Hospitality Properties Trust (now Service Properties Trust): Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; unaudited. The registrant was named Hospitality Properties Trust in this filing. Unless noted otherwise, dollar amounts below are in millions.
Business context
The REIT owned 291 hotels and owned or leased 185 travel centers at quarter-end. Hotel operations are reported as operating revenue; travel-center revenue is primarily rent from related party tenant TravelCenters of America (TA). Most hotels are operated under management agreements, with contractual minimum returns often supported by guarantees or security deposits.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total revenue | $394.3 | $354.5 | +11.2% |
| Operating income | $73.8 | $63.1 | +17.0% |
| Operating margin | 18.7% | 17.8% | +0.9 percentage points |
| Net income | $37.6 | $27.5 | +36.5% |
| Net income available to common shareholders | $32.4 | $19.4 | +66.9% |
| Basic and diluted earnings per common share | $0.22 | $0.15 | +46.7% |
| Operating cash flow | $79.1 | $48.2 | +$30.9 |
| Cash used in investing activities | $31.2 | $67.5 | +$36.3 less used |
| Cash used in financing activities | $36.5 | Cash provided: $17.3 | Shift to cash use |
- Hotel operating revenue rose 13.1% to $329.9; rental income increased 1.9% to $63.4. Hotel operating expenses rose 11.6% to $230.6 and depreciation and amortization rose 8.3% to $78.3.
- Management reported comparable-hotel RevPAR growth of 10.1% to $77.85 across 289 hotels. Across all 291 hotels in its operating-statistics table, RevPAR rose 9.7% to $77.63; the filing presents these as different hotel groupings.
- FFO was $110.7, or $0.74 per common share, versus $91.7, or $0.73 per share. Normalized FFO was $112.7, or $0.75 per share, versus $93.2, or $0.74 per share. These are non-GAAP measures, not substitutes for GAAP earnings or cash flow.
Balance sheet, debt and liquidity
- At March 31, total assets were $5.94 billion and total liabilities were $2.89 billion. Cash and cash equivalents were $33.8 million; restricted FF&E reserve cash was $26.9 million.
- Debt carrying amounts included a $400 million unsecured term loan, $2.345 billion of senior notes net of discounts, and $8.5 million of convertible notes. The $750 million revolving credit facility had no borrowings outstanding, leaving $750 million available, subject to covenants and other conditions.
- Operating cash flow was $79.1 million; property improvements and FF&E reserve funding contributed to $31.2 million of investing cash use. Common and preferred distributions paid totaled $77.0 million.
- In January, the company extended revolving-facility maturity to July 2018 and term-loan maturity to April 2019, and reduced borrowing spreads and facility fees. In February, it redeemed $300 million of 7.875% notes due 2014; in March, it issued $350 million of 4.65% notes due 2024. The amendment generated a $0.2 million early-extinguishment loss.
- Management said it was in compliance with debt covenants at quarter-end and believed operating cash flow would cover operating costs, interest and declared distributions for the next 12 months. This is a forward-looking assessment, not a guarantee.
Material changes and outlook
- Hotel industry conditions improved, and management attributed higher hotel revenue mainly to stronger room rates and occupancy, along with acquisitions completed since January 2013. Renovations disrupted occupancy at some properties; management expected most renovation activity to be completed by year-end 2014.
- For comparable hotels under renovation, RevPAR declined 4.2%; comparable hotels not under renovation reported 11.6% growth. Across 289 comparable hotels overall, ADR increased 3.3% and occupancy improved 4.4 percentage points.
- Management expected substantial renovation and improvement funding: approximately $108.2 million in 2014 and $22.8 million in 2015 for Sonesta hotels, with further planned funding under other hotel agreements. These projects increase contractual minimum returns in some cases, but do not assure improved property cash flows.
- The company agreed to acquire a 240-room Fort Lauderdale hotel for $65 million, subject to diligence and closing conditions, and expected the transaction in Q2 2014. It terminated a previously announced Orlando hotel acquisition after diligence. It sold a Myrtle Beach hotel for $4.5 million on April 29, 2014.
- Coverage for six of nine hotel operating agreements was below 1.0x for the 12 months ended March 31, ranging from 0.35x to 0.91x. Certain minimum-return shortfalls were covered by guarantees or security deposits; $17.2 million of shortfalls in the quarter was not funded by managers under the agreements.
- TA deferred rent of approximately $150 million remained unrecognized because collection was uncertain. TA had not yet filed its 2013 Form 10-K, citing delays in tax accounting and completion of accounting processes; the filing says timing of that report was uncertain.
- TA’s Roanoke travel center was taken by eminent domain. HPT received $6.2 million and reduced annual rent under the TA lease by $0.5 million; HPT and TA intended to challenge the valuation.
Risks, contingencies and unusual items
- Minimum returns and rents depend on hotel and travel-center performance and counterparties’ ability to pay. Guarantees and security deposits are limited; applying deposits to shortfalls does not provide new cash, and reserves may be depleted.
- Management specifically noted that Marriott No. 1 and Sonesta returns are not protected by security deposits or guarantees and depend on available hotel cash flow. The Marriott No. 234 guarantee is limited and expires in 2019; the InterContinental deposit requirements were temporarily adjusted for 2014–2015.
- TA is both a major tenant and a related party in which HPT held approximately 9.1% of outstanding shares. RMR provides HPT’s management services and is affiliated with HPT trustees and officers; Sonesta and AIC also have significant related-party connections. The filing describes potential conflicts of interest.
- Floating-rate debt exposes results to changes in LIBOR. Management estimated a 100-basis-point increase would add about $4.0 million in annual interest expense on the outstanding term loan; the impact would be greater if the revolver were fully drawn.
- Other notable items include an unrealized $5.4 million loss on TA shares in other comprehensive income and $6.2 million in eminent-domain proceeds. The Myrtle Beach hotel sale occurred after quarter-end.
Important facts for investors to verify
- Whether hotel performance and renovation returns sustain minimum payments, especially for agreements with sub-1.0x coverage and limited or no guarantees.
- TA’s ability to pay current and deferred rent, and the timing and contents of its delayed 2013 annual report.
- Remaining security-deposit and guarantee balances, including the Marriott No. 234 guarantee and InterContinental deposit requirements.
- Actual capital spending, project completion costs, and whether the Fort Lauderdale acquisition closed on expected terms.
- Liquidity after distributions and renovation funding, covenant compliance, refinancing access, and sensitivity to interest-rate increases.
- Related-party arrangements, including RMR management fees and HPT’s relationships with TA, Sonesta and AIC.