SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
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 of incorporation or organization)		(I.R.S. Employer Identification No.)
9336 Civic Center Drive, Beverly Hills, California		90210
(Address of principal executive offices)		(Zip code)

 

(310) 278-4321

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes  x     No  o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of July 29, 2005—Common Stock, $2.50 par value—380,965,072 shares.

PART I—FINANCIAL INFORMATION

Company or group of companies for which report is filed:

HILTON HOTELS CORPORATION AND SUBSIDIARIES

ITEM 1.     FINANCIAL STATEMENTS

Consolidated Statements of Income

(in millions, except per share amounts)

		Three Months Ended June 30,									Six Months Ended June 30,
		2004					2005				2004				2005
		(unaudited)									(unaudited)
Revenue
Owned hotels			$	546				575				1,028				1,070
Leased hotels			29					31				55				59
Management and franchise fees			97					117				186				219
Timeshare and other income			107					148				227				302
			779					871				1,496				1,650
Other revenue from managed and franchised properties			286					305				563				602
			1,065					1,176				2,059				2,252
Expenses
Owned hotels			380					391				751				767
Leased hotels			25					27				50				53
Depreciation and amortization			83					78				166				158
Impairment loss and related costs			—					5				—				7
Other operating expenses			89					116				190				238
Corporate expense			25					26				44				50
			602					643				1,201				1,273
Other expenses from managed and franchised properties			285					303				559				596
			887					946				1,760				1,869
Operating income from unconsolidated affiliates			10					16				20				26
Operating Income			188					246				319				409
Interest and dividend income			7					4				17				8
Interest expense			(72		)			(66	)			(142	)			(130	)
Net interest from unconsolidated affiliates and non-controlled interests			(8		)			(7	)			(14	)			(13	)
Net gain (loss) on asset dispositions and other			3					61				(1	)			72
Loss from non-operating affiliates			—					(4	)			—				(9	)
Income Before Taxes and Minority and Non-Controlled Interests			118					234				179				337
Provision for income taxes			(40		)			(25	)			(61	)			(61	)
Minority and non-controlled interests, net			(3		)			(7	)			(6	)			(10	)
Net Income			$	75				202				112				266
Basic Earnings Per Share			$	.20				.53				.29				.69
Diluted Earnings Per Share			$	.19				.49				.28				.65

P

See notes to consolidated financial statements

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Hilton Hotels Corporation and Subsidiaries
Consolidated Balance Sheets
(in millions)

		December 31, 2004					June 30, 2005
							(unaudited)
ASSETS
Current Assets
Cash and equivalents			$	303				267
Restricted cash			163					424
Accounts receivable, net			269					360
Inventories			144					165
Deferred income taxes			85					89
Current portion of notes receivable, net			68					42
Other current assets			74					69
Total current assets			1,106					1,416
Investments, Property and Other Assets
Investments and notes receivable, net			635					655
Property and equipment, net			3,510					3,343
Management and franchise contracts, net			336					320
Leases, net			111					109
Brands			970					970
Goodwill			1,240					1,224
Other assets			334					327
Total investments, property and other assets			7,136					6,948
Total Assets			$	8,242				8,364
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts payable and accrued expenses			$	611				690
Current maturities of long-term debt			14					14
Income taxes payable			4					16
Total current liabilities			629					720
Long-term debt			3,633					3,596
Non-recourse debt of non-controlled entity			100					100
Deferred income taxes and other liabilities			1,312					1,326
Stockholders’ equity			2,568					2,622
Total Liabilities and Stockholders’ Equity			$	8,242				8,364

 

See notes to consolidated financial statements

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Hilton Hotels Corporation and Subsidiaries
Consolidated Statements of Cash Flow
(in millions)

		Six Months Ended June 30,
		2004					2005
		(unaudited)
Operating Activities
Net income			$	112				266
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			166					158
Amortization of loan costs			4					4
Net loss (gain) on asset dispositions			1					(72	)
Loss from non-operating affiliates			—					9
Impairment loss and related costs			—					7
Change in working capital components:
Inventories			29					(22	)
Accounts receivable			(42		)			(88	)
Other current assets			(5		)			3
Accounts payable and accrued expenses			9					74
Income taxes payable			39					12
Restricted cash			(53		)			6
Change in deferred income taxes			26					61
Change in other liabilities			59					(27	)
Unconsolidated affiliates’ distributions in excess of (less than) earnings			10					(4	)
Change in timeshare notes receivable			(50		)			(49	)
Other			6					—
Net cash provided by operating activities			311					338
Investing Activities
Capital expenditures			(66		)			(255	)
Additional investments			(29		)			(21	)
Proceeds from asset dispositions			51					364
Asset disposition proceeds held in escrow as restricted cash			—					(267	)
Payments received on notes and other			34					35
Net cash used in investing activities			(10		)			(144	)
Financing Activities
Change in revolving loans			(160		)			—
Long-term borrowings			—					14
Reduction of long-term debt			(7		)			(7	)
Issuance of common stock			41					49
Repurchase of common stock			—					(271	)
Cash dividends			(15		)			(15	)
Net cash used in financing activities			(141		)			(230	)
Increase (Decrease) in Cash and Equivalents			160					(36	)
Cash and Equivalents at Beginning of Year			9					303
Cash and Equivalents at End of Period			$	169				267

 

See notes to consolidated financial statements

3

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1:   General

The consolidated financial statements presented herein have been prepared by Hilton Hotels Corporation in accordance with the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2004 and should be read in conjunction with the Notes to Consolidated Financial Statements which appear in that report.

The consolidated financial statements for the three and six months ended June 30, 2004 and 2005 are unaudited; however, in the opinion of management, all adjustments (which include normal recurring accruals) have been made which are considered necessary to present fairly the operating results and financial position for the unaudited periods.

Note 2:   Earnings Per Share

Basic EPS is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. The weighted average number of common shares outstanding totaled 383 million and 382 million for the three and six months ended June 30, 2004 and 381 million and 384 million for the three and six months ended June 30, 2005, respectively. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted. The dilutive effect of stock-based compensation and convertible securities increased the weighted average number of common shares by 34 million for both the three and six months ended June 30, 2004 and 35 million and 34 million for the three and six months ended June 30, 2005, respectively. In addition, the increase to net income resulting from interest on convertible securities assumed to have not been paid was $3 million for the three month periods ended June 30, 2004 and 2005, and $6 million for the six month periods ended June 30, 2004 and 2005. The sum of EPS for the first two quarters of 2004 and 2005 differs from the year to date EPS due to the required method of computing EPS in the respective periods.

Note 3:   Stock-Based Compensation

We apply Accounting Principles Board (APB) Opinion 25 and related interpretations in accounting for our stock-based compensation plans. Prior to 2004, our stock-based compensation consisted primarily of stock options. No compensation cost is reflected in our net income related to our stock option awards for the periods presented, as all stock options had an exercise price greater than or equal to the market value of the underlying common stock on the date of grant.

We granted 400,000 stock options with an exercise price of $22.19 per share and an estimated fair value of approximately $13.12 per share in 2005. No stock options were granted in 2004. For disclosure purposes, we estimated the fair value of each stock option grant on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 2005: dividend yield of one percent; expected volatility of 55 percent; risk-free interest rate of 4.1 percent and expected life of 8 years.

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During the first quarter of 2005, we granted 1,272,000 stock units and 811,000 performance units, both with a grant date fair value of approximately $22.19 per share. Stock units and performance units settle for shares of our common stock on a one-for-one basis. The stock units vest annually in a straight-line manner over four years. The performance units vest in full at the end of a three-year period, and are payable from 0% to 150% of the target amount based on the extent that pre-determined performance measures are achieved. In accordance with APB Opinion 25, compensation expense for the stock units is measured at the fair value of the underlying stock at the date of grant, and compensation expense associated with performance units is subject to adjustment for changes in the underlying stock price over the vesting period, as well as changes in estimates relating to whether the performance objectives will be achieved. Compensation expense for both stock units and performance units is amortized over the respective vesting periods. Consolidated compensation expense related to stock units and performance units was approximately $3 million for both the three and six months ended June 30, 2004 and $6 million and $11 million for the three and six months ended June 30, 2005, respectively.

We also provide supplemental retirement benefits to eligible senior officers in the form of stock units that settle for shares of our common stock on a one-for-one basis. The compensation expense associated with the benefits is expensed over the four-year vesting period. The pre-tax expense under these plans totaled approximately $1 million and $3 million for the three and six months ended June 30, 2004. The expense for the three and six months ended June 30, 2005 was less than $1 million.

Had the expense for all forms of our stock-based compensation been determined using the fair value based method defined in Financial Accounting Standard (FAS) 123, “Accounting for Stock-Based Compensation,” our net income and net income per share would have been reduced to the pro forma amounts indicated below. These pro forma results may not be indicative of the future results for the full fiscal year due to potential grants, vesting and other factors:

		Three months ended June 30,									Six months ended June 30,
		2004					2005				2004				2005
		(in millions, except per share amounts)
Net income:
As reported			$	75				202				112				266
Add back: Compensation expense included in reported net income, net of tax			3					4				4				7
Deduct: Fair-value compensation expense for all awards, net of tax			(6		)			(6	)			(10	)			(12	)
As adjusted			$	72				200				106				261
Basic earnings per share:
As reported			$	.20				.53				.29				.69
As adjusted			$	.19				.52				.28				.68
Diluted earnings per share:
As reported			$	.19				.49				.28				.65
As adjusted			$	.18				.49				.27				.64

 

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Note 4:   Comprehensive Income

		Three months ended June 30,									Six months ended June 30,
		2004					2005				2004					2005
		(in millions)									(in millions)
Net income			$	75				202				$	112				266
Change in unrealized gains and losses, net of tax			2					2				—					—
Cash flow hedge adjustment, net of tax			2					—				5					1
Cumulative translation adjustment, net of tax			—					(1	)			—					(1	)
Comprehensive income			$	79				203				$	117				266

 

Note 5:   Synthetic Fuel Investment

In August 2004, we acquired a 24 percent minority interest in a coal-based synthetic fuel facility for approximately $32 million. Our investment is accounted for using the equity method as we lack a controlling financial interest. The facility produced operating losses, our proportionate share of which totaled approximately $4 million and $9 million for the three and six months ended June 30, 2005, respectively. These losses are reflected in loss from non-operating affiliates in the accompanying consolidated statements of income.

The synthetic fuel produced at this facility qualifies for tax credits (based on Section 29 of the Internal Revenue Code) which reduce our provision for income taxes. The Section 29 credits are expected to be available for fuel produced at the facility through 2007. The tax credits, combined with the tax benefit associated with the operating losses, totaled approximately $6 million and $12 million for the three and six months ended June 30, 2005. As a result, the net benefit to our net income from the investment was approximately $2 million and $3 million for the three and six months ended June 30, 2005, respectively.

In the second quarter of 2005, we were informed that the IRS has issued a notice of proposed adjustment challenging the placed-in-service date of the facility. One of the conditions to qualify for the Section 29 credits is that the facility must have been placed in service before July 1, 1998. We believe that the facility meets the placed-in-service requirement and that this issue will be resolved in favor of the synthetic fuel joint venture partners. The joint venture is examining various procedural alternatives for pursuing this issue to resolution.

Note 6:   Derivative Instruments and Hedging Activities

We have an outstanding swap agreement which qualifies for hedge accounting as a cash flow hedge of a foreign currency denominated liability. The gain or loss on the change in the fair value of the derivative is included in earnings to the extent it offsets the earnings impact of changes in the fair value of the hedged obligation. Any difference is deferred in accumulated other comprehensive income, a component of stockholders’ equity.

We have an interest rate swap on certain fixed rate senior notes which qualifies as a fair value hedge. This derivative impacts earnings to the extent of increasing or decreasing actual interest expense on the hedged notes to simulate a floating interest rate. Changes in the fair value of the derivative are offset by an adjustment to the value of the hedged notes.

We assess on a quarterly basis the effectiveness of our hedges in offsetting the variability in the cash flow or fair value of the hedged obligations. There were no amounts recognized or reclassified into earnings for the three and six months ended June 30, 2004 or 2005 due to hedge ineffectiveness or due to excluding from the assessment of effectiveness any component of the derivatives.

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Concurrent with our investment in a synthetic fuel facility in August 2004, we entered into a derivative contract covering 2.5 million barrels of oil, which is effective for the calendar year ending December 31, 2005. The derivative contract involves two call options that provide for net cash settlement at expiration based on the full year 2005 average trading price of oil in relation to the strike price of each option. If the average price of oil in 2005 is less than $55 per barrel, the derivative will yield no payment. If the average price of oil exceeds $55 per barrel, the derivative will yield a payment equal to the excess of the average price over $55 per barrel, multiplied by the number of barrels covered, up to a maximum price per barrel of $68. The purpose of the transaction is to provide economic protection against an increase in oil prices that could limit the amount of tax credits available under Section 29 of the Internal Revenue Code. The strike prices of the two call options are intended to approximate the price ranges under which the tax credit could be reduced or eliminated by an increase in oil prices. This agreement does not qualify for hedge accounting and, as a result, changes in the fair value of the derivative agreement are reflected in earnings. Results for the three and six months ended June 30, 2005 include a pre-tax loss of $2 million and a pre-tax gain of $3 million, respectively, resulting from adjustments to the market value of this derivative contract. These amounts are included in net gain on asset dispositions and other in the accompanying consolidated statements of income.

Note 7:   New Accounting Standards

In September 2004, the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) reached a consensus regarding accounting issues related to certain features of contingently convertible debt and the effect on diluted earnings per share (EITF Issue No. 04-8, “The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share”). In November 2004, the EITF changed the transition provisions of the consensus to require that the guidance be applied to reporting periods ending after December 15, 2004. Under previous interpretations of FAS 128, “Earnings per Share,” issuers of contingently convertible debt excluded the potential common shares underlying the debt instrument from the calculation of diluted earnings per share until the contingency was met. The EITF consensus requires that potential shares underlying the debt instrument should be included in diluted earnings per share computations (if dilutive) regardless of whether the contingency has been met.

Our consolidated debt balance includes $575 million of contingently convertible debt, which was issued in the second quarter of 2003. As required, the consensus has been retroactively applied to all periods during which the instrument was outstanding. Our calculation of diluted earnings per share for the three and six month periods ended June 30, 2004 and 2005 reflects the impact of the required implementation of EITF 04-8, which resulted in a reduction of previously reported diluted EPS for the six months ended June 30, 2004 from $.29 per share to $.28 per share. There was no impact to the amount previously reported for the three months ended June 30, 2004.

In December 2004, the FASB issued FAS 123R, “Share-Based Payment,” which eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally requires that such transactions be accounted for using a fair-value-based method. Pro forma disclosure is no longer an alternative. FAS 123R also requires that the tax benefit associated with these share-based payments be classified as financing activities in the statement of cash flow rather than operating activities as currently permitted. In April 2005, the Securities and Exchange Commission adopted a rule that delayed the compliance dates for adoption of FAS 123R, which we had previously been required to adopt no later than July 1, 2005. The SEC’s rule allows companies to implement FAS 123R at the beginning of their next fiscal year. As a result, we intend to adopt FAS 123R effective January 1, 2006.

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As permitted by FAS 123, we currently account for share-based payments to employees using APB Opinion 25’s intrinsic value method and, as such, generally recognize no compensation expense for employee stock options. The adoption of FAS 123R will result in increased compensation expense in our reported results. Had we adopted FAS 123R in prior periods, the impact of the standard would have approximated the impact of FAS 123 as described in the disclosure of pro forma net income and earnings per share in Note 3.

In December 2004, the FASB issued FAS 152, “Accounting for Real Estate Time-Sharing Transactions.”  FAS 152 amends existing accounting guidance to reference the financial accounting and reporting guidance for real estate time-sharing transactions provided in AICPA Statement of Position 04-02, “Accounting for Real Estate Time-Sharing Transactions.”  FAS 152 will be effective for our financial statements issued after January 1, 2006. The new accounting guidance requires, among other things, that costs incurred to sell timeshare units generally be charged to expense as incurred, including marketing expenses. This is consistent with our existing accounting treatment and is not expected to impact our reported results. The new standard will also require a change in the classification of certain items currently reported as expenses, requiring these items to be reflected as reductions of revenue. The impact to reported revenue is not expected to be significant and timeshare operating income will not be affected.

FAS 152 will also impact the timing of expense recognition when pre-sales of projects under construction occur and we use the percentage of completion method of accounting. We are currently allowed to defer sales and marketing expenses in the same proportion as the deferred revenue during construction. FAS 152 allows only the deferral of “direct” sales and marketing expenses. This will result in earlier recognition of sales and marketing expenses during the construction period, but will not impact the total sales and marketing expenses recognized. The impact of this change is dependent on the timing and duration of construction and the extent of pre-sales; however, it is not expected to affect reported results in 2006.

Note 8:   Variable Interest Entities

We manage two hotels in which we have variable interests, as defined in FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46R), due to the terms of performance guarantees. The performance guarantee associated with one of the hotel management agreements does not expose us to the majority of expected cash flow variability; therefore, we are not the primary beneficiary and this hotel is not consolidated. Our maximum exposure to loss on this contract consists of future management fees and our potential obligation to fund the performance guarantee which, as of June 30, 2005, totaled approximately $40 million through 2012.

The second of the two contracts contains provisions that expose us to the majority of expected cash flow variability. As a result, we are considered to be the primary beneficiary under FIN 46R, and are required to consolidate the balance sheet and results of operations of the hotel. Our consolidated balance sheets at both December 31, 2004 and June 30, 2005 include the assets and liabilities of this non-controlled hotel, including approximately $10 million of cash and equivalents (reflected as restricted cash) and $100 million of debt which is non-recourse to us. The debt is secured by the fixed assets of the hotel with a historical cost of approximately $85 million. The net equity of the hotel is a retained deficit of approximately $60 million as of both dates and is reflected on our consolidated balance sheets in other assets. The revenue and operating expenses of this property are included in other revenue and expenses from managed and franchised properties in the consolidated statements of income. Our financial exposure to this property consists of the fees we earn under the management agreement and costs we may incur under the performance guarantee. The net effect of the other earnings of this property, which belongs to the hotel owners, is eliminated from our consolidated results through minority and non-controlled interests expense in the consolidated statements of income.

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In the second quarter of 2005, we completed two transactions whereby we will acquire land on Hawaii’s Big Island. In April 2005, we completed a transaction whereby we will acquire the fee interest in 62 acres of land on which the Hilton Waikoloa Village is located. The purchase price for this transaction is approximately $115 million. We had previously leased the land pursuant to an agreement expiring in 2061. In May 2005, we completed a transaction whereby we will acquire 112 acres of undeveloped land for approximately $65 million. This land is adjacent to one of two championship golf courses located within the Waikoloa Beach Resort. We are likely to utilize this land for future timeshare development, however specific plans are still being determined.

Both land acquisitions are expected to be effectuated through a reverse Internal Revenue Code Section 1031 tax-deferred exchange with one or more of the owned assets sold or expected to be sold during the second and third quarters of 2005 (see Note 10). As such, the acquisitions were completed through an exchange facilitator that retains legal title to the land until the exchange is completed or unwound. The cash to complete the acquisitions by the exchange facilitator was funded entirely by Hilton. The entities that hold title to the land qualify as variable interest entities of which Hilton is the primary beneficiary. As a result, the land acquired pursuant to these arrangements is reflected in our consolidated balance sheet as of June 30, 2005.

Note 9:   Segment Information

Our operations consist of three reportable segments which are based on similar products or services: Hotel Ownership, Managing and Franchising, and Timeshare. Segment results are presented net of consolidating eliminations for fee-based services, which is the basis used by management to evaluate segment performance. Managing and Franchising revenue includes reimbursements from managed properties and franchisees for certain costs incurred on their behalf, which are included in other revenue from managed and franchised properties in the consolidated statements of income. Segment results are as follows:

		Three months ended									Six months ended
		June 30,									June 30,
		2004					2005				2004				2005
		(in millions)									(in millions)
Revenue
Hotel Ownership			$	584				618				1,103				1,149
Managing and Franchising			383					422				749				821
Timeshare			98					136				207				282
			$	1,065				1,176				2,059				2,252
Operating income:
Hotel Ownership			$	122				145				190				221
Managing and Franchising			86					108				166				203
Timeshare			26					38				52				78
Corporate and other unallocated expenses			(46		)			(45	)			(89	)			(93	)
Total operating income			188					246				319				409
Interest and dividend income			7					4				17				8
Interest expense			(72		)			(66	)			(142	)			(130	)
Net interest from unconsolidated affiliates and non-controlled interests			(8		)			(7	)			(14	)			(13	)
Net gain (loss) on asset dispositions and other			3					61				(1	)			72
Loss from non-operating affiliates			—					(4	)			—				(9	)
Income before taxes and minority and non-controlled interests			118					234				179				337
Provision for income taxes			(40		)			(25	)			(61	)			(61	)
Minority and non-controlled interests, net			(3		)			(7	)			(6	)			(10	)
Net Income			$	75				202				112				266

 

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Note 10:   Asset Dispositions

In the 2005 first quarter, we sold the Hilton Tarrytown in New York for total cash consideration of approximately $9 million. The sale resulted in a pre-tax gain of approximately $5 million. After the sale, the hotel was converted to a Doubletree under a long-term franchise agreement.

In April 2005, we completed the sale of the Red Lion Austin in Texas for cash consideration of approximately $6 million. As the purchase price approximated our carrying value, no gain or loss was recorded on the sale. In May 2005, we completed the sale of two Homewood Suites by Hilton properties for total cash consideration of approximately $17 million, resulting in a pre-tax loss of approximately $1 million. We will continue to manage both hotels under long-term management agreements.

In June 2005, we completed the sale of seven wholly-owned and one majority-owned hotel. The Hilton Suites Phoenix in Arizona, Hilton Suites Anaheim in California and Embassy Suites Cleveland-Beachwood in Ohio were sold for cash consideration totaling approximately $72 million, resulting in a pre-tax gain totaling approximately $16 million. Each of the hotels will continue to operate under long-term franchise agreements. In addition, we will continue to manage the Hilton Suites Phoenix under a long-term management agreement. A pre-tax gain totaling approximately $13 million on the Hilton Suites Phoenix has been deferred, due to our continuing involvement in management of the hotel, and will be recognized over the life of the five-year management contract retained on this property. These three properties were sold to the RLJ Urban Lodging Fund, a hotel investment fund created by RLJ Development, LLC (RLJ). Robert L. Johnson, a director of the Company, is the Chairman and Chief Executive Officer of RLJ. In addition, we have a limited partnership interest in the RLJ Urban Lodging Fund totaling approximately $4 million at June 30, 2005, which is accounted for as a cost basis investment.

The Doubletree Bellevue in Washington was sold for approximately $49 million in cash, resulting in a pre-tax loss of approximately $13 million. The Hilton Suites Brentwood in Tennessee was sold for approximately $6 million in cash, resulting in a pre-tax loss of approximately $5 million. The Hilton Alexandria in Virginia was sold for cash totaling approximately $93 million, resulting in a pre-tax gain of approximately $37 million, and the Hilton Charlotte in North Carolina was sold for cash totaling approximately $56 million, resulting in a pre-tax gain of approximately $5 million. The sale of the Hilton Charlotte resulted in a reduction in our consolidated goodwill balance of approximately $3 million. We have retained long-term franchise agreements on each of the aforementioned properties.

Also in June 2005, we sold the majority-owned Hilton Glendale in California for cash consideration totaling approximately $80 million, resulting in a pre-tax gain of approximately $30 million. Amounts attributable to the minority partner, totaling approximately $7 million on a pre-tax basis, are reflected in the consolidated statements of income, net of tax, in minority and non-controlled interests, net. We have retained a long-term franchise agreement on the hotel. In addition, we will manage the hotel on a short-term basis during a transition period; therefore the gain has not been deferred.

In addition to the sales of wholly-owned and majority-owned hotels, we sold our minority or non-controlling interests in five joint venture hotel properties in the second quarter. Proceeds totaled approximately $26 million, resulting in a pre-tax gain of approximately $6 million.

The $61 million net gain on asset dispositions and other in our consolidated statement of income for the 2005 second quarter also includes a $2 million unrealized loss on our oil futures derivative (see Note 6) based on the market value of the contract at June 30, 2005 and a net gain of $1 million on the sale of other assets. The asset dispositions in the second quarter of 2005 generated capital gains for tax purposes which enabled us to utilize capital loss tax carryforwards that had been fully reserved. The utilization of these capital loss carryforwards resulted in a net benefit to our income tax provision of approximately $34 million in the 2005 second quarter.

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In January 2005, we engaged Eastdil Realty Company, LLC to act as our real estate investment banker for the sale of certain of our owned hotels. Fees earned by Eastdil related to owned hotels sold in the second quarter of 2005 totaled approximately $2 million. Benjamin V. Lambert, a director of the Company, is the Chairman and Chief Executive Officer of Eastdil.

The $1 million loss on asset dispositions in the first half of 2004 is primarily due to a $4 million loss related to the write-off of values assigned to certain long-term management and franchise agreements that were terminated in the period, net of a $3 million gain from the sale of our investment in Travelweb.

In the 2004 first quarter, we sold the Doubletree La Posada Resort - Scottsdale in Arizona for total consideration of approximately $30 million, including approximately $6 million in cash and a note receivable for approximately $24 million. The note receivable was repaid in the first quarter of 2005. No book gain or loss was realized on the sale; however, the transaction generated a capital gain for tax purposes, which enabled us to utilize existing capital loss tax carryforwards that had been fully reserved in prior periods. The transaction resulted in a net benefit to our income tax provision of approximately $2 million.

In the second quarter of 2004, we sold the Doubletree Modesto and Doubletree Bakersfield, both in California. Total consideration from the sale of both hotels was approximately $40 million in cash. Gains of approximately $3 million on Modesto and approximately $2 million on Bakersfield were deferred and, due to our continuing involvement with each hotel, will be recognized over the life of the long-term management agreement retained on each hotel. Both management agreements are for a term of ten years. The transaction also generated a capital gain for tax purposes, which enabled us to utilize existing capital loss tax carryforwards that had been fully reserved in prior periods. The transaction resulted in a net benefit to our income tax provision of approximately $4 million.

We consider properties to be held for sale when management approves and commits to a formal plan to actively market a property for sale, executes a formal sales contract, allows the buyer to complete its due diligence review, and receives a non-refundable deposit. Unless 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.

Upon designating a property as an asset held for sale, we review the carrying value of the property and, as appropriate, adjust its value to the lower of its carrying value or its estimated fair value less estimated cost to sell, and we stop recording depreciation expense. In June 2005, the Palmer House Hilton met these criteria and is classified as held for sale within property and equipment, net in our June 30, 2005 consolidated balance sheet. Since the contracted purchase price, less cost to sell, exceeds the carrying value of this property, no adjustment to the carrying value was required.

The sale of the Palmer House Hilton is expected to be completed in the third quarter of 2005. We anticipate that this sale will be effectuated through a reverse Internal Revenue Code Section 1031 tax-deferred exchange with the two land acquisitions completed in the second quarter of 2005 on Hawaii’s Big Island (see Note 8). As such, the sale will be completed through an exchange facilitator that will receive and hold the cash proceeds for our benefit until the exchange is completed or unwound. In addition to the anticipated sale of the Palmer House, certain of the owned hotel sales closed in the second quarter of 2005 were also completed through an exchange facilitator in order to serve as potential substitutes to the Palmer House in completing the exchange with the land acquired in Hawaii or to facilitate a separate exchange pursuant to which other property is acquired. As a result, approximately $267 million of sale proceeds from asset sales completed in the second quarter of 2005 are held for our benefit by the exchange facilitator at June 30, 2005. This cash is reflected as restricted cash in our June 30, 2005 consolidated balance sheet. We anticipate that all exchange activity will be completed or unwound during the third and fourth quarters of 2005. At such time, the cash will be used to acquire other property or will become unrestricted.

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To the extent we realize a gain 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 earnings over the term of the contract. Results in the three months ended June 30, 2004 and 2005 include the recognition of pre-tax deferred gains totaling $4 million in each period, and results in the six months ended June 30, 2004 and 2005 include the recognition of pre-tax deferred gains totaling $8 million in each period.

Note 11:   Impairment Loss and Related Costs

Results in the 2005 second quarter include pre-tax impairment loss and related costs totaling $5 million. This charge reduced the value of an owned hotel and our minority interest in eight joint venture hotels to their estimated fair values. The hotel and joint venture interest were sold in July 2005 (see Note 17). The charge for the six months ended June 30, 2005 also includes a $2 million pre-tax charge in the first quarter, representing the write down of a non-hotel cost basis investment to its estimated fair value.

Note 12:   Stock Repurchases

In the second quarter of 2005, we repurchased approximately 5.1 million shares of our common stock at a total cost of approximately $113 million. In the first half of 2005, we repurchased a total of 12.3 million shares at a total cost of approximately $271 million. No shares were repurchased in the 2004 first half. The timing of stock purchases is at the discretion of management. In March 2005, we announced that our Board of Directors authorized the repurchase of up to an additional 50 million shares of common stock. As of June 30, 2005, approximately 44.7 million shares remained authorized for repurchase under this authority.

Note 13:   Guarantees

We have established franchise financing programs with third party lenders to support the growth of our Hilton Garden Inn, Homewood Suites by Hilton, Hampton and Embassy Suites brands. As of June 30, 2005, we have provided guarantees of $33 million on loans outstanding under the programs. In addition, we have guaranteed $36 million of debt and other obligations of unconsolidated affiliates and third parties, bringing our total guarantees to $69 million. Our outstanding guarantees have remaining terms of one to seven years. We also have commitments under letters of credit totaling $56 million as of June 30, 2005. We believe it is unlikely that material payments will be required under our outstanding guarantees or letters of credit.

In addition, we remain a guarantor on 12 operating leases sold to WestCoast Hospitality Corporation as part of the sale of the Red Lion hotel chain in 2001. However, we have entered into an indemnification and reimbursement agreement with WestCoast, which requires WestCoast to reimburse us for any costs and expenses incurred in connection with the guarantee. The minimum lease commitment under these 12 operating leases totals approximately $5 million annually through 2020.

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We have also provided performance guarantees to certain owners of hotels which 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 June 30, 2005, we have two contracts containing performance guarantees with possible cash outlays totaling approximately $173 million through 2012. Funding under these performance guarantees totaled approximately $4 million in 2004, and is expected to total approximately $4 million in 2005. Funding under these guarantees in future periods is dependent on the operating performance levels of these hotels over the remaining term of the performance guarantee. 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 2005 pursuant to these guarantees.

Our consolidated financial statements at June 30, 2005 include liabilities of approximately $3 million for potential obligations under our outstanding guarantees.

Note 14:   Employee Benefit Plans

We have a noncontributory retirement plan (Basic Plan) which covers many of our non-union employees. Benefits are based upon years of service and compensation, as defined. Since December 31, 1996, employees have not accrued additional benefits under the Basic Plan. We do not expect to make any material contributions to the Basic Plan in 2005. Our net periodic benefit cost for the three and six months ended June 30, 2004 and 2005 consisted of the following:

		Three months ended									Six months ended
		June 30,									June 30,
		2004					2005				2004				2005
		(in millions)									(in millions)
Expected return on plan assets			$	5				4				10				9
Interest cost			(4		)			(4	)			(8	)			(8	)
Amortization of prior service cost			—					—				(1	)			(1	)
Net periodic benefit cost			$	1				—				1				—

 

Note 15:   Provision for Income Taxes

In addition to the synthetic fuel tax credits (see Note 5) and the utilization of capital loss tax carryforwards (see Note 10), our provision for income taxes in the second quarter of 2005 reflects a net benefit of $28 million from the reversal of tax reserves no longer required as the result of the completion of IRS audits of our 1997 through 2001 Federal income tax returns, partially offset by increases in state tax reserves and deferred tax liabilities principally attributable to statutory tax increases in various jurisdictions.

In accordance with the provisions of FAS 109, the reversal of reserve balances arising from the completion of the IRS audits that relate to our acquisition of Promus Hotel Corporation in 1999 were reflected as an adjustment of goodwill and did not impact our tax provision in the second quarter. These adjustments resulted in a reduction of goodwill totaling $13 million.

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Note 16:   Reclassifications

Our consolidated statement of cash flow for the six months ended June 30, 2004 has been reclassified to present the net change in timeshare notes receivable in cash provided by operating activities. We previously reflected the issuance of timeshare notes and the related payments received within investing activities. This reclassification resulted in a decrease in net cash provided by operating activities totaling $50 million in the 2004 first half, with a corresponding reduction in net cash used in investing activities. The reclassification has no impact on our previously reported consolidated statement of income or consolidated balance sheet.

Note 17:   Subsequent Events

In July 2005, we sold the Hilton East Brunswick for cash consideration totaling approximately $43 million. Results in the quarter ended June 30, 2005 include an impairment charge of $2 million to reduce this asset to its fair market value. We will manage the hotel on a short-term basis and have retained a long-term franchise agreement. Also in July 2005, we sold our minority interest in eight joint venture hotels. Proceeds totaled approximately $2 million. Results for the quarter ended June 30, 2005 include an impairment charge of $3 million to reduce the joint venture investment to its fair market value.

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ITEM 2.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company

We are engaged in the ownership, management and development of hotels, resorts and timeshare properties and the franchising of lodging properties. At June 30, 2005, our system contained 2,311 properties with approximately 364,000 rooms. Our brands include Hilton, Hilton Garden Inn, Doubletree, Embassy Suites, Hampton, Homewood Suites by Hilton and Conrad. 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 June 30, 2005 by brand and by type are as follows:

Brand				Properties				Rooms		Type			Properties				Rooms
Hilton					237			90,668		Owned(1)				38			27,733
Hilton Garden Inn					232			31,639		Leased				6			2,245
Doubletree					153			39,995		Joint Venture				60			18,860
Embassy Suites					178			43,402						104			48,838
Homewood Suites by Hilton					155			17,309		Managed				210			50,666
Hampton					1,305			131,517		Franchised				1,965			261,024
Other					19			5,998						2,175			311,690
Timeshare					32			3,846		Timeshare				32			3,846
Total					2,311			364,374		Total				2,311			364,374

⁽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. The Timeshare segment consists of multi-unit timeshare resorts. This segment sells and finances timeshare intervals and operates timeshare resorts. 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.

Our results are significantly affected by occupancy and room rates achieved by hotels, our ability to manage costs, the relative mix of owned, leased, managed and franchised hotels, the quantity and pricing of timeshare interval sales and the change 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 “Forward-Looking Statements” for a detailed description of these and other conditions that could adversely affect our results of operations.

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We anticipate that a favorable economic environment will continue to benefit the lodging industry and our company during the remainder of 2005. 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 continued growth in our management and franchise fee business as the number of hotels in our system continues to increase, as well as a strong year from our timeshare business. Challenges are expected to include continued short reservation lead times for our group business and increasing costs. Increases in energy costs combined with higher property taxes are expected to put pressure on margins. Our results could also be impacted by potential labor disputes involving the hotel industry. 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 core strategies, combined with our financial strength, diverse market presence, strong brands and strategically located properties will enable us to remain competitive.

Critical Accounting Policies and Estimates

In our Annual Report on Form 10-K for the year ended December 31, 2004, we identified the critical accounting policies which affect our more significant estimates and assumptions used in preparing our consolidated financial statements. Those policies include accounting for notes receivable, long-lived assets, intangible assets, self-insurance reserves and commitments. We have not changed these policies from those previously disclosed in our annual report.

Development and Capital Spending

Overview

We intend to grow our hotel system primarily through franchising and the addition of management contracts, which require little or no capital investment. 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.

During the first six months of 2005, we added a total of 72 properties, primarily franchises, with approximately 10,500 rooms to our system. A total of 20 properties, primarily franchises, with approximately 4,500 rooms were removed from our system during the same period, including the 1,338-room Hilton Fontainebleau in Miami, Florida. We expect to add 160 to 170 hotels and 21,000 to 24,000 rooms to our system in 2005, with Hampton and Hilton Garden Inn accounting for most of the new development. We expect virtually all of this growth to be through franchise and management agreements.

In July, it was announced that Hampton Inn, Hilton Garden Inn (for the fourth straight year) and Homewood Suites by Hilton (for the third straight year) each earned first place rankings for customer satisfaction in their respective categories from J.D. Power and Associates. Hilton was the only hotel company with three top rankings. In addition, the Hilton, Doubletree and Embassy Suites brands all improved their respective customer satisfaction scores in the 2005 J.D. Power study.

We believe the continued strong performance of our brands has enabled us to significantly enhance our development pipeline versus our industry competitors. We had approximately 520 hotels, primarily franchises, with 64,000 rooms in our development pipeline at June 30, 2005. The consummation of transactions in our development pipeline is subject to various conditions and uncertainties.

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Our ability to grow the number of hotels in our system is affected by the factors referenced under “Forward-Looking Statements,” such as national and regional economic conditions; the effects of actual and threatened terrorist attacks and international conflicts; credit availability; relationships with franchisees and property owners; and competition from other hotel brands.

In total, we anticipate spending approximately $615 million on capital expenditures in 2005, which includes $125 million for routine improvements, $210 million on timeshare projects, $100 million in hotel renovation, ROI and special projects and $180 million related to land acquisitions on Hawaii’s Big Island. Routine improvements include expenditures for equipment, hotel fixtures and wall and floor coverings. Expenditures required to complete our capital spending programs will be financed through available cash flow from operations and general corporate borrowings. 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”). 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 hotels. As discussed in Note 10 to the consolidated financial statements, until 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 maintaining our brand.

Hotel Ownership

Capital expenditures during the first six months of 2005 totaled $255 million. Excluding the $180 million to purchase land on Hawaii’s Big Island, as discussed in Note 8 to the consolidated financial statements, our capital expenditures were $75 million, consisting primarily of routine improvements at our owned hotels. We continue to place a priority on making appropriate capital expenditures to maintain and upgrade our owned assets.

Managing and Franchising

Total property additions in the first six months of 2005 included 66 franchised properties and five managed properties. These additions included 12 properties which, due in part to the market share leadership of our brands, were converted to our family of brands in the period. The 12 conversions included six Doubletrees, five Hiltons and one Homewood Suites by Hilton.

While unit growth for the full-year 2005 is expected to be driven primarily by Hampton Inn and Hilton Garden Inn, we are seeing strong growth in our full-service Hilton and Doubletree brands as well. The Doubletree and Hilton brands expect to add approximately 10 to 15 hotels each to our system in 2005.

In the first quarter of 2005, we announced a major initiative with Hilton International Co. to actively develop the luxury Conrad brand on a global basis. The growth of the Conrad brand will continue to be primarily through management agreements, including a new Conrad hotel on the Las Vegas Strip (scheduled 2007 opening) and a new Conrad hotel in downtown Indianapolis (scheduled 2006 opening).

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Timeshare

We are currently developing new timeshare projects in Las Vegas and Orlando as well as in Waikoloa on the Big Island of Hawaii. The Waikoloa project will have 120 units and is scheduled for completion in early 2006. At our International Drive property in Orlando (Tuscany Village), the project has 166 units open, representing the first three phases. Construction is continuing on the next 140 units, with 70 units scheduled to open in the third quarter of 2005 and 70 units scheduled for spring 2006. Also in Orlando, we are adding 48 units to our existing property adjacent to Sea World. The second phase of our property on the Las Vegas Strip, which consists of 431 units, is on schedule for completion in summer 2006. Upon the opening of phase two, approximately half of the planned four-tower, 1,577-unit project will have been completed.

Capital expenditures associated with our timeshare operations during the first six months of 2005 totaled $67 million. Timeshare capital expenditures are expected to total approximately $210 million this year, as we continue to invest in the development of new product in Las Vegas, Orlando and Hawaii. 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 the first six months of 2005, we issued approximately $143 million of loans related to timeshare financings. Principal collections on timeshare notes during the first six months were approximately $94 million.

Liquidity and Capital Resources

Overview

Net cash provided by operating activities was $311 million and $338 million for the six months ended June 30, 2004 and 2005, respectively. The increase is primarily due to improved operating results, partially offset by an increase in accounts receivable attributable to improved results at our owned hotels and increased fee revenue. The net increase is also mitigated by an increase in net cash used in timeshare construction in excess of timeshare sales compared to the 2004 period.

Net cash used in investing activities was $10 million and $144 million for the six months ended June 30, 2004 and 2005, respectively. The increase is the result of higher capital expenditures, partially offset by an increase in net unrestricted proceeds from asset dispositions. Net cash used in financing activities was $141 million for the first six months of 2004 and $230 million for the first six months of 2005. The net change between periods is primarily due to share repurchases, partially offset by a lower level of debt repayments in the 2005 period. All amounts outstanding under our revolving line of credit were repaid in the second quarter of 2004.

Cash and equivalents decreased $36 million from $303 million at December 31, 2004 to $267 million at June 30, 2005. Restricted cash totaled $163 million at December 31, 2004 and $424 million at June 30, 2005, respectively. Restricted cash includes cash proceeds from asset dispositions that remain restricted, 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 a consolidated non-controlled entity. The increase in restricted cash primarily relates to proceeds from asset dispositions that remained restricted at the end of the reporting period (see Note 10 to the consolidated financial statements).

We believe that our operating cash flow, available borrowings under our revolving credit facility and our ability to obtain additional financing through various financial markets are sufficient to meet our liquidity needs (see “Liquidity and Capital Resources—Financing”). Any projections of future financial needs and sources of working capital are subject to uncertainty. See “Results of Operations” and “Other Matters -Forward-Looking Statements” for further discussion of conditions that could adversely affect our estimates of future financial needs and sources of working capital.

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Financing

We have a $1 billion revolving credit facility, with an option to increase the size of the facility by an additional $250 million. This facility was amended in the first quarter of 2005. The amendment lowered our all-in cost of borrowing under this facility by 50 basis points from LIBOR plus 125 basis points to LIBOR plus 75 basis points and extended the facility until March 2010. There were no amounts outstanding under the revolving credit facility at June 30, 2005. The capacity under our revolver is also used to support certain outstanding letters of credit. Total revolving debt capacity of approximately $860 million was available to us at June 30, 2005.

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 June 30, 2005, 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.

As of June 30, 2005, approximately 13% of our long-term debt, including the impact of interest rate swaps, was floating rate debt.

The following table summarizes our significant contractual obligations as of June 30, 2005, including long-term debt and operating lease commitments:

							Payments Due by Period
							Less than 1				1 - 3		4 - 5		After 5
Contractual Obligations				Total			year				years		years		years
				(in millions)
Long-term debt				$	3,610			14			862		417		2,317
Operating leases				493				34			62		54		343
Total contractual obligations				$	4,103			48			924		471		2,660

 

Long-term debt decreased by $37 million from December 31, 2004 to $3.61 billion at June 30, 2005, primarily as a result of the repayment of the mortgage on a hotel sold during the period. Operating lease commitments decreased by $216 million from December 31, 2004 to $493 million at June 30, 2005, primarily due to the purchase of land on which the Hilton Waikoloa Village is located (see Note 8 to the consolidated financial statements). We had previously leased this land pursuant to an agreement expiring in 2061. Our consolidated balance sheets as of December 31, 2004 and June 30, 2005 include the assets and liabilities of a non-controlled managed hotel, including $100 million of debt that is non-recourse to us. This amount is reflected on our consolidated balance sheets as non-recourse debt of non-controlled entity and is excluded from the contractual obligations table.

Development Financing and Other Commercial Commitments

To assist prospective franchisees in obtaining financing for hotel projects, we have programs to provide alternative capital sources to qualified franchisees. We have provided secondary financing to franchisees under a mezzanine financing program. Loans outstanding under this program at June 30, 2005 totaled approximately $32 million.

We have established franchise financing programs with third party lenders to support the growth of our Hilton Garden Inn, Homewood Suites by Hilton, Hampton and Embassy Suites brands. As of June 30, 2005 we have provided guarantees of $33 million on loans outstanding under the programs.

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As of June 30, 2005, in addition to the guarantees issued in connection with our development financing programs, we have guaranteed $36 million of debt and other obligations of unconsolidated affiliates and third parties, bringing our total guarantees to approximately $69 million. We also have commitments under letters of credit totaling $56 million as of June 30, 2005. We believe it is unlikely that material payments will be required under our outstanding guarantees or letters of credit.

The following table summarizes our development financing and other commercial commitments as of June 30, 2005:

									Amount of Commitment
				Total					Expiration per Period
				Amounts					Less than 1				1 - 3				4 - 5				After 5
Commercial Commitments				Committed					year				years				years				years
				(in millions)
Letters of credit					$	56				56				—				—				—
Guarantees					69					21				44				2				2
Total commercial commitments					$	125				77				44				2				2

 

In addition, we remain a guarantor on 12 operating leases sold to WestCoast Hospitality Corporation as part of the sale of the Red Lion hotel chain in 2001. However, we have entered into an indemnification and reimbursement agreement with WestCoast, which requires WestCoast to reimburse us for any costs and expenses incurred in connection with the guarantee. The minimum lease commitment under these 12 operating leases totals approximately $5 million annually through 2020.

We have also provided performance guarantees to certain owners of hotels which 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 June 30, 2005, we have two contracts containing performance guarantees with possible cash outlays totaling approximately $173 million through 2012. Funding under these performance guarantees totaled approximately $4 million in 2004, and is expected to total approximately $4 million in 2005. Funding under these guarantees in future periods is dependent on the operating performance levels of these hotels over the remaining term of the performance guarantee. 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 2005 pursuant to these guarantees.

Acquisitions and Dispositions

In the second quarter of 2005, we completed two transactions whereby we will acquire land on Hawaii’s Big Island for $180 million in cash consideration, as discussed in Note 8 to the consolidated financial statements. During the first of half of 2005 we sold 12 owned or majority-owned hotels, as well as our minority interests in several hotel joint ventures. See Note 10 to the consolidated financial statements for further discussion of these transactions.

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