SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 19, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR TRANSITION PERIOD FROM ___________ TO ___________
COMMISSION FILE NO. 1-14040
HOST MARRIOTT SERVICES CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 52-1938672
- --------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
6600 ROCKLEDGE DRIVE
BETHESDA, MARYLAND 20817
- ----------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
(301) 380-7000
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No __
The total number of shares of common stock issued and outstanding as of July 24,
1998, was 33,891,433.
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
INDEX
PAGE NO.
PART I. FINANCIAL INFORMATION (UNAUDITED):
Condensed Consolidated Statements of Operations -
For the Twelve Weeks and Twenty-Four Weeks Ended
June 19, 1998 and June 20, 1997 2
Condensed Consolidated Balance Sheets -
As of June 19, 1998 and January 2, 1998 3
Condensed Consolidated Statements of Cash Flows -
For the Twenty-Four Weeks Ended June 19, 1998 and
June 20, 1997 4
Condensed Consolidated Statement of Shareholders' Deficit -
For the Twenty-Four Weeks Ended June 19, 1998 5
Notes to Condensed Consolidated Financial Statements 6-8
Management's Discussion and Analysis of Financial Condition
and Results of Operations 9-19
Quantitative and Qualitative Disclosure About Market Risk n/a
PART II. OTHER INFORMATION AND SIGNATURE:
Legal Proceedings 20
Changes in Securities and Use of Proceeds 20
Defaults Upon Senior Securities 20
Submission of Matters to a Vote of Security Holders 20
Other Information 20
Exhibits and Reports on Form 8-K 21
Signature 22
Computations of Income Per Common Share 23-24
1
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
------------------------------- -------------------------------
JUNE 19, JUNE 20, JUNE 19, JUNE 20,
1998 1997 1998 1997
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES $322.6 $292.6 $599.9 $555.7
- ---------------------------------------------------------------------------------------------------------------------
OPERATING COSTS AND EXPENSES
Cost of sales 94.7 85.3 177.2 160.3
Payroll and benefits 95.5 87.5 185.4 171.6
Rent 49.9 46.1 94.3 90.1
Royalties 7.0 6.1 12.9 11.4
Depreciation and amortization 13.5 12.0 25.5 24.1
General and administrative 13.5 12.0 27.1 24.5
Other 30.0 27.0 57.0 55.8
- ---------------------------------------------------------------------------------------------------------------------
Total operating costs and expenses 304.1 276.0 579.4 537.8
- ---------------------------------------------------------------------------------------------------------------------
OPERATING PROFIT 18.5 16.6 20.5 17.9
Interest expense (9.2) (9.2) (18.4) (18.4)
Interest income 0.6 1.0 1.3 1.8
- ---------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 9.9 8.4 3.4 1.3
Provision for income taxes 3.7 3.3 1.1 0.5
- ---------------------------------------------------------------------------------------------------------------------
NET INCOME $ 6.2 $ 5.1 $ 2.3 $ 0.8
- ---------------------------------------------------------------------------------------------------------------------
INCOME PER COMMON SHARE:
Basic $ 0.18 $ 0.15 $ 0.07 $ 0.02
Diluted $ 0.17 $ 0.14 $ 0.06 $ 0.02
Weighted Average Common Shares Outstanding:
Basic 34.0 34.7 34.2 34.6
Diluted 35.7 36.2 35.9 36.2
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 19, JANUARY 2,
1998 1998
- ------------------------------------------------------------------------------ ----------------- -- ----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 53.4 $ 78.1
Accounts receivable, net 22.2 24.5
Inventories 42.1 41.1
Deferred income taxes 11.5 11.5
Prepaid rent 8.2 7.0
Other current assets 7.7 7.0
- ------------------------------------------------------------------------------ ----------------- -- ----------------
Total current assets 145.1 169.2
Property and equipment, net 291.4 279.9
Intangible assets 22.1 22.1
Deferred income taxes 57.5 56.4
Other assets 21.5 20.4
- ------------------------------------------------------------------------------ ----------------- -- ----------------
Total assets $ 537.6 $ 548.0
- ------------------------------------------------------------------------------ ----------------- -- ----------------
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 71.3 $ 72.2
Accrued payroll and benefits 47.0 46.0
Accrued interest payable 3.3 4.8
Current portion of long-term debt 1.0 1.0
Other current liabilities 41.7 41.5
- ------------------------------------------------------------------------------ ----------------- -- ----------------
Total current liabilities 164.3 165.5
Long-term debt 406.0 405.8
Other liabilities 52.3 52.9
- ------------------------------------------------------------------------------ ----------------- -- ----------------
Total liabilities 622.6 624.2
Common stock, no par value, 100 million shares authorized, 34,965,369
shares issued as of June 19, 1998 and
34,733,815 shares issued as of January 2, 1998 --- ---
Contributed deficit (107.3) (107.7)
Retained earnings 37.4 35.1
Accumulated other comprehensive income (0.2) (0.1)
Treasury stock - 1,091,100 shares at June 19, 1998
and 253,100 shares at January 2, 1998 (14.9) (3.5)
- ------------------------------------------------------------------------------ ----------------- -- ----------------
Total shareholders' deficit (85.0) (76.2)
- ------------------------------------------------------------------------------ ----------------- -- ----------------
Total liabilities and shareholders' deficit $ 537.6 $ 548.0
- ------------------------------------------------------------------------------ ----------------- -- ----------------
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN MILLIONS)
<TABLE>
<CAPTION>
TWENTY-FOUR WEEKS ENDED
--------------------------------------
JUNE 19, JUNE 20,
1998 1997
- ------------------------------------------------------------------------------ ----------------- -- -----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 2.3 $ 0.8
Adjustments to reconcile net income to cash from operations:
Depreciation and amortization 26.5 24.9
Amortization of deferred financing costs 0.6 0.6
Income taxes (1.1) (1.7)
Other 4.5 2.0
Working capital changes:
Decrease (increase) in accounts receivable 2.3 (0.1)
Increase in inventories (1.4) (1.5)
(Increase) decrease in other current assets (2.7) 1.6
Decrease in accounts payable and accruals (0.7) (34.8)
- ------------------------------------------------------------------------------ ----------------- -- -----------------
Cash provided by (used in) operations 30.3 (8.2)
INVESTING ACTIVITIES
Capital expenditures (39.0) (27.4)
Other, net (3.6) 1.0
- ------------------------------------------------------------------------------ ----------------- -- -----------------
Cash used in investing activities (42.6) (26.4)
FINANCING ACTIVITIES
Repayments of long-term debt (0.6) (0.7)
Issuance of long-term debt 0.9 ---
Proceeds from stock issuances 2.3 1.6
Payment to Host Marriott Corporation for Marriott
International options and deferred shares (3.5) (2.2)
Purchases of treasury stock (11.4) ---
Foreign currency translation adjustments (0.1) (0.4)
- ------------------------------------------------------------------------------ ----------------- -- -----------------
Cash used in financing activities (12.4) (1.7)
DECREASE IN CASH AND CASH EQUIVALENTS (24.7) (36.3)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 78.1 104.2
- ------------------------------------------------------------------------------ ----------------- -- -----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 53.4 $ 67.9
- ------------------------------------------------------------------------------ ----------------- -- -----------------
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT (UNAUDITED)
TWENTY-FOUR WEEKS ENDED JUNE 19, 1998
(IN MILLIONS)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON OTHER
SHARES COMMON CONTRIBUTED RETAINED COMPREHENSIVE TREASURY
OUTSTANDING STOCK DEFICIT EARNINGS INCOME STOCK TOTAL
- ----------- --------------------------------------- ---------- -------------- ---------- ----------------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
34.5 Balance, January 2, 1998 $ --- $(107.7) $ 35.1 $ (0.1) $ (3.5) $ (76.2)
- ----------- --------------------------------------- ---------- -------------- ---------- ----------------- ---------- -----------
Comprehensive income:
--- Net income --- --- 2.3 --- --- 2.3
Foreign currency translation
--- adjustments --- --- --- (0.1) --- (0.1)
----------- --------------------------------------- ---------- -------------- ---------- ----------------- ---------- -----------
--- Total comprehensive income --- --- 2.3 (0.1) --- 2.2
Common stock issued for
0.3 employee stock and option plans --- 2.3 --- --- --- 2.3
Payment to Host Marriott Corporation
for Marriott International options
--- and deferred shares --- (3.5) --- --- --- (3.5)
(0.8) Treasury stock purchases --- --- --- --- (11.4) (11.4)
(0.1) Deferred compensation --- 1.6 --- --- --- 1.6
- ----------- --------------------------------------- ---------- -------------- ---------- ----------------- ---------- -----------
33.9 BALANCE, JUNE 19, 1998 $ --- $(107.3) $ 37.4 $ (0.2) $ (14.9) $ (85.0)
- ----------- --------------------------------------- ---------- -------------- ---------- ----------------- ---------- -----------
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The accompanying condensed consolidated financial statements of Host
Marriott Services Corporation and subsidiaries (the "Company") have been
prepared without audit. Certain information and footnote disclosures
normally included in financial statements presented in accordance with
generally accepted accounting principles have been condensed or omitted.
The Company believes the disclosures made are adequate to make the
information presented not misleading. However, the condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended January 2, 1998 ("Form
10-K"). Capitalized terms not otherwise defined herein have the meanings
specified in the Form 10-K.
In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments (which include
only normal recurring adjustments) necessary to present fairly the
consolidated financial position of the Company as of June 19, 1998 and the
results of operations and cash flows for the interim periods presented.
Interim results are not necessarily indicative of fiscal year performance
because of the impact of seasonal and short-term variations.
The consolidated financial statements include the accounts of the Company
and its subsidiaries and controlled affiliates. Investments in 50% or less
owned affiliates over which the Company has the ability to exercise
significant influence are accounted for using the equity method. All
material intercompany transactions and balances between the Company and its
subsidiaries have been eliminated. Certain reclassifications were made to
the prior year financial statements to conform to the 1998 presentation.
2. Basic income per common share was computed by dividing net income by the
weighted-average number of outstanding common shares. Diluted income per
share was computed by dividing net income by the diluted weighted-average
number of outstanding common shares.
3. Restricted shares are issued to certain officers and key executives. As of
the end of the second quarter of 1998, there were approximately 409,000
restricted share awards outstanding. All current restricted share awards
expire at the end of fiscal year 1998. Compensation expense is recognized
over the award period and consists of time- and performance-based
components. The time-based expense is calculated using the fair value of
the shares on the date of issuance and is contingent on continued
employment. The performance-based expense is calculated using the fair
value of the Company's common stock during the award period and is
contingent on attainment of certain performance criteria.
4. The Company adopted SFAS No. 130, "Reporting Comprehensive Income," in
the first quarter of 1998 and the adoption did not have a material effect
on the Company's condensed consolidated financial statements. 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" during 1997. The
adoption of these standards did not have a material effect on the Company's
1997 consolidated financial statements. Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" and SOP 98-5, "Reporting on the Costs of Start-Up Activities"
were issued subsequent to the end of fiscal year 1997 and are required to
be adopted in fiscal years beginning after December 15, 1998, with earlier
adoption permitted. The Company will adopt SOP 98-1 and SOP 98-5 for its
1999 fiscal year and is currently evaluating the financial statement impact
of the adoptions.
5. In March 1993, Host Marriott Corporation, the Company's former parent
corporation, settled a class action lawsuit involving certain of its
bondholders by issuing to the bondholders warrants to purchase up to 7.7
million shares of Host Marriott Corporation common stock, approximately 7.3
million of which were unissued as of the Distribution Date. As a result of
the Distribution, such warrants are exercisable for one share of Host
Marriott Corporation's common stock and one fifth of one share of the
Company's common stock.
6
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
As of June 19, 1998, the Company had issued 1,381,668 common shares of the
Company resulting from the exercise of Host Marriott Corporation warrants.
Proceeds received from the issuance of these common shares were $5.9
million. As of June 19, 1998, the Company remains obligated to issue 56,517
shares of common stock for the remaining unexercised Host Marriott
Corporation warrants at a price of $5.33 per Company share. The warrants
expire on October 8, 1998.
6. The Company has three reportable operating segments: airports, travel
plazas and shopping malls and entertainment. The Company's management
evaluates performance of each segment based on profit or loss from
operations before allocation of general and administrative expenses,
unusual and extraordinary items, interest and income taxes. The accounting
policies of the segments are the same as those described in the summary of
significant accounting policies in the Company's Form 10-K. Financial
information for the Company's three operating segments are provided in the
following tables.
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
--------------------------- -----------------------------
JUNE 19, JUNE 20, JUNE 19, JUNE 20,
(IN MILLIONS) 1998 1997 1998 1997
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES:
Airports $ 231.3 $ 206.8 $ 439.0 $ 404.7
Travel plazas 75.5 72.8 130.7 125.5
Shopping malls
and entertainment 15.8 13.0 30.2 25.5
-----------------------------------------------------------------------------------------
Total segment revenues $ 322.6 $ 292.6 $ 599.9 $ 555.7
-----------------------------------------------------------------------------------------
OPERATING PROFIT:(1)
Airports $ 25.4 $ 21.2 $ 44.1 $ 38.1
Travel plazas 5.8 5.9 2.1 2.3
Shopping malls
and entertainment 0.8 1.5 1.4 2.0
-----------------------------------------------------------------------------------------
Total segment operating profit $ 32.0 $ 28.6 $ 47.6 $ 42.4
-----------------------------------------------------------------------------------------
<FN>
(1) Before general and administrative expenses.
</FN>
</TABLE>
<TABLE>
<CAPTION>
JUNE 19, JANUARY 2,
(IN MILLIONS) 1998 1998
---------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Airports $ 291.4 $ 272.9
Travel plazas 91.8 95.7
Shopping malls
and entertainment 28.0 32.9
---------------------------------------------------------------------------------------------
Total segment assets $ 411.2 $ 401.5
---------------------------------------------------------------------------------------------
</TABLE>
7
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Reconciliations of segment data to the Company's consolidated data follow:
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
--------------------------- ------------------------------
JUNE 19, JUNE 20, JUNE 19, JUNE 20,
(IN MILLIONS) 1998 1997 1998 1997
-----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATING PROFIT:
Segments $ 32.0 $ 28.6 $ 47.6 $ 42.4
General and administrative (13.5) (12.0) (27.1) (24.5)
expenses
-----------------------------------------------------------------------------------------------
Total operating profit $ 18.5 $ 16.6 $ 20.5 $ 17.9
-----------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
JUNE 19, JANUARY 2,
(IN MILLIONS) 1998 1998
------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Segments $ 411.2 $ 401.5
Corporate and other(1) 126.4 146.5
------------------------------------------------------------------------------------------
Total assets $ 537.6 $ 548.0
------------------------------------------------------------------------------------------
<FN>
(1)The majority of the decrease in corporate and other was
related to a decrease in corporate cash concentration
accounts with a significant amount related to $11.4 million
of treasury stock purchases during the first half of 1998.
</FN>
</TABLE>
8
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
REVENUES. Revenues for the twelve weeks ("quarter") ended June 19, 1998
increased by 10.3% to $322.6 million from the same period in 1997, with revenue
growth experienced in all business lines. Revenues for the twenty-four weeks
("first half") ended June 19, 1998 totaled $599.9 million, an increase of 8.0%.
These increases in revenues were driven by strong growth in domestic airport
food and beverage concessions particularly from sales at locations with recent
openings of new branded concepts. Revenue growth was also aided by an increase
in enplanements, customer traffic on tollroads, the opening of two new mall
contracts in the fourth quarter of 1997 and the conversion of the Miami
International Airport contract from a management agreement to an operating
agreement during the second quarter of 1998.
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
-------------------------- ----------------------------
JUNE 19, JUNE 20, JUNE 19, JUNE 20,
(IN MILLIONS) 1998 1997 1998 1997
--------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES BY BUSINESS LINE
AIRPORTS:
Domestic $215.8 $191.9 $409.5 $376.8
International 15.5 14.9 29.5 27.9
--------------------------------------------------------------------------------------------------
Total airports 231.3 206.8 439.0 404.7
--------------------------------------------------------------------------------------------------
TRAVEL PLAZAS 75.5 72.8 130.7 125.5
SHOPPING MALLS AND ENTERTAINMENT 15.8 13.0 30.2 25.5
--------------------------------------------------------------------------------------------------
Total revenues $322.6 $292.6 $599.9 $555.7
--------------------------------------------------------------------------------------------------
</TABLE>
The Company's diversified branded concept portfolio, which consists of over 100
internationally known brands, regional specialty concepts and proprietary
concepts, is a unique competitive advantage in the marketplace. Brand awareness,
customer familiarity with product offerings, and the perception of superior
value and consistency are all factors contributing to higher revenue per
enplaned passenger ("RPE") in branded facilities. Branded revenues increased
18.8% and 17.1% for the second quarter and first half of 1998 compared to a year
ago, the majority of which related to the continued expansion of branded
revenues at airports and revenues from new shopping mall food courts, which
consist primarily of branded food and beverage. Branded revenues in all of the
Company's venues have grown at a compound annual growth rate of 8.1% over the
last five fiscal years. The Company's exposure to any one brand is limited given
the diversity of brands that are offered and given that the Company's largest
branded concept, Burger King, accounted for only 10.1% of total revenues for the
first half of 1998.
AIRPORTS
Airport concession revenues were up 11.8% to $231.3 million for the second
quarter of 1998 compared to a year ago, with domestic airport concession
revenues up 12.5% and international airport revenues up 4.0%. International
revenues reflect increased revenues at the Montreal International Airport -
Dorval in Canada and the Schiphol Airport in the Netherlands offset by the
negative impact of exchange rate fluctuations and weak enplanements stemming
from the Asian economic situation.
Comparable domestic airport contracts exclude the negative impact of exited
contracts, contracts with significant changes in scope of operation and
contracts undergoing significant construction of new facilities, as well as, the
positive impact of new contracts. During the second quarter of 1998, the
Chicago, St. Louis, Miami and Columbus airport contracts were considered
noncomparable. Revenue growth at comparable domestic airport locations, which
comprise almost 90% of total domestic airport revenues, grew a solid 11.4% over
the second quarter of 1997. Passenger enplanements at comparable domestic
airports were up an estimated 3.0% over last year's second quarter while RPE
grew 8.2%. In March 1998, the FAA forecasted annual U.S. passenger enplanement
growth of U.S. carriers of 3.7% through the year 2009. Second quarter 1998
enplanement growth was below the FAA's long range forecast.
9
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
RPE, which is the primary measure of how effective the Company is capturing
potential customers and increasing customer spending, grew 8.2% at the Company's
comparable domestic airport locations in the second quarter of 1998 over the
same period last year. Approximately half of the RPE growth achieved during the
quarter can be attributed to the opening of new branded concepts at a number of
the Company's larger locations, including Los Angeles, San Francisco,
Minneapolis and Cleveland. In addition, moderate increases in menu prices and
various real estate maximization efforts also contributed to the 8.2% growth
rate. Branded revenues in airports showed an increase of 24.4% when comparing
the second quarter of 1998 to the same period in 1997. Airport branded revenues
in the second quarter increased to $69.3 million, or 30.0% of total airport
revenues, compared with $55.7 million, or 26.9% of total airport revenues, in
the second quarter of 1997.
Airport concession revenues were up 8.5% to $439.0 million for the first half of
1998 compared to a year ago, with domestic airport concession revenues up 8.7%
and international airport concession revenues up 5.7%. The opening of the
Montreal International Airport - Dorval in Canada during the second quarter of
1997 contributed significantly to the increase in international airport
revenues, which was partially offset by the negative impact of exchange rate
fluctuations and weak enplanements stemming from the Asian economic situation.
During the first half of 1998, the Chicago, St. Louis, Miami, Columbus and
Montreal airport contracts were considered noncomparable. Revenue growth at
comparable domestic airport locations grew a solid 9.2% over the first half of
1997. Passenger enplanements at comparable domestic airports were up an
estimated 1.8% over the first half of 1997.
RPE grew 7.2% at the Company's comparable domestic airport locations in the
first half of 1998 over the same period last year. Branded revenues in airports
showed an increase of 19.0% when comparing the first half of 1998 to the same
period in 1997. Airport branded revenues in the first half of 1998 increased to
$131.3 million, or 29.9% of total airport revenues, compared with $110.3
million, or 27.3% of total airport revenues, in the first half of 1997.
During the first quarter of 1998, the Company announced a new domestic airport
contract at the Southwest Florida International Airport in Fort Myers. This ten
year contract is for the development and operation of 16,000 square feet of food
and beverage concessions space throughout the airport's main terminal and its
two concourses.
Also during the first quarter of 1998, the Company announced several
international concession facilities at Kuala Lumpur International Airport and
Vancouver International Airport, both of which opened in the second quarter of
1998. The Company, along with its 51% Malaysian joint venture partner, Dewina
Berhad, was awarded several facilities at the Kuala Lumpur airport. The joint
venture will operate over 8,000 square feet of food and beverage concessions
space and will feature a mixture of international and local brand offerings.
This contract is the Company's first Southeast Asian contract, a key step in
establishing the Company's presence in Southeast Asia. The Company was awarded
two new concession facilities at the Vancouver International Airport, adding to
the Company's existing operations in the domestic terminal. The new facilities
include a Bar and Grill concept and a Starbucks Coffee location. This airport
was the Company's first Canadian airport contract, and since its opening, the
Company has received several awards on the design of the food and beverage and
retail operations at the airport.
During the second quarter of 1998, the Company announced that it has been
selected as the food and beverage master developer/operator at the Miami
International Airport, until the year 2007. The new contract is for the
development and operation of more than 56,000 square feet of food and beverage
space located throughout nine concourses and the main terminal of the airport.
Prior to this award, the Company operated the existing generic facilities for
Dade County under a management agreement and recorded management fees. The
Company will record revenues and expenses under the new agreement. When the
facilities are completed in 2000, the estimated annualized revenues are expected
to be approximately $30.0 million. The Company also announced a new joint
venture with Cool Planet, Inc., a subsidiary of Planet Hollywood International,
Inc., to bring a new ice cream and
10
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
dessert concept called Cool Planet to the Company's venues. The 50/50 joint
venture was formed to open up to 10 Cool Planet locations, five likely within
the next year.
Subsequent to the end of the second quarter of 1998, the Company announced
several development achievements. Food and beverage extensions were obtained at
the Jacksonville International Airport in Florida and at Terminal 3 of JFK
International Airport in New York. The Company won a new contract to operate
retail concessions in the north terminal at San Francisco International Airport
and announced a planned expansion at Chicago O'Hare International Airport with
the recent approval for a new 8,000 square foot business center at the airport.
Also, the Company has been selected by the Palm Beach Airport Authority to take
over food and beverage operations in October of 1998 in West Palm Beach. The
Company's selection requires the positive vote of the Palm Beach County Board of
Commissioners and the vote is expected in August.
The contracts won or renewed in core markets during or subsequent to the second
quarter described above are expected to generate more than $50 million in
revenues once opened and redeveloped.
TRAVEL PLAZAS
Travel plaza concession revenues for the second quarter of 1998 were up 3.7% to
$75.5 million when compared to the same period in 1997 due to low gasoline
prices, offset by inclement weather experienced throughout the northeastern U.S.
during much of the second quarter. Revenues for the travel plazas segment grew
4.1% to $130.7 million for the first half of 1998. This growth was the result of
increased tollroad traffic due to low gasoline prices, as well as moderate
increases in menu prices. Low gasoline prices, higher household income and
record-high consumer confidence have led the Energy Department and the Travel
Institute of America to forecast strong growth in vehicle miles traveled for
this summer of 3.9% and 3%, respectively.
The Company started to introduce the Starbucks concept to a number of travel
plazas during the first half of 1998 in an effort to increase customer capture
and enhance real estate productivity on the tollroads. Travel plazas in Maryland
and Pennsylvania are currently operating Starbucks kiosks and 12 more Starbucks
locations are planned.
SHOPPING MALLS AND ENTERTAINMENT
Shopping malls and entertainment concession revenues, primarily consisting of
merchandise, food and beverage sales at food courts in shopping malls, stadiums,
arenas, and other tourist attractions, increased by 21.5% to $15.8 million for
the second quarter of 1998 when compared with the second quarter of 1997.
Revenues for the shopping malls and entertainment segment grew 18.4% to $30.2
million for the first half of 1998 compared to the same period in 1997. These
increases can be attributed to the opening of the Grapevine Mills Mall and the
Vista Ridge Mall in the fourth quarter of 1997, as well as a significant
increase in revenues at an entertainment location.
During the second quarter of 1998, the Company announced its first mall food
court project with Chelsea GCA Realty, Inc. to master lease 13,000 square feet
of food and beverage facilities, including a food court and a 500 seat common
area, at the Leesburg Corner Premium Outlets in Virginia. The upscale outlet
center will be built in three phases with the first phase scheduled to open in
the fall of 1998.
Also during the second quarter of 1998, the Company announced that it reached an
agreement with Forest City Ratner Companies to develop and manage 35,000 square
feet of food and beverage operations in its 42nd Street Entertainment and Retail
Project in New York. This project will be one of the Company's largest mall and
entertainment projects with annual sales expected to exceed $15 million once
construction of the units has been completed in late 1999.
The Company currently has seven mall contracts with five leading developers and
discussions underway with many more developers. A number of projects are under
discussion, including two in Europe.
OPERATING COSTS AND EXPENSES. Total operating costs and expenses were $304.1
million for the second quarter of 1998, or 94.3% of total revenues, compared
with $276.0 million for the second quarter of 1997, or 94.3% of total
11
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
revenues. Total operating costs and expenses for the first half of 1998 were
$579.4 million, or 96.6% of total revenues, compared with $537.8 million, or
96.8% of total revenues for the first half of 1997. The improved operating
profit margin for the first half of 1998 reflects operating leverage benefits
derived from revenue growth and reduced costs, primarily in other operating
expenses.
Cost of sales for the second quarter of 1998 increased 11.0% to $94.7 million
when compared to the same period in 1997. Cost of sales for the first half of
1998 increased 10.5% to $177.2 million when compared with the first half of
1997. Cost of sales as a percentage of total revenues increased 20 basis points
and 70 basis points during the second quarter and first half of 1998,
respectively. The margins are influenced by start-up activities at new food and
beverage concepts that result in product waste. In addition, the Company
experienced commodity cost increases in dairy products and premium coffee beans.
Payroll and benefits totaled $95.5 million during the second quarter of 1998, a
9.1% increase over the second quarter of 1997. Payroll and benefits increased
8.0% to $185.4 million during the first half of 1998 when compared to the same
period in 1997. Payroll and benefits as a percentage of total revenues decreased
30 basis points for the second quarter and remained flat for the first half of
1998, reflecting benefits from the use of labor scheduling software and the
implementation of store manager training programs.
Rent expense totaled $49.9 million and $94.3 million for the second quarter and
first half of 1998, an increase of 8.2% and 4.7% above the second quarter and
first half of 1997, respectively. Rent expense as a percentage of total revenues
improved 30 basis points for the second quarter and 50 basis points for the
first half of 1998 and can be attributed to sales increases on contracts with
fixed rental rates, as well as new or renewed contracts with favorable rent
margins.
Royalties expense for the second quarter and first half of 1998 increased by
14.8% and 13.2% to $7.0 million and $12.9 million, respectively, when compared
with the same periods in 1997. As a percentage of total revenues, royalties
expense increased by 10 basis points for both the second quarter and first half
of 1998. These increases in royalties expense reflects the Company's continued
introduction of branded concepts to its concessions operations. Royalties
expense as a percentage of branded sales totaled 6.1% and 6.7% in the second
quarter of 1998 and 1997, respectively, and totaled 6.0% and 6.5% in the first
half of 1998 and 1997, respectively. These margin decreases were attributable to
the addition of branded concepts with lower-than-average royalty percentages.
Branded facilities generate higher sales per square foot and contribute toward
increased RPE, which more than offset royalty payments required to operate the
concepts.
Depreciation and amortization expense, excluding $0.5 million of corporate
depreciation on property and equipment which is included as a component of
general and administrative expenses, was $13.5 million for the second quarter of
1998, compared to $12.0 million, excluding $0.3 million of corporate
depreciation on property and equipment, for the second quarter of 1997.
Depreciation and amortization for the first half of 1998 and 1997 totaled $25.5
million and $24.1 million, excluding $1.0 million and $0.7 million of corporate
depreciation on property and equipment, respectively. Increased depreciation
related to the buildout of new branded locations and additional amortization of
pre-opening costs related to new mall contracts was partially offset by lower
depreciation related to the write-down of one impaired airport unit in the
fourth quarter of 1997.
General and administrative expenses were $13.5 million for the second quarter of
1998, an increase of 12.5% from a year ago. General and administrative expenses
for the first half of 1998 increased 10.6% to $27.1 million compared to the
first half of 1997. These increases were primarily attributable to the addition
of corporate resources in accounting, systems, business development and
strategic planning and marketing to focus on growth initiatives in the Company's
core markets and new venues, as well as increased consulting costs associated
with systems initiatives. During the first half of 1998, $400 thousand in
external costs was included in general and administrative expenses relating to
the Company's Year 2000 compliance program.
12
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
Other operating expenses, which includes utilities, casualty insurance,
equipment maintenance, trash removal and other miscellaneous expenses, were
$30.0 million for the second quarter of 1998, a 11.1% increase from the second
quarter of 1997. Other operating expenses increased 2.2% in the first half of
1998 to $57.0 million compared to a year ago. As a percentage of total revenues,
other operating expenses increased 10 basis points for the second quarter and
decreased 50 basis points for the first half of 1998 when compared with the same
periods in 1997. The majority of the margin improvement for the first half of
1998 was due to lower supplies expenses.
OPERATING PROFIT. As a result of the changes in revenues and operating costs and
expenses discussed above, operating profit increased 11.4% to $18.5 million or
5.7% of revenues for the second quarter of 1998, from $16.6 million or 5.7% of
revenues for the second quarter of 1997. Operating profit improved 14.5% to
$20.5 million for the first half of 1998, or 3.4% of revenues compared with
$17.9 million, or 3.2% of revenues for the same period in 1997.
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
--------------------------- ----------------------------
JUNE 19, JUNE 20, JUNE 19, JUNE 20,
(IN MILLIONS) 1998 1997 1998 1997
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATING PROFIT BY BUSINESS LINE (1)
AIRPORTS:
Domestic $ 24.5 $ 20.4 $ 43.0 $ 36.9
International 0.9 0.8 1.1 1.2
-----------------------------------------------------------------------------------------------------------
Total airports 25.4 21.2 44.1 38.1
-----------------------------------------------------------------------------------------------------------
TRAVEL PLAZAS 5.8 5.9 2.1 2.3
SHOPPING MALLS AND ENTERTAINMENT 0.8 1.5 1.4 2.0
-----------------------------------------------------------------------------------------------------------
Total operating profit $ 32.0 $ 28.6 $ 47.6 $ 42.4
-----------------------------------------------------------------------------------------------------------
<FN>
(1) Before general and administrative expenses
</FN>
</TABLE>
Operating profit margins increased for the airports business line, totaling
11.0% of airport revenues, before general and administrative expenses, for the
second quarter of 1998 as compared with 10.3% of airport revenues for the second
quarter of 1997. Airport operating profit margin, before general and
administrative expenses, improved 60 basis points to 10.0% in the first half of
1998 compared to the same period in 1997.
The travel plaza operating profit margin, before general and administrative
expenses, decreased 40 basis points to 7.7% for the second quarter of 1998 and
decreased 20 basis points to 1.6% for the first half of 1998. The slight
decrease in the travel plaza operating profit margin for the second quarter and
first half of 1998 can be attributed to inclement weather experienced throughout
the northeastern U.S. during much of the second quarter, as well as increased
cost of sales and upward pressure on wages.
The operating profit margin for shopping malls and entertainment, excluding
general and administrative expenses, decreased to 5.1% for the second quarter of
1998 from 11.5% in the second quarter of 1997 and decreased to 4.6% for the
first half of 1998 from 7.8% reported in the first half of 1997. The shopping
mall and entertainment operating profit margins were constrained by start-up
costs, including the amortization of pre-opening costs related to the opening of
two new mall contracts, the negative impact of the Asian crisis at one Hawaiian
location and costs associated with the closing of an entertainment location in
Florida.
INTEREST EXPENSE. Interest expense remained flat at $9.2 million and $18.4
million for the second quarter and first half of 1998 when compared to the same
periods in 1997, reflecting the 9.5% fixed rate of interest on the $400 million
of Senior Notes.
13
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
INTEREST INCOME. Interest income decreased to $0.6 million for the second
quarter of 1998 compared with $1.0 million in the second quarter of 1997. The
second quarter of 1997 included $0.4 million of non-recurring interest income
relating to a negotiated agreement with an Airport Authority which reimbursed
the Company for the cost of funding certain capital improvements. Interest
income decreased to $1.3 million for the first half of 1998 compared with $1.8
million for the same period in 1998.
INCOME TAXES. The provision for income taxes for the second quarter of 1998 and
1997 was $3.7 million and $3.3 million, reflecting an effective tax rate of
37.4% and 39.5% for the respective quarters. Provision for income taxes for the
first half of 1998 and 1997 was $1.1 million and $0.5 million, respectively,
reflecting an effective tax rate of 33.0% and 39.5% for the respective periods.
The decline in 1998 effective tax rates reflects the reversal of the valuation
allowance for the estimated benefit of recognizing certain tax credits
previously thought to be unrealizable.
NET INCOME AND INCOME PER COMMON SHARE. Net income for the second quarter of
1998 increased 21.6% to $6.2 million, or $0.17 per diluted common share,
compared with $5.1 million for the second quarter of 1997, or $0.14 per diluted
common share. Net income for the first half of 1998 increased to $2.3 million,
or $0.06 per diluted common share, compared with $0.8 million for the same
period in 1997, or $0.02 per diluted common share. The increase in net income
for the second quarter and first half of 1998 reflects strong revenue growth,
slightly improved operating profit margins and a favorable reduction in the
corporate tax rate.
WEIGHTED AVERAGE SHARES OUTSTANDING. The weighted average number of common
shares outstanding used to calculate basic income per common share for the
second quarter of 1998 and 1997 was 34.0 million and 34.7 million, respectively.
The weighted average number of common shares outstanding used to calculate
diluted income per common share for the second quarter of 1998 and 1997 was 35.7
million and 36.2 million, respectively.
The weighted average number of common shares outstanding used to calculate basic
income per common share for the first half of 1998 and 1997 was 34.2 million and
34.6 million, respectively. The weighted average number of common shares
outstanding used to calculate diluted income per common share for the first half
of 1998 and 1997 totaled 35.9 million and 36.2 million, respectively.
As of the end of the first half of 1998, common shares issued and outstanding
had decreased by approximately 0.6 million from year-end 1997 and totaled 33.9
million, primarily reflecting 0.8 million shares purchased by the Company under
the Company's share repurchase program partially offset by the issuance of
shares under the Company's Employee Stock Purchase Plan and Comprehensive Stock
Plan.
14
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
LIQUIDITY AND CAPITAL RESOURCES
The Company funds its capital requirements with a combination of existing cash
balances and operating cash flow. The Company believes that cash flow generated
from ongoing operations and current cash balances are more than adequate to
finance ongoing capital expenditures, as well as meet debt service requirements.
The Company also has the ability to fund its planned growth initiatives from
existing credit facilities and from the sources identified above; however,
should significant growth opportunities arise, such as business combinations or
contract acquisitions, alternative financing arrangements will be evaluated and
considered.
The Company's Senior Notes, which will mature in May 2005, were issued at par
and have a fixed coupon rate of 9.5%. The Senior Notes can be called beginning
in May 2000 at a price of 103.56%, declining to par in March 2003.
The Company is required to make semi-annual cash interest payments on its Senior
Notes at a fixed interest rate of 9.5%. The Company is not required to make
principal payments on the Senior Notes until maturity except in the event of (i)
certain changes in control or (ii) certain asset sales in which the proceeds are
not invested in other properties within a specified period of time. Management
does not expect either of these events to occur.
The Senior Notes are secured by a pledge of stock and are fully and
unconditionally guaranteed on a joint and several basis by certain subsidiaries
(the "Guarantors") of Host International, Inc. ("Host International"). Host
International is the primary operating subsidiary of the Company. The indenture
governing the Senior Notes (the "Indenture") contains covenants that, among
other things, limit the ability of Host International and certain of its
subsidiaries to incur additional indebtedness and issue preferred stock, pay
dividends or make other distributions, repurchase capital stock or subordinated
indebtedness, create certain liens, enter into certain transactions with
affiliates, sell certain assets, issue or sell capital stock of the Guarantors,
and enter into certain mergers and consolidations.
The First National Bank of Chicago, as agent for a group of participating
lenders, has provided credit facilities (the "Facilities") to Host International
consisting of a $75.0 million revolving credit facility (the "Revolver
Facility") and a $25.0 million letter of credit facility. The $75.0 million
Revolver Facility provides for working capital and general corporate purposes
other than hostile acquisitions. The $25.0 million letter of credit facility
provides for the issuance of financial and nonfinancial letters of credit. Any
borrowings under the Facilities are senior obligations of Host International and
are secured by the capital stock of Host International and the guarantors.
The loan agreements relating to the Facilities contain dividend and stock
retirement covenants that are substantially similar to those set forth in the
Senior Notes Indenture, except that dividends payable to the Company are limited
to 25% of Host International's consolidated net income, as defined in the loan
agreement. During the first quarter of 1998 and in compliance with the
Facilities, Host International paid $4.7 million of dividends to the Company.
The loan agreements also contain certain financial ratio and capital expenditure
covenants. Any indebtedness outstanding under the Facilities may be declared due
and payable upon the occurrence of certain events of default, including the
Company's failure to comply with the several covenants noted above, or the
occurrence of certain events of default under the Senior Notes Indenture. As of
June 19, 1998 and throughout the twelve weeks and twenty-four weeks ended June
19, 1998, there was no outstanding indebtedness under the Revolver Facility and
the Company was in compliance with the covenants described above.
The Company's cash flows from operating activities are affected by seasonality.
Cash from operations generally is the strongest in the summer months between
Memorial Day and Labor Day. Cash provided by operations, before changes in
working capital and income taxes, totaled $33.8 million for the first half of
1998 as compared with $28.3 million for the same period in 1997. Working capital
is managed throughout the year to effectively maximize the financial returns to
the Company. If needed, the Company's Revolver Facility provides funds for
liquidity, seasonal borrowing needs and other general corporate purposes.
15
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
The primary use of cash in investing activities consists of capital
expenditures. The Company incurs capital expenditures to build out new
facilities, including growth initiatives, to expand or reposition existing
facilities and to maintain the quality and operations of existing facilities.
The Company's capital expenditures in the first half of 1998 and 1997 totaled
$39.0 million and $27.4 million, respectively. For the entire fiscal year of
1998, the Company presently expects to make capital expenditure investments of
approximately $60.0 million in its core markets (domestic airport and travel
plaza business lines) and $15.0 million in growth markets (international
airports, food courts in U.S. shopping malls and other venues). The timing of
actual capital expenditures can vary from that expected due to issues pertaining
to project scheduling inherent in the construction and approval process. The
Company expects to fund 1998 expenditures with its operating cash flow.
The Company's cash used in financing activities in the first half of 1998 was
$12.4 million, compared with cash used in financing activities of $1.7 million
for the same period in 1997. The Company announced a share repurchase program
during 1997 for the repurchase of up to $15.0 million of the Company's stock on
the open market over a two-year period and as of the end of 1997, shares had
been repurchased at an aggregate purchase price of $3.5 million. The Company
purchased additional treasury stock during the first half of 1998 totaling $11.4
million. Subsequent to the end of the second quarter of 1998, the Company
completed the entire share repurchase program. The Company is considering a new
share repurchase program, pending necessary approvals, which will be similar in
size to or larger than the share repurchase program announced in 1997. The new
program, if approved, will be funded by available cash and will not interfere
with the Company's growth plans. In addition to treasury share repurchases, cash
used in financing activities during the first half of 1998 consisted of a $3.5
million payment in settlement of the Company's obligation to pay for the 1997
exercise of nonqualified stock options and the 1997 release of deferred stock
incentive shares held by certain former employees of Host Marriott Corporation
and $0.2 million of foreign currency translation adjustments. Offsetting these
cash outflows for financing activities in the first half of 1998 were proceeds
received for the issuance of common shares relating to the Company's employee
stock and option plans totaling $2.3 million and for the issuance of debt
totaling $0.9 million.
Cash used in financing activities in the first half of 1997 was primarily due to
a $2.2 million payment in settlement of the Company's obligation for the 1996
exercise of nonqualified stock options and release of deferred stock incentive
shares held by certain former employees of Host Marriott Corporation. In
addition, the Company had $0.7 million of debt repayments and $0.4 million of
foreign currency translation adjustments. Offsetting these cash payments was
cash received from issuance of common shares relating to the Company's employee
stock and option plans totaling $1.6 million.
The Company's consolidated earnings before interest expense, taxes,
depreciation, amortization and other non-cash items ("EBITDA") increased 8.8% to
$33.4 million in the second quarter of 1998. EBITDA increased 8.3% to $49.4
million for the first half of 1998. The EBITDA to revenue margin decreased
slightly to 10.4% compared to 10.5% in the second quarter of 1997 and remained
level at 8.2% for both the first half of 1998 and 1997. The cash interest
coverage ratio (defined as EBITDA to interest expense less amortization of
deferred financing costs) was 3.5 to 1.0 in the first half of 1998 compared with
3.0 to 1.0 for the same period in 1997. The Company believes that EBITDA is one
meaningful measure of its operating performance and is used by certain investors
to estimate the Company's ability to service debt, fund capital investments and
expand its business. EBITDA information should not be considered an alternative
to net income, operating profit, cash flows from operations, or any other
operating or liquidity performance measure recognized by Generally Accepted
Accounting Principles ("GAAP"). The calculation of EBITDA for the Company may
not be comparable to the same calculation by other companies because the
definition of EBITDA varies throughout the industry.
16
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
The following is a reconciliation of net income to EBITDA:
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
------------------------- -----------------------------
JUNE 19, JUNE 20, JUNE 19, JUNE 20,
(IN MILLIONS) 1998 1997 1998 1997
------------------------------------- ----------- ------------- -- --------------- -------------
<S> <C> <C> <C> <C>
NET INCOME $ 6.2 $ 5.1 $ 2.3 $ 0.8
Interest expense (1) 9.2 9.2 18.4 18.4
Provision for income taxes 3.7 3.3 1.1 0.5
Depreciation and amortization 14.0 12.3 26.5 24.8
Other non-cash items 0.3 0.8 1.1 1.1
------------------------------------- ----------- ------------- -- --------------- -------------
EBITDA $ 33.4 $ 30.7 $ 49.4 $ 45.6
------------------------------------- ----------- ------------- -- --------------- -------------
<FN>
(1) Amortization of deferred financing costs of $0.3 million and $0.4
million for the second quarter of 1998 and 1997, respectively, is
included as a component of interest expense. Amortization of
deferred financing costs of $0.6 million and $0.6 million for the
first half of 1998 and 1997, respectively, is included in interest
expense.
</FN>
</TABLE>
Excluding the $0.4 million in non-recurring interest income in the second
quarter of 1997, EBITDA would have increased by 10.2% for the second quarter of
1998 compared to the same period in 1997 and the EBITDA margin would have
remained level at 10.4% between the periods. Excluding the non-recurring
interest income, EBITDA would have increased by 9.3% for the first half of 1998
compared to the same period in 1997 and the EBITDA margin would have increased
to 8.2% in the first half of 1998 from 8.1% in the first half of 1997.
IMPAIRMENTS OF LONG-LIVED ASSETS
Effective September 9, 1995, the Company adopted SFAS No. 121, which requires
that an impairment loss be recognized when the carrying amount of an asset
exceeds the sum of the estimated undiscounted future cash flows of the asset. In
adopting SFAS No. 121 (and thereby changing its method of measuring long-lived
asset impairments from a business-line basis to an individual operating-unit
basis), the Company wrote down the assets (primarily leasehold improvements and
equipment) of 15 individual operating units to the extent the carrying value of
the assets exceeded the fair value of the assets in 1995. Twelve of the fifteen
units had projected cash flow deficits, and, accordingly, the assets of these
units were written-off in their entirety. The remaining three units had
projected positive cash flows and the assets were partially written down to
their estimated fair values.
During 1996 and 1997, 6 of the original 15 impaired units were either disposed
of or the lease term expired. As of June 19, 1998, the total cash flow deficit
(including operating cash flows and necessary capital expenditures) from the
remaining 9 operating units was projected to be approximately $10.0 million over
the remaining weighted-average life of the contracts of 3.8 years. Substantially
all of the remaining deficit is attributable to three operating units, which
include two airport units and one tollroad unit.
DEFERRED INCOME TAXES
Realization of the net deferred tax assets totaling $69.0 million as of June 19,
1998, is dependent on the Company's ability to generate future taxable income.
Management believes that it is more likely than not that future taxable income
will be sufficient to realize the net deferred tax assets recorded at June 19,
1998. Management anticipates that increases in taxable income will arise in
future periods primarily as a result of the Company's growth strategies and
profit improvement resulting from several strategic initiatives focused on the
Company's business processes. The anticipated improvement in operating results
is expected to increase the taxable income base to a level that would allow
realization of the existing net deferred tax assets within nine to twelve years.
During the second quarter of 1998, the Company revised its interim effective tax
rate to reflect the reversal of the valuation allowance for the estimated
benefit of recognizing certain tax credits that were previously
17
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
considered unrealizable. During the third quarter of 1997, the Company recorded
a $1.9 million benefit to recognize certain tax credits that were previously
considered unrealizable.
Future levels of operating income and other taxable gains are dependent upon
general economic and industry conditions, including airport and tollroad
traffic, inflation, competition, demand for development of concepts and other
factors beyond the Company's control, and no assurance can be given that
sufficient taxable income will be generated for full utilization of the tax
credits and deductible temporary differences giving rise to the net deferred tax
assets. Management has considered these factors in reaching its conclusion that
it is more likely than not that operating income will be sufficient to realize
the net deferred tax assets. The amount of the net deferred tax assets
considered realizable, however, could be reduced if estimates of future taxable
income are not achieved.
YEAR 2000
The Company is currently working to resolve the potential impact of the Year
2000 on the Company's operations. The Year 2000 problem is the result of
computer programs being written using two digits (rather than four) to define
the applicable year. Any of the Company's programs or computer hardware and
electronic equipment that have time-sensitive software or computer chips may
recognize a date using "00" as a date other than the Year 2000, which could
result in miscalculations or system failures. If the Company, its customers or
its vendors are unable to resolve such processing issues in a timely manner, it
could result in a material financial risk. Accordingly, the Company is devoting
resources to resolve all significant Year 2000 issues in a timely manner as they
are identified. An action plan consisting of three phases was formulated in 1997
and phase one was completed in the first quarter of 1998. The first phase
consisted of a formulation of an overall assessment of the issues and
documentation of an action plan. The Company anticipates that all mission
critical information technology systems at corporate headquarters, which perform
financial management processes, will be Year 2000 compliant by the end of 1998.
Full completion of the action plan should occur in 1999.
The Company currently anticipates the funding of external costs for its Year
2000 systems compliance program will total approximately $1.5 million in 1998,
$1.5 million in 1999 and $0.5 million in 2000. Additionally, final remediation
may require further capital investments to replace equipment and software.
During the first half of 1998, $0.4 million of the estimated $1.5 million in
external costs were incurred relating to Year 2000 implementation.
In addition to the risks noted above, the Company's operations may also be
affected by Year 2000 issues facing the Federal Aviation Administration related
to air traffic control and security systems used in airports. These issues could
potentially lead to degraded flight safety, grounded or delayed flights,
increased airline costs and customer inconvenience. Since the Company is not
responsible for addressing these issues, it cannot control or predict the impact
on future operations of the Year 2000 as it pertains to air traffic control and
airport security systems.
FORWARD LOOKING STATEMENTS
This report, the Company's other reports filed with the Securities and Exchange
Commission or furnished to shareholders and its public statements and press
releases may contain "forward-looking statements" within the meaning of the
federal securities laws, including statements concerning the Company's outlook
for 1998 and beyond; the growth in total revenue in 1998 and subsequent years;
the amount of additional revenues expected from new domestic and international
shopping mall food court and airport contracts that were added in 1997 or that
are expected to be added or renewed in 1998 and subsequent years; anticipated
retention rates of existing contracts in core business lines; capital spending
plans; projected cash flows from certain operating units; business strategies
and their anticipated results; and similar statements concerning future events
and expectations that are not historical facts.
18
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
These forward-looking statements are subject to numerous risks and
uncertainties, including the effects of seasonality, airline and tollroad
industry fundamentals and general economic conditions (including the current
economic downturn in Asia), competitive forces within the food, beverage and
retail concessions industries, the availability of cash flow to fund future
capital expenditures, government regulation and the potential adverse impact of
the Year 2000 issue on operations. For further information concerning risks
applicable to the Company's operations, see the Company's Form 10-K.
Forward-looking statements are inherently uncertain, and investors must
recognize that actual results could differ materially from those expressed or
implied by the statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Not applicable.
19
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION AND SIGNATURE
ITEM 1. LEGAL PROCEEDINGS
LITIGATION
The Company and its subsidiaries are involved in litigation incidental to
their businesses. Such litigation is not considered by management to be
significant and its resolution would not have a material adverse effect on
the financial condition or results of operations of the Company or its
subsidiaries.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareholders was held on May 5, 1998 in Chantilly,
VA. At the meeting, Rosemary M. Collyer, William W. McCarten, and William
J. Shaw were elected to the Board of Directors of the Company for
three-year terms expiring at the 2001 Annual Meeting of Shareholders. The
results of the election of Rosemary M. Collyer, were 28,509,033 votes for
and 959,200 votes withheld. The results of the election of William W.
McCarten were 28,917,263 votes for and 550,970 votes withheld. The results
of the election of William J. Shaw were 28,926,391 votes for and 541,842
votes withheld. Other members of the Company's Board of Directors are:
Richard E. Marriott
J.W. Marriott, Jr.
R. Michael McCullough
Gilbert T. Ray
Andrew J. Young
In addition to the election of Rosemary M. Collyer, William W. McCarten and
William J. Shaw, the shareholders ratified the appointment of Arthur
Andersen LLP as the Company's independent auditors. The results of the
appointment of Arthur Andersen LLP were 29,325,931 votes for, 61,392 votes
against and 80,910 votes withheld.
The shareholders ratified the amendment of the Company's Comprehensive
Stock Plan, increasing the number of shares of the Company's Common Stock
available to be awarded under the Plan from 6.5 million to 10 million
shares. The results of the amendment of the Comprehensive Stock Plan were
20,316,915 votes for, 4,537,383 votes against, 200,673 votes withheld and
4,413,262 broker non-votes.
The shareholders ratified the amendment of the Company's Employee Stock
Purchase Plan, increasing the number of shares of the Company's Common
Stock that may be purchased under the Plan from 750,000 to 1,250,000
shares. The results of the amendment of the Employee Stock Purchase Plan
were 24,235,373 votes for, 665,709 votes against, 153,889 votes withheld
and 4,413,262 broker non-votes.
ITEM 5. OTHER INFORMATION
None.
20
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION AND SIGNATURE, continued
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
11 Computations of Income Per Common Share
27 Financial Data Schedule (EDGAR Filing Only)
(b) Reports on Form 8-K:
Form 8-K dated April 16, 1998 announcing first quarter 1998 results
and containing forward-looking statements.
21
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION AND SIGNATURE, continued
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOST MARRIOTT SERVICES CORPORATION
JULY 31, 1998 /S/ BRIAN W. BETHERS
--------------- ----------------------------------
Date Brian W. Bethers
Senior Vice President
and Chief Financial
Officer (duly authorized
officer and chief
financial officer)
22
EXHIBIT 11
HOST MARRIOTT SERVICES CORPORATION
COMPUTATIONS OF INCOME PER COMMON SHARE
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWELVE WEEKS ENDED
JUNE 19, 1998 JUNE 20, 1997
------------------------------- -----------------------------
BASIC DILUTED BASIC DILUTED
------------- ----------------- ------------ ----------------
<S> <C> <C> <C> <C>
Net income available to common shareholders $ 6.2 $ 6.2 $ 5.1 $ 5.1
- --------------------------------------------------------- ------------- ----------------- -- ------------ ----------------
Shares:
Weighted average number of common
shares outstanding 34.0 34.0 34.7 34.7
Assuming distribution of shares issuable for Host
Marriott Corporation warrants in 1996, less
shares assumed purchased at applicable
market (1) --- --- --- ---
Assuming distribution of shares issuable for stock
options granted under the comprehensive stock
plan, less shares assumed purchased at
applicable market (1) --- 0.5 --- 0.3
Assuming distribution of shares issuable for Host
Marriott Corporation stock options held by former
employees of Host Marriott Corporation, less shares
assumed purchased at applicable market (1) --- 0.8 --- 0.9
Assuming distribution of shares issuable for Host
Marriott Corporation deferred stock held by former
employees of Host Marriott Corporation, less shares
assumed purchased at applicable market (1) --- 0.1 --- 0.1
Assuming distribution of shares reserved under
employee stock purchase plan, based on
withholdings to date, less shares assumed
purchased at applicable market (1) --- --- --- ---
Assuming distribution of shares granted under
deferred stock incentive plan, less shares
assumed purchased at applicable market (1) --- 0.3 --- 0.2
- --------------------------------------------------------- ------------- ----------------- -- ------------ ----------------
Total Weighted Average Common Shares Outstanding 34.0 35.7 34.7 36.2
- --------------------------------------------------------- ------------- ----------------- -- ------------ ----------------
Income Per Common Share $ 0.18 $ 0.17 $ 0.15 $ 0.14
- --------------------------------------------------------- ------------- ----------------- -- ------------ ----------------
<FN>
(1) The applicable market price for diluted income per common share is
the average market price for the period.
</FN>
</TABLE>
23
<PAGE>
EXHIBIT 11,
CONTINUED
HOST MARRIOTT SERVICES CORPORATION
COMPUTATIONS OF INCOME PER COMMON SHARE
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
TWENTY-FOUR WEEKS ENDED TWENTY-FOUR WEEKS ENDED
JUNE 19, 1998 JUNE 20, 1997
------------------------------- -------------------------------
BASIC DILUTED BASIC DILUTED
------------- ----------------- ------------ ------------------
<S> <C> <C> <C> <C>
Net income available to common shareholders $ 2.3 $ 2.3 $ 0.8 $ 0.8
- --------------------------------------------------------- ------------- ----------------- -- ------------ ------------------
Shares:
Weighted average number of common
shares outstanding 34.2 34.2 34.6 34.6
Assuming distribution of shares issuable for Host
Marriott Corporation warrants in 1996, less
shares assumed purchased at applicable
market (1) --- --- --- ---
Assuming distribution of shares issuable for stock
options granted under the comprehensive stock
plan, less shares assumed purchased at
applicable market (1) --- 0.5 --- 0.3
Assuming distribution of shares issuable for Host
Marriott Corporation stock options held by former
employees of Host Marriott Corporation, less shares
assumed purchased at applicable market (1) --- 0.8 --- 0.9
Assuming distribution of shares issuable for Host
Marriott Corporation deferred stock held by former
employees of Host Marriott Corporation, less shares
assumed purchased at applicable market (1) --- 0.1 --- 0.2
Assuming distribution of shares reserved under
employee stock purchase plan, based on
withholdings to date, less shares assumed
purchased at applicable market (1) --- --- --- ---
Assuming distribution of shares granted under
deferred stock incentive plan, less shares
assumed purchased at applicable market (1) --- 0.3 --- 0.2
- --------------------------------------------------------- ------------- ----------------- -- ------------ ------------------
Total Weighted Average Common Shares Outstanding 34.2 35.9 34.6 36.2
- --------------------------------------------------------- ------------- ----------------- -- ------------ ------------------
Income Per Common Share $ 0.07 $ 0.06 $ 0.02 $ 0.02
- --------------------------------------------------------- ------------- ----------------- -- ------------ ------------------
<FN>
(1) The applicable market price for diluted income per common share is the
average market price for the period.
</FN>
</TABLE>
24
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-01-1999
<PERIOD-START> JAN-03-1998
<PERIOD-END> JUN-19-1998
<CASH> 53,400
<SECURITIES> 0
<RECEIVABLES> 42,900
<ALLOWANCES> 19,100
<INVENTORY> 42,100
<CURRENT-ASSETS> 145,100
<PP&E> 707,300
<DEPRECIATION> 415,900
<TOTAL-ASSETS> 537,600
<CURRENT-LIABILITIES> 164,300
<BONDS> 407,000
0
0
<COMMON> 0
<OTHER-SE> (85,000)
<TOTAL-LIABILITY-AND-EQUITY> 537,600
<SALES> 599,900
<TOTAL-REVENUES> 599,900
<CGS> 177,200
<TOTAL-COSTS> 579,400
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 18,400
<INCOME-PRETAX> 3,400
<INCOME-TAX> 1,100
<INCOME-CONTINUING> 2,300
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,300
<EPS-PRIMARY> 0.07
<EPS-DILUTED> 0.06
</TABLE>
