
assure you that each of our lenders will be satisfied with the AA- rating level
of our current carrier. If the lenders are unwilling or unable to amend or waive
these covenants, or if we are unable to obtain insurance coverage that complies
with the covenants in these loan agreements the lenders may determine that we
are out of compliance with the terms of the relevant debt agreement in which
case to the extent the lenders chose to pursue their remedies and we were unable
to prevent this course of action we may be required to refinance the debt, with
debt carrying different insurance requirements. There can be no assurances that
we will be able to complete such a refinancing on terms acceptable to us or at
all. We describe changes to our insurance coverage and the risks related thereto
in Part II, Item 5 of this report.
Management and Other Agreements. On July 25, 2002, we completed our negotiations
with Marriott International of changes to the management and other agreements
for substantially all of our Marriott- and Ritz-Carlton-managed hotels. We
believe that these changes, which are effective as of December 29, 2001, will
provide meaningful benefits to us. We estimate that the cash flow benefit from
these modifications will be approximately $8 million in 2002 and increase to
approximately $25 million by 2006, of which approximately two-thirds is related
to cost reductions and other benefits and one-third is related to reduction in
incentive management fees. The management contract changes include the
following:
. Providing additional approval rights over hotel operating budgets,
capital budgets, shared service programs, and changes to certain
system wide programs;
. Reducing the amount of working capital requirements, and expanding an
existing agreement that allows us to fund FF&E expenditures as
incurred from a consolidated account rather than escrowing funds
at the hotel level, which collectively increases cash available to
us for general corporate purposes by approximately $125 million;
. Reducing incentive management fees payable on Marriott-managed hotels;
. Reducing the amount we pay related to frequent guest programs;
. Gradually reducing the amounts payable with respect to various
centrally administered programs; and,
. Providing additional territorial restrictions for certain hotels in 10
markets.
In addition to these modifications, we have expanded the pool of hotels
subject to an existing agreement that allows us to sell assets
unencumbered by a Marriott management agreement without the payment of
termination fees. The revised pool will include forty-six assets, 75%
(measured by EBITDA) of which may be sold over approximately a ten year or
greater period. This flexibility will enhance the value of these assets
and our ability to recycle capital.
We have also agreed to terminate Marriott International's right to
purchase up to 20% of each class of our outstanding voting shares upon
certain changes of control and to clarify existing provisions in the
management agreements that limit our ability to sell a hotel or our
company to a competitor of Marriott International.
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HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Change in Certifying Accountant. On May 22, 2002, upon the recommendation of our
Audit Committee, the Board of Directors dismissed Arthur Andersen LLP as the
Company's independent auditors and appointed KPMG LLP to serve as Host
Marriott's independent auditors for the current fiscal year, which ends on
December 31, 2002. The change in auditors was effective on May 22, 2002.
Increase in Ownership of San Diego Marina Hotel. We own our interest in the San
Diego Marriott Marina hotel through a partnership with outside investors. These
outside investors have a right to exchange their hotel partnership interests for
OP Units. In April 2002, the investors elected to exchange 6,875,844 partnership
units for OP Units, which increased our ownership in the partnership that owns
the hotel from a 51% interest to a 90% interest. The minority partner continues
to receive fees for marketing and other services, which totaled $1.7 million and
$2.0 million for the twenty-four weeks ended June 14, 2002 and June 15, 2001,
respectively. We have agreed to promptly register the equivalent shares of
common stock with the SEC for resale by such investors upon conversion of their
OP Units. We would receive no proceeds from the sale of these shares.
Lodging Performance
For the second quarter of 2002, RevPAR for comparable hotels decreased
approximately 9.8% when compared to the same period in 2001. The decline is the
result of a decrease in average occupancy of 1.6 percentage points and the
decline of average room rates of 7.9%. Also, year-to-date RevPAR decreased
11.0%, as occupancy decreased 1.9 percentage points and room rates declined by
8.6%. A significant portion of the decline in room rate is a result of the
change in the mix of business to lower rated group and transient segments rather
than simply a reduction in room rate. If the rate of economic growth continues
to improve and airline travel increases, we expect it to create a rising demand
for our properties, particularly amongst individual business travelers, a
segment which typically pays a higher rate.
-14-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The changes in our RevPAR reflect a decline in operations in every region for
the quarter and year-to-date; however, the decreases in RevPAR varied across the
country. For example, our hotels in the Pacific region had a significant decline
as a result of a weakened technology industry, declining attendance at citywide
events and significant reductions in airline travel to the San Francisco
Airport. RevPAR for the twenty-four weeks ended June 14, 2002 at our hotels in
San Francisco and Los Angeles declined 27.3% and 19.3%, respectively, when
compared to the same period in 2001. However, our performance in other cities
was much better. For example, our three hotels in Philadelphia and three hotels
in San Antonio had RevPAR improvements of 4.0% and 7.1%, respectively, for the
twenty-four week period ended June 14, 2002. These cities were able to take
advantage of strong convention sales to generate an increase in RevPAR.
The charts below set forth performance information for our comparable
properties as of June 14, 2002:
Comparable by Region
Twelve Weeks Ended
As of June 14, 2002 June 14, 2002 June 15, 2001
----------------------- -------------------------------- ---------------------------------
Average Average Percent
No. of No. of Average Occupancy Average Occupancy Change in
Properties (1) Rooms Daily Rate Percentages RevPAR Daily Rate Percentages RevPAR RevPAR
-------------- ------ -------------------------------- --------------------------------- ---------
Atlanta ................ 15 6,563 $ 147.85 69.0% $ 101.99 $ 159.06 70.5% $ 112.08 (9.0)%
DC Metro ............... 13 4,998 144.63 76.9 111.17 160.41 75.0 120.26 (7.6)
Florida ................ 13 7,581 163.43 73.4 119.95 173.42 74.4 129.00 (7.0)
International .......... 4 1,641 97.90 72.9 71.37 105.21 77.1 81.11 (12.0)
Mid-Atlantic ........... 9 6,222 191.15 79.0 150.93 200.35 81.4 163.18 (7.5)
Mountain ............... 8 3,313 107.90 69.3 74.79 116.10 70.6 81.91 (8.7)
New England ............ 6 2,277 134.37 69.1 92.91 158.15 71.7 113.38 (18.1)
North Central .......... 15 5,395 122.52 69.3 84.87 138.57 70.9 98.31 (13.7)
Pacific ................ 23 11,817 155.81 70.2 109.33 173.57 74.5 129.43 (15.5)
South Central .......... 12 6,515 134.14 81.0 108.66 140.18 79.1 110.86 (2.0)
------- -------
All Regions ....... 118 56,322 148.17 73.2 108.42 160.94 74.8 120.26 (9.8)
======= =======
Comparable by Region
Twenty-four Weeks Ended
As of June 14, 2002 June 14, 2002 June 15, 2001
----------------------- -------------------------------- ---------------------------------
Average Average Percent
No. of No. of Average Occupancy Average Occupancy Change in
Properties (1) Rooms Daily Rate Percentages RevPAR Daily Rate Percentages RevPAR RevPAR
-------------- ------ -------------------------------- --------------------------------- ---------
Atlanta ................ 15 6,563 $ 145.52 69.1% $ 100.50 $ 158.25 71.6% $ 113.25 (11.3)%
DC Metro ............... 13 4,998 140.51 70.2 98.66 159.82 70.3 112.35 (12.2)
Florida ................ 13 7,581 168.41 76.4 128.65 182.96 77.4 141.60 (9.1)
International .......... 4 1,641 96.26 68.7 66.09 103.36 73.3 75.73 (12.7)
Mid-Atlantic ........... 9 6,222 184.29 77.6 143.03 195.91 78.6 153.94 (7.1)
Mountain ............... 8 3,313 117.82 68.9 81.21 120.16 71.9 86.43 (6.0)
New England ............ 6 2,277 127.21 64.0 81.46 148.00 66.8 98.83 (17.6)
North Central .......... 15 5,395 117.92 65.7 77.52 133.45 67.8 90.41 (14.3)
Pacific ................ 23 11,817 156.51 70.3 110.08 177.35 74.5 132.14 (16.7)
South Central .......... 12 6,515 137.17 79.9 109.57 143.53 79.2 113.68 (3.6)
------- -------
All Regions ....... 118 56,322 148.15 72.1 106.81 162.15 74.0 120.06 (11.0)
======= =======
____________
(1) Consists of 118 properties owned, directly or indirectly, by us for the
entire first and second quarters of 2002 and 2001, respectively, excluding
properties with non-comparable operating environments as a result of
acquisitions, dispositions, property damage and expansions and development
projects during the periods being compared.
-15-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The charts below set forth performance information for our entire portfolio as
of June 14, 2002:
All Properties by Region
Twelve Weeks Ended
As of June 14, 2002 June 14, 2002 June 15, 2001
----------------------- -------------------------------- ---------------------------------
Average Average Percent
No. of No. of Average Occupancy Average Occupancy Change in
Properties(1) Rooms(1) Daily Rate Percentages RevPAR Daily Rate Percentages RevPAR RevPAR
---------- ----- -------------------------------- --------------------------------- ---------
Atlanta ................ 15 6,563 $ 147.85 69.0% $ 101.99 $ 159.06 70.5% $ 112.08 (9.0)%
DC Metro ............... 13 4,998 144.63 76.9 111.17 160.41 75.0 120.26 (7.6)
Florida ................ 14 7,876 167.10 72.9 121.78 173.42 74.4 129.00 (5.6)
International .......... 6 2,553 109.88 72.2 79.38 119.09 75.0 89.27 (11.1)
Mid-Atlantic ........... 10 6,726 190.62 78.8 150.14 200.33 81.5 163.35 (8.1)
Mountain ............... 8 3,313 107.87 69.3 74.77 116.60 69.1 80.56 (7.2)
New England ............ 7 3,416 134.85 69.2 93.33 158.15 71.7 113.38 (17.7)
North Central .......... 15 5,395 122.52 69.3 84.87 138.57 70.9 98.31 (13.7)
Pacific ................ 23 11,817 155.81 70.2 109.33 173.75 74.5 129.43 (15.5)
South Central .......... 12 6,515 134.14 81.0 108.66 137.76 78.6 108.34 0.3
------- -------
All Regions ....... 123 59,172 148.78 73.1 108.75 161.31 74.8 120.62 (9.8)
======= =======
All Properties by Region
Twenty-four Weeks Ended
As of June 14, 2002 June 14, 2002 June 15, 2001
----------------------- -------------------------------- ---------------------------------
Average Average Percent
No. of No. of Average Occupancy Average Occupancy Change in
Properties(1) Rooms(1) Daily Rate Percentages RevPAR Daily Rate Percentages RevPAR RevPAR
---------- ----- -------------------------------- --------------------------------- ---------
Atlanta ................ 15 6,563 $ 145.52 69.1% $ 100.50 $ 158.25 71.6% $ 113.25 (11.3)%
DC Metro ............... 13 4,998 140.51 70.2 98.66 159.82 70.3 112.35 (12.2)
Florida ................ 14 7,876 171.79 75.9 130.39 182.96 77.4 141.60 (7.9)
International .......... 6 2,553 109.61 69.2 75.83 112.88 72.8 82.20 (7.8)
Mid-Atlantic ........... 10 6,726 183.48 77.1 141.50 198.51 78.5 155.82 (9.2)
Mountain ............... 8 3,313 117.77 68.9 81.18 125.34 71.4 89.55 (9.4)
New England ............ 7 3,416 127.52 64.1 81.72 148.00 66.8 98.83 (17.3)
North Central .......... 15 5,395 117.92 65.7 77.52 133.45 67.8 90.41 (14.3)
Pacific ................ 23 11,817 156.51 70.3 110.08 177.35 74.5 132.14 (16.7)
South Central .......... 12 6,515 136.78 79.2 108.36 142.10 79.0 112.20 (3.4)
------- -------
All Regions ....... 123 59,172 148.67 72.0 106.97 163.28 74.1 121.00 (11.6)
======= =======
(1) For 2001, the results of operations represent 125 hotels with 60,080 rooms.
During the second quarter of 2001, we began to work with our managers to control
operating costs at our hotels through eliminating management positions, closing
unprofitable operations and other cost control measures. We continued these
measures during the first two quarters of 2002, which resulted in a decrease in
labor costs at the hotels, productivity improvements and lower utility costs.
Additionally, decreases in our hotel margins were partially offset by reduced
incentive management fees and relatively stronger food and beverage results.
However, our ability to achieve significant additional reductions in variable
costs is limited. We believe that we will see less of a year-over-year decline
in margins in the third quarter of 2002 than we saw in the second quarter of
2002. Furthermore, during the fourth quarter we expect margins to improve when
compared to the fourth quarter of 2001 as we experience significant increases in
RevPAR over the exceptionally depressed levels in 2001. For the full year of
2002, we expect an overall decline in comparable property-level operating
margins of 75 to 150 basis points when compared to 2001.
We continue to work with the Port Authority of New York and New Jersey and the
Lower Manhattan Development Corporation to determine how the World Trade Center
site in New York will be redeveloped. We anticipate that it will be several
years before these issues are resolved. We are also working closely with our
insurance companies to resolve our claims related to the destruction of the
-16-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Marriott World Trade Center and the damage to the New York Marriott Financial
Center, including negotiating insurance payments for property damage as well as
business interruption. We reopened the New York Marriott Financial Center on
January 7, 2002. We have received no insurance proceeds for property damage at
the World Trade Center. To the extent that we do, it will be held in escrow by a
trustee until a final resolution on the site is determined.
During 2002, we expect to receive additional business interruption proceeds for
what we believe our operating results would have been absent the terrorist
attacks, although the actual receipt of some of these proceeds may not happen
before December 31, 2002. In addition, special restrictive accounting rules
developed for the events of September 11, 2001 may delay our ability to
recognize a portion of the business interruption advances as income until we
resolve certain contingencies with our insurance providers. Since September 11,
2001, the Company has received $40 million in insurance proceeds with respect to
the two hotels, $10 million of which was received subsequent to June 14, 2002.
Of the $40 million received, we have offset $13 million of operating expenses at
the properties and spent an additional $5 million in building repairs.
Results of Operations
2002 Compared to 2001
Revenues. Hotel sales decreased $62 million, or 6.5%, to $896 million for the
twelve weeks ended June 14, 2002 and decreased $137 million, or 7.6%, to $1,660
million for the twenty-four weeks ended June 14, 2002. This decline reflects the
continued weakness in the lodging industry, primarily as a result of reduced
business travel. We have adjusted our rooms sales mix to reflect this trend and,
as a result, have increased the amount of group business at our properties.
Although group business typically has a lower rate as compared to individual
business travelers, the difference has been mitigated by greater occupancy
levels and additional food and beverage revenues.
Rental income decreased $12 million, or 33.3%, to $24 million for the second
quarter of 2002 compared to the second quarter of 2001 and decreased $20
million, or 28.6% to $50 million for the twenty-four weeks ended June 14, 2002,
when compared to the same period in 2001. Rental income for the twenty-four
weeks ended June 14, 2002 and June 15, 2001 includes: 1) lease income from our
limited service hotel leases of $31 million for both periods, 2) lease income
from full-service hotel leases of $17 million and $37 million, respectively, and
3) office space rental income of $2 million for both periods. We repurchased the
lessee entities with respect to four of the five full-service hotels leased to
third parties effective June 16, 2001, terminating those leases for financial
reporting purposes. As a result, we currently record rental income with respect
to only one full-service hotel.
Operating Costs and Expenses. Operating costs and expenses decreased $52
million, or 6.4%, to $771 million for the second quarter of 2002 compared to the
second quarter of 2001. For the twenty-four weeks ended June 14, 2002, operating
costs and expenses decreased $95 million, or 6.2%, to $1.45 billion from the
same period in 2001. This decline is the result of our efforts to control
operating costs at the hotels and the overall decline in demand. Rental and
other expense for the twenty-four weeks ended June 14, 2002 and June 15, 2001,
includes expense for our limited service hotel leases of $32 million and $33
million, respectively, and office building expenses of $1 million for both
periods. These expenses are included in taxes, insurance and other
property-level expenses on the consolidated statements of operations.
-17-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Depreciation and Amortization. Depreciation and amortization expense decreased
$16 million or 16.0% for the second quarter of 2002 versus the second quarter of
2001, and decreased $9 million or 5.1% year-to-date. The decline in depreciation
expense reflects a $13 million impairment charge due to the reclassification of
certain hotels from held-for-use to held-for-sale recorded during the second
quarter of 2001, the sale of three hotels during the second half of 2001, and
the loss of the Marriott World Trade Center as a result of the September 11th
terrorist attacks. These declines were partially offset by the increased
depreciation related to the opening of the Ritz-Carlton, Naples Golf Resort in
January, 2002 and the consolidation of three hotels and other equipment as a
result of the acquisition of the voting interests in Rockledge Hotel Properties,
Inc. during April 2001.
Corporate Expenses. For the twenty-four weeks ended June 14, 2002, corporate
expenses increased $3 million, primarily as a result of an increase in
stock-based compensation expense related to the increase in the Company's stock
price since year-end.
Minority Interest Expense. The variance in minority interest expense is due in
part to the decrease in the weighted average minority interest ownership in the
Operating Partnership from 17% as of June 15, 2001 to 8% as of June 14, 2002.
The decline is also a reflection of the decrease in our results of operations as
described above.
Equity in Earnings (Losses) of Affiliates. For the twenty-four weeks ended June
14, 2002, equity in losses of affiliates was $3 million compared to equity in
earnings of affiliates of $4 million during the twenty-four weeks ended June 15,
2001. The decrease primarily reflects our share of operating losses on
investments in CBM Joint Venture LLC and JWDC Limited Partnership.
Discontinued Operations. During January of 2002, we transferred the St. Louis
Marriott Pavilion to the mortgage lender in a non-cash transaction. In
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," which we adopted January 1, 2002, the hotel's income from
operations, net of tax, of $7 million was recorded as discontinued operations.
Additionally, the standard requires the reclassification of the previously
reported earnings of the discontinued hotel to discontinued operations. As a
result, for the first two quarters of 2001, we recorded a loss from discontinued
operations of $1 million, net of taxes, for the operations of the St. Louis
Marriott Pavilion.
Extraordinary Gain. During the twenty-four weeks ended June 14, 2002, we
recorded an extraordinary gain, net of tax, of $6 million representing the
extinguishment of debt on the St. Louis Marriott Pavilion, which we transferred
to the lender.
Net Income Available to Common Shareholders. The decrease reflects the
previously discussed changes in operations as well as the increase in dividends
on preferred stock due to the issuance of $144 million Class C preferred stock
during the second quarter of 2001.
Liquidity and Capital Resources
Our principal sources of cash are cash from operations, borrowings under our
revolving credit facility and our ability to obtain additional financing through
various financial markets. In addition, as a result of the recently completed
agreement with Marriott International, we will be receiving approximately $125
million in cash which will be available for general corporate purposes. Our
principal uses of cash are capital expenditures at our properties and payments
on debt and distributions to our equityholders and minority owners of the
operating partnership. We believe our sources of cash will be sufficient to meet
our liquidity needs.
During the twenty-four weeks ended June 14, 2002, we reported a decrease in cash
and cash equivalents of $109 million, primarily a result of $117 million of cash
used for the purchase of the Boston Marriott Copley Place. At June 14, 2002, we
maintained $243 million of cash on hand, no outstanding debt on our
-18-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
credit facility and no significant debt maturities until 2005. Our new long-term
credit facility, which we negotiated during the second quarter, is smaller but
contains less restrictive covenants than our previous facility. We do not
believe we will need to access the credit facility during 2002.
In addition to the recent acquisition of the Boston Marriott Copley, we remain
interested in both single asset and portfolio transactions and expect that over
the next couple of years there will be more opportunities to acquire assets that
are consistent with our target profile. On the disposition front, we are
continuing our efforts to sell non-core assets in slower growth markets that are
not consistent with our preferred portfolio. We are currently forecasting
dispositions of $75 to $100 million this year.
Cash from Operations. During 2002, our cash provided by operations increased by
$127 when compared to the same period in 2001. The increase over prior year is
primarily due to $204 million of operating cash used in the first half of 2001
for the purchase of the Crestline lessee entities, which was offset by the
declining cash from operations at the hotels.
Cash from/used in Investing Activities. Based on our assessment of the current
operating environment and to conserve capital, we have continued our disciplined
approach to capital expenditures during 2002. As a result, capital expenditures
at our properties have decreased by $48 million, or 33.3%, when compared to the
same period in 2001. We have achieved these decreases while focusing on property
maintenance and selected improvements to maintain high quality standards. We
anticipate spending approximately $185 million on capital expenditures in 2002.
As a result of the changes in the management agreements with Marriott
International discussed above, approximately $75 million of funds previously
held in escrow accounts for capital expenditures at certain properties will be
returned to us. While we continue to be obligated to fund capital expenditures
at these properties as such expenditures are approved by us, this modification
will enable us to use the available funds for general corporate purposes on an
ongoing basis. Other investing activity included the purchase of the Boston
Marriott Copley Place for $117 million of cash. The acquisition is consistent
with our strategy of buying upper-upscale properties in hard to duplicate urban,
convention and resort locations.
Cash from/used in Financing Activities. During 2002, the cash used in financing
activities primarily consisted of principal repayments on debt of $36 million
and preferred stock dividend payments of $18 million. On June 17, 2002, the
Company announced that the Board of Directors had declared a dividend of $0.625
per share of Preferred Stock, which was paid on July 15, 2002 to shareholders of
record on June 28, 2002. We have not declared a dividend on our common stock
during 2002. Our policy on paying common dividends has been to distribute the
minimum amount necessary to maintain REIT status, which is generally an amount
equal to our taxable income. We expect to be able to reinstate a minimal
dividend on our common stock during the fourth quarter of 2002 if we continue to
see improvement in our operations. It is our intention to continue to pay
dividends on our QUIPs and preferred stock.
-19-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Aggregate Debt Maturities and Minimum Annual Rental Commitments on
Non-Cancelable Leases. The table below summarizes our obligations for principal
payments on our debt and the minimum lease payments due on our operating leases.
Operating
Senior Notes Mortgage Debt Other Leases /(2)/
-------------- --------------- --------------- ---------------
2002/(1)/ .............. -- 26 -- 58
2003 ................... -- 136 -- 104
2004 ................... -- 83 -- 101
2005 ................... 513 57 3 97
2006 ................... 300 441 -- 95
Thereafter ............. 2,419 1,570 102 1,164
------------- -------------- --------------- ---------------
Total .............. 3,232 2,313 105 1,619
============= ============== =============== ===============
__________
/(1)/ Amounts shown for payments and minimum lease payments due on our
operating leases for 2002 are for the third and fourth quarters of 2002
only.
/(2)/ $839 million of the total operating lease expenditures is for ground
leases on our properties. $693 million of the total operating lease
expenditures above relate to our sale-leaseback relationships with
Hospitality Properties Trust (HPT) with regards to 53 Courtyard
properties and 18 Residence Inn properties. In connection with the
REIT conversion, we sublet the hotels to subsidiaries of Crestline
Capital Corporation (Crestline), now a subsidiary of Barcelo Hotels
and Resorts. Rent due to us under the non- cancelable sublease is
equal to the minimum rent payable by us under the lease with HPT and
includes an additional percentage rent payable to us. The percentage
rent payable under the subleases is sufficient to cover any additional
rent due under the non-recourse HPT lease, which is calculated based on
the hotel sales, and is guaranteed by Crestline, up to a maximum amount
of $30 million. Additionally, $41 million is due under the sublease with
regard to our former restaurant business. None of the $734 million of
rent due us under the subleases is included in the table above.
FFO and EBITDA
We consider Comparative Funds From Operations ("Comparative FFO"), which
consists of Funds From Operations, as defined by the National Association of
Real Estate Investment Trusts, adjusted for significant non-recurring items
detailed in the chart below, and our consolidated earnings before interest
expense, income taxes, depreciation, amortization and other non-cash items
(including contingent rent) ("EBITDA") to be indicative measures of our
operating performance due to the significance of our long-lived assets.
Comparative FFO and EBITDA are also useful in measuring our ability to service
debt, fund capital expenditures and expand our business. Furthermore, management
believes that Comparative FFO and EBITDA are meaningful disclosures that will
help shareholders and the investment community to better understand our
financial performance, including comparing our performance to other real estate
investment trusts. However, Comparative FFO and EBITDA as presented may not be
comparable to amounts calculated by other companies. This information should not
be considered as an alternative to net income, operating profit, cash from
operations, or any other operating or liquidity performance measure prescribed
by accounting principles generally accepted in the United States. Cash
expenditures for various long-term assets, interest expense (for EBITDA purposes
only) and other items have been, and will be incurred which are not reflected in
the EBITDA and Comparative FFO presentations.
We are the sole general partner in the Operating Partnership and as of June 14,
2002 and June 15, 2001 held approximately 90% and 92%, respectively, of the
outstanding OP Units. The $10 million and $26 million deducted from the
Comparative FFO for the twelve weeks ended June 14, 2002 and June 15, 2001,
respectively, and $16 million and $51 million for the twenty-four weeks ended
June 14, 2002 and June 15, 2001, respectively, represent the Comparative FFO
attributable to the interests in the Operating Partnership of those minority
partners. Additionally, the $30 million deducted from the EBITDA of Host
-20-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
LP for the twenty-four week period ended June 15, 2001 represents the
distributions made by the Company to the outside holders of the OP Units. No
distributions have been made during 2002. OP Units owned by holders other than
us are redeemable at the option of the holder, generally commencing one year
after the issuance of their OP Units. Upon redemption of an OP Unit, the holder
would receive from the Operating Partnership cash in an amount equal to the
market value of one share of our common stock, or at our option, a share of our
common stock.
Twelve Weeks Ended Twenty-four Weeks Ended
------------------------ ------------------------
June 14, June 15, June 14, June 15,
2002 2001 2002 2001
---------- ---------- ---------- ----------
Income from continuing operations ............................ $ 24 $ 50 $ 12 $ 82
Effect on revenue of SAB 101 ............................... 1 8 2 15
Interest expense ........................................... 106 104 211 207
Dividends on Convertible Preferred Securities .............. 8 8 15 15
Depreciation and amortization .............................. 84 100 168 177
Minority interest expense .................................. 6 11 11 26
Income taxes ............................................... 11 12 15 15
Equity in (earnings) losses of affiliates .................. (1) (2) 3 (4)
Lease repurchase expense ................................... -- 5 -- 5
Other non-cash changes, net ................................ (1) 8 6 4
---------- ---------- ---------- ----------
EBITDA of Host LP ............................................ 238 304 443 542
Distributions to minority interest partners of Host LP .... -- (13) -- (30)
---------- ---------- ---------- ----------
EBITDA of Host REIT .......................................... $ 238 $ 291 $ 443 $ 512
========== ========== ========== ==========
EBITDA of Host LP ............................................ 238 304 443 542
Interest expense .......................................... (106) (104) (211) (207)
Dividends on convertible preferred securities ............. (8) (8) (15) (15)
Dividends on preferred stock .............................. (9) (9) (18) (14)
Income tax expense ........................................ (11) (12) (15) (15)
Effective impact of lease repurchase ...................... 3 3 6 3
Partnership adjustments and other ......................... 3 (6) (8) --
---------- ---------- ---------- ----------
Comparative Funds From Operations of Host LP
available to common unitholders ........................... 110 168 182 294
Comparative Funds From Operations of minority
partners of Host LP ..................................... (10) (26) (16) (51)
---------- ---------- ---------- ----------
Comparative Funds From Operations available to
common shareholders of Host REIT .......................... $ 100 $ 142 $ 166 $ 243
========== ========== ========== ==========
Our interest coverage ratio, defined as EBITDA divided by cash interest expense,
was 2.2 times and 2.5 times for the 2002 and 2001 twenty-four week periods,
respectively, and 2.0 times for full year 2001. The ratio of earnings to fixed
charges and preferred dividends was 1.2 to 1.0 in the second quarter of 2002
versus 1.5 to 1.0 in the second quarter of 2001. We reported a ratio of earnings
to fixed charges of 1.2 to 1.0 for the full year 2001.
-21-
HOST MARRIOTT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Sensitivity
Historically, our debt has primarily been fixed rate, including all of our
outstanding senior notes. However, certain of our financial instruments are
sensitive to changes in interest rates, including our credit facility and the
mortgage debt on our Canadian properties. There were no amounts outstanding on
the credit facility during the second quarter and as of June 14, 2002. The
spread we pay over LIBOR on borrowings under the new credit facility will adjust
based on our leverage ratio. The Canadian mortgage debt, which is denominated in
US dollars and had a balance of $96.6 million at June 14, 2002, has an interest
rate based on LIBOR plus 275 basis points. The weighted average interest rate
for this mortgage debt was 4.7% for the twenty-four weeks ended June 14, 2002
and 5.5% for the year ended December 31, 2001.
Subsequent to the Series H senior note offering in December 2001, we entered
into an interest rate swap agreement that effectively converts our obligation
under the $450 million of indebtedness from a fixed rate to a floating rate
based on 30 day LIBOR plus 450 basis points. The swap became effective on
January 15, 2002 and matures in January 2007. A change in the LIBOR rate of 100
basis points will result in $4.5 million increase or decrease in interest
expense. The swap has been designated as a fair value hedge and changes in the
interest rate over the life of the agreement are recorded as an adjustment to
interest expense. Changes in the fair value of the swap and the notes are
reflected on the balance sheet as offsetting changes and have no income
statement effect.
During January of 2002, we purchased, for $3.5 million, a 5-year interest rate
cap with a notional amount of $450 million. The interest rate cap limits our
exposure under the Series H interest rate swap to the extent that the floating
rate we are required to pay under that agreement exceeds 14%. Changes in
interest rates will affect the fair value of the cap. The gains or losses from
the changes in the market value of the cap will be recorded in other income or
expense in the current period. The fair value of this cap has decreased during
2002 and we have recorded expenses of $2.2 million and $1.1 million for the
twenty-four weeks and twelve weeks ended June 14, 2002, respectively.
Exchange Rate Sensitivity
In connection with the mortgage debt discussed above, our Canadian subsidiaries
entered into currency forward contracts to hedge the currency exposure of
converting Canadian dollars to US dollars on a monthly basis to cover debt
service payments on the mortgage debt. This swap has been designated as a cash
flow hedge of the principal payments, and the forward contracts are recorded at
fair value on the balance sheet with offsetting changes recorded in accumulated
other comprehensive income. The fair value of the forward contracts was ($55)
thousand at June 14, 2002 and $1.5 million at December 31, 2001.
In addition, our hotels in Mexico have earnings that are denominated in pesos
while the debt obligations on these properties are denominated in dollars. We
have not hedged our currency risk in Mexico, however the peso has appreciated
significantly since our original investment in these hotels. To the extent that
the peso declines in value versus the dollar, some or all of the benefit due to
the appreciation of the peso may be offset. We are exploring refinancing the
debt on our hotels in Mexico, with the intent of replacing the current debt with
peso denominated debt. However, there can be no assurance that we be successful
in completing such a refinancing.
-22-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We believe all of the lawsuits in which we are a defendant are without
merit and we intend to defend vigorously against such claims; however, no
assurance can be given as to the outcome of any of the lawsuits. We do not
believe the outcome of any of the current lawsuits will materially effect our
financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Company held its Annual Meeting of Shareholders on May 16, 2002.
(c) (i) Votes regarding the election of one Director for a term expiring in
2005 were as follows:
Term expiring in 2005 FOR AGAINST WITHHELD
------------- ------- ---------
John G. Schreiber 226,010,422 0 1,793,223
(ii) Votes on a shareholder proposal that the Board of Directors take
the necessary steps to reinstate the election of all directors annually, instead
of the election of staggered classes were as follows:
ABSTENTIONS AND
FOR AGAINST BROKER NONVOTES
- ---------- ----------- ---------------
71,4455 123,037,013 1,324,039
(iii) Votes on a shareholder proposal that the Board of Directors take
the necessary steps to nominate at least two candidates for each open board
position were as follows:
FOR AGAINST ABSTENTIONS AND
- ---------- ----------- BROKER NONVOTES
---------------
5,491,772 187,678,919 2,683,816
(iv) Votes on a shareholder proposal that the Board of Directors take
the measures necessary to change the Company's jurisdiction of incorporation
from Maryland to Delaware were as follows:
FOR AGAINST ABSTENTIONS AND
- ---------- ----------- BROKER NONVOTES
---------------
38,659,040 155,675,350 1,520,117
-23-
Item 5. Other Items
RISK FACTORS
Risks of Ownership of Our Common Stock
There are limitations on the ability of investors to acquire our common stock
and to effect a change in control. Our charter and bylaws, the partnership
agreement of the Operating Partnership, our shareholder rights plan, the
Maryland General Corporation Law and certain contracts contain a number of
provisions that could delay, defer or prevent a transaction or a change in
control of us that might involve a premium price for our shareholders or
otherwise be in their best interests, including the following:
. Ownership limit. The 9.8% ownership limit described under "Risk
Factors--Risks of Ownership of Our Common Stock--There are possible
adverse consequences of limits on ownership of our common stock" may have
the effect of precluding a change in control of us by a third party
without the consent of our Board of Directors, even if the change in
control would be in the interests of our shareholders, and even if the
change in control would not reasonably jeopardize our REIT status.
. Staggered board. Our Board of Directors consists of seven director
positions, one of which is currently vacant, but our charter provides
that the number of our directors may be increased or decreased according
to our bylaws, provided that the total number of directors is not less
than three nor more than 13. Pursuant to our bylaws, the number of
directors will be fixed by our Board of Directors within the limits set
forth in our charter. Our Board of Directors is divided into three
classes of directors. Directors for each class are chosen for a
three-year term when the term of the current class expires. The staggered
terms for directors may affect our shareholders' ability to effect a
change in control of us, even if a change in control would be in the
interests of our shareholders.
. Removal of Board of Directors. Our charter provides that, except for any
directors who may be elected by holders of a class or series of shares of
capital stock other than our common stock, directors may be removed only
for cause and only by the affirmative vote of shareholders holding at
least two-thirds of our outstanding shares entitled to be cast for the
election of directors. Vacancies on the Board of Directors may be filled
by the concurring vote of a majority of the remaining directors and, in
the case of a vacancy resulting from the removal of a director by the
shareholders, by at least two-thirds of all the votes entitled to be cast
in the election of directors.
. Preferred shares; classification or reclassification of unissued shares
of capital stock without shareholder approval. Our charter provides that
the total number of shares of stock of all classes which we have
authority to issue is 800,000,000, initially consisting of 750,000,000
shares of common stock and 50,000,000 shares of preferred stock, of which
14,140,000 shares of preferred stock were issued and outstanding as of
July 15, 2002. Our Board of Directors has the authority, without a vote
of shareholders, to classify or reclassify any unissued shares of stock,
including common stock, into preferred stock, or vice versa, and to
establish the preferences and rights of any preferred or other class or
series of shares to be issued. The issuance of preferred shares or other
shares having special preferences or rights could delay or prevent a
change in control even if a change in control would be in the interests
of our shareholders. Because our Board of Directors has the power to
establish the preferences and rights of additional classes or series of
shares without a shareholder vote, our Board of Directors may give the
holders of any
-24-
class or series preferences, powers and rights, including voting rights,
senior to the rights of holders of our common stock.
. Consent rights of the limited partners. Under the partnership agreement
of the Operating Partnership, we generally will be able to merge or
consolidate with another entity with the consent of partners holding
percentage interests that are more than 50% of the aggregate percentage
interests of the outstanding limited partnership interests entitled to
vote on the merger or consolidation, including any limited partnership
interests held by us, as long as the holders of limited partnership
interests either receive or have the right to receive the same
consideration as our shareholders. We, as holder of a majority of the
limited partnership interests, would be able to control the vote. Under
our charter, holders of at least two-thirds of our outstanding shares of
common stock generally must approve the merger or consolidation.
. Maryland business combination law. Under the Maryland General Corporation
Law, specified "business combinations," including specified issuances of
equity securities, between a Maryland corporation and any person who owns
10% or more of the voting power of the corporation's then outstanding
shares, or an "interested shareholder," or an affiliate of the interested
shareholder are prohibited for five years after the most recent date in
which the interested shareholder becomes an interested shareholder.
Thereafter, any of these specified business combinations must be approved
by 80% of the outstanding voting shares, and by two-thirds of the voting
shares other than voting shares held by an interested shareholder unless,
among other conditions, the corporation's common shareholders receive a
minimum price, as defined in the Maryland General Corporation Law, for
their shares and the consideration is received in cash or in the same
form as previously paid by the interested shareholder. We are subject to
the Maryland business combination statute.
. Maryland control share acquisition law. Under the Maryland General
Corporation Law, "control shares" acquired in a "control share
acquisition" have no voting rights except to the extent approved by a
vote of two-thirds of the votes entitled to be cast on the matter,
excluding shares owned by the acquiror and by officers or directors who
are employees of the corporation. "Control shares" are voting shares
which, if aggregated with all other voting shares previously acquired by
the acquiror or over which the acquiror is able to exercise or direct the
exercise of voting power (except solely by virtue of a revocable proxy),
would entitle the acquiror to exercise voting power in electing directors
within one of the following ranges of voting power: (1) one-fifth or more
but less than one-third, (2) one-third or more but less than a majority
or (3) a majority or more of the voting power. Control shares do not
include shares the acquiring person is then entitled to vote as a result
of having previously obtained shareholder approval. A "control share
acquisition" means the acquisition of control shares, subject to
specified exceptions. We are subject to these control share provisions of
Maryland law, subject to an exemption for Marriott International pursuant
to its purchase right discussed below. See "Risk Factors--Risks of
Ownership of Our Common Stock--There are limitations on the ability of
investors to acquire our common stock and to effect a change in
control--Marriott International purchase right".
. Merger, consolidation, share exchange and transfer of our assets.
Pursuant to our charter, subject to the terms of any outstanding class or
series of capital stock, we can merge with or into another entity,
consolidate with one or more other entities, participate in a share
exchange or transfer our assets within the meaning of the Maryland
General Corporation Law if approved (1) by our Board of Directors in the
manner provided in the Maryland General Corporation Law and (2) by our
shareholders holding two-thirds of all the votes entitled to be cast on
the matter, except that any merger of us with or into a trust organized
for the purpose of changing our form of organization from a corporation
to a trust requires only the approval of our shareholders
-25-
holding a majority of all votes entitled to be cast on the merger. Under
the Maryland General Corporation Law, specified mergers may be approved
without a vote of shareholders and a share exchange is only required to
be approved by a Maryland corporation by its Board of Directors. Our
voluntary dissolution also would require approval of shareholders holding
two-thirds of all the votes entitled to be cast on the matter.
. Amendments to our charter and bylaws. Our charter contains provisions
relating to restrictions on transferability of our common stock, the
classified Board of Directors, fixing the size of our Board of Directors
within the range set forth in our charter, removal of directors and the
filling of vacancies, all of which may be amended only by a resolution
adopted by the Board of Directors and approved by our shareholders
holding two-thirds of the votes entitled to be cast on the matter. As
permitted under the Maryland General Corporation Law, our charter and
bylaws provide that directors have the exclusive right to amend our
bylaws. Amendments of this provision of our charter also would require
action of our Board of Directors and approval by shareholders holding
two-thirds of all the votes entitled to be cast on the matter.
. Shareholder rights plan. We adopted a shareholder rights plan which
provides, among other things, that when specified events occur, our
shareholders will be entitled to purchase from us a newly created series
of junior preferred shares, subject to our ownership limit described
below. The preferred share purchase rights are triggered by the earlier
to occur of (1) ten days after the date of a public announcement that a
person or group acting in concert has acquired, or obtained the right to
acquire, beneficial ownership of 20% or more of our outstanding shares of
common stock or (2) ten business days after the commencement of or
announcement of an intention to make a tender offer or exchange offer,
the consummation of which would result in the acquiring persons becoming
the beneficial owner of 20% or more of our outstanding common stock. The
preferred share purchase rights would cause substantial dilution to a
person or group that attempts to acquire us on terms not approved by our
Board of Directors.
There are possible adverse consequences of limits on ownership of our common
stock. To maintain our qualification as a REIT for federal income tax purposes,
not more than 50% in value of our outstanding shares of capital stock may be
owned, directly or indirectly, by five or fewer individuals, as defined in the
Internal Revenue Code to include some entities. In addition, a person who owns,
directly or by attribution, 10% or more of an interest in a tenant of ours, or a
tenant of any partnership in which we are a partner, cannot own, directly or by
attribution, 10% or more of our shares without jeopardizing our qualification as
a REIT. Primarily to facilitate maintenance of our qualification as a REIT for
federal income tax purposes, the ownership limit under our charter prohibits
ownership, directly or by virtue of the attribution provisions of the Internal
Revenue Code, by any person or persons acting as a group, of more than 9.8% of
the issued and outstanding shares of our common stock, subject to an exception
for shares of our common stock held prior to our conversion into a REIT
(referred to as the "REIT
-26-
conversion") so long as the holder would not own more than 9.9% in value of our
outstanding shares after the REIT conversion, and prohibits ownership, directly
or by virtue of the attribution provisions of the Internal Revenue Code, by any
person, or persons acting as a group, of more than 9.8% of the issued and
outstanding shares of any class or series of our preferred shares. Together,
these limitations are referred to as the "ownership limit". Our Board of
Directors, in its sole and absolute discretion, may waive or modify the
ownership limit with respect to one or more persons who would not be treated as
"individuals" for purposes of the Internal Revenue Code if the Board of
Directors is satisfied, based upon information required to be provided by the
party seeking the waiver and, if it determines necessary or advisable, upon an
opinion of counsel satisfactory to our Board of Directors, that ownership in
excess of this limit will not cause a person who is an individual to be treated
as owning shares in excess of the ownership limit, applying the applicable
constructive ownership rules, and will not otherwise jeopardize our status as a
REIT for federal income tax purposes (for example, by causing any of our tenants
to be considered a "related party tenant" for purposes of the REIT qualification
rules). Common stock acquired or held in violation of the ownership limit will
be transferred automatically to a trust for the benefit of a designated
charitable beneficiary, and the person who acquired the common stock in
violation of the ownership limit will not be entitled to any distributions
thereon, to vote those shares of common stock or to receive any proceeds from
the subsequent sale of the common stock in excess of the lesser of the price
paid for the common stock or the amount realized from the sale. A transfer of
shares of our common stock to a person who, as a result of the transfer,
violates the ownership limit may be void under certain circumstances, and, in
any event, would deny that person any of the economic benefits of owning shares
of our common stock in excess of the ownership limit. The ownership limit may
have the effect of delaying, deferring or preventing a change in control and,
therefore, could adversely affect the shareholders' ability to realize a premium
over the then-prevailing market price for our common stock in connection with
such transaction.
We depend on external sources of capital for future growth and we may be unable
to access capital when necessary. As with other REITs, but unlike corporations
generally, our ability to reduce our debt and finance our growth largely must be
funded by external sources of capital because we generally are required to
distribute to our shareholders at least 90% of our taxable income in order to
qualify as a REIT, including taxable income we recognize for tax purposes but
with regard to which we do not receive corresponding cash. Our ability to access
the external capital we require could be hampered by a number of factors many of
which are outside of our control, including, without limitation, declining
general market conditions, unfavorable market perception of our growth
potential, decreases in our current and estimated future earnings, excessive
cash distributions or decreases in the market price of our common stock. In
addition, our ability to access additional capital may also be limited by the
terms of our existing indebtedness, which, among other things, restricts our
incurrence of debt and the payment of dividends. The occurrence of any of these
above-mentioned factors, individually or in combination, could prevent us from
being able to obtain the external capital we require on terms that are
acceptable to us or at all and the failure to obtain necessary external capital
could materially adversely affect our future growth.
Sales of shares of our common stock that are, or become, available for sale,
could adversely affect the price for shares of our common stock. Sales of a
substantial number of shares of our common stock, or the perception that sales
could occur, could adversely affect prevailing market prices for our common
stock. Holders of units of limited partnership interest in the Operating
Partnership (referred to as "OP Units") may redeem their OP Units for cash, or
at our discretion, for shares of our common stock. Holders who redeem their OP
Units and receive common stock upon redemption will be able to sell those shares
freely, unless the person is our affiliate and resale of the affiliate's shares
is not covered by an effective registration statement. As of July 15, 2002,
there were approximately 28.1 million OP Units outstanding (not including OP
Units held directly or indirectly by us), all of which are currently
-27-
redeemable by the holder for cash or, at our election, for an equivalent number
of shares of common stock. Further, a substantial number of shares of our common
stock have been and will be issued or reserved for issuance from time to time
under our employee benefit plans, including shares of our common stock reserved
for options, and these shares of common stock would be available for sale in the
public markets from time to time pursuant to exemptions from registration or
upon registration. Moreover, we may issue additional shares of our common stock
in the future. We can make no prediction about the effect that future sales of
our common stock would have on the market price of our common stock.
Our earnings and cash distributions will affect the market price of shares of
our common stock. We believe that the market value of a REIT's equity securities
is based primarily upon the market's perception of the REIT's growth potential
and its current and potential future cash distributions, whether from
operations, sales, acquisitions, development or refinancings, and is secondarily
based upon the value of the underlying assets. For that reason, shares of our
common stock may trade at prices that are higher or lower than the net asset
value per share. Our failure to meet the market's expectation with regard to
future earnings and cash distributions would likely adversely affect the market
price of our common stock.
Our future cash distributions on common stock may be limited by the terms of our
indebtedness and the terms of our preferred stock. In order to maintain our
status as a REIT, we are required to distribute to our stockholders at least 90%
of our taxable income. We may be limited in our ability to pay dividends on our
common stock in excess of the minimum amount necessary to maintain our REIT
status because of restrictions contained in our new bank credit facility and the
indenture governing substantially all of our senior notes. Under the terms of
our new bank credit facility and the senior notes indenture, distributions to us
by the Operating Partnership, which we depend upon in order to obtain the cash
necessary to pay dividends, are permitted only to the extent that, at the time
of the distributions, the Operating Partnership can satisfy certain financial
covenant tests and meet other requirements. For example, to make distributions
to us, the Operating Partnership must in general have a consolidated coverage
ratio (measuring the pro forma ratio of its consolidated EBITDA to its
consolidated interest expense over a trailing four-quarter period) of greater
than 2.0 to 1.0 in addition to satisfying other requiremen