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 18, 1999
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 23,
1999, was 33,525,690.
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
INDEX
PAGE NO.
PART I. FINANCIAL INFORMATION (UNAUDITED):
Condensed Consolidated Statements of Operations -
For the Twelve Weeks Ended and Twenty-Four Weeks
Ended June 18, 1999 and June 19, 1998 2
Condensed Consolidated Balance Sheets -
As of June 18, 1999 and January 1, 1999 3
Condensed Consolidated Statements of Cash Flows -
For the Twenty-Four Weeks Ended June 18, 1999 and
June 19, 1998 4
Condensed Consolidated Statement of Shareholders'
Deficit - For the Twenty-Four Weeks Ended
June 18, 1999 5
Notes to Condensed Consolidated Financial Statements 6-7
Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-18
Quantitative and Qualitative Disclosure about
Market Risk 19
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 20
Signature 21
Computations of Income Per Common Share 22-23
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 18, JUNE 19, JUNE 18, JUNE 19,
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES $350.0 $322.6 $658.9 $599.9
- ------------------------------------------------------------------------------------------------------------------------------
OPERATING COSTS AND EXPENSES
Cost of sales 100.9 94.7 191.2 177.2
Payroll and benefits 105.1 95.5 207.1 185.4
Rent 53.1 49.9 100.9 94.3
Royalties 8.0 7.0 14.8 12.9
Depreciation and amortization 15.7 13.5 30.8 25.5
General and administrative 14.1 13.5 28.4 27.1
Other 32.8 30.0 62.9 57.0
- ------------------------------------------------------------------------------------------------------------------------------
Total operating costs and expenses 329.7 304.1 636.1 579.4
- ------------------------------------------------------------------------------------------------------------------------------
OPERATING PROFIT 20.3 18.5 22.8 20.5
Interest expense (9.6) (9.2) (19.0) (18.4)
Interest income 0.2 0.6 0.4 1.3
- ------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE 10.9 9.9 4.2 3.4
Provision for income taxes 4.3 3.7 1.7 1.1
- ------------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of change in
accounting principle 6.6 6.2 2.5 2.3
Cumulative effect of change in accounting for start-up
activities, net of tax benefit of $0.5 million --- --- (0.7) ---
- ------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 6.6 $6.2 $ 1.8 $2.3
- ------------------------------------------------------------------------------------------------------------------------------
INCOME PER COMMON SHARE
Basic:
Income before cumulative effect of change in
accounting principle $0.20 $0.18 $0.07 $0.07
Cumulative effect of change in accounting for
start-up activities --- --- (0.02) ---
- ------------------------------------------------------------------------------------------------------------------------------
Net income $0.20 $0.18 $0.05 $0.07
- ------------------------------------------------------------------------------------------------------------------------------
Diluted:
Income before cumulative effect of change in
accounting principle $0.19 $0.17 $0.07 $0.06
Cumulative effect of change in accounting for
start-up activities --- --- (0.02) ---
- ------------------------------------------------------------------------------------------------------------------------------
Net income $0.19 $0.17 $0.05 $0.06
- ------------------------------------------------------------------------------------------------------------------------------
Weighted Average Common Shares Outstanding:
Basic 33.6 34.0 33.7 34.2
Diluted 34.7 35.7 34.7 35.9
</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 18, JANUARY 1,
1999 1999
- -------------------------------------------------------------------------------- ---------------- -- ----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 33.9 $ 44.4
Accounts receivable, net 34.2 28.9
Inventories 41.4 41.1
Deferred income taxes 17.7 17.4
Prepaid rent 9.5 7.4
Other current assets 10.2 7.9
- -------------------------------------------------------------------------------- ---------------- -- ----------------
Total current assets 146.9 147.1
Property and equipment, net 339.1 314.2
Intangible assets 21.3 22.1
Deferred income taxes 62.8 62.2
Other assets 20.8 21.4
- -------------------------------------------------------------------------------- ------------------ ----------------
Total assets $ 590.9 $ 567.0
- -------------------------------------------------------------------------------- ---------------- -- ----------------
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 87.2 $ 79.7
Accrued payroll and benefits 41.7 44.5
Accrued interest payable 3.4 4.8
Current portion of long-term debt 1.2 1.1
Borrowings under line-of-credit agreement 27.7 11.6
Other current liabilities 40.6 40.4
- -------------------------------------------------------------------------------- ---------------- -- ----------------
Total current liabilities 201.8 182.1
Long-term debt 406.0 405.9
Other liabilities 55.9 51.6
- -------------------------------------------------------------------------------- ---------------- -- ----------------
Total liabilities 663.7 639.6
Common stock, no par value, 100 million shares authorized,
35,930,162 shares issued as of June 18, 1999 and
35,739,180 shares issued as of January 1, 1999 --- ---
Contributed deficit (105.8) (105.8)
Retained earnings 61.0 59.2
Accumulated other comprehensive income --- 0.1
Treasury stock - 2,360,510 shares at June 18, 1999
and 2,104,110 shares at January 1, 1999 (28.0) (26.1)
- -------------------------------------------------------------------------------- ---------------- -- ----------------
Total shareholders' deficit (72.8) (72.6)
- -------------------------------------------------------------------------------- ---------------- -- ----------------
Total liabilities and shareholders' deficit $ 590.9 $ 567.0
- -------------------------------------------------------------------------------- ---------------- -- ----------------
</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 18, JUNE 19,
1999 1998
- -------------------------------------------------------------------------------- ---------------- -- -----------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 1.8 $ 2.3
Cumulative effect of change in accounting principle, net of taxes 0.7 ---
- -------------------------------------------------------------------------------- ---------------- -- -----------------
Net income before cumulative effect of change in accounting principle 2.5 2.3
Adjustments to reconcile net income to cash from operations:
Depreciation and amortization 31.5 26.5
Amortization of deferred financing costs 0.6 0.6
Deferred income taxes (0.9) (1.1)
Other 0.2 3.5
Working capital changes:
Increase in accounts receivable (2.0) (1.8)
Increase in inventories (0.7) (1.4)
Increase in other current assets (5.1) (2.7)
Increase in accounts payable and accruals 3.1 0.3
- -------------------------------------------------------------------------------- ---------------- -- -----------------
Cash provided by operations 29.2 26.2
INVESTING ACTIVITIES
Capital expenditures (57.7) (34.9)
Other, net 4.5 (3.6)
- -------------------------------------------------------------------------------- ---------------- -- -----------------
Cash used in investing activities (53.2) (38.5)
FINANCING ACTIVITIES
Repayments of long-term debt (0.6) (0.6)
Issuance of long-term debt --- 0.9
Net borrowings under line-of-credit agreement 16.1 ---
Proceeds from stock issuances 1.7 2.3
Payment to Host Marriott Corporation for Marriott International
options and deferred shares (1.7) (3.5)
Purchases of treasury stock (1.9) (11.4)
Other (0.1) (0.1)
- -------------------------------------------------------------------------------- ---------------- -- -----------------
Cash provided by (used in) financing activities 13.5 (12.4)
DECREASE IN CASH AND CASH EQUIVALENTS (10.5) (24.7)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 44.4 78.1
- -------------------------------------------------------------------------------- ---------------- -- -----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 33.9 $ 53.4
- -------------------------------------------------------------------------------- ---------------- -- -----------------
</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 18, 1999
(IN MILLIONS)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON OTHER
SHARES CONTRIBUTED RETAINED COMPREHENSIVE TREASURY
OUTSTANDING DEFICIT EARNINGS INCOME STOCK TOTAL
- ----------------- ------------------------------------ -------------- ----------- ---------------- ----------- ------------
<C> <S> <C> <C> <C> <C> <C>
33.6 Balance, January 1, 1999 $(105.8) $59.2 $ 0.1 $ (26.1) $(72.6)
- ----------------- ------------------------------------ -------------- ----------- ---------------- ----------- ------------
Comprehensive income:
--- Net income --- 1.8 --- --- 1.8
Foreign currency translation
--- adjustments --- --- (0.1) --- (0.1)
- ----------------- -------------------------------------- ------------ ----------- ---------------- ----------- ------------
--- Total comprehensive income --- 1.8 (0.1) --- 1.7
Common stock issued for
0.2 employee stock and option plans 1.7 --- --- --- 1.7
Payment to Host Marriott
Corporation for Marriott
International options
--- and deferred shares (1.7) --- --- --- (1.7)
(0.2) Treasury stock purchases --- --- --- (1.9) (1.9)
- ----------------- -------------------------------------- ----------------------- ---------------- ----------- ------------
33.6 BALANCE, JUNE 18, 1999 $(105.8) $ 61.0 $ --- $ (28.0) $ (72.8)
- ----------------- -------------------------------------- ------------ ----------- ---------------- ----------- ------------
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO 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 1, 1999 ("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 18, 1999 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 1999 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 awarded to certain key executives. As of June 18,
1999, there were 823,000 restricted share awards outstanding, of which
approximately 751,000 were restricted shares issued in 1998 and 72,000 were
shares issued in prior years and will be released upon retirement of
certain executives.
Compensation expense related to the 751,000 shares awarded in 1998 consists
of 256,000 shares in an annual time-based component as well as 495,000
shares in a performance-based component. Compensation expense under both
components is calculated using the fair value of the shares on the date of
issuance and is contingent on continued employment. The vesting, and
corresponding compensation expense, of the 256,000 shares under the annual
time-based component occurs ratably over a three-year period beginning on
the grant date. The vesting, and corresponding compensation expense, of the
495,000 shares under the performance-based component can be accelerated
from a maximum seven-year period to a minimum three-year period by the
attainment of certain performance criteria as the average stock price must
meet or exceed the 75th percentile total shareholder returns of the Russell
2000 index during fiscal years 2001 through 2005.
Restricted share awards outstanding from prior grants totaled 256,000 at
the end of fiscal year 1998. During the first quarter of 1999, 131,000
shares were released, 53,000 shares were forfeited and the remaining 72,000
shares will be released upon retirement of certain executives.
4. During the first quarter of 1999, the Company adopted 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." As a result of the adoption of SOP 98-1, the Company
capitalized internal payroll and benefits costs of $0.1 million in the
second quarter and $0.2 million in the first half of 1999 that previously
would have been expensed. The adoption of SOP 98-5 in the first quarter of
1999 resulted in a $0.7 million charge, net of tax benefit of $0.5 million,
for a change in accounting principle. The Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income," during 1998 and the adoption did not have a material effect on the
Company's 1998 consolidated financial statements.
6
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
5. In the first half of 1999, the Company incurred a capital lease obligation
when it entered into a lease for new equipment totaling $0.7 million.
6. The Company's management evaluates the performance of each of its three
operating segments based on profit or loss from operations before
allocation of general and administrative expenses, interest, income taxes
and cumulative effects of changes in accounting principles. 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 business segments are provided in the
following tables.
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
--------------------------- -----------------------------
JUNE 18, JUNE 19, JUNE 18, JUNE 19,
(IN MILLIONS) 1999 1998 1999 1998
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES:
Airports $ 263.6 $ 242.7 $ 509.9 $ 460.2
Travel plazas 80.1 75.5 137.6 130.7
Shopping malls 6.3 4.4 11.4 9.0
------------------------------------------------------------------------------------------
Total segment revenues $ 350.0 $ 322.6 $ 658.9 $ 599.9
------------------------------------------------------------------------------------------
OPERATING PROFIT (LOSS):(1)
Airports $ 26.9 $ 26.7 $ 47.1 $ 46.2
Travel plazas 7.9 5.8 5.2 2.1
Shopping malls (0.4) (0.5) (1.1) (0.7)
------------------------------------------------------------------------------------------
Total segment operating profit $ 34.4 $ 32.0 $ 51.2 $ 47.6
------------------------------------------------------------------------------------------
<FN>
(1) Before general and administrative expenses.
</FN>
</TABLE>
<TABLE>
<CAPTION>
JUNE 18, JANUARY 1,
(IN MILLIONS) 1999 1999
----------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Airports $ 368.1 $ 347.2
Travel plazas 79.3 85.2
Shopping malls 15.0 12.8
----------------------------------------------------------------------------------------------
Total segment assets $ 462.4 $ 445.2
----------------------------------------------------------------------------------------------
</TABLE>
Reconciliations of segment data to the Company's consolidated data follow:
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
-------------------------- ------------------------------
JUNE 18, JUNE 19, JUNE 18, JUNE 19,
(IN MILLIONS) 1999 1998 1999 1998
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATING PROFIT:
Segments $ 34.4 $ 32.0 $ 51.2 $ 47.6
General and administrative expenses (14.1) (13.5) (28.4) (27.1)
------------------------------------------------------------------------------------------------
Total operating profit $ 20.3 $ 18.5 $ 22.8 $ 20.5
------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
JUNE 18, JANUARY 1,
(IN MILLIONS) 1999 1999
-------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Segments $ 462.4 $ 445.2
Corporate and other 128.5 121.8
-------------------------------------------------------------------------------------------
Total assets $ 590.9 $ 567.0
-------------------------------------------------------------------------------------------
</TABLE>
The Company's largest branded concept, Burger King, accounted for 10.4% of
total revenues in the second quarter and 10.1% of total revenues in the first
half of 1999.
7
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT EVENTS
Subsequent to the end of the second quarter of 1999, an announcement was made
that a definitive agreement had been approved by the Board of Directors of
Autogrill SpA ("Autogrill") to acquire all of the outstanding common stock of
the Company. The transaction has been unanimously approved by the Board of
Directors of the Company, which will recommend the transaction to its
shareholders, and remains subject to receipt of customary regulatory approvals.
Under the terms of the agreement, the Company's shareholders will receive $15.75
per share in cash from Autogrill in a tender offer expected to commence on
August 2, 1999. The tender will remain open for a period of 20 business days and
is subject to acceptance by at least two-thirds of the Company's shareholders.
This acquisition will create the leading global operator of commercial catering
for travelers with operations in North America, Europe, Australia and Asia with
annual sales of over $2.6 billion based on 1998 results.
RESULTS OF OPERATIONS
REVENUES. Revenues for the twelve weeks ("quarter") ended June 18, 1999
increased by 8.5% to $350.0 million from the same period in 1998, with strong
revenue growth in all business lines. Revenues for the twenty-four weeks ("first
half") ended June 18, 1999 totaled $658.9 million, an increase of 9.8%. The
increase in revenues was driven by strong performance in comparable domestic
airport concession operations, the conversion of the Miami International Airport
contract from a management agreement to an operating agreement in the second
quarter of 1998, solid growth in tollroad operations and the opening of three
new mall food courts in the last nine months.
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
-------------------------------------------------------------------------------
JUNE 18, JUNE 19, JUNE 18, JUNE 19,
(IN MILLIONS) 1999 1998 CHANGE 1999 1998 CHANGE
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
REVENUES BY BUSINESS LINE
AIRPORTS:
Domestic $234.6 $215.8 8.7% $454.5 $409.5 11.0%
International 17.3 15.5 11.6 33.8 29.5 14.6
Off-airports 11.7 11.4 2.6 21.6 21.2 1.9
-----------------------------------------------------------------------------------------------------------------
Total airports 263.6 242.7 8.6 509.9 460.2 10.8
-----------------------------------------------------------------------------------------------------------------
TRAVEL PLAZAS 80.1 75.5 6.1 137.6 130.7 5.3
SHOPPING MALLS 6.3 4.4 43.2 11.4 9.0 26.7
-----------------------------------------------------------------------------------------------------------------
Total revenues $350.0 $322.6 8.5% $658.9 $599.9 9.8%
-----------------------------------------------------------------------------------------------------------------
</TABLE>
The Company's diversified branded concept portfolio, which consists of over 100
franchised, licensed or internally developed brands, 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 in all of the Company's venues increased 14.0% and
13.8% for the second quarter and first half of 1999, respectively, compared to a
year ago. Branded revenues accounted for $152.9 million of the Company's total
revenues for the second quarter of 1999 and $279.2 million for the first half of
1999. The majority of the increases relate to the Company's continued
transformation of airport locations from generic offerings to internationally
known brands and unique local concepts. Branded concept revenues in all of the
Company's venues have grown at a compound annual growth rate of 13.2% since
1996. The Company's exposure to any one brand is limited given the diversity of
brands that are offered. The Company's largest branded concept, Burger King, is
an international favorite among consumers and accounted for 10.4% of total
revenues in the second quarter of 1999 and 10.1% of total revenues in the first
half of 1999.
8
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
AIRPORTS
Airport segment revenues were up 8.6% to $263.6 million for the second quarter
and up 10.8% to $509.9 million for the first half of 1999 compared to the same
periods of 1998. The majority of the increases for the quarter and first half of
1999 resulted from strong growth in both domestic and international airport
concessions and slight growth in off-airport concessions.
Comparable domestic airport concession revenues grew 8.4% for the second quarter
of 1999 compared to the second quarter of 1998, from an estimated 1.5% growth in
domestic passenger enplanements and 6.9% growth in RPE. Comparable domestic
airport concession revenues were up 9.0% for the first half of 1999 compared to
a year ago, driven by 1.9% growth in domestic passenger enplanements and 7.1%
growth in RPE. The passenger enplanement growth is estimated by the Air
Transport Association whose member airlines represent 95% of all passenger
traffic in the United States. RPE is the primary measure of how effective the
Company is at capturing potential customers and increasing customer spending.
Moderate increases in menu prices, increased revenues from recently renovated
facilities in the Las Vegas, Minneapolis, Tampa and Charlotte airports and
various real estate maximization efforts contributed to the growth in RPE.
International airport revenues were up 11.6% to $17.3 million for the second
quarter and up 14.6% to $33.8 million for the first half of 1999 compared to the
same periods in 1998. Revenues benefited from new contracts at Shenzhen
Huangtian International Airport and Kuala Lumpur International Airport as well
as the addition of new concepts and overall enplanement increases at Schiphol
Airport in the Netherlands.
Off-airport revenues increased 2.6% to $11.7 million in the second quarter of
1999 and increased 1.9% to $21.6 million in the first half of 1999 compared to
the same periods in 1998. The closing of three off-airport locations offset the
solid performance of two tourist attraction locations and one entertainment
location in the second quarter of 1999.
Subsequent to the end of the second quarter of 1999, the Company announced a
seven-year extension at the Salt Lake City International Airport. The Company
plans to develop and redesign new concession space and refurbish existing space
by mid-2000.
TRAVEL PLAZAS
Travel plaza concession revenues were up 6.1% to $80.1 million for the second
quarter and up 5.3% to $137.6 million for the first half of 1999 when compared
to the same periods in 1998. The Company's solid growth quarter-to-quarter and
year-to-year on all of its major tollroads was due to increased traffic, the
introduction of new branded concepts, menu price increases and the benefits from
several competitor plazas closed for construction on one tollroad.
In the first half of 1999, the Company won a five-year contract for two newly
built travel plazas on the Ohio Turnpike with expected annualized revenues of
$8.0 million. The Company's four existing locations on the turnpike are expected
to be closed for renovation by the Authority in late 1999 and re-bid in early
2000.
Subsequent to the end of the second quarter of 1999, the Company announced a
memorandum of understanding with the New Jersey Turnpike Authority for a 15-year
extension on the New Jersey Turnpike to 2018. The Company's current contract was
scheduled to expire in 2003. In total, $41 million will be invested in the
project, of which the Company is funding $25 million, with the New Jersey
Turnpike Authority funding the remainder. Construction is scheduled to begin in
the Fall of 1999, with completion scheduled in mid-2002. During the 2.5 years of
construction, the Company will renovate the travel plazas in three phases to
create minimal disruption to customers. When the travel plazas are completed in
2002, revenues are expected to increase to approximately $75 million.
9
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
SHOPPING MALLS
Shopping mall concession revenues increased by 43.2% to $6.3 million for the
second quarter and increased by 26.7% to $11.4 million for the first half of
1999 when compared with the same periods in 1998, despite seasonally low traffic
periods. The increases can be attributed to the opening of the MacArthur Center
Mall in the first quarter of 1999 and the openings of the Independence Center
Mall and the Leesburg Corner Premium Outlets in the fourth quarter of 1998.
Revenues at comparable locations that have been open at least one year increased
by 2.3% for the second quarter and decreased 4.4% for the first half of 1999
compared to the same periods in 1998.
OPERATING COSTS AND EXPENSES. The Company's total operating costs and expenses
were $329.7 million for the second quarter of 1999, or 94.2% of total revenues,
compared with $304.1 million for the second quarter of 1998, or 94.3% of total
revenues. Total operating costs and expenses for the first half of 1999 were
$636.1 million, or 96.5% of total revenues, compared with $579.4 million, or
96.6% of total revenues for the first half of 1998. The 10 basis point
improvement in the operating profit margin on both a quarter-to-quarter and
year-to-year basis reflects improvements in the cost of sales, rent and general
and administrative expense margins, offset by higher payroll, depreciation and
royalty expense margins. The improved operating profit margin reflects operating
leverage benefits derived from revenue growth, price increases and reduced
operating expenses. The reduction in operating expenses was due, in part, to the
initiation, trial and utilization of loss prevention programs and the use of
internally created programs to effectively manage and monitor the Company's
labor force.
Cost of sales increased 6.5% to $100.9 million for the second quarter and
increased 7.9% to $191.2 million for the first half of 1999 compared to the same
periods in 1998. The cost of sales margin has been on a downward trend over the
past two years - from 29.2% in 1997 to 28.8% in 1999. Cost of sales as a
percentage of total revenues improved 50 basis points during both the second
quarter and first half of 1999. This improvement has been driven by food and
beverage locations and reflects the impact of pricing and the utilization of
loss prevention programs in 1999.
Payroll and benefits totaled $105.1 million and $207.1 million for the second
quarter and first half of 1999, a 10.1% increase over the second quarter of 1998
and an 11.7% increase over the first half of 1998. Payroll and benefits as a
percentage of total revenues increased 40 basis points to 30.0% for the second
quarter and increased 50 basis points to 31.4% for the first half of 1999
compared to the comparable periods in 1998. The increases in payroll and
benefits margins for the second quarter and first half of 1999 were driven by an
increase in payroll costs due to tight labor markets. The Company is addressing
the tight labor markets with increased emphasis on recruitment and retention as
well as with training in and more consistent use of technology previously put in
place for labor productivity and scheduling.
Rent expense totaled $53.1 million for the second quarter of 1999, an increase
of 6.4% above the comparable period in 1998. Rent expense increased 7.0% to
$100.9 million in the first half of 1999 compared to a year ago. As a percentage
of total revenues, rent expense improved 30 basis points for the second quarter
and 40 basis points for the first half of 1999 and can be attributed to sales
increases on contracts with fixed rental rates and new or renewed contracts with
favorable rent margins.
Royalties expense increased by 14.3% to $8.0 million for the second quarter
compared to a year ago and increased 14.7% to $14.8 million for the first half
of 1999 compared to the same periods in 1998. As a percentage of total revenues,
royalties expense increased by 10 basis points for both the second quarter and
first half of 1999. The increases in royalties expense reflects the Company's
continued introduction of branded concepts to its airport concession operations
and the continued expansion into the heavily branded shopping mall food court
concession business. Royalties expense as a percentage of branded sales averaged
5.9% and 6.1% in the second quarter of 1999 and 1998, respectively, and totaled
5.9% and 6.1% for the first half of 1999 and 1998, respectively. The margin
improvements can be attributed to the addition of branded concepts with
lower-than-average royalty percentages. Branded facilities generate higher sales
per square foot, contribute toward increased RPE and position the Company to win
and retain concession contracts.
10
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
Depreciation and amortization expense, excluding $0.4 million of corporate
depreciation on property and equipment, which is included as a component of
general and administrative expenses, was $15.7 million for the second quarter of
1999, compared to $13.5 million, excluding $0.5 million of corporate
depreciation on property and equipment, for the second quarter of 1998.
Depreciation and amortization for the first half of 1999 and 1998 totaled $30.8
million and $25.5 million, excluding $0.7 million and $1.0 million of corporate
depreciation on property and equipment, respectively. The 30 basis point
increase for the second quarter and the 40 basis point increase for the first
half of 1999 in the depreciation and amortization expense margins are attributed
to the increased level of capital investments to win new contracts, to extend
existing contracts and to introduce branded facilities.
General and administrative expenses were $14.1 million for the second quarter of
1999, an increase of 4.4% from a year ago. General and administrative expenses
for the first half of 1999 increased 4.8% to $28.4 million compared to the first
half of 1998. These increases were primarily attributable to incremental
external Year 2000 costs of $0.6 million in the second quarter and $1.4 million
in the first half of 1999 compared to a year ago. The general and administrative
expense margin, which reflects leverage benefits from revenue growth, improved
20 basis points for both the second quarter and the first half of 1999 despite
the increases in Year 2000 costs. Excluding Year 2000 costs, the general and
administrative expense margin would have improved 30 basis points for the second
quarter and 50 basis points for the first half of 1999 compared to the same
periods in 1998.
Other operating expenses, which include utilities, casualty insurance, equipment
maintenance, trash removal and other miscellaneous expenses, increased 9.3% to
$32.8 million for the second quarter of 1999 when compared to the second quarter
of 1998. Other operating expenses increased 10.4% in the first half of 1999 to
$62.9 million compared to a year ago. As a percentage of total revenues, other
operating expenses increased 10 basis points for the second quarter of 1999 and
remained unchanged for the first half of 1999 compared to a year ago.
OPERATING PROFIT. As a result of the changes in revenues and operating costs and
expenses discussed above, operating profit increased to $20.3 million, or 5.8%
of revenues, for the second quarter of 1999 from $18.5 million, or 5.7% of
revenues, for the second quarter of 1998. Operating profit improved 11.2% to
$22.8 million for the first half of 1999, or 3.5% of revenues, compared with
$20.5 million, or 3.4% of revenues, for the same period in 1998. Excluding $0.8
million of Year 2000 costs in the second quarter of 1999 and $0.2 million of
Year 2000 costs in the second quarter of 1998, operating profit would have
increased by 12.8% to $21.1 million in the second quarter of 1999 when compared
to the second quarter of 1998. Excluding $1.8 million of Year 2000 costs in the
first half of 1999 and $0.4 million of Year 2000 costs in the first half of
1998, operating profit would have increased by 18.3% to $24.6 million.
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
--------------------------------------------------------
JUNE 18, JUNE 19, JUNE 18, JUNE 19,
(IN MILLIONS) 1999 1998 1999 1998
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
OPERATING PROFIT (LOSS) BY BUSINESS LINE (1)
AIRPORTS:
Domestic $ 24.8 $ 24.5 $ 43.8 $ 43.0
International 0.6 0.9 1.2 1.1
Off-airports 1.5 1.3 2.1 2.1
------------------------------------------------------------------------------------------------------------------
Total airports 26.9 26.7 47.1 46.2
------------------------------------------------------------------------------------------------------------------
TRAVEL PLAZAS 7.9 5.8 5.2 2.1
SHOPPING MALLS (0.4) (0.5) (1.1) (0.7)
------------------------------------------------------------------------------------------------------------------
Total operating profit $ 34.4 $ 32.0 $ 51.2 $ 47.6
------------------------------------------------------------------------------------------------------------------
<FN>
(1) Before general and administrative expenses.
</FN>
</TABLE>
11
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
The airport segment operating profit margin, before general and administrative
expenses, declined to 10.2% and 9.2% for the second quarter and first half of
1999, respectively, compared to 11.0% and 10.0% in the same periods a year ago.
The decline in the airport segment operating profit margins primarily reflect
increased depreciation (in seasonally low periods) related to capital
investments, higher payroll cost margins due to tight labor markets and start-up
inefficiencies at new international locations offset by improved cost of sales
margins. For the entire fiscal year of 1999, the Company is forecasting higher
airport operating profit margins.
The travel plaza segment operating profit margin, before general and
administrative expenses, improved significantly to 9.9% for the second quarter
of 1999 compared to 7.7% in the second quarter of 1998. The margin for the first
half of 1999 increased to 3.8% for the first half of 1999 compared to 1.6% in
the first half of 1998. These increases reflect solid revenue growth coupled
with active management of operating costs.
The operating loss margin for the shopping mall segment, excluding general and
administrative expenses, improved to 6.3% for the second quarter of 1999 and
declined to 9.6% for the first half of 1999. The shopping mall segment reflects
seasonally low traffic and continues to be affected by start-up inefficiencies
of new malls. On a comparable basis, the shopping mall operating profit margins
increased from negatives in 1998 to a positive 4.5% for the second quarter and a
positive 1.2% for the first half of 1999.
INTEREST EXPENSE. Interest expense increased 4.3% to $9.6 million for the second
quarter and increased 3.3% to $19.0 million for the first half of 1999 compared
to the same periods in 1998. The quarter-to-quarter and year-to-year increases
reflect additional interest incurred on borrowings under the revolving credit
facility to fund capital expenditures and share repurchases.
INTEREST INCOME. Interest income decreased to $0.2 million for the second
quarter of 1999 compared to $0.6 million for the second quarter of 1998 and
decreased to $0.4 million for the first half of 1999 compared to $1.3 million
for the first half of 1998. The decreases reflect lower cash balances during the
second quarter and first half of 1999 compared to the comparable periods in
1998.
INCOME TAXES. The provision for income taxes for the second quarter of 1999 was
$4.3 million compared to $3.7 million in the second quarter of 1998, reflecting
an effective tax rate of 39.5% and 37.4%, respectively. The provision for income
taxes for the first half of 1999 and 1998 was $1.7 million and $1.1 million,
respectively, reflecting effective tax rates of 39.5% and 33.0%. The effective
tax rates for 1998 were reduced to reflect the reversal of the valuation
allowance for the estimated benefit of recognizing certain tax credits
previously thought to be unrealizable.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. The Company adopted SOP
98-5 during the first quarter of 1999 that resulted in a one-time, after-tax
write-off of deferred pre-opening costs totaling $0.7 million. The new SOP
requires pre-opening costs to be expensed as incurred in 1999 and beyond.
NET INCOME AND INCOME PER COMMON SHARE. The Company's net income for the second
quarter of 1999 increased to $6.6 million, or $0.19 per diluted common share
compared to $6.2 million, or $0.17 per diluted common share, in the second
quarter of 1998. Excluding Year 2000 costs in the second quarter of 1999 and
1998, diluted income per common share would have improved by 16%.
Net income before the change in accounting principle increased to $2.5 million
for the first half of 1999, or $0.07 per diluted common share, compared to $2.3
million, or $0.06 per diluted common share, in the first half of 1998. Net
income after the change in accounting principle decreased to $1.8 million, or
$0.05 per diluted common share, compared to $2.3 million, or $0.06 per diluted
common share, in the first half of 1998.
WEIGHTED-AVERAGE SHARES OUTSTANDING. The weighted-average number of common
shares outstanding for the second quarter of 1999 and 1998 used to calculate
basic income per common share was 33.6 million and 34.0
12
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
million, respectively. The weighted-average number of common shares outstanding
for the first half of 1999 and 1998 used to calculate basic income per common
share was 33.7 million and 34.2 million, respectively.
The weighted-average number of common shares outstanding for the second quarter
of 1999 and 1998 used to calculate diluted income per common share was 34.7
million and 35.7 million, respectively. The weighted-average number of common
shares outstanding for the first half of 1999 and 1998 used to calculate diluted
income per common share was 34.7 million and 35.9 million, respectively.
As of the end of both the first half of 1999 and year end 1998, common shares
issued and outstanding totaled 33.6 million. Shares issued under the Company's
employee stock and option plans were offset by shares purchased under the
Company's share repurchase program.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has funded its ongoing capital expenditures,
debt-service requirements and treasury purchases from cash flow generated from
ongoing operations and current cash balances. The Company has more recently
drawn on existing credit facilities to fund increased capital spending. Given
the Company's expected capital requirements in 1999 and 2000, the current
favorable interest rate environment, the benefits of increased financial
flexibility for capital investment targets and the Company's interest in
repurchasing shares, the Company proceeded with a debt refinancing plan in the
second quarter of 1999, including a cash tender offer for its Senior Notes.
Subsequent to the end of the second quarter of 1999, the Company announced the
launch of the cash tender offer and consent solicitation for its Senior Notes.
The tender offer and consent solicitation for the Senior Notes were terminated
as a result of the proposed acquisition of the Company by Autogrill. At the time
of termination, $383.4 million had been tendered representing 95.9% of the
outstanding Senior Notes.
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 May 2003. The Company
would have had to pay a premium in addition to the call price of 103.56% in
order to complete the tender for the notes prior to May 2000.
The Company is required to make semi-annual cash interest payments on the 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)
a change in control triggering event or (ii) certain asset sales in which the
proceeds are not invested in other properties within a specified period of time.
The Senior Notes are secured by a pledge of stock and are fully and
unconditionally guaranteed (limited only to the extent necessary to avoid such
guarantees being considered a fraudulent conveyance under applicable law), 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 Senior Notes 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 ("Facilities") to Host International
consisting of a $75.0 million revolving credit facility and a $25.0 million
letter of credit facility. The revolving credit facility provides for working
capital and can be used for general corporate
13
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
purposes other than hostile acquisitions. At the end of the second quarter of
1999, the Company had drawn $27.7 million of outstanding indebtedness under the
revolving credit facility at an average interest rate of 6.64%. All borrowings
under the Facilities are senior obligations of Host International and are
secured by the Company's pledge of, and first perfected interest in, all of the
capital stock of Host International and certain of its subsidiaries.
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, and provide that dividends payable to the Company are
limited to 25% of Host International's consolidated net income, as defined in
the loan agreements. In compliance with the Facilities, Host International paid
$6.5 million of dividends to the Company in the second quarter of 1999 and $4.7
million of dividends in the first quarter of 1998. 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, a change in control,
or the occurrence of certain events of default under the Senior Notes Indenture.
As of June 18, 1999 and throughout the twelve weeks and twenty-four weeks ended
June 18, 1999, the Company was in compliance with the covenants described above.
If the Autogrill acquisition of the Company is successful, the Company will need
to amend the change of control provision.
During the first quarter of 1999, an international subsidiary of the Company was
granted a $7.5 million credit facility by ABN AMRO Bank N.V. consisting of a
$6.1 million overdraft facility with a variable interest rate until February 1,
2002 and a five-year loan of $1.4 million to fund business activities, including
planned capital expenditures. As of the end of the second quarter of 1999, no
funds had been drawn on the facility.
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 deferred income taxes, totaled $34.8 million for the first
half of 1999 as compared with $32.9 million for the same period in 1998.
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 1999 and 1998 totaled
$57.7 million and $34.9 million, respectively. For the entire fiscal year of
1999, the Company expects to make capital expenditure investments between
approximately $125.0 million to $135.0 million, with $90.0 million to $100.0
million related to core markets (domestic airport and travel plaza segments) and
$35.0 million related to growth markets (international airports and food courts
in shopping malls). In the year 2000, the Company expects capital expenditures
to decline totaling approximately $115.0 million. The timing of capital
expenditures is subject to the variability in contract renewals, the timing of
new contract wins and the timing of related construction.
The Company's cash provided by financing activities in the first half of 1999
was $13.5 million, compared with cash used in financing activities of $12.4
million for the same period in 1998. During the first half of 1999, the Company
had cash inflows from line-of-credit borrowings totaling $16.1 million and
proceeds from stock issuances of $1.7 million. Offsetting these cash inflows
were cash outflows of $1.7 million for the Company's obligation to pay for the
1998 exercise of nonqualified stock options and the 1998 release of deferred
stock incentive shares held by certain former employees of Host Marriott
Corporation, $0.6 million of debt repayments and $1.9 million of treasury stock
repurchases. As of the end of the first half of 1999, approximately 0.6 million
of additional shares can be purchased under the existing treasury stock program.
Cash used in financing activities in the first half of 1998 can be primarily
attributed to $11.4 million in treasury stock repurchases, 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 $0.6
million of debt repayments. Offsetting these cash outflows were proceeds
received for the issuance of
14
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
common shares relating to the Company's employee stock and option plans totaling
$2.3 million and for issuance of debt totaling $0.9 million.
The Company's consolidated earnings before net interest expense, taxes,
depreciation, amortization and other non-cash items ("EBITDA") increased 8.5% to
$35.6 million in the second quarter of 1999. EBITDA increased 10.0% to 52.9
million for the first half of 1999. The EBITDA margin remained flat at 10.2% of
revenues for both the second quarter of 1999 and 1998 and at 8.0% for both the
first half of 1999 and 1998. Excluding external Year 2000 costs, EBITDA would
have increased by 10.3% and the EBITDA margin would have improved 20 basis
points for the second quarter of 1999. Excluding external Year 2000 costs,
EBITDA would have increased 12.8% and the EBITDA margin would have improved 20
basis points for the first half of 1999. The Company's cash interest coverage
ratio (defined as EBITDA to interest expense less amortization of deferred
financing costs for the last four quarters) was 3.1 to 1.0 as of the end of the
second quarter of 1999 and 3.4 to 1.0 as of the end of the second quarter of
1998. The Company considers EBITDA to be a meaningful measure for assessing
operating performance. EBITDA can be used to measure 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.
The following is a reconciliation of net income to EBITDA:
<TABLE>
<CAPTION>
TWELVE WEEKS ENDED TWENTY-FOUR WEEKS ENDED
----------------------------- -----------------------------
JUNE 18, JUNE 19, JUNE 18, JUNE 19,
(IN MILLIONS) 1999 1998 1999 1998
--------------------------------------------------- --------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
NET INCOME $ 6.6 $ 6.2 $ 1.8 $ 2.3
Interest expense, net (1) (2) 9.4 8.6 18.6 17.1
Provision for income taxes 4.3 3.7 1.7 1.1
Depreciation and amortization 16.1 14.0 31.5 26.5
Cumulative effect of change in accounting --- --- 0.7 ---
principle
Other non-cash items (0.8) 0.3 (1.4) 1.1
--------------------------------------------------- --------------- ------------- -------------- --------------
EBITDA $ 35.6 $ 32.8 $ 52.9 $ 48.1
--------------------------------------------------- --------------- ------------- -------------- --------------
<FN>
(1) Amortization of deferred financing costs of $0.3 million for the
second quarter of 1999 and 1998 is included as a component of
interest expense. Amortization of deferred financing costs of $0.6
million for the first half of 1999 and 1998 is included as a
component of interest expense.
(2) In fiscal year 1998, the Company changed the calculation of EBITDA
to exclude interest income, which is more consistent with industry
standards. The 1998 EBITDA has been restated to conform to the
1999 presentation.
</FN>
</TABLE>
DEFERRED INCOME TAXES
The Company has recognized net deferred tax assets of $80.5 million at June 18,
1999 and $79.6 million at January 1, 1999 which generally represent tax credit
carryforwards and tax effects of future available deductions from taxable
income.
Realization of the net deferred tax assets 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 18, 1999. Management anticipates that
increases in taxable income will arise in future periods primarily as a result
of the Company's growth strategies and reduced operating costs resulting from
the ongoing restructuring of the Company's business processes. The anticipated
improvement in operating
15
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
results is expected to increase the taxable income base to a level that would
allow realization of the existing net deferred tax assets within eight to twelve
years.
Future levels of operating income and other taxable gains are dependent upon
general economic and industry conditions, including airport and tollroad
traffic, inflation, competition and demand for development of concepts and other
factors beyond the Company's control. No assurance can be given that sufficient
taxable income will be generated to realize the benefits of future available
deductions from taxable income. Management has considered the above factors in
reaching its conclusion that it is more likely than not that operating income
will be sufficient to utilize these deferred deductions fully. The amount of the
net deferred tax assets considered realizable, however, could be reduced if
estimates of future taxable income are not achieved. Conversely, the amount of
the net deferred tax assets considered realizable could be increased if
estimates of future taxable income are achieved, weighing positive and negative
evidence judgmentally.
At the time of the Company's spin-off from Host Marriott Corporation, a deferred
tax asset valuation allowance was recognized because the Company's three year
trend of operating losses provided evidence that it was more likely than not
that all of the Company's deferred tax assets would not be realized. At the end
of the second quarter of 1999, there was approximately $21.5 million of deferred
tax asset valuation reserves recorded on the balance sheet. The Company monitors
the realizability of deferred tax assets based upon the weighing of positive and
negative evidence.
YEAR 2000
The Company is currently addressing Year 2000 issues with action plans for its:
(1) information systems, (2) embedded chip systems, including equipment that
operates such items as the Company's freezers, air conditioning and cooling
systems, fryers and security systems, (3) third-party (vendor and supplier)
relationships and (4) contingency planning.
The Company has established a Year 2000 Project Team, headed by the Chief
Information Officer, who reports to the Chief Financial Officer, to resolve
significant Year 2000 issues in a timely manner as they are identified. The
project steering team includes executive management and employees with expertise
from various disciplines including information technology, finance, internal
audit, legal and operations. In addition, the Company has retained the services
of consulting firms with particular expertise in the Year 2000 problem.
INFORMATION SYSTEMS. To date, the Company has identified 20 internal systems
that will require correction. The Company is resolving Year 2000 issues through
replacement of equipment, modification of software and replacement of certain
software systems. For mission critical systems, third-party experts have been
engaged to verify Year 2000 compliance testing. All mission critical information
technology systems at corporate headquarters, which perform financial management
processes, are Year 2000 compliant. The Company anticipates that other systems
will be compliant by the third quarter of 1999.
EMBEDDED SYSTEMS. A comprehensive inventory of the Company's mission critical
and date-sensitive embedded systems has been completed for all of the Company's
locations. All manufacturers of inventoried components utilized in the
operations have been contacted in order to determine whether the components are
Year 2000 compliant. The Company intends to remediate or replace, as applicable,
any identified non-compliant mission critical systems and expects to complete
this process by August 1999. The quality of the responses received from
manufacturers, the estimated impact of the individual system on the Company, and
the ability of the Company to perform meaningful tests will influence its
decision regarding whether to conduct independent testing of embedded systems.
16
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
THIRD-PARTY RELATIONSHIPS. Formal communications with all critical third parties
have been initiated to determine potential exposure which would result in their
failure to remediate their own Year 2000 issues. These third parties have
included the Company's supply chain, airport authorities, financial institutions
and utility companies. New business relationships with alternate providers of
products and services will be considered if deemed necessary.
RISKS/CONTINGENCY PLANS. As part of the Company's normal business practice, it
maintains plans to follow during emergency circumstances, some of which could
arise from Year 2000-related problems. The Company's contingency planning for
the Year 2000 will address various alternatives and will include assessing a
variety of scenarios to which the Company may be required to react. The Company
continues to develop its contingency plans for Year 2000 issues, and each
individual location will develop a contingency plan for the impact of Year 2000
business interruptions. The Company's operations are geographically dispersed
and it has a large supplier base, which should mitigate any adverse impact
resulting from supplier problems.
POTENTIAL RISKS. Potential sources of risk include operational disruptions
caused by equipment failure and the inability of principal suppliers to be Year
2000 compliant, which could result in delays in product deliveries from such
suppliers. Utility services, including electric, telephone and water, are
necessary for the Company's basic operations. Should any of these critical
vendors fail, the impact of any such failure could become a significant
challenge to the Company's ability to operate its facilities at individual
locations. Based on the information supplied to date by the Company's critical
vendors and suppliers, the Company believes the probability of such failures to
be low. However, the Company's action plan emphasizes continued monitoring of
the progress of these critical vendors and suppliers toward their Year 2000
compliance.
In addition, the Company's operations may also be affected by Year 2000 issues
facing the Federal Aviation Administration and the airlines related to air
traffic control systems, aircraft equipment and security systems used in
airports. These issues could potentially lead to degraded flight safety,
grounded or delayed flights, selected airport closures, 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 problem as it pertains to air traffic control and airport security
systems. If airline passenger traffic declines significantly in late 1999 and
the year 2000 as a result of Year 2000 problems experienced by the FAA or
individual airlines or the public's fear of such problems, the Company's results
of operations may be materially adversely affected.
FINANCIAL IMPLICATIONS. The Company currently estimates that external costs,
such as consulting experts, for its Year 2000 systems compliance program will
total approximately $4.0 million in 1999 and $0.5 million in 2000. The Company
currently estimates that internal costs, such as remediation coding and system
support, for Year 2000 compliance will total approximately $1.1 million in 1999
and $0.3 million in 2000. Additionally, final remediation may require further
capital investments to replace equipment and software. During the second quarter
of 1999, approximately $0.8 million in external costs and approximately $0.3
million in internal costs were incurred relating to Year 2000 implementation
compared with approximately $0.2 million in external costs and approximately
$0.2 in internal costs in the second quarter of 1998. For the first half of
1999, approximately $1.8 million in external costs and approximately $0.6
million in internal costs were incurred relating to Year 2000 implementation
compared with approximately $0.4 million in external costs and approximately
$0.3 million in internal costs in the first half of 1998. The anticipated costs
associated with the Company's Year 2000 compliance program do not include time
and costs that may be expensed as a result of the failure of any third parties,
including suppliers, to become Year 2000 compliant or costs to implement any
contingency plans.
The discussion of the Company's efforts and expectations relating to Year 2000
compliance are forward-looking statements. The Company's ability to achieve Year
2000 compliance and the level of costs associated therewith, could be adversely
impacted by, among other things, the availability and cost of programming and
testing resources, vendors' ability to modify proprietary software, and
anticipated problems identified in the ongoing compliance review.
17
<PAGE>
HOST MARRIOTT SERVICES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS, CONTINUED
The statements contained in this section are "Year 2000 Readiness Disclosures"
as provided for in the Year 2000 Information and Readiness Disclosure Act.
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 contain "forward-looking statements" within the meaning of the federal
securities laws, including, but not limited to, statements concerning the
Company's outlook for 1999 and beyond; the growth in revenues in 1999 and
subsequent years; earnings per share in 1999; the amount of additional revenues
expected from new shopping mall food court, airport and travel plaza contracts
that were added in 1999 or that are expected to be added or renewed in 1999 and
subsequent years; efforts and expectations relating to Year 2000 compliance;
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.
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
union labor strikes and the Year 2000 issue on operations. For further
information concerning risks applicable to 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.
18
<PAGE>
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates, foreign
currency exchange rates and commodity prices, which could impact results of
operations and financial condition. Changes in market interest rates over the
next year would not materially impact earnings or cash flow as the Company's
cash investments are short-term, interest rates under the revolving credit
facility are short-term and the interest rates on the long-term debt are fixed.
The Company's exposure to changes in foreign currency exchange rates is not
material to earnings or cash flows. Due to the Company's wide variety of product
offerings and diverse brand portfolio, the Company would not expect fluctuations
in commodity prices to be material to earnings or cash flows.
The fair value of fixed rate long-term debt is sensitive to changes in interest
rates, which would result in gains/losses in the market value of this debt due
to differences between the market interest rates and rates at the inception of
the debt obligation. Based on a hypothetical immediate 150 basis point increase
in interest rates at the end of the second quarters of 1999 and 1998, the market
value of fixed rate long-term debt would result in a net decrease of $26.4
million and $26.9 million, respectively. Conversely, a 150 basis point decrease
in interest rates would result in a net increase in the market value of fixed
rate long-term debt outstanding at the end of the second quarter of 1999 and
1998 of $29.1 million and $34.1 million, respectively. Changes in fair value of
the Company's long-term debt does not impact earnings or cash flows.
The Company has the ability to borrow up to $75.0 million against a revolving
credit facility. As of the end of the second quarter of 1999, borrowings
outstanding under the revolving credit facility totaled $27.7 million. The
average balance was $38.0 million for the second quarter of 1999 at an average
interest rate of 6.59%. The average balance was $39.0 million for the first half
of 1999 at an average interest rate of 6.64%. A hypothetical 10% increase or
decrease in interest rates would not have a material effect on earnings for the
second quarter or first half of 1999.
An international subsidiary of the Company has the ability to borrow up to $6.1
million against an overdraft facility. As of the end of the second quarter of
1999, no funds had been drawn on the facility.
Significant changes in commodity prices could impact future operating profit
margins and cash flows. The Company has the ability to recover from sharp
increases in commodity prices by increasing its menu prices. However, in some
instances, increases in menu prices require prior landlord approval which would
cause a delay in the Company's ability to react to significant changes in
commodity prices.
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 11, 1999 in Baltimore,
Maryland. At the meeting, J.W. Marriott, Jr. and Andrew J. Young were
elected to the Board of Directors of the Company for three-year terms
expiring at the 2002 Annual Meeting of Shareholders. The results of the
election of J.W. Marriott, Jr., were 28,880,083 votes for and 484,847 votes
withheld. The results of the election of Andrew J. Young were 28,931,602
votes for and 433,328 votes withheld. Other members of the Company's Board
of Directors are:
Rosemary M. Collyer
Richard E. Marriott
William W. McCarten
R. Michael McCullough
Gilbert T. Ray
William J. Shaw
In addition to the election of J.W. Marriott, Jr. and Andrew J. Young, 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 29,249,493 votes for, 44,866 votes against and 70,571
votes withheld.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
11 Computations of Earnings Per Common Share
27 Financial Data Schedule (EDGAR Filing Only)
(b) Reports on Form 8-K:
Form 8-K dated April 22, 1999 announcing first quarter 1999 results and
containing forward-looking statements.
20
<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 30, 1999 /S/ BRIAN W. BETHERS
- ---------------- -------------------------
Date Brian W. Bethers
Executive Vice President
and Chief Financial
Officer (duly authorized
officer and chief
financial officer)
21
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 18, 1999 JUNE 19, 1998
------------------------- -------------------------
BASIC DILUTED BASIC DILUTED
------------ ------------ ------------- -----------
<S> <C> <C> <C> <C>
Net income available to common shareholders $ 6.6 $ 6.6 $ 6.2 $ 6.2
- ------------------------------------------------------------------------ ------------ ------------ -- ------------- -----------
Shares:
Weighted average number of common
shares outstanding 33.6 33.6 34.0 34.0
Assuming distribution of shares issuable for stock
options granted under the comprehensive stock
plan, less shares assumed purchased at
applicable market (1) --- 0.1 --- 0.5
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) --- 0.6 --- 0.8
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 --- 0.3
- ------------------------------------------------------------------------ ------------ ------------ -- ------------- -----------
Total Weighted Average Common Shares Outstanding 33.6 34.7 34.0 35.7
- ------------------------------------------------------------------------ ------------ ------------ -- ------------- -----------
Income Per Common Share $ 0.20 $ 0.19 $ 0.18 $ 0.17
- ------------------------------------------------------------------------ ------------ ------------ -- ------------- -----------
<FN>
(1) The applicable market price for diluted earnings per common share is the
average market price for the period.
</FN>
</TABLE>
22
<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 18, 1999 JUNE 19, 1998
---------------------------- ------------------------
BASIC DILUTED BASIC DILUTED
-------------- ------------- ------------ -----------
<S> <C> <C> <C> <C>
Net income before cumulative effect of change in
accounting principle $ 2.5 $ 2.5 $ 2.3 $ 2.3
Cumulative effect of change in accounting principle, net of tax (0.7) (0.7) --- ---
- ---------------------------------------------------------------------- -------------- ------------- -- ------------ -----------
Net income available to common shareholders $ 1.8 $ 1.8 $ 2.3 $ 2.3
- ---------------------------------------------------------------------- -------------- ------------- -- ------------ -----------
Shares:
Weighted average number of common
shares outstanding 33.7 33.7 34.2 34.2
Assuming distribution of shares issuable for stock
options granted under the comprehensive stock
plan, less shares assumed purchased at
applicable market (1) --- 0.1 --- 0.5
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) --- 0.6 --- 0.8
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) --- 0.2 --- 0.3
- ---------------------------------------------------------------------- -------------- ------------- -- ------------ -----------
Total Weighted Average Common Shares Outstanding 33.7 34.7 34.2 35.9
- ---------------------------------------------------------------------- -------------- ------------- -- ------------ -----------
Income Per Common Share:
Before cumulative effect of change in accounting principle $ 0.07 $ 0.07 $ 0.07 $ 0.06
Cumulative effect of change in accounting principle, net of tax (0.02) (0.02) --- ---
- ---------------------------------------------------------------------- -------------- ------------- -- ------------ -----------
Income Per Common Share $ 0.05 $ 0.05 $ 0.07 $ 0.06
- ---------------------------------------------------------------------- -------------- ------------- -- ------------ -----------
<FN>
(1) The applicable market price for diluted earnings per common share is the
average market price for the period.
</FN>
</TABLE>
23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-02-1999
<PERIOD-END> JUN-18-1999
<CASH> 33,900
<SECURITIES> 0
<RECEIVABLES> 49,500
<ALLOWANCES> 12,600
<INVENTORY> 41,400
<CURRENT-ASSETS> 146,900
<PP&E> 777,800
<DEPRECIATION> 438,700
<TOTAL-ASSETS> 590,900
<CURRENT-LIABILITIES> 201,800
<BONDS> 407,200
0
0
<COMMON> 0
<OTHER-SE> (72,800)
<TOTAL-LIABILITY-AND-EQUITY> 590,900
<SALES> 658,900
<TOTAL-REVENUES> 658,900
<CGS> 191,200
<TOTAL-COSTS> 636,100
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,000
<INCOME-PRETAX> 4,200
<INCOME-TAX> 1,700
<INCOME-CONTINUING> 2,500
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (700)
<NET-INCOME> 1,800
<EPS-BASIC> 0.05
<EPS-DILUTED> 0.05
</TABLE>
