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HOSPITALITY PROPERTIES TRUST 10-Q 2010

Table of Contents

 

 

 

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, 2010

 

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.)

 

 

 

400 Centre Street, 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

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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, $0.01 par value per share, outstanding as of November 7, 2010: 123,444,235

 

 

 



Table of Contents

 

HOSPITALITY PROPERTIES TRUST

 

FORM 10-Q

 

September 30, 2010

 

INDEX

 

 

 

 

 

Page

PART I

 

Financial Information (unaudited)

 

 

 

 

 

 

 

 

 

Item 1. Financial Statements

 

 

 

 

Condensed Consolidated Balance Sheets — September 30, 2010 and December 31, 2009

 

3

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income — Three and Nine Months Ended September 30, 2010 and 2009

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Nine Months Ended September 30, 2010 and 2009

 

5

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

 

 

 

 

 

 

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

 

17

 

 

 

 

 

 

 

Item 3
Quantitative and Qualitative Disclosures About Market Risk

 

31

 

 

 

 

 

 

 

Item 4
Controls and Procedures

 

33

 

 

 

 

 

 

 

Warning Concerning Forward Looking Statements

 

34

 

 

 

 

 

 

 

Statement Concerning Limited Liability

 

36

 

 

 

 

 

PART II

 

Other Information

 

 

 

 

 

 

 

 

 

Item 1A
Risk Factors

 

38

 

 

 

 

 

 

 

Item 2
Unregistered Sales of Equity Securities and Use of Proceeds

 

39

 

 

 

 

 

 

 

Item 6
Exhibits

 

39

 

 

 

 

 

 

 

Signatures

 

40

 

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.

 

2



Table of Contents

 

PART I                             Financial Information

 

Item 1.  Financial Statements

 

HOSPITALITY PROPERTIES TRUST

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(dollars in thousands, except share data)

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Real estate properties, at cost:

 

 

 

 

 

Land

 

$

1,377,108

 

$

1,392,472

 

Buildings, improvements and equipment

 

4,987,426

 

5,074,660

 

 

 

6,364,534

 

6,467,132

 

Accumulated depreciation

 

(1,316,278

)

(1,260,624

)

 

 

5,048,256

 

5,206,508

 

Cash and cash equivalents

 

4,862

 

130,399

 

Restricted cash (FF&E reserve escrow)

 

66,781

 

25,083

 

Other assets, net

 

210,071

 

186,380

 

 

 

$

5,329,970

 

$

5,548,370

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Revolving credit facility

 

$

123,000

 

$

 

Senior notes, net of discounts

 

1,885,973

 

1,934,818

 

Convertible senior notes, net of discount

 

77,161

 

255,269

 

Mortgage payable

 

3,407

 

3,474

 

Security deposits

 

131,838

 

151,587

 

Accounts payable and other liabilities

 

76,796

 

103,678

 

Due to affiliate

 

11,320

 

2,859

 

Dividends payable

 

4,754

 

4,754

 

Total liabilities

 

2,314,249

 

2,456,439

 

 

 

 

 

 

 

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; 3,450,000 shares issued and outstanding, aggregate liquidation preference $86,250

 

83,306

 

83,306

 

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

 

306,833

 

306,833

 

Common shares of beneficial interest, $0.01 par value; 150,000,000 shares authorized 123,444,235 and 123,380,335 issued and outstanding, respectively

 

1,234

 

1,234

 

Additional paid in capital

 

3,462,169

 

3,462,209

 

Cumulative net income

 

2,135,469

 

2,021,162

 

Cumulative other comprehensive income

 

1,736

 

3,230

 

Cumulative preferred distributions

 

(175,931

)

(153,521

)

Cumulative common distributions

 

(2,799,095

)

(2,632,522

)

Total shareholders’ equity

 

3,015,721

 

3,091,931

 

 

 

$

5,329,970

 

$

5,548,370

 

 

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

 

3



Table of Contents

 

HOSPITALITY PROPERTIES TRUST

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(in thousands, except per share data)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Revenues:

 

 

 

 

 

 

 

 

 

Hotel operating revenues

 

$

193,626

 

$

184,595

 

$

558,900

 

$

547,507

 

Rental income

 

81,695

 

75,136

 

241,774

 

223,862

 

FF&E reserve income

 

5,877

 

4,692

 

17,023

 

14,409

 

Total revenues

 

281,198

 

264,423

 

817,697

 

785,778

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

128,601

 

120,364

 

364,058

 

354,617

 

Depreciation and amortization

 

57,997

 

61,311

 

179,260

 

184,244

 

General and administrative

 

10,082

 

10,378

 

29,396

 

29,977

 

Total expenses

 

196,680

 

192,053

 

572,714

 

568,838

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

84,518

 

72,370

 

244,983

 

216,940

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

33

 

28

 

216

 

98

 

Interest expense (including amortization of deferred financing costs and debt discounts of $1,488, $2,354, $5,629 and $8,660, respectively)

 

(33,475

)

(34,943

)

(105,367

)

(106,510

)

Gain (loss) on extinguishment of debt

 

 

11,209

 

(6,720

)

51,097

 

Loss on asset impairment

 

 

 

(16,384

)

 

Equity in earnings (losses) of an investee

 

34

 

(23

)

(17

)

(132

)

Income before income taxes

 

51,110

 

48,641

 

116,711

 

161,493

 

Income tax expense

 

(878

)

(375

)

(2,404

)

(1,124

)

 

 

 

 

 

 

 

 

 

 

Net income

 

50,232

 

48,266

 

114,307

 

160,369

 

Preferred distributions

 

(7,470

)

(7,470

)

(22,410

)

(22,410

)

Net income available for common shareholders

 

$

42,762

 

$

40,796

 

$

91,897

 

$

137,959

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

123,399

 

118,780

 

123,389

 

102,796

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Net income available for common shareholders

 

$

0.35

 

$

0.34

 

$

0.74

 

$

1.34

 

 

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

 

4



Table of Contents

 

HOSPITALITY PROPERTIES TRUST

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

 

 

For the Nine Months Ended September 30,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

114,307

 

$

160,369

 

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

 

 

 

 

 

Depreciation and amortization

 

179,260

 

184,244

 

Amortization of deferred financing costs and debt discounts as interest

 

5,629

 

8,660

 

Security deposits applied to payment shortfalls

 

(19,749

)

(10,577

)

FF&E reserve income and deposits

 

(44,451

)

(37,833

)

(Gain) loss on extinguishment of debt

 

6,720

 

(51,097

)

Loss on asset impairment

 

16,384

 

 

Equity in losses of an investee

 

17

 

132

 

Other non-cash (income) expense, net

 

(1,943

)

(1,666

)

Changes in assets and liabilities:

 

 

 

 

 

(Increase) decrease in other assets

 

(1,585

)

1,213

 

Decrease in accounts payable and other liabilities

 

(23,730

)

(33,610

)

Increase in due to affiliate

 

8,461

 

8,249

 

Cash provided by operating activities

 

239,320

 

228,084

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Real estate acquisitions and improvements

 

(7,043

)

(6,500

)

FF&E reserve fundings

 

(55,004

)

(60,568

)

Investment in Affiliates Insurance Company

 

(76

)

(5,109

)

Cash used in investing activities

 

(62,123

)

(72,177

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common shares, net

 

 

372,958

 

Issuance of senior notes, net of discount

 

 

296,961

 

Repurchase of convertible senior notes

 

(185,626

)

(258,102

)

Repurchase of senior notes

 

 

(45,239

)

Repayment of senior notes

 

(50,000

)

 

Draws on revolving credit facility

 

228,000

 

389,000

 

Repayments of revolving credit facility

 

(105,000

)

(785,000

)

Deferred financing costs

 

(1,125

)

(2,149

)

Distributions to preferred shareholders

 

(22,410

)

(22,410

)

Distributions to common shareholders

 

(166,573

)

(72,374

)

Cash used in financing activities

 

(302,734

)

(126,355

)

(Decrease) increase in cash and cash equivalents

 

(125,537

)

29,552

 

Cash and cash equivalents at beginning of period

 

130,399

 

22,450

 

Cash and cash equivalents at end of period

 

$

4,862

 

$

52,002

 

 

5



Table of Contents

 

HOSPITALITY PROPERTIES TRUST

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)

(in thousands)

 

 

 

For the Nine Months Ended September 30,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

Cash paid for interest

 

$

126,619

 

$

118,832

 

Cash paid for income taxes

 

1,737

 

1,942

 

Non-cash investing activities:

 

 

 

 

 

Property managers’ deposits in FF&E reserve

 

$

45,309

 

$

37,718

 

Property managers’ purchases with FF&E reserve

 

(58,615

)

(61,551

)

Non-cash financing activities:

 

 

 

 

 

Issuance of common shares

 

$

1,018

 

$

624

 

 

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

 

6



Table of Contents

 

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, have been prepared without audit. 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, 2009, or the 2009 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.  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 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, or the Codification.   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

 

Effective January 1, 2010, we adopted the updated Consolidation Topic of the Codification that requires ongoing reassessments of whether an enterprise is the primary beneficiary of a VIE. The previous standard required reconsideration of whether an enterprise is the primary beneficiary of a VIE only when specific events occurred.  This Topic was updated to eliminate the quantitative approach previously required for determining the primary beneficiary of a VIE and amended certain guidance for determining whether an entity is a VIE.  The implementation of this guidance did not change our determination that each of our TRSs is a VIE that we must consolidate.

 

In January 2010, the FASB issued an accounting standards update requiring additional disclosures regarding fair value measurements. The update requires entities to disclose additional information regarding assets and liabilities that are transferred between levels within the fair value hierarchy. The update also clarifies the level of disaggregation at which fair value disclosures should be made and the requirements to disclose information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair values. The update is effective for interim and annual reporting periods beginning after December 15, 2009 except for the requirement to separately disclose purchases, sales, issuances and settlements in the Level 3 roll forward that becomes effective for fiscal periods beginning after December 15, 2010.  The implementation of this update did not, and is not expected to, cause any material changes to the disclosures in our condensed consolidated financial statements.

 

Note 3.  Revenue Recognition

 

We report hotel operating revenues for managed hotels in our condensed consolidated statements of 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,

 

7



Table of Contents

 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

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, 2010 and 2009, respectively.

 

 

We recognize rental income from operating leases on a straight line basis over the term of the lease agreements. Beginning in the 2008 second quarter, we ceased recognition of straight line rental income for our lease with TravelCenters of America, or TA, for 145 travel centers.  See Notes 10 and 11 for further information relating to TA.  We determine percentage rent due to us under our leases annually and recognize it at year end when all contingencies are met and the rent is earned. We had deferred percentage rent of $375 and $1,163 for the three and nine months ended September 30, 2010, respectively, and $180 and $1,163 for the three and nine months ended September 30, 2009, respectively.

 

We own all the capital expenditure reserves, or FF&E reserve escrows, 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 compute 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, 2010 or 2009.

 

Note 5.  Shareholders’ Equity

 

Distributions

 

On January 15, 2010, April 15, 2010 and July 15, 2010, we paid a $0.5546875 per share distribution to our Series B preferred shareholders with respect to the periods ended January 14, 2010, April 14, 2010 and July 14, 2010, respectively. On September 1, 2010, we declared a $0.5546875 per share distribution to our Series B preferred shareholders of record on September 30, 2010, with respect to the period ended October 14, 2010. We paid this amount on October 15, 2010.

 

On February 16, 2010, May 17, 2010 and August 16, 2010, we paid a $0.4375 per share distribution to our Series C preferred shareholders with respect to the periods ended February 14, 2010, May 16, 2010 and August 14, 2010, respectively.  On October 1, 2010, we declared a $0.4375 per share distribution to our Series C preferred shareholders of record on October 29, 2010, with respect to the period ending November 14, 2010. We expect to pay this amount on or about November 15, 2010.

 

On February 22, 2010, May 24, 2010 and August 24, 2010, we paid a $0.45 per share distribution to our common shareholders.  On October 13, 2010, we declared a $0.45 per share distribution to our common shareholders of record on October 29, 2010.  We expect to pay this amount on or about November 23, 2010.

 

Common Share Issuances

 

On April 15, 2010, pursuant to our equity compensation plan, we granted 2,000 common shares, valued at $26.00 per share, the closing price of our common shares on the New York Stock Exchange on that day, to each of our five trustees as part of their annual compensation.

 

On September 17, 2010, pursuant to our equity compensation plan, we granted an aggregate of 53,900 common shares, valued at $22.01 per share, the closing price of our common shares on the NYSE on that day, to our officers and certain key employees of Reit Management & Research LLC, or RMR.

 

8



Table of Contents

 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Comprehensive Income

 

Cumulative other comprehensive income represents the unrealized gain on the shares of TA common stock we own (see Note 11).  The following is a reconciliation of net income to comprehensive income for the three and nine months ended September 30, 2010 and 2009:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income

 

$

50,232

 

$

48,266

 

$

114,307

 

$

160,369

 

Increase (decrease) in unrealized gain on TA common stock

 

1,740

 

5,294

 

(1,494

)

5,341

 

Comprehensive income

 

$

51,972

 

$

53,560

 

$

112,813

 

$

165,710

 

 

Note 6.  Indebtedness

 

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 are amortizing the resulting discount as an increase to interest expense over the expected life of the debt (assuming holders exercise their put option on March 20, 2012).

 

·                  The net carrying amount of our 3.8% convertible senior notes due 2027 was $77,161 and $255,269 as of September 30, 2010 and December 31, 2009, respectively.

 

·                  The unamortized discount on the notes was $1,893 and $9,481 as of September 30, 2010 and December 31, 2009, respectively. We expect to amortize the discount through March 20, 2012, the first date on which the holders of our convertible notes may require that we redeem them.

 

·                  Interest expense for the three months ended September 30, 2010 and 2009 increased because of non-cash amortization of $380, or $0.00 per share, and $1,301, or $0.01 per share, respectively. For the nine months ended September 30, 2010 and 2009, interest expense increased because of non-cash amortization of $2,217, or $0.02 per share, and $5,651, or $0.05 per share, respectively.

 

·                  The equity component of the notes as of September 30, 2010 is $37,710.

 

During the second quarter of 2010, we repurchased an aggregate of $185,696 of our 3.8% convertible senior notes due 2027 at a total cost of $185,626, excluding accrued interest, and recognized a $6,720 non-cash loss on extinguishment of debt, net of unamortized discount and issuance costs of $7,260, $1,058 of the equity component of the notes and $588 of transaction costs.

 

We have a $750,000 interest only, unsecured revolving credit facility. In September 2010, we exercised our option to extend the final maturity date of our credit facility by one year to October 24, 2011, upon payment of a $1,125 extension fee.  The interest rate on drawings under the credit facility is LIBOR plus a spread and was 0.81% per annum at September 30, 2010. As of September 30, 2010, we had $123,000 outstanding under our revolving credit facility and $627,000 available to be drawn for general business purposes, including acquisitions.

 

On July 15, 2010, we redeemed at par plus accrued interest $50,000 of our 9.125% senior notes.

 

Note 7.  Real Estate Properties

 

At September 30, 2010, we owned 474 properties consisting of 289 hotels and 185 travel centers.  All of these properties are operated under 13 management agreements or leases.

 

During the nine months ended September 30, 2010, we funded $62,047 of improvements to certain of our properties, which resulted in a $5,500 increase in our annual minimum returns and rents.

 

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Table of Contents

 

HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

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, 2010, we recognized current tax expense of $878 and $2,404, respectively, which includes $35 and $105, respectively, of foreign taxes and $889 and $2,437, respectively, of federal alternative minimum tax and 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 September 30, 2010, we recognized a deferred tax benefit of $46 and $138, respectively, related to a tax versus book basis difference at our Puerto Rico hotel.

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Note 9.  Segment Information

 

 

 

For the Three Months Ended September 30, 2010

 

 

 

Hotels

 

Travel Centers

 

Corporate

 

Consolidated

 

Hotel operating revenues

 

$

193,626

 

$

 

$

 

$

193,626

 

Rental income

 

33,880

 

47,815

 

 

81,695

 

FF&E reserve income

 

5,877

 

 

 

5,877

 

Total revenues

 

233,383

 

47,815

 

 

281,198

 

 

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

128,601

 

 

 

128,601

 

Depreciation and amortization expense

 

38,205

 

19,792

 

 

57,997

 

General and administrative expense

 

 

 

10,082

 

10,082

 

Total expenses

 

166,806

 

19,792

 

10,082

 

196,680

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

66,577

 

28,023

 

(10,082

)

84,518

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

33

 

33

 

Interest expense

 

 

 

(33,475

)

(33,475

)

Equity in earnings of an investee

 

 

 

34

 

34

 

Income (loss) before income taxes

 

66,577

 

28,023

 

(43,490

)

51,110

 

Income tax expense

 

 

 

(878

)

(878

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

66,577

 

$

28,023

 

$

(44,368

)

$

50,232

 

 

 

 

For the Nine Months Ended September 30, 2010

 

 

 

Hotels

 

Travel Centers

 

Corporate

 

Consolidated

 

Hotel operating revenues

 

$

558,900

 

$

 

$

 

$

558,900

 

Rental income

 

100,023

 

141,751

 

 

241,774

 

FF&E reserve income

 

17,023

 

 

 

17,023

 

Total revenues

 

675,946

 

141,751

 

 

817,697

 

 

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

364,058

 

 

 

364,058

 

Depreciation and amortization expense

 

118,517

 

60,743

 

 

179,260

 

General and administrative expense

 

 

 

29,396

 

29,396

 

Total expenses

 

482,575

 

60,743

 

29,396

 

572,714

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

193,371

 

81,008

 

(29,396

)

244,983

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

216

 

216

 

Interest expense

 

 

 

(105,367

)

(105,367

)

Loss on extinguishment of debt

 

 

 

(6,720

)

(6,720

)

Loss on asset impairment

 

(16,384

)

 

 

(16,384

)

Equity in losses of an investee

 

 

 

(17

)

(17

)

Income (loss) before income taxes

 

176,987

 

81,008

 

(141,284

)

116,711

 

Income tax expense

 

 

 

(2,404

)

(2,404

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

176,987

 

$

81,008

 

$

(143,688

)

$

114,307

 

 

 

 

As of September 30, 2010

 

 

 

Hotels

 

Travel Centers

 

Corporate

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

3,084,978

 

$

2,224,642

 

$

20,350

 

$

5,329,970

 

 

11



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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, 2009

 

 

 

Hotels

 

Travel Centers

 

Corporate

 

Consolidated

 

Hotel operating revenues

 

$

      184,595

 

$

 

$

              —

 

$

     184,595

 

Rental income

 

32,583

 

42,553

 

 

75,136

 

FF&E reserve income

 

4,692

 

 

 

4,692

 

Total revenues

 

221,870

 

42,553

 

 

264,423

 

 

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

120,364

 

 

 

120,364

 

Depreciation and amortization expense

 

40,897

 

20,414

 

 

61,311

 

General and administrative expense

 

 

 

10,378

 

10,378

 

Total expenses

 

161,261

 

20,414

 

10,378

 

192,053

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

60,609

 

22,139

 

(10,378

)

72,370

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

28

 

28

 

Interest expense

 

 

 

(34,943

)

(34,943

)

Gain on extinguishment of debt

 

 

 

11,209

 

11,209

 

Equity in losses of an investee

 

 

 

(23

)

(23

)

Income (loss) before income taxes

 

60,609

 

22,139

 

(34,107

)

48,641

 

Income tax expense

 

 

 

(375

)

(375

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

        60,609

 

$

     22,139

 

$

     (34,482

)

$

       48,266

 

 

 

 

For the Nine Months Ended September 30, 2009

 

 

 

Hotels

 

Travel Centers

 

Corporate

 

Consolidated

 

Hotel operating revenues

 

$

547,507

 

$

 

$

 

$

547,507

 

Rental income

 

96,561

 

127,301

 

 

223,862

 

FF&E reserve income

 

14,409

 

 

 

14,409

 

Total revenues

 

658,477

 

127,301

 

 

785,778

 

 

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

354,617

 

 

 

354,617

 

Depreciation and amortization expense

 

121,837

 

62,407

 

 

184,244

 

General and administrative expense

 

 

 

29,977

 

29,977

 

Total expenses

 

476,454

 

62,407

 

29,977

 

568,838

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

182,023

 

64,894

 

(29,977

)

216,940

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

98

 

98

 

Interest expense

 

 

 

(106,510

)

(106,510

)

Gain on extinguishment of debt

 

 

 

51,097

 

51,097

 

Equity in losses of an investee

 

 

 

(132

)

(132

)

Income (loss) before income taxes

 

182,023

 

64,894

 

(85,424

)

161,493

 

Income tax expense

 

 

 

(1,124

)

(1,124

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

182,023

 

$

64,894

 

$

(86,548

)

$

160,369

 

 

 

 

As of December 31, 2009

 

 

 

Hotels

 

Travel Centers

 

Corporate

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

3,128,108

 

$

2,278,942

 

$

141,320

 

$

5,548,370

 

 

12



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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

Note 10. Significant Tenant

 

TA is the lessee of 39% of our real estate investments, at cost, as of September 30, 2010.  The following table presents summary financial information for TA for its quarter ended September 30, 2010, as reported in its Quarterly Report on Form 10-Q, or TA’s Quarterly Report:

 

 

 

For the Three Months Ended
September 30,

 

 

 

2010

 

2009

 

Operations

 

 

 

 

 

Total revenues

 

$

1,513,110

 

$

1,281,919

 

Total cost of goods sold

 

1,252,827

 

1,049,323

 

Net income (loss)

 

4,466

 

(12,237

)

 

 

 

For the Nine Months Ended
September 30,

 

 

 

2010

 

2009

 

Total revenues

 

$

4,401,220

 

$

3,376,807

 

Total cost of goods sold

 

3,682,898

 

2,701,661

 

Net loss

 

(35,577

)

(45,313

)

 

 

 

 

 

 

Cash Flows

 

 

 

 

 

Net cash provided by operating activities

 

48,085

 

68,152

 

Net cash used in investing activities

 

(33,735

)

(28,371

)

Net increase in cash

 

14,352

 

39,829

 

Cash and cash equivalents at the beginning of the period

 

155,632

 

145,516

 

Cash and cash equivalents at the end of the period

 

169,984

 

185,345

 

 

 

 

As of September 30,

 

 

 

2010

 

2009

 

Financial Position

 

 

 

 

 

Current assets

 

$

447,168

 

$

446,614

 

Noncurrent assets

 

478,339

 

478,848

 

Current liabilities

 

387,446

 

230,418

 

Noncurrent liabilities

 

257,727

 

336,546

 

Total shareholders’ equity

 

280,334

 

358,498

 

 

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 these financial statements to TA’s Quarterly Report are included as textual references only, and the information in TA’s Quarterly Report is not incorporated by reference into these financial statements.

 

During the three and nine months ended September 30, 2010 and 2009, TA deferred $15,000 and $45,000, respectively, of rent under the terms of the rent deferral agreement dated August 11, 2008. As of September 30, 2010, TA has deferred $135,000 of rent due to us and may defer additional rent of up to $5,000 per month until December 2010.  For the month of October 2010, TA continued to defer $5,000 of rent as permitted under the agreement.  If TA defers the maximum amount permitted by its rent deferral agreement with us, the deferred rent due to us will total $150,000 at December 31, 2010, although we have not recognized any of the deferred rent as rental income or as rents receivable due to uncertainties regarding future payments of these amounts by TA.  Our agreement with TA requires TA to pay us the entire balance due on or before July 1, 2011.  TA has reported in an SEC filing that it expects to engage in discussions with us to consider modifications of its leases with us and alternatives available to satisfy its obligations to pay the deferred rent amount that is due on or before July 1, 2011.  We expect to engage in such discussions.  We can provide no assurance that we will be able to reach an agreement on any such modifications or alternatives.  Under the terms of the deferral agreement, interest began to accrue on deferred amounts outstanding on January 1, 2010, at 1% per month, and we received and recorded $3,750, or $0.03 per share, and $9,900, or $0.08 per share, of income for the three and nine months ended September 30, 2010, respectively; these payments have been reflected as rental income in our condensed consolidated statements of income in accordance with GAAP.  We recognized rental income of $47,815 and

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

$141,751 for the three and nine months ended September 30, 2010, respectively, and $42,553 and $127,301 for the three and nine months ended September 30, 2009, respectively, under our lease agreements with TA.

 

Note 11. Related Person Transactions

 

RMR provides both business and property management services to us under a business management agreement and a property management agreement, each as amended in January 2010.  In connection with these agreements with RMR, we recognized expenses of $8,378 and $24,786, and $8,320 and $24,626 for the three and nine months ended September 30, 2010 and 2009, respectively.  These amounts are included in general and administrative expenses in our condensed consolidated statements of income.  Our Managing Trustees are the owners of RMR.

 

As of September 30, 2010, we have invested $5,209 in Affiliates Insurance Company, or Affiliates Insurance, concurrently with RMR and other companies to which RMR provides management services.  All of our trustees are currently serving on the board of directors of Affiliates Insurance. At September 30, 2010, we owned approximately 14.29% of Affiliates Insurance.  Although we own less than 20% of Affiliates Insurance, we use the equity method to account for this investment because we believe that we have significant influence over Affiliates Insurance because each of our trustees is a director of Affiliates Insurance. This investment is carried on our condensed consolidated balance sheets in other assets and had a carrying value of $5,058 and $5,000 as of September 30, 2010 and December 31, 2009, respectively. During the three and nine months ended September 30, 2010, we invested an additional $32 and $76, respectively, in Affiliates Insurance. During the three and nine months ended September 30, 2010, we recognized earnings of $34 and a loss of $17, respectively, related to this investment. During the three and nine months ended September 30, 2009, we recognized a loss of $23 and $132, respectively, related to this investment. In June 2010, we, RMR and other companies to which RMR provides management services, purchased property insurance pursuant to an insurance program arranged by Affiliates Insurance. Our annual premium for this property insurance of $4,816 was paid in June 2010. We are currently investigating the possibilities to expand our insurance relationships with Affiliates Insurance to include property insurance for additional properties we own and other types of insurance.

 

TA was formerly our 100% owned subsidiary and it became a public company in a spin off transaction in 2007.  As of September 30, 2010, we owned 1,540,000 common shares of TA (approximately 8.9% of its total shares outstanding).  RMR provides certain management services to both us and TA.

 

For more information about our related person transactions, including our dealings with TA, RMR, Affiliates Insurance, our Managing Trustees and their affiliates and about the risks which may arise as a result of these and other related person transactions, please see our 2009 Annual Report and our other filings made with the SEC, and, in particular, the sections captioned “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Related Person Transactions” in our 2009 Annual Report, the section captioned “Related Person Transactions and the Company Review of Such Transactions” in our Proxy Statement dated February 24, 2010 relating to our 2010 Annual Meeting of Shareholders and in Item 1.01 in our Current Report on Form 8-K filed with the SEC on January 20, 2010.

 

Note 12. Hotel Management Agreements and Leases

 

During the nine months ended September 30, 2010, all payments due to us under our hotel leases and management contracts were paid when due except for certain payments from Marriott International, Inc., or Marriott, and Barceló Crestline Corporation, or Crestline.

 

During the nine months ended September 30, 2010, the payments we received under our management contract with Marriott for 34 hotels that requires minimum annual payments to us of approximately $44,200 (which we have historically referred to as our Marriott No. 3 contract) and under our lease with Crestline for 19 hotels managed by Marriott that requires minimum annual rent payments to us of approximately $28,508 (which we have historically referred to as our Marriott No. 4 contract) were $11,255 and $8,489, respectively, less than the minimum amounts contractually required.  We applied the available security deposits to cover these deficiencies.  Also, during the period between September 30, 2010 and November 7, 2010, we did not receive payments to cure shortfalls for the Marriott No. 3 and Marriott No. 4 contracts of $734 and $246, respectively, and we applied the security deposits we hold to cover these amounts.  As of November 7, 2010, the remaining balances of the security deposits which we hold for the Marriott No. 3 and Marriott No. 4 contracts were $14,997 and $11,178, respectively.

 

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HOSPITALITY PROPERTIES TRUST

Notes to Condensed Consolidated Financial Statements

(dollars in thousands, except per share data)

 

At this time, we expect that Marriott will continue to pay us the net cash flows from operations of the hotels included in the defaulted contracts.  We believe the remaining amounts of security deposits we hold from Marriott and from Crestline for these contracts will exceed the 2010 shortfall of the payments we expect to receive compared to the minimum payments due to us under these contracts. Other than applying the security deposits to pay the differences between the net cash flows received from operations of these hotels and the contractual minimum payments, we have not determined what additional actions, if any, we may take as a result of these defaults.

 

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 cash flow to us of the deficiency amounts, but reducing amounts of security deposits does reduce the refunds due to the respective lessees or managers who have provided us with these deposits.  These deposits are not escrowed.  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 under the respective contracts.

 

As of November 7, 2010, all other payments due to us from our hotel managers and hotel tenants under our operating agreements were current.

 

Minimum return and minimum rent payments due to us under some of our hotel management agreements and leases are supported by guarantees. The guarantee provided by Hyatt Hotels Corporation, or Hyatt, with respect to the 22 hotels managed by Hyatt is limited to $50,000 ($27,201 remaining at September 30, 2010). The guarantee provided by Carlson Hotels Worldwide, or Carlson, with respect to the 11 hotels managed by Carlson is limited to $40,000 ($31,960 remaining at September 30, 2010). The combined guarantee provided by InterContinental Hotels Group plc, or InterContinental, for the 131 hotels managed or leased by InterContinental is limited to $125,000 ($24,745 remaining at September 30, 2010) and will expire if and when the hotels achieve stipulated operating results.  The guarantee provided by Marriott with respect to the one hotel leased by Marriott (our Marriott No. 5 contract) is unlimited and does not expire.

 

Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $18,573 and $59,322, less than the minimum returns due to us in the three and nine months ended September 30, 2010, respectively, and $16,287 and $46,585, less than the minimum returns due to us in the three and nine months ended September 30, 2009, respectively. We reflect these amounts in our condensed consolidated statements of income as a reduction to hotel operating expense when the minimum returns were funded by the manager of these hotels under the terms of our operating agreements, or in the case of our Marriott No. 3 agreement, applied from the security deposit we hold.

 

In November 2008, we were notified by Host Hotels & Resorts Inc., or Host, that it will not exercise its renewal option at the end of the current lease term for 18 hotels which we have historically referred to as our Marriott No. 2 contract.  Upon expiration of the agreement on December 31, 2010, we expect to return the $17,220 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.

 

Although Host has not notified us of its intentions, it has disclosed in filings with the SEC its intent not to 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 contract.  Under the terms of this lease, the tenant is required to provide us written notice of its renewal election no later than December 31, 2010.  If the tenant elects not to renew the lease, 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.

 

In July 2010, we were notified that the subleases between Host and Crestline for the 53 hotels under our Marriott No. 1 contract and the 18 hotels under our Marriott No. 2 contract have been terminated as a result of the Crestline subtenants’ failure to maintain the minimum net worths required by our agreements.  The terms of our leases with Host for these hotels, including the annual minimum rent payable to us under the leases, did not change as a result of the sublease terminations.

 

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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, 2010, categorized by the level of inputs used in the valuation of each asset.

 

 

 

 

 

Fair Value at Reporting Date Using

 

Description

 

Total

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Properties held for sale (1)

 

$

37,151

 

$

 

$

 

$

37,151

 

Investment securities (2)

 

$

5,313

 

$

5,313

 

$

 

$

 

 


(1)          Our properties held for sale are reported at estimated fair value less costs to sell and consist of four properties we expect to sell within one year.  In connection with a decision to pursue the sale of our Crowne Plaza® hotels in Hilton Head, SC and Dallas, TX and our Holiday Inn® hotel in Memphis, TN, we recorded a $16,384, or $0.13 per share, loss on asset impairment in the second quarter of 2010 to reduce the carrying value of these hotels to their estimated fair value less costs to sell.  Our Staybridge Suites® hotel in Dallas, TX, is also being offered for sale but we estimate the fair value less costs to sell of this hotel is greater than its carrying value.  We estimated the fair value of these hotels using standard industry valuation techniques and estimates of value developed by hotel brokerage firms (Level 3 inputs).  There was no change in the carrying value of these hotels during the three months ended September 30, 2010.  The carrying value of the properties is included in Other assets in our September 30, 2010, condensed consolidated balance sheet.

 

(2)          Our investment securities are reported at fair value which is based on quoted market prices (Level 1 inputs).

 

In addition to the investment securities included in the table above, our financial instruments include our cash and cash equivalents, restricted cash, revolving credit facility, senior notes and mortgage notes payable, and security deposits. At September 30, 2010 and December 31, 2009, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

 

 

 

 

 

 

 

 

 

 

Mortgage Note, due 2011 at 8.3%

 

3,407

 

3,548

 

3,474

 

3,496

 

Senior Notes, due 2012 at 6.85%

 

100,829

 

108,508

 

100,829

 

106,453

 

Senior Notes, due 2013 at 6.75%

 

287,000

 

311,280

 

287,000

 

299,250

 

Senior Notes, due 2014 at 7.875%

 

300,000

 

346,788

 

300,000

 

321,020

 

Senior Notes, due 2015 at 5.125%

 

280,000

 

294,981

 

280,000

 

262,330

 

Senior Notes, due 2016 at 6.3%

 

275,000

 

306,840

 

275,000

 

258,907

 

Senior Notes, due 2017 at 5.625%

 

300,000

 

317,948

 

300,000

 

270,594

 

Convertible Senior Notes, due 2027 at 3.8%

 

79,054

 

80,874

 

264,750

 

265,280

 

Senior Notes, due 2018 at 6.7%

 

350,000

 

394,942

 

350,000

 

337,051

 

Unamortized discounts

 

(8,749

)

 

(17,492

)

 

Total financial liabilities

 

$

1,966,541

 

$

2,165,709

 

$

2,143,561

 

$

2,124,381

 

 

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

 

16



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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 and with our 2009 Annual Report.

 

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

 

2010 Developments

 

U.S. hotel industry - The U.S. hotel industry continues to experience the financial effects of the recent recession.  In both 2008 and 2009, the U.S. hotel industry generally experienced declines versus the previous year in occupancy, revenues and profitability.  Although each of our hotel operators reported increases in occupancy during the first three quarters of 2010, the majority of our hotel properties continued to experience declines in average daily rate and higher operating expenses resulting in lower profitability at our hotels.  Nonetheless, as of September 30, 2010, all minimum returns and rent payments due to us under our hotel operating agreements were current except for the Marriott No. 3 and No. 4 agreements discussed below.

 

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 rents and returns is not assured, particularly if the U.S. economy and the lodging industry takes an extended period to recover from the severe declines experienced during the recent recession.  If our tenants, managers or guarantors default in their payment obligations to us, our cash flows will decline.

 

Our tenants and managers - During the nine months ended September 30, 2010, all payments due to us under our hotel leases and hotel management contracts were paid when due except for certain payments from Marriott and Crestline.

 

During the nine months ended September 30, 2010, the payments we received under our Marriott No. 3 contract that requires minimum annual payments to us of approximately $44,200, and under our Marriott No. 4 contract that requires minimum annual rent payments to us of approximately $28,508, were $11,255 and $8,489, respectively, less than the minimum amounts contractually required.  We applied the available security deposits to cover these deficiencies.  Also, during the period between September 30, 2010 and November 7, 2010, we did not receive payments to cure shortfalls for the Marriott No. 3 and Marriott No. 4 contracts of $734 and $246, respectively, and we applied the security deposits we hold to cover these amounts.  At November 7, 2010, the remaining balances of the security deposits which we hold for the Marriott No. 3 and Marriott No. 4 contracts were $14,997 and $11,178, respectively.

 

At this time, we expect that Marriott will continue to pay us the net cash flows from operations of the hotels included in the defaulted contracts.  We believe the remaining amounts of security deposits we hold from Marriott and from Crestline for these contracts will exceed the 2010 shortfall of the payments we expect to receive compared to the minimum payments due to us under these contracts. Other than applying the security deposits to pay the differences between the net cash flows received from operations of these hotels and the contractual minimum payments, we have not determined what additional actions, if any, we may take as a result of these defaults.

 

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 cash flow to us of the deficiency amounts, but reducing amounts of security deposits does reduce the refunds due to the respective lessees or managers who have provided us with these deposits.  These deposits are not escrowed.  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 under the respective contracts.

 

As of November 7, 2010, all other payments due to us from our hotel managers and hotel tenants under our operating agreements were current.

 

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

 

TA rent deferral - In each of the first three quarters of 2010 and 2009, respectively, TA deferred $15,000 of rent under the provisions of the rent deferral agreement entered by us and TA in August of 2008.  As of September 30, 2010, TA has deferred $135,000 of rent due to us and may defer additional rent of up to $5,000 per month until December 2010.  For the month of October 2010, TA continued to defer $5,000 of rent as permitted under the agreement.  If TA defers the maximum amount permitted by its rent deferral agreement with us, the deferred rent due to us will total $150,000 at December 31, 2010.  We have not recognized any of the deferred rent as rental income or as rents receivable due to uncertainties regarding future payments of these amounts by TA, our agreement with TA requires TA to pay us the entire balance due on or before July 1, 2011.  TA has reported in an SEC filing that it expects to engage in discussions with us to consider modifications of its leases with us and alternatives available to satisfy its obligations to pay the deferred rent amount that is due on or before July 1, 2011.  We expect to engage in such discussions.  We can provide no assurance that we will be able to reach an agreement on any such modifications or alternatives.  We are also unable to predict the effect that any agreement we may reach would have on the amount of the total rent deferral or the timing of its repayment to us.  Under the terms of this agreement, interest began to accrue on deferred amounts outstanding on January 1, 2010, at 1% per month, and we received and recorded $3,750, or $0.03 per share, and $9,900, or $0.08 per share, of income for the three and nine months ended September 30, 2010, respectively, which has been reflected as rental income in our condensed consolidated statements of income in accordance with GAAP.  TA was formerly our 100% owned subsidiary and it became a public company in a spin off transaction in 2007.  RMR provides management services to both us and TA.  For more information about our relationship with TA and RMR and concerning the risks inherent in TA’s business and arising from these relationships, please see our 2009 Annual Report under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors and our Proxy Statement dated February 24, 2010 relating to our 2010 Annual Meeting of Shareholders under the caption “Related Person Transactions and Company Review of Such Transactions”.

 

Management Agreements and Leases

 

At September 30, 2010, our 289 hotels were operated under 11 operating agreements, including 197 hotels leased to our wholly owned TRSs and managed by independent hotel operating companies and 92 hotels leased to third parties.  We lease our 185 travel centers to TA under two agreements. Our condensed consolidated statements of income include operating revenues and expenses of our managed hotels and rental income for leased hotels and travel centers. Additional information regarding the terms of our management agreements and leases is included in the table on pages 28 and 29 below.

 

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

 

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

 

Three Months Ended September 30, 2010 versus 2009

 

 

 

For the Three Months Ended September 30,

 

 

 

2010

 

2009

 

Increase
(Decrease)

 

% Increase
(Decrease)

 

Revenues:

 

 

 

 

 

 

 

 

 

Hotel operating revenues

 

$

193,626

 

$

184,595

 

$

9,031

 

4.9

%

Rental income:

 

 

 

 

 

 

 

 

 

Minimum rents - hotels

 

33,880

 

32,583

 

1,297

 

4.0

%

Minimum rents - travel centers

 

47,815

 

42,553

 

5,262

 

12.4

%

Total rental income

 

81,695

 

75,136

 

6,559

 

8.7

%

FF&E reserve income

 

5,877

 

4,692

 

1,185

 

25.3

%

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Hotel operating expenses

 

128,601

 

120,364

 

8,237

 

6.8

%

Depreciation and amortization - hotels

 

38,205

 

40,897

 

(2,692

)

(6.6

)%

Depreciation and amortization - travel centers

 

19,792

 

20,414

 

(622

)

(3.0

)%

Total depreciation and amortization

 

57,997

 

61,311

 

(3,314

)

(5.4

)%

General and administrative

 

10,082

 

10,378

 

(296

)

(2.9

)%

 

 

 

 

 

 

 

 

 

 

Operating income

 

84,518

 

72,370

 

12,148

 

16.8

%

 

 

 

 

 

 

 

 

 

 

Interest income

 

33

 

28

 

5

 

17.9

%

Interest expense

 

(33,475

)

(34,943

)

(1,468

)

(4.2

)%

Gain on extinguishment of debt

 

 

11,209

 

(11,209

)

 

Equity in earnings (losses) of an investee

 

34

 

(23

)

57

 

247.8

%

Income before income taxes

 

51,110

 

48,641

 

2,469

 

5.1

%

Income tax expense

 

(878

)

(375

)

503

 

134.1

%

 

 

 

 

 

 

 

 

 

 

Net income

 

50,232

 

48,266

 

1,966

 

4.1

%

Net income available for common shareholders

 

42,762

 

40,796

 

1,966

 

4.8

%

Weighted average shares outstanding

 

123,399

 

118,780

 

4,619

 

3.9

%

Net income available for common shareholders per common share

 

$

0.35

 

$

0.34

 

$

0.01

 

2.9

%

 

The increase in hotel operating revenues in the third quarter of 2010 compared to the third quarter of 2009 was caused by the increase in revenues at our managed hotels. Revenues at most of our managed hotels increased from the third quarter of 2009 due to higher occupancy rates, partially offset by declines in average daily room rates, or ADR at certain of our hotels. Additional operating statistics of our hotels are included in the table on page 30.

 

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 in 2009 and 2010.

 

The increase in rental income - travel centers is a result of contractual rent increases in our lease agreement with TA for 145 travel centers and $3,750 as a result of interest earned on deferred rent amounts in 2010.  Rental income for both periods excludes the $15,000 of rent deferred by TA under our rent deferral agreement discussed above.

 

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

 

FF&E reserve income represents amounts paid by 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 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 due to increases in the percentage of sales contributed to our FF&E reserves by some of our tenants in 2010 and increased levels of hotel sales in 2010 versus 2009 at our leased hotels. We do not report the amounts 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 increased expenses associated with higher occupancy at our managed hotels partially offset by the funding by certain of our managers of minimum return deficiencies and our application of a security deposit to cover minimum return deficiencies. Certain of our managed hotel portfolios had net operating results that were, in the aggregate, $18,573 and $16,287 less than the minimum returns due to us in the three months ended September 30, 2010 and 2009, respectively.  We reflect these amounts in our condensed consolidated statements of income as a reduction to hotel operating expense because the minimum returns were funded by the managers of these hotels under the terms of our operating agreements, or in the case of our Marriott No. 3 agreement, applied from the security deposit we hold.

 

The decrease in depreciation and amortization - hotels is primarily due to fully depreciated improvements that were retired, partially offset by the depreciation and amortization of assets acquired with funds from FF&E reserve accounts owned by us in 2009 and 2010.

 

The decrease in depreciation and amortization - travel centers is primarily due to fully depreciated improvements that were retired, partially offset by the depreciation and amortization of improvements made to our travel centers during 2009 and 2010.

 

The decrease in general and administrative costs is primarily due to lower professional services fees in 2010 versus 2009.

 

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

 

The increase in interest income is due to higher average restricted cash balances during 2010 versus 2009.

 

The decrease in interest expense is primarily due to lower average borrowings, partially offset by higher weighted average interest rates in the 2010 period compared to the 2009 period.

 

During the third quarter of 2009, we recorded a $11,209 gain on the extinguishment of debt relating to our purchase of $175,420 face amount of our 3.8% convertible senior notes due 2027 for an aggregate purchase price of $159,532, excluding accrued interest.  The gain on extinguishment of debt is net of unamortized issuance costs and discounts of $9,534 and a portion of the equity component of the notes of $4,854.

 

Equity in earnings (losses) of an investee represents our proportionate share of earnings (losses) of Affiliates Insurance.

 

The increase in income tax expense is primarily the result of an increase in taxable income for state income tax purposes as a result of lower tax depreciation in 2010.

 

The increase in weighted average shares outstanding is primarily a result of our public offerings of a total of 11,825,000 common shares during the third quarter of 2009.

 

The increase in net income, net income available for common shareholders and net income available for common shareholders per common share are primarily due to the investment, operating and financing activities discussed above.  On a per share basis, the percentage increase in net income available for common shareholders is lower due to the increase in our weighted average common shares outstanding described above.

 

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

 

Nine Months Ended September 30, 2010 versus 2009

 

 

 

For the Nine Months Ended September 30,

 

 

 

2010

 

2009

 

Increase
(Decrease)

 

% Increase
(Decrease)

 

Revenues:

 

 

 

 

 

 

 

 

 

Hotel operating revenues

 

$

558,900

 

$

547,507

 

$

11,393

 

2.1

%

Rental Income:

 

 

 

 

 

 

 

 

 

Minimum rents - hotels

 

100,023

 

96,561

 

3,462

 

3.6

%

Minimum rents - travel centers

 

141,751

 

127,301

 

14,450

 

11.4

%

Total rental income

 

241,774

 

223,862

 

17,912

 

8.0

%

FF&E reserve income

 

17,023

 

14,409

 

2,614

 

18.1

%