Service Properties Trust - Quarter Report: 2013 March (Form 10-Q)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2013

 

OR

 

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

 

Commission File Number 1-11527

 

HOSPITALITY PROPERTIES TRUST

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

617-964-8389

(Registrant’s Telephone Number, Including Area Code)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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

 

Number of registrant’s common shares of beneficial interest, $.01 par value per share, outstanding as of May 7, 2013: 139,737,424

 

 

 

HOSPITALITY PROPERTIES TRUST

 

FORM 10-Q

 

March 31, 2013

 

INDEX

 

		Page
PART I	Financial Information (unaudited)
	Item 1. Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets — March 31, 2013 and December 31, 2012	1
	Condensed Consolidated Statements of Income and Comprehensive Income — Three Months Ended March 31, 2013 and 2012	2
	Condensed Consolidated Statements of Cash Flows — Three Months Ended March 31, 2013 and 2012	3
	Notes to Condensed Consolidated Financial Statements	4
	Item 2.
	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.
	Quantitative and Qualitative Disclosures About Market Risk	33
	Item 4.
	Controls and Procedures	34
	Warning Concerning Forward Looking Statements	36
	Statement Concerning Limited Liability	40
PART II	Other Information
	Item 6.
	Exhibits	41
	Signatures	43

 

References in this Form 10-Q to “HPT”, “we”, “us” or “our” include Hospitality Properties Trust and its consolidated subsidiaries unless otherwise expressly stated or the context indicates otherwise.

 

 

 

Part 1    Financial Information

 

Item 1.  Financial Statements

 

HOSPITALITY PROPERTIES TRUST

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(dollars in thousands, except share data)

 

		March 31, 2013			December 31, 2012
ASSETS
Real estate properties, at cost:
Land		$	1,453,390		$	1,453,399
Buildings, improvements and equipment		5,498,521			5,445,710
		6,951,911			6,899,109
Accumulated depreciation		(1,601,342		)	(1,551,160		)
		5,350,569			5,347,949
Cash and cash equivalents		18,043			20,049
Restricted cash (FF&E reserve escrow)		37,930			40,744
Other assets, net		252,688			226,383
		$	5,659,230		$	5,635,125
LIABILITIES AND SHAREHOLDERS’ EQUITY
Unsecured revolving credit facility		$	10,000		$	320,000
Unsecured term loan		400,000			400,000
Senior notes, net of discounts		1,994,372			1,993,880
Convertible senior notes, net of discount		8,478			8,478
Security deposits		20,660			26,577
Accounts payable and other liabilities		106,776			132,032
Due to related persons		11,297			13,696
Dividends payable		6,664			6,664
Total liabilities		2,558,247			2,901,327
Commitments and contingencies
Shareholders’ equity:
Preferred shares of beneficial interest, no par value, 100,000,000 shares authorized:
Series C preferred shares; 7% cumulative redeemable; 6,700,000 shares issued and outstanding aggregate liquidation preference $167,500		161,873			161,873
Series D preferred shares; 7 1/8% cumulative redeemable; 11,600,000 shares issued and outstanding aggregate liquidation preference $290,000		280,107			280,107
Common shares of beneficial interest, $.01 par value; 200,000,000 shares authorized; 139,737,424 and 123,637,424 shares issued and outstanding, respectively		1,397			1,236
Additional paid in capital		3,851,456			3,458,144
Cumulative net income		2,412,382			2,384,876
Cumulative other comprehensive income		15,183			2,770
Cumulative preferred distributions		(261,523		)	(253,426		)
Cumulative common distributions		(3,359,892		)	(3,301,782		)
Total shareholders’ equity		3,100,983			2,733,798
		$	5,659,230		$	5,635,125

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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HOSPITALITY PROPERTIES TRUST

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

(in thousands, except per share data)

 

		Three Months Ended March 31,
		2013			2012
Revenues:
Hotel operating revenues		$	291,651		$	224,985
Rental income		62,212			73,260
FF&E reserve income		603			3,175
Total revenues		354,466			301,420
Expenses:
Hotel operating expenses		206,649			150,021
Depreciation and amortization		72,280			61,363
General and administrative		12,144			10,522
Acquisition related costs		276			1,060
Loss on asset impairment		—			889
Total expenses		291,349			223,855
Operating income		63,117			77,565
Interest income		19			66
Interest expense (including amortization of deferred financing costs and debt discounts of $1,512 and $1,578, respectively)		(35,188		)	(34,092		)
Equity in earnings of an investee		76			45
Income before income taxes		28,024			43,584
Income tax expense		(518		)	(636		)
Net income		27,506			42,948
Excess of liquidation preference over carrying value of preferred shares redeemed		—			(2,944		)
Preferred distributions		(8,097		)	(11,188		)
Net income available for common shareholders		$	19,409		$	28,816
Net income		$	27,506		$	42,948
Other comprehensive income (loss):
Unrealized gain on TravelCenters of America common shares		12,420			5,308
Equity interest in investee’s unrealized losses		(8		)	(1		)
Other comprehensive income		12,412			5,307
Comprehensive income		$	39,918		$	48,255
Weighted average common shares outstanding		125,426			123,523
Basic and diluted net income available for common shareholders per common share		$	0.15		$	0.23

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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HOSPITALITY PROPERTIES TRUST

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

		For the Three Months Ended March 31,
		2013			2012
Cash flows from operating activities:
Net income		$	27,506		$	42,948
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		72,280			61,363
Amortization of deferred financing costs and debt discounts as interest		1,512			1,578
Straight line rental income		(62		)	(354		)
Security deposits applied to payment shortfalls		(5,917		)	(16,250		)
FF&E reserve income and deposits		(6,845		)	(7,865		)
Loss on asset impairment		—			889
Equity in earnings of an investee		(76		)	(45		)
Other non-cash (income) expense, net		(1,100		)	170
Changes in assets and liabilities:
Increase in other assets		(14,923		)	(7,841		)
Decrease in accounts payable and other liabilities		(24,146		)	(13,010		)
Decrease in due to related persons		(3,026		)	(545		)
Cash provided by operating activities		45,203			61,038
Cash flows from investing activities:
Real estate acquisitions		—			(150,500		)
Real estate improvements		(49,364		)	(50,205		)
FF&E reserve fundings		(15,111		)	(25,502		)
Cash used in investing activities		(64,475		)	(226,207		)
Cash flows from financing activities:
Proceeds from issuance of common shares, net		393,473			—
Proceeds from issuance of preferred shares, net		—			280,108
Proceeds from unsecured term loan		—			400,000
Redemption of preferred shares		—			(86,250		)
Repurchase of convertible senior notes		—			(70,576		)
Borrowings under revolving credit facility		95,000			378,000
Repayments of revolving credit facility		(405,000		)	(527,000		)
Deferred financing costs		—			(2,432		)
Distributions to preferred shareholders		(8,097		)	(11,188		)
Distributions to common shareholders		(58,110		)	(55,585		)
Cash provided by financing activities		17,266			305,077
Increase (decrease) in cash and cash equivalents		(2,006		)	139,908
Cash and cash equivalents at beginning of period		20,049			8,303
Cash and cash equivalents at end of period		$	18,043		$	148,211
Supplemental cash flow information:
Cash paid for interest		$	55,064		$	54,938
Cash paid for income taxes		132			140
Non-cash investing activities:
Property managers’ deposits in FF&E reserve		$	5,891		$	7,133
Property managers’ purchases with FF&E reserve		(23,816		)	(28,187		)
Non-cash financing activities:
Issuance of common shares		$	—		$	878

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Note 1.  Basis of Presentation

 

The accompanying condensed consolidated financial statements of Hospitality Properties Trust and its subsidiaries, or we, our or us, are unaudited. Certain information and disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted. We believe the disclosures made are adequate to make the information presented not misleading. However, the accompanying condensed consolidated financial statements should be read in conjunction with the financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2012, as amended, or our 2012 Annual Report.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included in these condensed consolidated financial statements.  These condensed consolidated financial statements include the accounts of HPT and its subsidiaries, all of which are 100% owned directly or indirectly by HPT.  All material intercompany transactions and balances have been eliminated. Our operating results for interim periods and those of our managers and tenants are not necessarily indicative of the results that may be expected for the full year. Reclassifications have been made to the prior year’s condensed consolidated financial statements to conform to the current year’s presentation.

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates.  Significant estimates in the condensed consolidated financial statements include the allowance for doubtful accounts, purchase price allocations, useful lives of fixed assets and impairment of real estate and intangible assets.

 

We have determined that each of our taxable REIT subsidiaries, or TRSs, is a variable interest entity, or VIE, as defined under the Consolidation Topic of the Financial Accounting Standards Board, or FASB, Accounting Standards CodificationTM.   We have concluded that we must consolidate each of our TRSs because we are the entity with the power to direct the activities that most significantly impact such VIEs’ performance and we have the obligation to absorb the majority of the potential variability in gains and losses of each VIE, with the primary focus on losses, and are, therefore, the primary beneficiary of each VIE.  The assets of our TRSs were $50,119 as of March 31, 2013 and consist primarily of an acquired leasehold interest in a hotel and related leasehold improvements and working capital advances to certain of our hotel managers.  These assets can be used to settle obligations of both us and our TRSs.  The liabilities of our TRSs were $7,396 as of March 31, 2013 and consist primarily of deferred income tax liabilities and amounts payable to certain of our hotel managers.  Creditors have recourse to both us and our TRSs for these liabilities.

 

Note 2.  New Accounting Pronouncements

 

In January 2013, we adopted FASB Accounting Standards Update No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment. This update gives companies the option to first perform a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. The update is effective for interim and annual reporting periods beginning after September 15, 2012 with early adoption permitted. The implementation of this update did not cause any material changes to the disclosures in, or the presentation of, our condensed consolidated financial statements.

 

In January 2013, we adopted FASB Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This update requires companies to report, in one place, information about reclassifications out of accumulated other comprehensive income, or AOCI. Companies are also required to present details of reclassifications in the disclosure of change in AOCI balances. The update is effective for interim and annual reporting periods beginning after December 15, 2012 with early adoption permitted. The implementation of this update did not cause any material changes to the disclosures in, or the presentation of, our condensed consolidated financial statements.

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Note 3.  Revenue Recognition

 

We report hotel operating revenues for managed hotels in our condensed consolidated statements of income and comprehensive income. We generally recognize hotel operating revenues, consisting primarily of room and food and beverage sales, when services are provided. Our share of the net operating results of our managed hotels in excess of the minimum returns due to us, or additional returns, are generally determined annually. We recognize additional returns due to us under our management agreements at year end when all contingencies are met and the income is earned. We had no deferred additional returns for the three months ended March 31, 2013 and 2012.

 

We recognize rental income from operating leases on a straight line basis over the term of the lease agreements except for one lease in which there is uncertainty regarding the collection of future rent.  Rental income includes $62 and $354 for the three months ended March 31, 2013 and 2012, respectively, of adjustments necessary to record rent on the straight line basis.

 

We determine percentage rent due to us under our leases annually and recognize it at year end when all contingencies have been met and the rent is earned. We had deferred percentage rent of $610 and $1,309 for the three months ended March 31, 2013 and 2012, respectively.

 

We own all the capital expenditure reserves, or FF&E reserves, for our hotels. We do not report the amounts which are escrowed as FF&E reserves for our managed hotels as FF&E reserve income. We report deposits by our third party hotel tenants into the escrow accounts as FF&E reserve income.

 

Note 4.  Per Common Share Amounts

 

We calculate per common share amounts using the weighted average number of common shares outstanding during the period. We had no dilutive common share equivalents at March 31, 2013 or 2012.

 

Note 5.  Shareholders’ Equity

 

Distributions

 

On January 15, 2013, we paid a $0.4453 per share distribution to our Series D preferred shareholders with respect to the period ended January 14, 2013.  On March 4, 2013, we declared a $0.4453 per share distribution to our Series D preferred shareholder of record on March 28, 2013, with respect to the period ended April 14, 2013. We paid this amount on April 15, 2013.

 

On February 15, 2013, we paid a $0.4375 per share distribution to our Series C preferred shareholders with respect to the period ended February 14, 2013.  On April 1, 2013, we declared a $0.4375 per share distribution to our Series C preferred shareholders of record on April 30, 2013, with respect to the period ended May 14, 2013. We expect to pay this amount on or about May 15, 2013.

 

On February 22, 2013, we paid a $0.47 per share distribution to our common shareholders.  On April 10, 2013, we declared a $0.47 per share distribution to our common shareholders of record on April 26, 2013. We expect to pay this amount on or about May 24, 2013.

 

Common Share Issuances

 

On March 22, 2013, we sold 16,100,000 of our common shares at a price of $25.55 per share in a public offering. We used the net proceeds from this sale (approximately $393,473 after underwriting discounts and other offering expenses) to repay amounts outstanding under our unsecured revolving credit facility and for general business purposes.

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Other Comprehensive Income

 

Other comprehensive income represents the unrealized gain on the TravelCenters of America LLC, or TA, shares we own and our share of the comprehensive income of Affiliates Insurance Company, or AIC.  See Note 11 for further information regarding these investments.

 

Note 6.  Indebtedness

 

We have a $750,000 unsecured revolving credit facility that is available for general business purposes, including acquisitions. The maturity date of our revolving credit facility is September 7, 2015 and, subject to the payment of an extension fee and meeting certain other conditions, includes an option for us to extend the stated maturity date by one year to September 7, 2016. In addition, our revolving credit facility includes a feature under which maximum borrowings may be increased to up to $1,500,000 in certain circumstances. Borrowings under our revolving credit facility bear interest at a rate of LIBOR plus a premium of 130 basis points. We also pay a facility fee of 30 basis points per annum on the total amount of lending commitments under our revolving credit facility. Both the interest rate premium and the facility fee are subject to adjustment based upon changes to our credit ratings. As of March 31, 2013, the interest rate payable on borrowings under our revolving credit facility was 1.51%, and the weighted average annual interest rate for borrowings under our revolving credit facility was 1.51% and 1.59% for the three months ended March 31, 2013 and 2012, respectively. As of March 31, 2013, we had $10,000 outstanding and $740,000 available under our revolving credit facility.

 

We have a $400,000 unsecured term loan.  Our term loan matures on March 13, 2017, and is prepayable without penalty at any time.  In addition, our term loan includes a feature under which maximum borrowings may be increased to up to $500,000 in certain circumstances. Our term loan bears interest at a rate of LIBOR plus a premium, which was 145 basis points as of March 31, 2013. As of March 31, 2013, the interest rate for the amount outstanding under our term loan was 1.66% and the weighted average interest rate for the amount outstanding under our term loan was 1.66% for the three months ended March 31, 2013 and 1.70% for the period March 12, 2012 to March 31, 2012.

 

Our credit facility agreement and our term loan agreement provide for acceleration of payment of all amounts due thereunder upon the occurrence and continuation of certain events of default, including a change of control of us and the termination of our business management agreement with Reit Management & Research LLC, or RMR.  Our revolving credit facility agreement and our term loan agreement contain a number of covenants that restrict our ability to incur debt in excess of calculated amounts, restrict our ability to make distributions under certain circumstances and generally require us to maintain certain financial ratios.  We believe we were in compliance with the terms and conditions of our revolving credit facility agreement and our term loan agreement at March 31, 2013.

 

Note 7.  Real Estate Properties

 

At March 31, 2013, we owned 473 properties consisting of 288 hotels and 185 travel centers that were operated under eleven management agreements or leases and leased one hotel, which is operated under a separate management agreement.

 

During the three months ended March 31, 2013, we funded $64,475 of improvements to certain of our properties that pursuant to the terms of our management agreements and leases with our hotel managers and tenants resulted in increases in our contractual annual minimum returns and rents of $5,287.

 

In January 2013, we entered an agreement to acquire a 426 room full service hotel located in the Atlanta, GA metropolitan market for a contract purchase price of $29,700, excluding closing costs. We plan to convert this hotel as the Sonesta Gwinnett Place and add it to our Sonesta No. 1 agreement (see Notes 11 and 12 for more information regarding the Sonesta No. 1 agreement). We currently expect to acquire this hotel on or about May 17, 2013; however, this acquisition is subject to customary closing conditions and we can provide no assurance that we will acquire this property on that date or at all.

 

On February 27, 2013, we announced that we had entered a letter of intent with NH Hoteles, S.A., or NH Hoteles, under which we would loan NH Hoteles 170 million euros secured by four hotels located in Europe, acquire for $70,000 five

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

hotels located in Latin America and form a joint venture with NH Hoteles to acquire and renovate a hotel in New York City with an aggregate investment of up to $80,000.  On April 24, 2013, NH Hoteles notified us that it was unable to obtain the necessary bank approvals to allow it to complete the transaction as outlined in the letter of intent.  We have entered into discussions with NH Hoteles about possible modifications or alternatives to the proposed transaction originally announced, but at this time, the outcome of any such discussions is uncertain and no transaction may occur.

 

Note 8. Income Taxes

 

We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, and, accordingly are generally not subject to federal and most state income taxation on our operating income provided we distribute our taxable income to our shareholders and meet certain organization and operating requirements.  We are subject to income tax in Canada, Puerto Rico and certain states despite our REIT status.  Further, we lease our managed hotels to our wholly owned TRSs that, unlike most of our other subsidiaries, file a separate consolidated tax return and are subject to federal, state and foreign income taxes.  Our consolidated income tax provision includes the income tax provision related to the operations of our TRSs and certain state and foreign income taxes incurred by us despite our REIT status.

 

During the three months ended March 31, 2013, we recognized a current income tax expense of $730, which includes $350 of federal taxes, $31 of foreign taxes and $349 of certain state taxes that are payable without regard to our REIT status and TRS tax loss carry forwards. In addition, during the three months ended March 31, 2013, we recognized a deferred tax benefit of $212 related to book/tax basis differences at certain of our hotels and Canadian tax losses available to offset future income.

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Note 9.  Segment Information

 

		For the Three Months Ended March 31, 2013
		Hotels			Travel Centers			Corporate			Consolidated
Hotel operating revenues		$	291,651		$	—		$	—		$	291,651
Rental income		8,688			53,524			—			62,212
FF&E reserve income		603			—			—			603
Total revenues		300,942			53,524			—			354,466
Hotel operating expenses		206,649			—			—			206,649
Depreciation and amortization		48,677			23,603			—			72,280
General and administrative		—			—			12,144			12,144
Acquisition related costs		276			—			—			276
Loss on asset impairment		—			—			—			—
Total expenses		255,602			23,603			12,144			291,349
Operating income (loss)		45,340			29,921			(12,144		)	63,117
Interest income		—			—			19			19
Interest expense		—			—			(35,188		)	(35,188		)
Equity in earnings of an investee		—			—			76			76
Income (loss) before income taxes		45,340			29,921			(47,237		)	28,024
Income tax expense		—			—			(518		)	(518		)
Net income (loss)		$	45,340		$	29,921		$	(47,755	)	$	27,506
		As of March 31, 2013
		Hotels			Travel Centers			Corporate			Consolidated
Total assets		$	3,398,033		$	2,222,853		$	38,344		$	5,659,230
		For the Three Months Ended March 31, 2012
		Hotels			Travel Centers			Corporate			Consolidated
Hotel operating revenues		$	224,985		$	—		$	—		$	224,985
Rental income		21,942			51,318			—			73,260
FF&E reserve income		3,175			—			—			3,175
Total revenues		250,102			51,318			—			301,420
Hotel operating expenses		150,021			—			—			150,021
Depreciation and amortization		39,958			21,405			—			61,363
General and administrative		—			—			10,522			10,522
Acquisition related costs		1,060			—			—			1,060
Loss on asset impairment		889			—			—			889
Total expenses		191,928			21,405			10,522			223,855
Operating income (loss)		58,174			29,913			(10,522		)	77,565
Interest income		—			—			66			66
Interest expense		—			—			(34,092		)	(34,092		)
Equity in earnings of an investee		—			—			45			45
Income (loss) before income taxes		58,174			29,913			(44,503		)	43,584
Income tax expense		—			—			(636		)	(636		)
Net income (loss)		$	58,174		$	29,913		$	(45,139	)	$	42,948
		As of December 31, 2012
		Hotels			Travel Centers			Corporate			Consolidated
Total assets		$	3,384,221		$	2,209,970		$	40,934		$	5,635,125

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Note 10. Significant Tenant

 

TA is the lessee of 38% of our real estate properties, at cost, as of March 31, 2013.  The following table presents summary financial information for TA for the three months ended March 31, 2013, as reported in its Quarterly Report on Form 10-Q, or TA’s Quarterly Report: 

 

		For the Three Months Ended
		March 31,
		2013			2012
Operations
Total revenues		$	1,957,351		$	1,994,869
Total cost of goods sold		1,693,544			1,751,517
Net loss		(12,139		)	(14,185		)
Cash Flows
Net cash provided by operating activities		15,281			4,471
Net cash used in investing activities		(19,486		)	(27,231		)
Net cash provided by (used in) financing activities		104,989			(571		)
Net increase (decrease) in cash		100,775			(23,318		)
Cash and cash equivalents at the beginning of the period		35,189			118,255
Cash and cash equivalents at the end of the period		135,964			94,937

 

		As of March 31,
		2013			2012
Financial Position
Current assets		$	553,562		$	492,615
Noncurrent assets		631,469			540,008
Current liabilities		354,576			319,648
Noncurrent liabilities		488,522			407,903
Total shareholders’ equity		341,933			305,072

 

The summary financial information of TA is presented to comply with applicable accounting regulations of the Securities and Exchange Commission, or the SEC.  References in our financial statements to TA’s Quarterly Report are included to show the source of the information only, and the other information in TA’s Quarterly Report is not incorporated by reference into these financial statements.  See Note 11 for further information relating to our TA leases.

 

Note 11. Related Person Transactions

 

We have no employees.  Personnel and various services we require to operate our business are provided to us by RMR.  We have two agreements with RMR to provide management and administrative services to us: (1) a business management agreement, which relates to our business generally, and (2) a property management agreement, which relates to the property level operations of the office building component of only one property in Baltimore, MD, which also includes a Royal Sonesta hotel.

 

Under our business management agreement with RMR, we acknowledge that RMR also provides services to other companies, including TA and Sonesta International Hotels Corporation, or Sonesta.  One of our Managing Trustees, Mr. Barry Portnoy, is Chairman, majority owner and an employee of RMR.  Our other Managing Trustee, Mr. Adam Portnoy, is the son of Mr. Barry Portnoy, and an owner, President, Chief Executive Officer and a director of RMR.

 

9

 

 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Each of our executive officers is also an officer of RMR, including Mr. Ethan Bornstein, who is the son-in-law of Mr. Barry Portnoy and the brother-in-law of Mr. Adam Portnoy.  Certain of TA’s and Sonesta’s executive officers are officers of RMR.  Our Independent Trustees also serve as independent directors or independent trustees of other public companies to which RMR provides management services.  Mr. Barry Portnoy serves as a managing director or managing trustee of those companies, including TA, and Mr. Adam Portnoy serves as a managing trustee of a majority of those companies, but not TA.  In addition, officers of RMR serve as officers of those companies.

 

Pursuant to our business management and property management agreements with RMR, we recognized aggregate business management fees and property management fees for the three months ended March 31, 2013 and 2012 of $9,922 and $8,648, respectively.  These amounts are included in general and administrative expenses in our condensed consolidated financial statements.

 

TA is our former 100% owned subsidiary and our largest tenant, and we are TA’s largest shareholder.  TA was created as a separate public company in 2007 as a result of its spin off from us.  As of March 31, 2013, we owned 2,540,000 common shares of TA, representing approximately 8.6% of TA’s outstanding common shares.  Mr. Barry Portnoy, one of our Managing Trustees, is a managing director of TA.  Mr. Thomas O’Brien, an officer of RMR and a former officer of us prior to the TA spin off, is President and Chief Executive Officer and the other managing director of TA.  Mr. Arthur Koumantzelis, who was one of our Independent Trustees prior to the TA spin off, serves as an independent director of TA.  RMR provides management services to both us and TA.

 

TA has two leases with us, the TA No. 1 lease and the TA No. 2 lease, pursuant to which TA leases 185 travel centers from us.  The TA No. 1 lease is for 145 travel centers that TA operates under the “TravelCenters of America” or “TA” brand names.  The TA No. 2 lease is for 40 travel centers that TA operates under the “Petro” brand name.  The TA No. 1 lease expires on December 31, 2022.  The TA No. 2 lease expires on June 30, 2024, and may be extended by TA for up to two additional periods of 15 years each.  Both of these leases require TA to: (1) make payments to us of minimum rents; (2) pay us percentage rent equal to 3% of non-fuel revenues and 0.3% of fuel revenues above applicable base year revenues subject to certain limitations (with the first $2,500 of percentage rents under the TA No. 2 lease waived by us), respectively; (3) to pay us at lease expiration an amount equal to an estimate of the cost of removing underground storage tanks on our leased sites and (4) maintain the leased travel centers, including structural and non-structural components.  In addition to minimum and percentage rent, TA is obligated to pay us ground rent of approximately $5,126 per year under the TA No. 1 lease.  Previously deferred rent due from TA of $107,085 and $42,915 is due in December 2022 and June 2024, respectively.  We have not recognized any of the deferred rent as rental income or as rents receivable due to uncertainties regarding future collection.

 

We recognized rental income of $53,524 and $51,318 for the three months ended March 31, 2013 and 2012, respectively, under our leases with TA.  Rental income for the three months ended March 31, 2013 and 2012 includes $(73) and $357, respectively, of adjustments necessary to record the scheduled rent increase on our TA No. 1 lease and the estimated future payment to us by TA for the cost of removing underground storage tanks on a straight line basis.  As of March 31, 2013 and December 31, 2012, we had accruals for unpaid amounts of $29,987 and $29,300, respectively, owed to us by TA, excluding any deferred rents, which accrued amounts are included in other assets on our condensed consolidated balance sheets.  We had deferred percentage rent under our TA No. 1 lease of $610 and $729 for the three months ended March 31, 2013 and 2012, respectively.  We determine percentage rent due under our TA No. 1 lease annually and recognize it at year end when all contingencies are met.

 

Under the TA No. 1 and No. 2 leases, TA may request that we fund approved amounts for renovations, improvements and equipment at leased travel centers in return for increases in TA’s minimum annual rent.  We are not required to fund these improvements and TA is not required to sell them to us.  For the three months ended March 31, 2013, we funded $22,655 for capital improvements purchased from TA under this lease provision; and, as a result, TA’s minimum annual rent payable to us increased by approximately $1,926.

 

On April 15, 2013, TA entered an agreement with Shell Oil Products US, or Shell, pursuant to which Shell has agreed to construct a network of natural gas refueling lanes at up to 100 of TA’s travel centers located along the U.S. interstate highway system, including travel centers TA leases from us.  In connection with that agreement, on April 15, 2013, we

 

10

 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

and TA amended our leases to specify the economic equivalent for natural gas sales to diesel fuel sales for the calculation of percentage rent payable to us under the leases, with the intended effect that the amount of percentage rent be unaffected by the source of fuel sold, whether diesel fuel or natural gas.  That amendment also made certain administrative changes.  Also on that date, in order to facilitate TA’s agreement with Shell, we entered into a subordination, non-disturbance and attornment agreement with Shell, whereby we agreed to recognize Shell’s license and other rights with respect to the natural gas refueling lanes at our travel centers leased to TA on certain conditions and in certain circumstances.

 

On January 31, 2012, pursuant to a series of transactions, we effectively acquired entities that owned the Royal Sonesta Hotel Boston in Cambridge, MA, or the Cambridge Hotel, and had leasehold interests in the Royal Sonesta Hotel New Orleans in New Orleans, LA, or the New Orleans Hotel, for approximately $150,500, including the assumption of debt.  On that date, in connection with these transactions, we entered into hotel management agreements with Sonesta to manage the Cambridge Hotel and the New Orleans Hotel.  Since that time, we have rebranded additional hotels to Sonesta brands and management.

 

In April 2012, we entered into a pooling agreement with Sonesta that combines our management agreements with Sonesta for hotels that we own for purposes of calculating gross revenues, payment of hotel operating expenses, payment of fees and distributions and the calculation of minimum returns due to us.  We refer to this agreement and combination of hotels and management agreements as our Sonesta No. 1 agreement.  The management agreements for all of our hotels managed by Sonesta, excluding the New Orleans Hotel, are included in the Sonesta No. 1 agreement.  We refer to our management agreement for the New Orleans Hotel as our Sonesta No. 2 agreement.  See Note 12 for further information about our management agreements with Sonesta.

 

Pursuant to our management agreements with Sonesta, we incurred management, system and reservation fees payable to Sonesta of $1,895 and $459 for the three months ended March 31, 2013 and 2012, respectively.  These amounts are included in hotel operating expenses in our condensed consolidated statements of income and comprehensive income.  In addition, we also incurred procurement and construction supervision fees payable to Sonesta in connection with capital expenditures at our hotels managed by Sonesta of $482 and zero dollars for the three months ended March 31, 2013 and 2012, respectively.  These amounts have been capitalized in our condensed consolidated balance sheets.  Under our hotel management agreements with Sonesta, routine property maintenance, which is expensed, is an operating expense of the hotels and repairs and periodic renovations, which are capitalized, are funded by us, except in the case of the New Orleans Hotel where capital expenditures are borne in large part by the lessor.

 

On February 27, 2013, we announced that we had entered a letter of intent with NH Hoteles, under which we would loan NH Hoteles 170 million euros, acquire five hotels from NH Hotels and form a joint venture with NH Hoteles to acquire a hotel in New York City that would be branded jointly by NH Hoteles and Sonesta.  On April 24, 2013, NH Hoteles notified us that it was unable to obtain the necessary bank approvals to allow it to move forward with the transaction as outlined in the letter of intent.  We expect to enter into discussions with NH Hoteles about possible modifications or alternatives to the transaction originally announced, but at this time, the outcome of any such discussions is uncertain and no transaction may occur.

 

On March 6, 2013, we announced that we entered into a hotel management agreement with Sonesta for the Sonesta Gwinnett Place that we currently expect to acquire on or about May 17, 2013; however, this acquisition is subject to customary closing conditions and we can provide no assurance that we will acquire this property on that date or at all.  The management agreement will become effective as of the date we acquire the Sonesta Gwinnett Place and lease it to our TRS.  We intend to rebrand the property as a Sonesta hotel upon its acquisition, and add the management agreement to our Sonesta No. 1 agreement.

 

The stockholders of Sonesta are Mr. Barry Portnoy and Mr. Adam Portnoy, who are our Managing Trustees, and they also serve as directors of Sonesta.  In addition, RMR also provides certain services to Sonesta.

 

We, RMR, TA and five other companies to which RMR provides management services each currently own 12.5% of AIC, an Indiana insurance company.  All of our Trustees, all of the trustees and directors of the other publicly held AIC

 

11

 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

shareholders and nearly all of the directors of RMR currently serve on the board of directors of AIC.  RMR provides management and administrative services to AIC pursuant to a management and administrative services agreement with AIC.  As of March 31, 2013, we have invested $5,209 in AIC since its formation in November 2008.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because all of our Trustees are also directors of AIC.  Our investment in AIC had a carrying value of $5,697 and $5,629 as of March 31, 2013 and December 31, 2012, respectively, which amounts are included in other assets on our condensed consolidated balance sheets.  For the three months ended March 31, 2013 and 2012, we recognized income of $76 and $45, respectively, related to our investment in AIC.  We and the other shareholders of AIC have purchased property insurance providing $500,000 of coverage pursuant to an insurance program arranged by AIC and with respect to which AIC is a reinsurer of certain coverage amounts.  This program was modified and extended in June 2012 for a one year term and we paid a premium, including taxes and fees, of $5,256 in connection with that renewal, which amount may be adjusted from time to time as we acquire or dispose of properties that are included in this program.  We periodically consider the possibilities for expanding our insurance relationships with AIC to include other types of insurance and may in the future participate in additional insurance offerings AIC may provide or arrange.  We may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we are not obligated to do so.  By participating in this insurance business with RMR and the other companies to which RMR provides management services, we expect that we may benefit financially by possibly reducing our insurance expenses or by realizing our pro rata share of any profits of this insurance business.

 

Note 12. Hotel Management Agreements and Leases

 

Marriott No. 1 agreement. Our lease with Host Hotels & Resorts, Inc., or Host, for 53 hotels which we have historically referred to as our Marriott No. 1 agreement expired on December 31, 2012. As required upon the expiration of the agreement, we returned the $50,540 security deposit we held to Host. Effective January 1, 2013, we leased these hotels to one of our TRSs and continued the previously existing hotel brand and management agreements with Marriott International Inc., or Marriott. This management agreement expires in 2024. Because we no longer hold a security deposit for this agreement, the future minimum returns we receive from this agreement will depend exclusively upon the performance of the hotels.

 

Marriott No. 234 agreement.  During the three months ended March 31, 2013, the payments we received under our Marriott No. 234 agreement, which requires annual minimum returns to us of $103,151, were $1,704 less than the minimum amounts contractually required.  Pursuant to our Marriott No. 234 agreement, Marriott provided us with a limited guarantee for shortfalls up to 90% of our minimum returns.  During the three months ended March 31, 2013, Marriott made $657 of guaranty payments to us.  The available balance of this guaranty was $25,319 as of March 31, 2013. Also, during the period from March 31, 2013 to May 7, 2013, the payments we received for these hotels were $1,717 less than the contractual minimum returns due to us.

 

We currently expect to fund $45,000 of capital improvements in 2013 to complete renovations at certain of the hotels included in our Marriott No. 234 agreement. We funded $14,600 of this amount during the three months ended March 31, 2013. As we fund these improvements, the annual minimum returns payable to us increase by 9% of the amounts funded.

 

InterContinental agreement.  During the three months ended March 31, 2013, the payments we received under our agreement with InterContinental Hotels Group, plc, or InterContinental, covering 91 hotels and requiring minimum returns to us of $135,159, were $5,917 less than the minimum amounts contractually required.  We applied the available security deposit to cover these shortfalls.  Also, during the period from March 31, 2013 to May 7, 2013, the minimum return payments we received under our InterContinental agreement were $3,381 more than the minimum amounts due to us.  We replenished the available security deposit by the additional amounts received.  The remaining balance of the security deposit was $23,929 as of May 7, 2013.

 

When we reduce the amounts of the security deposits we hold for these agreements or any other operating agreements for payment deficiencies, we record income equal to the amounts by which these deposits are reduced up to the minimum return or minimum rent due to us. However, reducing the security deposits does not result in additional cash flow to us of the deficiency amounts, but reducing amounts of security deposits may reduce the refunds due to the

 

12

 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

respective lessees or managers who have provided us with these deposits upon expiration of the respective lease or management agreement.  The security deposits are non-interest bearing and are not held in escrow.  Under all of our hotel contracts that include a security deposit, any amount of the security deposits which are applied to payment deficits may be replenished from future cash flows from the applicable hotel operations pursuant to the terms of the respective contracts.

 

We currently expect to fund $77,232 of capital improvement in 2013 to complete renovations at certain of the hotels included in our InterContinental agreement.  We did not make any fundings during the three months ended March 31, 2013.  As we fund these improvements, the annual minimum returns payable to us increase by 8% of the amounts funded.

 

Sonesta No. 1 agreement.  In addition to recurring capital expenditures, we currently expect to fund an aggregate of $195,000 for rebranding, renovations and other improvements in 2013 and 2014 to these hotels.  We funded $15,880 of this amount during the three months ended March 31, 2013.  The annual minimum returns due to us under the Sonesta No. 1 agreement will increase by 8% to the extent amounts funded for these improvements exceed threshold amounts, as defined.

 

We do not have any security deposits or guarantees for our hotels managed by Sonesta.  Sonesta’s incentive management fees, but not its other fees, are only earned after we receive our minimum returns, and we may cancel these management agreements if approximately 75% of our minimum returns are not paid for certain periods.  Accordingly, the returns we receive from hotels managed by Sonesta will depend exclusively upon the performance of those hotels.

 

Wyndham agreement.  We currently expect to fund $85,000 of capital improvement in 2013 to complete renovations at certain of the hotels included in our Wyndham Worldwide Corporation, or Wyndham, agreement. We funded $10,081 of this amount during the three months ended March 31, 2013. As we fund these improvements, the annual minimum returns payable to us increase by 8% of the amounts funded.  During the three months ended March 31, 2013, Wyndham provided $5,091 of guaranty payments to us.

 

Other management agreement and lease matters.  As of May 7, 2013, all payments due to us from our managers and tenants under our other operating agreements were current.  Minimum return and minimum rent payments due to us under some of our hotel management agreements and leases are supported by guarantees. The guarantee provided by Marriott, with respect to the 68 hotels (Marriott No. 234 agreement) managed by Marriott is limited to $40,000 ($25,318 remaining at March 31, 2013) and expires on December 31, 2019. The guarantee provided by Hyatt Hotels Corporation, or Hyatt, with respect to the 22 hotels managed by Hyatt is limited to $50,000 ($16,025 remaining at March 31, 2013). The guarantee provided by Carlson Hotels Worldwide, or Carlson, with respect to the 11 hotels managed by Carlson is limited to $40,000 ($21,512 remaining at March 31, 2013). The guarantee provided by Wyndham with respect to the 21 hotels managed by Wyndham is limited to $29,000 ($16,459 remaining at March 31, 2013). Certain of these guarantees may be replenished by future cash flows from the hotels in excess of our minimum returns. The guarantee provided by Wyndham for the lease with Wyndham Vacation Resorts, Inc., or Wyndham Vacation, is unlimited. The guarantee provided by Marriott with respect to the one hotel leased by Marriott (Marriott No. 5 agreement) is unlimited.

 

Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $33,459 and $28,655 less than the minimum returns due to us for the three months ended March 31, 2013 and 2012, respectively. When managers of these hotels are required to fund the shortfalls under the terms of our operating agreements or their guarantees, we reflect such fundings (including security deposit applications) in our condensed consolidated statements of income and comprehensive income as a reduction of hotel operating expenses. The reduction to hotel operating expenses was $14,908 and $24,594 in the three months ended March 31, 2013 and 2012, respectively. We had $18,551 and $4,061 of shortfalls at certain of our managed hotel portfolios not funded by the managers of these hotels under the terms of our operating agreements during the three months ended March 31, 2013 and 2012, respectively, which represents the unguaranteed portion of our minimum returns from Marriott and Sonesta.

 

13

 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Note 13.  Fair Value of Assets and Liabilities

 

The table below presents certain of our assets carried at fair value at March 31, 2013, categorized by the level of inputs, as defined in the fair value hierarchy under GAAP, used in the valuation of each asset.

 

					Fair Value at Reporting Date Using
					Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
Description		Total			(Level 1)			(Level 2)			(Level 3)
Investment securities (1)		$	24,359		$	24,359		$	—		$	—

 

(1)         Our investment securities, consisting of our 2,540,000 shares of TA, which are included in our other assets, are reported at fair value which is based on quoted market prices (Level 1 inputs).  Our historical cost basis for these securities is $9,267.  The unrealized gain for these securities as of March 31, 2013, is included in cumulative other comprehensive income in our condensed consolidated balance sheets.

 

In addition to the investment securities included in the table above, our financial instruments include our cash and cash equivalents, restricted cash, rents receivable, revolving credit facility, unsecured term loan, senior notes and security deposits. At March 31, 2013 and December 31, 2012, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

 

		March 31, 2013						December 31, 2012
		Carrying			Fair			Carrying			Fair
		Amount			Value			Amount			Value
Senior Notes, due 2014 at 7.875%		300,000			324,739			300,000			333,360
Senior Notes, due 2015 at 5.125%		280,000			295,026			280,000			298,926
Senior Notes, due 2016 at 6.3%		275,000			310,385			275,000			306,078
Senior Notes, due 2017 at 5.625%		300,000			331,805			300,000			335,173
Senior Notes, due 2018 at 6.7%		350,000			412,098			350,000			417,293
Senior Notes, due 2022 at 5%		500,000			529,555			500,000			531,343
Convertible Senior Notes, due 2027 at 3.8%		8,478			9,033			8,478			9,092
Unamortized discounts		(10,628		)	—			(11,120		)	—
Total financial liabilities		$	2,002,850		$	2,212,641		$	2,002,358		$	2,231,265

 

We estimate the fair value of our indebtedness using discounted cash flow analysis and currently prevailing market interest rates (Level 3 inputs).

 

14

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q and with our 2012 Annual Report. We are a REIT organized under Maryland law.

 

Overview (dollar amounts in thousands, except per share amounts)

 

For the quarter ended March 31, 2013 compared to the same period in 2012 for our 285 comparable hotels: average daily rate, or ADR, increased 3.8% to $103.06; occupancy increased 2.1 percentage points to 66.4%; and revenue per available room, or RevPAR, increased 7.2% to $68.43.

 

During the quarter ended March 31, 2013, we had 38 comparable hotels under renovation for all or part of the quarter.  For the quarter ended March 31, 2013 compared to the same period in 2012 for our 247 comparable hotels not under renovation: ADR increased 3.4% to $101.92; occupancy increased 4.3 percentage points to 68.2%; and RevPAR increased 10.3% to $69.51.

 

Hotel operations. The U.S. hotel industry generally continues to show improvement in ADR, occupancy and RevPAR over 2012, but these measures are still below levels prior to the recent recession.  We believe the increases in ADR, occupancy and RevPAR at certain of our hotels in 2013 have been below hotel industry averages primarily due to the disruption and displacement caused by renovation and rebranding activities.  We expect our high level of hotel renovation activity to continue through the end of 2013.

 

Our hotel tenants and managers.  Many of our hotel operating agreements contain security features, such as guarantees and security deposits, which are intended to protect minimum returns and rents due to us in accordance with our operating agreements regardless of hotel performance.  However, the effectiveness of various security features to provide uninterrupted receipt by us of minimum returns and rents is not assured, particularly if the lodging industry takes an extended period to recover from the severe declines experienced during the recent recession, if economic conditions decline, or if our hotel renovation activities described above do not result in improved operating results at these hotels.  Further, certain of the guarantees that we hold are limited in amount and duration and do not provide for payment of the entire amount of the applicable minimum return shortfalls.  If our tenants, managers or guarantors do not earn or pay the minimum returns and rents due to us, our cash flows will decline and we may be unable to pay distributions to our shareholders, repay our debt or fund our debt service obligations.

 

Marriott No. 1 agreement.  Our lease with Host for 53 hotels, which we have historically referred to as our Marriott No. 1 agreement, expired on December 31, 2012. As required upon the expiration of the lease, we returned the $50,540 security deposit we held to Host. As of January 1, 2013, we leased these hotels to one of our TRSs and continued the previously existing hotel brand and management agreements with Marriott. Our management agreement with Marriott does not have a security deposit or guarantee. Accordingly, the future minimum returns we receive under this agreement will depend exclusively upon the performance of the hotels.

 

Marriott No. 234 agreement.  Additional details of this agreement are set forth in Note 12 to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q, which disclosure is incorporated herein by reference.

 

During the three months ended March 31, 2013, the payments we received under our Marriott No. 234 agreement, which requires annual minimum returns to us of $103,151, were $1,704 less than the minimum amounts contractually required.  Pursuant to our Marriott No. 234 agreement, Marriott International Inc., or Marriott provided us with a limited guarantee for shortfalls up to 90% of our minimum returns.  During the three months ended March 31, 2013, Marriott made $657 of guaranty payments to us.  The available balance of this guaranty was $25,319 as of March 31, 2013. Also, during the period from March 31, 2013 to May 7, 2013, the payments we received for these hotels were $1,717 less than the contractual minimum returns due to us.

 

InterContinental agreement.  Additional details of this agreement are set forth in Note 12 to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q, which disclosure is incorporated herein by reference.

 

15

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

During the three months ended March 31, 2013, the payments we received under our InterContinental agreement covering 91 hotels and requiring minimum returns to us of $135,159 were $5,917 less than the minimum amounts contractually required.  We applied the available security deposit to cover these shortfalls.  Also, during the period from March 31, 2013 to May 7, 2013, the minimum return payments we received under our InterContinental agreement were $3,381 more than the minimum amounts due to us.  We replenished the available security deposit by the additional amounts received.  The remaining balance of the security deposit was $23,929 as of May 7, 2013.

 

Other management agreement and lease matters. As of May 7, 2013, all payments due to us from our managers and tenants under our other operating agreements were current.  Additional details of our guarantees from Hyatt, Carlson and Wyndham and our agreements with TA and Sonesta are set forth in Notes 11 and 12 to our condensed consolidated financial statements in Part I, Item I of this Quarterly Report on Form 10-Q, which disclosure is incorporated herein by reference.  Other information about TA is set forth in Note 10 to our condensed consolidated financial statements in Part I, Item I of this Quarterly Report on Form 10-Q, which disclosure is incorporated herein by reference.

 

When we reduce the amounts of the security deposits we hold under our operating agreements for payment deficiencies, we record income equal to the amounts by which these deposits are reduced up to the minimum return or minimum rent due to us.  Reducing the security deposits does not result in additional cash flow to us of the deficiency amounts, but reducing amounts of security deposits may reduce the refunds due to the respective tenants or managers who have provided us with these deposits upon expiration of the respective lease or management agreement.  The security deposits we hold are non-interest bearing and are not held in escrow.  Under all of our hotel contracts that include a security deposit, any amounts of the security deposits which are applied to payment deficits may be replenished from future cash flows from the applicable hotel operations pursuant to the terms of the respective contracts.  When we receive payments under guarantees under our leases or operating agreements, we receive cash.  When we receive guaranty payments under our hotel operating agreements, generally the hotel operator is allowed to recapture payments it makes to us out of some or all of the hotels’ future cash flows after our minimum returns are paid.

 

Management Agreements and Leases

 

At March 31, 2013, we owned or leased 289 hotels operated under 10 operating agreements; 285 of these hotels are leased by us to our wholly owned TRSs and managed by hotel operating companies, one hotel is leased by one of our TRSs from a third party and managed by a hotel operating company and three are leased to hotel operating companies.  At March 31, 2013, we also owned 185 travel centers that are leased to TA under two agreements. Our condensed consolidated statements of income and comprehensive income include operating revenues and expenses of our managed hotels and rental income from leased hotels and travel centers.  Additional information regarding the terms of our management agreements and leases is included in the table on pages 25 through 27 below.

 

16

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Results of Operations (dollar amounts in thousands, except per share amounts)

 

Three Months Ended March 31, 2013 Compared to the Three Months Ended March 31, 2012

 

		For the Three Months Ended March 31,
								Increase			% Increase
		2013			2012			(Decrease)			(Decrease)
Revenues:
Hotel operating revenues		$	291,651		$	224,985		$	66,666		29.6%
Rental income:
Minimum rents - hotels		8,688			21,942			(13,254		)	(60.4)%
Minimum rents - travel centers		53,524			51,318			2,206			4.3%
Total rental income		62,212			73,260			(11,048		)	(15.1)%
FF&E reserve income		603			3,175			(2,572		)	(81.0)%
Expenses:
Hotel operating expenses		206,649			150,021			56,628			37.7%
Depreciation and amortization - hotels		48,677			39,958			8,719			21.8%
Depreciation and amortization - travel centers		23,603			21,405			2,198			10.3%
Total depreciation and amortization		72,280			61,363			10,917			17.8%
General and administrative		12,144			10,522			1,622			15.4%
Acquisition related costs		276			1,060			(784		)	(74.0)%
Loss on asset impairment		—			889			(889		)	(100.0)%
Operating income		63,117			77,565			(14,448		)	(18.6)%
Interest income		19			66			(47		)	(71.2)%
Interest expense		(35,188		)	(34,092		)	1,096			3.2%
Equity in earnings of an investee		76			45			31			68.9%
Income before income taxes		28,024			43,584			(15,560		)	(35.7)%
Income tax expense		(518		)	(636		)	(118		)	(18.6)%
Net income		27,506			42,948			(15,442		)	(36.0)%
Excess of liquidation preference over carrying value of preferred shares redeemed		—			(2,944		)	2,944			(100.0)%
Preferred distributions		(8,097		)	(11,188		)	3,091			(27.6)%
Net income available for common shareholders		19,409			28,816			(9,407		)	(32.6)%
Weighted average shares outstanding		125,426			123,523			1,903			1.5%
Net income available for common shareholders per common share		$	0.15		$	0.23		$	(0.08	)	(34.8)%

 

References to changes in the income and expense categories below relate to the comparison of consolidated results for the three month period ended March 31, 2013, compared to the three month period ended March 31, 2012.

 

The increase in hotel operating revenues is a result of the conversion of 53 hotels from leased to managed in January 2013 ($53,688), increased revenues at certain of our managed hotels due to increases in ADR and higher occupancies ($19,490) and the effects of our 2012 acquisitions ($8,576).  These increases were partially offset by decreased revenues

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

at certain of our managed hotels recently rebranded or undergoing renovations during the 2013 period due to decreases in ADR and lower occupancies ($9,887) and the effects of our 2012 dispositions ($5,201).  Additional operating statistics of our hotels are included in the table on page 28.

 

The decrease in rental income - hotels is a result of the conversion of 53 hotels from leased to managed in January 2013 ($16,214), partially offset by the effects of our 2012 acquisitions ($2,380) and increases in the minimum rents due to us as we funded improvements at certain of our leased hotels since January 1, 2012 ($580).

 

The increase in rental income - travel centers is primarily a result of increases in the minimum rents due to us from TA for improvements we purchased at certain of our travel centers since January 1, 2012. Rental income for the 2013 and 2012 periods includes ($73) and $357 of straight line rent, respectively.

 

FF&E reserve income represents amounts paid by certain of our hotel tenants into restricted accounts owned by us, the purpose of which is to accumulate funds for future capital expenditures. The terms of our hotel leases require these amounts to be calculated as a percentage of total sales at our hotels. The decrease in FF&E reserve income is primarily the result of the conversion of 53 hotels from leased to managed in January 2013 ($3,175), partially offset by increased levels of sales at certain of our leased hotels ($603). We do not report the amounts, if any, which are escrowed as FF&E reserves for our managed hotels as FF&E reserve income.

 

The increase in hotel operating expenses was primarily caused by the conversion of 53 hotels from leased to managed in January 2013 ($37,460), increased expenses associated with higher occupancies at certain of our managed hotels ($11,394) and the effect of our 2012 hotel acquisitions ($9,060), partially offset by operating expense decreases at certain properties recently rebranded or undergoing renovations during the 2013 period due to lower occupancies ($5,768) and the effect of our 2012 hotel dispositions ($5,204).  Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $33,459 and $28,655, less than the minimum returns due to us in the three months ended March 31, 2013 and 2012, respectively.  When the managers of these hotels are required to fund the shortfalls under the terms of our operating agreements or their guarantees, we reflect such fundings (including security deposit applications) in our condensed consolidated statements of income and comprehensive income as a reduction of hotel operating expenses. The reduction to operating expenses was $14,908 and $24,594 in the three months ended March 31, 2013 and 2012, respectively.  We had $18,551 and $4,061 of shortfalls at certain of our managed hotel portfolios not funded by the managers of these hotels under the terms of our operating agreements during the three months ended March 31, 2013 and 2012, respectively, which represents the unguaranteed portion of our minimum returns from Marriott and from Sonesta.

 

The increase in depreciation and amortization - hotels is primarily due to the depreciation and amortization of assets acquired with funds from our FF&E reserves or directly funded by us since January 1, 2012 ($8,469) and the effect of our 2012 acquisitions ($2,290), partially offset by certain of our depreciable assets becoming fully depreciated since January 1, 2012 ($2,040).

 

The increase in depreciation and amortization - travel centers is due to the depreciation and amortization of improvements made to our travel centers since January, 1 2012.

 

The increase in general and administrative costs is primarily due to an increase in business management fees and professional services expenses.

 

Acquisition related costs represent legal and other costs incurred in connection with our hotel acquisition activities.

 

The decrease in operating income is primarily due to the revenue and expense changes discussed above.

 

The increase in interest income is due to higher average cash balances.

 

The increase in interest expense is primarily due to higher average borrowings, partially offset by lower weighted average interest rates.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Equity in earnings of an investee represents our proportionate share of earnings of AIC.

 

The decrease in income tax expense is primarily the result of lower state income taxes during the 2013 period, partially offset by increased federal income taxes related to our TRSs.

 

Our net income available for common shareholders in 2012 was reduced by $2,944, which represented the amount by which the liquidation for our Series B cumulative redeemable preferred shares that we redeemed in February 2012 exceeded our carrying amount for those preferred shares as of the date of redemption.

 

The decrease in preferred distributions is the result of our redemption of 3,450,000 shares of our 8.875% Series B cumulative redeemable preferred shares in February 2012 and our redemption of 6,000,000 shares of our 7.0% Series C cumulative redeemable preferred shares in September 2012 partially offset by the issuance of 11,600,000 shares of our 7.125% Series D cumulative redeemable preferred shares in January 2012.

 

The decreases in net income, net income available for common shareholders and net income available for common shareholders per common share in the three months ended March 31, 2013, compared to the prior year period, are primarily a result of the changes discussed above.

 

Liquidity and Capital Resources (dollar amounts in thousands, except per share amounts)

 

Our Managers and Tenants

 

As of March 31, 2013, all 474 of our properties were operated under 12 management agreements or leases.  All costs of operating and maintaining our properties are paid by the hotel managers as agents for us or by our tenants for their own account. Our hotel managers and tenants derive their funding for property operating expenses and for returns and rents due to us generally from property operating revenues and, to the extent that these parties themselves fund our minimum returns and minimum rents, from their separate resources.  Our hotel managers include Marriott, InterContinental, Hyatt, Carlson, Sonesta, Wyndham and Morgans Hotel Group Co., or Morgans.  Our travel centers are leased to TA.

 

We define coverage for each of our hotel management agreements or leases as total property level revenues minus all property level expenses which are not subordinated to the minimum returns and minimum rents due to us divided by the minimum returns or minimum rent payments due to us. More detail regarding coverage, guarantees and other features of our hotel operating agreements is presented in the tables on pages 25 through 27.  During the twelve months ended March 31, 2013, eight of our ten hotel operating agreements generated coverage of less than 1.00x (0.20x to 0.92x); our Sonesta No. 2 and Marriott No. 1 agreements generated coverage of 1.78x and 1.00x, respectively, during the twelve months ended March 31, 2013.

 

We define coverage for our travel center leases as property level revenues minus all property level expenses divided by the minimum rent payments due to us.  During the twelve months ended March 31, 2013, the operating results from our 185 properties in our two travel center leases generated coverage of 1.68x.  Because a large percentage of TA’s business is conducted at properties leased from us, property level rent coverage may not be an appropriate way to evaluate TA’s ability to pay rents due to us.  We believe property level rent coverage is nonetheless one useful indicator of the performance and value of our properties as we believe it is what an operator interested to acquire these properties or the leaseholds might use to evaluate the contribution of these properties to their earnings before corporate level expenses.

 

Three hundred eight (308) of our properties, representing 63% of our total historical investments at cost as of March 31, 2013, are operated under seven management arrangements or leases which are subject to full or limited guarantees.  These guarantees may provide us with continued payments if the property level cash flows fail to equal or exceed guaranteed or secured amounts due to us.  Our minimum returns and minimum rents for 91 hotels are secured by a security deposit which we control.  Some of our managers and tenants, or their affiliates, may also supplement cash flow from our properties in order to make payments to us and preserve their rights to continue operating our properties even if they are not required to do so by guarantees. Guarantee payments, security deposit applications or supplemental

 

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