Service Properties Trust - Quarter Report: 2016 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2016

 

OR

 

☐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 ☒  No ☐

 

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 ☒  No ☐

 

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 ☐  No ☒

 

Number of registrant’s common shares of beneficial interest, $.01 par value per share, outstanding as of May  9,  2016:    151,547,288

 

 

 

 

HOSPITALITY PROPERTIES TRUST

 

FORM 10-Q

 

March 31, 2016

 

INDEX

 

References in this Quarterly Report on 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 IFinancial Information

 

Item 1.  Financial Statements

 

HOSPITALITY PROPERTIES TRUST

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(dollars in thousands, except share data)

 

 

 

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

HOSPITALITY PROPERTIES TRUST

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(in thousands, except per share data)

 

 

 

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

 

HOSPITALITY PROPERTIES TRUST

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

 

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

 

 

Note 1.  Basis of Presentation

 

The accompanying condensed consolidated financial statements of Hospitality Properties Trust and its subsidiaries, or HPT, 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, 2015, or our 2015 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 our subsidiaries, all of which are 100% owned directly or indirectly by HPT. All intercompany transactions and balances with or among our consolidated subsidiaries 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 years’ 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 our condensed consolidated financial statements include the allowance for doubtful accounts, purchase price allocations, useful lives of fixed assets, impairment of real estate and the valuation of 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 the VIEs’ economic performance and we have the obligation to absorb losses or the right to receive benefits from each VIE that could be significant to the VIE, and are, therefore, the primary beneficiary of each VIE.  The assets of our TRSs were $32,880 and $26,559 as of March 31, 2016 and December 31, 2015, respectively, and consist primarily of amounts due from, and working capital advances to, certain of their hotel managers.  The liabilities of our TRSs were $69,146 and $68,921 as of March 31, 2016 and December 31, 2015, respectively, and consist primarily of security deposits they hold from and amounts payable to certain of their hotel managers.  The assets of our TRSs are available to satisfy our TRSs’ obligations and we have guaranteed certain obligations of our TRSs.

 

Note 2.  New Accounting Pronouncements

 

On January 1, 2016, we adopted the FASB Accounting Standards Update, or ASU, No. 2015-02, Consolidation. Among other things, this update changed how an entity determines the primary beneficiary of a VIE. The implementation of this update did not have an impact in our condensed consolidated financial statements.

 

On January 1, 2016, we adopted FASB ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs to be presented in the balance sheets as a direct deduction from the associated debt liability, and ASU No. 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements – Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting, which addresses the presentation of debt issuance costs related to line of credit arrangements. The implementation of these updates resulted in the reclassification of certain of our capitalized debt issuance costs as an offset to the associated debt liability in our condensed consolidated balance sheets. The classification of capitalized debt issuance costs related to our unsecured revolving credit facility remains unchanged in accordance with ASU No. 2015-15. As of December 31, 2015, debt issuance costs related to our unsecured term loan and senior unsecured notes of $2,244 and $10,556, respectively, were reclassified from assets to an offset to the associated debt liability in our condensed consolidated balance sheets.

 

On January 1, 2016, we adopted FASB ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, acquirers must recognize measurement-period adjustments during the period in which

they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. The implementation of this update did not have an impact in our condensed consolidated financial statements.

 

In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. This update is effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted subject to certain conditions. Currently, changes in fair value of these investments are recorded through other comprehensive income. Under this update, these changes will be recorded through earnings. We are continuing to evaluate this guidance, but we expect the implementation of this guidance will affect the accounting for changes in the fair value of available for sale equity investments we hold in our condensed consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases, which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). ASU No. 2016-02 requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. ASU No. 2016-02 is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We are currently assessing the potential impact the adoption of ASU No. 2016-02 will have in our condensed consolidated financial statements.

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation, which identifies areas for simplification involving several aspects of accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, an option to recognize gross stock compensation expense with actual forfeitures recognized as they occur, as well as certain classifications on the statement of cash flows. ASU No. 2016-09 is effective for reporting periods beginning after December 15, 2016.  We are currently assessing the potential impact that the adoption of ASU No. 2016-09 will have in our condensed consolidated financial statements.

 

Note 3.  Revenue Recognition

 

We report hotel operating revenues for managed hotels in our condensed consolidated statements of comprehensive income. We generally recognize hotel operating revenues, consisting primarily of room and food and beverage sales, when goods and services are provided.

 

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 scheduled future rent increases.  Rental income includes $3,752 and $545 for the three months ended March 31, 2016 and 2015, respectively, of adjustments necessary to record scheduled rent increases under certain of our leases, the deferred rent obligations under our leases with TravelCenters of America LLC, or TA, and the estimated future payments to us by TA for the cost of removing underground storage tanks on a straight line basis.  See Note 10 for further information regarding our TA leases.  Due from related persons includes $32,766 and $29,122 and other assets, includes $1,949 and $1,841 of straight line rent receivables at March 31, 2016 and December 31, 2015, respectively.

 

We determine percentage rent due to us under our leases annually and recognize it when all contingencies have been met and the rent is earned. We had deferred estimated percentage rent of $260 and $1,240 for the three months ended March 31, 2016 and 2015, respectively. 

 

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

 

Note 4.  Weighted Average Common Shares

 

The following table provides a reconciliation of the weighted average number of common shares used in the calculation of basic and diluted earnings per share:

 

 

   

 

Note 5.  Shareholders’ Equity

 

Distributions

 

On each of January 15, 2016 and April 15, 2016, we paid a $0.4453 per share distribution, or $5,166, to our Series D preferred shareholders.

 

On February 23, 2016, we paid a regular quarterly distribution to common shareholders of record on January 22, 2016 of $0.50 per share, or $75,774. On April 13, 2016, we declared a regular quarterly distribution payable to common shareholders of record on April 25, 2016 of $0.51 per share, or $77,289.  We expect to pay this amount on or about May 19, 2016.

                                                                                                                                                                          

Cumulative Other Comprehensive Income (Loss)

 

Cumulative other comprehensive income (loss) represents the unrealized gain (loss) on our available for sale equity investments and our share of the comprehensive income (loss) of Affiliates Insurance Company, or AIC. See Notes 10 and 12 for further information regarding these investments.

 

Note 6.  Indebtedness

 

Our principal debt obligations at March 31, 2016 were: (1) our $230,000 of outstanding borrowings under our $1,000,000 unsecured revolving credit facility; (2) our $400,000 unsecured term loan; (3) an aggregate outstanding principal amount of $2,900,000 of public issuances of unsecured senior notes; and (4) our public issuance of $8,478 outstanding principal amount of convertible senior notes.

 

Our $1,000,000 unsecured revolving credit facility is available for general business purposes, including acquisitions.  The maturity date of our unsecured revolving credit facility is July 15, 2018 and, subject to the payment of an extension fee and meeting other conditions, we have the option to extend the stated maturity date of our unsecured revolving credit facility by one year to July 15, 2019. We can borrow, repay and reborrow funds available under our unsecured revolving credit facility until maturity, and no principal repayment is due until maturity. We are required to pay interest on borrowings under our unsecured revolving credit facility at an annual rate of LIBOR plus a premium, which was 110 basis points as of March 31, 2016. We also pay a facility fee on the total amount of lending commitments, which was 20 basis

points per annum at March 31, 2016 under our unsecured 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, 2016, the annual interest rate for the amount outstanding under our unsecured revolving credit facility was 1.53%. The weighted average annual interest rate for borrowings under our unsecured revolving credit facility was 1.53% and 1.27% for the three months ended March 31, 2016 and 2015, respectively.  As of March 31, 2016 and May 9, 2016, we had $230,000 and $139,000 outstanding under our unsecured revolving credit facility, respectively.

 

Our $400,000 unsecured term loan, which matures on April 15, 2019, is prepayable without penalty at any time.  We are required to pay interest on the amounts under our unsecured term loan at a rate of LIBOR plus a premium, which was 120 basis points as of March 31, 2016.  The interest rate premium is subject to adjustment based on changes to our credit ratings.  As of March 31, 2016, the annual interest rate for the amount outstanding under our unsecured term loan was 1.64%. The weighted average annual interest rate for borrowings under our unsecured term loan was 1.62% and 1.37% for the three months ended March 31, 2016 and 2015, respectively. 

 

Our credit agreement for our unsecured revolving credit facility and unsecured term loan also includes a feature under which maximum aggregate borrowings may be increased up to $2,300,000 on a combined basis in certain circumstances.  Our credit agreement for our unsecured revolving credit facility and unsecured term loan and our unsecured notes indentures and their supplements provide for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, such as, in the case of our credit agreement, a change of control of us, which includes The RMR Group LLC, or RMR LLC, ceasing to act as our business manager. Our credit agreement for our unsecured revolving credit facility and unsecured term loan and our senior unsecured notes indentures and their supplements also contain a number of covenants, including covenants that restrict our ability to incur debts or 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 credit agreement for our unsecured revolving credit facility and unsecured term loan and our senior unsecured notes indentures and their supplements at March 31, 2016.

 

On February 3, 2016, we issued $750,000 aggregate principal amount of unsecured senior notes in public offerings, which included $400,000 aggregate principal amount of 4.25% unsecured senior notes due 2021 and $350,000 aggregate principal amount 5.25% unsecured senior notes due 2026.  Net proceeds from these offerings were $731,523 after original issue discounts and offering expenses.

On March 11, 2016, we redeemed at par all of our outstanding 6.30% senior notes due 2016 for $275,000 and unpaid interest (an aggregate of $279,139) using cash on hand and borrowings under our unsecured revolving credit facility.  As a result of the redemption, we recorded a loss on early extinguishment of debt of $70 in the three months ended March 31, 2016 which represented the unamortized discounts and issuance costs of these notes.

Note 7.  Real Estate Properties

 

At March 31, 2016, we owned 305 hotels and 194 travel centers which are operated under 14 agreements.

 

During the three months ended March 31, 2016, we funded $33,157 for improvements to certain of our properties which, pursuant to the terms of our management and lease agreements with our hotel managers and tenants, resulted in increases in our contractual annual minimum returns and rents of $2,547.  See Notes 10 and 11 for further information about our management and lease agreements and our fundings of improvements to certain of our properties.

 

During the three months ended March 31, 2016, we acquired three hotels and one travel center.  Our allocation of the purchase price of these acquisitions based on the estimated fair value of the acquired assets is presented in the table below.  The allocations of purchase prices are based on preliminary estimates and may change upon completion of third party appraisals.

 

 

 

 

 

 

 

 

 

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 qualification for taxation as a REIT.  Also, we lease our managed hotels to our wholly owned TRSs that, unlike most of our other subsidiaries, file separate consolidated federal corporate income tax returns and are subject to federal, state and foreign income taxes.  Our consolidated income tax provision (or benefit) included in our condensed consolidated statements of comprehensive income includes the income tax provision (or benefit) related to the operations of our TRSs and certain state and foreign income taxes incurred by us despite our qualification for taxation as a REIT.

 

During the three months ended March 31, 2016, we recognized income tax expense of $375,  which includes $32 of foreign taxes, $53 of federal taxes and $290 of state taxes.  During the three months ended March 31, 2015, we recognized income tax expense of $291, which includes $23 of foreign taxes and $268 of state taxes.

Note 9.  Segment Information

 

We operate in two reportable business segments: hotel investments and travel center investments.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note 10. Related Person Transactions

 

We have relationships and historical and continuing transactions with TA, RMR LLC, Sonesta and others related to them, including other companies to which RMR LLC provides management services and which have trustees, directors and officers who are also our trustees or officers.  For further information about these and other such relationships and certain other related person transactions, please refer to our 2015 Annual Report.

TA:  TA was our 100% owned subsidiary until we distributed its common shares to our shareholders in 2007.  We are TA’s largest shareholder.  As of March 31, 2016, we owned 3,420,000 of TA’s common shares, representing approximately 8.8% of TA’s outstanding common shares.  TA is our largest tenant and property operator, leasing 36% of our gross carrying value of real estate properties as of March 31, 2016.

In June 2015, we entered a transaction agreement with TA pursuant to which, among other things, we agreed to purchase from TA five travel centers upon the completion of their development at a purchase price equal to their development costs, including the cost of the land, and we agreed to leaseback these development properties to TA.  On March 31, 2016, we purchased one of these development properties from TA, a travel center located in Hillsboro, TX, for $19,683, and we amended our TA No. 4 lease to add this property.  The annual minimum rent payable to us under our TA No. 4 lease increased by $1,673 as a result of the completion of this purchase and leaseback. Our purchase and leaseback of the remaining four development properties is subject to a maximum aggregate purchase price of  $95,000 and we are not obligated to purchase any development property that is not substantially complete prior to June 30, 2017.  TA has recently stated that it may not be able to complete development of one these properties prior to June 30, 2017.

As of March 31, 2016, we leased to TA a total of 194 travel centers.    As of March 31, 2016, the number of travel centers leased, the term, the annual minimum rent and the deferred rent balances under each of our TA leases were as follows:

 

We recognized rental income from TA of $68,117 and $56,691 for the three months ended March 31, 2016 and 2015, respectively.  Rental income for the three months ended March 31, 2016 and 2015 includes $3,644 and $415, respectively, of adjustments necessary to record the deferred rent obligations under our TA leases 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, 2016 and December 31, 2015, we had accruals for unpaid amounts owed to us by TA (and straight line rent adjustments) of $55,345 and $40,988, respectively; these amounts are included in due from related persons on our condensed consolidated balance sheets.

We funded $20,575 and $20,181 of qualifying capital improvements for the three months ended March 31, 2016 and 2015, respectively, under our TA leases, and, as a result, TA’s annual minimum rent payable to us increased by approximately $1,749, and $1,715, respectively.

We determine percentage rent due under our TA leases annually and recognize any resulting amount as rental income when all contingencies are met. We had aggregate deferred percentage rent under our TA leases of $250 and $1,240 for the three months ended March 31, 2016 and 2015, respectively, which amounts are net of any waived amounts.  We waived $311 and $259 of percentage rent for the three months ended March 31, 2016 and 2015, respectively. As of March 31, 2016, we have cumulatively waived $2,439 of the  $2,500 of percentage rent we previously agreed to waive.   

RMR LLC:  Pursuant to our business management agreement with RMR LLC, we recognized net business management fees of $13,781 and $18,987 for the three months ended March 31, 2016 and 2015, respectively.  The business management fees for the three months ended March 31, 2016 include estimated 2016 incentive fees of $5,316 based on our common share total return as of March 31, 2016.  The actual amount of incentive fees payable to RMR LLC for 2016, if any, will be based on our common share total return for the three year period ending December 31, 2016, and will be payable in 2017.  The net business management fees we recognized for the three months ended March 31, 2015 included $9,027 of then estimated 2015 incentive fees; in January 2016, we paid RMR LLC an incentive fee of $62,263 for 2015.  The net business management fees we recognized for the 2016 and 2015 periods are included in general and administrative expenses in our condensed consolidated statements of comprehensive income.

In accordance with the terms of our business management agreement, we issued 30,974 of our common shares to RMR LLC for the three months ended March 31, 2015 as payment for a part of the business management fee we recognized for that period.  Beginning June 1, 2015, all management fees under our business management agreement are paid in cash.

Pursuant to our property management agreement with RMR LLC, we recognized property management fees of $14 and $9 for the three months ended March 31, 2016 and 2015, respectively.  These amounts are included in hotel operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

We are generally responsible for all of our operating expenses, including certain expenses incurred by RMR LLC on our behalf. We reimbursed RMR LLC $38 and $33 for property management related expenses related to the office building component of one of our hotels for the three months ended March 31, 2016 and 2015, respectively; these amounts are included in hotel operating expenses in our condensed consolidated statements of comprehensive income.

We have historically awarded share grants to certain RMR LLC employees under our equity compensation plans.  In addition, under our business management agreement we reimburse RMR LLC for our allocable costs for internal audit services.  The amounts recognized as expense for share grants to RMR LLC employees and internal audit costs were $488 and $798 for the three months ended March 31, 2016 and 2015, respectively; these amounts are included in general and administrative expenses in our condensed consolidated statements of comprehensive income.

We lease office space to RMR LLC in the office building component of our property located in Baltimore, MD.  Pursuant to our lease agreement with RMR LLC, we recognized rental income from RMR LLC for leased office space of approximately $9 for each of the three months ended March 31, 2016 and 2015.

RMR Inc.:  In June 2015, we and three other real estate investment trusts, or REITs, to which RMR LLC provides management services, or collectively, the Other REITs, participated in a transaction whereby we and the Other REITs each acquired shares of class A common stock of The RMR Group Inc., or RMR Inc., and simultaneously amended our business and property managements with RMR LLC to, among other things, provide for continuing 20 year terms.  RMR Inc. is the managing member of RMR LLC and RMR LLC is a subsidiary of RMR Inc.  The controlling shareholder of RMR Inc., ABP Trust, is owned by our Managing Trustees.

In connection with our acquisition of shares of class A common stock of RMR Inc., we recorded a liability for the amount by which the estimated fair value of these shares exceeded the price we paid for these shares; this liability is included in accounts payable and other liabilities in our condensed consolidated balance sheets.  We are amortizing this liability ratably through December 31, 2035 as a reduction to our business management fees expense.  For the three months ended March 31, 2016, we amortized $896 of this liability, which is reflected in the net business management fees for the period.  As of March 31, 2016, the unamortized amount of this liability was $70,866.

As of March 31, 2016, we own 2,503,777 shares of class A common stock of RMR Inc.  We receive dividends on these shares as declared and paid by RMR Inc. to all holders of shares of RMR Inc. class A common stock.  We did not receive any dividends on these shares during the three months ended March 31, 2016. However, on April 13, 2016, RMR Inc. declared a dividend of $0.2993 on its shares of class A common stock payable to shareholders of record on April 25, 2016.  RMR Inc. has stated that this dividend represents a regular quarterly dividend of $0.25 per share of class A common stock for the quarter ended March 31, 2016 plus a pro rata dividend of $0.0493 per share of class A common stock for the period from December 14, 2015 to December 31, 2015.  RMR Inc. has stated that it expects to pay this dividend on or about May 19, 2016.

Sonesta:  Sonesta is owned by our Managing Trustees.  As of March 31, 2016, Sonesta managed 33 of our hotels pursuant to management and pooling agreements.

On February 1, 2016, we acquired two extended stay hotels with 262 suites located in Cleveland and Westlake, OH for $12,000, excluding acquisition related costs, and entered into a long term management agreement with Sonesta for each hotel on terms substantially consistent with those of our existing management agreements with Sonesta for extended stay hotels. These management agreements were added to our existing pooling agreement with Sonesta.

Pursuant to our Sonesta agreement, we incurred management, system, reservation fees and reimbursement of certain guest loyalty, marketing program and third party reservation transmission fees from Sonesta of $5,300 and $4,514 for the three months ended March 31, 2016 and 2015, respectively, and procurement and construction supervision fees of $343 and $353 for the three months ended March 31, 2016 and 2015, respectively.  These amounts are included in hotel operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

On January 4, 2016, we and Sonesta amended our pooling agreement and management agreements.  Under the amended pooling agreement, a hotel may be designated as “non-economic” and removed from the pooling agreement and subject to sale and we have an early termination right under each management agreement, in each case if the applicable hotel does not meet certain criteria for the stipulated measurement period.  Pursuant to the amendment, these stipulated measurement periods begin on the later of January 1, 2017 and January 1st of the year beginning at least 18 months following the effective date of the applicable management agreement.  The amendment to the pooling agreement and management agreements with Sonesta were negotiated and recommended by a Special Committee of our Board of Trustees comprised solely of our Independent Trustees, and were approved by our Independent Trustees and also by our Board of Trustees.

AIC:  We and six other companies to which RMR LLC provides management services each own in equal amounts AIC.  We and the other AIC shareholders participate in a combined property insurance program arranged and reinsured in part by AIC.

As of March 31, 2016, our investment in AIC had a carrying value of $6,963; this amount is included in other assets in our condensed consolidated balance sheets.  We recognized income of $77 and $72 related to our investment in AIC for the three months ended March 31, 2016 and 2015, respectively.  Our other comprehensive income includes our proportionate part of unrealized gains on securities which are owned by AIC of $52 and $45 for the three months ended March 31, 2016 and 2015, respectively.

 

For additional information about our agreements with TA and Sonesta, please see Note 11 below.

 

Note 11. Hotel Management Agreements and Leases

 

As of March 31, 2016, 302 of our hotels are leased to our TRSs and managed by independent hotel operating companies and three of our hotels are leased to third parties.

 

Marriott No. 1 agreement. Our management agreement with Marriott International, Inc., or Marriott, for 53 hotels provides that as of March 31, 2016 we are paid an annual minimum return of $68,400 to the extent that gross revenues of the hotels, after payment of hotel operating expenses and funding of the FF&E reserve, are sufficient to do so.  We do not have any security deposits or guarantees for our minimum returns from the 53 hotels included in our Marriott No. 1 agreement.  Accordingly, the minimum returns we receive from these hotels managed by Marriott are limited to available hotel cash flows after payment of operating expenses and funding of the FF&E reserve. Marriott’s base and incentive management fees are only earned after we receive our minimum returns.  We realized minimum returns of $17,093 and $17,006 during the three months ended March 31, 2016 and 2015, respectively, under this agreement. We also realized additional returns of $839 during the three months ended March 31, 2016, which represents our share of hotel cash flows in excess of the minimum returns due to us for the period.  We did not realize any additional returns during the three months ended March 31, 2015.

 

We funded $441 for capital improvements at certain of the hotels included in our Marriott No. 1 agreement during the three months ended March 31, 2016. We currently expect to fund $2,559 for capital improvements during the remainder of 2016 under this agreement. As we fund these improvements, the annual minimum returns payable to us increase by 10% of the amounts funded.

 

Marriott No. 234 agreement.  Our management agreement with Marriott for 68 hotels provides that as of March 31, 2016 we are paid an annual minimum return of $106,243.  We realized minimum returns of $26,560 and $25,006 during the three months ended March 31, 2016 and 2015, respectively, under this agreement.  Pursuant to our Marriott No. 234 agreement, Marriott has provided us with a security deposit to cover minimum return payment shortfalls, if any.  Under this agreement, this security deposit may be replenished and increased up to $64,700 from the hotel cash flows in excess of the minimum returns due to us and certain management fees. Marriott’s base and incentive management fees are only earned after we receive our minimum returns. During the three months ended March 31, 2016, our available security deposit was replenished by $772 from the hotel cash flows in excess of the minimum returns due to us for the period.  The available balance of this deposit was $7,024 as of March 31, 2016.  Pursuant to our Marriott No. 234 agreement, Marriott has also

provided us with a limited guarantee which expires in 2019 for shortfalls up to 90% of our minimum returns, if and after the available security deposit has been depleted. The available balance of the guarantee was $30,672 as of March 31, 2016. 

 

We currently expect to fund $8,000 for capital improvements to certain hotels under our Marriott No. 234 agreement during the remainder of 2016.  We did not make any funding for capital improvements to these hotels during the three months ended March 31, 2016. As we fund these improvements, the annual minimum returns payable to us increase by 9% of the amounts funded.

 

Marriott No. 5 agreement. We lease one hotel in Kauai, HI to Marriott.  This lease is guaranteed by Marriott and we realized $2,529 of rent for this hotel during each of the three months ended March 31, 2016 and 2015.  The guarantee provided by Marriott with respect to this leased hotel is unlimited.

 

InterContinental agreement. Our management agreement with InterContinental for 94 hotels provides that as of March 31, 2016, we are paid annual minimum returns and rents of $160,338.  We realized minimum returns and rents of $38,203 and $35,314 during the three months ended March 31, 2016 and 2015, respectively, under this agreement.  We also realized additional returns of $329 under this agreement during the three months ended March 31, 2016 from the hotel cash flows in excess of our minimum returns and rents due for the period.  We did not realize any additional returns during the three months ended March 31, 2015.

 

Pursuant to our InterContinental agreement, InterContinental has provided us with a security deposit to cover minimum payment shortfalls, if any.  Under this agreement, InterContinental is required to maintain a minimum security deposit of $37,000 and this security deposit may be replenished and increased up to $100,000 from future cash flows from the hotels, in excess of our minimum returns and certain management fees.

 

On March 16, 2016, we amended our management agreement with InterContinental in connection with our acquisition of the Kimpton Hotel Monaco located in Portland, OR. See Note 7 for further information regarding this acquisition. As a result of the amendment, the annual minimum returns due to us increased by an aggregate of 8% of our investment in the hotel ($9,120) and InterContinental provided us $9,000 to supplement the existing security deposit.

 

During the three months ended March 31, 2016, the available security deposit was replenished by $480 from the hotels’ cash flows in excess of the minimum payments due to us for the period.  The available balance of this security deposit was $56,696 as of March 31, 2016.

 

We did not make any fundings for capital improvements to our InterContinental hotels during the three months ended March 31, 2016.  We currently expect to fund $17,800 for capital improvements to certain hotels under our InterContinental agreement during the remainder of 2016.  As we fund these improvements, the annual minimum returns and rents payable to us increase by 8% of the amounts funded.

 

Sonesta agreement. Our Sonesta agreement provides that we are paid an annual minimum return ($84,004 as of March 31, 2016) equal to 8% of our invested capital, as defined in the agreement, to the extent that gross revenues of the hotels, after payment of hotel operating expenses, including certain management fees to Sonesta, are sufficient to do so.  We do not have any security deposits or guarantees for our hotels managed by Sonesta.  Accordingly, the returns we currently receive from hotels managed by Sonesta are limited to available hotel cash flows after payment of operating expenses. Sonesta’s incentive management fees, but not its other fees, are only earned after we receive our minimum returns. We realized returns of $8,766 and $8,061 during the three months ended March 31, 2016 and 2015, respectively, under this agreement.

 

Our Sonesta agreement does not require FF&E escrow deposits.  Under our Sonesta agreement, we are required to fund capital expenditures made at our hotels.  We funded $11,393 for renovations and other capital improvements to hotels included in our Sonesta agreement during the three months ended March 31, 2016.  We currently expect to fund $36,607 for renovations and other capital improvements during the remainder of 2016 under this agreement.  The annual minimum

returns due to us under the Sonesta agreement increase by 8% of the amounts funded in excess of threshold amounts, as defined therein. See Note 10 for further information regarding our relationship with Sonesta.

 

Wyndham agreements. Our management agreement with Wyndham Hotel Group, or Wyndham, for 22 hotels provides that as of March 31, 2016, we are paid annual minimum returns of $26,659.  Pursuant to our Wyndham agreement, Wyndham has provided us with a guarantee, which is limited to $35,656, subject to an annual payment limit of $17,828 and expires on July 28, 2020. As of December 31, 2015, $4,008 remained available to cover payment shortfalls of our minimum returns due under the management agreement.  During the three months ended March 31, 2016, the hotels under this agreement generated cash flows that were less than the minimum returns due to us and the remaining guaranty was depleted. This guaranty may be replenished from future cash flows from these hotels in excess of our minimum returns. We currently expect that for the year ended December 31, 2016, the hotels under this agreement will generate cash flows in excess of the minimum returns due to us under the management agreement. We also lease 48 vacation units in one of our hotels to Wyndham Vacation Resorts, Inc., a subsidiary of Wyndham, or Wyndham Vacation, which requires we are paid annual minimum rents of $1,366.  The guarantee provided by Wyndham with respect to the lease with Wyndham Vacation for part of one hotel is unlimited.  We realized returns and rents of $6,995 and $6,863 during the three months ended March 31, 2016 and 2015, respectively, under our Wyndham agreements. As of May 9, 2016, Wyndham has paid all of the minimum returns and rents due to us.

 

Under our Wyndham agreement, the FF&E reserve funding required for all hotels included in the agreement is subject to available cash flow after payment of our minimum return.  The reserve amount is 4% of total hotel sales in 2016 and increases to 5% of total hotel sales in 2017 through the end of the agreement term in 2038.  No FF&E escrow deposits were required during the three months ended March 31, 2016.

 

We funded $618 for capital improvements to certain hotels included in our Wyndham agreement during the three months ended March 31, 2016.  We currently expect to fund $3,982 for capital improvements to certain hotels during the remainder of 2016 under this agreement.  As we fund these improvements, the annual minimum returns payable to us increase by 8% of the amounts funded.

 

TA agreements.    Our 194 owned travel centers are leased to and operated by a subsidiary of TA under five agreements.  Our TA Nos. 1 and 4 leases for 39 travel centers expire in 2029 and 2030, respectively, and each have two 15 year renewal options.  Our TA Nos. 2 and 3 leases for 38 travel centers expire in 2028 and 2026, respectively, and each have two 15 year renewal options. Our TA No. 5 lease for 40 travel centers expires in 2024 and has  two 15 year renewal options. TA has guaranteed its subsidiary tenants’ obligations under these leases. Our travel center leases with TA do not require FF&E escrow deposits. However, TA is required to maintain the leased travel centers, including structural and non‑structural components. Under all of our TA leases, TA may request that we fund additional amounts for capital improvements to the leased facilities in return for minimum rent increases. We funded $20,575 for capital improvements to our travel center properties during the three months ended March 31, 2016. We currently expect to fund approximately $129,425 for renovations and other capital improvements during the remainder of 2016. As we fund these improvements, the annual minimum returns payable to us increase by 8.5% of the amounts funded. See Note 10 for information about our TA leases.  TA is not obligated to request and we are not obligated to fund any such improvements.

Other management agreement and lease matters. As of May 9, 2016, 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 these other hotel management agreements and leases are supported by guarantees.  The guarantee provided by Hyatt Hotels Corporation, or Hyatt, with respect to the 22 hotels managed by Hyatt is limited to $50,000  ($15,501 remaining at March 31, 2016).  The guarantee provided by Carlson Hotels Worldwide, or Carlson, with respect to the 11 hotels managed by Carlson is limited to $40,000 ($25,180 remaining at March 31, 2016).

 

Guarantees and security deposits generally. When we reduce the amounts of the security deposits we hold for payment deficiencies at our managed and leased hotels, we record income equal to the amounts by which this deposit is 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 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 these agreements, 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 agreements.

Certain of our managed hotel portfolios had net operating results that were, in the aggregate $16,429 and $15,492 less than the minimum returns due to us for the three months ended March 31, 2016 and 2015, respectively.  When the managers of these hotels fund these 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 comprehensive income as a reduction of hotel operating expenses. The reduction to hotel operating expenses was $4,377 and $4,006 in the three months ended March 31, 2016 and 2015, respectively, as a result of such fundings. We had shortfalls at certain of our managed hotel portfolios not funded by the managers of these hotels under the terms of our operating agreements of $12,052 and $11,486 in the three months ended March 31, 2016 and 2015, respectively, which represent the unguaranteed portions of our minimum returns from Sonesta.  

Certain of our managed hotel portfolios had net operating results that were in the aggregate $8,363 and $6,568 more than the minimum returns due to us in the three months ended March 31, 2016 and 2015, respectively. Certain of our guarantees and our security deposits may be replenished by future cash flows from the applicable hotel operations in excess of the minimum returns due to us pursuant to the terms of the respective agreements.  When our guarantees and our security deposits are replenished by cash flows from hotel operations, we reflect such replenishments in our condensed consolidated statements of comprehensive income as an increase to hotel operating expenses.  Hotel operating expenses were increased by $2,522 and $3,351 in the three months ended March 31, 2016 and 2015, respectively, as a result of such replenishments.

 

Note 12.  Fair Value of Assets and Liabilities

 

The table below presents certain of our assets carried at fair value at March 31, 2016, categorized by the level of inputs, as defined in the fair value hierarchy under GAAP, used in the valuation of each asset.

 

 

 

In addition to the investment securities included in the table above, our financial instruments include our cash and cash equivalents, restricted cash, rents receivable, unsecured revolving credit facility, unsecured term loan, senior unsecured notes

and security deposits. At March 31, 2016 and December 31, 2015, the fair values of these additional financial instruments approximated their carrying values in our condensed consolidated balance sheets due to their short term nature or variable interest rates, except as follows:

 

 

 

 

At March 31, 2016, we estimated the fair values of our senior unsecured notes using an average of the bid and ask price of our then outstanding issuances of senior unsecured notes (Level 2 inputs).  We estimated the fair value of our convertible senior unsecured notes using discounted cash flow analyses and currently prevailing market interest rates (Level 3 inputs) because no market quotes or other observable inputs for these notes were available at March 31, 2016 and December 31, 2015.

 

 

 

 

 

 

 

 

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 Part I, Item 1 of this Quarterly Report on Form 10-Q and with our 2015 Annual Report. We are a REIT organized under Maryland law.

 

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

 

Hotel operations. During the three months ended March 31, 2016, the U.S. hotel industry generally realized improvements in average daily rate, or ADR, and revenue per available room, or RevPAR, and a decline in occupancy, when compared to the same period in 2015.  Our comparable hotels that we owned continuously since January 1, 2015 have produced year over year increases in RevPAR in excess of the hotel industry generally that we believe are a result of recent renovations we made to our hotels.  However, we believe that certain of our hotels acquired since January 1, 2015 were negatively impacted by brand conversions and by the disruption and displacement caused by our renovation activities at those hotels during 2015 and the three months ended March 31, 2016.  

 

For the three months ended March 31, 2016 compared to the same period in 2015 for our 291 comparable hotels: ADR increased 4.0% to $124.79; occupancy increased 0.3 percentage points to 72.2%; and RevPAR increased 4.4% to $90.10.

 

During the three months ended March 31, 2016, we had two comparable hotels that we owned continuously since January 1, 2015 under renovation for all or part of the period.  For the three months ended March 31, 2016 compared to the same period in 2015 for these two hotels under renovation: ADR increased 6.0% to $96.42; occupancy decreased 20.1 percentage points to 55.4%; and RevPAR decreased 22.2% to $53.42.

 

For the three months ended March 31, 2016 compared to the same period in 2015 for our 289 comparable hotels that we owned continuously since January 1, 2015 not under renovation: ADR increased 3.9% to $124.92; occupancy increased 0.4 percentage points to 72.3%; and RevPAR increased 4.5% to $90.32.

 

Our hotel managers and tenants.  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 agreements regardless of hotel performance. However, the effectiveness of various security features to provide us uninterrupted receipt of minimum returns and rents is not assured, especially if economic conditions generally decline for a prolonged period or if our hotel renovation activities described above do not result in improved operating results. Also, 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 returns. 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 repay our debt or fund our debt service obligations or pay distributions to our shareholders or the amounts of our distributions may decline.

 

Additional details of our hotel operating agreements are set forth in Note 11 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.

 

TA agreements.  Details of our agreements with TA are set forth in Notes 10 and 11 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.

 

Management Agreements and Leases

 

At March 31, 2016, we owned 305 hotels operated under nine agreements; 302 of these hotels are leased by us to our wholly owned TRSs and managed by hotel operating companies and three are leased to hotel operating companies.  At March 31, 2016, our 194 owned travel centers are leased to TA under five agreements. Our condensed consolidated statements of comprehensive income include operating revenues and expenses of our managed hotels and rental income from our leased hotels and travel centers.  Additional information regarding the terms of our management agreements and leases is included in Note 11 to our condensed consolidated financial statements in Part I, Item 1 above and in the table and notes thereto on pages 28 through 30 below.

 

 

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

 

Three Months Ended March 31, 2016 Compared to the Three Months Ended March 31, 2015

 

 

 

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, 2016 compared to the three months ended March 31, 2015.

 

The increase in hotel operating revenues is a result of increased revenues at certain of our managed hotels due to increases in ADR and higher occupancies ($21,451) and the effects of our hotel acquisitions since January 1, 2015 ($9,559).  These increases were partially offset by the effect of decreased revenues at certain of our managed hotels as a result of lower occupancies compared to the 2015 period ($3,737) and decreased revenues at certain hotels undergoing renovations during all or part of the 2015 period primarily due to lower occupancies ($366).  Additional operating statistics of our hotels are included in the table on page 31.

 

The increase in rental income  - hotels is primarily a result of contractual rent increases under certain of our hotel leases and increases in the minimum rents due to us as we funded improvements at certain of our leased hotels since January 1, 2015.  Rental income - hotels for each of the 2016 and 2015 periods includes $108 and $130, respectively, of adjustments to record rent on a straight line basis.