Item 1. Business
The Company. The Company is a real estate investment trust ("REIT") formed to acquire, own and lease hotels to unaffiliated tenants. At December 31, 1996 the Company owned 82 hotels with 11,728 rooms or suites located in 26 states, purchased for approximately $813 million.
The Company was formed in February 1995 as a subsidiary of Health and Retirement Properties Trust ("HRP"), a healthcare REIT. In March 1995, the Company acquired 21 Courtyard by Marriott(R) Hotels for approximately $179.4 million. In August 1995, the Company completed an initial public offering of 8,325,000 Shares at an initial public offering price of $25.00 per Share, raising gross proceeds of $208.1 million which were principally used to repay indebtedness due to HRP and to acquire an additional 16 Courtyard by Marriott(R) Hotels for approximately $149.6 million. In early 1996, the Company completed a follow-on offering of an additional 14,250,000 common shares of beneficial interest (the "Follow-on Offering") raising net proceeds of approximately $360 million. Such proceeds and proceeds from borrowings were used to acquire, through subsidiaries, 11 Wyndham Garden(R) Hotels for approximately $135.3 million, 18 Residence Inn by Marriott(R) Hotels for approximately $172.2 million and an additional 16 Courtyard by Marriott(R) Hotels for approximately $176.4 million.
The Company's principal growth strategy is to expand its investments in hotels and to set minimum rents which produce income in excess of the Company's cost of raising capital. The Company seeks to provide capital to unaffiliated hotel operators who wish to divest their properties while remaining in the hotel business as tenants. The Company believes that its operating philosophy affords it opportunities to find high quality hotel investment opportunities on attractive terms. In addition, the Company's internal growth strategy is to participate through percentage rents in increases in Total Hotel Sales (including gross revenues from room rentals, food and beverage sales and other services) at the Company's hotels.
The Company is organized as a Maryland real estate investment trust. The Company's principal place of business is 400 Centre Street, Newton, Massachusetts 02158, and its telephone number is (617) 964-8389.
As of December 31, 1996 the Company's portfolio consisted of 82 hotels, located in 26 states. Information with respect to hotel revenues by state is contained in Item 2.
Item 2. Properties
General. As of December 31, 1996, the Company's hotels consist of 53 Courtyard by Marriott(R) hotels, 18 Residence Inn by Marriott(R) hotels, and 11 Wyndham Garden(R) hotels, with 11,728 rooms in 26 states. These hotels have an average age of approximately six years and the Company believes that the physical plant of each hotel in which it has invested is suitable and adequate for its present and any currently proposed uses. The hotels are all leased to the Lessees and operated by the Managers. See "Business -- The Hotels, Leases and Management Agreements."
The following table summarizes certain information about the properties as of December 31, 1996. All dollar figures are in thousands.
Total Number of Number of Investment at Annual Base State Hotels Rooms December 31, 1996 Rent - ----- ------ ----- ----------------- ----
Arizona 8 1,164 $ 67,628 $ 6,604 California 10 1,470 110,081 10,580 Delaware 1 152 12,830 1,210 Florida 3 449 38,882 3,780 Georgia 7 978 67,977 6,584 Illinois 3 514 39,879 3,811 Indiana 1 149 8,973 880 Iowa 1 108 8,034 780 Maryland 3 406 34,967 3,340 Massachusetts 8 1,072 71,919 6,970 Michigan 2 281 12,209 1,180 Minnesota 2 358 18,276 1,813 Missouri 2 298 16,934 1,620 New Jersey 3 416 33,096 3,170 New Mexico 1 112 12,543 1,190 New York 3 403 29,761 2,850 North Carolina 4 534 33,113 3,190 Ohio 1 106 6,741 650 Pennsylvania 4 567 46,353 4,450 Rhode Island 1 148 10,507 1,020 South Carolina 1 108 6,053 580 Tennessee 3 399 32,785 3,189 Texas 3 405 29,430 2,830 Virginia 3 462 40,331 3,870 Washington 3 522 44,442 4,369 Wisconsin 1 147 8,943 850 ------- -------- -------- -------- 82 11,728 $842,687 $ 81,360 ======= ======== ======== ========
Certain of the hotels are currently and from time to time may be made subject to mortgages securing the Company's lines of credit, secured borrowings of the Company's subsidiaries or other secured borrowings. See "Management's Discussion and Analysis of Results of Operations and Financial Condition -- Liquidity and Capital Resources."
The right to occupy the land underlying 10 of the hotels was acquired by an assignment of leasehold interest under long-term ground leases. In each case, the remaining term of the ground lease (including renewal options) is in excess of 42 years, and the ground lessors are unrelated to the sellers and the Company.
Rent payable under the 10 ground leases is the responsibility of the Company's Lessees and is generally calculated as a percentage of Hotel revenues. Eight of the 10 ground leases require minimum annual rent ranging from approximately $90,000 to $502,900 per year. If a ground lease terminates, the Lease with respect to the Hotel on such ground-leased land will also terminate. If a Lessee does not perform such obligations under the ground lease or elects not to renew any ground lease, the Company must perform such obligations under the ground lease or renew such ground lease in order to protect its investments in the affected Hotel. Any pledge of the Company's interests in a ground lease may also require the consent of the applicable ground lessor and its lenders.
Item 3.
Item 3. Legal Proceedings
Although in the ordinary course of business the Company is or may become involved in legal proceedings, the Company has a limited operating history and is not aware of any material pending legal proceeding affecting any of the hotels for which it might become liable.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of shareholders during the fourth quarter of the year covered by this Form 10-K.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's Shares are traded on the New York Stock Exchange (symbol: HPT). The following table sets forth for the periods indicated the high and low closing sale prices for the Shares as reported in the New York Stock Exchange Composite Transactions reports since the Company's initial public offering.
1995 High Low
August 22 to September 30 27 24 1/2 Fourth Quarter 26 3/4 24 3/8
1996 High Low
First Quarter 27 7/8 25 1/2 Second Quarter 27 24 5/8 Third Quarter 26 7/8 25 Fourth Quarter 29 1/2 25
The closing price of the Shares on the New York Stock Exchange on March 26, 1997 was $32.50 per Share.
As of March 4, 1997, there were 850 Shareholders of record and the Company estimates that as of such date there were approximately 38,000 beneficial owners of the Shares.
Information about the Company's dividends paid is summarized in the table below. Dividends are generally paid in the quarter following the quarter to which they relate.
Dividend Annualized Per Share Dividend Rate Third Quarter $0.24 $2.20 Fourth Quarter 0.55 2.20
First Quarter $0.58 $2.32 Second Quarter 0.58 2.32 Third Quarter 0.59 2.36 Fourth Quarter 0.59 2.36
All dividends declared have been paid. The Company intends to continue to declare and pay future dividends on a quarterly basis.
In order to qualify for the beneficial tax treatment accorded to REITs by Sections 856 through 860 of the Code, the Company is required to make distributions to shareholders which annually will be at least 95% of the Company's "real estate investment trust taxable income" (as defined in the Code). All distributions will be made by the Company at the discretion of the Board of Trustees and will depend on the earnings of the Company, cash available for distribution, the financial condition of the Company and such other factors as the Board of Trustees deems relevant. The Company intends to distribute substantially all of its "real estate investment trust taxable income" to its shareholders.
Item 6.
Item 6. Selected Financial Data
The following table sets forth selected financial and operating data on an historical and a pro forma basis for the Company for the years ended December 31, 1995 and 1996. The pro forma data for 1995 are unaudited and presented as if the Company's formation transactions, primarily the acquisition and leasing of the 37 hotels acquired in 1995 and the Company's initial public offering of Shares, and certain other transactions had been consummated as of the date or for the period presented. The pro forma data are not necessarily indicative of what the actual financial position or results of operations would have been, nor do they purport to represent the financial position or results of operations for future periods. The following selected and pro forma financial and operating data should be read in conjunction with the financial statements and the notes thereto included beginning at page of this
Report on Form 10-K.
Item 7.
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition
Overview
The Company was organized on February 7, 1995 and commenced operations on March 24, 1995 with the acquisition of its first 21 hotels. The Company completed its initial public offering of shares and acquired an additional 16 hotels on August 22, 1995. Since it has been recently formed and has limited historical financial data, the Company believes it is meaningful to an understanding of its present and ongoing operations to discuss the Company's pro forma results of operations as well as its historical results of operations.
The following discussion should be read in conjunction with the financial statements and the notes thereto included elsewhere herein. Pro forma results and percentage relationships set forth in the financial highlights section and in such financial statements may not be indicative of the future operations of the Company.
Historical and Pro Forma Results of Operations
Year Ended December 31, 1996 versus Pro Forma Year Ended December 31, 1995
The Company's assets increased to $871.6 million as of December 31, 1996 from $338.9 million at December 31, 1995. The increase primarily resulted from three hotel portfolio acquisitions completed during 1996. In March and April of 1996, the Company acquired 16 Courtyard by Marriott(R) hotels for $176.4 million and 18 Residence Inn(R) by Marriott hotels for $172.2 million. In May 1996, the Company acquired 11 Wyndham Garden(R) hotels for $135.3 million. These acquisitions were funded through the use of cash on hand, borrowings on the Company's line of credit, and the net proceeds form the offering of 14,250,000 shares in April 1996.
Total revenues in 1996 were $82.6 million versus pro forma 1995 revenue of $39.9 million. Total revenues were comprised principally of base and percentage rent of $69.5 million and FF&E reserve income of $12.2 million in 1996 versus $33.3 million and $6.4 million, respectively, in the pro forma period. The Company's results of operations in 1996 are reflective of the growth in the number of owned hotels to 82, from 37 at year end 1995. The leases for the Company's 82 hotels at December 31, 1996 call for base rent of $81.3 million annually, versus $32.9 million for the 37 hotels owned at December 31, 1995. During 1996, the Company earned revenue of approximately $1.2 million ($0.05/share) in percentage rents from its portfolio of 53 Courtyard hotels, reflective of continued increases in Total Hotel Sales at these properties.
Total expenses in 1996 were $31.0 million, including interest expense and depreciation and amortization of $5.6 million and $20.4 million, respectively, versus pro forma 1995 expenses of $11.8 million, including depreciation and amortization of $9.2 million. A portion of the hotels purchased in 1996 were financed with proceeds from the Company's line of credit which was ultimately repaid with prepayable floating rate mortgages. Such debt financing in 1996 gave rise to the $5.6 million of interest expense referred to above, versus zero for pro forma 1995, when the Company did not use third-party debt. The substantial increase in the number of hotels owned by the Company has also proportionately increased the Company's general expense levels, including depreciation and amortization and general and administrative expenses.
Net income in 1996 was $51.7 million ($2.23 per share) and cash available for distribution for the period was $60.8 million ($2.62 per share), based in both cases on average outstanding shares for the period of 23,170,000. This compares with pro forma 1995 net income of $28.0 million ($2.22 per share) and cash available for distribution of $30.8 million ($2.45 per share), based in both cases upon 13,600,900 outstanding shares. This 7% growth in CAD is primarily related to the effects of the Company's 1996 hotel acquisitions and
related financing activity as well as growth in percentage rent to $1.2 million in 1996 from $0.4 million in the 1995 pro forma period. During April 1996, the Company completed an offering of 14,250,000 common shares of beneficial interest raising net proceeds of approximately $358 million to fund its acquisitions and more than doubling its equity capitalization and shares outstanding.
Cash flow provided by (used for) operating, investing and financing activities was $61.7 million, ($448.7 million) and $422.9 million, respectively, for the year ended December 31, 1996.
February 7, 1995 (Inception) Through December 31, 1995
Total revenues from Inception through December 31, 1995 were $23.6 million, which included base and percentage rent of $19.5 million and FF&E reserve income of $4.0 million. Total expenses for the period were $12.3 million, including interest expense and depreciation and amortization of $5.0 million and $5.8 million, respectively. Net income for the period was $11.3 million ($2.51 per share) and cash available for distribution for the period was $13.2 million ($2.91 per share), based in both cases on average outstanding shares for the period of 4,515,000.
From Inception until completion of its initial public offering on August 22, 1995, the Company was a 100% owned subsidiary of HRP and was initially capitalized with $1 million of equity and $163.3 million of debt. The debt was provided by HRP at rates which were lower than the market rates which the Company would have paid on a stand alone basis. Accordingly, the Company does not believe that its results of operations while it was a wholly owned subsidiary of HRP are comparable to subsequent periods.
Cash flow provided by (used for) operating, investing and financing activities was $14.1 million, ($303.7 million) and $291.6 million, respectively, for the year ended December 31, 1996.
Pro Forma Year Ended December 31, 1995
The pro forma results of operations assume that the Company's formation transactions, the initial public offering of shares and the acquisition and leasing of the 37 hotels and related transactions all occurred on January 1, 1995. On this pro forma basis, total revenues would have been $39.9 million (principally base and percentage rents of $33.3 million and FF&E reserve income of $6.4 million). Total expenses would have been $11.8 million (including depreciation and amortization of $9.2 million and general and administrative expenses of $2.6 million). Net income would have been $28.0 million or $2.22 per share, and cash available for distribution would have been $30.8 million or $2.45 per share, based in both cases upon 12,600,900 shares outstanding.
Liquidity and Capital Resources
The Company's primary source of cash to fund its dividends and day to day operations is the base and percentage rent it receives. Base rent is paid monthly in advance and percentage rent is paid either monthly or quarterly in arrears. This flow of funds from rent has historically been sufficient for the Company to pay dividends and meet day to day operating expenses. The Company believes that its operating cash flow will be sufficient to meet its operating expenses and dividend payments.
In order to fund acquisitions and to accommodate occasional cash needs which may result from timing differences between the receipt of rents and the need to pay dividends or operating expenses, the Company has entered into a line of credit arrangement was with DLJ Mortgage Capital, Inc. ("DLJMC"). The line of credit is for up to $200 million, all of which was available at December 31, 1996. Drawings under the line of credit are secured by first mortgage liens on certain of the Company's hotels. Funds may be drawn, repaid and redrawn until maturity, and no principal repayment is due until maturity. The line of credit matures on December 31, 1998; however, upon request and subject to certain terms and conditions, the Company has the right (but not the obligation) to convert amounts outstanding at maturity, if any, into an amortizing mortgage loan due on December 31, 2008. Interest on borrowings under the line of credit are payable until maturity at a spread above LIBOR; and interest during the extended term, if any, will be set at market rates at the time the loan is extended.
During 1996, subsidiaries of the Company issued $125 million of commercial mortgage-backed securities ("Notes") in an unregistered 144A offering. The Notes are non-recourse notes sold to the public and secured by the Company's subsidiaries' assets including 18 Residence Inn by Marriott(R) and 11
Wyndham Garden(R) hotels. The Notes carry interest that floats with one-month LIBOR plus a spread and are due December 1, 2001, but may be prepaid by the Company at any time without penalty. In connection with this issuance of Notes, the Company entered into interest rate cap agreements for $125 million (notional amount) with a major financial institution (the "Cap Counterparty") which limit the Company's maximum interest rate exposure to 7.6925% on this debt.
The Company expects to use existing cash balances, borrowings under the Line of Credit and/or net proceeds of offerings of equity or debt securities to fund future hotel acquisitions. To the extent the Company borrows on the line of credit, the Company will explore various alternatives in both the timing and method of repayment of such amounts. Such alternatives may include incurring long term debt. On December 24, 1996, the Company's Shelf Registration for up to $500 million of securities, including debt securities, was declared effective by the Securities and Exchange Commission (SEC). An effective Shelf Registration enables HPT to issue specific securities on an expedited basis by filing a prospectus supplement with the SEC.
On January 8, 1997, the Company acquired a 381-room full service hotel in Salt Lake City, Utah, for $44 million. The hotel is leased to Wyndham Hotel Corporation and has been rebranded as a Wyndham(R) hotel. The Company's net cash funding for this acquisition was approximately $34 million for which it used cash then on hand, which was generated primarily from the Notes offering.
Although there can be no assurance that the Company will consummate any debt or equity security offerings, the Company believes it will have access to various types of financing in the future, including debt or equity securities offerings, with which to finance future acquisitions.
Seasonality
The Company's hotels have historically experienced seasonal differences typical of the hotel industry with higher revenues in the second and third quarters of calendar years compared with the first and fourth quarters. This seasonality is not expected to cause fluctuations in the Company's rental income because the Company believes that the revenues generated its hotels will be sufficient for the lessees to pay rents on a regular basis notwithstanding seasonal fluctuations.
Inflation
The Company believes that inflation should not have a material adverse effect on the Company. Although increases in the rate of inflation may tend to increase interest rates which the Company may be required to pay for borrowed funds, the Company has a policy of obtaining interest rate caps in appropriate circumstances to protect it from interest rate increases. In addition, the Company's leases provide for the payment of percentage rent to the Company based on increases in total sales, and such rent should increase with inflation.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements, related notes, schedule and reports of independent public accountants for the Company are included following Part IV, beginning on page, and identified in the index appearing at Item 14(a). The financial statements for HMH HPT Courtyard, Inc. and HMH HPT Residence, Inc. as of January 3, 1997 and for the period the ended and the report of independent public accountants begin on page.
Item 9.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure
None.
PART III
The information in Part III (Items, 10, 11, 12 and 13) is incorporated by reference to the Company's definitive Proxy Statement, which is expected to be filed not later than 120 days after the end of the Company's fiscal year.
PART IV
Item 14.
Item 14. Exhibits, Financial Statements, Schedule and Reports on Form 8-K.
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
Exhibits:
3.1* Declaration of Trust of the Registrant 3.2* Bylaws of the Registrant 4.1* Form of Share Certificate 8.1 Opinion of Sullivan & Worcester LLP as to certain tax matters 10.1* Purchase-Sale and Option Agreement dated as of February 3, 1995 by and among HMH Courtyard Properties, Inc., HMH Properties, Inc. and Hospitality Properties, Inc., as amended 10.2** Fifth Amendment to Purchase-Sale and Option Agreement dated February 26, 1996, by and between IIIT and IIMII Properties, Inc. 10.3* Form of Courtyard Management Agreement between HMH Courtyard Properties, Inc., d/b/a HMH Properties, Inc. and Courtyard Management Corporation 10.4* Form of First Amendment to Courtyard Management Agreement between Courtyard Management Corporation and Hospitality Properties, Inc. and Consolidation Letter Agreement by and between Courtyard Management Corporation and Hospitality Properties, Inc. 10.5* Form of Lease Agreement between Hospitality Properties, Inc. and HMH HPT Courtyard, Inc. 10.19** Form of Lease Agreement between HMH HPT Residence Inn, Inc. and Hospitality Properties Trust 10.10* Advisory Agreement(+) 10.11 Form of Revolving Credit Agreement by and between the Company and DLJ Mortgage Capital, Inc., as amended and restated on December 29, 1995, as further amended by Amendment No. 1, dated February 26, 1996 10.12 Amendment, dated November 25, 1996 to the Revolving Credit Agreement, amended and restated on December 29, 1995, by and between the Company and DLJ Mortgage Capital, Inc. 10.13** Form of Residence Inn Management Agreement between HMH Properties, Inc. and Residence Inn by Marriott(R), Inc. 10.14* Hospitality Properties Trust 1995 Incentive Share Award Plan(+) 10.15*** Promissory Note in the amount of $125,000,000 dated as of November 25, 1996 from HPTRI Corporation and HPTWN Corporation to Column Financial Inc. 10.16*** Loan Agreement dated as of November 25, 1996 by and between HPTRI Corporation and HPTWN Corporation, as borrowers, and Column Financial Inc., as lender 10.17*** Form of Deed of Trust, Assignment of Leases and Rents and Security Agreement from HPTRI Corporation, as Trustor, to Chicago Title Insurance Company, as Trustee, for benefit of Column Financial, Inc.
10.18*** Trust and Servicing agreement dated as of November 25, 1996 by and among Hospitality Properties Mortgage Acceptance Corp., as Depositor, AMRESCO Management, Inc., as Servicer, and The Chase Manhattan Bank, as Trustee 10.19 Lease Agreement by and between HPTSLC Corporation, as landlord, and WIIC Salt Lake Corporation, as tenant, dated January 1997
12 Ratio of Earnings to Fixed Charges
21 Subsidiaries of the Registrant
23.1 Consents of Arthur Andersen LLP
23.2 Consent of Sullivan & Worcester LLP (included in Exhibit 8.1 to this Registration Statement)
27 Financial Data Schedule
99 Certain Investment Considerations - ----------------------- Each exhibit marked by an (*) or a (**) is incorporated by reference to the corresponding document or instrument filed as an exhibit to the Company's Registration Statement on Form S-11 (File No. 33-93330) or File No. 333-1433, respectively. Each exhibit marked with a (***) is incorporated by reference to the corresponding document or instrument filed as an exhibit to the Company's Current Report on Form 8-K dated December 4, 1996.
(+) Management contract, compensatory plan or agreement.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Trustees and Shareholders of Hospitality Properties Trust:
We have audited the accompanying consolidated balance sheet of Hospitality Properties Trust (the "Company") as of December 31, 1995 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for the period from February 7, 1995 (inception) to December 31, 1995 and the year ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hospitality Properties Trust as of December 31, 1995 and 1996, and the results of operations and its cash flows for the period from February 7, 1995 (inception) to December 31, 1995 and the year ended December 31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Washington, D.C. January 10, 1997
See accompanying notes.
See accompanying notes.
See accompanying notes.
See accompanying notes.
HOSPITALITY PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per Share and percent data)
1. Organization and Commencement of Operations
Hospitality Properties Trust (HPT) was incorporated in the state of Delaware on February 7, 1995. Subsequently, HPT became a Maryland real estate investment trust and effected a 400-for-1 split of its common shares of beneficial interest (the Shares). HPT, which invests in income producing hotel and lodging related real estate, was a 100% owned subsidiary of Health and Retirement Properties Trust (HRP) from its inception through August 22, 1995, when it completed its initial public offering of Shares (the IPO). HRP remains an affiliate of HPT, owning approximately 15% of HPT's issued and outstanding Shares as of December 31,1996.
HPT commenced operations on March 24, 1995 and, through December 31, 1996, acquired 82 hotels and related replacement and refurbishment reserves (the FF&E Reserves) directly and through subsidiaries. The properties of HPT and its subsidiaries (the Company) are leased to and managed by subsidiaries (the Lessees and the Managers) of companies unaffiliated with HPT: Host Marriott Corporation; Marriott International, Inc. (Marriott); and Wyndham Hotel Corporation.
2. Summary of Significant Accounting Policies
Consolidation. These consolidated financial statements include the accounts of HPT and its subsidiaries. All intercompany transactions have been eliminated.
Real estate properties. Real estate properties are recorded at cost. Depreciation is provided for on a straight-line basis over the estimated useful lives ranging up to 40 years. The Company periodically evaluates the carrying value of its long-lived assets in accordance with Statement of Financial Accounting Standards No. 121 (SFAS 121), which it adopted on January 1, 1996. The adoption of SFAS 121 had no effect on the Company's financial statements.
Cash and cash equivalents. Highly liquid investments with maturities of three months or less at date of purchase are considered to be cash equivalents. The carrying amount of cash and cash equivalents is equal to its fair value.
Deferred interest and finance costs. Costs incurred to secure certain borrowings are capitalized and amortized over the terms of the related borrowing, and were $1,861 and $5,352 at December 31, 1995 and 1996, respectively, net of accumulated amortization of $24 and $313, respectively.
Revenue recognition. Rental income from operating leases is recognized on a straight line basis over the life of the lease agreements. Additional rent and interest income is recognized as earned.
Net income per share. Net income per share is computed using the weighted average number of shares outstanding during the period. The Company has no common share equivalents.
Financial Instruments--Interest Rate Cap Agreements. During 1996, in connection with a $125,000 debt issuance, certain subsidiaries of HPT entered into interest rate protection agreements to limit the Company's exposure to risks of rising interest rates. The cost of the agreements was capitalized and is being amortized over the life of the related borrowing as an adjustment to interest expense. Amounts receivable from the counterparties to the cap agreements are accrued as adjustments to interest expense. At December 31, 1996, the carrying value of such agreements was $2,498 (net of accumulated amortization of $52) and the fair value of such agreements was $2,756. During 1996 interest rates did not exceed the interest rate cap amounts and no balances were receivable under the cap agreements at December 31, 1996.
Use of estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates.
Income taxes. The Company elected to be taxed as a Real Estate Investment Trust (REIT) under Sections 856 through 860 of the Internal Revenue Code of 1986 (the "Code"), commencing with its first taxable year ended December 31, 1995, and intends to conduct its operations so as to continue to qualify as a REIT under the Code. As a REIT, the Company generally will not be subject to Federal income tax on its net income that it currently distributes to shareholders. Qualifications and taxation as a REIT depends on the Company's ability to meet certain dividend distribution tests, stock ownership requirements and various qualification tests prescribed in the Code. During 1996 the Company created several new 100% owned subsidiaries primarily for the purpose of acquiring and owning real estate. Such subsidiaries are all qualified REIT subsidiaries.
Subsequent to the IPO the dividends paid by the Company for 1995 ($0.79 per share) were 100% ordinary taxable income and for 1996 ($2.34 per share) were 85% ordinary taxable income and 15% return of capital.
3. Real Estate Properties
The Company's 82 hotel properties are leased pursuant to long term operating leases expiring between 2010 and 2012. The leases provide for various automatic renewal terms generally totaling 36-48 years unless the Lessee properly notifies the Company in accordance with the leases. Each lease is a triple net lease and generally requires the Lessee to pay: base rent, percentage rent of between 5% and 8% of increases in total hotel sales over a base year, 5% FF&E reserve escrows, and all operating costs associated with the leased property. Each Lessee posted a security deposit equal to one year's base rent. The FF&E reserve may be used by the Manager and Lessee to maintain the properties in good working order and repair. If the FF&E reserve is not available to fund such expenditures, the Lessees may require the Company to fund such expenditures, in which case annual base rent will be increased by a minimum of 10% of the amount so funded.
Under the management agreements with affiliates of Marriott, borrowings secured by certain of the Company's hotels are limited, according to a formula, to amounts less than 60% to 70% of the allocable purchase price of the hotel securing the borrowings.
Future minimum lease payments to be received by the Company during the remaining initial terms of its leases total $1,267,320 ($81,360 annually). As of December 31, 1996, the weighted average initial term of the Company's leases was 15.6 years, and the weighted average total term (including all renewal options) was 54.6 years.
4. Indebtedness
As of December 31, 1996, the Company had no borrowings outstanding under its $200,000 revolving acquisition credit facility ("Credit Facility") which provides for interest on borrowings at one-month LIBOR plus a premium. Borrowings, if any, may be repaid and reborrowed as necessary until December 31, 1998, at which time outstanding balances may, at the Company's option (subject to lender consent), be either repaid or converted into a 10-year loan. The Credit Facility is secured by certain assets of HPT and one of its subsidiaries. The weighted average interest rate on Credit Facility borrowings outstanding during 1996 was 7.05%. There were no borrowings outstanding at any time under the Credit Facility during the 1995 period.
During 1996, certain subsidiaries of the Company issued $125,000 of notes (Notes) through the issuance of certificates of participation. The Notes require payment of interest only through their maturity in December 2001, at which time the principal balance is due. The Notes are prepayable at any time without penalty. Interest on the Notes is equal to one month LIBOR plus a premium. The Notes are non-recourse to HPT and its subsidiaries and are secured by first mortgages on hotels owned by certain subsidiaries of the Company having a net carrying value of $310,000 at December 31, 1996. Approximately $30,820 of annual minimum lease payments are attributed to such hotels. Generally, the terms of the Notes limit the ability of certain subsidiaries of the Company to incur significant secured or unsecured liabilities and restrict the use of proceeds, if any, from the sale or other disposition of assets, if any. The Notes carried a weighted average interest rate from their date of issuance to December 31, 1996 of 6.32%. At December 31, 1996, the Notes carried an interest rate of 6.07%. The carrying amount of the Notes is equal to their fair value.
5. Transactions with Affiliates
The Company has an agreement with HRPT Advisors, Inc. ("Advisors") whereby Advisors provides investment, management and administrative services to the Company. Advisors is owned by Gerard M. Martin and Barry M. Portnoy. Messrs. Martin and Portnoy are Managing Trustees of HPT and HRP. Mr. Portnoy is also a partner in the law firm which provides legal services to the Company. The Company's officers are also employees of the Advisor.
Advisors is compensated at an annual rate equal to 0.7% of HPT's average real estate investments up to the first $250,000 of such investments and 0.5% thereafter. Advisory fees earned for the period from February 7, 1995 (inception) to December 31, 1995 and the year ended December 31, 1996 were $1,292 and $3,915, respectively. As of December 31, 1996, Advisors owned 250,000 shares of HPT. Incentive advisory fees are paid to Advisors in restricted Common Shares based on a formula, not to exceed 2 cents per weighted average share. The Company accrued $463 in incentive fees during 1996 to be paid in restricted Common Shares in 1997. No incentive fees were due for the 1995 period.
HRP owns 4,000,000 shares of HPT, 3,960,000 shares of which it received in consideration of cancellation of a loan receivable totaling $99,000 from the Company.
Under the provisions of the Company's Incentive Share Award Plan, 100,000 Common Shares have been reserved for issuance to officers of the Company, consultants to the Company and Independent Trustees of the Company. Each of the three Independent Trustees of HPT were awarded 300 shares under this plan in each of 1995 and 1996. In 1996, 5,000 shares were granted to officers of the Company under this plan and no shares were granted in 1995. Share grants expense is recognized over the related expected service period (one year) based on the market value of shares on the grant date and totaled $101 during 1996 and $10 during the 1995 period.
6. Concentration
At December 31, 1996, the Company's 53 Courtyard by Marriott(R) hotels are leased to a subsidiary (Host I) of Host Marriott Corporation (Host) and managed by a subsidiary of Marriott International, Inc. (Marriott). The Company's 18 Residence Inn by Marriott(R) hotels are leased to a subsidiary (Host II) of Host and managed by a subsidiary of Marriott. The Company's 11 Wyndham Garden(R) hotels are leased to a subsidiary (Wyndham I) of Wyndham Hotel Corporation (Wyndham) and managed by another Wyndham subsidiary. The percentage of the Company's annual minimum rents and equity investment attributable to each Lessee are approximately: Host I--63%; Host II--21%; and Wyndham I--16%.
The Company's 82 hotels contain 11,728 rooms and are located in 26 states, with 5% to 12% of its hotels in each of California, Massachusetts, Georgia, and Arizona.
7. Pro Forma Information (Unaudited)
In April 1996, the Company completed an offering of 14,250,000 common shares of beneficial interest and the acquisition of 45 additional hotels. If such transactions occurred on January 1, 1996, unaudited pro forma 1996 revenues, net income and earnings per share would have been $96,775, $59,330 and $2.22, respectively.
In the opinion of management, all adjustments necessary to reflect the effects of the transactions discussed above have been reflected in the pro forma data. The unaudited pro forma data is not necessarily indicative of what the actual consolidated results of operations for the Company would have been for the year indicated, nor does it purport to represent the results of operations for the Company for future periods.
8. Selected Quarterly Financial Data (Unaudited)
The following is a summary of the unaudited quarterly results of operations of the Company for 1995 and 1996.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Trustees and Shareholders of Hospitality Properties Trust:
We have audited in accordance with generally accepted auditing standards the consolidated financial statements of Hospitality Properties Trust and have issued our report thereon dated January 10, 1997. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule on pages and is the responsibility of Hospitality Properties Trust's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Washington, D.C. January 10, 1997
The accompanying notes are an integral part of this schedule.
HOSPITALITY PROPERTIES TRUST NOTES TO SCHEDULE III DECEMBER 31, 1996 (In thousands)
(A) The change in total cost of properties for the period from February 7, 1995 (inception) to December 31, 1996 is as follows:
1995 1996 ---- ----
Balance at beginning of period $ -- $305,447
Additions: Hotel acquisitions and capital expenditures 305,447 468,050 -------- --------
Balance at close of period $305,447 $773,497 ======== ========
(B) The change in accumulated depreciation for the period from February 7, 1995 (inception) to December 31, 1996 is as follows:
1995 1996 ---- ----
Balance at beginning of period $ -- $ 3,679
Additions: Depreciation expense 3,679 13,022 ------- -------
Balance at close of period $ 3,679 $16,701 ======= =======
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To HMH HPT Courtyard, Inc.:
We have audited the accompanying balance sheets of HMH HPT Courtyard, Inc. (the "Company") as of January 3, 1997 and December 29, 1995, and the related statements of operations, shareholder's equity and cash flows for the fiscal year ended January 3, 1997 and for the period March 24, 1995 (inception) through December 29, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of HMH HPT Courtyard, Inc. as of January 3, 1997 and December 29, 1995, and the results of its operations and its cash flows for the fiscal year ended January 3, 1997 and for the period March 24, 1995 (inception) through December 29, 1995, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Washington, D.C. February 28, 1997
See Notes to Financial Statements.
See Notes to Financial Statements.
See Notes to Financial Statements.
See Notes to Financial Statements.
HMH HPT COURTYARD, INC. NOTES TO FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
HMH HPT Courtyard, Inc. (the "Company") was incorporated in Delaware on February 7, 1995 as a wholly-owned indirect subsidiary of Host Marriott Corporation ("Host Marriott"). The Company had no operations prior to March 24, 1995 (the "Commencement Date" or "Inception").
On the Commencement Date, affiliates of Host Marriott (the "Sellers") sold 21 Courtyard properties to Hospitality Properties Trust ("HPT"). On August 22, 1995, HPT purchased an additional 16 Courtyard properties from the Sellers. On March 22, 1996 and April 4, 1996, a total of 16 additional Courtyard properties were purchased by HPT for a total of 53 Courtyard hotels (the "Hotels"). The Sellers contributed the assets and liabilities related to the operations of such properties to the Company, including working capital advances to the manager, prepaid rent under leasing arrangements and rights to other assets as described in Note 2. Such assets have been accounted for at the historical cost.
Fiscal Year
The Company's fiscal year ends on the Friday nearest to December 31.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenues
Revenues represent house profit from the Hotels because the Company has delegated substantially all of the operating decisions relating to the generation of house profit from the Hotels to Marriott International, Inc. (the "Manager" or "Marriott International"). House profit reflects the net revenues flowing to the Company as lessee and represents total hotel sales less property level expenses excluding depreciation and amortization, real and personal property taxes, lease payments, insurance, contributions to the property improvement fund and management fees.
Corporate Expenses
The Company operates as a unit of Host Marriott utilizing Host Marriott's employees, centralized system for cash management, insurance and administrative services. The Company has no employees. All cash received by the Company is deposited in and commingled with Host Marriott's general corporate funds. Operating expenses and other cash requirements of the Company are paid by Host Marriott and charged directly or allocated to the Company. Certain general and administrative costs of Host Marriott are allocated to the Company, principally based on Host Marriott's specific identification of individual cost items and otherwise based upon estimated levels of effort devoted by its general and administrative departments to individual entities. In the opinion of management, the methods for allocating corporate, general and administrative expenses and other direct costs are reasonable. It is not practicable to estimate the costs that would have been incurred by the Company if it had been operated on a stand-alone basis, however, management believes that these expenses are comparable to the expected expenses levels on a forward-looking basis.
Concentration of Credit Risk
The Company's largest asset is the security deposit (see Note 3) which constitutes 85% of the Company's total assets as of January 3, 1997. The security deposit is not collateralized and is due from HPT at the termination of the Lease.
Deferred Gain
Host Marriott contributed to the Company deferred gains relating to the sale of the 53 Courtyard properties to HPT in 1995 and 1996. The Company is amortizing the deferred gains over the initial term of the Lease.
NOTE 2. LEASE COMMITMENTS
On the Commencement Date, the Company entered into a lease for 21 Courtyard properties. On August 22, 1995, the Company entered into a lease for an additional 16 Courtyard properties. On March 22, 1996 and April 4, 1996, the Company entered into a lease for an additional 16 Courtyard properties (collectively, the "Lease"). The initial term of the Lease expires in 2012. Thereafter, the Lease automatically renews for three consecutive twelve-year terms at the option of the Company.
The Company is required to pay rents equal to aggregate minimum annual rent of $50,540,000 ("Base Rent") and percentage rent equal to 5% of the excess of total hotel sales over base year total hotel sales ("Percentage Rent"). A pro rata portion of Base Rent is due and payable in advance on the first day of thirteen predetermined accounting periods. Percentage Rent is due and payable quarterly in arrears. Additionally, the Company is required to make payments when due on behalf of HPT for real estate taxes and other taxes, assessments and similar charges arising from or related to the Hotels and their operation, utilities, premiums on required insurance coverage, rents due under ground and equipment leases and all amounts due under the terms of the management agreements described below. The Company is also required to provide the Manager with working capital to meet the operating needs of the Hotels. The Sellers had previously made advances related to the Hotels and transferred their interest in such amounts to the Company in the amount of $3,984,000 and $1,116,000 in 1995 and 1996.
The Lease also requires the Company to escrow, or cause the Manager to escrow, an amount equal to 5% of the annual total hotel sales into an HPT-owned furniture, fixture and equipment reserve (the "FF&E Reserve"), which is available for the cost of required replacements and renovation. Any requirements for funds in excess of amounts in the FF&E Reserve shall be provided by HPT ("HPT Fundings") at the request of the Company. In the event of HPT Fundings, Base Rent shall be adjusted upward by an amount equal to 10% of HPT Fundings.
The Company is required to maintain a minimum net worth equal to one year's base rent. For purposes of this covenant, the deferred gain is excluded from the calculation of net worth.
As of January 3, 1997, future minimum annual rental commitments for the Lease on the Hotels and other non-cancelable leases, including the ground leases described below, are as follows (in thousands): Other Operating Lease Leases ----- ------ 1997 ...................................... $ 50,540 $ 2,343 1998 ...................................... 50,540 2,005 1999 ...................................... 50,540 1,720 2000 ...................................... 50,540 1,572 2001 ...................................... 50,540 1,519 Thereafter.................................. 555,940 9,159 ---------- ---------- Total minimum lease payments.......... $ 808,640 $ 18,318 ========== ==========
The land under eight of the Hotels is leased from third parties. The ground leases have remaining terms (including all renewal options) expiring between the years 2039 and 2067. The ground leases provide for rent based on specific percentages of certain sales subject to minimum amounts. The minimum rentals are adjusted at various anniversary dates throughout the lease terms, as
defined in the agreements. Total minimum lease payments exclude Percentage Rent which was $716,000 and $271,000 for fiscal year 1996 and the period March 24, 1995 through December 29, 1995.
NOTE 3. SECURITY DEPOSIT
HPT holds $50,540,000 as a security deposit for the obligations of the Company under the Lease (the "Security Deposit"). The Security Deposit is due upon termination of the Lease.
NOTE 4. INCOME TAXES
The Company and Host Marriott are members of a consolidated group for federal income tax purposes. Host Marriott has contributed the Security Deposit and deferred gain without contributing their related tax attributes and have agreed that the Company will not be responsible for any tax liability or benefit associated with the Security Deposit or deferred gain. Accordingly, no deferred tax balances are reflected in the accompanying balance sheets. There is no difference between the basis of assets and liabilities for income tax and financial reporting purposes other than for the Security Deposit and the deferred gain.
The components of the Company's effective income tax rate follow:
1996 1995 ---- ---- Statutory Federal tax rate......................... 35.0% 35.0% State income tax, net of Federal tax benefit....... 5.0 6.0 --- --- 40.0% 41.0%
The provision for income taxes consists of the following (in thousands):
1996 1995 ---- ---- Current-Federal.................................... $3,674 $1,129
State.................................. 525 193 ------ ------ $4,199 $1,322 ====== ======
All current tax provision amounts are included in Due to Host Marriott Corporation on the accompanying balance sheets.
NOTE 5. MANAGEMENT AGREEMENTS
The Sellers' rights and obligations under management agreements (the "Agreements") with the Manager were transferred to HPT and then through the Leases to the Company. The Agreements have an initial term expiring in 2013 with an option to extend the Agreements on all of the Hotels for up to 30 years. The Agreements provide that the Manager be paid a system fee equal to 3% of hotel sales, a base management fee of 2% of hotel sales ("Base Management Fee") and an incentive management fee equal to 50% of available cash flow, not to exceed 20% of operating profit, as defined ("Incentive Management Fee"). In addition, the Manager is reimbursed for each Hotel's pro rata share of the actual costs and expenses incurred in providing certain services on a central or regional basis to all Courtyard by Marriott hotels operated by the Manager. Base Rent is to be paid prior to payment of Base Management Fees and Incentive Management Fees. To the extent Base Management Fees are so deferred, they must be paid in future periods. If available cash flow is insufficient to pay Incentive Management Fees, no Incentive Management Fees are earned by the Manager.
Pursuant to the terms of the Agreements, the Manager is required to furnish the Hotels with certain services ("Chain Services") which are generally provided on a central or regional basis to all hotels in the Marriott International hotel system. Chain Services include central training, advertising and promotion, a national reservation system, computerized payroll and accounting services, and such additional services as needed which may be more efficiently performed on a centralized basis. Costs and expenses incurred in providing such services are allocated among all domestic hotels managed, owned or leased by Marriott International or its subsidiaries. In addition, the Hotels participate in Marriott's Courtyard Club program. The cost of these programs are charged to all hotels in the system.
The Company is obligated to provide the Manager with sufficient funds to cover the cost of (a) certain non-routine repairs and maintenance to the Hotels which are normally capitalized; and (b) replacements and renewals to the Hotels' property and improvements. Under certain circumstances, the Company will be required to establish escrow accounts for such purposes under terms outlined in the Agreements.
Pursuant to the terms of the Agreements, the Company is required to provide Marriott International with funding for working capital to meet the operating needs of the hotels. Marriott International converts cash advanced by the Company into other forms of working capital consisting primarily of operating cash, inventories, and trade receivables. Under the terms of the Agreements, Marriott International maintains possession of and sole control over the components of working capital, and accordingly, the Company reports the total amounts so advanced to Marriott International as a component of Due from Marriott International, Inc. Upon termination of the Agreements, the working capital will be returned to the Company.
NOTE 6. REVENUES
As discussed in Note 1, hotel revenues reflect house profit from the Company's hotel properties. House profit reflects the net revenues flowing to the Company as lessee and represents all gross hotel operating revenues, less all gross property-level expenses, excluding depreciation, management fees, real and personal property taxes, lease payments, insurance, contributions to the property improvement fund and certain other costs, which are classified as operating costs and expenses.
The following table presents the detail of house profit for the fiscal year ended January 3, 1997 and for the period March 24, 1995 (inception) through December 29, 1995 (in thousands):
1996 1995 ---- ---- Hotel Sales: Rooms $164,738 $ 66,968 Food and beverage 14,167 6,225 Other 7,138 2,999 -------- -------- Total hotel sales 186,043 76,192 -------- -------- Rooms (A) 34,858 14,713 Food and beverage (B) 12,133 5,044 Other operating departments (C) 1,904 827 General and administrative (D) 19,956 7,768 Utilities (E) 7,200 2,955 Repairs, maintenance and accidents (F) 6,930 2,899 Marketing and sales (G) 2,290 1,121 Chain services (H) 6,611 3,052 -------- -------- Total expenses 91,882 38,379 -------- --------
Revenues (House Profit) $ 94,161 $ 37,813 ======== ========
(A) Includes expenses for linen, cleaning supplies, laundry, guest supplies, reservations costs, travel agents' commissions, walked guest expenses and wages, benefits and bonuses for employees of the rooms department. (B) Includes cost of food and beverages sold, china, glass, silver, paper and cleaning supplies and wages, benefits and bonuses for employees of the food and beverage department. (C) Includes expenses related to operating the telephone department. (D) Includes management and hourly wages, benefits and bonuses, credit and collection expenses, employee relations, guest relations, bad debt expenses, office supplies and miscellaneous other expenses. (E) Includes electricity, gas and water at the properties. (F) Includes cost of repairs and maintenance and the cost of accidents at the properties. (G) Includes management and hourly wages, benefits and bonuses, promotional expense and local advertising. (H) Includes charges from the Manager for Chain Services as allowable under the Agreements.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To HMH HPT Residence Inn, Inc.:
We have audited the accompanying balance sheet of HMH HPT Residence Inn, Inc. (the "Company") as of January 3, 1997 and the related statements of operations, shareholder's equity and cash flows for the period March 22, 1996 (inception) through January 3, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of HMH HPT Residence Inn, Inc. as of January 3, 1997, and the results of its operations and its cash flows for the period March 22, 1996 (inception) through January 3, 1997, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Washington, D.C. February 28, 1997
See Notes to Financial Statements.
See Notes to Financial Statements.
See Notes to Financial Statements.
See Notes to Financial Statements.
HMH HPT RESIDENCE INN, INC. NOTES TO FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
HMH HPT Residence Inn, Inc. (the "Company") was incorporated in Delaware as a wholly-owned indirect subsidiary of Host Marriott Corporation ("Host Marriott"). The Company had no operations prior to March 22, 1996 (the "Commencement Date" or "Inception").
On the Commencement Date, affiliates of Host Marriott (the "Sellers") sold 5 Residence Inn properties to Hospitality Properties Trust ("HPT"). The Sellers sold an additional 13 Residence Inn properties to Hospitality Properties Trust on April 4, 1996 for a total of 18 Residence Inn hotels (the "Hotels"). The Sellers contributed the assets and liabilities related to the operations of such properties to the Company, including working capital advances to the hotel manager, prepaid rent under leasing arrangements and rights to other assets as described in Note 2. Such assets have been accounted for at the historical cost.
Fiscal Year
The Company's fiscal year ends on the Friday nearest to December 31.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Revenues
Revenues represent house profit from the Hotels because the Company has delegated substantially all of the operating decisions relating to the generation of house profit from the Hotels to Marriott International, Inc. (the "Manager" or "Marriott International"). House profit reflects the net revenues flowing to the Company as lessee and represents total hotel sales less property level expenses excluding depreciation and amortization, real and personal property taxes, lease payments, insurance, contributions to the property improvement fund and management fees.
Corporate Expenses
The Company operates as a unit of Host Marriott utilizing Host Marriott's employees, centralized systems for cash management, insurance and administrative services. The Company has no employees. All cash received by the Company is deposited in and commingled with Host Marriott's general corporate funds. Operating expenses and other cash requirements of the Company are paid by Host Marriott and charged directly or allocated to the Company. Certain general and administrative costs of Host Marriott are allocated to the Company, principally based on Host Marriott's specific identification of individual cost items and otherwise based upon estimated levels of effort devoted by its general and administrative departments to individual entities. In the opinion of management, the methods for allocating corporate, general and administrative expenses and other direct costs are reasonable. It is not practicable to estimate the costs that would have been incurred by the Company if it had been operated on a stand-alone basis, however, management believes that these expenses are comparable to the expected expense levels on a forward-looking basis.
Concentration of Credit Risk
The Company's largest asset is the security deposit (see Note 3) which constitutes 82% of the Company's total assets as of January 3, 1997. The security deposit is not collateralized and is due from HPT at the termination of the Lease.
Deferred Gain
Host Marriott contributed to the Company deferred gains relating to the sale of the Residence Inn properties to Hospitality Properties Trust. The Company is amortizing the deferred gains over the initial term of the Lease.
NOTE 2. LEASE COMMITMENTS
On the Commencement Date, the Company entered into a lease (the "Lease") for the Hotels with HPT. The initial term of the Lease expires in 2010. Thereafter, the Lease automatically renews for one ten-year term and two consecutive 15-year terms, unless the Company properly notifies HPT in accordance with the Lease.
The Company is required to pay rents equal to aggregate minimum annual rent of $17,220,000 ("Base Rent") and percentage rent equal to 7.5% of the excess of total hotel sales over 1996 total hotel sales ("Percentage Rent"). A pro rata portion of Base Rent is due and payable in advance on the first day of thirteen predetermined accounting periods. Percentage Rent is due and payable quarterly in arrears. Additionally, the Company is required to make payments when due on behalf of HPT for real estate taxes and other taxes, assessments and similar charges arising from or related to the Hotels and their operation, utilities, premiums on required insurance coverage, rents due under ground and equipment leases and all amounts due under the terms of the management agreements described below. The Company is also required to provide the Manager with working capital to meet the operating needs of the Hotels. The Sellers had previously made advances related to the Hotels and transferred their interest in such amounts to the Company in the amount of $2,230,000 in 1996.
The Lease also requires the Company to escrow, or cause the Manager to escrow, an amount equal to 5% of the annual total hotel sales into an HPT-owned furniture, fixture and equipment reserve (the "FF&E Reserve"), which is available for the cost of required replacements and renovation. Any requirements for funds in excess of amounts in the FF&E Reserve shall be provided by HPT ("HPT Fundings") at the request of the Company. In the event of HPT Fundings, Base Rent shall be adjusted upward by an amount equal to 10% of HPT Fundings.
The Company is required to maintain a minimum net worth equal to one year's base rent. For purposes of this covenant, the deferred gain is excluded from the calculation of net worth.
As of January 3, 1997, future minimum annual rental commitments for the Lease on the Hotels and other non-cancelable leases, including the ground lease described below, are as follows (in thousands): Other Operating Lease Leases ----- --------- 1997 ..................................... $ 17,220 $ 259 1998 ..................................... 17,220 231 1999 ..................................... 17,220 207 2000 ..................................... 17,220 228 2001 ..................................... 17,220 120 Thereafter................................. 154,980 2,160 ---------- ---------- Total minimum lease payments......... $ 241,080 $ 3,205 ========== ==========
The land under one of the Hotels is leased from a third party. The lease has an initial term expiring in 2021 with two extension periods of a total of 20 years. Annual ground rent is equal to the greater of minimum rent or 3% of annual gross sales.
NOTE 3. SECURITY DEPOSIT
The Lessor holds $17,220,000 as a security deposit for the obligations of the Company under the Lease (the "Security Deposit"). The Security Deposit is due upon termination of the Lease.
NOTE 4. INCOME TAXES
The Company and Host Marriott are members of a consolidated group for federal income tax purposes. Host Marriott contributed the Security Deposit and deferred gain without contributing their related tax attributes and have agreed that the Company will not be responsible for any tax liability or benefit associated with the Security Deposit or deferred gain. Accordingly, no deferred tax balances are reflected in the accompanying balance sheet. There is no difference between the basis of assets and liabilities for income tax and financial reporting purposes other than for the Security Deposit and the deferred gain.
The components of the Company's effective income tax rate follow:
Statutory Federal tax rate......................... 35.0% State income tax, net of Federal tax benefit....... 5.7 ----- 40.7% =====
The provision for income taxes consists of the following (in thousands):
Current-Federal.................................... $ 1,300 State.................................... 211 -------- $ 1,511 ========
All current tax provision amounts are included in Due to Host Marriott Corporation in the accompanying balance sheet.
NOTE 5. MANAGEMENT AGREEMENTS
The Sellers' rights and obligations under management agreements (the "Agreements") with the Manager were transferred to HPT and then through the Lease to the Company. The Agreements have an initial term expiring in 2013 with an option to extend the Agreements on all of the Hotels for up to 30 years. The Agreements provide that the Manager be paid a system fee equal to 4% of hotel sales, a base management fee of 2% of hotel sales ("Base Management Fee") and an incentive management fee equal to 50% of available cash flow, not to exceed 20% of operating profit, as defined ("Incentive Management Fee"). In addition, the Manager is reimbursed for each Hotel's pro rata share of the actual costs and expenses incurred in providing certain services on a central or regional basis to all Residence Inn hotels operated by the Manager. Base Rent is to be paid prior to payment of Base Management Fees and Incentive Management Fees. To the extent Base Management Fees are so deferred, they must be paid in future periods. If available cash flow is insufficient to pay incentive management fees, no incentive management fees are earned by the Manager.
Pursuant to the terms of the Agreements, the Manager is required to furnish the Hotels with certain services ("Chain Services") which are generally provided on a central or regional basis to all hotels in the Marriott International hotel system. Chain Services include central training, advertising and promotion, a national reservation system, computerized payroll and accounting services, and such additional services as needed which may be more efficiently performed on a centralized basis. Costs and expenses incurred in providing such services are allocated among all domestic hotels managed, owned or leased by Marriott International or its subsidiaries.
The Company is obligated to provide the Manager with sufficient funds to cover the cost of (a) certain non-routine repairs and maintenance to the Hotels which are normally capitalized; and (b) replacements and renewals to the Hotels' property and improvements. Under certain circumstances, the Company will be required to establish escrow accounts for such purposes under terms outlined in the Agreements.
Pursuant to the terms of the Agreements, the Company is required to provide Marriott International with funding for working capital to meet the operating needs of the hotels. Marriott International converts cash advanced by the Company into other forms of working capital consisting primarily of operating cash, inventories, and trade receivables. Under the terms of the Agreements, Marriott International maintains possession of and sole control over the components of working capital, and accordingly, the Company reports the total amounts so advanced to Marriott International as a component of Due from Marriott International, Inc. Upon termination of the Agreements, the working capital will be returned to the Company.
NOTE 6. REVENUES
As discussed in Note 1, hotel revenues reflect house profit from the Company's hotel properties. House profit reflects the net revenues flowing to the Company as lessee and represents all gross hotel operating revenues, less all gross property-level expenses, excluding depreciation, management fees, real and personal property taxes, lease payments, insurance, contributions to the property improvement fund and certain other costs, which are classified as operating costs and expenses.
The following table presents the detail of house profit for the period March 22, 1996 (inception) through January 3, 1997 (in thousands):
Hotel Sales: Rooms................................................. $ 47,479 Other ............................................... 2,621 -------- Total hotel sales.............................. 50,100 -------- Expenses: Rooms (A)............................................. 9,632 Other operating departments (B)....................... 540 General and administrative (C)........................ 4,240 Utilities (D)......................................... 2,034 Repairs, maintenance and accidents (E)................ 2,538 Marketing and sales (F)............................... 2,746 Chain services (G).................................... 952 -------- Total expenses................................. 22,682 -------- Revenues (House Profit)...................................... $ 27,418 ========
(A) Includes expenses for linen, cleaning supplies, laundry, guest supplies, reservations costs, travel agents' commissions, walked guest expenses and wages, benefits and bonuses for employees of the rooms department. (B) Includes expenses related to operating the telephone department. (C) Includes management and hourly wages, benefits and bonuses, credit and collection expenses, employee relations, guest relations, bad debt expenses, office supplies and miscellaneous other expenses. (D) Includes electricity, gas and water at the properties. (E) Includes cost of repairs and maintenance and the cost of accidents at the properties. (F) Includes management and hourly wages, benefits and bonuses, promotional expense and local advertising. (G) Includes charges from the Manager for Chain Services as allowable under the Agreements.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HOSPITALITY PROPERTIES TRUST
By: /s/ John G. Murray John G. Murray President and Chief Operating Officer
Dated: March 28, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, or by their attorney-in-fact, in the capacities and on the dates indicated.