**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

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**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, 2005** |
| **OR**                                                |
| **o**                                                 | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Forthe transition period from                           to                           **

**Commission File Number 1-3427**

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**HILTON HOTELS CORPORATION**

(Exact Name of Registrant asSpecified 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 telephonenumber, including area code:   **(310) 278-4321**

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

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

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

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of Registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K.   Yes o  No x

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer and largeaccelerated 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 markwhether the registrant is a shell company (as defined in Rule 12b-2of the Act).   Yes o  No x

Based upon the June 30,2005, New York Stock Exchange closing price of $23.85 per share, the aggregatemarket value of the Registrant’s outstanding Common Stock held bynon-affiliates of the Registrant was approximately $8.4 billion. There were380,750,582 and 383,206,609 shares of Common Stock outstanding as of June 30,2005 and February 28, 2006, respectively.

**DOCUMENTSINCORPORATED BY REFERENCE**

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

 

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**TABLE OF CONTENTS**

|                                                                                                       | ** **                                                                                                             | **Page No.** |
|-------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------|-------------------|
| **PART I**                                                                                       | 1                                                                                                                      |
| **Item 1.**                                                                                           | **Business**                                                                                                           | 1                 |
| General Information                                                                                   | 1                                                                                                                      |
| Operations                                                                                            | 2                                                                                                                      |
| Additional Information                                                                                | 11                                                                                                                     |
| **Item 1A.**                                                                                          | **Risk Factors**                                                                                                       | 17                |
| **Item 1B.**                                                                                          | **Unresolved Staff Comments**                                                                                          | 21                |
| **Item 2.**                                                                                           | **Properties**                                                                                                         | 21                |
| **Item  3.**                                                                                          | **Legal  Proceedings**                                                                                                 | 21                |
| **Item 4.**                                                                                           | **Submission of Matters to a Vote of Security Holders**                                                                | 21                |
| **PART II**                                                                                      | 22                                                                                                                     |
| **Item 5.**                                                                                           | **Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities** | 22                |
| Rights Agreement                                                                                      | 22                                                                                                                     |
| **Item  6.**                                                                                          | **Selected  Financial Data**                                                                                           | 23                |
| **Item 7.**                                                                                           | **Management’s Discussion and Analysis of Financial  Condition and Results of Operations**                        | 24                |
| Overview                                                                                              | 24                                                                                                                     |
| Critical Accounting Policies and Estimates                                                            | 25                                                                                                                     |
| Development and Capital Spending                                                                      | 27                                                                                                                     |
| Liquidity and Capital Resources                                                                       | 29                                                                                                                     |
| Off-Balance  Sheet Arrangements                                                                       | 33                                                                                                                     |
| Results of Operations—Fiscal 2005 Compared with Fiscal  2004                                     | 33                                                                                                                     |
| Results of Operations—Fiscal 2004 Compared with Fiscal  2003                                     | 37                                                                                                                     |
| Other Matters                                                                                         | 40                                                                                                                     |
| **Item 7A.**                                                                                          | **Quantitative and Qualitative Disclosures About Market  Risk**                                                        | 41                |
| **Item 8.**                                                                                           | **Financial Statements and Supplementary Data**                                                                        | 43                |
| Consolidated Statements of Income                                                                     | 43                                                                                                                     |
| Consolidated  Balance Sheets                                                                          | 44                                                                                                                     |
| Consolidated Statements of Cash Flow                                                                  | 45                                                                                                                     |
| Consolidated Statements of Stockholders’ Equity                                                  | 46                                                                                                                     |
| Notes to Consolidated Financial Statements                                                            | 47                                                                                                                     |
| Report of Independent Registered Public Accounting  Firm                                              | 76                                                                                                                     |
| Report of Independent Registered Public Accounting  Firm on Internal Control over Financial Reporting | 77                                                                                                                     |
| Supplementary Financial Information (Unaudited)                                                       | 78                                                                                                                     |
| Five Year Summary                                                                                     | 79                                                                                                                     |
| **Item 9.**                                                                                           | **Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure**                              | 80                |

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| **Item 9A.**                                                           | **Controls and Procedures**                                                                         | 80 |
|------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------|----|
| Evaluation of Disclosure Controls and Procedures                       | 80                                                                                                  |
| Management’s Report on Internal Control over Financial  Reporting | 80                                                                                                  |
| **Item  9B.**                                                          | **Other  Information**                                                                              | 81 |
| **PART III**                                                      | 81                                                                                                  |
| **Item 10.**                                                           | **Directors and Executive Officers of the Registrant**                                              | 81 |
| **Item 11.**                                                           | **Executive Compensation**                                                                          | 81 |
| **Item 12.**                                                           | **Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters** | 81 |
| Equity Compensation Plan Information                                   | 82                                                                                                  |
| **Item 13.**                                                           | **Certain Relationships and Related Transactions**                                                  | 83 |
| **Item 14.**                                                           | **Principal Accounting Fees and Services**                                                          | 83 |
| **PART IV**                                                       | 83                                                                                                  |
| **Item 15.**                                                           | **Exhibits and Financial Statement Schedules**                                                      | 83 |
| (a) Index  to Financial Statements                                | 83                                                                                                  |
| (b) Exhibits                                                      | 83                                                                                                  |
| SIGNATURES                                                             | 84                                                                                                  |
| INDEX TO EXHIBITS                                                      | 85                                                                                                  |

 

ii

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**PART I**

**Item 1.   Business**

**GENERAL INFORMATION**

**Current Operations**

Hilton Hotels Corporation is engaged, together withits subsidiaries, in the ownership, management and development of hotels,resorts and timeshare properties and the franchising of lodging properties. Asof December 31, 2005, our system contained 2,388 properties withapproximately 375,000 rooms. Of such properties, we owned an interest in andoperated 84 hotels, leased six hotels, managed 210 hotels owned by others andfranchised 2,054 hotels owned and operated by third parties. Also included inthe number of properties in our system are 34 timeshare properties which wemanaged or franchised. All of these properties are located in the UnitedStates, with the exception of 16 hotels in which we own an interest and/ormanage and 63 hotels that we franchise.

At December 31, 2005, our hotel brands includedHilton, Hilton Garden Inn, Doubletree, Embassy Suites, Homewood Suites byHilton, Hampton and Conrad. We develop and operate timeshare resorts throughHilton Grand Vacations Company and its related entities, which we wholly own.We are also engaged in various other activities related or incidental to theoperation of hotels.

Hilton was organized inthe State of Delaware on May 29, 1946. Our principal executive offices arelocated at 9336 Civic Center Drive, Beverly Hills, California 90210, and ourtelephone number is (310) 278-4321.

**Acquisitionof Hilton International**

On February 23, 2006,we consummated our previously announced acquisition of the lodging assets ofHilton Group plc (the “HI Acquisition”) operated by its subsidiary, HiltonInternational Co. (“HI”), for approximately £3.3 billion, equivalent toapproximately $5.78 billion on the transaction date, in an all-cashtransaction. As a result of the HI Acquisition, we believe we are the largest,by revenue, and most geographically diverse lodging company in the world, withnearly 2,800 hotels and approximately 475,000 rooms in 80 countries. The HIproperties that we acquired consist of 387 hotels with over 100,000 rooms, ofwhich 41 hotels are owned, 194 are leased, eight are partially owned throughjoint ventures, 115 are managed and 29 are franchised. The hotels we acquiredin the HI Acquisition consist of 253 properties operated under the Hilton brand,128 properties operated under the mid-market Scandic brand, four propertiesoperated under the Coral by Hilton resort brand, one property under the Conradbrand and one property operated under an independent brand. We also acquired 80LivingWell health clubs, primarily in Europe, and four timeshare properties. Asa result of the HI Acquisition, we now wholly own the Hilton HHonors Worldwidefrequent guest program and the Hilton Reservations Worldwide reservationsystem, both of which were previously owned equally by HI and us. We alsoobtained worldwide ownership of the luxury Conrad hotel brand, which had beenoperated as a joint venture between HI and us since 2002. As a result of the HIAcquisition, we now own all the rights to the Hilton and Conrad brands,including the right to develop these brands on a worldwide basis.

**Recent Developments**

*Hotel Properties*

·       In2005, we sold 20 wholly or majority owned properties for approximately $1.082 billion,and retained management or franchise agreements on all but one of theproperties. The properties sold in 2005 included 15 Hiltons, two HomewoodSuites by Hilton, one Doubletree, one Embassy Suites and one independent hotel.

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·       InFebruary 2006, we commenced management of the Grand Wailea Resort Hotel &Spa in Maui, Hawaii, the Arizona Biltmore Resort & Spa in Phoenix,Arizona and the La Quinta Resort & Club in La Quinta, California. Theseproperties are included in our new Waldorf=Astoria Collection of luxury hotels,along with the Waldorf=Astoria in New York, New York.

·       In 2005, 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 satisfactionin their respective categories from J.D. Power and Associates. Hilton was theonly hotel company with three brands earning top rankings. In addition, theHilton, Doubletree and Embassy Suites brands all improved their respectivecustomer satisfaction scores in the 2005 J.D. Power study.

*TimeshareProperties*

·       Weare continuing to develop a 1,582-unit timeshare resort in Las Vegas,Nevada, with phase two of this project consisting of a 38-story, 423-unittower, scheduled to open in summer 2006.

·       Wehave opened 236 units of a 456-unit timeshare resort in Orlando, Florida,with an additional 70 units scheduled to open in spring 2006.

·       We are continuing todevelop a new 120-unit timeshare resort in Waikoloa, Hawaii, 22 units ofwhich opened in 2005, with the remaining units scheduled for completion inspring 2006.

*AdditionalInformation*

For a description of ourplanned expansion activities, see “Operations—Development.” For additionalinformation, see “Development and Capital Spending” under Item 7.

**Industry Segments**

As of December 31, 2005, we operated in threereportable business segments which are based on similar products or services:Hotel Ownership; Managing and Franchising; and Timeshare. For additionalinformation, see “Note 16: Segment Information” to the consolidatedfinancial statements under Item 8.

As of December 31,2005, we managed (and in some cases, partially owned) hotel properties inBelgium, Egypt, England, Hong Kong, Indonesia, Ireland, Mexico, Puerto Rico,Singapore, Thailand and Turkey. We also franchised hotel properties in Canada,Colombia, Costa Rica, Dominican Republic, Ecuador, Mexico, Peru, Puerto Ricoand Venezuela. Through December 31, 2005, the amounts of revenue,operating profits and assets attributable to geographic areas outside theUnited States have not been material.

**OPERATIONS**

**Hotel Properties**

*Owned Hotels*

As of December 31,2005, we owned a majority or controlling financial interest in and operated30 hotels, representing 22,971 rooms. The owned hotels include our largestand most profitable hotels, including:

·       the1,416-room Waldorf=Astoria;

·       the1,980-room Hilton New York;

·       the2,860-room Hilton Hawaiian Village;

·       the1,240-room Hilton Waikoloa Village;

·       the1,908-room Hilton San Francisco;

·       the1,544-room Hilton Chicago;

·       the 1,119-room HiltonWashington; and

·       the1,572-room Hilton New Orleans Riverside.

We lease the land uponwhich eight of our owned hotels are located. The expiration dates of the leasesrange up to 2091, with certain leases containing renewal options for 30 to 40years. Under these leases, we own the buildings and leasehold improvements andall furniture and equipment; we are responsible for repairs, maintenance,operating expenses and lease rentals; and we retain complete managerialdiscretion over operations. Lease terms generally require us to pay a fixedmonthly base rent and may require us to pay additional rent based on apercentage of revenue or income from the hotel. Upon the expiration of suchleases, the buildings and other leasehold improvements presently owned by usrevert to the landlords. For additional information, see “Note 17: Leases”to the consolidated financial statements under Item 8.

*Leased Hotels*

As of December 31,2005, we leased six hotels, representing 2,245 rooms. Under these leases, welease the hotel from its owner, manage the hotel and are generally responsiblefor all aspects of the hotel’s operations and recognize all revenues andsubstantially all expenses associated with the hotel’s operations. Although, ingeneral, replacement of furniture, fixtures and equipment is the landlord’sresponsibility, we are obligated under certain leases to maintain and replacethese items. Lease terms typically require us to pay a fixed monthly base rentregardless of the performance of the hotel and a variable rent based on apercentage of revenue or income. For additional information, see “Note 17:Leases” to the consolidated financial statements under Item 8.

*Joint Ventures*

As of December 31,2005, we had a minority or non-controlling financial interest in and operated54 hotels, representing 17,040 rooms. We have a right of first refusal topurchase additional equity interests in certain of these joint ventures. Wemanage each of the partially owned hotels for the entity owning the hotel. Foradditional information, see “Alliances” below.

*Managed Hotels*

As of December 31, 2005, we managed 210 hotels,representing 53,115 rooms, which are wholly owned by others. Under our standardmanagement agreement, we operate a hotel for the benefit of its owner, whicheither owns or leases the hotel and the associated personal property. Ourmanagement fee is generally based on a percentage of each hotel’s gross revenueplus, for the majority of properties, an incentive fee based on operatingperformance. The terms of our management agreements are for various periods andgenerally contain renewal options, subject to certain termination rights.

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

*Franchise Hotels*

As of December 31,2005, we franchised 2,054 hotels, representing 275,350 rooms, which are ownedand operated by third parties. In general, franchisees pay us an initial feebased on the number of rooms in a franchise hotel and a continuing fee based ona percentage of the hotel’s rooms revenue, which may be up to five percent ofrooms revenue depending on the brand. Although we do not directly participatein the management or operation of franchise hotels, we conduct periodicinspections to ensure that our standards are maintained and render advice withrespect to certain aspects of hotel operations. We generally approve the plansfor, and the location of, franchise hotels and assist in their design.

**Hotel Brands**

We operate hotels throughthe brands described below, which target a wide variety of markets andgeographic areas. According to data from Smith Travel Research, in 2005, ourHilton, Hilton Garden Inn, Embassy Suites, Homewood Suites by Hilton andHampton brands all commanded significant market share premiums in the system-widerevenue per available room (RevPAR) index, which represents the share of RevPARthese properties attain versus their respective competitive sets.

*Hilton*

Hilton hotels are ourupscale, full-service hotels that typically include swimming pools, gift shopsand retail facilities, meeting and banquet facilities, restaurants and lounges,room service, parking facilities and other services. The Hilton brand alsoincludes Hilton Suites hotels which are upscale, all-suite hotels. As of December 31,2005, there were 234 Hilton hotels, representing 90,478 rooms, located in 38states, the District of Columbia, Canada and Mexico. As of December 31,2005, there were 12 Hilton hotels under construction in the U.S., of which 10will be franchise hotels and two will be managed hotels.

*Hilton Garden Inn*

Hilton Garden Inn hotelsare our upper mid-market, focused service hotels that utilize a modular designconstructed around a courtyard containing an indoor or outdoor swimming pool.In 2005, the Hilton Garden Inn brand earned the first place J.D. Power Awardfor “Highest Customer Satisfaction” in its category for a fourth consecutiveyear. As of December 31, 2005, there were 259 Hilton Garden Inn hotels,representing 35,523 rooms, located in 39 states, the District of Columbia,Canada and Mexico. As of December 31, 2005, 41 Hilton Garden Inn hotelswere under construction, all of which will be franchise hotels.

*Doubletree*

Doubletree hotels are ourfull-service hotels in the mid-market to upscale hotel category. The Doubletreebrand also includes the Doubletree Guest Suites all-suite hotels and themoderately priced Doubletree Club hotels. As of December 31, 2005, therewere 160 Doubletree hotels, representing 42,168 rooms, located in 36states, the District of Columbia, Canada and Latin America. As of December 31,2005, nine Doubletree hotels were under construction, all of which will befranchise hotels.

*Embassy Suites*

Embassy Suites are ourupscale, all-suite hotels that feature two-room guest suites with a separateliving 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 31,2005, there were 182 Embassy Suites, representing 44,429 rooms, located in 38states, the District of Columbia, Canada, Dominican Republic, Puerto Rico andLatin America. As of December 31, 2005, six Embassy Suites hotels wereunder construction, of which five will be franchise hotels and one will be amanaged hotel.

*Homewood Suites byHilton*

Homewood Suites by Hiltonare our upscale, extended-stay hotels that feature residential styleaccommodations including business centers, swimming pools, convenience storesand limited meeting facilities. In 2005, the Homewood Suites by Hilton brandearned the first place J.D. Power Award for “Highest Customer Satisfaction” inits category for the third consecutive year. As of December 31, 2005,there were 164 Homewood Suites, representing 18,133 rooms, located in 37states, the District of Columbia and Canada. As of December 31, 2005, 37Homewood Suites hotels were under construction, all of which will be franchisehotels.

*Hampton*

Hampton Inn hotels are ourmoderately priced hotels with limited food and beverage facilities. The Hamptonbrand also includes Hampton Inn & Suites hotels which offer bothtraditional hotel room accommodations and apartment style suites within oneproperty. In 2005, the Hampton brand earned the first place J.D. Power Awardfor “Highest Customer Satisfaction” in its category. As of December 31,2005, there were 1,336 Hampton hotels, representing 134,121 rooms, locatedin 49 states, Canada, Puerto Rico and Latin America. As of December 31,2005, 103 Hampton hotels were under construction, of which 101 will befranchise hotels and two will be managed hotels.

*Other Brands*

In addition to the hotel brands described above, as ofDecember 31, 2005, we operated 19 hotels, representing 5,869 rooms,operated under our Conrad brand or under third party brands pursuant tocontractual arrangements. Conrad hotels are our upscale, full-service hotelslocated primarily outside the United States. As of December 31, 2005, wemanaged, and in some cases partially owned, 14 Conrad hotels, representing4,766 rooms, located in Chicago, Illinois, Miami, Florida and Belgium, Egypt,England, Hong Kong, Indonesia, Ireland, Singapore, Thailand and Turkey. As of December 31,2005, three Conrad hotels were under construction, all of which will be managedhotels.

In early 2006, weintroduced a new brand line, the Waldorf=Astoria Collection. This new, elitebrand designation debuts with New York’s legendary Waldorf=Astoria, along withthree world-class luxury resorts which are newly managed by us: the GrandWailea Resort Hotel & Spa on the island of Maui in Hawaii; the ArizonaBiltmore Resort & Spa in Phoenix, Arizona; and the La Quinta Resort &Club in La Quinta, California. We anticipate that the Waldorf=AstoriaCollection will grow primarily through branding of existing landmark orboutique hotels, co-branding of existing Hilton and Conrad hotels and openingnewly built properties in select cities.

**Timeshare Operations**

We conduct our timeshareoperations through Hilton Grand Vacations Company and its related entities (“HGVC”),which we wholly own. As of December 31, 2005, HGVC operated 21 timeshareresorts in Florida, four in Hawaii, three in Nevada and one in each of Coloradoand New York. We also manage one timeshare resort and franchise three timeshareresorts in the United States under the Embassy Vacation Resort name. In addition,HGVC operates HGVClub and Hilton Club, points-based reservation and exchangesystems with 34 affiliated timeshare resorts.

**Development**

*Hotel Properties*

We intend to grow our hotel system through theHI Acquisition (see “Note 20: Subsequent Events” to the consolidatedfinancial statements under Item 8), franchising and the addition ofmanagement contracts. We will also continue to invest in capital improvementsand select projects at our owned hotels. In addition, we may seek to acquireownership interests in hotel properties on a strategic and selective basis,either directly or through investments in joint ventures. See “Alliances” below.

During 2005, we added a total of 175 hotel and timeshareproperties, primarily franchises, with approximately 25,000 rooms to our system.A total of 46 properties, primarily franchises, with approximately 8,000 rooms,were removed from our system in 2005.

Total hotel property additions to our system in 2005included 163 franchise properties and nine managed properties owned by thirdparties. These additions included 34 properties which, due in part to themarket share leadership of our brands, were converted to our family of brandsin 2005. The 34 conversions included 17 Doubletrees, seven Hiltons, fourHilton Garden Inns, two Hamptons, two Homewood Suites by Hilton, one EmbassySuites and one Conrad.

In 2006, we expect to add approximately 200 hotels and28,000 rooms to our hotel system, with Hampton and Hilton Garden Inn accountingfor most of the new development. We expect virtually all of this growth to bethrough franchise and management agreements. This growth excludes potential newinternational development opportunities as a result of the HI Acquisition.

Our current development pipeline is our biggest yet,with approximately 600 hotels, primarily franchises, with 78,000 rooms, at December 31,2005, not including potential international development associated with the HIAcquisition. The consummation of transactions in our development pipeline issubject to certain conditions and uncertainties.

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

*TimeshareProperties*

HGVC has recentlyopened or is currently developing the following projects:

·       HGVCis continuing to develop a 120-unit timeshare resort in Waikoloa, Hawaii,near the Hilton Waikoloa Village, 22 units of which opened in 2005, with theremaining units scheduled for completion in spring 2006.

·       HGVCis continuing to develop a 1,582-unit timeshare resort located at thenorth end of the Las Vegas Strip in Las Vegas, Nevada. Phase two of thisproject, consisting of 423 units, is scheduled to open in summer 2006. Upon theopening of phase two, approximately 44% of the planned four-tower project willhave been completed.

·       HGVCis continuing to develop a timeshare resort at Tuscany Village on InternationalDrive in Orlando, Florida, with seven phases and a total of 456 units. Thefirst four phases of this project, consisting of 236 units, have opened and thefifth phase of this project, consisting of 70 units, is scheduled to becompleted in spring 2006. Also in Orlando, HGVC is adding 48 units to itsexisting property adjacent to Sea World.

HGVC is actively seekingnew management, development and acquisition opportunities in other destination markets.For additional information, see “Note 2: Summary of Significant AccountingPolicies” to the consolidated financial statements under Item 8.

**Alliances**

*Hilton Group*

In 1997, we entered into agreements with Hilton Groupplc whose wholly owned subsidiary, HI, owned the rights to the Hilton nameoutside the United States. The agreements provided for the reunification of theHilton brand worldwide through a strategic alliance between the companies,including cooperation on sales and marketing, loyalty programs and otheroperational matters. Pursuant to these agreements, both companies integratedtheir reservation systems under Hilton Reservations Worldwide, launched theHilton HHonors Worldwide loyalty program, integrated worldwide sales offices,developed joint marketing initiatives and adopted a Hilton brand identity usedby both companies. As a result of the HI Acquisition, we acquired all of HI’shotel properties and Hilton Reservations Worldwide and Hilton HHonors Worldwideare now wholly owned by us. See “General Information—Acquisition of HiltonInternational,” “Additional Information—Reservation System” and “—HHonors.”

In the first quarter of2005, we announced an initiative with HI to develop the luxury Conrad brand ona global basis. The development of the Conrad brand was through a joint venturecompany owned equally by HI and us. The joint venture sought to develop theConrad brand primarily through management agreements. As a result of the HIAcquisition, we now own all the rights to the Hilton and Conrad brands,including the right to develop Hilton, Conrad and our other brands on aworldwide basis. See “Territorial Restrictions” below.

*CNL Joint Ventures*

Since 2001, we haveentered into three separate joint venture partnerships with CNL HospitalityCorporation (“CNL”). The three partnerships own thirteen properties comprisingeight Hiltons, four Embassy Suites and one Doubletree (see “Note 3:Acquisitions and Dispositions” in the notes to the consolidated financialstatements under Item 8).

*FelCor*

As of December 31,2005, FelCor Lodging Trust Inc. (“FelCor”) owned or had an interest in 70of our hotels and we owned approximately 1.5 million shares of FelCorcommon stock, representing approximately 2% of FelCor’s outstanding commonstock.

**Development Financing**

We have establishedfranchise financing programs with third party lenders to support the growth ofour Hilton Garden Inn, Homewood Suites by Hilton, Hampton and Embassy Suiteshotels. As of December 31, 2005, we have provided guarantees of $35million on loans outstanding under these programs. In addition, we haveguaranteed $36 million of debt and other obligations of unconsolidatedaffiliates and third parties, bringing our total guarantees to approximately$71 million. Our outstanding guarantees have terms of one to seven years.We also have commitments under letters of credit totaling $56 million asof December 31, 2005. We believe it is unlikely that material paymentswill be required under our outstanding guarantees or letters of credit. See “Note18: Commitments and Contingencies” to the consolidated financial statementsunder Item 8.

**Territorial Restrictions**

Pursuant to an agreement entered into in 1964 at thetime we distributed all of the issued and outstanding capital stock of HI toour stockholders, we were prohibited from operating facilities outside theUnited States identified as “Hilton” hotels and HI was prohibited fromoperating facilities within the United States identified as “Hilton” hotels. Weentered into alliance agreements with Hilton Group plc, the parent company ofHI, pursuant to which HI granted a license to us to develop franchise propertiesunder the Hilton and Hilton Garden Inn names in Canada, Mexico and the Islandof St. John, U.S. Virgin Islands. As a result of the HI Acquisition (see “Note20: Subsequent Events” to the consolidated financial statements under Item 8),we now own the right to develop each of these brands on a worldwide basis. See “Alliances—HiltonGroup” above.

We have also entered intocertain management and franchise agreements that contain provisions which mayrestrict our right to own, manage or franchise additional hotels in specifiedgeographic areas.

**Potential Acquisitions**

On February 23, 2006,we consummated the HI Acquisition. See “General Information—Acquisition ofHilton International” above. We continue to evaluate other acquisitionopportunities and may, from time to time, negotiate to engage in a businesscombination transaction or other acquisition. However, there is no assurancethat we will engage in any such transactions.

**Property Transactions**

We will continue to reviewour owned hotel portfolio for potential repositioning or rebrandingopportunities. It is our intention to be opportunistic when evaluatingpotential asset sales and we will look to sell particular hotel properties tothe extent we can obtain premium prices. We are currently marketing for salecertain of our owned properties. See “Note 3: Acquisitions and Dispositions” tothe consolidated financial statements under Item 8.

**Seasonality**

The hospitality industry is seasonal in nature.However, the periods during which our properties experience higher or lowerlevels of demand vary from property to property and depend principally uponlocation.

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**Statistical Information**

Thefollowing table sets forth certain system-wide information for our propertieswith respect to the number of properties and rooms as of December 31, 2004and 2005:

| ** **                    | ** ** | **2004 Number of** | ** ** | **2005 Number of** | ** ** | **Change in Number of** | ** ** |
|-------------------------------|------------|------------------------------|------------|------------------------------|------------|----------------------------------------|------------|
| ** **                    | ** ** | **Properties**               | ** ** | **Rooms**                    | ** ** | **Properties**                         | ** ** | **Rooms** | ** ** | **Properties** | ** ** | **Rooms** | ** ** |
| **Hilton**                    |       |                         |       |                         |       |                                   |       |   |   |   |   |   |   |
| Owned                         |       | 36                           |       | 27,492                       |       | 21                                     |       | 20,524 |   | (15 | ) | (6,968 | ) |
| Leased                        |       | 1                            |       | 499                          |       | 1                                      |       | 499 |   | — |   | — |   |
| Joint Venture                 |       | 10                           |       | 4,177                        |       | 11                                     |       | 4,625 |   | 1 |   | 448 |   |
| Managed                       |       | 24                           |       | 13,822                       |       | 27                                     |       | 15,923 |   | 3 |   | 2,101 |   |
| Franchised                    |       | 159                          |       | 43,266                       |       | 174                                    |       | 48,907 |   | 15 |   | 5,641 |   |
| Total                         |       | 230                          |       | 89,256                       |       | 234                                    |       | 90,478 |   | 4 |   | 1,222 |   |
| **Hilton Garden Inn**         |       |                         |       |                         |       |                                   |       |   |   |   |   |   |   |
| Owned                         |       | 1                            |       | 162                          |       | 1                                      |       | 162 |   | — |   | — |   |
| Joint Venture                 |       | 1                            |       | 128                          |       | 1                                      |       | 128 |   | — |   | — |   |
| Managed                       |       | 6                            |       | 796                          |       | 7                                      |       | 886 |   | 1 |   | 90 |   |
| Franchised                    |       | 211                          |       | 28,755                       |       | 250                                    |       | 34,347 |   | 39 |   | 5,592 |   |
| Total                         |       | 219                          |       | 29,841                       |       | 259                                    |       | 35,523 |   | 40 |   | 5,682 |   |
| **Doubletree**                |       |                         |       |                         |       |                                   |       |   |   |   |   |   |   |
| Owned                         |       | 4                            |       | 1,702                        |       | 3                                      |       | 1,349 |   | (1 | ) | (353 | ) |
| Leased                        |       | 6                            |       | 2,144                        |       | 5                                      |       | 1,746 |   | (1 | ) | (398 | ) |
| Joint Venture                 |       | 24                           |       | 7,208                        |       | 14                                     |       | 4,306 |   | (10 | ) | (2,902 | ) |
| Managed                       |       | 38                           |       | 10,074                       |       | 30                                     |       | 8,060 |   | (8 | ) | (2,014 | ) |
| Franchised                    |       | 82                           |       | 19,794                       |       | 108                                    |       | 26,707 |   | 26 |   | 6,913 |   |
| Total                         |       | 154                          |       | 40,922                       |       | 160                                    |       | 42,168 |   | 6 |   | 1,246 |   |
| **Embassy Suites**            |       |                         |       |                         |       |                                   |       |   |   |   |   |   |   |
| Owned                         |       | 4                            |       | 881                          |       | 3                                      |       | 663 |   | (1 | ) | (218 | ) |
| Joint Venture                 |       | 27                           |       | 7,279                        |       | 25                                     |       | 6,586 |   | (2 | ) | (693 | ) |
| Managed                       |       | 54                           |       | 14,134                       |       | 56                                     |       | 14,832 |   | 2 |   | 698 |   |
| Franchised                    |       | 90                           |       | 20,421                       |       | 98                                     |       | 22,348 |   | 8 |   | 1,927 |   |
| Total                         |       | 175                          |       | 42,715                       |       | 182                                    |       | 44,429 |   | 7 |   | 1,714 |   |
| **Homewood Suites by Hilton** |       |                         |       |                         |       |                                   |       |   |   |   |   |   |   |
| Owned                         |       | 3                            |       | 398                          |       | 1                                      |       | 140 |   | (2 | ) | (258 | ) |
| Managed                       |       | 36                           |       | 4,304                        |       | 41                                     |       | 4,706 |   | 5 |   | 402 |   |
| Franchised                    |       | 104                          |       | 11,352                       |       | 122                                    |       | 13,287 |   | 18 |   | 1,935 |   |
| Total                         |       | 143                          |       | 16,054                       |       | 164                                    |       | 18,133 |   | 21 |   | 2,079 |   |
| **Hampton**                   |       |                         |       |                         |       |                                   |       |   |   |   |   |   |   |
| Owned                         |       | 1                            |       | 133                          |       | 1                                      |       | 133 |   | — |   | — |   |
| Managed                       |       | 35                           |       | 4,462                        |       | 34                                     |       | 4,453 |   | (1 | ) | (9 | ) |
| Franchised                    |       | 1,254                        |       | 125,803                      |       | 1,301                                  |       | 129,535 |   | 47 |   | 3,732 |   |
| Total                         |       | 1,290                        |       | 130,398                      |       | 1,336                                  |       | 134,121 |   | 46 |   | 3,723 |   |
| **Other(1)**                  |       |                         |       |                         |       |                                   |       |   |   |   |   |   |   |
| Owned                         |       | 1                            |       | 300                          |       | —                                 |       | — |   | (1 | ) | (300 | ) |
| Joint Venture                 |       | 3                            |       | 1,394                        |       | 3                                      |       | 1,395 |   | — |   | 1 |   |
| Managed                       |       | 13                           |       | 3,788                        |       | 15                                     |       | 4,255 |   | 2 |   | 467 |   |
| Franchised                    |       | —                       |       | —                       |       | 1                                      |       | 219 |   | 1 |   | 219 |   |
| Total                         |       | 17                           |       | 5,482                        |       | 19                                     |       | 5,869 |   | 2 |   | 387 |   |
| **Timeshare**                 |       | 31                           |       | 3,740                        |       | 34                                     |       | 3,948 |   | 3 |   | 208 |   |
| **Total**                     |       |                         |       |                         |       |                                   |       |   |   |   |   |   |   |
| Owned                         |       | 50                           |       | 31,068                       |       | 30                                     |       | 22,971 |   | (20 | ) | (8,097 | ) |
| Leased                        |       | 7                            |       | 2,643                        |       | 6                                      |       | 2,245 |   | (1 | ) | (398 | ) |
| Joint Venture                 |       | 65                           |       | 20,186                       |       | 54                                     |       | 17,040 |   | (11 | ) | (3,146 | ) |
| Managed                       |       | 206                          |       | 51,380                       |       | 210                                    |       | 53,115 |   | 4 |   | 1,735 |   |
| Franchised                    |       | 1,900                        |       | 249,391                      |       | 2,054                                  |       | 275,350 |   | 154 |   | 25,959 |   |
| Timeshare                     |       | 31                           |       | 3,740                        |       | 34                                     |       | 3,948 |   | 3 |   | 208 |   |
| **TOTAL  PROPERTIES**         |       | 2,259                        |       | 358,408                      |       | 2,388                                  |       | 374,669 |   | 129 |   | 16,261 |   |

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(1)   Includesproperties operated under our Conrad brand and properties operated under thirdparty brands pursuant to contractual arrangements.

For purposes of the table above, “owned” propertiesare those in which we have a majority or controlling financial interest and “jointventure” properties are those in which we have a minority or non-controllingfinancial interest. For additional information, see “Hotel Properties” above.

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Thefollowing table sets forth certain system-wide information for our hotels withrespect to occupancy rates, average room rates and revenue per available room(RevPAR) for the fiscal years ended December 31, 2004 and 2005:
|                               | ** ** | **2004(1)** | ** ** | **2005(1)** | ** ** | **%/pt  Change** | ** ** |
|-------------------------------|------------|-------------|------------|-------------|------------|------------------|------------|
| **Hilton**                    |       |        |       |        |       |             |       |
| Occupancy                     |       | 69.6        | %          | 71.7        | %          | 2.1              | pts        |
| Average rate                  |       | $           | 129.38     |        | $          | 140.42           |       | 8.5 | % |
| RevPAR(2)                     |       | $           | 90.06      |        | $          | 100.68           |       | 11.8 | % |
| **Hilton Garden Inn**         |       |        |       |        |       |             |       |
| Occupancy                     |       | 69.1        | %          | 71.1        | %          | 2.0              | pts        |
| Average rate                  |       | $           | 98.65      |        | $          | 104.74           |       | 6.2 | % |
| RevPAR(2)                     |       | $           | 68.14      |        | $          | 74.47            |       | 9.3 | % |
| **Doubletree**                |       |        |       |        |       |             |       |
| Occupancy                     |       | 68.2        | %          | 70.3        | %          | 2.1              | pts        |
| Average rate                  |       | $           | 102.29     |        | $          | 109.60           |       | 7.1 | % |
| RevPAR(2)                     |       | $           | 69.78      |        | $          | 77.01            |       | 10.4 | % |
| **Embassy Suites**            |       |        |       |        |       |             |       |
| Occupancy                     |       | 70.6        | %          | 73.2        | %          | 2.6              | pts        |
| Average rate                  |       | $           | 123.30     |        | $          | 129.98           |       | 5.4 | % |
| RevPAR(2)                     |       | $           | 87.01      |        | $          | 95.09            |       | 9.3 | % |
| **Homewood Suites by Hilton** |       |        |       |        |       |             |       |
| Occupancy                     |       | 73.5        | %          | 75.6        | %          | 2.1              | pts        |
| Average rate                  |       | $           | 96.51      |        | $          | 100.57           |       | 4.2 | % |
| RevPAR(2)                     |       | $           | 70.93      |        | $          | 76.05            |       | 7.2 | % |
| **Hampton**                   |       |        |       |        |       |             |       |
| Occupancy                     |       | 68.7        | %          | 71.5        | %          | 2.8              | pts        |
| Average rate                  |       | $           | 81.57      |        | $          | 86.98            |       | 6.6 | % |
| RevPAR(2)                     |       | $           | 56.00      |        | $          | 62.22            |       | 11.1 | % |
| **Other(3)**                  |       |        |       |        |       |             |       |
| Occupancy                     |       | 71.7        | %          | 71.5        | %          | (0.2             | )pts       |
| Average rate                  |       | $           | 133.03     |        | $          | 148.80           |       | 11.9 | % |
| RevPAR(2)                     |       | $           | 95.33      |        | $          | 106.33           |       | 11.5 | % |
|                               |            |             |            |             |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Statistics are forcomparable hotels, and include only those hotels in our system as of December 31,2005 and owned, operated or franchised by us since January 1, 2004. Comparablehotels exclude our owned hotels in New Orleans due to the interruption inoperations as a result of Hurricane Katrina.

(2)          RevPAR is equal to roomsrevenue divided by the number of available rooms.

(3)          Includes propertiesoperated under our Conrad brand and properties operated under third partybrands pursuant to contractual arrangements.

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

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Thefollowing table sets forth certain system-wide statistical information for ourhotels by geographic region as of and for the year ended December 31,2005:
| Regions                            | ** ** | ** ** | ** ** | **Properties** | ** ** | **Rooms** | ** ** | **Occupancy** | ** ** | **Room Rate** | ** ** | **RevPAR** | ** ** |
|------------------------------------|------------|------------|------------|----------------|------------|-----------|------------|---------------|------------|--------------------|------------|------------|------------|
| Owned, Leased and  Managed Hotels: |       |       |       |           |       |      |       |          |       |               |       |       |       |   |   |   |   |
| Pacific/Mountain                   |       |       | 87         |           |       | 31,844    |       |          | 74.7       | %                  |       |       | $          | 131.10 |   |   | $ | 97.98 |   |
| North Central                      |       |       | 36         |           |       | 11,862    |       |          | 70.7       |               |       |       | 129.89     |   |   | 91.84 |   |
| South Central                      |       |       | 57         |           |       | 14,947    |       |          | 68.5       |               |       |       | 109.51     |   |   | 75.03 |   |
| New England/Middle Atlantic        |       |       | 32         |           |       | 12,494    |       |          | 80.5       |               |       |       | 206.18     |   |   | 165.95 |   |
| South Atlantic                     |       |       | 71         |           |       | 18,578    |       |          | 73.3       |               |       |       | 132.93     |   |   | 97.37 |   |
| International                      |       |       | 17         |           |       | 5,646     |       |          | 72.5       |               |       |       | 150.08     |   |   | 108.84 |   |
| Total                              |       |       | 300        |           |       | 95,371    |       |          | 73.8       |               |       |       | 141.12     |   |   | 104.14 |   |
| Franchise Hotels                   |       |       | 2,054      |           |       | 275,350   |       |          | 71.0       | %                  |       |       | $          | 99.59 |   |   | $ | 70.74 |   |
|                                    |            |            |            |                |            |           |            |               |            |                    |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

In the table above,statistics are for comparable hotels, and include only those hotels in oursystem as of December 31, 2005 and owned, operated or franchised by ussince January 1, 2004. Comparable hotels exclude our owned hotels in NewOrleans due to the interruption in operations as a result of Hurricane Katrina(see “Note 19: Hurricane Katrina” to the consolidated financial statementsunder Item 8). For additional information regarding our number of properties,number of available rooms and statistical information, see “SupplementaryFinancial Information” and “Five Year Summary” under Item 8.

**ADDITIONAL INFORMATION**

**Casino Windsor**

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

**Design and Furnishing Services**

Hilton Supply Management,our wholly owned subsidiary, provides design and furnishing services to ourhotels and to hotels owned and operated by others. These services include thepurchase and distribution of furniture, furnishings, equipment, food, beverageand operating supplies. The volume of this operation depends primarily on thenumber of new hotels we operate or franchise and on refurbishing and remodelingof our existing hotels.

**Reservation System**

Hilton ReservationsWorldwide, LLC (“HRW”) oversees and operates a computerized, worldwidereservation system for hotels owned, operated or franchised by us, ouraffiliates and others. Prior to the HI Acquisition, Hilton and HiltonGroup 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 anautomated system that enables them to automatically cross-sell among all of ourhotel brands which has benefited, and which we expect will continue to benefit,all of our hotel brands. See “General Information—Acquisition of HiltonInternational” above.

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**HHonors**

Hilton HHonors Worldwide,LLC (“HHonors”) is our guest loyalty program. Prior to the HI Acquisition,Hilton and Hilton Group each owned a 50% interest in HHonors. As a result ofthe HI Acquisition, HHonors is now wholly owned by us. HHonors includesthe Hilton, Hilton Garden Inn, Doubletree, Embassy Suites, Homewood Suites byHilton, Hampton and Conrad brands, as well as the Scandic and Coral by Hiltonbrands acquired in the HI Acquisition. Members of the HHonors program earnpoints based on their spending at most of the hotel properties operated andfranchised by us and properties acquired in the HI Acquisition. HHonorsaccumulates and tracks points on the member’s behalf and fulfills the awardsupon request. Points can be redeemed for hotel stays at participatingproperties, and for a variety of other awards such as airline tickets, cruisesand car rentals. We expect HHonors to continue to have a positive impact on ourbrands. See “General Information—Acquisition of Hilton International” above and“Note 2: Summary of Significant Accounting Policies” to the consolidatedfinancial statements under Item 8.

**Technology and Distribution**

We operate the Hilton worldwide internet website(www.hiltonworldwide.com) and our various hotel brand websites which providecost effective customer service, including online hotel reservations andHHonors enrollment. We also provide various business, technology andinformation services for our hotel guests, including high speed internet accessat virtually all of our hotels system-wide and self-service check-in kiosks atcertain of our owned or managed hotels.

We operate our proprietary OnQ system, which is asingle technology platform that links our brands and hotels to enhance customerservice and loyalty, as well as maximize operational efficiencies. The OnQsystem has been installed at virtually all of the hotels in our system as ofDecember 31, 2005. As a result of the HI Acquisition, we intend tocommence the installation of the OnQ system in the hotels we acquired. We alsoutilize an integrated strategy related to electronic and online distribution ofrooms in our systems. The strategy provides for brand standards that permiteach domestic hotel to establish its own room rates, but requires the hotel tooffer such rates consistently across all designated distribution channels,including our proprietary websites, HRW call centers, Global DistributionSystems/travel agents, and through hotels directly. In addition, we haveimplemented 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 isdesigned to encourage customers to book their reservations through the abovereferenced distribution channels. We believe that this program, along withenhancements to our branded websites, has contributed to significantlyincreased numbers of transactions on our proprietary websites.

**Trademarks**

The following trademarksused herein are owned by us and are registered as trademarks in the UnitedStates and/or in certain foreign countries: Conrad®, Coral by Hilton®, DoubleDip®, Double Dipping®, Doubletree®, Doubletree Club Hotel®, Doubletree GuestSuites®, Embassy Suites Hotels®, Embassy Vacation Resort®, Finn &Porter®, Hampton®, Hampton Inn®, Hampton Inn & Suites®, HGVClub®,Hilton®, HHonors®, Hilton Garden Inn®, Hilton Grand Vacations Club®,Hilton Hawaiian Village®, Homewood Suites by Hilton®, LivingWell®, Points & Miles®,Scandic®, Senior HHonors®, Waldorf=Astoria® and Waldorf=Astoria CollectionTM. Weconsider all of these marks, and the associated name recognition, to bevaluable to our business. See “Note 2: Summary of Significant AccountingPolicies” to the consolidated financial statements under Item 8.

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**Marketing**

Our hotel properties offer multiple product lines to abroad range of customers in many geographic markets. Our properties includefull-service and limited service hotels in urban, airport, resort and suburbanlocations, as well as timeshare resorts.

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

In 2005, we announced oursponsorship of the U.S. Olympic Team through 2008, which entitles our family ofbrands to use the official hotel sponsor designation and Olympic logo inadvertising and marketing materials.

**Forward-Looking Statements**

*Forward-looking statements in thisreport, including without limitation, those set forth under the captions “Operations—Development,”“—Territorial Restrictions,” “—Potential Acquisitions” and “—PropertyTransactions” and “Additional Information—Reservation System,” “—HHonors,” “—Competition,”“—Environmental Matters” and “—Regulation and Licensing,” “Properties,” “LegalProceedings” and “Management’s Discussion and Analysis of Financial Conditionand Results of Operations,” and statements relating to our plans, strategies,objectives, expectations, intentions and adequacy of resources, are madepursuant to the safe harbor provisions of the Private Securities LitigationReform Act of 1995. The words “believes,” “anticipates,” “expects,” “intends,” “plans,”“estimates,” “projects,” “will,” “should,” “continues” and similar expressionsare intended to identify forward-looking statements. These forward-lookingstatements reflect our current views with respect to future events andfinancial performance and are subject to risks and uncertainties, includingthose identified under “Risk Factors” under Item 1A below and  under “Operations—Development” and “—TerritorialRestrictions,” “Additional Information—Marketing,” “—Regulation and Licensing,”and “Management’s Discussion and Analysis of Financial Condition and Results ofOperations.”  Any of these risks anduncertainties could cause actual results to differ materially from historicalresults or those anticipated. We undertake no obligation to publicly update orrevise any forward-looking statements to reflect current or future events orcircumstances except as required by law.*

**Competition**

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

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We believe that after theHI Acquisition, our position as a multi-branded owner, operator, manager andfranchisor of hotels makes us the largest, by revenue, and most geographicallydiverse lodging company in the world. Competition in the industry is basedprimarily on the level of service, quality of accommodations, convenience oflocations and room rates. Competition from other hotels, motels and inns,including facilities owned by local interests and facilities owned by nationaland international chains, is vigorous in all areas in which we operate orfranchise our facilities. Our hotels also generally compete with facilitiesoffering similar services in cities and other locations where our hotels arenot present. If hotel capacity is expanded by others in a city where ourbranded hotels are located, competition will increase. Competition in thetimeshare business is based primarily on the quality and location of timeshareresorts, the pricing of timeshare intervals and the availability of programbenefits, such as exchange programs. We believe that our focus on core businessstrategies, combined with our financial strength, diverse market presence,strong brands and strategically located properties, will enable us to remaincompetitive. For additional information, see “Risk Factors” under Item 1A.

**Environmental Matters**

We, like others in our industry, are subject tovarious Federal, state, local and, in some cases, foreign laws, ordinances andregulations that:

(i)            govern activities oroperations that may have adverse environmental effects, such as discharges toair and water, as well as handling and disposal practices for solid andhazardous or toxic wastes; or

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

Environmental Laws could make us liable for costs ofremoving or cleaning up hazardous or toxic substances on, under or in propertywe currently own or operate or that we previously owned or operated. Those lawscould impose liability without regard to whether we knew of, or wereresponsible for, the presence of hazardous or toxic substances or waste. Weendeavor to maintain compliance with Environmental Laws but, from time to time,our operations may have resulted or may result in noncompliance or liabilityfor cleanup pursuant to Environmental Laws. In that regard, as of December 31,2005, we had been notified of contamination resulting from past disposals ofwaste at six sites to which hazardous or non-hazardous waste may havebeen sent from our facilities in the past. Based on information reviewed by andavailable to us, including:

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

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

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

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

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**Regulation and Licensing**

*OntarioGaming Laws.*   Ontario, Canada has laws andregulations governing the conduct of casino gaming. Ontario law requires thatthe operator of a casino must be found suitable and be registered. Aregistration once issued remains in force until revoked. Ontario law definesthe grounds for registration, as well as revocation or suspension of suchregistration. The Ontario authorities have conducted an investigation of, andhave found suitable, Hilton and the other shareholder of Windsor Casino Limitedin connection with the Ontario registration of Windsor Casino Limited. See “AdditionalInformation—Casino Windsor” above.

*Other Laws andRegulations.*   Each of the hotels and timeshareresorts we operate is subject to extensive state, local and nationalregulations and, on a periodic basis, must obtain various licenses and permits,including those required to sell alcoholic beverages. Federal and state lawsand regulations also require certain registration, disclosure statements andother practices with respect to the franchising of hotels. As a result of theHI Acquisition, we are subject to the laws and regulations of approximately 80countries. We believe that we have obtained all required licenses and permitsand our businesses are conducted in substantial compliance with applicablelaws.

**Employees**

At December 31, 2005,we employed approximately 61,000 team members, of whom approximately 18,000were covered by various collective bargaining agreements providing, generally,for basic pay rates, working hours, other conditions of employment and orderlysettlement of labor disputes. We believe that the aggregate compensationbenefits and working conditions afforded our employees compare favorably withthose received by employees in the hotel industry generally. See “Risk Factors”under Item 1A.

**Available Information**

Our internet website is located atwww.hiltonworldwide.com. We make available free of charge through this websiteour annual report on Form 10-K, quarterly reports on Form 10-Q,current reports on Form 8-K, and amendments to those reports filedor furnished pursuant to Section 13(a) or 15(d) of theSecurities Exchange Act of 1934, as soon as reasonably practicable after weelectronically file such material with, or furnish it to, the Securities andExchange Commission. Our internet website also contains our Code of BusinessConduct and Ethics for officers, employees and directors, including our ChiefExecutive Officer and senior finance officers (the “Code of Ethics”), ourCorporate Governance Guidelines, Charters for our Audit, Compensation andCorporate Governance and Nominating Committees and information regardingstockholder communications with our Board of Directors. See “hiltonworldwide.com,”click on “Investor Relations,” then “Corporate Governance.” See also “Item 10.Directors and Executive Officers of the Registrant.” The information madeavailable through our website is not incorporated by reference in this Form 10-K.

We will provide withoutcharge to any person, on the written or oral request of such person, a copy ofour annual report on Form 10-K, Code of Ethics, Corporate GovernanceGuidelines and Charters for our Audit, Compensation and Corporate Governanceand Nominating Committees. Requests should be directed to our CorporateSecretary, Hilton Hotels Corporation, 9336 Civic Center Drive, Beverly Hills,California 90210 (telephone number (310) 278-4321).

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**Executive Officers of the Company**

Thefollowing table sets forth certain information with respect to our executiveofficers.

| **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                                                                                                                                                                                                                                                   |       |    | 63         |   |   |
| Matthew J. Hart        |       | President  and Chief Operating Officer since May 2004, and prior  thereto, Executive Vice President and Chief Financial Officer                                                                                                                                                                                                                                                   |       |    | 53         |   |   |
| 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 |       |    | 44         |   |   |
| Tim Harvey             |       | Executive  Vice President and Chief Information Officer since  January 2006, and prior thereto, Senior Vice President and  Chief Information Officer                                                                                                                                                                                                                              |       |    | 47         |   |   |
| Thomas L. Keltner      |       | Executive  Vice President and President—Brand Performance and  Development Group since March 2001, and prior thereto, Executive  Vice President and President—Franchise Hotel Group                                                                                                                                                                                     |       |    | 59         |   |   |
| Madeleine A.  Kleiner  |       | Executive  Vice President and General Counsel, and Corporate  Secretary since March 2001                                                                                                                                                                                                                                                                                          |       |    | 54         |   |   |
| 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                                                                                                                                                |       |    | 47         |   |   |

 

Unless otherwise noted in the table, all positions andoffices indicated have been continuously held since January 2001. Theexecutive officers are responsible for all major policy making functions andall other corporate and divisional officers are responsible to, and are underthe supervision of, the executive officers. None of the executive officerslisted above are related.

Mr. Bollenbach alsoserves as a director of Hilton. Additional information for our directors willbe included under “Election of Directors” in our definitive proxy statement tobe used in connection with our annual meeting of stockholders scheduled to beheld on May 24, 2006 (the “Proxy Statement”), and this information isincorporated in this Form 10-K. See Cover Page—“DocumentsIncorporated by Reference.”

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**Item 1A.   **Risk Factors****

***We are subject toall of the operating risks common in the lodging and timeshare industries andour results may be adversely impacted if any of these risks materialize.*****  **Our results are significantly affected by occupancyand room rates achieved by our hotels, our ability to manage costs, ourrelative mix of owned, leased, managed and franchised hotels, supply and demandchanges for hotel rooms and timeshare intervals in our markets, the quantityand pricing of timeshare interval sales and changes in the number of availablehotel rooms and timeshare intervals through acquisition, development anddisposition. Unfavorable changes in these factors as well as the occurrence ofother events described below could negatively impact hotel room demand andpricing which, in turn, could limit our ability to pass through operating costincreases in the form of higher room rates. Our ability to manage costs couldbe adversely impacted by significant increases in operating expenses, such aswages and other labor costs, healthcare, insurance, property taxes and energy,as well as increases in construction costs, resulting in lower operatingmargins. In addition, economic factors beyond our control in the U.S. andinternationally may create challenges for the lodging industry and us in 2006and beyond. A downturn in economic conditions could impact the demand for hotelrooms and put pressure on room rates. Increases in transportation and fuelcosts, the financial condition of the airline industry and its impact on airtravel and sustained recessionary periods in the U.S. and internationally couldalso unfavorably impact future results.

***Certain of ouremployees are covered by collective bargaining agreements and labor disputesmay disrupt our operations.*****  **Employeesat certain of our owned and managed hotels are covered by collective bargainingagreements that have either expired or will expire in 2006. These agreementsaffect a broad array of hotels in New York, San Francisco, Boston, Chicago,Honolulu, Pittsburgh, Los Angeles and Toronto. UNITE HERE, the unionrepresenting a majority of our unionized employees, has announced its intent tospecifically target activities at Hilton properties and, in several keymarkets, exclude us from traditional multiemployer negotiations. We arepreparing for the impact of potential labor activities, which may cause thediversion of business to other hotels, thereby impacting our results negatively.However, at this time, we cannot predict when or whether new agreements will bereached and what the impact of prolonged negotiations may be. Labor disputes inmarkets in which we have employees covered by collective bargaining agreementscould disrupt our operations and adversely impact our financial results inthese and other markets.

***We derive asignificant portion of our revenue from operations of our owned hotels andevents in the markets where these properties are located could adversely affectour overall financial results.*****  **We derived approximately 46% of our revenue in 2005from the operations of our owned hotels. A significant portion of theserevenues derived from our large convention hotels located in major U.S. cities.See “General Information—Recent Developments” and “Operations—Hotel Properties—Owned Hotels”above. In addition, we acquired 41 owned properties in the HI Acquisition.Soft economic conditions in any of the markets where our owned properties arelocated and reduced business travel could adversely affect our results fromthese properties and, therefore, our overall financial results. Our ownedproperties are also subject to risks that generally relate to investments incommercial real estate, including governmental regulations, real estate,insurance, zoning, tax and eminent domain laws, the ongoing need for capitalimprovements to maintain or upgrade properties, fluctuations in real estatevalues, and the relative illiquidity of real estate compared to otherinvestments. If our owned properties do not generate sufficient revenue to meetoperating expenses, including debt service and capital requirements, ourfinancial results will be adversely affected.

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***We face challengesin integrating the operations of HI, as well as risks related to owning andoperating real estate and hotels in international locations.*****  **We may not achieve expected synergies from theHI Acquisition, which include combining technology and distributionactivities, consolidating regional infrastructure and integrating our Conradbrand into regional operations. We may also experience difficulties integratingthe operations of HI, including integrating personnel with disparate businessbackgrounds and corporate cultures and managing relationships with hotelowners, lessors and other business partners on a worldwide basis. As a resultof the HI Acquisition, we are subject to varying degrees of risk relating tointernational real estate generally, including risks related to changes inlocal, political, economic and market conditions, interest rates, zoning laws,currency exchange rate fluctuations, compliance with environmental laws, costsand terms of financing and the potential for uninsured casualty and otherlosses. A number of the leased properties we acquired in the HI Acquisition aresubject to long-term contracts requiring fixed payments to the lessor. If theseproperties do not generate sufficient revenues, we may be required to fundshortfalls to the lessors which could adversely impact our financial results. Inacquiring an ongoing business, we have succeeded to certain obligations andliabilities related to the business acquired in the HI Acquisition and havelimited rights of indemnification with respect to such matters. As a result ofthe HI Acquisition, we are now subject to the laws and regulations ofapproximately 80 countries, which will expose us to risks relating to changesin franchise, tax, environmental, zoning, employment, repatriation of money,liquor license and other laws in the countries in which we operate. Someinternational jurisdictions restrict the repatriation of non-U.S.earnings. Various international jurisdictions also have laws limiting theability of non-U.S. entities to pay dividends and remit earnings to affiliatedcompanies unless specified conditions have been met. Sales in internationaljurisdictions typically are made in local currencies, which subject us to risksassociated with currency fluctuations. Currency devaluations and unfavorablechanges in international monetary and tax policies could have a materialadverse effect on our profitability and financing plans, as could other changesin the international regulatory climate and international economic conditions. Inaddition, the U.S. government prohibits U.S. companies from operating incertain countries that are subject to economic sanctions or are on theterrorist countries list. We will not do business in such countries, unless wedevelop or acquire a non-U.S. affiliate that is capable of managing hotels orwe get authorization from the U.S. Treasury Department’s Office of ForeignAssets Control to do so. Some investors would be prohibited by state law orself-imposed policies from investing in our securities if we were to dobusiness in such countries.

***We are more highlyleveraged as a result of the recent consummation of the HI Acquisition. If weare unable to make planned dispositions of certain of our owned hotels acquiredin the HI Acquisition, it would impede our ability to reduce our indebtedness.*****  **We are currently marketing for sale certain ownedhotel properties we acquired in the HI Acquisition. We are required to use thenet proceeds from such dispositions to repay amounts outstanding under ourcredit facilities which were incurred to finance the HI Acquisition. If we areunable to complete such dispositions on commercially reasonable terms withinanticipated timeframes, our ability to reduce our outstanding borrowings may beadversely affected, which could negatively impact our cost of borrowings, ourfinancial results and our ability to raise new capital to finance future growth.Our senior debt ratings were recently downgraded to Ba2 by Moody’s InvestorServices and BB by Standard & Poor’s Ratings Group subsequent to ourannouncement in December 2005 of our agreement to acquire the lodgingassets of Hilton Group plc. A downgrade by any rating agency of the Company’scredit rating adversely impacts the cost and availability of capital to us. Ourhigher level of debt and resulting interest expense may place us at acompetitive disadvantage to competitors with lower amounts of indebtednessand/or higher credit ratings.

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***If we have disputeswith the owners of hotels we manage, we could be subject to litigation.******  ***For our managed hotels, we have theresponsibility to manage each hotel at a level consistent with the standardrequired for its brand in the relevant management agreement. Such provisionsvary in scope and may be subject to differing interpretations. In the ordinarycourse of business, we encounter disagreements with the owners of our managedhotels as to whether the duties in our management agreements have beensatisfied. To the extent that such conflicts arise, we seek to resolve them bynegotiation with the relevant parties. In the event that such resolution cannotbe achieved, litigation may result in damages or other remedies against us. Suchremedies could include termination of the right to manage the relevant property.We may not be able to negotiate successfully or otherwise resolve suchconflicts in each instance.

***In competing formanagement, franchise and timeshare agreements and leases, we may make loans orprovide guarantees to third parties and could experience losses under theseloans or guarantee arrangements.*****  **The terms of ourmanagement, franchise and timeshare agreements and leases are influenced bycontract terms offered by our competitors at the time such agreements areentered into. Accordingly, we may not enter into contracts or renew contractsin the future on terms that are as favorable to us as those under existingagreements. In connection with entering into these contracts, we may becomeobligated to make loans to or guarantee the obligations of third parties orguarantee minimum income to third parties. Weak performance, in particular as aresult of a soft economy, could give rise to losses under these loans andguarantees. Changes in legislation or regulatory changes may be implementedthat have the effect of favoring franchisees relative to brand owners.

***The growth ofinternet reservation channels could harm our profitability.*****  **Some of our hotel rooms are booked through internettravel intermediaries. If these bookings increase, these intermediaries may beable to obtain higher commissions or other significant contract concessionsfrom us. We believe that the aim of such intermediaries is to have consumersdevelop loyalties to their reservation systems rather than to our lodgingbrands. Although we expect most of our business to continue to be derived fromtraditional channels and our proprietary branded internet websites, if theamount of sales made through internet intermediaries increases significantly,our ability to control the supply, presentation and price of our room inventoryand our profitability may be harmed.

***We are a party tojoint venture arrangements and investing through joint ventures decreases ourability to manage risk.******  ***We have from time to time invested,and expect to continue to invest, as a co-venturer. Joint venturers often haveshared control over the operation of the joint venture assets. Therefore, jointventure investments may involve risks such as the possibility that theco-venturer in an investment might become bankrupt, or have economic orbusiness interests or goals that are inconsistent with our business interestsor goals, or be in a position to take action contrary to our instructions orrequests or contrary to our policies or objectives. Consequently, actions by aco-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 jointventure partners, or our joint venture partners could take actions binding onthe joint venture without our consent.

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

***Our properties aresubject to risks relating to acts of God, terrorist activity and war and anysuch event could materially adversely affect our operating results.*****  **Our financial andoperating performance may be adversely affected by acts of God, such as naturaldisasters, particularly in locations where we own and/or operate significantproperties. Some types of losses, such as those from earthquake, hurricane,terrorism and environmental hazards, may be either uninsurable or too expensiveto justify insuring against. Should an uninsured loss or a loss in excess ofinsured limits occur, we could lose all or a portion of the capital we haveinvested in a property, as well as the anticipated future revenue from theproperty. In that event, we might nevertheless remain obligated for anymortgage debt or other financial obligations related to the property. Similarly,war (including the potential for war) and terrorist activity (including threatsof terrorist activity), epidemics (such as SARs and bird flu), travel-relatedaccidents, as well as geopolitical uncertainty and international conflict,which impact domestic and international travel, have caused in the past, and maycause in the future, our results to differ materially from anticipated results.Terrorism incidents such as the events of September 11, 2001 and wars suchas the Iraq war in 2003 significantly impact international travel andconsequently global demand for hotel rooms. In addition, inadequatepreparedness, contingency planning or recovery capability in relation to amajor incident or crisis may prevent operational continuity and consequentlyimpact the value of the brand or the reputation of our business.

***If we fail tocomply with privacy regulations, we could be subject to fines or otherrestrictions on our business.*****  **Wecollect and maintain information relating to our guests for various businesspurposes, including maintaining guest preferences to enhance our customerservice and for marketing and promotion purposes. The collection and use ofpersonal data are governed by privacy laws and regulations enacted in the U.S.and other international jurisdictions in which we operate. Privacy regulationis an evolving area in which different jurisdictions may subject us toinconsistent compliance requirements. Compliance with applicable privacyregulations may increase our operating costs and/or adversely impact ourability to service our guests and market our products, properties and servicesto our guests. In addition, non-compliance with applicable privacy regulationsby 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 ourproprietary reservation systems and any failures in such systems couldnegatively affect our business.******  ***We invest in sophisticatedtechnology and systems for property management, procurement, reservations, andthe operation of our HHonors customer loyalty program. If our systems fail tooperate as anticipated, or we fail to replace our systems with new systemsintroduced by our competitors, our business could suffer. In addition, we intendto combine the systems used by the hotels acquired in the HI Acquisition withours, and if we experience difficulties in merging these systems, it coulddisrupt our operations.

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Inaddition, see the cautionary factors set forth under Item 1 “Business—AdditionalInformation—Competition” and “—Environmental Matters.”

**Item 1B.   Unresolved Staff Comments**

***None.***

**Item 2.   Properties**

We consider our hotels to be leading establishmentswith respect to desirability of location, size, facilities, physical condition,quality and the variety of services offered in most of the areas in which theyare located. Obsolescence arising from age and condition of facilities is afactor in the hotel industry. Accordingly, we spend, and intend to continue tospend, substantial funds to maintain the condition of our owned facilities inorder to remain competitive.

Hotels and timeshareproperties owned, leased, managed and franchised by us are briefly describedunder Item 1 and, in particular, under the caption “Operations.” Inaddition, new properties presently under construction that we will operate arebriefly described under “Operations—Development” under Item 1.

**Item 3.   Legal Proceedings**

Incorporated by referenceto the description of legal proceedings in “Note 18: Commitments andContingencies” to the consolidated financial statements under Item 8.

**Item 4.   Submission of Matters to a Vote ofSecurity Holders**

Not applicable.

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**PART II**

**Item5.   Market for Registrant’s Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities**

OurCommon Stock is listed on the New York Stock Exchange and is traded under thesymbol “HLT.” As of December 31, 2005, we had approximately 12,300stockholders of record. The high and low reported sales prices per share of ourCommon Stock and dividends declared per share of Common Stock are set forth inthe following table for the periods indicated:

| ** **                                 | ** ** | **High** | ** ** | **Low** | ** ** | **Dividend  Per Share** | ** ** |
|--------------------------------------------|------------|----------|------------|---------|------------|------------------------------|------------|
| 2004                                       |       |     |       |    |       |                         |       |   |   |
| 1st Quarter                                |       | $        | 17.29      |    | 15.10      |                         |       | .02 |   |   |
| 2nd Quarter                                |       | 18.70    |       | 16.29   |       |                         | .02        |   |   |
| 3rd Quarter                                |       | 19.21    |       | 16.32   |       |                         | .02        |   |   |
| 4th Quarter                                |       | 22.96    |       | 18.70   |       |                         | .02        |   |   |
| 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 (through  March 10, 2006) |       | 26.05    |       | 23.35   |       |                         | .04        |   |   |
|                                            |            |          |            |         |            |                              |            |  |  |  |

 

**Rights Agreement**

On November 29, 1999, we adopted a preferredshare purchase rights plan (the “Rights Plan”) and declared a dividenddistribution of one preferred share purchase right (a “Right”) on eachoutstanding share of our Common Stock. The Rights Plan replaced our priorrights plan which had been originally adopted in 1988 and readopted in 1998prior to its expiration. We have entered into a rights agreement, dated as of November 29,1999, which was amended as of February 15, 2001 to provide for thesubstitution of The Bank of New York as Rights Agent (as amended, the “RightsAgreement”). The Rights are transferred only with the Common Stock, unless anduntil they become exercisable. The Rights will expire on November 29,2009, subject to our right to extend, unless earlier redeemed or exchanged byus or terminated.

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

(i)            acquires beneficialownership of 20% or more of the Common Stock (such person or group, an “AcquiringPerson”), or

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

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

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

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

Prior to a person or group becoming an AcquiringPerson, the Rights are redeemable for $.001 per Right at the option of ourBoard of Directors.

“Hilton Interests” refer to Barron Hilton and theConrad N. Hilton Fund and the shares of Common Stock beneficially owned bythem.

The Rights Agreement, asamended, 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.

**Item 6.   Selected Financial Data**

Thefollowing selected financial data as of and for the years ended December 31,2001 through 2005 has been derived from our consolidated financial statements. Thefollowing data should be read in conjunction with our consolidated financialstatements, the related notes thereto contained under Item 8 and “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” underItem 7.

| ** **                         | ** ** | **Year Ended December 31,**                           | ** ** |
|------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2001**                                                             | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                         | ** ** | **(in millions, except per share amounts)** | ** ** |
| **Results of Operations:**         |       |                                                                 |       |   |   |   |   |   |   |   |   |
| Revenue                            |       | $                                                                    | 3,952      |   | 3,816 |   | 3,819 |   | 4,146 |   | 4,437 |   |
| Net income                         |       | 166                                                                  |       | 198 |   | 164 |   | 238 |   | 460 |   |
| Net income per  share—Basic   |       | .45                                                                  |       | .53 |   | .43 |   | .62 |   | 1.20 |   |
| Net income per  share—Diluted |       | .45                                                                  |       | .53 |   | .43 |   | .60 |   | 1.13 |   |
| **Other  Financial Data:**         |       |                                                                 |       |   |   |   |   |   |   |   |   |
| Dividends per  common share        |       | $                                                                    | .08        |   | .08 |   | .08 |   | .08 |   | .12 |   |
| **Balance  Sheet Data:**           |       |                                                                 |       |   |   |   |   |   |   |   |   |
| Total assets                       |       | $                                                                    | 8,785      |   | 8,348 |   | 8,183 |   | 8,242 |   | 8,743 |   |
| Long-term debt                     |       | 4,950                                                                |       | 4,554 |   | 3,801 |   | 3,633 |   | 3,572 |   |

 

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

**OVERVIEW**

We are engaged in the ownership, management anddevelopment of hotels, resorts and timeshare properties and the franchising oflodging properties. At December 31, 2005, our system contained 2,388properties totaling approximately 375,000 rooms, primarily in the United States.Our brands include Hilton, Hilton Garden Inn, Doubletree, Embassy Suites,Hampton, Homewood Suites by Hilton and Conrad. In addition, we develop andoperate timeshare resorts through Hilton Grand Vacations Company and itsrelated entities. In February 2006, we completed the acquisition of thelodging assets of Hilton Group plc for approximately £3.3 billion, equivalentto approximately $5.78 billion on the transaction date (see “Note 20:Subsequent Events” to the consolidated financial statements under Item 8). Weare also engaged in various other activities related or incidental to theoperation of hotels.

Thenumber of properties and rooms at December 31, 2005 by brand and by typeare as follows:

| **Brand**                  | ** ** | ** ** | ** ** | **Properties** | ** ** | **Rooms** | ** ** | **Type**      | ** ** | ** ** | ** ** | **Properties** | ** ** | **Rooms** | ** ** |
|----------------------------|------------|------------|------------|----------------|------------|-----------|------------|---------------|------------|------------|------------|----------------|------------|-----------|------------|
| Hilton                     |       |       | 234        |           |       | 90,478    |       | Owned(1)      |       |       | 30         |           |       | 22,971    |       |
| Hilton Garden Inn          |       |       | 259        |           |       | 35,523    |       | Leased        |       |       | 6          |           |       | 2,245     |       |
| Doubletree                 |       |       | 160        |           |       | 42,168    |       | Joint Venture |       |       | 54         |           |       | 17,040    |       |
| Embassy Suites             |       |       | 182        |           |       | 44,429    |       |          |       |       | 90         |           |       | 42,256    |       |
| Homewood Suites  by Hilton |       |       | 164        |           |       | 18,133    |       | Managed       |       |       | 210        |           |       | 53,115    |       |
| Hampton                    |       |       | 1,336      |           |       | 134,121   |       | Franchised    |       |       | 2,054      |           |       | 275,350   |       |
| Other                      |       |       | 19         |           |       | 5,869     |       |          |       |       | 2,264      |           |       | 328,465   |       |
| Timeshare                  |       |       | 34         |           |       | 3,948     |       | Timeshare     |       |       | 34         |           |       | 3,948     |       |
| Total                      |       |       | 2,388      |           |       | 374,669   |       | Total         |       |       | 2,388      |           |       | 374,669   |       |

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(1)          Includes majority ownedand controlled hotels.

Our operations consist of three reportable segmentswhich are based on similar products or services: Hotel Ownership, Managing andFranchising, and Timeshare. The Hotel Ownership segment derives earnings fromowned, majority owned and leased hotel properties and equity earnings fromunconsolidated affiliates (primarily hotel and other real estate jointventures). The Managing and Franchising segment provides services includinghotel management and licensing of our family of brands to franchisees. Thissegment generates its revenue from fees charged to hotel owners. As a managerof hotels, we are typically responsible for supervising or operating the hotelin exchange for fees based on a percentage of the hotel’s gross revenue,operating profits, cash flow, or a combination thereof. We charge franchisefees, depending on the brand, of up to five percent of rooms revenue inexchange for the use of one of our brand names. The Timeshare segment consists of multi-unit timeshare resorts. Thissegment sells and finances timeshare intervals and operates timeshare resorts.The hospitality industry is seasonal in nature. However, the periods duringwhich our properties experience higher or lower levels of demand may vary fromproperty to property and depend principally upon location.

Our results are significantly affected by occupancyand room rates achieved by hotels, our ability to manage costs, the relativemix of owned, leased, managed and franchised hotels, the quantity and pricingof timeshare interval sales and the change in the number of available hotelrooms and timeshare intervals through acquisition, development and disposition.Results are also impacted by economic conditions and capacity. Unfavorablechanges in these factors could negatively impact hotel room demand and pricingwhich, in turn, could limit our ability to pass through operating costincreases in the form of higher room rates. Additionally, our ability to managecosts could be adversely impacted by significant increases in operatingexpenses, resulting in lower operating margins. See “Risk Factors” under Item 1Afor a description of these and other conditions that could adversely affect ourresults of operations.

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We anticipate that afavorable economic environment will continue to benefit the lodging industryand our company in 2006. 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 ourmanagement and franchise fee business as the number of hotels in our systemcontinues to increase, as well as strong results from our timeshare business. Increasesin energy and healthcare costs combined with higher property taxes are expectedto continue to put pressure on margins. Increases in construction costs couldresult in downward pressure on the margins achieved by our timeshare business. Ourresults could also be impacted by potential labor disputes involving the hotelindustry and certain of our properties. We will continue to focus on managingour costs, achieving revenue per available room (RevPAR) premiums in themarkets where we operate, increasing occupancy, adding new units to our familyof brands, leveraging technology and delivering outstanding customer service. Webelieve that our focus on these core strategies, combined with our financialstrength, diverse market presence, strong brands, and strategically locatedproperties will enable us to remain competitive.

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requires usto make estimates and assumptions that affect the reported amounts of assetsand liabilities and the disclosure of contingent assets and liabilities at thedate of the financial statements and the reported amounts of revenue andexpenses during the reporting period. We evaluate our estimates and assumptionson an ongoing basis. We base our estimates and judgments on historicalexperience and other factors we believe to be reasonable under thecircumstances, which form the basis for making judgments about the carryingvalue of assets and liabilities that are not readily apparent from othersources.

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

Notes receivable are reflected net of an estimatedallowance for uncollectible amounts. For timeshare notes receivable, thisestimate is based primarily on historical experience and assumptions withrespect to future payment trends. Allowances for uncollectible amounts of othernotes receivable, which includes notes from managed, franchised andunconsolidated joint venture properties, are estimated based primarily onhistorical trends and analysis of underlying real estate collateral. Assessmentof collateral may include estimates of future cash flow from the underlyingreal estate. Total notes receivable, including timeshare, totaled $350 millionand $401 million, net of allowances for uncollectible amounts of $18 millionand $24 million as of December 31, 2004 and 2005, respectively.

Property and equipment are stated at cost lessaccumulated depreciation. We also maintain cost and equity method investmentsin entities that own and operate hotel properties and entities that performother activities related or incidental to the operation of hotels. Theassessment of long-lived assets for possible impairment requires us to makecertain judgments, including estimates of real estate values and future cashflow from the respective properties and investments. We review therecoverability of our long-lived assets when events or changes in circumstancesindicate that the carrying amount of an asset may not be fully recoverable. Resultsin 2003, 2004 and 2005 include pre-tax impairment charges of approximately $4 million,$5 million and $5 million, respectively, to reduce the value of property andequipment and equity method investments to estimated fair value.

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We account for the sale of real estate in accordancewith Statement of Financial Accounting Standards (FAS) 66, “Accounting forSales of Real Estate.”  To the extent werealize gains from the sale of real estate and maintain significant continuinginvolvement in the form of a long-term management contract, the gain isdeferred and recognized in earnings over the term of the contract. The deferralof pre-tax gains on such sales totaled $92 million, $5 million and $236 millionin 2003, 2004 and 2005, respectively. Results in 2003, 2004 and 2005 includethe recognition of pre-tax deferred gains totaling $10 million, $15 million and$23 million, respectively. The deferral of gain recognition is dependenton the structure of individual sale transactions.

Our intangible assets include management and franchisecontracts, leases, brands and goodwill. We account for management and franchisecontracts in accordance with FAS 144 “Accounting for the Impairment or Disposalof Long-Lived Assets,” which requires that we review our management andfranchise contracts for impairment when circumstances indicate that theircarrying amounts may not be recoverable. The values of our management andfranchise contracts and leases are amortized using the straight-line methodover the life of the agreements. The assessment of management and franchisecontracts and leases requires us to make certain judgments, including estimatesof future cash flow from the respective properties. Management and franchisecontracts, net, totaled $336 million and $302 million at December 31,2004 and 2005, respectively. We account for brands and goodwill in accordancewith FAS 142, “Goodwill and Other Intangible Assets,” which requires thatintangible assets with indefinite lives are not amortized, but are reviewedannually for impairment. The annual impairment review requires estimates offuture cash flow with respect to the brands and estimates of the fair value ofour company and its components with respect to goodwill.

We are self-insured for various levels of generalliability, workers’ compensation and employee medical and dental insurancecoverage at our owned locations. We purchase insurance coverage for claimamounts which exceed our self-insured retentions. Depending on the type ofinsurance, these self-insured retentions range from $250,000 to $500,000 perclaim. The undiscounted amount of our self-insurance reserves totaled $148million and $146 million at December 31, 2004 and 2005, respectively. Ourinsurance reserves are accrued based on estimates of the present value ofclaims expected to occur during the covered period. These estimates areprepared with the assistance of outside actuaries and consultants. Ouractuaries periodically review the volume and amount of claims activity, andbased upon their findings, we adjust our insurance reserves accordingly. Theultimate cost of claims for a covered period may differ from our originalestimates. General liability and workers compensation claim estimates arediscounted to determine the present value of projected settlements; thediscount rates used in the 2003 through 2005 program years were approximately3.0% to 4.25%, which we considered reasonable based on claims settlementpatterns. Since medical and dental claims are generally paid within severalmonths, we do not discount the related insurance reserves.

We have issued letters of credit and guaranteedcertain debt and obligations of unconsolidated affiliates and third partiestotaling $127 million at December 31, 2005. Under certain circumstances,we may be obligated to provide additional letters of credit or guaranteestotaling $6 million. Assessment of the probability that we will be required tofund under these commitments requires us to make estimates of the ability ofothers to meet their obligations.

The estimates andassumptions related to notes receivable, long-lived assets, intangible assets,commitments and self-insurance reserves are subject to change based on thefactors identified above. We believe our estimates and assumptions arereasonable and have resulted in accurate measurement of the related accounts inour historical financial statements in conformity with accounting principles generallyaccepted in the United States. Because estimates are used, it is reasonablylikely that there will be some variability between projected results and actualresults over time. In addition, given the significance of these accounts to ourconsolidated financial position, the variability between projected and actualresults could be material to our financial position or results of operations.

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**DEVELOPMENT AND CAPITAL SPENDING**

***Overview***

In February 2006, we completed the acquisition ofthe lodging assets of Hilton Group plc for approximately £3.3 billion,equivalent to approximately $5.78 billion on the transaction date. The all cashtransaction was financed with existing cash on hand at the time of the closingand with borrowings under our new senior credit facilities (see “Liquidity andCapital Resources—Financing” and “Note 20: Subsequent Events” to theconsolidated financial statements under Item 8).

We also intend to grow our hotel system throughfranchising and the addition of management contracts, which require little orno capital investment. We will also continue to invest in capital improvementsand select projects at our owned hotels and the development of timeshareproperties. In addition, we may seek to acquire ownership interests in hotelproperties on a strategic and selective basis, either directly or throughinvestments in joint ventures.

During 2005, we added a total of 175 properties,primarily franchises, with approximately 25,000 rooms to our system. A total of46 properties, primarily franchises, with approximately 8,000 rooms wereremoved from our system in 2005. We expect to add approximately 200 hotels and28,000 rooms to our hotel system in 2006, with Hampton and Hilton Garden Innaccounting for most of the new development. We expect virtually all of thisgrowth to be through franchise and management agreements. This growth excludespotential new international development opportunities as a result of the HIAcquisition.

We believe our brand growth strategy continues tobenefit from the significant market share premiums most of our brands commandover their respective competitive sets. With 100 representing a brand’s fairshare of the market, our brands (according to Smith Travel Research) postedrevenue per available room (RevPAR) index numbers as follows for 2005: EmbassySuites, 119.7; Hampton, 118.1; Hilton Garden Inn, 112.5; Homewood Suites byHilton, 111.8; Hilton, 108.8; and Doubletree, 97.3.

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

We believe the continued strong performance of ourbrands has enabled us to significantly enhance our development pipeline versusour industry competitors. We had approximately 600 hotels, primarilyfranchises, with 78,000 rooms in our development pipeline at December 31,2005, excluding potential development associated with the HI Acquisition. Theconsummation of transactions in our development pipeline is subject to variousconditions and uncertainties.

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

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We will continue to reviewour owned hotel portfolio for potential repositioning or re-brandingopportunities (see “Liquidity and Capital Resources—Acquisitions andDispositions”) and we may seek to sell certain assets, including assetsacquired in the HI Acquisition (see “Note 20: Subsequent Events” to theconsolidated financial statements under Item 8). It is our intention to beopportunistic when evaluating potential asset sales and we will look to sellparticular hotel properties to the extent we can obtain premium prices. We arecurrently marketing for sale certain of our owned hotels. As discussed in “Note3: Acquisitions and Dispositions” to the consolidated financial statementsunder Item 8, until the necessary approvals have been received and substantiveconditions to the buyer’s obligation to perform have been satisfied, we do notconsider a sale to be probable. When we sell a hotel property, it is generallyour preference to retain a management or franchise agreement; however, we maysell hotels without retaining our brand.

***Hotel Ownership***

Capital expendituresduring 2005, excluding timeshare projects, totaled $423 million. Excluding the$180 million to purchase land on Hawaii’s Big Island, as discussed in “Note 3:Acquisitions and Dispositions” to the consolidated financial statements underItem 8, our capital expenditures were $243 million, consisting primarilyof routine improvements at our owned and leased hotels. We continue to place apriority on making appropriate capital expenditures to maintain and upgrade ourowned assets. During 2005, we spent approximately $43 million to upgrade thebedding and televisions at our owned and leased hotels.

***Managing and Franchising***

Total property additions to our system in 2005included 163 franchise properties and nine managed properties owned by thirdparties. These additions included 34 properties which, due in part to themarket share leadership of our brands, were converted to our family of brandsin 2005. The 34 conversions included 17 Doubletrees, seven Hiltons, four HiltonGarden Inns, two Hamptons, two Homewood Suites, one Embassy Suites and oneConrad.

In the first quarter of 2005, we announced aninitiative with HI, formerly a wholly-owned subsidiary of Hilton Group plc, andnow a wholly-owned subsidiary of ours (see “Note 20: Subsequent Events” to theconsolidated financial statements under Item 8), to develop the luxury Conradbrand on a global basis. The growth in the Conrad brand will continue to beprimarily through management agreements, including a new luxury property inChicago (opened fourth quarter 2005), a new hotel in downtown Indianapolis(scheduled 2006 opening) and a new Conrad hotel on the Las Vegas Strip(scheduled 2008 opening). In the third quarter of 2005, Conrad announced thesigning of a management contract for a 320-room luxury property inJakarta, Indonesia, scheduled to open in 2008. We also hold a 10 percentinvestment in the partnership that is developing the Conrad Jakarta.

In early 2006, weintroduced a new brand, the Waldorf=Astoria Collection. This new, elite branddesignation debuts with New York’s legendary Waldorf=Astoria, along with threeworld-class luxury resorts newly managed by Hilton: the Grand Wailea ResortHotel & Spa on the island of Maui in Hawaii; the Arizona BiltmoreResort & Spa in Phoenix, and La Quinta Resort & Club in LaQuinta, California. We anticipate that the Waldorf=Astoria Collection will growprimarily through branding of existing landmark or boutique hotels, co-brandingof existing Hilton and Conrad hotels and opening newly built properties inselect cities.

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***Timeshare***

We are currently developing new timeshare projects inLas Vegas, Nevada, Orlando, Florida and Waikoloa, Hawaii. The Waikoloa projectis expected to have 120 units, of which 22 units opened in 2005, with theremaining units scheduled for completion in spring 2006. At our InternationalDrive property in Orlando (Tuscany Village), the project has 236 units open,representing four phases. Construction is continuing on the next 70 units,which are scheduled to open in spring 2006. Also in Orlando, we are adding 48units to our existing property adjacent to Sea World. The second phase of ourproperty on the Las Vegas Strip, which consists of 423 units, is on schedulefor completion in summer 2006. Upon the opening of phase two, approximately 44%of the planned four-tower, 1,582-unit project will have been completed.

Capital expendituresassociated with our timeshare operations during 2005 totaled $179 million. Thecapital expenditures associated with our non-lease timeshare products arereflected as inventory until the timeshare intervals are sold. We also providefinancing to the buyers of our timeshare intervals. During 2005, we issuedapproximately $292 million of loans related to timeshare financings. Principalcollections on timeshare notes during the same period were approximately $193million.

**LIQUIDITY AND CAPITAL RESOURCES**

***Overview***

Net cash provided by operating activities totaled $380million, $548 million and $486 million for the years ended December 31,2003, 2004 and 2005, respectively. The net decrease in 2005 relates primarilyto net cash used by timeshare construction in excess of timeshare sales and areduction in deferred income taxes resulting from the sale of assets in 2005. Thesedecreases were partially offset by improved operating results. The net increasein 2004 compared to 2003 was due primarily to improved operating results andnet cash provided by timeshare sales in excess of new timeshare constructionduring the 2004 year. The increase in cash from operating activities alsoreflected timing differences resulting in an increased minimum pensionliability and the deferral of revenue on timeshare sales. These increases werepartially offset by increases in restricted cash and an increase in the net balanceof timeshare notes receivable.

Net cash provided by operating activities in 2003,2004 and 2005 each benefited from a reduction in the valuation allowance forcapital loss tax carryforwards and other items which reduced the provision forincome taxes (See “Liquidity and Capital Resources—Acquisitions andDispositions” and “Note 12: Income Taxes” to the consolidated financialstatements under Item 8). Our ability to utilize capital loss tax carryforwardsto reduce our provision for income taxes is dependent on the availability ofcapital loss tax carryforwards and the existence of transactions that enablethese capital loss carryforwards to be utilized. Therefore, it should not beassumed that such benefits will be available to us in the future.

Net cash used in investing activities totaled $132million in 2004 and net cash provided by investing activities totaled $620million in 2005. The increase in net cash provided by investing activities wasprimarily due to an increase in net proceeds from asset dispositions in 2005compared to the prior year, partially offset by higher capital expenditures. Netcash provided by investing activities totaled $60 million in 2003 compared tonet cash used in investing activities of $132 million in 2004. The increase innet cash used in investing activities in 2004 was primarily due to reducedproceeds from asset dispositions in 2004 compared to 2003, as well as anincrease in additional investments in 2004 over the prior year. This increasein net cash used was partially offset by higher payments received onnon-timeshare notes receivable in 2004.

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Net cash used in financing activities totaled $451million, $122 million and $255 million in 2003, 2004 and 2005, respectively. Theincrease in 2005 reflects increased share repurchases and lower proceeds fromthe issuance of common stock, reflecting a lower volume of stock optionexercises, partially offset by a lower level of debt repayments in the 2005period. All amounts outstanding under our revolving credit facility were repaidin the second quarter of 2004. Net cash used in financing activities in 2003and 2004 primarily represents the repayment of long-term debt in excess ofadditional long-term borrowings. The decrease in net cash used in financingactivities in 2004 compared to 2003 reflects a lower level of debt repayment inthe 2004 period once the revolving credit facility was repaid, and higherproceeds from the issuance of common stock in 2004, reflecting a higher volumeof stock option exercises. This combined decrease in the net cash used infinancing activities was partially offset by share repurchases in 2004.

Our ratio of earnings to fixed charges for the yearsended December 31, 2003, 2004 and 2005 was 1.6x, 2.2x and 3.1x,respectively.

Cash and equivalentstotaled $1.154 billion at December 31, 2005, an increase of $851 millionfrom December 31, 2004. The increase in cash and equivalents is dueprimarily to the assets dispositions and increased operating results during2005 over the previous year. In February 2006, we used approximately $850million of cash to partially fund the purchase of the lodging assets of HiltonGroup plc (see “Note 20: Subsequent Events” to the consolidated financialstatements under Item 8 and “Liquidity and Capital Resources—Financing”). Restrictedcash totaled $182 million at December 31, 2005, an increase of $19 millionfrom the prior year. Restricted cash includes cash related to certainconsolidated hotels, the use of which is restricted for hotel purposes underthe terms of collateralized borrowings; refundable deposits on the sale oftimeshare intervals; and cash balances held by a consolidated non-controlledentity. We believe that our operating cash flow, available borrowings under ourrevolving credit facilities and our ability to obtain additional financingthrough various financial markets are sufficient to meet our liquidity needs(see “Liquidity and Capital Resources—Financing”). However, any projections offuture financial needs and sources of working capital are subject touncertainty. See “Results of Operations” below, “Additional Information—Forward-LookingStatements” under Item 1 and “Risk Factors” under Item 1A for further discussionof conditions that could adversely affect our estimates of future financialneeds and sources of working capital.

***Financing***

At December 31, 2005, we had a $1 billionrevolving credit facility, with an option to increase the size of the facilityby an additional $250 million. This facility was amended in the first quarterof 2005. The amendment lowered our all-in cost of borrowing under this facilityby 50 basis points from LIBOR plus 125 basis points to LIBOR plus 75 basispoints and extended the facility until March 2010. There were no amountsoutstanding under the revolving credit facility at December 31, 2005. Thecapacity under our revolver was also used to support certain outstandingletters of credit. Total revolving debt capacity of approximately $855 millionwas available to us at December 31, 2005.

In connection withthe HI Acquisition in February 2006 (see “Note 20: Subsequent Events” tothe consolidated financial statements under Item 8), we entered into new seniorcredit facilities in an aggregate principal U.S. dollar equivalent amount ofapproximately $5.75 billion with a syndicate of financial institutions. Thesefacilities replaced our $1 billion revolving credit facility and are secured bya pledge of the capital stock of certain of our wholly-owned subsidiaries. Thecredit facilities consist of the following three tranches:

·       U.S.Dollar Denominated Revolver—5 year, $3.25 billion available in U.S. dollars,British Pounds Sterling, Euros and Swedish Kronor or other currenciesacceptable to the administrative agent. Interest at a variable rate dependingupon our leverage ratio and senior debt ratings, with initial borrowings atLIBOR plus 150 basis points (which includes a 25 basis point annual facilityfee).

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·       ForeignCurrency Denominated Term Loan A—5 year, approximate equivalent of $2 billionto be denominated in £675 million, €675 million and Australian$140 million. Interest at a variable rate depending upon our leverage ratio andsenior debt ratings, with initial borrowings at LIBOR plus 150 basis points.

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

We also have the option to increase the creditfacilities by $500 million.

In February 2006, we borrowed an aggregateprincipal U.S. dollar equivalent amount of approximately $4.8 billion underthese facilities to partially fund the HI Acquisition.

Subsequent to our announcement in December 2005of our agreement to acquire the lodging assets of Hilton Group plc,Standard & Poor’s Ratings Group lowered our senior debt rating fromBBB- to BB. In addition, Moody’s Investor Services lowered our senior debtrating from Baa3 to Ba2. These downgrades are reflected in the interest rates andfacility fee of our new $5.75 billion credit facilities. Under the terms of thecredit facilities, the proceeds from the sale of certain owned propertiesacquired as part of the HI Acquisition are required to be used for therepayment of our senior credit facilities. In addition, we expect that excesscash flow will be used to repay outstanding debt balances to improve our creditposition.

Provisions under various loan agreements require us tocomply with certain covenants which include limiting the amount of ouroutstanding indebtedness. Our revolving credit facility at December 31,2005, contained two significant financial covenants: a leverage ratio and adebt service coverage ratio. We were in compliance with our financial covenantsas of December 31, 2005.

In October 1997, we filed a shelf registration statementwith the Securities and Exchange Commission registering up to $2.5 billion indebt or equity securities. At December 31, 2005, available financing underthe shelf totaled $825 million. The terms of any additional securities offeredunder the shelf will be determined by market conditions at the time ofissuance.

Provisions of the financing agreement related to our7.95% collateralized borrowings due 2010 require that certain cash reserves bemaintained and also restrict the transfer of excess cash generated by therelated properties from the subsidiary hotels to the parent company if net cashflow falls below a specified level (the cash trap). The cash trap becameeffective in 2003 due to reduced cash flow from the collateralized properties,primarily the Hilton San Francisco. As of December 31, 2005, cashrestricted under the terms of the collateralized borrowings, including requiredreserves and the cash trap, totaled $146 million. The impact of the cash trap,which is expected to remain in effect throughout 2006, is not expected to havea material impact on our liquidity.

As of December 31, 2005, approximately 13% of ourlong-term debt, including the impact of interest rate swaps, was floating ratedebt.

Thefollowing table summarizes our significant contractual obligations as of December 31,2005, including long-term debt and operating lease commitments:

| ** **                                      | ** ** | ** ** | ** ** | **Payments Due by Period** | ** ** |
|-------------------------------------------------|------------|------------|------------|-------------------------------------------|------------|
| **Contractual Obligations (in  millions)** | ** ** | ** ** | ** ** | **Total**                                 | ** ** | **Less than  1 year** | ** ** | **1 – 3  years** | ** ** | **4 – 5  years** | ** ** | **After  5 years** | ** ** |
| Long-term debt                                  |       | $          | 3,619      |                                      |       | 47 |   |   |   | 883 |   |   |   | 921 |   |   |   | 1,768 |   |   |
| Operating leases                                |       | 420        |       |                                      | 31         |   |   |   | 57 |   |   |   | 51 |   |   |   | 281 |   |   |
| Total contractual obligations                   |       | $          | 4,039      |                                      |       | 78 |   |   |   | 940 |   |   |   | 972 |   |   |   | 2,049 |   |   |
|                                                 |            |            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Total debt decreased by $28 million from December 31,2004 to $3.619 billion at December 31, 2005. This decrease was primarilydue to the repayment of two mortgages on one hotel sold during the 2005 secondquarter. Operating lease commitments decreased by $289 million from December 31,2004 to $420 million at December 31, 2005 primarily due to the purchase ofland on which the Hilton Waikoloa Village is located (see “Note 3: Acquisitionsand Dispositions” to the consolidated financial statements under Item 8). Wehad previously leased this land pursuant to an agreement expiring in 2061. Inaddition, during the 2005 fourth quarter, we sold the Hilton San Diego whichwas subject to a long-term ground lease.

As a result ofimplementing FASB Interpretation Number (FIN) 46R “Consolidation of VariableInterest Entities” in 2004, our consolidated balance sheets as of December 31,2004 and 2005 include the assets and liabilities of a non-controlled managedhotel, including $100 million of debt that is non-recourse to us. This amountis reflected on our consolidated balance sheet as non-recourse debt ofnon-controlled entity and is excluded from the contractual obligations table(see “Note 4: Variable Interest Entities” in the notes to the consolidatedfinancial statements under Item 8).

***Development Financing and Other Commercial Commitments***

Thefollowing table summarizes our development financing and other commercialcommitments as of December 31, 2005: 

| ** **                                              | ** ** | ** ** | ** ** | **Amount of Commitment Expiration  Per Period** | ** ** |
|---------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------|------------|
| **Commercial Commitments (in millions)** | ** ** | ** ** | ** ** | **Total**                                                           | ** ** | **Less than  1 year** | ** ** | **1 – 3  years** | ** ** | **4 – 5  years** | ** ** | **After  5 years** | ** ** |
| Letters of credit                                       |       | $          | 56         |                                                                |       | 56 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Guarantees                                              |       | 71         |       |                                                                | 57         |   |   |   | 10 |   |   |   | 2 |   |   |   | 2 |   |   |
| Total  commercial commitments                           |       | $          | 127        |                                                                |       | 113 |   |   |   | 10 |   |   |   | 2 |   |   |   | 2 |   |   |
|                                                         |            |            |            |                                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See “Note 18: Commitments and Contingencies” to theconsolidated financial statements under Item 8, for further discussion ofour development financing and other commercial commitments.

***Acquisitions and Dispositions***

During 2005 we sold 20 owned or majority owned hotels,as well as our minority interests in several hotel joint ventures. In thesecond quarter of 2005, we completed two transactions involving the acquisitionof land on Hawaii’s Big Island for $180 million. See “Note 3: Acquisitions andDispositions” to the consolidated financial statements under Item 8, forfurther discussion of these transactions.

In February 2006, wecompleted the acquisition of the lodging assets of Hilton Group plc. See “Note20: Subsequent Events” to the consolidated financial statements under Item 8for further information.

***Stockholders’ Equity***

In the 2005 third quarter, our Board of Directorsapproved an increase to our common stock dividend of $.02 per share to $.04 pershare. Annual dividends paid on common shares were $.08, $.08 and $.12 pershare in 2003, 2004 and 2005, respectively.

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During 2005, werepurchased approximately 12.3 million shares of our common stock at atotal cost of approximately $271 million. The timing of stock purchases is madeat the discretion of management. We did not repurchase any shares in the secondhalf of 2005 because we were engaged in discussions with Hilton Group plcregarding a potential acquisition of their lodging business (see “Note 20:Subsequent Events” to the consolidated financial statements under Item 8). In2004 we repurchased approximately 2.3 million shares of our common stockat a total cost of approximately $48 million. In March 2005, we announcedthat our Board of Directors authorized the repurchase of up to an additional 50million shares of common stock. As of December 31, 2005, approximately44.7 million shares remained authorized for repurchase under this authority.

**OFF-BALANCE SHEET ARRANGEMENTS**

We have outstandingguarantees issued in connection with our development financing programs andother guarantees of debt and other obligations of unconsolidated affiliates andthird parties, as well as commitments under letters of credit. See “Note 18:Commitments and Contingencies” to the consolidated financial statements underItem 8, for more information. We maintain investments in unconsolidatedaffiliates, including hotel joint ventures as well as other entities thatsupport the operations of our hotel properties. We do not have investments inor obligations with respect to unconsolidated special purpose entities and wehave not entered into synthetic leasing arrangements.

**RESULTS OF OPERATIONS**

The following discussionpresents an analysis of our results of operations for the three years ended December 31,2005. Our operations consist of three reportable segments which are based onsimilar products or services: Hotel Ownership, Managing and Franchising, andTimeshare.

**FISCAL2005 COMPARED WITH FISCAL 2004**

***Overview***

Asummary of our consolidated results for the years ended December 31, 2004and 2005 is as follows:

| ** **       | ** ** | **2004**                                                             | ** ** | **2005** | ** ** | **% Change** | ** ** |
|------------------|------------|----------------------------------------------------------------------|------------|----------|------------|-------------------|------------|
| ** **       | ** ** | **(in millions, except per share amounts)** | ** ** |
| Revenue          |       | $                                                                    | 4,146      |     | 4,437      |              |       | 7 | % |   |
| Operating income |       | 658                                                                  |       | 805      |       |              | 22         |   |   |
| Net income       |       | 238                                                                  |       | 460      |       |              | 93         |   |   |
| Basic EPS        |       | .62                                                                  |       | 1.20     |       |              | 94         |   |   |
| Diluted EPS      |       | .60                                                                  |       | 1.13     |       |              | 88         |   |   |
|                  |            |                                                                      |            |          |            |                   |            |  |  |  |

 

Results in 2005 benefited from strong increases inroom nights and average daily rate (ADR) across all business segments, withparticularly strong increases in ADR, resulting in double-digit RevPAR growthand margin improvement at many of our comparable owned hotels. Management andfranchise fee revenue was our highest to date, increasing 18 percent over theprior year as a result of RevPAR growth and the addition of new units. Resultsin 2005 also benefited from strong results at our timeshare business. Netincome in 2005 also benefited from gains associated with the sale of ownedhotels and a reduction in the provision for income taxes. Revenue growth wasadversely impacted by the aforementioned asset sales and the impact ofHurricane Katrina on our two owned hotels in New Orleans.

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Revenue from owned hotels totaled $2.049 billion in2005, a one percent decrease from $2.062 billion in 2004, and total expenses in2005 were down three percent to $1.459 billion. Strong results at ourcomparable owned hotels were partially offset by the impact of asset sales andHurricane Katrina. Our two owned hotels in New Orleans are excluded from thecomparable numbers due to interruptions in operations caused by the hurricane. See“Note 19: Hurricane Katrina” to the consolidated financial statements underItem 8. Excluding the impact of assets sales and our two owned hotels in NewOrleans, owned hotel revenue in 2005 was up 10 percent to $1.670 billion from$1.519 billion in 2004, while owned hotel expenses increased seven percent to$1.190 billion from $1.109 billion in 2004.

Results at our comparable owned properties benefitedfrom continued strong demand and average rate increases from groups, businessand leisure travelers, including double-digit rate and RevPAR increases fromthe leisure and business segments. Results in New York and Hawaii wereparticularly strong in 2005. Strong results were also reported at our ownedhotels in Boston, Washington D.C. and Atlanta, while San Francisco remainedcomparably weak. RevPAR for comparable owned properties increased 11.9 percentfor the year, with occupancy rising 2.2 points to 77.3 percent and averagedaily rate up 8.7 percent to $178.35. Approximately 75 percent of the RevPARincrease at the comparable owned hotels was attributable to rate gains.

While strong RevPAR increases led to solid growth inrooms revenue, other comparable owned hotel revenue also performed well, withfood and beverage revenue increasing seven percent over 2004. Group roomnights, which typically generate higher margin food and beverage business, wereup two percent at our comparable owned hotels. Margins at our comparable ownedhotels (revenue less expenses as a percentage of revenue for comparable ownedhotels) improved 180 basis points in 2005 to 28.8 percent.Cost-per-occupied-room increased 4.5 percent in 2005, reflecting a 17 percentincrease in energy costs.

Leased hotel revenue totaled $111 million in 2005,consistent with 2004, while leased hotel expenses decreased two percent to $99million. Due to the relatively large size of the lease payments required in ahotel operating lease, the leased properties operate at margins significantlylower than our owned hotels. Leased hotel revenue and expenses are includedwith our owned hotels in our Hotel Ownership segment results.

Operating income from unconsolidated affiliatesdecreased $5 million in 2005 to $44 million. The decrease relates primarily toa $10 million pre-tax gain in the 2004 period, resulting from a joint venturethat developed a condominium project in Myrtle Beach, South Carolina. Thisdecrease was partially offset by improved results at joint venture propertiesand the termination or sale of certain joint venture interests that generatedlosses in 2004. Operating income from unconsolidated affiliates is included inour Hotel Ownership segment results.

Management and franchise fee revenue increased $68million or 18 percent to a record $452 million in 2005. Fee revenue is basedprimarily on rooms revenue at franchise properties and total operating revenue(and to a lesser extent gross operating profits or cash flow) at managedproperties. The strong demand among business, groups and leisure travelers thatbenefited our owned hotels also resulted in strong RevPAR gains for each of ourbrands on a system-wide basis (including managed and franchised properties).The increase in management and franchise fees in 2005 also reflects theaddition of new units to our system of hotels.

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Revenue from our timeshare operations (included intimeshare and other income) totaled $554 million, an increase of $133million or 32 percent from $421 million in 2004. Timeshare expenses in 2005(included in other operating expenses) were $420 million compared to $316million in the prior year. Timeshare revenue and earnings are generated throughdeveloping timeshare resorts and selling the related intervals, financing thesale of timeshare intervals and through management of timeshare resorts. Overalltimeshare unit sales were up eight percent in 2005, reflecting continued strongsales at our projects in Hawaii, Las Vegas and Orlando. The average unit salesprice increased two percent across the system. Timeshare revenue andprofitability also benefited from higher resort fees and higher financingincome due to increased sales. Timeshare results in 2005 also reflect therecognition of previously deferred revenue and expenses at our Waikoloaproject, due to the required percentage-of-completion accounting. Constructionat the Waikoloa project was approximately 75 percent complete at the end of2005. In contrast, construction was not beyond a preliminary stage at the endof 2004.

Depreciation and amortization expense decreased $31million in 2005 to $299 million, primarily due to asset sales and loweramortization expense related to certain long-term management and franchiseagreements that were either terminated or expired.

Results in 2005 includeimpairment loss and related costs totaling $7 million, which includes a pre-taxcharge of $2 million related to an owned hotel and a $3 million pre-tax chargerelated to our minority interests in eight joint venture hotels to reduce theirrespective carrying values to their estimated fair values. The 2005 charge alsoincludes a $2 million pre-tax charge representing the write down of a non-hotelcost basis investment to its estimated fair value. The $5 million impairmentcharge is included in our Hotel Ownership segment results, while the $2 millioncharge on the non-hotel investment is not allocated among our reportablesegments. Results in 2004 include impairment loss and related costs totaling $5million. This pre-tax charge was to reduce the value of an owned hotel to itsestimated fair value and is included in Hotel Ownership segment results.

***Corporate Activity***

Corporate expense totaled $103 million in 2005, anincrease of $18 million from 2004. The increase is primarily the result ofincreased expense associated with stock-based compensation, increased hotelteam member performance awards and contributions to Hurricane Katrina reliefefforts. Corporate expense is not allocated among our reportable businesssegments.

Interest and dividend income increased $6 millioncompared to the prior year. This increase reflects an increase in cashmanagement activities, reflecting higher cash balances in 2005 due primarily toproceeds from asset sales. This increase was partially offset by lower interestincome due to the repayment by Caesars Entertainment, Inc. of the $325million 7% Senior Notes in July 2004. Interest on the notes is reflectedas both interest income and interest expense in our consolidated statements ofincome through repayment in July 2004. Interest expense, net of amountscapitalized, decreased $15 million compared to 2004, due primarily to theaforementioned repayment by Caesars.

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The $103 million gain on asset dispositions and otherin 2005 includes gains from asset sales of $112 million (see “Note 3:Acquisitions and Dispositions” to the consolidated financial statements underItem 8), a $10 million loss on our foreign currency options (see “Note 2:Summary of Significant Accounting Policies—Derivative Instruments” to theconsolidated financial statements under Item 8) based on the market value ofthe options at December 31, 2005, and a $3 million gain on our oil futuresderivative (see “Note 2: Summary of Significant Accounting Policies—DerivativeInstruments” to the consolidated financial statements under Item 8) based onthe market value of the contract at December 31, 2005. Also included in2005 is a net loss of $1 million related to the write-off of several long-termmanagement and franchise agreements which were terminated during the year and a$1 million loss on the disposition of other fixed assets. The $5 millionpre-tax loss on asset dispositions and other in 2004 represents the sale of twoDoubletree properties, the write off of the value assigned to several long-termmanagement and franchise agreements which were terminated during the year and aloss due to the fair market value adjustment of our derivative instruments,partially offset by the gain from the sale of certain investments.

The loss from non-operating affiliates of $6 millionand $17 million in 2004 and 2005, respectively, represents equity lossesassociated with our 24 percent minority interest in a coal-based synthetic fuelfacility. The synthetic fuel produced at this facility qualifies for taxcredits based on Section 29 of the Internal Revenue Code; these creditsreduce our provision for income taxes (see “Note 3: Acquisitions andDispositions” to the consolidated financial statements under Item 8). Weacquired our minority interest in August 2004, which results in thecomparably low amount in the prior year.

The effective income tax rate for 2005 decreased to26% from 34% in 2004. The effective rate in 2005 includes a benefit of $28million resulting from closures of IRS audits, a reduction in the valuationallowance for capital loss tax carryforwards totaling $34 million associated withasset sales and the utilization of Section 29 synthetic fuel productioncredits of approximately $17 million. The 2005 effective tax rate also includesnet state tax credits of approximately $2 million. The effective tax rate in2004 benefited from a reduction in the valuation allowance for capital loss taxcarryforwards of approximately $7 million resulting from the sale of threeDoubletree properties (La Posada in Arizona, as well as Bakersfield and Modestoin California) and the sale of our interest in Travelweb. In addition, the 2004effective tax rate also reflects the utilization of Section 29 syntheticfuel production credits of approximately $7 million. Excluding theaforementioned items, our effective rate was 39% in 2005 and 38% in 2004. Oureffective tax rate is determined by the level and composition of pre-tax incomeand the mix of income subject to varying foreign, state and local taxes.

Minority andnon-controlled interests expense, net, increased $4 million to $12 million in2005, reflecting a distribution to our minority partner on the sale of theHilton Glendale (see “Note 3: Acquisitions and Dispositions” to theconsolidated financial statements under Item 8).

36

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***Hotel Statistics***

RevPARfor U.S. owned hotels and system-wide for the years ended December 31,2004 and 2005 is as follows:

| ** ** | ** ** | **U.S. owned(1)** | ** ** |
|------------|------------|------------------------|------------|
| ** ** | ** ** | **2004**               | ** ** | **2005** | ** ** | **% Change** | ** ** |
| Hilton     |       | $                      | 128.32     |   | 144.00 |   | 12.2 | % |
| All other  |       | 84.58                  |       | 91.45 |   | 8.1 |   |
| Total      |       | 123.24                 |       | 137.90 |   | 11.9 |   |
|            |            |                        |            |  |  |  |  |  |

----

(1)          Statisticsare for comparable U.S. hotels, and include only hotels in the system as ofDecember 31, 2005 and owned by us since January 1, 2004. Comparable hotelsexclude our owned hotels in New Orleans due to the interruptions in operationsas a result of Hurricane Katrina.

| ** **                 | ** ** | **System-wide(2)** | ** ** |
|----------------------------|------------|--------------------|------------|
| ** **                 | ** ** | **2004**           | ** ** | **2005** | ** ** | **% Change** | ** ** |
| Hilton                     |       | $                  | 90.06      |   | 100.68 |   | 11.8 | % |
| Hilton Garden Inn          |       | 68.14              |       | 74.47 |   | 9.3 |   |
| Doubletree                 |       | 69.78              |       | 77.01 |   | 10.4 |   |
| Embassy Suites             |       | 87.01              |       | 95.09 |   | 9.3 |   |
| Homewood Suites  by Hilton |       | 70.93              |       | 76.05 |   | 7.2 |   |
| Hampton                    |       | 56.00              |       | 62.22 |   | 11.1 |   |
| Other                      |       | 95.33              |       | 106.33 |   | 11.5 |   |
|                            |            |                    |            |  |  |  |  |  |

----

(2)          Statisticsare for comparable hotels, and include only hotels in the system as of December31, 2005 and owned, operated or franchised by us since January 1, 2004.Comparable hotels exclude our owned hotels in New Orleans due to theinterruptions in operations as a result of Hurricane Katrina.

**FISCAL2004 COMPARED WITH FISCAL 2003**

***Overview***

Asummary of our consolidated results for the years ended December 31, 2003and 2004 is as follows:

| ** **       | ** ** | **2003**                                                             | ** ** | **2004** | ** ** | **% Change** | ** ** |
|------------------|------------|----------------------------------------------------------------------|------------|----------|------------|-------------------|------------|
| ** **       | ** ** | **(in millions, except per share amounts)** | ** ** |
| Revenue          |       | $                                                                    | 3,819      |     | 4,146      |              | 9          | % |
| Operating income |       | 515                                                                  |       | 658      |       | 28                |       |
| Net income       |       | 164                                                                  |       | 238      |       | 45                |       |
| Basic EPS        |       | .43                                                                  |       | .62      |       | 44                |       |
| Diluted EPS      |       | .43                                                                  |       | .60      |       | 40                |       |
|                  |            |                                                                      |            |          |            |                   |            |  |

 

Results in 2004 benefited from RevPAR growth at ourcomparable owned hotels due to increased demand from both business travelersand group business, combined with continued strong demand from leisuretravelers. This shift in the mix of business to higher rated room nights frombusiness travelers and groups resulted in increased pricing power in 2004. Feeincome increased in 2004 as a result of RevPAR growth at managed and franchisedhotels and the addition of new units. Results in 2004 also benefited fromstrong results at our timeshare business and lower interest expense. Overallresults in 2003 were adversely impacted by business declines related to theconflict in Iraq and a soft U.S. economy. In addition, 2003 was negativelyimpacted by a pre-tax impairment charge totaling $22 million and cost increasesat our owned hotels.

37

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Results in 2004 also reflect the implementation of FIN46R, which resulted in the consolidation of a previously unconsolidated managedhotel, effective January 1, 2004. The implementation of FIN 46R resultedin an increase in other revenue and expenses from managed and franchisedproperties and certain other expenses in 2004. However, it had no impact onreported net income or net income per share.

Revenue from owned hotels totaled $2.062 billion in2004, a two percent increase from $2.031 billion in 2003, and total expenses in2004 were flat with 2003 at $1.501 billion. Strong results at our comparableowned hotels were partially offset by the impact of asset sales. Excluding theimpact of assets sales, owned hotel revenue increased seven percent from $1.893billion in 2003 to $2.026 billion in 2004, while owned hotel expenses increasedfive percent from $1.398 billion in 2003 to $1.473 billion in 2004.

Results at our comparable owned properties improvedcompared to 2003 due to business and group travel gains, combined with strongleisure demand. The more favorable mix of business helped drive an increase inaverage rate, particularly in the latter half of the year. The strong groupbusiness also led to an increase in food and beverage profits in 2004. Resultsat our owned hotels in 2004 also benefited from our continued focus on costs. Cost-per-occupied-roomincreased less than one percent in 2004. Profitability at our owned hotels in2003 was negatively impacted by the aforementioned soft U.S. economy andreduced travel as a result of the conflict in Iraq, along with increasedhealthcare, insurance and property tax costs. Margins at our comparable ownedhotels improved 110 basis points compared to the prior year.

RevPAR for comparable owned properties increased 6.8percent for the year, with occupancy rising 2.6 points to 73.3 percent andaverage daily rate up 3.1 percent to $153.72. Our owned properties in Boston,New York and Hawaii achieved particularly strong results in 2004. Asanticipated, our owned properties in downtown Chicago posted weaker resultscompared to 2003 due to a reduction in the number of citywide conventions inthis market. Excluding the impact of Chicago from both periods, RevPAR forcomparable owned properties increased 8.2 percent in 2004.

Leased hotel revenue totaled $111 million in 2004, aneight percent increase compared to 2003, while leased hotel expenses increasedfive percent to $101 million. Operating income from unconsolidated affiliatesincreased $15 million in 2004 to $49 million. The increase is primarily theresult of $10 million in pre-tax earnings from a joint venture that developed a251-unit condominium project in Myrtle Beach, South Carolina. The projectclosed on the sale of all units in the third quarter of 2004. Operating incomefrom unconsolidated affiliates also benefited from improved results at ourjoint venture hotel properties.

Management and franchise fee revenue in 2004 increased$47 million or 14 percent to $384 million. The strong demand among business,groups and leisure travelers that benefited our owned hotels also resulted instrong RevPAR gains for each of our brands on a system-wide basis (includingmanaged and franchised properties). The increase in management and franchisefees in 2004 also reflects the addition of new units to our system of hotels.

Revenue from our timeshare operations totaled $421million, an increase of $76 million from $345 million in 2003, whiletimeshare expenses in 2004 totaled $316 million, an increase of $57 millionfrom $259 million in the prior year. Overall timeshare unit sales were up 35percent in 2004, with robust sales at our projects in Hawaii, Las Vegas andOrlando. The average unit price increased five percent across the system. Timesharerevenue and profitability also benefited from higher resort fees and higherfinancing income due to increased sales. The growth from increased sales volumeand price were partially offset by unfavorable deferrals compared to the 2003period, due to the required percentage-of-completion accounting. Results in2004 were negatively impacted by the deferral of revenue and expenses at ourWaikoloa project, as construction was not beyond a preliminary stage. Incontrast, results in 2003 benefited from the recognition of previously deferredrevenue and expenses as phases of our developments in Orlando and Las Vegaswere substantially completed or opened during 2003.

38

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Depreciation and amortization expense decreased by $4million in 2004 to $330 million. The 2003 period includes a $5 million one-timedepreciation expense reduction at certain properties. The adjusted decrease of$9 million in 2004 reflects asset sales and retirements combined with loweramortization expense related primarily to certain long-term management andfranchise agreements that were either terminated or expired.

Results in 2004 includeimpairment loss and related costs totaling $5 million. This pre-tax charge isto reduce the value of an owned hotel to its estimated fair value and isincluded in Hotel Ownership segment results. Results in 2003 include impairmentloss and related costs totaling $22 million. These costs include a $17 millionpre-tax charge related to the decline in value of certain equity securitiesheld by us. The decline in value of the securities was deemed to beother-than-temporary in the 2003 first quarter, thus requiring an earningscharge, primarily based on the length of time the securities had traded belowcost. The 2003 charge also includes a $5 million pre-tax charge to reduce thevalue of an owned hotel and a management contract to their respective fairvalues. The write-down of the hotel and management contract are included inHotel Ownership and Managing and Franchising segment results, respectively,while the charge related to the marketable securities is included in corporateand other unallocated expenses in our reported segment results.

***Corporate Activity***

Corporate expense totaled $85 million in 2004, anincrease of $4 million from 2003. The increase is primarily the result ofexpense associated with stock compensation in 2004 and increased legal feescompared to 2003.

Interest and dividend income decreased $3 millioncompared to the prior year. The net decrease reflects the repayment by Caesarsof the $325 million 7% Senior Notes in July 2004. As these notes wereassumed by Caesars but remained our legal obligation prior to repayment,interest on the notes is reflected both in interest income and interest expensein the consolidated statements of income. This decrease in interest income waspartially offset by interest received in 2004 on a favorable tax settlement ofa prior year Federal income tax matter and interest received on certain notesreceivable that had been previously reserved. Interest expense, net of amountscapitalized, decreased $21 million reflecting lower outstanding debt balances,as well as the aforementioned repayment by Caesars.

The $5 million pre-tax loss on asset dispositions andother in 2004 represents the sale of two Doubletree properties and the writeoff of the value assigned to several long-term management and franchiseagreements which were terminated during the year, partially offset by the gainfrom the sale of our investment in Travelweb. The $6 million pre-tax loss onasset dispositions and other in 2003 represents the sale of four Homewood Suitesby Hilton hotel properties, one Embassy Suites property and the write off ofthe value assigned to several long-term management and franchise contractswhich were terminated during the year, partially offset by the gain on the saleof certain marketable securities.

The loss from non-operating affiliates totaling $6million in 2004 represents equity losses associated with our 24 percentminority interest in a coal-based synthetic fuel facility. The synthetic fuelproduced at this facility qualifies for tax credits based on Section 29 ofthe Internal Revenue Code, which reduce our provision for income taxes.

39

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The effective income taxrate for 2004 increased to 34% from 24% in 2003. The effective rate in 2004benefited from a reduction in the valuation allowance for capital loss taxcarryforwards resulting from the sale of three Doubletree properties (La Posadain Arizona, as well as Bakersfield and Modesto in California) and the sale ofour interest in Travelweb. The 2004 effective tax rate also reflects the utilizationof Section 29 synthetic fuel production credits. The effective rate in2003 benefited from a reduction in the valuation allowance for capital loss taxcarryforwards, primarily as a result of the transactions with CNL. In addition,the 2003 effective rate benefited from a reduction in the valuation allowancefor capital loss carryforwards due to higher than expected utilization on our2002 Federal tax return filed in 2003. The 2003 effective rate also benefitedfrom a settlement related to a tax liability associated with a prior year taxreturn. These benefits were partially offset by the write-off of an unutilizeddeferred tax asset resulting from a stock option exercise. Excluding theaforementioned items, our effective rate was 38% in 2004 and 35% in 2003. Oureffective tax rate is determined by the level and composition of pre-tax incomeand the mix of income subject to varying foreign, state and local taxes.

***Hotel Statistics***

RevPARfor U.S. owned hotels and system-wide for the years ended December 31,2003 and 2004 is as follows:

| ** ** | ** ** | **U.S. owned(1)** | ** ** |
|------------|------------|------------------------|------------|
| ** ** | ** ** | **2003**               | ** ** | **2004** | ** ** | **% Change** | ** ** |
| Hilton     |       | $                      | 109.31     |   | 117.21 |   | 7.2 | % |
| All other  |       | 76.20                  |       | 77.30 |   | 1.4 |   |
| Total      |       | 105.47                 |       | 112.62 |   | 6.8 |   |
|            |            |                        |            |  |  |  |  |  |

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(1)          Statistics are forcomparable U.S. hotels, and include only hotels in the system as of December31, 2004 and owned by us since January 1, 2003.

| ** **                 | ** ** | **System-wide(2)** | ** ** |
|----------------------------|------------|--------------------|------------|
| ** **                 | ** ** | **2003**           | ** ** | **2004** | ** ** | **% Change** | ** ** |
| Hilton                     |       | $                  | 83.82      |   | 90.39 |   | 7.8 | % |
| Hilton Garden Inn          |       | 62.30              |       | 67.70 |   | 8.7 |   |
| Doubletree                 |       | 65.40              |       | 70.50 |   | 7.8 |   |
| Embassy Suites             |       | 83.05              |       | 87.52 |   | 5.4 |   |
| Homewood Suites  by Hilton |       | 66.76              |       | 71.03 |   | 6.4 |   |
| Hampton                    |       | 51.93              |       | 55.73 |   | 7.3 |   |
| Other                      |       | 70.94              |       | 91.14 |   | 28.5 |   |
|                            |            |                    |            |  |  |  |  |  |

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(2)          Statisticsare for comparable hotels, and include only hotels in the system as of December31, 2004 and owned, operated or franchised by us since January 1, 2003.

**OTHER MATTERS**

***New Accounting Standards***

See “Note 2: Summary ofSignificant Accounting Policies—New Accounting Standards” to the consolidatedfinancial statements under Item 8, for discussion of new accounting standards.

40

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***Other***

We are involved in variouslegal matters arising in the normal course of business, some of which include claimsfor substantial sums. Accruals are recorded when the outcome is probable andcan be reasonably estimated. While the ultimate results of claims andlitigation cannot be predicted with certainty, we do not expect that theresolution of all pending overtly threatened claims and litigation as ofDecember 31, 2005 will have a material adverse effect on our consolidatedresults of operations or financial position. However, depending on the amountand timing, an unfavorable resolution of some or all of these matters couldmaterially affect our future results of operations in a particular period.

**Item 7A.   Quantitative and QualitativeDisclosures About Market Risk**

We are exposed to market risk in the form of changesin interest rates and the potential impact such changes may have on the cashflow from our floating rate debt and the fair values of our fixed rate debt. Weattempt to limit the impact of changes in interest rates to our debt portfolioby attaining an appropriate mix of floating rate borrowings relative to ourlong-term fixed rate debt. We are also exposed to interest rate risk on ourfloating rate notes receivable and the fair values of our fixed rate notesreceivable.

We utilize, on a selective basis, interest rate swapsto manage our relative levels of fixed and floating rate debt. As of December 31,2005, we had a derivative contract which swaps the fixed interest payments onour $375 million 7.95% Senior Notes due 2007 to a floating interest rateequal to the six month LIBOR rate plus 415 basis points. We are also exposed tomarket risk in the form of changes in foreign currency exchange rates and thepotential impact such changes may have on the cash flow related to our foreigncurrency denominated debt. In August 2001, we issued $100 million of7.43% bonds due 2009 denominated in Chilean Pesos. Payments of principal andinterest on the bonds are adjusted for movements of the Unidad de Fomento (theChilean inflation index) published monthly by the Central Bank of Chile. Wehave swapped out the Chilean currency exchange rate and inflation risk byentering into a derivative contract which swaps the principal payment to afixed U.S. dollar amount of $100 million with fixed interest payments at7.65% of that amount. We believe it is unlikely that the counterparty will beunable to perform under the terms of the derivative instrument.

Concurrent with the announcement of our agreement toacquire the lodging assets of Hilton Group plc in December 2005 (see “Note20: Subsequent Events” to the consolidated financial statements under Item 8),we entered into foreign currency options to mitigate the risk associated withchanges in foreign currency exchange rates on our agreement to fund theacquisition price in British Pounds Sterling. These options, which wereexercised in the 2006 first quarter and were purchased for a total ofapproximately $54 million, covered approximately 2.3 billion British PoundsSterling. These derivatives included options to purchase British PoundsSterling with U.S. Dollars and Euros. As of December 31, 2005, the optionshad a carrying value of approximately $44 million, and are reflected in theaccompanying consolidated balance sheet in other current assets.

41

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Concurrent with our investment in a synthetic fuelfacility in August 2004, we entered into a derivative contract covering2.5 million barrels of oil, which was effective for the calendar year ending December 31,2005. The derivative contract involved two call options that provided for netcash settlement at expiration based on the full year 2005 average trading priceof oil in relation to the strike price of each option. If the average price ofoil in 2005 was less than $55, the derivative would yield no payment. If the averageprice of oil exceeded $55, the derivative would yield a payment equal to theexcess of the average price over $55 per barrel, multiplied by the number ofbarrels covered, up to a maximum price per barrel of $68. The purpose of thetransaction was to provide economic protection against an increase in oilprices that could limit the amount of tax credits available under Section 29of the Internal Revenue Code. The strike prices of the two call options areintended to approximate the price ranges under which the tax credit could bereduced or eliminated by an increase in oil prices.

Thefollowing table sets forth the scheduled maturities and the total fair value ofour derivative and other financial instruments as of December 31, 2005:

| ** **                                                                                                              | ** ** | **Maturities by Period** | ** ** | **Total**                     | ** ** | ** **       | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|-------------------------------|------------|------------------|------------|
| ** **                                                                                                              | ** ** | **Within  1 year**            | ** ** | **2 years**              | ** ** | **3 years** | ** ** | **4 years** | ** ** | **5 years** | ** ** | **After 5  years** | ** ** | **Carrying  Amount** | ** ** | **Total Fair  Value** | ** ** |
| ** **                                                                                                              | ** ** | ** **                         | ** ** | **($ in millions)** | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ***ASSETS******—Maturities represent  principal receipts, fair values represent assets***                          |       |                               |       |                          |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Timeshare notes receivable                                                                                              |       | $                                  | 40         |                          | 45         |             | 49         |   | 52 |   | 49 |   | 116 |   | 351 |   | 356 |   |
| Average interest rate                                                                                                   |       |                               |       |                          |       |             |       |   |   |   |   |   |   | 12.9 | % |   |   |
| Other notes receivable                                                                                                  |       | $                                  | —     |                          | —     |             | 5          |   | 7 |   | 1 |   | 37 |   | 50 |   | 59 |   |
| Average interest rate                                                                                                   |       |                               |       |                          |       |             |       |   |   |   |   |   |   | 6.3 | % |   |   |
| ***LIABILITIES******—Maturities represent principal payments, fair values represent  liabilities***                |       |                               |       |                          |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Fixed rate debt                                                                                                         |       | $                                  | (47        | )                             | (388       | )                | (473       | ) | (363 | ) | (558 | ) | (1,686 | ) | (3,515 | ) | (3,745 | ) |
| Average interest rate                                                                                                   |       |                               |       |                          |       |             |       |   |   |   |   |   |   | 7.1 | % |   |   |
| Floating rate debt                                                                                                      |       | $                                  | —     |                          | (22        | )                | —     |   | — |   | — |   | (82 | ) | (104 | ) | (104 | ) |
| Average interest rate                                                                                                   |       |                               |       |                          |       |             |       |   |   |   |   |   |   | 3.8 | % |   |   |
| ***INTEREST RATE SWAPS—******Maturities represent notional  amounts, fair values represent assets (liabilities)*** |       |                               |       |                          |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Fixed to variable                                                                                                       |       | $                                  | —     |                          | 369        |             | —     |   | — |   | — |   | — |   | 369 |   | (6 | ) |
| Average pay rate                                                                                                        |       |                               |       |                          |       |             |       |   |   |   |   |   |   | 8.9 | % |   |   |
| Average receive rate                                                                                                    |       |                               |       |                          |       |             |       |   |   |   |   |   |   | 8.0 | % |   |   |
| Fixed (CLP) to Fixed ($US)                                                                                              |       | $                                  | —     |                          | —     |             | —     |   | 148 |   | — |   | — |   | 148 |   | 59 |   |
| Average pay rate                                                                                                        |       |                               |       |                          |       |             |       |   |   |   |   |   |   | 7.7 | % |   |   |
| Average receive rate                                                                                                    |       |                               |       |                          |       |             |       |   |   |   |   |   |   | 7.4 | % |   |   |
| ***OTHER  DERIVATIVE CONTRACTS***                                                                                       |       |                               |       |                          |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Call options on oil prices                                                                                              |       | $                                  | 4          |                          | —     |             | —     |   | — |   | — |   | — |   | 4 |   | 4 |   |
| Call options on  foreign currencies                                                                                     |       | $                                  | 44         |                          | —     |             | —     |   | — |   | — |   | — |   | 44 |   | 44 |   |

 

As of December 31, 2005, approximately 13% of ourlong-term debt (including the impact of interest rate swaps) was floating ratedebt.

42

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**Item 8.   Financial Statements and SupplementaryData**

**Hilton Hotels Corporation and SubsidiariesConsolidated Statements ofIncome(in millions, except per share amounts)**

| ** **                                                                | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenue                                                                   |       |                                       |       |   |   |   |   |
| Owned hotels                                                              |       | $                                          | 2,031      |   | 2,062 |   | 2,049 |   |
| Leased hotels                                                             |       | 103                                        |       | 111 |   | 111 |   |
| Management and franchise fees                                             |       | 337                                        |       | 384 |   | 452 |   |
| Timeshare and other income                                                |       | 378                                        |       | 463 |   | 606 |   |
|                                                                      |       | 2,849                                      |       | 3,020 |   | 3,218 |   |
| Other revenue from managed and franchised properties                      |       | 970                                        |       | 1,126 |   | 1,219 |   |
|                                                                      |       | 3,819                                      |       | 4,146 |   | 4,437 |   |
| Expenses                                                                  |       |                                       |       |   |   |   |   |
| Owned hotels                                                              |       | 1,500                                      |       | 1,501 |   | 1,459 |   |
| Leased hotels                                                             |       | 96                                         |       | 101 |   | 99 |   |
| Depreciation and amortization                                             |       | 334                                        |       | 330 |   | 299 |   |
| Impairment loss and related costs                                         |       | 22                                         |       | 5 |   | 7 |   |
| Other operating expenses                                                  |       | 335                                        |       | 395 |   | 497 |   |
| Corporate expense                                                         |       | 81                                         |       | 85 |   | 103 |   |
|                                                                      |       | 2,368                                      |       | 2,417 |   | 2,464 |   |
| Other expenses from managed and franchised  properties                    |       | 970                                        |       | 1,120 |   | 1,212 |   |
|                                                                      |       | 3,338                                      |       | 3,537 |   | 3,676 |   |
| Operating income from unconsolidated affiliates                           |       | 34                                         |       | 49 |   | 44 |   |
| Operating Income                                                          |       | 515                                        |       | 658 |   | 805 |   |
| Interest and dividend income                                              |       | 29                                         |       | 26 |   | 32 |   |
| Interest expense                                                          |       | (295                                       | )          | (274 | ) | (259 | ) |
| Net interest from unconsolidated affiliates and  non-controlled interests |       | (20                                        | )          | (26 | ) | (26 | ) |
| Net (loss) gain on asset dispositions and other                           |       | (6                                         | )          | (5 | ) | 103 |   |
| Loss from non-operating affiliates                                        |       | —                                     |       | (6 | ) | (17 | ) |
| Income Before Taxes and Minority and Non-Controlled  Interests            |       | 223                                        |       | 373 |   | 638 |   |
| Provision for income taxes                                                |       | (53                                        | )          | (127 | ) | (166 | ) |
| Minority and non-controlled interests, net                                |       | (6                                         | )          | (8 | ) | (12 | ) |
| Net Income                                                                |       | $                                          | 164        |   | 238 |   | 460 |   |
| Basic Earnings Per Share                                                  |       | $                                          | .43        |   | .62 |   | 1.20 |   |
| Diluted Earnings  Per Share                                               |       | $                                          | .43        |   | .60 |   | 1.13 |   |

 

See notes to consolidated financial statements.

43

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**HiltonHotels Corporation and SubsidiariesConsolidated Balance Sheets(in millions)**

| ** **                                                                  | ** ** | **December 31,  2004** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                  | ** ** |                        | ** ** |                        |       |   |   |   |   |
| **Current  Assets**                                                         | ** ** |                        | ** ** |                        |       |   |   |   |   |
| Cash and equivalents                                                        |       |                        | $          | 303                         |       |   |   |   1,154 |   |   |
| Restricted cash                                                             |       |                        | 163        |                        |       |   | 182 |   |   |
| Accounts receivable, net                                                    |       |                        | 269        |                        |       |   | 312 |   |   |
| Inventories                                                                 |       |                        | 144        |                        |       |   | 219 |   |   |
| Deferred income taxes                                                       |       |                        | 85         |                        |       |   | 85 |   |   |
| Current portion of notes receivable, net                                    |       |                        | 68         |                        |       |   | 40 |   |   |
| Other current assets                                                        |       |                        | 74         |                        |       |   | 97 |   |   |
| Total current assets                                                        |       |                        | 1,106      |                        |       |   | 2,089 |   |   |
| **Investments,  Property and Other Assets**                                 | ** ** |                        | ** ** |                        |       |   |   |   |   |
| Investments and notes receivable, net                                       |       |                        | 635        |                        |       |   | 707 |   |   |
| Property and equipment, net                                                 |       |                        | 3,510      |                        |       |   | 2,985 |   |   |
| Management and franchise contracts, net                                     |       |                        | 336        |                        |       |   | 302 |   |   |
| Leases, net                                                                 |       |                        | 111        |                        |       |   | 107 |   |   |
| Brands                                                                      |       |                        | 970        |                        |       |   | 970 |   |   |
| Goodwill                                                                    |       |                        | 1,240      |                        |       |   | 1,216 |   |   |
| Other assets                                                                |       |                        | 334        |                        |       |   | 367 |   |   |
| Total investments, property and other assets                                |       |                        | 7,136      |                        |       |   | 6,654 |   |   |
| **Total  Assets**                                                           |       |                        | $          | 8,242                       |       |   |   | 8,743 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                              | ** ** |                        | ** ** |                        |       |   |   |   |   |
| **Current  Liabilities**                                                    | ** ** |                        | ** ** |                        |       |   |   |   |   |
| Accounts payable and accrued expenses                                       |       |                        | $          | 611                         |       |   |   | 772 |   |   |
| Current maturities of long-term debt                                        |       |                        | 14         |                        |       |   | 47 |   |   |
| Income taxes payable                                                        |       |                        | 4          |                        |       |   | 45 |   |   |
| Total current liabilities                                                   |       |                        | 629        |                        |       |   | 864 |   |   |
| Long-term debt                                                              |       |                        | 3,633      |                        |       |   | 3,572 |   |   |
| Non-recourse debt of non-controlled entity                                  |       |                        | 100        |                        |       |   | 100 |   |   |
| Deferred income taxes                                                       |       |                        | 781        |                        |       |   | 678 |   |   |
| Insurance reserves and other                                                |       |                        | 531        |                        |       |   | 718 |   |   |
| Total liabilities                                                           |       |                        | 5,674      |                        |       |   | 5,932 |   |   |
| **Commitments  and Contingencies**                                          | ** ** |                        | ** ** |                        |       |   |   |   |   |
| **Stockholders’  Equity**                                              | ** ** |                        | ** ** |                        |       |   |   |   |   |
| Common Stock, 389 million and 382 million shares  outstanding, respectively |       |                        | 997        |                        |       |   | 1,010 |   |   |
| Additional paid-in capital                                                  |       |                        | 1,086      |                        |       |   | 1,158 |   |   |
| Retained earnings                                                           |       |                        | 689        |                        |       |   | 1,125 |   |   |
| Accumulated other comprehensive loss                                        |       |                        | (3         | )                           |       |   | (11 | ) |   |
|                                                                        |       |                        | 2,769      |                        |       |   | 3,282 |   |   |
| Less treasury stock, at cost                                                |       |                        | (201       | )                           |       |   | (471 | ) |   |
| Total stockholders’ equity                                             |       |                        | 2,568      |                        |       |   | 2,811 |   |   |
| **Total Liabilities and  Stockholders’ Equity**                        |       |                        | $          | 8,242                       |       |   |   | 8,743 |   |   |

 

See notes to consolidated financial statements.

44

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**Hilton Hotels Corporation and SubsidiariesConsolidated Statementsof Cash Flow(in millions)**

| ** **                                                                         | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Operating Activities**                                                           | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                          | 164        |   | 238 |   | 460 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Depreciation and amortization                                                      |       | 334                                        |       | 330 |   | 299 |   |
| Amortization of loan costs                                                         |       | 13                                         |       | 9 |   | 9 |   |
| Net loss (gain) on asset dispositions                                              |       | 6                                          |       | 5 |   | (103 | ) |
| Loss from non-operating affiliates                                                 |       | —                                     |       | 6 |   | 17 |   |
| Impairment loss and related costs                                                  |       | 22                                         |       | 5 |   | 7 |   |
| Change in working  capital components:                                             | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Inventories                                                                        |       | (34                                        | )          | 45 |   | (77 | ) |
| Accounts receivable                                                                |       | 37                                         |       | (24 | ) | (41 | ) |
| Other current assets                                                               |       | 2                                          |       | (9 | ) | 18 |   |
| Accounts payable and accrued expenses                                              |       | (26                                        | )          | 59 |   | 99 |   |
| Income taxes payable                                                               |       | —                                     |       | — |   | 41 |   |
| Restricted cash                                                                    |       | (39                                        | )          | (90 | ) | (19 | ) |
| Change in deferred income taxes                                                    |       | (48                                        | )          | 27 |   | (63 | ) |
| Change in other liabilities                                                        |       | 35                                         |       | 49 |   | (35 | ) |
| Unconsolidated affiliates’ distributions in excess  of earnings               |       | 17                                         |       | 20 |   | 1 |   |
| Change in timeshare notes receivable                                               |       | (73                                        | )          | (105 | ) | (99 | ) |
| Other                                                                              |       | (30                                        | )          | (17 | ) | (28 | ) |
| Net cash provided by operating activities                                          |       | 380                                        |       | 548 |   | 486 |   |
| **Investing  Activities**                                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Capital expenditures                                                               |       | (202                                       | )          | (178 | ) | (423 | ) |
| Additional investments                                                             |       | (25                                        | )          | (72 | ) | (47 | ) |
| Proceeds from asset dispositions                                                   |       | 279                                        |       | 80 |   | 1,041 |   |
| Payments received on notes and other                                               |       | 8                                          |       | 38 |   | 49 |   |
| Net cash provided by (used in) investing activities                                |       | 60                                         |       | (132 | ) | 620 |   |
| **Financing  Activities**                                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Change in revolving loans                                                          |       | (510                                       | )          | (160 | ) | — |   |
| Long-term borrowings                                                               |       | 562                                        |       | — |   | 14 |   |
| Reduction of long-term debt                                                        |       | (513                                       | )          | (14 | ) | (15 | ) |
| Issuance of common stock                                                           |       | 40                                         |       | 131 |   | 63 |   |
| Repurchase of common stock                                                         |       | —                                     |       | (48 | ) | (271 | ) |
| Cash dividends                                                                     |       | (30                                        | )          | (31 | ) | (46 | ) |
| Net cash used in financing activities                                              |       | (451                                       | )          | (122 | ) | (255 | ) |
| (Decrease) Increase in Cash and Equivalents                                        |       | (11                                        | )          | 294 |   | 851 |   |
| Cash and  Equivalents at Beginning of Year                                         |       | 20                                         |       | 9 |   | 303 |   |
| **Cash  and Equivalents at End of Year**                                           |       | $                                          | 9          |   | 303 |   | 1,154 |   |

 

See notes to consolidated financial statements.

45

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**Hilton Hotels Corporation and SubsidiariesConsolidated Statementsof Stockholders’ Equity(in millions, except per share amounts)**

| ** **                                                                      | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                      | ** ** | **2003**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| **COMMON STOCK**                                                                | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of  year                                                   |       | $                                          | 962        |   | 971 |   | 997 |   |
| Issuance of common  stock                                                       |       | —                                     |       | — |   | 1 |   |
| Exercise of stock options                                                       |       | 9                                          |       | 26 |   | 12 |   |
| **Balance  at end of year**                                                     |       | $                                          | 971        |   | 997 |   | 1,010 |   |
| **ADDITIONAL PAID-IN CAPITAL**                                                  | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of  year                                                   |       | $                                          | 950        |   | 970 |   | 1,086 |   |
| Issuance of common stock                                                        |       | 1                                          |       | (4 | ) | 6 |   |
| Exercise of stock options                                                       |       | 13                                         |       | 105 |   | 51 |   |
| Deferred compensation                                                           |       | 6                                          |       | 15 |   | 15 |   |
| **Balance  at end of year**                                                     |       | $                                          | 970        |   | 1,086 |   | 1,158 |   |
| **RETAINED EARNINGS**                                                           | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of  year                                                   |       | $                                          | 322        |   | 456 |   | 689 |   |
| Net income                                                                      |       | 164                                        |       | 238 |   | 460 |   |
| Exercise of stock options                                                       |       | —                                     |       | 26 |   | 22 |   |
| Common dividends ($.08,  $.08 and $.12 per share, respectively)                 |       | (30                                        | )          | (31 | ) | (46 | ) |
| **Balance  at end of year**                                                     |       | $                                          | 456        |   | 689 |   | 1,125 |   |
| **ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)**                               | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of  year                                                   |       | $                                          | (11        | ) | (1 | ) | (3 | ) |
| Cash flow hedge adjustment,  net of deferred tax                                |       | 5                                          |       | 7 |   | — |   |
| Cumulative translation  adjustment, net of deferred tax                         |       | 1                                          |       | — |   | (1 | ) |
| Change in unrealized gain  / loss on marketable securities, net of deferred tax |       | 11                                         |       | 3 |   | 2 |   |
| Minimum pension  obligation adjustment, net of deferred tax                     |       | (7                                         | )          | (12 | ) | (9 | ) |
| **Balance  at end of year**                                                     |       | $                                          | (1         | ) | (3 | ) | (11 | ) |
| **TREASURY STOCK, AT COST**                                                     | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of  year                                                   |       | $                                          | (170       | ) | (157 | ) | (201 | ) |
| Issuance of common stock                                                        |       | 1                                          |       | 4 |   | 1 |   |
| Exercise of stock options                                                       |       | 12                                         |       | — |   | — |   |
| Repurchase of common  stock                                                     |       | —                                     |       | (48 | ) | (271 | ) |
| **Balance  at end of year**                                                     |       | $                                          | (157       | ) | (201 | ) | (471 | ) |
| **TOTAL STOCKHOLDERS’ EQUITY**                                             | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of  year                                                   |       | $                                          | 2,053      |   | 2,239 |   | 2,568 |   |
| Net income                                                                      |       | 164                                        |       | 238 |   | 460 |   |
| Cash flow hedge  adjustment, net of deferred tax                                |       | 5                                          |       | 7 |   | — |   |
| Cumulative translation  adjustment, net of deferred tax                         |       | 1                                          |       | — |   | (1 | ) |
| Change in unrealized gain  / loss on marketable securities, net of deferred tax |       | 11                                         |       | 3 |   | 2 |   |
| Minimum pension  obligation adjustment, net of deferred tax                     |       | (7                                         | )          | (12 | ) | (9 | ) |
| Comprehensive income                                                            |       | 174                                        |       | 236 |   | 452 |   |
| Issuance of common stock                                                        |       | 2                                          |       | — |   | 7 |   |
| Exercise of stock options                                                       |       | 34                                         |       | 157 |   | 86 |   |
| Repurchase of common  stock                                                     |       | —                                     |       | (48 | ) | (271 | ) |
| Deferred compensation                                                           |       | 6                                          |       | 15 |   | 15 |   |
| Common dividends ($.08,  $.08 and $.12 per share, respectively)                 |       | (30                                        | )          | (31 | ) | (46 | ) |
| **Balance at end of year**                                                      |       | $                                          | 2,239      |   | 2,568 |   | 2,811 |   |

 

See notes to consolidated financial statements.

46

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**Notes To Consolidated Financial Statements December 31, 2005**

**NOTE 1:** BASISOF PRESENTATION AND ORGANIZATION

Hilton Hotels Corporationis engaged in the ownership, management and development of hotels, resorts andtimeshare properties and the franchising of lodging properties. We operate inselect markets throughout the world, predominately in the United States. Revenueand income are derived from three reportable segments: Hotel Ownership,Managing and Franchising, and Timeshare.

**NOTE2:** SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

**Principles of Consolidation**

The consolidated financialstatements include the accounts of Hilton Hotels Corporation, our wholly ownedsubsidiaries, variable interest entities where we are the primary beneficiaryand entities in which we have a controlling financial interest. Thedetermination of controlling financial interest is based upon the terms ofindividual joint venture agreements, including evaluation of rights held byother ownership interests. Entities in which we have a controlling financialinterest are generally comprised of majority owned joint ventures. All materialintercompany transactions are eliminated and net earnings are reduced by theportion of earnings of affiliates applicable to other ownership interests.

**Cash and Equivalents**

Cash and equivalentsinclude all highly liquid investments with initial maturities of three monthsor less.

**Restricted Cash**

Restricted cash includescash related to certain consolidated hotels, the use of which is restricted forhotel purposes under the terms of collateralized borrowings; refundabledeposits on the sale of timeshare intervals; and cash balances held by aconsolidated non-controlled entity.

**Accounts Receivable**

Accounts receivable arereflected net of allowance for uncollectible accounts of $27 million and$25 million as of December 31, 2004 and 2005, respectively.

**Investments**

We maintain investments inunconsolidated affiliates, including hotel joint ventures as well as otherentities that support the operations of our hotel properties. Investments areaccounted for using the equity method when we exercise significant influenceover the venture but lack a controlling financial interest, which is determinedbased upon the terms of individual joint venture agreements, includingevaluation of rights held by other ownership interests. Generally, we accountfor investments using the equity method when we own more than a minimalinvestment but have no more than a 50% ownership interest. When we have acontrolling financial interest in the venture, which is generally when ourownership exceeds 50%, the balance sheet and results of operations areconsolidated, with net earnings reduced by the portion of earnings applicableto other ownership interests. All other investments in unconsolidatedaffiliates are generally accounted for under the cost method. The hotels inwhich we own a non-controlling financial interest are an integral component ofour hotel ownership segment and are strategically and operationally importantto that segment’s results. Therefore, our operating income from unconsolidatedaffiliates is included as a component of consolidated operating income in theaccompanying consolidated statements of income.

47

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

**Currency Translation**

Assets and liabilitiesdenominated in most foreign currencies are translated into U.S. dollars atyear-end exchange rates and related gains and losses, net of applicabledeferred income taxes, are reflected in stockholders’ equity. Gains and lossesfrom foreign currency transactions are included in earnings.

**Valuation of Long-Lived Assets**

The carrying value of ourlong-lived assets are reviewed when events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. If it isdetermined that an impairment loss has occurred based on the lowest level ofidentifiable expected future cash flow, then a loss is recognized in the incomestatement using a fair value based model.

**Property and Equipment**

Property and equipment are stated at cost lessaccumulated depreciation. Interest incurred during construction of facilitiesis capitalized and depreciated over the life of the asset. Costs ofimprovements are capitalized. These capitalized costs may include structuralcosts, equipment, fixtures and floor and wall coverings. Costs of normalrepairs and maintenance are charged to expense as incurred.

Depreciation is providedusing the straight-line method over the estimated useful life of the assets. Leaseholdimprovements are depreciated over the shorter of the asset life or lease term. Theestimated useful lives of assets are generally 40 years for buildings and threeto eight years for building improvements and furniture and equipment. Depreciationexpense for 2003, 2004 and 2005 was $270 million, $271 million and $247million, respectively.

**Management and Franchise Contracts**

Management and franchisecontracts acquired in acquisitions that were accounted for as purchases arerecorded at the estimated present value of net cash flow expected to bereceived over the lives of the contracts. This value is amortized using thestraight-line method over the remaining contract lives. Costs incurred toacquire individual management and franchise contracts are amortized using thestraight-line method over the life of the respective contract. Accumulatedamortization of management and franchise contracts totaled $211 millionand $227 million at December 31, 2004 and 2005, respectively.

**Leases**

Leases acquired in acquisitionsthat were accounted for as purchases are recorded at the estimated presentvalue of net cash flow expected to be received over the lives of the leaseagreements. This value is amortized using the straight-line method over theremaining lease terms. Accumulated amortization of leases totaled$19 million and $23 million at December 31, 2004 and 2005,respectively.

**Brands**

The brand names of hotelsacquired in acquisitions are assigned a fair market value. To arrive at a valuefor each brand name, an estimation is made of the amount of royalty income thatcould be generated from the brand name if it was licensed to an independentthird-party owner. The resulting cash flow is discounted back using theestimated weighted average cost of capital for each respective brand name. Weaccount for brands in accordance with Statement of Financial AccountingStandard (FAS) 142, which requires that intangible assets with indefinite livesare not amortized, but are reviewed annually for impairment.

48

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

**Goodwill**

Goodwill represents theexcess of the purchase price over the fair value of net assets of businessesacquired. We account for goodwill in accordance with FAS 142, which requiresthat goodwill is not amortized, but is reviewed annually for impairment. During2005, the amount of goodwill decreased by $24 million due to $13 millionin adjustments to tax reserves (see “Note 12: Income Taxes”) and $11 milliondue to asset sales (see “Note 3: Acquisitions and Dispositions”).

**Derivative Instruments**

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

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

We assess on a quarterly basis the effectiveness ofour hedges in offsetting the variability in the cash flow or fair values of thehedged obligations. There were no amounts recognized or reclassified intoearnings for the years ended December 31, 2003, 2004 or 2005 due to hedgeineffectiveness or due to excluding from the assessment of effectiveness anycomponent of the derivatives.

Concurrent with our investment in a synthetic fuelfacility in August 2004, we entered into a derivative contract covering2.5 million barrels of oil, which was effective for the calendar year ending December 31,2005. The derivative contract involved two call options that provided for netcash settlement at expiration based on the full year 2005 average trading priceof oil in relation to the strike price of each option. If the average price ofoil in 2005 was less than $55 per barrel, the derivative would yield no payment.If the average price of oil exceeded $55 per barrel, the derivative would yielda 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 barrelof $68. The purpose of the transaction was to provide economic protectionagainst an increase in oil prices that could limit the amount of tax creditsavailable under Section 29 of the Internal Revenue Code. The strike pricesof the two call options were intended to approximate the price ranges underwhich the tax credit could be reduced or eliminated by an increase in oil prices.This agreement did not qualify for hedge accounting and, as a result, changesin the fair value of the derivative agreement are reflected in earnings. Resultsin 2004 and 2005 include a pre-tax loss of $1 million and a pre-tax gain of $3million, respectively, which is reflected in net (loss) gain on assetdisposition and other in the accompanying consolidated financial statements.

49

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Concurrent with theannouncement of our agreement to acquire the lodging assets of Hilton Group plcin December 2005 (see “Note 20: Subsequent Events”), we entered intoforeign currency options to mitigate the risk associated with changes inforeign currency exchange rates on our agreement to fund the acquisition pricein British Pounds Sterling. These options, which were exercised in the 2006first quarter and were purchased for a total of approximately $54 million,covered approximately 2.3 billion British Pounds Sterling. These derivativesincluded options to purchase British Pounds Sterling with US Dollars and Euros.As of December 31, 2005, the options had a carrying value of approximately$44 million, and are reflected in the accompanying consolidated balance sheetin other current assets. These foreign currency options did not qualify forhedge accounting and, as a result, changes in the fair value of the derivativeinstruments are reflected in earnings. Results in 2005 include a pre-tax lossof $10 million, which is reflected in net (loss) gain on asset disposition andother in the accompanying consolidated financial statements.

**Unamortized Loan Costs**

Debt discount and issuancecosts incurred in connection with the placement of long-term debt arecapitalized and amortized using the effective interest method to interestexpense over the lives of the related debt. These balances are included inother assets in our consolidated balance sheets.

**Self-Insurance**

We are self-insured for various levels of generalliability, workers’ compensation and employee medical and dental insurancecoverage at our owned locations. Managed properties may be required toparticipate in certain of the programs where we are the employer of theemployees at the hotel. Managed properties may also elect to participate in ourself-insured liability insurance program. We purchase insurance coverage forclaim amounts which exceed our self-insured retentions. Depending on the typeof insurance, these self-insured retentions range from $250,000 to $500,000 perclaim. Our self-insurance reserves are included in accounts payable and accruedexpenses (current portion) and insurance reserves and other (long-term portion)in the accompanying consolidated balance sheets. The undiscounted amount of ourself-insurance reserves totaled $148 million and $146 million at December 31,2004 and 2005, respectively.

Our insurance reserves areaccrued based on estimates of the present value of claims expected to occurduring the covered period. These estimates are prepared with the assistance ofoutside actuaries and consultants. Our actuaries periodically review the volumeand amount of claims activity, and based upon their findings, we adjust ourinsurance reserves accordingly. The ultimate cost of claims for a coveredperiod may differ from our original estimates. General liability and workerscompensation claim estimates are discounted to determine the present value ofprojected settlements; the discount rates used in the 2003 through 2005 programyears were approximately 3.0% to 4.25%, which we considered reasonable based onclaims settlement patterns. Since medical and dental claims are generally paidwithin several months, we do not discount the related insurance reserves.

**Revenue Recognition**

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

50

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Management fees represent fees earned from hotelsmanaged by us, usually under long-term contracts with the hotel owner. Managementfees include a base fee, which is generally a percentage of hotel revenue, andan incentive fee, which is generally based on the hotel’s profitability after astated return threshold to the owner. We recognize base fees as revenue whenearned in accordance with the terms of the contract. In interim periods werecognize incentive fees that would be due if the contract were terminated atthe end of the interim period.

Franchise fees represent fees received in connectionwith the franchise of our brand names, usually under long-term contracts withthe hotel owner. Depending on the brand, we charge franchise royalty fees of upto five percent of rooms revenue. We recognize fee revenue as earned, inaccordance with FAS 45, “Accounting for Franchise Fee Revenue.”

Timeshare and other income primarily consists ofearnings from our timeshare operations. Timeshare revenue is generatedprimarily from the sale and financing of timeshare intervals and operatingtimeshare resorts. We recognize revenue from deeded timeshare sales inaccordance with FAS 66, “Accounting for Real Estate Sales.”  Sales are included in revenue when a minimumof a 10 percent down payment has been received, certain minimum salesthresholds have been attained, the purchaser’s period to cancel for a refundhas expired and the related receivable is deemed to be collectible. We deferrevenue recognition for sales that do not meet these criteria. During periodsof construction, profits from timeshare sales are recognized under thepercentage-of-completion method. Our Hilton City Club timeshare product isaccounted for as a long-term lease with a reversionary interest rather than thesale of a deeded interest in real estate. Hilton City Club sales revenue isrecognized over the term of the lease.

Timeshare and other income also includes revenuegenerated by the incidental support of hotel operations and the recognition ofdeferred gains on asset sales. We account for the sale of real estate inaccordance with FAS 66. To the extent we realize gains from the sale of realestate and maintain significant continuing involvement in the form of along-term management contract, the gain is deferred and recognized in earningsover the term of the contract. Results in 2003, 2004 and 2005 include therecognition of pre-tax deferred gains totaling $10 million, $15 million and $23million, respectively. The deferral of gain recognition is dependent on the structureof individual sale transactions.

We incur certainreimbursable costs on behalf of managed hotel properties and franchisees. Wereport reimbursements received from managed properties and franchisees asrevenue and the costs incurred on their behalf as expenses. These costs, whichrelate primarily to payroll costs at managed properties where we are theemployer, are reflected in reimbursed costs in the consolidated statements ofincome. Since the reimbursements are made based upon the costs incurred with noadded margin, the presentation of these reimbursable costs has no effect on ouroperating income, total or per share net income, cash flow or financialposition.

**Hilton HHonors**

Hilton HHonors is a guest loyalty program operated byHilton HHonors Worldwide (HHW), a joint venture 50% owned by us and 50% ownedby Hilton Group plc at December 31, 2005. Hilton Group’s wholly-ownedsubsidiary, Hilton International Co., owned the rights to the Hilton brand nameoutside the United States. In February 2006, we completed the acquisitionof the lodging assets of Hilton Group plc, including their 50% interest in HHW(see “Note 20: Subsequent Events”). The HHonors program is operated for thebenefit of the Hilton family of brands worldwide.

51

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Members of the HHonors program earn points based ontheir spending at most of the hotel properties operated and franchised by usand Hilton Group. HHW accumulates and tracks points on the member’s behalf andfulfills the awards upon request. Points can be redeemed for hotel stays atparticipating properties, and for a variety of other awards such as airlinetickets, cruises and car rentals. As we exercised significant influence overthe operation of HHW but lacked a controlling financial interest on December 31,2004 and 2005, our investment in HHW is accounted for under the equity method.

HHonors is provided as aguest loyalty program to participating hotels. HHW charges the cost ofoperating the program, including the estimated fair value of award redemption,to participating hotels based on member’s qualifying expenditures. The chargesdo not include a markup or profit element. We record our share of programcosts, which we expense and pay to HHW based upon contractual amounts whenqualified members stay at our hotels. When members redeem awards at our hotels,we receive contractual amounts from HHW.

**Earnings Per Share (EPS)**

Basic EPS is computed bydividing net income available to common stockholders by the weighted averagenumber of common shares outstanding for the period. The weighted average numberof common shares outstanding for 2003, 2004 and 2005 were 378 million,384 million and 383 million, respectively. Diluted EPS reflects thepotential dilution that could occur if securities or other contracts to issuecommon stock were exercised or converted. The dilutive effect of the assumedexercise of stock options and convertible securities increased the weightedaverage number of common shares by 32 million in 2003 and 34 millionin 2004 and 2005. In addition, the increase to net income resulting frominterest on convertible securities assumed to have not been paid wasapproximately $14 million in 2003 and $12 million in 2004 and 2005.

**Stock-Based Compensation**

We apply Accounting Principles Board (APB) Opinion 25and related interpretations in accounting for our stock-based compensationplans. Prior to 2004, our stock-based compensation consisted primarily of stockoptions. No compensation cost is reflected in our net income related to ourstock option awards for the periods presented, as all options had an exerciseprice greater than or equal to the market value of the underlying common stockon the date of grant. Effective January 1, 2006, we will account for ourstock-based compensation in accordance with FAS 123R (see “Note 2: Summary ofSignificant Accounting Policies—New Accounting Standards”).

We granted 7,144,775 options with a grant date fairvalue of approximately $4.00 per share in 2003, while no options were grantedin 2004. We granted 400,000 stock options with an exercise price of $22.19 pershare and an estimated fair value of approximately $13.12 per share in 2005. Fordisclosure purposes, we estimated the fair value of each option grant on thedate of grant using the Black-Scholes option-pricing model with the followingweighted average assumptions used for grants in 2003 and 2005, respectively:dividend yield of one percent for both years; expected volatility of 35 and55 percent, respectively; risk-free interest rates of 3.0 and 4.1 percent,respectively, and expected lives of five years and eight years, respectively.

52

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

In 2004 and 2005, we awarded restricted stock underthe 2004 Omnibus Equity Compensation Plan which includes two forms ofrestricted stock:  time-based (TBU) andperformance-based (PBU). The TBU awards vest annually in a straight-line mannerover four years. The PBU awards vest in full at the end of a three-year period,and vest at a level between 0% and 150% of the target amount based on theextent that pre-determined performance measures are achieved. In accordancewith APB 25, compensation expense for the TBU awards is measured at the fairvalue of the underlying stock at the date of grant. Compensation expenseassociated with the PBU awards is subject to adjustment for changes in theunderlying stock price over the vesting period, as well as changes in estimatesrelating to whether the performance objective will be achieved. In 2004, wegranted 1,560,670 TBUs and 765,309 PBUs, both with a grant date fair value of $17.37per share. In 2005, we granted 1,272,313 TBUs and 810,749 PBUs, both with agrant date fair value of $22.19 per share. No restricted stock units wereawarded in 2003. Compensation expense for both the TBU and PBU awards isamortized over the respective vesting periods. Consolidated compensationexpense under the 2004 plan was approximately $6 million and $21 millionin 2004 and 2005, respectively.

We also provide supplemental retirement benefits toeligible senior officers in the form of fixed stock units that settle forshares of our common stock on a one-for-one basis. We granted 8,425 units witha grant date fair value of $12.65 per share in 2003. No units were granted in2004 and 2005. The compensation expense associated with the benefits isexpensed over a four year vesting period. The aggregate expense under theseplans totaled $6 million, $4 million and $1 million in 2003,2004 and 2005, respectively.

Hadthe expense for all forms of our stock-based compensation been determined usingthe fair value based method defined in FAS 123, “Accounting for Stock-BasedCompensation,” our net income and net income per share would have been reducedto the pro forma amounts indicated below. These pro forma results may not beindicative of the future results for the full fiscal year due to potentialgrants, vesting and other factors:

| ** **                                                                  | ** ** | **2003**                                                         | ** ** | **2004** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                  | ** ** | **(in millions, except per  share amounts)** | ** ** |
| Net income:                                                                 |       |                                                             |       |     |       |     |       |
| As reported                                                                 |       | $                                                                | 164        |     | 238        |     | 460        |   |
| Add back: Compensation expense included in reported  net income, net of tax |       | 4                                                                |       | 6        |       | 14       |       |
| Deduct: Fair-value compensation expense for all  awards, net of tax         |       | (21                                                              | )          | (18      | )          | (23      | )          |
| As adjusted                                                                 |       | $                                                                | 147        |     | 226        |     | 451        |   |
| Basic earnings  per share:                                                  |       |                                                             |       |     |       |     |       |
| As reported                                                                 |       | $                                                                | .43        |     | .62        |     | 1.20       |   |
| As adjusted                                                                 |       | $                                                                | .39        |     | .59        |     | 1.18       |   |
| Diluted earnings  per share:                                                |       |                                                             |       |     |       |     |       |
| As reported                                                                 |       | $                                                                | .43        |     | .60        |     | 1.13       |   |
| As adjusted                                                                 |       | $                                                                | .39        |     | .57        |     | 1.11       |   |

 

53

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

**Use of Estimates**

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires us to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reporting period. Actualresults could differ from our estimates and assumptions.

**Reclassifications**

The consolidated financialstatements for prior years reflect certain reclassifications to conform withclassifications adopted in 2005. These classifications have no effect on netincome.

**New Accounting Standards**

In December 2004, the Financial AccountingStandards Board (FASB) issued FAS 123R, “Share-Based Payment,” which eliminatesthe ability to account for share-based compensation transactions using APBOpinion No. 25, “Accounting for Stock Issued to Employees,” and generallyrequires that such transactions be accounted for using a fair-value-basedmethod. Pro forma disclosure is no longer an alternative. FAS 123R alsorequires that the tax benefit associated with these share-based payments beclassified as financing activities in the statement of cash flow rather than operatingactivities as currently permitted. In April 2005, the Securities andExchange Commission (SEC) adopted a rule that delayed adoption of FAS123R, 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 thebeginning of their next fiscal year. As a result, we intend to adopt FAS 123Reffective January 1, 2006.

As permitted by FAS 123, we currently account forshare-based payments to employees using APB 25’s intrinsic value method and, assuch, generally recognize no compensation expense for employee stock options. Theadoption of FAS 123R will result in increased compensation expense in ourreported results. Had we adopted FAS 123R in prior periods, the impact of thestandard would have approximated the impact of FAS 123 as described in thedisclosure of pro forma net income and earnings per share in the Stock-BasedCompensation section of this Note 2.

We estimate the adoption of FAS No. 123R, usingthe modified prospective method, will result in incremental pre-tax expense infiscal year 2006 of approximately $12 million, based on the quantity ofunvested stock options at December 31 2005, estimated new stock optiongrants in 2006, less applicable forfeiture rates, and at their respective grantdate fair values.

In December 2004, the FASB issued FAS 152, “Accountingfor Real Estate Time-Sharing Transactions.” FAS 152 amends existing accountingguidance to reference the financial accounting and reporting guidance for realestate time-sharing transactions provided in AICPA Statement of Position 04-02,“Accounting for Real Estate Time-Sharing Transactions.” FAS 152 will beeffective for our financial statements issued after January 1, 2006. Thenew accounting guidance requires, among other things, that costs incurred tosell timeshare units generally be charged to expense as incurred, includingindirect sales and marketing expenses. The new standard will also require achange in the classification of certain items currently reported as expenses,requiring these items to be reflected as reductions of revenue. The newclassifications will not affect timeshare operating income, and operatingmargin will improve.

54

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

FAS 152 will also impactthe timing of expense recognition when pre-sales of projects under constructionoccur and we use the percentage of completion method of accounting. We arecurrently allowed to defer sales and marketing expenses in the same proportionas the deferred revenue during construction. FAS 152 allows only thedeferral of “direct” sales and marketing expenses. This will result in earlierrecognition of sales and marketing expenses during the construction period, butwill not impact the total sales and marketing expenses recognized. The impactof this change is dependent on the timing and duration of construction and theextent of pre-sales; however, it is not expected to materially affect reportedresults in 2006.

**NOTE3:** ACQUISITIONSAND DISPOSITIONS

We consider properties to be held for sale when managementapproves and commits to a formal plan to actively market a property for sale,executes a formal sales contract, allows the buyer to complete its duediligence review and receives a non-refundable deposit. Until necessaryapprovals have been received and substantive conditions to the buyer’sobligation to perform have been satisfied, we do not consider a sale to beprobable.

Upon designation as an asset held for sale, we reviewthe carrying value of the property and, as appropriate, adjust the value to thelower of its carrying value or its estimated fair value less estimated cost tosell, and we cease recording depreciation expense.

To the extent we realize again from the sale of real estate and maintain significant continuinginvolvement in the form of a long-term management contract, the gain isdeferred and recognized in earnings over the term of the contract. Results forthe years ending December 31, 2003, 2004 and 2005 include the recognitionof pre-tax deferred gains totaling $10 million, $15 million and $23 million,respectively.

***Fiscal Year 2005 Transactions***

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

In April 2005, we completed the sale of the RedLion Austin in Texas for cash of approximately $6 million. As the purchaseprice 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 Hiltonproperties for total cash of approximately $17 million, resulting in a pre-taxloss of approximately $1 million. We will continue to manage both hotels underlong-term management agreements.

In the second quarter of 2005, we completed twotransactions whereby we acquired land on Hawaii’s Big Island. The firsttransaction occurred in April 2005 involving the acquisition of 62 acresof land on which the Hilton Waikoloa Village is located. The purchase price forthis transaction was approximately $115 million. We had previously leased theland pursuant to an agreement expiring in 2061. In May 2005, we completedthe second transaction whereby we acquired 112 acres of undeveloped land forapproximately $65 million. This land is adjacent to one of two championshipgolf courses located within the Waikoloa Beach Resort. We are likely to utilizethis land for future timeshare development; however, specific plans are still beingdetermined.

55

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

In June 2005, we completed the sale of sevenwholly-owned and one majority-owned hotel. The Hilton Suites Phoenix inArizona, Hilton Suites Anaheim in California and Embassy SuitesCleveland-Beachwood in Ohio were sold for cash totaling approximately $72million, resulting in a pre-tax gain totaling approximately $16 million. Eachof the hotels will continue to operate under long-term franchise agreements. Inaddition, we will continue to manage the Hilton Suites Phoenix under along-term management agreement. A pre-tax gain totaling approximately $13million on the Hilton Suites Phoenix has been deferred, due to our continuinginvolvement in management of the hotel, and will be recognized over the life ofthe five-year management contract retained on this property. These threeproperties were sold to the RLJ Urban Lodging Fund, a hotel investment fundcreated by RLJ Development, LLC (RLJ). Robert L. Johnson, was a director of theCompany and the Chairman and Chief Executive Officer of RLJ at the time of thesale. In addition, we have a limited partnership interest in the RLJ UrbanLodging Fund totaling approximately $13 million at December 31, 2005,which is accounted for as a cost basis investment.

The Doubletree Bellevue in Washington was sold in June 2005for approximately $49 million in cash, resulting in a pre-tax loss ofapproximately $13 million. The Hilton Suites Brentwood in Tennessee was soldfor approximately $6 million in cash, resulting in a pre-tax loss ofapproximately $5 million. The Hilton Alexandria in Virginia was sold for cashof approximately $93 million, resulting in a pre-tax gain of approximately $37million, and the Hilton Charlotte in North Carolina was sold for cash ofapproximately $56 million, resulting in a pre-tax gain of approximately $5million. The sale of the Hilton Charlotte resulted in a reduction in ourconsolidated goodwill balance of approximately $3 million. We have retainedlong-term franchise agreements on each of the aforementioned properties.

Also in June 2005, we sold the majority-ownedHilton Glendale in California for cash of approximately $80 million, resultingin a pre-tax gain of approximately $30 million. Amounts attributable to theminority partner, totaling approximately $7 million on a pre-tax basis, arereflected in the consolidated statements of income, net of tax, in minority andnon-controlled interests, net. We have retained a long-term franchise agreementon the hotel. In addition, we will manage the hotel on a short-term basisduring a transition period; therefore the gain has not been deferred.

In addition to the salesof wholly-owned and majority-owned hotels, we sold our minority ornon-controlling interests in five joint venture hotel properties in the secondquarter. Proceeds totaled approximately $26 million, resulting in a pre-taxgain of approximately $6 million.

In July 2005, we soldthe Hilton East Brunswick in New Jersey for cash of approximately $43 million. Resultsat December 31, 2005 include an impairment charge of $2 million to reducethis asset to its fair market value. We will manage the hotel on a short-termbasis and have retained a long-term franchise agreement. Also in July 2005,we sold our minority interests in eight joint venture hotels. Proceeds totaledapproximately $2 million. Results for the year ended December 31, 2005include an impairment charge of $3 million to reduce the joint ventureinvestment to its fair market value.

In August 2005, wesold the Palmer House Hilton in Illinois for cash of approximately $230 million.We will continue to manage the Palmer House Hilton under a long-term managementagreement. A pre-tax gain totaling approximately $168 million has beendeferred, due to our continuing involvement in management of the hotel, andwill be recognized over the ten-year life of the management contract retainedon this property.

56

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

In October 2005, wesold the Hilton Boston Back Bay in Massachusetts for cash of approximately $110 million.We will continue to manage the Hilton Boston Back Bay under a long-termmanagement agreement. A pre-tax gain totaling approximately $35 million hasbeen deferred, due to our continuing involvement in management of the hotel,and will be recognized over the 20 year life of the management contractretained on this property. The sale of the Hilton Boston Back Bay resulted in areduction in our consolidated goodwill balance of approximately $1 million.

In November 2005, wesold the Hilton Southfield in Michigan for cash of approximately $6 million,resulting in a pre-tax gain of approximately $3 million. In addition, we haveretained a long-term franchise agreement.

In December 2005, wecompleted the sale of four wholly-owned hotels. The Hilton Portland in Oregonwas sold for cash of approximately $84 million. We will continue to manage theHilton Portland under a long-term management agreement. A pre-tax gain totalingapproximately $19 million has been deferred due to our continuing involvementin the management of the hotel, and will be recognized over the 20 year life ofthe management contract retained on this property. The Hilton San Diego inCalifornia was sold for cash of approximately $90 million, resulting in apre-tax gain of approximately $66 million. The Hilton Dallas Fort Worth inTexas was sold for cash of approximately $66 million, resulting in a pre-taxloss of approximately $23 million and the Hilton Anchorage in Alaska was soldfor cash of approximately $65 million, resulting in a pre-tax loss ofapproximately $1 million. The sale of the Hilton Dallas Fort Worth resulted ina reduction in our consolidated goodwill balance of approximately $7 million.We have retained long-term franchise agreements on each of the aforementionedproperties.

The $103 million net gain on asset dispositions andother in our consolidated statement of income for 2005 also includes a $3million gain on our oil futures derivative (see “Note 2: Summary of SignificantAccounting Policies—Derivative Instruments”) based on the market value of thecontract at December 31, 2005, and a $10 million loss on foreign currencyoptions based on the market value of the options as of December 31, 2005(see “Note 2: Summary of Significant Accounting Policies—Derivative Instruments”).Also included in the 2005 period are a net loss of $1 million related to thedisposition of certain management and franchise agreements to which value hadbeen assigned, and a $1 million loss on the disposition of other fixed assets. Theasset dispositions in 2005 also generated capital gains for tax purposes, whichenabled us to utilize capital loss tax carryforwards that had been fullyreserved. The utilization of these capital loss carryforwards resulted in a netbenefit to our income tax provision of approximately $34 million in 2005.

In 2005, we engaged Eastdil Realty Company, LLC to actas our broker for the sale of certain of our owned hotels. Fees earned byEastdil related to owned hotels sold in 2005 were approximately $3 million. BenjaminV. Lambert, a director of the Company, is the Chairman and Chief ExecutiveOfficer of Eastdil.

On February 23, 2006,we consummated the acquisition of the lodging assets of Hilton Internationalfor approximately £3.3 billion, equivalent to approximately $5.78 billion onthe transaction date, in an all-cash transaction. See “Note 20: SubsequentEvents” for further details.

***Tax-Deferred Asset Exchange***

The sale of the Palmer House Hilton was effectuatedthrough a reverse Internal Revenue Code Section 1031 tax-deferred exchangewith the two land acquisitions on Hawaii’s Big Island. As such, the sale wascompleted through an exchange facilitator that received and held the cashproceeds for our benefit until the exchange was completed.

57

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

In addition, certain ofthe owned hotel sales closed in the second quarter of 2005 were also completedthrough an exchange facilitator in order to serve as potential substitutes tothe Palmer House in completing the exchange with the land in Hawaii or tofacilitate a separate exchange pursuant to which other property might beacquired. As a result, approximately $267 million of sale proceeds from assetsales completed in the second quarter of 2005 were held for our benefit by theexchange facilitator. As a result of the sale of the Palmer House Hilton in thethird quarter, approximately $119 million of these proceeds were released to usand the cash became unrestricted. In October, approximately $84 million of theproceeds from the sale of the Palmer House Hilton were released to us andbecame unrestricted with the completion of the tax deferred-exchange related tothe 112 acres of undeveloped land in Hawaii. The remaining $64 million ofrestricted cash related to exchange activity became unrestricted in the fourthquarter of 2005.

***Fiscal Year 2004 Transactions***

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

In the second quarter of 2004, we sold the DoubletreeModesto and Doubletree Bakersfield, both in California, for a total ofapproximately $40 million in cash. Gains of approximately $3 million on Modestoand approximately $2 million on Bakersfield were deferred and, due to ourcontinuing involvement with each hotel, will be recognized over the life of thelong-term management agreement retained on each hotel. Both managementagreements are for a term of ten years. The transaction also generated acapital gain for tax purposes, which enabled us to utilize existing capitalloss tax carryforwards that had been fully reserved in prior periods. Thetransaction resulted in a net benefit to our income tax provision ofapproximately $4 million.

In the fourth quarter of 2004, we sold the DoubletreeJantzen Beach and the Doubletree Columbia River, both near Portland Oregon, fora total of approximately $29 million in cash. The sale resulted in a pre-taxloss of approximately $3 million. The pre-tax loss on asset dispositions andother of $5 million in 2004 includes the $3 million loss on the sale of the twoDoubletrees, a $4 million loss related to the write-off of values assigned tocertain long-term management and franchise agreements that were terminated in2004 and a $1 million loss due to the fair market value adjustment of ourderivative instruments. These losses were partially offset by a $3 million gainfrom the sale of our investment in Travelweb.

In August 2004, we acquired a 24 percent minorityinterest in a coal-based synthetic fuel facility for approximately $32 million.Our investment is accounted for using the equity method as we lack acontrolling financial interest. The facility produced operating losses, ourproportionate share of which totaled approximately $6 million and $17 millionin 2004 and 2005, respectively. This loss is reflected as loss fromnon-operating affiliates in the accompanying consolidated statements of income.

The synthetic fuelproduced at this facility qualifies for tax credits based on Section 29 ofthe Internal Revenue Code, which reduce our provision for income taxes. The taxcredits, combined with the tax benefit associated with the operating losses,totaled approximately $9 million and $23 million in 2004 and 2005, respectively.As a result, the benefit to our net income of the investment totaledapproximately $3 million and $6 million for the years ended December 31,2004 and December 31, 2005, respectively.

58

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

***2003 Transactions***

In the 2003 first quarter, we sold four HomewoodSuites by Hilton hotel properties in two separate transactions forapproximately $40 million. We continue to operate three of the hotels underlong-term management agreements and we have retained a long-term franchisecontract on the fourth hotel. In the fourth quarter of 2003, an Embassy Suiteshotel in which we held a 65% interest was sold, resulting in a pre-tax loss ofapproximately $4 million. We retained a long-term franchise contract on thishotel. Also in the 2003 fourth quarter, we sold certain marketable securities,which resulted in a pre-tax gain of approximately $2 million. In addition, wewrote off the value assigned to certain long-term management and franchiseagreements that were terminated in 2003 totaling approximately $4 million. Inthe aggregate, these transactions resulted in a net pre-tax loss on assetdispositions and other of $6 million in 2003.

In the first quarter of 2003, in connection withpartnership we formed with CNL Hospitality Corp. in 2002, we contributed the 437-roomHilton Rye Town in Rye Brook, New York and CNL contributed the 630-roomDoubletree Crystal City in Arlington, Virginia to the partnership. The gainresulting from our contribution of the Hilton Rye Town of approximately $35million has been deferred and will be recognized over the ten year life of thelong-term management contract retained on the property. Also in the firstquarter of 2003, the partnership acquired the 257-suite Embassy SuitesSanta Clara in Santa Clara, California, the 267-suite Embassy SuitesCrystal City in Arlington, Virginia, and the 174-suite Embassy SuitesOrlando Airport in Orlando, Florida. We operate all seven hotels underlong-term management contracts and have a 25% ownership interest in thepartnership.

In connection with the structuring of the CNLpartnership, including our contribution of the Hilton Rye Town, we received acash distribution totaling approximately $46 million in the 2003 first quarter.This distribution is reflected as proceeds from asset dispositions in theaccompanying consolidated statements of cash flow. In addition, the tax gainresulting from the contribution of the Hilton Rye Town enabled us to utilizecapital loss tax carryforwards, resulting in a reduction in our provision forincome taxes totaling approximately $4 million.

In the fourth quarter of2003, we entered into another partnership with CNL to own two hotel properties.We contributed the 544-room Capital Hilton in Washington, D.C. and the 394-roomHilton La Jolla Torrey Pines outside of San Diego, California to thepartnership. The gain resulting from our contribution of the two hotels totalingapproximately $57 million has been deferred and will be recognized over the ten-yearlife of the long-term management contracts retained on the properties. We havea 25% ownership interest in the partnership. In connection with thistransaction, we received a distribution from the partnership of approximately$190 million. This distribution is reflected as proceeds from assetdispositions in the accompanying consolidated statements of cash flow. Thistransaction also resulted in tax gains that enabled us to utilize capital losstax carryforwards, resulting in a reduction in our provision for income taxestotaling approximately $22 million.

**NOTE 4:** VARIABLE INTEREST ENTITIES

We manage two hotels in which we have variableinterests, as defined in FIN 46R, due to the terms of performance guarantees. Theperformance guarantee associated with one of the hotel management agreementsdoes not expose us to the majority of expected cash flow variability;therefore, we are not the primary beneficiary and this hotel is notconsolidated. Our maximum exposure to loss on this contract consists of futuremanagement fees and our potential obligation to fund the performance guaranteewhich, as of December 31, 2005, totaled approximately $35 million through2012.

59

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

The second of the twocontracts contains provisions that expose us to the majority of expected cashflow variability. As a result, we are considered to be the primary beneficiaryunder FIN 46R, and are required to consolidate the balance sheet and results ofoperations of the hotel. Our consolidated balance sheets at both December 31,2004 and December 31, 2005 include the assets and liabilities of thisnon-controlled hotel, including approximately $10 million of cash andequivalents (reflected as restricted cash) and $100 million of debt which isnon-recourse to us. The debt is secured by the fixed assets of the hotel with ahistorical cost of approximately $82 million. The net equity of the hotel is aretained deficit of approximately $60 million at both December 31, 2004and 2005, and is reflected on our consolidated balance sheets in other assets. Therevenue and operating expenses of this property are included in other revenueand expenses from managed and franchised properties in the consolidatedstatements of income. Our financial exposure to this property consists of thefees we earn under the management agreement, costs we may incur under anyperformance guarantee shortfalls and earnings we retain in excess of theperformance guarantee. The net effect of the earnings which belong to the hotelowners under the guarantee are eliminated from our consolidated results throughminority and non-controlled interests expense in the consolidated statements ofincome.

**NOTE5:** IMPAIRMENTLOSS AND RELATED COSTS

Results in 2005 include pre-tax impairment loss andrelated costs totaling $7 million. This includes a $2 million charge related toan owned hotel and a $3 million charge related to our minority interests ineight joint venture hotels to reduce their respective carrying values to theirestimated fair values. These two charges are included in Hotel Ownershipsegment results. The hotel and joint venture interests were sold in July 2005(see “Note 3: Acquisitions and Dispositions”). The charge in 2005 also includesa $2 million pre-tax charge in the first quarter, representing the writedown of a non-hotel cost basis investment to its estimated fair value. Thischarge is included in corporate and other unallocated expenses in our reportedsegment results.

Results in 2004 include impairment loss and relatedcosts totaling $5 million. This pre-tax charge is to reduce the value of anowned hotel to its estimated fair value and is included in Hotel Ownershipsegment results.

Results in 2003 includeimpairment loss and related costs totaling $22 million. These costs include a$17 million pre-tax charge related to the decline in value of certain equitysecurities held by us. The decline in value of the securities was deemed to beother-than-temporary in the 2003 first quarter, thus requiring an earningscharge, primarily based on the length of time the securities had traded belowcost. The 2003 charge also includes a $5 million pre-tax charge to reducethe value of an owned hotel and a management contract to their respective fairvalues. The write-down of the hotel and management contract are included inHotel Ownership and Managing and Franchising segment results, respectively,while the charge related to the marketable securities is included in corporateand other unallocated expenses in our reported segment results.

**NOTE 6:** INVENTORIES

Included in inventories atDecember 31, 2004 and 2005 are unsold intervals at our timeshareproperties of $132 million and $209 million, respectively. Inventoriesare valued at the lower of cost or estimated net realizable value. The capitalexpenditures associated with our non-lease timeshare products are reflected asinventory until the timeshare intervals are sold. The company uses the relativesales value method of costing our timeshare sales and relieving inventory inaccordance with FAS 67, “Accounting for Costs and Initial Rental Operations ofReal Estate Projects.”

60

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

**NOTE7:** INVESTMENTSAND NOTES RECEIVABLE

Investmentsand notes receivable at December 31, 2004 and 2005 are as follows:

| ** **                                                                   | ** ** | **2004**               | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                                   | ** ** | **(in millions)** | ** ** |
| Equity  investments                                                          |       |                   |       |     |       |
| Hotels                                                                       |       | $                      | 272        |     | 269        |   |
| Other                                                                        |       | 46                     |       | 28       |       |
| Timeshare notes  receivable, with an average rate of 12.9%, due 2006 to 2015 |       | 262                    |       | 351      |       |
| Other notes  receivable, with an average rate of 6.3%, due 2006 to 2015      |       | 88                     |       | 50       |       |
| Marketable securities                                                        |       | 25                     |       | 29       |       |
| Foreign currency  options                                                    |       | —                 |       | 44       |       |
| Other investments                                                            |       | 10                     |       | 20       |       |
| ** **                                                                   |       | 703                    |       | 791      |       |
| Less current  portion of notes receivable and foreign currency options       |       | (68                    | )          | (84      | )          |
| Total                                                                        |       | $                      | 635        |     | 707        |   |

 

Notes receivable are reflected net of an estimatedallowance for uncollectible amounts. For timeshare notes receivable, thisestimate is based primarily on historical experience and assumptions withrespect to future payment trends. Allowances for uncollectible amounts of othernotes receivable, which includes notes from managed, franchised andunconsolidated joint venture properties, are estimated based primarily onhistorical trends and analysis of underlying real estate collateral. Assessmentof collateral may include estimates of future cash flow from the underlyingreal estate. For timeshare notes receivable, interest income is recognizedmonthly from the date that the loan is closed. Any fees, including processingfees and late fees, are recognized in the month of collection.

Total notes receivable, including timeshare, totaled$350 million and $401 million, net of allowances for uncollectible amounts of$18 million and $24 million as of December 31, 2004 and 2005, respectively.

Our investments in unconsolidated affiliates accountedfor under the equity method totaled $318 million and $297 million at December 31,2004 and 2005, respectively, representing approximately four percent and threepercent of total assets at the end of 2004 and 2005, respectively. At December 31,2005, our unconsolidated affiliates accounted for under the equity method hadtotal assets of approximately $2.39 billion and total debt ofapproximately $1.15 billion. Of the $1.15 billion of total debt,$1.11 billion is secured solely by the affiliate’s assets or is guaranteedby other partners without recourse to us. We are the creditor on $46 millionof the $1.15 billion of debt.

During December 2005we entered into foreign currency options to mitigate the risk associated withchanges in foreign currency exchange rates on our agreement to fund the HI Acquisitionprice in British Pounds Sterling. These options expire in the 2006 firstquarter and are carried at fair market value in other current assets on theconsolidated balance sheets. See “Note 2: Summary of Significant AccountingPolicies—Derivative Instruments” for additional information.

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

**NOTE 8:** PROPERTY AND EQUIPMENT

Propertyand equipment at December 31, 2004 and 2005 are as follows:

| ** **                             | ** ** | **2004**               | ** ** | **2005** | ** ** |
|----------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                             | ** ** | **(in millions)** | ** ** |
| Land                                   |       | $                      | 513        |     | 590        |   |
| Buildings and  leasehold improvements  |       | 3,650                  |       | 3,009    |       |
| Furniture and  equipment               |       | 829                    |       | 703      |       |
| Property held for  sale or development |       | 46                     |       | 48       |       |
| Construction in  progress              |       | 20                     |       | 32       |       |
|                                   |       | 5,058                  |       | 4,382    |       |
| Less accumulated  depreciation         |       | (1,548                 | )          | (1,397   | )          |
| Total                                  |       | $                      | 3,510      |     | 2,985      |   |

 

**NOTE9:** ACCOUNTSPAYABLE AND ACCRUED EXPENSES

Accountspayable and accrued expenses at December 31, 2004 and 2005 are as follows:

| ** **                           | ** ** | **2004**               | ** ** | **2005** | ** ** |
|--------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                           | ** ** | **(in millions)** | ** ** |
| Accounts and  notes payable          |       | $                      | 95         |     | 139        |   |
| Accrued  compensation and benefits   |       | 150                    |       | 153      |       |
| Foreign currency  derivative payable |       | —                 |       | 54       |       |
| Insurance  reserves                  |       | 45                     |       | 45       |       |
| Deposits                             |       | 42                     |       | 40       |       |
| Accrued interest                     |       | 35                     |       | 37       |       |
| Accrued property  tax                |       | 28                     |       | 19       |       |
| Other accrued  expenses              |       | 216                    |       | 285      |       |
| Total                                |       | $                      | 611        |     | 772        |   |

 

**NOTE 10:** LONG-TERM DEBT

Long-termdebt at December 31, 2004 and 2005 is as follows:

| ** **                                                            | ** ** | **2004**               | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                            | ** ** | **(in millions)** | ** ** |
| Industrial  development revenue bonds at adjustable rates, due 2015   |       | $                      | 82         |     | 82         |   |
| Senior notes,  with an average rate of 7.9%, due 2007 to 2031(1)      |       | 2,045                  |       | 2,040    |       |
| Mortgage notes,  6.0% to 8.6%, due 2006 to 2011(1)                    |       | 341                    |       | 310      |       |
| 7.95%  Collateralized borrowings, due 2010                            |       | 471                    |       | 463      |       |
| Chilean  inflation-indexed note, effective rate of 7.65%, due 2009(1) |       | 131                    |       | 148      |       |
| 3.375%  Contingently convertible senior notes due 2023                |       | 575                    |       | 575      |       |
| Other                                                                 |       | 2                      |       | 1        |       |
|                                                                  |       | 3,647                  |       | 3,619    |       |
| Less current  maturities of long-term debt                            |       | (14                    | )          | (47      | )          |
| Net long-term  debt                                                   |       | $                      | 3,633      |     | 3,572      |   |

----

(1)          Interest rates includethe impact of interest rate swaps.

62

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Interest paid, net of amounts capitalized, was$261 million, $246 million and $244 million in 2003, 2004 and2005, respectively. Capitalized interest totaled $7 million, $3 millionand $8 million in 2003, 2004 and 2005, respectively.

Debtmaturities are as follows:

| ** ** | ** ** | **(in millions)** | ** ** |
|------------|------------|------------------------|------------|
| 2006       |       |                   | $          | 47 |   |   |
| 2007       |       |                   | 410        |   |   |
| 2008       |       |                   | 473        |   |   |
| 2009       |       |                   | 363        |   |   |
| 2010       |       |                   | 558        |   |   |
| Thereafter |       |                   | 1,768      |   |   |
| Total      |       |                   | $          | 3,619 |   |   |

 

At December 31, 2005, we had a $1 billionrevolving credit facility, with an option to increase the size of the facilityby an additional $250 million. This facility was amended in the first quarterof 2005. The amendment lowered our all-in cost of borrowing under this facilityby 50 basis points from LIBOR plus 125 basis points to LIBOR plus 75 basispoints and extended the facility until March 2010. There were no amountsoutstanding under the revolving credit facility at December 31, 2005. Thecapacity under our revolver was also used to support certain outstandingletters of credit. Total revolving debt capacity of approximately $855 millionwas available to us at December 31, 2005.

In connection withthe HI Acquisition in February 2006 (see “Note 20: Subsequent Events”), weentered into new senior credit facilities in an aggregate principal U.S. dollarequivalent of approximately $5.75 billion with a syndicate of financialinstitutions. These facilities replaced our $1 billion revolving creditfacility and are secured by a pledge of the capital stock of certain of ourwholly-owned subsidiaries. The credit facilities consist of the followingtranches:

·       U.S.Dollar Denominated Revolver—5 year, $3.25 billion available in U.S. dollars,British Pounds Sterling, Euros and Swedish Kronor or other currenciesacceptable to the administrative agent. Interest at a variable rate dependingupon our leverage ratio and senior debt ratings, with initial borrowings atLIBOR plus 150 basis points (which includes a 25 basis point annual facilityfee).

·       ForeignCurrency Denominated Term Loan A—5 year, approximate equivalent of $2 billionto be denominated in £675 million, €675 million and Australian$140 million. Interest at a variable rate depending upon our leverage ratio andsenior debt ratings, with initial borrowings at LIBOR plus 150 basis points.

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

We also have theoption to increase the credit facilities by $500 million.

In February 2006, we borrowed an aggregateprincipal U.S. dollars equivalent amount of approximately $4.8 billion underthese facilities to partially fund the HI Acquisition.

63

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Subsequent to our announcement in December 2005of our agreement to acquire the lodging assets of Hilton Group plc,Standard & Poor’s Ratings Group lowered our senior debt rating fromBBB- to BB. In addition, Moody’s Investor Services lowered our senior debtrating from Baa3 to Ba2. These downgrades are reflected in the interest rates andfacility fee of our new $5.75 billion credit facilities. Under the terms of thecredit facilities, the proceeds from the sale of certain owned propertiesacquired as part of the HI Acquisition are required to be used for therepayment of our senior credit facilities. In addition, we expect that excesscash flow will be used to repay outstanding debt balances to improve our creditposition.

In October 1997, we filed a shelf registrationstatement with the Securities and Exchange Commission registering up to$2.5 billion in debt or equity securities. At December 31, 2005,available financing under the shelf totaled $825 million. The terms of anyadditional securities offered under the shelf will be determined by marketconditions at the time of issuance.

In 2003, we sold $575 million of 3.375% ConvertibleSenior Notes due in 2023 in a private placement transaction. The notes areconvertible to shares of our common stock at an initial conversion price of$22.50 per share of common stock, upon the occurrence of certain events.

In November 2002, we entered into a derivativecontract which swaps the fixed interest payments on our $375 million 7.95%Senior Notes due 2007 to a floating interest rate equal to the six-month LondonInterbank Offered Rate plus 415 basis points. In connection with our$100 million 7.43% bonds due 2009 denominated in Chilean pesos, we have aderivative contract which swaps the principal payment to a fixed U.S. dollaramount of $100 million and fixed interest payments at 7.65% of thatamount.

As of December 31, 2005, approximately 13% of ourlong-term debt (including the impact of interest rate swaps) was floating ratedebt.

Provisions under various loan agreements require us tocomply with certain covenants which include limiting the amount of ouroutstanding indebtedness. Our revolving credit facilities contained twosignificant financial covenants: a leverage ratio and a debt service coverageratio. We were in compliance with our financial covenants as of December 31,2005.

Provisions of thefinancing agreement related to our 7.95% collateralized borrowings due 2010require that certain cash reserves be maintained and also restrict the transferof excess cash generated by the related properties to Hilton if net cash flowfalls below a specified level (the cash trap). The cash trap became effectivein 2003 due to reduced cash flow from the collateralized properties, primarilythe Hilton San Francisco. As of December 31, 2005, cash restricted underthe terms of the collateralized borrowings, including required reserves and thecash trap, totaled $146 million. The impact of the cash trap, which isexpected to remain in effect throughout 2006, is not expected to have amaterial impact on our liquidity.

64

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

**NOTE 11:** FINANCIAL INSTRUMENTS

Theestimated fair values of our financial instruments at December 31, 2004and 2005 are as follows:

| ** **                                                    | ** ** | **2004**               | ** ** | **2005**        | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|-----------------|------------|
| ** **                                                    | ** ** | **Carrying  Amount**   | ** ** | **Fair  Value** | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| ** **                                                    | ** ** | **(in millions)** | ** ** |
| Cash and  equivalents and long-term marketable securities     |       | $                      | 330        |            | 330        |   | 1,183 |   | 1,183 |   |
| Restricted cash                                               |       | 163                    |       | 163             |       | 182 |   | 182 |   |
| Timeshare notes  receivable (including current portion)  |       | 262                    |       | 265             |       | 351 |   | 356 |   |
| Other notes  receivable (including current portion)           |       | 88                     |       | 89              |       | 50 |   | 59 |   |
| Derivative assets                                             |       | 44                     |       | 44              |       | 107 |   | 107 |   |
| Long-term debt  (including current maturities)                |       | (3,647                 | )          | (4,088          | )          | (3,619 | ) | (3,849 | ) |
| Derivative liabilities                                        |       | (1                     | )          | (1              | )          | (6 | ) | (6 | ) |
|                                                               |            |                        |            |                 |            |  |  |  |  |  |

 

**CashEquivalents, Long-Term Marketable Securities and Restricted Cash**

The fair value of cashequivalents, long-term marketable securities and restricted cash is estimatedbased on the quoted market price of the investments.

**Timeshareand Other Notes Receivable**

The estimated fair valueof timeshare and other notes receivable is based on recent market prices or theexpected future cash flows discounted at risk adjusted rates.

**Long-Term Debt**

The estimated fair valueof long-term debt is based on the quoted market prices for the same or similarissues or on the current rates offered to us for debt of the same remainingmaturities.

**Derivative Instruments**

The fair value ofderivative assets and liabilities is based on the present value of estimatedfuture cash flow, including the use of foreign currency forward exchange rates,as appropriate.

**NOTE 12:** INCOME TAXES

Theprovisions for income taxes for the three years ended December 31 are asfollows:

| ** **               | ** ** | **2003**               | ** ** | **2004** | ** ** | **2005** | ** ** |
|--------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **               | ** ** | **(in millions)** | ** ** |
| Current                  |       |                   |       |     |       |     |       |
| Federal                  |       | $                      | 77         |     | 114        |     | 207        |   |
| State, foreign and local |       | 16                     |       | 25       |       | 52       |       |
|                     |       | 93                     |       | 139      |       | 259      |       |
| Deferred                 |       | (40                    | )          | (12      | )          | (93      | )          |
| Total                    |       | $                      | 53         |     | 127        |     | 166        |   |

 

65

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

During 2003, 2004 and 2005, we paid income taxes of$44 million, $99 million and $209 million, respectively, net ofrefunds received.

Theincome tax effects of temporary differences between financial and income taxreporting that gave rise to deferred income tax assets and liabilities at December 31,2004 and 2005 are as follows:

| ** **                               | ** ** | **2004**               | ** ** | **2005** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                               | ** ** | **(in millions)** | ** ** |
| Deferred tax assets                      |       |                   |       |     |       |
| Compensation                             |       | $                      | 96         |     | 115        |   |
| Deferred income                          |       | —                 |       | 68       |       |
| Insurance                                |       | 49                     |       | 48       |       |
| Franchise system funds                   |       | 13                     |       | 22       |       |
| Reserves                                 |       | 23                     |       | 22       |       |
| NOL carryforwards, expiring 2005 to 2009 |       | 1                      |       | 6        |       |
| Capital loss carryforward                |       | 6                      |       | —   |       |
| Other                                    |       | 3                      |       | 1        |       |
|                                     |       | 191                    |       | 282      |       |
| Valuation allowance                      |       | (10                    | )          | (11      | )          |
|                                     |       | 181                    |       | 271      |       |
| Deferred tax liabilities                 |       |                   |       |     |       |
| Basis difference                         |       | (168                   | )          | (153     | )          |
| Property                                 |       | (194                   | )          | (186     | )          |
| Investments                              |       | (107                   | )          | (105     | )          |
| Brand value                              |       | (378                   | )          | (383     | )          |
| Deferred income                          |       | (1                     | )          | —   |       |
| Accrued interest expense                 |       | (20                    | )          | (33      | )          |
| Other                                    |       | (9                     | )          | (4       | )          |
|                                     |       | (877                   | )          | (864     | )          |
| Net deferred tax  liability              |       | $                      | (696       | )        | (593       | ) |

 

Thereconciliations of the Federal income tax rate to our effective tax rate forthe three years ended December 31 are as follows:

| ** **                                                 | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal income  tax rate                                   |       | 35.0     | %          | 35.0     |       | 35.0     |       |
| Increase (reduction) in  taxes                             |       |     |       |     |       |     |       |
| State and local income taxes, net of Federal tax  benefits |       | .8       |       | 4.7      |       | 5.9      |       |
| Foreign taxes , net                                        |       | 2.3      |       | 1.3      |       | .4       |       |
| Federal income tax credits                                 |       | (3.8     | )          | (4.3     | )          | (4.1     | )          |
| Closing of prior years tax audits                          |       | —   |       | —   |       | (8.0     | )          |
| Change in deferred tax asset valuation allowance           |       | (13.3    | )          | (2.3     | )          | (5.1     | )          |
| Option exercises                                           |       | 4.4      |       | —   |       | —   |       |
| Refund claim                                               |       | (2.8     | )          | —   |       | —   |       |
| Other                                                      |       | 1.2      |       | (.4      | )          | 1.9      |       |
| Effective tax rate                                         |       | 23.8     | %          | 34.0     |       | 26.0     |       |

 

66

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Net operating loss carryforwards and foreign taxcredits are recorded as deferred tax assets and are fully reserved untilevidence indicates that it is more likely than not that the benefit will berealized.

Our tax provision, deferredtaxes and effective rate in 2005 were impacted by the utilization of syntheticfuel tax credits of approximately $17 million (see “Note 3: Acquisitions andDispositions”), a reduction in the valuation allowance for capital loss taxcarryforwards of approximately $34 million (see “Note 3: Acquisitions andDispositions”) and a net benefit of $28 million from the reversal of taxreserves no longer required as the result of the completion of IRS audits ofour 1997 through 2001 Federal income tax returns, partially offset by increasesin state tax reserves and deferred tax liabilities principally attributable tostatutory tax increases in various jurisdictions. The provision for incometaxes also reflects a net benefit of approximately $2 million related tostate tax credits received in 2005. Excluding the impact of these items,our effective rate in 2005 was 39 percent.

In accordance with theprovisions of FAS 109, the reversal of reserve balances arising from thecompletion of the IRS audits that relate to our acquisition of Promus HotelCorporation in 1999 were reflected as an adjustment of goodwill and did notimpact our tax provision in 2005. These adjustments resulted in a reduction ofboth goodwill and other liabilities totaling approximately $13 million.

Our tax provision, deferred taxes and effective ratein 2004 were impacted by a reduction in the valuation allowance for capitalloss tax carryforwards, primarily as a result of the sale of three Doubletreeproperties and the sale of our interest in Travelweb. The 2004 effective ratealso reflects the utilization of Section 29 synthetic fuel productioncredits. Excluding the impact of these items, our effective rate in 2004 was 38percent.

Our tax provision, deferred taxes and effective ratein 2003 were impacted by a reduction in the valuation allowance for capitalloss tax carryforwards, primarily as a result of the transactions with CNL. Inaddition, our tax provision, deferred taxes and effective rate were impacted bya reduction in the valuation allowance for capital loss tax carryforwards dueto higher than expected utilization on our 2002 Federal tax return filed in2003, as well as a settlement relating to a tax liability associated with aprior year tax return. These items resulted in a reduction of the tax provisionand effective rate in 2003. These benefits were partially offset by thewrite-off of an unutilized deferred tax asset resulting from a stock optionexercise. Excluding the impact of these items, our effective rate in 2003 was35 percent.

Deferred taxes were alsoimpacted in 2003 by the settlement and closure of certain tax audits and theadjustment of certain deferred tax balances, each related to our acquisition ofPromus Hotel Corporation in 1999. In accordance with the provisions of FAS 109,these changes in estimates were reflected as an adjustment of goodwill relatedto the Promus acquisition and did not impact the tax provision in 2003. Theseadjustments resulted in a reduction of both goodwill and deferred income taxesand other liabilities totaling approximately $48 million.

**NOTE 13:** STOCKHOLDERS’ EQUITY

Five hundred million shares of common stock with a parvalue of $2.50 per share are authorized, of which 399 million and404 million were issued at December 31, 2004 and 2005, respectively,including treasury shares of ten million in 2004 and 22 million in 2005. Wehave 25 million shares of preferred stock with a par value of $1.00 pershare authorized for issuance. No preferred shares were issued or outstandingat December 31, 2004 and 2005.

67

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

During 2005, we repurchased a total of 12.3 millionshares of our common stock at a total cost of approximately $271 million. During2004, we repurchased approximately 2.3 million shares of our common stock for atotal cost of approximately $48 million. No shares were repurchased during 2003.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 anadditional 50 million shares of common stock. As of December 31, 2005,approximately 44.7 million shares remained authorized for repurchase under thisauthority.

We have a Preferred SharePurchase Rights Plan under which a right is attached to each share of ourcommon stock. The rights may only become exercisable under certaincircumstances involving actual or potential acquisitions of 20% or more of ourcommon stock by certain people or groups. Depending on the circumstances, ifthe rights become exercisable, the holder may be entitled to purchase units ofour junior participating preferred stock, shares of our common stock or sharesof common stock of the acquirer. The rights remain in existence until November 2009unless they are terminated, exercised or redeemed.

**NOTE 14:** STOCK PLANS

At December 31, 2005, 42 million shares ofcommon stock were reserved for issuance under our stock incentive plans. Wehave three active stock plans with substantially identical terms that allow thegrant of options plus the 2004 Omnibus Equity Compensation plan, which wasapproved in 2004 and allows the grant of options, stock units, performanceunits, and other stock-based awards. 400,000 stock options were granted in 2005and no stock options were granted in 2004. See “Note 2: Summary of SignificantAccounting Policies—Stock-Based Compensation” for discussion of the optionsgranted in 2005 and restricted stock awards granted in 2004 and 2005.

Options may be granted to salaried officers, directorsand other key employees to purchase our common stock at not less than the fairmarket value at the date of grant. Generally, options vest over a four yearperiod, contingent upon continued employment, and remain outstanding for tenyears from the date of grant. Options may generally be exercised ininstallments commencing one year after the date of grant. At December 31,2005, there were approximately 26 million shares available for issuance underthe 2004 plan and no authorized shares remaining under the other three stockplans.

68

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Asummary of the status of our stock option plans as of December 31, 2003,2004 and 2005, and changes during the years ending on those dates, is presentedbelow:

| ** **                         | ** ** | **Options Price  Range  (per share)** | ** **             | **Weighted  Average Price  (per share)** | ** ** | **Options  Outstanding** | ** ** | **Available for  Grant** | ** ** |
|------------------------------------|------------|-------------------------------------------------|------------------------|----------------------------------------------------|------------|--------------------------|------------|-------------------------------|------------|
| Balance at  December 31, 2002 |       | $                                               | 6.66 - 27.53 |                                               |       | $                        | 13.33      |                          |       | 36,890,765 |   | 18,443,094 |   |
| Granted                            |       | 11.87 - 13.40                         |                   |                                               | 11.88      |                     |       | 7,144,775                     |       | (7,144,775 | ) |
| Exercised                          |       | 6.66 - 16.23                          |                   |                                               | 11.46      |                     |       | (9,542,341                    | )          | — |   |
| Cancelled                          |       | 6.66 - 19.65                          |                   |                                               | 13.27      |                     |       | (1,248,825                    | )          | 1,209,025 |   |
| Balance at  December 31, 2003 |       | 6.66 - 27.53                          |                   |                                               | 13.56      |                     |       | 33,244,374                    |       | 12,507,344 |   |
| Authorized                         |       |                                            |                   |                                               |       |                     |       | —                        |       | 30,000,000 |   |
| Granted                            |       |                                            |                   |                                               |       |                     |       | —                        |       | (2,325,979 | ) |
| Exercised                          |       | 6.66 - 19.65                          |                   |                                               | 12.68      |                     |       | (10,337,449                   | )          | — |   |
| Cancelled                          |       | 6.66 - 20.66                          |                   |                                               | 12.12      |                     |       | (1,292,425                    | )          | (12,496,515 | ) |
| Balance at  December 31, 2004 |       | 6.66 - 27.53                          |                   |                                               | 14.06      |                     |       | 21,614,500                    |       | 27,684,850 |   |
| Granted                            |       | 22.19 - 22.19                         |                   |                                               | 22.19      |                     |       | 400,000                       |       | (2,486,461 | ) |
| Exercised                          |       | 6.66 - 20.66                          |                   |                                               | 13.21      |                     |       | (4,759,680                    | )          | 137,997 |   |
| Cancelled                          |       | 11.85 - 19.65                         |                   |                                               | 12.87      |                     |       | (357,900                      | )          | 187,224 |   |
| Balance at  December 31, 2005 |       | 6.66 - 27.53                          |                   |                                               | 14.52      |                     |       | 16,896,920                    |       | 25,523,610 |   |
|                                    |            |                                                 |                        |                                                    |            |                          |            |                               |            |  |  |  |  |

 

Thefollowing table summarizes information about stock options outstanding at December 31,2005:

| ** **              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                            | ** ** |
|-------------------------|------------|------------------------------|------------|---------------------------------------------------------|------------|
| **Exercise Price** | ** ** | **Number  Outstanding**      | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| $6.66 - 11.63 |       | 1,322,731                    |       |                                                    | 3.9        |   |   |   | $ | 9.25 |   |   | 1,322,731 |   |   | $ | 9.25 |   |   |
| 11.85 - 11.87 |       | 8,683,573                    |       |                                                    | 6.6        |   |   |   | 11.86 |   |   | 4,286,885 |   |   | 11.86 |   |   |
| 12.22 - 17.15 |       | 3,767,816                    |       |                                                    | 3.5        |   |   |   | 13.80 |   |   | 3,767,816 |   |   | 13.80 |   |   |
| 18.38 - 27.53 |       | 3,122,800                    |       |                                                    | 3.3        |   |   |   | 25.01 |   |   | 722,800 |   |   | 19.60 |   |   |
| 6.66 - 27.53  |       | 16,896,920                   |       |                                                    | 5.1        |   |   |   | 14.52 |   |   | 10,100,232 |   |   | 12.79 |   |   |

 

**NOTE 15:** EMPLOYEE BENEFIT PLANS

Wehave a noncontributory retirement plan (Basic Plan) which covers many of ournon-union employees. Benefits are based upon years of service and compensation,as defined. The annual measurement date for the Basic Plan is December 31.Since December 31, 1996, employees have not accrued additional benefitsunder the Basic Plan. Therefore, the projected benefit obligation is equal tothe accumulated benefit obligation, and both are referred to simply as the “benefitobligation” below. Plan assets will be used to pay benefits due employees forservice through December 31, 1996. As employees have not accruedadditional benefits since 1996, we do not utilize a rate of compensationincrease assumption in calculating our benefit obligation. The assumptions usedto determine our benefit obligations at December 31, 2004 and 2005 are asfollows:

| ** **    | ** ** | **2004** | ** ** | **2005** | ** ** |
|---------------|------------|----------|------------|----------|------------|
| Discount Rate |       | 5.50     | %          | 5.25     |       |

 

69

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Therollforwards of our benefit obligations and fair value of plan assets for theyears ended December 31, 2004 and 2005 are as follows:

| ** **                               | ** ** | **2004**               | ** ** | **2005** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                               | ** ** | **(in millions)** | ** ** |
| Benefit  obligation at beginning of year |       | $                      | 297        |     | 324        |   |
| Interest cost                            |       | 18                     |       | 17       |       |
| Actuarial loss                           |       | 27                     |       | 8        |       |
| Benefits paid                            |       | (18                    | )          | (21      | )          |
| Benefit obligation at  end of year       |       | $                      | 324        |     | 328        |   |

 

| ** **                                      | ** ** | **2004**               | ** ** | **2005** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                      | ** ** | **(in millions)** | ** ** |
| Fair value of  plan assets at beginning of year |       | $                      | 278        |     | 288        |   |
| Actual return on plan assets                    |       | 28                     |       | 12       |       |
| Benefits paid                                   |       | (18                    | )          | (21      | )          |
| Fair value of  plan assets at end of year       |       | $                      | 288        |     | 279        |   |

 

Theinvestment objectives for the Basic Plan are preservation of capital, currentincome and long-term growth of capital. Substantially all plan assets aremanaged by outside investment managers. Asset allocations are reviewedquarterly. Equity securities are primarily S&P 500 and S&P 400 indexfunds. Equity securities include Hilton common stock in the amounts of$10 million and $11 million at December 31, 2004 and 2005,respectively, representing approximately 3% and 4% of total plan assets in eachperiod. Debt securities are U.S. Treasury and government agency debt securities.The expected long-term return on plan assets is based on the following assumedrates of return for the assets held: 4% to 7% for government debt securitiesand 8% to 10% for U.S. common stocks. The asset allocations for the Basic Plan,as a percentage of total plan assets at December 31, 2004 and 2005, are asfollows:

| ** **        | ** ** | **2004** | ** ** | **2005** | ** ** |
|-------------------|------------|----------|------------|----------|------------|
| Equity securities |       | 56       | %          | 62       |       |
| Debt securities   |       | 44       |       | 38       |       |
| Total             |       | 100      | %          | 100      |       |

 

Thefollowing table provides a reconciliation between the funded status of theBasic Plan and the accrued benefit cost liability on the balance sheet for theyears ended December 31, 2004 and 2005, as well as the other componentsrecognized in our consolidated balance sheets:

| ** **                                                  | ** ** | **2004**               | ** ** | **2005** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                  | ** ** | **(in millions)** | ** ** |
| Funded status                                               |       | $                      | (36        | )        | (50        | ) |
| Unrecognized actuarial loss                                 |       | 32                     |       | 47       |       |
| Unamortized prior service cost                              |       | 4                      |       | 3        |       |
| Accrued benefit  cost                                       |       | —                 |       | —   |       |
| Intangible assets                                           |       | 4                      |       | 3        |       |
| Additional  minimum liability                               |       | (36                    | )          | (50      | )          |
| Accumulated other  comprehensive loss, excluding tax impact |       | 32                     |       | 47       |       |
| Net amount  recognized                                      |       | $                      | —     |     | —     |   |

 

70

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Comprehensive income includes adjustments of$7 million, $12 million and $9 million net of the deferred tax impact,reflecting increases of $11 million, $21 million, and $15 million relatedto the minimum pension liability, for 2003, 2004 and 2005, respectively.

Asdescribed above, employees have not accrued additional benefits under the BasicPlan since 1996. Therefore, we do not utilize a rate of compensation increaseassumption in calculating the net periodic benefit cost. The key actuarialassumptions used to determine the annual benefit cost for the years ended December 31,2003, 2004 and 2005 are as follows:

| ** **                                | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discount Rate                             |       | 6.75     | %          | 6.00     |       | 5.50     |       |
| Expected long-term  return on plan assets |       | 7.25     |       | 7.25     |       | 7.25     |       |

 

Ourannual benefit income for the years ended December 31, 2003, 2004 and 2005consisted of the following:

| ** **                          | ** ** | **2003**               | ** ** | **2004** | ** ** | **2005** | ** ** |
|-------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                          | ** ** | **(in millions)** | ** ** |
| Expected return  on plan assets     |       | $                      | 20         |     | 20         |     | 20         |   |
| Interest cost                       |       | (18                    | )          | (18      | )          | (17      | )          |
| Amortization of prior  service cost |       | (1                     | )          | (1       | )          | (1       | )          |
| Amortization of  net loss           |       | —                 |       | —   |       | (1       | )          |
| Net annual  benefit income          |       | $                      | 1          |     | 1          |     | 1          |   |

 

We donot expect to make any contribution to the Basic Plan in 2006. As of December 31,2005, the benefits expected to be paid in the next five fiscal years and in theaggregate for the five fiscal years thereafter are as follows:

| ** **            | ** ** | **(in millions)** | ** ** |
|-----------------------|------------|------------------------|------------|
| 2006                  |       |                   | $          | 18 |   |   |
| 2007                  |       |                   | 18         |   |   |
| 2008                  |       |                   | 18         |   |   |
| 2009                  |       |                   | 19         |   |   |
| 2010                  |       |                   | 19         |   |   |
| 2011 - 2015 |       |                   | 97         |   |   |

 

We also have plans covering qualifying employees andnon-officer directors (Supplemental Plans). Benefits for the Supplemental Plansare based upon years of service and compensation, as defined. Since December 31,1996, employees and non-officer directors have not accrued additional benefitsunder the Supplemental Plans. These plans are self-funded by us and thereforehave no plan assets isolated to pay benefits due employees. As of December 31,2004 and 2005, these plans have benefit obligations of $9 million and $10million, respectively, which are fully accrued in our consolidated balancesheets. Pension expense under the Supplemental Plans for the years ended December 31,2003, 2004 and 2005 was not significant.

Certain employees are covered by union sponsored,collectively bargained multi-employer pension plans. We contributed and chargedto expense $18 million, $19 million and $23 million for the years ended December 31,2003, 2004 and 2005, respectively, for such plans. Information from the plans’administrators is not sufficient to permit us to determine our share, if any,of unfunded vested benefits.

71

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

We have various employeeinvestment plans whereby we contribute matching percentages of employeecontributions. The aggregate expense under these plans totaled $12 millionin both 2003 and 2004 and $13 million in 2005.

**NOTE 16:** SEGMENT INFORMATION

Our operationsconsist of three reportable segments which are based on similar products orservices: Hotel Ownership, Managing and Franchising, and Timeshare. The HotelOwnership segment derives revenue primarily from owned, majority owned andleased hotel properties. The Managing and Franchising segment provides servicesincluding hotel management and licensing of our family of brands to franchisees.This segment generates its revenue from fees charged to hotel owners. TheTimeshare segment consists of multi-unit timeshare resorts. This segmentproduces its results from the sale and financing of timeshare intervals andoperating timeshare resorts. Segment results are presented net of consolidatingeliminations for fee based services at the operating income level, withoutallocating corporate expenses, which is the basis used by management toevaluate segment performance.

Segmentresults for the three years ended December 31 are as follows:

| ** **                                                                | ** ** | **2003**               | ** ** | **2004** | ** ** | **2005** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
| ** **                                                                | ** ** | **(in millions)** | ** ** |
| Revenue                                                                   |       |                   |       |     |       |     |       |
| Hotel Ownership                                                           |       | $                      | 2,167      |     | 2,215      |     | 2,212      |   |
| Managing and Franchising                                                  |       | 1,307                  |       | 1,510    |       | 1,671    |       |
| Timeshare                                                                 |       | 345                    |       | 421      |       | 554      |       |
|                                                                      |       | $                      | 3,819      |     | 4,146      |     | 4,437      |   |
| Operating income                                                          |       |                   |       |     |       |     |       |
| Hotel Ownership                                                           |       | $                      | 343        |     | 394        |     | 450        |   |
| Managing and Franchising                                                  |       | 284                    |       | 343      |       | 417      |       |
| Timeshare                                                                 |       | 82                     |       | 99       |       | 129      |       |
| Corporate and other unallocated expenses                                  |       | (194                   | )          | (178     | )          | (191     | )          |
| Total operating  income                                                   |       | 515                    |       | 658      |       | 805      |       |
| Interest and dividend income                                              |       | 29                     |       | 26       |       | 32       |       |
| Interest expense                                                          |       | (295                   | )          | (274     | )          | (259     | )          |
| Net interest from unconsolidated affiliates and  non-controlled interests |       | (20                    | )          | (26      | )          | (26      | )          |
| Net (loss) gain on asset dispositions and other                           |       | (6                     | )          | (5       | )          | 103      |       |
| Loss from non-operating affiliates                                        |       | —                 |       | (6       | )          | (17      | )          |
| Income before  taxes and minority and non-controlled interests            |       | 223                    |       | 373      |       | 638      |       |
| Provision for income taxes                                                |       | (53                    | )          | (127     | )          | (166     | )          |
| Minority and non-controlled interests, net                                |       | (6                     | )          | (8       | )          | (12      | )          |
| Net Income                                                                |       | $                      | 164        |     | 238        |     | 460        |   |

 

72

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

Segmentassets as of December 31 are as follows:

| ** **               | ** ** | **2004**               | ** ** | **2005** | ** ** |
|--------------------------|------------|------------------------|------------|----------|------------|
| ** **               | ** ** | **(in millions)** | ** ** |
| Assets                   |       |                   |       |     |       |
| Hotel Ownership          |       | $                      | 4,825      |     | 4,283      |   |
| Managing and Franchising |       | 2,112                  |       | 2,083    |       |
| Timeshare                |       | 507                    |       | 659      |       |
| Corporate and other      |       | 798                    |       | 1,718    |       |
| Total assets             |       | $                      | 8,242      |     | 8,743      |   |

 

At December 31, 2005,the Hotel Ownership segment includes goodwill and brand values totaling$585 million and $98 million, respectively, and the Managing andFranchising segment includes goodwill and brand values totaling$631 million and $872 million, respectively.

**NOTE 17:** LEASES

We lease hotel properties and land under operatingleases. As of December 31, 2005, we leased six hotels. Our hotel leasesrequire the payment of rent equal to the greater of a minimum rent orpercentage rent based on a percentage of revenue or income, and expire through December 2020,with varying renewal options. Our land leases represent ground leases forcertain owned hotels and, in addition to minimum rental payments, may requirethe payment of additional rents based on varying percentages of revenue orincome. Total rent expense incurred under our leases was $54 million,$57 million and $55 million in 2003, 2004 and 2005, respectively,which included minimum rent payments of $39 million in 2003 and$41 million in both 2004 and 2005.

Minimumlease commitments under non-cancelable operating leases are as follows:

| ** ** | ** ** | **(in millions)** | ** ** |
|------------|------------|------------------------|------------|
| 2006       |       |                   | $          | 31 |   |   |
| 2007       |       |                   | 29         |   |   |
| 2008       |       |                   | 28         |   |   |
| 2009       |       |                   | 26         |   |   |
| 2010       |       |                   | 25         |   |   |
| Thereafter |       |                   | 281        |   |   |
|       |       |                   | $          | 420 |   |   |

 

**NOTE18:** COMMITMENTSAND CONTINGENCIES

We have established franchise financing programs withthird party lenders to support the growth of our Hilton Garden Inn, HomewoodSuites by Hilton, Hampton and Embassy Suites hotels. As of December 31,2005, we have provided guarantees of $35 million on loans outstandingunder the programs. In addition, we have guaranteed $36 million of debtand other obligations of unconsolidated affiliates and third parties, bringingour total guarantees to approximately $71 million. Our outstandingguarantees have terms of one to seven years. We also have commitments underletters of credit totaling $56 million as of December 31, 2005. Webelieve it is unlikely that material payments will be required under ouroutstanding guarantees or letters of credit.

73

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

In addition, we remain a guarantor on 12 operatingleases sold to WestCoast Hospitality Corporation as part of the sale of the RedLion hotel chain in 2001. In September 2005, WestCoast changed its name toRed Lion Hotels Corporation (RLH). We have entered into an indemnification andreimbursement agreement with RLH, which requires RLH to reimburse us for anycosts and expenses incurred in connection with the guarantee. The minimum leasecommitment under these 12 operating leases totals approximately $5 millionannually through 2020.

We have also provided performance guarantees tocertain owners of hotels we operate under management contracts. Most of theseguarantees allow us to terminate the contract rather than fund shortfalls ifspecified performance levels are not achieved. In limited cases, we areobligated to fund performance shortfalls. At December 31, 2005, we havetwo contracts containing performance guarantees with possible cash outlaystotaling approximately $142 million through 2012. Funding under theseperformance guarantees totaled approximately $4 million in 2005, and isexpected to total approximately $4 million in 2006. Funding under theseguarantees in future periods is dependent on the operating performance levelsof these hotels over the remaining term of the performance guarantee. Althoughwe anticipate that the future operating performance levels of these hotels willbe largely achieved, there can be no assurance that this will be the case. Inaddition, we do not anticipate losing a significant number of managementcontracts in 2006 pursuant to these guarantees.

Our consolidated financial statements at December 31,2005 include liabilities of approximately $6 million for potentialobligations under our outstanding guarantees. Under certain circumstances, wemay be obligated to provide additional guarantees or letters of credit totaling$6 million at December 31, 2005.

At December 31, 2005, we had contractualcommitments of approximately $56 million for construction and renovationprojects at certain owned and majority owned properties, including timeshare.

We are involved in variouslegal matters arising in the normal course of business, some of which includeclaims for substantial sums. Accruals are recorded when the outcome is probableand can be reasonably estimated. While the ultimate results of claims andlitigation cannot be predicted with certainty, we do not expect that theresolution of all pending overtly threatened claims and litigation as ofDecember 31, 2005 will have a material adverse effect on our consolidatedresults of operations or financial position. However, depending on the amountand the timing, an unfavorable resolution of some or all of these matters couldmaterially affect our future results of operations in a particular period.

**NOTE 19:** HURRICANE KATRINA

On August 29, 2005, Hurricane Katrina hit theGulf Coast, affecting two of our consolidated hotels; the majority-owned HiltonNew Orleans Riverside and the wholly-owned Hilton New Orleans Airport. Bothproperties suffered some physical damage, and both properties were closed topaying guests for a period following the hurricane. We have insurance policiesthat provide coverage for physical damage and business interruption, includinglost profits. These policies also reimburse us for other costs and expensesincurred relating to the damages and losses suffered.

Based on our claims filed and initial estimates fromthe insurance carriers, we expect to receive insurance payments in excess ofthe approximate $4 million net book value of the damaged assets. As a result,the impairment charge related to the damaged assets has been offset by theexpected recovery in our consolidated statement of income for the year ended December 31,2005.

74

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**Notes To Consolidated Financial Statements December 31, 2005 (Continued)**

In addition, based on our claims filed and initialestimates from the insurance carriers, we expect that the other costs andexpenses incurred during the period in the aftermath of the hurricane will beless than the business interruption and other insurance proceeds to be received.As such, post-storm costs incurred in 2005 totaling approximately $22 millionhave been offset by the expected recovery and do not impact results in theyear.

Through December 31,2005, we have received approximately $15 million of insurance proceeds relatedto our Hurricane Katrina claims. To the extent that the insurance proceedsultimately exceed the book value of the impaired assets or the post-hurricanecosts incurred, the excess will be reflected as income in the period thoseamounts are finalized.

**NOTE 20:** SUBSEQUENT EVENTS

On December 29, 2005, we announced an agreementto acquire the lodging assets of Hilton Group plc (known collectively as HiltonInternational or HI) for approximately £3.3 billion, equivalent toapproximately $5.78 billion on the transaction date. In February 2006, wecompleted the acquisition of the lodging assets of Hilton International for thepreviously agreed upon price in an all-cash transaction. As a result of the HIacquisition, we believe we are the largest, by revenue, and most geographicallydiverse lodging company in the world, with nearly 2,800 hotels and approximately475,000 rooms in 80 countries. The HI properties that that we acquired consistof 387 hotels with over 100,000 rooms, of which 41 hotels are owned, 194 areleased, eight are partially owned through joint ventures, 115 are managed and29 are franchised. The hotels we acquired in the HI acquisition consist of 259properties operated under the Hilton brand and 128 properties operated underthe mid-market Scandic brand, four properties operated under the Coral byHilton resort brand, one property under the Conrad brand and one propertyoperated under an independent brand. We also acquired 80 Living Well HealthClubs, primarily in Europe. As a result of the HI acquisition, we now whollyown the Hilton HHonors Worldwide frequent guest program and the HiltonReservations Worldwide reservation system, both of which were previously ownedequally by us and HI. We also obtained worldwide ownership of the luxury Conradhotel brand, which had been operated as a joint venture between us and HI since2002. As a result of the HI acquisition, we now own all the rights to theHilton and Conrad brands, including the right to develop these brands on aworldwide basis.

The company has not yet finalized the evaluation andallocation of the purchase price as the analysis of the valuation of tangibleand intangible assets is not yet complete. In order to fund the acquisition ofHI, we used approximately $850 million of cash and borrowed approximately $4.8billion under new senior credit facilities with a syndicate of financialinstitutions (see “Note 10: Long-Term Debt” for further information).

75

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**Reportof Independent Registered Public Accounting Firm**

The Board of Directors and Stockholders of HiltonHotels Corporation

We have audited the accompanying consolidated balancesheets of Hilton Hotels Corporation, a Delaware corporation, and subsidiaries(the Company) as of December 31, 2005 and 2004, and the relatedconsolidated statements of income, stockholders’ equity, and cash flow for eachof the three years in the period ended December 31, 2005. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of Hilton Hotels Corporation andsubsidiaries at December 31, 2005 and 2004, and the consolidated resultsof their operations and their cash flow for each of the three years in theperiod ended December 31, 2005, in conformity with U.S. generally acceptedaccounting principles.

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of Hilton Hotel Corporation’s internal control over financialreporting as of December 31, 2005, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated March 10, 2006expressed an unqualified opinion thereon.
|                         |
|-------------------------|
| Los Angeles, California |
| March 10, 2006          |

 

76

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**Reportof Independent Registered Public Accounting Firmon Internal Control over Financial Reporting**

The Board of Directors andStockholders of Hilton Hotels Corporation

We have audited management’sassessment, included in the accompanying Annual Report on Form 10-K,that Hilton Hotels Corporation, a Delaware corporation, and subsidiaries (theCompany) maintained effective internal control over financial reporting as of December 31,2005, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(the COSO criteria). Hilton Hotel Corporation’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting.Our responsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the company’s internal control over financialreporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such otherprocedures as we considered necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinion.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directors ofthe company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherent limitations,internal control over financial reporting may not prevent or detectmisstatements. Also, projections of any evaluation of effectiveness to futureperiods are subject to the risk that controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

In our opinion, management’sassessment that Hilton Hotels Corporation maintained effective internal controlover financial reporting as of December 31, 2005, is fairly stated, in allmaterial respects, based on the COSO criteria. Also, in our opinion, HiltonHotels Corporation maintained, in all material respects, effective internalcontrol over financial reporting as of December 31, 2005, based on theCOSO criteria.

We alsohave audited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheets of HiltonHotels Corporation as of December 31, 2004 and 2005, and the relatedconsolidated statements of income, stockholders’ equity, and cash flow for eachof the three years in the period ended December 31, 2005 and our reportdated March 10, 2006 expressed an unqualified opinion thereon.
|                          |
|--------------------------|
| Los Angeles,  California |
| March 10, 2006           |

 

77

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**SUPPLEMENTARYFINANCIAL INFORMATION (UNAUDITED)**

**Quarterly FinancialData**

| ** **       | ** ** | **1st   Quarter**                                               | ** ** | **2nd  Quarter** | ** ** | **3rd  Quarter** | ** ** | **4th  Quarter** | ** ** | **Total** | ** ** |
|------------------|------------|----------------------------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| ** **       | ** ** | **(in millions, except per share amounts)** | ** ** |
| **2005**         |       |                                                                 |       |             |       |             |       |             |       |      |       |   |   |   |   |   |   |   |   |
| Revenue          |       |                                                                 | $          | 1,076            |       |             |       | 1,176            |       |      |       | 1,102 |   |   |   | 1,083 |   |   | 4,437 |   |
| Operating income |       |                                                                 | 163        |             |       |             | 246        |             |       |      | 203        |   |   |   | 193 |   |   | 805 |   |
| Net income       |       |                                                                 | 64         |             |       |             | 202        |             |       |      | 89         |   |   |   | 105 |   |   | 460 |   |
| Basic EPS(1)     |       |                                                                 | $          | .17              |       |             |       | .53              |       |      |       | .23 |   |   |   | .28 |   |   | 1.20 |   |
| Diluted EPS      |       |                                                                 | $          | .16              |       |             |       | .49              |       |      |       | .22 |   |   |   | .26 |   |   | 1.13 |   |
| **2004**         |       |                                                                 |       |             |       |             |       |             |       |      |       |   |   |   |   |   |   |   |   |
| Revenue          |       |                                                                 | $          | 994              |       |             |       | 1,065            |       |      |       | 1,033 |   |   |   | 1,054 |   |   | 4,146 |   |
| Operating income |       |                                                                 | 131        |             |       |             | 188        |             |       |      | 171        |   |   |   | 168 |   |   | 658 |   |
| Net income       |       |                                                                 | 37         |             |       |             | 75         |             |       |      | 61         |   |   |   | 65 |   |   | 238 |   |
| Basic EPS(1)     |       |                                                                 | $          | .10              |       |             |       | .20              |       |      |       | .16 |   |   |   | .17 |   |   | .62 |   |
| Diluted EPS      |       |                                                                 | $          | .10              |       |             |       | .19              |       |      |       | .15 |   |   |   | .16 |   |   | .60 |   |

----

(1)          EPSfor the full year differs from the sum of quarterly EPS amounts due to therequired method of computing EPS in the respective periods.

**Comparable System-Wide Statistical Information(2)**
| Year ended December 31, 2005 | ** ** | ** ** | ** ** | **Occupancy** | ** ** | **Average Rate** | ** ** | **RevPAR** | ** ** |
|--------------------------------------------------|------------|------------|------------|---------------|------------|-----------------------|------------|------------|------------|
| Hilton                                           |       |       | 71.7       | %             |       |                  | $          | 140.42     |       |   |   | $ | 100.68 |   |   |
| Change from prior year                           |       |       | 2.1        | pts           |       |                  | 8.5        | %          |       |   | 11.8 | % |   |
| Hilton Garden Inn                                |       |       | 71.1       | %             |       |                  | $          | 104.74     |       |   |   | $ | 74.47 |   |   |
| Change from prior year                           |       |       | 2.0        | pts           |       |                  | 6.2        | %          |       |   | 9.3 | % |   |
| Doubletree                                       |       |       | 70.3       | %             |       |                  | $          | 109.60     |       |   |   | $ | 77.01 |   |   |
| Change from prior year                           |       |       | 2.1        | pts           |       |                  | 7.1        | %          |       |   | 10.4 | % |   |
| Embassy Suites                                   |       |       | 73.2       | %             |       |                  | $          | 129.98     |       |   |   | $ | 95.09 |   |   |
| Change from prior year                           |       |       | 2.6        | pts           |       |                  | 5.4        | %          |       |   | 9.3 | % |   |
| Homewood Suites by Hilton                        |       |       | 75.6       | %             |       |                  | $          | 100.57     |       |   |   | $ | 76.05 |   |   |
| Change from prior year                           |       |       | 2.1        | pts           |       |                  | 4.2        | %          |       |   | 7.2 | % |   |
| Hampton                                          |       |       | 71.5       | %             |       |                  | $          | 86.98      |       |   |   | $ | 62.22 |   |   |
| Change from prior year                           |       |       | 2.8        | pts           |       |                  | 6.6        | %          |       |   | 11.1 | % |   |
| Other                                            |       |       | 71.5       | %             |       |                  | $          | 148.80     |       |   |   | $ | 106.33 |   |   |
| Change from prior  year                          |       |       | (0.2)      | pts           |       |                  | 11.9       | %          |       |   | 11.5 | % |   |
|                                                  |            |            |            |               |            |                       |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

(2)          Statistics are forcomparable hotels, and include only those hotels in the system as of December 31,2005 and owned, operated or franchised by us since January 1, 2004. Comparablehotels exclude our owned hotels in New Orleans.

As of December 31, 2005 there were approximately12,300 stockholders of record.

78

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**FIVE YEAR SUMMARY**

| ** **                        | ** ** | **Year ended December 31,**                                   | ** ** |
|-----------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                        | ** ** | **2001**                                                                     | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(dollars in millions, except per share amounts)** | ** ** |
| **OPERATING DATA**                |       |                                                                         |       |   |   |   |   |   |   |   |   |
| REVENUE                           |       | $                                                                            | 3,952      |   | 3,816 |   | 3,819 |   | 4,146 |   | 4,437 |   |
| NET INCOME                        |       | $                                                                            | 166        |   | 198 |   | 164 |   | 238 |   | 460 |   |
| BASIC EARNINGS PER SHARE          |       | $                                                                            | .45        |   | .53 |   | .43 |   | .62 |   | 1.20 |   |
| DILUTED EARNINGS PER SHARE        |       | $                                                                            | .45        |   | .53 |   | .43 |   | .60 |   | 1.13 |   |
| CASH DIVIDENDS PER COMMON SHARE   |       | $                                                                            | .08        |   | .08 |   | .08 |   | .08 |   | .12 |   |
| **OTHER  INFORMATION**            |       |                                                                         |       |   |   |   |   |   |   |   |   |
| NUMBER OF PROPERTIES AT  YEAR END |       |                                                                         |       |   |   |   |   |   |   |   |   |
| Owned(1)                          |       | 65                                                                           |       | 63 |   | 55 |   | 50 |   | 30 |   |
| Leased                            |       | 9                                                                            |       | 7 |   | 7 |   | 7 |   | 6 |   |
| Joint venture                     |       | 65                                                                           |       | 65 |   | 67 |   | 65 |   | 54 |   |
| Managed                           |       | 210                                                                          |       | 201 |   | 206 |   | 206 |   | 210 |   |
| Franchised                        |       | 1,612                                                                        |       | 1,721 |   | 1,808 |   | 1,900 |   | 2,054 |   |
| Timeshare                         |       | 25                                                                           |       | 27 |   | 30 |   | 31 |   | 34 |   |
| Total                             |       | 1,986                                                                        |       | 2,084 |   | 2,173 |   | 2,259 |   | 2,388 |   |
| AVAILABLE ROOMS  AT YEAR END      |       |                                                                         |       |   |   |   |   |   |   |   |   |
| Owned(1)                          |       | 33,536                                                                       |       | 34,664 |   | 32,526 |   | 31,068 |   | 22,971 |   |
| Leased                            |       | 2,836                                                                        |       | 2,650 |   | 2,643 |   | 2,643 |   | 2,245 |   |
| Joint venture                     |       | 19,604                                                                       |       | 19,093 |   | 20,556 |   | 20,186 |   | 17,040 |   |
| Managed                           |       | 53,776                                                                       |       | 52,004 |   | 52,088 |   | 51,380 |   | 53,115 |   |
| Franchised                        |       | 214,824                                                                      |       | 225,588 |   | 237,026 |   | 249,391 |   | 275,350 |   |
| Timeshare                         |       | 2,911                                                                        |       | 3,117 |   | 3,644 |   | 3,740 |   | 3,948 |   |
| Total                             |       | 327,487                                                                      |       | 337,116 |   | 348,483 |   | 358,408 |   | 374,669 |   |

----

(1)          Includes majority ownedand controlled hotels.

 

79

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**Item 9.   Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

None.

**Item 9A.   Controls and Procedures**

**Evaluationof Disclosure Controls and Procedures**

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in our reportsfiled under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms, and that such information is accumulated and communicated to ourmanagement, including the Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated can provide only reasonable assurance of achieving the desired controlobjectives, and management is required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures. Also, we haveinvestments in certain unconsolidated entities. As we do not control theseentities, our disclosure controls and procedures with respect to such entitiesare necessarily substantially more limited than those we maintain with respectto our consolidated subsidiaries.

As required by Rule 13a-15(b) underthe Exchange Act, we carried out an evaluation, under the supervision and withthe participation of our management, including the Chief Executive Officer andthe Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures as of December 31, 2005, the endof the period covered by this report. Based on the foregoing, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures were effective at the reasonable assurance level.

**Management’sReport on Internal Control over Financial Reporting**

Management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rules 13a-15(f). Our internal control overfinancial reporting is a process designed under the supervision of our ChiefExecutive Officer and Chief Financial Officer to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of ourfinancial statements for external reporting purposes in accordance with UnitedStates generally accepted accounting principles.

As of December 31, 2005, management assessed theeffectiveness of our internal control over financial reporting based on theframework established in “Internal Control—Integrated Framework” published bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO). Basedon this assessment, management has concluded that our internal control overfinancial reporting as of December 31, 2005 was effective.

Ernst & Young LLP, the independent registeredpublic accounting firm that audited our consolidated financial statementsincluded in this Form 10-K, has issued an attestation report onmanagement’s assessment of the effectiveness of our internal control overfinancial reporting as of December 31, 2005. The report, which expressesunqualified opinions on management’s assessment and on the effectiveness of ourinternal control over financial reporting as of December 31, 2005, isincluded in Item 8 under the heading “Report of Independent Registered PublicAccounting Firm on Internal Control over Financial Reporting.”

There have been no changes in our internal controlover financial reporting during our most recent fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

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**Item 9B.   Other Information**

None.

**PART III**

**Item 10.   Directors and Executive Officers of theRegistrant**

Certain of the information respecting executiveofficers required by this Item is set forth under the caption “ExecutiveOfficers of the Company” under Item 1. Other information respectingexecutive officers, as well as the required information for directors, will beset forth under “Election of Directors” and “Section 16(a) BeneficialOwnership Reporting Compliance” in our Proxy Statement, and reference isexpressly made to the Proxy Statement for the specific information incorporatedin this Form 10-K.

The Company has adopted aCode of Business Conduct and Ethics (the “Code of Ethics”) that applies to ourofficers, employees and directors, including the Company’s principal executiveofficer, principal financial officer, principal accounting officer andcontroller or persons performing similar functions. This Code of Ethics is alsoposted on our internet website located at www.hiltonworldwide.com (click on “InvestorRelations,” then “Corporate Governance”). See “Additional Information—AvailableInformation” under Item 1. In the event of any amendment to, or waiver from, aprovision of the Code of Ethics that applies to any of the aforementionedofficers that relates to the requirements of Regulation S-K Item406, we intend to disclose such information on our website.

**Item 11.   Executive Compensation**

The information requiredby this Item will be set forth under “Executive Compensation,” “CompensationCommittee Report on Executive Compensation—Chief Executive OfficerCompensation,” “Retirement Plans” and “Change of Control Agreements” in ourProxy Statement, and reference is expressly made to the Proxy Statement for thespecific information incorporated in this Form 10-K.

**Item 12.   Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters**

Certain of the informationrequired by this Item will be set forth under “Security Ownership of CertainBeneficial Owners, Directors and Executive Officers” and “Election of Directors”in our Proxy Statement, and reference is expressly made to the Proxy Statementfor the specific information incorporated in this Form 10-K.

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**EquityCompensation Plan Information**

Thefollowing table provides information as of December 31, 2005 with respectto shares of our Common Stock that may be issued under our existing equitycompensation plans.

| **Plan category**                                         | ** ** | ** ** | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights**(a) | ** ** | **Weighted average exercise  price of outstanding  options, warrants and  rights**(b) | ** ** | **Number of securities  remaining available for  future issuance under equity  compensation plans  (excluding securities  reflected in column (a))**(c) | ** ** |
|----------------------------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders(1)     |       |       | 19,228,890 |                                                                                                                                                |       |                                                                                                                | $          | 14.52                                                                                                                                                                                                               | (4)        |   |   | 25,523,610 | (6) |   |
| Equity  compensation plans not approved by security holders(2) |       |       | 2,561,167  | (3)                                                                                                                                                 |       |                                                                                                                | N/A        | (5)                                                                                                                                                                                                                 |       |   | 652,695 | (7) |   |
| Total                                                          |       |       | 21,790,057 |                                                                                                                                                |       |                                                                                                                | $          | 14.52                                                                                                                                                                                                               | (4)        |   |   | 26,176,305 |   |   |

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(1)          Consistsof our 1990 Stock Option and Stock Appreciation Rights Plan, 1996 StockIncentive Plan, 1997 Independent Director Stock Option Plan and 2004 OmnibusEquity Compensation Plan. Of such plans, the 2004 Omnibus Equity CompensationPlan is the only plan with shares remaining available for grant as of December 31,2005.

(2)          Consistsof our Supplemental Retirement and Retention Plan and Directors’ Stock andDeferred Retainer Plan.

(3)          Consistsof 2,526,934 units under the Supplemental Retirement and Retention Plan and34,233 units under the Directors’ Stock and Deferred Retainer Plan that entitlethe recipients to receive an equivalent number of shares of Common Stock,subject to satisfaction of the conditions set forth in the respective plans.

(4)          Representsthe weighted average exercise price of outstanding stock options. There are noexercise prices associated with grants of restricted stock units andperformance stock units under the 2004 Omnibus Equity Compensation Plan.

(5)          Thereare no exercise prices associated with units included in the referenced plans.

(6)          Consistsof 25,523,610 shares available for future issuance under the 2004 OmnibusEquity Compensation Plan.

(7)          Consists of 652,695shares available for future issuance under the Supplemental Retirement andRetention Plan. The Directors’ Stock and Deferred Retainer Plan does not limitthe number of shares that may be issued thereunder.

*SupplementalRetirement and Retention Plan*

The SupplementalRetirement and Retention Plan (the “SRRP”) was approved by our Board ofDirectors as of June 9, 2000. The SRRP is not a stockholder approved plan.Under the SRRP, a total of up to 3,500,000 supplemental retirement benefitunits (“Units”) may be granted to our senior officers. Each grant of Unitsvests 25% per year over a four-year period and entitles the grantee to receiveshares of Common Stock on a one-for-one basis upon retirement, with limiteddistribution available during employment. The SRRP also provides for an upwardadjustment in the number of Units in a participant’s account based upon dividendsand distributions paid by us with respect to the underlying shares of CommonStock, until distribution of such shares. The Units will become immediatelyvested in the event of a change of control of Hilton, as defined in the SRRP.Shares of Common Stock issued under the SRRP consist of treasury shares ofHilton. As of December 31, 2005, 2,526,934 Units were outstanding underthe SRRP and 652,695 Units remained available for grant.

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*Directors’ Stockand Deferred Retainer Plan*

The Directors’ Stock andDeferred Retainer Plan (“Director Retainer Plan”) was approved by our Board ofDirectors on September 11, 2001, effective as of January 1, 2002. TheDirector Retainer Plan is not a stockholder approved plan. The DirectorRetainer Plan provides non-employee directors the right to elect to receivetheir annual retainer fees in the form of (i) cash; (ii) Common Stockpayable on a quarterly basis; or (iii) deferred units that vestimmediately and are payable in shares of Common Stock on a one-for-one basissubsequent to a director’s retirement from the Board. The number of shares ofCommon Stock or deferred units received by a participant each quarter is basedupon the closing price of our Common Stock on the NYSE on the last trading dateof such quarter. Shares of Common Stock issued under the Director Retainer Planconsist of treasury shares of Hilton. As of December 31, 2005, tennon-employee directors were eligible to defer all or a portion of their annualretainer fees into Common Stock or deferred units under the Director RetainerPlan. As of December 31, 2005, 31,742 shares of Common Stock had beenissued under the Director Retainer Plan and 34,233 deferred units wereallocated to the accounts of non-employee directors.

**Item 13.   Certain Relationships and RelatedTransactions**

The information requiredby this Item will be set forth under “Certain Relationships and RelatedTransactions” in our Proxy Statement, and reference is expressly made to theProxy Statement for the specific information incorporated in this Form 10-K.

**Item 14.   Principal Accounting Fees and Services**

The information requiredby this Item will be set forth under “Election of Directors—Audit Fee Summary”and “—Audit Committee Pre-Approval Policy” in our Proxy Statement, andreference is expressly made to the Proxy Statement for the specific informationincorporated in this Form 10-K.

**PART IV**

**Item 15.   Exhibits and Financial StatementSchedules**

**(a)   Index to Financial Statements**

1.      Financial Statements:

The consolidated financial statements andsupplementary data are set forth under Item 8 of this Form 10-K.

2.      Financial Statement Schedules:

All schedules are inapplicable or the requiredinformation is included elsewhere herein.

**(b)   Exhibits**

Reference is made to the Index to Exhibits,immediately preceding the exhibits to this Form 10-K.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, as of March 10,2006.

|        |   | HILTON  HOTELS CORPORATION                             |
|--------|--------|--------------------------------------------------------|
|   |   | (Registrant)                                           |
|   | By:    | /s/ ROBERT M. LA FORGIA                           |
|   |   | Robert M. La  Forgia                                   |
|   |   | Executive Vice  President and  Chief Financial Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities indicated as of March 10, 2006.

| /s/ STEPHEN F. BOLLENBACH                                                    |       | /s/ BENJAMIN V. LAMBERT |
|-----------------------------------------------------------------------------------|------------|------------------------------|
| Stephen F.  Bollenbach                                                            |       | Benjamin V.  Lambert         |
| Co-Chairman of  the Board and  Chief Executive Officer                            |       | Director                     |
| /s/ BARBARA BELL COLEMAN                                                     |       | /s/ JOHN H. MYERS       |
| Barbara Bell  Coleman                                                             |       | John H. Myers                |
| Director                                                                          |       | Director                     |
| /s/ A.  STEVEN  CROWN                                                   |       | /s/ JOHN L. NOTTER      |
| A. Steven Crown                                                                   |       | John L. Notter               |
| Director                                                                          |       | Director                     |
| /s/ CHRISTINE GARVEY                                                         |       | /s/ DONNA F. TUTTLE     |
| Christine Garvey                                                                  |       | Donna F. Tuttle              |
| Director                                                                          |       | Director                     |
| /s/ PETER M. GEORGE                                                          | ** ** | /s/ PETER V. UEBERROTH  |
| Peter M. George                                                                   |       | Peter V.  Ueberroth          |
| Director                                                                          |       | Director                     |
| /s/ BARRON HILTON                                                            |       | /s/ SAM YOUNG           |
| Barron Hilton                                                                     |       | Sam Young                    |
| Co-Chairman of  the Board                                                         |       | Director                     |
| /s/ ROBERT M. LA FORGIA                                                      |       |                         |
| Robert M. La  Forgia                                                              |       |                         |
| Executive Vice  President and Chief Financial Officer  (Chief Accounting Officer) | * *   | * *                     |

 

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**INDEX TO EXHIBITS**
| Exhibit   Number | ** ** |                                                                                                                                                                                                                                                                                                                                                                                                  | **Description** | ** ** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------|------------|
| 2.1              |       | Sale and Purchase  Agreement, dated as of December 29, 2005, among Registrant, Hilton Group  plc, Ladbroke Group International Limited, Ladbroke Group Limited and  Town & County Factors Limited (incorporated herein by reference from  Exhibit 2.1 to Registrant’s Current Report on Form 8-K, dated  December 30, 2005)                                    |
| 3.1              |       | Restated Certificate of  Incorporation of Registrant, as amended (incorporated herein by reference  from Exhibit 4.1 to Registrant’s Registration Statement on Form S-3  (File No. 333-18523))                                                                                                                                                                          |
| 3.2              |       | Amendment to Restated  Certificate of Incorporation of Registrant, relating to Exhibit 3.1  hereto (incorporated herein by reference from Exhibit 3.1 to  Registrant’s Quarterly Report on Form 10-Q for the period ended  June 30, 1997)                                                                                                                               |
| 3.3              |       | Amendment to Restated  Certificate of Incorporation of Registrant, relating to Exhibits 3.1 and 3.2  hereto (incorporated herein by reference from Appendix F to Registrant’s  Registration Statement on Form S-4 (File No. 333-89437))                                                                                                                                           |
| 3.4              |       | By-Laws of Registrant,  as amended and restated (incorporated herein by reference from  Exhibit 3.1 to Registrant’s Current Report on Form 8-K, dated  January 23, 2006)                                                                                                                                                                                                     |
| 4.1              |       | Indenture, dated as of  July 1, 1988, between Registrant and Morgan Guaranty Trust Company of  New York, as Trustee, regarding Registrant’s Senior Debt Securities  (incorporated herein by reference from Exhibit 4.1 to Post Effective  Amendment No. 1 to Registrant’s Registration Statement on Form S-3  (File No. 2-99967))                             |
| 4.2              |       | First Supplemental  Indenture, dated as of June 30, 1992, between Registrant and Morgan  Guaranty Trust Company of New York, as Trustee, regarding Registrant’s Senior  Debt Securities, relating to Exhibit 4.1 hereto (incorporated herein by  reference from Exhibit 4.3 to Registrant’s Annual Report on Form 10-K  for the year ended December 31, 1992) |
| 4.3              |       | Indenture, dated as of  April 22, 2003, between Registrant and BNY Western Trust Company, as  Trustee, regarding Registrant’s 3.375% Convertible Senior Notes due 2023,  including the form of Note thereof (incorporated herein by reference from  Exhibit 4.1 to Registrant’s Registration Statement on Form S-3  (File No. 333-107159))                         |
| 4.4.1            |       | Indenture, dated as of  April 15, 1997, between Registrant and BNY Western Trust Company, as  Trustee, regarding Registrant’s Debt Securities (incorporated herein by  reference from Exhibit 4.3 to Registrant’s Current Report on Form 8-K,  dated April 15, 1997)                                                                                               |
| 4.4.2            |       | Officers’ Certificate  containing terms of 7.95% Senior Notes due 2007 (incorporated herein by  reference from Exhibit 99 to Registrant’s Current Report on Form 8-K,  dated April 15, 1997)                                                                                                                                                                            |
| 4.4.3            |       | Officers’ Certificate  containing terms of 7.20% Senior Notes due 2009 and 7.5% Senior Notes due  2017 (incorporated herein by reference from Exhibit 4.1 to Registrant’s  Current Report on Form 8-K, dated December 17, 1997)                                                                                                                                         |
| 4.4.4            |       | Officers’ Certificate  containing terms of 8.25% Senior Notes due 2011 (incorporated herein by  reference from Exhibit 99.01 to Registrant’s Current Report on  Form 8-K, dated February 12, 2001)                                                                                                                                                                      |
| 4.4.5            |       | Officers’ Certificate  containing terms of 7.625% Senior Notes due 2008 (incorporated herein by  reference from Exhibit 99.01 to Registrant’s Current Report on  Form 8-K, dated May 10, 2001)                                                                                                                                                                          |

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| 4.4.6 |   | Officers’ Certificate  containing terms of 8% Quarterly Interest Bonds due 2031 (incorporated herein  by reference from Exhibit 99.01 to Registrant’s Current Report on  Form 8-K, dated August 16, 2001)                                                                                                                                                                                                                                                         |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 4.4.7 |   | Officers’ Certificate  containing terms of 7.43% Chilean Inflation Indexed (UF) Notes due 2009  (incorporated herein by reference from Exhibit 99.01 to Registrant’s  Current Report on Form 8-K, dated August 29, 2001)                                                                                                                                                                                                                                          |
| 4.4.8 |   | Officers’ Certificate  containing terms of 7.625% Senior Notes due 2012 (incorporated herein by  reference from Exhibit 99.01 to Registrant’s Current Report on  Form 8-K, dated November 21, 2002)                                                                                                                                                                                                                                                               |
| 4.5   |   | Credit Agreement, dated  as of February 22, 2006, among Registrant, Bank of America, N.A., as  Administrative Agent, Swing Line Lender and Issuing Lender, UBS Loan Finance,  as Syndication Agent, and the financial institutions signatory thereto  (incorporated herein by reference from Exhibit 4.1 to Registrant’s  Current Report on Form 8-K, dated February 28,  2006)                                                                                   |
| 4.6   |   | Loan Agreement, dated as  of September 27, 2000, among Phoenix SP Hilton LLC,  S.F. Hilton, Inc., Chicago Hilton LLC, Short Hills Hilton LLC and  McLean Hilton LLC, as Borrowers, and Secore Financial Corporation, as Lender  (incorporated herein by reference from Exhibit 99.01 to Registrant’s  Quarterly Report on Form 10-Q for the period ended  September 30, 2000)                                                                           |
| 4.7   |   | First Amendment to Loan  Agreement, dated as of October 30, 2000, among Phoenix SP Hilton LLC,  S.F. Hilton, Inc., Chicago Hilton LLC, Short Hills Hilton LLC and  McLean Hilton LLC, as Borrowers, and Morgan Stanley Dean Witter Mortgage  Capital Inc., as Lender, relating to Exhibit 4.6 hereto (incorporated  herein by reference from Exhibit 99.02 to Registrant’s Quarterly Report  on Form 10-Q for the period ended September 30, 2000) |
| 4.8   |   | Rights Agreement, dated  as of November 29, 1999, between Registrant and ChaseMellon Shareholder  Services, L.L.C., as Rights Agent (incorporated herein by reference from  Exhibit 1 to Registrant’s Registration Statement on Form 8-A,  dated December 1, 1999)                                                                                                                                                                                                |
| 4.9   |   | Amendment to Rights  Agreement Changing Rights Agent, dated as of February 15, 2001, between  Registrant and The Bank of New York, as Rights Agent, relating to  Exhibit 4.8 hereto (incorporated herein by reference from  Exhibit 4.22 to Registrant’s Annual Report on Form 10-K for  the year ended December 31, 2000)                                                                                                                                   |
| 10.1  |   | 1990 Stock Option and  Stock Appreciation Rights Plan of Registrant, together with the Stock Option  Agreement relating thereto, both as amended (incorporated herein by reference  from Exhibit 10.4 to Registrant’s Annual Report on Form 10-K  for the year ended December 31, 1990)*                                                                                                                                                                               |
| 10.2  |   | Amendment, dated  January 20, 1994, to the 1990 Stock Option and Stock Appreciation Rights  Plan of Registrant, relating to Exhibit 10.1 hereto (incorporated herein  by reference from Exhibit 10.5 to Registrant’s Annual Report on  Form 10-K for the year ended December 31, 1993)*                                                                                                                                                                      |
| 10.3  |   | Amendment, dated  January 19, 1995, to the 1990 Stock Option and Stock Appreciation Rights  Plan of Registrant, relating to Exhibits 10.1 and 10.2 hereto (incorporated  herein by reference from Exhibit 10.5 to Registrant’s Annual Report on  Form 10-K for the year ended December 31, 1994)*                                                                                                                                                                 |

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| 10.4    |   | Amendment, dated  November 14, 1996, to the 1990 Stock Option and Stock Appreciation  Rights Plan of Registrant, relating to Exhibits 10.1, 10.2 and 10.3 hereto  (incorporated herein by reference from Exhibit 10.7 to Registrant’s  Annual Report on Form 10-K for the year ended December 31,  1996)*      |
|---------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.5    |   | Fourth Amendment, dated  as of December 31, 1998, to the 1990 Stock Option and Stock Appreciation  Rights Plan of Registrant, relating to Exhibits 10.1 through 10.4 hereto  (incorporated herein by reference from Exhibit 99.9 to Registrant’s  Current Report on Form 8-K, dated January 8, 1999)*          |
| 10.6    |   | Amended and Restated  1996 Stock Incentive Plan of Registrant (incorporated herein by reference  from Exhibit 4.1 to Registrant’s Post Effective Amendment No. 1 to  Registration Statement on Form S-8 (File No. 333-04273))*                                                                                 |
| 10.7    |   | Amendment, dated as of  November 14, 2001, to the Amended and Restated 1996 Stock Incentive Plan  of Registrant, relating to Exhibit 10.6 hereto (incorporated herein by  reference from Exhibit 10.11 to Registrant’s Annual Report on Form 10-K  for the year ended December 31, 2001)*                 |
| 10.8    |   | 1997 Independent  Director Stock Option Plan of Registrant (incorporated herein by reference  from Exhibit 10.10 to Registrant’s Annual Report on Form 10-K  for the year ended December 31, 1997)*                                                                                                                 |
| 10.9    |   | First Amendment, dated  as of December 31, 1998, to the 1997 Independent Director Stock Option  Plan of Registrant, relating to Exhibit 10.8 hereto (incorporated herein  by reference from Exhibit 99.11 to Registrant’s Current Report on  Form 8-K, dated January 8, 1999)*                            |
| 10.10   |   | Second Amendment, dated  as of November 11, 1999, to the 1997 Independent Director Stock Option  Plan of Registrant, relating to Exhibits 10.8 and 10.9 hereto (incorporated  herein by reference from Exhibit 10.15 to Registrant’s Annual Report on  Form 10-K for the year ended December 31, 1999)*        |
| 10.11   |   | Third Amendment, dated  as of November 14, 2001, to the 1997 Independent Director Stock Option  Plan of Registrant, relating to Exhibits 10.8, 10.9 and 10.10 hereto  (incorporated herein by reference from Exhibit 10.17 to Registrant’s  Annual Report on Form 10-K for the year ended December 31,  2001)* |
| 10.12   |   | 2004 Omnibus Equity  Compensation Plan of Registrant (incorporated herein by reference from  Exhibit B Registrant’s Proxy Statement, dated as of April 8, 2004)*                                                                                                                                                         |
| 10.12.1 |   | Form of stock unit  grant agreement under 2004 Omnibus Equity Compensation Plan of Registrant  (incorporated herein by reference from Exhibit 10.12.1 to Registrant’s  Annual Report on Form 10-K for the year ended December 31,  2004)*                                                                      |
| 10.12.2 |   | Form of performance  unit grant agreement under 2004 Omnibus Equity Compensation Plan of  Registrant (incorporated herein by reference from Exhibit 10.12.2 to  Registrant’s Annual Report on Form 10-K for the year ended  December 31, 2004)*                                                                |
| 10.13   |   | Directors’ Stock and  Deferred Retainer Plan of Registrant (incorporated herein by reference from  Exhibit 99.1 to Registrant’s Registration Statement on Form S-8  (File No. 333-72906))*                                                                                                                     |
| 10.14   |   | Amendment 2005-1  to Directors’ Stock and Deferred Retainer Plan of Registrant, relating to  Exhibit 10.13 hereto*                                                                                                                                                                                                            |
| 10.15   |   | Annual Incentive Plan of  Registrant (incorporated herein by reference from Exhibit C to  Registrant’s Proxy Statement, dated as of April 8, 2004)*                                                                                                                                                                      |

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| 10.16 |   | Supplemental Executive  Retirement Plan of Registrant, as amended (incorporated herein by reference  from Exhibit 10.6 to Registrant’s Annual Report on Form 10-K  for the year ended December 31, 1991)*                                                                                                         |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.17 |   | Amendment, effective  April 1, 1994, to the Supplemental Executive Retirement Plan of  Registrant, relating to Exhibit 10.16 hereto (incorporated herein by  reference from Exhibit 10.10 to Registrant’s Annual Report on  Form 10-K for the year ended December 31, 1994)*                            |
| 10.18 |   | Amendment, effective  December 31, 1996, to the Supplemental Executive Retirement Plan of  Registrant, relating to Exhibits 10.16 and 10.17 hereto (incorporated herein  by reference from Exhibit 10.19 to Registrant’s Annual Report on  Form 10-K for the year ended December 31, 1996)*                  |
| 10.19 |   | Doubletree Hotels  Corporation Supplemental Executive Retirement Plan, dated as of  February 15, 1997, as amended by letter dated December 9, 1997  (incorporated herein by reference from Exhibit 10.29 to the Promus Hotel  Corporation Annual Report on Form 10-K for the year ended  December 31, 1998)* |
| 10.20 |   | Directors’ Retirement  Benefit Plan of Registrant, as amended (incorporated herein by reference from  Exhibit 10.7 to Registrant’s Annual Report on Form 10-K for  the year ended December 31, 1991)*                                                                                                        |
| 10.21 |   | First Amendment, dated  July 31, 1997, to the Directors’ Retirement Benefit Plan of Registrant,  relating to Exhibit 10.20 hereto (incorporated herein by reference from  Exhibit 10.22 to Registrant’s Annual Report on Form 10-K for  the year ended December 31, 1997)*                         |
| 10.22 |   | Retirement Benefit  Replacement Plan of Registrant, as amended (incorporated herein by reference  from Exhibit 10.9 to Registrant’s Annual Report on Form 10-K  for the year ended December 31, 1992)*                                                                                                            |
| 10.23 |   | Amendment, dated as of  January 1, 1994, to the Retirement Benefit Replacement Plan of Registrant,  relating to Exhibit 10.22 hereto (incorporated herein by reference from  Exhibit 10.12 to Registrant’s Annual Report on Form 10-K for  the year ended December 31, 1993)*                           |
| 10.24 |   | Amendment, effective  April 1, 1994, to the Retirement Benefit Replacement Plan of Registrant,  relating to Exhibits 10.22 and 10.23 hereto (incorporated herein by reference  from Exhibit 10.14 to Registrant’s Annual Report on Form 10-K  for the year ended December 31, 1994)*                         |
| 10.25 |   | Amendment, effective  December 31, 1996, to the Retirement Benefit Replacement Plan of  Registrant, relating to Exhibits 10.22, 10.23 and 10.24 hereto (incorporated  herein by reference from Exhibit 10.24 to Registrant’s Annual Report on  Form 10-K for the year ended December 31, 1996)*              |
| 10.26 |   | Executive Deferred  Compensation Plan of Registrant (incorporated herein by reference from  Exhibit 4.1 to Registrant’s Registration Statement on Form S-8  (File No. 333-122019))*                                                                                                                               |
| 10.27 |   | Amendment 2005-1  to the Executive Deferred Compensation Plan of Registrant, relating to  Exhibit 10.26 hereto*                                                                                                                                                                                                                  |
| 10.28 |   | 2005 Executive  Deferred Compensation Plan of Registrant, as amended and restated*                                                                                                                                                                                                                                                    |
| 10.29 |   | Promus Hotel Corporation  Executive Deferred Compensation Plan, as amended and restated (incorporated  herein by reference from Exhibit 10.27 to the Promus Hotel Corporation  Annual Report on Form 10-K for the year ended December 31,  1998)*                                                                      |

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| 10.30 |   | Supplemental Retirement  and Retention Plan of Registrant, dated as of June 1, 2000 (incorporated  herein by reference from Exhibit 10.42 to Registrant’s Annual Report on  Form 10-K for the year ended December 31, 2000)*                                                                               |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.31 |   | First Amendment to the  Supplemental Retirement and Retention Plan of Registrant, relating to  Exhibit 10.30 hereto (incorporated herein by reference from Exhibit 10.46  to Registrant’s Annual Report on Form 10-K for the year ended  December 31, 2001)*                                               |
| 10.32 |   | Form of Change of  Control Agreement between Registrant and each of Matthew J. Hart, Thomas L.  Keltner, Madeleine A. Kleiner and Robert M. La Forgia (incorporated herein by  reference from Exhibit 10.43 to Registrant’s Annual Report on  Form 10-K for the year ended December 31, 1999)*             |
| 10.33 |   | First Amendment to form  of Change of Control Agreement, relating to Exhibit 10.32 hereto  (incorporated herein by reference from Exhibit 10.48 to Registrant’s  Annual Report on Form 10-K for the year ended December 31,  2001)*                                                                        |
| 10.34 |   | Amended and Restated  Employment Agreement, dated as of November 11, 2004 and amended as of  January 27, 2005, between Registrant and Stephen F. Bollenbach  (incorporated herein by reference from Exhibit 10.30 to Registrant’s  Annual Report on Form 10-K for the year ended December 31,  2004)* |
| 10.35 |   | Employment Agreement, dated as of March 10,  2006, between Hilton U.K. Hotels Limited and Ian R. Carter (incorporated  herein by reference from Exhibit 10.1 to Registrant’s Current Report on Form  8-K, dated March 14, 2006)*                                                                                     |
| 11    |   | Computation of  Earnings Per Share                                                                                                                                                                                                                                                                                                  |
| 12    |   | Computation of  Ratios of Earnings to Fixed Charges                                                                                                                                                                                                                                                                                 |
| 21    |   | List of  Registrant’s Subsidiaries                                                                                                                                                                                                                                                                                             |
| 23    |   | Consent of  Independent Registered Public Accounting Firm                                                                                                                                                                                                                                                                           |
| 31.1  |   | Certification of  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                                                                      |
| 31.2  |   | Certification of  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                                                                           |
| 32.1  |   | Certification of  Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                                                                      |
| 32.2  |   | Certification of  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002                                                                                                                                                                                                                           |
| 99    |   | Undertakings                                                                                                                                                                                                                                                                                                                        |

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*                    Managementcontracts or compensatory plans or arrangements required to be filed asexhibits to this Form 10-K by Item 601(b)(10)(iii) of RegulationS-K, previously filed where indicated and incorporated herein by reference.

89

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Pursuant to Regulation §229.601, Item 601(b)(4)(iii) ofRegulation S-K, upon request of the Securities and Exchange Commission, theRegistrant hereby undertakes to furnish a copy of any unfiled instrument whichdefines the rights of holders of long-term debt of the Registrant and itsconsolidated subsidiaries (and for any of its unconsolidated subsidiaries forwhich financial statements are required to be filed) wherein the total amountof securities authorized thereunder does not exceed 10% of the total consolidatedassets of the Registrant.

90

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