UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-K

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                            to                           

Commission File Number 1-3427


HILTON HOTELS CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Delaware

 

36-2058176

(State or other jurisdiction

 

(I.R.S. Employer

of incorporation or organization)

 

Identification Number)

9336 Civic Center Drive

 

 

Beverly Hills, California

 

90210

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:   (310) 278-4321

Securities registered pursuant to Section 12(b) of the Act:

 

Name of each exchange

Title of each class

 

 

on which registered

 

Common Stock, par value $2.50 per share

 

New York

8% Quarterly Interest Bonds due 2031

 

New York

 

Securities registered pursuant to Section 12(g) of the Act:   None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes x  No o

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.   Yes o  No x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (Check one):

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).   Yes o  No x

Based upon the June 30, 2006, New York Stock Exchange closing price of $28.28 per share, the aggregate market value of the Registrant’s outstanding Common Stock held by non-affiliates of the Registrant was approximately $10.2 billion. There were 385,556,381 and 388,953,623 shares of Common Stock outstanding as of June 30, 2006 and January 31, 2007, respectively.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of Registrant’s definitive proxy statement, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the Registrant’s fiscal year, are incorporated by reference under Part III.

 




TABLE OF CONTENTS

 

 

 

Page No.

PART I

 

1

Item 1.

 

Business

 

1

General Information

 

1

Operations

 

3

Additional Information

 

15

Item 1A.

 

Risk Factors

 

21

Item 1B.

 

Unresolved Staff Comments

 

25

Item 2.

 

Properties

 

25

Item 3.

 

Legal Proceedings

 

25

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

25

PART II

 

26

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

26

Rights Agreement

 

26

Performance Graph

 

28

Item 6.

 

Selected Financial Data

 

29

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

30

Overview

 

30

Critical Accounting Policies and Estimates

 

31

Development and Capital Spending

 

35

Liquidity and Capital Resources

 

38

Off-Balance Sheet Arrangements

 

41

Results of Operations—Fiscal 2006 Compared with Fiscal 2005

 

42

Results of Operations—Fiscal 2005 Compared with Fiscal 2004

 

46

Other Matters

 

49

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

49

Item 8.

 

Financial Statements and Supplementary Data

 

52

Consolidated Statements of Income

 

52

Consolidated Balance Sheets

 

53

Consolidated Statements of Cash Flow

 

54

Consolidated Statements of Stockholders’ Equity

 

55

Notes to Consolidated Financial Statements

 

56

Report of Independent Registered Public Accounting Firm

 

98

Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

 

98

Supplementary Financial Information (Unaudited)

 

100

Five Year Summary

 

101

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

102

Item 9A.

 

Controls and Procedures

 

102

Evaluation of Disclosure Controls and Procedures

 

102

Management’s Report on Internal Control over Financial Reporting

 

102

i




 

Item 9B.

 

Other Information

 

103

PART III

 

103

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

103

Item 11.

 

Executive Compensation

 

103

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

103

Equity Compensation Plan Information

 

104

Item 13.

 

Certain Relationships and Related Transactions and Director Independence

 

105

Item 14.

 

Principal Accounting Fees and Services

 

105

PART IV

 

106

Item 15.

 

Exhibits, Financial Statement Schedules

 

106

(a) Index to Financial Statements

 

106

(b) Exhibits

 

106

SIGNATURES

 

107

INDEX TO EXHIBITS

 

108

 

ii




PART I

Item 1.                        Business

GENERAL INFORMATION

Current Operations

Hilton Hotels Corporation is engaged, together with its subsidiaries, in the ownership, management and development of hotels, resorts and timeshare properties and the franchising of lodging properties. As of December 31, 2006, our system contained 2,935 properties with approximately 501,000 rooms in 78 countries and territories. Of such properties, we owned and operated 60 hotels, leased and operated 203 hotels, owned an interest in and operated 53 hotels, managed 343 hotels owned by others and franchised 2,242 hotels owned and operated by third parties. Also included in the number of properties in our system are 34 timeshare properties which we managed.

Our hotel brands include Hilton, Hilton Garden Inn, Doubletree, Embassy Suites, Homewood Suites by Hilton, Hampton, Scandic, Conrad and the Waldorf=Astoria Collection. We develop and operate domestic timeshare resorts through Hilton Grand Vacations Company and its related entities, which we wholly own. We are also engaged in various other activities related or incidental to the operation of hotels.

Hilton was organized in the State of Delaware on May 29, 1946. Our principal executive offices are located at 9336 Civic Center Drive, Beverly Hills, California 90210, and our telephone number is (310) 278-4321.

Acquisition of Hilton International

On February 23, 2006, we consummated the acquisition of the lodging assets of Hilton Group plc (the “HI Acquisition”) including its operating subsidiary, Hilton International Co. (“HI”), for approximately £3.3 billion, equivalent to approximately $5.7 billion on the transaction date, excluding acquisition costs, in an all-cash transaction. As a result of the HI Acquisition, we believe we are one of the largest and most geographically diverse lodging companies in the world. The HI properties that we acquired consisted of 392 hotels with approximately 102,000 rooms, including 39 owned, 201 leased, four partially owned through joint ventures, 118 managed and 30 franchised properties. The hotels we acquired in the HI Acquisition consisted of 249 properties operated under the Hilton brand, 131 properties operated under the mid-market Scandic brand, one property under the Conrad brand and 11 other properties. We also acquired 80 LivingWell health clubs, primarily in Europe, and six timeshare properties. As a result of the HI Acquisition, we now wholly own the Hilton HHonors Worldwide frequent guest program and the Hilton Reservations Worldwide reservation system, both of which were previously owned equally by us and HI. We also obtained worldwide ownership of the luxury Conrad hotel brand, which had been operated as a joint venture between us and HI since 2002. As a result of the HI Acquisition, we now own all the rights to the Hilton and Conrad brands, including the right to develop these brands, along with all of our other proprietary brands, on a worldwide basis. See “Note 3: Purchase of Hilton International” to the consolidated financial statements under Part II—Item 8.

Recent Developments

Hotel Properties

·       In 2006, we commenced management of the Grand Wailea Resort Hotel & Spa in Maui, Hawaii, the Arizona Biltmore Resort & Spa in Phoenix, Arizona, the La Quinta Resort & Club in La Quinta, California and the Qasr Al Sharq in Jeddah, Saudi Arabia.  These properties, together with the Waldorf=Astoria in New York, New York, are included in our new Waldorf=Astoria Collection of luxury hotels.




·       In the fourth quarter of 2006, we announced plans to form a joint venture with real estate developer DLF Limited to develop hotel properties and serviced apartments in India. The joint venture company plans to develop and own 50 to 75 mid-scale and extended-stay hotels over the next seven years. We also announced an alliance with Deutsche Asset Management and HQ Asia Pacific in which they will develop an initial 25 Hilton Garden Inns in Beijing, Shanghai and Tianjin, China, which are expected to be franchised hotels.

·       In 2006, we sold the following assets we acquired as part of the HI Acquisition for aggregate gross proceeds of approximately $1.281 billion as of the transaction dates: the Hilton London Metropole, the Hilton Birmingham Metropole and the Wembley hotel, all in the United Kingdom; the Hilton Toronto Airport, the Hilton Toronto Downtown, the Hilton Quebec City, the Hilton Montreal Airport and the Hilton Saint John, all in Canada; the stand alone LivingWell health clubs; and the leasehold for the Drake Hotel in Chicago, Illinois. We have retained multi-year management agreements on all of these dispositions except for LivingWell.

·       In 2006, we sold three wholly owned domestic properties and our minority interest in joint ventures owning three properties. We retained management or franchise agreements on each of these properties, which included four Hiltons and two Embassy Suites.

Timeshare Properties

·       We are continuing to develop a 1,582-unit timeshare resort in Las Vegas, Nevada, of which 45 percent of the planned four-tower project has been completed.

·       We are developing or have developed three timeshare resorts in Orlando, Florida: a 440-unit resort at Tuscany Village on International Drive, of which 376 units are opened; a completed resort adjacent to Sea World, of which 48 units were added in 2006; and a new resort at Ruby Lake, of which the first phase is expected to contain 141 units.

·       In Waikoloa, Hawaii, we have completed development of a 120-unit timeshare resort called Kohala Coast Vacation Suites, and commenced construction of a new timeshare project called Kings Land, of which 198 units are scheduled for completion in 2010.

·       In Honolulu, Hawaii, we have commenced construction of the Waikikian Tower, a new 331-unit timeshare project adjacent to the Hilton Hawaiian Village, scheduled for completion in late 2008.

·       In 2006, we announced the development of the 57th Street Tower, a new 161-unit timeshare project in New York City scheduled for completion in early 2009.

Additional Information

For a description of our planned expansion activities, see “Operations—Development.” For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Development and Capital Spending” under Part II—Item 7.

Industry Segments

As of December 31, 2006, we operated in three reportable business segments which are based on similar products or services: Hotel Ownership; Managing and Franchising; and Timeshare. For additional information, see “Note 16: Segment Information” to the consolidated financial statements under Part II—Item 8.

2




OPERATIONS

Hotel Properties

Owned Hotels

As of December 31, 2006, we owned a majority or controlling financial interest in and operated 60 hotels, representing 29,647 rooms. The owned hotels include some of our largest and most profitable hotels, including:

·       the 1,416-room Waldorf=Astoria;

·       the 1,980-room Hilton New York;

·       the 2,860-room Hilton Hawaiian Village;

·       the 1,240-room Hilton Waikoloa Village;

·       the 1,908-room Hilton San Francisco;

·       the 1,544-room Hilton Chicago;

·       the 1,119-room Hilton Washington; and

·       the 1,616-room Hilton New Orleans Riverside.

Our owned hotels include six properties for which we lease the underlying land. The expiration dates of the leases range up to 2044, with certain leases containing renewal options for 10 to 40 years. Under these leases, we own the buildings and leasehold improvements and all furniture and equipment; we are responsible for repairs, maintenance, operating expenses and lease rentals; and we retain complete managerial discretion over operations. Lease terms generally require us to pay a fixed monthly base rent and may require us to pay additional rent based on a percentage of revenue or income from the hotel. Upon the expiration of such leases, the buildings and other leasehold improvements presently owned by us revert to the landlords. For additional information, see “Note 17: Leases” to the consolidated financial statements under Part II—Item 8.

Leased Hotels

As of December 31, 2006, we leased 203 hotels, representing 46,663 rooms. Under these leases, we lease the hotel from its owner, manage the hotel and are generally responsible for all aspects of the hotel’s operations and recognize all revenue and substantially all expenses associated with the hotel’s operations. In general, replacement of furniture, fixtures and equipment is our responsibility. Our hotel leases may require the payment of fixed rent payments, variable rent payments based on a percentage of revenue or income, or the payment of rent equal to the greater of a minimum fixed rent or variable rent based on a percentage of revenue or income. The terms of our leases are for various periods expiring through 2097 and generally provide for certain renewal options, subject to certain termination rights. For additional information, see “Note 17: Leases” to the consolidated financial statements under Part II—Item 8.

Joint Ventures

As of December 31, 2006, we had a minority or non-controlling financial interest in and operated 53 hotels, representing 17,232 rooms. We have a right of first refusal to purchase additional equity interests in certain of these joint ventures. We manage each of the partially owned hotels for the entity owning the hotel.

3




Managed Hotels

As of December 31, 2006, we managed 343 hotels, representing 97,536 rooms, which are wholly owned by others. Under our standard management agreement, we operate a hotel for the benefit of its owner, which either owns or leases the hotel and the associated personal property. Our management fee is generally based on a percentage of each hotel’s gross revenue, operating profits, cash flow or a combination thereof. For the majority of properties, we may also earn an incentive fee based on operating performance. The terms of our management agreements are for various periods and generally contain renewal options, subject to certain termination rights.

In general, under our management agreements all operating and other expenses are paid by the owner and we are reimbursed for our out-of-pocket expenses. In turn, our managerial discretion is subject to approval by the owner in certain major areas, including the approval of capital expenditure budgets.

Franchise Hotels

As of December 31, 2006, we franchised 2,242 hotels, representing 306,660 rooms, which are owned and operated by third parties. In general, franchisees pay us an initial fee based on the number of rooms in a franchise hotel and a continuing fee based on a percentage of the hotel’s rooms revenue, which may be up to five percent of rooms revenue depending on the brand. Although we do not directly participate in the management or operation of franchise hotels, we conduct periodic inspections to ensure that our standards are maintained and render advice with respect to certain aspects of hotel operations. We generally approve the plans for, and the location of, franchise hotels and assist in their design.

Hotel Brands

We operate hotels through the brands described below, which target a wide variety of markets and geographic areas. According to data from Smith Travel Research, in 2006, our domestic Hilton, Hilton Garden Inn, Doubletree, Embassy Suites, Homewood Suites by Hilton and Hampton brands all commanded market share premiums in the system-wide revenue per available room (“RevPAR”) index, which represents the share of RevPAR these properties attain versus their respective competitive sets.

Hilton

Hilton hotels are our upscale, full-service hotels that typically include swimming pools, gift shops and retail facilities, meeting and banquet facilities, restaurants and lounges, room service, parking facilities and other services. The Hilton brand also includes Hilton Suites hotels, which are upscale, all-suite hotels. As of December 31, 2006, there were 498 Hilton hotels, representing 172,605 rooms, located in 38 states, the District of Columbia and an additional 71 countries and territories throughout the world. As of December 31, 2006, 36 Hilton hotels were under construction, of which 20 are expected to be managed hotels and 16 are expected to be franchise hotels.

Hilton Garden Inn

Hilton Garden Inn hotels are our upper mid-market, focused service hotels that generally utilize a modular design constructed around a courtyard containing an indoor or outdoor swimming pool. In 2006, the Hilton Garden Inn brand earned the first place J.D. Power Award for “Highest Customer Satisfaction” in its category for a fifth consecutive year. As of December 31, 2006, there were 302 Hilton Garden Inn hotels, representing 41,669 rooms, located in 44 states, the District of Columbia, Canada, Germany, Italy and Mexico. As of December 31, 2006, 57 Hilton Garden Inn hotels were under construction, of which 55 are expected to be franchise hotels and two are expected to be managed hotels.

4




Doubletree

Doubletree hotels are our full-service hotels in the mid-market to upscale hotel category. The Doubletree brand also includes the Doubletree Guest Suites all-suite hotels and the moderately priced Doubletree Club hotels. As of December 31, 2006, there were 173 Doubletree hotels, representing 45,119 rooms, located in 39 states, the District of Columbia, Canada and Latin America. As of December 31, 2006, six Doubletree hotels were under construction, all of which are expected to be franchise hotels.

Embassy Suites

Embassy Suites are our upscale, all-suite hotels that feature two-room guest suites with a separate living room and dining/work area and a complimentary cooked-to-order breakfast. Most Embassy Suites hotels are built around a landscaped atrium. As of December 31, 2006, there were 185 Embassy Suites, representing 45,172 rooms, located in 38 states, the District of Columbia, Canada, Latin America and the Caribbean. As of December 31, 2006, eight Embassy Suites hotels were under construction, all of which are expected to be franchise hotels.

Homewood Suites by Hilton

Homewood Suites by Hilton are our upscale, extended-stay hotels that feature residential style accommodations including business centers, swimming pools, convenience stores and limited meeting facilities. As of December 31, 2006, there were 192 Homewood Suites, representing 21,141 rooms, located in 41 states, the District of Columbia and Canada. As of December 31, 2006, 28 Homewood Suites hotels were under construction, of which 26 are expected to be franchise hotels and two are expected to be managed hotels.

Hampton

Hampton Inn hotels are our moderately priced hotels with limited food and beverage facilities. The Hampton brand also includes Hampton Inn & Suites hotels which offer both traditional hotel room accommodations and apartment style suites within one property. As of December 31, 2006, there were 1,392 Hampton hotels, representing 138,487 rooms, located in 49 states, the District of Columbia, Canada, Latin America and the Caribbean. As of December 31, 2006, 127 Hampton hotels were under construction, all of which are expected to be franchise hotels.

Scandic

Scandic hotels are our mid-market, full-service hotels located in Northern Europe. As of December 31, 2006, there were 129 Scandic hotels, representing 22,808 rooms, located in Belgium, Denmark, Estonia, Finland, Germany, Italy, Lithuania, the Netherlands, Norway and Sweden. As of December 31, 2006, one Scandic hotel was under construction, which is expected to be a leased hotel.

Conrad

Conrad hotels are our upscale, full-service hotels located primarily outside the United States. As of December 31, 2006 we managed, and in some cases partially owned, 15 Conrad hotels, representing 5,152 rooms, located in Chicago, Illinois; Miami, Florida; Indianapolis, Indiana; and Belgium, China, Egypt, Indonesia, Ireland, Japan, Singapore, Thailand, Turkey and the United Kingdom.  We have entered into agreements to manage new Conrad hotels in Shanghai, China and Koh Samui, Thailand.

5




Waldorf=Astoria Collection

In early 2006, we introduced a new brand line, the Waldorf=Astoria Collection. This elite brand designation debuted with New York’s legendary Waldorf=Astoria, which is wholly owned, along with three world-class luxury resorts managed by us under long-term agreements: the Grand Wailea Resort Hotel & Spa on the island of Maui in Hawaii; the Arizona Biltmore Resort & Spa in Phoenix, Arizona; and the La Quinta Resort & Club in La Quinta, California. Also in 2006, we commenced management of the Qasr Al Sharq in Jeddah, Saudi Arabia, the newest member of the Waldorf=Astoria Collection. We anticipate that the Waldorf=Astoria Collection will grow primarily through branding of existing landmark or boutique hotels and opening newly built Waldorf=Astoria hotels in select cities.

Hotels By Region

The following table sets forth the number of properties and rooms in our hotel system, excluding timeshare properties, by region and country as of December 31, 2006. The inclusion of hotels in regions in the table below is consistent with the reporting of regional information throughout this annual report.

Region/Country

 

 

 

Hotels

 

Rooms

 

North America

 

 

 

 

 

Canada

 

56

 

11,648

 

United States

 

2,416

 

376,700

 

Total

 

2,472

 

388,348

 

United Kingdom & Ireland

 

 

 

 

 

Ireland

 

5

 

750

 

United Kingdom

 

70

 

15,727

 

Total

 

75

 

16,477

 

Continental Europe

 

 

 

 

 

Austria

 

4

 

1,340

 

Belgium

 

8

 

1,684

 

Bulgaria

 

1

 

245

 

Croatia

 

1

 

147

 

Cyprus

 

2

 

492

 

Czech Republic

 

1

 

788

 

France

 

9

 

2,660

 

Germany

 

16

 

4,890

 

Greece

 

2

 

928

 

Hungary

 

2

 

552

 

Israel

 

2

 

1,064

 

Italy

 

14

 

3,265

 

Luxembourg

 

1

 

337

 

Malta

 

1

 

294

 

Netherlands

 

6

 

1,180

 

Romania

 

1

 

272

 

Spain

 

3

 

1,043

 

Switzerland

 

2

 

537

 

Turkey

 

8

 

2,607

 

Total

 

84

 

24,325

 

6




 

Africa

 

 

 

 

 

Algeria

 

1

 

410

 

Cameroon

 

1

 

257

 

Ethiopia

 

1

 

379

 

Kenya

 

1

 

293

 

Madagascar

 

1

 

170

 

Mauritius

 

1

 

193

 

Morocco

 

1

 

269

 

Nigeria

 

1

 

670

 

Republic of Seychelles

 

1

 

40

 

South Africa

 

2

 

654

 

Total

 

11

 

3,335

 

Middle East

 

 

 

 

 

Egypt

 

19

 

7,038

 

Kuwait

 

1

 

350

 

Oman

 

1

 

147

 

Saudi Arabia

 

4

 

2,207

 

United Arab Emirates

 

8

 

1,673

 

Total

 

33

 

11,415

 

Asia Pacific

 

 

 

 

 

Australia

 

7

 

2,507

 

China

 

5

 

2,537

 

Guam

 

1

 

682

 

India

 

8

 

1,409

 

Indonesia

 

1

 

298

 

Japan

 

8

 

3,876

 

Korea

 

4

 

1,564

 

Malaysia

 

4

 

1,478

 

Maldives

 

1

 

150

 

New Zealand

 

2

 

197

 

Philippines

 

1

 

246

 

Republic of Fiji

 

1

 

218

 

Singapore

 

2

 

931

 

Sri Lanka

 

2

 

552

 

Thailand

 

4

 

1,909

 

Vietnam

 

1

 

269

 

Total

 

52

 

18,823

 

Latin America & Caribbean

 

 

 

 

 

Argentina

 

1

 

418

 

Bahamas

 

1

 

291

 

Barbados

 

1

 

350

 

Brazil

 

2

 

846

 

Colombia

 

2

 

384

 

Costa Rica

 

1

 

100

 

Curacao

 

1

 

196

 

Dominican Republic

 

2

 

351

 

Ecuador

 

3

 

689

 

7




 

El Salvador

 

1

 

204

 

Honduras

 

1

 

120

 

Jamaica

 

1

 

303

 

Mexico

 

17

 

3,516

 

Nicaragua

 

1

 

104

 

Peru

 

1

 

110

 

Puerto Rico

 

5

 

1,739

 

Trinidad & Tobago

 

2

 

578

 

Venezuela

 

4

 

1,439

 

Total

 

47

 

11,738

 

Nordic

 

 

 

 

 

Denmark

 

20

 

3,455

 

Estonia

 

3

 

206

 

Finland

 

21

 

4,056

 

Lithuania

 

1

 

60

 

Norway

 

15

 

2,487

 

Sweden

 

67

 

13,013

 

Total

 

127

 

23,277

 

Total Hotel Properties (78 countries and territories)

 

2,901

 

497,738

 

 

North America

As of December 31, 2006, there were 2,472 properties, representing 388,348 rooms, in our hotel system located in the United States and Canada. These properties consist of 239 Hiltons, 296 Hilton Garden Inns, 172 Doubletrees, 179 Embassy Suites, 192 Homewood Suites by Hilton, 1,381 Hamptons, three Conrads and ten other hotels. Our properties in North America consist of 27 owned, five leased, 46 joint venture, 205 managed and 2,189 franchised hotels.

United Kingdom and Ireland

As of December 31, 2006, there were 75 properties, representing 16,477 rooms, in our hotel system located in the U.K. and Ireland, consisting of 70 Hiltons, three Conrads and two other hotels. Our properties in the U.K. and Ireland consist of 14 owned, 32 leased, one joint venture and 28 managed hotels.

Continental Europe

As of December 31, 2006, there were 84 properties, representing 24,325 rooms, in our hotel system located in 19 countries in Continental Europe (exclusive of the Nordic region). These properties consist of 70 Hiltons, three Hilton Garden Inns, seven Scandics, two Conrads and two other hotels. Our properties in Continental Europe consist of 12 owned, 33 leased, three joint venture, 26 managed and ten franchised hotels.

Africa

As of December 31, 2006, there were 11 properties, representing 3,335 rooms, in our hotel system located in ten countries in Africa, each of which is a Hilton branded hotel. Our properties in Africa consist of one owned, three leased, six managed and one franchised hotel.

8




Middle East

As of December 31, 2006, there were 33 properties, consisting of 11,415 rooms, in our hotel system located in five countries in the Middle East, consisting of 30 Hiltons, two Conrads and one other hotel. Our properties in the Middle East consist of two leased, one joint venture and 30 managed hotels.

Asia Pacific

As of December 31, 2006, there were 52 properties, representing 18,823 rooms, in our hotel system located in 16 countries and territories in the Asia Pacific region, consisting of 47 Hiltons and five Conrad hotels. Our properties in the Asia Pacific region consist of one owned, five leased, two joint venture, 31 managed and 13 franchised hotels.

Latin America & Caribbean

As of December 31, 2006, there were 47 properties, representing 11,738 rooms, in our hotel system located in 18 countries and territories in Latin America and the Caribbean, consisting of 26 Hiltons, three Hilton Garden Inns, one Doubletree, six Embassy Suites, and 11 Hampton hotels. Our properties in Latin America and the Caribbean consist of two owned, four leased, 15 managed and 26 franchised properties.

Nordic

As of December 31, 2006, there were 127 properties, representing 23,277 rooms, in our hotel system located in 6 countries in the Nordic region, consisting of five Hiltons and 122 Scandic hotels. Our properties in the Nordic region consist of three owned, 119 leased, two managed and three franchised hotels.

Timeshare Operations

We conduct our domestic timeshare operations through Hilton Grand Vacations Company and its related entities (“HGVC”), which we wholly own. As of December 31, 2006, HGVC operated 34 timeshare resorts, consisting of 3,740 rooms, including 21 resorts in Florida, four in Hawaii, three in Nevada and one in each of Colorado and New York. We also operate three timeshare resorts in the United Kingdom and one in Egypt which we acquired in the HI Acquisition. HGVC operates HGVClub and Hilton Club, points-based reservation and exchange systems with 34 affiliated timeshare resorts.

Development

Hotel Properties

We intend to grow our hotel system through franchising and the addition of management contracts. We will also continue to invest in capital improvements and select projects at our owned hotels. In addition, we may seek to acquire ownership interests in hotel properties on a strategic and selective basis, either directly or through investments in joint ventures. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Development and Capital Spending” under Part II—Item 7.

During 2006, in addition to the properties added to our system in the HI Acquisition, we added a total of 223 properties, primarily franchises, with approximately 36,000 rooms to our system. A total of 74 properties, primarily franchises, with approximately 12,000 rooms were removed from our system in 2006.

Total hotel property additions to our system in 2006 included 204 franchise properties, 17 managed properties owned by third parties and two leased properties. These additions included 32 properties which, due in part to the market share leadership of our brands, were converted to our family of brands in 2006. The 32 conversions included 16 Doubletrees, eight Hiltons, five Hamptons and three Hilton Garden Inns.

9




Included in the property additions in 2006 are long-term management agreements we acquired for the following properties:  the Grand Wailea Resort Hotel & Spa on the island of Maui in Hawaii; the Arizona Biltmore Resort & Spa in Phoenix, Arizona; and the La Quinta Resort & Club in La Quinta, California. Also in 2006, we commenced management of the Qasr El Sharq in Jeddah, Saudi Arabia. These properties are included in our new, elite brand designation, the Waldorf=Astoria Collection. See “Operations—Hotel Brands—Waldorf=Astoria Collection” above. In 2006, we also acquired a long-term management agreement for the Hilton Anatole in Dallas, Texas.

In the fourth quarter of 2006, we announced plans to form a joint venture with DLF Limited to develop hotel properties and serviced apartments in India. The joint venture company plans to develop and own 50 to 75 mid-scale and extended-stay hotels over the next seven years. We also announced an alliance with Deutsche Asset Management and HQ Asia Pacific in which they will develop an initial 25 Hilton Garden Inns in Beijing, Shanghai and Tianjin, China, which are expected to be franchised hotels.

In 2007, we expect to add approximately 255 hotels and 35,000 rooms to our hotel system. We expect virtually all of this growth to be through franchise and management agreements.

Our current development pipeline is our largest to date, with more than 775 hotels, primarily franchises, with 110,000 rooms at December 31, 2006. Approximately 90 percent of the hotels in the current development pipeline are in the Americas (U.S., Canada, Mexico and South America), though international development is expected to comprise an increasingly larger percentage of our development pipeline within the next few years. The consummation of transactions in our development pipeline is subject to various conditions and uncertainties.

Our ability to grow the number of managed and franchised hotels is affected by the factors set forth under Item 1A “Risk Factors,” including but not limited to international, national and regional economic conditions; the effects of actual and threatened terrorist attacks and international conflicts; acts of God, such as natural disasters; credit availability; relationships with franchisees and property owners; and competition from other hotel brands.

Timeshare Properties

We have recently opened or are currently developing the following timeshare projects:

·       We are continuing to develop a 1,582-unit timeshare resort located at the north end of the Las Vegas Strip in Las Vegas, Nevada. Phase two of this project, consisting of 431 units, opened in 2006. Approximately 45 percent of the planned four-tower project has been completed.

·       We are continuing to develop a timeshare resort at Tuscany Village on International Drive in Orlando, Florida, with seven phases and a total of 440 units. We have opened the first six phases of this project, consisting of 376 units, including 70 units opened in January 2007. The final phase of this project, consisting of 64 units, is scheduled for completion in spring 2008. Also in Orlando, we have added 48 units to our existing property adjacent to Sea World. In 2007, we began construction of our new timeshare project at Ruby Lake in Orlando. Phase I of the Ruby Lake project is expected to contain 141 units and is scheduled for completion in 2009.

·       In 2006, we completed the remaining 98 units of a 120-unit timeshare resort called Kohala Coast Vacation Suites in Waikoloa, Hawaii, near the Hilton Waikoloa Village. We are also developing a new timeshare project in Waikoloa called Kings Land, the first phase of which is expected to consist of 198 units and is scheduled for completion in 2010.

·       In 2006, we began construction of the Waikikian Tower, a new timeshare project in Honolulu, Hawaii, adjacent to the Hilton Hawaiian Village. The Waikikian Tower is expected to contain 331 units upon completion which is scheduled for late 2008.

10




·       In 2006, we announced the development of a new timeshare project in New York City on West 57th Street. The 57th Street Tower is expected to contain 161 units and is scheduled for completion in early 2009.

Property Dispositions

In 2006, we sold the following assets we acquired as part of the HI Acquisition: the Hilton London Metropole, the Hilton Birmingham Metropole and the Wembley hotel, all in the United Kingdom; the Hilton Toronto Airport, the Hilton Toronto Downtown, the Hilton Quebec City, the Hilton Montreal Airport and the Hilton Saint John, all in Canada; the stand alone LivingWell health clubs; and the leasehold for the Drake Hotel in Chicago, Illinois. We have retained multi-year management agreements on all of these dispositions except for LivingWell.

In 2006, we sold the following wholly owned domestic hotel properties: the Pointe Hilton Tapatio Cliffs in Arizona; the Hilton Minneapolis in Minnesota; and the Hilton Pittsburgh in Pennsylvania. Also during 2006, we sold our minority interest in the joint ventures owning the following hotels:  the Hilton Times Square in New York; the Embassy Suites San Diego-La Jolla in California; and the Embassy Suites Battery Park in New York. We retained long-term management agreements for the Pointe Hilton Tapatio Cliffs, the Hilton Minneapolis and the Embassy Suites San Diego-La Jolla, and long-term franchise agreements for the Hilton Pittsburgh, the Hilton Times Square and the Embassy Suites Battery Park.

For additional information, see “Note 5: Acquisitions and Dispositions” to the consolidated financial statements under Part II—Item 8.

Development Financing

We have established franchise financing programs with third party lenders to support the growth of our brands. As of December 31, 2006, we have provided guarantees of $16 million on loans outstanding under these programs. In addition, we have guaranteed $27 million of debt and other obligations of unconsolidated affiliates and third parties, bringing our total guarantees to approximately $43 million. Our outstanding guarantees have terms ranging from one to 14 years. We also have commitments under letters of credit totaling $110 million as of December 31, 2006. We believe it is unlikely that material payments will be required under these guarantees or letters of credit. See “Note 18: Commitments and Contingencies” to the consolidated financial statements under Part II—Item 8.

Territorial Restrictions

Prior to the HI Acquisition, we were subject to certain restrictions on our right to operate hotels outside the U.S. identified as “Hilton” hotels. As a result of the HI Acquisition, we now own the right to develop each of our brands on a worldwide basis. See “General Information—Acquisition of Hilton International” above.

We have also entered into certain management and franchise agreements that contain provisions which may restrict our right to own, manage or franchise additional hotels in specified geographic areas.

Potential Acquisitions

We continue to evaluate acquisition opportunities and may, from time to time, negotiate to engage in a business combination transaction or other acquisition. However, there is no assurance that we will engage in any such transactions.

11




Property Transactions

We will continue to review our owned hotel portfolio for potential repositioning or rebranding opportunities and we may seek to sell certain assets, including assets acquired in the HI Acquisition. It is our intention to be opportunistic when evaluating potential asset sales and we will look to sell particular hotel properties to the extent we can obtain premium prices. We are currently marketing for sale certain of our owned and leased hotels, including ten hotels in continental Europe, the Hilton Caledonian in Scotland and six properties in the U.S. We are also marketing for sale the Scandic brand of hotels.

Seasonality

The hospitality industry is seasonal in nature. However, the periods during which our properties experience higher or lower levels of demand vary from property to property and depend principally upon location. Based upon historical results, we generally expect our revenue to be lower in the first fiscal quarter of each year than in each of the three subsequent quarters.

12




Statistical Information

The following table sets forth certain system-wide information for our properties with respect to the number of properties and rooms as of December 31, 2005 and 2006:

 

 

2005 Number of

 

2006 Number of

 

Change in Number of

 

 

 

Properties

 

Rooms

 

Properties

 

Rooms

 

Properties

 

Rooms

 

Hilton

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

57

 

32,369

 

47

 

26,347

 

(10

)

(6,022

)

Leased

 

79

 

23,460

 

80

 

23,798

 

1

 

338

 

Joint Venture

 

16

 

6,844

 

14

 

6,156

 

(2

)

(688

)

Managed

 

137

 

47,709

 

152

 

56,633

 

15

 

8,924

 

Franchised

 

193

 

54,784

 

205

 

59,671

 

12

 

4,887

 

 

 

482

 

165,166

 

498

 

172,605

 

16

 

7,439

 

Hilton Garden Inn

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

1

 

162

 

1

 

162

 

 

 

Joint Venture

 

1

 

128

 

1

 

128

 

 

 

Managed

 

7

 

886

 

7

 

886

 

 

 

Franchised

 

250

 

34,347

 

293

 

40,493

 

43

 

6,146

 

 

 

259

 

35,523

 

302

 

41,669

 

43

 

6,146

 

Doubletree

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

3

 

1,349

 

3

 

1,349

 

 

 

Leased

 

5

 

1,746

 

4

 

1,554

 

(1

)

(192

)

Joint Venture

 

14

 

4,306

 

12

 

3,761

 

(2

)

(545

)

Managed

 

30

 

8,060

 

27

 

7,487

 

(3

)

(573

)

Franchised

 

108

 

26,707

 

127

 

30,968

 

19

 

4,261

 

 

 

160

 

42,168

 

173

 

45,119

 

13

 

2,951

 

Embassy Suites

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

3

 

663

 

3

 

664

 

 

1

 

Joint Venture

 

25

 

6,586

 

23

 

5,788

 

(2

)

(798

)

Managed

 

56

 

14,832

 

56

 

14,918

 

 

86

 

Franchised

 

98

 

22,348

 

103

 

23,802

 

5

 

1,454

 

 

 

182

 

44,429

 

185

 

45,172

 

3

 

743

 

Homewood Suites by Hilton

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

1

 

140

 

1

 

140

 

 

 

Managed

 

41

 

4,706

 

41

 

4,706

 

 

 

Franchised

 

122

 

13,287

 

150

 

16,295

 

28

 

3,008

 

 

 

164

 

18,133

 

192

 

21,141

 

28

 

3,008

 

Hampton

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

1

 

133

 

1

 

133

 

 

 

Managed

 

34

 

4,453

 

34

 

4,447

 

 

(6

)

Franchised

 

1,301

 

129,535

 

1,357

 

133,907

 

56

 

4,372

 

 

 

1,336

 

134,121

 

1,392

 

138,487

 

56

 

4,366

 

Scandic

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

1

 

325

 

3

 

528

 

2

 

203

 

Leased

 

121

 

21,405

 

118

 

21,182

 

(3

)

(223

)

Managed

 

3

 

429

 

3

 

429

 

 

 

Franchised

 

5

 

715

 

5

 

669

 

 

(46

)

 

 

130

 

22,874

 

129

 

22,808

 

(1

)

(66

)

Conrad

 

 

 

 

 

 

 

 

 

 

 

 

 

Joint Venture

 

3

 

1,395

 

3

 

1,399

 

 

4

 

Managed

 

12

 

3,660

 

12

 

3,753

 

 

93

 

 

 

15

 

5,055

 

15

 

5,152

 

 

97

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

2

 

630

 

1

 

324

 

(1

)

(306

)

Leased

 

2

 

666

 

1

 

129

 

(1

)

(537

)

Managed

 

6

 

1,311

 

11

 

4,277

 

5

 

2,966

 

Franchised

 

6

 

2,434

 

2

 

855

 

(4

)

(1,579

)

 

 

16

 

5,041

 

15

 

5,585

 

(1

)

544

 

Timeshare

 

40

 

4,272

 

34

 

3,740

 

(6

)

(532

)

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Owned

 

69

 

35,771

 

60

 

29,647

 

(9

)

(6,124

)

Leased

 

207

 

47,277

 

203

 

46,663

 

(4

)

(614

)

Joint Venture

 

59

 

19,259

 

53

 

17,232

 

(6

)

(2,027

)

Managed

 

326

 

86,046

 

343

 

97,536

 

17

 

11,490

 

Franchised

 

2,083

 

284,157

 

2,242

 

306,660

 

159

 

22,503

 

Timeshare

 

40

 

4,272

 

34

 

3,740

 

(6

)

(532

)

TOTAL PROPERTIES

 

2,784

 

476,782

 

2,935

 

501,478

 

151

 

24,696

 

 

13




For purposes of the table above, “owned” properties include those in which we have a majority or controlling financial interest and “joint venture” properties are those in which we have a minority or non-controlling financial interest. Statistics are presented pro forma as if the HI Acquisition had occurred January 1, 2005. For additional information, see “Hotel Properties” above.

The following table sets forth certain system-wide information for our hotels with respect to occupancy rates, average room rates and RevPAR for the fiscal years ended December 31, 2005 and 2006:

 

 

2005(1)

 

2006(1)

 

Change

 

Hilton

 

 

 

 

 

 

 

Occupancy

 

71.8

%

72.8

%

1.0

pts

Average Rate

 

$

138.55

 

$

149.86

 

8.2

%

RevPAR

 

$

99.50

 

$

109.11

 

9.7

%

Hilton Garden Inn

 

 

 

 

 

 

 

Occupancy

 

70.0

%

71.4

%

1.4

pts

Average Rate

 

$

103.89

 

$

111.34

 

7.2

%

RevPAR

 

$

72.70

 

$

79.55

 

9.4

%

Doubletree

 

 

 

 

 

 

 

Occupancy

 

70.4

%

71.6

%

1.2

pts

Average Rate

 

$

112.58

 

$

122.32

 

8.7

%

RevPAR

 

$

79.30

 

$

87.60

 

10.5

%

Embassy Suites

 

 

 

 

 

 

 

Occupancy

 

73.8

%

74.9

%

1.1

pts

Average Rate

 

$

129.93

 

$

140.18

 

7.9

%

RevPAR

 

$

95.85

 

$

105.05

 

9.6

%

Homewood Suites by Hilton

 

 

 

 

 

 

 

Occupancy

 

75.2

%

75.8

%

0.6

pts

Average Rate

 

$

101.31

 

$

108.31

 

6.9

%

RevPAR

 

$

76.19

 

$

82.14

 

7.8

%

Hampton

 

 

 

 

 

 

 

Occupancy

 

71.6

%

72.5

%

0.9

pts

Average Rate

 

$

87.80

 

$

94.69

 

7.8

%

RevPAR

 

$

62.87

 

$

68.66

 

9.2

%

Scandic

 

 

 

 

 

 

 

Occupancy

 

64.0

%

65.1

%

1.1

pts

Average Rate

 

$

104.86

 

$

109.92

 

4.8

%

RevPAR

 

$

67.11

 

$

71.58

 

6.7

%

Conrad

 

 

 

 

 

 

 

Occupancy

 

70.4

%

69.6

%

(0.8

)pts

Average Rate

 

$

153.35

 

$

173.75

 

13.3

%

RevPAR

 

$

107.90

 

$

120.94

 

12.1

%

Other

 

 

 

 

 

 

 

Occupancy

 

75.2

%

79.5

%

4.3

pts

Average Rate

 

$

132.99

 

$

145.13

 

9.1

%

RevPAR

 

$

99.98

 

$

115.36

 

15.4

%

Total

 

 

 

 

 

 

 

Occupancy

 

71.4

%

72.5

%

1.1

pts

Average Rate

 

$

115.43

 

$

124.58

 

7.9

%

RevPAR

 

$

82.46

 

$

90.27

 

9.5

%


(1)          Statistics are presented pro forma as if the HI Acquisition had occurred January 1, 2005. Includes hotels in our system as of December 31, 2006 which were in our hotel system or the hotel system of HI since January 1, 2005. Comparable hotels exclude data for HI franchise hotels and our owned hotels in New Orleans due to the interruption in operations as a result of Hurricane Katrina.

For additional information regarding our hotel brands, see “Hotel Brands” above.

14




The following table sets forth certain system-wide statistical information for our hotels by geographic region as of and for the year ended December 31, 2006:

Regions

 

 

 

Occupancy

 

Average Rate

 

RevPAR

 

North America

 

 

72.8

%

 

 

$

120.56

 

 

$

87.77

 

United Kingdom & Ireland

 

 

77.1

 

 

 

169.92

 

 

130.98

 

Continental Europe

 

 

69.0

 

 

 

161.27

 

 

111.29

 

Africa

 

 

71.3

 

 

 

133.52

 

 

95.16

 

Middle East

 

 

72.7

 

 

 

115.84

 

 

84.24

 

Asia Pacific

 

 

77.3

 

 

 

132.65

 

 

102.57

 

Latin America & Caribbean

 

 

71.4

 

 

 

128.03

 

 

91.47

 

Nordic

 

 

65.3

 

 

 

114.17

 

 

74.57

 

Total

 

 

72.5

 

 

 

124.58

 

 

90.27

 

 

In the table above, statistics are presented pro forma as if the HI Acquisition occurred January 1, 2005. This table includes hotels in our system as of December 31, 2006 which were in our hotel system or in the hotel system of HI since January 1, 2005. Comparable hotels exclude data for HI franchise hotels and our owned hotels in New Orleans due to the interruption in operations as a result of Hurricane Katrina. For additional information regarding our number of properties, number of available rooms and statistical information, see “Five Year Summary” under Part II—Item 8.

ADDITIONAL INFORMATION

Casino Windsor

We own a 50% equity interest in Windsor Casino Limited, which operates the 400-room Casino Windsor in Windsor, Ontario, Canada for the Ontario provincial government under a management contract that expires in 2012. This hotel casino features a 75,000 square foot casino and entertainment and meeting facilities. See “Additional Information—Regulation and Licensing—Ontario Gaming Laws” below.

Design and Furnishing Services

Hilton Supply Management, Inc., our wholly owned subsidiary, provides design and furnishing services to our hotels and to hotels owned and operated by others. These services include the purchase and distribution of furniture, furnishings, equipment, food, beverage and operating supplies. The volume of this operation depends primarily on the number of new hotels we operate or franchise and on refurbishing and remodeling of our existing hotels.

Reservation System

Hilton Reservations Worldwide, LLC (“HRW”) oversees and operates a computerized, worldwide reservation system for hotels owned, operated or franchised by us, our affiliates and others. Prior to the HI Acquisition, Hilton and Hilton Group plc each owned a 50% interest in HRW. As a result of the HI Acquisition, HRW is now wholly owned by us. The domestic HRW reservation agents utilize an automated system that enables them to automatically cross-sell among all of our hotel brands which has benefited, and which we expect will continue to benefit, our hotel brands.

15




HHonors

Hilton HHonors Worldwide, LLC (“HHW”) operates our guest loyalty program (“HHonors”). Prior to the HI Acquisition, Hilton and Hilton Group plc each owned a 50% interest in HHW. As a result of the HI Acquisition, HHW is now wholly owned by us. The HHonors program is operated for the benefit of our family of brands worldwide. Members of the HHonors program earn points based on their spending at most of the hotel properties operated and franchised by us. HHonors accumulates and tracks points on the member’s behalf and fulfills awards upon request. Points can be redeemed for hotel stays at participating properties and for a variety of other awards such as airline tickets, cruises and car rentals. We expect HHonors to continue to have a positive impact on our brands. See “Note 2: Summary of Significant Accounting Policies—Hilton HHonors” to the consolidated financial statements under Part II—Item 8.

Technology and Distribution

We operate the Hilton worldwide internet website (www.hiltonworldwide.com) and our various hotel brand websites which provide cost effective customer service, including online hotel reservations and HHonors enrollment. We also provide various business, technology and information services for our hotel guests, including high speed internet access at many of our hotels system-wide and self-service check-in kiosks at certain of our owned or managed hotels.

We operate our proprietary OnQ system, which is a single technology platform that links our brands and hotels to enhance customer service and loyalty, as well as to maximize operational efficiencies. The OnQ system has been installed at virtually all of the hotels in our domestic hotel system. We have commenced the installation of the OnQ system in the hotels we acquired in the HI Acquisition. We also utilize an integrated strategy related to electronic and online distribution of rooms in our systems. The strategy provides for brand standards that permit each hotel to establish its own room rates, but requires the hotel to offer such rates consistently across all designated distribution channels, including our proprietary websites, HRW call centers, the Global Distribution System used by travel agents, and through hotels directly. In addition, we have implemented enhancements to our major brand websites as part of the strategy.

“Our Best Rates. Guaranteed.” is our program which offers a price-matching guarantee that is designed to encourage customers to book their reservations through the above referenced distribution channels. We believe that this program, along with enhancements to our branded websites, has contributed to significantly increased numbers of transactions on our proprietary websites.

Trademarks

The following trademarks used herein are owned by us and are either registered or have been filed for registration as trademarks in the United States and/or in certain foreign countries: Conrad®, Double Dip®, Doubletree®, Doubletree Club Hotel®, Doubletree Guest Suites®, Doubletree by Hilton™, Embassy Suites Hotels®, Embassy Suites by Hilton™, Finn & Porter®, Garden Inn®, Hampton®, Hampton Inn®, Hampton Inn & Suites®, Hampton by Hilton™, Hawaiian Village®, HGVClub®, HHonors®, Hilton®, Hilton Garden Inn®, Hilton Grand Vacations Club®, Hilton Hawaiian Village®, Hilton Suites®, Homewood Suites by Hilton®, LivingWell®, OnQ™, Points & Miles®, Scandic®, Senior HHonors®, Waldorf=Astoria® and Waldorf=Astoria Collection®. We consider all of these trademarks, and the associated name recognition, to be valuable to our business. See “Note 2: Summary of Significant Accounting Policies—Brands” to the consolidated financial statements under Part II—Item 8.

16




Marketing

Our hotel properties offer multiple product lines to a broad range of customers in many geographic markets worldwide. Our properties include full-service and limited service hotels in urban, airport, resort and suburban locations, as well as timeshare resorts.

Our metropolitan and airport properties primarily serve the convention and meeting market and the business traveler market (business persons traveling as individuals or in small groups). Our resort properties primarily serve the tour and leisure market (tourists traveling either as individuals or in groups) and the convention and meeting market. Our suburban properties primarily serve the leisure and business traveler markets. As indicated in “Risk Factors” under Item 1A, these sources of business are sensitive to general economic and other conditions.

We are a sponsor of the U.S. Olympic Team through 2008, which entitles our family of brands to use the official hotel sponsor designation and Olympic logo in advertising and marketing materials.

Competition

We seek to maintain the quality of our lodging business while expanding both domestically and internationally, primarily through franchising and the addition of management contracts. We intend to improve our business by leveraging our strong brand names, maximizing operating efficiencies, utilizing cost containment programs and technology, and expanding and enhancing properties. We may also acquire or develop properties as appropriate, either directly or through investments in joint ventures.

We believe that our position as a multi-branded owner, operator, manager and franchisor of hotels makes us one of the largest and most geographically diverse lodging companies in the world. Competition in the industry is based primarily on the level of service, quality of accommodations, convenience of locations and room rates. Competition from other hotels, motels and inns, including facilities owned by local interests and facilities owned by national and international chains, is vigorous in all areas in which we operate or franchise our facilities. Our hotels also generally compete with facilities offering similar services in cities and other locations where our hotels are not present. If hotel capacity is expanded by others in a city where our branded hotels are located, competition will increase. Our management agreements are generally for long-term periods, but most allow the hotel owner to terminate the arrangement if certain financial or performance standards are not met. Competition in the timeshare business is based primarily on the quality and location of timeshare resorts, the pricing of timeshare intervals and the availability of program benefits, such as exchange programs. We believe that our focus on core business strategies, combined with our financial strength, diverse market presence, strong brands and strategically located properties, will enable us to remain competitive. For additional information, see “Risk Factors” under Item 1A.

Environmental Matters

We are subject to various Federal, state, local and foreign laws, ordinances and regulations that:

(i)            govern activities or operations that may have adverse environmental effects, such as discharges to air and water, as well as handling and disposal practices for solid and hazardous or toxic wastes; or

(ii)        may impose liability for the costs of cleaning up, and certain damages resulting from, sites of past spills, disposals or other releases of hazardous or toxic substances or wastes (together, “Environmental Laws”).

17




Environmental Laws could make us liable for costs of removing or cleaning up hazardous or toxic substances on, under or in property we currently own or operate or that we previously owned or operated. Those laws could impose liability without regard to whether we knew of, or were responsible for, the presence of hazardous or toxic substances or waste. We endeavor to maintain compliance with Environmental Laws but, from time to time, our operations may have resulted or may result in noncompliance or liability for cleanup pursuant to Environmental Laws. In that regard, as of December 31, 2006, we had been notified of contamination resulting from past disposals of waste at eight sites to which hazardous or non-hazardous waste may have been sent from our facilities in the past. Based on information reviewed by and available to us, including:

(i)            uncertainty whether our facilities in fact shipped any waste to such sites;

(ii)        the number of potentially responsible parties at such sites; and

(iii)    where available, the volume and type of waste sent to such sites;

we believe that any liability arising from such disposals under Environmental Laws would not have a material adverse effect on our financial position or results of operations. However, there can be no assurance that this will be the case.

Regulation and Licensing

Ontario Gaming Laws.   Ontario, Canada has laws and regulations governing the conduct of casino gaming. Ontario law requires that the operator of a casino must be found suitable and be registered. A registration once issued remains in force until revoked. Ontario law defines the grounds for registration, as well as revocation or suspension of such registration. The Ontario authorities have conducted an investigation and have found us and the other shareholder of Windsor Casino Limited suitable in connection with the Ontario registration of Windsor Casino Limited. See “Additional Information—Casino Windsor” above.

Other Laws and Regulations.   We are subject to the laws and regulations of 78 countries and territories. The hotels and timeshare resorts we operate are subject to extensive state, local and national regulations and, on a periodic basis, must obtain various licenses and permits, including those required to sell alcoholic beverages. National and state laws and regulations also require certain registration, disclosure statements and other practices with respect to the franchising of hotels. We believe that we have obtained all required licenses and permits and our businesses are conducted in substantial compliance with applicable laws.

Employees

At December 31, 2006, we had approximately 105,000 employees, of whom approximately 28,000 were covered by various collective bargaining agreements providing, generally, for basic pay rates, working hours, other conditions of employment and orderly settlement of labor disputes. We believe that the aggregate compensation benefits and working conditions afforded our employees compare favorably with those received by employees in the hotel industry generally. See “Risk Factors” under Item 1A.

18




Forward-Looking Statements

Forward-looking statements in this report, including without limitation, those set forth under the captions Item 1 “—Business—Hotel Brands,” “—Operations—Development,” “—Development Financing,” “—Territorial Restrictions,” “—Potential Acquisitions,” ”—Property Transactions” and “—Seasonality” and “Additional Information—Reservation System,” “—HHonors,” “—Competition,” “—Environmental Matters” and “—Regulation and Licensing,” Item 2 “—Properties,” Item 3 “—Legal Proceedings” and Item 7 “—Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and other statements relating to our plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “believes,” “anticipates,” “expects,” “intends,” “plans,” “estimates,” “projects,” “will,” “should,” “continues” and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect our current views with respect to future events and financial performance and are subject to risks and uncertainties, including those identified under Item 1A “—Risk Factors” below and under “Operations—Territorial Restrictions” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Any of these risks and uncertainties could cause actual results to differ materially from historical results or those anticipated. We undertake no obligation to publicly update or revise any forward-looking statements to reflect current or future events or circumstances except as required by law.

Available Information

Our internet website is located at www.hiltonworldwide.com. We make available free of charge through this website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Our internet website also contains our Code of Business Conduct and Ethics for officers, employees and directors, including our Chief Executive Officer and senior finance officers (the “Code of Ethics”), our Corporate Governance Guidelines, Charters for our Audit, Compensation and Corporate Governance and Nominating Committees and information regarding communications with our Board of Directors. See “hiltonworldwide.com,” click on “Investor Relations,” then “Corporate Governance.” See also “Directors, Executive Officers and Corporate Governance” under Part III—Item 10. The information made available through our website is not incorporated by reference in this Form 10-K.

We will provide without charge to any person, on the written or oral request of such person, a copy of our annual report on Form 10-K, Code of Ethics, Corporate Governance Guidelines and Charters for our Audit, Compensation and Corporate Governance and Nominating Committees. Requests should be directed to our Corporate Secretary, Hilton Hotels Corporation, 9336 Civic Center Drive, Beverly Hills, California 90210 (telephone number (310) 278-4321).

19




Executive Officers of the Registrant

The following table sets forth certain information with respect to our executive officers.

Name

 

Positions with the Company

 

Age

Stephen F. Bollenbach

 

Co-Chairman of the Board and Chief Executive Officer since May 2004, and prior thereto, President and Chief Executive Officer

 

64

Matthew J. Hart

 

President and Chief Operating Officer since May 2004, and prior thereto, Executive Vice President and Chief Financial Officer

 

54

Ian R. Carter

 

Executive Vice President and Chief Executive Officer—Hilton International Co. (a subsidiary of Hilton Hotels Corporation) since March 2006, Chief Executive Officer—Hilton International Co. (a subsidiary of Hilton Group plc) from January 2005 until March 2006, and prior thereto, President—Europe, Middle East and Asia Pacific, Black & Decker Corporation

 

45

Tim Harvey

 

Executive Vice President—Global Distribution Services and Chief Information Officer since January 2007, Executive Vice President and Chief Information Officer from January 2006 until January 2007, and prior thereto, Senior Vice President and Chief Information Officer

 

48

Thomas L. Keltner

 

Executive Vice President and Chief Executive Officer—Americas and Global Brands, since January 2007, and prior thereto, Executive Vice President and President—Brand Performance and Development Group

 

60

Madeleine A. Kleiner

 

Executive Vice President, General Counsel and Corporate Secretary

 

55

Robert M. La Forgia

 

Executive Vice President and Chief Financial Officer since January 2006, Senior Vice President and Chief Financial Officer from May 2004 until January 2006, and prior thereto, Senior Vice President and Controller

 

48

 

Unless otherwise noted in the table, all positions and offices indicated have been continuously held since January 2002. The executive officers are responsible for all major policy making functions and all other corporate and divisional officers are responsible to, and are under the supervision of, the executive officers. None of the executive officers listed above are related.

Messrs. Bollenbach and Hart also serve as directors of Hilton. Additional information for our directors will be included under “Election of Directors” in our definitive proxy statement to be used in connection with our annual meeting of stockholders scheduled to be held on May 24, 2007 (the “Proxy Statement”), and this information is incorporated by reference in this Form 10-K. See Cover Page—“Documents Incorporated by Reference.”

20




Item 1A.   Risk Factors

We are subject to all of the operating risks common in the lodging and timeshare industries and our results may be adversely impacted if any of these risks materialize.   Our results are significantly affected by occupancy and room rates achieved by our hotels, our ability to manage costs, foreign currency exchange rate movements related to our international operations, our relative mix of owned, leased, managed and franchised hotels, supply and demand changes for hotel rooms and timeshare intervals in our markets, the quantity and pricing of timeshare interval sales and changes in the number of available hotel rooms and timeshare intervals through acquisition, development and disposition. Unfavorable changes in these factors, as well as the occurrence of other events described below, could negatively impact hotel room demand and pricing which, in turn, could limit our ability to pass through operating cost increases in the form of higher room rates. Our ability to manage costs could be adversely impacted by significant increases in operating expenses, such as wages and other labor costs, healthcare, insurance, property taxes and energy, as well as increases in construction costs, resulting in lower operating margins. In addition, economic factors beyond our control in the U.S. and internationally may create challenges for the lodging industry and us in 2007 and beyond. A downturn in economic conditions could impact the demand for hotel rooms and put pressure on room rates. Increases in transportation and fuel costs, the financial condition of the airline industry and its impact on air travel and sustained recessionary periods in the U.S. and internationally could also unfavorably impact future results.

Certain of our employees are covered by collective bargaining agreements and labor disputes may disrupt our operations.   Employees at certain of our owned and managed hotels are covered by collective bargaining agreements. In July 2006, we announced a five-year agreement with UNITE HERE, the union representing a majority of our unionized employees, termed a “partnership for future growth” which includes agreement by the parties to work together toward labor peace in cities with collective bargaining. Since the announcement, collective bargaining agreements have been reached and ratified in key markets including New York, Chicago, Puerto Rico, San Francisco, Toronto and Honolulu. At this time, we cannot predict when or whether new agreements will be reached in other markets in which we have employees covered by collective bargaining agreements, and what the impact of prolonged negotiations could be. Labor disputes in markets in which we have employees covered by collective bargaining agreements could disrupt our operations by causing the diversion of business to other hotels, thereby impacting our financial results negatively.

We derive a significant portion of our revenue from operations of our owned hotels and events in the markets where these properties are located could adversely affect our overall financial results.   We derived approximately 31% of our revenue in 2006 from the operations of our owned hotels. A significant portion of this revenue was derived from our large convention hotels located in major U.S. cities. See “Operations—Hotel Properties—Owned Hotels” under Item 1. In addition, we acquired 39 owned properties in the HI Acquisition. Although we sold a number of owned properties since the HI Acquisition and are continuing to market certain properties for sale, soft economic conditions and reduced business travel in any of the markets where we currently own properties could adversely affect our results from these properties and, therefore, our overall financial results. Our owned properties are also subject to risks that generally relate to investments in commercial real estate, including governmental regulations; real estate, insurance, zoning, tax and eminent domain laws; the ongoing need for capital improvements to maintain or upgrade properties; fluctuations in real estate values; and the relative illiquidity of real estate compared to other investments. If our owned properties do not generate sufficient revenue to meet operating expenses, including debt service and capital requirements, our financial results will be adversely affected.

21




We face challenges in integrating the operations of HI, as well as risks related to owning and operating real estate and hotels in international locations.   We may experience difficulties in completing the integration of HI’s operations, including combining technology and distribution activities, consolidating regional infrastructure, integrating personnel with disparate business backgrounds and corporate cultures and managing relationships with hotel owners, lessors and other business partners on a worldwide basis. As a result of the HI Acquisition, we are subject to varying degrees of risk relating to international real estate generally, including risks related to changes in local, political, economic and market conditions, interest rates, zoning laws, currency exchange rate fluctuations, compliance with environmental laws, costs and terms of financing and the potential for uninsured casualty and other losses. A number of the leased properties we acquired in the HI Acquisition are subject to long-term contracts requiring fixed payments to the lessor. If these properties do not generate sufficient revenue, we may be required to fund shortfalls to the lessors which could adversely impact our financial results. We have assumed certain obligations and liabilities related to the business acquired in the HI Acquisition and have limited rights of indemnification with respect to such matters. As a result of the HI Acquisition, we are subject to the laws and regulations of 78 countries and territories, which exposes us to risks relating to changes in franchise, tax, environmental, zoning, employment, repatriation of money, liquor license and other laws in the countries in which we operate. As a U.S. company operating globally, we may be subject to inconsistent requirements resulting from conflicts between U.S. laws and the laws of the countries in which we operate. If taxation authorities in the countries in which we operate interpret our tax position in a manner that is materially different than our assumptions, our tax liabilities could increase which could materially adversely impact our financial results. Some international jurisdictions restrict the repatriation of non-U.S. earnings. Various international jurisdictions also have laws limiting the ability of non-U.S. entities to pay dividends and remit earnings to affiliated companies unless specified conditions have been met. Sales in international jurisdictions typically are made in local currencies, which subject us to risks associated with currency fluctuations. Currency devaluations and unfavorable changes in international monetary and tax policies could have a material adverse effect on our profitability and financing plans, as could other changes in the international regulatory climate and international economic conditions. In addition, the U.S. government prohibits U.S. companies from operating in certain countries that are subject to economic sanctions or are on the terrorist countries list. We will not do business in such countries, unless we develop or acquire a non-U.S. affiliate that is capable of managing hotels or we obtain authorization from the U.S. Treasury Department’s Office of Foreign Assets Control to do so. Some investors would be prohibited by state law or self-imposed policies from investing in our securities if we were to do business in such countries.

We are more highly leveraged as a result of the HI Acquisition. If we are unable to complete planned dispositions of certain of our owned hotels acquired in the HI Acquisition, our ability to reduce our indebtedness could be impacted.   We have sold certain hotel properties we acquired in the HI Acquisition and are continuing to market additional properties for sale. See “Note 5: Acquisitions and Dispositions” to the consolidated financial statements under Part II—Item 8. We are required to use the net proceeds from such dispositions to repay amounts outstanding under our credit facilities which were incurred to finance the HI Acquisition. If we are unable to complete such dispositions on commercially reasonable terms within anticipated timeframes, our ability to reduce our outstanding borrowings may be adversely affected, which could negatively impact our cost of borrowings, our financial results and our ability to raise new capital to finance future growth. Our senior debt is currently rated Ba1 by Moody’s Investor Services and BB by Standard & Poor’s Ratings Group. A downgrade by any rating agency of our credit rating could adversely impact the cost and availability of capital to us. Our higher level of debt and resulting interest expense may place us at a competitive disadvantage to competitors with lower amounts of indebtedness and/or higher credit ratings.

22




If we have disputes with the owners of hotels we manage, we could be subject to litigation.   For our managed hotels, we have the responsibility to manage each hotel at a level consistent with the standard required for its brand in the relevant management agreement. Such provisions vary in scope and may be subject to differing interpretations. In the ordinary course of business, we encounter disagreements with the owners of our managed hotels as to whether the duties in our management agreements have been satisfied. To the extent that such conflicts arise, we seek to resolve them by negotiation with the relevant parties. In the event that such resolution cannot be achieved, litigation may result in damages or other remedies against us. Such remedies could include termination of the right to manage the relevant property. We may not be able to negotiate successfully or otherwise resolve such conflicts in each instance.

In competing for management, franchise and timeshare agreements and leases, we may make loans or provide guarantees to third parties and could experience losses under these loans or guarantee arrangements.   The terms of our management, franchise and timeshare agreements and leases are influenced by contract terms offered by our competitors at the time such agreements are entered into. Accordingly, we may not enter into contracts or renew contracts in the future on terms that are as favorable to us as those under existing agreements. In connection with entering into these contracts, we may become obligated to make loans to or guarantee the obligations of third parties or guarantee minimum income to third parties. Most of our guarantees allow us to terminate the agreement rather than fund shortfalls if specified performance levels are not achieved. However, under certain agreements we are required to fund performance shortfalls. Weak performance, particularly as a result of a soft economy, as well as the financial condition of third party owners and franchisees, could give rise to losses under our loans and guarantees. Changes in legislation or regulatory changes may be implemented that have the effect of favoring franchisees relative to brand owners.

The growth of internet reservation channels could harm our profitability.   Some of our hotel rooms are booked through internet travel intermediaries. If these bookings increase, these intermediaries may be able to obtain higher commissions or other significant contract concessions from us. We believe that the aim of such intermediaries is to have consumers develop loyalties to their reservation systems rather than to our lodging brands. Although we expect most of our business to continue to be derived from traditional channels and our proprietary branded internet websites, if the amount of sales made through internet intermediaries increases significantly, our ability to control the supply, presentation and price of our room inventory and our profitability may be harmed.

We are a party to joint venture arrangements and investing through joint ventures decreases our ability to manage risk.   We have from time to time invested, and expect to continue to invest, as a co-venturer. Joint venturers often have shared control over the operation of the joint venture assets. Therefore, joint venture investments may involve risks such as the possibility that the co-venturer in an investment might become bankrupt, or have economic or business interests or goals that are inconsistent with our business interests or goals, or be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives. Consequently, actions by a co-venturer might subject hotels owned by the joint venture to additional risk. Additionally, we may be unable to take action without the approval of our joint venture partners, or our joint venture partners could take actions binding on the joint venture without our consent.

Our hotel and timeshare businesses are subject to risks related to the availability of capital.   Owners of our hotel and timeshare properties, including us, are required to spend money to construct, refurbish and maintain properties. This creates an ongoing need for cash which, if not generated by ongoing operations or otherwise obtained, is subject to the availability of credit in capital markets. The ability of our owners to spend money necessary to maintain the brand standards of our properties is significantly impacted by the cost and availability of capital, over which we have little control.

23




Our timeshare business is subject to extensive regulation and if we fail to comply with such regulation our timeshare business could suffer.   We develop, manage, market and sell timeshare intervals, which generally entitle the buyer to occupy a fully-furnished unit for a one-week period on either an annual or an alternative-year basis. We also provide financing to purchasers of timeshare intervals. Certain of these activities are subject to extensive state regulation in both the state in which the property is located and the states in which the property is marketed and sold, as well as Federal regulation of certain marketing practices. In addition, the laws of most states in which we sell timeshare intervals grant the purchaser a unilateral right to rescind the purchase contract within a statutory rescission period. If we fail to be in compliance with applicable Federal, state, and local laws and regulations to which timeshare properties, marketing, sales and operations are subject, including Federal telemarketing regulations, or a determination by a regulatory authority that we were not in compliance, our timeshare business could suffer.

Reported profits from our timeshare business may be negatively impacted by deferrals required under percentage-of-completion accounting.   During periods of construction, profits from timeshare sales are recognized under the percentage-of-completion accounting method. As we are currently constructing several new timeshare projects, we anticipate that this required accounting will negatively impact the reported profits from our timeshare business in 2007. We expect the impact of percentage-of-completion accounting on 2007 results to reverse in 2008. See “Note 2:  Summary of Significant Accounting Policies—New Accounting Standards” to the consolidated financial statements under Part II—Item 8.

Our properties are subject to risks relating to acts of God, terrorist activity and war and any such event could materially adversely affect our operating results.   Our financial and operating performance may be adversely affected by acts of God, such as natural disasters, particularly in locations where we own and/or operate significant properties. Some types of losses, such as those from earthquake, hurricane, terrorism and environmental hazards, may be either uninsurable or too expensive to justify insuring against. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property. In that event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. Similarly, war (including the potential for war) and terrorist activity (including threats of terrorist activity), epidemics (such as SARS and bird flu), travel-related accidents, as well as geopolitical uncertainty and international conflict, which impact domestic and international travel, have caused in the past, and may cause in the future, our results to differ materially from anticipated results. Terrorism incidents such as the events of September 11, 2001 and wars such as the Iraq war significantly impact international travel and, consequently, global demand for hotel rooms. In addition, inadequate preparedness, contingency planning or recovery capability in relation to a major incident or crisis may prevent operational continuity and consequently impact the value of the brand or the reputation of our business.

We may incur losses as a result of class actions or other lawsuits which have recently targeted hospitality companies.   Our financial results may be adversely impacted by legal or governmental proceedings brought by or on behalf of our employees or customers. In recent years, a number of hospitality companies have been subject to lawsuits, including class action lawsuits, alleging violations of federal and state law regarding workplace and employment matters, discrimination and similar matters. A number of these lawsuits have resulted in the payment of substantial damages by the defendants. Similar lawsuits have been and may be instituted against us from time to time, and we may incur substantial damages and expenses resulting from lawsuits of this type, which could have a material adverse effect on our business.

24




If we fail to comply with privacy regulations, we could be subject to fines or other restrictions on our business.   We collect and maintain information relating to our guests for various business purposes, including maintaining guest preferences to enhance our customer service and for marketing and promotion purposes. The collection and use of personal data are governed by privacy laws and regulations enacted in the U.S. and other international jurisdictions in which we operate. Privacy regulation is an evolving area in which different jurisdictions may subject us to inconsistent compliance requirements. Compliance with applicable privacy regulations may increase our operating costs and/or adversely impact our ability to service our guests and market our products, properties and services to our guests. In addition, non-compliance with applicable privacy regulations by us (or in some circumstances non-compliance by third parties engaged by us) could result in fines or restrictions on our use or transfer of data.

We rely on our proprietary systems and any failures in such systems could negatively affect our business.   We invest in sophisticated technology and systems for property management, procurement, reservations and the operation of our HHonors customer loyalty program. If our systems fail to operate as anticipated, or we fail to replace our systems with new systems introduced by our competitors, our business could suffer. In addition, we are combining the systems used by the hotels acquired in the HI Acquisition with ours, and if we experience difficulties in merging these systems, it could disrupt our operations.

In addition, see the cautionary factors set forth under Item 1 “Business—Additional Information—Competition” and “—Environmental Matters.”

Item 1B.   Unresolved Staff Comments

None.

Item 2.   Properties

We consider our hotels to be leading establishments with respect to desirability of location, size, facilities, physical condition, quality and the variety of services offered in most of the areas in which they are located. Obsolescence arising from age and condition of facilities is a factor in the hotel industry. Accordingly, we spend, and intend to continue to spend, substantial funds to maintain the condition of our owned facilities in order to remain competitive.

Hotels and timeshare properties owned, leased, managed and franchised by us are briefly described under Item 1 and, in particular, under the caption “Operations,” and are incorporated by reference herein. In addition, new properties presently under construction that we will operate are briefly described under “Operations—Development” under Item 1.

Item 3.   Legal Proceedings

The description of legal proceedings in “Note 18: Commitments and Contingencies” to the consolidated financial statements included under Part II—Item 8 is incorporated by reference herein.

Item 4.   Submission of Matters to a Vote of Security Holders

Not applicable.

25




PART II

Item 5.                        Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our Common Stock is listed on the New York Stock Exchange and is traded under the symbol “HLT.” As of December 31, 2006, we had approximately 11,500 stockholders of record, although we believe that there are a significantly larger number of beneficial holders of our Common Stock. The high and low reported sales prices per share of our Common Stock and dividends declared per share of Common Stock are set forth in the following table for the periods indicated:

 

 

High

 

Low

 

Dividend
Per Share

 

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

1st Quarter

 

 

23.36

 

 

 

20.93

 

 

 

.02

 

 

2nd Quarter

 

 

25.06

 

 

 

21.37

 

 

 

.02

 

 

3rd Quarter

 

 

25.81

 

 

 

21.10

 

 

 

.04

 

 

4th Quarter

 

 

24.35

 

 

 

18.78

 

 

 

.04

 

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

1st Quarter

 

 

26.05

 

 

 

22.76

 

 

 

.04

 

 

2nd Quarter

 

 

29.22

 

 

 

25.06

 

 

 

.04

 

 

3rd Quarter

 

 

28.53

 

 

 

23.19

 

 

 

.04

 

 

4th Quarter

 

 

35.79

 

 

 

27.16

 

 

 

.04

 

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

1st Quarter (through February 23, 2007)

 

 

37.82

 

 

 

33.27

 

 

 

.04

 

 

 

Rights Agreement

On November 29, 1999, we adopted a preferred share purchase rights plan (the “Rights Plan”) and declared a dividend distribution of one preferred share purchase right (a “Right”) on each outstanding share of our Common Stock. We have entered into a rights agreement, dated as of November 29, 1999, which was amended as of February 15, 2001 to provide for the substitution of The Bank of New York as Rights Agent (as amended, the “Rights Agreement”). The Rights are transferred only with the Common Stock, unless and until they become exercisable. The Rights will expire on November 29, 2009, subject to our right to extend, unless earlier redeemed or exchanged by us or terminated.

Generally, the Rights become exercisable only if a person or group (other than Hilton Interests, as defined below):

(i)            acquires beneficial ownership of 20 percent or more of the Common Stock (such person or group, an “Acquiring Person”); or

(ii)        announces a tender offer, the consummation of which would result in ownership by a person or group of 20 percent or more of the Common Stock.

When exercisable, each Right entitles a shareholder to purchase from us one one-hundredth of a share of Series A Junior Participating Preferred Stock at an exercise price of $80, subject to adjustment (the “Purchase Price”).

26




After a person becomes an Acquiring Person, each holder of a Right (other than Rights owned by the Acquiring Person) will have the right to receive, upon exercise of such Right, a number of shares of Common Stock having a market value equal to two times the then current Purchase Price of the Right. After a person becomes an Acquiring Person, if we engage in certain mergers or transfers of assets, each holder of a Right (other than Rights owned by the Acquiring Person) will have the right to receive upon exercise, at the Right’s exercise price, a number of the acquiring company’s common shares having a market value of twice the Right’s Purchase Price.

Once a person becomes an Acquiring Person, but prior to their acquisition of 50 percent or more of the outstanding Common Stock, our Board of Directors may cause us to exchange the Rights (other than Rights owned by an Acquiring Person), in whole or in part, for shares of Common Stock at an exchange ratio based on the value of the Common Stock at that time, subject to adjustment.

Prior to a person or group becoming an Acquiring Person, the Rights are redeemable for $.001 per Right at the option of our Board of Directors.

“Hilton Interests” refer to Barron Hilton and the Conrad N. Hilton Fund and the shares of Common Stock beneficially owned by them.

The Rights Agreement, as amended, has been filed as Exhibits 4.8 and 4.9 to this Form 10-K, and the foregoing summary is qualified in its entirety by reference thereto.

27




Performance Graph

The graph below shows the cumulative total stockholder return for the five years ended December 31, 2006, assuming the investment of $100 on December 31, 2001 (and the reinvestment of dividends and common stock equivalents) in each of our Common Stock, the S&P 500 Stock Index and the S&P 500 Hotels, Resorts and Cruise Lines Index.

Comparison of Five-Year Cumulative Total Return of the Company, S&P 500 Stock Index
and S&P 500 Hotels, Resorts and Cruise Lines Index

GRAPHIC

 

 

12/01

 

12/02

 

12/03

 

12/04

 

12/05

 

12/06

 

Hilton Hotels Corporation

 

$

100.00

 

117.13

 

158.76

 

211.65

 

225.59

 

328.43

 

S&P 500 Stock Index

 

$

100.00

 

77.90

 

100.25

 

111.15

 

116.61

 

135.03

 

S&P 500 Hotels, Resorts & Cruise Lines Index

 

$

100.00

 

89.56

 

136.22

 

198.37

 

201.40

 

230.83

 

 

28




Item 6. Selected Financial Data

The following selected financial data as of and for the years ended December 31, 2002 through 2006 has been derived from our consolidated financial statements. The following data should be read in conjunction with our consolidated financial statements, the related notes thereto contained under Item 8 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7.

 

 

Year Ended December 31,

 

 

 

2002

 

2003

 

2004

 

2005

 

2006

 

 

 

(in millions, except per share amounts)

 

Results of Operations:

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

3,816

 

3,819

 

4,146

 

4,437

 

8,162

 

Net income

 

198

 

164

 

238

 

460

 

572

 

Net income per share—Basic

 

.53

 

.43

 

.62

 

1.20

 

1.49

 

Net income per share—Diluted

 

.53

 

.43

 

.60

 

1.13

 

1.39

 

Other Financial Data:

 

 

 

 

 

 

 

 

 

 

 

Dividends per common share

 

$

.08

 

.08

 

.08

 

.12

 

.16

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

8,348

 

8,183

 

8,242

 

8,743

 

16,481

 

Long-term debt

 

4,565

 

4,139

 

3,647

 

3,619

 

6,968

 

 

Long-term debt includes current maturities and excludes non-recourse debt and capital lease obligations of non-controlled entities.

On February 23, 2006, we acquired Hilton International in a business combination accounted for as a purchase. Accordingly, our consolidated financial results include the results of Hilton International from the date of acquisition. See “Note 3: Purchase of Hilton International” to the consolidated financial statements under Item 8.

29




Item 7.                        Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

We are engaged in the ownership, management and development of hotels, resorts and timeshare properties and the franchising of lodging properties. At December 31, 2006, our system contained 2,935 properties totaling approximately 501,000 rooms in 78 countries and territories. Our brands include Hilton, Hilton Garden Inn, Doubletree, Embassy Suites, Homewood Suites by Hilton, Hampton, Scandic, Conrad and the Waldorf=Astoria Collection. In addition, we develop and operate timeshare resorts through Hilton Grand Vacations Company and its related entities. We are also engaged in various other activities related or incidental to the operation of hotels.

The number of properties and rooms at December 31, 2006 by brand and by type are as follows:

Brand

 

 

 

Properties

 

Rooms

 

Type

 

 

 

Properties

 

Rooms

 

Hilton

 

498

 

172,605

 

Owned(1)

 

60

 

29,647

 

Hilton Garden Inn

 

302

 

41,669

 

Leased

 

203

 

46,663

 

Doubletree

 

173

 

45,119

 

Joint Venture

 

53

 

17,232

 

Embassy Suites

 

185

 

45,172

 

 

 

316

 

93,542

 

Homewood Suites by Hilton

 

192

 

21,141

 

 

 

 

 

 

 

Hampton

 

1,392

 

138,487

 

Managed

 

343

 

97,536

 

Scandic

 

129

 

22,808

 

Franchised

 

2,242

 

306,660

 

Conrad

 

15

 

5,152

 

 

 

2,585

 

404,196

 

Other

 

15

 

5,585

 

 

 

 

 

 

 

Timeshare

 

34

 

3,740

 

Timeshare

 

34

 

3,740

 

Total

 

2,935

 

501,478

 

Total

 

2,935

 

501,478

 


(1)          Includes majority owned and controlled hotels.

Our operations consist of three reportable segments which are based on similar products or services: Hotel Ownership, Managing and Franchising, and Timeshare. The Hotel Ownership segment derives earnings from owned, majority owned and leased hotel properties and equity earnings from unconsolidated affiliates (primarily hotel and other real estate joint ventures). The Managing and Franchising segment provides services including hotel management and licensing of our family of brands to franchisees. This segment generates its revenue from fees charged to hotel owners. As a manager of hotels, we are typically responsible for supervising or operating the hotel in exchange for fees based on a percentage of the hotel’s gross revenue, operating profits, cash flow, or a combination thereof. We charge franchise fees, depending on the brand, of up to five percent of rooms revenue in exchange for the use of one of our brand names.  The Timeshare segment consists of multi-unit timeshare resorts. This segment sells and finances timeshare intervals and operates timeshare resorts.

Our results are significantly affected by occupancy and room rates achieved by our hotels, our ability to manage costs, foreign currency exchange rate movements related to our international operations, our relative mix of owned, leased, managed and franchised hotels, the quantity and pricing of timeshare interval sales and changes in the number of available hotel rooms and timeshare intervals through acquisition, development and disposition. Results are also impacted by economic conditions and capacity. Unfavorable changes in these factors could negatively impact hotel room demand and pricing which, in turn, could limit our ability to pass through operating cost increases in the form of higher room rates.   Additionally, our ability to manage costs could be adversely impacted by significant increases in operating expenses, resulting in lower operating margins. See “Risk Factors” under Item 1A for a description of these and other conditions that could adversely affect our results of operations.

30




The hospitality industry is seasonal in nature. However, the periods during which our properties experience higher or lower levels of demand vary from property to property and depend principally upon location. Based upon historical results, we generally expect our revenue to be lower in the first fiscal quarter of each year than in each of the three subsequent quarters.

We anticipate that a favorable economic environment will continue to benefit the lodging industry and us in 2007. A continuation of strong hotel demand among business, group and leisure travelers, combined with limited full-service hotel supply growth, should enable us to charge higher room rates. We also anticipate growth in our management and franchise fee business as the number of hotels in our system continues to increase. Increases in construction costs could result in downward pressure on the margins achieved by our timeshare business. Reported revenue and expenses from our timeshare business are also expected to be negatively impacted by deferrals required under percentage-of-completion accounting as we begin construction of new timeshare projects. We will continue to focus on managing our costs, achieving revenue per available room (“RevPAR”) premiums in the markets where we operate, increasing occupancy, adding new units to our family of brands, leveraging technology and delivering outstanding customer service. We believe that our focus on these objectives, combined with our financial strength, diverse market presence, strong brands, strategically located properties and ability to grow our brands internationally will enable us to remain competitive.

In July 2006, we announced a five-year agreement with UNITE HERE, the union representing a majority of our unionized employees, termed a “partnership for future growth” which includes agreement by the parties to work together toward labor peace in cities with collective bargaining. Since the announcement, collective bargaining agreements have been reached and ratified in key markets including New York, Chicago, Puerto Rico, San Francisco, Toronto and Honolulu. A description of certain risks relating to potential labor disputes is described in “Risk Factors” under Item 1A. At this time, we cannot predict when or whether new agreements will be reached in other markets in which we have employees covered by collective bargaining agreements, and what the impact of prolonged negotiations could be.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis. We base our estimates and judgments on historical experience and other factors we believe to be reasonable under the circumstances, which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.

We believe the following critical accounting policies, among others, affect our more significant estimates and assumptions used in preparing our consolidated financial statements. Actual results could differ from our estimates and assumptions.

Notes Receivable

Notes receivable are reflected net of an estimated allowance for uncollectible amounts. For timeshare notes receivable, this estimate is based primarily on historical experience and assumptions with respect to future payment trends. Allowances for uncollectible amounts of other notes receivable, which include notes from managed, franchised and unconsolidated joint venture properties, are estimated based primarily on historical trends and analysis of underlying real estate collateral. Assessment of collateral may include estimates of future cash flow from the underlying real estate. Total notes receivable, including timeshare, totaled $401 million and $479 million, net of allowances for uncollectible amounts of $24 million and $35 million as of December 31, 2005 and 2006, respectively.

31




Property and Investments

Property and equipment acquired in acquisitions that were accounted for as purchases are recorded at their estimated fair value as of the date acquired, less accumulated depreciation. Other property and equipment are stated at cost less accumulated depreciation. We also maintain cost and equity method investments in entities that own and operate hotel properties and entities that perform other activities related or incidental to the operation of hotels. The assessment of long-lived assets for possible impairment requires us to make certain judgments, including estimates of real estate values and future cash flow from the respective properties and investments. We review the recoverability of our long-lived assets when events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable. Results in 2004 and 2005 include pre-tax impairment charges to long-lived assets of approximately $5 million in each year to reduce the value of property and equipment and equity method investments to estimated fair value. There were no impairment charges in 2006.

Sales of Real Estate

We account for the sale of real estate in accordance with Statement of Financial Accounting Standards (“FAS”) 66, “Accounting for Sales of Real Estate.”  To the extent we realize gains from the sale of real estate and maintain significant continuing involvement in the form of a long-term management contract, the gain is deferred and recognized in revenue over the term of the contract. The deferral of pre-tax gains on such sales totaled $5 million, $236 million and $5 million in 2004, 2005 and 2006 respectively. Results in 2004, 2005 and 2006 include the recognition of pre-tax deferred gains totaling $15 million, $23 million and $38 million, respectively. The deferral of gain recognition is dependent on the structure of individual sale transactions.

Intangible Assets

Our intangible assets include management and franchise contracts, leases, brands and goodwill. We account for management and franchise contracts and leases in accordance with FAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets,” which requires that we review our management and franchise contracts and leases for impairment when circumstances indicate that their carrying amounts may not be recoverable. The values of our management and franchise contracts and leases are amortized using the straight-line method over the life of the agreements. The assessment of management and franchise contracts and leases requires us to make certain judgments, including estimates of future cash flow from the respective properties. Management and franchise contracts, net, totaled $302 million and $1.18 billion at December 31, 2005 and 2006, respectively. Leases, net, totaled $107 million and $319 million at December 31, 2005 and 2006, respectively. We account for brands and goodwill in accordance with FAS 142, “Goodwill and Other Intangible Assets,” which requires that intangible assets with indefinite lives are not amortized, but are reviewed annually for impairment. The annual impairment review requires estimates of future cash flow with respect to the brands and estimates of the fair value of our company and its components with respect to goodwill.

32




Self-Insurance

We are self-insured for various levels of general liability, workers’ compensation and employee medical and dental insurance coverage at our owned locations. We purchase insurance coverage for claim amounts which exceed our self-insured retentions. Depending on the type of insurance, these self-insured retentions generally range from $250,000 to $500,000 per occurrence in the U.S. and approximately $2,000 to $500,000 internationally. Our self-insurance reserves totaled $146 million and $156 million at December 31, 2005 and 2006, respectively. Our insurance reserves are accrued based on estimates of the ultimate cost of claims expected to occur during the covered period. These estimates are prepared with the assistance of outside actuaries and consultants. Our actuaries periodically review the volume and amount of claims activity, and based upon their findings, we adjust our insurance reserves accordingly. The ultimate cost of claims for a covered period may differ from our original estimates.

Commitments and Contingencies

We have issued letters of credit and guaranteed certain debt and obligations of unconsolidated affiliates and third parties totaling $153 million at December 31, 2006. Under certain circumstances, we may be obligated to provide additional letters of credit or guarantees totaling $74 million. Assessment of the probability that we will be required to fund under these commitments requires us to make estimates of the ability of others to meet their obligations.

We have also provided performance guarantees to certain owners of hotels we operate under management contracts. Most of these guarantees allow us to terminate the contract rather than fund shortfalls if specified performance levels are not achieved. In limited cases, we are obligated to fund performance shortfalls. At December 31, 2006, we have six contracts containing performance guarantees with possible cash outlays totaling approximately $523 million through 2020. Funding under these performance guarantees totaled approximately $2 million in 2006 and is expected to total approximately $3 million in 2007. Funding under these guarantees in future periods is dependent upon the operating performance levels of these hotels over the remaining term of the performance guarantees. In 2006 we increased the reserve for the performance guarantee at a managed hotel by approximately $12 million based on our estimate of the guarantee payment that will be required at the end of the contract term in 2012. Although we anticipate that the future operating performance levels of these hotels will be largely achieved, there can be no assurance that this will be the case. In addition, we do not anticipate losing a significant number of management contracts in 2007 pursuant to these guarantees.

Our consolidated financial statements at December 31, 2005 and 2006 include liabilities of approximately $6 million and $18 million, respectively, for potential obligations under our outstanding guarantees.

Currency Translation

Assets and liabilities denominated in foreign currencies are translated into U.S. dollars at year-end exchange rates and the related gains and losses, net of applicable deferred income taxes, are reflected in stockholders’ equity. Gains and losses from foreign currency transactions are included in earnings. Income and expense accounts are translated at the average exchange rate for the period. Gains and losses from foreign exchange rate changes related to intercompany receivables and payables of a long-term nature are generally included in other comprehensive income. Gains and losses from foreign exchange rate movement related to intercompany receivables and payables that are not of a long-term nature are reported currently in income.

33




Hilton HHonors

Hilton HHonors is a guest loyalty program operated by Hilton HHonors Worldwide, LLC (“HHW”), a wholly owned and consolidated subsidiary as of December 31, 2006. At December 31, 2005, HHW was a 50% joint venture accounted for under the equity method of accounting. As part of the acquisition of the lodging assets of Hilton Group plc on February 23, 2006 (the “HI Acquisition”), we acquired the remaining 50% ownership interest. The HHonors program is operated for the benefit of our family of brands worldwide. Members of the HHonors program earn points based on their spending at most of the hotel properties operated and franchised by us. HHW accumulates and tracks points on the member’s behalf and fulfills awards upon request. Points can be redeemed for hotel stays at participating properties and for a variety of other awards such as airline tickets, cruises and car rentals.

HHonors is provided as a guest loyalty program to participating hotels. HHW charges the cost of operating the program, including the estimated cost of award redemptions, to participating hotels based on members’ qualifying expenditures. These charges do not include a markup or profit element. Our owned hotels record our share of program costs when qualified members stay at our owned hotels. When the members redeem awards at our hotels, our owned hotels recognize revenue for reward stays.

We use outside actuaries to assist in determining the fair value of the future award redemption obligation based on statistical formulas which project future point redemptions based on factors including historical experience, an estimate of points that will never be redeemed, an estimate of the points that will eventually be redeemed and the cost of reimbursing hotels and other third parties in respect to other redemption opportunities available to members. These estimates are used to determine the required liability for outstanding points. Actual expenditures for awards may differ from the actuarially determined liability. The total liability recorded for outstanding points as of December 31, 2006 was $421 million.

Purchase Accounting

In connection with the HI Acquisition, we allocated the purchase price to the assets acquired, including goodwill and other intangible assets, and liabilities assumed based on their respective fair values at the acquisition date in accordance with FAS 141 “Business Combinations.”  In valuing acquired assets and assumed liabilities, fair values are based on factors including, but not limited to, quoted market prices, expected future cash flows, current replacement cost, disposition values of certain assets acquired in the HI Acquisition, market rate assumptions and appropriate discount and growth rates. See “Note 3: Purchase of Hilton International” to our consolidated financial statements under Item 8 for more information.

Revenue Recognition

Revenue is generally recognized as services are performed. Owned and leased hotel revenue represents primarily room rentals and food and beverage sales from owned, majority owned and leased hotels.

Management fees represent fees earned from hotels managed by us, usually under long-term contracts with the hotel owner. Management fees include a base fee, which is generally a percentage of hotel revenue, and an incentive fee, which is generally based on a fixed or variable percent of hotel profits after a stated return threshold to the owner. We recognize base fees as revenue when earned in accordance with the terms of the contract. In interim periods we recognize the incentive fees that would be due if the contract were terminated at the end of the interim period.

Franchise fees represent fees received in connection with the licensing of our brand names, usually under long-term contracts with the hotel owner. Depending on the brand, we charge franchise royalty fees of up to five percent of room revenue. We recognize fee revenue as earned, in accordance with FAS 45, “Accounting for Franchise Fee Revenue.”

34




Timeshare and other income primarily consists of earnings from our timeshare operations. Timeshare revenue is generated primarily from the sale and financing of timeshare intervals and operating timeshare resorts. We recognize revenue from deeded timeshare sales in accordance with FAS 66, “Accounting for Real Estate Sales.”  Sales are included in revenue when a minimum of a 10 percent down payment has been received, certain minimum sales thresholds have been attained, the purchaser’s period to cancel for a refund has expired and the related receivable is deemed to be collectible. We defer revenue recognition for sales that do not meet these criteria. During periods of construction, profits from timeshare sales are recognized under the percentage-of-completion method. Our Hilton City Club timeshare product is accounted for as a long-term lease with a reversionary interest rather than the sale of a deeded interest in real estate. Hilton City Club sales revenue is recognized on a straight-line basis over the term of the lease.

We incur certain reimbursable costs on behalf of managed hotel properties and franchisees. We report reimbursements received from managed properties and franchisees as revenue and the costs incurred on their behalf as expenses. These costs, which relate primarily to payroll costs at managed properties where we are the employer, are included in other revenue and expenses from managed and franchised properties in the consolidated statements of income. Since the reimbursements are made based upon the costs incurred with no added margin, the presentation of these reimbursable costs has no effect on our operating income, total or per share net income, cash flow or financial position.

Income Taxes

We account for income taxes in accordance with FAS 109, “Accounting for Income Taxes.”  The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and to recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns.

Current and deferred tax assets and liabilities are recognized for estimated taxes payable or refundable due to temporary differences and carryforwards. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed for some portion or all of a deferred tax asset. Judgment is used in considering the relative impact of negative and positive evidence.

Use of Estimates

The estimates and assumptions related to notes receivable, long-lived assets, intangible assets, self-insurance, commitments and contingencies, HHonors, purchase accounting, revenue recognition and income taxes are subject to change based on the factors identified above. We believe that our estimates and assumptions are reasonable and have resulted in accurate measurement of the related accounts in our historical financial statements in conformity with GAAP. Because estimates are used, it is reasonably likely that there will be some variability between projected results and actual results over time. In addition, given the significance of these accounts to our consolidated financial position, the variability between projected and actual results could be material to our financial position or results of operations.

DEVELOPMENT AND CAPITAL SPENDING

Overview

On February 23, 2006, we completed the acquisition of the lodging assets of Hilton Group plc for cash consideration of approximately £3.3 billion, equivalent to approximately $5.7 billion as of the transaction date, excluding acquisition costs. The HI Acquisition was financed with existing cash on hand and with borrowings under our new senior credit facilities (see “Liquidity and Capital Resources—Financing” and “Note 3: Purchase of Hilton International” to the consolidated financial statements under Item 8). As a result of the HI Acquisition, we added approximately 400 properties and 103,000 rooms to our system.

35




We also intend to grow our hotel system through franchising and the addition of management contracts. We will also continue to invest in capital improvements and select projects at our owned hotels and the development of timeshare properties. In addition, we may seek to acquire ownership interests in hotel properties on a strategic and selective basis, either directly or through investments in joint ventures.

In addition to the properties added to our system in the HI Acquisition, we added a total of 223 properties, primarily franchises, with approximately 36,000 rooms to our system during 2006. A total of 74 properties, primarily franchises, with approximately 12,000 rooms were removed from our system in 2006. We believe the continued strong performance of our brands has enabled us to significantly enhance our development pipeline versus our industry competitors. We have more than 775 hotels, primarily franchises, with 110,000 rooms in our development pipeline at December 31, 2006. Approximately 90 percent of the hotels in the current development pipeline are in the Americas (U.S., Canada, Mexico and South America), though international development is expected to comprise an increasingly larger percentage of our development pipeline over the next few years. In 2007, we expect to add approximately 255 hotels and 35,000 rooms to our hotel system. We expect virtually all of this growth to be through franchise and management agreements. The actual opening of hotels in our development pipeline is subject to various conditions and uncertainties.

We believe our brand growth strategy continues to benefit from the significant market share premiums most of our brands command over their respective competitive sets. With 100 representing a brand’s fair share of the market, our domestic brands (according to Smith Travel Research) posted RevPAR index numbers as follows for 2006: Embassy Suites, 124.7; Hampton Inn, 122.9; Homewood Suites by Hilton, 114.3; Hilton Garden Inn, 112.4; Hilton, 105.6; and Doubletree, 101.5.

Our ability to grow the number of hotels in our system is affected by the factors referenced under Item 1A “Risk Factors,” such as international, national and regional economic conditions; the effects of actual and threatened terrorist attacks and international conflicts; acts of God, such as natural disasters; credit availability; relationships with franchisees and property owners; and competition from other hotel brands.

In total, we anticipate spending approximately $985 million on capital expenditures in 2007, which includes approximately $320 million for routine improvements and technology, approximately $315 million for timeshare projects and approximately $350 million for hotel renovation, hotel investment and special projects. Routine improvements include expenditures for equipment, hotel fixtures, and wall and floor coverings. Expenditures required to complete our capital spending programs are expected to be financed through available cash flow from operations and general corporate borrowings. To the extent we complete additional asset sales in 2007, capital expenditures can be expected to decrease. Anticipated capital expenditures are subject to change due to, among other things, changes in business operations and economic conditions.

We will continue to review our owned hotel portfolio for potential repositioning or re-branding opportunities (see “Liquidity and Capital Resources—Acquisitions and Dispositions”) and we may seek to sell certain assets, including assets acquired in the HI Acquisition. It is our intention to be opportunistic when evaluating potential asset sales and we will look to sell particular hotel properties to the extent we can obtain premium prices. We are currently marketing for sale certain of our owned and leased hotels, including ten hotels in continental Europe, the Hilton Caledonian in Scotland and six properties in the U.S. We are also marketing for sale the Scandic brand of hotels. As discussed in “Note 5: Acquisitions and Dispositions” to the consolidated financial statements under Item 8, until the necessary approvals have been received and substantive conditions to the buyer’s obligation to perform have been satisfied, we do not consider a sale to be probable. When we sell a hotel property, it is generally our preference to retain a management or franchise agreement; however, we may sell hotels without retaining our brand.

36




Hotel Ownership

Capital expenditures during 2006 excluding timeshare projects totaled $613 million, consisting primarily of routine improvements and renovation projects at our owned and leased hotels. The 2006 expenditures include approximately $92 million for renovations at the Waldorf=Astoria, Hilton New York and Hilton Hawaiian Village. Renovation projects are expected to continue at these three properties in 2007. We continue to place a priority on making appropriate capital expenditures to maintain and upgrade our owned assets.

Managing and Franchising

Total property additions to our system in 2006 included 204 franchise properties, 17 managed properties owned by third parties and two leased properties. These additions included 32 properties which, due in part to the market share leadership of our brands, were converted to our family of brands in 2006. The 32 conversions included 16 Doubletrees, eight Hiltons, five Hamptons and three Hilton Garden Inns.

In early 2006, we introduced a new brand line, the Waldorf=Astoria Collection. This elite brand designation debuted with New York’s legendary Waldorf=Astoria, along with three world-class luxury resorts managed by us: the Grand Wailea Resort Hotel & Spa on the island of Maui in Hawaii; the Arizona Biltmore Resort & Spa in Phoenix; and the La Quinta Resort & Club in La Quinta, California. Also in 2006, we commenced management of the Qasr Al Sharq in Jeddah, Saudi Arabia. We anticipate that the Waldorf=Astoria Collection will continue to grow primarily through branding of existing landmark or boutique hotels and opening newly built properties in select cities.

In the fourth quarter of 2006, we announced plans to form a joint venture with real estate developer DLF Limited to develop hotel properties and serviced apartments in India. The joint-venture company plans to develop and own 50 to 75 mid-scale and extended-stay hotels over the next seven years. We also announced an alliance with Deutsche Asset Management and HQ Asia Pacific in which they will develop an initial 25 Hilton Garden Inns in Beijing, Shanghai and Tianjin, China, which are expected to be franchised hotels.

Timeshare

We are currently developing new timeshare projects in Las Vegas, Nevada, Orlando, Florida, New York, New York, Honolulu and Waikoloa, Hawaii. The Waikoloa (Kohala Coast Vacation Suites) project opened its remaining 98 units in 2006; this project contains 120 units in total. At our International Drive property in Orlando (Tuscany Village), the first six phases totaling 376 units are open, including 70 units opened in January 2007. Construction has begun on the final 64 units, which are scheduled to open in spring 2008. Also in Orlando, we added 48 units in 2006 to our existing property adjacent to Sea World. The second phase of our property on the Las Vegas Strip, which consists of 431 units, was completed in 2006. Approximately 45 percent of the planned four-tower, 1,582-unit project has been completed.

In 2006, we began construction of a new timeshare project in Honolulu, Hawaii at the Hilton Hawaiian Village. Upon completion scheduled for late 2008, the Waikikian Tower is expected to contain 331 units. We also began development of a new project in Waikoloa, Hawaii (“Kings Land”). Phase I of the Kings Land development is expected to contain 198 units and is scheduled for completion in 2010. In September 2006, we announced our development of a new timeshare project in New York, New York on West 57th Street. Upon completion in early 2009, the 57th Street Tower is expected to contain 161 units. In 2007, we began construction of our new timeshare project at Ruby Lake in Orlando. Phase I of the Ruby Lake project is expected to contain 141 units and is scheduled for completion in 2009.

As we are currently constructing several new timeshare projects, our timeshare business is expected to be negatively impacted, from a reporting standpoint, by percentage-of-completion accounting associated with new projects in 2007. We expect the impact of percentage-of-completion accounting on 2007 results to reverse in 2008.

37




Capital expenditures associated with our timeshare operations during 2006 totaled $261 million. Timeshare capital expenditures are expected to increase to approximately $315 million in 2007 as we continue to invest in the development of new product in Las Vegas, Orlando, Hawaii and New York. The capital expenditures associated with our non-lease timeshare products are reflected as inventory until the timeshare intervals are sold. We also provide financing to the buyers of our timeshare intervals. During 2006, we issued approximately $335 million of loans related to timeshare financings. Principal collections on timeshare notes during the same period were approximately $226 million.

LIQUIDITY AND CAPITAL RESOURCES

Overview

Net cash provided by operating activities totaled $548 million, $486 million and $652 million for the years ended December 31, 2004, 2005 and 2006, respectively. The net increase in 2006 relates primarily to improved operating results and operating cash flow as a result of the HI Acquisition, partially offset by net cash used for timeshare construction in excess of timeshare sales and increased restricted cash balances. The net decrease in 2005 compared to 2004 relates primarily to net cash used by timeshare construction in excess of timeshare sales and a reduction in deferred income taxes resulting from the sale of assets in 2005. These decreases were partially offset by improved operating results.

Net cash provided by operating activities in 2004 and 2005 each benefited from a reduction in the valuation allowance for capital loss tax carryforwards which reduced the provision for income taxes (See “Liquidity and Capital Resources—Acquisitions and Dispositions” below, and “Note 13: Income Taxes” to the consolidated financial statements under Item 8). Our ability to utilize capital loss tax carryforwards to reduce our provision for income taxes is dependent on the availability of capital loss tax carryforwards and the existence of transactions that enable these capital loss carryforwards to be utilized. Therefore, it should not be assumed that such benefits will be available to us in the future.

Net cash used in investing activities totaled $4.598 billion in 2006 and net cash provided by investing activities totaled $620 million in 2005. The net cash used in investing activities in 2006 was primarily due to the HI Acquisition (see “Note 3: Purchase of Hilton International” to the consolidated financial statements under Item 8), the acquisition of management contracts and higher capital expenditures. These increases in cash used in investing activities were partially offset by an increase in proceeds from asset sales in 2006 over the prior year and an increase in payments received on notes and other. Net cash used in investing activities totaled $132 million in 2004 and net cash provided by investing activities totaled $620 million in 2005. The increase in net cash provided by investing activities was primarily due to an increase in net proceeds from asset dispositions in 2005 compared to the prior year, partially offset by higher capital expenditures.

Net cash used in financing activities totaled $255 million in 2005 and net cash provided by financing activities totaled $2.918 billion in 2006. The net change between periods is primarily due to the new senior credit facilities used to partially fund the HI Acquisition, net of repayments, and share repurchases in the prior year. Net cash used in financing activities totaled $122 million in 2004 compared to $255 million in 2005. The increase in 2005 reflects increased share repurchases and lower proceeds from the issuance of common stock, reflecting a lower volume of stock option exercises, partially offset by a lower level of debt repayments in the 2005 period.

Our ratio of earnings to fixed charges for the years ended December 31, 2004, 2005 and 2006 was 2.2x, 3.1x and 2.3x, respectively.

38




Cash and equivalents totaled $138 million at December 31, 2006, a decrease of $1.016 billion from December 31, 2005. The decrease in cash and equivalents is due primarily to cash being used to partially fund the HI Acquisition. Restricted cash totaled $293 million, an increase of $111 million from the prior year resulting primarily from an increase in cash reserves related to our collateralized borrowings and the addition of three consolidated non-controlled entities as part of the HI Acquisition. Restricted cash includes cash related to certain consolidated hotels, the use of which is restricted for hotel purposes under the terms of collateralized borrowings; refundable deposits on the sale of timeshare intervals; and cash balances held by consolidated non-controlled entities. We believe that our operating cash flow, available borrowings under our revolving credit facilities and our ability to obtain additional financing through various financial markets are sufficient to meet our liquidity needs (see “Liquidity and Capital Resources—Financing”). However, any projections of future financial needs and sources of working capital are subject to uncertainty. See “Results of Operations” below and “Additional Information—Forward-Looking Statements” under Item 1 and “Risk Factors” under Item 1A for further discussion of conditions that could adversely affect our estimates of future financial needs and sources of working capital.

Financing

In connection with the HI Acquisition in February 2006 (see “Note 3: Purchase of Hilton International” to the consolidated financial statements under Item 8), we entered into new senior credit facilities in an initial aggregate principal U.S. dollar equivalent of approximately $5.75 billion with a syndicate of financial institutions. These facilities replaced our $1 billion revolving credit facility and are secured by a pledge of the capital stock of certain of our wholly owned subsidiaries. The senior credit facilities consist of the following:

·       U.S. Dollar Denominated Revolver—5 year, $3.25 billion available in U.S. dollars, British Pounds, Euros and Swedish Kronor or other currencies acceptable to the administrative agent. Interest is at a variable rate depending upon our leverage ratio and senior debt ratings, with initial borrowings at applicable London Interbank Offered Rate (“LIBOR”) plus 150 basis points (which includes a 25 basis point annual facility fee). The capacity under our revolver was also used to support certain outstanding letters of credit. Total revolving debt capacity of approximately $1.42 billion was available to us at December 31, 2006.

·       Foreign Currency Denominated Term Loan A—5 year, approximate equivalent of $2.32 billion at December 31, 2006, denominated in £675 million, 675 million and Australian $140 million. Interest is at a variable rate depending upon our leverage ratio and senior debt ratings, with initial borrowings at applicable LIBOR plus 150 basis points.

·       U.S. Dollar Denominated Term Loan B—7 year, $500 million term loan available only in U.S. dollars. Interest at LIBOR plus 137.5 basis points.

We also have the option to increase the credit facilities by $500 million. At December 31, 2006, we have an aggregate principal U.S. dollar equivalent of approximately $3.219 billion outstanding under these facilities.

Subsequent to our announcement in December 2005 of our agreement to acquire the lodging assets of Hilton Group plc, Standard & Poor’s Ratings Group lowered our senior debt rating from BBB- to BB. In addition, Moody’s Investor Services lowered our senior debt rating from Baa3 to Ba2. These downgrades are reflected in the interest rates and facility fee of our $5.75 billion senior credit facilities. On February 26, 2007, Moody’s Investor Services upgraded our senior debt rating to Ba1.

39




Under the terms of the senior credit facilities, proceeds, if any, from the sale of certain owned properties acquired as part of the HI Acquisition are required to be used for the repayment of our senior credit facilities. In addition, we expect that excess cash flow, if any, will be used to repay outstanding debt balances.

In October 1997, we filed a shelf registration statement with the Securities and Exchange Commission registering up to $2.5 billion in debt or equity securities. At December 31, 2006, available financing under the shelf totaled $825 million. The terms of any additional securities offered under the shelf will be determined by market conditions at the time of issuance.

Provisions under various loan agreements require us to comply with certain covenants which include limiting the amount of our outstanding indebtedness. Our revolving credit facilities contain two significant financial covenants: a leverage ratio and debt service coverage ratio. We are in compliance with our financial covenants as of December 31, 2006.

Provisions of the financing agreement related to our 7.95% collateralized borrowings due 2010 require that certain cash reserves be maintained and also restrict the transfer of excess cash generated by the related properties to us if net cash flow falls below a specified level (the cash trap). The cash trap became effective in 2003 due to reduced cash flow from the collateralized properties, primarily the Hilton San Francisco. As of December 31, 2006, cash restricted under the terms of the collateralized borrowings, including required reserves and the cash trap, totaled $214 million. The impact of the cash trap, which is expected to remain in effect throughout 2007, is not expected to have a material impact on our liquidity.

As of December 31, 2006, approximately 53% of our long-term debt, including the impact of interest rate swaps and excluding non-recourse debt and capital lease obligations of non-controlled entities, was floating rate debt. Our total debt, excluding non-recourse debt and capital lease obligations, has a weighted-average life of approximately 6.1 years and a weighted-average interest rate of approximately 6.6%.

The following table summarizes our significant contractual obligations as of December 31, 2006, including long-term debt and operating lease commitments:

 

 

 

 

Payments Due by Period

 

 

 

 

 

Less than

 

1 – 3

 

4 – 5

 

After

 

Contractual Obligations (in millions)

 

 

 

Total

 

1 year

 

years

 

years

 

5 years

 

Long-term debt

 

 

$

7,468

 

 

 

522

 

 

 

1,447

 

 

 

3,810

 

 

 

1,689

 

 

Operating leases

 

 

4,159

 

 

 

294

 

 

 

564

 

 

 

526

 

 

 

2,775

 

 

Less: Non-recourse debt and capital lease obligations of non-controlled entities

 

 

(500

)

 

 

(110

)

 

 

(25

)

 

 

(26

)

 

 

(339

)

 

Total contractual obligations

 

 

$

11,127

 

 

 

706

 

 

 

1,986

 

 

 

4,310

 

 

 

4,125

 

 

 

Both total debt and operating lease commitments increased from December 31, 2005 as a result of the HI Acquisition (see “Note 3: Purchase of Hilton International” and “Note 11: Long-Term Debt” to the consolidated financial statements under Item 8 for further information). Our total debt includes debt and capital lease obligations related to variable interest entities consolidated under FIN 46(R) that are non-recourse to us. These balances, totaling $500 million, have been deducted in arriving at the total contractual obligations as of December 31, 2006. These amounts are reflected on our consolidated balance sheets as non-recourse debt and capital lease obligations of non-controlled entities.

40




Development Financing and Other Commercial Commitments

We have issued guarantees in connection with development financing programs in order to support the growth of our brands. The following table summarizes our development financing and other commercial commitments as of December 31, 2006:

 

 

 

 

Amount of Commitment Expiration
Per Period

 

 

 

 

 

Less than

 

1 – 3

 

4 – 5

 

After

 

Commercial Commitments (in millions)

 

Total

 

1 year

 

years

 

years

 

5 years

 

Letters of credit

 

 

$

110

 

 

 

110

 

 

 

 

 

 

 

 

 

 

 

Guarantees

 

 

43

 

 

 

4

 

 

 

19

 

 

 

 

 

 

20

 

 

Total commercial commitments

 

 

$

153

 

 

 

114

 

 

 

19

 

 

 

 

 

 

20

 

 

 

See “Note 18: Commitments and Contingencies” to the consolidated financial statements under Item 8 for further discussion of our development financing and other commercial commitments.

Acquisitions and Dispositions

In February 2006, we completed the acquisition of the lodging assets of Hilton Group plc (see “Note 3: Purchase of Hilton International” to the consolidated financial statements under Item 8). Additionally, during 2006, we acquired four long-term management contracts and sold 11 wholly owned hotels, three joint venture interests, one leased hotel and the LivingWell health clubs (see “Note 5:  Acquisitions and Dispositions” to the consolidated financial statements under Item 8).

Stockholders’ Equity

In the 2005 third quarter, our Board of Directors approved an increase to our common stock dividend of $.02 per share to $.04 per share. Annual dividends paid on common shares were $.08, $.12 and $.16 per share in 2004, 2005 and 2006 respectively.

In 2004, we repurchased approximately 2.3 million shares of our common stock at a total cost of approximately $48 million. During 2005, we repurchased approximately 12.3 million shares of our common stock at a total cost of approximately $271 million. No shares were repurchased in 2006. The timing of stock purchases is made at the discretion of management. As of December 31, 2006, approximately 44.7 million shares remained authorized for repurchase.

OFF-BALANCE SHEET ARRANGEMENTS

We have outstanding guarantees issued in connection with our development financing programs and other guarantees of debt and other obligations of unconsolidated affiliates and third parties, as well as commitments under letters of credit. See “Note 18: Commitments and Contingencies” to the consolidated financial statements under Item 8. We maintain investments in unconsolidated affiliates, including hotel joint ventures as well as other entities that support the operations of our hotel properties. We do not have investments in or obligations with respect to unconsolidated special purpose entities.

RESULTS OF OPERATIONS

The following discussion presents an analysis of our results of operations for the three years ended December 31, 2006. Our operations consist of three reportable segments which are based on similar products or services: Hotel Ownership, Managing and Franchising, and Timeshare.

41




FISCAL 2006 COMPARED WITH FISCAL 2005

Overview

A summary of our consolidated results for the years ended December 31, 2005 and 2006 is as follows:

 

 

2005

 

2006

 

% Change

 

 

 

(in millions, except per share amounts)

 

Revenue

 

 

$

4,437

 

 

 

8,162

 

 

 

84

%

 

Operating income

 

 

805

 

 

 

1,274

 

 

 

58

 

 

Net income

 

 

460

 

 

 

572

 

 

 

24

 

 

Basic EPS

 

 

1.20

 

 

 

1.49

 

 

 

24

 

 

Diluted EPS

 

 

1.13

 

 

 

1.39

 

 

 

23

 

 

 

Revenue and operating income in 2006 benefited from the HI Acquisition and from strong rate increases and high demand in most of our major markets, which resulted in significant RevPAR gains at many of our comparable owned hotels. Management and franchise fee revenue was our highest ever, increasing 51 percent over the prior year as a result of the HI Acquisition, continued RevPAR growth and the addition of new units. Results in 2006 also benefited from strong results at our timeshare business. Net income in 2006 was impacted by increases in depreciation, amortization and interest expense due to the HI Acquisition, and benefited from net gains on foreign currency transactions. Net income in 2005 benefited from higher gains on property transactions compared to 2006, as well as a lower effective tax rate compared to 2006.

Revenue from owned hotels totaled $2.521 billion in 2006, a 23 percent increase from $2.049 billion in 2005, and total expenses in 2006 were up 22 percent to $1.780 billion. Strong results at our comparable owned hotels and the impact of the HI Acquisition were partially offset by the impact of asset sales and renovation disruptions in New York and Hawaii. Total revenue from comparable owned hotels (excluding the impact of asset sales, revenue from our two owned properties in New Orleans which were impacted by Hurricane Katrina, and the results of the acquired HI owned hotels) was up eight percent to $1.675 billion from $1.558 billion in the 2005 period, while comparable owned hotel expenses increased seven percent to $1.180 billion in 2006 from $1.098 billion in 2005.

Results at our comparable owned properties benefited from continued strong demand and average rate increases from groups, business and leisure travelers. Results in Chicago, San Francisco and Phoenix were particularly strong in 2006, each reporting double-digit RevPAR gains over the prior year. RevPAR growth at our owned hotels in New York City (the Waldorf=Astoria and the Hilton New York) and at the Hilton Hawaiian Village was significantly impacted by renovation disruptions, though all three properties achieved strong gains in average daily rate (“ADR”). Renovation disruptions are expected to continue to impact these three properties in 2007. RevPAR for comparable North American owned properties increased 8.8 percent for the year, with occupancy rising 0.2 points to 78.7 percent and ADR up 8.6 percent to $199.24.

Margins at our comparable North American owned hotels (revenue less expenses as a percentage of revenue for comparable owned hotels) improved 10 basis points in 2006 to 29.6 percent. The aforementioned renovation disruptions combined with higher insurance and marketing costs in the year negatively impacted margins by approximately 170 basis points. Cost-per-occupied-room increased 7.7 percent in 2006.

42




Leased hotel revenue totaled $2.347 billion in 2006 compared to $111 million in 2005, while leased hotel expenses were $1.985 billion in the current year versus $99 million in the prior year. In the 2006 period, leased hotel revenue and expenses include approximately 200 leased hotels acquired in the HI Acquisition. Prior to the HI Acquisition, we operated six leased hotels. Results from the leased hotels acquired in the HI Acquisition reflect business strength in the U.K., continental Europe and the Nordic region. Due to the relatively large size of the lease payments required in a hotel operating lease, the leased properties operate at margins significantly lower than our owned hotels. Leased hotel revenue and expenses are included with our owned hotels in our Hotel Ownership segment results.

Operating income from unconsolidated affiliates increased $13 million in 2006 to $57 million. The increase relates primarily to the addition of unconsolidated affiliates acquired in the HI Acquisition combined with improved operating results over the 2005 period. Operating income from unconsolidated affiliates is included in our Hotel Ownership segment results.

Management and franchise fee revenue in 2006 increased $232 million or 51 percent to $684 million. Fee revenue is based primarily on rooms revenue at franchise properties and total operating revenue (and to a lesser extent gross operating profits or cash flow) at managed properties. The strong demand among business, groups and leisure travelers that benefited our owned hotels also resulted in strong RevPAR gains for each of our brands on a system-wide basis (including managed and franchised properties). The increase in management and franchise fees in 2006 also reflects $109 million of fee revenue as a result of the HI Acquisition and $26 million of contract termination fees related to the Hilton Times Square and the Embassy Suites Battery Park in New York. The Times Square and Battery Park properties were sold in 2006 and we entered into franchise agreements with the new owners. Additionally, strong domestic development activity as well as the large number of conversions to management and franchise contracts resulting from our owned asset sales favorably impacted fee revenue.

Revenue from our timeshare operations (included in timeshare and other income) totaled $650 million, an increase of $96 million or 17 percent from $554 million in 2005. Timeshare expenses in 2006 (included in other operating expenses) were $491 million compared to $420 million in the prior year. Timeshare revenue and earnings are generated through developing timeshare resorts and selling the related intervals, financing the sale of timeshare intervals and through management of timeshare resorts. Overall timeshare unit sales were up two percent in 2006, while the average unit sales price increased 10 percent across the system. Timeshare revenue and profitability also benefited from higher financing income and the recognition of previously deferred revenue and expenses due to the required percentage-of-completion accounting.

Depreciation and amortization expense increased $142 million in 2006 to $441 million. This net increase reflects additional depreciation and amortization associated with the tangible and intangible assets acquired in the HI Acquisition, partially offset by a reduction in depreciation expense associated with asset sales.

Results in 2005 include impairment loss and related costs totaling $7 million, which includes a pre-tax charge of $5 million to reduce the value of an owned hotel and our minority interests in eight joint venture hotels to their estimated fair values and a $2 million pre-tax charge representing the write down of a non-hotel cost basis investment to its estimated fair value. The $5 million charge is included in our Hotel Ownership segment results, while the $2 million charge is not allocated among our reportable segments. There were no impairment losses in the 2006 period.

43




Corporate Activity

Corporate expense totaled $171 million in 2006, an increase of $68 million, or 66 percent, from 2005. The increase is primarily the result of incremental corporate costs related to the HI Acquisition, $12 million of non-recurring charges related to the HI Acquisition and the expensing of stock options under FAS 123(R) (see “Note 4: Stock Based Compensation” to the consolidated financial statements under Item 8). Other operating expenses in 2006 include a $12 million pre-tax charge to increase a performance guarantee reserve for a managed hotel (see “Note 18: Commitments and Contingencies” to the consolidated financial statements under Item 8). Corporate expense is not allocated among our reportable business segments.

Interest and dividend income decreased $5 million compared to the prior year. This decrease reflects higher cash balances in 2005 due primarily to proceeds from asset sales prior to the HI Acquisition. Interest expense, net of amounts capitalized, increased $239 million compared to 2005, due primarily to borrowings under our new senior credit facilities in order to partially fund the HI Acquisition. Net interest from unconsolidated affiliates and non-controlled interests increased by $19 million to $45 million in 2006, primarily due to the addition of non-consolidated interests as part of the HI Acquisition.

The net gain on foreign currency transactions of $24 million in 2006 is primarily the result of movement in the value of the British Pound prior to our completion of the HI Acquisition, which was funded in British Pounds. The net gain also includes the impact of foreign currency movements on intercompany loans that are deemed to be short-term in nature.

The $72 million net other gain in 2006 includes net gains from asset sales of $1 million (see “Note 5: Acquisitions and Dispositions” to the consolidated financial statements under Item 8), a $33 million gain from settlement recoveries related to mold found in certain areas of the Hilton Hawaiian Village in 2002, a $24 million gain on sales of certain marketable securities, a $17 million net gain related to insurance proceeds received in excess of the book value of assets written off as a result of damage from Hurricane Katrina (see “Note 19: Insurance Recoveries” to the consolidated financial statements under Item 8), a $3 million pre-tax loss on derivative instruments (see “Note 2: Summary of Significant Accounting Policies—Derivative Instruments” to the consolidated financial statements under Item 8) based on the market value of the derivatives at December 31, 2006, a $3 million loss on the termination of various management and franchise contracts to which we had value assigned, and $3 million in net other gains. The $103 million net other gain in 2005 includes gains from asset sales of $112 million, a $10 million loss on our foreign currency options based on the market value of the options at December 31, 2005, a $3 million gain on our oil futures derivative, and $2 million of other losses.

The loss from non-operating affiliates totaling $17 million and $16 million in 2005 and 2006, respectively, represents equity losses associated with our 24 percent minority interest in a coal-based synthetic fuel facility. The synthetic fuel produced at this facility qualifies for tax credits based on Section 45K of the Internal Revenue Code; these credits reduce our provision for income taxes (see “Note 5: Acquisitions and Dispositions” to the consolidated financial statements under Item 8).

The effective income tax rate for 2006 increased to 31% from 26% in 2005. The effective rate in 2006 reflects the utilization of Section 45K synthetic fuel production credits of approximately $11 million and a net benefit of $15 million primarily due to the favorable resolution of IRS audits for the years 2002 and 2003 and the required treatment of certain foreign currency gains. The effective rate in 2005 includes a benefit of $28 million resulting from closures of IRS audits, a reduction in the valuation allowance for capital loss tax carryforwards totaling $34 million associated with asset sales and the utilization of Section 45K synthetic fuel production credits of approximately $17 million. The 2005 effective tax rate also includes net state tax credits of approximately $2 million. Our effective tax rate is determined by the level and composition of pre-tax income and the mix of income subject to varying foreign, state and local taxes.

44




Excluding the aforementioned items, our effective rate was 34% in 2006 and 39% in 2005. The reduction in effective rate for 2006 compared to 2005 is primarily the result of the HI Acquisition. In 2005 and earlier, our tax liability was principally comprised of U.S. and state taxes imposed on domestic income. As a result of our acquisition of HI, our tax liability is comprised of both U.S. and foreign taxes and is impacted by the composition of pre-tax income by jurisdiction. Income from foreign jurisdictions is subject to lower levels of tax resulting in an overall worldwide blended effective rate that is lower than our 2005 effective rate.

Minority and non-controlled interests expense, net, decreased $5 million to $7 million in 2006, primarily due to a distribution to our minority partner on the sale of the Hilton Glendale in 2005 (see “Note 5: Acquisitions and Dispositions” to the consolidated financial statements under Item 8).

Hotel Statistics

RevPAR for U.S. owned hotels and system-wide for the years ended December 31, 2005 and 2006 is as follows:

 

 

North America (U.S. owned)(1)

 

 

 

2005

 

2006

 

% Change

 

Hilton

 

 

$

151.85

 

 

 

165.03

 

 

 

8.7

%

 

All other

 

 

91.45

 

 

 

101.06

 

 

 

10.5

 

 

Total

 

 

144.05

 

 

 

156.73

 

 

 

8.8

 

 

 


(1)          Statistics are for comparable U.S. hotels, and include only hotels in the system as of December 31, 2006, and owned by us since January 1, 2005. Comparable hotels exclude our owned hotels in New Orleans due to the interruption in operations as a result of Hurricane Katrina.

 

 

System-wide(2)

 

 

 

2005

 

2006

 

% Change

 

Hilton

 

 

$

99.50

 

 

 

109.11

 

 

 

9.7

%

 

Hilton Garden Inn

 

 

72.70

 

 

 

79.55

 

 

 

9.4

 

 

Doubletree

 

 

79.30

 

 

 

87.60

 

 

 

10.5

 

 

Embassy Suites

 

 

95.85

&nbs