ITEM 1. BUSINESS
Description of the Partnership
Courtyard by Marriott II Limited Partnership, a Delaware limited partnership (the "Partnership"), was formed on August 31, 1987 to acquire and own 70 Courtyard by Marriott hotels (the "Hotels") and the respective fee or leasehold interests in the land on which the Hotels are located. The Hotels are located in 29 states and contain a total of 10,335 guest rooms as of December 31, 1996. The Partnership commenced operations on October 30, 1987 and will terminate on December 31, 2087, unless earlier dissolved.
The sole general partner of the Partnership is CBM Two Corporation, a Delaware corporation (the "General Partner"), a wholly-owned subsidiary of Host Marriott Corporation. On December 29, 1995, Host Marriott Corporation's operations were divided into two separate companies: Host Marriott Corporation, which continued the business of owning lodging properties and Host Marriott Services Corporation which continued the business of concession operations at airports and toll roads.
The Partnership is engaged solely in the business of owning and operating hotels and therefore is engaged in one industry segment. The principal offices of the Partnership are located at 10400 Fernwood Road, Bethesda, Maryland 20817.
The Hotels are operated as part of the Courtyard by Marriott system, which includes over 286 hotels worldwide in the moderately-priced segment of the U.S. lodging industry. The Hotels are managed by Courtyard Management Corporation (the "Manager"), a wholly owned subsidiary of MII, under a long-term management agreement (the "Management Agreement"). The Management Agreement as restated on December 30, 1995 expires in 2013 with renewals at the option of the Manager for one or more of the Hotels for up to 35 years thereafter. The Hotels have the right to use the Courtyard by Marriott name pursuant to the Management Agreement and, if the Management Agreement is terminated or not renewed, the Partnership would lose that right for all purposes (except as part of the Partnership's name). See Item 13 "Certain Relationships and Related Transactions."
The objective of the Courtyard by Marriott system, including the Hotels, is to provide consistently superior lodging at a fair price with an appealing, friendly and contemporary residential character. Courtyard by Marriott hotels have fewer guest rooms than traditional, full-service hotels, containing approximately 150 guest rooms, including approximately 12 suites, as compared to full-service Marriott hotels which typically contain 350 or more guest rooms.
Each Courtyard by Marriott hotel is designed around a courtyard area containing a swimming pool (indoor pool in northern climates), walkways, landscaped areas and a gazebo. Each Hotel generally contains a small lobby, a restaurant with seating for approximately 50 guests, a lounge, a hydrotherapy pool, a guest laundry, an exercise room and two small meeting rooms. The hotels do not contain as much public space and related facilities as full-service hotels.
Courtyard by Marriott hotels are designed for business and vacation travelers who desire high quality accommodations at moderate prices. Most of the Hotels are located in suburban areas near office parks or other commercial activities. See Item 2
ITEM 2. PROPERTIES
Introduction
The properties consisted of 70 Courtyard by Marriott hotels as of December 31, 1996. The Hotels have been in operation for at least seven years. The Hotels range in age between 7 and 11 years. The Hotels are geographically diversified among 29 states, and no state has more than nine Hotels.
The lodging industry in general, and the moderately-priced segment in particular, is highly competitive, but the degree of competition varies from location to location and over time. On a combined basis, competitive forces affecting the Hotels are not, in the opinion of the General Partner, more adverse than the overall competitive forces affecting the lodging industry generally. See Item 1 "Business--Competition."
The following table summarizes certain attributes of each of the Hotels.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Certain Limited Partners of the Partnership have filed a lawsuit in Texas state court against the General Partner, the Manager and certain of their respective affiliates, officers and directors. These partners have alleged that the General Partner and the Manager have improperly operated the business affairs of the Partnership and its hotels. The General Partner believes that all of these claims are without foundation and intends to vigorously defend against them.
The Partnership and the Hotels 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 condition or results of operations of the Partnership.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE PARTNERSHIP'S LIMITED PARTNERSHIP UNITS AND RELATED SECURITY HOLDER MATTERS
There is currently no established public trading market for the Units and it is not anticipated that a public market for the Units will develop. Transfers of Units are limited to the first date of each accounting period and may be made only to accredited investors. All transfers are subject to approval by the General Partner. As of December 31, 1996, there were 1,633 holders (including holders of half-units) of record of the 1,470 Units.
In accordance with Sections 4.07 and 4.10 of the Partnership Agreement, cash available for distribution for any year will be distributed at least annually to the Partners of record at the end of each accounting period during such year as follows:
(i) first, through and including the end of the accounting period during which the Partners shall have received cumulative distributions of sales or refinancing proceeds ("Capital Receipts") equal to $77,368,421, 5% to the General Partner and 95% to the limited partners;
(ii) next, through and including the end of the accounting period during which the Partners shall have received cumulative distributions of Capital Receipts equal to $158,306,000, 10% to the General Partner and 90% to the limited partners; and
(iii) thereafter, 25% to the General Partner and 75% to the limited partners.
Distributions to the General Partner under clauses (i), (ii) and (iii) above shall be subordinate to an annual, non-cumulative 10% preferred return to the limited partners on their invested capital, as defined.
Cash available for distribution means, with respect to any fiscal period, the cash revenues of the Partnership from all sources during the fiscal period, other than Capital Receipts, plus amounts received by the Partnership pursuant to the Price Adjustment amount, less (i) all cash expenditures of the Partnership during such fiscal period, including, without limitation, repayment of all Partnership indebtedness to the extent required to be paid, but not including expenditures of Capital Receipts, plus fees for management services and administrative expenses and (ii) such reserves as may be determined by the General Partner, in its sole discretion (other than funds received under the Price Adjustment amount) to be necessary to provide for the foreseeable needs of the Partnership.
As of December 31, 1996, the Partnership has distributed a total of $67,024,650 ($45,595 per limited partner unit) since inception. In 1996, $6,982,500 ($4,750 per limited partner unit) was distributed and an additional $4,042,500 ($2,750 per limited partner unit) will be distributed in April 1997 bringing the total distribution from 1996 operations to $11,025,000 ($7,500 per limited partner unit). In 1995, no distributions were made to the Partners in order to retain funds to pay the costs associated with refinancing the Partnership's debt. The Partnership distributed $8,820,000 ($6,000 per limited partner unit) for 1994. No distributions of Capital Receipts have been made since inception.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data presents historical operating information for the Partnership for each of the five years in the period ended December 31, 1996 presented in accordance with generally accepted accounting principles.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following discussion and analysis addresses results of operations for the fiscal years ended December 31, 1996, 1995 and 1994. Since 1990, Courtyard by Marriott II Limited Partnership ("the Partnership") has owned the 70 hotels (the "Hotels") which, as of December 31, 1996, contain a total of 10,335 guest rooms. During the period from 1994 through 1996, Partnership revenues grew from $112.4 million to $133.2 million, while the Partnership's total hotel sales grew from $232.1 million to $263.7 million. Growth in room sales, and thus hotel sales, is primarily a function of combined average occupancy and room rates. During the period from 1994 through 1996, the Hotels' combined average room rate increased by $9.53 from $66.95 to $76.48, while the combined average occupancy decreased slightly from 81% to 80%.
The Partnership's operating costs and expenses are, to a great extent, fixed. Therefore, the Partnership derives substantial operating leverage from increases in revenue. This operating leverage is offset in part by variable expenses, including (i) base and Courtyard management fees under the management agreement, which are 3 1/2% and 2 1/2% of gross hotel sales, respectively and (ii) variable ground lease payments.
RESULTS OF OPERATIONS
The following table shows selected combined operating and financial statistics for the Hotels (in thousands, except combined average occupancy, combined average daily room rate, REVPAR and number of rooms):
The following table shows selected components of the Partnership's operating income as a percentage of total hotel sales.
1996 Compared to 1995:
Hotel Revenues. Hotel revenues (hotel sales less direct hotel operating costs and expenses) increased by $11.4 million in 1996, to $133.2 million, a 9.4% increase when compared to 1995. This increase in revenues was achieved primarily through an increase in hotel sales offset by an increase in hotel operating costs and expenses, as discussed below.
Hotel sales. Total 1996 hotel sales of $263.7 million represented a $17.9 million, or 7.3%, increase over 1995 results. This increase was achieved primarily through increases in the combined average room rate from $71.49 in 1995 to $76.48 in 1996. As a result, 1996 room sales increased by $16.9 million, or 7.7%, to $235.9 million from $219.0 million in 1995 despite a one percent decrease in occupancy to 80.4% during 1996. Forty of the Partnership's 70 Hotels posted occupancy rates exceeding 80% for 1996.
Direct hotel operating costs and expenses. Direct hotel operating costs and expenses in 1996 increased $6.4 million, or 5.2%. The increase in direct hotel operating costs and expenses is primarily due to an increase in certain variable costs related to the increase in room sales. However, as a percentage of total hotel sales, these costs and expenses decreased to 49.5% in 1996 as compared to 50.5% in 1995.
Indirect hotel operating costs and expenses. Indirect hotel operating costs and expenses increased by $3.9 million, or 5.3%, from $72.4 million in 1995 to $76.3 million in 1996. As a percentage of total hotel sales these costs and expenses decreased to 28.9% of total hotel sales in 1996 from 29.5% in 1995. The components of this category are discussed below:
Depreciation. Depreciation decreased slightly in 1996 as compared to 1995 due to a portion of the Hotels' furniture and equipment becoming fully depreciated in 1995.
Base and Courtyard management fees. The increase in base and Courtyard management fees of 7.4%, from $14.7 million in 1995 to $15.8 million in 1996 is due to the improved combined hotel sales for the 70 Hotels for 1996 when compared to 1995.
Ground rent. The 1996 ground rent expense of $11.9 million represents a 3.0% increase over 1995 levels as improved hotel operations resulted in Hotels paying more ground rent as a percent of sales rather than the minimum rent. As a percentage of total hotel sales, ground rent expense was 4.5% and 4.7% in 1996 and 1995, respectively.
Incentive management fees. In 1996, $12.0 million of incentive management fees were earned as compared to $10.5 million earned in 1995. The increase in incentive management fees earned was the result of improved combined hotel operating results.
Insurance and other. The 1996 insurance and other expenses increased by $1.2 million to $2.8 million when compared to 1995. The increase is primarily due to an increase in equipment rent, insurance expenses and prior year adjustments.
Operating income. Operating income (hotel revenues less all costs and expenses other than interest expense) increased by $7.6 million to $56.9 million in 1996, from $49.3 million in 1995, primarily due to higher revenues.
Interest expense. Interest expense increased 21.7% to $46.4 million in 1996 from $38.1 million in 1995. This increase in interest expense was due to the refinancing of the Partnership's debt at fixed rates which are higher than the prior year's variable interest rates. The weighted average interest rate in 1996 was 8.4% as compared to 7% in 1995.
Net income/(loss). In 1996, the Partnership had net income of $10.5 million, a decrease of $.7 million from 1995's net income of $11.2 million. This decrease was primarily due to higher interest expense.
1995 Compared to 1994:
Hotel Revenues. Hotel revenues (hotel sales less direct hotel operating costs and expenses) increased by $9.3 million in 1995, to $121.7 million, a 8.3% increase when compared to 1994. This increase in revenues was achieved primarily through an increase in hotel sales offset by an increase in operating costs and expenses, as discussed below.
Hotel sales. Total 1995 hotel sales of $245.8 million represented a $13.7 million, or 5.9%, increase over 1994 results. This increase was achieved primarily through increases in the combined average room rate from $66.95 in 1994 to $71.49 in 1995. As a result, 1995 room sales increased by $14.8 million, or 7.2%, to $219.0 million from $204.2 million in 1994 despite stable occupancy of approximately 81% during these periods. Forty-five of the Partnership's 70 Hotels posted occupancy rates exceeding 80% for 1995. Food and beverage sales decreased by 4.6% from $18.5 million in 1994 to $17.6 million in 1995 as a result of the Manager's continued efforts to match restaurant service to customer demands by eliminating under-utilized services at low volume restaurants.
Direct hotel operating costs and expenses. Direct hotel operating costs and expenses in 1995 increased $4.4 million, or 3.7%. The increase in direct hotel operating costs and expenses is
primarily due to an increase in certain variable costs related to the increase in room sales. However, as a percentage of total hotel sales, these costs and expenses decreased to 50.5% in 1995 as compared to 51.6% in 1994.
Indirect hotel operating costs and expenses. Indirect hotel operating costs and expenses decreased by $.4 million, or .5%, from $72.8 million in 1994 to $72.4 million in 1995. As a percentage of total hotel sales these costs and expenses decreased to 29.5% of total hotel sales in 1995 from 31.4% in 1994. The components of this category are discussed below:
Depreciation. Depreciation decreased slightly in 1995 as compared to 1994 due to a portion of the Hotels' furniture and equipment becoming fully depreciated in 1994.
Base and Courtyard management fees. The increase in base and Courtyard management fees of 5.9%, from $13.9 million in 1994 to $14.7 million in 1995 is due to the improved combined hotel sales for the 70 Hotels for 1995 when compared to 1994.
Ground rent. The 1995 ground rent expense of $11.5 million represents a 7.1% increase over 1994 levels as improved hotel operations resulted in Hotels paying more ground rent as a percent of sales rather than the minimum rent. As a percentage of total hotel sales, ground rent expense remained the same at 4.7% in 1994 and 1995.
Incentive management fees. In 1995, $10.5 million of incentive management fees were earned as compared to $9.4 million earned in 1994. The increase in incentive management fees earned was the result of improved combined hotel operating results.
Insurance and other. The 1995 insurance and other expenses decreased $1.4 million to $1.6 million when compared to 1994 due to a $1.2 million loss on fixed asset dispositions in 1994.
Operating income. Operating income (hotel expenses less all costs and expenses other than interest expense) increased by $9.7 million to $49.3 million in 1995, from $39.6 million in 1994, primarily due to higher hotel sales.
Interest expense. Interest expense decreased 11.6% to $38.1 million in 1995 from $43.1 million in 1994. This decrease in interest expense was due to the expiration of the interest rate swaps on Mortgage Debt A and Mortgage Debt B on August 4, 1994 and October 18, 1994, respectively. Incremental interest expense, as a result of the interest rate swaps, was $15.0 million for 1994.
Net income/(loss). In 1995, the Partnership had net income of $11.2 million, an increase of $14.8 million, over 1994's net loss of $3.6 million. This increase was primarily due to higher revenues and lower interest expense due to the expiration of the Partnership's interest rate swap agreements.
CAPITAL RESOURCES AND LIQUIDITY
Principal Sources and Uses of Cash
The Partnership's principal source of cash is cash from operations. Its principal uses of cash are to make debt service payments, fund the property improvement fund, and to make distributions to the limited partners. Cash provided from operations was $35.6 million, $36.0 million and $25.7 million for the years ended December 31, 1996, 1995 and 1994, respectively. During 1996, the Partnership repaid $11.3 million of principal on the Certificates, as defined below, and paid $42.5 million of interest on the Partnership's debt. The Partnership paid $42.1 million and $47.4 million in interest in 1995 and 1994, respectively. No principal payments were made on the Partnership's Mortgage Debt in 1995 or 1994. Contributions to the property improvement fund were $13.2 million, $12.3 million and $11.8 million for the years ended December 31, 1996, 1995, and 1994, respectively. Distributions to limited partners were $7.0 million in 1996, $2.7 million during 1995 from 1994 operations and $8.8 million in 1994.
Refinancing
Partnership Structure
On January 24, 1996, the Partnership completed a refinancing of the Partnership's existing debt through the private placements of $127.4 million of senior secured notes (the "Senior Notes") and $410.2 million of multi-class commercial mortgage pass-through certificates (the "Certificates").
In connection with the refinancing, the limited partners approved certain amendments to the partnership agreement and the management agreement. The partnership agreement amendment, among other things, allowed the formation of certain subsidiaries of the Partnership, including Courtyard II Finance Company ("Finance"), a wholly-owned subsidiary of the Partnership, who along with the Partnership is the co-issuer of the Senior Notes.
Additionally, the Partnership formed a wholly-owned subsidiary, Courtyard II Associates Management Corporation ("Managing General Partner"). Managing General Partner was formed to be the managing general partner with a 1% general partner interest in Courtyard II Associates, L.P. ("Associates"), a Delaware limited partnership. The Partnership owns a 1% general partner interest and a 98% limited partner interest in Associates. On January 24, 1996, the Partnership contributed 69 Hotels and their related assets to Associates. Formation of Associates resulted in the Partnership's primary assets being its direct and indirect interest in Associates. Additionally, substantially all of Associates' net equity will be restricted to dividends, loans or advances to the Partnership.
Associates holds a 99% membership interest in CBM Associates II LLC ("Associates II") and Managing General Partner holds the remaining 1% membership interest. On January 24, 1996, the Partnership contributed the Hotel located in Deerfield, IL (the "Deerfield Hotel") and its related assets to Associates and the Managing General Partner who simultaneously contributed the Hotel and its related assets to Associates II.
Each of the Managing General Partner, Associates and Associates II were formed as a single purpose bankruptcy-remote entity to facilitate the refinancing.
CBM Funding Corporation ("CBM Funding"), a wholly-owned subsidiary of Associates, was also formed to make a mortgage loan (the "Mortgage Loan") to Associates from the proceeds of the sale of the Certificates.
Debt Refinancing - Overview
On January 24, 1996, net proceeds from the placement of the Senior Notes and the Certificates and existing Partnership cash were used as follows: (i) to repay the Partnership's existing Mortgage Debt A of $275 million and Mortgage Debt B of $230.5 million, (ii) to repay the industrial revenue bond financing on certain Hotels (the "IRB Debt") of $25.6 million, (iii) to repay advances from Host Marriott related to certain Hotels of $6.5 million and (iv) to pay certain costs of structuring and issuing the Senior Notes and the Certificates.
Prior to the completion of the refinancing on January 24, 1996, Host Marriott or its wholly-owned subsidiary, CBM Two Corporation, (the "General Partner") provided additional credit support to the Partnership through the following: (i) debt service guarantees on Mortgage Debt A and B, (ii) foreclosure guarantees on the Mortgage Debt A and B, (iii) obligations to advance funds related to the IRB Debt and (iv) a facility for the Partnership to borrow funds to pay ground rent (the "Ground Rent Facility"). Upon repayment of Mortgage Debt A, Mortgage Debt B, and the IRB Debt, Host Marriott was released from these obligations.
Debt Refinancing - Senior Notes
The Senior Notes of $127.4 million were issued by the Partnership and Finance. The Senior Notes bear interest at 10 3/4%, require semi-annual payments of interest and require no payments of principal until maturity on February 1, 2008. The Senior Notes are secured by a first priority pledge by the Partnership of (i) its 99% partnership interest (consisting of a 98% limited partner interest and a 1% general partner interest) in Associates and (ii) its 100% equity interest in the Managing General Partner. Finance has nominal assets, does not conduct any operations and does not provide any additional security for the Senior Notes.
The terms of the Senior Notes include requirements of the Partnership to establish and fund a debt service reserve account in an amount equal to one six-month interest payment on the Senior Notes ($6,848,000) and to maintain certain levels of excess cash flow, as defined. In the event the Partnership fails to maintain the required level of excess cash flow, the Partnership will be required to (i) suspend distributions to its partners and other restricted payments, as defined, (ii) to fund a separate supplemental debt service reserve account (the "Supplemental Debt Service Reserve") in an amount up to two six-month interest payments on the Senior Notes and (iii) if such failure were to continue, to offer to purchase a portion of the Senior Notes at par.
The Senior Notes are not redeemable prior to February 1, 2001. Thereafter, the Senior Notes may be redeemed, at the option of the Partnership, at a premium declining to par in 2004. The Senior Notes are non-recourse to the Partnership and its partners.
On June 4, 1996, the Partnership and Finance completed an exchange offer of its unregistered 10 3/4% Series B Senior Secured Notes with an aggregate principal amount of $127.4 million ("Old Notes") due 2008 for an equal amount of registered notes ("New Notes"). The form and
terms of the New Notes are substantially identical to the form and terms of the Old Notes, except that the New Notes have been registered under the Securities Act of 1933, as amended and will not have any restrictions for transfer.
Debt Refinancing - Certificates
The Certificates in an initial principal payment of $410.2 million were issued by CBM Funding. Proceeds from the sale of the Certificates were utilized by CBM Funding to provide a Mortgage Loan to Associates. The Certificates/Mortgage Loan require monthly payments of principal and interest based on a 17-year amortization schedule. The Mortgage Loan matures on January 28, 2008. However, the maturity date of the Certificates/Mortgage Loan may be extended until January 28, 2013 with the consent of 66 2/3% of the holders of the outstanding Certificates affected thereby. The Certificates were issued in the following classes and pass-through rates of interest.
Initial Certificate Pass-Through Class Balance Rate
Class A-1 $ 45,500,000 7.550% Class A-2 $ 50,000,000 6.880% Class A-3P & I $ 129,500,000 7.080% Class A-3IO Not Applicable 0.933% Class B $ 75,000,000 7.480% Class C $ 100,000,000 7.860% Class D $ 10,200,000 8.645%
The Class A-3IO Certificates receive payments of interest only based on a notional balance equal to the Class A-3P & I Certificate balance.
The balance of the Certificates was $398.9 million at December 31, 1996. Principal amortization of $11.3 million of the Class A-1 Certificates was made during 1996.
The Certificates/Mortgage Loan maturities are as follows (in thousands):
1997 $ 13,298 1998 14,331 1999 15,443 2000 16,642 2001 17,934 Thereafter 321,205 ------------ $ 398,853 ============ The Mortgage Loan is secured primarily by 69 cross-defaulted and cross-collateralized mortgages representing first priority mortgage liens on (i) the fee or leasehold interest in the 69 Hotels, related furniture, fixtures and equipment and the property improvement fund, (ii) the fee interest in the land leased from MII or their affiliates on which 53 Hotels are located, (iii) a pledge of Associates membership interest in and the related right to receive distributions from Associates II which owns the Deerfield Hotel and (iv) an assignment of the Management Agreement, as defined below. The Mortgage Loan is non-recourse to Associates, the Partnership and its partners.
Operating profit from the Hotels in excess of debt service on the Mortgage Loan is available to be distributed to the Partnership. Amounts distributed to the Partnership are used for the following, in order of priority: (i) for debt service on the Senior Notes, (ii) to fund the Supplemental Debt Service Reserve, if necessary, (iii) to offer to purchase a portion of the Senior Notes at par, if necessary, (iv) for working capital, see Item 13 "Certain Relationship and Related Transaction," and (v) for distributions to the partners of the Partnership.
Prepayments of the Mortgage Loan are permitted with the payment of a premium (the "Prepayment Premium"). The Prepayment Premium is equal to the greater of (i) one percent of the Mortgage Loan being prepaid or (ii) a yield maintenance amount based on a spread of .25% or .55% over the U.S. treasury rate, as defined.
On June 30, 1996, CBM Funding completed an exchange offer of its Multiclass Mortgage Pass-Through Certificates, Series 1996-1A with a principal balance of $406.2 million at that time, ("Old Certificates") for an equal amount of Multiclass Mortgage Pass-Through Certificates, Series 1996-1B ("New Certificates"). The form and terms of the New Certificates are substantially identical to the form and terms of the Old Certificates, except that the New Certificates are registered under the Securities Act of 1933, as amended and their transfers are not restricted.
Deferred Management Fees and Ground Lease Payments
To facilitate the refinancing, effective December 30, 1995, the original management agreement was restated into two separate management agreements. Associates entered into a management agreement with the Manager for the 69 Hotels which Associates directly owns and Associates II entered into a management agreement for the Deerfield Hotel which Associates II owns, collectively, (the "Management Agreement").
Under the Management Agreement that became effective on December 30, 1995, the Manager agreed to subordinate a portion of the Courtyard management fees and all incentive management fees, and under an amendment to the ground leases with Marriott International, Inc. and its affiliates (the "Marriott Ground Lessors") that became effective on January 24, 1996, the Marriott Ground Lessors agreed to subordinate their ground rent payments, to the payment of interest, principal and premiums on the Mortgage Loan and the Senior Notes and debt incurred to refinance the Mortgage Loan or the Senior Notes that meets specified criteria. In addition, the Manager agreed to subordinate existing deferred base, Courtyard and incentive management fees to the payment of debt service.
Deferred base, Courtyard and incentive management fees do not accrue interest and will be repaid from a portion of operating cash flow but only after payment of (i) debt service, (ii) a priority return to the Partnership and (iii) certain other priorities as defined in the Management Agreement. Deferred ground rent owed to the Marriott Ground Lessors does not accrue interest and will be repaid from a portion of operating cash flow, but only after payment of debt service. Payment of such deferred fees and deferred ground rent are restricted payments under the covenants of the Senior Notes.
Historically, under the management agreement, the Manager subordinated receipt of the Courtyard management fee to the payment of debt service (through the debt refinancing date of January 24, 1996) and a 6% return to the limited partners (through 1993). As of December 31,
1996, cumulative deferred base and Courtyard management fees totaled $30.2 million.
Prior to 1994 no incentive management fees were earned by the Manager. For the year ended December 31, 1995, $10.5 million in incentive management fees were earned and paid to the Manager. For the year ended December 31, 1996, $12.0 million in incentive management fees were earned and $11.4 million were paid. Therefore, $.6 million was deferred in 1996. In the future, additional incentive management fees may be earned, but payment will be limited by the terms of the Management Agreement to 80% of the amount by which operating profit less debt service exceeds the priority return to the Partnership.
The priority return to the Partnership, as defined, was reduced from 10% of invested capital to 7% in 1996, 8% in 1997, 9% in 1998 and then returning to 10% for 1999 and thereafter. Operating profit from the Hotels (which reflects the deduction of the base and Courtyard management fees and MII ground rent) will be used to pay the following, in order of priority: (i) debt service on the Senior Notes and Mortgage Loan, (ii) to repay working capital loans to the Manager, (iii) to repay deferred ground rent to MII and their affiliates, (iv) to repay ground lease advances to MII and their affiliates, (v) the priority return to the Partnership which is 7% of invested capital for 1996, (vi) eighty percent of the remaining operating profit is applied to the payment of current incentive management fees, (vii) to repay advances to the Partnership, (viii) to repay foreclosure avoidance advances to the Manager and (ix) fifty percent of the remaining operating profit to repay deferred management fees to the Manager and fifty percent of remaining operating profit is paid to the Partnership. In 1996, the Partnership had $2.5 million of remaining operating profit after the payment of i) through viii) above. Fifty percent of this remaining operating profit was used to repay a portion of 1996 deferred incentive management fees to the Manager and the remainder was paid to the Partnership.
Property Improvement Fund
The Management Agreement requires annual contributions to a property improvement fund to ensure that the physical condition and product quality of the Hotels are maintained. Contributions to this fund are based on a percentage of annual total hotel sales, currently equal to 5%. The Partnership believes that the 5% contribution requirement is consistent with industry standards and provides a sufficient reserve for the future capital repair and replacement needs of the Hotels. In accordance with the Management Agreement, the annual required contribution percentage may increase to up to 6% after December 31, 2000. The balance in the fund totaled $36.6 million as of December 31, 1996. During the period from 1992 through 1995, room renovation projects were completed at all of the Hotels at an aggregate cost of approximately $30.7 million. Total capital expenditures for 1996, 1995 and 1994 were $11.2 million, $8.8 million and $13.4 million, respectively. All such capital expenditures were funded from the property improvement fund.
General
As previously discussed, the Partnership's debt was refinanced on January 24, 1996. The General Partner believes that cash from hotel operations combined with the ability to defer certain management fees to the Manager and ground rent payments to MII and affiliates will provide adequate funds in the short term and long term for the operational and capital needs of the Partnership.
Competition
The moderately priced lodging segment continues to be highly competitive. An increase in supply growth began in 1996 with the introduction of a number of new national brands. For 1997, the outlook continues to be positive. Courtyards continue to command a premium share of the market in which they are located in spite of the growth of new chains. It is expected that Courtyard will continue outperforming both national and local competitors. The brand is continuing to carefully monitor the introduction of new mid-priced brands including Wingate Hotels, Hilton Garden Inns, Four Points by Sheraton, Mainstay, Candlewood, Club Hotels and Clarion.
Inflation
The rate of inflation has been relatively low in the past four years. The Manager is generally able to pass through increased costs to customers through higher room rates and prices. In 1996, average rates of Courtyard hotels exceeded inflationary costs, but lagged the increases of direct competitors who have been able to realize higher rates due to climbing occupancies. In January 24, 1996, the Partnership refinanced its mortgage debt and fixed its interest costs thereby eliminating the Partnership's exposure to the impact of inflation on future interest costs.
Seasonality
Demand, and thus room occupancy, is affected by normally recurring seasonal patterns. For most of the Hotels, demand is higher in the spring and summer months (March through October) than during the remainder of the year.
Forward-Looking Statements
Certain matters discussed herein are forward-looking statements within the meaning of the Private Litigation Reform Act of 1995 and as such may involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance or achievements of the Partnership to be different from any future results, performance or achievements expressed or implied by such forward-looking statements. 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. These risks are detailed from time to time in the Partnership's filings with the Securities and Exchange Commission. 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.
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO COURTYARD BY MARRIOTT II LIMITED PARTNERSHIP:
We have audited the accompanying consolidated balance sheet of Courtyard by Marriott II Limited Partnership (a Delaware limited partnership) as of December 31, 1996 and 1995, and the related consolidated statements of operations, changes in partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1996. These financial statements and the schedule referred to below are the responsibility of the General Partner's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Courtyard by Marriott II Limited Partnership as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index at Item 14(a)(2) are presented for purposes of complying with the Securities and Exchange Commission's rules and are not a required part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Washington, D.C. March 13, 1997
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CONSOLIDATED STATEMENT OF OPERATIONS
Courtyard by Marriott II Limited Partnership For the Years Ended December 31, 1996, 1995 and 1994 (in thousands, except per Unit amounts)
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CONSOLIDATED BALANCE SHEET
Courtyard by Marriott II Limited Partnership December 31, 1996 and 1995 (in thousands)
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CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
Courtyard by Marriott II Limited Partnership For the Years Ended December 31, 1996, 1995 and 1994 (in thousands)
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CONSOLIDATED STATEMENT OF CASH FLOWS
Courtyard by Marriott II Limited Partnership For the Years Ended December 31, 1996, 1995 and 1994 (in thousands)
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CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
Courtyard by Marriott II Limited Partnership For the Years Ended December 31, 1996, 1995 and 1994 (in thousands)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Courtyard by Marriott II Limited Partnership December 31, 1996 and 1995
NOTE 1. THE PARTNERSHIP
Description of the Partnership
Courtyard by Marriott II Limited Partnership (the "Partnership"), a Delaware limited partnership, was formed August 31, 1987 to acquire and own 70 Courtyard by Marriott hotels (the "Hotels") and the land on which certain of the Hotels are located. The Partnership's 70 hotel properties are located in 29 states in the United States: nine in Illinois; eight in California; five in Florida; four in Georgia; four in Texas and three or less in each of the other 24 states. On December 29, 1995, Host Marriott Corporation's operations were divided into two separate companies: Host Marriott Corporation ("Host Marriott") and Host Marriott Services Corporation. The Hotels are managed as part of the Courtyard by Marriott hotel system by Courtyard Management Corporation (the "Manager"), a wholly-owned subsidiary of Marriott International, Inc. ("MII"). The sole general partner of the Partnership, with a 5% interest, is CBM Two Corporation (the "General Partner"), a wholly-owned subsidiary of Host Marriott.
On January 18, 1988 (the "Final Closing Date"), 1,470 limited partnership interests (the "Units"), representing a 95% interest in the Partnership, had been sold in a private placement offering. The offering price per Unit was $100,000, $21,200 payable at subscription with the balance due in four annual installments through February 28, 1991, or, as an alternative, $94,357 in cash at closing as full payment of the subscription price. The limited partners paid $39,938,000 as of the Final Closing Date, representing 1,350 Units purchased on the installment basis and 120 Units paid in full. The limited partners' obligations to make the installment payments were evidenced by promissory notes (the "Investor Notes") payable to the Partnership and secured by the Units. On October 30, 1987 (the "Initial Closing Date"), the General Partner made a capital contribution of equipment valued at $11,306,000 for its 5% general partner interest.
On the Initial Closing Date, the Partnership began operations and executed a purchase agreement (the "Purchase Agreement") with Host Marriott to acquire the Hotels and the land on which certain of the Hotels are located for a total price of $643.1 million. Of the total purchase price, $507.9 million was paid in cash from the proceeds of the mortgage financing and sale of the Units, $40.2 million from assumption of industrial development revenue bond financing (the "IRB Debt") from Host Marriott and $95 million from a note (the "Deferred Purchase Note") payable to Host Marriott. Twenty of the Hotels were conveyed to the Partnership in 1987, thirty-four Hotels in 1988, twelve Hotels in 1989 and the final four Hotels during the first half of 1990.
Under the Purchase Agreement, Host Marriott agreed to reduce the purchase price of the Hotels by up to $9.3 million if the Hotels did not provide cash flow in excess of debt service, as defined, equivalent to $9.3 million in 1989, (the "Price Adjustment"). The required Price Adjustment for 1989 was $8,843,000. The Price Adjustment was allocated as a reduction to the Partnership's property and equipment in the accompanying consolidated financial statements.
In accordance with the partnership agreement, in 1990 and 1991 the General Partner purchased 20.5 Units from defaulting investors. Additionally, on July 15, 1995, a limited partner assigned one Unit to the General Partner. Therefore, as of December 31, 1996, the General Partner owns a total of 21.5 Units representing a 1.39% limited partnership interest in the Partnership.
- ----------------------------------------------------------------------------- On January 24, 1996, the Partnership completed a refinancing of the Partnership's existing debt through the private placements of $127.4 million of senior secured notes (the "Senior Notes") and $410.2 million of multi-class commercial mortgage pass-through certificates (the "Certificates").
In connection with the refinancing, the limited partners approved certain amendments to the partnership agreement and the Management Agreement. The partnership agreement amendment, among other things, allowed the formation of certain subsidiaries of the Partnership, including Courtyard II Finance Company ("Finance"), a wholly-owned subsidiary of the Partnership, who along with the Partnership is the co-issuer of the Senior Notes.
Additionally, the Partnership formed a wholly-owned subsidiary, Courtyard II Associates Management Corporation ("Managing General Partner"). Managing General Partner was formed to be the managing general partner with a 1% general partner interest in Courtyard II Associates, L.P. ("Associates"), a Delaware limited partnership. The Partnership owns a 1% general partner interest and a 98% limited partner interest in Associates. On January 24, 1996, the Partnership contributed 69 Hotels and their related assets to Associates. Formation of Associates resulted in the Partnership's primary assets being its direct and indirect interest in Associates. Additionally, substantially all of Associates' net equity will be restricted to dividends, loans or advances to the Partnership.
Associates holds a 99% membership interest in CBM Associates II LLC ("Associates II") and Managing General Partner holds the remaining 1% membership interest. On January 24, 1996, the Partnership contributed the Hotel located in Deerfield, IL (the "Deerfield Hotel") and its related assets to Associates and the Managing General Partner who simultaneously contributed the Hotel and its related assets to Associates II.
Each of the Managing General Partner, Associates and Associates II were formed as a single purpose bankruptcy-remote entity to facilitate the refinancing.
CBM Funding Corporation ("CBM Funding"), a wholly-owned subsidiary of Associates, was also formed to make a mortgage loan (the "Mortgage Loan") to Associates from the proceeds of the sale of the Certificates.
Partnership Allocations and Distributions
Partnership allocations and distributions are generally made as follows:
a. Cash available for distribution is distributed (i) first, 5% to the General Partner and 95% to the limited partners until the General Partner and the limited partners (collectively, the "Partners") have received cumulative distributions of sale proceeds and/or refinancing proceeds ("Capital Receipts") equal to $77,368,421; (ii) next, 10% to the General Partner and 90% to the limited partners until the Partners have received cumulative distributions of Capital Receipts equal to $158,306,000; and (iii) thereafter, 25% to the General Partner and 75% to the limited partners. Distributions to the General Partner are subordinate to an annual 10% non-cumulative preferred return to the limited partners on their invested capital, as defined.
b. Refinancing proceeds not retained by the Partnership will be distributed (i) first, 5% to the General Partner and 95% to the limited partners until the Partners have received cumulative distributions of refinancing proceeds equal to $158,306,000 minus adjusted sale proceeds, as defined; and (ii) thereafter, 25% to the General Partner and 75% to the limited partners.
- ------------------------------------------------------------------------------ c. Proceeds not retained by the Partnership from the sale or other disposition of less than substantially all of the assets of the Partnership will be distributed (i) first, 5% to the General Partner and 95% to the limited partners until the Partners have received cumulative distributions of Capital Receipts equal to $158,306,000; and (ii) thereafter, 25% to the General Partner and 75% to the limited partners.
Proceeds from the sale of substantially all of the assets of the Partnership or from a related series of Hotel sales leading to the sale of substantially all of the assets of the Partnership will be distributed to the Partners pro-rata in accordance with their capital account balances.
d. Net profits are generally allocated in the same ratio in which cash available for distribution is distributed.
e. All items of gain, deduction or loss attributable to the contributed equipment will be allocated to the General Partner.
f. In general, gain recognized by the Partnership will be allocated, with respect to any year, in the following order of priority: (i) to all Partners whose capital accounts have negative balances until such negative balances are brought to zero; (ii) to all Partners up to the amount necessary to bring their respective capital account balances to an amount equal to their invested capital, as defined; and (iii) thereafter 25% to the General Partner and 75% to the limited partners.
Gain arising from the sale or other disposition (or from a related series of sales or dispositions) of substantially all the assets of the Partnership will be allocated (i) to the limited partners in an amount equal to the excess, if any, of (1) the sum of 15% times the weighted average of the limited partners' invested capital each year, over (2) the sum of distributions to the limited partners of Capital Receipts in excess of the limited partners' cumulative capital and distributions to limited partners of cash available for distribution; and (ii) next, to the General Partner until it has been allocated an amount equal to 33.33% of the amount allocated to the limited partners under clause (i); and (iii) thereafter, 25% to the General Partner and 75% to the limited partners.
g. For financial reporting purposes, profits and losses are generally allocated among the Partners based on their stated interests in cash available for distribution.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Accounting
The Partnership records are maintained on the accrual basis of accounting and its fiscal year coincides with the calendar year.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
- ------------------------------------------------------------------------------ Working Capital and Supplies
Pursuant to the terms of the Partnership's management agreement discussed in Note 8, the Partnership is required to provide the Manager with working capital and supplies to meet the operating needs of the Hotels. The Manager converts cash advanced by the Partnership into other forms of working capital consisting primarily of operating cash, inventories, and trade receivables and payables which are maintained and controlled by the Manager. Upon the termination of the management agreement, the Manager is required to convert working capital and supplies into cash and return it to the Partnership. As a result of these conditions, the individual components of working capital and supplies controlled by the Manager are not reflected in the accompanying consolidated balance sheet.
Revenues and Expenses
Revenues represent house profit from the Partnership's Hotels since the Partnership has delegated substantially all of the operating decisions related to the generation of house profit of the Hotels to the Manager. House profit reflects hotel operating results which flow to the Partnership as property owner and represents hotel sales less property-level expenses, excluding depreciation and amortization, base, Courtyard and incentive management fees, real and personal property taxes, ground rent and equipment rent, insurance and certain other costs, which are disclosed separately in the consolidated statement of operations.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:
Buildings and improvements 40 years Leasehold improvements 40 years Furniture and equipment 4-10 years
Certain property and equipment was pledged to secure the mortgage debt described in Note 6.
The Partnership assesses impairment of its real estate properties based on whether estimated undiscounted future cash flows from such properties will be less than their net book value. If a property is impaired, its basis is adjusted to fair market value.
Deferred Financing Costs
Prior to 1996, deferred financing costs consist of costs incurred in connection with obtaining Partnership financing for Mortgage Debt A and B, as defined in Note 6. During 1996 and 1995, the Partnership paid $15,835,000 and $2,990,000, respectively, in financing costs related to the debt refinancing discussed in Note 6. Financing costs are amortized using the straight-line method, which approximates the effective interest rate method, over the remaining life of the respective mortgage debt. At December 31, 1996 and 1995, accumulated amortization of financing costs totalled $1,453,000 and $3,806,000, respectively.
- -------------------------------------------------------------------------------- Cash and Cash Equivalents
The Partnership considers all highly liquid investments with a maturity of three months or less at date of purchase to be cash equivalents.
Ground Rent
The land leases with MII or affiliates of MII (see Note 7) include scheduled increases in minimum rents per property. These scheduled rent increases, which are included in minimum lease payments, are being recognized by the Partnership on a straight-line basis over the lease terms which approximate 80 years. The adjustment included in ground rent expense and Due to Marriott International, Inc. and affiliates to reflect minimum lease payments on a straight-line basis for 1996, 1995 and 1994 totalled $119,000 per year.
Income Taxes
Provision for Federal taxes has not been made in the accompanying consolidated financial statements since the Partnership does not pay income taxes, but rather, allocates its profits and losses to the individual Partners. Significant differences exist between the net income/loss for financial reporting purposes and the net income/loss reported in the Partnership's tax return. These differences are due primarily to the use for income tax purposes of accelerated depreciation methods, shorter depreciable lives for the assets, difference in the timing of recognition of certain fees and straight-line rent adjustments. As a result of these differences, the excess of the net Partnership liabilities reported in the accompanying consolidated financial statements over the tax basis in the net Partnership liabilities was $7,819,000 and $3,381,000, respectively as of December 31, 1996 and 1995.
Interest Rate Swap Agreements
The Partnership was a party to two interest rate swap agreements (prior to their expiration in 1994) to reduce the Partnership's exposure to floating interest rates. The Partnership accounted for the swap arrangements as a hedge of obligations to pay floating rates of interest and accordingly, recorded interest expense based upon its payment obligations at fixed interest rates.
Statement of Financial Accounting Standards
In the first quarter of 1996, the Partnership adopted Statement of Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Adoption of SFAS No. 121 did not have an effect on its consolidated financial statements.
Reclassifications
Certain reclassifications were made to the prior year financial statements to conform to the 1996 presentation.
- -------------------------------------------------------------------------------- NOTE 3. HOTEL REVENUES
Partnership Hotel revenues consist of Hotel operating results for the three years ended December 31 (in thousands):
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NOTE 5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The fair values of financial instruments not included in this table are estimated to be equal to their carrying amounts.
The 1996 estimated fair value of debt obligations was based on the quoted market prices at December 31, 1996. The 1995 estimated fair values of debt obligations and amounts due to Host Marriott Corporation are based on their carrying amounts as these items were repaid on January 24, 1996. Consistent with the prior year, the 1996 management fees due to the Courtyard Management Corporation are valued based on the expected future payments from operating cash flow discounted at risk adjusted rates.
NOTE 6. MORTGAGE DEBT
Overview
The Partnership's initial financing consisted of up to $500 million of non-recourse mortgage debt (the "MFS Mortgage Debt") from Marriott Financial Services, Inc. ("MFS"), a wholly-owned subsidiary of Host Marriott, to provide financing for the purchase of 65 of the Hotels (the "non-IRB Hotels"). The Partnership assumed the $40.2 million of IRB Debt to provide financing for the purchase of the remaining 5 Hotels (the "IRB Hotels"). In 1988 and 1989, the Partnership borrowed $275 million (the "Mortgage Debt A") and $230.5 million (the "Mortgage Debt B") from two banks (the "Banks") to repay the MFS Mortgage Debt and to pay financing costs.
On January 24, 1996, the Partnership completed a refinancing of the Partnership's existing debt through the private placements of $127.4 million of senior secured notes (the "Senior Notes") and $410.2 million of multi-class commercial mortgage pass-through certificates (the "Certificates").
The net proceeds from the placement of the Senior Notes and the Certificates and existing Partnership cash were used as follows: (i) to repay the Partnership's existing Mortgage Debt A of $275 million and Mortgage Debt B of $230.5 million, (ii) to repay the IRB Debt of $25.6 million, (iii) to repay the advances from Host Marriott related to certain IRB Hotels of $6.5 million and (iv) to pay certain costs of structuring and issuing the Senior Notes and the Certificates.
Upon repayment of Mortgage Debt A and Mortgage Debt B, Host Marriott was released from its obligations under (i) the Mortgage Debt A and Mortgage Debt B debt service guarantees, (ii) the foreclosure guarantee and (iii) the Ground Rent Facility, as defined.
- -------------------------------------------------------------------------------- Bank Mortgage Debt
Mortgage Debt A and B were non-recourse and bore interest at a floating rate equal to (i) the adjusted CD Rate or LIBOR, as defined, plus (ii) .75 percentage points. Mortgage Debt A and B required no principal amortization prior to maturity on December 15, 1995 and September 5, 1996, respectively.
During the period from 1989 through 1994, to reduce the Partnership's exposure to floating interest rates, the Partnership entered into two swap agreements effectively fixing the interest rates on Mortgage Note A and a large portion of Mortgage Note B.
The combined effective interest rate for Mortgage Debt A and B was 6.67% from January 1, 1996 through January 23, 1996, 7% for 1995, and 8.08% for 1994. The combined average interest rate at January 23, 1996 for Mortgage Debt A and B was 6.58%.
As security for the Mortgage Debt A (36 Hotels) and Mortgage Debt B (29 Hotels) the Banks held mortgages on the Partnership's fee or leasehold interest on the respective Hotels. The Banks also had security interests under their respective mortgages in the personal property associated with those Hotels and obtained an assignment of the Partnership's rights under the management agreement and the Purchase Agreement.
On December 15, 1995, the Partnership and the Mortgage Debt A lenders amended the loan agreement to extend the maturity date of Mortgage Debt A from December 15, 1995 to February 15, 1996 (the "Extension Period"). This amendment provided for interest during the Extension Period equal to the following:
December 16, 1995 through January 15, 1996....................Adjusted CD Rate or LIBOR plus 1 percentage point
January 16, 1996 through February 15, 1996....................Adjusted CD Rate or LIBOR plus 1.25 percentage points
In connection with the Mortgage Debt A extension, the Partnership paid an extension fee to the Banks of $1,085,000 of which the 1995 portion is included in interest expense on the consolidated statement of operations.
Bank Mortgage Debt Guarantees
Prior to the initial refinancing, in 1987 Host Marriott had guaranteed payment of up to $60 million of debt service on the MFS Mortgage Debt. As a result of the initial refinancing, this guarantee was allocated $32.6 million to Mortgage Debt A and $27.4 million to Mortgage Debt B. Any payments by Host Marriott under the Mortgage Debt guarantees were treated as loans to the Partnership and bore interest at one percentage point in excess of the prime rate of interest announced by Bankers Trust Company of New York (the "Prime Rate").
During 1995, Host Marriott was released from its original Mortgage Debt A guarantee obligation of $32.6 million as certain debt service coverage requirements were met. As a result, as of December 31, 1995, $5.4 million and $27.4 million, respectively, was available under Mortgage Debt A and B guarantees. Host Marriott was released from the original guarantees on January 24, 1996, the date when Mortgage Debt A and Mortgage Debt B were repaid in full.
During 1994, the Partnership, Manager and Mortgage Debt A and B lenders agreed that the Partnership would establish reserve accounts for Mortgage Debt A and B and contribute 1% of Hotel sales on the respective Mortgage Debt A and B
- ------------------------------------------------------------------------------ properties to these reserves from 1993 through the respective loan maturities. The initial contribution, made in 1994, included the required contribution for 1993. On January 24, 1996, these reserves were used to pay costs associated with the refinancing of these loans and to repay a portion of these loans upon maturity.
In addition, the General Partner had provided a guarantee to MFS that, in the event of a foreclosure, proceeds under the MFS Mortgage Debt would be at least $75 million. This foreclosure guarantee was allocated $40.8 million to Mortgage Debt A and $34.2 million to Mortgage Debt B. Upon completion of the debt refinancing on January 24, 1996, Host Marriott was released from its obligations pursuant to the foreclosure guarantee.
IRB Debt
The IRB Debt was refinanced on January 24, 1996 and the IRB Debt was repaid in full. The $25.6 million of IRB Debt outstanding at December 31, 1995 was backed by direct-pay letters of credit from commercial banks that would have expired in 1996. These issues were subject to mandatory prepayment upon expiration of the letters of credit unless replacement letters of credit were secured. The IRB Debt bore interest at daily, weekly or fixed rates at the option of the Partnership, and was limited to a maximum interest rate of 15%. From January 1, 1996 through January 23, 1996, the interest rates on the IRB Debt ranged from 2.65% to 6.1%. In 1995 and 1994, the interest rates on the IRB Debt ranged from 1.9% to 6.1% and 1.15% to 6.05%, respectively. The interest rate on the IRB Debt was 3.2% at January 23, 1996.
The bondholders had the right to demand purchase of any of the bonds at the expiration of specified interest rate periods. Had the Partnership failed to make the required payments of principal and interest on the IRB Debt, Host Marriott would have been required to make such payments ("Host Marriott's IRB Liability"). Through January 24, 1996, the Partnership purchased a total of $15.4 million of bonds/IRB Debt with proceeds advanced by Host Marriott (see below) when presented by certain bondholders. These loans bore interest at one percentage point in excess of the Prime Rate (8.5% at January 23, 1996). The weighted average interest rate was 9.5% for the period from January 1, 1996 through January 23, 1996, 9.83% for 1995 and 8.14% for 1994. In 1993 and 1994, the Partnership was able to repay the General Partner $8.9 million. As of December 31, 1995, $6.5 million of Host Marriott IRB Liability loans were outstanding. As discussed above, the $6.5 million of Host Marriott IRB Liability loans were repaid on January 24, 1996 from proceeds of the debt refinancing.
Ground Rent Facility
Fifty-three of the Hotels are situated on land leased from MII or affiliates of MII, eight of the Hotels are situated on land leased from third parties. MFS had agreed to lend the Partnership up to $25 million (the "Ground Rent Facility") to the extent that the Partnership has insufficient funds to pay ground rent under any ground lease, including third party ground leases, after payment of (i) hotel operating expenses (except for ground rent) and (ii) debt service. No amounts were ever advanced under the Ground Rent Facility. Upon refinancing of the Partnership debt on January 24, 1996, MFS was released from the Ground Rent Facility.
Debt Refinancing - Senior Notes
The Senior Notes of $127.4 million were issued by the Partnership and Finance. The Senior Notes bear interest at 10 3/4%, require semi-annual payments of interest and require no payments of principal until maturity on February 1, 2008. The Senior Notes are secured by a first priority pledge by the Partnership of (i) its 99% partnership interest (consisting of a 98%
- ------------------------------------------------------------------------------- limited partner interest and a 1% general partner interest) in Associates and (ii) its 100% equity interest in the Managing General Partner. Finance has nominal assets, does not conduct any operations and does not provide any additional security for the Senior Notes.
The terms of the Senior Notes include requirements of the Partnership to establish and fund a debt service reserve account in an amount equal to one six-month interest payment on the Senior Notes ($6,848,000 which is included as restricted cash on the accompanying consolidated balance sheet at December 31, 1996) and to maintain certain levels of excess cash flow, as defined. In the event the Partnership fails to maintain the required level of excess cash flow, the Partnership will be required to (i) suspend distributions to its partners and other restricted payments, as defined, (ii) to fund a separate supplemental debt service reserve account (the "Supplemental Debt Service Reserve") in an amount up to two six-month interest payments on the Senior Notes and (iii) if such failure were to continue, to offer to purchase a portion of the Senior Notes at par.
The Senior Notes are not redeemable prior to February 1, 2001. Thereafter, the Senior Notes may be redeemed, at the option of the Partnership, at a premium declining to par in 2004. The Senior Notes are non-recourse to the Partnership and its partners.
On June 4, 1996, the Partnership and Finance completed an exchange offer of its unregistered 10 3/4% Series B Senior Secured Notes with an aggregate principal amount of $127.4 million ("Old Notes") due 2008 for an equal amount of registered notes ("New Notes"). The form and terms of the New Notes are substantially identical to the form and terms of the Old Notes, except that the New Notes have been registered under the Securities Act of 1933, as amended and will not have any restrictions for transfer.
Debt Refinancing - Certificates
The Certificates in an initial principal payment of $410.2 million were issued by CBM Funding. Proceeds from the sale of the Certificates were utilized by CBM Funding to provide a Mortgage Loan to Associates. The Certificates/Mortgage Loan require monthly payments of principal and interest based on a 17-year amortization schedule. The Mortgage Loan matures on January 28, 2008. However, the maturity date of the Certificates/Mortgage Loan may be extended until January 28, 2013 with the consent of 662/3% of the holders of the outstanding Certificates affected thereby. The Certificates were issued in the following classes and pass-through rates of interest.
Initial Certificate Pass-Through Class Balance Rate ------------------- ------------------- ------------ Class A-1 $ 45,500,000 7.550% Class A-2 $ 50,000,000 6.880% Class A-3P & I $ 129,500,000 7.080% Class A-3IO Not Applicable 0.933% Class B $ 75,000,000 7.480% Class C $ 100,000,000 7.860% Class D $ 10,200,000 8.645%
The Class A-3IO Certificates receive payments of interest only based on a notional balance equal to the Class A-3P & I Certificate balance.
- ------------------------------------------------------------------------------- The balance of the Certificates was $398.9 million at December 31, 1996. Principal amortization of $11.3 million of the Class A-1 Certificates was made during 1996. The weighted average interest rate on the Certificates was 7.7% from January 24, 1996 through December 31, 1996, and the average interest rate was 7.6% at December 31, 1996.
The Certificates/Mortgage Loan maturities are as follows (in thousands):
1997 $ 13,298 1998 14,331 1999 15,443 2000 16,642 2001 17,934 Thereafter 321,205 ------------------- $ 398,853 ===================
The Mortgage Loan is secured primarily by 69 cross-defaulted and cross-collateralized mortgages representing first priority mortgage liens on (i) the fee or leasehold interest in the 69 Hotels, related furniture, fixtures and equipment and the property improvement fund, (ii) the fee interest in the land leased from MII or their affiliates on which 53 Hotels are located, (iii) a pledge of Associates membership interest in and the related right to receive distributions from Associates II which owns the Deerfield Hotel and (iv) an assignment of the Restated Management Agreement, as defined below. The Mortgage Loan is non-recourse to Associates, the Partnership and its partners.
Operating profit from the Hotels in excess of debt service on the Mortgage Loan is available to be distributed to the Partnership. Amounts distributed to the Partnership are used for the following, in order of priority: (i) for debt service on the Senior Notes, (ii) to fund the Supplemental Debt Service Reserve, if necessary, (iii) to offer to purchase a portion of the Senior Notes at par, if necessary, (iv) for working capital as discussed in Note 8 and (v) for distributions to the partners of the Partnership. The restricted net assets of Associates is $81.1 million as of December 31, 1996.
Prepayments of the Mortgage Loan are permitted with the payment of a premium (the "Prepayment Premium"). The Prepayment Premium is equal to the greater of (i) one percent of the Mortgage Loan being prepaid or (ii) a yield maintenance amount based on a spread of .25% or .55% over the U.S. treasury rate, as defined.
On June 30, 1996, CBM Funding completed an exchange offer of its Multiclass Mortgage Pass-Through Certificates, Series 1996-1A with a principal balance of $406.2 million at that time, ("Old Certificates") for an equal amount of Multiclass Mortgage Pass-Through Certificates, Series 1996-1B ("New Certificates"). The form and terms of the New Certificates are substantially identical to the form and terms of the Old Certificates, except that the New Certificates are registered under the Securities Act of 1933, as amended and their transfers are not restricted.
NOTE 7. LEASES
The land on which 53 of the Hotels are located is leased from MII or affiliates of MII. In addition, eight of the Hotels are located on land leased from third parties. The land leases have remaining terms (including all renewal options) expiring between the years 2024 and 2068. The MII land leases and the third party land leases provide for rent based on specific percentages (from 2% to 15%) of certain sales categories subject to minimum amounts. The minimum rentals are adjusted at various anniversary dates throughout the lease terms, as defined in the agreements. The Partnership also rents certain equipment for use in the Hotels.
- ------------------------------------------------------------------------------- In connection with the refinancing, the Partnership, as lessee, transferred it rights and obligations pursuant to the 53 ground leases with MII and affiliates to Associates. Additionally, MII and affiliates agreed to defer receipt of their ground lease payments to the extent that the Partnership or Associates has insufficient funds for debt service payments on the Senior Notes and the Mortgage Loan.
Minimum future rental payments during the term of these operating leases are as follows (in thousands):
Telephone Lease Land Equipment Other Year Leases Leases Leases
1997 $ 9,230 $ 1,125 $ 966 1998 9,230 1,106 561 1999 9,230 787 101 2000 9,230 589 -- 2001 9,230 -- -- Thereafter 542,213 -- -- ---------- -------------- -----------
$ 588,363 $ 3,607 $ 1,628 ========== ============== ===========
Total rent expense on land leases was $11,899,000 for 1996, $11,550,000 for 1995 and $10,787,000 for 1994.
NOTE 8. MANAGEMENT AGREEMENT
To facilitate the refinancing, effective December 30, 1995, the original management agreement was restated into two separate management agreements. Associates entered into a management agreement with the Manager for the 69 Hotels which Associates directly owns and Associates II entered into a management agreement for the Deerfield Hotel which Associates II owns, collectively, (the "Management Agreement").
Term
The Management Agreement has an initial term expiring in 2013. The Manager may renew the term, as to one or more of the Hotels, at its option, for up to three successive terms of 10-years each and one final term of five years. The Partnership may terminate the Management Agreement if, during any three consecutive years after 1992, specified minimum operating results are not achieved. However, the Manager may prevent termination by paying to the Partnership the amount by which the minimum operating results were not achieved.
Management Fees
The Management Agreement provides for annual payments of (i) the base management fee equal to 3 1/2% of gross sales from the Hotels, (ii) the Courtyard management fee equal to 2 1/2% of gross sales from the Hotels, and (iii) the incentive management fee equal to 15% of operating profit, as defined (20% of operating profit after the Partners have received refinancing proceeds equal to 50% of the excess of (a) $154,736,842 over (b) cumulative distributions of adjusted sale proceeds (the "First Equity Refinancing").
- ------------------------------------------------------------------------------ Deferral Provisions
Due to the refinancing, beginning in 1996, one percent of the Courtyard management fee is deferred through maturity of the Senior Notes and the Mortgage Loan to the extent that the Partnership or Associates has insufficient funds for debt service payments on the Senior Notes and the Mortgage Loan. This change eliminated the previous deferral of the total Courtyard management fee to debt service through December 31, 1997.
To the extent any Courtyard management fee, base management fee or incentive management fee is deferred, it will be added to deferred management fees. Deferred management fees accrue without interest, and will be payable out of 50% of available cash flow after payment of certain priorities as discussed below.
The priority return to the Partnership, as defined, was reduced from 10% of invested capital to 7% in 1996, 8% in 1997, 9% in 1998 and then returning to 10% for 1999 and thereafter. Operating profit from the Hotels (which reflects the deduction of the base and Courtyard management fees and MII ground rent) will be used to pay the following, in order of priority: (i) debt service on the Senior Notes and Mortgage Loan, (ii) to repay working capital loans to the Manager, (iii) to repay deferred ground rent to MII and their affiliates, (iv) to repay ground lease advances to MII and their affiliates, (v) the priority return to the Partnership which is 7% of invested capital for 1996, (vi) eighty percent of the remaining operating profit is applied to the payment of current incentive management fees, (vii) to repay advances to the Partnership, (viii) to repay foreclosure avoidance advances to the Manager and (ix) fifty percent of the remaining operating profit to repay deferred management fees to the Manager and fifty percent of remaining operating profit is paid to the Partnership. In 1996, the Partnership had $2.5 million of remaining operating profit after the payment of i) through viii) above. Fifty percent of this remaining operating profit was used to repay a portion of 1996 deferred incentive management fees to the Manager and the remainder was paid to the Partnership.
During 1996, $633,000 of incentive management fees were deferred while during 1995, $162,000 were repaid. Deferred incentive management fees were $6,197,000 and $5,564,000 as of December 31, 1996 and 1995, respectively. Deferred Courtyard management fees totalled $22,341,000 as of December 31, 1996 and 1995. Deferred base management fees as of December 31, 1996 and 1995 were $7,904,000 and $8,066,000, respectively.
Chain Services
The Manager is required to furnish certain services ("Chain Services") which are furnished generally on a central or regional basis to all hotels managed, owned or leased in the Courtyard by Marriott hotel system. The total amount of Chain Services allocated to the Partnership was $9,474,000 in 1996, $9,224,000 in 1995 and $8,981,000 in 1994.
Working Capital
The Partnership is required to provide the Manager with working capital and fixed asset supplies to meet the operating needs of the Hotels. The refinancing required certain enhancements to the cash management system of the Manager such that additional working capital may be required for the operation of the Hotels. Therefore, on January 24, 1996, the Partnership, Associates and the Manager entered into a working capital maintenance agreement (the "Working Capital Agreement") and deposited $2.5 million as additional working capital for the operation of the Hotels. Upon termination of the Management Agreement, the working capital and supplies will be returned to the Partnership. As of December 31, 1996, the working
- -------------------------------------------------------------------------------- capital balance was $8,761,000. This includes the $8,846,000 originally advanced less the $2,585,000 of excess working capital returned to the Partnership in 1991 and the $2,500,000 advanced on January 24, 1996. At December 31, 1996 and 1995, accumulated depreciation related to the supplies totalled $2,060,000.
In addition, the Working Capital Agreement provides that the Partnership and Associates, collectively, reserve $2 million by February 1, 1997 and additional amounts such that the total balance is $5 million by February 1, 1998 (the "Working Capital Reserve"). The $2 million was reserved on January 31, 1997. The Working Capital Reserve will be available for payment of hotel operating expenses in the event that there is a downgrade in the long-term senior unsecured debt of MII to below a certain level, as described in the Mortgage Loan.
The obligation to fund the amounts required by the Working Capital Agreement is subordinate to debt service on the Senior Notes and the Mortgage Loan.
Property Improvement Funds
The Management Agreement provides for the establishment of a repairs and equipment reserve (property improvement fund) for the Hotels. The funding of this reserve is based on a percentage of gross Hotel sales. During 1994, the Partnership, Manager and the Mortgage Debt A and B lenders agreed that the Partnership would establish refinancing reserve accounts and contribute 1% of Hotel sales on the respective Mortgage Debt A and B properties to these reserves. Correspondingly, the Management Agreement was amended in order to reduce the contribution to the property improvement fund from 6% to 5% of gross Hotel sales for the Mortgage Debt A and B properties for 1993 through the respective loan maturities. The contribution for the five IRB Hotels remained at 6%. Upon completion of the refinancing on January 24, 1996, the contribution to the property improvement fund was established initially at 5% for all Hotels and may be increased, at the option of the Manager, to 6% of gross Hotel sales in 2001. Additionally, the Partnership is no longer required to contribute 1% of gross Hotel sales from the Mortgage Debt A and Mortgage Debt B Hotels to the refinancing reserves.
NOTE 9. ENVIRONMENTAL CONTINGENCY
Based upon a study completed in December 1995, the Partnership has become aware of environmental contamination at one of its fee-owned properties, the Deerfield Hotel, caused by the previous use of the site as a landfill and not caused by the Partnership. The property represents less than 5% of the Partnership's total assets and revenues as of December 31, 1996 and for the year ended, respectively. The Partnership is unable to determine the need for remediation, its potential responsibility, if any, for remediation and the extent of the Partnership's possible liability for any remediation costs. There can be no assurance that the Partnership will not have liability with respect to remediation of contamination at that site. The Partnership does not believe that any of the environmental matters are likely to have a material adverse effect on the business and operations of the Partnership.
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO COURTYARD II ASSOCIATES LIMITED PARTNERSHIP AND SUBSIDIARIES:
We have audited the accompanying consolidated balance sheet of Courtyard II Associates, L.P. (a Delaware limited partnership) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 1996 and the statement of changes in partners' capital for the period from January 24, 1996 to December 31, 1996. These financial statements and the schedule referred to below are the responsibility of the General Partner of Courtyard by Marriott II Limited Partnership. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Courtyard II Associates, L.P. and subsidiaries as of December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index at Item 14(a)(2) is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Washington, D.C. March 13, 1997
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CONSOLIDATED STATEMENT OF OPERATIONS
Courtyard II Associates, L.P. and Subsidiaries For the Years Ended December 31, 1996, 1995 and 1994 (in thousands)
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CONSOLIDATED BALANCE SHEET
Courtyard II Associates, L.P. and Subsidiaries December 31, 1996 and 1995 (in thousands)
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CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' CAPITAL
Courtyard II Associates, L.P. and Subsidiaries For the Period from January 24, 1996 through December 31, 1996 (in thousands)
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CONSOLIDATED STATEMENT OF CASH FLOWS
Courtyard II Associates, L.P. and Subsidiaries For the Years Ended December 31, 1996, 1995 and 1994 (in thousands)
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CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
Courtyard II Associates, L.P. and Subsidiaries For the Years Ended December 31, 1996, 1995 and 1994 (in thousands)
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Courtyard II Associates, L.P. and Subsidiaries December 31, 1996 and 1995
NOTE 1. COURTYARD II ASSOCIATES, L.P. AND SUBSIDIARIES
Description
Courtyard II Associates, L.P. and subsidiaries ("Associates"), a Delaware limited partnership, was formed December 22, 1995. Substantially all of the assets of Associates were contributed to Associates by Courtyard by Marriott II Limited Partnership (the "Partnership") on January 24, 1996, in connection with the Partnership's refinancing (see Note 6). The managing general partner of Associates is Courtyard II Associates Management Corporation (a wholly-owned subsidiary of the Partnership) with a 1% interest and the Partnership owns a 1% general partner interest and a 98% limited partner interest. CBM Funding Corporation ("CBM Funding") a wholly-owned subsidiary of Associates, was formed on December 29, 1995, to make a mortgage loan to Associates in connection with the refinancing (see Note 6). Associates directly owns 69 Courtyard hotels and the land on which certain of the Hotels, as defined below, are located. One hotel located in Deerfield, Illinois (the "Deerfield Hotel"), is owned by CBM Associates II LLC ("Associates II"). Associates hold a 99% membership interest in Associates II and Courtyard II Associates Management Corporation holds the remaining 1% interest in Associates II. The 70 hotel properties (the "Hotels") are located in 29 states in the United States: nine in Illinois; eight in California; five in Florida; four in Georgia; four in Texas; and three or less in each of the other 24 states. The Hotels are managed as part of the Courtyard by Marriott hotel system by Courtyard Management Corporation (the "Manager"), a wholly-owned subsidiary of Marriott International, Inc. ("MII").
Partnership Allocations and Distributions
Allocations and distributions for Associates are generally made in accordance with the respective ownership interests as follows: (i) 98% to the limited partner, the Partnership and (ii) 1% to each general partner, the Partnership and Courtyard II Associates Management Corporation.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements of Associates present the financial position, results of operations and cash flows of Associates as if it were a separate subsidiary of the Partnership for all periods presented. The Partnership's historical basis in the assets and liabilities contributed to Associates have been carried over. Intercompany transactions and balances between Associates and its subsidiaries have been eliminated. Changes in Investment in and Net Advances to Associates for all periods presented prior to January 24, 1996, represent the net income of Associates net of cash transferred to the Partnership. There were no terms of settlement or interest charges associated with the Investment in and Net Advances to Associates balance.
- -------------------------------------------------------------------------------- An analysis of the activity in Investment in and Net Advances to Associates for the two years ended December 31, 1995 and the period from January 1, 1996 through January 24, 1996, is as follows (in millions):
Balance, December 31, 1994....................................$ 67 Cash transfers to (from) Associates, net.................. (28) Net income................................................ 19
Balance, December 31, 1995.................................... 58 Cash transfers to Associates, net......................... 16 Amount reclassified as Partners' Capital.................. (74) ---
Balance, January 24, 1996........................................$ -- ===
The average balance for Investment in and Net Advances to Associates for each of the years 1994 and 1995 was $76 million and $62.5 million, respectively. On January 24, 1996, the Partnership contributed substantially all of its assets to Associates for a 1% general partner interest and a 98% limited partner interest. Courtyard II Associates Management Corporation owns the remaining 1% general partner interest.
On January 24, 1996, Associates consummated the offering of $410,200,000 of multi-class mortgage pass-through certificates (the "Certificates"), the net proceeds of which were used to repay certain obligations of the Partnership as discussed in Note 6. The accompanying consolidated financial statements present the pushed-down effects of the debt which was repaid with the proceeds of the offering as discussed in Note 6.
A concurrent offering of $127,400,000 of senior notes (the "Senior Notes") by the Partnership was also completed on January 24, 1996. The Senior Notes are secured by a first priority pledge of the Partnership's 99% partnership interest in Associates and the Partnership's 100% equity interest in Courtyard II Associates Management Corporation. As a result, the Partnership owns directly or indirectly 100% of Associates. The Senior Notes are not reflected in the accompanying consolidated financial statements of Associates because Associates does not guarantee the Senior Notes nor do the assets of Associates secure the Senior Notes. Payments on the Senior Notes are made from distributions of the excess cash of Associates to the Partnership; such distributions are restricted only upon a monetary event of default under the Mortgage Loan, as defined in Note 6. The Partnership has no other source of cash flow other than distributions from Associates.
Basis of Accounting
The records of Associates are maintained on the accrual basis of accounting and its fiscal year coincides with the calendar year.
- -------------------------------------------------------------------------------- Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Working Capital and Supplies
Pursuant to the terms of Associates management agreement discussed in Note 8, Associates is required to provide the Manager with working capital and supplies to meet the operating needs of the Hotels. The Manager converts cash advanced by Associates into other forms of working capital consisting primarily of operating cash, inventories, and trade receivables and payables which are maintained and controlled by the Manager. Upon the termination of the management agreement, the Manager is required to convert working capital and supplies into cash and return it to Associates. As a result of these conditions, the individual components of working capital and supplies controlled by the Manager are not reflected in the accompanying consolidated balance sheet.
Revenues and Expenses
Revenues represent house profit from Associates' Hotels since Associates delegated substantially all of the operating decisions related to the generation of house profit of the Hotels to the Manager. House profit reflects hotel operating results which flow to Associates as property owner and represents hotel sales less property-level expenses, excluding depreciation, base, Courtyard and incentive management fees, real and personal property taxes, ground rent and equipment rent, insurance and certain other costs, which are disclosed separately in the consolidated statement of operations.
Property and Equipment
Property and equipment is recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:
Buildings and improvements 40 years Leasehold improvements 40 years Furniture and equipment 4-10 years
Certain property and equipment was pledged to secure the mortgage debt described in Note 6.
Associates assesses impairment of its real estate properties based on whether estimated undiscounted future cash flows from such properties on an individual hotel basis will be less than their net book value. If a property is impaired, its basis is adjusted to fair market value.
- -------------------------------------------------------------------------------- Deferred Financing Costs
Prior to 1996, deferred financing costs consist of costs incurred in connection with obtaining Mortgage Debt A and B, as defined in Note 6. Financing costs are amortized using the straight-line method, which approximates the effective interest rate method, over the remaining life of the respective mortgage debt. At December 31, 1996 accumulated amortization related to Mortgage Debt A and B, as defined in Note 6, was $2,904,000. At December 31, 1996, costs related to Mortgage Debt A and B were fully amortized. On January 24, 1996, the Partnership contributed substantially all of its assets to Associates including $2,630,000 the Partnership had paid in 1995 in financing costs related to the debt refinancing discussed in Note 6. During 1996, Associates paid $10,627,000 in financing costs. At December 31, 1996, accumulated amortization related to the Certificates, as defined in Note 6, was $1,023,000.
Cash and Cash Equivalents
Associates considers all highly liquid investments with a maturity of three months or less at date of purchase to be cash equivalents.
Ground Rent
The land leases with MII or affiliates of MII (see Note 7) include scheduled increases in minimum rents per property. These scheduled rent increases, which are included in minimum lease payments, are being recognized by Associates on a straight-line basis over the lease terms which approximate 80 years. The adjustment included in ground rent expense and Due to Marriott International, Inc. and affiliates to reflect minimum lease payments on a straight-line basis for 1996, 1995 and 1994 totalled $119,000 per year.
Income Taxes
Provision for Federal taxes has not been made in the accompanying consolidated financial statements since Associates does not pay income taxes, but rather, allocates its profits and losses to the individual partners.
Interest Rate Swap Agreements
Associates was a party to two interest rate swap agreements (prior to their expiration in 1994) to reduce Associates' exposure to floating interest rates. Associates accounted for the swap arrangements as a hedge of obligations to pay floating rates of interest and accordingly, recorded interest expense based upon its payment obligations at fixed interest rates. Interest expense on the consolidated statement of operations reflects the "pushed down" effect of a proportionate amount of total swap interest.
New Statement of Financial Accounting Standards
In the first quarter of 1996, Associates adopted Statement of Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Adoption of SFAS No. 121 did not have an effect on its consolidated financial statements.
- -------------------------------------------------------------------------------- NOTE 3. REVENUES
Revenues for Associates consist of Hotel operating results for the three years ended December 31 (in thousands):
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following as of December 31 (in thousands):
1996 1995 ----------- -------------
Land...............................$ 25,392 $ 25,392 Leasehold improvements............. 438,921 435,913 Building and improvements.......... 78,559 77,053 Furniture and equipment............ 142,663 135,908 ------------- ------------- 685,535 674,266
Less accumulated depreciation...... (226,848) (199,786) ------------- ------------- $ 458,687 $ 474,480 ============= =============
- ------------------------------------------------------------------------------- NOTE 5. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments are shown below. The fair values of financial instruments not included in this table are estimated to be equal to their carrying amounts (in thousands):
The 1996 estimated fair value of mortgage debt obligations was based on the quoted market prices at December 31, 1996.
The 1995 estimated fair values of mortgage debt obligations and amounts due to Host Marriott Corporation are based on their carrying amounts as these items were repaid on January 24, 1996. Consistent with the prior year, the 1996 management fees due to the Courtyard Management Corporation are valued based on the expected future payments from operating cash flow discounted at risk adjusted rates.
NOTE 6. MORTGAGE DEBT
Overview
For 1995, the accompanying consolidated financial statements reflect the pushed-down effects of an equivalent principal amount of the Partnership's debt which was repaid with the proceeds of the offering as discussed below. Therefore, debt consisted of the following at December 31, 1995 (in thousands):
Partnership Associates
Mortgage Debt A.......................$ 275,000 $ 209,612 Mortgage Debt B....................... 230,500 175,976 IRB Debt.............................. 25,600 19,690 Host Marriott IRB Liability loans..... 6,489 4,922 --------- ---------- $ 537,589 $ 410,200 ========= ==========
The following discussion of bank mortgage debt, swaps, debt service guarantees, foreclosure guarantees, Host Marriott IRB Liability advances and repayments and the ground rent facility reflect actual amounts in relation to the Partnership. Therefore, amounts discussed herein are not reflective of "push down" amounts to Associates.
- -------------------------------------------------------------------------------- On January 24, 1996, the Partnership and Associates completed two refinancings of the existing debt through the private placements of $127.4 million of Senior Notes and $410.2 million of multiclass commercial mortgage pass-through certificates, respectively.
The net proceeds from the placement of the Senior Notes and the Certificates and existing Partnership cash were used as follows: (i) to repay the Partnership's existing Mortgage Debt A of $275 million and Mortgage Debt B of $230.5 million, (ii) to repay the IRB Debt of $25.6 million, (iii) to repay advances from the Host Marriott related to certain IRB Hotels loans of $6.5 million and (iv) to pay certain costs of structuring and issuing the Senior Notes and the Certificates.
Upon repayment of Mortgage Debt A and Mortgage Debt B, Host Marriott was released from its obligations under (i) the Mortgage Debt A and Mortgage Debt B debt service guarantees, (ii) the foreclosure guarantee and (iii) the Ground Rent Facility as defined.
Bank Mortgage Debt
Mortgage Debt A and B were non-recourse and bore interest at a floating rate equal to (i) the adjusted CD Rate or LIBOR, as defined, plus (ii) .75 percentage points. Mortgage Debt A and B required no principal amortization prior to maturity on December 15, 1995 and September 5, 1996, respectively.
During the period from 1989 through 1994, to reduce the Partnership's exposure to floating interest rates, the Partnership entered into two swap agreements effectively fixing the interest rates on Mortgage Note A and a large portion of Mortgage Note B.
The combined effective interest rate for Mortgage Debt A and B was 6.67% from January 1, 1996 through January 23, 1996, 7% for 1995, and 8.08% for 1994. The combined average interest rate at January 23, 1996 for Mortgage Debt A and B was 6.58%.
As security for the Mortgage Debt A (36 Hotels) and Mortgage Debt B (29 Hotels) the banks held mortgages on the Partnership's fee or leasehold interest on the respective Hotels. The banks also had security interests under their respective mortgages in the personal property associated with those Hotels and obtained an assignment of the Partnership's rights under the management agreement and the Purchase Agreement.
On December 15, 1995, the Partnership and the Mortgage Debt A lenders amended the loan agreement to extend the maturity date of Mortgage Debt A from December 15, 1995 to February 15, 1996 (the "Extension Period"). This amendment provided for interest during the Extension Period equal to the following:
December 16, 1995 through January 15, 1996........Adjusted CD Rate or LIBOR plus 1 percentage point
January 16, 1996 through February 15, 1996........Adjusted CD Rate or LIBOR plus 1.25 percentage points
In connection with the Mortgage Debt A extension, the Partnership paid an extension fee to the Banks of $1,085,000 which was amortized as interest expense during the Extension Period.
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Bank Mortgage Debt Guarantees
Prior to the initial refinancing, in 1987 Host Marriott had guaranteed payment of up to $60 million of debt service on the $500 million of non-recourse mortgage debt (the "MFS Mortgage Debt") from Marriott Financial Services, Inc. ("MFS"), a wholly-owned subsidiary of Host Marriott. As a result of the initial refinancing, this guarantee was allocated $32.6 million to Mortgage Debt A and $27.4 million to Mortgage Debt B. Any payments by Host Marriott under the Mortgage Debt guarantees were treated as loans to the Partnership and bore interest at one percentage point in excess of the prime rate of interest announced by Bankers Trust Company of New York (the "Prime Rate").
During 1995, Host Marriott was released from its remaining original Mortgage Debt A guarantee obligation of $32.6 million as certain debt service coverage requirements were met. Host Marriott was released from the remaining original guarantees on January 24, 1996, the date when Mortgage Debt A and Mortgage Debt B were repaid in full.
During 1994, the Partnership, Manager and Mortgage Debt A and B lenders agreed that the Partnership would establish reserve accounts for Mortgage Debt A and B and contribute 1% of Hotel sales on the respective Mortgage Debt A and B properties to these reserves for 1993 through the respective loan maturities. The initial contribution, made in 1994, included the required contribution for 1993. On January 24, 1996, these reserves were used to pay costs associated with the refinancing of these loans and to repay a portion of these loans upon maturity.
In addition, the General Partner had provided a guarantee to MFS that, in the event of a foreclosure, proceeds under the MFS Mortgage Debt would be at least $75 million. This foreclosure guarantee was allocated $40.8 million to Mortgage Debt A and $34.2 million to Mortgage Debt B. Upon completion of the debt refinancing on January 24, 1996, Host Marriott was released from its obligations pursuant to the foreclosure guarantee.
IRB Debt
The IRB Debt was refinanced on January 24, 1996 and the IRB Debt was repaid in full. The $25.6 million of IRB Debt outstanding at December 31, 1995 was backed by direct-pay letters of credit from commercial banks that would have expired in February, November and December 1996. These issues were subject to mandatory prepayment upon expiration of the letters of credit unless replacement letters of credit were secured. The IRB Debt bore interest at daily, weekly or fixed rates at the option of the Partnership, and was limited to a maximum interest rate of 15%. During the period from January 1, 1996 through January 23, 1996, the interest rates on the IRB Debt ranged from 2.65% to 6.1%. In 1995 and 1994, the interest rates on the IRB Debt ranged from 1.9% to 6.1% and 1.15% to 6.05%, respectively. The interest rate on the IRB Debt was 3.2% at January 23, 1996.
The bondholders had the right to demand purchase of any of the bonds at the expiration of specified interest rate periods. Had the Partnership failed to make the required payments of principal and interest on the IRB Debt, Host Marriott would have been required to make such payments ("Host Marriott's IRB Liability"). Through January 24, 1996, the Partnership purchased a total of $15.4 million of bonds/IRB Debt with proceeds advanced by Host Marriott (see below) when presented by certain bondholders. These loans bore interest at one percentage point in excess of the Prime Rate (8.5% at January 23, 1996). The weighted average interest rate was 9.5% for the period from January 1, 1996 through January 23, 1996, 9.83% for 1995 and 8.14% for 1994. As of December 31, 1995, $6.5 million of Host Marriott IRB Liability loans were outstanding. As discussed above, the $6.5 million of Host Marriott IRB Liability loans were repaid on January 24, 1996, from proceeds of the debt refinancing.
- ------------------------------------------------------------------------------- Ground Rent Facility
Fifty-three of the Hotels are situated on land leased from MII or affiliates of MII, eight of the Hotels are situated on land leased from third parties. MFS had agreed to lend the Partnership up to $25 million (the "Ground Rent Facility") to the extent that the Partnership has insufficient funds to pay ground rent under any ground lease under certain circumstances. No amounts were ever advanced under the Ground Rent Facility. Upon refinancing of the Partnership Debt on January 24, 1996, MFS was released from the Ground Rent Facility.
Debt Refinancing - Certificates
The Certificates in an initial principal amount of $410.2 million were issued by CBM Funding. Proceeds from the sale of the Certificates were utilized by CBM Funding to provide a mortgage loan (the "Mortgage Loan") to Associates. The Certificates/Mortgage Loan require monthly payments of principal and interest based on a 17-year amortization schedule. The Mortgage Loan matures on January 28, 2008. However, the maturity date of the Certificates/Mortgage Loan may be extended until January 28, 2013 with the consent of 662/3% of the holders of the outstanding Certificates affected thereby. The Certificates were issued in the following classes and pass-through rates of interest.
Initial Certificate Pass-Through Class Balance Rate ------------------- ------------------- ------------ Class A-1 $ 45,500,000 7.550% Class A-2 $ 50,000,000 6.880% Class A-3P & I $ 129,500,000 7.080% Class A-3IO Not Applicable 0.933% Class B $ 75,000,000 7.480% Class C $ 100,000,000 7.860% Class D $ 10,200,000 8.645%
The Class A-3IO Certificates receive payments of interest only based on a notional balance equal to the Class A-3P & I Certificate Balance.
The balance of the Certificates was $398.9 million at December 31, 1996. Principal amortization of $11.3 million of the Class A-1 Certificates was made during 1996. The weighted average interest rate for January 24, 1996, through December 31, 1996, was 7.7%. The average interest rate at December 31, 1996 was 7.6%.
The Certificates maturities are as follows (in thousands):
1997 $ 13,298 1998 14,331 1999 15,443 2000 16,642 2001 17,934 Thereafter 321,205 --------- $ 398,853 =========
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The Mortgage Loan is secured primarily by 69 cross-defaulted and cross-collateralized mortgages representing first priority mortgage liens on (i) the fee or leasehold interest in the 69 Hotels, related furniture, fixtures and equipment and the property improvement fund, (ii) the fee interest in the land leased from MII or their affiliates on which 53 Hotels are located, (iii) a pledge of Associates membership interest in and the related right to receive distributions from Associates II which owns the Deerfield Hotel and (iv) an assignment of the Management Agreement, as defined below. The Mortgage Loan is non-recourse to Associates, the Partnership and its partners.
Operating profit from the Hotels in excess of debt service on the Mortgage Loan is available to be distributed to the Partnership and Courtyard II Associates Management Corporation.
Prepayments of the Mortgage Loan are permitted with the payment of a premium (the "Prepayment Premium"). The Prepayment Premium is equal to the greater of (i) one percent of the Mortgage Loan being prepaid or (ii) a yield maintenance amount based on a spread of .25% or .55% over the U.S. treasury rate, as defined.
On June 30, 1996, CBM Funding completed an exchange offer of its Multiclass Mortgage Pass-Through Certificates, Series 1006-1A with a principal balance of $406.2 million at that time ("Old Certificates"), for an equal amount of Multiclass Mortgage Pass-Through Certificates, Series 1996-1B ("New Certificates"). The form and terms of the New Certificates are substantially identical to the form and terms of the Old Certificates, except that the New Certificates are registered under the Securities Act of 1933, as amended and their transfers are not restricted.
NOTE 7. LEASES
The land on which 53 of the Hotels are located is leased from MII or affiliates of MII. In addition, eight of the Hotels are located on land leased from third parties. The land leases have remaining terms (including all renewal options) expiring between the years 2024 and 2068. The MII land leases and the third party land leases provide for rent based on specific percentages (from 2% to 15%) of certain sales categories subject to minimum amounts. The minimum rentals are adjusted at various anniversary dates throughout the lease terms, as defined in the agreements. The Partnership also rents certain equipment for use in the Hotels.
In connection with the refinancing, the Partnership, as lessee, transferred its rights and obligations pursuant to the 53 ground leases with MII and affiliates to Associates. Additionally, MII and affiliates agreed to defer receipt of their ground lease payments to the extent that the Partnership or Associates has insufficient funds for debt service payments on the Senior Notes and the Mortgage Loan.
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Minimum future rental payments during the term of these operating leases are as follows (in thousands):
Telephone Lease Land Equipment Other Year Leases Leases Leases -------------- ---------- -------------- --------- 1997 $ 9,230 $ 1,125 $ 966 1998 9,230 1,106 561 1999 9,230 787 101 2000 9,230 589 -- 2001 9,230 -- -- Thereafter 542,213 -- -- ---------- -------------- ----------- $ 588,363 $ 3,607 $ 1,628 ========== ============== ===========
Total rent expense on land leases was $11,899,000 for 1996, $11,550,000 for 1995 and $10,787,000 for 1994.
NOTE 8. MANAGEMENT AGREEMENT
To facilitate the refinancing, effective December 30, 1995, the original management agreement was restated into two separate management agreements. Associates entered into a management agreement with the Manager for the 69 Hotels which Associates directly owns and Associates II entered into a management agreement for the Deerfield Hotel which Associates II owns, collectively, (the "Management Agreement").
Term
The Management Agreement has an initial term expiring in 2013. The Manager may renew the term, as to one or more of the Hotels, at its option, for up to three successive terms of 10-years each and one final term of five years. The Partnership may terminate the Management Agreement if, during any three consecutive years after 1992, specified minimum operating results are not achieved. However, the Manager may prevent termination by paying to the Partnership the amount by which the minimum operating results were not achieved.
Management Fees
The Management Agreement provides for annual payments of (i) the base management fee equal to 3 1/2% of gross sales from the Hotels, (ii) the Courtyard management fee equal to 2 1/2% of gross sales from the Hotels, and (iii) the incentive management fee equal to 15% of operating profit, as defined (20% of operating profit after the partners have received refinancing proceeds equal to 50% of the excess of (a) $154,736,842 over (b) cumulative distributions of adjusted sale proceeds (the "First Equity Refinancing").
Deferral Provisions
Due to the refinancing, beginning in 1996, one percent of the Courtyard management fee is deferred through maturity of the Senior Notes and the Mortgage Loan to the extent that the Partnership or Associates has insufficient funds for debt service payments on the Senior Notes and the Mortgage Loan. This change eliminated the previous deferral of the total Courtyard management fee to debt service through December 31, 1997.
- ------------------------------------------------------------------------------- To the extent any Courtyard management fee, base management fee or incentive management fee is deferred, it will be added to deferred management fees. Deferred management fees accrue without interest, and will be payable out of 50% of available cash flow after payment of certain priorities as discussed below.
The priority return to the Partnership, as defined, was reduced from 10% of invested capital to 7% in 1996, 8% in 1997, 9% in 1998 and then returning to 10% for 1999 and thereafter. Operating profit from the Hotels (which reflects the deduction of the base and Courtyard management fees and MII ground rent) will be used to pay the following, in order of priority: (i) debt service on the Senior Notes and Mortgage Loan, (ii) to repay working capital loans to the Manager, (iii) to repay deferred ground rent to MII and their affiliates, (iv) to repay ground lease advances to MII and their affiliates, (v) the priority return to the Partnership which is 7% of invested capital for 1996, (vi) eighty percent of the remaining operating profit is applied to the payment of current incentive management fees, (vii) to repay advances to the Partnership, (viii) to repay foreclosure avoidance advances to the Manager and (ix) fifty percent of the remaining operating profit to repay deferred management fees to the Manager and fifty percent of remaining operating profit is paid to the Partnership. In 1996, the Partnership had $2.5 million of remaining operating profit after the payment of i) through viii) above. Fifty percent of this remaining operating profit was used to repay a portion of 1996 deferred incentive management fees to the Manager and the remainder was paid to the Partnership.
During 1996, $633,000 of incentive management fees were deferred while during 1995, $162,000 were repaid. Deferred incentive management fees were $6,197,000 and $5,564,000 as of December 31, 1996 and 1995, respectively. Deferred Courtyard management fees totalled $22,341,000 as of December 31, 1996 and 1995. Deferred base management fees as of December 31, 1996 and 1995 were $7,904,000.
Chain Services
The Manager is required to furnish certain services ("Chain Services") which are furnished generally on a central or regional basis to all hotels managed, owned or leased in the Courtyard by Marriott hotel system. The total amount of Chain Services allocated to the Partnership was $9,474,000 in 1996, $9,224,000 in 1995 and $8,981,000 in 1994.
Working Capital
Associates is required to provide the Manager with working capital and fixed asset supplies to meet the operating needs of the Hotels. The refinancing required certain enhancements to the cash management system of the Manager such that additional working capital may be required for the operation of the Hotels. Therefore, on January 24, 1996, the Partnership, Associates and the Manager entered into a working capital maintenance agreement (the "Working Capital Agreement") and deposited $2.5 million as additional working capital for the operation of the Hotels. Upon termination of the Management Agreement, the working capital and supplies will be returned to Associates. As of December 31, 1996, the working capital balance was $8,761,000. This includes the $8,846,000 originally advanced less the $2,585,000 of excess working capital returned to the Partnership in 1991 and the $2,500,000 advanced during 1996. At December 31, 1996 and 1995, accumulated depreciation related to the supplies totalled $2,060,000.
- -------------------------------------------------------------------------------- In addition, the Working Capital Agreement provides that the Partnership and Associates, collectively, reserve $2 million by February 1, 1997, and additional amounts such that the total balance is $5 million by February 1, 1998 (the "Working Capital Reserve"). The $2 million was reserved by Associates on January 31, 1997. The Working Capital Reserve will be available for payment of hotel operating expenses in the event that there is a downgrade in the long-term senior unsecured debt of MII to below a certain level, as described in the Mortgage Loan.
The obligation to fund the amounts required by the Working Capital Agreement is subordinate to debt service on the Senior Notes and the Mortgage Loan.
Property Improvement Fund
The Management Agreement provides for the establishment of a repairs and equipment reserve (property improvement fund) for the Hotels. The funding of this reserve is based on a percentage of gross Hotel sales. During 1994, the Partnership, Manager and the Mortgage Debt A and B lenders agreed that the Partnership would establish refinancing reserve accounts and contribute 1% of Hotel sales on the respective Mortgage Debt A and B properties to these reserves. Correspondingly, the Management Agreement was amended in order to reduce the contribution to the property improvement fund from 6% to 5% of gross Hotel sales for the Mortgage Debt A and B properties for 1993 through the respective loan maturities. The contribution for the five IRB Hotels remained at 6%. Upon completion of the refinancing on January 24, 1996, the contribution to the property improvement fund was established initially at 5% for all Hotels and may be increased, at the option of the Manager, to 6% of gross Hotel sales in 2001.
NOTE 9. ENVIRONMENTAL CONTINGENCY
Based upon a study completed in December 1995, Associates has become aware of environmental contamination at one of the fee-owned properties owned by Associates II, the Deerfield Hotel, caused by the previous use of the site as a landfill and not caused by Associates. The property represents less than 5% of Associates' total assets and revenues as of December 31, 1996 and for the year ended, respectively. Associates is unable to determine the need for remediation, its potential responsibility, if any, for remediation and the extent of Associates' possible liability for any remediation costs. There can be no assurance that Associates will not have liability with respect to remediation of contamination at that site. Associates does not believe that any of the environmental matters are likely to have a material adverse effect on its business and operations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The Partnership has no directors or officers. The business and policy making functions of the Partnership are carried out through the directors and executive officers of CBM Two Corporation, the General Partner, who are listed below:
Age at Name Current Position December 31, 1996
Robert E. Parsons President and Director 41 Christopher G. Townsend Vice President and Director 49 Bruce F. Stemerman Vice President and Director 41 Earla L. Stowe Vice President and 35 Chief Accounting Officer Anna Mary Coburn Secretary 41 Bruce Wardinski Treasurer 36
Business Experience
Robert E. Parsons joined Host Marriott's Corporate Finance Planning staff in 1981. In 1984, Mr. Parsons was made Director, Project Finance of Host Marriott's Treasury Department and in 1986 he was made Vice President, Project Finance of Host Marriott's Treasury Department. He was made Assistant Treasurer of Host Marriott in 1988 and was made Senior Vice President and Treasurer of Host Marriott in 1993. In October 1995, he was made Executive Vice President and Chief Financial Officer of Host Marriott. He also serves as a director and an officer of numerous Host Marriott subsidiaries.
Christopher G. Townsend joined Host Marriott's Law Department in 1982 as a Senior Attorney. In 1984 he was made Assistant Secretary of Host Marriott. In 1986 he was made an Assistant General Counsel. He was made Senior Vice President, Corporate Secretary and Deputy General Counsel of Host Marriott in 1993. In January 1997, he was made General Counsel of Host Marriott. He also serves as a director and an officer of numerous Host Marriott subsidiaries.
Bruce F. Stemerman joined Host Marriott in 1989 as Director--Partnership Services. He became Vice President--Lodging Partnerships in 1994 and became Senior Vice President--Asset Management in 1996. Prior to joining Host Marriott, Mr. Stemerman spent ten years with Price Waterhouse and became Senior Vice President--Asset Management in 1996. He also serves as a director and an officer of numerous Host Marriott subsidiaries.
Earla L. Stowe was appointed to Vice President and Chief Accounting Officer of CBM Two Corporation on October 8, 1996. Ms. Stowe joined Host Marriott Corporation in 1982 and held various positions in the tax department until 1988. She joined the Partnership Services department as an accountant in 1988 and in 1989 she became an Assistant Manager--Partnership Services. She was promoted to Manager--Partnership Services in 1991 and to Director--Asset Management in 1996.
Anna Mary Coburn joined Host Marriott as an Attorney in 1988, became Assistant General Counsel in 1993, and was elected Corporate Secretary and Associate General Counsel in 1997. Prior to joining Host Marriott, Ms. Coburn was an Attorney for the law firm of Shawe & Rosenthal and was a law clerk for the United States Court of Appeals for the Fourth Circuit.
Bruce Wardinski joined Host Marriott in 1987 as a Senior Financial Analyst of Financial Planning & Analysis and was named Manager in June 1988. He was appointed Director, Financial Planning & Analysis in 1989, Director of Project Finance in January 1990, Senior Director of Project Finance in June 1993, Vice President--Project Finance in June 1994, and Senior Vice President of International Development in October 1995. In June 1996, Mr. Wardinski was named Senior Vice President and Treasurer of Host Marriott. Prior to joining Host Marriott, Mr. Wardinski was with the public accounting firm Price Waterhouse.
ITEM 11. MANAGEMENT REMUNERATION AND TRANSACTIONS
As noted in Item 10 above, the Partnership has no directors or officers nor does it have any employees. Under the Partnership Agreement, however, the General Partner has the exclusive right to conduct the business and affairs of the Partnership subject only to the management agreements described in Items 1 and 13. The General Partner is required to devote to the Partnership such time as may be necessary for the proper performance of its duties, but the officers and directors of the General Partner are not required to devote their full time to the performance of such duties. No officer or director of the General Partner devotes a significant percentage of time to Partnership matters. To the extent that any officer or director does devote time to the Partnership, the General Partner is entitled to reimbursement for the cost of providing such services. For the fiscal years ending December 31, 1996, 1995 and 1994, the Partnership reimbursed the General Partner in the amount of $221,000, $306,000 and $219,000, respectively, for the cost of providing all administrative and other services as General Partner. For information regarding all payments made by the Partnership to Host Marriott and subsidiaries, see Item 13 "Certain Relationships and Related Transactions."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of December 31, 1996, no person owned of record, or to the Partnership's knowledge owned beneficially, more than 5% of the total number of limited partnership Units. The General Partner owns a total of 21.5 Units representing a 1.39% limited partnership interest in the Partnership.
The executive officers and directors of the General Partner, Host Marriott, MII and their respective affiliates do not own any units as of December 31, 1996.
The Partnership is not aware of any arrangements which may, at a subsequent date, result in a change in control of the Partnership.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Management Agreement
To facilitate the refinancing, effective December 30, 1995, the original Management Agreement was restated into two separate management agreements. Associates entered into a management agreement with the Manager for the 69 Hotels which Associates directly owns and Associates II entered into a management agreement for the Deerfield Hotel which Associates II owns, collectively, (the "Management Agreement").
Term
The Management Agreement has an initial term expiring in 2013. The Manager may renew the term, as to one or more of the Hotels, at its option, for up to three successive terms of 10-years each and one final term of five years. The Partnership may terminate the Management Agreement if, during any three consecutive years after 1992, specified minimum operating results are not achieved. However, the Manager may prevent termination by paying to the Partnership the amount by which the minimum operating results were not achieved.
Management Fees
The Management Agreement provides for annual payments of (i) the base management fee equal to 3 1/2% of gross sales from the Hotels, (ii) the Courtyard management fee equal to 2 1/2% of gross sales from the Hotels, and (iii) the incentive management fee equal to 15% of operating profit, as defined (20% of operating profit after the Partners have received refinancing proceeds equal to 50% of the excess of (a) $154,736,842 over (b) cumulative distributions of adjusted sale proceeds (the "First Equity Refinancing").
Deferral Provisions
Until 1998, the Courtyard management fee will be deferred to the extent the Partnership does not have sufficient funds for debt service. Prior to 1994, the incentive management fee earned and paid was limited to a maximum of 55% of the remainder of (i) available cash flow, as defined, less (ii) the priority return. Thereafter, payment of any earned incentive management fee is limited to 80% of the amount by which available cash flow exceeds the priority return.
Beginning in 1996, one percent of the Courtyard management fee is deferred through maturity of the Senior Notes and the Mortgage Loan to the extent that the Partnership or Associates has insufficient funds for debt service payments on the Senior Notes and the Mortgage Loan.
To the extent any Courtyard management fee, base management fee or incentive management fee is deferred, it will be added to deferred management fees. Deferred management fees accrue without interest, and will be payable out of 50% of available cash flow after payment of certain priorities as discussed below.
The priority return to the Partnership, as defined, was reduced from 10% of invested capital to 7% in 1996, 8% in 1997, 9% in 1998 and then returning to 10% for 1999 and thereafter. Operating profit from the Hotels (which reflects the deduction of the base and Courtyard management fees and MII ground rent) will be used to pay the following, in order of priority: (i) debt service on the Senior Notes
and Mortgage Loan, (ii) to repay working capital loans to the Manager, (iii) to repay deferred ground rent to MII and their affiliates, (iv) to repay ground lease advances to MII and their affiliates, (v) the priority return to the Partnership which is 7% of invested capital for 1996, (vi) eighty percent of the remaining operating profit is applied to the payment of current incentive management fees, (vii) to repay advances to the Partnership, (viii) to repay foreclosure avoidance advances to the Manager and (ix) fifty percent of the remaining operating profit after payment of (i) through (viii) to repay deferred management fees to the Manager and the other fifty percent is paid to the Partnership. In 1996, the Partnership had $2.5 million of remaining operating profit after the payment of i) through viii) above. Fifty percent of this remaining operating profit was used to repay a portion of 1996 deferred incentive management fees to the Manager and the remainder was paid to the Partnership.
During 1996, $633,000 of incentive management fees were deferred while during 1995, $162,000 were repaid. Deferred incentive management fees were $6,197,000 and $5,564,000 as of December 31, 1996 and 1995, respectively. Deferred Courtyard management fees totalled $22,341,000 as of December 31, 1996 and 1995. Deferred base management fees as of December 31, 1996 and 1995 were $7,904,000.
Chain Services
The Manager is required to furnish certain services ("Chain Services") which are furnished generally on a central or regional basis to all hotels managed, owned or leased in the Courtyard by Marriott hotel system. The total amount of Chain Services allocated to the Partnership was $9,474,000 in 1996, $9,224,000 in 1995 and $8,981,000 in 1994.
Working Capital
The Partnership is required to provide the Manager with working capital and fixed asset supplies to meet the operating needs of the Hotels. The refinancing required certain enhancements to the cash management system of the Manager such that additional working capital may be required for the operation of the Hotels. Therefore, on January 24, 1996, the Partnership, Associates and the Manager entered into a working capital maintenance agreement (the "Working Capital Agreement") and deposited $2.5 million as additional working capital for the operation of the Hotels. Upon termination of the Management Agreement, the working capital and supplies will be returned to the Partnership. As of December 31, 1996, the working capital balance was $8,761,000. This includes the $8,846,000 originally advanced less the $2,585,000 of excess working capital returned to the Partnership in 1991 and the $2,500,000 advanced on January 24, 1996. At December 31, 1996 and 1995, accumulated depreciation related to the supplies totalled $2,060,000.
In addition, the Working Capital Agreement provides that the Partnership and Associates, collectively, reserve $2 million by February 1, 1997 and additional amounts such that the total balance is $5 million by February 1, 1998 (the "Working Capital Reserve"). The $2 million was reserved on January 31, 1997. The Working Capital Reserve will be available for payment of hotel operating expenses in the event that there is a downgrade in the long-term senior unsecured debt of MII to below a certain level, as described in the Mortgage Loan.
The obligation to fund the amounts required by the Working Capital Agreement is subordinate to debt service on the Senior Notes and the Mortgage Loan.
Property Improvement Funds
The Management Agreement provides for the establishment of a repairs and equipment reserve (property improvement fund) for the Hotels. The funding of this reserve is based on a percentage of gross Hotel sales. During 1994, the Partnership, Manager and the Mortgage Debt A and B lenders agreed that the Partnership would establish refinancing reserve accounts and contribute 1% of Hotel sales on the respective Mortgage Debt A and B properties to these reserves. Correspondingly, the Management Agreement was amended in order to reduce the contribution to the property improvement fund from 6% to 5% of gross Hotel sales for the Mortgage Debt A and B properties for 1993 through the respective loan maturities. The contribution for the five IRB Hotels remained at 6%. Upon completion of the refinancing on January 24, 1996, the contribution to the property improvement fund was established initially at 5% for all Hotels and may be increased, at the option of the Manager, to 6% of gross Hotel sales in 2001. Additionally, the Partnership is no longer required to contribute 1% of gross Hotel sales from the Mortgage Debt A and Mortgage Debt B Hotels to the refinancing reserves.
Payments to MII and Subsidiaries
The following table sets forth the amount paid to MII and affiliates under both the Management Agreement and the ground lease agreements for the years ended December 31, 1996, 1995 and 1994 (in thousands). The table also sets forth accrued but unpaid base, Courtyard and incentive management fees: 1996 1995 1994 ----------- ---------- ------- Incentive management fee...............$ 11,407 $ 10,480 $ 3,839 Ground rent............................ 10,172 9,856 9,284 Chain services allocation.............. 9,474 9,224 8,981 Base management fee.................... 9,230 8,604 8,123 Courtyard management fee............... 6,592 6,145 5,802 Deferred incentive management fees..... -- 162 -- ----------- ---------- ----------- $ 46,875 $ 44,471 $ 36,029 =========== =========== ===========
Accrued but unpaid fees: Incentive management fee...............$ 633 $ -- $ 5,564 =========== ========== ===========
IRB Advances and General Partner Loans
The IRB Debt was refinanced on January 24, 1996 and the IRB Debt was repaid in full. The $25.6 million of IRB Debt outstanding at December 31, 1995 was backed by direct-pay letters of credit from commercial banks that would have expired in February, November and December 1996. These issues were subject to mandatory prepayment upon expiration of the letters of credit unless replacement letters of credit were secured. The IRB Debt bore interest at daily, weekly or fixed rates at the option of the Partnership, and was limited to a maximum interest rate of 15%. From January 1, 1996, through January 23, 1996, the interest rates on the IRB Debt ranged from 2.65% to 6.1%. In 1995 and 1994, the interest rates on the IRB Debt ranged from 1.9% to 6.1% and 1.15% to 6.05%, respectively. The interest rate on the IRB Debt was 3.2% at January 23, 1996.
The bondholders had the right to demand purchase of any of the bonds at the expiration of specified interest rate periods. Had the Partnership fail to make the required payments of principal and interest on the IRB Debt, Host Marriott would have been required to make such payments ("Host Marriott's IRB Liability"). Through January 24, 1996, the Partnership purchased a total of $15.4 million of
bonds/IRB Debt with proceeds advanced by Host Marriott when presented by certain bondholders. These loans bore interest at one percentage point in excess of the Prime Rate (8.5% at January 23, 1996). The weighted average interest rate was 9.5% for the period from January 1, 1996 through January 23, 1996, 9.83% for 1995 and 8.14% for 1994. In 1993 and 1994, the Partnership was able to repay the General Partner $8.9 million. As of December 31, 1995, $6.5 million of Host Marriott IRB Liability loans were outstanding. As discussed above, the $6.5 million of Host Marriott IRB Liability loans were repaid on January 24, 1996 from proceeds of the debt refinancing.
Payments to Host Marriott and Subsidiaries
The following sets forth amounts paid by the Partnership to Host Marriott and its subsidiaries for the years ended December 31, 1996, 1995 and 1994 (in thousands):
Mortgage Debt Guarantees
Prior to the initial refinancing, in 1987 Host Marriott had guaranteed payment of up to $60 million of debt service on the MFS Mortgage Debt. As a result of the initial refinancing, this guarantee was allocated $32.6 million to Mortgage Debt A and $27.4 million to Mortgage Debt B. Any payments by Host Marriott under the Mortgage Debt guarantees were treated as loans to the Partnership and bore interest at one percentage point in excess of the prime rate of interest announced by Bankers Trust Company of New York (the "Prime Rate").
During 1995, Host Marriott was released from its original Mortgage Debt A guarantee obligation of $32.6 million as certain debt service coverage requirements were met. As a result, as of December 31, 1995, $5.4 million and $27.4 million, respectively, was available under Mortgage Debt A and B guarantees. Host Marriott was released from the original guarantees on January 24, 1996, the date when Mortgage Debt A and Mortgage Debt B were repaid in full.
During 1994, the Partnership, Manager and Mortgage Debt A and B lenders agreed that the Partnership would establish reserve accounts for Mortgage Debt A and B and contribute 1% of Hotel sales on the respective Mortgage Debt A and B properties to these reserves for 1993 through the respective loan maturities. The initial contribution, made in 1994, included the required contribution for 1993. On January 24, 1996, these reserves were used to pay costs associated with the refinancing of these loans and to repay a portion of these loans upon maturity.
In addition, the General Partner had provided a guarantee to MFS that, in the event of a foreclosure, proceeds under the MFS Mortgage Debt would be at least $75 million. This foreclosure guarantee was allocated $40.8 million to Mortgage Debt A and $34.2 million to Mortgage Debt B. Upon completion of the debt refinancing on January 24, 1996, Host Marriott was released from its obligations pursuant to the foreclosure guarantee.
PART IV
ITEM 14. EXHIBITS, SUPPLEMENTAL FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of Documents Filed as Part of This Report
(1) Financial Statements All financial statements of the registrant as set forth under Item 8