SECURITIES
AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 11, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-16777
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
Delaware 52-1508601
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(State or other jurisdiction
of incorporation or organinazation) (I.R.S. Employer Identification No.)
10400 Fernwood Road, Bethesda, MD 20817-1109
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 301-380-2070
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
Securities registered pursuant to Section 12(g) of the Act:
Units of Limited Partnership Interest
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes |X| No ____. The Partnership became subject to Section 13
reporting August 29, 1997.
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DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP
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TABLE OF CONTENTS
PAGE NO.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statement of Operations
Twelve and Thirty-Six Weeks Ended September 11, 1998 (Unaudited)
and September 12, 1997 (Unaudited)...................................1
Condensed Consolidated Balance Sheet
September 11, 1998 (Unaudited) and December 31, 1997.....................2
Condensed Consolidated Statement of Cash Flows
Thirty-Six Weeks ended September 11, 1998 (Unaudited)
and September 12, 1997 (Unaudited). .................................3
Notes to Condensed Consolidated Financial Statements (Unaudited)..............4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................7
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.................................................14
Item 6. Exhibits and Reports on Form 8-K..................................14
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited)
(in thousands, except per Unit amounts)
Twelve Weeks Ended Thirty-Six Weeks Ended
September 11, September 12, September 11, September 12,
1998 1997 1998 1997
---------------- --------------- ---------------- ----------
REVENUES (NOTE 4)
Hotel revenues
Rooms...........................................$ 5,489 $ -- $ 30,883 $ --
Food and beverage............................... 6,186 -- 30,923 --
Other........................................... 3,608 -- 18,528 --
---------------- --------------- ---------------- ---------------
Total hotel revenues.......................... 15,283 -- 80,334 --
Hotel rentals..................................... -- 5,357 -- 17,845
---------------- --------------- ---------------- ---------------
15,283 5,357 80,334 17,845
---------------- --------------- ---------------- ---------------
OPERATING COSTS AND EXPENSES
Hotel property-level costs and expenses
Rooms........................................... 2,084 -- 7,211 --
Food and beverage............................... 5,154 -- 20,778 --
Other department costs and expenses............. 2,653 -- 10,756 --
Selling, administrative and other............... 4,213 -- 13,119 --
---------------- --------------- ---------------- ---------------
Total hotel property-level costs and expenses. 14,104 -- 51,864 --
Depreciation...................................... 1,658 1,785 4,972 5,353
Base management fees.............................. 458 -- 2,410 --
Incentive management fees......................... (486) -- 1,355 --
Property taxes and other.......................... 777 547 2,416 1,711
---------------- --------------- ---------------- ---------------
16,511 2,332 63,017 7,064
---------------- --------------- ---------------- ---------------
OPERATING (LOSS) PROFIT.............................. (1,228) 3,025 17,317 10,781
Interest expense (including third quarter and
year-to-date 1998 amounts related to
Host Marriott debt of $1,759 and $5,696)........ (4,149) (3,357) (12,952) (10,127)
Interest income and other......................... 330 190 784 403
---------------- --------------- ---------------- ---------------
NET (LOSS) INCOME ...................................$ (5,047) $ (142) $ 5,149 $ 1,057
================ =============== ================ ===============
ALLOCATION OF NET (LOSS) INCOME
General Partner...................................$ (50) $ (1) $ 51 $ 11
Limited Partners.................................. (4,997) (141) 5,098 1,046
---------------- --------------- ---------------- ---------------
$ (5,047) $ (142) $ 5,149 $ 1,057
================ =============== ================ ===============
NET (LOSS) INCOME PER LIMITED
PARTNER UNIT (900 Units)..........................$ (5,552) $ (157) $ 5,664 $ 1,162
================ =============== ================ ===============
See Notes to Condensed Consolidated Financial Statements (Unaudited).
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(in thousands)
September 11, December 31,
1998 1997
(Unaudited)
ASSETS
Property and equipment, net.........................................................$ 151,151 $ 151,401
Due from Marriott Hotel Services, Inc............................................... -- 1,368
Property improvement fund........................................................... 2,750 1,598
Deferred financing, net of accumulated amortization................................. 2,925 3,000
Restricted cash reserves............................................................ 6,776 10,236
Cash and cash equivalents........................................................... 14,396 4,553
---------------- ---------------
$ 177,998 $ 172,156
================ ===============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
LIABILITIES
Mortgage debt.......................................................................$ 101,989 $ 103,000
Note payable........................................................................ 19,396 20,000
Note payable to Host Marriott Corporation and affiliates............................ 59,727 59,727
Due to Marriott Hotel Services, Inc................................................. 1,774 2,122
Accounts payable and accrued expenses............................................... 6,899 1,972
---------------- ---------------
Total Liabilities.............................................................. 189,785 186,821
---------------- ---------------
PARTNERS' CAPITAL (DEFICIT)
General Partner..................................................................... 7 (21)
Limited Partners.................................................................... (11,794) (14,644)
---------------- ---------------
Total Partners' Deficit........................................................ (11,787) (14,665)
---------------- ---------------
$ 177,998 $ 172,156
================ ===============
See Notes to Condensed Consolidated Financial Statements(Unaudited).
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
(in thousands)
Thirty-Six Weeks Ended
September 11, September 12,
1998 1997
---------------- ----------
OPERATING ACTIVITIES
Net income...........................................................................$ 5,149 $ 1,057
Noncash items........................................................................ 5,145 6,007
Changes in operating accounts........................................................ 6,760 5,910
---------------- ---------------
Cash provided by operating activities............................................ 17,054 12,974
---------------- ---------------
INVESTING ACTIVITIES
Additions to property and equipment, net............................................. (4,722) (2,054)
Change in property improvement fund.................................................. (1,152) (352)
Change in restricted cash reserves................................................... 752 --
---------------- ---------------
Cash used in investing activities................................................ (5,122) (2,406)
---------------- ---------------
FINANCING ACTIVITIES
Capital distribution to partners..................................................... (2,271) --
Change in restricted cash reserves................................................... 1,895 (9,428)
Repayment of mortgage debt........................................................... (1,011) --
Repayment of note payable............................................................ (604) (900)
Payment of refinancing costs......................................................... (98) (107)
---------------- ---------------
Cash used in financing activities................................................ (2,089) (10,435)
---------------- ---------------
INCREASE IN CASH AND CASH EQUIVALENTS................................................... 9,843 133
CASH AND CASH EQUIVALENTS at beginning of period........................................ 4,553 5,755
---------------- ---------------
CASH AND CASH EQUIVALENTS at end of period..............................................$ 14,396 $ 5,888
================ ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for mortgage and other interest............................................$ 8,421 $ 9,574
================ ===============
See Notes to Condensed Consolidated Financial Statements (Unaudited).
DESERT SPRINGS MARRIOTT LIMITED PARTNERSHIP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The accompanying condensed financial statements have been prepared by the
Desert Springs Marriott Limited Partnership (the "Partnership") 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 from the
accompanying statements. The Partnership believes the disclosures made
are adequate to make the information presented not misleading. However,
the condensed financial statements should be read in conjunction with the
Partnership's financial statements and notes thereto included in the
Partnership's Form 10-K/A for the fiscal year ended December 31, 1997.
In the opinion of the Partnership, the accompanying unaudited condensed
consolidated financial statements reflect all adjustments (which include
only normal recurring adjustments) necessary to present fairly the
financial position of the Partnership as of September 11, 1998, the
results of operations for the twelve and thirty-six weeks ended September
11, 1998 and September 12, 1997 and cash flows for the thirty-six weeks
ended September 11, 1998 and September 12, 1997. Interim results are not
necessarily indicative of fiscal year performance because of seasonal and
short-term variations (see Note 4).
For financial reporting purposes, net income of the Partnership is
allocated 99% to the limited partners and 1% to Marriott Desert Springs
Corporation (the "General Partner"). Significant differences exist
between the net income for financial reporting purposes and the net
income for Federal income tax purposes. These differences are due
primarily to the use, for income tax purposes, of accelerated
depreciation methods, shorter depreciable lives, no estimated salvage
values for the assets and differences in the timing of the recognition of
rental income.
2. Certain reclassifications were made to prior year financial statements to
conform to the 1998 presentation.
3. In connection with the mortgage debt refinancing in November 1997 (see
Note 4), the General Partner received unrevoked consents of limited
partners approving certain amendments to the partnership agreement. The
amendments, among other things, allowed the formation of certain
subsidiaries of the Partnership including Marriott DSM LLC and DS Hotel
LLC. The Partnership contributed the Hotel and its related assets to
Marriott DSM LLC, which in turn contributed them to DS Hotel LLC, a
bankruptcy remote subsidiary. Marriott DSM LLC, a bankruptcy remote
subsidiary of the Partnership, owns 100% interest in DS Hotel LLC. The
Partnership owns 100% interest in Marriott DSM LLC.
4. On November 25, 1997, the Partnership completed a refinancing of its
mortgage debt. In connection with the refinancing, the Partnership
converted its operating lease with Marriott Hotel Services, Inc. ("MHS")
to a management agreement (the "Conversion"). Prior to the Conversion,
the Partnership recognized estimated annual hotel rental income on a
straight-line basis throughout the year. The profits from the Marriott's
Desert Springs Resort and Spa (the "Hotel") are seasonal and first and
second quarter results are generally higher than the last two quarters of
the year. Lease payments in excess of the income recognized by the
Partnership were deferred and, to the extent not subject to possible
future repayment to the Hotel tenant, were recognized as income during
the remainder of the year. Pursuant to the terms of the Operating Lease,
Annual Rental, as defined, was equal to the greater of Basic Rental
(80% of Operating Profit, as defined) and Owner's Priority, as defined.
Additionally, the Hotel tenant was required to pay property taxes, make
contributions equal to a percentage of Hotel sales to a property
improvement fund (4.5% in 1997 and 5.5% thereafter) and pay rental on the
second golf course.
Subsequent to the Conversion, the Partnership applied EITF 97-2,
"Application of FASB Statement No. 94 and APB Opinion No. 16 to Physician
Practice Management Entities and Certain Other Entities with Contractual
Management Arrangements." As a result, the Partnership now records as
revenues gross sales generated by the Hotel. Hotel property-level costs
and expenses reflect all property-level costs and expenses.
The following are summaries of hotel revenues and Partnership operating
costs and expenses on a comparative basis, for the twelve and thirty-six
weeks ended September 11, 1998 and September 12, 1997 (in thousands).
Hotel revenues and Partnership operating costs and expenses for the
twelve and thirty-six weeks ended September 12, 1997 are a "pro forma"
presentation which assumes the Conversion occurred at the beginning of
fiscal year 1997. In this pro forma presentation, hotel revenues include
property-level sales; operating costs and expenses include hotel
property-level costs and expenses, base and incentive management fees and
certain other expenses such as insurance and equipment rent.
Twelve Weeks Ended Thirty-Six Weeks Ended
September 11, September 12, September 11, September 12,
1998 1997 1998 1997
--------------- --------------- ---------------- ----------
(pro forma) (pro forma)
HOTEL REVENUES
Hotel revenues
Rooms.................................$ 5,489 $ 4,747 $ 30,883 $ 27,812
Food and beverage..................... 6,186 5,156 30,923 28,143
Other................................. 3,608 3,171 18,528 16,494
--------------- --------------- ---------------- ---------------
Total hotel revenues...............$ 15,283 $ 13,074 $ 80,334 $ 72,449
=============== =============== ================ ===============
OPERATING COSTS AND EXPENSES
Hotel property-level costs and expenses
Rooms.................................$ 2,084 $ 1,786 $ 7,211 $ 6,320
Food and beverage..................... 5,154 4,594 20,778 18,960
Other hotel operating expenses........ 6,866 6,666 23,875 22,431
--------------- --------------- ---------------- ---------------
Total hotel property-level costs
and expenses..................... 14,104 13,046 51,864 47,711
Depreciation............................ 1,658 1,785 4,972 5,353
Base management fees.................... 458 392 2,410 2,173
Incentive management fees............... (486) (204) 1,355 1,458
Property taxes and other................ 777 686 2,416 2,159
--------------- --------------- ---------------- ---------------
Total operating costs and expenses $ 16,511 $ 15,705 $ 63,017 $ 58,854
=============== =============== ================ ===============
5. Pursuant to the terms of the management agreement, MHS earns an
incentive management fee based on Operating Profit as defined. For fiscal
year 1998, the Partnership is entitled to the first $21.5 million of
Operating Profit (the "Owner's Priority"). Thereafter, MHS will receive
the next $1.8 million of Operating Profit as an incentive management fee
and any operating profit in excess of $23.3 million will be divided 75%
to the Partnership and 25% to MHS. Any such payments will be made
annually after completion of the audit of the Partnership's financial
statements. For interim reporting purposes, the Partnership estimates the
total expected annual incentive management fee and accrues it quarterly
based on operating results for that quarter. Pursuant to the terms of the
management agreement, contributions to the property improvement fund
in 1998 are 5.5% of gross Hotel sales, a one percentage point increase
over the prior year level.
6. Host Marriott Corporation ("Host Marriott"), the parent company of the
General Partner of the Partnership, has adopted a plan to restructure its
business operations so that it will qualify as a real estate investment
trust("REIT"). As part of this restructuring (the "REIT Conversion"),
Host Marriott and its consolidated subsidiaries will contribute their
full-service hotel properties and certain other businesses and assets to
Host Marriott, L.P., a Delaware limited partnership (the "Operating
Partnership"), in exchange for units of limited partnership interest in
the Operating Partnership ("OP Units")and the assumption of liabilities.
As part of the REIT Conversion, Host Marriott proposes to merge into HMC
Merger Corporation (to be renamed "Host Marriott Corporation"),
a Maryland corporation ("Host REIT"), and thereafter continue and expand
its full-service hotel ownership business. Host REIT expects to qualify
as a REIT beginning with its first full taxable year commencing after the
REIT Conversion is completed, which Host Marriott currently expects to be
the year beginning January 1, 1999 (but which might not be until the year
beginning January 1, 2000). Host REIT will be the sole general partner
of the Operating Partnership.
The Operating Partnership is proposing to acquire by merger (the
"Merger") the Partnership. The Limited Partners in the Partnership have
been given an opportunity to receive, on a tax-deferred basis, OP Units
in the Operating Partnership in exchange for their current limited
partnership interests. At any time prior to 5:00 p.m. on the fifteenth
trading day following the effective date of the Merger, the Limited
Partners can elect to exchange the OP Units received in connection with
the Merger for either common stock of Host REIT or a 6.56% callable note
due December 15, 2005 of the Operating Partnership. Exercise of either
the election to receive common stock or a note would be a taxable
transaction.
Beginning one year after the Merger, Limited Partners who retain OP Units
may exchange such OP Units for Host REIT common stock on a one-for-one
basis (or their cash equivalent, as determined by Host REIT).
On June 2, 1998, the Operating Partnership filed a Registration Statement
on Form S-4 with the Securities and Exchange Commission. In October 1998,
the Prospectus/Consent Solicitation Statement, which formed a part of
such Registration Statement, was mailed to the Limited Partners who have
until December 12, 1998 to vote on this Merger, unless extended.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain matters discussed in this Form 10-Q include forward-looking statements
including, without limitation, statements related to the proposed REIT
conversion, the terms, structure and timing thereof, and the expected effects of
the proposed REIT conversion and business and operating strategies in the
future. All forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual transactions,
results, performance or achievements to be materially different from any future
transactions, results, performance or achievements expressed or implied by such
forward-looking statements. Certain of the transactions described herein are
subject to certain consents of shareholders, lenders, debtholders and partners
of Host Marriott and its affiliates and of other third parties and various other
conditions and contingencies, and future results, performance and achievements
will be affected by general economic, business and financing conditions,
competition and government actions. The cautionary statements set forth in
reports filed under the Securities Act of 1934 contained important factors with
respect to such forward-looking statements, including: (i) national and local
economic and business conditions that will, among other things, affect demand
for hotels and other properties, the level of rates and occupancy that can be
achieved by such properties and the availability and terms of financing; (ii)
the ability to maintain the properties in a first-class manner; (iii) the
ability to compete effectively; (iv) the ability to obtain required consents of
shareholders, lenders, debtholders, partners and ground lessors in connection
with Host Marriott's proposed conversion to a REIT and to consummate all of the
transactions constituting the REIT conversion; (v) changes in travel patterns,
taxes and government regulations; (vi) governmental approvals, actions and
initiatives; (vii) the effects of tax legislative action; and (viii) the timing
of Host Marriott's election to be taxed as a REIT and the ability to satisfy
complex rules in order to qualify for taxation as a REIT for federal income tax
purposes and to operate effectively within the limitations imposed by these
rules. Although the Partnership believes the expectations reflected in such
forward-looking statements are based upon reasonable assumptions, it can give no
assurance that its expectations will be attained or that any deviations will not
be material. The Partnership undertakes no obligation to publicly release the
result of any revisions to these forward-looking statements that may be made to
reflect any future events or circumstances.
RESULTS OF OPERATIONS
Revenues. As discussed in Note 4 to the Condensed Consolidated Financial
Statements, the Partnership converted its operating lease to a management
agreement in connection with its debt refinancing on November 25, 1997 (the
"Conversion"). Subsequent to the Conversion, the Partnership's revenues reflect
hotel sales. Revenues reported for the twelve and thirty-six weeks ended
September 11, 1998 are not comparable to the Hotel Rentals reported for the
twelve and thirty-six weeks ended September 12, 1997. Prior to the Conversion,
the Partnership recognized estimated annual hotel rental income on a
straight-line basis throughout the year. The profits from the Hotel are seasonal
and first and second quarter results are generally higher than the last two
quarters of the year. Lease payments in excess of the income recognized by the
Partnership were deferred and, to the extent not subject to possible future
repayment to the Hotel lessee, were recognized as income during the remainder of
the year. Pursuant to the terms of the Operating Lease, Annual Rental, as
defined, was equal to the greater of Basic Rental (80% of Operating Profit, as
defined) and Owner's Priority, as defined. Additionally, the Hotel tenant was
required to pay taxes, make contributions equal to a percentage of Hotel sales
to a property improvement fund (4.5% in 1997 and 5.5% thereafter) and pay rental
on the second golf course.
Subsequent to the Conversion, the Partnership records as revenues gross sales
generated by the Hotel. Hotel property-level costs and expenses reflect all
property-level costs and expenses. For comparability, revenues for the twelve
and thirty-six weeks ended September 12, 1997 are discussed below on a "pro
forma" basis which assumes the Conversion occurred at the beginning of fiscal
year 1997 (see Note 4).
On a comparative basis, hotel sales increased $2.2 million or 17%, from $13.1
million in third quarter 1997 to $15.3 million in third quarter 1998 due to
increases in food and beverage and rooms revenues. REVPAR, or revenue per
available room, represents the combination of the average daily room rate
charged and the average daily occupancy achieved and is a commonly used
indicator of hotel performance (although it is not a GAAP, or generally accepted
accounting principles, measure of revenue). For the third quarter of 1998,
REVPAR increased 16% to approximately $74 due to a 3% increase in the average
room rate to approximately $109 coupled with an increase in average occupancy of
seven percentage points over the same quarter in 1997. Average room rates
increased as a result of a 10% increase in the transient business rate.
Additionally, the average occupancy was impacted favorably by the increase in
group business during this quarter. For the third quarter of 1998, group
roomnights sold increased by over 9,000 or 43% from third quarter 1997. As a
result of the increase in REVPAR, hotel room sales increased 16% or $742,000 in
third quarter 1998 when compared to the same quarter in 1997. Food and beverage
revenue for the third quarter of 1998 was $6.2 million, compared to $5.2 million
for the comparable period in 1997, which represents a $1.0 million or 19%
increase. The improvement was the result of an overall increase in roomnights
sold and a $655,000 increase in catering sales.
For the first three quarters of 1998, compared to pro forma results, hotel sales
increased $7.9 million or 11% from $72.4 million in the first three quarters of
1997 to $80.3 million in the first three quarters of 1998 due primarily to
increases in rooms and food and beverage revenues. For the year, REVPAR
increased 11% over the same period of the prior year to approximately $139 due
primarily to a 6% increase in the average room rate to approximately $183
coupled with a three percentage point increase in average occupancy to
approximately 76%. Room sales and profit increased 11% and 10% respectively, due
to strong demand in the leisure transient segment during the first two quarters
and strong group demand during the third quarter of 1998. On a year-to-date
basis, food and beverage revenues increased $2.8 million, or 10% to $30.9
million over $28.1 million during the same period in 1997. The year-to-date
improvement in overall roomnights sold of over 7,000 contributed to the increase
in food and beverage sales.
Operating Costs and Expenses. Compared to pro forma results, operating costs and
expenses increased $806,000 from $15.7 million in third quarter 1997 to $16.5
million in third quarter 1998. On a year-to-date basis, operating costs and
expenses increased $4.1 million from $58.9 million in 1997 to $63 million in
1998. The quarter and year-to-date increases are due primarily to increases in
direct rooms and food and beverage expenses. These costs increased as a result
of higher occupancy levels and because higher food sales resulted in higher food
cost of sales. However, as a percentage of hotel revenues, the year-to-date 1998
ratio of property-level costs and expenses decreased by one percentage point to
65% when compared to 1997.
Prior to the Conversion, incentive management fee expense was not a component of
operating expense. Rather, accrued incentive management fee expense was deducted
from the additional lease payments in excess of rental income that were deferred
by the Partnership. Additionally, the base management fee and certain other
expenses such as insurance and equipment rent, though components in the
calculation of Operating Profit prior to the Conversion, were not components of
the Partnership's operating costs.
Compared to pro forma results, incentive management fee for the third quarter of
1998 decreased $282,000 compared to the same period in 1997. On a third quarter
year-to-date basis, compared to pro forma results, incentive management fee
decreased $103,000, or 7% from $1.5 million in 1997 to $1.4 million in 1998. The
Partnership recognizes incentive management fee expense on the basis of the
projected cumulative percentage earned, as of any interim period, of the full
year hotel operating profit. For example, as of third quarter, due to the
cyclical nature of the Hotel's operations, it is projected that the Partnership
has earned approximately 73% of the hotel operating profit that will be earned
for the full fiscal year. Pursuant to an agreement with MHS, in 1997 MHS was
entitled to a maximum incentive management fee of $2 million. As of third
quarter 1997, the manager had earned approximately $1.5 million of its $2
million incentive management fee for the year. Beginning in 1998, the management
agreement provides that the Partnership is entitled to the first $21.5 million
of hotel operating profit. Thereafter, the manager will receive the next $1.8
million of hotel operating profit as an incentive management fee and any
operating profit in excess of $23.3 million will be divided 75% to the
Partnership and 25% to the manager. As of third quarter 1998, based on projected
full year hotel operating profit and the new fee payment structure, the
Partnership recognized only $1.4 million in incentive management fee compared to
$1.5 million for the same period in 1997.
Compared to pro forma results, base management fee for the third quarter of 1998
increased $66,000, or 17% from $392,000 in third quarter 1997 to $458,000 in
third quarter 1998 due to the increase in hotel operations discussed above. On a
third quarter year-to-date basis, base management fee increased $237,000, or 11%
from $2.2 million in 1997 to $2.4 million in 1998.
Depreciation. Depreciation decreased $127,000, or 7%, for third quarter 1998
when compared to the same quarter in 1997. On a year-to-date basis, depreciation
decreased $381,000, or 7%, when compared to the same quarter in 1997 as the
Partnership's original 10-year equipment became fully depreciated during 1997.
Interest Expense. On November 25, 1997 the Partnership refinanced its $160
million mortgage debt with $182.7 million of debt. The increase in debt along
with an increase in the weighted average interest rate from 8.4% in the third
quarter of 1997 to 9.8% in the third quarter of 1998 resulted in an increase in
interest expense of $792,000, or 23%, from $3.4 million to $4.1 million. On a
year-to-date basis, interest expense increased approximately $2.9 million, or
29%, from $10.1 million to $13 million. On a year-to-date basis, the weighted
average interest rate increased from 8.4% in 1997 to 9.8% in 1998.
Interest Income and Other. Interest income and other includes $59,000 in third
quarter 1998 which represents payments made to the Partnership by Marriott
Vacation Club International ("MVCI") for the rental of a gallery and marketing
desk in the Hotel's lobby. In third quarter 1997, MVCI rental of $59,000 was
recognized and included in the $5.4 million of Hotel rental income. On a
year-to-date basis, $191,000 of MVCI rental income is included in interest
income and other, compared to $198,000 in the same period in the prior year
which was included in hotel rental income.
Net (Loss) Income. Net loss increased $4.9 million to $5.0 million in the third
quarter of 1998 when compared to the third quarter of 1997. On a year-to-date
basis, net income increased $4.1 million to $5.1 million from prior year as a
result of the changes discussed above, primarily the Conversion, and improved
hotel operating results.
CAPITAL RESOURCES AND LIQUIDITY
The Partnership's financing needs have historically been funded primarily
through loan agreements with independent financial institutions and Host
Marriott. The General Partner believes that the Partnership will have sufficient
capital resources and liquidity to continue to conduct its operations in the
ordinary course of business.
On November 25, 1997, the Partnership completed a refinancing of its mortgage
debt. The financing consists of a $103 million senior loan, a $20 million
mezzanine loan and a $59.7 million junior loan. In connection with the
refinancing, the Partnership converted its operating lease with Marriott Hotel
Services, Inc. ("MHS") to a management agreement (the "Conversion").
Principal Sources and Uses of Cash
The Partnership's principal source of cash is from hotel operations. Its
principal uses of cash are to make debt service payments, fund the hotel's
property improvement fund and establish reserves required by the lender.
Cash provided by operating activities for the thirty-six weeks ended September
11, 1998 and September 12, 1997 was $17.1 million and $13.0 million,
respectively. Cash provided by operating activities increased $4.1 million as a
result of an increase in accounts payable of $4.9 million due to increased
accrued interest liability, offset by the payment of $2.0 million of accrued
incentive management fees to MHS in second quarter 1998. $2.0 million from the
restricted cash reserves was utilized to pay the accrued incentive management
fees to MHS. Additionally, through September 11, 1998, an additional $2.1
million was transferred into the tax and insurance reserve account and $984,000
was disbursed to pay accrued real estate taxes. The tax and insurance reserve is
included in restricted cash reserves and the resulting tax and insurance
liability is included in accounts payable and accrued expenses in the
accompanying balance sheet.
Cash used in investing activities for the thirty-six weeks ended September 11,
1998 and September 12, 1997 was $5.1 million and $2.4 million, respectively. The
Partnership's cash used in investing activities consists primarily of
contributions to the property improvement fund, contributions to and
expenditures from the air conditioning reserve fund, and capital expenditures
for improvements at the hotel. Contributions to the property improvement fund
for the thirty-six weeks ended September 11, 1998 and September 12, 1997 were
$4.4 million and $3.3 million, respectively. Contributions in 1998 increased due
to a $7.9 million increase in gross hotel sales and an increase in the
contribution rate from 4.5% in 1997 to 5.5% in 1998. Capital expenditures from
the property improvement fund were $3.4 million and $2.0 million for the
thirty-six weeks ended September 11, 1998 and September 12, 1997, respectively.
Capital expenditures during the thirty-six weeks ended September 11, 1998 also
include $1.3 million for the replacement of the Hotel's air conditioning system.
The $752,000 change in restricted cash consists of a $500,000 contribution to
the air conditioning reserve fund, $42,000 of interest income earned on the
account, and approximately $1.3 million of disbursements from the reserve. The
General Partner believes that the property improvement fund and capital
expenditure reserves will provide adequate funds in the short and long term to
meet the Hotel's capital needs.
Cash used in financing activities for the thirty-six weeks ended September 11,
1998 and September 12, 1997 was $2.1 million and $10.4 million, respectively.
The Partnership's cash financing activities consist primarily of payments of the
mortgage debt, contributions to and withdrawals from the restricted debt service
cash reserves and cash distributions. Year-to-date 1998 contributions to the
restricted cash reserves consist of interest income earned year-to-date of
$152,000. Disbursements from the reserves include approximately $2.0 million for
debt service payments on the mortgage debt and note payable. Year-to-date
contributions to the restricted cash reserves in 1997 consisted of $9.4 million
of excess cash from Hotel operations held for future debt service. During the
second quarter of 1998, the Partnership distributed $2.3 million to the partners
($2,500 per limited partner unit) from 1997 operations.
YEAR 2000 ISSUE
The "Year 2000 Issue" has arisen because many existing computer programs and
chip-based embedded technology systems use only the last two digits to refer to
a year, and therefore do not properly recognize a year that begins with "20"
instead of the familiar "19." If not corrected, many computer applications could
fail or create erroneous results. The following disclosure provides information
regarding the current status of the Partnership's Year 2000 compliance program.
The Partnership processes its records on computer hardware and software systems
maintained by Host Marriott Corporation ("Host Marriott"), the parent company of
the General Partner of the Partnership. Host Marriott has adopted a compliance
program because it recognizes the importance of minimizing the number and
seriousness of any disruptions that may occur as a result of the Year 2000
Issue. Host Marriott's compliance program includes an assessment of Host
Marriott's hardware and software computer systems and embedded systems, as well
as an assessment of the Year 2000 issues relating to third parties with which
the Partnership has a material relationship or whose systems are material to the
operations of the Partnership's Hotel. Host Marriott's efforts to ensure that
its computer systems are Year 2000 compliant have been segregated into two
separate phases: in-house systems and third-party systems.
In-House Systems. Host Marriott has invested in the implementation and
maintenance of accounting and reporting systems and equipment that are intended
to enable the Partnership to provide adequately for its information and
reporting needs and which are also Year 2000 compliant. Substantially all of
Host Marriott's in-house systems have already been certified as Year 2000
compliant through testing and other mechanisms and Host Marriott has not delayed
any systems projects due to the Year 2000 Issue. Host Marriott is in the process
of engaging a third party to review its Year 2000 in-house compliance. Host
Marriott believes that future costs associated with Year 2000 Issues for its
in-house systems will be insignificant and will therefore not impact the
Partnership's business, financial condition and results of operations. Host
Marriott has not developed, and does not plan to develop, a separate contingency
plan for its in-house systems due to their current Year 2000 compliance.
However, Host Marriott does have detailed contingency plans for its in-house
systems covering a variety of possible events, including natural disasters,
interruption of utility service and similar events.
Third-Party Systems. The Partnership relies upon operational and accounting
systems provided by third parties, primarily the Manager of its Hotel, to
provide the appropriate property-specific operating systems (including
reservation, phone, elevator, security, HVAC and other systems) and to provide
it with financial information. Based on discussions with the third parties that
are critical to the Partnership's business, including the Manager of its Hotel,
Host Marriott believes that these parties are in the process of studying their
systems and the systems of their respective vendors and service providers and,
in many cases, have begun to implement changes, to ensure that they are Year
2000 compliant. To the extent these changes impact property-level systems, the
Partnership may be required to fund capital expenditures for upgraded equipment
and software. Host Marriott does not expect these charges to be material, but is
committed to making these investments as required. To the extent that these
changes relate to the Manager's centralized systems (including reservations,
accounting, purchasing, inventory, personnel and other systems), the
Partnership's management agreement generally provides for these costs to be
charged to the Partnership's Hotel. Host Marriott expects that the Manager will
incur Year 2000 costs for its centralized systems in lieu of costs related to
system projects that otherwise would have been pursued and therefore, its
overall level of centralized charges allocated to the Hotel will not materially
increase as a result of the Year 2000 compliance effort. Host Marriott believes
that this deferral of certain system projects will not have a material impact on
its future results of operations, although it may delay certain productivity
enhancements at the Partnership's Hotel. Host Marriott will continue to monitor
the efforts of these third parties to become Year 2000 compliant and will take
appropriate steps to address any non-compliance issues. The Partnership believes
that in the event of material Year 2000 non-compliance caused by a breach of the
Manager's duties, the Partnership will have the right to seek recourse against
the Manager under its third party management agreement. The management agreement
generally does not specifically address the Year 2000 compliance issue.
Therefore the amount of any recovery in the event of Year 2000 non-compliance at
a property, if any, is not determinable at this time.
Host Marriott will work with the third parties to ensure that appropriate
contingency plans will be developed to address the most reasonably likely worst
case Year 2000 scenarios, which may not have been identified fully. In
particular, Host Marriott has had extensive discussions regarding the Year 2000
Issue with Marriott International, the Manager of the Hotel. Due to the
significance of Marriott International to the Partnership's business, a detailed
description of Marriott International's state of readiness follows.
Marriott International has adopted an eight-step process toward Year 2000
readiness, consisting of the following: (i) Awareness: fostering understanding
of, and commitment to, the problem and its potential risks; (ii) Inventory:
identifying and locating systems and technology components that may be affected;
(iii) Assessment: reviewing these components for Year 2000 compliance, and
assessing the scope of Year 2000 issues; (iv) Planning: defining the technical
solutions and labor and work plans necessary for each particular system; (v)
Remediation/Replacement: completing the programming to renovate or replace the
problem software or hardware; (vi) Testing and Compliance Validation: conducting
testing, followed by independent validation by a separate internal verification
team; (vii) Implementation: placing the corrected systems and technology back
into the business environment; and (viii) Quality Assurance: utilizing a
dedicated audit team to review and test significant projects for adherence to
quality standards and program methodology.
Marriott International has grouped its systems and technology into three
categories for purposes of Year 2000 compliance: (i) information resource
applications and technology (IT Applications) -- enterprise-wide systems
supported by Marriott International's centralized information technology
organization ("IR"); (ii) Business-initiated Systems ("BIS") - systems that have
been initiated by an individual business unit, and that are not supported by
Marriott International's IR organization; and (iii) Building Systems - non-IT
equipment at properties that use embedded computer chips, such as elevators,
automated room key systems and HVAC equipment. Marriott International is
prioritizing its efforts based on how severe an effect noncompliance would have
on customer service, core business processes or revenues, and whether there are
viable, non-automated fallback procedures (System Criticality).
Marriott International measures the completion of each phase based on documented
and quantified results, weighted for System Criticality. As of the end of the
1998 third quarter, the awareness and inventory phases were complete for IT
Applications and nearly complete for BIS and Building Systems. For IT
Applications, the Assessment, Planning and Remediation/Replacement phases were
each over 80 percent complete, and Testing and Compliance Validation had been
completed for a number of key systems, with most of the remaining work in its
final stage. For BIS and Building Systems, Assessment and Planning were in the
mid- to upper-range of completion, with a substantial amount of work in process,
while the progress level for Remediation/Replacement and Testing and Compliance
Validation had not yet been documented and quantified. Quality Assurance is also
in progress for IT Applications and is scheduled to begin for BIS and Business
Systems in the near future. Marriott International's goal is to substantially
complete the Remediation/Replacement and Testing phases for its System Critical
IT Applications by the end of 1998, with 1999 reserved for unplanned
contingencies and for Compliance Validation and Quality Assurance. For System
Critical BIS and Building Systems, the same level of completion is targeted for
June 1999 and September 1999, respectively.
Marriott International has initiated Year 2000 compliance communications with
its significant third party suppliers, vendors and business partners, including
its franchisees. Marriott International is focusing its efforts on the business
interfaces most critical to its customer service and revenues, including those
third parties that support the most critical enterprise-wide IT Applications,
franchisees generating the most revenues, suppliers of the most widely used
Building Systems and BIS, the top 100 suppliers, by dollar volume, of non-IT
products, and financial institutions providing the most critical payment
processing functions. Responses have been received from a majority of the firms
in this group.
Marriott International is also establishing a common approach for testing and
addressing Year 2000 compliance issues for its managed and franchised
properties. This includes a guidance protocol for operated properties, and a
Year 2000 "Toolkit" for franchisees containing relevant Year 2000 compliance
information. Marriott International is also utilizing a Year 2000 best-practices
sharing system.
Risks. There can be no assurance that Year 2000 remediation by the Partnership
or third parties will be properly and timely completed, and failure to do so
could have a material adverse effect on the Partnership, its business and its
financial condition. The Partnership cannot predict the actual effects to it of
the Year 2000 Issue, which depends on numerous uncertainties such as: (i)
whether significant third parties properly and timely address the Year 2000
Issue; and (ii) whether broad-based or systemic economic failures may occur.
Host Marriott is also unable to predict the severity and duration of any such
failures, which could include disruptions in passenger transportation or
transportation systems generally, loss of utility and/or telecommunications
services, the loss or distortion of hotel reservations made on a centralized
reservation system and errors or failures in financial transactions or payment
processing systems such as credit cards. Due to the general uncertainty inherent
in the Year 2000 Issue and the Partnership's dependence on third parties, the
Partnership is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the Partnership. Host Marriott's
Year 2000 compliance program is expected to significantly reduce the level of
uncertainty about the Year 2000 Issue and Host Marriott believes that the
possibility of significant interruptions of normal operations should be reduced.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Partnership and the Hotel are involved in routine litigation and
administrative proceedings arising in the ordinary course of business, some of
which are expected to be covered by liability insurance and which collectively
are not expected to have a material adverse effect on the business, financial
conditions or results of operations of the Partnership.
On March 16, 1998, limited partners in several partnerships sponsored by Host
Marriott Corporation ("Host Marriott") filed a lawsuit, styled Robert M. Haas,
Sr. and Irwin Randolph Joint Tenants, et al. v. Marriott International, Inc., et
al., Case No. 98-CI-04092, in the 57th Judicial District Court of Bexar County,
Texas against Marriott International, Inc. ("Marriott International"), Host
Marriott, various of their subsidiaries, J.W. Marriott, Jr., Stephen Rushmore,
and Hospitality Valuation Services, Inc. (collectively, the "Defendants"). The
lawsuit relates to the following limited partnerships: Courtyard by Marriott
Limited Partnership, Courtyard by Marriott II Limited Partnership, Marriott
Residence Inn Limited Partnership, Marriott Residence Inn II Limited
Partnership, Fairfield Inn by Marriott Limited Partnership, Desert Springs
Marriott Limited Partnership and Atlanta Marriott Marquis Limited Partnership
(collectively, the "Partnerships"). The plaintiffs allege that the Defendants
conspired to sell hotels to the Partnerships for inflated prices and that they
charged the Partnerships excessive management fees to operate the Partnerships'
hotels. The plaintiffs further allege, among other things, that the Defendants
committed fraud, breached fiduciary duties, and violated the provisions of
various contracts. The plaintiffs are seeking unspecified damages. The
Defendants, which do not include the Partnerships, believe that there is no
truth to the plaintiffs' allegations and that the lawsuit is totally devoid of
merit. The Defendants intend to vigorously defend against the claims asserted in
the lawsuit. They have filed an answer to the plaintiffs' petition and asserted
a number of defenses. Although the Partnerships have not been named as
Defendants in the lawsuit, the partnership agreements relating to the
Partnerships include an indemnity provision which requires the Partnerships,
under certain circumstances, to indemnify the general partners against losses,
expenses and fees.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits - None.
b. Reports on Form 8-K
September 17, 1998 - In this filing, Item 5 -- Other Events discloses that
the General Partner sent the limited partners of the Partnership a letter
to inform them that September 18, 1998 will be the record date for voting
in the forthcoming consent solicitation. Those limited partners whose
ownership is reflected on the records of the General Partner as of
September 18, 1998 will be eligible to vote on the merger and proposed
amendments to the partnership agreement. A copy of the letter was included
as an Item 7--Exhibit in this Form 8-K filing.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this Form 10-Q to be signed on its behalf
by the undersigned, thereunto duly authorized.
DESERT SPRINGS MARRIOTT
LIMITED PARTNERSHIP
By: MARRIOTT DESERT SPRINGS CORPORATION
General Partner
/s/ Earla L. Stowe
October 27, 1998 By: ------------------
Earla L. Stowe
Vice President and Chief Accounting Officer