ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

The following discussion should be read in conjunction with our unaudited consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q.

We own the sole general partner’s interest in the Partnership. Our principal source of cash flows is from the operations of the Hotels and management and licensing contracts with affiliated and third-party hotels.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

In our Annual Report on Form 10-K for the year ended January 31, 2010, we identified the critical accounting policies that affect our more significant estimates and assumptions used in preparing our consolidated financial statements. We believe that the policies we follow for the valuation of our hotel properties, which constitute the majority of our assets, are our most critical policies. Those policies include methods used to recognize and measure any identified impairment of our hotel properties assets. There have been no material changes to our critical accounting policies since January 31, 2010.

 

LIQUIDITY AND CAPITAL RESOURCES

Our principal source of cash to meet our cash requirements, including distributions to our shareholders, is our share of the Partnership’s cash flow and our direct ownership of the Yuma, Arizona property.  The Partnership’s principal source of revenue is hotel operations for the four hotel properties it owns.  Our liquidity, including our ability to make distributions to our shareholders, will depend upon our ability and the Partnership’s ability to generate sufficient cash flow from hotel operations.

Hotel operations are significantly affected by occupancy and room rates, which decreased from the first nine months of fiscal year 2010 to the first nine months of fiscal year 2011. Results are also significantly impacted by overall economic conditions and conditions in the travel industry. Unfavorable changes in these factors could negatively impact hotel room demand and pricing, which would reduce our profit margins on rented suites.

We have principal of $210,368 due and payable for the remainder of fiscal year 2011 under mortgage notes payable. For the period between November 1, 2010 and October 31, 2011, we have principal of $8,256,621 due and payable under mortgage notes payable. The mortgage note payable secured by the Ontario, California property matures in May 2011, at which time a final principal payment of approximately $7.5 million will be due.  We will actively seek to either extend our current loan agreement or refinance the balance with another lender.  Our ability to extend or refinance the Ontario note will depend on several factors, including the condition of credit markets and economic trends in both the hospitality industry in general and at the property specifically.  We anticipate that current cash balances, future cash flows from operations and available credit will be sufficient to satisfy obligations related to the other four mortgages as they become due. In the event cash flows from operations are insufficient to satisfy these obligations as they become due, we may seek to refinance properties, negotiate additional credit facilities or issue debt instruments.

On August 1, 2010, the Partnership established a $1.0 million line of credit with Rare Earth Financial, LLC, an affiliate of Mr. Wirth.  The line of credit bears interest of 7.0% per annum on advances, with monthly interest-only payments, and terminates on March 1, 2012.  The agreement requires the Partnership to repay 50% of any principal outstanding under the line of credit on March 1, 2011, with the remaining 50% due on April 1, 2011.  Beginning on June 1, 2011, the Partnership may resume receiving advances under the line of credit through the termination date.  As of October 31, 2010, the Partnership had drawn no funds under the line of credit.  On November 29, 2010, the Partnership terminated the line of credit agreement.

On March 3, 2008, we established an $850,000 revolving line of credit, replacing a $750,000 line of credit that matured on May 18, 2008. The line of credit, with an original maturity date of July 15, 2009, had no financial covenants and bore interest at Wall Street Journal prime. During the second quarter of fiscal year 2010, we extended the maturity date of the line of credit to June 30, 2010.  The line of credit agreement was not extended by the bank and therefore expired on June 30, 2010.

On November 23, 2010, the Trust established a new revolving bank line of credit agreement, with a credit limit of $500,000.  The line of credit bears interest at the prime rate plus 2.75% per annum, has no financial covenants and matures on May 23, 2011.  If the Trust maintains bank balances of at least $250,000 with the lender, the line of credit bears interest at the prime rate plus 1.0% with a 6.0% rate floor.  The line is secured by a junior security interest in the Yuma, Arizona property and by the Trust's accounts receivable.  Mr. Wirth is a guarantor on the new line of credit.

During the first quarter of fiscal year 2011, we increased our mortgage note payable secured by the Yuma, Arizona property.  The new balance of the mortgage note payable is $5.0 million.  The additional $1.0 million borrowed bears interest at 8.0% and matures on December 31, 2013.  The note is due in monthly interest-only installments of $30,000, an increase of $6,667 from the previous monthly interest-only installments of $23,333.  We used the $1.0 million to build operating reserves and reduce payables.

We may seek to negotiate additional credit facilities or issue debt instruments. Any debt incurred or issued by us may be secured or unsecured, long-term, medium-term or short-term, bear interest at a fixed or variable rate and be subject to such other terms as we consider prudent.

We continue to contribute to a Capital Expenditures Fund (the “Fund”) an amount equal to 4% of the Hotels’ room revenues. The Fund is restricted by the mortgage lender for four of our properties. As of October 31, 2010, $66,898 was held in restricted capital expenditure funds and is included on our Balance Sheet as “Restricted Cash.” The Fund is intended to be used for capital improvements to the Hotels and for refurbishment and replacement of furniture, fixtures and equipment, in addition to other uses of amounts in the Fund considered appropriate from time to time. During the nine months ended October 31, 2010, the Hotels spent $714,335 for capital expenditures. We consider the majority of these improvements to be revenue producing. Therefore, these amounts have been capitalized and are being depreciated over their estimated useful lives. The Hotels also spent $884,216 and $891,619 during the nine-month periods ended October 31, 2010 and 2009, respectively, on repairs and maintenance.  The Hotels spent $259,166 and $296,297 during the three-month periods ended October 31, 2010 and 2009, respectively, on repairs and maintenance.  These amounts have been charged to expense as incurred.

As of October 31, 2010, we have no commitments for capital expenditures beyond the 4% reserve for refurbishment and replacements set aside annually for each hotel property.

COMPLIANCE WITH CONTINUED LISTING STANDARDS OF NYSE AMEX

On September 30, 2010, the Trust received a letter from the NYSE Amex LLC (the "NYSE Amex") informing the Trust that the staff of the NYSE Amex's Corporate Compliance Department has determined that the Trust is not in compliance with Section 1003(a)(ii) of the NYSE Amex Company Guide due to the Trust having stockholders' equity of less than $4.0 million.

The NYSE Amex's letter informed the Trust that, to maintain its listing, it must submit a plan of compliance by November 1, 2010, addressing how it intends to regain compliance with the NYSE Amex's continued listing standards within a maximum of 18 months.  The NYSE Amex's letter provides that if the plan submitted by the Trust is accepted by the NYSE Amex, the Trust may be able to continue its listing during the 18-month plan period, during which time it will be subject to periodic review to determine whether it is making progress consistent with the Trust's plan.

The Trust submitted its plan on November 1, 2010.  The plan includes improved hotel operating profits as the economy and hospitality industry continue to recover, the sale of membership interests in the Albuquerque entity above carrying value, and the potential sale of membership interests in other hotel properties owned by the Trust and Partnership above carrying value.  The Trust expects to regain compliance within the 18-month plan period.

RESULTS OF OPERATIONS

Our expenses consist primarily of hotel operating expenses, property taxes, insurance, corporate overhead, interest on mortgage debt, professional fees and depreciation of the Hotels. Our operating performance is principally related to the performance of the Hotels. Therefore, management believes that a review of the historical performance of the operations of the Hotels, particularly with respect to occupancy, calculated as rooms sold divided by the number of rooms available, average daily rate (“ADR”), calculated as total room revenue divided by number of rooms sold, and revenue per available room (“REVPAR”), calculated as total room revenue divided by the number of rooms available, is appropriate for understanding revenue from the Hotels. Occupancy was 54.5% for the nine months ended October 31, 2010, a decrease of 4.1% from the prior year same period. ADR decreased $2.07, or 2.8%, to $71.41. The decrease in ADR and reduced occupancy resulted in a decrease of $4.16, or 9.7%, in REVPAR to $38.90 from $43.06 in the prior year period. The decrease in occupancy is due to the downward trend in our economy, which caused less vacation and fewer business travelers.

 

The following table shows occupany, ADR and REVPAR for the periods indicated:

 

		FOR THE  NINE MONTHS ENDED
		October 31, 2010
		2010			2009
OCCUPANCY			54.5	%		58.6	%
AVERAGE DAILY RATE (ADR)		$	71.41		$	73.48
REVENUE PER AVAILABLE ROOM (REVPAR)		$	38.90		$	43.06

 

No assurance can be given that the trends reflected in this data will improve or that occupancy, ADR or REVPAR will not continue to decrease as a result of changes in national or local economic or hospitality industry conditions. We expect the current global economic conditions to negatively affect our business at least through the end of this current fiscal year.

For the nine months ended October 31, 2010, our total revenue was $11.8 million, a decrease of $1.3 million, or 10.2%, compared with the prior year period total of $13.1 million. Revenues from hotel operations, which include Room, Food and Beverage, Telecommunications and Other revenues, decreased 10.1% to $9.7 million for the nine months ended October 31, 2010, from $10.8 million for the nine months ended October 31, 2009. Hotel operations, including Food and Beverage operations, experienced decreases in revenues during the first nine months of fiscal year 2011 due to lower occupancy and increased rate pressure, most prominently at our Yuma, Arizona location as a result of increased supply in the area. Expenses may not decline proportionately with a decline in revenues due to a high degree of operational and financial leverage in the hotel industry.

 

Total expenses were $13.6 million for the nine months ended October 31, 2010, a decrease of $631,000, or 4.4%, from the prior year period total of $14.2 million.  Total operating expenses were $12.4 million for the nine months ended October 31, 2010, a decrease of $653,000, or 5.0%, from the prior year period total of $13.1 million.  The majority of the hotel operating expenses decreased due to lower occupancy.

General and administrative expense was $2.2 million for the nine months ended October 31, 2010, consistent with the prior year period.

Total interest expense was $1.2 million for the nine months ended October 31, 2010, consistent with the prior year period.  Interest on other notes payable increased $21,000, or over 100.0%, to $31,000 for the nine months ended October 31, 2010, due primarily to notes payable entered into during the last half of fiscal year 2010 to repurchase shares of beneficial interest.

For the three months ended October 31, 2010, our total revenue was $3.3 million, a decrease of $283,000, or 7.8%, compared with the prior year period total of $3.6 million. Revenues from hotel operations, which include Room, Food and Beverage, Telecommunications and Other revenues, decreased 2.4% to $2.8 million for the three months ended October 31, 2010, from $2.9 million for the three months ended October 31, 2009. Hotel operations, including Food and Beverage operations, experienced decreases in revenues during the third quarter of fiscal year 2011, although to a lesser extent then in the previous two quarters, due to lower occupancy and increased rate pressure, most prominently at our Yuma, Arizona location as a result of increased supply in the area. Expenses may not decline proportionately with a decline in revenues due to a high degree of operational and financial leverage in the hotel industry.

 
 

Total expenses were $4.2 million for the three months ended October 31, 2010, a decrease of $192,000, or 4.3%, from the prior year period total of $4.4 million.  Total operating expenses were $3.8 million for the three months ended October 31, 2010, a decrease of $181,000, or 4.5%, from the prior year period total of $4.0 million.  The majority of the hotel operating expenses decreased due to lower occupancy.

General and administrative expense was $664,000 for the three months ended October 31, 2010, consistent with the prior year period.

Total interest expense was $401,000 for the three months ended October 31, 2010, consistent with the prior year period.

FUNDS FROM OPERATIONS (FFO)

We recognize that industry analysts and investors use Funds From Operations (“FFO”) as a financial measure to evaluate and compare equity REITs. We also believe it is meaningful as an indicator of net income, excluding most non-cash items, and provides information about our cash available for distributions, debt service and capital expenditures. We follow the March 1995 interpretation of the National Association of Real Estate Investment Trusts (“NAREIT”) definition of FFO, as amended January 1, 2000, which is calculated (in our case) as net income or loss (computed in accordance with GAAP), excluding gains (or losses) from sales of property, depreciation and amortization on real estate property and extraordinary items. FFO does not represent cash flows from operating activities in accordance with GAAP and is not indicative of cash available to fund all of our cash needs. FFO should not be considered as an alternative to net income or any other GAAP measure as an indicator of performance and should not be considered as an alternative to cash flows as a measure of liquidity. In addition, our FFO may not be comparable to other companies' FFO due to differing methods of calculating FFO and varying interpretations of the NAREIT definition.  The following table shows the reconciliation of FFO to Net Income Attributable to Shares of Beneficial Interest:

 

FFO decreased approximately $778,000 for the nine month period ended October 31, 2010, reflecting a decrease of over 100% when compared to the prior year period. The decrease was primarily due to lower occupancies and room rates resulting in less revenue during the period.

 

FFO decreased approximately $164,000 for the three month period ended October 31, 2010, reflecting a decrease of over 100.0% when compared to the prior year period. The decrease was primarily due to lower occupancies and room rates resulting in less revenue during the period.

OFF-BALANCE SHEET FINANCINGS AND LIABILITIES

Other than lease commitments and legal contingencies incurred in the normal course of business, we do not have any off-balance sheet financing arrangements or liabilities. We do not have any majority-owned subsidiaries that are not included in the consolidated financial statements. (See Note 2 - “Summary of Significant Accounting Policies.”)

SEASONALITY

The Hotels’ operations historically have been seasonal. The three southern Arizona hotels experience their highest occupancy in the first fiscal quarter and, to a lesser extent, the fourth fiscal quarter. The second fiscal quarter tends to be the lowest period of occupancy at those three southern Arizona hotels. This seasonality pattern can be expected to cause fluctuations in our quarterly revenue. The two hotels located in California and New Mexico historically experience their most profitable periods during the second and third fiscal quarters (the summer season), providing some balance to the general seasonality of our hotel business. To the extent that cash flows from operations are insufficient during any quarter, because of temporary or seasonal fluctuations in revenue, we may utilize cash on hand or borrowings to make distributions to our shareholders or to meet operating needs. No assurance can be given that we will make distributions in the future.

FORWARD-LOOKING STATEMENTS

Certain statements in this Form 10-Q, including statements containing the phrases “believes,” “intends,” “expects,” “anticipates,” “predicts,” “will be,” “should be,” “looking ahead,” “may” or similar words, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend that such forward-looking statements be subject to the safe harbors created by such Acts. These forward-looking statements include statements regarding our intent, belief or current expectations in respect of (i) the declaration or payment of dividends; (ii) the leasing, management or operation of the Hotels; (iii) the adequacy of reserves for renovation and refurbishment; (iv) our financing plans; (v) our position regarding investments, acquisitions, developments, financings, and other matters; and (vi) trends affecting our or any Hotel’s financial condition or results of operations.

These forward-looking statements reflect our current views in respect of future events and financial performance, but are subject to many uncertainties and factors relating to the operations and business environment of the Hotels that may cause our actual results to differ materially from any future results expressed or implied by such forward-looking statements. Examples of such uncertainties include, but are not limited to:

•	local or national economic and business conditions, including, without limitation, conditions which may affect public securities markets generally, the hospitality industry or the markets in which we operate or will operate;

•	fluctuations in hotel occupancy rates;

•	changes in room rental rates that may be charged by InnSuites Hotels in response to market rental rate changes or otherwise;

•	seasonality of our business;

•	interest rate fluctuations;

•	changes in government regulations, including federal income tax laws and regulations;

•	competition;

•	any changes in our financial condition or operating results due to acquisitions or dispositions of hotel properties;

•	insufficient resources to pursue our current strategy;

•	concentration of our investments in the InnSuites Hotels® brand;

•	loss of franchise contracts;

•	real estate and hospitality market conditions;

•	hospitality industry factors;

•	our ability to meet present and future debt service obligations;

•	terrorist attacks or other acts of war;

•	outbreaks of communicable diseases;

•	natural disasters; and

•	loss of key personnel.

We do not undertake any obligation to update publicly or revise any forward-looking statements whether as a result of new information, future events or otherwise. Pursuant to Section 21E(b)(2)(E) of the Securities Exchange Act of 1934, the qualifications set forth hereinabove are inapplicable to any forward-looking statements in this Form 10-Q relating to the operations of the Partnership.