SVC

Business Context and Reporting Period

Company: Hospitality Properties Trust (HPT), a Maryland real estate investment trust (REIT).

Reporting Period: Fiscal year ended December 31, 2005.

Business Overview: HPT owns and invests in hotels, which are operated by unaffiliated third parties under long-term management agreements or leases. As of December 31, 2005, the portfolio consisted of 298 hotels with 42,376 rooms located in 38 U.S. states, Canada, and Puerto Rico. The company's strategy focuses on acquiring high-quality hotels that generate returns exceeding operating costs, utilizing a mix of fixed minimum rents/returns and percentage participation in revenue growth.

Key Financial Metrics

Debt Structure: Debt consists of $921.6 million in senior unsecured notes (fixed rates ranging from 5.125% to 9.125%), a $35.0 million balance on a $750 million revolving credit facility (variable rate), and a $3.8 million mortgage note. Debt represented approximately 34% of total book capitalization.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 29.3% to $834.4 million, driven primarily by a 37.0% increase in hotel operating revenues ($682.5 million) due to the acquisition of 13 hotels from InterContinental in 2005 and improved lodging industry conditions (higher occupancy and average daily rates).
• Expense Increases: Hotel operating expenses rose 42.8% to $476.9 million, consistent with the increase in managed properties. Interest expense increased 29.5% to $65.3 million due to higher average borrowings.
• Impairment Loss: The company recorded a $7.3 million loss on asset impairment in Q2 2005 related to a Prime Hotel in Atlanta, Georgia, which was subsequently sold.
• Capital Structure: Shareholders' equity increased by $169.6 million, bolstered by a public offering of 4.7 million common shares in June 2005 (net proceeds of $199.2 million) and the issuance of $300 million in 5.125% senior notes due 2015.
• Dividends: Common distributions increased slightly to $2.90 per share from $2.88 per share in 2004.

Guidance, Outlook, and Risks

Outlook and Subsequent Events:

• Acquisitions: In January 2006, HPT purchased the Harbor Court Complex in Baltimore for $78 million and eight additional hotels for $166.2 million. A ninth hotel (Holiday Inn SunSpree Resort in Jamaica) was under contract for approximately $30 million but delayed pending regulatory approvals.
• Capital Improvements: The company expects to fund approximately $77.3 million in capital improvements in 2006, including rebranding AmeriSuites to Hyatt Place and renovations for Carlson-branded hotels.
• Financing: HPT maintains a $750 million revolving credit facility with $715 million available as of year-end. The company intends to maintain debt below 50% of total capitalization.

Risks and Contingencies:

• Operator Concentration: Two operators manage approximately 80% of the portfolio by investment. Disputes or failures by these operators could materially impact cash flows.
• REIT Status: Failure to qualify as a REIT would subject the company to corporate income tax, significantly reducing cash available for distribution.
• Market Conditions: The hotel industry is sensitive to economic downturns, terrorism, and interest rate fluctuations. Rising interest rates could increase costs on variable-rate debt and reduce the value of fixed-rate securities.
• Guarantees: While many agreements include guarantees from parent companies, these may be limited or exhausted if hotel performance declines significantly.

Investor Verification Checklist

• Acquisition Closing: Verify the closing status and regulatory approval of the Holiday Inn SunSpree Resort in Jamaica, which was delayed as of the filing date.
• Operator Performance: Monitor the coverage ratios (cash flow vs. minimum rent) for the two primary operators managing 80% of the portfolio, specifically the Carlson-branded hotels undergoing rebranding.
• Debt Covenants: Confirm continued compliance with financial covenants in the $750 million credit facility and senior note indentures, particularly regarding leverage ratios and minimum net worth.
• Capital Expenditures: Track the execution of the $77.3 million planned capital improvements in 2006 and their impact on minimum return increases.
• REIT Compliance: Review quarterly distributions to ensure they meet the 90% taxable income distribution requirement to maintain REIT tax status.