Service Properties Trust (then Hospitality Properties Trust) — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. The filing identifies the registrant as Hospitality Properties Trust (HPT), not Service Properties Trust. Financial statements are unaudited; dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $343.2 | $313.8 | $644.6 | $595.8 |
| Operating income | $73.7 | $85.1 | $151.3 | $171.8 |
| Net income | $37.7 | $51.6 | $80.6 | $104.7 |
| Net income available to common shareholders | $27.0 | $44.2 | $55.8 | $89.8 |
| Basic and diluted earnings per common share | $0.22 | $0.36 | $0.45 | $0.73 |
| Normalized FFO per share | $0.75 | $0.89 | $1.53 | $1.72 |
Revenue increased 9% in Q2 and 8% for the first half, but operating income fell 13% and 12%, respectively. Calculated operating margin declined to 21.5% from 27.1% in Q2 and to 23.5% from 28.8% for the half. Hotel operating revenue grew, while operating expenses rose faster; hotel operating expense increased 26% in Q2 and 21% for the half. Rental income decreased, mainly reflecting the prior-year conversion of 19 hotels from leased to managed operations. Occupancy across the hotel portfolio was down 3.7 percentage points for both Q2 and year to date, while average daily rate rose 6.7% in Q2.
Cash flow, balance sheet and debt
- First-half operating cash flow was $180.4 million, versus $166.9 million; investing cash outflow was $301.8 million, versus $48.1 million, driven by acquisitions and property improvements. Financing provided $137.8 million, versus a $120.4 million outflow.
- Cash was $24.8 million at June 30, 2012; restricted FF&E reserve cash was $47.5 million. The $750 million revolving facility was undrawn and fully available.
- Debt carrying value was approximately $2.20 billion, including a $400 million unsecured term loan and approximately $1.80 billion of publicly issued notes and convertible notes. The term loan matures in 2017; scheduled public debt maturities include $287 million in 2013, $300 million in 2014, $280 million in 2015, $275 million in 2016 and $700 million in 2017. Management reported covenant compliance.
- First-half common distributions were $0.90 per share, unchanged from the comparable 2011 period. Management said it expected operating cash flow to cover declared distributions and operating needs, while warning that reduced tenant or manager payments could force a distribution reduction.
Material developments, outlook and risks
- HPT acquired the entities owning or leasing the Royal Sonesta hotels in Cambridge and New Orleans for $153.1 million, including assumed net liabilities, and entered management arrangements with Sonesta. It also shifted hotel portfolios from InterContinental to Sonesta and Wyndham brands and management.
- Management anticipated substantial improvement spending: approximately $43 million for 18 Marriott hotels; $130–$150 million for 19 Sonesta-rebranded hotels; up to $75 million for 20 Wyndham hotels; and further InterContinental renovations. These investments are expected to increase contractual minimum returns, but the filing cautions that costs and operating results are uncertain.
- Hotel-industry indicators were generally improving, but renovations disrupted operations. HPT reported 72 hotels under renovation for all or part of Q2 and expected elevated renovation activity to continue into 2013.
- Managers did not fund $6.4 million of first-half hotel minimum-return shortfalls, an unguaranteed portion related to Marriott and Sonesta. InterContinental shortfalls were covered by security deposits; such applications can generate accounting income but do not provide new cash. Marriott’s security deposit was exhausted; its limited guarantee had $31.8 million available as of August 7, 2012. Sonesta returns have no guarantee or security deposit.
- TravelCenters of America (TA) leased 185 travel centers and represented 38% of HPT real estate properties at cost. Deferred rent of $150 million is due in 2022 and 2024; HPT had not recognized it because collection was uncertain. TA’s ability to pay current and deferred rent is a stated risk.
- After quarter end, HPT sold a Marriott hotel for $28.9 million net proceeds and expected a third-quarter gain of about $10.3 million. It also agreed to sell two hotels for a combined $5.6 million to entities affiliated with its manager and trustees; closings remained conditional. The filing describes extensive related-party relationships involving RMR, Sonesta, TA and HPT’s trustees.
- Other risks include hotel and travel-center demand, tenant or guarantor performance, depletion or expiration of guarantees and deposits, renovation outcomes, access to future financing, floating-rate exposure, REIT qualification, and potential conflicts of interest. HPT disclosed that a 10% increase in the term-loan rate would increase annual interest expense by about $0.7 million.
Investor verification priorities
- Confirm the reported decline in common earnings and normalized FFO, and assess whether operating costs and renovation disruptions continue to outpace revenue growth.
- Track actual funding, completion and returns from the Marriott, Sonesta, InterContinental and Wyndham renovation and rebranding programs.
- Review minimum-return collections, remaining guarantees and security deposits, and whether hotel shortfalls are being funded with cash or merely covered by accounting applications.
- Assess TA’s current rent-paying capacity and prospects for collection of the deferred rent, which HPT has not recognized as income.
- Review debt maturities, covenant headroom, floating-rate borrowing costs and funding available for planned capital spending and distributions.
- Examine related-party transaction terms and the status and approval process for sales to trustee-affiliated buyers.