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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998 Commission File No. 001-14625
HOST MARRIOTT CORPORATION
Maryland 53-0085950
(State of Incorporation) (I.R.S. Employer Identification
Number)
10400 Fernwood Road
Bethesda, Maryland 20817
(301) 380-9000
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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Common Stock, $.01 par value (227,669,276
shares New York Stock Exchange
outstanding as of March 19, 1999) Chicago Stock Exchange
Purchase Share rights for Series A Junior
Participating Pacific Stock Exchange
Preferred Stock, $.01 par value Philadelphia Stock Exchange
The aggregate market value of shares of common stock held by non-affiliates
at March 19, 1999 was $2,561,000,000.
Indicate by check mark whether the registrant (i) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (ii) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Document Incorporated by Reference
Notice of 1999 Annual Meeting and Proxy Statement
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FORWARD-LOOKING STATEMENTS
Certain matters discussed herein are forward-looking statements. Certain,
but not necessarily all, of such forward-looking statements can be identified
by the use of forward-looking terminology, such as "believes," "expects,"
"may," "will," "should," "estimates" or "anticipates" or the negative thereof
or other variations thereof or comparable terminology. All forward-looking
statements 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.
Although we believe the expectations reflected in such forward-looking
statements are based upon reasonable assumptions, we can give no assurance
that our expectations will be attained or that any deviations will not be
material. We undertake no obligation to publicly release the result of any
revisions to these forward-looking statements that may be made to reflect any
future events or circumstances. The following risk factors should be
considered by prospective investors who should carefully consider the material
risks described below.
We do not control our hotel operations and are dependent on the managers and
lessees of our hotels
Because federal income tax laws restrict real estate investment trusts and
"publicly traded" partnerships from deriving revenues directly from operating
a hotel, we operate virtually none of our hotels. Instead, we lease virtually
all of our hotels to subsidiaries of Crestline which, in turn, retain managers
to manage our hotels pursuant to management agreements. Thus, we are dependent
on the lessees but, under the hotel leases, we have little influence over how
the lessees operate our hotels. Similarly, we are dependent on the managers,
principally Marriott International, Inc., but we have virtually no influence
over how the managers manage our hotels. We have no recourse if we believe
that the hotel managers do not maximize the revenues from our hotels, which in
turn will maximize the rental payments we receive under the leases. We may
seek redress under most leases only if the lessee violates the terms of the
lease and then only to the extent of the remedies set forth in the lease.
Each lessee's ability to pay rent accrued under its lease depends to a large
extent on the ability of the hotel manager to operate the hotel effectively
and to generate gross sales in excess of its operating expenses. Our rental
income from the hotels may therefore be adversely affected if the managers
fail to provide quality services and amenities and competitive room rates at
our hotels or fail to maintain the quality of the hotel brand names. Although
the lessees have primary liability under the management agreements while the
leases are in effect, we remain liable under the leases for all obligations
that the lessees do not perform. We may terminate a lease if the lessee
defaults, but terminating the lease could, unless another suitable lessee is
found, impair our ability to qualify as a REIT for federal income tax purposes
and the ability of the operating partnership (as defined in the business and
properties section) to qualify as a partnership for federal income tax
purposes unless another suitable lessee is found. As described below, our
inability to qualify as a REIT or the operating partnership's inability to
qualify as a partnership for federal income tax purposes would have a material
adverse effect on us.
We do not control certain assets held by the non-controlled subsidiaries
We own economic interests in certain taxable corporations, which we refer to
as non-controlled subsidiaries. These non-controlled subsidiaries hold various
assets which, under our credit facility may not exceed, in the aggregate, 15%
of the value of our assets. These assets consist primarily of interests in
certain partnerships and hotels which are not leased, and certain FF&E (as
defined below) used in our hotels. Ownership of these assets by us could
jeopardize our REIT status and the operating partnership's status as a
partnership for federal income tax purposes. Although we own approximately 95%
of the total economic interests of the non-controlled subsidiaries, all of the
voting common stock, representing approximately 5% of the total economic
interests, is owned by Host Marriott Statutory Employee/Charitable Trust, the
beneficiaries of which are a trust formed for the benefit of a number of our
employees and the J. Willard and Alice S. Marriott Foundation. These voting
stockholders elect the directors who are responsible for overseeing the
operations of the non-controlled subsidiaries. The directors are currently
employees of the operating partnership, although this is not required. As a
result, we have no control over the operation or management of the hotels or
other assets owned by the non-
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controlled subsidiaries, even though we depend upon the non-controlled
subsidiaries for a significant portion of our revenues. Also, the activities
of non-controlled subsidiaries could cause us to be in default under our
principal debt facilities.
We are dependent on the ability of Crestline and the lessees to meet their
rent payment obligations
The lessees' rent payments are the primary source of our revenues. Crestline
guarantees the obligations of its subsidiaries under the hotel leases, but
Crestline's liability is limited to a relatively small portion of the
aggregate rent obligation of its subsidiaries. Crestline's and each of its
subsidiaries' ability to meet its obligations under the leases will determine
the amount of our revenue and, likewise, our ability to meet our obligations.
We have no control over Crestline or any of its subsidiaries and cannot assure
you that Crestline or any of its subsidiaries will have sufficient assets,
income and access to financing to enable them to satisfy their obligations
under the leases or to make payments of fees under the management agreements.
Although the lessees have primary liability under the management agreements
while the leases are in effect, we and our subsidiaries remain liable under
the management agreements for all obligations that the lessees do not perform.
Because of our dependence on Crestline, our credit rating will be affected by
its creditworthiness.
Our revenues and the value of our properties could be adversely affected by
conditions affecting the lodging industry
If our assets do not generate income sufficient to pay our expenses, service
our debt and maintain our properties, we will be unable to make expected
distributions to our stockholders. Factors that could adversely affect our
revenues and the economic performance and value of our properties include:
. changes in the national, regional and local economic climate,
. local conditions such as an oversupply of hotel properties or a reduction
in demand for hotel rooms,
. the attractiveness of our hotels to consumers and competition from
comparable hotels,
. the quality, philosophy and performance of the managers of our hotels,
primarily Marriott International, Inc.,
. the ability of any hotel lessee to maximize rental payments,
. changes in room rates and increases in operating costs due to inflation
and other factors and
. the need to periodically repair and renovate our hotels.
Our expenses may remain constant even if our revenues drop
The expenses of owning a property are not necessarily reduced when
circumstances such as market factors and competition cause a reduction in
income from the property. If a property is mortgaged and we are unable to meet
the mortgage payments, the lender could foreclose and take the property. Our
financial condition and ability to service debt and make distributions to our
stockholders could be adversely affected by:
.interest rate levels,
.the availability of financing,
.the cost of compliance with government regulation, including zoning and
tax laws and
.changes in laws and governmental regulations, including those governing
usage, zoning and taxes.
New acquisitions may fail to perform as expected or we may be unable to make
acquisitions on favorable terms
We intend to acquire additional full service hotels and other types of real
estate. Newly acquired properties may fail to perform as expected, which could
adversely affect our financial condition. We may underestimate the costs
necessary to bring an acquired property up to standards established for its
intended market position. We expect to acquire hotels and other types of real
estate with cash from secured or unsecured financings and
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proceeds from offerings of equity or debt, to the extent available. We may not
be in a position or have the opportunity in the future to make suitable
property acquisitions on favorable terms. Competition for attractive
investment opportunities may increase prices for hotel properties, thereby
decreasing the potential return on our investment. In addition, in order to
maintain our status as a REIT we must lease virtually all of the properties we
acquire. We cannot guarantee that the leases for newly acquired hotels will be
as favorable to us as the existing leases.
Competition for acquisitions may result in increased prices for hotels
Other major investors with significant capital compete with us for
attractive investment opportunities. These competitors include other REITs and
hotel companies, investment banking firms and private institutional investment
funds. This competition may increase prices for hotel properties, thereby
decreasing the potential return on our investment.
The seasonality of the hotel industry may affect the ability of the lessees to
make timely rent payments
The seasonality of the hotel industry may, from time to time, affect either
the amount of rent that accrues under the hotel leases or the ability of the
lessees to make timely rent payments under the leases. A lessee's or
Crestline's inability to make timely rent payments to us could adversely
affect our financial condition and ability to service debt and make
distributions to our stockholders.
We may be unable to sell properties when appropriate because real estate
investments are illiquid
Real estate investments generally cannot be sold quickly. We may not be able
to vary our portfolio promptly in response to economic or other conditions.
This inability to respond promptly to changes in the performance of our
investments could adversely affect our financial condition and ability to
service debt and make distributions to our stockholders. In addition, sales of
appreciated real property could generate material adverse tax consequences,
which may make it disadvantageous for us to sell hotels.
We may be unable to renew leases or find other lessees
Our current hotel leases have terms generally ranging from seven to ten
years. There can be no assurance that upon expiration of our leases, our
hotels will be relet to the current lessees, or if relet, will be relet on
terms favorable to us. If our hotels are not relet, we will be required to
find other lessees who meet certain requirements of the management agreements
and of the federal income tax rules that govern REITs. We cannot assure you
that we would be able to find satisfactory lessees or that the terms of any
new leases would be favorable. Failure to find satisfactory lessees could
cause us to lose our REIT status, and cause the operating partnership to be
considered a "publicly traded partnership" taxable as a "C" corporation. Under
these circumstances the operating partnership would have to pay substantial
federal income taxes as well as distribute more cash to us to enable us to
meet our tax burden. This would significantly impair, if not eliminate, our
ability to raise additional capital. Failure to enter leases on satisfactory
terms could also result in reduced cash available for servicing debt and for
distributions to stockholders.
A significant number of our hotels are subject to ground leases
As of December 31, 1998, we leased 54 of our hotels pursuant to ground
leases. These ground leases generally require increases in ground rent
payments every five years. Our ability to make cash distributions to our
stockholders could be adversely affected to the extent that the rents payable
by the lessees under the leases do not increase at the same or a greater rate
as the increases under the ground leases. In addition, if we were to sell a
hotel encumbered by a ground lease, the buyer would have to assume the ground
lease, which could result in a lower sales price.
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Some potential losses are not covered by insurance
We carry comprehensive liability, fire, flood, extended coverage and rental
loss (for rental losses extending up to 12 months) insurance with respect to
all of our hotels. We believe the policy specifications and insured limits of
these policies are of the type customarily carried for similar hotels. Certain
types of losses, such as from earthquakes and environmental hazards, however,
may be either uninsurable or too expensive to justify insuring against. Should
an uninsured loss or a loss in excess of insured limits occur, we could lose
all or a portion of the capital we have invested in a hotel, as well as the
anticipated future revenue from the hotel. In such an event, we might
nevertheless remain obligated for any mortgage debt or other financial
obligations related to the property.
Leases and management agreements could impair the sale or other disposition of
our hotels
Each lease with a subsidiary of Crestline generally requires us to make a
termination payment to the lessee if we terminate the lease prior to the
expiration of its term. A termination payment is required even if we terminate
a lease because of a change in the federal income tax laws that either would
make continuation of the lease jeopardize our REIT status or would enable us
to operate our hotels ourselves. The termination fee generally is equal to the
fair market value of the lessee's leasehold interest in the remaining term of
the lease, which could be a significant amount. In addition, if we decide to
sell a hotel, we may be required to terminate its lease, and the payment of
the termination fee under such circumstances could impair our ability to sell
the hotel and would reduce the net proceeds of any sale.
Under the terms of the management agreements, we generally may not sell,
lease or otherwise transfer the hotels unless the transferee assumes the
related management agreements and meets certain other conditions. Our ability
to finance, refinance or effect a sale of any of the properties managed by
Marriott International or another manager may, depending upon the structure of
such transactions, require the manager's consent. If Marriott International or
other manager did not consent, we would be prohibited from consummating the
financing, refinancing or sale without breaching the management agreement.
The acquisition contracts relating to certain hotels limit our ability to sell
or refinance such hotels
For reasons relating to federal income tax considerations of the former
owners of certain of our hotels, we have agreed to restrictions on selling
certain hotels or repaying or refinancing the mortgage debt thereon for lock-
out periods which vary depending on the hotel. We anticipate that, in certain
circumstances, we may agree to similar restrictions in connection with future
hotel acquisitions. As a result, even if it were in our best interests to sell
such hotels or refinance their mortgage debt, it may be difficult or
impossible to do so during their respective lock-out periods.
Marriott International's and Crestline's operation of their respective
businesses could result in decisions not in our best interest
Marriott International, a public company in the business of hotel
management, manages a significant number of our hotels. In addition, Marriott
International manages hotels owned by others that compete with our hotels. As
a result, Marriott International may make decisions regarding competing
lodging facilities which it manages that would not necessarily be in our best
interests. Further, J.W. Marriott, Jr., a member of our Board of Directors,
and Richard E. Marriott, our Chairman of the Board and J.W. Marriott, Jr.'s
brother, serve as directors, and, in the case of J.W. Marriott, Jr., also an
officer, of Marriott International. J.W. Marriott, Jr. and Richard E. Marriott
also beneficially owned approximately 10.6% and 10.4%, respectively, as of
January 1, 1999 of the outstanding shares of common stock of Marriott
International, and approximately 5.7% and 6.0%, respectively, as of March 24,
1999 of the outstanding shares of common stock of Crestline, but neither
serves as an officer or director of Crestline. As a result, J.W. Marriott, Jr.
and Richard E. Marriott have potential conflicts of interest as directors of
Host Marriott when making decisions regarding Marriott International,
including decisions relating to the management agreements involving the
hotels, Marriott International's management of competing lodging properties
and Crestline's leasing and other businesses.
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Our Board of Directors and Marriott International's Board of Directors
follow appropriate policies and procedures to limit the involvement of Messrs.
J.W. Marriott, Jr. and Richard E. Marriott in conflict situations, including
requiring them to abstain from voting as directors of either company or their
subsidiaries on certain matters which present a conflict between the
companies. If appropriate, these policies and procedures will apply to other
directors and officers.
Provisions of our charter and bylaws could inhibit changes in control that
could be beneficial to our stockholders
Certain provisions of our charter and bylaws may delay or prevent a change
in control or other transaction that could provide our stockholders with a
premium over the then-prevailing market price of their shares or which might
otherwise be in their best interests. These include a staggered Board of
Directors and the ownership limit described below. Also, any future class or
series of stock may have certain voting provisions that could delay or prevent
a change in control or other transaction that might involve a premium price or
otherwise be good for our stockholders.
The Marriott International purchase right may discourage a takeover that could
be beneficial to our stockholders
Marriott International has the right to purchase up to 20% of each class of
our outstanding voting shares at the then fair market value upon the
occurrence of specified certain change of control events. We refer to this
right as the Marriott International purchase right. The Marriott International
purchase right will continue in effect until June 2017, subject to certain
limitations intended to protect the our REIT status. The Marriott
International purchase right may have the effect of discouraging someone from
attempting to take us over, because any person considering acquiring a
substantial or controlling block of our common stock will face the possibility
that its ability to obtain or exercise control would be impaired or made more
expensive by the exercise of the Marriott International purchase right.
We have adopted Maryland law limitations on changes in control
Maryland corporate law prohibits certain "business combinations" between a
Maryland corporation and any person who owns 10% or more of the voting power
of the corporation's then outstanding shares of stock (an "Interested
Stockholder") or an affiliate of the Interested Stockholder unless a business
combination is approved by the board of directors any time before an
Interested Stockholder first becomes an Interested Stockholder. The
prohibition lasts for five years after the Interested Stockholder becomes an
Interested Stockholder. Thereafter, any such business combination must be
approved by stockholders under certain special voting requirements. We will be
subject to such provisions although we may elect to "opt-out" in the future.
As a result, a change in control or other transaction that could provide our
stockholders with a premium over the then-prevailing market price of their
shares or which might otherwise be in their best interests may be prevented or
delayed. Our Board of Directors has exempted from this statute the acquisition
of shares by Marriott International pursuant to the terms of the Marriott
International purchase right as well as any other transactions involving us
and Marriott International or our respective subsidiaries, or J.W. Marriott,
Jr. or Richard E. Marriott, provided that, if any such transaction is not in
the ordinary course of business, it must be approved by a majority of our
directors present at a meeting at which a quorum is present, including a
majority of the disinterested directors, in addition to any vote of
stockholders required by other provisions of Maryland corporate law.
Maryland control share acquisition law could delay or prevent a change in
control
Under Maryland corporate law, unless a corporation elects not to be subject
thereto, "control shares" acquired in a "control share acquisition" have no
voting rights except to the extent approved by stockholders 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 would entitle the
acquiror to exercise voting power in electing directors within certain
specified ranges of voting power.
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A "control share acquisition" means the acquisition of control shares, subject
to certain exceptions. We are subject to these control share provisions of
Maryland law and, as a result, a change in control or other transaction that
could provide our stockholders with a premium over the then-prevailing market
price of their shares or which might otherwise be in their best interests may
be delayed or prevented. Our bylaws contain an exemption from this statute for
any shares acquired by Marriott International, together with its successors
and permitted assignees, pursuant to the Marriott International purchase
right.
We have adopted a rights agreement which could delay or prevent a change in
control
Our rights agreement provides, among other things, that upon the occurrence
of certain events, stockholders will be entitled to purchase shares of our
stock, subject to the ownership limit. These purchase rights would cause
substantial dilution to a person or group that acquires or attempts to acquire
20% or more of our common stock on terms not approved by the Board of
Directors and, as a result, could delay or prevent a change in control or
other transaction that could provide our stockholders with a premium over the
then-prevailing market price of their shares or which might otherwise be in
their best interests.
We have a stock ownership limit primarily for REIT tax purposes
Primarily to facilitate maintenance of our REIT qualification, our charter
imposes an ownership limit on our common stock and preferred stock. The
attribution provisions of the federal tax laws that are used in applying the
ownership limit are complex. They may cause one stockholder to be considered
to own the stock of a number of related stockholders. As a result, these
provisions may cause a stockholder whose direct ownership of stock does not
exceed the ownership limit to, in fact, exceed the ownership limit.
The ownership limit could delay or prevent a change in control and,
therefore, could adversely affect stockholders' ability to realize a premium
over the then-prevailing market price for the common stock in connection with
such transaction.
The large number of shares available for future sale could adversely affect
the market price of our publicly traded securities
In connection with our REIT conversion at the end of 1998, we reserved
approximately 96.4 million shares of our common stock for future issuance of
which approximately 20 million shares were issued in February 1999. Such
common stock will be freely transferable upon receipt. The balance of the
reserved common stock may be issued upon the redemption of units of limited
partnership interest in our operating partnership. These limited partnership
units will become redeemable at various times over the next year, with
approximately 23.9 million limited partnership units becoming redeemable
beginning on July 1, 1999, pursuant to each holder's right under the operating
partnership's partnership agreement to redeem them for shares of our common
stock or, at our election, the cash equivalent thereof. In addition, we have
reserved a substantial number of shares of our common stock for issuance
pursuant to benefit plans or outstanding options, and such shares of our
common stock will be available for sale in the public markets from time to
time. Moreover, we may issue additional shares of our common stock in the
future. We cannot predict the effect that future sales of shares of our common
stock, or the perception that such sales could occur, will have on the market
prices of our equity securities.
Our FFO and cash distributions will affect the market price of our publicly
traded securities
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,
including its prospects for accretive acquisitions and development, and its
current and potential future cash distributions, and is secondarily based upon
the real estate market value of the underlying assets. For that reason, our
common stock may trade at prices that are higher or lower than the net asset
value per share. To the extent we retain operating cash flow for investment
purposes, working capital reserves or other purposes, these retained funds,
while increasing the value of our underlying assets, may not correspondingly
increase the market price of our common stock. Our failure to meet the
market's expectations with regard to future FFO and cash distributions would
likely adversely affect the market price of our publicly traded securities.
6
Market interest rates may have an effect on the value of our publicly traded
securities
One of the factors that investors consider important in deciding whether to
buy or sell shares of a REIT is the distribution rate on such shares, as a
percentage of the price of such shares relative to market interest rates. If
market interest rates go up, prospective purchasers of our equity securities
may expect a higher dividend yield. Higher interest rates would not, however,
result in more funds for us to distribute and, in fact, would likely increase
our borrowing costs and potentially decrease cash available for distribution
to the extent that our indebtedness has floating interest rates. Thus, higher
market interest rates could cause the market price of our publicly traded
securities to go down.
We are dependent on external sources of capital
To qualify as a REIT, we must distribute to our stockholders each year at
least 95% of our net taxable income, excluding any net capital gain. Because
of these distribution requirements, it is not likely that we will be able to
fund all future capital needs, including acquisitions, from income from
operations. We therefore will have to rely on third-party sources of capital,
which may or may not be available on favorable terms or at all. Our access to
third-party sources of capital depends upon a number of factors, including
general market conditions, the market's perception of our growth potential,
our current and potential future earnings and cash distributions and the
market price of our common stock. Moreover, additional equity offerings may
result in substantial dilution of stockholders' interests, and additional debt
financing may substantially increase our leverage.
Our degree of leverage could limit our ability to obtain additional financing
Our debt-to-total market capitalization ratio was approximately 59% as of
December 31, 1998. We have a policy of incurring debt only if, immediately
following such incurrence, our debt-to-total market capitalization ratio on a
pro forma basis would be 60% or less. Our degree of leverage could affect our
ability to obtain financing in the future for working capital, capital
expenditures, acquisitions, development or other general corporate purposes
and to refinancing borrowings on favorable terms. Our leveraged capital
structure also makes us more vulnerable to a downturn in our business or in
the economy generally. Moreover, there are no limitations in our
organizational documents that limit the amount of indebtedness that we may
incur, although our existing debt instruments contain certain restrictions on
the amount of indebtedness that we may incur. Accordingly, our Board of
Directors could alter or eliminate the 60% policy without stockholder approval
to the extent permitted by our debt agreements. If this policy were changed,
we could become more highly leveraged, resulting in an increase in debt
service payments that could adversely affect our cash flow and consequently
our ability to service our debt and make distributions to stockholders.
Rental revenues from hotels are subject to prior rights of lenders
The mortgages on certain of our hotels require that rent payments under the
leases on such hotels be used first to pay the debt service on such mortgage
loans. Consequently, only the cash flow remaining after debt service will be
available to satisfy other obligations, including property taxes and
insurance, FF&E reserves for the hotels and capital improvements, and debt
service on unsecured debt, and to make distributions to stockholders.
We depend on our key personnel
We depend on the efforts of our executive officers and other key personnel.
While we believe that we could find replacements for these key personnel, the
loss of their services could have a significant adverse effect on our
operations. We do not intend to obtain key-man life insurance with respect to
any of our personnel.
The REIT conversion could result in litigation
Over the last several years, business reorganizations involving the
combination of several partnerships into a single entity have occasionally
given rise to investor lawsuits. These lawsuits have involved claims against
the
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general partners of the participating partnerships, the partnerships
themselves and related persons involved in the structuring of, or benefiting
from, the conversion or reorganization, as well as claims against the
surviving entity and its directors and officers. If any lawsuits are filed in
connection with the partnership mergers or other transactions in connection
with our REIT Conversion, such lawsuits could result in substantial damage
claims against us, as successor to the liabilities of our predecessors. Such
lawsuits, if successful, could adversely affect our financial condition and
our ability to service our debt and make distributions to stockholders.
Joint venture investments have additional risks
Instead of purchasing hotel properties directly, we may invest as a co-
venturer. Joint venturers often share control over the operation of the joint
venture assets. Actions by a co-venturer could subject such assets to
additional risk. Our co-venturer in an investment might have economic or
business interests or goals that are inconsistent with our interests or goals,
or be in a position to take action contrary to our instructions or requests or
contrary to our policies or objectives. Although we generally will seek to
maintain sufficient control of any joint venture to permit our objectives to
be achieved, we might not be able to take action without the approval of our
joint venture partners. Also, our joint venture partners could take actions
binding on the joint venture without our consent. A joint venture partner
could go bankrupt, leaving us liable for its share of joint venture
liabilities. Also, the requirement that we lease our assets to qualify as a
REIT may make it more difficult for us to enter into joint ventures in the
future.
The year 2000 problem may adversely impact our business and financial
condition
Year 2000 issues have arisen because many existing computer programs and
chip-based embedded technology systems use only the last two digits to refer
to a year, and therefore do not properly recognize a year that begins with
"20" instead of the familiar "19." If not corrected, many computer
applications could fail or create erroneous results. Our potential year 2000
problems include issues relating to our in-house hardware and software
computer systems, as well as issues relating to third parties with which we
have a material relationship or whose systems are material to the operations
of our hotels.
In-House systems
Since October of 1993, we have invested in the implementation and
maintenance of accounting and reporting systems and equipment that are
intended to enable us to provide adequately for our information and
reporting needs and which are also year 2000 compliant. Substantially all
of our in-house systems have already been certified as year 2000 compliant
through testing and other mechanisms. We have not delayed any systems
projects due to the year 2000 issue. We have engaged a third party to
review our year 2000 in-house compliance.
Third-Party systems
We rely upon operational and accounting systems provided by third
parties, primarily the managers of our hotels, to provide the appropriate
property-specific operating systems, including reservation, phone,
elevator, security, HVAC and other systems, and to provide us with
financial information. We will continue to monitor the efforts of these
third parties to become year 2000 compliant and will take appropriate steps
to address any non-compliance issues.
Risks
We believe that future costs associated with year 2000 issues for its in-
house systems will be insignificant and therefore not impact our business,
financial condition and results of operations. However, the actual effect
that year 2000 issues will have on our business will depend significantly
on whether other companies and governmental entities properly and timely
address year 2000 issues and whether broad-based or systemic failures
occur. We cannot predict the severity or duration of any such failures,
which could include disruptions in passenger transportation or
transportation systems generally, loss of utility and/or telecommunications
services, the loss or disruption of hotel reservations made on centralized
reservation systems and errors or failures in financial transactions or
payment processing systems such as credit cards.
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Moreover, we are dependent upon Crestline to interface with third parties
in addressing year 2000 issues at our hotels leased to its subsidiaries.
Due to the general uncertainty inherent with respect to year 2000 issues
and our dependence on third parties, including Crestline, we are unable to
determine at this time whether the consequences of year 2000 failures will
have a material impact on us. Although our joint year 2000 compliance
program with Crestline is expected to significantly reduce uncertainties
arising out of year 2000 issues and the possibility of significant
interruptions of normal operations, we cannot assure you that this will be
the case.
Environmental problems are possible and can be costly
We believe that our properties are in compliance in all material respects
with applicable environmental laws. Unidentified environmental liabilities
could arise, however, and could have a material adverse effect on our
financial condition and performance. Federal, state and local laws and
regulations relating to the protection of the environment may require a
current or previous owner or operator of real estate to investigate and clean
up hazardous or toxic substances or petroleum product releases at such
property. The owner or operator may have to pay a governmental entity or third
parties for property damage and for investigation and clean-up costs incurred
by such parties in connection with the contamination. These laws typically
impose clean-up responsibility and liability without regard to whether the
owner or operator knew of or caused the presence of the contaminants. Even if
more than one person may have been responsible for the contamination, each
person covered by the environmental laws may be held responsible for all of
the clean-up costs incurred. In addition, third parties may sue the owner or
operator of a site for damages and costs resulting from environmental
contamination emanating from that site. Environmental laws also govern the
presence, maintenance and removal of asbestos. These laws require that owners
or operators of buildings containing asbestos properly manage and maintain the
asbestos, that they notify and train those who may come into contact with
asbestos and that they undertake special precautions, including removal or
other abatement, if asbestos would be disturbed during renovation or
demolition of a building. These laws may impose fines and penalties on
building owners or operators who fail to comply with these requirements and
may allow third parties to seek recovery from owners or operators for personal
injury associated with exposure to asbestos fibers.
Compliance with other government regulations can also be costly.
Our hotels are subject to various forms of regulation, including Title III
of the Americans with Disabilities Act, building codes and regulations
pertaining to fire safety. Compliance with such laws and regulations could
require substantial capital expenditures. We do not believe, however, that
substantial non-budgeted capital expenditures will be required with respect to
our existing hotels based on existing laws and regulations. Such regulations
may be changed from time to time, or new regulations adopted, resulting in
additional or unexpected costs of compliance. Any such increased costs could
reduce the cash available for servicing of debt and distributions to
stockholders.
We intend to qualify as a REIT, but we cannot guarantee that we will qualify
We intend to operate to qualify as a REIT for tax purposes beginning in
1999. If we qualify as a REIT, we generally will not be taxed on income that
we distribute to our stockholders so long as we distribute currently at least
95% of our net taxable income, excluding net capital gain. We cannot
guarantee, however, that we will qualify as a REIT in 1999 or in any future
year. Many of the REIT requirements are highly technical and complex. The
determination that we are a REIT requires an analysis of various factual
matters and circumstances that may not be totally within our control. For
example, to qualify as a REIT, at least 95% of our gross income must be income
specified in the REIT tax laws, such as "rents from real property." We are
also required to distribute to shareholders at least 95% of our REIT taxable
income, excluding capital gains. The fact that we hold our assets through the
operating partnership and its subsidiaries further complicates the application
of the REIT requirements. Even a technical or inadvertent mistake could
jeopardize our REIT status. Furthermore, Congress and the IRS might make
changes to the tax laws and regulations, and the courts might issue new
rulings that make it more difficult, or impossible, for us to remain qualified
as a REIT. In addition, it is possible that
9
even if we do qualify as a REIT, new tax rules will change the way we are
taxed. If we fail to qualify as a REIT, we will be subject to federal income
tax at regular corporate rates. In this event, we may cause the operating
partnership to distribute adequate amounts to us and its other unitholders to
permit us to pay our tax liabilities and our ability to raise additional
capital could be impaired. This would significantly reduce the cash we would
have available to service debt. Furthermore, our failure to qualify as a REIT
could create a default under some of our debt instruments, including our
credit facility. If we fail to qualify as a REIT, then unless certain specific
statutory provisions apply, we will be disqualified from treatment as a REIT
for the next four taxable years.
If the operating partnership is treated as a corporation, we will fail to
qualify as a REIT
The operating partnership intends to qualify as a partnership for federal
income tax purposes. However, it will be treated as a corporation, instead of
a partnership, for federal income tax purposes if it is a "publicly traded
partnership" unless at least 90% of its income is qualifying income as defined
in the tax code. The income requirements applicable to REITs and the
definition of qualifying income for purposes of this 90% test are similar in
most, but not all, respects. Qualifying income for the 90% test generally
includes passive income, such as specified types of real property rents,
dividends and interest. However, real property rent will not be qualifying
income if the operating partnership or one or more actual or constructive
owners of 5% of the operating partnership actually or constructively own 10%
or more of the tenant. The partnership agreement of the operating partnership
contains ownership restrictions intended to prevent the disqualification of
income based on these ownership restrictions. We believe that it will meet
this qualifying income test, but we cannot guarantee that it will. If it were
to be taxed as a corporation, it would incur substantial tax liabilities, we
would fail to qualify as a REIT for tax purposes, we may require it to
distribute adequate amounts to us to permit us to pay our tax liabilities, and
our and its ability to raise additional capital could be impaired.
The operating partnership may need to borrow money or issue additional equity
in order for us to qualify as a REIT
A REIT must distribute to its shareholders at least 95% of its net taxable
income, excluding any net capital gain. The source of the distributions we
make to our stockholders will be money distributed to us by the operating
partnership. We intend to meet this 95% requirement, but there are a number of
reasons why the operating partnership's cash flow alone may be insufficient
for us to meet this requirement. First, as a result of some of the
transactions of certain of our predecessor entities, the operating partnership
and its subsidiaries, we expect to recognize large amounts of taxable income
in future years for which the operating partnership will have no corresponding
cash flow or earnings before interest, taxes, depreciation and other non cash
items which is referred to as EBITDA. This type of income is often referred to
as "phantom income." Second, in order to qualify as a REIT in 1999, we need to
distribute to our stockholders, prior to the end of 1999, all of the "earnings
and profits" that accumulated prior to 1999. If we do not meet this
requirement by virtue of the distributions declared in connection with the
REIT Conversion, we will be required to make further distributions prior to
the end of 1999. The operating partnership may not have cash flow that
corresponds to these distributions. Third, the seasonality of the hospitality
industry could cause a further mismatch of our income and cash flow.
In addition, even if a REIT meets the 95% requirement, it may still be
subject to a 4% nondeductible excise tax. This excise tax applies to the
amount by which certain of the REIT's distributions in a given calendar year
are less than the sum of 85% of its ordinary income, 95% of its capital gain
net income and any undistributed taxable income from prior years. We intend to
make distributions to our stockholders so that we will not be subject to this
excise tax, but for the reasons described above, the operating partnership's
cash flow alone may be insufficient for it to distribute to us the funds we
will need.
The operating partnership's partnership agreement requires it to distribute
enough cash to us for us to meet the 95% distribution requirement and avoid
the 4% excise tax, and the operating partnership has to make proportionate
distributions to its other equityholders. If its cash flow alone is
insufficient for it to distribute to us the money we need to meet the 95%
distribution requirement or to avoid the 4% excise tax, it may need to issue
additional equity or borrow money. We cannot guarantee that these sources of
funds will be available to it on favorable terms or even at all. Any problems
the operating partnership has in borrowing money could be
10
exacerbated by two factors. First, it will need to distribute most if not all
of our earnings to us and other holders of its partnership units. Therefore,
it will be unable to retain these earnings. Accordingly, it generally will
need to refinance its maturing debt with additional debt or equity and rely on
third-party sources to fund future capital needs. Second, its borrowing needs
will be increased if we are required to pay taxes or liabilities attributable
to prior years. If the operating partnership is unable to raise the money
necessary to permit us to meet the 95% distribution requirement, we will fail
to qualify as a REIT. If the operating partnership is able to raise the money,
but only on unfavorable terms, then our financial performance may be damaged.
We are required to distribute all of our prior earnings and profits, but we
cannot guarantee that we will be able to do so
In order to qualify as a REIT for 1999, we are required to distribute to our
stockholders, prior to the end of 1999, all of our earnings and profits that
we accumulated prior to 1999. We believe that we will meet this requirement.
However, it is very hard to determine the exact level of our pre-1999 earnings
and profits because the determination depends on an extremely large number of
factors. The complexity of the determination is compounded by the fact that we
started accumulating earnings and profits in 1929. Also, it is difficult to
value our distributions which have not been cash, such as the distribution of
Crestline common stock we made in December 1998. Therefore, we cannot
guarantee that we will meet this requirement. If we do not meet this
requirement, then we will not qualify as a REIT at least for 1999.
We will qualify as a REIT only if the rent from the leases meets a number of
tests, but we cannot guarantee that it will
A REIT's income must meet certain tests relating to its source. If the
income meets the tests, it is called "good income." Almost all of our income
will be rent from the hotel leases. This rent will be good income only if the
leases are respected as true leases for federal income tax purposes. If the
leases are treated as service contracts, joint ventures or some other type of
arrangement, then this rent will not be good income and we will fail to
qualify as a REIT.
In addition, the rent from any particular hotel lease will be good income
only if we own less than 10% of the lessee of the hotel. For purposes of this
test, we are treated as owning both any interests that we hold directly and
the interests owned by a person who owns more than 10% of our stock. In
determining who owns more than 10% of our stock, a person may be treated as
owning the stock of another person who is either a relative or has common
financial interests. We will not directly own more than 10% of any of the
lessees. In addition, we intend to enforce the ownership limit in our charter,
which restricts the amount of our capital stock that any person can own. If
the ownership limit is effective, then no person will ever own more than 10%
of our capital stock and we should never own more than 10% of the lessees.
However, we cannot guarantee that the ownership limit will be effective. If
the ownership limit is not effective, our ownership in the lessees may exceed
the 10% limit. As a result, the rent from our leases would not be good income
and we would fail to qualify as a REIT.
Furthermore, rent from any particular hotel lease will be good income only
if no portion of the rent is based on the income or profits of the lessee of
the hotel. The rent, however, can be based on the gross revenues of the
lessees, unless the arrangement does not conform to normal business practice
or is being used as a device to base rent on the income or profits of the
lessees. The rent from the current leases, other than the Harbor Beach Resort
lease, is based on the gross revenues of the lessees. We believe that the
leases conform to normal business practice and, other than the Harbor Beach
Resort lease, are not being used as a device to base rent on the income or
profits of the lessees. We cannot guarantee that the IRS will agree with our
position. If rent from leases in addition to the Harbor Beach Resort lease is
found to be based on the income or profits of the lessees, the rent would not
be good income and we would fail to qualify as a REIT.
Host Marriott will qualify as a REIT and, if we are a "publicly traded
partnership," we would qualify as a partnership only if the personal property
arrangements are respected by the IRS
Rent that is attributable to personal property is not good income under the
REIT rules or the rules applicable to "publicly traded partnerships." Hotels
contain significant personal property. Therefore, in order to protect our
11
ability to qualify as a REIT and the operating partnership's ability to
qualify as a partnership, we sold an estimated $59 million of personal
property associated with some of our hotels to the non-controlled
subsidiaries. The non-controlled subsidiaries lease the personal property
associated with each hotel directly to the lessee that is leasing the hotel.
Under each personal property lease, the non-controlled subsidiary receives
rent payments directly from the applicable lessee. We believe the amount of
the rent represents the fair rental value of the personal property. If for any
reason these lease arrangements are not respected by the IRS for federal
income tax purposes and we were treated as the lessor, we would not qualify as
a REIT and, if the operating partnership is considered a "publicly traded
partnership," it likely would not qualify as a partnership.
We will be subject to taxes even if we qualify as a REIT
Even if we qualify as a REIT, we will be subject to some federal, state and
local taxes on our income and property. For example, we will have to pay tax
on income that we do not distribute. We also will be liable for any tax that
the IRS successfully asserts against our predecessors for corporate income
taxes for years prior to 1999. Furthermore, we will derive income from the
non-controlled subsidiaries and they will be subject to regular corporate
taxes.
In addition, we and our subsidiaries contributed a large number of assets to
the operating partnership with a value that was substantially greater than our
tax basis in the assets. We refer to these assets as assets with "built-in
gain." We will be subject to tax on the built-in gain if the operating
partnership sells these assets prior to the end of 2008. We also have
substantial deferred tax liabilities that we or one of the non-controlled
subsidiaries will recognize, without the receipt by us of any corresponding
cash. Even if the operating partnership does not sell the built-in gain assets
prior to the end of 2008, there are a number of other transactions that likely
would cause us to be subject to the tax on the built-in gain. In connection
with this gain, neither we nor the operating partnership will receive any
corresponding cash.
Proposed legislation, if enacted, could require us to restructure our
ownership of the non-controlled subsidiaries
The Clinton Administration's fiscal year 2000 budget proposal, announced
February 1, 1999, includes a proposal that would limit a REIT's ability to own
more than 10%, by vote or value, of the stock of another corporation.
Currently, a REIT cannot own more than 10% of the outstanding voting
securities of any one issuer. A REIT can, however, own more than 10% of the
value of the stock of a corporation provided no more than 25% of the value of
the REIT's assets consists of subsidiaries that conduct impermissible
activities and that the stock of any one single corporation does not account
for more than 5% of the total value of the REIT's assets. The budget proposal
would allow a REIT to own all of the voting stock and value of a "taxable REIT
subsidiary" provided all of a REIT's taxable subsidiaries do not represent
more that 15% of the REIT's total assets. In addition, under the budget
proposal, a "taxable REIT subsidiary" would not be entitled to deduct any
interest on debt funded directly or indirectly by the REIT. The budget
proposal, if enacted in its current form, may require that we restructure our
ownership of the non-controlled subsidiaries because we currently own more
than 10% of the value of the non-controlled subsidiaries. The budget proposal,
if enacted in its current form, would be effective after the date of its
enactment and would provide transition rules to allow corporations, like the
non-controlled subsidiaries, to convert into "taxable REIT subsidiaries" tax-
free. It is presently uncertain whether any proposal regarding REIT
subsidiaries, including the budget proposal, will be enacted, or if enacted,
what the terms of such proposal (including its effective date) will be.
Items 1 & 2. Business and Properties
We are a self-managed and self-administered real estate investment trust, or
"REIT," owning full service hotel properties. Through our subsidiaries, we
currently own 125 hotels, representing approximately 58,000 rooms located
throughout the United States and Canada. These hotels are generally operated
under the Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt brand
names, which are among the most respected and widely recognized brand names in
the lodging industry. As described more fully below, our hotels are held by
our
12
subsidiaries and leased by our subsidiaries to lessees, principally
subsidiaries of Crestline Capital Corporation. The hotels are managed on
behalf of the lessees by subsidiaries of Marriott International and other
companies.
We were formed as a Maryland corporation in 1998, under the name HMC Merger
Corporation, as a wholly owned subsidiary of Host Marriott Corporation, a
Delaware corporation, in connection with Host Marriott's efforts to reorganize
its business operations to qualify as a REIT for federal income tax purposes.
As part of this reorganization, which we refer to as the REIT conversion, and
which is described below in more detail, on December 29, 1998, we merged with
Host Marriott and changed our name to Host Marriott Corporation. As a result,
we have succeeded to the hotel ownership business formerly conducted by Host
Marriott, which is described more fully below.
The REIT conversion
During 1998, Host Marriott and its subsidiaries and affiliates consummated a
series of transactions intended to enable us to qualify as a REIT for federal
income tax purposes. As a result of these transactions the hotel ownership
business formerly conducted by Host Marriott and its subsidiaries and other
affiliates is conducted as an umbrella partnership REIT, or UPREIT through
Host Marriott, L.P., a Delaware limited partnership in which we are the sole
general partner, and its subsidiaries. In this Form 10-K, we refer to Host
Marriott, L.P. as the operating partnership. We intend to elect to be treated
as a REIT for federal income tax purposes effective January 1, 1999.
Certain of the transactions comprising the REIT conversion are described
below.
Reorganization of lodging assets under the operating partnership. During
1998, Host Marriott reorganized its hotel ownership assets and certain other
assets so that they were owned by the operating partnership and its
subsidiaries. In exchange for the hotel ownership business, Host Marriott
received a number of units of limited partnership interests in the operating
partnership (which we refer to as "OP Units") equal to the number of then-
outstanding shares of Host Marriott common stock, and the operating
partnership and its subsidiaries assumed substantially all of the liabilities
of Host Marriott and its subsidiaries.
As a result of this reorganization, our merger with Host Marriott and
related transactions as described below, we are the sole general partner in
the operating partnership and hold approximately 78% of the outstanding OP
Units. Our hotel ownership business is conducted by the operating partnership
and its subsidiaries.
Host Marriott did not transfer to the operating partnership (and the
operating partnership therefore does not own) certain other assets formerly
held by Host Marriott and its subsidiaries (principally consisting of 31
retirement communities and controlling interests in the entities that lease
our hotels). Most of these assets are owned by Crestline, formerly a wholly
owned subsidiary of Host Marriott. Crestline became a separate publicly traded
company on December 29, 1998 as part of the shareholder distribution discussed
below.
Acquisitions by the operating partnership. Prior to the REIT conversion,
Host Marriott and several of its separate direct and indirect wholly owned
subsidiaries were the sole general partners of eight publicly traded limited
partnerships and four private partnerships in which Host Marriott or a
subsidiary owned or held a controlling interest in 28 full-service hotels
operating under the Marriott brand. The following table lists each of these
partnerships and the hotel properties owned by it or in which it holds a
controlling interest.
Partnership Hotel Properties Rooms
----------- ----------------------------- ------
Public
Atlanta Marriott Marquis II Limited
Partnership (1) Atlanta Marriott Marquis 1,671
Desert Springs Marriott Limited
Partnership (1) Desert Springs Resort and Spa 884
Hanover Marriott Limited Partnership
(1) Hanover, New Jersey 353
13
Partnership Hotel Properties Rooms
----------- -------------------------------------- ------
Public (continued)
Marriott Diversified American
Hotels Limited Partnership Dayton, Ohio 399
Fairview Park, Virginia 395
Livonia, Michigan 224
Fullerton, California 224
Research Triangle Park, North Carolina 224
Southfield, Michigan 226
Marriott Hotel Properties
Limited Partnership (1) Orlando World Center 1,503
Harbor Beach Resort, Florida 624
Marriott Hotel Properties II
Limited Partnership (1) San Antonio Rivercenter 999
New Orleans 1,292
San Ramon, California 368
Santa Clara, California 754
Mutual Benefit Chicago
Marriott Suite Hotel Limited
Partnership Chicago O'Hare Suites 256
Potomac Hotel Limited
Partnership Albuquerque, New Mexico 411
Greensboro/High Point, North Carolina 299
Houston Medical Center 386
Mountain Shadows Resort, Arizona 337
Miami Biscayne Bay 605
Raleigh Crabtree, North Carolina (2) 375
Seattle Sea-Tac Airport 459
Tampa Westshore (2) 309
Private
HMC BN Limited Partnership
(3) Ritz-Carlton, Buckhead, Georgia 553
Ritz-Carlton, Naples, Florida 463
Ivy Street Hotel Limited
Partnership (3) Atlanta Marriott Marquis 1,671
Times Square Marquis Hotel
Limited Partnership (3) New York Marriott Marquis 1,919
HMC/RGI Hartford Limited
Partnership (3) Hartford/Farmington 380
- --------
(1) We owned or had a controlling interest in these partnerships prior to the
REIT conversion. These properties were previously consolidated by Host
Marriott.
(2) We consolidated these properties through our investments including the
ownership of mortgage notes prior to the REIT conversion.
(3) We acquired substantially all of the unaffiliated partnership interests
prior to the REIT conversion. These properties were previously
consolidated by Host Marriott.
In addition to the partnerships listed above, we own controlling interests
in certain private partnerships which we had previously consolidated. Certain
of the minority partners in these partnerships retain the right to exchange
their interests in these partnerships for OP Units subject to certain
conditions. We estimate that as many as approximately 7 million OP Units could
be issued at various points in time in the event that all such minority
partners were to elect to exchange their partnership interests.
As part of the REIT conversion, the operating partnership, directly and
through its subsidiaries, acquired all of the publicly-traded partnerships and
the four private partnerships identified on the table above in exchange for
approximately 25 million OP Units. Approximately 8.5 million of these OP Units
have been converted into shares of our common stock. Additionally, certain
limited partners of the publicly-traded partnerships elected to exchange OP
Units for approximately $3 million aggregate principal amount unsecured notes
due December 15, 2005 issued by the operating partnership.
The operating partnership also acquired on December 30, 1998 from the
Blackstone Group, a Delaware limited partnership, and a series of funds
controlled by affiliates of Blackstone Real Estate Partners (together, the
"Blackstone Entities"), ownership of or a controlling interest in 12 upscale
and luxury full-service hotels in the U.S. and a mortgage loan secured by a
thirteenth hotel and certain other assets. As part of the Blackstone
acquisition, the operating partnership also acquired a 25% interest in the
U.S. Swissotel management company
14
which was sold in turn to Crestline at book value. In exchange for these
assets, the operating partnership issued to the Blackstone Entities
approximately 43.9 million OP Units, which OP Units are redeemable for cash
(or at our option, our common shares), assumed debt and made cash payments
totaling approximately $920 million and distributed approximately 1.4 million
shares of Crestline common stock and other consideration to the Blackstone
Entities. The actual number of OP Units to be issued to the Blackstone
Entities will fluctuate based upon certain adjustments to be determined at the
close of business on March 31, 1999. Based on current stock prices, the
operating partnership will be required to issue to the Blackstone Entities in
April 1999 approximately 3.7 million additional OP Units pursuant to such
adjustments. As a result of the consummation of the Blackstone Acquisition,
after all the adjustments the Blackstone Entities will own approximately 16.4%
of the outstanding OP Units. The Blackstone hotel portfolio consists of two
Ritz-Carlton, two Four Seasons, one Grand Hyatt, three Hyatt Regency and four
Swissotel properties. John G. Schreiber, co-chairman of Blackstone Real Estate
Partners' investment committee, is a member of our Board of Directors.
Contribution of assets to non-controlled subsidiaries. In connection with
the REIT conversion, two taxable corporations were formed in which the
operating partnership owns approximately 95% of the economic interest but none
of the voting interest--Rockledge Hotel Properties, Inc. and Fernwood Hotel
Assets, Inc. (we refer to these two subsidiaries as the non-controlled
subsidiaries). The non-controlled subsidiaries hold various assets which were
originally contributed by Host Marriott and its subsidiaries to the operating
partnership, the direct ownership of which by the operating partnership or its
other subsidiaries would jeopardize our status as a REIT and the operating
partnership's status as a partnership for federal income tax purposes. These
assets primarily consist of interests in certain partnerships or other
interests in hotels which are not leased, and certain furniture, fixtures and
equipment (also known as FF&E) used in the hotels and certain international
hotels. The operating partnership has no control over the operation or
management of the hotels or other assets owned by the non-controlled
subsidiaries. The Host Marriott Statutory Employee/Charitable Trust, the
beneficiaries of which are a trust formed for the benefit of certain employees
of the operating partnership and the J. Willard and Alice S. Marriott
Foundation, acquired all of the voting common stock of each non-controlled
subsidiary, representing, in each case, the remaining approximately 5% of the
total economic interests in each non-controlled subsidiary.
Leases of hotels. Under current federal income tax law, a REIT cannot derive
income from the operation of hotels but can derive rental income by leasing
hotels. Therefore, as part of the REIT conversion the operating partnership
and its subsidiaries have leased virtually all of their hotel properties to
certain subsidiaries of Crestline. Generally, there is a separate lessee for
each hotel property or there is a separate lessee for each group of hotel
properties that has separate mortgage financing or has owners in addition to
the operating partnership and its wholly owned subsidiaries. Each lessee is
generally a limited liability company whose purpose is limited to acting as
lessee under an applicable lease. The lessees under leases of hotels that are
managed by subsidiaries of Marriott International are owned 100% by a wholly
owned subsidiary of Crestline, although Marriott International or its
appropriate subsidiary has a non-economic voting interest on certain matters.
The LLC operating agreement or the limited partnership agreement, as
applicable, for such lessees provides that the Crestline subsidiary or general
partner of the lessee will have full control over the management of the
business of the lessee, except with respect to certain decisions for which the
consent of members or partners and the manager will be required.
The hotel management agreements to which Host Marriott or its subsidiaries
were parties were assigned to the lessees for the term of the applicable
leases. Although the lessees have primary liability under the management
agreements while the leases are in effect, the operating partnership retains
contingent liability under the management agreements for all obligations that
the lessees do not perform. The operating partnership also remains primarily
liable for certain obligations under the management agreements.
From time to time, legislation has been proposed that would have the effect
of enabling a REIT to lease hotels to a wholly owned subsidiary corporation
that could operate hotels directly, provided that the subsidiary contracts out
the management functions to independent third parties. In the event that
legislation is enacted that would have the effect of enabling the operating
partnership to lease its hotels to a wholly owned subsidiary, then
15
Host Marriott, at its discretion, may elect to terminate the leases of its
hotels with Crestline subsidiaries and pay certain termination fees.
The shareholder distributions. As part of the REIT conversion, Host Marriott
made certain taxable distributions to its shareholders in which they received,
for each share of common stock, (1) one-tenth of one share of common stock of
Crestline and, (2) either $1 cash or 0.087 share of Host Marriott common stock
at the election of the shareholder. The aggregate value of the Crestline
common stock, the common stock and cash distributed to shareholders of Host
Marriott was approximately $510 million.
Operations as a REIT
We are the sole general partner of the operating partnership and manage all
aspects of the business of the operating partnership. This includes decisions
with respect to, sales and purchases of hotels, the financing of the hotels,
the leasing of the hotels, and capital expenditures for the hotels (subject to
the terms of the leases and the management agreements described below).
Under current federal income tax law, REITs are restricted in their ability
to derive revenues directly from the operations of hotels. Therefore, the
operating partnership and its subsidiaries lease virtually all of their hotels
to certain entities we refer to as the "lessees." The lessees pay rent to the
operating partnership and its subsidiaries generally equal to a specified
minimum rent plus rent based on specified percentages of different categories
of aggregate sales at the relevant hotels to the extent such "percentage rent"
would exceed the minimum rent. The lessees operate the hotels pursuant to
management agreements with the managers. Each of the management agreements
provides for certain base and incentive management fees, plus reimbursement of
certain costs, as further described below. Such fee and cost reimbursements
are the primary obligation of the lessees and not the operating partnership or
its subsidiaries (although operating partnership or its subsidiaries remain
liable under the management agreements and the obligation of the lessees to
pay such fees could adversely affect the ability of the lessees to pay the
required rent to the operating partnership or its subsidiaries). A summary of
the material terms of these leases and management agreements is provided
below.
The leases, through the sales percentage rent provisions, are designed to
allow the operating partnership and its subsidiaries to participate in any
growth above specified levels in room sales at the hotels, which management
expects can be achieved through increases in room rates and occupancy levels.
Although the economic trends affecting the hotel industry will be the major
factor in generating growth in lease revenues, the abilities of the lessees
and the managers will also have a material impact on future sales growth.
In addition to external growth generated by new acquisitions, the operating
partnership intends to carefully and periodically review its portfolio to
identify opportunities to selectively enhance existing assets to improve
operating performance through major capital improvements. The leases of the
operating partnership and its subsidiaries provide the operating partnership
and its subsidiaries with the right to approve and finance major capital
improvements.
Business Strategy
Our primary objective is to acquire upscale and luxury full service hotel
lodging properties and achieve long-term sustainable growth in "Funds from
Operations" (i.e., net income computed in accordance with generally accepted
accounting principles, excluding gains or losses from debt restructuring and
sales of properties, plus real estate related depreciation and amortization,
and after adjustments for less than 100% owned partnerships and joint
ventures) per common share and cash flow. Since the beginning of 1994 through
the date hereof, we have grown our hotel portfolio, directly or through our
respective subsidiaries, by 105 full-service hotels representing more than
48,000 rooms for an aggregate purchase price of approximately $6.2 billion.
Based upon data provided by Smith Travel Research, we believe that our full-
service hotels outperform the industry's average occupancy rate by a
significant margin. Our full-service hotels averaged 78.8% occupancy for 1998,
for comparable properties, compared to a 71.1% average occupancy for our
competitive set. Our competitive set
16
refers to hotels in the upscale and luxury full-service segment of the lodging
industry, the segment which is most representative of our full-service hotels,
and consists of Marriott Hotels, Resorts and Suites; Crowne Plaza; Doubletree;
Hyatt; Hilton; Radisson; Red Lion; Sheraton; Westin; and Wyndham.
One commonly used indicator of market performance for hotels is REVPAR,
which measures daily room revenues generated on a per room basis. This does
not include food and beverage or other ancillary revenues generated by the
property. REVPAR represents the product of the average daily room rate charged
and the average daily occupancy achieved. The relatively high occupancy rates
of our hotels, along with increased demand for full-service hotel rooms, have
allowed the managers of our hotels to increase average daily room rates by
selectively raising room rates and by replacing certain discounted group
business with higher-rate group and transient business. As a result, on a
comparable basis, REVPAR for our full-service properties increased
approximately 7.3% and 12.6% in 1998 and 1997, respectively.
Although competition for acquisitions has increased, we believe that the
upscale and luxury full-service segments of the market offer opportunities to
acquire assets at attractive multiples of cash flow and at discounts to
replacement value. We intend to increase our pool of potential acquisition
candidates by considering acquisitions of select non-Marriott and non-Ritz-
Carlton hotels that offer long-term growth potential and are consistent with
the overall quality of our current portfolio. We will focus on upscale and
luxury full-service properties in difficult to duplicate locations with high
barriers to entry, such as hotels located in downtown, airport and
resort/convention locations, which are operated by quality managers. We
believe this ability to acquire hotel properties operated by a variety of
quality managers under long-term contracts represents a strategic advantage
over a number of competitors. For example, in December 1998, we consummated
the Blackstone Acquisition for approximately $1.55 billion in a combination of
OP Units, assumed debt, and other consideration.
In certain circumstances, we have improved the results of under-performing
hotels by converting them to the Marriott brand. In general, based upon data
provided by Smith Travel Research, we believe that the Marriott brand has
consistently outperformed the industry. Demonstrating the strength of the
Marriott brand name, our comparable properties generated a 26% REVPAR premium
over our competitive set for 1998. Accordingly, management anticipates that
any additional full-service properties acquired in the future and converted
from other brands to the Marriott brand should achieve higher occupancy rates
and average room rates than has previously been the case for those properties
as the properties begin to benefit from Marriott's brand name recognition,
reservation system and group sales organization. Of our 105 full-service
hotels acquired from the beginning of 1994 through the date hereof, sixteen
were converted to the Marriott brand following their acquisition although such
opportunities have been more limited recently.
We also plan to selectively develop new upscale and luxury full-service
hotels in major urban markets and convention/resort locations with strong
growth prospects, unique or difficult to duplicate sites, high barriers to
entry for other new hotels and limited new supply. We intend to target only
development projects that show promise of providing financial returns that
represent a premium to acquisitions. In 1997, Host Marriott announced that it
would develop the 717-room Tampa Convention Center Marriott for $104 million,
including a $16 million subsidy provided by the City of Tampa.
We believe we are well qualified to pursue our acquisition and development
strategy. Management has extensive experience in acquiring and financing
lodging properties and believes its industry knowledge, relationships and
access to market information provide a competitive advantage with respect to
identifying, evaluating and acquiring hotel assets.
Recent Acquisitions, Dispositions and Developments
In January 1998, one of our subsidiaries acquired an additional interest in
Atlanta Marquis, which owns an interest in the 1,671-room Atlanta Marriott
Marquis Hotel, for approximately $239 million, including the assumption of
approximately $164 million of mortgage debt. It previously owned a 1.3%
general and limited partnership interest. As noted above, the remaining
limited partner interests in Atlanta Marquis were acquired as part of the REIT
conversion.
17
In March 1998, one of our subsidiaries acquired a controlling interest in
the partnership that owns three hotels: the 359-room Albany Marriott, the 350-
room San Diego Marriott Mission Valley and the 320-room Minneapolis Marriott
Southwest for approximately $50 million. In the second quarter of 1998, one of
our subsidiaries acquired the partnership that owns the 289-room Park Ridge
Marriott in Park Ridge, New Jersey for $24 million. It previously owned a 1%
managing general partner interest and a note receivable interest in such
partnership. In addition, our subsidiary acquired the 281-room Ritz-Carlton,
Phoenix for $75 million, the 397-room Ritz-Carlton, Tysons Corner in Virginia
for $96 million and the 487-room Torrance Marriott near Los Angeles,
California for $52 million. In the third quarter of 1998, Host Marriott
acquired the 308-room Ritz-Carlton, Dearborn for approximately $65 million; a
subsidiary of Host Marriott also acquired the 336-room Ritz-Carlton, San
Francisco for approximately $161 million, and Host Marriott acquired the 404-
room Memphis Crowne Plaza (which was converted to the Marriott brand upon
acquisition) for approximately $16 million. These assets are currently held by
the operating partnership and its subsidiaries.
As noted above, in December 1998, we completed acquisitions of eight public
partnerships and interests in four private partnerships which own or control
28 properties and we consummated the Blackstone Acquisition. The Blackstone
hotel portfolio is one of the premier collections of hotel real estate
properties which includes: the 449-room Ritz-Carlton, Amelia Island; the 275-
room Ritz-Carlton, Boston; the 793-room Hyatt Regency Burlingame at San
Francisco Airport; the 469-room Hyatt Regency Cambridge, Boston; the 514-room
Hyatt Regency Reston, Virginia; the 439-room Grand Hyatt Atlanta; the 365-room
Four Seasons Philadelphia; the 246-room Four Seasons Atlanta; the 494-room
Drake (Swissotel) New York; the 630-room Swissotel Chicago; the 498-room
Swissotel Boston and the 348-room Swissotel Atlanta. Additionally, the
transaction included: a $65.6 million first mortgage loan on the 285-room Four
Seasons Beverly Hills; two office buildings in Atlanta--the offices at The
Grand (97,879 sq. ft.) and the offices at the Swissotel (67,110 sq. ft.); and
a 25% interest in the Swissotel U.S. management company (which was transferred
to Crestline).
During 1997, we or our subsidiaries acquired, or purchased controlling
interests in, 17 full-service hotels, containing 8,624 rooms, for an aggregate
purchase price of approximately $765 million (including the assumption of
approximately $418 million of debt). Our subsidiaries also completed the
acquisition of the 504-room New York Marriott Financial Center following the
acquisition of the mortgage on the hotel for $101 million in late 1996.
In 1997, we or our subsidiaries acquired, or obtained controlling interests
in, five affiliated partnerships, adding 10 hotels to our portfolio. In
January 1997, a subsidiary of Host Marriott acquired a controlling interest in
MHP. MHP owns the 1,503-room Marriott Orlando World Center and a 50.5%
interest in the 624-room Marriott Harbor Beach Resort. In April, a subsidiary
of Host Marriott acquired a controlling interest in the 353-room Hanover
Marriott. In the fourth quarter, a subsidiary of Host Marriott acquired the
Chesapeake Hotel Limited Partnership. This partnership owns the 430-room
Boston Marriott Newton; the 681-room Chicago Marriott O'Hare; the 595-room
Denver Marriott Southeast; the 588-room Key Bridge Marriott in Virginia; the
479-room Minneapolis Airport Marriott in Minnesota; and the 221-room Saddle
Brook Marriott in New Jersey. In December 1997, a subsidiary obtained a
controlling interest in the partnership that owns the 884-room Marriott's
Desert Springs Resort and Spa in California and acquired the remaining
interests in December 1998 as part of the REIT conversion.
In addition to investments in partnerships in which we already held minority
interests, we have been successful in adding properties to our portfolio
through partnership arrangements with either the seller of the property or the
incoming managers (typically Marriott International or a Marriott franchisee).
We have the financial flexibility and, due to our existing private partnership
investment portfolio, the administrative infrastructure in place to
accommodate such arrangements. We view this ability as a competitive advantage
and expect to enter into similar arrangements to acquire additional properties
in the future.
Through subsidiaries, we currently own four Canadian properties, with 1,636
rooms, and will continue to evaluate other attractive acquisition
opportunities in Canada. In addition, the overbuilding and economic stress
currently being experienced in some European and Pacific Rim countries may
eventually lead to additional
18
international acquisition opportunities. We will acquire international
properties only when such acquisitions achieve satisfactory returns after
adjustments for currency and country risks and tax consequences.
We may also expand certain existing hotel properties where strong
performance and market demand exists. Expansions to existing properties create
a lower risk to us as the success of the market is generally known and
development time is significantly shorter than new construction. We recently
began construction on a 500-room expansion and an additional 15,000 square
feet of meeting space to the 1,503-room Marriott Orlando World Center, which
is due to be completed in early 2000. In July 1998, a subsidiary purchased a
13-acre parcel of land for the development of a 295-room Ritz-Carlton that
will serve as an extension of the 463-room Ritz-Carlton, Naples, which was
purchased in September 1996. The existing hotel just completed room,
restaurant and public space refurbishment and is in the process of adding a
world-class spa. In addition, a subsidiary of one of the non-controlled
subsidiaries has entered into a joint venture through which it owns 49% of the
surrounding newly developed 27-hole world-class Greg Norman designed golf
course development. The golf course joint venture was transferred to a non-
controlled subsidiary in connection with the REIT conversion. The total
investment by the operating partnership in expansions and improvements of the
Ritz-Carlton, Naples property is expected to be approximately $97 million.
In February 1999, we sold the Minneapolis/Bloomington Marriott for $35
million and recorded a gain on the sale of approximately $13 million. We also
may selectively dispose of other hotel assets where we believe we can earn
higher returns on our invested capital.
Hotel Lodging Industry
The lodging industry posted strong gains in 1998 as higher average daily
rates drove increases in revenue per available room, or REVPAR. Over the last
five years, the lodging industry has benefited from a favorable supply/demand
imbalance, driven in part by low construction levels in our submarkets
combined with high gross domestic product (GDP) growth. Recently, however,
supply has begun to moderately outpace demand, causing slight declines in
occupancy rates in the upscale and luxury full-service segments in which we
operate. According to Smith Travel Research, supply in our competitive set
increased 1.2% for the year ended December 31, 1998 versus the same period one
year ago while demand in our competitive set decreased 0.3% for the same
period. At the same time, occupancy declined 1.5% in our competitive set for
the year ended December 31, 1998 versus the same period one year ago.
These declines in occupancy, however, were more than offset by increases in
average daily rates which generated higher REVPAR. According to Smith Travel
Research, for the year ended December 31, 1998, average daily rate and REVPAR
for our competitive set increased 6.5% and 5.0%, respectively, versus the same
period one year ago. The current amount of excess supply in the lodging
industry is relatively moderate and much less severe than that experienced in
the lodging industry beginning in 1989, in part because of the greater
financial discipline and lending practices imposed by financial institutions
and public markets today relative to those during the late 1980's.
Within the upscale and luxury full-service segment, our hotels have
outperformed the overall sector. The attractive locations of our hotels, the
limited availability of new building sites for new construction of competing
full-service hotels, and the lack of availability of financing for new full-
service hotels has allowed us to maintain REVPAR and average daily rate
premiums over our competitors in these service segments. On a comparable
basis, average daily rates for our full service hotels increased 6.9% during
1998 compared with 1997. The increase in average daily rate helped generate a
strong increase in comparable hotel REVPAR of 7.3% for the same period.
Furthermore, because our lodging operations have a high fixed-cost component,
increases in REVPAR generally yield greater percentage increases in EBITDA.
While we do not benefit directly from increases in EBITDA levels at our
properties due to the structure of our leases, we should benefit from such
increases due to expected higher market valuations of our properties based on
such elevated EBITDA levels.
19
We believe that the current environment of excess supply will most likely
continue over the next twelve to eighteen months, although any excess supply
is expected to be moderate given the fact that demand is expected to grow at
the same 1% to 2% rate as projected GDP and new construction has been limited
by capital constraints. Given the relatively long lead time to develop urban,
convention and resort hotels, we believe that growth in room supply in upscale
and luxury full-service sub-markets in which we operate will remain moderate
through the year 2000. However, there can be no assurance that growth in
supply will remain moderate or that REVPAR and EBITDA will continue to
improve.
Hotel Lodging Properties
Our lodging portfolio currently consists of 125 upscale and luxury full
service hotels with approximately 58,000 rooms. Our hotel lodging properties
represent quality assets in the upscale and luxury full-service lodging
segments. All but thirteen of our hotel properties are currently operated
under the Marriott or Ritz-Carlton brand names.
To maintain the overall quality of our lodging properties, each property
undergoes refurbishments and capital improvements on a regularly scheduled
basis. Typically, refurbishing has been provided at intervals of five years,
based on an annual review of the condition of each property. For the fiscal
years 1998, 1997 and 1996, we spent $165 million, $129 million and $87
million, respectively, on capital improvements to existing properties. As a
result of these expenditures, we will be able to maintain high quality rooms
at our properties.
Our hotels average nearly 465 rooms. Thirteen of our hotels have more than
750 rooms. Hotel facilities typically include meeting and banquet facilities,
a variety of restaurants and lounges, swimming pools, gift shops and parking
facilities. Our hotels primarily serve business and pleasure travelers and
group meetings at locations in downtown and suburban areas, near airports and
at resort convention locations throughout the United States. The properties
are generally well situated in locations where there are significant barriers
to entry by competitors including downtown areas of major metropolitan cities
at airports and resort/convention locations where there are limited or no
development sites. Marriott International serves as the manager for 99 of our
125 hotels and all but 13 are part of Marriott International's full-service
hotel system. The Marriott brand name has consistently delivered occupancy and
REVPAR premiums over other brands. Based upon data provided by Smith Travel
Research, our comparable properties have an eight percentage point occupancy
premium and a 26% REVPAR premium over the competitive set for 1998.
The average age of our properties is sixteen years, although several of the
properties have had substantial, more recent renovations or major additions.
In 1998, a subsidiary substantially completed a two-year $25 million dollar
capital improvement program at the New Orleans Marriott which included
renovations to all guest rooms, refurbishment of ballrooms and restaurant
updates. In early 1998, a subsidiary of Host Marriott completed a $15 million
capital improvement program at the Denver Marriott Tech Center. The program
included replacement of guestroom interiors, remodeling of the lobby,
ballroom, meeting rooms and corridors, as well as renovations to the exterior
of the building.
A number of our full-service hotel acquisitions such as the Memphis Marriott
which was acquired in 1998 were converted to the Marriott brand upon
acquisition. The conversion of these properties to the Marriott brand is
intended to increase occupancy and room rates as a result of Marriott
International's nationwide marketing and reservation systems, its Marriott
Rewards program, group sales force, as well as customer recognition of the
Marriott brand name. The invested capital with respect to these properties is
primarily used for the improvement of common areas, as well as upgrading soft
and hard goods (i.e., carpets, drapes, paint, furniture and additional
amenities). The conversion process typically causes periods of disruption to
these properties as selected rooms and common areas are temporarily taken out
of service. Historically, the conversion properties have shown improvements as
the benefits of Marriott International's marketing and reservation programs,
group sales force and customer service initiatives take hold. In addition,
these properties have generally been integrated into Marriott International's
systems covering purchasing and distribution, insurance, telecommunications
and payroll processing.
20
The chart below sets forth performance information for our comparable
hotels:
1998 1997
------- -------
Comparable Full-Service Hotels(1)
Number of properties.......................................... 78 78
Number of rooms............................................... 38,589 38,589
Average daily rate............................................ $142.67 $133.45
Occupancy percentage.......................................... 78.8% 78.5%
REVPAR........................................................ $112.39 $104.79
REVPAR % change............................................... 7.3% --
- --------
(1) Consists of the 78 properties owned directly or indirectly by us for the
entire 1998 and 1997 fiscal years, respectively. These properties, for the
respective periods, represent the "comparable properties". Properties held
for less than all of the periods discussed above, respectively, are not
considered comparable.
The chart below sets forth certain performance information for our hotels:
1998 1997 1996
------- ------- -------
Number of properties............................... 126(1) 95 79
Number of rooms.................................... 58,445(1) 45,718 37,210
Average daily rate................................. $140.35 $133.74 $119.94
Occupancy percentage............................... 77.7% 78.4% 77.3%
REVPAR............................................. $109.06 $104.84 $ 92.71
- --------
(1) Number of properties and rooms as of December 31, 1998 and includes 25
properties (9,965 rooms) acquired in the public partnerships merger and
the Blackstone Acquisition.
The following table presents full service hotel information by geographic
region for 1998:
Number Average Number Average Average
Geographic Region of Hotels of Guest Rooms Occupancy(1) Daily Rate(1) REVPAR(1)
- ----------------- --------- -------------- ------------ ------------- ---------
Atlanta................. 11 486 72.3% $139.25 $100.67
Florida................. 13 513 78.9% 141.22 111.45
Mid-Atlantic............ 17 364 76.5% 122.56 93.75
Midwest................. 17 369 74.5% 114.71 85.41
New York................ 12 631 85.2% 183.21 156.18
Northeast............... 11 379 78.9% 107.93 85.13
South Central........... 18 497 77.0% 123.94 95.46
Western................. 27 491 78.1% 150.80 117.76
Average--All regions.... 126 463 78.0% 140.38 109.44
- --------
(1) The operating results of the 25 properties acquired through the Blackstone
Acquisition and the merger of the public partnerships are not included.
During 1995 and 1996, we divested virtually all of our limited-service hotel
properties through the sale and leaseback of 53 Courtyard properties and 18
Residence Inn properties. During 1998, limited-service properties represented
less than 2% of our EBITDA from hotel properties and we expect this percentage
to continue to decrease as we continue to acquire full service properties.
These 71 properties that we lease continue to be reflected in our revenues.
The Courtyard and Residence Inn properties are subleased to subsidiaries of
Crestline under sublease agreements and are managed by Marriott International
under long-term management agreements. The owners of the 71 limited-services
properties that we lease have not yet consented to the subleases but have
agreed to waive any defaults under the related leases until April 23, 1999, to
provide us with additional time to obtain such consents (which could require
modifications in the terms of the sublease and structural or other changes
related thereto). If such consents are not obtained, we may be required to
terminate the subleases and
21
contribute to a non-controlled subsidiary our equity interests in the
subsidiaries leasing the properties. This change would have the effect of
reducing our revenues by $297 million and $282 million for 1998 and 1997,
respectively, and increasing our net income by approximately $5 million and $4
million for 1998 and 1997, respectively.
The following table sets forth as of March 1, 1999, the location and number
of rooms relating to each of our 125 hotels. All of the properties are leased
to a subsidiary of Crestline and operated under Marriott brands by Marriott
International, unless otherwise indicated.
Location Rooms
- -------- ------
Alabama
Grand Hotel Resort and Golf
Club.......................................................... 306
Arizona
Mountain Shadows Resort........................................ 337
Scottsdale Suites.............................................. 251
The Ritz-Carlton, Phoenix...................................... 281
California
Coronado Island Resort(1)(2)................................... 300
Costa Mesa Suites.............................................. 253
Desert Springs Resort and Spa.................................. 884
Fullerton(2)................................................... 224
Hyatt Regency, Burlingame(3)................................... 793
Manhattan Beach(1)(2)(4)....................................... 380
Marina Beach(1)(2)............................................. 368
Newport Beach.................................................. 570
Newport Beach Suites........................................... 250
Ontario Airport(4)............................................. 299
Sacramento Airport(2)(3)(7).................................... 85
San Diego Marriott Hotel and
Marina(2)(6).................................................. 1,355
San Diego Mission Valley(4)(7)................................. 350
San Francisco Airport.......................................... 684
San Francisco Fisherman's
Wharf(4)...................................................... 285
San Francisco Moscone Center(2)................................ 1,498
San Ramon(2)................................................... 368
Santa Clara(2)................................................. 754
The Ritz-Carlton, Marina del
Rey(2)........................................................ 306
The Ritz-Carlton, San Francisco................................ 336
Torrance....................................................... 487
Colorado
Denver Southeast(2)............................................ 595
Denver Tech Center(1).......................................... 625
Denver West(2)................................................. 307
Marriott's Mountain Resort at
Vail(1)....................................................... 349
Connecticut
Hartford/Farmington............................................ 380
Hartford/Rocky Hill(2)......................................... 251
Florida
Fort Lauderdale Marina(2)...................................... 580
Harbor Beach Resort(2)(5)(6)(7)................................ 624
Jacksonville(2)(4)............................................. 256
Miami Airport(2)............................................... 782
Miami Biscayne Bay(2).......................................... 605
Orlando World Center........................................... 1,503
Palm Beach Gardens(4).......................................... 279
Singer Island Holiday Inn(3)................................... 222
Tampa Airport(2)............................................... 295
Tampa Westshore(2)............................................. 309
The Ritz-Carlton, Amelia Island................................ 449
The Ritz-Carlton, Naples....................................... 463
Georgia
Atlanta Marriott Marquis(6).................................... 1,671
Atlanta Midtown Suites(2)...................................... 254
Georgia (Continued)
Atlanta Norcross............................................... 222
Atlanta Northwest.............................................. 400
Atlanta Perimeter(2)........................................... 400
Four Seasons, Atlanta(3)....................................... 246
Grand Hyatt, Atlanta(3)........................................ 439
JW Marriott Hotel at Lenox(2).................................. 371
Swissotel, Atlanta(3).......................................... 348
The Ritz-Carlton, Atlanta(2)................................... 447
The Ritz-Carlton, Buckhead..................................... 553
Illinois
Chicago/Deerfield Suites....................................... 248
Chicago/Downers Grove Suites................................... 254
Chicago/Downtown Courtyard..................................... 334
Chicago O'Hare(2).............................................. 681
Chicago O'Hare Suites(2)....................................... 256
Swissotel, Chicago(3).......................................... 630
Indiana
South Bend(2).................................................. 300
Louisiana
New Orleans.................................................... 1,290
Maryland
Bethesda(2).................................................... 407
Gaithersburg/Washingtonian
Center........................................................ 284
Massachusetts
Boston/Newton.................................................. 430
Hyatt Regency, Cambridge(3).................................... 469
Swissotel, Boston(3)........................................... 498
The Ritz-Carlton, Boston....................................... 275
Michigan
The Ritz-Carlton, Dearborn..................................... 308
Detroit Livonia................................................ 224
Detroit Romulus................................................ 245
Detroit Southfield............................................. 226
Minnesota
Minneapolis City Center(2)..................................... 583
Minneapolis Southwest(4)(7).................................... 320
Missouri
Kansas City Airport(2)......................................... 382
New Hampshire
Nashua......................................................... 251
New Jersey
Hanover........................................................ 353
Newark Airport(2).............................................. 590
Park Ridge(2).................................................. 289
Saddle Brook................................................... 221
New Mexico
Albuquerque(2)................................................. 411
New York
Albany(4)(7)................................................... 359
New York Marriott Financial
Center........................................................ 504
New York Marriott Marquis(2)(6)................................ 1,919
Marriott World Trade
Center(1)(2).................................................. 820
Swissotel, The Drake(3)........................................ 494
22
Location Rooms
- -------- -----
North Carolina
Charlotte Executive Park(4).......................................... 298
Greensboro/Highpoint(2).............................................. 299
Raleigh Crabtree Valley.............................................. 375
Research Triangle Park............................................... 224
Ohio
Dayton............................................................... 399
Oklahoma
Oklahoma City........................................................ 354
Oklahoma City Waterford(1)(4)........................................ 197
Oregon
Portland............................................................. 503
Pennsylvania
Four Seasons, Philadelphia(3)........................................ 365
Philadelphia Convention
Center(2)........................................................... 1,200
Philadelphia Airport(2).............................................. 419
Pittsburgh City Center(1)(2)(4)...................................... 400
Tennessee
Memphis(1)(2)........................................................ 404
Texas
Dallas/Fort Worth Airport............................................ 492
Dallas Quorum(2)..................................................... 547
El Paso(2)........................................................... 296
Houston Airport(2)................................................... 566
Houston Medical Center(2)............................................ 386
JW Marriott Houston.................................................. 503
Plaza San Antonio(1)(2)(4)........................................... 252
San Antonio Rivercenter(2)........................................... 999
San Antonio Riverwalk(2)............................................. 500
Utah
Salt Lake City(2).................................................... 510
Virginia
Dulles Airport(2).................................................... 370
Fairview Park(2)..................................................... 395
Hyatt Regency, Reston(3)............................................. 514
Key Bridge(2)........................................................ 588
Norfolk Waterside(2)(4).............................................. 404
Pentagon City Residence Inn.......................................... 300
The Ritz-Carlton, Tysons
Corner(2)........................................................... 397
Washington Dulles Suites............................................. 254
Westfields(1)........................................................ 335
Williamsburg(1)...................................................... 295
Washington
Seattle SeaTac Airport............................................... 459
Washington, DC
Washington Metro Center(1)........................................... 456
Canada
Calgary(1)........................................................... 380
Toronto Airport...................................................... 423
Toronto Eaton Center(2).............................................. 459
Toronto Delta Meadowvale(3).......................................... 374
------
TOTAL................................................................. 57,975
======
- --------
(1) This property was converted to the Marriott brand after acquisition.
(2) The land on which this hotel is built is leased under one or more long-
term lease agreements.
(3) This property is not operated under the Marriott brand and is not managed
by Marriott International.
(4) This property is operated as a Marriott franchised property.
(5) This property is leased to Marriott International.
(6) This property is not wholly owned by the operating partnership.
(7) This property is not leased to Crestline.
Investments in Affiliated Partnerships
The operating partnership and certain of its subsidiaries also manage our
partnership investments and conduct the partnership services business. As
previously discussed, in connection with the REIT conversion, the non-
controlled subsidiaries were formed to hold various assets. The direct
ownership of those assets by us or the operating partnership could jeopardize
our status as a REIT or the operating partnership's treatment as a partnership
for federal income tax purposes. Substantially all our general and limited
partner interests in partnerships owning 220 limited-service hotels were held
by the non-controlled subsidiaries at year end. Additionally, of the 20 full-
service hotels in which we had general and limited partner interests 13 were
acquired by the operating partnership, two were sold, four were transferred to
the non-controlled subsidiary and one was retained.
The managing general partner of the partnership retained is responsible for
the day-to-day management of the partnership operations, which generally
includes payment of partnership obligations from partnership funds,
preparation of financial reports and tax returns and communications with
lenders, limited partners and regulatory bodies. As the general partner, we
are reimbursed for the cost of providing these services subject to limitations
in certain cases.
The partnership hotel is currently operated under a management agreement
with Marriott International or its subsidiaries. As the general partner, we
oversee and monitor Marriott International and its subsidiaries' performance
pursuant to these agreements.
23
Cash distributions provided from these partnerships including distributions
related to partnerships sold, transferred or acquired in 1998 are tied to the
overall performance of the underlying properties and the overall level of
debt. Distributions from these partnerships to us were $2 million in 1998 and
$5 million in each of 1997 and 1996. All debt of these partnerships is
nonrecourse to us and our subsidiaries, except that we are contingently liable
under various guarantees of debt obligations of certain of the limited-service
partnerships.
Marketing
As of March 1, 1999, 99 of our 125 hotel properties were managed by Marriott
International as Marriott or Ritz-Carlton brand hotels. Thirteen of the 26
remaining hotels are operated as Marriott brand hotels under franchise
agreements with Marriott International. We believe that these Marriott-managed
and franchised properties will continue to enjoy competitive advantages
arising from their participation in the Marriott International hotel system.
Marriott International's nationwide marketing programs and reservation systems
as well as the advantage of the strong customer preference for Marriott brands
should also help these properties to maintain or increase their premium over
competitors in both occupancy and room rates. Repeat guest business in the
Marriott hotel system is enhanced by the Marriott Rewards program, which
expanded the previous Marriott Honored Guest Awards program. Marriott Rewards
membership includes more than 7.5 million members.
The Marriott reservation system provides Marriott reservation agents
complete descriptions of the rooms available for sale and up-to-date rate
information from the properties. The reservation system also features
connectivity to airline reservation systems, providing travel agents with
access to available rooms inventory for all Marriott and Ritz-Carlton lodging
properties. In addition, software at Marriott's centralized reservations
centers enables agents to immediately identify the nearest Marriott or Ritz-
Carlton brand property with available rooms when a caller's first choice is
fully occupied. Our website (www.hostmarriott.com) currently permits users to
connect to the Marriott reservation system to reserve rooms in its hotels.
Competition
Our hotels compete with several other major lodging brands in each segment
in which they operate. Competition in the industry is based primarily on the
level of service, quality of accommodations, convenience of locations and room
rates. Although the competitive position of each of our hotel properties
differs from market to market, we believe that our properties compare
favorably to their competitive set in the markets in which they operate on the
basis of these factors. The following table presents key participants in
segments of the lodging industry in which we compete:
Segment Representative Participants
------- ---------------------------
Luxury Full-Service Ritz-Carlton; Four Seasons
Upscale Full-Service Crown Plaza; Doubletree; Hyatt; Hilton; Marriott Hotels,
Resort and Suites; Radisson; Red Lion; Sheraton;
Swissotel; Westin; Wyndham
Other Real Estate Investments
We have lease and sublease activity relating primarily to Host Marriott's
former restaurant operations. Additionally, as part of the Blackstone
Acquisition, we acquired 165,000 square feet of office space in two buildings
in Atlanta. Prior to the REIT conversion, we owned 12 undeveloped parcels of
vacant land, totaling approximately 83 acres, originally purchased primarily
for the development of hotels or senior living communities, which are now
owned by one of the non-controlled subsidiaries.
Employees
We are managed by our Board of Directors and we have no employees who are
not employees of the operating partnership.
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Currently, the operating partnership has approximately 175 management
employees, and approximately 16 other employees which are covered by a
collective bargaining agreement that are subject to review and renewal on a
regular basis. We believe that we and our managers have good relations with
labor unions and have not experienced any material business interruptions as a
result of labor disputes.
Environmental and Regulatory Matters
Under various federal, state and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real property may be
liable for the costs of removal or remediation of hazardous or toxic
substances on, under or in such property. Such laws may impose liability
whether or not the owner or operator knew of, or was responsible for, the
presence of such hazardous or toxic substances. In addition, certain
environmental laws and common law principles could be used to impose liability
for release of asbestos-containing materials, and third parties may seek
recovery from owners or operators of real properties for personal injury
associated with exposure to released asbestos-containing materials.
Environmental laws also may impose restrictions on the manner in which
property may be used or business may be operated, and these restrictions may
require expenditures. In connection with our current or prior ownership or
operation of hotels, we may be potentially liable for any such costs or
liabilities. Although we are currently not aware of any material environmental
claims pending or threatened against us, no assurance can be given that a
material environmental claim will not be asserted against us.
The Leases
In order for us to qualify as a REIT and for the operating partnership to be
treated as a partnership for federal income tax purposes, neither we nor the
operating partnership may operate our hotels or related properties.
Accordingly, we lease the hotels to the lessees, which are primarily wholly
owned, indirect subsidiaries of Crestline.
Lessees. There generally is a separate lessee for each hotel or group of
hotels that is owned by a separate subsidiary of the operating partnership.
Each lessee is generally a Delaware limited liability company, whose purpose
is limited to acting as lessee under the applicable lease(s).
For those hotels where it is the manager, Marriott International or a
subsidiary has a non-economic membership interest in the lessee entitling it
to certain voting rights but no economic rights. The operating agreements for
such lessees provide that the Crestline member of the lessee has full control
over the management of the business of the lessee, except with respect to
certain decisions for which the consent of the members or partners and the
manager are required. These decisions are:
. dissolving, liquidating, consolidating, merging, selling or leasing all
or substantially all of the assets of the lessee;
. engaging in any other business or acquiring any assets or incurring any
liabilities not reasonably related to the conduct of the lessee's
business;
. instituting voluntary bankruptcy or similar proceedings or consenting to
involuntary bankruptcy or similar proceedings;
. terminating the management agreement relating to the lessee's hotel,
other than by reason of a breach by the manager or upon exercise of
express termination rights in the management agreement;
. challenging the status or rights of the manager or the enforceability of
the manager's consent rights; or
. incurring debt in excess of certain limits.
Upon any termination of the applicable management agreement, these special
voting rights of Marriott International (or its subsidiary) will cease.
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Lease terms. Each lease has a fixed term ranging generally from seven to ten
years, depending upon the lease, subject to earlier termination upon the
occurrence of certain contingencies described in the lease, including,
particularly, the provisions described below under "--Damage or Destruction,"
"--Termination of the Leases upon Disposition of Full-Service Hotels" and "--
Termination of the Leases upon Changes in Tax Laws".
Minimum rent; percentage rent; additional charges. Each lease requires the
lessee to pay (1) minimum rent in a fixed dollar amount per annum plus (2) to
the extent it exceeds minimum rent, percentage rent based upon specified
percentages of aggregate sales from the applicable hotel, including room
sales, food and beverage sales and other income ("Gross Revenues"), in excess
of specified thresholds.
Minimum rent is a fixed dollar amount specified in each lease less the FF&E
adjustment (which is described under "--Personal Property Limitation" below).
Any amounts other than minimum rent and percentage rent due to the lessor
under the leases are referred to as "additional charges".
The amount of minimum rent and the percentage rent thresholds are to be
adjusted each year. The annual adjustment with respect to minimum rent equals
a percentage of any increase in the Consumer Price Index, or CPI, during the
previous twelve months. The annual adjustment with respect to percentage rent
thresholds is a specified percentage equal to the weighted average of a
percentage of any increase in CPI plus a specified percentage of any increase
in a regional labor cost index agreed upon by the lessor and the lessee during
the previous twelve months. Neither minimum rent nor percentage rent
thresholds will be decreased because of the annual adjustment.
Rental payments will be made on a fiscal year basis. The "fiscal year" means
the fiscal year used by the manager. Payments of rent are to be made within
two business days after the required payment date under the management
agreement for each accounting period. "Accounting period" means, for those
hotels where Marriott International is the manager, any of the thirteen four-
week accounting periods which are used in the manager's accounting system.
Rent payable for each accounting period will be the sum of (1) the excess (if
any) of (x) the greater of cumulative minimum rent year-to-date or cumulative
percentage rent year-to-date over (y) the total amount of minimum rent and
percentage rent paid year-to-date plus (2) any additional charges due. If the
total amount of minimum rent and percentage rent paid year-to-date, as of any
rent payment date, is greater than both cumulative minimum rent year-to-date
and cumulative percentage rent year-to-date, then the lessor must remit the
difference to the lessee.
The leases generally provide for a rent adjustment in the event of damage,
destruction, partial taking, certain capital expenditures or an FF&E
adjustment.
Lessee expenses. Each lessee is responsible for paying all of the expenses
of operating the applicable hotel(s), including all personnel costs, utility
costs and general repair and maintenance of the hotel(s). The lessee also is
responsible for all fees payable to the applicable manager, including base and
incentive management fees, chain services payments and franchise or system
fees, with respect to periods covered by the term of the lease. The lessee is
not obligated to bear the cost of any capital improvements or capital repairs
to the hotels or the other expenses to be borne by the lessor, as described
below.
Lessor expenses. The lessor (typically, the operating partnership or its
subsidiary) is responsible for the following expenses: real estate taxes,
personal property taxes (to the extent the lessor owns the personal property),
casualty insurance on the structures, ground lease rent payments, required
expenditures for FF&E (including maintaining the FF&E reserve, to the extent
such is required by the applicable management agreement) and capital
expenditures.
The consent of the lessor is required for any capital expenditures (except
in an emergency or where the owner's consent is not required under the
management agreement) or a change in the amount of the FF&E reserve payment.
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Crestline guarantee. Crestline and certain of its subsidiaries have entered
into a limited guarantee of the lease and management agreement obligations of
each lessee. For each of four identified "pools" of hotels, the cumulative
limit of the guarantee at any time is 10% of the aggregate rents under all
leases in such pool paid with respect to the preceding thirteen full
accounting periods (with an annualized amount based upon the minimum rent for
those leases that have not been in effect for thirteen full accounting
periods). In the event of a payment default under any lease or failure of
Crestline to maintain certain minimum net worth or debt service coverage
ratios, the obligations under the guarantees of leases in each pool are
secured by excess cash flow of each lessee in such pool. Such excess cash flow
will be collected, held in a cash collateral account, and disbursed in
accordance with agreed cash management procedures.
Security. The obligations of the lessee are secured by a pledge of all
personal property (tangible and intangible) of the lessee related to or used
in connection with the operation of the hotels (including any cash and
receivables from the manager or others held by the lessee as part of working
capital).
Working capital. Each lessor sold the existing working capital, including
inventory and fixed asset supplies (as defined in the Uniform System of
Accounts for Hotels) and receivables due from the manager, net of accounts
payable and accrued expenses to the applicable lessee upon the commencement of
the lease at a price equal to the fair market value of such assets. The
purchase price is represented by a note evidencing a loan that bears interest
at a rate per annum equal to the long-term applicable federal rate in effect
on the commencement of the lease. Interest owed on the working capital loan is
due simultaneously with each periodic rent payment and the amount of each
payment of interest will be credited against such rent payment. The principal
amount of the working capital loan will be payable upon termination of the
lease. At the termination or expiration of the lease, the lessee will sell to
the lessor the then existing working capital at a price equal to the value of
such assets at that time. The lessor will pay the purchase price of the
working capital by offsetting the purchase price against the outstanding
principal balance of the working capital loan. To the extent that the value of
the working capital delivered to the lessor exceeds the value of the working
capital delivered by the lessor to the lessee at the commencement of the
lease, the lessor will pay to the lessee an amount equal to the difference in
cash. To the extent that the value of the working capital delivered to the
lessor is less than the value of the working capital delivered by the lessor
to the lessee at the commencement of the lease, the lessee will pay to the
lessor an amount equal to the difference in cash.
Termination of leases upon disposition of full-service hotels. In the event
the applicable lessor enters into an agreement to sell or otherwise transfer
any full-service hotel free and clear of the applicable lease, the lessor must
pay the lessee a termination fee equal to the fair market value of the
lessee's leasehold interest for the remaining term of the lease. For purposes
of determining the fair market value, a discount rate of 12% will be used, and
the annual income for each remaining year of the lease will be assumed to be
the average annual income generated by the lessee during the three fiscal
years preceding the termination date or if the hotel has not been in operation
for at least three fiscal years, then the average during the preceding fiscal
years that have elapsed, and if the hotel has not been in operation for at
least twelve months, then the assumed annual income shall be determined on a
pro forma basis. Alternatively, the lessor would be entitled to (1) substitute
a comparable hotel or hotels (in terms of economics and quality for the lessor
and the lessee as agreed to by the lessee) for any hotel that is sold or (2)
sell the hotel subject to the lease (subject to the lessee's reasonable
approval if the sale is to an entity that does not have sufficient financial
resources and liquidity to fulfill the "owner's" obligations under the
management agreement and the lessor's obligations under the lease, or does not
satisfy specified character standards) without being required to pay a
termination fee. In addition, the lessors collectively and the lessees
collectively each have the right to terminate up to twelve leases without
being required to pay any fee or other compensation as a result of such
termination, but the lessors are permitted to exercise such right only in
connection with sales of hotels to an unrelated third party or the transfer of
a hotel to a joint venture in which the operating partnership does not have a
two-thirds or greater interest.
Termination of the leases upon changes in tax laws. In the event that
changes in the federal income tax laws allow the lessors, or subsidiaries or
affiliates of the lessors, to directly operate the hotels without jeopardizing
our status as a REIT, the lessors have the right to terminate all, but not
less than all, of the leases
27
(excluding leases of hotels that must still be leased following the tax law
change) in return for paying the lessees the fair market value of the
remaining terms of the leases, valued in the same manner as provided above
under "--Termination of Leases upon Disposition of Hotels". The payments are
payable in cash or, subject to certain conditions, shares of our common stock,
at the election of the lessor and us.
Damage or Destruction. If a hotel is partially or totally destroyed and is
no longer suitable for use as a hotel (as reasonably determined by the
lessor), the lease of such hotel will automatically terminate and the
insurance proceeds will be retained by the lessor, except for any proceeds
attributable to personal property owned by the lessee or business interruption
insurance. In this event, no termination fee will be owed to the lessee. If a
hotel is partially destroyed but is still suitable for use as a hotel (as
reasonably determined by the lessor), the lessee, subject to the lessor
agreeing to release the insurance proceeds to fund the cost of repair and
restoration, must apply the insurance proceeds to restore the hotel to its
preexisting condition. The lessor must fund any shortfall in insurance
proceeds less than or equal to five percent of the estimated cost of repair.
The lessor may fund such deficiency, in its sole discretion, in the event the
sum of (a) the insurance proceeds and (b) that portion of the insurance
deductible, if any, which is greater than 5% of the cost of repair, is less
than 95% of the cost of the repair, provided that if the lessor elects not to
fund such shortfall, the lessee may terminate the lease and the lessor must
pay to the lessee a termination fee equal to the lessee's operating profit for
the immediately preceding fiscal year. The term "lessee's operating profit"
shall mean for any fiscal year an amount equal to revenues due to the lessee
from the leased property after the payment of all expenses relating to the
operation or leasing of the leased property less rent paid to the lessor. If
and to the extent any damage or destruction results in a reduction of gross
revenues which would otherwise be realizable from the operation of the hotel,
the lessor will receive all loss of income insurance and the lessee will have
no obligation to pay rent, for any accounting period until the effects of the
damage are restored, in excess of the greater of (1) one-thirteenth of the
total rent paid in the fiscal year prior to the casualty or (2) percentage
rent calculated for the current accounting period.
Events of default. Except as otherwise provided below, and subject to the
notice and, in some cases, cure periods in the lease, the lease may be
terminated without penalty by the applicable lessor if any of the following
events of default (among others) occur:
. Failure to pay rent within ten days after the due date;
. Failure to comply with, or observe any of, the terms of the lease (other
than the failure to pay rent) for 30 days after notice from the lessor,
including failure to properly maintain the hotel (other than by reason of
the failure of the lessor to perform its obligations under the lease),
such period to be extended for up to an additional 90 days if such
default cannot be cured with due diligence within 30 days;
. Acceleration of maturity of certain indebtedness of the lessee with a
principal amount in excess of $1,000,000;
. Failure of Crestline to maintain minimum net worth or debt service
coverage ratio requirements;
. Filing of any petition for relief, bankruptcy or liquidation by or
against the lessee;
. The lessee voluntarily ceases to operate the hotel for 30 consecutive
days, except as a result of a casualty, condemnation or emergency
situation;
. A change in control of Crestline, the lessee or any subsidiary of
Crestline that is a direct or indirect parent of the lessee. Unless the
change in control involves an adverse party which would include a
competitor in the hotel business, a party without adequate financial
resources, a party that has been convicted of a felony (or controlled by
such a person), or a party who would jeopardize our qualification as a
REIT, the lessor must pay a termination fee equal to the lessee's
operating profit from the hotel for the immediately preceding fiscal
year; or
. The lessee, the lessee's direct parent or Crestline defaults under the
assignment of management agreement, the guarantees described above, the
non-competition agreement described below or certain other related
agreements between the parties or their affiliates.
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Assignment of lease. A lessee is permitted to sublet all or part of the
hotel or assign its interest under its lease, without the consent of the
lessor, to any wholly owned and controlled single purpose subsidiary of
Crestline, provided that Crestline continues to meet the minimum net worth
test and all other requirements of the lease. Transfers to other parties are
permitted if approved by the lessor.
Subordination to qualifying mortgage debt. The rights of each lessee are
expressly subordinate to qualifying mortgage debt and any refinancing thereof.
A default under the loan documents may result in the termination of the lease
by the lender. The lender is not required to provide a non-disturbance
agreement to the lessee.
The lessor is obligated to compensate the lessee, on a basis equal to the
lease termination provision described in "--Termination of Leases upon
Disposition of Hotels" above, if the lease is terminated because of a non-
monetary default under the terms of a loan that occurs because of an action or
omission by the lessor (or its affiliates) or a monetary default where there
is not an uncured monetary event of default of the lessee. In addition, if any
loan is not refinanced in a timely manner, and the loan amortization schedule
is converted to a cash flow sweep structure, the lessee has the right to
terminate the lease after a twelve-month cure period and the lessor would owe
a termination fee as provided above. During any period of time that a cash
flow sweep structure is in effect, the lessor must compensate the lessee for
any lost revenue resulting from such cash flow sweep. The operating
partnership has guaranteed these obligations.
Personal property limitation. If a lessor reasonably anticipates that the
average tax basis of the items of the lessor's FF&E and other personal
property that are leased to the applicable lessee will exceed 15% of the
aggregate average tax basis of the real and personal property subject to the
applicable lease, the following procedures would apply, subject to obtaining
lender consent where required:
. The lessor would acquire any replacement FF&E that would cause the
applicable limits to be exceeded, and immediately thereafter the lessee
would be obligated either to acquire such excess FF&E from the lessor or
to cause a third party to purchase such FF&E.
. The lessee would agree to give a right of first opportunity to a non-
controlled subsidiary of the operating partnership to acquire the excess
FF&E and to lease the excess FF&E to the lessee at an annual rental equal
to the market leasing factor times the cost of the excess FF&E. If such
non-controlled subsidiary does not agree to acquire the excess FF&E and
to enter into such lease, then the Lessee may either acquire the excess
FF&E itself or arrange for another third party to acquire such excess
FF&E and to lease the same to the lessee.
. The annual rent under the applicable lease would be reduced in accordance
with a formula based on market leasing rates for the excess FF&E.
Certain actions under the leases. The leases prohibit the lessee from taking
the following actions with respect to the management agreement without notice
to the lessor and, if the action would have a material adverse effect on the
lessor, the consent of the lessor:
. terminate the management agreement prior to the expiration of the term
thereof;
. amend, modify or assign the management agreement;
. waive (or fail to enforce) any right of the "owner" under the management
agreement;
. waive any breach or default by the manager under the management agreement
(or fail to enforce any right of the "owner" in connection therewith);
. agree to any change in the manager or consent to any assignment by the
manager; or
. take any other action which reasonably would be expected to materially
adversely affect the lessor's rights or obligations under the management
agreement for periods following the termination of the lease (whether
upon the expiration of its term or upon earlier termination as provided
for therein).
29
Change in manager. A lessee is permitted to change the manager or the brand
affiliation of a hotel only with the approval of the applicable lessor, which
approval may not be unreasonably withheld. Any replacement manager must be a
nationally recognized manager with substantial experience in managing hotels
of comparable quality. No such replacement can extend beyond the term of the
lease without the consent of the lessor, which consent may be withheld in the
lessor's sole discretion.
The Management Agreements
General
The lessees lease the hotels from the operating partnership or its
subsidiaries. Upon leasing the hotels, the lessees assumed substantially all
of the obligations of such subsidiaries under the management agreements
between those entities and the subsidiaries of Marriott International and
other companies that currently manage the hotels. As a result of their
assumptions of obligations under the management agreements, the lessees have
substantially all of the rights and obligations of the "owners" of the hotels
under the management agreements for the period during which the leases are in
effect (including the obligation to pay the management and other certain fees
thereunder) and hold the operating partnership harmless with respect thereto.
The subsidiaries of the operating partnership remain liable for all
obligations under the management agreements. See "--Management Services
Provided by Marriott International and Affiliates," "--Assignment of
Management Agreements".
Management services provided by Marriott International and affiliates
General. Under each management agreement related to a Marriott
International-managed hotel, the manager provides complete management services
to the applicable lessees in connection with its management of such lessee's
hotels.
Operational services. The managers have sole responsibility and exclusive
authority for all activities necessary for the day-to-day operation of the
hotels, including establishment of all room rates, the processing of
reservations, procurement of inventories, supplies and services, periodic
inspection and consultation visits to the hotels by the managers' technical
and operational experts and promotion and publicity of the hotels. The manager
receives compensation from the lessee in the form of a base management fee and
an incentive management fee, which are normally calculated as percentages of
gross revenues and operating profits, respectively.
Executive supervision and management services. The managers provide all
managerial and other employees for the hotels; review the operation and
maintenance of the hotels; prepare reports, budgets and projections; provide
other administrative and accounting support services, such as planning and
policy services, financial planning, divisional financial services, risk
planning services, product planning and development, employee planning,
corporate executive management, legislative and governmental representation
and certain in-house legal services; and protect the "Marriott" trademark and
other tradenames and service marks. The manager also provides a national
reservations system.
Chain services. The management agreements require the manager to furnish
chain services that are furnished generally on a central or regional basis to
hotels in the Marriott hotel system. Such services include: (1) the
development and operation of computer systems and reservation services, (2)
regional management and administrative services, regional marketing and sales
services, regional training services, manpower development and relocation
costs of regional personnel and (3) such additional central or regional
services as may from time to time be more efficiently performed on a regional
or group level. Costs and expenses incurred in providing such services are
allocated among all hotels in the Marriott hotel system managed by the manager
or its affiliates and each applicable lessee is required to reimburse the
manager for its allocable share of such costs and expenses.
Working capital and fixed asset supplies. The lessee is required to maintain
working capital for each hotel and fund the cost of fixed asset supplies,
which principally consist of linen and similar items. The applicable lessee
also is responsible for providing funds to meet the cash needs for the
operations of the hotels if at any time the funds available from operations
are insufficient to meet the financial requirements of the hotels.
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Use of affiliates. The manager employs the services of its affiliates to
provide certain services under the management agreements. Certain of the
management agreements provide that the terms of any such employment must be no
less favorable to the applicable lessee, in the reasonable judgment of the
manager, than those that would be available from the manager.
FF&E replacements. The management agreements generally provide that once
each year the manager will prepare a list of FF&E to be acquired and certain
routine repairs that are normally capitalized to be performed in the next year
and an estimate of the funds necessary therefor. Under the terms of the
leases, the lessor is required to provide to the applicable lessee all
necessary FF&E for the operation of the hotels (including funding any required
FF&E replacements). For purposes of funding the FF&E replacements, a specified
percentage (generally 5%) of the gross revenues of the hotel is deposited by
the manager into a book entry account. These amounts are treated under the
leases as paid by the lessees to the lessor and will be credited against their
rental obligations. If the manager determines that more than 5% of the gross
revenues of the hotel is required to fund repairs for a certain period, the
manager may increase the percentage of gross revenues to be deposited into the
FF&E reserve account for such periods. In such event, the lessor may elect to
fund such increases through annual increases in the amount deposited by the
manager in the FF&E reserve account or to make a lump-sum contribution to the
FF&E reserve account of the additional amounts required. If the lessor adopts
the first election, the deductions are credited against the rental obligations
of the lessee. If the lessor fails to elect either option within thirty days
of the request for additional funds or fails to pay the lump-sum within 60
days of its election to do so, the manager may terminate the management
agreement. Under certain circumstances, the manager may make repairs in
addition to those set forth on its list, but in no event may it expend more
than the amount in the FF&E reserve account without the consent of the
operating partnership and the lessee.
Under certain of the management agreements, the lessor must approve the FF&E
replacements, including any FF&E replacements proposed by the manager that are
not contained on the annual list which was approved by the lessor and the
lessee. If the manager and the lessor agree, the lessor would acquire or
otherwise provide the FF&E replacements set forth on the approved list. If the
lessor and the manager are unable to agree on the list within 60 days of its
submission, the lessor would be required to make only those FF&E replacements
specified on such list that are no more extensive than the system standards
for FF&E replacements that the manager requires for Marriott hotels. For
purposes of funding the FF&E replacements required to be paid for by the
operating partnership, each management agreement and the lessor's loan
agreements require the lessor to deposit a designated amount into the FF&E
reserve account periodically. The lessees have no obligation to fund the FF&E
reserve accounts (and any amounts deposited therein by the manager from funds
otherwise due the lessee under the management agreement will be credited
against the lessee's rental obligation).
Under each lease, the lessor is responsible for the costs of FF&E
replacements and for decisions with respect thereto (subject to its
obligations to the lessee under the lease).
Building alterations, improvements and renewals. The management agreements
require the manager to prepare an annual estimate of the expenditures
necessary for major repairs, alterations, improvements, renewals and
replacements to the structural, mechanical, electrical, heating, ventilating,
air conditioning, plumbing and vertical transportation elements of each hotel.
Such estimate must be submitted to the lessor and the lessee for their
approval. In addition to the foregoing, the management agreements generally
provide that the manager may propose such changes, alterations and
improvements to the hotel as are required, in the manager's reasonable
judgment, to keep the hotel in a competitive, efficient and economical
operating condition or in accordance with Marriott standards. The cost of the
foregoing is paid from the FF&E reserve account; to the extent that there are
insufficient funds in such account, the operating partnership is required to
pay any shortfall. Under the management agreements (and the leases), neither
the lessor nor the lessee may unreasonably withhold consent to repairs and
other changes which are required under applicable law or any of the manager's
"life-safety" standards and, if the lessor and the lessee fail to approve any
of the other proposed repairs or other changes within 75 days of the request
therefor, the manager may terminate the management agreement. Under certain of
the other management agreements, if the lessor and the manager are unable to
agree on the estimate within 60 days of its submission, the lessor is required
to make only those expenditures that are no more extensive than the
31
manager requires for Marriott hotels generally, as the case may be. Under the
terms of the leases, the lessor is responsible for the costs of the foregoing
items and for decisions with respect thereto (subject to its obligations to
the lessees under the leases).
Service marks. During the term of the management agreements, the service
mark "Marriott" and other symbols, logos and service marks currently used by
the manager and its affiliates may be used in the operation of the hotels.
Marriott International (or its applicable affiliates) intends to retain its
legal ownership of these marks. Any right to use the service marks, logo and
symbols and related trademarks at a hotel will terminate with respect to that
hotel upon termination of the management agreement with respect to such hotel.
Termination fee. Certain of the management agreements provide that if the
management agreement is terminated prior to its full term due to casualty,
condemnation or the sale of the hotel, the manager would receive a termination
fee as specified in the specific management agreement. Under the leases, the
responsibility for the payment of any such termination fee as between the
lessee and the lessor depends upon the cause for such termination.
Termination for failure to perform. Most of the management agreements may be
terminated based upon a failure to meet certain financial performance
criteria, subject to the manager's right to prevent such termination by making
certain payments to the lessee based upon the shortfall in such criteria.
Events of default. Events of default under the management agreements
include, among others, the following:
. the failure of either party to make payments pursuant to the management
agreement within ten days after written notice of such nonpayment has
been made;
. the failure of either party to perform, keep or fulfill any of the
covenants, undertakings, obligations or conditions set forth in the
management agreement and the continuance of such default for a period of
30 days after notice of said failure or, if such default is not
susceptible of being cured within 30 days, the failure to commence said
cure within 30 days or the failure thereafter diligently to pursue such
efforts to completion;
. if either party files a voluntary petition in bankruptcy or insolvency or
a petition for reorganization under any bankruptcy law or admits that it
is unable to pay its debts as they become due;
. if either party consents to an involuntary petition in bankruptcy or
fails to vacate, within 90 days from the date of entry thereof, any order
approving an involuntary petition by such party; or
. if an order, judgment or decree by any court of competent jurisdiction,
on the application of a creditor, adjudicating either party as bankrupt
or insolvent or approving a petition seeking reorganization or appointing
a receiver, trustee, or liquidator of all or a substantial part of such
party's assets is entered, and such order, judgment or decree continues
unstayed and in effect for any period of 90 days.
As described above, all fees payable under the management agreements are
obligations of the lessees, to be paid by the lessees for so long as the
leases remain in effect. The lessees' obligations to pay these fees, however,
could adversely affect the ability of one or more lessees to pay base rent or
percentage rent payable under the leases, even though such amounts otherwise
are due and owing to the lessor. Moreover, the operating partnership remains
obligated to the manager to the extent the lessee fails to pay these fees.
Assignment of management agreements. The management agreements applicable to
each hotel have been assigned to the applicable lessee for the term of the
lease of such hotel. The lessee is obligated to perform all of the obligations
of the lessor under the management agreement during the term of its lease,
other than certain retained obligations including, without limitation, payment
of real property taxes, property casualty insurance and ground rent, and
maintaining a reserve fund for FF&E replacements and capital expenditures, for
which the lessor retains responsibility. Although the lessee has assumed
obligations of the lessor under the management agreement, the lessor is not
released from its obligations and, if the lessee fails to perform any
obligations, the
32
manager will be entitled to seek performance by or damages from the lessor. If
the lease is terminated for any reason, any new or successor lessee must meet
certain requirements for an "approved lessee" or otherwise be acceptable to
Marriott International. The requirements for an "approved lessee" include that
the entity:
. has sufficient financial resources and liquidity to fill the obligations
under the management agreement;
. is not in control of or controlled by persons who have been convicted of
felonies;
. is not engaged, or affiliated with any person or entity engaged in the
business of operating a branded hotel chain having 5,000 or more guest
rooms in competition with Marriott International; and
. must be a single purpose entity in which Marriott International has a
non-economic membership interest with the same rights as it has in the
current lessee.
Any new lease must be in substantially the same form as the current lease or
otherwise be acceptable to Marriott International.
Non-competition agreements
Pursuant to a non-competition agreement entered into in connection with the
leases, Crestline has agreed, among other things, that until the earlier of
December 31, 2008 and the date on which it is no longer a lessee for more than
25% of the number of the hotels owned by us on December 29, 1998, it will not
(1) own, operate or otherwise control (as owner or franchisor) any full-
service hotel brand or franchise, or purchase, finance or otherwise invest in
full-service hotels, or act as an agent or consultant with respect to any of
the foregoing activities, or lease or manage full-service hotels (other than
hotels owned by the operating partnership) if its economic return therefrom
would be more similar to returns derived from ownership interests in such
hotels except for acquisitions of property used in hotels as to which a
subsidiary of Crestline is the lessee, investments in full-service hotels
which represent an immaterial portion of a merger or similar transaction or a
minimal portfolio investment in another entity, limited investments (whether
debt or equity) in full-service hotels as to which a subsidiary of Crestline
is the lessee or activities undertaken with respect to its business of
providing asset management services to hotel owners, or (2) without our
consent, manage any of the hotels owned by the operating partnership, other
than to provide asset management services.
We have agreed with Crestline, among other things, that, (1) until December
31, 2003, we will not purchase, finance or otherwise invest in senior living
communities, or act as an agent or consultant with respect to any of the
foregoing activities (except for acquisitions of communities which represent
an immaterial portion of a merger or similar transaction or for minimal
portfolio investments in other entities) and (2) until the earlier of December
31, 2008 and the date on which subsidiaries of Crestline are no longer lessees
for more than 25% of the number of the hotels owned by Host Marriott on
December 29, 1998, we will not lease, as tenant or subtenant, limited- or
full-service hotel properties from any "real estate investment trust" within
the meaning of Sections 856 through 859 of the Internal Revenue Code where it
will not be the operator or manager of the hotel (other than through a
contractual arrangement with a non-affiliated party) and where its rental
payments qualify as "rents from real property" within the meaning of Section
856(d) of the Internal Revenue Code, or purchase, finance or otherwise invest
in persons or entities which engage in any of the foregoing activities, or act
as an agent or consultant with respect to any of the foregoing activities
(except for acquisitions of entities which engage in any of the foregoing
activities where the prohibited activities represent an immaterial portion of
a merger or similar transaction, or minimal portfolio investments in other
entities which engage in any of the foregoing activities, or certain leasing
arrangements existing on December 29, 1998 or entered into in the future
between us and certain other related parties, or by our management of any
hotels in which it has an equity interest). In addition, both Crestline and we
have agreed not to hire or attempt to hire any of the other company's senior
employees at any time prior to December 31, 2000.
We entered into a noncompetition agreement with Marriott International that
defines our rights and obligations with respect to certain businesses operated
by each of us. Crestline became an additional party to this agreement at the
time its shares were distributed to our stockholders. At that time, we also
entered into an
33
agreement with Crestline under which we agreed with Crestline about the
allocation between us of the rights to engage in certain activities permitted
under the agreement with Marriott International. In general, until October 8,
2000, we and our subsidiaries are prohibited from entering into or acquiring
any business that competes with the hotel management business (i.e., managing,
operating or franchising full-service or limited-service hotels) as conducted
by Marriott International. Pursuant to this agreement, we cannot (1) operate
any hotel under a common name with any other hotel we operate or with any
hotel operated by Crestline, (2) have a manager (other than Marriott
International or one of its affiliates) manage any limited-service hotel for
us under a common name with any other limited-service hotel managed by such
manager for use or for Crestline, (3) have a manager (other than Marriott
International or one of its affiliates) manage more than the greater of (a) 10
full-service hotels under a common name which is a brand other than "Delta,"
"Four Seasons," "Holiday Inn," "Hyatt" and "Swissotel" (the "Existing Brands")
or (b) 25% of any system operated by such manager under a common name which is
not an Existing Brand, (4) have a manager (other than Marriott International
or one of its affiliates) manage more than the greater of (a) 5 full-service
hotels under a common name which is an Existing Brand or (b) 12.5% of any
system operated by such manager under a common name which is an Existing
Brand, (5) franchise as franchisor any limited-service hotel under a common
name with any other limited-service hotel for which we or Crestline is a
franchisor or (6) franchise as franchisor more than 10 full-service hotels
under a common name.
Item 3. Legal Proceedings
In connection with the REIT Conversion, the operating partnership assumed
all liability arising under legal proceedings filed against us and will
indemnify us as to all such matters. We believe all of the lawsuits in which
we are a defendant, including the following lawsuits, 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.
Texas Multi-Partnership Lawsuit. On March 16, 1998, limited partners in
several limited partnerships sponsored by us filed a lawsuit, Robert M. Haas,
Sr. and Irwin Randolph Joint Tenants, et al. v. Marriott International, Inc.,
et al., Case No. 98-CI-04092, in the 57th Judicial District Court of Bexar
County, Texas, alleging that the defendants conspired to sell hotels to the
partnerships for inflated prices and that they charged the partnerships
excessive management fees to operate the partnerships' hotels. The plaintiffs
further allege that the defendants committed fraud, breached fiduciary duties
and violated the provisions of various contracts. The plaintiffs are seeking
unspecified damages. On March 18, 1999, two limited partners in Courtyard by
Marriott Limited Partnership filed a class action petition in intervention
seeking to convert the lawsuit into a class action. The court has not yet
ruled on this petition.
Atlanta Marquis. Certain limited partners of Atlanta Marriott Marquis
Limited Partnership ("AMMLP") filed a putative class action lawsuit, Hiram and
Ruth Sturm v. Marriott Marquis Corporation, et al., Case No. 97-CV-3706, in
the U.S. District Court for the Northern District of Georgia, on December 12,
1997 against AMMLP's general partner, its directors and us, regarding the
merger of AMMLP into a new partnership as part of the refinancing of AMMLP's
debt. The plaintiffs allege that the defendants misled the limited partners in
order to induce them to approve the AMMLP merger, violated securities
regulations and federal roll-up regulations and breached their fiduciary
duties to the partners. The plaintiffs sought to enjoin, or in the
alternative, rescind the AMMLP merger and damages. The partnership agreement
includes provisions which require AMMLP to indemnify the general partners
against losses, expenses and fees. On November 13, 1998, the court dismissed
all of the federal securities law claims and retained jurisdiction over the
state law claims for breach of fiduciary duty and breach of contract.
Another limited partner of AMMLP sought similar relief and filed a separate
lawsuit, styled Poorvu v. Marriott Marquis Corporation, et al., Civil Action
No. 16095-NC, on December 19, 1997, in Delaware State Chancery Court. The
defendants have filed an answer to the complaint.
Courtyard II. A group of partners in Courtyard by Marriott II Limited
Partnership ("CBM II") filed a lawsuit, Whitey Ford, et al. v. Host Marriott
Corporation, et al., Case No. 96-CI-08327, on June 7, 1996, in the
34
285th Judicial District Court of Bexar County, Texas, against us, Marriott
International and others alleging breach of fiduciary duty, breach of
contract, fraud, negligent misrepresentation, tortious interference, violation
of the Texas Free Enterprise and Antitrust Act of 1983 and conspiracy in
connection with the formation, operation and management of CBM II and its
hotels. The plaintiffs are seeking unspecified damages. On January 29, 1998,
two other limited partners filed a petition in intervention seeking to convert
the lawsuit into a class action. The defendants have filed an answer, the
class has been certified, class counsel has been appointed, and discovery is
underway. On March 11, 1999, Palm Investors, L.L.C., the assignee of a number
of limited partnership units acquired through various tender offers, filed a
plea in intervention to bring additional claims relating to the 1993 split of
Marriott Corporation and to the 1995 refinancing of CBM II's indebtedness.
This plea also seeks the addition of Ernst & Young, L.L.P. and E&Y Kenneth
Leventhal Real Estate Services Co. as additional defendants for their
appraisal role in the 1995 refinancing. The original plaintiffs subsequently
filed a second amended complaint on March 19, 1999.
MHP II. Limited partners of Marriott Hotel Properties II Limited Partnership
("MHP II") are asserting putative class claims in lawsuits filed in Palm Beach
County Circuit Court on May 10, 1996, Leonard Rosenblum, as Trustee of the
Sylvia Bernice Rosenblum Trust, et al. v. Marriott MHP Two Corporation, et
al., Case No. CL-96-4087-AD, and, in Delaware State Chancery Court on April
24, 1996, Cary W. Salter, Jr., et al. v. MHP II Acquisition Corp., et al.,
respectively, against us and certain of our affiliates alleging that the
defendants violated their fiduciary duties and engaged in fraud and coercion
in connection with the tender offer for MHP II units.
The defendants removed the Florida action to the United States District
Court for the Southern District of Florida and, after hearings on various
procedural motions, the District Court remanded the case to state court on
July 25, 1998. The defendants then filed motions to dismiss Rosenblum's fifth
amended complaint or, in the alternative, to deny class certification in the
state court case. The state court held a hearing on these motions on October
27, 1998 but did not issue a ruling at that time. Thereafter, and prior to any
ruling on the defendants' motions, Rosenblum filed a motion seeking leave to
file a sixth amended complaint adding allegations relating to the partnership
merger of MHP II and adding additional plaintiffs. On February 2, 1999, the
court granted Rosenblum's motion to file an amended complaint and denied as
moot the defendants' motion to dismiss the earlier complaint.
On June 12, 1996, the Delaware Chancery Court entered an order denying the
Delaware plaintiffs' application to enjoin the tender offer for MHP II units.
The Delaware plaintiffs subsequently moved to voluntarily dismiss the Delaware
action. The Chancery Court granted this motion, but with the proviso that the
plaintiffs could only refile in the Florida federal action. After the District
Court's remand of the Rosenblum case to Florida state court, two of the three
original Delaware plaintiffs asked the Chancery Court to reconsider its order
granting their voluntary dismissal. The Chancery Court refused to allow the
plaintiffs to join the Rosenblum action in Florida and, instead, reinstated
the Delaware case, now styled In Re Marriott Hotel Properties II Limited
Partnership Unitholders Litigation, Consolidated Civil Action No. 14961. On
January 29, 1999, Cary W. Slater alone filed an Amended Consolidated Class
Action Complaint in the Delaware action, adding allegations relating to the
partnership merger of MHP II. As a result of these recent developments in the
Delaware case, the defendants filed a motion to stay the Florida action. The
Florida court denied this motion, and the defendants have appealed to the
Fourth District Court of Appeal of Florida.
Potomac Hotel Limited Partnership. On July 15, 1998, one limited partner in
Potomac Hotel Limited Partnership, or PHLP, filed a class action lawsuit
styled Michael C. deBerardinis v. Host Marriott Corporation, Civil Action No
WMN 98-2263, in the United States District Court for the District of Maryland.
The plaintiff alleged that we misled PHLP's limited partners in order to
induce them into approving the sale of one of PHLP's hotels, violated the
securities regulations by issuing a false and misleading consent solicitation
and breached fiduciary duties and the partnership agreement. The complaint
sought unspecified damages. On February 16, 1999, the District Court dismissed
the federal securities claims with prejudice and the state law claims without
prejudice. On March 9, 1999, the plaintiff filed a class action complaint in
Montgomery County, Maryland
35
Circuit Court in a case styled Michael C. deBerardinis v. Host Marriott
Corporation, Civil No. 197694-V, to further pursue the state law claims.
Item 4. Submission of matters to a vote of security holders
On December 15, 1998, a special meeting of the stockholders of our
predecessor, Host Marriott Corporation (a Delaware corporation) was held. At
this meeting, the stockholders approved an agreement and plan of merger which
included, among other things, the re-incorporation from Delaware to Maryland
by means of a merger of Host Marriott Corporation with and into us. The
stockholders present, either in person or by proxy, voted as follows:
168,147,578 for the agreement and plan of merger; 587,073 against the
agreement and plan of merger; and 952,151 abstained.
36
PART II
Item 5. Market for our common stock and related stockholder matters
Our common stock is listed on the New York Stock Exchange, the Chicago Stock
Exchange, the Pacific Stock Exchange and the Philadelphia Stock Exchange and
is traded under the symbol "HMT." The following table sets forth, for the
fiscal periods indicated, the high and low sales prices per share of the
common stock as reported on the New York Stock Exchange Composite Tape. We did
not declare any cash dividends on the common stock during the two fiscal years
ended January 2, 1998. Host Marriott declared a special stock and cash
dividend on December 18, 1998, in conjunction with the REIT conversion, and
payable in February 1999 to stockholders of record on December 28, 1998. (See
Note 2 to the consolidated financial statements for further discussion). The
common stock prices listed below have not been adjusted for the special stock
dividend as the effect is immaterial. On December 29, 1998, we spun off to our
shareholders one share of Crestline for every ten shares of our common stock
held. Crestline primarily represented the assets and liabilities of our senior
living communities. (See Note 2) As a result of the REIT conversion, we are
required to use available funds to pay dividends to the extent of 95% of
taxable income in order to maintain our REIT qualification. We have indicated
an intent to pay dividends equal to 100% of taxable income for each year.
Payment of these dividends is expected to be funded by distributions from the
operating partnership. To the extent that the operating partnership's cash
flow is not sufficient to make distributions to holders of OP Units in an
amount sufficient so that we can pay such dividends, the operating partnership
may be required to borrow money to pay such dividends. As of March 19, 1999,
there were approximately 53,000 holders of record of common stock and
approximately 2,900 holders of record of OP Units (each of which is
convertible into common stock on a one-for-one basis or the cash equivalent
thereof, at our option, beginning at various times in the future, but no later
than January 2000).
High Low
--------- --------
1997
1st Quarter............................................. $18 3/4 $15 3/4
2nd Quarter............................................. 18 1/8 15 1/4
3rd Quarter............................................. 20 13/16 17 1/2
4th Quarter............................................. 23 3/4 18 1/16
1998
1st Quarter............................................. $20 9/16 $17 1/2
2nd Quarter............................................. 22 1/8 17
3rd Quarter............................................. 19 12 9/16
4th Quarter............................................. 15 7/16 10
For several technical reasons relating to the federal income tax law, our
ability to qualify as a REIT under the Internal Revenue Code is facilitated by
limiting the number of shares of our stock that a person may own. Primarily
because the Board of Directors believes it is desirable for us to qualify as a
REIT, our Articles of Incorporation provide that, subject to certain limited
exceptions, no person or persons acting as a group may own, or be deemed to
own by virtue of the attribution provisions of the Internal Revenue Code, more
than
. 9.8% of the lesser of the number or value of shares of common stock
outstanding; or
. 9.8% of the lesser of the number or value of the issued and outstanding
preferred or other shares of any class or series of our stock.
The Board of Directors has the authority to increase the ownership limit
from time to time, but does not have the authority to do so to the extent that
after giving effect to such increase, five beneficial owners of capital stock
could beneficially own in the aggregate more than 49.5% of the outstanding
capital stock. These limitations on the ownership of our stock could have the
effect of delaying, deferring or preventing a takeover or other transaction in
which holders of some, or a majority, of the common stock might receive a
premium for their common stock over the then prevailing market price or which
such holders might believe to be otherwise in their best interest.
37
Item 6. Selected Financial Data
The following table presents certain selected historical financial data
which has been derived from our audited consolidated financial statements for
the five most recent fiscal years ended December 31, 1998. The 1998 and 1997
financial information reflects the discontinued operations related to the
spin-off of Crestline in conjunction with the REIT conversion.
Fiscal Year
-----------------------------------------
1998(3) 1997(3) 1996(1) 1995(2) 1994(3)
------- ------- ------- ------- -------
(in millions, except per share data)
Income Statement Data:
Revenues............................. $3,513 $2,823 $1,957 $1,362 $1,011
Operating profit before minority
interest, corporate expenses and
interest............................ 661 432 233 114 152
Income (loss) from continuing
operations.......................... 194 47 (13) (62) (13)
Income (loss) before extraordinary
items............................... 195 47 (13) (123) (19)
Net income (loss)(4)................. 47 50 (13) (143) (25)
Basic earnings (loss) per common
share:(5)
Income (loss) from continuing
operations........................ .90 .22 (.06) (.36) (.08)
Income (loss) before extraordinary
items............................. .91 .22 (.06) (.72) (.12)
Net income (loss)(4)............... .22 .23 (.06) (.84) (.15)
Diluted earnings (loss) per common
share:(5)
Income (loss) from continuing
operations........................ .84 .22 (.06) (.36) (.08)
Income (loss) before extraordinary
items............................. .85 .22 (.06) (.72) (.12)
Net income (loss)(4)............... .27 .23 (.06) (.84) (.15)
Cash dividends declared per common
share............................... 1.00 -- -- -- --
Balance Sheet Data:
Total assets(6)...................... $8,268 $6,141 $5,152 $3,557 $3,366
Debt................................. 5,131 3,466 2,647 2,178 1,871
- --------
(1) Fiscal year 1996 includes 53 weeks.
(2) Operating results for 1995 include a $10 million pre-tax charge to write
down the carrying value of five limited service properties to their net
realizable value and a $60 million pre-tax charge to write down an
undeveloped land parcel to its estimated sales value. In 1995, we
recognized a $20 million extraordinary loss, net of taxes, on the
extinguishment of debt.
(3) In 1998, we recognized a $148 million extraordinary loss, net of taxes, on
the extinguishment of debt. In 1997, we recognized a $3 million
extraordinary gain, net of taxes, on the extinguishment of certain debt.
In 1994, we recognized a $6 million extraordinary loss, net of taxes, on
the required redemption of senior notes.
(4) We recorded income from discontinued operations, net of taxes, of $6
million in 1998, as a result of the Distribution. We also recorded a loss
from discontinued operations, net of taxes, of $61 million in 1995 and $6
million in 1994, as a result of the spin-off of Host Marriott Services
Corporation. The 1995 loss from discontinued operations includes a pre-tax
charge of $47 million for the adoption of SFAS No. 121, "Accounting For
the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed
Of," a pre-tax $15 million restructuring charge and an extraordinary loss
of $10 million, net of taxes, on the extinguishment of debt.
(5) Basic earnings (loss) per common share is computed by dividing net income
(loss) by the weighted average number of shares of common stock
outstanding. Diluted earnings (loss) per share is computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding plus other dilutive securities. Diluted earnings (loss) per
share has not been adjusted for the impact of the Convertible Preferred
Securities for 1997 and 1996 and for the comprehensive stock plan and
warrants for 1994 through 1996, as they are anti-dilutive.
(6) Total assets includes $236 million related to Net Investment in
Discontinued Operations for 1997.
38
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Lack of Comparability Following the REIT Conversion
Because substantially all of our hotels are leased due to the REIT
conversion, we do not believe that the historical results of operations are
comparable to what our results of operations following the REIT conversion.
Therefore, in addition to the historical presentation, we have presented a
discussion of the results of operation on a pro forma basis as if the REIT
conversion had occurred on the first day of each respective year.
Results of Operations
Our historic revenues primarily represent gross property-level sales from
our hotels, net gains (losses) on property transactions and equity in the
earnings of affiliates.
On November 20, 1997, the Emerging Issues Task Force (or EITF) of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
We considered the impact of EITF 97-2 on our financial statements and
determined that EITF 97-2 required us to include property-level sales and
operating expenses of our hotels in the statements of operations. We have
given retroactive effect to the adoption of EITF 97-2 in the accompanying
consolidated statements of operations. Application of EITF 97-2 to the
consolidated financial statements for the fiscal years ended December 31,
1998, January 2, 1998 and January 3, 1997 increased both revenues and
operating expenses by approximately $2.1 billion, $1.7 billion and $1.2
billion, respectively, and had no impact on operating profit, net income or
earnings per share.
Our hotel operating costs and expenses have been, to a great extent, fixed.
Therefore, we have derived substantial operating leverage from increases in
revenue. This operating leverage was somewhat diluted, however, by the impact
of base management fees which were calculated as a percentage of sales,
variable ground lease payments and incentive management fees tied to operating
performance above certain established levels. Successful hotel performance
resulted in certain of our properties reaching levels which allowed the
manager to share in the growth of profits in the form of higher management
fees.
For the periods discussed below, our hotel properties experienced
substantial increases in REVPAR. REVPAR is a commonly used indicator of market
performance for hotels which represents the combination of the average daily
room rate charged and the average occupancy achieved. REVPAR does not include
food and beverage or other ancillary revenues generated by the property. The
REVPAR increase primarily reflects strong percentage increases in room rates,
while occupancy increases have been more moderate. Increases in average room
rates have generally been achieved by the managers through shifting
occupancies away from discounted group business to higher-rated group and
transient business and by selectively increasing room rates. This has been
made possible by increased travel due to improved economic conditions and by
the favorable supply/demand characteristics existing in the upscale and luxury
full-service segments of the lodging industry.
1998 Compared to 1997 (Historical)
Revenues. Revenues increased $0.7 billion, or 24%, to $3.5 billion for 1998
from $2.8 billion for 1997. Our revenue and operating profit were impacted by
improved results for comparable full-service hotel properties, the addition of
18 full-service hotel properties during 1997 and 36 full-service hotel
properties during 1998 and the gain on the sale of two hotel properties in
1998.
Hotel sales, which are gross hotel sales, including room sales, food and
beverage sales, and other ancillary sales such as telephone sales, increased
$0.6 billion, or 23%, to over $3.4 billion in 1998, reflecting the REVPAR
39
increases for comparable units and the addition of full-service hotels in 1997
and 1998. Improved results for our full-service hotels were driven by strong
increases in REVPAR for our 78 comparable units of 7.3% to $112.39 for 1998.
Results were further enhanced by approximately one percentage point increase
in the house profit margin for comparable full-service properties. Average
room rates increased nearly 6.9% for our comparable full-service hotels.
As discussed in Note 2 to the financial statements, we spun off our senior
living communities. We have accounted for these revenues and expenses as
discontinued operations and has shown the amount, net of taxes, below income
from continuing operations. Revenues generated from our 31 senior living
communities totaled $241 million for 1998 compared to $111 million for 1997,
as the assets were purchased in the third quarter of 1997.
Revenues were also impacted by the gains on the sales of two hotels. The New
York East Side Marriott was sold for $191 million resulting in a pre-tax gain
of approximately $40 million. The Napa Valley Marriott was sold for $21
million resulting in a pre-tax gain of approximately $10 million.
Operating Costs and Expenses. Operating costs and expenses principally
consisted of property-level operating costs, depreciation, management fees,
real and personal property taxes, ground, building and equipment rent,
insurance and certain other costs. Operating costs and expenses increased $0.5
billion to $2.9 billion, primarily representing increased hotel operating
costs. Hotel operating costs increased $0.5 billion to $2.8 billion for 1998,
primarily due to the addition of 54 full-service hotel properties during 1997
and 1998 and increased management fees and rentals tied to improved property
results. As a percentage of hotel revenues, hotel operating costs and expenses
decreased slightly to 82% for 1998 from 84% of revenues for 1997, due to the
significant increases in REVPAR discussed above, offset by increases in
management fees and property-level operating costs, including higher labor
costs in certain markets.
Operating Profit. As a result of the changes in revenues and operating costs
and expenses discussed above, our operating profit increased $0.2 billion, or
53%, to $0.7 billion for 1998. For 1998, property-level operating profit
increased $0.2 billion, or 39%, to $0.6 billion, or 18% of hotel revenues, for
1998 compared to $0.4 billion, or 16% of hotel revenues, for 1997.
Specifically, hotels in New York City, San Francisco, Toronto and Mexico City
reported significant improvements for 1998 over 1997. Properties in Florida
reported some temporary declines in operating results due to exceptionally
poor weather in 1998.
Minority Interest. Minority interest expense increased $21 million to $52
million for 1998, primarily reflecting the impact of the consolidation of
affiliated partnerships and the acquisition of controlling interests in newly-
formed partnerships during 1997 and 1998.
Corporate Expenses. Corporate expenses increased $5 million to $50 million
for 1998. As a percentage of revenues, corporate expenses decreased to 1.4% of
revenues for 1998 from 1.6% in 1997, reflecting our efforts to control
corporate expenses in spite of the substantial growth in revenues.
REIT Conversion Expenses. REIT conversion expenses reflect the professional
fees, consent fees, and other expenses associated with our conversion to a
REIT and totaled $64 million for 1998. There were no REIT conversion expenses
prior to 1998.
Interest Expense. Interest expense increased 16% to $335 million in 1998,
primarily due to additional debt assumed in connection with the 1997 and 1998
full-service hotel additions as well as the issuance of the senior notes and
establishment of a new credit facility in 1998.
40
Dividends on Convertible Preferred Securities of Subsidiary Trust. The
dividends on the convertible preferred securities reflect the dividends on the
$550 million in 6.75% Convertible Preferred Securities issued by a subsidiary
trust of Host Marriott in December 1996.
Interest Income. Interest income decreased $1 million to $51 million for
1998, primarily reflecting the lower level of cash and marketable securities
held in 1998 compared to 1997.
Discontinued Operations. Income from discontinued operations of $6 million
for 1998 represents the senior living communities' business results of
operations for the entire year. The provision for loss on disposal of $5
million for 1998 includes organizational and formation costs related to
Crestline Capital Corporation.
Income before Extraordinary Item. Income before extraordinary item for 1998
was $195 million, compared to $47 million for 1997.
Extraordinary Gain (Loss). In connection with the purchase in August 1998 of
our old senior notes, we recognized an extraordinary loss of $148 million,
which represents the bond premium and consent payments totaling approximately
$175 million and the write-off of deferred financing fees of approximately $52
million related to the old senior notes, net of taxes. In March 1997, we
purchased 100% of the outstanding bonds secured by a first mortgage on the San
Francisco Marriott Hotel. We purchased the bonds for $219 million, which was
an $11 million discount to the face value of $230 million. In connection with
the redemption and defeasance of the bonds, we recognized an extraordinary
gain of $5 million, which represents the $11 million discount and the write-
off of deferred financing fees, net of taxes. In December 1997, we refinanced
the mortgage debt secured by Marriott's Orlando World Center. In connection
with the refinancing, we recognized an extraordinary loss of $2 million, which
represents payment of a prepayment penalty and the write-off of unamortized
deferred financing fees, net of taxes.
Net Income (Loss). Net income for 1998 was $47 million compared to net
income of $50 million for 1997. Basic earnings (loss) per common share was
$.22 and $.23 for 1998 and 1997, respectively. Diluted earnings (loss) per
common share was $.27 and $.23 for 1998 and 1997, respectively.
1997 Compared to 1996 (Historical)
Revenues. Revenues increased $866 million, or 44%, to $2,823 million for
1997. Our revenues and operating profit were impacted by:
--improved lodging results for comparable full-service hotels;
--the addition of 23 full-service hotels during 1996 and 18 full-service
hotels during 1997;
--the 1996 sale and leaseback of 16 Courtyard properties and 18 Residence
Inns; and
--the 1997 results including 52 weeks versus 53 weeks in 1996.
Hotel sales increased $864 million, or 44%, to over $2,806 million in 1997,
reflecting the REVPAR increases for comparable units and the addition of full-
service properties during 1996 and 1997. Improved results for our full-service
hotels were driven by strong increases in REVPAR for comparable units of 12.6%
in 1997. Results were further enhanced by a more than two percentage point
increase in the house profit margin for comparable full-service properties. On
a comparable basis for our full-service properties, average room rates
increased almost 11%, while average occupancy increased over one percentage
point.
Operating Costs and Expenses. Operating costs and expenses increased $667
million to $2,391 million for 1997, primarily representing increased hotel
operating costs, including depreciation and management fees. Hotel operating
costs increased $676 million to $2,362 million, primarily due to the addition
of 41 full-service properties during 1996 and 1997, and increased management
fees and rentals tied to improved property results. As a percentage of hotel
revenues, hotel operating costs and expenses decreased to 84% of revenues for
1997, from 87% of revenues for 1996, reflecting the impact of increased 1997
revenues spread over relatively fixed operating costs and expenses.
Operating Profit. As a result of the changes in revenues and operating costs
and expenses discussed above, our operating profit increased $199 million, or
85%, to $432 million in 1997. Hotel operating profit increased
41
$188 million, or 73%, to $444 million, or 16% of hotel revenues, for 1997
compared to $256 million, or 13% of hotel revenues, for 1996. In nearly all
markets, our hotels recorded improvements in comparable operating results. In
particular, our hotels in the Northeast, Mid-Atlantic and Pacific coast
regions benefited from the upscale and luxury full-service room supply and
demand imbalance. Hotels in New York City, Philadelphia, San Francisco/Silicon
Valley and Southern California performed particularly well. In 1997, our
suburban Atlanta properties (three properties totaling 1,022 rooms) generally
reported decreased results due to higher activity in 1996 related to the
Summer Olympics and the impact of the additional supply added to the suburban
areas. However, the majority of our hotel rooms in Atlanta are in the core
business districts in downtown and Buckhead where they realized strong year-
over-year results and were only marginally impacted by the additional supply.
Minority Interest. Minority interest expense increased $25 million to $31
million for 1997, primarily reflecting the impact of the consolidation of
affiliated partnerships and the acquisition of controlling interests in newly-
formed partnerships during 1996 and 1997.
Corporate Expenses. Corporate expenses increased $2 million to $45 million
in 1997. As a percentage of revenues, corporate expenses decreased to 1.6% of
hotel sales in 1997 from 2.2% of hotel sales in 1996. This reflects our
efforts to control corporate expenses in spite of the substantial growth in
revenues.
Interest Expense. Interest expense increased $51 million to $288 million in
1997, primarily due to the additional mortgage debt of approximately $1.1
billion assumed in connection with the 1996 and 1997 full-service hotel
additions, approximately $315 million in debt incurred in conjunction with the
acquisition of senior living communities, as well as the issuance of $600
million of 8 7/8% senior notes in July 1997.
Dividends on Convertible Preferred Securities of Subsidiary Trust. The
dividends on the convertible preferred securities reflect the dividends on the
$550 million in 6.75% Convertible Preferred Securities issued by a subsidiary
trust of Host Marriott in December 1996.
Interest Income. Interest income increased $4 million to $52 million for
1997, primarily reflecting the interest income on the available proceeds
generated by the December 1996 offering of convertible preferred securities
and the proceeds generated by the issuance of our 8 7/8% senior notes in July
1997.
Discontinued Operations. Income from discontinued operations was breakeven
in 1997. There were no discontinued operations in 1996.
Income (Loss) Before Extraordinary Items. Income before extraordinary items
for 1997 was $47 million, compared to a $13 million loss before extraordinary
items for 1996, as a result of the items discussed above.
Extraordinary Gain (Loss). In March 1997, we purchased 100% of the
outstanding bonds secured by a first mortgage on the San Francisco Marriott
Hotel. We purchased the bonds for $219 million, which was an $11 million
discount to the face value of $230 million. In connection with the redemption
and defeasance of the bonds, we recognized an extraordinary gain of $5
million, which represents the $11 million discount less the write-off of
unamortized deferred financing fees, net of taxes. In December 1997, we
refinanced the mortgage debt secured by Marriott's Orlando World Center. In
connection with the refinancing, we recognized an extraordinary loss of $2
million, which represents payment of a prepayment penalty and the write-off of
unamortized deferred financing fees, net of taxes.
Net Income (Loss). Our net income in 1997 was $50 million, compared to a net
loss of $13 million in 1996. Basic and diluted earnings per common share was
$.23 for 1997, compared to a basic and diluted loss per common share of $.06
in 1996.
42
1998 Compared to 1997 (Pro Forma)
Pro Forma
--------------
1998 1997
------ ------
(in millions,
except
per share
amounts)
Revenues
Hotels...................................................... $1,264 $1,167
Other....................................................... 15 6
------ ------
Total revenues............................................ 1,279 1,173
------ ------
Operating costs and expenses
Hotels...................................................... 599 626
Other....................................................... 26 23
------ ------
Total operating costs and expenses........................ 625 649
------ ------
Operating profit.............................................. 654 524
Minority interest............................................. (23) (12)
Corporate expenses............................................ (50) (44)
Interest expense.............................................. (449) (446)
Dividends on Convertible Preferred Securities of subsidiary
trust........................................................ (37) (37)
Interest income............................................... 27 12
------ ------
Income (loss) from continuing operations before income taxes.. 122 (3)
Provision for income taxes.................................... (6) --
------ ------
Income (loss) from continuing operations...................... $ 116 $ (3)
====== ======
Basic earnings (loss) per common share from continuing
operations................................................... $ .51 $ (.01)
====== ======
Weighted average shares outstanding........................... 225.6 225.6
Revenues. Revenues primarily represent lease revenues and net gains (losses)
on property transactions. Revenues increased $106 million, or 9%, to $1.3
billion for 1998 from $1.2 billion for 1997.
Improved results for our hotels were driven by strong increases in REVPAR of
7.4% to $110.93 for 1998, while average occupancy remained unchanged year over
year.
Operating Costs and Expenses. Operating costs and expenses principally
consist of depreciation, property taxes, ground rent, insurance and certain
other costs. Operating costs and expenses decreased $24 million to $625
million in 1998. As a percentage of rental revenues, hotel operating costs and
expenses decreased to 47% of rental revenues in 1998 from 54% of rental
revenues in 1997 due to the increase in minimum rent under our leases.
Operating Profit. As a result of the changes in rental revenues and
operating costs and expenses discussed above, our operating profit increased
$130 million, or 25%, to $654 million for 1998. Hotel operating profit
increased $124 million to $665 million, or 53% of rental revenues, for 1998
from $541 million, or 46% of rental revenues, for 1997. Our hotels recorded
significant improvements in comparable operating results. Specifically, hotels
in New York City, Boston, Toronto and Mexico reported significant improvements
for 1998. Properties in Florida reported some temporary declines in operating
results due to exceptionally poor weather in 1998.
Minority Interest. Minority interest expense increased $11 million to $23
million for 1998, primarily reflecting improved hotel operations.
Corporate Expenses. Corporate expenses increased $6 million to $50 million
for 1998 due to increased staffing levels and the impact of inflation.
43
Interest Expense. Interest expense increased $3 million to $449 million in
1998, primarily due to amortization related to certain leases.
Dividends on Convertible Preferred Securities of Subsidiary Trust. The
dividends on convertible preferred securities reflect the dividends accrued on
the $550 million in 6.75% Convertible Preferred Securities issued by a
subsidiary trust in December 1996.
Interest Income. Interest income increased $15 million to $27 million for
1998, primarily due to interest income from excess cash and marketable
securities.
Income (Loss) from Continuing Operations. The income from continuing
operations for 1998 was $116 million, compared to a loss of $(3 million) for
1997.
Liquidity and Capital Resources
We fund our capital requirements with a combination of operating cash flow,
debt and equity financing and proceeds from sales of selected properties and
other assets. We utilize these sources of capital to acquire new properties,
fund capital additions and improvements and make principal payments on debt.
As a result of the REIT conversion, we are required to use available funds to
pay dividends to the extent of 95% of taxable income in order to maintain our
REIT qualification, and we have indicated an intent to pay dividends
equivalent to 100% of taxable income for each year. Payment of these dividends
is expected to be funded by the operating partnership. To the extent that the
operating partnership's cash flow is not sufficient for this purpose, it may
be required to borrow money to pay such dividends.
Capital Transactions. We substantially changed our debt financing through
the following series of transactions which were intended to facilitate the
consummation of the REIT conversion.
On April 20, 1998, we and certain of our subsidiaries filed a shelf
registration statement on Form S-3 with the Securities and Exchange Commission
for $2.5 billion in securities, including debt, equity or any combination
thereof. HMH Properties, Inc., then our wholly-owned subsidiary utilized $2.2
billion of the capacity under this shelf registration to issue the new senior
notes described further below.
On August 5, 1998, HMH Properties, which was merged into the operating
partnership as part of the REIT conversion, purchased substantially all of its
(i) $600 million of 9 1/2% senior notes due 2005, (ii) $350 million of 9%
senior notes due 2007 and (iii) $600 million of 8 7/8% senior notes due 2007.
Concurrently with each offer to purchase, HMH Properties solicited consents
from registered holders of these old senior notes to certain amendments to
eliminate or modify substantially all of the restrictive covenants and certain
other provisions contained in the indentures pursuant to which the old senior
notes were issued. HMH Properties simultaneously utilized the shelf
registration to issue an aggregate of $1.7 billion in new senior notes, in two
series: $500 million of 7 7/8% Series A notes due in 2005 and $1.2 billion of
7 7/8% Series B notes due in 2008.
The August 1998 consent solicitations facilitated the merger of HMC Capital
Resources Holdings Corporation, then our wholly-owned subsidiary, with and
into HMH Properties. HMC Capital Resources, the owner of eight of our hotel
properties, was the obligor under our old $500 million revolving credit
facility. In August 1998, HMH Properties entered into a new $1.25 billion
credit facility with a group of commercial banks, which replaced the old
credit facility. The credit facility provides (i) a $350 million term loan
facility, subject to certain increases, and (ii) a $900 million revolving
credit facility. The new credit facility has an initial three-year term with
two one-year extension options. Borrowings under the new credit facility
generally bear interest at the Eurodollar rate plus 1.75% (7.5% at December
31, 1998) and the interest rate and commitment fee on the unused portion of
the facility fluctuate based on certain financial ratios. As of December 31,
1998, $350 million was outstanding under the credit facility. The net proceeds
from the offering of the $1.7 billion senior notes and borrowings under the
credit facility were used to purchase substantially all of HMH Properties' old
senior notes, to repay amounts outstanding under the old credit facility and
to make bond premium and consent payments totaling $175 million. These costs,
along with the write-off of deferred financing fees of approximately $52
million related to the old senior notes and the old credit facility, were
recorded as a pre-tax extraordinary loss on the extinguishment of debt in
1998.
44
In December 1998, HMH Properties issued $500 million of 8.45% Series C
senior notes due in 2008 under the same indenture and with the same covenants
as the Series A and Series B senior notes previously issued. The proceeds were
used to pay down other debt and pay expenses of the REIT conversion. HMH
Properties had a total of $2.2 billion in senior notes outstanding as of its
merger with the operating partnership on December 16, 1998. These senior
notes, and obligations under the new credit facility, became obligations of
the operating partnership at that time. In February 1999, the operating
partnership issued $300 million of 8 3/8% Series D senior notes due in 2006
under the same indenture and with the same covenants as the new senior notes
and Series C senior notes. The debt was used to refinance, or purchase,
approximately $299 million of debt acquired in the partnership mergers,
including approximately $40 million of other mortgage debt.
In July 1997, HMH Properties and HMC Acquisition Properties, Inc. each of
which is our wholly-owned subsidiary, completed consent solicitations with
holders of their senior notes to amend certain provisions of their senior
notes indentures. The 1997 consent solicitations facilitated the merger of
Acquisitions with and into HMH Properties. Concurrent with the 1997 consent
solicitations and the HMH Properties and Acquisitions merger, HMH Properties
issued an aggregate of $600 million of 8 7/8% senior notes at par with a
maturity of July 2007. HMH Properties received net proceeds of approximately
$570 million, net of the costs of the 1997 consent solicitations and the
offering. HMH Properties paid dividends to Host Marriott of $54 million and
$29 million in 1997 and 1996, respectively, as permitted under the indentures.
No dividends were paid in 1998.
In addition to the capital resources provided by its debt financings, in
December 1996 Host Marriott Financial Trust, one of our wholly-owned
subsidiary trusts, issued 11 million shares of 6 3/4% Convertible Quarterly
Income Preferred Securities, with a liquidation preference of $50 per share
for a total liquidation amount of $550 million. The convertible preferred
securities represent an undivided beneficial interest in the assets of the
trust and, pursuant to various agreements entered into in connection with the
transaction, are fully, irrevocably and unconditionally guaranteed by us.
Proceeds from the issuance of the convertible preferred securities were
invested in 6 3/4% Convertible Subordinated Debentures due December 2, 2026
issued by us, which are the trust's sole assets. Each of the convertible
preferred securities is convertible at the option of the holder into shares of
our common stock at the rate of 3.2537 shares per convertible preferred
security equivalent to a conversion price of $15.367 per share of our common
stock. This conversion ratio includes adjustments to reflect distributions
made to our common stockholders in connection with the REIT conversion. During
1998, 1997 and 1996, no shares were converted into common stock. Holders of
the convertible preferred securities are entitled to receive preferential
cumulative cash distributions at an annual rate of 6 3/4% accruing from the
original issue date, commencing March 1, 1997, and payable quarterly in
arrears thereafter. The distribution rate and the distribution and other
payment dates for the convertible preferred securities correspond to the
interest rate and interest and other payment dates on the convertible
subordinated debentures. We may defer interest payments on the convertible
subordinated debentures for a period not to exceed 20 consecutive quarters. If
interest payments on the convertible subordinated debentures are deferred, so
too are payments on the convertible preferred securities. Under this
circumstance, we would not be permitted to declare or pay any cash
distributions with respect to our capital stock or debt securities that rank
equal in right of payment with or junior to the convertible subordinated
debentures. Subject to certain restrictions, the convertible preferred
securities are redeemable at our option upon any redemption of the convertible
subordinated debentures after December 2, 1999. Upon repayment at maturity or
as a result of the acceleration of the convertible subordinated debentures
upon the occurrence of a default, the convertible preferred securities are
subject to mandatory redemption. We may, from time to time, make market
repurchases of these securities as conditions permit.
In connection with consummation of the REIT conversion, the operating
partnership assumed primary liability for repayment of the convertible
subordinated debentures, although we also retain liability. Upon conversion by
a convertible preferred securities holder, we will issue shares of our common
stock, which will be delivered to such holder. Upon the issuance of such
shares by Host Marriott, the operating partnership will issue to us a number
of OP Units equal to the number of shares of our common stock issued in
exchange for the debentures.
45
In March 1996, we completed the issuance of 31.6 million shares of common
stock for net proceeds of nearly $400 million.
Capital Acquisitions, Additions and Improvements. We seek to grow primarily
through opportunistic acquisitions of full-service hotels. We believe that the
upscale and luxury full-service hotel segments of the market offer
opportunities to acquire assets at attractive multiples of cash flow and at
discounts to replacement value, including under-performing hotels which may be
improved by conversion to the Marriott or Ritz-Carlton brands. In the first
quarter of 1998, we acquired a controlling interest in the partnership that
owns the 1,671-room Atlanta Marriott Marquis Hotel for $239 million, including
the assumption of $164 million of mortgage debt. We also acquired a
controlling interest in the partnership that owns the 359-room Albany
Marriott, the 350-room San Diego Marriott Mission Valley and the 320-room
Minneapolis Marriott Southwest for approximately $50 million. In the second
quarter of 1998, we acquired the 289-room Park Ridge Marriott for $24 million
and acquired the 281-room Ritz-Carlton, Phoenix for $75 million. In addition,
we acquired the 397-room Ritz-Carlton, Tysons Corner, Virginia for $96 million
and the 487-room Torrance Marriott near Los Angeles, California, for $52
million. In the third quarter of 1998, we acquired the 308-room Ritz-Carlton,
Dearborn for approximately $65 million, the 336-room Ritz-Carlton, San
Francisco for approximately $161 million and the 404-room Memphis Crowne Plaza
(which was converted to the Marriott brand upon acquisition) for approximately
$16 million. We are regularly engaged in discussions with respect to other
potential acquisition properties.
In December 1998, we completed the acquisition of, or controlling interests
in, twelve world-class luxury hotels and certain other assets, including a
mortgage note on a thirteenth hotel property from affiliates of the Blackstone
Group. The operating partnership paid approximately $920 million in cash and
assumed debt and issued approximately 43.9 million OP Units, along with other
consideration for a total value of approximately $1.55 billion. The number of
OP Units issued in the Blackstone acquisition will fluctuate based upon
certain closing adjustments to be determined on March 31, 1999. Based on
current stock prices, the operating partnership will be required to issue the
Blackstone Entities approximately 3.7 million additional OP Units pursuant to
such adjustments in April 1999.
In December 1998, subsidiaries of the operating partnership merged with
eight public partnerships and acquired limited partnership interests in four
private partnerships, which collectively own or control 28 properties 15 of
which were controlled by us and consolidated on our financial statements prior
to December 1998. The operating partnership issued approximately 25 million OP
Units, 8.5 million of which were subsequently converted to our common stock,
for interests in these partnerships valued at approximately $333 million. As a
result of these transactions, the operating partnership increased its
ownership of most of the 28 properties to 100% while consolidating 13
additional hotels (4,445 rooms).
In connection with our conversion to a REIT, we formed two non-controlled
subsidiaries, which own approximately $264 million in assets. The ownership of
most of these assets by us and the operating partnership could jeopardize our
status as a REIT and the operating partnership's status as a partnership for
federal income tax purposes. These assets primarily consist of partnership or
other interests in hotels which are not leased and certain furniture, fixtures
and equipment used in the hotels. In exchange for the operating partnership's
contribution of these assets to the non-controlled subsidiaries, the operating
partnership received only nonvoting common stock representing 95% of the total
economic interests of the non-controlled subsidiaries. The Host Marriott
Statutory Employee/Charitable Trust, the beneficiaries of which are 1) a trust
formed for the benefit of certain employees of the operating partnership and
2) the J. Willard Marriott Foundation, acquired all of the voting common stock
representing the remaining 5% of the total economic interests, and reflecting
100% of the control of each non-controlled subsidiary. As a result, as of
December 31, 1998, we did not control the non-controlled subsidiaries.
During 1997, we acquired eight full-service hotels (3,600 rooms) and
controlling interests in nine additional full-service hotels (5,024 rooms) for
an aggregate purchase price of approximately $766 million (including the
assumption of approximately $418 million of debt). We also completed the
acquisition of the 504-room New
46
York Marriott Financial Center, after acquiring the mortgage on the hotel for
$101 million in late 1996. During 1996, we acquired six full-service hotels
(1,964 rooms) for an aggregate purchase price of $189 million and controlling
interests in 17 additional full-service properties (8,917 rooms) for an
aggregate purchase price of approximately $1.1 billion (including the
assumption of $696 million of debt).
In November 1997, we announced a committment to develop and construct the
717-room Tampa Convention Center Marriott for a cost estimated at
approximately $88 million, net of an approximate $16 million subsidy provided
by the City of Tampa.
We may also expand existing hotel properties where strong performance and
market demand exists. Expansions to existing properties create a lower risk to
us as the success of the market is generally known and development time is
significantly shorter than new construction. We recently committed to add
approximately 500 rooms and an additional 15,000 square feet of meeting space
to the 1,503-room Marriott's Orlando World Center. In July 1998, we announced
the purchase of a 13-acre parcel of land for the development of a 295-room
Ritz-Carlton that will serve as an extension of the 463-room Ritz-Carlton
Naples, which was purchased in September 1996. The existing hotel just
completed a restaurant and public space refurbishment and is in the process of
adding a world-class spa. In addition, a subsidiary of one of the non-
controlled subsidiaries entered into a joint venture through which a non-
controlled subsidiary owns 49% of the surrounding 27-hole world-class Greg
Norman designed golf course development. The golf course joint venture was
transferred to a non-controlled subsidiary in connection with the REIT
conversion. The total investment by us in expansion and investments in the
Ritz-Carlton, Naples property is expected to be approximately $97 million.
In 1997, we acquired the outstanding common stock of the Forum Group from
Marriott Senior Living Services, Inc., a subsidiary of Marriott International.
We purchased the Forum Group portfolio of 29 senior living communities for
approximately $460 million, including approximately $270 million in debt.
Additionally, during 1997 and 1998, we completed certain expansions and
acquired two additional senior living properties for $100 million, including
$48 million of debt. The properties, which continued to be operated by
Marriott International were owned by a subsidiary of Crestline and distributed
to our shareholders in connection with the REIT conversion and are reflected
as discontinued operations in our financial statements. In December 1998, we
discontinued the senior living business as a result of the distribution of the
Crestline common stock to our shareholders.
Asset Dispositions. We historically have disposed of, and may from time to
time in the future consider opportunities to sell or exchange, real estate
properties at attractive valuations when the proceeds could be redeployed into
investments with more favorable returns. During the second quarter of 1998, we
disposed of the 662-room New York Marriott East Side for proceeds of $191
million and recorded a pre-tax gain of approximately $40 million and the Napa
Valley Marriott for proceeds of $21 million and recorded a pre-tax gain of
approximately $10 million. During 1997, we disposed of the 255-room Sheraton
Elk Grove Suites for proceeds of approximately $16 million. We also sold 90%
of an 174-acre parcel of undeveloped land in Germantown, Maryland for
approximately $11 million, which approximated its carrying value. During the
first and second quarters of 1996, 16 of our Courtyard properties and 18 of
our Residence Inn properties were sold, subject to a leaseback, to Hospitality
Properties Trust for approximately $314 million, with approximately $35
million to be received upon expiration of the leases. A gain on the
transactions of approximately $45 million was deferred and is being amortized
over the initial term of the leases. In February 1999, we disposed of the
Minneapolis/Bloomington Marriott for $35 million and recorded a pre-tax gain
on sale of approximately $13 million.
In cases where we have made a decision to dispose of particular properties,
we assess impairment of each individual property to be sold on the basis of
expected sales price less estimated costs of disposal. Otherwise, we assess
impairment of our real estate properties based on whether it is probable that
undiscounted future cash flows from such properties will be less than their
net book value. If a property is impaired, its basis is adjusted to its fair
market value.
47
Cash Flows. Our cash flow from continuing operations in 1998, 1997 and 1996
totaled $312 million, $432 million and $205 million, respectively. Cash flow
from (used in) discontinued operations totaled $29 million, $32 million and
($4 million) in 1998, 1997 and 1996, respectively.
Our cash used in investing activities from continuing operations in 1998,
1997 and 1996 totaled $655 million, $807 million and $504 million,
respectively. Cash from investing activities primarily consists of net
proceeds from the sales of assets, offset by the acquisition of hotels and
other capital expenditures previously discussed, as well as the purchases and
sales of short-term marketable securities. Cash used in investing activities
from continuing operations was significantly impacted by the purchase of $354
million of short-term marketable securities in 1997 and the net sale of $354
million of short-term marketable securities in 1998. Cash flow from investing
activities from discontinued operations totaled $50 million and $239 million
in 1998 and 1997, respectively. There was no cash flow from (used in)
investing activities from discontinued operations in 1996.
Our cash from financing activities from continuing operations was $265
million for 1998, $392 million for 1997 and $806 million for 1996. Our cash
from financing activities from continuing operations primarily consists of the
proceeds from debt and equity offerings, mortgage financing on certain
acquired hotels and borrowings under our credit facilities offset by
redemptions and payments on senior notes, prepayments on hotel mortgages and
other scheduled principal payments. Cash flow from (used in) financing
activities from discontinued operations totaled $24 million and ($3 million)
in 1998 and 1997, respectively. There was no cash flow from (used in)
financing activities from discontinued operations in 1996.
EBITDA. Our consolidated earnings before interest, taxes, depreciation,
amortization and other non-cash items, which is referred to as EBITDA,
increased $180 million, or 25%, to $888 million in 1998 from $708 million in
1997.
Hotel EBITDA increased $180 million, or 26%, to $870 million in 1998 from
$690 million in 1997, reflecting comparable full-service hotel EBITDA growth,
as well as incremental EBITDA from 1997 and 1998 acquisitions. Full-service
hotel EBITDA from comparable hotel properties increased 9.6% on a REVPAR
increase of 7.3%. Our senior living communities contributed $61 million of
EBITDA in 1998.
The following is a reconciliation of EBITDA to our income before
extraordinary items (in millions):
Fifty-two Fifty-two
Weeks Ended Weeks Ended
December 31, 1998 January 2, 1998
----------------- ---------------
EBITDA................................... $ 888 $ 708
REIT conversion expense.................. (64) --
Interest expense......................... (335) (302)
Dividends on convertible preferred
securities.............................. (37) (37)
Depreciation and amortization............ (243) (240)
Minority interest expense................ (52) (32)
Income taxes............................. 20 (36)
Gain (loss) on disposition of assets and
other non-cash charges, net............. 18 (14)
----- -----
Income before extraordinary items...... $ 195 $ 47
===== =====
The ratio of earnings to fixed charges was 1.5 to 1.0, 1.3 to 1.0 and 1.0 to
1.0 in 1998, 1997 and 1996, respectively.
Comparative FFO. Management believes that Comparative Funds From Operations
or "Comparative FFO," which represents Funds From Operations, as defined by
NAREIT, plus deferred tax expense, is a meaningful disclosure that will help
the investment community to better understand our financial performance. FFO
is meaningful due to the significance of our long-lived assets and because
such data is considered useful by
48
the investment community to better understand our results, and can be used to
measure our ability to service debt, fund capital expenditures and expand its
business. FFO is defined by NAREIT as net income computed in accordance with
GAAP, excluding gains or losses from debt restructurings and sales of
properties, plus real estate related depreciation and amortization, and after
adjustments for unconsolidated partnerships and joint ventures. FFO should not
be considered as an alternative to net income, operating profit, cash flows
from operations or any other operating or liquidity performance measure
prescribed by GAAP. FFO is also not an indicator of funds available for our
cash needs, including distributions. Our method of calculating FFO may be
different from methods used by other REITs and, accordingly, is not comparable
to such other REITs.
Comparative FFO from total operations increased $107 million, or 36%, to
$402 million in 1998. Comparative FFO from total operations increased $131
million, or 80%, to $295 million in 1997. The following is a reconciliation of
our income before extraordinary items to Comparative FFO (in millions):
Fiscal
Year
----------
1998 1997
---- ----
Income before extraordinary items................................ $195 $ 47
Depreciation and amortization.................................... 265 240
Other real estate activities..................................... (53) 6
Partnership adjustments.......................................... (11) (13)
Deferred taxes................................................... 46 15
Other non-recurring adjustments:
REIT conversion expenses....................................... (37) --
Change in reporting period(a).................................. (3) --
---- ----
Comparative FFO from total operations........................ 402 295
Discontinued operations.......................................... (28) (10)
---- ----
Comparative FFO from continuing operations....................... $374 $285
==== ====
- --------
(a) We changed our method of recording operations for certain non-Marriott
owned properties in 1998, resulting in the recognition of 13 months of
operations in 1998. This amount represents the incremental operations
recognized.
Cash expenditures for various long-term assets and income taxes have been, and
will be, incurred which are not reflected in the Comparative FFO presentation.
We consider EBITDA and Comparative FFO to be indicative measures of our
operating performance due to the significance of our long-lived assets and
because such data is considered useful by the investment community to better
understand our results, and can be used to measure our ability to service
debt, fund capital expenditures and expand its business, however, such
information should not be considered as an alternative to net income,
operating profit, cash from operations, or any other operating or liquidity
performance measure prescribed by generally accepted accounting principles.
Cash expenditures for various long-term assets, interest expense (for EBITDA
purposes only) and income taxes have been, and will be, incurred which are not
reflected in the EBITDA and Comparative FFO presentation.
Partnership Activities. Prior to the REIT conversion, we had general and
limited partner interests in numerous limited partnerships which owned 240
hotels including 20 full-service hotels, managed by Marriott International.
Debt of the hotel limited partnerships was typically secured by first
mortgages on the properties and was generally nonrecourse to the limited
partnerships and their partners. However, we committed to advance amounts to
certain affiliated limited partnerships, if necessary, to cover certain future
debt service requirements; these commitments now have been assumed by the
operating partnership. These commitments are limited, in the aggregate, to $22
million. Amounts repaid to us under these guarantees totaled $14 million and
$2 million in 1998 and 1997, respectively. Fundings by us under these
guarantees amounted to $10 million in 1997. There were no fundings in 1998 or
1996. As a result of the REIT conversion, our interests in the 220 limited-
service hotels were transferred to the non-controlled subsidiaries.
Additionally, as part of the REIT conversion, 13 of the 20 full-service hotels
were acquired by the operating partnership, two were sold, four were
transferred to one of the non-controlled subsidiaries and one was retained by
us.
Leases. We lease certain property and equipment under noncancelable
operating leases, including the long-term ground leases for certain hotels,
generally with multiple renewal options. The leases related to the 53
Courtyard properties and 18 Residence Inn properties sold during 1995 and
1996, are nonrecourse to us and contain provisions for the payment of
contingent rentals based on a percentage of sales in excess of stipulated
amounts. We remain contingently liable on certain leases related to divested
non-lodging properties. Such
49
contingent liabilities aggregated $93 million at December 31, 1998. However,
management considers the likelihood of any substantial funding related to
these divested properties' leases to be remote.
Inflation. Our hotel lodging properties have been impacted by inflation
through its effect on increasing costs and on the managers' ability to
increase room rates. Unlike other real estate, hotels have the ability to
change room rates on a daily basis, so the impact of higher inflation
generally can be passed on to customers. Our exposure to inflation is less now
that substantially all of our hotels are leased to others.
A substantial portion of our debt bears interest at fixed rates. This debt
structure largely mitigates the impact of changes in the rate of inflation on
future interest costs. However, we are currently exposed to some variable
interest rate debt, whose market risk is hedged through interest rate exchange
agreements with financial institutions with an aggregate notional amount of
$365 million. Under the agreements, we collect interest based on one-month
LIBOR (rate of 5.06% at December 31, 1998) and pay interest at fixed rates
ranging from 5.72% to 6.60%. The agreements expire between August 2000 and
August 2002. Accordingly, the amount of our interest expense under the
interest rate exchange agreements and the floating rate debt for a particular
year will be affected by changes in short-term interest rates.
Year 2000 Issue
Year 2000 issues have arisen because many existing computer programs and
chip-based embedded technology systems use only the last two digits to refer
to a year, and therefore do not properly recognize a year that begins with
"20" instead of the familiar "19". If not corrected, many computer
applications could fail or create erroneous results. The following disclosure
provides information regarding the current status of our Year 2000 compliance
program.
We have adopted the compliance program because we recognize the importance
of minimizing the number and seriousness of any disruptions that may occur as
a result of the Year 2000 issue. Our compliance program includes an assessment
of our hardware and software computer systems and embedded systems, as well as
an assessment of the Year 2000 issues relating to third parties with which we
have a material relationship or whose systems are material to the operations
of our hotel properties. Our efforts to ensure that our computer systems are
Year 2000 compliant have been segregated into two separate phases: in-house
systems and third-party systems. Following the REIT conversion, Crestline, as
the lessee of most of our hotels, will deal directly with Year 2000 matters
material to the operation of the hotels, and Crestline has agreed to adopt and
implement the program outlined below with respect to third-party systems for
all hotels for which it is the lessee.
In-House Systems. Since the distribution of Marriott International on
October 8, 1993, we have invested in the implementation and maintenance of
accounting and reporting systems and equipment that are intended to enable us
to provide adequately for our information and reporting needs and which are
also Year 2000 compliant. Substantially all of our in-house systems have
already been certified as Year 2000 compliant through testing and other
mechanisms and we have not delayed any systems projects due to the Year 2000
issue. We are in the process of engaging a third party to review our Year 2000
in-house compliance. Management believes that future costs associated with
Year 2000 issues for our in-house systems will be insignificant and therefore
not impact our business, financial condition and results of operations. We
have not developed, and do not plan to develop, a separate contingency plan
for our in-house systems due to their current Year 2000 compliance.
Third-Party Systems. We rely upon operational and accounting systems
provided by third parties, primarily the managers and operators of our hotel
properties, to provide the appropriate property-specific operating systems,
including reservation, phone, elevator, security, HVAC and other systems, and
to provide us with financial information. Based on discussion with the third
parties that are critical to our business, including the managers and
operators of our hotels, we believe that these parties are in the process of
studying their systems and the systems of their respective vendors and service
providers and, in many cases, have begun to implement changes, to ensure that
they are Year 2000 compliant. However, we have not received any oral or
written assurances that these third parties will be Year 2000 compliant on
time. To the extent these changes impact
50
property-level systems, we may be required to fund capital expenditures for
upgraded equipment and software. We do not expect these charges to be
material, but we are committed to making these investments as required. To the
extent that these changes relate to a third party manager's centralized
systems, including reservations, accounting, purchasing, inventory, personnel
and other systems, management agreements generally provide for these costs to
be charged to our properties subject to annual limitations, which costs will
be borne by Crestline under the leases. We expect that the third party
managers will incur Year 2000 costs in lieu of costs for their centralized
systems related to systems projects that otherwise would have been pursued
and, therefore, the overall level of centralized systems charges allocated to
the properties will not materially increase as a result of the Year 2000
compliance effort. We believe that this deferral of certain systems projects
will not have a material impact on our future results of operations, although
it may delay certain productivity enhancements at our properties. We and
Crestline will continue to monitor the efforts of these third parties to
become Year 2000 compliant and will take appropriate steps to address any non-
compliance issues. We believe that, in the event of material Year 2000 non-
compliance, we will have the right to seek recourse against the manager under
our third party management agreements. The management agreements, however,
generally do not specifically address the Year 2000 compliance issue.
Therefore, the amount of any recovery in the event of Year 2000 non-compliance
at a property, if any, is not determinable at this time, and only a portion of
such recovery would accrue to us through increased lease rental payments from
Crestline.
We and Crestline will work with the third parties to ensure that appropriate
contingency plans will be developed to address the most reasonably likely
worst case Year 2000 scenarios, which may not have been identified fully. In
particular, we and Crestline have had extensive discussions regarding the Year
2000 problem with Marriott International, the manager of a substantial
majority of our hotel properties. Due to the significance of Marriott
International to our business, a detailed description of Marriott
International's state of readiness follows.
Marriott International has adopted an eight-step process toward Year 2000
readiness, consisting of the following: (1) Awareness: fostering understanding
of, and commitment to, the problem and its potential risks; (2) Inventory:
identifying and locating systems and technology components that may be
affected; (3) Assessment: reviewing these components for Year 2000 compliance,
and assessing the scope of Year 2000 issues; (4) Planning: defining the
technical solutions and labor and work plans necessary for each affected
system; (5) Remediation/Replacement: completing the programming to renovate or
replace the problem software or hardware; (6) Testing and Compliance
Validation: conducting testing, followed by independent validation by a
separate internal verification team; (7) Implementation: placing the corrected
systems and technology back into the business environment; and (8) Quality
Assurance: utilizing an internal audit team to review significant projects for
adherence to quality standards and program methodology.
Marriott International has grouped its systems and technology into three
categories for purposes of Year 2000 compliance: (i) information resource
applications and technology (IT Applications)--enterprise-wide systems
supported by Marriott International's centralized information technology
organization ("IR"); (ii) Business-initiated Systems ("BIS")--systems that
have been initiated by an individual business unit, and that are not supported
by Marriott International's IR organization; and (iii) Building Systems--non-
IT equipment at properties that use embedded computer chips, such as
elevators, automated room key systems and HVAC equipment. Marriott
International is prioritizing its efforts based on how severe an effect
noncompliance would have on customer service, core business processes or
revenues, and whether there are viable, non-automated fallback procedures
(System Criticality).
Marriott International measures the completion of each phase based on
documented and quantified results, weighted for System Criticality. As of
January 1, 1999, the Awareness and Inventory phases were complete for IT
Applications and substantially complete for BIS and Building Systems. For IT
Applications, the Assessment, Planning Remediation/Replacement and Testing
phases were each over 95 percent complete, and Compliance Validation had been
completed for nearly half of key systems, with most of the remaining work in
its final stage. BIS and Building Systems, Assessment and Planning are nearly
complete. Remediation/Replacement and Testing is 20 percent complete for BIS,
and Marriott International is on track for completion of initial Testing of
Building
51
Systems by the end of the first quarter of 1999. Compliance Validation is in
progress for both BIS and Building Systems. Marriott International remains on
target for substantial completion of Remediation/Replacement and Testing for
System Critical BIS and Building Systems by June 1999 and September 1999,
respectively. Quality Assurance is in progress for IT Applications, BIS and
Building Systems.
Year 2000 compliance communications with Marriott International's
significant third party suppliers, vendors and business partners, including
its franchisees are ongoing. Marriott International's efforts are focused on
the connections most critical to customer service, core business processes and
revenues, including those third parties that support the most critical
enterprise-wide IT Applications, franchisees generating the most revenues,
suppliers of the most widely used Building Systems and BIS, the top 100
suppliers, by dollar volume, of non-IT products, and financial institutions
providing the most critical payment processing functions. Responses have been
received from a majority of the firms in this group. A majority of these
respondents have either given assurances of timely Year 2000 compliance or
have identified the necessary actions to be taken by them or Marriott
International to achieve timely Year 2000 compliance for their products.
Marriott International has established a common approach for testing and
addressing Year 2000 compliance issues for its managed and franchised
properties. This includes a guidance protocol for operated properties, and a
Year 2000 "Toolkit" for franchisees containing relevant Year 2000 compliance
information. Marriott International is also utilizing a Year 2000 best-
practices sharing system.
Risks. There can be no assurances that Year 2000 remediation by us or third
parties will be properly and timely completed, and failure to do so could have
a material adverse effect on us, our business and our financial condition. We
cannot predict the actual effects to us of the Year 2000 problem, which depend
on numerous uncertainties such as: whether significant third parties properly
and timely address the Year 2000 issue and whether broad-based or systemic
economic failures occur. Moreover, we are reliant upon Crestline to interface
with third parties in addressing the Year 2000 issue at the hotels leased by
Crestline. We are also unable to predict the severity and duration of any such
failures, which could include disruptions in passenger transportation or
transportation systems generally, loss of utility and/or telecommunications
services, the loss or disruption of hotel reservations made on centralized
reservation systems and errors or failures in financial transactions or
payment processing systems such as credit cards. Due to the general
uncertainty inherent in the Year 2000 problem and our dependence on third
parties, including Crestline, we are unable to determine at this time whether
the consequences of Year 2000 failures will have a material impact on us. Our
Year 2000 compliance program, and Crestline's adoption thereof, are expected
to significantly reduce the level of uncertainty about the Year 2000 problem
and management believes that the possibility of significant interruptions of
normal operations should be reduced.
Accounting Standards. In the fourth quarter of 1996, we adopted SFAS No.
123, "Accounting for Stock Based Compensation." The adoption of SFAS No. 123
did not have a material effect on our financial statements. During 1997, we
adopted SFAS No. 128, "Earnings Per Share," SFAS No. 129, "Disclosure of
Information About Capital Structure" and SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information." The adoption of these
statements did not have a material effect on our consolidated financial
statements and the appropriate disclosures required by these statements have
been incorporated herein.
As of January 1, 1998, we adopted SFAS No. 130, "Reporting Comprehensive
Income" which establishes new rules for the reporting and display of
comprehensive income and its components. SFAS 130 requires unrealized gains or
losses on our right to receive Host Marriott Services Corporation stock and
foreign currency translation adjustments, to be included in other
comprehensive income. For 1998 and 1997, our other comprehensive income (loss)
was ($16 million) and $7 million, respectively. As of December 31, 1998 and
January 2, 1998, our accumulated other comprehensive income (loss) was
approximately ($4 million) and $12 million, respectively.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Statement
establishes accounting and reporting standards requiring
52
that every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either an
asset or liability measured at its fair value. The Statement requires that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement and requires that a company
must formally document, designate and assess the effectiveness of transactions
that receive hedge accounting. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. We have not determined the impact of SFAS No.
133, but we do not believe it will be material.
On November 20, 1997, the Emerging Issues Task Force of the Financial
Accounting Standards Board reached a consensus of EITF 97-2, "Application of
FASB Statement No. 94 and APB Opinion No. 16 to Physician Practice Management
Entities and Certain Other Entities with Contractual Management Arrangements."
EITF 97-2 addresses the circumstances in which a management entity may include
the revenues and expenses of a managed entity in its financial statements.
As discussed in Note 1 to the financial statements, we have adopted EITF 97-
2 in the fourth quarter of 1998 with retroactive effect in prior periods to
conform to the new presentation. Application of EITF 97-2 to the consolidated
financial statements for the fiscal years 1998, 1997 and 1996 increased both
revenues and operating expenses by approximately $2.1 billion, $1.7 billion
and $1.2 billion, respectively, and had no impact on operating profit, net
income or earnings per share.
53
Item 7.a Quantitative and Qualitative Disclosures About Market Risk
The table below provides information about our derivative financial
instruments and other financial instruments that are sensitive to changes in
interest rates, including interest rate swaps and debt obligations. For debt
obligations, the table presents principal cash flows and related weighted
average interest rates by expected maturity dates. For interest rate swaps,
the table presents notional amounts and weighted average interest rates by
expected (contractual) maturity dates. Notional amounts are used to calculate
the contractual payments to be exchanged under the contract. Weighted average
variable rates are based on implied forward rates in the yield curve at the
reporting date. As of December 31, 1998, the change in current yields between
one-year and five-year U.S. Treasury bonds is three basis points, thus,
minimal fluctuations in the average interest rates are anticipated over the
maturity periods.
Expected Maturity Date
--------------------------------------------- Fair
1999 2000 2001 2002 2003 Thereafter Total Value
----- ----- ----- ----- ----- ---------- ----- -----
($ in millions)
Liabilities
Long-term Debt--
variable(5):
Potomac Hotel Limited
Partnership(1)........ $ 163 $ -- $ -- $ -- $ -- $ -- $ 163 $163
Marriott Diversified
American Hotels,
LP(1)................. 96 -- -- -- -- -- 96 96
New York Marriott
Marquis............... 145 -- -- -- -- -- 145 145
San Diego Marriott..... 5 5 6 6 7 167 196 190
Grand Hyatt,
Atlanta(2)............ -- -- -- 40 -- -- 40 40
Hyatt Regency,
Cambridge............. -- 45 -- -- -- -- 45 45
Hyatt Regency, Reston.. -- -- 49 -- -- -- 49 49
Hyatt Regency,
Burlingame............ -- 54 -- -- -- -- 54 54
The Ritz-Carlton,
Amelia Island......... -- -- -- -- 90 -- 90 90
Swissotel.............. -- -- -- 200 -- -- 200 200
Credit Facility........ -- -- 350 -- -- -- 350 350
Average Interest
Rate(3)............... 7.42% 6.71% 7.47% 7.63% 7.73% 7.73% 7.32%
Other:
Convertible preferred
securities at 6 3/4%.. -- -- -- -- -- -- 550 449
Expected Expiration Date
------------------------------------------- Notional
1999 2000 2001 2002 2003 Thereafter Amount
----- ----- ----- ----- ---- ---------- --------
($ in millions)
Interest Rate
Derivatives(6)
Receivables:
Grand Hyatt,
Atlanta(2)............ $ -- $ -- $ -- $ 37 $-- $-- $ 37
Hyatt Regency,
Cambridge............. -- 20 -- -- -- -- 20
Hyatt Regency,
Cambridge............. -- 20 -- -- -- -- 20
Hyatt Regency, Reston.. -- -- 24 -- -- -- 24
Hyatt Regency, Reston.. -- -- 24 -- -- -- 24
Hyatt Regency,
Burlingame............ -- 42 -- -- -- -- 42
Hyatt Regency,
Burlingame............ -- 10 -- -- -- -- 10
Swissotel.............. -- -- -- 188 -- -- 188
Payables:
Grand Hyatt,
Atlanta(2)............ -- -- -- 37 -- -- 37
Hyatt Regency,
Cambridge............. -- 20 -- -- -- -- 20
Hyatt Regency,
Cambridge............. -- 20 -- -- -- -- 20
Hyatt Regency, Reston.. -- -- 24 -- -- -- 24
Hyatt Regency, Reston.. -- -- 24 -- -- -- 24
Hyatt Regency,
Burlingame............ -- 42 -- -- -- -- 42
Hyatt Regency,
Burlingame............ -- 10 -- -- -- -- 10
Swissotel.............. -- -- -- 188 -- -- 188
Average Interest Rate
Receivables(3)......... 5.55% 5.55% 5.55% 5.55% -- -- 5.55%
Payables(4)............ 6.16% 6.15% 6.17% 6.17% -- -- 6.20%
- --------
(1)Subsequent to year-end, the long-term debt amounts were refinanced with
fixed interest rate obligations.
(2) Subsequent to year-end, the long-term debt amounts were refinanced with
fixed interest rate obligations and the related interest rate derivative
was terminated.
(3) Interest rates are based on one-month LIBOR plus certain basis points
which range from zero to 275 basis points. The one-month LIBOR rate at
December 31, 1998 was 5.06%. As noted above, the current yield curve is
flat over the expected maturity dates and, therefore, we have calculated
the average interest rates using the one-month LIBOR rate at December 31,
1998.
(4)Interest rates are at fixed rates ranging from 5.72% to 6.60%.
(5) Our fixed rate debt of $3.7 billion has a fair value which exceeds its
carrying value by $20 million. Substantially all of our fixed rate debt
matures in years subsequent to 2003.
(6) The fair value of the interest rate swaps is $14 million as of December
31, 1998. See Note 5 to the consolidated financial statement.
54
Item 8. Financial Statements and Supplementary Data
The following financial information is included on the pages indicated:
Page
----
Report of Independent Public Accountants................................. 45
Consolidated Balance Sheets as of December 31, 1998 and January 2, 1998.. 46
Consolidated Statements of Operations for the Fiscal Years Ended December
31, 1998 January 2, 1998 and January 3, 1997............................ 47
Consolidated Statements of Shareholders' Equity for the Fiscal Years
Ended December 31, 1998, January 2, 1998 and January 3, 1997............ 48
Consolidated Statements of Cash Flows for the Fiscal Years Ended December
31, 1998, January 2, 1998 and January 3, 1997........................... 49
Notes to Consolidated Financial Statements............................... 50
55
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Host Marriott Corporation:
We have audited the accompanying consolidated balance sheets of Host
Marriott Corporation and subsidiaries as of December 31, 1998 and January 2,
1998, and the related consolidated statements of operations, shareholders'
equity and comprehensive income and cash flows for each of the three fiscal
years in the period ended December 31, 1998. These financial statements and
the schedule referred to below are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Host
Marriott Corporation and subsidiaries as of December 31, 1998 and January 2,
1998, and the results of their operations and their cash flows for each of the
three fiscal years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
As discussed in Note 1 to the consolidated financial statements, the Company
has given retroactive effect to the change to include property-level sales and
operating expenses of its hotels in the consolidated statements of operations.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index at
Item 14(a)(2) is presented for purposes of complying with the Securities and
Exchange Commission's rules and are not part of the basic financial
statements. This schedule has been subjected to the auditing procedures
applied in the audit of the basic financial statements and, in our opinion,
fairly states in all material respects the financial data required to be set
forth therein in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Washington, D.C.
March 5, 1999
56
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and January 2, 1998
1998 1997
------ ------
(in millions)
ASSETS
Property and equipment, net..................................... $7,201 $4,634
Notes and other receivables, net (including amounts due from
affiliates of $134 million and $23 million, respectively)...... 203 52
Due from managers............................................... 19 87
Investments in affiliates....................................... 33 13
Other assets.................................................... 376 272
Short-term marketable securities................................ -- 354
Cash and cash equivalents....................................... 436 493
Net investment in discontinued operations....................... -- 236
------ ------
$8,268 $6,141
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Debt
Senior notes issued by the Company or its subsidiaries........ $2,246 $1,585
Mortgage debt................................................. 2,438 1,784
Other......................................................... 447 97
------ ------
5,131 3,466
Accounts payable and accrued expenses........................... 204 84
Deferred income taxes........................................... 97 487
Other liabilities............................................... 460 296
------ ------
Total liabilities........................................... 5,892 4,333
------ ------
Minority interest............................................... 515 58
Company-obligated mandatorily redeemable convertible preferred
securities of a subsidiary trust whose sole assets are the
convertible subordinated debentures due 2026 ("Convertible
Preferred Securities")......................................... 550 550
------ ------
Shareholders' equity
Common Stock, 750 million shares authorized; 225.6 million
shares in 1998 and 203.8 million shares in 1997 issued and
outstanding.................................................. 2 204
Additional paid-in capital.................................... 1,867 935
Accumulated other comprehensive income........................ (4) 12
Retained (deficit) earnings................................... (554) 49
------ ------
Total shareholders' equity.................................. 1,311 1,200
------ ------
$8,268 $6,141
====== ======
See Notes to Consolidated Financial Statements.
57
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal years ended December 31, 1998, January 2, 1998 and January 3, 1997
(in millions, except per common share amounts)
1998 1997 1996
------ ------ ------
REVENUES
Rooms................................................. $2,220 $1,850 $1,302
Food and beverage..................................... 984 776 515
Other................................................. 238 180 125
------ ------ ------
Total hotel revenues.................................. 3,442 2,806 1,942
Net gains (losses) on property transactions........... 57 (11) 1
Other................................................. 14 28 14
------ ------ ------
Total revenues........................................ 3,513 2,823 1,957
------ ------ ------
OPERATING COSTS AND EXPENSES
Hotel property-level costs and expenses
Rooms................................................. 524 428 313
Food and beverage..................................... 731 592 406
Other department costs and deductions................. 843 693 506
Management fees and other (including Marriott
International management fees of $196 million,
$162 million and $101 million, respectively)......... 726 649 461
Other................................................. 28 29 38
------ ------ ------
Total operating costs and expenses.................... 2,852 2,391 1,724
------ ------ ------
OPERATING PROFIT BEFORE MINORITY INTEREST, CORPORATE
EXPENSES AND INTEREST................................. 661 432 233
Minority interest...................................... (52) (31) (6)
Corporate expenses..................................... (50) (45) (43)
REIT conversion expenses............................... (64) -- --
Interest expense....................................... (335) (288) (237)
Dividends on Convertible Preferred Securities of
subsidiary trust...................................... (37) (37) (3)
Interest income........................................ 51 52 48
------ ------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES................................................. 174 83 (8)
Provision for income taxes............................. (86) (36) (5)
Benefit from change in tax status...................... 106 -- --
------ ------ ------
INCOME (LOSS) FROM CONTINUING OPERATIONS............... 194 47 (13)
DISCONTINUED OPERATIONS
Income from discontinued operations (net of income tax
expense of $4 million in 1998)........................ 6 -- --
Provision for loss on disposal (net of income tax
benefit of $3 million in 1998)........................ (5) -- --
------ ------ ------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEMS............... 195 47 (13)
Extraordinary items--gain (loss) on early
extinguishment of debt (net of income tax (benefit)
expense of
($80) million and $1 million in 1998 and 1997,
respectively)......................................... (148) 3 --
------ ------ ------
NET INCOME (LOSS)...................................... $ 47 $ 50 $ (13)
====== ====== ======
BASIC EARNINGS (LOSS) PER COMMON SHARE:
CONTINUING OPERATIONS.................................. $ .90 $ .22 $ (.06)
Discontinued operations (net of income taxes).......... .01 -- --
Extraordinary items--gain (loss) on early
extinguishment of debt (net of income taxes).......... (.69) .01 --
------ ------ ------
BASIC EARNINGS (LOSS) PER COMMON SHARE................. $ .22 $ .23 $ (.06)
====== ====== ======
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
CONTINUING OPERATIONS.................................. $ .84 $ .22 $ (.06)
Discontinued operations (net of income taxes).......... .01 -- --
Extraordinary items--gain (loss) on early
extinguishment of debt (net of income taxes).......... (.58) .01 --
------ ------ ------
DILUTED EARNINGS (LOSS) PER COMMON SHARE............... $ .27 $ .23 $ (.06)
====== ====== ======
See Notes to Consolidated Financial Statements.
58
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME OF
HOST MARRIOTT CORPORATION
(predecessor to Host Marriott, L.P.)
Fiscal years ended December 31, 1998, January 2, 1998 and January 3, 1997
Accumulated
Common Additional Other
Shares Common Paid-in Retained Comprehensive Comprehensive
Outstanding Stock Capital Earnings Income (Loss) Income (Loss)
----------- ------ ---------- -------- ------------- -------------
(in millions) (in millions)
Balance, December 29,
159.7 1995.................... $ 160 $ 499 $ 16 $ -- $ --
-- Net loss................ -- -- (13) -- (13)
Other comprehensive
-- income:
Unrealized gain on HM
Services common stock... -- -- -- 5 5
----
-- Comprehensive loss...... $ (8)
====
Adjustment to Host
Marriott
-- Services dividend....... -- -- (4) --
3.9 Common stock issued for
the comprehensive stock
and employee stock
purchase plans.......... 3 12 -- --
6.8 Common stock issued for
warrants exercised...... 7 42 -- --
Common stock issued in
31.6 stock offering.......... 32 368 -- --
- -------------------------------------------------------------------------------------------------
Balance, January 3,
202.0 1997.................... 202 921 (1) 5 --
-- Net income.............. -- -- 50 -- 50
Other comprehensive
-- income:
Unrealized gain on HM
Services common stock... -- -- -- 7 7
----
-- Comprehensive income.... $ 57
====
1.8 Common stock issued for
the comprehensive stock
and employee stock
purchase plans.......... 2 14 -- --
- -------------------------------------------------------------------------------------------------
Balance, January 2,
203.8 1998.................... 204 935 49 12 --
-- Net income.............. -- -- 47 -- 47
Other comprehensive
-- income (loss):
Unrealized loss on HM
Services common stock... -- -- -- (5) (5)
Foreign currency
translation adjustment.. -- -- -- (9) (9)
Reclassification of gain
realized on HM Services
common stock--net
income.................. -- -- -- (2) (2)
----
-- Comprehensive income.... $ 31
====
1.4 Common stock issued for
the comprehensive stock
and employee stock
purchase plans.......... -- 8 -- --
-- Adjustment of stock par
value from $1 to $.01
per share............... (202) 202 -- --
11.9 Common stock issued for
Special Dividend........ -- 143 (143) --
8.5 Common stock issued for
the REIT roll-up of
partnerships (Note 12).. -- 113 -- --
-- Increase in Operating
Partnership equity due
to issuance of OP Units
for limited partner
interests (net of $368
million minority
interest of the
Operating Partnership)
........................ -- 466 -- --
-- Distribution of stock of
Crestline Capital
Corporation............. -- -- (438) --
-- Cash portion of Special
Dividend................ -- -- (69) --
- -------------------------------------------------------------------------------------------------
Balance, December 31,
225.6 1998.................... $ 2 $1,867 $(554) $ (4)
- -------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
59
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal years ended December 31, 1998, January 2, 1998 and January 3, 1997
1998 1997 1996
------ ------ ----
(in millions)
OPERATING ACTIVITIES
Income (loss) from continuing operations................ $ 194 $ 47 $(13)
Adjustments to reconcile to cash from operations:
Depreciation and amortization.......................... 243 231 168
Income taxes........................................... (103) (20) (35)
Amortization of deferred income........................ (4) (4) (6)
Net (gains) losses on property transactions............ (50) 19 4
Equity in earnings of affiliates....................... (1) (4) (3)
Other.................................................. 39 62 49
Changes in operating accounts:
Other assets........................................... (56) 57 9
Other liabilities...................................... 50 44 32
------ ------ ----
Cash from continuing operations........................ 312 432 205
Cash from (used in) discontinued operations............ 29 32 (4)
------ ------ ----
Cash from operations................................... 341 464 201
------ ------ ----
INVESTING ACTIVITIES
Proceeds from sales of assets........................... 227 51 373
Less non-cash proceeds................................. -- -- (35)
------ ------ ----
Cash received from sales of assets...................... 227 51 338
Acquisitions............................................ (988) (359) (702)
Capital expenditures:
Capital expenditures for renewals and replacements..... (165) (129) (87)
New investment capital expenditures.................... (87) (29) (72)
Purchases of short-term marketable securities........... (134) (354) --
Sales of short-term marketable securities............... 488 -- --
Notes receivable collections............................ 4 6 13
Affiliate notes receivable issuances and collections,
net.................................................... (13) (6) 21
Other................................................... 13 13 (15)
------ ------ ----
Cash used in investing activities from continuing
operations............................................ (655) (807) (504)
Cash used in investing activities from discontinued
operations............................................ (50) (239) --
------ ------ ----
Cash used in investing activities...................... (705) (1,046) (504)
------ ------ ----
FINANCING ACTIVITIES
Issuances of debt....................................... 2,496 857 46
Debt prepayments........................................ (1,898) (403) (173)
Cash contributed to Crestline at inception.............. (52) -- --
Cash contributed to Non-Controlled Subsidiary........... (30) -- --
Cost of extinguishment of debt.......................... (175) -- --
Scheduled principal repayments.......................... (51) (90) (82)
Issuances of common stock............................... 1 6 454
Issuances of Convertible Preferred Securities, net...... -- -- 533
Other................................................... (26) 22 28
------ ------ ----
Cash from financing activities from continuing
operations............................................ 265 392 806
Cash from (used in) financing activities from
discontinued operations............................... 24 (3) --
------ ------ ----
Cash from financing activities......................... 289 389 806
------ ------ ----
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (75) (193) 503
CASH AND CASH EQUIVALENTS, beginning of year............ 511 704 201
------ ------ ----
CASH AND CASH EQUIVALENTS, end of year.................. $ 436 $ 511 $704
====== ====== ====
Non-cash financing activities:
Assumption of mortgage debt for the acquisition of, or
purchase of controlling interests in, certain hotel
properties and discontinued senior living communities... $1,215 $ 733 $696
====== ====== ====
Distribution of net assets in connection with the
discontinued operations................................ $ 438
======
Contribution of net assets to Non-Controlled
Subsidiaries........................................... $ 12
======
See Notes to Consolidated Financial Statements.
60
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Description of Business
Host Marriott Corporation a Maryland corporation formerly named HMC Merger
Corporation ("Host REIT"), operating through an umbrella partnership
structure, is the owner of full-service hotel properties. Host REIT operates
as a self-managed and self-administered real estate investment trust ("REIT")
and its operations are conducted solely through an operating partnership and
its subsidiaries. As REITs are not permitted to derive revenues directly from
the operations of hotels, Host REIT leases substantially all of the hotels to
subsidiaries of Crestline Capital Corporation ("Crestline" or the "Lessee")
and certain other lessees as further discussed at Note 9.
As of December 31, 1998, Host REIT owned, or had controlling interests in,
126 upscale and luxury, full-service hotel lodging properties generally
located throughout the United States and operated primarily under the
Marriott, Ritz-Carlton, Four Seasons, Swissotel and Hyatt brand names. Most of
these properties are managed by Marriott International, Inc. ("Marriott
International"). Host REIT also has certain economic, non-voting interests in
certain Non-Controlled Subsidiaries, whose hotels are also managed by Marriott
International (see Note 4).
Basis of Presentation
On April 16, 1998, the Board of Directors of Host Marriott Corporation,
("Host Marriott"), a Delaware corporation and the predecessor to Host REIT,
approved a plan to reorganize Host Marriott's business operations through the
spin-off of Host Marriott's senior living business as part of Crestline and
the contribution of Host Marriott's hotels and certain other assets and
liabilities to a newly formed Delaware limited partnership, Host Marriott,
L.P. (the "Operating Partnership"). Host Marriott merged into HMC Merger
Corporation (the "Merger"), a newly formed Maryland corporation (renamed Host
Marriott Corporation) which intends to qualify, effective January 1, 1999, as
a real estate investment trust ("REIT") and is the sole general partner of the
Operating Partnership. Host Marriott's and its subsidiaries' contribution of
its hotels and certain assets and liabilities to the Operating Partnership and
its subsidiaries (the "Contribution") in exchange for units of partnership
interest in the Operating Partnership was accounted for at Host Marriott's
historical basis. As of December 31, 1998, Host REIT owned approximately 78%
of the Operating Partnership.
In these consolidated financial statements, the "Company" or "Host Marriott"
refers to Host Marriott Corporation, both before and after the Merger and its
conversion to a REIT (the "REIT Conversion").
On December 29, 1998, the Company completed the previously announced spin-
off of Crestline (see Note 2), through a taxable stock dividend to its
shareholders. Each Host Marriott shareholder of record on December 28, 1998
received one share of Crestline for every ten shares of Host Marriott common
stock owned (the "Distribution").
As a result of the Distribution, the Company's financial statements have
been restated to present the senior living communities' business results of
operations and cash flows as discontinued operations. See Note 2 for further
discussion of the Distribution. All historical financial statements presented
have been restated to conform to this presentation, with the historical assets
and liabilities of that segment presented on the balance sheet as Net
Investment in Discontinued Operations.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries and controlled affiliates. Investments in affiliates over
which the Company has the ability to exercise significant
61
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
influence, but does not control, are accounted for using the equity method.
All material intercompany transactions and balances have been eliminated.
Fiscal Year End Change
The U.S. Internal Revenue Code of 1986, as amended, requires REITs to file
their U.S. income tax return on a calendar year basis. Accordingly in 1998,
the Company changed its fiscal year-end to December 31 for both financial and
tax reporting requirements. Previously, the Company's fiscal year ended on the
Friday nearest to December 31. Fiscal year 1998 and 1997 included 52 weeks
compared to 53 weeks for fiscal year 1996.
Revenues and Expenses
Revenues primarily represent the gross sales generated by the Company's
hotel properties and net gains (losses) on property transactions. As discussed
below, the Company previously recorded only the house profit generated by the
Company's hotels as revenue. House profit is total hotel sales less certain
hotel property-level costs and expenses, which reflects the net revenues
flowing to the Company as the property owner.
On November 20, 1997, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board reached a consensus on EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." EITF 97-2 addresses the circumstances in which a
management entity may include the revenues and expenses of a managed entity in
its financial statements.
The Company considered the impact of EITF 97-2 on its financial statements
and determined that EITF 97-2 requires the Company to include property-level
sales and operating expenses of its hotels in its statements of operations.
The Company has given retroactive effect to the adoption of EITF 97-2 in the
accompanying consolidated statements of operations. Application of EITF 97-2
to the consolidated financial statements for the fiscal years ended December
31, 1998, January 2, 1998 and January 3, 1997 increased both revenues and
operating expenses by approximately $2.1 billion, $1.7 billion and $1.2
billion, respectively, and had no impact on operating profit, net income
(loss) or earnings per share.
In prior years operations for certain of the Company's hotels were recorded
from the beginning of December of the prior year to November of the current
year due to a one-month delay in receiving results from those hotel
properties. Upon conversion to a REIT, all operations are required to be
reported on a calendar year basis in accordance with Federal income tax
regulations. As a result, the Company has recorded one additional period of
operations in fiscal year 1998 for these properties. The effect on revenues
and net income was to increase revenues by $44 million and net income by $6
million and diluted earnings per share by $.02.
Earnings (Loss) Per Common Share
Basic earnings per common share are computed by dividing net income by the
weighted average number of shares of common stock outstanding. Diluted
earnings per common share are computed by dividing net income by the weighted
average number of shares of common stock outstanding plus other dilutive
securities. Diluted earnings per common share has not been adjusted for the
impact of the Convertible Preferred Securities for 1997 and 1996 and for the
comprehensive stock plan and warrants for 1996 as they were anti-dilutive. In
December 1998, the Company declared the Special Dividend (Note 2) and, in
February 1999, the Company distributed 11.9 million shares to existing
shareholders in conjunction with the Special Dividend. The weighted average
number of common shares outstanding and the basic and diluted earnings per
share computations have been restated to reflect these shares as outstanding
for all periods presented.
62
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In February 1999, the Company issued 8.5 million shares in exchange for 8.5
million OP Units issued to certain limited partners in connection with the
Partnership Mergers (see Note 12) which are deemed outstanding at December 31,
1998.
A reconciliation of the number of shares utilized for the calculation of
diluted earnings per common share follows:
1998 1997 1996
----- ----- -----
Weighted average number of common shares outstanding...... 216.3 215.0 200.6
Assuming distribution of common shares granted under
comprehensive stock plan, less shares assumed purchased
at average market price.................................. 4.0 4.8 --
Assuming conversion of Convertible Preferred Securities... 35.8 -- --
Other..................................................... 0.3 0.3 --
----- ----- -----
Shares utilized for the calculation of diluted earnings
per share................................................ 256.4 220.1 200.6
===== ===== =====
A reconciliation of net income (loss) to earnings (loss) used for the
calculation of diluted earnings per common share follows:
1998 1997 1996
---- ---- ----
Net income (loss).......................................... $47 $ 50 $(13)
Dividends, net of tax benefit, assuming conversion of
Convertible Preferred Securities.......................... 22 -- --
--- ---- ----
Earnings used for the calculation of diluted earnings per
share..................................................... $69 $ 50 $(13)
=== ==== ====
International Operations
The consolidated statements of operations include the following amounts
related to non-U.S. subsidiaries and affiliates: revenues of $121 million,
$105 million and $49 million and income (loss) before income taxes of $7
million, ($9 million) and ($2 million) in 1998, 1997 and 1996, respectively.
Minority Interest
The 22% of the Operating Partnership equity owned by outside third parties
is presented as minority interest ($368 million as of December 31, 1998).
Minority interest also includes minority interests in consolidated investments
of the Operating Partnership of $147 million.
Property and Equipment
Property and equipment is recorded at cost. For newly developed properties,
cost includes interest, ground rent and real estate taxes incurred during
development and construction. Replacements and improvements are capitalized.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, generally 40 years for buildings and three to ten
years for furniture and equipment. Leasehold improvements are amortized over
the shorter of the lease term or the useful lives of the related assets.
Gains on sales of properties are recognized at the time of sale or deferred
to the extent required by generally accepted accounting principles. Deferred
gains are recognized as income in subsequent periods as conditions requiring
deferral are satisfied or expire without further cost to the Company.
63
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In cases where management is holding for sale particular hotel properties,
the Company assesses impairment based on whether the estimated sales price
less costs of disposal of each individual property to be sold is less than the
net book value. A property is considered to be held for sale when the Company
has made the decision to dispose of the property. Otherwise, the Company
assesses impairment of its real estate properties based on whether it is
probable that undiscounted future cash flows from each individual property
will be less than its net book value. If a property is impaired, its basis is
adjusted to its fair market value.
Deferred Charges
Financing costs related to long-term debt are deferred and amortized over
the remaining life of the debt.
Cash, Cash Equivalents and Short-term Marketable Securities
The Company considers all highly liquid investments with a maturity of 90
days or less at the date of purchase to be cash equivalents. Cash and cash
equivalents includes approximately $22 million and $115 million at December
31, 1998 and January 2, 1998, respectively, of cash related to certain
consolidated partnerships, the use of which is restricted generally for
partnership purposes to the extent it is not distributed to the partners.
Short-term marketable securities include investments with a maturity of 91
days to one year at the date of purchase. The Company's short-term marketable
securities represent investments in U.S. government agency notes and high
quality commercial paper. The short-term marketable securities are categorized
as available for sale and, as a result, are stated at fair market value.
Unrealized holding gains and losses are included as a separate component of
shareholders' equity until realized.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash, cash equivalents
and short-term marketable securities. The Company maintains cash and cash
equivalents and short-term marketable securities with various high credit-
quality financial institutions. The Company performs periodic evaluations of
the relative credit standing of these financial institutions and limits the
amount of credit exposure with any institution.
The Company is also subject to credit risk as a party to interest rate swap
agreements. The Company monitors the creditworthiness of its contracting
parties by evaluating credit exposure and referring to the ratings of widely
accepted credit rating services. The Standard and Poors' long-term debt
ratings for the contracting parties are AA-, AA- and BBB+. The Company is
exposed to credit loss in the event of non-performance by the contracting
party to the interest rate swap agreements; however, the Company does not
anticipate non-performance by any of the contracting parties.
In addition, on January 1, 1999, subsidiaries of Crestline became the
lessees of virtually all the hotels and, as such, their rent payments are the
primary source of the Company's future revenues. Rent payments are provided
from pools of hotels which are guaranteed by Crestline. For discussion of the
guarantee, see Note 9. However, management believes that due to Crestline's
substantial assets, net worth and ability to operate as a separate publicly
traded company, Crestline will have the financial stability and access to
capital necessary to meet the substantial obligations as lessee under the
leases.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
64
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
REIT Conversion Expenses
The Company has incurred certain costs related to the REIT Conversion. These
costs consist of professional fees, printing and filing costs, consent fees
and certain other related fees and are classified as REIT conversion expenses
on the consolidated statement of operations. As of December 31, 1998, $48
million of REIT Conversion expenses were accrued and included in accounts
payable and accrued expenses.
Interest Rate Swap Agreements
The Company has entered into a limited number of interest rate swap
agreements for non-trading purposes. The Company uses such agreements to fix
certain of its variable rate debt to a fixed rate basis. The interest rate
differential to be paid or received on interest rate swap agreements is
recognized as an adjustment to interest expense.
Other Comprehensive Income
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income" (SFAS 130) which establishes new rules for the reporting
and display of comprehensive income and its components. SFAS 130 requires
unrealized gains or losses on the Company's right to receive HM Services stock
(see Note 10) and foreign currency translation adjustments, to be included in
other comprehensive income. Prior year financial statements have been
reclassified to conform to the requirements of SFAS 130.
The components of total accumulated other comprehensive income in the
balance sheet are as follows (in millions):
1998 1997
---- ----
Net unrealized gains ............................................. 5 12
Foreign currency translation adjustment........................... (9) --
--- ---
Total accumulated other comprehensive income (loss)............... $(4) $12
=== ===
Application of New Accounting Standards
During 1996, the Company adopted Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation." In 1997, the
Company adopted SFAS No. 128, "Earnings Per Share;" SFAS No. 129, "Disclosure
of Information About Capital Structure" and SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information." The adoption of these
statements did not have a material effect on the Company's consolidated
financial statements and comprehensive income.
As discussed above, the Company has retroactively adopted EITF 97-2.
65
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." The Statement
establishes accounting and reporting standards requiring that derivative
instruments (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at its fair value. The Statement requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement and requires that a company must formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999. The Company has not determined the impact of SFAS No. 133, but
management does not believe it will be material.
The EITF reached a consensus in May 1998 on Issue 98-9, "Accounting for
Contingent Rents in Interim Financial Periods," which required a lessor to
defer recognition of contingent rental income in interim periods until the
specified target that triggers the contingent rental income is achieved. In
November 1998, EITF 98-9 was rescinded; however, the impact of the accounting
principles outlined in EITF 98-9 must continue to be disclosed in quarterly
financial statements. The Company's accounting policy is to recognize rental
income based on an estimate of full-year rental income and disclose in the
footnotes to the financial statements the portion of rental income that is
contingent.
2. Distribution and Special Dividend
In December 1998, the Company distributed to its shareholders through a
taxable distribution the outstanding shares of common stock of Crestline (the
"Distribution"), formerly a wholly owned subsidiary of the Company, which, as
of the date of the Distribution, owned and operated the Company's senior
living communities, owned certain other assets and held leasehold interests in
substantially all of the Company's hotels. The Distribution provided Company
shareholders with one share of Crestline common stock for every ten shares of
Company common stock held by such shareholders on the record date of December
28, 1998. As a result of the Distribution, the Company's financial statements
have been restated to present the senior living communities' business results
of operations and cash flows as discontinued operations. Revenues for the
Company's discontinued operations totaled $241 million and $111 million in
1998 and 1997, respectively. The provision for loss on disposal includes
organizational and formation costs related to Crestline.
For purposes of governing certain of the ongoing relationships between the
Company and Crestline after the Distribution and to provide for an orderly
transition, the Company and Crestline entered into various agreements,
including a Distribution Agreement, an Employee Benefits Allocation Agreement
and a Tax Sharing Agreement. Effective as of December 29, 1998, these
agreements provide, among other things, for the division between the Company
and Crestline of certain assets and liabilities.
On December 18, 1998, the Board of Directors declared a special dividend
which entitled shareholders of record on December 28, 1998 to elect to receive
either $1.00 in cash or .087 of a share of common stock of the Company for
each outstanding share of the Company's common stock owned by such shareholder
on the record date (the "Special Dividend"). Cash totaling $69 million and
11.9 million shares of common stock that were elected in the Special Dividend
were paid and/or issued on February 10, 1999.
66
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Property and Equipment
Property and equipment consists of the following:
1998 1997
------ ------
(in millions)
Land and land improvements................................ $ 740 $ 418
Buildings and leasehold improvements...................... 6,613 4,329
Furniture and equipment................................... 740 686
Construction in progress.................................. 78 36
------ ------
8,171 5,469
Less accumulated depreciation and amortization............ (970) (835)
------ ------
$7,201 $4,634
====== ======
The detail of property and equipment above excludes net book value of the
discontinued senior living business of $583 million at January 2, 1998.
Interest cost capitalized in connection with the Company's development and
construction activities totaled $4 million in 1998, $1 million in 1997 and $3
million in 1996.
In 1997, the Company, through an agreement with the ground lessor of one of
its properties terminated its ground lease and recorded a $15 million loss on
the write-off of its investment, including certain transaction costs, which
has been included in net gains (losses) on property transactions in the
accompanying consolidated financial statements.
In 1996, the Company recorded a $4 million charge to write down an
undeveloped land parcel to its net realizable value based on its expected
sales value.
4. Investments in and Receivables from Affiliates
Investments in and receivables from affiliates consist of the following:
Ownership
Interests 1998 1997
--------- ------ ------
(in millions)
Equity investments
Rockledge Hotel Properties, Inc................... 95% $ 31 $ --
Fernwood Hotel Assets, Inc........................ 95% 2 --
Hotel partnerships(1)............................. 1%-50% -- 13
Notes and other receivables from affiliates, net.... -- 134 23
------ ------
$ 167 $ 36
====== ======
- --------
(1) During 1998, all or substantially all of the interests in the previously
unconsolidated hotel partnerships were consolidated or contributed to the
Non-Controlled Subsidiaries (defined herein) as a result of the REIT
Conversion and the Partnership Mergers.
In connection with the REIT Conversion, Rockledge Hotel Properties, Inc. and
Fernwood Hotel Assets, Inc. (together, the "Non-Controlled Subsidiaries") were
formed to own various assets of approximately $264 million contributed by the
Company to the Operating Partnership, the direct ownership of which by the
Company or the Operating Partnership could jeopardize the Company's status as
a REIT. These assets primarily consist of
67
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
partnership or other interests in hotels which are not leased and certain
furniture, fixtures and equipment ("FF&E") used in the hotels. In exchange for
the contribution of these assets to the Non-Controlled Subsidiaries, the
Operating Partnership received only non-voting common stock of the Non-
Controlled Subsidiaries, representing 95% of the total economic interests
therein. The Host Marriott Statutory Employee/Charitable Trust, the
beneficiaries of which are certain employees of the Company and the J.W.
Marriott Foundation concurrently acquired all of the voting common stock
representing the remaining 5% of the total economic interest. As a result, as
of December 31, 1998, the Company did not control the Non-Controlled
Subsidiaries. The Non-Controlled Subsidiaries own three full-service hotels
and interests in partnerships that own an additional two full-service hotels
and 220 limited-service hotels.
In connection with the REIT Conversion, the Company completed the
Partnership Mergers and, as a result, investments in affiliates in prior years
include earnings and assets, which are now consolidated. (See Note 12 for
discussion.)
In 1997, the Company acquired all of the outstanding interests in Chesapeake
Hotel Limited Partnership ("CHLP") that owns six hotels and acquired
controlling interests in four affiliated partnerships for approximately $550
million, including the assumption of approximately $410 million of debt. In
early 1998, the Company obtained a controlling interest in the partnership
that owns the 1,671-room Atlanta Marriott Marquis for approximately $239
million, including the assumption of $164 million of mortgage debt.
Receivables from affiliates are reported net of reserves of $7 million at
December 31, 1998 and $144 million at January 2, 1998. Net amounts funded by
the Company totaled $10 million in 1997, and repayments were $14 million in
1998 and $2 million in 1997. There were no fundings in 1998 and 1996.
The Company's pre-tax income from affiliates includes the following:
1998 1997 1996
------ ------ ----
(in millions)
Interest income......................................... $ 1 $ 11 $17
Equity in net income.................................... 1 5 3
------ ------ ---
$ 2 $ 16 $20
====== ====== ===
Combined summarized balance sheet information for the Company's affiliates
follows:
1998 1997
------ ------
(in millions)
Property and equipment, net............................. $1,656 $1,979
Other assets............................................ 258 283
------ ------
Total assets.......................................... $1,914 $2,262
====== ======
Debt, principally mortgages............................. $1,622 $2,179
Other liabilities....................................... 300 412
Partners' deficit....................................... (8) (329)
------ ------
Total liabilities and partners' deficit............... $1,914 $2,262
====== ======
68
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Combined summarized operating results for the Company's affiliates follow:
1998 1997 1996
------ ------ ------
(in millions)
Revenues............................................. $1,123 $1,393 $1,740
Operating expenses:
Cash charges (including interest).................. (930) (1,166) (1,469)
Depreciation and other non-cash charges............ (151) (190) (229)
------ ------ ------
Income before extraordinary items.................... 42 37 42
Extraordinary items--forgiveness of debt............. 4 40 12
------ ------ ------
Net income......................................... $ 46 $ 77 $ 54
====== ====== ======
5. Debt
Debt consists of the following:
1998 1997
------ ------
(in millions)
Series A senior notes, with a rate of 7 7/8% due August
2005........................................................ $ 500 $ --
Series B senior notes, with a rate of 7 7/8% due August
2008........................................................ 1,192 --
Series C senior notes, with a rate of 8.45% due December
2008........................................................ 498 --
Senior secured notes, with a rate of 9 1/2% due May 2005..... 21 600
Senior secured notes, with a rate of 8 7/8% due July 2007.... -- 600
Senior secured notes, with a rate of 9% due December 2007.... -- 350
Senior notes, with an average rate of 9 3/4% at December 31,
1998,
maturing through 2012....................................... 35 35
------ ------
Total senior notes......................................... 2,246 1,585
------ ------
Mortgage debt (non-recourse) secured by $3.3 billion of real
estate assets,
with an average rate of 7.77% at December 31, 1998, maturing
through
February 2023............................................... 2,438 1,762
Line of credit, terminated in August 1998.................... -- 22
------ ------
Total mortgage debt........................................ 2,438 1,784
------ ------
Line of credit, with a variable rate of Eurodollar plus 1.75%
(7.5% at
December 31, 1998).......................................... 350 --
Other notes, with an average rate of 7.39% at December 31,
1998, maturing through December 2017........................ 90 89
Capital lease obligations.................................... 7 8
------ ------
Total other................................................ 447 97
------ ------
$5,131 $3,466
====== ======
The detail above excludes $317 million of debt relating to the discontinued
senior living business in 1997.
On July 10, 1997, HMH Properties, Inc. ("Properties," an indirect wholly
owned subsidiary of Host Marriott) and HMC Acquisitions Properties, Inc.
("Acquisitions", an indirect, wholly owned subsidiary of Host Marriott)
completed consent solicitations (the "1997 Consent Solicitations") with
holders of their senior notes ($600 million of 9 1/2% senior notes due 2005
and $350 million of 9% senior notes due 2007) to amend
69
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
certain provisions of their senior indentures. The 1997 Consent Solicitations
facilitated the merger of Acquisitions with and into Properties. The
amendments to the indentures also increased the ability of Properties to
acquire, through certain subsidiaries, additional properties subject to non-
recourse indebtedness and controlling interests in corporations, partnerships
and other entities holding attractive properties and increased the threshold
required to permit Properties to make distributions to affiliates.
Concurrent with the 1997 Consent Solicitations and the Properties and
Acquisitions merger, Properties issued an aggregate of $600 million of 8 7/8%
senior notes at par with a maturity of July 2007. Properties received net
proceeds of approximately $570 million, net of the costs of the 1997 Consent
Solicitations and the offering.
In conjunction with the REIT Conversion, Properties was merged with the
Operating Partnership and all of the debt of Host Marriott and Properties was
assumed by the Operating Partnership.
During 1997, the Company, through its wholly owned subsidiary, HMC Capital
Resources Corporation ("Resources"), entered into a credit facility (the "Old
Credit Facility") with a group of commercial banks under which it could borrow
up to $500 million for the acquisition of lodging real estate and for the
Company's working capital purposes. During August 1998, the Old Credit
Facility was terminated.
The Company also purchased 100% of the outstanding bonds secured by a first
mortgage on the San Francisco Marriott in 1997. The Company purchased the
bonds for $219 million, an $11 million discount to the face value of $230
million. In connection with the redemption and defeasance of the bonds, the
Company recognized an extraordinary gain of $5 million, which represents the
$11 million discount less the write-off of unamortized deferred financing
fees, net of taxes. In 1997, the Company also incurred approximately $418
million of mortgage debt in conjunction with the acquisition of 11 hotels.
In connection with the acquisition of the outstanding common stock of Forum
Group, Inc. (the "Forum Group") in June 1997, the Company assumed debt of
approximately $270 million. In 1997, an additional $33 million of debt
financing was provided by Marriott International. The Company also assumed
approximately $15 million of debt in conjunction with the acquisition of the
Leisure Park retirement community in 1997. As a result of the Distribution,
the debt related to the Forum Group and Leisure Park retirement community is
included in net investments of discontinued operations for 1997 (Note 2). The
Company continues to provide a guarantee on the Leisure Park debt.
In the fourth quarter of 1996, the Company repaid the $109 million mortgage
on the Philadelphia Marriott. In the first quarter of 1997, the Company
obtained $90 million in first mortgage financing from two insurance companies
secured by the Philadelphia Marriott. The mortgage bears interest at a fixed
rate of 8.49% and matures in April 2009.
In December 1997, the Company successfully completed the refinancing of the
MHP (defined herein) mortgage debt for approximately $152 million. The new
mortgage bears interest at 7.48% and matures in January 2008. In connection
with the refinancing, the Company recognized an extraordinary loss of $2
million which represents payment of a prepayment penalty and the write-off of
unamortized deferred financing fees, net of taxes.
On April 20, 1998, the Company and certain of its subsidiaries filed a shelf
registration on Form S-3 (the "Shelf Registration") with the Securities and
Exchange Commission for the issuance of up to $2.5 billion in securities.
70
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
On August 5, 1998, the Company (through Properties) utilized the Shelf
Registration to issue an aggregate of $1.7 billion in new senior notes (the
"New Senior Notes"). The New Senior Notes were issued in two series, $500
million of 7 7/8% Series A notes due in 2005 and $1.2 billion of 7 7/8% Series
B notes due in 2008. The Company utilized the proceeds from the New Senior
Notes to purchase substantially all of its (i) $600 million in 9 1/2% senior
notes due 2005; (ii) $350 million in 9% senior notes due 2007; and (iii) $600
million in 8 7/8% senior notes due 2007 (collectively, the "Old Senior
Notes"). Approximately $21 million of the Old Senior Notes remain outstanding.
In connection with the purchase of substantially all of the Old Senior Notes,
the Company recorded a charge of approximately $148 million (net of income tax
benefit of $80 million) as an extraordinary item representing the amount paid
for bond premiums and consent fees, as well as the write-off of deferred
financing fees on the Old Senior Notes.
Concurrently with each offer to purchase, Properties successfully solicited
consents (the "1998 Consent Solicitations") from registered holders of the Old
Senior Notes to certain amendments to eliminate or modify substantially all of
the restrictive covenants and certain other provisions contained in the
indentures pursuant to which the Old Senior Notes were issued.
In conjunction with the issuance of the New Senior Notes, Properties entered
into a $1.25 billion credit facility (the "New Credit Facility") with a group
of commercial banks. The New Credit Facility has an initial three-year term
with two one-year extension options. Borrowings under the New Credit Facility
bear interest currently at the Eurodollar rate plus 1.75% (7.5% at December
31, 1998). The interest rate and commitment fee on the unused portion of the
New Credit Facility fluctuate based on certain financial ratios. The New
Senior Notes and the New Credit Facility were assumed by the Operating
Partnership in connection with the REIT Conversion. As of December 31, 1998,
$350 million was outstanding under the New Credit Facility.
The New Credit Facility and the indenture under which the New Senior Notes
were issued contain covenants restricting the ability of Properties and
certain of its subsidiaries to incur indebtedness, grant liens on their
assets, acquire or sell assets or make investments in other entities, and make
certain distributions to equityholders of Properties, the Company, and the
Operating Partnership. The New Credit Facility also contains certain financial
covenants relating to, among other things, maintaining certain levels of
tangible net worth and certain ratios of EBITDA to interest and fixed charges,
total debt to EBITDA, unencumbered assets to unsecured debt, and secured debt
to total debt. In connection with the REIT Conversion, Properties was merged
with, and into, the Operating Partnership in December 1998.
In December 1998, the Operating Partnership issued $500 million of 8.45%
Series C notes due in 2008 under the same indenture and with the same
covenants as the New Senior Notes. In February 1999, the Company issued $300
million of 8 3/8% Series D notes due in 2006. The debt was used to refinance,
or purchase, approximately $299 million of debt acquired in the Partnership
Mergers, and approximately $40 million of other mortgage debt.
In December 1998, the Company became party to eight interest rate swap
agreements in connection with the Blackstone Acquisition discussed in Note 12.
The notional amount of the agreements is approximately $365 million, with
expiration dates between August 2000 and August 2002. The Company receives
interest based on one month LIBOR (5.06% at December 31, 1998) and pays
interest at fixed rates ranging from 5.72% to 6.60%. The interest rate swap
agreements allow the Company to effectively eliminate the variability of the
interest rates on certain secured debt. The Company was party to an interest
rate swap agreement with a financial institution with an aggregate notional
amount of $100 million which expired in December 1998. In 1997, the Company
was party to two additional interest rate swap agreements with an aggregate
notional amount of $400 million which expired in May 1997. The Company
realized a net reduction of interest expense of $1 million in 1997 and $6
million in 1996 related to interest rate swap agreements. The reduction in
interest expense in 1998 was not material as the Company did not assume the
agreements until December 30.
71
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company's debt balance at December 31, 1998, includes $87 million of
debt that is recourse to the parent company. Aggregate debt maturities at
December 31, 1998 are (in millions):
1999.............................................................. $ 405
2000.............................................................. 206
2001.............................................................. 435
2002.............................................................. 430
2003.............................................................. 121
Thereafter........................................................ 3,523
------
5,120
Discount on senior notes.......................................... (10)
Interest rate swap agreements..................................... 14
Capital lease obligation.......................................... 7
------
$5,131
======
Cash paid for interest for continuing operations, net of amounts
capitalized, was $325 million in 1998, $278 million in 1997 and $220 million
in 1996. Deferred financing costs, which are included in other assets,
amounted to $98 million and $96 million, net of accumulated amortization, as
of December 31, 1998 and January 2, 1998, respectively. Amortization of
deferred financing costs totaled $10 million, $7 million and $5 million in
1998, 1997 and 1996, respectively.
6. Company-obligated Mandatorily Redeemable Convertible Preferred Securities
of a Subsidiary Trust Whose Sole Assets are the Convertible Subordinated
Debentures Due 2026
In December 1996, Host Marriott Financial Trust (the "Issuer"), a wholly-
owned subsidiary trust of the Company, issued 11 million shares of 6 3/4%
convertible quarterly income preferred securities (the "Convertible Preferred
Securities"), with a liquidation preference of $50 per share (for a total
liquidation amount of $550 million). The Convertible Preferred Securities
represent an undivided beneficial interest in the assets of the Issuer. The
payment of distributions out of moneys held by the Issuer and payments on
liquidation of the Issuer or the redemption of the Convertible Preferred
Securities are guaranteed by the Company to the extent the Issuer has funds
available therefor. This guarantee, when taken together with the Company's
obligations under the indenture pursuant to which the Debentures (defined
below) were issued, the Debentures, the Company's obligations under the Trust
Agreement and its obligations under the indenture to pay costs, expenses,
debts and liabilities of the Issuer (other than with respect to the
Convertible Preferred Securities) provides a full and unconditional guarantee
of amounts due on the Convertible Preferred Securities. Proceeds from the
issuance of the Convertible Preferred Securities were invested in 6 3/4%
Convertible Subordinated Debentures (the "Debentures") due December 2, 2026
issued by the Company. The Issuer exists solely to issue the Convertible
Preferred Securities and its own common securities (the "Common Securities")
and invest the proceeds therefrom in the Debentures, which is its sole asset.
Separate financial statements of the Issuer are not presented because of the
Company's guarantee described above; the Company's management has concluded
that such financial statements are not material to investors as the Issuer is
wholly-owned and essentially has no independent operations.
Each of the Convertible Preferred Securities is convertible at the option of
the holder into shares of Company common stock at the rate of 3.2537 shares
per Convertible Preferred Security (equivalent to a conversion price of
$15.367 per share of Company common stock). The Debentures are convertible at
the option of the holders into shares of Host Marriott common stock at a
conversion rate of 3.2537 shares for each $50 in
72
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
principal amount of Debentures. The Issuer will only convert Debentures
pursuant to a notice of conversion by a holder of Convertible Preferred
Securities. During 1998, 1997 and 1996, no shares were converted into common
stock. The conversion ratio and price were adjusted to reflect the impact of
the Distribution and the Special Dividend.
Holders of the Convertible Preferred Securities are entitled to receive
preferential cumulative cash distributions at an annual rate of 6 3/4%
accruing from the original issue date, commencing March 1, 1997, and payable
quarterly in arrears thereafter. The distribution rate and the distribution
and other payment dates for the Convertible Preferred Securities will
correspond to the interest rate and interest and other payment dates on the
Debentures. The Company may defer interest payments on the Debentures for a
period not to exceed 20 consecutive quarters. If interest payments on the
Debentures are deferred, so too are payments on the Convertible Preferred
Securities. Under this circumstance, the Company will not be permitted to
declare or pay any cash distributions with respect to its capital stock or
debt securities that rank pari passu with or junior to the Debentures.
Subject to certain restrictions, the Convertible Preferred Securities are
redeemable at the Issuer's option upon any redemption by the Company of the
Debentures after December 2, 1999. Upon repayment at maturity or as a result
of the acceleration of the Debentures upon the occurrence of a default, the
Convertible Preferred Securities are subject to mandatory redemption.
In connection with consummation of the REIT Conversion, the Operating
Partnership assumed primary liability for repayment of the Debentures of the
Company underlying the Convertible Preferred Securities. Upon conversion by a
Convertible Preferred Securities holder, the Company will issue shares of
Company common stock, which will be delivered to such holder. Upon the
issuance of such shares by the Company, the Operating Partnership will issue
to the Company a number of OP Units equal to the number of shares of Company
common stock issued in exchange for the Debentures.
7. Shareholders' Equity
Seven hundered fifty million shares of common stock, with a par value of
$0.01 per share, are authorized, of which 225.6 million and 203.8 million were
outstanding as of December 31, 1998 and January 2, 1998, respectively. Fifty
million shares of no par value preferred stock are authorized with none
outstanding.
In conjunction with the Merger, the Blackstone Acquisition and the
Partnership Mergers (Note 12), the Operating Partnership issued approximately
64.5 million OP Units which are convertible into cash (or at Host Marriott's
option shares of Host Marriott common stock). These OP Units are restricted
from converting until July 1999, October 1999 and January 2000 when 23.9
million, 11.9 million and 28.8 million units, respectively, are eligible for
conversion.
The Company issued 11.9 million shares of common stock as part of the
Special Dividend (Note 2) and 8.5 million shares of common stock in exchange
for 8.5 million OP Units issued to certain limited partners in connection with
the Partnership Mergers (Note 12). Also, as part of the REIT Conversion, the
Company changed its par value from $1 to $0.01 per share. The change in par
value did not affect the number of shares outstanding.
On March 27, 1996, the Company completed the issuance of 31.6 million shares
of common stock for net proceeds of nearly $400 million.
In connection with a class action settlement, the Company issued warrants to
purchase up to 7.7 million shares of the Company's common stock at $8.00 per
share through October 8, 1996 and $10.00 per share thereafter. During 1996,
6.8 million warrants were exercised at $8.00 per share and an equivalent
number of
73
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
shares of Company common stock were issued. During 1997 and 1998, 60,000 and
98,000 warrants were exercised at $10.00 per share. On October 8, 1998, the
remaining warrants expired.
In November 1998, the Board of Directors adopted a shareholder rights plan
(as amended December 24, 1998) under which a dividend of one preferred stock
purchase right was distributed for each outstanding share of the Company's
common stock. Each right when exercisable entitles the holder to buy 1/1,000th
of a share of a series A junior participating preferred stock of the Company
at an exercise price of $55 per share, subject to adjustment. The rights were
exercisable 10 days after a person or group acquired beneficial ownership of
at least 20%, or began a tender or exchange offer for at least 20%, of the
Company's common stock. Shares owned by a person or group on November 3, 1998
and held continuously thereafter were exempt for purposes of determining
beneficial ownership under the rights plan. The rights are non-voting and
expire on November 22, 2008, unless exercised or previously redeemed by the
Company for $.005 each. If the Company was involved in a merger or certain
other business combinations not approved by the Board of Directors, each right
entitles its holder, other than the acquiring person or group, to purchase
common stock of either the Company or the acquiror having a value of twice the
exercise price of the right.
8. Income Taxes
In December 1998, the Company restructured itself to enable the Company to
qualify for treatment as a REIT, pursuant to the US Internal Revenue Code of
1986, as amended, effective January 1, 1999. In general, a corporation that
elects REIT status and distributes at least 95% of its taxable income to its
shareholders and complies with certain other requirements (relating primarily
to the nature of its assets and the sources of its revenues) is not subject to
Federal income taxation to the extent it distributes its taxable income.
Management believes that the Company was organized and will operate so as to
qualify as a REIT as of January 1, 1999 (including distribution of at least
95% of its REIT taxable income to shareholders in 1999 and subsequent years).
Management expects that the Company will pay taxes on "built-in gains" on only
certain of its assets. Based on these considerations, management does not
believe that the Company will be liable for income taxes at the federal level
or in most of the states in which it operates in future years, and the Company
eliminated $106 million of its net existing deferred tax liabilities as of
December 31, 1998. The Company does not expect to provide for any material
deferred income taxes in future periods except in certain states and foreign
countries. In connection with the Distribution and formation of the Non-
Controlled Subsidiaries, the Company reduced deferred income tax liabilities
by $102 million.
In order to qualify as a REIT for federal income tax purposes, among other
things, the Company must have distributed all of the accumulated earnings and
profits ("E&P") of Host Marriott Corporation to its stockholders in one or
more taxable dividends prior to the end of the first full taxable year for
which the REIT election of the Company is effective, which currently is
expected to be the taxable year commencing January 1, 1999.
74
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In an effort to help accomplish the requisite distributions of the
accumulated E&P, Host Marriott made an initial E&P distribution consisting of
approximately 20.4 million shares of Crestline valued at $297 million, $69
million in cash, and approximately 11.9 million shares of Host Marriott stock
valued at $143 million.
The actual amount of the initial E&P distribution was based, in part, upon
the estimated amount of accumulated E&P of Host Marriott as of the last day of
its taxable year. To the extent that the initial E&P distribution was not
sufficient to eliminate Host Marriott's accumulated E&P, Host Marriott will
make one or more additional taxable distributions to its stockholders (in the
form of cash or securities) prior to the last day of Host Marriott's first
full taxable year as a REIT.
Where required, deferred income taxes are accounted for using the asset and
liability method. Under this method, deferred income taxes are recognized for
temporary differences between the financial reporting bases of assets and
liabilities and their respective tax bases and for operating loss and tax
credit carryforwards based on enacted tax rates expected to be in effect when
such amounts are realized or settled. However, deferred tax assets are
recognized only to the extent that it is more likely than not that they will
be realized based on consideration of available evidence, including tax
planning strategies and other factors.
Total deferred tax assets and liabilities at December 31, 1998 and January
2, 1998 were as follows:
1998 1997
------- ------
(in millions)
Deferred tax assets..................................... $ 32 $ 159
Deferred tax liabilities................................ (129) (646)
------- ------
Net deferred income tax liability..................... $ (97) $ (487)
======= ======
The tax effect of each type of temporary difference and carryforward that
gives rise to a significant portion of deferred tax assets and liabilities as
of December 31, 1998 and January 2, 1998 follows:
1998 1997
------- ------
(in millions)
Investments in affiliates............................... $ -- $ (310)
Property and equipment.................................. -- (179)
Safe harbor lease investments........................... (24) (65)
Deferred tax gain....................................... (105) (92)
Reserves................................................ -- 103
Alternative minimum tax credit carryforwards............ 32 41
Other, net.............................................. -- 15
------- ------
Net deferred income tax liability..................... $ (97) $ (487)
======= ======
75
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The provision (benefit) for income taxes consists of:
1998 1997 1996
---- ---- ----
(in millions)
Current--Federal............................................ $116 $19 $(2)
--State.............................................. 27 4 3
--Foreign............................................ 4 3 3
---- --- ---
147 26 4
---- --- ---
Deferred--Federal........................................... (49) 8 2
--State............................................. (12) 2 (1)
---- --- ---
(61) 10 1
---- --- ---
$ 86 $36 $ 5
==== === ===
At December 31, 1998, the Company had approximately $32 million of
alternative minimum tax credit carryforwards available which do not expire.
Through 1997, the Company settled with the Internal Revenue Service ("IRS")
substantially all issues for tax years through 1993. The Company expects to
resolve any remaining issues with no material impact on the consolidated
financial statements. The Company made net payments to the IRS of
approximately $27 million, $10 million and $45 million in 1998, 1997 and 1996,
respectively, related to these settlements. Certain adjustments totaling
approximately $2 million in 1996 were made to the tax provision related to
those settlements.
A reconciliation of the statutory Federal tax rate to the Company's
effective income tax rate follows (excluding the impact of the change in tax
status):
1998 1997 1996
---- ---- -----
Statutory Federal tax rate.............................. 35.0% 35.0 % (35.0)%
State income taxes, net of Federal tax benefit.......... 5.8 4.9 21.7
Tax credits............................................. (1.7) (2.7) --
Additional tax on foreign source income................. 4.2 6.0 40.8
Tax contingencies....................................... -- -- 25.0
Permanent non-deductible REIT Conversion expenses....... 4.6 -- --
Other permanent items................................... 1.2 .1 9.0
Other, net.............................................. 0.3 .1 1.0
---- ---- -----
Effective income tax rate............................. 49.4% 43.4 % 62.5 %
==== ==== =====
Crestline and the Company entered into a tax sharing agreement (the "Tax
Sharing Agreement") which defines each party's rights and obligations with
respect to deficiencies and refunds of federal, state and other income or
franchise taxes relating to Crestline's business for taxable years prior to
the Distribution and with respect to certain tax attributes of Crestline after
the Distribution. The Company is responsible for filing consolidated returns
and paying taxes for periods through the date of the Distribution, and
Crestline is responsible for filing its returns and paying taxes for
subsequent periods.
Cash paid for income taxes, including IRS settlements, net of refunds
received, was $83 million in 1998, $56 million in 1997 and $40 million in
1996.
76
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Leases
As of January 1, 1999, the Company leases substantially all of its hotels to
subsidiaries of Crestline. Additionally, the Company also leases certain
property and equipment under non-cancellable operating and capital leases.
Hotel Leases. Due to current federal income tax law restrictions on a REIT's
ability to derive revenues directly from the operation of a hotel, the Company
leases its hotels (the "Leases") to one or more lessees (the "Lessees").
There generally is a separate Lessee for each hotel or group of hotels that
is owned by a separate subsidiary of the Company. The operating agreements for
such Lessees provide that the Crestline member of the Lessee has full control
over the management of the business of the Lessee, subject to blocking rights
by Marriott International, where it is the manager, over certain decisions by
virtue of its non-economic, limited voting interest in the lessee
subsidiaries. Each full-service hotel Lease has a fixed term generally ranging
from seven to ten years, subject to earlier termination upon the occurrence of
certain contingencies as defined in the Leases. Each Lease requires the Lessee
to pay 1) minimum rent in a fixed dollar amount per annum plus 2) to the
extent it exceeds minimum rent, percentage rent based upon specified
percentages of aggregate sales from the applicable hotel, including room
sales, food and beverage sales, and other income in excess of specified
thresholds. The amount of minimum rent and the percentage rent thresholds will
be adjusted each year based upon any increases in the Consumer Price Index and
the Employment Cost Index during the previous 10 months, as well as for
certain capital expenditures and casualty occurrences.
If the Company anticipates that the average tax basis of the Company's FF&E
and other personal property that are leased by any individual lessor entity
will exceed 15% of the aggregate average tax basis of the fixed assets in that
entity, then the Lessee would be obligated either to acquire such excess FF&E
from the Company or to cause a third party to purchase such FF&E. The Lessee
has agreed to give a right of first opportunity to a Non-Controlled Subsidiary
to acquire the excess FF&E and to lease the excess FF&E to the Lessee.
Each Lessee is responsible for paying all of the expenses of operating the
applicable hotel(s), including all personnel costs, utility costs and general
repair and maintenance of the hotel(s). The Lessee also is responsible for all
fees payable to the applicable manager, including base and incentive
management fees, chain services payments and franchise or system fees, with
respect to periods covered by the term of the Lease. Host Marriott also
remains liable under each management agreement.
The Company is responsible for paying real estate taxes, personal property
taxes (to the extent the Company owns the personal property), casualty
insurance on the structures, ground lease rent payments, required expenditures
for FF&E (including maintaining the FF&E reserve, to the extent such is
required by the applicable management agreement) and other capital
expenditures.
Crestline Guarantees
Crestline and certain of its subsidiaries entered into limited guarantees of
the Lease obligations of each Lessee. For each of four identified "pools" of
hotels (determined on the basis of the term of the particular Lease with all
leases having generally the same lease term placed in the same "pool"), the
cumulative limit of Crestline's guaranty obligation is the greater of 10% of
the aggregate rent payable for the immediately preceding fiscal year under all
Leases in the pool or 10% of the aggregate rent payable under all Leases in
the pool. For each pool, the subsidiary of Crestline that is the parent of the
Lessees in the pool (a "Pool Parent") also is a party to the guaranty of the
Lease obligations for that pool.
77
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The obligations of the Pool Parent under each guaranty is secured by all
funds received by the applicable Pool Parent from the hotels in the pool, and
the hotels in the pool are required to distribute their excess cash flow to
the Pool Parent for each accounting period, under certain conditions as
described by the guaranty.
In the event that Crestline's obligation under a guaranty is reduced to
zero, the applicable Pool Parent can elect to terminate its guaranty and the
pooling agreement for that pool by giving notice to the Operating Partnership.
In that event, subject to certain conditions, the Pool Parent's guaranty will
terminate six months after the effective date of such notice, subject to
reinstatement in certain limited circumstances.
The Operating Partnership sold the existing working capital to the
applicable Lessee upon the commencement of the Lease at a price equal to the
fair market value of such assets. The purchase price is represented by a note
evidencing a loan that bears interest at a rate of 5.12%. Interest accrued on
the working capital loan is due simultaneously with each periodic rent
payment, and the amount of each payment of interest is credited against such
rent payment. The principal amount of the working capital loan is payable upon
termination of the Lease. The Lessee can return the working capital in
satisfaction of the note. As of December 31, 1998, the note receivable from
Crestline for working capital was $95 million.
In the event the Company enters into an agreement to sell or otherwise
transfer any full-service hotel free and clear of the applicable Lease, the
Lessor must pay the Lessee a termination fee equal to the fair market value of
the Lessee's leasehold interest in the remaining term of the Lease using a
discount rate of 12%. Alternatively, the Lessor will be entitled to (i)
substitute a comparable hotel or hotels for any hotel that is sold or (ii)
sell the hotel subject to the Lease and certain conditions without being
required to pay a termination fee.
In the event that changes in the Federal income tax laws allow the Company,
or subsidiaries or affiliates of the Company, to directly operate the hotels
without jeopardizing the Company's status as a REIT, the Company will have the
right to terminate all, but not less than all, of the full-service and HPT
hotel Leases in return for paying the Lessees the fair market value of the
remaining terms of the full-service hotel Leases, valued in the same manner as
discussed above. The payment is payable in cash or, subject to certain
conditions, shares of the Company's common stock, at the election of the
Company. The rights of each Lessee will be expressly subordinated to
qualifying mortgage debt and any refinancing thereof.
The Company sold and leased back 37 of its Courtyard properties in 1995 and
an additional 16 Courtyard properties in 1996 to Hospitality Properties Trust
("HPT"). Additionally, in 1996, the Company sold and leased back 18 of its
Residence Inns to HPT. These leases, which are accounted for as operating
leases and are included in the table below, have initial terms expiring
through 2012 for the Courtyard properties and 2010 for the Residence Inn
properties, and are renewable at the option of the Company. Minimum rent
payments are $51 million annually for the Courtyard properties and $17 million
annually for the Residence Inn properties, and additional rent based upon
sales levels are payable to the owner under the terms of the leases.
In connection with the REIT Conversion, the Operating Partnership sublet the
HPT hotels (the "Subleases") to separate indirect sublessee subsidiaries of
Crestline ("Sublessee"), subject to the terms of the applicable HPT Lease.
The term of each Sublease expires simultaneously with the expiration of the
initial term of the HPT lease to which it relates and automatically renews for
the corresponding renewal term under the HPT lease, unless either the HPT
lessee (the "Sublessor") elects not to renew the HPT lease, or the Sublessee
elects not to renew the Sublease at the expiration of the initial term
provided, however, that neither party can elect to terminate fewer than all of
the Subleases in a particular pool of HPT hotels (one for Courtyard by
Marriott hotels and one for Residence Inn hotels). Rent under the Sublease
consists of the Minimum Rent payable under the HPT lease and an additional
percentage rent payable to the Sublessor. The percentage rent is sufficient to
cover the additional
78
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
rent due under the HPT lease, with any excess being retained by the Sublessor.
The rent payable under the Subleases is guaranteed by Crestline, up to a
maximum amount of $30 million which amount is allocated between the two pools
of HPT hotels.
A number of the Company's leased hotel properties also include long-term
ground leases for certain hotels, generally with multiple renewal options.
Certain leases contain provision for the payment of contingent rentals based
on a percentage of sales in excess of stipulated amounts. Future minimum
annual rental commitments for all non-cancelable leases for which the Company
is the lessee are as follows:
Capital Operating
Leases Leases
------- ---------
(in millions)
1999....................................................... $ 2 $ 119
2000....................................................... 1 116
2001....................................................... 1 111
2002....................................................... 1 106
2003....................................................... 1 102
Thereafter................................................. 4 1,292
--- ------
Total minimum lease payments............................... 10 $1,846
======
Less amount representing interest.......................... (3)
---
Present value of minimum lease payments.................. $ 7
===
Certain of the lease payments included in the table above relate to
facilities used in the Company's former restaurant business. Most leases
contain one or more renewal options, generally for five or 10-year periods.
Future rentals on leases have not been reduced by aggregate minimum sublease
rentals from restaurants and HPT subleases of $103 million and $915 million,
respectively, payable to the Company under non-cancellable subleases.
The aggregate minimum rental payments to be received by the Operating
Partnership under the hotel leases are $774 million in 1999 and will be
adjusted in future periods based on changes in the Consumer Price Index and
Employment Cost Index.
In conjunction with the refinancing of the mortgage of the New York Marriott
Marquis, the Company also renegotiated the terms of the ground lease. The
renegotiated ground lease provides for the payment of a percentage of the
hotel sales (3% in 1998, 4% in 1999 and 5% thereafter) through 2017, which is
to be used to amortize the existing deferred ground rent obligation of $116
million. The Company has the right to purchase the land under certain
circumstances.
The Company remains contingently liable at December 31, 1998 on certain
leases relating to divested non-lodging properties. Such contingent
liabilities aggregated $93 million at December 31, 1998. However, management
considers the likelihood of any substantial funding related to these leases to
be remote.
Rent expense consists of:
1998 1997 1996
---- ---- ----
(in millions)
Minimum rentals on operating leases........................... $104 $ 98 $83
Additional rentals based on sales............................. 26 20 16
---- ---- ---
$130 $118 $99
==== ==== ===
79
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Employee Stock Plans
At December 31, 1998, the Company maintained two stock-based compensation
plans, including the comprehensive stock plan (the "Comprehensive Plan"),
whereby the Company may award to participating employees (i) options to
purchase the Company's common stock, (ii) deferred shares of the Company's
common stock and (iii) restricted shares of the Company's common stock and the
employee stock purchase plan (the "Employee Stock Purchase Plan").
Total shares of common stock reserved and available for issuance under the
Comprehensive Plan at December 31, 1998 was 26.6 million.
Employee stock options may be granted to officers and key employees with an
exercise price not less than the fair market value of the common stock on the
date of grant. Non-qualified options generally expire up to 15 years after the
date of grant. Most options vest ratably over each of the first four years
following the date of the grant. In connection with the Marriott International
Distribution in 1993, the Company issued an equivalent number of Marriott
International options and adjusted the exercise prices of its options then
outstanding based on the relative trading prices of shares of the common stock
of the two companies.
In connection with the Host Marriott Services ("HM Services") spin-off in
1995, outstanding options held by current and former employees of the Company
were redenominated in both Company and HM Services stock and the exercise
prices of the options were adjusted based on the relative trading prices of
shares of the common stock of the two companies. Pursuant to the distribution
agreement between the Company and HM Services, the Company has the right to
receive up to 1.4 million shares of HM Services' common stock or an equivalent
cash value subsequent to exercise of the options held by certain former and
current employees of Marriott International. As of December 31, 1998, the
Company valued this right at approximately $9 million, which is included in
other assets.
Effective December 29, 1998, the Company adjusted the number of outstanding
stock options and the related exercise prices to maintain the intrinsic value
of the options to account for the Special Dividend and the Distribution. The
vesting provisions and option period of the original grant was retained. No
compensation expense was recorded by the Company as a result of these
adjustments. Employee optionholders that remained with the Company received
options only in the Company's stock and those employee optionholders that
became Crestline employees received Crestline options in exchange for the
Company's options.
The Company continues to account for expense under its plans according to
the provisions of Accounting Principle Board Opinion 25 and related
interpretations as permitted under SFAS No. 123. Consequently, no compensation
cost has been recognized for its fixed stock options under the Comprehensive
Plan and its Employee Stock Purchase Plan.
For purposes of the following disclosures required by SFAS No. 123, the fair
value of each option granted has been estimated on the date of grant using an
option-pricing model with the following weighted average assumptions used for
grants in 1997 and 1996, respectively: risk-free interest rate of 6.2% and
6.6%, respectively, volatility of 35% and 36%, respectively, expected lives of
12 years and no dividend yield. The weighted average fair value per option
granted during the year was $13.13 in 1997 and $8.68 in 1996. No options were
granted in 1998. Pro forma compensation cost for 1998, 1997 and 1996 would
have reduced (increased) net income (loss) by approximately $524,000, $330,000
and ($150,000), respectively. Basic and diluted earnings per share on a pro
forma basis were not impacted by the pro forma compensation cost in 1998, 1997
and 1996.
The effects of the implementation of SFAS No. 123 are not representative of
the effects on reported net income in future years because only the effects of
stock option awards granted in 1996 and 1997 have been considered.
80
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
A summary of the status of the Company's stock option plan for 1998, 1997
and 1996 follows:
1998 1997 1996
---------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
(in millions) Exercise Price (in millions) Exercise Price (in millions) Exercise Price
------------- -------------- ------------- -------------- ------------- --------------
Balance, at beginning of
year................... 6.8 $ 4 8.3 $ 4 10.0 $ 4
Granted................. -- -- .1 20 .2 13
Exercised............... (1.3) 5 (1.6) 4 (1.9) 4
Forfeited/Expired....... (0.6) 4 -- -- -- --
Adjustment for
Distribution and
Special Dividend....... 0.7 3 -- -- -- --
---- ---- ----
Balance, at end of
year................... 5.6 3 6.8 4 8.3 4
==== ==== ====
Options exercisable at
year-end............... 5.5 6.4 7.6
==== ==== ====
The following table summarizes information about stock options at December
31, 1998:
Options Outstanding Options Exercisable
---------------------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Shares Contractual Exercise Shares Exercise
Range of Exercise Prices (in millions) Life Price (in millions) Price
------------------------ ------------- ----------- -------- ------------- --------
$ 1 - 3 4.1 8 $ 2 4.1 $ 2
4 - 6 0.8 6 5 0.8 5
7 - 9 0.4 11 8 0.4 8
10 - 12 0.1 12 10 0.1 10
13 - 15 0.1 13 13 0.1 13
19 - 22 0.1 14 18 -- --
--- ---
5.6 5.5
=== ===
Deferred stock incentive plan shares granted to officers and key employees
after 1990 generally vest over 10 years in annual installments commencing one
year after the date of grant. Certain employees may elect to defer payments
until termination or retirement. The Company accrues compensation expense for
the fair market value of the shares on the date of grant, less estimated
forfeitures. In 1998, 1997 and 1996, 12,000, 14,000 and 13,000 shares were
granted, respectively, under this plan. The compensation cost that has been
charged against income for deferred stock was not material in 1998, 1997 and
1996. The weighted average fair value per share granted during each year was
$19.21 in 1998, $15.81 in 1997 and $11.81 in 1996.
The Company from time to time awards restricted stock plan shares under the
Comprehensive Plan to officers and key executives to be distributed over the
next three to 10 years in annual installments based on continued employment
and the attainment of certain performance criteria. The Company recognizes
compensation expense over the restriction period equal to the fair market
value of the shares on the date of issuance adjusted for forfeitures, and
where appropriate, the level of attainment of performance criteria and
fluctuations in the fair market value of the Company's common stock. In 1998,
1997 and 1996, 2,900, 198,000 and 2,511,000 shares of additional restricted
stock plan shares were granted to certain key employees under these terms and
conditions. Approximately 16,842 and 161,000 shares were forfeited in 1998 and
1996, respectively. There were no shares forfeited in 1997. The Company
recorded compensation expense of $11 million, $13 million and $11 million in
1998, 1997 and 1996, respectively, related to these awards. The weighted
average fair value per share granted during each year was $18.13 in 1998,
$16.88 in 1997 and $14.01 in 1996. Under these awards 925,000 shares were
outstanding at December 31, 1998. The Board has voted to approve 3,199,000
shares for award in 1999 under similar terms.
81
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In 1998, 568,408 stock appreciation rights ("SARs") were issued under the
Comprehensive Plan to certain directors of the Company as a replacement for
previously issued options that were cancelled during the year. The conversion
to SARs was completed in order to comply with ownership limits applicable to
the Company upon conversion to a REIT. The SARs are fully vested and the grant
prices range from $1.20 to $5.13. In 1998, the Company recognized compensation
expense of $4.8 million related to this grant. Additionally, in future
periods, the Company will recognize compensation expense for outstanding SARs
as a result of fluctuations in the market price of the Company's common stock.
Under the terms of the Employee Stock Purchase Plan, eligible employees may
purchase common stock through payroll deductions at 90% of the lower of market
value at the beginning or market value at the end of the plan year.
11. Profit Sharing and Postemployment Benefit Plans
The Company contributes to profit sharing and other defined contribution
plans for the benefit of employees meeting certain eligibility requirements
and electing participation in the plans. The amount to be matched by the
Company is determined annually by the Board of Directors. The Company provides
medical benefits to a limited number of retired employees meeting restrictive
eligibility requirements. Amounts for these items were not material in 1996
through 1998.
12. Acquisitions and Dispositions
The Company acquired or gained controlling interest in 36 hotels with 15,166
rooms in 1998, 18 hotels with 9,128 rooms in 1997 and 24 hotels with 11,385
rooms in 1996. The Company has also disposed of a number of hotels, including
two hotels since 1997 and one subsequent to year-end 1998. Twenty-five of the
1998 acquisitions, consisting of the Blackstone Acquisition and the
Partnership Mergers, were completed on December 30, 1998 in conjunction with
the REIT Conversion. Additionally, three full-service properties were
contributed to one of the Non-Controlled Subsidiaries (Note 4). Each of these
transactions is discussed separately below.
1998 Acquisitions. In January 1998, the Company acquired an additional
interest in Atlanta Marriott Marquis II Limited Partnership, which owns an
interest in the 1,671-room Atlanta Marriott Marquis Hotel, for $239 million,
including the assumption of $164 million of mortgage debt. The Company
previously owned a 1.3% general and limited partnership interest. In March
1998, the Company acquired a controlling interest in a partnership that owns
three hotels: the 359-room Albany Marriott, the 350-room San Diego Marriott
Mission Valley and the 320-room Minneapolis Marriott Southwest for
approximately $50 million. In the second quarter of 1998, the Company acquired
the partnership that owns the 289-room Park Ridge Marriott in Park Ridge, New
Jersey for $24 million. The Company previously owned a 1% managing general
partner interest and a note receivable interest in such partnership. In
addition, the Company acquired the 281-room Ritz-Carlton, Phoenix for $75
million, the 397-room Ritz-Carlton in Tysons Corner, Virginia for $96 million
and the 487-room Torrance Marriott near Los Angeles, California for $52
million. In the third quarter of 1998, the Company acquired the 308-room Ritz-
Carlton, Dearborn for $65 million, the 336-room Ritz-Carlton, San Francisco
for $161 million and the 404-room Memphis Crowne Plaza (which was converted to
the Marriott brand upon acquisition) for $16 million.
Blackstone Acquisition. In December 1998, the Company completed the
acquisition of, or controlling interests in, twelve hotels and one mortgage
loan secured by an additional hotel (the "Blackstone Acquisition") from the
Blackstone Group, a Delaware limited partnership, and a series of funds
controlled by affiliates of Blackstone Real Estate Partners (together, the
"Blackstone Entities"). In addition, the Company acquired a 25% interest in
Swissotel Management (USA) L.L.C., which operates five Swissotel hotels in the
United States, from
82
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the Blackstone Entities, which the Company transferred to Crestline in
connection with the Distribution. The Operating Partnership issued
approximately 43.9 million OP Units, which OP Units are redeemable for cash
(or at Host Marriott's option, shares of common stock of Host Marriott)
assumed debt and made cash payments totaling approximately $920 million and
distributed 1.4 million of the shares of Crestline common stock to the
Blackstone Entities. The actual number of OP Units to be issued to the
Blackstone Entities will fluctuate based upon certain adjustments to be
determined on March 31, 1999. Based on current stock prices, the Operating
Partnership will be required to issue to the Blackstone Entities approximately
3.7 million additional units in April 1999. The consideration received by the
Blackstone Entities was determined through negotiations between the Company
and Blackstone and was not based upon appraisals of the assets. Each OP Unit
is exchangeable for one share of the Company's common stock (or its cash
equivalent, at the Company's election). After all adjustments, the Blackstone
Entities will own approximately 16.4% of the outstanding OP Units of the
Operating Partnership.
At the closing of the Blackstone Acquisition, the hotels were leased to
subsidiaries of Crestline but will continue to be managed on behalf of the
Lessees under their existing management agreements.
Partnership Mergers. In December 1998, the Company announced the completion
of the Partnership Mergers which was the roll-up of eight public partnerships
and four private partnerships which own or control 28 properties, 13 of which
were already consolidated (the "Partnership Mergers"). The Operating
Partnership issued approximately 25 million OP Units to partners for their
interests valued at approximately $333 million. The eight public partnerships
that merged are: the Atlanta Marriott Marquis II, Limited Partnership
("Atlanta Marquis"); Desert Springs Marriott Limited Partnership ("Desert
Springs"); Hanover Marriott Limited Partnership ("Hanover"); Marriott
Diversified American Hotels, Limited Partnership ("MDAH"); Marriott Hotel
Properties, Limited Partnership ("MHP"); Marriott Hotel Properties II, Limited
Partnership ("MHP2"); Mutual Benefit Chicago Marriott Suite Hotel Partners,
Limited Partnership ("Chicago Suites") and Potomac Hotel Limited Partnership
("PHLP") (collectively, the "Public Partnerships"). The four private
partnerships in which all or controlling interests also were acquired include
privately-held ownership interests in the Atlanta Marriott Marquis; The Ritz-
Carlton, Naples; The Ritz-Carlton, Buckhead; the New York Marriott Marquis and
the Hartford Marriott (collectively, the "Private Partnerships"). The Company
had previously not consolidated three of the 12 partnerships. Those three
partnerships are: 1) MDAH, the owner of six full-service Marriott hotels; 2)
PHLP, the owner of eight Marriott hotels (two of which were previously
consolidated) and 3) Chicago Suites, the owner of the 256-room Marriott O'Hare
Suites. As a result of these transactions, the Company has increased its
ownership of most of the 28 properties to 100% while consolidating 13
additional hotels (4,445 rooms).
1998 Dispositions. In 1998, the Company sold the 662-room New York Marriott
East Side for approximately $191 million and recorded a pre-tax gain of
approximately $40 million. The Company also sold the 191-room Napa Valley
Marriott for approximately $21 million and recorded a pre-tax gain of
approximately $10 million.
1999 Dispositions. In February 1999, the Company sold the 479-room
Minneapolis/Bloomington Marriott for approximately $35 million and recorded a
pre-tax gain of approximately $13 million.
1997 Acquisitions. In 1997, the Company acquired eight full-service hotels
totaling 3,600 rooms for approximately $145 million. In addition, the Company
acquired controlling interests in nine full-service hotels totaling 5,024
rooms for approximately $621 million, including the assumption of
approximately $418 million of debt. The Company also completed the acquisition
of the 504-room New York Marriott Financial Center, after acquiring the
mortgage on the hotel for $101 million in late 1996.
83
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Also in 1997, the Company acquired the outstanding common stock of the Forum
Group from Marriott Senior Living Services. The Company purchased the Forum
Group portfolio of 29 senior living communities for approximately $460
million, including approximately $270 million in debt. The Company also
acquired 49% of the remaining 50% interest in the partnership which owned the
418-unit Leisure Park retirement community for approximately $23 million,
including the assumption of approximately $15 million of debt. The Company
contributed these assets in conjunction with the Distribution of Crestline.
1996 Acquisitions. In 1996, the Company acquired six full-service hotels
totaling 1,964 rooms for an aggregate purchase price of approximately $189
million. In addition, the Company acquired controlling interests in 17 full-
service hotels totaling 8,917 rooms for an aggregate purchase price of
approximately $1.1 billion, including the assumption of approximately $696
million of debt. The Company also purchased the first mortgage of the 504-room
New York Marriott Financial Center for approximately $101 million.
In the first and second quarters of 1996, the Company completed the sale and
leaseback of 16 of its Courtyard properties and 18 of its Residence Inn
properties for $349 million. The Company received net proceeds of
approximately $314 million and will receive approximately $35 million upon
expiration of the leases. A deferred gain of $45 million on the sale/leaseback
transactions is being amortized over the initial term of the leases.
The Company's summarized, unaudited consolidated pro forma results of
operations, assuming the above transactions occurred on January 3, 1997, are
as follows (in millions, except per share amounts):
1998 1997
------ ------
Revenues................................................... $4,220 $3,919
Income before extraordinary items.......................... 189 71
Net income (loss).......................................... 41 74
Basic earnings (loss) per common share:
Income before extraordinary items........................ .88 .33
Basic earnings (loss) per common share................... .19 .34
Diluted earnings (loss) per common share:
Income before extraordinary items........................ .83 .32
Diluted earnings (loss) per common share................. .25 .33
13. Fair Value of Financial Instruments
The fair values of certain financial assets and liabilities and other
financial instruments are shown below:
1998 1997
--------------- ---------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------ -------- ------
(in millions)
Financial assets
Short-term marketable securities.......... $ -- $ -- $ 354 $ 354
Receivables from affiliates............... 134 141 23 26
Notes receivable.......................... 69 69 29 46
Other..................................... 9 9 20 20
Financial liabilities
Debt, net of capital leases............... 5,110 5,125 3,458 3,493
Other financial instruments
Convertible Preferred Securities.......... 550 449 550 638
84
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Short-term marketable securities and receivable Convertible Preferred
Securities are valued based on quoted market prices. Receivables from
affiliates, notes and other financial assets are valued based on the expected
future cash flows discounted at risk-adjusted rates. Valuations for secured
debt are determined based on the expected future payments discounted at risk-
adjusted rates. The fair values of the New Credit Facility and other notes are
estimated to be equal to their carrying value. Senior notes are valued based
on quoted market prices.
The fair value of the liability related to the interest rate swap agreements
assumed in the Blackstone Acquisition was $14 million. The fair value is based
on the estimated amount the Company would pay or receive to terminate the swap
agreements. The aggregate notional amount of the agreements was $365 million
at December 31, 1998 and $100 million at January 2, 1998.
14. Marriott International Distribution and Relationship with Marriott
International
The Company and Marriott International (formerly a wholly owned subsidiary,
the common stock of which was distributed to the Company's shareholders on
October 8, 1993) have entered into various agreements in connection with the
Marriott International Distribution and thereafter which provide, among other
things, that (i) the majority of the Company's hotel lodging properties are
managed by Marriott International under agreements with initial terms of 15 to
20 years and which are subject to renewal at the option of Marriott
International for up to an additional 16 to 30 years (see Note 15); (ii) 13 of
the Company's full-service properties are operated under franchise agreements
with Marriott International with terms of 15 to 30 years; (iii) Marriott
International provided the Company with $92 million of financing at an average
rate of 9% in 1997 related to the Company's discontinued senior living
operations; (iv) the Company acquired 49% of Marriott International's 50%
interest in the Leisure Park retirement community in 1997 for $23 million,
including approximately $15 million of assumed debt; (v) Marriott
International guarantees the Company's performance in connection with certain
loans and other obligations ($70 million at December 31, 1998); (vi) the
Company borrowed and repaid $109 million of first mortgage financing for
construction of the Philadelphia Marriott (see Note 5); (vii) Marriott
International and the Company formed a joint venture and Marriott
International provided the Company with $29 million in debt financing at an
average interest rate of 12.7% and $28 million in preferred equity in 1996 for
the acquisition of two full-service properties in Mexico City, Mexico; and
(viii) Marriott International provides certain limited administrative
services.
In 1998, 1997 and 1996, the Company paid to Marriott International $196
million, $162 million and $101 million, respectively, in hotel management
fees; $4 million, $13 million and $18 million, respectively, in interest and
commitment fees under the debt financing and line of credit provided by
Marriott International, and $3 million, $3 million and $4 million,
respectively, for limited administrative services. The Company also paid
Marriott International $9 million, $4 million and $2 million, respectively, of
franchise fees in 1998, 1997 and 1996. In connection with the discontinued
senior living communities' business, the Company paid Marriott International
$13 million and $6 million in management fees during 1998 and 1997,
respectively.
Additionally, Marriott International has the right to purchase up to 20% of
the voting stock of the Company if certain events involving a change in
control of the Company occur.
15. Hotel Management Agreements
Most of the Company's hotels are subject to management agreements (the
"Agreements") under which Marriott International manages the Company's hotels,
generally for an initial term of 15 to 20 years with renewal terms at the
option of Marriott International of up to an additional 16 to 30 years. The
Agreements generally provide for payment of base management fees equal to one
to four percent of sales and incentive management
85
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
fees generally equal to 20% to 50% of Operating Profit (as defined in the
Agreements) over a priority return (as defined) to the Company, with total
incentive management fees not to exceed 20% of cumulative Operating Profit, or
20% of current year Operating Profit. In the event of early termination of the
Agreements, Marriott International will receive additional fees based on the
unexpired term and expected future base and incentive management fees. The
Company has the option to terminate certain management agreements if specified
performance thresholds are not satisfied. No agreement with respect to a
single lodging facility is cross-collateralized or cross-defaulted to any
other agreement and a single agreement may be canceled under certain
conditions, although such cancellation will not trigger the cancellation of
any other agreement.
As a result of the REIT Conversion, all fees payable under the Agreements
for subsequent periods are the primary obligations of the Lessees. The
obligations of the Lessees are guaranteed to a limited extent by Crestline.
The Company remains obligated to the managers in case the Lessee fails to pay
these fees (but it would be entitled to reimbursement from the Lessee under
the terms of the Leases).
Pursuant to the terms of the Agreements, Marriott International is required
to furnish the hotels with certain services ("Chain Services") which are
generally provided on a central or regional basis to all hotels in the
Marriott International hotel system. Chain Services include central training,
advertising and promotion, a national reservation system, computerized payroll
and accounting services, and such additional services as needed which may be
more efficiently performed on a centralized basis. Costs and expenses incurred
in providing such services are allocated among all domestic hotels managed,
owned or leased by Marriott International or its subsidiaries. In addition,
the Company's hotels also participate in the Marriott Rewards program. The
cost of this program is charged to all hotels in the Marriott hotel system.
Crestline, as the Company's Lessee, is obligated to provide the manager with
sufficient funds to cover the cost of (a) certain non-routine repairs and
maintenance to the hotels which are normally capitalized; and (b) replacements
and renewals to the hotels' property and improvements. Under certain
circumstances, Crestline will be required to establish escrow accounts for
such purposes under terms outlined in the Agreements.
Crestline assumed franchise agreements with Marriott International for 10
hotels. Pursuant to these franchise agreements, Crestline generally pays a
franchise fee based on a percentage of room sales and food and beverage sales
as well as certain other fees for advertising and reservations. Franchise fees
for room sales vary from four to six percent of sales, while fees for food and
beverage sales vary from two to three percent of sales. The terms of the
franchise agreements are from 15 to 30 years.
Crestline assumed management agreements with The Ritz-Carlton Hotel Company,
LLC ("Ritz-Carlton"), an affiliate of Marriott International, to manage ten of
the Company's hotels. These agreements have an initial term of 15 to 25 years
with renewal terms at the option of Ritz-Carlton of up to an additional 10 to
40 years. Base management fees vary from two to five percent of sales and
incentive management fees are generally equal to 20% of available cash flow or
operating profit, as defined in the agreements.
Crestline also assumed management agreements with hotel management companies
other than Marriott International and Ritz-Carlton for 23 of the Company's
hotels (10 of which are franchised under the Marriott brand). These agreements
generally provide for an initial term of 10 to 20 years with renewal terms at
the option of either party or, in some cases, the hotel management company of
up to an additional one to 15 years. The agreements generally provide for
payment of base management fees equal to one to four percent of sales.
Seventeen of the 23 agreements also provide for incentive management fees
generally equal to 10 to 25 percent of available cash flow, operating profit,
or net operating income, as defined in the agreements.
86
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
16. Relationship with Crestline Capital Corporation
The Company and Crestline have entered into various agreements in connection
with the Distribution as discussed in Note 2 and further outlined below.
Distribution Agreement
Crestline and the Company entered into a distribution agreement (the
"Distribution Agreement"), which provided for, among other things, (i) the
distribution of shares of Crestline in connection with the Distribution; (ii)
the division between Crestline and the Company of certain assets and
liabilities; (iii) the transfer to Crestline of the 25% interest in the
Swissotel management company acquired in the Blackstone Acquisition and (iv)
certain other agreements governing the relationship between Crestline and the
Company following the Distribution. Crestline also granted the Company a
contingent right to purchase Crestline's interest in Swissotel Management
(USA) L.L.C. at fair market value in the event the tax laws are changed so
that the Company could own such interest without jeopardizing its status as a
REIT.
Subject to certain exceptions, the Distribution Agreement provides for,
among other things, assumptions of liabilities and cross-indemnities designed
to allocate to Crestline, effective as of the date of the Distribution,
financial responsibilities for liabilities arising out of, or in connection
with, the business of the senior living communities.
Asset Management Agreement
The Company and the Non-Controlled Subsidiaries entered into asset
management agreements (the "Asset Management Agreements") with Crestline
whereby Crestline agrees to provide advice on the operation of the hotels and
review financial results, projections, loan documents and hotel management
agreements. Crestline also agrees to consult on market conditions and
competition, as well as monitor and negotiate with governmental agencies,
insurance companies and contractors. Crestline will be paid a fee not to
exceed $4.5 million for each calendar year for its consulting services under
the Asset Management Agreements, which includes $0.25 million related to the
Non-Controlled Subsidiaries. The Asset Management Agreements each have terms
of two years with an automatic one year renewal, unless earlier terminated by
either party in accordance with the terms thereof.
Non-Competition Agreement
Crestline and the Company entered into a non-competition agreement that
limits the respective parties' future business opportunities. Pursuant to this
non-competition agreement, Crestline agrees, among other things, that until
the earlier of December 31, 2008, or the date on which it is no longer a
Lessee of more than 25% of the number of hotels owned by the Company at the
time of the Distribution, it will not own any full service hotel, manage any
limited service or full service hotel owned by the Company, or own or operate
a full service hotel franchise system operating under a common name brand,
subject to certain exceptions. In addition, the Company agrees not to
participate in the business of leasing, operating or franchising limited
service or full service properties, subject to certain exceptions.
1998 Employee Benefits and Other Employment Matters Allocation Agreement
As part of the REIT Conversion, the Company, the Operating Partnership and
Crestline entered into the 1998 Employee Benefits Allocation Agreement
relating to various compensation, benefits and labor matters. Under the
agreement, the Operating Partnership and Crestline each assumed certain
liabilities related to covered benefits and labor matters arising prior to the
effective date of the Distribution and relating to employees of
87
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
each organization, respectively, after the Distribution. The agreements also
govern the treatment of awards under the Comprehensive Plan and requires the
adoption of such a plan by Crestline and the Operating Partnership.
17. Litigation
The Company is and from time-to-time will be the subject of, or involved in,
judicial proceedings. Management believes that any liability or loss resulting
from such matters will not have a material adverse effect on the financial
position or results of operations of the Company.
In the fourth quarter of 1997, the Company reached a settlement in a lawsuit
against Trinity Industries and others for claims related to construction of
the New York Marriott Marquis. In settlement of the lawsuit, the Company and
its affiliate received a cash settlement of approximately $70 million, the
majority of which was considered a recovery of construction costs and $10
million of which has been recorded as other revenues in the accompanying
consolidated financial statements.
18. Geographic and Business Segment Information
The Company operates one business segment, hotel ownership. The Company's
hotels are primarily operated under the Marriott or Ritz-Carlton brands,
contain an average of nearly 465 rooms, as well as supply other amenities such
as meeting space and banquet facilities; a variety of restaurants and lounges;
gift shops and swimming pools. They are typically located in downtown,
airport, suburban and resort areas throughout the United States.
The Company evaluates the performance of its segment based primarily on
operating profit before depreciation, corporate expenses, and interest
expense. The Company's income taxes are included in the consolidated Federal
income tax return of the Company and its affiliates and is allocated based
upon the relative contribution to the Company's consolidated taxable
income/loss and changes in temporary differences. The allocation of taxes is
not evaluated at the segment level and, therefore, the Company does not
believe the information is material to the consolidated financial statements.
88
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following table presents revenues and other financial information
excluding amounts related to the Company's discontinued senior living business
(in millions):
1998
-----------------------------
Corporate
Hotels & Other Consolidated
------ --------- ------------
Revenues.......................................... $3,492 $ 21 $3,513
Operating profit ................................. 618 43 661
Interest expense.................................. 328 7 335
Interest income................................... 37 14 51
Depreciation and amortization..................... 238 5 243
Capital expenditures.............................. 247 5 252
Total assets...................................... 7,908 360 8,268
1997
-----------------------------
Corporate
Hotels & Other Consolidated
------ --------- ------------
Revenues.......................................... $2,806 $ 17 $2,823
Operating profit (loss)........................... 444 (12) 432
Interest expense.................................. 281 7 288
Interest income................................... 40 12 52
Depreciation and amortization..................... 226 5 231
Capital expenditures.............................. 154 4 158
Total assets...................................... 5,789 116 5,905
1996
-----------------------------
Corporate
Hotels & Other Consolidated
------ --------- ------------
Revenues.......................................... $1,942 $ 15 $1,957
Operating profit (loss)........................... 256 (23) 233
Interest expense.................................. 228 9 237
Interest income................................... 31 17 48
Depreciation and amortization..................... 165 3 168
Capital expenditures.............................. 156 3 159
Total assets...................................... 4,770 382 5,152
During most of 1998, the Company's foreign operations consisted of six full-
service hotel properties located in Mexico and Canada. As of December 31,
1998, the Company's foreign operations had decreased to four Canadian hotel
properties, as the hotels in Mexico were contributed to Rockledge Hotel
Properties, Inc. There were no intercompany sales between the properties and
the Company. The following table presents revenues and long-lived assets for
each of the geographical areas in which the Company operates (in millions):
1998 1997 1996
------------------- ------------------- -------------------
Long-lived Long-lived Long-lived
Revenues Assets Revenues Assets Revenues Assets
-------- ---------- -------- ---------- -------- ----------
United States...... $3,392 $7,112 $2,718 $4,412 $1,908 $3,587
International...... 121 89 105 222 49 218
------ ------ ------ ------ ------ ------
Total............. $3,513 $7,201 $2,823 $4,634 $1,957 $3,805
====== ====== ====== ====== ====== ======
The long-lived assets for 1997 exclude $583 million of assets related to the
discontinued senior living business.
89
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
19. Quarterly Financial Data (unaudited)
1998
--------------------------------------------------------
First Second Third Fourth Fiscal
Quarter Quarter Quarter Quarter Year
--------- --------- --------- ---------- ----------
(in millions, except per common share amounts)
Revenues.................. $ 791 $ 839 $ 745 $ 1,138 $ 3,513
Operating profit before
minority interest,
corporate expenses and
interest................. 147 208 111 195 661
Income from continuing
operations............... 28 62 2 102 194
Income before
extraordinary items...... 30 66 4 95 195
Net income (loss)......... 30 66 (144) 95 47
Basic earnings (loss) per
common share:
Income from continuing
operations............. .13 .29 .01 .47 .90
Income before
extraordinary items.... .14 .31 .02 .44 .91
Net income (loss)....... .14 .31 (.67) .44 .22
Diluted earnings (loss)
per common share:
Income from continuing
operations............. .13 .26 .01 .43 .84
Income before
extraordinary items.... .14 .28 .02 .40 .85
Net income (loss)....... .14 .28 (.65) .40 .27
1997
--------------------------------------------------------
First Second Third Fourth Fiscal
Quarter Quarter Quarter Quarter Year
--------- --------- --------- ---------- ----------
(in millions, except per common share amounts)
Revenues.................. $ 624 $ 643 $ 615 $ 941 $ 2,823
Operating profit before
minority interest,
corporate expenses and
interest................. 91 124 82 135 432
Income from continuing
operations............... 6 26 6 9 47
Income before
extraordinary items...... 6 26 6 9 47
Net income................ 11 26 6 7 50
Basic earnings per common
share:
Income from continuing
operations............. .03 .12 .03 .04 .22
Income before
extraordinary items.... .03 .12 .03 .04 .22
Net income.............. .05 .12 .03 .03 .23
Diluted earnings per
common share:
Income from continuing
operations............. .03 .12 .03 .04 .22
Income before
extraordinary items.... .03 .12 .03 .04 .22
Net income.............. .05 .12 .03 .03 .23
The quarterly data in the table above has been restated to reflect the
Company's senior living business as a discontinued operation and the impact of
the 1998 stock portion of the Special Dividend on earnings per share.
The first three quarters consist of 12 weeks each in both 1998 and 1997, and
the fourth quarter includes 16 weeks. The sum of the basic and diluted
earnings (loss) per common share for the four quarters in 1998 and 1997
differs from the annual earnings per common share due to the required method
of computing the weighted average number of shares in the respective periods.
90
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
The information called for by Items 10-13 is incorporated by reference from
our 1999 Annual Meeting of Shareholders Notice and Proxy Statement (to be
filed pursuant to Regulation 14A not later than 120 days after the close of
fiscal year).
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT
(i) FINANCIAL STATEMENTS
All financial statements of the registrant as set forth under Item 8 of
this Report on Form 10-K.
(ii)FINANCIAL STATEMENT SCHEDULES
The following financial information is filed herewith on the pages
indicated.
Financial Schedules:
Page
----------
III. Real Estate and Accumulated Depreciation.................. S-1 to S-2
All other schedules are omitted because they are not applicable or the
required information is included in the consolidated financial statements or
notes thereto.
(iii)EXHIBITS
Exhibit
No. Description
------- -----------
2.1 Agreement and Plan of Merger by and among Host Marriott Corporation,
HMC Merger Corporation and Host Marriott L.P. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 333-
64793).
3.3 Bylaws of Host Marriott Corporation dated September 28, 1998
(incorporated by reference to Host Marriott Corporation Registration
Statement No. 333-64793).
3.4 Articles of Amendment and Restatement of Articles of Incorporation of
Host Marriott Corporation (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
4.1 Form of Common Stock Certificate of Host Marriott Corporation
(incorporated by reference to Host Marriott Corporation Registration
Statement No. 333-55807).
91
Exhibit
No. Description
------- -----------
4.2 Guarantee Agreement, dated December 2, 1996, between Host Marriott
Corporation and IBJ Schroeder Bank & Trust Company, as Guarantee
Trustee (incorporated by reference to Exhibit 4.6 of Host Marriott
Corporation Registration Statement No. 333-19923).
4.3(i) Rights Agreement between Host Marriott Corporation and The Bank of
New York as Rights Agent dated as of November 23, 1998 (incorporated
by reference to Host Marriott Corporation Current Report on Form 8-K
dated November 23, 1998).
4.3(ii) Amendment No. 1 to Rights Agreement between Host Marriott
Corporation and The Bank of New York as Rights Agent dated as of
December 18, 1998 (incorporated by reference to Host Marriott
Corporation Current Report on Form 8-K dated December 18, 1998).
4.4 Indenture by and among HMC Acquisition Properties, Inc., as Issuer,
HMC SFO, Inc., as Subsidiary Guarantors, and Marine Midland Bank, as
Trustee (incorporated by reference to Host Marriott Corporation
Registration Statement No. 333-00768).
4.5 Indenture by and among HMH Properties, Inc., as Issuer, HMH
Courtyard Properties, Inc., HMC Retirement Properties, Inc.,
Marriott Financial Services, Inc., Marriott SBM Two Corporation, HMH
Pentagon Corporation and Host Airport Hotels, Inc., as Subsidiary
Guarantors, and Marine Midland Bank, as Trustee (incorporated by
reference to Host Marriott Corporation Registration Statement
33-95058).
4.6 Indenture by and among HMH Properties, Inc., as Issuer, and the
Subsidiary Guarantors named therein, and Marine Midland Bank, as
Trustee (incorporated by reference to Host Marriott Corporation
Current Report on Form 8-K dated August 6, 1998).
4.7 Indenture for the 6 3/4% Convertible Debentures, dated December 2,
1996, between Host Marriott Corporation and IBJ Schroeder Bank &
Trust Company, as Indenture Trustee (incorporated by reference to
Exhibit 4.3 of Host Marriott Corporation Registration Statement No.
333-19923).
4.8 Amended and Restated Trust Agreement, dated December 2, 1996, among
Host Marriott Corporation, IBJ Schroeder Bank & Trust Company, as
Property Trustee, Delaware Trust Capital Management, Inc., as
Delaware Trustee, and Robert E. Parsons, Jr., Bruce D. Wardinski and
Christopher G. Townsend, as Administrative Trustees (incorporated by
reference to Exhibit 4.2 of Host Marriott Corporation Registration
Statement No. 333-19923).
4.9 Amended and Restated Trust Agreement, dated as of December 29, 1998,
among HMC Merger Corporation, as Depositor, IBJ Schroder Bank &
Trust Company, as Property Trustee, Delaware Trust Capital
Management, Inc., as Delaware Trustee, and Robert E. Parsons, Jr.,
Ed Walter and Christopher G. Townsend, as Administrative Trustees.
10.1 Second Amended and Restated Agreement of Limited Partnership of Host
Marriott, L.P. (incorporated by reference to Exhibit 3.1 of Host
Marriott Corporation Registration Statement No. 333-55807).
10.2 Indenture between Host Marriott L.P., as Issuer, and Marine Midland
Bank, as Indenture Trustee, and Form of 6.56% Callable Note due
December 15, 2005 (incorporated by reference to Exhibit 4.1 of Host
Marriott Corporation Registration Statement No. 333-55807).
10.3 Amended and Restated Credit Agreement dated as of June 19, 1997 and
Amended and Restated as of August 5, 1998 among Host Marriott
Corporation, Host Marriott Hospitality, Inc., HMH Properties, Inc.,
Host Marriott, L.P., HMC Capital Resources Corp., Various Banks,
Wells Fargo Bank, National Association, The Bank of Nova Scotia and
Credit Lyonnais New York Branch, as Co-Arrangers, and Bankers Trust
Company as Arranger and Administrative Agent (incorporated by
reference to Host Marriott Corporation Current Report on Form 8-K
dated September 11, 1998).
10.4* First Amendment and Waiver of Amended and Restated Credit Agreement
dated as of June 19, 1997 and Amended and Restated as of August 5,
1998, among Host Marriott Corporation, Host Marriott Hospitality
Inc., HMH Properties, Inc., Host Marriott, L.P., HMC Capital
Resources Corp., Various Banks, Wells Fargo Bank, National
Association, The Bank of Nova Scotia and Credit Lyonnais New York
Branch, as Co-Arrangers and Bankers Trust Company as Arranger and
Administrative Agent dated as of November 25, 1998.
92
Exhibit
No. Description
------- -----------
10.5* Second Amendment and Consent to Credit Agreement of Amended and
Restated Credit Agreement dated as of June 19, 1997 and Amended and
Restated as of August 5, 1998, among Host Marriott Corporation, Host
Marriott Hospitality Inc., HMH Properties, Inc., Host Marriott, L.P.,
HMC Capital Resources Corp., Various Banks, Wells Fargo Bank, National
Association, The Bank of Nova Scotia and Credit Lyonnais New York
Branch, as Co-Arrangers and Bankers Trust Company as Arranger and
Administrative Agent dated as of December 17, 1998.
10.6* Third Amendment and Waiver to Credit Agreement Amended and Restated
Credit Agreement dated as of June 19, 1997 and Amended and Restated as
of August 5, 1998, among Host Marriott Corporation, Host Marriott
Hospitality Inc., HMH Properties, Inc., Host Marriott, L.P., HMC
Capital Resources Corp., Various Banks, Wells Fargo Bank, National
Association, The Bank of Nova Scotia and Credit Lyonnais New York
Branch, as Co-Arrangers and Bankers Trust Company as Arranger and
Administrative Agent dated as of March 15, 1999.
10.7* Host Marriott L.P. Executive Deferred Compensation Plan effective as
of December 29, 1998 (formerly the Marriott Corporation Executive
Deferred Compensation Plan).
10.8 Host Marriott Corporation 1997 Comprehensive Incentive Stock Plan
(incorporated by reference to Host Marriott Corporation's Proxy
Statement filed April 3, 1997).
10.9 Distribution Agreement dated as of September 15, 1993 between Marriott
Corporation and Marriott International, Inc. (incorporated by
reference from Host Marriott Corporation Current Report on Form 8-K
dated October 23, 1993).
10.10 Amendment No. 1 to the Distribution Agreement dated December 29, 1995
by and among Host Marriott Corporation, Host Marriott Services
Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Current Report on Form 8-K
dated January 16, 1996).
10.11 Amendment No. 2 to the Distribution Agreement dated June 21, 1997 by
and among Host Marriott Corporation, Host Marriott Services
Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 333-
64793).
10.12 Amendment No. 3 to the Distribution Agreement dated March 3, 1998 by
and among Host Marriott Corporation, Host Marriott Services
Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 333-
64793).
10.13 Amendment No. 4 to the Distribution Agreement by and among Host
Marriott Corporation and Marriott International Inc. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 333-
64793).
10.14* Amendment No. 5 to the Distribution Agreement dated December 18, 1998
by and among Host Marriott Corporation, Host Marriott Services
Corporation and Marriott International Inc.
10.15 Distribution Agreement dated December 22, 1995 by and between Host
Marriott Corporation and Host Marriott Services Corporation
(incorporated by reference to Host Marriott Corporation Current Report
on Form 8-K dated January 16, 1996).
10.16* Amendment to Distribution Agreement dated December 22, 1995 by and
between Host Marriott Corporation and Host Marriott Services
Corporation
10.17 Tax Sharing Agreement dated as of October 5, 1993 by and between
Marriott Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Current Report on Form 8-K
dated October 23, 1993).
93
Exhibit
No. Description
------- -----------
10.18* License Agreement dated as of December 29, 1998 by and among Host
Marriott Corporation, Host Marriott, L.P., Marriott International,
Inc. and Marriott Worldwide Corporation.
10.19* Noncompetition Agreement between Host Marriott Corporation, Host
Marriott, L.P. and Crestline Capital Corporation and other parties
named therein.
10.20 Tax Administration Agreement dated as of October 8, 1993 by and
between Marriott Corporation and Marriott International, Inc.
(incorporated by reference to Host Marriott Corporation Current Report
on Form 8-K dated October 23, 1993).
10.21 Restated Noncompetition Agreement dated March , 1998 by and among
Host Marriott Corporation, Marriott International, Inc. and Sodexho
Marriott Services, Inc. (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
10.22 First Amendment to Restated Noncompetition Agreement by and among Host
Marriott Corporation, Marriott International, Inc. and Sodexho
Marriott Services, Inc. (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
10.23 Host Marriott Lodging Management Agreement--Marriott Hotels, Resorts
and Hotels dated September 25, 1993 by and between Marriott
Corporation and Marriott International, Inc. (incorporated by
reference to Host Marriott Corporation Registration Statement No. 33-
51707).
10.24 Employee Benefits and Other Employment Matters Allocation Agreement
dated as of December 29, 1995 by and between Host Marriott Corporation
and Host Marriott Services Corporation (incorporated by reference to
Host Marriott Corporation Current Report on Form 8-K dated January 16,
1996).
10.25 Tax Sharing Agreement dated as of December 29, 1995 by and between
Host Marriott Corporation and Host Marriott Services Corporation
(incorporated by reference to Host Marriott Corporation Current Report
on Form 8-K dated January 16, 1996).
10.26* Host Marriott, L.P. Retirement and Savings Plan and Trust.
10.27 Contribution Agreement dated as of April 16, 1998 among Host Marriott
Corporation, Host Marriott, L.P. and the contributors named therein,
together with Exhibit B (incorporated by reference to Exhibit 10.18 of
Host Marriott Corporation Registration Statement No. 333-55807).
10.28 Amendment No. 1 to Contribution Agreement dated May 8, 1998 among
Marriott Corporation, Host Marriott, L.P. and the contributors named
therein (incorporated by reference to Exhibit 10.19 of Host Marriott
Corporation Registration Statement No. 333-55807).
10.29 Amendment No. 2 to Contribution Agreement dated May 18, 1998 among
Host Marriott Corporation, Host Marriott, L.P. and the contributors
named therein (incorporated by reference to Exhibit 10.20 of Host
Marriott Corporation Registration Statement No. 333-55807).
#10.30 Form of Lease Agreement (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
#10.31 Form of Management Agreement for Full-Service Hotels (incorporated by
reference to Host Marriott Corporation Registration Statement No. 33-
51707).
#10.32 Form of Owner's Agreement between Host Marriott Corporation, Marriott
International and Crestline Capital Corporation (incorporated by
reference to Crestline Capital Corporation Registration Statement No.
333-64657).
10.33 Employee Benefits and Other Employment Matters Allocation Agreement
between Host Marriott Corporation, Host Marriott, L.P. and Crestline
Capital Corporation (incorporated by reference to Host Marriott
Corporation Registration Statement No. 333-64793).
94
Exhibit
No. Description
------- -----------
10.34* Amendment to the Employee Benefits and Other Employment Matters
Allocation Agreement effective as of December 29, 1998 by and between
Host Marriott Corporation, Marriott International, Sodexho Marriott
Services, Inc., Crestline Capital Corporation and Host Marriott, L.P.
10.35 Pool Guarantee Agreement between Host Marriott Corporation, the
lessees referred to therein and Crestline Capital Corporation
(incorporated by reference to Host Marriott Corporation Registration
Statement No. 333-64793).
10.36 Pooling and Security Agreement by and among Host Marriott Corporation
and Crestline Capital Corporation (incorporated by reference to Host
Marriott Corporation Registration Statement No. 333- 64793).
10.37 Amended and Restated Communities Noncompetition Agreement
(incorporated by reference to Host Marriott Corporation Registration
Statement No. 333-64793).
10.38 Asset Management Agreement between Host Marriott, L.P. and Crestline
Capital Corporation (incorporated by reference to Crestline Capital
Corporation Registration Statement No. 333-64657).
12.1* Computation of Ratios of Earnings to Fixed Charges.
21* List of Subsidiaries of Host Marriott Corporation.
23.1* Consent of Arthur Andersen LLP.
27.1 Financial Data Schedule. (Incorporated by reference to Host Marriott
Corporation 8-K/A filed on March 15, 1999)
- --------
# Agreement filed is illustrative of numerous other agreements to which the
Company is a party.
* Filed herewith.
95
(b) REPORTS ON FORM 8-K
. November 25, 1998--Report of the announcement that Host Marriott mailed a
Proxy Statement to its stockholders relating to a special meeting of its
stockholders to be held on December 15, 1998.
. December 10, 1998--Report that Host Marriott and The Bank of New York
entered into an Amendment No. 3 to the Rights Agreement, dated November
23, 1998 which was originally entered into on February 3, 1989 and as
amended by Amendment No. 1, dated October 8, 1993, and further amended by
Amendment No. 2, dated November 3, 1998.
. December 22, 1998--Report of the announcement that Host Marriott and
certain of its subsidiaries executed an underwriting agreement and Host
Marriott agreed to issue and sell $500,000,000 aggregate principal amount
of 8.45% Series C Senior Notes due 2008 which was consummated on December
11, 1998.
. December 22, 1998--Report of the announcement of Host Marriott's
declaration of a special dividend payable in either cash or common stock
of Host Marriott, at the election of each Host Marriott stockholder, a
dividend of shares of Crestline Capital Corporation, a subsidiary of Host
Marriott, and a receipt of the necessary partnership approvals to acquire
eight public limited hotel partnerships.
. December 29, 1998--Report of the announcement that HMC Merger
Corporation, a Maryland corporation and formerly a wholly owned
subsidiary of Host Marriott Corporation, a Delaware corporation,
completed its merger with Host Marriott Corporation and, as the surviving
corporation in the merger, HMC Merger Corporation changed its name from
HMC Merger Corporation to Host Marriott Corporation.
. December 31, 1998--Report of the announcement that Host Marriott
successfully completed the final steps in its conversion to a real estate
investment trust ("REIT") and that it is positioned to elect REIT status
effective January 1, 1999. Also the announcement that Host Marriott
acquired ownership of, or controlling interests in, 12 upscale and luxury
full-service hotels and certain other assets from the Blackstone Group
and a series of funds controlled by Blackstone Real Estate Partners.
. January 14, 1999--Report that Host Marriott Corporation, through its
subsidiary Host Marriott L.P., acquired ownership of, or controlling
interests in, twelve upscale and luxury full-service hotels and certain
other assets from the Blackstone Group and a series of funds controlled
by Blackstone Real Estate Partners, and financial statements will be
filed within 60 days of the filing of the report.
. January 14, 1999--Report on the December 29, 1998 Host Marriott
Corporation distribution of Crestline shares to shareholders of record
and Host Marriott belief that the fair market value of the Crestline
shares on December 29, 1998 was $15.30 per share (a distribution value of
$1.53 per Host Marriott share) which is the value determined by the Host
Marriott Board of Directors.
. January 15, 1999--Report of the announcement that on December 30, 1998
Host Marriott Corporation had completed the final steps in its conversion
to a real estate investment trust ("REIT") and had positioned itself to
elect REIT status, effective January 1, 1999.
. January 22, 1999--Report that, based upon its annual budget for 1999,
Host Marriott Corporation estimates that on a standalone basis its 1999
Earnings Before Interest, Expense, Taxes, Depreciation and Amortization
and other non-cash items will be in the range of approximately $1.0
billion to $1.05 billion while its 1999 Funds From Operations will be in
the range of approximately $565 million to $595 million.
. March 15, 1999--Report that on December 30, 1998, Host Marriott
Corporation, through its subsidiary Host Marriott, L.P., acquired
ownership of, or controlling interests in, 12 upscale and luxury full-
service hotels and certain other assets from the Blackstone Group, and a
series of funds controlled by affiliates Blackstone Real Estate Partners.
In exchange for these assets, (1) Host Marriott, L.P. issued
approximately 43.9 million of its limited partnership units, assumed debt
and made cash payments totaling approximately $920 million and (2) Host
Marriott distributed 1.4 million shares of Crestline Capital Corporation.
The actual number of OP Units to be issued to the Blackstone Entities
will fluctuate based upon certain adjustments to be determined on March
31, 1999.
(d) OTHER INFORMATION
96
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of Bethesda, State of
Maryland, on March 24, 1999.
Host Marriott Corporation
/s/ Robert E. Parsons, Jr.
By: _________________________________
Robert E. Parsons, Jr.
Executive Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
Signatures Title Date
---------- ----- ----
/s/ Terence C. Golden President, Chief Executive March 24, 1999
______________________________________ Officer and Director
Terence C. Golden (Principal Executive
Officer)
/s/ Robert E. Parsons, Jr. Executive Vice President March 24, 1999
______________________________________ and Chief Financial
Robert E. Parsons, Jr. Officer (Principal
Financial Officer)
/s/ Donald D. Olinger Senior Vice President and March 24, 1999
______________________________________ Corporate Controller
Donald D. Olinger (Principal Accounting
Officer)
/s/ Richard E. Marriott Chairman of the Board of March 24, 1999
______________________________________ Directors
Richard E. Marriott
/s/ R. Theodore Ammon Director March 24, 1999
______________________________________
R. Theodore Ammon
/s/ Robert M. Baylis Director March 24, 1999
______________________________________
Robert M. Baylis
/s/ J.W. Marriott, Jr. Director March 24, 1999
______________________________________
J.W. Marriott, Jr.
/s/ Ann Dore McLaughlin Director March 24, 1999
______________________________________
Ann Dore McLaughlin
97
Signatures Title Date
---------- ----- ----
/s/ John G. Schreiber Director March 24, 1999
______________________________________
John G. Schreiber
/s/ Harry L. Vincent, Jr. Director March 24, 1999
______________________________________
Harry L. Vincent, Jr.
98
SCHEDULE III
Page 1 of 2
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1998
(in millions)
Gross Amount at
Initial Costs December 31, 1998
----------------- Subsequent ------------------------ Date of
Buildings & Costs Buildings & Accumulated Completion of Date
Description Debt Land Improvements Capitalized Land Improvements Total Depreciation Construction Acquired
----------- ------ ---- ------------ ----------- ---- ------------ ------ ------------ ------------- --------
Full-service hotels:
New York Marriott
Marquis Hotel, New
York, NY.......... $ 145 $-- $552 $24 $-- $576 $576 $(144) 1986 N/A
Other full-service
properties, each
less than 5% of
total............. $2,293 $724 $5,638 $376 $727 $6,032 $6,759 $(413) various various
------ ---- ------ ---- ---- ------ ------ -----
Total full-
service......... 2,438 724 6,190 400 727 6,608 7,335 (557)
Other properties,
each less than 5%
of total.......... -- 13 5 -- 13 5 18 (18) various N/A
------ ---- ------ ---- ---- ------ ------ -----
Total........... $2,438 $737 $6,195 $400 $740 $6,613 $7,353 $(575)
====== ==== ====== ==== ==== ====== ====== =====
Depreciation
Description Life
----------- ------------
Full-service hotels:
New York Marriott
Marquis Hotel, New
York, NY.......... 40
Other full-service
properties, each
less than 5% of
total............. 40
Total full-
service.........
Other properties,
each less than 5%
of total.......... various
Total...........
S-1
SCHEDULE III
Page 2 of 2
HOST MARRIOTT CORPORATION AND SUBSIDIARIES
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1998
(in millions)
Notes:
(A) The change in total cost of properties for the fiscal years ended December
31, 1998, January 2, 1998 and January 3, 1997 is as follows:
Balance at December 29, 1995......................................... $2,986
Additions:
Acquisitions....................................................... 1,087
Capital expenditures............................................... 77
Transfers from construction-in-progress............................ 28
Deductions:
Dispositions and other............................................. (322)
------
Balance at January 3, 1997......................................... 3,856
Additions:
Acquisitions....................................................... 1.459
Capital expenditures............................................... 117
Transfers from construction-in-progress............................ 30
Deductions:
Dispositions and other............................................. (145)
------
Balance at January 2, 1998........................................... 5,317
Additions:
Acquisitions....................................................... 2,849
Capital Expenditures............................................... 46
Transfers from construction-in-progress............................ 14
Deductions:
Dispositions and other............................................. (91)
Transfers to Non-Controlled Subsidiary............................. (139)
Transfers to Spin-Off (Crestline Capital Corporation).............. (643)
------
Balance at December 31, 1998......................................... $7,353
======
(B) The change in accumulated depreciation and amortization of real estate
assets for the fiscal years ended December 31, 1998, January 2, 1998 and
January 3, 1997 is as follows:
Balance at December 29, 1995........................................... $374
Depreciation and amortization.......................................... 96
Dispositions and other................................................. (59)
Balance at January 3, 1997............................................. 411
Depreciation and amortization.......................................... 126
Dispositions and other................................................. (31)
----
Balance at January 2, 1998............................................. 506
Depreciation and amortization.......................................... 132
Dispositions and other................................................. (13)
Transfers to Non-Controlled Subsidiary................................. (29)
Transfers to Spin-Off (Crestline Capital Corporation).................. (21)
----
Balance at December 31, 1998........................................... $575
====
(C) The aggregate cost of properties for Federal income tax purposes is
approximately $5,786 million at December 31, 1998.
(D) The total cost of properties excludes construction-in-progress properties.
S-2