10-Q 1 a12-19982_110q.htm 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 September 30, 2012

 

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)

 

Maryland

 

04-3262075

(State or Other Jurisdiction of

Incorporation or Organization)

 

(IRS Employer Identification No.)

 

Two Newton Place, 255 Washington Street, Suite 300, Newton, Massachusetts

02458

(Address of Principal Executive Offices)

(Zip Code)

 

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.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

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 November 6, 2012: 123,637,424

 

 

 



 

HOSPITALITY PROPERTIES TRUST

 

FORM 10-Q

 

September 30, 2012

 

INDEX

 

 

 

 

Page

PART I

Financial Information (unaudited)

 

 

 

 

 

 

 

Item 1. Financial Statements (unaudited)

 

 

 

Condensed Consolidated Balance Sheets — September 30, 2012 and December 31, 2011

 

1

 

 

 

 

 

Condensed Consolidated Statements of Income and Comprehensive Income — Three and Nine Months Ended September 30, 2012 and 2011

 

2

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2012 and 2011

 

3

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

4

 

 

 

 

 

Item 2.

 

 

 

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

 

21

 

 

 

 

 

Item 3.

 

 

 

Quantitative and Qualitative Disclosures About Market Risk

 

43

 

 

 

 

 

Item 4.

 

 

 

Controls and Procedures

 

44

 

 

 

 

 

Warning Concerning Forward Looking Statements

 

45

 

 

 

 

 

Statement Concerning Limited Liability

 

48

 

 

 

 

PART II

Other Information

 

 

 

 

 

 

 

Item 1A.

 

 

 

Risk Factors

 

49

 

 

 

 

 

Item 2.

 

 

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

50

 

 

 

 

 

Item 6.

 

 

 

Exhibits

 

51

 

 

 

 

 

Signatures

 

53

 

References in this Form 10-Q to “HPT”, “we”, “us” or “our” include Hospitality Properties Trust and its consolidated subsidiaries unless otherwise noted 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)

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Real estate properties, at cost:

 

 

 

 

 

Land

 

$

1,412,945

 

$

1,360,773

 

Buildings, improvements and equipment

 

5,184,527

 

4,879,908

 

 

 

6,597,472

 

6,240,681

 

Accumulated depreciation

 

(1,501,592

)

(1,367,868

)

 

 

5,095,880

 

4,872,813

 

Property held for sale

 

 

18,440

 

Cash and cash equivalents

 

17,124

 

8,303

 

Restricted cash (FF&E reserve escrow)

 

38,919

 

50,196

 

Other assets, net

 

221,009

 

183,821

 

 

 

$

5,372,932

 

$

5,133,573

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Unsecured revolving credit facility

 

$

 

$

149,000

 

Unsecured term loan

 

400,000

 

 

Senior notes, net of discounts

 

1,993,387

 

1,887,891

 

Convertible senior notes, net of discount

 

8,478

 

78,823

 

Security deposits

 

88,952

 

106,422

 

Accounts payable and other liabilities

 

88,100

 

103,668

 

Due to related persons

 

12,354

 

3,713

 

Dividends payable

 

6,664

 

4,754

 

Total liabilities

 

2,597,935

 

2,334,271

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred shares of beneficial interest, no par value, 100,000,000 shares authorized:

 

 

 

 

 

Series B preferred shares; 8 7/8% cumulative redeemable; zero and 3,450,000 shares issued and outstanding, respectively, aggregate liquidation preference zero and $86,250, respectively

 

 

83,306

 

Series C preferred shares; 7% cumulative redeemable; 6,700,000 and 12,700,000 shares issued and outstanding, respectively, aggregate liquidation preference $167,500 and $317,500, respectively

 

161,873

 

306,833

 

Series D preferred shares; 7 1/8% cumulative redeemable; 11,600,000 and zero shares issued and outstanding, respectively, aggregate liquidation preference $290,000 and zero, respectively

 

280,107

 

 

Common shares of beneficial interest, $.01 par value; 200,000,000 shares authorized; 123,637,424 and 123,521,535 shares issued and outstanding, respectively

 

1,236

 

1,235

 

Additional paid in capital

 

3,466,066

 

3,463,534

 

Cumulative net income

 

2,350,261

 

2,232,953

 

Cumulative other comprehensive income

 

4,455

 

1,605

 

Cumulative preferred distributions

 

(245,329

)

(213,281

)

Cumulative common distributions

 

(3,243,672

)

(3,076,883

)

Total shareholders’ equity

 

2,774,997

 

2,799,302

 

 

 

$

5,372,932

 

$

5,133,573

 

 

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

 

1



 

HOSPITALITY PROPERTIES TRUST

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

(in thousands, except per share data)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenues:

 

 

 

 

 

 

 

 

 

Hotel operating revenues

 

$

251,722

 

$

242,995

 

$

741,775

 

$

670,867

 

Rental income

 

73,915

 

72,305

 

220,863

 

230,078

 

FF&E reserve income

 

4,431

 

3,389

 

12,033

 

13,537

 

Total revenues

 

330,068

 

318,689

 

974,671

 

914,482

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

184,566

 

168,278

 

527,806

 

450,845

 

Depreciation and amortization

 

66,566

 

57,106

 

192,206

 

171,050

 

General and administrative

 

10,336

 

11,292

 

32,333

 

30,746

 

Acquisition related costs

 

84

 

387

 

1,648

 

1,150

 

Loss on asset impairment

 

 

 

889

 

7,263

 

Total expenses

 

261,552

 

237,063

 

754,882

 

661,054

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

68,516

 

81,626

 

219,789

 

253,428

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

116

 

11

 

233

 

54

 

Interest expense (including amortization of deferred financing costs and debt discounts of $1,694, $1,614, $4,648 and $4,623, respectively)

 

(34,854

)

(33,513

)

(101,660

)

(100,183

)

Gain on sale of real estate

 

10,602

 

 

10,602

 

 

Equity in earnings of an investee

 

115

 

28

 

236

 

111

 

Income before income taxes

 

44,495

 

48,152

 

129,200

 

153,410

 

Income tax benefit (expense)

 

163

 

(621

)

(3,908

)

(1,188

)

 

 

 

 

 

 

 

 

 

 

Net income

 

44,658

 

47,531

 

125,292

 

152,222

 

Excess of liquidation preference over carrying value of preferred shares redeemed

 

(5,040

)

 

(7,984

)

 

Preferred distributions

 

(10,138

)

(7,470

)

(32,048

)

(22,410

)

 

 

 

 

 

 

 

 

 

 

Net income available for common shareholders

 

$

29,480

 

$

40,061

 

$

85,260

 

$

129,812

 

Net income

 

$

44,658

 

$

47,531

 

$

125,292

 

$

152,222

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on TravelCenters of America common shares

 

737

 

(4,877

)

2,820

 

(2,530

)

Equity interest in investee’s unrealized gains

 

35

 

15

 

31

 

58

 

Other comprehensive income (loss)

 

772

 

(4,862

)

2,851

 

(2,472

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

45,430

 

$

42,669

 

$

128,143

 

$

149,750

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

123,577

 

123,465

 

123,553

 

123,453

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Net income available for common shareholders

 

$

0.24

 

$

0.32

 

$

0.69

 

$

1.05

 

 

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

 

2



 

HOSPITALITY PROPERTIES TRUST

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

 

 

For the Nine Months Ended September 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

125,292

 

$

152,222

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

192,206

 

171,050

 

Amortization of deferred financing costs and debt discounts as interest

 

4,648

 

4,623

 

Straight line rental income

 

(243

)

(3,684

)

Security deposits applied to payment shortfalls

 

(17,493

)

(27,814

)

FF&E reserve income and deposits

 

(16,631

)

(39,592

)

Loss on asset impairment

 

889

 

7,263

 

Equity in earnings of an investee

 

(236

)

(111

)

Gain on sale of real estate

 

(10,602

)

 

Other non-cash (income) expense, net

 

(482

)

134

 

Changes in assets and liabilities:

 

 

 

 

 

Increase in other assets

 

(5,679

)

(3,546

)

Decrease in accounts payable and other liabilities

 

(15,354

)

(20,413

)

Increase in due to related persons

 

8,347

 

8,596

 

Cash provided by operating activities

 

264,662

 

248,728

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Real estate acquisitions

 

(150,500

)

 

Real estate improvements

 

(195,089

)

(45,614

)

FF&E reserve fundings

 

(67,652

)

(11,425

)

Net proceeds from sale of real estate

 

34,204

 

6,905

 

Investment in TravelCenters of America common shares

 

 

(5,690

)

Increase in security deposits

 

 

37,000

 

Cash used in investing activities

 

(379,037

)

(18,824

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of preferred shares, net

 

280,107

 

 

Proceeds from unsecured term loan

 

400,000

 

 

Proceeds from issuance of senior notes, net of discount

 

491,975

 

 

Redemption of preferred shares

 

(236,250

)

 

Repayment of senior notes

 

(387,829

)

 

Repurchase of convertible senior notes

 

(70,576

)

 

Repayment of mortgage note

 

 

(3,383

)

Borrowings under revolving credit facility

 

378,000

 

200,000

 

Repayments of revolving credit facility

 

(527,000

)

(229,000

)

Deferred financing costs

 

(6,394

)

(6,852

)

Distributions to preferred shareholders

 

(32,048

)

(22,410

)

Distributions to common shareholders

 

(166,789

)

(166,654

)

Cash provided by (used in) financing activities

 

123,196

 

(228,299

)

Increase in cash and cash equivalents

 

8,821

 

1,605

 

Cash and cash equivalents at beginning of period

 

8,303

 

4,882

 

Cash and cash equivalents at end of period

 

$

17,124

 

$

6,487

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

120,153

 

$

117,958

 

Cash paid for income taxes

 

1,535

 

1,354

 

Non-cash investing activities:

 

 

 

 

 

Property managers’ deposits in FF&E reserve

 

$

17,452

 

$

42,497

 

Property managers’ purchases with FF&E reserve

 

(101,381

)

(92,795

)

Non-cash financing activities:

 

 

 

 

 

Issuance of common shares

 

$

2,533

 

$

1,366

 

 

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

 

3



 

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 HPT, 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, 2011, as amended, or our 2011 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.

 

Note 2.  New Accounting Pronouncements

 

In January 2012, we adopted FASB Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRS.  This update clarified the application of existing fair value measurement requirements.  This update also required reporting entities to disclose additional information regarding fair value measurements categorized within Level 3 of the fair value hierarchy.  This update was effective for interim and annual reporting periods beginning after December 15, 2011.  The implementation of this update did not cause any material changes to the disclosures in, or presentation of, our condensed consolidated financial statements.

 

In January 2012, we adopted FASB Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income.  This update eliminates the prior option to report other comprehensive income and its components in the statement of shareholders’ equity.  This update is intended to enhance comparability between entities that report under GAAP and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity.  The update was effective for interim and annual reporting periods beginning after December 15, 2011.  The implementation of this update did not cause any changes to our condensed consolidated financial statements other than the presentation of the condensed consolidated statements of comprehensive income.

 

In July 2012, the FASB issued 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 is not expected to cause any changes to our condensed consolidated financial statements.

 

4



 

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 and nine months ended September 30, 2012 and 2011.

 

We recognize rental income from operating leases on a straight line basis over the term of the lease agreements.  Rental income includes ($52) and $243 for the three and nine months ended September 30, 2012, respectively, of adjustments necessary to record rent on the straight line basis and $1,193 and $3,610 for the three and nine months ended September 30, 2011, 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 $919 and $3,481 for the three and nine months ended September 30, 2012, respectively, and $481 and $1,417 for the three and nine months ended September 30, 2011, 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 September 30, 2012 or 2011.

 

Note 5.  Shareholders’ Equity

 

Preferred Shares

 

In January 2012, we sold 11,600,000 7.125 % Series D cumulative redeemable preferred shares at a price of $25.00 per share in a public offering for net proceeds of $280,108 (after underwriting and other offering expenses).  Each of our Series D preferred shares has a distribution rate of $1.78125 per annum, payable in equal quarterly amounts, and a liquidation preference of $25.00 per share ($290,000 in aggregate). The Series D preferred shares are redeemable for $25.00 per share each plus accrued and unpaid distributions at our option at any time on or after January 15, 2017, or at the option of the holders of the Series D preferred shares if a change of control occurs which results in our common shares (or the common securities of an acquiring or surviving entity) not being listed or quoted on the New York Stock Exchange, or NYSE, or certain other exchanges or quotation systems.  Also, upon the occurrence of such a change of control, holders of Series D preferred shares that are not redeemed may at their option convert those Series D preferred shares into our common shares (or certain alternative consideration) at a conversion rate generally based on their $25.00 liquidation preference and the market price of our common shares at the time of conversion, subject to a cap.

 

In February 2012, we redeemed our 3,450,000 outstanding 8.875% Series B cumulative redeemable preferred shares at the stated liquidation preference price of $25.00 per share plus accrued and unpaid distributions to the date of redemption. We reduced net income available for common shareholders by $2,944, which represented the amount by which the liquidation preference for our Series B cumulative redeemable preferred shares that we redeemed exceeded our carrying amount for those preferred shares as of the date of redemption.

 

In September 2012, we redeemed 6,000,000 of our 12,700,000 outstanding 7.00% Series C cumulative redeemable preferred shares at the stated liquidation preference of $25.00 per share plus accrued and unpaid distributions to the date of redemption.  We reduced net income available for common shareholders by $5,040, which represented the amount by

 

5



 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

which the liquidation preference for our Series C cumulative redeemable preferred shares that we redeemed exceeded our carrying amount for those preferred shares as of the date of redemption.

 

Distributions

 

On January 17, 2012, we paid a $0.5546875 per share distribution to our Series B preferred shareholders with respect to the period ended January 14, 2012.

 

On each of February 15, 2012, May 15, 2012 and August 15, 2012, we paid a $0.4375 per share distribution to our Series C preferred shareholders with respect to the periods ended February 14, 2012, May 14, 2012 and August 14, 2012, respectively.  On October 1, 2012, we declared a $0.4375 per share distribution to our Series C preferred shareholders of record on October 31, 2012, with respect to the period ending November 14, 2012. We expect to pay this amount on or about November 15, 2012.

 

On April 16, 2012, July 16, 2012 and October 15, 2012, we paid a $0.43046875, $0.4453125 and $0.4453125 per share distribution to our Series D preferred shareholders with respect to the periods ended April 14, 2012, July 14, 2012 and October 14, 2012, respectively.

 

On each of February 23, 2012, May 24, 2012 and August 22, 2012, we paid a $0.45 per share distribution to our common shareholders.  On October 9, 2012, we declared a $0.47 per share regular quarterly distribution to our common shareholders of record on October 22, 2012.  We expect to pay this amount on or about November 21, 2012.

 

Common Share Issuances

 

As further described in Note 11, under the terms of our business management agreement with Reit Management & Research LLC, or RMR, on March 29, 2012 we issued 33,132 of our common shares of beneficial interest, $.01 par value per share, or our common shares, to RMR in payment of an incentive fee of approximately $741 for services rendered to us by RMR during 2011.

 

On May 9, 2012, pursuant to our equity compensation plan, we granted 2,000 of our common shares, valued at $25.58 per share, the closing price of our common shares on the NYSE on that day, to each of our five Trustees as part of their annual compensation.

 

On September 14, 2012, pursuant to our equity compensation plan, we granted an aggregate of 74,017 of our common shares, valued at $25.02 per share, the closing price of our common shares on the NYSE on that day, to our officers and certain employees of RMR.

 

Other Comprehensive Income (Loss)

 

Other comprehensive income (loss) represents the unrealized gain (loss) 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 acquisitions, working capital and general business purposes.  Our revolving credit facility matures on September 7, 2015, and subject to our payment of an extension fee and meeting certain other conditions, we may extend the maturity date for 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 LIBOR plus a spread 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 spread and the facility fee are subject to adjustment based upon changes to our credit ratings.  We had no amounts outstanding during the three months ended September 30,

 

6



 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

2012 and the weighted average interest rate for borrowings under our revolving credit facility was 1.58% for the nine months ended September 30, 2012.  As of September 30, 2012, we had no amounts outstanding and $750,000 available under our revolving credit facility.

 

On March 12, 2012, we entered into a five year $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.  The amount outstanding under our term loan bears interest at LIBOR plus a spread of 145 basis points that is subject to adjustment based upon changes to our credit ratings.  The weighted average interest rate for borrowings under our term loan was 1.70% for the three months ended September 30, 2012 and for the period from March 12, 2012 to September 30, 2012.

 

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 September 30, 2012.

 

On March 20, 2012, we repurchased at par plus accrued and unpaid interest $70,576 of our 3.8% convertible senior notes due 2027 which were tendered by the holders of these notes for repurchase by us.

 

We separately account for the liability (debt) and equity (conversion option) components of our 3.8% convertible senior notes due 2027 to reflect the fair value of the liability component based on our non-convertible borrowing cost at the issuance date. We measured the fair value of the debt components of the notes at issuance based on an estimated effective interest rate of 6.06% and amortized the resulting discount as an increase to interest expense over the expected life of the debt (assuming holders of the notes exercised in full their options to require us to repay the notes on March 20, 2012).

 

·                  The net carrying amount of our 3.8% convertible senior notes due 2027 was $8,478 and $78,823 as of September 30, 2012 and December 31, 2011, respectively.

·                  The unamortized discount on such notes was $0 and $231 as of September 30, 2012 and December 31, 2011, respectively. We amortized the discount through March 20, 2012, the first date on which the holders of our 3.8% convertible senior notes could require that we redeem them.

·                  Interest expense with respect to our 3.8% convertible senior notes for the three months ended September 30, 2012 and 2011 includes non-cash amortization of $0 and $404, respectively.  Interest expense for the nine months ended September 30, 2012 and 2011 includes non-cash amortization of $270 and $1,194, respectively.

·                  The amount allocated as the equity component of the 3.8% convertible senior notes was $37,710 as of September 30, 2012 and December 31, 2011 and is included in additional paid in capital in our Condensed Consolidated Balance Sheets.

 

On April 11, 2012, we redeemed at par all of our outstanding 6.85% senior notes due 2012 for $100,829 plus accrued and unpaid interest.

 

On August 16, 2012, we issued $500,000 of 5.00% senior notes due 2022 in a public offering for net proceeds of $487,946 (after underwriting and other offering expenses).

 

On September 10, 2012, we redeemed at par all of our outstanding 6.75% senior notes due 2013 for $287,000 plus accrued and unpaid interest.

 

Note 7.  Real Estate Properties

 

At September 30, 2012, we owned 471 properties consisting of 286 hotels and 185 travel centers that were operated under ten management agreements or leases and leased one hotel, which is operated under a separate management agreement.

 

7



 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

During the nine months ended September 30, 2012, we funded $262,471 of improvements to certain of our properties, which pursuant to the terms of our management agreements and leases with our hotel managers and tenants, resulted in a $20,376 increase in our annual minimum returns and rents.

 

On January 31, 2012, we completed an acquisition of the entities which own the Royal Sonesta Hotel Boston in Cambridge, MA, or the Cambridge Hotel, (400 rooms) and lease the Royal Sonesta Hotel New Orleans in New Orleans, LA, or the New Orleans Hotel, (483 rooms) for total cash consideration of $150,500, excluding related acquisition costs of $3,261.  We have included the results of these hotels in our condensed consolidated financial statements from the date of acquisition.  The pro forma impact of including the results of operations of the hotels from the beginning of the period is not material to our condensed consolidated financial statements.  The following table summarizes our allocation of the acquisition cost to estimated fair value of the assets we acquired and the liabilities we assumed:

 

Land

 

$

32,436

 

Building

 

78,764

 

Furniture, fixtures and equipment

 

19,536

 

Intangible assets (including the leasehold value of the New Orleans Hotel)

 

22,326

 

Goodwill

 

7,658

 

Other, net

 

(2,562

)

Deferred tax liability

 

(7,658

)

Total

 

$

150,500

 

 

Simultaneous with this acquisition, we entered into management agreements with Sonesta International Hotels Corporation (formerly known as Sonesta Acquisition Corp.), or Sonesta.  See Notes 11 and 12 for further information about these transactions.

 

On July 12, 2012, we sold our Marriott International, Inc. or Marriott, branded hotel in St. Louis, MO for net proceeds of $28,850.  We recorded a gain on sale of $10,210 in the third quarter of 2012.

 

On August 24, 2012, we sold our Staybridge Suites branded hotel in Schaumburg, IL for net proceeds of $1,872.  We recorded a gain on sale of $329 in the third quarter of 2012.

 

On August 29, 2012, we sold our Staybridge Suites branded hotel in Auburn Hills, MI for net proceeds of $3,482.  We recorded a gain on sale of $63 in the third quarter of 2012.

 

On November 1, 2012, we acquired a full service hotel in Chicago, IL, or the Chicago hotel, for $85,000, excluding closing costs.  See Note 12 for further information about this transaction.

 

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 (or benefit) 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 REIT status.

 

During the three and nine months ended September 30, 2012, we recognized a current income tax benefit (expense) of $276 and ($4,550), respectively, which includes $410 and ($1,921), respectively, of federal taxes, ($26) and ($78), respectively, of foreign taxes and ($108) and ($2,551), respectively, of certain state taxes that are payable without regard to our REIT status and TRS tax loss carry forwards. In addition, during the three and nine months ended

 

8



 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

September 30, 2012, we recognized a deferred tax benefit (expense) of ($113) and $642, respectively, related to a basis difference at our Puerto Rico and New Orleans hotels and Canadian tax losses available to offset future income.

 

9



 

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 September 30, 2012

 

 

 

Hotels

 

Travel
Centers

 

Corporate

 

Consolidated

 

Hotel operating revenues

 

$

251,722

 

$

 

$

 

$

251,722

 

Rental income

 

22,198

 

51,717

 

 

73,915

 

FF&E reserve income

 

4,431

 

 

 

4,431

 

Total revenues

 

278,351

 

51,717

 

 

330,068

 

 

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

184,566

 

 

 

184,566

 

Depreciation and amortization

 

44,682

 

21,884

 

 

66,566

 

General and administrative

 

 

 

10,336

 

10,336

 

Acquisition related costs

 

84

 

 

 

84

 

Total expenses

 

229,332

 

21,884

 

10,336

 

261,552

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

49,019

 

29,833

 

(10,336

)

68,516

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

116

 

116

 

Interest expense

 

 

 

(34,854

)

(34,854

)

Gain on sale of real estate

 

10,602

 

 

 

10,602

 

Equity in earnings of an investee

 

 

 

115

 

115

 

Income (loss) before income taxes

 

59,621

 

29,833

 

(44,959

)

44,495

 

Income tax benefit

 

 

 

163

 

163

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

59,621

 

$

29,833

 

$

(44,796

)

$

44,658

 

 

 

 

For the Nine Months Ended September 30, 2012

 

 

 

Hotels

 

Travel
Centers

 

Corporate

 

Consolidated

 

Hotel operating revenues

 

$

741,775

 

$

 

$

 

$

741,775

 

Rental income

 

66,237

 

154,626

 

 

220,863

 

FF&E reserve income

 

12,033

 

 

 

12,033

 

Total revenues

 

820,045

 

154,626

 

 

974,671

 

 

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

527,806

 

 

 

527,806

 

Depreciation and amortization

 

127,244

 

64,962

 

 

192,206

 

General and administrative

 

 

 

32,333

 

32,333

 

Acquisition related costs

 

1,648

 

 

 

1,648

 

Loss on asset impairment

 

889

 

 

 

889

 

Total expenses

 

657,587

 

64,962

 

32,333

 

754,882

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

162,458

 

89,664

 

(32,333

)

219,789

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

233

 

233

 

Interest expense

 

 

 

(101,660

)

(101,660

)

Gain on sale of real estate

 

10,602

 

 

 

10,602

 

Equity in earnings of an investee

 

 

 

236

 

236

 

Income (loss) before income taxes

 

173,060

 

89,664

 

(133,524

)

129,200

 

Income tax expense

 

 

 

(3,908

)

(3,908

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

173,060

 

$

89,664

 

$

(137,432

)

$

125,292

 

 

 

 

As of September 30, 2012

 

 

 

Hotels

 

Travel
Centers

 

Corporate

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

3,144,935

 

$

2,188,857

 

$

39,140

 

$

5,372,932

 

 

10



 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Note 9.  Segment Information (continued)

 

 

 

For the Three Months Ended September 30, 2011

 

 

 

Hotels

 

Travel
Centers

 

Corporate

 

Consolidated

 

Hotel operating revenues

 

$

242,995

 

$

 

$

 

$

242,995

 

Rental income

 

21,708

 

50,597

 

 

72,305

 

FF&E reserve income

 

3,389

 

 

 

3,389

 

Total revenues

 

268,092

 

50,597

 

 

318,689

 

 

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

168,278

 

 

 

168,278

 

Depreciation and amortization

 

36,421

 

20,685

 

 

57,106

 

General and administrative

 

 

 

11,292

 

11,292

 

Acquisition related costs

 

387

 

 

 

387

 

Total expenses

 

205,086

 

20,685

 

11,292

 

237,063

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

63,006

 

29,912

 

(11,292

)

81,626

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

11

 

11

 

Interest expense

 

 

 

(33,513

)

(33,513

)

Equity in earnings of an investee

 

 

 

28

 

28

 

Income (loss) before income taxes

 

63,006

 

29,912

 

(44,766

)

48,152

 

Income tax expense

 

 

 

(621

)

(621

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

63,006

 

$

29,912

 

$

(45,387

)

$

47,531

 

 

 

 

 

For the Nine Months Ended September 30, 2011

 

 

 

Hotels

 

Travel
Centers

 

Corporate

 

Consolidated

 

Hotel operating revenues

 

$

670,867

 

$

 

$

 

$

670,867

 

Rental income

 

79,395

 

150,683

 

 

230,078

 

FF&E reserve income

 

13,537

 

 

 

13,537

 

Total revenues

 

763,799

 

150,683

 

 

914,482

 

 

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

450,845

 

 

 

450,845

 

Depreciation and amortization

 

110,222

 

60,828

 

 

171,050

 

General and administrative

 

 

 

30,746

 

30,746

 

Acquisition related costs

 

1,150

 

 

 

1,150

 

Loss on asset impairment

 

7,263

 

 

 

7,263

 

Total expenses

 

569,480

 

60,828

 

30,746

 

661,054

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

194,319

 

89,855

 

(30,746

)

253,428

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

54

 

54

 

Interest expense

 

 

 

(100,183

)

(100,183

)

Equity in earnings of an investee

 

 

 

111

 

111

 

Income (loss) before income taxes

 

194,319

 

89,855

 

(130,764

)

153,410

 

Income tax expense

 

 

 

(1,188

)

(1,188

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

194,319

 

$

89,855

 

$

(131,952

)

$

152,222

 

 

 

 

As of December 31, 2011

 

 

 

Hotels

 

Travel
Centers

 

Corporate

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

2,905,065

 

$

2,202,199

 

$

26,309

 

$

5,133,573

 

 

11



 

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 39% of our real estate properties, at cost, as of September 30, 2012.  The following table presents summary financial information for TA for the three and nine months ended September 30, 2012, as reported in its Quarterly Report on Form 10-Q, or TA’s Quarterly Report:

 

 

 

For the Three Months Ended

 

 

 

September 30,

 

 

 

2012

 

2011

 

Operations

 

 

 

 

 

Total revenues

 

$

2,034,153

 

$

2,087,285

 

Total cost of goods sold

 

1,745,847

 

1,806,079

 

Net income

 

18,990

 

20,793

 

 

 

 

For the Nine Months Ended

 

 

 

September 30,

 

 

 

2012

 

2011

 

Operations

 

 

 

 

 

Total revenues

 

$

6,070,529

 

$

5,964,356

 

Total cost of goods sold

 

5,244,648

 

5,177,291

 

Net income

 

34,657

 

26,049

 

 

 

 

 

 

 

Cash Flows

 

 

 

 

 

Net cash provided by operating activities

 

89,373

 

12,816

 

Net cash used in investing activities

 

(104,383

)

(59,193

)

Net cash provided by (used in) financing activities

 

(1,663

)

51,587

 

Net increase (decrease) in cash

 

(16,645

)

5,145

 

Cash and cash equivalents at the beginning of the period

 

118,255

 

125,396

 

Cash and cash equivalents at the end of the period

 

101,610

 

130,541

 

 

 

 

 

As of September 30,

 

As of December 31,

 

 

 

2012

 

2011

 

Financial Position

 

 

 

 

 

Current assets

 

$

527,350

 

$

484,250

 

Noncurrent assets

 

602,538

 

532,281

 

Current liabilities

 

373,549

 

287,816

 

Noncurrent liabilities

 

401,270

 

410,114

 

Total shareholders’ equity

 

355,069

 

318,601

 

 

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.  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.  Each of our

 

12



 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

executive officers is also an officer of RMR.  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 and Mr. Adam Portnoy serves as a managing trustee of a majority of those companies.

 

Pursuant to our business management and property management agreements with RMR, we incurred expenses of $8,068 and $9,432 for the three months ended September 30, 2012 and 2011, respectively, and $26,650 and $26,306 for the nine months ended September 30, 2012 and 2011, respectively.  These amounts are included in general and administrative expenses in our condensed consolidated financial statements.  In March 2012, we issued 33,132 shares to RMR in satisfaction of the incentive fee RMR earned for services provided to us during 2011, in accordance with the terms of the business management agreement.

 

TA is our former 100% owned subsidiary.  TA became a public company in a spin off transaction in 2007. We are TA’s largest shareholder and, as of the date of this report, we owned 2,540,000 common shares of TA, or approximately 8.8% of TA’s outstanding common shares.  One of our Managing Trustees, Mr. Barry Portnoy, is also a managing director of TA.  RMR provides management services to both us and TA.

 

TA is our largest tenant and has two leases with us, the TA No. 1 lease and the TA No. 2 lease, pursuant to which TA currently 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 over threshold amounts established in 2011 and to be established in 2012 (with the first $2,500 of percentage rents under the TA No. 2 lease waived by us), respectively; and (3) 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 from our leases with TA of $51,717 and $50,597 for the three months ended September 30, 2012 and 2011, respectively, and $154,626 and $150,683 for the nine months ended September 30, 2012 and 2011, respectively.  Rental income for the three and nine months ended September 30, 2012 and 2011 includes ($69) and $218, respectively, and $1,195 and $3,594, respectively, of adjustments necessary to record rent on our TA No. 1 lease on a straight line basis.  We had deferred percentage rent under our TA No. 1 lease of $77 and $1,277 for the three and nine months ended September 30, 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 both of our leases with TA, TA may request that we purchase capital improvements to the leased facilities in return for minimum rent increases; however TA is not required to request that we purchase those capital improvements it makes to our properties and we are not required to fund any such request.  We purchased $48,282 of capital improvements from TA under this lease provision during the nine months ended September 30, 2012, which resulted in a $4,104 increase in our annual minimum rents.  See Note 10 above for more information about TA.

 

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.  As noted above, Messrs. Barry and Adam Portnoy have relationships with RMR and RMR provides services to us and to Sonesta.

 

On November 2, 2011, we entered into a purchase agreement, or the Purchase Agreement, with Sonesta and its wholly owned subsidiary, PAC Merger Corp., or Merger Sub, and together with Sonesta, the Sellers, to purchase from Sonesta the entities, or the Hotel Entities, that own the Cambridge Hotel and lease the New Orleans Hotel.  At that time, the Cambridge Hotel and the New Orleans Hotel were owned or leased and operated by subsidiaries of what was then known as Sonesta International Hotels Corporation, or SNSTA.  The Purchase Agreement was a component part of a

 

13



 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

transaction that involved the acquisition by merger, or the Merger, of all of SNSTA’s shares by Sonesta pursuant to an agreement and plan of merger, or the Merger Agreement, which was entered into between Sonesta, Merger Sub and SNSTA on November 2, 2011.

 

Pursuant to the Merger Agreement, on January 31, 2012, Merger Sub merged with and into SNSTA.  Pursuant to the Purchase Agreement, we advanced the approximately $150,500 aggregate purchase price for the Hotel Entities to the Sellers for the purpose of the Sellers consummating the Merger under the Merger Agreement.  The purchase price was reduced by the outstanding principal and accrued interest owed under a variable rate mortgage loan due in 2015 secured by the Cambridge Hotel, or the Cambridge Loan. We prepaid this mortgage loan, which had an outstanding principal balance of approximately $31,035, and unwound a related interest rate hedge agreement for $2,525 on January 31, 2012.

 

Pursuant to the Purchase Agreement, following the consummation of the Merger, Sonesta initiated a restructuring of SNSTA, which resulted in SNSTA owning equity interests of the Hotel Entities and certain related assets and the Hotel Entities owning only the real estate comprising the Cambridge Hotel and the leasehold for the New Orleans Hotel and related furniture, fixtures and equipment and certain other assets, and in Sonesta or its subsidiaries (other than SNSTA and its subsidiary Hotel Entities) owning the other assets of SNSTA, including its management businesses and brands and assuming all liabilities of SNSTA, other than the liabilities associated with the Cambridge Loan, income taxes, taxes related to retained assets and certain payables and other liabilities. Pursuant to the Purchase Agreement, after giving effect to that restructuring, Sonesta then transferred to us all of the then issued and outstanding capital stock of SNSTA (which then owned the Hotel Entities, which in turn own or lease the Cambridge Hotel and the New Orleans Hotel), free and clear of any liens, encumbrances or other restrictions (other than the Cambridge Loan and certain other matters).  Sonesta retained the management business of SNSTA and Sonesta manages certain of our other hotels, as described below, and we currently expect that Sonesta and its Sonesta management team will be available to operate other of our hotels in the future.

 

Simultaneously with consummation of the Purchase Agreement on January 31, 2012, we entered hotel management agreements with Sonesta, which provide for Sonesta to manage for us each of the Cambridge Hotel and the New Orleans Hotel.

 

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.

 

During the period April 2012 through August 2012, we entered into 17 hotel management agreements with Sonesta for 17 hotels historically owned by us and managed by InterContinental Hotels Group, plc, or InterContinental, which hotels have been rebranded with Sonesta brands.  Thirteen of these agreements relate to the former Staybridge Suites branded, limited service hotels located in Burlington, MA, Orlando, FL, Andover, MA, Parsippany, NJ, Malvern, PA, Somerset, NJ, Princeton, NJ, Houston, TX, Columbia, MD, Charlotte, NC, Atlanta, GA, St. Louis, MO, and Myrtle Beach, SC, two agreements relate to the former InterContinental branded, full service hotels located in Baltimore, MD and Houston, TX and two agreements relate to the former Crowne Plaza branded, full service hotels located in Hilton Head, SC and Philadelphia, PA. The thirteen former Staybridge Suites hotels have been rebranded as Sonesta ES Suites hotels, the former InterContinental hotels have been rebranded as Royal Sonesta hotels and the former Crowne Plaza hotels have been rebranded as Sonesta hotels.  All of the management agreements for these hotels were added to the Sonesta No. 1 agreement.

 

In August 2012, we entered into hotel management agreements with Sonesta for two additional hotels historically owned by us and managed by Marriott (these hotels were removed from our Marriott No. 234 agreement, which agreement is further described in Note 12 below).  These two agreements relate to the former Residence Inn branded, limited service hotels located in Flagstaff, AZ and Dublin, OH.  Both of those hotels have been rebranded as Sonesta ES Suites hotels and the management agreements for those hotels were added to the Sonesta No. 1 agreement.  For more information about our management agreements with Sonesta, please see Note 12 below.

 

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Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Pursuant to our management agreements with Sonesta, we incurred management, system and reservation fees payable to Sonesta of $1,903 and $3,536 for the three and nine months ended September 30, 2012, respectively.  These amounts are included in hotel operating expenses in our condensed consolidated financial statements.  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 $185 and $209 for the three and nine months ended September 30, 2012.  These amounts have been capitalized in our condensed consolidated financial statements.  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.

 

In August 2012, we sold two hotels that were managed by InterContinental that we previously disclosed we had agreed to sell, consistent with our agreement with InterContinental.  One of those hotels was the Staybridge Suites branded, limited service hotel located in Schaumburg, IL, which we sold for a cash purchase price of $2,060, and the other hotel was the Staybridge Suites branded, limited service hotel located in Auburn Hills, MI, which we sold for a cash purchase price of $3,510.  We recognized a gain on these sales totaling $392.  The purchaser was New 165 South Union Road, Inc., an entity owned by Mr. Barry Portnoy, as assignee of Schaumberg Suites LLC and Auburn Hills Suites LLC, entities owned by Mr. Barry Portnoy and Mr. Adam Portnoy, and both of the hotels were removed from our management agreement with InterContinental (which agreement is further described in Note 12 below).  We understand these two hotels are subject to management agreements with Sonesta and have been rebranded as Sonesta ES Suites hotels and that, after giving effect to the acquisition transactions, the owners and operators of these hotels will be affiliates of RMR, our manager, that are owned by Mr. Barry Portnoy and Mr. Adam Portnoy, who are our Managing Trustees.  As noted above, Mr. Barry Portnoy and Mr. Adam Portnoy have relationships with RMR and RMR provides services to us and to Sonesta.  The purchase price paid for these two hotels was equal to prices agreed between us and InterContinental and the sale was approved by our Independent Trustees after considering an appraisal report.

 

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 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.  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 $5,558 and $5,291 as of September 30, 2012 and December 31, 2011, respectively.  We recognized income of $115 and $28 for the three months ended September 30, 2012 and 2011, respectively, and $236 and $111 for the nine months ended September 30, 2012 and 2011, respectively, related to this investment.  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 that program.  We are also currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance.  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.

 

For further information about these and other such relationships and related person transactions, please see elsewhere in this Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” in Part I, Item 2, “Warning Concerning Forward Looking Statements” in Part I, and “Other Information” in Part II, Item 5 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, as amended, or our June 2012 Quarterly Report, and our 2011 Annual Report, our Proxy Statement for our 2012 Annual Meeting of Shareholders dated February 29, 2012, or our Proxy Statement, our Current Reports on Forms 8-K dated April 23, 2012, May 30, 2012, June 12, 2012, July 6, 2012, July 16, 2012 and July 25, 2012, and our other filings with the SEC, including Note 8 to our Consolidated Financial Statements included in our 2011 Annual

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Report, the sections captioned “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” and “Warning Concerning Forward Looking Statements” of our 2011 Annual Report and the section captioned “Related Person Transactions and Company Review of Such Transactions” and the information regarding our Trustees and executive officers in our Proxy Statement.  In addition, please see the section captioned “Risk Factors” of our 2011 Annual Report for a description of risks that may arise from these transactions and relationships.  Our filings with the SEC, including our 2011 Annual Report and our Proxy Statement, are available at the SEC’s website at www.sec.gov.  Copies of certain of our agreements with our related parties, including our business management agreement and property management agreement with RMR, various agreements we have with TA and Sonesta, our purchase and sale agreements with affiliates of RMR and our shareholders agreement with AIC and its shareholders, are also publicly available as exhibits to our public filings with the SEC and accessible at the SEC’s website.

 

Note 12. Hotel Management Agreements and Leases

 

Marriott No. 234 agreement.  During the three and nine months ended September 30, 2012, the payments we received under our Marriott No. 234 agreement, which requires annual minimum returns to us of $100,622, were $2,318 and $6,989 less than the minimum amounts contractually required, respectively.  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 and nine months ended September 30, 2012, Marriott was not required to make any guaranty payments to us because the payments received by us were in excess of the guaranty threshold amount (90% of the minimum returns due to us). During the three months ended September 30, 2012, the amount available under Marriott’s guaranty was replenished by the $400 of hotel cash flows in excess of the guaranty threshold amount.  Also, during the period from September 30, 2012 to November 6, 2012, the payments we received for these hotels were $1,555 less than the contractual minimum returns due to us.  Marriott was not required to make any guaranty payments to us because the minimum return payments received were in excess of the guaranty threshold.  The balance of this guaranty was $30,873 as of November 6, 2012.

 

We and Marriott previously identified 21 Marriott hotels included in our Marriott No. 234 agreement for potential sale.  In May 2012, we announced we had entered agreements with Marriott to retain ownership of and renovate 18 of the 21 hotels.  We currently expect to fund approximately $43,000 for certain improvements to these 18 hotels.  As we fund these amounts, our annual minimum returns due under the Marriott No. 234 agreement will be increased by 9% of the amounts funded.  As discussed in Note 7, in July 2012 we sold one of these 21 hotels, a full service Marriott hotel in St. Louis, MO.  We received net proceeds of $28,850 from the sale and our annual minimum returns under the Marriott No. 234 agreement were decreased by $2,597 when this hotel was sold.  In August 2012, we removed the remaining two of the 21 hotels from the Marriott No. 234 agreement and converted them to the Sonesta ES Suites brand and Sonesta management.  Our annual minimum returns under the Marriott No. 234 agreement were reduced by $990 when these two hotels were removed from the Marriott No. 234 agreement.

 

The May 2012 agreements with Marriott provide that the FF&E reserve funding requirements for all hotels included in the Marriott No. 234 agreement are eliminated during 2012 (effective May 29, 2012 and retroactive to January 1, 2012), reduced in 2013 and 2014, and then increased in 2015 through the remaining agreement term of 2025.  The May 2012 agreements with Marriott also provide that Marriott’s limited guarantee of the minimum return amounts due to us under the Marriott No. 234 agreement will be extended through 2019.

 

InterContinental agreement.  During the three and nine months ended September 30, 2012, the payments we received under our agreement with InterContinental covering 91 hotels and requiring minimum returns to us of $131,654 were $2,743 and $17,493 less than the minimum amounts contractually required, respectively.  We applied the available security deposit to cover these shortfalls.  Also, during the period from September 30, 2012 to November 6, 2012, the minimum return payments we received under our InterContinental agreement were $5,061 less than the minimum amounts due to us.  We applied the available security deposit to cover these shortfalls.  The remaining balance of the security deposit was $33,266 as of November 6, 2012.

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

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 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.

 

Under the InterContinental agreement, we had the option to sell or rebrand up to 42 hotels included in the agreement.  In April 2012, we and InterContinental agreed to retain three of the 42 hotels in the InterContinental agreement.  We provided notices to InterContinental during the period from February 2012 to June 2012 that we planned to remove the remaining 39 of the 42 hotels from the InterContinental agreement.  We entered into management agreements with Sonesta for 17 of these hotels, which were converted to Sonesta brands and management during the second and third quarters of 2012.  As described below, in May 2012, we entered into an agreement with Wyndham Hotel Group, or Wyndham, a member of the Wyndham Worldwide Corporation for 20 of these 39 hotels.  We converted these 20 hotels to Wyndham brands and management on August 1, 2012.  In August 2012, we sold the remaining two of the 39 hotels for combined net proceeds of $5,354.  Our annual minimum returns due under the InterContinental agreement were reduced by an aggregate of $34,990 when these 39 hotels were removed.

 

Sonesta agreements.  As described in Note 11, on January 31, 2012, we entered into two management agreements with Sonesta to manage our Cambridge Hotel and our New Orleans Hotel.  The management agreement for our Cambridge Hotel, which is included in our Sonesta No. 1 agreement, provides that we are paid a fixed minimum return equal to 8% of our invested capital, as defined in the management agreement for our Cambridge Hotel, if gross revenues of the hotels, after payment of hotel operating expenses and base fees to Sonesta, are sufficient to do so.  Under the terms of this agreement, we may earn additional returns of 80% of cash flow after payment of our minimum returns and reimbursement of operating losses or working capital advances, if any.  We are required to fund operating losses or working capital shortfalls, but may recover these amounts from future cash flows, if any.  As described above, during the second and third quarters of 2012, we removed 17 hotels from our InterContinental agreement and two hotels from our Marriott No. 234 agreement and converted them to Sonesta brands and management.  We entered into hotel management agreements with Sonesta for these hotels and added them to our Sonesta No. 1 agreement.  The terms of these management agreements are substantially the same as our Cambridge Hotel management agreement, except that in the case of limited service hotels the base management fee payable to Sonesta is 5% of gross revenues (compared to 3% of gross revenues for other Sonesta branded hotels) and our working capital required advance per room is less ($750 per key compared to $1,500 per key for the full service Sonesta hotels).  In addition, in April 2012, we entered into a pooling agreement with Sonesta as further described in Note 11.  Under the terms of the pooling agreement, results from the hotels included in our Sonesta No. 1 agreement are combined 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.  Our annual minimum returns as of September 30, 2012 for the 20 hotels included in the Sonesta No. 1 agreement were $36,476.  We currently expect to fund between $130,000 and $150,000 for rebranding, renovations and other improvements to the 19 hotels we rebranded as Sonesta hotels.  The annual minimum returns due to us under the Sonesta No. 1 agreement will increase to the extent amounts funded for these improvements exceed threshold amounts, as defined.

 

We lease the New Orleans Hotel from a third party.  The annual rent payable by us under the lease is calculated as 75% of the sum of the net profit of the hotel (hotel operating revenues less hotel operating expenses, including a 3% management fee to Sonesta), less capital expenditures made during the lease year.  The management agreement for our New Orleans Hotel, which we refer to as our Sonesta No. 2 agreement, provides that we are paid all cash flow of the hotel after the payment of operating expenses, including a management fee to Sonesta and rent expense.

 

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

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

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.  As described above, on May 21, 2012, we entered an agreement to rebrand 20 of our hotels which were managed by InterContinental to Wyndham brands, which conversion occurred on August 1, 2012.  All 20 hotels are being managed by Wyndham under a long term management contract with an initial term of 25 years and two renewal terms of 15 years each.  Our annual minimum return under our Wyndham agreement for these 20 hotels was $9,681 as of September 30, 2012, and such payment was subject to a $20,000 limited guarantee by Wyndham (and an annual payment limit of $10,000).  The cash flows generated by our Wyndham hotels were $3,547 less than the minimum returns due for the period August 1, 2012 through September 30, 2012 and Wyndham provided guaranty payments to cover these shortfalls.  There was $16,453 remaining at September 30, 2012 under our Wyndham guarantee.  We have agreed to provide up to $75,000 for refurbishment and rebranding of these hotels to “Wyndham Hotels and Resorts” (four hotels) and “Hawthorn Suites by Wyndham” (16 hotels) brand standards.  As these amounts are funded, the annual minimum returns due to us under the management agreement will increase by 8% of the amounts funded.

 

On November 1, 2012, we acquired the Hotel 71, a full service hotel in Chicago, IL for $85,000, excluding closing costs, and added it to our Wyndham agreement.  Upon completion of a planned renovation, the property will consist of 348 hotel rooms managed by Wyndham and 48 vacation units leased to Wyndham Vacation Resorts, Inc., a subsidiary of Wyndham Worldwide Corporation.  Our annual minimum returns under the Wyndham agreement increased by $5,800 and the limited guaranty provided by Wyndham increased by $9,000 upon closing of this hotel acquisition (and increased the annual payment limit to $14,500).  The lease with Wyndham Vacation Resorts, Inc. provides for annual initial rent to us of $1,000 increasing 3% per annum.  We plan to convert this hotel to the “Wyndham Grand Chicago Riverfront” hotel and have agreed to provide up to $18,000 for the rebranding and renovation of this hotel.  As these rebranding and renovation amounts are funded, the annual minimum return due to us under the Wyndham agreement will increase by 8% of the amounts funded.

 

Other management agreement and lease matters.  As of November 6, 2012, all payments due to us from our managers and tenants under our other operating agreements were current.  Certain amounts of minimum return and minimum rent payments due to us under some of our other hotel management agreements and leases are supported by guarantees. The guaranty provided by Hyatt Hotels Corporation, or Hyatt, with respect to the 22 hotels managed by Hyatt is limited to $50,000 ($18,141 remaining at September 30, 2012). The guaranty provided by Carlson Hotels Worldwide, or Carlson, with respect to the 11 hotels managed by Carlson is limited to $40,000 ($24,130 remaining at September 30, 2012).  The guaranty provided by Marriott with respect to the one hotel leased by Marriott (our Marriott No. 5 agreement) is unlimited and continues throughout the lease term.

 

Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $20,300 and $6,653, less than the minimum returns due to us in the three months ended September 30, 2012 and 2011, respectively, and $46,697 and $37,875 less than the minimum returns due to us in the nine months ended September 30, 2012 and 2011, respectively.  When the shortfalls are funded by the managers of these hotels under the terms of our operating agreements, 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 $12,791 and $6,653 in the three months ended September 30, 2012 and 2011, respectively, and $30,483 and $37,875 in the nine months ended September 30, 2012 and 2011, respectively.  We had $9,840 and $16,210 of shortfalls not funded by managers during the three and nine months ended September 30, 2012, respectively, which represents the unguaranteed portion of our minimum returns from Marriott and from Sonesta.

 

In November 2010, Host Hotels & Resorts, Inc., or Host, notified us that it will not exercise its renewal option at the end of the current lease term for 53 hotels which we have historically referred to as our Marriott No. 1 agreement.  In the absence of any default by Host, upon expiration of the agreement on December 31, 2012, we expect to return the $50,540 security deposit to Host, to lease these hotels to one of our TRSs and to continue the existing hotel brand and management agreements with Marriott with respect to these hotels; this management agreement with Marriott expires in 2024.

 

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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 September 30, 2012, 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

 

Significant Other

 

Significant

 

 

 

 

 

for Identical

 

Observable

 

Unobservable

 

 

 

 

 

Assets

 

Inputs

 

Inputs

 

Description

 

Total

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Properties held for sale(1)

 

$

 

$

 

$

 

$

 

Investment securities (2)

 

$

13,614

 

$

13,614

 

$

 

$

 

 


(1)         We sold the one Marriott hotel we held for sale at June 30, 2012 in July 2012.  We removed 20 Marriott branded hotels with a carrying value of $104,585 from held for sale status in March 2012.  As described in Note 12, we have agreed to retain 18 of these hotels in our Marriott No. 234 agreement and retained and rebranded the remaining two hotels to Sonesta brands and management. We recorded an $889 loss on asset impairment in the first quarter of 2012 in connection with our decision to remove these hotels from held for sale status.

 

(2)         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 September 30, 2012, 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 September 30, 2012 and December 31, 2011, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

 

 

 

September 30, 2012

 

December 31, 2011

 

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Amount

 

Value

 

 

 

 

 

 

 

 

 

 

 

Senior Notes, due 2012 at 6.85%(1) 

 

$

 

$

 

$

100,829

 

$

105,407

 

Senior Notes, due 2013 at 6.75%(2) 

 

 

 

287,000

 

301,871

 

Senior Notes, due 2014 at 7.875%

 

300,000

 

328,402

 

300,000

 

333,887

 

Senior Notes, due 2015 at 5.125%

 

280,000

 

293,894

 

280,000

 

290,052

 

Senior Notes, due 2016 at 6.3%

 

275,000

 

307,878

 

275,000

 

291,572

 

Senior Notes, due 2017 at 5.625%

 

300,000

 

326,993

 

300,000

 

313,106

 

Senior Notes, due 2018 at 6.7%

 

350,000

 

406,123

 

350,000

 

386,942

 

Senior Notes, due 2022 at 5%

 

500,000

 

508,184

 

 

 

Convertible Senior Notes, due 2027 at 3.8% (3) 

 

8,478

 

8,937

 

79,054

 

80,087

 

Unamortized discounts

 

(11,613

)

 

(5,169

)

 

Total financial liabilities

 

$

2,001,865

 

$

2,180,411

 

$

1,966,714

 

$

2,102,924

 

 


(1)         We redeemed these notes at par plus accrued interest on April 11, 2012.

 

(2)         We redeemed these notes at par plus accrued interest on September 10, 2012.

 

(3)         On March 20, 2012, we repurchased $70,576 of our 3.8% convertible senior notes due 2027 which were tendered by the holders of those notes for repurchase.

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

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

 

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HOSPITALITY PROPERTIES TRUST

 

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 2011 Annual Report.

 

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

 

Hotel operations. The U.S. hotel industry generally continues to show improvement in average daily rate, or ADR, occupancy and revenue per available room, or RevPAR, over 2011, 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 2012 have been below hotel industry averages primarily due to the disruption and displacement caused by renovation and rebranding activities. During the three and nine months ended September 30, 2012, we had 27 and 123, respectively, of our hotels under renovation for all or part of the period and we rebranded 35 and 39 hotels, respectively during those periods. We expect our high level of hotel renovation activity to continue through the remainder of 2012 and into 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 U.S. economy and the lodging industry take 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 have been granted to us 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. 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 and nine months ended September 30, 2012, the payments we received under our Marriott No. 234 agreement, which requires annual minimum returns to us of $100,622, were $2,318 and $6,989 less than the minimum amounts contractually required, respectively. 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 and nine months ended September 30, 2012, Marriott was not required to make any guaranty payments to us because the payments received by us were in excess of the guaranty threshold amount (90% of the minimum returns due to us). During the three months ended September 30, 2012, the amount available under Marriott’s guaranty was replenished by the $400 of hotel cash flows in excess of the guaranty threshold amount. Also, during the period from September 30, 2012 to November 6, 2012, the payments we received for these hotels were $1,555 less than the contractual minimum returns due to us. Marriott was not required to make any guaranty payments to us because the minimum return payments received were in excess of the guaranty threshold. The balance of this guaranty was $30,873 as of November 6, 2012.

 

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.

 

During the three and nine months ended September 30, 2012, the payments we received under our agreement with InterContinental covering 91 hotels and requiring minimum returns to us of $131,654 were $2,743 and $17,493 less than the minimum amounts contractually required, respectively. We applied the available security deposit to cover these shortfalls. Also, during the period from September 30, 2012 to November 6, 2012, the minimum return payments we received under our InterContinental agreement were $5,061 less than the minimum amounts due to us. We applied the available security deposit to cover these shortfalls. The remaining balance of the security deposit was $33,266 as of November 6, 2012.

 

21



 

HOSPITALITY PROPERTIES TRUST

 

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

 

Sonesta agreements. On January 31, 2012, we completed our acquisition of the entities which own the Cambridge Hotel and the New Orleans Hotel for $153,062 ($150,500 cash consideration and $2,562 of assumed net liabilities), excluding acquisition costs. Additional details of this transaction are set forth in Notes 7, 11 and 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.

 

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. 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.

 

Other management agreement and lease matters. As of November 6, 2012, all payments due to us from our managers and tenants under our other operating agreements were current. Additional details of our guarantees from Hyatt and Carlson and our lease agreements with TA 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. 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. Security deposits are non-interest bearing and are not required to be 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. 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.

 

In November 2010, Host notified us that it will not exercise its renewal option at the end of the current lease term for 53 hotels which we have historically referred to as our Marriott No. 1 agreement. In the absence of any default by Host, upon expiration of the agreement on December 31, 2012, we expect to return the $50,540 security deposit to Host, to lease these hotels to one of our TRSs and to continue the existing hotel brand and management agreements with Marriott with respect to these hotels; this management agreement with Marriott expires in 2024.

 

Management Agreements and Leases

 

At September 30, 2012, we owned or leased 287 hotels operated under nine operating agreements; 231 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 55 are leased to third parties. At September 30, 2012, 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 35 and 36 below.

 

22



 

HOSPITALITY PROPERTIES TRUST

 

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 September 30, 2012 versus 2011

 

 

 

For the Three Months Ended September 30,

 

 

 

 

 

 

 

Increase

 

% Increase

 

 

 

2012

 

2011

 

(Decrease)

 

(Decrease)

 

Revenues:

 

 

 

 

 

 

 

 

 

Hotel operating revenues

 

$

251,722

 

$

242,995

 

$

8,727

 

3.6%

 

Rental income:

 

 

 

 

 

 

 

 

 

Minimum rents - hotels

 

22,198

 

21,708

 

490

 

2.3%

 

Minimum rents - travel centers

 

51,717

 

50,597

 

1,120

 

2.2%

 

Total rental income

 

73,915

 

72,305

 

1,610

 

2.2%

 

FF&E reserve income

 

4,431

 

3,389

 

1,042

 

30.7%

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

184,566

 

168,278

 

16,288

 

9.7%

 

Depreciation and amortization - hotels

 

44,682

 

36,421

 

8,261

 

22.7%

 

Depreciation and amortization - travel centers

 

21,884

 

20,685

 

1,199

 

5.8%

 

Total depreciation and amortization

 

66,566

 

57,106

 

9,460

 

16.6%

 

General and administrative

 

10,336

 

11,292

 

(956

)

(8.5)%

 

Acquisition related costs

 

84

 

387

 

(303

)

(78.3)%

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

68,516

 

81,626

 

(13,110

)

(16.1)%

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

116

 

11

 

105

 

954.5%

 

Interest expense

 

(34,854

)

(33,513

)

1,341

 

4.0%

 

Gain on sale of real estate

 

10,602

 

 

10,602

 

 

Equity in earnings of an investee

 

115

 

28

 

87

 

310.7%

 

Income before income taxes

 

44,495

 

48,152

 

(3,657

)

(7.6)%

 

Income tax benefit (expense)

 

163

 

(621

)

(784

)

(126.2)%

 

 

 

 

 

 

 

 

 

 

 

Net income

 

44,658

 

47,531

 

(2,873

)

(6.0)%

 

Excess of liquidation preference over carrying value of preferred shares redeemed

 

(5,040

)

 

(5,040

)

 

Preferred distributions

 

(10,138

)

(7,470

)

(2,668

)

35.7%

 

Net income available for common shareholders

 

29,480

 

40,061

 

(10,581

)

(26.4)%

 

Weighted average shares outstanding

 

123,577

 

123,465

 

112

 

0.1%

 

Net income available for common shareholders per common share

 

$

0.24

 

$

0.32

 

$

(0.08

)

(25.0)%

 

 

References to changes in the income and expense categories below relate to the comparison of consolidated results for the three month period ended September 30, 2012 compared with the three month period ended September 30, 2011.

 

The increase in hotel operating revenues in the third quarter of 2012 compared to the third quarter of 2011 was caused primarily by increased revenue at certain of our managed hotels due to increases in ADR and higher occupancies and our acquisition of the entities that own or lease the Cambridge Hotel and the New Orleans Hotel in January 2012. These increases were partially offset by decreases in revenues at certain of our managed hotels undergoing renovations or rebrandings during the 2012 period which resulted in lower occupancies and the sale of three hotels during the third quarter of 2012. Additional operating statistics of our hotels are included in the table on page 39.

 

23



 

HOSPITALITY PROPERTIES TRUST

 

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

 

The increase in rental income - hotels is a result of increases in the minimum rents due to us as we funded improvements at certain of our leased hotels since July 1, 2011.

 

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 July 1, 2011. Rental income for the 2012 and 2011 periods includes ($69) and $1,195 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 increase in FF&E reserve income is primarily the result of increased levels of sales at our leased hotels during the respective periods of 2012 versus 2011. 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 our hotel acquisitions and increased expenses associated with higher occupancy at certain of our managed hotels, partially offset by operating expense decreases at certain hotels undergoing renovations. Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $20,300 and $6,653, less than the minimum returns due to us in the three months ended September 30, 2012 and 2011, respectively. When the shortfalls are funded by the managers of these hotels under the terms of our operating agreements, 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 $12,791 and $6,653 in the three months ended September 30, 2012 and 2011, respectively. We had $9,840 of shortfalls not funded by managers during the three months ended September 30, 2012 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 July 1, 2011 and our hotel acquisitions, partially offset by certain of our depreciable assets becoming fully depreciated since July 1, 2011.

 

The increase in depreciation and amortization - travel centers is primarily due to the depreciation and amortization of improvements made to our travel centers since July 1, 2011.

 

The decrease in general and administrative costs is primarily due to a decrease in incentive business management fees partially offset by increased equity compensation expense in the respective periods of 2012 versus 2011.

 

Acquisition related costs represent legal and other costs incurred in connection with our 2012 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 during the respective periods of 2012 versus 2011.

 

The increase in interest expense is primarily due to higher average borrowings, partially offset by lower weighted average interest rates in the 2012 period, compared to the 2011 period.

 

We recorded a $10,602 gain on sale of real estate in the third quarter of 2012 in connection with the sale of our Marriott hotel in St. Louis, MO in July 2012 and the sales of our Staybridge Suites hotels in Auburn Hills, MI and Schaumburg, IL in August 2012.

 

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

 

24



 

HOSPITALITY PROPERTIES TRUST

 

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

 

The decrease in income tax expense is primarily the result of an adjustment to reduce accrued state income taxes during the 2012 period due to a decrease in our estimated 2012 state tax liability partially offset by federal taxes related to our TRS that leases the New Orleans Hotel acquired on January 31, 2012.

 

We reduced net income available for common shareholders for the three months ended September 30, 2012, by $5,040, which represents the amount by which the liquidation preference for our Series C cumulative redeemable preferred shares that were redeemed in September 2012 exceeded our carrying amount for those preferred shares as of the date of redemption.

 

The increase in preferred distributions is the result of our issuance of 11,600,000 shares of our 7.125% Series D cumulative redeemable preferred shares in January 2012, partially offset by 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 7.00% Series C cumulative redeemable preferred shares in September 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 September 30, 2012, compared to the prior year period, are primarily a result of the changes discussed above.

 

25



 

HOSPITALITY PROPERTIES TRUST

 

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)

 

Nine Months Ended September 30, 2012 versus 2011

 

 

 

For the Nine Months Ended September 30,

 

 

 

 

 

 

 

Increase

 

% Increase

 

 

 

2012

 

2011

 

(Decrease)

 

(Decrease)

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Hotel operating revenues

 

$

741,775

 

$

670,867

 

$

70,908

 

10.6%

 

Rental income:

 

 

 

 

 

 

 

 

 

Minimum rents - hotels

 

66,237

 

79,395

 

(13,158

)

(16.6)%

 

Minimum rents - travel centers

 

154,626

 

150,683

 

3,943

 

2.6%

 

Total rental income

 

220,863

 

230,078

 

(9,215

)

(4.0)%

 

FF&E reserve income

 

12,033

 

13,537

 

(1,504

)

(11.1)%

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

527,806

 

450,845

 

76,961

 

17.1%

 

Depreciation and amortization - hotels

 

127,244

 

110,222

 

17,022

 

15.4%

 

Depreciation and amortization - travel centers

 

64,962

 

60,828

 

4,134

 

6.8%

 

Total depreciation and amortization

 

192,206

 

171,050

 

21,156

 

12.4%

 

General and administrative

 

32,333

 

30,746

 

1,587

 

5.2%

 

Acquisition related costs

 

1,648

 

1,150

 

498

 

43.3%

 

Loss on asset impairment

 

889

 

7,263

 

(6,374

)

(87.8)%

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

219,789

 

253,428

 

(33,639

)

(13.3)%

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

233

 

54

 

179

 

331.5%

 

Interest expense

 

(101,660

)

(100,183

)

1,477

 

1.5%

 

Gain on sale of real estate

 

10,602

 

 

10,602

 

 

Equity in earnings of an investee

 

236

 

111

 

125

 

112.6%

 

Income before income taxes

 

129,200

 

153,410

 

(24,210

)

(15.8)%

 

Income tax expense

 

(3,908

)

(1,188

)

2,720

 

229.0%

 

 

 

 

 

 

 

 

 

 

 

Net income

 

125,292

 

152,222

 

(26,930

)

(17.7)%

 

Excess of liquidation preference over carrying value of preferred shares redeemed

 

(7,984

)

 

(7,984

)

 

Preferred distributions

 

(32,048

)

(22,410

)

(9,638

)

43.0%

 

Net income available for common shareholders

 

85,260

 

129,812

 

(44,552

)

(34.3)%

 

Weighted average shares outstanding

 

123,553

 

123,453

 

100

 

0.1%

 

Net income available for common shareholders per common share

 

$

0.69

 

$

1.05

 

$

(0.36

)

(34.3)%

 

 

References to changes in the income and expense categories below relate to the comparison of consolidated results for the nine month period ended September 30, 2012 compared with the nine month period ended September 30, 2011.

 

The increase in hotel operating revenues in the first nine months of 2012 compared to the first nine months of 2011 was caused primarily by increased revenues at certain of our managed hotels due to increases in ADR and higher occupancies, the conversion of 19 hotels from leased to managed properties in June 2011 and our hotel acquisitions as described above. These increases were partially offset by decreases in revenues at certain of our managed hotels undergoing renovations or rebrandings during the 2012 period which resulted in lower occupancies. Additional operating statistics of our hotels are included in the table on page 39.

 

26



 

HOSPITALITY PROPERTIES TRUST

 

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

 

The decrease in rental income - hotels is a result of the conversion of the 19 hotels from leased to managed in June 2011 as described above, partially offset by increases in the minimum rents due to us as we funded improvements at certain of our leased hotels since January 1, 2011.

 

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, 2011. Rental income for the 2012 and 2011 periods includes $218 and $3,594 of straight line rent, respectively.

 

The decrease in FF&E reserve income is primarily the result of the conversion of the 19 hotels from leased to managed in June 2011 as described above, partially offset by increased levels of sales at our leased hotels in the respective periods of 2012 versus 2011.

 

The increase in hotel operating expenses was primarily caused by the conversion of the 19 hotels from leased to managed in June 2011 as described above, our hotel acquisitions and increased expenses associated with higher occupancy at certain of our managed hotels, partially offset by operating expense decreases at certain hotels undergoing renovations. Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $46,697 and $37,875 less than the minimum returns due to us in the nine months ended September 30, 2012 and 2011, respectively. When the shortfalls are funded by the managers of these hotels under the terms of our operating agreements, we reflect such fundings (including security deposit applications) in our Condensed Consolidated Statements of Income and Comprehensive Income as a reduction to hotel operating expenses. The reduction to operating expenses was $30,483 and $37,875 in the nine months ended September 30, 2012 and 2011, respectively. We had $16,210 of shortfalls not funded by managers during the nine months ended September 30, 2012 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, 2011 and our hotel acquisitions, partially offset by certain of our depreciable assets becoming fully depreciated since January 1, 2011.

 

The increase in depreciation and amortization - travel centers is primarily due to the depreciation and amortization of improvements made to our travel centers since January 1, 2011.

 

The increase in general and administrative costs is primarily due to increased business management fees, franchise taxes and professional services expense in the respective periods of 2012 versus 2011.

 

Acquisition related costs represent legal and other costs incurred in connection with our hotel acquisition activities in 2012.

 

We recorded an $889 loss on asset impairment in the first quarter of 2012 in connection with our decision to remove 20 Marriott branded hotels from held for sale status. We recorded a $7,263 loss on asset impairment in the second quarter of 2011 in connection with our consideration of selling certain InterContinental and Marriott hotels.

 

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 during the respective periods of 2012 versus 2011.

 

The increase in interest expense is primarily due to higher average borrowings partially offset by lower weighted average interest rates in the 2012 period, compared to the 2011 period.

 

We recorded a $10,602 gain on sale of real estate in the third quarter of 2012 in connection with the sale of our Marriott hotel in St. Louis, MO in July 2012 and the sale of our Staybridge Suites hotels in Auburn Hills, MI and Schaumburg, IL in August 2012.

 

27



 

HOSPITALITY PROPERTIES TRUST

 

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 increase in income tax expense is primarily the result of an increase in state income taxes as a result of higher taxable income in certain states in the 2012 period compared to the 2011 period and federal taxes related to our TRS that leases the New Orleans Hotel acquired on January 31, 2012.

 

We reduced net income available for common shareholders for the nine months ended September 30, 2012, by an aggregate of $7,984, which represented the amount by which the liquidation preference for our Series B cumulative redeemable preferred shares that were redeemed in February 2012 and for our Series C cumulative redeemable preferred shares that were redeemed in September 2012 exceeded our carrying amount for those preferred shares as of the date of redemption.

 

The increase in preferred distributions is the result of our issuance of 11,600,000 of our 7.125% Series D cumulative redeemable preferred shares in January 2012, partially offset by our redemption of 3,450,000 of our 8.875% Series B cumulative redeemable preferred shares in February 2012 and our redemption of 6,000,000 of our 7.00% Series C cumulative redeemable preferred shares in September 2012.

 

The decreases in net income, net income available for common shareholders and net income available for common shareholders per common share in the nine months ended September 30, 2012 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 September 30, 2012, all 472 of our properties were operated under 11 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 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 and Wyndham.  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 35 and 36.  During the twelve months ended September 30, 2012, eight of our nine hotel operating agreements generated coverage of less than 1.0x (0.40x to 0.94x); our Sonesta No. 2 agreement generated coverage of 2.04x during the twelve months ended September 30, 2012.

 

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 September 30, 2012, the operating results from our 185 properties in our two travel center leases generated coverage of 1.71x.  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 seven (307) of our properties, representing 63% of our total investments at cost as of September 30, 2012, are operated under seven management arrangements or leases which are subject to full or limited guarantees.  Our minimum returns and minimum rents for certain of our hotels are secured by security deposits which we control.  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. Some of our managers and tenants, or their affiliates, may also supplement cash flow

 

28



 

HOSPITALITY PROPERTIES TRUST

 

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

 

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 payments to us, if any, made under any of our management agreements or leases do not subject us to repayment obligations, but, under some of our agreements, the manager or tenant may recover these guarantee or supplemental payments and the security deposits may be replenished from the future cash flows from our properties after our future minimum returns and minimum rents are paid.

 

As described above, certain of our agreements are generating cash flows that are less than the minimum amounts contractually required and we have been utilizing the security features in our agreements to cover these shortfalls.  However, several of the guarantees and all the security deposits we hold are for limited amounts and are for limited durations and may be exhausted or expire, especially if the U.S. economy does not fully recover from the recent recession in a reasonable time period or if our hotel renovation and rebranding activities described above do not result in improved operating results at these hotels.  Accordingly, the effectiveness of our various security features to provide uninterrupted payments to us is not assured.  If any of our hotel managers, tenants or guarantors default in their payment obligations to us, our cash flows will decline.

 

Our Operating Liquidity and Capital Resources

 

Our principal source of funds for current expenses and distributions to shareholders are minimum returns from our managed hotels and minimum rents from our leased hotels and travel centers. We receive minimum returns and minimum rents from our managers and tenants monthly. We receive additional returns, percentage returns and rents and our share of the operating profits of our managed hotels after payment of management fees and other deductions, if any, either monthly or quarterly. This flow of funds has historically been sufficient for us to pay our operating expenses, interest expense on our debt and distributions to shareholders declared by our Board of Trustees. We believe that our operating cash flow will be sufficient to meet our operating expenses, interest expense and distribution payments declared by our Board of Trustees for the next twelve months and the foreseeable future thereafter.  However, because of the impact of the weak U.S. economy on the hotel and travel center industries, our managers and tenants may be unable to pay minimum returns and minimum rents to us when due, in which case our cash flow and net income will decline and we may need to reduce the amount of, or even eliminate, our distributions to common shareholders.

 

Changes in our cash flows in the nine months ended September 30, 2012 compared to the same period in 2011 were as follows: (1) cash flow provided by operating activities increased from $248,728 in 2011 to $264,662 in 2012; (2) cash used in investing activities increased from $18,824 in 2011 to $379,037 in 2012; and (3) cash provided by (used in) financing activities increased from ($228,299) in 2011 to $123,196 in 2012.

 

The increase in cash provided by operating activities between the 2012 and 2011 periods is due primarily to a reduction in the application of security deposits to fund payment shortfalls in 2012, the increase in rental income we received related to our TA leases, and income from our hotel acquisitions. The increase in cash used in investing activities is primarily due to our January 2012 hotel acquisitions and our purchases in 2012 of improvements under our TA, InterContinental and Marriott No. 234 agreements.  The net increase in cash provided by financing activities between the 2012 and 2011 periods is primarily a result of the issuance of our 5.00% senior notes due 2022 and our Series D preferred shares and proceeds from our unsecured term loan in 2012, partially offset by the redemption of our Series B preferred shares and some of our Series C preferred shares, the repayment of our 6.85% and 6.75% senior notes and the repurchase of certain of our 3.8% convertible senior notes in 2012.

 

We maintain our status as a REIT under the Internal Revenue Code by meeting certain requirements. As a REIT, we do not expect to pay federal income taxes on the majority of our income. Federal legislation known as the REIT Modernization Act, among other things, allows a REIT to lease hotels to a TRS if the hotel is managed by an independent third party. The income realized by our TRSs in excess of the rent they pay to us is subject to U.S. federal income tax at corporate tax rates.  The income we receive from our hotels in Canada and Puerto Rico is subject to taxes in those jurisdictions and we are subject to taxes in certain states where we have properties.  Our provision for tax expense in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 increased by $2,720 primarily because of higher state taxes imposed despite our tax status as a REIT and despite our

 

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HOSPITALITY PROPERTIES TRUST

 

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

 

TRS tax loss carry forwards and federal taxes related to our TRS that leases the New Orleans Hotel that we acquired on January 31, 2012.

 

Our Investment and Financing Liquidity and Capital Resources

 

Various percentages of total sales at some of our hotels are escrowed as FF&E reserves to fund future capital improvements. During the nine months ended September 30, 2012, our hotel managers and hotel tenants contributed $17,452 to these accounts and $101,381 was spent from the FF&E reserve escrow accounts and from separate payments by us to renovate and refurbish our hotels.  As of September 30, 2012, there was $38,919 on deposit in these escrow accounts, which was held directly by us and is reflected on our Condensed Consolidated Balance Sheets as restricted cash.

 

Our hotel operating agreements generally provide that, if necessary, we may provide our managers and tenants with funding for capital improvements to our hotels in excess of amounts otherwise available in escrowed FF&E reserves or when no FF&E reserves are available. To the extent we make such additional fundings, our annual minimum returns or minimum rents generally increase by a percentage of the amount we fund. During the nine months ended September 30, 2012, we funded $214,189 for capital improvements in excess of FF&E reserve fundings available from hotel operations to our hotels as follows:

 

·                  During the nine months ended September 30, 2012, we funded $508 for improvements to hotels included in our Marriott No. 1 agreement using cash on hand and borrowings under our revolving credit facility.  We currently do not expect to make significant fundings for capital improvements under this agreement during the remainder of 2012.

 

·                  Pursuant to the June 2011 and May 2012 agreements we entered with Marriott for management of 68 hotels (Marriott No. 234), we agreed to provide approximately $145,000 of funding from 2011 through 2013 for renovations of certain of these hotels and for other improvements.  As of September 30, 2012, $64,500 has been funded.  We funded $59,500 of this amount during the nine months ended September 30, 2012 using existing cash balances and borrowings under our revolving credit facility.  We currently expect to fund approximately $26,000 during the remainder of 2012 using existing cash balances or borrowings under our revolving credit facility.  As we fund these improvements, the minimum return payable to us increases.

 

·                  Pursuant to the July 2011 agreement we entered with InterContinental for management of 91 hotels, we have agreed to provide approximately $290,000 of funding from 2011 through 2013 for renovations of certain of these hotels and other improvements.  As of September 30, 2012, $168,955 has been funded.  We funded $130,317 of this amount during the nine months ended September 30, 2012 using existing cash balances and borrowings under our revolving credit facility.  We currently expect to fund approximately $67,000 during the remainder of 2012, using existing cash balances or borrowings under our revolving credit facility.  As we fund these improvements, the minimum return payable to us increases.